Moelis & Company (MC) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Moelis & Company Earnings Conference Call for the Fourth Quarter of 2022. To begin, I'll turn the call over to Mr. Matt Tsukroff.

Good afternoon, and thank you for joining us for Moelis & Company's fourth quarter 2022 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 that 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. 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.

Thanks, Matt. Good afternoon, everyone. On today's call, I'll go through our financial results, and then Ken will comment further on the business. First, we achieved $202 million of adjusted revenues in the fourth quarter. For the full year, our adjusted revenues of $970 million were down 38% from the record prior year. Regarding expenses, our full year compensation expense ratio is 63%. For the full year, we reported a non-compensation ratio of 15.6%. The increase in full year non-compensation expenses is largely due to a normalization of travel and related expenses. Looking to the first quarter, we expect non-compensation expenses to be in the $40 million range, excluding episodic transaction-related costs. Our full year pretax margin is 22.5%. Regarding taxes, our normalized corporate tax rate for the year was approximately 27%, and our effective tax rate was approximately 22%. The difference is driven primarily by excess tax benefits related to the delivery of equity-based compensation in the first quarter of 2022. We may recognize a tax benefit in the first quarter of 2023 related to the annual vesting of RSUs later this month. For purposes of quantifying the excess tax benefit, we expect the impact to EPS to be approximately $0.01 for each $1.25 difference between the vesting and breakeven price of $36 per share. Regarding capital allocation, we remain committed to returning 100% of our excess capital. Our Board declared a $0.60 per share dividend. We will have returned approximately $316 million to shareholders with respect to the 2022 performance year, which includes this declared dividend. And lastly, we continue to maintain a fortress balance sheet with $413 million of cash and liquid investments and no funded debt. I'll now turn the call over to Ken.

Thanks, Joe. Before I begin, I just want to thank our bankers and the entire organization for their focus on our clients and their commitment to excellence in what has been a challenging year for M&A and the capital markets. The financing markets are the lubricant to complete M&A and financing has been a challenge. Despite the difficulties of completing transactions, our new business origination activities remained strong. However, as long as access to capital is limited, M&A transaction volumes are likely to be less robust. We also price our services based on transaction values, which have been lower. And at the same time, we're experiencing inflation in our costs, primarily compensation. The current business environment, however, is the reason that we have maintained an unlevered balance sheet since our founding. This environment will change and our goal is to be ready for it when it does. Restructuring activity is increasing, but this cycle will be longer to fully develop. However, it might also be more sustainable over a longer period of time. Companies took advantage of attractive debt markets between 2019 and 2021 to refinance their debt, and are now just beginning to see the higher -- the impact of higher interest rates. Again, global market capitalization has doubled since 2012 and private equity AUM has more than tripled over the past 10 years. As markets expand, transactions follow, and there'll be increased demand for high-caliber bankers operating within a focused organization, delivering comprehensive advice. This is the opportunity we are pursuing and the reason why we continue to build for the long-term. We hired 4 new Managing Directors and promoted 8 since the beginning of the year. By continuing to invest in the platform, I remain confident in our ability to execute for our clients, employees and shareholders. And with that, I'll open up for questions.

[Operator Instructions] The first question is from the line of Devin Ryan with JMP Securities.

This is Brian McKenna for Devin. So I'm curious how the dialogue with sponsors have trended thus far in 2023 relative to the last couple of months in 2022? Has there been any pickup in conversations? And then, are you seeing any early signs of dialogue starting to move through the process towards formal announcements?

Yes. I'd say, it's fairly volatile. And I think the sponsor dialogue has been improving pretty significantly as of the start of the year. There is an opening in the financing markets. We've actually seen -- a dividend recap deal was in the sponsor community, is a pretty significant event. Terms are better. But it remains to me very volatile as these markets -- as I said, I think Chairman Powell effectively shut down the market or really market deteriorated pretty significantly in the September speech at Jackson Hole. Last week in the beginning of the year, a lot of the market has taken it to mean party on, and started to get fairly optimistic, at least part of the market. But I think it remains volatile. As I said, the indication that we're all waiting around for a single individual statements, to me is an indication that the market is not healthy. We hadn't done that for 5 years before that. It's probably not a good indication. But again, the activity level I would have to characterize is getting more active over the last 3 or 4 weeks than 8 weeks prior, and maybe significantly so, at least in conversation. I might even say significantly so,. but we'll see if the markets hold long enough to complete some of these.

