Reko International Group Inc.
TSX VENTURE : REK

Reko International Group Inc.

March 10, 2011 15:30 ET

Reko Announces Second Quarter Results for Fiscal 2011

WINDSOR, ONTARIO--(Marketwire - March 10, 2011) - Reko International Group Inc. (TSX VENTURE:REK) today announced results for its second quarter ended January 31, 2011.

Financial Highlights (complete statements follow):

  Three Months   Six Months  
  (unaudited)   (unaudited)  
  Fiscal   Fiscal   Fiscal   Fiscal  
  2011   2010   2011   2010  
Sales $ 8,518   $ 8,795   $ 18,360   $ 18,050  
Net loss   (1,256 )   (1,867 )   (2,541 )   (3,044 )
EPS basic   (0.20 )   (0.29 )   (0.40 )   (0.47 )
Working capital               (1,060 )   13,981  
Shareholders' equity               33,617     40,579  
Shareholders' Equity per Share               5.24     6.32  

Consolidated sales for the quarter ended January 31, 2011, were $8.5 million, compared to $8.8 million in the prior year, a decrease of $0.3 million or 3.4%. The decrease in sales in the quarter primarily related to delays in kick-offs of new vehicle launches by our OEM and Tier 1 suppliers. Consolidated sales for the six months ended January 31, 2011, were $18.4 million, compared to $18.1 million in the prior year, an increase of $0.3 million.

The gross profit for the three months ended January 31, 2011, was $0.5 million, or 5.9% of sales, compared to a gross loss of $0.6 million in the prior year. The increase in gross profit over the prior year is primarily related to lower wage and benefit costs in the current year. The gross profit for the six months ended January 31, 2011, was $0.8 million, or 4.3% of sales, compared to a gross loss of $0.5 million in the prior year.

During the quarter, Reko increased the valuation allowance associated with its SR&ED tax credits by $0.3 million, while also decreasing the valuation allowance associated with its Canadian non-capital loss carryforwards by the same amount. This had the effect of reducing Reko's gross profit by $0.3 million, while having no impact on Reko's net loss. Absent this adjustment of valuation allowances, Reko's gross profit for the three months ended January 31, 2011 would have been $0.7 million, or 8.2% of sales. For the six months ended January 31, 2011, Reko made the same adjustment but in the amount of $0.6 million. Absent this adjustment of valuation allowances, Reko's gross profit for the six months ended January 31, 2011 would have been $1.4 million, or 7.6% of sales.

Selling and administrative expenses for the three months ended January 31, 2011 were $1.5 million, or 17.6% of sales, compared to $1.6 million, or 18.1% sales, in the prior year. Selling and administrative expenses for the six months ended January 31, 2011, were $3.0 million, the same amount as in the prior year.

Net loss for the quarter was $1.3 million or $0.20 per share, compared to $1.9 million or $0.29 per share, in the same period of the prior year. Net loss for the six months ended January 31, 2011, was $2.5 million or $0.40 per share, compared to $3.0 million or $0.47 per share, in the same period last year.

The Company's working capital at January 31, 2011 is negative $1.1 million; however, this calculation of working capital includes $11.1 million related to the final real estate mortgage payment due on our mortgage in the fourth quarter of 2011. Absent this final payment, the working capital calculation at January 31, 2011, would have been $10.0 million. The Company is currently in discussions with existing and prospective lenders to refinance the mortgage.

"Reko continues to see gradual improvement in the capital equipment market, which is positive for the Company's operating results," stated Diane St. John, Reko's C.E.O. "The continued recovery in our markets, combined with the actions we have taken to lower our cost structure, represent solid building blocks toward a return to profitability. I look forward to making significant strides toward financial health in all areas of the business during the remainder of the fiscal 2011."

Founded in 1976, Reko International Group (TSX VENTURE:REK) is a manufacturing firm providing high precision machining of very large parts, as well as tooling and automated solutions for the transportation, energy, automotive, aerospace and consumer product markets, all delivered through its eight production facilities in Ontario.

REKO INTERNATIONAL GROUP INC.
Second Quarter Report
 
 
 
INTERIM CONSOLIDATED BALANCE SHEETS
As at January 31, 2011 with comparative figures for July 31, 2010 (in 000's)
  January 31, July 31,
  (unaudited) (audited)
  2011 2010
ASSETS        
  Current        
  Cash and cash equivalents $ -- $ 1,303
  Accounts receivable   16,051   10,657
  Other receivables   299   367
  Non-hedging financial derivatives   937   591
  Income taxes receivable   47   22
  Work-in-progress   13,068   19,826
  Prepaid expenses and deposits   561   536
    30,963   33,302
 
Capital assets   30,837   32,825
Future income taxes   2,654   2,814
SR & ED tax credits   4,078   4,460
  $ 68,532 $ 73,401
 
LIABILITIES        
Current        
  Bank indebtedness $ 15,088 $ 14,292
  Accounts payable and accrued liabilities   4,646   6,201
  Current portion of long-term debt   12,289   12,678
    32,023   33,171
 
