Envoy Communications Group Inc.
Second Quarter Report 2006
Dear Shareholders
Revenues for the quarter were $7.7 million compared to $10.2 million for the second quarter of 2005. Net earnings for the quarter were a loss of $0.4 million, or ($0.02) per common share, compared to net earnings of $0.8 million, or $0.04 per common share for the same period of 2005.
For the six months ended March 31, 2006, revenues were $16.4 million compared to $19.3 million for second quarter of 2005. Net earnings for the period were a loss of $1.6 million or ($0.07) per common share, compared to net earnings of $1.5 million or $0.06 per common share for the same period last year.
Envoy announced the launch of its Merchant Banking Division, Envoy Capital, during the second quarter. “We have and will continue to be very cautious in investing this capital. Our stated objective at the time we launched the Merchant Bank was to generate superior returns. However, we also understand the importance of preserving our capital and we are moving forward carefully as it is invested”, said Envoy’s CFO Joe Leeder. Our investment income for the six months ended March 31, 2006 was $1.4 million compared to $1.5 million for the six months ending March 31, 2005.
Envoy acquired an additional 5% of Parker Williams Design Limited in the United Kingdom at the beginning of March, 2006 and increased its ownership to 70%.
In the first six months of this fiscal year Envoy repurchased 70,200 shares under its normal course issuer bid program. As at March 31, 2006 there were 20,937,317 shares outstanding.
Going forward, Envoy’s management anticipates the company will be profitable and cash flow positive for the year.
Management’s discussion and analysis, containing a full analysis of financial results, is available on SEDAR.
Geoffrey B. Genovese
President, Chairman & CEO
Envoy Communications Group Inc.
NOTICE OF NO AUDITOR REVIEW OF INTERIM FINANCIAL STATEMENTS
Under National Instrument 51-102, Part 4, subsection 4.3(3)(a), if an auditor has not performed a review of the interim financial statements; they must be accompanied by a notice indicating that the financial statements have not been reviewed by an auditor.
The accompanying unaudited interim financial statements of the Company have been prepared by and are the responsibility of the Company’s management.
The Company’s independent auditor has not performed a review of these financial statements in accordance with standards established by the Canadian Institute of Chartered Accountants for a review of interim financial statements by an entity’s auditor.
Envoy Communications Group Inc.
Consolidated Balance Sheets
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Consolidated Balance Sheets
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
As at: | March 31 | September 30 | ||||||||||
2006 | 2005 | |||||||||||
Assets | ||||||||||||
Current | ||||||||||||
Cash | $ | 2,780,744 | $ | 4,209,920 | ||||||||
Investments | note 2 | 5,000,000 | 22,113,957 | |||||||||
Accounts receivable | 10,331,049 | 16,665,140 | ||||||||||
Future income taxes | 301,384 | 301,384 | ||||||||||
Prepaid expenses | 1,135,806 | 1,203,814 | ||||||||||
Loans receivable | note 9 | 265,082 | 265,082 | |||||||||
19,814,065 | 44,759,297 | |||||||||||
Investments | note 2 | 32,782,824 | 10,994,238 | |||||||||
Loans receivable | note 9 | 1,743,625 | 1,810,403 | |||||||||
Capital assets | note 5 | 6,564,573 | 6,879,312 | |||||||||
Goodwill | note 5 | 12,812,255 | 12,949,126 | |||||||||
Intangible assets | note 5 | 206,039 | 241,886 | |||||||||
Other assets | 9,176 | 9,176 | ||||||||||
Future income taxes | 5,901,786 | 5,308,089 | ||||||||||
$ | 79,834,343 | $ | 82,951,527 | |||||||||
Liabilities and Shareholders’ Equity
Current | ||||||||||||
Accounts payable and accrued liabilities | $ | 6,476,052 | $ | 7,663,658 | ||||||||
Income taxes payable | 435,925 | 456,459 | ||||||||||
Deferred revenue | 584,289 | 614,051 | ||||||||||
Current portion of long-term debt | note 4 | 92,114 | 108,925 | |||||||||
7,588,380 | 8,843,093 | |||||||||||
Long-term debt | note 4 | 209,974 | 252,093 | |||||||||
7,798,354 | 9,095,186 | |||||||||||
Minority interest | note 3 | 294,913 | 300,858 | |||||||||
Shareholders’ equity | ||||||||||||
Share capital | note 6 | 104,853,064 | 105,204,765 | |||||||||
Contributed surplus | 5,800,759 | 5,574,057 | ||||||||||
Warrants | 6,542,456 | 6,542,456 | ||||||||||
Deficit | (43,965,198 | ) | (42,402,587 | ) | ||||||||
Stock based compensation | note 8 | 834,430 | 789,792 | |||||||||
Cumulative translation adjustment | (2,324,435 | ) | (2,153,000 | ) | ||||||||
71,741,076 | 73,555,483 | |||||||||||
$ | 79,834,343 | $ | 82,951,527 | |||||||||
See accompanying notes to consolidated financial statements.
Envoy Communications Group Inc.
Consolidated Statements of Operations
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Consolidated Statements of Operations
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
For the six months ended: | March 31 | March 31 | ||||||||||
2006 | 2005 | |||||||||||
Net revenue | note 5 | $ | 16,397,691 | $ | 19,258,764 | |||||||
Operating expenses: | ||||||||||||
Salaries and benefits | note 8 | 12,616,952 | 12,533,269 | |||||||||
General and administrative | 2,860,849 | 3,693,070 | ||||||||||
Occupancy costs | 1,554,703 | 1,825,246 | ||||||||||
17,032,504 | 18,051,585 | |||||||||||
Depreciation | 1,043,505 | 1,175,446 | ||||||||||
Amortization of intangible assets | 35,629 | — | ||||||||||
Investment Earnings | note 2 | (1,423,234 | ) | (1,502,555 | ) | |||||||
Interest (income) expense and financing costs | (43,445 | ) | (21,846 | ) | ||||||||
16,644,959 | 17,702,630 | |||||||||||
(Loss) earnings before restructuring expense, income taxes, minority interest and discontinued operations | (247,268 | ) | 1,556,134 | |||||||||
Restructuring expense | note 10 | (1,856,417 | ) | — | ||||||||
(Loss) earnings before income taxes, minority interest and discontinued operations | (2,103,685 | ) | 1,556,134 | |||||||||
Income tax (recovery) expense | (818,565 | ) | 29,185 | |||||||||
(Loss) earnings before minority interest and discontinued operations | (1,285,120 | ) | 1,526,949 | |||||||||
Minority interest | note 3 | 277,491 | 8,012 | |||||||||
(Loss) earnings from continuing operations | (1,562,611 | ) | 1,518,937 | |||||||||
(Loss) earnings from discontinued operations, net of income taxes | note 7 | — | (60,188 | ) | ||||||||
Net (loss) earnings | $ | (1,562,611 | ) | $ | 1,458,749 | |||||||
(Loss) earnings per share | ||||||||||||
Basic | $ | (0.07 | ) | $ | 0.06 | |||||||
Diluted | $ | (0.07 | ) | $ | 0.06 | |||||||
(Loss) earnings per share — continuing operations | ||||||||||||
Basic | $ | (0.07 | ) | $ | 0.07 | |||||||
Diluted | $ | (0.07 | ) | $ | 0.07 | |||||||
(Loss) earnings per share — discontinued operations | ||||||||||||
Basic | $ | — | $ | (0.00 | ) | |||||||
Diluted | $ | — | $ | (0.00 | ) | |||||||
Weighted average number of common shares outstanding — basic | 21,004,935 | 22,705,236 | ||||||||||
Weighted average number of common shares outstanding — fully diluted | 21,019,136 | 22,705,236 | ||||||||||
Envoy Communications Group Inc.
Consolidated Statement of Deficit
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Consolidated Statement of Deficit
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Deficit, beginning of period | $ | (42,402,587 | ) | $ | (48,344,277 | ) | ||
Net (loss) earnings | (1,562,611 | ) | 1,458,749 | |||||
Deficit, end of period | $ | (43,965,198 | ) | $ | (46,885,528 | ) | ||
See accompanying notes to consolidated financial statements.
Envoy Communications Group Inc.
