Moelis & Co Q3 FY2020 Earnings Call

Good day, and welcome to the Moelis & Company Q3 2020 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would like now to turn the conference over to Mr. Chett Mandel, Head of Investor Relations. Please go ahead.

Good afternoon, and thank you for joining us for Moelis & Company’s third 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 include references to certain 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. The 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 will now turn the call over to Joe to discuss our results. Joe?

Thanks, Chett. Good afternoon everyone. On today's call I'll go through our financial results and then Ken will discuss our business further. We achieved a strong third quarter earning $208 million in revenues. This resulted in sequential growth for the second consecutive quarter since the onset of COVID-19. The general M&A landscape dramatically improved in the third quarter, leading to a solid contribution from both strategic and sponsors. Our restructuring-related activity was the highest it's ever been, exceeding last year's record third quarter contribution. We experienced particular strength in out-of-court restructurings, a specialty of ours. We continue to excel in offering innovative solutions which, in certain cases, can accelerate the timeline to the resolution and avoid a lengthy Chapter 11 process. In addition, our restructuring retainers remain significantly elevated over the prior year and our capital markets business continues to make a steady contribution to revenues. Moving to expenses, adjusted compensation expense was accrued at 61% in the third quarter. Our non-comp ratio was 14% in the third quarter and we recorded $28 million in non-comp expenses due to continued low travel and continued expense discipline. Our normalized corporate tax rate remained at approximately 25%. This quarter's effective tax rate was higher than the normalized rate due to the reversal of some CARES benefits previously accrued due to current quarter profitability. Regarding capital allocation, the board declared a dividend of $0.3825 per share, an increase of 50% from the second quarter, which is halfway back to our former regular dividend. We've always operated from a position of financial discipline and remain committed to returning 100% of our excess capital. And lastly, we continue to maintain a fortress balance sheet with substantial liquidity and no debt. We ended the quarter with $266 million in cash and liquid investments and an undrawn revolver. And I'll now turn the call over to Ken.

Good afternoon and thank you all for joining the call. I know from looking at a lot of our people listening to our calls, internal people. So I just wanted to say how grateful I am for the dedication and focus you showed during this unusual time. You've all worked together to come up with innovative solutions for our clients, which has created a powerful and positive energy within the company, even though everyone has been working remotely. I'm awed by the breadth and depth of the leadership demonstrated by the firm during this crisis. Our unique culture sets us apart and allowed our people to come together creatively to solve client problems, which is why our business has been able to rebound so quickly. The fact that we have no debt and a fortress balance sheet enables everyone in the organization to put their heads down and concentrate on clients. Nobody was concerned about the financial health of our company, and everybody was busy helping clients focus on opportunities. Also, without the friction of an internal commission structure, we were able to rapidly form new teams to deal with client matters, many of which that we have never seen before, even thought of or faced. And lastly, I do believe COVID-19 will continue to reshape the global economy for years to come. The ramifications of the pandemic will force companies to make large-scale decisions about their marketing position, growth strategy, and capitalization. And they will need an adviser who can quickly pivot their resources in stride with the changing environment. This is exactly what we do. I believe we are the best at it, and that is why I feel so great about the future of the firm. And with that, I'll open up to questions.

We will begin the question-and-answer session. Our first question comes from Ken Worthington with JPMorgan. Please go ahead.

Hi good morning, I’m sorry good afternoon. Thank you for taking the question. You mentioned an accelerated path to restructuring by solutions; how big a driver was that accelerated path to the restructuring success that you had this quarter? And in terms of the restructuring outlook, did you continue to see a ramp in activity levels throughout the quarter or has restructuring started to level off given the environment?

No, I just said it was on a current basis that our retainers remain elevated. So restructuring continues. It's really a bifurcated economy, 75% of it is really headlong looking at M&A, 25% is having troubles and something like that. And so we continue to elevate and find restructurings. And Ken, we’re just pointing out we always do out-of-court. It's sort of a specialty of ours. It's a continuation. There was really nothing unusual about it other than people prefer it, and we've done a lot. We've always done it. I forget the exact percentage, but a significant percentage of our restructuring is done without doing it in court. And we think it's innovative, and as far as we’re concerned, most companies prefer to stay out of Chapter 11. I've found very few that like going in, especially after the fact after they've been through it.

