2003 Annual Report. Advantex Marketing International Inc. Experiencing New Growth

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1 2003 Annual Report Advantex Marketing International Inc. Experiencing New Growth

2 2003 Table of Contents / Letter to Shareholders 04 / The Loyalty Marketing Landscape 05 / Building Momentum 12 / Management Discussion & Analysis 18 / Management s Responsibility for Financial Reporting 19 / Auditor s Report 23 / Notes to Consolidated Financial Statements

3 Letter to Shareholders Dear Shareholders, G. Randall Munger Chairman and Chief Executive Officer Advantex Marketing International Inc. I am pleased to provide the following progress report on Advantex activities for fiscal We took important steps forward this past year towards achieving our long-term strategic growth plan; initiating the expansion of our merchant partner base in new and existing markets, and diversifying and broadening our channel partner relationships. Advantex annual revenue was $95,969,000 for fiscal 2003, an increase of 3.8% over fiscal 2002 revenue of $92,410,000. Advantex s net loss for fiscal 2003 was $2,216,000 or $.04 per share compared to a net loss of $3,264,000 or $.07 per share for the previous year, a 32% year-overyear improvement. 2 I Advantex Marketing International I 2003 ANNUAL REPORT Results from the Company s established loyalty marketing business improved year over year despite the negative effects of SARS and merchant and cardholder uncertainties surrounding Air Canada and its Aeroplan subsidiary commencing in the fourth quarter of fiscal Revenue generated by the small number of new Canadian and U.S. retail merchant partnerships that commenced in the final months of the reporting year was not material. We signed agreements with CIBC, UAL Loyalty Services, US Airways and Bank of America that will more than quadruple our cardholder base, from 800,000 cardholders in fiscal 2003 to 3.6 million cardholders for 2004 and beyond. This expanded cardholder base enables Advantex to attract an increased number of merchant partners to its loyalty marketing programs. The affects of this increase will not be positively reflected in our financial results until all new markets are opened and fully operational. Planned Growth Initiatives Canada In Canada, we expanded our partnership with CIBC, successfully testmarketing our CIBC Aerogold ADVANTEX Benefit with selected high-

4 end retailers in multiple categories. A limited number of retail partners were added in the final months of the fiscal year. We also laid the foundation for CIBC Bonus Rewards, a new ADVANTEX Benefit program offering holders of CIBC Gold, CIBC Vacationgold and CIBC Dividend Platinum VISA cards bonus rewards specific to the loyalty currency offered on their card on purchases at participating establishments. The CIBC Bonus Rewards pilot was conducted this summer with selected golf courses, and roll-out is planned for Planned Growth Initiatives U.S. In the U.S., we expanded our relationship with US Airways to include Bank of America, integrating an ADVANTEX Benefit program into US Airways Dividend Miles Visa credit cards issued by the bank. A pilot of the program commenced in June in the Philadelphia area. Plans are in the works to begin an extensive roll-out of the program beginning in calendar We announced a new alliance with UAL Loyalty Services, launching the new Mileage Plus Mall at Our relationship is now growing to include an ADVANTEX Benefit program for United Mileage Plus Visa cards issued by First USA, as well as a registered card program for its entire membership base of more than 40 million members. The United Mileage Plus Retail program is scheduled to begin live testing late this fall. Amidst a weak investment environment, we retired an existing Convertible Debenture, and replaced it with a new Convertible Debenture financing with significantly better terms. Financial results for fiscal 2004 are expected to be impacted by many of the same factors that affected the Company s business in fiscal Operating losses are anticipated for fiscal 2004 as the Company continues to incur and expense the costs of growing its merchant partner base. Increasing the number of merchants participating in our loyalty marketing programs is an important part of the Company s growth and profit plan. Primary thrusts for the Company over the next few years will be the opening and development of key U.S. markets from coast to coast, and continued vertical market development within the retail merchant category. I look forward to reporting our progress to you over the next 12 months. G. Randall Munger, Chairman and Chief Executive Officer November 5, I Advantex Marketing International I 2003 ANNUAL REPORT

5 The Loyalty Market ing Landscape Advantex programs strengthen the relationships between major organizations and their valued customers, while building new and ongoing relationships between those customers and networks of merchants, service providers, and packaged goods manufacturers. 4 I Advantex Marketing International I 2003 ANNUAL REPORT Loyalty marketing is a booming, multi-billion dollar, worldwide industry, driven by consumers desire for personal recognition and rewards for their patronage. According to Web Flyer, a respected independent information source on the frequent flyer industry, there are more than 120 million members of airline frequent flyer programs in the world, 74 million of whom live in the U.S. As a result of the Company s long-term relationships with major airlines and their credit card issuing partners, Advantex is able to efficiently reach and influence large segments of this important market audience. Financial institutions have long realized the value of rewarding their cardholders as part of their credit card marketing strategy. Credit cardholders form a powerful target market, highly motivated by opportunities to shop and dine where they can earn frequent flyer miles or other specific loyalty currencies with their card purchases. Advantex provides its merchant partners with the ability to effectively target airline credit cardholders in their local area, communicate with them on a regular basis, and provide frequent flyer mile rewards to drive purchase activity.