Long-term debt   1,309   1,925
Future income taxes   1,583   2,149
 
SHAREHOLDERS' EQUITY        
Share capital   18,772   18,772
Contributed surplus   1,752   1,750
Retained earnings   13,093   15,634
    33,617   36,156
  $ 68,532 $ 73,401
 
 
See accompanying notes to the interim consolidated financial statements
 
 
INTERIM CONSOLIDATED STATEMENTS OF LOSS AND COMPREHENSIVE LOSS AND RETAINED EARNINGS  
Three months and six months ended January 31, 2011 with comparative figures for January 31, 2010 (in 000's except per share data)  
  For the three months   For the six months  
  ended January 31,   ended January 31,  
  (unaudited)   (unaudited)  
  2011   2010   2011   2010  
Sales $ 8,518   $ 8,795   $ 18,360   $ 18,050  
Costs and expenses                        
  Cost of sales   7,131     8,212     15,655     16,258  
  Selling and administrative   1,491     1,571     2,987     3,034  
  Amortization   932     1,194     1,870     2,260  
    9,554     10,977     20,512     21,552  
Loss before the following   (1,036 )   (2,182 )   (2,152 )   (3,502 )
   
   
Interest on long-term debt   219     263     445     541  
Interest on other interest bearing obligations, net   197     104     414     216  
    416     367     859     757  
Loss before income taxes   (1,452 )   (2,549 )   (3,011 )   (4,259 )
Future income taxes recovered   (196 )   (682 )   (470 )   (1,215 )
   
Net loss and comprehensive loss   (1,256 )   (1,867 )   (2,541 )   (3,044 )
   
   
Retained earnings, beginning of period   14,349     21,926     15,634     23,103  
Net loss   (1,256 )   (1,867 )   (2,541 )   (3,044 )
Retained earnings, end of period $ 13,093   $ 20,059   $ 13,093   $ 20,059  
Loss per common share                        
Basic $ (0.20 ) $ (0.29 ) $ (0.40 ) $ (0.47 )
Diluted $ (0.20 ) $ (0.29 ) $ (0.40 ) $ (0.47 )
                         
See accompanying notes to the interim consolidated financial statements
 
 
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS  
Three months and six months ended January 31, 2011 with comparative figures for January 31, 2010 (in 000's)  
  For the three months   For the six months  
  ended January 31,   ended January 31,  
  (unaudited)   (unaudited)  
  2011   2010   2011   2010  
   
OPERATING ACTIVITIES                        
Net loss for the period $ (1,256 ) $ (1,867 ) $ (2,541 ) $ (3,044 )
Adjustments for:                        
  Amortization   932     1,194     1,870     2,260  
  Future income taxes   (196 )   (682 )   (470 )   (1,215 )
  SR&ED credits   175     175     417     75  
  Loss (gain) on sale of capital assets   34     44     27     (16 )
  Stock option expense   1     2     2     6  
    (310 )   (1,134 )   (695 )   (1,934 )
Net change in non-cash working capital   1,278     1,552     (490 )   4,803  
Cash provided by operating activities   968     418     (1,185 )   2,869  
   
CASH FLOW FROM FINANCING ACTIVITIES                        
Proceeds from (net payments on) bank indebtedness   (637 )   757     796     (1,189 )
Payments on long-term debt   (494 )   (595 )   (1,005 )   (1,606 )
Cash used in financing activities   (1,131 )   162     (209 )   (2,795 )
   
CASH FLOWS FROM INVESTING ACTIVITIES                        
Investment in capital assets   (87 )   (462 )   (166 )   (573 )
Proceeds on sale of capital assets   250     (52 )   257     534  
Cash provided by investing activities   163     (514 )   91     39  
   
Net change in cash and cash equivalents   --     (66 )   (1,303 )   (35 )
Cash and cash equivalents, beginning of period   --     --     1,303     --  
Cash and cash equivalents, end of period $ --   $ --   $ --   $ --  
                         
See accompanying notes to the interim consolidated financial statements

Notes to unaudited interim consolidated financial statements for the three and six months ended January 31, 2011
(in 000's, except for share and per share figures)

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.

2. Continuing operations and liquidity risk

The Company has experienced reduced revenues and significant operating losses in both the current year and the previous year caused primarily by the temporary decline in capital equipment markets occurring concurrent with the global recession and from structural changes in the automotive industry which eventually led to General Motors and Chrysler's bankruptcies. In addition, the Company is currently working with its primary lender under reduced financial covenants and has a bullet payment due on its mortgage within the next six months. In combination, these conditions pose challenges to the Company's continued operations and its ability to meet its obligations as they fall due. Management is actively addressing these conditions, as discussed in the following paragraphs:

Operating losses

The Company needs to further reduce and eliminate its operating losses. The Company's ability to do this may be impacted by the speed of the current economic recovery, increased competitiveness and pricing pressure in the plastic injection mold industry and its ability to manage its cost structure based on changing market and economic conditions.

