Marcus & Millichap, Inc. (MMI) Q2 2022 Earnings Report, Transcript and Summary

Greetings, and welcome to the Marcus & Millichap Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Brad Cohen of ICR. Thank you. You may begin.

Thank you. Good morning, and welcome to Marcus & Millichap's Second Quarter 2022 Earnings Conference Call. With us today are President and Chief Executive Officer, Hessam Nadji; and Chief Financial Officer, Steve DeGennaro. Before I turn the call over to management, please remember that our prepared remarks and the responses to questions may contain forward-looking statements. Words such as may, will, expect, believe, estimate, anticipate, goal and variations of these words and similar expressions are intended to identify forward-looking statements. Actual results can differ materially from those implied by such forward-looking statements due to a variety of factors, including, but not limited to, general economic conditions and commercial real estate market conditions; the company's ability to retain and attract 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, 2022. Although the company believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can make no assurance that its expectations will be attained. The company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. In addition, certain financial information presented on this call represents non-GAAP financial measures. The company's earnings release, which was issued this morning and is available on the company's website, represents a reconciliation to the appropriate GAAP measures and explains why the company places with such non-GAAP measures are useful to investors. This conference is being webcast. The webcast link is available on the Investor Relations section of the website at www.marcusmillichap.com, along with a slide presentation that may be referenced during the prepared remarks. With that, it is my pleasure to turn the call over to our CEO, Hessam Nadji. Hessam?

Thank you, Brad. On behalf of the entire Marcus & Millichap team, good morning, everyone, and welcome to our Second Quarter 2022 Earnings Call. I'm pleased to report that our second quarter and first half results set new records. The second quarter was also the second best overall period for us with nearly $400 million of revenue and net income of $42 million. Revenue was up 39%, while net income grew 34% over the second quarter of 2021. Our Private Client business increased 33%. Middle Market and larger transactions were up a combined 59%, and our financing business, MMCC, delivered growth of 31% year-over-year. This is a testament to the dedication, creativity and energy of our sales force management team and support personnel, and we thank them for their unwavering commitment to our clients and the firm. We believe strategic growth initiatives implemented over the past few years have directly contributed to productivity gains, the retention of key producers and the addition of many experienced professionals to the MMI platform. These include a steady flow of technology upgrades and new tools, numerous marketing campaigns and increased client outreach as well as the constant elevation of our research content. Growth in our institutional division, IPA, and MMCC's financing business, also reflect the success of our diversification strategy and targeted acquisitions. Investor motivation to close transactions ahead of further interest rate increases continued to support positive momentum in the second quarter. For MMI, this heightened motivation also bolstered activity and resulted in some pull-forward of closings into the quarter. Once again, we saw a significant movement of capital across property types and geographic markets. This is another factor behind MMI's strong second quarter results as we are extremely well positioned to facilitate portfolio strategy shifts and changes for both private and institutional clients. Our access to the largest pool of buyers custom match to every listing we represent, and leading volume of 1031 exchange transactions resulted in 50% and of the best and final buyers of our listings coming from out of state. This clearly illustrates the company's tremendous market reach. For the first half, the company achieved year-over-year revenue growth of 53% and net income growth of 61% while maintaining its fortress balance sheet, leading brand and strong market position. The rapid rise in interest rates since March, expectations for an aggressive stance by the Fed and a widening bid-ask spread began to impact trading volume in the second quarter. Based on data provided by RCA, total U.S. market sales by transaction count were down an estimated 15% over the second quarter of 2021. Despite the drop in transactions in the overall market, I'm pleased to report that MMI's brokerage transactions increased 15% in the second quarter. Our key metrics remained healthy throughout the quarter, including a steady rise in inventory levels and year-over-year pipeline growth, although at a lower degree than the last few quarters. This is a function of transaction closing and marketing time lines starting to extend due to the market shift. As expected and messaged on previous calls, we continue to experience a reduction in sales force head count primarily due to the elevated fallout of newer professionals hired over the past three years. This cadre of trainees did not fully benefit from our traditional in-person training and development programs because of the pandemic. Similar to other industries, hiring new and experienced individuals has become far more challenging than previous cycles as a result of an extremely tight and competitive labor market. Our success in retaining productive professionals, the steady addition of experienced individuals and teams and positive results from our acquisitions have more than offset the gap in growing head count in the entry-level segment. The management team is highly focused on increasing our head count through new hiring initiatives and expanded development programs. Our traditional organic growth channel remains critical to the future expansion and diversification of the sales force. Looking forward, expectations of additional rate hikes and tightening financial conditions necessary to fight inflation are likely to result in further deceleration of trading volumes in the near term. This is a function of a buyer and seller recalibration on pricing by property type and market, adjusting loan-to-value ratios and a more cautious outlook due to recession fears. To offset these market challenges, our team is focused on reinforcing our ability to help investors formulate and execute the right strategy based on their specific needs and timing. A multitude of marketing channels are actively promoting our deep market expertise, property-type specialization, real-time marketing system and access to a wide network of lenders. As a case in point, MMCC closed nearly 700 transactions in the second quarter with 216 separate lenders. Our recent acquisitions are making significant progress, and we remain actively engaged with a number of additional targets that should result in incremental market coverage and other benefits to MMI. On the expense side, the return of in-person events as well as support staff additions in line with higher business volumes are essential to keeping the company competitive. However, we remain committed to tight cost management and investing in the right people and projects. We're encouraged by three major factors that, in our opinion, support a favorable long-term outlook. First, real estate fundamentals are generally healthy, thanks to the lack of overbuilding. Secondly, in an inflationary environment, real estate should continue to attract capital as an effective hedge. And if job losses occur due to a recession, they should be moderate since we're experiencing an engineered slowdown by the Fed to bring inflation in check as opposed to systemic issues. Despite the tightening cycle and excess liquidity sweep underway, the financial system is quite strong. The cycle is not marked by mortgage overspeculation, banking and corporate illiquidity and high levels of consumer debt, which caused the great financial crisis in 2008. To the contrary, consumers are flushed with cash. There are more job openings that available workers. Lenders have ample capital and remain active, albeit a lot more cautiously. In closing, our balance sheet continues to be a point of strength. Earlier this week, we announced Board authorization for our first stock repurchase plan, coupled with our second semiannual regular dividend declaration. The addition of a stock repurchase program reflects our commitment to continuously optimize our capital allocation strategy. Let me reiterate that accretive acquisitions and investments in the MMI platform remain our top capital allocation priorities. The company is in the enviable position of having an extremely strong balance sheet to pursue growth, first and foremost, while increasing shareholder returns at the same time. And with that, I will turn the call over to Steve for more details on the quarter. Steve?

