Earnings Call Transcript - RCMT Q2 2024

Kevin Miller, CFO

Good morning. Thank you for joining us. This is Kevin Miller, Chief Financial Officer of RCM Technologies. I am joined today by Brad Vizi, RCM's Executive Chairman. Our presentation in this call will contain forward-looking statements. The information contained in the forward-looking statements is based on our beliefs, estimates, assumptions, and information currently available to us, and these matters may materially change in the future. Many of these beliefs, estimates, and assumptions are subject to rapid change. For more information on our forward-looking statements and the risks, uncertainties, and other factors to which they are subject, please see the periodic reports on Forms 10-K, 10-Q, and 8-K that we filed with the SEC as well as our press releases that we issue from time to time. I will now turn the call over to Brad Vizi, Executive Chairman, to provide an overview of RCM's operating performance during the second quarter.

Brad Vizi, Executive Chairman

Thanks, Kevin. Good morning, everyone. Second quarter growth was led by Engineering as project activity continues to ramp, building on the foundation carefully laid over the last several years. More importantly, Engineering's leadership corroborates a fundamental aspect of the RCM thesis. The success of our company is not predicated on any one division or discipline. In 2022, performance was propelled by the success of health care. In 2023, Life Sciences data and Solutions were a key pillar to maintaining the company's trajectory, completing the transition to a post-COVID world. And now in 2024, we are witnessing the emergence of a world-class Engineering division with the infrastructure to scale. Five years ago, we presented RCM not as a health care company, not as an IT practice, nor an engineering outfit, but as an emerging world-class professional services firm that can compete and win on the global stage. That was the vision then, and this is our reality today. Also of note, we anticipate continued strong contribution from engineering, along with increased strength in the other two divisions in the back half of the year. Now, I will provide a more granular update on the progress of each of our teams, starting with health care. RCM's Healthcare division finished the school year strong. Looking ahead to the 2024 and 2025 school year, we are extremely encouraged about our prospects. We have successfully added many new school districts to our portfolio, several potentially requiring 50 to 75 new providers. While the exact value of these districts is yet to be determined, RCM has a proven track record of entering new districts and quickly becoming the primary vendor. Our dedicated team is working tirelessly to streamline our recruiting and credentialing processes, reducing the time it takes to bring new providers on board and into the field. This commitment to efficiency is not at the cost of quality but to ensure that we can meet the growing demand swiftly and maintain the high standard of service our clients expect. In addition to our domestic growth, we have significantly expanded our operations in the Philippines. This expansion includes not only increasing our recruitment team but also building a robust operational support team. Investments in both our domestic and international operations, coupled with our unwavering commitment to efficiency and high standards, position us strongly for continued growth and success. We are not just hopeful but confident that our efforts will drive significant value for our stakeholders as we continue to expand our footprint and enhance our service offerings. In Life Sciences, Data & Solutions, the second quarter showed continued progress as we implemented our solutions integrated approach. We have seen a structural profitability increase relative to the historic performance and work to continue to strengthen the business. We believe our HCM practice is one of the premier partners in the industry. For the eighth straight quarter, we have exceeded implementation quotas for one strategic client. In Life Sciences, our Puerto Rico team just completed a successful nine-month, 15% quality control project for a major pharma packaging company. Our Life Science commercial practice leads our growth as it continues to demonstrate its ability to assist clients in bringing new products to market faster, cheaper, while improving compliance reporting. We continue to see strong interest in our managed service offerings. We can support a broad range of functions ranging from our industry-leading RPC to quality, to validation and qualification to application support. Transitioning to Engineering, starting with Energy Services. The second quarter of 2024 demonstrated robust results, delivering revenue and EBITDA figures exceeding forecast. Backlog remains solid and activity is healthy. As we continue to execute against large Engineering substation