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Good day, ladies and gentlemen. Thank you for standing by. Welcome to Houlihan Lokey Second Quarter Fiscal 2019 Earnings Conference Call. [Operator Instructions] Please note that this conference call is being recorded today October 25, 2018.
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 second quarter fiscal 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 similar phrases are not guarantees of future performance. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect, and therefore, you should exercise caution when interpreting and relying on them. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. We encourage investors to review our regulatory filings, including the Form 10-Q for the quarter ended September 30, 2018, 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 second quarter fiscal 2019 earnings call. We produced adjusted earnings per share for our second quarter ended September 30 of $0.70, up 25% from the same quarter last year. This was achieved on revenues of $275 million, our highest quarterly revenues ever and up 14% versus the same quarter last year. Our latest 12-month revenues are $999 million, just a shade under a significant milestone.
Our results in this quarter were achieved with strong revenue growth in Financial Restructuring versus the same quarter last year and solid results from our Corporate Finance and Financial Advisory Services business.
Over the last several months, we have heard increased concern from analysts and investors as to how much longer stable M&A markets will continue, and the impact these macro market conditions will have on our Corporate Finance business. We have repeatedly communicated our limits in predicting market conditions but instead focus on our more controllable results.
In the quarter ended September 30, 2018, the number of global closed M&A transactions declined once again. And in fact, the number of global closed M&A transactions has declined over the last few years. In recent weeks, equity markets have increased in volatility, and there has been specific pressure on the boutique M&A adviser sector where we reside. Putting stock market conditions aside and in spite of these somewhat negative macro M&A trends in mid-cap M&A, we believe our growing brand image, continued geographic expansion and improvements in productivity have resulted in continued increases in our mid-cap M&A market share. These improvements can be seen in our continued growth and the number of transactions Houlihan Lokey closes annually.
There are a number of factors that we look to in order to determine the health of the M&A and capital markets, and I wanted to take a moment to share with you what we're seeing. We continue to see a solid economy that is resulting in increased cash flow and profitability for our clients, leading to positive client confidence. We continue to see stability in the debt markets and solid access to capital. And we continue to see significant activity in private equity markets and year-over-year increases in fundraising. These types of market conditions historically provide support for growth in both our Corporate Finance and Financial Advisory Services businesses. And as a result, our outlook for the balance of our fiscal year has not changed over the last several months.
For our Financial Restructuring business, we are pleased with how well the group has done in a strong economy with relatively low default rates. We reported a solid first half for our fiscal year 2019, despite overall soft restructuring market conditions. In addition, activity levels have recently improved somewhat and prospects for this group remain encouraging. It is important to remember that our restructuring business is our lumpiest business segment, and our results have and will likely continue to vary significantly quarter-by-quarter. In the second quarter, the number of transactions closed and the average transaction fee per closed transaction increased significantly when compared to the same quarter last year. Year-to-date, growth in number of closed transactions and average transaction fees were also up nicely. Regarding new business, our restructuring practice is experiencing steady activity across the globe as a result of rising interest rates and ongoing sector or company-specific disruptions.
Our Financial Advisory Services business continues to show solid performance in this market environment and benefits from a diversified portfolio of service lines and large number of clients. Overall, the stable business environment and continued investment in people have supported growth in our FAS business segment.
On the hiring front, we added 3 MDs this quarter in our Corporate Finance business, 1 in the U.S., 1 in Europe and 1 in the Middle East. These 3 new senior hires added to our existing TMT group, industrials groups and private funds group. Over the last few years, excluding internal promotions and acquisitions, we have typically added around 3 new lateral MDs a quarter, and this quarter we maintained trend. On the acquisition front, our pipeline is as active as it has ever been, and we are encouraged by the quality of the companies that we have met and the increased interest in the Houlihan Lokey platform. Furthermore, our 2 most recent acquisitions continue to perform on plan. However, we still expect it will take several more quarters before our newest acquisitions achieve optimum integration with the balance of the firm's capabilities.
