================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
Form 10-Q/A
(Amendment No. 1)
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 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 Identification No.)
incorporation or organization)
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 May 10, 2004 were: 22,574,366 Class
A shares and 2,502 Class B shares.
Website Access to Company Reports
MDC Partners Inc.'s internet website address is www.mdc-partners.com. The
Company's annual reports on Form 40F, 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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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 Ended March 31, 2004 and March 31, 2003......... 4
Condensed Consolidated Balance Sheets as of
March 31, 2004 (unaudited) and December 31, 2003............. 5
Condensed Consolidated Statements of Cash Flows (unaudited)
Three Months Ended March 31, 2004 and March 31, 2003 ........ 6
Notes to Condensed Consolidated Financial Statements
(unaudited).................................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations.................................... 41
Item 3. Quantitative and Qualitative Disclosures about Market Risk...... 54
Item 4. Controls and Procedures......................................... 54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 56
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities ................................. 56
Item 6. Exhibits and Reports on Form 8-K ............................... 57
Signatures................................................................ 59
EXPLANATORY NOTE
This Form 10-Q/A for the quarter ended March 31, 2004 is being filed to restate
our interim unaudited condensed consolidated financial statements 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) the recognition
of fair value adjustments related to an embedded derivative in the Company's
exchangeable debentures, (4) 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 (5) correction for the timing of recognition
and the classification of certain foreign exchange gains and losses on
intercompany balances, (6) corrections to revenue recognition related to certain
Secure Products contracts, (7) corrections to the accounting for certain
investments, (8) corrections to the purchase price allocations for certain
business acquisitions and the related amortization of identified intangible
assets, (9) corrections in the timing of the recognition of stock-based
compensation, and (10) 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
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.
In addition, the Company has restated and reflected corresponding corrections to
the Management Discussion and Analysis in Part I, Item 2. In addition, the
Company revised Item 4 to include information about the impact of the
restatements on its internal controls. This Form 10-Q/A does not reflect events
occurring after the original filing date of the Form 10-Q.
2
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(thousands of United States dollars, except per share amounts)
Three Months Ended March 31,
-------------------------------
2004 2003
-------------- -------------
(Restated - (Restated -
See Note 2) See Note 2)
Revenue:
Services $51,958 $37,782
Products 18,037 43,314
-------------- -------------
69,995 81,096
-------------- -------------
Operating Expenses:
Cost of products sold 11,175 18,507
Salary and related costs * 36,271 26,597
General and other operating costs 25,714 27,280
Depreciation and amortization 2,545 2,710
-------------- -------------
75,705 75,094
-------------- -------------
Operating Profit (Loss) (5,710) 6,002
-------------- -------------
Other Income (Expenses):
Gain on sale of assets and settlement
of long-term debt (Note 10) 16,311 -
Foreign exchange gain (loss) 170 (655)
Interest expense (2,774) (4,877)
Interest income 421 93
-------------- -------------
14,128 (5,439)
-------------- -------------
Income Before Income Taxes, Equity in Affiliates and Minority
Interests 8,418 563
Income Taxes (Recovery) 197 (26)
-------------- -------------
Income Before Equity in Affiliates and Minority Interests 8,221 589
Equity in Affiliates 1,541 562
Minority Interests in Income of Consolidated Subsidiaries (1,297) (939)
-------------- -------------
Net Income $8,465 $212
============== =============
Earnings Per Common Share:
Basic - Net Income $0.45 $0.01
Diluted - Net Income 0.41 0.01
Weighted Average Number of Common Shares:
Basic 18,918,608 16,915,341
Diluted 22,469,320 16,951,759
* Includes stock-based compensation of $6,059 and nil, respectively in 2004 and
2003.
The accompanying notes to the unaudited condensed consolidated
financial statements are an integral part of these statements.
3
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands of United States dollars)
March 31, December 31,
2004 2003
---------------- --------------
(Unaudited)
(Restated - See (Restated - See
Note 2) Note 2)
ASSETS
Current Assets:
Cash and cash equivalents $58,609 $65,929
Accounts receivable, less allowance for doubtful accounts
of $774 and $529 95,100 58,864
Expenditures billable to clients 7,803 7,153
Inventories (Note 7) 8,447 7,735
Prepaid expenses and other current assets 6,808 4,863
---------------- --------------
Total Current Assets 176,767 144,544
Fixed Assets, at cost, less accumulated depreciation
and amortization of $54,199 and $51,596 43,316 38,775
Investment in Affiliates 22,383 34,362
Goodwill 121,592 83,199
Intangibles, less accumulated amortization of $240 3,860 -
Deferred Tax Asset 10,578 11,563
Other Assets 8,162 9,096
---------------- --------------
Total Assets $386,658 $321,539
================ ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $68,606 $38,451
Accruals and other liabilities 62,028 34,245
Advance billings 28,743 15,731
Current portion of long-term debt (Note 8) 31,446 16,378
Deferred acquisition consideration 1,113 1,113
---------------- --------------
Total Current Liabilities 191,936 105,918
Long-Term Debt (Note 8) 48,665 95,970
Convertible Notes (Note 11) 36,605 37,794
Other Liabilities 483 516
---------------- --------------
Total Liabilities 277,689 240,198
---------------- --------------
Minority Interest 1,095 2,432
---------------- --------------
Commitments and Contingencies (Note 13)
Subsequent event (Note 11)
Shareholders' Equity:
Share capital (Note 12) 131,520 115,996
Share capital to be issued 3,909 -
Additional paid-in capital 6,796 4,610
Retained earnings (deficit) (30,704) (39,169)
Accumulated other comprehensive income (loss) (3,647) (2,528)
---------------- --------------
Total Shareholders' Equity 107,874 78,909
---------------- --------------
Total Liabilities and Shareholders' Equity $386,658 $321,539
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 STATEMENTS OF CASH FLOWS (unaudited)
(thousands of United States dollars)
Three Months Ended March 31,
-----------------------------
2004 2003
------------- -------------
(Restated - (Restated -
See Note 2) See Note 2)
Cash flows from operating activities:
Net income $8,465 $212
Adjustments for non-cash items:
Stock-based compensation 6,059 -
Depreciation and amortization 2,545 2,710
Amortization and write-off of deferred finance charges 536 619
Non-cash interest expense - 954
Deferred income taxes 909 165
Foreign exchange (170) 655
Gain on sale of assets and settlement of long-term debt (Note 10) (16,311) -
Earnings of affiliates, net of distributions 616 (1,155)
Minority interest and other (75) (151)
Changes in non-cash working capital (4,141) (3,524)
------------- -------------
Net cash provided by (used in) operating activities (1,567) 485
------------- -------------
Cash flows from investing activities:
Capital expenditures (3,091) (2,288)
Acquisitions, net of cash acquired 3 (1,115)
Other assets, net 117 (148)
------------- -------------
Net cash used in investing activities (2,971) (3,551)
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of long-term debt - 159
Repayment of long-term debt (2,162) (1,863)
Issuance of share capital 2,041 -
Purchase of share capital (1,468) -
------------- -------------
Net cash used in financing activities (1,589) (1,704)
------------- -------------
Effect of exchange rate changes on cash and cash equivalents (1,193) 717
------------- -------------
Net decrease in cash and cash equivalents (7,320) (4,053)
Cash and cash equivalents at beginning of period 65,929 31,226
------------- -------------
Cash and cash equivalents at end of period $58,609 $27,173
============= =============
Supplemental disclosures:
Income taxes paid $160 $449
Interest paid $1,766 $612
Non-cash consideration:
Share capital issued, or to be issued, on acquisitions (Note 9) $18,860 -
Stock-based awards issued, on acquisitions (Note 9) $1,827 -
Settlement of debt with investment in affiliate
Exchangeable securities (Note 10) $(33,991) -
Proceeds on sale of investment (Note 10) $33,991 -
The accompanying notes to the unaudited condensed consolidated
financial statements are an integral part of these statements.
5
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") in 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.
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 ended March 31,
2004 and 2003 is set out in Note 14.
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 for the three and six
months ended June 30, 2003 and 2004 and for the three and nine months
ended September 30, 2003 contained misapplication of Canadian and US
GAAP and those financial statements required restatement.
6
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) the recognition of fair value adjustments related
to an embedded derivative in the Company's exchangeable debentures,
(4) 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, (5) correction for the timing of
recognition and the classification of certain foreign exchange gains
and losses on intercompany balances, (6) corrections to revenue
recognition related to certain Secure Products contracts, (7)
corrections to the accounting for certain investments, (8) corrections
to the purchase price allocations for certain business acquisitions
and the related amortization of identified intangible assets, (9)
corrections in the timing of the recognition of stock-based
compensation, and (10) corrections to the computation of the dilutive
effect of convertible debentures on diluted earnings per share.
The impact of the adjustments noted above is reflected in the beginning
balance sheet as of January 1, 2004. The adjustments relating to the
first quarter of 2003 have been reflected in the financial statements
included herein for that period.
The Company has restated its consolidated financial statements 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 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. Reliance
should be placed solely on the financial statements in the Form 40-F/A
and in this Form 10-Q/A and not on the previously filed Form 40-F dated
May 10, 2004, previously filed Form 10-Q for the three months ended
March 31, 2004 and 2003 dated May 10, 2004 or any other previously
reported financial statements for the periods identified above.
