Stagwell Inc. (STGW) Q4 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the MDC Partners Fourth Quarter and Year-End Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Alex Delanghe, Chief Communications Officer.

Thank you. Good afternoon, everyone. I’d like to thank you for taking the time to listen to this MDC Partners conference call for the fourth quarter and full year 2019. Joining me today from MDC 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 subsequent SEC filings. For your reference, we posted an investor presentation to our website. We also refer you to the accompanying 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.

Thank you. Good afternoon. I am pleased to join all of you to discuss our fourth quarter and full year results and to provide an update on the progress we have made on our new world strategic plan. The business delivered a solid performance to round out 2019 with a strong finish. Our prudent cost management and focus on driving profitable growth led to a year-over-year increase in adjusted EBITDA of 14% in Q4 and 13% for the full year, excluding the impact of our Kingsdale divestiture. Building off this covenant, EBITDA totaled $184.2 million in the fourth quarter, a 7% increase versus prior year and at the high end of our guidance range. Top line revenue also rebounded nicely after a soft Q3 with organic revenue down 1.5% in Q4 and down 3% in 2019, in line with expectations for the year. The revenue bounce back in the quarter was driven by particularly strong continued organic revenue growth of 15% in our Specialist Communications segment and 3% organic growth in our Global Integrated segment. Following Stagwell’s investment in MDC and my joining the company, net new business in the last three quarters surged $105 million, including $37 million in the fourth quarter, up from negative $11 million in Q1. Net new business was over $93 million in 2019, our best annual performance in four years. Notable wins in the quarter include the previously announced win with Audi at 72andSunny, Johnson & Johnson at Doner, along with California Pizza Kitchen and TGI Fridays at YML, Manitoba Harvest at CP+B, Peps Brewing at MDC Media and Anomaly added products with Facebook and more brands with General Mills. In fact, COMvergence’s recently released U.S. Creative New Business Barometer, in that barometer, MDC placed third in the ranking of wins despite being only a fraction of the size of the massive holding companies that finished both ahead and behind us. This remarkable result even prompted the study’s CEO to comment "By placing third, this is the first time MDC has landed so high in our rankings. As a result, you could argue that domestically, they are a legitimate threats to the Big 6 MarCom holding companies." In addition, client retention has shown a dramatic improvement over the last three quarters, as our net new business wins indicate. Losses shrank from $60 million in Q1 to under $8 million in the fourth quarter, down seven fold and positioning us for growth in the coming year. We’re also seeing continued and encouraging growth in delivering creative technology solutions for clients from partners like Instrument, YML and Gale as well as innovative production and technology from our full-service agencies like Anomaly and 72andSunny. Operationally, I’m very pleased with how the combination of net new business wins and our rigorous cost management increased our cash position in the quarter. We successfully lowered our leverage ratio to 4.5x from 5x as we eliminated our revolver borrowing and ended the year with an impressive cash balance of over $100 million. This performance keeps us on plan to deliver against our target of generating $100 million of free cash flow through year-end 2020 from when I started. 2019 has been a year of transition and fast implementation of our new world plan. We have accomplished a lot of change in a short period of time, though there’s also much more to do. We are on a relentless march to position ourselves as a modern marketing company of choice combining data and creativity in unique and game-changing ways. We are also transitioning from a holder of companies to an alternative to the holding companies, one that is nimble, cost-effective and yet offering the kind of Creative that has set MDC apart from its larger rivals. One component of this plan was to bring together the best in technology, creativity and communications into new networks that bring to market all of the great deals within in MDC. Four multi-agency networks have been informed to solve client challenges more directly and holistically, support organic growth, share resources and knowledge and build on existing capabilities. The MDC Media Partners and Gale Network, this is a new media, technology and data network designed to bring addressability to the center of advertising strategy and Creative media execution. The Doner partner network brings together Doner, one of our largest U.S. advertising agencies with six complementary specialist agencies. The Anomaly alliance is led by one of our most highly recognized agencies, Anomaly and its leader, Carl Johnson. And our most recent network known as Constellation, a collective made up of 72andSunny, CPB, HO, Instrument and Redscout. These are in addition to two other networks already in place, the Allison & Partners group and the Forsman & Bodenfors network formed in the fall of 2018. We now have over 85% of our revenues organized in six networks. We are putting more businesses in the hands of our most experienced and entrepreneurial managers while improving customer offerings, streamlining costs and creating new shared service opportunities. In addition to reorganizing our