Heidrick & Struggles International Inc (HSII) 2016 Q3 法說會逐字稿

Good afternoon. This is Heidrick & Struggles' third-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.

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

Today we'll 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 23 in our supporting slides.

Throughout the course of our remarks, we'll 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 will turn the call over to you.

Thanks Julie, and good afternoon everyone. Today we reported third-quarter results that demonstrate progress on a number of initiatives. The results also reflect our heightened level of investment during the past year.

First, let me highlight three positives in the quarter. Number one, we invested in the growth of Search and Leadership Consulting through two acquisitions, JCA Group, a distinguished executive search advisory firm in London that gives us greater access to the C-suite and board level in London and Europe. And Philosophy IB, a boutique management consultancy based in New Jersey, that enhances our leadership development and executive coaching expertise.

Second, we added 30 new search and leadership consultants in the third quarter, 14 through acquisitions and the rest through hiring. And consistent with what we saw in 2015, turnover has remained very low. Third, Europe continued to show strong growth in revenue, up 27%, or $6.9 million. Over half of this growth was attributable to the Co Company and JCA acquisitions, with the remainder driven by our legacy business. This is encouraging improvement.

Balancing the positives, we fell short in two areas. Number one, overall revenue growth. Revenue growth in the Americas Search and LC segment was flat. July and August were slower than we expected, but we saw a strong increase in September. Asia Pacific, consistent with the trends we've seen throughout 2016, recorded weaker revenue against the prior year. And Culture Shaping was impacted by weaker results in one of its most important verticals, namely energy. Second, general and administrative expenses are higher. Much of the increase is explained by the expenses of four businesses we acquired beginning in the fourth quarter of last year. Rick will comment more on this later in the call.

Let me now step back and more broadly give you my thoughts on the quarter across our three service offerings. I'll frame my comments by referring back to our second-quarter conference call in July, where I outlined the three initiatives we believe are key to creating shareholder value. Namely one, the improvement of our competitiveness in the critical markets for premium executive search. Two, 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. Three, the connectivity with our clients with executive search, leadership consulting, and culture shaping. So let me give you a progress report by service offering.

First, Executive Search. Search is the engine of Heidrick & Struggles, and we must continuously invest to grow and improve our impact in the market. In the third quarter we made additional significant investments in people, adding 26 new search consultants, including 11 from JCA Group in London, a critical market for premium executive search. JCA's team of exceptional professionals and their clients fit well with our culture and strategy. We are already benefiting from their contribution in collaboration with our professionals. The investments in people that we have made over the last year have helped us build a larger, more stable higher quality base of search consultants, which positions us for growth and profitability of our business going forward.

Next, Leadership Consulting. Our leadership Consulting business is still reported with Executive Search while we invest to grow our diversified portfolio of leadership advisory services. We are pleased with what we've accomplished in the past year. Last October we acquired Co Company led by Colin Price. This business has become the foundation from which we are expanding our service offering, helping companies accelerate their performance at the leader, team and organizational levels. We then acquired two complementary leadership consulting businesses, the first Decision Strategies International, and more recently Philosophy IB, further enhancing our talent, intellectual property, and client service capabilities.

We are continuing to develop additional client solutions around our methodology, branded as accelerating performance. Accelerating performance helps clients mobilize their talent and adapt quickly in order to maximize the potential and achieve value creation faster than their competitors in a dynamic environment. On the strength of this methodology we are competing and winning new business, primarily in Europe, for leadership advisory projects that warrant higher fee levels than we previously could command.

We now need to scale this business profitably and globally on a platform which we did not have a year ago. Next year we should see some increase in profitability as we progress our integration of the three acquisitions and continue to grow the business. The rate of that improvement will be highly dependent on the pace in which we invest. Overall, we believe we are building an LC business that has higher growth characteristics than search, and upon achieving scale will have returns that are no less.

Finally, Culture Shaping. This has also been a year of significant investment in Culture Shaping, specifically in new people who are poised to capitalize on what we have today and achieve what we believe this business has the potential of doing in the future. We signaled this investment at the end of this last year and have been recognizing the financial impact of the additional professionals throughout 2016. The new consultants are now integrated into the business and are up to speed on clients and business development activity.

We have seen tremendous mentoring from the legacy partners, which in part has been the reason the revenue has not expanded. We expect to see an operating margin from this business next year in the low to mid teens. Assuming revenue growth accelerates, the mix of enterprise revenue and consulting revenue remains balanced, and investment and retention costs are less of a factor, and by 2018 we expect that margins should be 20%.

