Stagwell Inc (STGW) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis are based on and should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Form 10-K. The following discussion and analysis contains forward-looking statements and should be read in conjunction with the disclosures and information contained and referenced under the captions “Forward-Looking Statements” and “Risk Factors” in this Form 10-K. The following discussion and analysis also includes a discussion of certain non-GAAP financial measures. A description of the non-GAAP measures discussed in this section and reconciliations to the comparable GAAP measures are below.
In this section, the terms “Stagwell,” “we,” “us,” “our” and the “Company” refer (i) with respect to events occurring or periods ending before August 2, 2021, to Stagwell Marketing Group LLC and its direct and indirect subsidiaries and (ii) with respect to events occurring or periods ending on or after August 2, 2021, to Stagwell Inc. and its direct and indirect subsidiaries. References to a “fiscal year” mean the Company’s year commencing on January 1 of that year and ending December 31 of that year (e.g., fiscal 2021 means the period beginning January 1, 2021, and ending December 31, 2021).
Executive Summary
Business Combination
On December 21, 2020, MDC Partners Inc. (“MDC”) and Stagwell Media LP (“Stagwell Media”) announced that they had entered into the Transaction Agreement, providing for the combination of MDC with the operating businesses and subsidiaries of Stagwell Media (the “Stagwell Subject Entities”). The Stagwell Subject Entities comprised Stagwell Marketing Group LLC (“Stagwell Marketing” or “SMG”) and its direct and indirect subsidiaries.
On August 2, 2021 (the “Closing Date”), we completed the previously announced combination of MDC and the Stagwell Subject Entities and a series of steps and related transactions (such combination transactions, the “Transactions”). In connection with the Transactions, among other things, (i) MDC completed a series of transactions pursuant to which it emerged as a wholly owned subsidiary of the Company, converted into a Delaware limited liability company and changed its name to Midas OpCo Holdings LLC (“OpCo”); (ii) Stagwell Media contributed the equity interests of Stagwell Marketing and its direct and indirect subsidiaries to OpCo; and (iii) the Company converted into a Delaware corporation, succeeded MDC as the publicly-traded company and changed its name to Stagwell Inc.
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The Transactions were treated as a reverse acquisition for financial reporting purposes, with MDC treated as the legal acquirer and Stagwell Marketing treated as the accounting acquirer. As a result of the Transactions and the change in our business and operations, under applicable accounting principles, the historical financial results of Stagwell Marketing prior to August 2, 2021 are considered our historical financial results. Accordingly, historical information presented in this Form 10-K for events occurring or periods ending before August 2, 2021 does not reflect the impact of the Transactions and may not be comparable with historical information for events occurring or periods ending on or after August 2, 2021, which do not include the financial results of MDC. See Note 4 of the Notes included herein for additional information in connection with the Transaction.
Overview
Stagwell conducts its business through its networks, which provide marketing and business solutions that realize the potential of combining data and creativity. Stagwell’s strategy is to build, grow and acquire market-leading businesses that deliver the modern suite of services that marketers need to thrive in a rapidly evolving business environment. Stagwell’s differentiation lies in its creative roots and proven entrepreneurial leaders, which together with innovations in technology and data, bring transformational marketing, activation, communications and strategic consulting services to clients. Stagwell leverages its range of services in an integrated manner, offering strategic, creative and innovative solutions that are technologically forward and media-agnostic. The Company’s work is designed to challenge the industry status quo, realize outsized returns on investment, and drive transformative growth and business performance for its clients and stakeholders.
Stagwell manages its business by monitoring several financial and non-financial performance indicators. The key indicators that we focus on are revenue, operating expenses, capital expenditures and the non-GAAP measures described below. Revenue growth is analyzed by reviewing a mix of measurements, including (i) growth by major geographic location, (ii) growth by line of business, (iii) growth from existing clients and the addition of new clients, (iv) growth by principal capability, (v) growth from currency changes, and (vi) growth from acquisitions. In addition to monitoring the foregoing financial indicators, the Company assesses and monitors several non-financial performance indicators relating to the business performance of our networks. These indicators may include a network’s recent new client win/loss record; the depth and scope of a pipeline of potential new client account activity; the overall quality of the services provided to clients; and the relative strength of the network’s next generation team that is in place as part of a potential succession plan to succeed the current senior executive team.
While a recovery from the COVID-19 pandemic appears to be underway, we expect economic conditions will continue to be volatile as long as COVID-19 remains a public health threat. We will continue to monitor the worldwide public health threat, government actions to combat COVID-19 and the impact or potential impact that such developments may have on the overall economy, our clients and our operations. If the impact of the pandemic continues to go beyond expectations, we believe we are well positioned through the actions implemented at the onset of the pandemic to successfully work through the effects of COVID-19 on our business. The impact of the pandemic and the corresponding actions are reflected in our judgments, assumptions and estimates in the preparation of our financial statements. The judgments, assumptions and estimates will be updated and could result in different results in the future depending on the severity, duration and continued impact of the COVID-19 pandemic.
Recent Developments
On March 11, 2022, the Company and Mark Penn, Chief Executive Officer of the Company, entered into (i) a Second Amended and Restated Employment Agreement (the “Second A&R Employment Agreement”) and (ii) an Amended and Restated Stock Appreciation Rights Agreement (the “A&R SARs Agreement”). The Second A&R Employment Agreement and the A&R SARs Agreement provide that, with respect to the December 14, 2021 award to Mr. Penn of 1,500,000 stock appreciation rights (“SARs”) in respect of the Company’s Class A common stock with a base price equal to $8.27 under the Company’s 2016 Stock Incentive Plan (the “Plan”), (i) the SARs will be settled only in cash upon any exercise, and (ii) the SARs will be considered to have been granted outside of the Plan and are not subject to stockholder approval.
Significant Factors Affecting our Business and Results of Operations
The most significant factors affecting our business and results of operations 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 (i) our clients’ desire to change marketing communication firms, and (ii) the digital and data-driven products that our Brands offer. A client may choose to change marketing communication firms for several reasons, such as a change in leadership where 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. Clients also change firms as a result of the firm’s failure to meet marketing performance targets or other expectations in client service delivery.
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Seasonality
Historically, we typically generate the highest quarterly revenue during the fourth quarter in each year, In addition, client concentration increases during election years due to the cyclical nature of our advocacy Brands. The highest volumes of retail related consumer marketing increase with the back-to-school season through the end of the holiday season.
