Stagwell Inc. (NASDAQ:STGW) Q1 2023 Earnings Call Transcript May 14, 2023

Ben Allanson: Good morning from Stagwell’s worldwide headquarters at One World Trade Center in New York City and welcome to Stagwell Inc.’s Earnings Webcast for the First Quarter of 2023. My name is Ben Allanson and I recently joined Stagwell to lead the Investor Relations function. With me today are Mark Penn, Stagwell’s Chairman and Chief Executive Officer; and Frank Lanuto, Chief Financial Officer. Mark will provide a business update and Frank will share our financial review. After the prepared remarks, we will open the floor for Q&A. You are welcome to submit questions through the chat function. 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 filings. Please refer to our website, stagwellglobal.com/investors, for an investor presentation and additional resources. This morning’s press release and slide deck provide definitions, explanations and reconciliations of non-GAAP financial data. With that, I’d like to turn the call over to our Chairman and CEO, Mark Penn.

Mark Penn: Thank you, Ben, and thank you to everyone for joining us for our earnings call. Today is an important day for Stagwell, its future and for its investors. I can announce that Stagwell Inc. has entered into a definitive agreement, negotiated by a group of independent directors, advised by legal and advisory teams to repurchase over 23 million shares of Stagwell Inc. class A stock from AlpInvest. This move will not affect the float, but will reduce the number of shares outstanding by 8% to about 267 million and should avoid the necessity of any further secondary issuances in relation to exiting AlpInvest. In addition, as per a separate release from the Stagwell Group, the remaining investors in Stagwell Media have stepped up and are in advanced negotiations expected to go to final documentation soon to redeem any remaining Stagwell Media LP interest held by AlpInvest.

I believe these actions will remove an overhang from the stock. Let me address Q1 earnings. These results are in line with management’s expectations for the quarter, especially when compared to Q1 2022, which featured an extraordinary 24% organic net revenue growth, far above the 14% average last year. This means that performance that would be growth compared to the average of last year is overshadowed by 2022 Q1. This math will work in reverse in the last two quarters, which we expect to show double-digit growth. Remember that Q1 2023 is at the bottom of the four-year political cycle, is a time of investment and building up our marketing cloud, is in the face of tech company slowdowns and is compared to our strongest previous quarter of growth.

We rang up $622 million of revenue and $522 million of net revenue this quarter. Revenue, ex-advocacy, increased by 1% after a 31.5% increase last year, and net revenue, ex-advocacy, increased by 1% after a 23.5% increase in Q1 2022. As expected, advocacy revenue declined 42%. On a purely organic basis net revenue ex-advocacy declined 1% after a 23% increase last year. The two-year stack of 21% net organic growth is on target with our long-term growth targets. While we do not give quarter-by-quarter guidance, we reaffirm our previously issued guidance for the year, an organic growth target of 7.5% to 10% for the year. Why do we have confidence in that given the headwinds previously noted of slowing tech companies and a slowing economy? Two important reasons.

Growing new business wins and increased industry recognition of Stagwell and its great companies as at the forefront of modern marketing. Net new business for Q1 is at $53 million in line with over $212 million of net new business over the last 12 months and consistent with continued client growth. After the close of the quarter, however, the company has racked up an additional $40 million of new wins in April alone as important pitches that were holding back in Q1 broke in our favor. Notable wins during the quarter included T-Mobile at Code and Theory, Sleep Number at 72andSunny, Brooks Running at Assembly Global. Stagwell also expanded its public relations remit with U.S. Steel and won business with the National Restaurant Association. The April wins included a major European cosmetic company for Assembly, an American fast casual restaurant chain for Creative Advertising and new assignments at Microsoft and Google which were good signs on the tech companies beginning to make a comeback.

The growing industry recognition for a company with less than 2% market share has been exceptional. Anomaly was previously named Adweek’s 2022 Agency of the Year and listed as one of the ten agencies on Ad Age’s most recent A-List. This year, Gale, which grew 140% last year and is off to another strong start of 11% growth in 2023, was named Adweek Breakthrough Media Agency of the Year, number five on AdAge’s A-list and is running a path-breaking campaign now for MilkPEP based on the idea of Wood Milk. And Doner Partner Network was named as Standout Agency of the Year on the AdAge list as well and just last week Allison+Partners was named the SABRE’s North American Agency of the Year. We have top award winning brands in digital transformation, advertising, media and PR far above our market share, which is why we continue to have a strengthening pipeline that we expect to exceed 2022’s $1 billion in pitches by 20% or more.