The Company is addressing its operating losses through: (i) increased sales in the capital equipment market, tied to the economic recovery; (ii) targeted entrances into new markets, such as aerospace, with greater sales opportunities and higher margins, (iii) changes in its product mix, moving away from heavily competitive low margin sales categories and into less competitive higher margin categories; and, (iv) an improved cost structure developed through the targeted restructurings completed in the past three years.

The Company's quarterly losses, after reaching a peak of $2,266 in the third quarter of 2010 have declined in each of the past three quarters to the current level of $1,256.

Continued support of its primary lender

The Company needs to maintain the continued support of its primary lender, through its willingness to accept reduced financial covenants while the Company addresses its operating losses. The primary lender's decision to continue its support may be impacted by their view of the speed, with which the Company improves its operating results and their view of the markets in which the Company competes.

To address the continued support of its primary lender, the Company has built and will continue to build a proactive and open relationship with the lender, involving timely and frequent dialogue and an analysis strategy of the Company based on rolling six month intervals as opposed to more traditional one year intervals.

Prior to April 2010, a debt service coverage ratio covenant existed with the Company's primary lender. The debt service coverage ratio covenant was calculated as follows: EBITDA less cash taxes (for the previous 52 weeks) divided by the sum of interest expense and repayments of long-term debt (based on the upcoming 52 weeks). Effective April 2010, the Company's primary lender removed this quarterly debt service coverage covenant and replaced it with a monthly EBITDA target, established based on rolling six month analyses. As at January 31, 2011, the Company's monthly EBITDA target is established for the months of February, March and April 2011. During the month of March, the primary lender will establish the monthly EBITDA target for the months of May, June and July 2011.

Refinancing of the mortgage

The Company needs to refinance its mortgage prior to July 1, 2011. The Company's ability to address this need may be impacted by a lack of normally available financing and the perception of its mortgage lender or prospective mortgage lenders on the Company's ability to address its operating losses.

The Company began addressing the refinancing of its mortgage in September 2010, when it secured current appraisals for its real estate. The appraisals received support a mortgage borrowing based on a loan to asset value of less than 70%. The Company currently is approaching both its existing mortgage lender and other prospective lenders and will continue to work to finalize its refinancing efforts in the third quarter of 2011.

Further information related to liquidity risks is provided in Note 5 to these interim consolidated financial statements.

While the Company believes that the steps it has taken with respect to eliminating its operating losses, maintaining the continued support of its primary lender and refinancing its mortgage will be successful, the outcome of these matters cannot be predicted at this time.

3. Share capital

The Company had 6,420,920 common shares outstanding at January 31, 2011. During the quarter, no options were granted and no options were exercised.

4. 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 January 31, 2011 was $1.

5. 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:

  January 31, July 31,
  2011 2010
  $ $
Held for trading financial assets        
  Cash and cash equivalents $ -- $ 1,303
  Non-hedging financial derivatives   937   591
  $ 937 $ 1,894
Held for trading financial liabilities        
  Bank indebtedness $ 15,088 $ 14,292
Loans and receivables        
  Accounts receivable $ 16,051 $ 10,657
Other financial liabilities        
  Accounts payable and accrued liabilities $ 4,646 $ 6,201
  Current portion of long-term debt   12,289   12,678
  Long-term debt   1,309   1,925
  $ 18,244 $ 20,804

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 $13,598. Based on current interest rates for debt with similar terms and maturities, the fair value of the long-term debt is estimated to be $13,795.

Impairment losses recognized on trade receivables

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

  January 31,  
    2011  
Opening allowance for doubtful accounts $ 673  
Less: write-off of allowance and receivables   (33 )
Plus: bad debt expense   10  
Plus: effect of foreign exchange on U.S. denominated balances   (12 )
Closing allowance for doubtful accounts $ 638  

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 January 31, 2011, 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 January would, assuming all other variables remain constant, have decreased net income by $3, 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 January 31, 2011, the Company had entered into foreign exchange contracts to sell an aggregate amount of $25,000 (USD). These contracts hedge our expected exposure to U.S. dollar denominated net assets and mature at the latest on May 15, 2012, at an average exchange rate of $1.045 Canadian. The mark-to-market value on these financial instruments as at January 31, 2011 was an unrealized gain of $937; the change in this value from October 31, 2010 has been recorded in net loss for the quarter.

             
As at January 31, 2011 Maturity Notional Average Notional Carrying & fair  
    value rate USD value  
        equivalent asset  
          (liability)  
Sell USD / Buy CAD 0 – 6 months $ 12,549 $ 1.0520 $ 12,000 $ 549  
Sell USD / Buy CAD 7 – 12 months   9,236   1.0350   9,000   236  
Sell USD / Buy CAD 12 – 24 months   4,152   1.0470   4,000   152  
   
    $ 25,937 $ 1.0450 $ 25,000 $ 937  
   
As at July 31, 2010 Maturity Notional Average Notional Carrying & fair  
    value rate USD value  
        equivalent asset )  
          (liability  
Sell USD / Buy CAD 0 – 6 months $ 11,216 $ 1.0640 $ 10,800 $ 461  
Sell USD / Buy CAD 7 – 12 months   7,199   1.0590   7,000   198  
Sell USD / Buy CAD 13 – 24 months   6,976   1.0340   7,000   (23 )
   
    $ 25,391 $ 1.0538 $ 24,800 $ 591  
                     

Interest rate risk

The Company's interest rate risk primarily arises from its floating rate debt, in particular its bank indebtedness. At January 31, 2011, $15,088 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 January 31, 2011, 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 $19, 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 left United States bankruptcy protection in the last year, 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, January 31, 2011, sales to the Company's three largest customers represented 34% of its total sales. These same customers represent approximately 38% of its total accounts receivable, as at January 31, 2011.