In closing, I'd like to thank Ron Barger, Bob Lenhardt and Paul Wilson, 3 of our long-standing board representatives from ORIX, for their years of service and guidance to the firm.
As outlined in our stockholders agreement with ORIX that was entered into when we went public, When ORIX's stock ownership drops below 10%, as it did in our second fiscal quarter, 3 of their 4 seats are relinquished. With that event and consistent with our efforts to continually evolve as a public company, the Board has decided to replace one of the ORIX's relinquished seats with an Independent Director and eliminate 2 of the ORIX relinquished seats and reduce our board to 9 people from 11.
With that, I'm thrilled to welcome Paul Zuber, our newest independent board member. Paul is an operating partner at a leading private equity firm focused on the application software, infrastructure software and technology-enabled services sector, where he brings 25 years of CEO level experience and successfully creating and growing technology companies. Paul's experience and insights into how to use technology to drive business success make him a valuable addition to our board. Paul, we welcome you to the Houlihan Lokey board and family.
We are excited about the business opportunities that lie ahead of us and remain steadfast in our commitment to our highly diversified business model.
With that, I'll turn the call over to Lindsey.
Thank you, Scott. In Corporate Finance, revenues were relatively flat at $146 million for the quarter when compared to the same quarter last year. Although our average transaction fee on closed deals was slightly higher compared with the same quarter last year, we closed 62 transactions in the quarter compared to 64 in the same period last year. As a reminder, we had an exceptionally strong first half for fiscal year 2018, and we are pleased that Corporate Finance was able to perform well against it for the first half of fiscal 2019.
Financial Restructuring revenues were $93 million for the quarter, a 46% increase from the same quarter last year. We closed 20 transactions in the quarter compared to 14 transactions in the same period last year, and our average transaction fee on closed deals was significantly higher compared with last year. As we suggested in our comments last quarter, our Financial Restructuring business often has large fee events and a quarter's performance may be affected by the timing of those events. This quarter benefited from a handful of larger-fee transactions. Our year-to-date revenues in Financial Restructuring were up 17% versus the same period last year. However, as we approach the third quarter, I want to remind everyone that the third quarter of fiscal year 2018 was an exceptionally strong quarter for Financial Restructuring.
In Financial Advisory Services, revenues were $36 million for the quarter, a 10% increase from the same quarter last year. We completed 469 fee events in the quarter compared to 532 in the same period last year. New business activity in FAS has remained robust, and we have seen some improvements in managing director productivity over the last several quarters. Turning to expenses. Our adjusted compensation expenses were $169 million for the second quarter versus $155 million for the same period last year. This resulted in an adjusted compensation ratio of 61.5% for the quarter and 61.1% year-to-date, both within our targeted range for fiscal year 2019 of between 60.5% and 61.5%. Our adjusted non-compensation expenses in the second quarter were $41 million, which were up significantly when compared with the second quarter last year, in part due to the new accounting pronouncement that requires that expense reimbursements be included in revenues, resulting in an increase in non-compensation expenses. That number for the second quarter was $5.2 million. Also driving higher non-compensation expenses was an increase in rent expense, which was primarily driven by the fact that we are consolidating offices in London and are paying duplicative rent in the interim. This resulted in an adjusted non-compensation ratio of 15% for the second quarter and 15.8% year-to-date.
We are running a bit higher than our targeted range of between 14% and 15%. However, historically, our non-compensation ratio has run higher in the first half of the year and lower in the second half of the year.
This quarter, we adjusted out of our non-compensation expenses approximately $1.6 million of acquisition-related amortization and $600,000 in nonrecurring legal costs associated with the setup of HL Finance. We will continue to adjust for these 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 million versus a gain during the same period last year of $30,000. Most of our income in this line item for the quarter was a result of a gain associated with our joint venture in Italy and interest income on our cash balance throughout the quarter.
Our adjusted effective tax rate for the quarter was 29.8%, slightly above our targeted range of between 27% and 29% for the fiscal year.
