Reko International Group Inc.
TSX : REK

Reko International Group Inc.

December 03, 2009 14:45 ET

Reko Announces First Quarter Results for Fiscal 2010

WINDSOR, ONTARIO--(Marketwire - Dec. 3, 2009) - Reko International Group Inc. (TSX:REK) today announced results for its first quarter ended October 31, 2009.



Financial Highlights (complete statements follow):
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Period Ended October 31, Three Months
(in $,000 except per share amounts) Unaudited
2009 2008
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Sales $9,255 $13,881
Net (loss) income (1,177) 437
EPS (basic) (0.18) 0.06
Working capital 15,468 15,458
Shareholders' equity 42,444 44,508
Shareholders' equity per share 6.61 6.28
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Consolidated sales for the quarter ended October 31, 2009, were $9.3 million, compared to $13.9 million in the previous year. This represents a decline of 33%, mainly due to volume decreases across all divisions. Reko continues to be impacted by the global credit crunch and its resultant impact on the capital equipment markets.

The gross profit for the three months ended October 31, 2009, was $0.1 million, or 1.5% of sales, compared to $2.4 million in the prior year, or 17.4% of sales. The decline in gross margin, of approximately $2.3 million, relates to the abnormally low level of business, which resulted in unabsorbed overhead.

Selling and administrative expenses for the three months ended October 31, 2009 were $1.5 million, or 15.8% of sales, compared to $1.5 million, or 10.8% of sales for the same period in the prior year. Although slightly reduced in absolute terms, selling, general and administrative expenses increased dramatically relative to revenue as a result of the 33% volume decline during the quarter.

Net loss for the quarter was $1.2 million or $(0.18) per share, compared to a net income of $0.4 million, or $0.06 per share, in the same period of the prior year.

"Reko's first fiscal quarter experienced low awards of work, mainly due to weakness in the capital equipment purchase market and program delays at the Detroit 3, resulting from General Motors' and Chrysler's bankruptcies," said Diane St. John, CEO. "Quoting activity is increasing, and we are maintaining and advancing our cost cutting initiatives. We remain optimistic that our expertise and dedication to improving our processes will result in an improvement in awarded business. As we slowly recover from the difficult economic environment, we remain cautious in our expectations for the remainder of the fiscal year."

Founded in 1976, Reko International Group (TSX:REK) is a highly integrated, technology driven engineering and manufacturing firm providing engineered solutions for the plastics segment of the automotive, aerospace and consumer product markets. In its nine production facilities in Ontario, Reko designs and manufactures precision moulds and other related industrial tooling, in addition to its own proprietary line of CNC machining centres.



INTERIM CONSOLIDATED BALANCE SHEETS
As at October 31, 2009 with comparative figures for July 31, 2009 (in 000's)
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October 31, July 31,
(unaudited) (audited)
2009 2009
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ASSETS
Current
Cash and cash equivalents $ -- $ 3,084
Accounts receivable 13,942 17,959
Other receivables 261 204
Non-hedging financial derivatives (Note 4) 1,526 1,522
Income taxes receivable 36 24
Work-in-progress 15,230 14,852
Prepaid expenses and deposits 615 572
Future income taxes 12 12

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31,622 38,229
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Capital assets 36,073 37,512
Future income taxes 2,996 3,409
SR & ED tax credits 4,785 4,685
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$ 75,476 $ 83,835
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LIABILITIES
Current
Bank indebtedness $ 7,469 $ 12,500
Accounts payable and accrued liabilities 5,967 6,148
Current portion of long-term debt 2,718 2,640
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16,154 21,288
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Long-term debt 14,092 15,181
Future income taxes 2,786 3,749

SHAREHOLDERS' EQUITY
Share capital (Note 2) 18,772 18,772
Contributed surplus 1,746 1,742
Retained earnings 21,926 23,103
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42,444 43,617
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$ 75,476 $ 83,835
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See accompanying notes to the interim consolidated financial statements


INTERIM CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME AND
RETAINED EARNINGS
Three months ended October 31, 2009 with comparative figures for October 31,
2008 (in 000's except per share data)
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For the three months
ended October 31,
(unaudited)
2009 2008
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Sales $ 9,255 $ 13,881
Costs and expenses
Cost of sales 8,046 10,233
Selling and administrative 1,463 1,500
Amortization 1,066 1,239
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10,575 12,972
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(Loss) income before the following (1,320) 909
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Interest on long-term debt 278 258
Interest on other interest bearing
obligations, net 112 140
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390 398
------------------------------
(Loss) income before income taxes (1,710) 511
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Income taxes (recovered)
Current -- 64
Future (533) 10
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(533) 74
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Net (loss) income and comprehensive
(loss) income (1,177) 437
------------------------------
------------------------------

Retained earnings, beginning of period 23,103 22,904
Net (loss) income (1,177) 437
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Retained earnings, end of period $ 21,926 $ 23,341
------------------------------
------------------------------
(Loss) earnings per common share
Basic $ (0.18) $ 0.06
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------------------------------
Diluted $ (0.18) $ 0.06
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------------------------------

