Marcus & Millichap Inc (MMI) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Marcus & Millichap Third 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, Investor Relations.

Thank you. Good afternoon, and welcome to Marcus & Millichap's Third 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 commercial real estate market conditions; the company's ability to retain and attract transactional professionals; the company's ability to retain its business philosophy and partnership culture amid 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 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 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 reconciliations to the appropriate GAAP measure and explanations of why the company believes such GAAP -- 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, www.marcusmillichap.com, along with a slide presentation you may reference during the prepared remarks.

With that, it is now my pleasure to turn the call over to Hessam.

Thank you, Evelyn. On behalf of the entire Marcus & Millichap team, good afternoon, everyone, and thank you for joining our third quarter 2017 earnings call. The company's third quarter performance began to show key improvements resulting from our four-pronged strategy going into 2017. Those strategies include rebuilding our inventory and new business pipelines after the productivity disruption we experienced in the fourth quarter of 2016. As you may recall, this was a result of the postelection interest rate spike and ensuing wait-and-see market sentiment.

Expanding our investor outreach and business development campaigns was the second strategy, which helped to counter a slowing sales market.

The third strategy was continuing to hire and develop brokers, particularly increasing the experienced sales and financing professionals that we're recruiting.

And leveraging the recent enhancements to our financing platform and [limited] relationships to grow our financing business was the fourth strategy.

Throughout the year, we've also been steadfast on long-term growth initiatives, including expanding our footprint in strategically importing metros as well as investing in new technology, proprietary tools and brokerage support.

In the third quarter, we achieved modest year-over-year topline growth of 1.5% for the first time since the onset of a more challenging market environment in the fourth quarter of last year. This improvement also comes against a tough comparison to last year's third quarter revenue growth of 8.7% and was the result of the specific strategies I summarized above as market headwinds persisted during the quarter.

Let me take a moment to recognize the exceptional efforts and client results of our sales and financing professionals which led to this improvement.

Our efforts over the last year to manage costs in certain areas while investing in strategic initiatives helped to produce modest net income improvement of 2.2% during the quarter. While these numbers and improving trend lines for the company are encouraging, we clearly view these positive results as incremental progress toward returning to much more robust growth. The entire management team recognizes that much more work lies ahead to achieve this critical goal.

Let me now highlight a few other important developments during the quarter, starting with a 7% increase in Private Client transactions for a total of nearly 1,300 closings. This is in contrast to a slight decrease in market sales in the quarter based on preliminary estimates and points to steady share gains for MMI. Our market share in this segment now stands at an estimated 8.7%, the highest in the industry by a wide margin and 2 percentage points higher than the time of our IPO in 2013.

Through our product diversification initiatives, we're seeing healthy growth in our office, industrial, multi-tenant shopping center and hospitality market penetration. In addition to these growth areas, we continue to see market share expansion opportunity in apartments and single tenant retail despite our market leadership in these critical segments. Large apartments, senior housing and self-storage are experiencing the sharpest year-over-year decline, all of which is related to the significant slowdown in market sales in these particular asset types.

Our financing business was essentially flat for the third quarter due to a moderate decline in refinancing activity after rising by almost 40% during the first half of the year. On a year-to-date basis, financing revenue was up 11%, supported by recent hiring of experienced financing professionals and new lender partnerships we put into place earlier this year. Our strategic partnerships with PGIM, formerly Prudential, and ReadyCap are off to a great start this year as they offer competitive pricing and best-of-class service to our clients and will contribute to our financing growth going forward.

In the last 12 months, we added a net 95 investment brokerage professionals, excluding interns and trainees, for a growth of just over 6%. Our recruitment efforts have yielded a number of highly experienced brokers and teams as well as many mid-level professionals we believe will become more productive by being part of our platform.

I want to note that our hiring does reflect some slowing due to the need to be more selective in new hiring. We're also seeing a normal uptick in the turnover of newer brokers in light of a more challenging market environment. At the same time, we believe that our annual goal of 100 net hires is still a reasonable benchmark going forward.

Also, as discussed on our last quarterly call, headcount reductions for our financing team is the result of transitioning the division to a more experienced profile, which should improve overall performance in the long term. This shift is also important from a margin perspective, since our financing compensation includes base salary and, as such, the ramp-up of experienced individuals increases costs.

