Annual Report Enabling Supply Chain Excellence

Transcription

1 Annual Report 2006 Enabling Supply Chain Excellence

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3 Our Mission "To deliver the highest value to our clients, with unparalleled industry solutions that are based on our advanced, proven technologies and feature-rich enterprise suite of applications." Backed up by the breadth and depth of our employees' expertise and focused by our "Customer for Life" philosophy, we continue to be the software vendor of choice because of our value as a strategic partner. By leveraging the full power of our solutions to improve the efficiency and profitability of their businesses, our clients continue to be leaders in their respective fields. US $ Millions TECSYS Revenue Growth Market Position _ In the top 10 high-growth software companies in Canada! Branham Group, a leading "Go To Market" consultancy firm, exclusively focused on the technology sector, ranked TECSYS, in the 2006 Branham300 research, as the 23rd largest software company in Canada and number 7 on the list of the fastest growing in that group.

4 Table of Contents Message to Shareholders... 3 Chairman s Perspective... 5 Management s Discussion and Analysis... 7 Management s Report Auditors Report Financial Section General Information Directors and Executive Management Corporate Information Forward Looking Statements The statements in this report relating to matters that are not historical fact are forward looking statements that are based on management s beliefs and assumptions. Such statements are not guarantees of future performance, and are subject to a number of uncertainties, including but not limited to future economic conditions, the markets that TECSYS Inc. serves, the actions of competitors, major new technological trends and other factors beyond the control of TECSYS Inc., which could cause actual results to differ materially from such statements. 2 TECSYS Inc. Annual Report 2006

5 M essage to Shareholders Fiscal 2006 was a year of high growth -- a year in which we have reached another milestone in revenue; $33.8 million, the highest in our history. We took initial steps to consolidate business operations to improve margins and reduce cost. We continued to solidify our position in the market, with an increase in both new account and base business that was incremental to our acquisition related growth. Allow me to fill you in on some of the more significant details: Culminating two years of R&D, we launched a strategic product offering that delivered the industry's first pure Service-Oriented Architecture (SOA)-based sales order desk, positioning us very favorably with our target customers and further increasing our win rate. We increased our penetration of the 3PL (Third Party Logistics Providers) market with five new providers on board. We also made further strides in the healthcare industry and signed a substantial number of import-to-retail distributors as well as general high-volume distributors, with Caterpillar dealers as a key new vertical with good potential for growth. The world around us continued to change and we responded. Here are a few key areas of change: Imports from China According to the U.S. Census Bureau, imports from China have more than doubled in the past five years, growing from US$100 billion in 2000 to $243.5 billion in This growth is expanding the import-to-retail distribution sector and increasing the need for unique expertise and software solutions such as those offered by TECSYS. We responded with software improvements to handle multinational purchasing and tracking of goods on the water. Our account base in this sector keeps growing. Demand for Logistics Software Growth According to ARC Advisory Group -- the thought leader in manufacturing, logistics, and supply chain solutions -- the worldwide market for supply chain execution, a market in which TECSYS plays a key role, is expected to grow at a Compounded Annual Growth Rate (CAGR) of 9.2 percent over the next five years. The market was $4.2 billion in 2005 and is forecasted to be almost $6.6 billion in We increased our direct lead generation efforts to ensure our participation in this upswing. TECSYS Inc. Annual Report

6 Continued Industry Consolidation The supply chain management software industry continued to see consolidation, leaving fewer competitors in the landscape, and strengthening our competitive position. Technology SOA, Service-Oriented Architecture, has been a hot topic in the high-technology industry in the last couple of years. SOA provides a framework and standards for building the supply chain of the future. It enables end-to-end integrated business processes for enterprises and with their key partners, suppliers and customers. It allows them to respond with flexibility and speed to any customer demand, market opportunity or external threat. With TECSYS' strong balance sheet, we made a strategic decision to invest heavily in R&D and complete a major initiative to deliver version 7.5 of our flagship product the EliteSeries. This SOA-based product release further differentiates us competitively and provides the basis for expanding our ASP offering to continue to build our recurring revenues. As at the end of fiscal 2006, recurring revenue represented about 25% of total revenues, and we will now be reporting it each quarter. After the end of fiscal 2006, TECSYS' management, in consultation with its auditors, determined that in order for TECSYS to fully comply with SOP 97-2, there was a need to restate certain license revenue for fiscal years 2004 and 2005, and the first three quarters of fiscal The restatement represents the recognition of license revenue over the initial contractual support period of certain contracts, generally over twelve months. A total of $946,000 of deferred revenue will be carried forward into fiscal For further details, please see the Management Discussion and Analysis section. In summary, we are pleased with the resurgence in the supply chain management software industry. Our technology continues to be a leading differentiator in the competitive landscape and our expertise in distribution continues to be one of the primary reasons customers choose us over our competitors. Our solutions and expertise have helped customers save substantially, and earn more through better management, visibility and responsiveness. TECSYS has all of the ingredients to ride the new wave of growth and profitability in our industry by leveraging our strategic assets of people, technology, expertise and experienced management. My sincere thanks to our customers, employees, partners and shareholders for their support throughout 2006, and to our Board of Directors for their continued guidance and support for our business initiatives over the past fiscal year. We look forward to your continued support in fiscal Sincerely, Peter Brereton President and Co-CEO 4 TECSYS Inc. Annual Report 2006