projects while maintaining high levels of client satisfaction. The EPC Group maintains strong relations with existing clients but also targets additional potential customers for new projects in the U.S., including Puerto Rico. To participate in the growing energy markets internationally, Energy Services is evaluating cooperation agreements in Latin America and Europe. The German office sees a significant increase in high-voltage substation demand and has begun staffing to prepare for further growth. Increasing our market awareness, Energy Services continued a strong presence in the most significant technical associations during the IEEE events in Puerto Rico and Anaheim, California, becoming a major contributor in the electrical engineering industry. For the upcoming SEGRO Paris session this August, Energy Services will present together with a large U.S. utility and an innovative technical paper on a future-oriented microgrid substation. In Process and Industrial, RCM Thermal Kinetics remains active in the zero-carbon chemical production market with three equipment projects in various stages of completion. The Thermal Kinetics office is also executing two ethanol plant optimization expansion studies that integrate the patented energy integration design, enabling clients to lower their carbon intensity score. The team is also completing a detailed process design for a planned SAF facility for a U.S.-based customer. Various tests are being conducted for our customers utilizing test rigs for crystallization, filtration, and evaporation. The sales team is focused on the current market needs and has strategically pursued business in the lithium markets. That focus has yielded an engineering order placement this week for a lithium production facility in the United States. The engineering order involves the development of the lithium solution chemistry and processing equipment design. The team also expects to close an equipment order for lithium refinement, which employs crystallization technology and downstream drawing of crystals. This project is a good example of the strength of the TK team and the supporting test center. The theoretical chemistry used in the lithium solution chemistry is complex and is derisked by running the process in the test center with the chemical engineers designing the plant. The test center continues to gain momentum and is at 100% utilization through Q2 and well into Q3 2024. We continually evaluate further investment in additional equipment for the test center that benefits our clients. RCM Thermal Kinetics recently presented at the fuel ethanol workshop trade show in June. The focus, again, was plant optimization and identifying areas of improvement that our engineers excel at. The team remains focused on the continuation of our emergence as a market leader in responsible and sustainable chemical process design. The Aerospace and Defense Group had mixed results in Q2 2024 due to a slower-than-anticipated recovery in the aftermarket. However, EBITDA for the division remains healthy. The engineering business is thriving, executing with three new clients in Q2 of 2024. Our estimate of realizing a healthy increase in EBITDA for 2024 holds true, and the overall strategy remains the same, recognizing most of our customer spend in the Engineering domain. RFIs, RFQs, and MSAs expected to finalize have begun to produce new revenue in Q2, with an aggressive increase in headcount, revenue, and profit anticipated to escalate in the second half of 2024. The most significant piece of the business that has had an immediate impact is in the Engineering arena with some of our new vertical customers, our current space customers, as well as our expansion into other divisions with one of our existing aerospace component manufacturers. We have realized much-anticipated increases in customer requirements in Q2. Our world-class recruitment team continues to successfully execute, which has allowed us to experience a noteworthy increase in new hires. We have experienced a 54% increase in new hires in Q2 2024 versus Q1 2024. We expect to see this increase quarter-over-quarter in Q3 and Q4. We continue to drive and expand our model-based expertise, software systems, mechanical, and avionics expertise throughout the customer base in Q2 2024 with continuous inventories and partnership opportunities as well. Our new service offering, involving solving quality and production issues within the supply base of our clients, continues to grow with interest. New statements of work with major OEMs have been received with expanded skills and scheduled starts in Q3, Q4 2024, and Q1 2025. We will continue to expand our reach with these clients and prioritize these engagements throughout 2024 and 2025. We have received three large RFQs for engineering and aftermarkets within our OEM client base and with a potential new client in the air mobility arena. The outlook for the second half of 2024 is bright.

