UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

Commission file number: 1-6686

 

 

THE INTERPUBLIC GROUP OF COMPANIES, INC.
(Exact name of registrant as specified in its charter)

 

 

 

 

1114 Avenue of the Americas, New York, New York 10036
(Address of principal executive offices) (Zip Code)

 

(212) 704-1200
(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The number of shares of the registrant’s common stock outstanding as of May 1, 2006 was 436,237,262.

 

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

 

INDEX

 

STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE

 

This report on Form 10-Q contains forward-looking statements. Statements in this report that are not historical facts, including statements about management’s beliefs and expectations, constitute forward-looking statements. These statements are based on current plans, estimates and projections, and are subject to change based on a number of factors, including those outlined in our 2005 Annual Report on Form 10-K under Item 1A, Risk Factors. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events.

 

Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include, but are not limited to, the following:

 

 

Investors should carefully consider these factors and the additional risk factors outlined in more detail in our 2005 Annual Report on Form 10-K under Item 1A, Risk Factors.

 

AVAILABLE INFORMATION

 

Information regarding our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports, will be made available, free of charge, at our website at http://www.interpublic.com, as soon as reasonably practicable after we electronically file such reports with, or furnish them to, the SEC. Any document that we file with the SEC may also be read and copied at the SEC’s Public Reference Room located at Room 1580, 100 F Street, N.E., Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our filings are also available to the public from the SEC’s website at http://www.sec.gov, and at the offices of the New York Stock Exchange. For further information on obtaining copies of our public filings at the New York Stock Exchange, please call (212) 656-5060.

 

Our Corporate Governance Guidelines, Code of Conduct and each of the charters for the Audit Committee, Compensation Committee and the Corporate Governance Committee are available free of charge on our website at http://www.interpublic.com, or by writing to The Interpublic Group of Companies, Inc., 1114 Avenue of the Americas, New York, NY 10036, Attention: Secretary.

EXPLANATORY NOTE

 

On March 22, 2006, we restated our previously published financial statements for the quarter ended March 31, 2005. The restatement is set forth in our 2005 Annual Report on Form 10-K. The Consolidated Statements of Operations, Cash Flows and Comprehensive Loss for the quarter ended March 31, 2005 in this report are presented as restated. For information on the restatement and the impact of the restatement on our financial statements for the quarter ended March 31, 2005, we refer you to Item 8, Financial Statements and Supplementary Data, Note 23, Results by Quarter (Unaudited), in our 2005 Annual Report on Form 10-K. We also refer you to Note 16, Quarterly Restatement, within this Form 10-Q.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

Restatement.  The Consolidated Statements of Operations, Cash Flows and Comprehensive Loss for the quarter ended March 31, 2005 in this report are presented as restated. For information on the restatement and the impact of the restatement on our financial statements for the quarter ended March 31, 2005, we refer you to Item 8, Financial Statements and Supplementary Data, Note 23, Results by Quarter (Unaudited), in our 2005 Annual Report on Form 10-K.

 

Basis of Presentation.  The accompanying unaudited Consolidated Condensed Financial Statements have been prepared by The Interpublic Group of Companies, Inc. (the “Company”, “Interpublic”, “we”, “us”, or “our”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, include all adjustments of a normal and recurring nature necessary for a fair statement of the Consolidated Statements of Operations, Condensed Consolidated Balance Sheets, Consolidated Statements of Cash Flows and Consolidated Statements of Comprehensive Loss for each period presented. The consolidated results for interim periods are not necessarily indicative of results for the full year. These financial results should be read in conjunction with our 2005 Annual Report on Form 10-K.

 

 

The following table sets forth the computation of basic and diluted loss per common share for net loss available to common stockholders:

 

 

Basic and diluted shares outstanding and loss per share are equal for the three months ended March 31, 2006 and 2005 because our stock options, restricted stock and convertible securities are anti-dilutive as a result of the net loss applicable to common stockholders in each period. The following table presents the weighted-

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

average number of incremental anti-dilutive shares excluded from the computations of diluted loss per share for the three months ended March 31, 2006 and 2005:

 

 

 

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R requires compensation costs related to share-based transactions, including employee stock options, to be recognized in the financial statements based on fair value. SFAS No. 123R revises SFAS No. 123, as amended, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”

 

Effective January 1, 2006, we implemented SFAS No. 123R using the modified prospective transition method. Under this transition method, the compensation expense recognized beginning January 1, 2006 includes compensation expense for (i) all stock-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. No. 123, and (ii) all stock-based payments granted subsequent to December 31, 2005 based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. Compensation cost is generally recognized ratably over the requisite service period. Prior period amounts have not been restated.