6 Building Momentum Advantex has developed a unique loyalty marketing model around the concept of awarding frequent flyer miles on purchases through specific airline credit cards. The Company is leveraging its time-tested model and established supporting infrastructure to build momentum into lucrative new markets and merchant sectors throughout North America. Major new agreements with CIBC, US Airways and its partner, Bank of America, and with UAL Loyalty Services, demonstrate the growing confidence that airlines and their credit card issuing partners have in Advantex. Advantex s expertise and proven track record is allowing the Company to significantly expand its cardholder base across North America at a time when demand for effective credit card reward programs is growing faster than ever before. In fiscal 2003, Advantex signed agreements to more than quadruple its cardholder customer base by diversifying its airline and bank partnerships, in addition to beginning a significant new expansion of its merchant base into high-end and speciality retailing. Important growth initiatives initialized in the final months of the reporting year are being piloted in selected markets. Preparations are underway to begin rolling out these initiatives on a larger scale, starting in calendar ,000,000 More cardholders and more participating merchants provide the 3,500, Million opportunity for a significant increase in 3,000,000 reward transactions the driver of Advantex s growth and profitability. 2,500,000 2,000,000 1,500,000 1,000, ,000 0 NUMBER OF CARDHOLDERS 800, I Advantex Marketing International I 2003 ANNUAL REPORT

7 Earning More of the Rewards Cardholders are Committed to Collecting CIBC Aerogold ADVANTEX Benefit CIBC Aerogold is Canada s leading bank-issued Gold VISA card, with more than 800,000 cardholders, acknowledged to be one of the most coveted customer groups in the country. CIBC Aerogold cardholders are typically upscale, upper income, frequent travelers, who pay an annual fee of $120 and earn one Aeroplan Mile per dollar on all purchases. CIBC Aerogold VISA Card Aeroplan Miles is Canada s leading loyalty currency, issued by Air Canada s Aeroplan subsidiary company. Aeroplan Miles are collected by one out of every two Canadian households and are redeemable for reward travel on Air Canada, Star Alliance airlines, other airlines and travel service providers. 6 I Advantex Marketing International I 2003 ANNUAL REPORT US Airways Dividend Miles Visa Cards Through Advantex, CIBC Aerogold cardholders earn Bonus Aeroplan Miles (over and above the one mile per dollar normally earned) on purchases at hundreds of quality fine and casual restaurants, as well as selected small inns and resorts, spas, and premier golf courses throughout Canada. Retail is a new merchant segment for this program. US Airways Dividend Miles Rewards Dividend Miles Rewards is an ADVANTEX Benefit program embedded into US Airways Dividend Miles Visa credit cards issued by Bank of America. Through Advantex, cardholders earn one or more additional Dividend Miles on their card purchases at a wide range of participating merchants. US Airways Dividend Miles Visa credit cardholders enjoy an affluent lifestyle, with well above average income levels. Dividend Miles Rewards soft launched in June 2003 in the Philadelphia area. Plans are underway by Advantex to expand the program on a market-by-market basis to key U.S. cities.

8 United Mileage Plus Shopping Advantex is developing a shopping program for United Mileage Plus members offering United Mileage Plus Miles on purchases at local, regional and national retailers in multiple categories. There are more than 40 million enrolled members in the United Mileage Plus program. The benefit will be available to members as an embedded enhancement of the United Mileage Plus Visa credit card. United Mileage Plus members who do not carry a Mileage Plus Visa card will be able to earn miles by pre-registering any credit card of their choice with Advantex. United Mileage Plus Visa Card The program will begin with a single market release in November The program is expected to launch in major U.S. markets, commencing over the next twelve months. Bringing Partners Together Advantex Suite of Services Channel Partners Value Partners Airlines Financial Institutions Daily Newspapers Mass Merchandisers Pharmacies Supermarkets + Restaurants Online/Offline Retailers Small Inns & Resorts Golf & Ski Facilities Product Marketers 7 I Advantex Marketing International I 2003 ANNUAL REPORT

