Stagwell Inc
NASDAQ:STGW
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Good morning from Stagwell's global headquarters at One World Trade Center in New York City, and welcome to Stagwell Inc.'s earnings webcast for Q2 2023. My name is Ben Allanson, and I lead the Investor Relations function here at Stagwell. With me today are Mark Penn, Stagwell's Chairman and Chief Executive Officer; and Frank Lanuto, the 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.
And with that, I'd like to turn the call over to our Chairman and CEO, Mark Penn.
Thank you, Ben, and thank you to everyone for joining us for our earnings call. In the face of significant industry and sector headwinds, Stagwell posted sequential quarter-over-quarter improvements in revenue, EBITDA and margin. We expect to continue to improve on all metrics throughout the rest of the year as new business wins have continued to accelerate.
As promised for the first time, we'll be breaking out the Stagwell Marketing Cloud Group results this quarter which show that our investments in that area are paying off and have great potential to enhance our value proposition as we strive for a leadership position in marketing AI.
Our reputation within the industry continues to grow, or being invited to record numbers of new business pitches. We delivered second quarter net revenue of $535 million (sic) $539 million, down about 3% from the prior year, which had increased by 16%. This means that we continue to maintain a strong 2-year stack of growth against our long-term targets as we power through this more challenging economic environment.
In this quarter, we continued to deliver sequentially improving net new business of $75 million, following $53 million in the first quarter and $42 million in the fourth quarter of 2022. This brings our last 12 months net new business to more than $0.25 billion, a record for Stagwell. This net new business won during these periods should stack up over the remainder of the year.
Our largest clients continue to get larger as the top 25 clients showed 12% growth year-over-year with 3 clients comping $50 million in net revenue in the last 12 months. Even as tech and financial companies pulled back, the increase in the top client shows we are successfully reorienting the company from smaller projects to larger multifaceted relationships.
Our international business or net new revenue increased by 9% year-over-year, led by particularly strong growth in Asia Pacific of 17%. As we previously said, expansion in international markets is a strategic priority for us and will be a key driver of growth for the future and in our ability to land more global relationships.
As to headwinds, we believe we are hitting the bottom of a cycle government-induced economic slowdowns, advertising industry-specific pullbacks, particularly in the tech and financial sectors and a Hollywood writers and actors strike, which affects our entertainment industry research. We're also at the bottom of the political cycle, which is about to kick off in earnest with the first presidential debates.
Our adjusted EBITDA came in at $91 million, a 26% sequential improvement over the first quarter, representing a 17% margin as we took proactive steps to preserve margin without sacrificing either the quality of our work or the needed investment in new tech areas and products.
During the second quarter, we realized approximately $28 million of annualized salary savings related to restructuring actions in the first 3 months of the year. We also took further steps to reduce staffing costs during the second quarter, which we expect to deliver $20 million of additional annualized staff savings.
These actions have reduced our head count by about 4% globally since the beginning of the year. We'll continue to be proactive in controlling staffing costs. And since the end of the quarter, we've taken actions that should realize a further $15 million in annualized sales. Our staff costs as a percentage of net revenue came down to 64%, a 280 basis point improvement sequentially.
In addition to the actions related to staffing levels, we continue to work to streamline operations through our shared services network. Many of our central systems now online will be coming online in the next few months helping us to realize further cost synergies across the company. Completion of these systems allows us to shift attention to the next $35 million in central expense reductions we announced on the first quarter call. These steps revolve around the deployment of increased automation and AI across Stagwell but especially in our media operations. We aim to make these operations a model of efficiency over the next year.
And looking at our EBITDA for the quarter, it's important to factor in that we're now spending about $5 million per quarter in Cloud investments and that we made a significant investment in marketing our firm to the broader industry at the Cannes festival, the world's biggest marketing event. We posted $0.16 of adjusted earnings per share during the quarter, a 25% improvement on the first quarter.
Stagwell remains well positioned to achieve strong EBITDA and cash flows this year. We expect to generate $410 million to $440 million of EBITDA and convert 50% to 60% of that figure's free cash flow. This should translate into about $0.80 of adjusted EPS. We expect overall organic net revenue growth to be between 0% and 2% in this nonpolitical year.
