Advantage Solutions Inc. Q4 FY2022 Earnings Call

Ladies and gentlemen, good afternoon, and welcome to Advantage Solutions Fourth Quarter and Full Year 2022 Earnings Conference Call. Today's call is being recorded and we have allocated one hour for prepared remarks and Q&A. At this time, I'd just like to turn the conference over to Kimberly Esterkin, Investor Relations for Advantage. Thank you. You may begin.

Thank you, operator. Thank you, everyone, for joining us on Advantage Solutions fourth quarter and fiscal year 2022 earnings conference call. On the call with me today are Dave Peacock, Chief Executive Officer; and Brian Stevens, Chief Financial Officer and Chief Operating Officer. After their prepared remarks, we will open the call for a question-and-answer session. During this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and involve assumptions, risks and uncertainties that are difficult to predict and could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Actual outcomes and results could differ materially due to a number of factors, including those described more fully in the sections titled Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operations announcement in the Company's filings with the Securities and Exchange Commission. All forward-looking statements are expressly qualified in their entirety by such factors. The Company does not undertake any duty to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. Please note management's remarks today will highlight certain non-GAAP financial measures. Our earnings release, which was issued today, presents reconciliations of these non-GAAP financial measures to the most comparable GAAP measure, which can be found on the Investors section of our website at advantagesolutions.net. The Company has also prepared presentation slides, which are posted on the website. You may refer to the slides during today's call. This call is being webcast, and a recording of this call will also be available on the website. And now, I'd like to turn the call over to Advantage's CEO, Dave Peacock.

Thanks, Kimberly. Good afternoon, everyone, and thank you for joining us. I also want to thank everyone on the Advantage team who has helped to welcome me to the Company. I'm excited for the work we are embarking upon together. Today is my first earnings call since joining Advantage, and it also marks exactly one month since I joined the Company. In the past four weeks, I've spent time with our team understanding the state of our business. I've spent time with our Board of Directors to review our financial performance and discuss our strategic plans for growth. I've spent time with clients and associates. In my brief time here, I've seen new opportunities for our company which serve as constant reminders that my decision to join this team at this time was the right one. In talking with our clients, it's clear that the work we do is highly valued and critical to the success of their businesses. It's also clear that Advantage's capabilities are as relevant now as they've ever been, given the challenging labor market for our retail customers and intense competition among CPG players. Our company is a necessary component of our clients' ongoing operations. Due to our scale, breadth and depth of experience, we are able to adapt as their needs evolve. I see opportunities to reinforce our connection to our clients by enhancing the processes and analytics that underpin the relationship. We will also be driving value for clients by leveraging insights across our sales and marketing platform to help better inform our collective decisions and actions. My visits with associates and retail trade thus far have left me motivated by the culture and diversity of Advantage's team and the legacy of winning that has been nurtured throughout the organization. This culture sits at the intersection of CPG and retail and promotes the seamless functioning of the broader consumer ecosystem. As I reflect on the experience of working at Advantage for our associates, we need to be more intentional in our onboarding efforts and provide a clear path for those associates who are looking to advance within our company. I also see the potential to convey both our purpose and role in the work that we do and how we articulate our value to associates and all stakeholders. In joining Advantage, I am most proud of our people. They are the reason our core business is so resilient as they bring excellence in service to our clients and customers every day. For the ninth consecutive year, Advantage holds the number one market share in essential sales and marketing services and the number one position in experiential and event marketing. Revenue for the full year also topped $4 billion for the first time in company history. Those top line results are indicative of a proven track record across economic cycles and serve as a great foundation to build upon. With not quite 30 days under my belt, I'm continuing to immerse myself fully in our business and spend the next few months building a deeper understanding of our capabilities, challenges, and opportunities that will allow us to deliver value to all of our stakeholders in the years to come. I will be providing that outlook later this summer, focusing on five key themes to guide my initial thinking. First, our relentless focus on the core value proposition to customers is paramount to an effective organization. Next, this business should provide strong cash flow yield, which will be a guiding focus for how we operate going forward. This leads into the importance of our balance sheet. A strong balance sheet is the foundation of any good business, and we will reduce our debt level and associated ratios over time. Fourth, people make all the difference in this business. So a transparent, effective process for assessing, retaining, and attracting talent at all levels is critical, as is ensuring an inclusive culture with clear opportunities for upward mobility. Finally, we must have optimized processes supported by systems and analytics that are executed with precision. A company like ours should leverage scale and relative market position effectively to create value for all constituents. I am excited about this team's commitment to deliver, and I look forward to sharing more about our strategy in the months to come. With that, I'll turn it over to Brian for more about our financial performance and outlook.

