Stagwell Inc. (STGW) Q3 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the MDC Partners' Third Quarter Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Matt Chesler, VP, Investor Relations and Finance. Please go ahead.

Good afternoon everyone. I'd like to thank you for taking the time to listen to the MDC Partners' conference call for the third quarter of 2017. Joining me today from MDC are Scott Kauffman, Chairman and CEO; and David Doft, Chief Financial Officer. Before we begin our prepared remarks, I'd like to remind you all that the following discussion contains forward-looking statements and non-GAAP financial data. As we all know, forward-looking statements about the company are subject to uncertainties referenced in the cautionary statement 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 posted an investor presentation to our website. We also refer you to this afternoon'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 CEO, Scott Kauffman.

Thanks Matt, and good afternoon, everyone. We delivered strong financial results in the third quarter. Revenue of $376 million increased 8% year-over-year, continuing our industry-leading organic growth at 7.8% or 6% on a net basis. Year-to-date, organic growth was 8.4%. For the quarter, organic revenue was up 6% in the U.S.; Canada increased modestly; and international remained very strong with 24% organic growth. We continue to see double-digit gains in key client verticals, led by communications, financials, and even CPG. We generated nearly $54 million of adjusted EBITDA, which was an increase of 16% year-over-year, with margins expanding 110 basis points. Our profitability this quarter was driven by the continued growth of our business, the yields we're now beginning to see from the investments we've made and have been making in emerging growth areas, and the leveraging of our cost structure. Net new business was nearly $26 million, including wins that we can publicly disclose from brands such as Hershey's, Carnival Cruise lines, IKEA and McDonald's local co-ops. We also brought in some meaningful assignments from a number of major tech players and cutting-edge disruptors of their respective industries. With one quarter to go, we're pacing very well against our full year 2017 financial goals and we reiterate guidance for approximately 7% organic revenue growth, and improvement in adjusted EBITDA margins of approximately 60 basis points. And David will elaborate on that in just a moment. Last quarter, you heard us speak about MDC's core strategic positioning, our modern operating model, and our entrepreneurial mindset. These differentiated elements of our business have positioned us nicely against the competition, and in turn, we've amassed a long-term track record of market share gains. In the nearly 11 years since we became a pure-play in the space, we've averaged 9.6% organic revenue growth versus the industry, which is at less than 3%. Saying that we have these characteristics is one thing, but seeing how they translate into successful relationships is quite another. Our work with Hershey's is a terrific illustration as it shows how we've been able to not only win, but also to organically grow with existing clients. This relationship began a little over two years ago with a single brand at a single agency and a single country and has now expanded to multiple MDC agencies, including Crispin Porter + Bogusky, Anomaly and Mono. It spans many of their brands, marketing disciplines, and multiple geographies, but the most significant development came this summer when CP+B and Anomaly consolidated creative campaign work for the most iconic brands, including the Hershey's masterbrand, KitKat and Reese's. Meanwhile, our modern global model, characterized by regional hubs and lean physical infrastructure has enabled us to grow the relationship from the U.S., where it began, to Canada with digital and social and then into China, where we provide support across all Hershey's brands. This relationship also shows that MDC agencies compete very effectively and win more than our fair share against legacy agencies. What we found is that marketers looking to reinvent themselves and to undertake business transformation tend to need more nimble, digitally savvy, integrated, highly creative agencies that are strategic in their thinking and that collaborate well with others. And our focus is to make sure that MDC continues to be that strategic solution. Clients simply aren't satisfied, nor should they be, with the status quo. It's the key reason why CPG has become one of our best-performing verticals because we can consistently provide progressive, integrated solutions in a rapidly changing world. Finally, Hershey's demonstrates that we're well-positioned in consolidation. Often, brands look to reduce the number of agencies they work with in order to improve quality and reduce inefficiencies. By consolidating with MDC or one of our lead agencies, marketers get the best of both worlds by partnering with best-in-class specialists while also tapping into the capabilities of a broader network. We've also done this with General Mills, Seventh Generation and Diageo. Another great example of how we're differentiated is our growing IKEA relationship. Like Hershey's, IKEA has recently begun to engage with multiple MDC agencies across multiple disciplines, including strategy, communications planning, creative execution, consumer public relations, and media. It's a blue-chip brand, and it's global. What IKEA illustrates best is how we're now taking our world-class agencies and integrated modern approach and successfully executing in new geographies. We're increasingly delivering customized partnerships to provide a single point of contact into MDC and access to the best talent in the industry. Our working model is highly client-centric, reflecting our distinct ability to collaborate with our sister firms, with client teams and even with our clients' other partners. It's true that our agency brands and particularly, the MDC Partners holding company brand haven't been historically well recognized in Europe. But now with these inroads with brands like IKEA, one of the world's most innovative companies and widely known for picking only the best creative partners as well, as Huawei in Europe, a category leader in mobile, we're now increasingly playing at the highest levels of strategy, creativity, and innovation in other markets around the world. Clients are recognizing that our agencies represent an exciting contrast to the traditional models and solutions. The power of the MDC network is also evident when it comes to talent. Our agencies continue to be a magnet for the industry's best people. CP+B recently tapped award-winning and renowned creative leader, Linus Karlsson, as its new Global Chief Creative Officer. And meanwhile, agencies like KBS, YML, and Gale have made significant recent senior hires from top firms in the areas of technology, digital, design, and strategy to advance each of their respective offerings. There's a reason I'm going deep on these specific examples. You've seen over the past couple of weeks -- the past couple of quarters, in fact, the disappointing results and outlooks from the big advertising holding companies. Their challenges are not our challenges and in many cases, represent opportunity for us. This is why we're outperforming and why we're well-positioned to continue to be a leader for years to come. We're confident that we have a long runway of growth ahead of us. And with that, I'd like to turn the call over to David.

