Moelis & Co (MC) 2018 Q4 法說會逐字稿

Good day, and welcome to the Moelis & Company Fourth Quarter 2018 Earnings Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Ms. Michele Miyakawa. Please go ahead.

Great. Thank you, and good afternoon, everyone. Thank you for joining us for Moelis & Company's Fourth Quarter and Full Year 2018 Financial Results Conference Call. On the phone today are Ken Moelis, Chairman and CEO; and Joe Simon, Chief Financial Officer.

Before we begin, I'd like to note that the remarks made on this call may contain certain forward-looking statements which are subject to various risks and uncertainties, including those identified from time to time in the Risk Factors section of Moelis & Company's filings with the SEC. Actual results could differ materially from those currently anticipated. The firm undertakes no obligation to update any forward-looking statements.

Our comments today include references to certain adjusted financial measures. We believe these measures, when presented together with comparable GAAP measures, are useful to investors to compare our results across several periods and to better understand our operating results.

The reconciliation of these adjusted financial measures with the relevant GAAP financial information and other information required by Reg G is provided in the firm's earnings release, which can be found on our Investor Relations website at investors.moelis.com.

I'll now turn the call over to Ken.

Thanks, Michele, and good afternoon, everyone. 2018 was a tremendous year for the firm. We achieved record fourth quarter revenues of $238 million, up 41% from the prior year period, and record full year revenues of $886 million, up 29% from the prior period. Our full year revenue growth was driven by a greater number of transaction completions with higher average fees across all products and record revenues in M&A, restructuring and private funds advisory.

Our elite M&A franchise provided high quality and discrete advice on complex transactions throughout the world. Having a full suite of expert capabilities, including debt capital markets advisory and shareholder defense, allows us to increase our dialogue with clients, creating additional fee opportunities for the firm. Additionally, we earned greater average M&A fees across deals greater than $5 billion, with a meaningful increase in fees earned on deals with values over $10 billion.

Our restructuring franchise achieved record revenues despite a low default rate environment, surpassing the level that we experienced in the height of the financial crisis. We continue to gain market share and ended the year as the #1 adviser in the U.S. for completed and announced transaction volumes, according to Thomson Reuters. We advised on 7 of the year's 10 top global completed restructuring deals, with key assignments in Asia and EMEA.

We returned a record amount of capital in 2018 as well, which Joe will touch on shortly, as we continue to stay focused on cash flow generation for the benefit of our shareholders. We increased our regular dividend, we've announced another special dividend, we bought shares in the open market and authorized a $100 million share repurchase program.

I would like to turn the call over to Joe, who will take you further through our financial results, and then I'll come on to discuss our Managing Director hires and the current market environment. Joe?

Thanks, Ken. Since Ken has already taken you through our strong revenue results, I'll take you through expenses, including taxes, as well as some more details on capital allocation.

Starting with expenses. Our adjusted compensation expense ratio of 57.5% for the quarter and the year is in line with the target. Our non-compensation ratio decreased to 16.4% for the full year of 2018 from 17.4% in the prior year. But the impact of the new accounting masked the true impact of the improvement. If 2017 had not applied expense reimbursements as a contra expense, like '18 does, the '17 ratio would have been approximately 19.2%. So we had a year-over-year improvement of about 280 basis points. We operate the business with strong financial discipline, resulting in a full year pretax margin of 27%.

On taxes, our 2018 corporate effective rate of 16.4% compares with 33.8% in 2017. The 2018 rate includes the impact of the federal corporate rate decrease, plus the positive impact of excess tax benefits related to vesting events, which were largely concentrated in the first half of the year. The underlying normalized corporate tax rate for the year approximated 25.3%.

As a reminder, our adjusted net income presentation reflects all of the firm's income tax -- income taxed at our calculated effective corporate tax rate. Going forward, on the same adjusted basis, we expect our underlying corporate effective tax rate to remain at approximately 25% to 26%, assuming a geographical mix of revenues similar to 2018.

The normalized rate excludes the tax impact of share price changes related to vested equity. Our primary annual vest occurs towards the end of this month. For purposes of quantifying the excess tax benefit in quarter 1, the breakeven share price for this vest is approximately $30 a share. For each $2 change in share price at vesting, we expect the impact to be approximately $0.01 of EPS.

