Houlihan Lokey Inc (HLI) 2017 Q3 法說會逐字稿

Good day ladies and gentlemen, and thank you for standing by. Welcome to the Houlihan Lokey fiscal third quarter 2017 earnings conference call.

(Operator Instructions)

Please note that this conference is being recorded today, February 1, 2017. I will now turn the call over to Christopher Crain, Houlihan Lokey's General Counsel.

Thank you, operator and hello, everyone. By now, everyone should have access to our third-quarter FY17 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 third quarter ended December 31, 2016 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 Lindsay Alley, Chief Financial Officer of the company. They will provide some opening remarks and we'll then open the call to questions. With that, I'll turn the call over to Scott.

Thank you, Christopher. Hello everyone and welcome to our third-quarter FY17 earnings call. Overall, this was a very good quarter for Houlihan Lokey. We reported record third-quarter revenues of $248 million, up 21% from the previous year. Our nine-month revenues of $615 million were also a record and were also up 21% from the previous year. Through December 2016, our latest 12 month revenues are $799 million, a record for the firm and just shy of another revenue milestone. Our adjusted earnings per share for the quarter is $0.57, versus $0.47 from the previous year, and our adjusted earnings per share for the nine months are $1.29, versus $1.03 last year.

Our firm continues to benefit from the ongoing investments we've made over the last few years. Additionally we expect to benefit from the improved business and market environment since the US elections. These factors have enabled all three of our business segments to report year-to-date revenue growth over the previous year.

One of the factors driving our growth is the investment we have made in senior bankers. As of December 31, we had 166 financial managing directors versus 123 two years ago, an increase of 35%. This increase is a result of internal promotions, opportunistic hiring, and acquisitions. We have and will continue to see our new MDs mature and improve their productivity levels as they effectively utilize the firm platform we've build. Our reach, both in terms of industry expertise and geographical coverage has never been greater, and our brand awareness continues to grow. Enabling us to more effectively hire and retain quality senior and junior bankers.

On the acquisition front, we continue to remain disciplined and opportunistic. We are excited about our most recent acquisition of Blackstone IP, which we announced on January 18 after the close of the quarter. Blackstone IP is a boutique firm focused on providing financial advisory and investment banking services exclusively in the intellectual property space. Blackstone IP has advised companies with their intellectual property assets in the context of valuations, mergers and acquisition transactions, capital raising, and financial restructurings. This acquisition further enhances Houlihan Lokey's capabilities with companies who are considering maximizing the use of their intellectual property assets.

Additionally, the external markets have also contributed to our growth this quarter and we are optimistic that this will continue through calendar year 2017. Uncertainty always exists with the change in our elected and appointed officials, but since the US elections, CEO confidence has improved, transaction dialogue in the suite has increased, asset values have risen and availability of capital for business has remained strong. Potential and anticipated changes in corporate and individual tax rates should create a whole new set of transaction and advisory opportunities for our firm. But until these changes occur, it is difficult to assess the impact on our business. That being said, Houlihan Lokey has always excelled in times of change.

Now for some comments regarding each of our three business segments. Corporate finance produced $123 million of revenue this quarter and $319 million year-to-date. Our revenue growth in corporate finance year-to-date versus last year is up 9,% while during the same nine month period, the number of transactions that were announced across the globe declined modestly. We will once again ranked as the number one M&A advisor for all US transactions by number of transactions completed in calendar year 2016 by Thomson Reuters. And this was the second consecutive year we were in the top 10 for most active global M&A advisors.

We continue to make good progress across several areas that have been a focus of ours. Most importantly, our continued expansion into geographies outside the US is resulting in increased overseas closed transactions, better cross-border advice for our clients and larger and more attractive business opportunities.

In addition, we continue to grow our financing business and invest in our liquid financial asset product line. The vast majority of the growth in MD headcount over the last two years has been in our corporate finance business, and we expect that these new MDs will further contribute to growth in our results over the coming quarters as they mature on our platform.

Financial restructuring produced $90 million of revenues this quarter and $223 million year-to-date, resulting in revenue growth of 80% for the quarter and 56% for the nine-month period. These are the best financial results that financial restructuring has experienced in over five years. We were once again ranked as the number one worldwide restructuring firm in calendar 2016 by Thomson Reuters, having restructured over $155 billion of debt during the calendar year.