Okay, okay fair enough. And then maybe your thoughts about a special dividend this year. Maybe it's a little bit of the cart before the horse, but given potential changes to the dividend tax rate under certain election scenarios, would you consider pulling forward a special dividend into 2020, or is the policy really to wait until March of the following year if you should choose to move in that direction?

Let's put it this way. I think our balance sheet, and you know we’ve brought the dividend back, but we still have a substantial amount of liquidity; no leverage on our balance sheet is a fortress. Again, we are pretty conservative with the virus floating around in case look, people have a different read on it and we just don't know if we're done with it. It feels like we're done business-wise, I mean things are picking up pretty dramatically. If there would be a substantial, I think you’ll take a substantial change in the election and an indication that there is some relevance in bringing a dividend forward that would be a benefit. We would definitely think about it. And I want to say anymore because that involves our board, that we have the capabilities of thinking quickly, being nimble. And if there was something in the tax future that we could foresee that this was a real benefit, yeah we would respond to it.

Our next question comes from Devin Ryan from JMP Securities. Please go ahead.

Could you provide some insights into the current M&A environment and how it compares to pre-pandemic levels when business was quite strong? It seems like M&A activity is returning to earlier levels, while restructuring is at a higher level, suggesting a solid outlook for 2021. How would you characterize the current M&A landscape in relation to the pace before the pandemic?

I believe our M&A activity is at an all-time high, with our backlog also positioned strongly. Back in July, during our second earnings quarter, we noted a significant uptick. It seems that our sponsor community may have reacted quickly, leading to this growth. However, larger transactions might be influenced more significantly by election outcomes and global tax policies. For clients experiencing growth rates of 20% to 40% annually, the impact of elections is less pronounced. This trend started to emerge around June and July, as we discussed in our second quarter call. Currently, we are exceptionally busy, experiencing two notable developments: first, our bankers are using their time more efficiently than ever. Many have mentioned working from 7:00 AM to 7:00 PM, whereas previously a significant portion of their time was spent traveling to and from airports. This change is dramatically increasing our productivity while also reducing expenses. Overall, I feel that our M&A sentiment is stronger than it has ever been.

Yeah. Okay, terrific. And then this ties into the point you just made, Kenneth. I guess for Joe just around expenses, so your non-comp costs are down 20% year-over-year at least in the third quarter and clearly some tailwinds there just with the limited travel. But as business starts to continues to recover hopefully and travel hopefully at some point here starts to pick back up. Where do you see that I guess balancing out and how should we think about non-compensation costs trending into next year? Just contemplating kind of maybe some recovery but at the same time maybe you pull back in some spending areas. Travel may not quite get back to where it was and also contemplating some of the headcount expansion that you're also talking about.

I believe that for the next quarter, non-compensation costs will likely remain around the $30 million mark, assuming travel remains stable. While I can't accurately forecast travel patterns, I am fairly confident that we won't return to the levels we experienced in 2021. It seems that we could see a decrease of about $8 million per quarter attributed to travel. Additionally, it's important to note that the new lease expense in New York is included in that $30 million run rate. Therefore, the main variable impacting this will be travel.

Okay. Got it. I just want to make sure the $8 million is where we get back to or that's the …

No no …

…ongoing benefit.

If you want to think about a boundary, we're currently spending modest amounts on travel. A couple million dollars a quarter used to be probably $10 million a quarter. So there's an $8 million delta on a quarterly basis. I don't know how to judge how much of that is going to have return. I'm assuming that it's going to be quite a bit less than the full $8 million gap right now.

Yeah. Okay. Terrific. I'll leave it there. Thank you guys.

Thank you.

Our next question comes from Manan Gosalia from Morgan Stanley. Please go ahead.

Hi, good afternoon. To follow up on the general line of questions, do you think we are at the beginning of another two to three year cycle in M&A? Your earlier comments on the call were quite optimistic overall, but what I’m trying to understand is that we usually experienced two to three year downturns during recessions. This time, however, it was only two to three months. How strong do you believe this current inflection is, and does this rebound have significant potential for further growth?