7 Chairman s Perspective TECSYS Today During the past two years we have put together a number of strategic pieces, some of which were accomplished in 2006, that give us a platform in place for the next few years to leverage the collective strengths of TECSYS and take it to the next level. These strategic pieces include: Acquisitions that brought people, expertise, new vertical markets and a significant customer base. Strategic investment in R&D that propels TECSYS' position in the competitive landscape and provides our solutions with the ability to co-exist with major players such as SAP, Oracle and IBM. Investment in the start-up of our European subsidiary, TECSYS Europe Limited, as well as the investment in our South American partner, TECSYS Latin America (TLA). These two initiatives, along with our on-going sales and marketing thrust in North America, make TECSYS an attractive vendor not only to regional prospective clients, but also to companies with global reach. Today, TECSYS is about improving business operations for high-volume distributors by removing logistics costs and providing them with unprecedented visibility to their business. We enable supply chain excellence for demand-driven distribution operations, a market that continues to flourish based on recent research, one of which is referred to in Peter's message. As the founder and largest shareholder of TECSYS, I feel positive about what the future holds for our company. Recurring Revenue Our acquisition strategy is focused on bringing into the fold select organizations with quality people and expertise in our space to extend TECSYS' knowledge further in the overall supply chain management arena, and also specifically in certain vertical market areas where we can compete with an acceptable ROI, both business wise and certainly from an investment point of view as shareholders. These acquisitions bring strong relationships with satisfied customers and a substantial opportunity to extend our core products and technology to further secure commitments to our growing recurring revenue from our customer base. Today, TECSYS revenue from existing customers represents about 50% of total revenue. TECSYS' Performance I am very pleased with the overall growth of the top line of fiscal 2006 and with the number of new clients that have joined us. Our focus continues to be on profitability. In May 2006, we brought together two business groups; Transportation Management Group and Logistics Management Group. Two closely knit business groups under one management to improve business operations with a focus on customers, and also to reduce the cost structure and improve overall margins. TECSYS Inc. Annual Report

8 Furthermore, we brought together our information and financial systems and resources to improve decision making and responsiveness. More recently we have brought together our divisional marketing activities into a consolidated organization. This will allow us to leverage and expand the strengths that previously existed within each divisional marketing organization, while eliminating any duplication of efforts. Moving forward, TECSYS' management is making every effort to improve margins. Our management team is cost conscious and achieving profitability is high on the priority of each member's business goals. Community TECSYS continues, through the TECSYS Foundation for Youth, its on-going efforts to certain community programs to support youth and the under-privileged. I am pleased with their on-going initiatives and achievements. I would like to take this opportunity to extend my sincere thanks to the members of our Board of Directors for their very valuable guidance, and to our employees, customers, partners, shareholders and the investment community for their continued support. I would also like to take this opportunity to thank TECSYS management and employees who have worked diligently to make the financial review and required restatements possible within a reasonably short period of time. Sincerely, David Brereton Executive Chairman and Co-CEO 6 TECSYS Inc. Annual Report 2006

9 Management s Discussion and Analysis of Financial Condition and Results of Operations TECSYS Inc. Annual Report 2006 TECSYS Inc. Annual Report

10 Management s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis dated August 15, 2006 should be read in conjunction with the Consolidated Financial Statements and Notes thereto, which are included in this document. The Company's fiscal year ends on April 30. Fiscal 2006 refers to the twelve-month period ended April 30, The Company's consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles, and all financial data derived therefrom in this annual report are expressed in U.S. dollars. The Company's reporting currency is the U.S. dollar; however, the functional currency is the Canadian dollar. Accordingly, the financial statements for the years ended April 30, 2006, 2005 and 2004 are translated into U.S. dollars using the current rate method. All gains and losses resulting from the translation of the consolidated financial statements into U.S. dollars are reflected in the cumulative translation adjustment in shareholders' equity. In addition, the consolidated financial statements include a reconciliation of the significant measurement differences between Canadian and United States generally accepted accounting principles as they relate to the Company. Overview The Company is a leading Supply Chain Management (SCM) software provider that delivers powerful enterprise distribution, warehouse and transportation logistics management solutions. The resurgence in the supply chain software market represents a significant positive trend for the Company, which is well entrenched in the mid-market sector. The Company maintains its vigilance to insure that its business operating model is in line with realistic revenue and margin expectations. This is primarily due to the continuing challenges on margins and profitability as the Canadian dollar has gained considerable strength over the past few years. The Company also continued its investment in research and development and launched its latest suite of enterprise distribution applications EliteSeries 7.4. As globalization and free trade are increasing the opportunities for the international distributor, this new release focuses on automated buy / sell between international subsidiaries, consolidated multi-currency financials, and better import management components. The Company remains watchful and prepared for strategic acquisition opportunities to leverage its strength and expertise in the SCM software industry. In May 2005, the Company launched its European operations, based in the UK, under the name of TECSYS Europe Limited (TEL). The new company was formed with experienced local partners and will be to the benefit of certain of the Company's customers who are operating as international conglomerates. This expansion into Europe will serve as a platform for sales and services growth as the Company's suite of software applications are inherently multinational and multilingual. On December 13, 2005, the Company acquired an equity interest in TECSYS Latin America ("TLA"). TLA, a long-standing partner since the mid nineties, is a privately-held company that markets, sells, implements, and supports international software solutions in the areas of distribution, warehousing, logistics and transportation management. With this transaction, both organizations are provided with a stronger market position in the region by substantially strengthening the combined competitive stance to serve global clients with the need for multinational solution deployment, while at the same time providing them with the localized customer services and support. TLA has operating offices in Venezuela, Chile, and Columbia with customers in ten countries in Latin America. Please refer to note 9 to the consolidated financial statements for further details. During fiscal 2005, on February 28, 2005, the Company acquired 100% of the issued and outstanding shares of Application Solutions Inc. ("ASI"), a leading Canadian provider of best-of-breed warehouse management systems, Radio Frequency Identification Device (RFID) solutions, and system integration services on the IBM iseries platform. ASI's solutions have integrated with key ERP solutions in the market including SAP, 8 TECSYS Inc. Annual Report 2006

