Good morning, and welcome to the RCM Technologies Second Quarter Earnings Conference Call. Your host today is Bradley Vizi. Mr. Vizi, you may now begin.

Good morning, everyone. This is Brad Vizi, Executive Chairman of RCM Technologies. Welcome to the RCM Technologies 2019 Second Quarter 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 business units before opening it up for questions. Kevin?

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. 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 filed with the SEC as well as our press releases that we issue from time to time.

Thanks, Kevin. I'll begin the call by highlighting an important attribute about RCM that I believe is unique when benchmarked against most of our microcap peers. The drivers of each of our three business units are relatively resilient, but this is due to the economic cycle. Specific to our engineering segment, the majority of the business is driven by CapEx budgets of major North American utilities. In the health care segment, the majority of operating performance is delivered servicing the medical and behavioral needs of students in major school systems throughout the United States. Finally, as it relates to our IT business, profitability is substantially driven by servicing the pharmaceutical industry. Though it is implicit that the price of any publicly-traded security may not reflect the economic reality of its underlying business, our view on this, not to highlight the resilience of our company during a time of increasing global uncertainty. Now I am pleased to highlight the operating performance of our second quarter and fiscal 2019 results. More importantly, we believe we are poised for a strong finish in fiscal 2019 and have effectively positioned the company to demonstrate higher earnings power in 2020. I will discuss each division separately. Our specialty health care staffing group set a second quarter record with $23.4 million of revenue, growing by 3% over the second quarter of 2018. It is important to note that we have 148 cumulative school days for our big three school contracts during the second quarter of 2019 versus 160 cumulative school days for the first quarter of 2019. On a per school day basis, revenue for big three schools grew by 7% versus the first quarter of 2019 and 17% versus the second quarter of 2018. During the second quarter, we were awarded a three-year contract to place registered behavior technicians or RBTs with the Hawaii Department of Education. Under a new mandate passed by the state, the Hawaii DOE is adding RBTs to its contract. An RBT is a certified paraprofessional, who practices under the close ongoing supervision of a Board-certified behavioral analysts. The RBT is responsible for the direct implementation of behavior analytics services, primarily for autistic kids. The annual value of this contract is anticipated to be $40 million. It is important to note that this new RBT contract with Hawaii is not a sole source contract. However, based on our market share and historical performance with the client, we anticipate the contract to provide material accretion to operating performance in 2020 and begin to ramp next month. Our engineering second quarter revenue of $18.6 million declined by 14% as compared to fiscal 2018. As previously discussed, though we anticipate year-over-year softness in 2019 for this segment, we expect to finish the year strong and deliver substantially higher operating performance in 2020. We recently won the preliminary engineering for a $50 million EPC contract to build a new calcium chloride manufacturing plant. We anticipate that after the completion of preliminary engineering, we will be selected to manage and implement this contract. Additionally, we won an engagement with a Canadian company manufacturing various products in the cannabis market. We would -- we will engineer and provide certain equipment to extract CBD oil using ethanol. This is our first engagement in the fast-growing CBD oil market. We've already received a half dozen inquiries about similar projects from potential new customers. Lastly, we remain in the final stages of contention for two additional $50 million EPC contracts with the major U.S. utility clients. I reiterate, activity and leading indicators are encouraging. Despite the current top line softness, we have not pulled back on investments to fortify our engineering business and position it to deliver sustainable long-term results. We anticipate continued softness in our engineering segment in the third quarter, but expect to see an uptick in run rate as we approach year-end. Our information technology group demonstrated continued strong growth with revenue of $8.7 million in the second quarter of 2019, a 20% increase over the prior year. The upward trajectory and the performance of our IT group is the result of a significant transformation of sales, recruiting and management personnel since we made a leadership change in the first half of 2018. Before this change, we had a staff of 41 people, 24 of whom have been terminated. Today, we have a staff of 36, including 19 recent hires. We have replaced seven of nine members of our senior management staff. Our leadership team is focused on driving sustainable improvement to the business. Though at times these changes may be at odds with short-term performance, we are confident that they align with the long-term success of the enterprise. Though investors should expect typical third quarter seasonality, on a consolidated basis, we anticipate that 2019 second half performance will exceed the comparable fiscal 2018 period. This concludes our prepared remarks. At this time, we will open the call up for questions.

[Operator Instructions] Our first question will be coming from Bill Sutherland. Please go ahead.

Just looking here at healthcare real quick. As you look at your mix of business going forward, are you seeing any pickup? I know permanent placements been an area that you've wanted to see a better trend here, is that showing any signs of life?

We have not seen any meaningful change to that business, Bill. We remain encouraged and excited about the teams that we have in place, but we have not seen any meaningful uptick there.

Okay. So the outlook for the school business, is this add-on to the Hawaii contract? And in your past experience in those contracts where you aren't the sole source, what portion have you realized in terms of the total contract?