Non-GAAP Measures
The Company reports its financial results in accordance with accounting principles generally accepted in the United States (“GAAP”). In addition, the Company has included non-GAAP financial measures and ratios, which management uses to operate the business, which it believes provide useful supplemental information to both management and readers of this report in making period-to-period comparisons in measuring the financial performance and financial condition of the Company. These measures do not have a standardized meaning prescribed by GAAP and should not be construed as an alternative to other titled measures determined in accordance with GAAP. The non-GAAP measures included are “organic revenue growth or decline” and “Adjusted EBITDA.”
“Organic revenue growth” and “organic revenue decline” refer to the positive or negative results, respectively, of subtracting both the foreign exchange and acquisition (disposition) components from total revenue growth. The acquisition (disposition) component is calculated by aggregating prior period revenue for any acquired businesses, less the prior period revenue of any businesses that were disposed of during the current period. The organic revenue growth (decline) component reflects the constant currency impact of (a) the change in revenue of the brands that the Company has held throughout each of the comparable periods presented, and (b) “Net acquisitions, (divestitures).” Net acquisitions, (divestitures) consists of (i) for acquisitions during the current year, the revenue effect from such acquisition as if the acquisition had been owned during the equivalent period in the prior year and (ii) for acquisitions during the previous year, the revenue effect from such acquisitions as if they had been owned during that entire year (or the same prior year period as the current reportable period), taking into account their respective pre-acquisition revenues for the applicable periods, and (iii) for dispositions, the revenue effect from such disposition as if they had been disposed of during the equivalent period in the prior year.
Adjusted EBITDA is defined as Net income (loss) attributable to Stagwell Inc. common shareholders excluding non-operating income or expense to achieve operating income (loss), plus depreciation and amortization, stock-based compensation, deferred acquisition consideration adjustments, and other items. Other items include restructuring costs, acquisition-related expenses, and non-recurring items.
All amounts are in dollars unless otherwise stated. Amounts reported in millions herein are computed based on the amounts in thousands. As a result, the sum of the components, and related calculations, reported in millions may not equal the total amounts due to rounding.
The percentage changes included in the tables herein that are not considered meaningful are presented as “NM.”
Segments
The Company determines an operating segment if a component (i) engages in business activities from which it earns revenues and incurs expenses, (ii) has discrete financial information, and is (iii) regularly reviewed by the Chief Operating Decision Maker (“CODM”), who is Mark Penn, Chief Executive Officer and Chairman, to make decisions regarding resource allocation for the segment and assess its performance. Once operating segments are identified, the Company performs an analysis to determine if aggregation of operating segments is applicable. This determination is based upon a quantitative analysis of the expected and historic average long-term profitability for each operating segment, together with a qualitative assessment to determine if operating segments have similar operating characteristics.
The CODM uses Adjusted EBITDA as a key metric, to evaluate the operating and financial performance of a segment, identify trends affecting the segments, develop projections and make strategic business decisions.
The Company has three reportable segments as follows: “Integrated Agencies Network,” “Media Network” and the “Communications Network.” In addition, the Company combines and discloses operating segments that do not meet the aggregation criteria as “All Other.” The Company also reports corporate expenses, as further detailed below, as “Corporate.” All segments follow the same basis of presentation and accounting policies. See Note 2 of the Notes included herein for the Company’s significant accounting policies.
In addition, Stagwell reports its corporate office expenses incurred in connection with the strategic resources provided to the networks, as well as certain other centrally managed expenses that are not fully allocated to the operating segments as Corporate. Corporate provides client and business development support to the networks as well as certain strategic resources, including accounting, administrative, financial, real estate, human resource and legal functions.
The following discussion focuses on the operating performance of the Company for the twelve months ended December 31, 2021 and 2020 and the financial condition of the Company as of December 31, 2021.
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Results of Operations:
| Twelve Months Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||
| (Dollars in Thousands) | ||||||
| Revenue | ||||||
| Integrated Agencies Network | $ | 819,758 | $ | 229,646 | ||
| Media Network | 374,930 | 254,311 | ||||
| Communications Network | 248,832 | 382,815 | ||||
| All Other | 25,843 | 21,260 | ||||
| Total Revenue | $ | 1,469,363 | $ | 888,032 | ||
| Operating Income | $ | 44,726 | $ | 83,740 | ||
| Other Income (Expenses) | ||||||
| Interest expense, net | (31,894) | (6,223) | ||||
| Foreign exchange, net | (3,332) | (721) | ||||
| Gain on sale of business and other, net | 50,058 | 544 | ||||
| Income before income taxes and equity in earnings of non-consolidated affiliates | 59,558 | 77,340 | ||||
| Income tax expense | 23,398 | 5,937 | ||||
| Income before equity in earnings of non-consolidated affiliates | 36,160 | 71,403 | ||||
| Equity in (income) losses of non-consolidated affiliates | (240) | 58 | ||||
| Net income | 35,920 | 71,461 | ||||
| Net income attributable to noncontrolling and redeemable noncontrolling interests | (14,884) | (15,105) | ||||
| Net income attributable to Stagwell Inc. common shareholders | $ | 21,036 | $ | 56,356 | ||
| Reconciliation to Adjusted EBITDA | ||||||
| Net income attributable to Stagwell Inc. common shareholders | $ | 21,036 | $ | 56,356 | ||
| Non-operating items | 23,690 | 27,384 | ||||
| Operating income | 44,726 | 83,740 | ||||
| Depreciation and amortization | 77,503 | 41,025 | ||||
