S4 Capital plc (SFOR.L) Q3 FY2025 Earnings Call Transcript & Summary

Good morning, everybody. Welcome to our Q3 third quarter update. Radhika will give a background on the trading in Q3, and then Scott will talk about market momentum and some client analysis, and I'll come back and give a brief summary and outlook. Over to you, Radhika.

Good morning, everybody. I will start with the financial headlines for the third quarter and 2025 year-to-date. Performance in the period continued to be impacted by the ongoing volatile global macroeconomic conditions. Client caution has continued given the uncertainty. Revenue in the quarter was GBP 191.7 million, down 1% on a like-for-like basis and 3.4% on a reported basis. Year-to-date revenue was GBP 552.1 million, down 8.4% like-for-like and 11.1% on a reported basis. Net revenue in the quarter was GBP 167 million, down 4.4% on a like-for-like basis and 6.9% on a reported basis. Year-to-date, net revenue was GBP 495.2 million, down 8.2% like-for-like and 10.8% on a reported basis. We expect stronger profitability in the second half with weighting towards the fourth quarter. This reflects recent new business wins and cost reductions actioned. The number of Monks are circa 6,500, down 5% from circa 6,900 at June 2025 and down 13% from circa 7,500 this time last year. This program primarily focused on a range of nonbillable roles across the business and further back-office efficiencies. We closed the period with a net debt of GBP 151 million, lower than GBP 180 million at 30th of September 2024 or GBP 194 million on a like-for-like basis. Net debt increased by GBP 5 million compared to GBP 146 million at half year, reflecting the group's inaugural dividend payment, restructuring costs and continuing FX headwinds. Average month-end net debt for the quarter was GBP 154 million compared to GBP 184 million for the same quarter last year or GBP 197 million on a like-for-like basis. Leverage has improved to 1.8x pro forma 12-month operational EBITDA compared to this time last year at 2.2x and against the half year at 2x. Moving on to the full year guidance. We expect like-for-like net revenue to be down by upper single digits. Full year like-for-like operational EBITDA is targeted to be broadly similar to 2024. We expect net debt to be in the range of GBP 100 million to GBP 140 million. Moving on now to the net revenue by practice and geography. Marketing Services net revenue for the quarter was GBP 150.8 million, down 2.8% on a like-for-like basis and 5.3% on a reported basis. Year-to-date, Marketing Services net revenue has decreased 5.2% like-for-like or 8.1% reported to GBP 449.8 million. This reflects the slower onboarding of recent client wins, including General Motors, Amazon, T-Mobile and PIF and now 2 unannounced leading U.S.-based global FMCG companies alongside general client caution. Technology Services was impacted by longer sales cycles for new business and ongoing challenging macroeconomic conditions. Net revenue in the quarter decreased 16.5% like-for-like or 19.4% reported to GBP 16.2 million. Year-to-date, Technology Services net revenue has decreased 29.6% like-for-like or 31.4% reported to GBP 45.4 million. From a geographical perspective, the Americas, which represent around 80% of net revenue was up 1.6% like-for-like in the third quarter to GBP 136.1 million with stronger growth in Latin America. Year-to-date, net revenue declined by 5.6% like-for-like to GBP 394.3 million. Europe, the Middle East and Africa were down 26.6% like-for-like in the third quarter to GBP 22.6 million. Year-to-date, net revenue was down like-for-like 17.3% to GBP 74.4 million. Asia Pacific net revenue down 16.2% like-for-like in the third quarter to GBP 8.3 million. Year-to-date was down 15.3% like-for-like to GBP 26.5 million. With that, I hand over to Scott for the market update.