offerings, we have actively trimmed our overall cost structure to establish a nimbler and more competitive organization. Our efforts in this area have been focused on lowering our compensation-to-revenue ratio, reducing the administrative support costs and reining in corporate costs. As promised, we moved our corporate headquarters from the expensive and slanky Fifth Avenue palace to excess space in our network. We have now signed a deal to bring 11 of our New York based agencies into One World Trade Center, the Freedom Tower. When complete later this year, centralization of our New York real estate portfolio will allow for significant cost savings of $10 million to $12 million annually starting in 2021, better efficiencies and alignments among our agency partners and enhanced interagency collaboration. We will reduce costs while furthering the key goals of our transformation plan. Adding to this, we made significant progress in reducing our compensation-to-revenue ratio. Over the past several months, we’ve worked closely with our agencies to increase rigor in this area and move towards more competitive targets. As a result, we successfully lowered our partner network comp-to-revenue ratio by 2% in the fourth quarter and expect to see continued improvements of another 1.5% in 2020. Combined, these efforts have helped us to achieve our goal of $35 million of run rate savings and enhancements. We reduced corporate overhead alone by over $8 million. Overall, I’m very pleased with what we’ve achieved to date, delivering significant progress against our plan and creating the energy, early wins and momentum we need to succeed. We’re seeing excellent initial progress from our network strategy as agency collaboration has already resulted in some incremental new business. As we look ahead to 2020, MDC is today far better positioned to compete in the new world of marketing on all fronts. We’re seeing strong client activity, supported by a growing pipeline of new pitches across agency and sectors. Our group of highly talented and entrepreneurial leaders are motivated and committed to the future and the growth of the business. We are seeing greater collaboration across agencies and continued game-changing client solutions that blend technology and creativity to drive marketer success in an evolving marketplace. In 2020, we will execute the next level of our strategic plan. Now formed, our new networks will hit the ground running and work more closely than ever with our data and media operations. We’ll be positioned to go after larger network pitches, both with these new combinations and by harnessing the full power of our $1.4 billion suite of talent along with the companies at Stagwell. Greater emphasis will be put on internally harnessing our unique technologies and data offerings to get the right ad to the right person at the right time. We will incubate the best in outside and internally developed products, and this year, we’ll be launching a predictive analytics product to serve both brands and agencies in the communications field. It will be our first subscription product. We will complete our New York real estate consolidation, which will bring together 11 agencies in ways that will cut their rent in average of 36% and yet provide modern, attractive workspace that will help drive talent and marketing and cost synergies. We have now formed a new business operations group, which is poised to leverage our combined purchasing power and make smart investments across the portfolio. We’ll implement the next set of central strategies to benefit our agencies across areas like T&E, legal, IT and others. We are committed to saving an additional $25 million in run rate by the end of 2020 through these initiatives in real estate, IT, HR, legal, travel and other back-office functions. We’ll continue to focus on improving our compensation-to-revenue ratio by another 1.5% to make our agencies more competitive, more profitable and ensure we are investing efficiently in talent. This is an industry that requires both great work and continually lowered costs, and we’re achieving both, as evidenced by the results this quarter. Given the recent trends in our business and the annual agency review process we just completed, we’re maintaining our current 2020 outlook with organic revenue in 2020 of 2% to 4%. Growth and covenant EBITDA of $200 million to $210 million. I took on the role of Chairman and CEO and invested $100 million as part of Stagwell – of the Stagwell Group in MDC a year ago because I knew this company was nowhere near meeting its potential. I knew that with motivated leadership, a disciplined plan and integrated collaborative operations, the extraordinary collective assets that make up this network could thrive in a way as never before. I’m proud to report that we’re beginning to see the results of that strategic new world plan. In the last year, we have implemented our network structure; significantly improved our net new business; expanded profit margins; reduce costs materially; lowered our leverage; paid down all borrowings; and importantly, delivered transformative work for clients in every category. We represent but a fraction of this industry, and yet, every day we turn heads with Creative that delivers outsized results, inspires consumers to action and emotion and challenges the status quo. In closing, I’m excited for what lies ahead in the new year. MDC is made up of industry-leading talent and many of the very best agencies in the world. We intend to claim our rightful place in this industry and deliver ambitious sustainable growth as we position ourselves for long-term success. With that, let me turn things over to Frank to run through financials in detail.