See accompanying notes to the interim consolidated financial statements


INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended October 31, 2009 with comparative figures for October 31,
2008 (in 000's)
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For the three months
ended October 31,
(unaudited)
2009 2008
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OPERATING ACTIVITIES
Net (loss) income for the period $ (1,177) $ 437
Adjustments for:
Amortization 1,066 1,239
Future income taxes (533) 10
SR & ED credits (100)
(Gain) loss on sale of capital assets (60) 20
Stock option expense 4 7
------------------------------
(800) 1,713
Net change in non-cash working capital 3,251 2,421
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Cash provided by operating activities 2,451 4,134
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CASH FLOWS FROM FINANCING ACTIVITIES
Net payments on bank indebtedness (1,946) (4,043)
Payments on long-term debt (1,011) (369)
Cost of repurchase of shares -- (75)
------------------------------
Cash used in financing activities (2,957) (4,487)
------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES
Investment in capital assets (111) (196)
Proceeds on sale of capital assets 586 --
Proceeds on sale of assets held for sale -- 1,018
------------------------------
Cash provided by investing activities 475 822
------------------------------
Effect of foreign exchange rate changes on
cash and cash equivalents 31 (469)
------------------------------
Cash and cash equivalents, beginning of period -- --
------------------------------
Cash and cash equivalents, end of period $ -- $ --
------------------------------
------------------------------

See accompanying notes to the interim consolidated financial statements


1. Significant accounting policies

Management prepared these unaudited interim consolidated financial statements in accordance with Canadian generally accepted accounting principles using the historical cost basis of accounting and approximation and estimates based on professional judgment. These unaudited interim consolidated financial statements contain all adjustments that management believes are necessary for a fair presentation of the Company's financial position, results of operations and cash flows. These statements should be read in conjunction with the Company's most recent annual consolidated financial statements. The accounting policies and estimates used in preparing these unaudited interim consolidated financial statements are consistent with those used in preparing the annual consolidated financial statements, except as noted below.

Changes in accounting policy

Effective August 1, 2009, the Company adopted the Canadian Institute of Chartered Accountants ("CICA") accounting standards Section 3064 "Goodwill and intangible assets." The Company adopted this new recommendation effective August 1, 2009 without restatement of prior periods.

2. Share capital

The Company had 6,420,920 common shares outstanding at July 31, 2009. During the quarter, no options were granted and no options were exercised. On July 13, 2009 the Company announced a normal course issuer bid, which expired on July 21, 2009 after being completely filled. In the opinion of the Board of Directors, such purchases may, from time-to-time, constitute a good use of corporate funds.

Share capital transactions during the quarter were as follows:



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Shares Amount
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Balance as at July 31, 2009 6,420,920 $18,772
Shares re-purchased in respect of normal course
issuer bid: -- --
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Balance as at October 31, 2009 6,420,920 $18,772
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3. Stock based compensation

The Company has established a stock option plan for directors, officers and key employees. The terms of the plan state that the aggregate number of shares, which may be issued and sold, will not exceed 10% of the issued and outstanding common shares of the Company on a non-diluted basis. The issue price of the shares shall be determined at the time of the grant based on the closing market price of the shares on the specified date of issue. Options shall be granted for a period of five years with a vesting progression of 30% in the year of the grant, 30% in the second year and 40% in the third year with the option expiring after five years. Options given to outside directors vest immediately and can be exercised immediately.

During the quarter, no options were granted. Stock based compensation for the three months ended October 31, 2009 was $4.

4. Financial instruments and risk management

Categories of financial assets and liabilities

Under Canadian generally accepted accounting principles, financial instruments are classified into one of the following five categories: held for trading, held to maturity investments, loans and receivables, available-for-sale financial assets and other financial liabilities. The carrying values of the Company's financial instruments are classified into the following categories:



October 31, July 31,
2009 2009
$ $
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Held for trading financial assets
Cash and cash equivalents $ -- $ 3,084
Non-hedging financial derivatives 1,526 1,522
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$ 1,526 $ 4,810
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Held for trading financial liabilities
Bank indebtedness $ 7,469 $ 12,500
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Loans and receivables
Accounts receivable $ 13,942 $ 17,959
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Other financial liabilities
Accounts payable and accrued liabilities $ 5,967 $ 6,148
Current portion of long-term debt 2,718 2,640
Long-term debt 14,092 15,181
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$ 22,777 $ 23,969
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The Company has determined the estimated fair values of its financial instruments based on appropriate valuation methodologies; however, considerable judgment is required to develop these estimates. The fair values of the Company's financial instruments are not materially different from their carrying value, with the exception of the Company's long-term debt of $16,810. Based on current interest rates for debt with similar terms and maturities, the fair value of the long-term debt is estimated to be $17,433.

Impairment losses recognized on trade receivables

During the quarter, the Company recorded the following transactions with respect to its allowance for doubtful accounts:



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October 31,
2009
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Opening allowance for doubtful accounts $885
Less: write-off of allowance and receivables (150)
Plus: bad debt expense --
Plus: effect of foreign exchange on U.S. denominated
balances 3
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Closing allowance for doubtful accounts $738
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Notes to Unaudited interim consolidated financial statements for the three months ended October 31, 2009
(in 000's, except for share and per share figures)

Risks arising from financial instruments and risk management

The Company's activities expose it to a variety of financial risks: market risk (including foreign exchange and interest rate), credit risk and liquidity risk. The Company's overall risk management program focuses on the unpredictability of financial markets and seeks to minimize potential adverse effects on the Company's financial performance from quarter to quarter. The Company uses derivative financial instruments to achieve this objective. The Company does not purchase any derivative financial instruments for speculative purposes.

Foreign exchange risk

The Company operates in Canada and its functional and reporting currency is Canadian dollars, however a significant portion of its sales are denominated in U.S. dollars. Foreign exchange risk arises because the amount of the receivable or payable for transactions denominated in a foreign currency may vary due to changes in exchange rates ("transaction exposures") and because certain long-term contractual arrangements denominated in a foreign currency may vary due to changes in exchange rates ("translation exposures").

