Consolidated Financial Statements
(Expressed in Canadian dollars)
ENVOY COMMUNICATIONS GROUP INC.
Years ended September 30, 2001, 2000 and 1999
Auditors' Report to the shareholders
We have audited the consolidated balance sheets of Envoy Communications
Group Inc. as at September 30, 2001 and 2000 and the consolidated statements
of operations, retained earnings and cash flows for each of the years in the
three-year period ended September 30, 2001. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
With respect to the consolidated financial statements for the years ended
September 30, 2001 and 2000, we conducted our audits in accordance with
Canadian generally accepted auditing standards and United States generally
accepted auditing standards. With respect to the consolidated financial
statements for the year ended September 30, 1999, we conducted out audit in
accordance with Canadian generally accepted auditing standards. Those
standards require that we plan and perform an audit to obtain reasonable
assurance whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Company as at September 30,
2001 and 2000 and the results of its operations and its cash flows for each of
the years in the three-year period ended September 30, 2001 in accordance with
Canadian generally accepted accounting principles.
KPMG
Chartered Accountants
Toronto, Canada
November 23, 2001
ENVOY COMMUNICATIONS GROUP INC.
Consolidated Balance Sheets
(In Canadian dollars)
September 30, 2001 and 2000
2001 2000
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Assets
Current assets:
Cash $ 21,781,809 $ 7,105,418
Restricted cash (note 4) 158,500 456,462
Accounts receivable (note 3) 26,940,137 34,234,974
Income taxes recoverable 230,389 -
Future income taxes 712,000 -
Prepaid expenses 1,315,009 1,540,159
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51,137,844 43,337,013
Restricted cash (note 4) - 375,875
Capital assets (note 6) 11,533,736 10,448,625
Goodwill and other assets (note 7) 50,356,502 47,179,760
Future income taxes 822,156 966,715
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$ 113,850,238 $ 102,307,988
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Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 38,728,210 $ 24,247,075
Income taxes payable - 1,190,313
Deferred revenue 300,071 1,044,873
Amounts collected in excess of
pass-through costs incurred 1,574,407 2,307,047
Current portion of long-term debt (note 8) 10,965,089 2,848,430
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51,567,777 31,637,738
Long-term debt (note 8) 963,076 7,983,449
Shareholders' equity:
Share capital (note 9) 54,883,305 54,597,762
Retained earnings 5,603,200 8,403,367
Cumulative translation adjustment 832,880 (314,328)
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61,319,385 62,686,801
Subsequent events (note 2(f))
Commitments (note 12)
Contingencies (note 2)
Reconciliation to United States
accounting principles (note 15)
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$ 113,850,238 $ 102,307,988
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See accompanying notes to consolidated financial statements.
On behalf of the Board:
------------------------------- Director
------------------------------- Director
ENVOY COMMUNICATIONS GROUP INC.
Consolidated Statements of Operations
(In Canadian dollars)
Years ended September 30, 2001, 2000 and 1999
2001 2000 1999
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Net revenue $ 80,792,381 $ 58,606,235 $ 41,787,125
Operating expenses:
Salaries and benefits 53,653,694 35,132,814 25,710,153
General and administrative 15,380,269 10,769,853 6,918,465
Occupancy costs 4,754,875 2,552,854 1,878,090
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73,788,838 48,455,521 34,506,708
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Earnings before depreciation,
interest expense, income taxes
and goodwill amortization 7,003,543 10,150,714 7,280,417
Depreciation 2,866,679 1,986,691 1,444,110
Interest expense 743,600 407,473 346,515
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Earnings before income taxes, goodwill
amortization and unusual items 3,393,264 7,756,550 5,489,792
Unusual items (note 11) 1,917,334 - -
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Earnings before income taxes and
goodwill amortization 1,475,930 7,756,550 5,489,792
Income tax expense, excluding
the undernoted (note 10) 1,259,731 3,252,354 2,002,995
Impact of tax rate changes
(note 10) 100,000 - -
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Earnings before
goodwill amortization 116,199 4,504,196 3,486,797
Goodwill amortization, net of income
tax recovery of $24,000
(2000 - $24,000; 1999 - $11,000) 3,011,571 1,593,769 610,034
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Net earnings (loss) $ (2,895,372) $ 2,910,427 $ 2,876,763
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Net earnings (loss) per share (note 9(g)):
Basic $ (0.14) $ 0.15 $ 0.20
Fully diluted (0.14) 0.15 0.20
Earnings per share before goodwill
amortization:
Basic 0.01 0.24 0.24
Fully diluted 0.01 0.24 0.24
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See accompanying notes to consolidated financial statements.
ENVOY COMMUNICATIONS GROUP INC.
Consolidated Statements of Retained Earnings
(In Canadian dollars)
Years ended September 30, 2001, 2000 and 1999
2001 2000 1999
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Retained earnings,
beginning of year $ 8,403,367 $ 5,492,940 $ 2,682,142
Gain (loss) on redemption of shares
(note 9(d) and (f)) 95,205 - (65,965)
Net earnings (loss) (2,895,372) 2,910,427 2,876,763
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Retained earnings, end of year $ 5,603,200 $ 8,403,367 $5,492,940
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See accompanying notes to consolidated financial statements.
ENVOY COMMUNICATIONS GROUP INC.
Consolidated Statements of Cash Flows
(In Canadian dollars)
Years ended September 30, 2001, 2000 and 1999
2001 2000 1999
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Cash flows from operating activities:
Net earnings (loss) $ (2,895,372) $ 2,910,427 $ 2,876,763
Items not involving cash:
Future income taxes (567,441) (285,344) 76,000
Depreciation 2,866,679 1,986,691 1,444,110
Goodwill amortization 3,035,571 1,617,769 621,034
Amortization of deferred
financing charges 65,936 9,990 -
Net change in non-cash working
capital balances:
Restricted cash 297,962 - -
Accounts receivable 7,389,275 1,823,856 (1,395,987)
Prepaid expenses (174,654) 124,424 (397,950)
Accounts payable and
accrued liabilities 12,440,922 (10,519,909) 229,132
Income taxes payable (1,145,133) (787,622) 1,794,028
Deferred revenue (758,380) 1,044,873 -
Amounts collected in excess of
pass-through costs incurred (777,930) 518,410 (3,656,333)
Other 159,003 (126,812) 46,284
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Net cash provided by (used in)
operating activities 19,936,438 (1,683,247) 1,637,081
Cash flows from financing activities:
Long-term debt 8,137,183 5,198,442 5,000,000
Long-term debt repayments (8,097,536) (5,497,140) (1,410,467)
Issuance of common shares for cash 383,670 10,939,807 1,361,172
Redemption of common shares (1,295,475) - (65,965)
Reduction (increase) in
restricted cash 394,625 (277,330) 187,718
Net proceeds from special warrant issue - - 16,192,731
Other 190,143 - -
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Net cash provided by (used in)
financing activities (287,390) 10,363,779 21,265,189
Cash flows from investing activities:
Acquisition of subsidiaries, net of cash
acquired (bank indebtedness assumed)
of $214,179 (2000 - $(941,385);
1999 - $5,919,627) (1,669,168) (14,640,994) (8,416,977)
Purchase of capital assets (3,756,134) (2,428,228) (2,017,796)
Increase in other assets - (67,356) (20,000)
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Net cash used in
investing activities (5,425,302) (17,136,578) (10,454,773)
Change in cash balance due to
foreign exchange 452,645 261,010 (267,201)
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Increase (decrease) in cash 14,676,391 (8,195,036) 12,180,296
Cash, beginning of year 7,105,418 15,300,454 3,120,158
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Cash, end of year $ 21,781,809 $ 7,105,418 $ 15,300,454
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Cash flow from operations per share
(note 9(g)):
Basic $ 0.12 $ 0.33 $ 0.34
Fully diluted 0.12 0.33 0.34
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Supplemental cash flow information:
Interest paid $ 704,604 $ 407,474 $ 334,229
Income taxes paid 3,407,801 3,489,185 68,774
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Supplemental disclosure of non-cash
transactions:
Shares issued for non-cash
consideration $ 3,908,156 $ 6,850,311 $ 3,691,800
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See accompanying notes to consolidated financial statements.
