Heidrick & Struggles International Inc (HSII) 2016 Q2 法說會逐字稿

Good day. This is the Heidrick & Struggles second quarter 2016 quarterly 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, ma'am.

Good afternoon, everyone, and thank you for participating in Heidrick & Struggles's second-quarter 2016 conference call. Joining me on the call today is our CEO, Tracy Wolstencroft, and our Chief Financial Officer, Rich Pehlke. During the call today, we are going to be referring to some supporting slides that are available on the IR home page of our website at Heidrick.com, and we encourage you to follow along or print them.

Today 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 22 in our supporting slides.

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

And with that, Tracy, I will turn the call over you.

Thanks, Julie, and good afternoon, everyone. Today we reported solid second-quarter results. The 12% year-over-year growth in consolidated net revenue was driven by both business lines, executive search and leadership consulting, and culture shaping, up 12% and 16% respectively. Specific to executive search and leadership consulting, revenue in the Americas grew 11% and Europe grew 30% compared to last year's second quarter, partially offset by Asia-Pacific revenue, which declined 5%.

Our five largest industry practices achieved year-over-year revenue growth and all of our key business metrics improved. The revenue growth in the second quarter drove the improvements in operating income and adjusted EBITDA. Operating income in the second quarter increased 28% and the operating margin improved to 8%. Adjusted EBITDA increased 29% and the adjusted EBITDA margin was 12%.

I would attribute our solid second-quarter results to several drivers. First and foremost, our people. We have made significant and important investments in our people, especially in executive search, through hiring and development over the last few years. The impact of those investments is most evident in North America and Europe.

Two, our recent acquisitions in leadership consulting of Co Company in October and DSI in February. They contributed to revenue growth in the second quarter, but, more importantly, helped us establish our platform for growing leadership consulting.

I would encourage you to visit our website and download an outstanding piece of thought leadership that we recently published titled Accelerating Performance. This is an example of distinguishing content that is resonating with our clients and elevating our capability as a leadership advisor.

And three, our brand and the access it gives us to working at the top. We believe that our reputation in the global marketplace is strengthening, especially in the board room. This in turn is fueling new client relationships and deeper advisory assignments.

I will turn the call over to Rich, who will give you further details about the second quarter, and then I will finish with some additional color on our strategic initiatives.

Thanks, Tracy. Good afternoon, everyone. I'll start with some additional detail from the second-quarter results beginning on slide 2.

Second-quarter net revenue of $149 million was up 12% compared to last year's second quarter, and the impact of currency exchange rates was less than 1%. As Tracy mentioned, both segments drove this growth.

As in the first quarter, the Americas and Europe had great quarters, up 11% and 30% respectively year over year. It was a key to our business growth in the segment. Asia-Pacific was down 5%, although only 3% in constant currency. It's worth reminding you when looking at slides 5, 6 and 7 that these results reflect the trailing 12-month results for the regions. This removed some of the quarter-to-quarter volatility and gives you a better perspective of the run rate of each of the segments.

Referring to slides 8 and 9, we ended the quarter with 336 executive search and leadership consulting consultants, of which 316 are specific to executive search. Beginning in 2016, leadership consulting consultants include only partners, of which there were 20 at June 30. Consultant productivity as shown on slide 10 rose to $1.7 million in the quarter and $1.6 million on a trailing 12-month basis.

Turning to slide 11, all of our major industry practices contributed to the year-over-year growth.

Specific to executive search, and referring to slides 13 and 14, we confirmed 5% more in executive searches in the year's second-quarter, and the average revenue per search worldwide on a trailing 12-month basis increased almost $117,000.

Turning to slide 15, the culture shaping segment reported a 16% year-over-year increase. We are also showing trailing 12-month results for this segment to account for the quarter-to-quarter variability of results, which are largely a function of the timing of project executions.

Looking at slide 16, salaries and employee benefits expense increased 12%, or about $11 million in the second quarter. Variable compensation expense accounted for approximately $3 million, mostly highly related to -- mostly related to higher bonus accruals for consultant performance. Fixed compensation expense increased approximately $8 million related to acquisitions and new hires made over the last year and the investments we are making in new and existing partners in culture shaping.