The Company's balance sheet includes U.S. dollar denominated cash, accounts receivable, work-in-progress, capital assets, future income taxes, bank indebtedness and accounts payable and accrued liabilities. The Company is required to revalue these U.S. dollar denominated items to their current Canadian dollar value at each period end.

The objective of the Company's foreign exchange risk management activities is to minimize translation exposures and the resulting volatility of the Company's earnings. The Company manages this risk by entering into foreign exchange option contracts.

Based on the Company's foreign currency exposures, as at October 31, 2009, a change in the U.S. dollar/Canadian dollar foreign exchange rate to reflect a 100 basis point strengthening of the U.S. dollar for the month of October would, assuming all other variables remain constant, have decreased net income by $15, with an equal but opposite effect for an assumed 100 basis point weakening of the U.S. dollar. We caution that this sensitivity is based on an assumed net U.S. dollar denominated asset or liability balance at a point in time. Our net U.S. dollar denominated asset or liability position changes on a daily basis, sometimes materially.

Foreign exchange contracts

The Company utilizes financial instruments to manage the risk associated with fluctuations in foreign exchange. At October 31, 2009, the Company had entered into foreign exchange contracts to sell an aggregate amount of $24,500 (USD). These contracts hedge our expected exposure to U.S. dollar denominated net assets and mature at the latest on February 14, 2011, at an average exchange rate of $1.1427 Canadian. The mark-to-market value on these financial instruments as at October 31, 2009 was an unrealized gain of $1,526; the change in this value from July 31, 2009 has been recorded in net loss for the quarter.



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As at October 31, 2009 Maturity Notional Average Notional Carrying & fair
value rate USD value
equivalent asset(liability)
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Sell USD / Buy CAD 0 - 6 $14,391 1.1786 $13,100 $1,291
months
Sell USD / Buy CAD 7 - 12 8,107 1.1066 7,900 207
months
Sell USD / Buy CAD 12 - 18 3,528 1.0899 3,500 28
months
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$26,026 1.1427 $24,500 $1,526
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As at July 31, 2009 Maturity Notional Average Notional Carrying & fair
value rate USD value
equivalent asset liability)
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Sell USD / Buy CAD 0 - 6 $ 9,465 $1.1921 $ 8,500 $ 965
months
Sell USD / Buy CAD 7 - 12 7,955 1.1683 7,300 655
months
USD Call / CAD put 0 - 6 9,768 1.0775 9,600 168
months
CAD Call / USD put 0 - 6 9,334 1.0580 9,600 (266)
months
Elimination of
conjoined put / calls (9,600) 1.0856 (9,600) --
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$26,922 $1.1386 $25,400 $1,522
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Interest rate risk

The Company's interest rate risk primarily arises from its floating rate debt, in particular its bank indebtedness. At October 31 2009, $7,469 of the Company's total debt portfolio is subject to movements in floating interest rates.

Based on the value of interest-bearing financial instruments, subject to movements in floating interest rates, as at October 31, 2009, an assumed 0.5 percentage point increase in interest rates on the first day of the quarter would, assuming all other variables remain constant, have decreased net income by $9, with an equal but opposite effect for an assumed 0.5 percentage point decrease.

The objective of the Company's interest rate risk management activities is to minimize the volatility of the Company's earnings. Since the Company's exposure to floating interest rates is limited to its bank indebtedness, the Company's ability to effectively manage the volatility of interest rates is limited to locking portions of the Company's bank indebtedness into fixed rates for relatively short periods of time, usually 30 or 90 days.

Credit risk

Credit risk arises from cash and cash equivalents held with banks and financial institutions, derivative financial instruments as well as credit exposure to clients, including outstanding accounts receivable and unbilled contract revenue. The maximum exposure to credit risk is equal to the carrying value of the financial assets.

The objective of managing counterparty credit risk is to prevent losses in financial assets. The Company assesses the credit quality of the counterparties, taking into consideration their financial position, past experience and other factors. Management also monitors the utilization of credit limits regularly. In cases where credit quality of a client does not meet the Company's requirements sales opportunities may be terminated, progress payments may be required or continuing security interests in our products may be required.

In the normal course of business, the Company is exposed to credit risk from its customers, the majority of whom are in the automotive industry. While these accounts receivable are subject to normal industry credit risks, the ultimate source of funds to pay our accounts receivable balances may come from the Detroit 3 original equipment manufacturers, which are currently rated below investment grade by credit rating agencies, two of whom recently left United States bankruptcy protection, and in the event that they are unable to satisfy their financial obligations or seek protection from their creditors, the Company may incur additional expenses as a result of such credit exposure. The Company may be able to mitigate a portion of this credit risk through the use of accounts receivable insurance, when and if available to individual customers.

For the three months ended, October 31, 2009, sales to the Company's three largest customers represented 42.9% of its total sales. These same customers represent approximately 16.5% of its total accounts receivable, as at October 31, 2009.

Liquidity risk

Liquidity risk arises through an excess of financial obligations over available financial assets due at any point in time. The Company's objective in managing liquidity risk is to maintain sufficient readily available reserves in order to meet its liquidity requirements at any point in time. The Company achieves this by maintaining sufficient cash and cash equivalents and through the availability of funding from credit facilities. As at October 31, 2009, the Company has undrawn lines of credit available to it of approximately $12,531.