As you can see from the net new business number, the growth estimates are a reflection not of client losses, but of temporary disallocations as many tech companies laid off tens of thousands of workers. We've seen transitory reductions in media spend among clients impacted by these tech restructurings and uncertainty around the regional banks. Revenue from retail clients was 29% lower as they took a more bearish stance on the economy.
As a variable cost business, we have the ability to typically in quarter 2 to adjust our cost base and become leaner so that when turnarounds happen, the surge of new business and lower organization costs can result in a jump, margin in the bottom line. We see this coming by the fourth quarter of this year. We're well positioned for a banner 2024 that will have a full political season and end to a Hollywood strike, a surge in AI-based digital transformation and expanded large client remits.
As I mentioned previously, the second quarter showed a second biggest ever net new business result coming in at about $75 million. We saw significant multimillion dollar wins with Buffalo Wild Wings at Anomaly, Wingstop at 72andSunny, a large American consumer health company at Donor, Virgin Mobile and Patagonia assembly, Mandarin Oriental at FB, athenahealth at Gale. Additionally, 3 months since Crispin Porter announced a new integrated creative offering, the agency achieved continued momentum, expanding existing client relationships and adding 7 new client partners.
At the Cannes Lions Festival held in June, Stagwell's agencies picked up 18 awards, recognizing the transformational work we have done over the last 12 months. These wins include a Gold Lion for Gale in the creative data category for their work totally on the highly successful Doppelganger campaign. At Cannes, we created and executed Sport Beach, a novel marketing experience, spearheaded by Beth Sidhu, our Chief Brand and Communications Officer. We brought together 38 athletes, 23 partners and 17 agencies to play sports and talk about the future of sports fandom and culture.
Throughout the week, we have more than 5,000 marketers attend the festivities and led virtually all major ad industry publications as "The Winner" at Cannes for hosting this unique go-to event, raising our industry visibility. We are already signing multimillion dollar deals as a result of the event, and we continue to show momentum and pitch eligibility.
Last year, we participated in about 1 billion of pitches. We've already hit that mark and expect to exceed our target of 1.2 billion in opportunities this year with about a 25% win rate in pitches we participate in. For the first time, we're providing additional granularity around the Stagwell Marketing Cloud Group, which consists of 2 divisions; the software platform products, principally driven by SaaS revenue and the advanced media platforms, principally driven by advertising and sponsorships.
We're coming out of the gates with a net revenue in excess of $48 million, representing growth of 29% year-over-year. We expect this revenue will be lower margin, but higher gross margin and for growth to accelerate particularly next year as the products enter the market. We fully expect our media studio to be a fully competitive position combined with the DSP to compete for a wide range of small and large clients in programmatic media. Tests combined with our data on behalf of clients are showing results that beat the Trade Desk, look for continued news on this front.
Our Harris Brand Terminal, which has over 130 corporate clients now is combined with Maru, to a suite of Harris branded research products, AI-driven analysis of research tables, open engines and focus groups are quickly being developed, tested and deployed as products.
Our PRophet product is now signed on Alpha IR, Drive PR in digital, radical company and impact partners in the enterprise client category and has won another PR industry contest as the best new product out there. We expect by the end of the year to be fully competitive with larger systems from Cision and serve as a full replacement. We've already deployed generative AI in the product to produce news releases, briefing books and pitches. As a system, it will save communications professionals a tremendous number of hours and improve it's value. We paid over 1,000 users now and have an expanding pipeline.
Our latest product smart assets essentially uses AI to category its content, bring it up to brand standard and pointed to where it could be most effective. It's already been tested by one of Europe's largest CPG companies. Stagwell Marketing Cloud CTO, Mansoor Basha is heading up the company-wide efforts to deploy predictive and generative AI across our agencies and combined with experts from code and theory and the new partnership reached with Oracle, we are bringing AI marketing to clients.
Given our high ratio of engineers to designers, we are well positioned to take a leadership position in the application of AI to marketing and to take advantage of our recently announced AI partnership. We expect the political cycle to pick up in the second half once the Republican debates get underway, and we anticipate the 2024 election will be the biggest in history with over $12 billion in expenditures.
