Heidrick & Struggles International Inc (HSII) 2015 Q1 法說會逐字稿

Good morning. This is Heidrick & Struggles' first-quarter 2015 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' 2015 first-quarter 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 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 slide 20 in 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 shown in the bottom right-hand corner of each slide. And now, Tracy, I'll turn the call over to you.

Thanks, Julie, and good morning, everyone.

As you have seen from our press release, first-quarter results were driven by solid performance in the Americas and Asia-Pacific regions in our executive search business, as well as from our culture shaping segment. Increases in net revenue were the primary driver for the improvements in operating income in each of these segments.

Another highlight of the first quarter, continuing a trend from last year, is that we continue to grow our consultant base. As a result of hiring and promotions, we ended the quarter with 323 executive search and leadership consultants, an increase of 20, or about 7%, compared to a year ago. All of the new hires in the first quarter were experienced search professionals, many of whom were highlighted in a separate press release issued earlier this morning. It's worth mentioning that there were only three consultant departures in the first quarter, compared to 11 in last year's first quarter.

We are encouraged by the quality and development of our recently hired and promoted consultants. While many are not yet at full productivity levels, we believe they will grow increasingly successful on our platform. Similar to our clients, nothing is more important to the firm's long-term success than attracting, developing, and retaining top talent. We will continue to invest in the development, support, and engagement of our people in order to be the employer of choice for highly motivated professionals in our industry. I'll have more to say about our initiatives after Rich gives you a review of our results in the quarter.

Thanks, Tracy, and good morning, everyone. I'll give you an overview of the first-quarter results, and I'll begin on slide 2.

Consolidated net revenue in the first quarter of $115 million was up 4%, or $4 million, compared to last year's first quarter. Exchange rates adversely impacted our first-quarter results in every region as well as culture shaping, but especially in Europe and Asia-Pacific. Excluding the impact of currency, consolidated net revenue would have increased 8% year over year, or approximately $9 million.

Looking at slide 3, executive search and leadership consulting revenue grew about 2% year over year, or approximately $2 million. And revenue from culture shaping increased 25%, or almost $2 million on higher volumes of client work. I want to remind you that because of the size of the culture shaping segment and the timing of project initiations, we will likely continue to see variability in quarterly results from this business segment over time.

Referring to slides 4 through 9, in the executive search and leadership consulting segment, we ended the first quarter with 323 consultants. The Americas region was the key driver of the first-quarter year-over-year revenue growth, up almost $7 million, or 12%. Asia-Pacific also had a good quarter, up $2 million, or 10%. Excluding the impact of currency, net revenue in Asia-Pacific grew over $3 million, or about 17%. Revenue in Europe declined $6.6 million, or 25%. Excluding the impact of currency, revenue declined 14%. The year-over-year decline reflects a combination of lower fourth-quarter confirmations and backlog going into the first quarter as well as slower-than-expected starts in 2015.

Looking at slides 10 through 14, the financial services and industrial practices were the drivers of year-over-year revenue growth globally. Consultant productivity was essentially flat. Specific to executive search, search confirmations in the first quarter were up 2% year over year, and the average revenue per search was up slightly. Because of the quarter-to-quarter variability, we encourage you to look at the trailing 12-month trends for productivity and average revenue per search.

Looking at slides 15 and 16, 2014 salaries and employee benefits expensed increased $2.6 million, or about 3%, to $78.5 million and represented 68% of net revenue. Variable compensation increased $2 million mostly as a result of the higher net revenue, while fixed compensation expense increased $600,000.

Turning to slide 17, general and administrative expenses declined 13%, or $4.4 million, and represented 26% of net revenue. The decline reflects lower professional services fees, lower unbillable travel and the absence of a state franchise tax matter which we had in last year's first quarter. It is worth noting that in the second quarter, we are holding regional operating meetings for our consultants for which we have budgeted approximately $2 million of expense in the quarter.

Now on slides 18 and 19, adjusted EBITDA in the first quarter improved to $12.3 million compared to $6 million in the comparable quarter of last year. And the adjusted EBITDA margin increased to 10.7% compared to 5.4%. Because of the quarterly variability in our business, these two slides don't show the improvement in profitability as well as indicated on slides 21 and 22. When you look at the trailing 12 months of adjusted EBITDA and adjusted EBITDA margin, you can clearly see the improvements that we've achieved.

