Heidrick & Struggles International Inc (HSII) 2013 Q3 法說會逐字稿

Good morning, this is Heidrick & Struggles' third-quarter 2013 conference call. Please note that this call is being recorded. It may not be reproduced or retransmitted without the Company's consent. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be provided at that time. Now I will turn the call over to Julie Creed, VP of Investor Relations and Real Estate. Please go ahead, ma'am.

Good morning, everyone, and thank you for participating in Heidrick & Struggles' 2013 third-quarter conference call. Joining me on today's call are Jory Marino, our interim Chief Executive Officer, and Rich Pehlke, Heidrick & Struggles Chief Financial Officer. As a reminder, we will be referring to supporting slides that are available on our website at heidrick.com, and we encourage you to follow along or print them.

As always, we advise you that this call may not be reproduced or retransmitted without our consent. In today's call we are going to be using the terms adjusted EBITDA and adjusted EBITDA margin. These are non-GAAP financial measures that we believe better explain some of our results. A reconciliation between GAAP and non-GAAP financial measures can be found on page 3 and page 7 of our press release and on slides 3 and 30 in our supporting slides.

Throughout the course of our remarks we'll be making forward-looking statements and ask that you please refer to the Safe Harbor language contained in our news release and on slide 1 of our presentation. This slide numbers that we are going to be referring to are shown in the bottom right-hand corner of each slide. And now I will turn the call over to you, Jory. Please start on slide 2.

Thanks, Julie, and good morning, everyone, and thank you for joining today's call. Over the course of the last three months I have had the opportunity to connect with hundreds of employees around the globe. My goal has been to listen and learn, learn how we can better connect and make sure our people have what they need to serve our clients to the best of their ability.

It is clear that we have a very talented and experienced group of professionals who are passionate about our firm and focused on delivering superior results to our clients as we help them build the best leadership teams in the world. We have an opportunity to build on this foundation and deliver more value to each of our constituencies.

As you saw in this morning's release, we reported third-quarter net revenue of $119 million, up 1% year over year and down 3% compared to our second quarter. Revenue for the first nine months of 2013 increased 1% compared to the first nine months of 2012.

Adjusted EBITDA, as shown on the next three slides, was down 2% year over year, although up 15% compared to second quarter. Year to date for the nine-month period adjusted EBITDA was down 2% and the adjusted EBITDA margin is 9.4%.

Improving profitability continues to be a key focus and we are pleased with the progress we have made over the course of this year in both adjusted EBITDA and adjusted EBITDA margin. This improvement is reflected in slide 6.

The EBITDA improvement was one of several positives in the third quarter. As you see on slide 7, we continue to benefit from the addition of Senn Delaney. In addition to performing in line with our expectations from a revenue and margin perspective, the ability to speak to culture has allowed us to introduce a new dimension to our client conversations that will lead to deeper and longer-term relationships.

As you will see on slide 8, Asia-Pacific and Europe also showed good progress. In Asia-Pacific, where Heidrick & Struggles holds a market leading position, revenue grew 7% on a constant currency basis. And revenue in Europe was the highest in five quarters, up 12% year over year on a constant currency basis, a result of improving market conditions and our focus on adding capabilities in the three key markets of the UK, Germany and France.

While we don't want to read too much into one quarter, we do believe that our European operations have begun to stabilize.

Our search practices delivered mixed results, but Consumer Markets and Life Sciences were both up more than 10% year over year. And the average fee per Executive Search improved to $124,500 in the third quarter.

That said, consultant turnover continues to be higher than we would like which impacted confirmation trends in the third quarter. In the Americas the combination of voluntary and involuntary turnover impacted revenue, but at the same time improved productivity.

Market conditions are improving around the world and we intend to capture more of this upside. Our management team is committed to executing the firm's Leadership Advisory strategy and we are aligned around the steps necessary to get there and to restore growth.

Our clients want a talent partner who can serve all of the leadership needs and we believe our firm is well-positioned to be that partner. We hold the enviable position of serving leading global organizations throughout the world and a significant amount of our work continues to be at the top of the market.

In fact, through the first nine months of 2013, our CEO & Board Practice confirmed 40% more non-executive director engagements for Fortune 1000 clients versus 2012, and has won 45% of known Fortune 500 CEO search and succession planning opportunities in 2013.

