Stagwell Inc Q3 FY2022 Earnings Call

Good morning, everyone. Welcome to the Stagwell Inc. webcast for the Third Quarter of 2022. On today's webcast, Mark Penn, Chairman and Chief Executive Officer, will first provide an overview of Stagwell's third quarter, followed by a full review of the financial results from our Chief Financial Officer, Frank Lanuto. We will then take questions, which you can submit through the chat function on the video webcast portal. Before we begin our prepared remarks, I'd like to remind you the following discussion contains forward-looking statements, non-GAAP financial data. Forward-looking statements about the Company, including those relating to earnings guidance, are subject to uncertainties referenced in the cautionary statements included in our earnings release and slide presentation and are further detailed in the Company's SEC filings. Unless otherwise stated, comparisons to prior year periods and historical results discussed on this webcast will be pro forma for the combination, giving full effect to historical results, as if the combination had been completed on January 1st, 2021. For your reference, we've posted an investor presentation to our website at stagwelglobal.com. We also refer you to this morning's press release and slide presentation for definitions, explanations and reconciliations of non-GAAP financial data. And now to get started, I'd like to turn it over to our Chairman and Chief Executive Officer, Mark Penn.

Thank you, Michaela, and thank you for joining us to discuss Stagwell's third quarter 2022 results. Stagwell achieved another quarter of double-digit organic growth, strong margin expansion, reduced net debt, and record new business. We continue to outpace most large technology companies and are taking market share from global marketing service incumbents. In the third quarter, revenue reached $664 million, representing a pro forma increase of 17% from the previous year, with 16% organic growth. Year-to-date revenue was $1.98 billion, reflecting a 23% increase on both a reported and organic basis. Net revenue, excluding pass-through costs, rose 12% to $556 million, driven by 11% organic growth. Year-to-date, net revenue grew 16% to $1.64 billion, with 17% organic growth. Alongside top-line growth, third quarter margins and profitability were robust. Adjusted EBITDA rose 15% year-over-year to $115 million, with margins expanding 60 basis points to 20.7% of net revenue. Year-to-date, EBITDA is up 19% to $328 million, with margins increasing 50 basis points to 20%. We effectively manage labor costs while investing to support our rapid growth and new business generation. Our margin remains strong despite including an additional $5 million in investments in Stagwell Marketing Cloud and technology services. Overall, our compensation to revenue ratio remained steady at 63%. In the third quarter, net new business was $86 million, our highest ever, and healthy pitch activity gives us confidence heading into 2023. Our top 25 clients contributed an average of $6.1 million in net revenue per client, which is also a new record. Our strong growth in margins has resulted in significant bottom-line growth. Net income for the third quarter was $35 million, with GAAP earnings per share at $0.08 and $0.21 on an adjusted basis. Year-to-date, we've generated $93 million in net income, with GAAP earnings per share of $0.27 and adjusted EPS of $0.68. We are on track for an estimated $0.90 per share of adjusted EPS. Based on adjusted EPS metrics, we believe our stock is still undervalued in the market, but we’re starting to gain wider traction with our narrative. Stagwell is well-positioned to gain market share and has achieved greater relative scale in the digital service layer than competitors while offering a full-service creative package. We are effectively managing costs and will continue to evolve by adding significant SaaS offerings and new media platforms alongside our service business while maintaining our margins. Evidence suggests that we are gaining market share, reinforcing our confidence in achieving our long-term growth target of 10% to 12% annually. Although new business lagged in the second quarter, we experienced a strong uptick after participating in the Cannes Lions International Festival of Creativity, resulting in a record $86 million net new business this quarter, which bodes well for 2023. Our creative agencies, particularly Anomaly and 72andSunny, secured impressive wins, notably with Anomaly winning the major creative pitch to manage Bud Light's North American creator. Other significant wins included assignments from Dropbox, NFL, Stella, Topgolf, and