Earnings Call Transcript - STGW Q4 2020

Operator, Operator

Good day, and welcome to the MDC Partners Fourth Quarter and Year-End Results Conference Call. All participants will be in a listen-only mode. After today’s presentation there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Alexandra Ewing. Please go ahead.

Alexandra Ewing, SVP

Thank you, and good morning, everyone. Welcome to the MDC Partners conference call for the fourth quarter and full year 2020. Joining me today are Mark Penn, Chairman and Chief Executive Officer; Frank Lanuto, Chief Financial Officer; and David Ross, General Counsel. Before we begin our prepared remarks, I'd like to remind you that the following discussion contains forward-looking statements and non-GAAP financial data. Forward-looking statements about the company, including those related 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 Form 10-K and subsequent SEC filings. For your reference, we've posted an investor presentation to our website. 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 start the call, I'd like to turn it over to our Chairman and Chief Executive Officer, Mark Penn.

Mark Penn, Chairman and CEO

Thank you, Alex. Good morning, and thank you for joining us. We'll cover a few important topics in the call today. First, we'll review MDC's progress in Q4 2020 against the backdrop of uniquely challenging global conditions. I'll discuss our planned combination with Stagwell and the opportunities we see ahead. Frank Lanuto will provide further detail on MDC's operating results and balance sheet. After that, we will be happy to answer any questions you may have. We understand that Stagwell will soon announce a date and time to release its financial results for 2020, and they will hold a call to review those results. Let me first review MDC's performance in 2020. Just as MDC Partners achieved renewed industry-leading growth in Q1 2020, the pandemic hit and changed everything. Our industry came to a virtual halt, stock and bond values plummeted, and many businesses related to experiential and travel stopped completely. Tech companies scaled back, pitches dried up, and marketing budgets were significantly reduced, resulting in a decrease in this year's revenue. We responded to these challenges in various ways, including extending our credit, purchasing $30 million of our bonds at a discount, and cutting $168 million in expenses while lowering staff cost margins by 200 basis points. We had anticipated revenue declines for the year in the range of 10% to 15%, and we worked closely with our agency partners to safeguard margins and employment for our talented teams during these tough times. In contrast to the broader industry, our digital and tech offerings experienced over 50% growth in business as more clients recognized the shift to e-commerce and digital performance marketing. Our PR companies also saw growth as businesses shifted their messaging. Today, I can report we closed out the year within our expected revenue loss of 10% to 15%, yet achieved adjusted EBITDA above 2019 levels. Meanwhile, our business is gradually being rebuilt quarter by quarter as the pandemic subsides and marketers resume their activities. We are consistently gaining new business. While we project it will take until 2022 to return to pre-pandemic revenue levels, our execution of a plan for the new world has equipped us to respond quickly to the crisis, and the cost savings implemented in 2019 continue to benefit us. We expect the strong sequential growth we saw in Q3 and Q4 to persist, with 7% to 9% organic growth in 2021 and similar positive results for EBITDA. Given that Q1 2020 was one of our strongest quarters ever, we anticipate Q1 2021 to be a challenging comparison. However, subsequent quarters present opportunities for significant year-over-year improvement. Specifically regarding MDC's results, our fourth-quarter revenue improved 15.8% sequentially due to strong segment growth, with Consumer Products and Technology segments experiencing increases of 45% and 35%, respectively, compared to Q3. We also observed double-digit sequential growth in Healthcare, Food, Beverage, Financials, and Automotive, as these segments rebounded from low points in the second quarter. For the full year, net revenue decreased 13.9%, aligning with our 10% to 15% revenue guidance. Year-over-year organic revenue fell 13.7% in Q4 and 13.9% for the full year, consistent with our expectations. Net revenue, excluding pass-through costs, decreased 13% in the quarter and 12.3% for the full year on an organic basis. Our disciplined cost management enabled us to achieve our strongest covenant EBITDA in the last three years at $190 million for the full year 2020, a 5.3% increase year-over-year. Our adjusted EBITDA margins rose sharply by 250 basis points to 14.8% from 12.3% in 2019, spurred by improving fundamentals and careful cost management. We concluded the year in a strong cash position, with $61 million in net cash and no revolver borrowings, while our leverage ratio declined to 4.4 times. On the new business front, we are witnessing a resurgence in client