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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period
ended September 30, 2004 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the transition period
from to Commission file number: 000-50303
______________
MDC Partners Inc.
(Exact name of registrant as specified in its charter)
Ontario, Canada n / a
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
45 Hazelton Avenue M5R 2E3
Toronto, Ontario, Canada (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code:
(416) 960-9000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12(b)-2 of the Act). Yes [X] No [ ]
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING
THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Act subsequent
to the distributions of securities under a plan confirmed by a court.
Yes [ ] No [ ]
The numbers of shares outstanding as of December 15, 2004 were: 21,934,371
Class A shares and 2,502 Class B shares.
1
Website Access to Company Reports
MDC Partners Inc.'s Internet website address is www.mdc-partners.com. The
Company's annual reports on Form 40-F, quarterly reports on Form 10-Q and
current reports on Form 8-K, and any amendments to those reports filed or
furnished pursuant to section 13(a) or 15(d) of the Exchange Act will be made
available free of charge through the Company's website as soon as reasonably
practical after those reports are electronically filed with, or furnished to,
the Securities and Exchange Commission.
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2
MDC PARTNERS INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements............................................ 4
Condensed Consolidated Statements of Operations (unaudited)
Three Months and Nine Months Ended September 30, 2004 and
September 30, 2003.............................................. 4
Condensed Consolidated Balance Sheets as of
September 30, 2004 (unaudited) and December 31, 2003......... 5
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine Months Ended September 30, 2004 and September 30, 2003 .
6
Notes to Condensed Consolidated Financial Statements
(unaudited).................................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations.................................... 51
Item 3. Quantitative and Qualitative Disclosures about Market Risk...... 69
Item 4. Controls and Procedures......................................... 69
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 72
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities ................................. 72
Item 6. Exhibits and Reports on Form 8-K................................ 73
Signatures................................................................... 75
EXPLANATORY NOTE
This Form 10-Q for the quarter ended September 30, 2004 is being filed to
restate our interim unaudited condensed consolidated financial statements for
the three and nine months ended September 30, 2003, previously furnished on
Form 6-K, to reflect: (1) corrections in the recognition of compensation
expense on the privatization of Maxxcom, (2) corrections in the timing of
recognition and the classification of the amortization and write-off of
deferred financing fees, (3) corrections in the timing and amounts recognized
on the gain on sale of the investment in Custom Direct Inc. and the correction
of an associated income tax expense, (4) correction for the timing of
recognition and the classification of certain foreign exchange gains and losses
on intercompany balances, (5) corrections to revenue recognition related to
certain Secure Products contracts, (6) corrections to the accounting for
certain investments, (7) corrections in the timing of the recognition of
stock-based compensation, and (8) corrections to the computation of the
dilutive effect of convertible debentures on diluted earnings per share.
Refer to Note 2 of the notes to the interim unaudited condensed consolidated
financial statements included herein which discloses the adjustments to the
Company's interim unaudited condensed consolidated financial statements for the
three and nine months ended September 30, 2003 resulting from these
restatements.
Several of the corrections relate to transactions and events that arose in
prior periods. The Company has filed an amended Form 40-F/A for the fiscal year
ended December 31, 2003 and amended Forms 10-Q/A for the quarters ended March
31, 2004, and June 30, 2004.
In addition, the Company has restated and reflected corresponding corrections
to the Management Discussion and Analysis in Part I, Item 2.
3
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(thousands of United States dollars, except share and per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------- -------- -------- --------
(Restated-See (Restated-See
Note 2) Note 2)
Revenue:
Services $63,380 $42,872 $173,665 $123,398
Products 20,039 19,214 55,309 95,612
---------------- -------------- ------------ ---------------
83,419 62,086 228,974 219,010
---------------- -------------- ------------ ---------------
Operating Expenses:
Cost of products sold 12,433 12,509 33,994 45,948
Salary and related costs * 37,431 25,537 104,801 79,428
General and other operating costs 28,943 20,320 82,311 76,242
Other charges (recoveries) (2,350) 1,333 (2,350) 1,333
Depreciation and amortization 3,223 1,951 8,796 7,328
Write-down of fixed assets and other assets - - - 8,126
Goodwill charges - - - 10,012
---------------- -------------- ------------ ---------------
79,680 61,650 227,552 228,417
---------------- -------------- ------------ ---------------
Operating Profit (Loss) 3,739 436 1,422 (9,407)
---------------- -------------- ------------ ---------------
Other Income (Expenses):
Gain on sale of assets and settlement
of long-term debt(Note 11) (1,291) 2,861 14,947 47,486
Foreign exchange gain (loss) (614) 20 (156) (1,511)
Interest expense (2,753) (2,718) (7,842) (13,056)
Interest income 136 495 607 666
---------------- -------------- ------------ ---------------
(4,522) 658 7,556 33,585
---------------- -------------- ------------ ---------------
Income (Loss) Before Income Taxes, Equity
in Affiliates and Minority
Interests (783) 1,094 8,978 24,178
Income Taxes (Recovery) 294 (1,305) (98) 4,605
---------------- -------------- ------------ ---------------
Income (Loss) Before Equity in
Affiliates and Minority Interests (1,077) 2,399 9,076 19,573
Equity in Affiliates 455 1,383 3,339 3,174
Minority Interests in Income
of Consolidated Subsidiaries (2,252) (1,502) (5,892) (2,618)
---------------- -------------- ------------ ---------------
Net Income (Loss) ($2,874) $2,280 $6,523 $20,129
================ ============== ============ ===============
Earnings (Loss) Per Common Share:
Basic - Net Income (Loss) ($0.13) $0.12 $0.31 $1.16
Diluted- Net Income (Loss) (0.13) 0.12 0.28 0.99
Weighted Average Number of Common Shares:
Basic 22,392,533 18,361,746 21,063,632 17,397,476
Diluted 22,392,533 22,890,025 22,984,224 21,539,530
* Includes stock-based compensation expense of $1,907 and $1,746, during the three months ended September 30, 2004
and 2003, respectively, and an expense of $6,906 and $2,721 during the nine months ended September 30, 2004 and 2003,
respectively.
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.
4
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands of United States dollars)
September 30, December 31,
2004 2003
------------------ -----------------
(Unaudited) (Restated-
See Note 2)
ASSETS
Current Assets:
Cash and cash equivalents (Note 3) $16,349 $65,929
Accounts receivable, less allowance for doubtful accounts
of $1,080 and $529 107,408 58,864
Expenditures billable to clients 21,079 7,153
Inventories (Note 7) 8,815 7,735
Prepaid expenses and other current assets 6,636 4,863
------------------ -----------------
Total Current Assets 160,287 144,544
Fixed Assets, at cost, less accumulated depreciation
and amortization of $59,457 and $51,596 54,482 38,775
Investment in Affiliates 8,238 34,362
Goodwill 182,186 83,199
Intangibles, less accumulated amortization of $920 3,180 -
Deferred Tax Asset 11,862 11,563
Other Assets 8,473 9,096
------------------ -----------------
Total Assets $428,708 $321,539
================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Bank debt (Note 8) $13,836 $ -
Accounts payable 68,161 38,451
Accruals and other liabilities 56,727 34,245
Advance billings 44,916 15,731
Current portion of long-term debt (Note 8) 2,427 16,378
Deferred acquisition consideration 416 1,113
------------------ -----------------
Total Current Liabilities 186,483 105,918
Long-Term Debt (Note 8) 54,234 95,970
Convertible Notes (Note 12) - 37,794
Other Liabilities 4,091 516
------------------ -----------------
Total Liabilities 244,808 240,198
------------------ -----------------
Minority Interests 37,186 2,432
------------------ -----------------
Commitments and Contingencies (Note 13)
Subsequent events (Note 14)
Shareholders' Equity:
Share capital (Note 12) 163,106 115,996
Share capital to be issued 3,909 -
Additional paid-in capital 16,803 4,610
Retained earnings (deficit) (36,312) (39,169)
Accumulated other comprehensive income (loss) (792) (2,528)
------------------ -----------------
Total Shareholders' Equity 146,714 78,909
------------------ -----------------
Total Liabilities and Shareholders' Equity $428,708 $321,539
================== =================
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.
5
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands of United States dollars)
Nine Months Ended September 30,
2004 2003
-------- --------
(Restated-
See Note 2)
Cash flows from operating activities:
Net income $6,523 $20,129
Adjustments for non-cash items:
Stock-based compensation 6,906 2,721
Depreciation and amortization 8,796 7,328
Amortization and write-off of deferred finance charges 5,993 3,365
Non-cash interest expense - 3,408
Deferred income taxes (108) 4,614
Foreign exchange 156 1,511
Gain on sale of assets and settlement of long-term debt (Note 11) (18,613) (49,158)
Write-down of fixed assets and other assets - 8,126
Goodwill charges - 10,012
Earnings of affiliates, net of distributions 2,113 (2,161)
Minority interest and other (2,146) (1,207)
Changes in non-cash working capital (4,381) (4,918)
---------------- ----------------
Net cash provided by operating activities 5,239 3,770
---------------- ----------------
Cash flows from investing activities:
Capital expenditures (11,437) (12,925)
Proceeds of dispositions - 118,722
Acquisitions, net of cash (17,137) (21,529)
Other assets, net (2,939) 3,957
---------------- ----------------
Net cash provided by (used in) investing activities (31,513) 88,225
---------------- ----------------
Cash flows from financing activities:
Increase in bank indebtedness 13,836 -
Proceeds from issuance of long-term debt 67,346 11,439
Repayment of long-term debt (94,471) (87,985)
Issuance of share capital 3,608 1,652
Purchase of share capital (12,110) (6,343)
---------------- ----------------
Net cash used in financing activities (21,791) (81,237)
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (1,692) 4,387
---------------- ----------------
Net increase (decrease) in cash and cash equivalents (49,757) 15,145
Cash and cash equivalents at beginning of period 66,106 31,226
---------------- ----------------
Cash and cash equivalents at end of period $16,349 $46,371
================ ================
Supplemental disclosures:
Cash income taxes paid $1,092 $1,057
Cash interest paid $5,859 $3,869
Non-cash consideration:
Share capital issued, or to be issued, on acquisitions (Note 9) $20,840 -
Share capital issued on settlement of convertible notes $34,919 -
Stock-based awards issued, on acquisitions (Note 9) $1,315 $2,530
Settlement of debt with investment in affiliate:
Reduction in exchangeable securities (Note 11) ($33,991) -
Proceeds on sale of investment (Note 11) $33,991 -
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.
6
MDC PARTNERS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(thousands of United States dollars, unless otherwise stated)
1. Basis of Presentation
MDC Partners Inc. (the "Company") has prepared the unaudited
condensed consolidated interim financial statements included herein
pursuant to the rules of the United States Securities and Exchange
Commission (the "SEC"). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles ("GAAP") of the United
States of America ("US GAAP") have been condensed or omitted pursuant
to these rules.
The accompanying financial statements reflect all adjustments,
consisting of normally recurring accruals, which in the opinion of
management are necessary for a fair presentation, in all material
respects, of the information contained therein. These statements
should be read in conjunction with the consolidated financial
statements and related notes included in the Company's amended annual
report on Form 40-F/A for the year ended December 31, 2003.
Results of operations for interim periods are not necessarily
indicative of annual results.
As of the first quarter of 2004, the Company changed its method of
accounting from Canadian GAAP to US GAAP. The comparative financial
statements included in these interim financial statements have been
restated following US GAAP. This change in accounting method resulted
from the conversion of Class B multiple voting shares into Class A
subordinate voting shares during the first quarter of 2004 (see Note
12). Due to the conversion of these shares, the majority of
shareholder votes now belong to shareholders of the Company who
reside in the US and, as a result, the Company is now deemed to be a
US domestic issuer as defined under the SEC regulations to which the
Company is subject.
As of September 22, 2004, the Company was required to consolidate,
pursuant to FASB Interpretation 46R on Variable Interest Entities
("FIN 46R"), Crispin Porter + Bogusky, LLC, a non-controlled
affiliate, which was previously accounted for under the equity
method. This change in accounting method was a result of a change in
the relationship between the Company and Crispin Porter + Bogusky,
LLC and its officers, affected by the Company's senior credit
agreement entered into on September 22, 2004. (See Note 10).
Under Canadian securities requirements, the Company is required to
provide a reconciliation setting out the differences between US and
Canadian GAAP as applied to the Company's financial statements for
the interim periods and years ended in the fiscal periods for 2004
and 2005. This required disclosure for the three months and nine
months ended September 30, 2004 and 2003 is set out in Note 15.
2. Restatement of Financial Statements
In preparing the financial statements for the three and nine-month
periods ended September 30, 2004, the Company determined that its
previously filed audited consolidated financial statements for the
years ended December 31, 2001, 2002 and 2003 and its previously
issued interim unaudited condensed consolidated financial statements
for the three months ended March 31, 2003 and 2004; the three and six
months ended June 30, 2003 and 2004; and the three and nine months
ended September 30, 2003 contained misapplication of Canadian and US
GAAP and those financial statements required restatement.
7
These adjustments pertained to the correction of the accounting for
various transactions including the correction for the following: (1)
corrections in the recognition of compensation expense on the
privatization of Maxxcom, (2) corrections in the timing of recognition
and the classification of the amortization and write-off of deferred
financing fees, (3) corrections in the timing and amounts recognized
on the gain on sale of the investment in Custom Direct Inc. and the
correction of an associated income tax expense, (4) correction for the
timing of recognition and the classification of certain foreign
exchange gains and losses on intercompany balances, (5) corrections to
revenue recognition related to certain Secure Products contracts, (6)
corrections to the accounting for certain investments, (7) corrections
in the timing of the recognition of stock-based compensation, and (8)
corrections to the computation of the dilutive effect of convertible
debentures on diluted earnings per share.
The Company has restated its consolidated financial statements as at
and for the year ended December 31, 2003, 2002 and 2001, the effect of
which is described in the Company's restated 2003 Annual Report as
filed on Form 40-F/A dated December 20, 2004. The Company has also
restated its interim unaudited condensed consolidated financial
statements for the three months ended March 31, 2004 and 2003; for the
three and six months ended June 30, 2004 and 2003; and the three and
nine months ended September 30, 2003. Reliance should be placed solely
on the restated financial statements in the Form 40-F/A, and in the
Forms 10Q/A and not on the previously filed Form 40-F dated May 10,
2004, previously filed Form 10-Q for the three and six months ended
June 30, 2004 filed on August 4, 2004 or any other previously reported
financial statements for the periods identified above. The interim
unaudited condensed consolidated financial statements for the three
and nine months ended March 31, 2004, and 2003; June 30, 2004 and
2003; and September 30, 2003, to reflect the following restatement
adjustments:
(1) The correction in the compensation expense on the
privatization of Maxxcom. The correction of the recognition
of stock based compensation related to Maxxcom Inc.
acquisition pursuant to SFAS 123 "Accounting for Stock Based
Compensation" related to the stock option remeasurement
required on the issuance of vested and unvested options of
the Company in exchange for vested and unvested stock options
of Maxxcom Inc. associated with the acquisition of the 26%
minority interest holding of Maxxcom Inc. by the Company in
July 2003 and on the modification of certain options and
stock appreciation rights on the termination of an employee.
These corrections increased salary and related costs,
reducing operating profit and net income for the nine months
ended September 30, 2004, by $148. These corrections
increased salary and related costs, thus reducing operating
profit (loss) and net income for the three and nine months
ended September 30, 2003, by $284. The correction of
severance costs previously capitalized as part of the cost of
the acquisition of the 26% minority interest holding of
Maxxcom Inc. in July 2003, rather than being expensed. This
correction increased other charges by $1,333, reduced
operating profit by $1,333 during the three months and nine
months ended September 30, 2003;
8
(2) The reclassification of the amortization of deferred
financing fees to interest expense. Previously, the
amortization of certain deferred financing fees were
classified as depreciation in amortization expense or were
netted against the gain on sale of assets. The amortization
of deferred financing fees should be classified as interest
expense and the write-off of deferred financing costs
included in the loss on the settlement of debt. These
corrections reduced depreciation and amortization, and
increased interest expense, by $473 and $1,693 for the three
months and nine months ended September 30, 2003,
respectively, resulting in no change to net income in either
period;
(3) To correct certain errors in the calculation of the gain
on the disposal of the Company's 80% interest in Customs
Direct, Inc. in June 2003. Associated with this transaction,
income tax expense was corrected due to income tax benefits
having been calculated incorrectly. These corrections reduced
the gain on sale of assets by $4,239 in the nine months ended
September 30, 2003;
(4) The correction of the accounting for foreign exchange
gains and losses related to certain intercompany balances
previously reflected in accumulated comprehensive income
rather than being recognized in statement of operations. This
change resulted in a foreign exchange gain of $20 and a loss
of $1,511 for the three and nine months ended September 30,
2003, respectively, correspondingly affecting net income by
the same amounts;
9
(5) The correction of revenue recognition related to various
revenue arrangements in accordance with the SEC's Staff
Accounting Bulletin 101, Revenue Recognition in Financial
Statements ("SAB 101"), and as revised and updated by SAB 104
and EITF Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables ("EITF 00-21"). The correction of the accounting
includes: (a) The Company incorrectly accounted for certain
contracts entered into in the Secured Products segment
relating to multiple element manufacturing arrangements. The
Company incorrectly recognized revenue on an "as billed"
basis as they completed various deliverables under the
contract. The Company has determined that multiple elements
revenue should be accounted for as one unit of accounting
under both SAB 101, as amended and under EITF 00-21 as the
Company does not have reliable, verifiable and objectively
determinable evidence of the fair value of the various
elements in these arrangements, and specifically the
undelivered elements. Revenue should be recognized when the
final element of the arrangement is completed and the product
is shipped to the customer or end user. Amounts received in
advance of this date have been deferred and recognized at the
shipping date; (b) The Company incorrectly recorded revenue
related to its stamp printing business using the percentage
of completion method consistent with the guidance provided by
Statement of Position 81-1, Accounting for Performance of
Construction/Production Contracts ("SOP 81-1"). The
manufacture of stamps is not within the scope of SOP 81-1.
Revenue related to the manufacture of stamps has been
restated to be recognized when the stamps are shipped to the
customer and the Company's obligations under the contractual
arrangements are completed; and (c) Under the contractual
arrangements in both (a) and (b) above, the Company has the
ability to recover any costs incurred to date under possible
termination of the contract, and accordingly the Company has
restated the financial statements to give effect to the
deferral of costs related to the manufacturing activates as
inventory work-in-progress. To reflect this correction, the
Company has retroactively restated its annual financial
statements at the beginning of the first quarter of 2001 as
presented in the Company's restated annual consolidated
financial statements included in the Company's Form 40-F/A
for the year-ended December 31, 2003, with retained earnings
at January 1, 2001 adjusted for the effects of the
restatement on prior years. For the three months ended
September 30, 2003, these corrections increased product
revenue by $316, costs of sales by $436, reduced operating
profit by $120, reduced income taxes expense by $27 and net
income by $93. This correction reduced product revenue by
$561, costs of sales by $474, operating profit by $87,
increased income taxes expense by $16 and reduced net income
by $103 for the nine months ended September 30, 2003;
10
(6) The correction of the accounting for three investments:
(a) A joint venture operating entity owning a rental
property, in which the significant financial operating
policies are by contractual arrangement jointly controlled by
all parties having an equity interest in the entity, was
previously accounted for on a proportionately consolidated
basis. Pursuant to APB Opinion No. 18 "The Equity Method of
Accounting for Investments in Common Stock", the investment
in the joint venture is now accounted for using the equity
method; A majority owned investee, Accumark Promotions Group,
Inc., was previously accounted for on a consolidated basis.
Upon evaluation pursuant to EITF 96-16 "Investor's Accounting
for an Investee When the Investor Has a Majority of the
Voting Interest but the Minority Shareholder or Shareholders
Have Certain Approval or Veto Rights", management determined
the investee could not be consolidated and accordingly it is
now accounted for by the Company using the equity method; (c)
The Company's 20% interest in CDI, up to the date of its sale
in February 2004, was previously accounted for on the cost
basis and has now been restated and accounted for under the
equity method as management has determined significant
influence existed. Due to the nature of the adjustments, this
correction impacted most amounts on the statement of
operations and balance sheets. However, other than item (c)
above, the collections had no impact on net income (loss).
For the period, the impact of these changes was to decrease
operating profit for the three and nine months ended
September 30, 2003 by $1,222 and $2,431, respectively;
(7) The correction of the accounting for stock-based
compensation to recognize, on a cumulative basis,
compensation cost to the end of each reporting period at
least equal to the value of the vested portion of the
stock-based award at that same date. This change increased
salary and related costs by $65 for the three months ended
September 30, 2003, and by $58 and $271 for the nine months
ended September 30, 2004 and 2003, respectively; and
(8) The correction to the computation of the dilutive effect
of convertible debentures in calculating dilutive earnings
per share figures.
The Company has restated its consolidated financial statements for the
years ended December 31, 2003, 2002 and 2001, the effect of which is
described in the Company's 2003 Annual Report as filed on Form 40-F/A.
