10 32 Repayment of long-term debt (34) (49) (801) (180) Share issue costs - (8) - (2,743) Options exercised - 89 70 187 Share issue - - - 35,503 Share redemption - - - (904) Dividends of Class "D" preferred shares - - - (17) ------------------------------------------------------------------------ Cash flows from financing activities (24) 32 (780) 31,878 ------------------------------------------------------------------------
Effect of changes in exchange rate on cash held in foreign currencies (680) 328 196 (25) ------------------------------------------------------------------------ Net increase in cash and cash equivalents 3,065 1,292 19,495 16,030 Cash and cash equivalents, beginning of period 21,964 18,607 5,534 3,869 ------------------------------------------------------------------------ Cash and cash equivalents, end of period 25,029 19,899 25,029 19,899 ------------------------------------------------------------------------
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The following information is an extract of the Management Discussion and Analysis of operating results for the Third Quarter ended July 31, 2006. For the complete version, readers should refer to the Management Discussion and Analysis of operating results for the Third Quarter ended July 31, 2006 which has been filed on SEDAR.
EXTRACT OF THE MANAGEMENT DISCUSSION AND ANALYSIS
(Interim report for the three and nine months ended July 31, 2006)
The following report, dated September 6, 2006, is a discussion relating to the financial results and condition of 20-20 Technologies Inc. "20-20" or the "Company" for the three and nine months ended July 31, 2006 and 2005. The discussion should be read in conjunction with the selected consolidated financial information shown in this report and with 20-20's interim unaudited consolidated financial statements and the accompanying notes thereto. These financial statements have been prepared in accordance with Canadian generally accepted accounting principles (Canadian GAAP) and are presented in U.S. dollars as a significant proportion of the Company's revenues are recorded in U.S. dollars. The Company's financial statements result from having been translated from the currency of measurement, the Canadian dollar, to the U.S. dollar using the current rate method. Additional information relating to 20-20, including the Company's Annual Information Form, Annual Report and, interim unaudited consolidated financial statements and related management reports for the year ended October 31, 2005, can be obtained on SEDAR at www.sedar.com. Information contained in this report is qualified by reference to the discussion concerning forward-looking statements detailed below.
Unless otherwise noted or the context otherwise indicates, "20-20", the "Company", and "Management" refers to 20-20 Technologies Inc. and its direct and indirect subsidiaries. Unless otherwise indicated, all dollar amounts in this report are expressed in U.S. dollars. References to "$" or "U.S." are to U.S. dollars and references to "C$" are to Canadian dollars. Disclosure of information in this report has been limited to that which management has determined to be "material", on the basis that omitting or misstating such information would influence or change a reasonable investor's decision to purchase, hold or dispose of securities in the Company.
YEAR-END ADJUSTMENT IN THE COMPARATIVE FINANCIAL STATEMENTS
During the fourth quarter of the year ended October 31, 2005, an amount of new product development was capitalized relating to work performed over the twelve months then ended that met Canadian GAAP capitalization criteria, but for which no capitalization had been recorded in the third quarter and first nine months of fiscal 2005 amounting to approximately $228,000, net of associated amortization expense of $48,000 and $590,000, net of amortization expense of $81,000 respectively. The figures for the third quarter and the nine months ended July 31, 2005 have been adjusted for this amount resulting in an increase in net earnings of $147,000 to $1,539,000 for the third quarter and $385,000 to $3,232,000 for the nine months then ended, including the related adjustment to income taxes of $80,000 and $204,000 respectively.
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The interim unaudited consolidated financial statements of 20-20 Technologies Inc. and the financial information contained in this report are the responsibility of management and have been approved by the Board of Directors of the Company. The said financial statements have been prepared by management in accordance with Canadian GAAP and include amounts based on management's best judgment and estimates. In order to ensure the accuracy and objectivity of information included in the financial statements, management has designed, implemented and maintains internal accounting control systems. Management is of the opinion that these internal accounting controls provide reasonable assurance, at a reasonable cost, regarding the complete and accurate maintenance of accounting records necessary for the preparation of financial statements and the safeguarding of assets. The Board of Directors exercises its responsibility over the financial statements through the Company's Audit Committee. The Audit Committee is comprised of directors who are not officers or employees of the Company and reviews the consolidated financial statements and recommends their approval to the Board of Directors. Raymond Chabot Grant Thornton LLP, independent auditors designated by the shareholders, meets regularly with the Audit Committee to discuss audit activities, financial reporting matters and other related subjects.
This report and the Company's interim unaudited consolidated financial statements were reviewed by the Company's Audit Committee on September 6, 2006 and approved by 20-20's Board of Directors on September 12, 2006.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report constitute forward-looking information within the meaning of securities laws.
Implicit in this information, particularly in respect of future operating results and economic performance of the Company are assumptions regarding projected revenues and expenses. These assumptions, although considered reasonable by the Company at the time of preparation, may prove to be incorrect. Readers are cautioned that actual future operating results and economic performance of the Company are subject to a number of risks and uncertainties, including general economic, market and business conditions and could differ materially from what is currently expected.
For more exhaustive information on these risks and uncertainties you should refer to our most recently filed Annual Information Form which is available at www.sedar.com. Forward-looking information contained in this report is based on management's current estimates, expectations and projections, which Management believes are reasonable as of the current date. The reader should not place undue importance on forward-looking information and should not rely upon this information as of any other date. While the Company may elect to, it is under no obligation and does not undertake to update this information at any particular time, unless required by applicable securities law. In addition to presenting an analysis of results for the three and nine months ended July 31, 2006 and 2005, this report also discusses certain important elements that occurred between such date and September 6, 2006.
THIRD QUARTER IN REVIEW
Management is focused on deriving synergies at all levels of the organization, following the integration of the businesses acquired over the last twelve months.
Virtual Systems International, Inc.
