Moelis & Co Q1 FY2020 Earnings Call

Good day, and welcome to the Moelis & Company First Quarter Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Chett Mandel, VP of Investor Relations. Please go ahead.

Thank you. Good afternoon, and thank you for joining us for Moelis & Company’s first quarter 2020 financial results conference call. On the phone today are Ken Moelis, Chairman and CEO; and Joe Simon, Chief Financial Officer. Before we begin, I would like to note that the remarks made on this call may contain certain forward-looking statements, which are subject to various risks and uncertainties, including those identified from time to time in the Risk Factors section of Moelis & Company’s filings with the SEC and in our earnings release. Actual results could differ materially from those currently anticipated. The firm undertakes no obligation to update any forward-looking statements. Our comments today may include references to adjusted financial measures. We believe these measures, when presented together with comparable GAAP measures, are useful to investors to compare our results across several periods and to better understand our operating results. A reconciliation of these adjusted financial measures with the relevant GAAP financial information and other information required by Reg G is provided in the firm’s earnings release, which can be found on our Investor Relations website at investors.moelis.com. I’ll now turn the call over to Ken to discuss our results.

Thanks, Chett, and good afternoon, everyone. During the COVID-19 health crisis, we quickly adapted to a work-from-home world in efforts to support the health and well-being of our team. We have been very active in helping our clients who need quality advice, judgment, and focus during this challenging time. While this has certainly been an unprecedented environment, I have absolute faith in science and human ingenuity to defeat this pandemic. The world has completely changed during the first quarter of 2020. The first two months of the year were nothing like the third month, and right now is completely different from where we were in March. From the moment it became clear that the virus would radically impact the global economy, we shifted our focus to advising clients on the importance of balance sheets and their business models. Companies are seeking our expertise to better understand their capital and liquidity needs, the resilience of their business, and how they should adapt to this new environment. So just as these matters are central to our clients right now, I felt that it was important to walk you through the fundamentals of our own balance sheet and the strength of the Moelis business model as well. First, we have a fortress balance sheet and substantial liquidity. We have $145 million of cash and an undrawn revolver. We have absolutely zero debt on our balance sheet. Third, we have very favorable and low-cost lease obligations. Most importantly, we have not undertaken any commitments on additional space for growth, giving us a lot of flexibility there. Lastly, on the balance sheet front, we have virtually no cash compensation obligations arising from prior years. Secondly, regarding the strength of our business model, we have the best restructuring and capital solutions team in the world. Our collaborative one-firm model with one P&L and no segmented commission structure delivers the full capabilities of the firm seamlessly to provide the best solutions to clients. We have already shifted tremendous resources throughout the firm to support the rapidly changing needs of our clients, which has led to strong activity levels since the middle of March. At the same time, we are still engaging in significant M&A dialogues; however, most of these transactions will probably be on hiatus in this environment. As indicated in our press release, after careful deliberation, we halved our regular dividend to $0.251 per share. Modifying our regular dividend is the prudent thing to do in the current uncertain environment. One of my all-time favorite quotes comes from a book, Adventures in the Screen Trade, by the late William Goldman. Goldman wrote, 'Nobody knows anything.' He was referring to the ability of movie experts to reliably pick winning movies. I feel that sentiment accurately describes today’s economic environment and the unknown timing of the recovery. Therefore, we have decided to retain capital until we know more. However, we remain committed to returning all of our excess capital to shareholders, and when the future is more certain and business activity stabilizes, we will not hesitate to restore our dividend and declare a special dividend if appropriate. I’ll now pass it to Joe, who will walk you through our financial results, and then I’ll conclude with a few final thoughts on the environment. Joe?