ENVOY COMMUNICATIONS GROUP INC.
Notes to Consolidated Financial Statements
(In Canadian dollars)
Years ended September 30, 2001, 2000 and 1999
The Company, continued under the Business Corporations Act (Ontario), with
operations in the United States, the United Kingdom, Continental Europe and
Canada, provides integrated marketing and communication services. The core
disciplines are: advertising, branding and digital professional services,
which include strategy, creative design and technology infrastructure services
necessary to build and maintain successful e-businesses.
1. Significant accounting policies:
(a) Basis of presentation:
The consolidated financial statements have been prepared 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 15.
Certain of the comparative figures have been reclassified to conform with
the current year's financial statement presentation.
(b) Principles of consolidation:
The consolidated financial statements include the accounts of the Company
and its subsidiaries, collectively known as Envoy Communications Group Inc.
Intercompany balances and transactions are eliminated on consolidation.
Significant subsidiaries are as follows:
% of Jurisdiction of
Company ownership incorporation
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Communique Incentives Inc. 100 Ontario
The Communique Group Inc. 100 Ontario
Promanad Communications Inc. 100 Ontario
Hampel Stefanides, Inc. 100 Delaware
Devlin Multimedia Inc. 100 Ontario
Watt International Inc. 100 Ontario
Sage Information Consultants Inc. 100 Ontario
Gilchrist Brothers Limited 100 United Kingdom
International Design Group 100 Ontario
John Street Inc. 70 Ontario
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Effective October 1, 2000, Promanad Communications Inc. was amalgamated
with The Communique Group Inc.
Effective July 2001, the Company established John Street Inc.
(c) Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
(d) Capital assets:
Capital assets are recorded at cost and are depreciated over their
estimated useful lives as follows:
Asset Basis Rate
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Audiovisual equipment Straight line 2 - 5 years
Computer equipment and software Declining balance 30% - 50%
Furniture and equipment Declining balance 20%
Leasehold improvements Over term of leases
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(e) Revenue recognition:
The Company presents as net revenue its net commission and fee income
earned as compensation for its services. Further, the balance sheet
reflects the following:
(i) deferred revenue represents only fees billed and collected in advance
of such fees being earned; and
(ii) the reimbursable pass-through costs are included in unbilled accounts
receivable.
Net revenue represents the Company's compensation for its agency and
non-agency services and is recognized only when collection of such net
revenue is probable. Agency services are those that require the Company to
incur external media and production costs on behalf of its clients and for
which it is entitled to pass through the costs for reimbursement from its
clients. The reimbursement of pass-through costs are not included in net
revenue. The Company's agency and non-agency projects are short-term in
nature.
Fees earned for non-agency services are recognized either upon the
performance of the Company's services when the Company earns a per-diem
fee, or in the case of a fixed fee, when the Company's services are
substantially complete and accepted by the client. Fees earned but not
yet billed are included in accounts receivable. Fees billed to clients in
excess of fees recognized as net revenue are classified as deferred
revenue.
When the Company's compensation for its agency services is based on
commissions, net revenue is comprised of: (i) commissions earned from media
expenditures, which are recognized at the time the advertising appears or
is broadcast, or in respect of on-line advertising, either ratably over the
period of time the advertising appears or based on the actual impressions
delivered at the contractual rate per impression, depending upon the terms
of the arrangement; and (ii) commissions earned on expenditures for the
production of advertisements, which are recognized upon the completion of
the Company's services and acceptance by the client, being the time at
which the Company has no further substantial obligations with respect
thereto.
When the Company's compensation for its agency services is fee-based, net
revenue is comprised of non-refundable monthly agency fees, which are
recognized in the month earned.
Pass-through costs related to production are accrued and recorded in
accounts receivable, as unbilled reimbursable costs, at the time the third
party suppliers render their services. Pass-through costs related to media
are accrued at the time the advertisement appears or is broadcast.
(f) Goodwill:
Goodwill, being the excess of purchase price over the fair values of net
assets acquired, is initially stated at cost with amortization being
provided on a straight-line basis ranging from seven to 25 years.
Annually, the Company assesses the recoverability of the carrying value of
its goodwill and the related amortization period. As part of the
evaluation, the Company 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 a permanent impairment
of goodwill.
Goodwill is considered to be impaired if the future anticipated
undiscounted operating cash flows from the acquired businesses are less
than the carrying value of the goodwill. These cash flow projections
require management to make certain assumptions regarding future revenue
and expenses. 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. The impact of such write-downs on the amortization
period is simultaneously assessed. The Company believes there has been
no impairment in the value of goodwill.
(g) Foreign currency translation:
The financial statements of the Company's foreign subsidiaries, all of
which are self-sustaining operations, are translated using the current
rate method, whereby the assets and liabilities of such foreign
operations are translated at the exchange rate in effect at the balance
sheet date. Revenue and expenses are translated at the average exchange
rate for the year. Translation gains or losses are deferred and included
as a separate component of shareholders' equity.
In respect of the Company's and its subsidiaries' foreign currency
transactions, at the transaction date, each asset, liability, revenue and
expense is translated into Canadian dollars by the use of the exchange
rate in effect at that date. At the year-end date, monetary assets and
liabilities are translated into Canadian dollars by using the exchange
rate in effect at that date. The resulting foreign exchange gains and
losses are included in earnings in the current year. However, unrealized
gains or losses on long-term debt that is designated as a hedge of
investments in foreign subsidiaries are deferred and recorded as a
separate component of shareholders' equity.
The Company used derivative financial instruments to manage risks from
fluctuations in foreign exchange rates. These instruments are foreign
exchange forward contracts, and are used only for risk management
purposes and are designated as hedges of accounts receivable and future
cash flows. The Company accounts for these financial instruments as
hedges and, as a result, the carrying values of the financial instruments
designated as hedges of future cash flows are not adjusted to reflect
their current market values.
(h) Income taxes:
Effective October 1, 2000, the Company was required to adopt on a
retroactive basis the new accounting standard of The Canadian Institute
of Chartered Accountants ("CICA") for income taxes. Under this accounting
standard, the Company is not required to restate its comparative figures
for prior years.
Under this new standard, future tax assets and liabilities are recognized
for the future tax consequences attributable to differences between
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Future tax assets and liabilities are
measured using enacted or substantively enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be received or settled. A valuation allowance is recorded
against any future income tax asset if it is more likely than not that the
asset will not be realized. Income tax expense or benefit is the sum of
the Company's provision for current income taxes and the difference
between opening and ending balances of future income tax assets and
liabilities.
Prior to adoption of this new standard, income tax expense was determined
using the deferred method. Under this method, deferred income tax expense
was based on differences between the accounting and tax incomes and was
measured at tax rates in effect in the year the differences originated.
The benefits of tax losses were not recognized at the time they were
incurred unless there was virtual certainty of realization.
There is no cumulative effect as of October 1, 2000 of this change in
accounting policy.
As at October 1, 2000, the Company's temporary differences are principally
in respect of deductible share issue costs that were recorded directly in
capital stock rather than as a credit to income tax expense. As a result
of the announcements by the government to introduce legislation to reduce
income taxes over the next four years, the Company was required to revalue
its future tax assets during the year by $100,000. Under the CICA's new
accounting standards, the Company is required to record this item as an
adjustment to income tax expense, notwithstanding the fact that such
amounts were not previously reflected in income tax expense when recorded.
