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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q/A
(AMENDMENT NO. 1)
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2004 or
[ ] 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: 000-50303
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MDC PARTNERS INC.
(Exact name of registrant as specified in its charter)
ONTARIO, CANADA N / A
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
45 HAZELTON AVENUE M5R 2E3
Toronto, Ontario, Canada (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(416) 960-9000
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12(b)-2 of the Act). Yes [X] No [ ]
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 [ ] No [ ]
The numbers of shares outstanding as of August 3, 2004 were: 22,208,696
Class A shares and 2,502 Class B shares.
1
WEBSITE ACCESS TO COMPANY REPORTS
MDC Partners Inc.'s internet website address is www.mdc-partners.com. The
Company's annual reports on Form 40-F, 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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2
MDC PARTNERS INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements ........................................... 5
Condensed Consolidated Statements of Operations (unaudited)
Three Months and Six Months Ended June 30, 2004 and
June 30, 2003................................................ 5
Condensed Consolidated Balance Sheets as of
June 30, 2004 (unaudited) and December 31, 2003.............. 6
Condensed Consolidated Statements of Cash Flows (unaudited)
Six Months Ended June 30, 2004 and June 30, 2003 ............ 7
Notes to Condensed Consolidated Financial Statements
(unaudited).................................................. 8
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations.................................... 52
Item 3. Quantitative and Qualitative Disclosures about Market Risk...... 69
Item 4. Controls and Procedures......................................... 70
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .............................................. 72
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities ................................. 72
Item 4. Submission of Matters to a Vote of Security Holders ............ 73
Item 6. Exhibits and Reports on Form 8-K................................ 74
Signatures............................................................... 75
EXPLANATORY NOTE
This Form 10-Q/A for the quarter ended June 30, 2004 is being filed to restate
our interim unaudited condensed consolidated financial statements to reflect (1)
corrections in the recognition of compensation expense on the privatization of
Maxxcom, (2) corrections in the timing of recognition and the classification of
the amortization and write-off of deferred financing fees, (3) the recognition
of fair value adjustments related to an embedded derivative in the Company's
exchangeable debentures, (4) corrections in the timing and amounts recognized on
the gain on sale of the investment in Custom Direct Inc. and the correction of
an associated income tax expense, (5) correction for the timing of recognition
and the classification of certain foreign exchange gains and losses on
intercompany balances, (6) corrections to revenue recognition related to certain
Secure Products contracts, (7) corrections to the accounting for certain
investments, (8) corrections to the purchase price allocations for certain
business acquisitions and the related amortization of identified intangible
assets, (9) corrections in the timing of the recognition of stock-based
compensation, and (10) corrections to the computation of the dilutive effect of
convertible debentures on diluted earnings per share.
Refer to Note 2 of the notes to the interim unaudited condensed consolidated
financial statements included herein which discloses the adjustments to the
Company's interim unaudited condensed consolidated financial statements
resulting from these restatements.
Several of the corrections relate to transactions and events that arose in prior
periods. The Company has filed an amended Form 40-F/A for the fiscal year ended
December 31, 2003 and an amended Form 10-Q/A for the quarter ended March 31,
2004.
3
In addition, the Company has restated and reflected corresponding corrections to
the Management Discussion and Analysis in Part I, Item 2. In addition, the
Company revised Item 4 to include information about the impact of the
restatements on its internal controls. This Form 10-Q/A does not reflect events
occurring after the original filing date of the Form 10-Q.
4
Item 1. Financial Statements
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(thousands of United States dollars, except share and per share amounts)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Restated - (Restated - (Restated - (Restated -
See Note 2) See Note 2) See Note 2) See Note 2)
Revenue:
Services $ 58,327 $ 42,744 $ 110,285 $ 80,526
Products 17,233 33,084 35,270 76,398
------------ ------------ ------------ ------------
75,560 75,828 145,555 156,924
------------ ------------ ------------ ------------
Operating Expenses:
Cost of products sold 10,386 14,932 21,561 33,439
Salary and related costs * 31,099 27,294 67,370 53,891
General and other operating costs 27,654 28,642 53,368 55,922
Depreciation and amortization 3,028 2,667 5,573 5,377
Write-down of fixed assets and other assets -- 8,126 -- 8,126
Goodwill charges -- 10,012 -- 10,012
------------ ------------ ------------ ------------
72,167 91,673 147,872 166,767
------------ ------------ ------------ ------------
Operating Profit (Loss) 3,393 (15,845) (2,317) (9,843)
------------ ------------ ------------ ------------
Other Income (Expenses):
Gain (loss) on sale of assets and settlement of long-term debt
(Note 11) (73) 44,625 16,238 44,625
Foreign exchange gain (loss) 288 (876) 458 (1,531)
Interest expense (2,315) (5,461) (5,089) (10,338)
Interest income 50 78 471 171
------------ ------------ ------------ ------------
(2,050) 38,366 12,078 32,927
------------ ------------ ------------ ------------
Income Before Income Taxes, Equity in Affiliates and Minority
Interests 1,343 22,521 9,761 23,084
Income Taxes (Recovery) (589) 5,936 (392) 5,910
------------ ------------ ------------ ------------
Income Before Equity in Affiliates and Minority Interests 1,932 16,585 10,153 17,174
Equity in Affiliates 1,343 1,229 2,884 1,791
Minority Interests in Income of Consolidated Subsidiaries (2,343) (177) (3,640) (1,116)
------------ ------------ ------------ ------------
Net Income $ 932 $ 17,637 $ 9,397 $ 17,849
============ ============ ============ ============
Earnings Per Common Share:
Basic - Net Income $ 0.04 $ 1.04 $ 0.46 $ 1.06
Diluted - Net Income 0.04 0.81 0.42 0.84
Weighted Average Number of Common Shares:
Basic 21,772,706 16,915,341 20,388,169 16,915,341
Diluted 23,727,869 22,378,850 22,470,050 22,257,281
* Includes stock-based compensation recovery of $1,060 and an expense of
$975, during the three months ended June 30, 2004 and 2003, respectively,
and an expense of $4,999 and $975 during the six months ended June 30,
2004 and 2003, respectively.
The accompanying notes to the unaudited condensed consolidated financial
statements are an integral part of these statements.
5
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands of United States dollars)
JUNE 30, DECEMBER 31,
2004 2003
--------------- ---------------
(UNAUDITED)
(Restated - See (Restated - See
Note 2) Note 2)
ASSETS
Current Assets:
Cash and cash equivalents $ 48,069 $ 65,929
Accounts receivable, less allowance for doubtful accounts
of $959 and $529 99,225 58,864
Expenditures billable to clients 7,159 7,153
Inventories (Note 7) 8,459 7,735
Prepaid expenses and other current assets 6,086 4,863
--------- ---------
Total Current Assets 168,998 144,544
Fixed Assets, at cost, less accumulated depreciation
and amortization of $55,254 and $51,596 45,163 38,775
Investment in Affiliates 22,875 34,362
Goodwill 122,237 83,199
Intangibles, less accumulated amortization of $580 3,520 --
Deferred Tax Asset 11,381 11,563
Other Assets 7,606 9,096
--------- ---------
Total Assets $ 381,780 $ 321,539
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 74,724 $ 38,451
Accruals and other liabilities 50,446 34,245
Advance billings 21,557 15,731
Current portion of long-term debt (Note 8) 36,835 16,378
Deferred acquisition consideration 791 1,113
--------- ---------
Total Current Liabilities 184,353 105,918
Long-Term Debt (Note 8) 45,064 95,970
Convertible Notes (Note 13) -- 37,794
Other Liabilities 502 516
--------- ---------
Total Liabilities 229,919 240,198
--------- ---------
Minority Interests 2,040 2,432
Commitments and Contingencies (Note 14) --------- ---------
Subsequent event (Note 12)
Shareholders' Equity:
Share capital (Note 13) 165,806 115,996
Share capital to be issued 3,909 --
Additional paid-in capital 14,903 4,610
Retained earnings (deficit) (31,584) (39,169)
Accumulated other comprehensive income (loss) (3,213) (2,528)
--------- ---------
Total Shareholders' Equity 149,821 78,909
--------- ---------
Total Liabilities and Shareholders' Equity $ 381,780 $ 321,539
========= =========
The accompanying notes to the unaudited condensed consolidated financial
statements are an integral part of these statements.
6
MDC PARTNERS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(thousands of United States dollars)
Six Months Ended June 30,
-----------------------------
2004 2003
----------- -----------
(Restated - (Restated -
See Note 2) See Note 2)
Cash flows from operating activities:
Net income $ 9,397 $ 17,849
Adjustments for non-cash items:
Stock-based compensation 4,999 975
Depreciation and amortization 5,573 5,377
Amortization and write-off of deferred financing charges 3,063 2,892
Non-cash interest expense -- 2,064
Deferred income taxes 510 5,214
Foreign exchange (458) 1,531
Gain on sale of assets and settlement of long-term debt (Note 11) (18,160) (46,297)
Write-down of fixed assets and other assets -- 8,126
Goodwill charges -- 10,012
Earnings of affiliates, net of distributions 1,729 (2,393)
Minority interest and other 97 (843)
Changes in non-cash working capital (7,093) 543
-------- --------
Net cash provided by (used in) operating activities (343) 5,050
-------- --------
Cash flows from investing activities:
Capital expenditures (8,065) (7,559)
Proceeds of dispositions (5,739) 83,474
Other assets, net 349 2,845
-------- --------
Net cash provided by (used in) investing activities (13,455) 78,760
-------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 2,007 11,439
Repayment of long-term debt (4,185) (87,517)
Issuance of share capital 3,245 --
Purchase of share capital (5,117) --
-------- --------
Net cash used in financing activities (4,050) (76,078)
-------- --------
Effect of exchange rate changes on cash and cash equivalents (12) 2,082
-------- --------
Net decrease in cash and cash equivalents (17,860) 9,814
Cash and cash equivalents at beginning of period 65,929 31,226
-------- --------
Cash and cash equivalents at end of period $ 48,069 $ 41,040
======== ========
Supplemental disclosures:
Income taxes paid $ 949 $ 932
Interest paid $ 4,312 $ 2,878
Non-cash consideration:
Share capital issued, or to be issued, on acquisitions (Note 9) $ 18,860 --
Share capital issued on settlement of convertible notes $ 34,919 --
Stock-based awards issued, on acquisitions (Note 9) $ 1,315 --
Settlement of debt with investment in affiliate
Reduction in exchangeable securities (Note 11) ($ 33,991) --
Proceeds on sale of investment (Note 11) $ 33,991 --
The accompanying notes to the unaudited condensed consolidated financial
statements are an integral part of these statements.
7
MDC PARTNERS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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 of the United States Securities and Exchange Commission (the
"SEC"). Certain information and footnote disclosures normally included
in 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. These statements should
be read in conjunction with the consolidated financial statements and
related notes included in the Company's amended annual report on Form
40-F/A for the year ended December 31, 2003.
Results of operations for interim periods are not necessarily
indicative of annual results.
As of the first quarter of 2004, the Company changed its method of
accounting from Canadian GAAP to US GAAP. The comparative financial
statements included in these interim financial statements have been
restated following US GAAP. This change in accounting method resulted
from the conversion of Class B multiple voting shares into Class A
Subordinate Voting Shares during the first quarter of 2004 (see Note
13). Due to the conversion of these shares, the majority of shareholder
votes now belong to shareholders of the Company who reside in the US
and, as a result, the Company is now deemed to be a US domestic issuer
as defined under the SEC regulations to which the Company is subject.
Under Canadian securities requirements, the Company is required to
provide a reconciliation setting out the differences between US and
Canadian GAAP as applied to the Company's financial statements for the
interim periods and years ended in the fiscal periods for 2004 and
2005. This required disclosure for the three months and six months
ended June 30, 2004 and 2003 is set out in Note 15.
2. RESTATEMENT OF FINANCIAL STATEMENTS
In preparing the financial statements for the three and nine-month
periods ended September 30, 2004, the Company determined that its
previously filed audited consolidated financial statements for the
years ended December 31, 2001, 2002 and 2003 and its previously issued
interim unaudited condensed consolidated financial statements for the
three months ended March 31, 2003 and 2004 for the three and six months
ended June 30, 2003 and 2004 and for the three and nine months ended
September 30, 2003 contained misapplications of Canadian and US GAAP
and those financial statements required restatement.
8
These adjustments pertained to the correction of the accounting for
various transactions including the correction for the following: (1)
corrections in the recognition of compensation expense on the
privatization of Maxxcom, (2) corrections in the timing of recognition
and the classification of the amortization and write-off of deferred
financing fees, (3) the recognition of fair value adjustments related
to an embedded derivative in the Company's exchangeable debentures, (4)
corrections in the timing and amounts recognized on the gain on sale of
the investment in Custom Direct Inc. and the correction of an
associated income tax expense, (5) correction for the timing of
recognition and the classification of certain foreign exchange gains
and losses on intercompany balances, (6) corrections to revenue
recognition related to certain Secure Products contracts, (7)
corrections to the accounting for certain investments, (8) corrections
to the purchase price allocations for certain business acquisitions and
the related amortization of identified intangible assets,
(9) corrections in the timing of the recognition of stock-based
compensation, and (10) corrections to the computation of the dilutive
effect of convertible debentures on diluted earnings per share.
The Company has restated its consolidated financial statements as at
and for the years ended December 31, 2003, 2002 and 2001, the effect of
which is described in the Company's restated 2003 Annual Report as
filed on Form 40-F/A dated December 20, 2004. The Company has also
restated its interim unaudited condensed consolidated financial
statements for the three months ended March 31, 2004 and 2003. Reliance
should be placed solely on the financial statements in the Form 40-F/A
and in this Form 10-Q/A and not on the previously filed Form 40-F dated
May 10, 2004, and not on the previously filed Form 10-Q for the three
months and the six months ended June 30, 2004 and 2003 dated August 4,
2004 or any other previously reported financial statements for the
periods identified above.
The interim unaudited condensed consolidated financial statements for
the three and six months ended June 30, 2004 and 2003 reflect the
following restatement adjustments:
9
(1) The correction in the compensation expense on the privitization of
Maxxcom. The correction of the recognition of stock-based compensation
pursuant to SFAS 123 "Accounting for Stock Based Compensation" related
to the stock option remeasurement required on the issuance of vested
and unvested options of the Company in exchange for vested and unvested
stock options of Maxxcom Inc. associated with the acquisition of the
26% minority interest holding of Maxxcom Inc. by the Company in July
2003 This correction increased salary and related costs, thus reducing
operating profit and net income for both the three and six months ended
June 30, 2004, by $45 and $148, respectively;
(2) The reclassification of the amortization of deferred financing fees to
interest expense and a correction of the period in which the
amortization and write-off of deferred financing fees was recorded.
Previously, the amortization of certain deferred financing fees were
classified as depreciation and amortization expense or were netted
against the gain on sale of assets. The amortization of deferred
financing fees should be classified as interest expense and the write
off of deferred financing fees included in the loss on the settlement
of debt. Certain deferred financing fees were written off in the
quarter ended December 31, 2003 in anticipation of the refinancing of
debt rather than in the quarters ended March 31, 2004 and September 30,
2004 when the debt was repaid. These corrections increased the loss on
settlement of debt by $1,922 and increased interest expense by $1,141,
resulting in a decrease in net income of $3,063, for the six months
ended June 30, 2004. These corrections also increased interest expense
by $605, reducing net income by the same amount for the three months
ended June 30, 2004. These corrections reduced depreciation and
amortization, and increased interest expense, by $601 and $1,220 for
the three months and six months ended June 30, 2003, respectively,
resulting in no change to net income in either period;
(3) The recognition of the fair value adjustment related to an embedded
derivative in the Company's exchangeable debentures, as required under
SFAS 133, as amended by SFAS 138, "Accounting for Derivative
Instruments and Hedging Activities", that was not previously
recognized, and to separately account for the loss on the exchangeable
debentures that was previously netted within the gain on sale of assets
delivered on the settlement of the debentures. The loss associated with
the change in fair value of the embedded derivative of $3,974 from
December 1, 2003, the date of issuance to December 31, 2003, was not
previously recognized in 2003. When the exchangeable debentures were
settled in February 2004, the cumulative loss from the date of issuance
of $7,647 was netted against the gain on the sale of investment in
Custom Direct Inc. ("CDI"), for which the debentures were exchangeable.
The change in fair value of the embedded derivative has been recognized
in the applicable period as a correction of an error in the restatement
of fiscal 2003. As a result of the correction of this error, for the
six months ended June 30, 2004, the fair value adjustment on the
embedded derivative increased by $3,974 and the loss on the settlement
of the debentures increased by $7,674 and the gain on the sale of
assets increased by $7,647 and net income increased by $3,974.
(4) To correct for certain errors in the calculation of the gain on the
disposal of the Company's 80% interest in CDI in May 2003, and the
corresponding adjustment to the gain on the sale of the remaining 20%
interest in CDI in February 2004 relating primarily to the allocation
of the cost base of the CDI assets between the two gain amounts.
Associated with this transaction, income tax expense was corrected due
to income tax benefits having been calculated incorrectly. For the six
months ended June 30, 2004, these corrections increased the gain on
sale of assets by $7,094, income taxes decreased by $1,361, and net
income increased by $8,455. These corrections reduced the gain on sale
of assets and net income by $4,239 in the three and six months ended
June 30, 2003;
(5) The correction of the accounting for foreign exchange gains and losses
related to certain intercompany balances previously reflected in
accumulated comprehensive income rather than being recognized in the
statement of operations. This change resulted in foreign exchange gains
of $288 and $458 for the three and six months ended June 30, 2004,
respectively, correspondingly affecting net income by the same amounts.
This change resulted in foreign exchange losses of $876 and $1,531 for
the three and six months ended June 30, 2003, respectively,
correspondingly affecting net income by the same amounts;
10
(6) The correction of revenue recognition related to various revenue
arrangements in accordance with the SEC's Staff Accounting Bulletin
101, Revenue Recognition in Financial Statements ("SAB 101"), and as
revised and updated by SAB 104 and EITF Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables ("EITF 00-21). The correction
of the accounting includes: (a) The Company incorrectly accounted for
certain contracts entered into in the Secured Products segment relating
to multiple element manufacturing arrangements. The Company incorrectly
recognized revenue on an "as billed" basis as they completed various
deliverables under the contract. The Company has determined that the
multiple elements should be accounted for as one unit of accounting
under both SAB 101, as amended and under EITF 00-21 as the Company does
not have reliable, verifiable and objectively determinable evidence of
the fair value of the various elements in these arrangements, and
specifically the undelivered elements. Revenue should be recognized
when the final element of the arrangement is completed and the product
shipped to the customer or end user. Amounts received in advance of
this date have been deferred and recognized at the shipping date; (b)
The Company incorrectly recorded revenue related to its stamp printing
business using the percentage of completion method consistent with the
guidance provided by Statement of Position 81-1, Accounting for
Performance of Construction/Production Contracts ("SOP 81-1"). The
manufacture of stamps is not within the scope of SOP 81-1. Revenue
related to the manufacture of stamps has been restated to be recognized
when the stamps are shipped to the customer and the Company's
obligations under the contractual arrangements are completed; and (c)
Under the contractual arrangements in both (a) and (b) above, the
Company has the ability to recover any costs incurred to date under
possible termination of the contract, and accordingly the Company has
restated the financial statements to give effect to the deferral of
costs related to the manufacturing activities as inventory
work-in-process. To reflect this correction, the Company has
retroactively restated its annual financial statements at the beginning
of the first quarter of 2001 as presented in the Company's restated
annual consolidated financial statements included in the Company's Form
40-F/A for the year ended December 31, 2003, with retained earnings at
January 1, 2001 adjusted for the effects of the restatement on prior
years.
This increased product revenue by $74, reduced costs of sales by $344,
increased operating profit by $418, increased income taxes expense by
$48 and net income by $370 for the three months ended June 30, 2004.
This reduced product revenue by $736, reduced costs of sales by $736,
operating profit by nil, reduced income taxes expense by $89 and
increased net income by $89 for the six months ended June 30, 2004.
Similarly, for the three months ended June 30, 2003, these corrections
reduced product revenue by $666, reduced costs of sales by $688,
increased operating profit by $22, increased income taxes expense by
$12 and increased net income by $10. This reduced product revenue by
$877, costs of sales by $910, increased operating profit by $33,
reduced income taxes expense by $43 and reduced net income by $10 for
the six months ended June 30, 2003. This correction increased inventory
by $1,310 and advance billings by $3,524 as at June 30, 2004;
11
(7) The correction of the accounting for five investments: (a) A joint
venture operating entity owning a rental property, in which the
significant financial operating policies are by contractual arrangement
jointly controlled by all parties having an equity interest in the
entity, was previously accounted for on a proportionately consolidated
basis. Pursuant to APB Opinion No. 18 "The Equity Method of Accounting
for Investments in Common Stock", the investment in the joint venture
is now accounted for using the equity method; (b) The accounting for an
investment in an affiliate, previously equity accounted commencing in
the quarter ended June 30, 2004, was determined to be a variable
interest entity for which the Company was the primary beneficiary, thus
requiring consolidation pursuant to Financial Accounting Standards
Board Interpretation No. 46, "Consolidation of Variable Interest
Entities an interpretation of ARB 51 (revised December 2003)" ("FIN
46R"); (c) A majority owned investee, Accumark Promotions Group, Inc.,
was previously accounted for on a consolidated basis. Upon evaluation
pursuant to EITF 96-16 "Investor's Accounting for an Investee When the
Investor Has a Majority of the Voting Interest but the Minority
Shareholder or Shareholders Have Certain Approval or Veto Rights",
management determined the investee could not be consolidated and
accordingly it is now accounted for by the Company using the equity
method; (d) A 49.9% owned investee, Mono Advertising, LLC, ("Mono")
acquired in April 2004 which was previously accounted for on a
consolidated basis as the Company believed it controlled the
significant financial operating policies through a contractual
arrangement with Mono and its other shareholders. However such
contractual arrangements did not meet the requirements for
consolidation accounting and the investee is now being accounted for
under the equity method; (e) The Company's 20% interest in CDI, up to
the date of its sale in February 2004, was previously accounted for on
the cost basis and has now been restated and accounted for under the
equity method as management has determined significant influence
existed. Due to the nature of the adjustments, the corrections impacted
most line items on the statement of operations and balance sheets.