Thanks, Ken. We earned first-quarter revenues of $154 million, up 12% from the prior year period. Toward the end of the quarter, we saw transactions being put on hold, with most of those deals delayed due to the uncertainty and market volatility caused by COVID-19. At the same time, our restructuring business, coupled with our capital markets capabilities, has experienced a tremendous increase in mandates recently, and we feel very confident about its longer-term contribution. However, there is a transition period in the short term as we earn retainers and interim capital raising fees, but expect a lag before we earn completion fees on most restructuring transactions. Moving to expenses, our first-quarter adjusted compensation expense ratio was 62%. The fixed compensation costs are always slightly elevated in the first quarter due to retirement accounting for our annual equity grants and payroll tax charges. Our non-compensation ratio was 22% for the first quarter of 2020 versus 28% in the prior year period. Absolute non-compensation expenses declined 10% versus the prior year, largely driven by decreased travel and other business development expenses due to social distancing restrictions implemented for most of March. Moving to taxes, our underlying corporate tax rate was 25.2% for the quarter before the discrete tax benefits, primarily related to our equity award settlements. This resulted in an overall net tax benefit for the quarter. And now I’ll hand the call back to Ken.

Thanks, Joe. So let me conclude with this. I’ve experienced many different cycles and environments throughout my 40-year career, but I’ve never seen an economic cessation caused by a global health crisis. A lot of what will happen in the coming weeks and months will be dictated by governments, medical experts, and circumstances that are completely unpredictable and out of our control. Because the timing of the recovery is uncertain, a fortress balance sheet and having a diversified, flexible, and collaborative business model is of paramount importance. We have come prepared; it puts us in a position to do what we do best, which is to empower our employees, exceed our clients’ expectations, and execute for our shareholders. And with that, I’ll open it up to questions.

We’ll now begin the question-and-answer session. Our first question will come from Ken Worthington with JPMorgan.

Hi, good afternoon, and thank you for taking my questions. I’ll start with costs. First, regarding compensation, $95 million. Last year’s compensation for the year averaged and touched under $120 million for the quarter. In hindsight, it seemed like Moelis may have under-accrued in the first part of the year in compensation and moved to a higher level of compensation in the second half of the year. So, as we think about the $95 million, is that a comfortable level for you if revenue generation is low for 2020 to persist for the rest of the year? And if so, that would suggest about $100 million less in compensation in 2020 versus 2019. Is that a level that feels right to you or not?

The answer is, I don’t know. I am going to try to be very careful. I think the next couple of quarters and maybe even the recovery quarters, if they come as soon as the end of the year, are so unknowable, Ken, that I’m not going to – that was the first quarter – it was the first quarter, and we did ratios pursuant to the first quarter. I believe we’ve got a really – this is a year that, again, I have no control over. There are no tools I can use as the CEO to turn the economy back on, to cure the virus, and to affect the medical expertise. So in that regard, I am just going to leave it as we’re going to all have to wait and see what this – how the year unfolds, and we’ll make decisions around that when we know more. That’s really all I’m going to say.

Okay, okay. I think it’s fair. And then on the non-compensation side, social distancing and the slowdown in travel happened towards the end of the quarter, not for the full quarter. As we think about at least the next quarter, and maybe I’ll throw out the assumption that the social distancing continues, what should we expect from you guys in terms of the non-comp if travel remains as slow as it was in the latter part of 1Q? And I guess my assumption is that, that travel and meeting with clients has really slowed, maybe that’s an error, and you guys are able to get out on the road. But if my assumption is correct, what should we think about for non-comp?

You’re correct on that. Joe – we’re not having a lot of in-person meetings and not a lot of flights. So Joe, do you want to take that?

Yes, sure. Look, just as background, we’re constantly reviewing non-comp. You might recall, in 2019, we decreased the absolute dollar amount of overall non-comp versus 2008 while still adding headcount. This year, we are seeing a natural reduction in T&E. We’re also taking action on a variety of other areas. I think I’d expect the second quarter to be probably less than $30 million going into the second quarter.

Okay, great. Thank you very much.

Yes.

Our next question comes from Devin Ryan with JMP Securities.

Great. Good afternoon, Ken, and Joe.

Good afternoon, Devin.

A question I get pretty frequently from our clients is trying to frame the upside case for restructuring and restructuring revenues. I appreciate the long timeline on restructuring closings, and so, there tends to be a little bit of a mismatch as M&A slows. But how do you guys think about, as maybe the potential upside case, is there conditions for doubling or more? Or any other kind of frameworks that you think about how much better business could get to the extent this stress continues? I appreciate you guys have a pretty good opinion just given that the firm was set up really at the beginning of the prior restructuring cycle?