In brief, I believe in the diversified leadership solutions platform that we are building. The combination of Search, Leadership Consulting, and Culture Shaping makes Heidrick & Struggles a highly unique and differentiated leadership advisory firm. We believe that Leadership Consulting and Culture Shaping are businesses that can grow and are more resistant to economic and market cycles. Armed with all three, we are able to offer our clients a more meaningful value proposition that goes far beyond the acquisition of talent. And with that, let me turn the call over to Rich who will give you further details about the third-quarter results.

Thanks Tracy, and good afternoon everyone. I'll start with some additional details on third-quarter results, beginning on slide 2. Third-quarter net revenue of $143.5 million was up 4% compared to last year's third quarter. The impact of currency exchange rates was less than 1%. The increase in Executive Search and Leadership Consulting revenue of 4% more than offset the 6% decline in Culture Shaping.

Europe continued to show improvement, up 27%, or $7 million year over year, and was a key driver of growth in our Executive Search and Leadership Consulting business. The acquisitions of Co Company last October and JCA Group in August provided more than half of this growth, with the balance coming from the Heidrick's legacy business.

Revenue from the Americas segment was essentially flat. We had a slow start in the third quarter. And I am encouraged that we finished with good momentum in September. As you'll see on slide 28, our estimate for October confirmation is on pace -- is on a pace that indicates there is still strength in the business. And Americas still accounts for the majority of that business. Asia Pacific revenue is down 5% compared to last year's third quarter. The decline in revenue reflects a combination of softness in certain economies like China, and practices such as financial services and technology and services during the quarter.

It's worth reminding you when looking at slides 5, 6, and 7 that these results reflect the trailing 12-months results for the region. This removes some of the quarter-to-quarter volatility and gives you a better perspective of the run rate of each of these segments.

Referring to slides 8 and 9, we ended the quarter with 356 executive search and leadership consulting consultants, of which 334 are executive search and 22 are leadership consulting. During the third quarter we acquired 14 consultants through the acquisitions of JCA and Philosophy IB, we hired 16 new consultants. 10 consultants left the firm, including 4 who retired. Largely reflecting the increase in new consultants, consultant productivity is shown on slide 10 with $1.5 million in the quarter and $1.6 million on a trailing 12-month basis.

On slide 11 we show the increase or decrease of revenue in each of our major industry practices for the third quarter compared to the prior year, but to remove some of the volatility results I'd encourage you to also look at slide 12 where we show the year-to-date revenue growth of the industry practices compared to the same period of 2015. Specific to Executive Search, referring to slides 14 and 15, we confirmed 6% more executive searches in the year's third quarter and average revenue per search worldwide on a trailing 12-month basis is just under $115,000.

Turning to slide 16. The Culture Shaping segment reported a 6% year-over-year decline in revenue, or about $600,000. We are also showing trailing 12-month results for this segment to account for the quarter-to-quarter variability, which is largely a function of the timing of project execution. Culture Shaping has also been affected by a decline in revenue in one of its most important vertical specialties, energy.

Looking at slide 17, salaries and employee benefits expense in third quarter decline less than $400,000 to $95.4 million. Fixed compensation expense increased $7.3 million and reflects compensation related to four acquisitions, as well as the investments we made in new and existing talent for all of the businesses. In the periods of high investment the fixed portion of our compensation expense will be higher due to the incentives and guarantees that are part of the consultant hiring cost. As a result of the higher fixed compensation expense and an increase in the use of third-party consultants and contractors whose costs are included in general and administrative expenses, variable compensation declined $7.7 million in the quarter, reflecting the overall profitability within the businesses.

Salaries and employee benefit expense was 66.4% of net revenue for the quarter compared to 69.2% in the 2015 third quarter. On a quarterly basis we can see more variability in this expense line. However for the nine months ended September 30, salaries and employees benefit expense was 68.2% in 2016 and 68.5% in 2015, which is consistent with the overall compensation expense levels we expect to see in the business.

Now, turning to slide 18. General and administrative expenses increased 21.5%, or $6.4 million to $36.2 million, when half of this increase or $3.2 million reflects costs we absorbed from the acquisitions of Co Company, DSI, JCA Group, and Philosophy IB. $3.2 million includes $1.3 million for third-party consultants and contractors to execute work for Leadership Consulting Services. It also includes approximately $700,000 of earned-out and intangible amortization expense and $1.2 million of expenses which are primarily business support and business development.

