Heidrick & Struggles International Inc (HSII) 2014 Q1 法說會逐字稿

Good morning. This is the Heidrick & Struggles first-quarter 2014 conference call. 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. (Operator Instructions)

Now I will turn the call over to Julie Creed, Vice President of Investor Relations and Real Estate. Please go ahead.

Good morning, everyone, and thank you for participating on our first-quarter 2014 conference call. Joining me on today's call is our CEO, Tracy Wolstencroft; and Rich Pehlke, the Chief Financial Officer. As a reminder, we will be referring to some 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. And in today's call we will 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 the last page of our press release and on slide 19 on our supporting slides.

Throughout the course of our remarks, we will 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. The slide numbers that we'll be referring to are in the bottom right-hand corner of each slide.

Tracy, before I turn it over to you, I'm going to ask the Operator to check into a lot of background noise that we are hearing on our end. A lot of feedback.

All right. Tracy, I'll turn it over to you, and maybe Wes can check on that.

Thanks, Julie, and good morning. It's been just under three months since I joined Heidrick & Struggles, and as I said on my first call back in February, my top priority is our people: getting to know them and working to establish and reestablish their confidence. In that context I have traveled to our offices in Europe, Asia, Canada, and throughout the United States to meet with employees and clients.

Each meeting reinforces an observation that I've had since my first days here: our people are very committed to Heidrick & Struggles and to our clients. We have strong client relationships, and the opportunity is there to leverage and expand those relationships across all of our service lines.

In general, economic conditions continue to show improvement. Now is time to capitalize on the increasing confidence of Boards of Directors and executive teams who want to invest and grow.

Our first quarter was a step in the right direction. There were some encouraging signs of progress. Revenue grew 8% year over year. A good portion of this growth was driven by our European region, which achieved its fourth sequential quarter of growth. First-quarter executive search confirmations were the highest in three years, and consultant productivity increased year over year. And for the first time in ten quarters, there was a sequential increase in consultant headcount.

There is still much to be done. These results also illuminate the work that is required to improve what flows to our bottom line. Delivering improved growth and profitability requires us to leverage our capabilities and to go to market as one integrated Company.

Let me turn it over to Rich to give you a review of our results, and then I'll come back with a summation of the priorities that we see going forward.

Thanks, Tracy, and good morning, everyone. I'll review some of the key financial and operating metrics and explain select variances on those slides. We're going to begin looking at slides 2, 3, and 4, where consolidated revenue in the first quarter was $111.1 million, up 8% or $8 million from last year's first quarter. Executive search and leadership consulting revenue grew about 7% year over year, or approximately $7 million. Culture-shaping revenue increased 17% or just under $1 million.

Europe, shown on slide 5, was the key driver of the year-over-year revenue growth in the quarter. This region was up almost $8 million, $7 million on a constant currency basis. We ended the quarter with 87 consultants in that region, up from 83 at the end of December, three fewer than March 31 of last year. Virtually every industry practice group in Europe contributed meaningfully to the year-over-year growth. Improvement in consultant productivity and an increase in the average revenue per search also helped drive the results. Along with the revenue increase, Europe also achieved a significant improvement in operating income and operating margin.

On slide 6, revenue in Asia-Pacific increased 5% year over year or $1 million. Consultant headcount increased to 87, up from 84 at the end of the fourth quarter and flat with the first quarter of last year.

Consultant productivity improved slightly in this region. The global technology and services practice was the key driver of growth, but consumer markets and financial services also contributed to the year-over-year progress.

The growth in Europe and Asia-Pacific was partially offset by the Americas region, where revenue declined about 3% or approximately $2 million. Productivity in the Americas improved substantially. The consumer markets, financial services, and global technology and services practices achieved year-over-year growth.

However, these improvements were not quite strong enough to offset the decline in consultant headcount. We ended the quarter with 129 consultants, down from 148 a year ago.

