Marcus & Millichap, Inc. (MMI) Q2 2019 Earnings Report, Transcript and Summary

Greetings. Welcome to the Marcus & Millichap Second Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Evelyn Infurna, Investor Relations. Ms. Infurna, you may begin.

Thank you. Good afternoon and welcome to Marcus & Millichap’s second quarter 2019 earnings conference call. With us today are President and Chief Executive Officer, Hessam Nadji and Chief Financial Officer, Martin 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 filed with the Securities and Exchange Commission on March 1, 2019. Although the company believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can make no assurance that its expectations will be attained. The company undertakes no obligation to update any forward-looking statement whether as a result of new information, future events or otherwise. In addition, certain financial information presented on this call represents non-GAAP financial measures. The company’s earnings release, which was issued this afternoon and is available on the company’s website, represents reconciliation to the appropriate GAAP measures 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, www.marcusmillichap.com, along with the slide presentation you may reference during the prepared remarks. With that, it is my pleasure to turn the call over to Hessam Nadji.

Thank you, Evelyn. On behalf of the entire Marcus & Millichap team, good afternoon, everyone and thank you for joining our second quarter 2019 earnings call. I am happy to report that our intensified client outreach and marketing campaign in the past several months, combined with steady hiring and acquisitions, resulted in revenue growth of 5.1% or a second quarter record of nearly $210 million. This reflects sequential progress in replenishing our transaction pipeline and listing inventory, which has been depleted in the fourth quarter of 2018 due to our record closings. Renewed momentum in our brokerage revenue growth after a record-breaking 2018 has been gradual and more challenging this year due to a shift in investor sentiment. As we noted on our last earnings call, heightened economic concerns and the Fed interest rate course reversal have pushed many investors back into a wait-and-see mode, particularly in anticipation of falling interest rates. As a reflection of this shift, overall market sales declined by an estimated 7% in the second quarter and 13% for the first half according to RCA. One of the hallmarks for the Marcus & Millichap platform is our ability to mobilize our sales force and fine-tune the educational and advisory service value our team brings to investors at times of market change. This remains our core strategy, combined with a steadfast focus on broker hiring and development while supplementing organic growth with acquisitions. For the quarter, revenue growth of nearly 9% in private client brokerage and 14% in our financing business were points of strength. We also closed some delayed transactions from the first quarter and resurrected some transactions that had fallen out of contract. Also on a positive note, our died transaction ratio has eased back to its 3-year average, and our sales force grew by 124 or 7% over the past 12 months. This includes the addition of many experienced sales and financing professionals. Our middle-market and larger transaction revenues declined by 8% and 11% in the first half of this year. Combined revenue in these categories had grown 37% in the first half of 2018 as a comparable. As we have shared many times in the past, these transactions involve major private investors as well as institutions, and they tend to be more variable for us. Buyers have become particularly cautious this year in this higher-priced category given record valuations and interest rate volatility. We are also challenged by a slowdown in multifamily sales this year after posting exceptional revenue growth in 2018, particularly in larger multifamily assets. While multifamily remains the darling of the industry, we are seeing some pushback on record low cap rates as well as concerns regarding potential rent control measures in some major metro. Affordable apartment sales have been adversely impacted by delays in HUD financing and their backlog throughout the first half, which stems from the government shutdown earlier this year. Despite these factors, multifamily property fundamentals remain exceptionally strong, especially in the workforce housing segment, which makes up the vast majority of the U.S. rental stock and MMI’s multifamily brokerage business. We believe this is an adjustment period that will work its way through the market, especially given the recent drop in interest rate. Our growth in office, industrial, self-storage and seniors housing revenue helped to offset declines in our multifamily sales. From a market perspective, we continued to see solid occupancies, rents, strong loan performance and ample availability of debt and equity capital, all of which is supported by steady job growth. Notwithstanding the rollercoaster ride of trade wars and the effect of tariffs nibbling at GDP growth, the U.S. economic expansion continues at a moderate but steady pace. The challenge for us is extended marketing and transaction closing time line and lingering price expectation gaps. It is simply taking longer to bring buyers and sellers together, and the process requires more investor education and tighter underwriting. Let me emphasize that well-priced assets are still clear in the market, and there is plenty of higher demand for a full spectrum of investments ranging from core to value add. Therefore, we are cautiously optimistic that investor sentiment will be bolstered by lower interest rates as they permeate through the marketplace in the coming months. Most importantly, our growth strategy remains on track. In the immediate term, we are further refining our client outreach of brokerage training to help more investors navigate real-time market conditions and take advantage of ample opportunities across various property types and markets. Expansion efforts in our financing business, IPA division and diversification in various property types are successfully moving forward. Specific to our financing business, we have continued to enhance our platform through developments in technology, training and loan originator support while expanding our lender programs, expanding agency lending capacity and pursuing additional acquisitions. As mentioned on our previous calls, we are managing our expenses tightly while making strategic investments that we believe are critical to the company’s long-term competitiveness. As such, the quarter’s year-over-year diluted EPS decline of 3.6% reflects recent acquisitions that are still in revenue ramp-up as well as investments in technology, marketing and client services. We continue to see the strength of our balance sheet as a positive force and a competitive advantage. Having ample capital and optionality towards synergistic acquisition remains our top priority for capital deployment. Our recent acquisitions are showing very positive signs in the early stages of integration and we have continued to see opportunities with more realistic valuation expectation. We are gradually adding more resources as we establish the right formula for scaling our acquisitions while deploying the right underwriting controls to minimize risk. In this spirit, I am happy to report that we have entered an agreement for another acquisition, Form Real Estate Advisors in Vancouver, British Columbia. Form is a leading local brokerage firm specializing in retail with an established culture and client-centric model that is much like ours. With 4 highly experienced principals, leading a winning team of brokers and outstanding support team, Form will bring substantial synergies, value and market coverage to our platform. We’re excited to further strengthen our Vancouver office and our presence in Canada through this acquisition. Looking forward, we see our top private client market position, expansion into larger institutional transactions, significant runway in our financing business, and industry-leading brand as strategic advantages to further build up. We also believe our reenergized and streamlined management team is a key driver of future growth. Over the past 3 years, we’ve made critical changes and improvements in our management lineup, communication and decision-making. Our COO, Mitch LaBar, has been a pivotal part of this process and has decided to transition back into retirement by the end of this year. Mitch has been a long-term leader within the firm and made a significant impact in the early years of growing the market in the WeChat platform. Over the past 3 years, he has been an exceptional partner in helping me shape the new leadership team, supporting our brokers and executing strategies to make the company better in every way. Several months ago, Mitch and I promoted J.D. Parker and Richard Matricaria to Executive Vice President, who will assume Mitch’s current responsibilities upon his retirement. Richard and J.D. are company veterans with extensive brokerage experience and track record of leading top offices, divisions, and corporate projects. Their complementary geographic focus and skill set will increase our leadership bandwidth as the company enters the next phase of growth and evolution. We are also fortunate to have a strong group of veteran division managers and other senior executives who are already partnering with J.D. and Richard in leading the firm. On behalf of the entire management team, we thank Mitch for all of his contributions to the company since 1984, particularly his role as COO since 2015. With that, I will now turn the call over to Marty to discuss our financial results in more detail. Marty?