The Company has also restated its interim unaudited condensed
consolidated financial statements for the three months ended March 31,
2004 and 2003 and for the three and six months ended June 30, 2004 and
2003, as filed on Forms 10-Q/A. The cumulative effect of these
adjustments to all restated periods through June 30, 2004 was to
increase accumulated deficit by $5,001 and to decrease total
shareholderes' equity by $1,118. The following statements present the
effect of these deficits by $5,001 and to restatements and these
changes in classification for the three and nine months ended
September 2003:
11
Three Months Ended September 30, 2003
-------------------------------------------------
As Reported Adjustments As Restated
---------------- -------------- ---------------
Revenue:
Services $45,987 ($3,115) $42,872
Products 18,898 316 19,214
---------------- -------------- ---------------
64,885 (2,799) 62,086
---------------- -------------- ---------------
Operating Expenses:
Cost of products sold 12,073 436 12,509
Salary and related costs 25,698 (161) 25,537
General and other operating costs 21,662 (1,342) 20,320
Other charges (recoveries) - 1,333 1,333
Depreciation and amortization 2,465 (514) 1,951
---------------- -------------- ---------------
61,898 (248) 61,650
---------------- -------------- ---------------
Operating Profit 2,987 (2,551) 436
---------------- -------------- ---------------
Other Income (Expenses):
Gain (loss) on sale of assets and other 1,842 1,019 2,861
Foreign exchange gain - 20 20
Interest expense (2,321) (397) (2,718)
Interest income 495 - 495
---------------- -------------- ---------------
16 642 658
---------------- -------------- ---------------
Income Before Income Taxes, Equity in Affiliates and Minority
Interests 3,003 (1,909) 1,094
Income Taxes (Recovery) (1,221) (84) (1,305)
---------------- -------------- ---------------
Income Before Equity in Affiliates and Minority Interests 4,224 (1,825) 2,399
Equity in Affiliates 530 853 1,383
Minority Interests (1,596) 94 (1,502)
---------------- -------------- ---------------
Net Income $3,158 ($878) $2,280
================ ============== ===============
Earnings Per Common Share:
Basic $0.17 $0.12
Diluted 0.15 0.12
Weighted Average Number of Common Shares:
Basic 18,361,746 18,361,746
Diluted 23,249,320 22,890,025
12
Nine Months Ended September 30, 2003
-------------------------------------------------
As Reported Adjustments As Restated
---------------- -------------- ---------------
Revenue:
Services $131,525 ($8,127) $123,398
Products 96,173 (561) 95,612
--------------- -------------- ---------------
227,698 (8,688) 219,010
--------------- -------------- ---------------
Operating Expenses:
Cost of products sold 46,422 (474) 45,948
Salary and related costs 80,503 (1,075) 79,428
General and other operating costs 80,189 (3,947) 76,242
Other charges (recoveries) - 1,333 1,333
Depreciation and amortization 9,140 (1,812) 7,328
Write-down of fixed assets and other assets 8,126 - 8,126
Goodwill charges 10,012 - 10,012
--------------- -------------- ---------------
234,392 (5,975) 228,417
--------------- -------------- ---------------
Operating Profit (Loss) (6,694) (2,713) (9,407)
--------------- -------------- ---------------
Other Income (Expenses):
Gain (loss) on sale of assets 50,436 (2,950) 47,486
Foreign exchange loss - (1,511) (1,511)
Interest expense (11,583) (1,473) (13,056)
Interest income 666 - 666
--------------- -------------- ---------------
39,519 (5,934) 33,585
--------------- -------------- ---------------
Income Before Income Taxes, Equity in Affiliates and Minority
Interests 32,825 (8,647) 24,178
Income Taxes (Recovery) 4,770 (165) 4,605
--------------- -------------- ---------------
Income Before Equity in Affiliates and Minority Interests 28,055 (8,482) 19,573
Equity in Affiliates 1,752 1,422 3,174
Minority Interests (2,975) 357 (2,618)
--------------- -------------- ---------------
Net Income $26,832 ($6,703) $20,129
=============== ============== ===============
Earnings Per Common Share:
Basic - Net Income $1.50 $1.16
Diluted - Net Income 1.24 0.99
Weighted Average Number of Common Shares:
Basic 17,397,476 17,397,476
Diluted 23,541,571 21,539,530
13
For the Nine Months Ended September 30, 2003
------------------------------------------------------
As Reported Adjustments As Restated
--------------------- -------------- ---------------
Cash flows from operating activities:
Net income $26,832 ($6,703) $20,129
Adjustments for non-cash items:
Stock-based compensation 2,166 555 2,721
Depreciation and amortization 9,140 (1,812) 7,328
Amortization and write-off of deferred finance charges - 3,365 3,365
Non-cash interest expense 3,408 - 3,408
Deferred income taxes 4,598 16 4,614
Foreign exchange - 1,511 1,511
Gain on sale of assets (50,436) 1,278 (49,158)
Write-down of fixed assets and other assets 8,126 - 8,126
Goodwill charges 10,012 - 10,012
Earnings of affiliates, net of distributions (2,457) 296 (2,161)
Minority interest and other (1,207) - (1,207)
Changes in non-cash working capital (5,627) 709 (4,918)
--------------------- -------------- ---------------
Net cash provided by (used in) operating activities 4,555 (785) 3,770
--------------------- -------------- ---------------
Cash flows from investing activities:
Capital expenditures (12,918) (7) (12,925)
Proceeds of dispositions 118,722 - 118,722
Acquisitions, net of cash (22,862) 1,333 (21,529)
Other assets, net 3,933 24 3,957
--------------------- -------------- ---------------
Net cash provided by (used in) investing activities 86,875 1,350 88,225
--------------------- -------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 11,439 - 11,439
Repayment of long-term debt (88,055) 70 (87,985)
Issuance of share capital 1,652 - 1,652
Purchase of share capital (6,343) - (6,343)
--------------------- -------------- ---------------
Net cash used in financing activities (81,307) 70 (81,237)
--------------------- -------------- ---------------
Effect of exchange rate changes on cash and cash equivalents 4,387 - 4,387
--------------------- -------------- ---------------
Net decrease in cash and cash equivalents 14,510 635 15,145
Cash and cash equivalents at beginning of period 32,250 (1,024) 31,226
--------------------- -------------- ---------------
Cash and cash equivalents at end of period $46,760 ($389) $46,371
===================== ============== ===============
Supplemental disclosures:
Income taxes paid $1,057 - $1,057
Interest paid $3,869 - $3,869
Non-cash consideration:
Stock-based awards issued, on acquisitions $1,900 630 $2,530
3. Significant Accounting Policies
The Company's significant accounting policies are summarized as
follows:
Principles of Consolidation. The accompanying condensed
consolidated financial statements include the accounts of MDC
Partners Inc. (formerly MDC Corporation Inc.) and its domestic and
international controlled subsidiaries that are not considered
variable interest entities and variable interest entities for which
the Company is the primary beneficiary.
Intercompany balances and transactions have been eliminated.
(See Notes 6 and 10)
Use of Estimates. The preparation of financial statements in
conformity with US GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results
could differ from those estimates.
14
Cash and Cash Equivalents. The Company's cash equivalents
are primarily comprised of investments in overnight interest-bearing
deposits, commercial paper and money market instruments and other
short-term investments with original maturity dates of three months
or less at the time of purchase. Included in cash and cash
equivalents at September 30, 2004 is $1,715 of cash restricted as to
withdrawal pursuant to a collateral agreement and a customer's
contractual requirement.
Allowance for Doubtful Accounts. Trade receivables are
stated at invoiced amounts less allowances for doubtful accounts. The
allowances represent estimated uncollectible receivables associated
with potential customer defaults usually due to customers' potential
insolvency. The allowances include amounts for certain customers
where a risk of default has been specifically identified. The
assessment of the likelihood of customer defaults is based on various
factors, including the length of time the receivables are past due,
historical experience and existing economic conditions.
Expenditures Billable to Clients. Expenditures billable to
clients consist principally of costs incurred on behalf of clients
when providing advertising, marketing and corporate communications
services to clients that have not been invoiced. Such amounts are
invoiced to clients at various times over the course of the
production process. In the majority of the Company's Marketing
Communications businesses, it acts as agent and records revenue equal
to the net amount retained when the fee or commission is earned.
Inventories. Finished goods and work-in-process inventories
are valued at the lower of cost and net realizable value. Raw
materials are valued at the lower of cost and replacement cost. Cost
is determined on a first-in, first-out method.
Depreciation of Fixed Assets. Buildings are depreciated on a
straight-line basis over the estimated useful lives of 20 to 25
years. Computers, furniture and fixtures are depreciated on a
declining balance basis at rates of between 20% to 50% per year.
Machinery and equipment are depreciated on a declining balance basis
at rates of between 10% to 20% per year. Leasehold improvements are
amortized on a straight-line basis over the lesser of the term of the
related lease or the estimated useful life of the asset.
Long-lived Assets. In accordance with SFAS 144 "Accounting
for the Impairment or Disposal of Long-lived Assets," a long-lived
asset or asset group is tested for recoverability whenever events or
changes in circumstances indicate that its carrying amount may not be
recoverable. When such events occur, the Company compares the sum of
the undiscounted cash flows expected to result from the use and
eventual disposition of the asset or asset group to the carrying
amount of the long-lived asset or asset group. If this comparison
indicates that there is an impairment, the amount of the impairment
is typically calculated using discounted expected future cash flows
where observable fair values are not readily determinable. The
discount rate applied to these cash flows is based on the Company's
weighted average cost of capital, risk adjusted where appropriate.
Equity Method Investments. The equity method is used to
account for investments in entities in which the Company has an
ownership interest of less than 50% and has significant influence, or
joint control over the operating and financial policies of the
affiliate; or has an ownership interest of greater than 50% however
the substantive participating rights of the minority interest
shareholders preclude the Company from exercising unilateral control
over, the operating and financial policies of the affiliate. The
Company's investments accounted for using the equity method include
Accumark Promotions Group Inc., 55% owned by the Company, Cliff
Freeman & Partners, LLC ("CF"), 19.9% owned by the Company, Mono
Advertising LLC, 49.9% owned by the Company, Zig, Inc., 49.9% owned by
the Company, and a 50% undivided interest in a real estate joint
venture. Until September 22, 2004, this also included Crispin Porter +
Bogusky, LLC, 49.9% owned by the Company, which, after this date, was
consolidated in the accompanying financial statements under the
accounting standards for variable interest entities (see Note 10). The
Company's management periodically evaluates these investments to
determine if there have been any, other than temporary, declines in
value.
15
Goodwill. In accordance with SFAS 142, "Goodwill and Other
Intangible Assets", goodwill acquired as a result of a business
combination for which the acquisition date was after June 30, 2001 is
no longer amortized, but is periodically tested for impairment.
Additionally, in accordance with SFAS 141, "Business Combinations",
the cost of an acquired entity is allocated to the assets acquired
and liabilities assumed based on their estimated fair values
including other identifiable intangible assets, as applicable, such
as trade names, customer relationships and client lists.
Goodwill is tested annually for impairment, and is tested for
impairment more frequently if events and circumstances indicate that
the asset might be impaired. An impairment loss is recognized to the
extent that the carrying amount exceeds the asset's fair value. This
determination is made at the reporting unit level and consists of two
steps. First, the Company determines the fair value of a reporting
unit and compares it to its carrying amount. Second, if the carrying
amount of a reporting unit exceeds its fair value, an impairment loss
is recognized for any excess of the carrying amount of the reporting
unit's goodwill over the implied fair value of that goodwill. The
implied fair value of goodwill is determined by allocating the fair
value of the reporting unit in a manner similar to a purchase price
allocation, in accordance with FASB Statement No. 141, "Business
Combinations". The residual fair value after this allocation is the
implied fair value of the reporting unit goodwill. Impairment losses,
where applicable, will be charged to operating profit (loss).
Intangible Assets. In accordance with SFAS 142, "Goodwill
and Other Intangible Assets", intangibles with a definite life, other
than goodwill, acquired as a result of a business combination are
subject to amortization. The method of amortization selected reflects
the pattern in which the economic benefits of the specific intangible
asset is consumed or otherwise used up. If that pattern cannot be
reliably determined, a straight-line amortization method is used.
Intangible assets that are subject to amortization are reviewed for
potential impairment in accordance with SFAS 144 at least annually or
whenever events or circumstances indicate that carrying amounts may
not be recoverable. The Company is amortizing its intangible assets
on a straight-line basis over a period of 3 years.
.
Deferred Taxes. Deferred income taxes are provided for the
temporary difference between the financial reporting basis and tax
basis of the Company's assets and liabilities. Deferred tax benefits
result principally from recording certain expenses in the financial
statements that are not currently deductible for tax purposes and
from differences between the tax and book basis of assets and
liabilities recorded in connection with acquisitions. Deferred tax
liabilities result principally from deductions recorded for tax
purposes in excess of that recorded in the financial statements.
Guarantees. Guarantees granted by the Company to third
parties (or modified) after January 1, 2003 are generally recognized,
at the inception of a guarantee, as a liability for the obligations
it has undertaken in issuing the guarantee, including its ongoing
obligation to stand ready to perform over the term of the guarantee
in the event that the specified triggering events or conditions
occur. The initial measurement of that liability is the fair value of
the guarantee at its inception. The recognition of the liability is
required even if it is not probable that payments will be required
under the guarantee. The Company's liability associated with
guarantees is insignificant.
Revenue Recognition. The Company generates services revenue
from its Marketing Communications reportable segment and product
revenue from its Secure Products reportable segment.
16
Marketing Communications
Substantially all of the Marketing Communications reportable segment
revenue is derived from fees for services. Additionally, the Company
often earns commissions based upon the placement of advertisements in
various media. Generally, the Company acts as agent for its customers
and records revenue equal to the net amount retained. Revenue is
realized when the service is performed in accordance with the terms
of each client arrangement and upon completion of the earnings
process. This includes when services are rendered, upon presentation
date for media, when costs are incurred for radio and television
production and when print production is completed and collection is
reasonably assured and all other revenue recognition criteria have
been met.
A small portion of the Company's contractual arrangements with
clients includes performance incentive provisions, which allow the
Company to earn additional revenues as a result of its performance
relative to both quantitative and qualitative goals. The Company
recognizes the incentive portion of revenue under these arrangements
when specific quantitative goals are achieved, or when performance
against qualitative goals is determined by the Company's clients.
Secured Products
Substantially all of the Secured Products International reportable
segment revenue is derived from the sale of products. The Company has
the following revenue recognition policies.
Revenue derived from the stamp operations is recognized upon shipment
or upon delivery of the product to the customer when the Company's
obligations under the contractual arrangements are completed, the
customer takes ownership and assumes the risk of loss of the product,
the selling price is determined and the collection of the related
receivable is reasonably assured. The Company performs extensive
quality control testing procedures prior to shipment to ensure that
its contractual obligations are met. Under these contractual
arrangements, the Company has the ability to recover any costs
incurred to date under possible termination of the contract,
accordingly the Company accounts for the manufacturing costs incurred
as inventory work-in-process, until completion of production.
Revenue derived from secured printing arrangements whereby the
Company manufactures and stores the printed product for a period of
time at the direction of its customer with delivery at a future date
(within a 90 day period) is accounted for on a "bill and hold" basis
whereby the Company allocates the arrangement consideration on a
relative fair value basis between the printing service and the
storage service. The Company recognizes the printing revenue when the
customized printed products moves to the secure storage facility and
the printing process is complete and when title transfers to the
customer. The Company has no further obligations under the printing
segment of the arrangement. The Company recognizes the storage fee
revenue when the customized printed products are delivered to the
customer or the end user. Although amounts are generally not billed by
the Company until the customized print product is delivered to the
customer's premises, collection of the entire consideration is due
under certain contracts within 90 days of completion of the printing
segment of the arrangement.
17
Revenue derived from the design, manufacturing, inventory management
and personalization arrangements of secured cards is recognized as a
single unit of accounting when the secured card is shipped to the
cardholder and the Company's service obligations to the card issuer
are complete under the terms of the contractual arrangement and the
total selling price related to the card is known and collection of the
related receivable is reasonably assured. Any amounts billed and/or
collected in advance of this date are deferred and recognized at the
shipping date. Under these contractual arrangements, the Company has
the ability to recover any costs incurred to date under possible
termination of the contract, accordingly the Company accounts for the
effect of costs incurred related to design and manufacturing relative
to the secured card arrangement as inventory work-in-process related
to the arrangements.
The Company's revenue recognition policies are in compliance with the
SEC Staff Accounting Bulletin 104, "Revenue Recognition" ("SAB 104").
SAB 104 summarizes certain of the SEC staff's views in applying
generally accepted accounting principles to revenue recognition in
financial statements. Also, in July 2000, the EITF of the Financial
Accounting Standards Board released Issue 99-19, "Reporting Revenue
Gross as a Principal versus Net as an Agent ("EITF 99-19"). This Issue
summarized the EITF's views on when revenue should be recorded at the
gross amount billed because it has earned revenue from the sale of
goods or services, or the net amount retained because it has earned a
fee or commission. In the Marketing Communications businesses, it acts
as an agent and records revenue equal to the net amount retained, when
the fee or commission is earned.
In June 2003, EITF No. 00-21, Revenue Arrangements with Multiple
Deliverables ("EITF 00-21"), became effective. This issue addressed
certain aspects of the accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities.
Additionally, in January 2002, the EITF released Issue No. 01-14,
Income Statement Characterization of Reimbursements Received for
"Out-of-Pocket" Expenses Incurred ("EITF 01-14"). This Issue
summarized the EITF's views on when out-of-pocket expenses should be
characterized as revenue. The adoption of the provisions of these two
EITF's had no material impact on the Company's financial position,
results of operations, or cashflows. The Company's revenue recognition
policies are in compliance with SAB 104, EITF 99-19, EITF 00-21 and
EITF 01-14.
Stock-Based Compensation. Effective January 1, 2003, the
Company prospectively adopted fair value accounting for stock based
awards as prescribed by SFAS 123 "Accounting for Stock-Based
Compensation". Prior to January 1, 2003, the Company elected not to
apply fair value accounting to stock-based awards to employees, other
than for direct awards of stock and awards settleable in cash, which
required fair value accounting. Prior to January 1, 2003, for awards
not elected to be accounted for under the fair value method, the
Company accounted for stock-based compensation in accordance with
Accounting Principles Board Opinion 25, "Accounting for Stock Issued
to Employees" ("APB 25"). APB 25 is based upon an intrinsic value
method of accounting for stock-based compensation. Under this method,
compensation cost is measured as the excess, if any, of the quoted
market price of the stock issuance at the measurement date over the
amount to be paid by the employee.
The Company adopted fair value accounting for stock-based awards using
the prospective application transitional alternative available in SFAS
148 "Accounting for Stock-Based Compensation - Transition and
Disclosure". Accordingly, the fair value method is applied to all
awards granted, modified or settled on or after January 1, 2003. Under
the fair value method, compensation cost is measured at fair value at
the date of grant and is expensed over the service period, that is the
award's vesting period. When awards are exercised, share capital is
credited by the sum of the consideration paid together with the
related portion previously credited to additional paid-in capital when
compensation costs were charged against income or acquisition
consideration.
Stock-based awards that are settled in cash or may be settled in cash
at the option of employees are recorded as liabilities. The
measurement of the liability and compensation cost for these awards is
based on the intrinsic value of the award, and is recorded into
operating income over the service period, that is the vesting period
of the award. Changes in the Company's payment obligation subsequent
to vesting of the award and prior to the settlement date are recorded
as compensation cost over the servce period in operating income in the
period incurred. The final payment amount for Share Appreciation
Rights is established on the date of the exercise of the award by the
employee.
18
Stock-based awards that are settled in cash or equity at the option of
Company are recorded at fair value on the date of grant and recorded
as additional paid-in capital. The fair value measurement of the
compensation cost for these awards is based on using the Black-Scholes
service period, that is the option pricing model, and is recorded into
operating income over the vesting period of the award. When awards are
exercised, share capital is credited with the related portion
previously credited to additional paid-in capital.
As noted, prior to January 1, 2003, the Company did not use the fair
value method to account for certain employee stock-based compensation
plans but disclosed this pro forma information for options granted
commencing fiscal in 1995. The table below summarizes the quarterly
pro forma effect for the three months and nine months ended September
30, 2004 and 2003, respectively, had the Company adopted the fair
value method of accounting for stock options and similar instruments
for awards issued prior to 2003:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ---------------------------
2004 2003 2004 2003
------------ ------------- --------- --------------
(Restated - (Restated -
See Note 2) See Note 2)
Net income (loss) as reported ($2,874) $2,280 $6,523 $20,129
Fair value costs, net of income tax, of
stock-based employee compensation for options
issued prior to 2003 225 455 894 1,450
------------ ------------- --------- --------------
Net income (loss), pro forma
($3,099) $1,825 $5,629 $18,679
============ ============= ========= ==============
Basic net income (loss) per share, as reported ($0.13) $0.12 $0.31 $1.16
Basic net income (loss) per share, pro forma ($0.14) $0.10 $0.27 $1.07
Diluted net income (loss) per share, as reported ($0.13) $0.12 $0.28 $0.99
Diluted net income (loss) per share, pro forma ($0.14) $0.10 $0.24 $0.92
The fair value of the stock options and similar awards at the grant date used to compute pro forma net income (loss) and
net income (loss) per share was estimated using the Black-Scholes option-pricing model with the following weighted
average assumptions for each of the three months ended:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ----------------------------
2004 2003 2004 2003
-------------- ------------- ------------ ------------
Expected dividend 0% 0% 0% 0%
Expected volatility 40% 40% 40% 40%
Risk-free interest rate 4.0% 6.0% 4.0% 6.0%
Expected option life in years 3.71 5 3.71 5
Weighted average stock option
fair value per option granted $3.63 $4.27 $4.65 $2.53
19
Earnings Per Common Share. Basic earnings per share is based
upon the weighted average number of common shares outstanding during
each period, including the "Share capital to be issued" as reflected
in the Shareholders' Equity on the balance sheet. Diluted earnings
per share is based on the above, plus, if dilutive, common share
equivalents, which include outstanding options, warrants, stock
appreciation rights and restricted stock units. For purposes of
computing diluted earnings per share for the three months ended
September 30, 2004 and 2003, respectively, nil and 4,528,279 shares,
and for the nine months ended September 30, 2004 and 2003,
respectively, 1,920,592 and 6,115,279 shares, were assumed to have
been outstanding related to common share equivalents. Additionally,
the assumed increase in net income related to the after-tax interest
costs of convertible debentures used in the computations was $0 and
$402 for the three months ended September 30, 2004 and 2003,
respectively, and $0 and $1,165 for the nine months ended September
30, 2004 and 2003, respectively.
The following table details the weighted average number of common
shares outstanding for each of the three months and nine months ended
September 30, 2004 and 2003, respectively:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- --------------------------------
2004 2003 2004 2003
-------------- ------------- ------------- ---------------
Basic weighted average shares outstanding 22,392,533 18,361,746 21,063,632 17,397,476
Weighted average shares dilution adjustments:
Dilutive stock options (a) - 750,330 1,920,592 364,105
7% convertible senior notes - 3,777,949 - 3,777,949
-------------- ------------- ------------- ---------------
Diluted weighted average shares outstanding (b) 22,392,533 22,890,025 22,984,224 21,539,530
============== ============= ============= ===============
(a) Dilutive and anti-dilutive stock options and similar awards were determined by using the average closing
price of the Class A subordinate voting shares for the period. For the three months ended September 30,
2004 and 2003, the average share price used was $11.54 per share and $9.32 per share, respectively. For
the nine months ended September 30, 2004 and 2003, the average share price used was $12.81 per share and
$6.28 per share, respectively.
(b) Had certain stock options, similar awards and the convertible debt been dilutive, they would have added
1,392,226 dilutive shares and nil dilutive shares for the three months ended September 30, 2004 and 2003,
respectively, and added 1,197,355 dilutive shares and nil dilutive shares for the nine months ended
September 30, 2004 and 2003, respectively.
Foreign Currency Translation. The Company's financial
statements were prepared in accordance with the requirements of SFAS
No. 52, "Foreign Currency Translation". The functional currency of the
Company is Canadian dollars and it has decided to use U.S. dollars as
its reporting currency for consolidated reporting purposes. All of the
Company's subsidiaries use their local currency as their functional
currency in accordance with SFAS 52. Accordingly, the currency impacts
of the translation of the balance sheets of the Company's non-US
dollar based subsidiaries to U.S. dollar statements are included as
cumulative translation adjustments in other accumulated comprehensive
income. Cumulative translation adjustments are not included in net
earnings unless they are actually realized through a sale or upon
complete or substantially complete liquidation of the Company's net
investment in the foreign operation. The income statements of non-US
dollar based subsidiaries are translated at average exchange rates for
the period.
Gains and losses arising from the Company's foreign currency
transactions are reflected in net earnings other than those
unrealized gains or losses arising on the translation of certain
intercompany foreign currency transactions that are of a long-term
nature (that is settlement is not planned or anticipated in the
future) and which are included as cumulative translation adjustments
in other accumulated comprehensive income.
20
Derivative Financial Instruments. The Company adopted SFAS
No. 133, "Accounting for Derivative Instruments and Hedging
Activities", on January 1, 2001. SFAS No. 133 establishes accounting
and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts
and debt instruments) be recorded in the balance sheet as either an
asset or liability measured at its fair value. The Company issued
adjustable rate exchangeable debentures, in December 2003, which
included an embedded derivative. The derivative met the SFAS No. 133
criteria for separation from the debt contract and was marked to
market, with changes in the fair value being recorded in net earnings
for the period, until the exchangeable debentures were settled on
February 13, 2004.
Effective July 1, 2002, management designated the Company's
10.5% U.S. senior subordinated notes ("Notes") as an economic hedge
against foreign exchange exposure of the U.S. operation, Custom
Direct, Inc. ("CDI"). The hedge was applied prospectively from the
effective date whereby any foreign exchange translation adjustment of
the Notes reduced any offsetting foreign exchange translation
adjustment of the U.S. operations, the net of which was reflected in
the cumulative translation account within shareholders' equity. The
application of hedge accounting ceased on the repayment of the
Company's 10.5% US senior subordinated notes on June 30, 2003 which
corresponded with the Company's sale of 80% of its investment in CDI.
4. Comprehensive Income (Loss)
Total comprehensive income and its components were:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ----------------------------
2004 2003 2004 2003
------------ ------------- ----------- -------------
(Restated - (Restated -
See Note 2) See Note 2)
Net income (loss) for the period ($2,874) $2,280 $6,523 $20,129
Unrealized gain on marketable securities - 550 - 2,640
Reclassification adjustment for realized loss - (2,640) - (2,640)
Foreign currency cumulative translation
adjustment 2,421 811 1,736 (12,042)
------------ ------------- ----------- -------------
Comprehensive income (loss) for the period ($453) $1,001 $8,259 $8,087
============ ============= =========== =============
5. New Accounting Pronouncements
The following recent pronouncements were issued by the Financial
Accounting Standards Board ("FASB") and became effective in 2004:
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities, An Interpretation of
ARB No. 51" ("FIN 46"). This Interpretation addresses the
consolidation by business enterprises of variable interest entities,
as defined in the Interpretation. The Interpretation was to be
applied immediately to variable interests in variable interest
entities created after January 31, 2003, and to variable interests in
variable interest entities obtained after January 31, 2003. In
December 2003, the FASB issued FASB Interpretation No. 46R,
"Consolidation of Variable Interest Entities Revised" ("FIN 46R").
FIN 46R modifies certain scope exceptions provided in FIN 46.
Entities would be required to replace FIN 46 provisions with FIN 46R
provisions for all newly created post-January 31, 2003 entities as of
the end of the first interim or annual reporting period ending after
March 15, 2004. See Note 10 for the impact the effective provisions
of FIN 46R had on the Company's consolidated financial statements.
21
In November 2003, the EITF reached a consensus on Issue No. 03-01,
"The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments" ("EITF 03-01"). EITF 03-01 established additional
disclosure requirements for each category of SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" ("SFAS 115"),
investments in a loss position. Effective for years ended after
December 15, 2003, the adoption of this EITF requires the Company to
include certain quantitative and qualitative disclosures for debt and
marketable equity securities classified as available-for-sale or
held-to-maturity under SFAS 115 that are impaired at the balance sheet
date for which an other-than-temporary impairment has not been
recognized. Additionally, certain qualitative disclosures should be
made to clarify a circumstance whereby an investment's fair value that
is below cost is not considered other-than-temporary. In October 2004,
the EITF temporarily delayed the effective date of the recognition and
measurement provisions of EITF 03-01 until such time as a proposed
FASB Staff Position provides guidance on the application of those
provisions. The effective provisions of this consensus do not have a
material impact on the Company's interim unaudited condensed
consolidated financial statements.
6. Segmented Information
Based on the Company's internal management structure, the Company's
operations form two reportable segments - Marketing Communications
and Secure Products International.
Marketing Communications services, through the Company's network of
entrepreneurial firms, include advertising and media, customer
relationship management, and marketing services. These businesses
provide communications services to similar type clients on a global,
national and regional basis. The businesses have similar cost
structures and are subject to the same general economic and
competitive risks. Given these similarities, the results are
aggregated into one reportable segment.
Secure Products International operations provide security products
and services in three primary areas: electronic transaction products
such as credit, debit, telephone and smart cards; secure ticketing
products such as airline, transit and event tickets; and stamps, both
postal and excise. Again, given the similarities in types of clients,
cost structure, risks and long-term financial results, the results
are aggregated into one reportable segment. The significant
accounting polices of these segments are the same as those described
in the summary of significant accounting policies included in these
notes to the unaudited condensed consolidated financial statements,
except as where indicated.
Many of the Company's Marketing Communications businesses have
significant other interestholders and in some cases, the Company
operates the business as a joint venture with these other
interestholders in a fashion similar to a joint venture. The
Company's management oversees these businesses as active managers
rather than a passive investor, reviewing all aspects of their
operations with the management of these businesses, regardless of the
Company's ownership interest. Within the marketing communications
industry, operating costs, such as salary and related costs, relative
to revenues, among other things, are key performance indicators.
Consequently, the Company's management reviews, analyses and manages
these elements of the businesses as a whole, rather than just being
concerned with it as an investment. Management believes the
presentation of the whole of the businesses comprising this segment
also provides readers with a complete view of the elements of all
operations that significantly affect the Marketing Communications
reportable segment's profitability. Accumark Promotions Group Inc,
owned 55% by the Company, Cliff Freeman & Partners, LLC, owned 19.9%
by the Company, Mono Advertising LLC, owned 49.9% by the Company,
and, Zig, Inc., owned 49.9% by the Company, are required to be equity
accounted for under US GAAP. Additionally, for all presented periods
prior to September 22, 2004, Crispin Porter + Bogusky, LLC, owned 49%
by the Company, was also required to be equity accounted for and, for
subsequent periods consolidated, under US GAAP. (See Note 10 -
Variable Interest Entities). For purposes of the segmented
information disclosure, 100% of the results of operations of these
three entities have been combined with the other business of the
Marketing Communications reportable segment and the alternate
operating results have been described as "Combined". A reconciliation
of "Combined" results of operations of the Marketing Communications
reportable segment to the US GAAP reported results of operations has
been provided by the Company in the tables included in the segmented
information disclosure.
22
Summary financial information concerning the Company's reportable segments for
the three months ended September 30 is shown in the following table:
Three Months Ended September 30, 2004:
Combined As Reported under US GAAP
-------------------- --------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
------------------ -------------- ------------------ --------------- --------------- ---------------
Revenue $77,450 $14,070 $63,380 $20,039 $ - $83,419
----------------- -------------- ------------------ --------------- --------------- ---------------
Operating Expenses:
Cost of products sold - - - 12,433 - 12,433
Salary and related costs* 38,169 8,103 30,066 3,580 3,785 37,431
General and other
operating costs 28,273 3,825 24,448 2,243 2,252 28,943
Other charges (recoveries) - - - - (2,350) (2,350)
Depreciation and
amortization 2,683 462 2,221 877 125 3,223
----------------- -------------- ------------------ --------------- --------------- ---------------
69,125 12,390 56,735 19,133 3,812 79,680
----------------- -------------- ------------------ --------------- --------------- ---------------
Operating Profit (Loss) $8,325 $1,680 $6,645 $906 ($3,812) 3,739
================= ============== ================== =============== ===============
Other Income (Expense):
Gain on sale of assets
and settlement of
long-term debt (1,291)
Foreign exchange loss (614)
Interest expense, net (2,617)
---------------
Income (Loss) Before Income Taxes, Equity in Affiliates and
Minority Interests (783)
Income Taxes 294
---------------
Income (Loss) Before Equity in Affiliates and Minority (1,077)
Interests
Equity in Affiliates 455
Minority Interests (2,252)
---------------
Net Income (Loss) ($2,874)
===============
Capital expenditures $1,513 $247 $1,266 $2,106 $ - $3,372
*Includes stock-based
compensation $162 $91 $71 $ - $1,836 $1,907
23
Three Months Ended September 30, 2003 (Restated - See Note 2):
Combined As Reported under US GAAP
-------------------- --------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
------------------ -------------- ------------------ --------------- --------------- ---------------
Revenue $51,343 $8,471 $42,872 $19,214 $ - $62,086
---------------- -------------- ------------------ --------------- --------------- ---------------
Operating Expenses:
Cost of products sold - - - 12,509 - 12,509
Salary and related costs* 23,605 3,614 19,991 3,069 2,477 25,537
General and other
operating costs 19,572 2,864 16,708 2,548 1,064 20,320
Other charges (recoveries) - - - - 1,333 1,333
Depreciation and
amortization 1,619 163 1,456 359 136 1,951
---------------- -------------- ------------------ --------------- --------------- ---------------
44,796 6,641 38,155 18,485 5,010 61,650
---------------- -------------- ------------------ --------------- --------------- ---------------
Operating Profit (Loss) $6,547 $1,830 $4,717 $729 ($5,010) 436
================ ============== ================== =============== ===============
Other Income (Expense):
Gain on sale of assets 2,861
Foreign exchange gain 20
Interest expense, net (2,223)
---------------
Income Before Income Taxes, Equity in Affiliates and Minority Interest 1,094
Income Taxes (Recovery) (1,305)
---------------
Income Before Equity in Affiliates and Minority Interests 2,399
Equity in Affiliates 1,383
Minority Interests (1,502)
---------------
Net Income $2,280
===============
Capital expenditures $2,330 $148 $2,186 $3,180 $ - $5,366
*Includes stock-based
compensation $251 $ - $251 $ - $1,495 $1,746
24
Nine Months Ended September 30, 2004:
Combined As Reported under US GAAP
-------------------- --------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
------------------ -------------- --------------- --------------- --------------- ---------------
Revenue $215,551 $41,886 $173,665 $55,309 $ - $228,974
------------------ -------------- --------------- --------------- --------------- ---------------
Operating Expenses:
Cost of products sold - - - 33,994 - 33,994
Salary and related costs* 103,138 20,190 82,948 10,426 11,427 104,801
General and other
operating costs 80,726 10,757 69,969 6,744 5,598 82,311
Other charges
(recoveries) - - - - (2,350) (2,350)
Depreciation and
amortization 7,253 993 6,260 2,359 177 8,796
------------------ -------------- --------------- --------------- --------------- ---------------
191,117 31,940 159,177 53,523 14,852 227,552
------------------ -------------- --------------- --------------- --------------- ---------------
Operating Profit (Loss) $24,434 $9,946 $14,488 $1,786 ($14,852) 1,422
================== ============== =============== =============== ===============
Other Income (Expense):
Gain on sale of assets
and settlement of
long-term debt 14,947
Foreign exchange loss (156)
Interest expense, net (7,235)
---------------
Income Before Income Taxes, Equity in Affiliates and Minority Interest 8,978
Income Taxes (Recovery) (98)
---------------
Income Before Equity in Affiliates and Minority Interests 9,076
Equity in Affiliates 3,339
Minority Interests (5,892)
---------------
Net Income $6,523
===============
Capital expenditures $6,962 $1,165 $5,797 $5,566 $74 $11,437
*Includes stock-based
compensation $439 $165 $274 $ - $6,632 $6,906
25
Nine Months Ended September 30, 2003 (Restated - See Note 2)
Combined As Reported under US GAAP
-------------------- --------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
------------------ -------------- --------------- --------------- --------------- ---------------
Revenue $147,929 $24,531 $123,398 $95,612 $ - $219,010
------------------ -------------- --------------- --------------- --------------- --------------
Operating Expenses:
Cost of products sold - - - 45,948 - 45,948
Salary and related costs* 70,009 10,553 59,456 14,835 5,137 79,428
General and other
operating costs 55,936 7,444 48,492 25,067 2,683 76,242
Other charges - - - - 1,333 1,333
Depreciation and
amortization 4,710 393 4,317 2,614 397 7,328
Write-down of fixed assets
and other assets - - - 8,126 - 8,126
Goodwill charges - - - 10,012 - 10,012
------------------ -------------- --------------- --------------- --------------- --------------
130,655 18,390 112,265 106,602 9,550 228,417
------------------ -------------- --------------- --------------- --------------- --------------
Operating Profit (Loss) $17,274 $6,141 $11,133 ($10,990) ($9,550) (9,407)
================== ============== =============== =============== ===============
Other Income (Expenses):
Gain on sale of assets 47,486
Foreign exchange loss (1,511)
Interest expense, net (12,390)
-----------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 24,178
Income Taxes 4,605
-----------
Income Before Equity in Affiliates and Minority Interests 19,573
Equity in Affiliates 3,174
Minority Interests (2,618)
-----------
Net Income $20,129
===========
Capital expenditures $9,265 $4,542 $4,723 $8,199 $3 $12,925
*Includes stock-based
compensation $251 $ - $251 $ - $2,470 $2,721
26
A summary of the Company's revenue geographic area as of September 30,
2004 and 2003 is set forth in the following table.
Australia & the
United States Canada United Kingdom Total
------------------- ------------------ --------------- -------------
Revenue
Three Months Ended September 30,
2004 $55,821 $20,266 $7,332 $83,419
2003 (Restated - See Note 2) 33,324 21,292 7,470 62,086
Revenue
Nine Months Ended September 30,
2004 $150,520 $59,121 $19,333 $228,974
2003 (Restated - See Note 2) 143,809 57,223 17,978 219,010
Long-lived Assets
at September 30,
2004 $30,348 $19,663 $5,742 $55,753
2003 (Restated - See Note 2) 14,833 17,276 4,420 36,529
7. Inventories
The components of inventory are listed below:
September 30, December 31,
2004 2003
------------------- -------------------
(Restated - See
Note 2)
Raw materials and supplies $3,703 $3,743
Work-in-process 5,112 3,992
------------------- -------------------
Total $8,815 $7,735
=================== ===================
8. Long-Term and Bank Debt
During the second quarter of 2004, the Company reached agreements
with its senior credit lenders to amend the terms of the credit
facility of its subsidiary, Maxxcom Inc., to eliminate the scheduled
quarterly borrowing reductions after March 31, 2004 and to change the
facility's maturity date from March 31, 2005 to September 30, 2004.
As a result of this amendment, the Company was not required to make a
debt repayment in the second quarter of $5.2 million (C$7.0 million).
On June 10, 2004, MDC Partners Inc. entered into a revolving credit
facility with a syndicate of banks providing for borrowings of up to
$18.7 million (C$25.0 million) maturing in May of 2005. The facility
was available for general corporate purposes including acquisitions,
however, it could not be used to repay existing debt or to provide
financial assistance to businesses securing such debt. This facility
bore interest at variable rates based upon LIBOR, Canadian bank prime
or US bank base rate, at the Company's option. Based on the level of
debt relative to certain operating results, the interest rates on
loans were calculated by adding between 175 to 275 basis points to
the LIBOR and Bankers Acceptance based interest rate loans and
between 75 to 175 basis points to all other loan interest rates. The
provisions of the facility contained various covenants pertaining to
debt to EBITDA ratios, debt to capitalization ratio, and the
maintenance of certain interest coverage and minimum shareholders'
equity levels. The facility was secured by a pledge of the Company's
assets principally comprised of ownership interests in its
subsidiaries and by the underlying assets of the businesses
comprising the Company's Secure Products International operating
segment and Kirshenbaum Bond + Partners, LLC ("KBP").
27
On September 22, 2004, MDC Partners Inc. and certain of its
wholly-owned subsidiaries entered into a revolving credit facility
with a syndicate of banks providing for borrowings of up to $100
million (including swing-line advances of up to $10 million) maturing
in September 2007 (the "Credit Agreement'). This facility bears
interest at variable rates based upon the Eurodollar rate, US bank
prime rate, US base rate, and Canadian bank prime rate, at the
Company's option. Based on the level of debt relative to certain
operating results, the interest rates on loans are calculated by
adding between 200 and 275 basis points on Eurodollar and Bankers
Acceptance based interest rate loans, and between 50 and 125 basis
points on to all other loan interest rates. The provisions of the
facility contain various covenants pertaining to a minimum ratio of
debt to net income before interest, income taxes, depreciation and
amortization ("EBITDA"), a maximum debt to capitalization ratio, the
maintenance of certain liquidity levels and minimum shareholders'
equity levels. The facility restricts, among other things, the levels
of capital expenditures, investments, distributions, dispositions and
incurrence of other debt. The facility is secured by a senior pledge
of the Company's assets principally comprised of ownership interests
in its subsidiaries and by the underlying assets of the businesses
comprising the Company's Secure Products International operating
segment and by a substantial portion of the underlying assets of the
businesses comprising the Company's Marketing Communications
operating segment, the underlying assets being carried at a value
represented by the total assets reflected on the Company's
consolidated balance sheet at September 30, 2004. At September 30,
2004, the aggregate amount of swing line advances, plus outstanding
checks was $13,836, and the unused portion of the total facility was
$37,164.
This Credit Agreement is available for general corporate purposes,
including acquisitions. Funds from this facility were initially used
to repay in full and cancel the Maxxcom credit facility maturing
September 30, 2004, the Maxxcom subordinated debenture maturing
September 2005, the MDC Partners revolving credit facility entered
into in June 2004 and maturing May 2005, and certain subsidiaries'
current bank loans.
See Note 14, Subsequent Events, for a discussion of the subsequent
violation of debt covenants and the waivers that have been obtained
to ensure compliance with the Company's Credit Agreement.
The Company has classified the swing-line component of this revolving
credit facility as a current liability in accordance with EITF 95-22,
Balance Sheet Classification of Borrowings Outstanding under
Revolving Credit Agreements that include both a Subjective
Acceleration Clause and a Lock-Box Arrangement. This component,
reflected as bank debt on the balance sheet, is classified as a
current liability in accordance with EITF 95-22 since the swing-line
contains a lock box arrangement that requires the cash receipts of
the Company to be used to repay amounts outstanding under the
swing-line and the entire credit facility is subject to subjective
acceleration clauses.
At September 30, 2004 and at December 31, 2003, the Company's
long-term indebtedness was comprised as follows:
September 30, December 31,
2004 2003
------------------- -------------------
Adjustable rate exchangeable securities $ - $30,318
Note payable and other bank loans - 4,249
Maxxcom credit facility - 30,718
Maxxcom subordinated debenture - 39,849
MDC revolving credit facility 49,000 -
------------------- -------------------
49,000 105,134
Obligations under capital leases 7,661 7,214
------------------- -------------------
56,661 112,348
Less: current portion 2,427 16,378
------------------- -------------------
$54,234 $95,970
=================== ===================
28
As at September 30, 2004, $4,173 (December 31, 2003 - $9,725) of the
consolidated cash position is held by subsidiaries, which, although
available for the subsidiaries' use, does not represent cash that is
distributable as earnings to MDC Partners Inc. for use to reduce MDC
Partners Inc. indebtedness.
Included in long-term debt, as at December 31, 2003, is an obligation
in the amount of $3,974, being the fair value of the embedded
derivative in the Company's exchangeable debentures. On February 13,
2004, the exchangeable debentures were settled in full as described in
Note 11.
9. Acquisitions
First Quarter 2004 Acquisitions
Kirshenbaum Bond + Partners
On January 29, 2004, the Company acquired a 60% ownership interest in
KBP in a transaction accounted for under the purchase method of
accounting. KBP is comprised of four units: Kirshenbaum Bond (New York
and San Francisco) which are primarily advertising agencies, LIME
Public Relations + Promotion, The Media Kitchen, which handles media
buying and planning, and Dotglu, an interactive and direct marketing
unit. KBP is recognized for creating very successful non-traditional
marketing campaigns and as such was acquired by the Company to enhance
the creative talent within the MDC Partners Marketing Communications
segment of businesses. As part of the acquisition, the Company paid
$21,129 in cash, issued 148,719 shares of the Company's common stock
to the selling interestholders of KBP (valued at approximately $2,027
based on the share price on or about the announcement date of the
closing), issued warrants to purchase 150,173 shares of the Company's
common stock to the selling interestholders of KBP (the fair value of
which, using a Black-Scholes option pricing model, was approximately
$955 based on the share price during the period on or about the
announcement date) and incurred transaction costs of approximately
$1,138. Under the terms of the agreement, the selling interestholders
of KBP could receive additional cash and/or share consideration,
totaling up to an additional $735 within one year from the date of
acquisition, based upon achievement of certain predetermined earnings
targets. Based on current earnings levels, the additional
consideration is expected to be $735. Such contingent consideration
will be accounted for as goodwill when the contingency is resolved and
the amount becomes determinable.
Exclusive of future contingent consideration, the recorded purchase
price of the net assets acquired in the transaction was $25,249. The
purchase price was allocated to the fair value of net assets acquired
as follows:
Previously
Reported Adjustments As Reported
-------------------------------------------
Cash and cash equivalents $25,283 ($7,377) $17,906
Accounts receivable and other current assets 18,540 (2,119) 16,421
Fixed assets and other assets 3,872 764 4,636
Goodwill 25,340 (719) 24,621
Intangible assets 1,200 - 1,200
Accounts payable, accrued expenses and other liabilities (48,643) 9,905 (38,788)
Minority interest (731) (16) (747)
-------------------------------------------
Total purchase price $24,811 438 $25,249
The components of the net assets acquired was revised in the third
quarter based on the completion of the audit of the acquired balance
sheet as at the date of the acquisition, with a resulting $719
decrease in goodwill. However, the allocation of the purchase price
to assets acquired and liabilities assumed is still based on
preliminary estimates of fair value and certain assumptions that the
Company believes are reasonable under the circumstances and will
continue to be adjusted in a subsequent period upon finalization of
such assumptions and estimates. The Company's consolidated financial
statements include KBP's results of operations subsequent to its
acquisition on January 29, 2004. During the nine months ended
September 30, 2004, the operations of KBP contributed $34,255 of
revenue and $2,764 of net income to the Company's consolidated
operating results.
29
Accent Marketing Services
On March 29, 2004, the Company acquired an additional 39.3% ownership
interest in the Accent Marketing Services LLC ("Accent"), increasing
its total ownership interest in this subsidiary from 50.1% to
approximately 89.4%. Accent has established itself as an integrated
direct marketing services company providing customer contact centers
and direct mail services to its clients, offering a unique customer
relationship and product life cycle management program to its clients.
As part of the acquisition, the Company paid $1,444 in cash, issued,
and to be issued, 1,103,331 shares of the Company's common stock to
the selling interestholders of Accent (valued at approximately $16,833
based on the share price on or about the announcement date), and
incurred transaction costs of approximately $82. Under the terms of
the agreement, the selling interestholders of Accent could receive up
to a maximum additional consideration of 742,642 common shares of the
Company, or the cash equivalent at the option of the Company, based
upon achievement of certain predetermined earnings targets, by June
2005. Such contingent consideration will be accounted for when it
becomes determinable. This acquisition was accounted for as a purchase
and accordingly, the Company's consolidated financial statements,
which have consolidated Accent's financial results since 1999, reflect
a further 39% ownership participation subsequent to the additional
acquisition on March 29, 2004.
The purchase price was allocated based on the fair value of the net
assets acquired of the purchase price, $12,545 was allocated to
goodwill, and $1,200 was allocated to intangible assets.
The allocation of the purchase price to assets acquired and
liabilities assumed is based on preliminary estimates of fair values
and certain assumptions that the Company believes are reasonable
under the circumstances and will be adjusted in a subsequent period
upon finalization of such estimates and assumptions.
Other First Quarter 2004 Acquisitions
During the quarter ended March 31, 2004, the Company acquired several
other ownership interests. In March 2004, the Company acquired a 19.9%
ownership interest in Cliff Freeman & Partners LLC ("CF") in a
transaction accounted for under the equity method of accounting. CF is
a New York based advertising agency. CF has long been recognized for
its creative abilities, winning numerous national and international
advertising awards, and as such was acquired by the Company to enhance
the creative talent within the MDC Partners Marketing Communications
segment of businesses. Also during the quarter, the Company acquired
further equity interests in the existing subsidiaries of Allard
Johnson Communications Inc. and Targetcom LLC, as well as several
other insignificant investments. In aggregate, as part of these
acquisitions, the Company paid $3,076 in cash and incurred transaction
costs of approximately $413. Under the terms of the CF agreement, the
selling interestholders could receive additional cash and/or share
consideration after two years based upon achievement of certain
predetermined cumulative earnings targets. Based on current earnings
levels, the additional consideration would be $nil. Such contingent
consideration will be accounted for as goodwill when it becomes
determinable.