Our marketing timelines and bid-ask spread, although expanded from their low points in the first half of 2015, remained stable in the third quarter. Our died transactions and expired listings also remained within historical norms. Our leading indicators, particularly new listing inventory, also continued to improve gradually during the quarter. We have progressively closed the gap on new inventory and pipeline throughout 2017 in the aftermath of the productivity disruption in the fourth quarter of last year. However, the deficit continues to be a challenge.

Revenue from larger transactions grew 13% in the third quarter. While this improvement is particularly strong coming on the heels of the 25% increase in the third quarter of last year, it is somewhat of a catch-up from the measurable decreases in the first half of this year in a segment that is much more variable for us. To this point, year-to-date, large sales are down nearly 17% this year compared to an increase of 39% for the same period in 2016.

As for the outlook, we see a healthy and sustainable economic expansion continuing into 2018 with steady job growth. We also expect property fundamentals to remain strong with overbuilding limited to luxury apartments and self-storage in a number of specific metros. We see no major factor tilting the healthy supply/demand balance for the industry in the foreseeable future.

On the capital markets front, we expect interest rates to increase moderately thanks to still low inflation levels. The market largely expects an accommodating Fed with the appointment of Powell, assuming he's confirmed as the next Fed chief. Similar to Janet Yellen, he's unlikely to get overly aggressive on rate hikes or the unwinding of the Fed balance sheet and cause a market disruption. Lenders remain cautious from an underwriting perspective but are providing plenty of debt capital across the board, with the exception of construction lending, which is acting as a barrier to overbuilding.

The proposed tax reform package in its current form appears generally positive for commercial real estate, but the ultimate impact will depend on the final package that comes back.

On the equity side, there's no shortage of capital or buyer interest in assets. But sellers' unwillingness to narrow the bid-ask gap is still lagging. Realistically priced assets are generating multiple offers and have plenty of lenders at the table for virtually every property type and market area. As we've seen many times before, buyers and sellers will eventually find alignment but the process is taking time.

In the short term, we expect the recent investment sales trend to continue its recent path of moderate year-over-year decline until more of a catalyst emerges in the marketplace. For MMI, this means doubling down on the strategies that are working in terms of market share gains, product coverage diversity and further expansion of our sales force.

Before I turn the call over to Marty, I'd like to provide some depth in key areas of our operations and recent management focuses. Over the last 18 months, we've talked about increased investment in infrastructure and tools, and I wanted to elaborate a bit on some of these projects and their benefits. Our infrastructure investments include office expansion in metros we believe have significant long-term growth opportunity. As opposed to opening new offices, we believe expanding existing ones under the same local management creates more synergy for our sales force and will be more cost effective in the long run. Examples of these expansions include our Manhattan office, Denver, Encino, San Diego, Chicago, Phoenix and our South Bay office in Los Angeles. Coupled with a natural increase in office rents, the expanded footprints typically increase costs but enable our managers to grow revenue through additional hiring.

Our increased technology spending includes a new proprietary in-house legacy system that has essentially automated the steps involved for our brokers to analyze and present property and market evaluations to clients and prospects. The system, called MNet-Offering, is now a web-based application deployed company-wide with many fluid features, functions and outputs with much more efficiency. Other areas of tech spending includes enhancements to our electronic marketing technology and provider partnerships, internal data warehousing and analytics, office automation applications and cyber security.

The feedback from our sales force and clients has been very positive regarding all these initiatives, and they have played a key role in specific recruiting and retention efforts. Over the long term, we strongly believe these and many other planned enhancements to our proprietary tools will play a big role in maintaining Marcus & Millichap's competitive advantage. For more than 45 years, we've had a tradition of integrating technology, culture and a unique property marketing platform into a powerful delivery system for investors. And these investments are essential to enhancing our value proposition to our clients and to our brokers. As we have stated, the bulk of these major projects were planned to run through 2016 and 2017, and we expect a leveling off of related costs in 2018.

Last but not least, as part of our 2018 business plan, we will be updating our capital allocation plan as well. Our capital allocation plan has always been designed to allow for appropriate reserves given the cyclical nature of our business; funding for key internal investments to improve the Marcus & Millichap platform; as well as strategic acquisitions which we're actively pursuing, as I mentioned on our last call.

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

Thank you, Hessam. I'll be discussing our third quarter 2017 results in greater detail. Total revenues in the third quarter increased 1.5% on a year-over-year basis to $183 million, primarily driven by real estate brokerage commissions, which saw a revenue growth of 2.2% to $169 million. This increase was partially offset by a decrease in other revenue, which includes consulting and advisory services, while financing revenue was relatively flat.

