Houlihan Lokey, Inc. (HLI) Q4 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Houlihan Lokey Fourth Quarter Fiscal 2019 Earnings Conference Call. [Operator Instructions] Please note that this conference is, call is being recorded today, May 8, 2019. I'll now turn the call over to Christopher Crain, Houlihan Lokey's General Counsel. Please go ahead, sir.

Thank you, operator, and hello, everyone. By now, everyone should have access to our fiscal year and fourth quarter 2019 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-K for the fiscal year-ended March 31, 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.

Thank you, Christopher. Hello, everyone, and welcome to our fourth quarter fiscal 2019 earnings call. We are pleased to report record revenues for fiscal 2019 of $1.084 billion and record adjusted earnings per share of $2.87. For the quarter, we achieved $291 million in revenues and $0.86 in adjusted earnings per share, both records for the fourth quarter. Our Corporate Finance and Financial Advisory businesses both reported record annual revenues and our Financial Restructuring business reported its second-highest annual revenues, eclipsed only by fiscal 2010 when we were in the middle of the global recession. Our results in fiscal 2019 and confidence in our outlook positioned our Board to raise our quarterly dividend by approximately 15% from $0.27 to $0.31 per share. During fiscal 2019, we achieved several accomplishments. We added a net of 16 Managing Directors versus a net of only 4 Managing Directors in fiscal 2018. These new Managing Directors were added through a combination of internal promotions, lateral hires and acquisitions. We continue to invest in our corporate services group adding several new corporate officers in finance and accounting, human capital, marketing and office management. We acquired Quayle Munro and BearTooth in early fiscal 2019. Quayle Munro added new investment banking capabilities in data and analytics, and BearTooth established a starting point for us in the private funds advisory business. We launched HL Finance, which continue to fill out our portfolio of financing advisory products offered to our clients through our capital markets business. Our Financial Restructuring business worked on a significant number of international mandates. We focused on growing our dispute resolution and transaction advisory practice in our FAS business segment and succeeded in both goals. We increased our revenues outside of the U.S. to nearly 20% of total firm revenues. Finally, we hold our number 1 position in the U.S. in M&A transactions, Financial Restructuring and fairness opinions as ranked by Thomson Reuters. I would like to turn now to current business trends we are seeing across our 3 product lines. Fourth quarter fiscal 2019 saw a return to a healthy stock and bond market after a very poor fiscal third quarter. The last few quarters of market volatility helped caused a double-digit decline in the number of reported global deals in the last 12 months. Despite this decline in market activity, Houlihan Lokey once again reported an increase in the number of transactions closed, a testament to our continued success in growing market share as we build an industry-leading global mid-cap investment banking platform. Overall, Corporate Finance reported $607 million in revenues for the fiscal year and $144 million in revenues for the fourth quarter. And despite volatile equity and debt markets over the last 12 months, our capital markets business achieved another record level of revenues. As we head into fiscal 2020, new business activity remains healthy across industry sectors and geographies. Though a word of caution, we are seeing transactions take somewhat longer to close, and we have seen a slight uptick in transactions being put on hold or not closing. However, these mini trends have come and gone over the last few quarters and thus may affect individual quarter results but generally not annual results. Consistent with previous years, in fiscal 2020, we expect to continue to experience seasonality in our quarterly revenues for Corporate Finance. The second half of our fiscal year is normally much higher than the first half, and the first fiscal quarter is normally our weakest quarter. With respect to the distressed market environment, even with global corporate default rates at their lowest levels in years, there are always pockets of opportunity for our market-leading financial restructuring practice. We are seeing an expanding list of companies globally, which are experiencing some level of distress. This enabled our Financial Restructuring business to generate $318 million in revenues for fiscal 2019, an 8% increase over fiscal 2018. We believe the size of our restructuring team, our worldwide reputation and sophisticated and creative advice have allowed us to achieve annual revenues of approximately $300 million consistently over the last 3 years despite low default rates. Furthermore, the combination of highly skilled restructuring bankers and highly knowledgeable industry bankers resulted in more debtor revenues versus creditor business in fiscal 2019 for the first time in recent history. For the quarter, Financial Restructuring reported $100 million in revenues. This is at the higher end of our more typical range in quarterly revenues of between $50 million and $100 million. As transaction fees and Financial Restructuring can be lumpy, we anticipate continued quarterly revenue variability in Financial Restructuring for fiscal 2020. Our Financial Advisory business continued to grow the number of fee events this fiscal year and also increased the average fee per event. Over the last several years, our FAS business has increased its capabilities, adding new services and providing unique industry expertise to specific valuation tasks. This continued investment generated above-average revenue growth for FAS in fiscal 2019. Financial Advisory services reported $159 million in revenues for the year and $47 million in revenues for the quarter, both records for the firm. Our FAS business continues to benefit from a healthy U.S. economy and recently resurgent stock market. We continue to focus strategically and tactically on what we can do to enhance our business and our return to shareholders. We are cognizant of the volatility of the external markets and economies, and we believe we have built a business that can succeed in various market conditions. Over the last few years, Houlihan Lokey has experienced growth in corporate finance, growth in financial advisory and growth in financial restructuring. We believe the resilience of our diversified business model will continue to bode well for our shareholders, employees and clients. And with that, I'll turn the call over to Lindsey.

