Envoy Communications Group Inc.
1st quarter report 2002
Management Discussion and Analysis
RESULTS OF OPERATIONS
-- Net revenue
Net revenue for the three months ending December 31, 2001 was $16.6 million
compared to $21.8 million in the three months ended December 31, 2000,
representing a decrease of $5.2 million or 24%. The decrease in revenue results
from a combination of a general economic slowdown in the North American and
U.K. marketplace as well as a specific slowdown within the advertising and
technology markets, particularly in New York. Our revenue from marketing
activities decreased by $3.7 million from $7.7 million to $4.0. The largest
portion of this decrease being a decline in revenue of $2.8 million in
New York and a further net decrease of approximately $900,000 in revenue
relating to Canadian marketing operations. Technology revenue decreased $1.7
million in the first quarter from $4.7 million last year to $3 million. Again
the reduction in revenue relates largely to the decline in business in our New
York operations. Net revenue from design services increased marginally, or
$256,000. Revenue increases within the North American segment of the business
were offset by a decline in revenue from the U.K. In addition, part of the
increase relates to the establishment of Watt Russell and the acquisition of
The International Design Group (Canada) Inc. (IDG) on January 1, 2001. This
acquisition was accounted for using purchase accounting and as a result of
this acquisition there are three months of net revenues included in the three
months ended December 31, 2001 that were not included in our results of
operations for the three months ended December 31, 2000.
In the three months ended December 31, 2001, net revenue from marketing
operations represented approximately 24% of our net revenue, while design and
technology represented 58% and 18% respectively. In the three months ended
December 31, 2000, marketing represented approximately 35% of net revenue,
while design and technology represented 43% and 22% respectively.
The geographical breakdown of our net revenue for the three months ended
December 31, 2001 was 47% from the U.S., 22% from the U.K. and Continental
Europe, and 31% from Canada. Net revenue for the three months ended December
31, 2000 was 47% from the U.S., 25% from the U.K. and Continental Europe, and
28% from Canada.
-- EBITDA
For the three months ended December 31, 2001, we had an EBITDA loss,
before restructuring costs, of ($251,853) and for the three months ended
December 31, 2000, we earned $4.4 million in EBITDA.
-- Operating expenses
Overall, operating expenses for the three months ended December 31, 2001 were
$16.9 million, down approximately $470,000 from the total operating expenses
for the three months ended December 31, 2000.
Salaries and benefits expenses for the three months ended December 31, 2001
was $13.2 million compared with $12.2 million in the three months ended
December 31, 2000, representing a net increase of $1.0 million. Although
salaries and benefits expenses were down in the advertising and technology
businesses because of the slowdown in business, these reductions were offset
by increased expenses in the design business and at the corporate level.
Principally, salary expenses were higher in the design business as a result of
the acquisition of IDG and the opening of Watt Russell.
General and administrative expenses for the three months ended December 31,
2001 was $2.4 million compared with $4 million for the three months ended
December 31, 2000. The decrease in general and administrative expenses was
largely due to reduced expenditures in the area of marketing, promotion and
shareholder relations as well as reduced expenditures associated with reduced
level of revenue. Occupancy costs for the three months ended December 31, 2001
was $1.3 million compared to $1.1 million for the three months ended December
31, 2000. Occupancy costs increased primarily relating to additional space in
New York.
The decrease in interest charges was due to lower interest rates offset by
additional interest expenses relating to the amortization of deferred financing
costs that are recorded as interest expense.
In the first quarter of this year, approximately $386,000 in severance expenses
were incurred in order to restructure our marketing business operations. In
all, 36 people were affected by the restructuring, 21 in the U.S. and 15 in
Canada. All severance costs associated with the restructuring were paid by
December 31, 2001. The annual expense savings in salaries and benefits
associated with this restructuring is approximately $3.6 million. Management
continues to monitor the business activity and will make further reductions in
the second quarter in order to bring expense levels back in line with
historical expense ratios.
The above factors resulted in a decrease in our earnings before income taxes
and goodwill amortization from $3.5 million to ($1.6) million.
Effective October 1, 2000, the Company was required to adopt, on a retroactive
basis, the new accounting standards of the Canadian Institute of Chartered
Accountants (CICA) for income taxes. The impact of this was to increase the
Company's tax provision for the three months ended December 31, 2000 by
$100,000. See Note 1 to the consolidated financial statements.
Goodwill amortization increased slightly from $731,000 to $795,000 due to the
increased amount of goodwill derived from the acquisitions discussed above.
