Reko International Group Inc.
TSX VENTURE : REK

Reko International Group Inc.

June 29, 2011 15:43 ET

Reko Announces Third Quarter Results for Fiscal 2011

WINDSOR, ONTARIO--(Marketwire - June 29, 2011) - Reko International Group Inc. (TSX VENTURE:REK) today announced results for its third quarter ended April 30, 2011.

Financial Highlights (complete statements follow):

Three MonthsNine Months
(unaudited)(unaudited)
Fiscal 2011Fiscal 2010Fiscal 2011Fiscal 2010
Sales$11,257$9,329$29,617$27,379
Net loss(6,659)(2,269)(9,200)(5,313)
EPS basic(1.04)(0.36)(1.44)(0.83)
Working capital6,58511,507
Shareholders' equity26,96038,311
Shareholders' Equity per Share4.205.97

Consolidated sales for the quarter ended April 30, 2011, were $11.3 million, compared to $9.3 million in the prior year, an increase of $2.0 million or 20.7%. The increase in sales in the quarter related to additional work at all of our facilities. Consolidated sales for the nine months ended April 30, 2011, were $29.6 million, compared to $27.4 million in the prior year, an increase of $2.2 million.

The gross profit for the three months ended April 30, 2011 was $0.7 million, or 5.8% of sales, compared to a gross loss of $0.5 million in the prior year. The increase in gross profit over the prior year is related to increased sales in the quarter and lower wage and benefit costs. The gross profit for the nine months ended April 30, 2011, was $1.5 million, or 5.0% of sales, compared to a gross loss of $0.9 million in the prior year.

During the quarter, Reko increased the valuation allowance associated with its SR&ED tax credits by $0.4 million, while also decreasing the valuation allowance associated with its Canadian non-capital loss carry-forwards by the same amount. This had the effect of reducing Reko's gross profit by $0.4 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 April 30, 2011 would have been $1.0 million, or 9.3% of sales. For the nine months ended April 30, 2011, Reko made the same adjustment but in the amount of $1.0 million. Absent this adjustment of valuation allowances, Reko's gross profit for the nine months ended April 30, 2011 would have been $2.4 million, or 8.2% of sales.

Selling and administrative expenses for the three months ended April 30, 2011 were $1.5 million, or 13.8% of sales, compared to $1.4 million, or 15.3% sales, in the prior year. Selling and administrative expenses for the nine months ended April 30, 2011, were $4.5 million, the same amount as in the prior year.

The adjusted net loss for the quarter was $1.0 million or $0.16 per share, compared to $2.3 million or $0.36 per share, in the same period of the prior year. Adjusted net loss for the nine months ended April 30, 2011was $3.6 million or $0.55 per share, compared to $5.3 million or $0.83 per share. The Company notes that adjusted net loss is not a measure of financial performance under Canadian GAAP. Please refer to the first page of our MD&A for a definition of this measure.

Net loss for the quarter was $6.7 million or $1.04 per share, while the net loss for the nine months ended April 30, 2011, was $9.2 million or $1.44 per share.

"The necessity of our business transformation project is evident in our third quarter results," stated Diane St. John, Reko's C.E.O. "Even though we experienced increased sales and gross margins over the prior year due to operational improvements, the adjusted net loss for the quarter is still unacceptable at over $1 million. Once our business transformation project is complete, I expect significant operational improvement from having everything under one roof. The operational improvement coupled with lower overhead cost should allow Reko to become a profitable and stronger company."

