Heidrick & Struggles International Inc (HSII) 2015 Q3 法說會逐字稿

Good morning and welcome to the Heidrick & Struggles third-quarter 2015 conference call. Today's call is being recorded. It may not be reproduced or retransmitted without the Company's consent. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (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 thanks for participating in Heidrick & Struggles third-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 some supporting slides that are available on our website Heidrick.com and we encourage you to follow along or print them.

As always we advise you the 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. Reconciliation between GAAP and non-GAAP financial measures can be found in the last page of our press release and on slide 21 of our supporting slides.

Throughout the course of our remarks today, we will be making some forward looking statement and ask that you please refer to the safe harbor language contained in our news release and on slide one of our presentation. The slide numbers that we will be referring to are shown in the bottom right-hand corner of the slide. Tracy will cover the first 12 slides. And Tracy, I will turn it over to you.

Thanks, Julie, and good morning. I am pleased with our third-quarter results. They reflect continued solid progress to strengthen and grow our business. Compared to the same period in 2014, consolidated net revenue increased 10% to $138 million. Similar to the second quarter, currency exchange rate adversely impacted our year-over-year comparisons, especially in Europe and Asia.

Our executive search and leadership consulting business had a solid quarter. Excluding the impact of currency, every region achieved year-over-year and sequential revenue growth. The Americas region was the driver of the growth, up 20% as reported or 22% on a constant currency basis. Europe reported a 5% year-over-year decline, but excluding the impact of currency revenue increased almost 8%. Asia-Pacific reported a 7% increase in revenue and was up almost 19% in constant currency. We ended the quarter with 334 search and leadership consulting consultants. The Americas region has steadily grown its consultant base over the last year, adding mostly experienced consultants. Additionally, many of our seasoned consultants in this region are having the best years ever. The combination has driven year-to-date revenue growth of 13% in the Americas.

In Asia, we had a net 10 consultants in the first nine months and productivity has improved, resulting in year-to-date revenue growth in constant currency of almost 14%. By contrast, in Europe our headcount this year was flat. We are still very focused on targeted hiring initiatives in these regions to grow our talent base.

From a practice perspective, three stand out. The healthcare and life sciences, global technology and services, and financial services practices were the primary drivers of growth in third quarter with billings up 89%, 43% and 9% respectively. The improvement in healthcare and life sciences is not a surprise. Our hiring in this practice over the last year has been very deliberate, targeted, and that increasing our market share in the sector that will continue to grow in importance globally. Year-to-date billings in healthcare and life sciences are up 41%.

Our culture shaping segment, Sam Delaney, reported a decline in revenue of $1 million compared to last year's third quarter, which was a record revenue quarter for this business. In this year's second quarter, Sam Delaney booked a record number of new clients. What you are seeing in the variability of these results is largely a function of the timing of project executions. We are expecting a stronger fourth quarter for culture shaping.

As we said in the past, our operational infrastructure can support higher revenue growth. With this leverage, more falls to the bottom line as revenue improves. This quarter was a good example of net leverage. Adjusted EBITDA and EBITDA margin improved, operating income and operating margin increased and net income and earnings per share were higher.

I will have more to say after Rich gives you a deeper review of our results for the quarter.

Thanks Tracy, and good morning, everyone. I am going to begin my comments on the third quarter results on slide 13 and cover some of our other key financial and operational metrics.

All the revenue drivers work together to improve the results in the executive search leadership consulting business. Consultant productivity improved $1.6 million even with a 7% year-over-year increase in headcount. On a trailing 12-month basis, consultant productivity has now been at $1.5 million for six quarters in a row, a first since 2008. As shown on slide 14, executive search confirmations in the third quarter were up 13% year over year.

Turning to slide 15, reported average revenue per search of $121.2 million was down slightly compared to the last year's third quarter. When adjusted for constant currency, the revenue per search was $127.8 million. The trailing 12-month trends would also look much better if not for the impact of currency fluctuations.

Turning to slide 16 and 17, 2014 salaries and employee benefits expense increased approximately $12 million or about 14% to $96 million, and represents 69% of net revenue. With the improvement in revenue this quarter, more consultants became bonus-eligible, explaining most of the $8 million increase in variable compensation. Fixed compensation expense, up about $4 million, reflects an increase in the cost associated with the hiring we did over the last year especially in the Americas, partially offset by the impact of currency in other regions.

