Rocco Campanelli - President, Chief Executive Officer Kevin Miller - Chief Financial Officer, Treasurer, Secretary

Andrew Fleming - Heartland Advisors

Welcome to the RCM Technologies second quarter warnings call. Your host, Mr. Rocco Campanelli, will now begin.

Good morning everyone. This is Rocco Campanelli and I am joined by Kevin Miller, our Chief Financial Officer. Welcome to RCM Technologies second quarter earnings call. The format of this call is that Kevin will start by discussing some of the financial results of our second quarter, I will discuss the operational performance of the company and then we will open it up for questions. Kevin?

Great. Good morning, everyone. Our presentation in this call will contain forward-looking statements. The information contained in the forward-looking statements is based on our beliefs, estimates and assumptions and information currently available to us and these matters may materially change in the future. 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 Form 10-K, 10-Q and 8-K that we file with the SEC, as well as our press releases that we issue from time to time. Thank you. So I will now provide some of the sectorial [ph] and other pertinent data. As you know from the press release, our consolidated revenues were $49,509,000 which grew 17% over the second quarter of last year. Our engineering revenues were $26,056,000, which grew about 24% over Q2 of last year. That's our highest quarterly revenue in company history for engineering again. Our IT revenues were $14,651,000 which, Q2-to-Q2, grew about 3%. This is the IT group's seventh straight quarter with prior year-over-year growth. At the same time, the IT group has managed to grow its gross margin percentage for the six months year-to-date over last year by just under 100 basis points. So increase in gross margin percentage by a full percentage point, almost. And they have accomplished while at the same time decreasing the SG&A and getting a lot of leverage as far as the contributions towards the large increase in the consolidated operating income for the company. Health care revenues were $8,802,000 which grew approximately 22%, and that's the highest quarterly revenue in company history, second only to the first quarter of this year. So this is the second highest quarterly revenue that our health care company has produced in company history. The consolidated gross margin percentage was 26.2%, which is an increase over the first quarter of this year of 2014 by almost a full percentage point. Engineering gross margin percentage for the quarter was 23.4%. The information technology group's gross margin percentage was 29.6% and our health care gross margin percentage was 28.7% for Q2. So as we look out to the balance of this year, I just want to make a couple of comments. We are very hopeful and expect that we will see nice year-over-year improvement in Q3 and Q4 as compared to Q3 and Q4 of last year, certainly expect operating income to be improved and gross profit dollars to be improved as well. And we also expect to see continued improvement in the consolidated gross margin in Q3 and Q4 as compared to Q1 and Q2. I do want to put a little bit of a caution out there for people that aren't necessarily really, really familiar with sort of the quarterly gyrations in RCM. We do see a pretty large seasonal dip in Q3, in both our revenues and gross profit dollars, typically from when you compare Q3 to Q1 and Q2. And that's mainly due to summer vacations across all lines of the business. Obviously, when our people are taking some deserved time off, they are not billing clients and that certainly impacts the revenues and the gross profit dollars generated. We see that more in Q3 than Q4, even though Q4 with Thanksgiving and Christmas holidays and all that, it does impact the fourth quarter as well, but it not as pronounced as it is in Q3. In Q3, we see of a really big drop in our health care group, just because we have two large school systems as clients and they take off for summer vacations. Historically, the drop in revenues from Q2 to Q3 is about to $2 million to $2.5 million in revenue and we expect to see something in that range again this year. We also do expect to see a little bit of a drop in our engineering revenue run rate, particularly in Canada, just because there will be a decrease in revenues associated with some of our procurement and some work performed by subcontractors. However, the flipside to that is we do expect to see a gross margin percentage increase that would offset some of the drop in the top line revenues. So we are not necessarily expecting any sort of drop in gross profit dollars, just that we would see in our engineering group, a little bit of a drop as far as the top line is concerned. Talk a little bit about Q2 operating cash flow which, I am sure people noticed, was really strong. We generated $6.7 million in the second quarter. Obviously, that was due in large part to the strong earnings that we had been in Q2 and increase in gross margin percentage. Additionally, we have a $2.5 million gap between our transit AP exceeding our transit AR. That delta between our transit accounts payable and transit AR is a bit haphazard from -to-quarter, but we were fortunate to end the quarter with a $2.5 million gap which obviously helped our Q2 ending cash balance. And we also saw a slight improvement in our DSOs in Q2 from Q1 and Q4 of last year. We are cautiously optimistic that we will continue to see some nice drops in the DSOs, not so much in Q3, but certainly in Q4. And by the time that we get to the end of the year, we are cautiously optimistic that we are going to see a nice drop on our DSOs and continue to see some nice cash flow in both Q3 and Q4. And as we said in our press release, the Board is certainly considering various alternatives. Should the cash flow that we expect to happen in Q3 and Q4 materialize, the Board is considering various options to return some of the cash to the shareholders. No decisions have been made there, but it is something that the Board feels comfortable sharing with the shareholders that the Board is optimistic that it will do something as far as returning some cash to the shareholders this year. So that's all the prepared that I have.

