Heidrick & Struggles International Inc (HSII) 2014 Q2 法說會逐字稿

Good morning, this is Heidrick & Struggles second-quarter 2014 conference call. This call is being recorded. It may not be reproduced or retransmitted without the Company's consent. (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 in Heidrick & Struggles second-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. Also, 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 20 in our supporting slides.

Throughout the course of our remarks we'll be making some 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 will be referring to are shown at the bottom right-hand corner in each slide. And, Tracy, I will turn the call over to you now.

Thanks, Julie, and good morning, everyone, and thank you for joining this morning's call. Our second-quarter results reflect more encouraging signs of progress. Revenue growth was the biggest driver, up 12% year over year. Europe achieved its fifth sequential quarter of growth and was the biggest contributor to the quarter, up 34%.

Second-quarter Executive Search confirmations and average revenue per search were both up year over year and sequentially. Productivity reached $1.6 million in revenue per consultant, the highest since the second quarter of 2008. And importantly, we achieved another sequential increase in consultant headcount.

The improvement in adjusted EBITDA and operating income in the second quarter reflects the power of achieving greater scale in our business. Our reported 9.2% operating margin is the highest since the fourth quarter of 2009. But we need to increase it further. There is still much to be done to grow revenue and improve what flows to our bottom line.

To deliver consistent improvements in growth and profitability we will leverage our capabilities and go to market as one integrated firm. I'll have more to say about that after Rich gives you a review of our results.

Thanks, Tracy, and good morning, everyone. I will review some of the key financial and operational metrics and touch on some of the variances.

Slides 2, 3 and 4 indicate what Tracy has already highlighted. Consolidated net revenue in the second quarter was $136.1 million, up 11.5% or a $14 million increase from last year's second quarter.

Executive Search and Leadership Consulting revenue grew about 9% year over year or approximately $10 million.

Europe, shown on slide 5, was a key driver of the year-over-year revenue growth in this segment, almost up $8 million or $6 million on a constant currency basis. The Financial Services, Industrial and Global Technology & Services practices were the key drivers of growth in this region. We ended the quarter with 89 consultants in Europe, the same as at the end of June last year. But an improvement and consultant productivity and an increase in the average revenue per search helped drive strong results. Along with the revenue increase, Europe also achieved a significant improvement in operating income and operating margin.

Revenue in the Americas region, which is shown on slide 6, increased about 3% compared to last year's second quarter. Good growth from the Consumer Markets and Global Technology & Services practices were partially offset by declines in the Industrial and Healthcare & Life Sciences practices. Consultant headcount was lower by 4 compared to last year, but productivity improved as did the average revenue per search. Operating income was essentially the same as last year and the operating margin was 27.2%.

As shown on slide 7, revenue in Asia-Pacific was flat compared to last year at $25.1 million. On a constant currency basis revenue increased about 2%. Growth in Global Technology & Services, Consumer Markets and Healthcare & Life Sciences practices were offset by a decline in the Industrial practice. Consultant headcount at the end of the second quarter was 87, the same as the last year's second quarter. Productivity was unchanged and the operating margin was the same, 11.7%.

Looking at the industry practices globally, on slides 8 and 9, you will see that the Consumer Markets, Financial Services and Global Technology & Services practices achieved double-digit growth, while the Industrial practice was down 6%. The decline in the Industrial practice was specific to the Americas and Asia Pacific regions.

Now looking at our Culture Shaping segment on slide 10, revenue increased 72% or just under $1 million. It was a very good quarter for Culture Shaping, but I will remind you of some of the additional context. Our reported results this year did benefit from favorable comparisons due to deferred revenue that we were unable to recognize in 2013 from Senn Delaney as a result of purchase accounting -- which was $1.5 million in last year's second quarter and only $166,000 in this year's second quarter. But even taking that into account, the year-over-year increase in revenue was a very strong 37%.

Also recall what we said in our discussion of the first-quarter results, that because of the size of this business and the timing of project initiations there could be some variability in quarterly results. If you compare Culture Shaping results for the six months of 2014 against the first six months of 2013, and add back the unrecognizable revenue, Culture Shaping revenue growth was approximately 11%. More importantly, you will see that the Culture Shaping segment achieved an operating margin of 14% in the second quarter and 5% for the first six months and it was accretive for both the quarter and year to date periods.

