Earnings Call Transcript - PWP Q1 2023

Operator, Operator

Good morning and welcome to the Perella Weinberg Partners First Quarter 2023 Earnings Conference Call. This conference call is being recorded. At this time, I'd like to turn the conference over to Taylor Reinhardt, Head of Investor Relations. Please proceed.

Taylor Reinhardt, Head of Investor Relations

Thank you, operator, and welcome to our first-quarter 2023 earnings call. Joining me today are Andrew Bednar, Chief Executive Officer; and Gary Barancik, Chief Financial Officer. A replay of this call will be available through the Investors page on the company's website approximately two hours following the conclusion of this live broadcast through May 11, 2023. For those who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, May 4, 2023, and have not been updated subsequent to the initial earnings call. Before we begin, I'd like to note that this call may contain forward-looking statements, including PWP's expectations of future financial and business performance and conditions and industry outlook. Forward-looking statements are inherently subject to risks, uncertainties, and assumptions. It could cause actual results to differ materially from those expressed in the forward-looking statements and are not guarantees of future events or performance. Please refer to PWP's most recent SEC filings for a discussion of certain of these risks and uncertainties. The forward-looking statements are based on our current beliefs and expectations and the firm undertakes no obligation to update any forward-looking statements. During the call, there will also be a discussion of some metrics, which are non-GAAP financial measures, which management believes are relevant in assessing the financial performance of the business. PWP has reconciled these items to the most comparable GAAP measures in the press release filed with today's Form 8-K, which can be found on the company's website. I will now turn the call over to Andrew Bednar to discuss our results.

Andrew Bednar, CEO

Thank you, Taylor, and good morning. Today we reported first-quarter revenues of $131 million, down 13% from the year ago, and that's against a challenging operating environment for the traditional M&A business. During the quarter, we continued to see longer transaction timelines and a more tentative transaction environment generally, and as a result recorded fewer fees related to large-scale transactions. Geographically, our revenues turned even more towards the US, still within the range of our historical split between the United States and Europe. Across our platform, healthcare and financial technology continued to be active as well as energy and infrastructure. Although mandates in our financing and capital solutions business are up significantly versus last year, driven by traditional restructuring, fees attributable to our financing and capital solutions business this quarter were down year over year, largely the result of the sizable restructuring transaction in Q1 '22, which made for a difficult comparison. In our capital markets advisory business, we are now experiencing the lag effect from Fed policy decisions as market conditions worsened in '22 and remained challenging in this quarter. In private capital markets, specifically, we are still seeing a reset of valuation expectations by both companies and investors, which has slowed the pace of closings. Looking at the broader market, new uncertainty has been ushered in with the bank failures and forced mergers this spring that shook global markets and importantly for our business affected CEO confidence. With less urgency and conviction in the boardroom relating to traditional M&A, we witnessed a number of deals expected to announce or close in Q1 get pushed to Q2 and beyond, contributing to elongated transaction timelines across our platform that I mentioned earlier. Continued lack of economic clarity, a broad range of uncertainty, and market instability affect confidence and perhaps as importantly, conviction. These conditions are likely to adversely influence deal timing going forward. Notwithstanding these current conditions, we are playing the long game, and our focus remains the same: to scale our business. Here is our opinion: we spent time on what we can control, getting even closer to our clients in challenging times, capitalizing on an attractive recruiting environment to build our coverage teams, and always being vigilant about our expense base. With all our efforts, we continue to position PWP for market-leading growth opportunity ahead. With ambition to scale our business, we're strategically investing in talent to increase our client footprint. Recruiting conditions have improved materially this year compared to prior periods. We added five senior bankers, three partners, and two MDs in key strategic coverage areas, and all are excited to join the firm in the coming months. Given where we are in our lifecycle, our platform offers a unique value proposition to experienced hires, and our recruiting pipeline remains robust. Importantly, we continue to grow organically as well. Year to date, we promoted two partners and six managing directors in our advisory business. We are a small firm with a big brand, and the value of size is closing that gap. We will continue expanding our industry reach and breadth of product capabilities while doing what we do best: providing world-class advice to our clients. We are built to weather cycles and to take advantage of cycles like this. We are encouraged by the opportunity in front of us right now to grow our footprint. I want to take a moment to recognize the PWP team for their continued hard work and commitment to our mission. Across our 10 offices in five countries, our teams stayed focused on our clients, helped scale the business, and collaborated effectively to deliver market-leading results in this quarter in very difficult conditions. Thank you, team. Gary, I will now turn the call over to you to discuss our results in more detail.

