Heidrick & Struggles International Inc (HSII) 2014 Q4 法說會逐字稿

Good morning. This is Heidrick & Struggles' fourth-quarter 2014 conference call. This call is being recorded and may not be produced 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 on Heidrick & Struggles' fourth-quarter and 2014 conference call. Joining me on today's call is our CEO, Tracy Wolstencroft, and Rich Pehlke, our 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. 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 slides 16 and 34 in our supporting slides.

Throughout the course of our remarks, we will be making some forward-looking statements, and I 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 shown in the bottom right-hand corner of each slide.

Now, Tracy, I'll turn the call over to you.

Thanks, Julie. Good morning, everyone, and thank you for joining this morning's call. We have much to report in the way of progress this morning as we continue to strengthen our business and improve the foundation for sustainable profitable growth. Our fourth-quarter results contributed to a solid year for the firm. In 2014, all of our key business and financial metrics were improved. We grew consultant headcount, confirmed more executive searches, improved average revenue per search and increased productivity. These all contributed to growth in net revenue, EBITDA and operating margin, and net income.

We began our most significant integrated and diversified solutions assignment to date, and we launched two assessment tools. These results represent solid progress toward many of the initial goals we established when I arrived at Heidrick a year ago, namely to strengthen our business by attracting and retaining exceptional talent and by fostering collaboration and teamwork across our global platform.

We are focused on leveraging what we accomplished in 2014 to deliver an even deeper level of service to our clients, accelerate growth and drive increased shareholder value in 2015 and beyond. I will have more to say about the priorities for our business after Rich gives you a review of our results in the quarter and for the year.

Thanks, Tracy, and good morning, everyone. I'll spend just a few minutes on the fourth-quarter results and more time focused on reviewing the annual results. Please refer to slides 2 through 18. Our fourth-quarter results were as we expected and helped us to deliver a solid 2014. Consolidated net revenue in the fourth quarter of $121.3 million was up 3%, or $3.3 million, compared to last year's fourth quarter. Exchange rates adversely impacted our fourth-quarter results in every region but especially Europe. Excluding the impact of currency, consolidated net revenue would have increased 5% year over year, or approximately $6 million.

Executive search and leadership consulting revenue grew about 2% year over year, or approximately $2 million. Culture-shaping revenue increased 19%, or just over $1 million.

In the Executive search and leadership consulting segment, the Americas region was the key driver of the fourth-quarter, year-over-year revenue growth, up almost $4 million, or 6%. Globally, the financial services and consumer markets practices were the drivers of our growth. Productivity was essentially flat. Specific to executive search, search confirmations in the fourth quarter were flat year over year but generated more revenue as a result of an increase in the average revenue per search.

Adjusted EBITDA in the fourth quarter improved to $9.5 million compared to $7.4 million in the comparable quarter of last year. The adjusted EBITDA margin increased to 7.9% compared to 6.3%. Operating income in the fourth quarter improved to $3.8 million, and the operating margin increased to 3.1%. The improvements in adjusted EBITDA and operating income mostly reflect higher net revenue and lower G&A expenses, which were partially offset by an increase in salaries and employee benefits.

Now turning to the annual results, I'll reiterate what Tracy highlighted earlier: 2014 was a good year. Referring to slides 20 through 23, consolidated net revenue increased 7%, or $32 million, to $494 million in 2014.

While foreign currency exchange rates did have an impact on our fourth-quarter results, the impact on the full year of 2014 net revenue was negligible. The executive search and leadership consulting segment grew net revenue 5% year over year, or approximately $22 million. Europe was a key driver of this growth, up almost $19 million, or 21%, driven by good performance in the UK and Germany. And despite the adverse impact on the fourth quarter, currency exchange rates positively impacted Europe's results for the year as a whole, representing about 3%, or $3 million of its revenue growth. The consumer markets, financial services, and global technology and services practices were the drivers of growth globally on a practice basis.