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.
Third Quarter Report
INTERIM CONSOLIDATED BALANCE SHEETS
As at April 30, 2011 with comparative figures for July 31, 2010 (in 000's)
April 30,July 31,
(unaudited)(audited)
20112010
ASSETS
Current
Cash and cash equivalents$--$1,303
Accounts receivable13,44510,657
Other receivables755367
Non-hedging financial derivatives1,870591
Income taxes receivable--22
Work-in-progress11,43319,826
Prepaid expenses and deposits790536
28,29333,302
Capital assets26,53932,825
Future income taxes2,5302,814
SR & ED tax credits3,7584,460
$61,120$73,401
LIABILITIES
Current
Bank indebtedness$12,920$14,292
Accounts payable and accrued liabilities6,7606,201
Current portion of long-term debt2,02812,678
21,70833,171
Long-term debt11,0511,925
Future income taxes1,4012,149
SHAREHOLDERS' EQUITY
Share capital18,77218,772
Contributed surplus1,7541,750
Retained earnings6,43415,634
26,96036,156
$61,120$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 nine months ended April 30, 2011 with comparative figures for April 30, 2010 (in 000's except per share data)
For the three months ended April 30,For the nine months ended April 30,
(unaudited)(unaudited)
2011201020112010
Sales$11,257$9,329$29,617$27,379
Costs and expenses
Cost of sales9,6868,79225,34125,050
Selling and administrative1,5481,3774,5354,411
Amortization9221,0202,7923,280
12,15611,18932,66832,741
Loss before the following(899)(1,860)(3,051)(5,362)
Interest on long-term debt210246656787
Interest on other interest bearing obligations, net199117612333
4093631,2681,120
Loss before income taxes and other items(1,308)(2,223)(4,319)(6,482)
Asset impairment3,400--3,400--
Business transformation project expenses2,215--2,215--
5,615--5,615--
Loss before income taxes(6,923)(2,223)(9,934)(6,482)
Future income taxes (recovered) expense(264)46(734)(1,169)
Net loss and comprehensive loss(6,659)(2,269)(9,200)(5,313)
Retained earnings, beginning of period13,09320,05915,63423,103
Net loss(6,659)(2,269)(9,200)(5,313)
Retained earnings, end of period$6,434$17,790$6,434$17,790
Loss per common share
Basic$(1.04)$(0.36)$(1.44)$(0.83)
Diluted$(1.04)$(0.36)$(1.44)$(0.83)
See accompanying notes to the interim consolidated financial statements
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months and nine months ended April 30, 2011 with comparative figures for April 30, 2010 (in 000's)
For the three months ended April 30,For the nine months ended April 30,
(unaudited)(unaudited)
2011201020112010
OPERATING ACTIVITIES
Net loss for the period$(6,659)$(2,269)$(9,200)$(5,313)
Adjustments for:
Amortization9221,0202,7923,280
Asset impairment3,400--3,400--
Business transformation expenses2,215--2,215--
Unrealized foreign exchange loss (gain) on
foreign tax losses210--270--
Future income taxes(264)46(734)(1,169)
SR&ED credits320(65)70210
Loss (gain) on sale of capital assets--(2)27(18)
Stock option expense1147
145(1,269)(524)(3,203)
Net change in non-cash working capital2,5691,4652,0503,150
Cash provided by (used in) operating activities2,7141961,526(53)
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from (net payments on) bank indebtedness(2,169)1,169(1,372)(20)
Payments on long-term debt(518)(1,171)(1,524)(2,778)
Cash used in financing activities(2,687)(2)(2,896)(2,798)
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in capital assets(27)(196)(190)(769)
Proceeds on sale of capital assets--2257536
Cash (used in) provided by investing activities(27)(194)67(233)
Net change in cash and cash equivalents----(1,303)(3,084)
Cash and cash equivalents, beginning of period----1,3033,084
Cash and cash equivalents, end of period$--$--$--$--
See accompanying notes to the interim consolidated financial statements
Notes to unaudited interim consolidated financial statements for the three and nine months ended April 30, 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.

Principles of consolidation

The unaudited consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, Reko Tool & Mould (1987) Inc., Reko International Holdings, Inc. and Reko International Sales, Inc. and its 50% membership interest in Reko Global Services, LLC ("RGS"). All material inter-company accounts and transactions with wholly-owned subsidiaries have been eliminated on consolidation.

During the quarter, the Company began reporting financial results from its 50% membership interest in RGS, using proportional consolidation.

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 in the current quarter announced a business transformation project that involves disposing of surplus assets with a net book value of $3,328. The financial losses pose challenges to the Company's continued operations and its ability to meet its obligations as they fall due. Management is actively addressing this condition, 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, its ability to manage its cost structure based on changing market and economic conditions and the success of its business transformation project.

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 and its business transformation project.

The Company's quarterly adjusted net losses, after reaching a peak of $2,266 in the third quarter of fiscal 2010 have declined in each of the past three quarters to the current level of $1,044.

Continued support of its primary lender

The Company needs to maintain the continued support of its primary lender, through the lender's 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 the lender's 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 a strategy of analyzing 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 April 30, 2011, the Company's monthly EBITDA target is established for the months of May, June and July 2011. During the month of June, the primary lender will establish the monthly EBITDA target for the months of August, September and October 2011.