Referring to slide 11, we ended the second quarter with 311 consultants. Our year-to-date growth in consultant headcount largely reflects our hiring efforts to date as well as our annual promotion process. Developing our colleagues is as important to us as attracting new talent to the firm and Heidrick has a long history of successfully promoting from within. This year our annual promotion cycle resulted in 15 of our best being promoted into the consultant ranks effective April 1.

Turning to slide 12, second-quarter annualized consultant productivity improved to $1.6 million compared to $1.5 million in last year's second quarter. The trailing 12 month consultant productivity is now running at $1.5 million. We do expect that we will see some variability in that metric when additional investments in consultants are made. But it was a good trend and we are pleased to see the results in the quarter.

As you can see an slide 13 which is specific to Executive Search, search confirmations in the second quarter increased 3.5% year over year and were the highest they have been in 11 quarters.

Slide 14 shows the average revenue per search -- $117,400 in the quarter and running at $115,100 on a trailing 12 month basis.

Referring now to slides 15 and 16, salary and employee benefits expense increased $9.1 million to $92.1 million overall, representing 67.7% of net revenue. Variable compensation increased $9.5 million as a result of the higher revenue. Like in the first quarter, Europe's year-over-year growth in revenue was a key driver of this increase. We are pleased to see that fixed compensation expense declined about $500,000 during the same period.

Turning to slide 17, general and administrative expenses declined $1.8 million or 5% to $31.4 million representing 23.1% of net revenue. The decrease came from a number of areas, but the largest decline was in professional services fees. In the third quarter we will see additional G&A expense of approximately $2 million related to our Global Partners meeting which we held earlier this month in Chicago.

Moving to slides 18 through 22, adjusted EBITDA in the second quarter was $18.9 million compared to $11.9 million in the comparable quarter of last year and the adjusted EBITDA margin was 13.9% compared to 9.7%. Operating income in the second quarter increased $12.5 million and the operating margin improved to 9.2%. The improvements mostly reflect the higher net revenue helped by the decline in G&A expenses.

As we turn to slides 23 and 24, we reported net income in the second quarter of $3.8 million and diluted earnings per share of $0.21, almost double what we reported in last year's second quarter and this is despite an effective quarterly tax rate from a book standpoint of 70.3%. These results highlight the positive effect that scale and revenue growth have on our bottom line.

Looking at the slide 25, cash and cash equivalents at June 30 increased to $123.4 million from $101.4 million at the end of March. Our deposition continues to decrease and it is down to $32.5 million at the end of June from $34 million at March 30. Cash provided by operating activities in the second quarter was $29.6 million compared to $20.6 million in last year's second quarter.

Looking forward to the third quarter, our Executive Search backlog is shown on slide 26, and monthly confirmation trends are shown on slide 27. We are forecasting third-quarter net revenue of between $123 million and $133 million. As always, the factors on which we base our forecast include our current backlog, monthly confirmation trends for Executive Search and Leadership Consulting, the anticipated fees, expectations for our Culture Shaping business, the number of consultants, but current economic climate and the stable currency rates.

And with that I will turn the call back over to Tracy.

Thanks, Rich. Our people have been my top priority since I arrived here earlier this year. Strengthening our business begins through a combination of attracting great people and then investing in them through training, development, all along fostering collaboration, trust, teamwork and the ability to embrace change.

Earlier this month 280 of our firm's leaders from 30 countries gathered for our biennial Partners meeting, this time in Chicago. By any measure it was a very positive experience. The energy and the enthusiasm from everyone who attended was palpable.

The meeting also provided Heidrick the opportunity to expand our Culture Shaping initiative throughout the firm. We embarked on our own Culture Shaping journey in June and since then almost 100 of our Partners and corporate leaders have participated in the initial phase. By late fall our intent is that all Partners and Principals and key corporate leaders will have completed this initial work.

The reception to Culture Shaping has been equally very positive. Not only are people excited about the opportunity to actively shape Heidrick & Struggles' culture, they are excited about the opportunity to learn firsthand the value of one of our Company's core service offerings.

Although our people have been my top priority, clients are at the center of our business. And since joining the firm almost six months ago I have now met with dozens of clients in order to personally understand our value proposition and how we can strengthen it. Quite simply, our clients want more from Heidrick. They went to great search judgment, deeper assessment and more of a strategic relationship with us around succession.