As discussed on previous calls, our results this year have been substantially bolstered by restructuring in the energy space. Year-to-date, our energy related restructuring revenues have been a primary driver of growth and financial restructuring, and we expect continued strength of energy revenues through the end of FY17. Our expectation for FY18 is that our energy related revenues will decline.

However, over the last several months, we are experiencing increased restructuring activity in many other industries and geographies, and have started to see a greater number of larger restructurings with higher fees than what we've experienced over the last couple of years. We expect that building dynamic can mitigate the expected pressure in energy related restructuring revenues next fiscal year and enable us to have another strong year in financial restructuring.

Financial advisory services produced $34 million of quarterly revenues and $92 million year-to-date, resulting in revenue growth of 10% for the quarter and 5% for the nine months. As we head into FY18, remember that historically, our financial advisory services business has done well in a dynamic regulatory and tax environment. The kind of environment which is looking more likely to be the case with the new administration.

So in closing, we are pleased with our results with all three of our business segments, which are showing year-to-date growth. The business environment has improved since the election and any significant reduction in corporate tax rates should have a meaningful impact on our earnings per share, given our weighting in the US. Our prospects look bright and we will continue to our best to be successful regardless of the business, political, or economic environment that we are in. With that, I will turn the call over to Lindsey.

Thank you Scott. Revenues for the quarter were $248 million, up 21% from the same quarter last year. As Scott suggested, this was a very strong quarter. Especially in financial restructuring, as we had several high [B] transactions close during the period. For our fourth fiscal quarter, we expect to see the same seasonal trend as we've seen in the last two fiscal years. That is, typically our third fiscal quarter has been our strongest, followed by our fourth fiscal quarter, which has historically been our second strongest quarter.

In corporate finance revenues were essentially flat at $123 million for the quarter, compared with the same period last year. We closed 50 transactions in the quarter, compared to 52 in the same period last year and our average transaction fee on closed deals was 7% higher. Year-to-date, our corporate finance revenue is up over 9% compared with the same period last year. And we closed 154 transactions in the first nine months of the year, compared to 122 transactions in the same period last year, an increase of 26%.

Financial restructuring revenues were $90 million for the quarter, an increase of 80% from the prior year. We closed 23 transactions in the quarter, compared to 14 transactions in the same period last year, and our average transaction fee on closed deals was 16% higher than in the same quarter last year. The growth in revenues was primarily driven by a significant increase in the number of transactions closed for the quarter, as well as an increase in the average transaction fees versus last year.

Energy represents the largest sector contributing revenues and expectations are that we will continue to see this dynamic in the fourth quarter. As a reminder, the natural restructuring revenues generally fluctuate more than our other business lines due to fewer, but larger fee engagements, and this quarter benefited from a couple of larger fees. In financial advisory services, revenues were $34 million for the quarter, a 10% increase from the prior year.

Similar to last quarter's call, portfolio valuation, transaction advisory services and strategic consulting are all experiencing revenue growth, while transaction opinion work has declined. That being said, our transaction opinion revenues in the third quarter represent the first year-over-year increase in several quarters. FAS grew the number of fees events for the quarter by 2% and also saw an uptick in average project fees for the quarter, as compared to the same quarter last year.

Turning to expenses. Our adjusted compensation expenses were $159 million for the third-quarter of FY17, versus $128 million for the same period last year. The rise in adjusted compensation expenses was primarily due to the increase in revenues for the quarter. For the third-quarter FY17, we had one adjustment of $6.5 million relating to the vesting of grants that were issued in connection with our IPO, and we expect this adjustment to continue until our last tranche of pre-IPO grants vest in April 2020. This resulted in an adjusted awarded compensation ratio of 65.5% for the third-quarter of FY17, versus 65.2% for the third quarter last year. For the nine-month period ended December 31, 2016, the adjusted awarded compensation ratio was 65.4%.

As we have said in the past, we manage our business using an adjusted awarded compensation ratio, as we believe this ratio best matches current competition costs with current revenues. For the third quarter, our GAAP compensation ratio, adjusted for pre-IPO grants, was 64%. We expect that through next quarter the GAAP compensation ratio adjusted for pre-IPO grants will be between 125 and 175 basis points lower than our adjusted awarded compensation ratio.