Consolidated Statements of Cash Flows
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Consolidated Statements of Cash Flows
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
For the six months ended: | March 31 | March 31 | ||||||
2006 | 2005 | |||||||
Cash flows from operating activities: | ||||||||
Earnings (loss) from continuing operations | $ | (1,562,611 | ) | $ | 1,518,937 | |||
Items not involving cash: | ||||||||
Future income taxes | (593,697 | ) | (345,743 | ) | ||||
Depreciation | 1,043,505 | 1,175,446 | ||||||
Minority interest | 277,491 | 8,012 | ||||||
Amortization of intangible assets | 35,629 | — | ||||||
Stock based compensation | 44,638 | 306,641 | ||||||
Net change in non-cash working capital balances: | ||||||||
Accounts receivable | 6,334,091 | (155,721 | ) | |||||
Prepaid expenses | 68,008 | 131,474 | ||||||
Accounts payable and accrued liabilities | (1,187,606 | ) | (1,810,603 | ) | ||||
Income taxes payable/recoverable | (20,534 | ) | (191,381 | ) | ||||
Deferred revenue | (29,762 | ) | (646,390 | ) | ||||
Long-term restructuring costs | — | — | ||||||
Net cash provided by operating activities | 4,409,152 | (9,328 | ) | |||||
Cash flows from financing activities: | ||||||||
Long-term debt repayments | (58,930 | ) | (211,088 | ) | ||||
Dividend payment to minority shareholders | (213,925 | ) | — | |||||
Share buy back under normal course issuers bid | (124,999 | ) | (4,517,102 | ) | ||||
Net cash (used in) provided by financing activities | (397,854 | ) | (4,728,190 | ) | ||||
Cash flows from investing activities: | ||||||||
Acquisition of subsidiaries, net of cash acquired of $62,727 ( 2005 — $730,496) | (42,031 | ) | (4,050,024 | ) | ||||
Loans receivable | 66,777 | — | ||||||
Purchase of capital assets | (728,766 | ) | (1,400,630 | ) | ||||
Investments | (4,674,628 | ) | 8,256,354 | |||||
Net cash provided by (used in) investing activities | (5,378,648 | ) | 2,805,700 | |||||
Change in cash balance due to foreign exchange | (61,826 | ) | (60,525 | ) | ||||
Discontinued operations | — | 20,444 | ||||||
Net change in cash | (1,429,176 | ) | (1,971,899 | ) | ||||
Cash,beginning of period | 4,209,920 | 4,643,263 | ||||||
Cash,end of period | $ | 2,780,744 | $ | 2,671,364 | ||||
Supplemental cash flow information: | ||||||||
Interest paid | $ | 15,572 | $ | 36,959 | ||||
Income taxes paid (received) | (162,051 | ) | 365,968 | |||||
See accompanying notes to consolidated financial statements.
Envoy Communications Group Inc.
Consolidated Statements of Operations
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Consolidated Statements of Operations
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
For the three months ended: | March 31 | March 31 | ||||||||||
2006 | 2005 | |||||||||||
Net revenue | note 5 | $ | 7,655,664 | $ | 10,156,871 | |||||||
Operating expenses: | ||||||||||||
Salaries and benefits | note 8 | 6,316,308 | 6,508,351 | |||||||||
General and administrative | 1,187,215 | 2,027,666 | ||||||||||
Occupancy costs | 764,351 | 946,482 | ||||||||||
8,267,874 | 9,482,499 | |||||||||||
Depreciation | 506,855 | 599,036 | ||||||||||
Amortization of intangible assets | 17,924 | — | ||||||||||
Investment Earnings | note 2 | (490,699 | ) | (487,038 | ) | |||||||
Interest (income) expense and financing costs | (26,645 | ) | (29,945 | ) | ||||||||
8,275,309 | 9,564,552 | |||||||||||
(Loss) earnings before income taxes, minority interest and discontinued operations | (619,645 | ) | 592,319 | |||||||||
Income tax (recovery) expense | (301,364 | ) | (233,541 | ) | ||||||||
(Loss) earnings before minority interest and discontinued operations | (318,281 | ) | 825,860 | |||||||||
Minority interest | note 3 | 116,796 | 8,012 | |||||||||
(Loss) earnings from continuing operations | (435,077 | ) | 817,848 | |||||||||
(Loss) earnings from discontinued operations, net of income taxes | note 7 | — | (5,729 | ) | ||||||||
Net (loss) earnings | $ | (435,077 | ) | $ | 812,119 | |||||||
(Loss) earnings per share | ||||||||||||
Basic | $ | (0.02 | ) | $ | 0.04 | |||||||
Diluted | $ | (0.02 | ) | $ | 0.04 | |||||||
(Loss) earnings per share — continuing operations | ||||||||||||
Basic | $ | (0.02 | ) | $ | 0.04 | |||||||
Diluted | $ | (0.02 | ) | $ | 0.04 | |||||||
(Loss) earnings per share — discontinued operations | ||||||||||||
Basic | $ | — | $ | (0.00 | ) | |||||||
Diluted | $ | — | $ | (0.00 | ) | |||||||
Weighted average number of common shares outstanding — basic | 20,999,739 | 22,329,631 | ||||||||||
Weighted average number of common shares outstanding — fully diluted | 21,013,941 | 22,329,631 | ||||||||||
Envoy Communications Group Inc.
Consolidated Statement of Deficit
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Consolidated Statement of Deficit
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Deficit, beginning of period | $ | (43,530,121 | ) | $ | (47,697,647 | ) | ||
Net (loss) earnings | (435,077 | ) | 812,119 | |||||
Deficit, end of period | $ | (43,965,198 | ) | $ | (46,885,528 | ) | ||
See accompanying notes to consolidated financial statements.
Envoy Communications Group Inc.
Consolidated Statements of Cash Flows
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
Consolidated Statements of Cash Flows
Unaudited — Prepared by Management
(Expressed In Canadian dollars)
For the three months ended: | March 31 | March 31 | ||||||
2006 | 2005 | |||||||
Cash flows from operating activities: | ||||||||
Earnings (loss) from continuing operations | $ | (435,077 | ) | $ | 817,848 | |||
Items not involving cash: | ||||||||
Future income taxes | (592,571 | ) | (693,686 | ) | ||||
Depreciation | 506,855 | 599,036 | ||||||
Minority interest | 116,796 | 8,012 | ||||||
Amortization of intangible assets | 17,924 | — | ||||||
Stock based compensation | 25,780 | 183,233 | ||||||
Net change in non-cash working capital balances: | ||||||||
Accounts receivable | 1,864,298 | (1,285,718 | ) | |||||
Prepaid expenses | 207,098 | (23,981 | ) | |||||
Accounts payable and accrued liabilities | (18,864 | ) | 969,257 | |||||
Income taxes payable/recoverable | 435,925 | 25,708 | ||||||
Deferred revenue | (100,981 | ) | (259,429 | ) | ||||
Long-term restructuring costs | (14,917 | ) | — | |||||
Net cash provided by operating activities | 2,012,266 | 340,280 | ||||||
Cash flows from financing activities: | ||||||||
Long-term debt repayments | (26,161 | ) | (62,056 | ) | ||||
Dividend payment to minority shareholders | (213,925 | ) | — | |||||
Share buy back under normal course issuers bid | (124,999 | ) | (2,138,700 | ) | ||||
Net cash (used in) provided by financing activities | (365,085 | ) | (2,200,756 | ) | ||||
Cash flows from investing activities: | ||||||||
Acquisition of subsidiaries, net of cash acquired of $62,727 (2005 — $730,496) | (42,031 | ) | (4,050,024 | ) | ||||
Loans receivable | 66,777 | — | ||||||
Purchase of capital assets | (340,694 | ) | (534,947 | ) | ||||
Investments | (2,669,230 | ) | 5,517,186 | |||||
Net cash provided by (used in) investing activities | (2,985,178 | ) | 932,215 | |||||
Change in cash balance due to foreign exchange | (188,628 | ) | (313,228 | ) | ||||
Discontinued operations | — | (380,521 | ) | |||||
Net change in cash | (1,526,625 | ) | (1,622,010 | ) | ||||
Cash,beginning of period | 4,307,369 | 4,293,374 | ||||||
Cash,end of period | $ | 2,780,744 | $ | 2,671,364 | ||||
Supplemental cash flow information: | ||||||||
Interest paid | $ | 7,446 | $ | 8,099 | ||||
Income taxes paid (received) | (162,051 | ) | 174,090 | |||||
See accompanying notes to consolidated financial statements.
