Stagwell Inc Q1 FY2024 Earnings Call

Good morning from Stagwell's offices in Washington, D.C. and welcome to Stagwell, Inc.'s earnings webcast for the first quarter of 2024. My name is Ben Allanson. I lead the Investor Relations function here at Stagwell. With me today are Mark Penn, Stagwell's Chairman and Chief Executive Officer, and Frank Lanuto, the Chief Financial Officer. Mark will provide a business update, and Frank will share a financial review. After the prepared remarks, we will open the floor for Q&A. Before we begin, I'd like to remind you that the following remarks include forward-looking statements and non-GAAP financial data. Forward-looking statements about the company, including those related to earnings guidance, are subject to uncertainties and risk factors addressed in our earnings release, slide presentation, and the company's SEC results. Please refer to our website, stagwellglobal.com/investors for an investor presentation and additional resources. This morning's press release and the slide deck provide definitions, explanations, and reconciliations of non-GAAP financial data. And with that, I'd like to turn the call over to our Chairman and CEO, Mark Penn.

Thank you, Ben, and thank you to everyone joining us for our first quarter earnings call. On our Q4 call in February, I talked about our excitement and confidence in 2024, highlighting that we expect to return to growth in the first half of this year. Several factors give us confidence, including the abatement of industry headwinds, such as tech restructuring activities, strong new business trends, our record-breaking political cycle, and our continued investments in digital innovation beginning to contribute to growth. Today, I'm pleased to share that these trends are beginning to play out exactly as we anticipated. Stagwell delivered $670 million of revenue in the first quarter. These figures represent an encouraging growth in revenue of 8%. Additionally, we continue to post record net new business figures for both the first quarter and last 12 months. Importantly, we delivered these growth figures while effectively managing our costs. Actions we took in 2023 helped us grow our adjusted EBITDA by 25% year-over-year to $90 million. These results are highly encouraging and give us the confidence to reiterate our full year guidance today. We also draw our confidence from tailwinds. Advertising is once again growing. Our reputation has expanded, and we are participating in record new business pitches. AI will, within the year, create vast digital transformation opportunities. International work is proving to be a fertile area for expansion, and the advocacy season promises to be historic. This quarter's performance was driven by two double-digit growing capabilities. Performance Media and Data grew 13% in revenue and 12% in net revenue. Advocacy showed 80% revenue growth, leading to a 54% net revenue increase. Digital transformation, led by double-digit growth, has returned to revenue growth, but it's still building up an expanded pipeline as tech companies are beginning to come back online and research is still overcoming the impact of last year's trends. Continuing the trend from last year, we saw outsized year-over-year growth in our relationships with our largest, most impactful customers. In the first quarter, our top 100 customers, now representing 50% of our total net revenue, grew 25%. Geographically, we saw a return to growth in the United States, our largest market, with total revenue growth of 9% year-over-year. Our international businesses also continued their momentum with revenue growth of 7% in the quarter. Europe has been a major area of focus for us recently, and we opened our new regional headquarters, Bluefin, in London just a few weeks ago. This focus is translating into strong revenue momentum, with the EMEA region growing 14% year-over-year. Turning to cost and profitability. As I mentioned previously, we delivered $90 million of adjusted EBITDA in the first quarter, 25% higher than the first quarter of last year, representing a 17% margin improvement of 320 basis points year-over-year. This impressive figure is a direct consequence of the proactive steps we took last year to manage our costs. In 2023, we took staffing actions that resulted in $98 million of annual savings. As a result, our labor costs are 2% lower in the first quarter of 2024, helping to deliver a staffing-to-net revenue ratio of 64.3%, an improvement of 270 basis points over the first quarter of last year. Also driving this margin improvement is a laser focus on managing our G&A expenses. Despite our growing net revenue in the quarter, our total G&A expenses were almost exactly the same as in the same period last year. We're installing modern systems for back office, utilizing offshoring, and adding AI capabilities to streamline operations. We've seen particularly strong growth in adjusted EBITDA from our performance media and data capability, growing 212%, and creativity and communications growing 42%, a testament to the focus that all of Stagwell is placing on controlling our costs. Net new business continues to bring company records, giving us increased confidence in our full year guidance. In the quarter, we delivered $66 million of net new business, a record for the first quarter for Stagwell. This brings our last 12-month net new business figure to $284 million, also a company record. Quarter after quarter, we've increased the LTM net new business figure from $212 million a year ago. Importantly, the size of our wins has grown impressively, contributing value