As with many of the financial and operational metrics, it is often quarter-to-quarter variability in salary and employee benefits expense, based on revenue and Company performance in general. We encourage you to look at the year-to-date results as well.

Turn to slide 18. General and administrative expenses declined about 8% or approximately $2 million, to just under $30 million for the quarter and represented 21.5% of net revenue. The decline reflects the impact of foreign currency exchange rate fluctuations, as well as lower expenses in a number of areas across the Company.

Now, I will refer to slide 19 through 25.

Tracy mentioned earlier the improvement in revenue flow-through to our operating earnings. Adjusted EBITDA in the third quarter improved to $18 million compared to $15 million in the comparable quarter of last year. The adjusted EBITDA margin was 13.1% compared to 11.9%.

Operating income in the third quarter improved to $13 million and the operating margin was 9.3%, the highest operating margin we've achieved since the fourth quarter of 2009. Net income in the third quarter of $7.5 million and diluted earnings per share of $0.40 reflect an effective tax rate of 32.7% in the quarter and a full-year projected tax rate of approximately 42%.

Both the third quarter and annual rates are based on the affected mix of pretax income for the year. With the improvement in the third-quarter results, we were able to use some of our net operating loss carryforwards and had smaller losses in countries with valuation allowances.

Now referring to slide 26, cash and cash equivalents at September 30 was $129 million compared to $159.5 million at September 30 of 2014. The year-over-year decrease reflects the increase in CapEx related to new office buildouts.

Also, on September 30, we repaid in full the outstanding amount of $26.5 million on our term loan facility. You will recall that the debt was established when we acquired Senn Delaney nearly three years ago. I feel extremely comfortable with retiring the debt.

Our senior unsecured revolving credit facilities that we've established of $100 million with an optional increase of up to $150 million, combined with our strong balance sheet and capital structure, give us a great deal of financial flexibility to grow and invest in our business and meet all of our obligations.

After the close of the third quarter on October 1, we acquired Co Company, a London-based advisory boutique specializing in accelerating organizational performance. We paid an initial all-cash consideration of $10.4 million.

Looking forward to the third quarter, our executive search backlog is shown on slide 27 and monthly confirmation trends are shown on slide 28. Other factors on which we base our forecast include anticipated fees, the expectations for our leadership consulting assignments and culture-shaping services, the number of consultants and their productivity, the seasonality of the business and the current economic climate.

As we experienced in the last several quarters, we continue to expect more volatility from foreign currency exchange rates and this could lead to an adverse impact in the year-over-year comparison of net revenue.

We are currently forecasting fourth-quarter net revenue of between $128 million and $138 million. Reported net revenue was $121.3 million in last year's fourth quarter. Slide 30 shows that on a constant currency basis, last year's fourth quarter net revenue would be $116.6 million, which we believe is the more relevant comparison against our guidance forecast.

With that, I will turn the call back over to Tracy.

Thanks, Rich. Our results this quarter are another good step in the right direction. Yet I know we are capable of even more.

I said last quarter we have four priorities that drive shareholder value. Namely, our talent, number two, our clients, three, our diversified offering of search, leadership consulting and culture shaping, and lastly, our operations. Let me quickly review.

First, our talent. We made meaningful progress attracting, developing and retaining the very best talent. In the third quarter we hired 22 consultants, the vast majority of whom were experienced. In the same period 13 consultants left the firm, more than half related to performance management. Our year-to-date total turnover voluntary and involuntary is 8%, which compares to 18% in 2014 and 21% in 2013. Even with the hiring we've completed this year, our productivity was $1.6 million per consultant in third quarter.

Second, our clients. I am encouraged and impressed by the work we are doing in the top of many of the most important organizations around the world. I meet with clients regularly, both current and prospective, and am humbled by the trust they place in our people across search, leadership consulting and culture shaping. The Heidrick brand is strong and growing stronger. I see our distinct solutions resonating in meetings more than ever.

I know that we can win more, and that there is even greater potential to build deeper client relationships as a leadership advisor.

Towards our third priority, our distinctive service offering, we took an important step on October 1 with the acquisition of Co Company. Co Company expands our leadership consulting services and is complementary to our culture-shaping business. I appointed Colin Price, the CEO of Co Company, to lead our leadership consulting practice globally. Colin has spent his career advising senior leaders on key facets of organizational performance as well as building businesses as a leader himself.