Thanks, Radhika, and good morning, everybody. Thank you for joining the call. As we continue to address the challenges that the business has been facing and rebuild our foundations for growth, we are seeing some progress that makes us more optimistic as we move forward. First, the pace of technology client spend cuts has slowed. Now whilst the investments in CapEx continue to grow at really significant pace, and in the past week, we've seen several of the big tech companies report increased AI investment for both 2025 and 2026, combining this with continued focus on operating expenses and in some cases, significant job cuts, we are starting to see stabilization in their marketing spends as they start to invest in differentiation for their AI products in a highly competitive market and illustrate some ROI on those CapEx investments. High-profile campaigns from the likes of OpenAI, Anthropic and Perplexity have added to the competitive tension. Secondly, we continue to innovate our product, launching our AI platform, Monks.Flow at CES in January 2024. Over the course of the past 2 years, we've continued to innovate, win awards, bring onboard partners such as Google, OpenAI, NVIDIA, Adobe and Runway and implement at scale with existing clients such as Google, BMW, SC Johnson and Amazon. We've also developed and started to convert a specific AI-focused sales pipeline, which is progressing beyond proof of concepts to more significant scaled transformational assignments, such as the recent 2 FMCG wins. We are also building traction in AI film production with almost 20 agentic films currently in production, a new revenue stream for us. Thirdly, client wins. The whopper client losses are mostly out of our comparables, and we've had a stronger pipeline and new business performance recently. Starting with GM a year ago, we've had a regular cadence of significant wins, including T-Mobile, Amazon, PIF and more recently, 2 leading U.S.-based FMCGs, one a new client and one an expanded remit with an existing client. Fourthly, on people. Whilst the overall number of Monks has declined, we have continued to hire across country and regional management, capabilities, growth and client leadership, talent who are now driving these new business wins. We've also made hires with an operational focus on the optimization of pricing, utilization, billability and improving our margins and getting those staff cost ratios in line. Fifth and finally, centralization and cost control. From an integration perspective, the mergers are now fully integrated, and we go to market as a single brand, Monks. We've centralized key functions such as finance, legal, HR and IT, and the company operates on the same platforms such as Slack, Salesforce, Workday and Google Workspace. Our migration to a single ERP is well underway and will be completed in early 2026. We've simplified the business around Marketing and Technology Services. We have a clearly articulated organizational structure based around geographical leadership and capability expertise. We have and continue to implement cost controls with the goal of getting our staff cost ratios in line with the industry averages. So overall, with positive new business trends and some stabilization in tech company spend, continued progress in our AI product offering and a strong focus on cost, we are seeing an improved performance in H2. We reiterate our EBITDA guidance for 2025 and are starting to set up well for 2026. I have a couple of the agentic films, which I referenced earlier that we've been working on to share with you. The first one is an ad for Progressive Insurance, which just aired this week. On this one, we were brought in by their creative agency who came up with the concept to produce the film using artificial intelligence, using technology from partners such as Google Veo, Nuke, FLUX, Runway and Stable Diffusion. [Presentation]

And the second film is some work for General Motors, which is a fully agentic film where we created agents to do everything from research to creating the brief, script writing and ultimately production. In this case, it was all based around our internal technology, Monks.Flow, but using external technology from partners such as again, Google Veo, Nuke and FLUX. [Presentation]

From a client perspective, we continue to have a really compelling client list where some of the world's leading and most innovative companies. In 2024, 9 of them were what we call whoppers, that's with revenues of $20 million plus, which is a differentiator for a company of our scale. Most of our direct competitors have a much more fragmented client list with smaller relationships. As you can see, we continue to have a significant presence in the technology industry. You can see the GM win has also positively impacted our auto share and other recent wins have been in telco, financial services and FMCG. These are strong relationships that help us attract and retain talent to work on them. In terms of comparing the scale of our largest clients, just to be clear on the methodology here, we are comparing the top 10, 20 and 50 current clients with the top 10, 20 and 50 client cohorts in the same period in 2024. We are now seeing some stabilization here with a small bit of growth in the average size of our top 10 clients and far smaller declines in our top 20 and 50. If we look at the year-to-date actual growth of our current top 10 clients versus their equivalent position in 2024, we see 7% growth for our top 10, 7% growth for our top 20 clients and 6% for our top 50, illustrating our focus on building scaled relationships with enterprise clients is paying off. And now I'll pass you back to Martin for the summary.