| Impairment and other losses | 16,240 | — | ||||
| Stock-based compensation | 75,032 | — | ||||
| Deferred acquisition consideration | 18,721 | 4,497 | ||||
| Total other items, net | 21,430 | 13,906 | ||||
| Adjusted EBITDA | $ | 253,652 | $ | 143,168 |
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TWELVE MONTHS ENDED DECEMBER 31, 2021 COMPARED TO TWELVE MONTHS ENDED DECEMBER 31, 2020
Consolidated Results of Operations
The components of operating results for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Twelve Months Ended December 31, | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||
| $ | % | ||||||||||||||||||
| Revenue: | $ | 1,469,363 | $ | 888,032 | $ | 581,331 | 65.5 | % | |||||||||||
| Operating Expenses: | |||||||||||||||||||
| Cost of services sold | 906,856 | 571,588 | 335,268 | 58.7 | % | ||||||||||||||
| Office and general expenses | 424,038 | 191,679 | 232,359 | NM | |||||||||||||||
| Depreciation and amortization | 77,503 | 41,025 | 36,478 | 88.9 | % | ||||||||||||||
| Impairment and other losses | 16,240 | — | 16,240 | 100.0 | % | ||||||||||||||
| $ | 1,424,637 | $ | 804,292 | $ | 620,345 | 77.1 | % | ||||||||||||
| Operating income | $ | 44,726 | $ | 83,740 | $ | (39,014) | (46.6) | % |
| Twelve Months Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||||||
| (Dollars in Thousands) | ||||||||||||||
| $ | % | |||||||||||||
| Net Revenue | $ | 1,268,937 | $ | 633,230 | $ | 635,707 | NM | |||||||
| Billable costs | 200,426 | 254,802 | (54,376) | (21.3) | % | |||||||||
| Revenue | 1,469,363 | 888,032 | 581,331 | 65.5 | % | |||||||||
| Billable costs | 200,426 | 254,802 | (54,376) | (21.3) | % | |||||||||
| Staff costs | 790,121 | 359,679 | 430,442 | NM | ||||||||||
| Administrative costs | 144,294 | 83,295 | 60,999 | 73.2 | % | |||||||||
| Unbillable and other costs, net | 80,870 | 47,088 | 33,782 | 71.7 | % | |||||||||
| Adjusted EBITDA | 253,652 | 143,168 | 110,484 | 77.2 | % | |||||||||
| Stock-based compensation | 75,032 | — | 75,032 | 100.0 | % | |||||||||
| Depreciation and amortization | 77,503 | 41,025 | 36,478 | 88.9 | % | |||||||||
| Deferred acquisition consideration | 18,721 | 4,497 | 14,224 | NM | ||||||||||
| Impairment and other losses | 16,240 | — | 16,240 | 100.0 | % | |||||||||
| Other items, net | 21,430 | 13,906 | 7,524 | 54.1 | % | |||||||||
| Operating Income (1) | $ | 44,726 | $ | 83,740 | $ | (39,014) | (46.6) | % | ||||||
| (1) See the Results of Operations section above for a reconciliation of Operating Income to Net Income attributable to Stagwell Inc. common shareholders. |
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Revenue
Revenue for the twelve months ended December 31, 2021 was $1,469.4 million compared to $888.0 million for the twelve months ended December 31, 2020, an increase of $581.3 million.
Net Revenue
The components of the fluctuations in net revenue for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Net Revenue - Components of Change | Change | |||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Twelve Months Ended December 31, 2020 | Foreign Currency | Net Acquisitions (Divestitures) | Organic | Total Change | Twelve Months Ended December 31, 2021 | Organic | Total | |||||||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||||||||||
| Integrated Agencies Network | $ | 220,502 | $ | 3,172 | $ | 379,467 | $ | 128,084 | $ | 510,723 | $ | 731,225 | 58.1 | % | NM | |||||||||||||
| Media Network | 233,189 | 3,993 | 52,925 | 55,712 | 112,630 | 345,819 | 23.9 | % | 48.3 | % | ||||||||||||||||||
| Communications Network | 158,279 | 202 | 31,096 | (23,527) | 7,771 | 166,050 | (14.9) | % | 4.9 | % | ||||||||||||||||||
| All Other | 21,260 | 561 | (5,826) | 9,848 | 4,583 | 25,843 | 46.3 | % | 21.6 | % | ||||||||||||||||||
| $ | 633,230 | $ | 7,928 | $ | 457,662 | $ | 170,117 | $ | 635,707 | $ | 1,268,937 | 26.9 | % | NM | ||||||||||||||
| Component % change | 1.3% | 72.3% | 26.9% |
For the twelve months ended December 31, 2021, organic net revenue increased $170.1 million, or 26.9%, primarily attributable to higher spending by clients in connection with the recovery from the COVID-19 pandemic.
The geographic mix in net revenues for the twelve months ended December 31, 2021 and 2020 was as follows:
| 2021 | 2020 | |||||
|---|---|---|---|---|---|---|
| (Dollars in Thousands) | ||||||
| United States | $ | 1,039,934 | $ | 550,274 | ||
| United Kingdom | 101,900 | 55,915 | ||||
| Other | 127,103 | 27,041 | ||||
| Total | $ | 1,268,937 | $ | 633,230 |
Operating Income
Operating income for the twelve months ended December 31, 2021 was $44.7 million compared to $83.7 million for the twelve months ended December 31, 2020, representing a decrease of $39.0 million, primarily driven by the increase in revenue, more than offset by higher operating expenses. The twelve months ended December 31, 2021 was impacted by an increase in stock-based compensation expense and amortization expense in connection with the merger as well as an impairment and other loss of $16.2 million in connection with a write-down of trade names no longer in use.
Adjusted EBITDA
Adjusted EBITDA for the twelve months ended December 31, 2021 was $253.7 million, compared to $143.2 million for the twelve months ended December 31, 2020, representing an increase of $110.5 million, principally resulting from the acquisition of MDC.
Gain on Sale of Business and Other, net
Gain on sale of business and other, net, for the twelve months ended December 31, 2021 was income of $50.1 million, compared to $0.5 million for the twelve months ended December 31, 2020, primarily due to a gain of approximately $43.0 million in connection with the sale of Reputation Defender in the third quarter of 2021.
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Foreign Exchange Transaction Loss
The foreign exchange loss for the twelve months ended December 31, 2021 was $3.3 million compared to a loss of $0.7 million for the twelve months ended December 31, 2020.
Interest Expense, Net
Interest expense, net, for the twelve months ended December 31, 2021 was $31.9 million compared to $6.2 million for the twelve months ended December 31, 2020, representing an increase of $25.7 million, primarily driven by a higher level of debt in connection with the acquisition of MDC.
Income Tax Expense
The Company had an income tax expense for the twelve months ended December 31, 2021 of $23.4 million (on a pre-tax income of $59.6 million resulting in an effective tax rate of 39.3%) compared to income tax expense of $5.9 million (on pre-tax income of $77.3 million resulting in an effective tax rate of 7.7%) for the twelve months ended December 31, 2020.
