Stagwell Inc. (STGW) Q3 2019 Earnings Report, Transcript and Summary

Good afternoon everyone and welcome to MDC Partners Third Quarter Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please also note today's event is being recorded. At this time, I would like to turn the conference call over to Alex Delanghe, Chief Communications Officer. Ma'am, please go ahead.

Thank you. Good afternoon, everyone. Welcome to the MDC Partners conference call for the third quarter of 2019. Joining me today are Mark Penn, Chairman and Chief Executive Officer; and Frank Lanuto, Chief Financial Officer. 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 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’ve 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 Chief Executive Officer, Mark Penn.

Good afternoon. Thank you for joining us today. I am pleased to be here to discuss MDC’s recent performance and provide an update on progress against our New World plan. During the third quarter, we continue to move quickly to execute on our strategic priorities, pursuing initiatives that we believe will position the business for growth and profitability. In terms of performance, the significant cost reduction actions taken in late 2018 and throughout this year in tandem with prudent financial management helped deliver a 6% increase in adjusted EBITDA on a year-to-date basis. Q3 adjusted EBITDA was down year-on-year against a strong 2018 third quarter. Revenue softness was driven by the clients in media healthcare and one of the global creative agencies. We're addressing all of the issues as part of the New World plan and are seeing a rebound in new business in some of those areas. Although revenue was down for the quarter net new business was again solid at over $30 million, with several notable wins including Nature's Bounty at Doner, Vodafone Global and expanded assignments with ancestry.com and anomaly, international creative duties with Electrolux Group and F&B, creative AOR for two significant brands from the no record [ph] portfolio at Crispin Porter and Qualcomm and Allison Partners. In addition, last quarter, we reported that we won Häagen-Dazs global creative duties with F&B and we've since further expanded this relationship to a new General Mills brand with another MBC agency. This momentum has continued into Q4 with 72andSunny's fantastic win of Audi global creative duties announced just this morning, on top of Doners recent win of three, Johnson & Johnson's most recognizable brands, Tylenol, Listerine and Zyrtec. The latest Doner achievement is not only a significant win for MDC, but since it was one together with the Stagwell Group's, Colle and theory [ph], it's an indicator of the potential success that can come from such collaboration. I want to call attention to some of the agencies that are demonstrating significant bottom line growth, even in a difficult marketing environment. I've highlighted Anomaly as an agency showing particularly strong execution, with its combination of strategy, innovation and creativity, hitting a sweet spot in the marketplace today. Other strong performers include Doner, Moto, Allison+Partners, and digital agencies YML and Instrument. Operationally our disciplined cost management and other efficiency improvements across the business helped to offset much of a decline in revenue. We also drove strong cash generation, as we successfully reduced our revolver from $27 million to $8 million in the quarter. This result keeps us on track to deliver on my target of generating $100 million of free cash flow since I became CEO in March through the year-end of 2020. Let me now take a few minutes to provide an update on the execution of our strategy to date against our new world plan that we laid out on our last call. As a reminder at a high level, our strategy is built around the following key transformational principles. Our agencies are better together than apart whenever possible. Data and creativity go hand-in-hand, online and offline creative are one and the same today, efficient operations across the Group enhance great agency cultures and creativity, investment should be in digital technologies, it's for growth not real estate, that increases overhead. In order to meet these objectives, we're taking smart actions that will organize our offerings, reduce our costs, capitalize on our strengths and enhance our go-to-market capabilities. In terms of organizing our offerings during the second quarter, we announced the alliance between MDC Media Partners and Gale, bringing our media agencies in our sophisticated data analytics more closely together. The new team is effectively reuniting media with creative and has identified numerous pitch opportunities among existing clients. We're about to enter the next phase of our plan with the formation of two additional multi-agency networks led by two of our flagship agencies that take advantage in a variety of ways of complementary resources, knowledge, capabilities, and geographic reach. The substantive details have been finalized. We're in the process of operationalizing those networks. Together with the combination of MDC Media Partners and Gale, we expect to reduce our 25 reporting units by nearly half. Importantly, we also expect that these actions will drive significant synergies, both in terms of go-to-market opportunities and cost savings. I look forward to sharing more details on both of these new networks within the coming weeks. I've also been extremely pleased with the way that our partners have rallied around the imperative of a unified MDC especially as it relates to MDC global pitch activity, multi country interdisciplinary, interdisciplinary team. These early pitches are definitely proving that we can indeed compete and consolidate its global pitches, and our world class firms create a truly unique go-to-market strategy. At the same time, we're furthering the unity of MDC across firms, with employees at all levels through the creation of content and communications that were previously foreign to the federation culture at MDC. From an operational perspective, we're moving to create more active management at the center, more efficient, proven finance, IT, HR and legal resources. At the same time we're bringing discipline management to cost structure, particularly the compensation to revenue ratio, administrative expenses and CapEx. Proper management of these factors is integral to running successful profitable agencies and create headroom to hire the best talent. We're also rapidly progressing on our real estate consolidation efforts with priority placed in our expansive New York portfolio. A co-location plan is expected to reduce our footprint by nearly 30% creating synergies including revenue generating interagency collaboration, cross selling opportunities, streamline administration services, as well as a natural hedge to fluctuating real estate needs. We expect to complete our full New York transformation by the end of 2020, and generate future annualized cost savings of about $10 million. As we move forward, I'm excited to see what the future holds, and I'm heartened by all the progress we're making in all fronts, particularly the momentum that we're seeing that building with some significant new client wins. I will now turn the call over to Frank to provide more color on third quarter results. Frank?