Exclusive of future contingent consideration, the aggregate purchase
price of the net assets acquired in these transactions was
approximately $3,489. The purchase price was allocated based on the
fair value of the net assets acquired of the purchase price, $2,142
was allocated to goodwill and intangible assets.
The allocation of the purchase price to assets acquired and
liabilities assumed is based on preliminary estimates of fair value
and certain assumptions that the Company believes are reasonable
under the circumstances and will be adjusted in a subsequent period
upon finalization of such estimates and assumptions.
The Company's consolidated financial statements include the results
of operations and balance sheet, accounted for on a consolidated
basis except for CF, which is accounted for on an equity basis due to
the significant influence of the management of the operation obtained
through contractual rights. During the nine months ended September
30, 2004, the aggregated operations of these acquisitions contributed
no revenue to, and had no material effect on net income in, the
Company's consolidated operating results.
30
Second Quarter 2004 Acquisitions
During the quarter ended June 30, 2004, the Company acquired several
other ownership interests. On April 14, 2004, the Company acquired a
65% ownership interest in henderson bas ("HB") in a transaction
accounted for under the purchase method of accounting. HB is a Toronto
based agency providing interactive and direct marketing advertising
services. HB has been recognized for its creative abilities, winning
several interactive advertising awards, and as such was acquired by
the Company to enhance the creative talent within the MDC Partners
Marketing Communications segment of businesses. On May 27, 2004, the
Company acquired a 50.1% ownership interest in Bruce Mau Design Inc.
("BMD") in a transaction accounted for under the purchase method of
accounting. BMD is a Toronto based design studio providing visual
identity and branding such as environmental graphics, exhibition
development and design, and cultural and business programming
services. BMD is world-renowned, working with internationally
acclaimed architects and leading cultural and commercial enterprises
and as such was acquired by the Company to add a new aspect to the
creative talent within the Marketing Communications segment of
businesses. During the quarter ended June 30, 2004, the Company also
acquired the following interests in three smaller agencies: a 49.9%
interest in Mono Advertising LLC ("Mono"), a 51% interest in Hello
Design, LLC and a 51% interest in Banjo, LLC a variable interest
entity in which the Company is the primary beneficiary. These agencies
provide advertising, interactive direct marketing, and film production
related marketing communications services, respectively. These
transactions were all accounted for under the purchase method of
accounting. Subsequently, these acquisitions are consolidated from the
date of acquisition, with the exception of, except for Mono, which is
accounted for under the equity method.
During the quarter-ended June 30, 2004, in aggregate, the Company paid
and will pay $4,194 in cash, issued warrants to purchase 90,000 shares
of the Company's common stock to certain selling interestholders
(valued at approximately $360 using the Black-Scholes option-pricing
model assuming a 40% expected volatility, a risk free interest rate of
3.3% and an expected option life of 3 years) and incurred transaction
costs of approximately $353 for these acquisitions completed during
the quarter ended June 30, 2004. Under the terms of the Mono, Hello
Design, LLC, and BMD agreements, the selling interest holders could
receive additional cash and/or share consideration after two to three
years based on achievement of certain pre-determined cumulative
earning targets. Based on current earning levels, the additional
consideration is expected to be $100. Such contingent consideration
will be accounted for as goodwill when it becomes determinable.
The aggregate purchase price of the net assets acquired in these
transactions was approximately $4,907. The purchase price was
allocated to the fair value of the net tangible net assets acquired of
the purchase price, $1,232 was allocated to goodwill and intangible
assets.
The allocation of the purchase price to assets acquired and liabilities
assumed is based on preliminary estimates and certain assumptions that the
Company believes are reasonable under the circumstances and will be adjusted
in a subsequent period upon finalization of such estimates and assumptions.
The Company's consolidated financial statements include the results of
operations and balance sheets of these acquired entities, accounted for on a
consolidated basis. During the nine months ended September 30, 2004, the
aggregated operations of these acquisitions contributed $4,070 of revenue and
$591 of net income to the Company's consolidated operating results.
31
Third Quarter 2004 Acquisitions
VitroRobertson
On July 27, 2004, the Company acquired a 68% ownership interest in
VitroRobertson Acquisition, LLC ("VR") in a transaction accounted for
under the purchase method of accounting. VR is located in San Diego,
California, and is recognized for its expertise in brand market share
management and as such was acquired by the Company to enhance both
the range of services and the creative talent within the MDC Partners
Marketing Communications segment of businesses. As part of the
acquisition, the Company paid $7,009 in cash, issued 42,767 shares of
the Company's common stock to the selling interestholders of VR
(valued at approximately $473 based on the share price on the
announcement date), and incurred transaction costs of approximately
$118. Under the terms of the agreement, the selling interestholders
of VR could receive additional cash consideration, totaling up to an
additional $500 based upon achievement of certain predetermined
earnings targets measured at the end of 2005. Based on current
earnings levels, the additional consideration is expected to be $0.
Such contingent consideration will be accounted for as goodwill when
it becomes determinable.
Exclusive of future contingent consideration, the recorded purchase
price of the net assets acquired in the transaction was $7,600. The
purchase price was allocated to the net assets acquired as follows:
Cash and cash equivalents $3,502
Accounts receivable and other current assets 6,383
Fixed assets and other assets 406
Goodwill and intangible assets 7,282
Accounts payable, accrued expenses and other liabilities (9,823)
Minority interest (150)
-----------
Total purchase price $7,600
===========
The allocation of the purchase price to assets acquired and
liabilities assumed is based on preliminary estimates and certain
assumptions that the Company believes are reasonable under the
circumstances and will be adjusted in a subsequent period upon
finalization of such assumptions and estimates. The Company's
consolidated financial statements include VR's results of operations
subsequent to its acquisition on July 27, 2004. During the nine
months ended September 30, 2004, the operations of VR contributed
$1,498 of revenue and $189 of net income to the Company's
consolidated operating results.
Other Third Quarter Acquisitions
During the quarter ended September 30, 2004, the Company acquired
several other ownership interests. At August 31, 2004, the Company
acquired a 49.9% ownership interest in Zig Inc ("Zig") in a
transaction accounted for under the equity method of accounting. Zig
is a Toronto, Canada, based advertising agency. Zig is
internationally recognized for its unique creative abilities and as
such was acquired by the Company to enhance the creative talent
within the MDC Partners Marketing Communications segment of
businesses. Also during the quarter, the Company acquired further
equity interest in the existing subsidiary Fletcher Martin Ewing LLC,
as well as several other insignificant investments. In aggregate, as
part of these acquisitions, the Company paid $2,587 in cash, issued
125,628 shares of the Company's common stock to the selling interest
holders (valued at approximately $1,507 based on the share price
during the period on or about the date of closing and the press
release) and incurred transaction costs of approximately $84. Under
the terms of the Zig agreement, the selling interestholders could
receive additional cash and share consideration totaling $570 based
upon achievement of certain predetermined earnings targets for 2004.
Based on current earnings levels, the additional consideration is
expected to be $0. Such contingent consideration, if earned, will be
accounted for as goodwill when it becomes determinable.
Exclusive of future contingent consideration, the aggregate purchase
price of the net assets acquired in these transactions was
approximately $4,178. The purchase price was allocated to the net
assets acquired of the purchase price, $1,135 was allocated to
goodwill and intangible assets.
32
The allocation of the purchase price to assets acquired and
liabilities assumed is based on preliminary estimates and certain
assumptions that the Company believes are reasonable under the
circumstances and will be adjusted in a subsequent period upon
finalization of such estimates and assumptions.
The Company's consolidated financial statements include the results
of operations and balance sheet, accounted for on a consolidated
basis except for Zig, which is accounted for on an equity basis due
to the significant influence of the management of the operation
obtained through ownership interest and contractual rights. During
this period, the incremental effect of the aggregated operations of
these acquisitions did not have a material effect on the Company's
results of operations.
The following unaudited pro forma results of operations of the
Company for the periods ended September 30, 2004 and 2003,
respectively, assume that the acquisition of the operating assets of
the businesses acquired during the first nine months of 2004 had
occurred on January 1, 2004 and 2003, respectively. These unaudited
pro forma results are not necessarily indicative of either the actual
results of operations that would have been achieved had the companies
been combined during these periods, or are they necessarily
indicative of future results of operations. The unaudited pro forma
results may also require adjustment pending finalization of the
purchase price allocation to the assets and liabilities acquired.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ----------------------------
2004 2003 2004 2003
------------- -------------- ------------ ------------
(Restated - (Restated -
See Note 2) See Note 2)
Revenues $84,095 $75,416 $239,116 $257,752
Net income (loss) (2,799) 3,158 6,911 22,331
Earnings (loss) per share:
Basic - net income (loss) ($0.12) $0.17 $0.33 $1.28
Diluted - net income (loss) ($0.12) $0.16 $0.30 $1.09
10. Variable Interest Entities
In December 2003, the FASB issued Interpretation No. 46 "Consolidation
of Variable Interest Entities Revised" ("FIN 46R"), which addresses
how a business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting
rights, and accordingly, whether it should consolidate the entity. The
Company was required to apply FIN 46R to such variable interest
entities ("VIEs") commencing with the quarter ended March 31, 2004. In
addition, the Company is required, upon the occurrence of certain
triggering events, to reconsider whether an entity is a VIE.
(i) The Company acquired a 49% voting interest in Crispin Porter +
Bogusky, LLC ("CPB"), a marketing services business, in 2001 and has
accounted for its investment under the equity method of accounting.
The equity carrying value of the investment in CPB as at June 30,
2004 was $18,110. Pursuant to the terms of the CPB Shareholders'
Agreement, the Company is entitled to 49% of earnings, plus an
additional 8.5% of annual earnings in excess of $4,171. While CPB is
a VIE, prior to September 22, 2004, the Company was not the primary
beneficiary of its operations and thus, was not permitted to
consolidated CPB under FIN 46R.
Effective September 22, 2004, in connection with the refinancing of
the Company's bank credit facilities, the CPB Shareholders Agreement
was amended to permit all of the assets of CPB to be pledged by the
Company as security for its new bank credit facilities and in
addition, earlier in the third quarter, certain of the other
investors in CPB became officers of a subsidiary of the Company. As a
result of these changes, the Company became the primary beneficiary
of CPB and is required to consolidate its operations under FIN 46R,
commencing September 22, 2004.
33
Under FIN 46R, for VIE's that must be consolidated, the assets,
liabilities and minority interest of the VIE initially would be
measured at their fair value as if the initial consolidation had
resulted from a business combination on that date. Based on
management's best estimate of the fair values of the assets,
liabilities and non-controlling interests of CPB, the Company's
consolidated balance sheet reflects the following changes as at
September 22, 2004 in connection with the consolidation of this VIE:
Assets
Cash and cash equivalents $ -
Receivables and other current assets 32,854
Goodwill and intangible assets 51,059
Investment in affiliates (17,535)
Other assets 6,138
----------------
Total assets $72,516
================
Liabilities
Accounts payable and other current liabilities $17,542
Advance billings 18,205
Other liabilities 1,579
Minority Interest 35,190
----------------
Total liabilities and minority interest $72,516
================
The Company intends to obtain an independent valuation of CPB.
Accordingly, the aggregate fair value of the assets, liabilities and
minority interest at September 22, 2004, is based on preliminary
estimates and certain assumptions that the Company believes are
reasonable in the circumstances and may be adjusted in a subsequent
period upon finalization of such estimates and assumptions.
The liabilities recognized as a result of consolidating CPB do not
represent additional claims on the Company's general assets, rather,
they represent claims against the specific assets of the VIE. While
assets recognized as a result of consolidating CPB do not represent
additional assets that could be used to satisfy claims against the
Company's general assets, as a result of the amendments to the CPB
Shareholders' Agreement and the Company's bank credit facility
entered into September 22, 2004, the assets recognized have been
pledged as security for the Company's borrowings under its bank
credit facilities.
As a result of consolidating CPB with effect from September 22, 2004,
included in the Company's results of operations for the three months
and nine months ended September 30, 2004 is the following with
respect of CPB:
Revenue $1,178
-------------
Operating expenses:
Salary and related costs 645
General and related costs 227
Depreciation and amortization 29
-------------
901
-------------
Operating profit 277
Income taxes 51
Minority interest 141
-------------
Net income $85
=============
(ii) Based upon a review of the provisions of FIN 46R, the Company has
identified Banjo, a business in which the Company acquired a majority
voting interest in the second quarter of 2004, as a variable interest
entity for which the Company is the primary beneficiary. In addition,
the Company has also identified an investee in which the Company has a
45% investment as a variable interest entity for which the Company is
the primary beneficiary, thereby requiring consolidation. To date the
Company has funded $1.2 million to this start-up venture to finance
the development of proprietary content-driven marketing material. The
venture, which commenced operations in the second quarter of 2004, has
no significant assets or liabilities and no revenues, and amounts
expended by the venture have been principally in respect of salaries
and related costs, and general and other operating costs.
34
11. Gain on Sale of Assets and Settlement of Long-term Debt
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ----------------------------
2004 2003 2004 2003
------------- -------------- ------------ ------------
(Restated - (Restated -
See Note 2) See Note 2)
Loss on settlement of exchangeable
debentures $ - $ - $(9,569) $ -
Fair value adjustment on
embedded derivative - - (3,974) -
Gain (loss) on sale of assets ($17) $2,708 (90) 31,364
Gain (loss) on settlement of long-term
debt (1,274) - (1,274) (4,908)
Gain on sale of interests in Custom
Direct, Inc. - - 21,906 51,030
------------- -------------- ------------ ------------
$(1,291) $2,861 $14,947 $47,486
============= ============== ============ ============
In February 2004, the Company sold its remaining 20% interest in
Custom Direct Income Fund (the "Fund") through the exchange of its
interest in the Fund for the settlement of the adjustable rate
exchangeable debentures issued on December 1, 2003 with a face value
of $26,344. Based on the performance of the Fund for the period ended
December 31, 2003, the Company was entitled to exchange its shares of
Custom Direct, Inc. for units of the Fund. On February 13, 2004, the
adjustable rate exchangeable debentures were exchanged for units of
the Fund in full settlement of the adjustable rate exchangeable
debentures.
The embedded derivative within the exchangeable debentures had a fair
value of nil at the date of issuance and an unrealized loss of $3,974
as at December 31, 2003. At the date of settlement, the fair value of
the CDI units for which the debentures were exchangeable was $33,991
which exceeded the issue price of the debentures by $7,647. The total
loss on settlement of the exchangeable debenture of $9,569 includes
$1,922 in respect of the write off of unamortized deferred financing
costs.
From January 1, 2004 to the date of settlement, the accrued loss on
the derivative increased by $3,673 to a total of $7,647 at the date of
settlement. The fair value adjustment for the six months ended June
30, 2004 represents the increase to the accrued loss net of the amount
realized on settlement. The fair value of the units of the Fund on
February 13, 2004 received by the Company exceeded the Company's
equity carrying value of the 20% interest in Custom Direct, Inc., of
$12,085, accordingly the Company recognized a gain on the sale of the
CDI equity of $21,906.
As described in note 8, during the quarter, the Company repaid the
Maxxcom credit facility, Maxxcom subordinated debentures and certain
other bank borrowings. The loss on settlement principally represents
the write off of unamortized deferred financing costs.
In the second quarter of 2003, the Company completed an Initial
Public Offering ("IPO") of the Custom Direct Income Fund ("the Fund")
and sold 80% of its interest in Custom Direct Inc. to the Fund for
cash and units of the Fund representing an 18.9% interest. Such units
were sold in July 2003 for cash consideration equivalent to the IPO
price per share. On June 30, 2003, the Company completed the
repurchase of the remaining 10.5% senior subordinated notes for
103.5% of the face value of the notes, resulting in a loss on
redemption of $4,908, including the writeoff of $1,672 of unamortized
deferred financing costs.
35
12. Share Capital
Changes to the Company's issued and outstanding share capital during
the nine months ended September 30, 2004 are as follows:
Class A Shares Amount
-------------- -------------
Balance, January 1, 2004 18,369,451 $115,861
Shares acquired and cancelled pursuant to a normal course issuer bid (1,039,200) (8,444)
Share options exercised 238,171 2,270
Stock appreciation rights exercised 1,998 25
Shares issued - private placement 120,919 1,409
Shares issued - acquisitions (Note 8) 1,243,753 16,931
Shares issued upon conversion of Class B shares 447,968 134
Shares issued on settlement of convertible notes 2,582,027 34,919
-------------- -------------
Balance, September 30, 2004 21,965,087 163,105
-------------- -------------
Class B
Balance, January 1, 2004 450,470 135
Shares converted to Class A shares (447,968) (134)
-------------- -------------
Balance, September 30, 2004 2,502 1
-------------- -------------
Total Class A and Class B share capital 21,967,589 $163,106
============== =============
During the nine months ended September 30, 2004, the Company acquired
and cancelled, pursuant to a normal course issuer bid, 1,039,200
Class A subordinate voting shares for $12,110. The premium paid on
the repurchase of the Class A subordinate voting shares, in the
amount of $3,666, was charged to retained earnings. During the third
quarter, the Company issued 90,164 Class A subordinate shares for $0
proceeds as additional consideration related to the maintenance of
the market value of the same securities issued as purchase
consideration for an acquisition completed in the first quarter of
2004.
During the second quarter of 2004, the Company amended its share
appreciation rights ("SAR") plan to amend the method of settlement
from cash exclusively to cash or equity settlement at the option of
the Company. The amendment caused the existing SAR awards to be
modified, triggering a remeasurement date for accounting purposes.
The modification is accounted for as a settlement of the old awards
through the issuance of new awards. As a result, the Company measured
the settlement value of the SARs immediately prior to the
modification date and adjusted the previously accumulated amortized
expense and liability based on the revised calculation. The
settlement value of $6,142 was reclassed from accounts payable and
accrued liabilities to additional paid-in capital and the adjustment
to the accumulated expense resulted in a recovery of $2,591. The
Company then measured the fair value of the equity settleable SAR
awards using the Black-Scholes option pricing model on the date of
modification. The excess of the fair value calculated using the
Black-Scholes option pricing model over the settlement value of
$5,046 will be accounted for as additional compensation expense over
the remaining vesting period of the SAR awards.
On May 5, 2004, the Company settled in full the $34,919 (C$48,000) of
7% Convertible Notes with the issuance of 2,582,027 Class A
subordinate voting shares.
On March 17, 2004, the Company completed a private placement issuing
120,919 shares at an average price of $11.65 per share and issuing
120,919 warrants with exercise prices ranging from C$15.72 to C$19.13
and expiring in March 2009. The Company undertook the private
placement as a means to provide the Company's Board of Directors and
potential Board members the ability to increase their share holdings
in the Company in order to further align their interests with those
of the Company. As a result of the offering, a stock-based
compensation charge in the amount of $1.0 million was taken in the
first quarter to account for the fair value of the benefits conveyed
to the recipients of the awards on the granting of warrants and the
issuing of shares at a price less than the trading value on the day
of issuance.
36
On February 26, 2004 the Company's then controlling shareholder,
Miles S. Nadal (the Company's Chairman and Chief Executive Officer)
gave formal notice to the Company's Board of Directors that he had
initiated the process to effect conversion of 100% of his Class B
multiple voting shares into Class A subordinate voting shares on a
one-for-one basis, without any cash or non-cash consideration. The
conversion was completed during the first quarter of 2004. Mr.
Nadal's equity interest in the Company prior to the conversion was
approximately 20.2%, and he controlled 44.9% of the voting rights
attached to the corporation. Prior to the conversion Mr. Nadal owned
447,968 Class B multiple voting shares, which represented 99% of the
Class B shares and carry 20 votes per share, in addition to 3,400,351
Class A subordinate voting shares, which carry one vote per share.
After the conversion, both Mr. Nadal's equity interest and voting
interest in the Company are approximately 20.2%, or 3,848,319 Class A
subordinate voting shares.
Additional paid-in capital increased during the nine months ended
September 30, 2004 as follows:
Additional
paid-in capital
------------------
Balance at December 31, 2003 $4,610
Stock-based compensation 4,833
Acquisition purchase price consideration 1,313
Transfer from accounts payable and accrual liability 6,142
Options exercised (71)
SAR's exercised (24)
------------------
Balance at September 30, 2004 $16,803
==================
Share option transactions during the nine months ended September 30, 2004 are summarized as follows:
Options Outstanding Options Exercisable
------------------------------------ ---------------------------------
Weighted
Number Average Price Number Price per
Outstanding per Share Outstanding Share
--------------- ---------------- ---------------- -------------
Balance, beginning of period 2,066,728 $6.60 870,979 $7.82
Granted 169,052 $10.79
Exercised (238,171) $9.13
Expired and cancelled (38,243) $19.15
--------------- ---------------- ---------------- -------------
Balance, end of period 1,959,366 $6.57 969,241 $6.78
=============== ================ ================ =============
Shares options outstanding as at September 30, 2004 are summarized as follows:
Options Outstanding Options Exercisable
-------------------------------------------------- -------------------------------
Range of Outstanding Weighted Average Weighted Exercisable Weighted
Average
Price per Average Price
Exercise Prices Number Contractual Life Share Number per Share
-------------------- ---------------- ------------------ -------------- --------------- ---------------
$3.06 - $4.50 744,474 3.1 $4.24 322,813 $4.22
$4.51 - $6.00 480,702 3.6 $5.74 195,229 $5.74
$6.01 - $9.00 333,750 4.5 $7.41 266,364 $7.50
$9.01 - $15.30 391,729 4.0 $10.82 179,935 $10.63
$22.50 - $44.75 8,711 5.0 $27.82 4,900 $37.10
37
Warrants issued and outstanding as of September 30, 2004 are as
follows:
Class A Stock
Warrants
------------------
Balance at December 31, 2002 -
Issued (a) 507,146
------------------
Balance at December 31, 2003 507,146
Issued (b) 736,186
------------------
Balance at September 30, 2004 1,243,332
==================
(a) During the year ended December 31, 2003, the Company issued 507,146
warrants with a weighted average exercise price of C$14.28 and terms
of two to five years. These warrants were issued as compensation to a
lender and to an advisor.
(b) During the nine months ended September 30, 2004, the Company issued
736,186 warrants with a weighted average exercise price of C$17.66
and a term of five years. Of these warrants, 496,013 were issued as
acquisition consideration and 240,173 were issued as compensation and
treated as such for accounting purposes.
