Marcus & Millichap, Inc.

Greetings and welcome to Marcus and Millichap's fourth quarter and year-end 2022 earnings conference call. As a reminder, this call is being recorded. I would now like to turn the conference over to your host, Jacques Cornet. Thank you. You may begin.

Thank you. Good morning and welcome to Marcus and Millichap's fourth quarter and year-end 2022 earnings conference call. With us today are President and Chief Executive Officer, Hossam Nagy, and Chief Financial Officer, Steve DiGennaro. Before I turn the call over to management, please remember that our prepared remarks and the responses to questions may contain forward-looking statements. Words such as may, will, expect, believe, estimate, anticipate, goal, and variations of these words And similar expressions are intended to identify forward-looking statements. Actual results can differ materially from those implied by such forward-looking statements due to a variety of factors, including but not limited to general economic conditions and commercial real estate market conditions, the company's ability to retain and attract transactional professionals, the company's ability to retain its business philosophy and partnership culture amid competitive pressures, company's ability to integrate new agents and sustain its growth and other factors discussed in the company's public filings, including its annual report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2022. Although the company believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can make no assurance that its expectations will be attained. The company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise. In addition, certain financial information presented on this call represents non-GAAP financial measures. The company's earnings release, which was issued this morning and is available on the company's website, represents a reconciliation to the appropriate GAAP measures and explains why the company believes such non-GAAP measures are useful to investors. This conference is being webcast. The webcast link is available on the investor relations section of our website at www.marcusmillichap.com, along with the slide presentation you may reference during the prepared remarks. With that, it is my pleasure to turn the call over to CEO, Hassam Najee.