Thank you, Mark, and good afternoon, everyone. Before reviewing our financial results, I want to point out that we reclassified one of our agency businesses, from the domestic creative to the media services segment at the beginning of the quarter. The realignment is based on the operational management of the business under the recently announced media network. Prior periods have been reclassified to facilitate the comparability of results. As Mark mentioned, in the third quarter, we had some scrolling performances at a number of agencies. And at the same time, we experienced continued challenges in a select number of our businesses. This led us to report revenue of $343 million down 8.8% and organically down 7.5%. For the nine month period, reported revenue was $1.03 billion down 3.7% on an organic basis from $1.08 billion a year-ago. Pass-through costs continue to benefit our reported organic revenue by approximately 1% and 1.5%, for the three and nine month periods respectively. For the quarter, we saw continued positive momentum in our specialist communication segment, delivering 6% organic revenue growth, as they continue to capture market share. We are seeing our public relations agencies take on larger-and-larger remits as corporations recognize the growing importance of the Chief Communications Officer in an environment where one tweet or mismanaged business decision can swiftly and severely derail a brand narrative. Additionally, our PR agencies are increasingly connected to CMOs with larger budgets in this environment. This unique specialty positioning in our PR businesses continues to drive results. Offsetting this, the downward pressure we experienced was largely driven by three agencies. First, or media business, inclusive of the previously mentioned reclassification declined 28%, of which approximately one quarter is related to pass-through costs, with no related impact on EBITDA. The remaining amount was principally related to the loss of two accounts resulting from client acquisitions and to a lesser extent the deferral of some project work. These losses have minimal impact on EBITDA. The second factor was the cycling of two previously announced high profile accomplices at one agency and our global integrated segment. We expect the impact of these losses to run its course by the end of the year and be offset in 2020. This is a fundamentally strong award winning and resilient business as evidenced by recent account wins, and we continue to have great confidence in its future. Softness in the segment was partially offset by a strong performance at two global leaders in the group resulting in an overall 6% organic decline in the segment for the quarter. The final contributing factor was in our healthcare portfolio reported in our all other segment, which declined by approximately 12% organically. Delayed and regulatory approvals and certain reductions in client spending were the principle drivers, but we expect improvement in this segment as some solid recent wins position us well for next year. We also saw strength in our digital agencies in this segment in Q3, as demand continues to rise at the intersection of consumer experience and technology enabled creativity. Excluding the impact of these three businesses, EBITDA would have been up over 20% year-to-date. For the quarter, adjusted EBITDA decreased 17% to $49 million as compared to an unusually strong performance in the prior year, but increased 6% to $117 million through the first nine months. In both periods, adjusted EBITDA was aided by the significant cost reduction initiatives implemented initially in 2018 and continuing in each of the first three quarters in 2019. Severance and other charges from incremental cost reduction was taken in the third quarter through a covenant EBITDA of $51 million leading to trailing 12-month covenant EBITDA of $179 million. We also continued to make progress against our cost savings initiatives in the quarter, delivering approximately $2.6 million in restructuring severance, including $0.6 million in charges at the corporate office. For the nine months period, we recorded a total of $8 million in charges, including $2 million at the corporate office, with estimated annualized savings of nearly $30 million. Notably, we have reduced our corporate overhead by over $8 million on an annualized basis. We are committed to delivering further improvements, and therefore I would expect incremental restructuring actions in the fourth quarter that will help us achieve our goal of $35 million and run rate savings by the end of the year. Moving to the balance sheet, we delivered another solid working capital performance. We funded approximately $7 million of the third acquisition related payments, $2 million in minority interest distributions and $1 million and interest and cash taxes, while further reducing borrowings on our credit facility from $27 million to $8 million. Net debt was $901 million, flat as compared to Q2, but down from $959 million at year-end. Given the cash performance and change in covenant, EBITDA, our total leverage ratio on the revolver was essentially flat to the prior quarter. The funding of acquisition-related payments reduce the remaining liabilities related to VAC [ph] and minority interest obligations to approximately $138 million, with up to $7 million expected to be paid in the fourth quarter of this year. Overall, we remain on track to exit the revolver by year-end and achieve significant net positive cash flow. Given the trends through nine months, we are maintaining our 2019 covenant EBITDA guidance of $175 to $185 million, though on lower forecasted organic revenue, which we anticipate will be down 3% to 5% for the full year. As we look ahead, we are focused on expeditiously executing against our new world plan, driving the strategic initiatives of combining creativity with strategy and fostering enhanced cross agency collaboration, while simultaneously eliminating unnecessary costs to proven profitability and strengthening our balance sheet. Thank you. Operator, would you please open the line for questions?