However, other than item (e) above, the corrections had no impact on
net income (loss). For the period, the impact of these changes was to
decrease operating profit for the three months ended June 30, 2004 and
2003 by $997 and $962, respectively and to decrease operating profit
for the six months ended June 30, 2004 and 2003 by $1,232 and $1,209,
respectively;
(8) The correction related to the allocation to identifiable amortizable
intangibles acquired in business combinations that resulted in a
reallocation of a gross amount of $4,100 as at June 30, 2004 from
goodwill to other identifiable amortizable intangible assets. This
change increased depreciation and amortization and reduced net income
by $340 and $580 for the three and six months ended June 30, 2004,
respectively;
(9) The correction of the accounting for stock-based compensation to
recognize, on a cumulative basis, compensation cost to the end of each
reporting period equal to the value of the vested portion of the
stock-based award at that same date. This change increased salary and
related costs by $24 and $206 for the three months ended June 30, 2004
and 2003,respectively, and by $58 and $206 for the six months ended
June 30, 2004 and 2003, respectively. Net income was reduced by the
same amounts in the corresponding periods; and
(10) The correction to the computation of the dilutive effect of convertible
debentures, in calculating diluted earnings per share figures.
12
The Company has restated its consolidated financial statements for the years
ended December 31, 2003, 2002 and 2001 the effect of which is described in the
Company's 2003 Annual Report as filed on Form 40-F/A. The effect of this
restatement was to increase the accumulated deficit by $14,021 as of January 1,
2004. The Company has also restated its interim unaudited condensed consolidated
financial statements for the three months ended March 31, 2004 and 2003 as filed
on Form 10-Q/A. The cumulative effect of these restatement adjustments to all
restated periods through March 31, 2004 was to increase the accumulated deficit
by $4,538 and to decrease shareholder's equity by $458. The following tables
present the effect of these restatements and these changes in classification for
the three and six months ended June 30, 2004 and 2003, and as at June 30, 2004:
For the Three Months Ended June 30, 2004
----------------------------------------------------
As Reported Adjustments As Restated
------------ ------------ ------------
Revenue:
Services $ 58,828 ($501) $ 58,327
Products 17,159 74 17,233
------------ ------------ ------------
75,987 (427) 75,560
------------ ------------ ------------
Operating Expenses:
Cost of products sold 10,730 (344) 10,386
Salary and related costs 31,424 (325) 31,099
General and other operating costs 26,726 928 27,654
Depreciation and amortization 2,726 302 3,028
------------ ------------ ------------
71,606 561 72,167
------------ ------------ ------------
Operating Profit 4,381 (988) 3,393
------------ ------------ ------------
Other Income (Expenses):
Gain (loss) on sale of assets (73) -- (73)
Foreign exchange gain -- 288 288
Interest expense (1,784) (531) (2,315)
Interest income 51 (1) 50
------------ ------------ ------------
(1,806) (244) (2,050)
------------ ------------ ------------
Income Before Income Taxes, Equity in Affiliates and Minority
Interests 2,575 (1,232) 1,343
Income Taxes (Recovery) (386) (203) (589)
------------ ------------ ------------
Income Before Equity in Affiliates and Minority Interests 2,961 (1,029) 1,932
Equity in Affiliates 939 404 1,343
Minority Interests (2,505) 162 (2,343)
------------ ------------ ------------
Net Income $ 1,395 ($463) $ 932
============ ============ ============
Earnings Per Common Share:
Basic $ 0.06 $ 0.04
Diluted 0.06 0.04
Weighted Average Number of Common Shares:
Basic 21,772,706 21,772,706
Diluted 23,870,460 23,727,869
13
For the Three Months Ended June 30, 2003
--------------------------------------------------------
As Reported Adjustments As Restated
------------ ------------ ------------
Revenue:
Services $ 45,849 ($3,105) $ 42,744
Products 33,750 (666) 33,084
------------ ------------ ------------
79,599 (3,771) 75,828
------------ ------------ ------------
Operating Expenses:
Cost of products sold 15,620 (688) 14,932
Salary and related costs 27,666 (372) 27,294
General and other operating costs 30,165 (1,523) 28,642
Depreciation and amortization 3,310 (643) 2,667
Write-down of fixed assets and other assets 8,126 -- 8,126
Goodwill charges 10,012 -- 10,012
------------ ------------ ------------
94,899 (3,226) 91,673
------------ ------------ ------------
Operating Profit (Loss) (15,300) (545) (15,845)
------------ ------------ ------------
Other Income (Expenses):
Gain (loss) on sale of assets and settlement of long-term debt 48,594 (3,969) 44,625
Foreign exchange gain (loss) -- (876) (876)
Interest expense (4,936) (525) (5,461)
Interest income 78 -- 78
------------ ------------ ------------
43,736 (5,370) 38,366
------------ ------------ ------------
Income Before Income Taxes, Equity in Affiliates and Minority
Interests 28,436 (5,915) 22,521
Income Taxes (Recovery) 6,012 (76) 5,936
------------ ------------ ------------
Income Before Equity in Affiliates and Minority Interests 22,424 (5,839) 16,585
Equity in Affiliates 724 505 1,229
Minority Interests (361) 184 (177)
------------ ------------ ------------
Net Income $ 22,787 ($5,150) $ 17,637
============ ============ ============
Earnings Per Common Share:
Basic $ 1.35 $ 1.04
Diluted 0.99 0.77
Weighted Average Number of Common Shares:
Basic 16,915,341 16,915,341
Diluted 23,469,828 22,378,850
14
For the Six Months Ended June 30, 2004
--------------------------------------------------------
As Reported Adjustments As Restated
------------ ------------ ------------
Revenue:
Services $ 115,094 ($4,809) $ 110,285
Products 36,006 (736) 35,270
------------ ------------ ------------
151,100 (5,545) 145,555
------------ ------------ ------------
Operating Expenses:
Cost of products sold 22,297 (736) 21,561
Salary and related costs 68,192 (822) 67,370
General and other operating costs 55,841 (2,473) 53,368
Depreciation and amortization 5,069 504 5,573
------------ ------------ ------------
151,399 (3,527) 147,872
------------ ------------ ------------
Operating Profit (Loss) (299) (2,018) (2,317)
------------ ------------ ------------
Other Income (Expenses):
Gain (loss) on sale of assets 7,092 9,146 16,238
Foreign exchange gain -- 458 458
Interest expense (4,097) (992) (5,089)
Interest income 471 -- 471
------------ ------------ ------------
3,466 8,612 12,078
------------ ------------ ------------
Income Before Income Taxes, Equity in Affiliates and Minority
Interests 3,167 6,594 9,761
Income Taxes (Recovery) 1,367 (1,759) (392)
------------ ------------ ------------
Income Before Equity in Affiliates and Minority Interests 1,800 8,353 10,153
Equity in Affiliates 2,385 499 2,884
Minority Interests (3,808) 168 (3,640)
------------ ------------ ------------
Net Income $ 377 $9,020 $ 9,397
============ ============ ============
Earnings Per Common Share:
Basic $ 0.02 $ 0.46
Diluted 0.02 0.42
Weighted Average Number of Common Shares:
Basic 20,388,169 20,388,169
Diluted 22,593,239 22,470,050
15
For the Six Months Ended June 30, 2003
----------------------------------------------------
As Reported Adjustments As Restated
------------ ------------ ------------
Revenue:
Services $ 85,538 ($5,012) $ 80,526
Products 77,275 (877) 76,398
------------ ------------ ------------
162,813 (5,889) 156,924
------------ ------------ ------------
Operating Expenses:
Cost of products sold 34,349 (910) 33,439
Salary and related costs 54,805 (914) 53,891
General and other operating costs 58,527 (2,605) 55,922
Depreciation and amortization 6,675 (1,298) 5,377
Write-down of fixed assets and other assets 8,126 -- 8,126
Goodwill charges 10,012 -- 10,012
------------ ------------ ------------
172,494 (5,727) 166,767
------------ ------------ ------------
Operating Profit (Loss) (9,681) (162) (9,843)
------------ ------------ ------------
Other Income (Expenses):
Gain (loss) on sale of assets and settlement of long-term debt 48,594 (3,969) 44,625
Foreign exchange gain (loss) -- (1,531) (1,531)
Interest expense (9,262) (1,076) (10,338)
Interest income 171 -- 171
------------ ------------ ------------
39,503 (6,576) 32,927
------------ ------------ ------------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 29,822 (6,738) 23,084
Income Taxes (Recovery) 5,991 (81) 5,910
------------ ------------ ------------
Income Before Equity in Affiliates and Minority Interests 23,831 (6,657) 17,174
Equity in Affiliates 1,222 569 1,791
Minority Interests (1,379) 263 (1,116)
------------ ------------ ------------
Net Income $ 23,674 ($5,825) $ 17,849
============ ============ ============
Earnings Per Common Share:
Basic - Net Income $ 1.40 $ 1.06
Diluted - Net Income 0.99 0.84
Weighted Average Number of Common Shares:
Basic 16,915,341 16,915,341
Diluted 24,575,935 22,257,281
16
At June 30, 2004
---------------------------------------------
As Reported Adjustments As Restated
----------- ----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 48,668 ($599) $ 48,069
Accounts receivable, net 100,352 (1,127) 99,225
Expenditures billable to clients 7,753 (594) 7,159
Inventories 7,149 1,310 8,459
Prepaid expenses and other current assets 6,138 (52) 6,086
--------- --------- ---------
Total Current Assets 170,060 (1,062) 168,998
Fixed Assets, net 48,364 (3,201) 45,163
Investment in Affiliates 19,328 3,547 22,875
Goodwill 129,029 (6,792) 122,237
Intangibles, less accumulated amortization -- 3,520 3,520
Deferred Tax Asset 10,938 443 11,381
Other Assets 6,693 913 7,606
--------- --------- ---------
Total Assets $ 384,412 ($2,632) $ 381,780
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable and other liabilities $ 125,511 ($341) $ 125,170
Advance billings 18,957 2,600 21,557
Current portion of long-term debt 36,972 (137) 36,835
Deferred acquisition consideration 791 -- 791
--------- --------- ---------
Total Current Liabilities 182,231 2,122 184,353
Long-Term Debt 48,848 (3,784) 45,064
Other Liabilities 502 -- 502
--------- --------- ---------
Total Liabilities 231,581 (1,662) 229,919
--------- --------- ---------
Minority Interests 1,892 148 2,040
--------- --------- ---------
Shareholders' Equity:
Share capital $ 165,806 -- 165,806
Share capital to be issued 3,909 -- 3,909
Additional paid-in capital 13,359 1,544 14,903
Retained earnings (deficit) (26,583) (5,001) (31,584)
Accumulated other comprehensive income (loss) (5,552) 2,339 (3,213)
--------- --------- ---------
Total Shareholders' Equity 150,939 (1,118) 149,821
--------- --------- ---------
Total Liabilities and Shareholders' Equity $ 384,412 ($2,632) $ 381,780
========= ========= =========
17
For the Six Months Ended June 30, 2004
-------------------------------------------
As Reported Adjustments As Restated
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 377 $ 9,020 $ 9,397
Adjustments for non-cash items:
Stock-based compensation 4,793 206 4,999
Depreciation and amortization 5,069 504 5,573
Amortization and write-off of deferred finance charges -- 3,063 3,063
Deferred income taxes 1,970 (1,460) 510
Foreign exchange -- (458) (458)
Gain on sale of assets (7,092) (11,068) (18,160)
Earnings of affiliates, net of distributions 1,566 163 1,729
Minority interest and other -- 97 97
Changes in non-cash working capital (7,370) 277 (7,093)
-------- -------- --------
Net cash provided by (used in) operating activities (687) 344 (343)
-------- -------- --------
Cash flows from investing activities:
Capital expenditures (8,113) 48 (8,065)
Acquisitions, net of cash (5,493) (246) (5,739)
Other assets, net 349 -- 349
-------- -------- --------
Net cash provided by (used in) investing activities (13,257) (198) (13,455)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 2,007 -- 2,007
Repayment of long-term debt (4,237) 52 (4,185)
Issuance of share capital 3,245 -- 3,245
Purchase of share capital (5,117) -- (5,117)
-------- -------- --------
Net cash used in financing activities (4,102) 52 (4,050)
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents (12) -- (12)
-------- -------- --------
Net decrease in cash and cash equivalents (18,058) 198 (17,860)
Cash and cash equivalents at beginning of period 66,726 (797) 65,929
-------- -------- --------
Cash and cash equivalents at end of period $ 48,668 ($599) $ 48,069
======== ======== ========
Supplemental disclosures:
Income taxes paid $ 949 $ 949
Interest paid $ 4,312 $ 4,312
Non-cash consideration:
Share capital issued, or to be issued, on acquisitions $ 18,860 $ 18,860
Share capital issued on settlement of convertible notes $ 34,919 $ 34,919
Stock-based awards issued, on acquisitions $ 1,315 $ 1,315
Settlement of debt with investment in affiliate
Reduction in exchangeable securities ($26,344) (7,647) ($33,991)
Proceeds on sale of investment $ 26,344 7,647 $ 33,991
18
For the Six Months Ended June 30, 2003
-------------------------------------------
As Reported Adjustments As Restated
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 23,674 ($5,825) $ 17,849
Adjustments for non-cash items:
Stock-based compensation 769 206 975
Depreciation and amortization 6,675 (1,298) 5,377
Amortization and write-off of deferred finance charges -- 2,892 2,892
Non-cash interest expense 2,064 -- 2,064
Deferred income taxes 5,171 43 5,214
Foreign exchange -- 1,531 1,531
Gain on sale of assets and settlement of long-term debt (48,594) 2,297 (46,297)
Write-down of fixed assets and other assets 8,126 -- 8,126
Goodwill charges 10,012 -- 10,012
Earnings of affiliates, net of distributions (2,526) 133 (2,393)
Minority interest and other (843) -- (843)
Changes in non-cash working capital 198 345 543
-------- -------- --------
Net cash provided by operating activities 4,726 324 5,050
-------- -------- --------
Cash flows from investing activities:
Capital expenditures (7,543) (16) (7,559)
Acquisitions, net of cash 83,474 -- 83,474
Other assets, net 2,816 29 2,845
-------- -------- --------
Net cash provided by (used in) investing activities 78,747 13 78,760
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 11,439 -- 11,439
Repayment of long-term debt (87,562) 45 (87,517)
-------- -------- --------
Net cash used in financing activities (76,123) 45 (76,078)
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents 2,082 -- 2,082
-------- -------- --------
Net decrease in cash and cash equivalents 9,432 382 9,814
Cash and cash equivalents at beginning of period 32,250 (1,024) 31,226
-------- -------- --------
Cash and cash equivalents at end of period $ 41,682 ($642) $ 41,040
======== ======== ========
Supplemental disclosures:
Income taxes paid $ 932 $ 932
Interest paid $ 2,878 $ 2,878
3. 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. (formerly MDC Corporation 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.
Use of Estimates. The preparation of financial statements in
conformity with US GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those
estimates.
Cash and Cash Equivalents. The Company's cash equivalents are
primarily comprised of investments in overnight interest-bearing
deposits, commercial paper and money market instruments and other
short-term investments with original maturity dates of three months or
less at the time of purchase. Included in cash and cash equivalents at
June 30, 2004 is $1,215 of cash restricted as to withdrawal pursuant to
a collateral agreement.
19
Allowance for Doubtful Accounts. Trade receivables are stated
at invoiced amounts less allowances for doubtful accounts. The
allowances represent estimated uncollectible receivables associated
with potential customer defaults usually due to customers' potential
insolvency. The allowances include amounts for certain customers where
a risk of default has been specifically identified. The assessment of
the likelihood of customer defaults is based on various factors,
including the length of time the receivables are past due, historical
experience and existing economic conditions.
Expenditures Billable to Clients. Expenditures billable to
clients consist principally of costs incurred on behalf of clients when
providing advertising, marketing and corporate communications services
to clients that have not been invoiced. Such amounts are invoiced to
clients at various times over the course of the production process. In
the majority of the Company's Marketing Communications businesses, it
acts as agent and records revenue equal to the net amount retained when
the fee or commission is earned.
Inventories. Finished goods and work-in-process inventories
are valued at the lower of cost and net realizable value. Raw materials
are valued at the lower of cost and replacement cost. Cost is
determined on a first-in, first-out method.
Depreciation of Fixed Assets. Buildings are depreciated on a
straight-line basis over the estimated useful lives of 20 to 25 years.
Computers, furniture and fixtures are depreciated on a declining
balance basis at rates of between 20% to 50% per year. Machinery and
equipment are depreciated on a declining balance basis at rates of
between 10% to 20% per year. Leasehold improvements are amortized on a
straight-line basis over the lesser of the terms of the related lease
or the estimated useful life of these assets.
Long-lived Assets. In accordance with SFAS 144 "Accounting for
the Impairment or Disposal of Long-lived Assets," a long-lived asset or
asset group is tested for recoverability whenever events or changes in
circumstances indicate that its carrying amount may not be recoverable.
When such events occur, the Company compares the sum of the
undiscounted cash flows expected to result from the use and eventual
disposition of the asset or asset group to the carrying amount of the
long-lived asset or asset group. If this comparison indicates that
there is an impairment, the amount of the impairment is typically
calculated using discounted expected future cash flows where observable
fair values are not readily determinable. The discount rate applied to
these cash flows is based on the Company's weighted average cost of
capital, risk adjusted where appropriate.
Equity Method Investments. The equity method is used to
account for investments in entities in which the Company has an
ownership interest of less than 50%, and has significant influence, or
joint control over; the operating and financial policies of the
affiliate; or has an ownership interest of greater than 50%, however,
the substantive participating rights of the minority interest
shareholders preclude the Company from exercising unilateral control
over the operating and financial policies of the affiliate. The
Company's investments accounted for using the equity method are
Accumark Promotions Group Inc., 55% owned by the Company, Crispin
Porter + Bogusky, LLC, 49.9% owned by the Company and, and a 50%
undivided interest in a real estate joint venture. In 2004 this also
included Cliff Freeman & Partners, LLC, 19.9% owned by the Company and
Mono Advertising LLC, 49.9% owned by the Company. The Company's
management periodically evaluates these investments to determine if
there have been any, other than temporary, declines in value.
Goodwill. In accordance with SFAS 142, "Goodwill and Other
Intangible Assets", goodwill acquired as a result of a business
combination for which the acquisition date was after June 30, 2001 is
no longer amortized, but is periodically tested for impairment.
Additionally, in accordance with SFAS 141, "Business Combinations", the
cost of an acquired entity is allocated to the assets acquired and
liabilities assumed based on their estimated fair values including
other identifiable intangible assets, as applicable, such as trade
names, customer relationships and client lists.
20
Goodwill is tested annually for impairment, and is tested for
impairment more frequently if events and circumstances indicate that
the asset might be impaired. An impairment loss is recognized to the
extent that the carrying amount exceeds the asset's fair value. This
determination is made at the reporting unit level and consists of two
steps. First, the Company determines the fair value of a reporting unit
and compares it to its carrying amount. Second, if the carrying amount
of a reporting unit exceeds its fair value, an impairment loss is
recognized for any excess of the carrying amount of the reporting
unit's goodwill over the implied fair value of that goodwill. The
implied fair value of goodwill is determined by allocating the fair
value of the reporting unit in a manner similar to a purchase price
allocation, in accordance with FASB Statement No. 141, "Business
Combinations". The residual fair value after this allocation is the
implied fair value of the reporting unit goodwill. Impairment losses,
where applicable, will be charged to operating profit (loss).
Intangible Assets. In accordance with SFAS 142, "Goodwill and
Other Intangible Assets", intangibles with a definite life, other than
goodwill, acquired as a result of a business combination are subject to
amortization. The method of amortization selected reflects the pattern
in which the economic benefits of the specific intangible asset is
consumed or otherwise used up. If that pattern cannot be reliably
determined, a straight-line amortization method is used. Intangible
assets that are subject to amortization are reviewed for potential
impairment in accordance with SFAS 144 at least annually or whenever
events or circumstances indicate that carrying amounts may not be
recoverable. The Company is amortizing its intangible assets on a
straight-line basis over a period of 3 years.
Deferred Taxes. Deferred income taxes are provided for the
temporary difference between the financial reporting basis and tax
basis of the Company's assets and liabilities. Deferred tax benefits
result principally from recording certain expenses in the financial
statements that are not currently deductible for tax purposes and from
differences between the tax and book basis of assets and liabilities
recorded in connection with acquisitions. Deferred tax liabilities
result principally from deductions recorded for tax purposes in excess
of that recorded in the financial statements.