11 SSA, Oracle / Peoplesoft / JDE, and Microsoft Dynamics. ASI was wound-up into TECSYS Inc. on March 1, 2005, and the results of its operations are included in the accompanying financial statements commencing on that date. Similarly during fiscal 2005, on March 31, 2005, the Company acquired 100% of the issued and outstanding shares of Symplistech Inc. ("Symplistech"), a Canadian consulting practice specializing in the implementation of SAP solutions for manufacturing, warehousing, and distribution businesses. Symplistech was wound-up into TECSYS Inc. on April 1, 2005 as an integral part of the operations of the Logistics Management Group (LMG, formerly ASI), and the results of its operations are included in the accompanying financial statements commencing on that date. For fiscal 2006, LMG (formerly ASI and Symplistech) contributed $10.7 million to revenue and $408,000 to losses from operations in comparison to revenue of $2.5 million and earnings from operations of $480,000 for the two-month period ended April 30, During fiscal 2004, on December 31, 2003, the Company acquired 100% of the issued and outstanding shares of PointForce Inc. ("PointForce"), a company which develops, markets, and sells distribution software primarily to the gift and home decor market. PointForce was wound-up into TECSYS Inc. on January 1, 2004 and the results of its operations are included in the accompanying financial statements commencing January 1, PointForce currently operates as a division of TECSYS known as the Small Medium Business (SMB) group. During fiscal 2006, the Company renewed its banking agreement with the National Bank of Canada as described in note 10 of the consolidated financial statements. This agreement requires the Company to respect certain covenants in the form of financial ratios, which have been respected. The Company generates revenue through the licensing of proprietary and third-party products, including third-party software licenses and hardware, and the provision of related information technology services. Services revenue includes both the fees associated with implementation assistance and billings for ongoing services. These ongoing services include consulting, training, product adaptations, implementation assistance, maintenance and customer support. Such revenue is typically derived from contracts based on a fixed-price or time-and-material basis and is recognized as the services are performed. Products revenue has two components: third-party products and the Company's proprietary products. In fiscal 2006, third-party products represented 28% of total revenue (19% in fiscal 2005 and 22% in fiscal 2004) and include products developed by Oracle Corporation, IBM Corporation, SAP Canada Inc., Psion Teklogix Inc., Cognos Incorporated, Intermec Systems Corporation, Optio Software Inc., Best Software Canada Ltd, and Radio Beacon Inc. Proprietary products' revenue was 14% of revenue for fiscal year 2006 and 15% for fiscal years 2005 and Cost of revenue comprises the cost of products purchased for re-sale and the cost of services, made up mainly of salaries, incentives, benefits and travel expenses of all personnel providing services. Also included in the cost of services is a portion of overhead and multimedia tax credits available under a Quebec government incentive program designed to support the development of the multimedia industry (as described in note 2). This program became effective in fiscal Cost of products purchased for re-sale includes all products not developed by the Company that are required to complete customer solutions. These are typically other software products and hardware such as radio frequency equipment and computer servers. Sales and marketing, as well as general and administration expenses, include all human resources costs involved in these functions. They also include all other costs related to sales and marketing, such as travel, rent, professional fees, office expenses, training, telecommunications, bad debts, and equipment rentals TECSYS Inc. Annual Report