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 January 31, 2011, the Company has undrawn lines of credit available to it of approximately $4,912 however, under its current margining provisions with its lender, the maximum it can draw on its available undrawn lines of credit is limited to $1,823.

The Company's mortgage on its land and building are due on July 1, 2011 in the amount of $10,616. The Company has begun discussions with its existing and prospective lenders, and has obtained an updated valuation of its capital assets in support of its efforts to refinance this obligation.

The Company met all of its financial covenants during the second quarter of 2011. The Company's current financial forecasts suggest that it will earn sufficient levels of EBITDA to meets its minimum monthly EBITDA covenant for the third quarter of 2011, the only period for which the covenant is already set. Despite the Company's current forecasts suggesting the Company will achieve this financial covenant, the Company is exposed to a number of risks that could prevent it from achieving its primary lender defined monthly minimum EBITDA covenant.

6. 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 January 31, 2011, the above capital management criteria can be illustrated as follows:

         
  January 31,   July 31,  
  2011   2010  
  $   $  
Net debt        
  Bank indebtedness 15,088   14,292  
  Current portion of long-term debt 12,289   12,678  
  Long-term debt 1,309   1,925  
  Less: cash and cash equivalents --   (1,303 )
Net debt 28,686   27,997  
Shareholders' equity 33,617   36,156  
Ratio 0.85   0.77  

As part of the Company's existing debt agreements, three financial covenants are monitored and communicated by management, as required by the terms of credit agreements, on a monthly, quarterly or annual basis depending on the covenant to ensure compliance with the agreements. The annual covenant is a debt service ratio – calculated as EBITDA less cash taxes (for the previous 52 weeks) divided by interest coverage plus repayments of long-term debt (based on the upcoming 52 weeks). The quarterly covenants are: i) debt to equity ratio – calculated as total debt, excluding future income taxes divided by shareholders' equity minus minority interest, if any; and (ii) current ratio – calculated as current assets, which for the first quarter of 2011 excludes all amounts related to the mortgage obligation, divided by current liabilities. The monthly covenant is a minimum EBITDA target.

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 January 31, 2011 and the audited consolidated financial statements and MD&A for the year ended July 31, 2010 included in our 2010 Annual Report to Shareholders. The unaudited interim consolidated financial statements for the three months ended January 31, 2011 have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"), and the audited consolidated financial statements for the year ended July 31, 2010 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 profit (loss), which is not a measure of financial performance under Canadian GAAP. The Company calculates gross profit (loss) 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 March 9, 2011.

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 nine 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 (i) a favourable U.S. dollar versus the Canadian dollar; (ii) the levels of new model releases of automobiles and light trucks by North American OEMs; and, (iii) 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, 2010, remain substantially unchanged in respect of the six months ended January 31, 2011, however, the most significant of which are repeated below.

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. The Company's continued relationship with its lenders is tied to the Company's ability to meet the financial covenant conditions placed on it by its lenders. During the past year, our lender has agreed, to revisit and revise our financial covenants while the Company deals with general economic pressure, industry specific pricing pressure and certain operational issues. There can be no assurance as to the length of time our lender is willing to provide the Company to return its operations to its historically normal financial covenants. Further, additional equity financings may result in dilution to existing shareholders.

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

As global market conditions begin to improve from the previous two years' financial lows, demand for our customers' products 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 recovery, Reko may continue to experience significant reductions in securing out-sourced work from customers.

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

As the automotive industry completes the restructuring of its operations and deals with the production volume volatility that is commonplace today, our OEM and Tier 1 customers continue to operate at substantially reduced design support levels for 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.

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, the volatility of gasoline prices has 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.

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 programmes employed, foreign currency transactions are not fully impacted by the recent movements in exchange rates. Economic hedging programmes 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.

CONTINUING OPERATIONS AND LIQUIDITY RISK

We have experienced reduced revenues and significant operating losses in both the current year and the previous year caused primarily by the temporary decline in capital equipment markets occurring concurrent with the global recession and from structural changes in the automotive industry which eventually led to General Motors and Chrysler's bankruptcies. In addition, we are currently working with our primary lender under reduced financial covenants and have a bullet payment due on our mortgage within the next six months. In combination, these conditions pose challenges to our continued operations and our ability to meet our obligations as they fall due. Management is actively addressing these conditions, as discussed in the following paragraphs:

Operating losses

We need to further reduce and eliminate our operating losses. Our ability to do this may be impacted by the speed of the current economic recovery, increased competitiveness and pricing pressure in the plastic injection mold industry and our ability to manage our cost structure based on changing market and economic conditions.

