Marcus & Millichap Inc (MMI) 2017 Q1 法說會逐字稿

Greetings, and welcome to the Marcus & Millichap First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Evelyn Infurna. Ms. Infurna, thank you, you may begin.

Thank you, operator. Good afternoon, and welcome to Marcus & Millichap's First Quarter 2017 Earnings Conference Call. With us today are President and Chief Executive Officer, Hessam Nadji; and Chief Financial Officer, Marty Louie.

Before I turn the call over to management, please remember that our prepared remarks and 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 could 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 global real estate market conditions, including the recent conditions in global markets; the company's ability to retain and attract transactional professionals; the company's ability to retain its business philosophy and partnership culture amidst competitive pressures; the 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, which was filed with the Securities and Exchange Commission on March 16, 2017.

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 obtained. The company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, certain of the financial information presented on this call represents non-GAAP financial measures. The company's earnings release, which was issued this afternoon and is available on the company's website, presents reconciliation to the appropriate GAAP measure and explanations of why the company believes such non-GAAP measures are useful to investors.

Finally, this conference call 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 is now my pleasure to turn the call over to Hessam. Hessam?

Thank you, Evelyn. On behalf of the entire Marcus & Millichap team, good afternoon, everyone, and thank you for joining our first quarter 2017 earnings call. As we had anticipated and messaged during our last earnings call, the first quarter of 2017 was challenging for MMI's financial results in comparison to last year. Our revenue declined 6.7% on a year-over-year basis, while net income declined to $12 million from $14.8 million. These readings are certainly not indicative of our growth potential and truly highlights the importance of evaluating our business on a long-term basis. As importantly, there are also a number of underlying strengths and positive factors, both internally and externally, that should not be overshadowed by the pure statistical results of the past 90 days. Before I talk about these and additional details for the quarter, I'd like to first summarize the key drivers of the past 2 quarters for a clearer understanding of where we are and where we believe we're headed.

Three major developments occurred that impacted our business. First, the interest rate spike of 75 basis points within a matter of weeks after the presidential election threw many pending transactions into renegotiation and requalification for financing during the fourth quarter of 2016. For private client deals, which have lower price points typically and higher loan-to-value ratios, the impact of the interest rate jump was more acute than on larger deals and widened the bid-ask spread further, our [died deal] ratio spiked in the fourth quarter for the first time in several years and our team spent a tremendous amount of time keeping or putting deals back together for our clients. This significantly reduced new business pipelines going into the new year as we indicated on our last call.

Secondly, the uncertainty regarding pending tax reform legislation and economic stimuli moved a lot of investors to the sideline, waiting to see what specifics these initiatives would bring. Ironically, consumer and business sentiment has been boosted by the Trump growth orientation but lack of details on key policies has created a pause. In the past 2 quarters, sales in the marketplace, particularly in the sub-$10 million price point, have declined 10% to 15% according to third-party estimates. This was a drastic change from a much more gradual easing of the sales trends in the first 9 months of 2016. While the modest interest rate decline and recalibration on price expectations in the past few weeks is slowly helping to bring buyers and sellers back together, we believe the market, particularly for the private client, will be held back until more policy clarity emerges.

Last but not least, our $20 million-plus sales had been on a major upswing throughout most of last year and were expected to slow from this unusually high level. Let me emphasize again that large transactions, various property specialty focuses, are complementary strategies to our primary business in the $1 million to $10 million Private Client Market segment. However, given the higher price point and typically higher volatility, larger transactions in a given quarter can impact our overall results.

In the first quarter of 2016, we closed a record 61 transactions valued at $20 million or higher for a volume of $2.8 billion, including a portfolio sale valued at nearly $500 million. By contrast, in the first quarter of this year, we closed 38 larger deals for a volume of $1.7 billion, which significantly pulled down key metrics such as average deal size and average commission per transaction, the primary cause of our overall revenue decline. On a long-term basis, growing larger transactions, both through our IPA division and senior Marcus & Millichap brokers, is a part of our growth plan. This is an important strategy for the retention of our maturing brokers and our ability to service larger private and institutional clients.