Looking at the industry practices globally, on slides 8 and 9 you'll see that three of the four largest industry practice groups achieved double-digit year-over-year growth in revenue: consumer markets, global technology, and financial services. What was encouraging is that we experienced revenue growth in each of the three regions in all of these practices, as well.

Tracy touched on consultant headcount earlier. Referring to slide 10, we started 2014 with 293 search and leadership consulting consultants. We ended the first quarter with 303 consultants as a result of our hiring efforts so far this year.

Developing our colleagues is as important to us as attracting new talent to the Firm, and Heidrick has a long history of promoting and developing from within. This year our annual promotion cycle resulted in 15 of our best being promoted to principal consultant effective April 1, and that number will be reflected in the second quarter.

Turning to slide 11, Q1 annualized consultant productivity was $1.4 million compared to $1.2 million in last year's first quarter. The trailing 12 months' consultant productivity has shown stability and is trending upwards from $1.4 million.

As you can see on slide 12, which is specific to executive search, search confirmations in the first quarter increased 8.5% year over year and were higher than in the 2012 first quarter, as well. So as Tracy mentioned, the best start we've had in three years.

Slide 13 shows the variability in revenue per search from quarter to quarter, as we provide you with the average revenue per search on a trailing 12-month basis, where you can see that it has held steady over the last few quarters at about $113,000.

I mentioned earlier that reported revenue from culture shaping increased almost $1 million in the year's first quarter, but this doesn't fully explain the results. You may recall that in last year's first quarter, we were unable to recognize $2 million of preacquisition deferred revenue because of the purchase accounting adjustments.

So if you take into account the unrecognized revenue in both quarters, the comparable results of the business would reflect a slight decline in culture shaping. Because of the size of this position and the timing of project initiations, which are driven largely by our clients' activity, we will likely continue to see variability in quarterly results for this business.

Referring now to slides 14 and 15, salaries and employee benefits expense was $75.9 million, representing 68.3% of the net revenue. Year-over-year salaries and employee benefits expense increased $4.4 million or 6.2%. Of the $4.4 million, variable compensation, most related to bonus accruals, was up $7.5 million.

Europe's revenue growth was a key driver of this increase. Last year at this time there was virtually no accrual for Europe in the first quarter. Fixed compensation expense declined $3 million, mostly related to the lower headcount compared to last year.

Turning to slide 16, general and administrative expenses increased $3.3 million or 10.7% to $34.4 million, representing 31% of net revenue. Three items account for most of this increase. One is higher-than-normal legal and professional services fees, most of which were project-specific and not expected to recur.

The second is a one-time state franchise tax matter. And the third is a year-over-year increase in unbillable travel-related expenses related to an increase in new business development and training activity. We should see our run rate for expenses be lower than the first quarter for the remainder of the year.

Moving to slides 17, 18, and 19, adjusted EBITDA in the first quarter was $6 million compared to $6.6 million in the comparable quarter of last year. And the adjusted EBITDA margin was 5.4% compared to 6.5%. The decline mostly relates to the higher G&A expenses I just referred to.

On slide 24: our cash position remains strong, and we have the financial flexibility to continue to invest and grow the business. Cash and cash equivalents at March 31 were $101.4 million or $67.5 million net of our debt.

Reflecting the payment of bonuses in the first quarter, cash used in operating activities was $74.9 million compared to $69.1 million used in last year's first quarter. Our cash position builds throughout the year as we accrue for bonuses, which are paid out in the spring of the following year. We paid out approximately $89 million in February and March related to variable or deferred bonus payments, and this month we'll pay approximately another $7 million related to payroll taxes.

Looking at the second quarter, our executive search backlog is shown on slide 25, and monthly confirmation trends are shown on slide 26. We are forecasting a first-quarter net revenue of between $120 million and $130 million.

As always, the factors on which we base our forecast include our current backlog; confirmation trends for executive search and leadership consulting, as well as the anticipated fees, the expectations for our culture shaping services, the number of consultants, the current economic climate, and stable currency rates.

So with that, I'll turn the call back over to Tracy.