The interim unaudited condensed consolidated financial statements for
the three months ended March 31, 2004 and 2003 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 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. This correction increased salary and
related costs, thus reducing operating profit and net income
by $103 for the three months ended March 31, 2004;
(2) The reclassification of the amortization of deferred
financing fees to interest expense and a correction of the
period in which the amortization and write-off of deferred
financing fees was recorded. Previously, the amortization of
certain deferred financing fees were classified as
depreciation and 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 fees included in the loss
on settlement of debt. Certain deferred financing fees were
written off in the quarter ended December 31, 2003 in
anticipation of the refinancing of debt rather than in the
quarters ended March 31, 2004 and September 30, 2004 when the
debt was reported. These corrections decreased the gain on
sale of assets by $466, increased interest expense by $536,
and decreased net income by $1,002 as at and for the three
months ended March 31, 2004. These corrections decreased
depreciation and amortization, and increased interest
expense, by $619, resulting in no change to net income for
the three months ended March 31, 2003;
7
(3) The recognition of the fair value adjustment related to
an embedded derivative in the Company's exchangeable
debentures, as required under SFAS 133, as amended by SFAS
138, "Accounting for Derivative Instruments and Hedging
Activities", that was not previously recognized, and to
separately account for the loss on the exchangeable
debentures that was previously netted within the gain on sale
of assets delivered on the settlement of the debentures. The
loss associated with the change in fair value of the embedded
derivative of $3,974 from December 1, 2003, the date of
issuance to December 31, 2003, was not previously recognized
in 2003. When the exchangeable debentures were settled in
February 2004, the cumulative loss from the date of issuance
of $7,647 was netted against the gain on the sale of
investment in Custom Direct Inc. ("CDI"), for which the
debentures were exchangeable. The change in fair value of the
embedded derivative has been recognized in the applicable
period as a correction of an error in the restatement of
fiscal 2003. As a result of the correction of this error, for
the three months ended March 31, 2004, the fair value
adjustment on the embedded derivative increased by $3,974,
the loss on settlement of the debentures increased by $7,647
and the gain on the sale of assets increased by $7,647 and
net income increased by $3,974. There was no impact on
earnings for the quarter ended March 31, 2003;
(4) To correct for errors in the calculation of the gain on
the disposal of the Company's 80% interest in CDI in June
2003, and the corresponding adjustment to the gain on the
sale of the remaining 20% interest in CDI in February 2004
relating primarily to the allocation of the cost base of the
CDI assets between the two gain amounts. Associated with this
transaction, income tax expense was corrected due to income
tax benefits having been calculated incorrectly. For the
three months ended March 31, 2004, these errors increased the
gain on sale of the assets by $5,638, decreased income tax
expense by $1,361 and increased net income by $6,999;
(5) 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 $170 and a
foreign exchange loss of $655, for the three months ended
March 31, 2004, and 2003, respectively, correspondingly
affecting net income by the same amounts;
(6) 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 the multiple
elements 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 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. This correction reduced product
revenue by $810, reduced costs of sales by $392, reduced
operating profit by $418, reduced income taxes expense by
$137 and reduced net income by $281 for the three months
ended March 31, 2004. Similarly, for the three months ended
March 31, 2003, on adoption of this standard, these
corrections reduced product revenue by $211, reduced costs of
sales by $222, improved operating profit by $11, increased
income tax expense by $31 and reduced net income by $20. In
addition inventory and deferred revenue increased by $596 and
$ 3,228 as at March 31, 2004;
8
(7) 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; (b) 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, and; (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, has been restated
and accounted for under the equity method as management has
determined significant influence existed. Due to the nature
of these adjustments, the corrections impacted most line
items on the statement of operations and balance sheets.
However, other than item (c) above, these corrections had no
impact on net income (loss). For the period, the impact of
these changes was to decrease operating profit (loss) for the
three months ended March 31, 2004 and 2003 by $235 and $247,
respectively;
(8) The correction related to the allocation to identifiable
amortizable intangibles acquired in business combinations that
resulted in a reallocation of $4,100 as at March 31, 2004 from
goodwill to other identifiable amortizable intangible assets.
This change increased depreciation and amortization and
reduced net income by $240 for the three months ended March
31, 2004;
(9) 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
$34 and nil for the three months ended March 31, 2004 and
2003, respectively. Net income was reduced by the same amounts
in the corresponding periods; and
(10) The correction to the computation of the dilutive effect
of convertible debentures, in calculating diluted earnings per
share figures.
9
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 effect of this restatement
was to increase the accumulated deficit by $14,021 as of
January 1, 2004. The following tables present the effect of
these restatements and these changes in classification for the
three months ended March 31, 2004 and 2003, and as at March
31, 2004:
For the Three Months Ended March 31, 2004
-----------------------------------------
As Reported Adjustments As Restated
------------- ------------ ------------
Revenue:
Services $56,266 ($4,308) $51,958
Products 18,847 (810) 18,037
------------- ------------ ------------
75,113 (5,118) 69,995
------------- ------------ ------------
Operating Expenses:
Cost of products sold 11,567 (392) 11,175
Salary and related costs 36,768 (497) 36,271
General and other operating costs 29,115 (3,401) 25,714
Depreciation and amortization 2,343 202 2,545
------------- ------------ ------------
79,793 (4,088) 75,705
------------- ------------ ------------
Operating Profit (Loss) (4,680) (1,030) (5,710)
------------- ------------ ------------
Other Income (Expenses):
Gain (loss) on sale of assets and settlement of long-term debt 7,165 9,146 16,311
Foreign exchange gain - 170 170
Interest expense (2,313) (461) (2,774)
Interest income 420 1 421
------------- ------------ ------------
5,272 8,856 14,128
------------- ------------ ------------
Income Before Income Taxes, Equity in Affiliates and Minority 592 7,826 8,418
Interests
Income Taxes (Recovery) 1,753 (1,556) 197
------------- ------------ ------------
Income (Loss) Before Equity in Affiliates and Minority Interests (1,161) 9,382 8,221
Equity in Affiliates 1,446 95 1,541
Minority Interests (1,303) 6 (1,297)
------------- ------------ ------------
Net Income (Loss) ($1,018) $9,483 $8,465
============= ============ ============
Earnings (Loss) Per Common Share:
Basic ($0.05) $0.45
Diluted (0.05) 0.41
Weighted Average Number of Common Shares:
Basic 18,918,608 18,918,608
Diluted 18,918,608 22,469,320
10
For the Three Months Ended March 31, 2003
----------------------------------------------
As Reported Adjustments As Restated
------------ ----------- ------------
Revenue:
Services $39,689 ($1,907) $37,782
Products 43,525 (211) 43,314
------------ ----------- ------------
83,214 (2,118) 81,096
------------ ----------- ------------
Operating Expenses:
Cost of products sold 18,729 (222) 18,507
Salary and related costs 27,139 (542) 26,597
General and other operating costs 28,362 (1,082) 27,280
Depreciation and amortization 3,365 (655) 2,710
------------ ----------- ------------
77,595 (2,501) 75,094
------------ ----------- ------------
Operating Profit 5,619 383 6,002
------------ ----------- ------------
Other Income (Expenses):
Foreign exchange gain (loss) - (655) (655)
Interest expense (4,326) (551) (4,877)
Interest income 93 - 93
------------ ----------- ------------
(4,233) (1,206) (5,439)
------------ ----------- ------------
Income Before Income Taxes, Equity in Affiliates
and Minority Interests 1,386 (823) 563
Income Taxes (Recovery) (21) (5) (26)
------------ ----------- ------------
Income Before Equity in Affiliates and Minority Interests 1,407 (818) (589)
Equity in Affiliates 498 64 562
Minority Interests (1,018) 79 (939)
------------ ----------- ------------
Net Income $887 ($675) $212
============ =========== ============
Earnings Per Common Share:
Basic - Net Income $0.05 $0.01
Diluted - Net Income 0.05 0.01
Weighted Average Number of Common Shares:
Basic 16,915,341 16,915,341
Diluted 26,403,555 16,951,759
11
At March 31, 2004
-----------------------------------------------
As Reported Adjustments As Restated
------------- ------------- --------------
ASSETS
Current Assets:
Cash and cash equivalents $59,158 ($549) $58,609
Accounts receivable, net 96,958 (1,858) 95,100
Expenditures billable to clients 8,294 (491) 7,803
Inventories 7,851 596 8,447
Prepaid expenses and other current assets 6,844 (36) 6,808
------------- ------------- --------------
Total Current Assets 179,105 (2,338) 176,767
Fixed Assets, net 46,543 (3,227) 43,316
Investment in Affiliates 19,579 2,804 22,383
Goodwill 129,917 (8,325) 121,592
Intangibles, less accumulated amortization - 3,860 3,860
Deferred Tax Asset 10,097 481 10,578
Other Assets 5,615 2,547 8,162
------------- ------------- --------------
Total Assets $390,856 ($4,198) $386,658
============= ============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable and other liabilities $132,162 ($1,528) $130,634
Advance billings 26,869 1,874 28,743
Current portion of long-term debt 31,554 (108) 31,446
Deferred acquisition consideration 1,113 - 1,113
------------- ------------- --------------