Thank you, Hessam. We are pleased to have delivered a record second quarter with significant year-over-year growth in revenue and earnings. Beyond the headline numbers that Hessam mentioned, real estate brokerage commissions for the second quarter accounted for 90% of our total revenues or $355 million, an increase of 40% year-over-year. This represents transaction volume of $20 billion across 2,685 deals and year-over-year increases of 47% and 15%, respectively. This quarter's volume was also the second highest in the firm's history. Larger deals helped drive average deal size to $7.4 million per transaction up from $5.8 million a year ago. Within brokerage, our core Private Client business accounted for 59% of revenue for the quarter or $210 million, which was a 33% increase compared to the second quarter of 2021. Our Middle Market and Larger Transaction segments together accounted for 39% of total brokerage revenue at $138 million, an increase of 59% over last year. Moving on to our financing division, MMCC. Revenues were $37 million in the second quarter, an increase of 30% year-over-year. Fees from refinancing, which accounted for 43% of loan originations for the quarter, increased seven percent over the prior year. The financing transaction count was in line with last year, but at the same time, financing volume increased to a record $4.5 billion, representing a year-over-year increase of 56%. Other revenues, comprised primarily of consulting and advisory fees, along with referral fees, were $4.5 million for the quarter up 17% compared to the second quarter last year. Total operating expenses for the quarter were $339 million, an increase of 39% year-over-year and in line with revenue growth for the period. Cost of services was $256 million or 64.7% of total revenue, 200 basis points higher than the second quarter of 2021. As mentioned last quarter, our sales professionals have reached revenue thresholds earlier in the year as a result of our outperformance. SG&A in the second quarter was up 29% year-over-year to $80 million primarily due to sales support costs and normalization of in-person events. However, as a percentage of revenue, SG&A decreased to 20.2% for the quarter compared to 21.7% last year demonstrating leverage in the period due largely to out of warrants in revenue. For the quarter, we generated $1.04 of earnings per diluted share compared to $0.78 in the second quarter of 2021. Adjusted EBITDA was $63 million or 15.9% of total revenue compared to $48 million or 16.9% in the prior year. Our tax rate was 24.9% for the quarter compared to 26.4% last year. This decrease is primarily due to a windfall tax benefit related to settlement of deferred stock-based compensation. Moving to the balance sheet. We remain in a strong position with $542 million in cash, cash equivalents and marketable securities, which is an increase of $67 million over last year. As Hessam mentioned, the Board authorized our first stock repurchase program of up to $70 million and declared the next $0.25 per share dividend. Our exceptionally strong balance sheet, consistent operating performance and cash flow generation provide the foundation for continued investment in technology, talent and efficiency, sourcing accretive M&A opportunities and returning capital to shareholders through dividends and stock repurchases. These actions are not mutually exclusive and reflect our confidence in the long-term operating outlook and the durability of our platform through any business cycle. In the short term, transaction velocity will be challenged by the market headwinds that Hessam referenced as well as the increased variability of transaction closing time lines. This market shift will also make comparisons to last year's record velocity challenging. Cost of services for the third quarter as a percentage of revenue should follow the historical trend and increased sequentially and throughout the rest of the year as our sales professionals achieve higher revenue thresholds. On a year-over-year basis, SG&A for the third quarter is expected to increase in absolute dollars and as a percentage of revenue due to return-to-normal business activities and higher sales force support expenses tied to prior year outperformance. Lastly, we expect our full year tax rate to be in the 26.5% to 27.5% range. With that, we can now open the call for Q&A.

