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MDC PARTNERS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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 2013 means the period beginning January 1, 2013, and ending December 31, 2013). The Company reports its financial results in accordance with generally accepted accounting principles ("GAAP") of the United States of America ("US GAAP"). However, the Company has included certain non-US GAAP financial measures and ratios, which it believes provide useful information to both management and readers of this report in measuring the financial performance and financial condition of the Company. One such term is "organic revenue", which means growth in revenues from sources other than acquisitions or foreign exchange impacts. These measures do not have a standardized meaning prescribed by US GAAP and, therefore, may not be comparable to similarly titled measures presented by other publicly traded companies, nor should they be construed as an alternative to other titled measures determined in accordance with US GAAP. 19 -------------------------------------------------------------------------------- TABLE OF CONTENTS Executive Summary The Company's objective is to create shareholder value by building market-leading subsidiaries and affiliates that deliver innovative, value-added marketing communications and strategic consulting to their clients. Management believes that shareholder value is maximized with an operating philosophy of "Perpetual Partnership" with proven committed industry leaders in marketing communications. MDC manages the business by monitoring several financial and non-financial performance indicators. The key indicators that we review focus on the areas of revenues and operating expenses and capital expenditures. Revenue growth is analyzed by reviewing the components and mix of the growth, including: growth by major geographic location; existing growth by major reportable segment (organic); growth from currency changes; and growth from acquisitions. MDC conducts its businesses through the Marketing Communications Group. Within the Marketing Communications Group, there are two reportable operating segments: Strategic Marketing Services and Performance Marketing Services. In addition, MDC has a "Corporate Group" which provides certain accounting, administrative, financial, human resource and legal functions. Marketing Communications Businesses Through its operating "partners", MDC provides advertising, consulting, customer relationship management, and specialized communication services to clients throughout the world. The operating companies earn revenue from agency arrangements in the form of retainer fees or commissions; from short-term project arrangements in the form of fixed fees or per diem fees for services; and from incentives or bonuses. Additional information about revenue recognition appears in Note 2 of the Notes to the Consolidated Financial Statements. MDC measures operating expenses in two distinct cost categories: cost of services sold, and office and general expenses. Cost of services sold is primarily comprised of employee compensation related costs and direct costs related primarily to providing services. Office and general expenses are primarily comprised of rent and occupancy costs and administrative service costs including related employee compensation costs. Also included in operating expenses is depreciation and amortization. Because we are a service business, we monitor these costs on a percentage of revenue basis. Cost of services sold tend to fluctuate in conjunction with changes in revenues, whereas office and general expenses and depreciation and amortization, which are not directly related to servicing clients, tend to decrease as a percentage of revenue as revenues increase because a significant portion of these expenses are relatively fixed in nature. We measure capital expenditures as either maintenance or investment related. Maintenance capital expenditures are primarily composed of general upkeep of our office facilities and equipment that are required to continue to operate our businesses. Investment capital expenditures include expansion costs, the build out of new capabilities, technology or call centers, or other growth initiatives not related to the day to day upkeep of the existing operations. Growth capital expenditures are measured and approved based on the expected return of the invested capital. Certain Factors Affecting Our Business Overall Factors Affecting our Business and Results of Operations. The most significant factors include national, regional and local economic conditions, our clients' profitability, mergers and acquisitions of our clients, changes in top management of our clients and our ability to retain and attract key employees. New business wins and client losses occur due to a variety of factors. The two most significant factors are; clients' desire to change marketing communication firms, and the creative product our firms are offering. A client may choose to change marketing communication firms for a number of reasons, such as a change in top management and the new management wants to retain an agency that it may have previously worked with. In addition, if the client is merged or acquired by another company, the marketing communication firm is often changed. Further, global clients are trending to consolidate the use of numerous marketing communication firms to just one or two. Another factor in a client changing firms is the agency's campaign or work product is not providing results and they feel a change is in order to generate additional revenues. 20 -------------------------------------------------------------------------------- TABLE OF CONTENTS Clients will generally reduce or increase their spending or outsourcing needs based on their current business trends and profitability. These types of changes impact the Performance Marketing Services Group more than the Strategic Marketing Services Group due to the Performance Marketing Services Group having clients who require project-based work as opposed to the Strategic Marketing Services Group who primarily have retainer-based relationships. Acquisitions and Dispositions. Our strategy includes acquiring ownership stakes in well-managed businesses with strong reputations in the industry. We engaged in a number of acquisition and disposal transactions during the 2010 to 2013 period, which affected revenues, expenses, operating income and net income. Additional information regarding material acquisitions is provided in Note 4 "Acquisitions" and information on dispositions is provided in Note 10 "Discontinued Operations" in the Notes to the Consolidated Financial Statements. Foreign Exchange Fluctuation. Our financial results and competitive position are affected by fluctuations in the exchange rate between the US dollar and non-US dollars, primarily the Canadian dollar. See also "Quantitative and Qualitative Disclosures About Market Risk - Foreign Exchange." Seasonality. Historically, with some exceptions, we generate the highest quarterly revenues during the fourth quarter in each year. The fourth quarter has historically been the period in the year in which the highest volumes of media placements and retail related consumer marketing occur. Fourth Quarter Results. Revenues for the fourth quarter of 2013 increased to $307.1 million, compared to 2012 fourth quarter revenues of $292.6 million. The increase consisted of organic growth of $14.5 million, acquisition revenue of $2.2 million and a decrease of $2.3 million due to foreign currency fluctuations. The Strategic Marketing Services segment had revenue growth of $17.7 million in 2013, of which $18.7 million was organic, offset by a decrease of $1.0 million due to foreign currency fluctuations. The Performance Marketing Services segment had decreased revenue of $3.3 million in 2013, of which $4.1 million was an organic decline and $1.4 million related to foreign currency fluctuations, offset by $2.2 million of acquisition related revenue. Operating results for the fourth quarter of 2013 resulted in a loss of $71.6 million, compared to a loss of $6.9 million in 2012. The decrease in operating profits was primarily related to two compensation related items: a stock based compensation charge of $55.8 million relating to the Company's settlement of its outstanding SAR's in cash, and a one-time bonus to the Company's CEO of $9.6 million for the Company's stock price hitting certain targets. These decreases were offset in part by the increase in revenue. Loss from continuing operations for the fourth quarter of 2013 was $91.8 million, compared to $21.9 million in 2012. Other expense net increased to expense of $4.6 million in 2013, compared to income of $0.4 million in 2012 due to unrealized losses due to foreign currency fluctuations. Interest expense was lower in 2013 by $0.3 million, income tax expense was also higher by $0.3 million and equity in earnings of affiliates was $0.1 million in 2013, compared to $0.2 million in 2012. Interest expense decreased due to the Company's refinancing of its outstanding indebtedness, in which the Company issued 6.75% Notes and redeemed all of its outstanding 11% Notes. 