Yes. I don’t have an exact number, and it’s hard to know, but doubling seems easy. I think, as we get going and ramp it up, again, Joe said, there is a transition when you go from – it’s like the car was going forward, and we put it in stop, and now we’re going backward; how fast can we go? We can go fast. I’ve probably been pleasantly surprised at how fast the level of conversations and calls are picking up. I think one of the reasons is, one of the benefits is, M&A is a relationship business. You have to be out on the road and meeting your clients over weeks and weeks before they will hire you. I’ve always said that restructuring is kind of a fire department type of business. You don’t spend a lot of time with the person who’s going to restructure your balance sheet because you’re not thinking that, and most places aren’t planning on that. The calls are fairly immediate, and actually, not being there in person is much less of a barrier; not having that personal interaction. We’re able to get calls and work done extremely quickly because, as I said, nobody is at their kid’s ballgame or out for dinner or on an airplane or at a Board meeting. When we’ve gotten calls to come up with ideas and help people, we had everybody on the phone just 5 or 10 minutes later. It’s stunningly efficient. So the short answer is, I think M&A became a fairly large business over the last three, four years. I don’t know that restructuring could ever replace it, but I think restructuring can become a lot larger than it was in the 2008, 2009 cycle, given how much paper is out there. And in our firm, we’ve retained almost our whole team. We probably promoted five people from within over that time to be MDs or more. As I said, last cycle, we went back and looked; every one of our MDs, except one, actually worked, transitioning from working on M&A and advice to restructuring. In this cycle, we’re committed to finding that one guy and making sure he gets to work too.

Got it. Very helpful, Ken. Just a follow-up on maybe a little bit more of an M&A spin, but pretty clear that pretty much every company in the world moved from normal business operations to a hyper focus on health of their employees and clients as well. You’re talking about maybe some of the dialogues starting to pick back up a bit here, but we’re early days, and there’s still a lot of uncertainty. What are some of the signposts that you would maybe think about as indicators from the outside that would suggest there’s more willingness to move forward on a transaction? If anything, is there any nuance between sponsors and how they’re thinking behaving versus your corporate clients at the moment?

So you’re talking about M&A. There is a lot of – I call it, transactions. They’re just not for control. There’s a lot of PIPE and transactional volume around rescue financing. The risk-adjusted return in many of those cases comes in at levels above common stock or sometimes in a secured position for rates of return that are close to equity return. Right now, there is a lot of transactions, and that’s where they’re going. I think the signpost – you’ll almost be able to see when we see it; it’s about being able to underwrite the next 12 months. You cannot buy a company if you cannot underwrite to some level of certainty the next 12 months of operations or even the 12 months after that. Right now, you couldn’t do either. Again, because we’re not in control of this, I just want to say that’s one of the reasons M&A has to slow down. In the 2009 crisis, maybe you could figure out what you wanted to do because it was a financial crisis, and you could wager on your own expertise in understanding how deep and how long a financial crisis is. The health crisis is outside of the purview of most boards and management teams to underwrite, and remember, that also relates to the government reaction to the health crisis. You have to see two things: the ability to control your own destiny return to the boardroom or C-suite and the ability to underwrite some level of an economy or the business you can do. That’s why M&A is not happening. There are some companies involved in technology and health care that are uniquely not negatively affected by this, but the significant majority are.

Right. Is there any nuance between sponsors that need outside financing and have more leverage, but there are also some differences there versus corporates that could use equity? All equities or values have moved lower, so maybe there’s still kind of a fair swap. Is there any difference in those conversations, or would you say it’s all quite similar in terms of how your firms are reacting to thoughts on M&A?