Gary Barancik, CFO

Thank you, Andrew. As Andrew already spoke to top-line performance in his remarks, I'll begin with a review of our expenses. In the first quarter, we accrued adjusted compensation expense of 65% of revenues, keeping within our medium-term mid-60s guidance range and below our full year 2022 expense accrual level. This compensation margin was set based on assumptions at quarter end and our accrual could be revised as the year progressed based on business conditions and the pace of bringing senior talent to our platform at year-end industry compensation levels. Our adjusted non-compensation expense was $35 million for the first quarter, up 7% both year over year and quarter over quarter, largely driven by an increase in travel and related expenses and overlapping rent. For the full year, we continue to expect growth in non-comp spend of 15% to 20% over 2022, with overlapping rents in New York into the fourth quarter and the related step-up in depreciation expense tied to our new headquarters projects. Potential legal expenses, increased travel and entertainment expenses, continued investment in technology, and some inflationary pressures overall are contributing to the increase. Expected growth in non-comp expense in 2023, including some one-time items, for example, overlapping rents, is not representative of a go-forward growth rate for this cost base. We continue to look for opportunities to rationalize expenses. In this more challenging environment, we managed our expenses tightly which may lead to eliminating or deferring certain expenditures as we progress through the year. For the first quarter, we reported adjusted operating income of $11.5 million and an adjusted operating income margin of 9%. Adjusted net income and adjusted if-converted net income totaled $10 million and $8 million, respectively. Adjusted if-converted earnings were $0.09 during the same period. We continued to generate strong cash flow and returned $33 million to our investors through repurchases, net settlements, release share issuances, common stock dividends, and pro rata distributions. Our original buyback authorization still has approximately $10 million in capacity remaining, and we have our second $100 million authorization pending. Additionally, this morning, we declared a quarterly dividend of $0.07 per share. With that, we'll now turn the call back to the operator to open the line for questions.

Operator, Operator

Devin Ryan, JMP Securities.

Devin Ryan, Analyst

Hey, good morning, Andrew and Gary. How are you?

Andrew Bednar, CEO

Very good. How are you, Devin?

Devin Ryan, Analyst

Yes, first question, just wanted to touch on the recruiting environment. Andrew, you talked about it being fairly attractive. Right now we're hearing that from others as well. I just want to talk about the expectations there and then the interplay with the compensation ratio, because the compensation ratio obviously was set in the normal target range in the first quarter. But just curious kind of your maybe where that could evolve to the extent you really want to lean into this recruiting environment this year. Do you expect to do that? And then maybe the interplay. How far would you allow that compensation ratio to migrate higher to the extent we're in a once-in-a-decade recruiting environment? Thanks.

Andrew Bednar, CEO

Yes, thanks, Devin. I think that's well said. It is a once-in-a-decade recruiting environment. I think the last time we saw this was probably in the '08, '09 timeframe. So we are leaning in for sure. We've shown that already, and we continue to be very, very active in recruiting. I think we're seeing just a quality of candidates that match up very well to our strategic ambitions, which are all around increasing our client footprint. So we're very excited about the environment. I think in terms of compensation margin, it's early in the year. We last year took up our margin as we headed into the fourth quarter. Number one, it's just early in the year to make a forecast regarding where we're going to end up. Secondly, I've always tried to explain that part of our compensation margin is CapEx. We're all well aware that from an accounting perspective, it ends up in the P&L. But the way we look at the business, part of our compensation margin is CapEx. It takes more than a year, probably on average two-plus years for our new hires to ramp up and actually begin producing revenue. And so we have a two-plus years CapEx cycle for all of our hires, and the time to really deploy capital is usually in depressed markets as the one that we're experiencing now. So you're necessarily going to have a bit of a mismatch in the timing of when you deploy that capital for new hires and when you're going to see the return. We are definitely leaning in. I think it's early on forecasting where the compensation margin will end up, but we are investing in this cycle, and we think we're going to be rewarded for that as we head into '24 and beyond.

Devin Ryan, Analyst

Thank you for that insight. I'd like to follow up on the current environment. I recognize that macro uncertainties are prolonging the themes we've been discussing for about a year now. Could you elaborate further on the level of discussions with clients? Have we seen any progress in the last couple of quarters? Additionally, as you noted, you've brought on many new bankers in recent years. How is the balance between these new bankers beginning to contribute and the ongoing challenging macro environment? Thank you.

Andrew Bednar, CEO

Yes, the macro is challenging. There's no question about that. I think most of us in the industry felt better coming into January and February. I think March was a setback. As I said in my commentary, it ushered in a new element of uncertainty. Most of our clients are just seeing mixed signals. We operate our business in five key industries and utilize a very client-centric coverage model. We don't sell products to clients; we help clients solve problems. Right now, many of the problems for our clients are around financing capital structure. Our capital solutions team and liability management restructuring teams are very busy. Those mandates are up for sure. Traditional M&A is flat in terms of number of engagements for us. However, we do have a very active dialogue, particularly among our healthiest clients who have strong balance sheets and are looking to make strategic moves where they have a differentiated advantage versus others that may need financing and private equity, which continues to remain quite inactive relative to prior periods. We are very busy, and I think it speaks to the strength of our brands and the quality of our teams. Strategic investments around our energy transition, our infrastructure team, and around technology and business services are all indicative of target-rich environments for future M&A activity. So I feel good about our positioning. But right now, there's no question there's a macro headwind for all of us.