21 -------------------------------------------------------------------------------- TABLE OF CONTENTS Summary of Key TransactionsYear Ended December 31, 2013 On March 20, 3013, the Company issued and sold $550 million aggregate principal amount 6.75% Notes. The Company received net proceeds from the offering of the 6.75% Notes equal to approximately $537.6 million. The Company used the net proceeds to redeem all of the existing 11% Senior Notes due 2016, together with accrued interest, related premiums, fees and expenses and recorded a charge for loss on redemption of notes of $55.6 million, including write offs of unamortized original issue premium and debt issuance costs. Remaining proceeds were used for general corporate purposes. In addition, the Company entered into an amended and restated $225 million senior secured revolving credit agreement due 2018. On November 15, 2013, the Company issued an additional $110 million aggregate principal amount of its 6.75% Notes. The additional notes were issued under the Indenture governing the 6.75% Notes and treated as a single series with the original 6.75% Notes. The additional notes were sold in a private placement in reliance on exceptions from registration under the Securities Act of 1933, as amended. The Company received net proceeds before expenses of $111.9 million, which included an original issue premium of $4.1 million, and underwriter fees of $2.2 million. The Company used the net proceeds of the offering for general corporate purposes. Year Ended December 31, 2012 The Company completed several key acquisitions and transactions in 2012. These acquisitions included the acquisition of Doner Partners LLC ("Doner"). The Company acquired a 30% voting interest and a convertible preferred interest that allows the Company to increase ordinary voting ownership to 70% at MDC's option, at no additional cost to the Company. Doner is a full service integrated creative agency. In addition, the Company acquired a 70% interest in TargetCast LLC ("TargetCast"), a full service integrated media agency. The total aggregate purchase price for these 2012 transactions was $82.8 million, which included closing cash payments equal to $18.5 million and $8.0 million of working capital payments, plus additional estimated contingent purchase payments in future years of approximately $59.5 million. See Note 4 of the Notes to the Consolidated Financial Statements included herein for additional information on these and other acquisitions. On December 10, 2012, the Company and its wholly-owned subsidiaries, as guarantors, issued and sold an additional $80 million aggregate principal amount of 11% Notes due 2016. The additional notes were issued under the Indenture governing the 11% Notes and treated as a single series with the original 11% Notes. The additional notes were sold in a private placement in reliance on exceptions from registration under the Securities Act of 1933, as amended. The Company received net proceeds before expenses of $83.2 million, which included an original issue premium of $4.8 million, less underwriter fees of $1.6 million. The Company used the net proceeds of the offering to repay the outstanding balance under the Company's revolving credit agreement described elsewhere herein, and for general corporate purposes. Year Ended December 31, 2011 The Company completed several key acquisitions in 2011. These acquisitions included the acquisition of a 70% interest in Concentric Partners, LLC ("Concentric"), a 65% interest in Laird + Partners, New York LLC ("Laird"), a 100% interest in RJ Palmer Partners LLC ("RJ Palmer"), a 75% interest in Trade X Partners LLC ("Trade X") and a 60% interest in Anomaly Partners, LLC ("Anomaly"). The total aggregate purchase price for these 2011 transactions was $76.8 million, which included closing cash payments equal to $40 million plus additional estimated contingent purchase payments in future years of approximately $36.8 million. See Note 4 of the Notes to the Consolidated Financial Statements included herein for additional information on these and other acquisitions. On April 19, 2011, the Company and its wholly-owned subsidiaries, as guarantors, issued and sold an additional $55 million aggregate principal amount of 11% Notes due 2016. The additional notes were issued under the Indenture governing the 11% Notes and treated as a single series with the original 11% Notes. The additional notes were sold in a private placement in reliance on exceptions from registration under the Securities Act of 1933, as amended. The Company received net proceeds before expenses of $59.6 million, 22 -------------------------------------------------------------------------------- TABLE OF CONTENTS which included an original issue premium of $6.1 million, and underwriter fees of $1.5 million. The Company used the net proceeds of the offering to repay the outstanding balance under the Company's WF Credit Agreement described elsewhere herein, and for general corporate purposes. Results of Operations for the Years Ended December 31, 2013, 2012 and 2011: [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] For the Year Ended December 31, 2013 Strategic Marketing Performance Marketing Corporate Total Services Services Revenue $ 805,439 $ 343,442 $ - $ 1,148,881 Cost of services 510,014 244,480 - 754,494 sold Office and 186,369 73,696 126,714 386,779 general expenses Depreciation and 23,720 14,486 1,394 39,600 amortization Operating profit 85,336 10,780 (128,108 ) (31,992 ) (loss) Other income (expense): Other income, net 2,531 Foreign exchange (5,537 ) loss Interest expense, finance charges, and loss on (100,592 ) redemption of notes, net Loss from continuing operations before (135,590 ) income taxes, equity in affiliates Income tax (4,291 ) recovery Loss from continuing operations before (131,299 ) equity in affiliates Equity in earnings of 281 non-consolidated affiliates Loss from continuing (131,018 ) operations Loss from discontinued operations attributable to (11,384 ) MDC Partners Inc., net of taxes Net loss (142,402 ) Net income attributable to (4,889 ) (1,572 ) - (6,461 ) non-controlling interests Net loss attributable to $ (148,863 ) MDC Partners Inc. Stock based $ 7,249 $ 3,425 $ 89,731 $ 100,405 compensation 23 -------------------------------------------------------------------------------- TABLE OF CONTENTS [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] For the Year Ended December 31, 2012 Strategic Marketing Performance Marketing Corporate Total Services Services Revenue $ 719,364 $ 343,901 $ - $ 1,063,265 Cost of services 479,060 254,740 - 733,800 sold Office and 188,954 71,798 38,847 299,599 general expenses Depreciation and 27,260 17,190 1,342 45,792 amortization Operating profit 24,090 173 (40,189 ) (15,926 ) (loss) Other income (expense): Other income, net 117 Foreign exchange (976 ) loss Interest expense and finance (46,190 ) charges, net Loss from continuing operations before (62,975 ) income taxes, equity in affiliates Income tax 9,553 expense Loss from continuing operations before (72,528 ) equity in affiliates Equity in earnings of 633 non-consolidated affiliates Loss from continuing (71,895 ) operations Loss from discontinued operations attributable to (6,681 ) MDC Partners Inc., net of taxes Net loss (78,576 ) Net income attributable to (5,167 ) (1,696 ) - (6,863 ) non-controlling interests Net loss attributable to $ (85,439 ) MDC Partners Inc. Stock based $ 9,186 $ 8,227 $ 14,784 $ 32,197 compensation 24 -------------------------------------------------------------------------------- TABLE OF CONTENTS [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] For the Year Ended December 31, 2011 Strategic Marketing Performance Marketing Corporate Total Services Services Revenue $ 608,022 $ 326,266 $ - $ 934,288 Cost of services 425,316 241,402 - 666,718 sold Office and 137,824 44,172 35,432 217,428 general expenses Depreciation and 22,378 16,457 826 39,661 amortization Operating profit 22,504 24,235 (36,258 ) 10,481 (loss) Other income (expense): Other income, net 116 Foreign exchange (1,677 ) loss Interest expense and finance (41,561 ) charges, net Loss from continuing operations before (32,641 ) income taxes, equity in affiliates Income tax 41,735 expense Loss from continuing operations before (74,376 ) equity in affiliates Equity in earnings of 213 non-consolidated affiliates Loss from continuing (74,163 ) operations Loss from discontinued operations attributable to (2,082 ) MDC Partners Inc., net of taxes Net loss (76,245 ) Net income attributable to (6,414 ) (2,015 ) - (8,429 ) non-controlling interests Net loss attributable to $ (84,674 ) MDC Partners Inc. Stock based $ 5,149 $ 3,695 $ 14,813 $ 23,657 compensation 25 -------------------------------------------------------------------------------- TABLE OF CONTENTS Year Ended December 31, 2013 Compared to Year Ended December 31, 2012 Revenue was $1.15 billion for the year ended 2013, representing an increase of $85.6 million, or 8.1%, compared to revenue of $1.06 billion for the year ended 2012. This increase relates primarily to an increase in organic revenue of $88.5 million and acquisition growth of $2.6 million. A strengthening of the US Dollar, primarily versus the Canadian dollar during the year ended December 31, 2013, resulted in a decrease of $5.4 million. Operating loss for the year ended 2013 was $32.0 million, compared to a loss of $15.9 million in 2012. Operating profit increased by $61.2 million in the Strategic Marketing Services segment and by $10.6 million in the Performance Marketing Services segment. Corporate operating expenses increased by $87.9 million in 2013. Loss from continuing operations was a loss of $131.0 million in 2013, compared to a loss of $71.9 million in 2012. This increase in loss of $59.1 million was primarily attributable to a decrease in operating profits of $16.1 million (primarily due to an increase in stock based compensation of $68.2 million), and an increase in net interest expense equal to $54.4 million, offset by a decrease in tax expense of $13.8 million. The increase in net interest expense was primarily due to the Company's redemption of its 11% Notes in March 2013 and related premium, fees and expenses of $55.6 million. These amounts were also impacted by an increase in foreign exchange losses of $4.6 million in 2013 and an increase in other income, net of $2.4 million. Marketing Communications Group Revenues attributable to the Marketing Communications Group, which consists of two reportable segments - Strategic Marketing Services and Performance Marketing Services, were $1.15 billion in the aggregate in 2013, compared to $1.06 million in 2012, representing a year-over-year increase of 8.1%. The components of the revenue for 2013 are shown in the following table: [[Image Removed]] [[Image Removed]] [[Image Removed]] Revenue $000's % Year ended December 31, 2012 $ 1,063,265 Acquisition 2,572 0.3 % Organic 88,479 8.3 % Foreign exchange impact (5,435 ) (0.5 )% Year ended December 31, 2013 $ 1,148,881 8.1 % The geographic mix in revenues was relatively consistent between 2013 and 2012 and is demonstrated in the following table: [[Image Removed]] [[Image Removed]] [[Image Removed]] 2013 2012 US 82 % 81 % Canada 12 % 14 % Europe and other 6 % 5 % The operating profit of the Marketing Communications Group increased by $71.9 million to $96.1 million from $24.3 million. Operating margins increased by 6.1% and were 8.4% for 2013, compared to 2.3% for 2012. The increase in operating profit and operating margin was primarily due to increases in revenue and decreases in direct costs, office and general expenses, and depreciation and amortization. Total staff costs were consistent at approximately 59%. Direct costs (excluding staff costs) decreased as a percentage of revenues from 16.8% in 2012, to 13.4% in 2013. Direct costs decreased as there were fewer pass-through costs incurred on the clients' behalf during 2013 where the company was acting as principal versus agent for certain client contracts. Office and general expenses decreased as a percentage of revenue from 24.5% in 2012, to 22.6% in 2013. This decrease was primarily due to a reduction of $17.1 million in expense relating to estimated deferred acquisition consideration and the increase in revenue on relatively fixed costs. Depreciation and amortization as a percentage of revenue decreased from 4.2% in 2012 to 3.3% in 2013. 