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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

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FORM 10-Q

 

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2007
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________ to ______________

Commission file number: 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)
45 Hazelton Avenue
Toronto, Ontario, Canada		M5R 2E3
(Address of principal executive offices)		(Zip Code)

 

(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 May 1, 2007 were: 25,098,017 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.

 

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MDC PARTNERS INC.

 

QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

				Page
		PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements		2
		Condensed Consolidated Statements of Operations (unaudited) for the Three Months Ended March 31, 2007 and 2006		2
		Condensed Consolidated Balance Sheets as of March 31, 2007 (unaudited) and December 31, 2006		3
		Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2007 and 2006		4
		Notes to Unaudited Condensed Consolidated Financial Statements		5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		32
Item 4.		Controls and Procedures		32
		PART II. OTHER INFORMATION
Item 1.		Legal Proceedings		33
Item 1A.		Risk Factors		33
Item 2.		Unregistered Sales of Equity and Use of Proceeds		33
Item 4.		Submission of Matters to a Vote of Security Holders		33
Item 6.		Exhibits		34
Signatures				35

 

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(thousands of United States dollars)

 

		March 31, 2007			December 31, 2006
		(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	4,786		$	6,591
Accounts receivable, less allowance for doubtful accounts of $1,120 and $1,633			126,023			125,744
Expenditures billable to clients			42,310			28,077
Prepaid expenses			8,361			4,816
Other current assets			1,446			1,248
Total Current Assets			182,926			166,476
Fixed assets, at cost, less accumulated depreciation of $55,582 and $52,359			44,536			44,425
Investment in affiliates			2,015			2,058
Goodwill			199,381			203,693
Other intangibles assets, net			47,696			48,933
Deferred tax asset			13,505			13,332
Other assets			14,334			14,584
Total Assets		$	504,393		$	493,501
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Short-term debt		$	534		$	4,910
Revolving credit facility			78,350			45,000
Accounts payable			68,753			90,588
Accruals and other liabilities			63,057			75,315
Advance billings			73,576			51,804
Current portion of long-term debt			1,129			1,177
Deferred acquisition consideration			2,037			2,721
Total Current Liabilities			287,436			271,515
Long-term debt			5,658			5,754
Convertible notes			38,975			38,613
Other liabilities			5,488			5,512
Deferred tax liabilities			1,136			1,140
Total Liabilities			338,693			322,534
Minority interests			47,370			46,553
Commitments, contingencies and guarantees (Note 12)
Shareholders’ Equity:
Preferred shares, unlimited authorized, none issued			—			—
Class A Shares, no par value, unlimited authorized, 24,611,503 and 23,923,522 shares issued in 2007 and 2006			186,999			184,698
Class B Shares, no par value, unlimited authorized, 2,502 shares issued in 2007 and 2006, each convertible into one Class A share			1			1
Share capital to be issued, 66,350 shares at March 31, 2007			509			—
Additional paid-in capital			26,059			26,216
Accumulated deficit			(95,411	)		(86,614	)
Treasury stock, at cost; 83,253 Class A shares at March 31, 2007			(660	)		—
Stock subscription receivable			(459	)		(643	)
Accumulated other comprehensive income			1,292			756
Total Shareholders’ Equity			118,330			124,414
Total Liabilities and Shareholders’ Equity		$	504,393		$	493,501

See notes to the unaudited condensed consolidated financial statements.

 

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MDC PARTNERS INC. AND SUBSIDIARIES

(thousands of United States dollars)

 

		Three Months Ended March 31,
		2007			2006
Cash flows from operating activities:					Reclassified (Note 1)
Net loss		$	(8,797	)	$	(5,132	)
Loss from discontinued operations			—			(734	)
Loss from continuing operations			(8,797	)		(4,398	)
Adjustments to reconcile net loss from continuing operations to cash provided by (used in) operating activities
Depreciation			3,693			2,659
Amortization of intangibles			2,272			4,121
Non-cash stock-based compensation			1,692			3,304
Goodwill impairment			4,475			—
Amortization of deferred finance charges			578			411
Deferred income taxes			(177	)		(889	)
Earnings of non-consolidated affiliates			50			(278	)
Minority interest and other			718			(796	)
Changes in non-cash working capital:
Accounts receivable			(499	)		(3,241	)
Expenditures billable to clients			(14,233	)		(12,094	)
Prepaid expenses and other current assets			(3,809	)		(828	)
Accounts payable, accruals and other liabilities			(34,010	)		20,379
Advance billings			21,772			(376	)
Cash flows provided by (used in) continuing operating activities			(26,275	)		7,974
Discontinued operations			—			1,041
Net cash provided by (used in) operating activities			(26,275	)		9,015
Cash flows from investing activities:
Capital expenditures			(3,637	)		(5,021	)
Acquisitions, net of cash acquired			(416	)		(2,735	)
Distributions received from non-consolidated affiliates			—			460
Discontinued operations			—			(782	)
Net cash used in investing activities			(4,053	)		(8,078	)
Cash flows from financing activities:
Decrease in bank indebtedness			(4,376	)		(1,487	)
Proceeds from (payments under) revolving credit facility			33,350			(7,100	)
Repayment of long-term debt			(349	)		(316	)
Issuance of share capital			452			150
Subsidiary issuance of share capital from exercise of stock options			—			385
Proceeds from stock subscription receivable			184			—
Purchase of treasury shares			(660	)		—
Discontinued operations			—			(269	)
Net cash provided by (used in) financing activities			28,601			(8,637	)
Effect of exchange rate changes on cash and cash equivalents			(78	)		75
Net decrease in cash and cash equivalents			(1,805	)		(7,625	)
Cash and cash equivalents at beginning of period			6,591			12,923
Cash and cash equivalents at end of period		$	4,786		$	5,298
Supplemental disclosures:
Cash paid to minority partners		$	7,093		$	3,660
Cash income taxes paid		$	564		$	397
Cash interest paid		$	3,310		$	1,400
Non-cash transactions:
Share capital issued on acquisitions		$	—		$	4,459
Capital leases		$	169		$	—
Note receivable exchanged for shares in subsidiary		$	—		$	1,155