[Operator instructions] Our first question today comes from Avi Steiner from JPMorgan. Please go ahead with your question.

Thanks, I got a couple here. So I recognize how difficult it is to forecast this business. But I'm wondering if you can dig a little deeper into what happened on the revenue side, I heard you mentioned the deferral, some account losses, the healthcare side. But I'm really trying to understand what happens, I guess from early August when we -- you last spoke to the market through the end of the quarter, did that all materialize in the back half and then on the deferral part, how do we think about that coming back? And then I have few others. Thank you.

So I think there's a couple of pieces to that probably. The first thing is, as you know, a fair amount of budget is based on projected revenues for project work, an increasing portion of our work has become project oriented. So therefore, you don't always have the visibility that far out. But we use some macro, approach to try and estimate what those trends will be. Sometimes that work shows up and sometimes it doesn't. So there's a little bit of that going on. Second, we win and lose business every day. So you get softness in client spending, you get regulatory delays, which happens in certain about businesses, which just as a part of the business, so your expectations aren't always met on that. So I think that's overall, sort of where some of the softness comes from.

And this is Mark. And this I think, look I think the third quarter last year was particularly strong one and as several of our losses that occurred just as I was coming on and cycled through some of the winds we're seeing are really, as you can see, we've had two back-to-back quarters, after if you go back to the first quarter, we had significant net loss of new business. We've had two quarters of net wins of business. But it takes longer, I think for revenue to come on stream these days, because the business has to be finally fully contrasted and the agencies brought on, the old agencies are taken off the business as it goes, and I see that we're beginning to have some of the first major wins now, as we did with Johnson & Johnson and an Audi. So, I think that those things are kind in the sequencing of things. I think, I think that's what, that's what really hasn't resulted in somewhat less revenue than we were hoping for through the end of the year.