We will watch closely two important segments of our business. The tech industry, which is 18% of our net revenue and grew 32% for us in 2022. It grew only 3% in Q1 as these companies went into slowdown mode, but we still managed some growth out of them. We are seeing some lifting of the curtain there now as tech earnings were solid this quarter and generative AI is set to bring on a renewed competition in marketing and the tech industry with a new generation of products and experiences. The second industry is finance and banking which is about 6% of our business and grew 10% in 2022. This industry declined 3% in the quarter. We had no Silicon Valley Bank exposure, but we did have First Republic Bank as a digital platform client, but we also had JPMorgan, their acquirer, as a major client.

Our exposure here is limited. We posted in excess of $72 million of EBITDA this quarter in line with our internal expectations. Comparisons to last year included a one-time $5 million rent credit, lower levels of investment in the marketing cloud and the addition of cloud-related companies such as Maru and Epicenter Data that carried revenue but are still scaling to generate EBITDA. We also faced some slowdowns in the tech clients and kept teams intact as these companies typically come back as they reorganize after cutbacks. As clients are moving from capability to capability, however, we have taken out about $25 million in annualized comms savings that will hit in the second quarter and are taking out an additional $20 million that will hit in the third quarter and this ability to make such shifts gives us confidence to reaffirm our guidance on EBITDA for the year and return us to normal margins as business ramps up and political work begins in the second half of the year heading into the Presidential Election.

As noted previously, our central systems are coming online in midyear and that will enable us to kick off a planned next $35 million in central expense reductions based on the deployment of increased automation and AI across the company but especially in our media operations. This quarter was uneventful in terms of debt and liquidity, as this is the time of the year that bonuses, taxes and earnouts are paid so that our position is consistent with previous years. We expect to be at about 2.25 times net leverage at the end of the year with normal M&A activities and including the 23 million shares stock buyback transaction. During the quarter, we took several internal moves of significance. We combined our health companies into Concentric Life to give them greater scale and efficiency.

We just added In the Company of Huskies in April a digital-first creative marketing company in Ireland which strengthens our European offerings. And we combined several smaller but high powered agencies to relaunch Crispin Porter + Bogusky brand at scale under the leadership of Brad Simms and Maggie Malek with a wealth of talent. Crispin is already getting access to larger new pitches. Our strategic combination of digital, creative and media as represented by the Brand Performance Network, sets a new paradigm that is the key to disrupting competitors. Importantly, we continue to ramp up our commitment and development of our tech products known collectively as the Stagwell Marketing Cloud group. Starting next quarter, we intend to break out the finances of the Cloud group, which involves two divisions, pure software plays that represent about $65 million of expected software net revenue growing over 30% this year and the advanced media platforms that are about $170 million in net revenue and growing at 12%.

We expect to invest up to $20 million this year in Cloud development as we build the media studio products that will provide us with full capabilities of the trade desk and more and we infuse that through our network and make it available externally later this year. We will be fully deploying AI tools across all our agencies and believe it will over time significantly enhance efficiency. We will be ramping up the sales forces of three key products that are available right now around the augmented reality stadium experience already delighting fans at four major stadiums across three sports leagues. The Harris Brand Terminal with over 120 clients growing 100% last year and an average subscription of $60,000 a year, and PRophet, a generative AI product that was recently honored with a prestigious PR industry award for its innovative software.

PRophet just announced its partnership with LexisNexis to expand its journalist and content database. I invite you to go to www.prprophet.ai. That’s www.prprophet.ai and sign up for the premium addition and try it out yourself. It represents the stack-run edge in our ability to use and deploy advanced high value state-of-the-art technology. Lastly, let me note that we just announced Code and Theory’s partnership with Oracle to co-develop generative AI applications across verticals. This is the first of what will be many partnerships with major tech companies, recognizing that we have the scale and expertise to work together to establish new products and services for their clients in the consumer marketing space. This is a new direction for us and Code and Theory is taking the lead here.

In closing, we are really excited about the buyback transaction we announced this morning. We have simplified our shared ownership structure, eliminated some uncertainty and done so in a way that creates value. We will be relentless in working to get full value for our shareholders. We have I believe the world’s most talented group of managers and professionals in 34 countries combining creativity and technology. Through pandemics, near-recessions, tech slowdowns, we never stand still at Stagwell. We are continually advancing in scale, growing with new clients, building new technology and moving onward in 2023. Now I’d like to hand it over to Frank Lanuto our Chief Financial Officer to walk you through some of our financial results in more detail.

Frank Lanuto: Thank you, Mark. Good morning, everyone. And thank you for joining us to discuss our first quarter results. As a reminder, if you would like to ask a question after the prepared remarks conclude, please feel free to submit them through the chat function. I will start by reiterating Mark’s earlier comments, that results for the first quarter were in line with our budgeted expectations and consistent with our year-end remarks that the first half of 2023 would have lighter growth. This is principally attributed to a shift in phasing of client spend and to a lesser extent the biannual cycle of our advocacy business and finally to our extraordinary growth in Q1 2022, which was uncharacteristic given our historically stronger second half performance.

