RCMT

Business Context and Reporting Period

Company: RCM Technologies, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Nine months ended July 31, 1999 (Unaudited)
Business Overview: A national provider of professional services and business solutions focusing on Information Technology, Professional Engineering, and Government Services. The company pursues an aggressive growth strategy through acquisitions and internal development to transition from staff augmentation to higher-margin project engagements.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 66.3% ($91.6 million) year-over-year, driven primarily by the completion of ten acquisitions and internal growth. Acquired companies contributed $94.0 million in revenue for the period.
• Profitability: Net income increased 66.0% to $10.9 million. Operating income rose 65.4% to $18.6 million. Gross margin remained stable at 23.9%.
• Expense Increases: Cost of services rose 66.4% due to higher salaries associated with revenue growth. Selling, general, and administrative (SG&A) expenses increased 63.9%, though as a percentage of revenue, SG&A decreased slightly from 15.1% to 14.9% due to operating leverage.
• Amortization: Depreciation and amortization expenses increased 117.2% ($1.1 million) due to the amortization of intangible assets from recent acquisitions.
• Cash Flow Deterioration: Operating cash flow turned negative, using $6.2 million compared to providing $0.3 million in the prior year. This was primarily caused by a $26.0 million increase in accounts receivable.
• Debt and Liquidity: The company utilized a $75 million Revolving Credit Facility, with $32.2 million outstanding as of July 31, 1999. Cash and cash equivalents decreased significantly from $22.2 million to $1.4 million due to acquisition spending ($47.1 million used in investing activities).

Guidance, Outlook, Risks, and Unusual Items

• Acquisition Strategy: Management anticipates continued growth through acquisitions. Future funding will be derived from the Revolving Credit Facility, operations, or future financing. The company has no material commitments for capital expenditures other than lease obligations.
• Contingent Consideration: The company is obligated to pay approximately $41.7 million in deferred consideration to selling shareholders of acquired businesses over the next few years (2000-2002) based on earnings targets. Earnouts are also possible but cannot be estimated with certainty.
• Year 2000 (Y2K) Compliance: The company is implementing a new SAP R/3 enterprise resource planning system to ensure Y2K compliance. The total cost is estimated at $2.2 million, with $1.9 million incurred as of the filing date. Management believes internal systems will be compliant by the end of 1999, though risks remain regarding third-party suppliers and customers.
• Risks: Key risks include economic conditions affecting staffing demand, the ability to integrate acquired businesses, uncertainties regarding earnout payments, and reliance on executive officers. The credit facility prohibits dividend payments without bank consent.

Investor Verification Checklist

• Accounts Receivable Quality: Verify the collectability of the $66.4 million in accounts receivable, which increased by $25.7 million and drove the negative operating cash flow.
• Acquisition Integration: Assess the performance of the ten companies acquired in the current period to ensure they meet the earnings targets required for deferred consideration payments.
• Debt Covenants: Review the financial standards required by the $75 million Revolving Credit Facility with Mellon Bank N.A. to ensure compliance.
• Y2K Contingency: Confirm the status of third-party vendor and customer Y2K compliance, as the company notes potential material impacts could originate from these external parties.
• Cash Burn Rate: Monitor the cash balance ($1.4 million) relative to the $32.2 million debt and ongoing acquisition spending to assess liquidity sufficiency for the next 12 months.