Thanks, Mark. Good afternoon, everyone. As Mark mentioned, in the fourth quarter, we delivered sequential revenue growth [Audio Dip] at several agencies as we benefited from improved revenue trends relative to earlier in the year. We reported revenue of $382 million, down 3% and organically down 1.5%. For 2019, reported revenue was $1.42 billion, down 3.1% on an organic basis from $1.48 billion a year ago. Excluding the impact of our Kingsdale divestiture, adjusted EBITDA increased 14% in the fourth quarter and 13% for the full year. As reported, adjusted EBITDA increased 10% to $57 million in the quarter and 7% to $174 million for the full year. In both periods, adjusted EBITDA was aided by the cost reduction initiatives implemented initially in 2018 and continuing throughout 2019. Severance and other restructuring charges of $3.2 million from incremental cost reduction actions taken in the fourth quarter drove covenant EBITDA of $61 million. For 2019, we recorded a total of $11 million in restructuring charges, including $2 million at the corporate office with estimated annualized savings of approximately $35 million. Approximately half of the estimated savings were realized in 2019, and the rest will be realized in 2020. Notably, we have reduced our corporate overhead by over $8 million on an annualized basis. And in total, our actions led to trailing 12-month covenant EBITDA of $184 million, near the upper end of our guidance. Now breaking down the results by segment. We saw continued strength in our Specialist Communications segment, delivering 15% organic revenue growth in the quarter and 9% growth for the year as they continued to capture market share. Adjusted EBITDA grew 90% in the quarter and 26% for the full year. Our largest segment, Global Integrated, delivered 3% organic revenue growth and 24% EBITDA growth in the fourth quarter with strong progress in our largest global agencies. For the full year, revenue was essentially flat as the segment rebounded from client losses in the beginning of the year while adjusted EBITDA increased 16%. The All Other segment delivered organic revenue growth of approximately 1% in Q4, and excluding the effect of the Kingsdale divestiture, delivered adjusted EBITDA growth of nearly 12% for the same period. At the same time, we continued to experience top line pressure in our domestic Creative and Media Service segments. We took action, however, to reduce costs during 2019 in both businesses, positioning them for improved profitability. And as a result, domestic Creative more than offset revenue softness and delivered 29% growth in adjusted EBITDA for the full year. In media, selective new business wins pushed revenue higher sequentially from the third quarter, and we’re seeing those trends continue into early 2020. We are encouraged by the combination of media and data and expect the increased agency collaboration from our recently formed networks to generate more opportunities for our media platform. Now moving to our balance sheet. We generated $92 million in cash flow from operations in the fourth quarter, driven by increased EBITDA, good working capital performance and seasonal improvements in media cash. We funded approximately $30 million in interest on our notes and revolver, $1 million of deferred acquisition-related payments and $3 million in minority interest distributions. We exited the revolver during the quarter, reduced our total leverage to 4.5x, lowered our net debt to $832 million from $959 million a year ago and ended the year with $107 million of cash on our balance sheet. Funding of acquisition-related payments reduced the remaining liabilities related to DAC and minority interest obligations partially offset by increases related to improved agency performance resulting in an overall small net increase acquisition-related liabilities to a total of $149 million. We currently expect to fund approximately $65 million in acquisition-related liabilities in 2020, with the largest outflow in the second quarter, consistent with historical trends. Although seasonal trends will affect working capital, we expect continued progress toward our goal of reducing leverage by 3.25 of return annually. In terms of ongoing initiatives and opportunities, as Mark mentioned, we are on schedule with our New York real estate transformation project, having signed our lease at One World Trade Center. This will bring 11 of our New York based agencies into one location to promote collaboration, create a natural hedge against shifting space needs and, ultimately, reducing administrative costs. Savings from the move will reduce our occupancy cost by at least $10 million annually, and we expect to realize most of those savings beginning in 2021. Now turning to our guidance. We currently anticipate organic revenue growth of 2% to 4% for the full year with the first half of the year softer as we anniversary client losses from Q1 2019, followed by more robust growth later in 2020. Assuming prevailing FX rates, we expect covenant EBITDA of approximately $200 million to $210 million. Our net CapEx is expected to be approximately $30 million to $35 million in 2020 inclusive of the costs related to our New York real estate consolidation program. Regarding the corona news – coronavirus, excuse me, we are a people business, and our first concern is for the safety of our talent. But let me also point out that less than 2% of our revenue comes from China and Japan, so we have much less exposure to the region than some of our peers. And we have not made any adjustment to our 2020 outlook. We will continue to monitor the situation closely. As a final note, we completed the sale of our Sloane subsidiary to SKDK, a division of Stagwell, early in Q1 2020. The estimated sales price is approximately $26 million including a performance-based earn-out. This sale completes our divestiture of shareholder services businesses that began with the sale of Kingsdale in Q1 2019. As we look ahead, we are excited about our plan and remain focused on continued execution in 2020, driving growth through our strategic initiatives while simultaneously reducing costs, improving profitability and strengthening our balance sheet. Thank you. Operator, please open the line for questions.