Thank you, Dave. It's great to have you as part of the team, and I look forward to continuing our partnership together. Let's begin with our P&L results for the fourth quarter. On a consolidated basis, fourth quarter revenues improved 6.8% year-over-year to $1.1 billion. Sales segment revenues of $665 million increased 5% year-over-year. Sales segment adjusted EBITDA of $78 million declined 17% year-over-year. Revenue improvement was driven by the strength in our lower-margin business services, including retail and merchandising services, which was partially offset by a decrease in third-party selling and retail services. The decline in adjusted EBITDA is largely a result of continued inflationary pressures discussed on previous earnings calls. The marketing segment revenues of $438 million were up 9% year-over-year. The growth was primarily driven by the continued return to our in-store sampling and demonstration services to higher event count volumes. Marketing segment adjusted EBITDA of $35 million was down 42% year-over-year, driven largely by ongoing spend and inflationary impacts of recruiting, wage, and employee benefit expenses, coupled with headwinds in our higher-margin digital business services. In aggregate, as anticipated, adjusted EBITDA margins came in at 10.2%, which is down 470 basis points year-over-year, reflecting a decline of 320 basis points in the sales segment and 690 basis points in the marketing segment. Moving on to discuss balance sheet items. In October, we conducted our annual impairment test, which led to a non-cash goodwill impairment of $1.368 billion and a $205 million non-cash intangible asset impairment charge. These impairment charges were mainly due to a sustained decline in the Company's quoted share price, headwinds from inflation, and rising interest rates. This impairment is a non-cash charge in the fourth quarter and does not impact cash flow for the Company. Our net debt to adjusted EBITDA finished in the fourth quarter at approximately 4.5x, and it remains our goal to deleverage our balance sheet and reduce our leverage ratio over time. We are open to considering various initiatives that adhere to that goal. For the full year, we achieved levered free cash flow conversion prior to earnouts or M&A of approximately 20% of adjusted EBITDA, which we believe will improve in 2023. Staying in line with previous quarters, our debt profile remains healthy, and we have no meaningful maturities in the next four years. At the end of the fourth quarter, our total funded debt outstanding continued to be approximately $2 billion. A summary of our debt and equity capitalization can be found on Slide 6 in the supplementary slides for the fourth quarter results posted in the Investors section of our website. Now turning to the outlook for fiscal 2023. For the year, we anticipated adjusted EBITDA in the range of $400 million to $420 million prior to adjustments related to any acquisitions and divestitures. While this is a decline from our 2022 results, we believe it is prudent given the continued industry headwinds and uncertain macroeconomic conditions. As quarters progress and we have more visibility around our business, we will revisit our annual guidance. While we do not provide revenue guidance, I would note that as we refine our business and refocus our efforts on our core areas of strength, we will consider several strategic alternatives such as making divestitures of certain business services that do not align with our main focus areas. These divestitures could result in a decline in our revenue and EBITDA, but as currently contemplated, would improve our overall leverage position. With that said, I'd like to provide some more insight into why as of the date of this call we believe this is the right adjusted EBITDA range for the year. First, labor availability continues to be tight. Relative to our previous expectations, this has resulted in a more gradual rebuild on our in-store sampling and demonstration business services as well as our retail merchandising business services despite continued demand for our offerings. While labor is beginning to show signs of improvement, this improvement is slower than the Company had previously anticipated. We expect labor to remain a top challenge in 2023, and we plan to continue investing in our ability to attract and retain talent. On a positive note, we are continuing to see benefits from our new recruiting software that has improved our speed to hire despite the challenging market backdrop. Overall, speed to hire in 2022 was approximately 25% faster than in 2021. In the fourth quarter, Advantage made approximately 1,500 net new hires. Second, inflationary pressures have negatively impacted the profitability of our business. In operating with a subscale workforce, we are not able to fully leverage certain fixed costs in our labor-intensive business services, which has negatively impacted our margins. Furthermore, we continue to see a price lag associated with our sales business segment given the ongoing higher-than-average increases in wages, travel, gasoline, and other expenses. Third, broad macroeconomic uncertainty has challenged consumers, retailers, and CPG brands, resulting in volatile demand signals across the ecosystem. In the new year, we will continue to pursue pricing opportunities to offset wage and ancillary spend increases and preserve margin. While year-over-year wage inflation slowed to mid-single digits in the second half of 2022, compared to high single digits to low double digits in the first half of the year, this is still well above our long-term inflationary rate increases. As labor costs increase, we remain diligent regarding pricing and continue to approach our customers for price increases. We will also continue to prioritize deleveraging our balance sheet in 2023 and work to drive the continued rebound of our in-store sampling and demonstration services. Although securing labor remains challenging, we remain confident that the business will continue to build back this year. Thank you for your time. I'll turn it back over to you, Dave.