On February 9, 2006, the Company completed the acquisition of North Carolina-based Virtual Systems International, Inc. ("VSI"). VSI is involved in the development, sale and integration of manufacturing solutions for medium to large North American woodworking manufacturing operations which can be seamlessly integrated with various horizontal ERP platforms. VSI employs 27 people, including two former senior MBI employees, thereby offering further potential for operational synergies once combined with that of MBI and 20-20. This transaction represents a major step in establishing the Company as the world leading vertically - integrated ERP, engineering and manufacturing solutions provider in its addressable markets.
A portion of the purchase price was determined by VSI's financial results as of December 31, 2005. On July 21, 2006, the parties agreed that the amount payable would be $1,108,140. The consolidated financial statements have been adjusted to reflect this final agreement.
Shanghai Rena and DesignTec Co. Ltd.
The Company entered into an agreement to purchase all of the assets of Shanghai Rena (China) and DesignTec Co. Ltd. (Taiwan), last December. The transactions have yet to close as the Company is currently in the process of completing the legal requirements in order to comply with Chinese legislation, thereby permitting a wholly foreign-owned Chinese entity to conduct business in China.
Amortization of Acquired Intangibles
The Company's recent acquisitions have resulted in the addition of significant intangible assets to the Consolidated Balance Sheet that is being amortized over periods ranging from 3 to 15 years. These intangible assets consist of acquired development costs (software), client lists, trade names and a non-compete agreement.
The amortization related to these intangible assets amounted to $404,000 for the three months ended July 31, 2006 compared to $57,000 for the third quarter in 2005 and $1,017,000 for the nine months ended July 31, 2006 compared to $114,000 in the first nine months of 2005.
Recent acquisitions mentioned in section 3 below have contributed $4.3 million or 28.9% of revenues for the third quarter and $11.0 million or 25.7% of revenues for the nine months ended July 31, 2006. The revenue mix for these acquisitions, largely due to MBI and VSI, is different from that of 20-20 excluding acquisitions. This difference has had a significant impact on the consolidated gross margin of the group from 80.6% in 2005 to 76.3% in 2006 for the nine month periods ended July 31.
------------------------------------------------------------------------ ------------------------------------------------------------------------ Excluding Acquisitions Acquisitions Total ------------------------------------------------------------------------ Q3 Y-T-D Q3 Y-T-D Q3 Y-T-D
------------------------------------------------------------------------ % % % % % % Revenues License sales 26.8 26.2 42.8 44.0 38.2 39.5 Maintenance and other recurring revenues 41.8 38.8 44.0 42.0 43.3 41.1 Professional services 31.4 35.0 13.2 14.0 18.5 19.4 ------------------------------------------------------------------------ 100.0 100.0 100.0 100.0 100.0 100.0
Gross margin (%) 61.5 65.5 78.7 79.9 73.7 76.3 ------------------------------------------------------------------------ ------------------------------------------------------------------------
However, as a percentage of revenues, operating expenses incurred by acquisitions are lower than those of ex-acquisition 20-20. For the three months ended July 31, 2006, acquisition operating expenses amounted to 61.7% of revenue while ex-acquisition expenses totalled 71.6%. For the nine month period, acquisition operating expenses amounted to 62.4% while organic operating expenses totalled 71.1%.
Following the launch of new products this year and our software integration and localization efforts accomplished to date, our focus in product management and marketing is on introducing these products in other geographical markets where we are already active and also expand our activities into adjacent markets in order to increase our licenses sales. This will not only contribute to our organic growth but also progressively improve our gross margins over the coming quarters.
Research and Development
We continue to focus in the coming quarters on integrating solutions acquired over the past fifteen months in order to deliver an industry-specific and fully-integrated solutions offering for all participants in the interior design market - from sales and design tools, and product configuration, to ERP and manufacturing execution systems. In essence, 20-20 will continue to reinforce its position as the world leading provider of an end-to-end solution that effectively integrates all of the interior design industry's critical business processes. This will namely be done by maintaining and leveraging a unique comprehensive foundation of industry data that will be used seamlessly across all of 20-20's tools and solutions. Management believes this strategy will allow the Company to increasingly offer its customers the ability to produce and deliver customized products on an industrial scale, which is rapidly becoming vital for those participants wishing to remain competitive and profitable in today's operating environment.
As a result of these efforts, the Company continues to maintain additional resources to research and development work, advancing the integration of Company-wide products and data and deliver on its end-to-end solution.
It is expected that the first half of fiscal 2006 represented the peak in terms of percentage of revenue for gross R&D expenditure for the Company. As projects approach completion, the amount invested in capitalized development costs will decline as a proportion of the total expenditure while the amortization of development costs will be increasing in the near term.
R&D Expenses and Development Costs Analysis (Amounts in thousands of U.S. dollars) ------------------------------------------------------------------------ ------------------------------------------------------------------------ Three months Nine months ------------------------------------------------------------------------ ended July 31, ended July 31, ------------------------------------------------------------------------ ------------------------------------------------------------------------ 2006 2005 2006 2005 ------------------------------------------------------------------------ (Unaudited) (Unaudited) (Unaudited) (Unaudited) $ $ $ $ Research and Development Gross Expenditure 2,827 1,632 8,156 4,950 Less: tax credits (33) (60) (111) (184) ------------------------------------------------- 2,794 1,572 8,045 4,766 ------------------------------------------------- ------------------------------------------------- Capitalized cost 1,772 990 5,467 2,945 Development costs acquired 439 475 439 575 Tax credits (251) (160) (825) (514) ------------------------------------------------- Per cash flow statement 1,960 1,305 5,081 3,006 ------------------------------------------------- -------------------------------------------------
Gross Expenditure 2,827 1,632 8,156 4,950 Less: Expenses capitalized 1,772 990 5,467 2,945 ------------------------------------------------- As per note 4 to the Financial Statements 1,055 642 2,689 2,005 Less: Tax Credits (33) (60) (111) (184) Amortization - Development costs internal 773 624 1,909 1,681 Amortization - Development costs acquired 251 36 621 76 ------------------------------------------------- Per earnings statement 2,046 1,242 5,108 3,578 ------------------------------------------------- -------------------------------------------------
Investment tax credits ---------------------- Credited to Earnings 33 60 111 184 Reducing Capitalization 251 160 825 514 ------------------------------------------------- 284 220 936 698 ------------------------------------------------- -------------------------------------------------
Currency Exchange Risk
The Company's currency of measure is the Canadian dollar. However, financial statements are presented in U.S. dollars. With the recent decline in value of the U.S. dollar versus most major currencies, the company's operating results have been affected, particularly in cases where the expenditure is in a currency other than the U.S. dollar. The most significant impact is due to expenses incurred in Canadian dollars, given that most North American sales are in U.S. dollars, thereby eliminating the natural hedge we otherwise would have with revenues and expenses in other currencies such as the Euro or the Pound Sterling where revenues and expenses are incurred in the same currency.