To meet our clients' needs we must deliver a seamless solution set that brings together an integrated platform of Search, Leadership Consulting and Culture Shaping across all our geographies and industries. We will not only help our clients find the right leaders, we'll work to ensure their success.

In closing, our people, our client, and our brand are the core strengths we will leverage to grow this Company and improve profitability. I challenged everyone at our Partner's meeting to feel a sense of urgency about what needs to be done. And I encourage them to be energized by the incredible opportunity to return to and exceed the financial performance of our very best years.

Let me pause and say Rich and I would be happy to take any of your questions. Doug, back to you.

(Operator Instructions). Tim McHugh, William Blair.

Hey, good morning, it is Stephen Sheldon in for Tim. Thanks for taking my questions. First, it looks like you had another sequential increase in headcount, about 8 this quarter. So I was curious how many consultants you hired in the quarter and then how many left whether voluntarily or involuntarily?

Hi, this is Julie, started the quarter with at 303, hired 13, promoted 15 and 20 left for a variety of reasons including voluntary and involuntary.

Okay, great. And that was hoping you could give some more color on what drove the improvement in the Culture Shaping business and how sustainable you would view that improvement. Specifically should we be expecting the absolute revenue achieved in the quarter to be fairly sustainable moving forward?

Yes, good morning, Steve, this is Rich. As I indicated in my remarks, we are going to see variability in that business a little bit from quarter to quarter because much of the revenue recognition relates to how projects initiate with the clients.

So we are right on track with where we thought it would be, quite frankly, on a year-to-date basis. And with the pipeline that we see for the year, we had a little ground to make up from the early part of the year and some of that was made up in the second quarter so it was a very encouraging second quarter.

And as Tracy indicated in his remarks as well, we are very bullish on that offering relative to its integration, both into Heidrick as well as to standalone prospects. It is a hot topic in the leadership area, a lot of our clients are talking about culture and its impact on their leadership and on their effectiveness as organizations. And we think we are extremely well-positioned and we have a very strong belief in the business.

Okay, great. And then just one last one. I was just curious what kind of approximate operating margins and tax rate you would expect for the third quarter.

Well, we don't forecast margin and tax rate, we only give guidance on the revenue levels. As we have said all along, our target for this business has been to drive operating and profit margins into the double-digits, we saw good improvement in that in the second quarter.

Just a reminder again that our operating margin will trail our EBITDA margin over the course of the periods that we deal with the earn out from the Senn Delaney acquisition, which is why we disclosed both because the EBITDA margin more closely relates to our cash flow and true cash impact on the earnings level of the business.

So clearly our margin is driven right now by the power of scale, as we indicated. And if we continue to have run rates like we saw in the second quarter, I'm optimistic.

Okay, great, thanks.

(Operator Instructions). Brad Evans, Heartland.

Congrats on a good quarter. Tracy, as you highlighted, you have been here for six months now and I just would love for you to maybe just to amplify a little bit on as you are in your seat where are you ahead of plan and where might you be maybe perhaps a little bit behind plan in the first -- for the first six months of your tenure -- if anywhere?

Thanks, Brad, for the question. A couple of thoughts on that. As you know, the primary focus, as I referenced this morning, is on our people. And very close to that obviously is our clients who are at the center of what we do.

So the way I think about our progress is I look at our people, I look at are we building our consultant ranks and are we building it with the right people and where we need to. Are we -- as Julie referenced, are we asking some folks that it is time. And so, there is nothing more important, Brad, than building and rebuilding our consultant ranks so we can interact with the client.

I would say secondly there is still much work to be done there. As everyone on this phone call knows, Heidrick lost consultants in the last couple years and we are not going to make all that up in a couple of quarters. And so we view this as a positive March, but we view it as one that is going to take some time. So I don't know whether or not I would characterize that behind or ahead, but I would consider it forward.

And then lastly I would say, as you can see in the quarter, Europe has done well, the United States has done solid, Asia has been relatively flat and I think that talks about just how competitive the environment is in Asia, but it also says there is opportunity there to grow our consultant ranks which we are focused on.

Okay. In terms of people, the consultant base, are you where you thought you would have been or relative to your early expectations in terms of your ability to grow the consultant base? Or where do you stand today versus where you thought you would be maybe when you first were on board into the organization?

I can't give you the exact number. What I can tell you is what I am focused on is growing the base but also growing the quality of the offering we present to our clients. And so, going back to an earlier question, and I referenced, clearly our most important offering is what we do around core search.