1. | Basis of Presentation |
(a) | These unaudited interim consolidated financial statements have been prepared by management in accordance with generally accepted accounting principles in Canada for interim financial statements. These interim financial statements do not include all the note disclosure required for annual financial statements and therefore should be read in conjunction with Envoy’s annual consolidated financial statements for the year ended September 30, 2005. The significant accounting policies follow that of the most recently reported annual financial statements. | ||
(b) | Certain comparative figures have been reclassified to conform to the financial statement presentation adopted for 2006. |
2. | Investments |
March 31, | September 30, | |||||||
2006 | 2005 | |||||||
Short term | ||||||||
Cash | $ | 1,120,060 | $ | 1,217,017 | ||||
Discount securities | 3,879,940 | 20,896,940 | ||||||
$ | 5,000,000 | $ | 22,113,957 | |||||
Long term | ||||||||
Discount securities | $ | 490,927 | $ | 8,541,760 | ||||
Fixed income | 20,534,288 | 1,703,543 | ||||||
Equities | 11,757,609 | 748,935 | ||||||
$ | 32,782,824 | $ | 10,994,238 | |||||
Total investments | $ | 37,782,824 | $ | 33,108,195 | ||||
The portfolio is invested in marketable securities, including discount notes, fixed income securities and common shares. All financial instruments held in the portfolio are traded in active and liquid markets, and the fair market value of the portfolio was determined by using the closing market prices at March 31, 2006 of the individual financial instruments. At March 31, 2006, the discount securities mature within six months at the face value. The fixed income securities are interest bearing instruments with maturities up to ten years, and bear interest at rates that average 3.0%. | ||
The fair value of the short term and long term investments at March 31, 2006 was $5,000,000 and $32,922,291 (at September 30, 2005, $22,113,957 and $10,988,369), respectively. The investment portfolio earned $1,423,234 during the first two quarters ended March 31, 2006, compared to $1,502,555 for the same period in fiscal 2005, after deducting expenses. | ||
3. | Acquisition of subsidiary | |
On February 28, 2005, the Company through its subsidiary ECG Holdings (UK) Limited (“ECGH”), acquired 65% of the outstanding shares of Parker Williams Design Limited (“Parker Williams”), a London, UK based packaging design and brand specialist company. The purchase price of £1,818,000, equivalent to $4,324,113, was paid in cash on completion. The remaining 35% of the Parker Williams shares (“Management Shares”) will continue to be held by senior management of Parker Williams (“Management Shareholders”), subject to certain options described below. | ||
ECGH has the option to acquire from the Management Shareholders and the Management Shareholders will have the option to require ECGH to purchase from them, at various stages over a period of 4 years following completion, the Management Shares for a purchase price based on the profitability of Parker Williams for certain defined periods following completion. |
The acquisition has been accounted for using the purchase method of accounting. The fair value of the net assets acquired was £128,961 consisting of working capital and capital assets. The resulting excess purchase price, including acquisition expenses, over the fair value of the net assets acquired of £1,884,894 was allocated to goodwill and an amount of £139,000 was allocated to intangible assets consisting of customer relationships and non-compete agreements. | ||
In March 2006, the Company, through its subsidiary ECGH, acquired an additional 5% of the shares of Parker Williams from two former employees as per the terms and conditions of the sale and purchase agreement for £52,679 ($104,758). | ||
The additional acquisition has been accounted for using the purchase method of accounting. The fair value of the net assets acquired was £34,955 ($69,511) consisting of working capital and capital assets, resulting in goodwill of £17,725 ($35,247). | ||
Parker Williams acquisition in Canadian Dollars |
Original | Additional | |||||||
Assets acquired and liabilities assumed: | Acquisition | Acquisition | ||||||
(65%) | (5%) | |||||||
Total assets | $ | 1,796,438 | 2,489,308 | |||||
Total liabilities | (1,324,541 | ) | (1,099,084 | ) | ||||
Previously owned | — | (903,646 | ) | |||||
Minority interest | (165,164 | ) | (417,067 | ) | ||||
Net Assets acquired | 306,733 | 69,511 | ||||||
Intangible assets | 330,849 | — | ||||||
Goodwill | 4,152,369 | 35,247 | ||||||
Purchase price including costs | $ | 4,789,951 | $ | 104,758 | ||||
4. | Long term debt |
March 31 | September 30 | |||||||
2006 | 2005 | |||||||
Loan payable to landlord, 3.5% per annum, due July 1, 2009, repayable in monthly installments of $7,665 principal and interest | $ | 283,687 | $ | 324,341 | ||||
Capital leases, 8.6% to 14% over the lease period, repayable in monthly installments of $36,273 principal and interest, due between April 2006 and February 2007 | 18,401 | 36,677 | ||||||
302,088 | 361,018 | |||||||
Less current portion | 92,114 | 108,925 | ||||||
$ | 209,974 | $ | 252,093 | |||||
5. | Segmented information | |
The Company provides integrated marketing communication services to its clients. While the Company has subsidiaries in Canada, the United States, the United Kingdom and Continental Europe, it operates as an international business and has no distinct reportable business segments. | ||
The tables below set out the following information: |
(a) | The Company’s external net revenue | ||
Net revenue by region in which the customer is located |
March 31 | March 31 | |||||||
For the six months ended: | 2006 | 2005 | ||||||
Canada | $ | 2,831,025 | $ | 3,277,550 | ||||
United States | 2,344,521 | 5,040,204 | ||||||
United Kingdom and Continental Europe | 11,222,145 | 10,941,010 | ||||||
$ | 16,397,691 | $ | 19,258,764 | |||||
Net revenue by type of service |
March 31 | March 31 | |||||||
For the six months ended: | 2006 | 2005 | ||||||
Consumer and retail branding | $ | 16,397,691 | $ | 19,258,764 | ||||
(b) | The Company’s identifiable assets for each geographic area in which it has operations: | ||
Capital assets |
March 31 | September 30 | |||||||
As at: | 2006 | 2005 | ||||||
Canada | $ | 2,344,848 | $ | 2,755,415 | ||||
United Kingdom and Continental Europe | 4,219,725 | 4,123,897 | ||||||
$ | 6,564,573 | $ | 6,879,312 | |||||
Goodwill |
March 31 | September 30 | |||||||
As at: | 2006 | 2005 | ||||||
Canada | $ | 2,725,296 | $ | 2,725,296 | ||||
United Kingdom and Continental Europe | 10,086,959 | 10,223,830 | ||||||
$ | 12,812,255 | $ | 12,949,126 | |||||
Intangible assets |
March 31 | September 30 | |||||||
As at: | 2006 | 2005 | ||||||
United Kingdom and Continental Europe | $ | 206,039 | $ | 241,886 | ||||
6. | Share capital | |
Authorized: 40,000,000 common shares without par value | ||
Issued: |
Six months ended | Fiscal year ended | |||||||||||||||
March 31, 2006 | September 30, 2005 | |||||||||||||||
Number | Number | |||||||||||||||
of shares | Amount | of shares | Amount | |||||||||||||
Balance, beginning of period | 21,007,517 | $ | 105,204,765 | 23,416,600 | $ | 117,447,261 | ||||||||||
Common shares issued pursuant to: | ||||||||||||||||
Stock options exercised | — | — | 38,334 | 47,917 | ||||||||||||
Repurchase of shares pursuant to share issuer bid | (70,200 | ) | (351,701 | ) | (2,447,417 | ) | (12,290,413 | ) | ||||||||
Balance, end of period | 20,937,317 | $ | 104,853,064 | 21,007,517 | $ | 105,204,765 | ||||||||||
Under the terms of the normal course issuer bid, the Company may repurchase and cancel up to 10% of the public float of the shares over the twelve month period commencing August 26, 2004. | ||
7. | Discontinued operations | |
Effective June 30, 2005, Envoy completed the sale of the shares of its John Street Inc. subsidiary (“John Street”) and related assets to the management of John Street. The purchase price for the shares was $1,200,000 and for the related capital assets was $300,000. John Street was also indebted to Envoy in the amount of $675,000 on account of an inter-company loan. These loans are payable over a period of 5 years and, except for interest free periods totaling 12 months, carry interest at the rate of 8% per annum. Prior to its sale, John Street was reported primarily as part of Canadian net revenue in the marketing segment. |
Income Statement — John Street | March 31 | March 31 | ||||||
For the six months ended: | 2006 | 2005 | ||||||
Net revenue | $ | — | $ | 1,957,766 | ||||
Operating expenses | — | 1,984,793 | ||||||
Interest expense | — | 33,750 | ||||||
Depreciation | — | 28,596 | ||||||
Income Taxes | — | (29,185 | ) | |||||
Earnings from discontinued operations | $ | — | $ | (60,188 | ) | |||
8. | Stock based compensation | |
On May 25th, 2004, the Company granted certain employees and directors a total of 375,000 options at an exercise price of $4.00 per share. These options vest over periods ranging from one year to three years, and expire on May 24th, 2009. The value of the options granted has been calculated using the Black-Scholes Option pricing model and the option value will be expensed over the vesting period of the options. For the six months ended March 31, 2006, an expense of $44,638 ($306,641 for the six months ended March 31, 2005), reflecting the option amortization for the period, has been included in salaries and benefits expense. | ||
9. | Related party transactions | |
At September 30, 2004, Envoy purchased from the executive officers of John Street Inc. the 30% of the shares of John Street Inc. which it did not already own. Effective June 30, 2005, Envoy completed the sale of the shares of its John Street Inc. subsidiary (“John Street”) and related assets to the management of John Street for a gross sale price of $1,500,000. The purchase price for the shares was $1,200,000 and for the related assets was $300,000. The sale transaction produced a net gain of $1,801,507. As at June 30, 2005, John Street was also indebted to Envoy in the amount of $675,000 on account of an inter-company loan. These loans are payable over a period of 5 years and, except for interest free periods totaling 12 months, carry interest at the rate of 8% per annum. The repayment of these loans requires quarterly payments totaling $100,501 to be made by June 30, 2006, followed by 48 monthly payments of $41,145 beginning July 31, 2006. These loans are secured against 100% of the common shares in the capital of John Street Inc. and security interest in the assets. At March 31, 2006, the amount of these loans receivable was $2,008,707 of which $265,082 was current and $1,743,625 was long term. | ||
Related party transactions are recorded at the exchange amount, being the amount agreed to by related parties. |
10. | Restructuring costs | |
In response to a number of economic uncertainties, competitive challenges and business risks that will impact client spending commitments of its operating subsidiaries, in November 2005, the Company announced that its Board of Directors had approved the immediate implementation of a restructuring plan. Management believes that, by implementing this restructuring plan, Envoy will be better positioned to remain profitable, if its clients’ historical spending patterns do not materialize in the short term. The restructuring involved the downsizing of its subsidiaries workforce, and writing off redundant capital assets. Accordingly, the Company recorded a restructuring expense of $1.9 million in the first quarter of fiscal 2006. Termination costs related to 73 employees, of which 44 employee terminations are in North America and 29 in the United Kingdom and Continental Europe. | ||
Total restructuring costs accrued at March 31, 2006 are classified as: |
Accounts payable and accrued liabilities | $ | 674,808 | ||
The tables below set out the following information: | ||
The Company’s total restructuring activities: |
Contractual | Total | Non- | ||||||||||||||||||
Termination | Accrued | cash | ||||||||||||||||||
Benefits | Other | Liability | Charge | Total | ||||||||||||||||
October 1, 2005 | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Provision | 1,625,284 | 156,839 | 1,782,123 | 68,971 | 1,851,094 | |||||||||||||||
Non cash charges | (68,971 | ) | (68,971 | ) | ||||||||||||||||
Cash payments | (960,182 | ) | (147,133 | ) | (1,107,315 | ) | (1,107,315 | ) | ||||||||||||
Amounts Outstanding at March 31, 2006 | $ | 665,102 | $ | 9,706 | $ | 674,808 | $ | — | $ | 674,808 | ||||||||||
We expect to complete these restructuring actions throughout fiscal 2006 and into fiscal 2007. Cash outlays are funded from cash on hand. |
Envoy Communications Group Inc.