The Company incurs cost in Canadian dollars of approximately C$6.2 million per quarter. In the third quarter of 2006, the average Canadian dollar exchange rate was $0.8959 compared to $0.8065 in the third quarter of fiscal 2005. This 11.1% increase in value resulted in an increase of $554,000 in expenses and a corresponding decrease in operating income simply due to the exchange rate variation.
For the nine months ended July 31, 2006, the effect on expenses of the Canadian dollar appreciation against the U.S. dollar amounted to $1.1 million.
The Company enters into forward exchange contracts as described in Note 20 to our 2005 Consolidated Audited Annual Financial Statements in order to improve predictability in the short term with respect to the impact of the variations in exchange rates between the Canadian and U.S. dollars. Gains and losses resulting from these contracts amounting to a loss of $95,000 for the third quarter ended July 31, 2006 and a gain of $242,000 for the nine month period then ended compared to a gain of $170,000 and a gain of $106,000 for the respective periods in 2005, are recorded in the "Financial Expenses (Income)" line of our Consolidated Earnings Statement.
1. PERFORMANCE OVERVIEW
Revenues for the third quarter of fiscal 2006 amounted to $14.9 million, representing a $4.2 million, or 38.9% increase over what had been recorded in the same period in the preceding fiscal year. The increase in revenues in the three months ended July 31, 2006 compared to the same period in fiscal 2005 is attributable to revenues amounting to $4.3 million generated by businesses recently acquired including that of MBI (effective December 1, 2005), CMS (effective September 1, 2005), Data One (effective December 1, 2005) and VSI (effective February 1, 2006). In addition, K/BIS, the premier trade show in North America for the kitchen and bath industry sponsored by the National Kitchen and Bath Association ("NKBA"), took place during the second quarter of 2006 compared to the third quarter, last year.
Revenues for the first nine months of fiscal 2006 amounted to $43.0 million, representing a $13.4 million, or 45.3% increase over revenues recorded in the same period in fiscal 2005. The increase in revenues is essentially attributable to the same reasons as those indicated above for the third quarter with business acquisitions identified above contributing $11.0 million for the nine months.
On an organic basis, excluding revenues from acquisitions over the last 12 months, revenues grew by 9.0% for the third quarter, after adjusting for the effect of the K/BIS trade show and increased by 8.0% for the nine months ended July 31, 2006 over the comparable periods in 2005. Revenues for the third quarter ended July 31, 2005 were bolstered by license sales generated at the K/BIS show held in Las Vegas in May 2005. The show was held in Chicago during the second quarter this year.
The Company's gross margin improved by $2.2 million, or 25.5% to $11.0 million for the three months ended July 31, 2006 compared with $8.7 million for the comparable period in 2005, representing 73.7% and 81.6% of total revenues, respectively. As mentioned earlier, the decline in the overall gross margin (as a percentage of revenues) is namely attributable to MBI revenues recorded during the interim period which were heavily weighted to maintenance and professional services revenue, with negligible contribution from higher-margin license sales revenues as well as VSI revenues whose mix includes a greater proportion of integration and professional services. With respect to MBI, this was anticipated following the acquisition as 20-20 repositions the business of MBI following its financial difficulties in mid-2005, namely by first securing follow-on services revenues from existing MBI customers which had temporarily postponed their investments in waiting for a definitive resolution of MBI's financial difficulties. The decline in percentage is also attributable to lower gross margins recorded by CMS as it is namely involved in reselling certain hardware which generally yield low margins.
For the nine months ended July 31, 2006, gross margins improved by $8.9 million, or 37.5% to $32.8 million compared to $23.9 million for the same period last year, representing 76.3% and 80.6% of total revenues, respectively. This decline in gross margin (as a percentage of revenues) is due to essentially the same factors as those described above for the third quarter of fiscal 2006.
The operating income declined to $748,000 for the three months ended July 31, 2006 compared with the same period in fiscal 2005, representing 5.0%. This compares with $2.1 million or 19.3% of total revenues for the three months ended July 31, 2005. The decline in operating income as a percentage of revenues is namely attributable to: (i) one-time benefits recorded as a reduction of expenses in the third quarter of 2005 totalling $505,000 with respect to a release received for a government loan and the favourable judgement received in a dispute where cost provisions had been taken; (ii) additional investments in sales and marketing from which Management expects progressively increasing benefits, including cross-selling synergies; (iii) the addition of resources to sustain the Company's growth and compliance requirements; (iv) the negative effect on operating expenses of the appreciation of the Canadian dollar against the U.S. dollar amounting to $554,000, and (v) the incremental amortization of intangible assets created upon accounting for the acquisitions completed subsequently to the end of the third quarter of fiscal 2005, including acquired development costs (accounted for in the research and development operating expense line), client lists and trade names and a non-compete agreement (all accounted for in the general and administrative operating expense line) amounting to $304,000.
With respect to the nine months ended July 31, 2006, operating income decreased to $3.2 million compared with $4.9 million for the same period in fiscal 2005, representing 7.4% and 16.5% of total revenues for each period, respectively. The decline in operating income both in dollars and as a percentage of revenues is namely attributable to: (i) one-time benefits recorded as a reduction of expenses in the third quarter mentioned above; (ii) additional investments in sales and marketing; (iii) the addition of resources to sustain the Company's growth and compliance requirements (iv) the negative effect on operating expenses of the appreciation of the Canadian dollar against the U.S. dollar amounting to approximately $1.1 million and, (v) the incremental amortization of intangible assets created upon accounting for the acquisitions completed subsequently to the end of the third quarter of fiscal 2005 amounting to $747,000, including acquired development costs (accounted for in the research and development operating expense line), client lists and trade names and a non-compete agreement (all accounted for in the general and administrative operating expense line).
