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 September 30, 2006 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer Accelerated Filer Non-Accelerated Filer 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 the Registrant's class of common stock, as of the latest practicable date. Common Stock, $0.05 par value, 11,806,674 shares outstanding as of November 8, 2006. <page> RCM TECHNOLOGIES, INC. AND SUBSIDIARIES <TABLE> <CAPTION> PART I - FINANCIAL INFORMATION ----------------------------------------------------------------------------------------------- Page Item 1 - Consolidated Financial Statements <S> <C> <C> <c> Consolidated Balance Sheets as of September 30, 2006 (Unaudited) and December 31, 2005 3 Unaudited Consolidated Statements of Income and Comprehensive Income for the Thirty-Nine Weeks Ended September 30, 2006 and October 1, 2005 5 Unaudited Consolidated Statements of Income and Comprehensive Income for the Thirteen Weeks Ended September 30, 2006 and October 1, 2005 7 Unaudited Consolidated Statement of Changes in Stockholders' Equity for the Thirty-Nine Weeks Ended September 30, 2006 9 Unaudited Consolidated Statements of Cash Flows for the Thirty-Nine Weeks Ended September 30, 2006 and October 1, 2005 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 6 - Exhibits 43 Signatures 44 </TABLE> 2 The accompanying notes are an integral part of these financial statements.
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------- RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS September 30, 2006 and December 31, 2005 ASSETS <TABLE> <CAPTION> September 30, December 31, -------------- 2005 2006 - ---------------------------------------------------------------------------------------------------------------- (Unaudited) Current assets <S> <C> <C> Cash and cash equivalents $6,666,362 $3,761,063 Accounts receivable, net of allowance for doubtful accounts of $1,683,000 (September 30, 2006) and $1,792,000 (December 31, 2005), respectively 48,836,192 44,930,276 Restricted cash 8,572,064 Prepaid expenses and other current assets 2,774,607 2,840,700 Deferred tax assets 4,157,070 4,012,340 - ---------------------------------------------------------------------------------------------------------------- Total current assets 62,434,231 64,116,443 - ---------------------------------------------------------------------------------------------------------------- Property and equipment, at cost Equipment and leasehold improvements 9,945,999 10,038,094 Less: accumulated depreciation and amortization 5,469,699 6,017,593 - ---------------------------------------------------------------------------------------------------------------- 4,476,300 4,020,501 - ---------------------------------------------------------------------------------------------------------------- Other assets Deposits 183,014 166,814 Goodwill 38,110,616 37,660,320 Intangible assets, net of accumulated amortization of $635,648 (September 30, 2006) and $405,376 (December 31, 2005), respectively 749,352 808,624 - ---------------------------------------------------------------------------------------------------------------- 39,042,982 38,635,758 - ---------------------------------------------------------------------------------------------------------------- Total assets $105,953,513 $106,772,702 ================================================================================================================ </TABLE> 3 The accompanying notes are an integral part of these financial statements.
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - CONTINUED September 30, 2006 and December 31, 2005 - ------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY <TABLE> <CAPTION> September 30, December 31, -------------- 2005 2006 - ---------------------------------------------------------------------------------------------------------------- (Unaudited) Current liabilities <S> <C> <C> Line of credit $3,900,000 $3,900,000 Accounts payable and accrued expenses 9,708,326 14,979,127 Accrued compensation 8,424,209 7,087,897 Payroll and withheld taxes 1,117,544 867,274 Income taxes payable 2,101,154 4,249,779 - ---------------------------------------------------------------------------------------------------------------- Total current liabilities 25,251,233 31,084,077 - ---------------------------------------------------------------------------------------------------------------- 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; 11,788,674 and 11,728,261 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively 589,434 586,413 Accumulated other comprehensive income 1,037,465 981,772 Additional paid-in capital 101,170,606 100,235,338 Accumulated deficit (22,095,225) (26,114,898) - ---------------------------------------------------------------------------------------------------------------- 80,702,280 75,688,625 - ---------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $105,953,513 $106,772,702 ================================================================================================================ </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 September 30, 2006 and October 1, 2005 (Unaudited) - ------------------------------------------------------------------------------ <TABLE> <CAPTION> 2006 2005 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- <S> <C> <C> Revenues $147,728,501 $133,796,641 Cost of services (1) 110,565,755 102,477,944 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Gross profit 37,162,746 31,318,697 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Operating costs and expenses Selling, general and administrative (2) 30,521,288 26,045,339 Depreciation 884,261 800,561 Amortization 230,272 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- 31,635,821 26,845,900 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Operating income 5,526,925 4,472,797 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Other expenses Interest expense, net of interest income 204,243 171,502 Loss on foreign currency transactions 15,784 6,701 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- 220,027 178,203 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Income before income taxes 5,306,898 4,294,594 Income taxes 1,287,225 1,577,052 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Net income 4,019,673 2,717,542 Other comprehensive income Foreign currency translation adjustment 55,693 176,521 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Comprehensive income $4,075,366 $2,894,063 ======================================================================== === ============== == === ============= <FN> (1) Includes stock based compensation expense of $29,750 for the thirty-nine weeks ended September 30, 2006. (2) Includes stock based compensation expense of $662,925 for the thirty-nine weeks ended September 30, 2006. </FN> </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 September 30, 2006 and October 1, 2005 (Unaudited) - ------------------------------------------------------------------------------ <TABLE> <CAPTION> 2006 2005 - ----------------------------------------------------------------------------------------------------------------- Basic earnings per share <S> <C> <C> Basic earnings per share $.34 $.24 ================================================================================================================= Weighted average number of common shares outstanding 11,764,056 11,407,806 ================================================================================================================= Diluted earnings per share Diluted earnings per share $.33 $.23 ================================================================================================================= Weighted average number of common and common equivalent shares outstanding (includes dilutive securities relating to options of 256,845 and 209,638 in 2006 and 2005, respectively) 12,020,901 11,617,444 ================================================================================================================= </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 September 30, 2006 and October 1, 2005 (Unaudited) - ------------------------------------------------------------------------------ <TABLE> <CAPTION> 2006 2005 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- <S> <C> <C> Revenues $51,649,791 $43,390,661 Cost of services (1) 38,697,545 33,237,445 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Gross profit 12,952,246 10,153,216 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Operating costs and expenses Selling, general and administrative (2) 10,250,503 8,710,506 Depreciation 306,594 272,709 Amortization 87,208 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- 10,644,305 8,983,215 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Operating income 2,307,941 1,170,001 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Other