Q1 2024 Houlihan Lokey Inc Earnings Call
Participants
Christopher M. Crain; MD, General Counsel & Secretary; Houlihan Lokey, Inc.
J. Lindsey Alley; MD & CFO; Houlihan Lokey, Inc.
Scott Lee Beiser; CEO & Director; Houlihan Lokey, Inc.
Benjamin Ward Rubin; Associate Analyst; UBS Investment Bank, Research Division
Brendan James O'Brien; Research Analyst; Wolfe Research, LLC
James Edwin Yaro; Research Analyst; Goldman Sachs Group, Inc., Research Division
Kenneth Brooks Worthington; MD; JPMorgan Chase & Co, Research Division
Michael William Falco; Research Analyst; JMP Securities LLC, Research Division
Ryan Michael Kenny; Equity Analyst; Morgan Stanley, Research Division
Presentation
Operator
Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Houlihan Lokey's First Quarter Fiscal Year 2024 Earnings Conference Call. (Operator Instructions) Please note that this conference call is being recorded today, July 27, 2023.
I would now turn the call over to Christopher Crain, Houlihan Lokey's General Counsel.
Christopher M. Crain
Thank you, operator, and hello, everyone. By now, everyone should have access to our first quarter fiscal year 2024 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 year ended June 30, 2023, 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 Lee Beiser
Thank you, Christopher. Welcome, everyone, to our first quarter fiscal 2024 earnings call. We ended the quarter with revenues of $416 million and adjusted earnings per share of $0.89. For the quarter, revenues were down 1% and adjusted earnings per share were down 19% from a year earlier. We entered our first quarter hopeful to see some growth after a challenging fiscal 2023, but the M&A markets remain sluggish and deal closings in both M&A and financial valuation advisory were soft. However, throughout the quarter, we saw improvements in client confidence as a result of improving equity and debt capital markets, which has positively affected the appetite for M&A.
Although still too early to call it a trend, we are seeing an improvement in deal momentum in M&A and a renewed interest from our clients in testing today's market conditions after sitting on the sidelines for over a year. As we look forward, we don't see any material macroeconomic overhangs that might slow this momentum down and economic statistics support the soft landing and likely increased M&A activity.
Our Corporate Finance business produced $227 million in revenues for the quarter. This was a decline from both the prior year period and last quarter. Lower results in Corporate Finance were driven by our typical first quarter seasonality but also a sluggish first quarter market for M&A closings. From a geographic standpoint, our U.S. corporate finance business, in fact, grew quarter-over-quarter, while Europe lagged due to ongoing economic headwinds.
As we have mentioned in previous quarters, the number and quality of new business opportunities continues to remain strong. And for the first time in a long time, we are seeing discrete improvements in the M&A environment for deal closings. Also encouraging, albeit episodic is that several mandates, which have been on hold for months recently became active. While interest remain -- interest rates remain much higher than in recent years, the market consensus is that we are at or near the peak of this interest rate cycle and inflation is improving. With this stability, the debt capital markets environment, especially for middle market firms is more active than it has been in several quarters.
Our Financial Restructuring business had another strong quarter, producing revenues of $123 million. Both the number of quarterly closed transactions and the number of new mandates have increased steadily over the last several quarters when compared to the same periods in the previous year. The restructuring business continues to benefit from higher interest rates and a fast approaching debt maturity wall. Since this restructuring cycle is not the result of a one-off crisis, we continue to expect financial restructuring to achieve elevated revenues over the next couple of years.
Financial and Valuation Advisory produced $65 million in quarterly revenues. Overall, our more stable FVA business grew slightly last year but has stalled in this market environment. Our market neutral service lines are performing well, but the service lines that are tied to the M&A markets continue to be soft in our first fiscal quarter. If the green shoots we are seeing in Corporate Finance and the overall M&A markets do, in fact, produce an increase in M&A activity, we would expect FVA to see revenue momentum in the back half of our fiscal year.
During the quarter, we announced the signing of our acquisition of 7 Mile Advisors in IT services investment banking firm headquartered in Charlotte, North Carolina. We expect this deal will close in our second fiscal quarter. Also during the quarter, we hired 6 new managing directors as well as added 18 managing directors from internal promotions as previously reported. Whenever we enter a challenging M&A environment like the one we have experienced over the last 18 months or so, we recognize that our most important asset is our people, and we work very hard to keep that workforce motivated and in place through the cycle. In fact, we believe that supplementing that workforce with strong acquisitions and senior hires is crucial as many of our smaller competitors don't have the benefits of our more diversified business platform.
