Earnings Call Transcript - HLI Q1 2022

Operator, Conference Operator

Thank you for your patience. This is the conference operator. Welcome to the Houlihan Lokey, Inc. Fiscal First Quarter 2022 Earnings Conference Call. The conference is being recorded. I would now like to turn the conference over to Christopher Crain, Houlihan Lokey's General Counsel. Please proceed.

Christopher Crain, General Counsel

Thank you, operator, and hello, everyone. By now, everyone should have access to our first quarter fiscal year 2022 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 the 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 June 30, 2021, 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. Welcome, everyone, to our first quarter fiscal 2022 earnings call. We are pleased to report another strong quarter. We achieved $373 million in first quarter revenues, up 77% from a year ago. This significant increase was compared to a relatively weak first quarter last year as a result of the pandemic. While our first quarter revenues were down from our exceptionally strong third and fourth fiscal 2021 quarters, $373 million in first quarter revenues were the best ever for what is usually our seasonally lowest quarter. All 3 of our business segments did very well. Corporate Finance and Financial and Valuation Advisory exhibited continued strength in a very robust M&A market environment. Financial Restructuring delivered strong revenues and continued to maintain its significant market share during a challenging restructuring market environment. On the expense side, we reduced our compensation ratio from last year's level while maintaining historically low non-compensation expenses as we slowly return to in-person events and business travel. For the first fiscal quarter of 2022, we reported adjusted earnings of $1.19 per share, up 112% from last year. Our Corporate Finance business continues to benefit from a historically strong market with all key metrics experiencing positive trends. New business activity remained at record levels. Our average transaction size and average fee per closed transaction were higher than previous years. Close rates were up with fewer transactions put on hold. Nearly every industry sector and geography experienced improved market environments. Our core product offerings of M&A, capital markets, and private funds advisory showed year-over-year growth. Our FVA business has done incredibly well over the last few years, growing its revenues at a 5-year compounded average growth rate of just under 10%. All of our service lines within FVA performed above last year's levels. The number of our clients, number of new clients, recurring clients, complexity of assignments, and average fees all increased. Our Financial Restructuring business continues to slow from the torrid pace it experienced last year. As previously discussed, Financial Restructuring is now operating at pre-pandemic activity levels, and we expect that level of business to continue for the foreseeable future. However, an ever-increasing amount of corporate leverage, coupled with effects from the pandemic and continued disruption from technology, provides optimism for this business segment in the medium and long term. During the first quarter, we announced 16 newly promoted MDs, our largest class ever, and we hired 5 MDs mostly in Corporate Finance. While competitive, we believe the hiring market remains strong, and we remain in active dialogue with a number of key prospective hires. Regarding our acquisition activity, we are excited to announce our commencement of a tender offer to acquire all of the outstanding equity of GCA Corporation for a total cash purchase price of approximately $591 million. The transaction is expected to be funded with cash on our balance sheet. GCA is a well-known global investment banking firm publicly traded on the Tokyo Stock Exchange. They have significant operations in the U.K. and Europe, the Asia Pacific region and the U.S. Their primary focus is in technology and related sectors, but they also have expertise in a couple of additional core industries complementary to our existing business. We plan to commence the tender offer for GCA shares shortly, and we anticipate closing the tender offer in the beginning of October. In the meantime, we have started planning for a smooth and successful integration of our two businesses. Within the press release issued yesterday announcing the transaction, we provided a link to a summary of GCA that gives a snapshot of the company and the transaction that explains our strategic rationale for wanting to commence the tender offer to make this acquisition. Let me highlight a few pro forma statistics from that presentation. Upon completion of the tender offer, Houlihan Lokey will have over 2,000 employees generating more than $1.8 billion in revenues on an annualized basis. We will have offices in 17 countries, and over 30% of our combined revenues will be outside of the United States. As a combined firm, revenues in our technology, media and telecom industry group will go from being under-weighted relative to the industry size to becoming our largest and most global industry group. In many regards, this transaction is similar to the dozen or so transactions we have completed over the last decade. It's a business we know well, run by a management team that has a similar culture and business philosophy as we do. GCA and Houlihan Lokey share a number of important cultural traits, including a collaborative entrepreneurial approach, independent thoughtful advice, and a relentless focus on its clients. While we believe this is an exciting transaction for our collective clients, employees, and shareholders, we also recognize the time and effort it will take to integrate these two businesses effectively. This is by far the largest transaction we've ever pursued, but we are prepared for the challenge, and we are focused on a successful outcome. And with that, I'll turn the call over to Lindsey.