(i) Stock-based compensation:
The Company has a stock option plan for key employees and officers. All
stock options issued under this plan have an exercise price equal to or
greater than the fair market value of the underlying common shares on the
date of the grant. The Company does not record compensation expense on the
grant or modification of options under the Plan. The stock option plan is
described in note 9(e).
(j) Deferred financing charges:
The costs of obtaining bank and other debt financing are deferred and
amortized on a straight-line basis over the effective life of the debt to
which they relate.
2. Acquisition of subsidiaries:
(a) Effective January 1, 2001, the Company acquired 100% of the outstanding
shares of The International Design Group, a Toronto-based international
retail planning and design firm. Under the terms of the acquisition, the
initial purchase price, which consisted of $1,090,000 in cash
consideration and 61,728 common shares of the Company with a fair value
of $284,332, was paid upon closing. Additional consideration may be paid
over a three-year period if certain performance milestones are achieved
for the 12-month periods ending December 31. The earn-out amounts earned
will be satisfied by a maximum of $2,000,000 in cash and a maximum of
154,321 common shares of the Company. The acquisition has been accounted
for using the purchase method of accounting.
The fair value of the net assets acquired was $1,198,684, excluding cash
acquired of $214,179. The net assets acquired consisted of working
capital and fixed assets. The resulting excess purchase price over the
fair value of the net assets acquired of $336,382 was allocated to
goodwill and is being amortized over 25 years.
(b) Effective July 1, 2000, the Company acquired 100% of the outstanding
shares of Gilchrist Brothers Ltd. ("Gilchrist"), a United Kingdom-based
digital imaging and design firm, in exchange for cash consideration of
$3,235,798 (british pounds 1,460,000) and a $5,325,215 (british pounds
2,402,750) non-interest bearing promissory note, repayable in semi-annual
instalments over the next two years to June 30, 2002. The present value
of the promissory note of $5,067,763 (british pounds 2,261,486), together
with the initial cash consideration, represent the total purchase price.
At September 30, 2001, $2,689,781 (british pounds 1,156,200) (2000 -
$4,564,856 (british pounds 2,059,674)) is included in long-term debt
(note 8). The acquisition has been accounted for using the purchase method
of accounting and the resulting goodwill is being amortized over 20 years.
The fair value of the net assets acquired at July 1, 2000 was as follows:
Non-cash working capital $ 1,046,094
Capital assets 2,001,319
Long-term debt (2,165,325)
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Net assets 882,088
Total consideration, including bank indebtedness assumed 8,593,970
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Excess of purchase price over fair value
of net assets acquired allocated to goodwill $ 7,711,882
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(c) Effective June 1, 2000, the Company, acquired 100% of the outstanding
shares of Sage Information Consultants Inc. ("Sage"), a digital
professional service firm operating in the United States and Canada, in
exchange for cash consideration of $6,750,000 and the issuance of 503,145
common shares of the Company with a fair value of $4,000,000.
During 2001, the Company reached an agreement with the former owner of
Sage to extend his indemnification of receivables at the acquisition date
to also cover receivables arising out of contracts in progress on the date
of acquisition. Under this indemnification, the Company is owed $1,714,047
as at September 30, 2001 (note 5).
In June 2001, the Company determined that additional consideration was
payable based on Sage's operating results for the twelve months ended
May 31, 2001 and agreed to amend the terms of the purchase agreement with
respect to the payment of the earnout for this period. Under the amended
terms, the Company agreed to pay $1,392,154 in cash consideration, rather
than the issuance of cash and shares under the original terms. The excess
of the cash consideration payable over the fair value of the cash and
shares otherwise issuable amounted to $362,485 and is required to be
expensed under generally accepted accounting principles. As a result,
only $1,029,669 of the amount payable has been recorded as additional
goodwill. The Company may be required to pay additional consideration, to
a maximum amount of $10,107,846 in cash and 1,358,984 common shares, based
on the attainment of certain operating results over each of the next three
years to May 31, 2004.
The acquisition has been accounted for using the purchase method of
accounting and the resulting goodwill is being amortized over 10 years.
Future consideration will be accounted for as goodwill at the time it
becomes payable. The fair value of the net assets acquired at June 1, 2000
was as follows:
Non-cash working capital $ 104,663
Capital assets 141,578
Future income taxes 53,000
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Net assets 299,241
Total consideration, including bank indebtedness
assumed, June 1, 2000 12,270,724
Additional cash consideration 1,029,669
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Excess of purchase price over fair value
of net assets acquired allocated to goodwill $ 13,001,152
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(d) Effective May 1, 1999, the Company acquired substantially all of the
assets and the liabilities of Watt International Inc. (formerly The Watt
Design Group Inc.) ("Watt"), a packaging and retail environment design
business, in exchange for cash consideration of $6,700,000. Costs
associated with the acquisition of $470,000 were satisfied by the issuance
of 100,000 common shares of the Company with a fair value of $470,000.
The acquisition has been accounted for using the purchase method of
accounting and the resulting goodwill is being amortized over 25 years.
The fair value of the net assets acquired at May 1, 1999 was as follows:
Non-cash working capital $ 4,054,000
Capital assets 939,000
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Net assets 4,993,000
Total consideration, less cash acquired 7,569,000
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Excess of purchase price over fair value
of net assets acquired allocated to goodwill $ 2,576,000
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(e) Effective January 1, 1999, the Company acquired 100% of the outstanding
shares of Devlin Multimedia Inc. ("Devlin"), an interactive communication
services business, in exchange for initial cash consideration of $575,000
and the issuance of 225,060 common shares of the Company with a fair value
of $925,000. The Company may be required to pay additional consideration,
to a maximum of $4,500,000, based on Devlin's attainment of certain
operating results to December 31, 2001. However, management believes the
likelihood of paying this contingent consideration is remote. The
acquisition has been accounted for using the purchase method of accounting
and the resulting goodwill is being amortized over seven years. Future
consideration, if any, will be accounted for as additional goodwill at the
time it becomes payable.
The fair value of the net assets acquired at January 1, 1999 was as
follows:
Non-cash working capital $ 9,000
Capital assets 158,000
Long-term debt (88,000)
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Net assets 79,000
Total consideration, including bank indebtedness assumed 1,613,000
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Excess of purchase price over fair value
of net assets acquired allocated to goodwill $ 1,534,000
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(f) Effective October 1, 1998, the Company acquired 100% of the outstanding
shares of Hampel Stefanides, Inc. ("Hampel Stefanides"), a full-service
advertising and commercial design agency operating in the United States,
in exchange for initial cash consideration of $5,587,349 (U.S. $3,649,000)
and the issuance of 581,395 common shares with a fair value of $2,296,800
(U.S. $1,500,000). In September 1999, the Company recorded additional
consideration of $4,134,002. The consideration was paid on November 4,
1999 by way of a cash payment of $1,703,802 and the issuance of 450,040
common shares of the Company with a fair value of $2,430,200. During
fiscal 2000, additional cash consideration of $554,788 (U.S. $375,000)
was paid. Additional cash consideration of $375,875 (U.S. $250,000) is
included in accounts payable and accrued liabilities as at September 30,
2001 and has been included as part of total consideration.
In September 2000, the Company determined that additional consideration
was owing, in the form of cash and shares of the Company, based on Hampel
Stefanides's operating results for the year ended September 30, 2000 and
such amount has been recorded as at September 30, 2000. The aggregate
consideration of $5,348,600 was paid on November 1, 2000 by way of a cash
payment of $1,724,776, which is included in accounts payable and accrued
liabilities, and the issuance of 444,641 common shares of the Company with
a fair value of $3,623,824, which were included in share capital as at
September 30, 2000.