26 -------------------------------------------------------------------------------- TABLE OF CONTENTS Marketing Communications Businesses Strategic Marketing Services Revenues attributable to Strategic Marketing Services in 2013 were $805.4 million, compared to $719.4 million in 2012. The year-over-year increase of $86.1 million, or 12.0%, was attributable primarily to organic growth of $91.4 million or 12.7%; these increases were offset by a foreign exchange translation decrease due to the strengthening of the US dollar compared to the Canadian dollar. This organic revenue growth was driven by net new business wins. The operating profit of Strategic Marketing Services increased by $61.2 million from $24.1 million in 2012 to $85.3 million in 2013. Operating margins increased from 3.4% in 2012 to 10.6% in 2013. The increase in operating profits and operating margins were primarily due to increases in revenues and decreases in direct costs, office and general costs and depreciation and amortization. Total staff costs were relatively consistent at 60%. Direct costs (excluding staff labor) decreased as a percentage of revenue from 13.2% 2012 to 8.8% in 2013. Direct costs decreased as there were fewer pass-through costs incurred on the clients' behalf during 2013 where the company was acting as principal versus agent for certain client contracts. Office and general expenses decreased as a percentage of revenue from 26.3% in 2012 to 23.1% in 2013. The decrease was due to a reduction of $11.8 million in expense relating to estimated deferred acquisition consideration and the increased revenue on relatively fixed costs. Depreciation and amortization as a percentage of revenue decreased from 3.8% in 2012 to 2.9% in 2013. Performance Marketing Services Performance Marketing Services generated revenues of $343.4 million for 2013, a decrease of $0.5 million, or 0.1%, compared to revenues of $343.9 million in 2012. The year-over-year decrease was attributable primarily to an organic decline of $2.9 million offset by an increase in acquisition growth of $5.8 million, and a foreign translation decrease of $3.3 million. This organic revenue decline was driven by net new business wins offset by larger reductions of client spending amounts. The operating profit of Performance Marketing Services increased by $10.6 million, from $0.2 million in 2012 to $10.8 million in 2013. Operating margins increased from 0.1% in 2012 to 3.1% in 2013. The increase in operating profits and operating margins were primarily due to decreases in staff costs, direct costs (excluding staff labor) and depreciation and amortization. Total staff costs decreased from 58.3% in 2012 to 57.4% in 2013. Direct costs decreased from 24.2% in 2012 to 23.9% in 2013 due to decreased pass-through costs incurred on the clients' behalf during 2013 where the agency was acting as principal versus agent for certain client contracts. Office and general costs increased from 20.9% in 2012 to 21.5% in 2013 on relatively flat revenue. Depreciation and amortization decreased from 5.0% in 2012 to 4.2% in 2013. Corporate Operating costs related to the Company's Corporate operations increased by $87.9 million to $128.1 million in 2013, compared to $40.2 million in 2012. This increase was primarily related to increased compensation and related costs of $89.0 million. The increase in compensation and related costs is due to the Company's settlement of its SAR's in cash resulting in a stock based compensation charge of $78.0 million and a one-time bonus payment of $9.6 million to our CEO for the Company's stock price achieving specified targets. Increases in benefits and severance costs accounted for the remaining increase. Additional advertising and promotion costs, occupancy, travel and entertainment, professional fees, and other administrative costs were offset by the repayment in full of a previously fully reserved loan by the Company's CEO of $5.3 million. Other Income, Net Other income, net, increased by $2.4 million from income of $0.1 million in 2012 to income of $2.5 million in 2013. The increase was primarily related to a distribution received in excess of the assets carrying value of $3.1 million. 27 -------------------------------------------------------------------------------- TABLE OF CONTENTS Foreign Exchange The foreign exchange loss was $5.5 million for 2013, compared to a loss of $1.0 million recorded in 2012. This unrealized loss was due primarily to the fluctuation in the US dollar during 2013 and 2012 compared to the Canadian dollar relating to the Company's US dollar denominated intercompany balances with its Canadian subsidiaries. Interest Expense and Finance Charges, Net Interest expense and finance charges, net for 2013 was $100.6 million, an increase of $54.4 million over the $46.2 million of interest expense and finance charges, net incurred during 2012. This increase was due to the loss paid on the redemption of the Company's 11% Notes of $55.6 million, offset in part by lower borrowing costs related to the 6.75% Notes issued to replace those notes. Income Tax Expense Income tax expense in 2012 was $9.6 million compared to a benefit of $4.3 million for 2013. The Company's effective rate was substantially lower than the statutory rate in 2013, primarily due to nondeductible stock-based compensation, an increase in the valuation allowance, offset in part by noncontrolling interest charges. The Company's effective tax rate was substantially higher than the statutory rate in 2012 due to non-deductible stock-based compensation and an increase in the Company's valuation allowance, offset in part by noncontrolling interest charges. The Company's US operating units are generally structured as limited liability companies, which are treated as partnerships for tax purposes. The Company is only taxed on its share of profits, while noncontrolling holders are responsible for taxes on their share of the profits. Equity in Affiliates Equity in affiliates represents the income attributable to equity-accounted affiliate operations. In 2013, the Company recorded income of $0.3 million compared to income of $0.6 million in 2012. Noncontrolling Interests The effects of noncontrolling interest was $6.5 million for 2013, a decrease of $0.4 million from the $6.9 million during 2012. The decrease relates to step-up transactions of entities the Company does not own 100% in both the Strategic Marketing Services and Performance Marketing Service segments. Discontinued Operations The loss net of taxes from discontinued operations for 2013 was $11.4 million and $6.7 million in 2012. Net Loss Attributable to MDC Partners Inc. As a result of the foregoing, the net loss attributable to MDC Partners Inc. for 2013 was $148.9 million or a loss of $3.16 per diluted share, compared to a net loss of $85.4 million or $1.85 per diluted share reported for 2012. Year Ended December 31, 2012 Compared to Year Ended December 31, 2011 Revenue was $1.06 billion for the year ended 2012, representing an increase of $129.0 million, or 13.8%, compared to revenue of $934.3 million for the year ended 2011. This increase relates primarily to acquisition growth of $54.2 million and an increase in organic revenue of $77.3 million. A strengthening of the US Dollar, primarily versus the Canadian dollar during the year ended December 31, 2012, resulted in a decrease of $2.5 million. Operating loss for the year ended 2012 was $15.9 million, compared to operating profits of $10.5 million in 2011. Operating profit decreased by $24.1 million in the Performance Marketing Services segment, and was offset by an increase of $1.6 million in the Strategic Marketing Services segment. Corporate operating expenses increased by $3.9 million in 2012. Loss from continuing operations was a loss of $71.9 million in 2012, compared to a loss of $74.2 million in 2011. This increase in loss of $2.3 million was primarily attributable to a decrease in operating profits of 28 -------------------------------------------------------------------------------- TABLE OF CONTENTS $26.4 million resulting from an increase in deferred acquisition consideration of $40.2 million, offset by the increase in revenue and an increase in net interest expense equal to $4.6 million, offset by the decrease in tax expense of $32.2 million. The increase in net interest expense was primarily due to higher outstanding borrowing under the WF Credit Agreement and the Company's outstanding 11% notes. These amounts were impacted by a decrease in foreign exchange losses of $0.7 million in 2012 and an increase in equity in earnings of non-consolidated affiliates of $0.4 million. Marketing Communications Group Revenues attributable to the Marketing Communications Group, which consists of two reportable segments - Strategic Marketing Services and Performance Marketing Services, were $1.06 billion in the aggregate in 2012, compared to $934.3 million in 2011, representing a