12 and maintenance. The Company is also committed to donate approximately one-half of one percent of revenue to charitable organizations. Such amounts are included in general and administration expenses. Research and development (R&D) includes salaries, benefits, incentives and expenses of all staff assigned to R&D. Fees paid to external consultants and sub-contractors are also included, along with a portion of overhead. At the end of fiscal 2006, the Company employed 246 people in comparison to 241 at the end of fiscal The average number of employees in fiscal 2006 increased to 250 compared to 221 in fiscal Restatement of Prior Years' Financial Statements The Company has restated the consolidated balance sheets, statements of operations, statements of deficit, and statements of cash flows, including the applicable notes thereto for the years ended April 30, 2005 and 2004, and for the first three quarters of fiscal 2006 in order to be fully compliant with Statement of Position (SOP) 97-2, "Software Revenue Recognition". Historically, the Company generally recognized license revenue from perpetual software licenses sold under multiple element arrangements upon delivery of the software product, provided that a non-cancellable agreement exists, the fees are fixed and determinable, and collection is deemed probable. Based on the general framework of Statement of Position (SOP) 97-2, the fees associated with such agreements are allocated to the various revenue elements based on the vendor specific objective evidence (VSOE) of the fair value of each element. The revenue is recognized at the earlier point at which either sufficient vendor specific objective evidence of fair value exists or all the elements of the agreement have been delivered. In the course of preparing the financial statements for the year ended April 30, 2006, it was determined that certain software license agreements signed during the current and prior years, which included a contractual provision requiring the customers to renew annual support agreements in order to maintain the right to use the software, had not been accounted for appropriately. This provision has the effect of transforming a perpetual license into a renewable annual license. The VSOE of fair value cannot be established for annual support contracts under these circumstances since the customer is considered not to be renewing the annual support on a standalone basis, but rather is essentially making a decision to renew both the software license and the support agreement. Hence, the license revenue cannot be recognized upon delivery. Under generally accepted accounting principles for software revenue recognition as specified in Statement of Position (SOP) 97-2, a license fee from such agreements representing a significant and incremental premium over subsequent year renewal fees should be deferred and recognized as revenue over the period in which support is expected to be provided, which is generally considered to be the estimated useful life of the software license. Where the up-front license fee is not considered to represent a significant and incremental premium over subsequent year renewal fees, the license fee is recognized ratably over the initial contractual support period, which is generally one year. The Company's objective for promoting this contractual provision with its customers is to insure that they are well supported and to maximize the occurrence of annual support renewals representing recurring revenue. The Company's approach regarding these license agreements requiring the annual support renewal is essentially the same as those without the mandatory support renewals. From an economic perspective, there are no discernible and distinct policy differences regarding pricing for licenses, annual support, services, and the related payment terms. Additionally, the Company's outstanding future support obligations do not differ in any respects between the agreements with and without mandatory support. The Company has restated its financial statements to fully comply with generally accepted accounting principles. The restatement of revenue for each period represents the difference between the revenue originally reported as recognized but now deferred and the amortization of such deferred revenue over the initial contractual support period. Accordingly, the reported revenue and net earnings have been restated unfavorably by $184,000 and $436,000 for fiscal 2004 and fiscal 2005 respectively. Additionally, 10 TECSYS Inc. Annual Report 2006

13 the application of the revenue recognition principles discussed above has adversely affected revenue and net earnings by $238,000 for the first three quarters of fiscal The cumulative deferred revenue of $946,000 will be recognized in fiscal The restatement has no impact on cash flow from operating activities. The impact of this restatement on the consolidated statements of operations is presented in the tables below. The impact on the fiscal 2005 consolidated balance sheet is presented in note 1 to the consolidated financial statements. The relevant figures for fiscal 2005 and 2004 included in this management discussion and analysis have been restated to reflect the restatement principles discussed above. Quarterly Selected Financial Data (Restated) In thousands of U.S. dollars, except per share data Fiscal Year 2006 Fiscal Year 2005 Q1 Q2 Q3 Q4 Total Q1 Q2 Q3 Q4 Total Total Revenue 7,801 9,161 9,486 7,363 33,811 5,175 5,345 5,457 7,859 23,836 Net Earnings (Loss) (222) (1,431) (1,605) (34) (466) (102) Basic & Diluted Net Earnings (Loss) per Common Share (In U.S. dollars) - - (0.02) (0.10) (0.12) - (0.03) (0.01) Reconciliation of Selected Quarterly Financial Data (Restated) (Quarterly data are unaudited) In thousands of U.S. dollars, except per share data Fiscal Year 2006 Fiscal Year 2005 Fiscal Year 2004 Q1 Q2 Q3 Q4* Total Q1 Q2 Q3 Q4 Total Q1 Q2 Q3 Q4 Total Total Revenue As previously reported 8,005 8,968 9,713 7,363 34,049 5,345 5,495 5,303 8,129 24,272 3,766 4,147 4,175 5,462 17,550 Adjustment (204) 193 (227) - (238) (170) (150) 154 (270) (436) (474) (184) As restated 7,801 9,161 9,486 7,363 33,811 5,175 5,345 5,457 7,859 23,836 3,292 4,237 4,314 5,523 17,366 Net Earnings (Loss) As previously reported 225 (166) 5 (1,431) (1,367) 136 (316) Adjustment (204) 193 (227) - (238) (170) (150) 154 (270) (436) (474) (184) As restated (222) (1,431) (1,605) (34) (466) (102) (464) Basic & Diluted Net Earnings (Loss) per Common Share (In U.S. dollars) As previously reported 0.02 (0.02) - (0.10) (0.10) 0.01 (0.02) Adjustment (0.02) 0.02 (0.02) - (0.02) (0.01) (0.01) 0.01 (0.02) (0.03) (0.03) (0.01) As restated - - (0.02) (0.10) (0.12) - (0.03) (0.01) (0.03) *Q4 of fiscal year 2006 is not a restatement, however it is included in the table to reflect the impact of the appropriate application of generally accepted accounting principles as discussed earlier. TECSYS Inc. Annual Report