Turning to slide 24, we grew our consultant base last year and ended 2014 with 307 executive search and leadership consulting consultants. Today, as a result of our annual promotions process and new hires, consultant headcount is at 320. Hiring, training, developing and retaining the best search consultants in the world remain our highest priority. The increase in the productivity of our consultants in 2014, as shown on slide 25, from $1.4 million to $1.5 million is positive affirmation of these efforts.

Specific to executive search, our core business, slides 26 and 27 reflect improvements in the number of searches confirmed in 2014 as well as the average revenue per search. Our culture-shaping segment achieved a good year with revenue up 40%, or $10 million in 2014. The increase primarily reflects higher volumes of client work, but it also reflects that revenue in 2013 excluded $4.1 million of pre-acquisition deferred revenue that we were unable to recognize on the income statement as a result of purchase accounting.

Referring now to slides 28 and 29, 2014 salaries and employee benefits expense was $337.4 million, representing 68% of net revenue. Compared to 2013, salaries and employee benefits increased 5.6%, or about $18 million. Variable compensation increased $21 million as a result of higher net revenue and improved Company performance, while fixed compensation expense declined about $3 million primarily due to lower severance expense.

Turning to slide 30, general and administrative expenses increased $3.3 million, or less than 3%, to $130.2 million, representing 26.3% of net revenue. The increase reflects new online databases for more efficient search execution, higher hiring and staffing fees, and a state franchise tax matter which all increased G&A. These were partially offset by lower professional services fees and lower office expenses.

Moving to slide 32 through 36, adjusted EBITDA in 2014 improved to $48.9 million, compared to $39.7 million in 2013. The adjusted EBITDA margin was 9.9% compared to 8.6%. Operating income in 2014 increased to $26.7 million, and the operating margin improved to 5.4%. The improvements in both adjusted EBITDA and operating income reflect the higher net revenue.

Turning to slides 37 and 38, net income in 2014 was $6.8 million, and diluted earnings per share of $0.37 compare favorably to the net income of $6.3 million and EPS of $0.35 despite a higher effective tax rate. The effective tax rates in both years are higher than statutory rates primarily because of losses incurred that could not be benefited for tax purposes in foreign jurisdictions.

Looking at slide 39, cash and cash equivalents at December 31, 2014 was $211.4 million, compared to $181.6 million at December 31, 2013. Cash provided by operating activities was $58.8 million in 2014 compared to $55.9 million in 2013.

Those of you who follow us know that our cash position builds throughout the year as we accrue bonus payments, which are paid out in the following year. In the first quarter of 2015, we will pay out approximately $112 million. About $9 million relates to the payment of deferred consultant bonuses from the years 2011, 2012 and 2013. The balance of $103 million is a variable compensation which we'll pay related to 2014 performance.

In addition to our financing activities, it's worth noting that we're currently planning for higher than average capital expenditures of approximately $11 million in the coming year primarily for office build-outs in 5 of our US offices. In three of these instances, including our headquarters here in Chicago, we have had the opportunity to reduce our rentable square footage by building out a more efficient floor plan, which should help lower our run rate of office occupancy expenses. Our cash position is strong, and we are in a strong position to invest in growing the business as required as we continue forward.

Looking forward to the first quarter, our executive search backlog is shown on slide 40 and monthly confirmation trends are shown on slide 41. We are forecasting first-quarter net revenue of between $108 million and $118 million. As we experienced in the fourth quarter, we are expecting the strengthening dollar and the more volatile currency exchange rates to adversely impact year-over-year comparisons of net revenue more than we've seen in recent past quarters. We expect that at constant currency rates, first-quarter net revenue growth should be at or above the year-over-year growth rate we experienced in the fourth quarter. Other factors on which we based our forecast include our current backlog, our monthly confirmation trends for executive search and leadership consulting. We anticipate these expectations for our culture-shaping services and the number of consultants in the current economic climate.