expenses Interest expense, net of interest income 74,800 63,463 Loss on foreign currency transactions 5,086 2,328 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- 79,886 65,791 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Income before income taxes 2,228,055 1,104,210 Income tax expense 878,630 387,366 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Net income 1,349,425 716,844 Other comprehensive (loss) income Foreign currency translation adjustment (16,119 ) 246,203 - ------------------------------------------------------------------------ --- -------------- -- --- ------------- Comprehensive income $1,333,306 $963,047 ======================================================================== === ============== == === ============= <FN> (1) Includes stock based compensation credit of $691 for the thirteen weeks ended September 30, 2006. (2) Includes stock based compensation expense of $100,050 for the thirteen weeks ended September 30, 2006. </FN> </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 September 30, 2006 and October 1, 2005 (Unaudited) - ------------------------------------------------------------------------------- <TABLE> <CAPTION> 2006 2005 - ----------------------------------------------------------------------------------------------------------------- <S> <C> <C> Basic earnings per share $.11 $.06 ================================================================================================================= Weighted average number of common shares outstanding 11,788,581 11,451,202 ================================================================================================================= Diluted earnings per share $.11 $.06 ================================================================================================================= Weighted average number of common and common equivalent shares outstanding (includes dilutive securities relating to options of 215,169 and 259,862 in 2006 and 2005, respectively) 12,003,750 11,711,064 ================================================================================================================= </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 September 30, 2006 (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> <C> Balance, December 31, 2005 11,728,261 $586,413 $981,772 $100,235,338 ($26,114,898) $75,688,625 Issuance of stock under employee stock purchase plan 15,318 766 64,642 65,408 Exercise of stock options 45,095 2,255 177,951 180,206 Translation adjustment 55,693 55,693 Stock based compensation 692,675 692,675 expense Net income 4,019,673 4,019,673 - ----------------------------------- -------------- ----------- ----------------- ----------------- ---------------- --------------- Balance, September 30, 2006 11,788,674 $589,434 $1,037,465 $101,170,606 ($22,095,225) $80,702,280 =================================== ============== =========== ================= ================= ================ =============== </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 September 30, 2006 and October 1, 2005 (Unaudited) - ------------------------------------------------------------------------------- <TABLE> <CAPTION> 2006 2005 - ---------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: <S> <C> <C> Net income $4,019,673 $2,717,542 - ---------------------------------------------------------------------------------------------------------------- Adjustments to reconcile net income to net cash provided by operating activities, net of effects of acquisition: Depreciation and amortization 1,114,533 800,561 Stock-based compensation expense 692,675 Provision for losses on accounts receivable (109,000) (110,000) Deferred tax assets (144,730) 82,391 Changes in assets and liabilities: Accounts receivable (3,796,916) (1,762,160) Restricted cash 8,572,064 (204,871) Prepaid expenses and other current assets 66,093 806,022 Accounts payable and accrued expenses (5,270,800) 693,406 Accrued compensation 1,336,312 (1,038,872) Payroll and withheld taxes 250,268 (523,527) Income taxes payable (2,148,625) 1,136,860 - ---------------------------------------------------------------------------------------------------------------- Total adjustments 561,874 (120,190) - ---------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities $4,581,547 $2,597,352 - ---------------------------------------------------------------------------------------------------------------- </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 September 30, 2006 and October 1, 2005 (Unaudited) - ------------------------------------------------------------------------------ <TABLE> <CAPTION> 2006 2005 - ---------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: <S> <C> <C> Property and equipment acquired ($1,340,059) ($472,170) Increase in deposits (16,200) (23,712) Cash paid for acquisition, net of working capital acquired (621,296) 732,682 - ---------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (1,977,555) 236,800 - ---------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Sale of stock for employee stock purchase plan 65,408 80,475 Exercise of stock options 180,206 192,295 Repayments on line of credit (1,000,000) - ---------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 245,614 (727,230) - ---------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and cash equivalents 55,693 176,520 - ---------------------------------------------------------------------------------------------------------------- Increase in cash and cash equivalents 2,905,299 2,283,442 Cash and cash equivalents at beginning of period 3,761,063 2,401,794 - ---------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $6,666,362 $4,685,236 ================================================================================================================ Supplemental cash flow information: Cash paid for: Interest expense $1,176,185 $257,382 Income taxes $3,166,169 $524,895 </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 December 31, 2005. Certain information and footnote disclosures, which are normally included in financial statements prepared in accordance with generally accepted accounting principles, 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 September 30, 2006 are not necessarily indicative of the results to be expected for the full year. 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 December 31, 2005 was a 52-week reporting year. The third quarter of 2005, the 2005 fiscal year and the third quarter of 2006 ended on the following dates, respectively: Period Ending Weeks in Quarter Weeks in Year to Date -------------------------- ------------------- ------------------------- October 1, 2005 Thirteen Thirty-Nine December 31, 2005 Thirteen Fifty-Two September 30, 2006 Thirteen Thirty-Nine 3. Use of Estimates and Uncertainties The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America 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. economy, competition, demand for the Company's services, adverse litigation and claims, as well as the hiring, training and retention of key employees. 4. Acquisitions On April 17, 2006, the Company purchased the operating assets of Techpubs, LLC ("Techpubs"), a Rhode Island limited liability company. Techpubs is a specialty provider of engineering services. The acquisition has been accounted for as a purchase transaction in accordance with Statement of Financial Accounting Standards (SFAS) No. 141 "Business Combinations." Accordingly, the results of operations of the acquired company have been included in the consolidated results of operations of the Company from the date of acquisition and are included in the engineering segment. 12