Thank you, Kevin. Similar to our first quarter, our second quarter revenues, the best it's been in the past six years, with excellent performance in gross profit and operating income. Our strategy to develop new clients and expand services at existing clients and creating new service offerings has continued to generate excellent results. I am particularly pleased that our IT consulting and solutions division continues to see growth for the seventh consecutive quarter. What is also impressive is that while growing revenue they also managed to improve gross margins nearly 100 basis points during the first half of 2014 as compared to the first half of 2013. Our health care division had its second highest historic quarterly revenue, second only to last quarter. Our revenues generated from our school system contracts remain strong and our new health information management group, as well as our travel nurse program have shown promising results. As Kevin mentioned, third quarter within healthcare will have a seasonal slowdown due to school summer vacations in New York City on our New York City contract. However, the Hawaii school system has reopened August 1, which started the staffing last week. Engineering realized its best revenue for eighth consecutive quarter. I am excited about our recent acquisition of Point Comm, which will add to our client and service space and expand our services internationally. Point Comm is an engineering services company focused on transmission and distribution, substation design and engineering, commissioning and project management This acquisition is part of our overall strategy to develop the capability to provide energy-related services both in the U.S. and Canada as well as internationally. Point Comm's home base is Mississauga, Ontario. Point Comm has been awarded two new contracts following our close, one in Saudi Arabia and one in the U.K. that will begin immediately. Second quarter results from our Canadian division were excellent and our backlog remains strong. However, there has been some delay in issuing some of the new refurbishment contracts. I am optimistic that these delays will be resolved by the middle of the fourth quarter. Aerospace engineering had an excellent quarter and continues to expand mainly due to our technical publications service offerings. Our U.S. power systems services group and facilities design group's new service offerings of advanced metering infrastructure design and implementation and transmission and distribution engineering have posted excellent results. We continue to expect expanded results from these areas in the third and fourth quarter. Our feeling is that our performance for the remainder of 2014 should continue to remain strong. That concludes our prepared statements and we would like to open it up for any questions you may.

(Operator Instructions). Our first question is going to come from Andrew from RCM. Andrew, please go ahead. Andrew Fleming - Heartland Advisors: Good morning, Rocco and Kevin. This is Andrew Fleming from Heartland Advisors in Milwaukee.

Hello.

Hi, Andrew. Andrew Fleming - Heartland Advisors: I just had a few questions on that Point Comm acquisition. I am curious how much revenue do you expect that to add to the engineering segment? And what would be the margins coming in relative to the existing margins in that segment?

In the short term, we are probably looking at somewhere around the $1.5 million in revenues. Gross margins, probably in the low 20s. We are not expecting it to be immediately -- we are not expecting it to contribute a lot of operating income in the short-term. So we are not really expecting it to have a major impact on our financials this year. What's exciting to us about this acquisition is that historically, they have worked on some pretty big projects. And we believe that the combination of the skill sets that we are acquiring and combined with the inroads that we have in a lot of our clients where we are not necessarily providing the same services that they provide or certainly not providing those services at the level that we expect to in the future. We think this could be a real plus acquisition for us. We think we can triple it or quadruple it over some period of time.

Right. Our initial strategy with Point Comm is that historically, they have not done a significant amount of work in the United States and we feel that our U.S. utility clients would be very interested in some of their unique 3-D modeling capability, some of their commissioning capability, some of their AS building capability because much of the utilities industry have old infrastructure and their configuration management and drawings aren't the latest and Point Comm has some unique tools to economically establish AS building hardware that exist at the substations within United States. So we feel that we can make very early quick progress to expose their capability to our existing clients in the United States. Andrew Fleming - Heartland Advisors: Okay. So just to sum it up, $1.5 million revenue annually.

That's on an annualized basis. That's kind of where the run rate is right now. Andrew Fleming - Heartland Advisors: Okay. Coming in at approximately same gross profit margins?

Yes. Similar gross profit margins to what we already have. Yes. Andrew Fleming - Heartland Advisors: Okay, and then could you just expand on what you were saying earlier about potential returning cash to shareholders in the second half? Are you talking about dividend or are you talking about a buyback or what?

Well, it could be either, obviously, but I think the Board is more inclined to issue a dividend, assuming that we were in the cash position at the end of the year that we think we are going to be in, and obviously assuming that nothing else comes up as far as cash needs but I think there is a pretty strong predisposition on the part of the Board to issue some sort of special dividend this year. We think we are going to be in a position where we are going to have some cash and we think that a very good use of that is to send some of that back to shareholders. Andrew Fleming - Heartland Advisors: Okay. Just a final question then is, any updated thoughts on portfolio optimization going forward? When I say it, it is in the light of the recent Kforce transaction one-off, they divested their healthcare business for, I believe it was 1.3 times enterprise value to sales. I am just curious, when you look at that transaction and how you think of that portfolio going forward?