14 Other Selected Financial Data In thousands of U.S. dollars As at April Total Assets 22,854 22,743 20,157 Total Long-Term Financial Liabilities Long-Term Debt (including the current portion of long-term debt) Other Long-Term Liabilities (including the current portion in accounts payable and accrued liabilities) ,184 1,291 Results of Operations Year ended April 30, 2006 compared to year ended April 30, 2005 (Restated) Revenue Total revenue increased 42% or $10.0 million to $33.8 million in fiscal 2006 compared to $23.8 million in fiscal The Company's fiscal 2005 acquisitions, ASI and Symplistech (LMG) contributed $10.7 million in fiscal 2006 in comparison to $2.5 million in revenue for the two-month period ended April 30, 2005, accounting for $8.2 million of the total revenue increase. Excluding the revenue contributions of the above-mentioned acquisitions, revenue increased by $1.8 million or 8% in fiscal 2006 in comparison to fiscal Products revenue increased by 75% or $6.1 million to $14.3 million compared to $8.1 million for the previous fiscal year. LMG's products revenue contributed $5.3 million in comparison to $1.7 million for the two-month operating period in the previous fiscal year accounting for $3.6 million of that increase. Excluding LMG, products revenue increased by $2.6 million or 40% to $9.0 million in fiscal 2006 in comparison to $6.4 million for fiscal The increase comprises $786,000 more for proprietary products while third-party products increased by $1.8 million. In fiscal 2006, there were several large license agreements from existing customers as well as a few significant orders of third-party licenses and hardware products that contributed to the significant increase over fiscal Services revenue increased 25% to $18.7 million from $15.0 million in the previous year, an increase of $3.7 million. LMG attained services revenue of $5.2 million in fiscal 2006 compared to $790,000 for the two-month period in the previous fiscal year accounting for the increase. Excluding LMG, services revenue decreased $732,000 or 5% to $13.4 million in fiscal 2006 compared to $14.2 million in the previous fiscal year. The decline in services revenue was due primarily to lower product adaptation activity in fiscal As a percentage of total revenue, products revenue and services revenue were 42% and 55% respectively in fiscal 2006 in comparison to 34% and 63% respectively for fiscal TECSYS Inc. Annual Report 2006

15 The Canadian dollar has strengthened by approximately 7% against the U.S. dollar in fiscal 2006 in comparison to fiscal The Canadian dollar to U.S. dollar exchange rates for fiscal 2006 averaged in comparison to for fiscal Consequently, excluding LMG, the strengthened Canadian dollar affected the reported revenue favorably by an estimated $691,000 or 2% of total revenue in fiscal 2006 in comparison to the same period last year. On the other hand, excluding LMG, the strengthened Canadian dollar affected cost of revenue and operating expenses adversely by an estimated $515,000 and $667,000 respectively in fiscal Earnings from operations have been affected adversely by an estimated $491,000 due to the strengthened Canadian dollar. Source of Revenue FY 2006 Reimbursable Expenses 3 0 /0 Products 42 0 /0 Services 55 0 /0 Geographic Breakdown of Revenue FY 2006 Other 2 0 /0 Canada 56 0 /0 U.S /0 Cost of Revenue The total cost of revenue in fiscal 2006 increased by $9.4 million or 79% to $21.3 million in comparison to $11.9 million for the previous fiscal year. LMG accounted for $6.7 million of this increase for the twelve-month period in fiscal 2006 compared to the two-month period ended April 30, Services costs increased by $5.3 million or 67% to $13.3 million in fiscal 2006 compared to $8.0 million in fiscal LMG accounted for $3.9 million of this increase as it operated for a full twelve-month period in fiscal Excluding the above-mentioned acquisition, services costs increased by $1.4 million or 18% in fiscal 2006 in comparison to fiscal The increase in services costs, excluding LMG, is primarily attributable to the unfavorable impact of the strengthened Canadian dollar estimated at $500,000, the use TECSYS Inc. Annual Report