Renewal of the mortgage

Subsequent to the end of the quarter, the Company renewed its mortgage. The Company's renewed mortgage is amortized over 10 years, with a 2 year term and bears interest at 580 basis points above the 90 day bankers' acceptance rate, adjusted every 90 days. As a result of the renewal of the mortgage, the Company reclassified $10,051 from current portion of long-term debt to long-term debt.

Business transformation project

During the quarter, the Company announced a business transformation project that will substantially reduce the Company's manufacturing capacity associated with building plastic injection molds, a change in strategic direction for the Company to reduce its reliance on low margin business opportunities. The project will ultimately cost the Company approximately $7,500, of which $5,215 has already been recognized in these unaudited consolidated financial statements. Part of the capacity reduction involves disposing of real estate, with a current net book value of $1,978 and machinery and equipment, with a current net book value of $1,350 after recognition of the impairment of $3,000 on these assets.

Further information related to liquidity risks is provided in Note 7 to these interim consolidated financial statements.

While the Company believes that the necessary steps are being taken with respect to eliminating its operating losses, and that the business transformation project will be successful, the outcome of these matters cannot be predicated at this time. However, the ongoing support of Reko's primary lender is crucial to the future of the Company.

3.Share capital

The Company had 6,420,920 common shares outstanding at April 30, 2011. During the quarter, 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 April 30, 2011 was $1.

5.Business transformation project

The Company announced on April 28, 2011, a business transformation project that will enhance its competitive position in North America and build a solid foundation for future profitability. The project will place greater emphasis on its custom machining operations, reduce fixed costs and eliminate capacity in its plastic injection mold building operations.

The project will result in the closure of 7 manufacturing plants at two industrial sites, elimination of a portion of the Company's machining capacity, related to plastic injection molds and involve an employee head count rationalization. The Company anticipates completing all of the steps associated with implementing the business transformation project by July 31, 2011 and anticipates completing all non-strategic business asset divestitures associated with the plan by the end of its 2013 fiscal year. As a result of the project, the Company anticipates realizing $7,500 annually in improvements to its overhead cost structure, comprised of $4,000 related to fixed costs and $3,500 related to labour costs, and a reduction in its annual debt service costs to $2,300.

During the quarter, the Company recorded a severance charge of $2,215 related to its business transformation project. The Company included this amount in its income statement as Business transformation project expenses and on its balance sheet as Accounts payable and accrued liabilities.

The following is a summary of the amounts accrued and paid relating to restructuring costs:

For the three months ended April 30, 2011
Opening balance$--
Severance costs charged to expenses2,215
Cash payments--
$2,215

During the quarter, the Company recorded a $3,000 impairment of its capital assets used in the production of its plastic injection mold building and a $400 impairment of its capital assets used in its custom machining operations. The assets were determined to be impaired as a result of the Company's decision to implement its business transformation project and dispose of certain of its capital assets. The fair value of the capital assets to be disposed is based on an appraisal from an independent appraiser.

6. Reko Global Services, LLC

During the quarter, the Company began reporting financial results of its 50% membership interest in RGS, using proportional consolidation. At the end of the quarter, the following balances relate to the entity reporting under proportional consolidation.

Current assets229,786
Current liabilities129,885
Revenue470,404
Expenses370,503
Net income99,901
Cash flow from operating activities213,477

7. 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:

April 30, 2011July 31, 2010
$$
Held for trading financial assets
Cash and cash equivalents$--$1,303
Non-hedging financial derivatives1,870591
$1,870$1,894
Held for trading financial liabilities
Bank indebtedness$12,920$14,292
Loans and receivables
Accounts receivable$13,445$10,657
Other receivables755367
$14,200$11,024
Other financial liabilities
Accounts payable and accrued liabilities$6,760$6,201
Current portion of long-term debt2,02812,678
Long-term debt11,0511,925
$19,839$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 $13,079. Based on current interest rates for debt with similar terms and maturities, the fair value of the long-term debt is estimated to be $13,071.