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

Thanks, Rich. As I said at the start of the call, we accomplished much in 2014. By virtually every measure, we improved our business. We are starting 2015 with great people, deeper client relationships, a more integrated service offering, two new assessment tools and, importantly, a stronger spirit. The firm is in a better position than we were a year ago.

That said, there is still opportunity to improve and a strong desire to accelerate growth and drive increased shareholder value by building on what we achieved in 2014. For example, as we have said on every earnings call, our people are our top priority. We will continue investing to develop and grow our practices and add geographic reach where we see profitable opportunity. In addition to hiring, we see good potential for the consultants we have added and promoted over the last few years to become increasingly successful and productive on our platform. Ensuring this happens is a critical factor in our near-term success.

There is also opportunity to increase both the depth and breadth of our service capabilities to our clients. We will grow our leadership consulting capabilities and culture-shaping expertise globally. We are selectively looking to bolster our capabilities to deliver a diversified range of service offerings that can be tailored to our clients to more fully meet their talent and leadership needs.

For example, last quarter we told you about two new assessment tools we developed, namely Executive Culture Profile and Leadership Signature. Both have been very well received by clients as our consultants use them to assess leadership style and fit.

The one observation that I've been reminded of over and over again since joining Heidrick & Struggles is that our business is more relevant than ever. Last month, a group of us from Heidrick met with scores of global leaders across every industry at the World Economic Forum in Davos, Switzerland. This year, the themes of purposeful leadership, culture change, diversity, hiring top talent and assessment strategies were top of mind. Every session and every conversation we had reinforced the demand for leadership, demand for exceptional leadership that can operate in an uncertain world. And it's not just at Davos. We hear this from our clients every single day. There is no doubt that what we do is a vital need, and a more comprehensive and thoughtful approach to leadership advisory is valued.

In closing, we are better than we were a year ago but still not yet where we want to be. We see the potential of our firm and what it means for our clients, our people and our shareholders. This is a great time to be in our business. We will wisely invest to capitalize on the market opportunity, including people who can help us continue to improve our ability to service clients and deliver a return to shareholders.

I'd like to thank all of our nearly 1,500 colleagues for our 2014 results. The past year has gone by very quickly, and I am pleased with the renewed energy and dedication. With a new sense of confidence at Heidrick & Struggles, they have embraced our vision to go to market as one firm, a trusted advisor providing diversified leadership solutions to the world's leading organizations. There's great opportunity ahead for Heidrick and for our clients we are privileged to serve.

At this time, Rich and I would be happy to take your questions.

(Operator Instructions). Kevin McVeigh, Macquarie.

I wonder, can you give us a sense of how the fixed versus variable comp should trend as we think about 2015 versus 2014? And just what type of adjusted EBITDA -- you're making a nice progress on that front -- should we think about it as we think about 2015 to the extent you can give us any just direction on that?

Sure. Good morning, Kevin. Thanks for the question. Yes, we've had a nice, steady trend of changing the composition of the fixed and discretionary comp. And when you think about the nature of our business, that's exactly where we want to be. And we've made some structural changes, and we will continue to emphasize this shift as we go forward. So I would look for it to continue to trend downward. It won't be a rapid decline, but it should be a steady decline. That would certainly be our desire. Because really, if you think about it, the more we make our consultants successful on our platform, they really roll over into a higher discretionary comp, and that's really where we want to be.

So I think you're going to see the trend continue. I think that's by holding days salaries in check or maybe in some jurisdictions reducing them, and then driving the obvious incentives relative to overall production.

As far as EBITDA trends, we don't forecast anything but next-year quarters. But clearly what I think we hope 2014 results show is that we've had a tremendous emphasis companywide now on improving the quality of our growth and quality of our earnings. And we're my proud of what that does. I think we've highlighted over the last couple of years because of the Senn Delaney acquisition EBITDA because it more closely reflects the trend in our cash flow and the generation of our real cash earnings. We'd like to see that number stay up in the area that it is or possibly even grow, and much will depend upon the pace of the revenue growth.