In December 2001, the Company determined that additional consideration
was owing in the form of cash and shares, based on Hampel Stefanides's
operating results for the year ended September 30, 2001 and such amount
has been recorded as at September 30, 2001. The aggregate consideration
of $2,909,150 consists of cash consideration of $1,900,929, which is
included in accounts payable and accrued liabilities, and the issuance of
466,769 common shares of the Company with a fair value of $1,008,221,
which are included in share capital as at September 30, 2001 as shares to
be issued (note 9(a)).
The Company may be required to pay additional consideration, to a maximum
amount of $769,456 (U.S. $487,460) in cash and 258,936 common shares,
based on the attainment of operating results to September 30, 2002.
Future consideration, if any, will be accounted for as additional goodwill
at the time it becomes payable.
The acquisition has been accounted for using the purchase method of
accounting and the resulting goodwill is being amortized over 25 years.
The fair value of the net liabilities acquired on October 1, 1998 and
consideration accounted for to date was as follows:
Non-cash working capital deficiency $ (6,171,687)
Capital assets 1,676,664
Restricted cash 765,600
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Net liabilities (3,729,423)
Consideration, less cash acquired, September 30, 1999 7,475,961
Additional consideration, September 30, 2000:
Cash 1,724,776
Issuance of 444,641 common shares 3,623,824
Additional consideration, September 30, 2001:
Cash 1,900,929
Issuance of 466,769 common shares 1,008,221
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Total consideration, less cash acquired, September 30, 2001 15,733,711
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Purchase price and fair value of net liabilities
acquired allocated to goodwill $ 19,463,134
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(g) Effective June 1, 1998, the Company acquired 100% of the outstanding
shares of Promanad Communications Inc. ("Promanad"), a full service
advertising agency, in exchange for initial cash consideration of
$2,937,142 and the issuance of 119,047 common shares of the Company with
a fair value of $500,000. In June 1999, the Company determined that
additional cash consideration of $661,675 and the issuance of 52,514
common shares of the Company with a fair value of $367,598 was payable.
In June 2000, the Company determined that additional consideration was
payable based on Promanad's operating results for the twelve months ended
May 31, 2000. The consideration was comprised of cash of $678,636 and the
issuance of 53,860 common shares of the Company with a fair value of
$420,108.
This acquisition was accounted for using the purchase method of accounting
and the resulting goodwill is being amortized over 25 years.
The fair value of the net liabilities acquired at June 1, 1998 and
consideration accounted for to date was as follows:
Non-cash working capital deficiency $ (954,000)
Capital assets 522,000
--------------------------------------------------------------------------
Net liabilities (432,000)
Consideration, net of cash acquired, September 30, 1999 3,977,415
Additional consideration:
Cash 678,636
Issuance of 53,860 common shares 420,108
--------------------------------------------------------------------------
Total consideration, less cash acquired 5,076,159
--------------------------------------------------------------------------
Purchase price and fair value of net liabilities
acquired allocated to goodwill $ 5,508,159
--------------------------------------------------------------------------
3. Accounts receivable:
2001 2000
------------------------------------------------------------------------------
Trade receivables $ 20,501,517 $ 25,844,406
Accrued revenue 118,414 2,652,275
Unbilled pass-through costs 6,320,206 5,738,293
------------------------------------------------------------------------------
$ 26,940,137 $ 34,234,974
------------------------------------------------------------------------------
4. Restricted cash:
Restricted cash includes the following:
(a) A trust account established for Communique Incentives Inc. for customer
deposits of $158,500 (2000 - $456,462).
(b) At September 30, 2000, $375,875 (U.S. $250,000) bank certificate of
deposit pledged against a letter of credit for a building lease of Hampel
Stefanides. There were no amounts outstanding under this letter of credit
at September 30, 2001.
5. Related party transactions:
Certain management and administrative costs totalling $685,000
(2000 - $300,000; 1999 - $250,000) were incurred during the year in respect of
a company controlled by a director and are recorded at the exchange amount,
being the amount agreed to by the related parties. At September 30, 2001,
$338,400 (2000 - nil) of such amount was unpaid and was included in accounts
payable and accrued liabilities.
Included in accounts receivable as at September 30, 2001 is a net balance
of $321,893 owing from the former owner of Sage in respect of indemnified
receivables, net of the earnout payment owing by Envoy (note 2(c)).
6. Capital assets:
Accumulated Net book
2001 Cost depreciation value
------------------------------------------------------------------------------
Audiovisual equipment $ 780,919 $ 750,126 $ 30,793
Computer equipment and software 10,704,399 7,575,183 3,129,216
Furniture and equipment 3,967,088 2,714,054 1,253,034
Leasehold improvements 9,700,446 3,209,833 6,490,613
Equipment under capital leases 1,393,849 763,769 630,080
------------------------------------------------------------------------------
$ 26,546,701 $ 15,012,965 $ 11,533,736
------------------------------------------------------------------------------
Accumulated Net book
2000 Cost depreciation value
------------------------------------------------------------------------------
Audiovisual equipment $ 780,918 $ 741,376 $ 39,542
Computer equipment and software 8,860,993 6,107,275 2,753,718
Furniture and equipment 3,346,760 2,158,219 1,188,541
Leasehold improvements 7,900,367 2,314,080 5,586,287
Equipment under capital leases 1,416,437 535,900 880,537
------------------------------------------------------------------------------
$ 22,305,475 $ 11,856,850 $ 10,448,625
------------------------------------------------------------------------------
7. Goodwill and other assets:
2001 2000
------------------------------------------------------------------------------
Goodwill, net of accumulated amortization
of $5,969,743 (2000 - $2,934,156) $ 49,675,115 $ 46,707,924
Deferred financing charges, net of
accumulated amortization of
$70,410 (2000 - $9,990) 634,936 192,053
Mortgage receivable - 200,000
Other 46,451 79,783
------------------------------------------------------------------------------
$ 50,356,502 $ 47,179,760
------------------------------------------------------------------------------
8. Long-term debt:
2001 2000
------------------------------------------------------------------------------
Revolving credit facility, with annual
interest rates of Canadian prime plus
0% to 0.75% or at banker's acceptance plus
0.50% to 1.00%, U.S. base plus 0% to 0.75%
or at U.S. LIBOR plus 0.50% to 1.00%
or U.K. LIBOR plus 0.50% to 1.00% (a) $ 7,841,329 $ -
Revolving credit facility, U.S. prime rate
plus 0.125% to 0.250% or at LIBOR plus
1.75% to 2.25% (b) - 4,727,043
Non-interest bearing promissory note,
issued July 1, 2000, repayable in semi-annual
instalments over two years to
June 30, 2002 (c) 2,689,781 4,564,856
Loan payable to landlord, 3.5% per annum,
Due July 1, 2009, repayable in monthly
Instalments of $7,665 principal and interest 625,382 694,337
Loan payable to landlord, 0.925% per annum,
due January 1, 2003, repayable in monthly
instalments of $6,728 principal and interest 100,925 180,379
Loan payable to landlord, 10% per annum,
due April 1, 2010, repayable in monthly
instalments of $5,999 principal and interest 357,016 -
Capital lease, 12.3% over the lease period,
Repayable in quarterly instalments of
$60,129 (british pounds 25,330)
(2000 - $56,139 (british pounds 25,330))
principal and interest, due January 2003 284,507 459,731
Capital leases, 10.3% to 13.9% over the
lease period, repayable in quarterly
instalments of $14,950 (british pounds 6,426);
(2000 - $43,771 (british pounds 19,750))
principal and interest, due between
March 2002 and April 2002 29,225 178,563
Other - 26,970
------------------------------------------------------------------------------
11,928,165 10,831,879
Less current portion 10,965,089 2,848,430
------------------------------------------------------------------------------
$ 963,076 $ 7,983,449
------------------------------------------------------------------------------
(a) During 2001, the Company established an extendable revolving line of credit
under which it can borrow funds in either Canadian dollars, U.S. dollars or
U.K. Pounds Sterling, provided the aggregate borrowings do not exceed Cdn.
