Matt Chesler - MDC Partners, Inc. Scott L. Kauffman - MDC Partners, Inc. David B. Doft - MDC Partners, Inc..

Peter C. Stabler - Wells Fargo Securities LLC Christopher Barnes - Telsey Advisory Group LLC Leo Kulp - RBC Capital Markets LLC Barry L. Lucas - Gabelli & Company.

Good afternoon, and welcome to the MDC Partners' Second Quarter Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Matt Chesler. Please go ahead..

Good afternoon, everyone. I'd like to thank you for taking the time to listen to the MDC Partners' conference call for the second quarter of 2017. Joining me today from MDC are Scott Kauffman, Chairman and CEO; and David Doft, Chief Financial Officer.

Before we begin our prepared remarks, I'd like to remind you, all, that the following discussion contains forward-looking statements and non-GAAP financial data.

As we all know, forward-looking statements about the company are subject to uncertainties referenced in the cautionary statement included in our earnings release and slide presentation and are further detailed in the company's Form 10-K and subsequent SEC filings. For your reference, we've posted an investor presentation to our website.

We also refer you to this afternoon's press release and slide presentation for definitions, explanations and reconciliations of non-GAAP financial data. And now, to start the call, I'd like to turn it over to our chairman and CEO, Scott Kauffman..

Thank you, Matt, and good afternoon, everyone. We had a strong second quarter. Revenue of $390 million increased 16% year-over-year, including an acceleration of organic revenue growth to nearly 12% or 8% on a net basis, significantly outpacing the industry. Performance was particularly strong in the U.S.

with 11.5% organic growth and overseas with 28.5% organic growth. We generated $47 million of adjusted EBITDA, which was an increase of 12% year-over-year, even as we continue to allocate resources to our robust new business activity and to invest in emerging growth initiatives in order to sustain our competitive lead.

Adjusted EBITDA was also impacted by some revenue recognition delays. Net new business was a healthy $26 million, including wins such as Bombardier, Electrolux, IKEA and Amazon. Importantly, we're growing our relationships with our largest clients. Cash generation was strong, including a $17 million seasonal inflow of working capital.

And consistent with our priority to strengthen our balance sheet, after funding $84 million of acquisition-related payments during the quarter, we've now reduced our deferred consideration and minority interest to the lowest level in over five years.

At the midway point of the year, we believe we're pacing very well against our full year 2017 financial goals, and David will elaborate on how we're tracking in just a moment.

What I'd like to do now is spend a few minutes talking about why we are outperforming versus the industry and why we believe we're well positioned to continue to be a leader for years to come.

The successes we're having goes to the heart of the core strategic positioning of MDC, our modern operating model and our unique culture and entrepreneurial mindset. To be sure, we're operating in an intensely competitive, fast-changing world. New entrants are disrupting entire industries, putting real pressure on incumbent brands.

Both the incumbents and emerging players need us to reach prospects and customers, drive profitable sales growth and deliver ROI. We're extremely well positioned for this changing and fluid environment.

Remember that MDC became a pure play in the advertising and marketing services industry a decade ago at a time when the Internet already existed with the foundational premise that everything was digital or at least would eventually become so, a post (04:20)-digital world as we now call it.

Our mission was and continues to be to drive lasting competitive advantage and business growth for clients regardless of the media or method. And because of that premise, the businesses within our portfolio are adept at understanding changes in consumer behavior and adopting new technology solutions on behalf of our clients.

We're not invested in an infrastructure built around a TV model as others are, so the dramatic shifts taking place today related to advertising, content, and commerce are less monumental organizationally for us.

And when you're sitting with just a 1% share of the global market for advertising-related services, we see all of this disruption as a set of tremendous opportunities. It's incumbent upon a business like ours to continuously advance our offering.

Today, it's not just TV or even advertising, it's product innovation and design, e-commerce, CRM, building technology platforms, it's leveraging data analytics on omni-channel customers to drive marketing programs and increasingly to inform business decisions based on those insights.

Now, a lot has been written lately about the advent of traditional management consulting companies coming into our competitive landscape, but the reality is that we've been consultants all along in the form of outsourced functions with a specific and unique expertise that we bring to clients.

Where we're fundamentally different from those who lead with consulting, however, is that we bring unmatched creativity to our clients' business challenges. We made the bet that, in a changing world, new technologies will emerge and data will move front and center, but leveraging these assets to win will always depend on creativity at the core.