But because of that access to the client we also have an opportunity to expand that conversation around the components of Leadership Consulting which we talked a lot about at our conference and the importance of assessment and succession and then obviously Culture Shaping as Rich described.

So I view it as -- I don't have a specific consultant number, if that is what you are looking for. What I do have is the positive trend and also expanding the quality of our conversation with the client to obviously include search but also embrace the other services we have around Leadership Consulting and Culture Shaping.

But it sounds like you would be disappointed if you weren't able to continue to grow the consultant base into the back half of 2014?

We are certainly looking to grow it.

Okay, that is helpful. And in terms of just -- if you don't mind amplifying as well what you are hearing from your clients in terms of the demand cadence. I guess what -- as you look to the back half across the various geos that you participate in, what has you optimistic and what has you cautious in terms of the demand cadence that you are hearing from your global customers?

Well, certainly Europe speaks to a positive trend for us for two reasons, one is just the overall market trends in Europe, but obviously we are also benefited by some pretty low hurdle comparisons in the previous year and hence our growth rate there.

I would say that the United States, we are seeing two things in our clients broadly, one is they are very focused on talent and looking to bring in great talent wherever they can. At the same time the economy is showing some positive signs here and you can see that in the numbers. I think everyone is cautiously optimistic that will continue.

And I would say on Asia we would look to -- we would look for only more growth there, but I would also say that Asia is an extremely competitive marketplace.

So thank you for that amplification. The guidance for the third quarter is pretty positive. And can you just help us understand how just, not at a granular level but at a high level, how you arrived at that guidance in light of -- juxtaposed against the July confirmation number? Do you expect that number to pop back up in August? Are you seeing leading indicators that would imply that we start to bend that curve back to a higher trajectory?

Let me ask Rich just to walk through how we came up with that.

Yes, Brad, I will speak a little bit to that. As I mentioned, there is a number of factors that go into the components of developing the guidance and how we model it. One thing we saw and we have seen so far in 2014 is we have seen a little bit of a difference in some of our areas of business where we have seen acceleration of what we would call normal cycles in the financial services practice.

For example, where we see some relationship with core customers that usually kind of time out a little bit later in the fall have accelerated in time to kind of come forward a little bit earlier in the year. And we actually benefited a little bit of that in the second quarter because we closed some more activity and actually had very good upticks contributing to our revenue recognition.

Some of that impacts the ability of the timing of our revenue recognition as we look through the quarter and how it plays through. We did, as indicated in our slides, our July confirmations are probably trending a little lower than maybe we would have thought on average for the year, but we have already factored that into the guidance outlook into the Q3.

Some of that is driven by the fact we did take our Partners out of the market for a couple of days in our Chicago meeting as well as some of the activity we saw that flowed into the second quarter of this year.

Overall we really try and keep our finger on the pulse of where our people are active, where our practices are active and, as Tracy indicated, pretty much on a global basis our people are highly engaged in client activity. But again, it is still a market where we see some variability in timing, some transactions take a little longer than others.

We would like to bring our overall cycle on our search down a little bit in terms of days of completion, that is still a very active goal of ours and we take that all into consideration. But at the end of the day between the combination of the Culture Shaping and our current trend in the business and our higher productivity, we think it supports the forecast we have given for the quarter.

And just one last question. If I recall correctly, there is about $23 million available on the share repurchase plan, is that correct?

I don't have the current number at my fingertips. We will see if we can find it. That seems a little -- I thought that was high, but --.

Yes.

I guess just -- as you are looking for that number I guess the question around that is with the Company's valuation roughly around 5 -- a little less than 5 times 2014 EBITDA, I'm just curious, Tracy, your perspective with how the balance sheet is currently positioned, would a $10 million or $20 million share repurchase program meaningfully derail your strategy from either an internal investment opportunity or external?

Brad, the way I'd answer that is I would say what we are highly focused on right now is investing in our people and investing in scalable solutions that allow them to bring the highest value to our client base. Those priorities dominate right now. And as we discussed, while I take your point about valuation our number one focus with respect to investing is around people and solutions for our clients. And through that we think value will express itself in the marketplace.

I agree with you, but I would just -- the only pushback I would have for you is that a holistic approach to capital allocation that includes returning capital to shareholders. In light of some of the negative misperceptions around the Company, yes, so shareholders are rewarded as well as the investment you are making in our producers, which is obviously very, very important. So we are 100% supportive of that.