Disclosures related to exposure risks are included in the section "Liquidity and Capital Resources" of Management's Discussion and Analysis for the three months ended October 31, 2009, which is included as part of Reko's First Quarter 2010 Report to shareholders, along with these interim consolidated financial statements. Accordingly, these disclosures are incorporated into these interim consolidated financial statements by cross-reference.

5. Management of capital

The Company's objective in managing capital is to ensure sufficient liquidity to pursue its organic growth strategy, while at the same time taking a conservative approach to financial leverage and management of financial risk. The Company's capital is composed of net debt and shareholders' equity. Net debt consists of interest-bearing debt less cash and cash equivalents. The Company's primary uses of capital are to finance increases in non-cash working capital and capital expenditures for capacity expansion. The Company currently funds these requirements out of its internally generated cash flows and when internally generated cash flow is insufficient, its revolving bank credit facility.

The primary measure used by the Company to monitor its financial leverage is its ratio of net debt to shareholders' equity, which it aims to maintain at less than 1.0:1. As at October 31, 2009, the above capital management criteria can be illustrated as follows:



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October 31, July 31,
2009 2009
$ $
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Net debt
Bank indebtedness 7,469 12,500
Current portion of long-term debt 2,718 2,640
Long-term debt 14,092 15,181
Less: cash and cash equivalents -- (3,084)
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Net debt 24,279 27,237
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Shareholders' equity 42,444 43,617
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Ratio 0.57 0.62
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As part of the Company's existing debt agreements, three financial covenants are monitored and communicated, as required by the terms of credit agreements, on a quarterly basis by management to ensure compliance with the agreements. The covenants are: i) debt to equity ratio - calculated as total debt, excluding future income taxes divided by shareholders' equity minus minority interest, if any; ii) debt service coverage ratio - calculated as EBITDA less cash taxes (for previous 52 weeks) divided by interest expense plus repayments of long-term debt (based on upcoming 52 weeks); and (iii) current ratio - calculated as current assets divided by current liabilities.

The Company was in compliance with these covenants at all times during the period.

MANAGEMENT'S DISCUSSION AND ANALYSIS

The following is management's discussion and analysis of operations and financial position ("MD&A") and should be read in conjunction with the unaudited interim consolidated financial statements for the three months ended October 31, 2009 and the audited consolidated financial statements and MD&A for the year ended July 31, 2009 included in our 2009 Annual Report to Shareholders. The unaudited interim consolidated financial statements for the three months ended October 31, 2009 have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"), and the audited consolidated financial statements for the year ended July 31, 2009 have been prepared in accordance with Canadian GAAP. When we use the terms "we", "us", "our", "Reko", or "Company", we are referring to Reko International Group Inc. and its subsidiaries.

This MD&A has been prepared by reference to the MD&A disclosure requirements established under National Instrument 51-102 "Continuous Disclosure Obligations" ("NI 51-102") of the Canadian Securities Administrators. Additional information regarding Reko, including copies of our continuous disclosure materials such as our annual information form, is available on our website at www.rekointl.com or through the SEDAR website at www.sedar.com.

In this MD&A, reference is made to gross margin, which is not a measure of financial performance under Canadian GAAP. The Company calculates gross margin as sales less cost of sales (including depreciation and amortization). The Company included information concerning this measure because it is used by management as a measure of performance, and management believes it is used by certain investors and analysts as a measure of the Company's financial performance. This measure is not necessarily comparable to similarly titled measures used by other companies.

All amounts in this MD&A are expressed in 000's of Canadian dollars, except per share data and where otherwise indicated.

This MD&A is current to December 2, 2009.

OVERVIEW

Reko designs and manufactures a variety of engineered products and services for original equipment manufacturers ("OEMs") and their Tier 1 suppliers. These products include plastic injection molds, fixtures, gauges, lean cell factory automation, high precision custom machining, and assemblies. Customers are typically OEMs or their Tier 1 suppliers and are predominantly in the automotive market. Divisions of Reko are generally invited to bid upon programmes comprised of a number of custom products used by the customer to produce a complete assembly or product.

For the automotive industry, the Company designs and builds plastic injection molds, hydro-forming dies, two shot molds, and compression molds. Injection molds range in size from less than one cubic foot to approximately four feet wide, ten feet long, and six feet high. They range in weight from approximately 100 pounds to 50 tons. Typically, plastic injection molds are expected to perform up to 1,000,000 production cycles with limited maintenance. Each production cycle lasts between 30 and 120 seconds. Reko has extensive experience and knowledge in mold design and material flow and the impact of pressure on segments of the mold/die. In addition, it designs and builds custom lean factory cell automation for use primarily in the automotive industry and specialty custom machines for other industries. The factory automation systems include asynchronous assembly and test systems, leak and flow test systems, robotic assembly/machines vision work cells and various welding systems. For the transportation and oil and gas industry, the Company machines customer supplied metal castings to customer indicated specifications.

Our design and manufacturing operations are carried on in eight manufacturing plants located at four industrial sites in the suburbs of the City of Windsor in Southwestern Ontario.

INDUSTRY TRENDS AND RISKS

Historically, our success has been primarily dependent upon a favourable U.S. dollar versus the Canadian dollar, the levels of new model releases of cars and light trucks by North American OEMs and our ability to source moulding and automation programmes with them. OEM new model releases can be impacted by many factors, including general economic and political conditions, interest rates, energy and fuel prices, labour relation issues, regulatory requirements, infrastructure, legislative changes, environmental emissions and safety issues.