Got it. And then, Rich, is the mix of compensation on the Senn Delaney side similar to the core search business in terms of fixed versus variable, or is there any way to just parse that a little bit more just directionally?

It's a different business model than search. The approach is a little bit more of a -- not a traditional consulting, but a consulting type mix. What you'll see happen in the future with Senn Delaney, what would be our hope, is that we plan to invest in that business both in terms of some of the legacy people as well as some new people because we think culture is very relevant in today's world. And we'd like to ramp up the growth of that business more globally. So we are going to put some money into that business to invest in people. So while the mix overall probably won't change dramatically, fixed versus variable in their business model, I think overall we'd like to see compensation expense go up in that business because we're going to try and grow it.

Got it. Then just last question and I will jump back in. The office changes in terms of -- it sounds like certain ones, any sense of what the cost savings will be as a result of that?

Sure. They're going to go down. I can give you one clear example, which is one of our biggest ones is here in Chicago. We're moving from approximately 80,000 square feet to about 55,000 square feet, which is a big change and represents a savings of about $1 million a year. That's offset by a little bit of the build-out cost that we'll experience as we ramp up the CapEx.

And I think it's been evident in our financials over the past couple of years. Every chance we can, we move our occupancy expense to a more traditional model of what's happening in professional services today. We don't quite go as far as a lot of consulting companies where we do a hoteling concept or anything like that, but certainly we're becoming more efficient in the use of our space because we'd rather put the dollars towards our people than office space. So that's really behind the trend.

That's offset sometimes by the fact that in some of our markets -- we are in expensive markets. We're in major financial centers across the world, and right now some of those markets are rising in cost. So overall, I think you're not going to see dramatic moves, but we're going to continue to manage it as efficiently as possible.

Understood. Thanks so much.

You're welcome.

Tim McHugh, William Blair & Company.

Yes, Rich, I guess I was just going to follow up on one comment you just made there. I guess, I think you said generally for EBITDA margins you hope to maintain them or possibly even expand them a little bit. I guess not to nitpick, but I guess -- and I know you're not giving specific guidance, but I would have thought there was still a fair amount of margin improvement. So your comment was softer, I guess, than I would have thought at this point. And so I want to just understand. Do you view this as more of the stable level of margins now? And so if you get margin expansion, great, but the focus is more on top line? Or how are you thinking about the margin as it sits today relative to where you want to be?

Sure, Tim. Good morning. A couple of things. I don't intend it necessarily to be directionally soft or a hard forecast. But you know very well that what's going to drive the operating leverage in our business is really the top line. What we've set the platform up with our expense base is to hold a great deal more of revenue. If we see the top-line growth accelerate across all regions, it certainly has the potential to drive our margins higher because our platform can certainly hold a lot more revenue than we generate today. So we're set up for good operating leverage. But it's really -- it's not as contingent upon direct expense management as it is on the top line. At the end of the day, that's what's going to be the key.

Okay. I guess -- I mean, relative to that, you talk about investing first in Senn Delaney, as well as I guess productivity levels are high. Is there a level of investment needed up front here to accelerate that growth rate? Or have you already been making those?

Look, we've made some, but we certainly have set aside and at least earmarked in 2015 some investment dollars to bolster both Senn Delaney as well as continue to build out the core business. I think it's fair to say we'd like to be bigger in terms of the number of consultants that we have globally. I think Tracy pointed it out in his remarks, and I'll let him comment on it further. But I don't think there's an area that we serve from a client perspective that we couldn't have more athletes on the field. And so if we see the opportunity to do that, we're going to invest because we think we can bring that home in a good return.

Is there a target for headcount growth roughly? What's a fair estimate for what you'd like to achieve in 2015?