Guarantees. Guarantees granted by the Company to third parties
(or modified) after January 1, 2003 are generally recognized, at the
inception of a guarantee, as a liability for the obligations it has
undertaken in issuing the guarantee, including its ongoing obligation
to stand ready to perform over the term of the guarantee in the event
that the specified triggering events or conditions occur. The initial
measurement of that liability is the fair value of the guarantee at its
inception. The recognition of the liability is required even if it is
not probable that payments will be required under the guarantee. The
Company's liability associated with guarantees is insignificant.
Revenue Recognition. The Company generates services revenue
from its Marketing Communications reportable segment and product
revenue from its Secure Products reportable segment.
Marketing Communications
Substantially all of the Marketing Communications reportable segment
revenue is derived from fees for services. Additionally, the Company
often earns commissions based upon the placement of advertisements in
various media. Generally, the Company acts as agent for its customers
and records revenue equal to the net amount retained. Revenue is
realized when the service is performed in accordance with the terms of
each client arrangement and upon completion of the earnings process.
This includes when services are rendered, upon presentation date for
media, when costs are incurred for radio and television production and
when print production is completed and collection is reasonably assured
and all other revenue recognition criteria have been met.
21
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 performance against
qualitative goals is determined by the Company's clients.
Secured Products
Substantially all of the Secured Products International reportable
segment revenue is derived from the sale of products. The Company has
the following revenue recognition policies.
Revenue derived from the stamp operations is recognized upon shipment
or upon delivery of the product to the customer when the Company's
obligations under the contractual arrangements are completed, the
customer takes ownership and assumes the risk of loss of the product,
the selling price is determined and the collection of the related
receivable is reasonably assured. The Company performs quality control
testing procedures prior to shipment to ensure that its contractual
obligations are met. Under these contractual arrangements, the Company
has the ability to recover any costs incurred to date under possible
termination of the contract, accordingly the Company accounts for the
manufacturing costs incurred as inventory work-in-process, until
completion of production.
Revenue derived from secured printing arrangements whereby the Company
manufactures and stores the printed product for a period of time at the
direction of its customer with delivery at a future date within a 90
day period is accounted for on a "bill and hold" basis whereby the
Company allocates the arrangement consideration on a relative fair
value basis between the printing service and the storage service. The
Company recognizes the printing revenue when the customized printed
products moves to the secure storage facility and the printing process
is complete and when title transfers to the customer. The Company has
no further obligations under the printing segment of the arrangement.
The Company recognizes the storage fee revenue when the customized
printed products are delivered to the customer's premises. Although
amounts are generally not billed by the Company until the customized
print product is delivered to the customer's premises, collection of
the entire consideration is due under certain contracts within 90 days
of completion of the printing segment of the arrangement.
Revenue derived from the design, manufacturing, inventory management
and personalization arrangements of secured cards is recognized as a
single unit of accounting when the secured card is shipped to the
cardholder and the Company's service obligations to the card issuer are
complete under the terms of the contractual arrangement and the total
selling price related to the card is known and collection of the
related receivable is reasonably assured. Any amounts billed and/or
collected in advance of this date are deferred and recognized at the
shipping date. Under these contractual arrangements, the Company has
the ability to recover any costs incurred to date under possible
termination of the contract, accordingly the Company accounts for the
effect of costs incurred related to design and manufacturing relative
to the secured card arrangement as inventory work-in-process related to
the arrangements.
The Company's revenue recognition policies are in compliance with the
SEC Staff Accounting Bulletin 104 ("SAB 104"). SAB 104 summarizes
certain of the SEC staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements.
Also, in July 2000, the EITF of the Financial Accounting Standards
Board released Issue No. 99-19, "Reporting Revenue Gross as a Principal
versus Net as an Agent" ("EITF 99-19"). This Issue summarized the
EITF's views on when revenue should be recorded at the gross amount
billed because it has earned revenue from the sale of goods or
services, or the net amount retained because it has earned a fee or
commission. In the Marketing Communications businesses, it acts as an
agent and records revenue equal to the net amount retained, when the
fee or commission is earned.
22
In June 2003, EITF No. 00-21, Revenue Arrangements with Multiple
Deliverables ("EITF 00-21"), became effective. This issue addressed
certain aspects of the accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities. The
Company adopted the provisions of EITF 00-21 effective January 1, 2003.
Additionally, in January 2002, the EITF released Issue No. 01-14,
Income Statement Characterization of Reimbursements Received for
"Out-of-Pocket" Expenses Incurred ("EITF 01-14"). This Issue summarized
the EITF's views on when out-of-pocket expenses should be characterized
as revenue. The adoption of the provisions of these two EITF's had no
material impact on the Company's financial position, results of
operations, or cashflows. The Company's revenue recognition policies
are in compliance with SAB 104, EITF 99-19, EITF 00-21 and EITF 01-14.
Stock-Based Compensation. Effective January 1, 2003, the
Company prospectively adopted fair value accounting for stock based
awards as prescribed by SFAS 123 "Accounting for Stock- Based
Compensation". Prior to January 1, 2003, the Company elected not to
apply fair value accounting to stock-based awards to employees, other
than for direct awards of stock and awards settleable in cash, which
required fair value accounting. Prior to January 1, 2003, for awards
not elected to be accounted for under the fair value method, the
Company accounted for stock based compensation in accordance with
Accounting Principles Board Opinion 25, "Accounting for Stock Issued to
Employees" ("APB 25"). APB 25 is based upon an intrinsic value method
of accounting for stock-based compensation. Under this method,
compensation cost is measured as the excess, if any, of the quoted
market price of the stock issuance at the measurement date over the
amount to be paid by the employee.
The Company adopted fair value accounting for stock based awards using
the prospective application transitional alternative available in SFAS
148 "Accounting for Stock Based Compensation - Transition and
Disclosure". Accordingly, the fair value method is applied to all
awards granted, modified or settled on or after January 1, 2003. Under
the fair value method, compensation cost is measured at fair value at
the date of grant and is expensed over the service period, that is the
award's vesting period. When awards are exercised, share capital is
credited by the sum of the consideration paid together with the related
portion previously credited to additional paid-in capital when
compensation costs were charged against income or acquisition
consideration.
Stock-based awards that are settled in cash or may be settled in cash
at the option of employees are recorded as liabilities. The measurement
of the liability and compensation cost for these awards is based on the
intrinsic value of the award, and is recorded into operating profit
(loss) 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 profit (loss). The final
payment amount for Share Appreciation Rights is established on the date
of the exercise of the award by the employee.
23
Stock-based awards that are settled in cash or equity at the option of
Company are recorded at fair value on the date of grant and recorded as
additional paid-in capital. The fair value measurement of the
compensation cost for these awards is based on using the Black-Scholes
option pricing model, and is recorded into operating income over the
service period, that is the vesting period of the award. When awards
are exercised, share capital is credited with the related portion
previously credited to additional paid-in capital.
As noted, prior to January 1, 2003, the Company did not use the fair
value method to account for certain employee stock-based compensation
plans but disclosed this pro forma information for options granted
commencing in fiscal 1995.
The table below summarizes the quarterly pro forma effect for the three
months and six months ended June 30, 2004 and 2003, respectively, had
the Company adopted the fair value method of accounting for stock
options and similar instruments for awards issued prior to 2003:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ---------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
(Restated - See Note 2) (Restated - See Note 2)
Net income as reported $ 932 $ 17,637 $ 9,397 $ 17,849
Fair value costs, net of income tax, of stock-based
employee compensation for options issued prior to 2003 293 483 669 995
---------- ---------- ---------- ----------
Net income pro forma $ 639 $ 17,154 $ 8,728 $ 16,854
========== ========== ========== ==========
Basic net income per share, as reported $ 0.04 $ 1.04 $ 0.46 $ 1.06
Basic net income per share, pro forma $ 0.03 $ 1.01 $ 0.43 $ 1.00
Diluted net income per share, as reported $ 0.04 $ 0.81 $ 0.42 $ 0.84
Diluted net income per share, pro forma $ 0.03 $ 0.78 $ 0.39 $ 0.79
The fair value of the stock options and similar awards at the grant
date used to compute pro forma net income (loss) and net income (loss)
per share was estimated using the Black-Scholes option-pricing model
with the following weighted average assumptions for each of the three
months ended:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Expected dividend 0.00% 0.00% 0.00% 0.00%
Expected volatility 40% 40% 40% 40%
Risk-free interest rate 3.30% 6.00% 3.30% 6.00%
Expected option life in years 5 5 5 5
Weighted average stock option fair value per
option granted $ 4.98 $ 2.26 $ 5.11 $ 2.26
24
Earnings Per Common Share. Basic earnings per share is based
upon the weighted average number of common shares outstanding during
each period, including the "Share capital to be issued" as reflected in
the Shareholders' Equity on the balance sheet. Diluted earnings per
share is based on the above, plus, if dilutive, common share
equivalents, which include outstanding options and warrants. For
purposes of computing diluted earnings per share for the three months
ended June 30, 2004 and 2003, respectively, 1,955,163 and 5,463,509
shares, and for the six months ended June 30, 2004 and 2003,
respectively, 2,081,881 and 5,341,940 shares, were assumed to have been
outstanding related to common share equivalents. Additionally, the
assumed increase in net income related to the after tax interest costs
of convertible debentures used in the computations was $216 and $397
for the three months ended June 30, 2004 and 2003, respectively, and
$853 and $764 for the six months ended June 30, 2004 and 2003,
respectively.
The following table details the weighted average number of common
shares outstanding for each of the three months and six months ended
June 30, 2004 and 2003, respectively:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ---------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Basic weighted average shares outstanding 21,772,706 16,915,341 20,388,169 16,915,341
Weighted average shares dilution adjustments:
Dilutive stock options and warrants (a) 1,955,163 319,476 2,081,881 197,907
7% convertible senior notes -- 5,144,033 -- 5,144,033
---------- ---------- ---------- ----------
Diluted weighted average shares outstanding (b) 23,727,869 22,378,850 22,470,050 22,257,281
========== ========== ========== ==========
(a) Dilutive and anti-dilutive stock options and similar awards were determined
by using the average closing price of the Class A Subordinate Voting shares for
the period. For the three months ended June 30, 2004 and 2003, the average share
price used was $12.65 per share and $6.07 per share, respectively. For the six
months ended June 30, 2004 and 2003, the average share price used was $13.42 per
share and $4.85 per share, respectively
(b) Had certain stock options, similar awards and the convertible debt been
dilutive, they would have added 964,716 dilutive shares and nil dilutive shares
for the three months ended June 30, 2004 and 2003, respectively, and added
1,768,907 dilutive shares and nil dilutive shares for the six months ended June
30, 2004 and 2003, respectively.
Foreign Currency Translation. The Company's financial
statements were prepared in accordance with the requirements of SFAS
No. 52, "Foreign Currency Translation". The functional currency of the
Company is Canadian dollars and it has decided to use U.S. dollars as
its reporting currency for consolidated reporting purposes. All of the
Company's subsidiaries use their local currency as their functional
currency in accordance with SFAS 52. Accordingly, the currency impacts
of the translation of the balance sheets of the Company's non-US dollar
based subsidiaries to U.S. dollar statements are included as cumulative
translation adjustments in other accumulated comprehensive income.
Cumulative translation adjustments are not included in net earnings
unless they are actually realized through a sale or upon complete or
substantially complete liquidation of the Company's net investment in
the foreign operation. The income statements of non-US dollar based
subsidiaries are translated at average exchange rates for the period.
Gains and losses arising from the Company's foreign currency
transactions are reflected in net earnings other than those unrealized
gains or losses arising on the translation of certain intercompany
foreign currency transactions that are of a long-term nature (that is
settlement is not planned or anticipated in the future) and which are
included as cumulative translation adjustments in other accumulated
comprehensive income.
25
Derivative Financial Instruments. The Company adopted SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", on
January 1, 2001. SFAS No. 133 establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts and debt
instruments) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The Company issued adjustable
rate exchangeable debentures, in December 2003, which included an
embedded derivative. The derivative met the SFAS No. 133 criteria for
separation from the debt contract and was marked to market, with
changes in the fair value being recorded in net earnings for the
period, until the exchangeable debentures were settled on February 13,
2004.
Effective July 1, 2002, management designated the Company's 10.5% U.S.
senior subordinated notes ("Notes") as an economic hedge against
foreign exchange exposure of the U.S. operation, Custom Direct, Inc.
("CDI"). The hedge was applied prospectively from the effective date
whereby any foreign exchange translation adjustment of the Notes
reduced any offsetting foreign exchange translation adjustment of the
U.S. operations, the net of which was reflected in the cumulative
translation account within shareholders' equity. The application of
hedge accounting ceased on the repayment of the Company's 10.5% US
senior subordinated notes on June 30, 2003 which corresponded with the
Company's sale of 80% of its investment in CDI.
4. COMPREHENSIVE INCOME
Total comprehensive income and its components were:
(in thousands of dollars)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
-------- -------- -------- --------
(Restated - See Note 2) (Restated - See Note 2)
Net income for the period $ 932 $ 17,637 $ 9,397 $ 17,849
Unrealized gain on marketable securities -- 2,090 -- 2,090
Foreign currency cumulative translation
adjustment 434 (6,273) (685) (12,853)
-------- -------- -------- --------
Comprehensive income for the period $ 1,366 $ 13,454 $ 8,712 $ 7,086
======== ======== ======== ========
5. NEW ACCOUNTING PRONOUNCEMENTS
The following recent pronouncements were issued by the Financial
Accounting Standards Board ("FASB") and became effective in 2004:
In January 2003, the FASB issued Interpretation No. 46, Consolidation
of Variable Interest Entities, An Interpretation of ARB No. 51 ("FIN
46"). This Interpretation addresses the consolidation by business
enterprises of variable interest entities, as defined in the
Interpretation. The Interpretation was to be applied immediately to
variable interests in variable interest entities created after January
31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. In December 2003, the FASB issued FASB
Interpretation No. 46R, "Consolidation of Variable Interest Entities
Revised." (FIN 46R). FIN 46R modifies certain scope exceptions provided
in FIN 46. Entities would be required to replace FIN 46 provisions with
FIN 46R provisions for all newly created post-January 31, 2003 entities
as of the end of the first interim or annual reporting period ending
after March 15, 2004. See note 10 for the impact the effective
provisions of FIN46R had on the Company's consolidated financial
statements.
26
In November 2003, the EITF reached a consensus on Issue No. 03-01, The
Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments ("EITF 03-01"). EITF 03-01 established additional
disclosure requirements for each category of SFAS No. 115, Accounting
for Certain Investments in Debt and Equity Securities ("SFAS 115"),
investments in a loss position. Effective for years ended after
December 15, 2003, the adoption of this EITF requires the Company to
include certain quantitative and qualitative disclosures for debt and
marketable equity securities classified as available-for-sale or
held-to-maturity under SFAS 115 that are impaired at the balance sheet
date for which an other-than-temporary impairment has not been
recognized. Additionally, certain qualitative disclosures should be
made to clarify a circumstance whereby an investment's fair value that
is below cost is not considered other-than-temporary. The provisions of
this consensus do not have a material impact on the Company's interim
unaudited condensed consolidated financial statements.
6. SEGMENTED INFORMATION
Based on the Company's internal management structure, the Company's
operations form two reportable segments - Marketing Communications and
Secure Products International.
Marketing Communications services, through the Company's network of
entrepreneurial firms, include advertising and media, customer
relationship management, and marketing services. These businesses
provide communications services to similar type clients on a global,
national and regional basis. The businesses have similar cost
structures and are subject to the same general economic and competitive
risks. Given these similarities, the results are aggregated into one
reportable segment.
Secure Products International operations provide security products and
services in three primary areas: electronic transaction products such
as credit, debit, telephone and smart cards; secure ticketing products
such as airline, transit and event tickets; and stamps, both postal and
excise. Again, given the similarities in types of clients, cost
structure, risks and long-term financial results, the results are
aggregated into one reportable segment. The significant accounting
polices of these segments are the same as those described in the
summary of significant accounting policies included in these notes to
the unaudited condensed consolidated financial statements, except as
where indicated.
Many of the Company's Marketing Communications businesses have
significant other interestholders and in some cases, the Company
operates the business in a fashion similar to a joint venture with
these other interestholders. The Company's management oversees these
businesses as active managers rather than a passive investor, reviewing
all aspects of their operations with the management of these
businesses, regardless of the Company's ownership interest. Within the
marketing communications industry, the monitoring of operating costs,
such as salary and related costs, relative to revenues, among other
things, are key performance indicators. Consequently, the Company's
management reviews, analyses and manages these elements of the
businesses as a whole, rather than just being concerned with it as an
investment. Management believes the presentation of the whole of the
businesses comprising this segment also provides readers with a
complete view of the elements of all operations that significantly
affect the Marketing Communications reportable segment's profitability.
Accumark Promotions Group Inc., owned 55% by the Company, and Crispin
Porter + Bogusky, LLC, ("CPB"), owned 49% by the Company, which are
operated as joint ventures with the other interest holders, as well as
Cliff Freeman & Partners, LLC, owned 19.9% by the Company and Mono
Advertising LLC, owned 49.9% by the Company, are required to be equity
accounted for under US GAAP. For purposes of the segmented information
disclosure, 100% of the results of operations of these entities have
been combined with the other business of the Marketing Communications
reportable segment and the alternate operating results have been
described as "Combined". A reconciliation of "Combined" results of
operations of the Marketing Communications reportable segment to the US
GAAP reported results of operations has been provided by the Company in
the tables included in the segmented information disclosure.
27
Summary financial information concerning the Company's reportable segments for
the three months ended June 30 is shown in the following table:
THREE MONTHS ENDED JUNE 30, 2004 (Restated - See Note 2):
Combined As Reported under US GAAP
-------------- --------------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 73,669 $ 15,342 $ 58,327 $ 17,233 $ -- $ 75,560
-------- -------- -------- -------- -------- --------
Operating Expenses:
Cost of products sold -- -- -- 10,386 -- 10,386
Salary and related costs* 34,897 7,414 27,483 3,370 246 31,099
General and other
operating costs 27,699 4,108 23,591 2,100 1,963 27,654
Depreciation and
amortization 2,536 341 2,195 807 26 3,028
-------- -------- -------- -------- -------- --------
65,132 11,863 53,269 16,663 2,235 72,167
-------- -------- -------- -------- -------- --------
Operating Profit (Loss) $ 8,537 $ 3,479 $ 5,058 $ 570 ($ 2,235) 3,393
======== ======== ======== ======== ========
Other Income (Expense):
Loss on sale of assets (73)
Foreign exchange gain 288
Interest expense, net (2,265)
--------
Income Before Income Taxes,
Equity in Affiliates and
Minority Interests 1,343
Income Taxes (Recovery) (589)
--------
Income Before Equity in
Affiliates and Minority
Interests 1,932
Equity in Affiliates 1,343
Minority Interests (2,343)
--------
Net Income $ 932
========
Capital expenditures $ 3,272 $ 525 $ 2,747 $ 2,187 $ 40 $ 4,974
*Includes stock-based
compensation (recovery) $ 220 $ 74 $ 146 $ -- ($ 1,206) ($ 1,060)
28
THREE MONTHS ENDED JUNE 30, 2003 (Restated - See Note 2):
Combined As Reported under US GAAP
----------------------------- ---------------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 51,594 $ 8,850 $ 42,744 $ 33,084 $ -- $ 75,828
-------- -------- -------- -------- -------- --------
Operating Expenses:
Cost of products sold -- -- -- 14,932 -- 14,932
Salary and related costs* 23,523 3,521 20,002 5,683 1,609 27,294
General and other
operating costs 19,747 2,629 17,118 10,469 1,055 28,642
Depreciation and
amortization 1,587 138 1,449 1,081 137 2,667
Write-down of fixed assets
and other assets -- -- -- 8,126 -- 8,126
Goodwill charges -- -- -- 10,012 -- 10,012
-------- -------- -------- -------- -------- --------
44,857 6,288 38,569 50,303 2,801 91,673
-------- -------- -------- -------- -------- --------
Operating Profit (Loss) $ 6,737 $ 2,562 $ 4,175 ($ 17,219) ($ 2,801) (15,845)
======== ======== ======== ======== ========
Other Income (Expense):
Gain on sale of assets and settlement of long-term debt 44,625
Foreign exchange loss (876)
Interest expense, net (5,383)
--------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 22,521
Income Taxes 5,936
--------
Income Before Equity in Affiliates and Minority Interests 16,585
Equity in Affiliates 1,229
Minority Interests (177)
--------
Net Income $ 17,637
========
Capital expenditures $ 4,848 $ 3,057 $ 1,791 $ 3,480 $ -- $ 5,271
*Includes stock-based
compensation $ -- $ -- $ -- $ -- $ 975 $ 975
29
SIX MONTHS ENDED JUNE 30, 2004 (Restated - See Note 2):
Combined As Reported under US GAAP
----------------------------- ----------------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 138,101 $ 27,816 $ 110,285 $ 35,270 $ $ 145,555
--------- --------- --------- --------- --------- ---------
Operating Expenses:
Cost of products sold -- -- -- 21,561 -- 21,561
Salary and related costs* 64,969 12,087 52,882 6,846 7,642 67,370
General and other
operating costs 52,453 6,932 45,521 4,501 3,346 53,368
Depreciation and
amortization 4,570 531 4,039 1,482 52 5,573
--------- --------- --------- --------- --------- ---------
121,992 19,550 102,442 34,390 11,040 147,872
--------- --------- --------- --------- --------- ---------
Operating Profit (Loss) $ 16,109 $ 8,266 $ 7,843 $ 880 ($ 11,040) (2,317)
========= ========= ========= ========= =========
Other Income (Expense):
Gain on sale of assets 16,238
Foreign exchange gain 458
Interest expense, net (4,618)
---------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 9,761
Income Taxes (392)
---------
Income Before Equity in Affiliates and Minority Interests 10,153
Equity in Affiliates 2,884
Minority Interests (3,640)
---------
Net Income $ 9,397
=========
Capital expenditures $ 5,449 $ 918 $ 4,531 $ 3,460 $ 74 $ 8,065
*Includes stock-based
compensation $ 277 $ 74 $ 203 $ -- $ 4,796 $ 4,999
30
SIX MONTHS ENDED JUNE 30, 2003 (Restated - See Note 2):
Combined As Reported under US GAAP
----------------------------- ----------------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 96,586 $ 16,060 $ 80,526 $ 76,398 $ -- $ 156,924
--------- --------- --------- --------- --------- ---------
Operating Expenses:
Cost of products sold -- -- -- 33,439 -- 33,439
Salary and related costs* 46,404 6,939 39,465 11,766 2,660 53,891
General and other
operating costs 36,364 4,580 31,784 22,519 1,619 55,922
Depreciation and
amortization 3,091 230 2,861 2,255 261 5,377
Write-down of fixed assets
and other assets -- -- -- 8,126 -- 8,126
Goodwill charges -- -- -- 10,012 -- 10,012
--------- --------- --------- --------- --------- ---------
85,859 11,749 74,110 88,117 4,540 166,767
--------- --------- --------- --------- --------- ---------
Operating Profit (Loss) $ 10,727 $ 4,311 $ 6,416 ($ 11,719) ($ 4,540) (9,843)
========= ========= ========= ========= =========
Other Income (Expense):
Gain on sale of assets and settlement of long-term debt 44,625
Foreign exchange loss (1,531)
Interest expense, net (10,167)
---------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 23,084
Income Taxes 5,910
---------
Income Before Equity in Affiliates and Minority Interests 17,174
Equity in Affiliates 1,791
Minority Interests (1,116)
---------
Net Income $ 17,849
=========
Capital expenditures $ 6,931 $ 4,394 $ 2,537 $ 5,019 $ 3 $ 7,559
*Includes stock-based
compensation $ -- $ -- $ -- $ -- $ 975 $ 975
31
A summary of our revenue by geographic area as of June 30, 2004 and
2003 is set forth in the following table (Restated - See Note 2):
(in thousands of dollars)
------------------------------------------------------------
United States Canada Other Total
------------- ------ ----- -----
Revenue
Three Months Ended June 30,
2004 $ 48,474 $19,325 $ 5,761 $ 75,560
2003 52,236 17,821 5,771 75,828
Revenue
Six Months Ended June 30,
2004 $ 94,699 $38,855 $12,001 $145,555
2003 110,485 35,931 10,508 156,924
Long-lived Assets
at June 30,
2004 $ 23,019 $17,574 $ 5,409 $ 46,002
2003 11,308 17,896 4,572 $ 33,776
7. INVENTORIES
The components of inventory are listed below:
June 30, December 31,
2004 2003
-------- ------------
(Restated - See Note 2)
Raw materials and supplies $3,693 $3,743
Work-in-process 4,766 3,992
------ ------
Total $8,459 $7,735
====== ======
8. LONG-TERM DEBT
MDC Partners Inc. is principally a holding company and the Company's
assets consist principally of its investments in Maxxcom Inc.