expansions with Microsoft, Salesforce, 3M, and General Mills. We are increasingly winning pitches against the major five holding companies, with eight major pitches currently active. This year, we anticipate over $1 billion in pitch opportunities due to our increased scale. Last month, we officially rebranded the Stagwell Media Network to the Brand Performance Network to better convey our integrated offering. Our digital services saw strong growth, with combined net revenue increasing 21% in the quarter, building on 38% growth from 3Q 2021, resulting in a 30% increase year-to-date. Our digital transformation businesses led the network with 30% net revenue growth, driven by significant growth at our fully integrated digital agency GALE and our advocacy fundraising unit, Targeted Victory. Targeted Victory's growth was bolstered by online fundraising for political clients as we approach the midterm elections. The fundraising season started somewhat slowly this year compared to the 2020 Presidential cycle, with polling showing Republican leads and fewer contested markets reducing engagement from low-dollar donors amidst inflation. A significant impact from Hurricane Ian also paused operations in our vital Florida market during this key quarter. Watching developments in Georgia could further boost engagement if it decides Senate control. We project normalization of engagement next year as primary elections begin leading into a record Presidential cycle in 2024. Our Performance Media and Data divisions posted a 13% increase compared to last year, powered by a 60% surge in our Travel Media business reflecting post-pandemic recovery and high demand for connected TV and digital out-of-home offerings. Our consumer insights and strategy division also rose 13%, supported by strong demand at The Harris Poll from Fortune 500 C-level executives leading into larger brand strategy assignments. Stagwell is organized into distinct divisions led by experienced leaders, maintaining a balance between productivity and labor costs, which has kept our compensation to revenue ratio steady this quarter. Our core services team is rapidly implementing standardized accounting and HR systems, projected to reduce service costs and capture synergies by mid-2023. We generated strong free cash flow this quarter, allowing us to reduce net debt by $125 million, achieving a net leverage ratio of 2.7x as we strive for a long-term goal of 2.5x. The third quarter marked notable progress for the Stagwell Marketing Cloud, our suite of proprietary SaaS and DAS solutions for in-house marketers. We appointed Mansoor Basha as Chief Technology Officer to lead our technology roadmap, focusing on cloud integration and unifying data architecture. Stagwell Marketing Cloud is structured into four divisions, targeting specific marketer needs in multibillion-dollar addressable markets. We launched ARound, a shared augmented reality experience for stadiums, starting with the Minnesota Twins and expanding into the NFL and other major sports teams. ARound enables brands to sponsor experiences and reach fan bases. In the coming quarters, we’ll formally transition select products and businesses into the Stagwell Marketing Cloud and distribute them across our network, leveraging our extensive client base. Including recent acquisitions, we expect the Stagwell Marketing Cloud to generate around $140 million in revenue in 2023, with the potential to scale to a profitable $500 million run rate over the next five years. Regarding potential slowdowns, we will discuss our balance sheet and improved cash position cautiously while monitoring expenses closely to maximize cash flow. I believe we can further reduce our debt ratio next year while launching the Stagwell Marketing Cloud and capturing market share from competitors. We are reaffirming our guidance for 13% to 17% net revenue growth, excluding Advocacy, and adjusted EBITDA of $450 million to $480 million. With insights into the Advocacy fundraising contribution, we anticipate consolidated net revenue growth of 16% to 20% for the full year, along with roughly $0.90 in adjusted earnings per share. As Stagwell continues to surpass competitors, we believe that more are recognizing how our unique blend of talent and technology is reshaping marketing and driving high-value growth. We are gaining market share with record new business wins, expanding our digital services, managing and even increasing our margins, and rapidly developing new high-tech offerings for future success. Now, here’s a brief film summarizing the quarter, followed by our CFO, Frank Lanuto, who will provide more details on the numbers.

