UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 1, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 1-10245 RCM TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter) Nevada 95-1480559 ------ ---------- (State of Incorporation) (I.R.S. Employer Identification No.) 2500 McClellan Avenue, Suite 350, Pennsauken, New Jersey 08109-4613 (Address of principal executive offices) (Zip Code) (856) 486-1777 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES NO X ----- ----- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) YES NO X ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $0.05 par value, 11,566,180 shares outstanding as of November 8, 2005.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES <TABLE> <CAPTION> PART I - FINANCIAL INFORMATION Page Item 1 - Consolidated Financial Statements <S> <C> Consolidated Balance Sheets as of October 1, 2005 (Unaudited) and January 1, 2005 3 Unaudited Consolidated Statements of Income and Comprehensive Income for the Thirty-Nine Weeks Ended October 1, 2005 and Forty Weeks Ended October 2, 5 2004 Unaudited Consolidated Statements of Income and Comprehensive Income for the Thirteen Weeks Ended October 1, 2005 and Thirteen Weeks Ended October 2, 7 2004 Unaudited Consolidated Statement of Changes in Stockholders' Equity for the Thirty-Nine Weeks Ended October 1, 2005 9 Unaudited Consolidated Statements of Cash Flows for the Thirty-Nine Weeks Ended October 1, 2005 and Forty Weeks Ended October 2, 2004 10 Notes to Unaudited Consolidated Financial Statements 12 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 27 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 41 Item 4 - Controls and Procedures 41 PART II - OTHER INFORMATION Item 1 - Legal Proceedings 42 Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 43 Item 6 - Exhibits 44 Signatures 45 </TABLE>
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS October 1, 2005 and January 1, 2005 ASSETS <TABLE> <CAPTION> October 1, January 1, 2005 2005 --------------- --------------- (Unaudited) Current assets <S> <C> <C> Cash and cash equivalents $4,685,236 $2,401,794 Accounts receivable, net of allowance for doubtful accounts of $1,752,000 (October 1, 2005) and $1,862,000 (January 1, 2005), respectively 42,425,510 40,535,949 Restricted cash 8,500,496 8,295,625 Prepaid expenses and other current assets 680,054 1,503,477 Deferred tax assets 4,881,616 4,964,007 --------------- --------------- Total current assets 61,172,912 57,700,852 --------------- --------------- Property and equipment, at cost Equipment and leasehold improvements 9,984,137 9,572,546 Less: accumulated depreciation and amortization 5,724,927 5,153,519 --------------- --------------- 4,259,210 4,419,027 --------------- --------------- Other assets Deposits 161,870 138,158 Goodwill 38,236,841 35,842,896 --------------- --------------- 38,398,711 35,981,054 --------------- --------------- Total assets $103,830,833 $98,100,933 =============== =============== </TABLE> 3 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - CONTINUED October 1, 2005 and January 1, 2005 LIABILITIES AND STOCKHOLDERS' EQUITY <TABLE> <CAPTION> October 1, January 1, 2005 2005 --------------- --------------- (Unaudited) Current liabilities <S> <C> <C> Line of credit $3,900,000 $4,900,000 Accounts payable and accrued expenses 15,599,582 12,242,977 Accrued compensation 5,727,714 6,766,586 Payroll and withheld taxes 576,330 1,099,856 Income taxes payable 4,283,338 3,146,478 --------------- --------------- Total current liabilities 30,086,964 28,155,897 --------------- --------------- Stockholders' equity Preferred stock, $1.00 par value; 5,000,000 shares authorized; no shares issued or outstanding Common stock, $0.05 par value; 40,000,000 shares authorized; 11,560,180 and 11,383,470 shares issued and outstanding at October 1, 2005 and January 1, 2005, respectively 578,009 569,173 Accumulated other comprehensive income 912,649 736,128 Additional paid-in capital 99,186,653 98,290,719 Accumulated deficit (26,933,442) (29,650,984) --------------- --------------- 73,743,869 69,945,036 --------------- --------------- Total liabilities and stockholders' equity $103,830,833 $98,100,933 =============== =============== </TABLE> 4 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Thirty-Nine Weeks Ended October 1, 2005 and Forty Weeks Ended October 2, 2004 (Unaudited) <TABLE> <CAPTION> 2005 2004 -------------- ------------- <S> <C> <C> Revenues $133,796,641 $127,554,978 Cost of services 102,477,944 96,864,263 -------------- ------------- Gross profit 31,318,697 30,690,715 -------------- ------------- Operating costs and expenses Selling, general and administrative 26,045,339 25,649,389 Depreciation 800,561 853,807 Amortization 51,417 -------------- ------------- 26,845,900 26,554,613 -------------- ------------- Operating income 4,472,797 4,136,102 -------------- ------------- Other expenses Interest expense, net of interest income (171,502 ) (351,539 ) Loss on foreign currency transactions (6,701 ) (4,266 ) -------------- ------------- (178,203 ) (355,805 ) -------------- ------------- Income before income taxes 4,294,594 3,780,297 Income taxes 1,577,052 1,349,532 -------------- ------------- Net income 2,717,542 2,430,765 Other comprehensive income Foreign currency translation adjustment 176,521 86,050 -------------- ------------- Comprehensive income $2,894,063 $2,516,815 ============== ============= </TABLE> 5 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME - (Continued) Thirty-Nine Weeks Ended October 1, 2005 and Forty Weeks Ended October 2, 2004 (Unaudited) <TABLE> <CAPTION> 2005 2004 --------------- --------------- <S> <C> <C> Basic earnings per share $.24 $.21 ==== ==== Weighted average number of common shares outstanding 11,407,806 11,315,707 ========== ========== Diluted earnings per share $.23 $.21 ==== ==== Weighted average number of common and common equivalent shares outstanding (includes dilutive securities relating to options of 209,638 and 396,248 in 2005 and 2004, respectively) 11,617,444 11,711,955 ========== ========== </TABLE> 6 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Thirteen Weeks Ended October 1, 2005 and October 2, 2004 (Unaudited) <TABLE> <CAPTION> 2005 2004 -------------- ------------- <S> <C> <C> Revenues $43,390,661 $40,933,476 Cost of services 33,237,445 30,969,538 -------------- ------------- Gross profit 10,153,216 9,963,938 -------------- ------------- Operating costs and expenses Selling, general and administrative 8,710,506 8,322,372 Depreciation 272,709 288,355 Amortization 17,139 -------------- ------------- 8,983,215 8,627,866 -------------- ------------- Operating income 1,170,001 1,336,072 -------------- ------------- Other income (expenses) Interest expense, net of interest income (63,463 ) (118,952 ) Loss (gain) on foreign currency transactions (2,328 ) 3,522 -------------- ------------- (65,791 ) (115,430 ) -------------- ------------- Income before income taxes 1,104,210 1,220,642 Income taxes 387,366 455,128 -------------- ------------- Net income 716,844 765,514 Other comprehensive income Foreign currency translation adjustment 246,203 309,708 -------------- ------------- Comprehensive income $963,047 $1,075,222 ============== ============= </TABLE> 7 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME - (Continued) Thirteen Weeks Ended October 1, 2005 and October 2, 2004 (Unaudited) <TABLE> <CAPTION> 2005 2004 --------------- --------------- <S> <C> <C> Basic earnings per share $.06 $.07 ==== ==== Weighted average number of common shares outstanding 11,451,202 11,315,707 ========== ========== Diluted earnings per share $.06 $.07 ==== ==== Weighted average number of common and common equivalent shares outstanding (includes dilutive securities relating to options of 259,862 and 322,330 in 2005 and 2004, respectively) 11,711,064 11,638,037 ========== ========== </TABLE> 8 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Thirty-Nine Weeks Ended October 1, 2005 (Unaudited) <TABLE> <CAPTION> Accumulated Other Additional Common Stock Comprehensive Paid-in Accumulated Income Capital Deficit Total ------------------------- ----- ------- ------- ----- Shares Amount ------ ------ <S> <C> <C> <C> <C> <C> <C> <C> Balance, January 1, 2005 11,383,470 $569,173 $736,128 $98,290,719 ($29,650,984) $69,945,036 Issuance of stock under employee stock purchase plan 21,460 1,073 79,402 80,475 Exercise of stock options 55,250 2,763 189,532 192,295 Issuance of common stock in connection with acquisition 100,000 5,000 627,000 632,000 Translation adjustment 176,521 176,521 Net income 2,717,542 2,717,542 ----------- ------- --------- ------------ --------- --------- Balance, October 1, 2005 11,560,180 $578,009 $912,649 $99,186,653 ($26,933,442) $73,743,869 ========== ======== ======== =========== ============= =========== </TABLE> 9 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Thirty-Nine Weeks Ended October 1, 2005 and Forty Weeks Ended October 2, 2004 (Unaudited) <TABLE> <CAPTION> 2005 2004 --------------- -------------- Cash flows from operating activities: <S> <C> <C> Net income $2,717,542 $2,430,765 --------------- -------------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 800,561 905,224 Provision for losses on accounts receivable (110,000) 63,000 Changes in assets and liabilities: Accounts receivable (1,762,160) (1,407,988) Restricted cash (204,871) Prepaid expenses and other current assets 806,022 702,240 Deferred tax assets 82,391 Accounts payable and accrued expenses 693,406 (3,506,634) Accrued compensation (1,038,872) 109,893 Payroll and withheld taxes (523,527) 725,765 Income taxes payable 1,136,860 62,568 --------------- -------------- Total adjustments (120,190) (2,345,932) --------------- -------------- Net cash provided by operating activities $2,597,352 $84,833 --------------- -------------- </TABLE> 10 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued) Thirty-Nine Weeks Ended October 1, 2005 and Forty Weeks Ended October 2, 2004 (Unaudited) <TABLE> <CAPTION> 2005 2004 --------------- -------------- Cash flows from investing activities: <S> <C> <C> Property and equipment acquired ($472,170) ($225,861) Working capital acquired at acquisition of subsidiary 732,682 Increase in deposits (23,712) (38,256) --------------- -------------- Net cash provided by (used in) investing activities 236,800 (264,117) --------------- -------------- Cash flows from financing activities: Sale of stock for employee stock purchase plan 80,475 81,611 Exercise of stock options 192,295 175,565 Repayments on line of credit (1,000,000) (2,400,000) --------------- -------------- Net cash used in financing activities (727,230) (2,142,824) --------------- -------------- Effect of exchange rate changes on cash and cash equivalents 176,520 86,050 --------------- -------------- Increase (decrease) in cash and cash equivalents 2,283,442 (2,236,058) Cash and cash equivalents at beginning of period 2,401,794 5,142,499 --------------- -------------- Cash and cash equivalents at end of period $4,685,236 $2,916,441 =============== ============== </TABLE> <TABLE> <CAPTION> Supplemental cash flow information: Cash paid for: <S> <C> <C> Interest expense $257,382 $157,901 Income taxes $524,895 $1,181,377 </TABLE> 11 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. General The accompanying consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). This Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended January 1, 2005. Certain information and footnote disclosures, which are normally included in financial statements prepared in accordance with United States generally accepted accounting principles ("GAAP"), have been condensed or omitted pursuant to SEC rules and regulations. The information reflects all normal and recurring adjustments, that in the opinion of management, are necessary for a fair presentation of the consolidated financial position of the Company and its consolidated results of operations for the interim periods set forth herein. The results for the thirteen and thirty-nine weeks ended October 1, 2005 are not necessarily indicative of the results to be expected for the full year or any portion thereof. 2. Fiscal Year The Company follows a 52/53 week fiscal reporting calendar ending on the Saturday closest to December 31. A 53-week year occurs periodically. The fiscal year ended January 1, 2005 was a 53-week reporting year. The third quarter of 2004, the 2004 fiscal year and the third quarter of 2005 ended on the following dates, respectively: <TABLE> <CAPTION> Period Ending Weeks in Quarter Weeks in Year to Date <S> <C> <C> October 2, 2004 Thirteen Forty January 1, 2005 Thirteen Fifty-Three October 1, 2005 Thirteen Thirty-Nine </TABLE> 3. Use of Estimates and Uncertainties The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. The Company has risk participation arrangements with respect to workers compensation and health care insurance. The amounts included in the Company's costs related to this risk participation are estimated and can vary based on changes in assumptions, the Company's claims experience or the providers included in the associated insurance programs. The Company can be affected by a variety of factors including uncertainty relating to the performance of the U.S. and Canadian economies, competition, demand for the Company's services, adverse litigation and claims, and the hiring, training and retention of key employees. 12