Lindsey Alley, CFO

Thank you, Scott. Revenues in Corporate Finance were $210 million for the quarter, up 139% when compared to the same quarter last year. We closed 84 transactions this quarter compared to 35 in the same period last year, and our average transaction fee on closed deals increased. As a reminder, our Corporate Finance business was negatively impacted by the pandemic in the same period last year. Financial Restructuring revenues were $99 million for the quarter, an 11% increase from last year's first quarter. We closed 24 transactions this quarter compared to 29 in the same period last year, and our average transaction fee on closed deals was significantly higher. Our restructuring activity has now returned to more normal pre-pandemic levels. Unless something changes, we expect to see solid but significantly lower restructuring revenues for the balance of fiscal 2022. In Financial and Valuation Advisory, revenues were $64 million for the quarter, an 85% increase from the same period last year. We had 820 fee events during the quarter compared to 512 in the same period last year, and we continue to see an increase in revenues per fee event. Turning to expenses, our adjusted compensation expenses were $229 million for the first quarter versus $132 million for the same period last year. Our only adjustment was for deferred payments related to certain acquisitions. Our adjusted compensation expense ratio was 61.5% for the quarter. Our adjusted non-compensation expenses were $32 million for the quarter versus $30 million for the same quarter last year, an increase of 6%. This resulted in an adjusted non-compensation expense ratio of 8.5% for the quarter versus 14.2% in the same period last year. This quarter, we adjusted out of our non-compensation expenses $1.1 million in acquisition-related amortization. We expect to see a significant increase in non-compensation expenses in fiscal 2022 as we begin to return to more normalized travel and operations, but we do not expect that to occur until the second half of the fiscal year. Our adjusted other income and expense decreased for the quarter to income of approximately $101,000 versus income of approximately $1.2 million in the same period last year. This was primarily a result of lower interest earned on our cash and investment balances. Our adjusted effective tax rate for the quarter was 26.7% compared to 25.3% during the same quarter last year. As a reminder, a portion of the deferred stock that we issue as compensation to employees vest during the first quarter of each fiscal year, which was adjusted for to get to a more normalized effective tax rate for the quarter. Our long-term target for our adjusted effective tax rate is between 27% and 29%, although we expect our tax rate for fiscal 2022 to be closer to the lower end of the targeted range. Turning to the balance sheet and uses of cash. As of the quarter end, we had approximately $830 million of unrestricted cash and equivalents and investment securities. In our first quarter, we issued approximately 1.9 million net new shares to employees as part of their bonus compensation for fiscal 2021. We intend to offset this dilution through share repurchases throughout fiscal 2022. And in our first quarter, we repurchased 1.4 million shares through either open-market repurchases or repurchases meant to cover taxes on vesting shares at an average price of approximately $76.04 per share. Finally, moving to the acquisition of GCA. Given the length of the tender offer process, in the next quarter, we expect to be in a better position to answer questions that you will have regarding our integration strategy, the pro forma combined company financial profile, the accumulation and deployment of future cash, and the timing to achieve appropriate long-term targets. We believe this acquisition will be accretive to our shareholders at closing, and we look forward to sharing with you our plan to drive shareholder value through the combination of these two businesses. And with that, operator, we can open the line for questions.

Operator, Conference Operator

Our first question comes from Ken Worthington of JPMorgan.

Ken Worthington, Analyst

I wanted to focus on the GCA deal, recognizing that you mentioned discussing some of the strategic rationale in the next quarter. Can you provide some insight into the company’s growth? Clearly, 2021 is a strong year for M&A globally, and it appears that GCA is off to a good start this year. However, revenue was down in 2019. What has the growth looked like for this company over the past five years? Would you describe it as a fast-growing company? It seems like there might be more stagnant growth, but I don't have enough information yet to determine that. So first, please discuss the growth.

Scott Beiser, CEO

Ken, I think its performance and growth has been similar to not only our firm but other investment banking firms over the last couple of years. There's been some volatility, obviously, with the pandemic impact, especially in calendar 2020 for them. They're having a very good year in 2021 as is, I think, most everyone else in the marketplace. We think they're in a very good space clearly in technology, which is one of the leading, if not the leading industry, and they clearly have a lot of geographical diversity to continue to help their growth.

