Houlihan Lokey - Earnings Call - Q2 2020

Transcript

Operator (participant)

Okay, ladies and gentlemen, thank you for standing by. Welcome to Houlihan Lokey's Second Quarter Fiscal 2020 Earnings Conference Call. I will now turn the call over to Christopher Crain, Houlihan Lokey's general counsel.

Christopher Crain (Senior Executive)

Thank you, operator, and hello everyone. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference call is being recorded today, October 24, 2019. By now, everyone should have access to our second quarter fiscal 2020 earnings release, which can be found on the Houlihan Lokey website at www.hl.com in the investor relations section. Before we begin our formal remarks, we need to remind everyone that the discussion today will include forward-looking statements. These forward-looking statements, which are usually identified by use of words such as will, expect, anticipate, should, or other similar phrases, are not guarantees of future performance. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect, and therefore you should exercise caution when interpreting and relying on them.

We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. We encourage investors to review our regulatory filings, including the Form 10-Q for the quarter ended September 30, 2019, when it is filed with the SEC. During today's call, we will discuss non-GAAP financial measures, which we believe can be useful in evaluating the company's financial performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available in our earnings release and our investor presentation on the hl.com website. Hosting the call today, we have Scott Beiser, Houlihan Lokey's Chief Executive Officer, and Lindsey Alley, Chief Financial Officer of the company.

They will provide some opening remarks, and then we will open the call to questions. With that, I'll turn the call over to Scott.

Scott Beiser (CEO)

Thank you, Christopher. Hello, everyone, and welcome to our second quarter fiscal 2020 earnings call. Considering ongoing volatile macroeconomic and political factors, we are very pleased with the firm's financial performance in the second quarter of fiscal 2020. This quarter, we generated $273 million in revenues, with record second quarter revenues in both corporate finance and financial advisory services, and we had a solid quarter in financial restructuring compared to an exceptional second quarter in financial restructuring last year. Adjusted earnings per share were $0.70 for the second quarter, and we announced our quarterly dividend of $0.31 per share for the third quarter. Record first half revenues of $523 million are up 6% when compared to the first half of last year, and we enter the second half of fiscal 2020 with good momentum across all three of our business lines.

We believe there are a handful of factors that have contributed to our continued solid results. We remain committed to a diversified business model that reduces our reliance on any one banker, one product, one geography, one client, one transaction, or one industry. As a result of this differentiated platform, we believe we continue to gain market share and grow our corporate finance and financial advisory businesses while maintaining a natural hedge against an economic downturn with the largest and most diversified financial restructuring practice on the street. Despite the natural starts and stops of the restructuring marketplace, we believe the future business opportunity is very large and still growing. Our focus on the mid-cap space in corporate finance is unique among our publicly traded peers and results in less volatility, greater client diversification, and provides a very attractive platform to continue to grow our business.

While we are not immune to the impact of current trade disputes, the size and types of our investment banking transactions are likely less impacted than larger cross-border deals. Our financial advisory services business, which produces hundreds of distinct fee events per quarter, helps contribute to the firm's diversification and enhances the reliability of our revenues through the market cycles. Our continued focus on improving client relationships and utilizing industry expertise and SaaS has contributed to expanding our revenues per MD to record highs. Finally, although our stated goal is to continue to diversify internationally, the vast majority of our revenues are still U.S.-based, and the U.S. continues to remain the most vibrant deal marketplace for our business. However, in this environment, we are keeping an eye on factors that may put pressure on our results in the future. The political environment in the U.S.

has become more difficult and uncertain. While we have not seen it yet as we move towards the 2020 elections, uncertainty may weigh on executive confidence and may affect corporate transactions. Depending on the outcome of the elections, future changes in corporate and individual tax policy could have an impact on client results and transaction motivation, particularly with respect to our financial sponsor clients. Historically, when we have had challenging business environments or economic or political dislocation, our business mix has mitigated the effect of these challenges. In spite of the challenges in today's economy and as a result of the strength of our platform, our three business segments have done quite well year to date, with adjusted reported results, retained client mandates, and pipeline prospects all showing growth year-over-year.