We are addressing our operating losses through: (i) increased sales in the capital equipment market, tied to the economic recovery; (ii) targeted entrances into new markets, such as aerospace, with greater sales opportunities and higher margins, (iii) changes in our product mix, moving away from heavily competitive low margin sales categories and into less competitive higher margin categories; and, (iv) an improved cost structure developed through the targeted restructurings completed in the past three years.

Our quarterly losses, after reaching a peak of $2,266 in the third quarter of 2010 have declined in each of the past three quarters to the current level of $1,256.

Continued support of our primary lender

We need to maintain the continued support of our primary lender, through its willingness to accept reduced financial covenants while we address our operating losses. Our primary lender's decision to continue its support may be impacted by their view of the speed, with which we improve our operating results and their view of the markets in which we compete.

To address the continued support of our primary lender, we built and will continue to build a proactive and open relationship with the lender, involving timely and frequent dialogue and an analysis strategy of us based on rolling six month intervals as opposed to more traditional one year intervals.

Prior to April 2010, a debt service coverage ratio covenant existed with our primary lender. The debt service coverage ratio covenant was calculated as follows: EBITDA less cash taxes (for the previous 52 weeks) divided by the sum of interest expense and repayments of long-term debt (based on the upcoming 52 weeks). Effective April 2010, our primary lender removed this quarterly debt service coverage covenant and replaced it with a monthly EBITDA target, established based on our rolling six month analyses. As at January 31, 2011, our monthly EBITDA target is established for the months of February, March and April 2011. During the month of March, our primary lender will establish the monthly EBITDA target for the months of May, June and July 2011.

Refinancing of our mortgage

We need to refinance our mortgage prior to July 1, 2011. Our ability to address this need may be impacted by a lack of normally available financing and the perception of our mortgage lender or prospective mortgage lenders on our Company's ability to address our operating losses.

We began addressing the refinancing of our mortgage in September 2010, when we secured current appraisals for our real estate. The appraisals received support a mortgage borrowing based on a loan to asset value of less than 70%. We currently are approaching both our existing mortgage lender and other prospective lenders and will continue to work to finalize our refinancing efforts in the third quarter of 2011.

Further information related to liquidity risks is provided the section entitled Liquidity and Financial Resources in this Management Discussion & Analysis.

While we believe that the steps we have taken with respect to eliminating our operating losses, maintaining the continued support of our primary lender and refinancing our mortgage will be successful, the outcome of these matters cannot be predicted at this time.

UNUSUAL TRANSACTIONS IN THE QUARTER

Change in income tax valuation allowances

Currently, Reko maintains three income tax loss carry-forward balances: U.S. net operating losses; Canadian non-capital losses; and, Canadian SR&ED tax credits. Each quarter, Reko reviews and considers the expected net realizable value of its loss carry-forward balances. As Reko's view of the expected net realizable value of its loss carry-forward balances change, it adjusts the valuation allowance associated with each loss carry-forward balance.

Consistent with our practices since Third Quarter 2010, we did not record an income tax recovery on our non-capital losses in the current quarter. However, Reko subsequently determined that while its valuation allowance on all of its Canadian loss carry- forwards, both the non-capital losses and SR&ED tax credits, was appropriately stated, the allocation of the valuation allowance between the two tax carry-forward amounts was inappropriate. Accordingly, Reko increased the valuation allowance associated with its SR&ED tax credits and decreased the valuation allowance associated with its non-capital losses in the amount of $275, in the second quarter and $550 for the six months ended January 31, 2011.

As a result of this change in allocation of valuation allowance, the increase in the valuation associated with its SR&ED tax credits caused an increase in cost of sales in the second quarter of $275 and a corresponding increase in taxes recoverable of $275.

Launch of Reko Global Services, LLC

During the quarter, the Company acquired a 50% interest in the membership units of Reko Global Services, LLC ("RGS"), organized in the State of Alabama. The remaining 50% interest in the membership units is owned by an affiliate of Tool-Care US International LLC ("TC"), an unrelated third-party.

RGS was formed to improve Reko and TC's low-cost country purchases and to enhance our offerings to our customers. By joining with a partner to co-ordinate low-cost country purchases, we gained access to a more developed off-shore sourcing program as well as sharing the fixed costs associated with enhancing this program.

As part of the agreement, the Company will expand its manufacturing footprint to include a presence in Auburn, Alabama by co- locating at TC's existing facility. This expansion provides the Company access to the southeastern U.S. automotive industry at a time when its OEM and Tier 1 customers are expanding in the same region.

Financial activity at RGS is expected to commence in the third quarter. The Company will account for the financial transactions of RGS using proportional consolidation.

Sale of vacant land

During the quarter, the Company sold several parcels of vacant land for proceeds of $250. The parcels of vacant were acquired in the late 1990s and were being held in the event the Company wished to expand its tool & mould manufacturing operations. In the mid-2000s, the Company determined the likely need for expansion was minimal and as such deemed the vacant parcels of land to be surplus.

