Stagwell Inc quarterly report, Q1 FY2018

MDC Partners Inc. Form 10-Q Summary

Filing-period note: The request identifies Stagwell Inc., but the supplied filing is for MDC Partners Inc., the predecessor company, for the three months ended March 31, 2018. Amounts are in thousands of U.S. dollars unless otherwise stated.

Business Context and Reporting Period

MDC operated a global network of marketing communications and advertising firms across Global Integrated Agencies, Domestic Creative Agencies, Specialist Communications, Media Services, and All Other. The company served clients across multiple industries and geographies, with approximately 78.5% of first-quarter 2018 revenue generated in the United States.

The filing reflects unaudited results for the first quarter of 2018 compared with the first quarter of 2017. The company adopted ASC 606, Revenue from Contracts with Customers, effective January 1, 2018, using the modified retrospective method.

Financial Performance and Key Metrics

Metric	Q1 2018	Q1 2017	Change
Revenue	$327.0 million	$344.7 million	Down 5.1%
Operating profit (loss)	$(14.6) million	$8.4 million	Down $23.0 million
Net loss	$(28.5) million	$(9.7) million	Loss increased $18.8 million
Net loss attributable to MDC	$(29.4) million	$(10.6) million	Loss increased $18.9 million
Net loss attributable to common shareholders	$(31.4) million	$(11.1) million	Loss increased $20.3 million
Basic and diluted loss per share	$(0.56)	$(0.21)	Loss increased $0.35
Cash used in operating activities	$(61.0) million	$(33.2) million	Use increased $27.8 million
Capital expenditures	$3.8 million	$9.4 million	Down $5.6 million

Reported revenue included a $21.3 million reduction from ASC 606 adoption. Excluding that effect, adjusted revenue was $348.2 million, compared with $344.7 million in the prior-year period. Adjusted operating loss was $8.6 million, compared with 2017 operating profit of $8.4 million.

The reported operating margin was approximately (4.5)%, compared with 2.4% in Q1 2017. For the Advertising and Communications Group, management reported an adjusted operating margin of approximately 1.6%, compared with 4.9% in the prior-year period.

Segment and Operating Developments

Global Integrated Agencies: Revenue declined 16.1% to $150.4 million; operating loss increased to $15.8 million from $0.6 million. Results reflected client cutbacks, reduced existing-client spending, higher staff costs, and ASC 606 effects.
Domestic Creative Agencies: Revenue increased 1.8% to $21.3 million; operating profit was $3.5 million, broadly flat year over year.
Specialist Communications: Revenue increased 6.1% to $43.2 million; operating profit declined 7.1% to $4.0 million as direct costs increased.
Media Services: Revenue declined 11.3% to $31.3 million; operating profit declined 81.6% to $0.5 million, principally due to lower revenue and the effect of a prior disposition.
All Other: Revenue increased 17.9% to $80.9 million; operating profit increased slightly to $7.2 million, although the margin declined to 8.9% from 10.3%.

Liquidity, Cash Flow, Debt and Balance Sheet

Cash and cash equivalents were $29.2 million at March 31, 2018, down from $46.2 million at December 31, 2017.
Working capital deficit was $195.9 million, compared with a $232.9 million deficit at year-end 2017. Management noted significant effects from the timing of media payments and client collections.
Total debt, net of debt issuance costs, was $943.1 million, up from $883.1 million at December 31, 2017. This included $900.0 million of 6.50% senior unsecured notes due 2024 and $59.0 million drawn under the revolving credit facility.
Approximately $180.2 million remained available under the revolving credit facility, which matures in 2021. The company also had $5.2 million of undrawn letters of credit.
The company reported compliance with its debt covenants. The total leverage ratio was 5.1 versus a maximum of 5.5, the fixed charges ratio was 2.3 versus a minimum of 1.0, and covenant-defined EBITDA was $186.7 million versus a minimum of $105.0 million.
Operating cash flow was negative primarily because of the net loss, a $76.8 million decrease in accounts payable and other liabilities, increased expenditures billable to clients, and acquisition-related payments. These uses were partly offset by increased advance billings and lower accounts receivable.
Total shareholders’ deficit was $189.7 million at March 31, 2018, compared with $155.5 million at December 31, 2017.