Thanks, Scott. Thanks, Radhika. So just a brief summary. Q3 net revenue fell by almost 7% reported and 4.4%, which actually is a sequential improvement over Q2 by 4.4%. And that reflected ongoing client caution, as Scott has outlined, and the timing of significant new business wins. Year-to-date, revenue is down 10.8% and 8.2% like-for-like. Full year like-for-like net revenue is expected to be down by upper single digits. And third quarter month-end average like-for-like net debt fell by GBP 43 million from GBP 197 million last year on a constant currency basis to GBP 154 million despite the payment of the inaugural dividend, which cost about GBP 6 million to GBP 7 million. We maintain our full year guidance for EBITDA, which is expected to be broadly similar to 2024 on a like-for-like basis, with a stronger performance expected in the second half as last year, reflecting new business wins and implemented cost reductions. A program -- a cost reduction program was initiated to mitigate the revenue challenges that we've had. And this saw our number of Monks reduced by 5% to around 6,500 since June 2025 and by 13% from this time last year. This is clearly delivering in-year benefits and contributing to the rightsizing of the business, particularly as we go into 2026. We maintain our 2025 target net debt range of GBP 100 million to GBP 140 million. Monthly at the moment, we're varying between about GBP 120 million and GBP 150 million. And the Board will consider approving an enhanced final dividend for 2025 if the improved second half performance and liquidity targets are delivered. Those are the targets for 2025. We are seeing our AI initiatives, as Scott has pointed out, improve visualization and copywriting productivity, deliver considerably more effective and economic hyper-personalization at very significant scale, delivering more automated and integrated media planning and buying, improving general client and agency efficiency and democratizing knowledge and flattening organizations. We remain confident in the strategy, in the business model and in our talent, which together with the scaled client relationships, unusual for a company of our size, they position us very well for growth in the longer term. So with that as the background, we'll go into Q&A.

[Operator Instructions] We'll take our first question from Laura Metayer from Morgan Stanley.

I have 2, please. The first one is on production. You've mentioned that you produce movies for your clients. I understand this is not something that you were doing much before AI. Does that add a sustainable new revenue streams then? And then the second question is, you now expect a lower revenue base for 2025. What additional cost-saving measures are you taking to be able to maintain your previous EBITDA guidance?

Scott, do you want to take the first? And then Radhika, the second one.

Yes. Laura, so yes, absolutely. I mean it's not that we didn't do any film production before. We did some. But the -- what AI allows us to do is a lot more. And I think what we're seeing now is we're building up quite a pipeline of film work where some of it as a progressive example is where creative agencies are bringing us in as their specialized AI production partner. And that's actually the original traditional Media.Monks business model. So it's sort of reinvigorating that to a certain degree. But more often than not, we are essentially doing the whole thing using Monks.Flow to do the sort of research and sort of creative brief and script writing, et cetera, and then using external technology to do the actual production. So yes, this is a sustainable new revenue stream for us. It's relatively small at the moment. I think companies are still working out how they price these things. In many cases, they are proof of concepts because they're looking to understand how the technology works and what can actually be achieved. But going forward, I think this will be important for us.

And just to amplify that a little bit. We believe that create costs should be about 10% of media budgets. In many cases, the clients that we either have or talk to are spending as much as 15% or 20% on create costs. And we see a very significant opportunity to improving that ratio and freeing up money from create for media. So -- and Scott mentioned 20 or so projects of this nature going on at the moment. In addition to that, every conversation we have with CMOs, and for example, we've had 3 or 4 in the past couple of days, every conversation we have is punctuated with this issue or this focus on create costs. And inside organizations, it's not so much the CMOs and the CIOs and CTOs that focus on this. It's the CFOs. They are the prime driver of improved efficiency. Radhika, do you want to talk about cost mitigation?

