Marcus & Millichap, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; filed August 9, 2018. The company is a commercial real estate brokerage and financing firm operating 78 offices in the U.S. and Canada, with 1,841 investment sales and financing professionals as of quarter-end. It reported one operating segment.
Financial performance
Amounts are in millions of dollars except per-share data and where noted.
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $199.4 | $180.4 | $373.9 | $333.6 |
| Operating income | $29.0 | $25.0 | $52.4 | $44.0 |
| Operating margin | 14.5% | 13.9% | 14.0% | 13.2% |
| Net income | $22.2 | $15.6 | $40.2 | $27.6 |
| Net margin | 11.1% | 8.6% | 10.7% | 8.3% |
| Diluted EPS | $0.56 | $0.40 | $1.02 | $0.70 |
| Adjusted EBITDA (non-GAAP) | $33.7 | $28.7 | $61.2 | $51.1 |
- Revenue mix and drivers: Q2 brokerage commissions were $181.6 million, up 11.7%; financing fees were $15.6 million, up 22.5%; other revenue was $2.2 million, down 56.8%. For the first half, brokerage commissions rose 13.7% to $344.2 million and financing fees rose 11.1% to $25.3 million, while other revenue fell 44.6% to $4.5 million. The declines in other revenue mainly reflected a large prior-year consulting fee and lower consulting/advisory activity.
- Transaction activity: Q2 brokerage transaction count increased 7.9% and average transaction size rose 14.0%; sales volume increased 23.0%. First-half brokerage transaction count increased 7.2%, average transaction size rose 14.3%, and sales volume increased 22.5%. The greater mix of middle- and larger-market deals reduced average brokerage commission rates.
- Costs and margins: Q2 operating expenses grew 9.7%, slower than revenue growth of 10.6%. Cost of services was 60.1% of revenue versus 61.2% a year earlier; SG&A rose 12.3%, reflecting growth investments, marketing, compensation, stock-based compensation and office expansion. First-half operating expenses increased 11.1% against revenue growth of 12.1%.
- Taxes: Effective tax rates were 26.9% for Q2 and 26.4% for the first half, compared with 39.2% and 38.9% in 2017, primarily reflecting the reduction in the federal corporate tax rate to 21%. The company said its estimate of certain Tax Cuts and Jobs Act effects remained provisional and could be adjusted by year-end 2018.
- Cash flow: First-half operating cash flow was $23.0 million versus $0.5 million in 2017; investing cash use was $1.4 million versus $22.0 million; financing cash use was $2.4 million versus $2.0 million. Cash and cash equivalents rose $19.2 million to $240.0 million.
- Liquidity and debt: At June 30, cash was $240.0 million and available-for-sale marketable securities were $117.4 million. Current assets were $344.9 million and current liabilities $60.6 million. The $60 million revolving credit facility had no borrowings outstanding; $0.533 million of its letter-of-credit sublimit was used. Notes payable to former stockholders totaled $7.7 million and are due in installments, with final principal due in 2020. The company was compliant with credit-facility covenants.
- Other balance-sheet items: Total assets were $474.2 million, total liabilities $115.3 million and stockholders’ equity $358.9 million. Marketable securities were rated AA on average; the company reported unrealized losses but considered them temporary and recorded no impairment write-downs.
Material changes and notable items
- Q2 revenue rose 10.6% and first-half revenue rose 12.1% year over year; net income rose 42.4% and 45.7%, respectively. Lower tax expense contributed materially to the increase in net income.
- The company completed two related acquisitions, including Pinnacle Financial Group and PFG Servicing, for approximately $6.2 million net of cash received, plus contingent consideration with a fair value of $1.7 million tied to EBITDA targets. The acquisitions expand loan origination and add mortgage servicing. Goodwill of $4.2 million and net intangible assets of $1.5 million were recorded; acquired operations were not material to reported results.
- The company adopted the new revenue recognition standard on January 1, 2018; it said adoption did not change the manner or timing of revenue recognition. It adopted the simplified goodwill impairment standard in Q2 with no financial statement impact.
- Operating lease obligations for autos and offices were approximately $88.3 million at June 30. The company expects adoption of the new lease standard on January 1, 2019 to materially affect the balance sheet; the amount and effects on earnings and cash flows were not yet determined.
- Shares outstanding were 38,621,712 at August 2, 2018. Founder and Co-Chairman George M. Marcus beneficially owned approximately 44% at June 30.
Outlook, management commentary and risks
- No quantified financial guidance was provided. Management said it remained optimistic about economic expansion through the rest of 2018 and its potential support for commercial real estate investors, while cautioning that interim results are not necessarily indicative of full-year performance.
- Management described transaction activity as strong by historical standards, with a modest increase in investor sentiment and activity. It cited robust demand and available financing, alongside risks from rising interest rates, trade tensions, market volatility, a maturing cycle, cautious underwriting and possible oversupply in some metropolitan areas.
- The business depends on commercial property transaction volume, transaction size, recruiting and retaining professionals, and investor confidence. Revenue timing is transaction-dependent and can vary; brokerage commissions are also affected by deal mix and generally lower rates on larger transactions.
- The company believes cash, operating cash flows, marketable securities and available credit should cover requirements for at least 12 months, but cautioned that external capital may not be available on acceptable terms if needed. It also noted certain former-stockholder notes and SARs arrangements could accelerate repayment and affect liquidity.
- Ordinary-course litigation includes brokerage disputes, alleged disclosure or fraud issues, employment matters and claims challenging sales professionals’ independent-contractor classification. Most matters are insured subject to limits and deductibles; management did not expect a material adverse effect.
- A new risk factor highlights possible impairment of acquisition-related goodwill and intangible assets; any charge would be non-cash but could materially affect reported earnings and the share price. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue growth and improved operating margins persist, particularly as larger transactions reduce average brokerage commission rates.
- How much of earnings growth came from the lower tax rate versus underlying operating improvement, and whether further tax-law adjustments are required.
- Acquisition performance against EBITDA targets, contingent consideration outcomes, and the recoverability of the recorded goodwill and intangible assets.
- The eventual balance-sheet impact of recognizing the $88.3 million of operating lease commitments under the new lease standard.
- Cash conversion and working-capital trends, including timing of deferred commission payments and employee-related accruals; first-half operating cash flow is period-specific.
- Interest-rate and market risks affecting both commercial real estate transaction activity and the fair value of the $117.4 million securities portfolio.
- Potential developments in litigation, including independent-contractor classification matters, and any changes to credit-facility covenant compliance or liquidity needs.