16 of more outside consultants for $218,000, the expansion of the Company's operations in Europe for $346,000, and additional professional services consulting resources. Costs related to products increased $4.0 million or 124% to $7.1 million in fiscal 2006 compared to $3.2 million for the previous year. LMG accounted for $2.5 million of this increase as it relates to the increase of $3.6 million of products revenue for fiscal 2006 in comparison to the two-month period ended April 30, Excluding LMG, the increase of $1.4 million for products costs is related primarily to increased third-party products revenue of $1.8 million mentioned earlier. Gross Margin Total gross margin increased $572,000 or 5% to $12.6 million in fiscal 2006 compared to $12.0 million in the previous fiscal year. The gross margin percentage decreased to 37% (43% excluding LMG) in fiscal 2006 in comparison to 50% (51% excluding LMG) for fiscal The gross margin percentage decline, excluding LMG, of 8% on the existing business is primarily attributable to the strengthened Canadian dollar, the higher proportion of third-party products within the revenue mix, the increased services expenses related to outside consultants, incremental professional services consultants, and the expanded European operations. The reduction in the overall gross margin percentage is largely influenced by the addition of LMG, which realized an overall margin of 24% in fiscal 2006 in comparison to 41% for the two-month period in fiscal Products margin was $7.1 million or 50% ($5.3 million or 59% excluding LMG) of products revenue in fiscal 2006 compared to $5.0 million or 61% ($4.2 million or 65% excluding LMG) of products revenue in fiscal The reduction in products margin, excluding LMG, of 6% is largely attributable to the fact that third-party products comprise 53% of the products revenue mix in 2006 compared to 47% in fiscal 2005 and that they carry significantly less margin than proprietary products. LMG products gross margin was $1.8 million or 34% of revenue in fiscal 2006 compared to $764,000 or 45% for the two-month period ended April 30, The decline in the LMG margin percentage is due to the fact that the two-month period in fiscal 2005 included a very large third-party software order. The lower gross margin percentage of 34% in comparison to the rest of the business is indicative that LMG's products revenue mix is more heavily weighted on the resale of RF equipment, hardware and supplies, which carry a lower gross margin than proprietary or third-party software licenses. Services gross margin was $5.4 million or 29% ($4.6 million or 35% excluding LMG) of services revenue in fiscal 2006 compared to $7.0 million or 47% ($6.7 million or 48% excluding LMG) of services revenue in fiscal The decrease in the gross margin, excluding LMG, is due to the unfavorable impact of the strengthened Canadian dollar, the use of more outside consultants, incremental staffing for professional services consultants, and the expanded European operations. LMG services gross margin was $768,000 or 15% of services revenue in fiscal 2006 compared to $266,000 or 34% of revenue for the two-month period in fiscal LMG's gross margin for services is lower compared to the existing business mainly due to the fact that a portion of their services activity comprises the repair of third-party RF equipment and hardware products, which carries a significantly lower gross margin. The LMG services margin decline from 2005 to 2006 is indicative of the use of more outside consultants to provide consulting services for a fixed-price SAP implementation. Additionally, LMG does not benefit from the multimedia tax credits. Operating Expenses Total operating expenses increased 15% or $1.8 million to $13.7 million in fiscal 2006 compared to $11.9 million in fiscal LMG's full year of operations in fiscal 2006 incurred $3.0 million in operating expenses in comparison to $549,000 for the two-month period in fiscal 2005 accounting for a $2.4 million increase. Excluding LMG, operating expenses decreased 6% or $672,000 to $10.7 million in fiscal 2006 in comparison to $11.4 million for fiscal The discussion below will address the most significant variances. 14 TECSYS Inc. Annual Report 2006

17 As a result of the strengthened Canadian dollar against the U.S. dollar for fiscal 2006, as compared to fiscal 2005, operating expenses for fiscal 2006, excluding LMG, were unfavorably impacted by approximately $667,000 or 6% of 2005 operating expenses. Sales and Marketing Sales and marketing expenses increased 21% or $1.1 million to $6.2 million in fiscal 2006 from $5.1 million in fiscal LMG accounted for $1.4 million of the increase as it operated for a full year in fiscal 2006 as compared to a two-month period in fiscal Excluding LMG, sales and marketing expenses declined by $316,000 or 7% despite being adversely affected by the strengthened Canadian dollar which had an impact estimated at $261,000. The reduction in sales and marketing expenses, excluding LMG, is primarily attributable to fewer sales representatives averaging 25 in fiscal 2006 in comparison to 30 for fiscal General and Administration General and administration expenses increased 29% or $657,000 to $2.9 million in fiscal 2006 compared to $2.3 million in the previous year. The discussion hereunder describes the most significant variances contributing to increase of general and administration expenses. During fiscal 2005, the Company received a unanimous favorable judgment from the Quebec Court of Appeal in connection with a lawsuit brought forth by one of the Company's landlords regarding the disputed allocation of common area space. Since inception of the dispute with the landlord, the Company had accrued for the disputed amounts claimed by the landlord. In consideration of the above, the Company reversed the accumulated accruals of $245,000 in fiscal 2005 related to the dispute and reduced general and administration expenses. This favorable variance in fiscal 2005 is obviously not repeated in fiscal LMG's general and administration expenses increased by $161,000 to $264,000 for fiscal 2006 in comparison to $103,000 for the two-month period ended April 30, 2005 excluding $333,000 of allocated corporate overhead in fiscal The Company incurred $278,000 of bad debt in fiscal 2006 in comparison to $199,000 in the previous fiscal year accounting for an unfavorable impact of $79,000 in fiscal Excluding LMG, the strengthened Canadian dollar affected this activity unfavorably by approximately $147,000 in fiscal 2006 as compared to fiscal Research and Development (R&D) Gross R&D expenses increased by 13% or $513,000 to $4.5 million in fiscal 2006 compared to $3.9 million in fiscal 2005 ($3.8 million and $3.5 million, respectively, net of tax credits). LMG incurred $385,000 of gross R&D expenses in fiscal 2006 in comparison to $59,000 for the two-month period ended April 30, 2005 accounting for an increase of $326,000. Excluding LMG, gross R&D expenses increased by $187,000 or 5% over the comparable base from the previous fiscal year, of which approximately $265,000 can be attributed to the unfavorable impact of the strengthened Canadian dollar. The exchange impact was partially offset by the favorable impact of a diminished personnel headcount averaging 46 in fiscal 2006 compared to 49 for fiscal In fiscal 2006, gross R&D expenses were 13% of revenue compared to 17% in fiscal R&D tax credits increased by $152,000 or 31% in fiscal 2006 in comparison to fiscal LMG's tax credits in fiscal 2006 accounted for $44,000 of the increase. Excluding LMG, the $108,000 increase in tax TECSYS Inc. Annual Report

