Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-Q
(Mark
One)
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|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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|
|
For
the quarterly period ended June 30, 2006
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|
|
Or
|
|
|
o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For
the transition period from ______________ to
______________
Commission
file number: 001-13178
MDC
Partners Inc.
(Exact
name of registrant as specified in its charter)
Canada
|
98-0364441
|
(State
or other jurisdiction of
|
(IRS
Employer Identification No.)
|
incorporation
or organization)
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|
|
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45
Hazelton Avenue
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|
Toronto,
Ontario, Canada
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M5R
2E3
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(Address
of principal executive offices)
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(Zip
Code)
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(416)
960-9000
Registrant’s
telephone number, including area code:
950
Third Avenue, New York, New York 10022
(646)
429-1809
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 o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of “accelerated
filer” and “large accelerated filer” in Rule 12(b)-2 of the Exchange Act
(check one)
Large
Accelerated Filer o Accelerated
Filer x Non-Accelerated
Filer o
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.
Yes o No x
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 o No o
The
numbers of shares outstanding as of August 1, 2006 were: 24,159,715
Class A subordinate voting shares and 2,502 Class B multiple voting
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 10-K, 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.
MDC
PARTNERS INC.
QUARTERLY
REPORT ON FORM 10-Q
TABLE
OF CONTENTS
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Page
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PART I.
FINANCIAL INFORMATION
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Item
1.
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Financial
Statements
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Condensed
Consolidated Statements of Operations (unaudited) for the Three and
Six
Months Ended June 30, 2006 and 2005
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4
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Condensed
Consolidated Balance Sheets as of June 30, 2006 (unaudited) and
December 31, 2005
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5
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|
Condensed
Consolidated Statements of Cash Flows (unaudited) for the Six Months
Ended
June 30, 2006 and 2005
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6
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Notes
to Unaudited Condensed Consolidated Financial Statements
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|
7
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Item
2.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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26
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Item
3.
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Quantitative
and Qualitative Disclosures about Market Risk
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47
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Item
4.
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Controls
and Procedures
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47
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PART II.
OTHER INFORMATION
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Item
1.
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Legal
Proceedings
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49
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Item
1A.
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Risk
Factors
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49
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Item
2.
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Unregistered
Sales of Equity and Use of Proceeds
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49
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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50
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Item
6.
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Exhibits
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51
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Signatures
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52
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Item
1. Financial Statements
MDC
PARTNERS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(thousands
of United States dollars, except share and per share amounts)
|
|
Three
Months Ended June 30,
|
|
Six
Months Ended June 30,
|
|
|
|
2006
|
|
2005
|
|
2006
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|
2005
|
|
|
|
|
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|
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|
|
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|
Revenue:
|
|
|
|
|
|
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|
Services
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|
$
|
100,138
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|
$
|
90,355
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|
$
|
198,211
|
|
$
|
164,067
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold (1)
|
|
|
60,900
|
|
|
52,480
|
|
|
120,641
|
|
|
99,670
|
|
Office
and general expenses (2)
|
|
|
31,185
|
|
|
25,544
|
|
|
61,007
|
|
|
48,996
|
|
Depreciation
and amortization
|
|
|
5,118
|
|
|
6,320
|
|
|
11,900
|
|
|
9,770
|
|
|
|
|
97,203
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|
|
84,344
|
|
|
193,548
|
|
|
158,436
|
|
|
|
|
|
|
|
|
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|
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|
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Operating
profit
|
|
|
2,935
|
|
|
6,011
|
|
|
4,663
|
|
|
5,631
|
|
|
|
|
|
|
|
|
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|
|
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Other
Income (Expenses):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
509
|
|
|
851
|
|
|
1,073
|
|
|
1,013
|
|
Interest
expense
|
|
|
(1,780
|
)
|
|
(1,802
|
)
|
|
(4,431
|
)
|
|
(2,625
|
)
|
Interest
income
|
|
|
144
|
|
|
178
|
|
|
258
|
|
|
231
|
|
|
|
|
(1,127
|
)
|
|
(773
|
)
|
|
(3,100
|
)
|
|
(1,381
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes, equity in affiliates
and
minority interests
|
|
|
1,808
|
|
|
5,238
|
|
|
1,563
|
|
|
4,250
|
|
Income
tax recovery
|
|
|
530
|
|
|
685
|
|
|
1,009
|
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|
2,019
|
|
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|
|
|
|
|
|
|
|
|
|
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Income
from continuing operations before equity in affiliates and minority
interests
|
|
|
2,338
|
|
|
5,923
|
|
|
2,572
|
|
|
6,269
|
|
Equity
in earnings of non-consolidated affiliates
|
|
|
227
|
|
|
91
|
|
|
501
|
|
|
275
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(3,434
|
)
|
|
(5,493
|
)
|
|
(8,185
|
)
|
|
(8,302
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income/(Loss)
from continuing operations
|
|
|
(869
|
)
|
|
521
|
|
|
(5,112
|
)
|
|
(1,758
|
)
|
Discontinued
operations
|
|
|
(9,634
|
)
|
|
(1,485
|
)
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|
(10,524
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)
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|
(2,989
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)
|
|
|
|
|
|
|
|
|
|
|
|
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Net
Loss
|
|
$
|
(10,503
|
)
|
$
|
(964
|
)
|
$
|
(15,636
|
)
|
$
|
(4,747
|
)
|
|
|
|
|
|
|
|
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|
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|
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Income/(Loss)
Per Common Share:
|
|
|
|
|
|
|
|
|
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|
|
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|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(0.04
|
)
|
$
|
0.02
|
|
$
|
(0.22
|
)
|
$
|
(0.08
|
)
|
Discontinued
operations
|
|
|
(0.40
|
)
|
|
(0.06
|
)
|
|
(0.44
|
)
|
|
(0.13
|
)
|
Net
Loss
|
|
$
|
(0.44
|
)
|
$
|
(0.04
|
)
|
$
|
(0.66
|
)
|
$
|
(0.21
|
)
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(0.04
|
)
|
$
|
0.02
|
|
$
|
(0.22
|
)
|
$
|
(0.08
|
)
|
Discontinued
operations
|
|
|
(0.40
|
)
|
|
(0.06
|
)
|
|
(0.44
|
)
|
|
(0.13
|
)
|
Net
loss
|
|
$
|
(0.44
|
)
|
$
|
(0.04
|
)
|
$
|
(0.66
|
)
|
$
|
(0.21
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average Number of Common Shares Outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
23,858,327
|
|
|
23,521,175
|
|
|
23,818,182
|
|
|
22,867,842
|
|
Diluted
|
|
|
23,858,327
|
|
|
24,588,226
|
|
|
23,818,182
|
|
|
22,867,842
|
|
(1)
|
|
Includes
non cash stock-based compensation of $277 and $36 and $2,841 and
$71,
respectively in each of the three month periods ended June 30, 2006
and
2005, and in each of the six month periods ended June 30, 2006 and
2005,
respectively.
|
|
|
|
(2)
|
|
Includes
non cash stock-based compensation of $1,530 and $769 and $2,491 and
$1,725
respectively in each of the three month periods ended June 30, 2006
and
2005, and in each of the six month periods ended June 20, 2006 and
2005
respectively.
|
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of these statements.
MDC
PARTNERS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED BALANCE SHEETS
(thousands
of United States dollars)
|
|
June 30,
2006
|
|
December 31,
2005
|
|
|
|
(Unaudited)
|
|
|
|
ASSETS
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
5,182
|
|
$
|
12,923
|
|
Accounts
receivable, less allowance for doubtful accounts of $1,352 and
$1,250
|
|
|
116,376
|
|
|
117,319
|
|
Expenditures
billable to clients
|
|
|
14,712
|
|
|
7,838
|
|
Inventories
|
|
|
—
|
|
|
10,359
|
|
Prepaid
expenses
|
|
|
4,537
|
|
|
4,401
|
|
Other
current assets
|
|
|
542
|
|
|
356
|
|
Assets
held for sale
|
|
|
24,211
|
|
|
—
|
|
Total
Current Assets
|
|
|
165,560
|
|
|
153,196
|
|
Fixed
assets, at cost, less accumulated depreciation of $49,220 and
$71,220
|
|
|
39,699
|
|
|
63,528
|
|
Investment
in affiliates
|
|
|
11,059
|
|
|
10,929
|
|
Goodwill
|
|
|
197,921
|
|
|
195,026
|
|
Other
intangibles assets, net
|
|
|
50,999
|
|
|
57,139
|
|
Deferred
tax asset
|
|
|
16,973
|
|
|
16,057
|
|
Other
assets
|
|
|
11,037
|
|
|
11,440
|
|
Assets
held for sale
|
|
|
22,955
|
|
|
—
|
|
Total
Assets
|
|
$
|
516,203
|
|
$
|
507,315
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
Short-term
debt
|
|
$
|
940
|
|
$
|
3,739
|
|
Revolving
credit facility
|
|
|
71,500
|
|
|
73,500
|
|
Accounts
payable
|
|
|
76,454
|
|
|
63,452
|
|
Accruals
and other liabilities
|
|
|
72,368
|
|
|
69,891
|
|
Advance
billings
|
|
|
32,360
|
|
|
38,237
|
|
Current
portion of long-term debt
|
|
|
1,242
|
|
|
2,571
|
|
Deferred
acquisition consideration
|
|
|
1,001
|
|
|
1,741
|
|
Liabilities
related to assets held for sale
|
|
|
14,268
|
|
|
—
|
|
Total
Current Liabilities
|
|
|
270,133
|
|
|
253,131
|
|
Long-term
debt
|
|
|
5,157
|
|
|
8,475
|
|
Convertible
notes
|
|
|
40,315
|
|
|
38,694
|
|
Other
liabilities
|
|
|
6,815
|
|
|
7,937
|
|
Deferred
tax liabilities
|
|
|
2,333
|
|
|
2,446
|
|
Liabilities
related to assets held for sale
|
|
|
1,993
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Total
Liabilities
|
|
|
326,746
|
|
|
310,683
|
|
|
|
|
|
|
|
|
|
Minority
interests
|
|
|
45,984
|
|
|
44,484
|
|
Commitments,
contingencies and guarantees (Note 12)
|
|
|
|
|
|
|
|
Shareholders’
Equity:
|
|
|
|
|
|
|
|
Preferred
shares, unlimited authorized, none issued
|
|
|
—
|
|
|
—
|
|
Class A
Shares, no par value, unlimited authorized, 24,159,715 and 23,437,615
shares issued in 2006 and 2005
|
|
|
183,198
|
|
|
178,589
|
|
Class B
Shares, no par value, unlimited authorized, 2,502 shares issued in
2006
and 2005, each convertible into one Class A share
|
|
|
1
|
|
|
1
|
|
Share
capital to be issued, 266,856 Class A shares in 2005
|
|
|
—
|
|
|
4,209
|
|
Additional
paid-in capital
|
|
|
24,726
|
|
|
20,028
|
|
Accumulated
deficit
|
|
|
(68,711
|
)
|
|
(53,075
|
)
|
Accumulated
other comprehensive income
|
|
|
4,259
|
|
|
2,396
|
|
Total
Shareholders’ Equity
|
|
|
143,473
|
|
|
152,148
|
|
Total
Liabilities and Shareholders’ Equity
|
|
$
|
516,203
|
|
$
|
507,315
|
|
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of these statements.
MDC
PARTNERS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(thousands
of United States dollars)
|
|
Six Months Ended June
30,
|
|
|
|
2006
|
|
2005
Revised Note 1
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
loss
|
|
$
|
(15,636
|
)
|
$
|
(4,747
|
)
|
Loss
from discontinued operations
|
|
|
(10,524
|
)
|
|
(2,989
|
)
|
Loss
from continuing operations
|
|
|
(5,112
|
)
|
|
(1,758
|
)
|
Adjustments
to reconcile net loss to cash provided by (used in) operating
activities
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
11,900
|
|
|
9,770
|
|
Non-cash
stock-based compensation
|
|
|
4,851
|
|
|
1,794
|
|
Amortization
of deferred finance charges
|
|
|
824
|
|
|
588
|
|
Deferred
income taxes
|
|
|
(2,504
|
)
|
|
(2,960
|
)
|
Earnings
of non-consolidated affiliates
|
|
|
(501
|
)
|
|
(275
|
)
|
Minority
interest and other
|
|
|
(364
|
)
|
|
(112
|
)
|
Changes
in non-cash working capital:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(14,605
|
)
|
|
6,487
|
|
Expenditures
billable to clients.
|
|
|
(6,873
|
)
|
|
(3,407
|
)
|
Prepaid
expenses and other current assets
|
|
|
(944
|
)
|
|
(1,832
|
)
|
Accounts
payable, accruals and other liabilities
|
|
|
25,781
|
|
|
(11,716
|
)
|
Advance
billings
|
|
|
(846
|
)
|
|
(1,376
|
)
|
Cash
flows from continuing operating activities
|
|
|
11,607
|
|
|
(4,797
|
)
|
Discontinued
operations
|
|
|
1,604
|
|
|
1,513
|
|
Net
cash provided by (used in) operating activities
|
|
|
13,211
|
|
|
(3,284
|
)
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(11,297
|
)
|
|
(4,970
|
)
|
Acquisitions,
net of cash acquired
|
|
|
(3,591
|
)
|
|
(53,560
|
)
|
Proceeds
of dispositions
|
|
|
557
|
|
|
250
|
|
Distributions
from non-consolidated affiliates
|
|
|
392
|
|
|
536
|
|
Discontinued
operations
|
|
|
(1,186
|
)
|
|
(1,807
|
)
|
Net
cash used in investing activities
|
|
|
(15,125
|
)
|
|
(59,551
|
)
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Increase
(decrease) in bank indebtedness
|
|
|
(2,799
|
)
|
|
1,338
|
|
Proceeds
from issuance of long term debt
|
|
|
—
|
|
|
36,723
|
|
Proceeds
from (payments of) revolving credit facility
|
|
|
(2,000
|
)
|
|
25,500
|
|
Repayment
of long-term debt
|
|
|
(767
|
)
|
|
(3,256
|
)
|
Issuance
of share capital
|
|
|
150
|
|
|
16
|
|
Subsidiary
issuance of share capital
|
|
|
385
|
|
|
—
|
|
Deferred
financing costs
|
|
|
—
|
|
|
(3,316
|
)
|
Discontinued
operations
|
|
|
(521
|
)
|
|
(371
|
)
|
Net
cash (used in) provided by financing activities
|
|
|
(5,552
|
)
|
|
56,634
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
(275
|
)
|
|
(358
|
)
|
Net
decrease in cash and cash equivalents
|
|
|
(7,741
|
)
|
|
(6,559
|
)
|
Cash
and cash equivalents at beginning of period
|
|
|
12,923
|
|
|
22,673
|
|
Cash
and cash equivalents at end of period
|
|
$
|
5,182
|
|
$
|
16,114
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures:
|
|
|
|
|
|
|
|
Cash
income taxes paid
|
|
$
|
859
|
|
$
|
565
|
|
Cash
interest paid
|
|
$
|
4,746
|
|
$
|
2,790
|
|
Non-cash
transactions:
|
|
|
|
|
|
|
|
Share
capital issued on acquisitions
|
|
$
|
4,459
|
|
$
|
14,493
|
|
Capital
leases
|
|
|
—
|
|
$
|
122
|
|
Note
receivable exchanged for shares in subsidiary
|
|
$
|
1,155
|
|
$
|
|
|
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of these statements.
MDC
PARTNERS INC. AND SUBSIDIARIES
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(thousands
of United States dollars, unless otherwise stated)
MDC
Partners Inc. (the “Company”) has prepared the unaudited condensed consolidated
interim financial statements included herein pursuant to the rules and
regulations of the United States Securities and Exchange Commission (the “SEC”).
Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles (“GAAP”) of the United States of America (“US GAAP”) have been
condensed or omitted pursuant to these rules.
The
accompanying financial statements reflect all adjustments, consisting of
normally recurring accruals, which in the opinion of management are necessary
for a fair presentation, in all material respects, of the information contained
therein. Results of operations for interim periods are not necessarily
indicative of annual results.
These
statements should be read in conjunction with the consolidated financial
statements and related notes included in the annual report on Form 10-K for
the year ended December 31, 2005.
As
of the
quarter ended September 30, 2005, the Company changed the composition of
its reportable segments as disclosed in Note 11. Accordingly, to reflect this
change in composition, the Company has restated the previously reported segment
information for the three and six months ended June 30, 2005.
As
of the
quarter ended December 31, 2005, the Company revised the 2005 statement of
cash flows to separately disclose the operating, investing and financing
portions of the cash flows attributable to its discontinued operations.
Accordingly, the six months ended June 30, 2005 statement of cash flows has
been
revised to conform to such presentation.
As
of
June 30, 2006, the Company has classified the assets and liabilities of the
Company’s Secure Paper Business and Secure Cards Business as held for sale and
accordingly has classified the results of their operations as discontinued
operations.
2.
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. 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 in consolidation.
