Moelis & Company

Good day and welcome to the Moelis & Company Q3 2020 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would like now to turn the conference over to Mr. Chet Mendel. 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 Steinman, Chief Financial Officer. Before we begin, I'd 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 factor section of Moelis & Company's filings with the SEC 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 gap measures, are useful to investors to compare our results across several periods 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, Jack. 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 of 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 strategics 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 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've reported 28 million of 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 38.25 cents per share, an increase of 50% from the second quarter which is halfway back to our former regular dividend. We have 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 of 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 that a lot of our people listen to our calls, the internal people, so I just wanted to say how grateful I am for the dedication and focus you showed during the 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 thrown throughout 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 enabled 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 we had 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 advisor who can quickly pivot their resources and strive 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 it up to questions.

We will begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Ken Worthington with JP Morgan. Please go ahead.

Ken Worthington Hi. Good morning. I'm sorry. Good afternoon. Thank you for taking the question. You mentioned an accelerated path to restructuring resolutions. 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 kind of level off given the environment?

Joe 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 in M&A. 25% of it is having troubles and something like that. And so we continue to elevate and find restructurings. And Ken, we were just pointing out, we always do out of courts. 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 of, and we've always done it, I forgot the exact percentage, but a significant percentage of our restructuring is done without doing it out of court and we think it's innovative and it's, as far as we're concerned, most companies prefer to stay out of Chapter 11. I 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 we brought the dividend back, but we still have a substantial amount of liquidity, no leverage. Our balance sheet is fortress. Again, we are pretty conservative with the virus floating around. People have a different read on it, and we just don't know if we're done. It feels like we're done business-wise. I mean, things are picking up pretty dramatically. If there were to be a substantial change in the election and an indication that there were some relevance in bringing a dividend forward that would be a benefit, we would definitely think about it. I don't want to say any more because that involves our board, but we have the capabilities of thinking quickly, being nimble, and if there was something in the tax system

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

Great. Good afternoon, guys. Hi, Devin. So maybe to talk a little bit about the M&A environment and what you guys are seeing there. Can you maybe put just a little bit more flavor around the tone for business today and maybe how that compares relative to the pre-pandemic levels when business was obviously quite healthy? And really what I'm getting at here is it feels like M&A is getting back to kind of similar levels we were at. Restructuring is at a higher level, which would seem to come together for I think our M&A pace feels as high as it's ever been. Our backlog is as strong totally as it's ever been. We, I think, I forgot when was our second quarter was in late July. We said we started to, we really felt it.

It may be that we deal with a little bit of a growth here. A lot of what we do is in the sponsor community, and possibly they responded quicker. I think the larger transactions are a little more affected maybe by the election and tax policy and what happens globally. If you're growing 20% to 40% a year, I think those types of clients tend to, you know, the election doesn't make big difference if your growth rate is high and you're in that kind of a market. So we felt that starting in June, July, I think we talked about it on our second quarter call, and right now we feel like it's exceptionally busy. And two things are happening. One is we're getting extraordinary efficiency I think we're getting more production per hour The short answer is I feel like M&A might be as strong as we've ever felt. Let's put it that way.

Okay, terrific. And then this ties into the point you just made, Ken, and 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 or 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?

Yeah, so I think, you know, thinking about non-comp, you know, if I think about just the next quarter, I'm thinking that it's still probably in the 30 million level. Thereabouts, again, that's assuming that travel stays at current levels. I have no idea how to predict travel, but I'm fairly sure that it's not going to resort, you know, back to where we were in 2021, or I don't believe it will be. I think it's probably something on the order of, at this point, $8 million per quarter that we see in terms of the decrement in travel. And then on top of that, you should also know that the new New York lease expense is fully taken into account in that $30 million run rate. So the real swing factor is going to be travel.

Okay, got it. I just want to make sure the $8 million is where we get back to where that's the ongoing benefit. No, no.

I'm just saying if you want to think about a boundary, we're currently spending modest amounts on travel, a couple million dollars a quarter. It 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 return. I'm assuming that it's going to be quite Quite a bit less than the full 8 million gap right now.

Yep. Okay, perfect. I'll leave it there. Thank you, guys. Thank you.