Management Discussion and Analysis
Second quarter of fiscal 2006
May 8, 2006
Management Discussion and Analysis
Second quarter of fiscal 2006
May 8, 2006
The following section of our interim report sets forth Management’s Discussion and Analysis of the financial performance of Envoy Communications Group Inc. (“Envoy”, “we” or “us”) for the six months ended March 31, 2006 compared to the six months ended March 31, 2005. The analysis is based on our unaudited consolidated financial statements (the “Financial Statements”), including the accompanying notes, which are presented elsewhere in this report.
Discussion of results
The Financial Statements have been prepared by management in accordance with generally accepted accounting principles in Canada, which vary in certain significant respects from generally accepted accounting principles in the United States. A description of the significant differences, as applicable to the Company, is included in note 24 to the September 30, 2005 year end Audited Financial Statements.
OVERVIEW
Corporate — significant items
On 19th of January, 2006, Envoy announced that its Board of Directors approved the launch of Envoy Capital Group. Envoy Capital Group will be a merchant banking organization that focuses on providing financial services as well as equity and debt capital to small and mid-cap companies. Envoy has capitalized this new division with an investment of approximately $35 million.
Envoy Capital Group’s primary objective is to provide asset backed bridge loans of between $500,000 and $3,000,000 to private and publicly listed companies engaged in professional and marketing services, media, manufacturing and real estate development. It will compliment its bridge loan business by making equity investments in emerging companies as well as providing corporate financial services. Envoy Capital Group’s mission is to build wealth. Its investment strategy is to generate both yield and growth in a tax-efficient manner, while preserving capital. Envoy Capital Group’s goal is to deliver superior returns on a consistent basis and to create value for its shareholders.
On 18th of November, 2005, Envoy announced that its Board of Directors has approved the immediate implementation of a restructuring plan. Envoy incurred a restructuring charge of approximately $1.9 million in the first quarter of fiscal 2006. The annual savings in salaries, benefits and other expenses associated with this restructuring is estimated to be approximately $4.4 million. The restructuring involved downsizing of staff and writing off redundant capital assets. The restructuring charge includes termination benefits, legal fees and lease terminations. The Company has sufficient cash on hand to fund the restructuring charges. Management believes that by implementing the restructuring plan, Envoy will be better positioned to remain profitable if its clients’ historical spending patterns do not materialize in the short term.
On 10th of November, 2004, Envoy, through its subsidiary ECG Holdings (UK) Limited (“ECGH”), agreed to acquire 65% of the outstanding shares of Parker Williams Design Limited (“PW”, or “Parker Williams”), a London, UK based packaging design and brand specialist Company. The purchase price of £1,818,000 was paid in cash on closing. On March 1st 2006 Envoy acquired an additional 5% of the outstanding shares from former employees of Parker Williams and paid £52,679 in cash. The remaining 30% of the Parker Williams shares (“Management Shares”) will continue to be held by senior management of PW (“Management Shareholders”), subject to certain options described below.
ECGH will have the option to acquire from the Management Shareholders and the Management Shareholders will have the option to require ECGH to purchase from them, at various stages over a period of 4 years following completion, the Management Shares for a purchase price based on the profitability of PW for certain defined periods following closing. The transactions were accounted for using the purchase method of accounting. PW, whose clients include Sainsbury’s Supermarkets and Coop Norden, is a specialist in the retail area and has revenues of approximately $5.0 million annually. PW was formed in 1990 by designers Tamara Williams and Tony Parker who together have over 25 years design experience in Europe, America and the Far East. Both companies believe the combined expertise and focus within the retail arena will provide new opportunities across both Europe and North America.
Effective 30th of June, 2005, Envoy completed the sale of the shares of its John Street Inc. subsidiary (“John Street”) and related assets to the management of John Street for a gross sale price of $1.5 million. The purchase price for the shares was $1.2 million and for the related assets was $0.3 million. The balance of the purchase price for the shares of $1.1 million and for the related assets of $0.3 million is payable over a period of 5 years and, except for interest free periods totaling 12 months, carries interest at the rate of 8% per annum. As at June 30, 2005, John Street was also indebted to Envoy in the amount of $0.7 million, on account of an inter-company loan. This loan is repayable over a period of 5 years and, except for interest free periods totaling 12 months, carries interest at the rate of 8% per annum. The sale transaction produced a net gain of approximately $1.8 million. Envoy believes that the sale of John Street and the related assets was in the best interests of Envoy and its shareholders. John Street was an investment that was no longer consistent with Envoy’s strategic direction
On August 19, 2005 Envoy announced acceptance by the Toronto Stock Exchange (the “TSX”) of its notice of intention to purchase from time to time, if considered advisable, up to an aggregate of 2,013,702 common shares, representing approximately 10% of the public float of its common shares. All purchases of the common shares will be effected through the facilities of the TSX and/or the NASDAQ National Market (the “NASDAQ”). Purchases commenced on August 26, 2005 and will conclude on the earlier of the date on which purchases under the normal course issuer bid have been completed, and August 25, 2006. All shares purchased under this program will be cancelled. Under the terms of this normal course issuer bid, the Company had repurchased 477,280 common shares for cancellation paying cash consideration of $1.2 million up to March 31, 2006. The average price of the shares repurchased was $2.58 per share.
Pursuant to the terms of a normal course issuer bid which began on August 26, 2004 and ended on August 25, 2005, the Company was authorized to repurchase and cancel up to 10% of the public float of the shares. During fiscal 2005 the Company repurchased and cancelled 2,040,337 common shares for cash consideration of $6.2 million. The average price of the shares repurchased during fiscal 2005 was $3.04 per share.
The Board of Directors of Envoy Communications Group Inc. believes that the proposed purchases are in the best interests of Envoy Communications Group Inc. and are a desirable use of corporate funds. All common shares purchased by Envoy Communications Group Inc. will be cancelled.
On September 21, 2005, Envoy advised its U.S. shareholders that it believes it will be characterized under the U.S. Internal Revenue Code as a passive foreign investment company (“PFIC”) for the fiscal year ended September 30, 2005, and may be a PFIC for subsequent fiscal years. This determination was made following a preliminary review by Envoy of its financial position in anticipation of its fiscal year end. Based on the year-end audited financial statements, this analysis was updated and the Company confirmed that it will be characterized as a PFIC under the U.S. Internal Revenue Code.