Looking at slide 17, general and administrative expenses increased 7% year over year, or approximately $2 million, to $35.6 million in the quarter. And we are essentially flat when compared to the first quarter. As I've discussed on previous calls, our G&A line now includes both the administrative expenses of our leadership consulting acquisitions as well as the cost of independent contractors that are used as leverage resources within both the leadership consulting and culture shaping businesses. In the second quarter, these amounted to over $3 million, well above the increase overall for G&A expense in the quarter.

Now I will refer to slides 18 through 22. Second-quarter results are more reflective of our business models than the first quarter, where we had made a number of investments that impacted operating income and adjusted EBITDA. We experienced a 12% increase in second-quarter net revenue that helped drive a 28% increase in operating income and a 29% increase in adjusted EBITDA.

Now looking at slide 23, cash and cash equivalents at June 30 was $85 million, compared to $93 million net of debt on June 30 of 2015. The difference compared to last year reflects a combination of higher cash bonus payments, two acquisitions and contractual payments related to the Senn Delaney acquisition. Cash generated by operating activities was $34 million, compared to $25 million in last year's second quarter. Our cash position plus the cash we have access to through our revolving credit facility is quite strong, and we are in an excellent position to continue to invest in and grow our business.

Referring to slides 24 and 25, the effective tax rate in the second quarter was 44% based on a full-year estimated tax rate of 45%. Higher net revenue, improved operating income and the mix of that income, plus a lower tax rate, all contributed to a 34% increase in net income and diluted earnings per share of $0.35 compared to $0.27 in last year's second quarter.

Now looking out to the third quarter, our executive search backlog is shown on slide 26 and monthly confirmation trends are shown on slide 27. Other factors upon which we base our forecasts include anticipated fees, the expectations of our leadership consulting and culture shaping assignments, the number of consultants, their productivity, the seasonality of the business, the current economic climate and foreign currency exchange rates. We are forecasting 2016 third-quarter net revenue of between $140 million and $150 million. Reported net revenue was $138 million in the third quarter of 2015.

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

Thanks, Rich. I am pleased with what Heidrick & Struggles accomplished in the first quarter -- in the first half of 2016 and the improved profitability in the second quarter. We integrated two acquisitions into our leadership consulting business, creating a stronger platform from which to grow. And we are investing in culture shaping to build on our leadership in this market and support our long-term growth. Overall, we continue to lay the foundation for more diversified business, building on the strength of our people, our brand and our content.

Heidrick & Struggles is well-positioned to capitalize on the growing demand for leadership services. In the most recent 2016 CEO Challenge Survey conducted by the Conference Board, more than 500 CEOs from around the world were asked to identify their most critical hot-button issues. The top two issues cited were, one, the ability to attract and retain talent; and, two, developing next-generation leaders. These responses reinforced Heidrick strategic relevance and is aligned with our stated purpose. Executives are concerned about their organizational readiness to tackle the transformational change they believe will be necessary to remain competitive in tomorrow's market.

And at Heidrick, we are no different. While our efforts are ongoing, I am encouraged by the progress we have made. Our stabilization and subsequent growth have given us the room to begin to put a sharper focus on the longer-term competitive prospects for the firm.

To that end, our executive management team recently convened for a set of meetings to review and validate our strategic direction. On the basis of those discussions and in anticipation of further work to come, we continue to believe that the most attractive path to the creation or shareholder value lies in, one, the improvement of our competitiveness in the critical markets for premium executive search, too, the ongoing development of a diversified portfolio of leadership advisory and culture solutions that permit us to partner with boards and senior executives to improve individual team and organizational performance. And, three, the connectivity with our clients between executive search, leadership consulting and culture shaping.

We understand that achieving success in this path will necessarily require a combination of strong focus, outstanding operational execution and efficient capital allocation. However, we also believe that success in this regard permits us to create tremendous value for our clients, our shareholders and our people. As a trusted leadership advisor, we bring clients a unique global perspective. And while there will always be changing political, economic or market variables around the world, one thing is certain: now, more than ever, organizations need the right leaders to see them through uncertain, volatile times. Leadership talent is being called on more than ever across every organization and all geographies. The value we bring to our clients and helping them get that talent right in turbulent times is even more important than during high tides.