Now let me shift to a number of noteworthy positive factors. First of all, we closed 2,067 total transactions, including 1,489 brokerage transactions in the first quarter of 2017, which was essentially flat from a year ago. Our consistent level of closings, in contrast with the 10% to 15% decline in market sales I mentioned earlier, points to further market share gains for MMI, and illustrates the ability of our experienced sales force to service our clients at a time of uncertainty and market change.

Secondly, our died deal ratio eased in the first quarter after the spike we reported in the fourth quarter of last year. While the productivity disruption of Q4 for agents new business development has a ripple effect that is still playing out, we've increased our sales campaign and client outreach activities to raise inventory level going into the second half of the year. Third, we've increased our sales force by 9% or 137 professionals over the past year, with continued emphasis on experienced agent hiring. Although the ramp-up of new agents takes longer in a more challenging market environment, we believe our continued hiring and proven training programs will keep the company on a long-term growth path.

Now for a closer look at the quarter, our Private Client brokerage transactions were essentially flat compared to last year, while revenue in the segment declined 4.5%, and once again, comprised over 70% of total revenue for the company. As we've shared with you before, over the long term, particularly during major market corrections such as the 2008-2009 period, the Private Client Market segment has proven to be a steadier driver of the marketplace and our business, while the Larger Transaction Market has shown more variability, over time. However in a given period, private investors can react more quickly to factors such as tax law, interest rates and related uncertainty, which is what we're currently experiencing. Therefore, eventual clarity on these issues should have a positive effect on the transaction market.

In terms of our financing, MMCC achieved a 15% increase in revenues due to a 6% increase in transactions on top of the 13% increase in sales volume. The key drivers of this growth were the increase in refinancing activity in the slowing sales market, a recent hiring of more experienced professionals and early contributions from the new correspondent relationships we announced over the last 2 quarters. This includes our relationship with ReadyCap for financing in our small-balance multifamily business and Prudential Global Investment Management, PGIM, which is designed to offer financing capabilities for mid-market and larger multifamily assets. Both of these programs have been well received by our clients and financing professionals and are being rolled out on a more expanded basis.

Looking forward, let me now address the 4 pillars that impact our business, which include the economy, real estate supply and demand, capital markets and investment sales. Although overall, economic growth slowed during the first quarter, the labor market is on a steady trend of adding 2 million to 2.5 million jobs, which will continue to spur solid demand for commercial space. Unemployment fell to a 10-year low of 4.4% last month, which is likely to keep wages on the rise.

The second pillar, commercial real estate supply and demand, remains in balance, although pockets of overdevelopment, particularly in luxury apartments and self-storage, are emerging. Overall, the vacancy and rent growth outlook remains healthy for most property types.

Capital market, the third pillar of our business, have maintained ample liquidity levels for both debt and equity, but we continue to face lender caution. The Fed has signaled tightening monetary policies, which is to be expected as inflation begins to edge up in light of the low unemployment I mentioned earlier. Nevertheless, another interest rate spike, similar to what we saw in the fourth quarter, is unlikely and the regulatory easing could increase liquidity further if Dodd-Frank is repealed or changed substantially.

The fourth pillar, investment sales, will likely hampered, particularly in the private client market, until additional clarity on taxes and fiscal policy emerge. Let me emphasize that there is no shortage of buyer interest or capital in the marketplace. The issue is really around bid-ask spread and buy-sell timing, which were exacerbated by heightened uncertainty.

In closing, let me point out that throughout our 46-year history, we have proven that share gains during a challenging market environment lead to more client relationships and future revenue growth. Transactions in the Private Client Market segment may be somewhat challenged currently, but they still accounted for 83% of total commercial property sales and 60% of the commission pool in the marketplace over the past 12 months. This is a large and still fragmented market, where the top 10 brokerages, including MMI, had a 24% share by number of transaction. We are confident that MMI's constantly improving platform and brand will continue to capture more share in an evolving commercial real estate transaction environment and look forward to keeping you updated on our progress throughout 2017.