Yes. So to your point, Laura, so as you know, in June, we had 6,900 Monks. We've reduced that to 6,500, and that has been actioned and that is delivering the in-year savings to deliver the EBITDA guidance that we're sticking with. But continually, we are now really forensically looking at our cost base to make sure we are deploying the resources against the revenue, and we're doing that on a constant basis.

Yes. I'd just add to that, that we're very conscious of the fact we're still operating in excess of industry averages for staff costs to net revenue figures. The standard seems to be 65% with fully loaded bonuses, both short and long term. Those bonuses accounting for about 3% of net revenue. So 62% clean of bonuses, 65% with bonuses is where we think we should be. And our operating management accept that. The question in our minds is how long it will take us to get to that 65%. We expect an improvement next year. We're in the planning phase for next year, both our 3-year plans for '26 to '28 and our budget for '26. But that's going to be a significant part of what we look at next year in addition, of course, to focusing on the top line.

We're now taking our next questions from Julien from Barclays.

I had 3 questions and now I have 4. So the first one is upper single digit for '24, which is, I suppose, minus 8% to minus 9%. That would indicate minus 7% to minus 11% in Q4, i.e., worse than Q3, 4.4%. I know comps are 9 points tougher versus '24, but they are actually easier versus '22 and the years before. So why is Q4 slower than Q3? That's my first question. The second one is you're trying to convey a lot of positivity on clients and products, but organic is still poor. So taking into account, account wins, new products and same macro, do you think you will post positive organic next year? Third question for Radhika. You gave financial pointers for everything, but depreciation, interest and tax rate. So if you could get some pointers on those 3 things. And then the last one is for Martin and your remark saying that create costs are 15% to 20% of media budget but going to 10%. So first of all, I find that very high because if an advertiser spend $500 million on media, are they really going to spend $50 million to $100 million on creative? And then the question is, with the conversation you have, are clients really investing that savings into media or they are also saying we're going to take some on board to have higher margin, i.e., not 100% is reinvested?

Sure. The third question I didn't quite catch. Do you want to repeat the third one, just for the one you said was for Radhika?

Yes. So you're giving us numbers on everything, except 3 numbers, depreciation, interest and tax rate.

So on the first on Q4, do you want to say a little bit about Q4, Radhika?

So Q4 is down year-on-year. But last year, we -- it was reversed. So I think overall, we will be expecting it down year-on-year because of the client cautiousness and the slower buildup of the new business. But I think last year, we had a skewed Q4. But from the EBITDA guidance, we're still tracking online.

I mean organic growth for 2026, we'll see, Julien. We're in the midst, as I said before, of doing our budgets. Given our forecasting abilities, what I would say is we'll take a cautious approach to next year. And we'll also be looking, as I said before, very carefully at the staff cost to revenue ratio. The implied margin for this year is around 12% for the full year. And obviously, we want to improve on that. We still believe that 20% is where we need to get to, but we'll be looking for a significant improvement in margin next year, which, again, operational management is on board for and is looking at it very, very carefully. But I'd rather go into the budgets for next year and indeed the guidance next year cautious and hopefully, we can outperform that. So that's on the basis of a historic experience. Do you want to go through the additional items?

Yes. So the adjusting items in total, we're giving a range of GBP 75 million to GBP 88 million, on amortization GBP 45 million to GBP 50 million. Acquisition, restructuring and other expenses, Julien, GBP 25 million to GBP 30 million and then share-based payments, GBP 5 million to GBP 8 million. So that gives you -- it's pretty consistent to what we said at half year.

No, I know that these are the guidance you've given in the presentation. What I was asking is the numbers you haven't given, which are depreciation, interest and tax rate.

The actual breakdown?

Depreciation, interest and tax rate.

So the effective tax rate is 32.5%.

And depreciation?

Depreciation is...