Net earnings for the period decreased to $0.7 million for the period compared with $1.5 million for the comparable three month period in 2005. For the nine months ended July 31, 2006, net earnings stood at $3.2 million, unchanged from the same nine month period in 2005. The consolidated income tax expense for the three months stood at $262,000 or 27.9% of pre-tax earnings compared to $664,000 or 30.1% for the third quarter of 2005 and $775,000 or 19.5% of pre-tax earnings for the first nine months of fiscal 2006 compared to $1.7 million, or 34.1%, for the first nine months of fiscal 2005.
2. COMPARISON OF THE THREE AND NINE MONTHS ENDED JULY 31, 2006 AND 2005
ACQUISITIONS
The following information in regards to major acquisitions completed subsequently to the end of the third quarter of fiscal 2005 should be read in conjunction with Note 6 to the unaudited consolidated financial statements for the period ended July 31, 2006 for further details relating to basic considerations paid, future performance-based additional considerations, values attributed to the assets acquired (including intangible assets and goodwill) and assumed liabilities as of the date of the transactions, if applicable.
Build-Rite
On September 1, 2005, the Company completed the acquisition of the Build-Rite software for a total cash consideration of $1,300,000, of which $500,000 remains payable as a balance of purchase price. In addition, the Company has agreed to pay a royalty on license sales commencing, at the earlier of the date when the $500,000 balance of purchase price has been paid in full or September 1, 2010. The royalty payable is limited to $250,000, also payable in cash. There were no direct revenues recorded in relation to the Build-Rite software as work continues to integrate the application to 20-20 Design for Manufacturing Professional (DFM-PRO) to automate manufacturing directly from 20-20 Design files. The purchase price was entirely attributable to acquired development costs.
CMS Informatique SA
Effective September 1, 2005, the Company concluded the acquisition of CMS Informatique SA, a software company based in Cannes, France. CMS offers smaller woodworking shops and medium-sized manufacturing operations with flexible sales tools and tailored solutions for the manufacturing of custom cabinets and casework, windows and doors, closets and storage spaces, and staircases. The cash consideration paid for 100% of the shares in CMS amounted to 619,000 Euros, or $775,000, with 288,000 Euros, or $360,000 in net debt assumed as at the effective date of acquisition. Under the terms of the agreement, an additional cash amount of 90,000 Euros may be payable to the selling shareholder upon attainment of certain performance thresholds for the 2006 fiscal year. The purchase method of accounting for the transaction resulted in the creation of $588,000 in intangible assets (i.e. acquired development costs and client lists) and goodwill of $613,000.
Data One
Effective December 1, 2005, the Company acquired 100% of the shares of Data One for a total consideration of $1,303,000 paid in cash, with $62,000 in net cash assumed as at the effective date of acquisition. Data One develops services and sells layout, specification and catalog creation software for dealers, manufacturers and facilities managers of office furniture and case goods. The acquisition of Data One consolidates the Company's market position within design centers and allows for further enhancement of office furniture manufacturer data. The purchase method of accounting for the transaction resulted in the creation of $775,000 in intangible assets (i.e. acquired development costs and client lists) and goodwill of $1,017,000.
MBI Software Company GmbH
On December 1, 2005, the Company acquired all of the assets of Germany-based MBI, for a total consideration of 2,805,000 Euros ($3,332,000) paid in cash with $66,000 in net cash assumed as of the effective date of the acquisition. MBI develops markets and implements software solutions for the furniture manufacturing industry. The purchase method of accounting for the transaction resulted in the creation of $2,293,000 in intangible assets (i.e. acquired development costs and client lists) and goodwill of $3,405,000.
Virtual Systems International, Inc.
On December 12, 2005, the Company entered into an agreement to acquire 100% of the shares of Virtual Systems International, Inc. ("VSI"), based in Raleigh, North Carolina. The transaction was completed on February 9, 2006. VSI develops, sells and integrates advanced manufacturing software solutions for the cabinet, furniture and woodworking industries. The purchase method of accounting for the transaction resulted in the creation of $2,242,000 in intangible assets (i.e. acquired development costs, a non-compete agreement and client lists) and goodwill of $3,864,000.
REVENUES
Total revenues increased 38.9%, or $4.2 million, to $14.9 million for the three months ended July 31, 2006 compared with $10.7 million for the same period in fiscal 2005. For the nine months ended July 31, 2006, total revenues increased by $13.4 million, or 45.3% to $43.0 million, compared to $29.6 million for the same nine month period ended July 31, 2005.
Revenues - by Geography (In thousands of U.S. dollars) ------------------------------------------------------------------------ ------------------------------------------------------------------------ Three months ended Nine months ended ------------------------------------------------------------------------ July 31, July 31, ------------------------------------------------------------------------
2006 2005 2006 2005 ------------------------------------------------------------------------ (Unaudited) (Unaudited) (Unaudited) (Unaudited) $ % $ % $ % $ %
Revenues by geographic location North America 10,090 67.9 9,188 85.9 29,864 69.4 24,387 82.3 Europe 4,648 31.3 1,329 12.4 12,884 29.9 4,646 15.7 Rest of the World 126 0.8 182 1.7 292 0.7 592 2.0 ------------------------------------------------------------------------ 14,864 10,699 43,040 29,625 ------------------------------------------------------------------------ ------------------------------------------------------------------------
A significant portion of the Company's revenues continues to be generated in North America. However, in the third quarter of fiscal 2006, those revenues generated in European countries are approximately 3.5 times those reported in the same interim period in fiscal 2005. This is principally attributable to the contribution of results from operations of CMS and MBI, with said total contribution being more heavily weighted towards maintenance and professional services revenues as opposed to license sales.