As Hessam discussed, despite our improved performance in the third quarter, the sales transaction market continues to be challenging. And based on the results, we believe we continue to increase market share. Taking a closer look at the quarter, we were able to grow real estate brokerage commissions and transactions by 2.2% and 4%, respectively. This is the first time each of these metrics rose on a year-over-year basis since the third quarter of 2016. We believe this is a direct result of our brokers' efforts over the past three quarters to navigate our clients through a challenging environment of market uncertainty.

As in the second quarter, the distribution of transactions over our 4 key market segments in real estate brokerage varied widely. Most notably, we saw a 19% increase in larger transactions, a marked improvement over the first half of 2017, on top of last year's strong transaction growth of nearly 27%. This strong performance helped to raise average transaction size by 1.1% and reduced the average commission rate by 60 basis points as larger transactions carry lower commission rates.

Revenue from our real estate brokerage Private Client business for the third quarter grew 2.2% on a year-over-year basis as a result of a 7% increase in the number of transactions. This market segment makes up approximately 17 -- 70% of our total brokerage revenue. Revenue in our middle market, or $10 million to $20 million transaction size market segment, which typically accounts for approximately 15% of our brokerage business, was down by 1.9% and 9.6% in transaction count and sales volume, respectively, during the quarter. Revenue from financing fees generated by MMCC was relatively flat during the quarter.

In this period, we saw a higher proportion of our transactions come from purchases, a reversal from the prior three quarters, where refinancing was more prominent. In addition, in our efforts to attract and retain more experienced financing professionals, our productivity levels for our producers during the quarter was higher based on a lower number of loan originators.

Other revenues for the third quarter, which are comprised primarily of consulting and advisory fees, along with referral fees from other real estate brokers fell from $3.6 million in 2016 to $2.6 million. As a reminder, this category makes up a very small percentage of our total revenues and is highly variable based on periodic assignments by our clients.

Total operating expenses for the quarter slightly increased by 1.9% to $159 million, primarily due to a 4.3% increase in SG&A. SG&A was up primarily due to higher costs related to increased business development and marketing expenses as well stock-based compensation to our brokers and employees. These increases were primarily offset by lower compensation-related costs, including management compensation and related benefits. We continue to manage costs closely while supporting our brokers' abilities to develop and grow their businesses.

Cost of services increased by less than 1% in the third quarter to $115 million versus $114 million in the prior year due to a modest increase in revenue. However, as a percentage of total revenues, cost of services decreased by 40 basis points to 62.6% for the quarter, primarily due to a decrease in the proportion of larger transactions. As a reminder, this expense is primarily comprised of commissions paid to the company's investment sales professionals and compensation-related costs for financing activities.

For the third quarter of 2017, net income was $15.5 million compared to $15.1 million in 2016 for an increase of 2.2%. Adjusted EBITDA was $28.5 million during the quarter compared to $28.1 million in 2016, increasing by 1.4%. Our adjusted EBITDA margins of 15.5% for the quarter is down just 10 basis points year-over-year owning to both topline growth as well as continued efforts to manage expenses.

As indicated on prior calls, based on current market conditions and the company's investment needs, we expect that our margins will continue to be under pressure for the fourth quarter. However, we believe expense metro leveraging should resume sometime in 2018.

Turning to the balance sheet. Marcus & Millichap is well positioned to grow its business organically and to pursue selective acquisitions. Our liquidity levels are very healthy, as we ended the quarter with cash and core cash investments of approximately $274 million. As a reminder, our capital needs include reserves required to support our operations during both good times and bad; strategic internal investments to improve our platform, short- and long-term liabilities, which include deferred compensation related to our agents and our employees; and acquisition of brokers, teams and companies. As Hessam said earlier, we will have an updated assessment on capital allocation at the end of the year as part of our 2018 planning.

Before closing, I'd like to point out several key factors which may have an impact on our fourth quarter 2017 results. First, despite revenue growth for the first time in 3 quarters and an easier revenue comp in the fourth quarter, we continue to face market headwinds and a general lack of urgency among investors, which is limiting growth.

Secondly, our cost of services or commissions paid to our brokers typically experiences seasonality where commission rates peak during the fourth quarter.

