Rocco Campanelli - President and CEO Kevin Miller - CFO

Bill Sutherland - Emerging Growth Equity

Ladies and gentlemen, welcome to the RCM First Quarter Earnings Conference Call. Your host for today, Rocco Campanelli will now begin.

Thank you. Good morning, everyone. This is Rocco Campanelli. And welcome to the first quarter 2016 earnings call. I am joined today by Kevin Miller, our Chief Financial Officer. Kevin will begin with a legal disclaimer and then I will summarize the operating results for each of our operating segments, and then we will open it up for questions. Kevin?

Good afternoon, everyone. Our presentation and 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. Many of these beliefs, estimates and assumptions are subject to rapid changes. 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 file with the SEC as well as our press releases that we issue from time-to-time. Rocco?

Thanks, Kevin. We are pleased with the results of the first quarter of fiscal 2016, as they are in line with our internal expectations. We continue to build our pipeline with new and existing clients and believe we will have a strong second half of the year. Our healthcare segment continues to post outstanding results by setting historically high quarterly revenues and gross profits. 2016 Q1 revenues and gross profit grew over 2015 by approximately 50% and 30%, respectively. Our schools program continues to perform very well with a 100% of school openings filled in New York City, Chicago and Hawaii. I'm very pleased to announce that we were recently awarded the Hawaii power professional contract. We are cautiously optimistic that this contract will result in the placement of up to 50 or more power professionals in the first school year, starting in August 2016. The healthcare operating units that had the best quarter -- the best first quarter with the travel nursing and permanent placement divisions which set all time record quarterly revenues. Our travel nursing division is now at an annual run rate of $9.1 million. Our aerospace division continues to perform very well in both technical publications and engineering with the strong backlog. I am pleased to announce that we were recently informed we will be awarded a multiyear multimillion dollar contract to develop depot level maintenance manuals for combat rescue helicopters out of our Westerly, Rhode Island office. Our first quarter technical publications revenue and gross margin achieved historical highs. Our U.S. energy services division continues to do well with a nice backlog. Our offices in Pennsauken, Reading, Oakland and Mississauga are all exceeding our expectations. We are very pleased that RCM Energy Services name recognition has grown exponentially over the past year, confirmed by the 14 projects awarded by new clients in the first quarter alone. Included in the new client base are AEP and Bechtel who awarded projects within months of our first introductions as they recognized RCM’s unique capabilities. Being awarded contracts in this short timeframe is unusual in the transmission and distribution marketplace. As RCM's name recognition continues to grow, we are optimistic that energy services market share will grow accordingly for years to come. We're disappointed in our Canadian engineering performance in the first quarter. As I mentioned in our last call, Bruce Power has a significant spend profile for this year and the foreseeable future, and we are very well-positioned to benefit from this work. Unfortunately, they are behind schedule in awarding work because of internal issues. We continue to be awarded work, however not at the rate we expected, which results in a larger bench than we currently need. We have cut costs as much as we can without jeopardizing our ability to perform the work once it materializes. We are confident that our backlog at Bruce Power will continue to ramp up throughout 2016 and it has the potential to grow very rapidly, as I mentioned in our last call. As we mentioned -- as also mentioned in our last call, we anticipate a soft Q1 for our IT segment and the results were in line with expectations. It's important to note that the first quarter of 2015 includes $1 million in revenues and $550,000 in gross profit from our QAD Business, which we sold at the end of fiscal 2015. After considering the QAD Business revenues and gross profit, Q1 2016 decreased by 6.6% and 5.4%, respectively as compared to 2015. The main reason for the decline was that we had a very large project peak in the second half of fiscal 2015 and ended in early 2016, and we have not been able to replace that project yet. The leaders of our IT segment and in particular Tim Brandt have a multiyear track record of delivering growth. So, while we anticipate continued softness in Q2, we are optimistic we will see improvement in the second half of 2016. As we look ahead to the balance of this year, we expect continued softness in Q2, but if Canada ramps up as we expect, we will see a very strong second half of 2016. Thank you very much. And I'd like to open it up for questions.

Thank you. [Operator Instructions] Our first question comes from John Zoro at BCM. [Ph] Please go ahead.

I’m sorry. I missed the first part of the call. But, what gives you -- I mean, given everything that's going on in Canada and now we've got the fire in the rest of the stuff, and just the slowdown in the resource side, it doesn't seem that surprising that these guys are -- it's taking longer for them to get things approved and through the pipeline. And why do you think it will speed up in the second half of the year?

Mainly because we know that they are working diligently to put together their conceptual designs for us to propose on the detailed designs, which is really the bread and butter of our work. The conceptual designs are the specifications that we did to in developing the detail designs and our ultimate deliverables at Bruce Power. We know their behind in putting the conceptual designs together. And it really doesn’t have anything to do with the fires out west or any exterior…

I'm thinking more of just their economy out there and what's going on in the sort of different -- how it's affecting different commonwealth, if you well.