Operating income in the first quarter improved to $6.7 million, and the operating margin increased to 5.8%. The first-quarter year-over-year improvements in adjusted EBITDA and operating income mostly reflect higher net revenue and lower general and administrative expenses, which were partially offset by an increase in salaries and employee benefits.

Turning to slides 25 and 26, net income in the first quarter of $3.4 million and diluted earnings per share of $0.18 reflect an effective tax rate of 47.5% in the quarter and a full-year projected tax rate of approximately 41%. The first-quarter and annual rates are based on the expected mix of net income for the year. We expect to utilize a portion of our net operating loss carry-forwards, which accounts for some of the improvement in our effective tax rate.

Now referring to slide 27, those of you who follow us know that our cash position builds throughout the year as we accrue bonuses which are paid out in the following year. In the first quarter, we paid out approximately $104 million to employees. Approximately $9 million relates to the payment of bonuses that were deferred in years 2011 through 2013. The balance of $95 million was the variable compensation related specifically to 2014 performance. Reflecting those payments, cash and cash equivalents at March 31, 2015 was $107.6 million, or $79.6 million net of debt. Cash used in operating activities was $87.8 million compared to $74.9 million in last year's first quarter. We also expect to pay approximately $9 million in the second quarter related to 2014 bonuses, primarily due to payroll taxes on those bonus payments.

Our cash position is strong, and we are in a great position to continue to invest in and grow our business. In addition to financing activities in 2015, it's worth reminding you that we are currently planning for a higher-than-average capital expenditures of approximately $11 million this year for office build-outs in 5 of our U.S. offices. In three of these instances, including our headquarters office in Chicago, we had the opportunity to reduce our rentable square footage by building out a more efficient floor plan, which should assist us in lowering our annual lease expense run rate.

Looking forward to the second quarter, our executive search backlog is shown on slide 28, and monthly confirmation trends are shown on slide 29. Other factors in which we based our forecast include anticipated fees, the expectations for our culture shaping services, the number of consultants, and the current economic climate. As we experienced in the previous two quarters, we are expecting more volatility from foreign currency exchange rates, and this could lead to an adverse impact in the year-over-year comparisons of net revenue. We are forecasting second-quarter net revenue of between $127 million and $137 million. Reported net revenue was $136 million in last year's second quarter. Slide 31 shows that on a constant currency basis, last year's second quarter net revenue would be $128 million, which we believe is a more relevant comparison for our guidance.

With that, I'll turn the call back over to you, Tracy.

Thanks, Rich. We continue to move this Company forward, and first-quarter results reflect progress. Of course, we know there is still much room for improvement.

Specifically, let me speak to our performance in Europe. To be candid, we expected a better start to 2015. Europe is important to our global footprint, and I am committed to building a stronger, more consistent strategic and commercial presence in this region and restoring its profitability. As we have been rebuilding our consultant base, we have not yet established the consistent depth of relationships and presence among our European clients as we would like and are capable of achieving.

There are two actions we are taking in order to improve performance. First, we are investing in our current talent as well as focusing on attracting new, experienced talent. Second, we are taking more proactive initiatives to connect and support Europe with our global franchise to bring the best of our firm's capabilities to every client.

Overall, and as I mentioned earlier, we've made great strides building our consultant base throughout the last year. We have strengthened our capabilities across our functional and industry practices with the addition of experienced consultants globally. For example, in just the last six weeks we hired 4 partners in our healthcare and life sciences practice, including the new global head.

As important as hiring is to growing this firm, it is even more important to provide an environment that fosters a spirit of collaboration, learning, and client service in order for consultants to become increasingly successful and productive on our platform. Ensuring this happens is a critical factor in our near-term success.

In this regard, we are holding regional meetings this quarter in lieu of a worldwide partners' meeting. The first, later this week in Chicago, brings together the Americas team. It will focus on building on our momentum and sharing best practices to ensure we are delivering at a high level for our clients in every sector. The value of bringing our people together in these meetings goes well beyond the time and expense commitment. In my brief time here, I have felt the power of connectivity that comes from the work we do together. It is some of the best of our culture.