-- Net earnings (Loss)
Primarily as a result of the foregoing factors, we had a net loss of ($1.8)
million for the three months ended December 31, 2001, compared to net earnings
of $1.1 million for the three months ended December 31, 2000.
-- Per share amounts
The per share amounts are as follows: for the three months ended December 31,
2001, the fully diluted EBITDA per share was ($0.03), the fully diluted
earnings before goodwill per share was ($0.05) and the fully diluted net
earnings per share was ($0.09). For the three months ended December 31, 2000,
the fully diluted EBITDA per share was $0.20, the fully diluted earnings
before goodwill per share was $0.08 and the fully diluted net earnings per
share was $0.05.
CASH FLOWS
Net cash provided by (used in) operating activities before any increase and
decrease in non-cash operating working capital was ($926,000) for the three
months ended December 31, 2001 and $2.7 million for the three months ended
December 31, 2000. Decrease in net cash provided by operating activities is
primarily due to decreased earnings, as discussed previously.
Net cash used in financing activities was $202,000 for the three months ended
December 31, 2001 and net cash used in financing activities was $1.4 million
for the three months ended December 31, 2000. Decrease is primarily due to the
increase in debt in the current period reduced by the redemption of common
shares.
FINANCIAL CONDITION
As at December 31, 2001 compared to September 30, 2001, the working capital
balance deficit was ($2.6) million and the cash balance was $9.3 million at
December 31, 2001. As at September 30, 2001, working capital deficit was
($430,000) and the cash balance was $21.8 million. The decrease is primarily
due to an operating loss in the period as well as the purchase of capital
assets and the redemption of common shares during the period.
During fiscal 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
purposes (to a maximum of $2,000,000) and financing acquisitions which have
been approved by the lenders. As at December 31, 2001 approximately $10.2
million has been borrowed under the facility, none of which is for general
corporate purposes. As at December 31, 2001 the Company was not in compliance
with its covenant calculations involving trailing 12-month earnings before
interest, taxes, depreciation and amortization. The Company is currently in
discussions with its lenders regarding the amendments to the covenant
calculations going forward. As the lenders have the right to demand repayment
of outstanding borrowings if the covenants are not met, the entire amount of
the debt is classified as a current liability.
Envoy Communications Group Inc.
Consolidated Balance Sheet
(In Canadian dollars)
(Unaudited - Prepared by Management)
As at December 31 September 30
2001 2001
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ASSETS
Current assets:
Cash $9,280,814 $21,781,809
Restricted cash 688,344 158,500
Accounts receivable 21,080,692 26,940,137
Income taxes recoverable 289,627 230,389
Future income taxes 1,456,540 712,000
Prepaid expenses 1,534,200 1,315,009
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34,330,217 51,137,844
Capital assets 11,335,453 11,533,736
Goodwill 49,384,651 49,675,115
Other assets 718,405 681,387
Future income taxes 763,443 822,156
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$96,532,169 $113,850,238
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable
and accrued liabilities $23,407,414 $38,728,210
Deferred revenue 694,904 300,071
Amounts collected in excess of
pass-through costs incurred 1,276,518 1,574,407
Current portion of
long-term debt 11,577,804 10,965,089
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36,956,640 51,567,777
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Long-term debt 858,606 963,076
Shareholders' equity:
Share capital 54,255,222 54,883,305
Retained earnings 3,773,220 5,603,200
Cumulative translation
adjustment 688,481 832,880
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58,716,923 61,319,385
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$96,532,169 $113,850,238
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Envoy Communications Group Inc.
Consolidated Statements of Operations and Retained Earnings
(In Canadian dollars)
(Unaudited - Prepared by Management)
For the three months ended December 31 December 31
2001 2000
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Net revenue $16,620,236 $21,776,358
Operating expenses:
Salaries and benefits 13,169,678 12,210,069
General and administrative 2,371,900 4,044,752
Occupancy costs 1,330,511 1,087,311
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16,872,089 17,342,132
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Earnings (loss) before interest expense,
income taxes, depreciation, goodwill
amortization and restructuring costs (251,853) 4,434,226
Depreciation 746,942 710,490
Interest expense 190,564 233,243
Restructuring costs 386,000 -
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Earnings (loss) before income taxes
and goodwill amortization (1,575,359) 3,490,493
Income tax expense, excluding
the undernoted (540,792) 1,575,378
Impact of tax rate changes (Note 1) - 100,000
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Earnings (loss) before goodwill
amortization (1,034,567) 1,815,115
Goodwill amortization,
net of income taxes of
$6,000 (2000-$6,000) 795,413 730,867
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Net earnings (loss) $(1,829,980) $1,084,248
Retained earnings,
beginning of period 5,603,200 8,403,367
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Retained earnings,
end of period $3,773,220 $9,487,615
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Net earnings (loss) per share-basic $(0.09) $0.05
Net earnings (loss) per share-fully diluted (0.09) 0.05
Earnings (loss) per share before
goodwill amortization-basic (0.05) 0.09
Earnings (loss) per share before
goodwill amortization-fully diluted (0.05) 0.08
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See accompanying notes to consolidated financial statements.