Well, this particular client has a power purchase agreement with the government. And part of that power purchase agreement is funding associated with the refurbishment of their units. And this power purchase agreement was approved several months ago, which gave them the green light to proceed with their plans for modest -- updating their assets associated with six plants.

Right, I remember that.

So, I understand that the economy is hurt by the oil side of the business and the gas side of the business, but on the nuclear side of the business, the budget is available and we fully expect it to be spent on upgrading their assets for the next 10 years.

And then, I missed; I got in right at the tail end of this new contract that you won. Did you say it was...

Are you talking about in technical publications or…

Yes, technical publications.

In technical publications, this particular contract -- and I'm not at liberty to talk about the client, but it's a multiyear depot level maintenance program for an aircraft that will last about five years and that will require us to add significant resources to our Westerly, Rhode Island offices.

Our next question comes from Anthony Henley. [Ph] Please go ahead.

I noticed your cash position is on the low side and your accounts receivable increased. What's going on there?

This is Kevin. Nothing really in particular, in terms of anything long lasting, just sort of the typical quarter-to-quarter gyrations, specifically we had a couple of snap hews ph] in some of our school contracts where some of the billing got delayed and that caused it to spike a little bit from Q4. And then a few of our projects in Canada needed just a little bit more explanation to the client on some of the billings in order to get those invoices approved and billed. The collection so far -- knocking my disk here, in Q2, have been good. And we've got a couple of big jobs that particularly on the engineering side that we expect to get paid this quarter and we expect to get some of the school contracts -- those receivables improved significantly in the second quarter and into the third quarter and fourth quarter. So, the bad news is we had -- we have been making a lot of progress with our DSOs in 2015, we took a little bit of a step backwards in Q2 -- excuse me Q1, but we view that as kind of a temporary setback and we expect to continue to improve our DSOs from where they were at the end of Q4 in Q2, Q3 and Q4 this year. So, we do expect -- the good news is we expect to see some pretty significant improvement through the balance of this year on our DSOs. And depending obviously where the revenues go, we expect receivables to be down or maybe at similar levels, if we see higher sales, but we certainly expect the DSOs to improve significantly through the rest of this year.

[Operator Instructions] Our next question comes from Bill Sutherland with Emerging Growth Equity. Please go ahead.

The question I want to start with was actually the gross margin and healthcare, just little lower than I was thinking it would be; is there some color there?

Yes, there is a couple of things going on there, Bill. Frankly, it came in a little bit lower than we expected as well. However, some of that is due to some of the newer business lines that have really spiked, in particular the travel, the travel healthcare which has gross margins in the low 20s but very attractive net margins. And then Chicago margins, we billed to get that -- we bid pretty low, pretty aggressive bill rates to get that contract. Additionally, some of the margins are just not coming in even where we expected and due to the fact that we had to put 200 nurses out in like a month, right? So, we didn’t exactly have the best negotiating power when it comes to the pay rates. The bill rates on that contract are fixed, and we had to get a lot of nurses out very, very quickly. So, we're not realizing the margins. And we knew the margins weren’t going to be super high to begin with, with that contract. But since it is sole-source contract, we expect the operating margins to be good. But, they're coming in even lower than we expected for a variety of reasons. But, we're hoping that’s going to be a six-year contract and over time we expect the margins to improve there. Additionally, we had -- we re-classed about 120,000 in sales tax costs in Hawaii that we were accounted for in SG&A last year, but really we after sort of taking a closer look at it, decided it needed to be flipped up to direct cost. So that's about 80 basis points right there. That's a permanent change. Obviously, it doesn't impact the operating margins, but does impact the gross margins. So, the short of it is that our gross margins are probably going to be a little bit lower than what your customer is seeing because we're bringing in some business that has lower gross margins, but very attractive operating margins from our standpoint. But then do expect them to come up some from where they were in the first quarter, as we tweak things and improve some of our operations. And just Michael and Mark and their group do a fantastic job of really sort of tweaking things as they go along and getting margins up where maybe they're little bit lower than would like to see them.

Rocco, as far as Bruce turning around a detailed design for you guys, do you have a sense that they really have a timeframe for you yet?

Well, actually with meetings that I've had, they are trying to make up their schedule and they're behind schedule in issuing these specifications out for us and the other engineering companies that are going to participate in the master services agreement. And really there is two of us that have the bulk -- have the contracts for the balance of plant side of the work. So, what we've been told is that the third and fourth quarter should -- the activity should increase dramatically over the first and second quarter. And we have been winning projects, it's just that we're not winning the projects to remove the bench that we have and bring us to the point where we thought we would be at this time of the year.

Is it a matter of getting into all of the designated plants or is it more about just scaling the work…?