Thanks, Rich. The number one focus you heard from me last quarter remains the same: strengthening our business begins with the priority we place on our people. We are working to ensure that we have the very best consultants, and that they have to platform to provide clients unparalleled service and value as their trusted advisors.

We must foster collaboration, trust, teamwork, and the ability to embrace change. This starts with attracting great people and investing in them through training, developing, and mentoring.

With our people and the clients they serve as our top priority, there are three actions that need to happen more consistently and with scale to accelerate growth at Heidrick. One, collaborate across the regions and practices; two, collaborate between search, leadership consulting, and culture shaping; and three, ensure that the best ideas of our people are reaching our clients.

To be clear, clients are at the center of our business. To meet their needs, we must seamlessly bring together our regional and practice expertise and provide an integrated service offering. It is also how we will increase revenue and profitability.

One example of how this can work to meet the changing dynamics of the marketplace is our recent placement of the President and CEO of a large nonprofit in the United States. We differentiated our Firm by going beyond our capabilities to present not only a qualified slate of candidates, but provided an assessment of the cultural fit of each candidate. Interestingly, the search committee didn't just want to know if the candidate would fit their culture; they also wanted to know what kind of cultural change the candidates could bring to and develop at the organization.

As culture increasingly becomes more closely linked to an organization's long-term success, our search, leadership consulting, and culture shaping capabilities provide a uniquely integrated value proposition -- the kind of integrated leadership expertise that I know our Firm can increasingly provide to our global clients.

To further underscore the importance of our client focus and to further increase consultant accountability and collaboration I've asked Jory Marino to be Head of Global Markets and Krishnan Rajagopalan to be Head of Global Practices. They highlight the importance of our client coverage matrix -- namely, both geographic and industry practice.

Jory previously led the Americas region and served as Interim CEO. He will oversee the performance of our three geographic regions. Krishnan has led our global technology and services practice for the last five years. He will have responsibility for the industry and functional practice groups. Together they will drive our holistic, one-Firm approach that brings the best of our Firm to our clients in every case. Developing deeper, more strategic relationships will help us deliver profitable results for both our clients and our Firm.

A separate growth initiatives will be to expand the reach of our CEO and Board of Directors practice. Heidrick is known for the work that we do at the top of leading organizations. When we succeed at the CEO and Board level, our brand impact in the market is greatest and has the potential to help us everywhere in our business. The goal is to establish deep senior relationships across our client base to enhance the brand value of every practice, every region, and every service line in which we are engaged.

Our people, the work we do with our clients, and the brand that results are the core attributes we need to leverage to grow and increase profitability. Let me pause there and open it up to questions for Rich and myself.

Wes?

(Operator Instructions) Tobey Sommer, SunTrust.

I wanted to ask my first question about the employee retention or attrition. Has the initial response to the bonus payout -- what has that been like? Are there any changes to the compensation, either format or payout, that you are evaluating on a go-forward basis? Thanks.

Tobey, it's Tracey. First of all, on consultant headcount, we are encouraged by the comments that I made with regard to this being the first time in a number of quarters that we've seen a sequential increase in consultants, number one.

Number two, the compensation, as we referenced in the first quarter, was one that we felt hit the mark in terms of rewarding our consultants and employees for the year of 2013, which had a number of challenges; and yet through that, the productivity of those consultants increased. And for the moment there's no change with respect to any thoughts going forward on how we assess compensation. More work to do on that.

Okay. What were the gross hires, and promotions, and losses of consultants in the quarter?

Tobey, this is Julie. In the quarter we hired 21 people, and 11 people left for a variety of reasons.

Okay. Perfect. Thank you. I wanted to ask about financial services, which was up in the quarter. And historically, the demand for that has been a little bit better around this period of the year, or maybe the next couple of months. What's the outlook for financial services in 2Q and beyond?

Tobey, this is Rich. Financial services remains one of our largest and most important practices. You know, the area where we're seeing a lot of good activity is in the asset management and risk areas, which are broader than just maybe servicing the large banks, where you see a lot more volatility in headcount.