Ken Worthington, Analyst

How does this align with the Houlihan vision? It appears that this is an appealing asset class within technology and it diversifies the business geographically. Are there cost synergies here? I'm uncertain about that. Does it enhance restructuring or financial advisory in any way? Are there synergies relevant to your existing middle market M&A operations? Do you see opportunities for more cross-border deals with this company? Please help me understand the synergies you foresee.

Scott Beiser, CEO

Well, in many regards, we look at it very similar to the other dozen-or-so deals that we’ve done. Obviously, we mentioned this is a larger business in scale and scope. But we’ve experienced almost every time whenever we’ve acquired a business that eventually, we do get some revenue synergies. We’re putting together two teams that have a different set of clients and experiences. We add to the geographical bench. We clearly strengthened the TMT industry. They don’t have the restructuring business that we’ve got. They don’t really have the same level of depth of the valuation group that we have. They don’t have the same level of the financial sponsor group that we have. So all these things, we believe, combined would make both of the businesses stronger post deal. Having said that, we know it takes time, and it takes energy to get there. And that’s kind of our expectations on the revenue synergies and, I’d say, very similar to what we’ve experienced with our past deals.

Operator, Conference Operator

Our next question comes from Steven Chubak of Wolfe Research.

Steven Chubak, Analyst

So I wanted to just start off with a question on the restructuring outlook. To your credit, I think you were pretty early in calling out some signs of the slowdown. The updates from your peers have been increasingly tepid. I just was curious, based on the prior guidance you guys have given of $300 million to $350 million being a reasonable range, is that still the level that we should be underwriting just given the pace of activity in the near term, recognizing some of your optimism on the opportunity long term?

Lindsey Alley, CFO

Yes, I mean I think that's very specific guidance. I'm not sure we gave the $300 million to $350 million. But we did say, look, we are at activity levels that were consistent with pre-pandemic. And so you can take a look at kind of where we were a couple of years prior to entering into the pandemic, and that's not a terrible proxy. As we sit here today, I don't think any of our comments from previous calls have changed in terms of the restructuring market and our expectations for fiscal year 2022.

Steven Chubak, Analyst

Understood. And just for my follow-up, also relating to GCA, I was hoping to better unpack, recognizing that the transaction is financially compelling, but it does appear to increase your gearing to more cyclical revenue streams. I know talking to many investors, I think a big part of their optimism and bullishness on the prospects for Houlihan is that balanced revenue mix. I was hoping you can give us some context around how your thinking is evolving around the increased gearing it appears to Corporate Finance. And it sounded like, Scott, you alluded to maybe them being a little bit less indexed to sponsor activity, although it does feel like they're pretty active there as well. Any context you can give around the pro forma revenue mix and how it changes at least your relative cyclicality would be really helpful.

Scott Beiser, CEO

Yes. So Steven, just to clarify on the financial sponsors comment, they do a lot of work with financial sponsors. They just don't have as many dedicated financial sponsor coverage officers as we do. We clearly look at this as being very similar to what Houlihan Lokey does. In Corporate Finance, it's predominantly M&A, more sell-side than buy-side. They also have capital markets activities. They tend to work in both the middle market and upper middle market space. They add additional industry subsector expertise. And while, historically, they’ve not been focused on restructuring or valuation like our firm does, we think that is an opportunity just as we have those bankers and those capabilities. We think it will enhance the overall growth of the business. I do recognize your comment, yes, we are adding more, I'll call it, corporate finance activity statistically versus adding incremental restructuring or valuation revenues.

Lindsey Alley, CFO

But I do think it’s important to know, when you go as deep as we would go with this acquisition in an industry space like technology, that benefits the entire firm. That benefits our restructuring folks, enables them to win technology transactions because of industry expertise that we might not have been able to do previously. It benefits our FVA business in terms of credibility with sophisticated clients. So it’s not like – I mean, yes, their corporate finance – their revenues are predominantly corporate finance. But one of the reasons we do transactions like this is so that, that revenue mix, given the industry depth that we’re acquiring here, will improve for GCA and for Houlihan Lokey on a go-forward basis.

Operator, Conference Operator

Our next question comes from Michael Brown of KBW.