Thank you, Jacques. On behalf of the entire Marcus Millichap team, good morning, everyone, and welcome to our fourth quarter and year-end 2022 earnings call. The industry and our business experienced a dramatic shift in market conditions between the first half of 2022 and the latter part of the year. The Fed's missed opportunity in 2021 to begin normalizing financial conditions became the most aggressive financial tightening in 2022 to fight runaway inflation, in 40 years. The resulting 450 basis point interest rate increase and $500 billion of bond sales in a matter of months shifted the market tailwind in the first half of the year to a market disruption by September. With that backdrop, MMI still delivered record revenue of $1.3 billion, adjusted EBITDA of $166 million, and earnings per share of $2.59, both of which were the second best in our history. We closed over 12,000 total transactions for a volume of $86 billion and outperformed the market. Total U.S. commercial property sales, as reported by RCA, declined 25% last year, while our brokerage transactions were off by 6%. I'm also proud to reflect on the many advancements to the Marcus & Millichap platform in this past year. These range from new technologies such as our client application called MyMMI to the successful launch of our auction division and ongoing expansion of financing capabilities, especially in the agency lending arena. We saw many of our tenured sales and financing professionals reach new milestones and acquired numerous top-level groups, teams, and experienced individual producers last year. The ongoing elevation of the Marcus Millichap brand was on pace once again with marquee client webcasts, industry-leading research content, and commanding presence in the media as well as at industry conferences. These achievements were reached despite a very difficult fourth quarter stemming from the escalation of deal cancellations, and further widening of the bid-ask spread in the market. The growing number of lenders that either exited the market or significantly tightened underwriting criteria also became an obstacle in closing deals in the final quarter of the year. Overall, sales in the market dropped by an estimated 57% during the fourth quarter, according to RCA, making it the lowest fourth quarter sales volume in the marketplace since the fourth quarter of 2011. We continue to demonstrate the relative strength of the Marcus & Millichap platform as our team closed nearly 2,700 transactions and $16.4 billion in volume during the quarter. These numbers enabled MMI to outperform the market in the fourth quarter with a 38% decline in brokerage transactions. For the quarter, we delivered revenue of $262 million, adjusted EBITDA of $14 million, and earnings of 20 cents per share. The magnitude of the market disruption is reflected in the lack of investor urgency. In a normal market, the fourth quarter typically has the most deal volume as investors rush to transact and deploy capital by year end. However, 2022 was anything but typical as fourth quarter volume and revenue was the lowest for the year. Let me highlight a few additional factors to put the fourth quarter results into perspective. Keeping deals together required extraordinary efforts in troubleshooting, creativity, and finding alternative lenders, which caused a major distraction to our team in developing new business. The need to reprice listings became a challenge given the heightened degree of valuation uncertainty. This created a significant rise in canceled listings and disruption to listings going under contract and into our pipeline, and so on, moving through the usual deal continuum. Our most experienced professionals, who possess the skills to navigate and close deals in a tough market, accounted for a larger than usual portion of revenue. These senior producers qualify for our highest commission levels, leading to a higher than normal cost of services for the fourth quarter. Due to the broad nature of the market disruption, all market segments had lower year-over-year revenue for the quarter. Our private client revenue was off 41%, while middle market and larger transaction revenue were down 47% and 63%, respectively. Larger transactions, which have been a significant part of revenue growth over the past few years, were highly impacted by institutional investors rapidly going to the sidelines, as we've seen in previous downturns. Our finance division, MMCC, saw revenue fall 37% as the spike in rates made both transaction financing and refinancing much more difficult. Costs related to investments made over the past few years for talent acquisition, technology, infrastructure, marketing, and business development put outsized pressure on earnings as revenue production was hindered in the quarter. These ongoing investments have fundamental advantages over the long term and have proven to be creative in a normal operating environment. Our more experienced sales force and the addition of numerous market leaders in recent years were major contributors to our record performance in 2021 and the first half of 2022. We are confident they will once again have the same positive effect when we recover from the current market disruption. The reversal of expense leveraging we gained in 2021 is further pressuring our margins in the near term. Steve will elaborate more on that. Furthermore, we implemented