In North America, revenues increased by $0.9 million between the quarterly periods, or 9.4%, which is principally attributable to:
(i) revenue from VSI and Data One, partially offset by license sales generated at the K/BIS trade show held in the third quarter in fiscal 2005 compared to the second quarter this year, as well as slower than expected sales of our 20-20 Design product in the North American residential market;
(ii) an increase in maintenance and recurring revenue resulting from the expansion of our installed customer base, which in turn resulted from strong license sales recorded in North America in the last three fiscal years, as well as the addition of both Data One and VSI to the installed base.
(iii) Several new catalog creation projects in North America.
Revenues generated in the rest of the world remained stable at $0.3 million, for the three months ended July 31, 2006, largely due to weaker than expected sales in Japan as the Company is working on feature modifications to its products to better adapt them to the local market. In addition, revenues in 2005 included sales to Shanghai Rena and DesignTec Co. Ltd., our distributors for China and Taiwan. Revenue this year from these distributors has been recorded as deferred revenue, as we are in the process of acquiring their operations.
For the nine months ended July 31, 2006, North American revenues increased by $5.3 million or 21.8% compared to the same period in 2005. The increase is principally attributable to the same reasons as above.
In Europe, revenues grew by 177.2% or $8.2 million largely as a result of the MBI and CMS acquisitions. Revenues from Europe now account for 29.9% of the Company's consolidated revenues compared to 15.7% for the same period in fiscal 2005.
Revenues - by Type (In thousands of U.S. dollars) ------------------------------------------------------------------------ Three months ended Nine months ended July 31, July 31, ------------------------------------------------------------------------ 2006 2005 2006 2005 ------------------------------------------------------------------------ (Unaudited) (Unaudited) (Unaudited) (Unaudited) $ % $ % $ % $ % Revenues by Type License sales 5,674 38.2 5,102 47.7 16,975 39.5 13,535 45.7 Maintenance and other recurring revenues 6,442 43.3 3,909 36.5 17,702 41.1 11,592 39.1 Professional services 2,748 18.5 1,688 15.8 8,363 19.4 4,498 15.2 ------------------------------------------------------------------------ 14,864 10,699 43,040 29,625 ------------------------------------------------------------------------ ------------------------------------------------------------------------
As explained in previous shareholder communications, certain recent acquisitions' principal business is to market and sell manufacturing solutions (e.g. enterprise resource planning systems - "ERP") to their customers, which typically comprise a significantly higher services-to-software revenue ratio compared to that of our desktop products such as 20-20 Design, Giza, CAP and other solutions currently offered by 20-20. As such, the recently completed acquisitions of MBI and VSI, which are involved in the marketing and sale of manufacturing and enterprise solutions, have resulted in the Company's overall percentage of total revenues represented by professional services to increase.
Revenues from license sales increased 11.2%, or $0.6 million, to $5.7 million for the three months ended July 31, 2006. License sales in 2005 benefited from the K/BIS trade show, which was held in Las Vegas in May 2005. In 2006, the show was held in Chicago in the second quarter. License sales revenues recorded by CMS, MBI, VSI and Data One in the three months ended July 31, 2006 amounting to $1.2 million contributed significantly to the increase between the interim periods.
Revenues from license sales increased 25.4%, or $3.4 million, to $17.0 million for the nine months ended July 31, 2006. The acquisitions mentioned above contributed $2.9 million in license revenues for the nine month period in 2006.
Revenues from maintenance and other recurring revenues increased 64.8%, or $2.5 million, to $6.4 million for the three months ended July 31, 2006. Maintenance and recurring revenues recorded by CMS, MBI, VSI and Data One in the three months ended July 31, 2006 amount to $1.8 million. Finally, the increase in revenues is attributable to additional recurring support and maintenance service revenues generated from a growing licensee base, following record license sales revenues generated in fiscal 2005 and 2004, namely in the residential market.
Revenues from maintenance and other recurring revenues increased 52.7%, or $6.1 million, to $17.7 million for the nine months ended July 31, 2006. The acquisitions mentioned above contributed $4.3 million in maintenance and other recurring revenues for the nine month period in 2006. Finally, the increase in revenues are attributable to additional recurring support and maintenance service revenues generated from a growing licensee base, following record license sales revenues generated in fiscal 2005 and 2004, namely in the residential market as well as an increase in subscription revenues for clients accessing manufacturer catalogs, largely due to price increases in the year.
Revenues from professional services increased 62.8%, or $1.1 million, to $2.7 million for the three months ended July 31, 2006. Professional services revenues recorded by CMS, MBI, VSI and Data One in the three months ended July 31, 2006 amounted to $1.3 million.
Revenues from professional services increased by 85.9% or $3.9 million to $8.4 million for the nine months ended July 31, 2006. The acquisitions mentioned above contributed $3.9 million in professional services revenues for the nine month period in 2006. To a lesser extent, the increase is also attributable to professional services revenue from new data creation projects in North America in the commercial market. These items were partially offset from having recorded data creation revenues for specific projects in the second quarter of fiscal 2005 that did not reoccur in the second quarter of fiscal 2006.
COST OF REVENUES
Cost of revenues from license sales increased by $129,000 to $380,000 in the third quarter of fiscal 2006 compared to $251,000 in the third quarter of fiscal 2005. Over the periods, the cost increased from 4.9% of license sales revenues in the three months ended July 31, 2005 to 6.7% in the same period in the 2006 fiscal year. The increase is principally attributable to having a greater proportion of license reselling in 2006 compared to 2005. In addition, the CMS, MBI, VSI and Data One acquisitions contributed $67,000 to the overall dollar amount increase.
For the nine months ended July 31, 2006, cost of revenues from license sales increased by $0.7 million, to $1.5 million, compared to $0.8 million, in the first nine months of fiscal 2005. Over the periods, the cost increased from 6.0% of license sales revenues in the nine months ended July 31, 2005 to 8.6% in the same period in the 2006 fiscal year. The increase is principally attributable to having a greater proportion of license reselling in 2006 as compared to 2005. The acquisitions mentioned above contributed $0.5 million to the cost increase.