The economic, industry and risk factors discussed in our Annual Information Form and Annual Report, each in respect of the year ended July 31, 2009, remain substantially unchanged in respect of the three months ended October 31, 2008, however, the most significant of which are repeated below.

The increasing pressure from our customers to launch new awards without adequate design support could materially impact our profitability

As the automotive industry rushes to restructure its operations and deal with the frequent production slow downs that are commonplace today, our OEM and Tier 1 customers have substantially reduced the design support offered to new vehicle launches. Without an adequate level of support, the quality of information provided to the tool builders to begin their work has dropped significantly. In addition, the tool builders' ability to manipulate the poor quality information is limited as the appropriate resources to approve the manipulations are not available from the OEM or Tier 1. This has introduced significant inefficiencies to the process and decreased the ability of the tool builder to manufacture molds on a profitable basis.

Current outsourcing and in-sourcing trends could materially impact our profitability

As global market conditions remain weak, demand for our customers' products also remains weak. During periods of weakened demand, our customers traditionally revisit outsourcing decisions as a method of maintaining their employment levels. As a result of this and other factors, some of our customers are deciding to perform in-house work that in the recent past would have been performed by Reko. Depending upon the depth and breadth of the current economic downturn, Reko may continue to experience significant reductions in securing out-sourced work from customers.

The consequences of deteriorating financial condition of a large number of our customers and their resultant inability to satisfy their financial obligations could materially impact our profitability and cash flow

The financial condition of our traditional customers has deteriorated in recent years due in part to high labour costs (including health care, pension and other post-employment benefit costs), high raw materials, commodities and energy prices, declining sales and other factors. This deterioration ultimately led to General Motors and Chrysler filing for Chapter 11 bankruptcy protection. Additionally, increased gasoline prices have affected and could further threaten sales of certain of their models, such as full-size sport utility vehicles and light trucks. All of these conditions could further threaten the financial condition of some of our customers, putting additional pressure on us to reduce our prices and exposing us to greater credit risk. In the event that our customers are unable to satisfy their financial obligations or seek protection from their creditors, we may incur additional expenses as a result of our credit exposure.

Continued support of our lenders could have a material impact on our profitability and continued sustainability

The Company is engaged in a capital-intensive business; has significant financing requirements placed on it by its customers; and its financial resources are inferior to the financial resources of our customer base. There can be no assurance that, if, and when the Company seeks additional equity or debt financing, it will be able to obtain the additional financial resources required to successfully compete in its markets on favourable commercial terms or at all. Additional equity financings may result in dilution to existing shareholders.

Significant long-term fluctuations in relative currency values of the Euro, U.S. dollar and Canadian dollar could materially impact our profitability

Although we report our financial results in Canadian dollars, a significant portion of our sales are priced in U.S. dollars. Our profitability is affected by movements of the U.S. dollar against the Canadian dollar. However, as a result of economic hedging programs employed, foreign currency transactions are not fully impacted by the recent movements in exchange rates. Economic hedging programs are inherently short-term in nature. Despite these measures, significant long-term shifts in relative currency values could have an adverse effect on our profitability and financial condition and any sustained changes in relative currency values could adversely impact our competitiveness in both the short and long-terms.

CHANGES IN ACCOUNTING POLICY

On August 1, 2009, the Company adopted the Canadian Institute of Chartered Accountants ("CICA") accounting standards Section 3064 "Goodwill and intangible assets". The Company adopted this new recommendation effective August 1, 2009 without restatement of prior periods.

UNUSUAL ITEMS

Sale of land and building

During the first quarter, the Company sold underutilized real estate associated with its Tool & Mould operations. The Company realized net proceeds, after real estate commissions, of $528 on the sale. The land and building were recorded in the Company's records at a net book value of $395 and the Company incurred closing costs of $27, resulting in a gain on the sale of the land and building of $106.

As part of the sale, the Company was required to repay $553 to its mortgage lender. In order to make this repayment, the Company utilized the net proceeds less closing costs of $501 and $52 from its existing lines of credit.

As a result of the sale, the Company will save approximately $80 a year.

AVERAGE FOREIGN EXCHANGE/FINANCIAL AND OTHER INSTRUMENTS

As a result of the Company's foreign exchanging hedging programme, the Company's exposure to changes in the trading value between the Canadian and United States dollars is not consistent with the actual changes in trading value. The table below presents the average foreign exchange rates that effectively applied to Reko versus the actual average foreign exchange rates observed in the market for the periods identified. These foreign currency exchange rates impact our reported sales, expenses and income each period.



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For the three months ended October 31, For the year ended July 31,
2009 2008 2009 2008
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Reko Reko Reko Reko
Effective Effective Effective Effective
Actual Rate Actual Rate Actual Rate Actual Rate
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U.S.
Dollar
equals
Canadian
Dollar 1.0750 1.1360 1.0992 1.0178 1.1755 1.0749 1.0069 1.0412
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The preceding table compares the average foreign currency exchange rates for the disclosed periods and the average effective rates of the forward exchange contracts we booked during that period. This foreign currency exchange impacts our reported sales and income. At the end of the first quarter of fiscal 2010, we held forward exchange contracts of $24,500 compared to $28,100 at the end of the first quarter of fiscal 2009. During fiscal 2010, on average, we have had $26,600 of forward exchange contracts outstanding monthly, as compared to $26,800 in fiscal 2009. The decline in forward exchange contracts largely relates to declining sales volumes.

