##### 



As filed with the
Securities and Exchange Commission on February 22, 2005   SECURITIES AND EXCHANGE
COMMISSION WASHINGTON, D.C.
20549
 FORM 20-F o
    
    Registration statement pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of
1934ORþ
    
    Annual
report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the fiscal year ended September 30, 2004ORo
    
    Transition report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the transition period from ____________to ____________ Commission file number 0-30082 ENVOY COMMUNICATIONS GROUP INC. 
    Ontario, Canada 
 172 John Street, Toronto, Ontario, Canada M5T 1X5 
 Securities registered or to be registered pursuant to Section 12(b) of the Act: None Securities registered or to be registered pursuant to Section 12(g) of the Act. COMMON SHARES 
  The Nasdaq Small Cap Market 
 Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act. NONE 
 Indicate the number of outstanding shares of each of the issuers classes of capital or
common stock as of the close of the period covered by the annual report: At September 30, 2004
there were 23,416,600 common shares outstanding. Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.      YES þ      NO o Indicate by
check mark which financial statement item the Registrant has elected
to follow:      Item 17
þ      Item 18 o   1




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TABLE OF CONTENTS PART IItem 1. Identity of Directors, Senior Management and Advisers
    3Item 2. Offer Statistics and Expected Timetable
    3Item 3. Key Information
    3Item 4. Information on the Company
    6Item 5. Operating and Financial Review and Prospects
    12Item 6. Directors, Senior Management and Employees
    25Item 7. Major Shareholders and Related Party Transactions
    34Item 8. Financial Information
    35Item 9. The Offer and Listing
    36Item 10. Additional Information
    38Item 11. Quantitative and Qualitative Disclosures About Market Risk
    40Item 12. Description of Securities Other than Equity Securities
    40PART IIItem 13. Defaults, Dividend Arrearages and Delinquencies
    40Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
    40Item 15. Controls and Procedures
    41Item 16A Audit Committee Financial Expert
    41Item 16B Code of Ethics
    41Item 16C Principal Accountant Fees and Services
    41Item 16D Exemptions from the Listing Standards for Audit Committees
    41Item 16E Purchase of Equity Securities by the Issuer and Affiliated Purchasers
    41PART IIIItem 17. Financial Statements
    42Item 18. Financial Statements
    42Item 19. Exhibits
    42Signatures
    43Certifications
 2




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PART I 
 Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS Not applicable 
 Item 2.OFFER STATISTICS AND EXPECTED TIMETABLES Not applicable 
 Item 3.KEY INFORMATION A. Selected Financial Data1 The following table sets forth in Canadian dollars selected financial data for Envoy for the
fiscal years indicated below prepared in accordance with Canadian Generally Accepted Accounting
Principles unless otherwise noted. The following selected financial data should be read in
conjunction with the more detailed financial statements and the related notes thereto appearing
elsewhere in this Form 20-F and the discussion under Item 5 Operating and Analysis of Financial
Condition and Results of Operation herein. The selected financial data does not include statements
of operations data or balance sheet data of any acquired operations prior to their respective
acquisition effective dates. Fiscal Years Ended September 30
    
    20042
    
    
    20033
    
    
    20024
    
    
    20015
    
    
    20006(all amounts in thousands, except per share data)Statement of Operations Data:Net Revenue
    
    $
    40,803
    
    
    $
    40,853
    
    
    $
    56,897
    
    
    $
    81,680
    
    
    $
    59,109(Loss)Income From Continuing Operations
    
    
    (2,642
    )
    
    
    2,494
    
    
    
    (53,369
    )
    
    
    (2,788
    )
    
    
    2,808(Loss) Income From Continuing Operations Basic Earnings
Per Share
    
    ($
    0.25
    )
    
    $
    0.58
    
    
    ($
    12.71
    )
    
    ($
    0.66
    )
    
    $
    0.73(Loss) Income From Continuing Operations Diluted Earnings
Per Share
    
    ($
    0.15
    )
    
    $
    0.43
    
    
    ($
    12.71
    )
    
    ($
    0.66
    )
    
    $
    0.70Net (Loss) Earnings7
    
    
    (3,107
    )
    
    
    2,539
    
    
    
    (53,379
    )
    
    
    (2,895
    )
    
    
    2,910Net (Loss) Earnings Per Share7 Basic
    
    ($
    0.18
    )
    
    $
    0.59
    
    
    ($
    12.71
    )
    
    ($
    0.68
    )
    
    $
    0.76Net (Loss)Earnings Per Share7 Diluted
    
    ($
    0.18
    )
    
    $
    0.43
    
    
    ($
    12.71
    )
    
    ($
    0.68
    )
    
    $
    0.73
   1
 Effective May 1, 2003, Envoy uses the provisions of the CICA Handbook section 3475, Disposal
of long-lived assets and discontinued operations. The results of operations of a business that
has either been disposed of, or is held for sale, is reported as discontinued operations if the
operations and cash flows of the component have been (or will be) eliminated from the Companies
ongoing operations, and the Company will not have any significant continuing involvement in the
operations of the component after the disposal transaction. The results of discontinued operations,
less applicable taxes are reported as a separate element of income or loss before extraordinary
items for both current and prior periods. For 3




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businesses that were disposed of prior to the adoption of these new standards, Envoy includes the
results of their operations in the comparative financial results. At a meeting held on August 14, 2003, the Company shareholders approved the consolidation of the
Companys common shares on the basis to be determined by its board of directors (not to exceed a
ratio of 1 for 10). On January 15, 2005, the Companys board of directors approved the
consolidation of the common shares (a reverse stock split) on the basis of 1 for 5. On January 21,
2005 the Company filed Articles of Amendment consolidating its common shares on the basis of 1 new
common share for every 5 common shares outstanding. Outstanding shares and earnings per share
figures for all periods presented have been adjusted to give effect to the share consolidation.
Information on number of shares outstanding, and stock options are disclosed on a pre consolidation
basis. Fiscal Years Ended September 30
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(all amounts in thousands)Balance Sheet Data:Current Assets
    
    $
    59,259
    
    
    $
    18,844
    
    
    $
    27,447
    
    
    $
    51,138
    
    
    $
    43,337Total Assets
    
    
    88,880
    
    
    
    37,967
    
    
    
    49,174
    
    
    
    113,850
    
    
    
    102,308Total Debt8
    
    
    659
    
    
    
    11,425
    
    
    
    14,795
    
    
    
    11,928
    
    
    
    10,832Shareholders Equity9
    
    
    76,891
    
    
    
    12,359
    
    
    
    9,779
    
    
    
    61,319
    
    
    
    62,687Retained (Deficit) Earnings10
    
    
    (48,344
    )
    
    
    (45,237
    )
    
    
    (47,776
    )
    
    
    5,508
    
    
    
    8,403
   2
 3 The exchange rate utilized with respect to the Statement of Operations Data for the
year ended September 30, 2003 of Watt Gilchrist Limited (Gilchrist) is £1.00 to $2.3425 Cdn. and
with respect to the Balance Sheet Data of Gilchrist is £1.00 to $2.2448 Cdn. The exchange rate
utilized with respect to the Statement of Operations Data of US activities is $1.00 U.S. to $1.4635
Cdn. and with respect to the Balance Sheet Data of US activities is $1.00 U.S. to $1.3499 Cdn.
Except as set forth in footnotes 4, 5 and 6, no other acquisitions by Envoy materially affect the
comparability of the information in the Selected Financial Data. During fiscal 2003, Envoy
disposed of a number of subsidiaries including Sage Information Consultants Inc. Sage, Devlin
Multimedia Inc. (Devlin) and Hampel Stefanides Inc. (Hampel) as described in Notes 15 and 16 to
the consolidated financial statements. 4 The exchange rate utilized with respect to the Statement of Operations Data for the
year ended September 30, 2002 of Gilchrist is £1.00 to $2.3119 Cdn. and with respect to the Balance
Sheet Data of Gilchrist is £1.00 to $2.4894 Cdn. The exchange rate utilized with respect to the
Statement of Operations Data of Hampel is $1.00 U.S. to $1.5731 Cdn. and with respect to the
Balance Sheet Data of Hampel is $1.00 U.S. to $1.5872 Cdn. Except as set forth in footnotes 4, 5
and 6, no other acquisitions by Envoy materially affects the comparability of the information in
the Selected Financial Data. 5 The Statement of Operations Data for the year ended September 30, 2001 includes the
results of operations of The International Design Group (IDG), acquired effective as of January
1, 2001, for the nine month period from January 1, 2001 to September 30, 2001. See Item 4
Information on the Company for a description of this acquisition. The exchange rate utilized
with respect to the Statement of Operations Data of Gilchrist is £1.00 to $2.2122 Cdn. and with
respect to the Balance Sheet Data of Gilchrist is £1.00 to $2.3264 Cdn. The exchange rate utilized
with respect to the Statement of Operations Data of Hampel is $1.00 U.S. to $1.5785 Cdn. and with
respect to the Balance Sheet Data of Hampel is $1.00 U.S. to $1.5352 Cdn. Except as set forth in
footnotes 4, 5 and 6, no other acquisitions by Envoy materially affect the comparability of the
information in the Selected Financial Data. 6 The Statement of Operations Data for the year ended September 30, 2000 includes the
results of operations of Sage, acquired effective as of June 1, 2000, for the four month period
from June 1, 2000 to September 30, 2000, and the results of operations of Gilchrist, acquired
effective as of July 1, 2000, for the three month period from July 1, 2000 to September 30, 2000.
See Item 4 Information on the Company for a description of such acquisitions. The exchange rate
utilized with respect to the Statement of Operations Data of Gilchrist is £1.00 to $2.1885 Cdn. and
with respect to the Balance Sheet Data of Gilchrist is £1.00 to $2.2163 Cdn. The exchange rate
utilized with respect to the Statement of Operations Data of Hampel is $1.00 U.S. to $1.4722 Cdn.
and with respect to the Balance Sheet Data of Hampel is $1.00 U.S. to $1.5035 Cdn. Except as set
forth in footnotes 4, 5 and 6, no other acquisitions by Envoy materially affect the comparability
of the information in the Selected Financial Data. 4




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7 As reflected in Note 24 to the Notes to the audited Financial Statements of Envoy, the
net loss from continuing operations for the years ended September 30, 2004, 2003, and 2002 were
($3,106),($1,566)and ($15,878) respectively under U.S. GAAP. The net earnings (loss) for the
years ended September 30, 2004, 2003, and 2002 was ($3,571), $2,606 and ($53,376) respectively
under U.S. GAAP. The diluted net (loss) earnings per share for the years ended September 30, 2004,
2003, 2002 and 2001 was ($0.21), $0.43, ($12.71) and ($0.91), respectively under U.S. GAAP. As described in Note 11 and Note 23(b) to the Notes to the audited Financial Statements of
Envoy, on January 21, 2005 Envoy filed Articles of Amendment consolidating its common shares on the
basis of 1 new common share for every 5 common shares outstanding. Outstanding shares and earnings
per share figures for all periods presented have been adjusted to give effect to the share
consolidation. 8 Total debt includes both the current and long term portion of debt. 9 As reflected in Note 24 to the Notes to the audited Financial Statements of Envoy
the shareholders equity as at September 30, 2004 and 2003 was $77,066, and $11,765, respectively
under U.S. GAAP. Total assets as of September 30, 2004, 2003, 2002,and 2001, under US GAAP would
include the unrealized gain on securities for sale of $174, $nil, $nil, $nil, and $nil respectively 10 Retained earnings as of September 30, 2004, 2003, 2002, 2001, and 2000, excludes the
cumulative foreign currency translation adjustment of $74, ($236), $1,348, $833 and ($314)
respectively. See Note 2(f) to the Notes to the audited Financial Statements of Envoy. Envoy has never paid any dividends on its common shares and does not anticipate that it will
pay any cash dividends on its common shares in the foreseeable future. Exchange Rates On February 17, 2005, the noon buying rate for Canadian dollars as reported by the Federal Reserve
Bank of New York was $1.00 U.S. to 1.2310 Cdn. The following table sets forth for the periods
indicated certain information regarding the exchange rate into U.S. currency of Canadian dollars.
The rate of exchange means the noon buying rate in New York City for cable transfers in foreign
currencies as certified for customs purposes by the Federal Reserve Bank of New York. Fiscal Year Ended September 30,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Average*
    
    $
    1.2034
    
    
    $
    1.4553
    
    
    $
    1.5731
    
    
    $
    1.5353
    
    
    $
    1.4724
   *
    
    The average rate means the average of the exchange rates on the last day of each month during
the fiscal period. For the month endingJanuary
    
    
    December
    
    
    November
    
    
    October
    
    
    September
    
    
    August2005
    
    
    2004
    
    
    2004
    
    
    2004
    
    
    2004
    
    
    2004High
    
    $
    1.2422
    
    
    $
    1.2401
    
    
    $
    1.2263
    
    
    $
    1.2726
    
    
    $
    1.3071
    
    
    $
    1.3314Low
    
    
    1.1982
    
    
    
    1.1856
    
    
    
    1.1775
    
    
    
    1.2194
    
    
    
    1.2648
    
    
    
    1.2964
 B.Capitalization and Indebtedness Not applicable C.Reasons for the Offer and Use of Proceeds Not applicable D.Risk factors Envoys business, financial condition and results of operations could be materially adversely
affected by any of the following risks. This Form 20-F contains forward-looking statements that involve risks and uncertainties. Envoys
actual results could differ materially from those anticipated in these forward-looking statements
as a result of certain factors, including the risks faced by Envoy described below and elsewhere in
this form. General economic conditionsThe marketing and communication industry is cyclical and as a result
it is subject to downturns in general economic conditions and changes in client business and
marketing budgets. 5




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Foreign currency riskEnvoy is subject to currency risk through its activities in the United
States and in the United Kingdom. Unfavourable changes in the exchange rate may affect the
operating results of Envoy. Envoy does not currently use derivative instruments or foreign
currency contracts to reduce its exposure to foreign currency risk. Key personnelEnvoys success depends in part upon its ability to hire and retain key senior
management and skilled technical, client service and creative personnel able to create and maintain
solid relationships with clients. An inability to hire or retain qualified personnel could have a
material adverse effect on Envoy. Credit riskEnvoy manages its credit risk with respect to accounts receivable by acting as
an agent for its customers, by dealing primarily with large creditworthy customers and by billing
whenever possible in advance of rendering services or making commitments. Management believes that
Envoy is not subject to significant concentration of credit risk. As at September 30, 2004, Envoy
had one customer, who represented 15% of accounts receivable and one customer who represented 8% of
accounts receivable as at September 30, 2003. Envoys results of operations and its business depend on its relationship with a limited number of
large clients. Set forth below is the percentage of net revenue during the fiscal year ended
September 30, 2004 for each of Envoys clients that accounted for 10% or more of its net revenue
and for Envoys five largest clients combined: Fiscal Year EndedClient
    
    September 30, 2004ASDA Stores Limited
    
    37.0%Safeway Brands Inc.
    
    15.0%Wal-Mart Stores Inc.
    
    11.0%Five largest clients combined
    
    68%
 Although Envoy has over 75 clients, a relatively small number contribute a significant percentage
of Envoy consolidated net revenue. For the year ended September 30, 2004, the Companys top three
clients accounted for 63% of its consolidated net revenue. As Envoys relationships with these
clients have been long-standing ones, the Company expects reliance on such clients to continue into
the future. The failure to achieve continued design wins from one or more of these clients without
adding new sources of net revenue could have an adverse effect on Envoys financial results. There can be no assurance that Envoy will be able to maintain its historical rate of growth or its
current level of revenue derived from any client in the future. Contract RiskThe realization of expected revenues from certain agreements of the Company depends
on the ability of Envoy to make satisfactory proposals to its clients. Expected revenues may be
delayed if proposals are not submitted or accepted in the anticipated timeframe or may not be
realized at all if proposals are ultimately not accepted. 
 Item 4.INFORMATION ON THE COMPANY The following Information on the Company contains forward-looking statements, which involve risks
and uncertainties. Envoys actual results could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set forth under Item
3Risk Factors and elsewhere in this Form 20-F. 6




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ENVOY COMMUNICATIONS GROUP INC. General Envoy Communications Group Inc. (or the Company) is a marketing and international consumer and
retail branding company with offices throughout North America and Europe. Combining strategy,
creativity and innovation, Envoys interconnected network of companies delivers business-building
solutions to over 200 leading global brands and has successfully completed assignments in more than
40 countries around the world. Envoy conducts its branding services through its wholly-owned subsidiaries, Watt International Inc.
and Watt Gilchrist Limited (collectively, Watt), which together form one of the worlds largest
brand strategy and design consultancies. With seven offices located throughout North America, the
United Kingdom and Continental Europe, Watts clients include The Great Atlantic & Pacific Tea
Company (A&P), Asda Stores Ltd., Carulla Vivero S.A., Cencosud S.A, Cott Beverages Ltd., Famous
Players Ltd., Giant Food Inc., Gigante, S.A. de C.V., Immobilaria Las Verbenas S.A., Longs Drug
Store Corporation, Kraft Foods Inc., Next plc, Safeway Brands Inc., Shaws Supermarkets, Inc.,
Sobeys Inc., Sports Authority, Smart & Final Stores Corporation and Wal-Mart Stores Inc. Envoy provides advertising and communications services through a 100% owned subsidiary, John Street
Inc. Clients of John Street include Harveys (a division of Cara Operations Limited), Scott Paper
Ltd., Tetley Canada, Moores, Fuji Photo Film Canada Inc., The Family Channel Inc. and Viewers
Choice. In 2004 three customers accounted for 37%, 15% and 11% respectively of net revenue. In 2003, three
customers accounted for 26%, 16% and 12% of net revenue. In both years, no other customers
accounted for more than 10% of net revenue. Watt International Inc. and John Street Inc. each subsist under the laws of the Province of Ontario
and Watt Gilchrist Limited subsists under the laws of the United Kingdom. The principal place of business of Envoy is located at 172 John Street, Toronto, Canada M5T 1X5.
Envoy may be reached by telephone: (416) 593-1212 facsimile: (416) 593-4434. Envoys website is
www.envoy.to. Information contained in our website does not constitute a part of this Form 20-F. A.History and Development of the Company Envoy was incorporated under the laws of the Province of British Columbia, Canada as Potential
Mines Ltd. in December 1973 and was continued under the laws of the Province of Ontario, Canada in
December 1997. Since December 1997 Envoy has shifted the nature of its business to providing
marketing, communications and consumer and retail branding services for promoting clients
products, services and business messages utilizing such media as print, broadcast and the Internet.
Envoy has grown, in large part, through strategic acquisitions. Certain material acquisitions by
Envoy are described below. Effective as of June 1, 1998, Envoy acquired Promanad Communications Inc. (Promanad), an
advertising, public relations and corporate identity agency. Envoy expanded its geographic reach
into the U.S. marketplace through its acquisition of Hampel Stefanides Inc., (Hampel) effective
as of October 1, 1998. Effective as of January 1, 1999, Envoy acquired Devlin Multimedia Inc., a Toronto-based website
design and development company. Effective as of May 1, 1999, Envoy acquired Watt International Inc. (Watt International), through
which Envoy acquired the operations, substantially all of the assets and certain of the liabilities
of The Watt Design Group Inc. (Watt Design), a Toronto-based provider of design, packaging,
retail environments and marketing identity services to retailers. Envoy expanded its geographical
reach into the United Kingdom and the continental Europe marketplace through its acquisition of
Gilchrist Brothers Limited (Gilchrist), a United Kingdom based digital imaging and design firm,
effective as of July 1, 2000. Effective as of January 1, 2001, Envoy acquired The International
Design Group (Canada) Inc., (IDG) a Toronto-based retail planning and design firm. IDG was
amalgamated with Watt International effective September 30, 2001. Watt International, Gilchrist and
IDG are referred to collectively as (Watt). Effective as of June 1, 2000, Envoy acquired Sage Information Consultants Inc., a digital
professional service firm operating in the United States and Canada. During July 2001, Envoy launched John Street Inc. a Toronto based advertising and Communications
initiative to replace the advertising business previously conducted by the Communiqué Group Inc.
On September 30, 2004, Envoy purchased from the executive officers of John Street Inc. the 30% of
the shares of John Street Inc., which it did not already own. No amount 7




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has been accrued in the financial statements as the purchase price will be determined and paid over
a three-year period based on certain future performance milestones. Effective October 1, 2001, Envoy acquired 100% of the outstanding shares of Commordore Conference
Planners Inc. (Commodore), a conference and event marketing company. Commodore was amalgamated
with Communique Incentives Inc. on acquisition. On October 30, 2002, the assets of Devlin were sold to management of the company. On November 11, 2002, the operations of Sage were shut down and the assets of Sage were liquidated. On February 7, 2003, Envoy decided to discontinue the operations of Hampel after conducting a
review, in conjunction with Envoys banks, of the ongoing viability, future prospects, cash needs
and local debt situation of this company. Following the liquidation of the assets, the shares of
Hampel were sold for nominal consideration. On January 1, 2004, Envoy decided to sell all the shares of its corporate event and corporate
travel business. Communique Incentives Inc. (Communique), after conducting a review of its
ongoing viability, future prospects and cash requirements. The business was sold for a nominal
consideration. On November 10, 2004, Envoy, through its subsidiary ECG Holdings (UK) Limited (ECGH), agreed to
acquire 65% of the outstanding shares of Parker Williams Design Limited (Parker Williams), a
London, UK based packaging design and brand specialist company. The purchase price of £1,818,000 is
payable in cash on closing. The remaining 35% of the Parker Williams shares (Management Shares)
will continue to be held by senior management of Parker Williams (Management Shareholders),
subject to certain options described below. ECGH will have the option to acquire from the
Management Shareholders and the Management Shareholders will have the option to require ECGH to
purchase from them, at various stages over a period of 4 years following completion, the Management
Shares for a purchase price based on the profitability of Parker Williams for certain defined
periods following closing. The transaction is expected to be completed by February 21, 2005. The
acquisition will be accounted for using the purchase method of accounting. PW, whose clients
include Sainsburys Supermarkets and Coop Norden, is a specialist in the retail area. Parker
Williams was formed in 1990 by designers Tamara Williams and Tony Parker. With over 25 years design
experience in Europe, America and the Far East, Parker Williams has revenues of approximately $5.0
million annually. Both companies believe the combined expertise and focus within the retail arena
will provide new opportunities across both Europe and North America. B. Business Overview Services in the Envoy Group include: Consumer and retail branding  Watt International, a wholly owned subsidiary of Envoy, that
management believes to be one of the worlds leading brand strategy and design consultancies
provides the following services: strategic brand consulting, corporate identity and communications,
retail branding and store design, and package design. Watt International also provides brand
management, pre-press and film through Watt Gilchrist, a sister company with more than 100 years of
experience. Marketing  John Street. Inc., a 100% owned subsidiary of Envoy provides advertising and
communications services that include creative concept development, strategic planning and
consulting, advertising production, media planning and purchasing. Net revenue by type of service for the last three fiscal years is as follows: (all amounts in
thousands) Fiscal 2004
    
    
    Fiscal 2003
    
    
    Fiscal 2002Net revenue:Marketing
    
    $
    3,839
    
    
    $
    6,248
    
    
    $
    10,204Consumer and retail branding
    
    
    36,964
    
    
    
    34,313
    
    
    
    38,204Technology
    
    
    
    
    
    
    292
    
    
    
    8,489$
    40,803
    
    
    $
    40,853
    
    
    $
    56,897
 8




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Net revenue by geographic region, based on the region the customer is located, is as follows: (all
amounts in thousands) Fiscal 2004
    
    
    Fiscal 2003
    
    
    Fiscal 2002Net revenue:Canada
    
    $
    5,635
    
    
    $
    5,393
    
    
    $
    13,758United States
    
    
    14,444
    
    
    
    18,185
    
    
    
    27,709United Kingdom and
Continental Europe
    
    
    20,724
    
    
    
    17,275
    
    
    
    15,430$
    40,803
    
    
    $
    40,853
    
    
    $
    56,897
 Our Strategic Direction During fiscal 2004 Envoy sold all the shares of its corporate event and corporate travel business
and during fiscal 2003, Envoy divested its technology services. Envoy remains focused on the
expansion and prosperity of its core business of consumer and retail branding. The Watt group of
companies (Watt), our branding business, has proven successful at creating and executing private
label programs and landmark store design, making Envoy a world authority in brand strategy and
design for the retail sector. In November 2003, Watt announced the launch of Gilchrist North America (GNA), a state-of-the-art
reprographics and brand management business, with locations in Toronto, Bentonville and Boston.
GNA will leverage the highly experienced work force and sophisticated equipment of Gilchrist UK,
Watts UK based brand management company, to provide its clients with a superior product. GNA has
quickly become an integral part of our new client acquisition strategy. Also in November 2003, Watt announced the launch of Studio Watt, a niche-focused agency devoted to
serving the distinct needs of style-based specialty and boutique labels throughout North America. In January 2004, Watt announced the launch of ODIN, a web based software system that manages
every stage of the design process in real-time, from concept development and package design to
printing, packaging and getting the product to market. With anytime, anywhere access, ODIN
provides Watt clients the ability to efficiently track and manage their projects, and know
instantly if there are any project deviations, timeline extensions, or delays from suppliers. The
efficiency gained through ODIN offers a significant competitive advantage for Watt and its clients,
and which management believes will ensure at least a 20 percent increase in speed-to-market. Pursue strategic
acquisitions.

Our historical growth has been achieved partially by way of strategic acquisition. We have used
this strategic acquisition strategy to extend Envoys geographic reach and breadth of service
offering and to add a significant degree of diversification to our business model. During fiscal 2004 through two public offerings Envoy raised gross proceeds of $66.4 million and
net proceeds of $60.1 million. During the second quarter, we successfully negotiated with our
lenders and retired substantially all outstanding loan indebtedness. Management believes the offering will enable Envoy to achieve two important goals. In addition to
allowing Envoy to eliminate its debt, the size of this offering will permit Envoy to engage in a
meaningful M&A program. On November 10, 2004, Envoy, through its subsidiary ECG Holdings UK Limited (ECGH), agreed to
acquire 65% of the outstanding shares of Parker Williams Design Limited (Parker Williams), a
packaging design and brand specialist company based in London, United Kingdom. Both companies
believe the combined expertise and focus within the retail arena will provide exciting new
opportunities across both Europe and North America. Industry Overview Consumer and Retail Branding In all areas of marketing and product design, we believe that companies are looking to extend their
customer relationships and influence consumer behavior. Consumer and retail branding services
encompass the entire customer experience, from product packaging to the retail environment, and are
a key component of a companys marketing communications strategy. 9




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The consumer and retail branding services sector is rapidly evolving into a global marketplace, as
companies are increasingly looking for expertise in the development and maintenance of their brands
on a global basis. Companies are looking to firms that can deliver a consistent message to
consumers through packaging and retail design, regardless of geography. Retail is the second largest industry in the U.S. and one of the largest industries worldwide.
Unlike other, more volatile sectors, the retail industry continues to grow at a steady rate,
particularly as developing countries achieve greater economic stability. This reality, coupled with Watts lengthy history of success and innovation in the retail industry,
presents Envoy with a spectrum of opportunities  from overall brand strategy to store design to
private label program development  with key customers like grocers, mass merchants, pharmacies and
home improvement companies. Envoy has made a series of announcements subsequent to the 2003 fiscal
year-end that highlight the significant opportunities we are pursuing. In November 2003, Watt announced the launch of Gilchrist North America (GNA), a state-of-the-art
reprographics and brand management business, with locations in Toronto, Bentonville and Boston.
GNA will leverage highly experienced work forece and sophisticated equipment of Gilchrist UK,
Watts UK based brand management company, to provide its clients with a superior product. GNA has
quickly become an integral part of Envoys new client acquisition strategy. Also in November 2003, Watt announced the launch of Studio Watt, a niche-focused agency devoted to
serving the distinct needs of style-based specialty and boutique labels throughout North America. In January 2004, Watt announced the launch of ODIN, a web based software system that manages
every stage of the design process in real-time, from concept development and package design to
printing, packaging and getting the product to market. With anytime, anywhere access, ODIN
provides Watt clients the ability to efficiently track and manage their projects, and know
instantly if there are any project deviations, timeline extensions, or delays from suppliers. The
efficiency gained ODIN offers a significant competitive advantage for Watt and its clients, and
ensures at least a 20 cent increase in speed-to-market. In December 2004, Envoy announced that it has been selected by Carulla Vivero S.A. to re-define its
private label program. Carulla Vivero is the second largest retailer in Colombia, operating a chain
of 154 supermarkets, hypermarkets and discount stores throughout the country. The two companies
partnered in 2003 to re-position and design Vivero, the retailers hypermarket banner, and Watt
continues to help roll out the new concept in various locations. In August 2004, Watt and Carulla
Vivero broadened their relationship re-designing the latters supermarket chain, Carulla. This
latest initiative will ensure continuity of the Carulla Vivero brand across all banners: Carulla,
Vivero, Frescampo, Surtimax and Merquefacil. Advertising Market In this environment we are seeing a shift in the market with larger clients tapping into the
creative and strategic resources of smaller, more entrepreneurial shops where clients work directly
with the firms senior management. Not only are large Canadian clients assigning work to Canadian
boutiques, but US clients are also looking north of the border for a full range of agency services Government Regulations The marketing communications industry is subject to extensive government regulation, both domestic
and foreign, with respect to the truth in and fairness of advertising. There are also a number of
US federal and state laws and regulations directed at the advertising and marketing of specific
products, such as food and drug products. In addition, there has been an increasing tendency on
the part of businesses to resort to the judicial system, as well as industry self-regulatory
procedures, to challenge comparative advertising of their competitors on the grounds that the
advertising is false and deceptive. There can be no assurance Envoy will not be subject to claims
against it or Envoys clients by other companies or governmental agencies or that such claims,
regardless of merit, would not have a material adverse effect on Envoys future operating
performance. 10




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C. Organizational Structure Envoy has operations in the United States, the United Kingdom, Continental Europe and Canada.
Significant subsidiaries are as follows: Company
    
    %of Ownership
    
    Jurisdiction of IncorporationWatt International Inc.
    