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- 4. Acquisitions (Cont'd) The purchase consideration at closing consisted of $600,000 in cash, legal cost of $22,000 and $300,000 of deferred consideration contingent upon achieving certain base levels of operating income for each of the twelve month periods following the purchase. The allocation of the purchase price is as follows: Period of (in thousands) Amortization ------------------- -- ----------------- Non-compete agreements $31 5 years Customer relationships 140 5 years Goodwill 451 ---------------------------------- ------------------- -- ----------------- $622 ================================== =================== == ================= The purchase price allocation was finalized in the third quarter, which resulted in the allocation of $31,000 and $140,000 to non-compete agreements and customer relationships, respectively, from goodwill. In connection with certain acquisitions, the Company is obligated to pay contingent consideration to the selling shareholders upon the acquired business achieving certain earnings targets over periods ranging from two to three years following the acquisition. In general, the contingent consideration amounts fall into two categories: (a) Deferred Consideration - amounts are due, provided that the acquisition achieves a base level of earnings which has been determined at the time of acquisition and (b) Earnouts - amounts payable are not fixed and are based on the growth in excess of the base level earnings. The Company's outstanding Deferred Consideration obligations, which relate to various acquisitions, are anticipated to result in approximately the following payments: Amount Year Ending (in thousands) -------------------------------------- -- ---------------- December 30, 2006 (Three Months) $700 December 29, 2007 800 December 27, 2008 800 January 2, 2010 100 -------------------------------------- -- ---------------- $2,400 ====================================== == ================ The Deferred Consideration and Earnouts, when paid, will be recorded as additional purchase consideration and added to goodwill on the consolidated balance sheet. Earnouts cannot be estimated with any certainty. The following results of operations have been prepared assuming all acquisitions since January 2, 2005 had occurred as of the beginning of the periods presented. These results are not necessarily indicative of results of future operations nor of results that would have occurred had the acquisitions been consummated as of the beginning of the periods presented. <TABLE> <CAPTION> Thirteen Weeks Ended Thirty-Nine Weeks Ended ------------------------------------ ---------------------------------- September 30, October 1, September 30, October 1, 2006 2005 2006 2005 (Proforma) (Proforma) (Proforma) (Proforma) ---------------- - ----------------- -- -------------- -- ---------------- <S> <C> <C> <C> <C> Revenues $51,649,791 $45,889,256 $148,028,500 $139,854,195 Operating income 2,307,941 1,496,701 5,583,923 5,408,672 Net income $1,349,425 $888,644 $4,039,335 $3,206,167 Earnings per share $0.11 $0.08 $0.34 $0.27 </TABLE> 13
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 5. New Accounting Standards In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." ("SAB 108") is effective for fiscal years ending on or after November 15, 2006 and addresses how financial statement errors should be considered from a materiality perspective and corrected. The literature provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. Historically, there have been two common approaches used to quantify such errors: (i) the "rollover" approach, which quantifies the error as the amount by which the current year income statement is misstated, and (ii) the "iron curtain" approach, which quantifies the error as the cumulative amount by which the current year balance sheet is misstated. The SEC Staff believes that companies should quantify errors using both approaches and evaluate whether either of these approaches results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. Historically, the Company has evaluated uncorrected differences utilizing the "rollover" approach, and the Company is currently evaluating the impact, if any, of adopting the provisions of SAB 108 on our financial position, results of operations and liquidity. In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FAS 48"). The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Specifically, FAS 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The FAS 48 also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company is evaluating the impact of this new pronouncement on its consolidated financial statements. SFAS No. 123R "Share-Based Payment" ("SFAS 123R"), which the Company has adopted effective as of January 1, 2006, requires all share-based payments to employees, including grants of employee stock options, to be recognized as an expense in the Consolidated Statements of Operations based on their fair values as they are earned by the employees under the vesting terms. Pro forma disclosure of stock-based compensation expense, as was the Company's practice under SFAS 123, is not permitted after 2005, since SFAS 123R must be adopted no later than the first interim or annual period beginning after December 15, 2005. The Company followed the "modified prospective" method of adoption of SFAS 123R beginning in fiscal 2006, whereby earnings for prior periods are not to be restated as though stock based compensation had been expensed. In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error Corrections--A Replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS 154"). SFAS 154 requires retrospective application to prior periods' financial statements for changes in accounting principles, unless it is impractical to determine either the period-specific effects or the cumulative effects of a 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. The Company has adopted the provision of SFAS 154, as applicable, beginning in fiscal 2006. 14
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ---------------------------------------------------------------------------- 6. Line of Credit The Company and its subsidiaries are party to a loan agreement 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 2011. The weighted average interest rates under the Revolving Credit Facility for the thirty-nine weeks ended September 30, 2006 and October 1, 2005 were 8.8% and 6.0%, respectively. The amounts outstanding under the Revolving Credit Facility at September 30, 2006 and December 31, 2005 were $3.9 million at each date. At September 30, 2006, the Company had availability for additional borrowing under the Revolving Credit Facility of $21.0 million. The fifth amended Revolving Credit Facility extended the previous amended agreement from August 2006 until August 2011and the other terms and conditions remain principally the same as the previous amendment. 7. Interest Expense, Net Interest expense, net consisted of the following: <TABLE> <CAPTION> Thirty-Nine Thirty-Nine Thirteen Weeks Thirteen Weeks Weeks Ended Weeks Ended Ended Ended September 30, October 1, 2005 September 30, October 1, 2005 2006 2006 ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Interest expense $464,161 $427,722 $114,543 $144,203 Interest income (259,918) (256,220) (39,743) (80,740) ---------------------------------------------------------------------------------------------- $204,243 $171,502 $74,800 $63,463 ============================================================================================== </TABLE> 8. Goodwill and Intangibles SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") requires the Company to perform a goodwill impairment test on at least an annual basis. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for the businesses, the useful life over which cash flows will occur and determination of our weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions on goodwill impairment for each reporting unit. The Company conducts its annual goodwill impairment test as of November 30. The Company compares the fair value of each of its reporting units to their respective carrying values, including related goodwill. Future changes in the industry could impact the market multiples of comparable businesses and consequently could impact the results of future annual impairment tests. There were no events during the thirty-nine weeks ended September 30, 2006 that have indicated a need to perform the impairment test prior to the Company's annual test date. 15
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 8. Goodwill and Intangibles (Continued) The changes in the carrying amount of goodwill for the thirty-nine weeks ended September 30, 2006 are as follows (in thousands): <TABLE> <CAPTION> Information Technology Engineering Commercial Total ---- --------------------------------- -- -------------- -- ------------- -- ------------- --- ------------ <S> <C> <C> <C> <C> <C> Balance as of December 31, 2005 $30,132 $7,528 $37,660 Goodwill acquired during the period 451 451 ---- --------------------------------- -- -------------- -- ------------- -- ------------- --- ------------ Balance as of September 30, 2006 $30,132 $7,979 $38,111 ====================================== == ============== == ============= == ============= === ============ </TABLE> 9. Accounts Payable <TABLE> Accounts payable and accrued expenses consisted of the following at September 30, 2006 and December 31, 2005: September 30, December 31, 2006 2005 ------------------------------------------------------------------------------------- <S> <C> <C> Accounts payable - trade $9,437,434 $5,649,920 Due to sellers 270,892 794,894 Reserve for litigation 8,534,313 ------------------------------------------------------------------------------------- Total $9,708,326 $14,979,127 ===================================================================================== </TABLE> 10. Stockholders' Equity Common Stock Reserved <TABLE> <CAPTION> Shares of unissued common stock were reserved for the following purposes: September 30, December 31, 2006 2005 -------------------------------------------------------------------------------------- <S> <C> <C> Exercise of options outstanding 1,819,500 1,935,483 Future grants of options 28,694 36,486 -------------------------------------------------------------------------------------- Total 1,848,194 1,971,969 ====================================================================================== </TABLE> 16