Colin's directive is very clear: to grow and scale our leadership consulting business, to increase our impact with clients. The team that Colin brings with him from Co Company, coupled with our own leadership consultant, form a solid foundation on which to build this business.

We continue to make progress on our fourth priority, improving operations. We have built an infrastructure that generates good profit today, but can be leveraged even further as we continue to grow. We see this in our third-quarter results.

We will continue to invest in technology, systems and processes that will help increase the productivity of our consultants, support product development and scale our operations in leadership consulting and culture-shaping to further drive profitability.

By attracting and retaining the best professionals in the business, enhancing our overall client experience with distinctive service offerings and improving operations, we will continue to grow and strengthen our business around the world and provide greater return to our shareholders.

Let me pause there. Rich and I are now happy to take questions.

(Operator Instructions) Kevin McVeigh, Macquarie.

Great job. I want to get a sense, just really nice leverage in the culture-shaping business, any sense of where we think those margins can go? And as you get more leverage out of the model, how should we think about that? And then obviously nice ramp-up in hiring, too. Any sense of how that splits between the search of the LTC business as well would be helpful.

This is Rich. From the standpoint of the culture-shaping, I think a couple things drove profitability. First of all, we've always said that was a pretty strong operating margin business. We are in the final years of the earn-out from the acquisition, so I know the team has been focused on making sure that they deliver the profitability and the deals they have incentives to do so, so I'm sure that has something to do with making sure that we are running a very lean business right now.

Having said that, we are also working with the team to actually invest to grow the business. I actually think that over time we might see a little bit of erosion in that margin by a point or two just from the standpoint of we are going to continue to invest to grow that business. The team has committed to do that. So I still look for that business over time to average probably more between 25% and 30% type of margins as we go forward, and hopefully, and routine signs of this. And Tracy indicated a little bit in the call, while the project implementation tends to be lumpy, the pipeline looks very strong and we think the topline can grow next quarter as well as over the coming year.

On the other businesses, we have said all along as we constructively continue to invest in LC we are going to -- we are extremely pleased with the acquisition of Co Company and with the addition of Colin Price and how we are thinking about the business model going forward. We are going to be much more selectively targeting how we do business, the type of assignments we do, the type of project profitability we are going to bring to those projects.

I think it will actually be a good thing for our consultants. I think we are going to see many of our consultants flourish in this environment and actually do better, and that will be a more profitable business model. That business should be a business that sends off 20%-plus margins and we have not done that historically, so -- because we have not had the scale. So I think we are going to see over time as we continue to (technical difficulty) invest in that business, that be a bigger contributor to the overall pie.

As I mentioned in my remarks, we are not going to hold back in terms of hiring talent. Tracy indicated that talent is a key priority for driving the value of this business. We believe that strongly. We are investing in our people both in the -- heavily in our people, both who are here today as well as those that are joining us. But I think the biggest difference is we have been far more selective in the quality rather than the quantity of the types of people that have joined the firm and we see -- and that has paid off in terms of overall results, as well as integration, as well as better teaming with the clients, and I think that reflects the greater value we've received in the search business as well.

Got it, that's helpful. And then just any thoughts on just what tax rate we should use in the near term as we are thinking about the model in the back half of the year?

I think I indicated in the comments about 42% rate currently projected. As you know, over time, that rate has gone up and down like a yo-yo sometimes. But I think we've seen pretty steady performance. We've seen Europe start to calm down a little bit, which is one of the biggest drivers of volatility of that rate. Asia-Pacific is performing well, so we are seeing good results in areas where there either were valuation allowances or maybe were on the borderline of having established new ones or contribute to existing ones.

So, we've always been a company that has been able to use its carryforwards and its tax credits. We have not lost any in my time here and the team has done an outstanding job of managing that. And more importantly, we've gotten the performance that is the key to that.

So as we build our scale, the good news is that I think that can increase future cash flows and profitability, as well bottom line earnings if we are successful in executing that strategy.

Understood, thanks.

Tim McHugh, William Blair.

Good morning. It's Stephen Sheldon in for Tim. First, really strong performance in healthcare and life sciences; what kind of engagements are you seeing higher demand for there? And is that practice more heavily weighted towards a certain region? I would assume it would be obviously more weighted towards the Americas, but how does that break down regionally?