Others can execute, but they simply don't have our portfolio of the world's most creative agencies. At the same time, we've been investing across our company to continue to build out specialist capabilities to leverage against the portfolio and capture incremental budgets.

In digital transformation, we're doing this with focused agencies, such as GALE Partners, and by fueling more data-at-the-center offerings. In mobile strategy and development, we're doing it at Y Media Labs in addition to within our core businesses.

In artificial intelligence, we're doing it at our media business and its dedicated agency offering called BORN. In product innovation and business strategy at Redscout, and many others. This is in addition to the creative agencies which form the core of our portfolio and which offer many of these same components as part of an integrated solution.

It's not lost on us that a number of key industry verticals are ground zero for these massive shifts; CPG, retail, financial services, travel. But regardless of the vertical, our agencies are trusted advisors to our clients for how to grow their businesses and adapt to an ever-changing marketplace.

Our appeal as a change agent is particularly compelling to established brands, when some cases have been with their legacy agencies for decades. And because of our disruptive approach, we're equally attractive to emerging and challenger brands that are transforming their respective industries.

Maintaining a diverse portfolio of client relationships ensures that we remain relevant. A great example is food and beverage, where we're bucking industry trends and consolidating relationships with major brands. And we also count the giant disrupting tech firms among our largest clients.

With regard to international, our global hub model lines up quite nicely with growing client requirements for efficiency and consistency of message and new technologies which streamline the distribution of creative content and data.

We're just a handful of years into our global expansion and are, therefore, fortunate that we're not saddled with an extensive and distributed global infrastructure which just isn't needed anymore.

This year, you're seeing MDC agencies expand in Australia, Singapore, and Germany and we're doing so with a deliberate approach that's leading to new and growing client relationships with brands such as eBay, Bayer, Huawei, IKEA, Belvedere Vodka, Embraer, Volvo and Electrolux, all of which are leveraging our overseas offering in 2017.

It's clear to clients who are looking for seamless integration of services and collaboration across functions, but we don't need a buzzword to talk about how we're structured to optimize on behalf of clients. MDC is born out of like-minded entrepreneurs who are accustomed to partnering with other specialists.

It's in our DNA and that's why our top 10 clients work with an average of four separate MDC agencies. We're seeing particularly strong revenue increases from our largest clients with growth from our top 25 meaningfully exceeding the company's growth overall in the second quarter.

You've often heard us say that we're not a proxy for the advertising market and that's true, nor are we a proxy for the broadcast TV upfront or the scatter market or the sustainability of the pay TV bundle or the impact of click fraud and brand safety or whether anyone will emerge as a legitimate third player to challenge the Google/Facebook duopoly or the cost pressures faced by CPG companies and the move to zero-based budgeting or GDP growth in China or Brazil for that matter.

We're not a proxy for the acquisition de jure by choose your consulting firm or which industry will Amazon eat next for lunch. We aren't a proxy for any of those things, but there is so much noise out there about all of these issues. I want you to keep just one thing in mind.

Marketers are fed up with the status quo, and our agencies represent change, a fresh, modern, creative approach to traditional practices. The bottom line is that our performance is not tied up with the issues associated with the traditional legacy holding companies. All of those challenges for others represent opportunity for us.

The most common cause of an account loss is a change in the client stakeholder. And as the average tenure of the Chief Marketing Officer continues to decline, it's good to be a change agent. Ultimately, the success of MDC Partners is tied to our ability to deliver our clients – for our clients.

And in that regard, we're confident that we have a long runway of growth ahead of us. And now, I'd like to turn the call over to David..

Thank you, Scott, and good afternoon. It should be clear from Scott's remarks that we're confident in our business and our prospects. You've seen over the past few quarters that we've restored the growth profile of the company. We've turned cost management to a best practice both at the agencies as well as at the parent company.

And something I'm particularly satisfied about, we've put in the place a long-term capital structure suitable for a growth company like ours and have made real progress reducing our contingent liabilities.

With that brief intro, I'd like to begin by addressing a couple of items that drove adjusted EBITDA in the quarter, and then I'll speak more to our exceptionally strong top line in a moment. First is timing. There was about $3 million of revenue that we could not recognize in time for the second quarter for work already completed.