Our non-compensation expenses in the third quarter were $26 million or 10.5% of revenues, an adjusted $24 million or 11.9% of revenues in the third quarter last year. Given that our revenues tend to be weighted toward the second half of the year, we often achieve non-compensation ratios above our target of 12.5% to 13.5% in the first half of the year and below our target in the second half of the year. For the nine-month period ended December 31, 2016, our non-compensation expenses as a percentage of revenues were 12.8%, more in line with our target. We had no adjustment to our non-compensation expenses for this quarter.

Our GAAP effective tax rate for the third-quarter of FY17 was 39%. Which is similar to our rate in the first two quarters of FY17. Historically over the last few years, our adjusted tax rate has ranged between 39% and 41%, mostly driven by our US operations, which accounts for more than 80% of our total profits.

Moving to the balance sheet. As of December 31, 2016, we had $254 million of cash and equivalents and debt of $44 million. In the third quarter we paid our quarterly dividend and we made the scheduled principal payment of $7.5 million to ORIX on their outstanding note. We paid bonuses to our officers in May and we expect that the cash portion of the bonus payments will use a significant portion of the balance sheet cash that we have at the time.

Heading into the final quarter of our first fiscal year as a public company, we recognize that our business at times generates excess cash. To the extent that we do not use that excess cash to grow organically or to acquisitions, management will work with the board to evaluate the most efficient and effective way to return it to shareholders. In fact, because of our continued strong performance, today we are pleased to announce that our Board of Directors authorized an 18% increase in our quarterly dividend to $0.20 per share. The increase will be effective as of the next dividend payment date on March 15, 2017. With that, operator, we can open the line for questions.

(Operator Instructions)

Mike Needham, Bank of America Merrill Lynch.

Hello, guys. I just wanted -- something you could elaborate on, your comments about tax policy. You just made the point that it could take some time, but it's likely to lead to increased transaction activity. Is that more cash flow for companies, stronger economic growth, or are there other factors?

The tax policy, what we've all said is, everything that we've all read and understand is there's likely to be some changes in both corporate and potentially individual tax rates, which we think will get executives and shareholders and boards and financiers start to make new and different kinds of decisions. And typically whenever there are kinds of changes like that, it has net helped our business with more transaction activity, more valuation activity et cetera.

Got it. Just another one on taxes. Do you think the topic of potentially capping or eliminating interest deductibility for corporate [mentioned] expense, assuming you get a lower tax rate, do you think that has a meaningful impact on transaction volume?

I think any time there is going to be changes, you'll get two things, one, you can always get -- sometimes people will wait to see what those changes are before they start transacting. And any kind of changes, there will be some winners and losers. And that will affect, in fact, midterm or long-term increase transaction volume for us and everybody else in the industry.

Okay, got it. And then last one for me. Just on growth opportunities, I saw the Blackstone deal recently, and you guys addressed it. Can you elaborate more on the capabilities that, that business gives you? And for this calendar year, do you think you're going to be more active on the organic side versus last year? Thanks.

So on the Blackstone piece, what they analyze, sell, value, et cetera are different kinds of assets than typical cash flows of, call it, other kinds of companies. So they bring to us a capability to understand a unique asset that many of our clients and prospects have, so we're better equipped to provide advice and assistance for them. So we think it increases the breadth of what we have. And I forget your second question was -- ?

Just two years ago you done a few deals, last year it was a little bit lighter, I'm just talking calendar years. Just thinking about your pipeline or the things you are looking at. Do you think you will be more active on the acquisition front?

So I would describe our pipeline is modestly active. It's not with dozens of opportunities, but we are talking to several companies, as we always are. Typically though, when they might close and if they close is just some randomness and timing and what we saw in FY16 and FY15 was a lot of transactions close. Didn't have the same kind of volume that experience, for the most part over the last 12 months other than the Blackstone deal. I think we're always targeting some combination of internal promotions, lateral hiring, as well as acquisitions. I wouldn't say that we have any specific view. This next rolling 12 months will be different than the blended average that we've seen probably over the last five years. So if certain things break, we could do a couple of acquisitions and if things don't, it may stall out for several more quarters before transactions might occur.