There are many uncertainties right now due to an upcoming election and the ongoing virus situation. However, I believe we are entering a long-term merger and acquisition cycle that could last two to three years. This is partly because around 15% to 20% of the economy is undergoing restructuring, severely impacted by the virus. These companies may consolidate as they adjust. It's evident that size played a significant role during this downturn. Additionally, the pandemic has significantly altered the economic landscape. For example, our own business has experienced a shift; we might do around $4 million in travel, down from $8 million, but our productivity has improved. Every business is reassessing its strategies and making substantial decisions. Companies that are thriving may choose to expand, while those not prepared for the digital economy might need to rapidly adapt their strategies. The changes prompted by COVID will have a lasting impact on many businesses, affecting their decisions about capital and market approaches. This is where we come in, as we assist corporations in making critical decisions and implementing them. I believe this trend will continue for some time.

That's helpful. And then, last quarter I think you spoke about you’ve done 14 deals on the capital raising side. I don't know if I caught it, but did you mention how much it did on the capital raising side this quarter and how much of a deal win do you have in that business?

We are pleased with our business. We hired two experienced professionals who joined us over the summer. Looking at the third quarter, I noted the second quarter due to the immediate need for liquidity, and we were there to provide it. The third quarter also demonstrated strong performance. While the second quarter was an exception, the third quarter remained solid. We believe the business will continue to expand, with numerous new markets and opportunities emerging. We have significantly improved our performance. Joe, do you have those numbers available?

In the past year, it contributed about 2% to 4% of revenues. This quarter, it's likely around 8% to 10%.

Got it. That's helpful. Thank you.

And you know that’s capital markets advisory. We don't have any trade, so it was all advisory, Devin.

Our next question comes from Steven Chubak from Wolfe Research. Please go ahead.

I wanted to start with a question about MD productivity. Historically, your MD productivity peaked in 2018 at just over $7 million, while the five-year average is slightly above $6 million per MD. Given the optimistic outlook in the release, how should we view productivity in the coming year? Additionally, considering the current pipeline, how soon do you believe you can reach that $7 million plus productivity level?

I'm not going to provide guidance, but I think that's a solid analysis. When we were growing rapidly, we always brought in new personnel. During periods of fast growth, many new employees haven't had the chance to integrate fully. 2018 marked the conclusion of a significant growth phase, and subsequently, our revenue trends caught up. I don’t view it that way, but I have previously mentioned that there's been a lot of discussion about whether we have a compensation issue. We experienced a revenue shortfall in the first half of 2019, then COVID impacted us in March. We weren't able to showcase what we anticipated would be a substantial backlog entering 2020, which then stalled. I think what you're observing now is that backlog being released into the market since we were engaged with it at the start of the year. Long story short, I don't want to provide guidance, but I believe the situation is revenue supportive, and if we can enhance our productivity through Zoom calls, I hope we're on the right path. However, I don't want to set a specific timeline and we are not issuing guidance.

No. I could certainly appreciate that, Ken. But thanks for all that color. Just a follow-up on the since you brought up the topic of compensation, through the first nine months revenues are tracking flat year to date. I understand that the fixed comp base is going to grow as the firm grows but wanted to just get some insight in terms of why that variable comp piece is higher since the revenue production is tracking flat with last year and any specific factors that maybe you could speak to.

The revenue for the nine months was at 61%, and although we aren't back to full normal yet, we're just starting the third quarter and beginning to get back on track. I believe we will reach our target compensation goals soon. It's important to mention that our goal has always been a 25% pre-tax margin, which we are currently exceeding, even though we haven't fully ramped up yet. Looking at the nine-month period, there was a quarter where nothing happened in terms of mergers and acquisitions; the restructuring was just beginning. It's crucial not to focus solely on this year's numbers, as there was a complete standstill for three months. However, you can start to evaluate our performance based on our current run rate, and I think you'll be able to see our progress.

Right. And just one quick cleanup for me. Can you speak to the contribution from ratchet fees whether that was a meaningful contributor in the quarter and also just provide the MD headcount?

The MDs are 127. Correct exactly. And I would, yeah 127, and I don't have a specific number and one of the reasons is, I don't think ratchet played a major role in the third quarter. I mean I'm sure there was a deal or two but I'm usually knowledgeable of when we've had something really hit the top end of a ratchet or changed it. It's probably... I thought it was kind of minor. But Joe, you have a flavor?

I agree. I don't know that number off the top of my head. But it's not something that struck us as being something that popped off the page.

Right. Because I mean you know, look there were a lot of deals so it was meaningful we would know it. That's why it's not meaningful, it was meaningful we would know them under.

Our next question comes from Brennan Hawkins with UBS. Please go ahead.