We expect to recognize most, if not all, of this revenue in the third quarter. But we already booked the expense in Q2. So, it will drop right to the bottom line in Q3. And second, our margins in the quarter were impacted in a material way by the higher pass-through revenue.

One component came from Forsman & Bodenfors which we acquired this past year and which has a higher mix of principal relationships and therefore lower GAAP margin. The other piece came from the series of projects which were completed in the quarter and which had a higher component of billable costs.

The combined impact of these two specific items was to reduce our reported adjusted EBITDA margins by 70 basis points.

In other words, excluding these two items, our GAAP adjusted EBITDA margins would have expanded year-over-year by 30 basis points, and this is without taking into account the 70 basis points hit to margins from the $3 million of revenue being pushed out of Q2 into Q3. Those are the key variables.

Net-net, our revenue growth was tremendous and we expect to see better conversion of that revenue growth on a reported basis as we move through the year. Organic revenue growth was very strong, accelerating to 11.7% in the quarter from 5.6% in Q1.

This included 360 basis points of higher billable pass-throughs related to costs incurred on clients' behalf, as just noted. Any way you look at it, our organic growth for the second quarter is likely to shake out nearly five times better than the industry average or more.

In the U.S., our business outperformed with 11.5% organic growth driven by net new client wins and increased spending from existing clients. Canada continues to lag at a negative 2.5% that would improve sequentially by over 500 basis points from the first quarter and the decline was entirely due to the pass-through dynamic.

Our business outside of North America improved to 28.5% growth, driven by new client wins. And lastly, performance was broadly strong across client verticals, especially in communications, food and beverage and financials. Consumer products also increased with a decline in technology, but this was wholly due to the Samsung loss from 2016.

I'd also like to highlight a couple of items related to our balance sheet and cash flow. We ended the quarter with $20 million of cash on the balance sheet and $26 million drawn on our revolving credit facility.

Our revolver draw was up only modestly from the $5 million drawn in March despite making $30 million in cash interest payments including the six-month coupon on our senior notes and funding $60 million in cash acquisition-related payments. Cash flow from operation was strong.

Importantly, we have now passed a significant milestone in terms of reducing our deferred acquisition consideration liability and the burden on our cash generation.

During the quarter, we made a total of $84 million of acquisition-related payments, including $24 million funded with MDC Class A shares and this represents the peak amounts that we'll owe for prior acquisition, an inflection point. We expect to pay $30 million in the second half of this year.

And then, the annual payments are forecasted to come down materially in 2018 and thereafter relative to the full year 2017. This will have a positive impact on cash flow going forward, strengthening our credit profile and enabling us to allocate resources to appropriate long-term value-creating initiatives.

In terms of our financial outlook, given the strong top line trend year-to-date, we are pacing ahead of the approximately 4% organic growth target that we provided at the beginning of the year.

At the same time, a combination of higher-than-expected billable pass-through expenses and incremental costs associated with our robust new business and growth activities is translating to more modest margin expansion for the current year. Accordingly, we are updating our formal guidance.

We are now targeting approximately 7% organic revenue growth and an improvement in adjusted EBITDA margin of approximately 60 basis points.

Taken together, we remain on track to achieve our 2017 profit targets, and I would note that we're still tracking to deliver 100 basis points of margin improvement, if you backed out the impact of the higher pass-throughs. And now, I want to cover a couple of housekeeping items.

First, you'll notice that the prior period tax expense is slightly higher by $300,000 per quarter in 2016, as was the year-end 2016 deferred tax liability on the balance sheet by approximately $7 million.

These adjustments were identified internally through our normal course process and relate to the recalculation of our historical deferred tax liability attributable to prior acquisitions. They were deemed to be immaterial changes and will be reflected prospectively in our financials going forward.

The adjustments are also unrelated to any cash taxes paid in the past or owed in the future or to the tax-deductible structure of many of our acquisitions. There will be a related disclosure in our upcoming 10-Q.

And finally, for the last year or so, the company has been in ongoing correspondence and discussion with the SEC regarding our segment disclosures and these comments relating to segment reporting currently remain unresolved.

Given the reorganization of corporate leadership in the first half of 2016, per the accounting guidance, we reevaluated our reporting structure and its impact on our financial reporting. This led to two changes that we previously disclosed last year. One, is that we now test (18:08) for goodwill impairment at the operating segment or agency level.