Turning to the balance sheet and uses of cash for the quarter. As of the quarter-end, we had $254 million of unrestricted cash and equivalents and investment securities.
In the second quarter, we paid our quarterly dividend and invested $20 million repurchasing 413,000 shares at an average price of $48.38 per share as part of our share repurchase program.
With that, operator, we can open the line for questions.
[Operator Instructions] And the first question today comes from Devin Ryan with JMP securities.
This is Brian Mckenna for Devin. So the middle markets are quite different than the large cap space, which maybe has been more impacted by some of the recent macro factors. But could you talk a little bit about what you're hearing from your clients today? And has there been any change in appetite to transact?
So far what we have seen, it's been a very stable M&A marketplace for the areas that we operate in on the mid-cap space. As I mentioned in our prepared remarks, the economy still feels good to them. They're still seeing growth in their business, and they're still having the confidence in their business to be able to perform and they're still looking to do acquisitions.
Got it. And there has been a nice step-up in MD headcount over the past couple of quarters. I know some of this was a function of the acquisition, and I appreciate some of your commentary earlier on recruiting. But how is the pipeline today broadly speaking? And kind of what's your intermediate-term outlook on this front?
I think there's still a good number of folks that we continue to be in dialogue with. There's always some level of seasonality in terms of hiring lateral MDs. It tends to slow down as you get towards the end of people's review years in advance of them getting paid, and then it tends to pick up right after bonus time period. And as I mentioned, we're not targeting any particular number. It has been over the last, probably a couple of years, we tend to hire about 3 MDs quarter-by-quarter that are coming from the lateral standpoint.
Next will be Michael Needham with Bank of America Merrill Lynch.
So the first question I've got on the -- just the FAS MDs, that ticked down by a couple this quarter. Is there anything there?
Nothing unusual. There's always a few people that just slowly but surely are retiring. A few people who've moved on to other businesses and a few that we've continued to hire. But no unusual turnover at the FAS level.
Okay. All right. And for the Corporate Finance business, I don't know if you've given this in the past, but can you try to size how big private equity is as a client in terms of like revenues or how many deals you tend to do for them?
It represents a very large part of our business. And we've tried to look at it, whether it's by revenues or at what point they're touching a piece of our business. But we probably think approximately about 50% of our clients have some form of financial sponsor ownership, so that's both private equity as well as hedge funds. And they could own a minority piece, they can own a controlling piece. They could be influential on our creditors committee, or they can have, like I said, a minority piece of business. But approximately half of our clients have some form of financial sponsor ownership.
Okay. All right. Great. And last one from me on restructuring. Can you expand a little bit on what you're seeing that's driving incrementally higher activity? And then, for the quarter in particular, like I totally get that it's -- it was an unusually strong quarter. I think, last quarter was unusually weaker. If you kind of average it out, this year you're running at like $70 million a quarter, which is in line with the run rate from last year. Is that kind of $70 million level achievable in the current market?
Yes, I think we did try to caution everybody last quarter that it was -- it felt to us it was at the lower end. We, obviously, had a much better quarter this past quarter that we're in. And we do know that there's always some level of volatility in that. In terms of activity, it really is just a host, I think, what I would still say are the increase in interest rates has been more helpful to the restructuring business than it has really negatively impacted the Corporate Finance business. There continues to be all the different disruptors to business plans coming from technology and new business creations that are causing some firms to fail. And just I think, we're finding is we are more active and more widely known across the globe in different industry sectors. We're seeing more opportunities, and by no means are we anywhere in a high-default rate or even maybe a mid-default rate. But we are seeing just more conversations regarding potential restructurings appear to be occurring now than they have may be in the last couple of quarters.
Okay. And the like year-to-date, just it's not unusually strong or anything like that?