I want to begin with a discussion about the dividend. I appreciate your thoughts on considering a special dividend, but this year has certainly been a roller coaster for you all. I'm very interested in how your experiences this year might influence your views on the regular dividend and how you plan to manage it moving forward. Clearly, you have a more positive outlook on your business, and raising the dividend by 50% is a strong statement about that. Could you share your guidelines or overall philosophy regarding the regular dividend for the future?

I believe that we aim to return to our regular dividend strategy over time because we appreciate that approach. We've ended up with excess capital, which we distributed through special dividends. If you ask when the entire world will shut down again, I can say that I manage the company as if I own it entirely, focusing on safeguarding this valuable franchise we're developing. During the call, I mentioned that we're experiencing a strong recovery because no one in our company questioned its future or stability. Remember that moment on April 1 when people were really scared? I reassured everyone internally that we would be fine and that our clients should not worry about us. That reassurance carries significant value, and we believe it will pay off in the coming years as we've attracted excellent talent and built strong client relationships. While it has been a volatile period, I hope we won’t face another global shutdown anytime soon, and I plan to return to our usual dividend practices. If we were in a similar situation as we were on March 15, I'd take the same approach until I was confident everything was stable.

Yeah, I totally appreciate that April was a very different period and I'm not trying to…

Yeah.

I wasn't questioning whether the decision was good or not. I believe the business you’re engaged in is very strong and generates significant cash, as shown by your capital return policy. However, revenue trends can shift unexpectedly, whether due to cyclical factors or other reasons. My question was more focused on whether you might consider increasing the dividend at a more cautious pace as you expand. That's all.

No, I think we'll try to bring it back as soon. If you've told me the virus was cured tomorrow, I know where I'd be, and it would look pretty. Again, I'm speaking out of turn because I'd have to talk to the board, but we would probably bring it back pretty quick and we'd want to go back to that. We have a great balance in business; we have a great restructuring team and they usually it's counter-cyclical. And our cash flow is balanced for that reason. And we also have a very nimble team and they all move to do like in the second quarter they all move to help do the capital market side of the business. So I have a lot of faith in them to do things like that. I just had no idea of what would happen when we all went home and sat on our couches; that concerns me because I've never done it before. But I do know in a regular way if you've got a great restructuring team and you've got great thinkers, I know what we can do with cash, and by the way, we have no debt. So if there was a quarter, if there's a quarter of downturn I don't mind because we have such a fortress balance sheet. Quarters don't matter. So I'm pretty comfortable with it. We generate that kind of free cash flow, that's why for all those years we were shedding cash; we were having to do two specials, one mid-year, one at the beginning of the year, because the cash buildup is so quick. So I think I'd be, if you told me Brenna that you had cured the virus, I think I know what I'd recommend to the board. And it would be very, very similar to what it was prior.

That is very, very clear.

Yeah, I can't say the board would approve it. I have to speak for them but I know what I would recommend.

Great. Thank you. Thank you for that. And then just wanted to follow up on the MD headcount question. So 127, I think that's up one year-to-date. But you have either promoted or hired a total of 13. So can you help us square was that just the idea that maybe you had realized at the end of 2017 that you had previously gone through too fast a growth spurt and you needed to make some adjustments, or was that just regular way departures that happen all of the time; can you maybe, was there anything unusual happening on the MD count side.

We actively manage our headcount every year, often starting discussions with employees around this time and giving them until the end of the year. Many of these employees may leave in January and February, although they are still on the payroll at the end of December. We don't focus on the specific reasons for departures and do not incur extraordinary charges. Our compensation ratio includes all hiring, which represents investment spending and encompasses our people management efforts. We consider people management to be a core competency and do not separate it out; it's integrated into our annual evaluations. This year, I don't believe there were many departures; we aimed to avoid any headcount reductions early in the crisis and only communicated with people we had spoken to at the end of 2019, allowing them time to transition.

Okay. Great. Thanks for answering my question.

Thanks.

Our next question comes from Michael Brown with KBW. Please go ahead.

Great. Thank you, operator. Ken, I wanted to follow up on the compensation discussion we had earlier. As I mentioned, revenues have been flat year-to-date now that we are nearing the end of October. I’m curious about your thoughts on the full-year compensation ratio. There was a lot of uncertainty earlier this year, but now that we are getting closer to year-end, do you have any insight into where that ratio could land? Last year, it was at a 63% for the full year. I know there are increased fixed and variable costs in the compensation structure this year, but I’m trying to gauge if we might see it in the mid-60% range, especially with an election coming up, which could definitely be unpredictable.