During 2018, we returned over $300 million of capital to shareholders, a record level and confirmation of our commitment to return all of our excess capital in the form of dividends and buybacks. We bought back over 700,000 shares in 2018, including 185,000 shares purchased in the open market starting in late November through year-end at an average price of $36.35. We purchased another 95,000 shares in January. On a go-forward basis, the board approved $100 million for share repurchases.

In addition, our board declared an increase in our regular quarterly dividend from $0.47 to $0.50, as well as $1.25 special dividend, the second related to the year. We've increased our regular quarterly dividend and have declared at least one special dividend annually since becoming a public company. The $1.75 in dividends will be paid on March 29 to stockholders of record as of February 19.

And I'll now hand the call back to Ken.

Thanks, Joe. The quality and unique connectivity of our global platform drove these tremendous results. Additionally, we are proud of our focus on internal talent development, and the investment we have made in our talent is critical to our success. Earlier this year, we promoted our first analyst, hired 11 years ago, to a Managing Director. Currently, 30% of our Managing Directors have been internally promoted and, as they have grown their respective franchises, have become some of our most productive MDs at the firm.

During 2018, we grew our talent base by 14% on top of the 15% growth we achieved in 2017. And for the year, we promoted 5 and hired 5 Managing Directors and also added 2 Advisory Partners. Most exciting, we believe that we have rapidly become the #1 destination for the best talent on college campuses around the world, and that is our future.

We increased our focus on diversity with the hiring of a Senior Advisor focused on diversity and inclusion, and we look forward to holding our third annual young leaders diversity program this coming March.

As we look further into 2019, our activity across all our products remains strong. We expect to see a continued need for companies, financial sponsors and governments around the world to transact to stay competitive in the fast-changing global economy. We have a strong track record of growth in varying economic climates and a unique and differentiated model.

And with that, I'll open up to questions.

(Operator Instructions) Our first question comes from Devin Ryan at JMP Securities.

I guess, first question, just on the share repurchases. Is the intention moving forward to think about kind of through a 10b5-1 plan? Or are you guys kind of just do it opportunistically based on just where the shares are trading? Obviously, the stock came off quite a bit in the fourth quarter. It has recovered back a bit. But just trying to think about, is there a price range? What parameters you guys are looking at for the buyback?

So the answer to that is in the fourth quarter, we did start buying, but it was -- we were limited because we were in a blackout period. So as it got lower, we had a plan in place. And as Joe said, we were limited by our imagination. We just didn't see the stock going as low as it would have or we would have set up some formula that would have been more aggressive. And we couldn't change it midstream. We were on a 10b-5. So the way I think about share repurchase is we've always said this: At first, we did not want to destroy a limited float that was growing. But we've said as we had a float, we would then allocate capital back to shareholders, and we -- number one, we're going to return all our capital to shareholders. Number two, we're going to do it either through dividends or stock repurchases. We will not have an autopilot plan, though. I think maybe I'm just off the Super Bowl, but I'll use the analogy that when we get into the red zone, where it's obvious we're on the 20-yard line, we'll buy the stock aggressively. The other 80 yards of the playing field, we were kind of like we're not smart enough to know and we might use that part of the field to pay dividends. And you should probably think of us like that. We thought we were in the red zone last quarter. And if you're going to ask when that is, then I'm going to say to you also that will be dependent on market conditions and lots of things and we'll make that decision at the time. But that is the way we're going to think about stock repurchases.

Okay. Great. Appreciate the color, Ken. And just a follow-up. So the fourth quarter, pretty extreme market volatility, obviously, in the public markets. And I'm curious if there's been any kind of change in appetite, if you look at your client list, between public companies that just went through a pretty extreme kind of whipsaw here and kind of private companies that obviously didn't see the volatility and maybe just still feel good about their business and it's business as usual. So do you expect, as you look out over the next few quarters, there to be any kind of differentiation in themes between what's going on in the public company world versus the private? Or maybe even companies are looking at acquiring certain public companies that were sold off in the market that maybe it was overdone? I'm just curious kind of that dynamic and how that played into your outlook for business between the 2 markets.