I will now turn it over to Marty to discuss our results in more detail. Marty?

Thanks, Hessam. I'll be discussing our first quarter 2017 results in greater detail. Total revenue in the first quarter was $153 million compared to $164 million in the prior year, reflecting a decline of 6.7%. The decrease in revenue this quarter was primarily due to lower brokerage commissions, primarily in the Larger Transaction Market segment, partially offset by improvement in financing fees and other revenues.

Looking at the quarter more closely, we closed nearly the same number of transactions that we did in the first quarter of 2016, while the investment sales market declined an estimated 10% to 15%, including the Private Client Market segment. However, the distribution of transactions over our 4 market segments varied widely for brokerage, and the average transaction size declined by 13%. For the longer-term perspective, despite the year-over-year revenue decline, total transactions for the first quarter was the highest when compared to historical first quarter periods, while revenue for the quarter was the second highest. Revenue for our Private Client business for the first quarter declined by 4.5% due to a 5% reduction in sales volume, partially offset by a slight increase in transaction. As we have said in the past, our larger transaction business tends to be more volatile and is more affected by closing date variability. With that said, first quarter revenues from transactions greater than $20 million made up only 11% of our brokerage revenue, declining by 40% when compared to the outsized growth experienced during the first quarter of last year.

By comparison, during the first quarters of 2016 and 2015, this market segment grew 75% and 118%, respectively, on a year-over-year basis. In fact, since our IPO, revenue from our Larger Transaction business grew 32% on a compounded annual basis as a result of our strategy to become more competitive in this arena, as a supplement to our Private Client business. Although this segment is dominated by our institutional clients, a large portion of these transactions are with large -- larger private clients who have become more active in this asset class. Revenues from financing fees generated by MMCC grew by 15% to $10 million for the quarter, accounting for approximately 7% of total revenue. Our financing business improved in both transaction count and average deal size by 6% and 7%, respectively. The addition of some experienced professionals and early contribution from the correspondent relationships that Hessam mentioned earlier also contributed to our financing results. Other revenue, which is comprised primarily of consulting and advisory fees, along with referral fees from other real estate brokers, increased 61% to $3 million and contributed nearly 2% of our revenue stream. The gain was primarily due to increase in market and valuation studies requested by our clients as they formulate strategies to navigate current market condition.

Total operating expenses were $134 million for the quarter compared to $139 million for 2016 for a reduction of almost 4%. Lower expenses in the first quarter were primarily due to a 6.8% decline in cost of services directly related to lower revenues on a year-over-year basis, and the proportional drop of larger transactions by our more senior investment professionals. As a reminder, cost of services is primarily comprised of commissions paid to the company's investment sales professionals and compensation related to financing activities. Cost of services during the first quarter, as a percent of total revenues, was flat compared to last year. Generally, cost of services as a percentage of revenues gradually increases throughout the year as our sales professionals meet certain revenue thresholds.

SG&A for the quarter increased by 2.3% to $43.2 million compared to $42.3 million for the same period last year. The increase was mainly due to higher facilities expense from the expansion of existing offices as discussed on our fourth quarter 2016 earnings call, an increase in stock-based compensation due to stock price fluctuation and incremental stock awards according to our compensation programs, and an increase in costs related to agent business development. This was partially offset by decreases in management performance-related bonuses and cost containment measures that we've initiated during the previous quarter, while continuing our strategic investments in the infrastructure and technology development. For the first quarter 2017, net income was $12 million compared to $14.8 million in 2016 for a decline of 19%. Adjusted EBITDA was $22.4 million during the quarter compared to $27.2 million in 2016 for a decline of 17.5%. Our adjusted EBITDA margin was 14.6% for the quarter, reflects top line pressures from a slowing market and a shift in our internal transaction mix in the first quarter, as well as incremental expenses associated with investments in our infrastructure as discussed earlier. Based on current market conditions, our margins will continue to be pressured during 2017. However, we believe expense leveraging will take place starting in late 2017, and into early 2018. From a balance sheet perspective, Marcus & Millichap continues to be well positioned to grow its business organically and to pursue selective acquisitions. Our liquidity levels are very healthy, ending the quarter with cash and cash equivalents and core cash investments of approximately $216 million. The senior management team continues to explore avenues for external growth as well as return of capital alternatives given our liquidity levels and our continued strong cash flow generation. However, as we have said in the past, our strong balance sheet affords us tremendous flexibility and advantages.