Two, is that we amended the aggregation of our operating segments to a single reportable segment and in other segment. Based on our most recent conversations with the Commission, it's now clear that we need to reevaluate and recast the aggregation of our reportable segments.

This, in no way, changes the overall consolidated financials as they are reported or any underlying figures, not the least of which includes today's positive results. It also has nothing to do with goodwill. It only impacts how we group our portfolio of agencies and presented for public reporting and disclosure purposes.

Our team is working diligently to finalize the most appropriate allocations for new reporting segments in time for our upcoming 10-Q filing deadline on Wednesday. However, if our work is not completed by Wednesday, we will promptly obtain an extension to file the 10-Q. We'd now like to take your questions..

We will now begin the question-and-answer session. The first question comes from Peter Stabler with Wells Fargo Securities. Please go ahead..

Good afternoon. Thanks for taking the question. I got a couple. David, could you tell us – on the pass-through, generally speaking, our pass-through is increasing as a percent of total company revenue.

And then, secondly, can you remind us the status of MDC? You guys do or do not pass through any media buying in particular in the pass-through? And then, I've got one more. Thanks..

Sure. Thank you, Peter. So, clearly, in this quarter, pass-through did increase as a percent of revenue, which is why it was additive to the overall organic growth profile of the company. As you recall, we had prior periods where our revenue was impacted on the negative side by similar-sized swings to pass-throughs.

And I think the first half of last year was a great example of that. But it tends to be somewhat volatile and a bit unpredictable. Over time, outside of the Forsman & Bodenfors acquisition, which based on the structure of their contract that's principal (20:48), has a little bit more pass-through related to production costs than other agencies.

It shouldn't materially change from what we've seen in the past from what we can tell. As far as media, there is a minimal and very immaterial amount of media that we're a principal on. Our media buying business at MDC Media Partners goes to market entirely transparent. And so, it's not our practice to be – take principal positions in media..

Great. Helpful. Thanks. And then, a quick one for Scott, if I could. You talked in your prepared remarks about not being dependent upon legacy structures alluding to television. Wondering if you could offer a little bit more color there.

Are you saying that your agencies, kind of as a percent of output, are producing substantially less television? And could you help us understand what exactly – when you say kind of burdened by that infrastructure, what exactly does that mean? Thanks so much..

Sure. I'll tackle it in two ways. First, let's talk about the media selection process and the focus of the industry on the relative health of those various categories. It's somewhat immaterial to us in the sense that we are always agents for our clients, who have a prescribed need to affect a certain level of communication with prospects and customers.

Historically and traditionally, that was typically through traditional measured media, television, print and outdoor. There are many, many more choices available today, and the consumers are making themselves available in many different ways today.

And so, today's modern agency, while it can still execute television very well and we don't think television is going away anytime soon and we're certainly quite proficient at it, we're more focused on what the specific needs of each individual clients are and there's no formulaic answer.

So, when we think about creativity, we're really expanding the very definition of creativity and expanding the class of activity that comes under the guise of creativity. And so, again, we're not dependent on any one formula.

When we talk about infrastructure broadly, we're also talking about just the overall footprint, particularly as it relates to the increasingly global presence of our agencies and the ability to bring messaging across the globe on behalf of clients that are looking for a broader solution.

We used to be referred to as a collection of creative boutiques.

But with the advent of technology and the settling of the grid, those creative boutiques are now increasingly global agency of record for the world's most iconic brands and – but we're not burdened with a lot of offices in a lot of cities around the world or any of the feet on the street or infrastructure that the so called traditional holding companies are grappling with right now.

Being born in a modern age when the Internet was already in place allows us to operate in a far more efficient and effective manner on behalf of our clients..

Thank you..

The next question comes from Tom Eagan of Telsey Advisory Group. Please go ahead..

Hi. Good afternoon. This is actually Chris Barnes on for Tom. Thanks for taking our questions. So, we've heard from some of your other agency peers that U.S. clients are holding back on spending.

Are you seeing any political issues weighing on ad spending with any of your clients or any of your verticals?.

When we say we're not a proxy for what's going on in the industry, it's in large measure because clients are reevaluating a lot of those legacy relationships.

And so, as we look at just the extent of our organic growth and the current status of our pipeline, we see that we can be oftentimes the very beneficiary of that internal questioning of the status quo..

Okay. Thank you.

And then, could you just provide some more details on your plans to pay down debt after the DAC payments this year? Is it possible that we could see MDC return to the M&A market next year?.