We saw almost no difference. And by the way, we almost saw no discussion of the volatility. I mean, obviously, in the height of the volatility, people were talking about the markets a little bit. But it's also around Christmas time, so it's kind of quiet. But I will say that I don't believe the volatility diverted one conversation, both public or private, and I don't see any difference, to cut to the quick of your question. I continue to believe the companies have strategic imperatives, and they're thinking 3 to 5 years down the road in many industries that revolves around technology and your position in the world to compete. And again, the build versus buy decision, it has become dangerous to build because the speed with which industries are changing their competitive environment, and I think that's triggering a lot of M&A. And I did not see one conversation change because of the volatility. And so I didn't see any change in the level of discussion. It was still people who were on their front foot and were trying to implement their strategy.

Our next question comes from Michael Needham with Bank of America.

So just first cleanup. Does that $100 million authorization, does that include the tax settlement shares?

No. That's excluded from the authorization. That's just open market purchases.

Okay, got you. All right. And then just in terms of the deal pipeline, you put up a really strong fourth quarter, really strong year. So far we've heard sort of mix things from the other advisory firms in terms of how the pipelines are trending, how the first half of the year looks like it's going to shape up. Just wondering what you're seeing at your firm.

We've not seen any slowdown in M&A activity. And the recent volatility hasn't hurt it. The government slowdown hasn't hurt the ability of -- the desire for corporates to have conversations. We're very busy. There's this one element that I thought. The government shutdown had the possibility of -- they just weren't approving deals during that time. Things were slowing down. They are attempting to get back pretty quick. And we're watching that because there was -- the SEC was at half-speed during that time and it's too early to tell to make -- approve everything at the same level of time. But they are trying to catch up. And that was the only thing we saw that was affecting closings.

Okay. Got it. And last one for me on the restructuring business. Can you talk about how that business is doing? Obviously, there is meaningful potential in your business. It seems like it could be near a low and that things should picking up from here. Has the trend changed at all? I think in the past, you've said 20%, 25% of revenues. Or is it kind of still on that band?

First of all, we did our record revenues this year in restructuring, so we've had a great year in restructuring. It is still a low default rate environment. There's just a lot of companies out there and there's a lot of debt out there. So the same percentage of band is probably about right. It's just we had a big year, they had a big year. Now we are seeing elements of this -- there's a big difference between 2.5% interest rates and 0%. It is a big difference, and we are seeing elements of Europe show up. I think the European economy is slower. And so we're starting to see some restructuring pop up there. But we don't see a general recession around the world, the United States is strong, but I think restructuring could have as good or better a year depending on how the economy unfolds. There's a lot of leverage in the system, and I can't repeat enough, 2.5% is different than 0%.

Our next question comes from Richard Ramsden with Goldman Sachs.

Can I just ask a follow-up on the restructuring business? Can you talk a little bit about how the cadence of that business evolved over the course of the year? Did you see an acceleration in the fourth quarter? And are there any industries or geographies that really stand out as a specific opportunity? I know you talked about Europe, but perhaps you could talk a little bit about industries where you think there could be a big opportunity there.

I can't go through the cadence because I don't -- I think it started when -- energy has gone through another cycle. I think what -- and off the top of my head, I can't remember when energy prices cracked exactly. But that started to bring that industry back in the U.S. at least. Retail isn't giant but has a pocket of problems and they showed up and we participated in some of those. I think in Europe, it's different. Europe, we're not seeing it in any single industry, and that to me is usually a sign of kind of a general weakness in the economy, where you don't see a particular commodity or industry get hit, but you just see deals that were slightly overleveraged get hit by a slowing economy, and I think the continent is slowing. So in the U.S., I still think it's around the commodity sector, the energy sector, things like that. And in Europe, it's more general economy.

And then my second question is on financing conditions for M&A. There's obviously a lot of concerns in December about deterioration in both the private and public funding markets. If you were to take kind of a pulse of where we got to now, have we round-tripped? Or do you think that could be a headwind to getting certain types of deals done?

Let me give you 2 answers to that. We have -- I'd say we now round-trip on rates, so leverage finance rates have come back about halfway. I mean, they plummeted. Then I'd say they're about halfway back. But that's okay. The thing that came round-trip was availability. So the market capital is available. In the middle of December, I think there was a worry that capital wasn't going to be available. There was a real structural liquidity concern between some of the leveraged finance, closed-end funds, ETFs and what was going on in the liquidity of the market. And I think that, I'd call 100% round-tripped and rates are probably halfway back. But that's okay. People can price rates if they can get the capital. That might take a smidge off of a price in a leveraged transaction, but it won't stop it.

(Operator Instructions) Our next question comes from Michael Brown with KBW.