Thank you, Scott and good afternoon. For all the reasons Scott has been talking about, I hope it's clear that MDC Partners is doing very well and that ours is a platform that can grow and profit sustainably over the long-term. Combined with the balance sheet improvements that we're delivering, we are building long-term value for all of our stakeholders. Yes, it was a strong quarter for MDC. Organic revenue growth of 7.8% will likely shake out about eight times above the average for the big holding companies. While this was a deceleration from 11.7% last quarter, it is right in line with our expectations and embedded in our full year guidance of approximately 7%. Pass-through revenue was more moderate this quarter, but still added 180 basis points to organic revenue growth. Organic revenue growth in our largest market, the United States, was 6% in the third quarter compared to 10% growth in the first half. Much of the difference is accounted for by a couple of factors, such as the timing of some of our larger recent wins and losses. And as we discussed last time, our second quarter results benefited from a series of long-term projects, which were completed in that quarter. In the U.S., our strongest categories were similar to total MDC and were financials and communications followed closely by food and beverage, which itself was up over 20% in the quarter. In fact, the U.S. was our strongest region for food and beverage. From a profit perspective, it was also a solid quarter. Adjusted EBITDA increased 16.4%, and adjusted EBITDA margins expanded by 110 basis points. This, despite the quarter being impacted by over $1 million of incremental professional fees associated with our work around segment aggregation as well as preparing for the revenue recognition standard, which we expect to adopt as required, beginning with first quarter 2018 results. Reported margins were also dampened by 40 basis points from the higher pass-through revenue. Nevertheless, you can see the good progress we've made in our cost base with a 250 basis points improvement in our staff cost ratio on a year-over-year basis. In terms of cash flow, operating cash flow included a $29 million seasonal outflow of working capital. Ahead of our seasonally strong fourth quarter, year-to-date working capital usage is negative $57 million, which is our best performance since the MDC Media Partners strategy was put in place several years ago. As for our outlook, it is shaping up to be the improved year we expected, which as Scott mentioned, keeps us on track to achieve all of our full year financial targets. We are therefore reiterating guidance, which calls for approximately 7% organic revenue growth and an improvement in adjusted EBITDA margins of approximately 60 basis points. As you know, our year includes the contributions from acquisitions that we've already completed and as of Q2, we cycled past that impact. It should also reflect the impact of dispositions. At the end of August, we disposed of a business you haven't heard us talk much about called LBN, which is a local digital lead gen platform that was previously in our media services segment. While LBN was a nicely growing and profitable business, ultimately, we determined it was not core to our strategy. It is therefore appropriate for you to adjust your models to account for the impact of the sale. In the fourth quarter, you should expect the net impact of acquisitions and dispositions to be roughly negative 1% to revenue. Additionally, there was a $1.5 million -- there's a $1.5 million impact of adjusted EBITDA contribution expected from LBN, which we no longer will get in 2017 results. And now I'd like to discuss our balance sheet progress. As Scott mentioned, the strengthening of our financial profile continues to be a source of focus for the company. This allows us to allocate resources to appropriate long-term, value-creating initiatives. This quarter, we funded $24 million of acquisition-related payments. Additionally, NCI was reduced by $11 million as a result of the sale of our stake in LBN on top of the close to $13 million of net cash proceeds from the deal and an expected potential earn-out to MDC of a couple million dollars over the next 12 months, a total balance sheet benefit from the transaction of roughly $25 million. Our deferred acquisition consideration, plus minority interest, now totals $254 million, down $102 million year-to-date and stands at a new five-year low. In terms of what to expect going forward, most of our M&A-related payments for this year have already been made, as we see expect only $10 million in the fourth quarter. And then consistent with what we've previously discussed, the payments should come down significantly next year by roughly 40% to the $70 million to $80 million range, which should have a positive impact on overall cash flow. Our revolver balance at September 30 was $49 million, as we funded the seasonal working capital outflow and deferred acquisition payments. We continue to expect to finish the year fully out of the revolver and in a cash position. One final administrative item before we open it up to Q&A. As I know many companies are highlighting, we're also doing extensive work to prepare for the new revenue recognition rules that go into effect in 2018. This is a substantial initiative that is taking significant resources and costing a lot of money. At this point, we're expecting to incur $1.5 million to $2 million more in the aggregate cost and professional fees than we had budgeted for the full year. We'd now like to take your questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Steven Cahall of Royal Bank of Canada. Please go ahead.