    100
    
    OntarioWatt Gilchrist Limited
    
    100
    
    United KingdomJohn Street Inc.
    
    100
    
    Ontario
 D. Property, Plants and Equipment We currently operate offices in the following cities: Toronto, Canada, London, UK, Leeds, UK, San
Francisco, USA, Strassbourg, France, and Bentonville, USA. The terms of our principal leases are
as follows: Envoys principal executive offices consist of a four-story office building of approximately 20,000
square foot located at 172 John Street, Toronto, Ontario. In addition to Envoy, Watt IDG, a
division of Watt International, and John Street Inc. are also located at these premises. These
premises have been leased pursuant to a lease with a term that commenced on July 1, 1999 and
expires in June 2009 at a current annual rent of $177,000 Cdn. with rent increases each year of the
lease term. In connection with the lease negotiation, the landlord advanced to Envoy $750,000 Cdn.
as a loan, with an interest rate of 3.5% per annum to be repaid over 10 years. The leasehold
improvements involved modernization of the facilities and other modifications expected to benefit
both Envoy and the landlord. The principal balance of this loan at September 30, 2004 was
$406,000Cdn. Until January 2003, Envoys principal executive offices consisted of a five-story office building
of approximately 35,000 square feet located at 26-28 Duncan Street, Toronto, Ontario, Canada. In
January 2003, Envoy exited the Duncan Street facility after negotiating a release of the term of
the lease extension. Envoy had no further obligation to the landlord beyond February 1, 2003. In October 2002 Envoy sold the assets of Devlin to management of the subsidiary. The new company
formed to acquire Devlin has been assigned all future obligations for all leases formerly held by
Devlin. During fiscal 2004, Envoy negotiated to payoff all amounts owing with respect to the Hampel lease.
In 2003 when the Hampel business was closed down, Envoy negotiated a settlement with the landlord
agreeing to make 22 monthly payments of $33,316 (U.S) commencing on March 1, 2003, and a final
payment of $150,000.00 (U.S.) in February 2005. The payments were secured by a letter of credit
in the amount of $250,000 (U.S.) in favour of the landlord. During 2002 Envoy negotiated the exit
of approximately 18,000 square feet of office space located on the 12th floor of 111
Fifth Avenue, New York, New York. Under the terms of the lease settlement agreement Envoy agreed
to pay the landlord on September 30, 2002 $500,000 (U.S.) cash, issued 250,000 common shares of
Envoy at a price of $.50 (U.S.) per share and agreed to make 22 additional monthly payments of
$36,638 (U.S.) commencing October 1, 2002. The payments were secured by a letter of credit in the
amount of $250,000 (U.S.) in favour of the landlord. The total expense relating to the
12th floor termination agreement has been reflected as restructuring costs in fiscal
2002. The offices of Envoys wholly owned subsidiary, Watt International, consist of an office building
of approximately 26,600 square feet located at 300 Bayview, Toronto, Ontario, Canada. The premises
are leased pursuant to a lease with a current annual rent of $243,318 Cdn. that expires in March
2010. The offices of Envoys wholly-owned subsidiary, Gilchrist, consist of an industrial building of
approximately 72,000 square feet located on Ring Road, West Park, Leeds, West Yorkshire, England.
The premises are leased pursuant to a lease with a current annual rent of £150,000, which expires
in October 2006. Gilchrist has additional office space of approximately 950 square feet located at
12 Great Newport Street, London, England. The premises are leased pursuant to a lease with a
current annual rent of £57,000, which expires in August 2005. 11




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Item 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS The following discussion should be read in conjunction with, and is qualified in its entirety by,
the financial statements of Envoy and notes relating thereto included elsewhere in this Form 20-F.
The information contained in this Item# 5 refers to financial statements of Envoy, which are
presented in Canadian dollars and are prepared in accordance with Canadian GAAP. Canadian GAAP
differs in certain significant respects from U.S. GAAP. Reconciliation to U.S. GAAP is set forth
in Note 24 to the Notes to the audited Financial Statements of Envoy. Historical results of
operations, percentage relationships and any trends that may be inferred therefrom are not
necessarily indicative of the operating results of any future period. The following discussion contains forward-looking statements that are subject to significant risks
and uncertainties. There are a number of important factors that could cause actual results to
differ materially from historical results and percentages and results anticipated by the
forward-looking statements contained in the following discussion. Statements in this Form 20-F
concerning Envoys outlook or future economic performance, anticipated profitability, revenues,
commissions and fees, expenses or other financial items and statements made with respect to any
future events, conditions, performance or other matters are forward looking statements as that
term is defined under the U.S. federal securities laws. Forward-looking statements are subject to
risks, uncertainties, and other factors, which could cause actual results to differ materially from
those stated in such statements. Such risks, uncertainties and factors include, but are not
limited to, (i) the uncertain acceptance of the Internet and Envoys Internet and other technology,
(ii) there can be no assurance that Envoy will continue to be able to grow profitably or manage its
growth, (iii) risks associated with acquisitions, (iv) risks associated with competition, (v) that
Envoys quarterly operating results have fluctuated in the past and are expected to fluctuate in
the future, and (vi) that the loss of services of certain key individuals could have a material
adverse effect on Envoys business, financial condition or operating results. Overview Net Revenue.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 representing only fees billed and collected in advance of such fees being
earned; and(ii)
    the reimbursable pass-through costs which are included in unbilled accounts receivable.(iii)
    the amount collected in excess of pass-through costs incurred; and(iv)
    work in process represents costs incurred on projects for which revenue has not yet been
recognized for accounting purposes. 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. 12




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Operating Expenses.Salaries and benefits, general and administrative expenses and occupancy costs
represent our operating expenses. Salaries and benefits expenses include salaries, employee
benefits, incentive compensation, contract labour and other payroll related costs, which are
expensed as incurred. General and administrative costs include business development, office costs,
technology, professional services and foreign exchange. Occupancy costs represent the costs of
leasing and maintaining company premises. Tax Matters.With respect to Envoys 2004 fiscal year, Envoy had tax loss carry forwards
sufficient to cover its Canadian income tax liabilities and has approximately $18.0$ million in
loss carry forwards. Details on income taxes are set forth in Note 14 to the Notes to the audited
consolidated Financial Statements of Envoy. A. Operating Results OVERVIEW Through a public offering, on February 20, 2004, Envoy issued 26,315,800 units (the First Units)
at $1.33 per First Unit, each First Unit consisting of one common share and one-half of one
transferable common share purchase warrant. Each whole warrant entitles the holder to purchase one
common share at a price of $1.80 per common share for a period ending February 20, 2009. On March
3, 2004, pursuant to the exercise of the over-allotment option issued in connection with our
offering of units, we issued an additional 3,947,370 First Units. The total number of First Units
issued to the public was 30,263,170, with total gross proceeds of approximately $40.2 million.
During the second quarter, we successfully negotiated with our lenders and retired substantially
all outstanding loan indebtedness. The balance of the funds will be used for general corporate
purposes and potential acquisition and investment opportunities. Through a public offering, on May 12, 2004, Envoy issued 25,000,000 units (the Second Units) at
$1.05 per Second Unit, each Second Unit consisting of one common share and one-half of one
transferable common share purchase warrant. Each whole warrant entitles the holder to purchase one
common share at a price of $1.80 per common share for a period ending February 20, 2009. The total
gross proceeds from the offering was $26.2 million. The net proceeds of the Second Unit offering
will be used for general corporate purposes and potential acquisition and investment opportunities
that we determine have potential to create value for our shareholders and that either complement,
or provide an opportunity to diversify our current business. Net proceeds after deducting expenses from the two public offerings described above were
approximately $60.1 million. During fiscal 2004, pursuant to a normal course issuer bid, Envoy repurchased and cancelled
1,372,200 common shares for cash consideration of $816,549. Under the terms of the normal course
issuer bid, Envoy may repurchase and cancel up to 10% of the public float of the shares over the 12
month period commencing August 26, 2004. Subsequent to the year-end, Envoy has purchased for
cancellation an additional 4,543,682 common shares of Envoy, which is equivalent to 908,736 common
shares after giving effect to the share consolidation (reverse split) described in Note 23(b). At a meeting held on August 14, 2003, the Envoys shareholders approved the consolidation of the
common shares on the basis to be determined by Envoys board of directors (not to exceed a ratio of
1 for 10). On January 15, 2005, the Envoys board of directors approved the consolidation of the
common shares on the basis of 1 for 5. On January 21, 2005 Envoy filed Articles of Amendment
consolidating its common shares on the basis of 1 new common share for every 5 common shares
currently outstanding. The number of Envoy common shares outstanding prior to consolidation was
112,539,318 and post consolidation was approximately 22,507,864. Outstanding common shares and
earnings per share figures for all periods presented have been adjusted to give effect to the share
consolidation. The effective date for the post-consolidation trading of the common shares on the
Toronto Stock Exchange and the NASDAQ Stock Market was February 10, 2005. On November 10, 2004, Envoy, through its subsidiary ECG Holdings UK Limited (ECGH), agreed to
acquire 65% of the outstanding shares of Parker Williams Design Limited (Parker Williams), a
packaging design and brand specialist company based in London, United Kingdom. The purchase price
of £1,818,000 is payable in cash on completion. The remaining 35% of the Parker Williams shares the
Management Shares will continue to be held by senior management of Parker Williams (Management
Shareholders), subject to certain options described below. ECGH will have the option to acquire
from the Management Shareholders and the Management Shareholders will have the option to require
ECGH to purchase from them, at various stages over a period of 4 years following completion, the
Management Shares for a purchase price based on the profitability of Parker Williams for certain
defined periods following completion. The transaction is expected to be completed by February 21,
2005. The acquisition will be accounted for using the purchase method of accounting. Parker
Williams, whose clients include: Sainsburys Supermarkets and Coop Norden, are specialists in the
retail area. Parker Williams was formed in 1990 by designers Tamara Williams and Tony Parker. With
over 25 years design experience in Europe, America and the Far East, Parker Williams has revenues
of approximately $5.0 million annually. Both companies 13




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believe the combined expertise and focus within the retail arena will provide exciting new
opportunities across both Europe and North America. During fiscal 2003, Envoy divested its technology services to remain focused on the expansion and
prosperity of its core business of consumer and retail branding. The Watt group of companies
(Watt), our branding business, has proven successful at creating and executing private label
programs and landmark store design, making Envoy a world authority in brand strategy and design for
the retail sector. Effective January 1, 2004, Envoy decided to sell all the shares of its corporate event and
corporate travel business, Communique Incentives Inc. (Communique), after conducting a review of
its ongoing viability, future prospects and cash requirements. This business was sold for a
nominal consideration. Prior to its sale, Communique was reported as part of Canadian net revenue
in the marketing segment. As discussed in Note 22, the net revenue from this company was $0.4
million in fiscal 2004 and $1.6 million in fiscal 2003. Net earnings, excluding the loss on sale
of Communique were less than $0.1 million for fiscal 2004 and 2003. During the 2nd quarter of fiscal 2003, Envoy decided to discontinue the operations of our New York
advertising agency, Hampel Stefanides Inc. (Hampel, or the New York Agency) after conducting a
review, in conjunction with Envoys banks, of the ongoing viability, future prospects, cash needs
and local debt situation of this company. We also successfully terminated the real-estate lease
commitments associated with our New York Agency. The cost associated with this termination of the
real estate has been fully expensed in the Financial Statements. Following the liquidation of the
assets, the shares of Hampel were sold for a nominal consideration. In the first quarter of fiscal
2003, the assets of our technology company Devlin Multimedia Inc. (Devlin) were sold, and our
other technology company, Sage Information Consultants Inc. (Sage), was shut down. Envoys 2004 results compared to the previous year reflect managements continued execution of the
fiscal 2002 restructuring plan to more closely align costs with projected revenue, to divest of
non-core assets, to reduce bank indebtedness and to focus resources on our consumer and retail
branding businesses. Our salaries increased to $27.7 million from $26.9 million or 3.0% from the previous year. As we
stated in the third quarter, our goal was to improve our labour to net revenue ratio to 66% for the
full fiscal 2004 year. Our labour to net revenue ratio was 72.6% for the 4th quarter and was 67.8%
for fiscal 2004. We expect our labour to net revenue ratio for fiscal 2005 to be about 70.0%. Our occupancy costs have decreased to $3.0 million from $3.1 million or 1.6% from the previous
year. As we stated in the third quarter of fiscal 2004, we estimated that our occupancy to net
revenue ratio would be 6.8% for the full fiscal 2004. We achieved an occupancy to net revenue
ratio of 7.4% for the full fiscal 2004. We expect our occupancy to net revenue ratio to continue
to be in the 7.4% range in fiscal 2005. As a result of the early repayment in fiscal 2004 of the outstanding debentures, and the conversion
of the remaining convertible debentures, Envoy was required to expense the unamortized value of the
warrants and the conversion value of the convertibles. As a result, the accreted interest imputed
on warrants and debentures in fiscal 2004 increased by $1.8 million from fiscal 2003. Envoy has no
expected future requirement for debt financing, and so the accreted interest for fiscal 2005 is
expected to be $nil. Management continues to focus on our core strength, consumer and retail branding. In fiscal 2004,
Watt represented 91% of our business. In the third quarter of fiscal 2003, Watt signed new client
contracts valued at more than $12.0 million over a three to four year period. This new business
will continue to positively impact our revenue in fiscal 2005. Net revenue for the year ended September 30, 2004 was $40.8 million. At June 30, 2004 we had
estimated that our net revenue for the 4th quarter would be consistent with our 4th quarter of
fiscal 2003, in the range of $10.3 million. The actual net revenue for the 4th quarter was $10.1
million. Net revenue in the second half of fiscal 2004 increased 7.9% over the net revenue in the
first half of fiscal 2004, and increased 2.7% compared to the same period of fiscal 2003. We
expect net revenue to improve by about 16% in fiscal 2005 from fiscal 2004. As a result of the operational changes and financial changes discussed above, management believes
the business will continue to show improved earnings and a strengthened balance sheet. Consistent
with prior years, we expect the second half of fiscal 2005 to be stronger than the first half of
fiscal 2005, reflecting the seasonal patterns in our business. 14




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SELECTED ANNUAL INFORMATION Fiscal 2004

    
    Fiscal 2003

    
    Fiscal 2002Net revenue
    
    $
    40.8
    million
    
    $
    40.9
    million
    
    $
    56.9
    millionNet earnings (loss):From continuing operations
    
    ($
    2.6
    ) million
    
    $

    2.5
    million
    
    ($
    53.4
    ) millionIncluding discontinued operations
    
    ($
    3.1
    ) million
    
    $
    2.5
    million
    
    ($
    53.4
    ) millionNet earnings (loss) per shareFrom continuing operationsBasic
    
    $
    (0.15
    )
    
    $
    0.58
    
    
    $
    (12.71
    )Diluted
    
    $
    (0.15
    )
    
    $
    0.43
    
    
    $
    (12.71
    )Including discontinued operationsBasic
    
    $
    (0.18
    )
    
    $
    0.59
    
    
    $
    (12.71
    )Diluted
    
    $
    (0.18
    )
    
    $
    0.43
    
    
    $
    (12.71
    )
 As at:
    
    Sep 30, 2004

    
    Sep 30, 2003

    
    Sep 30, 2002Total assets
    
    $
    88.9
    million
    
    $
    38.0
    million
    
    $
    49.2
    millionTotal long-term financial liabilities
    
    $
    0.4
    million
    
    $
    4.9
    million
    
    $
    4.2
    millionCash dividends declared
    
    $
    nil
    
    
    $
    nil
    
    
    $
    nil
 RESULTS OF OPERATIONS Fiscal Year Ended September 30, 2004 compared to Fiscal Year Ended September 30, 2003 Net revenueOur net revenue represents our compensation for services. A portion of our
compensation from agency or advertising and marketing services is generated from non-refundable
monthly agency fees and the balance is from commissions. Our compensation from non-agency or
project related services is primarily generated from project fees and hourly charges. Net
revenue is net of any pass-through costs such as media and production costs incurred on behalf of
clients in acting as agent for them. Net revenue for the twelve months ended September 30, 2004 was $40.8 million, compared to $40.9
million for the twelve months ended September 30, 2003, a decrease of $0.1 million. For fiscal
2005, we expect net revenue of between $50 and $53 million, including the Parker Williams
acquisition. Revenue Mix by type of service and by client location: Net Revenue (in millions)2004

    
    % of total

    

    2003

    
    % of totalBy Type of ServiceMarketing
    
    $
    3.8
    
    
    9
    %

    
    $
    6.3
    
    
    15
    %Consumer and retail branding
    
    
    37.0
    
    
    91
    %
    
    
    34.3
    
    
    84
    %Technology
    
    
    nil
    
    
    nil
    
    
    
    0.3
    
    
    1
    %$
    40.8
    
    
    100.0
    %
    
    $
    40.9
    
    
    100.0
    %
 2004
    
    % of total
    
    
    2003
    
    % of totalBy Client LocationCanada
    
    $
    5.6
    
    
    14
    %
    
    $
    5.4
    
    
    13
    %United States
    
    
    14.5
    
    
    35
    %
    
    
    18.2
    
    
    45
    %Europe *
    
    
    20.7
    
    
    51
    %

    
    
    17.3

    
    
    42
    %$
    40.8
    
    
    100.0
    %
    
    $

    40.9
    
    
    100.0
    %
   * Europe includes the United Kingdom and Continental Europe Net revenue by type of service: 15




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Approximately $0.3 million of the decrease in revenue in fiscal 2004 compared to fiscal 2003 is
related to our exit from our technology business. In the first quarter of fiscal 2003, the assets
of Devlin were sold and Sage was shut down. Net revenue from marketing has decreased by approximately $2.5 million. After a lengthy review of
all options available to us, Envoy closed its New York Agency in February 2003 (see Note 15 to the
Financial Statements). The $3.1 million decrease in net revenue from the closure of our New York
Agency was offset in part by growth in our Canadian advertising agency, which increased by $0.7
million. Net revenue from consumer and retail branding services increased approximately $2.7 million, or
7.7%. There have been significant new business wins over the second half of fiscal 2004 which has
contributed to the improvement in net revenue. Revenue from these sources should continue to
improve in the coming year. Net revenue by customer location: Net revenue from Canada increased approximately $0.2 million, from $5.4 million in fiscal 2003 to
$5.6 million in fiscal 2004, an increase of 4.5%. Net revenue from the US has decreased
approximately $3.7 million, a decrease of 20.3%. Approximately $3.1 of the decline is due to the
closure of our New York Agency. The remainder of the decline is due to reductions in business with
other US customers in our ongoing operations. Net revenue from Europe in our consumer retail
branding has increased approximately $3.4 million during fiscal 2004, an increase of 20.0%. We
expect continued growth and improvement from Europe in fiscal 2005. Our three largest clients in fiscal 2004 accounted for 63% of our net revenue for fiscal 2004,
compared to 54% of our net revenue in fiscal 2003. In fiscal 2004, one client accounted for 37% of
our net revenue compared to fiscal 2003 when one client accounted for 26% of net revenue. Operating ExpensesSalaries and benefits, general and administrative expenses and occupancy costs
represent our operating expenses. Salaries and benefits expenses include salaries, employee
benefits, incentive compensation, contract labour and other payroll related costs, which are
expensed as incurred. General and administrative costs include business development, office costs,
technology, professional services and foreign exchange. Occupancy costs represent the costs of
leasing and maintaining company premises. Operating expenses increased by 5% to $37.7 million for fiscal 2004 from $35.8 million in fiscal
2003. The primary reasons for the increase in operating expenses, were an increase in salaries and
benefits of $0.8 million and an increase in general and administrative expenses of $1.2 million
from fiscal 2003. Occupancy costs decreased $0.1 million in fiscal 2004. Salaries and benefits expenses for fiscal 2004 were $27.7 million, compared to $26.9 million for
fiscal 2003, an increase of $0.8 million or 3%. We continue to closely monitor salaries and
benefits to ensure that our expected revenue matches our labour costs. General and administrative expenses for fiscal 2004 were $7.0 million, compared to $5.8 million for
the previous year. This represents an increase of $1.2 million, or 20%. Excluding the $0.1 million
foreign exchange gain in fiscal 2003 and the $0.4 million foreign exchange expense in fiscal 2004,
general and administrative expenses increased $0.7 million in fiscal 2004. Occupancy costs for fiscal 2004 were $3.0 million, compared to $3.1 million for fiscal 2003, a
decrease of 1.6%. We expect our annual occupancy expense going forward to be approximately $2.8
million as we continue to monitor these expenses. Depreciation expenseDepreciation expense for fiscal 2004 and fiscal 2003 was $2.4 million. Interest expenseInterest expense is made up of interest expense and financing costs due to holders
of the outstanding debt of the company, and non-cash accreted interest imputed on warrants and
debentures. The non-cash accreted interest arose as a result of the amortization of the value
assigned to the warrants granted to the debentures issued in fiscal 2004, and the value assigned to
the conversion option of the convertible debentures issued in fiscal 2002 and 2003. The interest
expense and financing costs for fiscal 2004 was $1.0 million, compared to $2.0 million for fiscal
2003. As detailed in Notes 8, 9 and 10, the Company had obtained debt financing to meet the
ongoing cash requirements of the business. The debt was repaid from the proceeds of the public
offering detailed in Note 11(b), As a result of the early repayment of the debentures, and the
conversion of the remaining convertible debentures, the unamortized warrant value and unamortized
conversion value was charged to accreted interest in fiscal 2004. 16




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Details of interest
expense and accreted interest imputed on warrants and
debentures

During the first quarter of fiscal 2004, we borrowed the amount of $4.5 million, of which $4.0
million was raised by way of secured debentures and $0.5 million by way of unsecured term notes.
As a condition of these loans, share purchase warrants to purchase 2,250,000 of our common shares
were transferred to the holders of the secured debentures and the unsecured term notes. In
addition, 50,000 warrants were transferred to the holder of the $0.5 million promissory note in
exchange for the renegotiation of the terms of the note. These 2,300,000 warrants were previously
issued to our bankers and were released by the bankers upon the condition that we raise additional
funds to further reduce our bank indebtedness. We used the Black-Scholes option pricing model to arrive at a value for the warrants based on an
analysis of the warrant exercise price, time to expiry and the volatility of our common share
price. The value assigned to the warrants is amortized over the life of the loan and a
corresponding periodic charge is made to interest expense. During the second quarter of fiscal
2004, the loans made by the holders of the warrants were repaid by Envoy and the remaining
unamortized value of $2.3 million assigned to the warrants, has been charged to accreted interest
imputed on warrants and debentures. Included in interest expense and financing costs is a charge
of $0.4 million paid to the holders of the secured debentures for the early repayment of their
loans. Investment earningsInvestment earnings for fiscal 2004 was $0.4 million, compared to $nil for
fiscal 2003. Investment earnings are the income earned on the amounts invested in cash and cash
equivalents. We expect investment earnings of $1.5 million for fiscal 2005. Loss from discontinued operationsAs detailed in Note 22 of the consolidated financial statements,
Envoy sold its shares of Communique effective January 1st, 2004. The loss of $0.5
million for fiscal 2004 reflects the loss realized as a result of the sale, compared to income of
less than $0.1 million for fiscal 2003, earned by Communique during that period. Gain on Closure of SubsidiariesDuring the 2nd quarter of fiscal 2003, Envoy decided to
discontinue the operations of Hampel after conducting a review, in conjunction with Envoys banks,
of the ongoing viability, future prospects, cash needs and local debt situation of Hampel. As
Envoys banks held a first charge on the assets of Hampel, the net proceeds from the liquidation of
those assets were applied in reduction of Envoys debt obligations to the banks. Consequently,
there was not sufficient proceeds from the liquidation to make any payment to the unsecured
creditors of Hampel. Following the liquidation of the assets, the shares of Hampel were sold for a
nominal consideration. As Envoy has no obligation to pay the creditors of Hampel, the consolidated
accounts of Envoy reflect a gain on the shut-down of Hampel. We also successfully terminated the
real-estate lease commitments associated with Hampel. The cost associated with the termination of
this lease commitment has been fully expensed in the Financial Statements. Further details are
provided in Note 15 to the Financial Statements. In the first quarter of fiscal 2003, we ended our
technology operations by disposing of Devlin and shutting down Sage. As a result of the above, we experienced a gain on closure of subsidiaries of $2.5 million in
fiscal 2003. Income taxesIn 2004, our effective income tax rate, as a percentage of income before income
taxes, goodwill amortization and write-down and discontinued operations, was 6.0% compared to the
2003 rate of 8.7%. Details are provided in Note 2(g) and Note 14 to the Financial Statements. GoodwillIn accordance with the accounting standards outlined in sections 1581 and 3062 of the
CICA Handbook, goodwill is no longer amortized, but is tested at least annually for impairment. As
a result, there was no amortization of goodwill during fiscal 2004 or 2003. At September 30, 2004,
Envoy performed an impairment test on the Goodwill and determined that no write-down was required. Net earnings (loss)Envoy experienced a net loss of ($3.1) million in fiscal 2004, compared to
net earnings of $2.5 million in fiscal 2003. We expect net earnings of between $4.7 and $5.2
million for fiscal 2005, after considering the impact of the items discussed above, including the
results of Parker Williams. 17




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##### 



ANALYSIS OF USE OF PROCEEDS FROM PUBLIC OFFERING Through public offerings in fiscal 2004, Envoy raised $66.5 million gross proceeds ($60.1 million
of net proceeds). In the short form prospectus issued with the public offerings, Envoy indicated
that the net proceeds of the offering would be used for general corporate purposes and potential
acquisition and investment opportunities that it determined have the potential to create value for
Envoy shareholders, and that either complement or provide an opportunity to diversify the current
business of Envoy. Envoy retained broad discretion in allocating the net proceeds of the public
offering. Fiscal 2004
    
