Stagwell Inc. (STGW) Earnings Call Transcript & Summary

Good morning, and thank you for joining us for Stagwell's second quarter earnings webcast. I'm Ben Olson, and I lead the Investor Relations function here at Stagwell. With me are Mark Penn, Stagwell's Chairman and Chief Executive Officer; and Ryan Green, Stale's Chief Financial Officer. Mark will provide a business update before Ryan shares our financial review. [Operator Instructions] 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, stagerglobal.com/investors for an investor presentation and some 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. When I founded Stagwell, I was convinced that the marketing services industry needed transformation. Stagwell was founded as a tech forward challenger to the legacy players for the vision of providing customers with everything from global full-service platform self-service solutions. Stagwell's first half and especially the second quarter, this validation of these founding principles and the work we have done to do with Stagwell over the last decade and incredible teams of people here will really make Stagwell what it is. AI is the tech transformation that we were built for, and our business is thriving as we become recognized as the leader of cutting-edge agenetic marketing.. This was the biggest second quarter in the history of the company. Organic revenue grew 10% year-over-year. Organic net revenue grew 5%. The standdown was 18% organic net revenue growth in digital transformation, along with 12% for communications. Geographically, we saw 7% organic net revenue growth in the U.S. and 13% organic growth in the U.K. Adjusted EBITDA of $109 million is more than 15% higher than last year, and the margin of 17.2% is 140 basis points higher. This improvement in profitability shows a result of continued focus on cost management. Our labor ratio in the quarter stood at 61% and almost 300 basis point improvement year-over-year. Net new business of $171 million was our highest average 45% greater than 2Q '25 led by some major new assignments and adjusted EPS grew 39% year-over-year $2.25. I've said last quarter that 2026 is a pivotal year for Stagwell. The results we are steadily moving ahead of the competition. Starting with net new business, the run of flagship wins clearly signifies us moving into a top 4 position in the industry when it comes to key capabilities. We continued our strength with tech companies by taking IBM's creative business away from a 30-plus year legacy incumbent. We expanded our relationship with Adobe and added Columbia-based leading Adobe input presentation firm, Cuestas, consulting to the Code and Theory network just earlier this week. We continue to grow our government work by winning visit California, an account that hadn't turned over 20 years. We made inroads in the packaged food segment by Fenia legacy competitors for mandates with both Hershey and Mondelez. We expanded our European presence during Heineken's roster and winning both higher Europe and all win. And we celebrated wins with Navy Federal Credit Union, Allegiant Airlines and countless others. This new business momentum is a testament to the tech forward collaborative approach, Stagwell brings to its pitches and the great quality of its people. The feedback when we win these mandates is consistent, Stagwell is the right combination of strong creativity, great technology and agility. Our pipeline has never been stronger. We expect cumulative VR pipeline to be about 30% higher than last year. I've said digital transformation is going to be a major driver of our business this year. In 2Q, we saw organic net revenue growth of 18%, bringing our 2-year organic net revenue back to more than 29% and a meaningful acceleration versus Q1 and the eighth consecutive quarter of improvement on that metric. This is all on top of digital transformation, posting a 30% adjusted EBITDA margin in the second quarter. I'm regularly asked how does our digital transformation business is like potent theory, How they have been able to generate mid-teens plus organic net revenue growth over the last 12 to 18 months, while the IT services and legacy telco digital transformation businesses have declined for a best day flat. As well as how is Stagwell able to generate more than 3x the revenue per head of its IT service players. The answer is simple. The market is increasingly moving away from commoditized IT services with thousands of low-cost engineers for the higher value work that combined business strategy, technology creativity and AI transformation. This intersection is exactly where