And then just a question on the comp ratio. Assuming the first half of this year is still somewhat slo,w and then, if revenues start to normalize in the back half of the year, should we expect the comp ratio in the first half to be in a similar zip code as the back half of 2022, and then you'll kind of true that up into 3Q and 4Q? Or should we expect somewhat of a steady accrual throughout the year?

I'm going to turn it over to Joe for the first quarter, because we do have some events in the first quarter that always cause us to have a differential in timing. Our belief is that the general comp ratio of the firm should fall between where it fell over the last 3 or 4 years. Again, that depending on revenues because our comp ratio did increase last year based on a very difficult market and our desire to hold the culture and team together. So again, depending on the revenue, I think that's the range we are viewing for the entire year. But I want to turn it over to Joe because we have some first quarter…

Yes. So in the first quarter, that -- in a couple of weeks, we'll be granting equity. We expense all the equity granted to retirement eligible partners at the time of grant. Accordingly, our pre-bonus comp expense is likely to be much larger in the first quarter than the next 3. So within a challenging revenue environment, which we're still experiencing, the comp ratio is likely to be higher than the target ratio. And I would imagine that we would think of, whatever, probably what you were just describing, it's probably the 6 to 8-point spike in the first quarter. But again, we expect that the full year ratio will settle back, assuming again, revenues pick up.

The next question is from the line of James Yaro with Goldman Sachs.

I just wanted to return to previous comments that you made, Ken, in December around the middle markets slowing down quite precipitously. And I -- maybe that's not exactly your language. But I guess the question is, how would you compare and contrast the dialogue across larger versus middle market firms and in terms of your expectations for which might come back to transacting on the M&A side first?

When you say larger, middle, you're talking about the sponsor community?

I mean, I guess, it would be interesting to hear both sponsor and strategic from that perspective.

Okay. So I'll start with the strategic dialogue. It's been pretty active. I found the strategics to be -- it's a good time. They don't have -- they have -- most of it when you talk about investment-grade strategics, has access to financial markets. They -- it's a good time for them. The financing markets have moved in basis points, not in availability, and they do have goals they want to achieve. So they've been actively discussing now, and a significant amount of transactions. Some of that -- by the way, I do think some of the regulatory environment is also impacting that to the negative, but there is a lot of dialogue there. On the sponsor community, I believe there is a huge pent-up demand. Sponsors cannot sit still. I'm not sure it's that different within large and middle market because both are trying to figure out an economy and a cost of capital that makes sense for them to invest in. So I think some of the larger ones have switched their focus maybe to providing other sorts of capital and might be more active just because they can more easily deploy their capital in other areas and maybe they also have -- get more pockets of alternative capital, providing solutions, preferreds, things of that nature. So -- but the dialogue is definitely, I'd say, improving. I think October, November, December, you really had a wait-and-see attitude. They knew that they were in the middle of a cycle of interest rate raises. I think now you're starting to see people take a view that we are possibly near the end. Some people want to be more aggressive on that, but that's what makes markets. But I think you're having some part of the market, say -- I think I see 1 or 2 raises. And as soon as that's done, I really think most of them feel like it's time to start figuring out prices, accessing financing markets at the new levels and moving on.

Just for my follow-up, when you think about some of the -- putting aside M&A and restructuring, what do you think about your capital advisory businesses, in particular, the sort of fundraising businesses? How do you expect that -- those to perform over the course of 2023 and what appears to be a somewhat more challenged sponsor fundraising backdrop?

Well, last year -- I think last year was a unique year. There was a lot of capital committed going into the year, then everybody talks about the numerator-denominator problem. You had a shrinkage in the denominator, total assets under management as all assets shrunk. And therefore, people ran out of ability to commit. Now I think that slate starts clean in January. And again, it will depend if the denominator holds and we have markets -- public markets that hold. So I think that might return over the course of the year to a positive fundraising market. And what we're really focused on is more secondaries, continuation funds, a little more higher value-add part of that process. And I do think that we'll be active, and we're building into that part of the private equity services much more than primary fundraising.

The next question is from the line of Ken Worthington with JPMorgan.