    
    Fiscal 2003
    
    
    Fiscal 2002(in millions)
    
    
    (in millions)
    
    
    (in millions)Net proceeds from public offering
    
    $
    60.1
    
    
    $
    nil
    
    
    $
    nilNet proceeds were used to:Repay short-term debt
    
    
    6.9
    
    
    
Nil
    
    
    
    nilRedeem outstanding shares
    
    
    0.8
    
    
    
Nil
    
    
    
    nilRepay long term debt
    
    
    5.2
    
    
    
Nil
    
    
    
    nilAllocated to investment portfolio
    
    
    46.7
    
    
    
Nil
    
    
    
    nilOther working capital changes
    
    
    0.5
    
    
    
Nil
    
    
    
    nilTotal use of proceeds
    
    $
    60.1
    
    
    $
    nil
    
    
    $
    nil
 As a result of repaying the outstanding debt, Envoy has established financial flexibility and is
able to take advantage of acquisition opportunities as they are identified. SUMMARY OF QUARTERLY RESULTS Fiscal 2004
    
    Q4 2004

    
    Q3 2004

    
    Q2 2004
    
    Q1 2004Net revenue
    
    $
    10.1
    million
    
    $
    11.1
    million
    
    $
    10.6
    million
    
    $
    9.0
    millionNet earnings (loss):From continuing operations
    
    ($
    0.3
    ) million
    
    $
    1.2
    million
    
    ($
    3.1
    ) million
    
    ($
    0.5
    ) millionIncluding discontinued operations
    
    ($
    0.3
    ) million
    
    $
    1.2
    million
    
    ($
    3.6
    ) million
    
    ($
    0.5
    ) millionNet earnings (loss) per shareFrom continuing operationsBasic
    
    ($
    0.01
    )
    
    $
    0.06
    
    
    ($
    0.26
    )
    
    ($
    0.06
    )Diluted
    
    ($
    0.01
    )
    
    $
    0.06
    
    
    ($
    0.26
    )
    
    ($
    0.06
    )Including discontinued operationsBasic
    
    ($
    0.01
    )
    
    $
    0.06
    
    
    ($
    0.30
    )
    
    ($
    0.06
    )Diluted
    
    ($
    0.01
    )
    
    $
    0.06
    
    
    ($
    0.30
    )
    
    ($
    0.06
    )
 Fiscal 2003

    

    Q4 2003

    
    Q3 2003

    
    Q2 2003

    
    Q1 2003Net revenue

    $
    10.3
    million
    
    $
    10.4
    million
    
    $
    8.7
    million
    
    $
    11.5
    millionNet earnings (loss):From continuing operations

    $
    0.8
    million
    
    $
    1.0
    million
    
    $
    1.4
    million
    
    ($
    0.6
    ) millionIncluding discontinued operations

    $
    0.8
    million
    
    $
    1.0
    million
    
    $
    1.4
    million
    
    ($
    0.6
    ) millionNet earnings (loss) per shareFrom continuing operationsBasic

    $
    0.17
    
    
    $
    0.23
    
    
    $
    0.30
    
    
    ($
    0.13
    )Diluted

    $
    0.09
    
    
    $
    0.16
    
    
    $
    0.29
    
    
    ($
    0.13
    )Including discontinued operationsBasic

    $
    0.15
    
    
    $
    0.25
    
    
    $
    0.35
    
    
    ($
    0.15
    )Diluted

    $
    0.10
    
    
    $
    0.15
    
    
    $
    0.30
    
    
    ($
    0.15
    )
 18




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##### 



Net revenue:Net revenue for the three months ended September 30, 2004 was $10.1 million, compared
to $10.3 million for the three months ended September 30, 2003. This represents a decrease of $0.2
million or 1.8%. Operating expenses:Operating expenses for the three months ended September 30, 2004 were $10.2
million, compared to $8.2 million for the three months ended September 30, 2003. This represents an
increase of $2.0 million or 24.7%. Salaries expense increased by $1.0 million, occupancy expense by
$0.3 million and general and administrative expense by $0.7 million compared to the three months
ended September 30, 2003. Excluding the effect of foreign exchange, general and administrative
expense, increased by $0.3 million, or 19.7% compared to the same period in fiscal 2003. Net earnings (loss):As a result of the foregoing factors, Envoy had a net loss of ($0.3) million
for the three months ended September 30, 2004, compared to net earnings of $0.8 million for the
three months ended September 30, 2003. Share Consolidation (Reverse stock split)On April 1, 2004, we received written notification from
The Nasdaq SmallCap Market (NASDAQ) that our common shares had closed below the minimum US$1.00
per share requirement for continued listing under NASDAQ Marketplace Rule 4310(c)(4) (the Rule).
Consequently, we were provided 180 calendar days, or until September 28, 2004, to regain
compliance. Since we did not regain compliance with the Rule by September 28, 2004, but otherwise
met NASDAQs initial listing criteria, NASDAQ notified us that we had been granted an additional
180 calendar day compliance period. If we have not regained compliance within the second 180 day
compliance period, but otherwise satisfy the initial listing criteria, we may be afforded an
additional compliance period, up to our next shareholder meeting, provided we commit to NASDAQ to
seek shareholder approval for a consolidation (reverse split) of our common shares at or before our
next shareholder meeting and promptly thereafter effect the consolidation (reverse split). If we do
not regain compliance with the Rule and are not eligible for an additional compliance period,
NASDAQ will provide notification that our common shares will be delisted. At a special meeting held on August 14, 2003, our shareholders passed a special resolution
authorizing a consolidation (reverse split) of the common shares on a basis to be determined by our
Board of Directors, such consolidation not to exceed one new common share for each ten common
shares issued and outstanding. On January 21, 2005, Envoy announced that its board of directors has
approved the filing of Articles of Amendment to consolidate its common shares on the basis of one
new common share for every five common shares currently outstanding. The share consolidation
(reverse stock split) affected all common shares, warrants and stock options of Envoy that were
currently outstanding. Any fractional shares resulting from this consolidation (reverse stock
split) will be adjusted to the nearest full common share. The number of Envoy common shares
outstanding prior to consolidation was 112,539,318 and post consolidation is expected to be
approximately 22,507,864. Envoys board of directors made the decision to effect the stock consolidation (reverse stock
split) immediately in order to allow Envoy sufficient time to comply with the Rule. The common
shares commenced trading on a consolidated basis on the Toronto Stock Exchange and the NASDAQ Stock
Market on February 10, 2005. Amendment to terms of
warrants

At a meeting held on June 25, 2004, the holders of the warrants (the First Warrantholders) issued
pursuant to the warrant indenture (the First Warrant Indenture) between Envoy and Computershare
Trust Company of Canada (Computershare) dated February 20, 2004, approved the replacement of the
warrant indenture (the Second Warrant Indenture) between Envoy and Computershare dated May 12,
2004 by the First Warrant Indenture as the instrument governing the terms of the warrants issued
pursuant to the Second Warrant Indenture. Increase in authorized
share capital
At a special meeting of shareholders Envoy held on January 8, 2004, the shareholders approved an
amendment to the Articles of Envoy to increase its authorized share capital from 50 million common
shares to 200 million common shares. At September 30, 2004, there were 117,083,000 common shares of Envoy issued, compared to 31,047,027
issued at September 30, 2003. Giving effect to the share consolidation (reverse stock split)
detailed above, the common shares issued at September 30, 2004 and at September 30, 2003 would be
23,416,600 and 6,209,405 respectively. Fiscal Year Ended September 30, 2003 compared to Fiscal Year Ended September 30, 2002 Net revenue for the twelve months ended September 30, 2003 was $40.9 million, compared to $56.9
million for the twelve months ended September 30, 2002, a decrease of $16.0 million or 28%. 19




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##### 



Revenue Mix by type of service and by client location: By Type of Service
    
    2003
    
    
    % of total
    
    
    2002
    
    
    % of totalMarketing
    
    $
    6.3
    
    
    
    15
    %
    
    $
    10.2
    
    
    
    18
    %Consumer and retail
branding
    
    
    34.3
    
    
    
    84
    %
    
    
    38.2
    
    
    
    67
    %Technology
    
    
    0.3
    
    
    
    1
    %
    
    
    8.5
    
    
    
    15
    %$
    40.9
    
    
    
    100
    %
    
    $
    56.9
    
    
    
    100
    %
 By Client Location
    
    2003
    
    
    % of total
    
    
    2002
    
    
    % of totalCanada
    
    $
    5.4
    
    
    
    13
    %
    
    $
    13.8
    
    
    
    24
    %United States
    
    
    18.2
    
    
    
    45
    %
    
    
    27.7
    
    
    
    49
    %Europe *
    
    
    17.3
    
    
    
    42
    %
    
    
    15.4
    
    
    
    27
    %$
    40.9
    
    
    
    100
    %
    
    $
    56.9
    
    
    
    100
    %
  * Europe includes the United Kingdom and Continental Europe Net revenue by type of service: Approximately $8.2 million of the decrease in revenue in fiscal 2003 compared to fiscal 2002 is
related to a decline in revenue from our technology business. In the first quarter of fiscal 2003,
the assets of our technology company, Devlin Multimedia Inc. (Devlin), were sold and our other
technology company, Sage Information Consultants Inc. (Sage), was shutdown. Net revenue from marketing has decreased by approximately $3.9 million. After a lengthy review of
all options available to us, Envoy closed its New York Agency in February 2003 (see Note 15 to the
Financial Statements). The $5.0 million decrease in net revenue from the closure of our New York
Agency was offset in part by growth in our Canadian advertising agency, which increased by $1.1
million. Net revenue from consumer and retail branding services decreased approximately $3.9
million, from $38.2 million to $34.3 million, a decline of 10%. Approximately $1.9 million of this
decrease relates to the closing of certain unprofitable parts of the design business during fiscal
2002, including our operations in Sweden, Boston and New York. Although net revenue in fiscal 2003
from our consumer and retail branding services are lower than last year, there have been
significant new business wins over the second half of fiscal 2003. We believe that the balance of
the decline in revenue is related primarily to the timing of customer branding programs. Therefore,
revenue from these sources should improve in the coming year. Net revenue by customer location: Net revenue from Canada decreased approximately $8.4 million, from $13.8 million in fiscal 2002 to
$5.4 million in fiscal 2003, a decline of 61%. Approximately, $8.2 million of that was due to the
restructuring of business in 2002, the shutdown of Sage and the sale of the assets of Devlin in
2003. Net revenue from the US has decreased approximately $9.5 million. Approximately $5.0 of
the decline is due to the closure of our New York Agency, the US revenue related to our shutdown of
Sage and the closure of the Boston and New York consumer and retail branding part of the business.
The remainder of the decline is due to reductions in business with other US customers in our
ongoing operations. Net revenue from Europe in our consumer retail branding has increased
approximately $1.8 million during fiscal 2003. We expect continued growth and improvement from
Europe in fiscal 2004. Our three largest clients in fiscal 2003 accounted for 54% of our net revenue for the current
period, while our three largest clients in fiscal 2002 accounted for 44% of our net revenue. In
fiscal 2003, one client accounted for 26% of our net revenue compared to fiscal 2002 when there
were no clients that accounted for more than 20% of net revenue. Operating ExpensesOperating expenses decreased by 40% to $35.8 million for fiscal 2003 from $59.5
million in fiscal 2002. Salaries and benefits expenses for fiscal 2003 were $26.9 million,
compared to $43.5 million for fiscal 2002, a decrease of $16.6 million or 38%. We continue to
closely monitor salaries and benefits to ensure that our expected revenue matches our labour costs. 20




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##### 



General and administrative expenses for fiscal 2003 were $5.9 million, compared to $11.4 million
for the previous year. This represents a decrease of $5.5 million, or 48%. Included in general and
administrative expenses for fiscal 2003 is a foreign exchange gain of $0.3 million. This gain
consists of a foreign exchange loss from operations of ($0.5) million and the recognition of
deferred foreign exchange gains of $0.8 million from the closure of our New York Agency, details of
which are provided in Note 15 to the Financial Statements. Excluding the foreign exchange gain
related to the closure of our New York Agency, general and administrative expenses declined by 42%.
This decline reflects the significant efforts we have been making to reduce expenses prudently and
to incur expenditures that will add revenue and improve efficiencies. In addition to the cost
cutting reductions in our ongoing business, our general and administrative expenses have decreased
as a result of the disposal of subsidiaries. Occupancy costs for fiscal 2003 were $3.1 million, compared to $4.6 million for fiscal 2002. This
decrease of $1.5 million is a result of the termination of office space obligations in both New
York and Toronto, our restructuring initiative in fiscal 2002, and the shutdown of our New York
Agency. We expect our annual occupancy expense going forward to be approximately $2.8 million as
the effect of our reductions impacts the full fiscal period. Depreciation expenseDepreciation expense for fiscal 2003 decreased to $2.4 from $2.8 million in
fiscal 2002, due to the closure of the subsidiaries discussed earlier. Interest expenseInterest charges for the year ended September 30, 2003 were $2.7 million,
compared to $1.2 million for the previous fiscal year. As described in Note 10 to the Financial
Statements, the increase in interest expense is due to a number of factors as indicated below. We issued $1.8 million of convertible debentures in April 2002, $2.0 million of convertible
debentures in September 2002 and $2.0 million of convertible debentures in April 2003. The
proceeds of the convertible debentures were used to help fund our restructuring costs and to pay
down our outstanding bank facility. The convertible debentures carry interest at the rate of 10%,
and an imputed, non-cash interest expense, details of which are explained in Note 9. During fiscal
2003, the imputed interest amounted to $0.7 million, compared to $0.1 million in fiscal 2002. We
also had expenses relating to our new credit facility of $0.5 million in fiscal 2003, compared to
$0.4 million in fiscal 2002. The interest rate of our bank facility increased from a blended rate
of approximately 3% in fiscal 2002 to 8% by the end of fiscal 2003. During fiscal 2003,
convertible debentures totaling $1.4 million were converted. Subsequent to the year-end all
outstanding convertible debentures were converted to common shares of Envoy. As a result of the above, we expect that our annual interest expense will decrease significantly by
approximately $1.5 million in fiscal 2004. Most of the decrease will be realized in the third and
fourth quarters of fiscal 2004. Unusual ItemDuring fiscal 2002, as a result of changes in the banking loan arrangements, Envoy was
no longer allowed to fully utilize its $40 million line of credit and repayment terms were
accelerated. Accordingly, the remaining unamortized portion of deferred financing charges,
totaling $0.8 million, was written off. In fiscal 2003, all charges on the credit facility were
expensed as part of interest expense and financing costs. RestructuringDuring fiscal 2002, management implemented a restructuring plan, downsizing its
workforce, exiting excess office space and writing off redundant capital assets. Accordingly,
Envoy recorded a restructuring expense of $10.9 million in fiscal 2002. The restructuring included
a reduction of 156 people, as well as the abandonment of 18,000 square feet of leased office space
in New York City and 35,000 square feet of leased office space in Toronto. The annual expense
savings in salaries, benefits and occupancy costs associated with the restructuring was
approximately $17.2 million. During fiscal 2003, a recovery of $0.3 million of restructuring costs
was recorded. Gain on Closure of SubsidiariesDuring the 2nd quarter of fiscal 2003, Envoy decided to discontinue
the operations of Hampel after conducting a review, in conjunction with Envoys banks, of the
ongoing viability, future prospects, cash needs and local debt situation of Hampel. As Envoys
banks held a first charge on the assets of Hampel, the net proceeds from the liquidation of those
assets were applied in reduction of Envoys debt obligations to the banks. Consequently, there were
not sufficient proceeds from the liquidation to make any payment to the unsecured creditors of
Hampel. Following the liquidation of the assets, the shares of Hampel were sold for nominal
consideration. As Envoy has no obligation to pay the creditors of Hampel, the consolidated
accounts of Envoy reflect a gain on the shutdown of Hampel. We also successfully terminated the
real-estate lease commitments associated with Hampel. The cost associated with the termination of
this real estate has been fully expensed in the Financial Statements. Further details are provided
in Note 15 to the Financial Statements. In the first quarter, we discontinued our technology
operations by disposing of Devlin, and shutting down Sage. As a result of the above, we experienced a gain on closure of subsidiaries of $2.5 million.
Further detail is provided in Note 16 to the Financial Statements. Also see Note 24 to the
Financial Statements for U.S. accounting. 21




---



##### 



Income taxesIn 2003, our effective income tax rate, as a percentage of pretax earnings before
goodwill write-down and amortization, was 8.7% compared to the 2002 recovery rate of (27.0%). The
difference relates primarily to Envoy having a pretax loss in fiscal 2002, compared to a pretax
profit in fiscal 2003. Details are provided in Note 2(g) and Note 14 to the Financial Statements. The major components of the 2003 income tax adjustments from the statutory rates were items that
were not taxable (or tax deductible) including the gain on disposal of subsidiaries, differences in
tax rates for income earned by subsidiaries in both the UK and USA, and an increase in the
valuation allowance in Canada. Envoy currently has recorded a substantial valuation allowance for losses generated in Canadian
companies that are not expected to be fully utilizable against future income. Canada does not have
a consolidated tax filing process like the USA, and as such, losses that exist must be applied only
against income of that company. Where the losses are not expected to be available to offset future
income, the full value of these losses have not been recorded. GoodwillIn accordance with the new accounting standards outlined in sections 1581 and 3062 of
the CICA Handbook, goodwill is no longer amortized, but is tested at least annually for impairment.
As a result, there was no amortization of goodwill during fiscal 2004 and 2003. At September 30,
2004, Envoy performed an impairment test on the Goodwill and determined that no write-down was
required. Transition rules in effect for fiscal 2002 had allowed for the amortization of goodwill
on businesses acquired before July 1, 2001. Goodwill amortized in fiscal 2002 was $2.2 million. During fiscal 2002, Envoy performed an assessment of the carrying values of goodwill recorded in
connection with its various businesses. The assessment was performed, because a number of factors
indicated that impairment had arisen. Accordingly, Envoy recorded a write-down of $37.9 million in
fiscal 2002, primarily related to the goodwill associated with the businesses of Sage, Promanad and
Hampel. See Note 7 to the Financial Statements. At September 30, 2003 and September 30 2004,
Envoy determined that no further charge for goodwill impairment was required. Net Earnings (loss)Envoy earned net earnings of $2.5 million in fiscal 2003, compared to a loss of
($53.4) million in fiscal 2002. Included in the loss for fiscal 2002 is a writedown of goodwill in
the amount of ($37.9) million, and an amortization of goodwill of ($2.2) million. The loss in
fiscal 2002 before the goodwill writedown and amortization was ($13.2) million.  B.
    Liquidity and Capital Resources In the first quarter of fiscal 2004, Envoy borrowed the amount of $4.5 million, of which $4.0
million was raised by way of secured debentures and $0.5 million by way of unsecured term notes.
The loans carried interest at the rate of 10% per annum, had a maturity date of October 31, 2006,
and carried warrants entitling the lenders to purchase, on or before April 24, 2008, one Envoy
common share for each $2.00 principal amount of the loan at a price of $0.15 per share. These
warrants were previously issued to Envoys bankers and were released to Envoy as part of its
commitment to the bankers to raise additional funds to further reduce its bank indebtedness. Envoy
used $3.8 million of the loan proceeds to pay down the bank debt. By February 2004, all of the
outstanding warrants had been exercised, resulting in the issuance of 2,300,000 common shares of
Envoy. During fiscal 2004, convertible debentures with a face value of $4.39 million were converted into
29.3 million common shares of Envoy. As at September 30, 2004, the aggregate debt component
carrying values of all of Envoys convertible debentures was $nil (2003 - $3.2 million). Through public offerings in the second and third quarters of fiscal 2004, Envoy raised gross
proceeds of $66.5 million. Part of the net proceeds was used to reduce the outstanding debt, when
this could be negotiated on reasonable terms. The balance of the funds is being used for general
corporate purposes, and to fund future acquisitions as they are identified. As at September 30, 2004, Envoy had working capital of $47.6 million and a cash balance of $4.6
million, compared to September 30, 2003, when it had a working capital deficit of ($1.9) million
and a cash balance of $2.0 million. Included in working capital at September 30, 2004 is $36.1
million that has been placed in a portfolio of marketable securities. Net cash used by operating activities was ($1.4) million for the year ended September 30, 2004
compared to net cash provided by operating activities of $4.3 million for the year ended September
30, 2003. Cash used by the growth in accounts receivable, the reduction in the accounts payable and
the net loss during the year, was partially offset by the cash generated from adding back non-cash
expenses. 22




---



##### 



Net cash provided by financing activities was $52.3 million for the year ended September 30, 2004
compared to net cash used in financing activities of ($1.6) million for the year ended September
30, 2003. During fiscal 2004, Envoy issued $4.0 million of secured debentures and $0.5 of
unsecured debentures. Envoy also raised share capital of $60.7 million through two separate public
offerings during fiscal 2004, and through the exercise of share options. The proceeds of the
public offering were used to repay the secured and unsecured debentures and the short tem bank
debt. See Note 8 and 9 to the Financial Statements. Further analysis on the use of proceeds from
the public offerings is provided in the table elsewhere in this MD&A. Net cash used in investing activities was ($48.1) million for the year ended September 30, 2004 and
($1.0) million for the year ended September 30, 2003. The cash raised in the public offering in
fiscal 2004, which was not immediately required for debt repayment, was invested in a portfolio of
marketable securities. In the first quarter of fiscal 2004, convertible debentures with a face value of $2.4 million were
converted into common shares of Envoy. In the second quarter, the remaining convertible debentures
with a face value of $2.0 million were converted. As a result, there will be no further interest
expense related to the convertible debentures. At a special meeting of shareholders of Envoy held on January 8, 2004, the shareholders approved an
amendment to the articles of Envoy to increase its authorized share capital from 50 million common
shares to 200 million common shares (40 million common shares after giving effect to the reverse
stock split). During fiscal 2004, 29,266,666 common shares of Envoy were issued as a result of the conversion of
all outstanding convertible debentures with a face value of $4.4 million. All of the outstanding
warrants were exercised, resulting in the issuance of 2,300,000 common shares. Share options
exercised resulted in the issuance of 578,336 common shares. Through a public offering, on February 20, 2004, Envoy issued 26,315,800 units at $1.33 per unit,
each unit consisting of one common share and one-half of one transferable common share purchase
warrant. On March 3, 2004, pursuant to the exercise of the over-allotment option issued in
connection with the public offering, we issued an additional 3,947,370 units. On May
12th 2004, through a second public equity offering, we issued 25,000,000 units, each
unit consisting of one common share and a one-half of one common share purchase warrant. The public
share offerings resulted in the issuance of a total of 55,263,170 common shares of Envoy and the
issuance of warrants for the purchase of 27,631,585 common shares of Envoy. These warrants have a
strike price of $1.80 per common share and expire on February 20, 2009. Net proceeds of $60.1
million, was raised by the public offerings. During the second quarter of fiscal 2004, we
successfully negotiated with our lenders and retired substantially all outstanding loan
indebtedness. The balance of the funds raised will be used for general corporate purposes, and for
potential acquisition and investment opportunities that we determine have potential to create value
for our shareholders and either complement, or provide an opportunity to diversify our current
business. During fiscal 2004, pursuant to a normal course issuer bid, Envoy repurchased and cancelled
1,372,200 common shares at a cash cost of $819,549. After the exercise of the warrants and the options, the conversion of the convertible debentures
the issuance of common shares through the public equity offerings, and the purchase for
cancellation of shares through the normal course issuer bid, there were 117,083,000 common shares
of Envoy outstanding at September 30, 2004, compared to 31,047,027 common shares of Envoy
outstanding at September 30, 2003. After giving effect to the reverse stock split, there were
23,416,600 common shares outstanding at September 30, 2004, compared to 6,209,405 outstanding at
September 30, 2003. As a result of the above, we expect that our interest and financing cost for 2005 fiscal year will
be less than $0.1 million. There will be no further expense related to the accretion of interest
imputed on debentures. On May 25th, 2004, Envoy granted 1,875,000 options to senior employees and directors. The options
vest over a periods varying from one year to three years, have an expiry date of May 24th, 2009 and
an exercise price of $0.80 per share. The value of the options granted has been calculated using
the Black-Scholes Option pricing model and the option value will be expensed to salaries expense
over the vesting period of the options. Management believes the offering will enable Envoy to achieve two important goals. In addition to
allowing Envoy to eliminate its debt, the size of this offering will permit Envoy to engage in a
meaningful M&A program. 23




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##### 



Critical Accounting Estimates The significant accounting policies used by Envoy in preparing its consolidated financial
statements are described in Note 2 to the Financial Statements and should be read to ensure a
proper understanding and evaluation of the estimates and judgements made by management in preparing
those Financial Statements. Envoys Financial Statements are prepared in accordance with Canadian
generally accepted accounting principles. Envoy also prepares a reconciliation to United States
generally accepted accounting principles, which is included in Note 24 to the Financial Statements. Inherent in the application of some of those policies is the judgement by management as to which of
the various methods allowed under generally accepted accounting principles is the most appropriate
to apply in the case of Envoy. As well, management must take appropriate estimates at the time the
financial statements are prepared. Although all of the policies identified in Note 2 to the Financial Statements are important in
understanding the Financial Statements, the policies discussed below are considered by management
to be central to understanding the Financial Statements, because of the higher level of measurement
uncertainties involved in their application. GoodwillGoodwill represents the price paid for acquisitions in excess of the fair market value of
net tangible and intangible assets acquired. Effective October 1, 2002, the Company adopted the
recommendations of the CICA Handbook Section 3062 Goodwill and Other Intangible Assets. These
standards require that goodwill and other intangible assets determined to have indefinite lives are
no longer amortized but tested for impairment based on the fair value of the Companys reporting
units on adoption of the standard and at least annually thereafter. Transitional impairment tests
for goodwill were completed as at October 1, 2002 and an annual impairment test completed on March
31, 2003, September 30, 2003 and September 30, 2004 and, as a result no write-down was required.
Prior to 2003, the Company amortized goodwill on a straight-line basis over periods ranging from 7
to 25 years and goodwill was considered to be impaired since the future anticipated undiscounted
cash flows from the acquired businesses were less than the carrying value of goodwill. Goodwill
arising on acquisitions completed after June 30, 2001 was not amortized. Income TaxesEnvoy accounts for income taxes using the liability method. Under this method,
future income taxes are recognized at the enacted or substantially enacted tax rate expected to be
applicable at the anticipated date of the reversal for all significant temporary differences
between the tax and accounting bases of assets and liabilities and for certain tax carry forward
items. Future income tax assets and liabilities are recognized only to the extent that, in the
opinion of management, it is more likely than not that the future income tax assets will be
realized. Future operating results and future tax rates could vary materially, and accordingly the
value of income tax assets and liabilities could change by material amounts. Envoy currently has recorded a substantial valuation allowance for losses generated in Canadian
companies that are not expected to be fully utilizable against future income. Canada does not have
a consolidated tax filing process like the USA, and as such, losses that exist must be applied only
against income of that company. Where the losses are not expected to be available to offset future
income, the full value of these losses have not been recorded. Stock Based Compensation and Other Stock based PaymentsEffective October 1, 2002, Envoy adopted
the recommendations of the Canadian Institute of Chartered Accountants (CICA) handbook section
3870, Stock-based Compensation and Other Stock-based Payments. These standards require that
direct awards of stock or liabilities incurred, or other compensation arrangements that are based
on the price of common stock, be measured at fair value at each reporting date, with the change in
fair value reported in the Statement of Operations. These standards encourage, but do not require,
the use of fair value method for all other types of employee stock based compensation plans. Envoy
did not use the fair value method to account for employees stock based compensation plans, but
disclosed pro-forma for options granted after October 1, 2002. .Effective October 1, 2003, Envoy
adopted the revisions to Section 3870 that required the use of the fair value method for all
stock-based compensation transactions. Envoy, as permitted by Section 3870, had adopted the change
prospectively for options granted on or after October 1, 2003. GoodwillIn accordance with the new accounting standards outlined in sections 1581 and 3062 of the
CICA Handbook, goodwill is no longer amortized, but is tested at least annually for impairment.
Transition rules in effect for fiscal 2002 had allowed for the amortization of goodwill on
businesses acquired before July 1, 2001. 24