Thanks, Mark. Good morning, everyone. We're happy to have you with us today to review our Q3 and nine-month results. Similar to our recent post-merger results, my remarks will touch on our GAAP results, which will be accompanied by pro forma combined results, reflecting the business combination as if it had occurred on January 1, 2021. Starting with our reported results, Q3 revenue was $664 million compared to $467 million in the same quarter last year, marking a 42% increase. Net revenue, excluding pass-through costs, reached $556 million versus $409 million in the prior year, which is a 36% increase. For the first nine months, revenue amounted to $1.98 billion versus $857 million in the same period last year, an increase of 131%. Net revenue, excluding pass-through costs, was $1.64 billion compared to $749 million previously, representing a 119% increase. Net income for Stagwell common shareholders was $10.6 million for Q3 and $33.7 million for the nine months, an increase of $12.7 million and $13.5 million over the respective prior periods. GAAP earnings per share for common shareholders was $0.08 and $0.27 for Q3 and the nine months, which is an increase of $0.14 and $0.33 compared to the previous period. In Q3, we also introduced adjusted net income and adjusted EPS as additional performance metrics. We believe these adjustments provide investors with a more comprehensive view of the company's performance. Adjusted net income is calculated as net income available to Stagwell common shareholders plus income attributable to Class C shareholders, excluding certain expenses. Adjusted EPS represents adjusted net income per diluted weighted share outstanding, complying with U.S. GAAP's anti-dilution rules. Adjusted earnings per share were $0.21 and $0.68 for Q3 and the nine months, respectively. Moving on to our balance sheet, during the quarter, we completed acquisitions including PEP Group Holdings, an omnichannel content creation company, and Apollo, a real-time AI software platform. In October, we also acquired Maru Group Limited, a software experience and insights platform, along with Epicenter Experience and the remaining 80% equity interest in Wolfgang. As of September 30, our deferred acquisition obligations were $160 million, down from $197 million in Q2 and $222 million at year-end. We have essentially completed this year’s M&A activities. For 2023, we anticipate making around $60 million in cash payments compared to $72 million in 2022. During the quarter, we bought approximately 2 million shares for $13.9 million under our stock repurchase program, returning value to our shareholders. Over the year, we have purchased about 4 million shares for $28.7 million and have roughly $96 million remaining under the $125 million authorization. Net CapEx for the quarter was $11 million and for the nine months, it was $25.5 million, which is about 1.2% of year-to-date revenue, consistent with our previous estimates. Regarding liquidity, strong cash flows have reduced our net debt by $125 million during the quarter. We closed the quarter with $165 million in cash and $245 million drawn against our $500 million revolver. Our net debt leverage ratio dropped to 2.7 times, down from 3.1 times last quarter and last year. We expect strong cash flows will further decrease our net debt and leverage ratio in Q4. S&P Global recently upgraded our credit rating to BB- from B+, citing our strong operating performance and expected decline in leverage. This upgrade followed Moody's improvement of our credit rating to B1 from B2. I will now shift to a deeper discussion of our pro forma results for Q3 and the nine months ended September 30. Revenue for Q3 was $664 million compared to $568 million last year, a 17% increase. Net revenue, excluding pass-through costs, rose 12% to $556 million from $498 million previously. Excluding Advocacy, revenue and net revenue increased by 10% and 7%, respectively. For the nine months, revenue increased to $1.98 billion from $1.61 billion last year, a 23% increase. Net revenue, excluding pass-through costs, rose to $1.64 billion from $1.41 billion, which is a 16% increase. Ex-Advocacy, revenue and net revenue climbed by 19% and 14%, respectively. On an organic basis, net revenue increased 11% and 17% for the quarter and nine months, respectively. We have organized our business into four main areas: digital transformation, performance media and data, consumer insights and strategy, and creativity and communications. Digital transformation showed robust growth in 2022, up 28% in Q3 and 38% year-to-date organically, thanks to significant growth at GALE, election cycle gains at Targeted Victory, and steady client wins at Instrument and Code and Theory. Performance Media & Data experienced a 5% rise in Q3 and a 13% increase year-to-date organically, propelled by strong expansion at Ink and steady growth from Multiview and Assembly. Consumer Insights and Strategy grew 11% in Q3 and 29% year-to-date organically, supported by strong performance at Harris Poll and ongoing contributions from NRG. Creativity and Communications saw a 5% increase in the quarter and a 6% increase year-to-date organically, attributed to strong performance in our Advocacy business, as well as growth in experiential services and public relations. Turning to costs, adjusted EBITDA rose to $115 million in Q3, a 15% increase from $100 million in the prior year, with an EBITDA margin of nearly 21%, up about 60 basis points from before. For the nine months, adjusted EBITDA increased to $328 million, around 19% growth compared to $274 million previously, with a margin of 20%, up approximately 50 basis points. We are managing efficient compensation to revenue ratios of 63% for Q3 and just under 64% year-to-date while contributing approximately 25% of our incremental net revenue to EBITDA in both periods. Lastly, regarding our guidance, we are reaffirming our forecast of 13% to 17% net revenue growth, excluding Advocacy, along with adjusted EBITDA of $450 million to $480 million and adjusted earnings per share of $0.86 to $0.94. Given additional visibility into Advocacy fundraising, we expect consolidated net revenue growth of 16% to 20% for the full year. This reflects a more modest contribution from Advocacy fundraising compared to the 2020 presidential cycle due to a decrease in closely contested races, ongoing inflation, and hurricane impacts in major markets. That concludes our prepared remarks for this morning. We will now turn to Q&A, starting with Laura Martin from Needham & Company, who is joining us live here at One World Trade Center. If you have questions on the live stream, please submit them via the chat button at the top of your screen. Now, let’s move on to some questions.