to larger global pitches. In the first quarter, the average win size increased 13% year-over-year. These net new business numbers were driven by some important wins, including Fogo de Chao, the Star Tribune, Fossil, and Wilson, as well as expansions for targeted initiatives. In Q1, Stagwell agencies captured over 70 of the top awards across major industry shows, including an array of Agency of the Year designations, with about 1% to 2% of the market participating. We are far exceeding that in terms of redistributing our recognition. These include four agencies featured on the Ad Age A list, including Code and Theory being recognized as Business Transformation Agency of the Year, GALE winning U.S. Advertising Agency of the Year by Campaign, Assembly being named Media Agency of the Year, and Exponent being recognized as the IT Communications Shop that won the Disruptive Agency of the Year award. Our M&A program was active. We might not have gotten every deal we sought, but the net revenue and adjusted EBITDA from companies acquired in the fourth and first quarters exceeded the net revenue and adjusted EBITDA loss from ConcentricLife disposition. We achieved this despite the initial outlier in acquisitions being only about 15% of the dispositions' growth proceeds. This is concrete evidence that our M&A machine can be a major driver of value for investors moving forward. As I've discussed previously, we're exploring further non-core dispositions and hope to have more color on that later here. In the first months of 2024, we made strong progress in expanding our global presence through acquisitions. We acquired a UK digital collective sidekick and our first French-created agency, Next Partners. Just last month, shortly after the end of the first quarter, we announced the acquisition of Pros, a digital-focused brand and marketing consultancy in Brazil, which significantly expands our Latin American presence. We're looking to become more competitive internationally by doubling our business outside of North America to 40% of net revenues over the coming years. Our current focus is in Western Europe, the Middle East, and Asia. This quarter, we took steps to sharpen our capabilities in data, media, and AI through a combination of internal initiatives and external partnerships. In the first quarter, we maintained a strong investment of $14 million into the Stagwell Marketing Cloud, our AI-enabled suite of products for modern marketers. We're now working to bring our research products under the Harris Quest brand to market and expect to see sales growth in the back half of the year. SMC orchestrated its first software launch with Google Cloud as we deepened the partnership with Gen AI announced last year. At Google Cloud, we launched a data cleanroom solution on Google's platform that will provide our clients with a private and secure space to mix and match their first-party data with Stagwell's vast trove of data solutions. We're also focused on growing AI leadership across our agencies. One focus will be scaling best-in-class use cases such as GALE's enterprise Alchemy.AI platform announced this quarter, which reduces the time spent on critical tasks across all disciplines in the agency to help GALE's nearly 800 people work smarter, better, and faster. Left Field Labs is incubating customer-facing solutions to elevate the customer experience. And our largest performance media agency, Assembly, is set to announce a new AI solution later this month. We are making significant progress on our media studios unit on building the last mile of the media chain from planning, targeting, and audience creation down to placement and media supply. On our last call, I announced we were building a Stagwell ID solution. Today, we are partnering with NEXON, a globally unified advertising technology platform. We'll have more to share on that partnership in the coming weeks as we roll out our new offerings in data and media. In other parts of our business, we're preparing for Sport Beach this June at the Cannes Lions Festival, where we'll return for a second year with more brand sponsors and more athletes, including Joe Burrow, JuJu Watkins, and Megan Rapinoe. Sport Beach continues to benefit the company by increasing our exposure worldwide and leading to new business opportunities. Finally, we're excited later this month to host our Definitive Future of News Summit in partnership with top publishers across the U.S., including Axios, Business Insider, New York Times, Politico, Wall Street Journal, Washington Post, The Trade Desk, and Ad Fontes Media. Recognizing that fears around brand safety have made advertisers more cautious about advertising across news and opinion sites, we're releasing a first-of-a-kind study for advertisers to better understand where and how they should advertise across the news industry. It's been a busy quarter. We are never standing still. We are marching forward to achieve our goal of offering everything from global full service to platform self-service. Wherever you look, Stagwell is evolving and bringing our partners along with us to the cutting edge of marketing services. We're on the forefront of AI, a global performance market of culturally relevant events, advancing online advocacy campaigns, transitioning to more social media and content, and reconvening the combination of media and creativity. These efforts, combined with a solid quarter of revenue growth, give us confidence about the year ahead. Now I will hand this over to Frank Lanuto, our Chief Financial Officer, to walk through some of our financial results in more detail.