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 11. Stock - Based Compensation Effective with the fiscal year ending December 30, 2006, the Company has adopted SFAS 123R. SFAS 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost is measured based on the fair value of the equity or liability instruments issued. SFAS 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. In addition to the accounting standard that sets forth the financial reporting objectives and related accounting principles, SFAS 123R includes an appendix of implementation guidance that provides expanded guidance on measuring the fair value of share-based payment awards. SFAS 123R replaces SFAS 123, Accounting for Stock-Based Compensation ("SFAS 123"), and supersedes Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"). SFAS 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, SFAS 123 permitted entities the option of continuing to apply the guidance in APB No. 25 as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. The impact of SFAS 123R, if it had been in effect, on the net earnings and related per share amounts of our fiscal years ended in December 31, 2005, January 1, 2005 and December 27, 2003 were disclosed in Note 1 Summary of Significant Accounting Policies - Stock-Based Compensation of the Company's Financial Statements included in our Form 10-K for the fiscal year ended December 31, 2005. Since the Company adopted SFAS 123R using the modified-prospective-transition-method, prior periods have not been restated. Under this method, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding as of the beginning of the period of adoption. The Company measured share-based compensation cost using the Black-Scholes option pricing model. At September 30, 2006, the Company has four share-based employee compensation plans. Share-based compensation of $692,675, or $0.06 per share, was recognized for the thirty-nine weeks ended September 30, 2006. Share-based compensation of $99,359, or $0.01 per share, was recognized for the thirteen weeks ended September 30, 2006. The Company anticipates that share-based compensation will not exceed $832,000 or approximately $0.07 per share for the year ending December 30, 2006. Reported net income, adjusting for share-based compensation that would have been recognized for the thirteen weeks and thirty-nine weeks ended October 1, 2005 if SFAS 123R had been followed, is (in thousands, except per share amounts): 17
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 11. Stock - Based Compensation (Continued) <TABLE> <CAPTION> October 1, 2005 ------------------------------------- Thirteen Thirty-Nine Weeks Ended Weeks Ended ---------------------------------------- ------------------ ---------------- <S> <C> <C> Net income, as reported $717 $2,718 Less: stock-based compensation costs determined under fair value based method for all awards 286 414 ---------------------------------------- ------------------ ---------------- Adjusted net income $431 $2,304 ================== ================ Earnings per share of common stock-basic: As reported $.06 $.24 Share-based compensation costs (.02 ) (.04 ) Adjusted net income $.04 $.20 Earnings per share of common stock-diluted: As reported $.06 $.23 Share-based compensation costs (.02 ) (.03 ) Adjusted net income $.04 $.20 </TABLE> The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model. There were options to purchase 12,000 shares of common stock granted during the thirty-nine weeks ended September 30, 2006, of which 2,000 were granted in the thirteen weeks ended September 30, 2006. The share-based compensation expense attributable to the 12,000 options was $1,117 and $2,818 for the thirteen weeks and thirty-nine weeks ended September 30, 2006, respectively. Expected volatility is based on the historical volatility of the price of our common stock since January 2, 2001. We use historical information to estimate expected life and forfeitures within the valuation model. The expected term of awards represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Compensation cost is recognized using a straight-line method over the vesting or service period and is net of estimated forfeitures. The stock price volatility, risk free interest rate and annualized forfeiture rate was 58.0%, 4.6% and 5.7% for the thirty-nine weeks ended September 30, 2006. As of September 30, 2006, we have approximately $1.0 million of total unrecognized compensation cost related to non-vested awards granted under our various share-based plans, which we expect to recognize over a weighted-average period of 1.9 years. These amounts do not include the cost of any additional options that may be granted in future periods nor any changes in the Company's forfeiture rate. We received cash from options exercised during the first thirty-nine weeks of fiscal years 2006 and 2005 of $180,206 and $192,295, respectively. The impact of these cash receipts is included in financing activities in the accompanying consolidated statements of cash flows. 18
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ---------------------------------------------------------------------------- 11. Stock - Based Compensation (Continued) 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 September 30, 2006, options to purchase 83,455 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 September 30, 2006, 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 in August 1996 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 September 30, 2006, options to purchase 1,064,545 shares of common stock were outstanding. 2000 Employee Stock Incentive Plan (the 2000 Plan) The 2000 Plan, approved by the Company's stockholders in April 2001, 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. 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 September 30, 2006, options to purchase 28,694 shares of common stock were available for future grants, and options to purchase 601,500 shares of common stock were outstanding. 19
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------- 11. Stock - Based Compensation (Continued) 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 September 30, 2006, there were 15,318 shares issued under the Purchase Plan for net proceeds of $65,408. As of September 30, 2006, there were 243,640 shares available for issuance under the Purchase Plan. The share based compensation expense attributable to the 15,318 shares issued was $11,489 and $-0- for the thirty-nine weeks and thirteen weeks ended September 30, 2006, respectively. 12. Income Taxes As of December 31, 2002, the Company had accrued approximately $2.5 million for income tax liabilities, which related to the potential repayment of tax benefits associated with tax deductions taken as a result of goodwill impairments. On June 8, 2006, the goodwill impairment deductions of approximately $13.5 million were disallowed by the Internal Revenue Service as a deduction in the December 31, 2002 income tax return. Based upon the methodology applied by the Internal Revenue Service, these deductions are best substantiated by facts and circumstances arising during 2005 and thus such deductions are included in the December 31, 2005 federal income tax return. This reclassification of the deduction from the year ended December 31, 2002 to the year ended December 31, 2005 results in the reversal of the income tax accrual of approximately $1.0 million, (equivalent to $.08 earnings per share diluted) the impact of which is included in the statement of income for the thirty-nine weeks ended September 30, 2006. The remaining income tax accrual of $1.5 million has been reserved for estimated unbilled interest and estimated disallowed tax net operating loss deductions. 20