No. I’d say it’s fairly similar because you sort of have to be able to do due diligence and underwrite a business model. Even if you’re going to swap your own stock and think your stock is low, you do have to do due diligence and become comfortable with the other person's business prospects, which is very hard to do in this environment. So that’s difficult. I think sponsors are willing to do things, but the rescue financing opportunities, risk-adjusted for where they can put their capital for the time being, are attracting their attention more than trying to do whole company transactions. The most difficult part of this to get back on track is going to be the middle market. Financing is already available to large caps. The Fed’s move to open the liquidity and start to buy investment-grade and fallen angel junk credits has helped those companies that have rushed to market. I think the part of the market that might take longer to come back is that basic financing, leveraged financing for the middle-market company that has to rebuild after and rebuilding that will take some time.

Yes. Got it. Appreciate, Ken. I’ll leave it there.

Thanks.

Our next question comes from Manan Gosalia with Morgan Stanley.

Hi, good afternoon. You mentioned that doubling of restructuring is very possible. Is there a limit on how much capacity you have to take on more business, given that multiple industries right now are facing pressure? You could see a pretty significant spike in restructuring activity. How easy is it for you to pivot your entire team towards restructuring?

No, I think we can do it. Is there a limit? Yes, there’s going to be a limit. If we stayed in this type of environment for a while, I think doubling would be the baseline for most restructuring. And remember, it depends on how you define restructuring. A lot of this rescue financing starts as restructuring and ends up as a capital markets trade, which is very good. It’s good for the companies and it’s a more immediate opportunity. But you might read that as capital markets and we might see that as having started as restructuring. It’s one of those businesses; if you’re willing to get into as a Managing Director, the trouble is sometimes you have some senior managing directors who don’t want to learn a new business. I mean, part of the reason I think our workforce is much more flexible in that regard. We hired a Managing Director in energy a few years ago who didn’t know what a restructuring was. When I told him we had a grid restructuring group, he shook my hand, saying, 'That’s really good to know.' Then he went home and Googled what a restructuring group does. Now he’s probably, he’s not in our restructuring group, but he’s probably our most experienced restructuring guy that we have, and that’s happened in retail and media before. I think we could really expand; the workforce will expand rapidly. We have about 50 or 60 dedicated restructuring people. We will pair them up with our leadership. They will do one or two deals in their space and then the leadership will be pretty expert in how to do it.

Got it. That’s helpful. And then, separately, can you give us a little more on how you’re thinking about your liquidity? I know you said you have $145 million in cash and short-term securities, and you know that’s higher than what you’ve had in some quarters. What buffer would you be comfortable building before you take the dividend back up?

It’s not really about the buffer. We’re in a great position. We have no debt. We have a low burn rate. We have the best lease structure of anyone and no deferred cash. I view it as an offensive move. There are two things that could happen: if someone cures this, and we’re all back to work, fine, I’ll pay a special. I’ll be embarrassed a little bit that I was overly careful or it could go further. I believe it’s a very offensive move. I think this is the time to get prepared to grow. Moelis & Company was created in the last crisis. People used to ask me five years ago, when we went public, what’s the one thing I regretted? And I said we only hired 60 people a year. It was the greatest moment we could ever have to acquire top talent that never becomes available. In this environment, people are going to look at their balance sheets of the companies they work for, whether it’s boutiques or big banks, and they’re going to want safety and they’re going to want to know that they have a great career in front of them. To me, it’s not about the buffer; this is an offensive move so we can be aggressive if we have the opportunity.

Got it. Thanks for taking my questions.

Our next question comes from Brennan Hawken with UBS.

Hey, good evening. Thanks for taking the question.

Hi, Brennan.

I wanted to follow up on the dividend question. You flagged the strength of your balance sheet, and I would certainly agree with you on that point. It seems very clear this is something that’s been a priority for you since the IPO. I think maybe what might be leading to some confusion is that if you have such a strong balance sheet and you think that this is an asset, are you worried about sending the mixed message of cutting the dividend, which might lead some to wonder whether or not you’re facing challenges? It’s usually seen as a move of weakness. How do you balance the risk of sending the wrong message, especially in light of what a priority is to have the fortress balance sheet that you’ve built up over these many years?