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##### 



Disposal of long - lived assets and discontinued operations Effective May 1, 2003, the Company uses the provisions of the CICA Handbook section 3475, Disposal
of long-lived assets and discontinued operations. The results of operations of a business that
has either been disposed of, or is held for sale, is reported as discontinued operations if the
operations and cash flows of the component have been (or will be) eliminated from the Companies
ongoing operations, and the Company will not have any significant continuing involvement in the
operations of the component after the disposal transaction. The results of discontinued operations,
less applicable taxes are reported as a separate element of income or loss before extraordinary
items for both current and prior periods. For businesses that were disposed of prior to the
adoption of these new standards, the Company includes the results of their operations in the
comparative financial results.  C.
    Research and Development, Patents and Licenses, etc. Not applicable  D.
    Trend Information Not applicable  E.
    Off-balance sheet arrangements None  F.
    Commitments and Contractual Commitments Set out below is a summary of the amounts due and committed under contractual cash obligations at
September 30, 2004 (all amounts in thousands): Total
    
    
    Due in 1 year
    
    
    Due between
    
    
    Due between
    
    
    Due after 5or less
    
    
    years 2 and 3
    
    
    years 4 and 5
    
    
    yearsOperating leases
    
    $
    3,241
    
    
    $
    893
    
    
    $
    1,213
    
    
    $
    907
    
    
    $
    228Long term debt
    
    
    659
    
    
    
    298
    
    
    
    203
    
    
    
    158
    
    
    
    Total contractual
cash obligations
    
    $
    3,900
    
    
    $
    1,191
    
    
    $
    1,416
    
    
    $
    1,065
    
    
    $
    228
 Other Commitments On September 30, 2004 Envoy purchased from the executive officers of John Street Inc. the 30% of
the shares of John Street Inc., which it did not already own. No amount has been accrued in the
financial statements as the purchase price will be determined and paid over a three-year period
based on certain performance milestones.  G.
    Safe Harbor Not applicable 
 Item 6.DIRECTORS AND SENIOR MANAGEMENT AND EMPLOYEES  A.
    Directors and Senior Management The following table sets forth certain information regarding the directors and senior managers
of Envoy as of January 31, 2005. Each director is elected at the annual meeting of shareholders to
serve until the next annual meeting or until a successor is elected or appointed. Name
    
    
    Age
    
    

Positions Held with EnvoyGeoffrey B. Genovese
    
    
    50
    
    
    President, Chairman and Chief Executive Officer and DirectorJohn H. Bailey
    
    
    59
    
    
    Executive Vice President, Corporate Secretary and DirectorDavid Hull1,2,3
    
    
    48
    
    
    DirectorHugh Aird1,2,3
    
    
    51
    
    
    DirectorDavid Parkes1,2,3
    
    
    58
    
    
    DirectorLinda Gilbert
    
    
    36
    
    
    Chief Financial Officer
   1 Member of the Audit Committee.2 Member of the Compensation Committee.3 Member of the Nominating and Corporate Governance Corporation 25




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##### 



The principal occupations and positions for the past five years and, in certain cases, prior
years of the directors and executive officers of Envoy are as follows: Geoffrey B. Genovese. Mr. Genovese founded The Incentive Design Company Ltd., a business and
marketing communications company, in 1981. Envoy acquired IDC in July 1991. Mr. Genovese
currently serves as Chairman, President and Chief Executive Officer of Envoy Communications Group
Inc. and Chief Executive Officer of Watt International Inc. Mr. Genovese was appointed Chairman in
September 2001. Mr. Genovese has been a Director of Envoy since July 1991. John H. Bailey. Mr. Bailey is a barrister and a solicitor who has been in private practice
since 1973. Mr. Bailey earned a Bachelor of Commerce and a Bachelor of Laws degree from the
University of Toronto, and a Master of Laws degree from York University. Mr. Bailey has been a
Director of Envoy since April 1994, Corporate Secretary since August 1997, and Executive
Vice-President since February 2004. David Hull. Mr. Hull has been the President of Hull Life Insurance Agencies Inc. since May
1991. Hull Life Insurance Agencies Inc. specializes in estate planning and life and disability
insurance. Prior thereto, Mr. Hull served as Executive Vice President of Hull Life Insurance
Agencies Ltd. and Thomas I. Hull Insurance Ltd., members of The Hull Group of Companies. Mr. Hull
has been a Director of Envoy since January 1995. Hugh Aird. Mr. Aird is presently a Director of First Associates Inc. . Prior to joining First
Associates Inc. in 2005, , Mr. Aird was a Senior Relationship Manager at Morgan Stanley Canada.
Mr. Aird was Vice President, Business Development, Mulvihill Capital Management Inc. Prior to
joining Mulvihill Capital Management Inc. in 2001, Mr. Aird was Vice Chairman of Merrill Lynch
Canada Inc. (formerly Midland Walwyn Capital Inc.). Mr. Aird first became a director of Envoy on
August 20, 1997. As a result of personal commitments, Mr. Aird resigned as a director on April 1,
2003. On November 24, 2003, Mr. Aird was re-elected as a director of Envoy. David ParkesMr. Parkes is presently President of Freefone Inc. Prior to joining Freefone
Inc. in 2003, Mr. Parkes founded David Parkes & Assoc. in 2001. Mr. Parkes was President and CEO of
Look Communications Inc. until 2001 and President and CEO of TeleSpectrum Canada Inc. until 1999.
Mr. Parkes has been a Director of Envoy since October 2002. Linda Gilbert,CAMrs. Gilbert joined Envoy in 1999 as Director of Finance. In 2003, Mrs.
Gilbert was promoted to the position of Chief Financial Officer. Prior to joining Envoy, Mrs.
Gilbert was a manager of KPMG LLP in Canada, an accounting firm. The Ontario Business Corporations Act requires that a majority of Envoys directors be Canadian
residents. There are no arrangements or understandings between any director or executive officer
of Envoy pursuant to which he was selected as such. 26




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##### 



B.Compensation The following table sets forth in Canadian dollars all compensation for the fiscal year ended
September 30, 2004 paid to the Chief Executive Officer of Envoy and the four other most highly
compensated officers who served as executive officers of the Company (the Named Executive
Officers): Annual Compensation
    
    
    
    Long Term CompensationAwards
    
    
    
    PayoutsRestrictedSecurities
    
    
    
    Shares orUnder
    
    
    
    Restricted
    
    
    
    
    
    
    
    All OtherName and Principal
    
    
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    
    Option/SARs
    
    
    
    Share Units
    
    
    
    LTIP Payouts
    
    

    
    CompensationPosition
    
    
    Salary ($)
    
    
    
    Bonus ($)
    
    
    
    Annual ($)
    
    
    
    Granted(#)
    
    
    
    ($)
    
    
    
    ($)
    
    
    
    ($)Geoffrey B. Genovese,
Chairman, President and
Chief Executive Officer
    
    
    
    541,530
    
    
    
    
    400,000
    
    
    
    
    150,000
    1
    
    
    
    400,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    154,539
    1Linda Gilbert, Chief
Financial Officer, Envoy
    
    
    
    150,000
    
    
    
    
    50,000
    
    
    
    
    6,000
    
    
    
    
    100,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    John H.
Bailey,Executive Vice
President, and Secretary
    
    
    
    200,000
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    200,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Arthur Fleischmann,
President, John Street
Inc.
    
    
    
    292,574
    
    
    
    
    
    
    
    
    

15,000
    
    
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Patrick Rodmell
Managing Director,
Watt International Inc.
    
    
    
    225,360
    
    
    
    

67,000
    
    
    
    
    30,000
    
    
    
    
    75,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
  1
    The amount was paid to a corporation related to Mr. Genovese as an annual management
fee.2
    Mr. Bailey was appointed Executive Vice President of the Corporation on February 1,
2004. Amount reflects fees paid for the personal services of Mr. Bailey provided to the
Corporation by Semper Consulting Inc. during the period February 1, 2004 to September 30,
2004.3
    Mr. Genovese received taxable benefits for life insurance premiums paid by the
Corporation. The following table sets forth options granted under the Stock Option Plan to the Named Executive
Officers of the Company in the most recently completed fiscal year: Market Value ofPercentage of Total
    
    
    
    
    
    
    
    
    
    
    
    
    Shares UnderlyingShares Under
    
    
    Options Granted to
    
    
    
    
    
    
    
    
    
    
    
    
    Options on Date ofOptions
    
    
    Employees in Financial
    
    
    
    
    
    
    
    Exercise Price
    
    
    GrantName
    
    
    Granted (#)
    
    
    Year
    
    
    Date of Grant
    
    
    ($/Security)
    
    
    ($/Security)

    
    
    Expiry DateGeoff Genovese
    
    
    
    400,000
    1
    
    
    
    21.33
    %
    
    
    May 25, 2004
    
    
    $
    0.80
    
    
    
    $
    0.80
    
    
    
    May 24, 2009Linda Gilbert
    
    
    

    100,000
    1
    
    
    
    5.33
    %
    
    
    May 25, 2004
    
    
    $
    0.80
    
    
    
    $
    0.80
    
    
    
    May 24, 2009Arthur Fleischmann
    
    
    
    50,000
    2
    
    
    
    2.67
    %
    
    
    May 25,2004
    
    
    $
    0.80
    
    
    
    $
    0.80
    
    
    
    May 24, 2009Patrick Rodmell
    
    
    
    75,000
    2
    
    
    
    4.00
    %
    
    
    May 25, 2004
    
    
    $
    0.80
    
    
    
    $
    0.80
    
    
    
    May 24, 2009John H. Bailey
    
    
    
    200,000
    1
    
    
    
    10.67
    %
    
    
    May 25, 2004
    
    
    $
    0.80
    
    
    
    $
    0.80
    
    
    
    May 24, 2009
 NOTES:   1.
    These options vest during the 2ndyear of a five year term.2.
    These options vest at the rate of 1/3rd during each of the 2nd,3rd and 4th years of a five year term. 27




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##### 



The following table sets forth options exercised under the Stock Option Plan to the Named Executive
Officers of the Company in the most recently completed fiscal year and the value of unexercised
options held by them as at the most recent fiscal year: Stock Options Exercised During 2004 Fiscal YearUnexercised OptionsNumber of
    
    
    
    
    
    at FY-End (#)
    
    
    Value of Unexercised In-the MoneyShares Acquired
    
    
    Aggregate Value
    
    
    Exercisable/Unexercis
    
    
    Options at FY-End ($)Name
    
    
    on Exercise
    
    
    Realized ($)
    
    
    able
    
    
    Exercisable/Unexercisable1Geoff Genovese
    
    
    Nil
    
    
    Nil
    
    

/400,000Linda Gilbert
    
    
    28,333
    
    
    $27,550
    
    
    5,000//8,333/100,000
    
    

//2,250/Arthur Fleischmann
    
    
    33,334
    
    
    $29,667
    
    

150,000//66,666/50,000
    
    

//18,000/Patrick Rodmell
    
    
    33,334
    
    
    $34,334
    
    

2,000//66,666/75,000
    
    

//18,000/John H. Bailey
    
    
    275,000
    
    
    $248,000
    
    
    /200,000
    
    
    /
 The Company does not provide any pension, retirement plan or other remuneration for its
directors or officers that constitutes an expense to the Company, nor are there any plans or
arrangements in respect of compensation received or that may be received by executive officers in
the Companys most recently completed or current fiscal year to compensate such officers in the
event of the termination of employment or a change in control of the Company. Employment Contracts and Termination Agreements The Company and its subsidiaries, John Street Inc. (John St.), and Watt International Inc.
(Watt), have entered into employment contracts with the Named Executive Officers. Geoffrey B. Genovese has agreed to act as the Companys Chairman and President and Chief Executive
Officer at an annual base salary of $550,000, together with a discretionary bonus based on the
achievement of agreed upon criteria established from time to time by the Compensation Committee.
This agreement provides for a severance payment equivalent to $300,000 plus an amount equal to two
times the total remuneration and other compensation paid to Mr. Genovese and his management company
during the 12 month period preceding termination, if Mr. Genoveses employment is terminated,
without cause, by the Company. An annual fee of $150,000, is also payable to Mr. Genoveses
management company pursuant to a management agreement with the Company. The management agreement
has a fixed term ending on September 30, 2005. Linda Gilbert has agreed to act as the Companys Chief Financial Officer at an annual salary of
$200,000. This agreement provides for a severance payment equivalent to her base salary for a
period of up to six months, if her employment is terminated, without cause, by the Company. Arthur Fleischmann has agreed to act as the President of John St. at an annual base salary of
$300,000, together with an annual cash bonus based on the performance of John St. This agreement
provides for a severance payment equivalent to his base salary and benefits for a period of ten
months, if his employment is terminated, without cause, by the Company. Patrick Rodmell has agreed to act as the Managing Director of Watt at an annual base salary of
$225,000 together with an annual cash bonus based on the performance of Watt. This agreement
provides for a severance payment equivalent to his base salary and benefits for a period of up to
four months, if his employment is terminated, without cause, by the Company. John H. Bailey was appointed Executive Vice President of the Corporation on February 1, 2004.
Pursuant to the terms of an agreement dated February 1, 2004 between the Corporation and Semper
Consulting Inc. (Semper), Semper agreed to provide certain financial advisory services as well as
general advice of a strategic nature, including the personal services of John H. Bailey. In
consideration for these services, the Corporation has agreed to pay Semper an annual fee of
$300,000 and to reimburse Semper for all expenses incurred by it in the performance of its
services. The agreement has a term ending on January 31, 2007, unless sooner terminated pursuant
to the provisions thereof. Upon termination of the agreement for any reason, other than cause,
Semper shall receive a payment equal to the greater of (a) the fees paid to Semper during the
twenty-four month period ending on the month immediately preceding the month in which the agreement
is terminated; and (b) the product determined by multiplying the monthly fee to which Semper is
entitled at the date of termination by the number of months from and including the month in which
such termination occurs to the and including the month of January, 2007. Semper is wholly-owned by
the spouse of John H. Bailey. 28




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##### 



Compensation of Directors All non-executive directors of the Corporation or any of its affiliates are compensated for their
services as directors and members of a committee through a combination of annual and meeting
attendance fees. Messrs. Aird, Hull and Parkes are each entitled to receive an annual
directors/committee members fee of $30,000.00. As the Lead Director, Mr. Aird receives an
additional $50,000 per year. A non-executive director receives an additional annual fee of $10,000
for presiding over a committee of the Board (other than the Audit Committee). For his part, the
Chairman of the Audit Committee receives an additional annual fee of $40,000. In addition, each
director receives an attendance fee of $1,000 for each Board or committee meeting attended. No
compensation is paid to the other directors, who are also executive officers, for their services as
directors. Directors are also entitled to participate in the Corporations Stock Option Plan. In the fiscal year ended September 30, 2004, Envoy paid approximately $266,100 Cdn. to John H.
Bailey, Barrister & Solicitor, for legal services provided to Envoy. Directors and Officers Liability Insurance The Company maintains liability insurance for the benefit of the directors and officers of the
Company and its subsidiaries against liability incurred by them in their respective capacities. The
current annual policy limit is $5,000,000. Under the policy, individual directors and officers are
reimbursed for losses incurred in their capacities as such, subject to a deductible of $250,000 for
claims arising in the United States and $150,000 for all other claims. The deductible is the
responsibility of the Company. The Company paid the annual premium of $131,250. C. Board Practices CORPORATE
GOVERNANCE
The Corporation is subject to a variety of corporate governance guidelines and requirements enacted
by the Toronto Stock Exchange (TSX), the Canadian Securities Administrators
("CSA"), The Nasdaq Stock Market ("NASDAQ") and by the
U.S. Securities and Exchange Commission (SEC) under its rules and those mandated by the United
States Sarbanes-Oxley Act of 2002. The Corporations corporate governance practices comply with the
TSX Company Manual Corporate Governance Guidelines (the TSX Guidelines), governance rules of the
NASDAQ applicable to foreign issuers and applicable requirements of the CSA and the SEC. The
Corporation is also in substantial compliance with the CSAs Multilateral Instrument pertaining to
audit committees that came into force on March 30, 2004 and is applicable in 2005, and with the
proposed corporate governance guidelines released for comment by the CSA on January 16, 2004 and
which are expected to be in force in 2005. The Corporation is required to disclose certain specified corporate governance information with
reference to the TSX Guidelines. The TSX Guidelines address items such as the constitution and
independence of corporate boards, the functions to be performed by boards and their committees and
the effectiveness of education of boards. The report of the Nominating and Corporate Governance
Committee, which compares the corporate governance practices of the Corporation to the guidelines
set forth in the TSX Guidelines, is set out in Schedule A attached hereto. As new regulations come into
effect, the Nominating and Corporate Governance Committee and the Board
of Directors (the Board) will continue to review the Corporations corporate governance practices
and make appropriate changes. Mandate of the
Board
The Board has the responsibility for the overall stewardship of the Corporation, establishing the
overall policies and standards for the Corporation in the operation of its businesses, and
reviewing and approving the strategic plans. In addition, the Board monitors and assesses overall
performance and progress in meeting the Corporations goals. Day to day management is the
responsibility of the President and Chief Executive Officer and senior management. The Board holds meetings whenever appropriate to oversee the conduct of the Corporations business
and monitor and evaluate the day-to-day management of the Corporation. With respect to risk
management activities, the Board is presented, at each meeting, reports on operations, financial
status, material contracts and litigation. The Board has also adopted a policy that it have an independent director (Lead Director) with
responsibility to ensure that the Board discharges its responsibilities effectively and
independently of management. The Lead Director chairs scheduled meetings of outside directors
without management present. The Board has determined that the Lead Director shall be appointed by
the Board based on the recommendations of the Nominating and Corporate Governance Committee. On
September 22, 2004, Hugh Aird was appointed the Lead Director. 29




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##### 



In addition to the Boards statutory responsibilities under the Business Corporations Act of
Ontario, the Boards stewardship responsibilities include the following: (a) assessing the
principal risks arising from or incidental to the business activities of the Corporation; (b)
appointing all senior executives of the Corporation and, through the Compensation Committee of the
Board, developing and implementing the executive compensation policies and reviewing the
performance of the President and Chief Executive Officer with reference to the Corporations
policies, stated budget and other objectives; (c) overseeing the Corporations policies regarding
public communications, investor relations and shareholder communications; and (d) monitoring and
assessing, through the Audit Committee of the Board, the scope, implementation and integrity of the
Corporations internal information, audit and control systems. The Corporation has delegated the responsibility for monitoring the effectiveness of the
Corporations internal information systems to the Audit Committee of the Board. The Audit
Committee is also responsible for reviewing and appraising the soundness, adequacy and application
of financial and other operating controls, determining the extent of compliance with established
policies, plans and procedures and ascertaining the reliability and timeliness of management data
developed within the organization. Composition of the Board The articles of the Corporation provide that there shall be a Board of not less than 3 or more than
10 directors. There are currently five directors of the Corporation, two of whom are inside and
related (as such terms are defined in the TSX Guidelines) directors and three of whom are outside
and unrelated directors. Geoffrey B. Genovese, the Chairman, President and Chief Executive Officer
of the Corporation and John H. Bailey, the Executive Vice President and Secretary of the
Corporation are the inside and related directors. Hugh Aird, David Hull and David Parkes are the
outside and unrelated directors of the Corporation. The Board intends to periodically examine its
size and constitution to ensure responsible corporate governance and effective corporate
management. Directors are elected annually at the annual meeting of shareholders. The term of
office of a director commences at the close of the meeting of shareholders a which he or she is
elected and terminates at the close of the first annual meeting of shareholders following his or
her election. If an election of directors is not held at the proper time, the incumbent directors
continue in office until their successors are elected. Each director holds office until the next
annual meeting of shareholders and until his or her successor is elected. Governing Committees The directors have established the Audit Committee, the Compensation Committee and the Nominating
and Corporate Governance Committee to focus resources and expertise in certain areas of the Boards
mandate. Audit Committee The Board has delegated to the Audit Committee of the Board responsibility for ensuring management
has designed and implemented an effective management system and for reviewing internal information,
audit, control and management systems. The Audit Committee is comprised of three directors, David
Parkes (Chairman, Hugh Aird and David Hull. All three members of the Audit Committee are outside
and unrelated directors of the Company. The Audit Committee is responsible for reviewing the Companys annual and quarterly consolidated
financial statements and reporting to the Board in connection therewith. The Audit Committee is
also responsible for monitoring the Companys internal controls and information gathering systems
and dealing with the Companys external auditors. On September 22, 2004, the Audit Committee
adopted a new audit committee charter, which specifies the auditors accountability to the Board
and the authority and responsibilities of the Audit Committee. Compensation Committee The purpose of the Compensation Committee is to assist the Board in its oversight responsibilities
relating to the compensation, nomination, evaluation and succession of the President and Chief
Executive Officer; the administration of the Corporations Stock Option/Stock Appreciation Right
Plan; and the review of executive compensation disclosure. The Compensation Committee is comprised
of three directors, David Hull (Chairman), David Parkes and Hugh Aird, all of whom are outside and
unrelated directors. Nominating and Corporate Governance Committee The Board has delegated to the Nominating and Corporate Governance Committee of the Board
responsibility for co-ordinating and managing the process of recruiting, interviewing and
recommending candidates to the Board; developing and recommending standards of performance of the
Board as a whole, its committees and individual directors; assessing the effectiveness of the
Board as a whole and its committees and the contribution of individual directors; making 30




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##### 



recommendations to the Board regarding the composition of committees of the Board; provide new
directors with an orientation program through a review of past Board materials and other public and
private documents concerning the Corporation; reviewing and making recommendations to the Board
with respect to developments in the area of corporate governance and the structure and practices of
the Board; and reviewing and assessing compliance by the Corporation with applicable corporate
governance rules and guidelines established by securities regulators and stock exchanges. The
Nominating and Corporate Governance Committee is comprised of three directors, David Hull
(Chairman), Hugh Aird and David Parkes. All three members of the Nominating and Corporate
Governance Committee are outside and unrelated directors of the Corporation. Expectations of the Board The Board expects management of the Company to report to the Board in a comprehensive, accurate and
timely fashion on the business and affairs of the Company generally and on specific matters that it
considers to have material consequences for the Company and its shareholders. Management is
expected to continually develop and review the Companys strategic plan to make the decisions
necessary to give effect to the plan; to adhere to the Companys operational policies; and to
monitor the Companys financial performance in comparison to the annual budget, with the ultimate
goal of enhancing shareholder value. Shareholder Communication The objective of the Companys shareholder communication policy is to ensure open and timely
exchange of information relating to the Companys business, affairs and performance, subject to the
requirements of applicable securities legislation and other statutory and contractual obligations
limiting the disclosure of such information. Information material to the Companys business is
released through news wire services, the general media, telephone conferences and shareholder
mailings, thereby ensuring timely dissemination. Additionally, individual queries, comments or
suggestions can be made at any time directly to the Companys secretarial department located at its
head office. D. Employees As at January 31, 2005, Envoy had 158 full time employees based in Toronto, Canada, 7 based in the
United States, 153 and based in the United Kingdom and Continental Europe. Of this total, 20
employees were engaged in marketing, and 326 in consumer and retail branding. As at January 31, 2004, Envoy had 154 full time employees based in Toronto, Canada, 12 based in the
United States, and 73 based in the United Kingdom and Continental Europe. Of this total, 17
employees were engaged in marketing, and 222 in consumer and retail branding. As at January 31, 2003, Envoy had 175 full time employees based in Toronto, Canada, 31 based in the
United States, and 133 based in the United Kingdom and Continental Europe. Of this total, 29
employees were engaged in marketing, and 310 in consumer and retail branding. As at January 31, 2002, Envoy had 292 full time employees based in Toronto, Canada, 60 based in the
United States, and 158 based in the United Kingdom and Continental Europe. Of this total, 75
employees were engaged in marketing, 361 in consumer and retail branding, and 73 in technology. E.Share Ownership As of January 31, 2005, the options and other rights to purchase common shares of Envoy consisted
of stock options to purchase 2,929,748 common shares. Options Stock Option Plan The Company has established a Stock Option Plan pursuant to which options to purchase Common Shares
and stock appreciation rights may be granted to directors, officers, employees or certain
consultants to the Company or any of its subsidiaries, as determined by the Board, at prices to be
fixed by the directors, subject to limitations imposed by any Canadian stock exchange on which the
Common Shares are listed for trading and any other regulatory authority having jurisdiction in such
matters. The Common Shares subject to each option shall become purchasable at such time or times
as may be determined by the directors. Stock appreciation rights (SARs) may only be granted in
conjunction with an option and, when exercised, entitle the holder to receive an amount equal in
value to the excess of the market value of the Common Shares over the price of the related option.
The excess amount is payable in Common Shares having a market value equal to such excess. Options
are non-assignable and non-transferable by the option-holder and shall be exercisable during the 31




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##### 



option-holders lifetime only by the option-holder. Stock appreciation rights are non-transferable
and terminate when the related option terminates. The maximum number of Common Shares currently reserved for issuance upon exercise of options under
the Stock Option Plan is 4,000,000 Common Shares. As at September 30, 2004 options to purchase
2,929,748 Common Shares have been granted and are outstanding under the Stock Option Plan. There
are no SARs outstanding under the Stock Option Plan. The aggregate number of Common Shares reserved
for issuance to any one individual under the Stock Option Plan may not exceed 5% of the issued and
outstanding Common Shares. During fiscal 2003, the President of the Company, Geoffrey B. Genovese, elected to cancel his stock
options to purchase 950,000 Common Shares, being all of the options to purchase Common Shares
granted to Mr. Genovese under the Stock Option Plan. The cancellation of these stock options
resulted in an additional 950,000 Common Shares being available for grant, without increasing the
maximum number of Common Shares reserved for issuance upon exercise of options under the Stock
Option Plan. The following table describes the options to acquire common shares that are outstanding pursuant to
the Stock Option Plan or otherwise as of January 31, 2005: Number of Common SharesClass of Optionee
    
    
    Under Options Granted
    
    
    Exercise Price
    
    
    Date of ExpiryGeoffrey Genovese
    
    
    
    400,000
    
    
    
    $0.80


    
    
    May 24, 2009Linda Gilbert
    
    
    
    8,333
    
    
    
    $0.25
    
    
    October 27, 2007Linda Gilbert
    
    
    
    100,000
    
    
    
    $0.80
    
    
    May 24, 2009Linda Gilbert
    
    
    
    5,000
    
    
    
    $3.05
    
    
    August 1, 2007Arthur Fleischmann
    
    
    
    66,666
    
    
    
    $0.25
    
    
    October 27, 2007Arthur Fleischmann
    
    
    
    150,000
    
    
    
    $3.05
    
    
    June 27,2006Arthur Fleischmann
    
    
    
    50,000
    
    
    
    $0.80
    
    
    May 24, 2009Patrick Rodmell
    
    
    
    66,666
    
    
    
    $0.25
    
    
    October 27, 2007Patrick Rodmell
    
    
    
    75,000
    
    
    
    $0.80
    
    
    May 24, 2009Patrick Rodmell
    
    
    
    7,500
    
    
    
    $3.05
    
    
    August 1, 2007John H. Bailey
    
    
    
    200,000
    
    
    
    $0.80
    
    
    May 24,2009John H. Bailey
    
    
    
    20,000
    
    
    
    $3.05
    
    
    June 27, 2006John H. Bailey
    
    
    
    15,000
    
    
    
    $7.40
    
    
    March 30, 2005Other
    
    
    
    408,333
    
    
    
    $0.25
    
    
    October 27, 200775,000
    
    
    
    $0.61
    
    
    May 29, 20071,025,000
    
    
    
    $0.80
    
    
    May 24, 200925,000
    
    
    
    $0.80
    
    
    June 5, 2009190,000
    
    
    
    $3.05
    
    
    June 27, 200612,250
    
    
    