Before I turn the call over to Rich Pehlke, I would like to take a moment to thank all of my colleagues around the firm for their commitment to helping our clients build the best leadership teams in the world. Your efforts and contributions have not gone unnoticed. With that, I am going to turn the call over to Rich who will provide further detail on the third quarter.

Thanks, Jory, and good morning, everyone. Since Jory provided a high-level overview of the quarter, I'd like to give you a bit more detail on a few line items on the financial statements.

Similar to the last two quarters, the year-over-year comparisons are affected by the acquisition of Senn Delaney, which was completed on December 31, 2012. In the third quarter we recorded $6.6 million of revenue from Senn Delaney. As you will recall, we've been limited in the amount of pre-acquisition deferred revenue that we've been able to recognize related to Senn Delaney as a result of purchase accounting. This quarter there was only about $340,000 that we were unable to recognize for accounting purposes. We expect the remaining balance to run out, in even smaller amounts, over the next two quarters.

Referring to slides 14 and 15, salaries and employee benefits expense was $81.7 million, up $2 million or 3% compared to last year's third quarter. Included in the quarter is $3 million of expense related to the separation agreement with the Company's former CEO.

Of the $2 million reported year-over-year increase in salaries and employee benefits, there was an increase in variable compensation of $3.2 million offset by a decrease in fixed compensation of $1.2 million. The increase in variable compensation reflects increases in bonus accruals related to our consultant performance, some of whom are having record years. The decrease in fixed compensation was attributable to lower expense as a result of lower headcount and decreases in guarantee and sign-on bonus expense.

Turning to slide 16, general and administrative expenses increased $1.5 million year over year, or 5%, to $29 million in the third quarter. There are several large items to point out in the G&A line. Last year's third quarter included an expense of approximately $2.5 million related to our global partners meeting. In this year's third quarter we have $3.3 million of expense related to the addition of Senn Delaney. If you were to exclude these two items from G&A in both quarters it would indicate that we have held our G&A expense run rate essentially flat in the core business.

Moving to slide 17 and 18, we reported net income in the quarter of $4.1 million and diluted earnings per share of $0.23. The effective quarterly tax rate was 45.4% based on a full-year projected tax rate of approximately 68%, up slightly from where we projected we would be for the year at the end of the second quarter, which is 64%. This is due to the projected mix of income worldwide.

Now looking at slide 19, Heidrick & Struggles cash position remains strong and we have ample financial flexibility to continue to invest in and grow our business. Cash and cash equivalents at September 30 were $132.8 million and our cash position net of debt was $95.8 million. Recall that we build our cash position throughout the year as we accrue for bonuses which are paid out in March of the following year.

While we are pleased with the trends and improvements we saw in the third quarter, the opportunity for growth is in front of us and there is work to be done. Our Executive Search backlog is shown on slide 20, and monthly confirmation trends are shown on slide 21. While October confirmations aren't final, August and September confirmations trended slightly lower than we had expected and that will impact fourth-quarter performance to a degree.

We are forecasting fourth-quarter net revenue of between $100 million and $110 million. The factors which we base our forecasts each quarter include our current backlog, confirmation trends for the Search and Leadership Consulting businesses, the anticipated fees associated with those businesses, expectations for Senn Delaney, the number of consultants and the current economic climate and stable currency rates. With that I will turn the call back over to Jory.

Thanks, Rich. The last several months reaffirmed that we have the right strategy, a solid service platform and world-class consultants. We have all the necessary elements for success. However, we are also acutely aware that we must execute more effectively to deliver the results that our clients, employees and shareholders expect. And that is what we are committed to do.

Operator, at this time Rich and I would be more than happy to take questions.

(Operator Instructions). Tim McHugh, William Blair.

Hi, this is Stephen Sheldon in for Tim this morning. Thanks for taking my question. First, just want to ask what was the turnover during the quarter? And how much of that was voluntary versus involuntary? And then also if we look over the last year, has any vertical been hit harder than others in the context of turnover? So any color there would be appreciated.

Total turnover for the quarter was 16, 13 of which was voluntary and three of which was involuntary.

The second part of your question was any vertical hit more than another. Our smallest vertical, oddly enough, which is our Education & Social Enterprise practice, was the hardest hit. But it also was the vertical that is a small piece of our business. All the other verticals were plus/minus what we would have anticipated. Consumer was up by 11%, Life Sciences was up by 20%, ESE as I mentioned a moment ago, was down about 25% and industrial was down 20%.