And with that, Rich and I are happy to take your questions. I will turn it back to Melissa.

(Operator Instructions) Tobey Sommer, SunTrust.

I'm wondering if you could comment on what your recent monthly trends have been. You don't have the numbers in the graphic, but it looks like June and July confirmations were down year over year, and, in the backlog, down mid-single digits sequentially from last quarter. Thank you.

Sure, Tobey. A couple things. On the recent monthly trends, we have seen a slight dip on year-over-year in terms of the number of transactions. I think that is being offset by a couple of things. Number one, we are seeing the higher-value and higher-quality assignments as we continue to make the shift in our business that we believe is contributing to some of the revenue growth that we are seeing.

So while I'm not deeply excited about that, I am also not overly concerned at this point in time. I think what we are trying to weed out is some of the smaller assignments that maybe came in to our business that, frankly, we just don't have interest in using our resources on smaller-value assignments.

On a backlog situation, one of the things that I think that's been trimming the backlog a little bit is the fact that we have seen upticks become more and more of a factor relative to our revenue and our revenue recognition. It's been the change in mix that we have probably commented on over the course of the last year. So, again, while not deeply surprising, it is a shift that we've seen in terms of a little bit more on the back end that represents the fact that there's been a higher-value completion of our assignments, and we have been getting rewarded for that. So, again, it's a little bit of a change in the mix, but doesn't really take away from our outlook going forward.

So in this kind of environment with both of those factors, is it possible for you to generate revenue growth with volume declines in the mid-single digits?

Well, I think we can achieve revenue growth, albeit it's not going to be extremely robust. I think there is revenue growth factored into our forecast. A couple of things have to happen. Number one, I think -- again, we see month-to-month variability. There hasn't been -- probably over the last two years, there hasn't been a consistent monthly pattern every time in each of our quarters. We have seen many times where one month is down and the next month is up. But I think we need to make sure that we see the higher value come through in both the retainers and we continue the high completion rates with the upticks on the search side.

The other way that we will experience revenue growth is that we're going to continue to benefit from the growth and integration of our LC business, which is continuing to ramp up. And it should be a good contributor in the second half of the year. And in addition, I think -- and then we saw the little bit in this quarter, Senn Delaney is back on track with the integration of the new people, so that will help our business as well.

Thank you. Just two other questions for me, and I'll get back in the queue. What are your plans for internal hiring going forward? Last year, you were adding bodies at a pretty rapid pace. And the impact of that is maybe for slowing year-over-year growth based on the numbers we know so far. And then I was curious if you could enumerate for us what your spendable cash is. Thank you.

On the first question, on hiring plans and people, last year, you are right to point out, was a big hire year for us in terms of numbers as well as the overall experience that we are bringing into the firm. We continue to look for experienced talent that we think will blend well with our culture, will differentiate us where we need further resources. But I would say the overall number of people that we will hire in 2016 will be less than what we hired in 2015 because frankly we just don't have as many spots that we need. Always looking for high-quality people, though.

Tracy, but you do anticipate growth in internal headcount?

We will have some growth. Yes.

And then the spendable cash, Rich?

Sure. We finished -- as I mentioned, we finished the quarter at about $85 million in cash on hand. As we have said a number of times, I think we are comfortable. And as long as -- I think it's about a $40 million balance on a global basis than any one point time. I kind of look to is kind of our, for lack of a better word, a cash operating reserve. So we have twice that in our current balance, and we are growing more cash every day. The cash generation in the quarter was very solid on a year-over-year basis. And obviously, we -- should anything come up in the interim, we certainly have the working capital reserves but we are not going to use that unless -- with the credit facility unless we have a significant reason to do so.

So, I'm still very comfortable. I am very pleased with how we have managed the cash to date and absorb the additional payments that I mentioned in my comments, and so I think we are in good shape.

Thank you.

(Operator Instructions) Tim McHugh, William Blair.

Just I guess maybe pulling back the cover a little bit more on the comment about the search confirmations, I guess besides the size of the engagements or the revenue size of the engagements, what about from a geographic or industry perspective? I think most people get a lot of questions about obviously Brexit and the European environment towards the end of the quarter and here in July as well as the financial services vertical. So if you can comment if that's -- if there's any story there in terms of what you're seeing.