expense reduction measures in the fourth quarter, resulting in one-time charges which caused additional drag on fourth quarter earnings. Let me now shift to our strategy and outlook. Effectively navigating the near-term challenges and protecting the company's financial performance is extremely important to our management team. At the same time, we strongly believe in sustaining our long-term mindset, building competitive advantages, and not changing course because of a cyclical market disruption. Therefore, our top priorities are as follows. First, we're focused on helping investors and our clients solve problems, find solutions to their specific circumstances, and source opportunities. This approach during the pandemic and throughout our history has led to outsized growth upon recovery because we never have left the market and instead have leaned into the crisis by increasing our client contact. This is exactly what we're doing now. Second, we're helping our sales force leverage a tough market environment to sharpen their skills, utilize our proprietary tools to maximize productivity, and partner with our financing professionals. To highlight some of their accomplishments, MMCC closed over 400 financing transactions during the fourth quarter alone and closed with over 450 separate lenders last year. This is a major advantage to our sales force and our clients as our financing professionals can access a wide network of capital sources and turn every stone to source debt for clients in this market environment. We're strategically deploying capital to maintain our presence at key industry events and conferences, and to provide sufficient production support to our sales force through the downturn. Although transaction counts may be down significantly, investors need for opinions of value, market analysis, exploring various financing options for recapitalization, and dealing with maturing loans have increased dramatically. We've tightened our belt while maintaining the capacity to service these critical needs as an investment in long-term growth, client relationships, and eventual recovery. Last but certainly not least, we are seeing more acquisition opportunities and have engaged in several explorations largely prompted by the display of MMI strength at a time of uncertainty. We have the balance sheet to be prudently offensive during the market dislocation and are encouraged by our current dialogue with targets. Strategic acquisitions remain our top capital allocation strategy while we continue our dividend policy and share repurchase plan. In terms of returning to organic growth, our commitment to renewing the company's cycle of sourcing, hiring, and training new professionals is steadfast. As we have reported since the pandemic, this process has been disrupted by the volatility in the market, impact of virtual employment choices now offered by many companies and an unusually tight labor market. Various strategies to boost local recruiting from key universities, the introduction of the William A. Millichap Fellowship, which attracts highly qualified new professionals, and our numerous internship programs remain on course. The return to in-person training throughout our offices should also help gradually reverse the trend of the past three years. The majority of the 5% headcount reduction over the past year remains concentrated in the one to three year cadre, which is experiencing higher than usual turnover rate. From a production perspective, our success in attracting experienced talent is offsetting the revenue impact. However, fundamentally returning to organic growth is a priority for the firm. Turning now to the outlook, The current market headwinds are likely to persist in the near term. However, we expect three factors to emerge and bring clarity and enable a transaction market recovery. First is the end of the Fed tightening cycle. We believe inflation is gradually coming down, especially as the lagging effect of the cost of shelter begins to show up in the CPI. This process will be bumpy from month to month, as we saw earlier this week. The overall trend points to a limited number of additional rate hikes, followed by an expected Fed pause. It is unlikely that the Fed will pivot to lowering interest rates anytime soon, in our opinion, given the continued strength in the labor market. We believe that simply ending the tightening cycle will bring clarity to the market. Second is further evidence of a sustainable, albeit slower, job market and the impact of any potential job losses on occupancies and rents. Third is price alignment. In our view, price adjustments always take time during a market transition, but expectations will eventually realign according to economic realities. In the near term, we're leaning into the downturn by amplifying the company's numerous competitive advantages. This includes our market leadership in the private client segment. sourcing more 1031 exchange buyers than any other firm. Our ability to get difficult deals done in this environment, our growing suite of proprietary technology, cutting-edge research, and hands-on management on the ground. We are positioning Marcus Milichap to lead into the eventual recovery, gain market share, and continue to build long-term shareholder value by investing in the future. With that, I will turn the call over to Steve for more details on the quarter. Steve?