$40,000,000. Advances under the line of credit can be used for general
corporate purposes (to a maximum of Cdn. $2,000,000) and for financing
acquisitions which have been approved by the lenders. The Company used
its borrowings under this facility to repay its U.S. dollar revolving
credit facility (note 8(b)). Included in the Company's borrowings as at
September 30, 2001, are foreign denominated loans of U.S. $1,914,250.
As at September 30, 2001, the Company had not drawn upon that portion of
the facility available for general corporate purposes.
Each year, the Company can request to have the facility renewed for a
subsequent one-year period subject to approval by the lenders. If not
renewed, the revolving credit facility becomes a reducing three-year term
loan. Interest rates on the facility are variable based on certain
leverage ratios and, at September 30, 2001, the effective interest rate
was 4.25%. The facility is secured by a general security agreement
guarantee against the Company and all of its subsidiaries.
Under the terms of the facility, the Company is required to maintain
certain financial ratios. As at September 30, 2001 the Company was not
in compliance with one of the debt covenants involving trailing 12 months
earnings before taxes, interest, depreciation and amortization and the
Company will continue to be in violation of this covenant in fiscal 2002.
The lenders have waived the violation of this covenant as of September 30,
2001 and are in discussions with the Company regarding amendments to the
covenant calculations going forward. Under the terms of the facility, if
the covenants are not met, the lenders can demand repayment of the
outstanding borrowings. Accordingly the entire amount of the loan is
classified as a current liability based on the lenders ability to
accelerate payment.
(b) In 2000, the Company established an $8,000,000 U.S. dollar revolving
credit facility and repaid its existing term loan. The term of the
facility was two years and could be converted on June 29, 2002, being the
second anniversary date, into a three-year term loan. Interest rates on
the facility were variable based on certain leverage ratios. At
September 30, 2001, the interest rate was 9.5%. The facility was secured
by a registered general security agreement guarantee. Under the terms of
the debt facility, the Company was required to maintain certain financial
ratios. The facility was repaid in 2001 using the Company's new revolving
credit facility described in note 8(a).
(c) The non-interest bearing promissory note due on June 30, 2002 in respect
of the Gilchrist acquisition (note 2(b)) (the "Gilchrist note") will be
refinanced under the Company's revolving credit facility. However, due
to a violation of one of the covenants under the facility, the Gilchrist
note cannot be presented as long-term debt.
Principal repayments are as follows:
2002, including the amounts borrowed under the
revolving credit facility and the Gilchrist note $ 10,965,089
2003 187,034
2004 113,108
2005 138,152
2006 363,358
Thereafter 161,424
--------------------------------------------------------------------------
$ 11,928,165
--------------------------------------------------------------------------
9. Share capital:
(a) Authorized:
50,000,000 common shares without par value
(2000 - 50,000,000; 1999 - 50,000,000)
Issued:
2001 2000 1999
------------------------------------------------------------------------------
Number Number Number
of shares Amount of shares Amount of shares Amount
------------------------------------------------------------------------------
Balance, beginning of year
21,098,222 $54,597,762 18,349,005 $35,613,907 13,231,618 $10,634,371
Common shares issued for cash pursuant to:
Public offering
- - 1,533,571 10,128,823 - -
Stock options exercised
101,000 383,670 214,000 811,100 273,000 873,810
Acquisitions (note 2)
61,728 284,332 557,005 4,420,108 958,969 4,076,544
Repurchase of shares pursuant to share issuer bid
(535,000) (1,390,680) - - - -
Special warrants exercised
- - - - 3,300,000 17,111,620
Warrants exercised
- - - - 135,378 487,362
------------------------------------------------------------------------------
20,725,950 53,875,084 20,653,581 50,973,938 17,898,965 33,183,707
Shares to be issued in respect of contingent consideration (note 2(f))
466,769 1,008,221 444,641 3,623,824 450,040 2,430,200
------------------------------------------------------------------------------
Balance, end of year
21,192,719 $54,883,305 21,098,222 $54,597,762 18,349,005 $35,613,907
------------------------------------------------------------------------------
(b) Public offering:
On June 5, 2000, the Company issued 1,533,571 common shares through a
public share offering for gross proceeds of $7.00 per share and aggregate
proceeds of $10,734,997. Net proceeds recorded as share capital were
$10,128,823 after deducting issue costs of $1,195,965 and recording the
related tax recovery of $589,791.
(c) Private placement transaction:
On May 11, 1999, the Company issued 3,300,000 special warrants in a private
placement for cash consideration of $5.50 per special warrant and aggregate
proceeds of $18,150,000. Net proceeds recorded as share capital, after
deducting issue costs of $1,957,269 and the related tax recovery of
$918,889, were $17,111,620. On July 30, 1999, the Company filed a final
prospectus with certain securities commissions in Canada to qualify
3,300,000 common shares which were issued on the exercise of the special
warrants.
(d) Repurchase of shares:
During 2001, pursuant to a normal course issuer bid, the Company
repurchased and cancelled 535,000 common shares at an average price of
$2.42 per common share for total consideration of $1,295,475. As a result
of these repurchases, $95,205 was recorded as a gain on redemption of
shares in retained earnings. Under the terms of the normal course issuer
bid, the Company may repurchase and cancel up to 10% of the public float
to July 26, 2002.
(e) Stock option plan:
The Company has reserved 4,000,000 common shares under its stock option
plan. Under the plan, the options are exercisable for one common share
and the exercise price of the option must equal the market price of the
underlying share at the grant date. Options granted after November 1997
have vesting periods ranging from date of grant and up to five years.
Options granted prior to November 1997 vested upon grant. Once vested,
options are exercisable at any time until expiry. Expiry dates range
between 2001 and 2006.
Details of the options are as follows:
Weighted
Number average exercise
of options price per share
--------------------------------------------------------------------------
Options outstanding, September 30, 1998 1,555,000 $ 3.60
Options granted 1,116,500 4.86
Options exercised (273,000) 3.20
Options cancelled (322,000) 3.75
--------------------------------------------------------------------------
Options outstanding, September 30, 1999 2,076,500 4.30
Options granted 774,000 7.43
Options exercised (214,000) 3.79
Options cancelled (296,000) 4.72
--------------------------------------------------------------------------
Options outstanding, September 30, 2000 2,340,500 5.33
Options granted 780,000 5.30
Options exercised (101,000) 3.80
Options cancelled (340,000) 5.87
--------------------------------------------------------------------------
Options outstanding, September 30, 2001 2,679,500 5.31
--------------------------------------------------------------------------
Options exercisable, September 30, 2001 1,491,510 $ 5.07
--------------------------------------------------------------------------
Options exercisable, September 30, 2000 1,137,673 $ 5.05
--------------------------------------------------------------------------
The range of exercise prices for options outstanding and options
exercisable at September 30, 2001 are as follows:
Options outstanding Options exercisable
----------------------------------- --------------------
Weighted Weighted Weighted
average average average
Range of exercise contractual exercise
exercise price Number price life Number price
--------------------------------------------------------------------------
$ 3.62 - 4.70 1,434,000 $ 3.67 2.63 years 856,668 $ 3.77
6.20 - 8.15 1,245,500 7.20 3.49 years 634,842 6.83
--------------------------------------------------------------------------
(f) Loss on redemption of shares:
During 1999, the Company paid $65,965 to an employee upon the surrender
and cancellation of 97,000 vested stock options. The cash payment
represented the excess of the fair value of the options of $332,040 over
the aggregate exercise price of $266,075 and has been charged to retained
earnings as a loss on redemption of shares.