Restructuring charges

During the quarter, the Company made changes in the senior management at one of its operating divisions. As a result of the change, the Company recorded a restructuring charge of $150 in the quarter.

AVERAGE FOREIGN EXCHANGE/FINANCIAL AND OTHER INSTRUMENTS

Reko is exposed to the impacts of changes in the foreign exchange rate between Canadian and United States ("U.S.") dollars. More specifically, approximately 90% of the Company's sales and 20% of its costs are incurred in U.S. dollars. In addition, the Company maintains a significant asset on its balance sheet which represents unutilized non-capital losses available to reduce future taxable income in the U.S., it operates a sales office in the U.S., maintaining working capital and capital assets, and it maintains an investment in RGS, as described above. 

In order to minimize our exposure to the impacts of changes in the foreign exchange rate, the Company maintains a forward foreign exchange hedging programme ("Programme"). Reko's Programme is based on maintaining our net exposure to the U.S. dollar (total U.S. exposure less forward foreign exchange contracts) between positive and negative $2,000. 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 net exposure to the U.S. dollar, most particularly during periods when our net exposure to the U.S. is outside of our target exposure. During periods of rapid fluctuation in the foreign exchange rate between the Canadian dollar and the U.S. dollar, regardless of our net exposure to the U.S. dollar, the Company can generate significant gains or losses, which will materially impact financial results. These significant gains or losses are entirely related to mark-to-market accounting rules and represent the product of our net exposure to the U.S. dollar and the change during any given month of the value of the U.S. dollar in relation to the Canadian dollar.

During each of the last four quarters, the Company's quarter-end exposure to the U.S. dollar has been:

  Total U.S. exposure   Forward foreign      
  before hedging   exchange contracts   Net exposure to  
Fiscal Period programme   booked   the U.S. dollar  
Q2 – 2011 $ 25,320   $ 25,000   $ 320  
Q1 – 2011 $ 26,516   $ 28,400   $ (1,884 )
Q4 – 2010 $ 26,050   $ 24,800   $ 1,250  
Q3 - 2010 $ 23,488   $ 24,100   $ (612 )

As a result of the Company's purchase of forward foreign exchange contracts ("FFECs"), the Company is subject to changes in foreign exchange rates that may not be consistent with changes in the current quoted foreign exchange rates. More specifically, the Company's foreign exchange risk is split such that its net exposure to the U.S. dollar, as detailed above is subject to the change in market foreign exchange rates on a monthly basis and the remainder of its U.S. dollar exposure is subject to foreign exchange risks based on the specific foreign exchange rates contained in its FFECs. The table below presents a comparison between actual foreign exchange rates and Reko's effective rate on its booked FFECs.

  For the three months January 31, 2011   For the six months ended January 31, 2011
  2011   2010   2011   2010
      Reko       Reko       Reko       Reko
      effective       effective       effective       effective
  Actual   rate   Actual   rate   Actual   rate   Actual   rate
U.S. Dollar equals Canadian Dollar 1.0047
  1.0456
  1.0526
  1.1203
  1.0185
  1.00503
  1.0638
  1.1281

The Company's FFECs represent agreements with an intermediary to trade a specified amount of U.S. dollars for Canadian dollars at a specific rate on a specific date. Currently, the date is between one and two years after the date on which the FFEC is booked. The specific rate entered into is not necessarily indicative of what either the intermediary or Reko believes the foreign exchange rate will be on the date the settlement of the trade occurs, rather it is a rate set by the intermediary which Reko can either accept or reject.

During the second quarter, the Company recorded a pre-tax gain of approximately $184 related to the fair value of its U.S. dollar exposures, as compared to a pre-tax gain of $68 in the prior year's second quarter. For the six months ended January 31, 2011, the Company recorded a pre-tax gain of $316 related to the fair value of its U.S. dollar exposures, as compared to a pre-tax gain of $350, in the same period of the prior year. These foreign exchange gains or losses are reported as part of our sales.

At the end of the second quarter of fiscal 2011, we held FFECs of $25,000 compared to $26,200 at the end of the second quarter of fiscal 2010. During the second quarter of fiscal 2011, on average, we have had $27,000 of FFECs outstanding monthly, compared to $26,400 during the same period as in the prior year.

The following table outlines the level of FFECs presently maintained and the average effective rate of these contracts:

     
  Contract value Effective average
Fiscal Period booked (000's) rate
Q3 – 2011 $ 25,000 1.0450
Q4 – 2011 $ 18,000 1.0408
Q1 – 2012 $ 12,000 1.0378
Q2 - 2012 $ 7,000 1.0386

The Company notes that at current levels of FFECs and U.S. dollar denominated assets and liabilities, an decrease in the value of the U.S. dollar against the Canadian dollar results in the Company recording losses and an decrease in the value of the Canadian dollar against the U.S. dollar results in financial gains for the Company.

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

RESULTS OF OPERATIONS

Sales

Sales for the three months ended January 31, 2011 decreased $277, or 3.2%, to $8,518 compared to $8,795 in fiscal 2010.