Stagwell's digital transformation agencies operate powered by cutting-edge software and forward deployed specialists, who realizes value for clients by driving adoption and optimizing workflows. The results from the digital transformation speak for themselves. Our tech products are increasingly becoming core to our value proposition across all segments. Our solutions like the machine, the Stagwell agent targeting system are set, which is built on Palantir's founder fit seamlessly to our customers' way of working. And we're doing the same with our media solutions, giving our customers more control and transparency over their media buy with the media machine and Stagwell curate all powered by AI. We are closing in now on creating a complete suite of agentic products for enterprise, including the machine, the noose machine, the targeting machine and the media machine. We're seeing real traction with products like the machine and SaaS. Through the first half of the year, we had $16 million of committed enterprise technology revenue in our pipeline exceeds another $16 million firmly on track to exceed our initial bookings goal for this year of $25 million. We see this as part of the flywheel that will drive our new business momentum in the coming years. As we look towards the second half, I want to call out the growing momentum in our Communications segment, which saw a 12% organic net revenue growth in the second quarter. This represents an almost 700 basis point quarter-over-quarter acceleration from the first quarter. Political is beginning to play an obvious part and will accelerate further as we get closer to the increasingly competitive midterm elections in November. Our PR work continues to rebound strongly us well. We also continue to make strong progress on our initiatives to reduce small client churn, which will also have a positive impact on organic net revenue growth throughout the year. We anticipate an acceleration in the second half with double-digit net revenue growth led by digital transformation and communications. The overwhelming majority of that growth will be organic. Our second quarter results are industry-leading and showing accelerating trends on all key metrics. Our new business successes over the last 12 months provide a strong foundation for the second half of the year. For that reason, we are updating our full year guidance today. As I've highlighted, we expect growth in the second half of the year to be overwhelmingly organic. We maintain our 8% to 12% total net revenue growth target and our adjusted EBITDA guidance of $75 million $525 million. We also reiterate our free cash conversion goal of 50% to 60% for the full year. However, we are raising our full year adjusted EPS guidance or $1.03 to $1.17, and this reflects our increasing confidence in the full year as well as the impact of year-to-date buyback activity. This is just the start of a multiyear growth cycle for Stagwell. As we look ahead to '27 and '28, our outstanding net new business trends provide increased visibility over the next 24 months plus, we're winning bigger longer-term contracts and some of the most preeminent brands of the world, and we continue to make headway on government contracts. We're winning these away from legacy competitors as clients were to help them adopt AI and new models of marketing. These wins will really make the full impact next year because it takes a while for them to come on board and ramp up as we continue our momentum throughout 2026. And this is all before we really start the political super cycle of the midterm elections, presidential primary of the largest election in American history in 2028. We are also careful in managing our costs throughout the business as we grow and expect our margins to continue expanding. This should mean solid growth in adjusted EBITDA in 2020 with an excellent growth in 2028 with the political season as well as we continue. And at the same time, we continue to make progress on our free cash generation. With industry leading growth, expanding margins and growing free cash flow, we do not believe that our current trading multiples are appropriate. To that end, we'll continue leveraging our buyback authorization to shrink our share count further to have a positive compounding impact on our adjusted EPS growth. It could see us raise our already increased adjusted EPS guidance for the year later in the year. The second quarter was excellent and it's just the start of a multiyear growth story for Stagwell. With that, I'd like to hand it over to Ryan, who will walk you through the financials in some more detail. Ryan?