Great. Okay. So just listening to the call, one of the things you guys said was you have $1 billion of pitch opportunities, and it looks like you have $86 million in new business, which is a record for 3Q. Could you tell us how they flow through the income statement? What's the lag in time between pitches to now you get new business? When does it start flowing into the P&L?

Sure. Look, I think just to put some context in, when I started as CEO of what was the old MDC, there was about in a year, about $300 million of pitches. Now we expect this year to give you context that the combined company will get about $1 billion of pitches that we monitor the great central marketing team that we have. We usually don't participate in about 20% of them, and then we're going to win a fair share of the $800 million remaining. These pitches will take somewhere between two and six months generally to be executed depending upon their size. They will then kind of go in almost immediately from the day of award. They will make an immediate transition and then they will ramp up over the first 30 to 60 days. But generally, you've seen the pattern where we came into this year with a $75 million new business in Q4, and you could really see that flow through into the following quarter. And you could see that our new business, as I reported in the previous call, was a little light going into Cannes, and you could see we were then, I think we're lighter coming into that, and you see coming out of this a really strong new business number. If you look at the chart, it goes like this and boom. And I really think that at Cannes we showed the kind of scale that we have and really our pitch opportunities have sizably increased as a result of that. And I also think there was a little pause in the marketplace, where people waited a little bit, and then there seems to be a lot of pitch activity out there continuing unabated.

So let's stay on that point. Yesterday on the Roku call, Roku is down big this morning. They said that they had seen cancellations in telecom, insurance and toys in the fourth quarter ad campaigns, talking about uncertainties. So tell us because you guys have a much broader view of both marketing services and advertising, tell us what you're seeing in the marketplace for Q4 in terms of ad campaign cancellations, pushing off, lowering toes, what's happening in the marketplace right now?

Look, we've seen some clients push off projects, but nothing at a level that would have given us extraordinary concern compared to, say, the pandemic or when I managed other properties in 2009. I don't see anything like that right now. I see new business being quite strong. I see some push-offs or caution in the marketplace, but nothing that I could consider. Remember, the Fed's problem is that the economy that we work in is considered too hot, and they haven't tamed that yet. So maybe someday, we're going to see it, maybe next year, we're going to see it. But that, we are right at the sweet spot of why they keep raising interest rates.

Okay. But you haven't seen slowdowns in Q4 which is not what we're hearing from Meta, Google, Roku, Paramount, all of them have said Q4 is horrible.

A lot of this is that we're in a share-gaining position. So when you look at our digital, you look at the services that are growing and you look at people turning to our unique combination of marketing, like I don't know what those numbers would be in a roaring economy as opposed to an obvious marketplace where it's push back. I do also think that when we did an analysis recently in the marketplace, there is more fragmentation of the digital dollar. TikTok has come in at the Amazon and Walmart marketplace. And so there are a lot of competitors out there, and there are only so many eyeballs, and part of this, I think, is fragmentation or necessarily over just slowdown.