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- 13. Segment Information The Company follows SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), which establishes standards for companies to report information about operating segments, geographic areas and major customers. SFAS 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 September 30, 2006 Technology Engineering Commercial Corporate Total ------------------------------ - --------------- - -------------- --- -------------- ------------- - ------------- <S> <C> <C> <C> <C> Revenue $74,759 $40,589 $32,381 $147,729 Operating expenses (1) (2) 70,157 39,942 30,989 141,088 ------------------------------ - --------------- - -------------- --- -------------- ------------- - ------------- EBITDA ((4)) 4,602 647 1,392 6,641 Depreciation 394 363 127 884 Amortization of intangibles 215 15 230 ------------------------------ - --------------- - -------------- --- -------------- ------------- - ------------- Operating income 3,993 269 1,265 5,527 Interest expense, net of (interest income) 103 56 45 204 Loss on foreign currency transactions 16 16 Income taxes 931 49 307 1,287 ------------------------------ - --------------- - -------------- --- -------------- ------------- - ------------- Net income $2,959 $148 $913 $4,020 ============================== = =============== = ============== === ============== ============= = ============= Total assets $50,152 $26,316 $13,069 $16,417 $105,954 Capital expenditures $146 $890 $305 $1,341 </TABLE> 21
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- 13. Segment Information (Continued) <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 35,308 24,580 128,523 ------------------------------------------------------------------------------------------------------------------- EBITDA (4) 4,478 21 775 5,274 Depreciation 407 277 117 801 ------------------------------------------------------------------------------------------------------------------- Operating income (loss) 4,071 (256 ) 658 4,473 Interest expense, net of (interest income) 94 45 33 172 Loss on foreign currency transactions 6 6 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> 22
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 13. Segment Information (Continued) <TABLE> <CAPTION> Thirteen Weeks Ended Information September 30, 2006 Technology Engineering Commercial Corporate Total --------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Revenue $25,872 $15,504 $10,274 $51,650 Operating expenses (1) (3) 24,045 14,985 9,919 48,949 --------------------------------------------------------------------------------------------------------------------- EBITDA (4) 1,827 519 355 2,701 Depreciation 136 130 40 306 Amortization of intangibles 72 15 87 --------------------------------------------------------------------------------------------------------------------- Operating income 1,619 374 315 2,308 Interest expense, net of interest income 37 22 16 75 Loss on foreign currency transactions 5 5 Income taxes 624 70 185 879 --------------------------------------------------------------------------------------------------------------------- Net income $958 $277 $114 $1,349 ===================================================================================================================== Total assets $50,152 $26,316 $13,069 $16,417 $105,954 Capital expenditures $149 $149 </TABLE> 23
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 13. 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 11,281 8,553 41,948 ------------------------------ - --------------- - -------------- -- -------------- - ------------ -- ------------- EBITDA (4) 1,450 (93 ) 86 1,443 Depreciation 137 94 42 273 ------------------------------ - --------------- - -------------- -- -------------- - ------------ -- ------------- Operating income (loss) 1,313 (187 ) 44 1,170 Interest expense, net of interest income 35 15 12 63 Loss on foreign currency transactions 2 2 Income taxes (benefit) 447 (71 ) 11 387 ------------------------------ - --------------- - -------------- -- -------------- - ------------ -- ------------- Net income (loss) $831 ($135 ) $21 $717 ============================== = =============== = ============== == ============== = ============ == ============= Total assets $52,173 $21,200 $9,890 $20,568 $103,831 Capital expenditures $56 $25 $81 <FN> (1) Operating expenses exclude depreciation and amortization. (2) Operating expenses include $692,675 of stock based compensation expense for the thirty-nine weeks ended September 30, 2006. (3) Operating expenses include $99,359 of stock based compensation expense for the thirteen weeks ended September 30, 2006. (4) EBITDA means earnings before interest, 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 and unusual 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 generally accepted accounting principles. </FN> </TABLE> 24
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 13. Segment Information (Continued) Revenues reported for each operating segment are from external customers. 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 September 30, 2006 and October 1, 2005 are as follows (in thousands): <TABLE> <CAPTION> Thirty-Nine Weeks Ended ----------------------------------------------------------------------------------- September 30, October 1, 2006 2005 ----------------------------------------------------------------------------------- Revenues <S> <C> <C> U. S. $139,524 $122,553 Canada 8,205 11,243 ----------------------------------------------------------------------------------- $147,729 $133,796 =================================================================================== Fixed Assets U. S. $4,397 $4,073 Canada 79 186 ----------------------------------------------------------------------------------- $4,476 $4,259 =================================================================================== </TABLE> Revenues by geographic area for the thirteen weeks ended September 30, 2006 and October 1, 2005 are as follows (in thousands): <TABLE> <CAPTION> Thirteen Weeks Ended ----------------------------------------------------------------------------------- September 30, October 1, 2006 2005 ----------------------------------------------------------------------------------- Revenues <S> <C> <C> U. S. $48,564 $39,971 Canada 3,086 3,419 ----------------------------------------------------------------------------------- $51,650 $43,390 =================================================================================== </TABLE> 25
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 14. Contingencies In late 1998, two shareholders who were formerly officers and directors of the Company filed suit against the Company alleging 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 acquisition transaction pursuant to which the plaintiffs became shareholders of the Company. The plaintiffs claimed damages in an amount equal to the difference between the amounts for which they 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. A trial resulted in an August 2003 judgment in favor of the plaintiffs for $7.6 million that the Company unsuccessfully appealed in the New Jersey appellate courts. In June 2006, the plaintiffs were paid $8,622,458 to satisfy and cancel the judgment. The payment did not affect the financial position of the Company as of September 30, 2006. In November 2002, the Company brought suit 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) the amount paid to satisfy the judgment; and (3) its costs and counsel fees incurred in the prosecution of the legal malpractice action itself. In September 2005, the Company and the various attorney and law firm defendants agreed to the dismissal of the original suit and the filing of a new action against the same defendants in another section of the Superior Court of New Jersey. The complaint in the new action, in which the Company has asserted certain additional claims against the defendants, was filed in October 2005. Discovery proceedings are continuing, and a trial will likely be scheduled for early 2007. 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. 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 RCM Technologies, Inc. ("RCM" or 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; and 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 from such statements. 