("Maxxcom"), which in turn owns a substantial portion of its interests
in the Marketing Communications businesses, and in the Secured Products
International (SPI) businesses.
Currently, substantially all of the long-term debt is held at Maxxcom
or its subsidiaries. Maxxcom's ability to meet the repayment of its
long-term debt and to make distributions to MDC Partners Inc., is
dependent upon the availability of cash from its parent MDC Partners
Inc. and from the cash flows from its subsidiaries and affiliated
companies through dividends, distributions, intercompany advances,
management fees and other payments. A number of Maxxcom's subsidiaries
are not wholly-owned and pursuant to operating agreements with some of
the other shareholders of these subsidiaries and affiliates and certain
subsidiary and affiliate lending agreements, there are certain
restrictions on the payment of dividends, distributions and advances to
Maxxcom. In addition, pursuant to certain lending agreements entered
into by MDC Partners Inc., there are restrictions on MDC's ability to
transfer available cash to Maxxcom.
As at June 30, 2004, $7,963 of (December 31, 2003 - $9,725) the
consolidated cash position is held by subsidiaries, which, although
available for the subsidiaries' use, does not represent cash that is
distributable as earnings to Maxxcom for use to reduce Maxxcom
indebtedness.
32
During the second quarter of 2004, the Company reached agreements with
its senior credit lenders to amend the terms of the credit facility of
its subsidiary, Maxxcom Inc., to eliminate the scheduled quarterly
borrowing reductions after March 31, 2004 and to change the facility's
maturity date from March 31, 2005 to September 30, 2004. As a result of
this amendment, the Company was not required to make a debt repayment
in the second quarter of $5.2 million (Canadian $7.0 million). At June
30, 2004 the maximum amount which would be borrowed under this facility
is $33.1 million (C$44.1 million) (December 31, 2003 - $39.4 million)
of which $30.0 million was utilized.
The Company is actively seeking to refinance the amounts owing on
September 30, 2004 under its bank credit facility. The Company has a
commitment letter with a lender and the lender is undertaking its due
diligence. In the event that such a definitive credit agreement cannot
be secured by September 30, 2004, the Company would need to seek
alternative sources of financing, seek an extension to the current
credit facility or reach an agreement with certain other shareholders
to permit the advance of cash balances held in those subsidiaries or
affiliates to Maxxcom in order to meet or amend its obligation under
its existing credit facilities. There is no certainty that such events
will occur.
On June 10, 2004, MDC Partners Inc. entered into a revolving credit
facility with a syndicate of banks providing for borrowings of up to
$18.7 million (Canadian $25.0 million) maturing in May of 2005. The
facility is available for general corporate purposes including
acquisitions, however may not be used to repay existing debt or to
provide financial assistance to businesses securing such debt. This
facility bears interest at variable rates based upon LIBOR, Canadian
bank prime or US bank base 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 175 to 275 basis points to
the LIBOR and Bankers Acceptance based interest rate loans and between
75 to 175 basis points to all other loan interest rates. The provisions
of the facility contain various covenants pertaining to debt to EBITDA
ratios, debt to capitalization ratio, and the maintenance of certain
interest coverage and minimum shareholders' equity levels. The facility
is secured by a pledge of the Company's assets principally comprised of
ownership interests in its subsidiaries and by the underlying assets of
the businesses comprising the Company's Secure Products International
operating segment and Kirshenbaum Bond + Partners, carried at a value
represented by the total assets reflected on the Company's consolidated
balance sheet at June 30, 2004. At June 30, 2004, the Company had not
drawn any funds under this facility.
Included in long-term debt, as at December 31, 2003, is an obligation
in the amount of $3,974, being the fair value of the embedded
derivative in the Company's exchangeable debentures. On February 13,
2004, the exchangeable debentures were settled in full as described in
Note 11.
33
9. ACQUISITIONS
FIRST QUARTER 2004 ACQUISITIONS
Kirshenbaum Bond + Partners
On January 29, 2004, the Company acquired a 60% ownership interest in
kirshenbaum bond + partners, LLC ("KBP") in a transaction accounted for
under the purchase method of accounting. KBP is comprised of four
units: kirshenbaum bond (New York and San Francisco) which are
primarily advertising agencies, LIME Public Relations + Promotion, The
Media Kitchen, which handles media buying and planning and Dotglu, an
interactive and direct marketing unit. KBP is recognized for creating
very successful non-traditional marketing campaigns and as such was
acquired by the Company to enhance the creative talent within the MDC
Partners Marketing Communications segment of businesses. As part of the
acquisition, the Company paid $20,654 in cash, issued 148,719 shares of
the Company's common stock to the selling interestholders of KBP
(valued at approximately $2,027 based on the share price on or about
the commencement date), issued warrants to purchase 150,173 shares of
the Company's common stock to the selling interestholders of KBP (the
fair value of which, using a Black Scholes option pricing model, was
approximately $955 based on the share price on the date of closing) and
incurred transaction costs of approximately $1,175. Under the terms of
the agreement, the selling interestholders of KBP could receive
additional cash and/or share consideration, totaling up to an
additional $735 within one year from the date of acquisition, based
upon achievement of certain predetermined earnings targets. Such
contingent consideration will be accounted for as goodwill when the
contingency is resolved and the amount becomes determinable.
Exclusive of future contingent consideration, the recorded purchase
price of the net assets acquired in the transaction was $24,811. The
purchase price was allocated to the fair value of net assets acquired
as follows:
Previously
Reported Adjustments As Reported
----------- ---------------------------
Cash and cash equivalents $ 25,283 $ -- $ 25,283
Accounts receivable and other current assets 18,540 -- 18,540
Furniture, equipment and leasehold improvements 3,872 -- 3,872
Goodwill 25,632 (292) 25,340
Intangible assets 1,200 -- 1,200
Accounts payable and accrued expenses (49,440) 747 (48,693)
Minority interest (432) (299) (731)
Total purchase price ----------- ----------- -----------
$ 24,655 $ 156 $ 24,811
=========== =========== ===========
The allocation of the purchase price to assets acquired and liabilities
assumed is based on preliminary estimates of fair value and certain
assumptions that the Company believes are reasonable under the
circumstances and will be adjusted in a subsequent period upon
finalization of such assumptions and estimates. The Company's
consolidated financial statements include KBP's results of operations
subsequent to its acquisition on January 29, 2004. During the six
months ended June 30, 2004, the operations of KBP contributed $20,960
of revenue and $1,631 of net income to the Company's consolidated
operating results.
34
Accent Marketing Services
On March 29, 2004, the Company acquired an additional 39.3% ownership
interest in the Accent Marketing Services LLC ("Accent"), increasing
its total ownership interest in this subsidiary from 50.1% to
approximately 89.4%. Accent has established itself as an integrated
direct marketing services company providing customer contact centers
and direct mail services to its clients, offering a unique customer
relationship and product life cycle management program to its clients.
As part of the acquisition, the Company paid $1,444 in cash, issued,
and to be issued, 1,103,331 shares of the Company's common stock to the
selling interestholders of Accent (valued at approximately $16,833
based on the share price on or about the commencement date), and
incurred transaction costs of approximately $72. Under the terms of the
agreement, the selling interestholders of Accent could receive up to a
maximum additional consideration of 742,642 common shares of the
Company, or the cash equivalent, based upon achievement of certain
predetermined earnings targets, by June 2005. Such contingent
consideration will be accounted for when it becomes determinable. This
acquisition was accounted for as a purchase and accordingly, the
Company's consolidated financial statements, which have consolidated
Accent's financial results since 1999, reflect a further 39.3%
ownership participation subsequent to the additional acquisition on
March 29, 2004.
The purchase price was allocated based on the fair value of the net
assets acquired of this purchase price, $12,534 was allocated to
goodwill and $1,200 was allocated to intangible assets.
The allocation of the purchase price to assets acquired and liabilities
assumed is based on preliminary estimates of fair values and certain
assumptions that the Company believes are reasonable under the
circumstances and will be adjusted in a subsequent period upon
finalization of such estimates and assumptions.
Other First Quarter 2004 Acquisitions
During the quarter ended March 31, 2004, the Company acquired several
other ownership interests. In March 2004, the Company acquired a 19.9%
ownership interest in Cliff Freeman + Partners LLC ("CF") in a
transaction accounted for under the equity method of accounting. CF is
a New York based advertising agency. CF has long been recognized for
its creative abilities, winning numerous national and international
advertising awards, and as such was acquired by the Company to enhance
the creative talent within the MDC Partners Marketing Communications
segment of businesses. Also during the quarter, the Company acquired
further equity interests in the existing subsidiaries of Allard Johnson
Communications Inc. and Targetcom LLC, as well as several other
insignificant investments. In aggregate, as part of these acquisitions,
the Company paid $3,076 in cash and incurred transaction costs of
approximately $413. Under the terms of the CF agreement, the selling
interestholders could receive additional cash and/or share
consideration after two years based upon achievement of certain
predetermined cumulative earnings targets. Based on current earnings
levels, the additional consideration would be nil. Such contingent
consideration will be accounted for as goodwill when it becomes
determinable.
Exclusive of future contingent consideration, the aggregate purchase
price of the net assets acquired in these transactions was
approximately $3,489. The purchase price was allocated based on the
fair value of the net assets acquired of the purchase price, $2,142 was
allocated to goodwill and intangible assets.
The allocation of the purchase price to assets acquired and liabilities
assumed is based on preliminary estimates of fair value and certain
assumptions that the Company believes are reasonable under the
circumstances and will be adjusted in a subsequent period upon
finalization of such estimates and assumptions.
The Company's consolidated financial statements include the results of
operations from their respective acquisition dates and balance sheet,
accounted for on a consolidated basis except for CF, which is accounted
for on an equity basis due to the significant influence of the
management of the operation obtained through contractual rights. During
this period, the aggregated operations of these acquisitions did not
have a material effect on the Company's results of operations.
35
SECOND QUARTER 2004 ACQUISITIONS
During the quarter ended June 30, 2004, the Company acquired several
other ownership interests. On April 14, 2004, the Company acquired a
65% ownership interest in Henderson bas ("HB") in a transaction
accounted for under the purchase method of accounting. HB is a Toronto
based agency providing interactive and direct marketing advertising
services. HB has been recognized for its creative abilities, winning
several interactive advertising awards, and as such was acquired by the
Company to enhance the creative talent within the MDC Partners
Marketing Communications segment of businesses. On May 27, 2004, the
Company acquired a 50.1% ownership interest in Bruce Mau Design Inc.
("BMD") in a transaction accounted for under the purchase method of
accounting. BMD is a Toronto based design studio providing visual
identity and branding such as environmental graphics, exhibition
development and design, and cultural and business programming services.
BMD is world-renowned, working with internationally acclaimed
architects and leading cultural and commercial enterprises and as such
was acquired by the Company to add a new aspect to the creative talent
within the Marketing Communications segment of businesses. During the
quarter ended June 30, 2004, the Company also acquired the following
interests in three smaller agencies: a 49.9% interest in Mono
Advertising LLC ("Mono"), a 51% interest in Hello Design, LLC and a 51%
interest in Banjo, LLC. These agencies provide advertising, interactive
direct marketing, and film production related marketing communications
services, respectively. These transactions were all accounted for under
the purchase method of accounting. Subsequently, these acquisitions are
consolidated from the date of acquisition with the exception of Mono,
which is accounted for under the equity method.
During the quarter-ended June 30, 2004, in aggregate, the Company paid
and will pay $4,194 in cash, issued warrants to purchase 90,000 shares
of the Company's common stock to certain selling interestholders of
certain businesses (valued at approximately $360 using the
Black-Scholes option-pricing model assuming a 40% expected volatility,
a risk free interest rate of 3.3% and an expected option life of 3
years) and incurred transaction costs of approximately $275 for these
acquisitions completed during the quarter ended June 30, 2004. Under
the terms of the Mono, Hello Design, LLC, and BMD agreements, the
selling interest holders could receive additional cash and/or share
consideration after two to three years based on achievement of certain
pre-determined cumulative earning targets. Based on current earning
levels, the additional consideration would be $0.1 million. Such
contingent consideration will be accounted for as goodwill when it
becomes determinable.
The aggregate purchase price of the net assets acquired in these
transactions was approximately $4,829. The purchase price was allocated
to the fair value of the net tangible assets acquired of this purchase
price, $1,278 was allocated to goodwill and nil to intangible assets.
The allocation of the purchase price to assets acquired and liabilities
assumed is based on preliminary estimates of fair value and certain
assumptions that the Company believes are reasonable under the
circumstances and will be adjusted in a subsequent period upon
finalization of such estimates and assumptions. During this period, the
aggregated operations of these acquisitions did not have a material
effect on the Company's results of operations.
36
The following unaudited pro forma results of operations of the Company
for the periods ended June 30, 2004 and 2003, respectively, assume that
the acquisition of the operating assets of the businesses acquired
during the first six months of 2004 had occurred on January 1, 2004 and
2003, respectively. These unaudited pro forma results are not
necessarily indicative of either the actual results of operations that
would have been achieved had the companies been combined during these
periods, or are they necessarily indicative of future results of
operations. The unaudited pro forma results may also require adjustment
pending finalization of the purchase price allocation to the assets and
liabilities acquired.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
(Restated - See Note 2) (Restated - See Note 2)
Revenues $ 76,186 $ 86,900 $ 151,146 $ 179,150
Net income 963 18,035 9,557 19,117
Earnings per share:
Basic - net income $ 0.04 $ 1.07 $ 0.47 $ 1.13
Diluted - net income $ 0.04 $ 0.82 $ 0.43 $ 0.89
10. VARIABLE INTEREST ENTITIES
In December 2003, the FASB issued Interpretation No. 46 "Consolidation
of Variable Interest Entities Revised" ("FIN 46R"), which addresses how
a business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting rights,
and accordingly, whether it should consolidate the entity. The Company
was required to apply FIN 46R to such variable interest entities
("VIEs") commencing with the quarter ended March 31, 2004. In addition,
the Company is required, upon the occurrence of certain triggering
events, to reconsider whether an entity is a VIE.
Based upon a review of the provisions of FIN 46R, the Company has
identified Banjo, a business in which the Company acquired a majority
voting interest in the second quarter of 2004, as a variable interest
entity for which the Company is the primary beneficiary. In addition,
the Company has also identified an investee in which the Company has a
45% interest, as a variable interest entity for which the Company is
the primary beneficiary, thereby requiring consolidation for the three
months ended June 30, 2004. To June 30, 2004, the Company has funded
$680 towards this start-up venture to finance the development of
proprietary content-driven marketing material. The venture, which
commenced operations in the second quarter of 2004, has no significant
assets or liabilities and no revenues, and amounts expended by the
venture have been principally in respect of salaries and related costs,
and general and other operating costs.
11. GAIN ON SALE OF ASSETS AND SETTLEMENT OF LONG-TERM DEBT
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
(Restated - (Restated - See Note 2)
See Note 2)
Fair value adjustment on
embedded derivative $ -- $ -- $ (3,974) $ --
Loss on settlement of exchangeable
debentures -- -- (9,569) --
Gain (loss) on sale of assets (73) (1,344) (73) (1,344)
Loss on settlement of long-term debt -- (4,908) -- (4,908)
Gain on sale of equity interest in
Custom Direct Inc. -- 50,877 21,906 50,877
-------- -------- -------- --------
($ 73) $ 44,625 $ 16,238 $ 44,625
======== ======== ======== ========
37
In February 2004, the Company sold its remaining 20% interest in Custom
Direct Income Fund (the "Fund") through the exchange of its interest in
the Fund for the settlement of the adjustable rate exchangeable
debentures issued on December 1, 2003 with a face value of $26,344.
Based on the performance of the Fund for the period ended December 31,
2003, the Company was entitled to exchange its shares of Custom Direct,
Inc. for units of the Fund. On February 13, 2004, the adjustable rate
exchangeable debentures were exchanged for units of the Fund in full
settlement of the adjustable rate exchangeable debentures.
The embedded derivative within the exchangeable debentures had a fair
value of nil at the date of issuance and an unrealized loss of $3,974
as at December 31, 2003. At the date of settlement, the fair value of
the CDI Units for which the debentures were exchangeable was $33,991
which exceeded the issue price of the debentures by $7,647. The total
loss on settlement of the exchangeable debenture of $9,569 includes
$1,922 in respect of the write off of unamortized deferred financing
costs.
From January 1, 2004 to the date of settlement, the accrued loss on the
derivative increased by $3,673 to a total of $7,647 at the date of
settlement. The fair value adjustment for the six months ended June 30,
2004 represents the increase to the accrued loss net of the amount
realized on settlement. The fair value of the units of the Fund on
February 13, 2004 received by the Company exceeded the Company's equity
carrying value of the 20% interest in Custom Direct, Inc., of $12,085,
accordingly the Company recognized a gain on the sale of the CDI equity
of $21,906.
In the second quarter of 2003, the Company completed an Initial Public
Offering ("IPO") of the Custom Direct Income Fund ("the Fund") and sold
80% of its interest in Custom Direct Inc. to the Fund for cash and
units of the Fund representing an 18.9% interest. Such units were sold
in July 2003 for cash consideration equivalent to the IPO price per
share. On June 30, 2003, the Company completed the repurchase of the
remaining 10.5% senior subordinated notes for 103.5% of the face value
of the notes, resulting in a loss on redemption of $4,908, including
the writeoff of $1,672 of unamortized deferred financing costs.
12. SUBSEQUENT EVENT
In July 2004, the Company acquired a 68% ownership interest in Vitro
Robertson, LLC in a transaction to be accounted for under the purchase
method of accounting. The agency's expertise is in brand market share
management. As part of the acquisition, the Company paid $7.0 million
in cash and will issue common stock with a fair value of valued at $0.5
million to the selling interestholders. Transaction costs of
approximately $0.2 million are also expected to be incurred. Under the
terms of this acquisition agreement, the selling interestholders could
receive additional cash and/or share consideration after two years
based upon achievement of certain predetermined cumulative earnings
targets. Based on current earnings levels, the additional consideration
would be nil.