U.S. shareholders who held Envoy’s common shares during fiscal 2005 (or who hold Envoy’s common shares during any subsequent fiscal year when it is a PFIC) may be able to mitigate
certain tax consequences of Envoy’s PFIC status by availing themselves of certain elections under the Internal Revenue Code, including a “qualified electing fund” (“QEF”) election or a “mark-to market” election. Envoy will complete the actions necessary, including providing the information necessary, for U.S. shareholders to make a QEF election. The deadline for a U.S. shareholder to file a QEF election or a “mark-to market” election is the due date of such U.S. shareholder’s federal income tax return (including extensions) for the taxable year to which such election relates. Envoy believes that this determination will not have any tax consequences to non-U.S. shareholders.
The application of the PFIC rules is complex. U.S. shareholders are urged to consult their own tax advisors about the U.S. federal income tax consequences of owning and disposing of stock in a PFIC, and about the advisability, procedure and timing of their making any of the available tax elections, including QEF or “mark-to-market” elections.
U.S. shareholders who choose to make a QEF election should refer to the Envoy website at www.envoy.to in order to receive the necessary financial information.
Operating companies — significant items
The Watt group of companies (“Watt”), Envoy’s branding business, has proven successful at creating and executing private label programs and landmark store design, making Envoy a world authority in brand strategy and design for the retail sector. Watt’s lengthy history of success and innovation in the retail industry presents it with a spectrum of opportunities — from overall brand strategy to store design to private label program development — with key customers like grocers, mass merchants, pharmacies and home improvement companies.
On March 23, 2006 Envoy issued a press release of winning a South America’s leading multi-format retailer, Cencosud S.A., for the retail design development of the Costanera Shopping Center in Santiago, Chile. The Costanera Center development will feature the tallest building in Santiago standing 300m tall, and is destined to become one of the cities great landmarks.
Watt International was chosen by Cencosud to prepare a design strategy for the center’s retail spaces and food court, and to develop a proprietary brand aesthetic that will further define the center as one of South America’s most unique shopping experiences, ultimately differentiating it from its competitors.
RESULTS OF OPERATIONS
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED MARCH 31, 2006 WITH THE SIX MONTHS ENDED MARCH 31, 2005
Foreign exchange ratesEnvoy applied following rates to translate applicable currency transactions: Balance sheet; GBP 2.0313 and USD 1.1676, Income statement; GBP 2.0387 and USD 1.1645.
Net revenueOur net revenue represents our compensation for services. Our compensation from non-agency or “project related” services is primarily generated from project fees and hourly charges.
Net revenue for the six months ended March 31, 2006 was $16.4 million, compared to $19.3 million (excluding discontinued operations) for the six months ended March 31, 2005, a decrease of $2.9 million or 15%.
Net revenue by type of service and by customer location:
Net Revenue for the Six months ended March 31 | ||||||||||||||||
(in millions) | ||||||||||||||||
By type of service | 2006 | % of total | 2005 | % of total | ||||||||||||
Consumer and retail branding | $ | 16.4 | 100 | % | $ | 19.3 | 100 | % | ||||||||
By customer location | 2006 | % of total | 2005 | % of total | ||||||||||||
Canada | $ | 2.8 | 17 | % | $ | 3.3 | 17 | % | ||||||||
United States | 2.4 | 15 | % | 5.1 | 26 | % | ||||||||||
Europe * | 11.2 | 68 | % | 10.9 | 57 | % | ||||||||||
$ | 16.4 | 100 | % | $ | 19.3 | 100 | % | |||||||||
* | Europe includes the United Kingdom and Continental Europe |
Net revenue by type of service:
Net revenue from consumer and retail branding services decreased by $2.9 million in the six months ended March 31, 2006 compared to the six months ended March 31, 2005 a decrease of 15%. After a review of client spending plans, we expect net revenue to decrease by about 22% in fiscal 2006.
Net revenue from consumer and retail branding services decreased by $2.9 million in the six months ended March 31, 2006 compared to the six months ended March 31, 2005 a decrease of 15%. After a review of client spending plans, we expect net revenue to decrease by about 22% in fiscal 2006.
Net revenue by customer location:
Net revenue from Canada decreased $0.5 million, for the six months ended March 31, 2006 compared to the six months ended March 31, 2005, a decrease of 15%.
Net revenue from Canada decreased $0.5 million, for the six months ended March 31, 2006 compared to the six months ended March 31, 2005, a decrease of 15%.
Net revenue from the U.S. has decreased $2.7 million for the six months ended March 31, 2006 compared to the six months ended March 31, 2005, a decrease of 53%. As a result of a large client loss and currency translation, we expect this trend of declining net revenue from U.S. clients to continue through the remainder of 2006.
Net revenue from Europe increased by $0.3 million for the six months ended March 31, 2006, compared to the six months ended March 31, 2005, an increase of 3%. The change in net revenues form Europe is a combination of factors including an increase in revenue from Parker
Williams (2005 was included only for one month, acquisition completed on February 28, 2005), a reduction in revenues from Gilchrist and a decrease in foreign exchange rate.
Operating ExpensesSalaries and benefits, general and administrative expenses and occupancy costs represent our operating expenses. Salaries and benefits expenses include salaries, employee benefits, incentive compensation, contract labour and other payroll related costs, which are expensed as incurred. General and administrative costs include business development, office costs, technology, professional services and foreign exchange. Occupancy costs represent the costs of leasing and maintaining company premises.
Operating expenses decreased by 6.0% to $17.03 million for the six months ended March 31, 2006 from $18.05 million for the six months ended March 31, 2005. Changes in operating expenses are as follow:
Salaries and benefits expense for the six months ended March 31, 2006 were $12.6 million, compared to $12.5 million for the six months ended March 31, 2005, an increase of $0.1 million or 1%. Salaries and benefits continue to be closely monitored to match expected revenues with labour costs. Salaries and benefits expense as a percent of net revenue was approximately 77% for the six months ended March 31, 2006 compared to 65% for the six months ended March 31 2005. March 31, 2006 salaries expense includes $1.4 million and March 31, 2005 includes $0.2 million related to Parker Williams. Envoy expects that salaries and benefits expense will be approximately 70% of sales in fiscal 2006.
General and administrative expenses for the six months ended March 31, 2006 were $2.9 million, compared to $3.7 million for the six months ended March 31, 2005. Included in general and administrative expenses is foreign exchange expense of $0.2 million for the six months ended March 31, 2006, compared to $0.2 million for the six months ended March 31, 2005. General and administrative expense as a percent of net revenue was 18% for the six months ended March 31, 2006 compared to approximately 19% for the six months ended March 31, 2005. Envoy expects that general and administrative expenses will be 16% of sales in fiscal 2006.
Occupancy costs for the six months ended March 31, 2006 were $1.6 million, compared to $1.8 million for the six months ended March 31, 2005. Occupancy costs as a percent of net revenue was 10% for the six months ended March 31, 2006 compared to 8% for the six months ended March 31, 2005. We expect occupancy costs to stay at current levels throughout the remainder of the year.
Depreciation and Amortization of intangible assetsDepreciation and Amortization expense for the six months ended March 31, 2006 was $1.1 million, compared to $1.2 million for the six months ended March 31, 2005.
Investment EarningsInvestment earnings for the six months ended March 31, 2006 was $1.4 million, compared to $1.5 million for the six months ended March 31, 2005. Investment earnings represent the income earned on the cash and marketable securities held in the investment portfolio.
Restructuring chargeFor the six months period ended on March 31, 2006, Envoy has taken a charge of $1.9 million to adjust its staffing need and assets employed in the operations compared to nil charge during the six months period ended on March 31, 2005. Termination costs relate to 73 employees, of which 44 employee terminations are in North America and 29 in the United Kingdom and Continental Europe.
(Loss) Earnings from discontinued operations net of income taxes(Loss) Earnings from discontinued operations net of income taxes was nil for the six months ended March 31, 2006 compared to a loss of $0.06 million for the six months ended March 31, 2005. The loss from discontinued operations relates to John Street advertising business which was sold effective June 30, 2005.
(Loss) Net earningsEnvoy had a net loss of $1.6 million or ($0.07) per share for the six months ended March 31, 2006, compared to net earnings of $1.5 million or $0.06 per share for the six months ended March 31, 2005.
Liquidity and Capital Resources
As at March 31, 2006, Envoy had working capital of $12.2 million and a cash balance of $2.8 million, compared to working capital of $35.9 million and a cash balance of $4.2 million at September 30, 2005. At March 31, 2006 working capital included $5.0 million of our investment portfolio compared to $22.1 million at September 30, 2005. The change in the current investment balance is due to Envoy launching Envoy Capital Group a merchant banking operation in fiscal 2006, whereby the majority of our portfolio is classified as long term investments.