Yes, I'd say year-to-date is kind of what we expected it to be. And I don't want to comment on what we think the balance of the year is going to be. But I think that as we sit here today, we thought that -- I think, we made some comments 2 quarters ago that we thought the restructuring business would have an okay year, and we still believe the restructuring business is going to have an okay year. And I don't think our views certainly in the short term, and short term means the next 6 months, have changed significantly since the beginning of the year.
And the next question comes from Brennan Hawken with UBS.
I actually kind of follow up on the question from Mike on restructuring. The -- we've seen a lot of growth in mid-market lending during this cycle, and actually, it's presented a business opportunity for you in launching the HL Finance business. But when you think about that and the strong growth, how do you think that restructuring mandates are going to play out from that market? And do you think that -- is it your expectation that your creditor-side relationships are going to translate that the investors involved to funding those loans are the same and whether or not the size of those loans being smaller are going to result in different economics for any related restructuring mandates?
You know what? There were a lot of questions in that, Brennan. But let me take a stab at least a few of them. We know that the total amount of leverage loans is much larger today than it was in the past cycle. So when the markets eventually turn, we and I think all of our peers expect that it will be a larger restructuring environment for all of us to play in. Money has gone more global and it continues to I would say each and every cycle just as westernized money has found different homes to go make investments. Don't necessarily think we will have the liquidity crisis that maybe we had in the prior cycle. But we do know we'll eventually get in an economic downturn at some point. And I think there's just more technology disruptors that are impacting businesses today than we probably have seen in the past. Those are the things that we kind of keep an eye on. We don't necessarily see the type of financing that's been put in place or the size of financing is going to meaningfully alter the type of business that we are getting or will get when the downturn comes.
I think one just reminder, Brennan. Most of our restructurings are occurring reasonably well above the mid-cap space. And so the robustness of the mid-capital lending environment now does not necessarily translate to increased restructuring work for us in the next cycle. A lot of the restructurings we're doing are just much larger than the type of M&A work we're doing, when ultimately those companies fail.
Sure. I just wasn't sure whether or not the growth in that market might have led you consider a development or any kind of tweak, but it sounds like not quite so much.
Yes, that's probably fair.
Okay, great. And then, just to follow up on the non-comp commentary. I totally appreciate that you guys are on a bit heavy on the non-comp ratio in the first half and then lighter in the back. But maybe, I think, Lindsey, you had indicated that you're paying double rent in London. And so how long do you expect that that's going to happen? And can you help us size that impact just for modeling purposes, so we can make the necessary adjustments?
I'd prefer not to size it. I think it will go on for another quarter or 2 before we consolidate operations in our London office. And it's more likely 2 quarters than 1. It's not a significant amount, but it is enough to call out. And it is just driving our non-compensation expenses towards the higher end of our range versus ideally in the middle, which is I think, where most of you were probably modeling it. So I just wanted to call that out is something that over time is a nonrecurring item but will probably affect the next couple of quarters.
And next is Jim Mitchell with Buckingham Research.
Maybe a question on just sort of the environment. You guys noted that the pipeline's active -- as active as it's ever been. But as you noted, the number of deals has been down or flat to down for a couple of years, and so not really a great environment. So where are you seeing the pickup? Is it in the PE firms that do seem to be a little more active? Just trying to get a sense of where you're seeing that growth and where you think that could continue going forward.
Yes, I think just to clarify maybe a couple of points we made, make sure you understand this. So the macro data that we all read does indicate that the number of completed deals in the mid-cap space have been declining over the last several quarters, maybe even the last few years. But as we've continued to add to our bench strength and whether that's adding bankers in new industry subsectors, adding bankers in the capital markets, adding bankers across geography, it allows us to go after and be more competitive to win business. So we think what's really been happening is, we've been adding key people. Our brand and skill set continues to increase, and therefore, even if the macro market is, in terms of number of deals announced or completed are shrinking, we've still been able to grow the number of deals that we're seeing. So what we describe is the marketplace we think is stable and is still strong for M&A. It may not be growing at the same pace that it did a couple of years ago, but it's still growing. And we've been able to -- when I say growing, we've been able to go after more business, even if the total number of deals that get announced is less than we've seen in the past.