    $3.05
    
    
    August 1, 200730,000
    
    
    
    $7.40
    
    
    March 30, 2005Total
    
    
    
    2,929,748
 32




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The following table sets forth shares owned by the Chairman, President and Chief
Executive Officer of Envoy and the four other most highly compensated officers who served as
executive officers of the Company as of January 31, 2005 (the Named Executive Officers): Number of Common SharesIdentity of Person
    
    Owned
    
    
    Percent of Outstanding ClassGeoff Genovese
    
    
    1,465,551
    
    
    
    1.30
    %Linda Gilbert
    
    
    18,733
    
    
    
    0
    %Arthur Fleischmann
    
    Nil
    
    
    NilPatrick Rodmell
    
    Nil
    
    
    NilJohn H. Bailey
    
    
    102,591
    
    
    
    0
    %
 Convertible Debentures In April 2003, as part of the renegotiation of the debt facility existing at that time, the
Company amended the terms of the debentures issued on April 29, 2002 and September 12, 2002 as
follows: the early repayment terms on the debentures were deferred to April 24, 2005; the
debentures became repayable in cash on maturity on April 24, 2008; both debentures were then
convertible into common shares at a price of $0.15 each, for a total of 25,333,333 common shares;
and, the warrants attached to the convertible debentures were cancelled. On April 24, 2003, the Company issued $2,000,000 in 10% convertible debentures as part of the
refinancing plan, which had a maturity date of April 24, 2008. These debentures were convertible
into common shares at a price of $0.15 each for a total of 13,333,333 common shares. Holders also
had the right to require the Company to purchase all or a portion of their debentures on or after
April 24, 2005 at the issue price plus accrued and unpaid interest. The debentures were bifurcated into a debt component, representing a yield to maturity of 25.6% per
annum over the five-year life, and an equity component with proceeds allocated $1,465,929 to
long-term debt and $534,071 to shareholders equity. That portion of offering expenses, related to
the debt component being $120,906 was recorded as deferred financing fees which were included in
prepaid expenses, with the remaining $44,049 applied to reduce the equity component. During fiscal 2003, convertible debentures with a face value of $1,410,000 were converted into
9,400,000 common shares of the Company. On April 29, 2002, the Company issued $1,800,000 in 10% convertible debentures with a maturity date
of April 29, 2007 (amended to April 24, 2008 as discussed above). Prior to the amendments
discussed above, the debentures were convertible until the maturity date into 2,500,000 units of
the Company at a conversion price of $0.72 per unit. Each unit consisted of one common share in
the capital of the Company and one purchase warrant of the Company. Each purchase warrant entitled the holder to purchase one common share (2,500,000 common shares in
aggregate) within the earlier of (a) 12 months of the date of conversion of the debenture, and (b)
the maturity date at a price of $0.90 per common share. Holders also had the right to require the
Company to purchase all or a portion of their debentures on or after April 29, 2004 at the issue
price plus accrued and unpaid interest. In addition, upon a change in control occurring on or
before April 29, 2004, the Company was required to offer to purchase the debentures at a purchase
price equal to 101% of the issue price plus accrued and unpaid interest to the repurchase date.
The debentures were secured by a charge over the Companys assets and undertakings, subject only to
security interests in favour of the Companys bankers, equipment leases and non-consensual liens.
The net proceeds from the sale of the debentures were used for general corporate purposes. The debentures were bifurcated into a debt component, representing a yield to maturity of 25.4% per
annum over the five-year life, and an equity component with proceeds allocated as $1,017,770 to
long-term debt and $782,230 to shareholders equity. That portion of offering expenses related to
the debt component, being $60,857 was recorded as deferred financing fees and were included in
prepaid expenses, with the remaining $46,565 applied to reduce the equity component. On September 12, 2002, the Company issued $2,000,000 in 10% convertible debentures with a maturity
date of September 12, 2007 (amended to April 24, 2008 as discussed above). Prior to the amendments
discussed above, the debentures were convertible until the maturity date into 5,882,353 units of
the Company at a conversion price of $0.34 per unit. Each unit consisted of one common share in
the capital of the Company and one purchase warrant of the Company. Each purchase 33




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warrant entitled the holder to purchase one common share (5,882,353 common shares in aggregate)
within the earlier of (a) twelve months of the date of conversion of the debenture, and (b) the
maturity date at a price of $0.34 per common share. Holders also had the right to require the
Company to purchase all or a portion of their debentures on or after September 12, 2005 at the
issue price plus accrued and unpaid interest. In addition, upon a change in control occurring on
or before September 12, 2005, the Company was required to offer to purchase the debentures at a
purchase price equal to 101% of the issue price plus accrued and unpaid interest to the repurchase
date. The debentures were secured by a charge over the Companys assets and undertakings, subject
only to security interests in favour of the Companys bankers, equipment leases and non-consensual
liens. The net proceeds from the sale of the debentures were used for general corporate purposes. The debentures were bifurcated into a debt component, representing a yield to maturity of 31.5% per
annum over the five-year life, and an equity component with proceeds allocated as $931,858 to
long-term debt and $1,068,142 to shareholders equity. That portion of the offering expenses
related to the debt component, being $72,365, was recorded as deferred financing fees and included
in prepaid expenses, with the remaining $82,948 applied to reduce the equity component. 
 Item 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS  A.
    Major Shareholders Ownership of Envoys securities are recorded on the books of its transfer agent in registered form,
however the majority of such shares are registered in the name of intermediaries such as brokerage
firms and clearing houses on behalf of their respective clients and in general Envoy does not have
knowledge of the beneficial owners thereof, except for the beneficial ownership by officers and
directors of Envoy. Envoy is not directly or indirectly owned or controlled by another corporation
or entity or by any foreign government. Envoy is not a party to any arrangement, and does not know
of any other arrangements, the operation of which may at a subsequent date result in a change in
control of Envoy. At a special meeting of the shareholders Envoy held on January 8, 2004, the shareholders approved
an amendment to the Articles of the Company to increase its authorized share capital from
50,000,000 common shares to 200,000,000. As of January 31, 2005, Envoy had an authorized share capital of 200,000,000 common shares without
par value, of which 113,314,318 shares were issued and outstanding. (22,662,864 after share
consolidation). The following table sets forth certain information regarding the ownership of outstanding common
shares of Envoy as of January 31, 2005 with respect to each person known by Envoy to be the owner
either of record or beneficially of more than 5% of the issued and outstanding common shares of
Envoy. As used in this table, beneficial ownership refers to the sole or shared power to vote or
direct the voting or to dispose or direct the disposition of any security. A person is deemed to
be the beneficial owner of securities that can be acquired within 60 days from the date of this
Form 20-F through the exercise of any option, warrant or right. Common shares subject to options,
warrants or rights which are currently exercisable or exercisable within 60 days are deemed
outstanding for computing the ownership percentage of the person holding such options, warrants or
rights, but are not deemed outstanding for computing the ownership percentage of any other person. Identity of Person or Group
    
    Number of Common Shares
    
    Percent of Outstanding ClassCDS & Co1
    
    
    109,776,522
    
    
    
    97
    %NCI AccountP.O. Box 1038 Station A25 The EsplanadeToronto, Ontario M5W 1G5Cede & Co.1
    
    
    3,149,367
    
    
    
    3
    %P.O. Box 20Bowling Green StationNew York, NY 10274USAGeoffrey B. Genevose2
    
    
    1,465,551
    
    
    
    1.30
    %%
   1
    CDS & Co. and Cede & Co., respectively, are the record holders of these shares
and in general the ultimate beneficial owners of these shares are not known to Envoy.2
    Includes common shares held by family members. 34




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See also Item 6.E. Share Ownership for information regarding outstanding stock options to
purchase common shares. As of January 31, 2005
there were 113,314,318 outstanding common shares of Envoy of which
109,812,637 were held of record by 34 Non-U.S. residents and 3,501,680 of which were held of record
by 143 U.S. residents. The foregoing information regarding the number and the country of residence
of Envoys shareholders does not reflect those shareholders whose shares are being held of record
by brokerage clearing houses and in general the ultimate beneficial owners of these shares are not
known to Envoy. B. Related Party Transactions As disclosed in Note 6 to the Financial statements, the following are transactions that took place
during fiscal 2004 that involved related parties: In October and November 2002 the Company sold the operations of Devlin Multimedia Inc. (Devlin)
and Sage to certain executives of the respective subsidiaries (see Note 16). During fiscal 2003, relatives of the CEO loaned the Company $225,000 of which $150,000 was
outstanding at September 30, 2003. The loan bore an interest of 10% per annum and was repayable on
demand. During fiscal 2004, the loan was repaid in full. During fiscal 2003, relatives of a director loaned the Company $75,000 which was repaid prior to
year end. The loan bore an interest rate of 10% per annum, and was repayable on demand. During fiscal 2003, relatives of the CEO and a director were part of the group that loaned the
Company $2.0 million of convertible debentures. In total, these relatives loaned the Company
$1,850,000, of which $1,070,000 was outstanding at September 30, 2003. During fiscal 2004 all the
debentures were converted into additional shares, as described in Note 9. During fiscal 2004, the
Company paid one of its directors $266,100 (2003 - $312,589; 2002 -
$265,936) for legal services. During fiscal 2004, certain executives of the Company loaned the Company an amount of $100,000, and
a relative of a director loaned the Company an amount of $150,000. These debentures bore an
interest of 10% per annum, and included warrants to purchase a total of 125,000 shares at $0.15 per
share. During fiscal 2004, these debentures were repaid. At January 1, 2004, the Company sold the operations of Communique Incentives Inc to an executive of
the subsidiary (see Note 22). At September 30, 2004, the Company purchased from the executive officers of John Street Inc. the
30% of the shares of John Street Inc. which it did not already own (see Note 19(b)). Related party transactions are recorded at the exchange amount, being the amount agreed to by the
related parties. Except as disclosed above, no director or executive officer, and no relative or spouse of the
foregoing persons (or relative of such spouse) who has the same house as such person or is an
executive officer, or director, of any parent or subsidiary of Envoy, has, or during the last
fiscal year of Envoy had, any material interest, direct or indirect, in any transactions, or in any
proposed transaction, which in either such case has materially affected or will materially affect
Envoy. Under the applicable Canadian provincial securities laws, insiders (generally officers and
directors of the Registrant and its subsidiaries) are required to file individual insider reports
of changes in their ownership in the Registrants securities within 10 days following any trade in
Envoys securities. Copies of such reports are available for public inspection at the offices of
the British Columbia Securities Commission, Suite 1100, 865 Hornby Street Vancouver, British
Columbia V6Z 21-14 (telephone 604/660-4800), at the offices of the Alberta Securities Commission,
410-300 5th Avenue, S.W., Calgary, Alberta T2P 3C4 (telephone 403/297-6454), at the
offices of the Quebec Securities Commission, Stock Tower Exchange, 800 Victoria Square, Montreal,
Quebec M42 1G3 (telephone 514/940-2150) and at the offices of the Ontario Securities Commission, 20
Queen Street West, 18th Floor, Toronto, Ontario M5H 358 (telephone 416/597-0681). 
 Item 8. FINANCIAL INFORMATION See Item 17 Financial Statements. 35




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Item 9. THE OFFER AND LISTING A. Offer and Listing Details Envoys common shares are listed for trading on the Toronto Stock Exchange (the TSX) under the
symbol ECG and on the Nasdaq Small Cap Market (Nasdaq) under the symbol ECGI. The common
shares began trading on Nasdaq on June 6, 2000 and on the TSX on September 3, 1997. From March
1984 until September 2, 1997 Envoys shares traded on the Vancouver Stock Exchange. The following table sets forth the reported high and low sale prices in Canadian dollars for the
common shares on the TSX for the fiscal, quarterly and monthly periods indicated. High
    
    LowFiscal 1999
    
    
    9.20
    
    
    
    3.40Fiscal 2000
    
    
    10.35
    
    
    
    4.80Fiscal 2001
    
    
    8.75
    
    
    
    2.10Fiscal 2002
    
    
    2.90
    
    
    
    0.20Quarterly 2003First Quarter
    
    
    0.47
    
    
    
    0.14Second Quarter
    
    
    0.32
    
    
    
    0.11Third Quarter
    
    
    0.58
    
    
    
    0.11Fourth Quarter
    
    
    1.55
    
    
    
    0.39Quarterly 2004First Quarter
    
    
    1.45
    
    
    
    1.04Second Quarter
    
    
    1.82
    
    
    
    0.87Third Quarter
    
    
    1.33
    
    
    
    0.64Fourth Quarter
    
    
    0.81
    
    
    
    0.49For the month endingJanuary 31, 2005
    
    
    0.73
    
    
    
    0.55December 31, 2004
    
    
    0.83
    
    
    
    0.63November 30, 2004
    
    
    0.85
    
    
    
    0.48October 31, 2004
    
    
    0.53
    
    
    
    0.47September 30, 2004
    
    
    0.58
    
    
    
    0.51August 31, 2004
    
    
    0.66
    
    
    
    0.52
 36




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The following table sets forth the reported high and low sale prices in US dollars of trading
for the common shares as reported on Nasdaq for the fiscal, quarterly and monthly periods
indicated. High
    
    
    LowFiscal 2000
    
    $
    10.50
    
    
    $
    4.34Fiscal 2001
    
    
    5.88
    
    
    
    1.40Fiscal 2002
    
    
    1.74
    
    
    
    0.13Quarterly 2003First Quarter
    
    
    0.29
    
    
    
    0.09Second Quarter
    
    
    0.22
    
    
    
    0.06Third Quarter
    
    
    0.42
    
    
    
    0.06Fourth Quarter
    
    
    1.14
    
    
    
    0.28Quarterly 2004First Quarter
    
    
    1.40
    
    
    
    0.66Second Quarter
    
    
    0.94
    
    
    
    0.80Third Quarter
    
    
    1.10
    
    
    
    0.89Fourth Quarter
    
    
    1.14
    
    
    
    0.92For the month endingJanuary 31, 2005
    
    
    0.60
    
    
    
    0.41December 31, 2004
    
    
    0.61
    
    
    
    0.59November 30, 2004
    
    
    0.71
    
    
    
    0.39October 31, 2004
    
    
    0.42
    
    
    
    0.37September 30, 2004
    
    
    0.45
    
    
    
    0.40August 31, 2004
    
    
    0.59
    
    
    
    0.38
 On January 31, 2005 the closing price of the common shares as reported on the TSX was $0.56
and on Nasdaq was US $0.45 See Item 6.E. with respect to Share Ownership for information regarding outstanding stock options
to purchase 2,929,748 common shares. B.Plan of Distribution Not applicable C.Markets See above section A. Offer and listing details D.Selling Shareholders Not applicable 37




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E.Dilution Not applicable F.Expenses of the issue Not applicable 
 Item 10. ADDITIONAL INFORMATION A.Share Capital Not applicable B.Memorandum and Articles of Association Envoys memorandum and articles of association were previously filed with our registration
statement on Form 20-F dated April 20, 2000 for the fiscal year ended September 30, 1999.  C.
    Material Contracts None  D.
    Exchange Controls and Other Limitations Affecting Security Holders There is no governmental law, decree or regulation in Canada that restricts the export or import of
capital, or that affects the remittance of dividends, interest or other payments to a non-resident
holder of common shares of Envoy, other than withholding tax requirement. See Item 10.E.
Taxation. There is no limitation imposed by the laws of Canada, the laws of Ontario or British Columbia or by
the charter or other constituent documents of Envoy on the right of a non-resident to hold or vote
common shares of Envoy, other than as provided in the Investment Canada Act (Canada) (the
Investment Act). The following discussion summarizes the material provisions of the Investment
Act which relate to the acquisition by a non-resident of common shares of Envoy. This summary is
not a substitute for independent advice from an investors own advisor, and it does not take into
account any future statutory or regulatory amendments. The Investment Act generally prohibits implementation of a reviewable investment by an individual,
government or agency thereof, corporation, partnership, trust or joint venture that is not a
Canadian as defined in the Investment Act (a non-Canadian), unless after review the minister
responsible for the Investment Act (the Minister) is satisfied that the investment is likely to
be of net benefit to Canada. An investment in common shares of Envoy by a non-Canadian, other than
a WTO investor (as defined in the Investment Act) at any time Envoy is not controlled by a WTO
investor, is reviewable under the Investment Act if the investment is to acquire control of Envoy
and the value of the assets of Envoy is over $5,000,000 Cdn. for a direct acquisition and over
$50,000,000 Cdn. for an indirect acquisition or if an order for review is made by the Federal
Cabinet on the grounds that the investment relates to Canadas cultural heritage or national
identity. An investment in common shares of Envoy by a WTO investor, or by a non-Canadian at any
time Envoy is controlled by a WTO investor, is reviewable under the Investment Act if the
investment is to acquire control of Envoy and the value of the assets of Envoy is not less than
Cdn. $150,000,000 in terms of constant 1992 dollars, which for 2003 is Cdn. $223,000,000. A
non-Canadian would acquire control of Envoy for the purposes of the Investment Act if such investor
acquired a majority of the common shares of Envoy unless it could be established that, on the
acquisition, Envoy was not controlled in fact by the acquiror through the ownership of common
shares. Certain transactions relating to common shares of Envoy would be exempt from the Investment Act
including:  (a)
    an acquisition of common shares of Envoy by a person in the ordinary course of
that persons business as a trader or dealer in securities,(b)
    an acquisition of control of Envoy in connection with the realization of
security granted for a loan or other financial assistance and not for a purpose related
to the provision of the Investment Act,(c)
    an acquisition of control of Envoy by reason of an amalgamation, merger,
consolidation or corporate reorganization following which the ultimate direct or
indirect control in fact of Envoy through the ownership of common shares, remained
unchanged, 38




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(d)
    an acquisition of voting interests by any person in the ordinary course of a
business carried on by that person that consists of providing, in Canada, venture
capital on terms and conditions not inconsistent with such terms and conditions as may
be fixed by the Minister, and(e)
    an acquisition of control of a Canadian business for the purpose of
facilitating its financing and not for any purpose related to the provisions of the
Investment Act on the condition that the acquirer divest itself of control within two
years after it is acquired or within such longer period as is approved by the Minister. E.Taxation The following discussion is intended to be a general summary of certain material Canadian federal
income tax considerations applicable to holders of common shares described below and is not
intended to be, nor should it be construed to be, legal or tax advice to any particular person, and
no opinion or representation with respect to income tax considerations is hereby given or made. It
does not take into account any particular partys individual circumstances and does not address
consequences peculiar to any party subject to special provisions of Canadian income tax law. Each
person should consult their own tax advisors with respect to the tax consequences of an investment
in the common shares in their own particular circumstances. The following summary is based upon the current provisions of the Income Tax Act (Canada) (the
ITA), and the regulations thereunder and the Canada-United States Income Tax Convention (1980) as
amended (the Convention), all proposed amendments to the ITA and the regulations thereunder and
the Convention publicly announced by the Department of Finance, Canada prior to the date hereof,
and the current published administrative policies and assessing practices of the Canada Customs and
Revenue Agency. Except for the foregoing, this summary does not take into account or anticipate
any changes in the law or the Convention or the administrative policies or assessing practices of
the Canada Customs and Revenue Agency whether by legislative, governmental or judicial action or
decision, and does not take into account or anticipate provincial, territorial or foreign tax
legislation or considerations, which may differ significantly from the Canadian federal income tax
considerations described herein. The summary discusses the principal Canadian federal income tax considerations under the ITA and
the regulations thereunder generally applicable to purchasers of common shares who at all times:
(i) for purposes of the ITA, are not, have not been and will not be or be deemed to be resident in
Canada while they held or hold common shares, deal at arms length with Envoy, are not affiliated
with Envoy, hold their common shares as capital property, do not use or hold, and will not and will
not be deemed to use or hold their common shares in, or in the course of carrying on a business in
Canada, and are not financial institutions for the purposes of the mark-to-market rules, and (ii)
for purposes of the Convention, are residents of the U.S. and not residents of Canada and will not
hold their common shares as part of the business property of, or so that their common shares are
effectively connected with, a permanent establishment in Canada or in connection with a fixed base
in Canada (a U.S. Holder). Amounts in respect of common shares paid or credited or deemed to be paid or credited as, on
account or in lieu of payment of, or in satisfaction of, dividends to a U.S. Holder will generally
be subject to Canadian non-resident withholding tax. Such withholding tax is levied at a rate of
25%, which may be reduced pursuant to the terms of the Convention. Under the Convention, the rate
of Canadian non-resident withholding tax on the gross amount of dividends beneficially owned by a
U.S. Holder is 15%. However, where such beneficial owner is a company which owns at least 10% of
the voting stock of Envoy, the rate of such withholding is 5%. A U.S. Holder will not be subject to tax under the ITA in respect of any disposition of common
shares (other than a disposition to Envoy) unless at the time of such disposition such common
shares constitute taxable Canadian property of the holder for purposes of the ITA. If the common
shares are listed on a prescribed stock exchange, for the purposes of the ITA, such as the TSX, at
the time they are disposed of, they will generally not constitute taxable Canadian property of
the U.S. Holder at the time of a disposition of such shares unless at any time during the 60-month
period immediately preceding the disposition of the common shares, 25% or more of the issued shares
of any class or series of Envoy, or an interest therein or an option in respect thereof, was owned
by the U.S. Holder, by persons with whom the U.S. Holder did not deal at arms length or by the
U.S. Holder and persons with whom the U.S. Holder did not deal at arms length. The common shares
may also be taxable Canadian property in certain other circumstances. Under the Convention, gains
derived by a U.S. Holder from the disposition of common shares will generally not be taxable in
Canada unless the value of the common shares is derived principally from real property situated in
Canada. If the common shares are listed on a prescribed stock exchange for the purposes of the
ITA at the time they are disposed of by a U.S. Holder, the U.S. Holder will generally not be
required to comply with the provisions of section 116 of the ITA, which requires notification to be
given to the Canada Customs and Revenue Agency when certain property is disposed of. 39




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##### 



F.Dividend and Paying Agents Not applicable G.Statement by experts Not applicable H.Documents on Display Any statement in this Annual Report about any of our contracts or other documents is not
necessarily complete. If the contract or document is filed as an exhibit to this Annual Report, the
contract or document is deemed to modify our description. You must review the exhibits themselves
for a complete description of the contract or document. You may review a copy of our filings with
the SEC, including exhibits and schedules filed with this Annual Report, at the SECs public
reference facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549.
You may also obtain copies of such materials from the Public Reference Section of the SEC, Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. You may
call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. The SEC
maintains a 67 Web site (http://www.sec.gov) that contains reports, proxy and information
statements and other information regarding registrants that file electronically with the SEC. We
began to file electronically with the SEC in May 2000. You may read and copy any reports,
statements or other information that we file with the SEC at the addresses indicated above and you
may also access some of them electronically at the Web site set forth above. These SEC filings are
also available to the public from commercial document retrieval services. We also file reports,
statements and other information with the Canadian Securities Administrators, or the CSAs, and
these can be accessed electronically at the CSAs System for Electronic Document Analysis and
Retrieval web-site at http://www.sedar.com. 
 Item 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Except as described below, Envoy does not have any material position or exposure with respect to
any market risk sensitive instruments (as defined in Item 11 in Form 20-F). Foreign Currency Risk The Company is subject to currency risk through its activities in the United
States and United Kingdom. Unfavourable changes in exchange rate may affect the operating results
of the Company. The Company does not actively use derivative instruments to reduce its exposure to
foreign currency risk. However, dependent on the nature, amount and timing of foreign currency
receipts and payments, the Company may enter into foreign currency contracts to mitigate the
associated risks. As at September 30, 2004 there were no foreign currency contracts outstanding. 
 Item 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Not applicable 
 PART II 
 Item 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES A. There has been no material default in the payment of principal, interest, a sinking or purchase
fund installment. B. There is no preferred stock of Envoy or any of its significant subsidiaries and accordingly
there has been no material arrearage in the payment of dividends or any other material delinquency
not cured within 30 days, with respect to any class of preferred stock of Envoy or any of its
significant subsidiaries. 
 Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS A. There have been no material modifications in the constituent instruments defining any class of
registered securities of Envoy. B. There has been no material limitation or qualification of the rights evidenced by any class of
registered securities of Envoy by the issuance or modification of any other class of securities of
Envoy. C. There has been no material withdrawal or substitution of assets securing any class of
registered securities of Envoy. D. Not applicable 40




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##### 



E. Not applicable 
 Item 15. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that the information
required to be disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms, and that such information
is accumulated and communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. After
evaluating the effectiveness of the Companys disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) September 30, 2004, the our Chief Executive Officer
and Chief Financial Officer have concluded that as of such date, the Companys disclosure controls
and procedure were adequate and effective to ensure that material information relating to the
Company and its consolidated subsidiaries would be made known to them by others within those
entities. There were no significant changes in our internal controls or in other factors that could
significantly affect these disclosure controls and procedures during the fiscal year, including any
significant deficiencies or material weaknesses of internal controls that would require corrective
action. Item 16. RESERVED 
 A.  Audit Committee Financial Expert The Board of Directors has determined that Envoy has at least one financial expert serving on its
audit committee, and that David Parkes is that audit committee financial expert. David Parkes is
an independent audit committee member. 
 B. Code of Ethics The Board of Directors has adopted a code of ethics (Code of Business Conduct) for all employees,
including Envoys CEO, CFO, chief accounting officer or controller and for persons performing
similar functions. A copy of the Code of Business Conduct is attached hereto as Exhibit 14. In
accordance with applicable rules, the code of ethics has been filed with the appropriate bodies and
posted on Envoys website at www.Envoy.to. Envoy undertakes to provide to any person without
charge, upon request, a copy of such Code of Business Conduct. A copy of the Code of Business
Conduct may be obtained by letter addressed to Envoy as follows: Investor Relations, Envoy
Communications Group Inc., 172 John Street, Toronto, Ontario, M5T 1X5. C.  Principal Accountant Fees and Services  (a)
    Audit Fees were $598 in 2004 and $165 in 2003. These fees include year end audit
work, consents, reviews and assistance with regulatory filings.(b)
    Audit-Related Fees were $43 in 2004 and $28 in 2003. These fees include assistance
with due diligence and accounting research.(c)
    Tax Fees were $71 in 2004 and $40 in 2003. These fees include tax compliance
services and tax advise.(d)
    All Other Fees were $nil in 2004 and $nil in 2003. D.  Exemptions from the Listing Standards for Audit Committees Not Applicable 
  E.
    Purchases of Equity Securities by the Issuer and Affiliated PurchasersNone 41




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##### 



PART III 
 Item 17. FINANCIAL STATEMENTS (a)
    
    Envoy Communications Group Inc.(i)
    
    Auditors Report on the financial statements for the year ended September 30, 2004Comments by Auditor for U.S. Readers On Canada-U.S. Reporting Difference
    
    F-1Auditors Report on the financial statements for the year ended September 30, 2003 and 2002(ii)
    
    Consolidated Balance Sheets as at September 30, 2004 and 2003
    
    F-2(iii)
    
    Consolidated Statements of Operations for the years ended September 30, 2004, 2003 and 2002
    
    F-3(iv)
    
    Consolidated Statements of Retained Earnings (Deficit) for the years ended September 30,
2004, 2003 and 2002
    
    F-4(v)
    
    Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003 and 2002
    
    F-5(vi)
    
    Notes to Consolidated Financial Statements
    
    F-6
 
 Item 18. FINANCIAL STATEMENTS Envoy has elected to provide financial statements pursuant to Item 17. 
 Item 19. EXHIBITS (a)
    
    Exhibit 1
    
    By-Law No. 1 of Envoy (as
amended on May 2, 2000) & Articles of Incorporation. Incorporatedby reference from the
annual report, on form 20-F previously filed the Securities Exchange Commission on May 15, 2000.Exhibit 2
    
    Not ApplicableExhibit 3
    
    Not ApplicableExhibit 4
    
    Not ApplicableExhibit 5
    
    Not ApplicableExhibit 6
    
    Not ApplicableExhibit 7
    
    Not ApplicableExhibit 8Subsidiaries of RegistrantEnvoy has operations in the United States, the United Kingdom, Continental Europe and Canada.Significant subsidiaries are as follows:
 Company
    
    
    
    % of ownership
    
    Jurisdiction of incorporationWatt International Inc.
    