Envoy Communications Group Inc.
Consolidated Statement of Cash Flows
(In Canadian dollars)
(Unaudited - Prepared by Management)
For the three months ended December 31 December 31
2001 2000
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $(1,829,980) $1,084,248
Items not involving cash:
Future income taxes (recovery) (683,689) 195,043
Depreciation 746,942 710,490
Goodwill amortization 801,413 736,867
Amortization of deferred financing charges 39,672 8,221
Net changes in non-cash working capital balances:
Restricted cash (529,844) -
Accounts receivable 6,306,575 (7,372,957)
Prepaid expenses (260,190) (584,180)
Accounts payable and accrued liabilities (15,886,510) 11,463,274
Income taxes payable (82,873) 307,441
Deferred revenue 363,242 (5,300)
Amounts collected in excess of
pass-through costs incurred (1,003,518) 342,594
Other (45,110) (73,019)
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Net cash provided by (used in)
operating activities (12,063,870) 6,812,722
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CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt 1,987,641 -
Long-term debt repayments (1,518,228) (1,459,996)
Issuance of common shares for cash - 267,573
Redemption of common shares (628,083) -
Reduction (increase) in restricted cash - (245,758)
Other (43,304) 19,197
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Net cash used in financing activities (201,974) (1,418,984)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries (net of
cash acquired (bank indebtedness
assumed) of $919,201; 2000-nil) 234,622 -
Purchase of capital assets (546,329) (612,198)
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Net cash used in investing activities (311,707) (612,198)
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Change in cash balance due to
foreign exchange 76,556 (43,159)
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(Decrease)/Increase in cash (12,500,995) 4,738,381
Cash, beginning of period 21,781,809 7,105,418
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Cash, end of period $9,280,814 $11,843,799
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Cash flow from operations per share:
Basic $(0.04) $0.13
Fully diluted $(0.04) $0.12
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Supplemental cash flow information:
Interest paid $140,744 $110,419
Income taxes paid 266,975 1,026,206
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Supplemental disclosure of non-cash transactions:
Shares issued for non-cash consideration - 3,623,824
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Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
1. Income Taxes
Effective October 1, 2000, the Company was required to adopt on a retroactive
basis the new accounting standards 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 these new standards, future tax assets and liabilities attributable to
all temporary differences are measured using the future tax rates expected to
be in effect when the items are recovered or settled. The effect of a change
in tax rates must be recognized in income at the enactment date.
Previously, future tax assets and liabilities were recorded at the tax rate
in effect in the period in which the temporary difference arose and were not
adjusted for subsequent tax rate changes. The Company's temporary differences
are principally in respect to deductible share issue costs that were recorded
directly in capital stock rather than as a credit to income tax expense. There
is no cumulative effect as of October 1, 2000 of this change in accounting
policy.
As a result of the December 2000 announcement by the government to introduce
legislation to reduce income tax rates over the next four years, the Company
was required to revalue its future tax assets as at December 31, 2000 to
reflect the reduction in future expected tax rates. This increased the
Company's tax provision for the three months ended December 31, 2000 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.
2. 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:
By Customer Location By Geographic Area
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December 31, 2001 Net Revenue Capital Assets Goodwill
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Canada $5,215,866 $8,181,913 $21,509,586
United States 7,760,326 1,251,848 19,898,249
United Kingdom and
Continental Europe 3,644,044 1,901,692 7,976,816
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$16,620,236 $11,335,453 $49,384,651
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December 31, 2000
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Canada $6,186,066 $7,552,382 $21,970,618
United States 10,317,488 697,288 16,449,966
United Kingdom and
Continental Europe 5,272,804 2,126,648 7,986,240
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$21,776,358 $10,376,318 $46,406,824
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The Company's external net revenue by type of service is as follows:
December 31 2001 2000
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Net Revenue:
Marketing $3,970,835 $7,668,623
Design 9,645,606 9,389,802
Technology 3,003,795 4,717,933
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$16,620,236 $21,776,358
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