 

See notes to the unaudited condensed consolidated financial statements.

 

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(thousands of United States dollars, unless otherwise stated)

 

1.           Basis of Presentation     

 

MDC Partners Inc. (the “Company”) has prepared the unaudited condensed consolidated interim financial statements included herein pursuant to the rules 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, 2006.

 

On November 14, 2006, the Company completed the sale of its Secure Products International Group and accordingly has reclassified its 2006 financial results to reflect 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.

 

 

3.           Loss Per Common Share

 

The following table sets forth the computation of basic and diluted loss per common share from continuing operations.

		Three Months Ended  March 31,
		2007			2006
Numerator
Numerator for basic loss per common share - loss from continuing operations		$	(8,797	)	$	(4,398	)
Effect of dilutive securities			—			—
Numerator for diluted loss per common share - loss from continuing operations plus assumed conversion		$	(8,797	)	$	(4,398	)
Denominator
Denominator for basic loss per common share - weighted average common shares			24,274,797			23,777,590
Effect of dilutive securities			—			—
Denominator for diluted loss per common share - adjusted weighted shares and assumed conversions			24,274,797			23,777,590
Basic loss per common share from continuing operations		$	(0.36	)	$	(0.19	)
Diluted loss per common share from continuing operations		$	(0.36	)	$	(0.19	)

 

The 8% convertible debentures, options and other rights to purchase 7,920,436 shares of common stock, which includes 253,614 shares of non-vested restricted stock, were outstanding during the three months ended March 31, 2007, but were not included in the computation of diluted loss per common share because their effect would be antidilutive. Similarly, during the three months ended March 31, 2006, the 8% convertible debentures, options and other rights to purchase 8,842,935 shares of common stock, which includes 263,500 shares of non-vested restricted stock, were outstanding but were not included in the computation of diluted loss per common share because their effect would be antidilutive.

 

4.           Acquisitions

 

First Quarter 2007 Acquisition

On February 2, 2007, the Company, through its subsidiary Bryan Mills Group Ltd. (“Bryan Mills”), acquired 100% of the issued and outstanding shares of Iradesso Communications Corp., a Canadian financial communications firm. This acquisition provides the Company an opportunity to expand its business, in terms of productive talent, service offerings and geographic presence. The purchase price for this transaction included a cash payment equal to approximately $342 and the issuance of shares in Bryan Mills representing 11.85% of the equity ownership in Bryan Mills, valued at approximately $815. The Company incurred transaction costs of approximately $40 for a total purchase price of approximately $1,197. This cost has been assigned to an intangible asset relating to the value of the new employment agreement with the former owner of Iradesso Communications Corp. and will be amortized over a five year term.

2006 Acquisitions

 

During 2006, the Company did not complete any material acquisitions. However, the Company did complete the following transactions:

On February 7, 2006, the Company purchased the remaining outstanding membership interests of 12.33% of Source Marketing LLC in 2006: (“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. On October 1, 2006, the options noted above were exercised. This exercise resulted in a dilution loss of $626 and reduced the Company’s ownership down to 80%.

 

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On July 1, 2006, the Company and Mono Advertising, LLC amended its operating agreement to eliminate certain governance limitations that the Company had on its ability to exercise control of Mono Advertising, LLC. Effective July 1, 2006 the Company has consolidated Mono Advertising, LLC which had previously been accounted for under the equity method.

On July 27, 2006, the Company settled a put option obligation for a fixed amount equal to $1,492, relating to the purchase of 4.3% of additional equity interests of Accent Marketing, LLC. The settlement of this put was satisfied by a cash payment of $424, plus the cancellation of an outstanding promissory note to the Company in a principal amount equal to $1,068. The purchase price was allocated as follows: $403 to identified intangibles, amortized over eight years and the balance of $1,089 as additional goodwill. The goodwill and intangibles are deductible for tax purposes. Including this transaction, the Company now owns 93.7% of Accent Marketing, LLC.