(g) Net earnings (loss) and cash flows from operations per share:
Earnings (loss) and cash flow figures per share are based on the weighted
average number of basic common shares outstanding during the year of
21,160,616 (2000 - 19,156,626; 1999 - 14,750,247) and fully diluted common
shares outstanding of 21,160,616 (2000 - 19,156,626; 1999 - 14,750,247).
Basic and fully diluted cash flows from operations per share have been
calculated using the cash flows from operating activities, excluding net
changes in non-cash working capital balances.
10. Income taxes:
Income tax expense (recovery) for the years ended September 30, 2001, 2000 and
1999 consists of:
Current Future Total
------------------------------------------------------------------------------
2001 $ 1,927,172 $ (567,441) $ 1,359,731
2000 3,537,698 (285,344) 3,252,354
1999 1,926,995 76,000 2,002,995
The income tax expense attributable to income from continuing operations
differs from the amounts computed by applying the Canadian statutory rates of
42.5% (2000 - 44.1%; 1999 - 44.6%) pre-tax income as a result of the following.
2001 2000 1999
------------------------------------------------------------------------------
Income taxes at statutory rates
$ 627,270 42.5% $ 3,420,638 44.1% $ 2,448,447 44.6%
Increase (decrease) in income taxes resulting from:
Adjustment to future tax assets for substantively
enacted changes in tax laws and rates
100,000 6.8 - - - -
Expenses deducted in the accounts which have
no corresponding deduction for income taxes
665,323 45.1 168,476 2.1 215,548 3.9
Lower basic tax rate on earnings
of foreign subsidiaries
(185,524) (12.6) (111,815) (1.4) - -
Utilization of previous years' losses
- - - - (721,000) (13.1)
Other 152,662 10.4 (224,945) (2.9) 60,000 1.1
------------------------------------------------------------------------------
$ 1,359,731 92.2% $ 3,252,354 41.9% $ 2,002,995 36.5%
------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant portions
of the future tax assets and liabilities at September 30, 2001 are presented
below:
Future tax assets:
Capital assets $ 333,006
Share issuance costs 530,891
Non-capital losses expiring in 2008 712,000
----------------------------------------------------------------------------
Total gross future tax assets 1,575,897
Future tax liabilities:
Goodwill 41,741
------------------------------------------------------------------------------
Total net future tax assets 1,534,156
Less current portion 712,000
------------------------------------------------------------------------------
$ 822,156
------------------------------------------------------------------------------
11. Unusual items:
During the year, the Company announced that it was terminating its discussions
in connection with the proposed acquisition of Leagas Delaney. Generally
accepted accounting principles require that all costs in connection with the
proposed acquisition and the related equity financing need to be expensed in
full as of the date of abandonment. Costs include legal, accounting,
consulting and other out-of-pocket expenses incurred in the negotiation and
preparation of legal documents and preparation of long-form prospectus
materials prepared in connection with the abandoned acquisition.
12. Commitments:
(a) The Company has entered into operating lease agreements for office premises
and equipment with minimum annual lease payments over the next five years
as follows:
2002 $ 4,029,233
2003 3,662,992
2004 3,424,226
2005 3,820,658
2006 3,706,608
--------------------------------------------------------------------------
$ 18,643,717
--------------------------------------------------------------------------
(b) At September 30, 2001, the Company has letters of credit outstanding of
$1,952,450 (U.S. $500,000 and british pounds 500,000) (2000 - nil).
13. Financial instruments:
(a) The carrying value and estimated fair values of the Company's financial
instruments are as follows:
(i) The carrying amounts of cash, restricted cash, accounts receivable,
accounts payable and accrued liabilities and non-interest bearing
promissory note approximate their fair values due to the short-term
nature of these instruments.
(ii) The fair values of the Company's capital leases and revolving credit
facilities approximate their carrying values as they bear interest
rates that approximate current market rates. The carrying values of
the loans payable to landlords are not significantly different from
their fair values.
(iii) The fair value of foreign currency contracts are estimated by
obtaining quotes of the amount that the Company would have to pay
counterparties to terminate agreements. As at September 30, 2001,
the carrying amounts of the contracts were $(104,218)
(2000 - $(119,254)) and their fair values were $(189,224)
(2000 - $(143,015)).
(b) Risk management activities:
(i) Currency risk:
During 2000, the Company entered into foreign currency contracts to
manage certain of its exposures to foreign currency risk on its U.S.
dollar receivables and future cash flows. The Company has provided
as security all of Watt's assets to support these foreign currency
contracts. As at September 30, 2001, the Company had outstanding
foreign exchange contracts to sell U.S. $4,689,000 (2000 - U.S.
$3,135,000) in exchange for Canadian dollars over a period of
12 months at a weighted average exchange rate of Cdn. $1.5407
(2000 - $1.46).
During 2001, the Company established a $40,000,000 revolving credit
facility. The U.S. dollar borrowings under this facility serve as a
hedge against the Company's investment in its U.S. operations,
managing exposure to foreign currency risk.
The Company's promissory note payable issued in connection with its
acquisition of Gilchrist (note 2(b)) serves as a hedge against the
Company's investment in its U.K. operations, managing exposure to
foreign currency risk.
(ii) Credit risk:
The Company 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. As at September 30, 2001,
the Company has one customer, which represents 18% of accounts
receivable (2000 - no customers exceeded 10% of accounts receivable).
The Company is exposed to credit risk in the event of non-performance
by counterparties in connection with its foreign currency contracts.
The Company does not obtain collateral or other security to support
financial instruments subject to credit risk but mitigates this risk
by dealing only with financially sound counterparties and,
accordingly, does not anticipate loss for non-performance.
14. 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 by geographic region based on the
region in which the customer is located is as follows:
2001 2000 1999
--------------------------------------------------------------------------
Net revenue:
Canada $ 19,833,117 $ 21,980,668 $ 19,153,216
United States 40,970,400 32,559,550 22,633,909
United Kingdom and
Continental Europe 19,988,864 4,066,017 -
--------------------------------------------------------------------------
$ 80,792,381 $ 58,606,235 $ 41,787,125
--------------------------------------------------------------------------
(b) The Company's identifiable assets for each geographic area in which it has
operations are as follows:
2001 2000
--------------------------------------------------------------------------
Capital assets:
Canada $ 7,997,668 $ 7,597,499
United States 1,316,098 805,482
United Kingdom and
Continental Europe 2,219,970 2,045,644
--------------------------------------------------------------------------
$ 11,533,736 $ 10,448,625
--------------------------------------------------------------------------
2001 2000
--------------------------------------------------------------------------
Goodwill:
Canada $ 21,956,307 $ 22,438,433
United States 19,706,227 16,654,008
United Kingdom and
Continental Europe 8,012,581 7,615,483
--------------------------------------------------------------------------
$ 49,675,115 $ 46,707,924
--------------------------------------------------------------------------
(c) The Company's external net revenue by type of service is as follows:
2001 2000 1999
--------------------------------------------------------------------------
Net revenue:
Marketing $ 24,374,986 $ 28,772,421 $ 30,317,254
Design 41,444,289 22,247,353 9,420,744
Technology 14,973,106 7,586,461 2,049,127
--------------------------------------------------------------------------
$ 80,792,381 $ 58,606,235 $ 41,787,125
--------------------------------------------------------------------------
(d) In 2001, the Company had one customer, which represented 13.6% of net
revenue. In each of 2000 and 1999, the Company had different customers
which represented 11.3% and 10.3% of net revenue, respectively.