We are in a good position where we have three business lines that are really performing very well. So we certainly don't have any concrete plans to do anything there, but as you know, as a public company, if a deal comes along that makes sense, we will take a look at that. But certainly, we are not actively pursuing anything like that. You never know. Andrew Fleming - Heartland Advisors: Okay.

And our next question is going to comes from John from Virginia Capital [ph]. Please go ahead, John.

Hi, guys. A quick question about, can you just talk a little bit more about the delays in the new refurbishments site? I am assuming that these contracts in general, where they are put out, everyone agrees that it is going to go forward. They sign the contracts and they just delay them.

The way it typically works is, we sign an MSA, right. So we have MSAs with two major clients in Canada where we are getting a lot of our growth currently. So we have an MSA which, in and of itself, doesn't guarantee you any work. You have to have the master services agreements to get the work. And it's a very small amount of companies that have MSAs up there and there is tons of work that needs to be let out. But once you sign the MSA, you get the work in individual purchase letters and they could be as small as a $200,000 or they could be as large as $10 million or $20 million. And there has just been a little bit of, and this is something that we are used to seeing, frankly, the large utilities don't necessarily move quickly to get contracts to get purchase order signed for the individual jobs. We have a lot of work that's out proposed, but there's just been a bit of a slowdown in the letting of some of that work. So there are some concerns that some of that work doesn't get let fast enough to maintain our current run rate. That being said, we are pretty optimistic that aren't going to be any issues there. We think we are going to continue to win a considerable amount of individual projects in Canada. So did I answer your question?

Yes, that's good. Then secondarily, obviously this acquisition is a good acquisition for you and certainly helps you expand. I guess the issue is that we seem to have a shortage of these expert engineers certainly around the U.S. and probably in Canada as well. And then, is that the competitive bidding type thing where you are doing that? Or is that a relationship that you guys had and that's how you ended up getting it?

It was relationship. One of our senior engineers in Canada was aware of this company made the introduction to Rocco and then we had a conversation with them for several months and realized that we had a real cultural fit. So this was not a bidding situation. This is a deal where, and I can't disclose the deal but I will tell you that a lot of it is on the backend in terms of what the principles of Point Comm are going to receive. A lot of what they are going to receive is to figuring them out. So they are going to need, jointly we are going to need to generate a fair amount of operating income in that new entity for them to realize the benefit of selling to RCM. And we are confident they will be able to do that.

Did you announce how many engineers you picked up?

Well, they had about 15 full-time employees, but they also have access to dozens of subcontractors, both in Canada and in Europe and India.

Belgrade.

Belgrade and India. And to be real frank with you, they didn't have a great pipeline when we bought them. So they were not necessarily using a lot of those subcontractor resources that they have available, but we believe that over some reasonable period of time that we are going to have a nice backlog of projects for these guys and that 15 can turn into 30 or 45 over time.

Okay, and then one last thing on the cash flow that you guys are thinking of generating in the next couple of quarters and your optimistic outlook. Obviously we are not to going to see the same kind of pick up that we saw this quarter, which seemed pretty substantial. Do you want to give us any sort of idea of what you think?

Well, if you take the cash flow in this quarter and you subtract out the sort of haphazardness of the trends in AP over the trends in AR, because I never assume that I am going to get that benefit in any given quarter, I think we can continue to generate similar dollars to that number.

So I can use that kind of as a simple model for now?

Yes, I mean I wouldn't assume that you are going to, you are looking at roughly $4 million after you strip out the impact from the trends at payables. We are going to generate $4 million in Q3 and Q4, that's pretty unlikely, but certainly we can generate half of that, I believe.

Okay. Great and I guess one last thing, if you don't mind. I know that you are not actively looking at portfolio optimization, but now that you have sort of been there and looked at these different, you have got these at least three if not four segments. Do they all fit together still in your mind? Or is that still a question?

I think it's a question. I think the IT and engineering fit together quite well. There is some in cross-selling that does take place there. But the thing with our health care group, while they may not fit real neatly with where engineering is, we have an outstanding management team there that is growing that business and has embarked on several different initiatives in terms of going into new service lines that we haven't realized the fruit yet that we believe we will. So that group is really performing well. From Rocco and my standpoint, it is nice because the people that are running it have been running it for 20 years and they do a great job, and they don't require a lot of maintenance from the corporate staff and we really like that business. Obviously it's very, very different from engineering and IT but it's a great business. We have great people running it and we love that business.

Thanks very much. Great job.

Thank you.

Thank you.

There are no further questions in the queue at this time.

Thank you, everyone. Thank you for your time and we look forward to providing you the results of the third quarter in about three months.

See you in three months.

See you in three months. Thank you.

Thanks, everyone.