Thank you, Scott. Revenues in Corporate Finance were $144 million for the quarter, up 11% when compared to the same quarter last year. We closed 64 transactions in the quarter compared to 56 in the same period last year, although our average transaction fee on closed deals was slightly lower this quarter versus last year. Financial Restructuring revenues were $100 million for the quarter, a 28% increase from the same quarter last year. We closed 27 transactions this quarter compared to 26 transactions in the same period last year, and our average transaction fee on closed deals was significantly higher compared with the same quarter last year. Our Financial Restructuring business often has large fee events, and this quarter's strong performance was partly due to timing on a handful of those large fee events. In Financial Advisory Services, revenues were $47 million for the quarter, a 27% increase from the same quarter last year and a record quarter for FAS. We worked on 605 fee events in the quarter compared to 602 in the same period last year, and we had several notable larger fee transactions that resulted in a very strong quarter. New business activity in FAS remained steady, and we have seen some improvements in Managing Director productivity in our FAS business over the last several quarters. Turning to expenses. Our adjusted compensation expenses were $177 million for the quarter versus $153 million for the same period last year. This quarter, in addition to adjusting for pre-IPO grants, we also adjusted for deferred consideration related to acquisition agreements associated primarily with our last 2 2019, fiscal 2019 acquisitions. This deferred consideration, primarily in the form of retention payments, will continue through fiscal year 2023, and it's contingent on both employment and, in some cases, the performance of the operating business we acquired. As a reminder, fiscal 2020 will be the last vesting year of our pre-IPO grants. The adjusted compensation ratio was 60.8% for the quarter and 60.9% for the fiscal year, both within our targeted range of between 60.5% and 61.5%. Our adjusted noncompensation expenses in the fourth quarter were $38 million, up significantly when compared with the fourth quarter last year. The increase in noncomp expenses is partially due to the new accounting pronouncement that clarifies that expense reimbursements be included in revenues. Also driving higher noncompensation expenses were an increase in global rent expense, an increase in headcount and investments in technology. We ended fiscal 2019 with an adjusted noncompensation ratio of 15.1%, just above our targeted range of between 14% and 15%. This quarter, we adjusted out of our noncompensation expenses approximately $1.6 million of acquisition-related amortization. We will continue to adjust for this and other similar types of expenses in the quarters in which they occur. Our adjusted other income and expense line item resulted in a gain for the quarter of approximately $1.5 million versus a gain during the same period last year of $1.1 million. Most of our income in this line item for the quarter was a result of interest income on our cash balances throughout the quarter. Our GAAP effective tax rate for the quarter was 27.5%, which resulted in an adjusted effective tax rate for the fiscal year of 28.5%, towards the high end of our targeted range of between 27% and 29%. As a reminder, a portion of the deferred stock that we issue as compensation to employees vests in May during the first quarter of our fiscal year. This is expected to have a significant effect on our GAAP effective tax rate next quarter, which we will adjust for in order to get to a normalized effective tax rate for the quarter. Turning to the balance sheet and uses of cash. As of the quarter end, we had $411 million of unrestricted cash and equivalents and marketable securities. We expect this number to decline significantly in the first quarter of fiscal 2020 as in May, we pay the majority of our cash bonuses to our financial staff. Finally, in May 2019, we intend to issue net new stock of approximately $41 million to our employees as part of their compensation for fiscal 2019. As in previous years, we intend to buy back enough shares in the open market over the next few quarters to offset the dilution associated with this new stock. With that, operator, we can open the line for questions.

[Operator Instructions] We'll take our first question from Devin Ryan with JMP Securities.

This is Brian Mckenna for Devin. I appreciate your comments on the backdrop, but I'm curious what you're seeing and hearing from financial sponsors specifically. Has there been any material change in dialogues or activity with these clients after the year-end volatility followed by the significant recovery in the market at the start of the year?