During the quarter, we recruited two managing directors in corporate finance, one joining our Private Funds Group and one joining our capital markets effort. We continue to look for talent to grow our capital markets business, and we believe it's one of the most exciting areas for us to grow the firm over the next decade. In addition, we continue to hire in the U.K. and Europe, and in fact, our London office is now our second largest office after New York. To support our growth in this part of the world, I am pleased to say that during the quarter, we opened our new London headquarters and consolidated all of our bankers into one location. Regarding acquisitions, we remain very active and are in various stages of dialogue with potential targets that we believe will help us continue to achieve our stated goals.

To that end, yesterday we announced that we have agreed to acquire Freeman & Company, a New York-based independent advisory firm that provides corporate finance advisory services to companies in the financial services industry. The acquisition is expected to close following regulatory approvals. Lastly, on the shareholder front, ORIX, which has been a significant Houlihan Lokey shareholder since 2006, sold its last shares in our firm in the July block trade. ORIX was instrumental in the development and maturity of our business over the years and very supportive of our collective decision to go public. They've been a great financial partner, and we thank them for their leadership, support, and relationship over these last 13 years. Overall, we are happy with the quarter, and we continue to believe that we offer our shareholders a unique business model that will allow us to achieve solid financial results through all market cycles.

With that, I'll turn the call over to Lindsey.

Lindsey Alley (CFO)

Thank you, Scott. Revenues in Corporate Finance were $156 million for the quarter, up 7% when compared to the same quarter last year. We closed 69 transactions in the quarter compared to 62 in the same period last year, and our average transaction fee on closed deals was slightly lower this quarter versus last year. Financial Restructuring revenues were $77 million for the quarter, a 17% decline from the same quarter last year, which you'll recall was an exceptionally strong second quarter. We closed 17 transactions this quarter compared to 20 transactions in the same period last year, and our average transaction fee on closed deals was lower compared to the same quarter last year. We would like to remind everyone of the lumpiness of our restructuring business across quarters, as it is often driven by the timing of large Fee Events.

In Financial Advisory Services, revenues were $40 million for the quarter, a 9% increase from the same quarter last year. We closed on 523 fee events during the quarter compared to 469 in the same period last year. New business activity in SaaS remained steady, and we have continued to see improvements in Managing Director productivity in our SaaS business. Turning to expenses, our adjusted compensation expenses were $165 million for the second quarter versus $169 million for the same period last year. Continuing this quarter, we adjusted for pre-IPO grants and for the deferred payments primarily related to acquisition agreements associated with our two fiscal 2019 acquisitions. The adjusted compensation ratio was 60.7% for the quarter, within our targeted range of between 60.5% and 61.5%. Our adjusted non-compensation expenses in the second quarter were $44 million versus $41 million for the same period last year.

Year to date, our adjusted non-compensation expense ratio declined to 15.6% versus 15.8% in the same period last year. As we had mentioned in the past, our adjusted non-compensation expense ratio typically runs higher in the first half of the year and lower in the second half of the year because of our revenue seasonality. Our long-term fiscal target for the adjusted non-compensation expense ratio is between 14% and 15% annually. This quarter, we adjusted out of our non-compensation expenses three items. First, approximately $250,000 in primarily legal and accounting costs associated with the registered block trade, which we completed in July of 2019. Second, $1.7 million of acquisition-related amortization. And third, $6.8 million related to the consolidation of our London bankers into a single new London headquarters.

The non-recurring expenses associated with this move are primarily the write-down of the lease assets and fixed assets that are no longer in use. In addition, we adjusted our occupancy expenses in London as if the consolidation and move occurred as of July 1st, the first day of the quarter, in order to best reflect the going forward occupancy costs for our London location. Our adjusted other income and expense line item resulted in a gain for the quarter of approximately $1.1 million versus a gain during the same period last year of $1 million. Our income in this line item for the quarter was primarily a result of interest income on our cash balances throughout the quarter. Our GAAP effective tax rate for the quarter was 28.4%, which is consistent with our targeted range of between 27%-29%. Turning to the balance sheet and uses of cash.

As of the quarter end, we had $305 million of unrestricted cash in equivalents and marketable securities. In the second quarter, we repurchased approximately 479,000 shares at an average price of $43.80 per share as part of our share repurchase program. As a reminder, a significant portion of our cash will be paid out as deferred cash bonuses in November to our banking staff. Each year, bonuses paid in May to our banking staff include both the deferred cash element and a deferred stock element. This November payment represents the deferred cash element. And with that, Operator, we can open the line for questions.

Operator (participant)

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. The 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 key. One moment, please, while we poll for questions. Our first question comes from the line of Devin Ryan of JMP Securities. Please proceed with your question.

Devin Ryan (Director of Financial Technology Research)

Great. Good afternoon, Scott and Lindsey. How are you guys?

Scott Beiser (CEO)

Hey, Devin.

Devin Ryan (Director of Financial Technology Research)

So the first question here, last quarter, you cited that there was kind of a lack of a clear trend, I think is how you framed it, in the middle markets at the moment, and that was leading to a little bit less steady M&A activity. And so when I listened to the call, your prepared remarks, it sounds like there's been a little more clarity recently and the backlog's been growing. So I'm just curious, has something shifted today versus three months ago where you're feeling better about at least the business? At the moment, I understand that obviously there's plenty of macro dynamics that could create uncertainty in the future, but it felt like a little bit of a different tone on this call, maybe a little more constructive. So I'm just trying to understand if I'm hearing that correctly.

Scott Beiser (CEO)

I think, Devin, that's a fair perspective. Probably feel a little better about our corporate finance opportunities for the foreseeable future today than a quarter ago, but still believe that we continue to see the changes in the winds from tailwinds to headwinds and vice versa. So yeah, it's a little better today. Don't know what tomorrow will bring, but opportunities do feel a little stronger today.

Devin Ryan (Director of Financial Technology Research)

Got it. Appreciate it, and then a follow-up here just on the restructuring business. Here's some of the messaging there as well. There's some high-profile assignments that we can all see in the press that you guys have been named on, and so I'm sure that helps a bit, but more broadly, are you seeing an acceleration in activity? And it sounds like you are finding pockets of dislocation, so I'm curious kind of where those are and just, again, any other ways you can frame kind of what's happening in that business would be helpful.

Scott Beiser (CEO)

I think we still see the long-term opportunity set continues to grow, total amount of indebtedness out there, potential problems that we feel may eventually evolve with certain circumstances, and I think it's much what we've said in the last couple of quarters. There are some pockets clearly in a few industries. There's still all the various technology disruptors. There's some companies with just ultimately too much debt, management issues, fraud issues, the whole series of issues that have occurred, but we're still by no means neither ourselves nor our peers do we believe we're in a robust restructuring environment. We think we've done very well and still a very low default rate, and there's still, I would say, ongoing trends and new pockets of restructuring activity.

Devin Ryan (Director of Financial Technology Research)

Got it. Okay, great. And then just last modeling one here. Lindsey, I apologize if you went through this, but on the other operating expense, I know that can be a bit lumpy, but I didn't hear anything flagged there, but that did step up from last quarter decently. So I'm just curious what was in that number and kind of how to think about a go-forward for the other expense.

Lindsey Alley (CFO)

This is our kind of below-the-line other income and expense line item that you're talking about?

Devin Ryan (Director of Financial Technology Research)

I'm looking at other operating expenses.

Lindsey Alley (CFO)

Within our non-compensation expense line?

Devin Ryan (Director of Financial Technology Research)

Yes, exactly. Within non-compensation.

Lindsey Alley (CFO)

Yeah. So I think if you're looking at the GAAP results, part of the add-back relating to the London move is incorporated in both rent and then also in other operating expenses. So there is an increase in that primarily driven by the London move. And that has been a part of our adjustment includes other operating expenses as well as rent.

Devin Ryan (Director of Financial Technology Research)

Got it. Okay. That makes sense. Okay. Terrific. Thank you very much, guys.

Operator (participant)

Our next question comes from Michael Brown of KBW. Please proceed with your question.

Michael Brown (Managing Director and Equity Research Analyst)

Hey, good afternoon, guys.

Lindsey Alley (CFO)

Mike.

Michael Brown (Managing Director and Equity Research Analyst)

So I just wanted to follow up on the non-comp. We were a bit surprised to see kind of the increase this quarter. So I appreciate the color, Lindsey, on the seasonality there. Could you just give some additional color on what was driving the increase in the IT and communication expenses this quarter? You saw that increase sequentially.

Lindsey Alley (CFO)

Yeah. So beginning, gosh, I don't remember, one or two quarters ago, we classified historically, we were classifying some consultants under professional service fees, and we reclassified them up under IT service costs because we thought they were more related to that line item. And so you're seeing an increase in IT and kind of, if you look back over quarters, probably a decrease in professional service fees, and it's simply a reclassification.

Michael Brown (Managing Director and Equity Research Analyst)

Okay. That's helpful. One of your peers had kind of mentioned that some of the deals experienced some timing issues, and it sounds like maybe the time to close was elongated on some of those transactions. I know that was an issue that you guys experienced at the beginning of the year. I was kind of curious if you had seen any of that occurring in the quarter or if you're seeing any pickup in that or any kind of deals being shelved at all.

Scott Beiser (CEO)

We mentioned that I think it was two quarters ago that we saw some delays in timing. Really have not seen that in the last quarter. There's always a subset of clients that our transactions might not close or get a little elongated, but nothing out of the ordinary in this particular quarter.

Michael Brown (Managing Director and Equity Research Analyst)

Okay, great. So it sounds like nothing systemic there. And then just one last one on Freeman & Co. Just kind of curious, how many employees and MDs are expected to join Houlihan once that transaction is closed?

Scott Beiser (CEO)

We announced that there'll be two MDs and one senior advisor, and it's like many of the other acquisitions. It's effectively a mid-sized group that will add to our bench strength in the FIG industry.

Michael Brown (Managing Director and Equity Research Analyst)

Great. Thank you for taking my questions.

Scott Beiser (CEO)

Thanks. Bye.

Operator (participant)

Our next question comes from Brennan Hawken of UBS. Please proceed with your question.

Brennan Hawken (Analyst)

Good afternoon, Scott and Lindsey. Thanks for taking the question. I just have one on restructuring. When we think about restructuring and modeling, this is obviously a really lumpy business. It's one that's prone to large fee events, even though I believe recently you've indicated that there's been some diversity in the size, some smaller fee mandates in there and percentage completion and such. Is there a good way to think about modeling this quarter to quarter, or is this just something where we should, as analysts of the company, just be resigned to understanding that quarter to quarter, we can not always understand how it might move around year to year and quarter to quarter, and comparisons are tough, and we should just look at a rolling average? Any insights on that front?

Scott Beiser (CEO)

Yeah. I think we're all better off probably looking at some rolling average, whether that's 12 months or whatever timeframe you want to use. We don't have a whole lot of control on the timing of closings and restructuring. And I think, unlike in corporate finance, they're not as often impacted by calendar year-end issues for tax reasons or even fiscal year-end issues. And so we do find it's a little tougher to predict from a quarter-to-quarter standpoint. I think historically, you could look at our FAS or corporate finance business and see that it does have certain seasonalities to it. Much harder for us to gauge any particular quarter versus another quarter in restructuring.

Brennan Hawken (Analyst)

Okay. Thanks for that. Appreciate it. And generally, it seems as though the outlook remains pretty steady there, continuing to see good levels of activity despite the low default environment. Is that fair? Is there any shift in that business since last quarter? Any additional color that you can give on how that market has developed?

Lindsey Alley (CFO)

Yeah. I mean, I think, Brennan, as we sit here today, similar to Scott's comments regarding corporate finance, we probably feel a little bit better about our restructuring business for the balance of the year than we did three months ago.

Brennan Hawken (Analyst)

Okay. Thanks very much.

Scott Beiser (CEO)

Thanks, Brennan.

Operator (participant)

Our next question comes from Jim Mitchell of Buckingham Research Group. Please proceed with your question.

Jim Mitchell (H.C. Wainwright)

Hey, good afternoon, guys. Maybe just a question on the you have a pretty big exposure to the private equity client base. Any sense on how they're feeling? I think earlier in this year, there was some hangover from that group and worried about valuations as the market tanked and then rebounded. What's your sense with that client base? Are they re-engaged pretty aggressively with lower rates? How do we think about the activity levels among the private equity buyers?

Scott Beiser (CEO)

Yeah. I think they've clearly picked up from the negative stock market activity from the low point to kind of December of 2018 or kind of recent lows. That being said, I think for the last year or so, when they're out buying businesses, they do model in some kind of a downturn in the economic case that they might not have done three, four, five years ago. So that's a vantage point that they have. But in terms of activity, both buying, selling, raising capital, being able to procure capital for transactions they're doing, we still see it as effectively a healthy marketplace.

Jim Mitchell (H.C. Wainwright)

So there's not a lot of valuation discrepancies holding things back, is what you're saying?

Scott Beiser (CEO)

No. Don't really think there's a huge disconnect between the buying and selling world, at least as of now.

Jim Mitchell (H.C. Wainwright)

Okay. And then maybe, Lindsey, just another question on just the geography of the charges. And how do we think about the London office? You said it's split between other and rent. I think you only disclose it in aggregate. Is there a way for us to know? Can you help us with the run rates in both those expense lines for modeling purposes?

Lindsey Alley (CFO)

Yeah. This is not going to be exact, but I would say it's probably about $1 million of the add-back is in your other operating expenses and the balances in rent. I mean, there's maybe a little bit in a couple of other categories, but that's probably the easiest way to think about it.

Jim Mitchell (H.C. Wainwright)

Okay. That's helpful. Thanks.

Operator (participant)

Our final question comes from the line of Jeff Harte of Sandler O'Neill. Please proceed with your question.

Jeff Harte (Managing Director and Equity Research Analyst)

Excuse me. Good afternoon, guys. A couple from me. I mean, we're kind of beating on non-comp a lot here. But as we look at non-comp, the current quarter or the last quarter is $44 million, a pretty clean starting point for us to think about trending forward and do kind of the historical seasonal trends that we've seen as far as this quarter rolling into next quarter. Do you think that general historical trend should still hold percentage change-wise?

Lindsey Alley (CFO)

Well, I think the historical trend, no reason to believe that shouldn't hold. And I think this is a pretty clean, on an adjusted basis, pretty clean quarter for non-comp expense relative to second quarters of previous years.

Jeff Harte (Managing Director and Equity Research Analyst)

Okay. As far as the competitive environment goes, and I'm thinking primarily in kind of the middle markets, corporate finance, but I suppose restructuring as well, we keep hearing more and more from bulge bracket firms kind of trying to move into the middle market and really focusing on smaller transactions. Have you noticed a change in the competitive environment there? And I guess just as much specifically, are you seeing more of the bulge bracket firms trying to compete in the middle markets?

Lindsey Alley (CFO)

No. We get this question a lot, and you may be hearing about it, but we're not seeing it. I think that largely the disconnect is when the bulge bracket talk about the middle market, they're still aiming higher than our average transaction size. That's not to say we don't compete against bulge bracket firms, but when we're competing against bulge bracket firms, that's at the very high end of our range, or I would say our normal range of clients. And for the vast majority of the transactions that we work on, we just don't see the bulge bracket. And I don't believe that when they talk about middle market, that's the size range they're talking about.

Jeff Harte (Managing Director and Equity Research Analyst)

Okay. And I suppose while I'm talking about the kind of environment, we've talked about restructuring as well. I'm thinking more from you guys are an established leader there, but it seems like every boutique we talk to is now trying to build up restructuring. Have you noticed a meaningful change in the competitive environment there as more and more firms seem to be focused on restructuring now?

Scott Beiser (CEO)

I still think the core competitors that we run across are pretty much the same today as they were three years ago or five years ago. That's not to say that there are some other probably newer entrants or smaller firms that are in it, but the core players, I think it's a very stable group over the last half a dozen or so years and haven't really seen any new competition meaningfully impacting the type of business that we're pursuing or winning.

Jeff Harte (Managing Director and Equity Research Analyst)

Okay. Thank you.

Scott Beiser (CEO)

All right. Thanks, Jeff.

Operator (participant)

Thank you for your questions. I will now hand the call over to Scott Beiser for any closing remarks.

Scott Beiser (CEO)

I want to thank you all for participating in our second quarter 2020 earnings call. We look forward to updating everybody on our progress when we discuss our third quarter results for fiscal 2020 this coming winter.

Operator (participant)

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