That’s a good question. We thought a lot about that. There are a lot of people out there skipping dividends, and we said, let’s go to half. By the way, was there extreme science around the half? I wish I could say yes, but it felt fair. Our capital return method has been to almost pay a 100% net income out in dividends. Until recently, we weren’t buying a lot of stock. A lot of our competitors have a much lower dividend payout and have managed the excess capital through share purchases. They can stop the share repurchase easier. We decided to do this. The biggest non-receiver of the cash is probably the largest shareholder, which is myself and the employee base. What I really want to own is the best franchise. People have asked me: will we be the best and largest investment bank in the world? It will happen because we are prepared for a downturn in a way that nobody else is. We’re not going to grow an extra 5% a year in the good markets by stretching, but we might grow 25% or 30% during the bad market. It’s here, and I’m not going to give up if it was tough. It was a long answer, but it’s important for everybody to know. I’m not driving the car on these decisions. Tony Fauci, Donald Trump, and the Governors are driving the car of when to get back in gear. I don’t know when that will happen. It would be a different decision if I could predict what I could do with things under my control. I’m not going to give up my advantage of keeping a clean balance sheet; I’ll keep that advantage no matter how tough it gets.

Okay, thank you for that. My follow-up is on the same topic. Is it too much to say that the Moelis approach to a dividend is just a flexible philosophy around the dividend? What you described some of the others in the comp set is using share repurchase as the valve; you all have used dividends. You’ve ratcheted up the regular very quickly and now you’re adjusting it also more quickly than others might. Is it just a difference in philosophy?

No. Let me tell you something. In our last dividend raise, we raised it slightly. The reason I raised it was to have in mind that 20 years from now, we’d be a dividend aristocrat, that we would have raised our dividend every year. I wanted to be one of those guys; that was my plan. But nobody told me they’d shut down the global economy for an unknowable amount of time. I didn’t have that in my planning; or maybe I did because we ended up with a good balance sheet. In the balance of whether to be a dividend aristocrat 20 years from now or to have the most powerful franchise position that I could take advantage of, I chose the powerful franchise. I hope one day, they’ll have a footnote around dividend aristocrats and say only skipped during a pandemic. It would be like Roger Maris’ home run asterisk.

Our next question comes from Jeff Harte with Piper Sandler.

Hey, good evening guys. A couple from me. One, you talked about restructuring and how things are very active, with a timeline to revenue recognition being longer. Can you give us an idea of what you think that timeline to revenue recognition would normally be and to what extent the pandemic environment may impact and stretch that out or make that longer, like it appears to be doing for strategic M&A?

Look, restructuring usually goes about six to 18 months, depending on whether it’s out of court or has to go to court. That’s kind of a restructuring; you get a monthly fee and you do it now. I think the pandemic restructuring fee stream could be slightly shorter, and I’ll tell you why: this is less about leverage. It may become an over-leveraged situation in the short-term, but in the very short term, it’s a liquidity crisis. A substantial amount of companies out there either have zero EBITDA and some have zero revenue, so how much cash becomes a problem? The solution is capital or something immediate. You don’t have enough time to fix the balance sheet; all you’re trying to do is fix the cash position. Therefore, I think a substantial amount of early assignments could actually conclude quicker and might be reported as capital markets, but usually, six to 18 months is a restructuring.

Okay. Along those lines, capital markets advisory, I would think there’s a potential for that to pick up some with the environment out there. Would you expect to see that pick up, and can you give us a general idea of what kind of fee sizes capital markets advisory tends to bring in relative to, say, advisory or normal advisory?

The fee pool is generally smaller. Right now, it’s all over the place, but anywhere from 1% to 3%. Equity is probably still 5% for private capital being brought in. It depends on the nature of the rescue capital; some is coming in as secured credit, some is coming in unsecured, some will be a PIPE, preferred PIPE, and some will be equity. I’d guess it’s a broad brush; there are a lot of specifics, but it could go anywhere from 1% for secured financing to as large as 5% on equity.

Okay. Finally, as far as ongoing client dialogue, can you talk a little bit about the strategic side, how conversations are still taking place? I guess I’m trying to get a feel for how underlying C-suite desire to act strategically today compares to prior recessions. If they’re not in survival mode, maybe they could turn back on more quickly.