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

Hi, good afternoon. Maybe just a follow-up on the prior line of questions. Do you think that we're on the start of another two- to three-year cycle in M&A? You know, your comments earlier in the call are pretty bullish overall, but basically what I'm trying to get at is, you know, we typically saw two to three year down cycles when we had a recession. This time it was two to three months. So how robust do you think this inflection is that we're seeing right now, and does this rebound have a lot more room to go from here?

So look, there's a lot of things up in the air, right? There's an election next week, and you know, there is a virus out there, but what I'm seeing would lead me to believe we're in a long-term M&A cycle, two to three years, easy. And one of the reasons is I think you have all this part of the economy, you have 25% or whatever it is, 15 to 20%, that's going through restructuring, you know, just affected so negatively by the virus. So they'll restructure and maybe, and I don't know what happens there, they might consolidate. I think size showed that size mattered in this downturn, number two. And lastly, and I think most importantly, the scope of the economy really changed. The pandemic has really, you know, I look at our own business and I said, you know, maybe we're a, you know, kind of a Zoom economy. Maybe we did save 8 million a traveler. Maybe it'll be 4. And maybe our productivity went up. And I think every business is looking at their business and is going to make, that's what I said at the end, is going to make large decisions. If you're a winner in this environment and your stock, you know, and you're booming, you might make a decision to change or, you know, to continue to grow. And if you were a company that was marginally, you know, you're not in restructuring, but you're kind of marginally off-center and you weren't ready for the digital economy, maybe you have to do something quick and change your strategy and go to market. I think what I said at the end is very important. COVID will change everything. And then last quarter, I think you spoke about you had done 14 deals on the capital raising side.

I don't know if I caught it, but did you mention how much you did on the capital raising side this quarter? And how much of a deal win do you have in that business?

We like that business. We hired two really seasoned veterans that joined us over the summer. I'd say the second quarter, if you remember, I pointed out because it was so immediate. People needed liquidity, and we were there to raise it. The third quarter continued that the business is good. The second quarter was an outlier. The third quarter was strong. Joe might have the number. We pointed it out in the second because it was one of the reasons. It was big enough to point out. We think that business will continue to grow. We see lots of new markets opening up and opportunities and places for us to play. and we really stepped up our game. So, Joe, I don't know if you have numbers.

Yeah, in the past, like if I look at last year, it was probably a couple of points of revenue, you know, 2% to 4% of revenues. This quarter, I think it's probably around 8% to 10%. Got it. That's helpful. Thank you.

And, you know, that's Capital Markets Advisory. Remember, we don't have any trading. It's all advisory revenues.

Our next question comes from Steven Chubach from Wolf Research. Please go ahead.

Hi, good afternoon. Hi. So, I wanted to start off with just a question on MD productivity. Just, you know, looking at the historical performance, you know, MD productivity for you guys peaked in 2018, you know, just above 7 million per. The five-year average is just above 6 million per MD. You know, just given the optimistic outlook in the release, How should we be thinking about the productivity looking out to next year? And just given what you're seeing in the current pipeline, how quickly do you believe that you can get to that 7 million plus productivity level?

You know, I'm not going to give guidance, but I think that's a good analysis. Remember, when we were growing fast, we always had a new fresh – whenever you're growing too fast, you're always taking on so many new people that the – you know, the New people don't add, so one of the things 2018 did, it was the end of a very significant growth period, so our revenue trend beat statistic caught up. I don't really think of it that way, but I do think, and I've said this before, that there was a lot of people talking about, do we have a comp problem? We had a revenue shortfall in the first half of 2019 that followed us for a while, and then COVID hit in March, so we didn't get to I think some of what you're seeing now is that backlog is coming to market because we were involved with it to begin the year. And it's a long way of saying I don't want to give guidance, but I think the fact that that was revenue-friendly and if we can get more productivity by Zoom calling, I would hope I would hope that that's the path we're on, but I don't want to give a time frame or, you know, we're not giving guidance.

No, I could certainly appreciate that, Ken, but thanks for all that color. Just to follow up on the, since you brought up the topic of compensation, you know, 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 I 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?