Every day I find energy in thinking about what Heidrick is and what it can be from three perspectives: our people, our clients, and our shareholders. Our business opportunity is becoming more vast and consequential than ever before, in large part due to a world that is more unpredictable and more complex and therefore places an increased premium on leadership.

We will continue to invest in the best people and in our capabilities. I am equally committed to increasing the quality and impact of the client work we do. Our clients are moving fast, and we must be with them strategically, across the globe, at the pace they demand. They will measure us by the value of our service, and this, in turn, will determine our success.

While the steps and progress we have shared with you today continue to move us in the right direction, we have much to do to capture the full value of the opportunity before us. I feel and share the urgency and importance of this opportunity, and it fuels my passion to bring out the best of what Heidrick & Struggles offers, which will lead to more consistent and impactful growth.

Let me pause there. Rich and I are now happy to answer any questions that you have.

(Operator Instructions) Tim McHugh, William Blair.

It's Stephen Sheldon in for Tim. First, on the headcount. I think you said this, but just wanted to confirm that the 11 hires that you announced today, those are already included in 1Q and in headcount. Is that correct?

About half of them are. About half of them started after quarter, right.

Okay, okay. And then I think you gave the three departures. How many promotions did you have in the first quarter?

About a dozen promotions in the first quarter.

Okay, great. And then it looks like you got quite a bit of leverage on G&A expenses from the lower professional fees and travel-related expenses among other things. How sustainable do you view that leverage? And just in a general sense, how should we think about full-year G&A expenses compared to last year, and could they actually be down some from levels in 2014?

Sure. A couple things. And thanks for all the questions, Stephen. As we have said many times, we were constantly and diligently going after G&A every time we can, particularly non-billable G&A, both in the operating -- in the field as well as at the corporate level.

Having said that, what you saw in the first quarter was better for couple of reasons. As I indicated in my remarks, we had some one-time items in last year's number which made us look a lot better on a year-over-year basis. As far as a run rate perspective, the $30 million this quarter is pretty reflective of the run rate. We will have some bumps along the way. For example in the second quarter, we have indicated that were going to have the partner regional meetings across our regions, which will bump up our non-billable travel to about $2 million of expense between meeting expense and travel. That will come at different time than our partner meeting last year, which was largely in the third quarter. So you'll see some quarter-to-quarter variability.

But I'm quite confident that I think we can hold the G&A platform relatively low growth, if any, compared to the prior year. We have said many times that the platform itself can handle a lot more revenue, so it's very leverageable. And as we continue to build our consultant base and we drive consultant productivity and client productivity across the regions and the globe, there is no -- we shouldn't see a big increase in G&A expense.

Okay, great. Thank you.

Kevin Steinke, Barrington Research.

Thanks for the comments on Europe. And I know you had a slower than expected start there, and it sounds like there are some internal things you want to fix. But could you attribute any of that to the macro environment as well?

Kevin, it's Tracy. There's a mix here. There's certainly a macro environment component, but what you are hearing in my remarks is that we don't want to put our performance solely on the back of what's happening externally. There are some things that we have to do, and that's really what you're hearing in my comments. We are certainly aware of the macro factors, but we are also aware that there's momentum. There's positive momentum in Europe right now. There is a -- overall, Europe right now is experiencing the benefits of the lower price of energy, a lower currency, and lower interest rates. And so there's a lot of positive momentum that's in that economy right now that we don't want to dismiss. And so, yes, there is macroeconomic factors as all that comes up to speed, but there's some internal issues that we have to work through, and that's what I'm referencing.

Okay. Thanks for that comment. And then Asia-Pacific conversely had a nice quarter relative to the last several quarters in terms of growth and margins. And also you added some consultants there. So any commentary on what's going on in Asia and the sustainability of the trend there?

Well, in Asia we had a healthier turnover in 2014 for a number of reasons, not the least of which was some very targeted actions that we had to take with respect to consultants. So there's enhanced ability coming into 2015 with the team that we have on the ground and the connections they are making both within the region but also across the globe. And they -- the positive momentum in Asia is being felt right now.