Kevin Miller, CFO

Now, I will return the call to Kevin to discuss the Q2 2024 financial results in more detail. Thank you, Brad. Regarding our consolidated results, consolidated gross profit for the second quarter of 2024 grew by 6.6% compared to 2023, from $18.8 million to $20.0 million. Adjusted EBITDA for the second quarter grew by 10.8% from $6.5 million to $7.2 million. Adjusted diluted EPS for the second quarter of 2024 grew by 12.0% from $0.50 to $0.56. As for our segment performance in the first quarter of 2024, Engineering gross profit grew by 23.7%. Life Sciences Data & Solutions gross profit decreased by 17.9%. Healthcare second quarter gross profit grew by 8.6%. If we remove the impact of COVID from the comparable second quarter of 2023, we estimate that second quarter 2024 revenue grew by about 11.1%. If we remove the impact of COVID and a deliberate reduction in services to a large long-time, but slow-paying rehab customer, we estimate that second quarter 2024 grew by about 19.1%. School revenue of $30.8 million for the second quarter of 2024 grew by 23.0% after removing COVID revenue from the second quarter of 2023. While we certainly consider our nonschool revenue important for our future growth, our health care business is largely a school-based health care delivery model. Our year-to-date school revenue in 2024 exceeds 83%. The 2023-2024 school year is the third school year since schools returned from virtual schooling. The 2023-2024 school year is also the first school year to comprise zero COVID-related revenue. We see some exciting trends. The 2023-2024 revenue of $109.8 million grew by 24.9% over 2022-2023 after removing COVID-related revenue from the prior school year. Our non-COVID school revenue in 2022-2023 grew by 29.2% over 2021-2022. School revenue from the last pre-COVID year of 2018-2019 was $60.2 million, which we nearly doubled in 2023-2024. We now have 15 school districts that exceed $500,000 in revenue. In 2018-2019, we had three. For 2021-2022, we had five. We are optimistic we'll get this well over 20 school districts that exceed $500,000 for the 2024-2025 school year that begins in August, September of this year. As our new school pipeline is the best it's ever been heading into a new school year. While we often don't know in July or August if a new school client will generate $50,000 or $500,000 in revenue, what I can say is that we've signed far more new school contracts for 2024-2025 than we have at any time in our long history serving school districts. As for the second half of fiscal 2024, we are optimistic that we will continue to see low double-digit consolidated adjusted EBITDA growth compared to fiscal 2023 with a similar quarterly cadence when compared to fiscal 2023. This concludes our prepared remarks. At this time, we will open the call for questions.

Operator, Operator

First off, we have Alex Rygiel of B. Riley Securities.

Alex Rygiel, Analyst

Brad and Kevin, very solid quarter. Nice to see. A couple of quick questions here. First, the schools business. Obviously, it's doing fantastic, but the strength in the schools business and the commentary with regards to Engineering or other segments, it all seems very bullish and more bullish than low double-digit EBITDA growth. So I wanted to talk to you a little bit about maybe helping us to understand that what I feel is maybe a conservative target.

Kevin Miller, CFO

Well, just keep in mind that we are discussing the third and fourth quarters of this year. A significant portion of that revenue is essentially predetermined. The schools usually don't start operating fully until about the second week of September, though there are some activities in August. We often have uncertainty about the initial performance of new schools, and even longstanding clients can start off somewhat slowly before increasing their activity. We are optimistic about the school year overall, but if you analyze the figures, there was a notable increase in the fourth quarter compared to the third quarter in 2023. We are expecting approximately a 10% increase in EBITDA, which takes into account a substantial growth in both revenue and EBITDA. However, we are being a bit conservative by choice, as circumstances can change quickly, and we prefer not to set overly ambitious targets.

Alex Rygiel, Analyst

And then Brad, as you think about sort of the next 12 months, from a revenue standpoint, what segment do you think grows the fastest?