year-over-year increase of 13.8%. The components of the revenue for 2012 are shown in the following table: [[Image Removed]] [[Image Removed]] [[Image Removed]] Revenue $000's % Year ended December 31, 2011 $ 934,288 Acquisition 54,198 5.8 % Organic 77,293 8.3 % Foreign exchange impact (2,514 ) (0.3 )% Year ended December 31, 2012 $ 1,063,265 13.8 % The geographic mix in revenues was relatively consistent between 2012 and 2011 and is demonstrated in the following table: [[Image Removed]] [[Image Removed]] [[Image Removed]] 2012 2011 US 81 % 80 % Canada 14 % 16 % Europe and other 5 % 4 % The operating profit of the Marketing Communications Group decreased by approximately 48.1% to $24.3 million in 2012, from $46.7 million in 2011. The decrease in operating profit of $22.4 million was primarily due to an increase in estimated deferred acquisition consideration adjustments of $40.2 million, an increase in stock based compensation of $8.6 million and increased depreciation and amortization of $5.6 million, all due to acquisitions. These amounts were offset by $32.0 million of increased operating profits driven by the increase in revenue following the Company's strategic investment spending in 2011. Operating margins decreased to 2.3% for 2012, compared to 5.0% for 2011. This decrease in operating margin was primarily related to an increase in office and general expenses as a percentage of revenue from 19.5% in 2011, to 24.5% in 2012. This increase was primarily due to estimated deferred acquisition consideration adjustments as a percentage of revenue which increased to 5.0% in 2012 compared to 1.4% in 2011. In addition, total staff costs increased as a percentage of revenue from 55.2% in 2011, to 59.3% in 2012. Offsetting these increases was a decrease in reimbursed client related direct costs (excluding staff costs) as a percentage of revenue from 22.8% in 2011, to 16.8% in 2012. Marketing Communications Businesses Strategic Marketing Services Revenues attributable to Strategic Marketing Services in 2012 were $719.4 million, compared to $608.0 million in 2011. The year-over-year increase of $111.4 million, or 18.3%, was attributable primarily to organic growth of $74.3 million or 12.2%; and acquisition growth of $38.6 million or 6.4%; these increases were offset by a foreign exchange translation decrease of $1.6 million due to the strengthening of the US dollar compared to the Canadian dollar. This organic revenue growth was driven by net new business wins. The operating profit of Strategic Marketing Services increased by $1.6 million to $24.1 million in 2012, from $22.5 million in 2011. Operating margins decreased to 3.3% in 2012 from 3.7% in 2011. The increase in 29 -------------------------------------------------------------------------------- TABLE OF CONTENTS operating profit is primarily related to the increase in revenue. This increase was offset by an increase in estimated deferred acquisition consideration adjustments of $24.3 million, increased depreciation and amortization of $4.9 million due to acquisitions, and an increase in stock based compensation of $4.0 million. The decrease in operating margin was primarily related to an increase in office and general expenses as a percentage of revenue from 22.7% in 2011 to 26.3% in 2012 due to the increased estimated deferred acquisition consideration adjustments of 6.6% in 2012 compared to 3.9% in 2011. In addition, total staff costs as a percentage of revenue increased from 56.2% in 2011 to 59.8% in 2012. Depreciation and amortization increased as a percentage of revenue from 3.7% during 2011 to 3.8% during 2012. Offsetting this decrease in margins was a decrease in direct costs (excluding staff costs) as a percentage of revenues from 20.1% of revenue in 2011, to 13.2% of revenue in 2012. Performance Marketing Services Performance Marketing Services generated revenues of $343.9 million for 2012, an increase of $17.6 million, or 5.4%, compared to revenues of $326.3 million in 2011. The year-over-year increase was attributable primarily to acquisition growth of $15.6 million, organic revenue growth of $2.0 million, and a foreign translation decrease of $0.9 million. This organic revenue growth was driven by net new business wins. The operating profit of Performance Marketing Services decreased by $24.0 million to $0.2 million in 2012, from an operating profit of $24.2 million in 2011. Operating margins decreased from 7.4% in 2011 compared to an operating margin of 0.1% in 2012. The decrease in operating profit was primarily due to an increase in estimated deferred acquisition consideration adjustments of $15.9 million and increased stock based compensation of $4.5 million. This decrease was offset in part by increased revenue. The decrease in operating margin in 2012 was due primarily to an increase in total staff costs as a percentage of revenue from 53.5% in 2011 to 58.3% in 2012. Office and general expenses as a percentage of revenue increased from 13.5% in 2011 to 20.9% in 2012 due to an increase in estimated deferred acquisition consideration adjustments as a percentage of revenue of 1.6% in 2012 from a positive net adjustment of 3.2% in 2011, and an increase in stock based compensation expense of $4.5 million. Offsetting these increases was a decrease in direct costs (excluding staff costs) as a percentage of revenue from 27.9% in 2011 to 24.2% in 2012. Corporate Operating costs related to the Company's Corporate operations increased by $3.9 million to $40.2 million in 2012, compared to $36.3 million in 2011. This increase was primarily related to increased compensation and related costs of $3.6 million. Additional depreciation and amortization and advertising and promotion costs were offset by decreases in, occupancy, travel and entertainment, professional fees, and other administrative costs. Other Expense, Net Other expense, net, remained consistent at income of $0.1 million. Foreign Exchange The foreign exchange loss was $1.0 million for 2012, compared to a loss of $1.7 million recorded in 2011. This unrealized loss was due primarily to the fluctuation in the US dollar during 2012 and 2011 compared to the Canadian dollar relating to the Company's US dollar denominated intercompany balances with its Canadian subsidiaries. Interest Expense and Finance Charges, Net Interest expense and finance charges, net for 2012 was $46.2 million, an increase of $4.6 million over the $41.6 million of interest expense and finance charges, net incurred during 2011. Interest expense and finance charges increased $4.6 million in 2012 due to the additional borrowings under the Company's WF Credit Agreement throughout 2012 and an additional $80 million 11% notes issued in December 2012. Interest income in 2012 was consistent at $0.2 million. 30 -------------------------------------------------------------------------------- TABLE OF CONTENTS Income Tax Expense Income tax expense in 2012 was $9.6 million compared to $41.7 million for 2011. The Company's effective tax rate was substantially higher than the statutory rate in 2012 and 2011 due to non-deductible stock-based compensation and an increase in the Company's valuation allowance, offset in part by noncontrolling interest charges. The Company's US operating units are generally structured as limited liability companies, which are treated as partnerships for tax purposes. The Company is only taxed on its share of profits, while noncontrolling holders are responsible for taxes on their share of the profits. Equity in Affiliates Equity in affiliates represents the income attributable to equity-accounted affiliate operations. In 2012, the Company recorded income of $0.6 million compared to income of $0.2 million in 2011. Noncontrolling Interests Noncontrolling interest expense was $6.8 million for 2012, a decrease of $1.6 million from the $8.4 million of noncontrolling interest expense incurred during 2011. The decrease relates to step-up transactions of entities the Company does not own 100%, both the Strategic Marketing Services and Performance Marketing Service segments. Discontinued Operations The loss net of taxes from discontinued operations for 2012 was $6.7 million and $2.1 million in 2011. Net Loss Attributable to MDC Partners Inc. As a result of the foregoing, the net loss attributable to MDC Partners Inc. for 2012 was $85.4 million or loss of $1.85 per diluted share, compared to a net loss of $84.7 million or $1.94 per diluted share reported for 2011. Liquidity and Capital Resources The following table provides information about the Company's liquidity position: [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Liquidity 2013 2012 2011 (In Thousands, Except for Long-Term Debt to Shareholders' Equity Ratio) Cash and cash equivalents $ 102,007 $ 60,330 $ 8,096 Working capital (deficit) $ (189,815 ) $ (226,682 ) $ (127,888 ) Cash from operating $ 59,299 $ 76,304 $ 4,548 activities Cash from (used in) $ (30,124 ) $ 7,811 $ (30,436 ) investing activities Cash from (used in) $ 10,492 $ (31,858 ) $ 23,299 financing activities Ratio of long-term debt (2.40 ) (5.09 ) (29.76 ) to shareholders' deficit As of December 31, 2013, 2012 and 2011, $0.7 million, $2.5 million and $0.9 million, respectively, of the Company's consolidated cash position was held by subsidiaries. Although this amount is available for the subsidiaries' use, it does not represent cash that is distributable as earnings to MDC for use to reduce its indebtedness. It is the Company's intent through its cash management system to reduce outstanding borrowings under the WF Credit Agreement by using available cash. Working Capital At December 31, 2013, the Company had a working capital deficit of $189.8 million, compared to a deficit of $226.7 million at December 31, 2012. Working capital deficit decreased by $36.9 million primarily related to a $51.3 million decrease in short term deferred acquisition consideration. The decrease was primarily due to timing in the amounts collected from clients, and when paid to suppliers, primarily media outlets. At December 31, 2013 and 2012, the Company had no borrowings under its Credit Agreement. The Company includes amounts due to noncontrolling interest holders, for their share of