Yes. I think I said earlier, we see occasional acceleration of their interest level of new deals. Sometimes, it slows down, but I think over the long haul really have seen them continue to be very active on a global basis across different industry sectors, and we still see quite a bit of strength in the financial sponsor marketplace, notwithstanding the decline we saw in the stock market in December and the recovery really since then.

Got it. And then just on restructuring, it's another solid year. I think revenues were up 8% in the business. I appreciate the commentary in the prepared remarks, but could you give any specifics on the backlog today, say, relative to a year ago? I mean I'm just trying to get a sense of the potential contribution from this business in the coming year.

So we don't discuss specific backlog, but I would say the environment has been turning more positive for restructuring probably over the last couple of quarters, and it continues to feel like a relatively healthy environment for restructuring, notwithstanding still we're in a low default rate and are not experiencing what we've seen obviously in different recessionary periods, but we've been very pleased to be able to produce some I think very strong financial results over the last couple of years in a relatively consistent low default environment.

Next, we'll move to Michael Needham with Bank of America Merrill Lynch.

So the first one I have is the capital markets business. It seems like a really interesting area given the relationships you've got with financial sponsors. You did a pretty big transaction this quarter, I think it was Citco financing. Just wondering if you can just talk about the steps you want to make with that business over the next couple of years and whether you think the market's moving more towards using advisers to source alternate financing.

So we continue to be very bullish on that part of our market. I think we will continue to see it grow, and we will continue to develop incremental skills along different components of the capital structure. We'll continue to develop incremental avenues from a geographical standpoint to provide services to clients, and we'll continue to grow that business also along sector lines. From a standpoint of what we've said in the past in regards to the biggest still competitor that we have is clients that don't think that they need to hire a financial adviser like our firm or others. And we think we're in the very early secular days for ourselves and the industry in general in where the whole agent scene, if you might, of financing services can go in the foreseeable future.

Okay. Great. And then just on the kind of broader M&A environment. The, it sounds like things are so reasonably healthy in terms of the part of the market that you guys are in. It did look like the, like for the data we can track and some of the peer companies, things do appear to be slowing down a little bit. I'm just curious if in kind of U.S. middle market, are you seeing a similar slowdown or not as much of change?

We're reading the same data that you do, and there have been these statistics, both probably in the U.S. and globally, in terms of number of M&A deals that have been trending downward for the last couple of quarters, maybe in the last couple of years. But in terms of the volume of activity, dialogues that we have with the executives in the C suite to the financial sponsors, we continue to see that it's a healthy environment.

Next, we'll move to Ken Worthington with JPMorgan.

Maybe first, you mentioned that transactions were getting delayed somewhat and some deals were put on hold. I missed this part. I assume that was just referring to the March quarter. And we heard from, we've been hearing that pricing between buyers and sellers was more of a focus in the March quarter than we've seen in the past. Is that something that maybe contributed to either the delay or the slowdown in transactions that you saw? And then since it's already kind of almost mid-May, to what extent are conversations really normalizing here given the improvements in broader equity market and rate conditions?

So at this point, I don't think we see any brand-new, longer-term trends in terms of percentage of deals that will close, duration that they take. And at any given time and we've seen this over the months over the last couple of quarters that for a variety of reasons, in different periods, we just seem to have a certain subset of deals that take a little longer to close or maybe will get delayed indefinitely or not close. And then likewise, we see other periods where they seem to get accelerated, and they close at a more rapid pace. So at this juncture, we don't attribute it to anything that's of a longer-term nature. Eventually, that might occur. But at this point, I think it's just kind of the ebbing and flowing of the marketplace. I think, and back to the fact that we are in corporate finance focused on the mid-cap market space, where there are just so many more potential deal transactions that we and our peers can and do work on, these are small changes that typically that you find in terms of a number of delayed deals or deals that close. It's not something, like I said, that I, at this juncture, we're seeing and has got long-term legs to it.

Okay. Fair enough. And then I'll just follow up on an earlier question. On the restructuring business, I think activity levels continued to impress me as well, and I'm trying to maybe better understand why the restructuring business, at least from a Houlihan revenue perspective, has been resilient as it has been. You'd mentioned I think in the prepared remarks non-U. S. opportunities. Is that one of the drivers of the resiliency that you guys are seeing in your business? And then I appreciate your desire to not talk about a pipeline, but given it's a low default rate environment, anything that you can do to help us think about what the outlook might look like over the next 12 to 18 months because I'm, despite your comments, I'm still just sort of grasping for how to think about that.