This latter point is evidenced by the strength of our two-year organic net revenue stack of 21%. We expect a pickup in client spending in the remaining quarters of the year and I have already begun to see signs that this is happening. With that, let me turn to the numbers. Starting with our reported results, our Q1 revenue was $622 million, a decline of 3% on the same period in the prior year. Net revenue, excluding pass-through costs, declined 0.9% year-over-year to $522 million. In organic terms, the decline was 3%. Turning to results by principal capability. Digital Transformation organic net revenue declined 9%. This was principally attributed to the expected cyclical decline in our Advocacy business. Excluding Advocacy, the organic net revenue decline was 3%.

The remainder of the decline is largely attributed to the trends that Mark spoke about in his prepared remarks, namely, a holdback in spending as companies restructured their workforces. On a two-year basis our Digital Transformation capability has seen organic net revenue growth of 40% or approximately an annual growth rate of 20%. Performance Media & Data saw a 5% growth in organic net revenue. This growth was driven by strong performance from our Ink and Assembly businesses. Again, looking at the two-year stack, Performance Media & Data has grown 23% or 11.5% on an annualized basis. Consumer Insights & Strategy saw 1% growth in organic net revenue coming off an exceptionally strong 56% growth in the prior year. And finally, our Creativity & Communications segment saw a 3% decline in organic net revenue in the quarter.

But, once again, looking at the two-year stack growth was 6% or 3% annualized, which is consistent with our projections for this capability. As you can see, by reviewing the results over the two-year period, our growth rates remain strong and are higher than our primary competition. Moving to costs, our operating expenses increased 3% year-over-year to $606 million in the first quarter. Our compensation to revenue ratio came in at 67% in the quarter, an increase of 230 basis points versus the same period in the prior year. The increase in the compensation ratio is driven principally by the temporary softness in client spending we experienced in Q1. Our brands have already taken action to reduce compensation expenses to align with revenue. We eliminated more than 300 roles in the first quarter, which will generate approximately $25 million in annualized savings.

And as Mark highlighted, we will take further action this quarter, which should result in additional run rate savings of approximately another $20 million. We will continue to monitor performance over the remainder of the year and, if necessary, we will make further adjustments. G&A expenses included increased by $15 million or 18% year-over-year. This was driven principally by the addition of eight post-Q1 acquisitions during 2022 representing approximately $6.2 million or 41% of the increase, higher T&E of $3.3 million or 22% of the increase, as business travel has returned to near pre-pandemic levels, and finally, the non-recurrence of approximately $5.1 million in favorable subletting arrangements of certain real estate properties representing 34% of the increase.

As a result, adjusted EBITDA came in at $72 million, ahead of our internal budget for the quarter. Net income attributable available, excuse me, available to common shareholders decreased to $443,000 from $12.7 million in the prior year, principally attributed to the decline in operating income that we discussed previously. And finally, earnings per share were negative $0.01 and adjusted EPS was positive $0.13 for the quarter. Moving to the balance sheet deferred acquisition consideration obligations increased slightly by $4 million from year end to $166 million due to the higher performance of the businesses under earnout, but was lower year-over-year by $59 million or 26%, as the company remains on target to reduce DAC to less than $100 million by the end of 2023.

We also acquired 2.6 million shares during the quarter at an average price of $6.91 per share for approximately $18 million under our recently expanded stock repurchase program. As a result, we ended the quarter with cash of $139 million and drawings under our revolver of $150 million. Our leverage was 2.63 times, as compared to 2.72 times a year ago. We remain on track to achieve our stated goal of bringing the leverage down to 2 times over the medium-term. And finally, on May 4th, we exercised a provision in our revolving credit agreement and expanded the credit limit to $640 million from $500 million. We took this opportunity to raise our credit limit as it provides the company with additional borrowing capacity and flexibility to pursue our business goals.

The rate structure and primary covenants remain unchanged and we expect to utilize the revolving facility to fund the repurchase of more than 23 million shares for approximately $150 million from AlpInvest, upon closing the transaction, will be accretive to earnings per share. And finally, moving to our guidance, we are reiterating our full-year guidance including organic net revenue growth of 7.5% to 10%, organic net revenue growth excluding Advocacy of 10% to 14%, adjusted EBITDA of $450 million to $490 million and adjusted earnings per share of $0.90 to $1.05. That concludes our prepared remarks for this morning. I will now turn the call back over to Ben Allanson to open the Q&A portion of the call.

A – Ben Allanson: Thank you Frank. Just a reminder, if you have any questions, please submit them via the chat button at the top of the screen. We will start with a question from Laura Martin at Needham. Could you please share your view of how generative AI like ChatGPT will impact your business moving forward?