Third, the Larger Transaction Market segment remains susceptible to variability from quarter-to-quarter, notwithstanding the improvement this quarter and the significant inroads we have made in this segment over the past years. The comparable for larger transactions during the fourth quarter will be challenging given last year's 15% revenue growth in this market segment.

Lastly, I'd like to note that the company adopted a new accounting pronouncement that required any windfall tax benefits net of shortfalls to be recorded as a discrete item against the company's tax provision. By comparison, this windfall tax benefit was reported in additional paid in capital in previous years.

These windfalls arise from the difference in the grant date price and the vesting date price of non-broker restricted stock units, deferred stock units and restricted stock awards. The company expects to recognize approximately $2.7 million in windfall tax benefits in the fourth quarter of 2017. This should equate to an estimated range of an additional $0.06 to $0.07 to the company's earnings per share. By comparison, in the fourth quarter of 2016, the company recorded $2.5 million of windfall tax benefits directly to [APEC]. In 2018, the company expects to realize tax windfall benefits from divesting of these RSUs, DSUs and RSAs, primarily from those that were issued in connection with the company's IPO and vest during the fourth quarter.

I'd like to now open up the call for questions. Operator?

(Operator Instructions) Our first question is from Brandon Dobell with William Blair.

Maybe for Hessam, a little more color on your thoughts around the various tax proposals that are floating out there, both from a perspective of are you seeing what you thought you would see, but also, in your discussions with clients, both on the listing side as well as the buy side, how do they view the current proposals relative to what they think about in terms of a transacting business, what kind of properties to own, et cetera?

Hi, Brandon. In addressing the question, I can tell you that the general reaction from our clients has been positive, given the current proposal in its form. Obviously, the 1031 exchange question was an important one. There was a lot of noise and back and forth. Again, right this minute, we really don't know what the final resolution will be, but the proposal was perceived well as it relates to 1031 exchanges, the interest deductibility, depreciation, carried interest and the 25% tax rate for pass-through businesses.

The question mark is how much change will the bill go through before it's final. Obviously, California residents and New York residents are concerned about the elimination of the state income tax. From an economic perspective, what does that do to the economy of those very important states, not just for us, but for the entire country, and the housing market, obviously, if the mortgage deduction is reduced significantly.

So it's still very speculative, but the general reaction from our client base over the past several days has been very positive regarding the specific areas that affect commercial real estate.

Got it. Okay, thanks. That's helpful. And then as you looked at, and maybe it's on a year-to-date basis but even more so this past quarter, at where the other transactions per producer or dollar volume producer trends were going kind of by cohort, right, so the more tenured, those that have been around a handful of years, those that have been around just a couple of years, I'm looking for some color, I guess, on if you see that top end of the tenured group still doing all the business or if there's been some sort of reversion back to the mean where you see the agents that have been around, the producers that have been around for 3 or 4 years starting to get a bigger chunk of the transaction volume?

Sure. So generally speaking, in a more challenging market environment, you can always expect the more experienced

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The more experienced people's skill set really comes to play.

Got it. And then final one for me. Marty, just to make sure I'm on the same page here as you guys, thinking about SG&A expense trends, the seasonality between Q3 and Q4 on the SG&A line has reversed a couple times in the past 3 years. So as you think about fourth quarter versus third quarter or fourth quarter versus last year's fourth quarter, anything that we should really focus on or you want to point out that would change how perhaps last year's seasonality looked, maybe some catch-up on spending, or something else that just flows through that SG&A line that may make it look a little strange.

Hi, Brandon. Yes, in terms of SG&A, during the third -- I mean, excuse me, the second quarter earnings call, I mentioned to everyone that the fourth quarter looked to be anywhere between $2 million to $3 million greater than the run rate. And as of today, that really still holds as we speak.

(Operator Instructions) Our next question is from Mitch Germain, JMP Securities.

I'm curious, Hessam, I know that you've talked about some of the private clients. Volatility clearly causes some slowdown and caution in their ability to -- in their willingness to transact, I should say. How much is the pricing environment and reinvestment risk creating a slowdown in their willingness to trade here?

That's a pretty big factor for sure. As you would expect, we've seen this before in other market cycles. As the market becomes very, very strong, as the market is today, with occupancies at very high levels, rent growth very healthy, prices having appreciated a lot, it becomes more challenging, especially in a market that has less distress, or actually next to no distress at all, to think about trading out of a particular property type into another property type or trading out of a particular geography into another, and that becomes a very natural cyclical hurdle.