I will give you an overall perspective on this. I think it is fair to say, and this goes with Tobey's question as well, that the world -- all the headlines around the world would summarize and tell you to be a little bit guarded with respect to economic growth and outlook. At the same time, what we are seeing in our business right now is just not that much of a reaction to those headlines. In the United States, we have seen good flows in Europe and UK post-Brexit. We just have not felt the impact yet in the core business from Brexit.

Will that come? To be determined, but we haven't seen that. We haven't seen that in the UK; we haven't seen that in Europe yet. So I don't know if that gives you as much color as you would like. But there is, if you will, headline risk, and this is actually what is happening in the business. We just haven't seen those headlines flow to our business.

No, that's fair. Is there a story in terms of by geography or by vertical for -- I guess, you comment on smaller type of searches are weaker. Is that in a particular area, or is that just across the business that you are kind of seeing that?

Yes, Tim, great question. It's Rich. The -- traditionally, we have had lower retainers and fees for search in our international geographies compared to the Americas, and our results to date are no different. The strongest contributor from a fee perspective is still the Americas almost across the board. We've seen some good improvement in Europe, and it's reflected in the results both in terms of some of the people that we have hired that it made a good contribution in terms of volume of business. We certainly would like to continue to move up the fee scale in that geography.

We are not quite where we want to be, but it is improving.

The Asia-Pacific region, which has been battling its comparison against last year all year, we would like to see that be a bit stronger. That has been hurt early on by some of the things we talked about last quarter in terms of uncertainty in the Far East, particularly in China. And, again, with some assignments that we would like to see at a higher value, so that's, again, a region where we would like to see a few more of our people working at the top than what we have experienced to date. So there is room for improvement.

What I think gives us some encouragement in that region is that even though there's been a drop in revenue, we've maintained relatively good operating income contribution from that region. So, the rate -- we have kind of got the ratios and some of the costs in a little bit better shape. There is no question we would like to see more contribution out of that region.

The final comment I would just say to it, and it speaks to a Tracy commented to as well as the unknown or the future, we are not sure exactly how much the currency will move and how much variation will happen in our reported revenues. Going forward, obviously because of Brexit, there was very little impact, as we noted, in the quarter. We're going to watch that very carefully. We've got a little bit of a natural hedge against that with the expenses, as you well know. But we are hoping that as things calm down and the UK deals with the issue and the issues across Europe, that at least stability will come in to play and that the lack of impact either in transactions or in clients reacting to it will more than offset any impact on currency.

I will come back and just say one last comment, which is the headline risk that we see tends to impact the market opportunities that are below the top of the companies. So if you're working at the top, you are working in the board room, you're working in the C suite, we see the demand relatively protected. When you get below that, that's where you start to feel it.

Okay. And Tracy, you made a comment on the strategy meetings, the third piece there. You talked about a relationship with the clients in-between -- I guess both executive search and in-between leadership. What were you trying to say with that? I guess I'm not (multiple speakers).

My comment is really the interconnectivity between search, LC and culture, i.e. a client may initially present to us as focused on (technical difficulty) the interest of that client to do other services with Heidrick. That was the point.

Okay. Thank you very much.

(Operator Instructions) Kevin Steinke, Barrington Research.

Following up on the question about your strategic meetings, the second point that you discussed was continued investment in your diversified offering. And obviously you made some investments in culture shaping and leadership consulting in the first quarter. Can you just update us on your plans in terms of investments in those areas for the remainder of 2016 and also longer-term?

I think overall, the -- I will just start with the foundation here, which is acquiring Co Company and acquiring DSI has given us the opportunity to build a platform around leadership consulting, which is just different than what we've had before. And the best expression of that is what I referenced early on with regard to the accelerating performance document that we have on our website and the content that gives us in developing a dialogue and a relationship with the client that goes beyond the actual assessment of any talent that gets to the broader equation of accelerating their performance.