Before closing, I'd like to point out a number of key items and highlights, which may have an impact on our second quarter 2017 results. First, the second quarter of 2017 will face another challenging comparison, given an overall slowdown in industry-wide CRE sales and its exacerbated effect on the private client in particular. Second, the strategic investments we outlined, which include office expansions, investment in technology and support for our agents will continue in 2017, given their importance to our long-term growth. However, we continue to look for ways to increase efficiencies and manage expenses throughout the organization. And last but not least, the Larger Transaction Market segment remains susceptible to variability from quarter-to-quarter, notwithstanding the inroads we have made in the segment over the past years. Like this quarter, the comparable for the Larger Transaction Market segment will be challenging, given last year's 25% growth in the $20 million and above transaction.

In closing, let me emphasize that we believe healthy real estate fundamentals and the Trump administration's overall growth orientation are positive factors in supporting the current economic and real estate expansion. These, combined with policy clarity, should be catalysts for higher sales velocity in the marketplace at some point and we are positioning MMI by taking share and investing in the future.

I'd like to now open up the call for Q&A. Operator?

(Operator Instructions) Our first question is from Peter Christiansen with Citigroup.

I was just wondering if you could dig in a little bit on the relative volatility you're seeing in the Private Client Market versus the other segments. I know you don't disclose time on the market, but I was wondering if you can provide us with at least a general commentary on how the private client market is doing relative to some of the segments in terms of how inventory is staying on the market.

Peter, absolutely happy to address it. It's little bit of unusual window of time, in that the interest rate increase in the fourth quarter and then the uncertainty that we've mentioned a few times related to tax policies and so on, happens to be on the higher end of the impact for the smaller transactions in the private client. Just because of the fact that the effect of the interest rate is bigger on the lower price point and then the psychology in terms of the effect of tax law changes and so on is weighing pretty heavily on them as well. So it's actually been a larger slowdown in the last few months in the sub-$10 million transaction, than the $20 million and larger transaction.

Have you seen any reversals, I guess, in the latest couple of weeks compared to what you were seeing in Q4 and most of Q1, has there been any signs of improvement?

Yes. As I mentioned on my comments. Just in the last few weeks there seems to be a little bit more of a movement in terms of some more inventory, possibly coming to the market. But I have to say, when you have a market event as we did in Q4, both externally in terms of everything that happened in the world and particularly the interest rate, and then internally, for us in terms of time that it took to make sure that we service our clients in the fourth quarter versus spending time on business development, those things don't really reverse overnight. It takes time to smooth out. And there's been improvement, but it's going to take time for both to basically work their way through.

So I guess, in the context of looking out for the next quarter, and assuming the pipeline is somewhat as it was in Q1, I mean, should we assume roughly a similar decline in activity in Q2, absent any large deals?

Well, we don't really give guidance as you well know. But I can tell you that the headwinds that we experienced in Q1 are enduring.

That's helpful. And the last question, I guess. Constantly, in the news, we're hearing more about brick-and-mortar being displaced and a number of store closings. Just wondering if you're seeing any of those knock-on impacts from some stores closing. And have any of your volumes been related to this theme?