38
13. SHARE CAPITAL
Changes to the Company's issued and outstanding share capital during
the six months ended June 30, 2004 are as follows:
Class A Shares Amount
----------- -----------
Balance, January 1, 2004 18,369,451 $ 115,861
Shares acquired and cancelled pursuant to a normal course issuer bid (423,200) (3,305)
Share options exercised 175,821 1,836
Shares issued - private placement 120,919 1,409
Shares issued - acquisitions (Note 9) 985,194 14,951
Shares issued upon conversion of Class B shares 447,968 134
Shares issued on settlement of convertible notes 2,582,027 34,919
----------- -----------
Balance, June 30, 2004 22,258,180 165,805
----------- -----------
Class B
Balance, January 1, 2004 450,470 135
Shares converted to Class A shares (447,968) (134)
----------- -----------
Balance, June 30, 2004 2,502 1
----------- -----------
Total Class A and Class B share capital 22,260,682 $ 165,806
=========== ===========
During the six months ended June 30, 2004, the Company acquired and
cancelled, pursuant to a normal course issuer bid, 423,200 Class A
subordinate voting shares for $5,117. The premium paid on the
repurchase of the Class A subordinate voting shares, in the amount of
$1,812, was charged to retained earnings.
During the second quarter of 2004, the Company amended its share
appreciation rights ("SAR") plan to amend the method of settlement from
cash exclusively to cash or equity settlement at the option of the
Company. The amendment caused the existing SAR awards to be modified,
triggering a remeasurement date for accounting purposes. The
modification is accounted for as a settlement of the old awards through
the issuance of new awards. As a result, the Company measured the
settlement value of the SARs immediately prior to the modification date
and adjusted the previously accumulated amortized expense and liability
based on the revised calculation. The settlement value of $6,142 was
reclassed from accounts payable and accrued liabilities to Additional
paid-in capital and the adjustment to the accumulated expense resulted
in a recovery of $2,591. The Company then measured the fair value of
the equity settleable SAR awards using the Black-Scholes option pricing
model on the date of modification. The excess of the fair value
calculated using the Black-Scholes option pricing model over the
settlement value of $5,046 will be accounted for as additional
compensation expense over the remaining vesting period of the SAR
awards.
On May 5, 2004, the Company settled in full the $34,919 (Canadian
$48,000) of 7% Convertible Notes with the issuance of 2,582,027 Class A
subordinate voting shares.
On March 17, 2004, the Company completed a private placement issuing
120,919 shares at an average price of $11.65 per share and issuing
120,919 warrants with exercise prices ranging from Canadian $15.72 to
Canadian $19.13 and expiring in March 2009. The Company undertook the
private placement as a means to provide the Company's Board of
Directors and potential Board members the ability to increase their
share holdings in the Company in order to further align their interests
with those of the Company. As a result of the offering, a stock-based
compensation charge in the amount of $1.0 million was taken in the
first quarter to account for the fair value of the benefits conveyed to
the recipients of the awards on the granting of warrants and the
issuing of shares at a price less than the trading value on the day of
issuance.
39
On February 26, 2004 the Company's then controlling shareholder, Miles
S. Nadal (the Company's Chairman and Chief Executive Officer) gave
formal notice to the Company's Board of Directors that he had initiated
the process to effect conversion of 100% of his Class B multiple voting
shares into Class A Subordinate Voting Shares on a one-for-one basis,
without any cash or non-cash consideration. The conversion was
completed during the first quarter of 2004. Mr. Nadal's equity interest
in the Company prior to the conversion was approximately 20.2%, and he
controlled 44.9% of the voting rights attached to the corporation.
Prior to the conversion Mr. Nadal owned 447,968 Class B multiple voting
shares, which represented 99% of the Class B shares and carry 20 votes
per share, in addition to 3,400,351 Class A subordinate voting shares,
which carry one vote per share. After the conversion, both Mr. Nadal's
equity interest and voting interest in the Company are approximately
20.2%, or 3,848,319 Class A subordinated voting shares.
Additional paid-in capital increased during the six months ended June
30, 2004 from $4,312 to $14,547 due primarily to the amendment of the
SARs during the period in the amount of $7,399 and an amount of $2,836
related to compensatory stock options and warrants granted during the
period.
Share option transactions during the six months ended June 30, 2004 are
summarized as follows:
Options Outstanding Options Exercisable
------------------------------- ----------------------------
Weighted
Number Average Price Number Price per
Outstanding per Share Outstanding Share
----------- --------- ----------- -----
Balance, beginning of period 2,066,728 $ 6.60 870,979 $ 7.82
Granted 69,052 11.48
Exercised (175,821) 10.44
Expired and cancelled (18,955) 12.03
----------
Balance, end of period 1,941,004 $ 6.19 986,661 $ 6.77
==========
Shares options outstanding as at June 30, 2004 are summarized as
follows:
Options Outstanding Options Exercisable
--------------------------------------------- ------------------------------
Weighted
Average Weighted
Range of Outstanding Weighted Average Price per Exercisable Average Price
Exercise Prices Number Contractual Life Share Number per Share
--------------- ------ ---------------- ----- ------ ---------
$2.89 - $4.50 770,474 3.3 $ 4.01 319,907 $ 3.99
$4.51 - $6.00 523,010 3.9 $ 5.44 219,594 $ 5.45
$6.01 - $9.00 355,055 4.5 $ 7.26 287,046 $ 7.35
$9.01 - $15.30 278,992 4.1 $10.52 146,641 $10.44
$22.50 - $42.50 13,473 1.0 $41.61 13,473 $41.61
40
Warrants issued and outstanding as of June 30, 2004 are as follows:
Class A Stock
Warrants
--------
Balance at December 31, 2002 --
Warrants issued (a) 507,146
---------
Balance at December 31, 2003 507,146
Warrants issued (b) 736,186
---------
Balance at June 30, 2004 1,243,332
=========
(a) During the year ended December 31, 2003, the Company issued 507,146
warrants with a weighted average exercise price of Canadian $14.28 and
terms of two to five years. These warrants were issued as compensation
to a lender and to an advisor.
(b) During the six months ended June 30, 2004, the Company issued 736,186
warrants with a weighted average exercise price of Canadian $17.66 and
a term of five years. Of these warrants, 496,013 were issued as
acquisition consideration and 240,173 were issued as compensation and
treated as such for accounting purposes.
14. COMMITMENTS AND CONTINGENCIES
In addition to the consideration paid by the Company in respect of its
acquisitions, additional consideration may be payable based on the
achievement of certain threshold levels of earnings. Should the current
level of earnings be maintained by these acquired companies, additional
consideration of approximately $1 million could be owing in 2004 and
2007, of which approximately $0.9 million could be payable in shares of
the Company at the Company's discretion.
Owners of interests in certain of the Company's subsidiaries and
investments have the right in certain circumstances to require the
Company to purchase additional ownership stakes. The exercise of these
rights at their earliest contractual date would result in obligations
of the Company to fund related amounts during the period 2004 to 2010.
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, and the growth rate of the earnings of the
relevant subsidiary during the period. The Company has not received any
notices to exercise such rights that are not currently reflected on the
Company's balance sheet.
Under the terms of a joint venture agreement to develop a certain
marketing communications product concept, the Company has committed to
fund up to $1.2 million in 2004. As of June 30, 2004, the Company has
funded $0.7 million.
The Company has agreed to provide to its Chairman, President and Chief
Executive Officer a bonus of Canadian $10 million in the event that the
market price of the Company's Class A subordinate voting shares is
Canadian $30 per share or more for more than 20 consecutive trading
days. The after tax proceeds of such bonus are to be applied first as
repayment of any outstanding loans due to the Company from this
officer, and his related companies in the amount of $5,113 (Cdn$6,820)
and $2,249 (Cdn$3,000) respectively, as at June 30, 2004, both of which
have been fully provided for in the Company's accounts.
In connection with certain dispositions of assets and/or businesses in
2001 and 2002, 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
relate to a liability retained by the Company. These types of
indemnification guarantees typically extend for a number of years.
41
In connection with the sale of the Company's investment in CDI, the
amounts of indemnification guarantees were limited to the total sale
price of approximately $84 million . For the remainder, the Company's
potential liability for these indemnifications are not subject to a
limit as the underlying agreements do not always specify a maximum
amount and the amounts are dependent upon the outcome of future
contingent events.
Historically, the Company has not made any significant indemnification
payments under such agreements and no amount has been accrued in the
accompanying consolidated financial statements with respect to these
indemnification guarantees. The Company continues to monitor the
conditions that are subject to guarantees and indemnifications to
identify whether it is probable that a loss has occurred, and would
recognize any such losses under any guarantees or indemnifications in
the period when those losses are probable and estimable.
For guarantees and indemnifications entered into after January 1, 2003,
in connection with the sale of the Company's investment in CDI, the
Company has estimated the fair value of its liability, which was
insignificant, and included such amount in the determination of the
gain or loss on the sale of the business.
15. CANADIAN GAAP RECONCILIATION
During the third quarter of fiscal 2003, the Company changed its
reporting currency from Canadian dollars to US dollars. The comparative
financial information for the three months and six months ended June
30, 2003 prepared under Canadian GAAP included in this reconciliation
differ from amounts previously reported as a result of the change in
reporting currency to US dollars and the impact of the adjustments
recorded in connection with the restatement described in Note 2. The
change in reporting currency had no impact on the measurement of
earnings under Canadian GAAP. Under Canadian securities requirements,
the Company is required to provide a reconciliation setting out the
differences between US and Canadian GAAP as applied to the Company's
financial statements for the interim periods and years ended in the
fiscal periods for 2004 and 2005.
The Company has restated its consolidated financial statements,
prepared in accordance with Canadian GAAP, as at and for the year ended
December 31, 2003, 2002, and 2001, the effect of which is described in
the Company's restated 2003 Annual Report filed on Form 40-F/A. The
Company has also restated its interim unaudited condensed consolidated
financial statements prepared in accordance with US GAAP, as described
in Note 2. As a result of these errors the Company has also restated
its Canadian GAAP reconciliation as follows: (i) to correct the
adjustment for "Proportionate Consolidation of Affiliates" for the
three months and six months ended June 30, 2004 and 2003 and as at June
30, 2004 and December 31, 2003 to now include the Company's
proportionate share of the financial position, results of operation and
cash flows of Accumark, a joint venture for Canadian GAAP purposes.
(See Note 2, Item 7(c)) and a joint venture owning rental property (See
Note 2, item 7(a)); and (ii) to correct the adjustment in respect of
derivatives as at December 31, 2003 and for the six months ended June
30, 2004, in respect of the fair value adjustment for the embedded
derivative in the Company's exchangeable debentures. (See Note 2, Item
3).
The reconciliation from US to Canadian GAAP, of the Company's results
of operations for the three months and six months ended June 30, 2004
and 2003, the Company's financial position as at June 30, 2004 and
December 31, 2003 are set out below:
42
Convertible Notes - 2003 Adjustments
Under US GAAP, the convertible notes are classified entirely as debt.
Accordingly, interest expense is recorded based upon the effective
interest rate associated with the underlying debt.
Under Canadian GAAP, in accordance with EIC 71, the Company has
classified the convertible notes as equity as the Company has the
ability and intent to satisfy the obligation on redemption or maturity
in freely tradeable Class A shares. Under Canadian GAAP, the Company
has recorded an amount in long-term and current debt representing the
present value of the future interest payments owing on the convertible
debt. The interest in respect of the convertible debt is recorded as a
credit on account of the equity portion of the compound financial
instrument such that the equity component is accreted to the face of
the convertible debt upon maturity.
This difference results in a reclassification on the balance sheet
between long-term debt and equity, and a reduction in the interest
expense for the amount of the accretion that is not expensed for
Canadian GAAP purposes.
Convertible Notes - 2004 Adjustments
During the quarter ended June 30, 2004, the notes were converted to
equity. Therefore, the adjustments reflected in 2004 pertain only to
the interest adjustment up to the date of conversion and the
accumulated reclassification from retained earnings to share capital.
Proportionate Consolidation of Affiliate - 2004 and 2003 Adjustment
Under US GAAP, joint ventures in which the Company has joint control
are accounted for under the equity method. Under Canadian GAAP, joint
ventures are accounted for on the proportionate consolidation method
whereby the Company consolidates on a line-by-line basis their interest
in the financial position and results of operations and cash flows of
the joint venture.
Exchangeable Debentures
Under Canadian GAAP, EIC 117 prohibits the bifurcation of the embedded
derivative in the Exchangeable debentures. In addition under EIC 56,
until such time as the exchange right is no longer contingent upon
future events, no adjustment to the carrying value of the debentures
are necessary. In February 2004, the debentures became Exchangeable for
CDI units and at that time the carrying value of the debenture was
required to be increased by $7,647 to reflect the underlying market
value of the CDI units, for which the debentures are exchangeable, with
a corresponding change to earnings.
Under US GAAP, the Company must recognize in earnings each period the
changes in the fair value of the embedded derivative within the
contingently exchangeable debentures and such amount cannot be
deferred. This results in a loss on the derivative of $3,974 in the
fourth quarter of 2003 and a further loss in the first quarter of 2004
of $3,673 immediately prior to settlement.
As a result of this difference, under Canadian GAAP, net income in the
first quarter of 2004 is lower than that reported under US GAAP by
$3,974, being loss on the embedded derivative recognized in the prior
period.
Stock-based Compensation - 2004 Adjustment
Under US GAAP, the Company accounted for the modification of the SAR
awards as a settlement, measuring the incremental value of the awards
based on the fair value of the modified awards on the date of
modification. Under Canadian GAAP, the Company measures the incremental
value based on the fair value of the award on the date of grant. The
difference in measurement date results in a lower amount of additional
compensation recorded under Canadian GAAP in the quarter and a
corresponding lower amount credited to Additional paid-in capital.
43
Goodwill Charges
Historically, under US GAAP, the Company expensed as incurred certain
costs related to existing plant closures where production was shifted
to acquired facilities. Historically, under Canadian GAAP, the
expenditures were accrued as part of the business acquired and
allocated to goodwill. Accordingly the timing of the recognition of
such costs in the statement of operations is different under Canadian
GAAP. The resulting gain on sale of such assets in the six months ended
June 30, 2004 is lower under Canadian GAAP than under US GAAP by
$2,780.
Other Adjustments
Other adjustments represent cumulative translation differences as a
result of timing differences between recognition of certain expenses
under US and Canadian GAAP. Accumulated other comprehensive income
under US GAAP represents the cumulative translation adjustment account,
the exchange gains and losses arising from the translation of the
financial statements of self sustaining foreign subsidiaries under
Canadian GAAP.
THREE MONTHS ENDED JUNE 30, 2004
(thousands of United States dollars)
Stock-based
Compensation
and Proportionate
US Convertible Consolidation of Canadian
GAAP Notes Affiliates GAAP
---- ----- ---------- ----
(Restated - (Restated) (Restated)
See Note 2)
Revenue:
Services $ 58,327 $ -- $ 7,263 $ 65,590
Products 17,233 -- -- 17,233
-------- -------- -------- --------
75,560 -- 7,263 82,823
-------- -------- -------- --------
Operating Expenses:
Cost of products sold 10,386 -- -- 10,386
Salary and related costs 31,099 (945) 2,850 33,004
General and other operating costs 27,654 -- 1,848 29,502
Depreciation and amortization 3,028 -- 182 3,210
-------- -------- -------- --------
72,167 (945) 4,880 76,102
-------- -------- -------- --------
Operating Profit 3,393 945 2,383 6,721
-------- -------- -------- --------
Other Income (Expenses):
Gain (loss) on sale of assets (73) -- -- (73)
Foreign exchange gain 288 -- -- 288
Interest expense (2,315) 197 (95) (2,213)
Interest income 50 -- 9 59
-------- -------- -------- --------
(2,050) 197 (86) (1,939)
-------- -------- -------- --------
Income Before Income Taxes, Equity in
Affiliates and Minority Interests 1,343 1,142 2,297 4,782
Income Taxes (Recovery) (589) -- 863 274
-------- -------- -------- --------
Income Before Equity in Affiliates
and Minority Interests 1,932 1,142 1,434 4,508
Equity in Affiliates 1,343 -- (1,434) (91)
Minority Interests (2,343) -- -- (2,343)
-------- -------- -------- --------
Net Income $ 932 $ 1,142 $ -- $ 2,074
======== ======== ======== ========
44
SIX MONTHS ENDED JUNE 30, 2004
(thousands of United States dollars)
Stock-based
Compensation
and Embedded Proportionate
US Convertible Derivative and Consolidation Canadian
GAAP Notes Goodwill Charges of Affiliates GAAP
---- ----- ---------------- ------------- ----
(Restated - (Restated) (Restated) (Restated)
See Note 2)
Revenue:
Services $ 110,285 $ -- $ -- $ 13,840 $ 124,125
Products 35,270 -- -- -- 35,270
--------- --------- --------- --------- ---------
145,555 -- -- 13,840 159,395
--------- --------- --------- --------- ---------
Operating Expenses:
Cost of products sold 21,561 -- -- -- 21,561
Salary and related costs 67,370 (945) -- 5,173 71,598
General and other operating costs 53,368 -- -- 3,426 56,794
Depreciation and amortization 5,573 -- -- 300 5,873
--------- --------- --------- --------- ---------
147,872 (945) -- 8,899 155,826
--------- --------- --------- --------- ---------
Operating Profit (Loss) (2,317) 945 -- 4,941 3,569
--------- --------- --------- --------- ---------
Other Income (Expenses):
Gain on sale of assets 16,238 -- (6,754) -- 9,484
Foreign exchange gain 458 -- -- -- 458
Interest expense (5,089) 718 -- (182) (4,553)
Interest income 471 -- -- 8 479
--------- --------- --------- --------- ---------
12,078 718 (6,754) (174) 5,868
--------- --------- --------- --------- ---------
Income Before Income Taxes, Equity
in Affiliates and Minority
Interests 9,761 1,663 (6,754) 4,767 9,437
Income Taxes (Recovery) (392) -- -- 1,792 1,400
--------- --------- --------- --------- ---------
Income Before Equity in Affiliates
and Minority Interests 10,153 1,663 (6,754) 2,975 8,037
Equity in Affiliates 2,884 -- (2,975) (91)
Minority Interests (3,640) -- -- -- (3,640)
--------- --------- --------- --------- ---------
Net Income $ 9,397 $ 1,663 ($ 6,754) $ -- $ 4,306
========= ========= ========= ========= =========
45
AS AT JUNE 30, 2004
(thousands of United States dollars)
Stock-based
Compensation
and Proportionate
US Convertible Consolidation Canadian
GAAP Notes of Affiliates GAAP
---- ----- ------------- ----
(Restated - (Restated) (Restated)
See Note 2)
Current Assets
Cash and cash equivalents $ 48,069 $ -- $ 5,636 $ 53,705
Accounts receivable, net 99,225 -- 12,540 111,765
Expenditures billable to
clients 7,159 -- 8,767 15,926
Inventories 8,459 -- -- 8,459
Prepaid expenses and other
current assets 6,086 -- 413 6,499
--------- --------- --------- ---------
Total Current Assets 168,998 -- 27,356 196,354
Fixed Assets, net 45,163 -- 5,940 51,103
Investment in Affiliates 22,875 -- (20,796) 2,079
Goodwill 122,237 -- 18,509 140,746
Intangibles 3,520 -- -- 3,520
Deferred Tax Assets 11,381 -- 228 11,609
Other Assets 7,606 -- 18 7,624
--------- --------- --------- ---------
Total Assets $ 381,780 $ -- $ 31,255 $ 413,035
========= ========= ========= =========
Current Liabilities
Accounts payable $ 74,724 $ -- $ 7,991 $ 82,715
Accruals and other liabilities 50,446 -- 8,764 59,210
Advance billings 21,557 -- 9,808 31,365
Current portion of long-term
debt 36,835 -- 109 36,944
Deferred acquisition
consideration 791 -- -- 791
--------- --------- --------- ---------
Total Current Liabilities 184,353 -- 26,672 211,025
Long-Term Debt 45,064 -- 3,784 48,848
Other Liabilities 502 -- 799 1,301
--------- --------- --------- ---------
Total Liabilities 229,919 -- 31,255 261,316
--------- --------- --------- ---------
Minority Interests 2,040 -- -- 2,040
--------- --------- --------- ---------
Shareholders' Equity
Share capital 165,806 1,296 -- 167,102
Share capital to be issued 3,909 -- -- 3,909