There was a lot of – we had a good backlog coming into the end of the crisis just on quality assets. When markets are peaking and valuations are high, the best assets were getting ready to come to market in January and February because we had all-time highs in valuation; people were putting their best assets up. We have a substantial backlog. We’re continuing to talk about that with them. We’ve put a lot of those conversations on hiatus; there’s part of the dialogue. Then people are discussing what they’d like to accomplish if the market comes back. I wouldn’t say it’s a should we approach; it’s more of an interesting asset at that price, and maybe they’ll need to do something and that’s the kind of conversation we’re having. So it’s conversational, but I wouldn’t say they have their finger on the trigger.

Okay. Thank you.

Our next question comes from Michael Brown with KBW.

Hey, good evening guys.

Hi.

Most of my questions have been asked, but I had a couple on restructuring. I wanted to get your thoughts on how you kind of think about this cycle, given it’s quite different than prior cycles? One element I was trying to get at is how you think about how some of these stimulus programs and how quick QE came to market will impact this cycle. Is it possible we see a second wave of restructuring when some of the support wears off, say, next year? Can you give a little bit of color on the debt advisory side?

Okay. Look, I don’t know. I like to stick with the 'Nobody knows anything,' so don’t try to be a genius here. There could be a second wave. Comparing this to the 2009 crisis, most people went to work every day. There was a crisis, but 99% of the jobs in restaurants, bars, and mom-and-pop retail went to work every day. This is unbelievable. The damage it will do is going to come in waves. Right now, it’s about liquidity; later, it’ll be about leverage. Yes, I do think there’ll be a second wave. Today, it’s about liquidity; later, it will be about leverage.

Okay. One quick follow-up. I appreciate all the color that you gave on the dividend and hunkering down for a very uncertain environment. Clearly, it sounds like you’re looking for an opportunity for hiring, similar to what you saw in the financial crisis. Given the significant shift in the environment, is this also a time to reassess your existing workforce? Is there some repositioning that could happen relative to the change in the environment? What may need to happen, given the outlook for the industry has radically changed?

Thank you. Yes. We don’t want to do anything during the crisis; people have a hard time. Secondly, we’ve been doing this continuously. We take workforce management as a continuing operation. Last year, we moved some people out. We do it continuously. It’s not a single event; it’s an everyday event. I will say that if the shape of the whole workforce changes, we may end up with the wrong workforce in the wrong places for post-COVID; we’ll address that. For now, we’re not planning anything, and we’re pretty happy with the majority of what we have. Look, everybody needs help, so we want all our sector bankers to contact their industries; even if it’s restructuring, we have great restructuring expertise. We don’t want to give up the connectivity, but yes, we’ll reassess if that’s your question.

Okay. Great. Thank you for taking my questions.

Our next question comes from Matt Coad with Autonomous Research.

Hey, Ken and Joe. Thanks for taking the question. I hope you guys are making it through this strange time really just fine. So like one open-ended one – I know it’s incredibly difficult where we stand right now – but given the number of conversations you have with various business leaders across the country and globe, could you provide your take on any potential ramifications this cycle could have on M&A activity once the economy begins to recover?

There is a very optimistic perspective – and I think it's possible that you could have both a continuing restructuring environment from over-leverage and also a consolidation M&A wave. Look, it’s not a good thing that this has happened to middle-market companies; they may not get back on their feet. The biggest firms in their industries, who had strong balance sheets and access to capital, could lead a large M&A wave in industries where consolidation is necessary to eliminate the middle. I could see both things happen. I don’t think that’s a this-year event; it would likely be next year, but it could happen.

Awesome. Thanks, Ken.

Thanks.

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

Okay. Thank you, everybody. Before I go, I wanted to thank Michele Miyakawa for her important contributions as a founding member of the firm. She is transitioning back to the banking side of the business. Taking over Investor Relations function is Chett Mandel, who many of you have met and have worked closely with over the past five years. Please try to throw Michele some business; she’s a great banker, and I’m sure you’ve all gotten to know her. Thank you for your time this afternoon. My thoughts are with all of you, your families, and your extended families as we navigate this difficult time. Please stay safe and healthy, and we look forward to speaking with you soon. Thanks.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.