I am pleased to report that whenever a more robust M&A market returns, we are extremely well positioned to capitalize on it as we have done an excellent job at retaining and recruiting our most important asset through this cycle.
And with that, I'll turn the call over to Lindsey.
J. Lindsey Alley
Thank you, Scott. Revenues in Corporate Finance were $227 million for the quarter, down 14% when compared to the same quarter last year. We closed 95 transactions this quarter compared to 124 in the same period last year, and our average transaction fee was higher for the quarter versus the same quarter last year.
In Financial Restructuring, revenues were $123 million for the quarter, a 56% increase from the same period last year. We closed 30 transactions in the quarter compared to 16 in the same period last year, though the average transaction fee on closed deals declined.
In Financial and Valuation Advisory, revenues were $65 million for the quarter, a 14% decrease from the same period last year. We had 786 fee events during the quarter compared to 876 in the same period last year.
Turning to expenses, our adjusted compensation expenses were $256 million for the first quarter versus $257 million for the same quarter last year. Our only adjustment was $7.8 million for deferred retention payments related to certain acquisitions. Our adjusted compensation expense ratio for the first quarter in both fiscal 2024 and fiscal 2023 was 61.5%. Given the current environment, we do not expect to change to our long-term target of 61.5% for our adjusted compensation expense ratio.
Our adjusted non-compensation expenses were $76 million for the quarter, an increase of $16 million over the same period last year and an increase of $8 million from the previous quarter. This resulted in an adjusted non-compensation ratio of 18.2% for the quarter compared to an adjusted non-compensation ratio of 14.2% for the same quarter last year and 15.3% for the previous quarter. On a per employee basis, our adjusted non-comp expense was $29,000 per employee this quarter versus $26,000 per employee for the same quarter last year as well as the previous quarter. As a result of the timing of certain expenses, the seasonality that we normally have in our first quarter that results in lower non-compensation expense did not occur. And our first quarter better represents a likely outcome for the rest of the year.
However, we continue to see pressure across all of our non-compensation expense line items, especially in [TM&E] as inflation for travel is running much higher than general inflation. Beyond this year, we continue to expect that our adjusted non-compensation ratio will settle in somewhere between 14% and 15% over the long term. For the quarter, we adjusted out of our non-compensation expenses, $3.4 million in non-cash acquisition-related amortization, the majority of which was related to the GCA transaction.
Our adjusted other income and expense decreased for the quarter to income of approximately $3 million versus an expense of approximately $500,000 in the same period last year. The improvement in this category was driven by higher interest rates, higher interest income on our cash balances across the globe as a result of higher interest rates.
Our adjusted effective tax rate for the quarter was 29.2% compared to 24.9% for the same quarter last year. Last year, we had some favorable items that lowered our effective tax rate. In addition, our effective tax rate in our first quarter increased slightly as a result of the increase in the corporate tax rate in the U.K. from 19% to 25% effective April 1, 2023. We adjusted out of our GAAP effective tax rate, a benefit that we received as a result of our stock vesting in the first quarter. We maintain our long-term range for our effective tax rate of between 27% and 29%, but we expect that our effective tax rate for the year will be at the higher end of that range.
Turning to the balance sheet. As of the quarter end, we had approximately $490 million of unrestricted cash and equivalents and investment securities. Our cash position declined this quarter as we paid a significant portion of our fiscal 2023 bonuses to employees in May. Also in our first quarter, we issued approximately 1.3 million new shares to employees as part of our fiscal 2023 year-end compensation and we repurchased through withhold to cover approximately 760,000 shares during the month of May.
Shares issued as part of our fiscal 2023 compensation will vest into fully diluted share count over a 4-year period from the date issue. We continue to take a conservative approach to share repurchases as we are prioritizing balance sheet flexibility to take advantage of acquisition and hiring opportunities in this market.
And with that, operator, we can open the line for questions.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from the line of Brennan Hawken with UBS.