What, I guess, I'm trying to get at also is, if things were to turn, and finally you start to see some pickup in volumes, where do you think that would most likely come from? Where do you see, I guess, where there's the most depressed number of deals? Or is it just the money, the wall of money at PE firms that if that starts to get more aggressively put to work, that's a big -- I'm trying to look at the opportunity set, if things start -- if the macro gets better in terms of number of deals?
I think, hard to really dissect that. We're all talking about, for the most part, probably Thomson Reuters numbers, when it's 10,000-plus in the U.S., 20,000-plus globally. And there's not enough detail on how much of that is by every specific industry subsector or exactly some size. Some of them are non-disclosed. Some of them don't use bankers. And rounding here, when Houlihan Lokey is doing, call it, roughly 200-ish deals a year, that's what everybody is dealing with is, how do we grow that 200 to 225, 250, whatever we can continue to grow it to. And yes, it's always helpful to have those macro numbers increase. But we've been able to find pockets to improve. And I don't think there's a particular industry or 2 or a geography or 2 that we're really saying if only they would meaningfully improve, look how much better we can do. We've always been a relatively diversified firm across industries and geographies and at any given time, certain sectors are doing better than others from an M&A standpoint.
Okay. Fair enough. And maybe just one other question on your kind of the new initiatives you announced last quarter. Any updates there, whether -- and, obviously, it's too early to be generating a material revenue there, just to kind of -- how far away from you or maybe getting at HL Finance is up and running, just sort of any kind of updates on that activity.
Yes, I think, both of the 2 acquisitions that I mentioned earlier as well as HL Finance, they're on plan. They're competing, winning business, have executed and closed on a few things but still very, very early. We're -- it will be several more quarters before I think we can really give some incremental commentary.
Okay. So on plan is the takeaway?
Yes.
Next will be Ken Worthington with JPMorgan.
So obviously, lots of comments around middle market M&A. I think, at one point you guys have commented that deal count is down, also that activity is robust. And then at some point the business is sort of stable and constant. So we've got sort of the spectrum of descriptions for the activity levels. Maybe if we think about Corporate Finance from a closed-transaction basis, as we think about the significance of corporate tax reform earlier this year, should we be seeing a more obvious step-up in activity levels at Houlihan at some point maybe linked back to that tax reform? And maybe the answer is, we've already gotten it. And maybe it's been offset or covered up by activity falling else -- somewhere else in the spectrum. So maybe what are your thoughts there? And maybe I'm just making too much the tax reform benefit in the first place. But maybe, if you could round out some comments on that, please.
Yes, I think what we found late in calendar 2017 and maybe very early in calendar 2018, that was one of the primary discussion points when we were talking with the clients, it has died down in terms of the key component that is now discussed. But obviously, most U.S. companies have benefited from lower tax rates and thus higher net income, higher valuations. But we didn't really see a whole lot of either pent-up transactions that closed in what would have been our third fiscal quarter or purposely pushed off into the fourth fiscal quarter in this time period. I think, there was a lot of discussion about it, but it didn't seem to overly drive our business positively or negatively between those 2 quarters. And like I said, today, it's one of the many things we talk about, but it's just not as prominent as it was probably 9 months ago.
Okay. And then as we look out maybe over the next 12 months, is there any thought that the benefit of tax reform is somehow cumulative and that there may be a benefit that you would see in the future? Or is this just something that it just doesn't feel like it's going to go much further than it's already gotten in terms of driving business for you?
I think it's probably the latter. I think most kind of sophisticated sellers have hired bankers and they've -- they price in any benefits from tax reform fully into the numbers on a pro forma basis. So we just don't expect there'd be -- most of that activity was occurring right about when tax reform happened. And my guess is companies are getting full value for it today and it's not going to fundamentally change over the next 6 to 12 months with respect to tax reform.