Michael Brown, Analyst

If I could start on GCA, I guess, first, I wanted to ask a little bit about the structure of the transaction. Given it's a tender, I wanted to ask, is there any retention component to the deal? Obviously, that's kind of key to success in deals in this space. And so just curious if that's contemplated here or if that maybe comes down the road.

Scott Beiser, CEO

Yes, we do have a retention pool contemplated. The exact details are not completely defined at this point.

Michael Brown, Analyst

Okay. Great. And then, obviously, M&A activity in Europe and Asia have lagged the U.S., and it's been steadily improving in Europe, and we're seeing that rebound there. Asia is kind of continuing to lag, but there's clearly some pent-up demand there. Can you just speak a little bit more to your outlook for each of those regions and your expectations there as you look forward?

Scott Beiser, CEO

I’d say we have a very similar view for probably the last I don’t know if it’s 3 years or 10 years, which is there’s a lot of growth potential in Europe, in Asia. Having said that, the U.S. has been kind of the star of business recovery, growth, et cetera, for quite some time. So we like to be able to have access to do work in really all of those key geographies because we think there’s opportunities not only in the United States but clearly in Europe, clearly in Asia, and there are other places in the globe that we’re still just touching on and would hope over time to eventually grow into some additional geographies.

Operator, Conference Operator

Our next question comes from Richard Ramsden of Goldman Sachs.

Richard Ramsden, Analyst

Just on GCA, could you just spend a few minutes talking about the due diligence process and what that looked like, obviously, given the travel restrictions and given the fact that this is, as you said, one of the bigger deals that you have done?

Scott Beiser, CEO

I will start with we've known some of the key people in the company for many years, so that's helped. We've been dialoguing with them for a decent amount of time. As you said, we've not been able to do the typical in-person diligence that you would like, but we've done a lot of Zoom and telephonic diligence. Much like all of us in the investment banking business, we've all figured out how to do deals for our clients not in person and feel the same way here. Sure, we'd prefer to have always been able to do more things in person, but we feel we got accomplished what we needed on both sides of the equation to get more comfortable with each other.

Richard Ramsden, Analyst

Okay. Great. And then just briefly on the FVA business, it continues to do very, very well. It's obviously an important driver of revenue growth for you. I know you touched on this in some of your upfront remarks, but can you just help us think through how much of this increase is recurring mandates that we should expect in future years? So to what extent do you think that this is a base from which you can grow just given the nature of the business or the new business that you're getting in FVA?

Scott Beiser, CEO

So first, I’d say we’re very optimistic overall about the growth profile of what’s happening in the FVA. When you ask the question about repeat clients, I’d look at it really in two ways. Number of clients or potential revenues truly under contract that you can almost totally identify year-by-year, similar probably in 1/3 to ½ of that business. But if you really look at almost any of our clients, I would argue it’s a much, much higher number from a repeat standpoint, meaning we do a lot of work for the various financial sponsors. We do a lot of work for a lot of companies. We may not know what that exact task is 3 months from now or 2 years from now, but a lot of the work that we do is something I would put in the repeat category. So it’s both growing by doing more work for existing clients, by adding additional clients as well as adding additional services over the last handful of years.

Operator, Conference Operator

Our next question comes from Brennan Hawken of UBS.

Brennan Hawken, Analyst

In regard to GCA, I understand you can't discuss the pro forma combined entity at this moment, but when examining the profit margins and operating margins of this business, they appear to be around half of Houlihan's low double digits, maybe even reaching the teens. During your evaluation of this company, did you identify any structural issues? Is this a reflection of the scaled profitability of the business? Alternatively, when integrating this company into Houlihan, is there enough overlap or duplication of overhead to achieve scale benefits? Or should we consider that this might likely decrease the long-term operating margin at Houlihan?

Scott Beiser, CEO

Look, Brennan, a couple of things I'd say. One, most, if not maybe all of the previous acquisitions we've done, those companies had lower margins than Houlihan Lokey. So this is not an unusual pattern for us. Two, just like the size that we were prior to going public, we had much lower margins than we're currently performing. So I do think there's a scale and size issue that occurs. And three, it's how they've historically operated. We do think while it will take some time, effectively by adding once again the incremental bench strength that we have combined with theirs, we'll be able to find more clients, do more work for clients with higher fees and increase close rates. None of what I've just said is unusual for this particular transaction. That's similar to what we've experienced with most of our previous transactions.