Yes. Thank you. Great operations in the quarter. Maybe, David, just one for you and then a bigger picture question for Scott. David, I was wondering if you could just talk about the implied guidance in Q4. I know you've got a tougher comp. So, is that really just the comp plus a little bit of conservatism that takes you to the sequential slowdown in organic growth for the fourth quarter? And then Scott, certainly, on the bigger picture side, as you pointed out, a lot of the big ad agency holding companies have seen some pretty weak growth numbers. We've seen a little bit of stuff in the press about M&A, but nothing ever really seems to happen. And you're certainly outgrowing your peers, so it seemed like the sort of thing they'd be interested in. What do you think is going on in M&A for the broader space, the industry, from where you're seeing? Thank you.

Thanks Steven. So, from a 4Q standpoint, we manage our year to the year. We don't guide individual quarters. And so in the totality of what we expected when we gave the updated guidance in midyear, we continue to track to that. There is timing around projects that impact quarter-to-quarter as well as pass-through expenses, which could have meaningful impacts on the reported organic growth versus the underlying fee revenue. So, at this point, given all those dynamics, we didn't think it made sense to really nickel and dime basis points around an annual guidance number and so we left the guidance as is.

And Steven with regard to M&A, we read and hear the same things you do. We don't speculate or comment on rumors and as you can tell from the results, we've had our heads down, and we've been executing against our plan. That plan for growth historically has included a combination of both organic growth and acquisition and we will continue to look to those markets. We will always be a beacon for brilliant entrepreneurial teams looking for a home and a culture to create Safe Harbor. That against the backdrop of our commitment to continue to pay close attention to the health of the balance sheet and to delever against the goals that we've put in place.

The next question comes from Dan Salmon with BMO Capital Markets. Please go ahead.

Hey guys. Good afternoon. One for each of you. Scott, you clearly appear to be bucking the industry trends, especially in the CPG sector. So this, admittedly, may not be as relevant for you as it may be for some of your larger competitors, but it seems that with the large global CPGs, where some of their challenges are coming in, is that they have a new breed of challenger brands. There's always new ones coming along, but these ones are much more digitally native. Maybe they started as online-only brands. And they do seem to approach their marketing a little bit differently as a result of that. And I'm just curious, at a high level; do you look at changing or evolving how you do business development to appeal to this group over time, which may be small early customers, but ones that are clearly challenging the bigger folks over time? And then David, a quick one for you. You mentioned $1.5 million to $2 million of extra fees related to new revenue recognition, also the lost benefit from the disposed business. It sounds as if you are still holding your guidance in light of that. And I just want to make sure I'm clear that we're implying that without those, we may actually be a little better. Thanks.