15. Reconciliation to United States generally accepted accounting principles:
These consolidated financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") as applied in Canada. Set
out below are the material adjustments to net earnings for the years ended
September 30, 2001, 2000 and 1999 required in order to conform to U.S. GAAP.
2001 2000 1999
------------------------------------------------------------------------------
Net earnings (loss):
Net earnings (loss) based
on Canadian GAAP $ (2,895,372) $ 2,910,427 $ 2,876,763
Adjustment to income tax
provision (a) - - (721,000)
Stock-based compensation
expense (b) (886,000) - (226,965)
Foreign currency contracts,
net of income tax recovery
of $35,703 (e) (49,303) - -
------------------------------------------------------------------------------
Net earnings (loss)
based on U.S. GAAP $ (3,830,675) $ 2,910,427 $ 1,928,798
------------------------------------------------------------------------------
The following adjustments are required in order to conform shareholders' equity
based on Canadian GAAP to shareholders' equity based on U.S. GAAP:
2001 2000
------------------------------------------------------------------------------
Shareholders' equity based on Canadian GAAP $ 61,319,385 $ 62,686,801
Foreign currency contracts, net of
income tax recovery of $35,703 (e) (49,303) -
------------------------------------------------------------------------------
Shareholders' equity based on U.S. GAAP $ 61,270,082 $ 62,686,801
------------------------------------------------------------------------------
Summary of accounting policy differences:
The areas of material difference between Canadian and U.S. GAAP and their
impact on the consolidated financial statements of the Company are set out
below:
(a) Income taxes:
Effective October 1, 2000, the Company adopted on a retroactive basis new
Canadian accounting standards for income taxes, which now require income
taxes to be accounted for using the asset and liability method, consistent
with U.S. GAAP. Previously, under Canadian GAAP, the deferral method of
providing for income taxes was used.
Under Canadian accounting standards, the Company is not required to restate
its comparative figures for prior years and, accordingly, there continue to
be differences between Canadian and U.S. GAAP pertaining to income taxes
for the year ended September 30, 2000 and 1999. There is no cumulative
effect as of October 1, 2000 of this change in accounting policy and there
should be no new differences between Canadian and U.S. GAAP with respect
to income taxes for periods subsequent to October 1, 2000.
The comparative disclosure required under U.S. GAAP for periods prior to
October 1, 2000 are set out below.
The Company's U.S. GAAP income tax expense consists of the following:
2001 1999
--------------------------------------------------------------------------
Earnings before income taxes
based on U.S. GAAP $ 6,138,781 $ 4,641,793
--------------------------------------------------------------------------
Computed income tax expense at basic
tax rate of 44.1% (1999 - 44.6%) $ 2,707,200 $ 2,070,000
Increase (decrease) in income taxes
resulting from:
Non-deductible goodwill amortization 689,500 265,000
Non-deductible stock-based compensation - 101,000
Lower basic tax rate on earnings of
foreign subsidiary (111,800) -
Other expenses deducted in the accounts
which have no corresponding deduction
for income taxes 168,500 217,000
Other (225,000) 60,000
--------------------------------------------------------------------------
$ 3,228,400 $ 2,713,000
--------------------------------------------------------------------------
(b) Stock-based compensation expense:
U.S. GAAP requires the Company to record compensation expense when
modifications are made which extend the lives of options. During the
year ended September 30, 2001, the Company extended the life of an
individual's option award and has therefore recorded the intrinsic value
of the option at the date of the extension as compensation expense.
U.S. GAAP requires that the excess of the fair value of options repurchased
by the Company in 1999 over their aggregate exercise price be recorded as
compensation expense. Under Canadian GAAP, the excess of $65,965 is
charged to retained earnings and, accordingly, there is no adjustment
required to shareholders' equity under U.S. GAAP.
In addition, during 1999, the Company granted stock options to non-
employees as compensation for services rendered. U.S. GAAP requires that
the Company measure compensation cost for these options based on their
fair value at the grant date, whereas Canadian GAAP does not require the
recognition of compensation expense for such options. The fair value of
these options is estimated to be $161,000.
(c) Business combinations:
U.S. GAAP requires the disclosure of the unaudited pro forma U.S. GAAP
consolidated results of operations for the year ended September 30, 2000
giving effect to the acquisition of Gilchrist as if it had occurred as of
October 1, 1999 which are as follows:
--------------------------------------------------------------------------
Net revenue $ 68,242,235
Net earnings 2,602,527
Basic net earnings per share 0.14
Diluted net earnings per share 0.13
--------------------------------------------------------------------------
U.S. GAAP requires the disclosure of the unaudited pro forma U.S. GAAP
consolidated results of operations for the year ended September 30, 2000
giving effect to the acquisition of Sage as if it had occurred as of
October 1, 1999 which are as follows:
--------------------------------------------------------------------------
Net revenue $ 63,102,395
Net earnings 950,950
Basic net earnings per share 0.05
Diluted net earnings per share 0.05
--------------------------------------------------------------------------
Earnings per common share amounts in accordance with U.S. GAAP are based
on U.S. GAAP net earnings. The calculation of basic net earnings per
share is the same under both Canadian and U.S. GAAP. However, for
purposes of calculating diluted net earnings per share, the dilutive
effects of outstanding options and warrants is computed by applying the
treasury stock method under U.S. GAAP, which is not permitted under
Canadian GAAP.
Basic net earnings (loss) per share under U.S. GAAP for the year ended
September 30, 2001 is $(0.18) (2000 - $0.15; 1999 - $0.13). Diluted net
earnings (loss) per share under U.S. GAAP for the year ended September 30,
2001 is $(0.18) (2000 - $0.15; 1999 - $0.12).
The diluted weighted average number of shares outstanding is calculated
as follows:
2001 2000 1999
--------------------------------------------------------------------------
Weighted average basic number
of shares outstanding 21,160,616 19,156,626 14,750,247
Dilutive effect of:
Special warrants - - 786,575
Warrants - 75 8,885
Options 102,410 773,276 682,732
Shares to be issued in
respect of contingent
consideration 466,769 - -
--------------------------------------------------------------------------
Weighted average diluted number
of shares outstanding 21,729,795 19,929,977 16,228,439
--------------------------------------------------------------------------
(d) Stock-based compensation disclosures:
The Company measures compensation expense relating to employee stock option
plans for U.S. GAAP purposes using the intrinsic value method specified by
APB Opinion No. 25, which in the Company's circumstances would not be
materially different from compensation expense as determined under Canadian
GAAP, except as disclosed in note 15(b).
Had the Company determined compensation costs based on the fair value at
the grant date of its stock options consistent with the method prescribed
under Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards No. 123 ("SFAS 123"), the Company's net earnings
(loss) and earnings (loss) per share would have been reported as the pro
forma amounts indicated below:
2001 2000 1999
--------------------------------------------------------------------------
Net earnings (loss)
in accordance with
U.S. GAAP as reported $ (3,830,675) $ 2,910,427 $ 1,928,798
Pro forma net
earnings (loss) (4,719,780) 1,853,385 1,335,046
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Pro forma basic earnings
(loss) per share $ (0.22) $ 0.10 $ 0.09
Pro forma diluted earnings
(loss) per share (0.22) 0.09 0.08
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Pro forma net earnings (loss) reflect only those options granted during the
five years ended September 30, 2001. Therefore, the full impact of
calculating compensation costs for stock options under SFAS 123 is not
reflected in the pro forma net earnings amounts presented above because
compensation cost is reflected over the expected lives of the options and
the compensation cost for options granted prior to October 1, 1995 is not
considered. The notional compensation expense associated with the
Company's options is not deductible for Canadian income tax purposes.