18 credits is primarily due to the amounts claimed and received with respect to tax credits for prior years exceeding the amounts initially accrued based upon preliminary information and management's best estimate at the time and because of the favorable impact of the strengthened Canadian dollar estimated at $39,000. During the 2006 fiscal year, the Company deferred $259,000 of new product development costs which will have an anticipated future economic benefit. Prior to fiscal 2006, qualifying product development costs were insignificant and no development costs were deferred. The objective of this development project is to accelerate the migration of the Company's existing product onto a Java platform. This project will span a two to three-year period and as at April 30, 2006, the Company was in the early stages of the project. Amortization of Intangible Assets The amortization of intangible assets increased by $223,000 or 64% to $572,000 in fiscal 2006 compared to fiscal The amortization attributable to the LMG acquisition for fiscal 2006 amounts to $264,000 in comparison to $39,000 for the two-month period in fiscal 2005 accounting for the increase. Restructuring Charges During fiscal 2006, the Company recorded a recovery of $242,000 relating to two transactions. The details of the transactions are described hereunder. During fiscal 2003, the Company entered into a sub-lease agreement with a third party regarding one floor at one of its facilities. The Company's remaining lease obligations to the lessor extended through April 30, 2010, while the sub-lease term expires on December 31, The sub-lessee had the option to renew the sub-lease for the remainder of the Company's contractual lease term, subject to the consent of the Company. Accordingly, during fiscal 2003, the Company had recorded a provision for restructuring costs, which represented the estimated excess of future contractual lease payments and operating expenses over the estimated future sub-lease revenue, as well as the write down of the associated leasehold improvements and furniture and fixtures to their estimated fair value. During fiscal 2006, the sub-lessee and the Company entered into an agreement to extend the sub-lease for the period from December 31, 2007 to April 30, 2010 at rental rates which exceeded the renewal rental rates applicable to such extension per the original sub-lease agreement. Accordingly, due to the more favorable terms, the Company has recorded a reduction of the provision and a recovery of the restructuring charges in the amount of $366,000. During fiscal 2006, the Company merged the Transportation Management Group (TMG) with the Logistics Management Group (LMG) division. As both groups are focused on logistics, TMG was strategically integrated within the LMG division to promote synergies and opportunities. The Company incurred $80,000 of employee termination costs and an additional $44,000 of lease buy-out costs associated with this restructuring plan. These costs offset the recovery discussed above resulting in the net restructuring recovery of $242,000. Other Income and Expenses As a result of the strengthened Canadian dollar against the U.S. dollar, the Company incurred an exchange loss of $516,000 in fiscal 2006 as compared to $284,000 in fiscal The exchange loss is primarily a result of carrying a net asset position, primarily cash and accounts receivable denominated in U.S. dollars. The U.S. monetary assets have depreciated by CA 13.7 cents or 10.9% in fiscal 2006 in comparison to CA 11.4 cents or 8.3% in fiscal 2005 in consideration of the exchange rates at April 30, 2006, 2005, and 2004 ( , , ). During the year, the Company protected a portion of its net monetary U.S. assets by means of forward exchange contracts selling U.S. dollars forward for maturity before the end of each quarter. The hedging strategy has reduced the exchange losses by $170,000 in fiscal 2006 in comparison to $61,000 for fiscal TECSYS Inc. Annual Report 2006

19 There were no foreign exchange contracts outstanding at the end of either the 2006 or 2005 fiscal years. Subsequent to the current year end, the Company undertook another foreign exchange contract to sell $2.0 million U.S. dollars forward at on July 31, Net Income The Company recorded net losses of $1.6 million ($0.12 per share) and $102,000 ($0.01 per share) in fiscal 2006 and 2005 respectively. The outstanding number of common shares at April 30, 2006 and 2005 was 13,650,697 and 13,923,297 respectively. On August 15, 2006, the date of this management discussion and analysis, the outstanding common shares numbered 13,600,697. Fourth quarter revenue in fiscal 2006 fell short of management's expectations. The relatively poor revenue performance in the fourth quarter are primarily attributable to the shortfall of new license orders and services in the LMG and Enterprise Supply Chain (ESC) divisions. The shortfall in revenue had a direct impact on net income. Results of Operations Year ended April 30, 2005 (Restated) compared to year ended April 30, 2004 (Restated) Revenue Total revenue increased 37% or $6.5 million to $23.8 million in fiscal 2005 compared to $17.4 million in fiscal The Company's latest acquisitions, ASI and Symplistech (LMG) contributed $2.5 million in revenue for the two-month period ended April 30, The Company's acquisition from the prior fiscal year, SMB (formerly PointForce), contributed to revenue for $5.5 million in fiscal 2005 compared to $1.9 million for four-month period ended April 30, 2004 in the previous fiscal year. Excluding the revenue contributions of the above-mentioned acquisitions in both fiscal periods, revenue increased by $366,000 or 2% in fiscal 2005 in comparison to fiscal Products revenue increased by 26% or $1.7 million to $8.1 million compared to $6.5 million for the previous fiscal year. LMG contributed $1.7 million of that increase, while SMB's products revenue for the twelve-month period in fiscal 2005 increased by $746,000 to $1.3 million in comparison to $528,000 for the four-month period in fiscal Excluding the revenue contributions of the above-mentioned acquisitions in both fiscal periods, products revenue decreased by $794,000 or 13% to $5.2 million in fiscal 2005 in comparison to $6.0 million for fiscal This decrease is due exclusively to decreases of third-party products revenue amounting to $928,000 while proprietary license revenue increased by $134,000. In fiscal 2004, several large orders of third-party products were shipped to significant customers. Services revenue increased 47% to $15.0 million from $10.2 million in the previous year, an increase of $4.8 million. LMG contributed $790,000 of that increase, while SMB's services revenue for the twelve-month period in fiscal 2005 increased $2.8 million to $4.1 million in comparison to $1.3 million for the four-month period in fiscal Excluding the revenue contributions of the above mentioned acquisitions in both fiscal periods, services revenue increased $1.2 million or 14% to $10.0 million in fiscal 2005 compared to $8.8 million in the previous fiscal year. The increased revenue was due to a higher number of accounts under implementation in fiscal 2005 as compared to fiscal 2004 in all service areas including consulting, product adaptations, and support. As a percentage of total revenue, products revenue and services revenue were 34% and 63% respectively in fiscal 2005 in comparison to 37% and 59% respectively for fiscal The reduction of the products revenue percentage is mainly attributable to the decrease of products revenue of $794,000 described above. The Canadian dollar has strengthened approximately 6% against the U.S. dollar in fiscal 2005 in comparison to fiscal The Canadian dollar to U.S. dollar exchange rates for fiscal 2005 averaged TECSYS Inc. Annual Report