The balance of the increase in G&A in the quarter can be attributed to the following items. First, higher professional services fees supporting technology implementation, training and development, marketing, and audit fees. Second, an increase in temporary help and hiring fees. Third, an increase in unbilled travel and business development expense. And, fourth, an increase in technology subscription costs reflecting additional headcount throughout the business for our cloud-based services.

Now I'll refer to slides 19 through 23. Reflecting continued investments in the third quarter to grow the business, operating income declined 7%, or $900,000 in the third quarter. And operating margin was 8.4% compared to 9.3%. Adjusted EBITDA declined 4%, or $700,000. And the adjusted EBITDA margin was 12.2% compared to 13.1%.

Now looking at slide 24. Cash and cash equivalents at September 30 was $100 million compared to $129 million at September 30, 2015. The difference compared to last year reflects the combination of higher cash bonus payments, four acquisitions, and contractual payments related to the Senn Delaney acquisition. Cash generated by operating activities was $35.9 million compared to $43.1 million in last year's third quarter. Our ability to generate cash throughout the year plus the cash we have access to through our revolving credit facility continues to put us in an excellent position to invest in and grow our business.

Referring to slide 25 and 26. Net income in the third quarter of $6.9 million and diluted earnings per share of $0.37 reflect an effective tax rate of 44% in the quarter with a full-year projected tax rate of approximately 48%. This compares to net income of $7.5 million and diluted earnings per share of $0.40 in last year's third quarter based on a lower effective tax rate of 32.7%. The tax rate was higher in this year's third quarter based on the mix of income from the higher tax jurisdictions.

Now looking out to the fourth 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 of our Leadership Consulting and Culture Shaping assignments, the number of consultants and their productivity, the seasonality of the business, the current economic climate, and foreign currency exchange rates. We are forecasting 2016 fourth-quarter net revenue of between $142 million and $152 million. Reported net revenue was $144.5 million in the fourth quarter of 2015. With that, I'll turn the call back over to Tracy.

Thanks, Rich. For the first nine months of 2016 consolidated net revenue increased 9% compared to the same period 2015. We invested heavily in the Company this year to build and grow all of our services, Executive Search, Leadership Consulting, and Culture Shaping. We made three acquisitions. We added 22 net Search and LC consultants through hiring and acquisitions, and vastly improved our ability to provide a scalable Leadership Consulting solution. Even with this level of investment, adjusted EBITDA for the first nine months was $46 million and the EBITDA margin was 11% compared to $44 million and 11.5% in 2015.

We continue to lay the foundation for a more diversified business of Leadership Advisory and Culture Solutions, building on the strength of our people, our brand, and our content. We believe that our success will create value for our clients, our people, and our shareholders. The challenge we face every day is balancing the cost of our investments and the growth of our business with the return to shareholders. Achieving a return of these investments and an increase in shareholder value that we expect will take time, and yet we fully realize that time is of the essence. It will require our committed focus and outstanding operational execution.

Now more than ever organizations need the right leaders to see them through uncertain, volatile times. Leadership talent is being called on across every organization in all geographies. In the last nine months we have increased the value proposition that Heidrick brings to its clients in helping them attract and develop their talent. I'm excited about the opportunities to fully capitalize on our investments for growth and profitability.

Let me pause there and open it up to any questions.

Thank you.

(Operator Instructions)

Tobey Sommer, SunTrust.

Thank you. Kind of longer-term question. What is the long-term goal for the revenue mix between Executive Search, Culture Shaping and Leadership Consulting?

Tobey, there is no specific number that I can give you on this. I would say this. You've got a firm right now that's 90% Search and 10% the Consulting practices really dominated by Culture Shaping.

We would like to see that balance over time in the -- we are going to do it in stages, but we are going to do it incrementally at -- get to 80/20, get to 70/30. I think when you start to get into the 60/40 range, we're going to hit the mix that we think makes sense.

You have to remember that Heidrick continues to be a very strong search firm and that gives us the right to have the conversation with client, the right to have the access to the top. And we want that to continue to be a very, very important part of what we do.

When I give you those numbers, I am giving you that over a very healthy period of time. We are not going to see that for a healthy period of time. And if we can get into that 80/20 mix as the first place to stop, we'll be happy with that.

Thank you.