 

Prior to January 1, 2006, we accounted for stock-based compensation plans in accordance with the provisions of APB Opinion No. 25, as permitted by SFAS No. 123, and accordingly, did not recognize compensation expense for the issuance of stock options with an exercise price equal to or greater than the market price at the date of grant. In addition, IPG’s Employee Stock Purchase Plan (“ESPP”) was not considered compensatory under APB Opinion No. 25 and, therefore, no expense was required to be recognized. Compensation expense was previously recognized for restricted stock, restricted stock units, performance-based stock units, and share appreciation performance-based units. The effect of forfeitures on restricted stock, restricted stock units and performance-based stock units was recognized when such forfeitures occurred.

 

The impact of adopting SFAS No. 123R for the three months ended March 31, 2006 on Loss before benefit of income taxes, Net loss, and Net loss applicable to common stockholders is a net benefit of $2.3, $1.5, and $1.5, respectively. The impact on basic and diluted earnings per share was less than one cent. There was no impact on cash flow from operations and financing activities as there were no stock options exercised in the three months ended March 31, 2006. As a result of the adoption of SFAS No. 123R on January 1, 2006, we recorded a benefit from the cumulative effect of the change in accounting of $3.6 ($2.3, net of tax) in salaries and related expenses on the Consolidated Statements of Operations. Additionally, our results for the three months ended March 31, 2006 included incremental stock-based compensation expense of $1.3, primarily related to our stock options. For the three months ended March 31, 2006 and 2005, we recognized total stock-

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

based compensation expense of $10.7 and $12.3, respectively, and a related tax benefit of $3.7 and $4.2, respectively. Certain stock-based compensation awards expected to be settled in cash have been classified as liabilities in the Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005.

 

Under the modified prospective application method, results for prior periods have not been restated to reflect the effects of implementing SFAS No. 123R. The following pro forma information presents our pro forma net loss applicable to common stockholders and loss per share if compensation expense, net of forfeitures, for our stock option plans and ESPP had been determined based on the fair value at the grant dates as defined by SFAS No. 123 and amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — An Amendment of FASB No. 123 for the three months ended March 31, 2005:

 

 

For purposes of the above pro forma information, the weighted-average fair value of the 15% discount received by employees on the date that stock was purchased under the ESPP was $1.97 per share and is included in the total fair value of stock-based employee compensation expense.

 

We issue stock and cash based incentive awards to our employees under a plan established by the Compensation Committee of the Board of Directors and approved by our shareholders. Common stock may be granted under the current plan, up to 4.5 shares for stock options and 14.0 shares for awards other than stock options, however there are limits as to the number of shares available for certain awards and to any one participant. We issue new shares to satisfy the exercise of stock options or the distribution of other stock-based awards.

 

Stock Options

 

Stock options are granted at the fair market value of our common stock on the date of grant, are generally exercisable between two and five years after the date of grant and expire ten years from the grant date.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

Following is a summary of stock option transactions during the three months ended March 31, 2006:

 

 

 

 

Following is a summary of nonvested stock option transactions during the three months ended March 31, 2006:

 

 

 

 

There were no stock options exercised for the three months ended March 31, 2006. The intrinsic value of stock options exercised for the three months ended March 31, 2005 was $0.4. As of March 31, 2006 there was $15.8 of total unrecognized compensation expense related to non-vested stock options granted and the unrecognized compensation expense is expected to be recognized over a weighted-average period of 3.3 years.

 

We use the Black-Scholes option-pricing model to estimate the fair value of options granted, which requires the input of subjective assumptions including the option’s expected term and the price volatility of the underlying stock. Changes in the assumptions can materially affect the estimate of fair value and our results of operations could be materially impacted. During the third quarter of 2005, we revised our assumptions for expected volatility and expected term and, accordingly, the pro forma information presented above for the

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

three months ended March 31, 2005 was calculated using the Black-Scholes assumptions in place prior to the third quarter of 2005. Our assumptions used for the three months ended March 31, 2006 were as follows:

 

Expected Volatility:  The expected volatility factor used to estimate the fair value of stock-options awarded is based on a blend of historical volatility of our common stock and implied volatility of our tradable forward put and call options to purchase and sell shares of our common stock.

 

Expected Term:  Our estimate of expected term is based on the average of an assumption that outstanding options are exercised upon achieving their full vesting date and will be exercised at the midpoint between the current date (i.e., the date awards have ratably vested through) and their full contractual term.