We are definitely seeing the effect of the negative headlines related to retail, a lot of which is overblown versus the fundamental data that we're tracking and others are tracking. So there is concern about retail, both in the multi-tenant shopping center world as well as the single-tenant world that is more affected by interest rates, of course. So we have seen more of a bid-ask gap there, and we've seen more of a slowdown in the sales velocity because of that. But fundamentally, if you look at the drivers of the single-tenant [lease] properties, which is basically the aging baby boomers looking for low management and sense of investments, the fact that this sector has not been overbuilt, yes, there's clearly an adjustment going on related to interest rates and interest rate expectation. But the big picture, macro drivers of the business are still very much intact beyond this current, if you will, sluggish market environment. On the multi-tenant side, there are number of retailers that are still under pressure, you're hearing about them every day in the news. But there's also a lot of retailers that are expanding, and we're also looking at a lot of technology companies like Apple and Microsoft opening stores, as well as Amazon looking to get into the grocery business. So there's just a lot going on, and retail is constantly reinventing itself. So I would not throw the baby out with the bathwater.

The next question is from Brandon Dobell with William Blair.

Maybe first for you Marty. Just so I understand how -- or kind of how you're positioning your margin commentary for 2017 sounds like we should still expect year-on-year margin declines in the first half, but then maybe year-on-year either flat to up margins in the back half. If I'm correct with that -- I guess I'm trying to understand how that -- what's driving operating leverage or, is it just some of the spending you've been pushing through on technology and process stuff starts to slow down?

Yes. Sure, Brandon. Yes, in terms of expenses, obviously, we've done quite a bit to manage our expenses as we've made in our commentary. The fact of the matter is that the SG&A for the first quarter is a good run rate for the second quarter. But overall, for the year, SG&A is probably looking anywhere between $175 million to $180 million, which is a little bit more than our last earnings call. And a lot has to do with some of the work we've been doing on our side in terms of containing cost. In terms of margin. Margin, just from that alone and how we see revenues throughout the year and the seasonality, you will see margins continue to grow for each quarter.

Okay. And then the -- it sounds like some decent early traction with some of the partnerships and MMCC. I want to make sure I got the numbers correct that you threw out there and how we should think about the balance of the year, expectations for MMCC at similar kind of revenue growth rates? I guess I'm trying to get a sense of how it's going to impact the balance of the year, relative to last year, for that part of the revenue stream?

Brandon, it's Hessam. I'll comment on that, in that we've put some things into place, as you know, both related to these correspondent relationships, the mix of hiring that we've modified in MMCC, some of the other internal things we're doing to increase internal capture of share. So we are very pleased with the early progress on all that. But again, just to make sure we're being realistic, these things don't pay off within a quarter or 2. They take time, especially with introduction of new people into the company, they have to get enculturated and trained and so on. So really, I have a lot of confidence that we're on the right growth track, but it's not a overnight or a quarterly jump. So I wouldn't raise expectations there too much.

Okay. So maybe to that point, Hessam. As you -- I think you mentioned talking about the further rollout of some of these partnerships, some of these structures, et cetera maybe where are we right now relative to the property types or the offices that you would expect to have these ideas or these processes rolled out to by year-end, are we talking first inning? Are we halfway through? Just trying to get a sense of how much work you've done so far, relative to how much the opportunity looks like in front of you?

Sure, absolutely. Both are very, very early-stage programs. They have been in pilot testing through a number of offices for the past few months, and they're just now starting to get rolled out company wide. They're both designed to enhance our multifamily business because of the targeted loan size, ReadyCap on the small balance program and Prudential on the middle market and upper-end apartment program. So the answer to your question is both are in very early stage rollout. We've just begun the company-wide rollout in the last couple of weeks, in fact. So there is more room to go there.

Okay. And then final one for me. As you look at the makeup of the producers now outside of MMCC, so just the core business, and makeup of those producers in terms of average tenure, attrition or churn within the past quarter. Just maybe some of the headcount or more HR-focused metrics that we might think about that gives us a sense for the direction of the headcount and the average maturity of that headcount looking out to the rest of the year, would be helpful.