Cost of revenues from maintenance and services increased 105.6%, or $1.8 million, to $3.5 million for the three months ended July 31, 2006 compared with $1.7 million for the same period in 2005, representing 38.3% and 30.7% of revenues from maintenance and services, respectively. The increase is attributable to: (i) cost of revenues from maintenance and recurring revenues recorded by CMS, MBI, VSI and Data One in the three months ended July 31, 2006 amounting to $1.6 million; (ii) the appreciation of the Canadian dollar against the U.S. dollar in the three months ended July 31, 2006 amounting to $126,000, compared with the same period in the previous year.
Cost of revenues from maintenance and services increased 77.3%, or $3.8 million, to $8.8 million for the nine months ended July 31, 2006 compared with $4.9 million for the same period in 2005, representing 33.6% and 30.7% of revenues from maintenance and services, respectively. The increase is attributable to: (i) cost of revenues amounting to $3.3 million from maintenance and services incurred by CMS, MBI, VSI and Data One in the nine month period, which in the case of CMS and MBI include the cost of hardware resold to its customers - i.e. low margins; (ii) the appreciation of the Canadian dollar against the U.S. dollar in the nine months ended July 31, 2006 amounting to $249,000, compared with the same period in the previous year.
GROSS MARGIN
The gross margin in dollars increased 25.5%, or $2.2 million, to $11.0 million for the three months ended July 31, 2006 compared with $8.7 million for the same period in 2005, representing 73.7% and 81.6% of total revenues for each period, respectively.
For the nine month period ended July 31, 2006, the gross margin increased 37.5%, or $8.9 million, to $32.8 million, compared with $23.9 million for the same period in 2005, representing 76.3% and 80.6% of total revenues for each period, respectively.
The decline in the overall gross margin as a percentage of revenues is namely attributable to MBI and VSI revenues recorded during the interim period which were weighted to maintenance and professional services revenue with a lesser contribution from higher-margin license sales revenues. This situation was anticipated following the acquisition, as 20-20 repositions the business of MBI following its financial difficulties in mid-2005, namely by first securing follow-on services revenues from existing MBI customers which had temporarily postponed their investments in waiting for a definitive resolution of MBI's financial difficulties. The decline in percentage is also attributable to lower gross margins recorded by CMS in the period as it is namely involved in reselling certain hardware which generally yield low margins.
If we exclude the effect of the recent acquisitions, gross margins decreased to 78.7% from 81.6% last year for the three month period ended July 31, 2006. For the nine months, gross margins remained stable at 79.9%, from 80.6% in 2005. The decrease in margin for the third quarter is principally attributable to higher margin license sales from the K/BIS show in 2005 which took place in the third quarter while for the current year the show took place during our second quarter.
Operating Expenses
Human resources
As at July 31, 2006, the Company employed 508 people on a full time and part time basis in the following geographies:
Canada 231 46% U.S.A 97 19% Europe 158 31% Rest of the World 22 4% --- ---- 508 100%
Sales and marketing expenses
Sales and marketing expenses increased 23.7%, or $0.9 million, to $4.9 million for the third quarter of fiscal 2006 compared with $3.9 million for the comparable period in 2005, and represented 32.8% and 36.8% of total revenues for each period, respectively. The increase in dollars is namely attributable to: (i) sales and marketing expenses incurred by CMS, MBI, Data One and VSI in the third quarter of fiscal 2006 amounting to $1.4 million; (ii) the reallocation and addition of certain staff and consultants to sales and marketing (including those employees now forming the Company's product management team), and (iii) the appreciation of the Canadian dollar against the U.S. dollar in the three months ended July 31, 2006 amounting to $141,000, compared with the same period in the previous year. In the third quarter of 2005, sales and marketing expenses included K/BIS costs, which were not repeated in 2006 as the show took place in the second quarter.
For the nine months, sales and marketing expenses increased 45.7%, or $4.5 million, to $14.3 million compared with $9.8 million for the comparable period in 2005, representing 33.2% and 33.1% of total revenues for each period, respectively. The increase in dollars is namely attributable to: (i) sales and marketing expenses incurred by CMS, MBI, Data One and VSI in the first nine months of fiscal 2006 amounting to $2.7 million; (ii) the timing of certain corporate marketing events that occurred in the first nine months of fiscal 2006 and not in the comparable period in the previous year; (iii) the reallocation and addition of certain staff and consultants to sales and marketing (including those employees now forming the Company's product management team); (iv) higher sales commissions and bonuses paid out to our sales force commensurate with the greater level of license revenues, and (v) the appreciation of the Canadian dollar against the U.S. dollar in the nine months ended July 31, 2006 amounting to $324,000, compared with the same period in the previous year.
Research and development expenses
Gross research and development expenses increased by 73.2%, or $1.2 million, to $2.8 million for the three months ended July 31, 2006, representing 18.8% of total revenues for the period, which compares to $1.6 million, for the same period in 2005, or 15.2% of total revenues for the period. Research and development expenditures increased between the periods namely as a result of: (i) research and development expenses incurred by MBI, CMS, Data One and VSI in the third quarter totalling $0.6 million; (ii) the addition of employees to research and development functions; (iii) the appreciation of the Canadian dollar against the U.S. dollar in the third quarter of fiscal 2006 compared with the same period in fiscal 2005 resulting in an increase in gross expenditure of $235,000 (i.e. as an important portion of research and development expenses are incurred in Canadian dollars), and (iv) higher amortization expenses related to research and development expenditures also contributed to the increase between the periods, namely due to the increase in amortization of intangible assets (i.e. acquired development costs) created upon accounting for the various acquisitions completed subsequently to the end of the third quarter of fiscal 2005 - including that of CMS, MBI, Data One and VSI, totalling $175,000.
The above mentioned increase in gross expenditures was partially offset by an increase in the amount of expenditures capitalized amounting to $782,000 between the two interim periods as the Company now covers a wider array of technologies within the end-to-end solution (including new categories such as the 3D Web Planner and vertical ERP and manufacturing execution software) and as additional efforts are deployed to advancing the integration of Company-wide products and data (including that of the Company's recently acquired businesses).
