Rocco Campanelli - CEO Kevin Miller - CFO

Frank Kelly - Private Investor Bill Sutherland - Emerging Growth Equity

Ladies and gentlemen, thank you for joining RCM Technologies’ 2016 Fourth Quarter Earnings Conference Call. Your host for today, Rocco Campanelli will begin.

Good morning, everyone. This is Rocco Campanelli, RCM’s President and CEO. Welcome to the RCM Technologies' 2016 fourth quarter earnings call. I'm joined today by Kevin Miller, our Chief Financial Officer. Kevin will begin with the legal disclaimer and then I will summarize the operating results for each of our operating units, then we will open it up for questions. Kevin?

Good morning. 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. 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.

Thank you, Kevin. We are pleased with our fourth quarter results, finishing the year with our best gross margin and our second best gross profit. As we look into fiscal 2017, we believe we are positioned to have a strong year with significantly better operating results as compared to 2016. It must be noted, due to the resetting of statutory payroll taxes and the fact that several large fixed price contracts ended in the fourth quarter, we expect a slow start to 2017 with sequentially quarterly results over the next three quarters steadily increasing. I'll discuss each segment in order. Healthcare continues to post outstanding results by setting an historic high revenue record in the fourth quarter with $16.4 million in revenue growing about 14% over fourth quarter 2015. Our travel nurse division had an exceptional year, ending with $10.6 million in revenue, growing 113% over 2015. Our fourth quarter run rate was $12.6 million in annualized revenue. We continue to aggressively seek and hire experienced travel nurse recruiters. Our schools program continues to perform very well across the country. We are especially proud of our 100% fill ratio track record in Chicago and Hawaii school nursing programs, both exclusive contracts. Our recently won Hawaii paraprofessional contract, ended 2016 with approximately 25 paraprofessionals full time equivalents on staff. We are optimistic that our paraprofessional roster will grow as the school year progresses and we have high hopes for future school years when we have an entire summer to recruit and train additional paraprofessionals. As of today, we have approximately 40 paraprofessionals full time equivalents on staff. In December, we made our first placement in our Locum Tenens division, which opened in early July. We have signed several Master Services Agreements and we are actively recruiting physicians for numerous openings. We expect to generate positive contribution margin by the third quarter of 2017. We also made our first healthcare acquisition on the last day of 2016, purchasing certain assets of Allied Health Professionals. This acquisition adds approximately 20 therapists and several new schools and other healthcare facilities to the RCM portfolio in the Chicago area. Congratulations to our entire healthcare team for a fantastic 2016. We look forward to another growth year in 2017. In the fourth quarter, engineering generated its highest revenue and gross profit quarter of 2016. Engineering also achieved its highest quarterly gross margin in history due in large part to several fixed price contracts that were successfully completed in the fourth quarter. Clients of both Canada Engineering and Engineering Services US, asked us to add resources and shorten the schedule such that these projects be completed by the end of the year. This allowed us to achieve utilization that allowed for outstanding gross margin for the fourth quarter. Although we expect a slow start in Canada due to several large contracts ending at the end of 2016, we expect significant growth in Canada in 2017 over 2016, which generated $19.9 million in revenue. Both our backlog and pipeline are in substantially better shape than at the same time last year. By way of comparison, we anticipate our current backlog of signed purchase orders to generate $16.7 million in revenues. At about the same time last year, that number was $12.4 million. That's an increase of 35% over last year. We also have a robust pipeline of projects we have bid and we expect to bid. We are budgeting for close to 25% growth in revenues in 2017. And of course, as we achieve higher revenues, we should experience improved gross margins over the 25% we experienced in 2016. In early January, we entered into contract with Bruce Power valued at more than $1.5 million for Bruce Power's Life Extension Program. The major component replacement lead in, lead out program is responsible for the activities that will take the unit from an operational state to one that allows the refurbishment work to be executed and then brings the unit back to operation following major component replacements. Although this revenue is modest, this is a very high profile project. We have also been awarded Bruce Power bulkhead project in excess of $1 million that will separate the unit being refurbished from the operating units during refurbishment. We are also actively planning and implementing a more substantial office in the Bruce Power area to house RCM staff that will support our entire Bruce portfolio of work. We have had a modest office there for the past 15 years and this expanded office will be designed to support our multi-year refurbishment work and operations and maintenance work from the six year master services agreement we were awarded in October of 2015. In addition, in January, we were awarded an OPG component condition assessment that will form the basis of extending Ontario Power Generation Pickering units one and four and five through eight through 2024. This project is also a multi-million dollar project. Our Energy Services USA group enjoyed a strong fourth quarter, also due in part to some fixed price contracts that needed to be completed by the end of 2016. We feel as though we had a great year in Energy Services because we added so many new clients, including ABB, Austin Power, American Electric Power, Baltimore Gas and Electric, Bechtel Power Company, Eversource Energy, GE Grid Solutions, Regency Energy Partners and Toshiba International Corporation. None of these clients are large clients for us today, but all have the potential to grow into much larger accounts over time. While we also expect a slow start to 2017 in Energy Services USA due to the several projects contracts ending in 2016, we have a strong backlog and pipeline in place and expect a healthy increase to both the $29.5 million in revenue and gross margin percentage of 24% generated in 2016. In 2017, there will be an emphasis on project oriented organization to improve efficiencies and to improve margins well into the future. The adoption of the project management and control software, CMIC in 2017, will help the team to continue to facilitate integrated project performance. Our transmission and distribution engineering and testing and commissioning service area, is expanding every month. As mentioned in our last call, our clients tell us there is a huge demand for service companies with this capability, which has proven to be accurate by the numerous awards we received over the past year. We are completing the protection and control engineering for a large Canadian high voltage DC project, which led to the award of a multi-million dollar contract to perform the testing and commissioning for this HVDC facility. US has also been a hot market for testing and commissioning services, with multiple awards in the northeastern United States as well as the Midwest. Our leading edge three dimensional engineering technologies continues to provide an entrance into new clients, which has led to repeat business. The use of this technology is proving to be the way of the future and a key to our success. Our aerospace division continues its steady performance with a good backlog in both technical publications and engineering. Gross profit in 2016 grew by 6% over 2015, allowing double digit growth in contribution operating income. In response to our clients need to understand and manage the ever changing regulatory landscape of export control reform, we developed an international trade compliance service within our aerospace division composed of engineers and customs and trade compliance experts. This team provides the client with very capable support in the area of jurisdiction and classification and harmonized tariff scheduling. Our ITC team has been instrumental in guiding our clients through several successful consent agreement audits. This team protects our clients from incurring significant international trade in arms restriction violation fines and customs penalty. In addition, we expanded our business development to focus on Canadian aerospace clients and expect close sales beginning this quarter. We also anticipate opening a new office in Huntsville sometime in the second quarter to support a new Sikorsky multi-year technical publications contract. We continue to deliver on existing contracts and are receiving new work on a daily basis. Our information technology group revenues for the fourth quarter continue to lag prior year results. In the last three quarters, we've experienced much shorter consulting assignments, as well as much fewer opportunities than in previous years. We continue to make investment in sales and recruiting resources in information technology, while focusing our increasing - our sales activity levels and improving our recruiting process. We are confident that within the next several quarters we will begin to see improved sequential results from our information technology business based on the recent changes we implemented and strong performance culture that has driven the impressive growth we realized in revenues, gross profit and contribution operating income in 2012 through 2015. It’s also important to note that the fourth quarter of 2015 includes $800,000 in revenue and $300,000 in gross profit from our former QAD business, which we sold at the end of fiscal 2015. The full fiscal 2015 includes $3.4 million in revenue and $1.4 million in gross profit from our former QAD business. We believe that the foundation laid in 2016 will set RCM up for significantly improved operational performance in 2017, particularly as we progress throughout the year. Thank you for attending RCM’s fourth quarter conference call. We look forward to updating you on 2017 in a few months. I’d like to open the call up for questions.