I'm not going to provide guidance for the fourth quarter. We believe our backlog is strong and the third quarter performance is solid. It may not reach the run rate of 2018, but it's stable. The way we assess our performance is different when there's no virus or full business shutdown. The second quarter of 2020, particularly, did not represent a normal business environment. So, blending the entire year involves three distinct phases, with the second being unique and the third showing our approach to business in a standard context. The fourth quarter will be what it will be, but the third quarter gives insight into our business outlook.

And you mentioned the backlog and because of this pandemic the drivers of this turnaround in M&A had been quite different. And we've seen certain areas that have been stronger and areas that have been a lot weaker here and so cross-border has been weak, large-cap strategic have had pockets of strength but we haven't seen a full bounce back there at least not yet. So how would you characterize some of the key themes supporting your backlog at this time? What are some of the key strengths there? And then I also wanted to hear about what you're seeing in Europe obviously the cases there have been spiking and just curious if that has sort of the impact deal activity over there in Europe? Thanks.

The interesting part is I can't almost everywhere is strong. I go around the world and I think Asia is fairly strong; our even, even our joint venture which nobody talks about. We do have significant exposure to Australia; they're doing well. The Middle East is booming; I will tell you that that franchise since we were involved with the Saudi Aramco IPO is leading, the lead advisor on that I think our activity there has never been higher. Europe is as good as it's been in a long time and we get a lot of headcount. We brought in some great people. We've done some maneuvering around Europe. Does it have the profitability of the US? No it doesn't have the velocity of deals that the US does. But I feel much better about what we're doing in Europe. The US is strong and the US is unbelievable how it recovers from these things. I think it's a real testament to our economy. And I think as we said all the businesses are really, really doing well. I can't think of I mean M&A is doing fine doing very well. Restructuring is elevated and even capital markets continues to go fairly well; I think well if I had maybe a mark. I don’t have that really that, everybody seems to be doing pretty good. I can't really think of a bad market.

Okay yeah appreciate the color. Think again.

Our next question comes from Jeff Harte from Piper Sandler. Please go ahead.

Hey good afternoon guys. Most have been asked, but just a couple of follow-ups. When we look at the M&A business, is it reasonable to think that the worst is kind of behind us now from the COVID announcement drop off?

Yes.

Okay.

In my opinion, the answer is not only yes but I believe many people are embracing opportunities. It may sound unusual since we are still at home and facing a lot of uncertainty. However, I feel that a significant number of individuals in leadership positions within companies and institutions, particularly in private equity, are eager to take action.

Okay, and as we look from the outside, kind of the industry data we can see shows mega deals and really big deals being awfully strong. But deal counts kind of lagging a bit. Are you starting to see some spillover from kind of the mega deals into more of the middle market?

I kind of see it the other way around. I thought the middle market when I was having the call in July and I said I saw the M&A market come back. I've got feedback that all you guys said I was seeing something different than everybody else. So I saw the first mover being the sponsor community coming back quickly. Then I saw, I felt that thing went to the big deal market, but that may just be me; but that's what I saw.

Yeah. It’s Interesting.

I want to clarify that I believe the market is substantial enough to attract institutional financing, which is significant. However, smaller deals seem to be facing challenges. The banking sector is not fully supportive, and I anticipate there will be real consequences for the wider economy, so caution is needed. I believe M&A activity has initiated in what we now refer to as the sponsor middle market, which typically ranges from $1 billion to $10 billion. This sector can access institutional money and credit markets, which is different from relying on banks. Since banks are not fully committed to financing, there may be a delay in response due to potential issues within the banking system regarding credit.

Thank you. You mentioned earlier the relative contribution from the capital markets business, and I thought I heard you say something about restructuring. Did I hear you correctly that restructuring was close to the top of the 25% revenue range it has historically been in during the third quarter of 2020?

I think that's accurate. Yes, for Q3, that's correct.

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

Thank you all for getting on. Next time we talk, the election would be behind us, it will be 2021, hard to believe and I hope we're talking from an office somewhere and not from home. So good luck, stay safe, and we'll see you in 2021. Thank you.

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