Yes. I think our comments in the restructuring marketplace today are not meaningfully different than maybe the last quarter or 2. It is being driven by a host of reasons in no particular order, but one I would say, there's just a certain number of companies do, do technology disruptors that is causing problems with their business plans that ultimately gets to some level of distress, and we've been able to get hired on many of those circumstances. In certain cases, there are just more companies globally than there ever was that have some level of high-yield debt, and we've been able to reach far and wide across, at this point, dozens and dozens of countries. And that's something that's probably different than where it was 10 or 20 years ago. The slight changes in interest rate, as I've mentioned in the past, have not been detrimental to our healthy M&A business but have been somewhat healthy to cause distress in companies that might already be considered highly leveraged. You always have some companies for different reasons, just maybe don't have the right management team, the right business plan, could be some litigation matters, a whole host of reasons that there's always, as we've described, pockets of opportunities. And I guess I'd say it's very similar to what we've seen in the last couple of quarters. And by no means are we in a robust restructuring environment, but we've been very proud and happy of what our groups have been able to succeed in this low default rate years for the last couple years.

[Operator Instructions] And we'll move next to Richard Ramsden with Goldman Sachs.

So perhaps we could talk a little bit about the competitive environment. We've obviously had a bit, a number of the large banks that talked about growing their middle market banking effort. Are you seeing any impact either in terms of availability to hire people? Or are you seeing any impact on the competitive environment when you've got them pitched for business so far?

It's still a competitive environment. I wouldn't describe because we've seen any meaningful change coming from the commentary of bulge bracket institutions saying that they are, want to get in the mid-cap space. The competition we still have, generally speaking, either in trying to hire people or to get hired on clients is, for the most part, the same competitive folks that we've had in the last year or 2 or 3. It's not, there's not new players that have meaningfully changed our ability to get hired on projects or to hire key MDs.

Okay. And then secondly, can you talk a little bit about the outlook for the noncomp ratio? I think if we adjust for the accounting change, it came in at about 11% I think, which is well below your target range. Is there anything in there that's one-off in nature? Or should we think about it normalizing back into your 14% to 15% range over time?

Yes. I think we intend to keep the 14% to 15% at this point. There are some incremental costs to a relatively large London move that will continue into fiscal 2020. I do expect that the noncomp ratio will likely be towards the higher end of that range, similar to this year. But that's, I think given how early we are in the year, that's our best guess. There were no other onetime items that occurred in fiscal 2019 that come to mind. We did continue to make significant investments in technology and on our corporate infrastructure, and we closed 2 acquisitions in the early part of the year, which tend to result in a higher TM&E for us. But I think that 2020, we'll continue to see some inflation in our noncomp expenses. And as we sit here today, I would estimate from a modeling standpoint that we'll be at the high end of that range.

We'll move next to Michael Brown with KBW.

Just wanted to touch on the FAS business. So we saw that revenues were up 27% year-over-year, still very strong results. And just wanted to see if you can provide some additional color to really what's driving the strength in that business. Is it kind of a shift to higher fee transaction, just overall market share gain? And how should we think about the persistency of the growth in that business?

That this is a very big market, in broadly defined business valuations. And I think our charge has always been finding those niche areas where we can and want to pursue. And in any given time, we are focused on a few subproducts, we've continued to try to implement and strengthen the utilization of industry expertise, still predominantly a U.S.-centric business. But I would just described, we've gotten better productivity out of our employees. We've been a little more successful on some higher fee projects. And most of the subproduct service areas that we've been operating in had a good year. There was nothing specific or unique that I would describe on an extraordinary standpoint. I think just more things probably worked out in fiscal '19 and maybe in previous years, but we've also continued to do it by hiring both senior people and junior people. And it is a business, to continue to grow it, we will need to continue to hire and bring in key individuals over time.

And just then to hit on the hiring front there. I did notice that the MD count ticked down in that business. Is there anything to really read into there? Or did you just have some new hires that will be onboarded shortly? Just want to, any type of color there will be helpful.

Yes, nothing in particular. At any given year, we'll always have a certain number of retirements. There are always a certain number of departers. We've continued to add through hirings there. And what you saw, most of our hiring, which has been the case over the last couple of years, has not been in corporate finance. And there's not been, at least on the statistical basis, generally big swings, either increases or decreases, in MD head count in either Financial Restructuring or FAS.

Great. And then just on Corporate Finance. I mean we heard from some of your peers that the second half of the calendar year is expected to be stronger than the first half, and part of it just being that they had a kind of soft first half or expecting a kind of softer first half. Obviously, your concentration in the middle market size transactions can give you kind of differentiated results. But as you think about, I guess, your fiscal second and third quarter results, would you expect to see a similar trend? And I guess is that kind of being, what are your expectations for the fiscal first quarter?