And then what kind of margin impacts could the associated revenue mix shift have on -- what kind of impact would we have on margin?

We are seeing right now, as you know, the investment in Culture Shaping and the impact that's had on margins as we invest this year. We have flagged in this, in our conversation today, what kind of margin we think we can get back to with respect to Culture as those investments concluded and we move forward. And we have indicated in my comments that the best way to think about Leadership Consulting is that that margin over time, when we get to the right scale, we believe those margins will be no less than Search.

We would look for those to be more than Search. But I'm saying what I think we think is a relatively balanced way to describe it, which is to knit your two questions together, get to a 80% Search/20% Consulting business where the margins on the Consulting side are at least as good as Search. And we believe when we get to scale have the right to be better.

Okay, thanks. A couple of numerical questions. Rich, what was organic growth in the third quarter and what's the organic growth assumed in the guidance range? Maybe the midpoint, for example?

Yes, the organic growth -- the growth was relatively flat on an organic basis in the quarter. The inclusion of the acquisitions made up the majority of the growth on the revenue side, Tobey. I think as we go forward into the fourth quarter that will reverse a little bit in that we'll have contributions from both.

I think as we noted in the comments, I think we would have expected the America segment to be a little bit stronger in the quarter. And I think because the momentum came at the last half of the quarter, last part of the quarter and October looks relatively good that I think we should see some organic growth in the business. So it should account for a portion of the growth implied by the guidance. That's also including some of the new people that aren't acquisition-related as well.

Sure. If we were able to see the monthly confirmations by geography, we would be able to discern kind of a rebound in the Americas region?

I'm not -- from a standpoint of just confirmations, there's a number of things that drive the revenue. Our confirmation trend has been a reasonable trend over time. It hasn't been -- it certainly has bounced up and down a little bit. So it certainly would show that -- I think if we have strength it'll come from Europe and Americas more than it will Asia Pac. It has been consistently a little bit off of this year compared to last year for some of the reasons mentioned.

I think from a standpoint of that. But the other things that really drive some of our growth right now, candidly, and we've talked about this before, is that we get -- it's the contribution of upticks, and as we have seen the assignments bill and complete, and in some cases fee revenue come in at the end, they have become an increasingly a larger part of our quarterly revenue. And so that's across all three regions.

So do you expect -- did the Americas region improve in September and October along with the Firm?

Yes.

Okay. Just two other numbers questions. I'll get back in the queue. What's the bonus accrual year to date? Rich, how would you characterize spendable cash at the end of third quarter? Thanks.

Spendable cash is relatively small right now from the standpoint that if you know our accruals through year to date on the balance sheet are down year over year. I would say our variable compensation accruals, I noted in my remarks, are lower. So accrued expenses are $128 million at September. And so that's down year over year.

The cash, we have spent a lot of the free cash on the acquisitions. I've chosen not to draw on the revolver at this time. We are -- still have plenty of cash because of the accrued bonuses. As we finish, whether or not and how much we withdraw on the revolver at bonus time will depend upon how we finish the fourth quarter.

Thank you very much. I'll get back in the queue.

Tobey, I would just add one more comment to your opening question about percentage, which is the most important governor that we are going to look at on that is frankly what's driving it from the client side. And so I think the right way to think about this is, our first stop is to get to 80/20 between Search and the non-search Consulting businesses. And it's going to be highly determinative from there about what kind of demand do we build from the client. We are obviously building this accelerating performance platform out of LC because we do think it does have scalability. But we are going to pay really close attention to what our clients are telling us about the demand. And that will have a big impact on how much it changes from there.

Thanks for elaborating, Tracy.

Tim McHugh, William Blair.

Hi, yes. First, following up on the bonus question, Rich, the comment that it's down slightly year over year. In trying to think about how much of a, I guess, higher accrual we need in the fourth quarter. Revenue is up. I think revenue per consultant is still up.

I know you mentioned there's a few new moving parts there. I know timing can impact from quarter to quarter. But if I'm thinking about margin level for Q4, just trying to reconcile that versus the revenue.

Yes. No, that's a great question, Tim. There's some potential that we will see some squeeze on the margin as we build bonus accrual. There are a lot of moving parts.

This year because of the large increase in consultant hiring that we did, our fixed compensation is higher year over -year. And as a result some of that will actually flip maybe in the fourth quarter, depending upon how we finish the year. So it's really hard to predict how much. And so I'm hopeful that if our earnings are more towards the high end of the guidance that that will give us a lot more cover to mitigate that margin pressure as the accruals flip. But right now that's the big variable.