Okay, makes sense, thank you.

Devin Ryan, JMP securities.

Thanks. Good evening, guys.

Hey, Devin.

Just coming back to some of those last comments. Just want to clarify here. So as we think about the timing of deal announcements, obviously some of the changes in DC could have a bigger impact on your clients, which ultimately hopefully leads to a better backdrop. But when you put it all together, does that create a little soft spot just in announcements as people recalibrate, or does it feel like things are actually improving realtime and could actually accelerate to the extent that we get certainty?

So we're 80 days post-election, which is not a whole lot of time. So far we've seen no slowing in terms of the number of opportunities that we are talking to executives about or in terms of number of new engagements we've been hired on. We thought that there could be some timing issues where some people for pending tax changes might have wanted to try to purposely close or not close a transaction in calendar 2016 versus calendar 2017. But when you put it all into the mix, so far we've seen a net increase of deal activity, and nothing that has caused it to slow. As I did mention in a previous response, as we get closer to more conversations going on in Washington about what might happen with taxes, I'm sure, like I said, there will be some people who will accelerate and want to do certain things and some people might want to slow down. But currently we've seen a net positive influence in terms of deal flow.

Got it. Okay, that's helpful color. Maybe drilling down a little more into some of the comments around restructuring. I'm curious what you guys are seeing driving that increasing restructuring activity outside of the energy complex. Is it idiosyncratic events or are there other themes in other industries, I don't know if it's retail or somewhere else that you would highlight that's driving deals? And when you put it all together, can you give any order of magnitude just to think about -- or new mandates on a net basis increasing or decreasing? Just some sense so we can think about the flow of that business, understanding that it's going to be lumpy from quarter to quarter.

So you mentioned retail, and that's clearly been an area of -- last couple months or last quarter or two, where we've seen an increase in activity. But is really what we would've -- previous quarters been dominating our conversations probably in oil and gas commodity, ship building, et cetera. It's a much broader, different kinds of companies, different industries and across different geographies, it's just a broader spectrum of opportunities that we've seen today. We're actually seeing some larger size transactions with larger fee potentials. Still not where we were in the recession of half a dozen plus years ago, but it is a bigger opportunity set. I'm not sure there is anything we can point to that's specifically driving it.

There is obviously some companies that will always fail for one reason or another. But so far, the slight increase in interest rates I think has not negatively impacted our corporate finance business, but for leverage companies, smaller increases can push them into a little more of a bind and needing to do something. I think it's just in marketplaces at the moment expanding in terms of restructuring opportunities in everything outside of the energy field. As we said, it will still be strong for a little bit longer, but the new business on the energy side is not nearly as robust as it was a year, year and half ago.

Got it. Great color. And then just a last quick one. I understand the Blackstone transaction is small. But just trying to think about the contribution and how we should be modeling that. Is there any framework to think about as we bake that in?

We hired as part of that acquisition, two were brought on, I should say two new MD's. And we looked at this acquisition just like any of the other acquisitions we've made, where we believe those MD's will, over some period of time, mature on our platform and drive revenue results consistent with the rest of our businesses. The MD's and Blackstone are hybrid in that they work on both valuation and corporate finance type engagements. So you've got the metrics in terms of productivity for the two and something in between is where were hoping to get. So we think there's some revenue synergies that will come from a larger platform, broader products that they can offer their clients.

Okay, great. Thanks a lot guys. I appreciate it.

Brennan Hawken, UBS.

Good afternoon Scott and Lindsey, thanks for taking the question. A follow-up actually on the some of the restructuring questions from Devon. So I'm kind of curious, I think it was last quarter where you all said you were starting to see a slow in mandates, and then this quarter we saw actually a pretty robust revenue quarter and now a more constructive outlook. How did things change seeming so quickly? Did something specific follow in this quarter and that was just episodic and just lead to noise, or was there some sort of pivot that you guys are seeing here? Maybe help us understand how that all shakes out?