We are open, but we are open quite carefully, to other opportunities. There is a greater demand at this point to consolidate around what we have, get that working even more fluidly, get that working with our clients and getting them used to what Heidrick can deliver with a new LC platform. We are not opposed to inorganic opportunities, but I would say that the principal focus there right now is consolidate what we have. Again, we will look at things opportunistically.

With regard to culture shaping, the same applies, which is we are right now investigating a number of opportunities we see in the broader marketplace where we can partner more effectively with our clients who are doing other business with us, as I referenced in Tim's question. But also the broader merit of that in the marketplace around culture is one that continues to grow, it's one that continues to be important and we are always looking for ways that we can intersect with that narrative more broadly. Again, our focus here is much more organic in building the team that we have and that we are investing in, as Rich described. We invested in it in the first quarter. We invested in it in the second quarter. You will see us continue to invest in our people throughout the remainder of the year. That's the primary focus.

Okay, that's helpful. And following up on those comments here, talking about consolidating what you already have and then getting it to work more fluidly -- and Rich, I think in your comments you talked about the investments you have already made this year in culture shaping and leadership consulting should help the results in the second half of the year. So are you talking about not only the top line, but also just getting more leverage out of those investments and having more drop to the bottom line in the second half as you generate more revenue and leverage the spending you've done there?

Yes, look, the second quarter is certainly much more reflective, Kevin, of how we would expect the model to work than we've seen in the couple of quarters previously. If you take into account what I indicated about the fact that our G&A now includes the inorganic G&A that came in from the acquisitions, which includes the cost of independent contractors, as well as a small amount of independent contractors from Senn Delaney, on a year-to-date basis we would've had basically all of our revenue increase on flat-to-down G&A when we take away that as well as that first-quarter charge that we did in LC.

So, I am pleased. We are never done, but I'm pleased that we saw it work that way in the second quarter and kind of through the first six months. That's our intention to go forward. We are constantly trying to tweak it. Now, given the size of acquisitions we've made, unfortunately it doesn't create a lot of immediate expense synergies on day one because in many cases as we are bringing companies into the fold of a public company, there's some infrastructure investments or control investments we have to make that can maybe offset the loss of the few people here or there, So it doesn't give you a whole big lump sum. So the key in our mind is always to drive more revenue and to drive more productivity and get the right kind of people in here and then leverage lower-cost resources to drive margins.

So, we are encouraged that it worked that way. It worked a bit better in the second quarter. That would be our hope going forward as we continue to see some revenue growth from across all lines of business.

And, again, I'll just come back and say that the takeaway you should have on this is we are going to continue to invest in these businesses. And we're going to continue to invest because the impact that we see that we are having with clients, both existing clients as well as new clients in the marketplace, is positive. And as long as we see clients responding to the diversified solutions that we can bring may be search and LC, it may be LC and culture shaping, it may be culture shaping and search, we are going to continue to do that as we help clients answer the question who, why and how.

Okay. Fair enough. And I think Tracy, in your prepared remarks you talked about one of the factors that you felt is driving your growth is that your relationships are strengthening at the top of your client organization. So could you maybe talk a little bit more about some examples that would lead you to believe that? And also if you believe those strengthened relationships are enabling you to take more share of the client spending perhaps or market share from others?

Sure. I think the broader connection here is that certainly one of the rhythms that you read out there in the marketplace is continued volatility. And the volatility almost always means that the leadership and leadership team is broadly defined, whether that is in the Boardroom or that is in the C suite, are going to be looking for how do they respond and how are they best positioned for the market opportunities out there. Whether or not there are positive opportunities or there are some negative headwinds they are going to confront.

So, what we have found is that, in some ways, success breeds success, which is we've had a good run here at the top of the house or the client, as it were, both in the boardroom and at the CEO level. And the more you do, the more you have the opportunity to explain the experiences you've gained from those and the more opportunity you have to do others. And so without putting specific numbers on it, we have seen that particularly in the United States in the opening of -- or in the first half of 2016. We have seen that in some markets within Europe, and then I would say selectively we have seen that in Asia as well.

So, connecting at the top is really aligned with the way we think about the brand of Heidrick and we think about opportunities that that brand gives us in the marketplace. And then as you point out, once you are in the top, the opportunity to expand that conversation beyond any one of our services -- beyond search, beyond LC or beyond culture shaping -- is, again, this point about that interconnectivity.