[Operator Instructions] Our first question comes from Frank Kelly. Please go ahead.

Hi gentlemen. Good morning. Question on our current cash position. I see where we were back at the end of the year. Now we’re almost - we’re a couple of months out. Where are we in relation to cash and accounts receivables?

Well, as you can probably - as you may have deduced, we improved our DSOs in the fourth quarter relative to the third quarter, but since we had a jump in revenues in the fourth quarter as compared to the third quarter, we had an increase in the receivables. More importantly, we believe that we're going to continue to see improvement in the DSOs as we progress through this year. Our DSOs were the lowest they've been in quite some time at the end of Q4 and we expect to continue to improve those. As far as cash flow is concerned, we certainly believe we're going to have another strong cash flow year in 2017. Now obviously the amount of revenue growth that we see in 2017 and we're hoping to see some pretty nice revenue growth, especially as we move out throughout the year on a quarter over quarter basis. So that talk - as you know, it's hard to predict exactly how great the cash flow is going to be because if we're growing revenues like we hope and expect, that is a detriment to cash flow obviously. But we do expect to have continued improvement on the DSO level, which should certainly improve the cash flow. Additionally, we expect significantly better operating income in 2017 as compared to 2016. So again that should also improve cash flow.

Great. Now the revenues, we’re talking about revenues. What does that revenues look like now that we’ve finished two out of the three months in the first quarter as compared to the first quarter 2016?