Okay, good. And Rich, you made a comment about -- as you have talked about many times before, typical variability in culture shaping due to product timing. Is that -- do you see any specific variability going into the second quarter here, or is that just more of a general comment?

Well, I think it's a general comment because we've indicated many times that the general overall size in the margin and profitability of this business, and that hasn't changed. Because of the scale of the business with an annual turnover running between $30 million and $35 million, it will come -- it very much is at the direction of the client because much of the work is directly client related. And for example, you can plan to start a project on Tuesday, and the client says, you know what, I need to do it three weeks from now. And that could affect revenue recognition and all kinds of issues like that. So we're still very comfortable with the size, scale, and direction of the business, but trying to get into quarter predictability of the revenue stream and that's what we're just indicating.

So no real change in the direction or profitability of the business. It's just we want to make sure that you will not only see smoothness in the revenue trends because of revenue recognition.

It's also worth looking at that business on the trailing 12 months (multiple speakers) variability.

Okay, perfect. And are you adding to culture shaping and leadership consulting now in terms of headcount or any success there in addition to search consultants?

We certainly want to grow that business. We have been working with the leadership team of culture shaping. They are in the last year of the deal earn-out. As you can imagine, they are very focused on making sure they deliver the business plan relative to the underwritten acquisition. At the same time, we've committed and have planned for additional investment. That's a business that we can still take father across both our platform and across our geographies.

It's a very hot topic among our clients. Tracy has mentioned many times the work we've done on leadership signature and executive search profile or culture profile that is integrated now into our search business. So there's lots of opportunities to grow that business.

I would just say in addition to the culture shaping, which Rich described, on the leadership consulting -- the other part of your question -- where we engage with clients on leadership consulting assignments, we do some of the very best work that I see done here at Heidrick. The focus that we have to take that work and that will create much more scale, and that is going to require investment on our part in leadership consulting. But, again, much of the work that we do in leadership consulting differentiates Heidrick with our client, adds value to our client as a result, and is some of the very best that I've seen at the front.

Okay, great. And you've highlighted the adds that you made in healthcare and life sciences, and I believe that's an area you've been wanting to beef up a little bit. So how do you feel about how that practice area stands now? And what other industry areas might you target for hiring?

So the reason that we highlighted it is simply because we have spoken about it in past calls in the past year as being an area where we knew we had to invest. And we had to find the right team. There have been a number of opportunities in the marketplace for us to now attract that right team. We feel very good about the people who we have -- who recently joined Heidrick. I've been with a number of them in the last couple of weeks just as they're coming on. They are fitting in seamlessly in the organization, and the impact they are having both with the existing healthcare and life sciences team is positive. And their reach (inaudible) clients is positive. So all that, we have very constructive and positive thoughts.

The other area that we talk about needing more investment is industrials. We have taken on more folks. We will need to take on more, and that's globally for similar reasons. And, again, we've got a market out there which, as my comments referenced, the more complex the world, the more volatile the world, the more predictable, the more opportunity there is for us to have a conversation regarding talent and leadership talent in particular. And the industrial slice of that in the world economy is just huge. So more investment there to come.

Okay, great. And one last question for me, Rich. Just any thoughts on the tax rate and the sustainability of this lower tax rate, not only in 2015 but as we think beyond this year?

Right. That's a great question. As I indicated in my remarks, currently we are predicting that the tax rate would finish the year somewhere in the low 40s. If that sustains itself, it allows us to use some of our tax loss carry-forwards more efficiently and bring some things off the balance sheet, which we have said many times is a great way for us to increase our cash flow and our profitability. It's heavily dependent obviously on some of the planned increases and profitability in some of our European countries as well as in Asia. Countries like Germany, for example, where we are off to a slower start but we do expect to recover. So my expectation is that I think we will have a more normalized tax rate for the year currently than we've seen in the last couple.

Okay. Thank you.

(Operator Instructions) Tobey Sommer, SunTrust.

I wanted to ask some -- get your perspective on the hiring environment for internal consultants. Just to kind of -- in light of your follow-on press release, bringing in a pretty decent-sized cadre in recent months of seasoned folks, what are your prospects and plans to continue hiring for the balance of the year? Thanks.