It's Tracy. Couple thoughts; one is just in general I would say that the healthcare life science business tracks where you are seeing broadly across the firm in terms of the strongest performance in the Americas, and then it goes from there, Europe and Asia. So your trend in healthcare and life sciences is no different than the overall business.

Number two, I think healthcare and life science is a good example of, to me, the overall takeaway from this quarter, which is when you put the right people with our brand in front of clients that have been targeted, good things happen. And we have the benefit of some pretty good tailwinds in general in the economy, particularly in the Americas. That obviously helps.

But healthcare and life sciences, as you know from almost any daily reading of the paper, there's a lot happening in that sector in the United States and globally. And that creates opportunities as well as challenges with respect to leadership, and that is where Heidrick can play a role.

Okay. And then on the G&A leverage, how much of the year-over-year decrease as a percent of revenue is due to foreign exchange rates? And can you give us some more color on what else is driving that decline as a percentage of revenue?

Yes, I think about -- a good rule of thumb as we have been experiencing the foreign currency fluctuations, about half of the delta usually is from foreign currency. I think we are pretty close on that metric. I don't think it's as much an absolute decrease as really a hold in terms of kind of our overall G&A.

We have talked to you before about certain timing of different expenses like partner meetings, etc., that marry up second quarter to third quarter, etc. At the end of the day, our team -- and I've been very fortunate in my time here to have the cooperation of our people both in the field at corporate that do a very good job of treating the money like their own. And I'm very proud of the work they do.

Generally, we try and make sure that when we incur expenses on behalf of the clients and the work that we do, we are very conscious at corporate that we want to drive productivity and make sure that our spend is driving things that will help be more productive over time. That is not always easy. We are a public company. We have compliance issues. We have other issues, day-to-day operations.

But for the most part, we've put together a great group of people who understand how to get the most out of every dollar. And as a result, we've been kind of holding constant the SG&A line around the $30 million mark, give or take, and unless we get an anomaly of a high professional services quarter or the meeting expense.

So, there is nothing magical to it. I am very pleased that in a strong quarter like this we did not see it rise. That confirms what we believed all along, is that the platform we have can hold a bigger base of consultants and revenue, as well as contributions from our other businesses. And I think that's a very good sign, because I think as we continue to invest to grow the revenue stream, the net incremental change in expense will be less and we will achieve greater scale and profitability.

Okay, great. Then, on the Senn Delaney commentary for a stronger fourth quarter, are you expecting that on a sequential basis or is that more on a year-over-year basis?

I think on a sequential basis. I think we should see -- we are expecting to see the quarter be a little -- probably the better quarter of the year.

Okay. And then I guess one more if I could, just talking about the -- you talked about you are still wanting to hire some more in Europe. Is it generally getting harder to find talent in Europe than I guess it has been for the last few years?

I would not say it is harder. I would say that as we develop more momentum globally as a firm, and as people see where we are working with clients that we had not before, we are working at a different level within clients that we had not before, and they recognize that there is a teaming that is going on around the world to make that happen. So the client may be domiciled in Europe and it may be more coordination within Europe to tackle that particular client or coordination between Europe and another region to address the client. As we see more of those, it becomes at the margin easier.

But as we said before, it indicates globally there is a broader war for talent out there and we certainly participate in that. But at the margin, I would say a bit easier as Heidrick performs in the marketplace. So our story has more confidence in the marketplace with the talent that is looking at us.

Okay, great, thank you.

(Operator Instructions) Toby Sommer, SunTrust.

Just curious, at this point in the cycle, are you starting to see executive compensation inflation? I saw the fees ticked up, but I know sometimes that can be a mix issue as opposed to just apples to apples inflation.

I would be careful on calling any trend here. I would go back to my earlier comment with respect to the broader war for talent out there in the world. Finding people who can drive profitable growth in the world that we are in right now certainly has a premium on it. So, when those executives are identified and recruited and retained, there is a very keen interest in making sure they are paid in a way that compensates for that.

So, is that a formal trend yet? I would probably hesitate a bit in saying that. But certainly it is consistent with the broader war for talent that we are seeing generally in the economy, particularly in the United States.

Thanks. Asked differently, did upticks occur more regularly where the compensation to fill the job was a little bit higher than originally scoped out?

No, we went through a period last year and somewhat this year where we did see very healthy trends and upticks. It kind of leveled off a bit. They are still an important part of the overall revenue contribution. Sometimes, that can be structural in terms of the deal versus necessarily tied to the compensation of the individual as well.