activity and engagement, with significant new business wins recorded in the fourth quarter. Our net new business for Q4 was $30 million compared to $31.9 million in Q3. For the full year 2020, net new business totaled $90.3 million versus $93.5 million in 2019, which is a strong performance given the challenges posed by COVID-19. Key wins in the quarter include clients such as Jimmy Johns, Hotels.com, Fetch Rewards, and Netflix at Anomaly, Indeed at 72andSunny, Yeti with Polestar at YML, Skyy Vodka and LifeSpace at Mono, Miracle-Ear at Doner, Air Paint, and others at Allison & Partners, along with collaborations such as Visit Sweden with F&B, and MilkPEP, which is focused on promoting fluid milk consumption, selecting the Gale Assembly Network and Hunter. MDC also had a strong presence in the Super Bowl, featuring seven national spots during the year's biggest sports and marketing event, including work for clients like Indeed, Jeep, Room, Jimmy Johns, and the NFL. As a network, we represent less than 1% of the global advertising market but accounted for more than 10% of the ads showcased in this prominent creative venue. In a year when marketing faced significant disruptions, our presence highlighted the unique value that clients see in MDC's ability to connect and drive culture. Building on our momentum, we are launching a differentiated global offering. In February, we announced a New Global Affiliate Program formalizing partnerships with new international agencies in the Middle East, Russia, and Taiwan to enhance the creative, performance media, and technology capabilities that brands require to succeed in the global economy. We aim to establish 50 affiliates by year-end, which will enhance our attractiveness in larger global pitches. To support our commitment to provide innovative, data-driven, and integrated solutions for modern global marketers, we have recently appointed Deirdre McGlashan as Chief Media Officer. This newly created position will concentrate on further developing MDC's global media and data technology capabilities, leading global media pitch opportunities, and providing advanced solutions to clients that enhance business results. We are not slowing down in our initiative to transform MDC into the modern marketing company of choice. We will maintain the cost reductions achieved thus far, the enhanced management structure, and add central marketing capabilities to improve our success with larger global contracts. The core of our strategy today is the combination with Stagwell. Currently, MDC is known for its award-winning creative talent serving the world's leading and most ambitious companies, while Stagwell was created with a strong technology foundation. Together, we will create a top 10 global integrated marketing services company, harnessing the power of talent and technology globally. I founded Stagwell with the goal of establishing a new type of marketing company ready to capitalize on the global digital transformation. In just five years, we've quietly positioned Stagwell as a digital-first market leader with nearly $900 million in run-rate GAAP revenue, primarily derived from digital work across four marketing services categories: digital transformation and performance marketing, research and insights, marketing communications, and digital content, all overseen by flagship agencies within their areas of expertise. We plan to generate a growing revenue stream from digital SaaS products and are already integrating this strength into MDC. In 2020, MDC launched PRophet, a tool developed jointly by Stagwell and MDC, using AI to forecast media coverage. The merger of MDC and Stagwell will create a modern marketing company, forming a $4.4 billion integrated media and data powerhouse with enhanced scale and sophistication, and a solid path to growth over the next five years. Together, we anticipate growing to $3 billion in revenue by 2025 through acquisitions, organic growth, and new digital products. We also expect our integrated services to yield approximately $30 million in annualized cost synergies, excluding the costs to achieve, and it should take about two years to realize 90% of these savings. Furthermore, joining forces will amplify MDC's focus on data-driven media offerings and more than triple its high-growth digital offerings to 32% of the combined business. This merger, marked by a lower leverage ratio, also opens the door to potentially improved financing terms, with current low-interest rates possibly saving us about $20 million a year in interest expenses, which we are exploring. We expect the merger to be finalized in the first half of 2021. Finally, regarding MDC's outlook for 2021, we anticipate achieving 7% to 9% organic revenue growth and 7% to 13% adjusted EBITDA growth, translating to $190 million to $200 million in EBITDA, an increase from $177 million in 2020. Our expectations are fueled by a sustained rebound in organic revenue post-pandemic, continued strength in our rapidly growing digital assets, demand for PR and communications, recovery in our creative agencies, and the resurgence of some experiential activities.