This is Michael Cho on for Ken. Ken, Joe, I just wanted to just touch on your restructuring business. I was hoping I can -- we can just get some updated commentary on kind of how mandates have trended sequentially? And if there's any particular industries or geographies that have been more active than others recently?

So on the geographies, I can't discern a real difference. I mean, I think the main markets are Europe and the U.S. where you see -- they're pretty much going into the cycle in a similar way, facing the same issues, whether people want to get ahead of the cycle and manage their liabilities. What was interesting is, again, we've said it was slower than the crisis restructuring markets of '08, '09 and even COVID. But this idea that the maturity wall was going to force people to -- there's always a discussion if there's a large maturity wall in '24 and '25, I think. I think -- I do not think that maturity wall will be as much of a motivating force as people are thinking. If the market stays at least where it is today -- all of a sudden, financing markets are opening up, people are finding solutions to not restructure but to access capital. By the way, it's one of the reasons why I think the previous questions was about our private funds group, but we have beefed up our capital advisory group, because we think innovative financings around that marginal 1 turn of leverage that you just have to solve in order to access the bank market and the private lending market. We think there'll be a lot of activity around that last turn of leverage that just keeps companies from having to enter restructuring. And that might actually be more active than the restructuring that every -- that people were focused on. Again, it is improving, but I do think we're not seeing stress. I was just with a major -- one of the leaders of a large group of private equity firms, and they said, there's no distress in the portfolio, no defaults. And companies are actually performing. And if the financing markets come back, I think the wall will take care of itself. Now, that's a lot of what ifs, though the financing market could change, and as I say, in a Jay Powell speech. But for now, they are trending in the direction of being accessible.

And I guess just to follow up on that. And just relating to your business today in terms of restructuring, I guess, behind those comments, I mean, is it fair to say you've seen some, I guess, deceleration of growth in terms of the mandate trends or for the [ "pretty strong" ] for the quarter as well?

They've been accelerating and they were building toward what I think was everybody looking -- again, when I say everybody, there's always a restructuring going on somewhere. Even in a good economy, 1% or 2% of the companies are having distress that needs to be addressed immediately. But the idea of getting in front of a '24, '25 wall, which was in -- it was getting in vogue in the late part -- half of last year -- that there would be no access, so get ahead of it. I think you're going to see companies delay and think about whether or not the financing markets might open again and give them a chance to regular way finance. So yes, our backlog is increasing. Our M&A -- our restructuring volume was up significantly year-over-year. But the idea that the wave of '24, '25 maturities would cause people to accelerate their plan to address their liabilities, I think it's slowing down a little bit. I think there's a hope and a belief that the capital markets might open and give people a regular way access to refinancing.

And if I could just squeeze one more in -- on the other side of the business when we kind of think about the M&A environment. I mean, you've made it clear around retaining culture and continuing to invest, and the MD headcount continues to develop as well. I guess, just near term, just given your statement around caution around the deal environment, I mean, do you think there's kind of a stabilized or normalized MD count number for this type of environment looking ahead in the near term?

Which type of environment are you referring to? The environment seems -- it's like this weather and you're living in New Hampshire. As I said, look, we want to build -- we have a lot of white space we can build to. What our goal in managing the company -- we do it every year -- is to go through our labor force, which is now 1,000 people, and figure out who's not right, who's not going to -- who's not the right skill set and proactively address that, and then continue to build around people who can address it and create quality. I do believe we're going to look back. At some point -- I hope it's months and soon, but there is a large pent-up demand for our clients to transact and to move forward. And lastly, one of the challenges we have is, those clients which we fought hard to get in the front door, both strategics and sponsors -- we talk about sponsors. But behind every sponsor transaction is an actual company with the CEO and a CFO who we get to know. These things aren't awarded like apples off the tree. You develop relations and expertise in that system as well. And we can't go dark on them and just say, so long your team is not around for the next 6 months, but we'll hire a team back when you want to transact. So I think we will continue to grow the footprint, but we will continue to also be very diligent in making sure that we're focusing on the bottom couple of percentile that we think does not make it, and be very careful, especially in a bad environment that -- we're analyzing that carefully and moving as quickly as we think we -- as we should.

The next question is from the line of Brennan Hawken with UBS.