Sure, Brandon. The mix has been very [fixed]. 35% of our sales force has been with the company for 5 years or more, and it's been very stable and obviously, they're the productive cadre of our team. And our hiring continues to focus on both new agents, brand-new professionals being trained from the ground up, as well as experienced agent hiring, which we've had pretty good success with, including a very experienced level office industrial team that we just hired in Chicago, which we believe is a huge market opportunity for us, both throughout the Midwest and nationally as we have stated before. Office and industrial both are growth areas for the company. So we're beginning to make some headway in terms of experienced agent hiring.

(Operator Instructions) The next question is from Mitch Germain with JMP Group.

I wanted to continue with that question in terms of hiring. Obviously, you're about a year into your tenure as CEO, and you've made a number of changes, particularly on the senior management side. I know you just hired a National Director for Multifamily IPA. So I'm curious kind of where the process of building that senior group of managers stands right now.

Thanks, Mitch. It's -- we made, like you mentioned, a number of key changes. We have a leadership team that is very focused and has proven to be very effective already in terms of increasing our experienced agent hiring, making sure that our current team that's on board is properly supported and properly guided. We've had some great successes in terms of improving agent productivity with some of our teams that were already on board. And so the effect of that management team is really important on the existing sales force and the improvement of things like our training programs and the improvement of the utilization of our technology and support systems. And because the new leadership team came from leading managers that ran major offices for a long time very successfully, they're very much up-to-date and very current on what it takes to make sure that our agents are being as productive as possible. So they've had a very positive impact on both experienced agent hiring. This is why we're seeing some of the improved numbers there, as well as the continuation of our new agent hiring. I mean, the millennials, obviously, have a whole different mindset and different support systems needs, and the new team is very much attune to that. And I think that's part of the reason they're being very effective.

Great. And I know there was a question about retail, some of the headwinds that you're seeing in that space. I'm just really curious if you look at the different asset classes that you guys represent, maybe the core 3 or 4, and then some of the other bucket. Where are you seeing the most growth, and where are you seeing the most year-over-year decline?

Sure. I'll talk about us in terms of where we saw the most deceleration if you will, all within the context of a very difficult comp because Q1 of 2016 had some pretty amazing numbers when it came to our senior housing, for example, which included almost $0.5 billion portfolio sale and as well as our self-storage, which had a record quarter of larger $20 million-plus transactions a year ago. So this is a very difficult comparison. But having said that, we already talked about the retail slowdown a little bit. We've seen a slowdown in retail as well as hospitality and self-storage. Those 3 in the core business have shown the biggest slowdown, again from record levels, both on the market about a year ago as well as internal numbers. And we've seen some improvement just in the last, like I said, 30 days or so, few weeks, and more inventory coming to the market. So it seems like it's no longer deteriorating, but the comparison is what's challenging for us.

Great. That's very helpful. And last question for me. It seems like if I look at your private customers, it seems like you probably have some guys that own asset or 2 or 3 versus ones that are really heavily invested in real estate. So I'm curious, one versus the other, are you seeing a general slowdown amongst both; or the ones that are really invested in real estate are still transacting and the more passive investors are the ones that are taking a bit of pause from the market?

It's really both, Mitch. It's hard to generalize, I know. And there are so many case-by-case situations and nuances that go into somebody's decision-making as to whether it's the right time for them to bring inventory to market, or if they just want to wait and see what happens. We're seeing this wait-and-see pretty much across the board as a factor. Let's not forget that we did close 1,489 transactions in the first quarter. So clearly, the market's moving, and as I mentioned in my formal comments, there are plenty of buyers in the marketplace. And we just have to keep the perspective on where we've come from, these record levels that we saw in 2015 and kind of easing of the sales trend in 2016 prior to the events of fourth quarter, were all pretty much in, what I would consider, a natural phase of this great cycle that we're in. But the psychological component that we're talking about here is pretty broad based. It's not exclusive to one group or the other.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would now like to turn the call back to Mr. Nadji, the CEO, for closing comments.

Let me thank everyone for joining the call on behalf of our team again. And we look forward to having you on our next earnings call. Thank you very much.

This concludes today's conference. You may disconnect your lines at this time, thank you for your participation.