Yes. I mean we haven't finished two months. We’ve finished one month. Obviously we have a pretty good idea where the revenues are going to come in in February I think the revenues are going to be down a little bit from the - will likely be down a little bit from the fourth quarter just due to some of the contracts that we have coming due. Or excuse me, that expired at the end of Q4. So from - obviously we're not happy that the revenues are going to be down Q1 to Q4, but that will help cash flow. And then the other thing that I'm sure you appreciate and recognize, Frank, we do have a little bit of randomness associated with the net difference between transit receivables and transit payables. We make a pretty conscious effort to expand that delta so that the payables exceed the receivables by as much as possible, and obviously that also impacts the cash flow. But there is a bit of randomness to that from quarter to quarter.

Great. I'm looking at the - on the debt side, it looks year over year that that's come down considerably. What is the firm's ratio that they're looking to be ideal?

Well, we're typically looking at maybe 1.5 to 2.25 on a debt to EBITDA ratio, Frank. There may be reasons from time to time to go a little bit above that so long as we're confident that in the not too distant future, we can get it back down. I think as you know, we're not a company that's looking to have significant debt to EBITDA ratios in the 2.5, 2.75. We generally don't want to be up in that area.

Great. So are there anticipations of utilizing some of the line or the debt facility to look at some return to stockholders?

These are the discussions that we have at the board level every meeting, right? So we look at a lot of different factors as you can appreciate. Acquisitions are one. We have - we do have several attractive acquisitions that are in the pipeline right now where we need to execute on one or two or three of those acquisitions. Obviously that would impact our ability to return - and I assume you're talking about a dividend, Frank. But that obviously would impact our ability to issue a dividend. Also we're very mindful of where the stock price is and the trade-offs between buying shares, which as you know is another form of returning cash to the stockholders or at least increasing our return on equity. So getting back to your question which I think is what you're asking is, will there be a dividend in 2017? And the answer to that is a strong maybe. We certainly are interested in doing it, but when we get towards the end of the year in 2017, we’ll see where our debt levels are. We'll see where our EBITDA is and how comfortable we are taking on more debt. And then we'll look at those capital allocation decisions relative to other capital allocation decisions, which would include acquisitions or repurchasing stock. I can tell you that there is a very, very strong focus at the board level and at management level on maximizing return on equity to shareholders and potential dividend is one component of that.

Great. Good luck in the first quarter. Thank you.

Our next question is going to come from Anthony (indiscernible). Please go ahead.

Question. What makes you think you're going to get your IT division back on track? Because I’m very disappointed with your earnings this year.

Well, if you really take a look at their performance from 2012 through 2015, they had year over year stellar performance in revenue gross profits and operating income. And the leadership of that division, we have a very high level of confidence in that leadership and the organization in general. And the fact that they're proactively adding services, managing their recruiting processes and enhancing their recruiting processes and adding to their sales and recruiting staff in order to improve their results. So based on past track record, the fact that they had a bad year in 2016, we know the people. We have confidence in the people and we're going to give them an opportunity to turn around their operation.

Listening to your comments last year in the first two quarters, I never really got any indication that there was anything coming trouble wise on that subsidiary until September. Then out of the blue, it looked like they lost these big contracts and they hit the fan. But there was no indication given to us in the first half of the year you were optimistic on the second half and I was very disappointed in the way you characterized it.

Well, we're obviously incredibly disappointed with the results as well, Rocco and I and obviously the leadership and IT. We're all upset about it. It’s not so much that we lost contracts. It’s that those contracts ended and unfortunately we just didn't replace them with bigger contracts.

Well, they just don’t end by surprise. I mean you know they’re going to end.

Well, sometimes we know they're going to end and sometimes we don't. It doesn't always work that way. Sometimes we think they're going to be extended and they're not extended. But yes, sometimes we know they're going to end. But we’re usually pretty confident that we're going to replace those contracts because we have in the past. And without getting into a lot of the details, there were a couple of nice sized contracts that we thought we were going to win that we could sort of seamlessly transition into those other contracts and unfortunately it didn't come to fruition. So we're very disappointed with the results, I can assure you and we're working very hard - everybody in this company is working very hard, especially the people running the IT group to get improvement there. And our operating results in engineering also were - while they didn't drop as much as IT, were also disappointing. So the combination of those two really impacted the overall consolidated operating income, which for 2016 was poor.

I didn't see that one coming either because in the first half of last year, you kept saying the second half would be better, that the engineering contracts were all being delayed because the specifications weren't given out on time.