 

Expected Dividend Yield:  The expected dividend yield is based on an assumption that no dividends are expected to be approved in the near future.

 

Risk Free Interest Rate:  The risk free rate is determined using the implied yield currently available for zero-coupon U.S. government issuers with a remaining term equal to the expected term of the options.

 

The fair value of each option grant has been estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

 

 

Restricted Stock

 

Restricted stock is granted to certain key employees and is subject to certain restrictions and vesting requirements as determined by the Compensation Committee. The vesting period is generally two to five years. No monetary consideration is paid by a recipient for a restricted stock award and the fair value of the shares on the grant date is amortized over the vesting period.

 

During the three months ended March 31, 2006 and 2005, we awarded 0.1 and 0.1 shares of restricted stock with a weighted-average grant date fair value of $10.04 and $12.47, respectively. The total fair value of restricted stock distributed to participants during the three months ended March 31, 2006 and 2005 was $2.0 and $4.1, respectively.

 

Performance-Based Stock

 

Performance-based stock awards are a form of stock-award in which the number of shares ultimately received by the holder depends on our performance against specific performance targets. Performance-based stock awards have been granted to certain key employees subject to certain restrictions and vesting requirements as determined by the Compensation Committee. The awards generally vest over a three year period tied to the employees’ continuing employment and the achievement of certain performance objectives.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

No monetary consideration is paid by a recipient for a performance-based stock award and the fair value of the shares on the grant date is amortized over the vesting period.

 

During the three months ended March 31, 2006, we awarded no shares of performance-based stock. During the three months ended March 31, 2005, we awarded 0.6 shares of performance-based stock with a weighted-average grant date fair value of $13.54. There were no performance-based stock vested during the three months ended March 31, 2006 and 2005.

 

Restricted Stock Units

 

Restricted stock units are granted to employees and generally vest in three years. The grantee is entitled to receive a payment in cash or in shares of common stock based on the fair market value of the corresponding number of shares of common stock upon completion of the vesting period. The holder of restricted stock units has no ownership interest in the underlying shares of common stock until the restricted stock units vest and the shares of common stock are issued.

 

During the three months ended March 31, 2006, we awarded less than 0.1 restricted stock units with a weighted-average grant date fair value of $10.09. We awarded 0.1 shares of restricted stock units with a weighted-average grant date fair value of $13.16 during the three months ended March 31, 2005. There were no restricted stock units vested during the three months ended March 31, 2006 and 2005.

 

A summary of the status of our nonvested restricted stock, performance-based stock, and restricted stock units as of March 31, 2006 and changes during the three months then ended are presented below:

 

 

 

 

Share Appreciation Performance-Based Units

 

In August 2005, we granted Michael Roth, Chairman of the Board and Chief Executive Officer, 0.3 share appreciation performance-based units (“SAPUs”) based on a weighted-average grant date stock price of $12.17. At our discretion, the grantee is entitled to receive a payment in cash or shares of common stock upon completion of a four-year vesting period. The holder of the SAPUs has no ownership interest in the underlying shares of common stock until the SAPUs vest and the shares of common stock are issued. The fair value of the share appreciation performance-based units is estimated using the Black-Scholes valuation model, using assumptions similar to those used for stock options. The expense recorded for SAPUs was $0.1 for the three months ended March 31, 2006. As of March 31, 2006, there was $0.7 of total unrecognized compensation

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

expense related to nonvested SAPUs that is expected to be recognized over a weighted-average period of 3.4 years.

 

Employee Stock Purchase Plans

 

Under the ESPP previously in effect, employees could purchase our common stock through payroll deductions not exceeding 10% of their compensation. The price an employee paid for a share of stock under the ESPP was 85% of the average market price on the last business day of each month. During the three months ended March 31, 2005 we issued 0.1 shares of stock under the ESPP. Shares issued to employees during the three months ended March 31, 2005 under the ESPP had no impact on the Consolidated Statement of Operations. No stock was purchased under the ESPP during the second, third or fourth quarters of 2005. The ESPP expired effective June 30, 2005 and shares are no longer available for issuance under the ESPP.

 

In November 2005, our stockholders approved the establishment of an Interpublic Group of Companies Employee Stock Purchase Plan (2006) (the “2006 Plan”) to replace the previously existing ESPP. Under the 2006 Plan, employees may purchase our common stock through payroll deductions not exceeding 10% of their compensation. The price an employee pays for a share of stock under the 2006 Plan is 90% of the lesser of the average market price of a share on the offering date or the average market price of a share on the last business day of the offering period. An aggregate of 15.0 shares are reserved for issuance under the 2006 Plan. Purchases under the 2006 Plan may commence when we file with the SEC the applicable registration statement required to activate the 2006 Plan.