The decrease in sales was largely related to:

- Delays in kick-offs of new vehicle launches by our OEM and Tier 1 customers; and,

- Lower sales dollars earned per hour of work on our automotive work as compared to our original budgets.

These factors were partially offset by:

- The slow economic recovery and its improved impacts on the demand for capital equipment, particularly in the aerospace industry; and,

- Changes in the fair value of U.S. dollar assets and liabilities, as described above.

Sales for the six months ended January 31, 2011 increased $310, or 1.7%, to $18,360 compared to $18,050 in the same period last year. The increase in sales for the six month period was largely related to:

- The slow economic recovery and its improved impacts on the demand for capital equipment, particularly in the aerospace industry;

- Increases in the awards we are sourced, which we out-source, often in off-shore markets;

- Sales generated in a new industry segment – aerospace; and,

- Changes in the fair value of U.S. dollar assets and liabilities, as described above.

Gross profit

The gross profit for the three months ended January 31, 2011 increased $1,066 to $455 or 5.3% of sales, compared to a gross loss of $611, or 7.0% of sales, in the same period in the previous fiscal year.

The increase in gross profit was largely related to:

- Lower wages and benefit costs in the current year, as a result of the restructuring initiatives taken in the prior year;

- Changes in the fair value of U.S. dollar assets and liabilities; and,

- Extremely low work volumes that were insufficient to absorb our then fixed overhead costs in the prior year.

These factors were partially offset by:

- The re-allocation of the valuation allowance associated with our SR&ED tax credits, discussed above. Absent this re- allocation of valuation allowances, Reko would have reported gross profit of $730, or 8.6% of sales, in the second quarter ended January 31, 2011.

The gross profit for the six months ended January 31, 2011 increased $1,303 to $835, or 4.5% of sales, compared to a gross loss of $468, or 2.6% of sales, for the same period in the prior year, primarily for the same reasons identified above. Absent the re-allocation of valuation allowances, Reko would have reported gross profit of $1,385, or 7.5% of sales, in the six months ended January 31, 2011.

Selling and administration

Selling and administration expenses ("S,G&A") decreased by $80, or 5.1%, to $1,491, or 17.5% of sales for the three months ended January 31, 2011, compared to $1,571, or 17.9% of sales for the same period in the prior year.

The decrease in S,G&A was largely related to:

- Decreases in bad debts; and,

- Decreases in travel and promotion costs.

These factors were partially offset by:

- Increases in restructuring costs, as described above; and,

- Increases in accounts receivable insurance, as our customer base strengthens and portions of them are again eligible to be insured.

S,G&A for the six months ended January 31, 2011 decreased $47, or 1.5%, to $2,987, or 16.3% of sales, compared to $3,034, or 16.8% of sales, in the same period in the prior year, primarily as a result of the reasons identified above.

Earnings overview

Net loss for the three months ended January 31, 2011 was $1,256, or $0.20 per share, compared to a net loss of $1,867, or $0.29 per share, in the same period of the prior year.

Net loss for the six months ended January 31, 2011 was $2,541 or $0.40 per share, compared to a net loss of $3,044, or $0.47 per share, in the same period of the prior year.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow provided by operations increased $550 from $418 for the second quarter last year compared to $968 in the current year. The increase in cash flow from operations is primarily a result of:

- Decrease in the net loss offset by non-cash charges, including but not limited to amortization, future income taxes and SR&ED tax credits; and,

- Increased collections on our accounts receivable balances during the quarter.

For the six months ended January 31, 2011, cash flow from operations decreased by $4,054 to cash used in operating activities of $1,185 from cash provided by operating activities of $2,869. The decrease in cash flow from operations is primarily a result of:

- Decrease in the net change in non-cash working capital balances.

This factor was partially offset by:

- Decrease in the net loss offset by non-cash charges, including but not limited to amortization, future income taxes and SR&ED tax credits.

Financial covenants

The Company met all of its financial covenants during the second quarter of 2011. The Company's current financial forecasts suggest that it will earn sufficient levels of EBITDA to meets its minimum monthly EBITDA covenant for the third quarter of 2011, the only period for which the covenant is already set. Despite the Company's current forecasts suggesting the Company will achieve this financial covenant, the Company is exposed to a number of risks that could prevent it from achieving its primary lender defined monthly minimum EBITDA covenant.

         
  Payments due by period
Contractual obligations Total Less than 1 year 1 – 3 years 4 – 5 years After 5 years
Long-term debt $ 13,195 $ 11,966 $ 1,229 $ -- $ --
Capital lease obligations   403   323   80   --   --
Operating leases   1   1   --   --   --
Purchase obligations   --   --   --   --   --
Other long-term obligations   --   --   --   --   --
Total contractual obligations $ 13,599 $ 12,290 $ 1,309 $ -- $ --

Capital assets and investment spending

For the three months ended January 31, 2011, the Company invested $87 in capital assets. The entire amount of this spending is considered maintenance capital expenditures intended to refurbish or replace assets consumed in the normal course of business.

For the six months ended January 31, 2011, the Company invested $166 in capital assets. The entire amount of this spending is considered maintenance capital expenditures intended to refurbish or replace assets consumed in the normal course of business.