In terms of M&A activities, our largest investment in this quarter was in our sales. In the first half of the year, we bought back about $40 million of stock. This is in addition to the $150 million bulk transaction that was announced in our first quarter. We also eliminated the Class B shares from our share count and our share count today has been reduced to 268 million shares lower than the quarterly average used to calculate EPS. We also recently acquired Tinsel, a marketing and design studio focused on immersive customer experience and experiential engagement.
For the rest of the year, we will generally be working to shore up the balance sheet, work back from here to hit the goal of net leverage near to the 2x mark as we consider some divestment of smaller noncore assets as our positive cash flow is typically weighted to the end of the year. However, we continue to look for key opportunities on the M&A front that will build out and expand our network to achieve the scale necessary to keep growing larger clients on a global basis.
As this year takes shape, it should be clear that we're going to manage EBITDA and cash flow carefully and position us for the coming turnaround in the economic, technology and political cycles. At an estimated $0.80 of adjusted EPS, we remain an undervalued investment relative to both this year and the greater potential for 2024 by this and virtually any other typical metric. With growing large company relationships, accelerating new business wins, concentrated focus on cost and efficiency and the development of game-changing tech products. we remain strongly positioned to benefit from the long-term growth in digital marketing and in particular, in the next revolution of AI-based digital transformation in marketing.
Now I'd like to hand it over to Frank Lanuto, our Chief Financial Officer, to work through some of our financial results in more detail. Frank?
Thank you, Mark. Good morning, everyone, and thank you for joining us to discuss our second 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.
Reported revenue for Q2 was $632 million, decline of 6% as compared to the same period in the prior year. Net revenue, excluding pass-through costs, declined 3% year-over-year to $539 million. In organic terms, the decline was 5%. Excluding advocacy, organic net revenue declined 4% for the period.
Results were impacted principally in the North American market. As internationally, net revenue grew organically at a robust 9%, led by gains in Asia Pacific and EMEA of 17% and 8%, respectively over the comparable period in the prior year. A combination of factors led to the decline in U.S. revenue, including a disruption in the tech sector within the digital transformation discipline, the actors and writers strike weighing adversely on our media and entertainment customers within research and strategy and regional banking turmoil, causing uncertainty in financial services.
The decline in organic net revenues spanned across all our principal capabilities. What was felt more acutely in digital transformation, where we experienced delays in enhancement of projects as our tech clients restructured their workforces. Importantly, we believe these circumstances are temporary with no significant impact on the strength of our clients or the inexorable shift to digital transformation and data-driven media solutions.
The demand for transformative digital projects remains very strong, with more than 25% of our new business in the second quarter derived from this area. We are well positioned to resume our strong revenue growth as these temporary conditions abate. From a larger trending standpoint, our stated strategy for delivering integrated services to our largest global clients is progressing as planned, with our top 100 customers now representing approximately 50% of net revenue, growing 15% organically year-over-year. We are also excited about our progress with the Stagwell Marketing Cloud Group, and we're pleased to initiate disclosure about certain specifics within the capability.
In the second quarter, a Stagwell Marketing Cloud Group delivered more than $48 million in net revenue, representing a 29% increase over the prior comparable period. $35 million of this net revenue came from our Advanced Media Platforms Group and approximately $13 million was derived from software platform products. Continued investments in the group will lead to increased margins as we achieve scale.
Moving to operating expenses and profitability. We responded to the slowing conditions in the first half of the year and took steps to align our cost structure with the prevailing revenue streams. The cost actions from Q1 and Q2 will generate annualized cost savings of approximately $28 million and $20 million, respectively, and resulted in the company reducing personnel costs as a percentage of net revenue to 64% for the quarter, an improvement of 280 basis points over the first quarter.
We also continue to take steps to reduce our real estate footprint. In Q2, we took a lease impairment charge of $9.2 million in connection with the exit of a property in New York City. This marks the early stages of our recently announced $35 million cost savings initiative. The company also fully expects to realize the $30 million in annualized cost savings from the program that was announced shortly after our merger. As a result, we delivered $91 million of adjusted EBITDA in the quarter, representing a 17% margin and paving the way to restoring our adjusted EBITDA margin to 19% to 20% annually, in line with our prior expectations.