 

On November 14, 2006, the Company purchased an additional 20% interest in Northstar Research Partners Inc. (“Northstar”) for $3,405 in cash. This transaction resulted in an allocation of the purchase price to goodwill of $2,989 and identifiable intangible assets of $415. In February 2007, Northstar acquired an additional 18% of Northstar Research (UK) Limited for approximately $27. This cost has been assigned to goodwill. Northstar now owns 82% of Northstar Research (UK) Limited.

On November 14, 2006, the Company through its subsidiary Zig Inc. purchased a 65% interest in Hadrian’s Wall Advertising, LLC for $550. Hadrian’s Wall Advertising, LLC is a creative advertising firm that was acquired to facilitate the expansion of the Zig Canada business into the US market. In addition the Company purchased an additional 0.2% of Zig Inc. for cash of $18 and 30,000 of the Company’s Stock Appreciation Rights (“SARs”), valued at $104. The purchase price was allocated to goodwill of $18 and the value of the SARs was considered to be compensation expense and will be amortized over the vesting period of the SARs. Effective November 17, 2006, as a result of the additional share purchase, the Company has consolidated Zig Inc. which had previously been accounted for under the equity method.

On December 15, 2006, the Company and Accumark Communications Group Inc. amended its operating agreement to eliminate certain minority rights. As a result of this amendment, effective December 15, 2006, the Company has consolidated Accumark Communications Inc. which had previously been accounted for under the equity method.

 

 

 

Total comprehensive loss and its components were:  

		Three Months Ended  March 31,
		2007			2006
Net loss for the period		$	(8,797	)	$	(5,132	)
Foreign currency cumulative translation adjustment		$	536		$	(82	)
Comprehensive loss for the period		$	(8,261	)	$	(5,214	)

 

 

 

			March 31,  2007			December 31, 2006
Short-term debt		$	534		$	4,910
Revolving credit facility			78,350			45,000
8% convertible debentures			38,975			38,613
Notes payable and other bank loans			5,065			5,206
			122,924			93,729
Obligations under capital leases			1,722			1,725
			124,646			95,454
Less:
Revolving credit facility			78,350			45,000
Short-term debt			534			4,910
Current portions			1,129			1,177
Long term portion		$	44,633		$	44,367

 

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

On September 22, 2004, MDC Partners Inc. and certain of its wholly-owned subsidiaries entered into a revolving credit facility with a syndicate of banks providing for borrowings of up to $100,000 (including swing-line advances of up to $10,000) maturing in September 2007 (the “Credit Facility”). At March 31, 2007, the maximum borrowing under the facility is $96,500, a reduction of $3,500 due to the sale of SPI. 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. The facility is secured by a senior pledge of the Company’s assets principally comprised of ownership interests in its subsidiaries 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 March 31, 2007. At March 31, 2007 and December 31, 2006, the aggregate amount of swing line advances, plus outstanding checks (disclosed as “Short-term debt” in Current Liabilities on the balance sheet) was $534 and $4,910, respectively. At March 31, 2007, the unused portion of the total facility was $13,756.

 

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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, and management believes that no such conditions will exist over the next twelve months. The weighted average interest rate on these current portions of debt was 8.36% and 8.13% as of March 31, 2007 and December 31, 2006, respectively.

 

Since securing the Credit Facility on September 22, 2004, the Credit Facility has been amended nine times prior to December 31, 2006 and two additional times as follows:

 

On March 8, 2007, the Company amended its Credit Facility. Pursuant to such amendment, the lenders agreed to amend the restrictive covenants to permit the Company to make two proposed acquisitions that provide for up to $10 million in cash to be paid at closing.

 

On April 4, 2007, the Company further amended its Credit Facility. Pursuant to such amendment, the lenders agreed to permit the Company to have issued letters of credit with a maturity date of one year beyond the termination of the Credit Facility, provided that such letters of credit are cash collateralized no later then 20 days prior to maturity of the Credit Facility.

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 until the currently scheduled expiration date of September 21, 2007.

As of March 31, 2007, and December 31, 2006, $3,563 and $2,414 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.

 

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 tradable 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 ($12.13 as of March 31, 2007) per Class A subordinate voting share being a ratio of approximately 71.4286 Class A subordinate voting shares per C$1,000.00 ($866 as of March 31, 2007) 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.

 

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Notes Payable

 

In connection with the Zyman acquisition, the Company assumed a note payable in the original principal 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 $5,001 and $5,100 at March 31, 2007 and December 31, 2006, respectively. The note agreement is secured by an aircraft and related equipment with a net book value of $4,289 at March 31, 2007. In April 2007, this note was fully repaid and extinguished. See Note 14.