Good morning. Thank you, Mark and thank you for joining us. I'm now going to provide some detail on our second quarter results and our progress against our full year objectives. This quarter reflects accelerating revenue growth and margin expansion while continuing to fund investments that will support our next phase of growth. We delivered 11% revenue growth to $786 million and 6% net revenue growth to $632 million. Second quarter organic revenue grew 10% and net revenue grew 5% and representing our strongest growth in the last 6 quarters. Organic contributions are expected to drive growth throughout the second half of 2026. Growth was broad-based across the portfolio, with all 5 operating segments delivering organic revenue and net revenue growth led by digital transformation and communications. Digital transformation net revenue increased 18% organically year-over-year to $107 million. Our teams are doing far more than system implementations. They are embedding teams alongside clients to drive meaningful business transformation. This is a premium service offering. And as a result [indiscernible] delivered a 30% margin is highest since the merger. Communications delivered small percepted net revenue growth to $112 million, recommending -- representing the segment's strongest second quarter since the merger. Corporate demand continues to grow its clients engage us to address critical communications and public affair challenges. Our differentiated approach combines senior strategic talent and canopies in targeting capabilities. that deliver results at both the national and local lots. We also expect election-related activity to attribute strongly to our second half results. The Marketing Cloud increased organic net revenue by 4% to $27 million. was driven by demand for AI embedded products, including 34% from leaders as well as higher platform utilization and additional subscription-based offerings. Marketing Services generated $243 million in net revenue, representing a 0.5% organic net revenue growth. Several significant creative assignments were awarded in the second quarter and are expected to scale throughout the second half of the year position name segment for stronger growth in 2027. Media and Commerce grew 1% organically to $155 million in net revenue. Geographically, the U.S., our largest region, reported 7.1% organic net revenue growth year-over-year, the U.K., our second largest region, continued to accelerate, delivering 13.4% organic growth. As the top line accelerated, we also improved the efficiency of our business. Since launching our cost reduction program in April 2025, we have actioned approximately $70 million of annualized savings and remain on track to achieve our year-end target of $80 million to $100 million. These actions are only contributing to margin expansion in 2026 and will be more fully reflected in 2027. Technology investments are improving efficiency across the organization. Back office automation initiatives are delivering results. The continued rollout of payroll, cash and expense automation platforms remain on track to generate more than 25,000 hours of monthly productivity efficiencies. Staff costs as a percent of net revenue declined 280 basis points year-over-year to 6.9%, our lowest second quarter labor ratio in 4 years. As a result, trailing 12-month revenue per head exceeded $280,000, up 6% from the second quarter last year. This remains the highest level in marketing services industry at more than 3x that of major IT providers. Even as margins expand, we continue investing in technology and talent to support future growth. We are investing in sales and account teams at both the stage and brand level as well as platforms and products such as the Stagwell content supply chain, the machine and marketing cloud offerings. As a result, second quarter adjusted EBITDA increased 15% year-over-year to $108 million to $108.7 million, with margin expanding 143 basis points to 17.2%. Stronger EBITDA performance is translating into improved cash flow, year-to-date cash flow from operations was $63.7 million, an increase of $9 million or 16% compared to the first half of 2025. We expect operating cash flow to improve as the year progresses driven by the seasonal pattern of our business and the expected second half increase in communications activity related to upon cycle election year. As a result, we remain confident in achieving our full year free cash flow conversion target of 50% to 60% of adjusted EBITDA, Deferred acquisition consideration was approximately $57 million at quarter end, and we expect it to be negligible by the end of the year. Our revolver balance was $360 million at quarter end, and we had $374 million of unused borrowing capacity under the credit agreement. Net leverage stood at 3.04x. We remain on track to exit 2026 with net leverage in the mid-2s. Turning to capital allocation. We remain active with share repurchases during the second quarter. We repurchased approximately 5.9 million shares at an average price of $6.22 per share. Year-to-date, we have repurchased approximately 14.4 million shares for $88 million at an average price of $6.10 per share. Shares outstanding at the end of the second quarter were 244.4 million shares, roughly $16.8 million or 6.4% below the same period last year. The lower share count, together with stronger EBITDA growth drove adjusted EPS of $0.25, an increase of $0.07 per share or 39% compared to the second quarter last year. Year-to-date CapEx and capitalized software are in line with our expectations and reflect the continued scaling of projects already underway. We expect full year capital expenditures and capitalized software investment to be in line with last year. We are reiterating our guidance for net revenue growth of 8% to 12% and adjusted EBITDA of $475 million to $525 million and free cash flow conversion of 50% to 60% of adjusted EBITDA. As Mark mentioned, we are raising our adjusted EPS guidance to a range of $1.03 to $1.17 per share, partially reflecting the impact of share repurchases completed year-to-date. The new guidance reflects our current share count, although continued repurchases could provide additional upside. Based on the limited acquisitions to date, we expect these targets to be achieved largely organically. Now I will hand it back over to Ben for questions.