The difference in the effective tax rate of 39.3% in the twelve months ended December 31, 2021 as compared to 7.7% in the same period in 2020 primarily results from a larger portion of income being subject to entity level tax as a result of the merger and non-deductible stock compensation in 2021.
Noncontrolling and Redeemable Noncontrolling Interests
The effect of noncontrolling and redeemable noncontrolling interests for the twelve months ended December 31, 2021 was $14.9 million compared to $15.1 million for the twelve months ended December 31, 2020.
Net Income Attributable to Stagwell Inc. Common Shareholders
As a result of the foregoing, net income attributable to Stagwell Inc. common shareholders for the twelve months ended December 31, 2021 was $21.0 million compared to net income attributable to Stagwell Inc. common shareholders of $56.4 million for the twelve months ended December 31, 2020.
Integrated Agencies Network
The components of operating results for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Twelve Months Ended December 31, | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||
| $ | % | ||||||||||||||||||
| Revenue | $ | 819,758 | $ | 229,646 | $ | 590,112 | NM | ||||||||||||
| Operating expenses | |||||||||||||||||||
| Cost of services sold | 537,642 | 134,513 | 403,129 | NM | |||||||||||||||
| Office and general expenses | 184,085 | 56,592 | 127,493 | NM | |||||||||||||||
| Depreciation and amortization | 40,087 | 9,616 | 30,471 | NM | |||||||||||||||
| Impairment and other losses | 1,394 | — | 1,394 | 100.0 | % | ||||||||||||||
| $ | 763,208 | $ | 200,721 | $ | 562,487 | NM | |||||||||||||
| Operating income | $ | 56,550 | $ | 28,925 | $ | 27,625 | 95.5 | % |
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| Twelve Months Ended December 31, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||
| (Dollars in Thousands) | |||||||||||||
| $ | % | ||||||||||||
| Net Revenue | $ | 731,225 | $ | 220,502 | $ | 510,723 | NM | ||||||
| Billable costs | 88,533 | 9,144 | 79,389 | NM | |||||||||
| Revenue | 819,758 | 229,646 | 590,112 | NM | |||||||||
| Billable costs | 88,533 | 9,144 | 79,389 | NM | |||||||||
| Staff costs | 440,670 | 119,184 | 321,486 | NM | |||||||||
| Administrative costs | 68,531 | 23,827 | 44,704 | NM | |||||||||
| Unbillable and other costs, net | 55,256 | 35,131 | 20,125 | 57.3% | |||||||||
| Adjusted EBITDA | 166,768 | 42,360 | 124,408 | NM | |||||||||
| Stock-based compensation | 47,584 | — | 47,584 | 100.0% | |||||||||
| Depreciation and amortization | 40,087 | 9,616 | 30,471 | NM | |||||||||
| Deferred acquisition consideration | 18,457 | 2,240 | 16,217 | NM | |||||||||
| Impairment | 1,394 | — | 1,394 | 100.0% | |||||||||
| Other items, net | 2,696 | 1,579 | 1,117 | 70.7% | |||||||||
| Operating Income | $ | 56,550 | $ | 28,925 | $ | 27,625 | 95.5% |
Revenue
Revenue for the twelve months ended December 31, 2021 was $819.8 million compared to $229.6 million for the twelve months ended December 31, 2020, an increase of $590.1 million.
Net Revenue
The components of the fluctuations in net revenue for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Net Revenue - Components of Change | Change | |||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Twelve Months Ended December 31, 2020 | Foreign Currency | Net Acquisitions (Divestitures) | Organic | Total Change | Twelve Months Ended December 31, 2021 | Organic | Total | |||||||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||||||||||
| Integrated Agencies Network | $ | 220,502 | $ | 3,172 | $ | 379,467 | $ | 128,084 | $ | 510,723 | $ | 731,225 | 58.1 | % | NM | |||||||||||||
| Component % change | 1.4 | % | NM | 58.1 | % |
The increase in organic net revenue was primarily attributable to increased spending by clients in connection with the recovery from the COVID-19 pandemic. The increase in net acquisition (divestitures) was driven by the acquisition of MDC.
The increase in expenses was driven by the impact from the acquisition of MDC. Stock-based compensation expense increased, driven by awards issued to SMG employees in connection with the merger, depreciation and amortization grew due to the recognition of amortizable intangible assets in connection with the acquisition of MDC.
Operating income and Adjusted EBITDA were higher driven by an increase in revenues, partially offset by higher expenses as detailed above.
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Media Network
The components of operating results for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Twelve Months Ended December 31, | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||
| $ | % | ||||||||||||||||||
| Revenue | $ | 374,930 | $ | 254,311 | $ | 120,619 | 47.4 | % | |||||||||||
| Operating expenses | |||||||||||||||||||
| Cost of services sold | 188,045 | 149,354 | 38,691 | 25.9 | % | ||||||||||||||
| Office and general expenses | 132,669 | 79,751 | 52,918 | 66.4 | % | ||||||||||||||
| Depreciation and amortization | 23,590 | 19,861 | 3,729 | 18.8 | % | ||||||||||||||
| Impairment and other losses | 14,846 | — | 14,846 | 100.0 | % | ||||||||||||||
| $ | 359,150 | $ | 248,966 | $ | 110,184 | 44.3 | % | ||||||||||||
| Operating income | $ | 15,780 | $ | 5,345 | $ | 10,435 | NM |
| Twelve Months Ended December 31, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||
| (Dollars in Thousands) | |||||||||||||
| $ | % | ||||||||||||
| Net Revenue | $ | 345,819 | $ | 233,189 | $ | 112,630 | 48.3% | ||||||
| Billable costs | 29,111 | 21,122 | 7,989 | 37.8% | |||||||||
| Revenue | 374,930 | 254,311 | 120,619 | 47.4% | |||||||||
| Billable costs | 29,111 | 21,122 | 7,989 | 37.8% | |||||||||
| Staff costs | 208,997 | 143,749 | 65,248 | 45.4% | |||||||||
| Administrative costs | 49,359 | 39,239 | 10,120 | 25.8% | |||||||||
| Unbillable and other costs, net | 24,693 | 22,532 | 2,161 | 9.6% | |||||||||
| Adjusted EBITDA | 62,770 | 27,669 | 35,101 | NM | |||||||||
| Stock-based compensation | 4,857 | — | 4,857 | 100.0% | |||||||||
| Depreciation and amortization | 23,590 | 19,861 | 3,729 | 18.8% | |||||||||
| Deferred acquisition consideration | 184 | — | 184 | 100.0% | |||||||||
| Impairment | 14,846 | — | 14,846 | 100.0% | |||||||||
| Other items, net | 3,513 | 2,463 | 1,050 | 42.6% | |||||||||
| Operating Income | $ | 15,780 | $ | 5,345 | $ | 10,435 | NM |
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Revenue
Revenue for the twelve months ended December 31, 2021 was $374.9 million compared to $254.3 million for the twelve months ended December 31, 2020, an increase of $120.6 million.