Use
of Estimates. The
preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions. These estimates and assumptions
affect the reported amounts of assets and liabilities including goodwill,
intangible assets, valuation allowances for receivables and deferred tax assets,
and the reporting of variable interest entities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. The estimates 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 could differ
from those estimates.
Concentration
of Credit Risk.
The
Company provides marketing communications services to clients who operate in
most industry sectors. Credit is granted to qualified clients in the ordinary
course of business. Due to the diversified nature of the Company’s client base,
the Company does not believe that it is exposed to a concentration of credit
risk; however, two clients
accounted for 11.7% and 11.2% of the Company’s consolidated accounts receivable
at June 30, 2006 and one client accounted for 16.9% and 15.1% of
revenue for the three and six months ended June 30, 2006 respectively. For
the
three and six months ended June 30, 2005, no client accounted for more than
10%
of revenue. As of December 31, 2005, no client accounted for more than 10%
of
accounts receivable.
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 June
30,
2006 and December 31, 2005, is $1,333 and $1,301, respectively, of cash
restricted as to withdrawal pursuant to a collateral agreement and a customer’s
contractual agreement.
Stock-Based
Compensation. Effective
January 1, 2003, the Company prospectively adopted fair value accounting
for stock-based awards as prescribed by SFAS No. 123 “Accounting for
Stock-Based Compensation” (“SFAS No. 123”). Prior to January 1, 2003,
the Company elected not to apply fair value accounting to stock-based awards
to
employees, other than for direct awards of stock and awards settleable in cash,
which required fair value accounting. Prior to January 1, 2003, for awards
not elected to be accounted for under the fair value method, the Company
accounted for stock-based awards 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 awards.
Under
this method, compensation cost is measured as the excess, if any, of the quoted
market price of the stock issuance at the measurement date over the amount
to be
paid by the employee.
The
Company adopted fair value accounting for stock-based awards using the
prospective application transitional alternative available in SFAS 148
“Accounting for Stock-Based Compensation—Transition and Disclosure”.
Accordingly, the fair value method is applied to all awards granted, modified
or
settled on or after January 1, 2003. Under the fair value method,
compensation cost is measured at fair value at the date of grant and is expensed
over the service period, that is the award’s vesting period. When awards are
exercised, share capital is credited by the sum of the consideration paid
together with the related portion previously credited to additional paid-in
capital when compensation costs were charged against income or acquisition
consideration.
Stock-based
awards that are settled in cash or may be settled in cash at the option of
employees are recorded as liabilities. The measurement of the liability and
compensation cost for these awards is based on the intrinsic value of the award,
and is recorded as a charge to operating income over the service period, that
is
the vesting period of the award in accordance with FASB Interpretation Number
28- “Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans—an interpretation of APB Opinions No. 15 and 25”(“FIN 28”).
Changes in the Company’s payment obligation subsequent to vesting of the award
and prior to the settlement date are recorded as compensation cost in operating
income in the period of the change. The final payment amount for such awards
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 the 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 as a
charge to operating income over the service period, that is the vesting period
of the award.
Effective
January 1, 2006, the Company adopted FAS 123(R) and has opted to use
the modified prospective application transition method. Under this method the
Company will not restate its prior financial statements. Instead, the Company
will apply FAS 123(R) for new awards granted after the adoption of FAS
123(R), any portion of awards that were granted after December 15, 1994 and
have not vested as of January 1, 2006, and any outstanding liability
awards.
Measurement
of compensation cost for awards that are outstanding and classified as equity,
at January 1, 2006, will be based on the original grant-date fair value
calculations of those awards. The Company had previously adopted FAS 123 and
as
such has been expensing the fair value of all awards issued after
January 1, 2003. For all previously issued awards, the Company has been
providing pro-forma disclosure for such awards. Upon the adoption of FAS 123(R),
the Company expenses the fair value of the awards granted prior to
January 1, 2003. The Company has adopted the straight-line attribution
method for determining the compensation cost to be recorded during each
accounting period. The adoption of FAS 123(R) did not have a material
effect on the Company’s financial position or results of
operations.
The
table
below summarizes what the quarterly pro forma effect for the three and six
months ended June 30, 2005, would have been had the Company adopted the fair
value method of accounting for stock options and similar instruments for awards
issued prior to 2003 and prior to the adoption of FAS 123(R):
|
|
Three Months Ended
June 30, 2005
|
|
Six Months Ended
June 30, 2005
|
|
Net
loss as reported
|
|
$
|
(964
|
)
|
$
|
(4,747
|
)
|
|
|
|
|
|
|
|
|
Fair
value costs, net of income tax, of stock-based employee compensation
for
options issued prior to 2003
|
|
|
170
|
|
|
361
|
|
Net
loss pro forma
|
|
$
|
(1,134
|
)
|
$
|
(5,108
|
)
|
|
|
|
|
|
|
|
|
Basic
net loss per share, as reported
|
|
$
|
(0.04
|
)
|
$
|
(0.21
|
)
|
Basic
net loss per share, pro forma
|
|
$
|
(0.05
|
)
|
$
|
(0.22
|
)
|
Diluted
net loss per share, as reported
|
|
$
|
(0.04
|
)
|
$
|
(0.21
|
)
|
Diluted
net loss per share, pro forma
|
|
$
|
(0.05
|
)
|
$
|
(0.22
|
)
|
The
fair
value of the stock options and similar awards at the grant date were estimated
using the Black-Scholes option-pricing model with the following weighted average
assumptions for the following period:
|
|
Three
and Six Months Ended
June 30, 2006
|
|
Three Months Ended
June 30, 2005
|
|
Six Months Ended
June 30, 2005
|
|
|
|
|
|
|
|
|
|
Expected
dividend
|
|
|
0.00
|
%
|
|
0.00
|
%
|
|
0.00
|
%
|
Expected
volatility
|
|
|
40
|
%
|
|
40
|
%
|
|
40
|
%
|
Risk-free
interest rate
|
|
|
4.95
|
%
|
|
3.3
|
%
|
|
3.3
|
%
|
Expected
option life in years
|
|
|
5-7
|
|
|
3
|
|
|
3
|
|
Weighted
average stock option fair value per option granted
|
|
$
|
4.74
|
|
$
|
3.74
|
|
$
|
3.78
|
|
On
February 28, 2006, the Company issued 247,500 Class A shares of
financial performance-based restricted stock, and 475,000 financial
performance-based restricted stock units, to its employees under the 2005 Stock
Incentive Plan. The Class A shares underlying each grant of restricted
stock or restricted stock units will vest upon achievement by the Company of
specified financial performance criteria in 2006, 2007 and 2008. Based on the
Company’s expected financial performance in 2006, the Company currently believes
that 50% of the financial performance-based awards to employees will vest on
March 15, 2007. Accordingly, the Company is recording a non-cash stock
based compensation charge of $3,089 from the date of grant through
March 15, 2007.
On
March 6, 2006, the Company issued 16,000 Class A shares of restricted
stock and 8,000 restricted stock units to its non-employee Directors under
the
2005 Stock Incentive Plan. These awards to non-employee Directors vest on the
third anniversary of the grant date. Accordingly, the Company is recording
a
$205 non-cash compensation charge over the three year vesting
period.
On
April
28, 2006, the Company issued 50,000 restricted stock units to an employee;
15,000 of these units will vest based upon the achievement by the Company of
specified financial criteria in 2006, 2007 and 2008. The remaining 35,000 of
these units will vest on the third anniversary of the grant date. Accordingly,
the Company is recording a $380 non-cash compensation charge over the three-year
vesting period. In addition, the Company issued 10,000 Stock Appreciation Rights
to the same employee. The Company also issued 125,000 options to certain
non-employee Directors.
For
the
three and six months ended June 30, 2006, the Company has recorded a charge
of
$789 and $1,042, respectively relating to the restricted stock and restricted
stock unit grants. The value of the awards was determined based on the fair
market value of the underlying stock on the date of grant. The 263,500
Class A shares of restricted stock granted to employees and non-employee
Directors are included in the Company’s calculation of Class A shares
outstanding as of June 30, 2006.
Derivative
Financial Instruments.
The
Company follows SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities”. 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
accounting for the change in fair value of the derivative depends on whether
the
instrument qualifies for and has been designated as a hedging relationship
and
on the type of hedging relationship. There are three types of hedging
relationships: a cash flow hedge, a fair value hedge and a hedge of foreign
currency exposure of a net investment in a foreign operation. The designation
is
based upon the exposure being hedged. Derivatives that are not hedges, or become
ineffective hedges, must be adjusted to fair value through
earnings.
Effective
June 28, 2005, the Company entered into a cross currency swap contract
(“Swap”), a form of derivative. The Swap contract provides for a notional amount
of debt fixed at $45,000 Canadian dollars (“C$”) and at $36,452, with the
interest rates fixed at 8% per annum for the Canadian dollar amount and fixed
at
8.25% per annum for the US dollar amount. Consequently, under the terms of
this
Swap, semi-annually, the Company will receive interest of C$1,800 and will
pay
interest of $1,503 per annum. At December 31, 2005, the Swap fair value was
estimated to be a receivable of $165, and is reflected in other assets on the
Company’s balance sheet with the change in the value of the swap reflected in
interest expense. On June 22, 2006, the Company settled this swap for its fair
value of $357, which resulted in a gain of $192 for the three and six months
ended June 30, 2006 and is included in other income.
3. Loss
Per Common Share
The
following table sets forth the computation of basic and diluted income (loss)
per common share from continuing operations for the three and six months ended
June 30:
|
|
Three Months Ended June
30,
|
|
Six Months Ended June
30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Numerator
|
|
|
|
|
|
|
|
|
|
Numerator
for basic income (loss) per common share - loss from continuing
operations
|
|
$
|
(869
|
)
|
$
|
521
|
|
$
|
(5,112
|
)
|
$
|
(1,758
|
)
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense on convertible debentures, net of taxes of nil
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Numerator
for diluted income (loss) per common share - loss from continuing
operations plus assumed conversion
|
|
$
|
(869
|
)
|
$
|
521
|
|
$
|
(5,112
|
)
|
$
|
(1,758
|
)
|
Denominator
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic loss per common share - weighted average common
shares
|
|
|
23,858,327
|
|
|
23,521,175
|
|
|
23,818,182
|
|
|
22,867,842
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8%
convertible debentures
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Employee
stock options, warrants, and stock appreciation rights
|
|
|
—
|
|
|
1,067,051
|
|
|
—
|
|
|
—
|
|
Dilutive
potential common shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for diluted loss per common share - adjusted weighted shares and
assumed
conversions
|
|
|
23,858,327
|
|
|
24,588,226
|
|
|
23,818,182
|
|
|
22,867,842
|
|
Basic
income (loss) per common share from continuing operations
|
|
$
|
(0.04
|
)
|
$
|
0.02
|
|
$
|
(0.22
|
)
|
$
|
(0.08
|
)
|
Diluted
income (loss) per common share from continuing operations
|
|
$
|
(0.04
|
)
|
$
|
0.02
|
|
$
|
(0.22
|
)
|
$
|
(0.08
|
)
|
The
8%
convertible debentures, options and other rights to purchase 8,928,870 shares
of
common stock, which includes 263,500 shares of non-vested restricted stock,
were
outstanding during the three and six months ended June 30, 2006, but were not
included in the computation of diluted loss per common share because their
effect would be antidilutive. Similarly, during the three and six months ended
June 30, 2005, options and other rights to purchase 1,815,705 and 4,970,105
shares, respectively of common stock were outstanding but were not included in
the computation of diluted loss per common share because either the exercise
prices were greater than the average market price of the common shares and/or
their effect would be antidilutive.
4. Acquisitions
2006
Acquisitions
On
February 7, 2006, the Company purchased the remaining outstanding
membership interests of 12.33% of Source Marketing LLC (“Source”) pursuant to an
exercise of a put option notice delivered in October 2005. The purchase
price of $2,287 consisted of cash of $1,830 and the delivery of 1,063,516 shares
of LifeMed Media Inc. (“LifeMed”) valued at $457. The Company’s carrying value
of these LifeMed shares was $27, thus the Company recorded a gain on the
disposition of these shares of $430, which has been included in other
income.
On
February 15, 2006, Source issued 15% of its membership interests to certain
members of management. The purchase price for these membership interests was
$1,540, which consisted of $385 cash and recourse notes in an aggregate
principal amount equal to $1,155. In addition, the purchaser also received
a
fully vested option to purchase an additional 5% of Source at an exercise price
equal to the price paid above. The option is exercisable any time prior to
December 31, 2010. An amended and restated LLC agreement was entered into
with these new members. The agreement also provides these members with an option
to put to the Company these membership interests from December 2008-2012.
As a result of the above transactions, the Company now owns 85% of Source.
During the quarter ended March 31, 2006, the Company recorded a non-cash
stock based compensation charge of $2,338 relating to the price paid for the
membership interests which was less than the fair value of such membership
interests and the fair value of the option granted.
2005
Acquisitions
Zyman
Group
On
April 1, 2005, the Company, through a wholly owned subsidiary, purchased
approximately 61.6% of the total outstanding membership units of Zyman Group,
LLC (“Zyman Group”) for purchase price consideration of $52,389 in cash and
1,139,975 Class A shares of the Company, valued at $11,257 based on the
share price on or about the announcement date. Related transaction costs of
approximately $976 were also incurred. In addition, the Company may be required
to pay up to an additional $12,000 to the sellers if Zyman Group achieves
specified financial targets for the twelve month periods ending June 30,
2006 and/or June 30, 2007. For the period ending June 30, 2006, such
financial targets were not achieved.
In
connection with the Zyman Group acquisition, the Company, Zyman Group and the
other unitholders of Zyman Group entered into a new Limited Liability Company
Agreement (the “LLC Agreement”). The LLC Agreement sets forth certain economic,
governance and liquidity rights with respect to Zyman Group. Zyman Group
initially has seven managers, four of whom were appointed by the Company.
Pursuant to the LLC Agreement, the Company will have the right to purchase,
and
may have an obligation to purchase, for a combination of cash and shares,
additional membership units of Zyman Group from the other members of Zyman
Group, in each case, upon the occurrence of certain events or during certain
specified time periods.
The
Zyman
Group name is well recognized for strategic marketing consulting and as such
was
acquired by the Company for its assembled workforce to enhance the creative
talent within the Company’s Strategic Marketing Service segment of
businesses.
The
Zyman
Group acquisition was accounted for as a purchase business combination. The
purchase price of the net assets acquired in this transaction is $64,622. The
final allocation of the cost of the acquisition to the fair value of net assets
acquired and minority interests is as follows:
Cash
and cash equivalents
|
|
$
|
5,653
|
|
Accounts
receivable and other current assets
|
|
|
6,734
|
|
Fixed
assets and other assets
|
|
|
7,785
|
|
Goodwill
(tax deductible)
|
|
|
45,349
|
|
Intangible
assets
|
|
|
20,143
|
|
Accounts
payable, accrued expenses and other liabilities
|
|
|
(7,475
|
)
|
Total
debt
|
|
|
(8,524
|
)
|
Minority
interest at carrying value
|
|
|
(5,043
|
)
|
Total
cost of the acquisition
|
|
$
|
64,622
|
|
Identifiable
intangible assets of $20,143 are comprised primarily of customer relationships
and related backlog and trademarks. The allocation of the purchase price to
assets acquired and liabilities assumed is based upon estimates of fair values
and certain assumptions that the Company believes are reasonable under the
circumstances. The Company’s consolidated financial statements include Zyman
Group’s results of operations subsequent to its acquisition on April 1,
2005.
During
the first five years following MDC’s acquisition of the Zyman Group, MDC’s
allocation of profits of the Zyman Group may differ from its proportionate
share
of ownership. On an annual basis, the Company receives a 20% priority return
calculated based on its total investment in Zyman Group. Thereafter, based
on
calculations set forth in the operating agreement of Zyman Group (the “LLC
Agreement”), the Company’s share of remaining Zyman Group profits in excess of
the annual “threshold” amount of $20,600 may be disproportionately less than its
equity ownership in Zyman Group. Specifically, on an annual basis, if Zyman
operating results exceed a defined operating margin, the Company would be
entitled to 25% of the excess margins in the first two years of the LLC
Agreement and 30% of the excess margins in the following three years of the
LLC
Agreement, rather than the Company’s equity portion of 61.6%. After the first
five years, the earnings of the Zyman Group will be allocated in a proportion
equal to the respective equity interests of the members.
As
of
June 30, 2006, the annual priority return is expected to be approximately
$12,700, with the minority owners receiving the next $7,900 up to the threshold
amount. If profits are insufficient to meet the Company’s priority return during
any of the first five years, the Company will receive a catch-up payment through
year five equal to any shortfall from the prior year(s). Furthermore, if profits
do not reach the threshold amount during the first five years, the minority
owners will be entitled to receive a catch-up payment through year five equal
to
any shortfall from the prior year(s). Based on Zyman Group’s expected results
for 2006, the Company does not expect to receive more than its priority return
from Zyman Group in 2006.