    100
    
    OntarioWatt Gilchrist Limited
    
    100
    
    United KingdomJohn Street Inc.
    
    100
    
    OntarioExhibit 9
    
    Not ApplicableExhibit 10
    
    Not ApplicableExhibit 11
    
    Not ApplicableExhibit 12
    
    See attachedExhibit 13
    
    See attachedExhibit 14
    
    See attached
 42




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##### 



SIGNATURES The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F
and that it has duly caused and authorized the undersigned to sign this annual report on its
behalf. Envoy Communications Group Inc.Date: February 17, 2005
    /s/ Geoffrey B. Genovese
    
Name:
    Geoffrey B. GenoveseTitle:
    Chairman, President and Chief Executive
Officer 43




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##### 



Envoy Communications
Group Inc.
Consolidated Financial Statements
(Expressed in Canadian dollars)
For the years ended September 30, 2004,
2003 and 2002 ContentsAuditors Report - BDO Dunwoody LLP
    
    
    2Comments by Auditor for U.S. Readers on Canada-U.S.
Reporting Differences
    
    
    3Auditors Report  KPMG LLP
    
    
    4Financial StatementsConsolidated Balance Sheets
    
    
    5Consolidated Statements of Operations
    
    
    6Consolidated Statements of Retained Earnings (Deficit)
    
    
    7Consolidated Statements of Cash Flows
    
    
    8-9Notes to Consolidated Financial Statements
    
    
    10-43




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##### 



Auditors Report
 
 To the Shareholders of Envoy Communications Group Inc. We have audited the consolidated balance sheets of Envoy Communications Group Inc. as at September
30, 2004 and 2003 and the consolidated statements of operations, retained earnings (deficit) and
cash flows for the years then ended. 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. We conducted our audits in accordance with Canadian generally accepted auditing standards and with
the standards of the Public Company Accounting Oversight Board (United States). 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, 2004 and 2003 and the results of its
operations and its cash flows for the years then ended in accordance with Canadian generally
accepted accounting principles. (signed) BDO Dunwoody LLP Chartered Accountants Toronto, Ontario
December 3, 2004 (except as to Note 23(b), which is as of February 10, 2005) 2




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##### 



F-1  Comments by Auditor for U.S. Readers
On Canada-U.S. Reporting Differences
 
 In the United States, reporting standards for auditors require the addition of an explanatory
paragraph (following the opinion paragraph) when there is a change in accounting principles that
has a material effect on the comparability of the Companys financial statements, such as the
change described in Note 2 (e), 2 (h) and 2 (m) of the financial statements. Our report to the
Shareholders dated December 3, 2004, (except as to Note 23(b), which is as of February 10, 2005).
is expressed in accordance with Canadian reporting standards which do not require a reference to
such a change in accounting principles in the Auditors Report when the change is properly
accounted for and adequately disclosed in the financial statements. (signed) BDO Dunwoody LLP Chartered Accountants Toronto, Ontario
December 3, 2004 (except as to Note 23(b), which is as of February 10, 2005) 3




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##### 



Auditors Report
 
 Independent Auditors Report The Board of Directors
Envoy Communications Group Inc. We have audited the accompanying consolidated statement of operations, retained earnings (deficit)
and cash flows of Envoy Communications Group Inc. for the year ended September 30, 2002. 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 audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform an audit to obtain
reasonable assurance about 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. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the results of its operations and the cash flows of the Company for the year
ended September 30, 2002 in accordance with Canadian generally accepted accounting principles. As discussed in Note 22 to the consolidated financial statements, the Company disposed of
a business operation and consequently, the Companys financial statements for the year
ended September 30, 2002 referred to above have been restated to reflect such business
operation as a discontinued operation. Accounting principles generally accepted in Canada vary in certain significant respects from U.S.
generally accepted accounting principles. Application of U.S. generally accepted accounting
principles would have affected results of operations for the year in ended September 30, 2002, to
the extent summarized in Note 24 to the consolidated financial statements. (signed) KPMG LLP
Chartered Accountants
Toronto, Ontario
January 9, 2003, (except as to note 24(d) which is as of February 2, 2004 and note 22 which is as
of February 10, 2005) 4




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##### 



F-2  Envoy Communications
Group Inc.
 
 Consolidated Balance Sheets
(Expressed in Canadian dollars)
 September 30
    
    2004
    
    
    2003AssetsCurrentCash
    
    $
    4,643,263
    
    
    $
    2,010,737Investments (Note 3)
    
    
    36,144,879
    
    
    
    Accounts receivable (Note 4)
    
    
    15,909,652
    
    
    
    13,623,131Future income taxes (Note 14)
    
    
    1,500,000
    
    
    
    498,172Prepaid expenses
    
    
    1,060,970
    
    
    
    842,605Discontinued operations (Note 22)
    
    
    
    
    
    
    1,869,32059,258,764
    
    
    
    18,843,965Investments(Note 3)
    
    
    10,285,563
    
    
    
    Capital assets(Note 5 & Note 21)
    
    
    5,229,232
    
    
    
    5,815,227Goodwill(Note 7 & Note 21)
    
    
    10,216,101
    
    
    
    10,059,178Other assets
    
    
    208,069
    
    
    
    39,271Future income taxes(Note 14)
    
    
    3,681,798
    
    
    
    2,668,224Discontinued operations(Note 22)
    
    
    
    
    
    
    540,898$
    88,879,527
    
    
    $
    37,966,763Liabilities and Shareholders EquityCurrentAccounts payable and accrued liabilities
    
    $
    8,682,417
    
    
    $
    10,364,168Income taxes payable
    
    
    485,217
    
    
    
    322,244Deferred revenue
    
    
    2,051,197
    
    
    
    1,195,515Amounts collected in excess of pass-through costs incurred
    
    
    110,673
    
    
    
    Bank credit facility and current portion of long-term debt (Note 8)
    
    
    297,294
    
    
    
    6,857,953Discontinued operations (Note 22)
    
    
    
    
    
    
    1,964,01111,626,798
    
    
    
    20,703,891Long-term debt(Note 8)
    
    
    361,230
    
    
    
    4,566,962Long-term portion of restructuring costs(Note 18)
    
    
    
    
    
    
    337,40711,988,028
    
    
    
    25,608,260Shareholders equityShare capital (Note 11)
    
    
    117,447,261
    
    
    
    55,988,817Contributed surplus (Note 12)
    
    
    726,554
    
    
    
    146,706Warrants (Note 11)
    
    
    6,542,456
    
    
    
    Convertible debentures (Note 9)
    
    
    
    
    
    
    1,673,408Deficit
    
    
    (48,344,277
    )
    
    
    (45,237,473
    )Stock based compensation (Note 11)
    
    
    445,641
    
    
    
    23,268Cumulative translation adjustment
    
    
    73,864
    
    
    
    (236,223
    )76,891,499
    
    
    
    12,358,503$
    88,879,527
    
    
    $
    37,966,763
 On behalf of the Board:(signed)
    
    
    
    (signed)Geoffrey B. Genovese,
    
    
    
    John H. Bailey,Director
    
    Director
 The accompanying notes are an integral part of these financial statements 5




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##### 



F-3  Envoy Communications
Group Inc.
 
 Consolidated Statements of Operations
(Expressed in Canadian dollars)
 For the years ended September 30
    
    2004
    
    
    2003
    
    
    2002Net revenue
    
    $
    40,802,790
    
    
    $
    40,853,283
    
    
    $
    56,896,689Operating expenses:Salaries and benefits (Note 11)
    
    
    27,672,600
    
    
    
    26,858,508
    
    
    
    43,480,392General and administrative (Note 15)
    
    
    7,041,213
    
    
    
    5,889,962
    
    
    
    11,355,246Occupancy costs
    
    
    3,012,394
    
    
    
    3,060,590
    
    
    
    4,622,42537,726,207
    
    
    
    35,809,060
    
    
    
    59,458,063Depreciation
    
    
    2,425,912
    
    
    
    2,370,934
    
    
    
    2,814,168Investment earnings(Note 3)
    
    
    (406,683
    )
    
    
    
    
    
    
    Accreted interest imputed on warrants
and debentures(Note 10)
    
    
    2,552,991
    
    
    
    718,321
    
    
    
    133,870Interest expense and financing costs(Note 10)
    
    
    995,601
    
    
    
    1,989,366
    
    
    
    1,069,82343,294,028
    
    
    
    40,887,681
    
    
    
    63,475,924Loss before unusual items, restructuring
costs, gain on disposal of subsidiaries,
income taxes, goodwill amortization and
write-down and discontinued operations
    
    
    (2,491,238
    )
    
    
    (34,398
    )
    
    
    (6,579,235
    )Unusual items (expense)(Note 17)
    
    
    
    
    
    
    
    
    
    
    (750,648
    )Restructuring costs recovery (expense)(Note 18)
    
    
    
    
    
    
    267,212
    
    
    
    (10,829,328
    )Gain on disposal of subsidiaries(Notes 15 & 16)
    
    
    
    
    
    
    2,499,604

    
    
    
    (Loss) income before income taxes,
goodwill amortization and write-down
and discontinued operations
    
    
    (2,491,238
    )
    
    
    2,732,418
    
    
    
    (18,159,211
    )Income tax expense (recovery)(Note 14)
    
    
    150,424
    
    
    
    238,404
    
    
    
    (4,911,772
    )(Loss) income before goodwill amortization and
write-down and discontinued operations
    
    
    (2,641,662
    )
    
    
    2,494,014
    
    
    
    (13,247,439
    )Goodwill amortization, net of income taxrecovery of $nil (2003 - $nil; 2002 - $24,000)
    
    
    
    
    
    
    
    
    
    
    (2,187,509
    )Write-down of goodwill(Note 7)
    
    
    
    
    
    
    
    
    
    
    (37,934,711
    )(Loss) income from continuing operations
    
    
    (2,641,662
    )
    
    
    2,494,014
    
    
    
    (53,369,659
    )(Loss) income from discontinued operations,net of income taxes(Note 22)
    
    
    (465,142
    )
    
    
    44,748
    
    
    
    (9,776
    )Net (loss) earnings
    
    $
    (3,106,804
    )
    
    $
    2,538,762
    
    
    $
    (53,379,435
    )Net (loss) earnings per share(Note 13)Basic
    
    $
    (0.18
    )
    
    $
    0.59
    
    
    $
    (12.71
    )Diluted
    
    $
    (0.18
    )
    
    $
    0.43
    
    
    $
    (12.71
    )Weighted average number of common
shares outstanding
    
    
    17,062,152
    
    
    
    4,334,813
    
    
    
    4,199,679
 The accompanying notes are an integral part of these financial statements 6




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##### 



F-4  Envoy Communications
Group Inc.
 
 Consolidated Statements of Retained Earnings (Deficit)
(Expressed in Canadian dollars)
 For the years ended September 30
    
    2004
    
    
    2003
    
    
    2002Retained earnings (deficit),beginning of year
    
    $
    (45,237,473
    )
    
    $
    (47,776,235
    )
    
    $
    5,603,200Net (loss) earnings
    
    
    (3,106,804
    )
    
    
    2,538,762
    
    
    
    (53,379,435
    )Deficit,end of year
    
    $
    (48,344,277
    )
    
    $
    (45,237,473
    )
    
    $
    (47,776,235
    )
 The accompanying notes are an integral part of these financial statements 7




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##### 



F-5  Envoy Communications
Group Inc.
 
 Consolidated Statements of Cash Flows
(Expressed in Canadian dollars)
 For the years ended September 30
    
    2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net (loss) earnings
from continuing operations
    
    $
    (2,641,662
    )
    
    $
    2,494,014
    
    
    $
    (53,369,659
    )Items not involving cash:Future income taxes (recovery)
    
    
    (334,016
    )
    
    
    143,828
    
    
    
    (1,875,536
    )Depreciation
    
    
    2,425,912
    
    
    
    2,370,934
    
    
    
    2,814,168Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    2,211,509Write-down of goodwill
    
    
    
    
    
    
    
    
    
    
    37,934,711Amortization of deferred financing
charges
    
    
    21,110
    
    
    
    108,996
    
    
    
    96,263Write-down of deferred
financing charges
    
    
    
    
    
    
    
    
    
    
    750,648Convertible debentures accretion
    
    
    126,273
    
    
    
    718,321
    
    
    
    133,870Debentures and term notes accretion
    
    
    2,426,718
    
    
    
    
    
    
    
    Stock based compensation
    
    
    200,117
    
    
    
    23,268
    
    
    
    Gain on disposal of subsidiaries
    
    
    
    
    
    
    (2,499,604
    )
    
    
    Recognition of cumulative translation
on closure of Hampel Stefanides
(Note 15)
    
    
    
    
    
    
    (841,081
    )
    
    
    Write-down of capital assets
    
    
    
    
    
    
    356,865
    
    
    
    3,481,105Other
    
    
    
    
    
    
    
    
    
    
    52,500Net change in non-cash working capital balances:Accounts receivable
    
    
    (2,286,521
    )
    
    
    (504,824
    )
    
    
    5,914,419Prepaid expenses
    
    
    (218,365
    )
    
    
    (141,282
    )
    
    
    340,263Accounts payable and accrued liabilities
    
    
    (1,681,751
    )
    
    
    92,707
    
    
    
    (17,461,721
    )Income taxes payable/recoverable
    
    
    162,973
    
    
    
    2,863,177
    
    
    
    (2,563,080
    )Deferred revenue
    
    
    855,682
    
    
    
    (63,917
    )
    
    
    1,672,829Amounts collected in excess of
pass-through costs incurred
    
    
    110,673
    
    
    
    76,591
    
    
    
    (547,439
    )Long-term restructuring costs
    
    
    (337,407
    )
    
    
    (454,868
    )
    
    
    792,275Other
    
    
    (197,802
    )
    
    
    (279,046
    )
    
    
    (94,129
    )Discontinued operations
    
    
    (18,935
    )
    
    
    (138,406
    )
    
    
    (115,546
    )Net cash provided by (used in)
operating activities
    
    
    (1,387,001
    )
    
    
    4,325,673
    
    
    
    (19,832,550
    )Cash flows from financing activities:Long-term debt borrowings
    
    
    4,500,000
    
    
    
    1,079,441
    
    
    
    1,580,459Long-term debt repayments
    
    
    (5,150,000
    )
    
    
    (4,835,314
    )
    
    
    (2,539,248
    )Short-term debt repayments
    
    
    (6,885,125
    )
    
    
    
    
    
    
    Issuance of common shares,
net of share issue costs
    
    
    60,670,009
    
    
    
    109,084
    
    
    
    Issuance of convertible debentures
    
    
    
    
    
    
    2,000,000
    
    
    
    3,800,000Redemption of common shares
    
    
    (816,549
    )
    
    
    
    
    
    
    (628,083
    )Net cash provided by (used in)
financing activities
    
    
    52,318,335
    
    
    
    (1,646,789
    )
    
    
    2,213,128
 The accompanying notes are an integral part of these financial statements 8




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##### 



Envoy Communications Group Inc.
Consolidated Statements of Cash Flows (continued)
(Expressed in Canadian dollars)
 For the years ended September 30
    
    2004
    
    
    2003
    
    
    2002Cash flows from investing activities:Acquisition of subsidiaries, net of cash
acquired of $nil (2003 - $nil;
2002 - $nil)
    
    
    
    
    
    
    (104,137
    )
    
    
    (2,075,929
    )Purchase of capital assets
    
    
    (1,729,638
    )
    
    
    (1,110,717
    )
    
    
    (1,789,205
    )Proceeds on sale of capital assets
    
    
    
    
    
    
    176,106
    
    
    
    Investments
    
    
    (46,382,502
    )
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (48,112,140
    )
    
    
    (1,038,748
    )
    
    
    (3,865,134
    )Change in cash balance due to foreign
exchange
    
    
    (186,668
    )
    
    
    74,585
    
    
    
    297,978Net change in cash
    
    
    2,632,526
    
    
    
    1,714,721
    
    
    
    (21,186,578
    )Cash,beginning of year
    
    
    2,010,737
    
    
    
    296,016
    
    
    
    21,482,594Cash,end of year
    
    
    4,643,263
    
    
    
    2,010,737
    
    
    
    296,016Supplemental cash flow information:Interest paid
    
    $
    993,634
    
    
    $
    1,977,822
    
    
    $
    643,199Income taxes paid
    
    
    742,443
    
    
    
    45,800
    
    
    
    496,122Supplemental disclosure of non-cash
transactions:Conversion of debentures
    
    
    4,200,284
    
    
    
    1,540,343
    
    
    
    Shares issued for non-cash consideration
    
    
    
    
    
    
    
    
    
    
    265,500Capital assets acquired under capital
leases
    
    
    56,163
    
    
    
    
    
    
    
    820,424
 The accompanying notes are an integral part of these financial statements 9




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##### 



F-6  Envoy Communications
Group Inc.
 
 Notes to Consolidated
Financial Statements
 For the years ended September 30, 2004, 2003 and 2002 
  1. Nature of Business The Company, continued under the Business Corporations Act (Ontario),
has operations in the United States, the United Kingdom and Canada and
provides marketing, consumer and retail branding services. Basis of Presentation  (a)
    The consolidated financial statements have been prepared by management in
accordance with generally accepted accounting principles in Canada, which vary in certain
significant respects from generally accepted accounting principles in the United States.
A description of the significant differences, as applicable to the Company, is included
in note 24.(b)
    Certain comparative figures have been reclassified to conform to the financial
statement presentation adopted for 2004.(c)
    The comparative figures have been restated as a result of the discontinued
operations described in Note 22. 
  2. Significant Accounting Policies  (a)
    Principles of ConsolidationThe 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 as at September 30, 2004 and 2003 and 2002 are as follows: 2004
    
    
    2003
    
    
    2002
    
    
    Jurisdiction ofCompany
    
    % ownership
    
    
    %ownership
    
    
    %ownership
    
    
    incorporationWatt International Inc.
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    OntarioWatt Gilchrist Limited
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    United KingdomJohn Street Inc.
    
    
    100
    
    
    
    70
    
    
    
    70
    
    
    Ontario
  (b)
    Use of EstimatesThe preparation of financial statements in conformity with Canadian generally accepted
accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenue and
expenses during the year. Actual results could differ from those estimates. 10




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   2.
    Significant Accounting Policies (continued)  (c)
    Capital Assets Capital assets are recorded at cost and are depreciated over their estimated useful lives
as follows: Asset
    
    Basis
    
    RateComputer equipment and
software
    
    Declining balance
    
    30% - 50%Furniture and equipment
    
    Declining balance
    
    20%Leasehold improvements
    
    Straight line
    
    Over term of leasesEquipment under capital leases
    
    Straight line
    
    3 - 5 yearsAudio visual equipment
    
    Straight line
    
    2 - 5 years
  (d)
    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 representing only fees billed and collected in advance of
such fees being earned; and(ii)
    the reimbursable pass-through costs which are included in unbilled accounts
receivable; and(iii)
    the amount collected in excess of pass-through costs incurred; and(iv)
    work in process represents costs incurred on projects for which revenue has not yet
been recognized for accounting purposes. Included in work in process are charges for staff time at standard cost and third party
charges. The standard cost rate provides for the recovery of actual labour and overhead
costs incurred. The third party charges are for actual costs related to outsourced goods
and services for specific projects 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. 11




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   2.
    Significant Accounting Policies (continued) 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 rateably 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.  (e)
    Goodwill Goodwill represents the price paid for acquisitions in excess of the fair market value of
net tangible and intangible assets acquired. Effective October 1, 2002, the Company
adopted the recommendations of the CICA Handbook section 3062 Goodwill and Other
Intangible Assets. These standards require that goodwill and other intangible assets
determined to have indefinite lives are no longer amortized but tested for impairment based
on the fair value of the Companys reporting units on adoption of the standard and at least
annually thereafter. The Company uses a two-step impairment test on an annual basis, or when
significant business changes have occurred that may have had an adverse impact on the
fair value of the goodwill. To determine whether impairment has occurred, the fair
value of the reporting unit is compared to its carrying amounts, including goodwill.
When the fair value is in excess of its carrying amount, the goodwill is not
considered to be impaired, and the second step of the impairment test is not
necessary. When the carrying amount of the reporting unit as determined in the first
step exceeds the fair value, then the fair value of the goodwill is determined in the
same manner as followed on a business combination. The excess of the fair value of
the reporting unit over the amounts assigned to its assets and liabilities is the fair
value of goodwill. An impairment loss is recognized when the carrying amount of the
goodwill of a reporting unit exceeds its fair value. It is not reversed in the event
that the fair value subsequently increases.  (f)
    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 as Cumulative Translation Adjustment. 12




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002  2. Significant Accounting Policies (continued) 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.  (g)
    Income Taxes The Company accounts for income taxes using the liability method. Under this method,
future income taxes are recognized at the enacted or substantially enacted tax rate
expected to be applicable at the date of reversal for all significant temporary differences
between the tax and accounting bases of assets and liabilities and for certain tax
carryforward items. Future income tax assets are recognized only to the extent that, in
the opinion of management, it is more likely than not that the future income tax assets
will be realized. Future income tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of the substantive enactment of the change.  (h)
    Stock-based Compensation For fiscal 2003, the Company adopted the recommendations of The Canadian
Institute of Chartered Accountants (CICA) handbook section 3870, Stock-Based
Compensation and Other Stock-Based Payments. These standards require that direct
awards of stock or liabilities incurred, or other compensation arrangements that are
based on the price of common stock, be measured at fair value at each reporting date,
with the change in fair value reported in the Statement of Operations. These
standards encourage, but do not require, the use of the fair value method for all
other types of employees stock-based compensation plans. The Company did not use the
fair value method to account for employees stock based compensation plans, but
disclosed pro-forma information for options granted in fiscal 2003 (See note 11). Effective October 1, 2003, the Company adopted the revisions to section 3870 that required
the use of the fair value method for all stock-based compensation transactions. The
Company, as permitted by section 3870, has adopted the change prospectively for options
granted on or after October 1, 2003.  (i)
    Earnings per Share The Company uses the provisions of CICA Handbook section 3500,
Earnings per Share. Basic earnings per share is computed using the
weighted average number of common shares that are outstanding during
the year. Diluted earnings per share is computed using the weighted
average number of common and potential common shares outstanding
during the year. Potential common shares consist of the incremental
common shares issuable upon the exercise of stock options and warrants
under the treasury stock method and potential shares issuable upon
conversion of convertible debt using the if converted method. 13




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   2.
    

    Significant Accounting Policies (continued)  (j)
    Business Combinations The Company uses the provisions of the CICA Handbook section 1581, Business Combinations.
All business combinations are accounted for using the purchase method of accounting. The
value of shares issued in a business combination are measured using the
average share price for a reasonable period before and after the date the terms of the
acquisition are agreed to and announced. Intangible assets that meet specific criteria are
recognized and reported apart from goodwill.  (k)
    Investments The Company uses the provisions of the CICA Handbook section 3010, Temporary Investments,
and section 3050 Long-term investments. Investments are classified as short term or long
term based on managements intended holding period. Investments are classified as current
assets only if capable of reasonably prompt liquidation, and include temporary holdings of
marketable securities. The short term investment basket is carried at the lower of
carrying value or market value of the basket at the balance sheet date. Investments are
classified as long term assets where management has indicated a long term intended holding
period. The long term basket is carried at carrying value and is written down to market
price if there has been a decline in value that is not considered to be temporary. Once a
write-down has been made of the short term or the long term basket, it is not reversed in
the event of a subsequent increase in value. For the purposes of calculating a gain or
loss on the sale of an investment, the cost of the investment sold is calculated on the
basis of the average carrying value.  (l)
    Impairment of long-lived assets New CICA Handbook Section 3063 establishes standards for the recognition,
measurement and disclosure of the impairment of long-lived assets held for use. Under
the new standards, an impairment loss is recognized when the carrying amount of an
asset held for use exceeds the sum of the undiscounted cash flows expected from its
use and eventual disposition. An impairment loss is measured as the amount by which
the assets carrying amount exceeds its fair value.  (m)
    Discontinued operations Effective May 1, 2003, the Company uses the provisions of the CICA Handbook section 3475,
Disposal of long-lived assets and discontinued operations. The results of
operations of a business that has either been disposed of, or is held for sale, is
reported as discontinued operations if the operations and cash flows of the component
have been (or will be) eliminated from the Companies ongoing operations, and the
Company will not have any significant continuing involvement in the operations of the
component after the disposal transaction. The results of discontinued operations, less
applicable taxes are reported as a separate element of income or loss before
extraordinary items for both current and prior periods. For businesses that were disposed of prior to the adoption of these new standards, the Company
includes the results of their operations in the comparative financial results. 14




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   3.
    Investments 2004
    
    
    2003Short term
Cost
    
    $
    36,144,879
    
    
    $
    Long term
Cost
    
    
    10,285,563
    
    
    
    $
    46,430,442
    
    
    $
    
 The net proceeds from the public offering described in Note 11 have been placed in a portfolio
managed by an external adviser, and will be drawn to fund acquisitions and business operations
as required. The portfolio is invested in marketable securities, including discount notes,
fixed income securities and common shares. All financial instruments held in the portfolio
are traded in active and liquid markets, and the fair market value of the portfolio was
determined by using the closing market prices at September 30, 2004 of the individual
financial instruments. The fair value of the short term and long term investments at September 30, 2004 was
$36,183,729 and $10,421,139, (2003 - $nil and $nil), respectively. The investment portfolio
earned $406,683 during fiscal 2004 (2003 and 2002 - $nil), after deducting portfolio
management and custody fees.  4.
    Accounts receivable 2004
    
    
    2003Trade receivables
    
    $
    7,603,821
    
    
    $
    7,034,344Accrued revenue
    
    
    7,466,778
    
    
    
    4,317,799Work in process
    
    
    839,053
    
    
    
    2,270,988$
    15,909,652
    
    
    $
    13,623,131
 15




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   5.
    Capital assets Accumulated
    
    
    Net book2004
    
    Cost
    
    
    depreciation
    
    
    valueComputer equipment and software
    
    $
    11,049,939
    
    
    $
    8,532,312
    
    
    $
    2,517,627Furniture and equipment
    
    
    502,402
    
    
    
    374,816
    
    
    
    127,586Leasehold improvements
    
    
    4,174,973
    
    
    
    1,893,191
    
    
    
    2,281,782Equipment under capital leases
    
    
    1,161,052
    
    
    
    864,826
    
    
    
    296,226Audio visual equipment
    
    
    6,679
    
    
    
    668
    
    
    
    6,011$
    16,895,045
    
    
    $
    11,665,813
    
    
    $
    5,229,232
 Accumulated
    
    
    Net book2003
    
    Cost
    
    
    depreciation
    
    
    valueComputer equipment and software
    
    $
    9,713,529
    
    
    $
    7,425,741
    
    
    $
    2,287,788Furniture and equipment
    
    
    414,626
    
    
    
    290,016
    
    
    
    124,610Leasehold improvements
    
    
    3,985,247
    
    
    
    1,485,008
    
    
    
    2,500,239Equipment under capital leases
    
    
    1,741,118
    
    
    
    838,528
    
    
    