Operator, Operator

James Yaro, Goldman Sachs.

James Yaro, Analyst

Good morning, and thank you for taking my questions. I would like to hear your thoughts on the recent bank stress. I'm interested in your longer-term views on how this situation could influence the M&A business and the restructuring business, given that regional banks have been involved in many syndicated financings. I would anticipate there might be some long-term effects as well.

Andrew Bednar, CEO

Yes, thanks, James. In the moment, the biggest impact from all of the banking situations that we saw through March and now into April and May is that clients and Boards, to the extent they're contemplating significant transactions, just have a moment of pause. I think it impacts confidence in the first instance, but it's not going to affect the long-term planning for our clients. I believe that the banking stress and the recent action around regional banks is unlikely to have a long-term impact on our clients' confidence and conviction to move forward on larger-scale M&A transactions; however, it does impact credit. Credit conditions have clearly tightened, and credit is now more expensive and less available. Traditional banks are continuing to do less of what they used to do. That's been a 20-year trend of disintermediation of traditional money-center banks, but there's also been a pulling back of traditional credit extension. A lot of that has been picked up by the private credit community and the non-bank lenders. That trend is a significant driver of activity for our business. We believe our industry and the advisory-focused firms will benefit from the trends in private credit. So we're quite encouraged by that dislocation and continued disintermediation.

James Yaro, Analyst

Okay. That's very helpful. Maybe if we just turn to restructuring, recession odds have clearly increased, I think among forecasters in recent weeks. Maybe just talk to the backdrop you're seeing for restructuring at this point. And then how much of this you would expect to impact this year versus 2024 and beyond?

Andrew Bednar, CEO

Yes, as I mentioned in the commentary a moment ago, there's a clear increase in our liability management and restructuring mandates. There are a lot of stressed companies. It's not as broad-based as we've seen in prior cycles, but it is quite active relative to a year ago without question. The decline in M&A is still showing counter-cyclicality with the restructuring business. As M&A has fallen off, we've seen an increase in restructuring. The revenue curves are different, however. The decline in M&A has an immediate impact on revenue, whereas the increase in restructuring has a lag effect in that curve. So I believe the revenue realization from today's increased activity in restructuring is likely to materialize as we head into Q3 and Q4 and into '24. Restructuring and financing advisory is a strong ballast for our business, which is very helpful. However, the revenue effect is lagging the decline in M&A, but we'll see that positive impact in revenue as we move into the back half of the year.

Operator, Operator

Steven Chubak, Wolfe Research.

Steven Chubak, Analyst

So Andrew, I was hoping to follow up on just the latest remarks you made about the expectation for some tailwinds potentially in the second half, recognizing that there are some closing delays. Just parsing some of the language in your prepared remarks, you alluded to restructuring and liability mandates being up significantly on engagements while the M&A side is flat. If we start to see some of these revenue tailwinds materialize in the back half, is it reasonable to expect revenues to potentially even grow in '23 versus '22, even in the face of some of the macro headwinds you cited? Or are these tailwinds more of a 2024 story, just given the delays in closings that we've seen thus far?

Andrew Bednar, CEO

Yes, thanks, Steven. It's really hard in our business to pinpoint the exact timing of our inflection points. We need mandates to get revenue. We have indicia of future revenue in our system, but pinpointing the timing is very challenging. I believe that the restructuring mandates we have will convert to revenue, and we'll likely see that in the back half of this year. I expect it will continue into 2024, but I'm not making broad predictions about how much of an offset that is to declining M&A. In M&A, while we're not completely tied to the broader market and we're certainly moving in lockstep with M&A trends, it's clear that we need to see an increase in announcement activity—that's critical for future closing revenue. While we see elongated timelines, we're not experiencing a decline in overall activity, but we're not getting the announcement events we were seeing last year and especially in '21.

Steven Chubak, Analyst

Right. And just for my follow-up on capital management, you still appear to have plenty of excess liquidity at the moment, having been relatively consistent with the buyback. Given some of the revenue uncertainty, but at the same time, the very attractive recruiting backdrop, just wanted to get a sense as to how we should be thinking about the magnitude or the cadence of buyback over the remainder of this year?

Gary Barancik, CFO

Yes, Steven, I'll take that. You are raising exactly the right considerations that we think about. Our balance sheet remains strong, and we have a great cash position. We obviously have no debt, but we are in an environment where there are potentially very accretive CapEx opportunities. We will monitor this closely and won’t project future levels of buybacks. If there are more attractive opportunities to deploy capital than purchasing shares, we will focus on those.