Reko's forward exchange contract programme is based on maintaining sufficient forward exchange contracts at all times that are practically equal to the U.S. dollar value of our accounts receivable and work-in-progress, net of any U.S. dollar denominated debt. This programme is designed to minimize the Company's exposure to foreign exchange risks over the mid-term. As a consequence of this mid-term exposure protection, the Company is subject to short-term paper gains and losses on its exposed foreign exchange contracts. During periods of rapid fluctuation in the foreign exchange rate between the Canadian dollar and the U.S. dollar, the Company can generate significant gains or losses, which will materially impact financial results.

As a result of the forward exchange contracts programme employed, foreign currency transactions in the current period were not, and in future periods may not, be fully impacted by movements in exchange rates. The following table outlines the level of forward exchange contracts presently maintained and the average effective rate of these contracts:



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Fiscal period Contract value Effective
booked (000's) average rate
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Q1 - 2010 $24,500 1.1427
Q2 - 2010 17,900 1.1224
Q3 - 2010 11,400 1.1015
Q4 - 2010 7,000 1.0890
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For the first quarter, the Company recorded a pre-tax gain of approximately $300 related to the fair value of its U.S. dollar exposures as compared to a loss of $758 in the prior year's first three months.

The Company notes that at current levels of forward exchange contracts, U.S. dollar denominated debt, unbilled contract revenue and accounts receivable, an increase in the value of the U.S. dollar against the Canadian dollar results in the Company recording gains and an increase in the value of the Canadian dollar against the U.S. dollar results in financial losses for the Company.

Foreign currency transactions are recorded at rates in effect at the time of the transaction. Forward exchange contracts are recorded at month-end at their fair value, with unrealized holding gains and losses recorded in sales.

SUBSEQUENT EVENTS

Subsequent to October 31, 2009, the following items occurred:

a) The Company reached a partial settlement with the Bankrupt Estate of Visteon Corporation ("Visteon") that resulted in the Company receiving a payment of $431. Previous to October 31, 2009, the Company reached an earlier partial settlement with Visteon in the amount of $64. After these partial settlements, Visteon owes the Company less than $125, for which the Company maintains its secured claim.

b) The Company adopted a restructuring and temporary layoff plan that resulted in the termination of 4 employment positions and temporarily laid off 36 employees across all of its operating divisions. The cost of the restructuring plan was $95, and is included in Selling and Administrative expenses. As a result of the restructuring and temporary layoff plan, the Company will save $265 a year, based on the terminations and $41 per week during the temporary layoff. As market conditions improve, the Company intends to recall portions of the temporarily laid off workforce based on actual workflows through our facilities.

RESULTS OF OPERATIONS

Sales

Sales for the three months ended October 31, 2009 decreased $4,626, or 33.8%, to $9,255 compared to $13,881 in fiscal 2009.

The decrease in sales was largely related to:

- lower sales volumes at all of our facilities, largely a result of the continued lack of global credit to support capital equipment additions and the lingering impacts of General Motors and Chrysler's bankruptcy proceedings on new vehicle designs and introductions.

The factor was partially offset by:

- changes in the fair value of foreign exchange future contracts, as described above.

While the Company continues to actively quote and receive new orders, certain products continue to experience customer-initiated delays. These delays impact the Company's ability to proactively manage the timing and amount of work completed during each quarter, as well as impact the ability of the Company to absorb fixed overhead costs.

Gross margin

The gross margin for the three months ended October 31, 2009 decreased $2,266 to $143 or 0.2% of sales, compared to $2,409, or 17.4% of sales, in the previous fiscal year.

The decrease in gross margin was largely related to:

- extremely low work volumes that were insufficient to absorb our fixed overhead costs.

This factor was partially offset by:

- productivity and efficiency improvements resulting from last year's restructuring activities;

- changes in the fair value of foreign exchange contracts, as described above, and

- gain on sale of underutilized real estate.

Selling and administration

Selling and administration expenses ("S,G&A") decreased by $37, or 2.5%, to $1,463, or 15.9% of sales for the three months ended October 31, 2009, compared to $1,500, or 10.8% of sales for the same period in the prior year. During the first quarter, we incurred various restructuring charges of $95 included in S,G&A, compared to $17 in the same period of the prior year.

The decrease in S,G&A was produced by savings achieved as a result of reductions in:

- the cost of commissioned sales representatives, as a result of decreased sales during the quarter;

- professional fees related to the savings associated with our change in auditors;

- lower levels of travel and promotion consistent with our decreased sales levels during the quarter; and,

- minor reductions related to insurance and wages and benefits.

These factors were partially offset by:

- increases in restructuring costs, as discussed in the subsequent events section of this MD&A;

- increases in bank charges imposed by our primary lender; and,

- minor increases in office and miscellaneous and telephone costs.

Earnings overview

Net loss for the three months ended October 31, 2009 was $1,177, or $0.18 per share, compared to net income of $437, or $0.06 per share, in the same period of the prior year.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow from operations decreased $1,683 from $4,134 for the first quarter last year compared to $2,451 in the current year.

The decrease in cash flow from operations is primarily a result of:

- decrease in net income offset by non-cash charges, including but not limited to amortization and future income taxes.

This factor was partially offset by:

- increase in the change in non-cash working capital during the three months.

The Company met its financial covenants at the end of the first quarter of 2010. The Company's current forecasts suggest that it will not meet the Debt Service Coverage Ratio portion of its financial covenants at the end of the second or third quarters of 2010. The Company's lenders have agreed to our requested covenant amendments; however, we are still working with our lenders to formally amend our Debt Service Coverage Ratio covenant for these periods.