And frankly we didn't see it coming either. I mean the engineering business can be very difficult. We have several big clients. No one client is massively material to the overall operation, but there's about a half a dozen clients. And we have our clients in Canada telling us repeatedly that they're going to start spending a ton of money and they're way behind schedule and they're going to be letting out all kinds of contracts and then they didn't. So it's not as if - what we expected unfortunately just didn't come to fruition. The good news is, is a lot of this work, particularly in Canada still hasn’t been done yet. So and we've recently won some nice contracts. We have some very nice contracts in the pipeline. Unfortunately this is the business we're in because utilities are notoriously slow. They'll notoriously tell you we're going to do this in March and May, June comes around and they still haven't done it yet, and they don't do it until they're ready to do it. And all our intelligence and all our marketing and sales is direct marketing and sales at very high levels. And when we're told that these contracts, especially the - a couple of the massive service agreements that we were awarded in 2015, at the end of 2015 our expectation was very high for the work to begin, and lo and behold it just didn't start.

Right. That’s all I have.

Our next question is going to come from Bill Sutherland. Please go ahead.

Good morning guys. I got in late. So was just wondering, you all - Kevin, you said the first quarter would be sequentially lower on revenue. And is that mostly due to IT because of seasonality going on?

Well, it's both. I mean it's in part going to be due to IT and it's in part going to be due to the fact that we had a bunch of engineering contracts that we needed to finish quickly in the end of fourth quarter. So that helped our revenues in the engineering group in the fourth quarter, but that's likely to hurt the first quarter. Additionally, we had several contracts that we thought were going to start early in the first quarter that still haven't started yet. I mean that's another thing with utilities. They often get out to a slow start in the beginning of the year as they're finalizing budgets and sort of pushing things out. So that combination and then when you take the fact that this has nothing to do with revenues, but as you know, Bill, the unemployment taxes and the Social Security taxes, those payroll taxes al; reset, right? So we typically - everything else being held constant, which is hard to do because everything never is held constant, but if you hold everything constant, you're looking at about $500,000 in payroll taxes that we typically have in Q1 that we don't have in Q4. Obviously when you look in Q1 to Q1, it's the same, but when you look in Q1 to Q4, you typically have a pretty big drop in gross margins. So we're probably going to have lower sales, lower revenues in Q1 compared to Q4 and we're definitely going to have lower gross margins as well. But our pipelines are really strong, particularly in engineering in both Canada and Energy Services USA, both the backlog and the pipeline is really, really good, much better than it was at the same time last year. Healthcare continues to grow. Healthcare continues to add new contracts. We have high hopes for the paraprofessionals. The travel nursing continues to do really well. Our HIM practice which had a weak second half of the year, we expect some pick up there. So we do have a number of good things happening. A lot of them just aren't necessarily going to show up in the first quarter.

Right. And then just to think about the full year in a general sense, should we still think healthcare is going to settle in to a low double digit growth rate. Is that something that you’re expecting for the full year of 2017, that that’s …

Yes. I think it's going to be hard for us to expect any more top line growth then low double digits. Certainly there are things that could happen to improve on that, but when you see the kind of growth two years in a row that's in the 20%, it's a little unrealistic to expect them to do that again a third year in a row. But these guys are working hard. We've got a few other new businesses that we're thinking about. We're not thinking about shorting them, starting them in the short term, but we are thinking about adding some more service lines. First we want to get Locum Tenens up and running and get that profitable because we're making an investment in Locum Tenens right now. It's a business we really believe in. We have a ton of requisitions there. Hiring doctors is a much - is longer sort of selling cycles than some of the other healthcare services that we provide, but we're excited about that. We think that there's a certain potential to really take off. We just don't know when that's going to happen. But once we get that rolling, we're going to - maybe in the second half, the later part of the year, we have two or three other types of healthcare related services that would be new service lines that we're going look to start. That likely won't impact 2017 all that much, but we're constantly looking out to 2018 and 2019 and how are we going to continue to get at least double digit growth. And I can tell you that the guys that run healthcare are really, really focused on getting that business to be $100 million business.

And then the last thing is, do you feel like you’re approaching stable level for IT far as projects rolling off and coming in?

We think we're at a stable level, but we had a - we were dealt a lot of difficult blows in 2016 and I don't want to mislead anybody. The IT business is - unless we win a couple of big projects, which certainly could happen because we have in the past, we're probably not looking at any kind of quick turnaround there. What we're expecting and hoping to see is sort of gradual improvement each quarter.

Yes. We're making a lot of changes in process and organization and enhancing our service areas and it's just a massive improvement, just won’t happen overnight. But we expect it to be pretty stable throughout the year.

From the first quarter level, whatever that adjusted?

Right.

Okay. All right guys, thank you.

[Operator Instructions] And Mr. Campanelli and Mr. Miller, I’m waiting for callers to join the queue. And gentlemen, at this present time, no one has joined the queue.

Well, thank you very much for attending our conference call and we look forward to our next call in - some time in the second quarter of 2017. Thank you very much.

I would like to say thank you ladies and gentlemen for joining. You may all disconnect and have a wonderful day. Thank you for your time.