Well, because it's really a nine-month, you know, the quarter was 61% for the revenue we produced and I think that's, if you look at the firm, we're not back to full normal. We're still the first Month of the third quarter was just beginning. Now we're getting back to full stride. I think you can see us get right back to where we want to be on comp. I want to point out one thing, too. I've always said we really aim for 25% pre-tax margin. We beat that right now, and I don't think we're full stride yet. And so you're looking at the nine months. There's a quarter in there where March, April, May, nothing happens. There was no M&A. The instruction was just getting started. So again, I keep telling people, do not look at this year's stats. There was a three-month complete black hole. But you can start to look at what we're doing on a run rate, and I think you can see what we're doing.

Great. 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

And these are 127, if I had it correct. Joe might know exactly.

Yeah, 127.

And I don't have a specific number, and one of the reasons is I don't think ratchets 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 change it. I thought it was kind of minor. But, Joe, do you have a flavor?

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

Right. Because, I mean, you know, look, they're in a lot of deals, so if it's meaningful, we would know it. That's why it's not meaningful. If it's meaningful, we would know the number.

Great. Thanks for taking my questions.

Our next question comes from Brendan Hawkin with UBS. Please go ahead.

Good afternoon. Thanks for taking the question.

Hey, Brendan.

How are you doing, Ken?

I'm good. How are you?

Good. Good, thanks. I just wanted to start it out on the dividend. I appreciate your comments before in considering maybe a special, but this has been quite a roller coaster for even the regular for you all. So I'm really curious about how your experience in this year maybe might inform how you think about how you manage the regular dividend, how your approach is going to be to the regular dividend going forward. Clearly, you're feeling a lot better about your business, which is, you know, and raising the dividend by 50% is a very powerful way to state that. Could you maybe help us think about what you might be instilling as far as guardrails go or overall philosophy around the regular dividend going forward?

I think if we would go back to where we were. Our goal over time is to go back to the regular dividend and the same philosophy. We liked it. We ended up with excess capital even at the end and paid it out in specials. Look, I can't, if you tell me when the next time the entire world will shut down and lock themselves in there, and anybody who didn't take emergency actions in March, you know, let me say it in the positive. I run the company as if I own the whole thing. You know, I run it as if it's my, I own every share. I did what I would do to protect what is one of the great franchises that we're building. And by the way, I said it during the call. We are rebounding much more. I think we're on a rapid rebound because there was not one person in this company who was concerned about the future of the company or its own stability. And if you remember on April 1st, by the way, it's hard to re-remember that moment. People were scared. And at least I could look everybody on our internal and say, you're fine. You're fine. Pick up the phone when the clients call. You're fine. Don't worry about us. That's worth a fortune, and we will bank that over the next few years as we picked up great people. We banked our clients, and we'll see that for five years now, the focus we were able to have. So, yeah, it was a roller coaster, but you tell me the next time we shut the entire global economy down, and that's the time I might go through that again. But in the interim, I'll assume we won't do that again, and I'll go back to regular way dividend. And by the way, if it was March 15th again, I'd do the exact same thing until I knew the coast was clear.

Yeah, I totally appreciate that April was a very different period, and I'm not trying to imply any kind of question about the decision and whether or not it was a good one. It just was more... The business that you're in is a great business. It takes off a ton of cash, as is evidenced by your capital return policy, but sometimes the trajectory of the revenue can change pretty dramatically, whether it's cyclically driven or what have you. My question was more based around that and whether or not you might approach raising the dividend at a more measured pace as you grow. That's all.

No, I think we'll try to bring it back as soon. If you told me the virus was cured tomorrow, I know where I'd be, and it would look pretty, you know, again, I'm speaking out of turn because I'd have to talk to the board. But, you know, we would probably bring it back pretty quick, and we'd want to go back to that. You know, we have a great balanced business. We have a great restructuring team, and usually it's counter-cyclical, and our cash flow is balanced for that reason. We also have a very nimble team, and they all moved to do it like in the second quarter. They all moved 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 what would happen when we all went home and sat on our couches. That concerned me because I'd 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 bankers, I know what we can do. 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. I think I'd be if you told me uh Brennan 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 they have to speak for them but I know what I would recommend great thank you thank you for that and then I just wanted to um follow up on the MD uh headcount question so it's at 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 2019 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 the time? Was there anything unusual that was happening on the MD count side?