Total Current Liabilities 191,698 238 191,936
Long-Term Debt 52,543 (3,878) 48,665
Convertible Notes 36,605 - 36,605
Other Liabilities 483 - 483
------------- ------------- --------------
Total Liabilities 281,329 (3,640) 277,689
------------- ------------- --------------
Minority Interests 1,195 (100) 1,095
------------- ------------- --------------
Shareholders' Equity:
Share capital 131,520 - 131,520
Share capital to be issued 3,909 - 3,909
Additional paid-in capital 5,321 1,475 6,796
Retained earnings (deficit) (26,166) (4,538) (30,704)
Accumulated other comprehensive income (loss) (6,252) 2,605 (3,647)
------------- ------------- --------------
Total Shareholders' Equity 108,332 (458) 107,874
------------- ------------- --------------
Total Liabilities and Shareholders' Equity $390,856 ($4,198) $386,658
============= ============= ==============
12
For the Three Months Ended March 31, 2004
---------------------------------------------
As Reported Adjustments As Restated
------------- -------------- ------------
Cash flows from operating activities:
Net income (loss) ($1,018) $9,483 $8,465
Adjustments for non-cash items:
Stock-based compensation 5,922 137 6,059
Depreciation and amortization 2,343 202 2,545
Deferred finance charges - 2,458 2,458
Deferred income taxes 2,407 (1,498) 909
Foreign exchange - (170) (170)
Gain on sale of assets (7,165) (11,068) (18,233)
Earnings of affiliates, net of distributions 581 35 616
Minority interest and other (75) - (75)
Changes in non-cash working capital (4,732) 591 (4,141)
------------- -------------- ------------
Net cash provided by (used in) operating activities (1,737) 170 (1,567)
------------- -------------- ------------
Cash flows from investing activities:
Capital expenditures (3,141) 50 (3,091)
Acquisitions, net of cash 3 - 3
Other assets, net 115 2 117
------------- -------------- ------------
Net cash provided by (used in) investing activities (3,023) 52 (2,971)
------------- -------------- ------------
Cash flows from financing activities:
Repayment of long-term debt (2,188) 26 (2,162)
Issuance of share capital 2,041 - 2,041
Purchase of share capital (1,468) - (1,468)
------------- -------------- ------------
Net cash used in financing activities (1,615) 26 (1,589)
------------- -------------- ------------
Effect of exchange rate changes on cash and cash equivalents (1,193) - (1,193)
------------- -------------- ------------
Net decrease in cash and cash equivalents (7,568) 248 (7,320)
Cash and cash equivalents at beginning of period 66,726 (797) 65,929
------------- -------------- ------------
Cash and cash equivalents at end of period $59,158 (549) $58,609
============= ============== ============
Supplemental disclosures:
Income taxes paid $160 - $160
Interest paid $1,766 - $1,766
Non-cash consideration:
Share capital issued, or to be issued, on acquisitions $18,860 - $18,860
Stock-based awards issued, on acquisitions $1,827 - $1,827
Settlement of debt with investment in affiliate:
Reduction in exchangeable securities ($26,344) (7,647) ($33,991)
Proceeds on sale of investment $26,344 (7,647) $33,991
13
For the Three Months Ended March 31, 2003
---------------------------------------------
As Reported Adjustments As Restated
------------- -------------- ------------
Cash flows from operating activities:
Net income $887 ($675) $212
Adjustments for non-cash items:
Depreciation and amortization 3,365 (655) 2,710
Deferred finance charges - 619 619
Non-cash interest expense 954 - 954
Deferred income taxes 134 31 165
Foreign exchange - 655 655
Earnings of affiliates, net of distributions (1,094) (61) (1,155)
Minority interest and other (151) - (151)
Changes in non-cash working capital (4,128) 604 (3,524)
------------- -------------- ------------
Net cash provided by (used in) operating activities (33) 518 485
------------- -------------- ------------
Cash flows from investing activities:
Capital expenditures (2,267) (21) (2,288)
Acquisitions, net of cash (1,115) - (1,115)
Other assets, net (179) 31 (148)
------------- -------------- ------------
Net cash provided by (used in) investing activities (3,561) 10 (3,551)
------------- -------------- ------------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 159 - 159
Repayment of long-term debt (1,884) 21 (1,863)
------------- -------------- ------------
Net cash used in financing activities (1,725) 21 (1,704)
------------- -------------- ------------
Effect of exchange rate changes on cash and cash equivalents 717 - 717
------------- -------------- ------------
Net decrease in cash and cash equivalents (4,602) 549 (4,053)
Cash and cash equivalents at beginning of period 32,250 (1,024) 31,226
------------- -------------- ------------
Cash and cash equivalents at end of period $27,648 (475) $27,173
============= ============== ============
Supplemental disclosures:
Income taxes paid $449 $449
Interest paid $612 $612
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.
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.
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
March 31, 2004 is $1,215 of cash restricted as to withdrawal pursuant
to a collateral agreement.
14
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 terms of the related lease
or the estimated useful life of these assets.
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 are Accumark
Promotions Group Inc, 55% owned by the Company, Crispin Porter +
Bogusky, LLC, 49.9% owned by the Company, Cliff Freeman & Partners,
LLC, 19.9% owned by the Company and a 50% undivided interest in a real
estate joint venture. The Company's management periodically evaluates
these investments to determine if there have been any, other than
temporary, declines in value.
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.
15
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.
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.
16
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 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's premises. 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.
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 No. 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.
17
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. The
Company adopted the provisions of EITF 00-21 effective January 1, 2003.
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 to not
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
vesting period of the award. 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 profit (loss) 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 service period in operating
profit (loss). The final payment amount for Share Appreciation Rights
is established on the date of the exercise of the award by the
employee.
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
option pricing model, and is recorded into operating income over the
service period, that is 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 in fiscal 1995.
18
The table below summarizes the quarterly pro forma effect for the three
months ended March 31, 2004 and 2003 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 March 31,
2004 2003
-------------- --------------
(Restated - See Note 2)
Net income (loss), as reported $8,465 $212
Fair value costs, net of income tax, of stock-based employee
compensation for options issued prior to 2003 376 512
-------------- --------------
Net income (loss), pro forma $8,089 ($300)
============== ==============
Basic net income per share, as reported $0.45 $0.01
Basic net income (loss) per share, pro forma $0.43 ($0.02)
Diluted net income per share, as reported $0.40 $0.01
Diluted net income (loss) per share, pro forma $0.39 ($0.02)
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 March 31,
2004
------------------
Expected dividend 0.00%
Expected volatility 40%
Risk-free interest rate 5.00%
Expected option life in years 5
Weighted average stock option fair value per option granted $5.16
There were no stock options granted during the three months ended March
31, 2003.
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 and warrants. For
purposes of computing diluted earnings per share for the three months
ended March 31, 2004 and 2003, respectively, 3,550,712 and 36,418
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 $637 and $0 for the three months ended March 31, 2004
and 2003, respectively.
19
The following table details the weighted average number of common
shares outstanding for each of the three months ended March 31, 2004
and 2003:
Three Months Ended March 31,
-------------------------------------
2004 2003
----------------- ----------------
(Restated - See Note 2)
Basic weighted average shares outstanding 18,918,608 16,915,341
Weighted average shares dilution adjustments:
Dilutive stock options and warrants (a) 1,173,297 36,418
7% convertible senior notes due January 8, 2007 2,377,415 -
----------------- ----------------
Diluted weighted average shares outstanding (b) 22,469,320 16,951,759
================= ================
(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 March 31, 2004 and 2003, the average share
price used was $14.20 per share and $3.69 per share,
respectively.
(b) Had certain stock options, similar awards and the convertible
debt been dilutive, they would have added nil dilutive shares
and 9,652,510 dilutive shares for the three months ended March
31, 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-U.S.
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-U.S.
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.
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.
20
4. Comprehensive Income (Loss)
Total comprehensive income and its components were:
Three Months Ended March 31
--------------------------------
2004 2003
-------------- --------------
(Restated - See Note 2)
Net income (loss) for the period $8,465 $212
Foreign currency cumulative translation adjustment (1,119) (6,580)
-------------- --------------
Comprehensive income (loss) for the period $7,346 ($6,368)
============== ==============
5. New Accounting Pronouncements
The following 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. The application of these Interpretations did not
have a material effect on the interim unaudited condensed consolidated
financial statements as of March 31, 2004.
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 ("ETIF 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. The provisions of
this consensus do not have a material impact on the Company's interim
unaudited condensed consolidated financial statements.
21
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
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, 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 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, and Crispin Porter + Bogusky, LLC, ("CPB"), owned
49% by the Company and Cliff Freeman + Partners, LLC owned 19.9% by the
Company, are equity accounted for under US GAAP. For purposes of the
segmented information disclosure, 100% of the results of operations of
CPB and Accumark 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 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 March 31 is shown in the following
table:
Three Months Ended March 31, 2004, (Restated see Note 2):
Combined As Reported under US GAAP
----------------- --------------------------------------------------------------
Combined Less Secure
Marketing Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
----------------- ------------- ----------------- --------------- ------------- ----------
Revenue $64,432 $12,474 $51,958 $18,037 $- $69,995
----------------- ------------- ----------------- --------------- ------------- ----------
Operating Expenses:
Cost of products sold - - - 11,175 - 11,175
Salary and related costs* 30,072 4,673 25,399 3,476 7,396 36,271
General and other
operating costs 24,754 2,824 21,930 2,401 1,383 25,714
Depreciation and
amortization 2,034 190 1,844 675 26 2,545
----------------- ------------- ----------------- --------------- ------------- ----------
56,860 7,687 49,173 17,727 8,805 75,705
----------------- ------------- ----------------- --------------- ------------- ----------
Operating Profit (Loss) $7,572 $4,787 $2,785 $310 ($8,805) (5,710)
================= ============= ================= =============== ============= ===========
Other Income (Expense):
Gain on sale of assets 16,311
Foreign exchange gain 170
Interest expense, net 2,353
Income Before Income Taxes, Equity in Affiliates and Minority Interests 8,418
Income Taxes 197
Income Before Equity in Affiliates and Minority Interests 8,221
Equity in affiliates 1,541
Minority interests (1,297)
Net Income (Loss) $8,465
Capital expenditures $2,012 $228 $1,784 $1,273 $34 $3,091
*Includes stock-based
compensation $57 $ - $57 $ - $6,002 $6,059
23
Three Months Ended March 31, 2003 (Restated - See Note 2):
Combined As Reported under US GAAP
--------------- --------------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
--------------- ------------- -------------- ------------- ----------- ------------
Revenue $44,992 $7,210 $37,782 $43,314 $ - $81,096
--------------- ------------- -------------- ------------- ----------- ------------
Operating Expenses:
Cost of products sold - - - 18,507 - 18,507
Salary and related
Costs 22,881 3,418 19,463 6,083 1,051 26,597
General and other
operating costs 16,617 1,951 14,666 12,050 564 27,280
Depreciation and
amortization 1,504 92 1,412 1,174 124 2,710
--------------- ------------- -------------- ------------- ----------- ------------
41,002 5,461 35,541 37,814 1,739 75,094
--------------- ------------- -------------- ------------- ----------- ------------
Operating Profit (Loss) $3,990 $1,749 $2,241 $5,500 ($1,739) 6,002
=============== ============= ============== ============= ===========
Other Income (Expense):
Foreign exchange gain (loss) (655)
Interest expense, net (4,784)
-----------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 563
Income Taxes (26)
-----------
Income Before Equity in Affiliates and Minority Interests 589
Equity in affiliates 562
Minority interests (939)
-----------
Net Income $212
===========
Capital expenditures $1,243 $497 $746 $1,539 $3 $2,288
A summary of our revenue and long-lived assets by geographic area as of
March 31, 2004 and 2003 is set forth in the following table (Restated -
See Note 2):
United States Canada Other Total
----------------- --------------- ------------ ------------
Revenue
Three Months Ended March 31,
2004 $44,225 $19,530 $6,240 $69,995
2003 58,249 18,110 4,737 81,096
24
7. Inventory
The components of inventory are listed below:
March 31, December 31,
2004 2003
-------------------------------
(Restated - See Note 2)
Raw materials and supplies $3,809 $3,743
Work-in-process 4,638 3,992
----------- ------------
Total $8,447 $7,735
=========== ============
8. Long-Term Debt
MDC Partners Inc. is principally a holding company and the Company's
assets consist principally of its investments in Maxxcom Inc.
("Maxxcom"), which in turn owns a substantial portion of its interests
in the Marketing Communications businesses, and in the Secured Products
International (SPI) businesses.
Currently, substantially all of the long-term debt is held at Maxxcom
or its subsidiaries. Maxxcom's ability to meet the repayment of its
long-term debt and to make distributions to MDC Partners Inc., is
dependent upon the availability of cash from its parent MDC Partners
Inc. and from the cash flows from its subsidiaries and affiliated
companies through dividends, distributions, intercompany advances,
management fees and other payments. A number of Maxxcom's subsidiaries
are not wholly-owned and pursuant to operating agreements with some of
the other shareholders of these subsidiaries and affiliates and certain
subsidiary and affiliate lending agreements, there are certain
restrictions on the payment of dividends, distributions and advances to
Maxxcom. In addition, pursuant to certain lending agreements entered
into by MDC Partners Inc., there are restrictions on MDC's ability to
transfer available cash to Maxxcom.
As at March 31, 2004, $8,913 (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 Maxxcom for use to reduce Maxxcom
indebtedness.
At March 31, 2004, the Company had secured committed revolving credit
lines of $39,031 (December 31, 2003 - $39,414), which were partially
drawn to $32,505 (December 31, 2003 - $30,718) and are reflected as
current portion of long-term debt and long-term debt. These secured
loans were comprised of local borrowings of the Company's U.S. and
Canadian subsidiaries.
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 10.
25
9. Acquisitions
Kirshenbaum Bond + Partners
On January 29, 2004, the Company acquired a 60% ownership interest in
kirshenbaum bond + partners, LLC ("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 $20,654 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, 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 on or about the
announcement date) and incurred transaction costs of approximately
$1,019. 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. 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 $24,655. The
purchase price was allocated to the fair value of net assets acquired
as follows:
Cash and cash equivalents $25,283
Accounts receivable and other current assets 18,540
Furniture, equipment and leasehold improvements 3,872
Intangible assets 1,200
Goodwill 25,632
Accounts payable and accrued expenses (49,440)
Minority interest (432)
-----------
Total purchase price $24,655
===========
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 assumptions and estimates. The Company's
consolidated financial statements include KBP's results of operations
subsequent to its acquisition on January 29, 2004. During this period,
the operations of KBP contributed $7,397 of revenue and $523 of net
income.
26
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 $63. 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, 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 this purchase price $12,147 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 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
immaterial investments. In aggregate, as part of these acquisitions,
the Company paid $3,076 in cash and incurred transaction costs of
approximately $397. 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 $3,473. The purchase price was allocated based on the
fair value of the net assets acquired of this purchase price, $2,128
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 this period, the aggregated operations of
these acquisitions did not have a material effect on the Company's
results of operations.
27
The following unaudited pro forma results of operations of the Company
for the three months ended March 31, 2004 and 2003 assume that the
acquisition of the operating assets of KBP, CF and the further interest
in Accent 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 March 31,
----------------------------------
2004 2003
------------- --------------
(Restated - See Note 2)
Revenues $73,590 $91,020
Net income 8,707 1,280
Earnings per share:
Basic - net income $0.46 $0.08
Diluted - net income 0.42 0.06
10. Gain on Sale of Assets and Settlement of Long-term Debt
Three Months Ended March 30,
--------------------------------
2004 2003
--------------- --------------
(Restated - See (Restated - See
Note 2) Note 2)
Loss on settlement of exchangeable debentures $(9,569) $ -
Fair value adjustment on embedded derivative 3,974 $ -
Gain on sale of interests in Custom Direct Inc. 21,906 $ -
--------------- --------------
$16,311 $ -
=============== ==============
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 debentures 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 three months ended March
31, 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 gain on the sale of the
CDI equity investment of $21,906.
28
11. Subsequent Event
Pursuant to the trust indenture, as amended, governing the Company's 7%
subordinated unsecured convertible debentures due January 8, 2007 (the
"Debentures"), the Company announced on April 5, 2004 that it would
redeem the Debentures on May 5, 2004 (the "Redemption Date"), at a
redemption price equal to the aggregate principal amount, and accrued
and unpaid interest. MDC has elected to satisfy its obligation to pay
the aggregate principal amount of the Debentures payable on redemption
by the issuance of Class A Subordinate Voting Shares of the Company.
Approximately $36.6 million aggregate principal amount of Debentures is
outstanding.
The number of Class A Subordinate Voting Shares issuable to holders of
Debentures on redemption will be approximately 2.58 million Class A
Subordinate Voting Shares. The Company is not required to issue any
fractional Class A Subordinate Voting Shares. Accrued interest on the
Debentures up to the Redemption Date will be paid in cash. No interest
will continue to be payable on the Debentures from and after the
Redemption Date.
12. Share Capital
Changes to the Company's issued and outstanding share capital during
the three months ended March 31, 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 (105,000) (1,468)
Share options exercised 69,807 632
Shares issued - private placement 120,919 1,409
Shares issued - acquisitions (Note 9) 985,194 14,951
Shares issued upon conversion of Class B shares 447,968 134
------------- -------------
Balance, March 31, 2004 19,888,339 131,519
------------- -------------
Class B
Balance, January 1, 2004 450,470 135
Shares converted to Class A shares (447,968) (134)
------------- -------------
Balance, March 31, 2004 2,502 1
------------- -------------
Total Class A and Class B share capital 19,890,841 $131,520
============= =============
During the first quarter of 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
Canadian $15.72 to Canadian $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 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.
29
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 affect 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 quarter. 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 Subordinated Voting Shares.