Neuwirth
On
December 1, 2005, the Company, through its subsidiary Northstar Research
Partners (USA) LLC (“NS LLC”), purchased the business of Neuwirth
Research, Inc. (“Neuwirth”) for purchase price consideration of $450 in
cash, a 20% equity interest in NS LLC valued at $225 based on the estimated
market value of NS LLC on or about the announcement date, and 48,391 MDC
Class A shares valued at $300. Related transaction costs of approximately
$100 were also incurred. In addition, the Company was required to pay up to
an
additional $625 in cash to the seller if the acquired Neuwirth business achieves
specified financial targets for the year ended December 31, 2005 and/or
December 31, 2006. As of March 31, 2006, the Company determined that
these targets were achieved and, accordingly, the $625 payment obligation was
settled by the Company’s issuance of 30,058 Class A shares MDC stock valued
at $250 and cash of $375.
In
connection with the Neuwirth acquisition, the Company and seller entered into
agreements related to governance and certain put option rights with respect
to
the seller’s 20% equity interest in NS LLC which becomes 50% exercisable in 2010
and 100% exercisable in 2015.
Neuwirth
is a recognized market research firm and was acquired by the Company for its
list of blue chip clients and synergies with NS LLC existing business. This
acquisition is part of the Specialized Communications Services segment of
businesses.
The
Neuwirth acquisition was accounted for as a purchase business combination.
The
allocation of the cost of the acquisition to the fair value of net assets
acquired is as follows:
Accounts
receivable and other current assets
|
|
$
|
492
|
|
Fixed
assets and other assets
|
|
|
50
|
|
Intangible
assets
|
|
|
1,680
|
|
Accounts
payable, accrued expenses and other liabilities
|
|
|
(522
|
)
|
Total
cost of the acquisition
|
|
$
|
1,700
|
|
Identifiable
intangible assets, consisting of an employment agreement, estimated to be
$1,680, is being amortized on a straight—line basis over ten years. The
allocation of the purchase price to assets acquired and liabilities assumed
is
based upon estimates of fair values and certain assumptions that the Company
believes are reasonable under the circumstances. The Company’s consolidated
financial statements include Neuwirth’s results of operations subsequent to its
acquisition on December 1, 2005.
Powell
On
July 25, 2005, the Company, through its subsidiary Margeotes Fertitta
Powell, LLC, (“MFP”) purchased the business of Powell, LLC (“Powell”) for
purchase price consideration of $332 in cash and a 5% equity interest in MFP
valued at $400 based on the estimated market value of MFP on or about the
announcement date. The issuance of equity interests by MFP resulted in a loss
of
$103 on the dilution of the Company’s equity interest in its subsidiary. Related
transaction costs of approximately $20 were also incurred. In addition, the
Company may be required to pay up to an additional $300 in cash to the seller
if
the acquired Powell business achieves specified financial targets for the year
ended July 31, 2006. As of December 31, 2005, the Company accrued $300
of the additional consideration as the financial targets have been met and
continue to be met as of June 30, 2006.
In
connection with the Powell acquisition, the Company and seller entered into
agreements related to governance and certain put option rights with respect
to
seller’s 5% equity interest in MFP, which become exercisable in
2010.
Powell
is
a well recognized, highly creative advertising agency and as such was acquired
by the Company for its creative talent to supplement existing creative agencies
within the Company’s Strategic Marketing Services segment of
businesses.
The
Powell acquisition was accounted for as a purchase business combination. The
allocation of the cost of the acquisition to the fair value of net assets
acquired is as follows:
Accounts
receivable and other current assets
|
|
$
|
32
|
|
Fixed
assets and other assets
|
|
|
31
|
|
Intangible
assets
|
|
|
1,130
|
|
Accounts
payable, accrued expenses and other liabilities
|
|
|
(141
|
)
|
Total
cost of the acquisition
|
|
$
|
1,052
|
|
Identifiable
intangible assets, consisting of an employment agreement, estimated to be
$1,130, is being amortized on a straight-line basis over five years. The
allocation of the purchase price to assets acquired and liabilities assumed
is
based upon estimates of fair values and certain assumptions that the Company
believes are reasonable under the circumstances. The Company’s consolidated
financial statements include Powell’s results of operations subsequent to its
acquisition on July 25, 2005.
Other
Acquisitions and Transactions
On
July 31, 2005, the Company acquired a further 20% equity interest in its
existing subsidiary MFP pursuant to the exercise of a put obligation under
the
existing purchase agreement with a minority interest holder. The purchase price
of $1,740 which includes $15 of acquisition costs was paid in cash. Of the
purchase price, $500 was allocated to customer relationship intangible assets
and $1,240 was allocated to goodwill. The allocation of the purchase price
to
assets acquired and liabilities assumed is based upon certain assumptions that
the Company believes are reasonable under the circumstances. As a result of
this
acquisition, and the Powell transaction discussed above, the Company retains
a
95% equity interest in MFP.
On
September 1, 2005, the Company, through a consolidated variable interest
entity, Crispin Porter + Bogusky, LLC (“CPB”), purchased 20% of the total
outstanding membership units of Fuseproject, LLC (“Fuseproject”) for purchase
price consideration of $750 in cash and an additional $400, which was paid
during the quarter ended March 31, 2006. Fuseproject is a design firm
acquired by CPB to complement its creative offerings. The Fuseproject
acquisition was accounted for using the equity method as CPB has significant
influence over the operations of Fuseproject. The purchase price of the net
assets acquired in this transaction is $1,150. The allocation of the cost of
the
acquisition to the fair value of the net assets acquired resulted in a portion
being attributed to intangible assets valued at $40 and $1,090 consisting of
goodwill. The allocation of the purchase price to assets acquired and
liabilities assumed is based upon estimates of fair values and certain
assumptions that the Company believes are reasonable under the circumstances.
The Company’s consolidated financial statements include Fuseproject’s results of
operations in equity in earnings of non-consolidated affiliates subsequent
to
its acquisition on September 1, 2005.
During
August 2005, Bryan Mills Group Ltd., (“BMG”) a subsidiary whose operations
are consolidated by the Company, completed the acquisition of 450 shares from
a
minority shareholder at a price of $515.00 per share, for a total purchase
price
of $232. This resulted in the Company’s ownership interest in BMG increasing to
71.2% from 68.0%. Also as a result of the equity transaction by BMG, the Company
recorded goodwill of $146.
During
the quarter ended March 31, 2005, the Company contributed $125 of cash as
additional paid in capital to its existing consolidated subsidiary, Banjo
Strategies Entertainment LLC. There was no change in the Company’s ownership
interest. This resulted in a loss on dilution of $61 and is reflected in the
Company’s consolidated statement of operations. During the quarter ended
June 30, 2005, the Company acquired further equity interests in the
existing consolidated subsidiaries of Allard Johnson Communications Inc. (0.3%)
and Banjo Strategies Entertainment LLC (7.2%). In aggregate, the Company paid
$143 in cash for these incremental ownership interests. During the quarter
ended
September 30, 2005, the Company acquired a further 0.7% equity interest in
the existing consolidated subsidiary, Allard Johnson Communications Inc., for
$148.
Pro
forma
Information
The
following unaudited pro forma results of operations of the Company for the
six
months ended June 30, 2005 assume that the acquisition of the operating assets
of the significant businesses acquired during 2005 had occurred on
January 1st
of the
respective year in which the business was acquired. 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
this period, or are they necessarily indicative of future results of
operations.
|
|
Six Months Ended
June
30, 2005
|
|
Revenues
|
|
$
|
178,453
|
|
Net
loss
|
|
$
|
(2,937
|
)
|
Loss
per common share:
|
|
|
|
|
Basic
- net loss
|
|
$
|
(0.13
|
)
|
Diluted
- net loss
|
|
$
|
(0.13
|
)
|
5. Inventory
The
components of inventory are listed below:
|
|
December 31, 2005
|
|
Raw
materials and supplies
|
|
$
|
4,860
|
|
Work-in-process
|
|
|
5,499
|
|
Total
|
|
$
|
10,359
|
|
6. Discontinued Operations
In
June
2006, the Company’s Board of Directors made the decision to sell or otherwise
divest the Company’s Secure Paper Business and Secure Card Business
(collectively, “SPI”). Since that date, the Company has engaged in active
negotiations for the sale of the SPI Group. As of the date of this Form 10-Q
filing, the Company continues to pursue the sale of the SPI Group with
interested parties, but has not entered into a definitive agreement with any
potential buyer.
Based
on
these events, management has concluded that the criteria for the
assets/liabilities of SPI to be accounted for as assets/liabilities held for
sale and the results of operations to be accounted for as discontinued
operations have been met. Discontinued operations relating to SPI for the three
months ended June 30, 2006 and 2005 amounted to net losses of $9,634 and $1,255,
respectively. For the six months ended June 30, 2006 and 2005, discontinued
operations relating to SPI amounted to net losses of $10,524 and $2,687,
respectively. Based on the estimated net proceeds from a sale, the Company
has
recorded an impairment loss relating to SPI’s net assets of approximately $7,900
for the three and six months ended June 30, 2006. This loss has been included
in
discontinued operations for the three and six months ended June 30, 2006. Based
on the estimated net proceeds and average borrowing rate for each period, the
Company has allocated interest expense to discontinued operations of $564 and
$1,128 for the three and six months ended 2006 and $418 and $835 for the three
and six months ended June 30, 2005.
During
July 2005, LifeMed, a variable interest entity whose operations had been
consolidated by the Company, completed a private placement issuing approximately
12.5 million shares at a price of $0.4973 per share. LifeMed received net
proceeds of approximately $6,200. Consequently, the Company’s ownership interest
in LifeMed was reduced to 18.3%, and of LifeMed, the Company recorded a gain
of
$1,300. This gain represents the Company’s reversal of a liability related to
funding obligations that the Company is no longer obligated to fund. The Company
no longer has any significant continuing involvement in the management or
operations of LifeMed, and has not participated in the purchase of significant
new equity offerings of LifeMed. Consequently, as of July 2005, the Company
no longer consolidated the operations of LifeMed, commenced accounting for
its
remaining investment in LifeMed on a cost basis, and has reported the results
of
operations of LifeMed as discontinued operations for all periods presented.
In
February 2006, the Company sold 27% of its remaining ownership in LifeMed
as partial settlement of a put option (see Note 4). As of June 30, 2006, the
Company holds a 13.4% interest in LifeMed. As of June 30, 2006 and December
31,
2005, other assets include $73 and $100, respectively of the Company’s net
investment in LifeMed.
In
November 2004, the Company’s management reached a decision to discontinue
the operations of a component of its business. This component is comprised
of
the Company’s UK based marketing communications business, a wholly owned
subsidiary named Mr. Smith Agency, Ltd. (“Mr. Smith”, formerly known as
Interfocus Networks Limited). The Company decided to dispose of the operations
of this business due to its unfavorable economics. Substantially all of the
net
assets of the discontinued business were sold during the fourth quarter of
2004
with the disposition of all activities of Mr. Smith and remaining sale of
assets was substantially complete by the end of the first quarter of 2005.
No
significant one-time termination benefits were incurred or are expected to
be
incurred. No further significant other charges are expected to be
incurred.
For
the
three and six months ended June 30, 2005, discontinued operations relating
to
LifeMed and Mr. Smith amounted to net losses of $230 and $302,
respectively.
Included
in discontinued operations in the Company’s consolidated statement of operations
for the three and six months ended June 30, 2006 and 2005 were the
following:
|
|
Three Months Ended June
30,
|
|
Six
Months Ended June 30, |
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenue
|
|
$
|
17,372
|
|
$
|
18,127
|
|
$
|
35,939
|
|
$
|
36,797
|
|
Depreciation
expense and impairment charge
|
|
$
|
9,065
|
|
$
|
1,071
|
|
$
|
10,189
|
|
$
|
2,136
|
|
Operating
loss
|
|
$
|
(8,364
|
)
|
$
|
(2,080
|
)
|
$
|
(8,740
|
)
|
$
|
(3,052
|
)
|
Other
expense
|
|
$
|
(1,395
|
)
|
$
|
(347
|
)
|
$
|
(1,927
|
)
|
$
|
(775
|
)
|
Income
tax recovery
|
|
$
|
125
|
|
$
|
942
|
|
$
|
143
|
|
$
|
578
|
|
Minority
interest recovery
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
260
|
|
Net
loss from discontinued operations
|
|
$
|
(9,634
|
)
|
$
|
(1,485
|
)
|
$
|
(10,524
|
)
|
$
|
(2,989
|
)
|
As
of
June 30, 2006, the carrying value on the Company’s balance sheet of the assets
and liabilities to be disposed were as follows:
|
|
June
30,
|
|
|
|
2006
|
|
Assets
held for sale:
|
|
|
|
Accounts
receivable
|
|
$
|
10,660
|
|
Inventories
|
|
|
11,872
|
|
Other
current assets
|
|
|
1,679
|
|
Fixed
assets
|
|
|
21,082
|
|
Other
long-term assets
|
|
|
1,873
|
|
Total
assets
|
|
$
|
47,166
|
|
|
|
|
|
|
Liabilities
related to assets held for sale:
|
|
|
|
|
Accounts
payable and other current liabilities
|
|
$
|
8,383
|
|
Advance
billings
|
|
|
5,082
|
|
Other
|
|
|
2,796
|
|
Total
liabilities
|
|
$
|
16,261
|
|
Total
comprehensive loss and its components were:
|
|
Three Months Ended June
30,
|
|
Six
Months Ended June 30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Net
loss for the period
|
|
$
|
(10,503
|
)
|
$
|
(964
|
)
|
$
|
(15,636
|
)
|
$
|
(4,747
|
)
|
Foreign
currency cumulative translation adjustment
|
|
$
|
1,379
|
|
$
|
(1,461
|
)
|
$
|
1,254
|
|
$
|
(2,006
|
)
|
Comprehensive
loss for the period
|
|
$
|
(9,124
|
)
|
$
|
(2,425
|
)
|
$
|
(14,382
|
)
|
$
|
(6,753
|
)
|
8. Short-Term
Debt, Long-Term Debt and Convertible Debentures
Debt
consists of:
|
|
June 30, 2006
|
|
December 31,
2005
|
|
Short-term
debt
|
|
$
|
940
|
|
$
|
3,739
|
|
Revolving
credit facility
|
|
|
71,500
|
|
|
73,500
|
|
8%
convertible debentures
|
|
|
40,315
|
|
|
38,694
|
|
Notes
payable and other bank loans
|
|
|
5,350
|
|
|
5,650
|
|
Obligations
under capital leases
|
|
|
1,049
|
|
|
5,396
|
|
|
|
|
119,154
|
|
|
126,979
|
|
Less:
|
|
|
|
|
|
|
|
Short-term
debt
|
|
|
940
|
|
|
3,739
|
|
Current
portions
|
|
|
1,242
|
|
|
2,571
|
|
|
|
$
|
116,972
|
|
$
|
120,669
|
|
Short-term
debt represents the swing line under the revolving credit facility and
outstanding checks at the end of the reporting periods.
MDC
Revolving Credit Facility
MDC
Partners Inc. and certain of its wholly-owned subsidiaries entered into a
revolving credit facility with a syndicate of banks, which as of June 30, 2006,
provides for borrowings of up to $100 million (including swing-line advances
of
up to $10 million) maturing in September 2007 (the “Credit Facility”). This
facility bears interest at variable rates based upon the Eurodollar rate, US
bank prime rate, US base rate, and Canadian bank prime rate, at the Company’s
option. Based on the level of debt relative to certain operating results, the
interest rates on loans are calculated by adding between 200 and 325 basis
points on Eurodollar and Bankers Acceptance based interest rate loans, and
between 50 and 175 basis points on all other loan interest rates. The provisions
of the facility contain various covenants pertaining to a minimum ratio of
debt
to net income before interest, income taxes, depreciation and amortization
(“EBITDA”), a maximum debt to capitalization ratio, the maintenance of certain
liquidity levels and minimum shareholders’ equity levels. The facility
restricts, among other things, the levels of capital expenditures, investments,
distributions, dispositions and incurrence of other debt. Effective
April 15, 2006, a 1.0% per annum facility fee is charged on the amount of
the revolving commitments under the Credit Facility in excess of $65,000, which
fee became payable beginning on April 15, 2006 and for so long as the
revolving commitments under the Credit Facility are in excess of $65,000. The
facility is secured by a senior pledge of the Company’s assets principally
comprised of ownership interests in its subsidiaries and by the underlying
assets of the businesses comprising the Company’s Secure Products International
Group and by a substantial portion of the underlying assets of the businesses
comprising the Company’s Marketing Communications Group, the underlying assets
being carried at a value represented by the total assets reflected on the
Company’s consolidated balance sheet at June 30, 2006. In addition, in the event
of a sale of the Company’s secure products business, the Company must repay
advances under the Credit Facility by an amount equal to the net proceeds
received by the Company from such sale (“Sale Net Proceeds”), and the revolving
commitments under the facility would be reduced by an amount equal to the Sale
Net Proceeds. At June 30, 2006, the unused portion of the total facility was
$23,039.