Brad Vizi, Executive Chairman

Well, that's an interesting question. Look, we think about the business every single day, so we work with the team leaders to help set that business up for success, T+2, T+3, and well into the future. So naturally, when you look at the strength of all three of these businesses being able to underwrite the success relative to one another over the short term based on drivers that we're invested in and put in place two or three years ago, it can become difficult from an underwriting perspective. However, I think that this emphasizes a really key point: quite a bit of confidence can be gained in the platform. This collection of businesses that was built up, when you think about the underwriting of outcomes, both short and long-term. But when you isolate any one of the divisions over a short period, inevitably, there could be some gyration that's expected and frankly unexpected. So sorry if it's a little bit too much or not enough, Alex, but I hope that answers your question.

Alex Rygiel, Analyst

And lastly, balance sheet is pretty strong. So quick thoughts on capital allocation priorities?

Brad Vizi, Executive Chairman

Yes, we have always aimed to be balanced, open-minded, and adaptable in our approach, allowing us to seize opportunities as they arise. Our focus is not strictly on achieving an optimal capital structure but rather on being flexible and managing our risk profile to keep it low. Regarding share buybacks, we have been quite active in recent years, having retired over 40% of the company. At the same time, our M&A pipeline continues to strengthen, and we will stick to our baseline plan when evaluating opportunities that can integrate well into our platform and enable substantial growth while aligning with our existing culture and vision. We believe in the idea that one plus one equals five. Currently, the most relevant opportunities are within Engineering, although that could change. On capital allocation, we have maintained consistency, staying under $1 million with one turn of EBITDA in leverage. While we are not bound to that threshold, it has naturally aligned with our model.

Operator, Operator

Next up, we have Bill Sutherland of Benchmark.

Bill Sutherland, Analyst

Brad, you mentioned a 54% increase in new hires, I think for first half. And I guess just if you could clarify if that's the time frame and whether it's all of Engineering?

Brad Vizi, Executive Chairman

Yes. That's aerospace. Frankly, Aerospace was a little bit more sluggish than we anticipated as a whole in the first half. However, our confidence and the crystallization of that pipeline is improving. So those remarks are relative to aerospace.

Bill Sutherland, Analyst

There's a slight decline from the previous quarter, which is more noticeable than what we typically observe in life-size. Is this due to project timing?

Brad Vizi, Executive Chairman

Yes, that's correct. It's primarily a matter of timing. We completed a high-margin project in the second quarter of last year, and the subsequent project will start a bit later in the third quarter. Therefore, we expect a significant improvement in that business as we move into the latter part of the third quarter and into the fourth quarter.

Bill Sutherland, Analyst

Okay. Rick, when Kevin mentions the districts in the pipeline, are those signed and just in the implementation phase, or is there more to it?

Kevin Miller, CFO

We currently have over 20 school districts signed, and we're optimistic about signing more than 30 new districts as we head into next year. This is a substantial figure. However, I must warn you that while we enter these schools, we sometimes find the number of representatives lower than expected. That said, we have never been in July with this many new school districts lined up for the next year. Our goal is to effectively engage with about 10 or more of them, but we will see how things develop. This is an exciting time for the health care business.

Bill Sutherland, Analyst

To clarify, the 20 you signed up for is more than 20. Is that for the full year of '25 and '26?

Kevin Miller, CFO

No. For '24, '25, they're starting in August, September. I mean, we're recruiting for some of these schools right now.

Bill Sutherland, Analyst

Okay. Okay.

Kevin Miller, CFO

When I say '24, '25, just to be clear, different schools in different parts of the country start at different times. They start anywhere from early August to early September and end anywhere from early May to late June. When I talk about school years, I'm talking about our third and fourth quarter added to our first and second quarter for a school year.

Bill Sutherland, Analyst

Right, right, right. And then last, just looking at the cash flow and seeing that second quarter kind of in terms of operating cash flow is pretty much in line with the first quarter. Should we think about the back half being like the first half?

Kevin Miller, CFO

I hope it improves. I expect the third quarter to be strong because we anticipate a revenue decline due to seasonality, which will naturally enhance cash flow. Revenue will obviously rebound in Q4, impacting cash flow negatively. However, we are making efforts to improve our days sales outstanding in Q4 to mitigate some of that. When comparing the second half to the first half, I expect the combined cash flow from Q3 and Q4 to exceed that of Q1 and Q2. I would be disappointed if we don't achieve that level of cash flow from operations.

