Moelis & Co quarterly report, Q3 FY2018

Moelis & Company — Q3 2018 Form 10-Q

Reporting period: Three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Moelis is a global, independent investment bank focused on advisory services, including M&A, recapitalizations, restructurings and other corporate finance matters.

Financial performance and liquidity

• Revenue drivers: Q3 revenue rose 22%; nine-month revenue rose 26%. Management attributed growth primarily to stronger M&A activity and higher average fees per completed transaction; Q3 also benefited from increased restructuring activity. U.S. revenue was $172.2m in Q3 and $544.4m for the nine months.
• Expenses and margins: Operating expenses increased 19% in Q3 and 24% year to date, slower than revenue growth. Compensation was 58% of revenue in both nine-month periods (59% in 2017); total operating expenses were 75% of revenue versus 76% in the prior-year period.
• Cash flow: Nine-month operating cash flow was $232.6m, versus $135.3m in 2017. Investing cash outflow was $53.7m and financing cash outflow was $304.3m, principally reflecting dividends and distributions. Cash, cash equivalents and restricted cash ended the period at $87.7m, down from $213.9m at year-end 2017.
• Liquidity and debt: Fair-value investments were $144.9m. The company had no borrowings on its $65.0m revolving facility; $60.3m remained available after letters of credit. The filing says the business generally does not borrow through issuing debt.
• Other balance-sheet items: Deferred tax assets were $412.9m and the tax receivable agreement (TRA) liability was $323.2m. Total assets were $823.0m and total equity was $326.9m at September 30.
• Dividends: $4.41 per share was declared for the first nine months, including two $1.50 special dividends and three regular quarterly dividends. A further $0.47 per share was declared after quarter-end, payable November 14, 2018.

Material changes and unusual items

• 2017 results included substantial gains associated with Moelis Australia’s share issuances and IPO-related events. Other income and expense was $33.0m for the first nine months of 2017 versus $3.0m in 2018; this contributed to 2018 pretax income rising only 4% year over year despite 26% revenue growth. Q3 other income and expense likewise fell from $15.0m to $1.1m.
• Moelis adopted the new revenue standard (Topic 606) in 2018. It recognized $16.2m in Q3 for transactions that closed after quarter-end, and $36.9m in Q2 for transactions that closed in Q3. The filing says these amounts would have been recognized in different periods under the prior policy. Client reimbursements are now presented gross in revenue and expenses.
• The Tax Cuts and Jobs Act lowered the U.S. federal corporate tax rate, contributing to lower effective tax rates: 18% versus 25% in Q3 and 11% versus 19% for the nine months. The company reported a $178.9m increase in its net deferred tax asset during the first nine months, primarily from tax-basis step-ups tied to 2018 unit exchanges and offerings. No material adjustment to the provisional Tax Act accounting had been recorded as of September 30.
• Class A shares outstanding rose to 45.7m from 33.5m at year-end 2017, while noncontrolling partnership ownership declined to 22% from 40%. The filing attributes changes principally to offerings, exchanges and equity compensation.

Outlook, risks and contingencies

Management gave no specific financial guidance. It described the market backdrop as supportive of continued M&A activity, citing technological disruption, shareholder activism, available capital, positive growth, corporate cash and credit availability. Restructuring remained a steady contributor despite low defaults. Management also expects deeper global collaboration as its banker team grows; the firm reported 588 advisory bankers and 19 locations.

• Revenue is transaction-dependent, timing is outside the company’s control, and fees may be delayed or lost if deals fail to close or encounter regulatory, approval, financing or market obstacles. Management cautioned that quarterly results may not predict full-year or future performance.
• Cash generation depends on client collections and successful transactions. Most U.S. and U.K. bank balances exceeded deposit-insurance coverage limits; the company noted that it does not hedge foreign-currency exposure.
• The $323.2m TRA obligation is an estimate. Payments generally follow realization of tax savings, but change-of-control or early-termination provisions could result in payments exceeding actual tax savings.
• The company reported ordinary-course legal and regulatory matters but said it was not aware of material pending proceedings expected to have a material effect. Potential losses could not be estimated. No material changes to the 2017 Form 10-K risk factors were reported.
• Operating leases extend through 2029; net minimum payments were $70.3m. The $65.0m revolving facility matures June 30, 2019. Management expects adoption of the new lease standard to add right-of-use assets and liabilities, without anticipating material income-statement changes.

Important facts for investors to verify

1. How much reported revenue reflects Topic 606 timing shifts, and whether future transaction completions or cancellations could reverse or change fee recognition.
2. Whether M&A activity and average fees sustain the 2018 revenue growth, given the firm’s dependence on deal flow and transaction closings.
3. The future realization of the $412.9m deferred tax asset and timing and assumptions underlying the $323.2m TRA liability.
4. Cash use and dividend sustainability after $286.1m of dividends and distributions in the first nine months, alongside the decline in cash balances.
5. The effects of equity compensation, partnership-unit exchanges and share offerings on dilution, per-share earnings and the allocation of earnings to noncontrolling interests.