We've had some very creative efforts within the practice to drive growth and opportunity in these areas. So it's a much more balanced approach. I think we have a good outlook for the industry overall or for the sector overall.

I don't think it will lead the practices in terms of its growth rate. I think we are probably thinking that maybe there might be higher growth in areas like technology. But it certainly, as we indicated, is one of the three big factors that contributed to the quarter.

Okay. My last question is about culture shaping, and I'll get back in the queue. Do you feel like you have the appropriate scale to compete and do work for your clients in that area now? Or do you need to invest a little bit more?

And secondly, do you have a sense for whether the private competitors that are out there in the global arena have invested as much as you? Or maybe you have a leg up on them in this regard? Thanks.

On culture shaping we don't believe that we need to go outside and invest more. What we do need to do is invest more internally.

And what I mean by that is to more forcefully integrate the culture shaping offering that we have and connect it to our existing clients as well as prospective ones. But in terms of any need to go outside, we don't see that.

Thank you. And relative to the competitors and what their offerings are in this regard, is this a distinguishing feature for Heidrick?

Yes. There's no question that having culture shaping at Heidrick is a distinguishing characteristic of the Firm. Your brother question about the competition and the number of players that are out there: as you know, it's a highly, highly fragmented sector. And so it is not easy to look at a -- from my old days, to look at a proverbial leaf table of culture shaping farms one through five and see how we mark.

What we know is from the dialogue and the quality of dialogue we are having with clients and the number that we are having, that what we have offers a dimension that they don't see in many other places.

Tobey, if I could build on that a little bit -- the last point that Tracy touched on is very important from the standpoint of that. One of the things that distinguishes our offering is the fact that we can integrate it into the human resource learning systems of our clients with some of the technology that we have.

So it's not only at the high end, a very consultative effort that starts at the top, but it works down very thoroughly within large-scale organizations and can become part of their ongoing efforts in learning and tie right to their human resources. And that establishes long relationships with clients. So it's a very unique offering, and one that's been very successful.

Thank you. Let me just refine the question a bit. I was kind of referring specifically to your large executive search competitors as opposed to culture shaping competitors. So is this aspect of your offering, culture shaping, a distinguishing feature that those other large executive search players -- primarily the private ones -- offer or not?

The short answer, Tobey, is yes. We think it's distinguishing to have the culture shaping experience of Senn Delaney part of Heidrick.

Tim McHugh, William Blair & Company.

Good morning. It's Stephen Sheldon in for Tim. First, you talked about some variability in the culture shaping business, but it's still down some sequentially. Is there any seasonality impact in the first quarter? And how should we think about the seasonality of that business moving forward through 2014?

In some cases there's a -- seasonality might not be quite the right word, but it certainly is -- as I mentioned in my comments, it's very impacted by client behavior and how they go about doing the process of some of the work with our consultants and with our teams. A great example that probably slightly impacted our run rate this year is the fact that -- for example, one of our major verticals is healthcare, and there has been a lot of issues going on in the healthcare space relative to Obamacare and how companies are dealing with it.

And so if you think about it from a client standpoint, clearly, looking at their roadmap about where they are going with their business might impact ways in which they work on the development of their organizations. Having said that, that doesn't mean that the work goes away, but it certainly could impact the timing of when work starts, and when work finishes, and how they progress to the next stage.

Because usually, when you experience our activities, you go through a period of one to three stages in terms of the type of work that's done with the client. The technology in the more integrated -- down in the organization is at the latter stage, that's a little bit more of an annuitized stream. The ones that are more variable are in the first and second stages, where you are working with the top teams of the organization. And that's clearly driven by when the client wants to start the work.

Okay. That's helpful. On the G&A expense side, you talked about the three kind of nonrecurring items. How big were those items in the quarter?

Yes, that was a little disappointing to me, and it probably cost us a couple of million dollars at least. The franchise tax matter was about $800,000, and the level of nonrecurring expenses were close to $1.5 million in terms of the professional services.