 

 

Acquisitions

 

We did not make any acquisitions during the three months ended March 31, 2006 and 2005. We made stock payments related to acquisitions in prior years valued at $0.1 and $1.8 during the three months ended March 31, 2006 and 2005, respectively. Details of the cash paid for prior acquisitions are as follows:

 

 

Dispositions

 

For the three months ended March 31, 2006, we completed the sale of several businesses in our Integrated Agency Networks (“IAN”) segment. We did not make any dispositions during the three months ended March 31, 2005. The results of operations as well as the gain or loss on sale of each of these agencies was not material to the Consolidated Financial Statements in any of the periods presented.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

During the three months ended March 31, 2006 and 2005, we recorded net (reversals) and charges related to lease termination and other exit costs and severance and termination costs for the 2003 and 2001 restructuring programs of $0.4 and ($6.9), respectively. The 2003 program was initiated in response to softness in demand for advertising and marketing services. The 2001 program was initiated following the acquisition of True North Communications Inc. and was designed to integrate the acquisition and improve productivity. Since their inception, total net charges for the 2003 and 2001 programs were $224.6 and $641.0, respectively. Substantially all activities under the 2003 and 2001 programs have been completed. A summary of the net (reversals) and charges by segment is as follows:

 

 

Net charges related to lease termination and other exit costs recorded for the three months ended March 31, 2006 was $0.4, comprised of charges of $0.3 and adjustments to management estimates of $0.1. Net reversals related to lease termination and other exit costs recorded for the three months ended March 31, 2005 was ($6.6), comprised of charges of $1.2, offset by adjustments to management estimates of ($7.8). During the three months ended March 31, 2006 and 2005, charges were recorded for the amortization of the discount of the net present value liability related to lease terminations for the 2003 program which is being amortized over the expected remaining term of the related leases. Given the remaining life of the vacated leased properties under the 2003 and 2001 programs, cash payments are expected to be made through 2015 and 2024, respectively.

 

Net reversals related to severance and termination costs of ($0.3) recorded for the three months ended March 31, 2005, resulted exclusively from the impact of adjustments to management’s estimates.

 

The significant factors that caused the adjustments to management’s estimates for lease termination and other exit costs were our negotiation of terms upon the exit of leased properties, changes in sublease rental income and utilization of previously vacated properties by certain of our agencies due to improved economic conditions in certain markets. The significant factors that caused the adjustments to management’s estimates for severance and termination costs were the change in amounts paid to terminated employees and change in estimates of taxes related to terminated employees. All adjustments to management’s estimates occurred during the period recorded.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

A summary of the remaining liability for the 2003 and 2001 restructuring programs is as follows:

 

 

 

The following table provides a summary of the components of land, building and equipment:

 

 

 

We review goodwill and other intangible assets with indefinite lives not subject to amortization (e.g., customer lists, trade names and customer relationships) annually or whenever events or significant changes in circumstances indicate that the carrying value may not be recoverable. We evaluate the recoverability of goodwill at a reporting unit level. Events or circumstances that might require impairment testing include the loss of a significant client, the identification of other impaired assets within a reporting unit, loss of key personnel, the disposition of a significant portion of a reporting unit, or a significant adverse change in business climate or regulations.

 

The fair value of a reporting unit is estimated using our projections of discounted future operating cash flows (without interest). Such projections require the use of significant estimates and assumptions as to matters such as future revenue growth, profit margins, capital expenditures, assumed tax rates and discount rates. We believe that the estimates and assumptions made are reasonable but they are susceptible to change from period to period. For example, our strategic decisions or changes in market valuation multiples could lead to impairment charges. Actual results of operations, cash flows and other factors used in a discounted cash flow valuation will likely differ from the estimates used and it is possible that differences and changes could be material.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

During the first quarter of 2006, we had a series of events at our Lowe reporting unit that required us to test goodwill and other indefinite lived intangible assets for impairment. Specifically, these events included changes in senior management including the appointment of a new Chief Executive Officer. In addition, we announced on March 27, 2006 a plan that Lowe would reduce its majority-owned offices in an effort to provide for more operational efficiency and target more profitable business going forward.