9 Strong Merchant Value Advantex loyalty marketing programs provide merchant partners with a competitive edge to help them build and maintain an active, loyal base of current and new customers. Through Advantex, merchant partners gain targeted access to the best customers in their local areas, along with proven incentives to drive purchase activity, extensive marketing and promotion to sustain top-of-mind customer awareness, seamless award process with zero administration at point of sale, performance-based pricing, and most importantly, measurable results. The Advantex pre-purchased receivable pricing model adds a powerful cash flow component to the merchant participation value proposition. There is a significant opportunity to expand the merchant participation base by increasing the amount merchants receive in advance, thus improving the merchants cash flow. Advantex pays cash to participating merchants for the rights to receive future purchases made on specific credit cards at the establishments. The rights to receive are acquired by Advantex at discounts to the face value of the future transactions. Advantex electronically acquires additional future purchases from merchant partners on an ongoing basis. Extensive Marketing The Advantex value proposition goes far beyond facilitating rewards on purchases. Advantex provides its partners with the enhanced customer communications they need to increase customer value. Advantex programs effectively promote the airline and credit card brand at hundreds of participating merchants, increasing awareness of the opportunity afforded to quickly achieve reward travel thresholds and other benefits. Merchant partners and their bonus offers are promoted extensively to Advantex cardholder customers. Advantex employs point-of-sale materials, program directories inserted into card statements, statement messaging, direct mail campaigns, repeat visit coupons and other powerful, highly-targeted marketing programs to drive transaction volumes at participating merchants by holders of partner credit cards. These marketing vehicles are complemented by web-based merchant directories, e-commerce web sites, co-op print advertising and other high-profile marketing initiatives. Program Guides Advantex produced over 400 direct mail campaigns in fiscal 2003 on behalf of its merchant partners, generating incremental business at key times throughout the year. A new cardholder publication, Advantex Lifestyle Rewards, introduced in fiscal 2003, expands the opportunity for Advantex to promote merchant partners to targeted groups of cardholders in a new magazine-size format, as well as begin developing new advertising revenue streams from outside sources.

10 Advantex Review Advantex Lifestyle Rewards Direct Mail Postcard Seamless Award Processing Newsletter The Company s proprietary point-of-sale credit card swipe technology and powerful relational databases enable the ADVANTEX Benefit to be embedded into participating credit cards, making awards easy for cardholders to earn and effortless for sales staff to administer. There are no secondary cards for customers to carry or present when making purchases, and no additional sign-up process required. Transaction data is automatically captured as designated credit cards are swiped at participating merchants. Advantex s system facilitates revenue collection and loyalty award processing with minimal administration by merchants. Loyalty awards or savings earned by the customer are calculated and processed, appearing on the customer s program or credit card account statement. 9 I Advantex Marketing International I 2003 ANNUAL REPORT

11 Online Capabilities Advantex s online expertise rounds out the Company s suite of loyalty marketing services, bringing Advantex to the attention of leading companies in a diverse range of industry sectors. Advantex built the technology to operate its online shopping mall programs through which registered members earn benefits on their purchases at participating e-retailers. Customer benefits are seamlessly calculated and awarded on shopping transactions originating from Advantex s online shopping mall sites. Advantex online shopping malls are customized, whitelabeled programs for the Company s partners. State-of-the-art privacy and security systems are employed by Advantex to safeguard customer information and award processing. The Company is pursuing new online Channel Partner relationships. Advantex currently operates the following online shopping mall initiatives: and offering bonus rewards to cardholders on ten different CIBC VISA credit cards on their online purchases at more than 40 Canadian and U.S. e-retailers. 10 I Advantex Marketing International I 2003 ANNUAL REPORT offering US Airways Dividend Miles members the ability to earn Dividend Miles when making purchases at more than 100 e-retailers in a diverse range of categories. offering United Mileage Plus members the opportunity to earn Mileage Plus Miles on their online purchases at more than 50 e-retailers.

12 Newspaper Subscriber Loyalty Programs TimesCard Directory New York Times TimesCard The New York Times TimesCard program uses registered loyalty card technology and database management techniques to provide mutually beneficial value to the newspaper, its customers, and participating merchants. TimesCard provides qualified subscribers with savings at hundreds of restaurants and other merchants in the New York City metropolitan area, as well as discounted admission to special events, pre-screenings of major films, and cultural events. The mix of participating venues is tailored to enhance the brand equity of The New York Times, reflecting the demographic profile and cultural interests of its subscribers. Customized Cash Books Advantex creates and markets customized Cash Books for daily newspapers to use in their subscriber loyalty and acquisition activities. Each book is customized for the newspaper partner and features hundreds of dollars of valuable savings and other benefits from a wide selection of restaurants, retailers, entertainment sites, sports teams, and cultural venues operating in the local area market. Customized Certificate Booklet Selective Sampling Samplex is one of the largest selective sampling company s in Canada, representing more than 150 brands and distributing over 20 million product samples to approximately 2.5 million consumers annually. Samplex offers a highly targeted sampling methodology for national brand packaged goods to cost-effectively generate trial of their products. Product marketers supply samples free of charge or well below cost. Product samples are combined into themed packs that are purchased by major pharmacy chains, supermarkets and mass merchandisers for sale or distribution to their customers as part of their ongoing promotion programs. Samplex packs typically retail for $6.99 and contain an assortment of national brand full- and trial-sized product samples with an aggregated retail value of $ Samplex pioneered this unique paid, targeted distribution system. Research confirms that the Samplex system of sample distribution is an effective means of generating consumer trial. Customized Samplex Pack 11 I Advantex Marketing International I 2003 ANNUAL REPORT

13 12 I Advantex Marketing International I 2003 ANNUAL REPORT Management Discussion and Analysis For the Year ended June 30, 2003