    902,590$
    15,854,520
    
    
    $
    10,039,293
    
    
    $
    5,815,227
   6.
    Related party transactions In October and November 2002 the Company sold the operations of Devlin Multimedia Inc.
(Devlin) and Sage to certain executives of the respective subsidiaries (see Note 16). During fiscal 2003, relatives of the Chief Executive Officer loaned the Company $225,000 of
which $150,000 was outstanding at September 30, 2003. The loan bore an interest rate of 10%
per annum and was repayable on demand. During fiscal 2004, the loan was repaid in full. During fiscal 2003, relatives of a director loaned the Company $75,000 which was repaid prior
to year end. The loan bore an interest rate of 10% per annum, and was repayable on demand. During fiscal 2003, relatives of the Chief Executive Officer and a director were part of the
group that loaned the Company $2.0 million of convertible debentures. In total, these
relatives loaned the Company $1,850,000, of which
$1,070,000 was outstanding at September 30, 2003. During fiscal 2004 all the debentures were
converted into additional shares, as described in Note 9. During fiscal
2004, the Company paid one of its directors $266,100 (2003 - $312,589; 2002 -
$265,936) for legal services. During fiscal 2004, certain executives of the Company loaned the Company an amount of
$100,000, and a relative of a director loaned the Company an amount of $150,000. These
debentures bore an interest rate of 10% per annum, and included warrants to purchase a total
of 125,000 shares at $0.15 per share. During fiscal 2004, these debentures were repaid. 16




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   6.
    Related party transactions (continued) At January 1, 2004, the Company sold the operations of Communique Incentives Inc to an
executive of the subsidiary (see Note 22). At September 30, 2004, the Company purchased from the executive officers of John Street Inc.
the 30% of the shares of John Street Inc. which it did not already own (see Note 19(b)). Related party transactions are recorded at the exchange amount, being the amount agreed to by
the related parties.   7.
    GoodwillThe changes in the carrying amount of goodwill for the year ended September 30 were as follows: 2004
    
    
    2003Goodwill  beginning of year
    
    $
    10,059,178
    
    
    $
    11,314,283Discontinued operations
    
    
    
    
    
    
    (466,607
    )Goodwill  beginning of year, adjusted
    
    
    10,059,178
    
    
    
    10,847,676Additions
    
    
    
    
    
    
    104,137Increase (decrease)charged to
cumulative translation adjustment
    
    
    156,923
    
    
    
    (892,635
    )Goodwill, end of year
    
    $
    10,216,101
    
    
    $
    10,059,178
 In 2002, the Company performed assessments of the carrying values of goodwill recorded in
connection with its various businesses. The assessment was performed because a number of
factors indicated that an impairment had arisen commencing in the period ending March 31,
2002. The main indicators of impairment were significant negative industry and economic
trends impacting both current operating results and expected future growth rates and loss of
significant clients. Based on these factors, the Company concluded that significant permanent
impairment existed with respect to the Companys goodwill and other assets, which primarily
related to the goodwill associated with the businesses of Sage, Promanad and Hampel
Stefanides. In quantifying the impairment charge, the Company compared the expected future undiscounted
cash flows of each acquisition, to the respective carrying value of the assets of the
business, including assigned goodwill. The cash flow periods used ranged between 5 and 25
years, consistent with the remaining goodwill amortization period. As a result of the review, the Company determined that the carrying values of certain acquired
businesses were not fully recoverable. Accordingly, the Company recorded two write-downs:
$28,426,266 in the second quarter of 2002
and $ 9,508,445 in the fourth quarter of 2002 based on the amount by which the goodwill
exceeded the expected future undiscounted cash flows of the respective operation. At September 30, 2004 and 2003 respectively, the Company assessed the carrying values of
Goodwill and concluded that no further write-down was required. 17




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   8.
    Bank credit facility and long-term debt 2004
    
    
    2003Bank credit facility (a)
    
    $
    
    
    
    $
    6,115,746Loan payable to landlord, 3.5% per annum, due
July 1, 2009, repayable in monthly instalments
of $7,666 principal and interest
    
    
    403,676
    
    
    
    481,297Loan payable to landlord, 10.0% per annum, due
March 1, 2010, repayable in monthly instalments of
$3,956 principal and interest
    
    
    
    
    
    
    227,556Loan payable to landlord, 10.0% per annum, due
April 1, 2005, repayable in monthly instalments of
$742 principal and interest
    
    
    25,389
    
    
    
    31,479Loan payable to landlord, 8.0% per annum, due
April 1, 2010, repayable in monthly instalments of
$561 principal and interest
    
    
    
    
    
    
    34,488Capital lease, 12.3% over the lease period, repayable
in quarterly instalments of £7,919 principal and
interest, due November 2004
    
    
    18,101
    
    
    
    86,295Capital leases, 8.6% to 14% over the lease period,
repayable in monthly instalments of $36,273 principal
and interest, due between January 2005 and
January 2006
    
    
    211,358
    
    
    
    566,788Promissory note, 10% per annum, due on demand
    
    
    
    
    
    
    150,000Promissory note, 10% per annum, due on
September 30, 2006 (b)
    
    
    
    
    
    
    500,000Convertible debentures (Note 9)
    
    
    
    
    
    
    3,231,266658,524
    
    
    
    11,424,915Less current portion
    
    
    297,294
    
    
    
    6,857,953$
    361,230
    
    
    $
    4,566,962
   (a)
    In the first quarter of fiscal 2004, the Company reduced its demand operating
facility from $7,000,000 to $3,000,000, using $3,800,000 of the proceeds from debentures
that were issued on October 31, 2003, and another $200,000 drawn from working capital.
Warrants, (the Bank Warrants) to purchase 2,300,000 of the Companys common shares were
released by the bankers upon the condition that Envoy raise additional funds to further
reduce its bank indebtedness.In the second quarter of fiscal 2004, with the proceeds raised in a public offering, the
Company paid off the remaining balance outstanding and cancelled the demand operating
facility. See note 11(b) for details of the public offering.(b)
    In September 2003, the holder of the $500,000 promissory note agreed to postpone
the maturity date of the promissory note from June 30, 2003 to September 30, 2006 and to
reduce the rate of interest from 15% to 10% per annum. In consideration of the
foregoing, in the first quarter of fiscal 2004, share purchase warrants to purchase, on
or before April 24, 2008, 50,000 of the Companys common shares at an exercise price of
$0.15 per share were transferred to the holder of the promissory note. 18




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   8.
    Bank credit facility and other debt (continued)  (c)
    On October 31, 2003, the Company borrowed the amount of $4,500,000, of which
$4,000,000 was raised by way of secured debentures and $500,000 by way of unsecured term
notes. These loans carried interest at the rate of 10% per annum and had a maturity date
of October 31, 2006.As a condition to the making of these loans, share purchase warrants to purchase 2,250,000
of the Companys common shares, on or before April 24, 2008, at an exercise price of $0.15
per share were transferred to the holders of the secured debentures and the unsecured term
notes. These warrants were part of the 2,300,000 warrants described in (a).The secured debentures and unsecured term notes were bifurcated into a debt component,
representing a yield to maturity of 36.1% per annum over the three-year life, and an equity
component with proceeds allocated $2,073,281 to long-term debt and $2,426,719 to warrants
in shareholders equity.As a result of the additional cash raised from the public offering in the second
quarter of fiscal 2004, the Company reached an agreement with the holders of the
secured debentures and unsecured term notes, resulting in the early repayment thereof
during the second quarter of fiscal 2004.    9.
    Convertible debentures In April 2003, as part of the renegotiation of the debt facility existing at that time, the
Company amended the terms of the debentures issued on April 29, 2002 and September 12, 2002 as
follows: the early repayment terms on the debentures were deferred to April 24, 2005; the
debentures became repayable in cash on maturity on April 24, 2008; both debentures were then
convertible into common shares at a price of $0.15 each, for a total of 25,333,333 common
shares; and, the warrants attached to the convertible debentures were cancelled. On April 24, 2003, the Company issued $2,000,000 in 10% convertible debentures as part of the
refinancing plan, which had a maturity date of April 24, 2008. These debentures were
convertible into common shares at a price of $0.15 each for a total of 13,333,333 common
shares. Holders also had the right to require the Company to purchase all or a portion of
their debentures on or after April 24, 2005 at the issue price plus accrued and unpaid
interest. The debentures were bifurcated into a debt component, representing a yield to maturity of
25.6% per annum over the five-year life, and an equity component with proceeds allocated
$1,465,929 to long-term debt and $534,071 to shareholders equity. That portion of offering
expenses, related to the debt component being $120,906 was recorded as deferred financing fees
which were included in prepaid expenses, with the remaining $44,049 applied to reduce the
equity component. During fiscal 2003, convertible debentures with a face value of $1,410,000 were converted into
9,400,000 common shares of the Company. 19




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   9.
    Convertible debentures (continued)On April 29, 2002, the Company issued $1,800,000 in 10% convertible debentures with a maturity
date of April 29, 2007 (amended to April 24, 2008 as discussed above). Prior to the
amendments discussed above, the debentures were convertible until the maturity date into
2,500,000 units of the Company at a conversion price of $0.72 per unit. Each unit consisted
of one common share in the capital of the Company and one purchase warrant of the Company.Each purchase warrant entitled the holder to purchase one common share (2,500,000 common
shares in aggregate) within the earlier of (a) 12 months of the date of conversion of the
debenture, and (b) the maturity date at a price of $0.90 per common share. Holders also had
the right to require the Company to purchase all or a portion of their debentures on or after
April 29, 2004 at the issue price plus accrued and unpaid interest. In addition, upon a
change in control occurring on or before April 29, 2004, the Company was required to offer to
purchase the debentures at a purchase price equal to 101% of the issue price plus accrued and
unpaid interest to the repurchase date. The debentures were secured by a charge over the
Companys assets and undertakings, subject only to security interests in favour of the
Companys bankers, equipment leases and non-consensual liens. The net proceeds from the sale
of the debentures were used for general corporate purposes.The debentures were bifurcated into a debt component, representing a yield to maturity of
25.4% per annum over the five-year life, and an equity component with proceeds allocated as
$1,017,770 to long-term debt and $782,230 to shareholders equity. That portion of offering
expenses related to the debt component, being $60,857 was recorded as deferred financing fees
and were included in prepaid expenses, with the remaining $46,565 applied to reduce the equity
component.On September 12, 2002, the Company issued $2,000,000 in 10% convertible debentures with a
maturity date of September 12, 2007 (amended to April 24, 2008 as discussed above). Prior to
the amendments discussed above, the debentures were convertible until the maturity date into
5,882,353 units of the Company at a conversion price of $0.34 per unit. Each unit consisted
of one common share in the capital of the Company and one purchase warrant of the Company.
Each purchase warrant entitled the holder to purchase one common share (5,882,353 common
shares in aggregate) within the earlier of (a) twelve months of the date of conversion of the
debenture, and (b) the maturity date at a price of $0.34 per common share. Holders also had
the right to require the Company to purchase all or a portion of their debentures on or after
September 12, 2005 at the issue price plus accrued and unpaid interest. In addition, upon a
change in control occurring on or before September 12, 2005, the Company was required to offer
to purchase the debentures at a purchase price equal to 101% of the issue price plus accrued
and unpaid interest to the repurchase date. The debentures were secured by a charge over the
Companys assets and undertakings, subject only to security interests in favour of the
Companys bankers, equipment leases and non-consensual liens. The net proceeds from the sale
of the debentures were used for general corporate purposes.The debentures were bifurcated into a debt component, representing a yield to maturity of
31.5% per annum over the five-year life, and an equity component with proceeds allocated as
$931,858 to long-term debt and $1,068,142 to shareholders equity. That portion of the
offering expenses related to the debt component, being $72,365, was
recorded as deferred financing fees and included in prepaid expenses, with the remaining
$82,948 applied to reduce the equity component. 20




---



##### 



Envoy Communications Group Inc.
Notes to Consolidated Financial Statements
 For the years ended September 30, 2004, 2003 and 2002   9.
    Convertible debentures (continued)In the first quarter of fiscal 2004, convertible debentures with a face value of $2,420,000
were converted into 16,133,334 common shares. During the second quarter of fiscal 2004, the
remaining convertible debentures, with a face value of $1,970,000, were converted into an
additional 13,133,333 common shares.As at September 30, 2004, the aggregate debt component carrying values of all of the Companys
convertible debentures was $nil (2003 - $3,231,266).  10.
    Interest and financing costsInterest and financing costs were charged to expense during the year for the following: 2004
    
    
    2003
    
    
    2002Cash interest paid on credit facility, landlord
loans and capital leases
    
    $
    354,781
    
    
    $
    912,255
    
    
    $
    592,974Financing fees on credit facility
    
    
    100,451
    
    
    
    311,053
    
    
    
    179,386Negotiation fee for early repayment of debt (Note 8)
    
    
    435,000
    
    
    
    
    
    
    
    Accrued financing fee charges on credit facility
    
    
    
    
    
    
    179,685
    
    
    
    200,000Accrued interest on debentures
    
    
    
    
    
    
    101,522
    
    
    
    38,333Cash interest paid on convertible debentures
and amortization of debenture issue costs
    
    
    105,369
    
    
    
    484,851
    
    
    
    59,130995,601
    
    
    
    1,989,366
    
    
    
    1,069,823Accreted interest imputed on warrants
and debentures
    
    
    2,552,991
    
    
    
    718,321
    
    
    
    133,870Total interest and financing costs
    
    $
    3,548,592
    
    
    $
    2,707,687
    
    
    $
    1,203,693
 Envoy assigned a value to the bank warrants using the Black-Scholes option pricing model,
based on an analysis of the warrant exercise price, time to expiry and the volatility of the
price of Envoys common shares. The Black-Scholes option pricing model indicated that the
value of the bank warrants was $2,426,719. As indicated in Note 8, the loans
made by the holders of the secured debentures and the unsecured term notes were repaid during
the second quarter of fiscal 2004 and, as a result, the remaining unamortized value assigned
to the bank warrants was charged to interest expense in the second quarter of fiscal 2004. 21




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 11. Share capital (a) Authorized:200,000,000 common shares without par value(2003 - 50,000,000; 2002 - 50,000,000)Issued:
 2004
    
    
    2003
    
    
    2002Number
    
    
    
    
    
    
    Number
    
    
    
    
    
    
    Numberof shares
    
    
    Amount
    
    
    of shares
    
    
    Amount
    
    
    of shares
    
    
    AmountBalance, beginning of year
before reverse stock split
    
    
    31,047,027
    
    
    $
    55,988,817
    
    
    
    21,258,693
    
    
    $
    54,339,390
    
    
    
    21,192,719
    
    
    $
    54,883,305Common shares issued pursuant to:Conversion of convertible
debentures (Note 9)
    
    
    29,266,667
    
    
    
    4,841,439
    
    
    
    9,400,000
    
    
    
    1,540,343
    
    
    
    
    
    
    
    Stock options exercised
    
    
    578,336
    
    
    
    224,852
    
    
    
    388,334
    
    
    
    109,084
    
    
    
    
    
    
    
    Warrants on new debentures
(Note 8)
    
    
    2,300,000
    
    
    
    2,771,719
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Public Offering (b)
    
    
    55,263,170
    
    
    
    55,016,831
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Acquisitions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150,000
    
    
    
    213,000Repurchase of shares pursuant
to share issuer bid (c)
    
    
    (1,372,200
    )
    
    
    (1,396,397
    )
    
    
    
    
    
    
    
    
    
    
    (299,400
    )
    
    
    (774,789
    )Shares issued to settle liability
with landlord (Note 18)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    250,000
    
    
    
    52,500117,083,000
    
    
    $
    117,447,261
    
    
    
    31,047,027
    
    
    $
    55,988,817
    
    
    
    21,293,319
    
    
    
    54,374,016Shares to be issued in respect of
contingent consideration
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (34,626
    )
    
    
    (34,626
    )Balance, before reverse split
    
    
    117,083,000
    
    
    $
    117,447,261
    
    
    
    31,047,027
    
    
    $
    55,988,817
    
    
    
    21,258,693
    
    
    $
    54,339,390Reverse stock split (Note 23(b))
    
    
    (93,666,400
    )
    
    
    
    
    
    
    (24,837,622
    )
    
    
    
    
    
    
    (17,006,954
    )
    
    
    Balance, end of year
    
    
    23,416,600
    
    
    $
    117,447,261
    
    
    
    6,209,405
    
    
    $
    55,988,817
    
    
    
    4,251,739
    
    
    $
    54,339,390
 At a special meeting of shareholders held on January 8, 2004, the shareholders approved
an amendment to the articles of the Company to increase its authorized share capital from
50,000,000 common shares to 200,000,000 common shares. As described in the Note 23(b), the Company completed a 5 for 1 reverse stock split. As a
result, the 117,083,000 common shares that were outstanding at September 30, 2004 (2003 -
31,047,027, 2002 - 21,258,693), are being consolidated into 23,416,600 common shares of the
Company (2003 - 6,209,405, 2002 - 4,251,739). 22




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 11. Share capital (continued)  (b)
    Public OfferingThrough a public offering, on February 20, 2004, Envoy issued 26,315,800 units (the First
Units) at 1.33 per First Unit, each First Unit consisting of one common share and
one-half of one transferable common share purchase warrant. Each whole warrant
entitles the holder to purchase one common share at a price of $1.80 per common share
for a period ending February 20, 2009. On March 3, 2004, pursuant to the exercise of
the over-allotment option issued in connection with Envoys offering of the First
Units, Envoy issued an additional 3,947,370 First Units. The total number of First
Units issued by Envoy to the public was 30,263,170, with total gross proceeds of
$40,250,016. As previously stated, part of the proceeds were used to retire
substantially all outstanding loan indebtedness. The balance of the funds will be
used for general corporate purposes and potential acquisition and investment
opportunities.Through a second public offering, on May 12, 2004, Envoy issued 25,000,000 units (the
Second Units) at $1.05 per Second Unit, each Second Unit consisting of one common share
and one-half of one transferable common share purchase warrant. Each whole warrant
entitles the holder to purchase one common share at a price of $1.80 per common share for a
period ending February 20, 2009. The total gross proceeds from the offering was
$26,250,000. The net proceeds of the Second Unit offering will be used for general
corporate purposes and potential acquisition and investment opportunities that the Company
determines have potential to create value for Envoy shareholders that either complement, or
provide an opportunity to diversify the current business of Envoy.The value assigned to these warrants was determined by deducting the $4,695,205 of expense
associated with the public offerings and the $245,524 assigned to the options provided to
the underwriter as indicated below, from the gross proceeds, to derive the net proceeds.
Using the ratio of the amounts that had been assigned to the warrants and the common shares, as indicated in the short form prospectus for each public offering, a value of $6,542,456 for the warrants was determined.At a meeting held on June 25, 2004, the holders of the warrants (the First
Warrantholders) issued pursuant to the warrant indenture (the First Warrant Indenture)
between Envoy and Computershare Trust Company of Canada (Computershare) dated February
20, 2004, the First Warrantholders approved the replacement of the warrant indenture (the
Second Warrant Indenture) between Envoy and Computershare dated May 12, 2004 by the First
Warrant Indenture as the instrument governing the terms of the warrants issued pursuant to
the Second Warrant Indenture.As part of the compensation for the public offering, the Company granted the underwriter a
total of 1,875,000 options at an exercise price of $1.05 per share. These options vested
immediately, and expire on May 5, 2005. The details of the options granted to the
underwriter that are outstanding at September 30, 2004 are as follows: Number
    
    
    Weighted Average
    
    
    NumberExercise Price
    
    Outstanding
    
    
    Contractual Life
    
    
    Exercisable$1.05
    
    
    1,875,000
    
    
    
    0.59
    
    
    
    1,875,000
 23




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 11. Share capital (continued)  c)
    Repurchase of sharesDuring fiscal 2004, pursuant to a normal course issuer bid, the Company repurchased and
cancelled 1,372,200 common shares for cash consideration of $816,549. Under the terms of
the normal course issuer bid, the Company may repurchase and cancel up to 10% of the public
float of the shares over the 12 month period commencing August 26, 2004.During fiscal 2002, pursuant to a normal course issuer bid, the Company repurchased and
cancelled 299,400 common shares for total cash consideration of $628,083.(d)
    Stock option planThe Company has reserved 4,000,000 common shares under its stock option plan (800,000
common shares after giving effect to the reverse stock split described in Note 23(b)).
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. The
options have vesting periods ranging from the date of grant up to five years. Once vested,
options are exercisable at any time until expiry. Expiry dates range between 2005 and
2009.On May 25, 2004 the Company granted certain employees and directors a total of 1,875,000
options at the exercise price of $0.80 per share. These options vest over periods ranging
from one to three years, and expire on May 24, 2009.In 2002, the Company obtained approval to re-price options. All employees, excluding
insiders and U.S. employees, were given the opportunity to cancel their existing stock
options with an exercise price greater than $6 per share and replace them with new stock
options. Options were cancelled on January 31, 2002 and new options, representing 50% of
the number of options cancelled, were granted on August 2, 2002 at an exercise price of
$3.05.The estimated fair value of the options granted during fiscal 2004, using the Black-Scholes
option pricing model was $864,533 (2003 - $175,203, 2002 - $279,759) of which $200,117
(2003 - $23,268, 2002 - $nil) was expensed in the financial statements. Of the remaining
option value, $418,892 will be expensed over the period ending May 2007, and $245,524 has
been included as part of stock based compensation in Shareholders Equity. No other value
associated with the stock options was recognized in the accounts of the Company. 24




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 11. Share capital (continued)  (e)
    Stock option detailsThe 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: 2004
    
    
    2003
    
    
    2002Risk-free interest rate
    
    
    3.1% - 4.0
    %
    
    
    4.00
    %
    
    
    4.00
    %Volatility factor of the future expected
market price of the Companys
common shares
    
    
    54
    %
    
    
    83
    %
    
    
    76
    %Weighted average expected life of the
options
    
    1.85 years
    
    1.95 years
    
    1.36 yearsExpected dividends
    
    
    Nil
    
    
    Nil
    
    
    Nil
 Details of the options, before giving effect to the reverse stock split described in Note 23(b), are as follows: WeightedaverageexerciseNumber
    
    
    price perof options
    
    
    shareOptions outstanding, September 30, 2001
    
    
    2,679,500
    
    
    $
    5.31Options granted
    
    
    1,719,000
    
    
    
    1.15Options cancelled
    
    
    (1,199,500
    )
    
    
    5.37Options outstanding, September 30, 2002
    
    
    3,199,000
    
    
    
    3.06Options granted
    
    
    1,820,000
    
    
    
    0.26Options exercised
    
    
    (388,334
    )
    
    
    0.28Options cancelled
    
    
    (2,889,250
    )
    
    
    2.74Options outstanding, September 30, 2003
    
    
    1,741,416
    
    
    
    1.27Options granted
    
    
    1,875,000
    
    
    
    0.80Options exercised
    
    
    (578,336
    )
    
    
    0.35Options cancelled
    
    
    (108,332
    )
    
    
    3.02Options outstanding, September 30, 2004
    
    
    2,929,748
    
    
    
    1.09Options exercisable, September 30, 2004
    
    
    663,084
    
    
    $
    2.40Options exercisable, September 30, 2003
    
    
    1,049,750
    
    
    $
    1.95Options exercisable, September 30, 2002
    
    
    2,322,084
    
    
    $
    3.35
 25




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##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 11. Share capital (continued) The range of exercise prices for options outstanding and exercisable options at September
30, 2004 are as follows: Number
    
    
    Weighted Average
    
    
    NumberExercise Price
    
    Outstanding
    
    
    Contractual Life
    
    
    Exercisable$7.40
    
    
    45,000
    
    
    
    0.42
    
    
    
    45,000$3.05
    
    
    360,000
    
    
    
    1.74
    
    
    
    360,000$0.61
    
    
    75,000
    
    
    
    2.66
    
    
    
    75,000$3.05
    
    
    24,750
    
    
    
    2.59
    
    
    
    24,750$0.25
    
    
    549,998
    
    
    
    2.99
    
    
    
    158,334$0.80
    
    
    1,875,000

    
    
    
    4.65
    
    
    
    2,929,748
    
    
    
    
    
    
    
    663,084
 In fiscal 2003, the Company did not expense the full value of the stock options in the
financial statements. The following pro forma information presents net income and earnings
per share, including the expense related to the stock options that would be calculated under
the fair value method: 2003Pro forma net earnings
    
    $
    2,386,827Pro forma earnings per shareBasic
    
    $
    0.55Diluted
    
    
    0.42
 As indicated in Note 2(h), the Company adopted the use of the fair value method for all stock
based compensation in fiscal 2004. 
 12. Contributed Surplus During fiscal 2004, pursuant to the normal course issuer bid described in Note 11(c), the
Company repurchased and cancelled 1,372,200 common shares at an average price of $0.60 per
common share for total cash consideration plus related expenses of $816,549. As the average
price paid was less than the average per share value of the outstanding common shares,
$579,848 was recorded in contributed surplus as a gain on redemption of shares. During 2002, pursuant to the normal course issuer bid described in Note 11(c), the Company
repurchased and cancelled 299,400 common shares at an average price of $2.10 per common share,
which was less than the average per share value of the outstanding common shares. As a result
of these repurchases, $146,706 was recorded in contributed surplus as a gain on redemption of shares. 26




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 13. Earnings per Share The following table sets forth the computation of basic and diluted earnings (loss) per
share: 2004
    
    
    2003
    
    
    2002Numerator:Net (loss) earnings
    
    $
    (3,106,804
    )
    
    $
    2,538,762
    
    
    $
    (53,379,435
    )Denominator:Denominator for basic net
earnings (loss) per share -
weighted average shares
outstanding (as adjusted for
Reverse stock split (Note 23(b))
    
    
    17,062,152
    
    
    
    4,334,813
    
    
    
    4,199,679Effect of dilutive potential common shares:Shares issuable pursuant to
warrants
    
    
    
    
    
    
    904,958
    
    
    
    Shares issuable under stock
options
    
    
    
    
    
    
    460,631
    
    
    
    Shares issuable under
conversion of debentures
    
    
    
    
    
    
    21,196,342
    
    
    
    Effect of reverse stock split adjustment to
dilutive potential common
shares (Note 23(b))
    
    
    
    
    
    
    (18,049,545
    )
    
    
    Denominator for diluted net
(loss) earnings per share
    
    
    17,062,152
    
    
    
    8,847,199
    
    
    
    4,199,679
  (i)
    For fully diluted earnings per share in 2003, the numerator is $3,843,456.
This difference is due to the accounting for convertible debentures which requires
them to be treated as if converted for purposes of fully diluted earnings per share.Included in the difference is cash interest of $477,377, accreted interest of $718,321
and amortized debenture issue costs of $108,996. 27




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 13. Earnings per Share (continued) 2004
    
    
    2003
    
    
    2002(Loss) income per share from
continuing operations:Basic
    
    $
    (0.15
    )
    
    $
    0.58
    
    
    $
    (12.71
    )Diluted
    
    
    (0.15
    )
    
    
    0.43
    
    
    
    (12.71
    )(Loss) income per share from
discontinued operations:Basic
    
    $
    (0.03
    )
    
    $
    0.01
    
    
    $
    (0.00
    )Diluted
    
    
    (0.03
    )
    
    
    0.00
    
    
    
    (0.00
    )
 As the Company experienced a loss for the years ended September 30, 2004 and 2002, all
potential common shares outstanding from dilutive securities are considered anti-dilutive
and are excluded from the calculation of loss per share. Details of potential dilutive securities are as follows: 2004
    
    
    2003
    
    
    2002Effect of dilutive potential common shares:Shares issuable pursuant to
warrants
    
    
    27,631,585
    
    
    
    
    
    
    
    7,882,353Shares issuable under stock
options
    
    
    4,804,748
    
    
    
    
    
    
    
    3,199,000Shares issuable upon
conversion of convertible
debentures
    
    
    
    
    
    
    
    
    
    
    8,382,353Before giving effect to
reverse stock split
    
    
    32,436,333
    
    
    
    
    
    
    
    19,463,706Effect of
reverse stock split adjustment to dilutive potential common shares (Note 23(b))
    
    
    (25,949,066
    )
    
    
    
    
    
    
    (15,570,965
    )After giving effect to
reverse stock split
    
    
    6,487,267
    
    
    
    
    
    
    
    3,892,741
 28




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 14. Income taxes Income tax expense (recovery) for the years ended September 30, 2004, 2003 and 2002 consists
of: 2004
    
    
    2003
    
    
    2002Current
    
    $
    484,440
    
    
    $
    94,576
    
    
    $
    (3,036,236
    )Future
    
    
    (334,016
    )
    