Net cash provided by operating activities was $4.4 million for the six months ended March 31, 2006 compared to a minimal net use of cash for the six months ended March 31, 2005. The majority of the increase is due to a reduction in accounts receivable of $6.3 million, offset by payments made in accounts payable and accrued liabilities of $1.2 million.
Net cash used in financing activities was $0.4 million for the six months ended March 31, 2006, compared to $4.7 million for the six months ended March 31, 2005. The main reason for the decrease was a reduction in share repurchases. Only $0.1 million was used to purchase shares through the company’s share buyback program during the six months ended March 31, 2006, compared to $4.5 million used to purchase shares under the share buyback program during the six months ended March 31, 2005.
Net cash used in investing activities was $5.4 million for the six months ended March 31, 2006, compared to net cash provided by investing activities of $2.8 million for the six months ended March 31, 2005, an increase in use of cash by $8.2 million. $4.7 million was used for investments in the six months ended in 2006 compared to $8.3 provided by the investments in the six months ended March 31, 2005, offset by $5.5 million used in acquiring subsidiaries and capital assets during same period of 2005.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2006 WITH THE THREE MONTHS ENDED MARCH 31, 2005
Foreign exchange ratesEnvoy applied following rates to translate applicable currency transactions: Balance sheet; GBP 2.0313 and USD 1.1676, Income statement; GBP 2.0387 and USD 1.1645.
Net revenueOur net revenue represents our compensation for services. Our compensation from non-agency or “project related” services is primarily generated from project fees and hourly charges.
Net revenue for the three months ended March 31, 2006 was $7.7 million, compared to $10.2 million (excluding discontinued operations) for the three months ended March 31, 2005, a decrease of $2.5 million.
Net revenue by type of service and by customer location:
Net Revenue for the three months ended March 31 | ||||||||||||||||
(in millions) | ||||||||||||||||
By type of service | 2006 | % of total | 2005 | % of total | ||||||||||||
Consumer and retail branding | $ | 7.7 | 100 | % | $ | 10.2 | 100 | % | ||||||||
By customer location | 2006 | % of total | 2005 | % of total | ||||||||||||
Canada | $ | 1.5 | 19 | % | $ | 1.7 | 17 | % | ||||||||
United States | 0.4 | 5 | % | 2.7 | 26 | % | ||||||||||
Europe * | 5.8 | 76 | % | 5.8 | 57 | % | ||||||||||
$ | 7.7 | 100 | % | $ | 10.2 | 100 | % | |||||||||
* | Europe includes the United Kingdom and Continental Europe |
Net revenue by type of service:
Net revenue from consumer and retail branding services decreased by $2.5 million in the three months ended March 31, 2006 compared to the three months ended March 31, 2005. After a review of client spending plans, we expect net revenue to decrease by about 22% in fiscal 2006.
Net revenue from consumer and retail branding services decreased by $2.5 million in the three months ended March 31, 2006 compared to the three months ended March 31, 2005. After a review of client spending plans, we expect net revenue to decrease by about 22% in fiscal 2006.
Net revenue by customer location:
Net revenue from Canada decreased by $0.2 million, for the three months ended March 31, 2006 compared to the three months ended March 31, 2005, a decrease of 12%.
Net revenue from Canada decreased by $0.2 million, for the three months ended March 31, 2006 compared to the three months ended March 31, 2005, a decrease of 12%.
Net revenue from the U.S. has decreased by $2.3 million for the three months ended March 31, 2006 compared to the three months ended March 31, 2005, a decrease of 85%. As a result of a large client loss and currency translation, we expect this trend of declining net revenue from U.S. clients to continue through the remainder of 2006.
Net revenue from Europe were 5.8 million during the three months ended March 31, 2006 and three months ended March 31, 2005, no change in dollar value but mix changed from 57% to 76% of total sales in current quarter compared to the same quarter of last year.
Operating ExpensesSalaries and benefits, general and administrative expenses and occupancy costs represent our operating expenses. Salaries and benefits expenses include salaries, employee benefits, incentive compensation, contract labour and other payroll related costs, which are expensed as incurred. General and administrative costs include business development, office costs, technology, professional services and foreign exchange. Occupancy costs represent the costs of leasing and maintaining company premises. Operating expenses decreased by $1.2 million or 13.0% to $8.3 million for the three months ended March 31, 2006 from $9.5 million for the three months ended March 31, 2005. Changes in operating expenses are as follow:
Salaries and benefits expense for the three months ended March 31, 2006 were $6.3 million, compared to $6.5 million for the three months ended March 31, 2005, a decrease of $0.2 million or 3%. Salaries and benefits continue to be closely monitored to match expected revenues with labour costs. Salaries and benefits expense as a percent of net revenue was approximately 82% for the three months ended March 31, 2006 compared to 64% for the three months ended December 31 2004. March 31, 2006 salaries expense includes $0.9 million and March 31, 2005 includes $0.2 million related to Parker Williams. Envoy expects that salaries and benefits expense will be approximately 70% of sales in fiscal 2006.
General and administrative expenses for the three months ended March 31, 2006 were $1.2 million, compared to $2.0 million for the three months ended March 31, 2005. Included in general and administrative expenses is foreign exchange gain of $0.08 million for the three months ended March 31, 2006, compared to loss of $0.16 million for the three months ended March 31, 2005. General and administrative expense as a percent of net revenue was 16% for the three months ended March 31, 2006 compared to approximately 20% for the three months ended March 31, 2005. Envoy expects that general and administrative expenses will be 16% of sales in fiscal 2006.
Occupancy costs for the three months ended March 31, 2006 were $0.8 million, compared to $0.9 million for the three months ended March 31, 2005. Occupancy costs as a percent of net revenue was 10% for the three months ended March 31, 2006 compared to 9% for the three months ended March 31, 2005. Envoy expects that occupancy expense will be approximately 10% of sales in fiscal 2006. The expected increase is primarily due to the Company’s UK operations relocating to new premises in fiscal 2006, and to the expectation that utilities costs will continue at higher levels than has been experienced recently.
Depreciation expenseDepreciation expense for the three months ended March 31, 2006 was $0.5 million, compared to $0.6 million for the three months ended March 31, 2005.
Investment EarningsInvestment earnings were $0.5 million in each of the three months period ended March 31, 2006 and March 31, 2005. Investment earnings represent the income earned on the cash and marketable securities held in the investment portfolio.
Restructuring chargeNo restructuring charge was recorded in the three months ended March 31, 2006 or 2005. A charge of $1.9 million was taken in Q1 of 2006 and the detailed information regarding the charges is provided in the six months results analysis.
(Loss) Earnings from discontinued operations net of income taxesThere are no losses from discontinued operations during the three months ended March 31, 2006 and minimal losses for the three months ended March 31, 2005. Discontinued operations relate to John Street advertising business which was sold on June 30, 2005.
(Loss) Net earningsEnvoy had a net loss of $0.4 million or ($0.02) per share for the three months ended March 31, 2006, compared to net earnings of $0.8 million or $0.04 per share for the three months ended March 31, 2005.
Liquidity and Capital Resources
As at March 31, 2006, Envoy had working capital of $12.2 million and a cash balance of $2.8 million, compared to working capital of $16.1 million and a cash balance of $4.3 million at December 31, 2005. At March 31, 2006 and December 31, 2005 working capital included $5.0 million of our investment portfolio. Envoy has capitalized its newly launched Envoy Capital Group a merchant banking operation division with approximately $35.0 million, of which $5.0 million of the investments are classified as current and the balance of $30.0 million as long term investments.
Net cash provided by operating activities was $2.0 million for the three months ended March 31, 2006 compared to $0.3 million for the three months ended March 31, 2005, an increase of $1.7 million. The majority of the increase is due to reduction in accounts receivable of $1.9 million.
Net cash used in financing activities was $0.4 million for the three months ended March 31, 2006, compared to $2.2 million used in the three months ended March 31, 2005. During the three months ended March 31, 2006, Envoy used cash of $0.1 million compared to $2.1 million used in three months ended March 31, 2005 to purchase shares through its share buyback program. No shares were purchased in the first quarter of fiscal 2006.
Net cash used in investing activities was $3.0 million for the three months ended March 31, 2006, compared to net cash provided by investing activities of $0.9 million for the three months ended March 31, 2005, a decrease of $3.9 million. The decrease was due to cash used by investments of $2.7 million and capital asset purchases of $0.3 million during the three month period ended March 31, 2006. During the comparative period of 2005, $4.0 million was used to purchase subsidiaries and $0.5 million for capital assets which was offset by $5.5 million provided by investments.