SAR's granted and outstanding as of September 30, 2004 are as follows:
SAR's Outstanding SAR's Excercisable
---------------------------------- ---------------------------------
Weighted Weighted
Average Average
Number Price Number Price Per
Outstanding per share Outstanding Share
---------------- -------------- -------------- ---------------
Balance at December 31, 2002 - - - -
Granted 1,650,479 $5.33
---------------- -------------- -------------- ---------------
Balance at December 31, 2003 1,650,479 5.33 - -
Granted 295,000 10.85
Exercised (5,000) 3.57
---------------- -------------- -------------- ---------------
Balance at September 30, 2004 1,940,479 $6.72 548,493 $5.91
================ ============== ============== ===============
SAR's outstanding as at September 30, 2004 are summarized as follows:
SAR's Outstanding SAR's Exercisable
-------------------------------------------------- -------------------------------
Range of Outstanding Weighted Average Weighted Exercisable Weighted
Average
Price per Average Price
Exercise Prices Number Contractual Life Share Number per Share
-------------------- ---------------- ------------------ -------------- --------------- ---------------
$3.90 - $6.00 855,000 2.3 $4.17 285,000 $4.17
$6.01 - $8.00 795,479 2.8 $7.80 263,493 $7.80
$10.01 - $12.00 280,000 3.7 $11.22 - -
$12.01 - $13.00 10,000 3.4 $12.68 - -
During the three months ended September 30, 2004, the Company issued
50,000 restricted stock units of which 16,500 vest on each of the
first and second anniversary dates with the remaining 17,000 vesting
on September 6, 2007.
38
13. Commitments and Contingencies
(a) During the period the Company has revised its estimate regarding a
probable loss associated with certain legal claims and recorded a
recovery of $2,350. Management's best estimate of the range of
exposure is now nil.
(b) In addition to the consideration paid by the Company in respect of
its acquisitions, additional consideration may be payable based on
the achievement of certain threshold levels of earnings. Should the
current level of earnings be maintained by these acquired companies,
additional consideration of approximately $875 would be expected to
be owing in 2004 and 2006, of which approximately $805 could be
payable in shares of the Company at the Company's discretion.
Owners of interests in certain of the Company's subsidiaries and
investments have the right in certain circumstances to require the
Company to purchase additional ownership stakes. The exercise of
these "put" option rights at their earliest contractual date would
result in obligations of the Company to fund related amounts during
the period 2004 to 2013. The amount payable by the Company in the
event such rights are exercised is dependent on various valuation
formulas and on future events such as the average earnings of the
relevant subsidiary through the date of exercise, and the growth rate
of the earnings of the relevant subsidiary during the period. The
Company has not received any notices to exercise such rights that are
not currently reflected on the Company's balance sheet.
The Company has agreed to provide to its Chairman, President and
Chief Executive Officer a bonus of Cdn$10 million in the event that the
market price of the Company's Class A subordinate voting shares is
Cdn$30 per share or more for more than 20 consecutive trading days. The
after-tax proceeds of such bonus are to be applied first as repayment
of any outstanding loans due to the Company from this officer and his
related companies in the amount of $5,406 (Cdn$6,820) and $2,378
(Cdn$3,000), respectively, as at September 30, 2004, both of which
have been fully provided for in the Company's accounts.
In connection with certain dispositions of assets and/or businesses
in 2001 and 2002, the Company has provided customary representations
and warranties whose terms range in duration and may not be
explicitly defined. The Company has also retained certain liabilities
for events occurring prior to sale, relating to tax, environmental,
litigation and other matters. Generally, the Company has indemnified
the purchasers in the event that a third party asserts a claim
against the purchaser that relate to a liability retained by the
Company. These types of indemnification guarantees typically extend
for a number of years.
In connection with the sale of the Company's investment in CDI, the
amounts of indemnification guarantees were limited to the total sale
price of approximately $84 million. For the remainder, the Company's
potential liability for these indemnifications are not subject to a
limit as the underlying agreements do not always specify a maximum
amount and the amounts are dependent upon the outcome of future
contingent events.
Historically, the Company has not made any significant
indemnification payments under such agreements and no amount has been
accrued in the accompanying consolidated financial statements with
respect to these indemnification guarantees. The Company continues to
monitor the conditions that are subject to guarantees and
indemnifications to identify whether it is probable that a loss has
occurred, and would recognize any such losses under any guarantees or
indemnifications in the period when those losses are probable and
estimable.
For guarantees and indemnifications entered into after January 1,
2003, in connection with the sale of the Company's investment in CDI,
the Company has estimated the fair value of its liability, which was
insignificant, and included such amount in the determination of the
gain or loss on the sale of the business.
39
14. Subsequent Events
(a) As a result of the Company's failure to file on a timely basis its
interim financial statements for the nine months ended September 30,
2004; and its restatement of previously filed audited annual and
unaudited interim financial statements, as at November 19, 2004, the
Company was in violation of certain covenants under its Credit
Agreement dated September 22, 2004 (the "Credit Agreement"). On
November 19, 2004, MDC Partners Inc. amended its Credit Agreement by
and among JPMorgan Chase Bank, The Toronto-Dominion Bank, Bank of
Montreal, Bank of Nova Scotia and Canadian Imperial Bank of Commerce
as lenders, and with the Company, Maxxcom Inc., an Ontario
corporation, and Maxxcom Inc., a Delaware corporation, as borrowers.
Pursuant to this amendment, the lenders (i) extended, until December
22, 2004, the due date for the Company to deliver to the lenders its
interim financial statements for the period ended September 30, 2004,
and (ii) waived violation of debt covenants in respect of the
potential inaccuracy of certain representations and warranties
previously made by the Company under the Credit Agreement relating to
the Company's previously filed financial statements if the Company
filed its interim financial statements by December 22, 2004 and its
financial covenant compliance certificate by December 29, 2004. The
debt has been classified as long-term because the Company is in
compliance with provisions of the waiver.
(b) In November 2004, the Company's management reached a decision to
discontinue the operations of a component of its business. This
component is comprised of the Company's UK based marketing
communications business, wholly owned subsidiary Mr. Smith Agency,
Ltd. (formerly known as Interfocus Networks, Ltd). The Company
decided to cease the operations of this business due to the
uneconomical cost structure and highly competitive market environment
in which this business was operating. The net assets of the
discontinued business are expected to be disposed of during the
fourth quarter of 2004 with the closure to be substantially completed
by the end of the first quarter of 2005.
Included in the consolidated operating results of the Company for the
three months and nine months ended September 30 were the following:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ----------------------------
2004 2003 2004 2003
------------- -------------- ------------- -----------
Revenue $1,272 $2,106 $3,733 $5,097
Operating profit (loss) (1,406) 59 (5,011) (1,086)
Net income (loss) (1,428) (73) (4,902) (1,397)
As of September 30, 2004, the carrying value on the Company's balance
sheet of the assets and liabilities to be disposed were as follows:
Assets
Cash and cash equivalents $1,228
Receivables and other current assets 2,287
Goodwill and intangible assets -
Fixed assets 733
--------------------
Total assets $4,248
====================
Liabilities
Accounts payable and other current liabilities $2,040
Advance billings 955
--------------------
Total liabilities $2,995
====================
40
15. Canadian GAAP Reconciliation
During the third quarter of fiscal 2003, the Company changed its
reporting currency from Canadian dollars to US dollars. The change in
reporting currency had no impact on the measurement of earnings under
Canadian GAAP. Under Canadian securities requirements, the Company is
required to provide a reconciliation setting out the differences
between US and Canadian GAAP as applied to the Company's financial
statements for the interim periods and years ended in the fiscal
periods for 2004 and 2005.
The Company has restated its consolidated financial statements,
prepared in accordance with Canadian GAAP, as at and for the years
ended December 31, 2003, 2002 and 2001, the effect of which is
described in the Company's restated 2003 Annual Report filed on Form
40-F/A. The Company has also restated its interim unaudited condensed
consolidated financial statements for the periods ending March 31,
2004 and 2003, June 30, 2004 and 2003, and September 30, 2003,
prepared in accordance with US GAAP, as described in Note 2. As a
result of these errors the Company has also restated its Canadian GAAP
adjustments as follows: (i) to correct the adjustment for
"Proportionate Consolidation of Affiliates" for the three months and
nine months ended September 30, 2003 and as at December 31, 2003 to
now include the Company's proportionate share of the financial
position, results of operation and cash flows of Accumark, a joint
venture for Canadian GAAP purposes. (See Note 2, Item 6(c)) and a
joint venture owning rental property (See Note 2 Item 6(a)); and (ii)
to correct the adjustment in respect of derivatives as at December 31,
2003, in respect of the fair value adjustment for the embedded
derivative in the Company's exchangeable securities as described in
Note 23 to the 2003 Annual Report on Form 40-F/A.
The reconciliation from US to Canadian GAAP, of the Company's results
of operations for the three and nine months ended September 30, 2004
and 2003, the Company's financial position as at September 30, 2004
and December 31, 2003 are set out below:
Convertible Notes - 2003 Adjustments
Under US GAAP, the convertible notes are classified entirely as debt.
Accordingly, interest expense is recorded based upon the effective
interest rate associated with the underlying debt.
Under Canadian GAAP, in accordance with EIC 71, the Company has
classified the convertible notes as equity as the Company has the
ability and intent to satisfy the obligation on redemption or maturity
in freely tradeable Class A shares. Under Canadian GAAP, the Company
has recorded an amount in long-term and current debt representing the
present value of the future interest payments owing on the convertible
debt. The interest in respect of the convertible debt is recorded as a
credit on account of the equity portion of the compound financial
instrument such that the equity component is accreted to the face of
the convertible debt upon maturity.
This difference results in a reclassification on the balance sheet
between long-term debt and equity, and a reduction in the interest
expense for the amount of the accretion that is not expensed for
Canadian GAAP purposes.
Convertible Notes - 2004 Adjustments
During the quarter ended June 30, 2004, the notes were converted to
equity. Therefore, the adjustments reflected in 2004 pertain only to
the interest adjustment up to the date of conversion and the
accumulated reclassification from retained earnings to share capital.
Proportionate Consolidation of Affiliate - 2004 and 2003 Adjustment
Under US GAAP, joint ventures in which the Company has joint control
are accounted for under the equity method. Under Canadian GAAP, joint
ventures are accounted for on the proportionate consolidation method
whereby the Company consolidates on a line-by-line basis their
interest in the financial position and results of operations and cash
flows of the joint venture.
41
Stock-based Compensation - 2004 Adjustment
Under US GAAP, the Company accounted for the modification of the SAR
awards as a settlement, measuring the incremental value of the awards
based on the fair value of the modified awards on the date of
modification. Under Canadian GAAP, the Company measures the
incremental value based on the fair value of the award on the date of
grant. The difference in measurement date results in a lower amount
of additional compensation recorded under Canadian GAAP and a
corresponding lower amount credited to additional paid-in capital.
Exchangeable Debentures
Under Canadian GAAP, EIC 117 prohibits the bifurcation of the embedded
derivative in the Exchangeable debentures. In addition under EIC 56,
until such time as the exchange right is no longer contingent upon
future events, no adjustment to the carrying value of the debentures
are necessary. In February 2004, the debentures became Exchangeable
for CDI units and at that time the carrying value of the debenture was
required to be increased by $7,647 to reflect the underlying market
value of the CDI units, for which the debentures are exchangeable,
with a corresponding change to earnings.
Under US GAAP, the Company must recognize in earnings each period the
changes in the fair value of the embedded derivative within the
contingently exchangeable debenture and such amount cannot be
deferred. This results in a loss on the derivative of $3,974 in the
fourth quarter of 2003 and a further loss in the first quarter of 2004
of $3,673 immediately prior to settlement.
As a result of this difference, under Canadian GAAP, the resulting
loss on the settlement of the exchangeable securities in the nine
months ended September 30, 2004 is lower than that reported under US
GAAP by $7,641, the amount of the change in fair value of the embedded
derivative recognized in the prior period.
Goodwill Charges - 2004 Adjustments
Historically, under US GAAP, the Company expensed as incurred certain
costs related to existing plant closures where production was shifted
to acquired facilities. Historically, under Canadian GAAP, the
expenditures were accrued as part of the business acquired and
allocated to goodwill. Accordingly the timing of the recognition of
such costs in the statement of operations is different under Canadian
GAAP. The resulting gain on sale of such assets in the nine
months ended September 30, 2004 is lower under Canadian GAAP than
under US GAAP by $2,780.
Foreign Exchange
Under US GAAP and Canadian GAAP, foreign currency translation
adjustments are not included in determining net income for the period
but are disclosed and accumulated in a separate component of
consolidated equity. Under US GAAP, such adjustments remain in this
separate component of consolidated equity until sale or until
complete, or substantially complete, liquidation of the net
investment, or the intercompany balance, that generated the
adjustment. However, under Canadian GAAP, an appropriate portion of
the foreign currency translation adjustments accumulated in the
separate component of consolidated equity is included in the
determination of net income when there is any reduction in the related
net investment or the related intercompany balance resulting in a loss
for Canadian GAAP purposes of $5,319 for the three months ended
September 30, 2004.
Other Adjustments
Other adjustments represent cumulative translation differences as a
result of timing differences between recognition of certain expenses
under US and Canadian GAAP. Accumulated other comprehensive income
under US GAAP represents the cumulative translation adjustment
account, the exchange gains and losses arising from the translation of
the financial statements of self sustaining foreign subsidiaries under
Canadian GAAP.
42
Three Months Ended September 30, 2004
(thousands of United Stated dollars)
Stock-based Proportionate
US Compensation and Consolidation of Canadian
GAAP Other Affiliates GAAP
--------------- ------------------ ------------------- --------------------
Revenue:
Services $63,380 $ - $6,236 $69,616
Products 20,039 - - 20,039
--------------- --------------- ---------------- -----------------
83,419 - 6,236 89,655
--------------- --------------- ---------------- -----------------
Operating Expenses:
Cost of products sold 12,433 - - 12,433
Salary and related costs 37,431 (615) 3,099 39,915
General and other operating costs 28,943 - 1,843 30,786
Other charges (recoveries) (2,350) - - (2,350)
Depreciation and amortization 3,223 - 152 3,375
--------------- --------------- ---------------- -----------------
79,680 (615) 5,094 84,159
--------------- --------------- ---------------- -----------------
Operating Profit 3,739 615 1,142 5,496
--------------- --------------- ---------------- -----------------
Other Income (Expenses):
Gain on sale of assets and
settlement of long-term debt (1,291) - - (1,291)
Foreign exchange loss (614) (5,319) - (5,933)
Interest expense (2,753) - (108) (2,861)
Interest income 136 - 18 154
--------------- --------------- ---------------- -----------------
(4,522) (5,319) (90) (9,931)
--------------- --------------- ---------------- -----------------
Income (Loss) Before Income Taxes,
Equity in Affiliates and Minority
Interests (783) (4,704) 1,052 (4,435)
Income Taxes 294 - 394 688
--------------- --------------- ---------------- -----------------
Income (Loss) Before Equity in
Affiliates and Minority Interests (1,077) (4,704) 658 (5,123)
Equity in Affiliates 455 - (658) (203)
Minority Interests (2,252) - - (2,252)
--------------- --------------- ---------------- -----------------
Net Income (Loss) ($2,874) ($4,704) $ - ($7,578)
=============== =============== ================ =================
43
Nine Months Ended September 30, 2004
(thousands of United Stated dollars)
Stock-based Unrealized
Compensation Derivative
and Other Loss & Proportionate Canadian
US Convertible Goodwill Consolidation of GAAP
GAAP Notes Charges Affiliates
--------------- ----------------- ---------------- ------------------ ----------------
Revenue:
Services $173,665 $ - $ - $20,076 $193,741
Products 55,309 - - - 55,309
-------------- -------------- ------------- --------------- -------------
228,974 - - 20,076 249,050
-------------- -------------- ------------- --------------- -------------
Operating Expenses:
Cost of products sold 33,994 - - - 33,994
Salary and related costs 104,801 (1,560) - 8,272 111,513
General and other operating -
costs 82,311 - 5,269 87,580
Other charges (recoveries) (2,350) - - - (2,350)
Depreciation and amortization 8,796 - - 452 9,248
-------------- -------------- ------------- --------------- -------------
227,552 (1,560) - 13,993 239,985
-------------- -------------- ------------- --------------- -------------
Operating Profit 1,422 1,560 - 6,083 9,065
-------------- -------------- ------------- --------------- -------------
Other Income (Expenses):
Gain on sale of assets and
settlement of long-term
debt 14,947 - (6,754) - 8,193
Foreign exchange loss (156) (5,319) - - (5,475)
Interest expense (7,842) 718 - (290) (7,414)
Interest income 607 - - 26 633
-------------- -------------- ------------- --------------- -------------
7,556 (4,601) (6,754) (264) (4,063)
-------------- -------------- ------------- --------------- -------------
Income Before Income Taxes,
Equity in Affiliates and
Minority Interests 8,978 (3,041) (6,754) 5,819 5,002
Income Taxes (Recovery) (98) - - 2,186 2,088
-------------- -------------- ------------- --------------- -------------
Income Before Equity in
Affiliates and Minority
Interests 9,076 (3,041) (6,754) 3,633 2,914
Equity in Affiliates 3,339 - - (3,633) (294)
Minority Interests (5,892) - - - (5,892)
-------------- -------------- ------------- --------------- -------------
Net Income (Loss)
$6,523 ($3,041) ($6,754) $ - ($3,272)
============== ============== ============= =============== =============
44
As at September 30, 2004 Stock-based
(thousands of United Stated dollars) Compensation
and Proportionate
US Convertible Consolidation Other Canadian
GAAP Notes of Affiliates Adjustments GAAP
-------------- ---------------- ----------------- --------------- ---------------
ASSETS
Current Assets
Cash and cash equivalents $16,349 $ - $1,626 $ - $17,975
Accounts receivable, net 107,408 - 2,018 - 109,426
Expenditures billable to
clients 21,079 - 428 - 21,507
Inventories 8,815 - - - 8,815
Prepaid expenses and other
current assets 6,636 - 141 - 6,777
------------- ------------- --------------- ----------- ------------
Total Current Assets 160,287 - 4,213 - 164,500
Fixed Assets, net 54,482 - 3,326 - 57,808
Investment in Affiliates 8,238 - (6,685) - 1,553
Goodwill 182,186 - 5,636 - 187,822
Intangibles 3,180 - - - 3,180
Deferred Tax Assets 11,862 - (21) - 11,841
Other Assets 8,473 - 96 - 8,569
------------- ------------- --------------- ----------- ------------
Total Assets $428,708 $ - $6,565 $ - $435,273
============= ============= =============== =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Bank indebtedness $13,836 $ - $ - $ - $13,836
Accounts payable 68,161 - 2,530 - 70,691
Accruals and other liabilities 56,727 - (899) - 55,828
Advance billings 44,916 - 800 - 45,716
Current portion of long-term
debt 2,427 - 117 - 2,544
Deferred acquisition
consideration 416 - - - 416
------------- ------------- --------------- ----------- ------------
Total Current Liabilities 186,483 - 2,548 - 189,031
Long-Term Debt 54,234 - 3,971 - 58,205
Other Liabilities 4,091 - 46 - 4,137
------------- ------------- --------------- ----------- ------------
Total Liabilities 244,808 - 6,565 - 251,373
------------- ------------- --------------- ----------- ------------
Minority Interests 37,186 - - - 37,186
------------- ------------- --------------- ----------- ------------
Shareholders' Equity
Share capital 163,106 1,296 - - 164,402
Share capital to be issued 3,909 - - - 3,909
Additional paid-in capital 16,803 (1,560) - - 15,243
Retained earnings (deficit) (36,312) 264 - (5,319) (41,367)
Accumulated other
comprehensive income (loss) (792) - - 5,319 4,527
------------- ------------- --------------- ----------- ------------
Total Shareholders' Equity 146,714 - - - 146,714
------------- ------------- --------------- ----------- ------------
Total Liabilities and
Shareholders' Equity $428,708 $ - $6,565 $ - $435,273
============= ============= =============== =========== ============
45
Nine Months Ended September 30, 2004
(thousands of United Stated dollars)
Embedded
Stock-based Derivative
Compensation, Loss & Proportionate
US Convertible Goodwill Consolidation Canadian
GAAP Notes and Other Charges of Affiliates GAAP
------------------ ----------------- ---------------- ---------------- ------------------
Operating Activities
Net income (loss) $6,523 (3,041) ($6,754) $ - ($3,272)
Stock-based compensation 6,906 (1,560) - - 5,346
Depreciation and amortization 8,796 - - 452 9,248
Amortization and write-off of
deferred finance charges 5,993 - - - 5,993
Deferred income taxes (108) - - 139 31
Foreign exchange 156 5,319 - - 5,475
Gain on sale of assets (18,613) - 6,754 - (11,859)
Earnings of affiliates, net of
distributions 2,113 - - (1,819) 294
Minority interest and other (2,146) - - (2,146)
Changes in non-cash working -
capital (4,381) - (2,405) (6,786)
--------------- --------------- ------------ ------------- ---------------
5,239 718 - (3,633) 2,324
--------------- --------------- ------------ ------------- ---------------
Investing activities
Capital expenditures (11,437) - - (799) (12,236)
Acquisitions, net of cash (17,137) - - 684 (16,453)
Other assets, net (2,939) - - (91) (3,030)
--------------- --------------- ------------ ------------- ---------------
(31,513) - - (206) (31,719)
--------------- --------------- ------------ ------------- ---------------
Financing activities
Increase in bank indebtedness 13,836 - - - 13,836
Proceeds from issuance of long-
term debt 67,346 - - - 67,346
Repayment of long-term debt
(94,471) (718) - (29) (95,218)
Issuance of share capital 3,608 - - - 3,608
Purchase of share capital (12,110) - - - (12,110)
--------------- --------------- ------------ ------------- ---------------
(21,791) (718) - (29) (22,538)
--------------- --------------- ------------ ------------- ---------------
Foreign exchange effect on cash
and cash equivalents (1,692) - - - (1,692)
--------------- --------------- ------------ ------------- ---------------
Net increase (decrease) in cash
and cash equivalents (49,757) - - (3,868) (53,625)
Cash and cash equivalents
beginning of period 66,106 - - 5,494 71,600
--------------- --------------- ------------ ------------- ---------------
Cash and cash equivalents
end of period $16,349 $ - $ - $1,626 $17,975
=============== =============== ============ ============= ===============
46
Three Months Ended September 30, 2003
(thousands of United Stated dollars)
Convertible Proportionate
US Notes and Consolidation Canadian
GAAP Other of Affiliate GAAP
-------------- -------------- ---------------- -----------------
(Restated - (Restated) (Restated) (Restated)
See Note 2)
Revenue:
Services $42,872 $ - $4,573 $47,445
Products 19,214 - - 19,214
----------- ---------- ------------- --------------
62,086 - 4,573 66,659
----------- ---------- ------------- --------------
Operating Expenses:
Cost of products sold 12,509 - - 12,509
Salary and related costs 25,537 - 1,815 27,352
General and other operating costs 20,320 - 1,493 21,813
Other charges 1,333 - - 1,333
Depreciation and amortization 1,951 185 108 2,244
----------- ---------- ------------- --------------
61,650 185 3,416 65,251
----------- ---------- ------------- --------------
Operating Profit 436 (185) 1,157 1,408
----------- ---------- ------------- --------------
Other Income (Expense):
Gain on sale of assets 2,861 - (12) 2,849
Foreign exchange gain 20 - - 20
Interest expense (2,718) 425 (118) (2,411)
Interest income 495 - 5 500
----------- ---------- ------------- --------------
658 425 (125) 958
----------- ---------- ------------- --------------
Income Before Income Taxes, Equity in
Affiliates and Minority Interests 1,094 240 1,032 2,366
Income Taxes (Recovery) (1,305) 57 403 (845)
----------- ---------- ------------- --------------
Income Before Equity in Affiliates and
Minority Interests 2,399 183 629 3,211
Equity in Affiliates 1,383 - (629) 754
Minority Interests (1,502) - - (1,502)
----------- ---------- ------------- --------------
Net Income $2,280 $183 $ - $2,463
=========== ========== ============= ==============
47
Nine Months Ended September 30, 2003
(thousands of United Stated dollars)
Convertible Proportionate
US Notes and Goodwill Consolidation Canadian
GAAP Other Charges of Affiliate GAAP
------------------ ---------------- ----------------- -------------- -------------
(Restated - See (Restated) (Restated) (Restated) (Restated)
Note 2)
Revenue:
Services $123,398 $ - $ - $13,289 $136,687
Products 95,612 - - - 95,612
------------- ------------ -------------- ----------- ------------
219,010 - - 13,289 232,299
------------- ------------ -------------- ----------- ------------
Operating Expenses:
Cost of products sold 45,948 - - - 45,948
Salary and related costs 79,428 - - 5,299 84,727
General and other operating costs 76,242 - - 4,230 80,472
Other charges 1,333 - - - 1,333
Depreciation and amortization 7,328 556 - 273 8,157
Write-down of fixed assets and other
assets 8,126 - - - 8,126
Goodwill charges 10,012 - - - 10,012
------------- ------------ -------------- ----------- ------------
228,417 556 - 9,802 238,775
------------- ------------ -------------- ----------- ------------
Operating Profit (Loss) (9,407) (556) - 3,487 (6,476)
------------- ------------ -------------- ----------- ------------
Other Income (Expense):
Gain on sale of assets and
settlement of long-term debt 47,486 - (11,121) 89 36,454
Foreign exchange loss (1,511) - - - (1,511)
Interest expense (13,056) 1,275 - (260) (12,041)
Interest income 666 - - 31 697
------------- ------------ -------------- ----------- ------------
33,585 1,275 (11,121) (140) 23,599
------------- ------------ -------------- ----------- ------------
Income (Loss) Before Income Taxes, Equity
in Affiliates and Minority Interests 24,178 719 (11,121) 3,347 17,123
Income Taxes 4,605 269 - 1,266 6,140
------------- ------------ -------------- ----------- ------------
Income (Loss) Before Equity in Affiliates
and Minority Interests 19,573 450 (11,121) 2,081 10,983
Equity in Affiliates 3,174 - - (2,081) 1,093
Minority Interests (2,618) - - - (2,618)
------------- ------------ -------------- ----------- ------------
Net Income $20,129 $450 ($11,121) $ - $9,458
============= ============ ============== =========== ============
48
As at December 31, 2003 Proportionate Convertible
(thousands of United Stated dollars) US Consolidation of Canadian
GAAP Notes Affiliate Other Adjustments GAAP
-------------- ---------------- -------------------- ------------------- ------------
(Restated - (Restated) (Restated) (Restated)
See Note 2)
ASSETS
Current Assets
Cash and cash equivalents $65,929 $ - $5,671 $ - $71,600
Accounts receivable, net 58,864 - 11,095 - 69,959
Expenditures billable to clients 7,153 - 3,183 - 10,336
Inventories 7,735 - - - 7,735
Prepaid expenses and other current assets 4,863 - 180 - 5,043
--------------- ------------- --------------- ------------- -----------
Total Current Assets 144,544 - 20,129 - 164,673
Fixed Assets, net 38,775 - 5,839 - 44,614
Investment in Affiliates 34,362 - (22,159) 2,943 15,146
Goodwill 83,199 - 18,580 - 101,779
Deferred Tax Benefits 11,563 - - - 11,563
Other Assets 9,096 - 19 - 9,115
--------------- ------------- --------------- ------------- -----------
Total Assets $321,539 $ - $22,408 $2,943 $346,890
=============== ============= =============== ============= ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $38,451 $ - $6,331 $ - $44,782
Accruals and other liabilities 34,245 - 10,579 - 44,824
Advance billings 15,731 - 573 - 16,304
Current portion of long-term debt 16,378 2,160 108 - 18,646
Deferred acquisition consideration 1,113 - - - 1,113
--------------- ------------- --------------- ------------- -----------
Total Current Liabilities 105,918 2,160 17,591 - 125,669
Long-Term Debt 95,970 - 3,950 (3,974) 95,946
Convertible Notes 37,794 (33,011) - - 4,783
Other Liabilities 516 - 867 - 1,383
--------------- ------------- --------------- ------------- -----------
Total Liabilities 240,198 (30,851) 22,408 (3,974) 227,781
--------------- ------------- --------------- ------------- -----------
Minority Interests 2,432 - - - 2,432
--------------- ------------- --------------- ------------- -----------
Shareholders' Equity
Share capital 115,996 1,296 - - 117,292
Additional paid-in capital 4,610 30,851 - - 35,461
Retained earnings (deficit) (39,169) (1,296) - 6,754 (33,711)
Accumulated other comprehensive income
(loss) (2,528) - - 163 (2,365)
--------------- ------------- --------------- ------------- -----------
Total Shareholders' Equity 78,909 30,851 - 6,917 116,677
--------------- ------------- --------------- ------------- -----------
Total Liabilities and Shareholders' Equity $321,539 $ - $22,408 $2,943 $346,890
=============== ============= =============== ============= ===========
49
Nine Months Ended September 30, 2003
(thousands of United Stated dollars)
Proportionate
US Convertible Consolidation Other Canadian
GAAP Notes of Affiliate Adjustments GAAP
------------- ----------------- ---------------- ------------- ------------------
(Restated - (Restated) (Restated)
See Note 2)
Operating Activities
Net income $20,129 $808 $ - ($11,479) $9,458
Stock-based compensation 2,721 - - - 2,721
Depreciation and amortization 7,328 - 273 556 8,157
Amortization and write-off of
deferred finance charges 3,365 - - - 3,365
Non-cash interest 3,408 - - - 3,408
Deferred income taxes 4,614 467 - (198) 4,883
Foreign exchange gain 1,511 - - - 1,511
Gain on sale of assets (49,158) - (89) 11,121 (38,126)
Write-down of fixed assets and
other assets 8,126 - - - 8,126
Goodwill charges 10,012 - - - 10,012
Earnings of affiliates, net of
distributions (2,161) - 2,574 - 413
Minority interest and other (1,207) - - - (1,207)
Changes in non-cash working
capital (4,918) - (1,140) - (6,058)
-------------- ------------- ------------ ----------- ---------------
3,770 1,275 1,618 - 6,663
-------------- ------------- ------------ ----------- ---------------
Investing activities
Capital expenditures (12,925) - (1,519) - (14,444)
Proceeds of dispositions 118,722 - - - 118,722
Acquistions, net of cash (21,529) - - - (21,529)
Other assets, net 3,957 - (24) - 3,933
-------------- ------------- ------------ ----------- ---------------
88,225 - (1,543) - 86,682
-------------- ------------- ------------ ----------- ---------------
Financing activities
Proceeds on issuance of long-term
debt 11,439 - - - 11,439
Repayment of long-term debt (87,985) (1,275) (70) - (89,330)
Issuance of share capital 1,652 - - - 1,652
Purchase of share capital (6,343) - - - (6,343)
-------------- ------------- ------------ ----------- ---------------
(81,237) (1,275) (70) - (82,582)
-------------- ------------- ------------ ----------- ---------------
Foreign exchange effect on cash and
cash equivalents 4,387 - - - 4,387
-------------- ------------- ------------ ----------- ---------------
Increase in cash and cash
equivalents 15,145 - 5 - 15,150
Cash and cash equivalents
beginning of period 31,226 - 6,211 - 37,437
-------------- ------------- ------------ ----------- ---------------
Cash and cash equivalents
end of period $46,371 $ - $6,216 $ - $52,587
============== ============= ============ =========== ===============
50
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Unless otherwise indicated, references to the "Company" mean MDC Partners Inc
and its subsidiaries, and references to a fiscal year means the Company's
fiscal year commencing on January 1 of that year and ending December 31 of
that year (e.g. Fiscal 2004 means the period beginning January 1 2004 and
ending December 31, 2004).
The following discussion focuses on the operating performance of MDC Partners
Inc. (the "Company") for the three-month and nine-month periods ended
September 30, 2004 and 2003, and the financial condition of the Company as at
September 30, 2004. This analysis should be read in conjunction with the
consolidated interim financial statements presented in this interim report and
the restated annual audited consolidated financial statements and Management's
Discussion and Analysis presented in the Annual Report to Shareholders for the
year ended December 31, 2003 as reported on Form 40-F/A. All amounts are in
thousands of US dollars unless otherwise stated.
As discussed in Note 2, the Company's financial statements for the three and
nine month periods ended September 30, 2003 have been restated for prior periods
to correctly reflect certain adjustments. The following discussion relates to
the results of the Company after giving effect to these adjustments.
Combined Revenue, Operating Costs and Operating Profits
Many of the Company's marketing communications businesses have significant
other interestholders and in some cases, the Company operates the business in
a fashion similar to a joint venture with these other interestholders. The
Company's management oversees the businesses as active managers rather than a
passive investor, reviewing all aspects of their operations with the
management of these businesses, regardless of the Company's ownership
interest. Within the marketing communications industry, the monitoring of
operating costs, such as salary and related costs, relative to revenues, among
other things, are key performance indicators. Consequently, the Company's
management reviews, analyses and manages these elements of the businesses as a
whole, rather than just being concerned with it as an investment. Management
believes the presentation of the whole of the Company's marketing
communications business provides readers with a complete view of all
operations that significantly affect the Marketing Communications reportable
segment's profitability and allows readers to evaluate the financial
presentation reviewed by management in making business decisions. Accumark
Promotions Group Inc. owned 55% but not unilaterally controlled by the
Company, Cliff Freeman & Partners, LLC, 19.9% owned by the Company, Mono
Advertising LLC, 49.9% owned by the Company, Zig, Inc., 49.9% owned by the
Company, and, until September 22, 2004, Crispin Porter + Bogusky, LLC,
("CPB"), owned 49.9% by the Company, are required to be equity accounted for
under US GAAP. (The financial statements of CPB are consolidated with the
Company's as of September 22, 2004) Consequently, for purposes of the
Management's Discussion and Analysis, 100% of the results of operations of
those entities which are required to be equity accounted for under US GAAP
have been combined with the other business of the Marketing Communications
reportable segment, and the alternate operating results have been described as
"Combined". These "Combined" results do not constitute a financial measure
prepared in accordance with US GAAP. A reconciliation of "Combined" results of
operations of the Marketing Communications reportable segment to the GAAP
reported results of operations has been provided by the Company in the tables
included in this Management's Discussion and Analysis.
51
Results of Operations:
For the Three Months Ended September 30, 2004
(thousands of United Stated dollars)
Combined As Reported under US GAAP
----------------- ------------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
----------------- -------------- ------------------ --------------- --------------- ---------------
Revenue $77,450 $14,070 $63,380 $20,039 $ - $83,419
----------------- -------------- ------------------ --------------- --------------- ---------------
Operating Expenses:
Cost of products sold - - - 12,433 - 12,433
Salary and related costs 38,169 8,103 30,066 3,580 3,785 37,431
General and other
operating costs 28,273 3,825 24,448 2,243 2,252 28,943
Other charges (recoveries) - - - - (2,350) (2,350)
Depreciation and
amortization 2,683 462 2,221 877 125 3,223
----------------- -------------- ------------------ --------------- --------------- ---------------
69,125 12,390 56,735 19,133 3,812 79,680
----------------- -------------- ------------------ --------------- --------------- ---------------
Operating Profit (Loss) $8,325 $1,680 $6,645 $906 ($3,812) 3,739
================= ============== ================== =============== ===============
Other Income (Expense):
Gain on sale of assets (1,291)
Foreign exchange loss (614)
Interest expense, net (2,617)
---------------
Income (Loss) Before Income Taxes, Equity in Affiliates and
Minority Interests (783)
Income Taxes 294
---------------
Income (Loss) Before Equity in Affiliates and Minority
Interests (1,077)
Equity in Affiliates 455
Minority Interests (2,252)
---------------
Net Income (Loss) ($2,874)
===============
52
For the Three Months Ended September 30, 2003, as restated (1):
(thousands of United Stated dollars)
Combined As Reported under US GAAP
---------------- ------------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
---------------- ---------------- ------------------ --------------- --------------- ---------------
Revenue $51,343 $8,471 $42,872 $19,214 $ - $62,086
---------------- ------------ --------------- ------------ ------------ ------------
Operating Expenses:
Cost of products sold - - - 12,509 - 12,509
Salary and related costs 23,605 3,614 19,991 3,069 2,477 25,537
General and other
operating costs 19,572 2,864 16,708 2,548 1,064 20,320
Other charges - - - - 1,333 1,333
Depreciation and
amortization 1,619 163 1,456 359 136 1,951
---------------- ------------ --------------- ------------ ------------ ------------
44,796 6,641 38,155 18,485 5,010 61,650
---------------- ------------ --------------- ------------ ------------ ------------
Operating Profit (Loss) $6,547 $1,830 $4,717 $729 ($5,010) 436
================ ============ =============== ============ ============
Other Income (Expenses):
Gain on sale of assets 2,861
Foreign exchange gain 20
Interest expense, net (2,223)
------------
Income Before Income Taxes, Equity in Affiliates and Minority Interest 1,094
Income Taxes (Recovery) (1,305)
------------
Income Before Equity in Affiliates and Minority Interests 2,399
Equity in Affiliates 1,383
Minority Interests (1,502)
------------
Net Income $2,280
============
(1) Refer to Note 2 of the notes to the interim unaudited condensed consolidated financial statements included
herein, which disclose the adjustments to the Company's interim unaudited condensed consolidated financial
statements for prior periods.
53
For the Nine Months Ended September 30, 2004
(thousands of United Stated dollars)
Combined As Reported under US GAAP
----------------- -------------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
------------------ --------------- ------------------ --------------- --------------- --------------
Revenue $215,551 $41,886 $173,665 $55,309 $ - $228,974
------------------ --------------- ------------------ --------------- --------------- --------------
Operating Expenses:
Cost of products sold - - - 33,994 - 33,994
Salary and related costs 103,138 20,190 82,948 10,426 11,427 104,801
General and other
operating costs 80,726 10,757 69,969 6,744 5,598 82,311
Other charges
(recoveries) - - - - (2,350) (2,350)
Depreciation and
amortization 7,253 993 6,260 2,359 177 8,796
------------------ --------------- ------------------ --------------- --------------- --------------
191,117 31,940 159,177 53,523 14,852 227,552
------------------ --------------- ------------------ --------------- --------------- --------------
Operating Profit (Loss) $24,434 $9,946 $14,488 $1,786 ($14,852) 1,422
================== =============== ================== =============== ===============
Other Income (Expense):
Gain on sale of assets 14,947
Foreign exchange loss (156)
Interest expense, net (7,235)
--------------
Income Before Income Taxes, Equity in Affiliates and Minority Interest 8,978
Income Taxes (Recovery) (98)
--------------
Income Before Equity in Affiliates and Minority Interests 9,076
Equity in Affiliates 3,339
Minority Interests (5,892)
--------------
Net Income $6,523
==============
54
For the Nine Months Ended September 30, 2003, as restated (1):
Combined As Reported under US GAAP
---------------- -------------------------------------------------------------------
Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
----------------- ---------------- ------------------- --------------- ---------------- --------------
Revenue $147,929 $24,531 $123,398 $95,612 $0 $219,010
----------------- ------------- --------------- ------------ ------------ -----------
Operating Expenses:
Cost of products sold - - - 45,948 - 45,948
Salary and related costs 70,009 10,553 59,456 14,835 5,137 79,428
General and other
operating costs 55,936 7,444 48,492 25,067 2,683 76,242
Other charges - - - - 1,333 1,333
Depreciation and
amortization 4,710 393 4,317 2,614 397 7,328
Write-down of fixed assets
and other assets - - - 8,126 - 8,126
Goodwill charges - - - 10,012 - 10,012
----------------- ------------- --------------- ------------ ------------ -----------
130,655 18,390 112,265 106,602 9,550 228,417
----------------- ------------- --------------- ------------ ------------ -----------
Operating Profit (Loss) $17,274 $6,141 $11,133 ($10,990) ($9,550) (9,407)
================= ============= =============== ============ ============
Other Income (Expense):
Gain on sale of assets 47,486
Foreign exchange loss (1,511)
Interest expense, net (12,390)
-----------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 24,178
Income Taxes 4,605
-----------
Income Before Equity in Affiliates and Minority Interests 19,573
Equity in Affiliates 3,174
Minority Interests (2,618)
-----------
Net Income $20,129
===========
(1) Refer to Note 2 of the notes to the interim unaudited condensed consolidated financial statements included
herein, which disclose the adjustments to the Company's interim unaudited condensed consolidated financial
statements for prior periods.
55
Three Months Ended September 30, 2004 Compared to Three months
Ended September 30, 2003
Marketing Communications
Marketing Communications revenue on a Combined basis was $77.5 million in the
quarter, 50.8% more than the comparable $51.3 million reported in the third
quarter of 2003. The increase in the quarter's Combined revenue as compared to
the same quarter in 2003 primarily resulted from several significant new
business developments which originated in the first quarter of 2004, as
described below. The revenue growth is also a result of the acquisitions by
the Company of several businesses. During the first quarter of 2004, the
Company acquired a controlling interest in the integrated marketing
communications group of agencies of Kirshenbaum Bond + Partners, LLC and an
equity interest in the advertising agency Cliff Freeman + Partners LLC. During
the second quarter of 2004 the Company acquired controlling interests in
Henderson bas, an interactive marketing agency, Mono Advertising LLC, an
advertising agency, Hello Design, LLC and Bruce Mau Design Inc., branding and
design studios, and Banjo, LLC, a production studio. During the third quarter
of 2004, the Company acquired VitroRobertson, LLC, and Zig Inc., advertising
agencies. These acquired operations contributed $20.5 million of revenue on a
Combined basis during the quarter. Excluding the revenue of these acquisitions
in 2004, Combined revenues increased 10.9% period over period. The currency
exchange rate effect of the strengthened Canadian dollar and Pound Sterling,
relative, in each case, to the US dollar, as compared to the same period in
2003, also contributed approximately $1.1 million to the increase in revenues
during this period.
Excluding the effects of acquisitions and foreign exchange rate changes,
Combined revenues would have improved by approximately 8.6% in the third
quarter of 2004, as compared to the same period in 2003. This reflects
significant organic revenue growth in the US businesses. The UK operations,
however, experienced a significant decrease in revenues during this period, as
compared to the third quarter in 2003. The growth in US Combined revenues was
driven by incremental revenues resulting from Crispin Porter + Bogusky's new
client, Burger King, and increased transaction volumes at Accent Marketing
Services. The UK operations experienced declines in revenues from existing
clients, while experiencing nominal new revenue additions.
The positive organic revenue growth, particularly revenues from US operations,
has resulted in a shift in the geographic mix of Combined revenues. Of the
Combined revenue for the quarter, 79% was from the United States, 17% was
derived from Canada and 4% came from the United Kingdom. This compared to 71%,
21% and 8%, respectively, in the third quarter of 2003.
During the third quarter of 2004, the Company's client base composition
shifted in several areas, as compared to the same quarter in 2003. The
Company's revenue's reflected increases in the proportion of total revenue
from spending by the retail and healthcare based clients, while consumer
products, and, to a lesser extent, telecommunications based client revenues
became a relatively smaller component of Combined revenue in 2004, as compared
to 2003. In dollar terms, however, revenues from most industry categories
increased, with significant additional revenue increases over the prior year
reflected in the consumer product, healthcare, telecommunications and retail
industry based clients. The composition of revenues added due to business
acquisitions in 2004, principally Kirshenbaum Bond + Partners, was
proportionately weighted more to the financial and service industry based
clients than the Combined revenues of the pre-existing businesses, which
contributed dollar revenues primarily from the consumer and financial
industries in particular.
Acquisitions in the first quarter did increase total dollar revenues and also
the proportionate share of revenues from advertising services, as compared to
the "below the line" services. For the third quarter of 2004, advertising
services Combined revenues represented approximately 46% of Combined revenues,
as compared to 35% for the same period in 2003. Excluding the effects of the
Kirshenbaum Bond + Partners acquisition, advertising services would have
increased to 38% in the quarter.
56
Combined operating costs increased at a slightly higher pace than the 50.8%
growth in Combined revenues, increasing 54.3% during the quarter, as compared
to the same quarter last year. While the "general and other operating" costs
component grew at only 44.5%, the staff costs increased at 61.7%. These
relative changes are a result of the following factors. If the effects of
acquired businesses were excluded from the Combined results, while revenues
would have increased at 10.9%, staff costs would have increased at 12.8% and
"general and other operating" costs would have increased 23.6%. The staff cost
increase indicated also includes incremental severances over 2003, which if
excluded in both periods, would have resulted in a 11.8% increase in staff
costs. The increase in the "general and other operating" costs beyond the
growth rate of revenues was the result of several factors. As in the second
quarter of 2004, the Company again invested approximately $0.7 million in the
development of a new initiative during this quarter. This venture relates to a
proprietary content-driven marketing initiative, which is still in the
research phase and is expected to continue in this phase through the fourth
quarter of 2004. Further, the Company's operations in the UK in particular
incurred significant costs re-aligning the business during the quarter,
resulting in operating losses of approximately $1.5 million in the current
quarter, compared to profits of approximately $0.1 million in 2003.
Depreciation and amortization expense includes an additional $340 in the third
quarter of 2004 related to an interim estimate of the portion of intangibles
acquired in business acquisitions during 2004 which are anticipated to be
amortizable, subject to finalization of the related professional valuations of
these acquisitions.
Excluding the effects in the quarter of the acquisitions, and the investments
in the new venture, as described above, Combined operating profits would have
been $4.7 million, as compared to $6.5 million in 2003, resulting in Combined
operating margins of approximately 8.2% in the third quarter of 2004, compared
to 12.8% in 2003, despite the $1.6 million reduction in contribution from the
UK business. With the addition of several acquisitions, most notably
Kirshenbaum Bond + Partners, and with the resulting impact of the factors
affecting revenues and operating costs, as discussed above, actual Combined
operating income improved by approximately 27.2% to $8.3 million, from $6.5
million, quarter over quarter, while operating margins were 10.7% for the
quarter, as compared to 12.8% in the same quarter last year. Excluding the
impact of the UK business from both periods, operating profits would have
increased 51.5% while operating margin would have decreased to 12.9% from
13.2%.
Secure Products International
Revenues of Secure Products International totaled $20.0 million for the third
quarter of 2004, an increase of $0.8 million or 4%, compared to the 2003 third
quarter revenues of $19.2 million. This improvement is primarily the result of
a significant increase in production at Ashton Potter related to the United
States Postal Service, or USPS, contract awarded in 2003, which generated a
102% improvement in the revenues of the stamp operation. Placard, the
Australian card operation, also reported increased revenues while revenues
attributable to Mercury, the Canadian ticketing business, and Metaca, the
Canadian card operation declined quarter-over-quarter.
For the three months ended September 30, 2004, operating costs incurred by the
Secure Products International Division were $19.1 million, compared to $18.5
million for the same period of 2003. However, when expressed as a percentage
of revenue, operating costs decreased to 95.5% from 96.2% last year. Cost of
sales, salaries and related costs and general and other operating expenses all
improved as a percentage of revenue in 2004, to 91.1% versus 94.3% in the same
period of 2003. The improvement is reflective of both an increase in volumes
and operating efficiencies achieved through the installation of
state-of-the-art production equipment at Ashton Potter. Third quarter
depreciation and amortization increased $0.5 million in 2004, versus the third
quarter of the prior year, and represented 4.4% of revenue compared to 1.9% of
revenue in the 2003. The increase is primarily related to the impact of the
investment spending in 2003 and the first half of 2004 to increase capacity at
Ashton Potter and open a west-coast plant for Metaca.
Secure Products International earned operating profits of $0.9 million for the
quarter, compared to $0.7 million, an improvement of $0.2 million that was a
result of increased production and profitability at Ashton Potter and Placard.
Operating income generated by Mercury increased marginally from the prior-year
third quarter, despite the impact of the NHL lockout on ticket revenues.
Metaca experienced a significant decline in volumes and revenues resulting in
operating losses during the period. Management continues to undertake
initiatives designed to reduce the cost structure and improve efficiencies at
the Canadian card operations. In connection with this effort, severance and
other related charges of $0.2 million were recorded in the quarter.
57
Corporate and Other
Operating expenses excluding other charges increased from $3.7 million in the
third quarter of 2003 to $6.2 million this quarter as a result of increased
compliance costs associated with US GAAP reporting and Sarbanes-Oxley
legislation, the merger of head offices upon the privatization of Maxxcom
Inc., an increase in the provision for stock-based compensation, and an
increase in overhead costs including the establishment of a US corporate
office in New York. Of the $2.5 million increase, approximately $1.3 million
related to salaries and benefits, which were $3.9 million for the quarter and
included $1.8 million of stock-based compensation expense. For the third
quarter of 2003, salaries and benefits were $2.5 million and included $1.5
million of stock-based compensation expense. In the third quarter of 2003, the
other charges of $1.3 million were related to severance incurred on the
privatization of Maxxcom. In the third quarter of 2004, the other recovery
relates to the reversal of a litigation related accrual as a result of new
facts and circumstances.
The operating loss of the Corporate and Other Division decreased from $5.0
million in 2003 to $3.8 million in 2004.
Gain on Sale of Affiliate and Settlement of Long-Term Debt
The loss of $1.3 million in the third quarter of 2004 was primarily related to
the settlement of debt, including the writeoff of the related unamortized
deferred financing costs, in connection with the establishment of a new credit
facility during the same period. The gain of $2.9 million reflected in the
third quarter of 2003 related to the disposition of units of the Custom Direct
Income Fund (the "Fund") and settlement of a holdback related to a purchase
and sale agreement.
Interest, Net
Net interest expense on a consolidated basis, at $2.6 million for the quarter,
was $0.4 million higher than for the same quarter in 2003. This was due to
lower levels of interest income for the period.
Income Before Income Taxes, Equity In Affiliates and Minority Interests
For the quarter, the loss before income taxes, equity in affiliates and
minority interests was $0.8 million, versus income of $1.1 million in 2003, a
decrease of $1.9 million. This change was primarily due to the impact of asset
dispositions and interest costs, partially offset by improved operating
profits.
Income Taxes
The income tax expense for the third quarter was $0.3 million, compared to a
recovery of $1.3 million for the same period in 2003. The current quarter's
income tax expense reflects operating losses incurred in the UK and in Canada
during the quarter for which a full valuation allowance has been established,
resulting in no net tax benefit being recognized in the operating results of
the Company.
Equity in Affiliates
The income attributable to equity-accounted affiliate operations, principally
Crispin Porter + Bogusky LLC ("CPB") prior to September 22, 2004 and Accumark
Promotions Group Inc, was $0.5 million for the third quarter of 2004,
comparable with the $1.4 million earned in the third quarter of 2003.
Effective September 22, 2004, the Company became the primary beneficiary of
the variable interest entity CPB resulting in a change from the equity method
of accounting to consolidation of the accounts of that agency. The change in
accounting treatment resulted from a change in the relationship between the
Company, CPB and its officers when the Company entered into its new senior
credit agreement.
58
Minority Interests
Minority interest expense of the Marketing Communications Division was $2.3
million for the third quarter of 2004, an increase of $0.9 million compared to
the same prior-year quarter. In 2003, Secure Products International and
Corporate and Other had a minority interest expense of $0.1 million related to
Metaca and Maxxcom, both of which are now wholly-owned.
Net Income
The net loss for the quarter ended September 30, 2004 was $2.9 million, versus
net income of $2.3 million during the same period in 2003.
Nine Months Ended September 30, 2004 Compared to Nine Months Ended
September 30, 2003
Marketing Communications
Marketing Communications revenue on a Combined basis was $215.6 million in the
first nine months of 2004, 45.7% more than the comparable $147.9 million
reported in the first nine months of 2003. The increase in the period's
Combined revenue, as compared to the same period in 2003, resulted primarily
from several significant new client additions which originated in the first
quarter of 2004, as described below. The growth also resulted from the
acquisition by the Company of several businesses in 2004, as compared to 2003.
As described above, during 2004, the Company acquired interests in Kirshenbaum
Bond + Partners, LLC, and Cliff Freeman + Partners LLC, Henderson bas, Mono
LLC, Hello Design, LLC, Bruce Mau Design Inc., Banjo, LLC, VitroRoberston LLC,
and Zig Inc. These acquired operations contributed $45.0 million of revenue on
a Combined basis during the first nine months of 2004. Excluding the revenue
of these acquisitions in 2004, Combined revenues would have increased 15.3%
period over period. The currency exchange rate effect of the strengthened
Canadian dollar and Pound Sterling, relative, in each case, to the US dollar,
as compared to the same period in 2003 also contributed approximately $3.6
million to the increase in revenues during this period.
Excluding the effects of acquisitions and foreign exchange rate changes,
Combined revenues would have improved by approximately 12.5% in the first nine
months of 2004, as compared to the same period in 2003. This reflects
significant organic revenue growth in the US businesses. The UK operations,
however, experienced a significant decrease in revenues during this period, as
compared to the same period in 2003. The growth in US Combined revenues was
driven by incremental revenues resulting from Crispin Porter + Bogusky's new
client, Burger King, increased transaction volumes at Accent Marketing
Services and Source Marketing's significant direct marketing projects this
year. Fletcher Martin Ewing's diminished revenues, as well as lower activity
at Mackenzie Marketing and Mr. Smith's UK operations mitigated this
substantial growth.
The positive organic growth, particularly revenues from US operations, has
resulted in a shift in the geographic mix of Combined revenues. Of the
Combined revenue for the first nine months, 78% was from the United States,
18% was derived from Canada and 4% came from the United Kingdom. This compared
to 71%, 22% and 7%, respectively, in first nine months of 2003.
During the first nine months of 2004, the Company's client base composition
shifted in several areas as compared to the same period in 2003. The Company
saw a relative increase in spending by the consumer products,
telecommunications industry based clients, while automotive based client
revenues became a relatively smaller component of Combined revenue in 2004, as
compared to 2003. In dollar terms, significant increases were noted in
revenues from consumer product, and financial, service industry based clients.
The composition of revenues added due to business acquisitions in the first
half of 2004, principally Kirshenbaum Bond + Partners, was proportionately
weighted more to the financial and service industry based clients than the
Combined revenues of the pre-existing businesses, contributing dollar revenues
primarily from the consumer and financial industries in particular.
59
Acquisitions in the first nine months of 2004 did increase the dollar revenues
and also the proportionate share of revenues from advertising services, as
compared to the "below the line" services. For the first nine months of 2004,
advertising services Combined revenues represented approximately 45% of
Combined revenues, as compared to 35% for the same period in 2003. Excluding
the effects of the KBP acquisition, advertising services would have increased
to 39% in the year to date period, as the Company's existing operations
obtained several new clients during the period requiring advertising services.
Combined operating costs increased at a slightly increased pace than the 45.7%
growth in Combined revenues, increasing 46.3% during the first nine months of
2004, as compared to the same period in 2003. Of the operating costs
components, Combined "general and other operating" costs grew at 44.3% and
while staff costs grew at 47.3%. These relative changes were a result of
several factors. Firstly, if the effects of acquired business were excluded
from the Combined results, while revenues would have increased at 15.3%, staff
costs would have increased at 10.6% and "general and other operating" costs
would have increased 28.1%. The reduced staff cost pace of growth relative to
revenues reflects the rapid revenue growth in the first quarter of 2004 that
outpaced the ability of certain businesses to increase staffing levels to the
appropriate sustainable levels for the business volumes, resulting in enhanced
profitability during that period. The increase in the "general and other
operating" costs beyond the growth rate of revenues was itself the result of
several factors. During 2004, the Company invested approximately $2.2 million
in the development of two new initiatives. During the second and third
quarters of 2004, the Company invested in a new venture to develop a
proprietary content-driven marketing initiative, which is still in the
research phase and is expected to continue in this phase through the fourth
quarter of 2004. The second venture invested in during 2004, which was not
continued beyond the second quarter of 2004, was related to a possible
expansion into a new geographic market. A further cause of the increase in
operating costs was the unusually high amount expended on new business
development during 2004, in particular by the UK business, which invested
significant resources into attracting new clients. Finally, Accent Marketing
Services expended significant costs to expand its customer service center
operations into near-shore and offshore facilities as it prepares for
additional business volumes and to maintain its competitive cost structure in
the long run. Depreciation and amortization expense for the three quarters
ended September 30, 2004 includes an additional $920 charge related to an
interim estimate of the portion of intangibles acquired in business
acquisitions during 2004 which are anticipated to be amortizable, subject to
finalization of the related professional valuations of these acquisitions.
60
Excluding the effects in the period of the acquisitions, and the investments
in new ventures and new business, as described above, Combined operating
profits would have decreased 2.2% to $16.7 million, from $17.3 million,
resulting in Combined operating margins of approximately 9.8% in 2004 to date
and 11.7% in the same period in 2003. With the addition of Kirshenbaum Bond +
Partners and with the resulting impact of the factors affecting revenues and
operating costs, as discussed above, actual Combined operating income improved
by approximately 41.4% to $24.4 million from $17.3 million, period over
period, while operating margins where 11.3% for the first nine months of 2004,
as compared to 11.7 % in the same period in 2003.
Secure Products International
Secure Products International generated revenues of $55.3 million during the
first three quarters of 2004, representing a decrease of $40.3 million or 42%
compared to the same period in 2003. The decrease was primarily due to the
divestiture of CDI last year as revenues from the remaining operations of the
Secure Products International Division increased 19% or $8.7 million. The most
significant increase was generated by the stamp operations of Ashton Potter,
where production increased due to the USPS contract awarded in 2003. Placard,
the Australian card operation, also experienced revenue growth, however,
revenues of Mercury, the Canadian ticketing business and the Canadian card
operation, Metaca, decreased period over period.
Operating costs of Secure Products International were $53.5 million for the
nine months ended September 30, 2004, compared to $106.6 million in 2003.
Excluding the impact of disposed operations, and the second quarter 2003
charges related to goodwill and a write-down of fixed and other assets from
the 2003 results, operating expenses increased $6.5 million, but as a
percentage of revenues, improved to 96.0% on a year-to-date basis in 2004,
from 100.9% for the same period of 2003.
As a result, the Secure Products International Division contributed operating
income of $1.8 million, an improvement of $12.8 million from the loss incurred
in 2003 of $11.0 million. This represents a year over year improvement of $2.1
million from the adjusted operating income of $0.1 million related to the
remaining operations, primarily as a result of the increased production at
Ashton Potter and Placard partially offset by declines at Metaca.
Corporate and Other
Operating costs, at $14.9 million, increased $5.3 million compared to the nine
months ended September 30, 2003, primarily related to a $4.2 million increase
in charges for stock-based compensation. Corporate and other costs also
increased as a result of the merger of head offices upon the privatization of
Maxxcom Inc, the establishment of a new US head office, and an increase in
compliance costs. In the third quarter of 2003, the other charges of $1.3
million were related to severance incurred on the privatization of Maxxcom. In
the third quarter of 2004, the other recovery relates to the reversal of a
litigation related accrual.
The operating losses of the Corporate and Other Division increased to $14.9
million in 2004, from $9.6 million in 2003.
Gain on Sale of Affiliate and Settlement of Long-Term Debt
The gain on sale of assets of $14.9 million for the first three quarters of
2004 primarily related to the divestiture of the remaining interest in CDI,
net of the loss on the settlement of the adjustable rate exchangeable
securities and fair value adjustment for the embedded derivative in the first
quarter. The prior-year gain was primarily related to the disposition of the
U.S. check operations.
61
Interest, Net
On a consolidated basis, net interest expense for the first nine months of the
year was $7.2 million, compared to the $12.4 million incurred during the same
year-earlier period. Interest expense decreased $5.2 million due primarily to
the repayment of the 10.5% senior subordinated notes and the redemption of the
convertible debentures. Interest income was relatively unchanged.
Income Before Income Taxes, Equity In Affiliates and Minority Interests
The consolidated income before income taxes, equity in affiliates and minority
interests for the year-to-date period ended September 30, 2004 was $9.0
million compared to $24.2 million during the same prior-year period. The
decrease was primarily due to the significant gain on sale of assets related
to CDI in 2003, net of goodwill charges and the write-down of assets also
recorded in that year.
Income Taxes
The income tax recovery recorded for the nine months ended September 30, 2004,
was $0.1 million, compared to an expense of $4.6 million for the same period
in 2003. Income taxes were negligible compared to income before income taxes,
equity in affiliates and minority interests, versus 19.0% in 2003. During 2004
significant taxable gains were offset by previously unrecognized taxable
losses.
Equity in Affiliates
Equity in affiliates represents the income attributable to equity-accounted
affiliate operations. For the first three quarters of 2004, income of $3.3
million was recorded. The increase of $0.1 million over the $3.2 million
earned in the first nine months of 2003 is principally due to greater income
generated by Crispin Porter + Bogusky offset by reduced operating results in
other affiliates.
Minority Interests
Minority interest expense of Marketing Communications was $5.9 million for the
first nine months of 2004, an increase of $2.3 million compared to the $3.6
million in the previous year. In 2003, a recovery of $1.0 million was recorded
related to Metaca and Maxxcom.
Net Income
The net income reported for the first nine months of 2004 was $6.5 million,
compared to the net income of $20.1 million achieved in 2003, primarily due to
more significant asset sale gains in 2003.
Subsequent Events
In November 2004, the Company's management reached a decision to discontinue
the operations of a component of its business. This component is comprised of
the Company's UK based marketing communications business, wholly owned
subsidiary Mr. Smith Agency, Ltd. (formerly known as Interfocus Networks,
Ltd). The Company decided to cease the operations of this business due to the
uneconomical cost structure and highly competitive market environment in which
this business was operating. The net assets of the discontinued business are
expected to be disposed of during the fourth quarter of 2004 with the closure
to be substantially completed by the end of the first quarter of 2005. See
also Note 14 of the notes to the consolidated financial statement included
herein.
62
Liquidity and Capital Resources
Working Capital
The working capital deficit at September 30, 2004 amounted to $26.2 million,
and $64.8 million less than the working capital of $38.6 million at December
31, 2003. The reduction in working capital is due primarily to cash payments
made for acquisitions, the repayment of debt during 2004, and the refinancing
of a portion of long-term debt as current debt, combined with a decrease in
working capital in the Marketing Communications subsidiaries, partially offset
by a decrease in the current portion of long-term debt. Compared to December
31, 2003, on a consolidated basis, excluding the effect of the initial
consolidation of CPB at September 22, 2004, the following were the changes in
working capital accounts: Cash decreased $50.1 million during the period;
Accounts receivable increased by $35.0 million and expenditures billable to
clients decreased by $3.3 million; Inventory and prepaid expenses increased
$0.9 million and $1.1 million, respectively; Bank debt, net of the change in
the current portion of long-term indebtedness, decreased $0.2 million;
Accounts payable, accruals and other liabilities increased by $37.3 million;
Advance billings increased by $11.1 million. These changes were in large part
due to acquisitions, such as KBP, during the nine month period.
At September 30, 2004, the Company had utilized approximately $63 million of
its $100 million facility in the form of drawings and letters of credit.
Cash and undrawn available bank credit facilities to support the Company's
future cash requirements, as at September 30, 2004, were approximately $25
million.
Long-Term Debt
At September 30, 2004, long-term indebtedness (including the current portion
of long-term debt) was $56.7 million, a reduction of $25.3 million compared to
the $82.0 million outstanding at June 30, 2004 and a reduction of $93.4
million compared to the $150.1 million outstanding at December 31, 2003. The
decrease in long-term debt can be attributed to the settlement in the first
quarter of the $26.3 million of adjustable rate exchangeable securities with
units of the Fund, the settlement in the second quarter of the $37.8 million
convertible notes through the issuance of approximately 2.6 million Class A
subordinate voting shares, and the introduction of a cash management program
in third quarter, which together with a new credit facility, allowed an
overall reduction in long-term debt.
During the quarter, the Company and certain of its wholly-owned subsidiaries
entered into a revolving credit facility with a syndicate of banks providing
for borrowings of up to $100 million, maturing in September 2007. Funds from
this facility, combined with a related cash management program, were used to
repay in full and cancel the Maxxcom credit facility that was to mature in
2005, the Maxxcom subordinated debenture, the MDC Partners Inc. revolving
credit facility entered into in June 2004 and certain subsidiary's current
bank loans. This new credit facility will reduce the Company's aggregate
borrowing costs and provide enhanced liquidity.
The Company has classified the swing-line component of the this revolving
credit facility as a current liability in accordance with EITF 95-22, Balance
Sheet Classification of Borrowings Outstanding under Revolving Credit
Agreements that include both a Subjective Acceleration Clause and a Lock-Box
Arrangement. This component, reflected as bank indebtedness on the balance
sheet, is classified as a current liability in accordance with EITF 95-22
since the swing-line contains a lock box arrangement that requires the cash
receipts of the Company to be used to repay amounts outstanding under the
swing-line and the entire credit facility is subject to subjective
acceleration clauses.
63
As a result of the Company's failure to file on a timely basis its interim
financial statements for the nine months ended September 30, 2004; and its
restatement of previously filed audited annual and unaudited interim financial
statements, as at November 19, 2004, the Company was in violation of certain
covenants under its Credit Agreement dated September 22, 2004 (the "Credit
Agreement"). On November 19, 2004, MDC Partners Inc. amended its Credit
Agreement by and among JPMorgan Chase Bank, The Toronto-Dominion Bank, Bank of
Montreal, Bank of Nova Scotia and Canadian Imperial Bank of Commerce as
lenders, and with the Company, Maxxcom Inc., an Ontario corporation, and
Maxxcom Inc., a Delaware corporation, as borrowers. Pursuant to this
amendment, the lenders (i) extended, until December 22, 2004, the due date for
the Company to deliver to the lenders its interim financial statements for the
period ended September 30, 2004, and (ii) waived violation of debt covenants
in respect of the potential inaccuracy of certain representations and
warranties previously made by the Company under the Credit Agreement relating
to the Company's previously filed financial statements.
As at September 30, 2004, $4,173 of the consolidated cash position is held by
subsidiaries, which, although available for the subsidiaries' use, does not
represent cash that is distributable as earnings to MDC Partners Inc. for use
to reduce MDC Partners Inc. indebtedness.
Deferred Acquisition Consideration (Earnouts)
Acquisitions of businesses by the Company typically include commitments to
contingent purchase consideration payable to the seller. The contingent
purchase obligations are generally payable annually over a three-year period
following the acquisition date, and are payable based on achievement of
certain thresholds of future earnings and, in certain cases, also based on the
rate of growth of those earnings The contingent consideration is recorded as
an obligation of the Company when the contingency is resolved and the amount
is reasonably determinable. At September 30, 2004, approximately $0.4 million
in deferred acquisition consideration relating to prior year acquisitions is
presented on the Company's balance sheet. Based on various assumptions as to
future operating results of the relevant entities, management estimates that
approximately $0.9 million of further additional deferred purchase obligations
could be triggered during 2004 or thereafter. The actual amount that the
Company pays in connection with the obligations may be materially different
from this estimate.
Put Rights of Subsidiaries' Minority Shareholders
Owners of interests in certain of the Marketing Communications subsidiaries
have the right in certain circumstances to require the Company to acquire the
remaining ownership interests held by them. The owners' ability to exercise
any such "put" right is subject to the satisfaction of certain conditions,
including conditions requiring notice in advance of exercise. In addition,
these rights cannot be exercised prior to specified staggered exercise dates.
The exercise of these rights at their earliest contractual date would result
in obligations of the Company to fund the related amounts during the period
2004 to 2013. Except as described below, it is not determinable, at this time,
if or when the owners of these rights will exercise all or a portion of these
rights.
The amount payable by the Company in the event such rights are exercised is
dependent on various valuation formulas and on future events, such as the
average earnings of the relevant subsidiary through the date of exercise, the
growth rate of the earnings of the relevant subsidiary during that period,
and, in some cases, the currency exchange rate at the date of payment.
Management estimates, assuming that the subsidiaries perform at their current
profit levels over the relevant future periods, that these "put" rights, if
all exercised, could require the Company, in future periods, to pay an
aggregate of approximately $84 million to the owners of such rights to acquire
the remaining ownership interests in the relevant subsidiaries. Of this
amount, the Company would be entitled, at its option, to fund approximately
$16 million by the issuance of shares of the Company's Class A stock.
The actual future amount payable in connection with the exercise of any of the
above described rights cannot be determined because it is dependent on the
future results of operations of the subject businesses and the timing of the
exercise of the rights. The actual amounts the Company pays may be materially
different from these estimates.
64
If all of the outstanding rights were exercised, the Company would acquire
incremental ownership interests in the relevant subsidiaries entitling the
Company to additional annual operating income before other charges estimated
by management, using the same earnings basis used to determine the aggregate
purchase price noted above, to be approximately $12 million. The actual
additional annual operating income earned by the relevant subsidiaries may be
materially different from this estimate.
The Company expects to fund obligations relating to the rights described
above, if and when they become due, through the issuance of its common shares
to the rights holders, and through the use of cash derived from operations,
bank borrowings, and equity and/or debt offerings. There can be no certainty
that the Company will have adequate means to satisfy its obligations in
respect of the rights described above, if and when such obligations become
due.
Approximately $4 million of the estimated $84 million that the Company could
be required to pay subsidiaries' minority shareholders upon the exercise of
outstanding put rights relates to rights exercisable in 2004 in respect of the
securities of three subsidiaries. The Company expects to fund the acquisition
of these interests, if and when they become due, through the use of cash
derived from operations and bank borrowings. Accordingly, the acquisition of
any equity interest in connection with the exercise of these rights in 2004
will not be recorded in the Company's financial statements until ownership is
transferred.
Cash Flow from Operations
For the first three quarters of 2004, cash flow provided by operations,
including changes in non-cash working capital, amounted to $5.2 million. The
increase of $1.4 million from the cash flow generated of $3.8 million during
the same period of 2003, was primarily the result of improved operating
profits generated by both the Marketing Communications Division and the
remaining operations of Secure Products International, offset partially by
increased corporate and other.
Cash flows used in investing activities was $31.5 million for the year-to-date
period ended September 30, 2004, compared with the cash flows generated in
2003 of $88.2 million. $5.8 million of the $11.4 million in capital
expenditures relate to the Marketing Communications Division and the remainder
to the purchase of manufacturing equipment in the Secure Products Division. In
2003, proceeds of dispositions primarily represent the net proceeds received
from the public offering of CDI.
Cash flows used in financing activities to September 30, 2004, were $21.8
million and comprised of the proceeds from the issuance of long-term debt of
$67.3 million, $13.8 million of bank indebtedness related to the new facility,
a repayment of $94.5 million of long-term debt, proceeds of $3.6 million from
the issuance of share capital through a private placement and the exercise of
options, and $12.1 million used to repurchase shares of the Company under a
normal course issuer bid.
65
Differences in MD&A Presentation Under Canadian GAAP
Under Canadian securities requirements, the Company is required to provide
supplemental information to highlight the significant differences that would
have resulted in the information provided in the MD&A had the Company prepared
the MD&A using Canadian GAAP financial information.
The Company has identified and disclosed the significant differences between
Canadian and US GAAP as applied to its interim consolidated financial
statements for the three months and nine months ended September 30, 2004 and
2003 in Note 15 to the condensed consolidated interim financial statements.
The primary GAAP difference impacting the components of operating profit
(loss) is the application under Canadian GAAP of proportionate consolidation
for investments in joint ventures, while US GAAP requires equity accounting
for such investments, and the treatment of certain foreign exchange gains and
loses on the repayment of intercompany loans. This GAAP difference does not
have a significant impact on the content of the MD&A as the discussion of the
results of the Company's marketing communications businesses has been
presented on a combined basis, consistent with the Company's segment
disclosures in its condensed consolidated interim financial statements. The
Combined financial information has been reconciled to US GAAP financial
information by adjusting for the equity accounting for certain the joint
ventures in this MD&A as well as in the segment information in Note 6 to the
condensed consolidated interim financial statements. If the reconciliation of
the Combined financial information were prepared to reconcile to Canadian GAAP
results, it would have adjusted for the proportionate consolidation of the
joint ventures.
Critical Accounting Policies
The following supplemental summary of accounting policies has been prepared to
assist in better understanding the Company's financial statements and the
related management discussion and analysis. Readers are encouraged to consider
this supplement together with the Company's consolidated interim financial
statements and the related notes to the condensed consolidated interim
financial statements for a more complete understanding of accounting policies
discussed below.
Estimates. The preparation of the Company's financial statements in
conformity with generally accepted accounting principles in the United States
of America, or "GAAP", requires management to make estimates and assumptions.
These estimates and assumptions affect the reported amounts of assets and
liabilities including valuation allowance for receivables, recognition of
goodwill, intangible assets, minority interest, income taxes, stock-based
compensation, accruals for bonus compensation and the disclosure of contingent
liabilities at the date of the financial statements, as well as the reported
amounts of revenue and expenses during a reporting period. The statements are
evaluated on an ongoing basis and estimates are based on historical
experience, current conditions and various other assumptions believed to be
reasonable under the circumstances. Actual results can differ from those
estimates, and it is possible that the differences could be material.
Acquisitions and Goodwill. A fair value approach is used in testing
goodwill for impairment under SFAS 142 to determine if an other than temporary
impairment has occurred. One approach utilized to determine fair values is a
discounted cash flow methodology. When available and as appropriate,
comparative market multiples are used. Numerous estimates and assumptions
necessarily have to be made when completing a discounted cash flow valuation,
including estimates and assumptions regarding interest rates, appropriate
discount rates and capital structure. Additionally, estimates must be made
regarding revenue growth, operating margins, tax rates, working capital
requirements and capital expenditures. Estimates and assumptions also need to
be made when determining the appropriate comparative market multiples to be
used. Actual results of operations, cash flows and other factors used in a
discounted cash flow valuation will likely differ from the estimates used and
it is possible that differences and changes could be material. Additional
information about impairment testing under SFAS 142 appears in the notes of
the condensed consolidated interim financial statements.
The Company has historically made and expects to continue to make selective
acquisitions of marketing communications businesses. In making acquisitions,
the price paid is determined by various factors, including service offerings,
competitive position, reputation and geographic coverage, as well as prior
experience and judgment.
66
Due to the nature of advertising, marketing and corporate communications
services companies, the companies acquired frequently have minimal tangible
net assets and identifiable intangible assets which primarily consist of
customer relationships. Accordingly, a substantial portion of the purchase
price is allocated to goodwill. An annual impairment test is performed in
order to assess that the fair value of the reporting units exceeds their
carrying value, inclusive of goodwill.
A summary of the Company's deferred acquisition consideration obligations,
sometimes referred to as earn-outs, and obligations under put rights of
subsidiaries' minority shareholders to purchase additional interests in
certain subsidiary and affiliate companies is set forth in the "Liquidity and
Capital Resources" section of this report. The deferred acquisition
consideration obligations and obligations to purchase additional interests in
certain subsidiary and affiliate companies are primarily based on future
performance. Contingent purchase price obligations are accrued, in accordance
with GAAP, when the contingency is resolved and payment is determinable.
Additional information about acquisitions and goodwill appears in the notes to
the condensed consolidated interim financial statements of this report.
Revenue. Substantially all of the revenue of the Marketing
Communications segment is derived from fees for services. Commissions are
earned based on the placement of advertisements in various media. Revenue is
realized when the service is performed, in accordance with terms of the
arrangement with the clients and upon completion of the earnings process. This
includes when services are rendered, generally upon presentation date for
media, when costs are incurred for radio and television production and when
print production is completed and collection is reasonably assured.
Revenue is recorded at the net amount retained when the fee or commission is
earned. In the delivery of certain services to clients, costs are incurred on
their behalf for which the Company is reimbursed. Substantially all of the
reimbursed costs relate to purchases on behalf of clients of media and
production services. There is normally little latitude in establishing the
reimbursement price for these expenses and clients are invoiced for these
expenses in an amount equal to the amount of costs incurred. These reimbursed
costs, which are a multiple of the Company's revenue, are significant.
However, the majority of these costs are incurred on behalf of the largest
clients and the Company has not historically experienced significant losses in
connection with the reimbursement of these costs by clients.
A small portion of the contractual arrangements with clients includes
performance incentive provisions designed to link a portion of the Company's
revenue to its performance relative to both quantitative and qualitative
goals. This portion of revenue is recognized when the specific quantitative
goals are achieved, or when the performance against qualitative goals is
determined by the client. Additional information about revenue appears in the
notes to the condensed consolidated interim financial statements.
Substantially all of the Secure Products International reportable segment
revenue is derived from the sale of products. Revenue derived from the stamp
operations is realized as services are performed or upon delivery. Revenue
derived from the sale of tickets and cards is realized when the product is
completed and either shipped or held in the Company's secure facilities at the
written request of the customer, title to the product has transferred to the
customer, and all bill and hold revenue recognition criteria have been met.
Additional information about revenue recognition appears in the notes to the
condensed consolidated interim financial statements.
Income tax valuation allowance. The Company records a valuation
allowance against deferred income tax assets when management believes it is
more likely than not that some portion or all of the deferred income tax
assets will not be realized. Management considers factors such as the reversal
of deferred income tax liabilities, projected future taxable income, the
character of the income tax asset, tax planning strategies, changes in tax
laws and other factors. A change to these factors could impact the estimated
valuation allowance and income tax expense.
67
Variable Interest Entities. The Company evaluates its various
investments in entities to determine whether the investee is a variable
interest entity and if so whether MDC is the primary beneficiary. Such
evaluation requires management to make estimates and judgments regarding the
sufficiency of the equity at risk in the investee and the expected losses of
the investee and may impact whether the investee is accounted for on a
consolidated basis.
Risks and Uncertainties:
This document contains forward-looking statements. The Company's
representatives may also make forward-looking statements orally from time to
time. Statements in this document that are not historical facts, including
statements about the Company's beliefs and expectations, particularly
regarding recent business and economic trends, estimates of amounts for
deferred acquisition consideration and "put" option rights, constitute
forward-looking statements. These statements are based on current plans,
estimates and projections, and are subject to change based on a number of
factors, including those outlined in this section. Forward-looking statements
speak only as of the date they are made, and the Company undertakes no
obligation to update publicly any of them in light of new information or
future events.
Forward-looking statements involve inherent risks and uncertainties. A number
of important factors could cause actual results to differ materially from
those contained in any forward-looking statements. Such risk factors include,
but are not limited to, the following:
o risks arising from the Company's delayed filing with the SEC of its
Form 10-Q for the quarter ended September 30, 2004, and the Company's
need to restate its previously filed financial statements for quarterly
periods ended June 30, 2004 and March 31, 2004, and the fiscal year
ended December 31, 2003;
o risks associated with effects of national and regional economic and
political conditions;
o the Company's ability to attract new clients and retain existing
clients;
o the financial success of the Company's clients;
o the Company's ability to retain and attract key employees;
o developments from changes in the regulatory and legal environment;
o foreign currency fluctuations;
o the successful completion and integration of acquisitions which
complement and expand the Company's' business capabilities; and
o risks arising from potential material weaknesses in internal control
over financial reporting.
Investors should carefully consider these risk factors and the additional risk
factors outlined in more detail in the Company's 2003 Form 40-F/A and other
SEC filings.
Supplementary Financial Information:
The Company reports its financial results in accordance with US GAAP. However,
the Company has included certain non-GAAP financial measures and ratios, which
it believes, provide useful information to both management and readers of this
report in measuring the financial performance and financial condition of the
Company. These measures do not have a standardized meaning prescribed by GAAP
and, therefore, may not be comparable to similarly titled measures presented
by other publicly traded companies, nor should they be construed as an
alternative to other titled measures determined in accordance with US GAAP.
68
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Quantitative Information About Market Risk
We are currently not invested in market risk sensitive instruments such as
derivative financial instruments or derivative commodity instruments.
Qualitative Information About Market Risk
Our Secure Products International businesses operate in North America and
Australia. Certain North American costs are payable in Canadian dollars while
North American revenues are principally collectible in US dollars. Our
Marketing Communications businesses operate in North America and the United
Kingdom, however each business's revenues are collectible and its costs are
generally payable in the same local currency. Consequently, our financial
results can be affected by changes in foreign currency exchange rates.
Fluctuations in the exchange rates between the US dollar, the Sterling Pound,
the Australian dollar and the Canadian dollar may have a material effect on
our results of operations. In particular, we may be adversely affected by a
significant strengthening of the Canadian dollar against any of these
currencies. We are not currently a party to any forward foreign currency
exchange contract, or other contract that could serve to hedge our exposure to
fluctuations in the US/Canada dollar exchange rate.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to ensure that
information required to be included in our SEC reports is recorded, processed,
summarized and reported within applicable time periods specified by the SEC's
rules and forms, and that such information is accumulated and communicated to
our management, including our Chief Executive Officer (CEO) and Chief
Financial Officer (CFO) as appropriate, to allow timely decisions regarding
required disclosures.
We conducted an evaluation, under the supervision and with the participation
of our management, including our CEO and CFO, of the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, our CEO and CFO concluded that as of
September 30, 2004 our disclosure controls and procedures were not effective
to ensure recording, processing, summarizing and reporting of information
required to be included in our SEC reports on a timely basis. Subsequent to
September 30, 2004, and up to the filing date of this Form 10-Q, we
implemented revised control activities to support improved processes under the
direction of our Vice Chairman & Executive Vice President. The revised control
activities and improved processes include expanded supervisory activities and
monitoring procedures, including the corrective actions described below. Based
on these changes and improvements, management believes that as of the date of
this filing, our disclosure controls and procedures are effective to ensure
that material information relating to our Company, including our consolidated
subsidiaries, is made known to our CEO and CFO by others within those
entities. Furthermore, our management, including our CEO and CFO, believe such
controls have improved since September 30, 2004, in providing reasonable
assurance that information required to be disclosed by us in the reports that
we file or submit to the SEC is recorded, processed, summarized and reported,
within the time periods specified in the SEC's rules and forms. We currently
are designing and implementing an improved control environment to address the
deficiencies described below.
69
Internal Control over Financial Reporting
In the light of restatements of the Company's previously issued financial
statements, as described in Note 2 to the Company's interim condensed
consolidated financial statements contained herein, the Company's management
has concluded that there are significant deficiencies in the design or
operation of internal controls which could adversely affect the Company's
ability to record, process, summarize and report financial data consistent
with the assertions of management in the financial statements. Management
believes that such deficiencies represent material weaknesses in internal
control over financial reporting that, by themselves or in combination, result
in a more than remote likelihood that a material misstatement in our financial
statements will not be prevented or detected by our employees in the normal
course of performing their assigned functions. Such material weaknesses in
internal control over financial reporting existed as at and prior to September
30, 2004.
Under applicable rules, management may not conclude that the Company's
internal control over financial reporting is effective if a material weakness
exists. Given the nature of the restatements, the Company's management
believes that its material weaknesses relate primarily to significant
transactions at the Company's head office accounting and reporting functions,
including the following:
o insufficient personnel resources and technical accounting expertise
within its accounting functions;
o failure in the design and operating effectiveness of identified
controls in preventing or detecting misstatements of accounting
information;
o absence of appropriate review of significant transactions and related
accounting entries, and the appropriate documentation and application
of U.S. GAAP for those significant transactions;
o failure to document approvals required for certain transactions; and
o inadequate procedures and oversight for appropriately assessing and
applying accounting principles and changes thereon.
Our management and Audit Committee have dedicated resources to assist in
assessing the underlying issues giving rise to the restatement and in ensuring
proper steps have been and are being taken to improve our control environment.
That assessment found and concluded that our finance and accounting personnel
made a number of accounting errors, but that there was no evidence of any
fraud, intentional misconduct or concealment on the part of the Company, its
officers or its employees. We currently are designing and implementing
improved controls to address the material weaknesses described above in our
control environment. Specifically, the Company has taken the following
corrective actions:
o Hired additional personnel resources, and is actively pursing
appropriate additional resources in its accounting and finance
functions, particularly those with US GAAP expertise;
o Developed, distributed and begun to communicate and implement
comprehensive accounting policies in a number of areas, including
revenue recognition;
o Developed and continues to refine procedures for ensuring appropriate
documentation of complex transactions and application of accounting
standards to ensure compliance with U.S. GAAP;
o Improving procedures for reviewing underlying business agreements and
analyzing, reviewing and documenting the support for management's
accounting entries and significant transactions; and
o Improving monitoring controls to ensure internal controls are operating
effectively.
The Company believes that these steps should remediate the identified material
weaknesses in control over financial reporting.
70
Section 404 Assessment
Section 404 of the Sarbanes-Oxley Act requires management's annual review and
evaluation of our internal controls, and an attestation of the effectiveness of
these controls by our independent registered public accountants beginning with
our Form 10-K for the fiscal year ending on December 31, 2004. We have
dedicated significant resources, including management time and effort, and
incurred substantial costs in connection with our ongoing Section 404
assessment. We are currently documenting and testing our internal controls and
evaluating necessary improvements for maintaining an effective control
environment. The evaluation of our internal controls is being conducted under
the direction of our senior management in consultation with independent third
party consulting firm. In addition, the Company's management is regularly
discussing the results of our testing and any proposed improvements to our
control environment with the Audit Committee. Despite the dedication of
significant resources for our Section 404 assessment, and the incurrence of
significant costs, the Company has determined that a significant amount of work
will be required to remediate the above-mentioned material weaknesses in its
internal control over financial reporting. Accordingly, the Company expects
that it is likely that it will have material weaknesses in internal control
over financial reporting at year-end. However, based on significant work
performed during the past several months, including the measures discussed
above, management believes that there are no material inaccuracies or omissions
of material fact in this third quarter Form 10-Q. Management, to the best of
its knowledge, also believes that the financial statements contained in this
third quarter Form 10-Q are fairly presented in all material respects. Despite
the potential for a material weakness in the Company's internal controls at
year-end, management further expects that its corrective measures and improved
internal controls will enable the Company to file financial statements for the
year ending December 31, 2004, in compliance with U.S. GAAP on a timely basis.
71
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company's operating entities are involved in legal proceedings of various
types. While any litigation contains an element of uncertainty, the Company
has no reason to believe that the outcome of such proceedings or claims will
have a material adverse effect on the financial condition of the Company.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
Issuer Purchases of Equity Securities:
Shares- Class A subordinate voting shares
- ------------------------- ----------------- --------------------- --------------------- --------------------
Period Total Number of Average Price Paid Total Number of Maximum Number of
Shares Purchased per Share Shares Purchased as Shares that may
Part of Publicly yet be Purchased
Announced Plans or under the Plans or
Programs Programs
- ------------------------- ----------------- --------------------- --------------------- --------------------
July 1, 2004 215,800 $11.27 215,800 1,346,722
- -July 31, 2004
- ------------------------- ----------------- --------------------- --------------------- --------------------
August 1, 2004 238,500 $10.55 238,500 1,108,222
- -August 31, 2004
- ------------------------- ----------------- --------------------- --------------------- --------------------
September 1, 2004 161,700 $12.51 161,700 946,522
- -September 30, 2004
- ------------------------- ----------------- --------------------- --------------------- --------------------
Total 616,000 $11.32 616,000
- ------------------------- ----------------- --------------------- --------------------- --------------------
The Class A subordinate voting shares were purchased pursuant to a publically announced plan which commenced June 7,
2004. The maximum number of shares that may be purchased under this plan is 1,816,822. This plan expires June 6, 2005.
Recent Sales of Unregistered Securities:
(1) On July 27, 2004, the Company acquired a 68% ownership interest
in VitroRobertson Acquisition, LLC ("VR"). As part of this acquisition, the
Company paid approximately $7 million in cash and issued 42,767 shares of the
Company's Class A common stock to VR and its members (valued at approximately
$473,000 on the date of issuance). The shares of MDC Class A common stock were
issued to VR by the Company without registration in reliance on Section 4(2)
under the Securities Act and Regulation D thereunder, based on the
sophistication of VR and its status as an "accredited investor" within the
meaning of Rule 501(a) of Regulation D. VR and its members had access to all
the documents filed by the Company with the SEC, including the Company's (i)
Annual Report on Form 40-F for the year ended December 31, 2003, and (ii)
Quarterly Report on Form 10-Q for the period ended March 30, 2004.
(2) On August 31, 2004, the Company acquired a 49.9% ownership
interest in Zig Inc. As part of the acquisition, the Company paid
approximately CDN$1.75 million in cash and issued 125,628 shares of the
Company's Class A common stock to the selling shareholders of Zig Inc. (valued
at approximately CDN$1.98 million on the date of issuance). The shares of MDC
Class A common stock were issued by the Company without registration in an
"offshore transaction" and solely to "non-U.S. persons" in reliance on Rule
903 of Regulation S under the Securities Act and in reliance on section 2.3 of
Ontario Securities Commission Rule 45-501.
72
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
10.13 Credit Agreement made September 22, 2004 between MDC Partners
Inc., a Canadian corporation, Maxxcom Inc., an Ontario
corporation, and Maxxcom Inc., a Delaware corporation, as
borrowers, the Lenders (as defined therein) and JPMorgan Chase
Bank, as U.S. Administrative Agent and Collateral Agent, and
JPMorgan Chase Bank, Toronto Branch, as Canadian Administrative
Agent, and schedules thereto;
10.14* Amendment No. 1, dated as of November 19, 2004, to the Credit
Agreement, dated as of September 22, 2004, among JPMorgan Chase
Bank, The Toronto-Dominion Bank, Bank of Montreal, Bank of Nova
Scotia and Canadian Imperial Bank of Commerce as lenders, and
with MDC Partners Inc., Maxxcom Inc., an Ontario corporation,
and Maxxcom Inc., a Delaware corporation, as borrowers.
10.15 Employment Agreement - between MDC Partners Inc. and Steven
Berns dated August 25, 2004;
21 Subsidiaries of Registrant ;
31 Certifications Pursuant to Rules 13a-14(a)/15d-14(a) under the
Securities Exchange Act of 1934 and Section 302 of the
Sarbanes-Oxley Act of 2002;
32 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed as Exhibit 10.1 to Form 8-K filed November 24, 2004.
(b) The Company filed the following Current Reports on Form 8-K during the
quarter ended September 30, 2004:
On August 27, 2004, the Company filed a Current Report on Form 8-K announcing
that it had agreed to material terms of an employment agreement that it will
enter into with Steven Berns who will serve as Vice Chairman and Executive
Vice President of the Company.
On September 27, 2004, the Company filed a Current Report on Form 8-K
announcing that it had entered into a material revolving credit agreement on
September 22, 2004 and that it had refinanced certain existing debt
instruments using the proceeds of the new facility.
On November 8, 2004, the Company filed a Current Report on Form 8-K to which
is attached Exhibit 99.1,which is a copy of the Company's earnings release
related to the period ended September 30, 2004, and Exhibit 99.2, which is the
investor presentation materials provided during the Company's earnings call
which discussed the earnings release related to the period ended September 30,
2004.
On November 15, 2004, the Company filed a Current Report on Form 8-K
announcing the Company had filed a Notification of Late Filing on Form 12b-25
stating that its Quarterly Report on Form 10-Q for the period ended September
30, 2004 could not be timely filed due to circumstances described therein.
Attached is Exhibit 99.1, a presentation outlining accounting issues currently
being reviewed by management and KPMG LLP, the Company's outside accountant.
73
On November 24, 2004, the Company filed a Current Report on Form 8-K
announcing (a) that the Company had amended its Credit Agreement, dated
September 22, 2004, (b) that the Company had received a Staff Determination
notice from The Nasdaq Stock Market Listing Qualifications Department, and (c)
attaching Exhibit 10.1, the amendment to the Credit Agreement, and Exhibit
99.1, the Company press release, dated November 22, 2004, announcing the
actions taken by Nasdaq.
On December 1, 2004, the Company filed a Current Report on Form 8-K to which
is attached Exhibit 99.1,which is a copy of the Company's press released dated
November 30, 2004, announcing, among other things, that it currently expects
to file its Quarterly Report on Form 10-Q for the period ended September 30,
2004 by December 6, 2004.
On December 7, 2004, the Company filed a Current Report on Form 8-K to which
is attached Exhibit 99.1,which is a copy of the Company's press released dated
December 7, 2004, announcing, among other things, the delivery by the Company
of financial statements to its outside accountants
74
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MDC PARTNERS INC.
/s/ Walter Campbell
_______________________
Walter Campbell
Chief Financial Officer
December 20, 2004
75
EXHIBIT INDEX
Exhibit No. Description
10.13 Credit Agreement made September 22, 2004 between MDC Partners
Inc., a Canadian corporation, Maxxcom Inc., an Ontario
corporation, and Maxxcom Inc., a Delaware corporation, as
borrowers, the Lenders (as defined therein) and JPMorgan Chase
Bank, as U.S. Administrative Agent and Collateral Agent, and
JPMorgan Chase Bank, Toronto Branch, as Canadian Administrative
Agent, and schedules thereto;
10.14* Amendment No. 1, dated as of November 19, 2004, to the Credit
Agreement, dated as of September 22, 2004, among JPMorgan Chase
Bank, The Toronto-Dominion Bank, Bank of Montreal, Bank of Nova
Scotia and Canadian Imperial Bank of Commerce as lenders, and
with MDC Partners Inc., Maxxcom Inc., an Ontario corporation,
and Maxxcom Inc., a Delaware corporation, as borrowers.
10.15 Employment Agreement - between MDC Partners Inc. and Steven
Berns dated August 25, 2004;
21 Subsidiaries of Registrant;
31 Certifications Pursuant to Rules 13a-14(a)/15d-14(a) under the
Securities Exchange Act of 1934 and Section 302 of the
Sarbanes-Oxley Act of 2002;
32 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed as Exhibit 10.1 to Form 8-K filed November 24, 2004
76