profits, in accrued and 31 -------------------------------------------------------------------------------- TABLE OF CONTENTS other liabilities. During 2013, 2012 and 2011, the Company made distributions to these noncontrolling interest holders of $5.5 million, $7.7 million and $12.3 million, respectively. At December 31, 2013, $5.2 million remains outstanding to be distributed to noncontrolling interest holders over the next twelve months. The Company expects that available borrowings under its Credit Agreement, together with cash flows from operations and other initiatives, will be sufficient over the next twelve months to adequately fund working capital deficits should there be a need to do so from time to time, as well as all of the Company's obligations including put options and capital expenditures. Operating Activities Cash flows provided by continuing operations for 2013 was $62.1 million. This was attributable primarily to a loss on the redemption of notes of $50.4 million, plus non-cash stock based compensation of $22.5 million, depreciation and amortization of $47.4 million, and adjustments to deferred acquisition consideration of $36.1 million, an increase in accounts payable, accruals and other current liabilities of $29.2 million, a decrease in accounts receivable of $17.6 million, an increase in advanced billings of $17.6 million and foreign exchange of $3.1 million. This was partially offset by a loss from continuing operations of $131.0 million, other non-current assets and liabilities of $9.8 million, an increase in prepaid expenses and other current assets of $7.8 million, deferred income tax of $5.4 million, an increase in expenditures billable to clients of $4.4 million, and distributions in excess of carrying value of $3.1 million. Discontinued operations used cash of $2.8 million. Cash flows provided by continuing operations for 2012 was $80.9 million. This was attributable primarily to a loss from continuing operations of $71.9 million, plus non-cash stock based compensation of $32.2 million, depreciation and amortization of $48.0 million, and adjustments to deferred acquisition consideration of $53.3 million, an increase in accounts payable accruals and other current liabilities of $66.1 million, deferred income taxes of $8.4 million, an increase in advanced billings of $1.7 million and foreign exchange of $0.9 million. This was partially offset by an increase in accounts receivable of $29.9 million, an increase in expenditures billable to clients of $17.2 million, other non-current assets and liabilities of $7.9 million, an increase in prepaid expenses and other current assets of $2.2 million and earnings of non-consolidated affiliates of $0.6 million. Discontinued operations used cash of $4.6 million. Cash flows provided by continuing operations for 2011 was $5.3 million. This was attributable primarily to a loss from continuing operations of $74.2 million, plus non-cash stock based compensation of $23.7 million, depreciation and amortization of $41.8 million, a decrease in expenditures billable to clients of $15.3 million, deferred income taxes of $40.3 million, and adjustments to deferred acquisition consideration of $13.5 million. This was partially offset by a decrease in advance billings of $32.5 million, increases in accounts receivable of $10.9 million, other non-current assets and liabilities of $2.0 million, a decrease in accounts payable, accruals and other liabilities of $9.6 million, and an increase in prepaid expenses and other current assets of $0.7 million. Discontinued operations used cash of $0.7 million. Investing Activities Cash flows used by investing activities were $30.1 million for 2013, compared with cash flows provided by investing activities of $7.8 million for 2012, and cash flows used by investing activities of $30.4 million in 2011. In the year ended December 31, 2013, capital expenditures totaled $19.5 million, of which $12.2 million was incurred by the Strategic Marketing Services segment, $5.2 million was incurred by the Performance Marketing Services segment, and $2.1 million was incurred by corporate. These expenditures consisted primarily of computer equipment, furniture and fixtures, and leasehold improvements. In the year ended December 31, 2013, the Company paid $11.9 million, net of cash acquired for acquisitions and $2.7 million for other investments. These outflows were offset by $3.8 million of profit distributions from affiliates, and $0.2 million of proceeds from the sale of assets. Cash provided by acquisitions during 2012 was $30.9 million, $26.6 million related to acquisition payments, offset by $57.5 million of cash acquired. The Company also used cash of $2.2 million for other investments. 32 -------------------------------------------------------------------------------- TABLE OF CONTENTS Expenditures for capital assets in 2012 were equal to $20.3 million. Of this amount, $11.5 million was incurred by the Strategic Marketing Services segment, $8.4 million was incurred by the Performance Marketing Services segment. These expenditures consisted primarily of computer equipment, leasehold improvements, furniture and fixtures, and $0.4 million related to the purchase of Corporate assets. These outflows were offset by $1.3 million in profit distributions. Cash used in acquisitions during 2011 was $6.8 million, $42.5 million related to acquisition payments, reduced by $35.8 million of media cash acquired, and $0.1 million related to deferred payments for acquisitions that closed prior to January 1, 2009. The Company used cash of $4.2 million for other investments. Expenditures for capital assets in 2011 were equal to $23.3 million. Of this amount, $11.7 million was incurred by the Strategic Marketing Services segment, $4.7 million was incurred by the Performance Marketing Services segment. These expenditures consisted primarily of computer equipment, leasehold improvements, furniture and fixtures, and $6.9 million related to the purchase of Corporate assets. These outflows were offset by $4.6 million in profit distributions. In 2013, discontinued operations used minimal cash relating to expenditures for capital assets. In 2012 and 2011, discontinued operations used cash of $2.1 million and $0.7 million relating to investing activities. Financing Activities During the year ended December 31, 2013, cash flows used in financing activities amounted to $10.5 million, and consisted of $119.6 million of acquisition related payments, the purchase of treasury shares for income tax withholding requirements of $13.8 million, distributions to noncontrolling partners of $5.5 million, payment of dividends of $22.0 million and repayments of long term debt of $2.0 million, offset by proceeds from the issuance of the 6.75% Notes of $664.1 million, which in turn was offset by the repayment of the 11% Notes of $425.0 million, and premium paid on redemption of notes of $50.4 million, deferred financing costs of $20.8 million, and bank overdrafts of $4.9 million. During the year ended December 31, 2012, cash flows used in financing activities amounted to $31.9 million and primarily consisted of $84.8 million of proceeds from the additional 11% Notes issuance, and bank overdrafts of $26.0 million. These proceeds were offset by acquisition related payments of $68.7 million, repayments of the revolving credit facility of $38.0 million, dividends paid of $22.0 million, distributions to noncontrolling shareholders of $7.7 million, purchase of shares of $3.3 million, deferred financing costs of $2.2 million and repayment of long-term debt of $0.7 million During the year ended December 31, 2011, cash flows provided by financing activities amounted to $23.3 million and primarily consisted of $61.1 million of proceeds from the additional 11% Notes issuance, proceeds from the WF Credit Agreement of $38.0 million and proceeds for the exercise of stock options of $1.1 million. These proceeds were offset by repayments from bank overdrafts of $5.7 million, by $3.1 million of deferred financing costs relating to the senior notes and revolving WF Credit Agreement. The proceeds of the 11% Notes issuance were partially offset by dividends paid of $16.4 million, distributions to noncontrolling shareholders of $12.3 million, purchase of treasury shares of $4.1 million and repayment of long-term debt of $1.1 million. In addition, the Company made acquisition related payments of $34.3 million of which $31.2 million related to earnout and deferred acquisition payments and $3.1 million related to acquisition of additional equity interests pursuant to put/call option exercises. Total Debt 6.75% Senior Notes Due 2020 On March 20, 2013, MDC Partners Inc. ("MDC") entered into an indenture (the "Indenture") among MDC, its existing and future restricted subsidiaries that guarantee, or are co-borrowers under or grant liens to secure, MDC's senior secured revolving credit agreement (the "Credit Agreement"), as guarantors (the "Guarantors") and The Bank of New York Mellon, as trustee, relating to the issuance by MDC of its 6.75% Senior Notes due 2020 (the "6.75% Notes"). The 6.75% Notes bear interest at a rate of 6.75% per annum, accruing from March 20, 2013. Interest is payable semiannually in arrears in cash on April 1 and October 1 of each year, beginning on October 1, 2013. The 6.75% Notes will mature on April 1, 2020, unless 33 -------------------------------------------------------------------------------- TABLE OF CONTENTS earlier redeemed or repurchased. The Company received net proceeds from the offering of the 6.75% Notes equal to approximately $537.6 million. The Company used the net proceeds to redeem all of the existing 11% Notes, together with accrued interest, related premiums, fees and expenses and recorded a charge during the nine months ended September 30, 2013, for loss on redemption of notes of $55.6 million, including write offs of unamortized original issue premium and debt issuance costs. Remaining proceeds were used for general corporate purposes. On November 15, 2013, the Company issued an additional $110 million aggregate principal amount of its 6.75% Notes. The additional notes were issued under the Indenture governing the 6.75% Notes