For us, it's a matter of defining the work. See, the way it works is they develop a conceptual design and we look at that conceptual design and give them what it's going to cost to make it a detailed design and make field ready work packages including all the materials associated with the design. It's important to do that so that they have a handle and hold us accountable for our pricing and our schedule. And in their power purchase agreement, the cost and schedule of these asset upgrades and refurbishments are very important to the government and Bruce Power. So, they are spending the time with the upfront work giving us fully definable scopes that they are going to hold us accountable to. And that's basically the holdup at this point.

Okay.

The work has been identified; it's just hasn’t been scoped to the level of detail they want to scope to.

And then the last from me is just prioritizing your use of cash as you think ahead, hopefully the cash flows continuing to build; what’s the Board thinking as far as first couple of priorities at this point?

We are very flexible Bill at the end of the day. I mean we think the stock is very attractively priced right now, so certainly we’re interested in continuing to buy stock. As far as -- and we don’t have any sort of eminent acquisitions in hand; we’re pretty selective when it comes to acquisitions. But, if we can find an acquisition that's kind of on the lower risk side and has some upside, we’re pretty interested in doing that. We’re looking at a couple right now; none of them are in a stage where that I would call serious. And then lastly, certainly when we get to the end of the year, if we’re in a position to issue a dividend, we will seriously consider that. But, that's not something that frankly will really have serious conversations about at the Board level until towards the end of the year because we don’t -- we just don’t know what's going to -- what opportunities are going to present themselves between now and then. So, I think we are looking at all options when it comes to capital allocation and we are looking at a general philosophy of maximizing capital allocation and staying flexible and seeing what opportunities are out there.

And the thought on the debt balance, just sounds like that's not…

We’re pretty comfortable with where the debt balance is right now. Obviously to the extent that the Company grows and the operating income grows and we can consider higher debt levels, we’re a company that does not want to have a big ratio of debt to operating income. But, something in the 1.5 to 2 times, 2.25 or if you want to go over that on a short-term basis, that's something we can consider. But, I think our Board certainly has a philosophy that we should always have some level of debt to maximize our return on invested capital. So, right now, I think we are in a pretty comfortable level. I don’t think we want to go significantly above where we are. We are pretty optimistic that we are going to generate some pretty good cash flow this year. And we are pretty optimistic that that will present options. And obviously as we look at the various ways of allocating capital, the key is to generate cash flow. And if we generate good cash flow, obviously that gives us more options.

Our next question comes from Frank Kelly. [Ph] Please go ahead

It looks like on a growth basis, so we had a tough first quarter and it sounds like 2Q from your comments are going to be more of the same. We look at IT being down over 7% net of QAD versus Q1 2015, but the real hit comes in, in engineering down $4 million or 18% QVQ. Where do we see that $4 million coming from?

It's mostly coming from Canada for the most part Frank and it's mostly much lower activity, although the exchange rate -- there is a little bit of an impact from the exchange rate as well, but it's primarily from Canada. As you know Frank, we have two major clients. And OPG is just down in their cycle of spending. We expect Bruce to come up in a big, big way, but the way that these two clients spend money tends to be pretty lumpy, as you know. So, we often wind up with these lumpy waves in our revenues. But, we expect Bruce Power to become our biggest client, maybe even this year. And certainly in 2017 and 2018, it would be really nice if we had a client that was even bigger than that. But, our expectation is that they’re going to be a very, very significant client, based on their spending profile. So, it's obviously disappointing to see the quarter-over-quarter numbers. But we think when we get to the end of the year, the year-over-year comparisons are going to look pretty good.

Now that we're halfway through Q2, do we see the same $1 million, $1 million down Q over Q in IT in another $4 million in engineering, do we see like those same numbers?

Yes, we'll probably see some pretty similar numbers in Q2 compared to -- Q2 to Q2 versus Q1 to Q1, probably something pretty similar.

Having said that, the increase in healthcare revenue is covering all the shortfalls in both the IT and engineering; so, that's the good news. And kudos to those guys, as they continue to do an outstanding job but that's to be commended.

Yes, they're doing great and there is a lot of momentum there and they're into a lot of new businesses that have been started the last couple of years. And those new businesses are doing very well, but so is the core, what I call the core business in New York is also doing very, very well. And we think that the new contract that we won in Hawaii towards the end of this year has the potential to really give us another big contract and give us some pretty significant growth in Q4 over Q4 of this year. I mean this is one of these deals where you have an MSA and you don't know exactly how many people you're going to place, but we feel like we can compete pretty well against the other four vendors that have that MSA.

[Operator Instructions] We have no further questions at this time.

Thank you very much everyone and we look forward to our call in August. Have a good week and thanks again.

Thank you, ladies and gentlemen. This concludes your call. You may disconnect at this time.