Sure. So, our capital structure is made up of our revolver and $900 million of senior notes that are due in 2024. We don't intend to prepay those senior notes in the short term.

And so, the cash generation of the company will continue to fund the deferred acquisition consideration that remains, pay down our revolver and we expect to be in a cash balance with zero drawn at the revolver at year-end. And then, that does begin to give us flexibility to potentially look to invest again in the business.

But I would add that our intentions is to do that in a way that is respectful of our balance sheet targets to continue to bring leverage down over time..

Okay. Thank you very much..

The next question comes from Leo Kulp with RBC Capital Markets. Please go ahead..

Hi. Good afternoon, and thanks for taking the question. I just had two quick ones.

First, can you talk about your expected margin ramp over the remainder of the year? You've got that $3 million zero cost revenue in 3Q, is that enough to drive meaningful margin expansion or is it going to be really 4Q weighted?.

So, we do expect to have margin expansion both in 3Q and 4Q. If you look at the trajectory of EBITDA for our year, what we're looking for in an absolute amount of EBITDA in the second half relative to our target for the full year is well within the range of what we've done historically in the second half.

And seasonally, second half typically has higher margins than the first half. I would also add, our comparisons in the second half are a little bit easier. Second half last year was not what any of us hoped for. So, our expectation is that we'll be able to see margin expansion both in 3Q and 4Q..

Got it. Okay.

And then, on your organic growth guidance for the full year, what are you assuming there in terms of pass-through for the impact on the top line? Will it be comparable to the – I think you said 360 bps you saw this quarter?.

We're assuming a bit more modest than that. The pass-through does tend to bounce around a bit. And as I said, it's a bit unpredictable. And so, we're not assuming that it contributes much to growth in the second half..

Thank you, David..

Thank you..

The next question comes from Barry Lucas with Gabelli & Company. Please go, ahead..

Thank you, and good afternoon. Scott, I was hoping you could talk about two things, one, the new business pipeline. And then, just to remind us when the Samsung business is lapped and we get beyond that picket (28:01)? And I have one other..

So, the new business pipeline, as you might have gathered, we often talk about it as being robust and you saw that reflected both in the combination of organic growth and net new business activity for the first half of the year. And it continues the pace.

And this gets back to what we're talking about as market peers are looking for new solutions, unhappy with the status quo and continuing to put rather significant pieces of business into review.

So, we are very oftentimes invited to those conversations and like our position and, again, believe we have a unique point of view and a unique place in the world and just doubling down on creativity and going forward with a set of product offerings that the marketers continually – are continuing to find quite compelling.

We don't get into specifics of any one review or any one bake-off. But this is a game of winning more than you lose. And as we've reflected in our net new business, we continue to do that..

As for Samsung, Barry, as we previously disclosed, we lost it in two parts last year. The first part was the end of 1Q, so we cycled that for 2Q. The second part we lost at the end of 3Q, so we have one more quarter of the drag of cycling that business..

Okay. Thank you, David.

And the last item for me, as you have looked at the balance sheet and the remaining deferred acquisition costs at, let's call it, at yearend, what – assuming no further M&A in 2018, where do you kind of ballpark the payments, on average, in 2018 and beyond?.

So, if you look at what we're telling you about the second half, we expect to fund $30 million in the second half. And offsetting that will be $3 million, $3.5 million a quarter of time value accretion because it's presented on the balance sheet at fair value. And so, that's – a time value discount is implied in that.

So, about $3.5 million a quarter of accretion so you can do the math from what we reported on this balance sheet to what the yearend may look like. And then, going forward 2018, at this point, we're looking for at least a 35%, maybe 40% drop from the amount of payments that were made in 2017.

But ultimately, actual performance, as we move through this year, will determine what the ultimate amount will be in 2018..

Great. Thanks for that, David..

Sure thing..

This concludes our question-and-answer session. I would like to turn the conference back over to Scott Kauffman for any closing remarks..

Thank you, operator. In closing, I just want to mark our progress halfway through the year and express our confidence that we're very well positioned to deliver on our expectations for the year. And with that, I'd like to extend my sincerest appreciation and deepest gratitude to our talented employees and partners and to you, our fellow shareholders.

Your continued confidence, investment and partnership in our business remains the very foundation of the value we work so hard to build upon each and every day. Good afternoon from New York City..

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect..