Marcus & Millichap, Inc. (NYSE:MMI) Q4 2022 Earnings Call Transcript

Marcus & Millichap, Inc. (NYSE:MMI) Q4 2022 Earnings Call Transcript February 17, 2023

Operator: Greetings, and welcome to the Marcus & Millichap Fourth Quarter and Year-End 2022 Earnings Conference Call. As a reminder, this call is being recorded. I would now like to turn the conference over to your host, Jacques Cornet. Thank you, you may begin.

Jacques Cornet: Thank you. Good morning, and welcome to Marcus & Millichap’s fourth quarter and year-end 2022 earnings conference call. With us today are President and Chief Executive Officer, Hessam Nadji; and Chief Financial Officer, Steve DeGennaro. Before I turn the call over to management, please remember that our prepared remarks and the responses to questions may contain forward-looking statements. Words such as may, will, expect, believe, estimate, anticipate, goal and variations of these words and similar expressions are intended to identify forward-looking statements. Actual results can differ materially from those implied by such forward-looking statements due to a variety of factors including, but not limited to, general economic conditions and commercial real estate market conditions; the company’s ability to retain and attract transaction professionals; the company’s ability to retain its business philosophy and partnership culture amid competitive pressures, company’s ability to integrate new agents and sustain its growth and other factors discussed in the company’s public filings, including its annual report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2022.

Although the company believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can make no assurance that its expectations will be attained. The company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. In addition, certain financial information presented on this call represents non-GAAP financial measures. The company’s earnings release, which was issued this morning and is available on the company’s website, represents a reconciliation to the appropriate GAAP measures and explains why the company believes such non-GAAP measures are useful to investors. This conference is being webcast. The webcast link is available on the Investor Relations section of our website at www.marcusmillichap.com, along with the slide presentation you may reference during the prepared remarks.

With that, it’s my pleasure to turn the call over to CEO, Hessam Nadji.

Hessam Nadji: Thank you, Jacque. On behalf of the entire Marcus & Millichap team, good morning everyone and welcome to our fourth quarter and year-end 2022 earnings call. The industry in our business experienced a dramatic shift in market conditions between the first half of 2022 and the latter part of the year. The Feds missed opportunity in 2021, to begin normalizing financial conditions became the most aggressive financial tightening in 2022, to fight runaway inflation in 40 years. The resulting 450 basis point interest rate increase and $500 billion of bond sales in a matter of months, shifted the market tailwind in the first half of the year to a market disruption at September. With that backdrop, MMI still delivered record revenue of $1.3 billion, adjusted EBITDA of $166 million and earnings per share of $2.59, both of which were the second best in our history.

We closed over 12,000 total transactions with volume of $86 billion and outperformed the market. Total U.S. commercial property sales, as reported by RCA declined 25% last year, while our brokerage transactions were off by 6%. I’m also proud to reflect on the many advancements to the Marcus & Millichap platform in this past year. This range from new technology such as our client application called My MMI, to the successful launch of our auction division, and ongoing expansion of financing capabilities, especially in the agency lending arena. We saw many of our tenured sales and financing professionals reach new milestones and acquired numerous top level groups, teams and experienced individual producers last year. The ongoing elevation of the Marcus & Millichap brand was on pace once again with Marquee Client webcast, industry leading research content and commanding presence in the media as well as at industry conferences.

These achievements were reached despite a very difficult fourth quarter, stemming from the escalation of deal cancellations, and further widening of the bid ask spread in the market. The growing number of lenders that either exited the market or significantly tightened underwriting criteria also became an obstacle in closing deals in the final quarter of the year. Overall, sales in the market dropped by an estimated 57% during the fourth quarter according to RCA, making it the lowest fourth quarter sales volume in the marketplace since the fourth quarter of 2011. We continue to demonstrate the relative strength of the Marcus & Millichap platform as our team closed nearly 2700 transactions and $16.4 billion in volume during the quarter. These numbers enabled MMI to outperform the market in the fourth quarter, with a 38% decline in brokerage transaction.

For the quarter we delivered revenue of $262 million, adjusted EBITDA of $14 million, and earnings of $0.20 per share. The magnitude of the market disruption is reflected in the lack of investor urgency. In a normal market, the fourth quarter typically has the most deal volume, as investors rush to transact and deploy capital by year end. However, 2022 was anything but typical as fourth quarter volume and revenue was the lowest for the year. Let me highlight a few additional factors to put the fourth quarter results into perspective. Keeping deals together required extraordinary efforts and troubleshooting creativity and finding alternative lenders which caused a major distraction to our team in developing new business. The need to reprice listings became a challenge given the heightened degree of valuation uncertainty.

This created a significant rise in cancelled listings and disruption to listings going under contract and into our pipeline, and so on moving through the usual deal continue. Our most experienced professionals who possess the skills to navigate and close deals at a tough market accounted for a larger than usual portion of revenue. The senior producers qualify for our highest commission levels, leading to a higher than normal cost of services for the fourth quarter. Due to the broad nature of the market disruption, all market segments had lower year-over-year revenue for the quarter. Our Private Client revenue was off 41% While middle market and larger transaction revenue were down 47% and 63%, respectively. Larger transactions which have been a significant part of revenue growth over the past few years were highly impacted by institutional investors rapidly going to the sidelines, as we’ve seen in previous downturns.

Our finance division MCC saw revenue fall 37% as the spike in rates made both transaction financing and refinancing much more difficult. Costs related to investments made over the past few years for Talent Acquisition, Technology and infrastructure marketing and business development put outside pressure on earnings as revenue production was hindered in the quarter. These ongoing investments have fundamental advantages over the long term and have proven to be accretive in a normal operating environment. Our more experienced sales force and the addition of numerous market leaders in recent years were major contributors to our record performance in 2021 and the first half of 2022, we are confident they will once again have the same positive effect when we recover from the current market disruption.

The reversal of expense leveraging we gained in 2021 is further pressuring our margins in the near term. Steve will elaborate more on that. Furthermore, we implemented expense reduction measures in the fourth quarter, resulting in one-time charges which caused additional drag on fourth quarter earnings. Let me now shift to our strategy and outlook. Effectively navigating the near term challenges and protecting the company’s financial performance is extremely important to our management team. At the same time, we strongly believe in sustaining our long-term mindset, building competitive advantages and not changing course because of a cyclical market disruption. Therefore, our top priorities are as follows. First, we’re focused on helping investors and our Clients solve problems, find solutions to their specific circumstances and source opportunities.

This approach during the pandemic and throughout our history has led to outsize growth upon recovery because we never have left the market and instead have leaned into the crisis by increasing our client contact. This is exactly what we’re doing now. Second, we’re helping our sales force leverage a tough market environment, to sharpen their skills utilize our proprietary tools to maximize productivity, and partner with our financing professionals. To highlight some of their accomplishments, MMCC closed over 400 financing transactions during the fourth quarter alone and closed with over 450 separate lenders last year. This is a major advantage to our sales force and our clients, as our financing professionals can access a wide network of capital sources and turn every stone to source debt for clients in this market environment.

We’re strategically deploying capital to maintain our presence at key industry events and conferences and to provide sufficient production support to our sales force through the downturn. Although transaction counts may be down significantly, investors need for opinions of value, market analysis, exploring various financing options for recapitalization and dealing with maturing loans have increased dramatically. We’ve tightened our belt while maintaining the capacity to service these critical needs as an investment in long term growth, client relationships and eventual recovery. Last but certainly not least, we are seeing more acquisition opportunities and have engaged in several explorations largely prompted by the display of MMI strength at a time of uncertainty.

We have the balance sheet to be prudently offensive during the market dislocation and are encouraged by our current dialogue with Targets. Strategic acquisitions remain our top capital allocation strategy while we continue our dividend policy and share repurchase plan. In terms of returning to organic growth, our commitment to renewing the company cycle of sourcing hiring and training new professionals is dead fast. As we have reported since the pandemic this process has been disrupted by the volatility in the market impact of virtual employment choices now offered by many companies and an unusually tight labor market. Various strategies to boost local recruiting from key universities. The introduction of the William A Millichap Fellowship, which attracts highly qualified new professionals and our numerous internship programs remain on course.

The return to in-person training throughout our offices should also help gradually reverse the trend of the past three years. The majority of the 5% headcount reduction over the past year remains concentrated in the one to three-year cadre, which is experiencing higher than usual turnover rate. From a production perspective, our success in attracting these experienced talent is offsetting the revenue impact, however, fundamentally returning to organic growth is a priority for the firm. Turning now to the outlook. The current market headwinds are likely to persist in the near term. However, we expect three factors to emerge and bring clarity and enable a transaction market recovery. First is the end of the Fed tightening cycle. We believe inflation is gradually coming down, especially as the lagging effect that the cost of shelter begins to show up in the CPI.

This process will be bumpy from month to month as we saw earlier this week. The overall trend points to a limited number of additional rate hikes, followed by an expected Fed pause. It is unlikely that the Fed will pivot to lowering interest rates anytime soon, in our opinion, given the continued strength in the labor market. We believe that simply ending the tightening cycle will bring clarity to the market. Second is further evidence of a sustainable, albeit slower job market and the impact of any potential job losses on occupancies and rents. Third is price alignment. In our view, price adjustments always take time during a market transition, but expectations will eventually realign according to economic realities. In the near term, we’re leaning into the downturn by amplifying the company’s numerous competitive advantages.

This includes our market leadership in the private client segments, sourcing more 1031 Exchange buyers in any other firm. Our ability to get difficult deals done in this environment, our growing suite of proprietary technology, cutting edge research and hands on management on the ground. We are positioning Marcus & Millichap to lead into the eventual recovery, gained market share and continue to build long term shareholder value by investing in the future. With that, I will turn the call over to Steve for more details on the quarter. Steve?

Steve DeGennaro: Thank you. As Hessam stated, revenue for the fourth quarter was $262 million, compared to last year’s record quarter of $495 million. For the full year, total revenue set a new record high of $1.3 billion, up slightly over the prior year record. Moving to segment details. Real estate brokerage revenue for the fourth quarter was $236 million, or 90% of total revenue, a similar percentage to historical levels. This represents transaction volume of $13 billion across more than 2000 deals a year-over-year decrease of 54% in volume, driven by 38% fewer transactions. Our average deal size was $6.4 million, compared to $8.7 million a year ago. For the full year real estate brokerage revenue was $1.2 billion, or roughly 90% of total revenue, again, a similar percentage to historical levels.

Full year results included transaction volume of $68 billion across more than 9000 deals, essentially flat with last year and a 6% decrease in transaction count. Our average deal size for the year increased to $7.5 million compared to $7 million in 2021. The contrast between fourth quarter and full year revenue and transaction metrics reflects the strong first half of the year, and investors heightened motivation to transact before the Feds aggressive interest rate actions, which then created a market disruption and weak second half of the year. Within brokerage, our core private client market segment in the fourth quarter accounted for 61.7% of brokerage revenue, or $146 million. This compares to $247 million in the prior year, reflecting the dramatic and broad slowdown in market activity.

Our middle market and larger transaction segments together contributed revenue of $85 million or 36.1% of total brokerage revenue for the quarter compared to $199 million last year, as many institutional buyers remained on the sidelines in Q4, waiting for more clarity on interest rates and pricing before reentering the market. For the full year, revenue from our Private Client market segment of $682 million was down 2% and the combined revenue of $463 million from middle market and larger transactions was up 4%. Turning to our financing division MMCC, revenue came in at $22 million in the fourth quarter compared to $34 million in the prior year. Fees from refinancing accounted for 45% of loan originations compared to 54% in the same period last year, driven by the sharp rise in interest rates during the year, our financing group closed 408 transactions compared to 696 during the same period in the prior year.

Despite market conditions, we continue to rank among the leading financing intermediaries nationally. Financing fees for the full year were $113 million, compared to $110 million in the prior year. Other revenue comprised primarily of consulting and advisory fees, along with referral fees was $5 million for the quarter, consistent with the fourth quarter last year. Other revenue for the full year was $18 million, compared to $16 million last year. Total operating expense for the fourth quarter was $257 million, compared to $413 million a year ago, a decrease of 38%. For the full year, total operating expenses were $1.16 billion, up $57 million over the prior year. Cost of services for the fourth quarter was $181 million or 68.9% of revenue, an increase of 160 basis points year-over-year.

This increase was primarily driven by the outperformance of revenue in the first half of the year, which meant agents reached higher commission rates as a surpassed revenue threshold earlier in the year. This is also driven by the maturing of our sales force, the addition of many experienced professionals and a larger share of revenue generated by more senior producers in a tough market environment. Cost of services for the full year was 65.4% of revenue, 60 basis points higher than the prior year. SG&A during the fourth quarter was $73 million, a decrease of 5.7% year-over-year, primarily due to lower employee compensation expense tied to company performance, partially offset by higher sales support costs. As a percentage of revenue SG&A was 27.6% for the quarter, compared to 15.6% last year, reflecting both the record revenue in Q4 of 2021 and the disproportionate impact of fixed costs when revenue was disrupted in Q4 of this year.

For the full year, SG&A was up 17.6% to $300 million, which as a percentage of revenue was an increase of 330 basis points over the prior year to 23%. As a reminder, the significant SG&A leverage we realized in 2021 resulted from exceptional revenue growth coming out of the pandemic, when expenses had not yet normalized. This gradually reversed during 2022, as transactional activity slowed, and expenses returned to normal. In December, we took action to reduce controllable expenses, including headcount reductions that will benefit us going forward. However, the savings won’t all be visible immediately, given the timing of certain sales and client activities that occur in the first half of the year. For the quarter, we generated $0.20 of earnings per diluted share, compared to $1.53 per diluted share in the fourth quarter of 2021.

Adjusted EBITDA for the quarter was $14.1 million, compared to $88.2 million in the prior year. The effective tax rate for the quarter was 21.4%, compared to 25.8% in the prior year. The decrease in rate is primarily due to a windfall tax benefit related to settlement of deferred stock based compensation. We do not anticipate this tax benefit going forward. On a full year basis, the effective tax rate was 26.6%. Moving to the balance sheet, we remain in an exceptionally strong position with no debt, and $558 million in cash, cash equivalents and marketable securities, a modest change from the prior quarters $572 million. As part of our expanded capital allocation strategy, during the quarter, we returned $32 million of capital to shareholders, including $10 million in dividends, and $22 million in share repurchases.

For the full year, we’ve returned more than $90 million of capital to shareholders with $63 million in dividends declared and $30 million in share repurchases. This leaves us with $40 million remaining under the current share repurchase authorization. Last week, we announced that our Board declared a semi-annual dividend of $0.25 per share, or approximately $10 million, payable on April 6 2023, to shareholders of record on March 14 2023. In addition to return of capital to shareholders, we are in a strong position to continue investing in our business through retention and recruiting of top producers, technology improvements, and evaluation of M&A opportunities. Turning now to the near term outlook, the transaction market headwinds are likely to remain challenging.

However, we are cautiously optimistic that the catalysts Hessam outlined will support improving market conditions starting in the second half of the year. From an expense standpoint, we are focused on managing controllable costs to minimize the impact of the near term market disruption without compromising our long term growth priorities. Revenue in the first quarter will be impacted more dramatically than the usual pattern of seasonality due to current market conditions. This is exacerbated by the fact that Q1 of 2020 to set a new record and will be a very tough, comparable. Cost of services for the first quarter of 2023 should follow the seasonal reset and decrease sequentially to a range of 61% to 63%. This is slightly higher than the first quarter of last year given current market dynamics.

SG&A for the first quarter should decrease year-over-year in absolute dollars consistent with lower revenue, but the in line with the fourth quarter. This is due to essential sales and client activities that traditionally occur in the first quarter. We expect our full year tax rate to be in the 26% 28% range. Looking forward, we remain opportunistic about the long run and view a market disruption like the period we are in as an opportunity to further build and strengthen our platform. We have an exceptionally strong balance sheet and have delivered consistent operating results over decades with substantial cash flow generation for our shareholders, built on the proven durability of our platform through multiple market cycles. That concludes our prepared marks.

Operator, we can now open the call for Q&A.

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Q&A Session

Operator: And our first question comes from the line of Blaine Heck with Wells Fargo. Please proceed with your question.

Blaine Heck : Great, thanks. Good morning out there. Hessam, it seems to me that this type of environment with significant declines in transactional activity would be very stressing on small brokerages. I’m sure you all have ongoing conversations with potential targets. Are you seeing any of them open up more to the idea of a sale? And are you seeing pricing expectations on potential M&A activity moderate? Or do you think the low end transactions would have to be maybe a little bit more extended to shake out better opportunities?

Hessam Nadji: Sure. Hi, Blaine, hope you’re doing well. Great question. We are living with those dynamics every day as we have engaged in a number of conversations. As I mentioned in my remarks, there few more conversations in the last 90 days than there have been exactly because of the market shock and the notion that Marcus and Millichap is a very stable and tool rich and support rich platform, we are seeing a lot more interest in those aspects of the company. And we are starting to see some adjustment in price expectations in term expectation. I would say that the market needs to have a little bit more time to see that this isn’t a quick fix, if you will. And in time, we believe there’ll be even more opportunities. But so we’re seeing opportunities in that boutique, local regional brokerage environment as well as some boutique financing in entities as well as some more I would say specialized and larger providers that could be a very nice fit for MMI.

Blaine Heck: Great, that’s helpful. Switching gears to the share repurchase front. Looks like he took down a little under half the $70 million authorization since announcing the buyback program in August last year. Can you just tell us how you’re thinking about share repurchases relative to other opportunities for capital allocation and whether you plan to kind of revisit that share buyback authorization levels or amount in the event that you do complete that 70 million that’s in place?

Steve DeGennaro : Yes, Blaine. This is Steve. You’re correct, we’ve taken down about $30 million of the $70 million that was authorized back in the August timeframe. As we said, then we’ll reiterate we’ll be opportunistic and take down shares as we deem appropriate. We want to reiterate that our capital allocation strategy starts first and foremost with investments internally. Infrastructure investments, platform investments, extends to M&A and then to returning capital to shareholders both in the form of dividends as well as a share repurchase program. Pointing to the balance sheet where we’ve got over $550 million $560 million of funds available. There are plenty we have opportunities to do all of those, implement all aspects of that strategy. As we get closer to taking down the fullness of that authorization, we certainly will be revisiting that with our board. And, again, I think we will continue to be active in the market with our repurchase program.

Blaine Heck: Okay, thanks. That’s helpful, Steve. It sounds like the changes in hiring processes, remote working trends and low unemployment are still kind of headwinds with respect to adding professionals. So with that backdrop, along with these comments on some headcount reduction and expense reductions in December, I guess, how should we think about the headcount levels at MMI as we move throughout 2023?