Operator, Operator

All right. And at this time, there are no further questions. We did get one more, Frank Kelly.

Frank Kelly, Analyst

Great quarter, gentlemen. It certainly appears to be on the right track, with some improvement in accounts receivable. However, Kevin, could you explain the increase in the SG&A line item? It's up over 6% year-over-year, while revenues have not increased. Last year at this time, during our call, we mentioned that we were investing in infrastructure and staff, and we have continued to do so. What is driving that additional 6% increase in SG&A? What steps are we taking to address this?

Kevin Miller, CFO

There are really a couple of main factors driving the increase. First, there's the natural inflation of costs—labor, technology, and rent have all gone up in certain areas. Second, we are making significant investments in technology, particularly in cybersecurity, to ensure our company remains protected against cyber threats. We've invested heavily in cybersecurity and other IT initiatives. Additionally, we're investing in infrastructure to support the growth we anticipate, especially in healthcare. If we happen to overhire in healthcare, we will manage that later on, but we're committed to hiring as many recruiters as we can find in that area. At the same time, we consistently seek to optimize our selling, general, and administrative expenses. However, certain costs, like those related to being a public company, have risen significantly in recent years, well above double digits. We will keep looking for opportunities to manage these costs. For example, Brad mentioned plans to open an office in the Philippines, which will allow us to take advantage of more affordable talent there. Our goal is to grow our gross profit significantly more than our SG&A expenses. That's the metric we focus on; the improvement in the ratio of gross profit to SG&A is what matters, and we believe we can continue to enhance that ratio.

Brad Vizi, Executive Chairman

Yes. So Frank, I want to emphasize that we're beginning to view the company as capable of reaching both $500 million and $1 billion. Historically, we've somewhat underinvested in our infrastructure. As we plan for significant growth and the potential of becoming an international company, we recognize the need to enhance our infrastructure and catch up on prior investments. The positive aspect is that we're already making progress. We're being strategic and careful about how we increase our expenditures. So far, everything is on track. As our revenue increases and gross profit accelerates, we expect to see a corresponding improvement.

Frank Kelly, Analyst

Right. Great. Understood. And things like bricks and mortar spots that are becoming more and more unnecessary at this point, I'm sure we're looking at those as well to bring down some of that expensive SG&A.

Kevin Miller, CFO

For sure. But our bricks-and-mortar costs have come down over the last couple of years back, which is obviously not going to be a surprise to you, but we do think that depending on the business, having bricks and mortar is really important. We don't need the same amount of space on a like per square foot per person that we needed six, seven years ago, but we still think it's really important to have bricks and mortar space for people who come to the office a couple of days a week, and again, it depends on the business. There are some businesses that we have that are pretty much 95% remote and there's others that aren't. But we'd like to have space where our employees want to come to work and they want to collaborate and they want to learn and they want to get trained. It's important to us to have that space. So we're not ever going to move to a fully remote company. But we’re always looking to keep those costs down. You know I love some leases and we have a couple of those that are pretty cheap. And we just continue to look to drive those costs down anywhere we can.

Brad Vizi, Executive Chairman

Yes, Frank, next time you're in Pensilhawkin, why don't you stop by HQ and you'll feel pretty good about the leases that we're investing in. And when you think about some of the little bit higher leases, right? They tend to resemble more training centers being much more functional. As you walk through the facilities, it's pretty clear that there's an ROI associated with those investments.

Operator, Operator

Ladies and gentlemen, there are no final questions in the queue.

Brad Vizi, Executive Chairman

Thank you for attending RCM's Second Quarter Conference Call. We look forward to our next update in November.

Operator, Operator

And with that, ladies and gentlemen, this does conclude your call. You may now disconnect your lines, and thank you again for joining us today.