Thank you, Mark. Good morning, everyone, and thank you for joining us to discuss our first quarter results. The company returned to revenue growth during Q1, driven by strong performance in our media and advocacy businesses, improving market conditions in the U.S., and continued momentum in the international markets in which we operate. For the quarter, we reported revenue of $670 million, an increase of 8% compared to the same period in the prior year. Net revenue, excluding pass-through costs, increased 2% for the same period to $532 million. Building on the trend for ’23, our largest customers continue to invest in their relationship with our agencies. In the first quarter of '24, our top 100 customers, now representing 50% of our consolidated net revenue, grew 25% versus the prior period, marking our largest improvement in the last 5 quarters. The number of relationships also expanded, with the number of customers in our top 100 being serviced by more than one of our agencies increasing 12% year-over-year, providing further evidence that our strategy of delivering integrated services is working. Another positive signal was the occurrence of an inflection point where period-to-period revenues with existing customers from growing relationships exceeded those from declining relationships. Our net new business performance for the quarter represented the fifth consecutive quarter of increasing trailing 12-month performance, setting another high watermark of $284 million. We are tangibly benefiting from being invited to participate in larger global pitches, as the average size of our wins increased 13% year-over-year. The combined impact of net new business and improving performance with existing clients allows us to reaffirm our guidance for the year. Turning to revenue by capability, the first quarter saw revenue growth in four of our five principal capabilities. Performance Media and Data delivered $77 million in revenue, an increase of 13% over the prior year period. This performance was driven by a combination of new business wins and growth from existing customers. Particular areas of strength included transportation and lodging, consumer products, and the financial services sectors. Creativity and Communications delivered $292 million of revenue, an increase of 11% over the prior period. We had strong growth from several consumer product customers, as well as clients in technology, media, and communication sectors, which grew about 2% over the prior period. Digital transformation returned to growth in the first quarter with revenue increasing to $196 million, a 6% improvement over the prior period, driven by strong performance in food and beverage, efficacy, and technology-based clients, which grew 20% period-over-period. This growth was partially offset by softness in financials, as we anniversary the regional metal crisis from early '23. Consumer Insights and Strategy reported $46 million of revenue, a decline of 7% year-over-year. This was largely a consequence of customers within the entertainment sector increasing spending more slowly following the Hollywood actors and writers strike late last year. The Stagwell Marketing Cloud totaled $60 million in revenue, an increase of 7% year-over-year. The suite of software products continues to be an investment priority for us. In the first quarter, we maintained our investment spending of approximately $14 million into the cloud as we continue to build an industry-leading suite of tech products for the modern marketer. Finally, advocacy is a significant contributor to the business mix in election years as we benefit from increased political fundraising and spending leading up to the elections in November. In the first quarter, efficacy revenue grew to $65 million, an increase of 80% over the prior period. Now turning to geographical breakdown, we saw continued strong revenue growth in our international businesses of 7%, which was led by exceptionally strong growth of 14% in the United Kingdom. In the U.S., our largest market, revenue increased 9% over the prior year. Turning to costs, management took decisive actions in '23 to rightsize our cost structure to better align with trending revenue. The results of these actions can clearly be seen in our first quarter results. In the first quarter, the company delivered $90 million in adjusted EBITDA, an increase of 25% over the prior period, and it also increased the related margin to 17%, an improvement of nearly 320 basis points over the prior quarter. Staffing is our largest cost. In '23, we took actions that reduced annualized salaries and headcount by $98 million and 4%, respectively. We benefited from the full effect of these successive actions during Q1, as labor costs were lower by more than 2% or $7 million, and the staffing cost-to-net revenue ratio was reduced to 64.3%, an improvement of 270 basis points versus the prior year and the lowest first quarter ratio since our merger. In addition to staffing, we also focused on efficiently managing our G&A costs. For the first quarter, our G&A expenses were just under $100 million, in line with the same period in '23. This results in G&A as a percentage of net revenue of 18.8%, an improvement of nearly 30 basis points versus the prior period. Our G&A costs also include certain unbillable expenses, which tend to grow in line with our net revenues. For both the first quarters of '23 and '24, our unbillable customer expenses as a percentage of net revenue remained stable at 6%. Adjusting G&A expenses to account for these unbillables, our G&A actually decreased by slightly more than $1 million year-over-year, representing a 2% decline excluding unbillables. The cumulative impact of our revenue growth and cost actions contributed to strong adjusted EBITDA performance during the quarter and allowed us to maintain our strong investment in the Stagwell Marketing Cloud. Excluding the $14 million of cloud investment in Q1, our first quarter adjusted EBITDA margin would have been approximately 19.9%. Now moving to the balance sheet, we continue to make efficient allocation of capital to maintain a strong financial position. Starting with deferred acquisition consideration, we reduced obligations from approximately $65 million at the end of the first quarter last year to $101 million at the end of the first quarter in '24. We remain on track to reduce our debt obligations to approximately $40 million by the end of the year. We also acquired 4 million shares during the quarter at an average price of $6.11 per share, for approximately $25 million. Our existing buyback authorization as of quarter end now has $114 million in remaining availability. CapEx and capitalized software for the quarter was $14 million, broadly in line with our targets. As a result, we ended the quarter with cash of $130 million and drawings under our revolver of $182 million. Our leverage ratio at quarter end was 3x. Finally, as highlighted by Mark in his remarks, we are reaffirming our full year '24 guidance as follows: Organic net revenue growth is expected to be between 5% to 7%. Organic net revenue, excluding advocacy growth, is expected to be 4% to 5%. Adjusted EBITDA is expected to be between $400 million to $450 million. We expect to deliver approximately 50% free cash flow conversion, and adjusted earnings per share are expected to be between $0.75 and $0.88. That concludes our prepared remarks this morning. I will now turn the call back over to Ben Allanson to open the Q&A portion of the call.