For the nine months ended July 31, 2006, gross research and development expenses increased by 64.8%, or $3.2 million, to $8.2 million, representing 18.9% of total revenues for the period, which compares to $5.0 million for the same period in 2005, or 16.7% of total revenues for the period. Research and development expenditures increased between the periods namely as a result of: (i) research and development expenses incurred by MBI, CMS, Data One and VSI in the nine months totalling $1.8 million; (ii) the addition of employees to research and development functions; (iii) the appreciation of the Canadian dollar against the U.S. dollar in the first nine months of fiscal 2006 compared with the same period in fiscal 2005 resulting in an increase in gross expenditure of $455,000 (i.e. as an important portion of research and development expenses are incurred in Canadian dollars), and (iv) higher amortization expenses related to research and development expenditures also contributed to the increase between the periods, namely due to the increase in amortization of intangible assets (i.e. acquired development cost) created upon accounting for the various acquisitions completed subsequently to the end of the third quarter of fiscal 2005 - including that of CMS, MBI, Data One and VSI totalling $418,000 for the nine month period.
The above mentioned increase in gross expenditures was partially offset by an increase in the amount of expenditures capitalized amounting to $2.5 million between the two interim periods for essentially the same reasons as those described for the third quarter.
General and administrative expenses
General and administrative expenses increased 127.5%, or $1.8 million, to $3.2 million, for the three months ended July 31, 2006, compared with $1.4 million in the same period in 2005, representing 21.6% and 13.2% of total revenues for each period, respectively. The increase is attributable to: (i) general and administrative expenses incurred by MBI, CMS, Data One and VSI for the third quarter amounting to $553,000; (ii) the addition of certain personnel progressively over fiscal 2005 including senior finance staff who are now full time in the third quarter; (iii) one-time benefits recorded as a reduction of expenses in the third quarter of 2005 totalling $505,000 with respect to a release received for a government loan and the favourable judgement received in a dispute where cost provisions had been taken; (iv) the appreciation of the Canadian dollar in the three months ended July 31, 2006 compared with the same period in 2005, as a majority of general and administrative expenses are incurred in Canadian dollars, namely at our head office in Laval, Quebec for approximately $178,000, and (v) increase in professional fees and fees related to the Company's public listing and ongoing costs associated with compliance requirements.
Amortization expenses related to general and administrative expenditures increased by $285,000 of which $131,000 was due to the amortization of intangible assets (i.e. client lists, trade names and a non-compete agreement) created upon accounting for the various acquisitions completed subsequently to the end of the third quarter of fiscal 2005 - including that of MBI, CMS, Data One and VSI. These acquisitions also contributed $93,000 in amortization for the quarter.
General and administrative expenses increased 85.0%, or $4.6 million, to $9.9 million for the nine months ended July 31, 2006, compared with $5.4 million in the same period in 2005, representing 23.1% and 18.1% of total revenues for each period, respectively. The increase is attributable to: (i) general and administrative expenses incurred by MBI, CMS, Data One and VSI for the nine months totalling $2.4 million; (ii) one-time benefits recorded as a reduction of expenses in the third quarter of 2005 totalling $505,000 with respect to a release received for a government loan and the favourable judgement received in a dispute where cost provisions had been taken; (iii) the addition of certain personnel progressively over fiscal 2005 including senior finance staff; (iv) an increase in office rental expenses as we increased the occupied space by our staff, in fiscal 2005, in the building where our head office is located as well as in Southern Europe; (v) the appreciation of the Canadian dollar in the three months ended July 31, 2006 compared with the same period in 2005, as a majority of general and administrative expenses are incurred in Canadian dollars, namely at our head office in Laval, Quebec for $397,000, and (vi) increase in professional fees and fees related to the Company's public listing and ongoing costs associated with compliance requirements.
Amortization expenses related to general and administrative expenditures increased by $644,000 of which $358,000 was due to the amortization of intangible assets (i.e. client lists, trade names and a non-compete agreement) created upon accounting for the various acquisitions completed subsequently to the end of the first quarter of fiscal 2005, as mentioned above. These acquisitions also contributed $181,000 in amortization expense for the nine months.
Stock-based compensation expenses
Stock-based compensation expenses amounted to $83,000 for the three months ended July 31, 2006, which compares to $72,000 for the same period in the previous year. The increase is principally attributable to options granted in 2006. The obligation recorded by the company for deferred share units granted to certain members of the Board of Directors was also reduced during the quarter, in line with the value of these units based on the Company's common share market value.
For the nine months, stock-based compensation expenses amounted to $291,000, which compares to $227,000 for the same period in the previous year. Refer to Note 10 of the unaudited consolidated financial statements for further details relating to the stock-based compensation expense.
OPERATING INCOME
As a result of the above, the Company's operating income declined to $748,000 for the three months ended July 31, 2006, representing 5.0% compared to $2.1 million or 19.3% for the same period in 2005. For the nine months ended July 31, 2006, operating income stood at $3.2 million from the $4.9 million recorded for the same period in 2005.
Operating Income (Amounts in percentages) ------------------------------------------------------------------------ ------------------------------------------------------------------------ Three months Nine months ended July 31, ended July 31, ------------------------------------------------------------------------ 2006 2005 2006 2005 ------------------------------------------------------------------------ (Unaudited) (Unaudited) (Unaudited) (Unaudited) % % % %
Revenue 100.0 100.0 100.0 100.0 Cost of Sales 26.3 18.4 23.7 19.4 ------------------------------------------------------------------------ Gross Margin 73.7 81.6 76.3 80.6 Sales & Marketing 32.8 36.8 33.2 33.1 Research & development 13.8 11.6 11.9 12.1 General and Administrative 21.6 13.2 23.1 18.1 Stock based compensation 0.5 0.7 0.7 0.8 ------------------------------------------------------------------------ Operating Income 5.0 19.3 7.4 16.5 ------------------------------------------------------------------------ ------------------------------------------------------------------------
Adjusted Operating Income
As the Company has made several acquisitions over the last several months we felt that it was important to provide a measure that enhances an overall understanding of our operational results and trends, on a comparable basis with the prior periods. Adjusted operating income is a non-GAAP measure related to operating income and is defined as operating income excluding stock-based compensation and amortization of acquisition-related intangibles and development costs. Adjusted operating income is a supplemental measure and should not be construed as an alternative to operating income as defined under Canadian generally accepted accounting principles (Canadian GAAP) as a measure of profitability. Our method of measuring adjusted operating income is unlikely to be comparable to similar measures provided by other companies.