We don't have -- we don't publish a hard target for numbers. We certainly want to be up higher. Clearly, if you historically look at the Company and you think about our platform, we have ample room to grow. And you and I have even talked about this in the past. If we can start in the near to short -- short to near term, start to get the numbers up in the 325 to 350 range, that would be a great move for the Company.

Okay. And then last, can I -- Asia-Pacific. I apologize if you said this earlier and I missed it, but headcount has been down, I guess, for two quarters now sequentially, and percentage wise for the size of that region a decent amount. Can you -- is there something -- is there a story there that explains what is underlying those numbers?

Tim, the drift in Asia on those numbers that you're referencing is largely driven by selective performance issues we've had with some consultants.

Is that certain regions, or is it across with the subregions, or is it across the --

Within Asia, it's two to three specific markets.

All right. Thank you.

Tobey Sommer, SunTrust.

I just had a quick question for you. What were gross hires and turnover like in 2014 or the quarter, whichever one you might have?

Either one, Tobey. In the quarter, we hire -- in the fourth quarter, we hired 8 and 12 left for one reason or another, sadly including one death. In the year, our voluntary turnover, which is a number we've quoted in the past, was about 14%. I think that's the number you're probably looking for, but I can give you the ins and outs of that.

Just to put that in context, how does 14% compare to the year before or something?

In 2013, it was 21%.

Okay. Thanks. Is the couple markets in Asia, where there maybe were some things, can you address that with relatively small amount of hiring, or how should we think about the timeline to be able to turn that around?

Tobey, Asia, like every market, so to include the United States and Europe, is getting a lot of attention at the firm right now. The opportunities in Asia are both centered around clients who are multi-national clients as well as indigenous opportunities in those markets from Australia to Japan.

The numbers that I referenced earlier that have come off is -- as large as we are, we're expecting more from our consultants. There is across the firm increased accountability on each of these consultants with respect to their performance and the impact they're having. And where we see opportunities to work with people to help them have an impact in the marketplace, that's our first and highest priority. But in those instances where it makes sense for us to part ways, we are also doing that.

Okay. Thank you for the fulsome answer. I'm just curious from your customer what your -- customers what you're hearing from them, particularly in North America. Are North American customers shifting more towards revenue growth than top-line projects as compared to the cost-cutting projects of the years directly following the recession? Is there anything visible in your confirmations that you could use to characterize what kind of broad themes there are among your customers?

It's an interesting question. My own observation, both from being in front of clients but also obviously close to our folks, is I'd say it's a real balance between revenue growth and increased productivity. I think that's the insight you're looking for. It's a real balance between those two. And where talent comes out is that the world is just a more volatile, more unpredictable, more complex playing field. And so the demands on leadership to effect that growth and to do it in a productive way only increase. And therein is the broader opportunity as we see it.

So I wouldn't say it's driven because they are looking for revenue growth versus productivity. I would say that there's a keen focus on both obviously technology comes into play here whether you're in specifically the technology business or in any business, which is every business, to which technology applies. That continues to be a very big theme.

Right, okay. And then one last question for me and I will get back in the queue. How do you feel the firm is positioned from an intellectual property standpoint and assessment standpoint? You cited a couple of tools that were recently developed internally. Is there much to do in terms of additions? And then maybe if you could comment about whether the bolstering of the IP can be done effectively through CapEx and internal development and hiring versus acquisitions. Thanks.

Yes, so let me start, and then Rich will add a comment here. In general, the Leadership Signature assessment tool that we developed in 2014 has been embraced by our consultants and mostly by our clients. That's going to continue. We can see it in the marketplace, and we can see that we're going to have to and want to create, if you will, Leadership Signature not only 1.0 but 2.0 and beyond. So from an IP point of view around that assessment tool, it is going to increase.