Moving to the balance sheet. We continue to take actions to improve the strength of the long-term balance sheet. Starting with deferred acquisition consideration, we reduced obligations by approximately $47 million from year-end to $114 million at the end of Q2. We expect to reduce that to less than $100 million by the end of 2023 and to de minimis levels by the end of 2024.
We also acquired 3.5 million shares during the quarter at an average price of $6.27 per share for approximately $22 million. This brings our total buyback activity for the first half to approximately $190 million, representing approximately 29 million shares at an average price of $6.45. CapEx for the quarter was $8 million, in line with our stated target of 1% to 1.5% of net revenue. As a result, we ended the quarter with cash of $105 million and draws under our revolver of $402 million.
Our leverage was 3.48x, and largely driven by the increase in the revolver balance used to finance our share repurchases this year. Excluding the effect of share repurchases, our net leverage would have been approximately 3x in line with the second quarter of 2022. We remain on track and committed to achieving our stated goal of bringing net leverage down to 2x over the medium term.
And finally, moving to guidance. In light of prevailing conditions, we are setting our full year guidance as follows: organic net revenue growth is now expected to be 0% to 2% for the full year. Adjusted EBITDA is expected to be between $410 million and $440 million. We expect to deliver 50% to 60% free cash flow conversion and adjusted earnings per share is expected to be between $0.76 and $0.85.
That concludes our prepared remarks for this morning. I will now turn the webcast back over to Ben Allanson to open the Q&A portion.
Thank you, Frank. And just a reminder, if you have any questions, please do submit them via the chat button at the top of the screen. We'll start off with just a little -- a question from Mark Zgutowicz, over at Benchmark talking about digital transformation. He asked, which dynamics proved more challenging in the second quarter with regards to our digital transformation organic revenue?
Well, I think what happened with digital transformation was that a lot of the tech companies had mass layoffs. And when they had mast layoffs, they frankly eliminated the heads of a lot of projects. And so that tended to have create a lot of disruption. And so I think those tech companies pulled back, particularly some of the large-scale business software companies pulled back or reduced some of the projects they were doing. And also, it took a number of months for there to be kind of reorganization within the companies. And at the same time, there was not during this period yet a real consideration of AI projects, which are really just being formulated now as people digest the importance of this new technology.
Great. Next question, just turning to net new business, and this is from Jeff Van Sinderen at B. Riley. Considering the net new business that you're winning, which obviously is a big number this year and this quarter. What are your latest thoughts on how the P&L progression might evolve in the second half in terms of revenue growth, margins and EBITDA being driven by this net new business?
Well, I think you can look at that through the implied math of guidance between where we are and where we're going. I think as I've said clearly in the script, you've seen sequential improvement on all metrics right, in this quarter, I would expect sequential improvement in all metrics in the third quarter and then again in the fourth quarter. Marketing is generally weighted towards the back half of the year. That's not unusual. So that's the progression that I'm expecting. And as I said, you could probably do a little bit of the math yourself and figure out what we see as remaining there.
Good. At costs [indiscernible] over at Goldman Sachs. You cited steps you've taken to make cost adjustments in the release, which these steps are now fully implemented and benefiting run rate OpEx in 3Q, which steps remain in progress?
We have affected all of the personnel head cap reductions as of this time and expect now just to start to realize the benefits of those. We don't have any material further actions to take in the back half of the year.
Great. Turning now just over to a question about advocacy, actually. What is Stagwell seeing -- and this is from Barton Crockett over at Rosenblatt. What is Stagwell seeing in the political ad environment? We're all reading about fundraising slowdowns in the Republican primary? Is that going to be an issue for Stagwell?
All signs so far are fairly positive about the next political season. There were a lot of fundraising slowdowns last season through this. But what we're really seeing is that things are tracking on the advocacy side, somewhat ahead of what they were. And I think we're all going to see what happens here in late August. Will there be a real primary, will this thing explode with the first primary debate. I think that's the event that we've got to kind of watch in a couple of weeks. But so far, we're seeing the kind of positive signals related to how advocacy is developing.
And as I said, once this does get going, whether it gets going towards the end of this year or the beginning of next, I don't think there's any question that will be the biggest election season in history.