Impairment losses recognized on trade receivables

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

April 30, 2011
Opening allowance for doubtful accounts638
Less: write-off of allowance and receivables(14)
Plus: bad debt expense47
Plus: effect of foreign exchange on U.S. denominated balances(20)
651

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 April 30, 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 April would, assuming all other variables remain constant, have increased net income by $36, 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 April 30, 2011, the Company had entered into foreign exchange contracts to sell an aggregate amount of $23,000 (USD). These contracts hedge our expected exposure to U.S. dollar denominated net assets and mature at the latest on May 16, 2012, at an average exchange rate of $1.0311 Canadian. The mark-to-market value on these financial instruments as at April 30, 2011 was an unrealized gain of $1,870; the change in this value from January 30, 2011 has been recorded in net loss for the quarter.

As at
April 30, 2011
MaturityNotional
value
Average
rate
Notional
USD
equivalent
Carrying &
fair
value
asset
(liability)
Sell USD / Buy CAD0 – 6 months$14,087$1.0361$13,000$1,087
Sell USD / Buy CAD7 – 12 months10,2401.03219,500740
Sell USD / Buy CAD12 – 24 months5430.985150043
$24,870$1.0311$23,000$1,870
As at
July 31, 2010
MaturityNotional
value
Average
rate
Notional
USD
equivalent
Carrying &
fair
value
asset
(liability)
Sell USD / Buy CAD0 – 6 months$11,216$1.0640$10,800$416
Sell USD / Buy CAD7 – 12 months7,1991.05907,000198
Sell USD / Buy CAD13 – 24 months6,9761.03407,000(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 April 30, 2011, $12,920 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 April 30, 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 $16, 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 within the last few years, 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 for individual customers.

For the three months ended, April 30, 2011, sales to the Company's three largest customers represented 36% of its total sales. These same customers represent approximately 16% of its total accounts receivable, as at April 30, 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 April 30, 2011, the Company has undrawn lines of credit available to it of approximately $7,080 however, under its current margining provisions with its lender, the maximum it can draw on its available undrawn lines of credit is limited to $2,023.

The Company met all of its financial covenants at the end of the third 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 fourth 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.

8. 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 April 30, 2011, the above capital management criteria can be illustrated as follows:

April 30, 2011July 31, 2010
$$
Net debt
Bank indebtedness12,92014,292
Current portion of long-term debt2,02812,678
Long-term debt11,0511,925
Less: cash and cash equivalents--(1,303)
Net debt25,99927,592
Shareholders' equity26,96036,156
Ratio0.960.76

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 divided by current liabilities. The monthly covenant is a minimum EBITDA target.

9.Purchase commitments

As part of the Company's business transformation project, it has entered into purchase commitments of $500, subsequent to April 30, 2011.

10.Subsequent event

Subsequent to April 30, 2011, the Company renewed its mortgage payable. The original mortgage payable was entered into in 2006, had a 15-year amortization, a 5-year term and bore interest at 6.26%. The renewed mortgage has a 10-year amortization, a 24 month term and bears interest at the 90 day Bankers' Acceptance rate plus 580 basis points. The mortgage is repayable at $123 monthly, including interest, due in full in July 2013, secured by land and buildings and a second position on a general assignment of book debts and work-in-progress. The long-term portion of the mortgage has been reclassified from current portion of long-term debt to long-term debt.

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 April 30, 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 April 30, 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) and adjusted net loss r, which are not measures of financial performance under Canadian GAAP. The Company calculates gross profit (loss) as sales less cost of sales (including depreciation and amortization). The Company calculates adjusted net loss as net income (loss) plus business transformation project expenses. 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 June 28, 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 custom machining of very large castings and assemblies to high precision tolerances, specialty machines and lean cell factory automation, compression molds, hydroform dies, plastic injection molds, fixtures and gauges. 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 concepts, designs and builds innovation solutions to manufacturing challenges, including specialty machines for gas tank assembly lines, work cell solutions for compression molds, repair of CNC machines, plastic secondaries, as well as compression molds, hydroform dies, two shot molds and plastic injection molds. Reko has extensive experience and knowledge in mold design and material flow and the impact of pressure on segments of the mold/die. 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 three industrial sites in the suburbs of the City of Windsor in Southwestern Ontario. The Company recently announced it would be shrinking its manufacturing footprint to two manufacturing plants.

BUSINESS TRANSFORMATION PROJECT

The Company announced, on April 28, 2011, a business transformation project that will enhance its competitive position in North America and build a solid foundation for future profitability. The project will place greater emphasis on its custom machining operations, reduce fixed costs and eliminate capacity in its plastic injection mold building operations.

