MDC Partners Inc. — Q1 2020 Form 10-Q Summary
Reporting period: Three months ended March 31, 2020. The filing is by MDC Partners Inc., not Stagwell Inc. MDC provides global marketing, advertising, communications, activation and strategic consulting services through its Partner Firms. The company reorganized its management structure in 2020 and recast prior periods into the Integrated Agencies Network, Media & Data Network and All Other categories.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $327.7 million | $328.8 million | Down 0.3% |
| Operating income | $29.3 million | $15.7 million | Up $13.6 million |
| Operating margin | 8.9% | 4.8% | Up approximately 4.2 points |
| Income before taxes | $15.3 million | $1.0 million | Up $14.3 million |
| Net income | $1.8 million | $0.3 million | Up $1.5 million |
| Net loss attributable to common shareholders | $2.4 million | $2.5 million | Improved modestly |
| Diluted loss per share | $0.03 | $0.04 | Improved |
| Cash flow from operations | $(20.0) million | $(81.2) million | Improved by $61.2 million |
| Cash and cash equivalents | $221.1 million | $26.4 million at March 31, 2019 | Higher year over year |
| Debt, net of issuance costs | $1.014 billion | $887.6 million at December 31, 2019 | Up $126.6 million sequentially |
Revenue was substantially flat on a reported basis. Management reported organic revenue growth of $6.4 million, or 2.0%, offset by a $5.7 million disposition impact and a $1.8 million foreign-exchange impact. The Integrated Agencies Network generated $208.3 million of revenue and $29.2 million of operating income, while the Media & Data Network generated $41.1 million of revenue and $0.6 million of operating income.
Material Changes Versus the Prior Comparable Period
- Operating income nearly doubled, primarily from cost-saving initiatives, including staffing reductions, lower direct costs and reduced administrative expenses.
- Integrated Agencies Network operating margin increased to 14.0% from 7.5%; Media & Data Network improved to a 1.5% margin from a 3.8% operating loss margin.
- Interest expense declined to $15.6 million from $16.8 million, primarily due to lower average revolving-facility borrowings during the comparable period.
- Foreign exchange results deteriorated from a $5.4 million gain to a $14.8 million loss, primarily due to the weakening Canadian dollar against the U.S. dollar and U.S.-dollar-denominated indebtedness at the Canadian parent.
- Other income was $16.3 million versus a $3.4 million loss, principally reflecting an approximately $16.1 million gain on the sale of Sloane and substantially all of its assets.
- Income tax expense rose to $13.5 million, producing an 88.3% effective tax rate versus 76.2% in Q1 2019. The filing attributes the high rate to capital gains, nondeductible stock compensation and the jurisdictional mix of earnings.
- Operating cash flow remained negative, although the deficit narrowed materially, reflecting unfavorable working-capital requirements, including media and supplier payments.
Liquidity, Debt and Capital Structure
- Cash increased to $221.1 million from $106.9 million at December 31, 2019, primarily because the company borrowed $125.0 million under its revolving credit facility.
- The company had $125.0 million drawn and approximately $86.2 million available under its $250.0 million secured revolving credit facility, which matures in May 2021.
- The company had $900.0 million of 6.50% senior notes due May 2024. It reported compliance with debt covenants at March 31, 2020.
- Reported covenant measures were a 4.29 total leverage ratio versus a 6.25 maximum, a 2.95 fixed-charges ratio versus a 1.00 minimum, and $200.7 million of covenant-defined EBITDA versus a $105.0 million minimum.
- Current liabilities exceeded current assets by approximately $24.6 million. Additional obligations included $72.7 million of deferred acquisition consideration, $35.7 million of redeemable noncontrolling interests and $259.3 million of operating lease liabilities.
- Three operating leases not yet commenced represented approximately $124.2 million of aggregate future liability, including approximately $112.0 million related to new space at One World Trade Center.
Guidance, Outlook, Risks and Unusual Items
- No specific quantitative revenue or earnings guidance was provided. Management stated that cash from operations, existing cash and revolver availability were expected to meet anticipated needs for the next twelve months, subject to future performance and market conditions.
- COVID-19 was expected to negatively affect revenue, cash flows and financial position. Management implemented work-from-home procedures, hiring freezes, staff reductions, furloughs, salary and benefit reductions, lower discretionary spending and tighter capital expenditures.
- COVID-19 may reduce client marketing budgets, increase client credit risk and impair demand for services. The duration and severity of the pandemic and related economic downturn remained highly uncertain.
- An interim goodwill impairment test did not produce a charge, but reporting units containing approximately $230 million of goodwill had fair values only marginally above carrying values. A prolonged or more severe downturn could result in future impairment.
- The company recorded a $161,000 impairment charge on a right-of-use lease asset and revised the useful life of a $14.6 million trademark from indefinite to five years.
- In April 2020, after quarter-end, the company repurchased approximately $30.0 million principal amount of its 6.50% notes at approximately 74% of principal, for total consideration of approximately $22.0 million plus accrued interest of approximately $946,000. It expected to recognize an approximately $8.0 million extinguishment gain.
- The filing disclosed an unremediated material weakness in internal control over financial reporting related to accounting for income taxes. Management concluded that disclosure controls and procedures were ineffective as of March 31, 2020, while remediation efforts continued.
- Potential cash obligations include deferred acquisition payments, redemption of noncontrolling interests, lease commitments, interest and debt maturities. Legal proceedings were not expected to have a material adverse effect, although litigation outcomes remain uncertain.
Investor Verification Priorities
- Confirm that the filing applies to MDC Partners Inc. and reconcile it with the requested Stagwell Inc. entity and any subsequent corporate name or ownership changes.
- Monitor COVID-19 effects on client spending, organic revenue, accounts receivable collections and operating cash flow.
- Reassess covenant headroom, revolver availability and refinancing requirements before the May 2021 revolver maturity and May 2024 notes maturity.
- Track goodwill impairment sensitivity for the reporting units with approximately $230 million of goodwill and the potential effect of a prolonged downturn.
- Review remediation of the income-tax internal-control material weakness and any resulting changes to reported tax expense or deferred tax assets.
- Verify the accounting and cash impact of the Sloane disposition, the April 2020 note repurchase and ongoing deferred acquisition and redeemable noncontrolling-interest obligations.