Benjamin Ward Rubin
This is Ben Rubin filling in for Brennan. Obviously, a challenging quarter for Corporate Finance, given the industry headwinds. I think when the last time we previously spoke, we kind of assumed that a range of around $215 million per quarter was kind of reasonable, assuming the environment -- the deal environment didn't inflect in either way. But it seems that this quarter, around $227 million, you guys kind of reached a new low. Were the results of this June quarter more about timing or there's something structural change in the backdrop, which kind of led to the lower revenue performance?
Scott Lee Beiser
Yes. I don't think there was anything from a timing standpoint that would suggest revenues fail to fall into this quarter, and they'll fall in next quarter. Having said that, so far, it does look like that April so far through our fiscal year and maybe through this whole trend is our trough, just I think, ongoing headwinds that existed, especially earlier part in the quarter just didn't produce the results that we had hoped for and slowly but surely seeing improved results kind of over the last several months.
Benjamin Ward Rubin
And then for my follow-up, my next question is on the kind of the state of the financial sponsor market. We've heard some of your peers say that they (inaudible) paying a pickup in sponsor-led transactions, especially as we approach the back half of this calendar year. But when -- based on the conversations you guys have, when can we -- when do you guys expect them to reengage to a greater extent, especially as it pertains to the middle market?
And lastly, is there any distinction between the willingness of sponsors to transact between, say, the domestic U.S. and international markets?
Scott Lee Beiser
At this point, I don't think we see a significant difference to -- answering your last question first, on the sponsor marketplace between the U.S. and Europe or other parts of the globe. We're already starting to see that sponsors are more active in terms of dialogue, interest in wanting to do something today versus 3 months ago or 6 months ago. The cautionary note at this point is even for deals that we're now more actively involved in versus which we're on hold, it's still going to take several months before those deals would close. So we're clearly seeing the improvements, but it doesn't translate into -- or revenues immediately. It will still take another quarter or two before I think you'll start seeing -- if this current level of activity holds, those kinds of revenues are going to more likely still show up in calendar 2024 versus the back half of calendar 2023.
Operator
Our next question comes from the line of James Yaro with Goldman Sachs.
James Edwin Yaro
I suspect that the private credit ecosystem puts a cap on the Chapter 11 restructuring activity ecosystem given less [lateness] to actually default and bring companies to bankruptcy. Maybe you could just talk about how you think private credit has impacted the restructuring ecosystem or not?
Scott Lee Beiser
Yes, I'm not sure the growing existence of private credit is making that much of a difference in terms of slowing down or stalling any of the restructuring activity. I think we had a couple of things occurring. One, just the total amount of leverage indebtedness as we've been talking about for years, is up substantially from where it was a couple years ago. You had all of the Feds putting in money in the system, which they're not doing anymore. Interest rates are materially higher. So what you had a couple of years ago was there were other alternatives for people to do some form of a reorganization restructuring that doesn't exist today or if it does, even if there are lenders who are willing to provide capital, it is at a higher interest rate. So all of these reasons amongst others, is why we continue to think that the restructuring businesses is going to be rather buoyant for another couple of years.
And it's helpful that there are other alternatives, as you mentioned, in the direct blending space. But at this point, we don't think it's having any material impact on what's happening in the restructuring world.
James Edwin Yaro
Maybe just on the non-M&A parts of Corporate Finance. Maybe if you could just sort of break down the broad buckets in there and how those businesses are performing in this environment.
Scott Lee Beiser
So there are couple of pieces. I mean, M&A is still the overwhelming majority for us in corporate finance. We do have what we'll call kind of our capital markets, which is the (inaudible) or playing the adviser in the placement predominantly debt capital. We also do fundraising for private equity and hedge funds and things of that nature. It's been a tough environment in raising capital for funds just because I think LPs are still looking to get some liquidity on existing money they deploy versus starting to deploy new money. One, we think that will eventually cause more M&A activity.
And on the more classical capital markets as we describe it, we are clearly hearing that there are more lenders and generally, once again, the private lenders that are more actively looking at transactions and we're actually getting multiple offer sheets, something we just haven't seen in the last couple of months or a couple of quarters. So that business is starting to see more activity. Still early days, I think, before it translates into, hopefully, some more additional revenues.
Operator
Our next question comes from the line of Ken Worthington with J.P. Morgan.
Kenneth Brooks Worthington
And maybe first, following up on that, how is financing availability developing today versus what you saw earlier in the calendar year, particularly for the middle market M&A customers? And to what extent is financing accessible today or developing for some of your restructuring clients as well?