    
    143,828
    
    
    
    (1,875,536
    )$
    150,424
    
    
    $
    238,404
    
    
    $
    (4,911,772
    )
 The income tax expense (recovery) attributable to income (loss) differs from the amounts
computed by applying the Canadian statutory rates of 36.12% (2003 - 37.1%; 2002 - 39.5%)
(loss) income before income taxes, goodwill amortization and write-down and discontinued
operations as a result of the following: 2004

    
    2003

    
    2002Income tax expense (recovery)
at statutory rates
    
    $
    (899,835
    )
    
    
    (36.1
    %)
    
    $
    1,013,727
    
    
    
    37.1
    %
    
    $
    (7,172,888
    )
    
    
    (39.5
    %)Increase (decrease) in
income taxes resulting from:Adjustment to future tax
assets for substantively
enacted changes in tax
laws and rates
    
    
    
    
    
    
    0.0
    %
    
    
    (179,597
    )
    
    
    (6.6
    %)
    
    
    654,691
    
    
    
    3.6
    %Expenses (revenues)
deducted (included) in
the accounts that have no
corresponding deduction
(included) for income taxes
    
    
    303,285
    
    
    
    12.2
    %
    
    
    (872,628
    )
    
    
    (31.9
    %)
    
    
    276,996
    
    
    
    1.5
    %Impact of different tax
rate on earnings of
foreign subsidiaries
    
    
    (43,454
    )
    
    
    (1.7
    %)
    
    
    (307,945
    )
    
    
    (11.3
    %)
    
    
    (483,406
    )
    
    
    (2.7
    %)Change in valuation
allowance
    
    
    1,044,524
    
    
    
    41.9
    %
    
    
    963,913
    
    
    
    35.3
    %
    
    
    2,407,144
    
    
    
    13.3
    %Other
    
    
    (254,096
    )
    
    
    (10.3
    %)
    
    
    (379,066
    )
    
    
    (13.9
    %)
    
    
    (594,309
    )
    
    
    (3.2
    %)$
    150,424
    
    
    
    6.0
    %
    
    $
    238,404
    
    
    
    8.7
    %
    
    $
    (4,911,772
    )
    
    
    (27.0
    %)
 29




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 14. Income taxes (continued) The tax effects of temporary differences that give rise to significant portions of the future
tax assets and liabilities at September 30, 2004 and 2003 are presented below: 2004
    
    
    2003Future tax assets:Capital assets
    
    $
    1,318,783
    
    
    $
    1,124,221Share issuance costs
    
    
    1,772,925
    
    
    
    399,008Non-capital losses expiring in 2014
    
    
    6,509,503
    
    
    
    4,849,933Other
    
    
    47,031
    
    
    
    183,5499,648,242
    
    
    
    6,556,711Less valuation allowance
    
    
    4,415,581
    
    
    
    3,371,057Net future tax assets
    
    
    5,232,661
    
    
    
    3,185,654Future tax liabilities:Goodwill
    
    
    50,863
    
    
    
    19,258Total net future tax assets
    
    
    5,181,798
    
    
    
    3,166,396Less current portion
    
    
    1,500,000
    
    
    
    498,172$
    3,681,798
    
    
    $
    2,668,224
 At September 30, 2004, the Company has non-capital losses of approximately $18,000,000
available to reduce future years taxable income, which expire as follows: 2008
    
    
    2,800,0002009
    
    
    5,900,0002010
    
    
    6,000,0002014
    
    
    3,300,000$
    18,000,000
 The Company has capital losses of approximately $14,000,000 for United States tax purposes
available for carryforward up to 2008 to be applied against future capital gains. No
provision has been made in the financial statements with respect to any potential future
income tax assets which may be associated with these capital losses. 30




---



##### 



Envoy Communications Group Inc.Notes to Consolidated Financial StatementsFor the years ended September 30, 2004, 2003 and 2002
 15. Closure of Hampel Stefanides Inc. (Hampel) On February 7, 2003, the Company decided to cease the operations of Hampel after conducting a
review, in conjunction with the Companys banks, of the ongoing viability, future prospects,
cash needs and local debt situation of Hampel. As the Companys banks held a first charge on
the assets of Hampel, the net proceeds from the liquidation of those assets were applied in
reduction of the Companys debt obligations to the banks. Consequently, there were not
sufficient proceeds from the liquidation to make any payment to the unsecured creditors of
Hampel. As the Company has no obligation to pay the creditors of Hampel, the consolidated
accounts of the Company for fiscal 2003 reflect a gain on the shut-down of Hampel. Following the liquidation of the assets, the shares of Hampel were sold for a nominal
consideration, and the purchaser assumed the liabilities. Based on the sale of the shares of
Hampel, included in general and administrative expenses is the recognition of a cumulative
translation gain of $841,081 in fiscal 2003. 
 16. Closure of Subsidiaries In the first quarter of fiscal 2003, the assets of our technology company Devlin Multimedia
Inc. (Devlin) were sold, and the Companys other technology company, Sage Information
Consultants Inc. (Sage), was shut down. The results of operations prior to these closures
have been included in the results of operations for 2003. The sale of assets of Devlin was completed on October 30, 2002 at a price equal to their net
book value, and correspondingly no gain or loss on the disposal was recorded. Legal expenses
related to the disposal were recorded to reduce the gain on disposal of subsidiaries, and
income taxes related to the closure of the company have been provided in the consolidated
provision in fiscal 2003. Sage was closed effective November 11, 2002. All operations of the business were halted and
the assets and liabilities of the company were realized over time. Envoy sold the right to
continue business with the customers of Sage to a company formed by certain management
employees of Sage, and the proceeds of this agreement were used to offset some of the costs
incurred to close the business. A loss of $114,684 has been recorded on the closure of Sage
in fiscal 2003. 
 17. Unusual items During 2002, as a result of changes in the bank loan arrangements, the Company was no longer
allowed to fully utilize its line of credit and, accordingly, the remaining unamortized
portion of deferred financing charges totalling $750,648 was written off in fiscal 2002. 31




---



##### 



18. Restructuring costs In response to a general economic downturn impacting the Companys business, management
implemented a restructuring plan during the first half of fiscal 2002 in order to bring costs
more in line with expected revenue. The restructuring involved downsizing its workforce,
exiting excess office space and writing off redundant capital assets. Accordingly, the
Company recorded a restructuring expense of $10,829,328. The restructuring included a
reduction of staff, as well as the abandonment of leased office space in New York City. As
part of the settlement with the landlord, the Company issued 250,000 common shares with a cost
of $52,500. During fiscal 2004, negotiations were held with the landlord resulting in the
Company discharging the ongoing payments to the landlord with a lump sum payment. Total restructuring costs accrued at September 30 are classified as: 
 2004
    
    
    2003
    
    
    2002Accounts payable and accrued liabilities
    
    $
    28,471
    
    
    $
    214,060
    
    
    $
    1,702,345Long-term portion of restructuring costs
    
    
    
    
    
    
    337,407
    
    
    
    792,275$
    28,471
    
    
    $
    551,467
    
    
    $
    2,494,620
 Total
    
    
    Accrual atrecovery
    
    
    September 30,Cash
    
    
    Non-cash
    
    
    2003
    
    
    2003Severance
    
    $
    (74,969
    )
    
    $
    
    
    
    $
    (74,969
    )
    
    $
    56,885Lease exit costs
    
    
    (192,243
    )
    
    
    
    
    
    
    (192,243
    )
    
    
    494,582$
    (267,212
    )
    
    $
    
    
    
    $
    (267,212
    )
    
    $
    551,467
 Total
    
    
    Accrual atprovision
    
    
    September 30,Cash
    
    
    Non-cash
    
    
    2002
    
    
    2002Severance
    
    $
    3,240,055
    
    
    $
    
    
    
    $
    3,240,055
    
    
    $
    1,013,424Lease exit costs
    
    
    4,055,668
    
    
    
    52,500
    
    
    
    4,108,168
    
    
    
    1,481,196Write-down of capital assets
    
    
    
    
    
    
    3,481,105
    
    
    
    3,481,105
    
    
    
    $
    7,295,723
    
    
    $
    3,533,605
    
    
    $
    10,829,328
    
    
    $
    2,494,620
 32




---



##### 



19. Commitments and contingencies  (a)
    The Company has entered into operating lease agreements for office premises and
equipment with minimum annual lease payments over the next five years and thereafter as
follows: 2005
    
    $
    893,3962006
    
    
    765,1132007
    
    
    447,7482008
    
    
    451,4422009
    
    
    455,137Thereafter
    
    
    228,492$
    3,241,328
 Rent expense under operating leases for the year ended September 30, 2004 amounted to
$1,373,628 (2003 - $2,645,288; 2002 - $2,041,417).  (b)
    On September 30, 2004, the Company purchased from the executive officers of John
Street Inc. the 30% of the shares of John Street Inc. which it did not already own. No
amount has been accrued in the financial statements as the purchase price will be
determined and paid over a three-year period based on certain performance milestones.(c)
    In the ordinary course of business, the Company and its subsidiaries have legal
proceedings brought against them. Management does not expect the outcome of these
proceedings, in aggregate, to have a material adverse effect on the Companys
consolidated financial position or results of operations. 
 20. Financial instruments The estimated fair value of a financial instrument is the amount at which the instrument could
be exchanged in a current transaction between willing parties, other than a forced or
liquidation sale. These estimates, although based on the relevant market information about
the financial instrument, are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with precision. Changes in
assumptions could significantly affect the estimates.  (a)
    The carrying values and estimated fair values of the Companys financial
instruments are as follows:  (i)
    The carrying amounts of cash, accounts receivable, accounts payable and
accrued liabilities and promissory notes approximate their fair values due to the
short-term nature of these instruments. As at September 30, 2004, the carrying value of the loans payable to landlords was
$429,065 (2003 - $774,820) and their fair value was $351,728 (2003 - $674,653).  (ii)
    The carrying amounts and fair value of short term investments and long term
investments are detailed in Note 3. 33




---



##### 



20. Financial instruments (continued)  (b)
    Risk management activities:  (i)
    Currency risk:The Company is subject to currency risk through its activities in the United States and
the United Kingdom. Unfavourable changes in the exchange rate may affect the operating
results of the Company. The Company does not actively use derivative instruments to
reduce its exposure to foreign currency risk. However, dependent on the nature, amount
and timing of foreign currency receipts and payments, the Company may enter into
foreign currency contracts to mitigate the associated risks. As at September 30, 2004,
there were no foreign currency contracts outstanding.(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, 2004,
one customer represented 15% of accounts receivable (2003 - one customer represented 8%
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 with financially sound counterparties only and,
accordingly, does not anticipate loss for non-performance. 
 21. 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: 2004
    
    
    2003
    
    
    2002Net revenue:Canada
    
    $
    5,635,240
    
    
    $
    5,392,693
    
    
    $
    13,758,032United States
    
    
    14,443,569
    
    
    
    18,185,170
    
    
    
    27,708,424United
Kingdom and Continental Europe
    
    
    20,723,981
    
    
    
    17,275,420
    
    
    
    15,430,233$
    40,802,790
    
    
    $
    40,853,283
    
    
    $
    56,896,689
 34




---



##### 



21. Segmented information (continued)  (b)
    The Companys external net revenue by type of service is as follows: 2004
    
    
    2003
    
    
    2002Net revenue:Marketing
    
    $
    3,838,833
    
    
    $
    6,248,321
    
    
    $
    10,204,157Consumer and retail branding
    
    
    36,963,957
    
    
    
    34,313,108
    
    
    
    38,203,746Technology
    
    
    
    
    
    
    291,854
    
    
    
    8,488,786$
    40,802,790
    
    
    $
    40,853,283
    
    
    $
    56,896,689
  (c)
    In 2004, the Company had three customers, which represented 37%, 15% and 11% of net
revenue respectively. In 2003, the Company had three customers which represented 26%,
16% and 12% of net revenue respectively. In 2002, the Company had three customers which
represented 20%, 12% and 12% of net revenue, respectively.(d)
    The Companys identifiable assets for each geographic area in which it has
operations are as follows: 2004
    
    
    2003Capital assets:Canada
    
    $
    3,061,671
    
    
    $
    3,585,786United Kingdom and Continental Europe
    
    
    2,167,561
    
    
    
    2,229,441$
    5,229,232
    
    
    $
    5,815,227
  2004
    
    
    2003Goodwill:Canada
    
    $
    2,725,296
    
    
    $
    2,725,296United Kingdom and Continental Europe
    
    
    7,490,805
    
    
    
    7,333,882$
    10,216,101
    
    
    $
    10,059,178
 35




---



##### 



22. Discontinued operations Effective January 1, 2004, Envoy decided to sell all the shares of its corporate event and
corporate travel business, Communique Incentives Inc. (Communique), after conducting a
review of its ongoing viability, future prospects and cash requirements. This business was
sold for a nominal consideration. Prior to its sale, Communique was reported as part of
Canadian net revenue in the marketing segment. Statement of OperationsFiscal year:
    
    2004
    
    
    2003
    
    
    2002Net revenue
    
    $
    398,114
    
    
    $
    1,573,960
    
    
    $
    2,224,401Operating expenses
    
    
    389,394
    
    
    
    1,480,012
    
    
    
    2,037,636Depreciation
    
    
    2,237
    
    
    
    16,883
    
    
    
    44,473Interest expense
    
    
    
    
    
    
    
    
    
    
    41,433Amortization of intangible asset
    
    
    6,049
    
    
    
    24,197
    
    
    
    24,197Restructuring costs
    
    
    
    
    
    
    
    
    
    
    28,206Income tax expense
    
    
    
    
    
    
    8,120
    
    
    
    58,232Earnings from discontinued operations
(excluding loss on sale)
    
    
    434
    
    
    
    44,748
    
    
    
    (9,776
    )Loss on sale of discontinued operations
    
    
    (465,576
    )
    
    
    
    
    
    
    (Loss) earnings from discontinued
operations
    
    $
    (465,142
    )
    
    $
    44,748
    
    
    $
    (9,776
    )
   23. Subsequent events  (a)
    On November 10, 2004, the Company, through its subsidiary ECG Holdings UK Limited
(ECGH), agreed to acquire 65% of the outstanding shares of Parker Williams Design Limited
(PW), a London, UK based packaging design and brand specialist company. The purchase
price of £1,818,000 is payable in cash on completion. The remaining 35% of the PW shares
(Management Shares) will continue to be held by senior management of PW (Management
Shareholders), subject to certain options described below.ECGH will have the option to acquire from the Management Shareholders and the Management
Shareholders will have the option to require ECGH to purchase from them, at various
stages over a period of 4 years following completion, the Management Shares for a
purchase price based on the profitability of PW for certain defined periods following
completion.The transaction is expected to be completed by February 21, 2005. The acquisition will
be accounted for using the purchase method of accounting. 36




---



##### 



23. Subsequent events (continued)  (b)
    At a meeting held on August 14, 2003, the Companys shareholders approved the
consolidation of the Companys common shares on the basis to be determined by its board
of directors (not to exceed a ratio of 1 for 10). On January 15, 2005, the Companys
board of directors approved the consolidation of the common shares (a reverse stock
split) on the basis of 1 for 5. On January 21, 2005 the Company filed Articles of
Amendment consolidating its common shares on the basis of 1 new common share for every 5
common shares outstanding. The effective date for post consolidation trading of the
shares is February 10, 2005. The number of Envoy common shares outstanding prior to
consolidation is 112,539,318 and post consolidation there is expected to be approximately
22,507,864 common shares outstanding. Outstanding shares and earnings per share figures
for all periods presented have been adjusted to give effect to the share consolidation.(c)
    Subsequent to the year-end, pursuant to the normal course issuer bid described in
Note 11(c), the Company has purchased for cancellation an additional 4,543,682 common
shares of the Company, which is equivalent to 908,736 common shares after giving effect
to the reverse stock split described in (b).   24. 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 (loss) for the years ended September 30, 2004, 2003 and 2002
required to conform to US GAAP. 2004
    
    
    2003
    
    
    2002Net (loss) earnings based on
Canadian GAAP
    
    $
    (3,106,804
    )
    
    $
    2,538,762
    
    
    $
    (53,379,435
    )Stock-based compensation (a)
    
    
    200,117
    
    
    
    
    
    
    
    Foreign currency contracts, net of
income tax recovery of $nil
(2003- $nil, 2002 -$35,703) (b)
    
    
    
    
    
    
    
    
    
    
    49,303Convertible debentures (c)
    
    
    (664,516
    )
    
    
    67,538
    
    
    
    (46,100
    )Net (loss) earnings based on
U.S. GAAP
    
    $
    (3,571,203
    )
    
    $
    2,606,300
    
    
    $
    (53,376,232
    )Net loss from continuing
operations
    
    $
    (3,106,061
    )
    
    $
    (1,565,749
    )
    
    $
    (15,878,394
    )Net (loss) earnings from discontinued
operations (Notes 22 and 24(e))
    
    $
    (465,142
    )
    
    $
    4,172,049
    
    
    $
    (37,497,838
    )
 37




---



##### 



24. Reconciliation to United States generally accepted accounting principles (continued) The calculation of diluted earnings (loss) per share used income from continuing operations as
the control number in determining whether potential common shares are dilutive or
antidilutive. Since each of fiscal 2004, 2003 and 2002 experienced a loss from continuing
operations, potential common shares are antidilutive. 2004
    
    
    2003
    
    
    2002Net (loss) earnings per share:Basic
    
    $
    (0.21
    )
    
    $
    0.60
    
    
    $
    (12.71
    )Diluted
    
    
    (0.21
    )
    
    
    0.43
    
    
    
    (12.71
    )Net loss per share from continuing
operations:Basic
    
    $
    (0.18
    )
    
    $
    (0.36
    )
    
    $
    (3.78
    )Diluted
    
    
    (0.18
    )
    
    
    (0.36
    )
    
    
    (3.78
    )
 The following adjustments are required in order to conform shareholders equity based on
Canadian GAAP to shareholders equity based on U.S. GAAP: 2004
    
    
    2003Shareholders equity based on Canadian GAAP
    
    $
    76,891,499
    
    
    $
    12,358,503Convertible debentures (c)
    
    
    
    
    
    
    (593,958
    )Accumulated other comprehensive income (f)
    
    
    174,426
    
    
    
    Shareholders equity based on U.S. GAAP
    
    $
    77,065,925
    
    
    $
    11,764,545
 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)
    Stock-based compensation disclosures:For fiscal 2002, 2003 and 2004, the Company measured 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 for 2002
and 2003. For fiscal 2004, the Company prospectively adopted the new provisions of the
CICA handbook as described in Note 2(h), under these provisions the expense for stock-based
compensation under Canadian GAAP is $200,117 greater than under US GAAP.The weighted average estimated fair value at the date of the grant for options granted in
fiscal 2004 was $0.33 per share (2003 - $0.12; 2002 -$0.16). 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 assumptions as indicated in Note 11(e). 38




---



##### 



24. Reconciliation to United States generally accepted accounting principles (continued)  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: 2004
    
    
    2003
    
    
    2002Net earnings (loss) in accordance
with U.S. GAAP as reported
    
    $
    (3,571,203
    )
    
    $
    2,606,300
    
    
    $
    (53,376,232
    )Pro forma net earnings (loss)
    
    
    (3,771,080
    )
    
    
    2,246,121
    
    
    
    (54,353,655
    )Pro forma basic earnings (loss)
per share
    
    $
    (0.22
    )
    
    $
    0.52
    
    
    $
    (12.94
    )Pro forma diluted earnings (loss)
per share
    
    
    (0.22
    )
    
    
    0.52
    
    
    
    (12.94
    )
  Compensation cost is reflected over the expected lives of the options. 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.(b)
    Derivative financial instruments: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 fiscal 2001, the Company entered into forward contracts to manage its exposure to
fluctuations in foreign exchange rates. The reconciliation to US GAAP reflects the
maturing in fiscal 2002 of contracts that had been outstanding at September 30, 2001, and
for which the market value had been included in net earnings based on US GAAP for fiscal
2001. As at September 30, 2004, 2003 and 2002, there were no foreign currency contracts
outstanding. 39




---



##### 



24. Reconciliation to United States generally accepted accounting principles (continued)  (c)
    Convertible debentures:During 2004, the Company did not issue any convertible debentures (2003 - $2,000,000, 2002
 - $3,800,000). The debentures issued in fiscal 2003 and 2002, were convertible at any time
at the option of the holder into common shares and common share purchase warrants of the
Company (note 9), and were redeemable in cash at the option of the holder two years after
the issue date. Under Canadian GAAP, the debentures issued in fiscal 2003 were bifurcated
into a debt component and an equity component, based on relative fair values, which
resulted in aggregate proceeds of $1,465,929 (2002 - $1,949,628) allocated to long-term
debt, and $534,071 (2002 - $1,850,372) to shareholders equity, respectively. Issue costs
in 2003 and 2002 were allocated between the debt and equity components which resulted in
$44,048 (2002 - $129,513) of the aggregate $314,955 (2002 - $262,465) issue costs being
applied to reduce the equity allocation. As a result of the conversion in 2004 an
additional $189,133 of issue costs were allocated to equity.Under Canadian GAAP the discount resulting from allocating proceeds to the equity component
must be recorded as additional interest expense, using the effective yield method, over the
minimum period to redemption. During fiscal 2004, all outstanding convertible debentures
were converted into common shares of the Company. As a result of the conversion and the
accretion of the discount, accreted interest of $126,273, (2003 - $718,321, 2002 -
$133,870) has been charged as interest expense for 2004.Under U.S. GAAP, any excess of the fair value of the shares over the proceeds allocated to
the common stock portion of the conversion option is considered a beneficial conversion
feature. For the debentures issued during 2002, an aggregate beneficial conversion feature
of $1,188,356 must be recorded as additional interest expense over the minimum period to
the earliest redemption date. Included in interest expense for 2004 under US GAAP is
$532,960 (2003 - $486,856, 2002 - $168,540). The interest expense for 2004 includes a
$420,758 charge for the write-off of the unamortized debt discount upon the conversion of
the debt.Under US GAAP, costs associated with issuance of the debentures cannot be apportioned
between the debt and equity components. During fiscal 2004, the remaining outstanding
convertible debentures were converted into common shares of the company, and as a result,
the unamortized deferred financing fees under US GAAP and Canadian GAAP was $Nil at the end
of the year. If the Company had recorded the issue costs in accordance with US GAAP,
additional amortization of $257,828 (2003 - $163,927, 2002 - $11,429) would have been
charged to interest expense. Additionally, share capital would be lower by $587,782 (2003 -
$130,343, 2002 - $Nil). 40




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24. Reconciliation to United States generally accepted accounting principles (continued)  (d)
    Discontinued operations:The businesses disposed of during fiscal 2003 in the Gain on closure of subsidiaries
described in Notes 15 and 16, are treated as discontinued operations under U.S. GAAP. This
treatment requires that the results of operations of these businesses be removed from the
normal operations of the Company, and be presented in summary form as earnings from
operations, gain on disposal of, and income taxes from those discontinued businesses.
Effective May 1, 2003, the Company adopted the new provisions of the CICA handbook,
described in Note 2(m), which are materially similar to US GAAP requirements. The
differences reported below relate to dispositions that occurred prior to the adoption of
the new CICA handbook provisions. There is no difference between US GAAP and Canadian GAAP
for discontinued operations in fiscal 2004.For fiscal 2004 and 2003, the amounts reported as assets and liabilities under US GAAP and
Canadian GAAP are the same.Under U.S. GAAP, the amounts reported as revenues and expenses in the Statements of
Operations of the Company would be different than those reported under Canadian GAAP for
fiscal 2003 and 2002. The revenues and expenses of the discontinued operations were as
follows: 2004
    
    
    2003
    
    
    2002Net revenue
    
    $
    
    
    
    $
    3,386,913
    
    
    $
    15,824,996Operating expenses
    
    
    
    
    
    
    2,649,784
    
    
    
    16,857,573Depreciation
    
    
    
    
    
    
    70,217
    
    
    
    520,401Interest expense and financing fees
    
    
    
    
    
    
    199
    
    
    
    727Restructuring costs
    
    
    
    
    
    
    
    
    
    
    5,691,023Unusual item
    
    
    
    
    
    
    
    
    
    
    Income taxes (recovery)
    
    
    
    
    
    
    (119,903
    )
    
    
    (2,552,010
    )Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    1,436,173Write-down of goodwill
    
    
    
    
    
    
    
    
    
    
    31,359,171Earnings (loss) from discontinued
Operations (excluding gain)
    
    $
    
    
    
    $
    786,616
    
    
    $
    (37,488,062
    )Pre-tax earnings (loss) from
discontinued operations
    
    $
    
    
    
    $
    906,519
    
    
    $
    (40,040,072
    )Gain on discontinued operations
    
    
    
    
    
    
    3,340,685
    
    
    
    Income taxes recovery from
discontinued operations
    
    
    
    
    
    
    119,903
    
    
    
    2,552,010Earnings (loss) from discontinued
operations
    
    
    
    
    
    
    4,127,301
    
    
    
    (37,488,062
    )Earnings (loss) from discontinued
operations accounted for consistent
with US GAAP (see Note 22)
    
    
    (465,142
    )
    
    
    44,748
    
    
    
    (9,776
    )$
    (465,142
    )
    
    $
    4,172,049
    
    
    $
    (37,497,838
    )
 41




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##### 



24. Reconciliation to United States generally accepted accounting principles (continued)  (e)
    Comprehensive income:The Companys comprehensive income represents U.S. GAAP net earnings plus the results of
certain changes in shareholders equity during a period from non-owner sources that are not
reflected in the consolidated statements of operations. 2004
    
    
    2003
    
    
    2002Net earnings (loss) for the year in
accordance with U.S. GAAP
    
    $
    (3,571,203
    )
    
    $
    2,606,300
    
    
    $
    (53,376,232
    )Unrealized gain on available
for sale securities
    
    
    174,426
    
    
    
    
    
    
    
    Change in cumulative translation
adjustment account
    
    
    310,087
    
    
    
    (1,584,672
    )
    
    
    515,569$
    (3,086,690
    )
    
    $
    1,021,628
    
    
    $
    (52,860,663
    )
  (f)
    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, share capital would be increased by $9,886,961 and
deficit would be increased by $9,886,961 as at September 30, 2004 and 2003.(g)
    Restructuring charges:Under U.S. GAAP restructuring charges would be included as operating expenses in the
consolidated statement of operations.(h)
    Goodwill amortization and goodwill write-downs:Under U.S. GAAP goodwill amortization and goodwill write-downs would be included as
operating expenses in the consolidated statement of operations and the income taxes
relating to these items would not be netted against operating expenses. The Company has
disclosed net earnings before goodwill amortization and write-down which is not a permitted
disclosure under US GAAP. The loss before income taxes and discontinued operations for
2004 under US GAAP would be $(2,955,637) (2003 - $(1,199,322), 2002 - $(18,203,924)). 42




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##### 



24. Reconciliation to United States generally accepted accounting principles (continued)  (i)
    Investments:The Company accounts for its investments in accordance with FAS 115, Accounting for Certain
Investments in Debt and Equity Securities under US GAAP. As of September 30, 2004, all of
the Companys investments have been classified as available-for-sale and accordingly,
recorded at market value. Unrealized gains and losses on these investments are included in
other comprehensive income, as a separate component of shareholders equity. Any
unrealized losses are recorded as a charge to income when they are deemed to be other than
temporary.(j)
    Recent Accounting Pronouncements:In December 2004, the Financial Accounting Standards Board (FASB) issued FASB
Statement No. 123R (Revised), Share-Based Payment which is a revision of FASB Statement No.
123, Accounting for Stock-Based Compensation. Statement
No. 123(R) supersedes APB Opinion
No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows. Statement No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the financial
statements based on their fair values and is effective at the beginning of the first
interim or annual period beginning after June 15, 2005. The Canadian and US GAAP
difference relating to share-based payments to employees will be eliminated for all such
payments after the adoption of these standards 43