COMMITMENTS AND CONTRACTUAL OBLIGATIONS
Set out below is a summary of the amounts due and committed under contractual cash obligations at March 31, 2006:
Due in 1 | Due between | Due between | Due after 5 | |||||||||||||||||
Total | year or less | years 2 and 3 | years 4 and 5 | years | ||||||||||||||||
Operating leases | $ | 8,204,216 | $ | 1,346,698 | $ | 2,752,340 | $ | 1,931,366 | $ | 2,173,812 | ||||||||||
Long term debt | 302,088 | 92,114 | 209,974 | — | — | |||||||||||||||
Total contractual cash obligations | $ | 8,506,304 | $ | 1,438,812 | $ | 2,962,314 | $ | 1,931,366 | $ | 2,173,812 | ||||||||||
SUMMARY OF QUARTERLY RESULTS
Q2 2006 | Q1 2006 | Q4 2005 | Q3 2005 | |||||||||||||
Net revenue | $7.7 million | $8.7 million | $11.9 million | $12.0 million | ||||||||||||
Net earnings (loss): | ||||||||||||||||
From continuing operations | $(0.4) million | $(1.1) million | $0.9 million | $1.7 million | ||||||||||||
Including discontinued operations | $(0.4) million | $(1.1) million | $0.9 million | $3.6 million | ||||||||||||
Net earnings (loss) per share | ||||||||||||||||
From continuing operations | ||||||||||||||||
Basic | $ | (0.02 | ) | $ | (0.05 | ) | $ | 0.04 | $ | 0.08 | ||||||
Diluted | $ | (0.02 | ) | $ | (0.05 | ) | $ | 0.04 | $ | 0.08 | ||||||
Including discontinued operations | ||||||||||||||||
Basic | $ | (0.02 | ) | $ | (0.05 | ) | $ | 0.04 | $ | 0.17 | ||||||
Diluted | $ | (0.02 | ) | $ | (0.05 | ) | $ | 0.04 | $ | 0.17 |
Q2 2005 | Q1 2005 | Q4 2004 | Q3 2004 | |||||||||||||
�� | ||||||||||||||||
Net revenue | $10.2 million | $9.1 million | $9.1 million | $10.0 million | ||||||||||||
Net earnings (loss): | ||||||||||||||||
From continuing operations | $0.8 million | $0.7 million | $(0.3) million | $1.1 million | ||||||||||||
Including discontinued operations | $0.8 million | $0.6 million | $(0.3) million | $1.2 million | ||||||||||||
Net earnings (loss) per share | ||||||||||||||||
From continuing operations | ||||||||||||||||
Basic | $ | 0.04 | $ | 0.03 | $ | (0.01 | ) | $ | 0.05 | |||||||
Diluted | $ | 0.04 | $ | 0.03 | $ | (0.01 | ) | $ | 0.05 | |||||||
Including discontinued operations | ||||||||||||||||
Basic | $ | 0.04 | $ | 0.03 | $ | (0.01 | ) | $ | 0.06 | |||||||
Diluted | $ | 0.04 | $ | 0.03 | $ | (0.01 | ) | $ | 0.06 |
TRANSACTIONS WITH RELATED PARTIES
There were no material related party transactions during the first two quarters of Fiscal 2006.
At September 30, 2004, Envoy purchased from the executive officers of John Street Inc. the 30% of the shares of John Street Inc. which it did not already own. Effective June 30, 2005, Envoy completed the sale of the shares of its John Street Inc. subsidiary (“John Street”) and related assets to the management of John Street for a gross sale price of $1,500,000. The purchase price for the shares was $1,200,000 and for the related assets was $300,000. The sale transaction produced a net gain of $1,801,507. As at June 30, 2005, John Street was also indebted to Envoy in the amount of $675,000 on account of an inter-company loan. These loans are payable over a period of 5 years and, except for interest free periods totaling 12 months, carry interest at the rate of 8% per annum. The repayment of the loans requires quarterly payments totaling $100,501 to be made by June 30, 2006, followed by 48 monthly payments of $41,145 beginning July 31, 2006. . These loans are secured by a combination of 100% of the common shares in the capital of John Street Inc. and a general security agreement on the assets. At March 31, 2006, the amount of these loans receivable was $2,008,707 of which $265,082 was
current and $1,743,625 was long term. Related party transactions are recorded at the exchange amount, being the amount agreed to by the related parties.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The significant accounting policies used by Envoy in preparing its financial statements are described in Note 2 to the September 30, 2005 year end Financial Statements and they should be read to ensure a proper understanding and evaluation of the estimates and judgments made by management in preparing those Financial Statements. Envoy’s Financial Statements are prepared in accordance with Canadian generally accepted accounting principles. Envoy also prepared a reconciliation to United States generally accepted accounting principles, which is included in Note 24 to the September 30, 2005 year end Financial Statements.
Inherent in the application of some of these policies is the judgment by management as to which of the various methods allowed under generally accepted accounting principles is the most appropriate to apply in the case of Envoy. As well, management must take appropriate estimates at the time the Financial Statements are prepared. These estimates are described on the September 30, 2005 year end Financial Statements.
Although all of the policies identified in Note 2 to the September 30, 2005 year end Financial Statements are important in understanding the Financial Statements, the policies discussed below are considered by management to be central to understanding the Financial Statements, because of the higher level of measurement uncertainties involved in their application.
GoodwillGoodwill represents the excess of the purchase price over the fair value of the net assets of the entities acquired at the respective dates of acquisition. Envoy assesses the recoverability of the carrying value of its goodwill on an annual basis. As part of the evaluation, Envoy considers several factors, including the operating results and trends, movement in major clients and key client service personnel, changes in client relationships and general economic conditions. Significant changes in these factors could result in an impairment of goodwill.
Goodwill is considered to be impaired if carrying value exceeds fair market value. Fair value can be characterized as the amount at which an item could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale. When impairment is determined, the related loss is charged to earnings and is measured by the excess of the carrying value of the goodwill over its fair value based on estimated discounted future operating cash flows.
Intangible assetsTo determine the value of intangible assets acquired in an acquisition, the Company considers the expected impact on cash flows of the asset, the inherent uncertainty of estimates, and the time value of money. The intangible assets are amortized over a period considered to represent their useful life. Intangible assets are reviewed each year and if circumstances indicate that the carrying amounts may not be recoverable, a write-down would be charged to operations in the period.
Income TaxesEnvoy accounts for income taxes using the liability method. Under this method, future income taxes are recognized at the enacted or substantially enacted tax rate expected to be applicable at the anticipated date of the reversal for all significant temporary differences between the tax and accounting bases of assets and liabilities and for certain tax carry-forward items. Future income tax assets and liabilities are recognized only to the extent that, in the opinion of management, it is more likely than not that the future income tax assets will be realized. Future operating results and future tax rates could vary materially, and accordingly the value of income tax assets and liabilities could change by material amounts.
Stock Based Compensation and Other Stock based PaymentsEffective October 1, 2003, Envoy adopted the revisions to CICA handbook Section 3870 that required the use of the fair value method for all stock-based compensation transactions. The application of this accounting methodology requires management to estimate a number of variables, including the risk free rate, and the expected volatility of the stock price. The amounts determined for these variables, which are detailed in Note 12(e) to the September 30, 2005 year end Financial Statements, have a significant impact on the values assigned to the stock options.
Restructuring chargesWe have recorded restructuring charges relating to the workforce which include employee severance and benefit costs, costs related to leased facilities that have been abandoned, cost of owned equipment and, cost of leased equipment that has been abandoned. The recognition of these charges requires management to make certain judgments and estimates regarding the nature, timing and amount associated with these plans. The estimated amount of future liability may change, requiring additional restructuring charges or a reduction of the liabilities already recorded. At the end of each reporting period, we evaluate the appropriateness of the remaining accrued balances.
IMPACT OF RECENTLY ISSUED CANADIAN ACCOUNTING STANDARDS
In January of 2005, the CICA issued Section 3855, “Financial Instruments — Recognition and Measurement”, Section 1530, “Comprehensive Income” and Section 3865, “Hedges”. The new standards will be effective for interim and annual financial statements commencing in fiscal year 2007. Earlier adoption is permitted. Most significantly for the Company, the new standards will require presentation of a separate statement of comprehensive income. Investments will be recorded in the balance sheet at fair value and changes in the fair value of investments will be recorded in comprehensive income or in the statement of operations, depending on the classification of the investments. The Company is assessing the impact of the new standards.
IMPACT OF RECENTLY ISSUED UNITED STATES ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123R (Revised), Share-Based Payment which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In addition, public companies using the fair value method will recognize compensation expense for the unvested portion of awards outstanding as of the effective date based on their grant date fair value as calculated under the original provisions of SFAS 123.
The pronouncement was to be effective at the beginning of the first interim or annual period beginning after June 15, 2005, however, in April 2005, an amendment was issued to delay the effective date to the first fiscal year that begins after June 15, 2005. The Company has adopted the new pronouncement effective October 1, 2005.