and treated as a single series with the original 6.75% Notes. The additional notes were sold in a private placement in reliance on exceptions from registration under the Securities Act of 1933, as amended. The Company received net proceeds before expenses of $111.9 million, which included an original issue premium of $4.1 million, and underwriter fees of $2.2 million. The Company used the net proceeds of the offering for general corporate purposes. The 6.75% Notes are guaranteed on a senior unsecured basis by all of MDC's existing and future restricted subsidiaries that guarantee, or are co-borrowers under or grant liens to secure, the Credit Agreement. The 6.75% Notes are unsecured and unsubordinated obligations of MDC and rank (i) equally in right of payment with all of MDC's or any Guarantor's existing and future senior indebtedness, (ii) senior in right of payment to MDC's or any Guarantor's existing and future subordinated indebtedness, (iii) effectively subordinated to all of MDC's or any Guarantor's existing and future secured indebtedness to the extent of the collateral securing such indebtedness, including the Credit Agreement, and (iv) structurally subordinated to all existing and future liabilities of MDC's subsidiaries that are not Guarantors. MDC may, at its option, redeem the 6.75% Notes in whole at any time or in part from time to time, on and after April 1, 2016 at a redemption price of 103.375% of the principal amount thereof if redeemed during the twelve-month period beginning on April 1, 2016, at a redemption price of 101.688% of the principal amount thereof if redeemed during the twelve-month period beginning on April 1, 2017 and at a redemption price of 100% of the principal amount thereof if redeemed on April 1, 2018 and thereafter. Prior to April 1, 2016, MDC may, at its option, redeem some or all of the 6.75% Notes at a price equal to 100% of the principal amount of the 6.75% Notes plus a "make whole" premium and accrued and unpaid interest. MDC may also redeem, at its option, prior to April 1, 2016, up to 35% of the 6.75% Notes with the proceeds from one or more equity offerings at a redemption price of 106.750% of the principal amount thereof. If MDC experiences certain kinds of changes of control (as defined in the Indenture), holders of the 6.75% Notes may require MDC to repurchase any 6.75% Notes held by them at a price equal to 101% of the principal amount of the 6.75% Notes plus accrued and unpaid interest. In addition, if MDC sells assets under certain circumstances, it must offer to repurchase the 6.75% Notes at a price equal to 100% of the principal amount of the 6.75% Notes plus accrued and unpaid interest. The Indenture includes covenants that, among other things, restrict MDC's ability and the ability of its restricted subsidiaries (as defined in the Indenture) to incur or guarantee additional indebtedness; pay dividends on or redeem or repurchase the capital stock of MDC; make certain types of investments; create restrictions on the payment of dividends or other amounts from MDC's restricted subsidiaries; sell assets; enter into transactions with affiliates; create liens; enter into sale and leaseback transactions; and consolidate or merge with or into, or sell substantially all of MDC's assets to, another person. These covenants are subject to a number of important limitations and exceptions. The 6.75% Notes are also subject to customary events of default, including cross-payment default and cross-acceleration provisions. Redemption of 11% Senior Notes Due 2016 On March 20, 2013, the Company redeemed all of the 11% Senior Notes due 2016. Revolving Credit Agreement On March 20, 2013, MDC, Maxxcom Inc. (a subsidiary of MDC) and each of their subsidiaries party thereto entered into an amended and restated, $225 million senior secured revolving credit agreement due 2018 (the "Credit Agreement") with Wells Fargo Capital Finance, LLC, as agent, and the lenders from time 34 -------------------------------------------------------------------------------- TABLE OF CONTENTS to time party thereto. Advances under the Credit Agreement will be used for working capital and general corporate purposes, in each case pursuant to the terms of the Credit Agreement. Capitalized terms used in this section and not otherwise defined have the meanings set forth in the Credit Agreement. Advances under the Credit Agreement bear interest as follows: (a)(i) LIBOR Rate Loans bear interest at the LIBOR Rate and (ii) Base Rate Loans bear interest at the Base Rate, plus (b) an applicable margin. The initial applicable margin for borrowing is 1.25% in the case of Base Rate Loans and 2.00% in the case of LIBOR Rate Loans. In addition to paying interest on outstanding principal under the Credit Agreement, MDC is required to pay an unused revolver fee to lenders under the Credit Agreement in respect of unused commitments thereunder. The Credit Agreement is guaranteed by substantially all of MDC's present and future subsidiaries, other than immaterial subsidiaries and subject to customary exceptions. The Credit Agreement includes covenants that, among other things, restrict MDC's ability and the ability of its subsidiaries to incur or guarantee additional indebtedness; pay dividends on or redeem or repurchase the capital stock of MDC; make certain types of investments; impose limitations on dividends or other amounts from MDC's subsidiaries; incur certain liens, sell or otherwise dispose of certain assets; enter into transactions with affiliates; enter into sale and leaseback transactions; and consolidate or merge with or into, or sell substantially all of MDC's assets to, another person. These covenants are subject to a number of important limitations and exceptions. The Credit Agreement also contains financial covenants, including a total leverage ratio, a senior leverage ratio, a fixed charge coverage ratio and a minimum earnings level (each as more fully described in the Credit Agreement). The Credit Agreement is also subject to customary events of default. The foregoing descriptions of the Indenture and the Credit Agreement do not purport to be complete and are qualified in their entirety by reference to the full text of the agreements. Debt excluding the premium on the notes as December 31, 2013 was $661.1 million, an increase of $229.4 million, compared with $431.7 million outstanding at December 31, 2012. This increase in debt was a result of the Company's issuance of its 6.75% Notes offset by the repayment of its 11% Notes. At December 31, 2013, approximately $220.1 million was available under the Credit Agreement. The Company is currently in compliance with all of the terms and conditions of the Credit Agreement, and management believes, based on its current financial projections, that the Company will be in compliance with its covenants over the next twelve months. If the Company loses all or a substantial portion of its lines of credit under the Credit Agreement, or if the Company uses the maximum available amount under the Credit Agreement, it will be required to seek other sources of liquidity. If the Company were unable to find these sources of liquidity, for example through an equity offering or access to the capital markets, the Company's ability to fund its working capital needs and any contingent obligations with respect to put options would be adversely affected. Pursuant to the Credit Agreement, the Company must comply with certain financial covenants including, among other things, covenants for (i) senior leverage ratio, (ii) total leverage ratio, (iii) fixed charges ratio, and (iv) minimum earnings before interest, taxes and depreciation and amortization, in each case as such term is specifically defined in the Credit Agreement. For the period ended December 31, 2013, the Company's calculation of each of these covenants, and the specific requirements under the Credit Agreement, respectively, were as follows: [[Image Removed]] [[Image Removed]] December 31, 2013 Total Senior Leverage Ratio (0.47 ) Maximum per covenant 2.00 Total Leverage Ratio 3.41 Maximum per covenant 5.50 Fixed Charges Ratio 3.11 Minimum per covenant 1.00 Earnings before interest, taxes, depreciation and $ 170.3 million amortization Minimum per covenant $ 105 million 35 -------------------------------------------------------------------------------- TABLE OF CONTENTS These ratios are not based on generally accepted accounting principles and are not presented as alternative measures of operating performance or liquidity. They are presented here to demonstrate compliance with the covenants in the Company's Credit Agreement, as non-compliance with such covenants could have a material adverse effect on the Company. Disclosure of Contractual Obligations and Other Commercial Commitments The following table provides a payment schedule of present and future obligations. Management anticipates that the obligations outstanding at December 31, 2013 will be repaid with new financing, equity offerings and/or cash flow from operations (in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Payments Due by Period Contractual Total Less than 1 - 3 Years 3 - 5 Years After Obligations 1 Year 5 Years Indebtedness $ 660,120 $ 40 $ 80 $ - $ 660,000 Capital lease 952 427 525 - - obligations Operating leases 265,578 41,166 76,340 61,376 86,696 Interest on debt 278,438 44,550 89,100 89,100 55,688 Deferred acquisition 153,913 53,041 78,624 22,248 - consideration Other Long-term 18,947 6,026 5,528 5,173 2,220 LiabilitiesTotal contractual $ 1,377,948 $ 145,250 $ 250,197 $ 177,897 $ 804,604 obligations(1) [[Image Removed]] (1) Pension obligations are not included since payments are not known. The following table provides a summary of other commercial commitments (in thousands) at December 31, 2013: [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Payments Due by Period Other Commercial Total Less than 1 - 3 Years 3 - 5 Years After Commitments 1 Year 5 Years Lines of credit $ - $ - $ - $ - $ - Letters of credit $ 4,884 4,884 - - - Total Other Commercial $ 4,884 $ 4,884 $ - $ - $ - Commitments For further detail on MDC's long-term debt principal and interest payments, see Note 11 Bank Debt and Long-Term Debt and Convertible Notes and Note 17 Commitments, Contingents and Guarantees of the Company's consolidated financial statements included in this Form 10-K. See also "Deferred Acquisition and Contingent Consideration (Earnouts)" and "Other-Balance Sheet Commitments" below. Capital Resources At December 31, 2013, the Company had only utilized the Credit Agreement in the form of undrawn letters of credit of $4.9 million. Cash and undrawn available bank credit facilities to support the Company's future cash requirements at December 31, 2012 was approximately $322.1 million. The Company expects to incur approximately $25 million of capital expenditures in 2014. Such capital expenditures are expected to include leasehold improvements, furniture and fixtures, and computer equipment at certain of the Company's operating subsidiaries. The Company intends to maintain and expand its business using cash from operating activities, together with funds available under the Credit Agreement. Management believes that the Company's cash flow from operations, funds available under the Credit Agreement and other initiatives will be sufficient to meet its ongoing working capital, capital expenditures and other cash needs over the next twelve months. If the Company continues to spend capital on future acquisitions, management expects that the Company may need to obtain additional financing in the form of debt and/or equity financing. 