Well, we only have one other significant contract with Hawaii, where we're not the sole source provider. Recall, we have two significant contracts with Hawaii Department of Education. One is the nursing, which is sole sourced to us. And every other nurse that work -- every nurse that works for the Hawaii Department of Education is an RCM employee. As far as the paraprofessionals, I think there's about maybe half a dozen vendors on that contract. And I would say about four kind of have the lion's share of the business. We are not the largest player there, but we're one of the largest players and hope to be the largest player at some point in the future. As far as the RBT contract is concerned, we don't know yet how large that contract is going to be. It has a maximum permitted purchasing value of $40 million per year per the contract. We believe there's about a dozen vendors on that list, but we really think maybe the same three, four, five companies will be the major players with us being one of them. We believe the rest are kind of more mom-and-pop specialist-type firms that probably won't grab a big share of it. But the fact is we don't really know what the impact is going to be from this contract, but we believe that it should be a material net add in terms of the regular paraprofessionals that will continue to work there versus the RBTs. As we get into the contract, which is effective with the August school year, we can give you a little bit more color and a little bit more statistics in terms of how meaningful it's going to be. But we believe it's going to be pretty significant. The bill rates on the RBTs are significantly higher than regular paraprofessionals, and we believe that the gross margin will be higher as well.

Okay. The other, in terms of the big three school business. What is the outlook there? I think there's a retroactive payment coming from New York relative to the rates, right?

Yes. It's just -- we still haven't -- we received some of that, but not all of it, we received some of it in Q3. We're going to have another chunk of that probably early in Q4. We had it recently, had a bill rate increase in Chicago that was effective in May, and that should continue to have a positive impact on the fourth quarter and at least the first half of 2020 as we finish out the '19, '20 school year. So we're very excited about everything that's going on with our big three schools. Things are harmonious. As Brad mentioned, Q2 versus Q2, we're up 17% on a per school day basis. And we expect to see continued strong performance from those three schools.

Great. And I know you guys don't provide a backlog number for engineering. Give us a sense -- and Brad called out two or three opportunities that are emerging. So I guess, maybe just in the aggregate, how to think about what you've got lined up at this point.

Right. Well, as Brad mentioned, we have three very significant EPC opportunities, all three of which we think will have a pretty good chance of winning. But it's pretty hard for us to really give guidance on binary opportunities, right? It could be zero or it could be huge. So in terms of stripping out these big opportunities, we also have a nice pipeline of more typical type of projects. But in terms of giving any sort of revenue guidance for next year is a little bit difficult at this point.

Our next question will be coming from Daniel Drawbaugh.

Just to start. Engineering gross margin, 28% in the quarter, that's up quite significantly sequentially and year-over-year. Can you just comment on that? Anything specific to call out? And what should we be thinking about going forward from gross margin in the engineering segment?

I think that is more typical of the type of margins that we expect to achieve on an ongoing basis. And the reason for the improvement from recent margins, frankly, is just better utilization, less rework on some of our fixed price to our managed task engagements, a little bit of belt tightening, so to speak, a little bit less sort of lower-margin T&M work as a mix. So there is really not one factor that I would point to for the improvement. As far as ongoing margins are concerned, you should expect to see quarters where, for whatever reasons, it drops. But 28% is more of what we expect, it is more of a target gross margin percentage. And I believe that if we're success -- as successful in 2020 as I think that we will be, those are the kind of margins you should expect to see in 2020.

Okay. Great. That's good to hear. And then the projects that you were talking about in the engineering business, specifically the calcium chloride and the cannabis project. Could you just give us a time frame sort of the -- when you guys begin executing on those? When they -- when we should be looking for revenue showing up sort of the magnitude? Can you shed some color?

Yes. Sure, sure. I mean neither one of those engagements that have been executed are significant in size. So the cannabis engagement is a $600,000 engagement, which we expect to finish by -- most of it by the end of the year. Although, some of it will probably spill into Q1 as well. What's exciting to us about the cannabis opportunity is -- and we're really just sort of getting into this market and researching it and crafting an offering, but as you know, this is a huge market, right? There's plants all over the US and Canada that already built or being built to answer the huge demand in CBD oil. So we're excited about that. We're not exactly sure yet what it means for us, but we think it's a pretty big opportunity. And we're excited to be in that space. As far as the EPC project, the preliminary engineering is going to be -- the first contract is about $300,000 in revenue. We're already talking about a second tighter engineering engagement on that, which should probably add another few hundred thousand dollars. But as far as the plant itself, which we believe could get started in early 2020, assuming it's a go, that's what we're excited about. Once we do the engineering, if the plant goes, we think that it will go early in 2020. And we believe the investors in this particular venture are looking at a pretty nice return. So typically, when you have those step scenario as opposed to trying to cram in budget dollars at a utility. Typically, the investors are pretty anxious to get going once they've determined that yes, yes, this is a go, and we're going to get a nice return on our investment. So we're cautiously optimistic that we'll start that in -- sometime in early 2020. Did I answer your question?

Great. That's really helpful color. Can you also talk a bit about kind of the market demand levels you're seeing in the IT business? I mean I know you've had some really nice growth year-to-date there and the compares were not terribly challenging. But I mean, it seems like 20-plus percent growth in both the first and second quarter. I mean are you taking a little bit more share from potential competitors? What are you sort of seeing in that business?