 

In evaluating the potential impact of the plan, we revised the budget and long term forecast for Lowe to reflect increased investment in the business as well as the strategy of the new management. The forecast is consistent with the growth we are expecting from our other agencies. We have forecasted that Lowe will achieve moderate peer growth rates by 2008. Given the inherent difficulties with long term growth projections we have increased the discount rate accordingly. As a result, our projections and valuations showed that there have been no declines in discounted future operating cash flows, which indicates that we do not have an impairment at Lowe. If we were to change our key discount rate assumption by increasing the rate by 1% we would still conclude that an impairment is not required.

 

The valuation is highly dependent upon the improved future growth rate and operating margin assumptions. Any downward revision to either of these assumptions, or if actual results do not attain the forecasted level of revenue and profitability growth assumed in the operating margin improvement, could result in a material change to our analysis and lead to an impairment charge in future periods. We will continue to monitor the results at Lowe and should operating performance change, we will update our valuation which could result in an impairment charge.

 

 

The following table sets forth the components of other income:

 

 

During the three months ended March 31, 2006, we sold our remaining ownership interest in Enterprise Nexus Communications, an agency within The Lowe Group, for a gain of $2.5, offset by net losses related to the sale of several small businesses.

 

During the three months ended March 31, 2005, we sold our remaining ownership interest in Delaney Lund Know Warren & Partners, an agency within The FCB Group, for a gain of approximately $8.5.

 

 

We recorded an income tax benefit of ($8.8) on a pretax loss of $179.2 for the three months ended March 31, 2006. For the three months ended March 31, 2005, we recorded an income tax benefit of ($40.6) on a pretax loss of $186.4. Our effective tax rate was (4.9%) and (21.8%) for the three months ended March 31, 2006 and 2005, respectively. The difference between the effective tax rate and statutory rate of 35% is due to state and local taxes and the effect of non-U.S. operations. Several discrete items also impacted the effective tax rate in the first quarter of 2006. The most significant items negatively impacting the effective tax rate were the establishment of valuation allowances on losses incurred in non-U.S. jurisdictions which receive

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

no benefit and the effect of non-U.S. taxes without offsetting US foreign tax credits that are normally available.

 

On April 21, 2003 the Internal Revenue Service (“IRS”) proposed additions to our taxable income for the years 1994 through 1996 that would have resulted in additional income taxes, including conforming state and local tax adjustments, of $41.5 plus appropriate interest. We have finalized a settlement covering all of the adjustments proposed by the IRS, and the IRS has also agreed to a refund claim which we filed in respect of certain business expenses for which we had previously failed to claim deductions in those years. Additional payments, which we anticipate remitting in the second quarter of 2006, will not have a material effect on our cash flow, financial position or results of operations.

 

The IRS has recently completed the field audit of the years 1997-2002 and has proposed additions to our taxable income. One of the adjustments proposed by the IRS would disallow the deduction of a loss claimed in 2002 on the grounds that we had not established that the claimed worthlessness of an acquired business had yet occurred in 2002. We had previously received a refund of approximately $45.0 of tax on account of this claimed loss. The proposed disallowance will result in us having to repay that amount, plus appropriate interest. Further, we intend to amend our 2004 tax return to claim this deduction in that return, which will be subject to audit by the IRS commencing in the second quarter of 2006.

 

Valuation Allowance

 

As required by SFAS 109, Accounting for Income Taxes (“SFAS 109”), we evaluate the realizability of its deferred tax assets on a quarterly basis. SFAS 109 requires a valuation allowance to be established when it is “more likely than not” that all or a portion of deferred tax assets will not be realized. In circumstances where there is “sufficient negative evidence”, establishment of a valuation allowance must be considered. A cumulative loss in the most recent three-year period represents sufficient negative evidence to consider a valuation allowance under the provisions of SFAS 109. As a result, we determined that certain of our deferred tax assets required the establishment of a valuation allowance. The deferred tax assets for which an allowance has been established relate primarily to foreign net operating losses, US capital losses, and foreign tax credit carryforwards.

 

The realization of our remaining deferred tax assets is primarily dependent on future earnings. Any reduction in estimated forecasted results, including but not limited to any future restructuring activities may require that we record additional valuation allowances against our deferred tax assets on which a valuation allowance has not previously been established. The valuation allowance that has been established will be maintained until there is sufficient positive evidence to conclude that it is “more likely than not” that such assets will be realized. An ongoing pattern of profitability will generally be considered as sufficient positive evidence. Our income tax expense recorded in the future will be reduced to the extent of offsetting decreases in the valuation allowance. The establishment of valuation allowances has had and could have a significant negative impact on our future earnings.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

The following table provides a summary of the components of accrued liabilities:

 

 

 

Long-term debt has a fair value of approximately $2,079.9 and $2,072.1 at March 31, 2006 and December 31, 2005, respectively.