So it sounds like you characterized M&A environment as strong. So I'm just interested to hear a little bit more about what you're seeing in Europe given some of the geopolitical uncertainty that we're still seeing there. And then what are your thoughts on some of the cross-border activity, particularly with China?

Well, it's strong and then you pick the 2 weakest elements of the market. So 2018 was not a great year for us in Europe. I don't think Europe had a big M&A year in general. And I'm not expecting 2019 to be a big year in Europe either. I think you have 2 things, both -- more than 2 things. You have Brexit, you have a slowing economy in the continent and multiple elections coming through the year that I think are going to cause havoc throughout the political system. So we're not depending on that and we're kind of assuming that's where it was in 2018 pretty much as an environment. Well, we hope to do better in our microcosm as a firm, but macro-wise, we're not looking for it to be much better. And then China, look, cross-border out of China, we're kind of assuming, if we go back 3 years ago to 2016 -- 2 years ago, we had maybe the largest market share, we thought, since we did 16 deals from China into the U.S. and Europe. I think last year we did none. And we're kind of depending -- we're not thinking of China as a big cross-border market. We are not pulling out. I think it's a big economy and we want to be there, and you can't go in and out. So we're going to stay there, but don't look for a lot of deals from China cross-border. And I'd say the same thing for cross-border around the world. Look, I do think large cross-border transactions are the one spot in M&A where you have to be concerned about regulatory, political, there's a whole bunch of reasons you'd have to look twice at those. But I think that's been the market for 6 months now.

I appreciate the color there. And then just to kind of tease out your commentary on how the M&A environment is currently strong. So how would you kind of characterize this environment and what the pipeline looks like for you now maybe compared to prior periods? Would you say it's stronger than what you saw this time last year?

I think we're bigger. It feels like we're at the same level and we're a bigger firm. So I guess the answer is the activity has probably grown proportional to the firm. And look, things like -- when I say China is having a tough M&A market. We have established a pretty good restructuring business in Asia. Some of our best transactions were done in Asia. And that might continue. And our restructuring business in Europe might pick up. And so there's a lot of offset around the world to take up some of that as well. So I'd say it feels about -- it feels the same to me, which is busy and strong and probably in proportion to the size of our business. So I'd say yes. As measured against 12 months ago, I would guess that the absolute size of our business is bigger in concert with the size of our firm.

Our next question is a follow-up from Devin Ryan with JMP Securities.

I guess, just a follow-up is for Joe, just on the model and thinking about kind of the operating margin from here. So to the extent we do have another good year of revenue growth, and then obviously, understanding you're still adding talent, is there any more room on the comp ratio? Is there any flexibility there below this kind of 57.5% level? And I guess, that's part 1. The other part of it is, I think the fourth quarter is a good reminder of planning for potential downturns. So just trying to think about just the broader flex in the operating model here to the extent that the revenue environment accurately does deteriorate. And kind of how you're thinking about maybe the lower end of where margins could go.

Sure. So I think on the comp ratio, I think 57.5% continues to be adequate. I think the way to think about that is we continue to make new investments and increase headcount, and we think that's important for the business. We remain in growth mode, and I think, therefore, thinking about 57.5% is probably still -- will remain appropriate. As it relates to a downturn, there's obviously -- there is flexibility in comp. Obviously, there's a large amount that's discretionary each year, and obviously, that will flex as revenue opportunities come. And on the non-comp side, I'd say in terms of the distribution, it's probably 2/3 fixed and 1/3 variable, so there's some flexibility there as well.

And let me just add to that. We had a long conversation about was our results good enough this year to go below 57.5%. And we thought the best economic decision for the firm was to let our 130 Managing Directors and our 800 employees on the front lines know that it's a fair deal, and if they exceed, that's their part of the transaction. They get in -- and on the downside, by the way, we expect to hold them to that as well and we will. If you look through our last 5 years, we've been pretty consistent at holding the comp level. But I felt the fair thing to do in the best interest of everybody on this phone call was to also let them know that if they exceed, they shouldn't retire in November because they've maxed out. Everybody should run through the finish line at full sprint. And I think we succeeded in that, by the way. It was a great year for, I hope, for our shareholders in terms of the returns and it was a great year for the participants in the bonus pool. I think that's what's going to make a great firm going forward. And it will also make it fair in a tough environment to hold that line as well, and we will hold that line. We know how to operate in all environments and we will hold the comp line in the downturn as well.