14 Business Description Advantex Marketing International Inc. is a leading marketing services firm, specializing in customer acquisition and loyalty marketing programs for its clients. The Company s partner/client base includes airlines, financial institutions, newspapers, drug, food and mass merchandise retail chains, product marketers, online retailers, local and national retailers, restaurants, golf courses, small inns and resorts, and entertainment venues. Advantex programs strengthen the relationships between major organizations and their valued customers, while building new and ongoing relationships between those customers and coalitions of merchants, product marketers and other service providers. The Company offers a comprehensive range of turn-key marketing services including: strategic planning; program design, development and execution; multi-media communications; Internet and database services; data capture and award processing interfaces; analytics and reporting; creative design and production, and customer service. The Company has two operating units: The Advantex Group and The Samplex Group. A significant portion of the Company s revenue is derived from the Advantex Group, best known for its customer loyalty marketing programs offering frequent flyer miles and other incentives through premium credit card issuers. Under the umbrella of each program, Advantex creates and sells syndicated marketing programs to participating merchants and service providers to stimulate new and repeat purchase activity. The Company s merchant partner base consists of restaurants, golf courses, small inns and resorts, spas, storefront and e-retailers. Revenue and marketing fees are generated by Advantex, as holders of designated credit cards make purchases at Advantex merchant partners. Merchants pay fees in return for a range of services including extensive marketing, loyalty awards to their customers on purchases, analytics and reporting. The Samplex Group is one of the largest product sampling companies in Canada. Samplex employs a mix of paid distribution and direct-to-consumer sampling methodologies, customer segmentation techniques, data capture and reporting to create cost-effective consumer trial opportunities for leading packaged goods marketers, major retailers, and their customers. Growth Strategy Advantex earns revenue as purchases are made at participating merchants by holders of credit cards in which the ADVANTEX Benefit is embedded. The Advantex Group has embarked upon a strategy to increase the number of credit cardholders and the number of merchants participating in its loyalty marketing programs. Throughout the year, Advantex has focused on several important growth initiatives to diversify its coalition of channel and merchant partnerships. A key focus this year has been the expansion of the Company s merchant partner base historically restaurants to include high-end retail merchants throughout North America. The Company has successfully diversified its channel partner relationships, increasing the number of cardholders accessing the Company s loyalty marketing programs. Channel partner agreements signed with CIBC, US Airways, Bank of America, and UAL Loyalty Services have more than quadrupled the size of the Advantex cardholder customer base, from 800,000 participating cardholders in fiscal 2003 to 3.6 million participating cardholders in fiscal 2004 and beyond. This expanded participating cardholder base creates a substantial platform for the development and implementation of new programs in Canada and the United States, and the impetus for growth in our merchant partner base. Increasing the number of merchants participating in our loyalty marketing programs is an important part of the Company s growth strategy. Results from Operations For the past year, Advantex Group partners in the travel, dining, and hospitality sectors, and the marketing industry overall, have operated under increasingly difficult business conditions. Spending by participating cardholders was further weakened by severe weather conditions, the impact of SARS, Mad Cow disease, and troubling geopolitical events, adversely affecting our channel and merchant partners. All of these factors, in conjunction with consumer and merchant uncertainties caused by Air Canada s filing for creditor protection under the Companies Creditors Arrangement Act (CCAA), have negatively impacted on the Company s financial 13 I Advantex Marketing International I 2003 ANNUAL REPORT

15 results. Results from the Company s established loyalty marketing business improved year over year despite the affects of SARS and merchant and consumer uncertainties surrounding Air Canada and its Aeroplan subsidiary in the fourth quarter of the fiscal In addition, Advantex s fiscal 2003 financial results include the costs incurred and expensed throughout the year to develop and launch its planned pilot retail programs in Canada and the United States. Advantex sales and fees were $95,969,000 for fiscal 2003, an increase of 3.8% over fiscal 2002 sales and fees of $92,410,000. The Company s operating loss was $795,000, compared to an operating loss of $256,000 in fiscal The year-over-year increase in the operating loss is the result of the investment incurred to expand the Company s merchant base by introducing the Company s loyalty marketing business into new markets. The Company is following a policy of writing off expansion costs rather than deferring these costs to future years. The Company s net loss from continuing operations was $2,216,000 for fiscal 2003, compared to a net loss from continuing operations of $2,547,000 for fiscal Advantex s net loss for fiscal 2003 was $2,216,000 or $.04 per share, compared to a net loss of $3,264,000 or $.07 per share for the previous year, a 32% year-overyear improvement. The Company had cash on hand of $3,258,000 at the end of the year, compared to $5,887,000 last year. 14 I Advantex Marketing International I 2003 ANNUAL REPORT Summary Financial Information Revenue Sales and fees from the Advantex Group (the Company s customer loyalty marketing business unit) were $88,276,000 for fiscal 2003, an increase of $2,431,000 or 2.8% from sales and fees of $85,845,000 in fiscal The majority of this increase was generated from the Company s CIBC Aerogold ADVANTEX Benefit program. Revenue generated by the small number of new Canadian and U.S. retail merchant partnerships that commenced in the final months of fiscal 2003 was not material. Revenue from the Company s three online shopping programs increased by $324,000 year over year, and continues to grow steadily. Sales and fees from the Samplex Group were $7,692,000, an increase of $1,127,000 or 17.2% over $6,565,000 in fiscal 2002, primarily from the introduction of new pack programs and an increase in one of the Company s most popular pack programs. Expenses Advantex s total direct costs and operating expenses were $96,764,000 in fiscal 2003, compared to $92,667,000 in fiscal 2002, representing an annual increase of $4,097,000 or 4.4%. The Company s selling expenses were $6,495,000, compared to $5,392,000, an increase of $1,103,000 or 20.5%. The increase in selling expenses is attributable to the Advantex Group, where the Company is expanding its loyalty marketing business through new markets and new merchants in both Canada and the United States. The costs associated with these planned expansion activities are being expensed as incurred. General and administrative expenses were $4,580,000 for the fiscal year, compared to $5,006,000 in fiscal 2003, a decrease of $426,000 or 8.5%. The decrease was a result of several factors including one-time shareholder expenses and professional fees that occurred in fiscal 2002 and did not occur in fiscal Net Results Divisional contribution (operating income before general and administrative expenses) for the 2003 fiscal year was $3,785,000, compared to $4,750,000 in the prior fiscal year, a decrease of $965,000. The divisional contribution for the Advantex Group was $2,999,000, compared to $3,614,000 in the previous year, as a result of the increase in selling expenses incurred to expand the Company s loyalty marketing business. The Samplex Group s divisional contribution was $786,000 in fiscal 2003, compared to $1,136,000 in fiscal