Okay. Let's stay on video. You brought up TikTok, which is digital video, and it does seem to be taking share from maybe some of the tech space and other mobile. You had a CTV growth rate of 13% for that was a sector that includes CTV. Can you talk about the shift towards connected television? Can you talk about where you're seeing strengths and weaknesses in different channels, big screens, small screens?

Yes. Look, I think that we're seeing something of a shift. I really think the big issue here is going to be Netflix. I think that's not going to be, we've been in kind of a mixture of video. And we're a very, very heavy Google shop over here. So that, in fact, the increase in video, I think, is an increase in kind of our mix of service. But I think really, Netflix is going to be hugely disruptive in the marketplace.

And Disney too?

Disney has eyeballs, but the number of our, again, so let's tell people Facebook came before Facebook advertising. TV came before TV advertising, Netflix and the number of hours of eyeball are just astronomical. I think those ads will really upset the marketplace in a positive way.

Driving down CPMs?

Yes. I hope it will provide more competition. Our goal is to make it easier for marketers to get to their consumers on an efficient basis. So a more fragmented competitive advertising marketplace is good for us and good for our clients.

Okay. Great. So Targeted Victory, what the heck? What's going on over there?

Well, the question is what's going on there in our nation, you have to understand.

So this is political fundraising from $20 and $40 donations.

So as gas prices went up, available funds, so people could allocate to fundraising went down. We think that's temporary. From our cash position, actually, it will be readjusted next year given that it was related to an earnout anyway. So it won't have a really net two-year cash effect. But we don't think it has a long-term impact on the business or the nature. We think this was a short-term impact. And we think that the presidential race is going to be the largest presidential race in history. And that if anything, I think donations will come back as the Fed turns back inflation.

Yes, we have some questions from investors and analysts through the chat from Mark Zgutowicz at Benchmark. For the Stagwell Marketing Cloud, how would you characterize each of the four segments near versus longer monetization prospects and which segments will require the most incremental investment over the next two to three years?

Yes, there's already very substantial revenue in the media platforms. And I think you see that because we have the travel platform in there. And so I think those show like the earliest promise to generate a revenue hockey stick. And I do think the ARound thing, which really is a kind of, you look at an AR experience stadium and then you realize that's really a new media platform, giving an ability for people to have a new kind of sponsorship and engagement with fans at stadiums. So I think that has a lot of revenue, a lot of immediate promise. I think the Comtech we've been out there in the marketplace, it's slowly snowballing. I think those products are largely built and require more sales than tech investment at this point. We recently acquired Maru. So again, we've got substantial nearly $50 million in revenue as a starting point in the research biz. And again, I think the technologies are largely developed and we're moving to sales. I think the biggest commitment to refining and making the technology useful is in the media studios. I think that's where a lot of the technology commitment will be. But of course, that we hope will be the premier product, and that will take a longer time to roll out.

Perhaps staying on that topic from Steve Cahall at Wells Fargo, how much revenue are you currently generating from the Marketing Cloud and what's the cumulative investment that you expect to make?

As we define the Marketing Cloud, as I said, we expect to have about $140 million in that basket in the coming year. I think when you figure that Maru was just acquired. And so I think that's the way I would characterize it. I think that the remarkable thing and one of the big advantages we have is that because we have the client base, because we have the expertise, because we already buy $5 billion of media and therefore, have the proving ground for our technologies. But I'm really able to keep, we're investing $5 million of OpEx, maybe we'll invest $10 million of OpEx next year. We're able to keep the level of investments in OpEx here, quite low. And also we are developing this in a way and an eye towards profit. So we're not looking to make the mistakes of companies out there that put huge sums of money into things that they hope to have our future. We are very cautious in the way we do this. We're getting a lot of power. You take a look on this stadium thing, we invested maybe $1 million or $2 million, and we beat every competitor out there to the marketplace with an in-stadium experience, and there were some big competitors out there. Remember, I was Chief Strategy Officer of Microsoft, the fact that we have an infrastructure of a service business allows us for relatively small investments to get the cloud off the ground. And that is our unique advantage compared to a lot of the startups and the other companies out there that don't have this full infrastructure or understanding of technology or ability to apply it in this way.