Okay, okay. That's helpful. And just one last question. Rich, you talked about -- well, both of you talked about the fact that you really haven't seen an impact from Brexit on your business, although obviously the British pound is weak. So I just -- I'm wondering what you have factored into your second-quarter guidance if anything in terms of overall impact on currency on revenue growth.

Kevin, we factored a slight impact relative to the devaluation of the currency into that outlook. Without giving you an exact number, as I mentioned, it was a minimal impact in the current quarter. I think it was about less than 1%; about 1% in terms of overall currency impact. And a couple million dollars maybe in terms of overall revenue.

So at the end of the day -- and, again, the key thing is going to be far more -- and I think I said this in my comments or in a question, it is really going to depend more upon the pure operational impact of how many confirmations or how business resumes relative to -- especially post-holiday in the UK and in Europe, how the quarter finishes out. Again, the early signs are lots of headlines, lots of talk and not a lot of impact on the business.

Yes. And, again, I would just differentiate between impact at the top of our clients' needs versus one step below or in the middle is -- there you see a difference. There, you absolutely see the difference.

So, it is a little bit too soon to tell. You are reading the same news stories we are. I'm sure we are talking to parallel people here in terms of their insight. And so we have factored it in, but we've tried to be prudent about it in terms of any hard and fast landings here right now.

We're obviously watch -- that said, we are watching it extremely carefully.

Okay, makes sense. Thanks for taking my questions.

(Operator Instructions) Tobey Sommer, SunTrust.

Wanted to ask you about consultant productivity which had a pretty impressive number in the quarter. Is there anything -- any kind of refining thoughts you may have about where that can go on maybe not a quarterly basis, but sort of an annualized basis? Thanks.

You know, again, without getting too forward-looking on things, we're certainly pleased. And I don't think what we have seen to date -- while it is certainly a high number for us, and it is boosted a little bit, and I think we've indicated this that with the inclusion of fewer consultants from the LC side because we only include partners, it certainly helps be at the higher side. And it's the [$1.6 million] on a trailing 12-month basis.

If we could start to get the productivity up even more importantly and the fees up in our international reach, it certainly would help. And certainly could go higher. We have had great -- but at the end of the day -- and, again, the strategy is based upon this -- is that we believe that we are going to get a higher-value productivity number across our lines of business by the fact that working at the top, staying near the strong decision-makers of our clients, it's a little bit more of recession-resilient or cyclical-resilient work. And so our concern now is maintaining and hopefully driving that up a little bit in continuing to drive lower-cost leverage and executing our assignments. It's a journey, but we are at least encouraged with the current trend.

You can back into these numbers. Our most productive consultants are in the United States, our next most is sitting in Europe and then Asia. And Europe, with the improvement in Europe, that also corresponds to an improvement in productivity, and that is helping the overall numbers. So it gives you a little bit more direction as to where it's coming from.

Thank you. Last question for me. If overall confirmations in June and July are down year over year, and Europe and the UK are holding up, does that imply that the Americas -- North America is the region where the decline has occurred? And if so, what kind of change are we talking about?

Yes, we have seen -- I've seen -- I think we've seen not as much a decline as we have seen kind of a holding steady in Americas, maybe slightly off.

Where is the decline? If Europe is holding and Americas are holding (multiple speakers) --

Well, yes, it would be in the Americas. But, again, just to be clear, that in part because it's been such a strong region. It hasn't been deeply concerning from the standpoint that we have seen times where we've seen a very robust period of time and it backs off a little bit for a month or two, and then it kicks back up. The narrative we are hearing in our business is consistent with what is reflected in our guidance and our tone. In the Americas, we have still seen pretty good strength in our CEO and Board practice and across our major industry groups; in particular, financial services, consumer, health care, life sciences, and GTS. So that is where it would be. And -- but again, we don't think it's a long-term trend, nor at this point in time do we see it as a major issue.

Thank you very much for the color.

(Operator Instructions) And at this time, I show no further questions in the queue.

Okay. Thank you very much. Thank you all. Have a good week.

That does conclude our conference for today. Thank you for your participation.