So when you look at it financial services was essentially flat, it was off by just a fraction. And as you look at the nine months for financial services, they were up 3%, which is indicative of the recovery that has been made year to date in that sector. So I don't think there was anything unusual hit in our core industry practices other than the one I referenced, which was ESE.

Okay, all right. And then I also wanted to ask for a little more detail on what you are seeing in Europe. Was the growth there due to the easier comp or is there something more fundamental that is driving that? And then also was there any notable change in Europe as you progressed through the quarter?

This is Rich, Stephen. I'm not sure there is anything particularly worth calling out from the standpoint of change. I think a couple things drove it, number one, that some of the newer consultants that we have hired and added to our team have started to ramp up and be -- experience steadier production. Some of the losses that we had experienced a couple years ago in Europe were pretty senior people and it takes a little bit longer to get those people on board and up to speed.

So I think a combination of a little bit of better economic environment in Europe as well as just some newer people getting up to speed have driven it. So we are encouraged by that. I think Europe still remains a tough marketplace because of, as we have said many times, capital investment and the trends in capital investment in that business.

But certainly there are brighter spots. I think London is a brighter spot, I think Germany improved a little bit in the quarter. We would like to see France get a little bit stronger, but that's one that -- where there is a lot of sovereign impact relative to risk characteristics in that market just because of the tax structure and some of the things going on there. But overall that is really been the nature. Europe will go for us largely driven by what happens in those three markets.

The only thing I would add to that, and this is Jory, is as you may recall at the beginning of this year we appointed a new region leader in Europe. And frankly with a little bit of focus, a little bit of tireless effort we are starting to see some of the benefits of that leadership change and that has been a big positive for us.

Okay, that is helpful. And then last, the tax rate came in a little lower than we expected this quarter. How do you think we should model that moving forward?

I wish I could give you a lot of clarity about the definitive, but, as we have said many times, the nature of the revenue mix and the income mix varies all over the map, especially when we are impacted by our European operations. So more -- if we can get more income out of Europe it is certainly going to help our tax rate a lot.

And as you can see, as we have got some benefit from the stabilization improvement in our international markets that's going to help. So right now I don't think there is a dramatic change in the modeling looking forward but I am hoping the current trend starts to stabilize.

Great, thanks.

Tobey Sommer, SunTrust.

This is actually Frank in for Toby. I have a question on confirmations. If we look at the monthly trends in August, September and October we see a little bit of weakness there. Is that market driven or do think that is related to the consultant headcount or any thoughts on just trends on a monthly basis?

This is Rich. I think a little bit was -- I think we've actually sensed that the market has picked up a little bit. And I think as some of ours related to a little bit more of confirmation trends related to consultant activity in the short-term. So I think a slightly larger impact on turnover versus market for us.

Okay. And then we got the headcount as the end of the quarter, I believe it was 308. Has that changed as of now?

Well we don't comment on individual fluctuations on any given week, day or month. I mean the reality is people -- we always have net impacts in and out. We will be hiring some people, some people may leave. So until we get to next quarter we won't talk about that.

Okay, great. And then I guess in the guidance, revenue guidance. What are you forecasting for Leadership Consulting and how is that area progressing?

I think Leadership Consulting business as is currently scaled in our business today is still relatively flattish. And the amount of impact is considered to be pretty stable in terms of overall contribution.

I think we are a little bit disappointed we haven't invested heavier in that business. And we are looking ways currently to boost that up a little bit more. Because I think we have got some very good consultants but we are still limited in their capacity and we haven't scaled that business effectively enough. So we have got to get a little bit better at that to get a stronger financial contribution.

Very pleased with what I am seeing with Senn Delaney relative to their contribution both in terms of revenue and operating margin. And in our search business we continue to see some consultants having exceptional years and doing very well. And there is still a population of our consultants that we need to help and mentor up a little bit in terms of their production rates and that can improve overall productivity.

This is Jory, just to add to that. As you may recall from our last earnings call where we talked about the things we are going to focus in on, clearly scale in our Leadership Consulting platform is a key driver. Being able to provide not only the high level custom solutions that our clients are looking for from us, but also to provide some scale and more technology-based solutions on a go-forward basis.

And then the second driver was around focusing on our core search business. And so, we haven't lost focus on that and those are the two themes that you will continue to see us driving towards.

Okay, and if I could sneak one or two quick ones in there. What is bonus accrual as it stands right now? And then comment a little bit on the hiring environment. Has anything changed from the competitive landscape from your competitors or where these folks are being hired from or your thinking in terms of the hiring process?