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) adverse effects on the market price of the Company's common stock due to the potential resale into the market of significant amounts of common stock; (vii) the adverse effect a potential 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 market that is cyclical in nature and extremely sensitive to economic changes. As a result, the impact of economic changes on revenues and operations can be volatile. RCM's operational performance in 2005 gained momentum with a moderate increase in revenues and earnings over the comparable period in 2004. This was attributed to an improvement in the general economy, strength in our sector and increased capital spending by clients in selected markets. Certain business units of the Company benefited from stronger economic conditions, specifically in our (Engineering) and (Commercial) segments. So far in 2006, RCM's financial performance has shown further modest improvement across all of the Company's business units due to the continued strengthening of the economy and the Company's receipt of several key contracts. In addition, RCM's management continues to monitor its operating cost structure with a strong focus on working capital management and cash flows. Over the years RCM has developed and assembled an attractive portfolio of capabilities, established a proven record of performance and credibility, and built an efficient pricing structure. The Company is committed to optimizing its business model as a single-source premier provider of business and technology solutions with a strong vertical focus offering an integrated suite of services through a global delivery platform. The Company believes that most companies recognize the importance of advanced technologies and business processes to compete in today's business climate. However, the process of designing, developing and implementing business and technology solutions is becoming increasingly complex. The Company believes that many businesses today are focused on return on investment analysis in prioritizing their initiatives. This has an impact on spending by current and prospective clients for many emerging new solutions. Nonetheless, the Company continues to believe that businesses must implement more advanced IT and engineering solutions to upgrade their systems, applications and processes so that they can maximize their productivity and optimize their performance in order to maintain a competitive advantage. Although working under budgetary, personnel and expertise constraints, companies are driven to support increasingly complex systems, applications and processes of significant strategic value. This has given rise to a demand for outsourcing. The Company believes that its current and prospective clients are continuing to evaluate the potential for outsourcing business critical systems, applications and processes. 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 are provided. 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 the allocation of the purchase price of an acquisition, which has been assigned to covenants not to compete, and customer lists. Acquisitions have been accounted for under SFAS No. 141 "Business Combinations," and have created goodwill. Critical Accounting Policies The consolidated 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 effect 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 consulting/staffing services. The Company's Engineering Services and Information Technology Services segments also perform project services. All of the Company's segments derive revenue from permanent placement fees. Project Services - The Company recognizes revenues in accordance with the Securities and Exchange Commission, Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition" ("SAB 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) Consulting/Staffing Services - Revenues derived from consulting/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 allowance 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 Goodwill represents the excess of the cost of businesses acquired over the fair market value of identifiable assets. In accordance with SFAS 142, "Goodwill and Other Intangible Assets," the Company performs its annual goodwill impairment testing, by reportable segment, in the fourth quarter, or more frequently if events or changes in circumstances indicate that goodwill may be impaired. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for the businesses, the useful life over which cash flows will occur, and determination of our weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions on goodwill impairment for each reporting unit. The Company conducted its annual goodwill impairment test for 2005 as of November 30, 2005 and identified no impairments. Goodwill at September 30, 2006 and December 31, 2005 was $38,111,000 and $37,660,000, respectively. Long-Lived Assets The Company evaluates long-lived assets and intangible assets with definite lives for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When it is probable that undiscounted future cash flows will not be sufficient to recover an asset's carrying amount, the asset is written down to its fair value. Assets to be disposed of by sale, if any, are reported at the lower of the carrying amount or fair value less cost to sell. 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 in the United States had allowed alternative methods of accounting for these awards. The Company had chosen to account for its stock plans (including stock option plans) under APB 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 Consolidated Statement of Income for periods ended prior to January 1, 2006. SFAS 123R replaces SFAS 123 and supersedes APB No. 25. SFAS 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, SFAS 123 permitted entities the option of continuing to apply the guidance in APB 25 as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. The impact of SFAS 123R, if it had been in effect, on the net earnings and related per share amounts of our fiscal years ended in December 31, 2005, January 1, 2005 and December 27, 2003 were disclosed in Note 1 Summary of Significant Accounting Policies - Stock-Based Compensation of our Financial Statements included in our Form 10-K for the fiscal year ended December 31, 2005. Since the Company adopted SFAS 123R, effective January 1, 2006 using the modified-prospective-transition-method, prior periods have not been restated. Under this method, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding as of the beginning of the period of adoption. The Company measured share-based compensation cost using the Black-Scholes option pricing model. 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 September 30, 2006, the Company had total net deferred tax assets of $4.2 million, primarily representing the tax effect of a tax net operating loss carryfoward. 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. 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. economy 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, 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 September 30, 2006 Compared to Thirty-Nine Weeks Ended October 1, 2005 A summary of operating results for the fiscal periods ended September 30, 2006 and October 1, 2005 is as follows (in thousands, except for earnings per share data): <TABLE> <CAPTION> September 30, 2006 October 1, 2005 - -------------------------------------------------------------------------------------------------------------- % of % of Amount Revenue Amount Revenue - -------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Revenues $147,729 100.0 $133,797 100.0 Cost of services 110,566 74.8 102,478 76.6 - -------------------------------------------------------------------------------------------------------------- Gross profit 37,163 25.2 31,319 23.4 - -------------------------------------------------------------------------------------------------------------- Selling, general and administrative 30,521 20.7 26,045 19.5 Depreciation and amortization 1,115 .8 801 .6 - -------------------------------------------------------------------------------------------------------------- 31,636 21.5 26,846 20.1 - -------------------------------------------------------------------------------------------------------------- Operating income 5,527 3.7 4,473 3.3 Other (expense) income 220 0.1 178 0.1 - -------------------------------------------------------------------------------------------------------------- Income before income taxes 5,307 3.6 4,295 3.2 Income taxes 1,287 0.9 1,577 1.2 - -------------------------------------------------------------------------------------------------------------- Net income $4,020 2.7 $2,718 2.0 ============================================================================================================== Earnings per share Basic: $.34 $.24 Diluted: $.33 $.23 ============================================================================================================== </TABLE> The above summary is not a presentation of results of operations under generally accepted accounting principles in the United States of America 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 year to date reporting periods ended September 30, 2006 and October 1, 2005 consisted of thirty-nine weeks each. Revenues. Revenues increased 10.4%, or $13.9 million, for the thirty-nine weeks ended September 30, 2006 as compared to the same period in the prior year (the "comparable prior year period"). Revenues increased $1.6 million in the Information Technology ("IT") segment, increased $5.3 million in the Engineering segment, and increased $7.0 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 2006 to remain generally consistent on a prorated basis with the revenues for the thirty-nine weeks ended September 30, 2006. Revenues that were attributable to acquisitions since October 1, 2005 which were not included in the comparable prior year period were approximately $8.3 million. 33