But I think there is a dual track that the balance sheet does afford and I think it is appropriate in light of where the Company's valued. So, thanks for that and good luck.

Thank you, Brad.

And just -- thanks, Brad, and confirmation, you are right, it is about $22 million that is available on the share repurchase program.

Doug, are there any other questions in the queue?

Kevin McVeigh, Macquarie.

Nice job. Hey, it looks like you had some real nice leverage on the SG&A line in Q2. And I know you are not giving kind of a formal guidance for Q3, but should we expect the same type of benefit? I mean obviously last year you picked up 300 basis points sequentially, but Q2 to Q3, I'm not suggesting 300 but should we model in continued improvement on that one?

We have done if you go back and look historically, Kevin, thanks for the question, we have done a pretty stringent job of trying to hold the line on the G&A line across the Company. And if you look at our segment results versus our overall income statement results, you would see that the corporate part of that G&A line usually hovers around 9% to 11% of revenue in the last few periods.

And I kind of use that as a guideline quite frankly. I really try and keep it around the 9% and 10% if I can. And our people do a very good job both in the field as well as corporate side of that. There is a lot of factors that drive it.

We occasionally will get blips. If you remember the first quarter we had a couple of items that for timing purposes, etc., on professional services and a state tax matter that came into the quarter that blipped our G&A up about $2 million -- $2 million to $3 million. As I indicated in my remarks for Q3, we will absorb the expenses from our Partners meeting which is going to be about $2 million.

Now we're going to try and offset some of that, but candidly that was an investment worth making. And so we may see a slightly higher run rate in the quarter. But I do not expect going forward that you are going to see much of a material movement in that G&A line up or down. We're just going to try and hold it as steady as possible, absorb inflationary increases and services and people and try and make that up through productivity by continuing to leverage technology and continuing to improve our processes wherever we can.

But what it also shows is the power of the leverage. If we get our revenue back up to where we've always talked about where we want to keep productivity in the $1.5 million or higher range on our consultant base, we drive pretty good operating leverage as we move through a year. And that is what we would like to see.

Got it. And are you pretty comfortable in terms of the office footprint at this point or is there some incremental opportunity around just office location?

Every lease that comes up we take the opportunity. We are actually working on now -- one right now in one of our larger offices in Chicago where we are going to -- we hope to take some cost out in the very near future as our lease is coming up and we are doing our renewals. So we take every opportunity we can to do that.

Julie actually has a second job in our real estate area and does a fantastic job there along with all our folks in the various offices. So I am pretty comfortable again with our real estate footprint and the cost of our real estate. And I am very pleased at the work that our people do out in the field to help us with that effort.

Got it. And then just, Tracy, as you think about hires going forward, what type of candidate from a tenure perspective are you thinking about? And are there any particular verticals you are focused on?

So I'll, Kevin, answer it two ways. One is the verticals Industrial and Life Sciences is where we are looking to invest. And in particular I would say more in the senior ranks. But I would also say that parallel to that is Junior people who we think have talent, not necessarily who have a background in search, but we think have the abilities to drive search business over time who we can develop, who we can train and we can mentor.

As we referenced, that has been an important talent pool for us over time. And keeping that going is something we are very committed to. So I would say it is on both sides, both at the junior level and at the senior level and I would call out Industrials and Life Sciences.

Got it. And then just the overall environment, it definitely seems like obviously the labor market has been firming up. Are you seeing that vis-a-vis the salaries your clients are willing to pay? Has there been any kind of meaningful uptick in that relative to the last couple years?

This is Rich, I will jump in on that. As we talk to our people both regionally as well as by practice, the [war] for talent is pretty active right now. So the good news about playing at the high end of the spectrum is that it is less a conversation about wages or pay, it is more about is it the right talent and is this somebody who can or will help me be successful from a client perspective.

So as we have indicated in some of our metrics relative to our fee levels, that hasn't been a big concern at all. We obviously operate in different markets, wage and pay levels and some of our developing markets are obviously lower than some of the more developed markets. But at the end of the day the averages speak for themselves and say the war for talent is still pretty active.

Excellent. Thank you.

It appears we have no further questions at this time.

Okay, thank you all for being with us this morning. We are working very hard on your behalf. We appreciate your questions both on this call but also throughout the quarter. And we will no doubt be talking with each of you soon. Thank you.

This concludes today's conference. Thank you for your participation.