Our next question comes from Brennan Hawken with UBS.

This is Brent Dilts on for Brennan. Just given you characterized the hiring pipeline as robust, should we expect above-average hiring in 2019? And how should we think about productivity given the pipeline and the MD adds from 2018?

The pipeline is good. And look, we want to be aggressive. I can't tell you. It will depend on market conditions and terms. But we have a great opportunity. There's a lot of the midsize, large financial institutions, especially in Europe, that we think are facing extremely difficult conditions, and we think several of them are going into retreat. So I think there might be an opportunity for more hiring than normal. But look, you've got to come to an agreement with people and you've got to do it economically, so I can't commit to that. But we're going to -- I think this is the year it's fair to say that we will probably try to be more aggressive and try to get there, but we're going to do it disciplined. What was the second part of the question?

It was just potential for productivity expansion given you've hired a decent amount of people recently and just if you add more through the pipeline, just kind of where you think productivity (inaudible).

Our productivity is up dramatically, and I think the real story behind that is these young Managing Directors who have been promoted from within and have not been paid to cross over. And lastly, let me say the most important part. Why is our company, I think, doing this consistency? Our turnover, and I'll be careful with saying this, our turnover that we don't wish for or provoke, if that's a good word, is almost 0 for the last couple of years, especially at the Managing Director level. I'm talking at the Managing Director level. Our clients are seeing consistent faces and teams, and so the productivity is going up dramatically from that point of view and I think it will continue. We have about 30% that are internally promoted are young and their franchises are growing, and you could see the power of what happens as they become more consistent and they deliver the firm consistently to clients and I think that's the productivity -- I know we don't break it out, but you could probably do the math, and it's up pretty significantly.

Our next question comes from Jeff Harte with Sandler O'Neill.

A couple kind of cleanup, I guess. From a share count perspective, how much did the price decline in the quarter reduce the share count? And I suppose, more importantly, as we look forward, assuming the share count kind of starts appreciating again, is the 500,000 a quarter and then kind of the 100,000 per dollar still the right way to think about increasing share count going forward?

So I'll have to look at the historical. But overall, the future dilution is about 700,000 shares a quarter before any buybacks or changes in average share price. And I think the average price or the sensitivity of dilution is about or a little less than 100,000 shares per dollar of price change. And the starting point, the average price per quarter 4 was, I think, between $42 and $43, so that would be kind of your reference point. The impact of the fourth quarter, we can come back to you with that.

Okay. Okay. And what was the MD count at year-end?

130? Maybe it's 125 -- it's 130 now. It was 125 at year-end.

That's right.

Okay. And when it comes to growing the MD count, I mean, you can hire, you can promote. Obviously, you guys promote as much, if not more than, hiring. How does that impact the timelines for revenue generation? I guess I'm thinking when you hire between garden leaves and re-establishing client relationships, it takes a while for hired MDs to generate revenues. How quick a process is that for promotes?

It should be fairly immediate. It's just the -- if you cross-hire a 25-year veteran, you'd probably get a backlog of what they've been working on. So we used to model that the first year, including garden leave and ramp-up, you get like 10% of their revenue within the next year, you get 2/3 and then you're back to full stream. That was just a rough thing. Because garden leave eats up a lot of part of the year. But you then go to a different number, right? A 30-year veteran has an interesting client base and can go to a higher number. The best part of the promotes is they've been with you, 7, 8, like the one I just talked about, an analyst who's been with us 11 years. We know who they are. They've worked with us at consistency. And they ramp up slower. Most of them will ramp up slower, but they're younger. You have a long duration on their life as a banker. There's no crossover pickups. I think it's a tremendously higher return on invested capital. I'd just say that, that's the key to us. The risk -- and the return on invested capital is so much higher on a promote. That's why we do it. It's culture, it's consistency, it motivates your junior people. And ultimately over the life of the hire, the returns are dramatically higher. And that's why I always fought against revenue per MD as any kind of measurement. I could jack that up anytime you want, but I don't know what the cost associated with it would be. I don't know what the lifetime expectancy of that banker would be. So we just feel like this program we have of hiring, training and promoting from within is, as you look out 10 to 20 years, is by far the highest return on invested capital.

This now concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Ken Moelis for any closing remarks.

Well, again, thank you. If you have any other questions, call Michele, myself or Joe, and I appreciate it. Thanks.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.