Net Revenue
The components of the fluctuations in net revenue for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Net Revenue - Components of Change | Change | ||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Twelve Months Ended December 31, 2020 | Foreign Currency | Net Acquisitions (Divestitures) | Organic | Total Change | Twelve Months Ended December 31, 2021 | Organic | Total | ||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||
| Media Network | $ | 233,189 | $ | 3,993 | $ | 52,925 | $ | 55,712 | $ | 112,630 | $ | 345,819 | 23.9 | % | 48.3 | % | |||||||||||||
| Component % change | 1.7 | % | 22.7 | % | 23.9 | % | 48.3 | % |
The increase in organic net revenue was primarily attributable to increased spending by clients in connection with the recovery from the COVID-19 pandemic. The increase in net acquisition (divestitures) was driven by the acquisition of MDC.
The increase in expenses was driven by the impact from the acquisition of MDC. Stock-based compensation expense increased, driven by awards issued to SMG employees in connection with the merger and an impairment loss of $14.8 million was recognized in connection with a write-down of trade names no longer in use.
Operating income and Adjusted EBITDA were higher driven by an increase in revenues, partially offset by higher expenses as detailed above.
Communications Network
The components of operating results for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Twelve Months Ended December 31, | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||
| $ | % | ||||||||||||||||||
| Revenue | $ | 248,832 | $ | 382,815 | $ | (133,983) | (35.0) | % | |||||||||||
| Operating expenses | |||||||||||||||||||
| Cost of services sold | 167,303 | 281,040 | (113,737) | (40.5) | % | ||||||||||||||
| Office and general expenses | 52,106 | 25,815 | 26,291 | NM | |||||||||||||||
| Depreciation and amortization | 7,553 | 5,903 | 1,650 | 28.0 | % | ||||||||||||||
| $ | 226,962 | $ | 312,758 | $ | (85,796) | (27.4) | % | ||||||||||||
| Operating income | $ | 21,870 | $ | 70,057 | $ | (48,187) | (68.8) | % |
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| Twelve Months Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||||||
| (Dollars in Thousands) | ||||||||||||||
| $ | % | |||||||||||||
| Net Revenue | $ | 166,050 | $ | 158,279 | $ | 7,771 | 4.9 | % | ||||||
| Billable costs | 82,782 | 224,536 | (141,754) | (63.1) | % | |||||||||
| Revenue | 248,832 | 382,815 | (133,983) | (35.0) | % | |||||||||
| Billable costs | 82,782 | 224,536 | (141,754) | (63.1) | % | |||||||||
| Staff costs | 104,173 | 69,493 | 34,680 | 49.9 | % | |||||||||
| Administrative costs | 16,106 | 10,416 | 5,690 | 54.6 | % | |||||||||
| Unbillable and other costs, net | 244 | (192) | 436 | NM | ||||||||||
| Adjusted EBITDA | 45,527 | 78,562 | (33,035) | (42.0) | % | |||||||||
| Stock-based compensation | 15,928 | — | 15,928 | 100.0 | % | |||||||||
| Depreciation and amortization | 7,553 | 5,903 | 1,650 | 28.0 | % | |||||||||
| Deferred acquisition consideration | 80 | 2,257 | (2,177) | (96.5) | % | |||||||||
| Other items, net | 96 | 345 | (249) | (72.2) | % | |||||||||
| Operating Income | $ | 21,870 | $ | 70,057 | $ | (48,187) | (68.8) | % |
Revenue
Revenue for the twelve months ended December 31, 2021 was $248.8 million compared to $382.8 million for the twelve months ended December 31, 2020, a decrease of $134.0 million.
Net Revenue
The components of the fluctuations in net revenue for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Net Revenue - Components of Change | Change | ||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Twelve Months Ended December 31, 2020 | Foreign Currency | Net Acquisitions (Divestitures) | Organic | Total Change | Twelve Months Ended December 31, 2021 | Organic | Total | ||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||
| Communications Network | $ | 158,279 | $ | 202 | $ | 31,096 | $ | (23,527) | $ | 7,771 | $ | 166,050 | (14.9) | % | 4.9 | % | |||||||||||||
| Component % change | 0.1 | % | 19.6 | % | (14.9) | % | 4.9 | % |
The decrease in organic net revenue was attributable to lower advocacy business compared to the prior year period that included higher levels of business in connection with the 2020 elections. The increase in net acquisition (divestitures) was driven by the acquisition of MDC.
The decrease in operating income was primarily due to higher expenses in connection with the acquisition of MDC, including stock-based compensation expense for awards issued to SMG employees in connection with the merger.
The decrease in Adjusted EBITDA was due to higher expenses as discussed above.
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All Other
The components of operating results for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Twelve Months Ended December 31, | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||
| $ | % | ||||||||||||||||||
| Revenue | $ | 25,843 | $ | 21,260 | $ | 4,583 | 21.6 | % | |||||||||||
| Operating expenses | |||||||||||||||||||
| Cost of services sold | 13,866 | 6,681 | 7,185 | NM | |||||||||||||||
| Office and general expenses | 12,785 | 16,473 | (3,688) | (22.4) | % | ||||||||||||||
| Depreciation and amortization | 2,498 | 3,681 | (1,183) | (32.1) | % | ||||||||||||||
| $ | 29,149 | $ | 26,835 | $ | 2,314 | 8.6 | % | ||||||||||||
| Operating loss | $ | (3,306) | $ | (5,575) | $ | 2,269 | (40.7) | % |
| Twelve Months Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||||||
| (Dollars in Thousands) | ||||||||||||||
| $ | % | |||||||||||||
| Net Revenue | $ | 25,843 | $ | 21,260 | $ | 4,583 | 21.6 | % | ||||||
| Billable costs | — | — | — | — | % | |||||||||
| Revenue | 25,843 | 21,260 | 4,583 | 21.6 | % | |||||||||
| Billable costs | — | — | — | — | % | |||||||||
| Staff costs | 16,454 | 20,830 | (4,376) | (21.0) | % | |||||||||
| Administrative costs | 9,481 | 12,732 | (3,251) | (25.5) | % | |||||||||
| Unbillable and other costs, net | 677 | (10,409) | 11,086 | NM | ||||||||||
| Adjusted EBITDA | (769) | (1,893) | 1,124 | 59.4 | % | |||||||||
| Stock-based compensation | 39 | — | 39 | 100.0 | % | |||||||||
| Depreciation and amortization | 2,498 | 3,681 | (1,183) | (32.1) | % | |||||||||
| Other items, net | — | 1 | (1) | (100.0) | % | |||||||||
| Operating Loss | $ | (3,306) | $ | (5,575) | $ | 2,269 | (40.7) | % |
Revenue
Revenue for the twelve months ended December 31, 2021 was $25.8 million compared to $21.3 million for the twelve months ended December 31, 2020, an increase of $4.6 million.