 

Cash Poolings

 

We use pooling arrangements with banks to help manage our liquidity requirements. In a pooling arrangement, several Interpublic agencies agree with a single bank that the cash balances of any of the agencies with the bank will be subject to a full right of setoff against amounts the other agencies owe the bank, and the bank provides overdrafts or advances as long as the net balance for all the agencies does not exceed an agreed level. Typically each agency pays interest on outstanding advances and receives interest on cash balances. Our balance sheet reflects cash net of advances for each pooling arrangement. At March 31, 2006 and December 31, 2005, a gross amount of $802.7 and $842.6, respectively, in cash was netted against an equal gross amount of advances under pooling arrangements.

 

Credit Arrangements

 

We have committed and uncommitted credit facilities with various banks that permit borrowings at variable interest rates. At March 31, 2006 and December 31, 2005 there were no borrowings under our committed facilities. However, there were borrowings under the uncommitted facilities made by several of our subsidiaries outside the U.S. totaling $46.5 and $53.7, respectively. We have guaranteed the repayment of some of these borrowings by our subsidiaries. The weighted-average interest rate on outstanding balances under the uncommitted short-term facilities at March 31, 2006 and December 31, 2005 was approximately 5% in each year.

 

Our primary bank credit agreement is a three-year revolving credit facility (“Three-Year Revolving Credit Facility”). The Three-Year Revolving Credit Facility expires on May 9, 2007 and provides for borrowings of up to $500.0, of which $200.0 is available for the issuance of letters of credit. The Three-Year Revolving Credit Facility has been modified several times since it was entered into in 2004. Refer to our 2005 Form 10-K

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

for further description of these modifications. We have been in compliance with all covenants under the Three-Year Revolving Credit Facility, as amended or waived from time to time.

 

On March 21, 2006 we amended the Three-Year Revolving Credit Facility to change the financial covenants, effective as of December 31, 2005, with respect to periods ended December 31, 2005, March 31, 2006 and June 30, 2006 and certain provisions relating to letters of credit, so that letters of credit issued under the facility may have expiration dates beyond the termination date of the facility, subject to certain conditions. Such conditions include, among others, the requirement for us, on the 105th day prior to the termination date of the facility, to provide a cash deposit in an amount equal to the total amount of the outstanding letters of credit with expiration dates beyond the termination date of the facility. The amendment also added one new financial covenant that requires us to maintain, based on a five business day testing period, in cash and securities, an average daily ending balance of $300.0 plus the aggregate principal amount of borrowings under the credit facility in domestic accounts with our lenders. We also obtained a waiver from the lenders under the Three-Year Revolving Credit Facility on March 21, 2006 to waive any default arising from the restatement of our financial data presented in our 2005 Annual Report on Form 10-K.

 

The Three-Year Revolving Credit Facility also sets forth financial covenants. These covenants require us to maintain with respect to each fiscal quarter set forth below:

 

(i) an interest coverage ratio for the four fiscal quarters then ended of not less than that set forth opposite the corresponding quarter in the table below:

 

 

 

 

(ii) a debt to EBITDA ratio, where debt is the balance at period-end and EBITDA is for the four fiscal quarters then ended, of not greater than that set forth opposite the corresponding quarter in the table below:

 

 

 

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

(iii) minimum levels of EBITDA for the four fiscal quarters then ended of not less than that set forth opposite the corresponding quarter in the table below:

 

 

We have in the past been required to seek and have obtained amendments and waivers of the financial covenants under our committed bank facility. There can be no assurance that we will be in compliance with these covenants in future periods. If we do not comply and are unable to obtain the necessary amendments or waivers at that time, we would be unable to borrow or obtain additional letters of credit under the Three-Year Revolving Credit Facility. At that time, we could choose to terminate the facility and provide a cash deposit in connection with any outstanding letters of credit. The lenders under the Three-Year Revolving Credit Facility would also have the right to terminate the facility, accelerate any outstanding principal and require us to provide a cash deposit in an amount equal to the total amount of outstanding letters of credit. The outstanding amount of letters of credit was $195.8 as of March 31, 2006. We have not drawn under the Three-Year Revolving Credit Facility over the past two years, and we do not currently expect to do so. So long as there are no amounts to be accelerated under the Three-Year Revolving Credit Facility, termination of the facility would not trigger the cross-acceleration provisions of our public debt.