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Payments Due by Period
-------------------------------------------------
Less
than After
Contractual Obligations Total 1 year 1- 3 years 4 - 5 years 5 years
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Long-term debt $ 15,292 $ 1,686 $ 12,981 $ 625 $ --
Capital lease obligations 1,513 1,028 485 -- --
Operating leases 5 4 1 -- --
Purchase obligations -- -- -- -- --
Other long-term obligations -- -- -- -- --
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Total contractual
obligations $ 16,810 $ 2,718 $ 13,467 $ 625 $ --
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Capital assets and investment spending

For the three months ended October 31, 2009, the Company invested $111 in capital assets. The entire amount of this spending is considered maintenance capital expenditure intended to refurbish or replace assets consumed in the normal course of business.

Cash resources/working capital requirements

As at October 31, 2009, Reko had borrowed $7,469 on its revolving line of credit, compared to $9,416 at July 31, 2009 and $8,939 at October 31, 2008. The revolver borrowings decreased by approximately $1,947 in the quarter and decreased approximately $1,470 for the year. We expect borrowings to display a mid-term trend of increasing over the next four quarters.

Reko has a $20,000 revolver available to it, of which approximately $12,531 was unused and available at October 31, 2009. Under the terms of our credit facilities, Reko must achieve certain financial covenants including a maximum Total Debt to Tangible Net Worth, a minimum Current Ratio and a minimum Debt Service Coverage Ratio.

Contractual obligations and off-balance sheet financing

Except as disclosed elsewhere in this MD&A, there have been no material changes with respect to the contractual obligations of the Company during the year.

Reko does not maintain any off balance sheet financing.

Share capital

The Company had 6,420,920 common shares outstanding at October 31, 2009. During the first quarter, Reko did not grant any options and there was no exercising of any existing options. In addition, since the Company's normal course issuer bid expired on July 21, 2009, after being completely filled, the Company did not purchase any shares during the quarter.



Outstanding share data

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Maximum number issuable
if convertible,
exercisable or
exchangable for
Designation of security Number outstanding common shares
----------------------------------------------------------------------------
Common shares 6,420,920
Stock options issued 121,000
Stock options exercisable 92,900
----------------------------------------------------------------------------
Total (maximum) number of
common shares 6,513,820
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CRITICAL ACCOUNTING ESTIMATES

The Company's discussion and analysis of its results of operations and financial position is based upon the consolidated financial statements, which have been prepared in accordance with Canadian GAAP. The preparation of the consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities. On an ongoing basis, management evaluates these estimates. However, actual results differ from these estimates under different assumptions or conditions.

Management believes the following critical accounting policies affect the more significant judgements and estimates used in the preparation of the consolidated financial statements of the Company. Management has discussed the development and selection of the following critical accounting policies with the Audit Committee of the Board of Directors and the Audit Committee has reviewed its disclosure relating to critical accounting estimates in this MD&A.

Allowances for doubtful accounts receivable

In order for management to establish appropriate allowances for doubtful accounts receivable, estimates are made with regard to economic conditions, potential recoverability through our accounts receivable insurer, and the probability of default by individual customers. The failure to estimate correctly could result in bad debts being either higher or lower than the determined provision as of the date of the balance sheet.

Revenue recognition and tooling and machinery contracts

Revenue from tooling and machinery contracts is recognized on the percentage of completion basis. The percentage of completion basis recognizes revenue and cost of sales on a progressive basis throughout the completion of the tooling or machinery.

Tooling and machinery contracts are generally fixed; however price changes, change orders and program cancellation may affect the ultimate amount of revenue recorded with respect to a contract. Contract costs are estimated at the time of signing the contract and are reviewed at each reporting date. Adjustments to the original estimates of total contract costs are often required as work progresses under the contract. When the current estimates of total contract revenue and total contract costs indicate a loss, a provision for the entire loss on the contract is made. Factors that are considered in arriving at the forecasted profit or loss on a contract include, amongst other items, cost overruns, non-reimbursable costs, change orders and potential price changes.

Impairment of long-lived assets

Management evaluates capital assets for impairment whenever indicators of impairment exist. Indicators of impairment include prolonged operating losses or a decision to dispose of, or otherwise change the use of, an existing capital asset. If the sum of the future cash flows expected to result from the asset, undiscounted and without interest charges, is less than the reported value of the asset, asset impairment must be recognized in the financial statements. The amount of impairment to be recognized is calculated by subtracting the fair value of the asset from the reported value of the asset.

Management believes that accounting estimates related to capital assets are 'critical accounting estimates' because: (i) they are subject to significant measurement uncertainty and are susceptible to change as management is required to make forward-looking assumptions regarding their impact on current operations; and (ii) any resulting impairment loss could have a material impact on the consolidated net income and on the amount of assets reported on the Company's consolidated balance sheet.

Future income taxes and SR&ED tax credits

Future tax assets, in respect of loss carry forwards and scientific research and experimental design credits related primarily to legal entities in Canada and the United States, are recorded in the Company's books. The Company evaluates the realization of its future tax assets by assessing the valuation allowance and by adjusting the amount of such allowance, if necessary. The facts used to assess the likelihood of realization are a forecast of future taxable income and available tax planning strategies that could be implemented to realize the future tax assets. The Company has, and continues to use, tax planning strategies to realize future tax assets in order to avoid the potential loss of benefits.

