Filing Overview
Registrant and period: The supplied filing is for MDC Partners Inc., not Stagwell Inc., and covers the quarter and nine months ended September 30, 2017. The filing was signed November 1, 2017. The company operated a global marketing communications and advertising network through Partner Firms.
Financial Performance and Position
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue | $375.8 million, up 7.6% | $1,111.0 million, up 11.6% |
| Operating profit | $37.2 million, versus $(10.8) million | $72.0 million, versus $21.9 million |
| Operating margin | 9.9%, versus (3.1)% | 6.5%, versus 2.2% |
| Net income | $22.0 million, versus $(31.1) million | $25.8 million, versus $(51.8) million |
| Net income attributable to MDC | $18.5 million | $19.2 million |
| Net income attributable to common shareholders | $16.5 million; diluted EPS $0.24 | $14.8 million; diluted EPS $0.24 |
| Cash flow from operations | Not separately provided | $22.1 million, versus $(41.4) million |
Revenue growth was driven by existing Partner Firms, new client wins, increased client spending, expanded scopes of service, and higher pass-through costs. Nine-month revenue also included $43.5 million from acquired Partner Firms, partly offset by $4.5 million from dispositions and a $2.0 million unfavorable foreign-exchange effect.
- Segment trends: For the nine-month period, Global Integrated Agencies revenue increased 17.8% to $576.9 million and operating profit increased 38.9% to $33.8 million. Media Services revenue increased 7.5% to $104.0 million and operating profit increased 145.5% to $8.6 million. Domestic Creative Agencies revenue increased 1.8% to $67.5 million, while operating profit declined 8.2% to $13.6 million. Specialist Communications revenue increased 2.0% to $125.5 million, while operating profit declined 24.9% to $13.4 million.
- Margins: Nine-month operating margin improved to 6.5% from 2.2%. Management attributed the improvement largely to the absence of the $29.6 million goodwill impairment recorded in 2016, lower staff costs as a percentage of revenue, and lower deferred acquisition consideration expense. Direct costs increased to 17.3% of revenue from 14.7%.
- Cash and liquidity: Cash and cash equivalents were $18.9 million at September 30, 2017, compared with $27.9 million at December 31, 2016. Working capital remained negative at $(220.3) million, although it improved from $(313.2) million.
- Debt: Debt, net of issuance costs, was $931.2 million, including $900.0 million of 6.50% senior unsecured notes due 2024 and $48.6 million drawn under the revolving credit agreement. Approximately $271.4 million of revolver commitments were undrawn. Interest expense was $48.3 million for the nine-month period.
- Equity: The company reported total shareholders’ deficit of $(388.9) million. In March 2017, it issued $95.0 million of Series 4 convertible preference shares, receiving approximately $90.2 million net of costs. The preference shares had a $99.4 million liquidation preference at September 30, 2017 and were convertible into approximately 9.9 million Class A shares at that date.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue increased $26.5 million, while operating profit improved $48.0 million and net income improved $53.1 million.
- Nine-month revenue increased $115.7 million, operating profit increased $50.1 million, and net income improved $77.5 million.
- The prior-year comparisons benefited from the absence of the $29.6 million goodwill impairment recognized in the third quarter of 2016 and the absence of the $33.3 million loss on redemption of notes recorded in the first quarter of 2016.
- Foreign-exchange gains increased other income by $18.8 million for the nine-month period, compared with $9.9 million in 2016; these gains were primarily related to U.S.-dollar-denominated indebtedness at the Canadian parent.
- Deferred acquisition consideration declined to $148.3 million at September 30, 2017 from $229.6 million at December 31, 2016, including $28.7 million settled through share issuance.
- The company identified a material weakness related to segment reporting aggregation and related disclosures as of December 31, 2016 and March 31, 2017. Management stated that enhanced controls were implemented and the weakness was fully remediated as of September 30, 2017. Certain SEC comments regarding segment reporting remained unresolved as of November 1, 2017.
- A second-quarter 2017 out-of-period tax accounting correction increased deferred tax liabilities at December 31, 2016 by $6.9 million. Management concluded the correction was not material to prior periods.
Outlook, Risks, Contingencies, and Unusual Items
- Management expected operating cash flow, existing cash, and revolver availability to fund anticipated needs for the foreseeable future and believed the company would remain compliant with debt covenants over the next twelve months.
- At September 30, 2017, reported covenant metrics were within limits: total leverage ratio 4.8 versus a maximum of 5.5, fixed charges ratio 2.2 versus a minimum of 1.0, senior leverage ratio 0.2 versus a maximum of 2.0, and covenant-defined EBITDA of $197.7 million versus a $105.0 million minimum.
- Key business risks include economic conditions, client spending and retention, new-business wins and losses, dependence on key employees, foreign-exchange volatility, acquisition integration, leverage, and the ability to fund deferred acquisition consideration and subsidiary put rights.
- Potential future payments for subsidiary noncontrolling-interest put rights were estimated at approximately $15.5 million, plus approximately $42.3 million payable only upon certain employment terminations or death. Actual amounts may vary materially based on future earnings and currency rates.
- The company was defending a Canadian securities class action alleging materially false or misleading public statements and omissions related to the SEC investigation. A motion concerning the proposed class definition was scheduled for November 21, 2017.
- A subsidiary received a U.S. Department of Justice Antitrust Division subpoena concerning production practices in the advertising industry and was cooperating with the confidential investigation.
- The company planned to adopt ASC 606 on January 1, 2018 using the modified retrospective method. Management expected changes in revenue timing for certain performance incentives but did not expect the change to be material to revenue.
- The company is seasonal, historically generating its lowest revenue in the first quarter and highest revenue and media-placement volume in the fourth quarter.
Investor Verification Checklist
- Verify the issuer identity: the supplied document names MDC Partners Inc., while the request identifies Stagwell Inc.
- Confirm the sustainability of revenue growth excluding acquisitions, dispositions, pass-through costs, and foreign-exchange effects.
- Assess recurring operating margins excluding the 2016 goodwill impairment and other acquisition-related valuation adjustments.
- Review liquidity against the company’s negative working capital, approximately $931.2 million of net debt, and seasonal media-payment requirements.
- Monitor covenant compliance, revolver availability, refinancing requirements, and future interest expense.
- Evaluate dilution and priority implications of the convertible preference shares and share-settled acquisition obligations.
- Follow the Canadian class action, DOJ antitrust investigation, and any remaining SEC comments regarding segment reporting.
- Reconcile future deferred acquisition consideration and subsidiary put-right obligations with expected operating cash generation.