Let's -- let me just come to your final question, Radhika, will dig out depreciation. But on the create cost, I didn't say, Julien, everybody was doing it, but there are significant cases, including our own client portfolio where 15% at least is the case. I can think of one client without name that spends GBP 2 billion and GBP 300 million on create costs, including the cost of an in-house agency. What the other interesting thing is that AI, one with the after effects of AI is it's forcing our clients to look much more carefully at cost. And often, create costs are buried inside operating P&Ls and are not obvious. But I would say we have been surprised at the extent to which create costs are above what I would normally regard as being 10%. I mean, going back in time, agencies were paid 15% a long time ago, 10% was allocated to creative and 5% to media. As procurement and efficiency squeeze that, agency fees probably were around 10%. And I can remember allocations of 7.5% to creative and 2.5% to media with media discounts making up the balance of volume discounts, some of which went back to clients and some of which didn't. We run an open book with the exception of Brazil. And we think that's the way the market is going to go with greater transparency. So you'll have greater transparency around create costs and for greater focus. And whether I like it, you like it or not, I think the figure that is in people's minds is 10%. The most efficient clients are sort of focusing on that. And I said -- as I said before, the vertical that's driving that inside organization is CFOs. In terms of where they're spending the saving, if you look at the presentation that Norm de Greve did at the ANA, I think it was last week. If you haven't got it, we can send it to you. He goes through there, what he did or has been doing at General Motors in order to make it more efficient -- the model more efficient. And as you may remember, he has sort of upper funnel strategic creative agencies, 4 of them for each brand, each of his 4 brands. And we're the foundational agency that drives the creation, production and distribution of that material. So I think that's one -- that's not the only model that clients will pursue. There are the end-to-end all-embracing models too, like we've seen at Coca-Cola, et cetera. But that's broadly, I think, where part of the market is going. Do you want to talk about depreciation?

Yes. So depreciation year-to-date is about GBP 6 million, and we expect it to be about GBP 7 million. I'm just confirming. I'll come back to you on the interest cost for the full year.

Anything else, Julien?

No. Very clear.

[Operator Instructions] we are now taking our next questions from Steve from Deutsche Numis.

Can I just ask Julien's question, maybe pull some of his questions in a different way. One is on -- for next year, if you added up your new business wins that you've announced and you've got sight on, if you kind of did a pro forma gross revenue and then maybe you could do a net revenue of losses as a percentage of net revenue. Can you just give us a feel of the kind of pro forma percentages as we go into '26 that the new business will give you on a gross basis and maybe on a net basis, too?

That's a disguised question to get us to give you the guidance for '26. And I'm sorry, we're not going to do that today. Other than...

Well, I mean, to be fair, you're giving us lots of new revenue, lots of new business wins. And it's a fair question, isn't it?

It's a fair question. All your questions are fair, whether we answer them or not is another question. Look, we haven't gone through -- we're in the midst of going through it. I would just sort of for the second time, say what I said before. When we look at next year, given our record on forecasting particularly the top line, bottom line is a little bit stronger, liquidity is a bit stronger. And we're going to take a cautious view to '26, whatever that number is. But you're right to point out that we've had some significant increases in key relationships, but we still got a lot of work to do. And as I say, we'll take a cautious view. On the general economic environment next year, I don't expect it to change very much, i.e., it will continue to be volatile. Tariffs are still -- the Chinese tariffs have been postponed, kick the can down the road for another 12 months. So we'll have to see how that pans out. Relations do seem to be improving at least in the short term between the U.S. and China. That will help. Middle East, we have seen, thankfully, some progress, and we hope it continues. Russia, Ukraine continues to be a problem. And as I said before, the tariffs on top of that. The interesting thing about the tariffs just is that so far, we haven't seen any margin compression despite the fact it seems to be the case that companies are not necessarily passing on the cost of tariffs to the consumer. Now it may be still too early and tariffs were signaled by Trump 2.0 upfront. So it may be that people took precautionary measures on shipping and inventory prior to April 2. But the forecast for margins next year for the S&P 500, the ones that I've seen indicate margins continuing at current levels, which are record levels, and if anything, sort of moving up a bit. So which seems to be -- it loops back to what we said about agentic and AI improvement. So clients have been looking for significant efficiency.