CONTROLS AND PROCEDURES

Management is responsible for implementing, maintaining and testing the operating effectiveness of adequate systems of disclosure controls and procedures. There are inherent limitations to the effectiveness of any system of disclosure including the possibility of human error and circumvention or overriding of the controls and procedures. Accordingly, even effective controls and procedures can only provide reasonable assurance of achieving their corporate objectives.

Our management used the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework to evaluate the effectiveness of internal controls over financial reporting. We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures during fiscal 2009, and concluded that Reko's controls and procedures are operating effectively to ensure that the information required to be disclosed is accumulated and communicated to management including the Chief Executive Officer and the Chief Financial Officer. A similar evaluation will be performed throughout fiscal 2010.

Based on these evaluations, the Chief Executive Officer and the Chief Financial Officer concluded that Reko's disclosure controls and procedures and internal controls over financial reporting do not include any material weaknesses and that they were effective in recording, processing, summarizing and reporting information required to be disclosed within the time period specified in the Canadian Securities Administrators (CSA) rules.

QUARTERLY RESULTS

The following table sets out certain unaudited financial information for each of the eight fiscal quarters up to and including the first quarter of fiscal 2010, ended October 31, 2009. The information has been derived from the Company's unaudited consolidated financial statements, which in management's opinion, have been prepared on a basis consistent with the audited consolidated financial statements contained elsewhere in this Annual Report and include all adjustments necessary for a fair presentation of the information presented. Past performance is not a guarantee of future performance and this information is not necessarily indicative of results for any future period.



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Jan/08 Apr/08 July/08 Oct/08
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Sales $11,766 $14,388 $14,091 $13,881
Net income (loss) (2,810) (383) (1,055) 437
Earnings (loss) per share:
Basic (0.30) (0.06) (0.14) 0.06
Diluted (0.30) (0.06) (0.14) 0.06
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----------------------------------------------------------------------------

Jan/09 Apr/09 July/09 Oct/09
----------------------------------------------------------------------------
Sales $16,480 $14,791 $10,128 $ 9,255
Net income (loss) 875 240 (1,353) (1,177)
Earnings (loss) per share:
Basic 0.12 0.05 (0.20) (0.18)
Diluted 0.12 0.05 (0.20) (0.18)
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NORMAL COURSE ISSUER BID

The Company's normal course issuer bid expired on July 21, 2009, when it was completely filled.

INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

For Reko's financial year ended July 31, 2012, Reko will no longer report its financial results using Canadian GAAP, as a result of changes announced by The Canadian Institute of Chartered Accountants in March 2008. This change affects all entities that are considered publicly accountable entities. Reko is considered a publicly accountable entity due to its listing on the Toronto Stock Exchange.

While not all GAAP and IFRS are different, one of the most significant changes deal with the overriding premise in GAAP that financial reporting is based on historical cost, while IFRS' overriding premise is fair value.

Due to the potential pervasiveness of the changes inherent in moving to IFRS, a significant amount of time is necessary for management to plan its implementation. Possible impacts, besides external financial reporting, include, but are not limited to: banking agreements, business processes, information systems, employee and management incentive programmes, and legal agreements.

During the past two years, management engaged internal resources to understand the new rules, educate its primary accounting staff on the differences between GAAP and IFRS and has concentrated its efforts on those portions of IFRS that are different than GAAP. In addition, management identified those business processes that will need to be amended to properly transition to IFRS. Management is currently concentrating on the development of model financial statements under IFRS and has engaged external resources to confirm management's internally developed model financial statements. Upon receipt of the external resource's report, management will be in a position to confirm the financial statement line item impacts associated with the transition to IFRS. Thereafter, management's conversion to IFRS plan will concentrate on the documentation supporting what will be its IFRS accounting policies.

This MD&A contains forward-looking information and forward-looking statements within the meaning of applicable securities laws. We use words such as "anticipate", "plan", "may", "will", "should", expect", "believe", "estimate" and similar expressions to identify forward-looking information and statements. Such forward-looking information and statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments, as well as other factors we believe to be relevant and appropriate in the circumstances. Readers are cautioned not to place undue reliance on forward-looking information and statements, as there can be no assurance that the assumptions, plans, intentions or expectations upon which such statements are based will occur. Forward-looking information and statements are subject to known and unknown risks, uncertainties, assumptions and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed, implied or anticipated by such information and statements. These risks are described in the Company's MD&A included in our 2009 Annual Information Form, this MD&A and, from time to time, in other reports and filings made by the Company with securities regulators.

While the Company believes that the expectations expressed by such forward-looking information and statements are reasonable, there can be no assurance that such expectations and assumptions will prove to be correct. In evaluating forward-looking information and statements, readers should carefully consider the various factors, which could cause actual results or events to differ materially from those, indicated in the forward-looking information and statements. Readers are cautioned that the foregoing list of important factors is not exhaustive. Furthermore, the Company disclaims any obligations to update publicly or otherwise revise any such factors of any of the forward-looking information or statements contained herein to reflect subsequent information, events or developments, changes in risk factors or otherwise.



REKO INTERNATIONAL GROUP INC.
5390 Brendan Lane
Oldcastle, Ontario
N0R 1L0
www.rekointl.com

SUBSIDIARIES/DIVISIONS:

Canada:
-------

- Reko Tool & Mould (1987) Inc.
Divisions -
- Reko Automation and
Machine Tool
- Concorde Machine Tool

United States:
--------------

- Reko International Sales Inc.
- Reko International Holdings Inc.


Contact Information

  • Reko International Group Inc.
    Carl A. Merton
    Chief Financial Officer
    (519) 737-6974