Well, I think from a hiring perspective I will deal with the last question first. We tend -- I think as I look back in the recent quarter it is been about a 50-50 split of people that we've brought in with either industry experience that are newer to the search versus people who are established search.

We look for qualifications based upon their ability to do business development, talk the language of the industry relative to the verticals they may come in, have good business acumen and have the ability to relate to clients and people very well. So I think we would like to tilt that a little bit more towards experience search because there is a faster ramp up time, but that can change from quarter to quarter.

And on it your first question, Frank, there is a slide in our deck we give each quarter, slide number 15. We don't provide the actual dollar bonus accrual, but if you use the variable and bonus-related expense in that slide, slide 15, that is the best proxy that we provide every quarter.

Okay, great. Thank you very much.

Kevin Steinke, Barrington Research.

I was wondering if you spent any time drilling into the -- down into the reasons behind the consultant turnover or if the turnover you felt was more of an isolated incident in the quarter. You said it was related to your smallest practice. So any color on that would be helpful.

Yes, so there are a couple things. As we think about it, people do leave for a variety of reasons, so I don't know that we have any themes that have emerged in people who decide to leave the firm. We look at people who we are attracting to the firm as well and there we're seeing some themes.

And so, if you think about our brand value in terms of the work of (inaudible) you have heard a little bit about some of our wins both on a percentage basis, on an actual basis in both our Board and CEO practice. That provides a nice attractive platform for us and a nice attractive platform for people to want to come to.

In terms of the materiality of departures, they have been all over the lot. Some of them have been individuals who were not performing up to what we believe our standards should be and they self select out. And there were one or two cases where we would've preferred not to lose the person, but we did. But at the same time we've also attracted in the quarter nine very good hires both here and abroad.

And, Kevin, if I just clarify something you said, just to make sure everyone on the call, when Jory was referring to industry practice growth rates, he was referring to revenue growth rates and increases and decreases and not consultant turnover in those practices.

Yes, that is exactly right and I should have mentioned that as well. But thank you for that catch, Julie.

Okay, no, thanks for clarifying that. So, do you continue the heightened focus on performance management? And do you think that has maybe led to some departures that maybe people who were performing at the lower end of the ranges or any commentary there?

Yes, Kevin, this is Rich. Just to add, look, I think it is the most heightened issue that we spend most of our time discussing because it is so critical to our business. We are a people oriented business, 70% of our revenue goes into the compensation of our people and people drive our business and obviously are client facing.

So we look at everything from, as Jory indicated, the people we hire to the tools we provide them to the training and support and how we make sure support gets to doing great work across the firm. And some places we do it better than others and we have just got to continually get better.

Obviously the turnover is higher than we would expect. And this is a business that is going through a lot of constructive change from the standpoint of just technology changes every day, the demand of client changes every day and we have just got to keep better pace with it and making sure our people are as well equipped as possible to deal with it.

And so it comes back to making sure that we do everything from adjusted profile of people we hire, but also engaging in people, making sure they are successful on the platform. Performance management sometimes gets too often skewed to thinking that you want to drive people out of the firm. And the reality is it is all about making people successful in the firm. And it starts at the frontline, people they interact with every day and continues down through everything that we invest in and try and give them support. So it has got to be a complete effort and we as leadership take it very seriously.

Yes, just to build on that last point. If I think about the two things that are clearly the most important to us on a go forward basis and frankly over the past 60 years at the firm it has been our clients and our people. Great clients and great people make a great business and the results generally follow.

So when I think about performance I think about managing performance not performance managing. We want to create a winning team; we want to create a winning culture. And the focus for all of us on the leadership team as evidenced by the fact that we invested in a new CHRO, head of HR a couple months back. And we are working through a whole host of programmatic shifts to ensure that our people are the best trained with the best tools and that this -- and that we indeed have a great place for them to build a career.

So people and clients are the big drivers for me and for the leadership team here at the firm. And we have great people and great clients and we continue to win we will have great results. And that probably is obvious to everybody on this call, but it is certainly -- you've got to walk that talk and you've got to live it every day.

All right, great. Thanks for that helpful commentary. I had one last question. In your last couple of press releases, earnings releases you have called out decreases in guarantee and sign-on bonus expense as a reason for decline in fixed compensation expense. I was wondering if there was something -- a conscious effort going on there to reduce sign-on bonuses or guarantees or if that is just a result of hiring trends or am I reading too much into that?