So I'm standing with Tracy on this one. It's hard to call it a trend. It certainly is the bigger factor of our life today.

What kind of contribution would the acquisition make to the fourth quarter?

We are not going to project individual businesses. I think we will get a slight contribution in revenue to fourth quarter, but not overly material to the business. And then as we think through next year, we are going through our planning cycle now, we will probably have more to say about the overall leadership consulting business and where we expect it to go.

Could you talk about what the size of the business was at trailing 12 months or something like that?

Not at this time. And frankly, and the reason I'm kind of avoiding that, as if you think through what we are going to do with the business, the history is less relevant to the future, because candidly, this is much more about building the right type of business than it is about what is the business we acquired.

It's a boutique with three or four partners. It's a very good team that comes with Colin. They do very good work.

But we are really in the process right now of integrating our business and our pure leadership consulting business in with him. And it will really be kind of the new beginning I think for us.

I think another way to say it is we are acquiring talent and a culture here that is focused on working at the top, that is very in sync with the leadership consultant that we have. And as Rich described, we think the way to think about this is what's going to happen coming down the road here as we integrate Colin and his team at Co Company with our leadership consultants.

Okay, just two last questions for me, one on the Senn Delaney. Is the business model there -- does it have a dedicated sales force? Or is some of the quarter-to-quarter variation a function of some individuals selling new services and then kind of going back to execute on those projects? Or is there a standalone sales force that can kind of drive growth in a perhaps more linear fashion?

There are dedicated consultants inside Senn Delaney, specific to the culture-shaping process. What we have begun to see this year with increased momentum is the opportunity where the culture-shaping consultants and the search consultants and the leadership consulting folks are working together more closely. The whole thesis of the combination of the partnership with Sam Delaney was to layer that into our broader leadership offering and we started see that momentum build in 2015.

So, to answer your question, they have their own consultant force. As Rich described, that is a team that we are investing in and adding to because of the demand we see out there for culture- shaping, about the coordination and collaboration between the culture-shaping and the search consultants has been enhanced this year.

Perfect. Two last questions for me. Do you have any comments about what the tax rate might look like going forward beyond the fourth quarter? Even a range? And then, from a mixed standpoint strategically, how do you view the business now, executive search versus other consulting services and what might that mix look like over the medium term? Thanks.

Well, let me talk about the tax rate first. I would love to see the tax rate hover around that 40%, so just above 40% line for the near term; until we achieve greater scale and better growth in our international markets we won't see it drop any lower than that in the foreseeable future. I just would like it to be more constant. I'm encouraged by what we've seen this year.

I will make a slight comment about the mix and I will certainly turn it over to Tracy. One of the things we are anxious to get to is obviously having a different mix of business, both for revenue volatility, financial risk, business risk, etc. And one of the things we are going to continue to evaluate as we go forward and build the plan for next year and the years beyond, which we are in the process of doing right now, is how we scope and invest into the leadership consulting side of the business, because that will be a combination of both organic and possibly inorganic opportunities along the way that will further enhance that platform and development.

But, so we don't have a magic slate anywhere that says it has to be X because the reality is we -- it goes back to what I said about our people. We are much more focused on quality than quantity and, in this game, talent is extremely important. And so the pace of growth and the investment and growth really is going to be gauged by what we can find in terms of the talent to execute the business that we want.

My comments, to add to that, is we don't have a specific number for you in terms of how that business across search, culture-shaping and leadership really is going to break down. What we can tell you is that what we are reacting to and the reason why we purchased Co Company is we are reacting to our clients. And our clients are telling us that they trust us with respect to search. And they are -- and they trust us with respect to all three businesses. And as they look at our businesses and where they see Heidrick add value, they are asking for more from leadership consulting and they are asking more from culture-shaping. And so we are responding to that.

The best way to answer it at this point is that our strategy, as always, begins with our clients and it is listening to them to determine how we pivot. And that is what you are beginning to see here a bit with this Co Company, and that is more a directional statement than hard numbers at this point.

Thank you.

At this time there are no other questions in the queue. I will turn it back to our presenters for any closing remarks.

Okay, if there are no other questions, thank you for your time this morning and your questions and listening. Have a good rest of the week. Thank you.

That does conclude today's conference call. We appreciate your participation.