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) - ------------------------------------------------------------------------------ Thirty-Nine Weeks Ended September 30, 2006 Compared to Thirty-Nine Weeks Ended October 1, 2005 (Continued) Cost of Services. Cost of services increased 7.9%, or $8.1 million, for the thirty-nine weeks ended September 30, 2006 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 decreased to 74.8% for the thirty-nine weeks ended September 30, 2006 from 76.6% for the comparable prior year period. This decrease was primarily attributable to increased revenues in the engineering segment which had higher gross margins as well as improved gross margins in the Commercial segment. Management anticipates the ratio of cost of sales to revenues for the remainder of fiscal 2006 to remain comparable to the thirty-nine weeks ended September 30, 2006. Selling, General and Administrative. Selling, general and administrative ("SGA") expenses increased 17.2%, or $4.5 million, for the thirty-nine weeks ended September 30, 2006 as compared to the comparable prior year period. As a percentage of revenues, SGA expenses were 20.7% for the thirty-nine weeks ended September 30, 2006 as compared to 19.5% for the comparable prior year period. This increase was primarily attributable to increased sales costs on higher revenues as well as additional administrative costs incurred from two acquisitions since September 30, 2005. Management reasonably expects SGA expenses for the remainder of fiscal 2006 to remain consistent with the SGA expenses for the thirty-nine weeks ended September 30, 2006. Depreciation and Amortization. Depreciation and amortization ("DA") increased 39.2%, or $314,000 for the thirty-nine weeks ended September 30, 2006 as compared to the comparable prior year period. This increase was attributable to the amortization of intangibles in the amount of $230,000 incurred subsequent to September 30, 2005. 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 September 30, 2006, actual interest expense of $464,000 was offset by $260,000 of interest income, which was principally earned from restricted cash and short-term money market deposits. Interest expense, net increased $129,000 for the thirty-nine weeks ended September 30, 2006 as compared to the comparable prior year period. This increase was primarily due to increased borrowing requirements as well as an increase in weighted average interest rates on borrowed funds. Losses on foreign currency transactions increased $9,000 in the thirty-nine weeks ended September 30, 2006 as compared to the comparable prior year period. This modest increase was attributable to the increase in the number of foreign currency transactions. Income Tax. Income tax expense decreased 18.4%, or $290,000, for the thirty-nine weeks ended September 30, 2006 as compared to the comparable prior year period. This decrease was attributable to a reversal of $1.0 million ($.08 diluted earnings per share) of previously accrued income taxes. (See footnote 12 to the consolidated financial statements). The effective tax rate before the reversal was 43.0% for the thirty-nine weeks ended September 30, 2006 as compared to 36.7% for the comparable prior year period. The increase in effective tax rate was attributable to the increased amount of non-tax-deductible amortization in relation to increased income before income tax purposes. 34
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) - ---------------------------------------------------------------------------- Thirty-Nine Weeks Ended September 30, 2006 Compared to Thirty-Nine Weeks Ended October 1, 2005 - (Continued) Segment Discussion (See Footnote 13) Information Technology IT revenues of $74.7 million in 2006 increased $1.6 million, or 2.3%, compared to 2005. The increase in revenue was attributable to the strengthening of demand for the Company's IT services. The IT segment EBITDA was $4.6 million, or 69.3% of the overall EBITDA for 2006, as compared to $4.5 million, or 84.9% of the overall EBITDA, for 2005. Engineering Engineering revenues of $40.6 million in 2006 increased $5.3 million, or 14.9%, compared to 2005. The increase in revenue was attributable to the strengthening of demand for the Company's engineering services. The Engineering segment EBITDA was $647,000, or 9.7% of the overall EBITDA for 2006, as compared to $20,000, or 0.4% of the overall EBITDA for 2005. Commercial Commercial revenues of $32.4 million in 2006 increased $7.0 million, or 27.8% compared to 2005. The increase in revenues was attributable to improvement in economic activity within this segment. The Commercial segment EBITDA was $1.4 million, or 21.0% of the overall EBITDA, as compared to $775,000, or 14.7% of the overall EBITDA for 2005. 35
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) - ---------------------------------------------------------------------------- Thirteen Weeks Ended September 30, 2006 Compared to Thirteen Weeks Ended October 1, 2005 A summary of operating results for the fiscal periods ended September 30, 2006 and October 1, 2005 is as follows (in thousands, except for earnings per share data): <TABLE> <CAPTION> September 30, 2006 October 1, 2005 - -------------------------------------------------------------------------------------------------------------- % of % of Amount Revenue Amount Revenue - -------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Revenues $51,650 100.0 $43,390 100.0 Cost of services 38,698 74.9 33,237 76.6 - -------------------------------------------------------------------------------------------------------------- Gross profit 12,952 25.1 10,153 23.4 - -------------------------------------------------------------------------------------------------------------- Selling, general and administrative 10,251 19.8 8,710 20.1 Depreciation and amortization 393 .8 273 .6 - -------------------------------------------------------------------------------------------------------------- - - 10,644 20.6 8,983 20.7 - -------------------------------------------------------------------------------------------------------------- Operating income 2,308 4.5 1,170 2.7 Other expense 80 .2 66 .2 - -------------------------------------------------------------------------------------------------------------- Income before income taxes 2,228 4.3 1,104 2.5 Income taxes 879 1.8 387 .9 - -------------------------------------------------------------------------------------------------------------- Net income $1,349 2.5 $717 1.6 ============================================================================================================== Earnings per share Basic: $.11 $.06 Diluted: $.11 $.06 ============================================================================================================== </TABLE> The above summary is not a presentation of results of operations under generally accepted accounting principles in the United States of America 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 second quarter reporting periods ended September 30, 2006 and October 1, 2005 consisted of thirteen weeks each. Revenues. Revenues increased 19.0%, or $8.3 million, for the thirteen weeks ended September 30, 2006 as compared to the same period in the prior year (the "comparable prior year period"). The revenue increased $2.3 million in the IT segment, increased $4.3 million in the Engineering segment and increased $1.6 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 remaining fiscal quarter to remain generally consistent with the thirteen weeks ended September 30, 2006. Revenues that were attributable to acquisitions since October 1, 2005 which were not included in the comparable prior year period were approximately $3.1 million. 36