Cash resources/working capital requirements

As at January 31, 2011, Reko had borrowed $15,088 on its revolving line of credit, compared to $15,725 at October 31, 2010 and $8,227 at January 31, 2010. The revolver borrowings decreased by approximately $637 in the quarter and increased approximately $6,861 in the past year. We expect borrowings to display a mid-term trend of decreasing over the next two quarters, followed by an increasing trend over the next two quarters thereafter.

Reko has a $20,000 revolver available to it; however, based on our current lender defined margining capabilities, our borrowings are limited to $16,911 of which approximately $1,823 was unused and available at January 31, 2011. 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 monthly EBITDA target.

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 January 31, 2011. During the second quarter, Reko did not grant any options and existing option holders did not exercise any options.

Outstanding share data

         




Designation of security
 



Number outstanding
  Maximum number
issuable if convertible,
exercisable or
exchangeable for
common shares
Common shares   6,420,920    
Stock options issued   83,000    
Stock options exercisable   73,000    
Total (maximum) number of common shares       6,493,920

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 2010, 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 2011.

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 second quarter of fiscal 2011, ended January 31, 2011. 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 MD&A 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.

   
  Apr/09   July/09   Oct/09   Jan/10  
Sales $ 14,791   $ 10,128   $ 9,255   $ 8,794  
Net income (loss)   240     (1,353 )   (1,177 )   (1,867 )
Earnings (loss) per share:                        
  Basic   0.05     (0.20 )   (0.18 )   (0.29 )
  Diluted   0.05     (0.20 )   (0.18 )   (0.29 )
                         
    Apr/10     Jul/10     Oct/10     Jan/11  
Sales $ 9,329   $ 12,773   $ 9,841   $ 8,518  
Net income (loss)   (2,269 )   (2,156 )   (1,287 )   (1,256 )
Earnings (loss) per share:                        
  Basic   (0.36 )   (0.33 )   (0.20 )   (0.20 )
  Diluted   (0.36 )   (0.33 )   (0.20 )   (0.20 )

NORMAL COURSE ISSUER BID

The Company does not currently have an open normal course issuer bid.

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. Instead it will report its financial results using IFRS. This change affects all entities that are considered publicly accountable entities. Reko is considered a publicly accountable entity due to its listing on the TSX Venture 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;

- Educated its primary accounting staff on the differences between GAAP and IFRS;

- Concentrated its efforts on those portions of IFRS that are different than GAAP;

- Identified those business processes that have the potential for amendment to properly transition to IFRS;

- Finalized its policy selections both on conversion and post conversion; and,

- Evaluated new financial statement disclosure.

As a result of this analysis, management has determined that the following financial statement line items will be impacted by the conversion to IFRS:

- Capital assets – on conversion to IFRS, Reko will need to revalue its capital assets. Reko is currently collecting information before deciding whether this revaluation will be based on fair value assessments or reconsideration of prior year amortization. At the present time, insufficient information is available to determine whether or not the revaluation of our capital assets will result in an increase or decrease in their net book value and whether or not the amount will be material;

- Current portion of deferred income taxes – under IFRS, there is no requirement nor is it allowed, to calculate and present the current portion of deferred income taxes (that portion of deferred income taxes expected to be recognized in the current year) as part of an entity's financial statements. Accordingly, Reko advises that the current portion of its deferred income taxes will be reduced to $Nil on conversion to IFRS. This reduction to $Nil, will impact the amount of the Company's current assets in future periods and any financial ratios or covenants that include the calculation of current assets;

- Deferred income taxes – on conversion to IFRS, Reko will need to revalue its capital assets. As a result of revaluing its capital assets, Reko will also revalue its deferred income taxes as it relates to its capital assets. At the present time, insufficient information is available to determine whether or not the revaluation of deferred income taxes will be material and whether deferred income taxes will increase or decrease as a result;

- Contributed surplus – on conversion to IFRS, Reko will need to revalue its contributed surplus as a result of timing differences in the recognition of stock compensation expenses. Until August 1, 2011, Reko is unable to calculate the exact amount of this adjustment. As a result of this adjustment, Reko anticipates its contributed surplus will increase however it does not expect the amount to be material;

- Retained earnings – as a result of all of the above items, Reko's opening retained earnings on conversion to IFRS will change to reflect the cumulative impact of each of the above items; and,

- Amortization expense – on conversion to IFRS, Reko will revalue its capital assets. As a result of this revaluation, Reko's expected amortization expense will increase or decrease, in similar proportion and direction with the increase or decrease in the revaluation of its capital assets. As indicated in our discussion on capital assets, insufficient information is available to determine whether amortization expenses in the future will increase or decrease or whether it is by a material amount or not upon conversion to IFRS.

Going forward, management is concentrating on the quantification of the impact of the changes to the financial statements in preparation for our conversion to IFRS on August 1, 2011.

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 2010 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.

Neither TSX Venture Exchange nor its Regulation Services Provider (as that term is defined in policies of the TSX Venture Exchange) accepts responsibility for the adequacy or accuracy of this release.

Contact Information

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