36 -------------------------------------------------------------------------------- TABLE OF CONTENTS Deferred Acquisition and Contingent Consideration (Earnouts) Acquisitions of businesses by the Company may include commitments to contingent deferred purchase consideration payable to the seller. These contingent purchase obligations are generally payable within a one to five-year period following the acquisition date, and are based on achievement of certain thresholds of future earnings and, in certain cases, also based on the rate of growth of those earnings. Contingent purchase price obligations for acquisitions completed prior to January 1, 2009 are accrued when the contingency is resolved and payment is certain. Contingent purchase price obligations related to acquisitions completed subsequent to December 31, 2008 are recorded as liabilities at estimated value and are remeasured at each reporting period and changes in estimated value are recorded in results of operations. At December 31, 2013, there was $153.9 million of deferred consideration included in the Company's balance sheet. Other-Balance Sheet Commitments Media and Production The Company's agencies enter into contractual commitments with media providers and agreements with production companies on behalf of our clients at levels that exceed the revenue from services. Some of our agencies purchase media for clients and act as an agent for a disclosed principal. These commitments are included in accounts payable when the media services are delivered by the media providers. MDC takes precautions against default on payment for these services and has historically had a very low incidence of default. MDC is still exposed to the risk of significant uncollectible receivables from our clients. The risk of a material loss could significantly increase in periods of severe economic downturn. Put Rights of Subsidiaries' Noncontrolling Shareholders Owners of interests in certain of the Company's subsidiaries have the right in certain circumstances to require the Company to acquire either a portion of or all of the remaining ownership interests held by them. The owners' ability to exercise any such "put option" right is subject to the satisfaction of certain conditions, including conditions requiring notice in advance of exercise. In addition, these rights cannot be exercised prior to specified staggered exercise dates. The exercise of these rights at their earliest contractual date would result in obligations of the Company to fund the related amounts during the period 2014 to 2019. 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 put option rights are exercised is dependent on various valuation formulas and on future events, such as the average earnings of the relevant subsidiary through that date of exercise, the growth rate of the earnings of the relevant subsidiary during that period, and, in some cases, the currency exchange rate at the date of payment. Management estimates, assuming that the subsidiaries owned by the Company at December 31, 2013, perform over the relevant future periods at their 2013 earnings levels, that these rights, if all exercised, could require the Company, in future periods, to pay an aggregate amount of approximately $17.8 million to the owners of such rights to acquire such ownership interests in the relevant subsidiaries. Of this amount, the Company is entitled, at its option, to fund approximately $1.3 million by the issuance of the Company's Class A subordinate voting shares. In addition, the Company is obligated under similar put option rights to pay an aggregate amount of approximately $130.7 million only upon termination of such owner's employment with the applicable subsidiary or death. The Company intends to finance the cash portion of these contingent payment obligations using available cash from operations, borrowings under the WF Credit Agreement (and refinancings thereof) and, if necessary, through incurrence of additional debt. The ultimate amount payable and the incremental operating income in the future relating to these transactions will vary because it is dependent on the future results of operations of the subject businesses and the timing of when these rights are exercised. Approximately $3.1 million of the estimated $17.8 million that the Company would be required to pay subsidiaries noncontrolling shareholders' upon the exercise of outstanding "put" rights, relates to rights exercisable within the next twelve months. Upon the settlement of the total amount of such put options, the Company estimates that it would receive incremental operating income before depreciation and amortization of $4.7 million that would be attributable to MDC Partners Inc. 37 -------------------------------------------------------------------------------- TABLE OF CONTENTS The following table summarizes the potential timing of the consideration and incremental operating income before depreciation and amortization based on assumptions as described above. [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Consideration(4) 2014 2015 2016 2017 2018 & Thereafter Total ($ Millions) Cash $ 2.7 $ 4.2 $ 3.7 $ 3.9 $ 2.0 $ 16.5 Shares 0.4 0.4 0.5 0.0 0.0 1.3 $ 3.1 $ 4.6 $ 4.2 $ 3.9 $ 2.0 $ 17.8 (1) Operating income before depreciation and $ 1.8 $ 1.9 $ 0.1 $ 0.9 $ 0.0 $ 4.7 amortization to be received(2) Cumulative operating income before $ 1.8 $ 3.7 $ 3.8 $ 4.7 4.7 depreciation and amortization(3) [[Image Removed]] (1) This amount is in addition to put options only exercisable upon termination or death of $130.7 million have been recognized in Redeemable Noncontrolling Interests on the Company balance sheet. (2) This financial measure is presented because it is the basis of the calculation used in the underlying agreements relating to the put rights and is based on actual 2013 operating results. This amount represents additional amounts to be attributable to MDC Partners Inc., commencing in the year the put is exercised. (3) Cumulative operating income before depreciation and amortization represents the cumulative amounts to be received by the company. (4) The timing of consideration to be paid varies by contract and does not necessarily correspond to the date of the exercise of the put. Guarantees Generally, the Company has indemnified the purchasers of certain assets in the event that a third party asserts a claim against the purchaser that relates to a liability retained by the Company. These types of indemnification guarantees typically extend for several years. Historically, the Company has not made any significant indemnification payments under such agreements and no provision 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. Transactions With Related Parties CEO Services Agreement On April 25, 2007, the Company entered into a new Management Services Agreement (as amended and restated on May 6, 2013, the "Services Agreement") with Miles Nadal and with Nadal Management, Inc. to set forth the terms and conditions on which Miles Nadal will continue to provide services to the Company as its Chief Executive Officer. The Services Agreement is subject to automatic one-year extensions unless either party gives to the other a 60-day advance written notice of its intention not to renew. Effective January 1, 2013, the annual retainer amount (base salary) under the Services Agreement was increased to $1,750,000, and effective January 1, 2014, the annual retainer amount was increased to $1,850,000. During 2011, 2012 and 2013 and in accordance with this Services Agreement, Mr. Nadal repaid an amount equal to $0.1 million, $0.5 million and $5.4 million of loans due to the Company. As of April 26, 2013, Mr. Nadal has repaid and satisfied in full the remaining principal balance of all previously outstanding loans made by the Company to Mr. Nadal and his affiliates. After giving effect to this final repayment by Mr. Nadal to the Company, there is currently $0 remaining due and owing to the Company in respect of all prior loans. For further information, see Note 16 Related Party Transactions. 