Scott Lee Beiser
So on the first piece, what we would say is there's been a growing number of providers of capital over the last handful of years and that continues to grow. But what we've found is there's been windows over the last probably 6 or 12 months where there was very, very little activity or all but for the best credits, if you might. Now there are more people who are willing to deploy capital and they're more willing to look at companies that are still good companies, but they may not be extraordinary companies. By no means would we say we're in a robust period, but it's not a period of no activity.
And as I mentioned in the previous question, we are just getting incremental people who are willing to participate in the marketplace and expect that will likely continue at a slow but sure pace, and part of it is just, I think, the expectation, interest rates are pretty darn close to the peak. There's a bit more certainty on where they think the economy is going, the company is going, et cetera.
And on your restructuring question, yes, the private capital providers are also people who are and are willing to participate in a restructuring. And ultimately, in a restructuring, you need to have a solution. And so if there's a party out there that will help get to a solution that's good for our business, it's not necessarily a solution that avoids some form of a restructuring or the necessity to -- or desire to hire advisers. So what I said before is they're a helpful hand in restructuring, they're actually not a negative perspective in restructuring as we see the marketplace today.
Kenneth Brooks Worthington
And then a quick follow-up. Can you talk about the opportunity in real estate restructuring for Houlihan?
Scott Lee Beiser
Look, I think everybody believes there is still a lot of turbulence out there in specific spots in real estate. Some things classically will go through restructuring, some of it really depends probably on the cap stack if there's just one mortgage lender and one property, they'll still need to come to a solution, but they may not hire advisers to do it. It's a very, very big marketplace. We are participating in it clearly, I think, way too early to tell, not so much on how much reorganization or restructuring needed to go on in real estate, it's at what point will they hire advisers? And at what point do the owners and the singular or direct lenders just handle things (inaudible).
J. Lindsey Alley
And I will add that although our real estate industry group is on the smaller side relative to other industry groups. Our expertise in real estate restructurings back during the great recession and we won our fair share of transactions in that category. So the restructuring folks who have expertise in real estate are the same ones that did it 12 years ago, 13 years ago are still here at the business at Houlihan and I think they are excited about the prospects over the coming years.
Operator
Our next question comes from the line of Devin Ryan with JMP Securities.
Michael William Falco
This is actually Michael Falco filling in for Devin. So maybe just to continue on the topic of restructuring. To the extent that the M&A market is recovering and equity and credit markets are settling down recently, does that impact the intermediate term outlook for restructuring at all or are these other factors, whether it be higher interest rates or looming maturities just too powerful until a prolonged cycle kind of feels inevitable?
Scott Lee Beiser
The quick answer is yes. But -- and a little bit more color there, we do think we are entered into an environment that all 3 of our primary product lines can and should grow over the foreseeable future. And it's just, I'll call it, both the pent-up demand issues on the restructuring side and we are just at higher interest rates. And so even if we don't believe that they're going to go up much more, they're not coming back down to 0, maybe ever or at least not for the foreseeable future.
So there just does feel like there's a lot of work out there for restructuring for the next couple of years, and it does feel, as we've said, that we're slowly but surely moving away from headwinds and hopefully tailwinds on the corporate finance side and FVA tends to net-net follow the M&A marketplace as well.
Michael William Falco
And then when you think about the potential for an M&A recovery and some of the improvement you're seeing in that market, do you expect it could be uneven and by that, I mean, could we see a scenario where high-quality assets will be sold with a lot of interest while asset side of the cycle or the macro will maybe continue to thin or sit, which could maybe mute the upside?
Scott Lee Beiser
I think you always find that in the worst of times, great assets are still bought and sold and probably in very robust time period to see even average or below average assets can trade. So we've experienced in the middle market, the exceptional businesses and even though I'll call it very good businesses, still been doing deals. And you are getting further into the core of different kinds of businesses. We've seen some stops and starts over the last 18 months. It's possible that could happen again. But we do think there's just certain factors going on in the marketplace today and maybe the evidence of the last 30, 60, 90 days just suggest that we're moving forward in M&A, just with the cautionary note, it's still going to take another quarter or two, I think, before you'll see some more meaningful revenue results.
Operator
Our next question comes from the line of Steven Chubak with Wolfe Research.