So 2 points I'd make. Some of our peers who were more focused on larger deals I think were more benefited or harmed by significant swings in the public stock market, which is what clearly happened in calendar 2018. It has less of an impact in our business due to the size of deals we do, the number of deals that are private versus public. So we typically won't necessarily see the same swings. But having said that, if you go through the last couple of years where we have published quarterly results, in almost all circumstances, the second half of our year is always better than the first half of the year. And as I said, the first fiscal quarter is always the slowest. Some of that is particularly unique issues in how we run and manage the business, some of it's tax motivated when you get to the December time period. But I would expect we'll have similar types of seasonality that we've had in the past.

And we'll move next to Jim Mitchell with Buckingham Research.

Maybe just can you talk a little bit about, I know Europe has been a big focus of growth. And obviously, it's a little tough or slow to do it with MD hires versus acquisitions, which could accelerate. Just trying to get a sense of given the weakness over there, are you seeing more opportunities for acquisitions to jump-start the growth over there? Just any color there on how you're investing in that business will be great.

So long term, we are still very excited about what we can achieve in Europe, but we've said it will take many, many years to get to a place that will probably feel like we really achieved our full amount of success, but we've made a lot of good headway in the last couple of years. Obviously, we've made a number of acquisitions to get us there. We're always, I would say, on the prowl and looking and talking to different kinds of companies, somewhere in Europe, somewhere in the U.S., et cetera. But short term, remember, we've added quite a bit through the acquisitions that we did in Leonardo, in McQueen, in Quayle Munro and BearTooth, so we're still digesting all of that. And we've made I think great headways with those businesses. And if the right thing comes up, yes, we're still open to do future acquisitions in the area as well as future hiring.

So when we think of uses of cash, is it still acquisition is first priority? Or are you sort of signaling that maybe you need to digest and maybe there's cash build this year because it looks like cash balances like were kind of flat year-over-year I assume because of the acquisitions?

I'll let Lindsey talk about just in total cash utilization. I think in the digest comment, we've got more digesting to do in Europe, but that doesn't mean we have the same level of digesting to do in the U.S. or other parts of our firm. So I won't necessarily think that we have changed our focus or interest or intent on doing future acquisitions. I think the comment really on digesting is really applicable to Europe where the total size of our head count there has grown rather rapidly in the last couple of years.

Yes. I think with respect to whether or not we believe we may accumulate some excess cash this year, the hope and the goal is to spend it on acquisitions after our dividends and after our share repurchases. And we believe that, that is absolutely positively the best way to return it to shareholders is to continue to grow the business through acquisitions given our historical success. And so if we see one that we can come to terms with and that we think is value-add to the business and where we're trying to take it, we will absolutely do another acquisition this year, if it makes sense.

Okay. That's really helpful. Maybe just one last quick question on the comp ratio. Any change to the comp ratio target of 60.5% to 61.5%?

No. We continue to maintain that as our long-term target compensation ratio.

[Operator Instructions] We'll move next to Jeffery Harte with Sandler O'Neill.

Most of the questions have been answered. Just got a couple kind of cleanups. As far as the tax rate for 2020, should we be thinking of it as being similar to 2019?

I mean as we sit here in mid-May, that's probably a good way to model it. I don't think there's any reason for me to believe that will change. Obviously, we have a long way to go through the year, but I think that's a decent way to model it.

Okay. In noncomp, the dollar amount is kind of what I'm looking at, and the increase year-over-year in the fourth quarter was not nearly as much as kind of what I was expecting or what the kind of run rate increases have been during the year. Taking the comp ratio guidance and keeping that in mind, as we look to next year, I mean is this kind of fourth quarter starting point a decent place to be starting that $38 million kind of quarterly run rate on a dollar basis? Or was there anything unusual that kind of made the fourth quarter, dollar-wise, maybe not quite as high as next year is going to end up being?

We do have some seasonality in our noncomp expenses. We have a fair amount of marketing in some of the industry groups that occur kind of in the middle half of the year or the second and third quarters. We do have training expenses that run through specific quarters. So we do have some lumpiness in that business. So I think you have to look at it on an annual basis. The fourth quarter noncomp here happened to be towards the lower side of noncomp expense for the year, but that I think is driven more by when we spend the money versus what noncomp will look like next year.

[Operator Instructions] We have no further questions in our queue at this time. I'll turn the call back over to Mr. Scott Beiser for any closing or additional remarks.

Thank you. And I want to thank you all for participating in our fiscal year and fourth quarter 2019 earnings call. And we look forward to updating everybody on our progress when we discuss our first quarter results for fiscal 2020 in the summer.

That does conclude our conference call for today, everyone. We do thank you for your participation. You may now disconnect your line.