Adjusted operating income decreased to $1.2 million or 8.3% of revenues, from $2.2 million or 20.7% of revenue, in the third quarter of 2005. For the nine month period ended July 31, 2006, adjusted operating income stood at $4.5 million or 10.4% of revenue compared to $5.2 million or 17.6% of revenue, for the same period in 2005.
Adjusted Operating Income (Amounts in thousands of U.S. dollars) ------------------------------------------------------------------------ ------------------------------------------------------------------------ Three months Nine months ended July 31, ended July 31, ------------------------------------------------------------------------ 2006 2005 2006 2005 ------------------------------------------------------------------------ (Unaudited) (Unaudited) (Unaudited) (Unaudited) $ $ $ $ Operating Income (GAAP) 748 2,070 3,180 4,882 Stock based compensation 83 72 291 227 Amortization of acquired intangibles 152 21 396 38 Amortization of acquired development costs 251 36 621 76 ------------------------------------------------------------------------ Adjusted Operating Income 1,234 2,199 4,488 5,223 ------------------------------------------------------------------------ ------------------------------------------------------------------------
Other Expenses
Financial income increased from $133,000 for the three months ended July 31, 2005, to a net financial income of $191,000 for the third quarter ended July 31, 2006. The increase is primarily attributable to higher prevailing interest rates on cash investments.
Financial income increased from $25,000 for the nine months ended July 31, 2005, to a net financial income of $792,000 for the nine months ended July 31, 2006. The increase of $767,000 is principally attributable to: (i) lower interest charges on long-term debt and debentures from $26,000 to $308,000 for the same period in fiscal 2006. The debentures were entirely converted into common shares upon closing of the Company's IPO on December 8, 2004; (ii) $320,000 in interest revenue during the period related to interest earned on refundable income taxes; (iii) $137,000 in additional interest revenue during the period generated from our investing a portion of available cash in short term investments at higher rates, compared to interest revenue for the nine months ended July 31, 2005; (iv) an exchange gain of $87,000 compared to an exchange loss of $26,000 for the same period in 2005, and (v) higher interest and bank charges largely attributable to recent acquisitions.
3. LIQUIDITY
Cash from Operations
In the three months ended July 31, 2006 and 2005, cash flows from operating activities before changes in working capital items were $2.5 million for each period. In the third quarter of fiscal 2006 and 2005, $2.0 million and $343,000 in cash were generated in working capital items respectively (excluding those working capital items from acquisitions as at the effective date of transactions which are included in the Business acquisitions item shown in investing activities in the cash flow statement). In the three months ended July 31, 2006, the source of working capital principally resulted from a significant decrease in accounts receivable and accounts payable, partially offset by an increase in deferred revenue.
For the nine months ended July 31, 2006 and 2005, cash flow from operating activities before changes in working capital items were $8.1 million and $6.4 million for each period, respectively. In the first nine months of fiscal 2006 and 2005, $245,000 and $1.3 million in cash were used in working capital items (excluding those working capital items from acquisitions as at the effective date of transactions, which are included in the Business acquisitions item shown in investing activities in the cash flow statement). The use of working capital principally resulted from the increase in accounts receivable, deferred revenue and contracts in progress, offset by increases in accounts payable and income taxes.
Investing activities
Our principal investing activities consist of business acquisitions, development costs (internal capitalized costs), and the purchase of property and equipment.
In the three months ended July 31, 2006, the Company used $1.1 million in cash in regard to considerations paid to complete the purchase of VSI while there were no acquisitions in the third quarter of 2005. Please refer to Note 6 to the audited consolidated financial statements for further details relating to the allocation of purchase prices and other specifics of these acquisitions.
For the nine months ended July 31, 2006, cash was used as follows with respect to acquisitions (net of cash on the acquired companies' balance sheets): (i) MBI - $3.2 million; (ii) Data One - $1.2 million, and (iii) VSI for $4.8 million.
In the three months ended July 31, 2006 and 2005, the Company capitalized internal development costs in the amounts of $1.5 million and $0.8 million, respectively (net of applicable credits). For the nine month period, capitalized internal development costs amounted to $4.6 million in 2006 compared to $2.4 million in 2005. The increase is attributable to executing development work on a growing product base, which results from the Company's various business combinations and acquisitions over past periods and to product and data integration efforts currently underway as further described in introduction and section 3 of this report. These increases do not include those that were acquired through the business acquisitions of MBI, VSI and Data One but they do include capitalized expenditures by these companies post acquisition.
The Company also acquired $439,000 in technology to support its end-to-end solution ($475,000 in 2005).
In the three months ended July 31, 2006 and 2005, the Company expended $787,000 and $619,000 respectively, towards the purchase of property and equipment, principally comprising computers, software and leasehold improvements. For the nine months, expenditures amounted to $1.3 million for 2006 and $1.1 million for 2005. No major projects have been undertaken during these periods and expenditures are essentially sustaining in nature. These additions do not include those that were acquired through the business acquisitions of MBI, VSI and Data One but they do include expenditures incurred by these companies post acquisition.
Financing activities
In the three months ended July 31, 2006, $34,000 in long term debt was repaid by the Company based on contracted repayment schedules compared to an amount of $49,000 for the same period last year.
In the nine months ended July 31, 2006, $801,000 in long term debt was repaid by the Company, which included repayment in full of a loan on leasehold improvements which carried an interest rate of 10% for $651,000. In addition $59,000 in bank indebtedness was repaid by the Company, which amount had been assumed upon closing of the M