Okay. Kind of steal one of Julien's other questions actually, which I kind of don't think you answered, which was on these AI project savings that we're talking about, with what you see and the evidence to date, I know it's early days. When the CFO gets involved, is the company net-net spending more or less on marketing in total? And i.e., is it redistributing the money to other...

I think they're investing the savings in media. So the 2 verticals where we've seen the greatest AI adoption so far has been autos. Why? Because of Chinese EVs and AVs. And then the other vertical is financial services. Why? Because there are fintech platforms that are extremely agile. So the CMOs of those vertical -- or in those verticals know that the CEO at some point in time is going to come and say, we have to lower our prices or lower our costs in order to be -- combat the AV or the EV or to combat the fintech platform. And in that environment, they are currently taking those savings in our experience and redeploying them into media. So not a reduction in spending. There is some data out there that says clients have reduced their marketing budgets as a percentage of revenue over the last year. I think there is some Gartner data to that effect. And that's been used as an explanation for the compression on the holding company's net revenue growth. I mean of the holding companies, there's only 2 out of 5 that have shown any growth. The other 3 -- or 4 -- sorry, the other 4 of the Big 6, so-called Big 6, the other 4 have not. So I think what we see is those savings that we've been talking about in the case of AI are being redeployed into media. So the CFO hasn't snaffled the money to improve margins or hold margins as yet.

I would stress also, it's still quite early days, Steve. There are very few clients that have fully changed their model to a pure AI-driven model. So what you see in the very early days is that they continue doing their marketing in the same way they always have. And in addition, they do some proof of concepts with AI. So it's actually additional. But I think, as I said, it's early days. We see a couple of clients that are really moving in this direction. The 2 FMCGs that we mentioned, the project or the assignments we've won with them is to fully AI-enable their marketing supply chain. So I think this is something we'll see over the next couple of years. And certainly, my view, and I think Wes has expressed it pretty bluntly as well is that over time, you'll see a variation in how clients do this. Some will invest -- reinvest in marketing and spend the same and get more for it. But I'm sure there will be CFOs out there that take some back as well.

And I think we are trying -- we haven't touched on this yet in this call. We've done it before. We are trying to move the model from a time-based model to an asset use model because we think that's the best way. That's not easy to do. Sometimes you find the marketing functions willing to do it and the procurement function, it's like Linus' safety blanket. They go back to the original way they did things and want to keep it that way. But we think over time, it's sort of inevitable that the model will move more to an asset use model. The other thing I would say is inevitably, there's going to be more transparency on the media planning and buying, which will be an advantage for us because we're not involved in enterprise, really in big enterprise media, but that's going to come under increasing examination for transparency, not just because of AI, but because of blockchain as well.

Great. Can I ask one last quick one. I hear what you're saying on the dividend or potentially increasing the dividend. I just wonder what's your take in terms of should you be doing share buybacks rather than dividends given where the share price is?

Well, you know, our argument both ways. Some people believe that's the best way. Some people say it just gets absorbed and doesn't have any long-term effect. We have significant management ownership still in the company. And it hasn't been an easy couple of years. So I think we will focus. That doesn't mean we're not going to focus on buybacks, too. We did a little buyback a year or so ago, a similar size to the dividend, but we think we will get greater traction from an increase in the dividend from the 1p last year than the buyback at this stage. But we'll look at it. It depends on our liquidity. If we can get the net debt under GBP 100 million, we will -- which we should do next year with a fair wind. Obviously, that will give us more flexibility.

It appears there are no further questions at this time. I'd like to turn the conference back to Sir Martin Sorrell for any additional or closing remarks. Please go ahead, sir.

Okay. thanks very much, everybody. Thanks for joining us, and we'll come back again next year when we've completed Q4 and focus on that dividend we were just talking about. Okay. Thank you very much.