A follow-up from Steve. Could you clarify the remark about persisting inflation as it relates to guidance? Is this related to the Advocacy revenue? Or are you signaling some macro reaction by advertisers?

That was related just specifically to the Advocacy and to the impact of gas prices and food prices on low dollar contributors.

A follow-up from Mark at Benchmark. Nice free cash flow results in the third quarter. How do you see the trend line in Q4? Any puts and takes to consider?

Frank?

Q4 is historically the strongest cyclical quarter for cash flow generation. And it's a combination of factors. It's forecasted revenues, but more so, it's the media dollars that customers intend to spend and production activities that take place. So if you have five Super Bowl spots, you're going to generate a lot more production dollars in the quarter that will then result in some outflows in Q1 and similar patterns for the media spend. So if history is the indicator of the trend line says that things are stable, we should see an improved Q4 over Q3.

And a follow-up from an investor on free cash flow in Q4. Will you use expected 4Q free cash flow to repay the revolver or will you carry cash on the balance sheet? If paying down the revolver, is it possible to be at zero draw by year-end?

We will generally use the excess cash in the U.S. to take down the revolver. We borrow under a couple of different arrangements. We have a daily borrowing facility, so to speak. And then we have a SOFR borrowing facility, which leads you to commit to 30, 60, 90-day borrowing periods. So sometimes you may find yourself you're down to zero in your daily borrowing, but you still have a mandatory position in the 30 or 60 days. And you may have to just take the cash and hold it on your balance sheet to that next window opens up. We try to ladder that based on how we see cash flow moving through the business so that we never find ourselves with too much extra cash that we can't use to offset the interest expense by paying down the revolver. So it's a bit of a timing and it's a bit of an exercise to plan that out.

And Frank, we're also making international cash more efficient, particularly in the U.K.

Yes. We recently put together a cash pooling arrangement in the U.K., which we believe now will allow us to aggregate our cash flows there and probably safely bring home to the states more cash that we can use, again, to apply against the revolver, which is generally U.S. based.

From Jeff Van Sinderen at B. Riley. Based on the caution you're seeing in the marketplace, is there a reason to think that your organic growth will moderate substantially in fiscal '23 as a result of that cautionary slowing by marketing and advertisers?

Well, look, I think we've been preparing ex Advocacy for 2023 during a lot of the year in terms of structuring and restructuring kind of our units here. So we're ready for a good 2023. I think when you look at our business, the jump up in new business to a record level is really says that we're going to be able to start out here quite well. I'm not going to, at this point, give you any guidance into the next year. But I think I’d be sitting here probably with fewer smiles on my face if we were sitting here with $20 million of new business, and I'd be saying, well, there's an obvious slowdown. We’re sitting here with a record $86 million. So I'm saying, well, obviously, as I keep emphasizing, we are gaining share. And so, as long as there are pitches and as long as clients rotate from one to another, we will now get into an increasing share of pitches and have a growing opportunity to get business in the marketplace. Sure. It would be better if it turns out that the market is growing or that Powell does a soft landing. But we have a lot of cushions here in the sense that, a, we have been good managers, up and down, if you look at how we did in the pandemic. We very carefully plan out and keep lots of headroom. We have a high variable cost business in terms of how things go up or go down. But most importantly here, we're gaining share against our competitors, and we’re more digital than our competitors. And those two factors should allow us to have a better growth curve than whatever the rest of the industry has. And if you look at the comparisons to the rest of the industry on an organic basis, we’re running about double what they are. So we hope that investors will give us credit for that.

And that concludes our questions from the chat. I'll turn it back to Mark for closing comments.

Thank you. I hope you just review everything carefully that this has been another strong quarter of double-digit growth and us moving in the right direction here at Stagwell, Inc. Thank you all.