Dan, well, we count among our clients, some of those disruptor and challenger brands. And of course, they are also changing, in dramatic ways, the landscape for the incumbent brands. And all of that disruption endorse [ph] to us, and we see that as a great opportunity both from CMOs, who simply can no longer afford to rely on the status quo and past practices and sometimes decades-old relationships with what used to be referred to as the blue chip brand names in the advertising agency world, to those disruptors. And so by bringing a nimble, more modern set of solutions to the table, ever-evolving, being agents for our clients as we've been talking about for these many quarters, and taking advantage of each and every new opportunity and new disruption, we've had a great growth in that category in particular. This category has also been suffering from some zero-based budgeting issues, some transparency issues with, again, the media operations that they've been accustomed to. So, there's a trust factor that's also playing into this. And again, all of this disruption plays to our advantage.

Dan to your second question. So, I guess I wasn't as clear in the prepared remarks as I hoped to be. So, I think for the disposition of LBN, we're saying you should adjust that because our expectation for the year included a full year of LBN. And so that's a $1.5 million impact, part of which we saw in 3Q because it was divested in the middle of the quarter, and the rest of which are -- will impact our 4Q. So, I would take the -- if you take the formula of organic growth and margin, plus the acquisition benefit of the six months of F&B that rolled through the first half of the year, you then should net the impact of the LBN divestiture. The flip side is we have a $25 million benefit to the balance sheet, as I indicated in the prepared remarks as well. And so it should -- I would expect, not really move your expectations overall from that standpoint of total value. In -- from the professional fees standpoint, we are looking to manage through that and deliver on the overall expectations. One-time costs are always a tough thing to think about. We try to limit the number of add-backs because we have enough of them as there is at this point. And so we are working hard to manage through those incremental costs and still deliver on the overall expectations of the business.

Okay. Thank you both.

Thank you.

[Operator Instructions] The next question comes from Peter Stabler with Wells Fargo Securities. Please go ahead.

Thanks. Good afternoon. A couple, if I could. David, wondering if it's -- at the risk of asking you to parse your results, but wondering if it's possible to characterize what kind of role new business wins have played as a contributor to organic growth this year versus the kind of trends you're seeing with underlying same-store clients. And then secondly whether you'd be in a position to give us any sort of early look to 2018 and where you would expect significant category outperformance next year as well. Thanks so much.

Sure. Thanks Peter. So, we don't really differentiate our efforts around going after new clients versus chasing organic expansion with existing clients. Our team and our agencies identify where there are opportunities and where there are needs, and they allocate their resources accordingly. We surely had a really strong year of gaining market share within clients, and Scott spoke to some very specific examples in his prepared remarks and we continue to chase a very substantial opportunity on that front. And there's been a trend that we've seen over the last few years, is that some of these very large brand companies that have dozens of brands underneath their umbrella often will test out an agency in the MDC portfolio with one brand, see how it goes. And then as time goes on, bring another brand and another brand as they seek solutions for underperformance that they're getting from maybe their other agency partners. And that's been a really strong case study for us kind of over and over again and a very strong opportunity. But at the same time, there's also been some great momentum on overall new business wins with clients that don't work with us. And we haven't seen really any slowdown on that front as well. And so not to avoid giving specifics, but ultimately, the opportunity is equally as large and our teams are equally as focused on both of them. As far as 2018 looks, we're just beginning our budgeting and planning for next year and so we've gone through no formal process at this point and near the end of October. But that being said, we see no reason for us not to continue to have a solid growth profile on our business next year and our hope and goal is to continue to outperform our competitors.

Thanks David. That's helpful. Just one clarifying follow-up if I could. So, when you guys talk about net new business wins of $77 million, are these new clients in terms of new roster clients? Or would you -- when you kind of put that number together, would you be adding in a new brand that happens to be a sister brand of an existing client? How do you guys go about putting that number together?

So, it is new pieces of business that could include a new client, also could include a new brand within an existing client.

Got it.

At this point, there's been such consolidation among brands. It is -- there's not many big parent company of brands anymore that anyone's not in. So, that number is always included both since the beginning of us calculating that 15 years ago.

Helpful. Thanks.

Sure.

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

Thank you very much. And in closing, these strong financial results, which set us up well to achieve our 2017 financial goals, as well as our unique agency model, give us a great deal of confidence as we head into the home stretch of the year into 2018 and beyond. We hope they also illustrate for you the ways in which we're truly differentiated from the so-called holding company competition and the way we're positioned to take advantage of the ample opportunities in front of us. Thank you all, once again, for your time and continued interest in MDC Partners and good afternoon from New York City.

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