Accordingly, the full amount of compensation expense is reflected in the
pro forma figures above, without any related tax recovery.
The weighted average estimated fair value at the date of the grant, as
defined by SFAS 123, for options granted in fiscal 2001 was $2.39 per
share (2000 - $3.07; 1999 - $1.20).
The fair value of each option granted was estimated on the date of the
grant using the Black-Scholes fair value option pricing model with the
following assumptions:
2001 2000 1999
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Risk-free interest rate 4.70% 4.70% 4.70%
Dividend yield - - -
Volatility factor of the future
expected market price of the
company's common shares 65% 60% 40%
Weighted average expected
life of the options 2.33 years 2.56 years 2.50 years
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The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the
expected price volatility. Because the Company's employee share options
have characteristics significantly different from those of traded options,
and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair
value of its employee share options.
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period on a
straight-line basis.
(e) Derivative financial instruments:
The Company enters into forward contracts to manage its exposure to
fluctuations in foreign exchange rates. Effective October 1, 2000, the
Company adopted the provisions of FASB Statement No. 133, "Accounting For
Derivatives and Hedging Activities." SFAS No. 133 requires that all
derivatives be recognized as assets and liabilities on the balance sheet
and measured at fair value. Hedge accounting is only applied to
derivatives if the hedging relationship has been identified, and the
Company has formally documented the designation of the hedging relationship
and the method for assessing the effectiveness of the hedging relationship.
Both at inception of the hedging relationship and throughout its term, the
relationship must be effective in achieving offsetting changes in the cash
flows of the hedged item.
Under SFAS No. 133 for derivatives designated and effective as hedges of
future cash flows, changes in the fair value of the derivative are
recognized in other comprehensive income, with no impact on net earnings
until the hedged item is recognized in earnings. To the extent the hedge
is ineffective, or not designated or documented as a hedge, the change in
fair value of the hedge would be recognized in earnings each period.
During 2001, the Company had not designated and documented its foreign
exchange contracts as a hedge of future cash flows and, therefore, must
record the change in fair value as a charge against earnings.
Under Canadian GAAP, no accounting recognition is given to the fair value
of those forward contracts which are a hedge of future cash flows. As at
September 30, 2001, the fair value of foreign exchange forward contracts,
which were otherwise designated as a hedge of future cash flows for
Canadian GAAP, totalled $(85,006). This amount represents an additional
liability under U.S. GAAP, and this amount net of the related tax recovery
is recorded as a charge to U.S. GAAP net earnings. On initial adoption of
SFAS No. 133 on October 1, 2000, the fair value of such foreign exchange
contracts totalled $(23,716).
(f) Comprehensive income:
The Company's comprehensive income represents U.S. GAAP net earnings plus
the change in the cumulative translation adjustment account in respect of
foreign operations as follows:
2001 2000 1999
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Net earnings (loss) for
the year in accordance
with U.S. GAAP $ (3,830,675) $ 2,910,427 $ 1,928,798
Decrease (increase) in
cumulative translation
adjustment account 1,147,208 180,516 (494,844)
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$ (2,683,467) $ 3,090,943 $ 1,433,954
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(g) Reduction of capital:
In 1997, the share capital of the Company was reduced by $9,886,961
pursuant to a special resolution of its shareholders and was applied
against the deficit. This reduction in capital is not permitted under
U.S. GAAP. While the adjustment has no impact on shareholders' equity,
under U.S. GAAP, capital stock would be increased by $9,886,961 and
retained earnings would be decreased by $9,886,961 as at September 30,
2001 and 2000.
(h) Statements of cash flows:
The Company has disclosed cash flows from operations per share, which is
not permitted under U.S. GAAP.
(i) Other disclosures:
U.S. GAAP and the United States Securities and Exchange Commission require
the Company to disclose the following items, for which disclosure is not
required under Canadian GAAP:
(i) The allowance for doubtful accounts as at September 30, 2001 was
$1,432,668 (2000 - $493,659).
(ii) Rent expense under operating leases for the year ended September 30,
2001 amounted to $1,980,592 (2000 - $1,680,822).
(iii) As at September 30, 2001, the Company had a $32,158,672 (2000 -
$15,218,794) unused line of credit, of which $2,000,000 is available
for general corporate purposes and the remainder for permitted
acquisitions.
(iv) U.S. GAAP requires the disclosure of accrued liabilities. Accrued
liabilities included in accounts payable and accrued liabilities as
at September 30, 2001 were $6,330,821 (2000 - $7,492,551). At
September 30, 2001, accrued liabilities include $2,263,266 related
to additional consideration for the acquisition of Hampel Stefanides
(note 2(f)). At September 30, 2000, accrued liabilities include
$2,100,651 related to additional consideration for the acquisition
of Hampel Stefanides and $935,439 related to accrued acquisition
expenses.
At September 30, 2001, there were no other accrued liabilities that
exceeded 5% of current liabilities.
(v) The Company has disclosed both net earnings before goodwill
amortization and net earnings per share before goodwill amortization,
which are not permitted disclosures under U.S. GAAP.
(j) Recent accounting pronouncements:
(i) In July 2001, the CICA and FASB issued new similar standards for
Business Combinations, Goodwill and Other Intangible Assets. These
standards provide new guidance on the accounting for a business
combination at the date a business combination is completed.
Specifically, they require use of the purchase method of accounting
for all business combinations initiated after June 30, 2001, thereby
eliminating use of the pooling-of-interests method. These standards
also require that goodwill and certain other intangible assets will
no longer be amortized and will be tested for impairment at least
annually and written down only when impaired. These statements will
apply to existing goodwill and intangible assets, and must be
adopted by the Company no later than its fiscal year beginning
October 1, 2002. The Company has not determined the impact of the
adoption of these standards on its consolidated financial statements.
(ii) Effective October 1, 2001, the Company will adopt the new Canadian
accounting standard for earnings per share. Under this new standard,
in computing diluted earnings per share, the dilutive effect of
outstanding options and warrants is computed by applying the treasury
stock method, consistent with the method required under U.S. GAAP.
(iii) In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial
accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and for the associated
asset retirement costs. SFAS No. 143 is effective for the Company's
fiscal year beginning October 1, 2002. The Company does not believe
that the adoption of SFAS No. 143 will have a material impact on its
consolidated financial statements.
(iv) In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets. This statement supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of" and related literature and
establishes a single accounting model, based on the framework
established in SFAS No. 121, for long-lived assets to be disposed of
by sale. The Company is required to adopt SFAS No. 144 for its
fiscal year beginning October 1, 2002. The Company does not believe
that the adoption of SFAS No. 144 will have a material impact on its
consolidated financial statements.
(v) Effective October 1, 2002, the Company will adopt the new Canadian
accounting standard for stock-based compensation and other stock-
based payments. The new standards will require additional
disclosures for options granted to employees and that a compensation
cost be recorded for the fair value of options granted to non-
employees. The new standards for non-employees will be similar in
many respects to SFAS No. 123. The Company has not determined the
impact of the adoption of these standards on its consolidated
financial statements.
(vi) Effective October 1, 2003, the Company will be required to adopt the
new Canadian Accounting Guideline, Hedging Relationships, that
establishes standards for the documentation and effectiveness of
hedging relationships that are substantially similar to the
corresponding requirements in SFAS No. 133. The Company has not
determined the impact of the adoption of these standards on its
consolidated financial statements.
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