No, you are not reading too much into it, Kevin, it is a couple things. Number one, I think there's been a constructive change in the way we have structured some hiring packages which have helped that somewhat. And sometimes it -- candidly in years past it was an abused element of our hiring process. Having said that, I wish it was a little bit stronger because I wish we were hiring more.

We have got to do a better job of filling that pipeline. It is not a restriction; it is something that we take on a case-by-case basis. I can tell you that we have never had a hiring freeze; we have not instituted a hiring freeze. We have got to do a better job of meeting our plans in terms of building our practices and our regional presence at the right level with the right people and money is not standing and the way of that.

Having said that we also want to -- I'm sorry, Kevin, let me just jump in for a quick second here. Having said that, we also want to be sensible in terms of the type of people we hire. We want to hire people that want to be here, we want to hire them for the right reasons and of course we are going to do all the things necessary to ensure that they are appropriately on board both professionally and financially.

It is easy to buy people I suppose and you can throw all kinds of money to buy talent and it has been done in your industry over the years. And as you probably saw last week, I guess Morgan Stanley and Bank of America called a truce on that at some level. And we are seeing broker hires guarantees and all of that are changing as well.

So I think it is around the value proposition, at the same time every firm, ours included, wants to be sensible as we bring people on board and again on board them both professionally and on board them financially appropriately so that we indeed attract the talent that we need to have to grow the platform.

All right, thanks for all the commentary and thanks for answering my questions.

(Operator Instructions), Kevin McVeigh, Macquarie.

I wonder if you could give us a sense in terms of the revenue on Q4 what type of margin assumptions do they have dialed in there between $100 million and $110 million. And if you said this, I apologize, but just the tax rate associated with that, number one.

And then number two, Rich, as you think about the business longer-term, I mean you peaked at almost $620 million of revenue and here if you annualize the kind of current run rate you are at $420 million, pretty deep into the recovery. I mean how are we thinking about peak earnings in this next up-cycle and the components of that from a margin perspective as well?

You have asked a lot -- first of all, good morning, Kevin. And you asked a lot of forward-looking questions that I'm not going to answer. But let me try and give you a little bit of color to try and direct you a little bit without going where I can't go.

First of all, I don't give margin guidance and we don't do any margin guidance. But let me speak to what I think we have been able to accomplish over the last few quarters that while we've seen the business not maybe stabilize at a level of revenue that I would like to see in terms of our scale, I think the Company has done a very good job of maintaining healthier margins than we've experienced in the past.

So through a combination of things we have done over the last couple years to stabilize our G&A expense rate, etc., I think those things are coming to fruition and our people have done a great job of managing expense across the business both in corporate and out in the field.

Having said that, we're still scaled to be a larger business, which really addresses the second part of your question. And we had anticipated being a larger business coming into this year and we have had a net turnover issue that is slightly higher than what we would've expected. And some of the issue in that revenue shortfall that disappoints us is that it is a combination both of turnover as well as some performance issues that could be better.

It is unfair to just paint a broad brush because we have people that are performing very well in this market. We have seen an uptick in the market and I am not sure the cycle is that late stage, quite frankly. Where we participate some of our markets are little bit more early stage than others. As I said in my commentary, I think the possibility for growth still remains here. And we have got to make sure that we capitalize the best we can and put ourselves in the best possible position.

Got it, okay, thank you.

As for the tax rate comment, as I check my notes and what you asked about the one thing I will just go back to is that I think we are slightly positive -- positively impacted by the book tax rate this quarter. Again, our book tax rate tends to be a little bit higher than our effective cash tax rate because of the European issues.

And again, if we get a little bit more improvement in that business over time that is going to certainly help that. From a cash perspective we are preserving the ability to use our foreign tax credits and some of those preferred tax assets. Should we continue to make progress in those markets it generates a lot of cash flow opportunities and profitability opportunities.

Great, thank you.

(Operator Instructions). And there are no further questions in the queue at this time.

If there are no other questions I want to thank everybody for your participation this morning. For our colleagues around the globe, I want to again give a shout out and thank everyone for all that you do for this firm and will continue to do for this firm. And all of you should know that your leadership is behind you. Have a great day, everyone, enjoy the rest of your day.

Thank you.

Again, that does conclude the call. We would like to thank everyone for their participation today.