Operator, Operator

Matt Moon, KBW.

Matt Moon, Analyst

You cited some shifting of the geographic revenue contributions in the US through this quarter. From the industry data, we can see the figures of the announcement picture, and this phenomenon should at least continue near term. But I'm curious if there's any divergence from that industry-wide data compared to what PWP is seeing specifically? Any other general comments on the environment from the US and Europe, the primary geographies would be great to hear.

Andrew Bednar, CEO

Yes. We are still within our traditional range between our US business and our European business. We may see some fluctuations from our average from time to time, but generally, we remain within that traditional band. Our bankers on the ground in Europe report conditions that are similar to those in the United States. They are active with clients, and as I mentioned, we are a very client-centric model. Our industry coverage teams continuously engage with clients to serve their needs. Companies are looking for ways to optimize their portfolios and grow, so M&A dialogue remains a fundamental part of corporate strategy in both the US and Europe.

Matt Moon, Analyst

Great. Sticking to the topic of different client bases, I'd like to drill down on what you're seeing between the strategic risk sponsors, teams, and the sponsor community. We're still seeing higher levels of degradation among sponsors; on the other hand, they could also turn quickly in the markets. What are you seeing and the milestones we need to observe for both those areas?

Andrew Bednar, CEO

Yes. You've seen the data as much as I have. Sponsor activity is down more than the broader market. We are seeing a slower environment for the financial sponsor community; however, they possess a substantial amount of capital that will be deployed, and we remain optimistic that the private equity community will be active in both buy and sell sides, as well as their private credit businesses that also need to deploy capital. As I mentioned earlier, this trend is positive for our business. Strategics have an advantage in a tougher credit market. We are still seeing a resetting and adjustment to tightening credit conditions. Recently, we had the 10th Fed move in a year. Once we achieve a full adjustment and settling in of the credit environment, I believe private equity will re-emerge as a very active player in the M&A business. We simply need to get through this adjustment phase.

Steven Chubak, Analyst

Hi, thanks for indulging the follow-ups. Gary, I wanted to ask about the non-comp growth trajectory. I recognize you're probably not ready to give 2024 guidance yet, but it feels like there are a number of one-timers inflating the level of growth in 2023. How should we think about the normalized cadence in terms of non-comp growth? What is your reasonable expectation given some of the recruiting targets you've outlined?

Gary Barancik, CFO

Yes. Looking at the non-comp growth this year, the increases are really tied to investments in various areas. We have the two headquarters build-outs, which include some double rent, and there will be an increased depreciation this year and going forward. Even though we've significantly increased our square footage in those two locations, our actual rent costs are flat, not a lot, but basically flat on much higher square footage. This has been an investment to allow for future growth. Some other increases are in IT, another area of growth for us. A significant portion of this year is somewhat outsized, and we aren't providing guidance for '24. However, as I mentioned in my prepared remarks, the year-over-year increases are not indicative of what we would expect to see into next year and beyond. We are seeing in new funds, evident from our numbers and those of our peers, that TME has really returned to levels similar to what we saw in 2019, still below on a per-head basis, but with the headcount growth we have seen, that's encouraging. This is beneficial for our business as it signifies our people are getting out in front of clients more. It represents another form of investment.

Steven Chubak, Analyst

Great. As it relates to the compensation ratio, the comp accrual of 65% is encouraging to see that it's below the full year comp accrual in '22. What does that contemplate in terms of activity levels as well as recruitment? Is that 65% a reasonable baseline for modeling the full year '23 based on your visibility today?

Andrew Bednar, CEO

Yes, Steven. As I mentioned earlier, that's a Q1 number based on what we are seeing in Q1. It's early to forecast where we will end up, but as I noted, any situation where we experience an elevated comp margin is really about CapEx and not about steady-state P&L that you may be considering in terms of the company's earnings power. We view it as CapEx and we are still early in the year to predict where we will be by year's end. We note that we have a very attractive recruiting environment, and we'll leverage that to build quality teams aligned with our strategic objectives. We've managed to find very high-quality hires.

Gary Barancik, CFO

If I could just add to what Andrew said, as a technical accounting matter, 65% was our view of the full year as of March 31. That was our best view as of that date. But to Andrew's point, it's still very early in the year.

Operator, Operator

Thank you. This concludes the Q&A portion of today's call. I would like to now turn the conference back to Mr. Andrew Bednar for any additional or closing remarks.

Andrew Bednar, CEO

Great. Thank you, everyone, for joining the call. We appreciate your continued support and interest in our firm and look forward to talking to everyone on our Q2 call in August. Thank you.

Operator, Operator

Thank you. This concludes the Perella Weinberg Partners first quarter 2023 earnings call and webcast. You may disconnect your line.