The project will result in the closure of 7 manufacturing plants at two industrial sites, elimination of a portion of the Company's machining capacity, related to plastic injection molds and involve an employee head count rationalization. The Company anticipates completing all of the steps associated with implementing the business transformation project by July 31, 2011 and anticipates completing all non-strategic business asset divestitures associated with the plan by the end of its 2013 fiscal year. As a result of the project, the Company anticipates realizing $7.5 million annually in improvements to its overhead cost structure, comprised of $4 million related to fixed costs and $3.5 million related to labour costs, and a reduction in its annual debt service costs to $2.3 million.

In order to implement the project, the Company will take $7.5 million in after-tax charges over the next two fiscal years. In the current quarter, the Company took a $3 million charge related to the write-down of non-strategic business assets, which the Company recorded as asset impairment, and a $2.2 million charge related to severance associated with adopting the plan, which the Company recorded as business transformation project expenses. Over the next two years, the Company will incur $1.6 million of carrying costs associated with its real estate, while it is held for sale. In the next fiscal quarter, the Company will incur $0.5 million of moving costs associated with implementing the project. Finally, the Company anticipates it will incur $0.2 million of asset restoration costs, which it will expense as part of the disposition costs of the real estate being held for sale. At April 30, 2011, the Company had not paid any amounts related to the business transformation project.

The Company does not anticipate a write-down of its real estate. Based on current appraised values for the real estate, Reko anticipates recording an after-tax gain of between $1.7 million and $2.4 million on the sale of real estate. Portions of this gain will be recorded as income as each real estate asset is sold.

The Company anticipates generating $9.5 million in cash as it implements the project. Of the total cash generated $1.3 million relates to the sale of non-strategic business assets, which the Company expects to realize on in the first quarter of 2012. Another $4.2 million relates to the sale of real estate assets, which the Company expects to realize on over the next 27 months. The final $4.0 relates to reductions in working capital associated with plastic injection mold builds, which the Company expects to realize on beginning in the first quarter of 2013.

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.

Success of our business transformation project could have a material impact on our profitability and cash flow

The Company announced a business transformation project on April 28, 2011. The project will be completed before July 31, 2011. The project is expected to have an after-tax cost of $7.5 million offset by a $2 million gain on the sale of real estate. In addition, the project is anticipated to generate $9.5 million of cash and result in a reduced annual debt service cost of $2.3 million. There can be no assurances that the Company will complete the business transformation project during the timeline identified or within the budget established for the project. There can be no assurances that the Company will sell the excess real estate created by the project within the timeframes identified, which may have a material impact on both the proceeds from the sale and the carrying costs associated with the real estate. There can be no assurances that the working capital reduction associated with project will be achieved or that it will be achieved within the timeframe suggested.

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 nine months ended April 30, 2011. The most significant ones 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 them. 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 grant the Company to return operations to 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 continue to improve from the previous two years' financial lows, demand for our customers' products remains below pre-recession levels but above recent weakened demand. 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 difficulty 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 and design releases for vehicle launches have been delayed 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 material, commodity 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 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

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 in the current quarter announced a business transformation project that involves disposing of surplus assets with a net book value of $3,328. The financial losses pose challenges to the Company's continued operations and its ability to meet its obligations as they fall due. Management is actively addressing this condition, as discussed in the following paragraphs:

Operating losses

Reko 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, its ability to manage its cost structure based on changing market and economic conditions and the success of its business transformation project.

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 and its business transformation project.

The Company's quarterly adjusted net losses, after reaching a peak of $2,266 in the third quarter of fiscal 2010 have declined in each of the past three quarters to the current level of $1,044.

Continued support of its primary lender

The Company needs to maintain the continued support of its primary lender, through the lender's willingness to accept reduced financial covenants while Reko 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 the lender's view of the markets in which Reko competes.

To address the continued support of its primary lender, Reko has built and will continue to build a proactive and open relationship with the lender, involving timely and frequent dialogue and a strategy of analyzing 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 April 30, 2011, the Company's monthly EBITDA target is established for the months of May, June and July 2011. During the month of June, the primary lender will establish the monthly EBITDA target for the months of August, September and October 2011.

Renewal of the mortgage

Subsequent to the end of the quarter, Reko renewed its mortgage. The Company's renewed mortgage is amortized over 10 years, with a 2 year term and bears interest at 580 basis points above the 90 day bankers' acceptance rate, adjusted every 90 days. As a result of the renewal of the mortgage, the Company reclassified $10,051 from current portion of long-term debt to long-term debt.

Business transformation project

During the quarter, the Company announced a business transformation project that will substantially reduce the Company's manufacturing capacity associated with building plastic injection molds, a change in strategic direction for the Company to reduce its reliance on low margin business opportunities. The project will ultimately cost the Company approximately $7,500, of which $5,215 has already been recognized in these unaudited consolidated financial statements. Part of the capacity reduction involves disposing of real estate, with a current net book value of $1,978 and machinery and equipment, with a current net book value of $1,350, after recognition of the impairment of $3,000 on these assets.

Further information related to liquidity risks is provided in Note 7 to these interim consolidated financial statements.

While Reko believes that the necessary steps are being taken with respect to eliminating its operating loss and that the business transformation project will be successful, the outcome of these matters cannot be predicted at this time. However, the ongoing support of Reko's primary lender is crucial to the future of the Company.

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 the 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 accounts 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 $400, in the second quarter and $950 for the nine months ended April 30, 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 third quarter of $400 and a corresponding increase in taxes recoverable of $400.

Launch of Reko Global Services, LLC

During the quarter, the Company began recognizing revenue and expenses from its 50% membership interest in Reko Global Services, LLC, using proportional consolidation. The remaining 50% interest in the membership units is owned by an affiliate of Tool-Care US International LLC ("TC"), an unrelated third-party.

During the quarter, the Company recorded $470 in sales and $100 in income before taxes.

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:

Fiscal PeriodTotal U.S. exposure before hedging programmeForward foreign exchange contracts bookedNet exposure to
the U.S. dollar
Q3 – 2011$19,334$23,000$(3,666)
Q2 – 2011$25,320$25,000$320
Q1 – 2011$26,516$28,400$(1,884)
Q4 – 2010$26,050$24,800$1,250

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 April 30,For the nine months ended April 30,
2011201020112010
ActualReko
effective
rate
ActualReko
effective
rate
ActualReko
effective
rate
ActualReko
effective
rate
U.S. Dollar equals Canadian Dollar0.97561.03581.02851.09111.00421.04541.05201.1158

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 third quarter, the Company recorded a pre-tax gain of approximately $461 related to the fair value of its U.S. dollar exposures, as compared to a pre-tax gain of $261 in the prior year's third quarter. For the nine months ended April 30, 2011, the Company recorded a pre-tax gain of $782 related to the fair value of its U.S. dollar exposures, as compared to a pre-tax gain of $611, 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 third quarter of fiscal 2011, we held FFECs of $23,000 compared to $24,100 at the end of the third quarter of fiscal 2010. During the third quarter of fiscal 2011, on average, we have had $26,000 of FFECs outstanding monthly, compared to $25,800 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:

Fiscal PeriodContract value
booked (000's)
Effective
average rate
Q4 – 2011$23,0001.0311
Q1 – 2012$16,0001.0300
Q2 - 2012$10,0001.0328
Q3 - 2012$4,0001.0515

The Company notes that at current levels of FFECs and U.S. dollar denominated assets and liabilities, a decrease in the value of the U.S. dollar against the Canadian dollar results in the Company recording gains and a decrease 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. 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 April 30, 2011 increased $1,928, or 20.7%, to $11,257 compared to $9,329 in fiscal 2010.

The increase in sales was largely related to:

  • The slow economic recovery and its improved impacts on the demand for capital equipment;

  • Improvements in the demand for the Company's products at all of our facilities; and,

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

These factors were partially offset by:

  • 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.

Sales for the nine months ended April 30, 2011 increased $2,238, or 8.2%, to $29,617 compared to $27,379 in the same period last year. The increase in sales for the nine 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 April 30, 2011 increased $1,132 to $649 or 5.8% of sales, compared to a gross loss of $483, or 5.2% 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 $1,049, or 9.3% of sales, in the third quarter ended April 30, 2011.

The gross profit for the nine months ended April 30, 2011 increased $2,435 to $1,484, or 5.0% of sales, compared to a gross loss of $951, or 3.5% 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 $2,434, or 8.2% of sales, in the nine months ended April 30, 2011.

Selling and administration

Selling and administration expenses ("S,G&A") increased by $171, or 12.4%, to $1,548, or 13.8% of sales for the three months ended April 30, 2011, compared to $1,377, or 14.8% of sales for the same period in the prior year.