Great. Now on to generative AI, the topic which we've talked about a lot internally from Laura Martin over at Needham. You mentioned GenAI in your press release. In what ways do you think it will drive economics for Stagwell, primarily cost savings or to drive additional revenue on side?
Well, I think over the next 12 to 18 months, we really see an explosion of digital transformation projects. And I think that's going to be really quite strong for our digital transformation division. I don't think people have fully realized that generative AI means a rewriting of almost all customer interfaces. It's an entirely new and improved way to converse and kind of take actions on behalf of consumers to get them what they want to see, when they want to see it. And I don't think we've even scratched the surface of that.
So I think while that's going to take a little time to snowball, but that's really going to be where the major marketing AI resources get put into and it's going to be very good for digital transformation. I think that's why we initially moved with the Oracle partnership to help them and their clients begin to tackle these problems.
I think, obviously, it's going to help us do some streamlining of processes. We're already testing now, taking all of our invoices and reducing processing costs of invoices from $2 or $3 down to $0.20 or $0.30 each. But we were looking at how it works with -- how to help produce storyboards and do a lot of internal work.
And thirdly, we're already deploying it, as I said, on our PRophet product. We've used generative AI to help generate and refine news releases and pitches. But we're also creating, I think, a series of products related to the research industry in which focus groups are analyzed kind of on the spot, open ended and are analyzed on a more efficient basis, even data tables will be read so that the amount of really gruntwork that analysts have to do to find conclusions and fair it out that is really greatly reduced, and we think that the research process will be much more efficient. We're going to sell that to the marketplace.
Just a reminder, if you have any additional questions, please do throw them in the chat. I will turn to a couple of investor questions. First, is Latin America important to the Stagwell future plan, what's being done to address a stronger group position in the region?
Latin America is important. I personally worked a great deal in Latin America, A few months ago, I was down in Brazil. We have a number of transactions, I think, underway at various stages of completion that will, I think, clearly expand our capabilities in Latin America. Having a full network, right, within Latin America is an absolute top priority. You can see in our growth rates here that we have a lot of potential growth in these international operations. I believe that we committed more resources now to growing in EMEA, where I think our companies have been too fragmented.
I'm looking particularly at bringing a Latin American market probably by the end of this year. I think you'll see significant developments on that. And then I'm looking, we're at the Mid East next as the second most important market for us to fill in more strongly.
Before we turn to a couple of questions we have here on capital allocation, a question just about the environment in general. Based on the guidance, what are the sales assumptions for tech and entertainment for the remainder of the year?
I think our assumptions are kind of modest relative to the writers strike. We're not sure when the writers strike is going to be over. We expect it to be over by next year and for it to end some time this year, but I think that our entertainment research company is treading very carefully, watching expenses until this strike is over.
And I think in terms of tech, again, I think that we've built in modest assumptions of growing recovery on a slow basis. We've tried to be, I think, conservative in our outlook here figuring that the comeback will strengthen in the fourth quarter, particularly as I think these companies see how much they really have to do to integrate generative AI.
And then I think the last question we have here, just on capital allocation in general, and I'm going to combine 2 of them as they're related. Can you remind us your priority for excess cash flow from here between M&A, buying an equity and repaying amounts outstanding under the revolver. And the related question, I think, is what are our thoughts on buying back bonds at a significant discounted price?
I think that's -- it's a fair question, and I think that we're -- we've said before that we plan to use 1/3 for new acquisitions, 1/3 to pay for old ones and 1/3 for various stockholder moves. Obviously, this year, we've departed somewhat from that as we've done more on the shareholder buyback side. And I think, as Frank said, we're taking some measures and as I noted, possibly a small disposition as well kind of to build up our cash flow, but our -- we are a growth company. So it's critically important for us to take our cash, grow our tech products and continue to make great investments to expand the network. And so I think that -- I think that's going to be the priority. At the same time, we've set a medium-term goal of getting to about to, it's possible we'll make a decision in terms of buying discount bonds, but we haven't made any such decisions to date.
Now I think that's the last question that we have. Thank you very much for joining us today. We really appreciate it. If you have any questions, please don't hesitate to reach out ir@stagwellglobal.com, happy to address all of those. And thank you once again for joining us.