So Tobey (multiple speakers) -- sorry. Talent and our people, as we described, is our highest priority. And we are actively out there in the market across all the practices and across regions talking with talent in the marketplace broadly defined that we think we can attract to Heidrick and add value to our client relationships.

We've been aggressive out of the blocks in 2015. And the pace that we are taking on talent is not necessarily one that we are looking to project out for four more quarters or three more quarters. But we are going to assume and take on talent as we see people who will fit with this organization. There's more that we will do in healthcare and life sciences. There's more that we will do in industrials. There's more that we will do in Europe, and this speaks to the comment that I made about where Europe is performing out of the blocks here, not at the level that we were looking for. We will do the same in Asia. So we've got our priorities, but I would say the pace here is one that we feel great about, but I wouldn't necessarily multiply it by four.

Okay. That makes sense. I've got another question about margins, which were pretty strong, I think, in the quarter. And I understand you've got your meeting in 2Q. But is there anything about 3Q and 4Q of note on the cost side that would prevent the Company from kind of returning back to this kind of level of profitability in the back half of the year?

Well, a couple things. Number one -- keep in mind that the nature of our business, depending upon how the revenue goes, drives some of the accruals on the variable compensation as well. So the biggest needle that will move is variable compensation relative to the revenue growth. Because if you think about our business model, we basically absorb the impact about fixed salaries in the early part of the year and variable compensation in the last part of the year. So on the expense line -- and that's the major part of our expense line -- that's probably the biggest variability.

I've said many times, Tobey, and we talked about this, again, it's a constant diligence effort relative to making sure that we hold the line on G&A. And our people are pretty disciplined across the business, and I think we've improved that discipline. And that's what shows up, and I think that indicated it in my remarks about the trailing 12 months if you look at marginal profitability and EBITDA direction over the last few years.

We have deliberately sought to improve our profitability and get it back up to competitive levels for a number of reasons, including the investment in hiring that Tracy just touched on.

So things that could impact our profitability in the short term would be, A, the pace of revenue growth on the positive side. And on the expense side and investment side, depending upon how aggressive we are on the hiring front and in terms of making investments, and some of that costs will be spread over multiple years if there's upfront expense. So if the revenue growth is there, I think we have a good chance of hanging on to the profitability.

Tobey, one quick note to my earlier comment, by the way, is on leadership consulting and culture shaping. And this aligns with what we said earlier: we will invest in talent in those segments as well.

Okay. Thank you. Just two follows-ups, if I could, and then I'll get back in the queue. One is of the new hiring in some of the seasoned people, are they subject to gardening leave, or are they able to contribute relatively quickly to the P&L?

And then, Tracy, I was curious on your perspective if you are seeing corporations and companies shift to -- from the cost-cutting programs in focus of the years after the recession towards more revenue growth? And I guess what I associate with that kind of shift would be entering new markets and launching new products and that kind of thing. Thanks.

To your first question on (inaudible), it's a mix. There are some people that we are hiring who need to pause before they can come. There are others who can contribute almost right away. So we are seeing a blend on that.

In terms of revenue versus us management, I would say certainly in the United States you feel that there is a keen interest in investing on the part of the corporates and a keen interest in furthering their growth in their top-line growth in particular. I would say that as you go around the world there is, as my comments earlier referenced, with a weaker currency in Europe and therefore increased competitiveness with a reduction in their energy costs, and then just their interest rate decline. There is -- and you can see it in what's happening in the broader financial markets, there is a positive view about those trend lines. And so we see corporates trying take advantage of that.

And then I would say in Asia, you have -- obviously, you have what's happening to the growth rate in China. And while that has come down, people believe that the quality of that growth is strong. And in general, I would say there is constructive optimism out there in terms of the C suites and the boards we are engaging in. These corporates, they definitely want to grow, and they feel that there's a constructive environment right now.

Thank you very much.

(Operator Instructions) And it appears there are no further questions, so would you like to make any closing remarks?

None more than thank you, everyone, for your time.

Thank you very much. That will conclude our conference for today. I would like to thank everyone for your participation, and have a great afternoon.