Material Changes, Unusual Items and Accounting Developments

ASC 606 reduced reported first-quarter revenue by $21.3 million and operating profit by $6.1 million relative to amounts adjusted to exclude the new standard. The adoption also increased opening accumulated deficit by $1.2 million.
The company recognized a $2.3 million long-lived asset impairment charge in the quarter.
Other expense was $6.2 million, compared with other income of $2.6 million in Q1 2017, primarily because of a $6.7 million foreign-exchange loss versus a $2.4 million gain in the prior year.
Interest expense and finance charges were $16.2 million, modestly below $16.8 million in the prior-year period.
The company acquired the remaining 24.5% interest in Allison & Partners LLC for estimated consideration of $10.0 million, including $9.7 million of deferred acquisition payments.
On April 2, 2018, after the reporting date, the company acquired 51% of Instrument LLC, a Portland, Oregon digital creative agency, for cash and 1,011,561 Class A shares.
Deferred acquisition consideration totaled $123.7 million, and redeemable noncontrolling interests totaled $54.3 million. Future payments depend on subsidiary performance, valuation formulas, currency rates, and employment conditions.

Guidance, Outlook, Commentary and Risks

The filing does not provide formal revenue or earnings guidance. Management stated that existing cash, expected operating cash flow, and available revolver capacity were expected to be sufficient for anticipated needs over the foreseeable future, while noting that liquidity depends on future operating performance and access to financing.

Management described the business as seasonal, with historically lower revenue in the first quarter and higher revenue in the fourth quarter. Excluding ASC 606, organic revenue growth was 1.0%, supported by international growth and new client wins, but partly offset by U.S. and Canadian client losses, spending reductions, and delays.

Key risks include client spending reductions, client concentration or loss, economic weakness, competition, retention of key personnel, and integration of acquisitions.
Foreign-exchange exposure is significant; management estimated that a one-cent change in the U.S. dollar/Canadian dollar exchange rate could affect the financial statements by approximately $3.5 million.
A 1% change in the weighted-average interest rate on revolver borrowings would affect interest expense by approximately $0.5 million.
The company faces potential future payments for deferred acquisition consideration and put rights of noncontrolling shareholders. Management estimated approximately $15.2 million of potential payments for certain put rights, plus approximately $33.4 million payable only upon specified employment termination or death events.
The company was defending an ongoing Canadian securities class action and cooperating with a confidential U.S. Department of Justice antitrust investigation involving a subsidiary agency.
The company had not completed its assessment of certain GILTI tax accounting implications and had not made a policy election regarding the treatment of related tax effects.

Investor Verification Checklist

Verify whether the intended issuer is MDC Partners Inc. or the later Stagwell Inc. entity, and confirm the applicable corporate history and reporting period.
Reconcile reported revenue and margins with results excluding ASC 606, particularly the $21.3 million revenue reduction and $6.1 million operating-profit impact.
Assess the sustainability of liquidity given negative first-quarter operating cash flow, the $943.1 million debt balance, and the $195.9 million working capital deficit.
Monitor compliance with the revolving-credit financial covenants, especially the total leverage ratio cushion of 0.4 turns.
Evaluate performance and staffing actions in Global Integrated Agencies, the largest segment and primary source of the quarterly operating deterioration.
Review the potential cash requirements from deferred acquisition consideration, redeemable noncontrolling interests, and put rights.
Track developments in the Canadian class action, DOJ antitrust investigation, foreign-exchange exposure, and future impairment charges.
Incorporate the post-quarter Instrument LLC acquisition and 1,011,561-share issuance into subsequent-period ownership, leverage, and dilution analyses.