RISKS AND UNCERTAINTIES
Envoy management monitors, understands and manages the risks associated with its business transactions and the general economic environment in which it operates. Risks reflect uncertainty regarding potential outcomes from changes in political, economic and capital market conditions. Envoy is subject to these risks and uncertainties and actively manages them as follows:
General economic conditionsThe marketing and communication industry is cyclical and as a result it is subject to downturns in general economic conditions and changes in client business and marketing budgets. A significant portion of our business is with large multinational businesses, including large packaged goods companies and large food retailers who are less impacted by downturns in the economy. In an effort to offer our clients services on an international scale, and to manage our exposure to broad economic conditions, Envoy has diversified geographically, operating across North America and in the United Kingdom and Continental Europe.
Client concentrationThe Company receives a significant portion of its revenues from a limited number of large clients. The loss of any such clients could adversely impact the Company’s prospects, business, financial condition and results of operations. For the three months ended March 31, 2006, the Company’s top three clients accounted for 46% of its consolidated net revenue. The Company expects reliance on a limited number of its clients to continue into the future. The failure to achieve continued design wins from one or more of these significant clients without adding new sources of net revenue could have an adverse effect on the Company’s financial results.
Interest rate riskEnvoy’s debt under its lending facilities is described in Note 9 to the September 30, 2005 year end Financial Statements. During fiscal 2004, Envoy repaid much of the debt that had been outstanding during previous years, including the bank credit facility that had carried a variable interest rate based on the prime rate. At March 31, 2006 Envoy had a small amount of fixed rate debt outstanding. Envoy has exposure to changes in the interest rate on its investment portfolio.
Market riskMarket risk is the risk of loss of value in Envoy’s portfolios resulting from changes in interest rates, foreign exchange rates, credit spreads, and equity prices.
Foreign currency riskEnvoy is subject to currency risk through its activities in the United States and in the United Kingdom. Unfavorable changes in the exchange rate may adversely affect the operating results of Envoy. Envoy does not currently use derivative instruments or foreign currency contracts to reduce its exposure to foreign currency risk, although the use of these instruments is currently being considered.
International exposureThe Company’s international operations are subject to a number of risks inherent in operating in different countries. These include, but are not limited to risks regarding restrictions on repatriation of earnings and changes in the political or economic conditions of a specific country or region, particularly in emerging markets. The occurrence of any of these events or conditions could adversely affect the Company’s ability to increase or maintain its operations in various countries.
Key personnelEnvoy’s success depends in part upon its ability to hire and retain key senior management and skilled technical, client service and creative personnel able to create and maintain solid relationships with clients. An inability to hire or retain qualified personnel could have a material adverse effect on Envoy. To reduce the risk of losing valued employees, Envoy strives to maintain a positive work environment that values the contributions of its employees.
Credit riskEnvoy manages its credit risk with respect to accounts receivable by acting as an agent for its customers, by dealing primarily with large creditworthy customers and by billing whenever possible in advance of rendering services or making commitments. Management believes that Envoy is not subject to significant concentration of credit risk.
Merchant Banking Services
Investors will be relying on the judgment of management and the board of directors as to the most effective use of the investment portfolio. If the Company does not use the proceeds effectively, its business, operations and financial results could be adversely affected. The
Investors will be relying on the judgment of management and the board of directors as to the most effective use of the investment portfolio. If the Company does not use the proceeds effectively, its business, operations and financial results could be adversely affected. The
Company intends to expand the size of its loan portfolio and the number of investments. There can be no assurances that the Company will be able to effectively manage its growth and, if it is unable to do so, the Company’s business, financial conditions and results could be adversely affected.
OTHER INFORMATION
Share Consolidation (Reverse stock split)
On January 21, 2005 Envoy announced that its Board of Directors had approved the filing of Articles of Amendment to consolidate its common shares on the basis of one new common share for every five common shares currently outstanding. The share consolidation affected all common shares, warrants and stock options of Envoy outstanding on the effective date of February 10, 2005. Any fractional shares resulting from this consolidation were adjusted to the nearest full common share. The number of Envoy common shares outstanding prior to consolidation was 112,539,318 and post-consolidation was 22,507,864. The earnings per share figures presented are after giving effect to the share consolidation.
On January 21, 2005 Envoy announced that its Board of Directors had approved the filing of Articles of Amendment to consolidate its common shares on the basis of one new common share for every five common shares currently outstanding. The share consolidation affected all common shares, warrants and stock options of Envoy outstanding on the effective date of February 10, 2005. Any fractional shares resulting from this consolidation were adjusted to the nearest full common share. The number of Envoy common shares outstanding prior to consolidation was 112,539,318 and post-consolidation was 22,507,864. The earnings per share figures presented are after giving effect to the share consolidation.
Increase in authorized share capital
At a special meeting of shareholders Envoy held on January 8, 2004, the shareholders approved an amendment to the Articles of Envoy to increase its authorized share capital from 10,000,000 common shares to 40,000,000 common shares.
At a special meeting of shareholders Envoy held on January 8, 2004, the shareholders approved an amendment to the Articles of Envoy to increase its authorized share capital from 10,000,000 common shares to 40,000,000 common shares.
Other items
At March 31, 2006, there were 20,937,317 common shares of Envoy issued and outstanding, compared to 21,007,517 issued at September 30, 2005.
At March 31, 2006, there were 20,937,317 common shares of Envoy issued and outstanding, compared to 21,007,517 issued at September 30, 2005.
Additional information relating to Envoy, including our Annual Information Form is available on SEDAR atwww.sedar.com.
Forward Looking Statements
All statements in this MD&A that do not directly and exclusively relate to historical facts constitute “forward-looking statements” within the meaning of that term in Section 27A of the United States Securities Act of 1933, as amended, and Section 21E of the United States Securities Exchange Act of 1934, as amended. These statements represent Envoy’s intentions, plans, expectations and beliefs, and are subject to risks, uncertainties and other factors, many of which are beyond the control of Envoy. These factors could cause actual results to differ materially from such forward-looking statements. These factors include but are not restricted to the timing and size of contracts, acquisitions and other corporate developments; the ability to attract and retain qualified employees; market competition in our industry; general economic and business conditions, foreign exchange and other risks identified in the MD&A, in Envoy’s Annual Report or Form 20-F filed with the U.S. Securities and Exchange Commission, or Envoy’s Annual Information Form filed with the Canadian securities authorities. The words “believe”, “estimate”, “expect”, “intend”, “anticipate”, “foresee”, “plan”, and similar expressions identify certain of such forward looking statements, which are valid only as of the date on which they are made. In particular, statements relating to future growth are forward looking statements. Envoy disclaims any intention or obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on these forward-looking statements
Shareholder Information
HEAD OFFICE | OFFICERS | AUDITORS | ||
172 John Street | Geoffrey B. Genovese | BDO Dunwoody LLP | ||
Toronto, Canada M5T 1X5 | President, Chairman | 60 Columbia Way, Suite 400 | ||
and Chief Executive Officer | Markham, Canada L3R 0C9 | |||
Telephone: (416) 593-1212 | ||||
Facsimile: (416) 593-4434 | J. Joseph Leeder | |||
Chief Financial Officer and Vice | ||||
President Mergers and Acquisitions | ||||
BANKERS | ||||
DIRECTORS | John H. Bailey | RBC Royal Bank | ||
John H. Bailey | Executive Vice President | 200 Bay Street | ||
B.Comm, J.D., LL.M | and Corporate Secretary | Toronto, Canada M5J 2J5 | ||
Barrister & Solicitor | ||||
David Parkes | AUDIT COMMITTEE | LEGAL COUNSEL | ||
Consultant | David Parkes (Chair) | Blake, Cassels & Graydon LLP | ||
David Parkes & Associates | Hugh Aird | Box 25, Commerce Court West | ||
David I. Hull | Toronto, Canada M5L 1A9 | |||
Geoffrey B. Genovese | ||||
President, Chairman and | COMPENSATION COMMITTEE | INVESTOR RELATIONS | ||
Chief Executive Officer | David I. Hull (Chair) | E-mail: info@envoy.to | ||
Envoy Communications Group Inc. | Hugh Aird | |||
David Parkes | Additional information is | |||
David I. Hull | available on our | |||
President | NOMINATING AND CORPORATE | Web site at www.envoy.to | ||
Hull Life Insurance Agencies Inc. | GOVERNANCE COMMITTEE | |||
David I. Hull (Chair) | ||||
Hugh Aird (Lead Director) | Hugh Aird | STOCK TRADING INFORMATION | ||
Director of Business Development | David Parkes | Toronto Stock Exchange: ECG | ||
Blackmont Capital Inc. | NASDAQ Exchange: ECGI | |||
TRANSFER AGENT | ||||
Computershare Trust | ||||
Company of Canada | ||||
100 University Avenue, 9th Floor | ||||
Toronto, Canada M5J 2Y1 |