 

 

The components of net periodic cost for the domestic pension plans, the principal foreign pension plans and the postretirement benefit plans are as follows:

 

 

During the three months ended March 31, 2006 we made contributions of $0.2 and $5.4 to our domestic and foreign pension plans, respectively. For the remainder of 2006, we anticipate making contributions of $17.6 and $17.0 to our domestic and foreign pension plans, respectively.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

 

Summarized financial information concerning our reportable segments is shown in the following table:

 

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

The following expenses are included in Corporate and other:

 

 

 

Shares Deliverable Under Securities Class Actions

 

In the fourth quarter of 2004, we reached a final settlement of the consolidated class action shareholders suits against us. The class actions were filed against the Company and certain of our present and former directors and officers on behalf of a purported class of purchasers of our stock shortly after our August 13, 2002 announcement regarding the restatement of our previously reported earnings for the periods January 1, 1997 through March 31, 2002. Under the terms of the settlement, we agreed to issue a total of 6.6 shares of our common stock. During the fourth quarter of 2004, we issued 0.8 of the shares to the plaintiffs’ counsel as payment for their fee. We issued the remaining 5.8 shares during the first quarter of 2006.

 

SEC Investigation

 

The SEC opened a formal investigation in response to the restatement we first announced in August 2002 and, as previously disclosed, the investigation has expanded to encompass the restatement set forth in our 2004 Annual Report on Form 10-K filed in September 2005 (the “2005 Restatement”). In particular, since we filed our 2004 Form 10-K, we have received subpoenas from the SEC relating to matters addressed in our 2005 Restatement. We have also responded to inquiries from the SEC staff concerning the restatement of the first three quarters of 2005 that we made in our 2005 Form 10-K. We continue to cooperate with the investigation. We expect that the investigation will result in monetary liability, but because the investigation is ongoing, in particular with respect to the 2005 Restatement, we cannot reasonably estimate either the amount or timing of a resolution. Accordingly, we have not yet established any provision relating to these matters.

 

Other Legal Matters

 

We are involved in other legal and administrative proceedings of various types. While any litigation contains an element of uncertainty, we do not believe that the outcome of such proceedings or claims will have a material adverse effect on our financial condition, results of operations or our cash flows.

 

Vendor Discounts or Credits and Other Liabilities

 

We have recorded liabilities related to Vendor Discounts or Credits, Internal Investigations, and International Compensation Arrangements.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

A summary of the remaining liabilities related to these matters is as follows:

 

 

During the three months ended March 31, 2006, our liabilities for Vendor Discounts or Credits decreased $12.8. The decrease is primarily due to payments of $13.4 and foreign currency rate changes.

 

 

In April 2006, FASB Staff Position (“FSP”) No. FIN 46R-6, Determining the Variability to be Considered in Applying FASB Interpretation No. 46R, was issued. This FSP clarifies that the variability to be considered in applying FIN 46R should be based on an analysis of the design of the potential variable interest entity. This FSP is effective for reporting periods beginning after June 15, 2006. We do not expect the adoption of FSP No. FIN 46R-6 to have a material impact on our Consolidated Balance Sheet or Statement of Operations.

 

In March 2006, FSP No. FTB 85-4-1, Accounting for Life Settlement Contracts by Third-Party Investors, was issued. This FSP requires companies to account for investments in life settlement contracts using either the investment method or the fair-value method. Life settlement investments are currently carried at the cash surrender value of the related contract in accordance with FASB Technical Bulletin (“FTB”) 85-4, Accounting for Purchases of Life Insurance. The excess of the cash paid to purchase these contracts over the cash surrender value at the date of purchase is recognized as a loss immediately. The accounting under the FSP does not require loss recognition at the inception of the contract. We are currently evaluating the investment and fair value methods and have until January 1, 2007 to make our election.

 

In February 2006, Statement of Financial Accounting Standards (“SFAS”) No. 155, Accounting for Certain Hybrid Financial Instruments, was issued, which amends SFAS No. 133 and SFAS No. 140. SFAS No. 155 permits fair value remeasurement for any hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation in accordance with the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, with changes in fair value recognized in the Statement of Operations. SFAS No. 155 is effective for fiscal years beginning after September 15, 2006. We do not expect the adoption of SFAS No. 155 to have a material impact on our Consolidated Balance Sheet or Statement of Operations.