Thank you, Brian. There is no doubt that 2022 was a difficult year for Advantage. While macro conditions remain challenging, we are taking the right steps to position the Company strongly for the future. Operational redesign, technology enhancements, efficiency initiatives, and aligning pricing to value are enabling us to weather the current environment and establish the necessary building blocks for long-term success. We welcome your questions, and we'll now open up the line. Operator?

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Our first question comes from Toni Kaplan from Morgan Stanley. Please go ahead.

This is Greg Parrish on for Toni. Welcome to Dave. I look forward to working with you. Dave, I wanted to start with you given your fresh perspective here. Clearly, there are some headwinds facing the Company. What moves the needle in the right direction? Is it just labor headwinds alleviating? What are your key initiatives really to drive this thing in the right direction?

Thanks, Greg, and I look forward to working with you and Toni. You've got external and internal opportunities for improvement, right? You've got a macro environment with significant labor inflation, and what is it now? I think two openings for every worker right now. It is a significantly different labor environment than we've seen historically. That, like any other cyclical dynamic, should bounce back eventually. The question is when. Internally, we have to find ways to deliver on our clients' and customers' expectations, leveraging technology and being more efficient, really understanding and decomposing our time to serve in the market. As Brian referenced in his comments, you will see, I think, a demonstration business continue to bounce back. We were encouraged to hear in last week's Cagney sessions that there was so much discussion around innovation. Typically, where there's innovation, there's a desire for sampling and to get products in front of people. We have several levers that we can pull both internally and externally, and we are optimistic that the macro environment will eventually be more favorable for our business.

Great. And then follow-up sort of along those lines, let me talk about passing through costs. I mean, I think it's been an issue, and I think even it's on one of the slides here. And Dave, you have a client-facing background, right? How do you go about enhancing the value proposition to really better be able to pass through costs to your customers?

Greg, you hit the nail on the head. It's reinforcing that value proposition. I've spent a lot of my time in the first 30 days visiting clients. I believe I've had 18 or 19 different client meetings, with a lot of traveling and understanding what's important to them, how we should be tracking their business alongside them, and getting ahead of any gaps in performance or opportunities for better performance in the marketplace. Addressing them right away and bringing them to their attention is key. It's not an overly complex business, but it's a highly execution-heavy complex business that requires attention to detail. That attention to detail can reinforce our value proposition. The moment of truth for many of our brands and products with their consumers is at retail. When a purchase decision is being made, we have a great opportunity to influence that, providing those insights back so that we and our clients can make better decisions regarding activity. It's all about building on that continuous loop and demonstrating a strong ROI that justifies the value we're creating for them.

Yes. Great. I just have one last one and then I'll hop out here. I wanted to ask about competition. I have two big competitors on the sales side who are more organized now than they were a few years ago, and they're also competing on price. How much of that is impacting you? Brian, you've said a couple of times over the last year that you haven't lost any customers yet to price; is that still the case? How much of that is playing a factor in your ability to pass through price right now? Can you provide an update on the competitive landscape?

At the end of the day, we're mindful of our competitors. However, we need to focus on our clients and customers and the job we're doing for them. If we do our best possible job for our clients and customers, our competitors become less relevant. We need to ensure that we have the highest level of satisfaction related to what we do, as that drives perceived value and efficiency in our service. While we obviously pay attention to what they're doing, we have a great relative market position across nearly all of our businesses; with more than 60,000 employees, over 3,000 clients, and a significant position in the marketplace, both with retailers and branded CPG companies. Our unique perspective is beneficial as we work at the intersection of these businesses and across a breadth of categories. The key for us remains managing these relationships properly and leveraging our collective intelligence to provide maximum value to our clients and customers.

Thank you. Our next question comes from the line of Jason English from Goldman Sachs. Please go ahead.

A pleasure to be here with you, Dave. I look forward to speaking in person. I have a number of questions. First, starting with your confidence in the $400 million to $420 million for next year. If we take where you finished the year and apply normal seasonality to it, normally, we deliver like 30% of the EBITDA in the fourth quarter. That implies $370 million of EBITDA at the run rate you exited. What gets better next year to get you to that $400 million to $420 million?