38 -------------------------------------------------------------------------------- TABLE OF CONTENTS Trapeze Media In 2000, the Company purchased 1,600,000 shares in Trapeze Media Limited ("Trapeze") for $0.2 million. At the same time, the Company's CEO purchased 4,280,000 shares of Trapeze for $0.6 million, the Company's former Chief Financial Officer and a Managing Director of the Company each purchased 50,000 Trapeze shares for $7,000 and a Board Member of the Company purchased 75,000 shares of Trapeze for $10,000. In 2001, the Company purchased an additional 1,250,000 shares for $0.2 million, and the Company's CEO purchased 500,000 shares for $0.1 million. In 2002, the Company's CEO purchased 3,691,930 shares of Trapeze for $0.5 million. All of these purchases were made at identical prices (C$0.20/unit). In 2003, the Company and the CEO exchanged their units in Trapeze for non-voting shares and entered into a voting trust agreement. During 2013 and 2011, an MDC Partner firm provided services to Trapeze in exchange for fees equal to $0.2 million and $0.4 million, respectively. Trapeze did not provide any services to MDC nor its partner firms in the three years ended December 31, 2013. The Company's Board of Directors, through its Audit Committee, has reviewed and approved these transactions. Critical Accounting Policies The following summary of accounting policies has been prepared to assist in better understanding the Company's consolidated financial statements and the related management discussion and analysis. Readers are encouraged to consider this information together with the Company's consolidated financial statements and the related notes to the consolidated financial statements as included herein 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 goodwill, intangible assets, redeemable noncontrolling interests, and deferred acquisition consideration, valuation allowances for receivables and deferred income tax assets and stock based compensation as well as the reported amounts of revenue and expenses during the 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. Revenue Recognition. The Company's revenue recognition policies are as required by the Revenue Recognition topics of the FASB Accounting Standards Codification. The Company earns revenue from agency arrangements in the form of retainer fees or commissions; from short-term project arrangements in the form of fixed fees or per diem fees for services; and from incentives or bonuses. 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 records revenue net of state taxes, when persuasive evidence of an arrangement exists, services are provided or upon delivery of the products when ownership and risk of loss has transferred to the customer, the selling price is fixed or determinable and collection of the resulting receivable is reasonably assured. The Company recognizes the incentive portion of revenue under these arrangements when specific quantitative goals are assured, or when the Company's clients determine performance against qualitative goals has been achieved. In all circumstances, revenue is only recognized when collection is reasonably assured. The Company records revenue net of sales and other taxes due to be collected and remitted to governmental authorities. In the majority of the Company's businesses, the Company acts as an agent and records revenue equal to the net amount retained, when the fee or commission is earned. In certain arrangements, the Company acts as principal and contracts directly with suppliers for third party media and production costs. In these arrangements, revenue is recorded at the gross amount billed. Additional information about our revenue recognition policy appears in Note 2 to our consolidated financial statements. Acquisitions, Goodwill and Other Intangibles. A fair value approach is used in testing goodwill for impairment to determine if an other than temporary impairment has occurred. One approach utilized to 39 -------------------------------------------------------------------------------- TABLE OF CONTENTS 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. As of December 31, 2013, there were no reporting units at risk of failing step one of the Company's annual goodwill impairment test. The Company has historically made and expects to continue to make selective acquisitions of marketing communications businesses. In making acquisitions, the price paid is determined by various factors, including service offerings, competitive position, reputation and geographic coverage, as well as prior experience and judgment. Due to the nature of advertising, marketing and corporate communications services companies; the companies acquired frequently have significant identifiable intangible assets, which primarily consist of customer relationships. The Company has determined that certain intangibles (trademarks) have an indefinite life, as there are no legal, regulatory, contractual, or economic factors that limit the useful life. Business Combinations. Valuation of acquired companies are based on a number of factors, including specialized know-how, reputation, competitive position and service offerings. Our acquisition strategy has been to focus on acquiring the expertise of an assembled workforce in order to continue building upon the core capabilities of our various strategic business platforms to better serve our clients. Consistent with our acquisition strategy and past practice of acquiring a majority ownership position, most acquisitions completed after 2010 include an initial payment at the time of closing and provide for future additional contingent purchase price payments. Contingent payments for these transactions, as well as certain acquisitions completed in prior years, are derived using the performance of the acquired entity and are based on pre-determined formulas. Contingent purchase price obligations for acquisitions completed prior to January 1, 2009 are accrued when the contingency is resolved and payment is certain. Contingent purchase price obligations related to acquisitions completed subsequent to December 31, 2008 are recorded as liabilities at estimated value and are remeasured at each reporting period. Changes in estimated value are recorded in results of operations. In addition, certain acquisitions also include put/call obligations for additional equity ownership interests. The estimated value of these interests are recorded as redeemable noncontrolling interests. As of January 1, 2009, the Company expenses acquisition related costs in accordance with the Accounting Standard's Codification's guidance on acquisition accounting. For each of our acquisitions, we undertake a detailed review to identify other intangible assets and a valuation is performed for all such identified assets. We use several market participant measurements to determine estimated value. This approach includes consideration of similar and recent transactions, as well as utilizing discounted expected cash flow methodologies. Like most service businesses, a substantial portion of the intangible asset value that we acquire is the specialized know-how of the workforce, which is treated as part of goodwill and is not required to be valued separately. The majority of the value of the identifiable intangible assets that we acquire is derived from customer relationships, including the related customer contracts, as well as trade names. In executing our acquisition strategy, one of the primary drivers in identifying and executing a specific transaction is the existence of, or the ability to, expand our existing client relationships. The expected benefits of our acquisitions are typically shared across multiple agencies and regions. Redeemable Noncontrolling Interest. The minority interest shareholders of certain subsidiaries have the right to require the Company to acquire their ownership interest under certain circumstances pursuant to a contractual arrangement and the Company has similar call options under the same contractual terms. The amount of consideration under the put and call rights is not a fixed amount, but rather is dependent upon 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 through the date of exercise, etc. 40 -------------------------------------------------------------------------------- TABLE OF CONTENTS Allowance for Doubtful Accounts. Trade receivables are stated less allowance for doubtful accounts. The allowance represents estimated uncollectible receivables usually due to customers' potential insolvency. The allowance includes amounts for certain customers where risk of default has been specifically identified. Income Tax Valuation Allowance. The Company records a valuation allowance against deferred income tax assets when management believes it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Management considers factors such as the reversal of deferred income tax liabilities, projected future taxable income, the character of the income tax asset, tax planning strategies, changes in tax laws and other factors. A change to any of these factors could impact the estimated valuation allowance and income tax expense. Interest Expense. Interest expense primarily consists of the cost of borrowing on the revolving WF Credit Agreement and the 6.75% Notes. The Company uses the effective interest method to amortize the original issue discount and original issue premium on the 6.75% Notes. The Company amortizes deferred financing costs using the effective interest method over the life of the 6.75% Notes and straight line over the life of the revolving WF Credit Agreement. Stock-based Compensation. The fair value method is applied to all awards granted, modified or settled. Under the fair value method, compensation cost is measured at fair value at the date of grant and is expensed over the service period that is the award's vesting period. When awards are exercised, share capital is credited by the sum of the consideration paid together with the related portion previously credited to additional paid-in capital when compensation costs were charged against income or acquisition consideration. Stock-based awards that are settled in cash or may be settled in cash at the option of employees are recorded as liabilities. The measurement of the liability and compensation cost for these awards is based on the fair value of the award, and is recorded into operating income over the service period, that is the vesting period of the award. Changes in the Company's payment obligation are revalued each period and recorded as compensation cost over the service period in operating income. The Company treats benefits paid by shareholders to employees as a stock based compensation charge with a corresponding credit to additional paid-in capital. New Accounting Pronouncements Information regarding new accounting guidance can be found in Note 18 to our consolidated financial statements. |