The same thing around culture. Rich described it. Culture conversations with our clients are expanding and deepening, not the opposite. So making sure we are current with that IP is in part what Rich is speaking to when we talk about our plan for 2015, our investment in Senn Delaney, both with respect to people but also making sure that IP continues to be edgy so that we're giving our clients our best advice. So by no means are we done.

I would say that I think it's hard to imagine we're ever going to be at a point where we won't have to invest in IP to deliver value-added leadership solutions to our clients. Whether that be in search, whether that be in leadership advisory or whether that be in culture shaping. Rich, what would you --

Yes, I guess the only thing I'd add is that as we invest in IP and think about that going forward, we would want to do it from the standpoint of certainly looking at platforms. And they don't always have to be large investments, but they have to be formidable investments because it's hard to do IP or platform-related investments one consultant at a time. That just isn't going to scale the business the way we need to do it. So we've made sure that we have enough -- we have ample firepower and certainly a strong-enough balance sheet or financial position to do what we need to do should the opportunity arise.

Yes, I would just say -- I may have mentioned this in a previous earnings call -- Leadership Signature is not only an assessment tool that we see working in the marketplace, but it is also a very important way for the firm to work together across search, across leadership advisory and a cross Culture Shaping to come up with a solution in-house. So part of your question is how much can you do this on our own and how much do we have to go outside. And that's an example where we certainly are aware of the platforms that are out there. But our judgment was let's build it ourselves and we will continue to do that where we see that kind of opportunity.

Thank you very much.

Kevin Steinke, Barrington Research.

Just wanted to follow up a little bit on the Americas. You saw the revenue growth rate improve there in the fourth quarter relative to where it was in the first nine months and also revenue was actually up sequentially despite the typical holiday impact. So any particular momentum or trends you're seeing in the business within America's that led to that?

Yes, good morning, Kevin. This is Rich. The Americas finished the year stronger than the balance of the regions, and certainly it started off 2015 as the strongest of our regions. So I think the best business overall climate -- and I think this matches would you're seeing in the global economy, candidly, of what's happening right now is that the business is healthier and stronger in the Americas region than it is elsewhere. So we're encouraged by that definitely because it's our largest regions, and I think we're very well positioned there.

And we'd still like to continue to invest and make that region bigger as well. And that would be warranted given the level of opportunity that's out there. We haven't quite seen the same momentum in Americas as we have in the other regions so far. Again, I think what's influencing Europe besides volatile currency rates which impacts which can impact economic activity is also the fact that you've just got the macro environment that's causing people to just be a little bit more cautious given what's happened.

As we've said many times, at least for the near-term, what happens in the UK, France and Germany will drive our European operations. Certainly we've seen some spotty issues relative to the political geopolitical as well as the overall climate that has nothing to do with our business impact those regions a little bit right now. So we're watching it very closely. In Asia-Pac, while the growth rate hasn't been as strong and robust as many people would have liked, it's more steady. Fees are slightly lower, but once we work out a few of these consultant issues we referenced earlier, I think we're going to be better positioned in Asia-Pac.

Okay, that's helpful. Thanks for touching on all the regions there. Just following up on that, encouraging that you expect similar constant currency revenue growth in the first quarter as you saw in the fourth quarter, although it looks like on the one slide, that confirmation trends in January and February were flat to down slightly. So does that imply you're seeing higher revenue per search coming through, or do you expect continued strength in culture shaping?

I think it reflects exactly what I just said, which is the mix of where the confirmations are. Remember that in our healthiest region we have the highest revenue and fee per search and engagement. It's also where -- Americas is where we participate in great detail in a much bigger way in culture shaping as well. So I think the large majority of our business is still in a very healthy environment right now. So I think that's part of what reflects that.

Okay, perfect. Thanks for taking my questions.

No problem.

We have no further questions over the funds at this time.

Okay. Thank you all again for joining us this morning, and we'll talk to you in a couple of months.

Thank you.

This concludes today's conference. We thank you for your participation.