The
Company has classified the swing-line component of this revolving credit
facility as a current liability in accordance with EITF 95-22, “Balance Sheet
Classification of Borrowings Outstanding under Revolving Credit Agreements
that
include both a Subjective Acceleration Clause and a Lock-Box Agreement”. This
component, reflected as short term debt on the balance sheet, is classified
as a
current liability in accordance with EITF 95-22 since the swing-line contains
a
lock box arrangement that requires the cash receipts of the Company to be used
to repay amounts outstanding under the swing-line and the entire credit facility
is subject to subjective acceleration clauses. Management believes that no
conditions have occurred that would result in subjective acceleration by the
lenders, nor do they believe that any such conditions will exist over the next
twelve months. The weighted average interest rate on these current portions
of
debt was 8.2% and 6.7% as of June 30, 2006 and December 31, 2005,
respectively.
The
Company is currently in compliance with all of the terms and conditions of
its
amended Credit Facility and management believes that, based on its current
financial projections, the Company will be in compliance with its financial
covenants over the next twelve months. However, as a result of the need to
obtain waivers and amend the Credit Facility in the past reporting periods,
the
Company has classified the outstanding debt under the Credit Facility as
current. Although such debt has been classified as current, the maturity of
the
Credit Facility remains September 22, 2007.
As
of
June 30, 2006 and December 31, 2005, $3,656 and $5,336 of the consolidated
cash position is held by subsidiaries, which, although available for the
subsidiaries’ use, does not represent cash that is available for use to reduce
MDC Partners Inc. indebtedness.
8%
Convertible Unsecured Subordinated Debentures
On
June 28, 2005, the Company completed an offering in Canada of convertible
unsecured subordinated debentures amounting to C$45,000 ($36,723) (the
“Debentures”). The Debentures mature on June 30, 2010 and bear interest at
an annual rate of 8.00% payable semi-annually, in arrears, on June 30 and
December 31 of each year. The Company did not have an effective resale
registration statement filed with the SEC on December 31, 2005, and as a
result the rate of interest increased by an additional 0.50% for the first
six
month period following December 31, 2005. As of April 19, 2006, the
Company had an effective resale registration statement and as a result the
interest rate returned to 8.0% effective July 1, 2006. Unless an event of
default has occurred and is continuing, the Company may elect, from time to
time, subject to applicable regulatory approval, to issue and deliver
Class A subordinate voting shares to the Debenture trustee in order to
raise funds to satisfy all or any part of the Company’s obligations to pay
interest on the Debentures in accordance with the indenture in which holders
of
the Debentures will be entitled to receive a cash payment equal to the interest
payable from the proceeds of the sale of such Class A subordinate voting
shares by the Debenture trustee.
The
Debentures are convertible at the holder’s option into fully-paid,
non-assessable and freely tradeable Class A subordinate voting shares of
the Company, at any time prior to maturity or redemption, subject to the
restrictions on transfer, at a conversion price of C$14.00 ($12.54 as of June
30, 2006) per Class A subordinate voting share being a ratio of
approximately 71.4286 Class A subordinate voting shares per C$1,000.00
($896.00 as of June 30, 2006) principal amount of Debentures.
The
Debentures may not be redeemed by the Company on or before June 30, 2008.
Thereafter, but prior to June 30, 2009, the Debentures may be redeemed, in
whole or in part from time to time, at a price equal to the principal amount
of
the Debenture plus accrued and unpaid interest, provided that the volume
weighted average trading price of the Class A subordinate voting shares on
the Toronto Stock Exchange during a specified period is not less than 125%
of
the conversion price. From July 1, 2009 until the maturity of the
Debentures, the Debentures may be redeemed by the Company at a price equal
to
the principal amount of the Debenture plus accrued and unpaid interest, if
any.
The Company may elect to satisfy the redemption consideration, in whole or
in
part, by issuing Class A subordinate voting shares of the Company to the
holders, the number of which will be determined by dividing the principal amount
of the Debenture by 95% of the current market price of the Class A
subordinate voting shares on the redemption date. Upon the occurrence of a
change of control of the Company involving the acquisition of voting control
or
direction over 50% or more of the outstanding Class A subordinate voting
shares prior to June 30, 2008, the Company shall be required to make an
offer to purchase all of the then outstanding Debentures at a price equal to
100% of the principal amount thereof plus an amount equal to the interest
payments not yet received on the Debentures calculated from the date of the
change of control to June 30, 2008, discounted at a specified rate. Upon
the occurrence of a change of control on or after June 30, 2008, the
Company shall be required to make an offer to purchase all of the then
outstanding Debentures at a price equal to 100% of the principal amount of
the
Debentures plus accrued and unpaid interest to the purchase date.
Notes
Payable
In
connection with the Zyman acquisition, the Company assumed a note payable in
the
original amount of $6,275. The note bears interest of 5.73% and is due on
June 8, 2009. The balance of the note payable was $5,350 and $5,589 at June
30, 2006 and December 31, 2005, respectively. The note agreement is secured
by an aircraft and related equipment with a net book value of $4,691 at June
30,
2006.
During
the six months ended June 30, 2006 Class A share capital increased by
$4,609, as the Company (i) issued 30,058 Class A shares in connection
with deferred acquisition consideration, (ii) issued 266,856 Class A
shares previously identified to be issued and (iii) 113,295 Class A
shares related to the exercise of stock options and stock appreciation right
awards. During the six months ended June 30, 2006 “Additional paid-in capital”
increased by $4,698, of which $4,883 related to stock-based compensation that
was expensed during the same period, of which $32 is included in equity in
earnings of non consolidated affiliates, offset by $185 related to the
resolution of a contingency based on the Company’s share price relating to a
previous acquisition.
|
|
Three Months Ended June
30,
|
|
Six
Months Ended June 30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Other
Income
|
|
$
|
—
|
|
$
|
—
|
|
$
|
128
|
|
$
|
35
|
|
Foreign
currency transaction gains
|
|
|
255
|
|
|
67
|
|
|
300
|
|
|
193
|
|
Gain
on sale of assets
|
|
|
254
|
|
|
784
|
|
|
645
|
|
|
785
|
|
|
|
$
|
509
|
|
$
|
851
|
|
$
|
1,073
|
|
$
|
1,013
|
|
11.
Segmented
Information
During
the quarter ended September 30, 2005, the Company reassessed its reportable
operating segments to consist of five segments plus corporate, instead of
reporting only two segments plus corporate. The Company has recast its prior
year disclosures to conform to the current year presentation. The segments
are
as follows:
|
·
|
The
Strategic
Marketing Services (“SMS”)
segment includes Crispin Porter & Bogusky, kirshenbaum bond +
partners, Zyman Group LLC among others. This segment consists of
integrated marketing consulting services firms that offer a full
complement of marketing consulting services including advertising
and
media, marketing communications including direct marketing, public
relations, corporate communications, market research, corporate identity
and branding, interactive marketing and sales promotion. Each of
the
entities within SMS share similar economic characteristics, specifically
related to the nature of their respective services, the manner in
which
the services are provided and the similarity of their respective
customers. Due to the similarities in these businesses, they exhibit
similar long term financial performance and have been aggregated
together.
|
|
·
|
The
Customer
Relationship Management (“CRM”)
segment provides marketing services that interface directly with
the
consumer of a client’s product or service. These services include the
design, development and implementation of a complete customer service
and
direct marketing initiative intended to acquire, retain and develop
a
client’s customer base. This is accomplished using several domestic and
foreign-based customer contact
facilities.
|
|
·
|
The
Specialized
Communications Services
(“SCS”) segment includes all of the Company’s other marketing services
firms that are normally engaged to provide a single or a few specific
marketing services to regional, national and global clients. These
firms
provide niche solutions by providing world class expertise in select
marketing services.
|
The
Company’s two other segments were the Secure Cards Business and Secure Paper
Business segments. In connection with a proposed sale of SPI, the Company has
included results of those segments in discontinued operations. See Note
6.
The
significant accounting polices of these segments are the same as those described
in the summary of significant accounting policies included in the notes to
the
consolidated financial statements included in the Company’s annual report on
Form 10-K for the year ended December 31, 2005, except as where
indicated.
The
SCS
segment is an “Other” segment pursuant SFAS 131 “Disclosures about Segments of
an Enterprise and Related Information”.
Summary
financial information concerning the Company’s operating segments is shown in
the following tables:
Three
Months Ended June 30, 2006
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
58,192
|
|
$
|
20,906
|
|
$
|
21,040
|
|
$
|
—
|
|
$
|
100,138
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
31,914
|
|
|
15,609
|
|
|
13,377
|
|
|
—
|
|
|
60,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expenses
|
|
|
17,314
|
|
|
3,858
|
|
|
3,693
|
|
|
6,320
|
|
|
31,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
3,641
|
|
|
1,126
|
|
|
288
|
|
|
63
|
|
|
5,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/(Loss)
|
|
|
5,323
|
|
|
313
|
|
|
3,682
|
|
|
(6,383
|
)
|
|
2,935
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
509
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,636
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes, equity in affiliates
and
minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,808
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
530
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,338
|
|
Equity
in earnings of non-consolidated affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
227
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(2,657
|
)
|
|
(8
|
)
|
|
(769
|
)
|
|
—
|
|
|
(3,434
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(869
|
)
|
Loss
from discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,634
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(10,503
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation
|
|
$
|
271
|
|
$
|
6
|
|
$
|
—
|
|
$
|
1,530
|
|
$
|
1,807
|
|
Supplemental
Segment Information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
4,860
|
|
$
|
1,051
|
|
$
|
271
|
|
$
|
94
|
|
$
|
6,276
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
and intangibles
|
|
$
|
194,373
|
|
$
|
28,531
|
|
$
|
26,016
|
|
$
|
—
|
|
$
|
248,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
324,473
|
|
$
|
55,566
|
|
$
|
72,842
|
|
$
|
63,322
|
|
$
|
516,203
|
|
Three
Months Ended June 30, 2005 (Restated)
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
54,435
|
|
$
|
16,159
|
|
$
|
19,761
|
|
$
|
—
|
|
$
|
90,355
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
27,227
|
|
|
12,322
|
|
|
12,931
|
|
|
—
|
|
|
52,480
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expense
|
|
|
14,957
|
|
|
2,892
|
|
|
3,044
|
|
|
4,651
|
|
|
25,544
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
5,192
|
|
|
870
|
|
|
219
|
|
|
39
|
|
|
6,320
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/(Loss)
|
|
|
7,059
|
|
|
75
|
|
|
3,567
|
|
|
(4,690
|
)
|
|
6,011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
851
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,624
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes, equity in affiliates
and
minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,238
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
685
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,923
|
|
Equity
in earnings of non-consolidated affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
91
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(4,512
|
)
|
|
(12
|
)
|
|
(969
|
)
|
|
—
|
|
|
(5,493
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
521
|
|
Loss
from discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,485
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(964
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation
|
|
$
|
8
|
|
$
|
28
|
|
$
|
—
|
|
$
|
769
|
|
$
|
805
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Segment Information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
2,604
|
|
$
|
743
|
|
$
|
181
|
|
$
|
17
|
|
$
|
3,545
|
|
Six
Months Ended June 30, 2006
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
118,590
|
|
$
|
39,812
|
|
$
|
39,809
|
|
$
|
—
|
|
$
|
198,211
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
63,654
|
|
|
29,407
|
|
|
27,580
|
|
|
—
|
|
|
120,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expenses
|
|
|
34,300
|
|
|
7,333
|
|
|
6,987
|
|
|
12,387
|
|
|
61,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
9,045
|
|
|
2,189
|
|
|
569
|
|
|
97
|
|
|
11,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/Loss)
|
|
|
11,591
|
|
|
883
|
|
|
4,673
|
|
|
(12,484
|
)
|
|
4,663
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,073
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,173
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes, equity in affiliates
and
minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,563
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,572
|
|
Equity
in earnings of non-consolidated affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
501
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(6,610
|
)
|
|
(38
|
)
|
|
(1,537
|
)
|
|
—
|
|
|
(8,185
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,112
|
)
|
Loss
from discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,524
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(15,636
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation
|
|
$
|
491
|
|
$
|
12
|
|
$
|
2,338
|
|
$
|
2,491
|
|
$
|
5,332
|
|
Supplemental
Segment Information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
6,067
|
|
$
|
4,619
|
|
$
|
419
|
|
$
|
192
|
|
$
|
11,297
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
and intangibles
|
|
$
|
194,373
|
|
$
|
28,531
|
|
$
|
26,016
|
|
$
|
—
|
|
$
|
248,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
324,473
|
|
$
|
55,566
|
|
$
|
72,842
|
|
$
|
|
|
$
|
516,203
|
|
Six
Months Ended June 30, 2005 (Restated)
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
94,112
|
|
$
|
32,502
|
|
$
|
37,453
|
|
$
|
—
|
|
$
|
164,067
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
48,586
|
|
|
25,518
|
|
|
25,566
|
|
|
—
|
|
|
99,670
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expense
|
|
|
26,915
|
|
|
5,121
|
|
|
6,250
|
|
|
10,710
|
|
|
48,996
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
7,539
|
|
|
1,724
|
|
|
434
|
|
|
73
|
|
|
9,770
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/(Loss)
|
|
|
11,072
|
|
|
139
|
|
|
5,203
|
|
|
(10,783
|
)
|
|
5,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,013
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
(2,394
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(Loss) from continuing operations before income taxes, equity in
affiliates and minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,250
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,269
|
|
Equity
in earnings of non-consolidated affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
275
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(6,649
|
)
|
|
(13
|
)
|
|
(1,640
|
)
|
|
—
|
|
|
(8,302
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,758
|
)
|
Loss
from discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(4,747
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation
|
|
$
|
16
|
|
$
|
55
|
|
$
|
—
|
|
$
|
1,725
|
|
$
|
1,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Segment Information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
$
|
3,680
|
|
$
|
933
|
|
$
|
305
|
|
$
|
52
|
|
$
|
4,970
|
|
A
summary
of the Company’s revenue by geographic area, based on the location in which the
services originated, is set forth in the following table:
|
|
United
States
|
|
Canada
|
|
United
Kingdom
|
|
Total
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
$
|
84,905
|
|
$
|
14,587
|
|
$
|
646
|
|
$
|
100,138
|
|
2005
|
|
$
|
75,752
|
|
$
|
13,113
|
|
$
|
1,490
|
|
$
|
90,355
|
|
Six
Months Ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
$
|
168,665
|
|
$
|
27,620
|
|
$
|
1,926
|
|
$
|
198,211
|
|
2005
|
|
$
|
133,493
|
|
$
|
26,662
|
|
$
|
3,912
|
|
$
|
164,067
|
|
12.
Commitments, Contingencies and Guarantees
Deferred
Acquisition Consideration.
In
addition to the consideration paid by the Company in respect of certain of
its
acquisitions at closing, additional consideration may be payable, or may be
potentially payable based on the achievement of certain threshold levels of
earnings. Should the current level of earnings be maintained by these acquired
companies, no additional consideration, in excess of the deferred acquisition
consideration reflected on the Company’s balance sheet at June 30, 2006 would be
expected to be owing in 2006.
Put
Options. Owners
of interests in certain Marketing Communications subsidiaries have the right
in
certain circumstances to require the Company to acquire the remaining ownership
interests held by them. The owners’ ability to exercise any such “put option”
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 2006 to 2013. It is not
determinable, at this time, if or when the owners of these rights will exercise
all or a portion of these rights.
The
amount payable by the Company in the event such rights are exercised is
dependent on various valuation formulas and on future events, such as the
average earnings of the relevant subsidiary through the date of exercise, the
growth rate of the earnings of the relevant subsidiary during that period,
and,
in some cases, the currency exchange rate at the date of payment.
Management
estimates, assuming that the subsidiaries owned by the Company at June 30,
2006,
perform over the relevant future periods at their 2005 earnings levels, that
these rights, if all exercised, could require the Company, in future periods,
to
pay an aggregate amount of approximately $113,785 to the owners of such rights
to acquire such ownership interests in the relevant subsidiaries. Of this
amount, the Company is entitled, at its option, to fund approximately $23,223
by
the issuance of share capital. The ultimate amount payable relating to these
transactions will vary because it is dependent on the future results of
operations of the subject businesses and the timing of when these rights are
exercised.
During
2005, a put option was exercised and the Company settled this put option during
the third quarter of 2006 in exchange for a fixed payment of approximately
$1,492 (see Note 14). This transaction will reduce the put option obligations
noted above as of June 30, 2006.
Natural
Disasters. Certain
of the Company’s operations are located in regions of the United States which
typically are subject to hurricanes. During the three and six months ended
June
30, 2006 and 2005, these operations did not incur any costs related to damages
resulting from hurricanes.
Guarantees. In
connection with certain dispositions of assets and/or businesses in 2001 and
2003, 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 relates 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 Custom Direct Inc.
(“CDI”), the amounts of indemnification guarantees were limited to the total
sale price of approximately $84,000. For the remainder, the Company’s potential
liability for these indemnifications are not subject to a limit as the
underlying agreements do not always specify a maximum amount and the amounts
are
dependent upon the outcome of future contingent events.
Historically,
the Company has not made any significant indemnification payments under such
agreements and no amount has been accrued in the accompanying consolidated
financial statements with respect to these indemnification guarantees. The
Company continues to monitor the conditions that are subject to guarantees
and
indemnifications to identify whether it is probable that a loss has occurred,
and would recognize any such losses under any guarantees or indemnifications
in
the period when those losses are probable and estimable.
For
guarantees and indemnifications entered into after January 1, 2003, in
connection with the sale of the Company’s investment in CDI, the Company has
estimated the fair value of its liability, which was insignificant.
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 or results of operations
of
the Company.
Commitments. The
Company has commitments to fund $660 in two investment funds over a period
of up
to three years. At June 30, 2006, the Company has $4,521 of undrawn outstanding
letters of credit.
13.
New
Accounting Pronouncements
In
June
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes. This
Interpretation clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. This Interpretation is effective
for fiscal years beginning after December 15, 2006, with earlier application
permitted. The Company is currently evaluating the impact if any this
Interpretation will have on its financial statements.
14.
Subsequent
Events
On
August
3, 2006, the Company amended the terms of its Credit Facility. Pursuant to
such
amendment, the lenders agreed to (i) permit the Company’s Marketing
Communications Group to incur capital expenditures in an aggregate amount not
to
exceed $25 million for the fiscal year ending December 31, 2006; (ii) exclude
capital expenditures incurred by Accent Marketing Services (a subsidiary of
the
Company) from the fixed charges ratio; and (iii) increase the permitted amount
of investments that may be made by the Company by an additional $2 million,
which amount would increase by an additional $1 million following the Company’s
disposition of the Secure Products International Group.
On
July
27, 2006, the Company settled a put option obligation for a fixed amount of
$1,492, relating to the purchase of 4.3% of additional shares of Accent
Marketing LLC. The settlement of this put will be satisfied by the cancellation
of an outstanding promissory note to the Company of $1,068 and cash of
$424.
On
July
31, 2006, one of the entities in the SMS segment ceased using its west coast
facility. As a result of this action the Company will record a charge to
operating income of approximately $1,600 and income from continuing operations
will be impacted by approximately $450.
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 2006 means the period beginning January 1, 2006, and
ending December 31, 2006).
The
Company reports its financial results in accordance with generally accepted
accounting principles (“GAAP”) of the United States of America (“US GAAP”).
However, the Company has included certain non-US 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. One such term is “organic revenue” which means growth
in revenues from sources other than acquisitions or foreign exchange impacts.
These measures do not have a standardized meaning prescribed by US 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.
The
following discussion focuses on the operating performance of the Company for
the
three and six month periods ended June 30, 2006 and 2005, and the financial
condition of the Company as of June 30, 2006. This analysis should be read
in
conjunction with the interim condensed consolidated financial statements
presented in this interim report and the annual audited consolidated financial
statements and Management’s Discussion and Analysis presented in the Annual
Report to Shareholders for the year ended December 31, 2005 as reported on
Form 10-K. All amounts are in U.S. dollars unless otherwise
stated.
Executive
Summary
MDC
manages the business by monitoring several financial and non-financial
performance indicators. The key indicators that we review focus on the areas
of
revenues and operating expenses. Revenue growth is analyzed by reviewing the
components and mix of the growth, including: growth by major geographic
location; existing growth by major reportable segment (organic); growth from
currency changes; and growth from acquisitions.
Effective
with the accounting classification of the Secure Products International Group
as
discontinued operations, MDC conducts its businesses through the Marketing
Communications Group. Within the Marketing Communications Group, there are
three
reportable operating segments: Strategic Marketing Services (“SMS”), Customer
Relationship Management (“CRM”) and Specialized Communications Services (“SCS”).
In addition, MDC has a “Corporate Group” which provides certain administrative,
accounting, financial and legal functions.
Marketing
Communications Group
Through
its operating “partners” in the Marketing Communications Group, MDC provides
advertising, consulting and specialized communication services to clients
throughout the United States, Canada, Mexico and Europe.
The
operating companies within the Marketing Communications Group earn revenue
from
agency arrangements in the form of retainer fees or commissions; from short-term
project arrangements in the form of fixed fees or per diem fees for services;
and from incentives or bonuses.
MDC’s
Marketing Communications Group measures operating expenses in two distinct
cost
categories: cost of services sold, and office and general expenses. Cost of
services sold is primarily comprised of employee compensation related costs
and
direct costs related primarily to providing services. Office and general
expenses are primarily comprised of rent and occupancy costs and administrative
service costs including related employee compensation costs.
Because
the Company is a service business, the Company monitors these costs on a
percentage of revenue basis. Cost of services sold tend to fluctuate in
conjunction with changes in revenues, whereas office and general expenses,
which
are not directly related to servicing clients, tend to decrease as a percentage
of revenue as revenues increase because a significant portion of these expenses
are relatively fixed in nature.
Certain
Factors Affecting Our Business
Acquisitions
and Dispositions. MDC’s
strategy includes acquiring ownership stakes in well-managed businesses with
strong reputations in the industry. MDC has entered into a number of acquisition
and disposal transactions in 2006 and 2005, which affected revenues, expenses,
operating income, net income, assets and liabilities. Additional information
regarding material acquisitions is provided in Note 4 “Acquisitions” and Note 6
“Discontinued Operations” in the notes to the consolidated financial statements
included in this Quarterly Report on Form 10-Q.
Foreign
Exchange Fluctuations. MDC’s
financial results and competitive position are affected by fluctuations in
the
exchange rate between the US dollar and the Canadian dollar. See also
“Quantitative and Qualitative Disclosures About Market Risk—Foreign
Exchange.”
Seasonality. Historically,
with some exceptions, the Marketing Communications Groups’ fourth quarter
generates the highest quarterly revenues in a year. The fourth quarter has
historically been the period in the year in which the highest volumes of media
placements and retail related consumer marketing occur.
Other
important factors that could affect our results of operations are set forth
in
“Item 1A Risk Factors” of the Company’s Form 10-K for the period ended
December 31, 2005. As of the quarter ended September 30, 2005, the
Company changed the composition of its reportable segments. Accordingly, to
reflect this change in composition, the Company has restated the previously
reported segment information for the comparable periods in 2005 to reflect
this
changed segment composition.
Summary
of Key Transactions
Secure
Products Group
In
June
2006, the Company’s Board of Directors made the decision to sell or otherwise
divest the Company’s Secure Paper Business and Secure Card Business
(collectively, “SPI”). These are non-core operations, and their divestiture will
allow MDC Partners to better focus on its Marketing Communications businesses.
Since that date, the Company has engaged in active negotiations for the sale
of
the SPI Group. As of the date of this Form 10-Q filing, the Company continues
to
pursue the sale of the SPI Group with interested parties, but has not entered
into a definitive agreement with any potential buyer.
Based
on
these events, management has concluded that the criteria for the
assets/liabilities of SPI to be accounted for as assets/liabilities held for
sale and the results of operations to be accounted for as discontinued
operations have been met. Discontinued operations relating to SPI for the three
months ended June 30, 2006 and 2005 amounted to net losses of $9.6 million
and
$1.3 million, respectively. For the six months ended June 30, 2006 and 2005
discontinued operations relating to SPI amounted to net losses of $10.5 million
and $2.7 million, respectively. Based on the estimated net proceeds from a
sale,
the Company has recorded an impairment loss relating to SPI’s net assets of
approximately $7.9 million for the three and six months ended June 30, 2006.
This loss has been included in discontinued operations for the three and six
months ended June 30, 2006. Based on the estimated net proceeds and average
borrowing rate for each period, the Company has allocated interest expense
to
discontinued operations of $0.6 million and $1.1 million for the three and
six
months ended June 30, 2006 and $0.4 million and $0.8 million for the three
and
six months ended June 30, 2005.
Zyman
Group Acquisition
On
April 1, 2005, MDC, through a wholly-owned subsidiary, purchased
approximately 61.6% of the total outstanding membership units of Zyman Group,
LLC (“Zyman Group”) for a purchase price equal to $52.4 million in cash and
1,139,975 Class A shares of MDC. In addition, MDC may be required to pay up
to an additional $12 million in cash and Class A shares to the sellers if
Zyman Group achieves specified financial targets for the twelve-month periods
ending June 30, 2006 and/or June 30, 2007. MDC’s acquisition of the Zyman
Group enabled MDC to expand its capabilities in the areas of strategic marketing
knowledge and solutions.
During
the first five years following MDC’s acquisition of the Zyman Group, MDC’s
allocation of profits of the Zyman Group may differ from its proportionate
share
of ownership. On an annual basis, the Company receives a 20% priority return
calculated based on its total investment in Zyman Group. Thereafter, based
on
calculations set forth in the operating agreement of Zyman Group (the “LLC
Agreement”), the Company’s share of remaining Zyman Group profits in excess of
the annual threshold amount may be disproportionately less than its equity
ownership in Zyman Group. Specifically, on an annual basis, if Zyman operating
results exceed a defined operating margin, the Company would be entitled to
25%
of the excess margins in the first two years of the LLC Agreement and 30% of
the
excess margins in the following three years of the LLC Agreement, rather than
the Company’s equity portion of 61.6%. After the first five years, the earnings
of the Zyman Group will be allocated in a proportion equal to the respective
equity interests of the members.
As
of
June 30, 2006, the annual priority return is expected to be approximately $12.7
million, with the minority owners receiving the next $7.9 million up to the
“threshold” amount of $20.6 million. If profits are insufficient to meet the
Company’s priority return during any of the first five years, the Company will
receive a catch-up payment through year five equal to any shortfall from the
prior year(s). Furthermore, if profits do not reach the threshold amount during
the first five years, the minority owners will be entitled to receive a catch-up
payment through year five equal to any shortfall from the prior year(s). Based
on Zyman Group’s expected results for 2006, the Company expects to receive not
more than its priority return from Zyman Group in 2006.
8%
Convertible Debentures
MDC
completed an issuance in Canada of convertible unsecured subordinated debentures
amounting to C$45.0 million as of June 28, 2005 ($36.7 million) (the
“Debentures”). The Debentures mature on June 30, 2010. The Debentures bear
interest at an annual rate of 8.00% payable semi-annually, in arrears, on
June 30 and December 31 of each year, commencing December 31,
2005. From January 1, 2006 until June 30, 2006, the Debentures had an
annual interest rate of 8.50%. Effective July 1, 2006, the Debentures reverted
back to an annual rate of 8.00%.
Results
of Operations:
For
the Three Months Ended June 30, 2006
(thousands
of United States dollars)
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
58,192
|
|
$
|
20,906
|
|
$
|
21,040
|
|
$
|
—
|
|
$
|
100,138
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
31,914
|
|
|
15,609
|
|
|
13,377
|
|
|
—
|
|
|
60,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expenses
|
|
|
17,314
|
|
|
3,858
|
|
|
3,693
|
|
|
6,320
|
|
|
31,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
3,641
|
|
|
1,126
|
|
|
288
|
|
|
63
|
|
|
5,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/(Loss)
|
|
|
5,323
|
|
|
313
|
|
|
3,682
|
|
|
(6,383
|
)
|
|
2,935
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
509
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,636
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes, equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,808
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
530
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before equity in affiliates and minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,338
|
|
Equity
in earnings of non-consolidated affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
227
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(2,657
|
)
|
|
(8
|
)
|
|
(769
|
)
|
|
—
|
|
|
(3,434
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from Continuing Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(869
|
)
|
Loss
from Discontinued Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,634
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(10,503
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation
|
|
$
|
271
|
|
$
|
6
|
|
$
|
—
|
|
$
|
1,530
|
|
$
|
1,807
|
|
Results
of Operations:
For
the Three Months Ended June 30, 2005
(thousands
of United States dollars)
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
Revenue
|
|
$
|
54,435
|
|
$
|
16,159
|
|
$
|
19,761
|
|
$
|
—
|
|
$
|
90,355
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
27,227
|
|
|
12,322
|
|
|
12,931
|
|
|
—
|
|
|
52,480
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expenses
|
|
|
14,957
|
|
|
2,892
|
|
|
3,044
|
|
|
4,651
|
|
|
25,544
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
5,192
|
|
|
870
|
|
|
219
|
|
|
39
|
|
|
6,320
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/(Loss)
|
|
|
7,059
|
|
|
75
|
|
|
3,567
|
|
|
(4,690
|
)
|
|
6,011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
851
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,624
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes, equity in affiliates
and
minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,238
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
685
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,923
|
|
Equity
in Earnings of Non-Consolidated Affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
91
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(4,512
|
)
|
|
(12
|
)
|
|
(969
|
)
|
|
—
|
|
|
(5,493
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from Continuing Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
521
|
|
Loss
from Discontinued Operation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,485
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(964
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation.
|
|
$
|
8
|
|
$
|
28
|
|
$
|
—
|
|
$
|
769
|
|
$
|
805
|
|
Results
of Operations:
For
the Six Months Ended June 30, 2006
(thousands
of United States dollars)
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
118,590
|
|
$
|
39,812
|
|
$
|
39,809
|
|
$
|
—
|
|
$
|
198,211
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
63,654
|
|
|
29,407
|
|
|
27,580
|
|
|
—
|
|
|
120,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expenses
|
|
|
34,300
|
|
|
7,333
|
|
|
6,987
|
|
|
12,387
|
|
|
61,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
9,045
|
|
|
2,189
|
|
|
569
|
|
|
97
|
|
|
11,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/(Loss)
|
|
|
11,591
|
|
|
883
|
|
|
4,673
|
|
|
(12,484
|
)
|
|
4,663
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,073
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,173
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes, equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,563
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before equity in affiliates and minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,572
|
|
Equity
in earnings of non-consolidated affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
501
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(6,610
|
)
|
|
(38
|
)
|
|
(1,537
|
)
|
|
—
|
|
|
(8,185
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from Continuing Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,112
|
)
|
Loss
from Discontinued Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,524
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(15,636
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation
|
|
$
|
491
|
|
$
|
12
|
|
$
|
2,338
|
|
$
|
2,491
|
|
$
|
5,332
|
|
Results
of Operations:
For
the Six Months Ended June 30, 2005
(thousands
of United States dollars)
|
|
Strategic
Marketing
Services
|
|
Customer
Relationship
Management
|
|
Specialized
Communications
Services
|
|
Corporate
|
|
Total
|
|
Revenue
|
|
$
|
94,112
|
|
$
|
32,502
|
|
$
|
37,453
|
|
$
|
—
|
|
$
|
164,067
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services sold
|
|
|
48,586
|
|
|
25,518
|
|
|
25,566
|
|
|
—
|
|
|
99,670
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
and general expenses
|
|
|
26,915
|
|
|
5,121
|
|
|
6,250
|
|
|
10,710
|
|
|
48,996
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
7,539
|
|
|
1,724
|
|
|
434
|
|
|
73
|
|
|
9,770
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Profit/(Loss)
|
|
|
11,072
|
|
|
139
|
|
|
5,203
|
|
|
(10,783
|
)
|
|
5,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,013
|
|
Interest
expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,394
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes, equity in affiliates
and
minority interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,250
|
|
Income
tax recovery
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before equity in affiliates and minority
interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,269
|
|
Equity
in Earnings of Non-Consolidated Affiliates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
275
|
|
Minority
interests in income of consolidated subsidiaries
|
|
|
(6,649
|
)
|
|
(13
|
)
|
|
(1,640
|
)
|
|
—
|
|
|
(8,302
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from Continuing Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,758
|
)
|
Loss
from Discontinued Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(4,747
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non
cash stock based compensation
|
|
$
|
16
|
|
$
|
55
|
|
$
|
—
|
|
$
|
1,725
|
|
$
|
1,796
|
|
Three
Months Ended June 30, 2006 Compared to Three Months Ended June 30,
2005
On
a
consolidated basis, revenue was $100.1 million for the second quarter of 2006,
representing an increase of $9.7 million or 11%, compared to revenue of $90.4
million in the second quarter of 2005. This increase includes $8.2 million
relating to organic growth, primarily resulting from new business wins and
additional revenues from existing clients, particularly in the United States.
In
addition, a weakening of the US dollar versus the Canadian dollar, in the second
quarter of 2006 as compared to the second quarter of 2005, resulted in increased
revenue of approximately $1.4 million.
Operating
profit for the second quarter of 2006 was $2.9 million, compared to $6.0 million
for the same quarter of 2005. The decrease in operating profit was primarily
the
result of a decrease in operating profit of $1.8 million in the Strategic
Marketing Services segment coupled with an increase in corporate expenses of
$1.7 million, partially offset by increases in operating profit in the Customer
Relationship Management and Specialized Communications Services
segment.
The
net
loss for the second quarter of 2006 increased from $1.0 million in 2005 to
$10.5
million in 2006, primarily as a result of a $7.9 million impairment charge
relating to the discontinued operations of SPI. In addition, operating profit
decreased by $3.1 million as discussed above, which was partially offset by
a
decrease in income attributable to minority interests of $2.1
million.
Marketing
Communications Group
Revenues
for the second quarter of 2006 attributable to Marketing Communications, which
consists of three reportable segments - Strategic Marketing Services (“SMS”),
Customer Relationship Management (“CRM”), and Specialized Communications
Services (“SCS”), were $100.1 million compared to $90.4 million in the second
quarter of 2005, representing an increase of $9.7 million or 11%.