Frank Lanuto, CFO

Thanks, Mark. Good morning, everyone. We have made good progress during 2020 despite significant ongoing disruption from the pandemic. We took actions early and swiftly and implemented comprehensive cost measures across the company that more than offset our revenue decline and helped us deliver higher year-over-year EBITDA in 2020. Adjusted EBITDA margins improved by 250 basis points over prior year, and our balance sheet remained flexible at year-end with $61 million in cash and no borrowings under our revolver. For the quarter, revenue declined 14.1% to $328 million; and on a full-year basis, declined 15.3% to $1.2 billion. Organic revenue declined 13.7% and 13.9% for the quarter and full year, respectively. Net revenue declined 13.6% to $271 million for the quarter and 13.9% to $1 billion for the year. Organic net revenue declined 13% and 12.3% for the quarter and full year, respectively. Pandemic-related slowdowns in our experiential and technology clients accounted for approximately 60% and 50% of the organic declines for the quarter and full-year periods, respectively. Partially offsetting these declines, our digital business continued to grow rapidly, up over 50% for the quarter and more than 40% for the full year. Sequentially, revenue continued to rebound from the pandemic-driven lows in the second quarter, increasing by 9% and 16% in the third and fourth quarters, respectively. Revenue rose in all four of our reported segments in the quarter, led by integrated networks A, up 37%; the all-other segment, up 20%; media & data, up 7%; and integrated networks B up slightly. The continued sequential growth was driven by double-digit revenue growth in virtually every client sector, led by Consumer Products, Technology, Healthcare, Automotive, Food and Beverage, and Financials. With respect to operating expenses, we continue to benefit from actions taken at the outset of the pandemic as well as those made in the latter part of 2019. For the fourth quarter, controllable costs were lower by $33 million or 13% compared to prior year, with over 70% of the savings coming from staff costs. For the full year, costs were lower by approximately $168 million or 16% from the prior year, with a similar percentage of savings coming from staff costs. Excluding Sloane and Kingsdale, the savings were $30 million for the quarter and $157 million for the year. We anticipate that approximately $45 million of these cost savings will be permanent. We recorded approximately $11 million in charges, including $2 million in Q4, primarily for severance to effect these cost savings. During the fourth quarter, we also completed our New York real estate transformation project as we moved into the World Trade Center. In connection with the completion of the project, we recorded approximately $22.6 million in planned charges related to the properties exited, which will generate approximately $10 million in savings annually. During the fourth quarter, we also recorded approximately $73.7 million of noncash, goodwill and tangible asset impairment charges related principally to COVID-driven business declines. We have taken a range of actions to generate cost savings, some are permanent, some temporary. And we'll continue to manage our cost carefully in line with the revenue recovery. With revenue continuing to recover and EBITDA outperforming 2019, we have restored some of the temporary cuts made across the organization during the year, including benefit plan contributions and management salaries across the organization. Adjusted EBITDA for the year increased 2% to $177 million versus $174 million in the prior year. Covenant EBITDA for the year increased to $190 million, up 5% from $180 million a year ago. The related adjusted EBITDA and covenant EBITDA margins increased sharply to 14.8% and 15.8%, respectively, reflecting the positive contributions of our cost savings actions. With respect to income taxes, the company's cash income taxes have been less than $10 million annually over the past three years. In 2020, the company recorded a provision for income taxes of $117 million, consisting of a noncash charge of $130 million to establish a valuation allowance against previously recorded U.S. deferred tax assets, offset partially by tax benefits recorded for certain international jurisdictions. The charge does not limit the company's ability to utilize existing NOLs and other tax-deductible items to offset future taxable income. Moving to the balance sheet. Liquidity remained strong as we generated $32.6 million in cash flow from operations and ended the year with net cash of $61 million and no borrowings under our revolver. Leverage further improved to 4.4 times, down from 4.5 times a year ago. With respect to acquisition-related liabilities, we funded $54 million during 2020. Sequentially, our M&A obligations increased from $112 million in Q3 to $151 million in Q4 and decreased from $152 million a year ago. The limited number of our remaining agencies under earn-out, led by our digital agencies, delivered strong performance during 2020, leading to an increase in our M&A obligations. With respect to CapEx, we incurred cost of $24 million versus $18 million a year ago driven principally by our New York real estate transformation project. As previously discussed, we moved into The World Trade Center in the fourth quarter, completing the project on time and on budget. In closing, I want to thank all our employees and other stakeholders for their continued support. We are excited about our opportunities and look forward enthusiastically to the combination with Stagwell and the year ahead.