[Operator Instructions] Our first questions come from the line of Blaine Heck with Wells Fargo. Please proceed with your question.

Great. Thanks. Good morning. Hessam, I wanted to start with your share buyback announcement earlier this week. Just talk about how you and the Board determine the size of the program and give some more color on how you think about balancing that repurchase of shares at an attractive price and effectively shrinking the float on the market versus your desire that you previously talked about to grow the company through external acquisitions to balance those two.

Hi. Good morning. Sure, I'll address that. You just basically walk through the balancing act that we designed almost to a t and that our priority, as I mentioned in my formal remarks, has been and remains acquisitions, improving the platform and looking forward with accretive growth initiatives. It's always been the case. It remains the case, but we are now in a position to assess the balance sheet having just introduced the dividend policy let's say, in 2022, included a special dividend as well as the initiation of a recurring dividend. And then on top of that, we wanted to strike that perfect balance that you just mentioned between the priority for growth initiatives, returning some capital to shareholders through the dividend policy and then being able to enhance that through just the right size of an initial buyback just to sort of start the process of expanding the capital allocation initiative in a way that doesn't conflict with the growth priority and the fact that given our transactional nature and the cyclical industry that we're in, we've always been committed to and remain committed to having a very strong balance sheet from a defensive perspective. So balancing all of that is how we ended up with our program.

Yes, Blaine, this is Steve. A couple of additional points there. If you look at the size of the program, it's roughly five percent of our market cap. It's only 12% of our available cash. Other factors we looked at, of course, the business is still generating a significant amount of cash in the business. So over time, that cash balance will tend to grow. It's also a way of offsetting dilution that comes from the roughly 300,000 to 500,000 shares on an annual basis that we grant for performance and new hire reasons. So additional set of factors that we considered in the decision.

Okay. That's helpful. I guess should we expect activity on those repurchases in the second half if the share price remains the same as it is here? Or is it too hard to tell just given you don't know what opportunities are going to come on the external side?

Yes, and a valid question. I will say that we do -- this is not just a window dressing repurchase authorization. We do plan to be active in both for -- and opportunistic. It's too early to tell at what point we would enter the market. But we do believe in the future of the business and believe that this expresses our confidence in the business going forward.

Let me just emphasize that this does not shift our priority from acquisitions at all because we are in a position to pursue acquisitions as aggressively as ever, which we are and, at the same time, increase the return to shareholders.

Great. No, I think that's clear. That's helpful. There was a pretty steep ramp in average deal size for your financing segment, and I think that has been the highest on record. Is that just the function of the deals that you've seen in the market today? Or is it maybe the result of some internal initiatives to focus on larger deals within that financing segment?

Blaine, it's a function of two things. One, MMCC continues to mature as a finance intermediary. We now have an expanded set of lender partnerships, particularly our announcement with M&T last year, albeit that partnership has not yet shown what it can do to its fullest scale because the agencies have not been as competitive looking backwards as they're becoming as the market changes. And we expect the agencies to become a lot more active, and therefore, the partnership with M&T will show even better results. But in general, MMCC has become a much more competitive, top-ranked intermediary and able to execute our Private Client business, which, of course, is the bread and butter but also incredibly better positioned today than even a year ago, especially two or three years ago, to do larger transactions. On top of that, our acquisitions have been focused both on brokerage and financing, and the financing-related acquisitions that we've executed have brought some very experienced senior-level talent to MMCC. They tend to have had a book of business with clients that do larger deals. And then the latest addition to MMCC is through the acquisition of the Eisendrath Financial Group earlier this year is yet another step toward doing institutional financing and various financing projects for larger private investors. So all of that coming together has resulted in larger transactions. There is no effort or initiative to shift focus away from our Private Client business. By contrast, we're just as sensitive to making sure our tenured originators have been with the company for a long time that do sub-$10 million, $15 million financing day in and day out, have the right technology support. In fact, we have a number of initiatives to make sure that part of the business has the benefit of productivity gains through technology and lender relationship expansion. So there is no shift in priority. We're just maturing as an intermediary.