Thanks, Hessam. I will be discussing our second quarter 2019 results in greater detail. Total revenues in the second quarter increased 5.1% year-over-year to $210 million driven by a 3.9% increase in real estate brokerage commissions to $189 million and a 14% rise in financing fees, which increased to $18 million. Real estate brokerage commissions, which account for 90% of our revenue, reflected the strength of our private client market segment, which is up nearly 9% in the second quarter to $129 million. This segment contributed approximately 68% of real estate brokerage commission revenue. Our middle-market revenue decreased 2.2% to $27 million, in part due to transaction count decreasing approximately 5.9% during the quarter as well as a difficult year-over-year comparison. In the prior year, this segment’s revenue increased over 35%. In addition, revenue from our larger transaction business decreased 11% year-over-year to $26 million compared to a 29% increase during the second quarter last year. Other than tough year-over-year comparison and the variability of larger deals discussed on past calls, we don’t see any fundamental change or issue in our long-term ability to penetrate larger transactions as a supplement to our private client business. During the quarter, total transactions increased 7.6% to 2,535 and total volume increased 14.1% year-over-year to $13 billion, with strength particularly in financing. Revenue from financing fees generated by MMCC grew a healthy 14% to $17.7 million for the quarter as a result of a 12% increase in financing transactions and a 2% increase in transaction size. For the period, we saw financing activities spread equally between purchase and refinance transactions. Other revenue, which is comprised primarily of consulting and advisory fees, along with referral fees from other real estate brokers, rose 44% to $3.2 million. The outsized increase was primarily driven by 2 large advisory fees earned during the quarter. And lastly, we finished the quarter with 1,965 sales and financing professionals for a net addition of 124 over the past 12 months. During the quarter, total operating expenses increased 7.1% to $183 million. The increase was due to higher cost of services, SG&A and depreciation and amortization. Cost of services rose 6.7% year-over-year to $128 million, in part due to higher revenues as well as increased commissions to more experienced agents in the quarter. 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. As a percent of total revenues, cost of services rose 90 basis points to 61%, offsetting first quarter’s lower than normal commission rate, which was 110 basis points lower on a year-over-year basis. For the first half of 2019, commission rate is on par with the previous year, which illustrates the importance of viewing our business on a long-term basis. SG&A increased 7.7% year-over-year to $53 million. This was primarily due to compensation-related costs, investment in our sales and financing professionals, business development and support systems, expansion of existing offices in strategic locations in support of our growing sales force and expenses related to certain beta licensing fees. The increase also includes support staff amenities that were acquired during the past 12 months. Most of these companies are in ramp-up and are making solid progress in their integration and future revenue contribution. These increases were partially offset by decreases in legal costs and stock-based compensation. Let me reiterate we are managing expenses tightly and balancing cost containment with key investments we believe are essential to the company’s long-term competitiveness. Diluted earnings for the quarter were $0.54 per share compared to $0.56 in Q2 of 2018. It should be noted that our results were impacted due to a higher tax rate. This was primarily caused by the elimination of certain operating expense deductions caused by recent IRS guidance related to the 2017 tax law. Going forward, we expect our effective tax rate for the full year to be between 26.8% and 27.5%. Adjusted EBITDA decreased 5.1% to $32 million during the quarter while our adjusted EBITDA margin decreased to 15.3%. As we have discussed in the past, our adjusted EBITDA margin like our overall performance should be viewed on a long-term basis and that there is variability from quarter-to-quarter. Moving on to the balance sheet, we finished the quarter with strong liquidity levels with approximately $361 million of cash, cash equivalents and core-cash investments. Our capital deployment priority remains centered on strategic acquisitions that broaden our market coverage and service offering. We are pleased with our growing pipeline of acquisition opportunities which are in various stages of discussion. Before closing, I’d like to point out a number of key items and highlights which may have an impact on our results for the remainder of the year. First, we are facing difficult year-over-year comparisons for the third and fourth quarters of 2019, which saw our total revenues increased nearly 15% and 14%, respectively. This was in large part due to revenues from transactions greater than $10 million growing 27% and 28% during those periods, respectively. Second, rebuilding our inventory and pipeline have been more gradual than usual given the market conditions that Hessam summarized. We anticipate that these key metrics will continue to build throughout the remainder of the year as we continue to execute our outreach and investor education program. Lastly, time to market and close transactions are above historical norms. We are cautiously optimistic that lower interest rates continue to have growth and healthy real estate fundamentals may support more market momentum. I would like to now open up the call for Q&A. Operator?