Brendan James O'Brien
This is Brendan O'Brien filling in for Steven. I guess to start, just wanted to touch on Europe. It sounds like that our business and Corporate Finance, in particular, saw some weakness this quarter, and the central banks in Europe are running a bit behind the Fed in terms of where they are in the rate hike cycle. And we see now the uncertainty on certain path of rates has impacted activity in the U.S. given you guys are close to that market, would be great to get your perspective on how the dynamics are playing out in that region relative to the U.S. at the moment?
J. Lindsey Alley
So yes, we had the same question for the M&A bankers as part of this earnings cycle. And their response was that the markets in Europe, although very soft in our Q1 are not operating at a much different pace than the U.S. So the activity levels, the desire to test these markets, the -- at least short-term optimism that exists in the U.S. we're seeing in Europe as well. So kind of looking forward over the next couple of quarters, we are hoping, based on that, that the European markets perform similarly to the way the U.S. markets are hoping to perform. And so it did have an outsized impact last quarter and we're hoping that, that's reversed itself, and we'll see in the next several months.
Brendan James O'Brien
And just a follow-up on Europe. Actually, there's been a lot of -- there's a Credit Suisse going under, Rothschild going private. I'm just interested to hear about how you're seeing market share gain opportunities within the region? I know you've continued to invest there after the GCA acquisition and have been integrating the platform, but it would be great to get a sense as to what the growth prospects are just beyond the general M&A market?
Scott Lee Beiser
Yes, we think we have made substantial strides in just our brand awareness out in Europe from where we are today from a couple of years ago. I think the (inaudible) Credit Suisse just in what they tend to do versus what we do has been much less of an impact positive or negative to us. And Rothschild is still going to be a very great competitor, whether they're public or private. I think we have continued to be able to attract and retain quality bankers that we might not have been able to a couple of years ago. And we continue to round out the different industry sectors that we specialize in Europe. We've added meaningfully to the financial sponsor coverage out in Europe that we didn't have.
And the one other thing I would add to Lindsey's comment of a minute ago, while our European business was softer than our U.S. business, addressing for headcount, part of it's also technology is -- that sector is a bigger percentage piece of our European corporate finance practice than it is of the U.S. and the technology industry sector across the globe has not performed as well year-over-year compared to some other industry groups. So part of the strategy is continue to be -- is to build out the various sub-industry sectors and the financial sponsor coverage that we've been very successful on in the U.S. and do it in Europe as well. And I think as we make ongoing headway there, I suspect we will continue to see improvements in our European business above and beyond whatever the European economy does relative to the U.S. economy.
Operator
Our next question comes from the line of Ryan Kenny with Morgan Stanley.
Ryan Michael Kenny
Wanted to follow up on the comments around non-comp expenses. You mentioned that they're elevated both on a reported basis and also on a per headcount basis and it sounds like they will remain elevated in that range for the foreseeable future. Is there anything you're doing to offset those headwinds or should we think about that as just the cost of doing business? And maybe it's a good thing because it shows you're getting in front of clients and the activity is picking up as the environment improves. How should we think through that?
J. Lindsey Alley
I think we have not pulled back on the expenses that helped drive revenue during this cycle. And PM&E is probably the most obvious one. We are continuing to encourage our bankers to get in front of clients. I think all expectations are that we are going to ride along with our peers, quite a wave here once the M&A markets return. And so the answer on the TM&E side is no. We are -- we think that the face-to-face interaction with our clients is as important as it's ever been.
On the rent side, I think we had a little bit of a perfect storm. We had kind of our 3 or 4 largest locations all come due over the last 18 months or so. We spent quite a bit of money on expanding those locations, and it's costly and it's shown up in our rent. And I think this year and really the last 18 months, we've seen some significant growth in rent. You will see that start to stabilize towards the second half of this year and return to normal, for lack of a better way to describe it.
So I think those are the 2 line items within non-comp that have driven sort of what I'd call outsized increases. And I think it's really timing from a rent standpoint and bankers kind of returning to in front of their clients on the TM&E side and it's a little hard to tell post-COVID what that's going to look like in terms of what the run rate is. But those are the 2 comments that I'd make on non-comp.
Operator
There are no further questions in the queue. I'd like to hand the call back to Scott Beiser for closing remarks.
Scott Lee Beiser
I want to thank you all for participating in our first quarter fiscal year 2024 earnings call, and we look forward to updating everyone on our progress when we discuss our second quarter results for fiscal 2024 this coming fall.
Operator
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