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Net Revenue
The components of the fluctuations in net revenue for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Net Revenue - Components of Change | Change | ||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Twelve Months Ended December 31, 2020 | Foreign Currency | Net Acquisitions (Divestitures) | Organic | Total Change | Twelve Months Ended December 31, 2021 | Organic | Total | ||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||
| All Other | $ | 21,260 | $ | 561 | $ | (5,826) | $ | 9,848 | $ | 4,583 | $ | 25,843 | 46.3 | % | 21.6 | % | |||||||||||||
| Component % change | 2.6 | % | (27.4) | % | 46.3 | % | 21.6 | % |
The increase in organic net revenue was attributable to higher levels of business at the central innovations group.
The decrease related to net acquisitions (divestitures) was attributable to the sale of Reputation Defender in the third quarter of 2021.
The increase in revenue was more than offset by higher expenses resulting in an operating loss in both periods.
Corporate
The components of operating results for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 were as follows:
| Twelve Months Ended December 31, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||||||
| (Dollars in Thousands) | |||||||||||||
| $ | % | ||||||||||||
| Staff costs | $ | 19,827 | $ | 6,423 | $ | 13,404 | NM | ||||||
| Administrative costs | 817 | (2,919) | 3,736 | NM | |||||||||
| Other, net | — | 26 | (26) | (100.0) | % | ||||||||
| Adjusted EBITDA | (20,644) | (3,530) | (17,114) | NM | |||||||||
| Stock-based compensation | 6,624 | — | 6,624 | 100.0 | % | ||||||||
| Depreciation and amortization | 3,775 | 1,964 | 1,811 | 92.2 | % | ||||||||
| Other items, net | 15,125 | 9,518 | 5,607 | 58.9 | % | ||||||||
| Operating Loss | $ | (46,168) | $ | (15,012) | $ | (31,156) | NM |
Operating expenses increased primarily in connection with the acquisition of MDC, including professional fees associated with the transaction.
Liquidity and Capital Resources:
Liquidity
The following table provides summary information about the Company’s liquidity position:
| December 31, 2021 | December 31, 2020 | |||||
|---|---|---|---|---|---|---|
| (Dollars in Thousands) | ||||||
| Net cash provided by operating activities | $ | 200,856 | $ | 138,080 | ||
| Net cash provided by (used in) investing activities | $ | 163,952 | $ | (29,021) | ||
| Net cash used in financing activities | $ | (273,414) | $ | (80,141) |
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We continue to monitor the worldwide public health threat, government actions to combat COVID-19 and the impact such developments may have on our liquidity. If the impact of the pandemic is beyond our expectation, the Company believes it is well positioned through the actions implemented at the beginning of the pandemic to successfully work through the effects of COVID-19 for the foreseeable future.
The Company had cash and cash equivalents of $184.0 million and $92.5 million as of December 31, 2021 and 2020, respectively. The Company intends to maintain sufficient cash and/or available borrowings to fund operations for the next twelve months. The Company has historically been able to maintain and expand its business using cash generated from operating activities, funds available under its revolving credit agreement, and other initiatives, such as obtaining additional debt and equity financing. At December 31, 2021, the Company had $110.2 million of borrowings outstanding, $24.3 million of outstanding and undrawn letters of credit resulting in $365.5 million available under its $500.0 million revolving credit agreement.
The Company’s obligations extending beyond twelve months primarily consist of deferred acquisition payments, purchases of noncontrolling interests, capital expenditures, scheduled lease obligation payments, and interest payments on borrowings under the Company’s 5.625% Notes (as defined below). Based on the current outlook, the Company believes future cash flows from operations, together with the Company’s existing cash balance and the availability of funds under the Company’s revolving credit agreement, will be sufficient to meet the Company’s anticipated cash needs for the next twelve months. The Company’s ability to make scheduled deferred acquisition payments, to make principal and interest payments, to refinance indebtedness or to fund planned capital expenditures will depend on future performance, which is subject to general economic conditions, the competitive environment and other factors, including those described in this Form 10-K and in the Company’s other SEC filings.
Cash Flows
Operating Activities
Cash flows provided by operating activities for the twelve months ended December 31, 2021 were $200.9 million, primarily reflecting earnings and favorable working capital requirements.
Cash flows provided by operating activities for the twelve months ended December 31, 2020 were $138.1 million, primarily reflecting earnings and favorable working capital requirements.
Investing Activities
During the twelve months ended December 31, 2021, cash flows provided by investing activities were $164.0 million, which was primarily driven by $150.3 million of MDC cash in connection with the combination, $37.2 million from the sale of Reputation Defender, partially offset by capital expenditures of $22.6 million.
During the twelve months ended December 31, 2020, cash flows used in investing activities were $29.0 million, which primarily consisted of $12.1 million of capital expenditures and $14.7 million for acquisitions.
Financing Activities
During the twelve months ended December 31, 2021, cash flows used in financing activities were $273.4 million, which primarily consisted of $884.4 million for the repurchase of the 7.50% Notes, $202.4 million in net repayments under the revolving credit agreement, $0.0 million in distributions to minority interest holders, as well as distributions of $233.2 million to Stagwell Media, offset by receipt of $1.1 billion from the issuance of the 5.625% Notes.
During the twelve months ended December 31, 2020, cash flows used in financing activities was $80.1 million, primarily driven by $40.0 million in net borrowings under the revolving credit agreement and $0.0 million in distributions to minority interest holders.