Share option transactions during the three months ended March 31, 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 44,052 11.70
Exercised (69,807) 9.09
Expired and cancelled (622) 10.05
---------------
Balance, end of period 2,040,351 $6.54 1,000,507 $7.60
===============
Shares options outstanding as at March 31, 2004 are summarized as
follows:
Options Outstanding Options Exercisable
----------------------------------------------- ------------------------------
Weighted Weighted Weighted
Average Average Average
Range of Outstanding Contractual Price per Exercisable Price per
Exercise Prices Number Life Share Number Share
---------------------------------------------------------------------------------------------------------------
$2.94 - $4.50 770,535 3.6 $4.08 322,813 $4.06
$4.51 - $6.00 518,865 4.1 $5.53 117,349 $5.52
$6.01 - $9.00 347,153 5.0 $7.27 273,852 $7.36
$9.01 - $15.30 390,325 2.9 $11.02 273,020 $11.21
$23.00 - $42.50 13,473 1.2 $42.33 13,473 $42.33
Warrants issued and outstanding as of March 31, 2004 are as follows:
Class A Stock
Warrants
-----------------
Balance at December 31, 2002 -
Warrants issued (a) 507,146
-----------------
Balance at December 31, 2003 507,146
Warrants issued (b) 626,092
-----------------
Balance at March 31, 2004 1,133,238
=================
(a) During the year ended December 31, 2003, the Company issued
507,146 warrants with a weighted average exercise price of
Canadian $14.28 and terms of two to five years. These warrants
were issued as compensation to a lender and to an advisor.
30
(b) During the three months ended March 31, 2004, the Company
issued 626,092 warrants with a weighted average exercise price
of Canadian $17.71 and a term of five years. Of these
warrants, 150,173 were issued as acquisition consideration and
475,919 were issued as compensatory and treated as such for
accounting purposes.
13. Commitments and Contingencies
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 $6 million could be owing in 2004 and
2005, of which approximately $5 million would be payable in shares of
the Company.
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
rights at their earliest contractual date would result in obligations
of the Company to fund related amounts during the period 2004 to 2010.
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 Canadian $10 million in the event that the
market price of the Company's Class A subordinate voting shares is
Canadian $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 $5,201 (Cdn$6,820) and
$2,288 (Cdn$3,000) respectively, as at March 31, 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 condensed 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.
31
14. Canadian GAAP Reconciliation
During the third quarter of fiscal 2003, the Company changed its
reporting currency from Canadian dollars to U.S. dollars. The
comparative financial information for the three months ended March 31,
2003 prepared under Canadian GAAP included in this reconciliation
differ from amounts previously reported as a result of the change in
reporting currency to U.S. dollars and the impact of the adjustments
recorded in connection with the restatement described in Note 2. 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 U.S. 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 prepared in accordance with U.S.
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 Affiliates"
for the three months ended March 31, 2004 and as at June 30, 2004 and
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 7(b)) and a joint venture-owing rental property (See Note 2, Item
6(a)); (ii) to correct the adjustment as at December 31, 2003 and for
the three months ended March 31, 2004, in respect of the fair value
adjustment for the embedded derivative in the Company's exchangeable
debentures. (See Note 2, Item 3)
The reconciliation from US to Canadian GAAP, of the Company's results
of operations for the three months ended March 31, 2004 and 2003, the
Company's financial position as at March 31, 2004 and December 31,
2003 are set out below.
Convertible Notes
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.
32
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
to fair value of the underlying CDI units is 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 charge to
the statement of operations.
Under U.S. GAAP, the Company must recognize in earnings each period
the changes in the fair value of the embedded derivative within the
contingently exchangeable debentures 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 2004 of $3,673
immediately prior to settlement.
As a result of this difference, under Canadian GAAP, net earnings in
the three months ended March 31, 2004 is lower than that reported
under U.S. GAAP by $3,974, being the loss on the embedded derivative
recognized in the prior period.
Goodwill Charges
Historically, under U.S. 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 three months
ended March 31, 2004 is lower under Canadian GAAP than under U.S. GAAP
by $2,780.
Other Adjustments
Other adjustments represent cumulative translation differences as a
result of timing differences between recognition of certain expenses
under U.S. 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.
33
Three Months Ended March 31, 2004
(thousands of United States dollars)
Embedded
Derivative Proportionate
US Convertible and Goodwill Consolidation Canadian
GAAP Notes Charge of Affiliate GAAP
------------ ------------ ------------ -------------- ------------
(Restated - (Restated) (Restated) (Restated)
See Note 2)
Revenue:
Services $51,958 $ - $ - $6,577 $58,535
Products 18,037 - - - 18,037
------------ ------------ ------------ -------------- ------------
69,995 - - 6,577 76,572
------------ ------------ ------------ -------------- ------------
Operating Expenses:
Cost of products sold 11,175 - - - 11,175
Salary and related costs 36,271 - - 2,323 38,594
General and other operating costs 25,714 - - 1,578 27,292
Depreciation and amortization 2,545 - - 118 2,663
------------ ------------ ------------ -------------- ------------
75,705 - - 4,019 79,724
------------ ------------ ------------ -------------- ------------
Operating Profit (Loss) (5,710) - - 2,558 (3,152)
------------ ------------ ------------ -------------- ------------
Other Income (Expenses):
Gain on sale of assets and other 16,311 - (6,754) - 9,557
Foreign exchange gain 170 - - - 170
Interest expense (2,774) 521 - (87) (2,340)
Interest income 421 - - (1) 420
------------ ------------ ------------ -------------- ------------
14,128 521 (6,754) (88) 7,807
------------ ------------ ------------ -------------- ------------
Income Before Income Taxes, Equity in
Affiliates and Minority Interests 8,418 521 (6,754) 2,470 4,655
Income Taxes 197 - - 929 1,126
------------ ------------ ------------ -------------- ------------
Income (Loss) Before Equity in
Affiliates and Minority Interests 8,221 521 (6,754) 1,541 3,529
Equity in Affiliates 1,541 - - (1,541) -
Minority Interests (1,297) - - - (1,297)
------------ ------------ ------------ -------------- ------------
Net Income (Loss) $8,465 $521 ($6,754) $ - $2,232
============ ============ ============ ============== ============
34
As at March 31, 2004
(thousands of United States dollars)
Proportionate
US Convertible Consolidation of Canadian
GAAP Notes Affiliates GAAP
------------ ------------- ----------------- ------------
(Restated - (Restated) (Restated)
See Note 2)
ASSETS
Current Assets
Cash and cash equivalents $58,609 $ - $4,914 $63,523
Accounts receivable 95,100 - 12,925 108,025
Expenditures billable to
clients 7,803 - 5,397 13,200
Inventories 8,447 - - 8,447
Prepaid expenses and other
current assets 6,808 - 392 7,200
------------ ------------- ----------------- ------------
Total Current Assets 176,767 - 23,628 200,395
Fixed assets 43,316 - 5,893 49,209
Investment in Affiliates 22,383 - (21,306) 1,077
Intangibles 3,860 - - 3,860
Goodwill 121,592 - 18,551 140,143
Deferred Tax Assets 10,578 - - 10,578
Other Assets 8,162 - 21 8,183
------------ ------------- ----------------- ------------
Total Assets $386,658 $ - $26,787 $413,445
============ ============= ================= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $68,606 $ - $6,917 $75,523
Accruals and other liabilities 62,028 - 14,280 76,308
Advance billings 28,743 - 779 29,522
Current portion of long-term
debt 31,446 2,128 108 33,682
Deferred acquisition
consideration 1,113 - - 1,113
------------ ------------- ----------------- ------------
Total Current Liabilities 191,936 2,128 22,084 216,148
Long-Term Debt 48,665 - 3,878 52,543
Convertible Notes 36,605 (32,532) - 4,073
Other Liabilities 483 - 825 1,308
------------ ------------- ----------------- ------------
Total Liabilities 277,689 (30,404) 26,787 274,072
------------ ------------- ----------------- ------------
Minority Interests 1,095 - - 1,095
------------ ------------- ----------------- ------------
Shareholders' Equity
Share capital 131,520 1,296 - 132,816
Share capital to be issued 3,909 - - 3,909
Additional paid-in capital 6,796 30,404 - 37,200
Retained earnings (deficit) (30,704) (1,296) - (32,000)
Accumulated other
comprehensive income (loss) (3,647) - - (3,647)
------------ ------------- ----------------- ------------
Total Shareholders' Equity 107,874 30,404 - 138,278
------------ ------------- ----------------- ------------
Total Liabilities and
Shareholders' Equity $386,658 $ - $26,787 $413,445
============ ============= ================= ============
35
Three Months Ended March 31, 2004
(thousands of United States dollars)
Embedded
Derivative Proportionate
US Convertible and Goodwill Consolidation Canadian
GAAP Notes Charge of Affiliates GAAP
-------------- -------------- ------------ ------------- -------------
(Restated - (Restated) (Restated) (Restated)
See Note 2)
Operating Activities
Net income $8,465 $521 ($6,754) $ - $2,232
Stock-based compensation 6,059 - - - 6,039
Depreciation and amortization 2,545 - - 118 2,663
Deferred finance charges 2,458 - - - 2,458
Deferred income taxes 909 - - - 909
Foreign exchange (170) - - (170)
Gain on sale of affiliate (18,233) - 6,754 - (11,479)
Earnings of affiliates, net
of distributions 616 - - (616) -
Minority interest and other (75) - - - (75)
Changes in non-cash working
capital (4,141) - - 17 (4,124)
-------------- -------------- ------------ ------------- -------------
(1,567) 521 - (481) (1,527)
-------------- -------------- ------------ ------------- -------------
Investing activities
Capital expenditures (3,091) - - (206) (3,297)
Acquisitions, net of cash
acquired 3 - - - 3
Other assets, net 117 - - (44) 73
-------------- -------------- ------------ ------------- -------------
(2,971) - - (250) (3,221)
-------------- -------------- ------------ ------------- -------------
Financing activities
Repayment of long-term
debt (2,162) (521) - (26) (2,709)
Issuance of share capital 2,041 - - - 2,041
Purchase of share capital (1,468) - - - (1,468)
-------------- -------------- ------------ ------------- -------------
(1,589) (521) - (26) (2,136)
-------------- -------------- ------------ ------------- -------------
Foreign exchange effect on
cash and cash equivalents (1,193) - - - (1,193)
-------------- -------------- ------------ ------------- -------------
Net increase (decrease) in
cash and cash equivalents (7,320) - - (757) (8,077)
Cash and cash equivalents
beginning of period 65,929 - - 5,671 71,600
-------------- -------------- ------------ ------------- -------------
Cash and cash equivalents
end of period $58,609 - - $4,914 $63,523
============== ============== ============ ============= =============
36
Three Months Ended March 31, 2003
(thousands of United States dollars)
Proportionate
US Convertible Consolidation of Canadian
GAAP Notes and Other Affiliates GAAP
--------------- --------------- ------------------ ----------------
(Restated - See (Restated) (Restated)
Note 2)
Revenue:
Services $37,782 $ - $3,927 $41,709
Products 43,314 - - 43,314
--------------- --------------- ------------------ ----------------
81,096 - 3,927 85,023
--------------- --------------- ------------------ ----------------
Operating Expenses:
Cost of products sold 18,507 - - 18,507
Salary and related costs 26,597 - 1,719 28,316
General and other operating costs 27,280 - 1,188 28,468
Depreciation and amortization 2,710 185 70 2,965
--------------- --------------- ------------------ ----------------
75,094 185 2,977 78,256
--------------- --------------- ------------------ ----------------
Operating Profit (Loss) 6,002 (185) 950 6,767
--------------- --------------- ------------------ ----------------
Other Income (Expense):
Foreign exchange gain (loss) (655) - - (655)
Interest expense (4,877) 425 (67) (4,519)
Interest income 93 - 16 109
--------------- --------------- ------------------ ----------------
(5,439) 425 (51) (5,065)
--------------- --------------- ------------------ ----------------
Income Before Income Taxes, Equity in
Affiliates and Minority Interests 563 240 899 1,702
Income Taxes (Recovery) (26) 155 337 466
--------------- --------------- ------------------ ----------------
Income Before Equity in Affiliates and
Minority Interests 589 85 562 1,236
Equity in Affiliates 562 - (562) -
Minority Interests (939) - - (939)
--------------- --------------- ------------------ ----------------
Net Income (Loss) $212 $85 $ - $297
=============== =============== ================== ================
37
As at December 31, 2003
(thousands of United States dollars)
Proportionate
US Convertible Consolidation Other Canadian
GAAP Notes of Affiliates Adjustments GAAP
------------ -------------- -------------- ----------- ------------
(Restated - (Restated) (Restated) (Restated)
See Note 2)
ASSETS
Current Assets
Cash and cash equivalents $65,929 $ - $5,671 $ - $71,600
Accounts receivable 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 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
============ ============== ============== =========== ============
38
Three Months Ended March 31, 2003
(thousands of United States dollars)
Proportionate
US Convertible Consolidation of Other Canadian
GAAP Notes Affiliates Adjustments GAAP
--------------- ----------- ---------------- -------------- -------------
(Restated - See (Restated) (Restated)
Note 2)
Operating activities
Net income $212 $270 $ - ($185) $297
Depreciation and amortization 2,710 - 70 185 2,965
Deferred finance charges 619 619
Non-cash interest 954 - - - 954
Deferred income taxes 165 155 - - 320
Foreign exchange 655 - - - 655
Earnings of affiliates, net of
distributions (1,155) - 1,155 - -
Minority interest and other (151) - - - (151)
Changes in non-cash working
capital (3,524) - (1,420) - (4,944)
--------------- ----------- ---------------- -------------- -------------
485 425 (195) - 715
--------------- ----------- ---------------- -------------- -------------
Investing activities
Capital expenditures (2,288) - (492) - (2,780)
Acquisitions, net of cash
acquired (1,115) - - - (1,115)
Other assets, net (148) - (31) - (179)
--------------- ----------- ---------------- -------------- -------------
(3,551) - (523) - (4,074)
--------------- ----------- ---------------- -------------- -------------
Financing activities
Proceeds on issuance of long-
term debt 159 - - - 159
Repayment of long-term debt (1,863) (425) (21) - (2,309)
--------------- ----------- ---------------- -------------- -------------
(1,704) (425) (21) - (2,150)
--------------- ----------- ---------------- -------------- -------------
Foreign exchange effect on cash
and cash equivalents 717 - - - 717
--------------- ----------- ---------------- -------------- -------------
Net increase (decrease) in cash
and cash equivalents (4,053) - (739) - (4,792)
Cash and cash equivalents
beginning of period 31,226 - 6,211 - 37,437
--------------- ----------- ---------------- -------------- -------------
Cash and cash equivalents
end of period $27,173 $ - $5,472 $ - $32,645
=============== =========== ================ ============== =============
39
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 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). THIS REPORT CONTAINS FORWARD LOOKING STATEMENTS
WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 WITH
RESPECT TO THE FINANCIAL CONDITION, RESULTS OF OPERATIONS, AND BUSINESS OF THE
COMPANY. THESE FORWARD LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND
UNCERTAINTIES. NO ASSURANCE CAN BE GIVEN THAT ANY OF SUCH MATTERS WILL BE
REALIZED. FACTORS THAT MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
CONTEMPLATED BY SUCH FORWARD LOOKING STATEMENTS INCLUDE, AMONG OTHERS, THE
FOLLOWING POSSIBILITIES: (1) COMPETITIVE PRESSURE IN THE COMPANY'S INDUSTRY
INCREASES SIGNIFICANTLY; (2) GENERAL ECONOMIC CONDITIONS ARE LESS FAVORABLE THAN
EXPECTED; (3) CHANGES IN THE FINANCIAL MARKETS AFFECTING THE COMPANY'S FINANCIAL
STRUCTURE AND THE COMPANY'S COST OF CAPITAL AND BORROWED MONEY; AND (4) THE
UNCERTAINTIES INHERENT IN INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY
FLUCTUATIONS. THE COMPANY HAS NO DUTY UNDER THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995 TO UPDATE THE FORWARD LOOKING STATEMENTS IN THIS QUARTERLY
REPORT ON FORM 10-Q AND THE COMPANY DOES NOT INTEND TO PROVIDE SUCH UPDATES.
The following discussion focuses on the operating performance of MDC Partners
Inc. (the "Company") for the three-month periods ended March 31, 2004 and 2003,
and the financial condition of the Company as at March 31, 2004. This analysis
should be read in conjunction with the interim condensed consolidated 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 U.S. dollars unless
otherwise stated.
The Company has restated its consolidated financial statements and related
footnote disclosures to reflect (1) corrections in the recognition of
compensation expense on the privatization of Maxxcom, (2) corrections in the
timing and classification of the amortization and write-off of deferred
financing fees, (3) the recognition of fair value adjustments related to an
embedded derivative in the Company's exchangeable securities, (4) corrections
in the timing and amounts recognized on the gain on sale of the investment in
Custom Direct Inc., (5) correction for the timing of recognition and
classification of foreign exchange gains and losses on intercompany balances,
(6) corrections to revenue recognition related to certain contract terms, (7)
corrections to the accounting for certain investments, (8) corrections to the
purchase price allocations for certain business acquisitions and the related
amortization of identified intangible assets, (9) corrections in the timing of
the recognition of stock-based compensation, and (10) correction of the diluted
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 condensed consolidated financial statements resulting from these
restatements.
The effects of these restatements have been reflected in corresponding
corrections to the Management Discussion and Analysis in this Form 10-Q/A. This
Form 10-Q/A does not reflect events occurring after the original filing date of
the Form 10-Q.
40
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 business comprising this request 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% but not unilaterally controlled by the Company and Crispin
Porter + Bogusky, LLC, ("CPB"), owned 49.9% by the Company, and Cliff Freeman &
Partners, LLC, owned 19.9% by the Company, are required to be equity accounted
for under US GAAP. Consequently, for purposes of the Management Discussion and
Analysis, 100% of the results of operations of these businesses have been
combined with the other businesses 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 GAAP reported results of operations has
been provided by the Company in the tables included in the Management Discussion
and Analysis.
41
Results of Operations:
For the Three Months Ended March 31, 2004, as restated (1):
(thousands of United States dollars)
Combined As Reported under US GAAP
-------------- ----------------------------------------------------------------------------
Combined Less Secure
Marketing Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ----------- ---------------- ------------- ------------ ----------
Revenue $64,432 $12,474 $51,958 $18,037 $- $69,995
-------------- ----------- ---------------- ------------- ------------ ----------
Operating Expenses:
Cost of products sold - - - 11,175 - 11,175
Salary and related costs 30,072 4,673 25,399 3,476 7,396 36,271
General and other
operating costs 24,754 2,824 21,930 2,401 1,383 25,714
Depreciation and
amortization 2,034 190 1,844 675 26 2,545
-------------- ----------- ---------------- ------------- ------------ ----------
56,860 7,687 49,173 17,727 8,805 75,705
-------------- ----------- ---------------- ------------- ------------ ----------
Operating Profit (Loss) $7,572 $4,787 $2,785 $310 ($8,805) (5,710)
============== =========== ================ ============= ============
Other Income (Expense)
Gain on sale of affiliate 16,311
Foreign exchange gain 170
Interest expense, net (2,353)
---------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 8,418
Income Taxes 197
---------
Income Before Equity in Affiliates and Minority Interests 8,221
Equity in Affiliates 1,541
Minority Interests (1,297)
---------
Net Income $8,465
=========
(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.
42
(2) For the Three Months Ended March 31, 2003, as restated (1):
(thousands of United States dollars)
Combined As Reported under US GAAP
-------------- ----------------------------------------------------------------------------
Combined Less Secure
Marketing Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ----------- ---------------- ------------- ------------ ----------
Revenue $44,992 $7,210 $37,782 $43,314 $ - $81,096
-------------- ----------- ---------------- ------------- ------------ ----------
Operating Expenses:
Cost of products sold - - - 18,507 - 18,507
Salary and related
costs 22,881 3,418 19,463 6,083 1,051 26,597
General and other
operating costs 16,617 1,951 14,666 12,050 564 27,280
Depreciation and
amortization 1,504 92 1,412 1,174 124 2,710
-------------- ----------- ---------------- ------------- ------------ ----------
41,002 5,461 35,541 37,814 1,739 75,094
-------------- ----------- ---------------- ------------- ------------ ----------
Operating Profit (Loss) $3,990 $1,749 $2,241 $5,500 ($1,739) 6,002
============== =========== ================ ============= ============
Other Income (Expense):
Foreign exchange loss (655)
Interest expense, net (4,784)
----------
Loss Before Income Taxes, Equity in Affiliates and Minority Interest 563
Income Taxes (Recovery) (26)
----------
Income Before Equity in Affiliates and Minority Interests 589
Equity in Affiliates 562
Minority Interests (939)
----------
Net Income $212
==========
(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.
43
Three Months Ended March 31, 2004 Compared to Three months Ended March 31, 2003
Marketing Communications
Marketing Communications revenue on a Combined basis was $64.4 million in the
quarter, 43% more than the $45.0 million in revenue reported in the first
quarter of 2003. The increase in Combined revenue as compared to the same
quarter in 2003 resulted primarily from several significant new business
developments in the quarter as described below. The growth also resulted from
the acquisition of kirshenbaum bond + partners, LLC ("KBP") at the end of
January 2004, which contributed $7.4 million of revenue in the quarter.
Excluding revenue generated by KBP in 2004, Combined revenue increased 26.7%.
Increases in the value of the Canadian dollar and Pound Sterling, measured in
U.S. dollars, as compared to the same period in 2003 had the effect of
increasing Combined revenue by approximately $1.8 million during the period. On
a pro forma basis, comparing a full three months of operations in both 2004 and
2003 for businesses operated by the segment on March 31, 2004, Combined revenue
improved by approximately 22% year over year. This reflected very significant
pro forma Combined revenue growth in the US businesses as well as the Canadian
operations during the quarter. The growth in Combined proforma revenue related
to US operations is attributable most notably to incremental revenue that the
Company's equity accounted affiliate, CPB, earned from its new client, Burger
King, and from incremental revenue earned by subsidiaries Source Marketing, LLC
and Accent Marketing Services, LLC, in connection with services performed for
clients in the financial and telecommunications industries.
The positive organic growth, particularly in the US, has resulted in a shift in
the geographic mix of Combined revenue. Of the Combined revenue for the quarter,
77% was derived from operations in the United States, 19% was derived from
operations in Canada and 4% was derived from operations in the United Kingdom.
This compares to 72%, 23% and 5%, respectively, in first quarter of 2003.
During the first quarter of 2004 the Marketing Communications Division saw a
relative increase, as compared to the same quarter in 2003, in revenue from
financial and telecommunications-based clients, and a relative decrease in
revenue from healthcare, media and, to a lesser extent, consumer products-based
clients In dollar terms, significant increases were noted in revenues from
financial-, consumer product- and telecommunications industry-based clients. The
composition of revenues added due to business acquisitions in the first quarter
of 2004, principally KBP, did not have a material effect on Combined revenue
composition, as revenue continues to be derived primarily from clients in the
consumer and financial industries.
Acquisitions completed during the first quarter did increase both total revenue
and the proportionate share of revenue from advertising services, as compared to
the "below-the-line" services. For the first quarter of 2004, Combined revenue
from advertising services represented approximately 43% of Combined revenue as
compared to 35% for the same period in 2003. Excluding the effects of the KBP
acquisition, advertising services would have increased to 40% in the quarter, as
the division's existing operations obtained several new advertising clients
during the quarter.
Combined operating costs increased 39%, as compared to the same quarter in 2003.
This rate of growth is lower than the 43% rate of growth exhibited by Combined
revenues, during the same period. Increases in staffing levels did not occur at
the same rate as increases in revenues from new business development. In
addition, the consolidation of Maxxcom's head office into the "Corporate and
Other" division upon the privatization of Maxxcom helped minimize the increase
in salary costs. Combined salary and related costs increased approximately 31%,
as compared to the same quarter in 2003. Combined general and other operating
costs, which include production costs, increased approximately 49% reflecting a
shift in the mix of business to direct marketing and database management
services. Excluding the effects of the KBP acquisition, Combined revenues
increased approximately 27%, while Combined operating costs increased 24%,
resulting in a Combined operating margin of 10.7% and a 52.5% increase in
Combined operating income. Following the acquisition of KBP, Combined operating
income improved by approximately 90%, as compared to the same quarter in 2003,
increasing operating margins to 11.8% for the quarter, as compared to 8.9 % in
the same quarter last year.
44
Had Combined operating income been adjusted on a pro forma basis, in the same
manner as described above relative to revenue, Combined operating income would
have increased by approximately 34%, as compared to the same quarter in 2003,
from approximately $6.1 million to approximately $8.2 million.
Secure Products International
Secure Products International revenue totaled $18.0 million for the quarter
ended March 31, 2004, $25.3 million or 58% lower than the $43.3 million reported
for the same period of 2003. This decrease related to the disposition of Custom
Direct ("CDI") in 2003. Revenue of the remaining operations of the Secure
Products International Division increased from $14.4 million in the first
quarter of 2003 to $18.0 million for the same period this year, an increase of
$3.6 million. The significant increase in revenue of the stamp operations of
Ashton Potter, primarily due to increased production related to the USPS
contract awarded in 2003, combined with the increase in revenues of Placard, the
Australian card operation, and of Mercury, the Canadian ticketing business, and
were partially offset by a decrease in revenues of the Canadian card operation,
Metaca.
Operating costs incurred by the Secure Products International Division amounted
to $17.7 million for the first quarter of 2004, compared to $37.8 million in the
first quarter of 2003, however, the 2003 results include $23.4 million of costs
related to CDI. After adjusting for those costs, operating expenses increased
$3.3 million compared to Q1 2003, but decreased to 98.3%, when expressed as a
percentage of revenue, compared to 100.7% last year. On the same basis, cost of
sales, salaries and related costs and depreciation increased from 81.1% to 85.0
% as a percentage of revenue in 2004, as compared to the same quarter in 2003,
and general and other operating expenses declined to 13.3% of revenue as
compared to 19.6% of revenue for the same quarter in 2003.
In the first quarter of 2004, the Secure Products International Division
contributed operating profit of $0.3 million, a decrease of $5.2 million from
the $5.5 million of operating profits achieved in the prior-year first quarter,
primarily as a result of the sale of CDI. Operating profit of the remaining
operations of Secure Products International improved $0.4 million from the $0.1
million operating loss incurred in Q1 2003 reflective of increased production at
Ashton Potter and the impact of EITF 00-21 on the first quarter of 2003,
partially offset by declines at Metaca.
Corporate and Other
Operating costs, at $8.8 million, increased $7.1 million compared to the quarter
ended March 31, 2003, primarily as a result of a $6.1 million stock-based
compensation charge recorded in 2004 related to stock appreciation rights and
options. Corporate and other costs also increased as a result of the merger of
head offices upon the privatization of Maxxcom Inc. and increased compliance
costs.
As a result, the operating loss of the Corporate and Other Division was $8.8
million for the first quarter of 2004 versus $1.7 million for the first quarter
of 2003.
Gain on Sale of Affiliate and Settlement of Long-Term Debt
The Company recorded a gain on the divestiture of its remaining interest in CDI
net of a loss on the settlement of the exxchangeable debentures and the fair
value adjustments on the related embedded derivative, resulting in a net gain
of $16.3 million.
Net Interest Expense
Net interest expense for the first quarter of 2004 on a consolidated basis was
$2.4 million, $2.4 million lower than the $4.8 million incurred during the
first quarter of 2003. Interest costs of $2.2 million in 2003 were related to
the 10.5% senior notes repaid with proceeds from the sale of CDI. Interest
expense of the remaining operations increased $1.0 million in 2004 due to
higher average borrowings under Marketing Communications facilities. Interest
income increased by $0.3 million due to higher cash balances at certain
agencies and head office in the first quarter of 2004.