I think our run rate will come down, back to where -- and I think at the end of the day, we are going to get closer to where we expect the G&A to be, and that drive a little more out of the business, but in a business our scale, sometimes when some of these metrics come in -- a great example is the franchise tax matter. We were notified by the state of that at the end of the quarter, and all of a sudden, you've got an $800,000 impact, and it's meaningful.

So we're going to appeal that, but we still recorded the liability. And whatever happens over time, we will finalize it through the financials. But I really see that the run rate should average its way down a little bit by a couple of million dollars.

Okay. And then last one, if I could. In the Americas, just kind of curious as to how demand kind of progressed through the quarter into the first part of the second quarter in April. Any notable change there?

Yes. So in Americas, the numbers, as you saw -- consultant headcount, off 19 year over year at this point, and yet productivity up. That productivity speaks to the demand in the marketplace. It also speaks to the way that we are targeting more sharply our client base.

So, clearly, we are looking to rebuild where we have lost some consultants. We are looking to invest more. But we've been able to take the group that we have and, through their increased productivity, deliver strong results.

Thank you.

Ty Govatos, TG Research.

A couple of things. On the backlogs, when you look at those, does it indicate the Americas, despite the decline in headcounts, will rebound?

As Tracy just indicated, I think it definitely does. In this quarter we experienced a little bit higher level of deferred revenue in terms of just the way some of our confirmations were flowing in some of the business activity.

So I feel very good about the range I gave you for second quarter, but I think it really speaks to the fact that Americas is still our strongest region and our largest region. And as Tracy indicated, when you think about the fact that year over year we were down in headcount but almost made it all up in productivity is a pretty strong sign.

It is. You said 10 promotions will show up in the second-Q consultant count?

15.

15. And the tax rate? Any ideas for the year? Still in -- about 50%?

Yes. The annual rate is probably around -- yes, the annual rate is around 50%. You're spot on. Obviously, because of the way our income flows not ratably through the year, it's unusually high in the first quarter.

Okay. Thanks. I appreciate the time.

Kevin McVeigh, Macquarie Research.

Great. Thanks. I apologize if you had mentioned this; I jumped on late. You saw a real nice rebound in Europe, and kind of the last quarter I think we were thinking you couldn't really count on the economy. Was there anything specific that drove that? And how should we think about that over the balance of the year?

Sure, Kevin. It's Rich. A couple of things. I think there was a little bit of a rebound in the economy in terms of -- I think the business climate is better. I don't think it's robust, but it certainly is better.

And certainly we saw impacts of it, especially in two of our areas, the UK and Germany, which was refreshing to see. I think there is another factor in that we have seen a nice rebound by a couple of our consultants, who maybe had had tough periods when the economy slowed down.

But even more importantly, that was an area that, you will recall, a couple of years ago got hit hard by attrition. And some of the people we've hired have really stepped up and filled voids and done a nice job of leveraging the brand and building a nice run rate of business.

So we've seen an improvement slowly building and finally breaking through a little bit in this quarter. And we are encouraged that we can keep that momentum going, but it's nice to see.

Great. Thank you.

(Operator Instructions) Kevin Steinke, Barrington Research Associates.

You referred to a separate growth initiative to expand the Board and CEO practice. Do you feel like that's something you can do with resources you have in-house? Or is that going to be a targeted focus of your hiring efforts going forward?

Kevin, the short answer is both. There is more we can do to target not only existing clients, but new ones. There's more we can do with our client base to cross the service offerings that we have across core search, leadership consulting, and culture shaping. And then there's some -- there's talent out there in the marketplace, away from Heidrick, that we are interested in having a dialogue with that we can bring into our CEO and Board practice. So it's both.

Okay. Do you think that changes the metrics in terms of what you will have to pay out to bring people in? Or should that just fit into your model now in terms of salary and employee benefits expense?

I think it fits into the model.

Yes.

Okay. Thanks for your time.

It appears there are no further questions at this time.

Okay. Thank you very much. We will look forward to talking to you in the quarter.

Thank you.

Thank you. And that does conclude today's conference call.