Thank you. As Hasan stated, revenue for the fourth quarter was $262 million compared to last year's record quarter of $495 million. For the full year, total revenue set a new record high of $1.3 billion, up slightly over the prior year record. Moving to segment details. Real estate brokerage revenue for the fourth quarter was $236 million, or 90% of total revenue, a similar percentage to historical levels. This represents transaction volume of $13 billion across more than 2,000 deals, a year-over-year decrease of 54% in volume driven by 38% fewer transactions. Our average deal size was $6.4 million compared to $8.7 million a year ago. For the full year, real estate brokerage revenue was $1.2 billion, or roughly 90% of total revenue, again, a similar percentage to historical levels. Full year results included transaction volume of $68 billion across more than 9,000 deals, essentially flat with last year, and a 6% decrease in transaction count. Our average deal size for the year increased to $7.5 million compared to $7 million in 2021. The contrast between fourth quarter and full year revenue and transaction metrics reflects the strong first half of the year and investors' heightened motivation to transact before the Fed's aggressive interest rate actions, which then created a market disruption and weak second half of the year. Within brokerage, Our core private client market segment in the fourth quarter accounted for 61.7% of brokerage revenue, or $146 million. This compares to $247 million in the prior year, reflecting the dramatic and broad slowdown in market activity. Our middle market and larger transaction segments together contributed revenue of $85 million, or 36.1% of total brokerage revenue for the quarter, compared to $199 million last year, as many institutional buyers remained on the sidelines in Q4, waiting for more clarity on interest rates and pricing before reentering the market. For the full year, revenue from our private client market segment of $682 million was down 2%, and the combined revenue of $463 million from middle market and larger transactions was up 4%. Turning to our financing division, MMCC, revenue came in at $22 million in the fourth quarter compared to $34 million in the prior year. Fees from refinancing accounted for 45% of loan originations compared to 54% in the same period last year, driven by the sharp rise in interest rates during the year. Our financing group closed 408 transactions compared to 696 during the same period in the prior year. Despite market conditions, we continue to rank among the leading financing intermediaries nationally. Financing fees for the full year were $113 million compared to $110 million in the prior year. Other revenue, comprised primarily of consulting and advisory fees along with referral fees, was $5 million for the quarter, consistent with the fourth quarter last year. Other revenue for the full year was $18 million compared to $16 million last year. Total operating expense for the fourth quarter was $257 million compared to $413 million a year ago, a decrease of 38%. For the full year, total operating expenses were $1.16 billion, up $57 million over the prior year. Cost of services for the fourth quarter was $181 million, or 68.9% of revenue, an increase of 160 basis points year over year. This increase was primarily driven by the outperformance of revenue in the first half of the year, which meant agents reached higher commission rates as they surpassed revenue thresholds earlier in the year. This is also driven by the maturing of our sales force the addition of many experienced professionals, and a larger share of revenue generated by more senior producers in a tough market environment. Cost of services for the full year was 65.4% of revenue, 60 basis points higher than the prior year. SG&A during the fourth quarter was $73 million, a decrease of 5.7% year over year, primarily due to lower employee compensation expense tied to company performance, partially offset by higher sales support costs. As a percentage of revenue, SG&A was 27.6% for the quarter compared to 15.6% last year, reflecting both the record revenue in Q4 of 2021 and the disproportionate impact of fixed costs when revenue was disrupted in Q4 of this year. For the full year, SG&A was up 17.6% to $300 million, which, as a percentage of revenue, was an increase of 330 basis points over the prior year to 23%. As a reminder, the significant SG&A leverage we realized in 2021 resulted from exceptional revenue growth coming out of the pandemic when expenses had not yet normalized. This gradually reversed during 2022 as transactional activity slowed and expenses returned to normal. In December, we took action to reduce controllable expenses, including headcount reductions, that will benefit us going forward. However, the savings won't all be visible immediately, given the timing of certain sales and client activities that occur in the first half of the year. For the quarter, we generated 20 cents of earnings per diluted share compared to $1.53 per diluted share in the fourth quarter of 2021. Adjusted EBITDA for the quarter was $14.1 million compared to $88.2 million in the prior year. The effective tax rate for the quarter was 21.4% compared to 25.8% in the prior year. The decrease in rate primarily due to a windfall tax benefit related to settlement of deferred stock-based compensation. We do not anticipate this tax benefit going forward. On a full-year basis, the effective tax rate was 26.6%. Moving to the balance sheet, we remain in an exceptionally strong position with no debt and $558 million in cash, cash equivalents, and marketable securities. a modest change from the prior quarter's $572 million. As part of our expanded capital allocation strategy, during the quarter, we returned $32 million of capital to shareholders, including $10 million in dividends and $22 million in share repurchases. For the full year, we returned more than $90 million of capital to shareholders, with $63 million in dividends declared and $30 million in share repurchases. This leaves us with $40 million remaining under the current share repurchase authorization. Last week, we announced that our board declared a semiannual dividend of $0.25 per share, or approximately $10 million, payable on April 6, 2023 to shareholders of record on March 14, 2023. In addition to return of capital to shareholders, we are in a strong position to continue investing in our business through retention and recruiting of top producers, technology improvements, and evaluation of M&A opportunities. Turning now to the near-term outlook, the transaction market headwinds are likely to remain challenging. However, we are cautiously optimistic that the catalyst Assam outlined will support improving market conditions starting in the second half of the year. From an expense standpoint, we are focused on managing controllable costs to minimize the impact of the near-term market disruption without compromising our long-term growth priorities. Revenue in the first quarter will be impacted more dramatically than the usual pattern of seasonality due to current market conditions. This is exacerbated by the fact that Q1 of 2022 set a new record and will be a very tough comparable. Cost of services for the first quarter of 2023 should follow the seasonal reset and decrease sequentially to a range of 61% to 63%. This is slightly higher than the first quarter of last year, given current market dynamics. SG&A for the first quarter should decrease year-over-year in absolute dollars, consistent with lower revenue, but be in line with the fourth quarter. This is due to essential sales and client activities that traditionally occur in the first quarter. We expect our full-year tax rate to be in the 26% to 28% range. Looking forward, we remain opportunistic about the long run and view a market disruption like the period we are in as an opportunity to further build and strengthen our platforms. We have an exceptionally strong balance sheet and have delivered consistent operating results over decades with substantial cash flow generation for our shareholders built on the proven durability of our platform through multiple market cycles. That concludes our prepared remarks. Operator, we can now open the call for Q&A.