Thank you, Frank. We're going to start with a question here from Barton Crockett at Rosenblatt. He says, can you please walk us through what you see as the drivers of acceleration of organic net revenue growth over the balance of 2024 from the 2% reported in Q1 to the 5% to 7% guidance today? How much visibility do you have into this acceleration? Do you think it's going to be steady, or is there going to be one major event that really drives it up?

Sure. Thank you, Barton, for that question. Look, I think as you analyze it, you can see international markets moving along nicely, advocacy progressing well, and media is firing on all cylinders already with double-digit growth. Our pipeline, when I look at it, is 50% higher than it was at this time last year. We are in a record number of new pitches of increased size given our enhanced reputation. Also, AI is gaining traction as customers begin to move beyond the phase of merely evaluating it and start to implement it. I believe you're going to see a strong second quarter, with growth building into the third and fourth quarters as advocacy and media trend towards their peak during the holiday season. So, I foresee strength building throughout the year as digital transformation picks up momentum and both media and advocacy excel in the second half.

Just on digital transformation, Jason Kreyer from Craig-Hallum is asking about the positive signs we’re seeing that support our confidence in returning to growth in that area.

Yes, we're seeing some of the companies that had cut back last year beginning to make a comeback. We're not only seeing growth, but it is connected to AI advancements. Companies that produce the technology and have the necessary cloud infrastructure now require applications to fully leverage them. We focus on building AI applications for our clients. First, clients need to be assured that their data will not be funneled into a global database, which is why we established clean rooms for internal and client data management, providing the necessary confidence. As clients gain assurance that AI can be used safely and securely, I anticipate demand will surge. Our evolving challenge will be finding engineers instead of work opportunities because the demand will significantly increase in the second half of the year, which I believe will be evident in technology companies' reports.

Now, regarding tech customers, could you elaborate on the key trends we're observing as technology clients begin to rebound?

Yes, while they are gradually returning, they have yet to resume full operations. There's still room for growth ahead. This year appears to be defined by increased competition. We've noted improvements; our list of top clients comprises significant technology companies. In many respects, we are a tech company for tech companies, assisting in developing AI for consumer interactions and creating new applications. However, caution still prevails among these clients. Nevertheless, they are progressing in expanding their programs for AI integration, and once they fully embrace it, I anticipate a significant wave of demand in the near future.

Shifting gears to the international side, a question from Mark Zgutowicz at Benchmark. With only about 12% of net revenue coming from outside the U.S., how should we understand growth by geography in relation to our guidance moving forward? Additionally, is the expansion into the Asia Pacific a significant initiative to unlock larger global contract opportunities?

I believe our acquisition strategy clearly demonstrates our approach. Several acquisitions focus on frontier marketing, such as Movers and Shakers and Left Field Labs, while others target Brazil and the U.K., and we will place greater emphasis on Asia and the Middle East in the coming months. We're now positioned to engage in larger pitches valued at $40 million to $60 million, showcasing Stagwell as a serious contender against major players. By consolidating our European agencies through Blue Fin, we're witnessing multi-million dollar opportunities that were previously inaccessible due to fragmented service offerings. Though the European market may not be high growth, our potential to capture market share has significantly improved through our new structure. We will adopt this region-by-region strategy until we establish a fully functional global network.