In terms of the new business activity, we just have seen an increased activity this quarter versus maybe the last quarter or two. What's your talking about from a revenue standpoint of course, is what we accrue in revenues and we've always said, especially in our business, the restructuring practice tends to have a smaller number of transactions closing in any particular quarter and their sizes are bigger. So when we closed -- had a lot more transactions close in this particular quarter than we have in many recent quarters, it's why we ended up with a larger revenue accrual for this quarter.

I think we've always tried to discuss with people that what we do in one quarter isn't necessarily something that you can expect to be repeated. Sometimes we'll do better, sometimes we'll do worse than that, and you can see the volatility in our quarter by quarter restructuring revenues are much greater than the quarter volatility that you seeing corporate finance or FAS.

What I would add to that is the commentary around kind of potential optimism changes for next year versus last quarter. It is driven in part by the fact that for the last couple of three years, we've been living off of singles and doubles in restructuring. And I think really recently there have been some much larger fee transactions that have come through that will or are expected to be close in FY18. As you know in that business, fee transactions can get large and can move the needle for us on restructuring, so that's another dynamic that has occurred really in the last several months.

Terrific, that's helpful color, thank you. And then when we think about your expectations of improvement on the back of likely some significant changes coming whether they be in policy or otherwise, do you expect that, that would detract from potential restructuring opportunities? Or would the idea that you might have -- change could cause some business models or methods? Whether it be interest rate deductibility or some other factor we're not sure about leading to or contributing to the potential opportunity in restructuring and it's just not clear exactly where it's going to fall in. It just seems like that's going to result in more demand for your services.

We still believe that, once again, changes however they might be, will net improve the deal flow on our financial results. You break it down by our products or industries and what time period, I don't think any of us are smart enough to know exactly what will happen or when. We'd only comment, once again, we've not seen anything from a restructuring standpoint in terms of how people are thinking about deals, who's silent, who's trying to do a prepack has changed really pre- or post-election. Obviously, if they changed deductibility of interest rates, that's going to have some impact to people. If there's certain relief or changes in regulations, that could help some other companies. All of that is kind of factored in the mix but at this point, I don't think we look at the outlook for restructuring as probably being significantly impacted by policy changes. There's just not enough information out there to have a concrete view on that.

Terrific. Thanks for the color.

Ann Dai, KBW.

Hi, thanks for taking my question. Most of them have been asked, so just one quick question on hiring. I know you mentioned you had two new MD's from the Blackstone position, and I'm sorry if I missed this, but what was the total number of hires in the quarter?

There was one new hire in the quarter, from the quarter that just ended. What Lindsey mentioned is there are two new MD's coming from the acquisition. It's a typical light quarter for us in the third fiscal quarter, just as you start heading towards bonus period for some of our peers. People tend not to move until they get paid and then you'll start seeing the activity pick up for us and our peers, we would anticipate in the first, second, et cetera calendar quarter.

Okay, great. That's it for me, thank you.

Conor Fitzgerald, Goldman Sachs.

Hi, this is James Yaro filling in for Conor Fitzgerald. Just a two quick questions, this is a similar question to one that was asked before. So if interest deductibility is removed as part of the tax reform plan from President Trump, what impact do you think this would have on sponsorship M&A?

Better to probably ask them and us. But honestly, I think it would [meaningfully] change their business and how they've historically operated or what kind of the capital structures they put into place. What people might value things at -- we all go down a lot of speculation. I think, like I said, until any of us know what's really going to be proposed, it's really hard to tell. But once again, we don't see any significant rush by private equity firms to rapidly do something tomorrow because they are worried about what might happen in the tax policy deductibility, et cetera. At this point, I think it's just anybody's speculation on what's going to happen.

Got it. Thanks. And then if corporate tax rates were lower, how should we think about that impacting your corporate tax rate? So I think about it 85% of your earnings are generated in the US. It is as simple as you would benefit by 85% of what the decline was or are there other things that we should consider?

Yes, I think that is a safe way to think about modeling a reduction in US tax rates. 85% of our profitability. It's very similar across the globe, so that's a good way to think about it.

Okay. Thanks.

And there are no further questions in the queue.

All right. I want to thank you all for participating in our third quarter, FY17 call. We look forward to updating everybody on our progress when we discuss our fourth-quarter results in the spring. Thank you, everybody.

That concludes today's conference and thank you for your participation.