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

And one moment, please, while we pull for any questions. And our first question comes from the line of Blaine Heck with Wells Fargo.

Please proceed with your question.

Great, thanks. Good morning out there. Hassam, it seems to me that this type of environment with significant declines in transactional activity would be very stressing on small brokerages. I'm sure you all have ongoing conversations with potential targets. Are you seeing any of them open up more to the idea of a sale and Are you seeing pricing expectations on potential M&A activity moderate, or do you think the lull in transactions would have to be maybe a little bit more extended to shake out better opportunities?

Sure. Hi, Glenn. I hope you're doing well. Great question. We are living with those dynamics every day as we have engaged in a number of conversations. As I mentioned in my remarks, there are a few more conversations in the last 90 days than there had been exactly because of the market shock and the notion that Marcus and Milchev is a very stable and tool-rich and support-rich platform. We are seeing a lot more interest in those aspects of the company, and we are starting to see some adjustment in price expectations and term expectations. I would say that the market needs to have a little bit more time to see that This isn't a quick fix, if you will. And in time, we believe there will be even more opportunities. But we're seeing opportunities in that boutique, local, regional brokerage environment, as well as some boutique financing entities, as well as some more, I would say, specialized and larger providers that could be a very nice fit for MMI.

Great. That's helpful. Switching gears to the share repurchase front, it looks like you took down a little under half the $70 million authorization since announcing the buyback program in August last year. Can you just tell us how you're thinking about share repurchases relative to other opportunities for capital allocation and whether you plan to kind of revisit that share buyback authorization level or amount in the event that you do complete that $70 million that's in place?

Yeah, Blaine, this is Steve. Yeah, you're correct. We've taken down about $30 million of the $70 million that was authorized back in the August timeframe. As we said then, we'll reiterate, we'll be opportunistic and take down shares as we deem appropriate. We want to reiterate that Our capital allocation strategy starts first and foremost with investments internally, infrastructure investments, platform investments, extends to M&A, and then to returning capital to shareholders, both in the form of dividends as well as a share repurchase program. Pointing to the balance sheet, where we've got over $550, $560 million of of funds available, there are plenty of opportunities to do all of those, implement all aspects of that strategy. As we get closer to taking down the fullness of that authorization, we certainly will be revisiting that with our board. And again, I think we will continue to be active in the market with our repurchase program.

Okay, thanks. That's helpful, Steve. It sounds like the changes in hiring processes, remote working trends, and low unemployment are still kind of headwinds with respect to adding professionals. So with that backdrop, along with Steve's comments on some headcount reduction and expense reductions in December, I guess how should we think about the headcount levels at MMI as we move throughout 2023?

Well, one thing to point out is that in the fourth quarter, we actually added net headcount in that many initiatives have been ongoing to address all the factors that have led to the reduction of headcount. We don't see those market forces changing anytime soon. Therefore, it's a matter of our actions that are going to overcome this part of the challenges that we face. The headcount reduction on the support side and expense reductions should not affect our ability to recruit, hire, train, and support new candidates coming into the company because those efforts are executed locally by our regional managers, our recruiting department, and our division managers who've always been very focused on it. We did not reduce expenses in that area. really strategically because it's such an important element for the company's long-term future. I want to highlight again that the success we've had in the last three years in attracting experienced professionals, teams, and groups has more than made up for the revenue production gap that we've experienced since the pandemic from new entrants coming into the business. That's not to say that our plan has changed. We really believe that we need both and we're going to have both. But the success on the experienced hiring front has been a tailwind for us and we continue to see success there. In fact, to your point, Blaine, about the market disruption, a lot more individuals and teams in other firms are curious about what we're doing and basically seeing the brand out there, especially with some of the new things we've done, like the auction platform, MyMMI, those got a lot of attention in the industry.

So we are leveraging that to continue to hire experienced professionals. Okay, that's good to hear. Thanks to Sam. Lastly, I wanted to ask a more specific kind of modeling type question, and sorry if I missed anything in your prepared remarks, but other revenue came in ahead of expectations, especially given the decline in deal activity this quarter. Can you talk about what drove that $2 million increase relative to the third quarter and how we should think about other revenue in 2023?

Yeah, Blaine, again, Steve, other revenue primarily relates to interest income. There are a number of other factors that go into that other income slash expense line item. But the primary contributor is interest income on our investments. And certainly as interest rates have ticked up and impacted Our business, as we've talked many times, we're also generating more income from our investments. Again, there are other line items that flow through there, but that's the primary factor.

Okay.

That makes a lot of sense.

Thanks, guys. That's it for me this quarter. Thanks, Glenn.

And we have reached the end of the question and answer session. I'll now turn the call back over to Hassam Najee for close remarks.

Thank you, Operator, and thank you, everyone, for joining our call. We look forward to seeing some of you on the road and getting prepared for our next earnings call. Thank you very much.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.