Total Debt
Debt, net of debt issuance costs, as of December 31, 2021 was $1,191.6 million as compared to $198.0 million outstanding at December 31, 2020. The increase of $993.6 million in debt was primarily a result of the Company’s issuance of the $1.1 billion aggregate principal amount of its 5.625% senior notes due 2029 (the “5.625% Notes”) in August 2021. See Note 11 of the Notes included herein for information regarding the 5.625% Notes and the $500.0 million revolving credit agreement.
The Company is currently in compliance with the terms and conditions of its revolving 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 its revolving credit agreement, or if the Company uses the maximum available amount under the 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,
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the Company’s ability to fund its working capital needs and any contingent obligations with respect to acquisitions and redeemable noncontrolling interests would be adversely affected.
Pursuant to the revolving credit agreement, the Company must comply with its total leverage ratio covenant, as such term is specifically defined in the agreement. For the period ended December 31, 2021, the Company’s calculation of each of these covenants, and the specific requirements under the revolving credit agreement, respectively, were calculated based on the trailing twelve months as follows:
| December 31, 2021 | |
|---|---|
| Total Leverage Ratio | 3.04 |
| Maximum per covenant | 4.75 |
These ratios and measures are not based on GAAP and are not presented as alternative measures of operating performance or liquidity. Some of these ratios and measures include, among other things, pro forma adjustments for acquisitions, one-time charges, and other items, as defined in the Credit Agreement. They are presented here to demonstrate compliance with the covenants in the Credit Agreement, as non-compliance with such covenants could have a material adverse effect on the Company.
Material Cash Requirements
The Company’s Agencies enter into contractual commitments with media providers and agreements with production companies on behalf of its 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 and Accruals and other liabilities when the media services are delivered by the media providers. Stagwell takes precautions against default on payment for these services and has historically had a very low incidence of default. Stagwell 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.
The following table summarizes current and long-term requirements as of December 31, 2021. Management anticipates that the obligations outstanding at December 31, 2021 will be repaid with new financing, equity offerings, asset sales and/or cash flow from operations:
| Payments Due by Period | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Material Cash Requirements | Total | Less than 1 Year | 1 – 3 Years | 3 – 5 Years | After 5 Years | ||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||
| Indebtedness (1) | $ | 1,100,000 | $ | — | $ | — | $ | — | $ | 1,100,000 | |||||||||
| Operating lease obligations | 477,439 | 87,311 | 152,966 | 93,764 | 143,398 | ||||||||||||||
| Interest on debt | 495,000 | 61,875 | 123,750 | 123,750 | 185,625 | ||||||||||||||
| Deferred acquisition consideration | 222,369 | 77,946 | 144,423 | — | — | ||||||||||||||
| Total | $ | 2,294,808 | $ | 227,132 | $ | 421,139 | $ | 217,514 | $ | 1,429,023 |
(1)Indebtedness includes no borrowings under the revolving credit agreement, which is due in 2026.
Deferred acquisition consideration on the balance sheet consists of deferred obligations related to contingent and fixed purchase price payments. See Note 9 of the Notes included herein for additional information regarding contingent deferred acquisition consideration.
When acquiring less than 100% ownership of an entity, the Company may enter into agreements that give the Company an option to purchase, or require the Company to purchase, the incremental ownership interests under certain circumstances. Where the incremental purchase may be required of the Company, the amounts are recorded as redeemable noncontrolling interests in mezzanine equity. See Note 13 of the Notes included herein for additional information regarding noncontrolling and redeemable noncontrolling interests.
The Company intends to finance the cash portion of these contingent payment obligations using available cash from operations, borrowings under the revolving credit agreement (and refinancings thereof), and, if necessary, through the incurrence of additional debt and/or issuance of additional equity. The ultimate amount payable 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.
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Guarantees
Generally, the Company has indemnified the purchasers of certain of its 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 a number of years. Historically, the Company has not made any significant indemnification payments under such agreements and no amounts 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.
Critical Accounting Estimates
Stagwell has prepared the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for reporting financial information on Form 10-K. Preparation of the consolidated financial statements and related disclosures requires us to make judgments, assumptions and estimates that affect the amounts reported and disclosed in the accompanying financial statements and footnotes. Our significant accounting policies are discussed in Note 2 of the Notes included herein. Our critical accounting policies are those that are considered by management to require significant judgment, use of estimates and that could have a significant impact on our financial statements. An understanding of our critical accounting policies is necessary to analyze our financial results.
Our critical accounting policies include our accounting for revenue recognition, business combinations, deferred acquisition consideration, redeemable noncontrolling interests, goodwill and intangible assets, income taxes and stock-based compensation. The financial 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 is recognized when control of the promised goods or services is transferred to our clients, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. See Note 5 of the Notes included herein for further information.
Business Combinations. Business combinations are accounted for using the acquisition method and accordingly, the assets acquired (including identified intangible assets), the liabilities assumed and any noncontrolling interest in the acquired business are recorded at their acquisition date fair values.
For each acquisition, the Company undertakes a detailed review to identify other intangible assets and a valuation is performed for all such identified assets. The Company uses several market participant measurements to determine the estimated value. This approach includes consideration of similar and recent transactions, as well as utilizing discounted expected cash flow methodologies. A substantial portion of the intangible assets value that the Company acquires 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 acquired is derived from customer relationships, including the related customer contracts, as well as trade names and trademarks.
Deferred Acquisition Consideration. Certain acquisitions include an initial payment at the time of closing and provide for future additional contingent purchase price payments. Contingent purchase price obligations for these transactions are recorded as deferred acquisition consideration liabilities on the balance sheet, at the acquisition date fair value and are remeasured at each reporting period. These liabilities are derived from the projected performance of the acquired entity. These arrangements may be dependent on future events, such as the growth rate of the earnings of the relevant subsidiary during the contractual period. At each reporting date, the Company models each business’ future performance, including revenue growth and free cash flows, to estimate the value of each deferred acquisition consideration liability. The liability is adjusted quarterly based on changes in current information affecting each subsidiary’s current operating results and the impact this information will have on future results included in the calculation of the estimated liability. These adjustments are recorded in the results of operations. In instances where such contingent payments require the sellers’ continuous employment with the Company after the transaction, they are recorded as compensation expense in the Audited Consolidated Statements of Operations.