The
components of revenue growth for the Marketing Communications Group, for
the second quarter of 2006 are shown in the following
table:
|
|
Revenue
|
|
|
|
(in
millions)
|
|
%
|
|
Three
months ended June 30, 2005
|
|
$
|
90.4
|
|
|
|
|
Organic
|
|
|
8.2
|
|
|
9
|
%
|
Acquisitions
|
|
|
0.1
|
|
|
0
|
%
|
Foreign
exchange impact
|
|
|
1.4
|
|
|
2
|
%
|
Three
months ended June 30, 2006
|
|
$
|
100.1
|
|
|
11
|
%
|
The
Marketing Communications Group had organic revenue growth of $8.2 million or
9%
for the second quarter of 2006, primarily attributable to new business wins
and
additional revenues from existing clients, particularly in the United States.
In
addition, a weakening of the U.S. dollar versus the Canadian dollar during
the
second quarter of 2006, as compared to the second quarter of 2005, resulted
in
increased revenues of approximately $1.4 million.
The
percentage of revenue by geographic region remained relatively consistent with
the prior year quarter and is demonstrated in the following table:
|
|
Revenue
|
|
|
|
Three Months Ended
June 30, 2006
|
|
Three Months Ended
June 30, 2005
|
|
US
|
|
|
85
|
%
|
|
84
|
%
|
Canada
|
|
|
14
|
%
|
|
14
|
%
|
UK
|
|
|
1
|
%
|
|
2
|
%
|
The
operating profit of the Marketing Communications Group for the second quarter
of
2006 decreased by approximately $1.4 million or 13% to $9.3 million from $10.7
million. Operating margins were 9.3% for 2006 as compared to 11.8% for the
second quarter of 2005. The decrease in operating margins was primarily
reflective of an increase in cost of services sold including in particular
direct costs and staff costs as a percentage of revenues, partially offset
by
decreased amortization of intangibles relating to the Zyman Group acquisition.
Office and other administrative expenses as a percentage of revenue remained
relatively consistent with the prior year period.
Strategic
Marketing Services
Revenues
attributable to SMS for the second quarter of 2006 were $58.2 million compared
to $54.4 million in the second quarter of 2005. This increase of $3.8 million
or
7% included organic revenue growth of approximately $3.2 million resulting
from
new client business wins. In addition, a weakening of the US dollar compared
to
the Canadian dollar in the second quarter of 2006 compared to the same quarter
in 2005 resulted in a $0.5 million increase in revenues from the division’s
Canadian-based operations.
The
operating profit of SMS for the second quarter of 2006 decreased by
approximately $1.8 million or 25% to $5.3 million from $7.1 million for the
second quarter of 2005, while operating margins were 9.1% for the second quarter
of 2006 as compared to 12.9% in the second quarter of 2005. The decreased
profits were primarily attributable to an increase in total staff costs as
a
percentage of revenue from 54% in 2005 to 58% in 2006, partially offset by
decreased amortization of intangibles resulting from the Zyman acquisition.
The
increase in staff as
a
percentage of revenue results from reduced revenue at certain business units,
offset in part by an increase in headcount resulting from organic growth at
several of the business units.
Customer
Relationship Management
Revenues
reported by the CRM segment for the second quarter of 2006 were $20.9
million, an increase of $4.7 million or 29% compared to the $16.2 million
reported for the first quarter of 2005. This growth was entirely organic and
was
due primarily to additional business from existing clients.
The
operating profit of CRM increased by approximately $0.2 million to $0.3 million
for the second quarter of 2006, from $0.1 million for the second quarter of
2005. Operating margins were 1.5% for the second quarter of 2006 as compared
to
0.5% in the second quarter of 2005. The increase primarily reflected a decrease
in the cost of services sold as a percentage of revenue, due to the
implementation of a new service contract with one of the segment’s large
clients. Office and general expenses as a percentage of revenue remained
relatively consistent as compared to the prior period.
Specialized
Communications Services
SCS
generated revenues of $21.0 million for the second quarter of 2006, $1.2 million
or 6% higher than the second quarter of 2005, of which $0.9 million related
to a
weakening of the U.S. dollar compared to the Canadian dollar in the second
quarter of 2006 compared to the same quarter in 2005. In addition, for the
second quarter of 2006, organic revenue increased by $0.3 million as a result
of
new business wins partially offset by non-recurring projects.
The
operating profit of SCS increased by 3% to $3.7 million in the second quarter
of
2006, from $3.6 million in the prior-year second quarter due primarily to the
increase in revenue of $1.2 million discussed above partially offset by an
increase in total staff costs as a percentage of revenue from 41% in the second
quarter of 2005 to 44% in the second quarter of 2006. As a result, operating
margins decreased to 17.5% for the second quarter of 2006 as compared to 18.0%
in the second quarter of 2005.
Corporate
Operating
expenses for the second quarter of 2006 increased by $1.7 million to $6.4
million from $4.7 million in the prior year quarter. The increase is primarily
attributable to increased compensation costs of $2.0 million, of which $0.8
million relates to stock based compensation, and increased capital taxes of
$0.4
million, partially offset by a decrease in professional fees of $0.9
million.
Other
Income (Expense)
Other
income decreased from $0.9 million in the second quarter of 2005 to $0.5 million
in the second quarter of 2006 due primarily to a $0.8 million gain on the
recovery of an asset in the second quarter of 2005, partially offset by an
increase in foreign currency transaction gains of $0.2 million and a gain on
sale of assets of $0.3 million in the second quarter of 2006.
Income
Taxes Recovery
The
income tax recovery recorded in the second quarter of 2006 was $0.5 million
as
compared to $0.7 million in the second quarter of 2005. The Company’s effective
tax rate was substantially lower than the statutory tax rate due to minority
interest charges and non-deductible, non-cash stock based compensation charges
in both the 2006 and 2005 second quarter.
The
Company’s US operating units are generally structured as limited liability
companies, which are treated as partnerships for tax purposes. The Company
is
only taxed on its share of profits, while minority holders are responsible
for
taxes on their share of the profits.
Minority
Interests
Minority
interest expense was $3.4 million for the second quarter of 2006, down $2.1
million from the $5.5 million of minority interest expense incurred during
the
second quarter of 2005 due primarily to the decrease in profitability of the
SMS
operating segment.
Discontinued
Operations
Loss
from
discontinued operations of $9.6 million and $1.5 million was reported for the
second quarter of 2006 and 2005 respectively, and primarily relates to the
expected disposition of SPI.
Beginning
in June of 2006, the Company began negotiating with buyers to sell the stock
of
SPI. Based on these negotiations, management has concluded all the criteria
for
the assets/liabilities of SPI to be accounted for as assets/liabilities held
for
sale and the results of operations to be accounted for as discontinued
operations. Discontinued operations relating to SPI for the three months ended
June 30, 2006 and 2005 amounted to net losses of $9.6 million and $1.3 million,
respectively. Based on the estimated net proceeds from a sale, the Company
has
recorded an impairment loss relating to SPI’s net assets of approximately $7.9
million for the three months ended June 30, 2006. This impairment has been
included in discontinued operations net loss for the three months ended June
30,
2006. Based on the estimated net proceeds and average borrowing rate for each
period, the Company has allocated interest expense to discontinued operations
of
$0.6 million and $0.4 million for the three months ended June 30, 2006 and
2005.
During
July 2005, LifeMed completed a private placement issuing approximately 12.5
million shares at a price of $0.4973 per share. LifeMed received net proceeds
of
approximately $6.2 million. Consequently, the Company’s ownership interest in
LifeMed was reduced to 18.3% from this transaction. The Company no longer has
any significant continuing involvement in the management or operations of
LifeMed, and has not participated in the purchase of significant new equity
offerings by LifeMed. Consequently, as of July 2005, the Company no longer
consolidates the operations of LifeMed, and commenced accounting for its
remaining investment in LifeMed on a cost basis and has reported the results
of
operations of LifeMed as discontinued operations for all 2005 periods presented
in the condensed consolidated statement of operations.
In
November 2004, the Company’s management reached a decision to discontinue
the operations of a component of its business. This component is comprised
of
the Company’s UK based marketing communications business, a wholly owned
subsidiary Mr. Smith Agency, Ltd. (formerly known as Interfocus Networks
Limited). The Company decided to dispose of the operations of this business
due
to its unfavorable economics. Substantially all of the net assets of the
discontinued business were sold during the fourth quarter of 2004 with the
disposition of all activities of Mr. Smith and remaining sale of assets was
substantially complete by the end of the first quarter of 2005. No significant
one—time termination benefits were incurred or are expected to be incurred. No
further significant other charges are expected to be incurred.
For
the
three months ended June 30, 2005, discontinued operations relating to LifeMed
and Mr. Smith amounted to net losses of $0.2 million.
Net
Income Loss
As
a
result of the foregoing, the net loss recorded for the second quarter of 2006
was $10.5 million, or a loss of $ (0.44) per diluted share, compared to the
net
loss of $1.0 million, or $ (0.04) per diluted share, reported for the second
quarter of 2005.
Six
Months Ended June 30, 2006 Compared to Six Months Ended June 30,
2005
Revenue
was $198.2 million for the first six months of 2006, representing an increase
of
$34.1 million or 21%, compared to revenue of $164.1 million in the first six
months of 2005. This increase includes $19.9 million relating to organic growth,
primarily resulting from new business wins in the United States, as well as
$12.2 million relating to acquisition growth. In addition, a weakening of the
US
dollar versus the Canadian dollar, in the first six months of 2006 as compared
to the first six months of 2005, resulted in increased revenue of approximately
$2.0 million.
Operating
profit for the first six months of 2006 was $4.7 million, compared to $5.6
million for the same period of 2005. The decrease in operating profit was
primarily the result of an increase in non-cash stock-based compensation of
$3.5
million and depreciation and amortization of $2.1 million relating to the Zyman
acquisition offset by the increase in revenue.
Cost
of
services sold and office and general expenses for the six months ended June
30,
2006, remained relatively consistent as a percentage of revenue as compared
to
the same prior year period.
The
net
loss for the first six months of 2006 increased by $10.9 million to $15.6
million from $4.7 million for the first six months of 2005, primarily as a
result of a $7.9 million impairment charge relating to the discontinued
operations of SPI. In addition, interest expense increased by $1.8 million
as a
result of the increased borrowings in connection with the Zyman acquisition
and
operating income decreased by $0.9 million as discussed above.
Marketing
Communications Group
Revenues
for the first six months of 2006 attributable to Marketing Communications,
which
consists of three reportable segments - SMS, CRM, and SCS, were $198.2 million
compared to $164.1 million in the first six months of 2005, representing an
increase of $34.1 million or 21%.
The
components of revenue growth for the Marketing Communications Group, for the
first six months of 2006 are shown in the following table:
|
|
Revenue
|
|
|
|
in
millions
|
|
%
|
|
Six
months ended June 30, 2005
|
|
$
|
164.1
|
|
|
|
|
Organic
|
|
|
19.9
|
|
|
12
|
%
|
Acquisitions
|
|
|
12.2
|
|
|
8
|
%
|
Foreign
exchange impact
|
|
|
2.0
|
|
|
1
|
%
|
Six
months ended June 30, 2006
|
|
$
|
198.2
|
|
|
21
|
%
|
The
Marketing Communications Group had organic revenue growth of $19.9 million
or
12% for the first six months of 2006, primarily attributable to new business
wins and additional revenues from existing clients, particularly in the U.S.
Acquisitions contributed revenue growth of $12.2 million, including $11.7
million related to the acquisition of the Zyman Group. In addition, a weakening
of the U.S. dollar versus the Canadian dollar during the first six months of
2006, as compared to the first six months of 2005, resulted in increased
revenues of approximately $2.0 million.
The
positive organic growth, combined with acquisitions, resulted in a shift in
the
geographic mix of revenues, causing an increase in the percentage of revenue
growth attributable to U.S. operations versus Canadian- and UK-based operations
compared to the geographic mix experienced in 2005.
This
shift is demonstrated in the following table:
|
|
Revenue
|
|
|
|
Six Months Ended
June 30, 2006
|
|
Six Months Ended
June 30, 2005
|
|
US
|
|
|
85
|
%
|
|
82
|
%
|
Canada
|
|
|
14
|
%
|
|
16
|
%
|
UK
|
|
|
1
|
%
|
|
2
|
%
|
The
operating profit of the Marketing Communications Group increased by
approximately $0.8 million or 5% to $17.2 million for the first six months
of
2006 from $16.4 million for the first six months of 2005, while operating
margins were 8.7% for 2006 as compared to 10% in 2005. The decrease in operating
margins was primarily reflective of increased amortization of intangibles
relating to the Zyman Group acquisition and increased stock based compensation
charges of $2.8 million. Cost of services and office and general expenses as
a
percentage of revenue remained relatively consistent with the prior year
period.
Strategic
Marketing Services
Revenues
attributable to SMS for the first six months of 2006 were $118.6 million
compared to $94.1 million in the first six months of 2005. The six month
increase of $24.5 million or 26% included organic revenue growth of
approximately $12.0 million resulting from new client business wins and
acquisition related growth of approximately $11.7 million. In addition, a
weakening of the US dollar compared to the Canadian dollar in the first six
months of 2006 compared to the same period in 2005 resulted in a $0.8 million
increase in revenues from the division’s Canadian-based operations.
The
operating profit of SMS for the first six months of 2006 increased by
approximately $0.5 million or 4.5% to $11.6 million from $11.1 million for
the
first six months of 2005, while operating margins were 9.8% for 2006 as compared
to 11.8% in 2005. The increased profits were primarily attributable to the
increase in revenue partially offset by an increase in staff costs and other
direct costs as a percentage of revenue in the first six months of 2006 compared
to the first six months of 2005, and increased stock based compensation and
increased amortization of intangibles resulting from the Zyman acquisition.
The
increase in staff costs as
a
percentage of revenue results from reduced revenue at certain business units,
offset in part by an increase in headcount resulting from organic growth at
several of the business units.
Customer
Relationship Management
Revenues
reported by the CRM segment for the six months ended June 30, 2006 were
$39.8 million, an increase of $7.3 million or 22% compared to the $32.5 million
reported for the first six months of 2005. This growth was entirely organic
and
was due primarily to additional business from existing clients.
The
operating profit of CRM increased by approximately $0.8 million to $0.9 million
for the first six months of 2006, from $0.1 million for the first six months
of
2005. Operating margins were 2.2% for the first six months of 2006 as compared
to 0.4% in the first six months of 2005. The increase primarily reflected a
decrease in the cost of services sold as a percentage of revenue, due to the
implementation of a new service contract with one of the segment’s large clients
partially offset by increases in office and general expenses as a percentage
of
revenue and depreciation and amortization. These increases resulted from the
startup of an additional service location.
Specialized
Communications Services
SCS
generated revenues of $39.8 million for the first six months of 2006, $2.4
million or 6.4% higher than the first six months of 2005, of which $1.3 million
related to a weakening of the U.S. dollar compared to the Canadian dollar in
the
first six months of 2006 compared to the same prior year period. In addition,
organic revenue increased $0.6 million as a result of new business wins offset
by non-recurring projects. The remaining revenue increased $0.5 million and
was
attributable to acquisition related growth.
The
operating profit of SCS decreased by approximately $0.5 million or 9.6% to
$4.7
million in the first six months of 2006, from $5.2 million in the first six
months of 2005 due primarily to the increase in stock-based compensation of
$2.3
million relating to the price paid for membership interests, which was less
than
the fair value of such membership interests and the fair value of an option
granted to certain members of management of Source Marketing LLC during the
first quarter of 2006. As a result, operating margins decreased to 11.7% for
2006 as compared to 13.9% in 2005.
Corporate
Operating
expenses for the six months ended June 30, 2006 increased by $1.7 million to
$12.5 million from $10.8 million in the prior year period. The increase is
primarily attributable to increased compensation costs of $2.2 million, of
which
$0.8 million relates to stock based compensation, and increased capital taxes
of
$0.2 million, partially offset by a decrease in professional fees of $0.7
million.
Net
Interest Expense
Net
interest expense for the first six months of 2006 was $4.2 million, $1.8 million
higher than the $2.4 million incurred during the first six months of 2005.
Interest expense increased $1.8 million in the first six months of 2006 compared
to the first six months of 2005 due to higher outstanding debt combined with
higher interest rates in 2006, due to the acquisition of the Zyman Group and
the
issuance of the 8% debentures (which accrued interest at 8.5% during the first
six months of 2006). Interest income remained consistent in the first six months
of 2006 as compared to the first six months of 2005.
Income
Taxes Recovery
The
income tax recovery recorded in the first six months of 2006 was $1.0 million,
compared to a recovery of $2.0 million for the first six months of 2005. The
Company’s effective tax rate was substantially lower than the statutory tax rate
due to minority interest charges and non deductible non-cash stock based
compensation charges in both 2006 and 2005.
The
Company’s US operating units are generally structured as limited liability
companies, which are treated as partnerships for tax purposes. The Company
is
only taxed on its share of profits, while minority holders are responsible
for
taxes on their share of the profits.
Equity
in
Affiliates
Equity
in
affiliates represents the income attributable to equity-accounted affiliate
operations. For the first six months of 2006, income of $0.5 million was
recorded, $0.2 million higher than the $0.3 million earned in the first six
months of 2005.
Discontinued
Operations
Loss
from
discontinued operations of $10.5 million and $3.0 million was reported for
the
first six months of 2006 and 2005 respectively, and primarily relates to the
expected disposition of SPI.
Beginning
in June of 2006, the Company began negotiating with buyers to sell the stock
of
SPI. Based on these negotiations, management has concluded the criteria for
the
assets/liabilities of SPI to be accounted for as assets/liabilities held for
sale and the results of operations to be accounted for as discontinued
operations. Discontinued operations relating to SPI for the six months ended
June 30, 2006 and 2005 amounted to net losses of $10.5 million and $2.7 million,
respectively. Based on the estimated net proceeds from a sale, the Company
has
recorded an impairment loss relating to SPI’s net assets of approximately $7.9
million for the six months ended June 30, 2006. This loss has been included
in
discontinued operations for the six months ended June 30, 2006. Based on the
estimated net proceeds and average borrowing rate for each period, the Company
has allocated interest expense to discontinued operations of $1.1 million and
$0.8 million for the six months ended June 30, 2006 and 2005.
During
July 2005, LifeMed completed a private placement issuing approximately 12.5
million shares at a price of $0.4973 per share. LifeMed received net proceeds
of
approximately $6.2 million. Consequently, the Company’s ownership interest in
LifeMed was reduced to 18.3% from this transaction. The Company no longer has
any significant continuing involvement in the management or operations of
LifeMed, and has not participated in the purchase of significant new equity
offerings by LifeMed. Consequently, as of July 2005, the Company no longer
consolidates the operations of LifeMed, and commenced accounting for its
remaining investment in LifeMed on a cost basis and has reported the results
of
operations of LifeMed as discontinued operations for all periods presented
in
the condensed consolidated statement of operations.
In
November 2004, the Company’s management reached a decision to discontinue
the operations of a component of its business. This component is comprised
of
the Company’s UK based marketing communications business, a wholly owned
subsidiary Mr. Smith Agency, Ltd. (formerly known as Interfocus Networks
Limited). The Company decided to dispose of the operations of this business
due
to its unfavorable economics. Substantially all of the net assets of the
discontinued business were sold during the fourth quarter of 2004 with the
disposition of all activities of Mr. Smith and remaining sale of assets was
substantially complete by the end of the first quarter of 2005. No significant
one—time termination benefits were incurred or are expected to be incurred. No
further significant other charges are expected to be incurred.
For
the
six months ended June 30, 2005, discontinued operations relating to LifeMed
and
Mr. Smith amounted to $0.3 million, respectively.
Net
Income Loss
As
a
result of the foregoing, the net loss recorded for the first six months of
2006
was $15.6 million, or a loss of $(0.66) per diluted share, compared to the
net
loss of $4.7 million, or $(0.21) per diluted share, reported for the first
six
months of 2005.
Liquidity
and Capital Resources:
Liquidity
The
following table provides summary information about the Company’s liquidity
position:
|
|
As
of and for the Six months
ended
June
30, 2006
|
|
As
of and for the Six months ended
June
30, 2005
|
|
As
of and for the Year ended
December 31,
2005
|
|
|
|
(000’s)
|
|
(000’s)
|
|
(000’s)
|
|
Cash
and cash equivalents
|
|
$
|
5,182
|
|
$
|
16,114
|
|
$
|
12,923
|
|
Working
capital (deficit)
|
|
$
|
(104,573
|
)
|
$
|
(32,237
|
)
|
$
|
(99,935
|
)
|
Cash
from operations
|
|
$
|
13,211
|
|
$
|
(3,284
|
)
|
$
|
4,670
|
|
Cash
from investing
|
|
$
|
(15,125
|
)
|
$
|
(59,551
|
)
|
$
|
(67,404
|
)
|
Cash
from financing
|
|
$
|
(5,552
|
)
|
$
|
56,634
|
|
$
|
52,316
|
|
Long-term
debt to shareholders’ equity ratio
|
|
|
0.85
|
|
|
0.79
|
|
|
0.81
|
|
Fixed
charge coverage ratio
|
|
|
1.28
|
|
|
1.95
|
|
|
2.04
|
|
As
of
June 30, 2006, and December 31, 2005, $3.7 million and $5.3 million of the
consolidated cash position was held by subsidiaries, which, although available
for the subsidiaries’ use, does not represent cash that is distributable as
earnings to MDC Partners Inc. for use to reduce its indebtedness.
Working
Capital
At
June
30, 2006, the Company had a working capital deficit of $104.6 million compared
to a deficit of $99.9 million at December 31, 2005. The decrease in working
capital is primarily due to seasonal shifts in the amounts billed to clients,
and paid to suppliers, primarily media outlets.
Since
September 30, 2005, the Company has classified the outstanding borrowings
under the Credit Facility of $71.5 million and $73.5 million as of June 30,
2006
and December 31, 2005, respectively, as a current liability. See Long-term
Debt below.
The
Company intends to maintain sufficient availability of funds under the Credit
Facility at any particular time to adequately fund such working capital deficits
should there be a need to do so from time to time.
Cash
Flows
Operating
Activities
Cash
flow
provided by operations, including changes in non-cash working capital, for
the
first six months of 2006 was $13.2 million. Cash flow provided by continuing
operations for the first six months of 2006 was $11.6 million. This was
attributable primarily to the net loss from continuing operations of $5.1
million, plus non-cash depreciation and amortization of $12.7 million, non-cash
stock based compensation of $4.9 million and cash flows from non-cash working
capital of $2.5 million. Cash used in continuing operations was $4.8 million
in
the first six months of 2005 and was primarily reflective of a net loss from
continuing operations of $1.8 million and uses of non-cash working capital
of
$11.8 million. This was partially offset by non-cash depreciation and
amortization of $10.4 million and non-cash stock based compensation of $1.8
million. Discontinued operations provided cash of $1.6 million in the first
six
months of 2006 compared to $1.5 million during the first six months of
2005.
Investing
Activities
Cash
flows used in investing activities were $15.1 million for the first six months
of 2006, compared with $59.6 million in the first six months of
2005.
Expenditures
for capital assets in the first six months of 2006 were $11.3 million. Of this
amount, $11.1 million were made by the Marketing Communications Group, which
consisted primarily of leasehold improvements, computer equipment and switching
equipment, and $0.2 million related to the purchase of corporate assets. In
the
first six months of 2005, capital expenditures totaled $5.0 million and
primarily related to the Marketing Communications Group’s acquisition of
computer and switching equipment.
Cash
flow
used in acquisitions was $3.6 million in the first six months of 2006 and
primarily related to investments in marketing communication businesses related
to the settlement of put options and earn out payments. In the first six months
of 2005, cash flow used in acquisitions was $53.6 million and related to the
purchase of the Zyman Group..
Distributions
received from non-consolidated affiliates amounted to $0.4 million and $0.5
million for the first six months of 2006 and 2005, respectively.
Discontinued
operations used cash of $1.2 million in 2006 and $1.8 million in 2005 relating
to capital asset purchases.
Financing
Activities
During
the first six months of 2006, cash flows used in financing activities amounted
to $5.6 million, and consisted of $5.6 million of repayments of debt from
continuing operations and $0.5 million of proceeds from the issuance of share
capital. During the first six months of 2005, cash flows provided by financing
activities amounted to $56.6 million, and consisted of proceeds from the
issuance of long term debt of $62.2 million relating to the issuance of $36.6
million of convertible debentures and borrowings under the Credit Facility
used
to fund the acquisition of the Zyman Group. Payments made of $3.3 million
consist of payments under capital leases and debt assumed in the Zyman Group
acquisition. In addition, the company incurred $3.3 million of finance costs
relating to both the convertible debentures and various amendments under the
Credit Facility.
Discontinued
operations used cash of $0.5 million and $0.4 million in 2006 and 2005
respectively, relating to payments under capital leases.
Long-Term
Debt
Long-term
debt (including the current portion of long-term debt) as of June 30, 2006
was
$118.2 million, a decrease of $5.0 million compared with the $123.2 million
outstanding at December 31, 2005. The decrease was primarily the result of
repayments under the Credit Facility and the reduction in capital lease
obligations in connection with the discontinued operations of SPI as a component
of liabilities related to assets held for sale.
The
Company is currently in compliance with all of the terms and conditions of
its
Credit Facility, and management believes, based on its current financial
projections, that the Company will be in compliance with covenants over the
next
twelve months. However, as a result of the need to obtain waivers and amend
the
Credit Facility in one of the past three reporting periods, the Company has
determined that the most conservative accounting classification is for the
outstanding debt under the Credit Facility to be classified as current.
Notwithstanding this accounting classification, management believes that the
Company will be in compliance with its financial covenants for at least the
next
twelve months. Although the outstanding balance under the Credit Facility of
$71.5 million as of June 30, 2006 has been classified as current, the maturity
date of the Credit Facility remains September 22, 2007.
If
the
Company loses all or a substantial portion of its lines of credit under the
Credit Facility, it will be required to seek other sources of liquidity. If
the
Company were unable to find these sources of liquidity, for example through
an
equity offering or access to the capital markets, the Company’s ability to fund
its working capital needs and any contingent obligations with respect to put
options would be adversely affected.
Pursuant
to the Credit Facility, the Company must comply with certain financial covenants
including, among other things, covenants for (i) total debt ratio,
(ii) fixed charges ratio, (iii) minimum liquidity, (iv) minimum
net worth, and (v) limitations on capital expenditures, in each case as
such term is specifically defined in the Credit Facility. For the period ended
June 30, 2006, the Company’s calculation of each of these covenants, and the
specific requirements under the Credit Facility, respectively, were as
follows:
|
|
June 30, 2006
|
|
Total
Debt Ratio
|
|
|
2.31
to 1.0
|
|
Maximum
per covenant
|
|
|
2.75
to 1.0
|
|
|
|
|
|
|
Fixed
Charges Ratio
|
|
|
1.42
to 1.0
|
|
Minimum
per covenant
|
|
|
1.05
to 1.0
|
|
|
|
|
|
|
Minimum
Liquidity
|
|
$
|
25.8
million
|
|
Minimum
per covenant
|
|
$
|
9.2
million
|
|
|
|
|
|
|
Net
Worth
|
|
$
|
143.5
million
|
|
Minimum
per covenant
|
|
$
|
132
million
|
|
Subsequent
to June 30, 2006, certain of these financial covenants under the Credit Facility
will become more restrictive. Specifically, the maximum Total Debt Ratio
covenant under the Credit Facility will be as follows: September 30, 2006
and thereafter—2.5 to 1.0. The minimum Fixed Charges Ratio covenant under the
Credit Facility will be as follows: September 30, 2006—1.15 to 1.00; and
December 31, 2006 and thereafter—1.25 to 1.00.
These
ratios are not based on generally accepted accounting principles and are not
presented as alternative measures of operating performance or liquidity. They
are presented here to demonstrate compliance with the covenants in the Company’s
Credit Facility, as noncompliance with such covenants could have a material
adverse effect on the Company.
Capital
Resources
At
June
30, 2006 the Company had utilized approximately $77.0 million of its Credit
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 June 30, 2006 was approximately $28.3 million.
The
Company expects to incur approximately $13.0 million of capital expenditures
for
the remainder of 2006. Such capital expenditures are expected to include
leasehold improvements at certain of the Company’s operating subsidiaries
including the opening of a new customer contact facility. The Company intends
to
maintain and expand its business using cash from operating activities, together
with funds available under the Credit Facility and, if required, by raising
additional funds through the incurrence of bridge or other debt (which may
include or require further amendments to the Credit Facility) or the issuance
of
equity. Management believes that the Company’s cash flow from operations and
funds available under the Credit Facility, and refinancings thereof, will be
sufficient to meet its ongoing working capital, capital expenditures and other
cash needs over the next eighteen months. If the Company has significant organic
growth or growth through acquisitions, management expects that the Company
may
need to obtain additional financing in the form of debt and/or equity
financing.
Deferred
Acquisition Consideration (Earnouts)
Acquisitions
of businesses by the Company include commitments to contingent deferred 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 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 June
30,
2006, approximately $1.0 million of deferred consideration is included in the
Company’s balance sheet and relates to acquisitions in prior years. Based on the
various assumptions as to future operating results of the relevant entities,
management estimates that approximately $113.8 million of additional deferred
purchase obligations could be triggered during 2006 or thereafter, including
approximately $23.2 million which may be paid in the form of issuance by the
Company of its Class A shares. The actual amount that the Company pays in
connection with the obligations may differ materially from this
estimate.
Off-Balance
Sheet Commitments
Put
Rights of Subsidiaries’ Minority Shareholders
Owners
of
interests in certain of the Marketing Communications Group subsidiaries have
the
right in certain circumstances to require the Company to acquire the remaining
ownership interests held by them. These rights are not freestanding. The owners’
ability to exercise any such “put” right is subject to the satisfaction of
certain conditions, including conditions requiring notice in advance of
exercise. In addition, these rights cannot be exercised prior to specified
staggered exercise dates. The exercise of these rights at their earliest
contractual date would result in obligations of the Company to fund the related
amounts during the period 2006 to 2013. 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.
Management
estimates, assuming that the subsidiaries owned by the Company at June 30,
2006,
perform over the relevant future periods at their 2005 earnings levels, that
these rights, if all exercised, could require the Company, in future periods,
to
pay an aggregate amount of approximately $113.8 million to the owners of such
rights to acquire such ownership interests in the relevant subsidiaries. Of
this
amount, the Company is entitled, at its option, to fund approximately $23.2
million by the issuance of the Company’s Class A subordinate voting shares.
The Company intends to finance the cash portion of these contingent payment
obligations using available cash from operations, borrowings under its credit
facility (and refinancings thereof) and, if necessary, through incurrence of
additional debt. The ultimate amount payable and the incremental operating
income in the future relating to these transactions will vary because it is
dependent on the future results of operations of the subject businesses and
the
timing of when these rights are exercised. Approximately $8.4 million of the
estimated $113.8 million that the Company would be required to pay subsidiaries
minority shareholders’ upon the exercise of outstanding put option rights,
relates to rights exercisable within the next twelve months. During July 2006,
the Company settled $1.5 million of these outstanding put option rights. Upon
the settlement of the total amount of such put options, the Company estimates
that it would receive incremental operating income before depreciation and
amortization of $19.4 million.
Critical
Accounting Policies
The
following summary of accounting policies has been prepared to assist in better
understanding the Company’s consolidated financial statements and the related
management discussion and analysis. Readers are encouraged to consider this
information together with the Company’s consolidated financial statements and
the related notes to the consolidated financial statements as included in the
Company’s annual report on Form 10-K 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
goodwill, intangible assets, valuation allowances for receivables and deferred
income tax assets, stock-based compensation, and the reporting of variable
interest entities at the date of the financial statements. 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.
Revenue
Recognition. The
Company generates services revenue from its Marketing Communications businesses.
The
Company’s revenue recognition policies are in compliance with the SEC Staff
Accounting Bulletin 104, “Revenue Recognition” (“SAB 104”), and accordingly,
revenue is generally recognized when services are earned or upon delivery of
the
products when ownership and risk of loss has transferred to the customer, the
selling price is fixed or determinable and collection of the resulting
receivable is reasonably assured.
The
Marketing Communications businesses earn revenue from agency arrangements in
the
form of retainer fees or commissions; from short-term project arrangements
in
the form of fixed fees or per diem fees for services; and from incentives or
bonuses.
Non-refundable
retainer fees are generally recognized on a straight-line basis over the term
of
the specific customer contract. Commission revenue is earned and recognized
upon
the placement of advertisements in various media when the Company has no further
performance obligations. Fixed fees for services are recognized upon completion
of the earnings process and acceptance by the client. Per diem fees are
recognized upon the performance of the Company’s services. In addition, for
certain service transactions the Company uses the Proportional Performance
model, which results in delivery being considered to occur over a period of
time.
Fees
billed to clients in excess of fees recognized as revenue are classified as
advance billings.
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 the
Company’s clients determine performance against qualitative goals has been
achieved. In all circumstances, revenue is only recognized when collection
is
reasonably assured.
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 Group businesses, the
business at times acts as an agent and records revenue equal to the net amount
retained, when the fee or commission is earned.
Acquisitions,
Goodwill and Other Intangibles. 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.
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. Due to the nature of advertising, marketing and
corporate communications services companies; the companies acquired frequently
have significant identifiable intangible assets, which primarily consist of
customer relationships. The Company has determined that certain intangibles
(trademarks) have an indefinite life, as there are no legal, regulatory,
contractual, or economic factors that limit the useful life.
A
summary
of the Company’s deferred acquisition consideration obligations, sometimes
referred to as earnouts, 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.
Allowance
for doubtful accounts. Trade
receivables are stated less allowance for doubtful accounts. The allowance
represents estimated uncollectible receivables usually due to customers’
potential insolvency. The allowance included amounts for certain customers
where
risk of default has been specifically identified.
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.
Stock-Based
Compensation. Effective
January 1, 2003, the Company prospectively adopted fair value accounting
for stock-based awards as prescribed by SFAS No. 123 “Accounting for
Stock-Based Compensation” (“SFAS No. 123”). Prior to January 1, 2003,
the Company elected not to apply fair value accounting to stock-based awards
to
employees, other than for direct awards of stock and awards settleable in cash,
which required fair value accounting. Prior to January 1, 2003, for awards
not elected to be accounted for under the fair value method, the Company
accounted for stock-based awards 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 awards.
Under
this method, compensation cost is measured as the excess, if any, of the quoted
market price of the stock issuance at the measurement date over the amount
to be
paid by the employee.
The
Company adopted fair value accounting for stock-based awards using the
prospective application transitional alternative available in SFAS 148
“Accounting for Stock-Based Compensation—Transition and Disclosure”.
Accordingly, the fair value method is applied to all awards granted, modified
or
settled on or after January 1, 2003. Under the fair value method,
compensation cost is measured at fair value at the date of grant and is expensed
over the service period, that is the award’s vesting period. When awards are
exercised, share capital is credited by the sum of the consideration paid
together with the related portion previously credited to additional paid-in
capital when compensation costs were charged against income or acquisition
consideration.
Stock-based
awards that are settled in cash or may be settled in cash at the option of
employees are recorded as liabilities. The measurement of the liability and
compensation cost for these awards is based on the intrinsic value of the award,
and is recorded into operating income over the service period, that is the
vesting period of the award in accordance with FASB Interpretation Number 28-
“Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans—an interpretation of APB Opinions No. 15 and 25”(“FIN 28”).
Changes in the Company’s payment obligation subsequent to vesting of the award
and prior to the settlement date are recorded as compensation cost in operating
income in the period of the change. The final payment amount for such awards
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 the 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.
Effective
January 1, 2006, the Company adopted FAS 123(R) and has opted to use
the modified prospective application transition method. Under this method the
Company will not restate its prior financial statements. Instead, the Company
will apply FAS 123(R) for new awards granted after the adoption of FAS
123(R), any portion of awards that were granted after December 15, 1994 and
have not vested as of January 1, 2006, and any outstanding liability
awards.
Measurement
of compensation cost for awards that are outstanding and classified as equity,
at January 1, 2006, will be based on the original grant-date fair value
calculations of those awards. The Company had previously adopted FAS 123 and
as
such has been expensing the fair value of all awards issued after
January 1, 2003. For all previously issued awards, the Company has been
providing pro-forma disclosure for such awards. Upon the adoption of FAS 123(R),
the Company expenses the fair value of the awards granted prior to
January 1, 2003. The Company has adopted the straight-line attribution
method for determining the compensation cost to be recorded during each
accounting period. The adoption of FAS 123(R) did not have a material
effect on the Company’s financial position or results of
operations.
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.
New
Accounting Pronouncements
In
June
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes. This
Interpretation clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. This Interpretation is effective
for fiscal years beginning after December 15, 2006, with earlier application
permitted. The Company is currently evaluating the impact if any this
Interpretation will have on its financial statements.
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, recent business and economic trends,
potential acquisitions, 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, if any.
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
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 remain in compliance with its debt agreements and the
Company’s ability to finance its contingent payment obligations when due
and payable, including but not limited to those relating to “put” options
rights;
|
|
·
|
risks
arising from identified and potential future material weaknesses
in
internal control over financial
reporting;
|
|
·
|
the
Company’s ability to retain and attract key
employees;
|
|
·
|
the
successful completion and integration of acquisitions which complement
and
expand the Company’s business capabilities;
|
|
·
|
foreign
currency fluctuations; and
|
|
· |
risks
arising from the Company’s internal review of its historical option grant
practices.
|
In
addition to improving organic growth for its existing operations, the Company’s
business strategy includes ongoing efforts to engage in material acquisitions
of
ownership interests in entities in the marketing communications services
industry. The Company intends to finance these acquisitions by using available
cash from operations and through incurrence of bridge or other debt financing,
either of which may increase the Company’s leverage ratios, or by issuing
equity, which may have a dilutive impact on existing shareholders proportionate
ownership. At any given time, the Company may be engaged in a number of
discussions that may result in one or more material acquisitions. These
opportunities require confidentiality and may involve negotiations that require
quick responses by the Company. Although there is uncertainty that any of these
discussions will result in definitive agreements or the completion of any
transactions, the announcement of any such transaction may lead to increased
volatility in the trading price of the Company’s securities.
Investors
should carefully consider these risk factors, the risk factors specified in
Item
1A of this Form 10-Q, and in the additional risk factors outlined in more detail
in the Company’s Annual Report on Form 10-K under the caption “Risk
Factors” and in the Company’s other SEC filings.
Item
3. Quantitative
and Qualitative Disclosures about Market Risk
The
Company is exposed to market risk related to interest rates and foreign
currencies.
Debt
Instruments. At June 30, 2006, the Company’s debt obligations consisted of
amounts outstanding under a revolving credit facility. This facility bears
interest at variable rates based upon the Eurodollar rate, US bank prime rate,
US base rate, and Canadian bank prime rate, at the Company’s option. The
Company’s ability to obtain the required bank syndication commitments depends in
part on conditions in the bank market at the time of syndication. Given the
existing level of debt of $72.4 million, as of June 30, 2006, a 1.0% increase
or
decrease in the weighted average interest rate, which was 8.15% during the
six
months ended June 30, 2006, would have an interest impact of approximately
$0.7
million annually.
Foreign
Exchange. The Company conducts business in three currencies, the US dollar,
the
Canadian dollar, and the British Pound. Our results of operations are subject
to
risk from the translation to the US dollar of the revenue and expenses of our
non-US operations. The effects of currency exchange rate fluctuations on the
translation of our results of operations are discussed in “Management’s
Discussion and Analysis of Financial Condition and Result of Operations”. For
the most part, our revenues and expenses incurred related to those revenues
are
denominated in the same currency. This minimizes the impact that fluctuations
in
exchange rates will have on profit margins. The Company does not enter into
foreign currency forward exchange contracts or other derivative financial
instruments to hedge the effects of adverse fluctuations in foreign currency
exchange rates.
Effective
June 28, 2005, the Company entered into a cross currency swap contract
(“Swap”), a form of derivative in order to mitigate the risk of currency
fluctuations relating to interest payment obligations. The Swap contract
provides for a notional amount of debt fixed at C$45.0 million and at $36.5
million, with the interest rates fixed at 8% per annum for the Canadian dollar
amount and fixed at 8.25% per annum for the US dollar amount. On June 22, 2006,
the Company settled this Swap.
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 the 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 our
President & Chief Financial Officer (CFO), who is our principal
financial officer, as appropriate, to allow timely decisions regarding required
disclosures. There are inherent limitations to the effectiveness of any system
of disclosure controls and procedures, including the possibility of human error
and the circumvention or overriding of the controls and procedures. Accordingly,
even effective disclosure controls and procedures can only provide reasonable
assurance of achieving their control objectives.
We
conducted an evaluation, under the supervision and with the participation of
our
management, including our CEO, our CFO and our management Disclosure Committee,
of the effectiveness of our disclosure controls and procedures as of June 30,
2006, pursuant to Rule 13a-15(b) of the Exchange Act. Based on that
evaluation, and in light of the facts and material weaknesses in the Company’s
internal control over financial reporting described below, the CEO and the
CFO
concluded that the Company’s disclosure controls and procedures were not
effective as of that date. Accordingly, the Company performed additional
analysis and procedures to ensure that its consolidated financial statements
were prepared in accordance with US GAAP. These procedures included monthly
analytic reviews of subsidiaries’ financial results, and quarterly
certifications by senior management of subsidiaries regarding the accuracy
of
reported financial information. In addition, the Company performed additional
procedures to provide reasonable assurance that the financial statements
included in this report are fairly presented in all material
respects.
Changes
in Internal Control Over Financial Reporting
Management
is responsible for establishing and maintaining adequate internal control over
financial reporting (as defined in Rules 13a-15(f) under the Exchange
Act). Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate. Management
previously assessed the effectiveness of our internal control over financial
reporting as of December 31, 2005, using the criteria set forth in
Internal
Control—Integrated Framework issued
by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Based on that assessment, management concluded that, as of December 31,
2005, the Company did not maintain effective internal control over financial
reporting due to several material weaknesses. These material weaknesses, which
are described in greater detail in the Company’s annual report on Form 10-K
for the year ended December 31, 2005, comprised:
a.
Accounting for Complex and Non-Routine Transactions - The
Company continues to have a material weakness with respect to accounting for
complex and non-routine transactions. The Company did not have a sufficient
number of finance personnel with sufficient technical accounting knowledge,
or
an appropriate process to address and review complex and non-routine accounting
matters.
b.
Revenue
Recognition and Accounting for Related Costs - As
a
result of certain deficiencies in the controls over the application of
accounting standards at certain subsidiaries within the Marketing Communications
Group, and deficiencies in controls over the recording of revenue and costs
of
revenue at certain subsidiaries, the Company continues to have a material
weakness with respect to revenue recognition and accounting for certain related
costs. Specifically, controls were not designed and in place to ensure that
customer contracts were analyzed to select the appropriate method of revenue
recognition. In addition, controls were not designed and in place to ensure
that
revenue transactions were analyzed for appropriate presentation and disclosure
of billable client pass-through expenses or for revenue recognition on a gross
or net basis.
c.
Segregation
of Duties —
The
Company continues to have control deficiencies within its accounting and finance
departments and its financial information systems over segregation of duties
and
user access respectively. Specifically, certain duties within the accounting
and
finance department were not properly segregated.
The
Company is currently designing and implementing improved controls to address
the
material weaknesses described above. In the second quarter of 2006, the Company
took (and, in certain cases, subsequently took or is continuing to take) the
following steps in an effort to enhance its overall internal control over
financial reporting and to address these material weaknesses. Specifically,
the
Company:
1.
Hired
additional accounting and finance department staff with US GAAP experience
for
its accounting and finance departments at the Company’s operating subsidiaries
and corporate head office;
2.
Continues to refine procedures for ensuring appropriate documentation of
significant transactions and application of accounting standards to ensure
compliance with US GAAP;
3.
Is
improving procedures for reviewing underlying business agreements and analyzing,
reviewing and documenting the support for management’s accounting entries and
significant transactions; and
4.
Hired
and
will continue to hire additional personnel to support management’s process for
evaluating internal controls over financial reporting.
The
Company continues to dedicate significant personnel and financial resources
to
the ongoing development and implementation of a plan to remediate its material
weaknesses in internal control over financial reporting. There
have been no other changes in the Company’s internal control over financial
reporting that occurred during the second quarter of 2006 or subsequently that
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
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 or results of operations
of
the Company.
There
are
no material changes in the risk factors set forth in Part I, Item 1A of the
Company’s Annual Report on Form 10-K for the year-ended December 31,
2005, other than the following item:
We
are conducting an ongoing review of our option grant practices and the results
of this review may give rise to uncertainties and liabilities.
The
Company and its Board of Directors are continuing to review the Company’s equity
award practices and procedures. Based on findings to-date, we
do not
expect that any material impact to, or restatement of, previously issued
financial statements should arise from the results of this review. However,
the
initial findings of this review indicate that the
exercise prices of option grants made during 2001 to 2003 were lower, by an
aggregate of approximately $3.5 million, than the market prices of the Company’s
stock on the grant dates. In
accordance with the underlying terms of the applicable Option Plan, the
Company has concluded that in the cases where the exercise price for an option
grant was originally established to be less than the market price on the date
on
which the Company had received final written Compensation Committee resolutions
to approve the grant, the exercise price of such option has been deemed amended
by a self-correcting provision to the extent necessary to bring the exercise
price into compliance with the provisions of the Option Plan. The
Company’s findings relating to its historical option grant activity may
nonetheless give rise to liabilities. In addition, the final results of this
review may raise further issues that may give rise to potential adverse
consequences for the Company.
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds.
There
were no transactions occurring during the second quarter of 2006 in which the
Company issued shares of its Class A subordinate voting shares that were not
registered with the SEC. The Company made no purchases of its equity securities
during the first six months of 2006.
|
(a)
|
This
item is answered in respect of the Annual Meeting of Shareholders
held on
June 1, 2006 (the “Annual Meeting”).
|
|
|
|
|
(b)
|
No
response is required to Paragraph (b) because (i) proxies for the
meeting
were solicited pursuant to Regulation 14 under the Securities Exchange
Act
of 1934, as amended; (ii) there was no solicitation in opposition
to
management's nominees as listed in the proxy statement; and (iii)
all such
nominees were elected.
|
|
|
|
|
(c)
|
At
the Annual Meeting, the following number of shares were cast with
respect
to each matter voted upon:
|
At
the
Annual Meeting, shareholder votes were cast for the election of management's
nominees for Director as follows:
NOMINEE
|
|
FOR
|
|
WITHHELD
|
|
|
|
|
|
|
|
|
|
Miles
S. Nadal
|
|
|
17,690,023
|
|
|
496,132
|
|
|
|
|
|
|
|
|
|
Steven
Berns
|
|
|
18,167,948
|
|
|
18,207
|
|
|
|
|
|
|
|
|
|
Thomas
N. Davidson
|
|
|
18,174,680
|
|
|
11,476
|
|
|
|
|
|
|
|
|
|
Richard
R. Hylland
|
|
|
18,172,680
|
|
|
13,475
|
|
|
|
|
|
|
|
|
|
Robert
J. Kamerschen
|
|
|
18,167,680
|
|
|
18,475
|
|
|
|
|
|
|
|
|
|
Scott
Kauffman
|
|
|
18,174,680
|
|
|
11,475
|
|
|
|
|
|
|
|
|
|
Senator
Michael J.L. Kirby
|
|
|
18,180,218
|
|
|
5,937
|
|
|
|
|
|
|
|
|
|
Stephen
M. Pustil
|
|
|
18,167,486
|
|
|
18,669
|
|
|
|
|
|
|
|
|
|
Francois
R. Roy
|
|
|
18,180,218
|
|
|
5,937
|
|
|
|
|
|
|
|
|
|
Thomas
Weigman
|
|
|
18,173,680
|
|
|
12,475
|
|
Exhibit No.
|
|
Description
|
|
|
|
10.1
|
|
Amended
and Restated Stock Appreciation Rights Plan, as amended on April 28,
2006 (incorporated by reference to the Company’s Form 10-Q filed on May 5,
2006);
|
|
|
|
10.2
|
|
Amendment
No. 8 dated as of August 3, 2006, to the Credit Agreement (made on
September 22, 2004)*
|
|
|
|
12
|
|
Statement
of computation of ratio of earnings to fixed charges;*
|
|
|
|
31.1
|
|
Certification
by Chief Executive Officer pursuant to Rules 13a-14(a) and
15d-14(a) under the Securities Exchange Act of 1934 and
Section 302 of the Sarbanes-Oxley Act of 2002*;
|
|
|
|
31.2
|
|
Certification
by President and CFO pursuant to Rules 13a-14(a) and
15d-14(a) under the Securities Exchange Act of 1934 and
Section 302 of the Sarbanes-Oxley Act of 2002*;
|
|
|
|
32.1
|
|
Certification
by Chief Executive Officer pursuant to 18 USC. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*;
|
|
|
|
32.2
|
|
Certification
by President and CFO pursuant to 18 USC. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*;
|
|
|
|
99.1
|
|
List
of the Company’s operating subsidiaries by reportable
segments.*
|
*
Filed
electronically herewith.
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/ Michael
Sabatino |
|
|
|
Michael
Sabatino
|
|
|
|
Chief
Accounting Officer
|
|
|
|
August 8,
2006
EXHIBIT INDEX
Exhibit No.
|
|
Description
|
|
|
|
10.1
|
|
Amended
and Restated Stock Appreciation Rights Plan, as amended on April 28,
2006 (incorporated by reference to the Company’s Form 10-Q filed on May 5,
2006);
|
|
|
|
10.2
|
|
Amendment
No. 8 dated as of August 3, 2006, to the Credit Agreement (made on
September 22, 2004)*
|
|
|
|
12
|
|
Statement
of computation of ratio of earnings to fixed charges;*
|
|
|
|
31.1
|
|
Certification
by Chief Executive Officer pursuant to Rules 13a-14(a) and
15d-14(a) under the Securities Exchange Act of 1934 and
Section 302 of the Sarbanes-Oxley Act of 2002*;
|
|
|
|
31.2
|
|
Certification
by President and CFO pursuant to Rules 13a-14(a) and
15d-14(a) under the Securities Exchange Act of 1934 and
Section 302 of the Sarbanes-Oxley Act of 2002*;
|
|
|
|
32.1
|
|
Certification
by Chief Executive Officer pursuant to 18 USC. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*;
|
|
|
|
32.2
|
|
Certification
by President and CFO pursuant to 18 USC. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*;
|
|
|
|
99.1
|
|
List
of the Company’s operating subsidiaries by reportable
segments*.
|
*
Filed electronically herewith.