16 2002. Although revenue was up, net results were down year over year, primarily the result of higher product acquisition costs. Capital and Liquidity Management During the year, the Company capitalized $468,000 of capital assets, compared to $86,000 in the previous year. Capitalized assets include $308,000 for computer hardware and $117,000 in computer software primarily for upgrades to the Company s sales management system. Amortization of capital assets was $474,000, compared to $667,000 in the previous year. The Company used $304,000 of cash (before financing and investing activities), an improvement of $452,000 from 2002 during which $756,000 cash was used by operations. On June 30, 2003, the Company had cash and cash equivalents of $3,258,000, plus purchased receivables of $2,612,000 for a total of $5,870,000 in liquid assets, representing a decrease of $1,573,000 from June 30, This change reflects a $1,400,000 payment against the Convertible Debenture Payable. Working capital was $4,071,000 as at June 30, 2003, compared to $2,696,000 as at June 30, 2002, an improvement of $1,375,000. Interest/financing costs incurred were $947,000 in 2003, compared to $1,081,000 in the previous year. In the fourth quarter of fiscal 2003, the Company issued new Convertible Debentures in the aggregate principal amount of $4,000,000 and repaid an existing Convertible Debenture. The new Convertible Debentures mature on April 25, 2008, bear interest at 10%, and are convertible into common shares of Advantex at $0.17 per share, representing a maximum of 23,529,412 shares. The debentures are secured by a general security interest over all of the assets of the Company. Refer to Note 4 of the Financial Statements for a description of the accounting policy relating to these debentures. In order to fund the Company s current operations and its planned expansion, the Company may consider public or private equity or debt financings. In November 2000, Advantex entered into five-year commercial agreements with both Canadian Imperial Bank of Commerce (CIBC) and Air Canada. The commercial agreements included a warrant agreement under which CIBC and Air Canada were issued warrants to purchase 15 million Advantex common shares at $1.08 each, expiring on February 6, 2006, and the opportunity to earn five-year incentive warrants to acquire up to 55 million Advantex common shares. The incentive warrants are awarded in annual traunches based on the contribution to Advantex s growth from new CIBC and Air Canada programs in the reporting calendar year. To date, a total of 175,974 incentive warrants have been issued. CIBC and Air Canada may earn warrants to acquire up to 54,824,026 Advantex common shares until December 31, The exercise price of any incentive warrant issued with respect to the 2003 calendar year (3rd year) will be $ Since the calculation is based on calendar years, it is not possible to determine the number of warrants, if any, earned to the fiscal year end of the Company. Effective July 1, 2002, the Company has adopted the recommendations published by the CICA relating to stockbased compensation. No compensation expense is recognized when stock options are issued to employees, but stock options issued to non-employees are recognized as compensation using the Black-Scholes option pricing mode. The Company presents in a note to financial statements pro forma information using the Black-Scholes option pricing model. During the year, the Company issued 125,000 stock options to its employees, of which 100,000 were forfeited by year end. Risks and Uncertainties In addition to economic factors, the profitability of the Company is subject to a number of risk factors including continued channel and merchant partner participation, merchant credit risk, competition, and consumer behavior. The Company has certain business risks linked to the collection of its receivables. However, based upon historical results and the fact that the Company generally acquires the rights to future purchases that are estimated to be fully collectible within 30 days, management believes that this risk is manageable. The Company monitors its receivables on a daily basis. 15 I Advantex Marketing International I 2003 ANNUAL REPORT

17 16 I Advantex Marketing International I 2003 ANNUAL REPORT A significant portion of the Company s current revenue is dependent upon its offline value-added loyalty program agreement with CIBC under which Aeroplan Miles are awarded to holders of certain CIBC VISA credit cards. The Company purchases Aeroplan Miles from CIBC which, in turn, purchases Aeroplan Miles from Aeroplan LP, a subsidiary of Air Canada. Air Canada is currently restructuring its business pursuant to the Companies Creditors Arrangement Act (CCAA). However, the issuer of Aeroplan Miles, Aeroplan LP, is not subject to this CCAA filing. As part of Air Canada s CCAA restructuring, Air Canada and CIBC entered into a new contract under which CIBC is entitled to purchase Aeroplan Miles which will be available to support the CIBC Aerogold ADVANTEX Benefit program respecting restaurants, golf courses, and small inns and resorts. If Aeroplan Miles cease to be available for award in respect of purchases by holders of CIBC VISA credit cards, the Company has agreed to offer to such cardholders the same rewards as CIBC offers to them as a replacement for Aeroplan Miles, so long as the per unit cost of such rewards to the Company is the same or less than the Company s per unit cost of Aeroplan Miles. As well, as part of the restructuring, Air Canada has advised the Company that effective December 31, 2003 it is repudiating its online and retail reward program agreements with Advantex and its agreement to permit Advantex to award Aeroplan Miles under the CIBC Aerogold ADVANTEX Benefit program for purchases at participating retail outlets, and that it intends to renegotiate these business arrangements prior to such date. Since these agreements do not currently generate any significant revenue for the Company, if they are not renegotiated and the related programs terminate, there will be minimal consequences to the Company s current operations, revenues, or profitability. If CIBC terminates its offline value-added loyalty program agreement with the Company, this could materially and adversely affect the Company. However, CIBC can only terminate such agreement with the Company if the Company is in material breach thereof. In the event that the agreement expires or is terminated by the Company as a result of a breach by CIBC, CIBC is not entitled to offer a similar program to its VISA cardholders for a specified period of time and the Company will be entitled to offer such cardholders a similar replacement program on the Company s behalf. Consumers perceived value of the CIBC Aerogold card may be affected by changes in the marketplace, in particular, the expected introduction of competitive Aeroplan Mile card products by American Express. Advantex is taking steps to diversify its relationships so that it is not so reliant on its programs supporting the CIBC Aerogold card, developing programs for additional CIBC credit cards, and for other airline and bank partners. The Company's current loyalty programs are dependent upon ongoing consumer interest in accumulating frequent flyer miles for the purpose of obtaining reward air travel on designated airlines. Due to the financial difficulties currently being experienced by the airline industry overall, and specifically the Company's airline partners (and more particularly, Air Canada), there is a risk that the underlying frequent flyer currencies used in these programs could become unavailable to Advantex, or that consumer interest in accumulating these currencies could decline. This, in turn, may result in difficulties in retaining and acquiring participating merchants, and may adversely affect the Company's revenue and cost of sales. As an acknowledged leader in out-sourced customer loyalty marketing services, the Company occupies a unique market position. In more general terms, the Company could be considered competitive with the mass media, direct mail firms, other promotional programs and in-house loyalty programs for a portion of a client s total marketing budget. If client promotional spending levels decrease, this could have a material effect on Advantex revenue. In addition, companies with greater resources could become a competitive challenge in the future in both Canada and the United States. For instance, idine, a U.S.-based loyalty marketing business carrying on a business similar to the Advantex Group, has announced that it intends to launch a dining program in Canada. Advantex believes its substantial client equity, state-of-the-art proprietary technology and systems, breadth of in-house services and significant channel partner contracts provide a strong platform for the Company to compete successfully in the North American marketplace, and respond to the new competition in Canada. The Samplex Group may encounter competition from other companies in the sampling industry. The success of the Samplex Group is based primarily upon its ability to source products for its various themed packs free or at low cost. The willingness of packaged goods manufacturers to continue to provide their products free or at low cost to the Company is a key to the success of this business segment. Other than the competitive advantage that the Company enjoys as a result of its market penetration and established business relationships, there are no

18 significant barriers to entry into this market by competitors. From time to time, the Company may be required to access additional funds, and this may be limited by general market conditions that adversely affect the availability or cost of financing, specific factors affecting the Company s attractiveness as a borrower or investment vehicle, or the market s perception of the Company s performance. Outlook Loyalty marketing is a multi-billion dollar, world-wide industry. Advantex occupies a unique position in the North American loyalty marketing sector, constructing and managing loyalty programs that deliver enhanced value for airlines, credit card issuers, newspapers, and other major organizations, as well as for a wide range of local, regional and national brand merchants. Advantex programs deliver measurable results with rich analytics and reporting, enabling merchant partners to better understand and motivate important segments of their customer base. Program results are used by Advantex to develop targeted marketing tools on behalf of its partners to achieve specific key business objectives. Financial results for fiscal 2004 are expected to be impacted by many of the same factors that affected the Company s business in fiscal Operating losses are anticipated for fiscal 2004 as the Company continues to incur and expense the costs of expanding its merchant partner base. However, the long-term outlook for the Company is positive. Advantex programs developed for CIBC VISA cards offering other bonus awards are expected to evolve over time, complementing the CIBC Aerogold ADVANTEX Benefit revenue stream. The Company will continue to focus its efforts on the U.S. programs begun during 2003, expanding its penetration into the U.S. marketplace and increasing the number of participating U.S. merchants. Management believes there is an opportunity to improve margins and expand its merchant participation base by increasing the pre-purchase amounts it pays to merchants. The size of the participating cardholder customer base and the number of participating merchants are principal factors influencing the long-term growth and profitability of the Company. The Company has more than quadrupled its cardholder customer base through agreements with CIBC, UAL Loyalty Services, US Airways and Bank of America. This expanded cardholder base enables Advantex to attract an increased number of merchant partners to its loyalty marketing programs. Increasing the merchant partner base is key to achieving profitability. The effects of this increase will not be positively reflected in the Company s financial results until all new markets are opened and fully operational. Few companies in North America provide the depth of Advantex s marketing expertise in combination with its breadth of products and services. The North American airline and credit card industries continue to be important target markets for Advantex coalition loyalty marketing programs, with many new partnership opportunities to develop. Included in this Management Discussion and Analysis and other sections of the Annual Report are forwardlooking statements. These include statements about management s expectations, beliefs, intentions or strategies for the future, which are indicated by words such as anticipate, believe, forecast, project, predict and expect 1 and similar words. These forward-looking statements by their nature necessarily involve risks and uncertainties that could cause the actual results to differ materially from those contemplated by such statements. The Company considers the assumptions on which the forward-looking statements are based to be reasonable at the time they were prepared, but caution readers that those assumptions may ultimately prove to be incorrect due to certain risks and uncertainties including, without limitation, the difficulty of predicting regulatory approvals, market acceptance and demand for new products, the impact of competitive products and any other similar or related risks, and uncertainties. If any of these risks or uncertainties were to materialize, or if assumptions underlying the forward-looking statements of management were to prove incorrect, actual results of the Company could vary materially from those that are expressed or implied by these forward-looking statements. The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 17 I Advantex Marketing International I 2003 ANNUAL REPORT

19 Management s Responsibility for Financial Reporting To our Shareholders: The accompanying consolidated financial statements have been prepared by management and approved by the Board of Directors of the Company. Management is responsible for the information and representations contained in these consolidated financial statements and other sections of this Annual Report. The Company maintains appropriate processes to ensure that relevant and reliable financial information is produced. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Canada. The significant accounting policies which management believes are appropriate for the Company are described in note 1 to the consolidated financial statements. 18 I Advantex Marketing International I 2003 ANNUAL REPORT The Board of Directors is responsible for reviewing and approving the consolidated financial statements and overseeing management s performance of its financial reporting responsibilities. An Audit Committee, the majority of whose members are non-management Directors, is appointed by the Board. The Audit Committee reviews the consolidated financial statements, adequacy and internal controls, the audit process and financial reporting with management and the external auditors. The Audit Committee reports to the Directors prior to the approval of the audited consolidated financial statements for publication. Shimmerman Penn, LLP, the Company s external auditors who are appointed by the shareholders, audited the consolidated financial statements in accordance with generally accepted auditing standards to enable them to express to the shareholders their opinion on the consolidated financial statements. Their report is set out on the following pages. G. Randall Munger Chairman and Chief Executive Officer Lois McRae Interim Chief Financial Officer

20 Auditor s Report To the Shareholders of Advantex Marketing International Inc.: We have audited the consolidated balance sheets of Advantex Marketing International Inc. as at June 30, 2003 and 2002 and the consolidated statements of loss, deficit and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 June 30, 2003 and 2002 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Shimmerman Penn, LLP Chartered Accountants Toronto, Canada August 20, I Advantex Marketing International I 2003 ANNUAL REPORT

21 Consolidated Balance Sheets As At June 30, 2003 and 2002 NOTE ASSETS Current: Cash and cash equivalents $ 3,258,141 $ 5,886,922 Accounts receivable 2,090,150 2,940,561 Purchased receivables 2,611,824 1,555,580 Inventory 1,675,623 1,050,734 Prepaid expenses and sundry assets 251, ,196 Deferred financing charges 2 327,671 9,886,992 12,123,664 Long Term: Capital 3 1,467,871 1,481,667 Deferred financing charges 2 366,262 1,834,133 1,481,667 TOTAL ASSETS $ 11,721,125 $ 13,605,331 LIABILITIES Current: Accounts payable and accrued liabilities $ 5,815,589 $ 4,027,695 Convertible debenture payable 5,400,000 5,815,589 9,427,695 Long Term: Convertible debenture payable 4 3,397, I Advantex Marketing International I 2003 ANNUAL REPORT 9,213,573 9,427,695 SHAREHOLDERS EQUITY Capital Stock: 5 Class A preference shares 3,815 3,815 Common shares 20,814,938 20,814,938 20,818,753 20,818,753 Contributed surplus 59,992 59,992 Equity portion of convertible debenture 4 546,315 Deficit (18,917,508) (16,701,109) 2,507,552 4,177,636 TOTAL LIABILITIES AND SHAREHOLDERS EQUITY $ 11,721,125 $13,605,331 Approved by the Board: Director John Frederick Director Allison L. Smith See accompanying notes

22 Consolidated Statements of Loss Years Ended June 30, 2003 and 2002 NOTE REVENUE Sales and fees $ 95,968,582 $ 92,410,272 Direct costs 85,687,790 82,268,291 10,280,792 10,141,981 OPERATING EXPENSES Selling 6,495,443 5,391,780 General and administrative 4,580,336 5,006,445 11,075,779 10,398,225 OPERATING LOSS (794,987) (256,244) Write-down of capital assets 7 543,212 Amortization 474, ,552 Interest 2 947,386 1,081,275 1,421,412 2,291,039 NET LOSS CONTINUING OPERATIONS (2,216,399) (2,547,283) NET LOSS DISCONTINUED OPERATIONS 8 (717,004) NET LOSS $ (2,216,399) $ (3,264,287) LOSS PER COMMON SHARE Continuing operations 9 $ (0.04) $ (0.05) Discontinued operations (0.02) Total $ (0.04) $ (0.07) Consolidated Statements of Deficit Years Ended June 30, 2003 and 2002 NOTE Balance at the beginning of the year $ (16,701,109) $ (13,436,822) Net loss (2,216,399) (3,264,287) Balance at the end of the year $ (18,917,508) $ (16,701,109) See accompanying notes 21 I Advantex Marketing International I 2003 ANNUAL REPORT

23 Consolidated Statements of Cash Flows Years Ended June 30, 2003 and CASH WAS PROVIDED BY (USED IN): OPERATING ACTIVITIES Net loss $ (2,216,399) $ (3,264,287) Items not affecting cash Write-down of capital assets 543,212 Amortization of capital assets 474, ,734 Accretion charge 14,756 Amortization of deferred financing charges 348, ,310 (1,379,162) (1,595,031) Changes in non-cash working capital items Accounts receivable 850, ,889 Purchased receivables (1,056,244) 999,298 Inventory (624,889) 118,666 Prepaid expenses and sundry assets 110, ,947 Accounts payable and accrued liabilities 1,795,393 (641,721) 1,075, ,079 (303,549) (755,952) FINANCING ACTIVITIES Repayment of convertible debenture (5,400,000) Net proceeds from issuance of convertible debenture 3,542,498 Issue of capital stock 2,000, I Advantex Marketing International I 2003 ANNUAL REPORT (1,857,502) 2,000,000 INVESTING ACTIVITIES Purchase of capital assets (467,730) (86,448) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,628,781) 1,157,600 Cash and cash equivalents at the beginning of the year 5,886,922 4,729,322 CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR$ 3,258,141 $ 5,886,922 ADDITIONAL INFORMATION Interest paid $ 595,775 $ 648,185 See accompanying notes

24 Notes To The Consolidated Financial Statements Years Ended June 30, 2003 and SIGNIFICANT ACCOUNTING POLICIES (a) Nature of business Advantex Marketing International Inc. ( the Company ) is a public company for which the common shares are listed on The Toronto Stock Exchange (trading symbol ADX). The Company is a diversified marketing firm offering customer value management services. Its affinity loyalty programs influence the purchasing behaviour of large dedicated groups of consumers, to enhance customer loyalty and generate incremental revenues for program sponsors and participants. (b) Basis of consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Advantex Dining Corporation, Advantex Marketing Corporation, Advantex Marketing International Inc. (U.S.) and Samplex Inc. (U.S.). (c) Revenue recognition The Company derives its revenue from two operating groups: Advantex and Samplex. The Advantex Group derives most of its revenue from a value-added benefit loyalty program integrated with a credit card from Canadian Imperial Bank of Commerce (CIBC). The Company acquires the rights to future customer purchases at a discount from participating establishments and provides free bonus Aeroplan Miles to cardholders for every dollar spent by cardholders at those establishments. The Aeroplan Miles are purchased from Aeroplan LP, a subsidiary of Air Canada, through CIBC. The revenue is recognized when a sale is charged to the credit card. The Advantex Group started receiving fee revenue from certain of its loyalty programs during the year. The revenue is recognized at the time that a customer purchases services or products from the member participants of these programs. The Samplex Group derives its revenue from the sale of consumer-related themed pack programs and, to a much lower extent, gift certificates. Revenue from theme packs is recognized on delivery. Gift Certificates may be redeemed at any time by the consumer. Revenue is deferred until the certificates are redeemed. (d) Use of estimates The preparation of these consolidated 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 consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. (e) Purchased receivables The Company, under its Advantex Group, purchases the rights to receive future cash flows associated with goods and services at a discount from participating establishments. The Company continuously reviews the collectability of the receivables and writes off receivables from establishments that have ceased operations. 23 I Advantex Marketing International I 2003 ANNUAL REPORT