No, but a lot of times what happens is we manage our head count actively every year. And what usually happens is we start talking to people like sometime around now. And we give them to the end of the year. And a lot of those then heads drop off in January and February. They're December 31st. We're still on the payroll formally. We give them time and then they go. The reason you don't know it, we don't do extraordinary charges. Our comp ratio includes all our hiring, which is investment spend, and all of our people management. We view people management as the core competency of what we do, so we don't segment it out. It's just in there. It's in there every year. Look, in a year like this, I don't know. I'll have to look at some people. I don't think it was a lot of this year because we really tried not to do anything during the tendency or the beginning of the crisis. We really didn't want to do any headcount. So if there was, it was people we talked to at the end of 2019 and gave time to find their way out.

Okay. Great. Thanks for answering my question. Thanks.

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

Great. Thank you, operator. So, Ken, I just wanted to follow up on the compensation discussion earlier. So, you know, as mentioned before, you know, revenues are kind of flat year to date. Now that we are towards the end of October, I'm just kind of curious how you think about that full-year comp ratio. I know that there was a lot of uncertainty earlier in the year, but now that we're kind of closer to the end of the year, any sense as to where that could end up? Last year you ended at a 63% comp ratio for the full year. I understand there's greater fixed and variable costs embedded in the comp structure this year. But just trying to get a sense if we could kind of get down into that Paul Schmitz,

So I think you can see how we think about comp when we don't have a virus, you know, when we don't have a shutdown going on or a complete stoppage of business. Look, very hard to say the second quarter and even the first quarter, the second quarter especially of 2020 reflected any natural business environment. So again, you're trying to blend the whole year into what was three distinct, you know, Lego blocks coming together for a year. The first, the second was The third is clean, and the fourth will be what it is, but I think if you look at the third, you can see the way we think about the business on a natural basis.

Okay, great. You mentioned the backlog, and because of this pandemic, the drivers of this turnaround in M&A have been quite different, and we've seen certain areas that have been a lot stronger and areas that have been a lot weaker here, and so Cross-border's been weak. Large-cap strategics 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 started to impact deal activity over there in Europe. Thanks.

The interesting part is almost everywhere is strong. I go around the world. I think Asia is fairly strong. 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 as lead advisor on that, I think Thank you for joining us. The U.S. is strong and the U.S. 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 doing well. I can't think of, I mean, M&A is doing fine, doing very well. Restructuring is elevated and even cap markets continues to go fairly well. I think If I had maybe a market, 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, I appreciate the call. Thank you, Kenneth.

Our next question comes from Jeff Harty 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. The answer to that is, from my viewpoint, the answer is not only a yes, but I also think people are leaning into things and really are It seems like, and I know it sounds strange, right, because we're in the middle, we're still home and there's still a lot of uncertainty, but I believe that the amount of people who, companies and institutions and especially private equity that want to do things is significant.

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 The deal count's 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'm trying to see it the other way around. I thought the middle market, you know, when I was on the call in July and I said I saw the M&A market come back, I got feedback that all you guys said, well, what's Ken's? But I was seeing something different than everybody else. So I saw the first mover being the sponsor community, Coming back quickly, and then I thought that then went to the big deal market, but that may just be me. But that's what I saw. Okay, interesting. By the way, I do think that it's the market that is big enough to access institutional financing. That's important. I think that the subscale deals, the smaller deal flow, I think does have trouble. The bank market is kind of like banks aren't fully backed. There's going to be a real price to pay here in the general economy. I do think you have to be careful. I do think M&A started in what we now call the middle market, which could be anywhere from $1 to $10 billion. They can access the institutional money markets and credit markets, which is a little different than having to go to banks. Banks are not fully back in the financing, and I think that you might see that lag a little bit because I think there's some troubles coming from just credits in the banking system.

Okay, you mentioned earlier the relative contribution kind of from the capital markets business, and I thought I heard you say something earlier about restructuring. Did I hear you right to say that restructuring was kind of close to the top of that 25% of revenue range that it's been in historically in 3Q20?

I think that's right, yes. For Q3, that's right.

Okay, thank you.

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 will be behind us. It'll 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.