Additional paid-in capital 14,903 (945) -- 13,958
Retained earnings (deficit) (31,584) (351) -- (31,935)
Accumulated other
comprehensive income (loss) (3,213) -- -- (3,213)
--------- --------- --------- ---------
Total Shareholders' Equity 149,821 -- -- 149,821
--------- --------- --------- ---------
Total Liabilities and
Shareholders' Equity $ 381,780 $ -- $ 31,255 $ 413,035
========= ========= ========= =========
46
SIX MONTHS ENDED JUNE 30, 2004
(thousands of United States dollars)
Stock-based
Compensation, Proportionate
US Convertible Consolidation Canadian
GAAP Notes and Other of Affiliates GAAP
---- --------------- ------------- ----
(Restated - (Restated) (Restated) (Restated)
See Note 2)
Operating Activities
Net income $ 9,397 $ 5,091 $ -- $ 4,306
Stock-based compensation 4,999 (945) -- 4,054
Depreciation and amortization 5,573 -- 300 5,873
Amortization and write-off of
deferred finance charges 3,063 -- -- 3,063
Deferred income taxes 510 -- -- 510
Foreign exchange (458) -- -- (458)
Gain on sale of assets (18,160) 6,754 -- (11,406)
Earnings of affiliates, net of
distributions 1,729 -- (1,206) 523
Minority interest and other 97 -- -- 97
Changes in non-cash working capital (7,093) -- 1,688 (5,405)
-------- -------- -------- --------
(343) 718 782 1,157
-------- -------- -------- --------
Investing activities
Capital expenditures (8,065) -- (471) (8,536)
Acquisitions, net of cash
acquired (5,739) -- (226) (5,965)
Other assets, net 349 -- (68) 281
-------- -------- -------- --------
(13,455) -- (765) (14,220)
-------- -------- -------- --------
Financing activities
Proceeds from issuance of long-
term debt 2,007 -- -- 2,007
Repayment of long-term debt (4,185) (718) (52) (4,955)
Issuance of share capital 3,245 -- -- 3,245
Purchase of share capital (5,117) -- -- (5,117)
-------- -------- -------- --------
(4,050) (718) (52) (4,820)
-------- -------- -------- --------
Foreign exchange effect on cash and
cash equivalents (12) -- -- (12)
-------- -------- -------- --------
Net increase (decrease) in cash
and cash equivalents (17,860) -- (35) (17,895)
Cash and cash equivalents
beginning of period 65,929 -- 5,671 71,600
-------- -------- -------- --------
Cash and cash equivalents
end of period $ 48,069 $ -- $ 5,636 $ 53,705
======== ======== ======== ========
47
THREE MONTHS ENDED JUNE 30, 2003
(thousands of United States dollars)
Convertible Proportionate
US Notes and Consolidation Canadian
GAAP Other of Affiliate GAAP
---- ----- ------------ ----
(Restated - (Restated) (Restated) (Restated)
See Note 2)
Revenue:
Services $ 42,744 $ -- $ 4,789 $ 47,533
Products 33,084 -- -- 33,084
-------- -------- -------- --------
75,828 -- 4,789 80,617
-------- -------- -------- --------
Operating Expenses:
Cost of products sold 14,932 -- -- 14,932
Salary and related costs 27,294 -- 1,765 29,059
General and other operating costs 28,642 -- 1,549 30,191
Depreciation and amortization 2,667 186 95 2,948
Write-down of fixed assets and other 8,126 -- -- 8,126
assets
Goodwill charges 10,012 -- -- 10,012
-------- -------- -------- --------
91,673 186 3,409 95,268
-------- -------- -------- --------
Operating Profit (Loss) (15,845) (186) 1,380 (14,651)
-------- -------- -------- --------
Other Income (Expense):
Gain on sale of assets and settlement of
long-term debt 44,625 (11,121) 101 33,605
Foreign exchange gain (loss) (876) -- -- (876)
Interest expense (5,461) 425 (75) (5,111)
Interest income 78 -- 10 88
-------- -------- -------- --------
38,366 (10,696) 36 27,706
-------- -------- -------- --------
Income Before Income Taxes, Equity in
Affiliates and Minority Interests 22,521 (10,882) 1,416 13,055
Income Taxes 5,936 57 526 6,519
-------- -------- -------- --------
Income Before Equity in Affiliates and
Minority Interests 16,585 (10,939) 890 6,536
Equity in Affiliates 1,229 -- (890) 339
Minority Interests (177) -- -- (177)
-------- -------- -------- --------
Net Income $ 17,637 ($10,939) $ -- $ 6,698
======== ======== ======== ========
48
SIX MONTHS ENDED JUNE 30, 2003
(thousands of United States dollars)
Convertible Proportionate
US Notes and Consolidation Canadian
GAAP Other of Affiliate GAAP
---- ----- ------------ ----
(Restated - See (Restated) (Restated) (Restated)
Note 2)
Revenue:
Services $ 80,526 $ -- $ 8,716 $ 89,242
Products 76,398 -- -- 76,398
--------- --------- --------- ---------
156,924 -- 8,716 165,640
--------- --------- --------- ---------
Operating Expenses:
Cost of products sold 33,439 -- -- 33,439
Salary and related costs 53,891 -- 3,484 57,375
General and other operating costs 55,922 -- 2,737 58,659
Depreciation and amortization 5,377 371 165 5,913
Write-down of fixed assets and other assets 8,126 -- -- 8,126
Goodwill charges 10,012 -- -- 10,012
--------- --------- --------- ---------
166,767 371 6,386 173,524
--------- --------- --------- ---------
Operating Profit (Loss) (9,843) (371) 2,330 (7,884)
--------- --------- --------- ---------
Other Income (Expense):
Gain on sale of assets and settlement of
long-term debt 44,625 (11,121) 101 33,605
Foreign exchange loss (1,531) -- -- (1,531)
Interest expense (10,338) 850 (142) (9,630)
Interest income 171 -- 26 197
--------- --------- --------- ---------
32,927 (10,271) (15) 22,641
--------- --------- --------- ---------
Income (Loss) Before Income Taxes, Equity
in Affiliates and Minority Interests 23,084 (10,642) 2,315 14,757
Income Taxes 5,910 212 863 6,985
--------- --------- --------- ---------
Income (Loss) Before Equity in Affiliates
and Minority Interests 17,174 (10,854) 1,452 7,772
Equity in Affiliates 1,791 -- (1,452) 339
Minority Interests (1,116) -- -- (1,116)
--------- --------- --------- ---------
Net Income $ 17,849 ($ 10,854) $ -- $ 6,995
========= ========= ========= =========
49
AS AT DECEMBER 31, 2003
(thousands of United States dollars)
Proportionate Embedded
US Convertible Consolidation of Derivative and Canadian
GAAP Notes Affiliate Other Adjustments GAAP
---- ----- --------- ----------------- ----
(Restated - (Restated) (Restated) (Restated)
See Note 2)
ASSETS
Current Assets
Cash and cash equivalents $ 65,929 $ -- $ 5,671 $ $ 71,600
Accounts receivable, net 58,864 -- 11,095 -- 69,959
Expenditures billable to clients 7,153 -- 3,183 -- 10,336
Inventories 7,735 -- -- -- 7,735
Prepaid expenses and other current assets 4,863 -- 180 -- 5,043
--------- --------- --------- --------- ---------
Total Current Assets 144,544 -- 20,129 -- 164,673
Fixed Assets, net 38,775 -- 5,839 -- 44,614
Investment in Affiliates 34,362 -- (22,159) 2,943 15,146
Goodwill 83,199 -- 18,580 -- 101,779
Deferred Tax Benefits 11,563 -- -- -- 11,563
Other Assets 9,096 -- 19 -- 9,115
--------- --------- --------- --------- ---------
Total Assets $ 321,539 $ -- $ 22,408 $ 2,943 $ 346,890
========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 38,451 $ -- $ 6,331 -- $ 44,782
Accruals and other liabilities 34,245 -- 10,579 -- 44,824
Advance billings 15,731 -- 573 -- 16,304
Current portion of long-term debt 16,378 2,160 108 -- 18,646
Deferred acquisition consideration 1,113 -- -- -- 1,113
--------- --------- --------- --------- ---------
Total Current Liabilities 105,918 2,160 17,591 -- 125,669
Long-Term Debt 95,970 -- 3,950 (3,974) 95,946
Convertible Notes 37,794 (33,011) -- -- 4,783
Other Liabilities 516 -- 867 -- 1,383
--------- --------- --------- --------- ---------
Total Liabilities 240,198 (30,851) 22,408 (3,974) 227,781
--------- --------- --------- --------- ---------
Minority Interests 2,432 -- -- -- 2,432
--------- --------- --------- --------- ---------
Shareholders' Equity
Share capital 115,996 1,296 -- -- 117,292
Share capital to be issued -- -- -- -- --
Additional paid-in capital 4,610 30,851 -- -- 35,461
Retained earnings (deficit) (39,169) (1,296) -- 6,754 (33,711)
Accumulated other comprehensive income
(loss) (2,528) -- -- 163 (2,365)
--------- --------- --------- --------- ---------
Total Shareholders' Equity 78,909 30,851 -- 6,917 116,677
--------- --------- --------- --------- ---------
Total Liabilities and Shareholders' Equity $ 321,539 $ -- $ 22,408 $ 2,943 $ 346,890
========= ========= ========= ========= =========
50
SIX MONTHS ENDED JUNE 30, 2003
(thousands of United States dollars)
Proportionate
US Convertible Consolidation Other Canadian
GAAP Notes of Affiliate Adjustments GAAP
---- ----- ------------ ----------- ----
(Restated - (Restated) (Restated)
See Note 2)
Operating Activities
Net income $ 17,849 $ 539 $ -- ($11,393) $ 6,995
Stock-based compensation 975 -- -- -- 975
Depreciation and amortization 5,377 -- 165 371 5,913
Amortization and write-off of
deferred finance charges 2,892 -- -- -- 2,892
Non-cash interest 2,064 -- -- -- 2,064
Deferred income taxes 5,214 311 -- (99) 5,426
Foreign exchange 1,531 -- -- -- 1,531
Gain on sale of assets and settlement
of long-term debt (46,297) -- (101) 11,121 (35,277)
Write-down of fixed assets and
other assets 8,126 -- -- -- 8,126
Goodwill charges 10,012 -- -- -- 10,012
Earnings of affiliates, net of
Distributions (2,393) -- 2,685 -- 292
Minority interest and other (843) -- -- -- (843)
Changes in non-cash working capital 543 -- (4,200) -- (3,657)
-------- -------- -------- -------- --------
5,050 850 (1,451) -- 4,449
-------- -------- -------- -------- --------
Investing activities
Capital expenditures (7,559) -- (1,069) -- (8,628)
Proceeds of dispositions 83,474 -- -- -- 83,474
Other assets, net 2,845 -- (29) -- 2,816
-------- -------- -------- -------- --------
78,760 -- (1,098) -- 77,662
-------- -------- -------- -------- --------
Financing activities
Proceeds on issuance of long-term debt 11,439 -- -- -- 11,439
Repayment of long-term debt (87,517) (850) (45) -- (88,412)
-------- -------- -------- -------- --------
(76,078) (850) (45) -- (76,973)
-------- -------- -------- -------- --------
Foreign exchange effect on cash and
cash equivalents 2,082 -- -- -- 2,082
-------- -------- -------- -------- --------
Increase in cash and cash equivalents 9,814 -- (2,594) -- 7,220
Cash and cash equivalents
beginning of period 31,226 -- 6,211 -- 37,437
-------- -------- -------- -------- --------
Cash and cash equivalents
end of period $ 41,040 $ -- $ 3,617 $ -- $ 44,657
======== ======== ======== ======== ========
51
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (RESTATED)
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 2004 MEANS THE PERIOD BEGINNING JANUARY 1, 2004, AND
ENDING DECEMBER 31, 2004). THIS REPORT CONTAINS FORWARD LOOKING STATEMENTS
WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 WITH
RESPECT TO THE FINANCIAL CONDITION, RESULTS OF OPERATIONS, AND BUSINESS OF THE
COMPANY. THESE FORWARD LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND
UNCERTAINTIES. NO ASSURANCE CAN BE GIVEN THAT ANY OF SUCH MATTERS WILL BE
REALIZED. FACTORS THAT MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
CONTEMPLATED BY SUCH FORWARD LOOKING STATEMENTS INCLUDE, AMONG OTHERS, THE
FOLLOWING POSSIBILITIES: (1) COMPETITIVE PRESSURE IN THE COMPANY'S INDUSTRY
INCREASES SIGNIFICANTLY; (2) GENERAL ECONOMIC CONDITIONS ARE LESS FAVORABLE THAN
EXPECTED; (3) CHANGES IN THE FINANCIAL MARKETS AFFECTING THE COMPANY'S FINANCIAL
STRUCTURE AND THE COMPANY'S COST OF CAPITAL AND BORROWED MONEY; AND (4) THE
UNCERTAINTIES INHERENT IN INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY
FLUCTUATIONS. THE COMPANY HAS NO DUTY UNDER THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995 TO UPDATE THE FORWARD LOOKING STATEMENTS IN THIS QUARTERLY
REPORT ON FORM 10-Q AND THE COMPANY DOES NOT INTEND TO PROVIDE SUCH UPDATES.
The following discussion focuses on the operating performance of MDC Partners
Inc. (the "Company") for the three-month and six-month periods ended June 30,
2004 and 2003, and the financial condition of the Company as at June 30, 2004.
This analysis should be read in conjunction with the consolidated interim
financial statements presented in this interim report and the restated annual
audited consolidated financial statements and Management's Discussion and
Analysis presented in the Annual Report to Shareholders for the year ended
December 31, 2003 as reported on Form 40-F/A. All amounts are in US dollars
unless otherwise stated.
The Company has restated its consolidated financial statements and related
footnote disclosures to reflect (1) corrections in the recognition of
compensation expense on the privatization of Maxxcom, (2) corrections in the
timing of recognition and the classification of the amortization and write-off
of deferred financing fees, (3) the recognition of fair value adjustments
related to an embedded derivative in the Company's exchangeable securities, (4)
corrections in the timing and amounts recognized on the gain on sale of the
investment in Custom Direct Inc., (5) correction for the timing of recognition
and the classification of certain foreign exchange gains and losses on
intercompany balances, (6) corrections to revenue recognition related to certain
contract terms, (7) corrections to the accounting for certain investments, (8)
corrections to the purchase price allocations for certain business acquisitions
and the related amortization of identified intangible assets, (9) corrections in
the timing of the recognition of stock-based compensation, and (10) corrections
to the computation of the dilutive effect of convertible debentures on diluted
earnings per share.
Refer to Note 2 of the notes to the interim unaudited condensed consolidated
financial statements included herein which discloses the adjustments to the
Company's consolidated financial statements resulting from these restatements.
The effects of these restatements have been reflected in corresponding
corrections to the Management Discussion and Analysis in this Form 10-Q/A. This
Form 10-Q/A does not reflect events occurring after the original filing date of
the Form 10-Q.
52
COMBINED REVENUE, OPERATING COSTS AND OPERATING PROFITS
Many of the Company's marketing communications businesses have significant other
interestholders and in some cases, the Company operates the business in a
fashion similar to a joint venture with these other interestholders. The
Company's management oversees the businesses as active managers rather than a
passive investor, reviewing all aspects of their operations with the management
of these businesses, regardless of the Company's ownership interest. Within the
marketing communications industry, the monitoring of operating costs, such as
salary and related costs, relative to revenues, among other things, are key
performance indicators. Consequently, the Company's management reviews, analyses
and manages these elements of the businesses as a whole, rather than just being
concerned with it as an investment. Management believes the presentation of the
whole of the Company's marketing communications business provides readers with a
complete view of all operations that significantly affect the Marketing
Communications reportable segment's profitability and allows readers to evaluate
the financial presentation reviewed by management in making business decisions.
Accumark Promotions Group Inc. owned 55% but not unilaterally controlled by the
Company and Crispin Porter + Bogusky, LLC, ("CPB"), owned 49.9% by the Company,
Cliff Freeman & Partners, LLC, 19.9% owned by the Company and Mono Advertising
LLC, 49.9% owned by the Company, are required to be equity accounted for under
US GAAP. Consequently, for purposes of the Management Discussion and Analysis,
100% of the results of operations of those entities which are required to be
equity accounted for under US GAAP have been combined with the other businesses
of the Marketing Communications reportable segment, and the alternate operating
results have been described as "Combined". These "Combined" results do not
constitute a financial measure prepared in accordance with US GAAP. A
reconciliation of "Combined" results of operations of the Marketing
Communications reportable segment to the GAAP reported results of operations has
been provided by the Company in the tables included in this Management
Discussion and Analysis.
53
RESULTS OF OPERATIONS:
FOR THE THREE MONTHS ENDED JUNE 30, 2004, AS RESTATED (1):
(thousands of United States dollars)
Combined As Reported under US GAAP
-------------- ---------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 73,669 $ 15,342 $ 58,327 $ 17,233 $ -- $ 75,560
-------- -------- -------- -------- -------- --------
Operating Expenses:
Cost of products sold -- -- -- 10,386 -- 10,386
Salary and related costs 34,897 7,414 27,483 3,370 246 31,099
General and other
operating costs 27,699 4,108 23,591 2,100 1,963 27,654
Depreciation and
Amortization 2,536 341 2,195 807 26 3,028
-------- -------- -------- -------- -------- --------
65,132 11,863 53,269 16,663 2,235 72,167
-------- -------- -------- -------- -------- --------
Operating Profit (Loss) $ 8,537 $ 3,479 $ 5,058 $ 570 ($ 2,235) 3,393
======== ======== ======== ======== ========
Other Income (Expense):
Loss on sale of assets (73)
Foreign exchange gain 288
Interest expense, net (2,265)
--------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 1,343
Income Taxes (Recovery) (589)
--------
Income Before Equity in Affiliates and Minority Interests 1,932
Equity in Affiliates 1,343
Minority Interests (2,343)
--------
Net Income $ 932
========
(1) Refer to Note 2 of the notes to the interim unaudited condensed
consolidated financial statements included herein, which disclose the
adjustments to the Company's interim unaudited condensed consolidated
financial statements.
54
FOR THE THREE MONTHS ENDED JUNE 30, 2003, AS RESTATED (1):
(thousands of United States dollars)
Combined As Reported under US GAAP
-------------- ----------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 51,594 $ 8,850 $ 42,744 $ 33,084 $ -- $ 75,828
-------- -------- -------- -------- -------- --------
Operating Expenses:
Cost of products sold -- -- -- 14,932 -- 14,932
Salary and related costs 23,523 3,521 20,002 5,683 1,609 27,294
General and other
operating costs 19,747 2,629 17,118 10,469 1,055 28,642
Depreciation and
amortization 1,587 138 1,449 1,081 137 2,667
Write-down of fixed assets
and other assets -- -- -- 8,126 -- 8,126
Goodwill charges -- -- -- 10,012 -- 10,012
-------- -------- -------- -------- -------- --------
44,857 6,288 38,569 50,303 2,801 91,673
-------- -------- -------- -------- -------- --------
Operating Profit (Loss) $ 6,737 $ 2,562 $ 4,175 ($17,219) ($ 2,801) (15,845)
======== ======== ======== ======== ========
Other Income (Expense):
Gain on sale of assets and settlement of long-term debt 44,625
Foreign exchange loss (876)
Interest expense, net (5,383)
--------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 22,521
Income Taxes 5,936
--------
Income Before Equity in Affiliates and Minority Interests 16,585
Equity in Affiliates 1,229
Minority Interests (177)
--------
Net Income $ 17,637
========
(1) Refer to Note 2 of the notes to the interim unaudited condensed
consolidated financial statements included herein, which disclose the
adjustments to the Company's interim unaudited condensed consolidated
financial statements.
55
FOR THE SIX MONTHS ENDED JUNE 30, 2004, AS RESTATED (1):
(thousands of United States dollars)
Combined As Reported under US GAAP
-------------- -------------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 138,101 $ 27,816 $ 110,285 $ 35,270 $ $ 145,555
--------- --------- --------- --------- --------- ---------
Operating Expenses:
Cost of products sold -- -- -- 21,561 -- 21,561
Salary and related costs 64,969 12,087 52,882 6,846 7,642 67,370
General and other
operating costs 52,453 6,932 45,521 4,501 3,346 53,368
Depreciation and
amortization 4,570 531 4,039 1,482 52 5,573
--------- --------- --------- --------- --------- ---------
121,992 19,550 102,442 34,390 11,040 147,872
--------- --------- --------- --------- --------- ---------
Operating Profit (Loss) $ 16,109 $ 8,266 $ 7,843 $ 880 ($ 11,040) (2,317)
========= ========= ========= ========= =========
Other Income (Expense):
Gain on sale of assets 16,238
Foreign exchange gain 458
Interest expense, net (4,618)
---------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 9,761
Income Taxes (392)
---------
Income Before Equity in Affiliates and Minority Interests 10,153
Equity in Affiliates 2,884
Minority Interests (3,640)
---------
Net Income $ 9,397
=========
(1) Refer to Note 2 of the notes to the interim unaudited condensed
consolidated financial statements included herein, which disclose the
adjustments to the Company's interim unaudited condensed consolidated
financial statements.
56
FOR THE SIX MONTHS ENDED JUNE 30, 2003, AS RESTATED (1):
(thousands of United States dollars)
Combined As Reported under US GAAP
-------------- --------------------------------------------------------------
Combined Secure
Marketing Less Equity Marketing Products Corporate &
Communications Affiliates Communications International Other Total
-------------- ---------- -------------- ------------- ----- -----
Revenue $ 96,586 $ 16,060 $ 80,526 $ 76,398 $ -- 156,924
--------- --------- --------- --------- --------- ---------
Operating Expenses:
Cost of products sold -- -- -- 33,439 -- 33,439
Salary and related costs 46,404 6,939 39,465 11,766 2,660 53,891
General and other
operating costs 36,364 4,580 31,784 22,519 1,619 55,922
Depreciation and
amortization 3,091 230 2,861 2,255 261 5,377
Write-down of fixed assets
and other assets -- -- -- 8,126 -- 8,126
Goodwill charges -- -- -- 10,012 -- 10,012
--------- --------- --------- --------- --------- ---------
85,859 11,749 74,110 88,117 4,540 166,767
--------- --------- --------- --------- --------- ---------
Operating Profit (Loss) $ 10,727 $ 4,311 $ 6,416 ($ 11,719) ($ 4,540) (9,843)
========= ========= ========= ========= =========
Other Income (Expense):
Gain on sale of assets and settlement of long-term debt 44,625
Foreign exchange loss (1,531)
Interest expense, net (10,167)
---------
Income Before Income Taxes, Equity in Affiliates and Minority Interests 23,084
Income Taxes 5,910
---------
Income Before Equity in Affiliates and Minority Interests 17,174
Equity in Affiliates 1,791
Minority Interests (1,116)
---------
Net Income $ 17,849
=========
(1) Refer to Note 2 of the notes to the interim unaudited condensed
consolidated financial statements included herein, which disclose the
adjustments to the Company's interim unaudited condensed consolidated
financial statements.