 

 

During the three months ended March 31, 2007 Class A share capital increased by $2,301, as the Company issued 687,981 Class A shares related to the exercise of stock options, vested restricted stock, and stock appreciation right awards. During the three months ended March 31, 2007 “Additional paid-in capital” decreased by $157, of which $1,692 related to an increase from stock-based compensation that was expensed during the same period, offset by a decrease of $1,849 related to the exercise of stock appreciation right awards.

In March 2007, the Company purchased 83,253 Class A shares for $660 from employees in connection with the required tax withholding resulting from the vesting of the restricted stock.

In May 2007 the Company issued 66,350 Class A shares, valued at $509 in connection with the settlement of an earn-out payment. Due to the contingent nature of this transaction, the Company has recorded the issuance of these shares as “Share capital to be issued”. See Note 14.

 

Three Months Ended March 31, 2006

(thousands of United States dollars) 

 

		Strategic Marketing Services			Customer Relationship Management			Specialized Communication Services			Corporate			Total
Revenue		$	56,892		$	18,906		$	22,276		$	—		$	98,074
Cost of services sold			29,043			13,797			16,900			—			59,740
Office and general expenses			16,002			3,474			4,279			6,067			29,822
Depreciation and amortization			5,260			1,063			424			33			6,780
Operating Profit/(Loss)			6,587			572			673			(6,100	)		1,732
Other Income (Expense):
Other income															561
Interest expense, net															(2,784	)
Loss from continuing operations before income taxes, equity in affiliates and minority interests															(491	)
Income tax recovery															570
Income from continuing operations before equity in affiliates and minority interests															79
Equity in earnings of non-consolidated affiliates															274
Minority interests in income of consolidated subsidiaries			(3,953	)		(30	)		(768	)		—			(4,751	)
Loss from continuing operations															(4,398	)
Loss from discontinued operations															(734	)
Net Loss														$	(5,132	)
Non cash stock based compensation		$	220		$	6		$	2,338		$	961		$	3,525
Supplemental Segment Information:
Capital expenditures		$	1,186		$	3,568		$	169		$	98		$	5,021

 

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			Other			Total
Revenue
Three Months Ended March 31,
2007		$	98,354		$	18,683		$	2,494		$	119,531
2006		$	83,760		$	13,033		$	1,281		$	98,074

 

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 March 31, 2007 would be expected to be owed in 2007.

Put Options. Owners of interests in certain 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 2007 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 March 31, 2007, perform over the relevant future periods at their trailing twelve-months earnings levels, that these rights, if all exercised, could require the Company, in future periods, to pay an aggregate amount of approximately $122,738 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 $25,537 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.

 

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 months ended March 31, 2007 and 2006, 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, 2003 and 2006, 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.

 

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For guarantees and indemnifications entered into after January 1, 2003, in connection with the sale of SPI and 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 $448 in one investment fund over a period of up to two years. At March 31, 2007, the Company has issued $4,792 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 has adopted this interpretation, the adoption of which did not have a material effect on its financial statements.

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements”. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for all fiscal year beginning after November 15, 2007 and interim periods within those fiscal years. Earlier application is encouraged. The Company is currently evaluating the impact of this statement on its financial statements.

In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. This statement expands the use of fair value measurement and applies to entities that elect the fair value option. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of this statement on its financial statements.

14.      Subsequent Events

 

On April 4, 2007, the Company acquired a 59% membership interest in HL Group Partners LLC (“HL”).  The Company intends to use 8% of the membership interests purchased for purposes of entering into a profits interest arrangement with other key executives of HL, or “Gen II” management. Gen II management will also have liquidity rights based on any appreciation of value over the original purchase price attributable to the 8% profits interest. HL is a marketing strategy and corporate communications firm with a specialty in high end fashion and luxury goods. HL is expected to expand the Company’s creative talent within the Strategic Marketing Services segment. The purchase price consisted of $4,408 in cash and $1,000 was paid in the form of 128,550 newly-issued Class A shares of the Company.

On April 11, 2007, the Company made an earn-out payment in relation to the Company’s prior acquisition of Hello Design, LLC for $2,546. Of this amount, $2,037 was paid in cash and $509 was paid in the form of 66,350 newly-issued Class A shares of the Company, which were issued in May 2007.

On April 17, 2007, the Company sold the plane that was acquired in connection with the Zyman acquisition for consideration equal to $6,368. In connection with the sale, the Company repaid the loan relating to the plane in an amount equal to $5,001 and will record a gain on the sale of assets of approximately $1,846 in the second quarter of 2007.

On April 27, 2007, the Company entered into a new Management Services Agreement (the “Agreement”) with Miles Nadal and with Nadal Management, Inc. to set forth the terms and conditions on which Mr. Nadal will continue to provide services to the Company as its Chief Executive Officer. Mr. Nadal’s prior services agreement with the Company was scheduled to expire on October 31, 2007, subject to two-year annual renewals. If the Company were not going to enter into a new agreement with Mr. Nadal and did not intend to allow the prior agreement to renew, it would have been required to give Mr. Nadal notice of such non-renewal by April 30, 2007.