Okay, great. And then maybe in advisory, the number of fee events is down for the second quarter in a row. Revenue is up nicely. Can you talk about how maybe the nature of the fee events may be changing? I guess, maybe the relevant period is year-over-year. Or maybe how the nature is changing, if there's any relevance to kind of the quarter-over-quarter because the revenue seems to be quite solid, just a number of events around it seems to be down.
Yes, there was not a particular strategy that we have that says let's purposely try to reduce the number of events and go after a different or a size client. I think, there's always some rotation in terms of our subproduct areas and sometimes transaction opinions versus portfolio evaluations versus transaction advisory services or litigations support might lead the way, and that can have some influence on the numbers. And when you're talking about literally hundreds of fee events, it's not the same as what we see in corporate financial restructuring. If you lose and don't get 5 or 10 deals, it makes a big difference. That's just not as significant. And effectively, we are accounting. I think, anytime we get a client that's going to provide at least $1,000 in fees in that particular quarter, it gets reported. And some of these clients can take multiple quarters in a task and some of them may only be a couple of weeks, so some of that has some influence over it. But there's nothing that we're seeing that is a trend that either we're specifically focused on or purposely tactfully trying to do. I think, we continue to go after and increase the different kinds of subproduct areas that we have and continue to introduce more and more industry expertise in our FAS business line, and those have been the 2 key areas and what we've been using to grow that business.
And next will be Jeff Harte with Sandler O'Neill.
A couple. One, looking at the buyback, it was bigger again this quarter after last quarter. Should we be thinking of kind of the higher buyback level as being here to stay going forward?
I think our position really with respect to share repurchases hasn't changed. Our goal is as quickly as we can and that makes sense, we intend to repurchase the shares in the same amount that we issue with respect to our compensation in the previous year. So we issue shares to our employees as part of the regular wave bonus cycle that's -- those are usually issued in May, and the goal would be the share repurchase over the next several months to offset that. We essentially accomplish that with this last grouping of share repurchases. And as we sit here today, there are no plans to repurchase shares to offset that amount because we fully accomplished it for the year. Having said that, we still have $80 million of availability. And if the board decides that they intend to go through share repurchases more on an opportunistic basis, that option still is available to the board to the extent it is instituted.
Okay. And on the middle markets, this is kind of a bigger picture question. But when we go through the key drivers, all of them seem to be really strong. And if we look at like small business sentiment surveys, it suggests owners are as confident as they had ever been. Yet, we still keep seeing industry deal counts go down and down. Could we actually see deal counts go up? And I'm wondering what it might take to do that when so many of the drivers are positive, yet deal count keeps going down.
Tough question to answer, Jeff. I think we have not -- we have tended not to focus on trends at the sub-$1 billion M&A deal volume. Because there are so many transactions across so many countries and we are such a small part of it, we are much more focused on increasing our deal count at Houlihan, in the industries where it makes sense, investing in the people who can drive our revenues and our deal count. And we are such a small player in the mid-cap space that the macro trends are just not -- I mean, it's not that they are not relevant to us, but they just don't generally drive our business. If we got to an environment where we started seeing mid-cap deal count significantly increase, our expectation would be similar to our argument that we're capturing market share. We think it will probably drive our business higher than -- growth rate greater than it is in a market like this. But we haven't seen that environment for a couple of years, so it's hard to guess what would happen. But we're thrilled with the way we are growing our mid-cap M&A business even given, what I would say is a flat, but stable market -- flat to slightly declining but stable market. And for us, Jeff, the stability of the market is a lot more important than whether it increases or decreases by a few percentage.
[Operator Instructions] And that does conclude the question-and-answer session. I'll now turn the conference back over to Scott Beiser for closing remarks.
I want to thank you all for participating in our second quarter earnings call, and we look forward to updating everybody on our progress when we discuss our third quarter results for fiscal 2019 in the winter.
Well, thank you. That does conclude today's conference. We do thank you for your participation. Have a wonderful day.