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 4. Acquisition On October 17, 2005, the Company acquired Soltre Technology, Inc., a Delaware Corporation, ("Soltre"), a Los Angeles, California based specialty provider of consulting and technology services. The acquisition was effective as of September 1, 2005, and was accomplished through a stock purchase transaction pursuant to which Soltre, through an exchange of all of its outstanding shares of stock for cash and shares of RCM's common stock, became a wholly-owned subsidiary of the Company. The purchase consideration paid to the former stockholders of Soltre consisted of $1,868,000 cash, 100,000 shares of RCM's common stock, par value $.05, valued at $632,000 and 100,000 of stock options and potential earn-out payments up to $2,400,000 of deferred consideration contingent upon Soltre achieving certain base levels of operating income for each of the three twelve month periods following the purchase. An additional earn-out payment may be made to the former stockholders at the end of each of the three twelve month periods following the purchase, to the extent that operating income exceeds these base levels. The acquisition has been accounted for under the purchase method of accounting. The cost in excess of net assets acquired of $2,394,000 is included in the RCM's Consolidated Balance Sheet as "Goodwill". The Company has not yet completed the process of identifying and valuing any intangible assets acquired in the transaction, and as a result the allocation of the purchase price has not been finalized. The deferred consideration and earnouts, if paid, will be recorded as additional purchase consideration. Earnouts cannot be estimated with any certainty. The following results of operations have been prepared assuming the acquisition had occurred as of the beginning of the periods presented. Those results are not necessarily indicative of results of future operations nor of results that would have occurred had the acquisition been consummated as of the beginning of the periods presented. <TABLE> <CAPTION> Thirty-Nine Forty Thirteen Thirteen Weeks Ended Weeks Ended Weeks Ended Weeks Ended (In thousands, except per October 1, October 2, October 1, October 2, share amounts) 2005 2004 2005 2004 --------------------------- ---------------- ----------------- ---------------- --------------- <S> <C> <C> <C> <C> Revenues $139,408 $130,177 $45,638 $41,932 Operating income 5,250 4,163 1,447 1,421 Net income $3,128 $2,405 $865 $802 Earnings per share $.27 $.21 $.07 $.06 </TABLE> 5. New Accounting Standards In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS" No. 123R (revised 2004), Share-Based Payment, which addresses the accounting for employee stock options. SFAS No. 123R eliminates the ability to account for shared-based compensation transactions using APB 25 and generally would require instead that such transactions be accounted for using a fair value-based method. SFAS No. 123R also requires that tax benefits associated with these share-based payments be classified as financing activities in the statement of cash flow rather than operating activities as currently permitted. SFAS No. 123R becomes effective at the beginning of the next fiscal year after June 15, 2005. Accordingly, the Company is required to apply SFAS No. 123R beginning fiscal quarter ending April 1, 2006. SFAS No. 123R offers alternative methods of adopting this final rule. At the present time, the Company has not yet determined which alternative method it will use. In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 ("FAS 109-1"), "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004, ("AJCA"). The AJCA introduces a special 9% tax deduction on qualified production activities. FAS 109-1 clarifies that this tax deduction should be accounted for as a special tax deduction in accordance with Statement 109. The Company does not expect the adoption of these new tax provisions to have a material impact on the Company's consolidated financial position, results of operations, or cash flows. 13
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 5. New Accounting Standards (Continued) In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107"), to provide further guidance regarding the interaction of the provisions of SFAS 123R and certain SEC rules and regulations. In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections--A Replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS 154 requires retrospective application to prior periods' financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in non-discretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date SFAS 154 is issued. The Company is required to adopt the provision of SFAS 154, as applicable, beginning in fiscal 2006. In June 2005, the FASB's Emerging Issues Task Force reached a consensus on Issue No. 05-6, "Determining the Amortization Period for Leasehold Improvements" ("EITF 05-6"). The guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. The Company does not expect the adoption of EITF 05-6 to have a material impact on the Company's consolidated financial position, results of operations, or cash flows. 6. Line of Credit On May 31, 2002, the Company and its subsidiaries entered into an amended and restated loan agreement, which was further amended on October 17, 2004, with Citizens Bank of Pennsylvania, administrative agent for a syndicate of banks, which provides for a $25 million Revolving Credit Facility (the "Revolving Credit Facility"). Availability of credit under the Revolving Credit Facility is based on 80% of the aggregate amount of accounts receivable for which not more than 90 days have elapsed since the date of the original invoice. Borrowings under the Revolving Credit Facility bear interest at one of two alternative rates, as selected by the Company at each incremental borrowing. These alternatives are: (i) LIBOR (London Interbank Offered Rate), plus applicable margin or (ii) the agent bank's prime rate. All borrowings under the Revolving Credit Facility are collateralized by all of the assets of the Company and its subsidiaries and a pledge of the stock of its subsidiaries. The Revolving Credit Facility also contains various financial and non-financial covenants, such as restrictions on the Company's ability to pay dividends. The Revolving Credit Facility expires in August 2006. The weighted average interest rates under the Revolving Credit Facility for the thirty-nine weeks ended October 1, 2005 and forty weeks ended October 2, 2004 were 6.0% and 2.84%, respectively. The amounts outstanding under the Revolving Credit Facility at October 1, 2005 and January 1, 2005 were $3.9 million and $4.9 million, respectively. At October 1, 2005, the Company had availability for additional borrowing under the Revolving Credit Facility of $21.0 million. 14
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 7. Interest (Expense) Income, Net <TABLE> <CAPTION> Interest (expense) income, net consisted of the following: ------------------------------------------------------------------------- Thirty-Nine Forty Thirteen Weeks Thirteen Weeks Ended Weeks Ended Ended Weeks Ended October 1, 2005 October 2, 2004 October 1, 2005 October 2, 2004 ----------------- ---------------- ------------------ ----------------- <S> <C> <C> <C> <C> Interest expense ($427,722) ($398,844) ($144,203) ($129,466) Interest income 256,220 47,305 80,740 10,514 ----------------- ---------------- ------------------ ----------------- $171,502 ($351,539) ($63,463) ($118,952) ================= ================ ================== ================= </TABLE> 8. Goodwill SFAS 142 requires the Company to perform a goodwill impairment test on at least an annual basis. For purposes of its 2004 annual impairment testing, the Company determined the fair value of its reporting units using relative market multiples for comparable businesses as of November 30, 2004, as well as forecasted operating income and cash flows of each reporting unit and prospects for future recovery. The Company compared the fair value of each of its reporting units to their respective carrying values, including related goodwill. Future changes in the industry could influence the market multiples of comparable businesses, and consequently could influence the results of future annual impairment tests. There were no events in the thirty-nine weeks ended October 1, 2005 that indicated a need to perform the impairment test prior to the Company's annual test date. There can be no assurance that future tests of goodwill impairment will not result in further impairment charges. <TABLE> <CAPTION> Information Professional Commercial Technology Engineering Services Total -------------- ------------- ------------- ------------ <S> <C> <C> <C> <C> Balance as of January 1, 2005 $28,315 $7,528 $35,843 Goodwill acquired during the period 2,394 2,394 -------------- ------------- ------------- ------------ Balance as of October 1, 2005 $30,709 $7,528 $38,237 ======= ====== ======= </TABLE> 15
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 9. Accounts Payable Accounts payable and accrued expenses consisted of the following at October 1, 2005 and January 1, 2005: <TABLE> <CAPTION> October 1, January 1, 2005 2005 --------------- ---------------- (Unaudited) <S> <C> <C> Accounts payable - trade $4,543,025 $4,024,164 Due to sellers 2,663,204 Reserve for litigation 8,393,353 8,218,813 --------------- ---------------- Total $15,599,582 $12,242,977 =============== ================ </TABLE> 10. Stockholders' Equity Common Stock Reserved Shares of unissued common stock were reserved for the following purposes: <TABLE> <CAPTION> October 1, January 1, 2005 2005 -------------- ---------------- (Unaudited) <S> <C> <C> Exercise of options outstanding 1,769,083 1,183,583 Future grants of options 353,486 994,236 -------------- ---------------- Total 2,122,569 2,177,819 ============== ================ </TABLE> 16
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 11. Stock - Based Compensation The Company accounts for stock options under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, which contains a fair value-based method for valuing stock-based compensation that measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. SFAS No. 123 permits entities to continue accounting for employee stock options and similar equity instruments under Accounting Principles Board Opinion ("APB") No. 25 Accounting for Stock Issued to Employees, and related interpretations. Entities that continue to account for stock options using APB No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. As of October 1, 2005, the Company had four stock-based employee compensation plans. Under APB No. 25, Accounting for Stock Issued to Employees, and related interpretations, stock-based employee compensation costs are not reflected in net earnings, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share amounts). <TABLE> <CAPTION> Thirty-Nine Forty Thirteen Weeks Thirteen Weeks Ended Weeks Ended Ended October Weeks Ended October 1, October 2, 2004 1, 2005 October 2, 2005 2004 --------------- ---------------- ---------------- --------------- <S> <C> <C> <C> <C> Net income, as reported $2,718 $2,431 $716 $766 Less: stock-based compensation costs determined under fair value based method for all awards 414 254 286 85 Net income, pro forma $2,304 $2,177 $430 $681 Earnings per share of common stock-basic: As reported $.24 $.21 $.06 $.07 Pro forma $.20 $.19 $.04 $.06 Earnings per share of common stock-diluted: As reported $.23 $.21 $.06 $.07 Pro forma $.20 $.19 $.04 $.06 </TABLE> 17