The Agreement has a three-year term with automatic one-year extensions. Pursuant to the Agreement, the base compensation for Mr. Nadal’s services will continue through 2007 at the current rate of $950, with annual increases of $25 in each of 2008 and 2009. The Agreement also provides for an annual bonus with a targeted payout of up to 250% of the base compensation. The Company will also make an annual cash payment of $500 in respect of retirement benefits, employee health benefits and perquisites. In addition, in the discretion of the Compensation Committee, grant equity incentives with a targeted grant-date value of up to 300% of his then current retainer.

As an incentive to enter into the Agreement, the Company paid a one-time non-renewal fee of $3,500 upon execution of the Agreement, which will be expensed during the second quarter of 2007. Mr. Nadal used a portion of the proceeds to repay to the Company the $2,678 (C$3,000) note receivable due on November 1, 2007 from Nadal Management, Inc. The Company had previously reserved the principal amount of this note receivable; the collection of this receivable will result in a one time recovery of $2,678, which will be included in operating income in the second quarter of 2007.

 

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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 2007 means the period beginning January 1, 2007, and ending December 31, 2007).

 

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 months ended March 31, 2007 and 2006, and the financial condition of the Company as of March 31, 2007. 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, 2006 as reported on Form 10-K. All amounts are in U.S. dollars unless otherwise stated.

 

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Executive Summary 

 

The Company’s objective is to create shareholder value by building market-leading subsidiaries and affiliates that deliver innovative, value-added marketing communications and strategic consulting to their clients. Management believes that shareholder value is maximized with an operating philosophy of “Perpetual Partnership” with proven committed industry leaders in marketing communications.

 

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.

 

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 Communication Services (“SCS”). In addition, MDC has a “Corporate Group” which provides certain administrative, accounting, financial and legal functions. During the fourth quarter of 2006, the Company reclassified Margeotes Fertitta Powell, LLC (“MFP”) from the SMS segment to the SCS segment as MFP’s performance for the foreseeable future is not expected to be consistent with the other operating units of the SMS group. All prior periods have been recast to conform to the current year presentation.

 

Marketing Communications Group

 

Through its operating “partners”, MDC provides advertising, consulting and specialized communication services to clients throughout the United States, Canada, Mexico and Europe.

 

The operating companies 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. Additional information about revenue recognition appears in Note 2 “Significant Accounting Policies” of the notes to the consolidated financial statements.

 

MDC 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. Also included in operating expenses is depreciation and amortization.

 

We monitor these costs referred to above on a percentage of revenue basis. Cost of services sold tend to fluctuate in conjunction with changes in revenues, whereas office and general expenses and depreciation and amortization, 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 acquisition and disposal transactions during the 2006 to 2007 period, which affected revenues, expenses, operating income and net income. Additional information regarding material acquisitions is provided in Note 4 “Acquisitions” and information on dispositions is provided in Note 6 “Discontinued Operations” in the notes to the consolidated financial statements.

 

Foreign Exchange Fluctuations. MDC’s financial results and competitive position are primarily affected by fluctuations in the exchange rate between the US dollar and non-US dollars, primarily the Canadian dollar. See also “Quantitative and Qualitative Disclosures About Market Risk—Foreign Exchange.”

 

Seasonality. Historically, with some exceptions, the 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 year ended December 31, 2006.

 

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Summary of Key Transactions

 

Sale of Secure Products International

 

On November 14, 2006, MDC completed the sale of its Secure Products International Group for consideration equal to approximately $27 million. Consideration was received in the form of cash of $20 million and additional $1 million annual payments over the next five years. In addition, MDC received a 7.5% equity interest in the newly formed entity acquiring the Secure Products International Group. During 2006, the Company recorded an impairment loss of $19.5 million and a gain on a sale of $1.8 million. The results of operations of the Secure Products International Group have been included in discontinued operations for the three months ended March 31, 2006.

 

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Results of Operations:

For the Three Months Ended March 31, 2007

(thousands of United States dollars)

 

		Strategic Marketing Services			Customer Relationship Management			Specialized Communication Services			Corporate			Total
Revenue		$	70,563		$	23,568		$	25,400		$	—		$	119,531
Cost of services sold			42,754			16,998			18,803			—			78,555
Office and general expenses			17,507			4,459			5,592			6,618			34,176
Depreciation and amortization			3,744			1,550			581			90			5,965
Goodwill impairment			—			—			4,475			—			4,475
Operating Profit/(Loss)			6,558			561			(4,051	)		(6,708	)		(3,640	)
Other Income (Expense):
Other expense															(734	)
Interest expense, net															(2,570	)
Loss from continuing operations before income taxes, equity in affiliates and minority interests															(6,944	)
Income tax recovery															2,488
Loss from continuing operations before equity in affiliates and minority interests															(4,456	)
Equity in earnings (loss) of non-consolidated affiliates															(50	)
Minority interests in income of consolidated subsidiaries			(3,716	)		(14	)		(561	)		—			(4,291	)
Net loss														$	(8,797	)
Non cash stock based compensation		$	249		$	5		$	3		$	1,659		$	1,916

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Liquidity and Capital Resources:

 

Liquidity

 

The following table provides summary information about the Company’s liquidity position:

 

			As of and for the three months ended March 31, 2007			As of and for the three months ended March 31, 2006			As of and for the year ended December 31, 2006
			(000’s)			(000’s)			(000’s)
Cash and cash equivalents		$	4,786		$	5,298		$	6,591
Working capital (deficit)		$	(104,510	)	$	(102,208	)	$	(105,039	)
Cash from operations		$	(26,275	)	$	9,015		$	39,705
Cash from investing		$	(4,053	)	$	(8,078	)	$	(14,315	)
Cash from financing		$	28,601		$	(8,637	)	$	(31,597	)
Long-term debt to shareholders’ equity ratio			0.39			0.32			0.37
Fixed charge coverage ratio			N/A			N/A			1.31
Fixed charge coverage deficiency		$	6,944			31			N/A

 

As of March 31, 2007, and December 31, 2006, $3.6 million and $2.4 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 for use to reduce its indebtedness.

 

Working Capital

 

At March 31, 2007, the Company had a working capital deficit of $104.5 million compared to a deficit of $105.0 million at December 31, 2006. The increase in working capital is primarily due to seasonal shifts in the amounts billed to clients, and paid to suppliers, primarily media outlets.

 

Included in current liabilities is the outstanding borrowings under the Credit Facility of $78.4 million, and $45.0 million as of March 31, 2007 and December 31, 2006, respectively. 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.

 

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 Cash Flows

 

Operating Activities

 

Cash flow used in operations, including changes in non-cash working capital, for the three months ended March 31, 2007 was $26.3 million. This was attributable primarily to a net operating loss of $8.8 million, payments of accounts payable and accrued liabilities, which resulted in a cash use from operations of $34.0 million, an increase in prepaid and other current assets of $3.8 million and an increase in expenditures billable to clients of $14.2 million. This use of cash was partially offset by depreciation and amortization, a goodwill impairment charge and non-cash stock compensation of $12.7 million and an increase of advance billings to clients of $21.8 million. Cash provided by continuing operations was $8.0 million in the three months ended March 31, 2006 and was primarily reflective of a net loss from continuing operations of $4.4 million plus non-cash depreciation and amortization of $7.2 million, non-cash stock based compensation of $3.3 million and cash flows from non-cash working capital of $3.8 million. Discontinued operations provided cash of $1.0 million in the three months ended March 31, 2006.

 

Investing Activities

 

Cash flows used in investing activities were $4.1 million for the three months ended March 31, 2007, compared with $8.1 million in the three months ended March 31, 2006.

 

Expenditures for capital assets in the three months ended March 31, 2007 were $3.6 million. Of this amount, $1.7 million was incurred by the SMS segment, $1.4 million was incurred by the CRM segment and $0.5 million was incurred by the SCS segment. These expenditures consisted primarily of computer equipment and leasehold improvements. In the three months ended March 31, 2006, capital expenditures totaled $5.0 million, of which $1.2 million was incurred by the SMS segment, $3.6 million was incurred by the CRM segment and $0.2 million was incurred by the SCS segment, which expenditures consisted primarily of leasehold improvements of computer and switching equipment and $0.1 million related to the purchase of corporate assets.

 

Cash flow used in acquisitions was $0.4 million in the three months ended March 31, 2007 and primarily related to the Company’s investment in Iradesso Communications Corp. In the three months ended March 31, 2006, cash flow used in acquisitions was $2.7 million and related to the settlement of put options and earn-out payments within the Marketing Communications Group.

 

Distributions received from non-consolidated affiliates amounted to $0.5 million for the three months ended March 31, 2006.

 

Discontinued operations used cash of $0.8 million in 2006 relating to capital asset purchases.

 

Financing Activities

 

During the three months ended March 31, 2007, cash flows provided by financing activities amounted to $28.6 million, and primarily consisted of $33.4 million of proceeds from the Credit Facility, which was partially offset by $4.7 million of net repayments of long-term debt and bank borrowings. During the three months ended March 31, 2006, cash flows used in financing activities amounted to $8.6 million, and consisted primarily of repayments of the Credit Facility of $7.1 million and repayments of long-term debt and bank debt of $1.8 million.

 

Discontinued operations used cash of $0.3 million in 2006, relating to payments under capital leases.

 

Long-Term Debt

 Long-term debt (including the current portion of long-term debt) as of March 31, 2007 was $124.1 million, an increase of $33.6 million compared with the $90.5 million outstanding at December 31, 2006. The increase was primarily the result of borrowings under the Credit Facility due primarily to seasonal shifts in the amounts billed to clients, and paid to suppliers, primarily media outlets.

On November 3, 2006, the Company further amended its Credit Facility. Pursuant to such amendment, among other things, the lenders (i) amended the “net worth” financial covenant to include an addition for any losses on sale or non-cash impairment charges recorded in connection with the disposition of the Secure Products International (“SPI”) business; (ii) reduced the commitment reduction requirement based upon net cash proceeds received from the sale of SPI in excess of $12.5 million; and (iii) modified the Company's “total debt ratio” covenant.

 

On March 8, 2007, the Company further amended its Credit Facility. Pursuant to such amendment, the lenders agreed to amend the restrictive covenants to permit the Company to make two proposed acquisitions that provide for up to $10 million in cash to be paid at closing.

 

On April 4, 2007, the Company further amended its Credit Facility. Pursuant to such amendment, the lenders agreed to permit the Company to have issued letters of credit with a maturity date of one year beyond the termination of the Credit Facility, provided that such letters of credit are cash collateralized no later then 20 days prior to maturity of the Credit Facility.

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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 until maturity of the Credit Facility on September 21, 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. The Company is currently in negotiations to refinance its Credit Facility, and expects to complete such refinancing prior to September 21, 2007. However, there can be no assurance that the Company will be able to complete such negotiations to refinance its Credit Facility in a timely manner.

 

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 March 31, 2007, the Company’s calculation of each of these covenants, and the specific requirements under the Credit Facility, respectively, were as follows:

 

			March 31,  2007
Total Debt Ratio			2.89 to 1.0
Maximum per covenant			3.00 to 1.0
Fixed Charges Ratio			1.61 to 1.0
Minimum per covenant			1.25 to 1.0
Minimum Liquidity		$	15.0 million
Minimum per covenant		$	12.7 million
Net Worth		$	136.0 million
Minimum per covenant		$	132.0 million

 

The total Debt Ratio covenant under the Credit Facility will be as follows: June 30, 2007 - 2.75 to 1.00. The minimum Fixed Charges Ratio covenant under the Credit Facility will be as follows: June 30, 2007 - 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.

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Capital Resources

 

At March 31, 2007 the Company had utilized approximately $82.7 million of its Credit Facility in the form of drawings and letters of credit. Cash and drawn available bank credit facilities to support the Company’s future cash requirements, as at March 31, 2007 was approximately $13.8 million.

 

The Company expects to incur approximately $11 million of capital expenditures during 2007. Such capital expenditures are expected to include leasehold improvements at certain of the Company’s operating subsidiaries. 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, the Company may need to obtain additional financing in the form of debt and/or equity financing upon fluctuations in working capital.

 

Deferred Acquisition Consideration (Earnouts)

 

Acquisitions of businesses by the Company may include commitments to contingent deferred purchase consideration payable to the seller. These contingent purchase obligations are generally payable within a one to 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 March 31, 2007, there was $2.0 million of deferred consideration included in the Company’s balance sheet. Based on the various assumptions as to future operating results of the relevant entities, management estimates that approximately $2.5 million of additional deferred purchase obligations could be triggered during 2007 or thereafter, including approximately $0.4 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. 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 of 2007 to 2013. It is not determinable, at this time, if or when the owners of these put option rights will exercise all or a portion of these rights.

 

The amount payable by the Company in the event such put option 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.

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Management estimates, assuming that the subsidiaries owned by the Company at March 31, 2007, perform over the relevant future periods at their trailing twelve-month earnings level, that these rights, if all exercised, could require the Company, in future periods, to pay an aggregate amount of approximately $122.7 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 $25.5 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 $9.5 million of the estimated $122.7 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. 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 $20.0 million.

 

 The following table summarizes the potential timing of the consideration and incremental operating income before depreciation and amortization based on assumptions as described above. 

 

Consideration (4)			2007			2008			2009			2010			2011 & Thereafter			Total
			($ Millions)
Cash		$	8.5		$	29.2		$	12.5		$	32.6		$	14.4		$	97.2
Shares			1.0			7.8			3.8			8.9			4.0			25.5
		$	9.5		$	37.0		$	16.3		$	41.5		$	18.4			$ 122.7	(1)
Operating income before depreciation and amortization to be received(2)		$	1.9		$	9.7		$	1.5		$	3.4		$	3.5		$	20.0
Cumulative operating income before depreciation and amortization(3)		$	1.9		$	11.6		$	13.1		$	16.5			(5	)

 

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(1)	Of this, approximately $43.3 million has been recognized in Minority Interest on the Company’s balance sheet as of September 22, 2004 in conjunction with the consolidation of CPB as a variable interest entity.

 

(2)	This financial measure is presented because it is the basis of the calculation used in the underlying agreements relating to the put rights and is based on actual 2006 and first quarter 2007 operating results. This amount represents amounts to be received in the year the put is exercised.

 

(3)	Cumulative operating income before depreciation and amortization represents the cumulative amounts to be received by the company.

 

(4)	The timing of consideration to be paid varies by contract and does not necessarily correspond to the date of the exercise of the put.

 

(5)	Amounts are not presented as they would not be meaningful due to multiple periods included.

 

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 “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 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’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 Company earns 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, which require delivery of a number of service acts, the Company uses the Proportional Performance model, which generally results in revenue being recognized based on the straight-line method due to the acts being non-similar and there being insufficient evidence of fair value for each service provided.

 

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 follows EITF 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 revenue has been earned from the sale of goods or services, or the net amount retained because a fee or commission has been earned. The Company’s businesses at times act as an agent and records revenue equal to the net amount retained, when the fee or commission is earned. The Company also follows EITF No. 01-14 for reimbursement received of out-of-pocket expenses. This Issue summarized the EITF’s views that reimbursements received for out-of-pocket expenses incurred should be characterized in the income statement as revenue. Accordingly, the Company has included in revenue such reimbused expenses.

 

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Acquisitions, Goodwill and Other Intangibles. A fair value approach is used in testing goodwill for impairment under SFAS 142 to determine if 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 incurred goodwill and intangible impairment charges of $4.5 million and $6.3 million in 2007 and 2006, respectively.

 

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 includes 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.

 

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 Stock-based compensation. 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 fair value of the award, and is recorded into operating income over the service period, that is the vesting period of the award. Changes in the Company’s payment obligation subsequent to vesting of the award and prior to the settlement date are recorded as compensation cost over the service period in operating income. The final payment amount for Share Appreciation Rights is established on the date of the exercise of the award by the employee.

 

Effective January 1, 2006, the Company adopted SFAS 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 SFAS 123(R) for new awards granted or modified after the adoption of SFAS 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.

 

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 has adopted this interpretation, the adoption of which did not have a material effect on its financial statements.

 

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements”. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for all fiscal year beginning after November 15, 2007 and interim periods within those fiscal years. Earlier application is encouraged. The Company is currently evaluating the impact of this statement on its financial statements.

 

In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. This statement expands the use of fair value measurement and applies to entities that elect the fair value option. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of this statement on its financial statements.

 

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 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;
	·	the Company's ability to refinance its debt facilities prior to September 21, 2007;

 

·

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 historical stock option grant practices.

 

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.

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The Company is exposed to market risk related to interest rates and foreign currencies.

 

Debt Instruments. At March 31, 2007, 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 $78.4 million, as of March 31, 2007, a 1.0% increase or decrease in the weighted average interest rate, which was 8.4% during the three months ended March 31, 2007, would have an interest impact of approximately $0.8 million annually.

 

Foreign Exchange. The Company conducts business in five currencies, the US dollar, the Canadian dollar, Jamaican dollar, the Mexican Peso 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 our non-US operations are denominated in their functional 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.

 

 Evaluation of 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 and 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. However, the Company’s disclosure controls and procedures are designed to provide reasonable assurances of achieving the Company’s 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 the end of the period covered by this report pursuant to Rule 13a-15(b) of the Exchange Act. Based on that evaluation, the Company has concluded that its disclosure controls and procedures were effective as of March 31, 2007.

Changes in Internal Control Over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting identified in connection with the foregoing evaluation that occurred during the first quarter of 2007 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

 

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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, 2006.

 

 

There were no transactions occurring during the first quarter of 2007 in which the Company issued shares of its Class A subordinate voting shares that were not registered with the SEC. The Company purchased 83,253 Class A shares during the first three months of 2007 in connection with the satisfaction of tax withholding obligations for certain employees upon the vesting of financial performance-based restricted stock grants made in February 2006.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

None.

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Exhibit No.		Description
10.1		Separation and Consulting Agreement between the Company and Stephen M. Pustil, dated as of January 12, 2007 (incorporated by reference to Exhibit 10.6 to the Company’s Form 10-K filed on March 16, 2007).*
10.2		Management Services Agreement relating to employment of Miles Nadal as Chief Executive Officer of the Company, dated April 27, 2007.*
10.3		Amendment No. 10 dated as of March 8, 2007, to the Credit Agreement made September 22, 2004 (incorporated by reference to Exhibit 10.15.10 to the Company’s Form 10-K filed on March 16, 2007).
10.4		Amendment No. 11 dated as of April 4 2007, to the Credit Agreement made September 22, 2004 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on April 10, 2007).
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 Chief Financial 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*;
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 Chief Financial Officer 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.

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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
May 8, 2007

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EXHIBIT INDEX

Exhibit No.		Description
10.1		Separation and Consulting Agreement between the Company and Stephen M. Pustil, dated as of January 12, 2007 (incorporated by reference to Exhibit 10.6 to the Company’s Form 10-K filed on March 16, 2007).*
10.2		Management Services Agreement relating to employment of Miles Nadal as Chief Executive Officer of the Company, dated April 27, 2007.*
10.3		Amendment No. 10 dated as of March 8, 2007, to the Credit Agreement made September 22, 2004 (incorporated by reference to Exhibit 10.15.10 to the Company’s Form 10-K filed on March 16, 2007).
10.4		Amendment No. 11 dated as of April 4 2007, to the Credit Agreement made September 22, 2004 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on April 10, 2007).
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 Chief Financial 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*;
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 Chief Financial Officer 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.

 

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