Again, our more experienced agents are masters at this, because what we do is provide the education to that particular investor that is very married to their existing cash flows, but they're not really paying attention to the yield arbitrage or the return on equity that they could really enhance by trading into another property type or a market area. And that's really the art of brokerage. We are facing that as a market-wide hurdle as we're interacting with our clients.

Got you. I know one of the core principles of the strategy when you guys first went public was looking at some of the alternative asset classes. I think you mentioned a couple, like lodging and self-storage on the call; one positive, one negatively. But I'm curious as to how that process has played out and is -- kind of what level are you sitting with some of those property sectors? Is there still a significant amount of investment? Or is it now just an education of existing brokers to try to build their -- greater penetration into those alternative assets?

Sure. It's really a local strategy when it comes to diversification by property type, where our managers are now supported by executives and have backgrounds in every one of the diversified product types that we want to expand into. So we have a head of office; we have a head of market -- the retail market; we have a head of our institutional practice and so on. That support level to the local regional manager in their ability to recruit experienced people in those specialties and then build around them, in some cases actually redeploy some of our existing people with better training and better specialized underwriting, specialized packaging happens at the local level with corporate support from our specialty division with these very skilled executives in charge of each property type.

On top of that, all the different events that occur within the industry for each property type, like self-storage, like hospitality, like office/industrial through, let's say, (inaudible) and all the other organizations that cater to each property type, ICSC for retail, National [Multifamily Housing] Council for apartments, are very important outlets for our branding, for our content, for us to have a major presence in. And we've made significant investment in making sure that the company's very well represented through these partners throughout the industry.

So these are some of the examples of the ways we've enhanced our ability to develop office specialty agents, multi-tenant retail. I mean, as you know, our single-tenant retail has been a dominant specialty for us, but even within retail, we have a lot of room for growth on the multi-tenant side. So a lot of our training and focus, including the recruiting part of it, is geared toward that within the retail segment. And this carries out for each major property type.

So I am very happy to tell you that diversification at the local level, supported by our national infrastructure, is a very important part of our strategy. And it's happening as we speak.

Great. That's very helpful. I wanted just to touch on the MMCC in terms of -- obviously we've seen some of the -- the number of dedicated professionals trend a little lower. I'm just curious, I know it's been a real big area of focus for you in terms of hiring professionals and the new relationships with Prudential and trying to get lenders on board. Is it just really more of a timing perspective? I know last quarter benefited from the refinancing activity. Is there anything that we should think about going on here? Or is it just maybe more or less just a function of timing and deals are flowing into maybe the fourth quarter?

Well, from the standpoint of the refinance activity, as you know, it's been very strong throughout the year, especially in Q1 and Q2 of this year, when the transaction market had slowed severely, particularly in the first quarter. And then we've seen a little bit of an easing on the degree of decline on the transaction side. So there was a little bit more tendency to actually transact than to refi in the third quarter than we've seen so far in 2017. Nothing dramatic in terms of what we're doing or how we're interacting with clients. The quarter just happened to be more driven by actual sales than refis. But our effort to provide both transaction financing, refi debt or just advisory service on how to navigate this market is still very much intact. I mean, those options are always on the table when we're interacting with our clients.

Regarding the headcount, it is a matter of timing in the way that the numbers are working right now. Because the time frame it takes to hire more experienced individuals obviously has a longer lead time and a longer process. But we feel it's important to make sure that we only have very qualified people on our team now, and where we don't, we're making the change. Even if it takes time to replace people that we may terminate with the right replacement, it is better to make sure that we're recruiting for the right people in the right market. And so that is just a matter of time, as you said.

Got you. Last one for me. Marty, is there a way to quantify kind of -- I guess you're suggesting that you should get a little more leverage on the slowdown in tech spending next year and then beyond. I guess I'm just trying to understand, maybe if you can quantify kind of what that means for the numbers, please?

Yes, sure, Mitch. I mean, we've always said that we're always trying to grow expenses at a lesser rate than revenues. So I've also mentioned that, in terms of trying to pin that down to a percentage, we typically look at anywhere between, say, 65% to 75% of revenue growth.

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

Thank you, operator, and thank you, everyone, for joining our call. We look forward to having you on our fourth quarter 2017 earnings call. Thanks a lot.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.