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 11. Stock - Based Compensation - Continued The pro forma compensation cost using the fair value-based method under SFAS No. 123 includes valuations related to stock options granted since January 1, 1995 using the Black-Scholes Option Pricing Model. The weighted average fair value of options granted using Black-Scholes Option Pricing Model for the thirty-nine weeks and forty weeks ended October 1, 2005 and October 2, 2004, respectively has been estimated using the following assumptions: <TABLE> <CAPTION> Thirty-Nine Weeks Forty Ended Weeks Ended October 1, 2005 October 2, 2004 -------------------- --------------------- <S> <C> <C> Risk-free interest rate 4.2% 4.0% Expected life of option 5 years 5 years Expected stock price volatility 58.6% 60.2% Expected dividend yield - - Weighted-average per share value granted $4.17 $4.86 </TABLE> There were 671,000 options granted during the thirty-nine weeks ended October 1, 2005, none of which were granted in the thirteen weeks ended October 1, 2005. Incentive Stock Option Plans 1992 Incentive Stock Option Plan (the 1992 Plan) The 1992 Plan, approved by the Company's stockholders in April 1992, and amended in April 1998, provided for the issuance of up to 500,000 shares of common stock per individual to officers, directors, and key employees of the Company and its subsidiaries, through February 13, 2002, at which time the 1992 Plan expired. The options issued were intended to be incentive stock options pursuant to Section 422A of the Internal Revenue Code. The option terms were not permitted to exceed ten years and the exercise price was not permitted to be less than 100% of the fair market value of the shares at the time of grant. The Compensation Committee of the Board of Directors determined the vesting period at the time of grant for each of these options. As of October 1, 2005, options to purchase 84,855 shares of common stock were outstanding. 1994 Non-employee Directors Stock Option Plan (the 1994 Plan) The 1994 Plan, approved by the Company's stockholders in May 1994, and amended in April 1998, provided for issuance of up to 110,000 shares of common stock to non-employee directors of the Company through February 19, 2004, at which time the 1994 Plan expired. Options granted under the 1994 Plan were granted at fair market value at the date of grant, and the exercise of options is contingent upon service as a director for a period of one year. Options granted under the 1994 Plan terminate when an optionee ceases to be a director of the Company. As of October 1, 2005, options to purchase 70,000 shares of common stock were outstanding. 1996 Executive Stock Option Plan (the 1996 Plan) The 1996 Plan, approved by the Company's stockholders and amended in April 1999, provides for issuance of up to 1,250,000 shares of common stock to officers and key employees of the Company and its subsidiaries through January 1, 2006. Options are generally granted at fair market value at the date of grant. The Compensation Committee of the Board of Directors determines the vesting period at the time of grant. As of October 1, 2005, options to purchase 332,180 shares of common stock were available for future grants, and options to purchase 826,645 shares of common stock were outstanding. 18
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 11. Stock - Based Compensation - Continued 2000 Employee Stock Incentive Plan (the 2000 Plan) The 2000 Plan, approved by the Company's stockholders in April 2000, provides for issuance of up to 1,500,000 shares of the Company's common stock to officers and key employees of the Company and its subsidiaries or to consultants and advisors utilized by the Company through January 10, 2010. The Compensation Committee of the Board of Directors may award incentive stock options or non-qualified stock options, as well as stock appreciation rights, and determines the vesting period at the time of grant. As of October 1, 2005, options to purchase 21,306 shares of common stock were available for future grants, and options to purchase 787,583 shares of common stock were outstanding. Employee Stock Purchase Plan The Company implemented an Employee Stock Purchase Plan (the "Purchase Plan") with stockholder approval, effective January 1, 2002. Under the Purchase Plan, employees meeting certain specific employment qualifications are eligible to participate and can purchase shares of Common Stock semi-annually through payroll deductions at the lower of 85% of the fair market value of the stock at the commencement or end of the offering period. The purchase plan permits eligible employees to purchase common stock through payroll deductions for up to 10% of qualified compensation. During the thirty-nine weeks ended October 1, 2005 there were 21,460 shares issued under the Purchase Plan for net proceeds of $80,475. As of October 1, 2005, there were 276,439 shares available for issuance under the Purchase Plan. 19
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 12. Segment Information The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for companies to report information about operating segments, geographic areas, and major customers. The adoption of SFAS No. 131 has no effect on the Company's consolidated financial position, consolidated results of operations or liquidity. The accounting policies of each segment are the same as those described in the summary of significant accounting policies (see Note 1). The Company uses earnings before interest and taxes (operating income) to measure segment profit. Segment operating income includes selling, general and administrative expenses directly attributable to that segment as well as charges for allocating corporate costs to each of the operating segments. The following tables reflect the results of the segments consistent with the Company's management system (in thousands <TABLE> <CAPTION> Thirty-Nine Weeks Ended Information October 1, 2005 Technology Engineering Commercial Corporate Total ---------------- --------------- --------------- -------------- -------------- <S> <C> <C> <C> <C> Revenue $73,113 $35,329 $25,355 $133,797 Operating expenses (1) 68,635 35,309 24,580 128,524 ---------------- --------------- --------------- -------------- EBITDA ((2)) 4,478 20 775 5,273 Depreciation 407 277 117 801 ---------------- --------------- --------------- -------------- Operating income (loss) 4,071 (257 ) 658 4,472 Interest expense, net of (interest income) 94 45 33 172 Loss on foreign currency transactions 5 5 Income taxes (benefit) 1,460 (112 ) 229 1,577 ---------------- --------------- --------------- -------------- -------------- Net income (loss) $2,517 ($195 ) $396 $2,718 ================ =============== =============== ============== ============== Total assets $52,173 $21,200 $9,890 $20,568 $103,831 Capital expenditures $158 $25 $289 $472 </TABLE> 20
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 12. Segment Information (Continued) <TABLE> <CAPTION> Forty Weeks Information Ended October 2, 2004 Technology Engineering Commercial Corporate Total --------------- ------------ -------------- ------------- ------------- <S> <C> <C> <C> <C> Revenue $70,439 $38,886 $18,230 $127,555 Operating expenses (1) 67,077 36,861 18,576 122,514 --------------- ------------ -------------- ------------- EBITDA (2) 3,362 2,025 (346 ) 5,041 Depreciation 468 305 81 854 Amortization of intangibles 15 32 4 51 --------------- ------------ -------------- ------------- Operating income (loss) 2,879 1,688 (431 ) 4,136 Interest expense, net of interest income 194 107 51 352 Loss on foreign currency transactions 4 4 Income taxes (benefit) 958 563 (172 ) 1,349 --------------- ------------ -------------- ------------- ------------- Net income (loss) $1,727 $1,014 ($310 ) $2,431 =============== ============ ============== ============= ============= Total assets $50,226 $21,558 $6,254 $19,431 $97,469 Capital expenditures $14 $45 $15 $152 $226 </TABLE> 21
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 12. Segment Information (Continued) <TABLE> <CAPTION> Thirteen Weeks Ended Information October 1, 2005 Technology Engineering Commercial Corporate Total --------------- -------------- -------------- ------------ ------------- <S> <C> <C> <C> <C> Revenue $23,564 $11,188 $8,639 $43,391 Operating expenses (1) 22,114 11,282 8,553 41,949 --------------- -------------- -------------- ------------- EBITDA (2) 1,450 (94 ) 86 1,442 Depreciation 137 93 42 272 --------------- -------------- -------------- ------------- Operating income (loss) 1,313 (187 ) 44 1,170 Interest expense, net of interest income 35 17 12 65 Loss on foreign currency transactions 1 1 Income taxes (benefit) 447 (71 ) 11 387 --------------- -------------- -------------- ------------ ------------- Net income (loss) $831 ($134 ) $21 $718 =============== ============== ============== ============ ============= Total assets $52,173 $21,200 $9,890 $20,568 $103,831 Capital expenditures $56 $25 $81 </TABLE> 22
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 12. Segment Information (Continued) <TABLE> <CAPTION> Thirteen Weeks Ended Information October 2, 2004 Technology Engineering Commercial Corporate Total --------------- -------------- -------------- ------------- ------------- <S> <C> <C> <C> <C> Revenue $22,803 $11,966 $6,164 $40,933 Operating expenses (1) 21,550 11,478 6,256 39,284 --------------- -------------- -------------- ------------- EBITDA (2) 1,253 488 (92 ) 1,649 Depreciation 159 100 29 288 Amortization of intangibles 5 11 1 17 --------------- -------------- -------------- ------------- Operating income (loss) 1,089 377 (122 ) 1,344 Interest expense, net of interest income 66 35 18 119 Loss on foreign currency transactions 4 4 Income taxes (benefit) 381 139 (65 ) 455 --------------- -------------- -------------- ------------- Net income (loss) $642 $199 ($75 ) $766 =============== ============== ============== ============= Total assets $50,226 $21,558 $6,254 $19,431 $97,469 Capital expenditures $14 $45 $15 $74 <FN> (1) Operating expenses excludes depreciation and amortization. (2) EBITDA means earnings before interest income, interest expense, income taxes, depreciation and amortization. We believe that EBITDA, as presented, represents a useful measure of assessing the performance of our operating activities, as it reflects our earnings trends without the impact of certain non-cash charges or income. EBITDA is also used by our creditors in assessing debt covenant compliance. We understand that, although security analysts frequently use EBITDA in the evaluation of companies, it is not necessarily comparable to EBITDA of other companies due to potential inconsistencies in the method of calculation. EBITDA is not intended as an alternative to cash flow provided by operating activities as a measure of liquidity, nor as an alternative to net income as an indicator of our operating performance, nor as an alternative to any other measure of performance in conformity with GAAP. </FN> </TABLE> 23
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 12. Segment Information (Continued) The Company is domiciled in the United States and its segments operate in the United States and Canada. Revenues and fixed assets by geographic area as of and for the thirty-nine weeks ended October 1, 2005 and the forty weeks ended October 2, 2004 are as follows (in thousands): <TABLE> <CAPTION> Thirty-Nine Forty Weeks Ended Weeks Ended October 1, 2005 October 2, 2004 -------------------- ------------------ Revenues <S> <C> <C> U. S. $122,553 $112,266 Canada 11,243 15,289 -------------------- ------------------ $133,796 $127,555 ==================== ================== Fixed Assets U. S. $4,073 $4,260 Canada 186 242 -------------------- ------------------ $4,259 $4,502 ==================== ================== </TABLE> Revenues by geographic area for the thirteen weeks ended October 1, 2005 and October 2, 2004 are as follows (in thousands): <TABLE> <CAPTION> Thirteen Weeks Thirteen Weeks Ended Ended October 1, 2005 October 2, 2004 ------------------ ------------------ Revenues <S> <C> <C> U. S. $39,971 $36,446 Canada 3,419 4,487 ------------------ ------------------ $43,390 $40,933 ================== ================== </TABLE> 24
