Houlihan Lokey, Inc. (NYSE:HLI) Q3 2023 Earnings Call Transcript

Houlihan Lokey, Inc. (NYSE:HLI) Q3 2023 Earnings Call Transcript January 31, 2023

Operator: Good day, ladies and gentlemen. Thank you for standing by. Welcome to Houlihan Lokey’s Third Quarter Fiscal Year 2023 Earnings Conference Call. 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, January 31, 2023. I will now turn the call over to Christopher Crain, Houlihan Lokey’s General Counsel.

Christopher Crain: Thank you, Operator, and hello, everyone. By now everyone should have access to our third quarter fiscal year 2023 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 December 31, 2022, 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 will turn the call over to Scott.

Scott Beiser: Thank you, Christopher. Welcome everyone to our third quarter fiscal year 2023 earnings call. We ended the quarter with revenues of $456 million and adjusted earnings per share of $1.14. Revenues were down 49% versus the same quarter last year and down 7% from the previous quarter. When comparing to last year’s third quarter, bear in mind that our December 2021 quarter was extraordinary. In fact, the prior year quarter was substantially higher than any previous quarter in our firm’s history, both in revenues and adjusted EPS. Furthermore, numerous external market factors have altered the typical seasonality of the M&A market globally. This year our results are consistent with the industry trends and that our December 2022 quarter was less than our September 2022 quarter.

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This is the first time our December quarter results were lower than our September quarter results since December 2008. While this quarter’s financial results are disappointing, we are encouraged by the fact that our nine-month year-to-date results are the second best in the firm’s history. Corporate Finance quarterly revenues were $292 million. We saw an increase in transaction closings this quarter versus last quarter offset by a reduction in average transaction fees. New Business activity remains robust as the number of new engagements was a quarterly high for this fiscal year. Partially offsetting these positive factors is that the financing market remains challenged. Mid-cap transactions can still get financing, but lenders are more selective.

The cost of debt is up significantly and some lenders have opted to sit on the sidelines until they perceive better visibility on the economy. This has resulted in pent-up demand in M&A, which we believe will ultimately be a positive for our business once there is more broad-based confidence in the economy. Financial and Valuation Advisory recorded $66 million in revenues. The decline in revenues versus the same quarter last year was primarily driven by lower revenues in transaction opinion and transaction advisory services. Both service lines were affected by reduced M&A activity, especially in the public marketplace. However, our portfolio valuation service line continues to do well and in certain circumstances, benefits from a more volatile market.

Financial Restructuring produced $99 million of revenues, another very strong quarter. For each quarter of this fiscal year, Financial Restructuring experiencing an increased number of closed transactions and an increased number of new engagements versus the prior quarter. Restructuring continues to see strong new business activity adding to our confidence in this business segment in the second half of the calendar year and throughout calendar 2024. New Business and Financial Restructuring is broad-based across all major geographies and most industry sectors. Our long-term focus on growing our business both internally and externally continues. We hired five managing directors this quarter. We announced the acquisition of Oakley Advisory, a digital infrastructure investment banking firm in the U.K. and we continue to have a robust pipeline of quality acquisition targets.

Finally, I wanted to end today’s comments with a recognition to all three of our business segments and the bankers that continue to deliver exceptional results to our clients and our shareholders. In calendar 2022, we continued our string of league table successes. Houlihan Lokey was ranked as the number one investment banking firm for all global M&A transactions under $1 billion and all transactions regardless of size in the U.S. based on transaction volume. We are again ranked the number one investment banking firm for all Financial Restructuring transactions, both in terms of value and volume. In addition, we were ranked as the most active fairness opinion firm by volume when measured for the period over the last 25 years. Overall, we are proud of our accomplishments in calendar 2022 and we fundamentally believe that our business model positions us effectively for long-term growth and strong shareholder returns.

And with that, I will turn the call over to Lindsey.

Lindsey Alley: Thank you, Scott. Revenues in Corporate Finance were $292 million for the quarter, down 7% when compared to last quarter and 59% when compared to the same quarter last year. We closed 125 transactions this quarter, compared to 114 last quarter, but our average transaction fee on closed deals was lower. Financial Restructuring revenues were $99 million for the quarter, an 11% increase from the same period last year. We closed 28 transactions in the quarter, compared to 21% in the same period last year and our average transaction fee on closed deals was lower. In Financial and Valuation Advisory, revenues were $66 million for the quarter, a 21% decrease from the same period last year. We had 876 fee events during the quarter, compared to 901 in the same period last year.

FVA’s quarter was heavily influenced by the slowdown in M&A activity for the quarter, both the transaction opinion and transaction advisory service lines were down versus the same quarter last year. Turning to expenses. Our adjusted compensation expenses were $281 million for the third quarter versus $547 million for the same period last year. Our only adjustment was $8.6 million for deferred retention payments related to certain acquisitions. Our adjusted compensation expense ratio for the third quarter was 61.5%, the same as last year. Our adjusted non-compensation expenses were $73 million for the quarter, an increase of $14 million over the same quarter last year, but flat versus last quarter. This resulted in a non-compensation ratio of 15.9% for the quarter.