[Operator Instructions] Our first question is from Mitch Germain at JMP Securities. Please proceed with your question.

Thank you. So the decline that you referenced in the multifamily sector, do you view that as temporary on the heels of some of the rent reform and other legislation that’s out there or do you think that – is it based on inventory? Is it pricing? What do you think is causing that decline?

Hi, Mitch. This is Hessam. First of all, I want to apologize to everybody for some technical difficulties that may have affected some of our attendees. I believe that has been resolved, and hopefully everyone was able to get back on. Mitch thanks for the question. The trend that we’re seeing right now we believe is temporary and that multifamily fundamentals are extremely strong. Yes, there’s been a lot of discussion and concerns about rent control in various metros. But if you look at the totality of the marketplace, there is so much inventory and so much investment opportunity for our clients everywhere. We did have an exceptionally strong year last year. And the market was also up last year versus a market decline in terms of sales so far this year. It is, for sure, an internal challenge for us after an exceptionally strong and record year last year but, also, we’ve seen a slowdown in market transactions as well that we believe will work its way through the market in the next couple of quarters.

Great. How do you quantify the return on the marketing and investor education events? I mean, it sounds like that activity is up. Assuming that it’s a bit of an initial drag, how is that – how do you kind of view the progress and return on those different events?

Every one of these events that we host and every one of the campaigns that we run has benchmark goals that we compare to previous campaigns and previous events. We look at the investor attendees. We look at the number of listings that are committed prior to the events. We look at the listing to eventual sales ratios and also track the clients that attend, whether it’s webcast or physical event. So there’s a pretty wide array of metrics that we measure on all of our events and activities because we want to know if they’re working and what else we need to do to enhance them. The incremental cost of these, you’re right, can be a drag in a given quarter or two when we accelerate these activities and different things that we do to promote listings or increase our client outreach. But over the long term, there are not significant incremental increases from quarter-to-quarter. We are very mindful of the fact that it all has to result in additional listings and closings eventually.

Got it. I think last one from me, hiring is obviously up and kind of in line or even ahead of kind of what you typically guide for a year. Just curious if – the composition of hiring, are you back to looking toward more entry-level or is still there a significant focus on experience?

Sure, Mitch. About 3 years ago, as you recall, we launched the initiative to increase our focus on experienced broker and loan originator hiring, and that has resulted in some very good additions to our company. That has not changed at all. We continue to emphasize that. If anything, we’re getting a little bit more traction. At the same time, we have not slowed down our entry-level, organic growth-based hiring and development either. But we’re going down both paths, and both are very important to the future growth of the company.