57
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003
Marketing Communications
Marketing Communications revenue on a Combined basis was $73.7 million in the
quarter, 43% more than the comparable $51.6 million reported in the second
quarter of 2003. The increase in the quarter's Combined revenue as compared to
the same quarter in 2003 primarily resulted from several significant new
business developments which originated in the first quarter of 2004, as
described below. The revenue growth is also a result of the acquisitions of
several businesses. During the first quarter of 2004, the Company acquired a
controlling interest in the integrated marketing communications group of
agencies of Kirshenbaum Bond + Partners, LLC and an equity interest in the
advertising agency Cliff Freeman + Partners LLC. During the second quarter of
2004 the Company acquired controlling interests in Henderson bas, an interactive
marketing agency, Mono Advertising LLC, an advertising agency, Hello Design, LLC
and Bruce Mau Design Inc., branding and design studios, and Banjo, LLC, a
production studio. These acquired operations contributed $17.1 million of
revenue on a Combined basis during the quarter. Excluding the revenue of these
acquisitions in 2004, Combined revenues increased 10% period over period. The
currency exchange rate effect of the strengthened Canadian dollar and Pound
Sterling, as compared to the same period in 2003, also contributed approximately
$0.7 million to the increase in revenues during this period. On a pro forma
basis, comparing a full three months of operations in both the second quarters
of 2004 and 2003 for the businesses operated by the Company on June 30, 2004,
Combined pro forma revenue would have improved by approximately 13% period over
period. This reflects significant pro forma Combined revenue growth in the US
businesses and significant revenue growth in the Canadian businesses. However,
the UK operations experienced a significant decrease in revenues during this
period, as compared to the second quarter in 2003. The growth in Combined pro
forma US revenues was driven by incremental revenues resulting from the
Company's equity accounted affiliate, Crispin Porter + Bogusky's new client,
Burger King, and from several new client wins at each of Kirshenbaum Bond +
Partners, the Bryan Mills Group, and Henderson bas. The UK operations
experienced declines in revenues from their technology industry based clients
while experiencing very little in new revenue additions.
The positive organic revenue growth, particularly in the US year over year, has
resulted in a shift in the geographic mix of Combined revenues. Of the Combined
revenue for the quarter, 78% was from the United States, 19% was derived from
Canada and 3% came from the United Kingdom. This compared to 72%, 22% and 6%,
respectively, in the second quarter of 2003.
During the second quarter of 2004, the Company's client base composition shifted
in several areas as compared to the same quarter in 2003. The Company
experienced a relative increase in spending by the consumer products,
information technology and telecommunications based clients, while financial,
and, to a lesser extent, media and healthcare based client revenues became a
relatively smaller component of Combined revenue in 2004 as compared to 2003. In
dollar terms, significant increases were noted in revenues from, consumer
product, telecommunications and service industry based clients. The composition
of revenues added due to business acquisitions in 2004, principally Kirshenbaum
Bond + Partners, was proportionately weighted more to the financial and service
industry based clients than the Combined revenues of the pre-existing
businesses, which contributed dollar revenues primarily from the consumer and
financial industries in particular.
Acquisitions in the first quarter did increase the dollar revenues and also the
proportionate share of revenues from advertising services, as compared to the
"below the line" services. For the second quarter of 2004, advertising services
Combined revenues represented approximately 45% of Combined revenues as compared
to 36% for the same period in 2003. Excluding the effects of the Kirshenbaum
Bond + Partners acquisition, advertising services would have increased to 38% in
the quarter, as the Company's existing operations obtained several new clients
during the quarter requiring advertising services.
58
Combined operating costs increased at a slightly higher pace than the 43% growth
in Combined revenues, increasing 45% during the quarter as compared to the same
quarter last year. While the "general and other operating" costs component grew
at only 40%, the staff costs increased at 48%. These relative changes are a
result of several factors. Firstly, if the effects of acquired businesses were
excluded from the Combined results, while revenues would have increased at 10%,
staff costs would have increased at 7% and "general and other operating" costs
would have increased 21%. The staff cost increases reflect some pricing
pressures primarily experienced by the Company's customer service center
operation, Accent Marketing Services. The increase in the "general and other
operating" costs beyond the growth rate of revenues was the result of several
factors. During the second quarter of 2004, the Company invested approximately
$0.7 million in the development of a new initiative. This venture relates to a
proprietary content-driven marketing initiative, which is still in the research
phase and is expected to continue in this phase through the third quarter of
2004. Also, the Company's operations expended an unusual amount on new business
development during the quarter, as the UK business in particular invested
significant resources into attracting new clients. Finally, Accent Marketing
Services expended significant costs expanding its customer service center
operations into near-shore and offshore facilities as it prepares for additional
business volumes and to maintain its competitive cost structure in the long run.
Excluding the effects in the quarter of the acquisitions, and the investments in
new ventures and new business, as described above, pro forma Combined operating
profits would have decreased 4% to $6.5 million, from $6.7 million, resulting in
pro forma Combined operating margins of approximately 11% in the second quarter
of 2004 and 13% during the same period in 2003. With the addition of Kirshenbaum
Bond + Partners and with the resulting impact of the factors affecting revenues
and operating costs, as discussed above, actual Combined operating income
improved by approximately 27% to $8.5 million from $6.7 million, quarter over
quarter, while operating margins were 11.6% for the quarter, as compared to 13.1
% in the same quarter last year.
Secure Products International
Revenues attributable to Secure Products International were $17.2 million for
the second quarter of 2004, representing a decrease of $15.9 million or 48%
compared to the $33.1 million recorded in the second quarter of 2003. The
decrease was primarily due to the divestiture of Custom Direct ("CDI") last year
as revenues from the remaining operations of Secure Products International
increased 27% or $3.7 million from $13.5 million in the second quarter of 2003.
Ashton Potter, the stamp operations, generated a 138% improvement in revenues
that related primarily to the USPS contract awarded in 2003. This improvement,
together with an increase in revenues from Placard, the Australian card
operation, and from Mercury Graphics, the Canadian ticketing business, were
partially offset by a decrease in revenues from Metaca, the Canadian card
operation.
Secure Products International reported operating costs of $16.7 million for the
second quarter, versus $50.3 million in the same quarter last year. Excluding
the impact of CDI, goodwill charges of $10.0 million and a charge related to the
write-down of fixed and other assets of $8.1 million from 2003, operating costs
increased $2.3 million or 16% compared to last year. However, operating costs
expressed as a percentage of revenue on the same basis, decreased to 96.7% from
106.7% last year. Cost of sales, salaries and related costs and depreciation of
the remaining operations of Secure Products International decreased as a
percentage of revenue in 2004 to 84.5% compared to 87.8% in the same period of
2003. General and other operating expenses also improved to 12.2% of revenue
from 18.1% of revenue in the 2003 second quarter.
As a result, actual operating profit earned by the Secure Products International
Division amounted to $0.6 million for the quarter ended June 30, 2004, compared
to a loss of $17.2 million in the same quarter of 2003. On a more comparative
basis, after adjusting the 2003 results to remove income from divested
operations, charges against goodwill and write-down of fixed assets and other
assets, the operating profit of the remaining Secure Products International
businesses improved by approximately $1.4 million as a result of increased
production at Ashton Potter and an improvement in profitability at Mercury
Graphics, partially offset by declines at Metaca. As a result of the decreased
revenues and operating profit generated by Metaca, management has commenced a
plan to reduce the cost structure and improve efficiencies. Severance and other
related charges of $0.2 million were recorded in the quarter.
59
Corporate and Other
Operating costs decreased from $2.8 million in the 2003 second quarter to $2.2
million this quarter primarily as a result of a recovery related to the
provision for stock-based compensation partially offset by an increase in
general and other costs. Excluding stock-based compensation, operating expenses
increased as a result of combining the corporate offices of MDC and Maxxcom Inc.
upon the privatization of Maxxcom Inc. in July 2003 and increased compliance
costs associated with US GAAP reporting and Sarbanes-Oxley legislation.
Gain on Sale of Affiliate and Settlement of Long-Term Debt
The loss on sale of assets was $0.1 million for the second quarter of 2004
compared to a net gain in 2003 of $44.6 million that primarily related to the
disposition of 80% of CDI through an income fund and the retirement of the
Company's remaining 10.5% senior subordinated notes.
Interest, Net
Net interest expense on a consolidated basis for the quarter, at $2.3 million,
was $3.1 million lower than in 2003, due to a decrease in interest expense
reflective of the second quarter redemption of the convertible debentures
through the issuance of Class A Subordinate Voting Shares and lower average
levels of indebtedness than in the prior year. Amortization of deferred finance
charges were $0.6 million in 2004 compared to $0.6 million in 2003. Interest
income was relatively unchanged compared to the second quarter of 2003.
Income Taxes
The income tax recovery recorded for the second quarter was $0.6 million,
compared to an expense of $6.0 million for the same period in 2003.
Income Before Equity In Affiliates and Minority Interests
For the quarter, income before equity in affiliates and minority interests was
$1.9 million versus $16.6 million in 2003, a decrease of $14.7 million due
primarily to the impact of asset dispositions in the second quarter of last
year, net of provisions taken against fixed and other assets and goodwill.
Equity in Affiliates
The income attributable to equity-accounted affiliate operations, principally
Crispin Porter + Bogusky LLC, was $1.3 million for the second quarter of 2004,
$0.1 million higher than the $1.2 million earned in the second quarter of 2003.
Minority Interests
Minority interest expense of Marketing Communications was $2.3 million for the
second quarter of 2004, an increase of $0.9 million compared to the same
prior-year quarter. In 2003, Secure Products International and Corporate and
Other had a minority interest recovery of $1.2 million related to Metaca and
Maxxcom, both of which are now wholly-owned.
Net Income
Net income for the quarter ending June 30, 2004 was $0.9 million versus $17.6
million in 2003.
60
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003
Marketing Communications
Marketing Communications revenue on a Combined basis was $138.1 million in the
first six months of 2004, 43% more than the comparable $96.6 million reported in
the first six months of 2003. The increase in the period's Combined revenue as
compared to the same quarter in 2003 resulted primarily from several significant
new client additions which originated in the first quarter of 2004, as described
below. The growth also resulted from the acquisition of several businesses. As
described above, during 2004, the Company acquired interests in Kirshenbaum Bond
+ Partners, LLC, and Cliff Freeman + Partners LLC, Henderson bas, Mono LLC,
Hello Design, LLC, Bruce Mau Design Inc. and Banjo, LLC. These acquired
operations contributed $24.5 million of revenue on a Combined basis during the
first six months of 2004. Excluding the revenue of these acquisitions in 2004,
Combined revenues would have increased 18% period over period. The currency
exchange rate effect of the strengthened Canadian dollar and Pound Sterling as
compared to the same period in 2003 also contributed approximately $2.5 million
to the increase in revenues during this period. On a pro forma basis, comparing
a full six months of operations in both the first six months of 2004 and 2003
for the businesses operated by the Company on June 30, 2004, pro forma Combined
revenue improved by approximately 14% period over period. This reflected very
significant pro forma Combined revenue growth in the US businesses and also
included significant revenue growth in the Canadian businesses, however, the UK
operations experienced a significant decrease in revenues during this period, as
compared to the first half of 2003. The growth in Combined pro forma US revenues
was driven by revenues derived from the Company's equity accounted affiliate,
Crispin Porter + Bogusky's new client, Burger King, and incremental revenues
resulting from several new client wins at Kirshenbaum Bond + Partners, increased
transaction volumes at Accent Marketing Services, the Bryan Mills Group investor
communications new initiatives, and Source Marketing's significant direct
marketing projects this year. The UK operations experienced declines in revenues
from their technology, and, to a lesser extent, financial industry based
clients, while experiencing very little in new revenue additions during 2004.
The positive organic growth particularly in the US year over year has resulted
in a shift in the geographic mix of Combined revenues. Of the Combined revenue
for the first six months, 78% was from the United States, 19% was derived from
Canada and 3% came from the United Kingdom. This compared to 72%, 22% and 6%,
respectively, in first half of 2003.
During the second quarter of 2004, the Company's client base composition shifted
in several areas as compared to the same quarter in 2003. The Company saw a
relative increase in spending by the consumer products, telecommunications and
information technology industry based clients, while healthcare, and, to a
lesser extent, media based client revenues became a relatively smaller component
of Combined revenue in 2004 as compared to 2003. In dollar terms, significant
increases were noted in revenues from consumer product, financial, service and
telecommunications industry based clients. The composition of revenues added due
to business acquisitions in the first half of 2004, principally Kirshenbaum Bond
+ Partners, was proportionately weighted more to the financial and service
industry based clients than the Combined revenues of the pre-existing
businesses, contributing dollar revenues primarily from the consumer and
financial industries in particular.
Acquisitions in the first half of 2004 did increase the dollar revenues and also
the proportionate share of revenues from advertising services as compared to the
"below the line" services. For the first half of 2004, advertising services
Combined revenues represented approximately 45% of Combined revenues as compared
to 36% for the same period in 2003. Excluding the effects of the KBP
acquisition, advertising services would have increased to 38% in the year to
date period, as the Company's existing operations obtained several new clients
during the period requiring advertising services.
61
Combined operating costs increased at a slower pace than the 43% growth in
Combined revenues, increasing 42% during the first half of 2004 as compared to
the same period in 2003. Of the operating costs components, Combined "general
and other operating" costs grew at 44% and while staff costs grew at only 40%.
These relative changes were a result of several factors. Firstly, if the effects
of acquired business were excluded from the Combined results, while revenues
would have increased at 18%, staff costs would have increased at 9% and "general
and other operating" costs would have increased 30%. The reduced staff cost pace
of growth relative to revenues reflects the rapid revenue growth in the first
quarter of 2004 that outpaced the ability of certain businesses to increase
staffing levels to the appropriate sustainable levels for the business volumes,
resulting in enhanced profitability during that period. The increase in the
"general and other operating" costs beyond the growth rate of revenues was the
result of several factors. During 2004, the Company invested approximately $1.4
million in the development of two new initiatives. During the second quarter of
2004, the Company invested in a new venture to develop a proprietary
content-driven marketing initiative, which is still in the research phase and is
expected to continue in this phase through the third quarter of 2004. The second
venture invested in during 2004, which will not continue beyond the second
quarter of 2004, was related to a possible expansion into a new geographic
market. A further cause of the increase in operating costs was the unusually
high amount expended on new business development during 2004, in particular by
the UK business, which invested significant resources into attracting new
clients. Finally, Accent Marketing Services expended significant costs to expand
its customer service center operations into near-shore and offshore facilities
as it prepares for additional business volumes and to maintain its competitive
cost structure in the long run.
Excluding the effects in the period of the acquisitions, and the investments in
new ventures and new business, as described above, pro forma Combined operating
profits would have increased 23% to $13.2 million, from $10.7 million, resulting
in pro forma Combined operating margins of approximately 11.6% in 2004 to date
and approximately 11.1% in the same period in 2003. With the addition of
Kirshenbaum Bond + Partners and with the resulting impact of the factors
affecting revenues and operating costs, as discussed above, actual Combined
operating income improved by approximately 50% to $16.1 million from $10.7
million, period over period, while operating margins where 11.7% for the first
half of 2004, as compared to 11.1% in the same period in 2003.
Secure Products International
Secure Products International revenues totaled $35.3 million for the first six
months of 2004. The decrease of $41.1 million, or 54% compared to revenues of
$76.4 million for the same period in 2003, was primarily due to the divestiture
of CDI. Revenues from the remaining operations of Secure Products International
increased 27% year over year. The most significant increase was generated by the
stamp operations of Ashton Potter, where production increased due to the USPS
contract awarded in 2003. Placard, the Australian card operation, and Mercury,
the Canadian ticketing business also experienced revenue growth. However,
revenues of the Canadian card operation, Metaca, decreased period over period.
Operating costs incurred by Secure Products International were $34.4 million for
the first half of the year compared to $88.1 million in 2003, which included
$41.5 million of costs related to CDI, and expenses related to provisions
against fixed assets and goodwill of $18.1 million. Excluding these costs from
the 2003 results, the remaining operations recorded an improvement in operating
expenses as a percentage of revenue, from 102.2% for the first half of 2003 to
97.5% for the first half of 2004.
In the 2004 first half, Secure Products International achieved operating income
of $0.9 million, an improvement of $12.6 million from the loss incurred in 2003
of $11.7 million. This represents a year over year improvement of $1.5 million
from the adjusted operating loss related to the remaining operations, primarily
as a result of the increased production at Ashton Potter partially offset by
declines at Metaca.
62
Corporate and Other
Operating costs, at $11.0 million, increased $6.5 million compared to the six
months ended June 30, 2003 of $4.5 million, primarily related to a $3.8 million
increase in charges for stock-based compensation. Corporate and other costs also
increased as a result of the merger of head offices upon the privatization of
Maxxcom Inc and an increase in compliance costs.
Gain on Sale of Affiliate and Settlement of Long-Term Debt
The gain on sale of assets of $16.2 million for the first two quarters of 2004
primarily related to the divestiture of the remaining interest in CDI upon
settlement of the adjustable rate exchangeable securities in the first quarter.
The 2003 gain related primarily to the disposition of the initial 80% interest
in the U.S. check operations.
Interest, Net
On a consolidated basis net interest expense for the first six months of the
year was $4.6 million, compared to the $10.2 million incurred during the same
year-earlier period. Interest expense decreased $5.3 million due primarily to
the repayment of the 10.5% senior subordinated notes and the redemption of the
convertible debentures. Interest income increased by $0.3 million due to higher
cash balances at certain agencies and head office in the first quarter of 2004.
Income Taxes
The income tax recoveries recorded for the six months ended June 30, 2004, were
$0.4 million compared to an expense of $5.9 million for the same period in 2003,
primarily due to the recognition of previously unrecognized tax loss benefits in
2004.
Income Before Equity In Affiliates and Minority Interests
The consolidated income before equity in affiliates and minority interests for
the year-to-date period ended June 30, 2004 was $10.2 million, $7.0 million
lower than the $17.2 million earned during the same prior-year period. The
decrease was primarily due to the significant gain on sale of assets related to
CDI in 2003, net of goodwill charges and the write-down of assets also recorded
in that year.
Equity in Affiliates
Equity in affiliates represents the income attributable to equity-accounted
affiliate operations. For the first two quarters of 2004, income of $2.9 million
was recorded. The increase of $1.1 million over the $1.8 million earned in the
first half of 2003 is principally due to greater income generated by Crispin
Porter + Bogusky.
Minority Interests
Minority interest expense of Marketing Communications was $3.6 million for the
first six months of 2004, an increase of $1.3 million compared to the $2.3
million in the previous year. In 2003, a recovery of $1.2 million was recorded
related to Metaca and Maxxcom.
Net Income
Net income for the first half of 2004 was $9.4 million versus the $17.8 million
achieved in 2003.
63
LIQUIDITY AND CAPITAL RESOURCES
Working Capital
The Company had a working capital deficit of $15.4 million at June 30, 2004,
$54.0 million less than the working capital of $38.6 million at December 31,
2003. The reduction in working capital is due primarily to cash payments made
for acquisitions completed during 2004, the movement of the senior credit
facility at Maxxcom from long-term debt to current portion of long-term debt and
a decrease in working capital in the Marketing Communications subsidiaries.
Compared to December 31, 2003, on a consolidated basis, cash decreased $17.9
million. Accounts receivable increased by $40.4 million. Inventory increased by
$0.7 million and prepaid expenses by $1.2 million. Accounts payable and accruals
and other liabilities increased by $52.5 million. Advance billings increased by
$5.8 million and the current portion of long-term debt increased by $20.5
million.
At June 30, 2004, Maxxcom had utilized approximately $30.0 million of its $33.1
million facility in the form of drawings and letters of credit. During the
second quarter, the Company reached agreements with its senior credit lenders to
amend the terms of the credit facility of its subsidiary, Maxxcom Inc., to
eliminate the scheduled quarterly borrowings reductions after March 31, 2004 and
to change the facility's maturity date from March 31, 2005 to September 30,
2004.
Currently, substantially all of the long-term debt is held at Maxxcom or its
subsidiaries. Maxxcom's ability to meet the repayment of its long-term debt is
dependent upon the availability of cash from its parent MDC Partners Inc. and
from the cash flows from its subsidiaries and affiliated companies through
dividends, distributions, intercompany advances, management fees and other
payments. A number of Maxxcom's subsidiaries are not wholly-owned and pursuant
to operating agreements with some of the other shareholders of these
subsidiaries and affiliates and certain subsidiary and affiliate lending
agreements, there are certain restrictions on the payment of dividends,
distributions and advances to Maxxcom. In addition, pursuant to certain lending
agreements entered into by MDC Partners Inc, there are restrictions on MDC's
ability to transfer available cash to Maxxcom.
On June 10, 2004, the Company entered into a revolving credit facility with a
syndicate of banks providing for borrowings of up to $18.7 million (CDN$25.0
million) maturing in May of 2005. This facility is secured by a pledge of the
Company's assets, principally comprised of ownership interest in its
subsidiaries and by the underlying assets of the businesses comprising the
Company's Secure Products International segment and Kirshenbaum Bond & Partners.