Thank you, Ryan. Just as a reminder, please do submit some questions via the chat button at the top of the screen.

If you'd like to ask any I'm going to start with a question about digital transformation, in particular, obviously, a really, really nice quarter, continuing a pretty meaningful trend here. So can you talk a little bit about what is sort of driving the strong level of growth there? And is it a sustainable thing in the back half of 2016 and into 2017 as well?

Well, I think it's sustainable for about 10 years. What's really driving it is the conversion to AI. I think, as I've said for actually 2 years now, every single company that touches the consumer will have to redo the way they communicate with that consumer based on AI. And that is going to create an enormous backlog of work for people like us and coated theories that really focus on that last mile with the consumer. So that's why we have the largest pipeline history related to those kinds of services. And we've also done some very smart things with the business in terms of broadening out the services now, doing the partnership with Adobe, working with Palantir, bringing in kind of the best tools that relates to either content creation or targeting. And let me tell you, at the same time, that work is getting far more efficient because about 75% of the coding now is done agentically. And so we are getting higher-level assignments, greater backlog, greater backlog of the pipeline and we're working more efficiently than ever to produce that work.

And maybe just a follow-up on that. And this question from Mara got to work it at Senex. Just talking about margin trajectory within that business, particularly in the second half and again into 30% plus, I think, in this quarter. Is that something we think we're going to be able to see some upside to it some leverage? How would you...

Well, look, again, I think the overall products that we're delivering are becoming more efficient because of our smart use of AI internally. And I also think the demand for content is they need this work done now. I think time is increasingly important to those clients. And in terms of getting kind of AI and the genetic work in place in terms of their communications for customers because they save money. So are they going to be -- where are they going to put their focus. Their focus has got to get on a get that to be getting online as quickly as possible.

I want to pivot quickly to new business, obviously, a very, very strong quarter continuing those trends. Question from Jason Cryer at Craton. We've heard agency peers in the market talking about a tougher environment for new business. how we like Stagwell seeing any shortage of new business opportunities. So can we maybe just lay out what we're seeing in the new deal environment right now? Are there any kind of key themes we're seeing in terms of what people are asking for? And why is Stagwell performed well when it comes to [indiscernible].

So obviously, you're seeing some comparative competitive differences really come to the fore. Step back for creativity and said, "Oh, maybe creativity will be done by AI or maybe it will be leaning for free. We step up with premium creativity that really helps brands differentiate themselves. And we're finding that, that is really winning in the marketplace. That's why as I went through in the script, we won so many bigger and amazing accounts really from legacy players because we think creativity, human creativity on top of being powered by AI is really what's going to win in the marketplace and with big companies need to differentiate themselves in this increasingly competitive world. And so consequently, we're seeing there in digital transformation, the open pipeline or government opened our pipelines globally as well as we built a division of out in other divisions out in the other parts of the world. You see that we basically also have taken what we had over in London and the U.K. We put in a new structure. We put in a really new team approach that is resulting in double-digit organic growth out there.

Somebody combined a couple of questions here because I think there's a lot of interesting things here. Laura Martin has asked, can you talk about how you're using AI to accelerate revenues and lower cost. But I will also bring in a little bit and how that's trending, how that's trended in the first half of the year and how we're thinking about that in the back half of year. So maybe, Mark, how we think about using AI acceleree that saves cost?

Yes. No. Look, I think that we set out really 1.5 years ago to sure that AI was infused throughout every single process. Remember, we've always had a strong internal technology first team built to help the entire enterprise, not connected just to individual brands within the enterprise. And so that team has been at the forefront of implementing AI. I'm Ryan here has been at the forefront taking those back office services and applying AI to them. And our engineers have been at the forefront of applying agentive coding again, to making the work faster, simpler, better. And all of those things, I think, are working to really continue to define Stagwell as the leading transformer of marketing today.

Maybe on the CapEx question?