 

In November 2005, the FASB issued FSP FAS 123R-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards (“FSP 123R-3”). FSP 123R-3 provides an elective alternative simplified method to calculate the windfall tax pool (the “APIC pool”). Under this FSP, a company may calculate the beginning balance of the APIC pool related to employee compensation and a simplified method to determine the subsequent impact on the APIC pool of employee awards that are fully vested and outstanding upon the adoption of SFAS No. 123R. We are currently evaluating this alternative transition method and have until December 31, 2006 to make our one-time election. We do not expect the adoption of FSP 123R-3 to have a material impact on our Consolidated Balance Sheet or Statement of Operations.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

 

The adoption of the following accounting pronouncements during 2006 did not have a material impact on our Consolidated Balance Sheet or Statement of Operations:

 

 

 

On March 22, 2006, we restated our previously published financial statements for the quarter ended March 31, 2005. The restatement is set forth in our 2005 Annual Report on Form 10-K. The Consolidated Statements of Operations, Cash Flows and Comprehensive Loss for the quarter ended March 31, 2005 in this report are presented as restated. The quarterly restatement adjustments related primarily to revenue recognition and a number of miscellaneous items including accounting for leases and international compensation arrangements. The tables below summarize for the three months ended March 31, 2005, the impact of each category of adjustment on previously reported revenue, operating loss, loss before benefit of income taxes, net loss and loss per share. Below is a description of the restatement adjustments.

 

Revenue Recognition related to Customer Contracts:  Adjustments were recorded to properly state the revenue in accordance with the terms of customer contracts and our policies. In certain transactions with our customers the persuasive evidence of the customer arrangement was not always adequate to support revenue recognition, or the timing of revenue recognition did appropriately follow the specific contract terms.

 

Other Adjustments:  We identified other items that did not conform to GAAP and recorded adjustments to the March 31, 2005 Consolidated Financial Statements which relate to previously reported periods.

 

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Amounts in Millions, Except Per Share Amounts)

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help you understand The Interpublic Group of Companies, Inc. and its subsidiaries (the “Company”, “Interpublic”, “we”, “us” or “our”). MD&A should be read in conjunction with our financial statements and the accompanying notes. Our MD&A includes the following sections:

 

RESULTS OF OPERATIONS provides an analysis of the consolidated and segment results of operations for the three months ended March 31, 2006 compared to 2005.

 

LIQUIDITY AND CAPITAL RESOURCES provides an overview of our cash flows and financing activities.

 

INTERNAL CONTROL OVER FINANCIAL REPORTING provides a description of the status of our compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and related rules.

 

CRITICAL ACCOUNTING ESTIMATES, by reference to our 2005 Annual Report on Form 10-K, provides a discussion of our accounting estimates that require critical judgment, assumptions and estimates.

 

OTHER MATTERS provides a discussion of significant non-operational items which impact our financial statements, such as the SEC investigation.

 

RECENT ACCOUNTING STANDARDS, by reference to Note 15 to the Consolidated Financial Statements, provides a description of accounting standards which we have not yet been required to implement and may be applicable to our operations, as well as those significant accounting statements which were adopted during 2006.

 

RESULTS OF OPERATIONS

 

Our 2005 Annual Report on Form 10-K summarizes key elements of our business strategy under “Overview” in Item 7. Our strategy is focused on improving organic revenue growth and operating margin, and we are working to achieve by 2008 a level of organic revenue growth comparable to industry peers and double-digit operating margin. For 2006, however, our revenues will continue to be adversely affected by the client losses and dispositions that occurred in 2005, and our operating margin will continue to be adversely affected by high expenses for professional fees. Our results for the first quarter of 2006 reflect the challenges we face in improving revenues and operating margins. Revenue was essentially flat compared to the same period in 2005, and operating margin was (12.0%) compared to (12.7%) for the same period of 2005. Organic revenue growth was 4.8% compared to the first quarter of 2005, with approximately half of the increase due to the timing of revenue recognition and the remainder attributable to increased spending by existing clients. Operating expenses were flat, declining 0.7% compared to the first quarter of 2005. Salaries and related expenses decreased 2.5% mainly due to exchange rate variations and the effect of dispositions, while office and general expenses increased 1.2% primarily because of higher professional fees.

 

Three Months Ended March 31, 2006 Performance

 

When we analyze period-to-period change in our operating performance, we determine the portion of the change that is attributable to changes in exchange rates and the portion of the change that is attributable to the net effect of acquisitions and divestitures, and we refer to the remainder of the change as organic change.

 

Organic revenue growth and operating margin are our key corporate metrics. Our revenue is directly dependent upon the advertising, marketing and corporate communications requirements of our clients.

 

THE INTERPUBLIC GROUP OF COMPANIES, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS — (Continued)
(Amounts in Millions, Except Per Share Amounts)