At June 30, 2004, the Company had not drawn any funds under this facility.
Cash and undrawn available bank credit facilities to support the Company's
future cash requirements, as at June 30, 2004, was approximately $70 million.
Long-Term Debt
Long-term indebtedness (including the current portion) at the end of the second
quarter was $81.9 million, a reduction of $68.2 million from the $150.1 million
outstanding at December 31, 2003. The $34.9 million outstanding convertible
notes were settled in full on May 5, 2004 with the issuance of approximately 2.6
million Class A subordinate voting shares.
MDC Partners Inc., the parent company, is in the process of refinancing its
indebtedness with a $100 million credit facility. A term sheet has been signed
with a major US financial institution and the credit facility agreement is
currently being negotiated. This new facility, combined with a related cash
management program, will be used to repay existing outstanding indebtedness
under the MDC senior credit facility, the Maxxcom senior credit facility, the
Maxxcom mezzanine facility and the Accent Marketing LLC credit facility.
Management believes that the new facility will be completed prior to September
30, 2004, the date the Maxxcom senior credit facility is due. Once completed,
the new credit facility will reduce the Company's aggregate borrowing costs and
provide enhanced liquidity. In the event the new credit facility is not
completed prior to maturity of the Maxxcom senior credit facility, management is
believes that the Maxxcom facility can be renegotiated and extended.
64
Deferred Acquisition Consideration (Earnouts)
Acquisitions of businesses by the Company typically include commitments to
contingent purchase consideration payable to the seller. The contingent purchase
obligations are generally payable annually over a three-year period following
the acquisition date, and are payable based on achievement of certain thresholds
of future earnings and, in certain cases, also based on the rate of growth of
those earnings The contingent consideration is recorded as an obligation of the
Company when the contingency is resolved and the amount is reasonably
determinable. At June 30, 2004, approximately $0.8 million in deferred
acquisition consideration relating to prior year acquisitions is presented on
the Company's balance sheet. Based on various assumptions as to future operating
results of the relevant entities, management estimates that approximately $1
million of further additional deferred purchase obligations could be triggered
during 2004 or thereafter. The actual amount that the Company pays in connection
with the obligations may be materially different from this estimate.
Put Rights of Subsidiaries' Minority Shareholders
Owners of interests in certain of the Marketing Communications subsidiaries have
the right in certain circumstances to require the Company to acquire the
remaining ownership interests held by them. The owners' ability to exercise any
such 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 2004 to 2010. Except
as described below, 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 perform at their current
profit levels over the relevant future periods, that these rights, if all
exercised, could require the Company, in future periods, to pay an aggregate of
approximately $73 million to the owners of such rights to acquire the remaining
ownership interests in the relevant subsidiaries. Of this amount, the Company
would be entitled, at its option, to fund approximately $18 million by the
issuance of the Company's share capital.
The actual future amount payable in connection with the exercise of any of the
above described rights cannot be determined because it is dependent on the
future results of operations of the subject businesses and the timing of the
exercise of the rights. The actual amounts the Company pays may be materially
different from these estimates.
If all of the outstanding rights were exercised, the Company would acquire
incremental ownership interests in the relevant subsidiaries entitling the
Company to additional annual operating income before other charges estimated by
management, using the same earnings basis used to determine the aggregate
purchase price noted above, to be approximately $10 million. The actual
additional annual operating income earned by the relevant subsidiaries may be
materially different from this estimate.
The Company expects to fund obligations relating to the rights described above,
if and when they become due, through the issuance of its common shares to the
rights holders, and through the use of cash derived from operations, bank
borrowings, and equity and/or debt offerings. There can be no certainty that the
Company will have adequate means to satisfy its obligations in respect of the
rights described above, if and when such obligations become due.
Approximately $4 million of the estimated $73 million that the Company could be
required to pay subsidiaries' minority shareholders upon the exercise of
outstanding put rights relates to rights exercisable in 2004 in respect of the
securities of three subsidiaries. The Company expects to fund the acquisition of
these interests, if and when they become due, through the use of cash derived
from operations and bank borrowings. Accordingly, the acquisition of any equity
interest in connection with the exercise of these rights in 2004 will not be
recorded in the Company's financial statements until ownership is transferred.
65
Cash Flow from Operations
Cash flow used in operations, including changes in non-cash working capital, for
the first six months of 2004 was $0.3 million, representing a $5.4 million
decrease from the cash flow generated of $5.1 million from the same period of
2003, primarily as a result of non-cash working capital usage, offset partially
by the improved operating profit achieved.
Cash flows used in investing activities amounted to $13.5 million for the six
months ended June 30, 2004, compared with the cash flows generated in the same
2003 period of $78.8 million. $4.6 million of the $8.1 million year-to-date
capital expenditures relate to the Marketing Communications segment and the
remainder to the purchase of manufacturing equipment in the Secure Products
segment. In 2003, proceeds on disposition primarily represent the net proceeds
received from the initial public offering of CDI.
At June 30, 2004, cash flows used in financing activities were $4.1 million and
comprised of the proceeds from the issuance of long-term debt of $2.0 million, a
repayment of $4.2 million of long-term indebtedness, proceeds of $3.2 million
from the issuance of share capital through a private placement and the exercise
of options, and $5.1 million used to repurchase shares of the Company under a
normal course issuer bid.
DIFFERENCES IN MD&A PRESENTATION UNDER CANADIAN GAAP
Under Canadian securities requirements, the Company is required to provide
supplemental information to highlight the significant differences that would
have resulted in the information provided in the MD&A had the Company prepared
the MD&A using Canadian GAAP financial information.
The Company has identified and disclosed the significant differences between
Canadian and US GAAP as applied to its interim consolidated financial statements
for the three months and six months ended June 30, 2004 and 2003 in note 15 to
the condensed consolidated interim financial statements. The primary GAAP
difference impacting the components of operating profit (loss) is the
application under Canadian GAAP of proportionate consolidation for investments
in joint ventures in the Marketing Communications businesses, while US GAAP
requires equity accounting for such investments. This GAAP difference does not
have a significant impact on the content of the MD&A as the discussion of the
results of the Company's marketing communications businesses has been presented
on a combined basis, consistent with the Company's segment disclosures in its
condensed consolidated interim financial statements. The Combined financial
information has been reconciled to US GAAP financial information by adjusting
for the equity accounting for certain the joint ventures in this MD&A as well as
in the segment information in note 6 to the condensed consolidated interim
financial statements. If the reconciliation of the Combined financial
information were prepared to reconcile to Canadian GAAP results, it would have
adjusted for the proportionate consolidation of the joint venture.
CRITICAL ACCOUNTING POLICIES
The following supplemental summary of accounting policies has been prepared to
assist in better understanding the Company's financial statements and the
related management discussion and analysis. Readers are encouraged to consider
this supplement together with the Company's consolidated interim financial
statements and the related notes to the condensed consolidated interim financial
statements for a more complete understanding of accounting policies discussed
below.
Estimates. The preparation of the Company's financial statements in
conformity with generally accepted accounting principles in the United States of
America, or "GAAP", requires management to make estimates and assumptions. These
estimates and assumptions affect the reported amounts of assets and liabilities
including valuation allowance for receivables, recognition of goodwill,
intangible assets, minority interest, income taxes, stock-based compensation,
accruals for bonus compensation and the disclosure of contingent liabilities at
the date of the financial statements, as well as the reported amounts of revenue
and expenses during a reporting period. 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.
66
Acquisitions and Goodwill. A fair value approach is used in testing
goodwill for impairment under SFAS 142 to determine if an other than temporary
impairment has occurred. One approach utilized to determine fair values is a
discounted cash flow methodology. When available and as appropriate, comparative
market multiples are used. Numerous estimates and assumptions necessarily have
to be made when completing a discounted cash flow valuation, including estimates
and assumptions regarding interest rates, appropriate discount rates and capital
structure. Additionally, estimates must be made regarding revenue growth,
operating margins, tax rates, working capital requirements and capital
expenditures. Estimates and assumptions also need to be made when determining
the appropriate comparative market multiples to be used. Actual results of
operations, cash flows and other factors used in a discounted cash flow
valuation will likely differ from the estimates used and it is possible that
differences and changes could be material. Additional information about
impairment testing under SFAS 142 appears in the notes of the condensed
consolidated interim financial statements.
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 acquired frequently have minimal tangible net assets and
identifiable intangible assets, which primarily consist of customer
relationships. Accordingly, a substantial portion of the purchase price is
allocated to goodwill. An annual impairment test is performed in order to assess
that the fair value of the reporting units exceeds their carrying value,
inclusive of goodwill.
A summary of the Company's deferred acquisition consideration obligations,
sometimes referred to as earn-outs, 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.
Additional information about acquisitions and goodwill appears in the notes to
the condensed consolidated interim financial statements of this report.
Revenue. Substantially all of the revenue of the Marketing
Communications segment is derived from fees for services. Commissions are earned
based on the placement of advertisements in various media. Revenue is realized
when the service is performed, in accordance with terms of the arrangement with
the clients and upon completion of the earnings process. This includes when
services are rendered, generally upon presentation date for media, when costs
are incurred for radio and television production and when print production is
completed and collection is reasonably assured.
Revenue is recorded at the net amount retained when the fee or commission is
earned. In the delivery of certain services to clients, costs are incurred on
their behalf for which the Company is reimbursed. Substantially all of the
reimbursed costs relate to purchases on behalf of clients of media and
production services. There is normally little latitude in establishing the
reimbursement price for these expenses and clients are invoiced for these
expenses in an amount equal to the amount of costs incurred. These reimbursed
costs, which are a multiple of the Company's revenue, are significant. However,
the majority of these costs are incurred on behalf of the largest clients and
the Company's has not historically experienced significant losses in connection
with the reimbursement of these costs by clients.
A small portion of the contractual arrangements with clients includes
performance incentive provisions designed to link a portion of the Company's
revenue to its performance relative to both quantitative and qualitative goals.
This portion of revenue is recognized when the specific quantitative goals are
achieved, or when the performance against qualitative goals is determined by the
client. Additional information about revenue appears in the notes to the
condensed consolidated interim financial statements.
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Substantially all of the Secure Products International reportable segment
revenue is derived from the sale of products. Revenue derived from the stamp
operations is realized as services are performed or upon delivery. Revenue
derived from the sale of tickets and cards is realized when the product is
completed and either shipped or held in the Company's secure facilities at the
written request of the customer, title to the product has transferred to the
customer, and all bill and hold revenue recognition criteria have been met.
Additional information about revenue recognition appears in the notes to the
consolidated interim financial statements.
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.
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.
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, particularly regarding recent business and
economic trends, 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.
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 and
political 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 retain and attract key employees;
- Developments from changes in the regulatory and legal environment;
- Foreign currency fluctuations;
- The successful completion and integration of acquisitions which
complement and expand the Company's' business capabilities, and;
- Risks arising from potential material weaknesses in internal control
over financial reporting.
Investors should carefully consider these risk factors and the additional risk
factors outlined in more detail in the Company's 2003 Form 40-F/A and other SEC
filings.
We hereby incorporate by reference the disclosure provided under the header
"Risks and Uncertainties" in the Company's Management Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
2003, included in the Company's Annual Report on Form 40-F/A for the year ended
December 31, 2003. As of June 30, 2004, no material change had occurred that
required the Company to update such disclosure.
68
OUTLOOK:
2004 will be a year of transformation for MDC. Our vision has been to enhance
the conglomerate, simplify the story and focus on the market place that best
positions the Company to deliver premium returns to its shareholders.
Our genesis was in the marketing communications business, and our experience and
knowledge is greatest in that area. Our growth strategy is based on empowering
our partners with equity and autonomy. We believe that combination will deliver
accretive investments and attract the best talent. We have identified an
opportunity to structure and complete the final act of our structural
transformation through the monetization of our secure print properties in the
form of an income fund. We are currently evaluating this opportunity.
SUPPLEMENTARY FINANCIAL INFORMATION:
The Company reports its financial results in accordance with US GAAP. However,
the Company has included certain non-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. These measures do not have a standardized meaning prescribed by 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
QUANTITATIVE INFORMATION ABOUT MARKET RISK
We are currently not invested in market risk sensitive instruments such as
derivative financial instruments or derivative commodity instruments.
QUALITATIVE INFORMATION ABOUT MARKET RISK
Our Secure Products International businesses operate in North America and
Australia. Certain North American costs are payable in Canadian dollars while
North American revenues are principally collectible in US dollars. Our Marketing
Communications businesses operate in North America and the United Kingdom,
however each business's revenues are collectable and its costs are generally
payable in the same local currency. Consequently, our financial results can be
affected by changes in foreign currency exchange rates. Fluctuations in the
exchange rates between the US dollar, the Sterling Pound, the Australian dollar
and the Canadian dollar may have a material effect on our results of operations.
In particular, we may be adversely affected by a significant strengthening of
the Canadian dollar against any of these currencies. We are not currently a
party to any forward foreign currency exchange contract, or other contract that
could serve to hedge our exposure to fluctuations in the US/Canada dollar
exchange rate.
69
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures designed to ensure that
information required to be included in our SEC reports is recorded, processed,
summarized and reported within 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 Chief Financial
Officer (CFO) as appropriate, to allow timely decisions regarding required
disclosures.
The Company disclosed in its quarterly report on Form 10-Q for the quarter ended
June 30, 2004 that an evaluation had been performed by the Company's management,
including its CEO and CFO, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures, and that based on that
evaluation, the Company's management concluded that the Company's disclosure
controls and procedures were effective as of June 30, 2004. Subsequently,
management determined that the Company's disclosure controls and procedures were
not effective as of June 30, 2004, because the Company had a "material weakness"
that resulted in the improper reporting of certain items, as described in Note 2
to the Company's interim condensed consolidated financial statements contained
herein.
Prior to the filing date of this Form 10-Q/A, the Company implemented revised
control activities to support improved processes under the direction of our Vice
Chairman & Executive Vice President. The revised control activities and improved
processes include expanded supervisory activities and monitoring procedures,
including the corrective actions described below. Based on these changes and
improvements, management believes that as of the date of this filing, our
disclosure controls and procedures are effective to ensure that material
information relating to our Company, including our consolidated subsidiaries, is
made known to our CEO and CFO by others within those entities. Furthermore, our
management, including our CEO and CFO, believe such controls have improved in
providing reasonable assurance that information required to be disclosed by us
in the reports that we file or submit to the SEC is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms. We currently are designing and implementing an improved control
environment to address the deficiencies described below.
INTERNAL CONTROL OVER FINANCIAL REPORTING
In the light of restatements of the Company's previously issued financial
statements, as described in Note 2 to the Company's interim condensed
consolidated financial statements contained herein, the Company's management has
concluded that there are significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's ability to record,
process, summarize and report financial data consistent with the assertions of
management in the financial statements. Management believes that such
deficiencies represent material weaknesses in internal control over financial
reporting that, by themselves or in combination, result in a more than remote
likelihood that a material misstatement in our financial statements will not be
prevented or detected by our employees in the normal course of performing their
assigned functions. Such material weaknesses in internal control over financial
reporting existed as at June 30, 2004.
70
Under applicable rules, management may not conclude that the Company's internal
control over financial reporting is effective if a material weakness exists.
Given the nature of the restatements, the Company's management believes that its
material weaknesses relate primarily to significant transactions at the
Company's head office accounting and reporting functions, including the
following:
- insufficient personnel resources and technical accounting expertise within
its accounting functions;
- failure in the design and operating effectiveness of identified controls
in preventing or detecting misstatements of accounting information;
- absence of appropriate review of significant transactions and related
accounting entries, and the appropriate documentation and application of
U.S. GAAP for those significant transactions;
- failure to document approvals required for certain transactions; and
- inadequate procedures and oversight for appropriately assessing and
applying accounting principles and changes thereon.
Our management and Audit Committee have dedicated resources to assist in
assessing the underlying issues giving rise to the restatement and in ensuring
proper steps have been and are being taken to improve our control environment.
That assessment found and concluded that our finance and accounting personnel
made a number of accounting errors, but that there was no evidence of any fraud,
intentional misconduct or concealment on the part of the Company, its officers
or its employees. We currently are designing and implementing improved controls
to address the material weaknesses described above in our control environment.
Specifically, the Company has taken the following corrective actions:
- Hired additional personnel resources, and is actively pursing appropriate
additional resources in its accounting and finance functions, particularly
those with US GAAP expertise;
- Developed, distributed and begun to communicate and implement
comprehensive accounting policies in a number of areas, including revenue
recognition;
- Developed and continues to refine procedures for ensuring appropriate
documentation of complex transactions and application of accounting
standards to ensure compliance with U.S. GAAP;
- Improving procedures for reviewing underlying business agreements and
analyzing, reviewing and documenting the support for management's
accounting entries and significant transactions; and
- Improving monitoring controls to ensure internal controls are operating
effectively.
The Company believes that these steps should remediate the identified material
weaknesses in control over financial reporting.
SECTION 404 ASSESSMENT
Section 404 of the Sarbanes-Oxley Act requires management's annual review and
evaluation of our internal controls, and an attestation of the effectiveness of
these controls by our independent registered public accountants beginning with
our Form 10-K for the fiscal year ending on December 31, 2004. We have dedicated
significant resources, including management time and effort, and incurred
substantial costs in connection with our ongoing Section 404 assessment. We are
currently documenting and testing our internal controls and evaluating necessary
improvements for maintaining an effective control environment. The evaluation of
our internal controls is being conducted under the direction of our senior
management in consultation with independent third party consulting firm. In
addition, the Company's management is regularly discussing the results of our
testing and any proposed improvements to our control environment with the Audit
Committee. Despite the dedication of significant resources for our Section 404
assessment, and the incurrence of significant costs, the Company has determined
that a significant amount of work will be required to remediate the
above-mentioned material weaknesses in its internal control over financial
reporting. Accordingly, the Company expects that it is likely that it will have
material weaknesses in internal control over financial reporting at year-end.
However, based on significant work performed during the past several months,
including the measures discussed above, management believes that there are no
material inaccuracies or omissions of material fact in this Form 10-Q/A.
Management, to the best of its knowledge, also believes that the financial
statements contained in this Form 10-Q/A are fairly presented in all material
respects. Despite the potential for a material weakness in the Company's
internal controls at year-end, management further expects that its corrective
measures and improved internal controls will enable the Company to file
financial statements for the year ending December 31, 2004, in compliance with
U.S. GAAP on a timely basis.
71
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company's operating entities are involved in legal proceedings of various
types. While any litigation contains an element of uncertainty, the Company has
no reason to believe that the outcome of such proceedings or claims will have a
material adverse effect on the financial condition of the Company.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Issuer Purchases of Equity Securities:
Shares- Class A Subordinate Voting Shares
Period Total Number of Average Price Paid Total Number of Maximum Number of
Shares Purchased per Share Shares Purchased as Shares that may
Part of Publicly yet be Purchased
Announced Plans or under the Plans or
Programs Programs
---------------- ------------------ ------------------- ------------------
April 1, 2004 nil $ -- -- 110,073
-April 30, 2004
May 1, 2004 46,100 $11.78 46,100 63,973
-May 31, 2004
June 1, 2004 17,800 $11.92 17,800 nil(1)
-June 30, 2004 254,300 $11.43 254,300 1,562,522(2)
Total 318,200 $11.33 318,200
1. The Class A subordinate voting shares were purchased pursuant to a publicly
announced plan which commenced May 30, 2003 and expired June 2, 2004. The
number of shares purchased under this plan was 1,223,716.
2. The Class A subordinate voting shares were purchased pursuant to a
publically announced plan which commenced June 7, 2004. The maximum number
of shares that may be purchased under this plan is 1,816,822. This plan
expires June 6, 2005.
72
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held it's annual shareholders' meeting on June 9, 2004. At the
meeting, votes were cast for the following proposals as follows:
To appoint KPMG LLP as auditors of the Company and authorizing the Company's
Board of Directors to fix the auditors' remuneration:
In excess of 95% of proxy votes were for this resolution.
To elect the following Directors:
Thomas Davidson
Guy P. French
Richard R. Hylland
Michael J.L. Kirby
Miles S. Nadal
Stephen M. Pustil
Francois R. Roy
In excess of 95% of proxy votes were for this resolution.
To approve the special resolution to approve the continuance of the Company from
the Business Corporations Act (Ontario) to the Canadian Business Corporations
Act:
In excess of 95% of proxy votes were for this resolution.
To approve the ordinary resolution to confirm By-Law No. 1 to be adopted by the
Company upon continuance of the Company from the Business Corporations Act
(Ontario) to the Canadian Business Corporations Act:
Votes For Votes Against
6,413,027 469,606
To the approve the ordinary resolution to approve an amendment to the Company's
Stock Appreciation Rights Plan:
Votes For Votes Against
6,669,903 1,115,044
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
----------- -----------
31 Rule 13a-14(a)/15d-14(a) certifications;
32 Section 1350 Certifications.
(b) The Company filed the following Current Reports on Form 8-K for the quarter
ended June 30, 2004:
On June 25, 2004, the Company furnished a Current Report on Form 8-K containing
historical financial information all prepared in accordance with, or derived
from, financial information prepared in accordance with United States generally
accepted accounting principles.
74
SIGNATURES
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/Walter Campbell
--------------------------------------
Walter Campbell
Chief Financial Officer
December 20, 2004
75
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
31 Rule 13a-14(a)/15d-14(a) certifications;
32 Section 1350 Certifications.
76