Great, moving on to net new business. Laura Martin at Needham inquires about the $66 million of net new business wins in Q1, which escalates to $284 million for the trailing 12 months. What do you believe is Stagwell's normalized revenue growth rate? Are we in mid-single digits or high single digits?

Well, it will depend on how the Federal Reserve impacts the broader economy today. However, we are effectively working towards our targets of achieving 10% year-over-year growth. After experiencing a 15% increase in 2022, 2023 fell short due to various exogenous factors: recession fears, media slowdowns, strikes in several industries, and technology pullbacks. We're aiming to return to those previous growth levels, recognizing that this is a transition year. By the end of the year, we hope to have a broad global network and our Stagwell marketing cloud products introduced fully. Looking ahead, our capabilities in media, our ID graph, and digital transformation will be at the forefront of AI development. Thus, I consider this a pivotal year in our journey back to our long-term growth targets.

A couple of questions focusing on advocacy. First from Steve Cahall at Wells Fargo. Did advocacy exceed your expectations regarding revenue, net revenue, and adjusted EBITDA in Q1? Although you didn't adjust guidance today, does this give you more confidence in achieving your advocacy and new business goals?

The strength of our advocacy undeniably boosts our confidence. Advocacy exceeded our expectations, particularly given the absence of significant primaries on either side. Observing such robust performance encourages the anticipation that 2028 may well exceed the record set in 2024, as both parties will have competitive primaries. Increasingly, I recognize that this year is shaping up to be monumental, and once the conventions commence, I anticipate the focus and activities around advocacy to heighten.

Just a follow-up on advocacy from Laura. There are rumors that legal fees may detract from spending and focus for the Trump campaign. Do you believe these legal proceedings will hinder advocacy revenue in 2024 versus expectations? What effects could this have on our business?

We do not fundraise for the Trump campaign. Our focus remains on House and Senate races, as well as Super PACs that operate independently of direct campaigns. Therefore, I do not see this factor affecting our operations either positively or negatively. The trend has shifted, with a growing number of citizens getting involved and contributing—up from about 1% of the public to around 10% to 12%. I expect strong engagement during this election cycle, particularly with limited external influences.

One last question about growth rates, then we'll shift to AI. Cameron McVeigh from Morgan Stanley asks what accounts for the variation in growth rates between gross and net revenue during the quarter. How significant was the impact from performance media?

The divergence isn't primarily linked to Performance Media. We have recently acquired several companies that report higher levels of GAAP revenue compared to net revenue. For instance, companies like Team Epiphany and Left Field Labs tend to focus more on event-oriented services, and some digital fundraising efforts generate significant GAAP revenue as well. These factors contribute to the observed differences. It’s essential we highlight GAAP revenue as it reflects economic activity and helps us understand our profitability. The trend of varying revenue streams will positively affect Stagwell throughout the year.

Great. Moving on to AI. Jeff van Sinderen has two-part question. One, can you discuss the developments you're witnessing in customer projects that involve AI? Second, would you kindly elaborate on how Stagwell is leveraging AI within its shared services platform and operations to enhance efficiency?

Certainly. We currently have about 300 to 400 employees engaged with our central AI innovation initiatives. Reflecting on our investment in the Stagwell Marketing Cloud and Central Innovation Group, these areas were foundational to our growth. As Frank indicated, our EBITDA could be even higher by approximately $14 million were it not for our continued investment in AI technologies and associated products. We're surveying our teams to identify their specific AI needs. On the client front, there is a demand for capabilities like summarizing information for clarity and diverse interactions with data, including text-to-video functions. Clients prioritize the safety of their data interactions, which is why we are developing secure AI applications to ensure data integrity. We envision monumental changes, enabling clients to query vast data sets seamlessly and effortlessly compared to prior manual processes, and we anticipate significant transformation as AI is integrated into clients' technologies.

Lastly, regarding your growth ambitions in media business and digital capabilities internationally, alongside potential divestitures. What do you foresee in terms of deleveraging by the end of 2024 given that we're presently at 3x leverage?

Indeed, we stand at a leverage ratio of 3x now. We expect this to trend down into the mid-2s by year-end, primarily driven by the stronger cash flows we anticipate in the latter half of the year. As we progress through Q2, Q3, and particularly in Q4, we expect substantial cash inflow to facilitate this reduction in our leverage ratio.

Great. That brings us to a close on our first-quarter earnings call. Thank you very much for joining us, and I hope you'll be able to join us in a few months for our second-quarter call.