Operator, Operator

The first question is from Avi Steiner with JPMorgan. Please go ahead.

Avi Steiner, Analyst

I want to start maybe big picture, if we can. What is the tone from CMOs the company is talking to? Are they itching to get out there and spend in market as the world gets better? Or is it still more of a cautious tone?

Mark Penn, Chairman and CEO

I think the Chief Marketing Officers are adopting a tone focused on returning to business. After a period of dormancy, we are now experiencing a significant influx of requests for proposals and competitive business opportunities. I would describe this as a time to shift back into business mode. There is some uncertainty among them regarding whether this return to business will occur in the summer or fall, but it is important to start preparing three months in advance for marketing initiatives.

Avi Steiner, Analyst

And then if I could dovetail that last answer with the company's guidance, which I assume is MDC only. Sitting here today, March 2, what sort of visibility do you have into the year or going forward at all?

Mark Penn, Chairman and CEO

Well, I think we've given clear guidance just as I gave clear guidance at the beginning of the pandemic. I think obviously, travel, tourism and experiential are the laggards here because they require a high degree of safety. But the rest of the industry; automotive, packaged goods, services, those seem to be, I think, coming along nicely. And as I said, we've had nice net new business wins moving forward. So based on the kind of extensive budgeting process that we go through each year, we believe that the 7% to 9% growth is achievable and represents kind of a good leg back. As I said, I don't think we can recover revenue entirely in a year. But after the year, then we're down 12% or 13% in organic net revenue and, at the same time, up in EBITDA. So we can keep building on that base too as revenue gets restored and won.

Avi Steiner, Analyst

Terrific. And one more big picture one, if I can. Clearly, during the pandemic, it seems there's been this greater shift to digital from linear platforms. And you noted digital and tech offering, I think in your opening, grew more than 50%. I don't want to misquote you. But my question really is, is this a permanent shift in your view? And if so, how do you see MDC positioned going forward?

Mark Penn, Chairman and CEO

Well, it is a permanent shift, I think most clearly. So it has been a permanent shift for the last decade. It got accelerated as people realized that they had been too slow to, I think, transfer to kind of a creative performance marketing. I think MDC, about 9% of the companies are in that high-growth digital area. And so we saw a lot of growth in that, and some of them are in earn-out, which also meant that our earn-out obligations went up. But that's a good thing in the sense that we're getting a much higher value because they're being appreciated and have a really solid book of business. Part of the point of the combination is that will greatly increase to 32%, the combined level of high-growth digital services and a much bigger number of digitally based services. And I think that's one of the key underpinnings of the combination is to greatly increase that number to take advantage of the transformation occurring in the marketplace.

Avi Steiner, Analyst

Terrific. And I will leave it here on this last one. The early February announcement of the Global Affiliate Program, if you could just spend a little more time walking through what that means for the company and maybe how we can think about it from an economic perspective, whether it's investments or anything else, that would be terrific?

Mark Penn, Chairman and CEO

The affiliate program is an effective way to address gaps we identified in emerging markets worldwide. By partnering with global affiliates in these regions, it's mutually beneficial as they gain access to global contracts and can refer additional business to us. This also strengthens our competitive edge against larger firms that have agencies everywhere. We often excel in creativity and technology, but we lack sufficient global reach, and this is a cost-effective method to expand that reach. There are numerous promising companies in these markets eager to ally with us for market entry. These affiliates will also act as a talent pool for potential acquisitions, providing us with valuable experience in the network and resources to compete more effectively on a global scale. Ultimately, this enhances our positioning, improves our marketing efforts, and serves as a source for acquisitions to solidify our global presence.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Penn for any closing remarks.

Mark Penn, Chairman and CEO

Thank you. I hope this has given you an overview of the progress that we continue to make during the difficult and trying year. I think this company, all the partners, and all the people, the employees, we're looking at a dire situation in March and April. They responded incredibly well. This company emerges from this with higher EBITDA, with a stronger financial position, and great cash position and looks forward to the possibilities of a combination with Stagwell. And Stagwell will shortly announce the call in which it will detail its year-end and full year financials so that people can get all the information they need. Thank you very much.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.