I appreciate it, Jason. I look forward to working with you. I'll give you some high-level thoughts initially. Brian may have an opinion as well. First, I'd say while there's been historic averages regarding how our EBITDA has been derived by quarter in this environment, especially with the volatility of both the labor market and timing of pricing, rolling in relative to contracts, you may see when one of those aspects can change. While we see the first quarter looking somewhat like the fourth, we have clear visibility on some of our contractual terms and an understanding of where rates should go, which provides us confidence in the guidance we've provided.

Yes, Jason, maybe I can add a bit more to that. I agree with what Dave is saying. If you look at Q4, first of all, if you consider the COVID impact of '21 versus '22, and you analyze the quarters from second quarter to second quarter and third quarter to third quarter, applying this to Q4 gives you about half of the gap to make up. Also, in Q4, specifically, we had a price increase in Q4 of '21 to address wage inflation in '22. We achieved a significant price increase in Q4 of this year, but it will take effect in Q1 of '23. So this timing difference will flow through in Q1 going forward. Additionally, we've faced headwinds in our digital advertising sector that impacted us in Q4. So, within the quarter, there are some differences we believe give us confidence in our $400 million to $420 million guidance for next year.

Okay. I want to come back to the pricing comment. I know you didn't give revenue guidance for next year, but we can back into reasonable assumptions. This implies a 9% to 10% EBITDA margin, which is similar to an outsourced manufacturer for CPG companies or a private label supplier to retailers. I don't think it's unreasonable to assume that they look to you as an outsourced provider, which raises the question of whether this is a reasonable base case and if you try to get greedy to chase a higher margin, whether that leads you to lose business. Can you provide a level set on expectations regarding run rate margins?

Jason, that's a great question. While you've read about this in the past, I believe this business should achieve low double-digit margins in the long term. You're witnessing volatility in the business due to significant margin swells that occurred when demo fell off during COVID, followed by a lag in pricing relative to labor cost inflation. Comparatively, when examining contract manufacturing, there are about 10 to 20 different contract manufacturers for the top private label categories. We, on the other hand, have only three national alternatives, with us being the largest regional network. We have fewer choices regarding vendors that can provide services on our level. I believe we can sustain a higher margin than what we currently are targeting, and if you look at trading multiples of contract manufacturers over the past seven years and apply that to our business, we could see a $5 stock price today. So there’s not a negative outlook, but we need to leverage insights from our unique position between CPG and retail to find as much value for our clients as possible. We think revenue is critical, so we are cautiously looking to drive home the importance of what we provide.

If your services are so critical and create so much value, why have you not been able to raise prices successfully?

Well, we have made some progress towards that, as Brian mentioned earlier, some of those price increases will start rolling through the year, and I believe there is still an opportunity to reinforce the ROI and engage in discussions with our clients and customers about prices. It's an opportunity moving forward. We have made some steps in that regard over the last 12 months, although the timing of contracts has created some lag in capturing prices for certain of our business segments.

Okay. I have one final question. I know I've been over my time. You've made a number of acquisitions in the last three years, amounting to around $250 million. Is it reasonable to assume that these acquisitions yielded something around 6x in terms of $40 million of EBITDA growth over the past three years from M&A? I'm just trying to gauge the underlying business's erosion.

Yes, Jason. It's not straightforward to make that comparison since a lot of businesses we are acquiring don't just bring revenue streams, but also servicing capabilities that can leverage our client relationships, retailer partnerships, and personnel expertise. Consequently, we look at these businesses together with our overall growth, not separately. So, it's not easy to isolate those components.

So you are paying higher multiples than 6x on average in aggregate?

Historically, we’ve talked about paying, on average, mid-single-digit multiples.

Ladies and gentlemen, since there are no further questions, I would like to turn the conference over to Dave Peacock, CEO, for closing comments.

Thank you, Ryan. I firmly believe Advantage has a bright future and a strong foundation from which to build an even better company. Along with my entire management team, one of our core goals is to rebuild credibility with you, our investors. Our associates are providing essential services that yield high returns for our clients and customers, effectively navigating the current environment. Our talented team is a true competitive advantage for our company, and we intend to unlock this value as we work to enable the organization to drive growth. Thank you again for your time today. I look forward to meeting some of you at the upcoming UBS conference later this month, as well as speaking on our first quarter call in May.

Thank you. The conference of Advantage Solutions has now concluded. Thank you for your participation. You may now disconnect your lines.