45
Income Taxes
Income tax expense recorded in the quarter ended March 31, 2004, was $0.2
million, compared to a nominal recovery for the same period in 2003. The Company
did not recognize a tax charge related to the gain on sale of affiliate as a
result of available tax losses, for which a full valuation allowance had
previously been recorded creating an income tax expense below normal rates.
Income (Loss) After Income Taxes
The consolidated income after income taxes was $8.2 million for the first
quarter of 2004, representing a $7.6 million increase from the $0.6 million
generated during the first quarter of 2003. The change was primarily due to the
gain on sale of affiliate, partially offset by a charge incurred for stock-based
compensation and income earned in 2003 related to CDI.
Equity in Affiliates
Equity in affiliates represents the income attributable to equity-accounted
affiliate operations, principally CPB. For the first quarter of 2004, income of
$1.5 million was recorded, $0.9 million higher than the $0.6 million earned in
the first quarter of 2003, primarily due to significant new business wins in
2004.
Minority Interests
Minority interest expense was $1.3 million for the first quarter of 2004, up
$0.4 million from the $0.9 million minority interest expense incurred during in
the first quarter of 2004.
Net Income
As a result of the foregoing, net income recorded for the first quarter of 2004
was $8.5 million, compared to $0.2 million reported for the first quarter of
2003.
Liquidity and Capital Resources:
Working Capital
At March 31, 2004, the Company had a working capital deficit of $15.2 million
compared to working capital of $38.6 million at December 31, 2003. The $53.8
million decrease is due primarily to cash used in connection with acquisitions
completed in the quarter, the movement of the senior credit facility at Maxxcom
from long-term debt to current portion of long-term debt and a decrease in
working capital in the Marketing Communications subsidiaries. Compared to
December 31, 2003, on a consolidated basis, cash decreased by $7.3 million.
Accounts receivable and expenditures billable to clients increased by $36.2
million and $0.7 million, respectively. Inventory increased by $0.7 million and
prepaid expenses increased by $1.9 million. Accounts payable and accrued
liabilities increased by $57.9 million. Advance billings increased by $13.0
million and the current portion of long-term debt increased by $15.1 million.
At March 31, 2004, Maxxcom had utilized approximately $29 million of its $34
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 March 31, 2004, was approximately $64 million.
46
Currently, substantially all of the long-term debt is held at Maxxcom or its
subsidiaries. Maxxcom's ability to meet the repayment of its long-term debt is
dependent upon the availability of cash from its parent MDC Partners Inc. and
from the cash flows from its subsidiaries and affiliated companies through
dividends, distributions, intercompany advances, management fees and other
payments. A number of Maxxcom's subsidiaries are not wholly-owned and pursuant
to operating agreements with some of the other shareholders of these
subsidiaries and affiliates and certain subsidiary and affiliate lending
agreements, there are certain restrictions on the payment of dividends,
distributions and advances to Maxxcom. In addition, pursuant to certain lending
agreements entered into by MDC Partners Inc, there are restrictions on MDC's
ability to transfer available cash to Maxxcom.
Long-term Debt
Long-term debt (including the current portion of long-term debt) at the end of
the first quarter of 2004 was $116.7 million, a reduction of $33.4 million
compared with the $150.1 million outstanding at December 31, 2003, primarily the
result of the settlement of the adjustable rate exchangeable securities in
February 2004. The convertible notes declined $1.2 million in the quarter as a
result of the repurchase of CDN$1.0 million of notes pursuant to a normal course
issuer bid with the remaining reduction related to weakness in the Canadian
dollar. The Company has provided a notice of redemption to Noteholders whereby
the Company will redeem the notes for Class A Subordinate Voting Shares. The
Company will issue approximately 2.58 million shares to redeem the notes on May
5, 2004.
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 March 31, 2004, approximately $1.1 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 $6
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 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 2010. 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 that 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.
The Company's management estimates, assuming that the subsidiaries perform over
the relevant future periods at their 2003 earnings levels, that these rights, if
all exercised, could require the Company, in future periods, to pay an aggregate
of approximately $57 million to the owners of such rights to acquire the
remaining ownership interests in the relevant subsidiaries. Of this amount, the
Company is entitled, at its option, to fund approximately $13 million by the
issuance of the Company's share capital.
47
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.
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 $8 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 $6 million of the estimated $57 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 four 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
Cash flow from operations, including changes in non-cash working capital, for
the first quarter of 2004 was a use of $1.6 million compared to the cash flow
generated of $0.5 million in the same quarter of 2003, primarily reflective of
the impact of changes in non-cash working capital.
Cash flows used in investing activities were $3.0 million for the first quarter
of 2004, compared with $3.6 million in the first quarter of 2003. $1.8 million
of the capital expenditures in the first quarter relate to the Marketing
Communications Division's acquisition of computer and switching equipment with
the balance used to purchase manufacturing equipment in the Secure Products
Division, primarily Ashton Potter.
During the quarter, cash flows used in financing activities amounted to $1.6
million and consisted of a repayment of $2.2 million of long-term indebtedness,
proceeds of $2.0 million from the issuance of share capital through a private
placement and the exercise of options, and $1.5 million used to repurchase
shares of the Company under a normal course issuer bid.
48
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 condensed consolidated financial
statements for the three months ended March 31, 2004 and 2003 in note 14 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
in the marketing communications businesses, while US GAAP requires equity
accounting for such investments. 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 the joint ventures in this MD&A as well as in the
segment information in note 5 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.
49
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. Marketing Communications substantially all revenue is derived
from fees for services. Commissions are earned based upon 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's 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 of the
product. Revenue derived from the sale of tickets 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 revenue recognition criteria have been met. Revenue derived
from the sale of cards is realized when the product is completed, mailed to the
client's specified recipient and all revenue recognition criteria have been met.
Additional information about revenue appears in the notes to the consolidated
interim financial statements.
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.
50
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.
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:
. Risks associated with effects of national and regional economic and
political conditions;
. The Company's ability to attract new clients and retain existing
clients;
. The financial success of the Company's clients;
. The Company's ability to retain and attract key employees;
. Developments from changes in the regulatory and legal environment;
. Foreign currency fluctuations;
. The successful completion and integration of acquisitions which
complement and expand the Company's' business capabilities, and;
. 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.
We hereby incorporate by reference the disclosure provided under the header
"Risks and Uncertainties" in the Company's Management Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
2003, included in the Company's Annual Report on Form 40-F/A for the year ended
December 31, 2003. As of March 31, 2004, no material change had occurred that
required the Company to update such disclosure.
Outlook:
2004 will be a year of transformation for MDC. Our vision has been to enhance
the conglomerate, simplify the story and focus on the market place that best
positions the Company to deliver premium returns to its shareholders.
Our genesis was in the marketing communications business, our experience and
knowledge is greatest in that area. Our growth strategy is based on empowering
our partners with equity and autonomy. We believe that combination will deliver
accretive investments and attract the best talent. We have identified an
opportunity to structure and complete the final act of our structural
transformation through the monetization of our secure print properties in the
form of an income fund. We anticipate filing a preliminary prospectus of the
fund in the second quarter.
51
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.
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 U.S. dollars. Our
Marketing Communications businesses operate in North America and the United
Kingdom, however each business's revenues are collectable 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 U.S. 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 U.S./Canada dollar exchange rate.
52
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 steps 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.
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
material weaknesses relate to:
. Insufficient personnel resources and technical accounting expertise
within its accounting functions;
. Failure in the design of identified controls in preventing or detecting
misstatements of accounting information;
. Absence of appropriate review of accounting entries and other
documentation surrounding significant transactions or application of
U.S. GAAP; and
. Inadequate procedures and oversight for appropriately assessing and
applying accounting principles and changes thereon.
53
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 steps:
. Hired additional personnel resources, and is actively pursing
appropriate additional resources in its accounting and finance
functions, particularly those with US GAAP expertise;
. Developed, distributed and begun to communicate and implement
comprehensive accounting policies in a number of areas, including
revenue recognition;
. 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;
. Improving procedures for analyzing, reviewing and documenting
significant transactions; and
. 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.
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 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.
54
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
-----------------------------------------------------------------------------------------------------------
January 1, 2004 5,000 $11.34 5,000 210,073
-January 31, 2004
February 1, 2004 95,000 14.03 95,000 115,073
-February 29, 2004
March 1, 2004 5,000 15.71 5,000 110,073
-March 31, 2004
-----------------------------------------------------------------------------------------------------------
Total 105,000 $13.98 105,000
-----------------------------------------------------------------------------------------------------------
1. The Class A subordinate voting shares were purchased pursuant to a
publicly announced plan commencing May 30, 2003. The maximum number of
shares that may be purchased under this plan is 1,269,889. This plan
expires June 2, 2004.
55
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
-------------- -----------
31 Rule 13a-14(a)/15d-14(a) certifications;
32 Section 1350 Certifications.
(b) The Company filed the following Current Reports on Form 8-K for the
quarter ended March 31, 2004:
None.
56
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
57
EXHIBIT INDEX
Exhibit No. Description
--------------- -----------
31 Rule 13a-14(a)/15d-14(a) certifications;
32 Section 1350 Certifications.
58