Got it. That's helpful. We touched on this last quarter, and you mentioned it in your prepared remarks. It does seem like broker count continues to decline seven percent below your highest level seen in early 2021. Is that something you guys are concerned about moving forward at all? Or do you think as you bring on kind of more seasoned brokers, their efficiency and productivity can continue to offset the overall decline in head count?

It is absolutely an important topic and an important initiative. We have the benefit of the offset from an immediate production perspective because we've had success bringing in experienced individual teams and the acquisitions. That's a great benefit that our strategy has brought to the table. That does not reduce the importance of getting back to net positive development of brand new individuals that we have traditionally been so effective at bringing on training and supporting to become incredibly successful long-term professionals. That's been the organic growth model of the company for 51 years, and we are not at all diverting away from that. We have the benefit of a combined strategy, which is paying off as we speak, but we have to get back to net positive growth of the sales force through our organic growth model. It's an aberration given what happened in the pandemic. Post pandemic, the effect of the lack of in-person development over the past 18, 24 months has a direct correlation to the numbers that we've been tracking. And on top of that, as I mentioned in my comments, in this employment market, it's a significantly higher mountain to climb in bringing in brand-new people into our platform with a significant training ramp-up. Remember, before we declare our professionals ready to get on the phone and go into client meetings, they go through a rigorous pretraining program. And we have not lowered those standards at all just to be able to alleviate the head count pressure. We want to do it right. We want to hire the individual people, train them as effectively as ever. The good news is that a number of our initiatives are paying off in turning the trend around. And also with the economy having reopened and our ability to get back together in person, we're already starting to see the positive benefits of that, but it will take time to turn the tide, particularly because the employment market is so tight. I mean this morning's announcement with 520,000-plus jobs just reaffirms how competitive the employment market still is.

Yes. That makes a lot of sense. The last topic to hit on, it's related to the first question, and it's another question that we continue to ask but I think an update isn't. Can you talk a little bit about your acquisition plans for fiscal 2022? What can you tell us about the pipeline or potential investment opportunities on the horizon and whether you have investments in mind that cater to specific sectors within real estate-specific markets? Or is it going to be more focused on the financing side as we've seen more recently?

Sure. We have an active pipeline on the financing side and the brokerage side. That pipeline includes a number of target firms and platforms that we're talking to as well as many individual experienced professionals and teams across the board. We're encouraged by all those activities. There is a lot of interest all around from people to join MMI. The success of a lot of experienced teams and acquisitions is a great testimonial for a lot of the new targets that we're speaking with. Some of the folks that have joined us in the last couple of years have become the great ambassadors for the brand and are actively helping us walk people through the specific benefits of being part of Marcus & Millichap. So we're really encouraged by our pipeline. It is a tough environment in that just as the bid-ask spread and the market conditions on the real estate side can go up and down. The price expectations and underwriting of acquiring companies also go up in that, as you can imagine. But -- so the market has become a little bit more challenging from a valuation perspective, an expectation perspective but not to the degree where any of our discussions have ended. And we'll continue to source deals. One of the key advantages that we have is our on-the-ground management team. Their local knowledge of boutiques and individual producers that they believe will fit culturally, and supplement that with our corporate acquisition and underwriting team as part of Steve's organization and the two working together to source just the right people, we do a lot of things to make sure we minimize the overlap and that the targets that we're bringing into the company are supplementary to the existing sales force in a local market or a property type. That tends to be the most important ingredient for success, and we've stuck with that, and it's been working so far.

Yes. So I guess just to follow up with respect to that bid-ask spread widening even on those external acquisition, I guess, have you seen any break in pricing for potential acquisitions yet? And if not, do you expect to see those opportunities emerge in the second half as market volatility has been increasing a lot of investments to reprice?

Yes, I will agree with that comment in that we've seen more interest from groups that we've spoken to before that didn't have a whole lot of motivation maybe a year or two ago. who are more interested now in reengaging with us just in the last 30 to 45 days. And I will say that the valuation has not become enough of a problem for us to stop dialogue with a number of groups that we've been talking to since earlier this year. And we've had to adjust valuation because of the change in the market environment to some degree, but that hasn't been enough to break the deal or discussion points. A thing that I'll point out is, in 2020, we executed a number of acquisitions even in the midst of a much, much bigger degree of uncertainty going into the pandemic than the market faces today. So deals can get done. We are very confident that the value of our platform and the -- really the contributions of our platform and our system as its own currency is as important as the actual financial terms of any deal. And we're really seeing that come to fruition with the acquisitions that we've made over the past few years.

Great. Thanks a lot for the time.

Blaine, great talking to you.

Thank you. This does conclude the Q&A session. I would now like to turn the call back over to management for any closing comments.

Thank you, operator, and thanks to all of you for joining our second quarter call, and we look forward to seeing you on the road and our next quarterly update. Thank you.

Thank you. This does concludes today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.