Well, as you know, Dan, we're a tiny little, tiny, tiny, tiny little speck in terms of the IT services firms, right? So that market is huge. So there's certainly plenty of market share to win to make a meaningful impact to our business. But in terms of the broader demand, we're seeing a lot of spending on IT, frankly. The scenarios in our business where we see probably more opportunities than others, particularly in the life sciences space. Our Human Capital Management space is the one that's probably, maybe not performing as we like it to perform, but there's plenty of opportunity there as well.

[Operator Instructions] Our next question will be coming from [Steven Bulva]

Congratulations on the improvement in, particularly, the outlook. Just a couple of quick questions. On the -- your three-year Hawaii RBT add, did I understand that it's $40 million per year that they will spend? Or is it $40 million over three years?

It's an annual cap of $40 million. This does not mean that we will spend $40 million.

Okay. No, I understand that, but I just wanted a clarification, whether it was annual or a three-year cap. So that's good.

It's annual. It's something we expect to kind of start slow with this school year since it's new. But what's exciting to us, really, is that we believe that over time, it's really only -- we believe it's only limited by the number of RBTs that we can find or train ourselves. And we do train them ourselves. We've trained at least 60 of our paraprofessionals and gotten them certified as RBTs. And we're continuing every day to try and train more and get more to pass the certification test that they need to pass. So it's exciting for us because really, we're just competing, it's in our view against finding RBTs and training RBTs.

Okay. Is it difficult to recruit capable people in that volume?

It's not easy, but it's certainly doable. We've recruited -- since we wanted a paraprofessional, we've recruited and/or trained approximately 350. And we've had more than that, that have worked on the contract. When we ended last year's school year, we had about 350 paraprofessionals. And we've already converted about 60, and we have another 20 to 30 that we think we can convert, and we're continuing to look for new RBTs and better-rated paras that we can switch over or new employees that we can get trained up. So I wouldn't say it's easy, but this is what we do. We have a really good training engine in place and a really good recruiting engine in place, and we're just going to continue to try and find as many RBTs as we can.

Okay. Would you expect any revenue from this contract to actually start in this quarter, third quarter?

We'll see a little bit in the third quarter. We'll see more in the fourth quarter. We'll see more in the first quarter of next year and more in the second quarter, like it's going to -- we expect to see kind of a gradual build. But we do think it will have a -- it's not going to have a huge impact on Q4 relative to the overall health care operation, but it will have a meaningful impact, we believe, in Q4.

Okay. Great. On your first quarter call, you indicated that the HIM practice grew 16% over prior year during the quarter. How did it do in second quarter?

It did not perform well in the second quarter, Steve. And that's relates to -- we tend to win fairly large engagements from our clients, where they need 40 or 50 coders. And we had a nice big assignment in Q1 that ended towards the end of Q1 and then we didn't get to replace it in Q2. We have another big assignment that we're gearing up for that is going to start in Q4. So we should see some pretty nice results out of HIM in Q4 this year and that project should spill over into Q1. So that tends to be a little bit like our engineering business, it tends to be -- the HIM tends to be a little bit lumpy because of -- there's sort of a steady amount of business, but then we tend to win big projects, which are typically going to go anywhere from two or three months to four or five months so -- and we have some interesting things going on there. We're in the process of -- in the final stages of developing an offshore capability, which we think will help the group long term. So we'll be able to sell HIM onshore and offshore. That's not going to have an immediate impact. But over time, we believe that'll be a meaningful piece of the overall business.

Okay. And finally, also in the first quarter call, you indicated you're going to venture then make a lot of progress on our accounts receivables. And I do see some improvement, was it at the magnitude that you expected?

No. I was disappointed, frankly, with the progress that we made in Q2. We did get a very big check from New York City Board of Education about three weeks after the quarter ended, over $5 million. So we do expect to see continued cash -- positive cash flow in Q3, and we should see it again in Q4, assuming things break the way we expect them to. But I will say this that paying down or getting our DSOs down and consequently paying our debt down from an operating standpoint is probably our number 1 priority outside of, obviously, driving revenues.

Yes. Okay. So the other target you think you'll hit at the end of this quarter on net debt?

I don't. I'm hesitant to give a target, Steve, just because so many other things can happen in a given quarter. But we're very, very focused on paying our debt down and -- as much and as quickly as possible. Obviously, the big driver of that is receivables, as you know.

Yes. Is most of that centered on your health care?

Health care and we've got an arbitration going on that we think is going to conclude by the end of the year, and we think that's going to provide a pretty meaningful amount of cash. So assuming that concludes this year, which we don't completely control, unfortunately, but we believe that's going to conclude this year, and we believe that we're going to win that arbitration. And we believe we're going to have a pretty big influx of cash at the end of the year.

[Operator Instructions] Okay. Gentlemen, we do not have any more callers in queue for questions.

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

Thank you, ladies and gentlemen, for joining. You may all disconnect at this time, and have a great day. Thank you.