We believe that our non-compensation expenses have settled into a post-COVID norm relating to TM&E and other operating expenses. We still see pressure on rent with additional space supporting our growth and general inflation, and we expect to continue to invest in technology as a point of differentiation as the firm grows. We continue to believe that our long-term target for our non-compensation ratio will be lower than what it was pre-COVID given the increased size of our business. However, we are seeing some pressure on that ratio this year given the current business climate. For the quarter, we adjusted out of non-compensation expenses, $10.4 million in non-cash acquisition-related amortization, the vast majority of which was amortization related to the GCA transaction.

Our adjusted other income and expense decreased for the quarter to income of approximately $2.2 million versus an expense of approximately $300,000 in the same period last year. We adjusted out of our other income and expense, $2.7 million related to the wind down of the SPAC that we co-sponsored. Given the wind down, there is no remaining asset related to the SPAC on our balance sheet. Our adjusted effective tax rate for the quarter was approximately 25%, compared to 30% when compared to the same quarter last year. Although, we received some benefits this quarter, which slightly reduced our effective tax rate, we continue to target a long-term range for our effective tax rate of between 27% and 28%. Turning to the balance sheet. As of the quarter end, we had approximately $586 million of unrestricted cash and equivalents and investment securities.

As is typical during our third quarter, the cash position was affected by a November payment of cash deferrals relating to bonuses accrued in fiscal year 2022. In this past quarter, we repurchased approximately 100,000 shares at an average price of $91.65 per share as part of our share repurchase program. We continue to be disciplined regarding share repurchases as we look to maintain balance sheet flexibility. Finally, the Board approved the quarterly dividend to be paid in March and also approved a change to our Board Committee structure, where effective immediately, our Compensation Committee and our Nominating and Governance Committee will be comprised solely of independent directors, consistent with our Audit Committee. And with that, Operator, we can open the line for questions.

Operator: Thank you. And we will go first to Brennan Hawken with UBS.

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Q&A Session

Brennan Hawken: Good afternoon, Scott. Lindsey, how are you?

Scott Beiser: Hi, Brennan.

Lindsey Alley: Hi, Brennan.

Brennan Hawken: So thanks for taking the question. I would love to start on Corporate Finance. So you spoke to financing becoming more challenging from banks, and so clearly, that was impacting the December quarter. But how has that — have you noticed any change here early in 2023, how is that continued availability trending here so far, has there been any change and how should we be thinking about the outlook for mid-market M&A?

Scott Beiser: On the financing front, I’d say, we have seen a slight improvement during the month of January versus the previous quarter in financings. I think there were some lenders who just did not want to deploy any capital on their books when they closed them out on December 31. So they were, I’d say, slightly more open-minded in terms of finding opportunities to lend, but it’s still a marketplace that’s rather challenged out there.

Brennan Hawken: Okay. And should we therefore keep our expectations toned down so long as the financing markets remain challenged as far as Corporate Finance goes in M&A?

Scott Beiser: I’d say there’s a dichotomy going on, which for the last several months, the last few quarters, I’d say, the amount of new business, the size of our prospects, pipeline, backlog, however, you might count it, actually continues to grow. That’s the very positive sign. But really have not seen a definitive turn in the marketplace yet, whether it’s willingness by buyers and sellers or lenders and borrowers to come together. So the transactions are occurring. They are just not occurring at the pace that we would think is typical for the size business that we have already got signed up. So I think we are all still waiting for eventually that improved pipeline to ultimately turn into revenues, but just haven’t seen a definitive turn in the marketplace at least as of yet.

Brennan Hawken: Okay. All right. Thanks for that. That’s appreciated. I’d love to use that as a segue to my follow-up question, which would be, if we do see continued challenging climate and environment, particularly for M&A and Corporate Finance, is there a point where your normally, very predictable, very reliable and very boring 61.5% comp ratio begins to see some upward pressure, maybe it becomes a little bit less boring? How should we be thinking about that and is there any point in which maybe it starts to become a bit more of a concern for you at least in the short-term?

Scott Beiser: I think all we can point to is, since we have gone public, we have had a very tight range and I believe it’s almost as tight as anybody in terms of what our payout ratio is and it’s typically not very much year-to-year or within the year. And as we see the marketplace as we see the results of our business, I think, we are still comfortable with the 61.5%. I don’t think you can ever say that it will never change, but there’s nothing sitting here in our minds right now that suggests it’s going to change in the foreseeable future.

Lindsey Alley: And I’d say, Brennan, even pre-public in the two recessions that occurred early 2000s and kind of 2008, there’s precedence of us managing to a fairly tight range as well. So I think we certainly have history to help us answer that question, but I agree with Scott, nobody knows what the next six months is going to look like.

Brennan Hawken: Okay. Thanks for the color. Appreciate it.

Scott Beiser: Thanks, Brennan.