Brennan Hawken, Analyst

When considering geographic diversity as a benefit of this deal, I want to push back a bit. Businesses that are geographically diverse have generally seen slower growth. Houlihan had a unique position focusing on middle markets, with three business units that worked well together and offered clear advantages. Introducing more European and APAC revenues, which are more corporate finance-oriented, raises the question of how that will continue to support the strong interaction between your businesses. While the revenue outlook for 2021 appears better than last year, historically, it suggests that revenues will just return to 2018 levels. This leads to concerns that the growth potential of the business you’re acquiring is lower. Many investors share this sentiment. What makes this asset more appealing, and how can that diversity actually work in your favor?

Scott Beiser, CEO

So I think you asked a couple of questions there, Brennan. Let me take on the geographical growth. We have said to ourselves, to our investors, over many, many years that we've wanted to increase our non-U.S. presence. We recognize in finance, finance is very much a global business. We’ve continually poured time and effort into growing our non-U.S. business. That's the good news. The fact pattern is, the U.S. has just continued to grow as well, and we've been at roughly an 80-20 mix for quite some time. We believe this will increase our non-U.S. positioning, not so much that it makes the U.S. a statistically much, much smaller place, but actually, we think it gets us more consistent with really where activity is across the globe. And as we do more work and as we do work on larger deals, it's just more important to have some access in different parts of the globe. We think deals like this, similar to acquisitions we made in the past, have been very good opportunities for us. In terms of the growth profile, once again, we've looked at the space they're in. We've looked at the space that we're in. We think it fills some holes and will continue to be able to grow over the years. Like I said, we think they're doing well, and the markets are doing well, so we think we can continue to do well as well. But caution everybody, we recognize that when we make acquisitions, it takes some time for all of those potential synergies to kick in.

Lindsey Alley, CFO

I think a couple of other things just to add, Brennan, we’re not growing overseas for the sake of growing overseas. We believe we have built, in all three of our product lines, a phenomenal platform here in the United States. Restructuring, in particular, has shown an ability to take that overseas incredibly effectively. We think we can do the exact same thing with Corporate Finance. We have a kind of long-term view of how we’re going to get there, and this is one step. It’s not how Europe is doing relative to the U.S. today. It is a long-term vision on taking our corporate finance platform to Europe, Asia, and globally. It’s not just for the sake of growing; it’s because our clients are insisting on it.

Operator, Conference Operator

Our next question comes from Devin Ryan of JMP Securities.

Devin Ryan, Analyst

Just another one here on GCA, but kind of a bigger picture just on the M&A strategy for Houlihan. Clearly, you guys have been incredibly active on the M&A front. This is, I think, your largest deal, and you had alluded to several large deals a year ago or so. I'm curious whether this was included in that contemplation? And then does this put you guys out of the market just because it's a larger transaction, integration is probably a little bit different here than some of the other deals? Or do you feel like you can continue to do deals over the intermediate term? Are there actually other large deals that are being contemplated?

Scott Beiser, CEO

We're still talking to other companies and still expect to be pursuing potential future acquisitions. I think it's probably unrealistic over the near term to do a similar size type of acquisition as GCA. Most of our historical deals have been much smaller, and if the right fact patterns present themselves over the next quarter or next year, we'll continue to pursue transactions.

Devin Ryan, Analyst

Okay. Great. And just a follow-up on middle market M&A broadly. If you can, Scott, talk a little bit about the competitive dynamics. Many firms throughout the last few quarters on earnings calls, large bulge brackets and independent firms have been talking and building out their capabilities, both in the middle markets, but more broadly, with sponsors. Clearly, you guys have a leading position there and have been doing it longer and deeper than many firms. I'm curious how the competitive dynamics are shifting and what strategies you are employing as more firms come in and you're trying to take share.

Scott Beiser, CEO

Yes. I don't think the competitive landscape today is any greater than it was a year, two, or three years ago. The market is more robust, so there's more activity and more deals for everybody to do. But I would say in terms of who we see from competition, who we compete against, what we have to do to win, it’s not dramatically different than it was in the last year or two.

Operator, Conference Operator

This concludes the question-and-answer session. I would like to turn the conference back over to Scott Beiser for any closing remarks.

Scott Beiser, CEO

Well, I want to thank you all for participating in our first quarter fiscal year 2022 earnings call, and we look forward to updating everyone on our progress when we discuss our second quarter results for fiscal '22 this coming fall.

Operator, Conference Operator

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.