Understood, and that's a good segue to my next question. So the high profile wins that you've talked to and we've seen in the trade prates. Sounds like the timing is uncertain. I want to make sure we shouldn't assume anything in the fourth quarter, number one. Number two, I think you'd mentioned at least one of the wins for the team in partnership with Stagwell and I'm trying understand maybe what the economic splits are how to think about a win vis-à-vis the contribution to MDC versus --?

Well, again, I think we have, we had, projected out the fourth quarter revenue without the anticipation of these wins. So, they came in the fourth quarter, whether exactly when they'll come online, I'm not going to predict this, as clients sometimes take longer or shorter, but I think these are significant wins. In terms of things that might be done in collaboration, as I always say, 100% of nothing is nothing. So I think both agencies benefit here. I'm not going to go through the amounts but these are -- were significant six figure wins for both agencies involved. So I think that unbalanced that kind of cooperative win has solid economics in that increases the percentage probability of winning and in that case, I think they displace agencies that have been there for over 60 years servicing that account. So we're hopeful that, that kind of thing will continue to have benefits in the future as agencies become comfortable working with each other across disciplines. And the other thing that's happening there in those partnerships is they typically will involve two disciplines. So the average sale itself is higher and so it's not as though either agency is losing, they're able to get a bigger contract by working together across several disciplines.

Okay. 2020 targets, I heard you, Mark, I believe reiterate your free cash flow target of $400 million from the time you joined to '20. I think you were previously and I don't want to get myself or anyone else in trouble here. But I think you've previously talked about 2% to 4% organic revenue growth for next year. And I'm wondering how you feel about that in context of how this year's ending and some of the new business wins that you talked?

So Avi, I think right now, we're not changing our 2020 forecast for guidance at this time. We're in the middle of our budgeting process and as we start to collect, even this very new news of winning accounts, we will factor that into our guidance for 2020 and we will update you at the end of the next quarter. And I think it's important to note in this business is just as a loss happens in the beginning of the year, as why I came on cycles to the entire year, and win at this time also cycles in the other direction across the next year.

Fair enough. And I want go back to and I apologize. I'll get off shortly. But I think to one of my earlier question, Frank, you talked about kind of the shift to more project work. Can you kind of dimensionalize that for us, kind of project versus other?

Well, look I think it's, it comes in a number of forms. Some agencies, by their nature are mostly project work. But even at some of our larger agencies, you will be one of a number of agencies on a roster. And even though you're, sort of pre-cleared with the client, you may find yourself sort of competing with another agency or two for some of that work throughout the year. So, you can make an estimate you can use some, like I said, some macro sort of math on it, but in the end, it may be plus or minus to what you estimate.

So, and this is Mark, let me just also comment on that, that the -- look, to the extent people switch from AORs to project work then generally they're switching from one agency to several agencies on a roster. And our response to that is a, to adapt to roster life when, when in fact clients choose that if their preferred route, some do, some don't. I think most importantly, the alliances that we're announcing that bring together multiple services also counter that because they sell into clients, coherent packages of services. And so even if it's not an AOR and Creative now, it couldn't stand the project work across three or four different disciplines. And so that's why we believe that the Alliance, our network strategy here that we're putting together and that we're in the process of announcing over the next few weeks that will, it will reduce our operating units from 25 to about half of that is critical in responding to the marketplace on this.

I appreciate the time Gentlemen, I will head back in queue. Thank you.

[Operator Instructions] And ladies and gentlemen at this time, I'm showing additional questions. I'd like to turn the conference call back over to Mark Penn for any closing remarks.

Thank you. I see they've managed to ask the questions for the group. We're appreciative. I think that we think we given a timely update of the New World plan that is, that is currently in progress. And we hoped that this combination of momentum that we're seeing with the plan will produce significant results for this company as we move forward. Thank you again for listening.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.