Redeemable Noncontrolling Interests. Many of the Company’s acquisitions include contractual arrangements where the noncontrolling shareholders have an option to purchase, or may require the Company to purchase, such noncontrolling shareholders’ incremental ownership interests under certain circumstances. The Company typically has similar call options under the same contractual terms. The amount of consideration under these contractual arrangements is not a fixed amount, but rather is dependent upon various valuation formulas, such as the average earnings of the relevant subsidiary through the date of exercise or the growth rate of the earnings of the relevant subsidiary during that period. In the event that an incremental purchase may be required by the Company, the amounts are recorded as redeemable noncontrolling interests in mezzanine
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equity on the Audited Consolidated Balance Sheets at their acquisition date fair value and adjusted for changes to their estimated redemption value through Retained earnings or Paid-in capital (when at an accumulated deficit) in the Audited Consolidated Balance Sheets (but not less than their initial redemption value), except for foreign currency translation adjustments. These adjustments will not impact the calculation of earnings (loss) per share if the redemption values are less than the estimated fair values.
Goodwill. Goodwill (the excess of the acquisition cost over the fair value of the net assets acquired) acquired as a result of a business combination which is not subject to amortization is tested for impairment, at the reporting unit level, annually as of October 1st of each year, or more frequently if indicators of potential impairment exist.
For the annual impairment test, the Company has the option of assessing qualitative factors to determine whether it is more likely than not that the carrying amount of a reporting unit exceeds its fair value or performing a quantitative goodwill impairment test. Qualitative factors considered in the assessment include industry and market considerations, the competitive environment, overall financial performance, changing cost factors such as labor costs, and other factors specific to each reporting unit such as change in management or key personnel.
If the Company elects to perform the qualitative assessment and concludes that it is more likely than not that the fair value of the reporting unit is more than its carrying amount, then goodwill is not considered impaired and the quantitative impairment test is not necessary. For reporting units for which the qualitative assessment concludes that it is more likely than not that the fair value of the reporting unit is less than its carrying amount and for reporting units for which the qualitative assessment is not performed, the Company will perform the quantitative impairment test, which compares the fair value of the reporting unit to its carrying amount. If the fair value of the reporting unit exceeds the carrying amount of the net assets assigned to that reporting unit, goodwill is not considered impaired. However, if the fair value of the reporting unit is lower than the carrying amount of the net assets assigned to the reporting unit, an impairment charge is recognized equal to the excess of the carrying amount over the fair value.
Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. The Company uses a combination of the income approach, which incorporates the use of the discounted cash flow (“DCF”) method, and the market approach, which incorporates the use of earnings and revenue multiples based on market data. The Company generally applies an equal weighting to the income and market approaches for the impairment test. The income approach and the market approach both require the exercise of significant judgment, including judgment about the amount and timing of expected future cash flows, assumed terminal value and appropriate discount rates.
The DCF estimates incorporate expected cash flows that represent a spectrum of the amount and timing of possible cash flows of each reporting unit from a market participant perspective. The expected cash flows are developed from the Company’s long-range planning process using projections of operating results and related cash flows based on assumed long-term growth rates, demand trends and appropriate discount rates based on a reporting unit’s WACC as determined by considering the observable WACC of comparable companies and factors specific to the reporting unit. The terminal value is estimated using a constant growth method which requires an assumption about the expected long-term growth rate. The estimates are based on historical data and experience, industry projections, economic conditions, and the Company’s expectations.
For the 2021 annual goodwill impairment test, the Company had approximately 35 reporting units, all of which were subject to the qualitative assessment, except four reporting units that were subject to the quantitative goodwill impairment test. For the reporting units under a qualitative assessment, we concluded that it is more likely than not that their fair value is in excess of the carrying value. The reporting units subject to the quantitative impairment test had a fair value in excess of their carrying amount (“headroom”) above 10%. The Company utilized a long-term growth rate of 3% and a WACC ranging from 13% to 25%. The Company performed a sensitivity analysis which included a 1% increase in the WACC, which would not result in an impairment.
The Company believes the estimates and assumptions used in the calculations are reasonable. However, if there was an adverse change in the facts and circumstances, then an impairment charge may be necessary in the future. Should the fair value of any of the Company’s reporting units fall below its carrying amount because of reduced operating performance, market declines, changes in the discount rate, or other conditions, charges for impairment may be necessary. The Company monitors its reporting units to determine if there is an indicator of potential impairment.
Income Taxes. We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates and laws expected to be in effect when the differences are expected to reverse. The Company records associated interest and penalties as a component of income tax expense. 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 evaluates on a quarterly basis all available positive and negative evidence considering factors such as the reversal of deferred income tax liabilities, taxable income in eligible carryback years, projected future taxable income, the
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character of the income tax asset, tax planning strategies, changes in tax laws and other factors. The periodic assessment of the net carrying value of the Company’s deferred tax assets under the applicable accounting rules requires significant management judgment. A change to any of these factors could impact the estimated valuation allowance and income tax expense.
Stock-Based Compensation. Under the fair value method, compensation cost is measured at fair value at the date of grant and is expensed over the service period, generally the award’s vesting period. The Company uses its historical volatility derived over the expected term of the award to determine the volatility factor used in determining the fair value of the award. The Company recognizes forfeitures as they occur.
Stock-based awards that are settled in cash or equity at the option of the Company are recorded at fair value on the date of grant. The fair value measurement of the compensation cost for these awards is based on using the Black-Scholes option pricing model or other acceptable method and is recorded in Operating income over the service period, in this case the award’s vesting period.
The Company has adopted the straight-line attribution method for determining the compensation cost to be recorded during each accounting period. The Company commences recording compensation expense related to awards that are based on performance conditions under the straight-line attribution method when it is probable that such performance conditions will be met.
New Accounting Pronouncements
In October 2021, the FASB issued ASU 2021-08, Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to the recognition of an acquired contract liability and other items. ASU 2021-08 is effective January 1, 2023; however, the Company has early adopted the standard and retrospectively applied it to the financial statements herein.
In March 2020, the FASB issued ASU 2020-04, and in January 2021 subsequently issued ASU 2021-01, Facilitation of the Effects of Reference Rate Reform on Financial Reporting, to provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. ASU 2020-04 is effective upon issuance, through December 31, 2022. The Company is evaluating the impact of the adoption of this guidance on the Company’s financial statements and disclosures.