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 13. Contingencies In late 1998, two shareholders who were formerly officers and directors of the Company filed suit against the Company alleging wrongful termination of their employment, failure to make required severance payments, wrongful conduct by the Company in connection with the grant of stock options, and wrongful conduct by the Company resulting in the non-vestiture of their option grants. The complaint also alleged that the Company wrongfully limited the number of shares of the Company's common stock that could have been sold by the plaintiffs under a registration rights agreement entered into in connection with the underlying acquisition transaction pursuant to which the plaintiffs became shareholders of the Company. The claim under the registration rights agreement sought the difference between the amount for which plaintiffs could have sold their RCM shares during the 12-month period ended March 11, 1999, but for the alleged wrongful limitation on their sales, and the amount for which the plaintiffs sold their shares during that period and thereafter. The claim relating to the wrongful termination of the employment of one of the plaintiffs and the claims of both plaintiffs concerning the grant of stock options were resolved in binding arbitration in early 2002. A trial on the remaining claims commenced on December 2, 2002 and a verdict was returned on January 24, 2003. On the claims by both plaintiffs, concerning the alleged wrongful limitation by the Company of the number of shares that the plaintiffs could sell during the 12-month period ended March 11, 1999, a verdict awarding damages of $7.6 million against the Company was returned. On June 23, 2003, the trial judge denied the Company's post-trial motions that challenged the jury verdict and upheld the verdict. On August 4, 2003, the trial judge entered a judgment in favor of the plaintiffs for $7.6 million in damages and awarded plaintiffs $172,000 in post-verdict pre-judgment interest. Post-judgment interest will continue to accrue on the damages portion of the judgment at the rate of 3% per annum in 2005. The Company has appealed to the Appellate Division of the Superior Court of New Jersey, and obtained a stay pending appeal of, that judgment. In order to secure the stay, the Company made a cash deposit in lieu of bond of $8.3 million with the Trust Fund of the Superior Court of New Jersey. This deposit is recorded as restricted cash on the consolidated balance sheet and earns interest at a rate that approximates the daily federal funds rate. The plaintiffs have cross-appealed from the Court's denial of pre-verdict, pre-judgment interest on the damages portion of the August 4, 2003 judgment and from the Court's refusal to grant judgment as a matter of law to one of the plaintiffs on his claim for severance pay in the amount of $240,000 plus interest. The briefing phase of the appeal was concluded in April 2004 and oral argument was heard on February 15, 2005. The timing of a ruling on the appeal cannot be predicted at this time but is expected in the fourth quarter of 2005. Further appellate proceedings are likely no matter which side prevails in the Appellate Division. In connection with this litigation, the Company accrued $9.7 million of litigation charges at December 31, 2002, which included the jury award of $7.6 million, professional fees of $1.1 million and an estimate of $1.0 million for attorney fees and pre-judgment interest. As of October 1, 2005, the accrued litigation reserve is $8.4 million. 25
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 13. Contingencies - (Continued) In addition, in November 2002 the Company brought suit in the Superior Court of New Jersey, Law Division, Bergen County, on professional liability claims against the attorneys and law firms who served as its counsel in the above-described acquisition transaction and in its subsequent dealings with the plaintiffs concerning their various relationships with the Company resulting from that transaction. In its lawsuit against the former counsel, the Company is seeking complete indemnification with respect to (1) its costs and counsel fees incurred in defending itself against the claims of the plaintiffs; (2) any sums for which the Company is ultimately determined to be liable to the plaintiffs; and (3) its costs and counsel fees incurred in the prosecution of the legal malpractice action itself. That litigation was temporarily stayed in the Law Division while the appeal of the underlying action went forward in the Appellate Division of the Superior Court. On May 16, 2005, the Law Division lifted that stay and pretrial discovery in the legal malpractice action ensued through September 2005. On September 14, 2005, as a consequence of certain procedural constraints imposed by the court, the Company and the various attorney and law firm defendants agreed to the dismissal of the action in Bergen County and the filing of a new action against the same defendants in the Superior Court of New Jersey, Law Division, Morris County. The Company has asserted certain additional claims against the defendants in the complaint for the new action which was filed on October 24, 2005. The Company is also subject to other pending legal proceedings and claims that arise from time to time in the ordinary course of its business, which may or may not be covered by insurance. The litigation and other claims previously noted are subject to inherent uncertainties and management's view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the Company's consolidated financial position and the consolidated results of operations for the period in which the effect becomes reasonably estimable. 26
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Private Securities Litigation Reform Act Safe Harbor Statement Certain statements included herein and in other reports and public filings made by the Company are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements regarding the adoption by businesses of new technology solutions; the use by businesses of outsourced solutions, such as those offered by the Company, in connection with such adoption; the outcome of litigation (at both the trial and appellate levels) involving the Company. Readers are cautioned that such forward-looking statements, as well as others made by the Company, which may be identified by words such as "may," "will," "expect," "anticipate," "continue," "estimate," "project," "intend," "believe," and similar expressions, are only predictions and are subject to risks and uncertainties that could cause the Company's actual results and financial position to differ materially. Such risks and uncertainties include, without limitation: (i) unemployment and general economic conditions affecting the provision of information technology and engineering services and solutions and the placement of temporary staffing personnel; (ii) the Company's ability to continue to attract, train and retain personnel qualified to meet the requirements of its clients; (iii) the Company's ability to identify appropriate acquisition candidates, complete such acquisitions and successfully integrate acquired businesses; (iv) uncertainties regarding pro forma financial information and the underlying assumptions relating to acquisitions and acquired businesses; (v) uncertainties regarding amounts of deferred consideration and earnout payments to become payable to former shareholders of acquired businesses; (vi) possible adverse effects on the market price of the Company's common stock due to the resale into the market of significant amounts of common stock; (vii) the potential adverse effect a decrease in the trading price of the Company's common stock would have upon the Company's ability to acquire businesses through the issuance of its securities; (viii) the Company's ability to obtain financing on satisfactory terms; (ix) the reliance of the Company upon the continued service of its executive officers; (x) the Company's ability to remain competitive in the markets that it serves; (xi) the Company's ability to maintain its unemployment insurance premiums and workers compensation premiums; (xii) the risk of claims being made against the Company associated with providing temporary staffing services; (xiii) the Company's ability to manage significant amounts of information, and periodically expand and upgrade its information processing capabilities; (xiv) the Company's ability to remain in compliance with federal and state wage and hour laws and regulations; (xv) uncertainties in predictions as to the future need for the Company's services; (xvi) uncertainties relating to the allocation of costs and expenses to each of the Company's operating segments; (xvii) the costs of conducting and the outcome of litigation involving the Company, and (xviii) other economic, competitive and governmental factors affecting the Company's operations, markets, products and services. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made. The Company undertakes no obligation to publicly release the results of any revision of these forward-looking statements to reflect these trends or circumstances after the date they are made or to reflect the occurrence of unanticipated events. 27
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Overview RCM participates in a sector that is cyclical in nature and sensitive to economic changes. As a result, the impact of economic changes on revenues and operations can be volatile. After a significant growth and expansion period in the late 1990s for the sector, the U.S. economy experienced a dramatic slowdown, forcing companies to curtail technology spending, consolidate operations, and reduce their demand for services and labor. Because of this slowdown, which began in 2000, RCM's revenues were adversely affected, prompting management to reconsider its business strategy. In response to declining revenues, the Company initiated reductions in its staff personnel and consolidated branches. Since that time, management has continued to monitor its operating cost structure in order to maintain a cost benefit relationship with revenues, while focusing on working capital management and cash flows. These efforts have resulted in an improvement in working capital and tangible net worth. Furthermore, the Company has improved discipline in its marketing and sales strategies by providing a more cohesive and relevant marketing and sales approach to new and existing customers and now focuses on growth in targeted vertical markets, on service offerings providing greater revenue opportunities and on several new business initiatives. With the economy strengthening over the past two years, the sector is beginning to see modest growth. Despite the improved economy, companies have been slow to adapt many technological enhancements. The process of designing, developing and implementing software solutions has become increasingly complex. The Company believes that many companies today are focused on return on investment analysis in prioritizing the initiatives they undertake. This has resulted in delays by clients or potential clients in the awarding of contracts or totally negating spending on many emerging new solutions which RCM management had previously anticipated. Nonetheless, the Company continues to believe that Information Technology ("IT") managers must integrate and manage computing environments, consisting of multiple computing platforms, operating systems, databases and networking protocols, and must implement packaged software applications to support existing business objectives. Companies also need continually to keep pace with new developments, which often render existing equipment and internal skills obsolete. Consequently, business drivers cause IT managers to support increasingly complex systems and applications of significant strategic value, while working under budgetary, personnel and expertise constraints. This has given rise to a demand for outsourcing. The Company believes that its current clients and prospective future clients are continuing to evaluate the potential for outsourcing business critical applications and entire business functions. The Company provides project management and consulting services, which are billed based on either an agreed -upon fixed fee or hourly rates, or a combination of both. The billing rates and profit margins for project management and solutions services are higher than those for professional consulting services. The Company generally endeavors to expand its sales of higher margin solutions and project management services. The Company also realizes revenues from client engagements that range from the placement of contract and temporary technical consultants to project assignments that entail the delivery of end-to-end solutions. These services are primarily provided to the client at hourly rates that are established for each of the Company's consultants based upon their skill level, experience and the type of work performed. The majority of the Company's services are provided under purchase orders. Contracts are utilized on certain of the more complex assignments where the engagements are for longer terms or where precise documentation on the nature and scope of the assignment is necessary. Although contracts normally relate to longer-term and more complex engagements, they do not obligate the customer to purchase a minimum level of services and are generally terminable by the customer on 60 to 90 days' notice. Revenues are recognized when services or deliverables are provided and accepted by the customer. 28
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Overview (Continued) Costs of services consist primarily of salaries and compensation-related expenses for billable consultants, including payroll taxes, employee benefits, and insurance. Selling, general and administrative expenses consist primarily of salaries and benefits of personnel responsible for business development, recruiting, operating activities and training, and include corporate overhead expenses. Corporate overhead expenses relate to salaries and benefits of personnel responsible for corporate activities, including the Company's corporate marketing, administrative and reporting responsibilities and acquisition program. The Company records these expenses when incurred. Depreciation relates primarily to the fixed assets of the Company. Amortization relates to a covenant not to compete resulting from one of the Company's acquisitions. Acquisitions have been accounted for under the purchase method of accounting for financial reporting purposes and have created goodwill. Critical Accounting Policies The financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make subjective decisions, assessments, and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the judgments increases, such judgments become even more subjective. While management believes that its assumptions are reasonable and appropriate, actual results may differ materially from estimates. The Company has identified certain critical accounting policies, described below, that require significant judgment to be exercised by management. Revenue Recognition The Company derives its revenues from several sources. All of the Company's segments perform staffing services. The Company's Engineering Services and Information Technology Services segments also perform project services. The Information Technology Services segment also derives revenue from permanent placement fees. Project Services - The Company recognizes revenues in accordance with the Securities and Exchange Commission SAB No. 104, "Revenue Recognition." SAB No. 104 clarifies application of U.S. generally accepted accounting principles to revenue transactions. Project services are generally provided on a cost-plus-fixed-fee or time-and-material basis. Typically, a customer will outsource a discrete project or activity and the Company assumes responsibility for the performance of such project or activity. The Company recognizes revenues and associated costs on a gross basis as services are provided to the customer and costs are incurred using its employees. The Company, from time to time, enters into contracts requiring the completion of specific deliverables. The Company recognizes revenue on these deliverables at the time the client accepts and approves the deliverables. In instances where project services are provided on a fixed-price basis and the contract will extend beyond a 12-month period, revenue is recorded in accordance with the terms of each contract. In some instances, revenue is billed and recorded at the time certain milestones are reached, as defined in the contract. In other instances, revenue is billed and recorded based upon contractual rates per hour. In addition, some contracts contain "Performance Fees" (bonuses) for completing a contract under budget. Performance Fees, if any, are recorded when the contract is completed and the revenue is reasonably certain of collection. Some contracts also limit revenues and billings to maximum amounts. Provision for contract losses, if any, is made in the period such losses are determined. For contracts where there are multiple deliverables and the work has not been 100% complete on a specific deliverable the costs have been deferred. The associated costs are expensed when the related revenue is recognized. 29
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Revenue Recognition (Continued) Staffing Services - Revenues derived from staffing services are recorded on a gross basis as services are performed and associated costs have been incurred using employees of the Company. In these circumstances, the Company assumes the risk of acceptability of its employees to its customers. In certain cases, the Company may utilize other companies and their employees to fulfill customer requirements. In these cases, the Company receives an administrative fee for arranging for, billing for, and collecting the billings related to these companies. The customer is typically responsible for assessing the work of these companies who have responsibility for acceptability of their personnel to the customer. Under these circumstances, the Company's reported revenues are net of associated costs (effectively the administrative fee). Permanent Placement Services - The Company earns permanent placement fees from providing permanent placement services. Fees for placements are recognized at the time the candidate commences employment. The Company guarantees its permanent placements on a prorated basis for 90 days. In the event a candidate is not retained for the 90-day period, the Company will provide a suitable replacement candidate. In the event a replacement candidate cannot be located, the Company will provide a prorated refund to the client. An allowance for refunds, based upon the Company's historical experience, is recorded in the financial statements. Revenues are recorded on a gross basis as a component of revenue. Accounts Receivable The Company's accounts receivable are primarily due from trade customers. Credit is extended based on evaluation of customers' financial condition and, generally, collateral is not required. Accounts receivable payment terms vary and are stated in the financial statements at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the payment terms are considered past due. The Company determines its allowances by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Goodwill and Intangibles The Company follows SFAS No. 142, "Goodwill and Other Intangible Assets." Accordingly, the Company evaluates the carrying value and recoverability of its goodwill by evaluating the fair market value of the reporting units within which goodwill resides. The process of estimating fair value relies in part on the use of forecasts to estimate future cash flows expected from a reporting unit as well as the use of market multiples in determining fair market value. In order to estimate future cash flows, management must make subjective judgments based on reasonable and supportable assumptions and projections. The periods for estimating future cash flows are uncertain, which increases the risk that actual future results could significantly deviate from estimates. Changes in future market conditions, the Company's strategy or other factors could have an effect upon the future values of these reporting units, which could result in future impairment charges. 30
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Accounting for Stock Options The Company has used stock options to attract, retain, and reward employees for long-term service. Generally accepted accounting principles allow alternative methods of accounting for these awards. The Company has chosen to account for its stock plans (including stock option plans) under APB Opinion No. 25, "Accounting for Stock Issued to Employees." Since option exercise prices reflect the market value per share of the Company's stock upon grant, no compensation expense related to stock options is reflected in the Company's income statement. In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R (revised 2004), Share-Based Payment, which addresses the accounting for employee stock options. SFAS No. 123R eliminates the ability to account for shared-based compensation transactions using APB No. 25 and generally would require instead that such transactions be accounted for using a fair value-based method. SFAS No. 123R also requires that tax benefits associated with these share-based payments be classified as financing activities in the statement of cash flow rather than operating activities as currently permitted. SFAS No. 123R becomes effective for interim or annual periods beginning after December 15, 2005. Accordingly, the Company is required to apply SFAS No. 123R beginning fiscal quarter ending April 1, 2006. SFAS No. 123R offers alternative methods of adopting this final rule. At the present time, the Company has not yet determined which alternative method it will use. Had SFAS 123R been adopted, the Company would have recorded additional pre-tax costs of approximately $414,000 and $286,000 for the thirty-nine weeks and forty weeks ended October 1, 2005 and October 2, 2004, respectively, and of approximately $286,000 and $85,000 for the thirteen weeks ended October 1, 2005 and October 2, 2004, respectively. The aforementioned pro forma compensation cost was calculated using the Black-Scholes Options Pricing Model, which includes estimates, based on assumptions for the risk-free interest rate, life of options and stock price volatility and is based upon freely traded options. Changes in the underlying assumptions could affect the pro forma compensation cost. In March 2005, the SEC issued SAB No. 107, to provide further guidance regarding the interaction of the provisions of SFAS No. 123R and certain SEC rules and regulations. Accounting for Income Taxes In establishing the provision for income taxes and deferred income tax assets and liabilities, and valuation allowances against deferred tax assets, the Company makes judgments and interpretations based on enacted tax laws, published tax guidance, and estimates of future earnings. As of October 1, 2005, the Company had total net deferred tax assets of $4.9 million. This included $1.0 million relating to federal and state net operating loss carry forwards and $3.2 million for a reserve for litigation charges. Realization of deferred tax assets is dependent upon the likelihood that future taxable income will be sufficient to realize these benefits over time, and the effectiveness of tax planning strategies in the relevant tax jurisdictions. In the event that actual results differ from these estimates and assessments, additional valuation allowances may be required. Currently, there is no valuation allowance. 31
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Forward-looking Information The Company's growth prospects are influenced by broad economic trends. The pace of customer capital spending programs, new product launches and similar activities have a direct impact on the need for consulting and engineering services as well as temporary and permanent employees. Should the U.S. and Canadian economies decline, the Company's operating performance could be adversely impacted. The Company believes that its fiscal discipline, strategic focus on targeted vertical markets and diversification of service offerings provides some insulation from adverse trends. However, further declines in the economy could result in the need for future cost reductions or changes in strategy. Additionally, changes in government regulations could result in prohibition or restriction of certain types of employment services or the imposition of new or additional employee benefits, licensing or tax requirements with respect to the provision of employment services that may reduce RCM's future earnings. There can be no assurance that RCM will be able to increase the fees charged to its clients in a timely manner and in a sufficient amount to cover increased costs as a result of any of the foregoing. The employment services market is highly competitive with limited barriers to entry. RCM competes in global, national, regional and local markets with numerous consulting, engineering and employment companies. Price competition in the industries the Company serves is significant, and pricing pressures from competitors and customers are increasing. RCM expects that the level of competition will remain high in the future, which could limit RCM's ability to maintain or increase its market share or profitability. 32
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Thirty-Nine Weeks Ended October 1, 2005 Compared to Forty Weeks Ended October 2, 2004 A summary of operating results for the fiscal periods ended October 1, 2005 and October 2, 2004 is as follows (dollars in thousands, except for earnings per share data): <TABLE> <CAPTION> October 1, 2005 October 2, 2004 ---------------------- ------------------------ % of % of Amount Revenue Amount Revenue ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Revenues $133,797 100.0% $127,555 100.0 % Cost of services 102,478 76.6 96,865 75.9 ---------- ---------- ---------- ---------- Gross profit 31,319 23.4 30,690 24.1 ---------- ---------- ---------- ---------- Selling, general and administrative 26,045 19.5 25,649 20.1 Depreciation and amortization 801 .6 905 .7 ---------- ---------- ---------- ---------- 26,846 20.1 26,554 20.8 ---------- ---------- ---------- ---------- Operating income 4,473 3.3 4,136 3.3 Other (expense) income 178 .1 356 .3 ---------- ---------- ---------- ---------- Income before income taxes 4,295 3.2 3,780 3.0 Income taxes 1,577 1.2 1,349 1.1 ---------- ---------- ---------- ---------- Net income $2,718 2.0% $2,431 1.9 % ========== ========== ========== ========== Earnings per share Basic: $.24 $.21 Diluted: $.23 $.21 ========== ========== </TABLE> The above summary is not a presentation of results of operations under generally accepted accounting principles and should not be considered in isolation or as an alternative to results of operations as an indication of the Company's performance. The Company follows a 52/53 week fiscal reporting calendar ending on the Saturday closest to December 31. A 53-week year occurs periodically. The fiscal year ended 2004 was a 53-week reporting year. The year to date reporting periods ended October 1, 2005 and October 2, 2004 consisted of thirty-nine weeks and forty weeks, respectively. The following discussion is not adjusted for the additional one week in fiscal 2004 unless specifically noted otherwise. Revenues. Revenues increased 4.9%, or $6.2 million, for the thirty-nine weeks ended October 1, 2005 as compared to the same period in the prior year (the "comparable prior year period"). Revenues increased $2.7 million in the Information Technology ("IT") segment, decreased $3.6 million in the Engineering segment, and increased $7.1 million in the Commercial segment. Management attributes the overall increase to an improvement of the general economy and successful marketing and sales efforts. Management expects revenues for the remainder of fiscal 2005 to remain generally consistent on a prorated basis with the revenues for the thirty-nine weeks ended October 1, 2005. 33
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Thirty-Nine Weeks Ended October 1, 2005 Compared to Forty Weeks Ended October 2, 2004- (Continued) Revenues (Continued). There was a sequential decline in revenues and operating income from the second quarter to the third quarter of 2005 primarily to two different unexpected events and a seasonal factor. Specifically, during the early part of the third quarter, a client of the Company's Power Systems group abruptly terminated fully negotiated but unsigned contracts with RCM and other suppliers to that client and reduced the scope of several other ongoing projects with the Company and other suppliers. RCM estimates the termination of these contracts and reduction in scope of the ongoing projects reduced revenues to RCM in the third quarter by approximately $1.5 million. In addition, early in the third quarter approximately 20 of the Company's consultants completed a major project with a pharmaceutical client. RCM had previously expected the majority of those consultants to immediately start on another project, which did not ultimately commence until early in the fourth quarter. Consequently, revenues for the pharmaceutical project were approximately $700,000 less in the third quarter than in the second quarter. In addition, revenues from a major commercial services client, which virtually shuts down during the summer months, declined as expected by approximately $900,000 in the third quarter as compared to the second quarter. Cost of Services. Cost of services increased 5.7%, or $5.6 million, for the thirty-nine weeks ended October 1, 2005 as compared to the comparable prior year period. This increase was primarily due to the increase in revenues. Cost of services as a percentage of revenues increased to 76.6% for the thirty-nine weeks ended October 1, 2005 from 75.9% for the comparable prior year period. This increase was primarily attributable to increased pricing pressures in the IT segment as well as increased revenues in the Commercial segment, which historically has had lower gross margins. Management anticipates the ratio of cost of sales to revenues for the remainder of fiscal 2005 to decrease as compared to the forty weeks ended October 2, 2004, which is consistent with historical performance. Selling, General and Administrative. Selling, general and administrative (SGA") expenses increased 1.5%, or $396,000, for the thirty-nine weeks ended October 1, 2005 as compared to the comparable prior year period. As a percentage of revenues, SGA expenses were 19.5% for the thirty-nine weeks ended October 1, 2005 as compared to 20.1% for the comparable prior year period. This modest decrease was primarily attributable to continued cost containment activities, which were offset by increased sales costs on higher revenues and increased legal fees. The Company experienced a substantial increase in legal fees in the third quarter for previously disclosed litigation in which the Company is both a defendant and a plaintiff. Legal fees related to this matter increased in the third quarter by approximately $290,000 and $260,000 as compared to the second and first quarters of 2005, respectively. Management reasonably expects SGA expenses for the remainder of fiscal 2005 to remain consistent with the SGA expenses for the thirty-nine weeks ended October 1, 2005. Depreciation and Amortization. Depreciation and amortization ("DA") decreased 11.5%, or $104,000, for the thirty-nine weeks ended October 1, 2005 as compared to the comparable prior year period. Depreciation and Amortization. Depreciation and amortization ("DA") decreased 11.5%, or $104,000, for the thirty-nine weeks ended October 1, 2005 as compared to the comparable prior year period. 34
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Thirty-Nine Weeks Ended October 1, 2005 Compared to Forty Weeks Ended October 2, 2004 - (Continued) Other Expense. Other expense consists of interest expense, net of interest income and gains and losses on foreign currency transactions. For the thirty-nine weeks ended October 1, 2005, actual interest expense of $427,700 was offset by $256,200 of interest income, which was principally earned from restricted cash and short-term money market deposits. Interest expense, net decreased $180,000 for the thirty-nine weeks ended October 1, 2005 as compared to the comparable prior year period. This decrease was primarily due to decreased borrowing requirements as well as increased interest income, which was offset by an increase in weighted average interest rates on borrowed funds. Losses on foreign currency transactions decreased $2,400 in the thirty-nine weeks ended October 1, 2005 as compared to the comparable prior year period. This modest increase was attributable to an increase in the number of foreign currency transactions. Income Tax. Income tax expense increased 16.9%, or $228,000, for the thirty-nine weeks ended October 1, 2005 as compared to the comparable prior year period. This increase was attributable to a higher level of income before taxes for the thirty-nine weeks ended October 1, 2005 compared to the comparable prior year period. The effective tax rate was 36.7% for the thirty-nine weeks ended October 1, 2005 as compared to 35.7% for the comparable prior year period. The increase in effective tax rate was attributable to the decreased amount of tax-deductible amortization in relation to increased income before income tax purposes. Segment Discussion (See Footnote 12) Information Technology IT revenues of $73.1 million in 2005 increased $2.7 million, or 3.8%, compared to 2004. The increase was principally attributable to an increase in demand for IT services. The IT segment EBITDA was $4.5 million, or 84.9% of the overall EBITDA for 2005 as compared to $3.4 million, or 66.7% of the overall EBITDA, for 2004. Engineering Engineering revenues of $35.3 million in 2005 decreased $3.6 million, or 9.1%, compared to 2004. The decrease in revenue was attributable to the softening of demand for the Company's engineering services. The Engineering segment EBITDA was $20,000, or .4% of the overall EBITDA for 2005 as compared to $2.0 million, or 40.1% of the overall EBITDA for 2004. Commercial Commercial revenues of $25.4 million in 2005 increased $7.1 million, or 39.1% compared to 2004. The increase in revenues for the Commercial segment was attributable to improvement in economic activity within this segment. The Commercial segment EBITDA was $775,000, or 14.7% of the overall EBITDA, as compared to a loss of $346,000 for 2004. 35
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Thirteen Weeks Ended October 1, 2005 Compared to Thirteen Weeks Ended October 2, 2004 A summary of operating results for the fiscal periods ended October 1, 2005 and October 2, 2004 is as follows (dollars in thousands, except for earnings per share data): <TABLE> <CAPTION> October 1, 2005 October 2, 2004 ---------------------- ------------------------ % of % of Amount Revenue Amount Revenue ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Revenues $43,390 100.0 % $40,933 100.0 % Cost of services 33,237 76.6 30,970 75.7 ---------- ---------- ---------- ---------- Gross profit 10,153 23.4 9,963 24.3 ---------- ---------- ---------- ---------- Selling, general and administrative 8,710 20.1 8,322 20.3 Depreciation and amortization 273 .6 305 .7 ---------- ---------- ---------- ---------- 8,983 20.7 8,627 21.0 ---------- ---------- ---------- ---------- Operating income 1,170 2.7 1,336 3.3 Other income (expense) 66 .2 115 .3 ---------- ---------- ---------- ---------- Income before income taxes 1,104 2.5 1,221 3.0 Income taxes 387 .9 455 1.1 ---------- ---------- ---------- ---------- Net income $717 1.6 % $766 1.9 % ========== ========== ========== ========== Earnings per share Basic: $.06 $.07 Diluted: $.06 $.07 ========== ========== </TABLE> The above summary is not a presentation of results of operations under generally accepted accounting principles and should not be considered in isolation or as an alternative to results of operations as an indication of the Company's performance. The Company follows a 52/53 week fiscal reporting calendar ending on the Saturday closest to December 31. A 53-week year occurs periodically. The fiscal year ended 2004 was a 53-week reporting year. The third quarter reporting periods ended October 1, 2005 and October 2, 2004 consisted of thirteen weeks. The following discussion is not adjusted for the additional one week in fiscal 2004 unless specifically noted otherwise. Revenues. Revenues increased 6.0%, or $2.5 million, for the thirteen weeks ended October 1, 2005 as compared to the same period in the prior year (the "comparable prior year period"). The revenue increased $761,000 in the Information Technology ("IT") segment, decreased $778,000 in the Engineering segment and increased $2.5 million in the Commercial segment. Management attributes the overall increase to an improvement of the general economy and successful marketing and sales efforts. 36
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Thirteen Weeks Ended October 1, 2005 Compared to Thirteen Weeks Ended October 2, 2004 - (Continued) Revenues (Continued). There was a sequential decline in revenues and operating income from the second quarter to the third quarter of 2005 primarily to two different unexpected events and a seasonal factor. Specifically, during the early part of the third quarter, a client of the Company's Power Systems group abruptly terminated fully negotiated but unsigned contracts with RCM and other suppliers to that client and reduced the scope of several other ongoing projects with the Company and other suppliers. RCM estimates the termination of these contracts and reduction in scope of the ongoing projects reduced revenues to RCM in the third quarter by approximately $1.5 million. In addition, early in the third quarter approximately 20 of the Company's consultants completed a major project with a pharmaceutical client. RCM had previously expected the majority of those consultants to immediately start on another project, which did not ultimately commence until early in the fourth quarter. Consequently, revenues for the pharmaceutical project were approximately $700,000 less in the third quarter than in the second quarter. In addition, revenues from a major commercial services client, which virtually shuts down during the summer months, declined as expected by approximately $900,000 in the third quarter as compared to the second quarter. Cost of Services. Cost of services increased 7.3%, or $2.3 million, for the thirteen weeks ended October 1, 2005 as compared to the comparable prior year period. This increase was primarily due to the increase in revenues. Cost of services as a percentage of revenues increased to 76.6% for the thirteen weeks ended October 1, 2005 from 75.7% for the comparable prior year period. This modest increase was attributable to the change in revenue amounts in each segment year over year and the related gross margin percentages from each segment. Management anticipates the ratio of cost of sales to revenues for the remainder of fiscal 2005 will decrease as compared to the thirteen weeks ended October 2, 2004, which is consistent with historical performance. SGA expenses increased 4.7%, or $388,000, for the thirteen weeks ended October 1, 2005 as compared to the comparable prior year period. As a percentage of revenues, SGA expenses were 20.1% for the thirteen weeks ended October 1, 2005 as compared to 20.3% for the comparable prior year period. This decrease was primarily attributable to continued cost containment activities, which were offset by increased sales costs on higher revenues and increased legal fees. The Company experienced a substantial increase in legal fees in the third quarter for previously disclosed litigation in which the Company is both a defendant and a plaintiff. Legal fees related to this matter increased in the third quarter by approximately $290,000 and $260,000 as compared to the second and first quarters of 2005, respectively. Management reasonably expects SGA expenses for the remainder of fiscal 2005 to remain consistent with the SGA expenses for the thirteen weeks ended October 1, 2005. Depreciation and Amortization. DA decreased 10.7, or $33,000, for the thirteen weeks ended October 1, 2005 as compared to the comparable prior year period. Other Expense. Other expense consists of interest expense, net of interest income and gains and losses on foreign currency transactions. For the thirteen weeks ended October 1, 2005, actual interest expense of $144,200 was offset by $80,700 of interest income, which was principally earned from restricted cash and short-term money market deposits. Interest expense, net, decreased $55,500 for the thirteen weeks ended October 1, 2005 as compared to the comparable prior year period. This decrease was primarily due to decreased borrowing requirements as well as increased interest income, which was offset by an increase in weighted average interest rates on borrowed funds. Losses on foreign currency transactions decreased $5,800 as compared to the comparable prior year period. This increase was attributable to an increase in the number of foreign currency transactions. Income Tax. Income tax expense decreased 14.9%, or $68,000, for the thirteen weeks ended October 1, 2005 as compared to the comparable prior year period. This increase was attributable to a lower level of income before taxes for the thirteen weeks ended October 1, 2005 compared to the comparable prior year period. The effective tax rate was 35.1% for the thirteen weeks ended October 1, 2005 as compared to 37.3% for the comparable prior year period. The increase in effective tax rate was attributable to the relationship of tax-deductible amortization to decreased income before income tax purposes. 37
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Thirteen Weeks Ended October 1, 2005 Compared to Thirteen Weeks Ended October 2, 2004 - (Continued) Other Expense. Other expense consists of interest expense, net of interest income and gains and losses on foreign currency transactions. For the thirteen weeks ended October 1, 2005, actual interest expense of $144,200 was offset by $80,700 of interest income, which was principally earned from restricted cash and short-term money market deposits. Interest expense, net, decreased $55,500 for the thirteen weeks ended October 1, 2005 as compared to the comparable prior year period. This decrease was primarily due to decreased borrowing requirements as well as increased interest income, which was offset by an increase in weighted average interest rates on borrowed funds. Losses on foreign currency transactions decreased $5,800 as compared to the comparable prior year period. This increase was attributable to an increase in the number of foreign currency transactions. Income Tax. Income tax expense decreased 14.9%, or $68,000, for the thirteen weeks ended October 1, 2005 as compared to the comparable prior year period. This increase was attributable to a lower level of income before taxes for the thirteen weeks ended October 1, 2005 compared to the comparable prior year period. The effective tax rate was 35.1% for the thirteen weeks ended October 1, 2005 as compared to 37.3% for the comparable prior year period. The increase in effective tax rate was attributable to the relationship of tax-deductible amortization to decreased income before income tax purposes. Segment Discussion (See Footnote 12) Information Technology IT revenues of $23.6 million in 2005 increased $761,000, or 3.4%, compared to 2004. This increase is attributable to an increase in demand for IT services. EBITDA for the IT segment was $1.5 million, or 101% of the overall EBITDA, for 2005 as compared to $1.3 million, or 76.0% of the overall EBITDA, for 2004. Engineering Engineering revenues of $11.2 million in 2005 decreased $778,000, or 6.5%, compared to 2004. The decrease in revenue was attributable to the softening of demand for the Company's engineering services. The Engineering segment EBITDA was a loss of $94,000, as compared to $488,000, or 29.6% of the overall EBITDA for 2004. Commercial Commercial revenues of $8.6 million in 2005 increased $2.5 million, or 40.2% compared to 2004. The increase in revenues for the Commercial segment was attributable to improvement in economic activity within this segment. The Commercial segment EBITDA was $86,000, or 6.0% of the overall EBITDA, as compared to a loss of $92,000 for 2004. 38
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Liquidity and Capital Resources The following table summarizes the major captions from the Company's Consolidated Statements of Cash Flows: Thirty-Nine Forty Weeks Ended Weeks Ended October 1, 2005 October 2, 2004 ----------------- ---------------- (In Thousands) ------------------------------------- Operating Activities $2,597 $84 Investing Activities $237 ($264) Financing Activities ($727) ($2,143) Operating Activities Operating activities provided $2.6 million of cash for the thirty-nine weeks ended October 1, 2005 as compared to using $84,000 for the comparable 2004 period. The increase in cash provided by operating activities was primarily attributable to increased earnings, a decrease in prepaid expenses and other current assets, an increase in income taxes payable, an increase in deferred tax assets and an increase in accounts payable and accrued expenses, which was offset by an increase in accounts receivable, an increase in restricted cash, a decrease in payroll and withheld taxes and a decrease in accrued compensation. Based on current operating activities and the drivers of those activities, management reasonably expects that cash will be provided from operating activities for the remainder of fiscal 2005. The Company continues to institute enhanced managerial controls and standardization over its receivables collection and disbursement processes. Investing Activities Investing activities provided $236,800 for the thirty-nine weeks ended October 1, 2005 as compared to a use of $264,000 for the comparable 2004 period. The increase in cash provided for investing activities was primarily attributable to working capital acquired upon the acquisition of a subsidiary, which was offset by an increase in expenditures for property and equipment. Financing Activities Financing activities principally consisted of debt reduction of $1.0 million in 2005 as compared to $2.4 million for the comparable 2004 period. On May 31, 2002, the Company and its subsidiaries entered into an amended and restated loan agreement, which was further amended on October 17, 2004, with Citizens Bank of Pennsylvania, administrative agent for a syndicate of banks, which provides for a $25 million Revolving Credit Facility (the "Revolving Credit Facility"). Availability of credit under the Revolving Credit Facility is based on 80% of the aggregate amount of accounts receivable for which not more than 90 days have elapsed since the date of the original invoice. Borrowings under the Revolving Credit Facility bear interest at one of two alternative rates, as selected by the Company at each incremental borrowing. These alternatives are: (i) LIBOR (London Interbank Offered Rate), plus applicable margin, or (ii) the agent bank's prime rate. All borrowings under the Revolving Credit Facility are collateralized by all of the assets of the Company and its subsidiaries and a pledge of the stock of its subsidiaries. The Revolving Credit Facility also contains various financial and non-financial covenants, such as restrictions on the Company's ability to pay dividends. 39
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Liquidity and Capital Resources (Continued) The Revolving Credit Facility expires in August 2006. The weighted average interest rates under the Revolving Credit Facility for the thirty-nine weeks ended October 1, 2005 and forty weeks ended October 2, 2004 were 6.0% and 2.84%, respectively. The amounts outstanding under the Revolving Credit Facility at October 1, 2005 and January 1, 2005 were $3.9 million and $4.9 million, respectively. At October 1, 2005, the Company had availability for additional borrowing under the Revolving Credit Facility of $21.0 million. The Company anticipates that its primary uses of capital in future periods will be for working capital purposes. Funding for any long and short-term capital requirements as well as future acquisitions will be derived from one or more of the Revolving Credit Facility, funds generated through operations or future financing transactions. The Company is involved in litigation as described in Footnote 13 (Contingencies) to the financial statements. The outcome of litigation is subject to inherent uncertainties and management's view of these matters may change in the future. Were an unfavorable final outcome to occur, there exists the possibility of a material adverse impact on our financial position, liquidity, and the results of operations for the period in which the effect becomes reasonably estimable. The Company anticipates that if the plaintiffs in the litigation matter, which is currently being appealed by the Company, are successful in their appeal of the damages, it would need to borrow funds under its Revolving Credit Facility in order to satisfy payment of the additional damages. The Company believes that its borrowing base is sufficient to allow this additional borrowing. The Company's business strategy is to achieve growth both internally through operations and externally through strategic acquisitions. The Company from time to time engages in discussions with potential acquisition candidates. As the size of the Company and its financial resources increase, however, acquisition opportunities requiring significant commitments of capital may arise. In order to pursue such opportunities, the Company may be required to incur debt or issue potentially dilutive securities in the future. No assurance can be given as to the Company's future acquisition and expansion opportunities or how such opportunities will be financed. The Company does not currently have material commitments for capital expenditures and does not currently anticipate entering into any such commitments during the next twelve months. The Company's current commitments consist primarily of lease obligations for office space. The Company believes that its capital resources are sufficient to meet its present obligations and those to be incurred in the normal course of business for the next twelve months. At October 1, 2005, the Company had a deferred tax asset totaling $4.9 million, primarily representing the tax effect of the net operating loss carry forwards, and the litigation reserve. The Company expects to utilize the deferred tax asset during the twelve months ending September 30, 2006 by offsetting the related tax benefits of such assets against tax liabilities incurred from forecasted taxable income. 40
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's exposure to market risk for changes in interest rates relates primarily to the Company's investment portfolio and debt instruments, which primarily consist of its line of credit. The Company does not have any derivative financial instruments in its portfolio. The Company places its investments in instruments that meet high credit quality standards. The Company is adverse to principal loss and ensures the safety and preservation of its invested funds by limiting default risk, market risk and reinvestment risk. As of October 1, 2005, the Company's investments consisted of cash and money market funds. The Company does not use interest rate derivative instruments to manage its exposure to interest rate changes. Presently the impact of a 10% (approximately 60 basis points) increase in interest rates on its variable debt (using average debt balances during the thirty-nine weeks ended October 1, 2005 and average interest rates) would have a relatively nominal impact on the Company's results of operations. The Company does not expect any material loss with respect to its investment portfolio. ITEM 4. CONTROLS AND PROCEDURES The Company's management, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that those disclosure controls and procedures as of the end of the period covered by this report were functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act recorded, is processed, summarized and reported within the time periods specified in the SEC's rules and forms and is accumulated and communicated to the Company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. There have been no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter and that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 41
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In late 1998, two shareholders who were formerly officers and directors of the Company filed suit against the Company alleging wrongful termination of their employment, failure to make required severance payments, wrongful conduct by the Company in connection with the grant of stock options, and wrongful conduct by the Company resulting in the non-vestiture of their option grants. The complaint also alleged that the Company wrongfully limited the number of shares of the Company's common stock that could have been sold by the plaintiffs under a registration rights agreement entered into in connection with the underlying acquisition transaction pursuant to which the plaintiffs became shareholders of the Company. The claim under the registration rights agreement sought the difference between the amount for which plaintiffs could have sold their RCM shares during the 12-month period ended March 11, 1999, but for the alleged wrongful limitation on their sales, and the amount for which the plaintiffs sold their shares during that period and thereafter. The claim relating to the wrongful termination of the employment of one of the plaintiffs and the claims of both plaintiffs concerning the grant of stock options were resolved in binding arbitration in early 2002. A trial on the remaining claims commenced on December 2, 2002 and a verdict was returned on January 24, 2003. On the claims by both plaintiffs, concerning the alleged wrongful limitation by the Company of the number of shares that the plaintiffs could sell during the 12-month period ended March 11, 1999, a verdict awarding damages of $7.6 million against the Company was returned. On June 23, 2003, the trial judge denied the Company's post-trial motions that challenged the jury verdict and upheld the verdict. On August 4, 2003, the trial judge entered a judgment in favor of the plaintiffs for $7.6 million in damages and awarded plaintiffs $172,000 in post-verdict pre-judgment interest. Post-judgment interest will continue to accrue on the damages portion of the judgment at the rate of 3% per annum in 2005. The Company has appealed to the Appellate Division of the Superior Court of New Jersey, and obtained a stay pending appeal of, that judgment. In order to secure the stay, the Company made a cash deposit in lieu of bond of $8.3 million with the Trust Fund of the Superior Court of New Jersey. This deposit is recorded as restricted cash on the consolidated balance sheet and earns interest at a rate that approximates the daily federal funds rate. The plaintiffs have cross-appealed from the Court's denial of pre-verdict, pre-judgment interest on the damages portion of the August 4, 2003 judgment and from the Court's refusal to grant judgment as a matter of law to one of the plaintiffs on his claim for severance pay in the amount of $240,000 plus interest. The briefing phase of the appeal was concluded in April 2004 and oral argument was heard on February 15, 2005. The timing of a ruling on the appeal cannot be predicted at this time but is expected in the fourth quarter of 2005. Further appellate proceedings are likely no matter which side prevails in the Appellate Division. In connection with this litigation, the Company accrued $9.7 million of litigation charges at December 31, 2002, which included the jury award of $7.6 million, professional fees of $1.1 million and an estimate of $1.0 million for attorney fees and pre-judgment interest. As of October 1, 2005, the accrued litigation reserve is $8.4 million. 42
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS (CONTINUED) In addition, in November 2002 the Company brought suit in the Superior Court of New Jersey, Law Division, Bergen County, on professional liability claims against the attorneys and law firms who served as its counsel in the above-described acquisition transaction and in its subsequent dealings with the plaintiffs concerning their various relationships with the Company resulting from that transaction. In its lawsuit against the former counsel, the Company is seeking complete indemnification with respect to (1) its costs and counsel fees incurred in defending itself against the claims of the plaintiffs; (2) any sums for which the Company is ultimately determined to be liable to the plaintiffs; and (3) its costs and counsel fees incurred in the prosecution of the legal malpractice action itself. That litigation was temporarily stayed in the Law Division while the appeal of the underlying action went forward in the Appellate Division of the Superior Court. On May 16, 2005, the Law Division lifted that stay and pretrial discovery in the legal malpractice action ensued through September 2005. On September 14, 2005, as a consequence of certain procedural constraints imposed by the court, the Company and the various attorney and law firm defendants agreed to the dismissal of the action in Bergen County and the filing of a new action against the same defendants in the Superior Court of New Jersey, Law Division, Morris County. The Company has asserted certain additional claims against the defendants in the complaint for the new action which was filed on October 24, 2005. The Company is also subject to other pending legal proceedings and claims that arise from time to time in the ordinary course of its business, which may or may not be covered by insurance. The litigation and other claims previously noted are subject to inherent uncertainties and management's view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the Company's consolidated financial position and the consolidated results of operations for the period in which the effect becomes reasonably estimable. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES On October 17, 2005, RCM issued 100,000 shares of its common stock, par value $0.05 (the "Shares") at an aggregate offering price of $632,000, to the former holders of all the issued and outstanding stock of Soltre as part of the consideration for the acquisition of Soltre. The issuance of the Shares was made in reliance on an exemption from registration of the Shares under Rule 506 of Regulation D ("Regulation D") promulgated under Section 5 of the Securities Act of 1933, as amended (the "Act"). Each holder of the Shares is an "accredited investor," as such term is defined in Regulation D. Each holder of the Shares has represented that he or she will not sell, transfer or otherwise dispose of the Shares unless the Shares are registered under the Act or unless an exemption from registration is available under applicable federal and state securities law. Each certificate representing the Shares contains a restrictive legend stating that the Shares have not been registered under the Act and may not be sold, transferred or otherwise disposed of unless registered under the Act or exempt from registration under applicable federal and state securities law. 43
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES ITEM 6. EXHIBITS 31.1 Certification of Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. 31.2 Certification of Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. 32.1 Certification of Chief Executive Officer Required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.) 32.2 Certification of Chief Financial Officer Required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.) 44
RCM TECHNOLOGIES, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. RCM Technologies, Inc. Date: November 10, 2005 By: /s/ Stanton Remer ----------------------------- Stanton Remer Executive Vice President, Chief Financial Officer Treasurer, Secretary and Director (Principal Financial Officer and Duly Authorized Officer of the Registrant) 45
Exhibit 31.1 RCM TECHNOLOGIES, INC. CERTIFICATIONS REQUIRED BY RULE 13a-14(a) OF THE SECURITIES EXCHANGE ACT OF 1934 CERTIFICATION I, Leon Kopyt, certify that: 1. I have reviewed this quarterly report on Form 10-Q of RCM Technologies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 10, 2005 /s/ Leon Kopyt Leon Kopyt Chief Executive Officer 46
Exhibit 31.2 RCM TECHNOLOGIES, INC. CERTIFICATIONS REQUIRED BY RULE 13a-14(a) OF THE SECURITIES EXCHANGE ACT OF 1934 CERTIFICATION I, Stanton Remer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of RCM Technologies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 10, 2005 /s/ Stanton Remer Stanton Remer Chief Financial Officer 47
Exhibit 32.1 RCM TECHNOLOGIES, INC. CERTIFICATIONS REQUIRED BY RULE 13a-14(a) OF THE SECURITIES EXCHANGE ACT OF 1934 I, Leon Kopyt, President and Chief Executive Officer of RCM Technologies, Inc., a Nevada corporation (the "Company"), hereby certify that, to my knowledge: (1) The Company's periodic report on Form 10-Q for the fiscal quarter ended October 1, 2005 (the "Form 10-Q") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. * * * /s/ Leon Kopyt Leon Kopyt Chief Executive Officer Date: November 10, 2005 48
Exhibit 32.2 RCM TECHNOLOGIES, INC. CERTIFICATIONS REQUIRED BY RULE 13a-14(a) OF THE SECURITIES EXCHANGE ACT OF 1934 I, Stanton Remer, Chief Financial Officer of RCM Technologies, Inc., a Nevada corporation (the "Company"), hereby certify that, to my knowledge: (1) The Company's periodic report on Form 10-Q for the fiscal quarter October 1, 2005 (the "Form 10-Q") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. * * * /s/ Stanton Remer Stanton Remer Chief Financial Officer Date: November 10, 2005 49