[Operator Instructions] Our next question is from Stephen Sheldon of William Blair. Please proceed with your question.

Good afternoon, and congrats on the results. You sounded pretty cautious last quarter with the need to rebuild the pipeline and seems like you’re able to do that pretty quickly. So a couple of things there. One, can you talk about how trends this quarter kind of played out relative to your own expectations? And then two, any detail you can provide on maybe what allowed you to return to growth so quickly? Was that more of the impact of what you did on your side with the outreach and the marketing efforts or did investor urgency maybe pick up, at least a little, throughout the quarter two?

Hi, Stephen. Yes, I’ve mentioned on our formal remarks, actually replenishing the pipeline and increasing our listing inventory has been gradual, and what we feel to be below normal in a situation where we had a record fourth quarter in 2018, actually really a record year in all of 2018. So we are making incremental progress. There is definitely visible improvement, and there was for the second quarter as well which contributed to our results. But the degree of it is below normal in our estimation. And that’s because of the wait-and-see attitude that has reemerged in the market. Primarily as a lot of private investors have noticed interest rates coming down starting in February, March, and in anticipation of further interest rate reductions, have become slower to act, both in terms of acquisitions that were underway and new acquisitions. So that’s the primary headwind that we faced in gaining the kind of momentum we’d like to see in our pipeline and our inventory. So I wanted to clarify that commentary from our formal remarks. And the pace continues at about the same rate in the current period. We’re not really seeing much change. Obviously, there’s a lot of market uncertainty. I mean, just in the last couple of days, there’s been a lot of negative headlines and concerns about global economic issues, trade wars escalating and so on. Those do affect investor sentiment. And our segment is not immune to it. But it comes down – for us, it comes down to contacting more clients, getting closer to more investors, assessing their situation, bringing in our platform’s variety of investment choices and being able to really connect with more people on what their options are, which includes refinancing and transactions. In the first quarter, as the news was really emerging with a shift from the Fed raising interest rates and signaling toward more increases to the opposite, refis really became a more popular option. We saw an evening out of that in the second quarter as the market absorbed the Fed reversal, if you will. So it’s really a combination of all those dynamics that are driving us. We’d like to see our pipeline and inventory grow at a faster rate, and we’re working through the headwinds and the current that’s been caused by these market factors.

Got it. Helpful. I guess, on the timing issue, I think you’ve mentioned some delayed closings in the first quarter that subsequently closed in the second quarter. Is there no way to quantify that impact? And then just with all the puts and takes, can you provide any commentary on where the pipeline currently or, I guess, at the end of the quarter kind of sat, year-over-year – on a year-over-year basis?

Let me address your first question regarding delayed transactions. Yes, we did see a portion of our business that was scheduled to close in the first quarter get delayed, and that did contribute to the second quarter. It was one of many contributors to the results in the second quarter. It was not a defining contributor, but it was one of several. And in terms of the pipeline, all I can say is that we’re seeing gradual increases in our pipeline. And the fact that there’s an internal complement to rebuilding the pipeline and inventory when you have a record, exceptionally high level of activity in the fourth quarter of 2018, that has 2 layers to it. One is the fact that you still more of your inventory than projected. And two, is that our sales force is so busy closing transactions and taking out our clients, they’re spending less time developing new business. So it takes us a couple of quarters usually to begin to recover from that. And then compounding it is the headwind that we discussed, that’s why it’s more gradual than we’d like.

Okay. Then last one from me courtesy of the Form Acquisition. Just as we think about layering that into our model, any detail you can provide on number of producers that acquisition would include?

Form has a great team of 4 senior partners and an overall team of 11 professionals, which includes support staff and additional producers. They’re top-notch. We’re very excited about having them on board. And their business philosophy is so well aligned with ours, we really think this is going to be a case of one plus one equals four or more as some of our other investments have begun to illustrate. Remember that it takes time for a new group coming in to a large organization to enculturate. There’s system integration steps, and for any brokerage group, remember the continuum includes contacting clients, getting new listings, marketing those listings and closings. So it’s typically about a 6 months or so transition process before there is a momentum of transaction closings and revenue production. All the companies that we bought are in various stages of this integration. Remember that our prior acquisitions were mostly done in the third and fourth quarter of 2018 and the first quarter of 2019. So we’re just in that ramp-up process, and with Form, we hope to accelerate that as much as possible. But there is that natural integration and enculturation process.

Great, thank you.

Thank you.

We have reached the end of the question-and-answer session, and I will now turn the call back over to Hessam Nadji for closing remarks.

Thank you, operator, and thank you, everyone, for joining our second quarter 2019 call again our apologies for any technical issues that you may have experienced. And we look forward to seeing you on the road and having you on our next quarterly call. Thank you very much.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.