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

  • Increases in commissions, as our sales volumes increase; and,

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

These factors were partially offset by:

  • Decreases in bad debts;

  • Decreases in wages and benefits; and,

  • Decreases in professional fees, largely related to our declining SR&ED tax credits earned.

S,G&A for the nine months ended April 30, 2011 increased $124, or 2.8%, to $4,535, or 15.3% of sales, compared to $4,411, or 16.1% of sales, in the same period in the prior year, primarily as a result of the reasons identified above.

Earnings overview before financial impacts of business transformation project

Net loss before the impacts of the business transformation project, for the three months ended April 30, 2011 was $1,044, or $0.16 per share, compared to a net loss of $2,269, or $0.36 per share, in the same period of the prior year.

Net loss before the impacts of the business transformation project, for the nine months ended April 30, 2011 was $3,585 or $0.56 per share, compared to a net loss of $5,313, or $0.83 per share, in the same period of the prior year.

Business transformation project

During the quarter, business transformation expenses were $5,215, comprised of $3,000 related to asset impairments and $2,215 related to severance.

Earnings overview

Net loss for the three months ended April 30, 2011, was $6,659, or $1.04 per share.

Net loss for the nine months ended April 30, 2011, was $9,200, or $1.44 per share.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow from operations was $2,714 for the third quarter compared to $196 in the previous 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, business transformation expenses, future income taxes and SR&ED tax credits; and,

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

For the nine months ended April 30, 2011, cash flow from operations increased to $1,526 compared to cash used of $53 in the prior year. The increase in cash flow from operations is primarily a result of:

  • Increased collections on our accounts receivable balances during the quarter; and,

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

This factor was partially offset by:

  • Decrease in the net change in non-cash working capital balances, other than accounts receivable and work-in-progress.

Financial covenants

The Company met all of its financial covenants at the end of the 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 fourth 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 obligationsTotalLess
than
1 year
1 – 3
years
4 – 5
years
After
5 years
Long-term debt$12,740$1,689$11,051$--$--
Capital lease obligations339339------
Operating leases----------
Purchase obligations----------
Other long-term obligations----------
Total contractual obligations$13,079$2,028$11,051$--$--

Capital assets and investment spending

For the three months ended April 30, 2011, the Company invested $27 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 nine months ended April 30, 2011, the Company invested $190 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 April 30, 2011, Reko had borrowed $12,920 on its revolving line of credit, compared to $15,088 at January 31, 2011 and $9,396 at April 30, 2010. The revolver borrowings decreased by approximately $2,168 in the quarter and increased approximately $3,524 in the past year. We expect borrowings to display a mid-term trend of increasing over the next year, as we complete and pay for our business transformation project.

Reko has a $20,000 revolver available to it; however, based on our current lender defined margining capabilities, our borrowings are limited to $14,943 of which approximately $2,023 was unused and available at April 30, 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.

Contractual obligations

As part of the Company's business transformation project, it has entered into purchase commitments of $500, subsequent to April 30, 2011.

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 April 30, 2011. During the third quarter, Reko did not grant any options and existing option holders did not exercise any options.

Outstanding share data

Designation of securityNumber outstandingMaximum
number issuable
if convertible,
exercisable or
exchangeable for
common shares
Common shares6,420,920
Stock options issued74,000
Stock options exercisable64,800
Total (maximum) number of common shares6,485,720

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 third quarter of fiscal 2011, ended April 30, 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.

July/09Oct/09Jan/10Apr/10
Sales$10,128$9,255$8,794$9,329
Net income (loss)(1,353)(1,177)(1,867)(2,269)
Earnings (loss) per share:
Basic(0.20)(0.18)(0.29)(0.36)
Diluted(0.20)(0.18)(0.29)(0.36)
Jul/10Oct/10Jan/11Apr/11
Sales$12,773$9,841$8,518$11,257
Net income (loss)(2,156)(1,287)(1,256)(6,659)
Earnings (loss) per share:
Basic(0.33)(0.20)(0.20)(1.04)
Diluted(0.33)(0.20)(0.20)(1.04)

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 ending 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.

  • Asset impairment – on conversion to IFRS, Reko will revalue its capital assets. 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 the impairment charge and whether or not the amount will be material.

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.

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.
Reko Global Services, LLC

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
    www.rekointl.com