20 in comparison to for fiscal Consequently, excluding LMG, the strengthened Canadian dollar affected the reported revenue favorably by an estimated $533,000 or 2% in fiscal On the other hand, the strengthened Canadian dollar affected services expenses and operating expenses adversely by an estimated $966,000 in fiscal Cost of Revenue The total cost of revenue in fiscal 2005 increased by $3.7 million or 45% to $11.9 million in comparison to $8.2 million for the previous fiscal year. LMG accounted for $1.5 million of this increase for the two-month period ended April 30, The Company's acquisition from the prior fiscal year, SMB, incurred cost of revenue for $2.9 million in fiscal 2005 compared to $1.1 million for four-month period ended April 30, 2004 in the previous fiscal year. Services costs increased by $2.6 million or 48% to $8.0 million in fiscal 2005 compared to $5.4 million in fiscal LMG accounted for $524,000 of this increase for the two-month period ended April 30, SMB incurred services expenses of $2.4 million in fiscal 2005 in comparison to $766,000 for the four-month period ended April 30, 2004 reflecting an increase of $1.6 million. Excluding the above-mentioned acquisitions in both fiscal periods, services costs increased by $470,000 or 10% in fiscal 2005 in comparison to fiscal 2004 while revenue increased 14%. The increase in services costs, excluding LMG and SMB, is primarily attributable to unfavorable impact of the strengthened Canadian dollar estimated at $263,000 and the reduction of $94,000 to $518,000 of multimedia tax credits in fiscal 2005 compared to $612,000 in fiscal The reduction in multimedia tax credits is due to the slightly reduced services headcount in fiscal 2005 in comparison to fiscal Costs related to products increased $1.1 million or 52% to $3.2 million in fiscal 2005 compared to $2.1 million for the previous year. LMG accounted for $949,000 of this increase for the two-month period ended April 30, 2005 while SMB incurred increased costs of $160,000 in fiscal 2005 compared to the four-month operating period in fiscal As a result of the strengthened Canadian dollar against the U.S. dollar for fiscal 2005 as compared to fiscal 2004, the cost of revenue for fiscal 2005, excluding LMG, was unfavorably impacted by approximately $398,000. Gross Margin Total gross margin increased $2.8 million or 30% to $12.0 million in fiscal 2005 compared to $9.2 million in the previous fiscal year. The gross margin percentage decreased to 50% in fiscal 2005 in comparison to 53% for fiscal The decline in the gross margin percentage is primarily attributable to a higher ratio of revenue derived from services (63% in fiscal 2005 compared to 59% in fiscal 2004) which carry a lower margin compared to products and the addition of LMG which has an overall gross margin of 41%. LMG contributed $1.0 million to the gross margin for the two-month period ended April 30, 2005 with an overall gross margin percentage of 41%. LMG's lower gross margin percentage is due to the fact that its products revenue mix is weighted more heavily on hardware and supplies, which carry a lower gross margin, than proprietary and third-party software licenses. Additionally, LMG's gross margin for services is lower compared to the gross margin of the existing business mainly due to the fact that a portion of their services revenue comprises the repair of third-party hardware products which carries a significantly lower gross margin. SMB's gross margin was 48% with a contribution of $2.6 million in fiscal 2005 compared to 44% and a contribution of $850,000 for the four-month period ended April 30, SMB's gross margin realization is 68% for products and 43% for services in fiscal 2005 compared to 53% for products and 43% for services for the four-month period in fiscal The increase of the products gross margin in fiscal 2005 compared 18 TECSYS Inc. Annual Report 2006