[Operator Instructions] The first question today comes from Avi Steiner of JPMorgan. Please go ahead.

Thank you. Good afternoon. I want to start here, if I can, starting with your reiterated positive outlook for 2020. Mark, how much of this reflects MDC-specific actions that you’ve taken? And how much does this reflect an improvement in the ad and pitching environment? And relatedly, given you’ve consolidated, now it’s like six 10-pole partners, how much of that change was designed to deliver maybe more compelling and robust offerings to existing and prospective clients? And how much of that was designed to streamline and eliminate costs? And then we got a few others.

Well, let me take the last part. The coming together of the networks was meant to do a number of things. First, it was meant to take what were individual units of varying size and enable them to leverage off of each other, combining the skills, because CMOs typically buy today multi-services. They used to just buy advertising and media. Today, they’re buying six or eight different services, and it was important to meet those needs. So first and foremost, I think it’s about serving clients and marketing on a more efficient basis to those clients. Second, it’s letting the business be driven by those very best leaders. As opposed to all 25 units or so individually reporting into corporate, having them work with in leadership teams with each other right down in the trenches is, I think, going to be far more effective in terms of both winning business and making decisions. And then finally, I think there are some cost synergy elements through the ability – a much greater ability to do centralized services. So I think those are – all of those reasons, now none of those things are really baked into the plan because they were just formed, and we are now getting the – they’re just going to market now. What was your first – the first element of your question?

The first part was – and I had a lot of words in there, I apologize. But really just trying to understand how much of this positive outlook reflects the positive actions you’ve taken since you’ve been there in March versus any kind of improvement in the ad environment, if there is one?

I wouldn’t say any of it reflects improvement or not in the ad industry. I think that the ad industry continues to go through some level of transformation as offline spending decreases and online spending increases and project work increases. I think that the – these projections are based on two major elements of change. One is that the net new business, before I came, $60 million went out the back door in Q1 of 2019. That has been reduced to a trickle of $8 million, and that means that the company itself is fully, I think, stabilized in that fashion, has a group of incredibly loyal and energized and excited clients. And that means it’s far easier with even the same level of new business to achieve net positive growth. And we’ve seen a very good uptick in new business wins going into the fourth quarter that typically reverberates into the following year, just as early losses in the fourth quarter would have reverberated into the following year, as we had to live through in 2019. And then on the second leg of it, the second leg is that they will do – they will be able to have greater margins through greater efficiency. And our emphasis there, I think, as Frank said, and if Frank wants to add a comment, it’s just – it’s clearly paying off. Frank, do you want to add a comment to that?

Nothing at the moment, Mark, sorry. I think you said it all.

Great. Thank you, Mark, that’s appreciated. Frank, maybe to pick on you a little bit, if I can, so the $100 million of free cash flow through 2020 was reiterated. Can you help us with what that means for free cash flow in 2020?

Yes. We see that by the end of the year, we believe we’re still on target. Certainly, one of the changing variables is the signing of the lease at World Trade Center, which is a significant investment for us. However, we believe that with the sales proceeds that we have from the sale of Sloane, plus all of the other cost initiatives we’ve taken, that we’re still on track to deliver that.

Okay. Just in terms of seasonality, you touched on $65 million of – and I say, seasonality of cash flows, but $65 million of deferred acquisition consideration going to be paid out this year. I think you said most of that is in the second quarter. Can you just help us with kind of cash flow seasonality through the year? And any other cash uses away from CapEx we should be thinking about?

So we have the traditional items that will use cash. It’s $30 million semiannually for our interest. The CapEx, we’ve quantified. Cash taxes will be $7 million, $8 million in 2020, so not a significant draw. Those are some of the bigger items. And of course, the DAC payments at $65 million represent the second largest obligation for us.

Okay. Last two for me, very quickly. The $26 million Sloane subsale that you talked about, I think you have – or remind me, you may have some bond buyback flexibility from asset sales. Am I correct in that? And how do you think about that use of cash?

That’s correct. We do…

I think we haven’t made any decisions about any uses of cash yet, but that is correct. We do have that flexibility.

Okay. And very last one. It’s, hopefully, an easy one. The delta between covenant and adjusted EBITDA in 2019 was about $10 million. So I guess, how do we – should we think about the severance and maybe other items between your guidance if I wanted to get to adjusted? And thank you for the time everyone.

Frank, I don’t know...

So Avi, we – as you know, we don’t forecast and budget for restructuring items. That’s principally what stands between adjusted EBITDA and covenant EBITDA, so we don’t forecast those items because we can’t time them exactly. So right now, the $200 million to $210 million reflects essentially adjusted EBITDA.

Okay. Thank you.

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

Thank you. I think for those of you who’ve followed MDC for a long period of time, I was really thrilled to take over the chairmanship and CEO role and to implement the strategic plan. And I think that, as you can see through these results, the kind of wins that they’re doing, the creation, I think, of the networks, the kind of work that’s being done out there by our companies and partners that this plan is beginning to show real fruit, that we’re managing to take a lot of the fat out of the costs that were sitting there because the network wasn’t as well managed as it could be, and at the same time, being able to enable our best talent to do the best work and to adapt to this changing field. And I think that you’re beginning to see those results, and we’re going to continue to press this plan forward just as quickly, if not more so. Thank you very much.

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