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) - ----------------------------------------------------------------------------- Thirteen Weeks Ended September 30, 2006 Compared to Thirteen Weeks Ended October 1, 2005 - (Continued) Cost of Services. Cost of services increased 16.4%, or $5.5 million, for the thirteen weeks ended September 30, 2006 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 decreased to 74.9% for the thirteen weeks ended September 30, 2006 from 76.6% for the comparable prior year period. This decrease was attributable to the change in revenue amounts in each segment year over year and the related gross margin percentages from each segment (See segment discussion on page 37). Management anticipates the ratio of cost of sales to revenues for the remainder of fiscal 2006 to decrease as compared to the thirteen weeks ended October 1, 2005, which is consistent with historical performance. Selling, General and Administrative. SGA expenses increased 17.7%, or $1.5 million, for the thirteen weeks ended September 30, 2006 as compared to the comparable prior year period. As a percentage of revenues, SGA expenses were 19.8% for the thirteen weeks ended September 30, 2006 as compared to 20.1% for the comparable prior year period. This percentage decrease was primarily attributable to higher revenues in which to absorb fixed costs, which was partially offset by additional administrative costs incurred from two acquisitions since September 30, 2005. Management reasonably expects SGA expenses for the remainder of fiscal 2006 to remain consistent with the SGA expenses for the thirteen weeks ended September 30, 2006. Depreciation and Amortization. DA increased 44.0%, or $120,000, for the thirteen weeks ended September 30, 2006 as compared to the comparable prior year period. This increase was attributable to the amortization of intangibles in the amount of $87,000 incurred subsequent to September 30, 2005. 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 September 30, 2006, actual interest expense of $115,000 was offset by $40,000 of interest income, which was principally earned from restricted cash and short-term money market deposits. Interest expense, net increased $11,000 for the thirteen weeks ended September 30, 2006 as compared to the comparable prior year period. This increase was primarily due to increased borrowing requirements as well as an increase in weighted average interest rates on borrowed funds. Gains on foreign currency transactions increased $3,000 in the thirteen weeks ended September 30, 2006 as compared to the comparable prior year period. Income Tax. Income tax expense increased 127.1%, or $492,000, for the thirteen weeks ended September 30, 2006 as compared to the comparable prior year period. The effective tax rate before the reversal of $1.0 million of previously accrued income taxes (See footnote 12 to the consolidated financial statements) was 39.5% for the thirteen weeks ended September 30, 2006 as compared to 35.1% for the comparable prior year period. The increase in effective tax rate was attributable to the increased amount of non-tax-deductible amortization in relation to increased 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 September 30, 2006 Compared to Thirteen Weeks Ended October 1, 2005 - (Continued) Segment Discussion (See Footnote 13) Information Technology IT revenues of $25.9 million in 2006 increased $2.3 million, or 9.8%, compared to 2005. The increase in revenue was attributable to the strengthening of demand for the Company's IT services. The IT segment EBITDA was $1.8 million, or 67.6% of the overall EBITDA, for 2006 as compared to $1.5 million, or 101% of the overall EBITDA, for 2005. Engineering Engineering revenues of $15.5 million in 2006 increased $4.3 million, or 38.6%, compared to 2005. The increase in revenue was attributable to the strengthening of demand for the Company's engineering services. The Engineering segment EBITDA was $519,000, or 19.2% of the overall EBITDA for 2006 as compared to an EBITDA loss of $94,000 for 2005. Commercial Commercial revenues of $10.3 million in 2006 increased $1.6 million, or 18.9% compared to 2005. The increase in revenue was attributable to improvement in economic activity within this segment. The Commercial segment EBITDA was $355,000, or 13.2% of the overall EBITDA, as compared to $86,000, or 6.0% of the overall EBITDA for 2005. 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: <TABLE> <CAPTION> Thirty-Nine Weeks Ended ----------------------------------------- September 30, October 1, 2006 2005 ------------------ -- ------------------- (In thousands) ----------------------------------------- <S> <C> <C> Operating Activities $4,582 $2,597 Investing Activities ($1,978) $237 Financing Activities $246 ($727) </TABLE> Operating Activities Operating activities provided $4.6 million of cash for the thirty-nine weeks ended September 30, 2006 as compared to $2.6 million for the comparable 2005 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 accrued compensation, an increase in payroll and withheld taxes and a decrease in restricted cash, which was offset by an increase in accounts receivable, an increase in deferred tax assets, a decrease in accounts payable and accrued expenses, and a decrease in income taxes payable. 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 2006. The Company continues to institute enhanced controls and standardization over its receivables collection and disbursement processes. Investing Activities Investing activities used $2.0 million for the thirty-nine weeks ended September 30, 2006 as compared to $237,000 for the comparable 2005 period. The increase in the use of cash for investing activities for 2006 as compared to the comparable 2005 period was primarily attributable to an increase in expenditures for property and equipment and cash used for acquisitions. Financing Activities Financing activities principally consisted of the sale of stock for the employee stock purchase plan and the exercise of stock options of $246,000 in 2006 as compared to debt reduction of $1.0 million of debt for the comparable 2005 period. The Company and its subsidiaries are party to a loan agreement 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 2011. The weighted average interest rates under the Revolving Credit Facility for the thirty-nine weeks ended September 30, 2006 and October 1, 2005 were 8.8% and 6.0%, respectively. The amounts outstanding under the Revolving Credit Facility at September 30, 2006 and December 31, 2005 were $3.9 million at each date. At September 30, 2006, 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-term 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 subject to 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. 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'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 September 30, 2006, the Company had a deferred tax asset totaling $4.2 million, primarily representing the tax effect of a tax net operating loss carryfoward. The Company expects to utilize the deferred tax asset during the twelve months ending September 29, 2007 by offsetting the related tax benefits of such assets against tax liabilities incurred from forecasted taxable income. Summarized below are the Company's obligations and commitments to make future payments under lease agreements and debt obligations as of September 30, 2006 (in thousands): <TABLE> <CAPTION> Payments Due by Period - --------------------------------------------------------------------------------------------------------------- Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years - --------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Long-Term Debt Obligations (1) $3,900 $3,900 Operating Lease Obligations 8,365 2,497 $3,297 $2,571 - --------------------------------------------------------------------------------------------------------------- Total $12,265 $6,397 $3,297 $2,571 =============================================================================================================== <FN> (1) The Revolving Credit Facility is for $25.0 million and includes a sub-limit of $5.0 million for letters of credit. The agreement expires in August 2011. At September 30, 2006, there was an outstanding letter of credit for $116,000. </FN> </TABLE> 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 September 30, 2006, 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 90 basis points) increase in interest rates on its variable debt (using average debt balances during the thirty-nine weeks ended September 30, 2006 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 information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, 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 See discussion of Legal Proceedings in Note 14 to the consolidated financial statements included in Item 1 of this report. 42
RCM TECHNOLOGIES, INC. AND SUBSIDIARIES ITEM 6. EXHIBITS - ----------------------------------------------------------------------------- 10 (a) Fifth Amendment and Modification to Amended and Restated Loan and Security Agreement dated August 7, 2006, between RCM Technologies, Inc. and all of its Subsidiaries and Citizens Bank of Pennsylvania as Administrative Agent and Arranger. 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.) 43
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 9, 2006 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) 44
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 9, 2006 /s/ Leon Kopyt Leon Kopyt Chief Executive Officer 45
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 9, 2006 /s/ Stanton Remer Stanton Remer Chief Financial Officer 46
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 quarter ended September 30, 2006 (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 9, 2006 47
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 quarter ended September 30, 2006 (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 9, 2006 48