Okay. Can you, to best you can, I guess the trends you saw in September and October versus June and July, what changed? I know we've heard similar commentary from Korn Ferry, and I've heard it from a few staffing companies. But it's not really clear what was happening in June and July other than Brexit. But it sounds like it was more US than it was international markets where you saw slower activity.

I'm not sure we would point to any one geography. I think the kind of experienced all across all of ours, at least in our case. We've pulled this a lot because we can't really point to one thing. Because as we saw, July and August kind of soft, we really did worry a little bit about was it a sign of some kind of a cyclical trend or a movement? September bounced back pretty well.

And so -- and as we talked to our folks and see what's out there and see how October is progressing, there's nothing we can really point to that says that there's one driving factor. So whether or not it could have been client decisions caused by things like Brexit, (inaudible) is certainly one of the factors that would've fallen into play. But there isn't any one thing that we can point to. And I don't know if you want to elaborate?

I would just add, as we described, September was a strong month. October is a darn good month. It's hard to understand why it evolved the way it did, to your question, Tim, other than vertical. I will just say this. The dialogue with clients across that four months has remained strong. So why clients decided to pull back in July and August, we don't have as much precision around that as we would like, let alone to answer your question.

The one thing I pointed to even in my G&A commentary is that we were surprised a little bit by the level of business development expense that we incurred at the end of the quarter. So that will match up against some of what we saw in September and October coming through because, as Tracy noted, the level of activity hasn't slowed down at all. Certainly there seems to be some intensity in conversations around clients. So we take that as a good sign.

And just by vertical, financial services, I guess, was the one that stood out that as weaker this quarter. Does that trend where you saw weakness and then improvement tied to financial services? Is that related to capital markets type activity at all? I guess anymore color on that would be helpful.

Certainly, the lack of capital markets activity relatively speaking to previous time periods in Asia has impacted financial services activity in that region of the world. Here there is, certainly as we see on a weekly basis, the regulatory overlay with respect to financial services, which creates an impact on overall demand for talent. I don't want to overly accentuate those themes beyond what we are seeing right now. I would just note them as two dimensions that flow through, and certainly impacting those numbers right now.

Okay. Thank you.

Thank you, Tim.

Kevin McVeigh, with Deutsche Bank.

Tracy, Rich, I wonder if you could just give us a sense overall on capital allocation that you folks have been pretty aggressive on the M&A side. How should we bracket that in with buyback, particularly given where the stock is? Just along those lines, given the cross-currents the last couple 3, 4 months, what gives you the confidence in terms of you must be seeing things internally that gives you the confidence to go out and make those hires and do those tuck-in acquisitions.

Just any thoughts on that? Is it purely just client conversation? Along those lines, Tracy, how are clients starting to position for 2017? I'd imagine you're starting to have some initial conversations in terms of where budget goes in 2017.

First of all, Kevin, I would say that some of this hiring, if you go back to where we were a couple years ago, as I entered the business here at Heidrick, one of the big themes we had was really to stabilize and rebuild as part of that stabilization. And so, some of this that you see is where we see pockets of opportunity to build a footprint consistent with the overall Heidrick brand.

A great example of that is, obviously, JCA in London where we have a solid business in London, a good business in London, but we saw an opportunity there really to jumpstart in one move the access to the top which we had lacked. And we could've done that one by one, but we decided it was advantageous to do it with a full team. And for reasons that we are comfortable with JCA and ourselves, we decided to come together in that acquisition.

So that's probably an example where we advanced that count of consultants probably faster than you would normally see. And other places where we are adding talent is really adding talent both at the senior basis, but also adding it at the principal basis where we can get leverage into our model.

That is additional to what we've seen in the past where we have principles supporting clients, supporting client teams that we think allow us to position ourselves even more strongly with the client. All those numbers add up into the count. So that gives you an overall perspective.

I would say on the capital allocation, look, we continue to look at probably the most difficult equation that any business has, whether it be ours or anyone in the world right now, which is balancing short term and long term. We know that there is a mathematical pop that can come from buying back stock. And we certainly look at that and we use that as one metric to measure against the acquisitions that we are making.

But we are not looking to do acquisitions just to do them. We're looking to do them to align with a client strategy. And where we see an acquisition that can accelerate what we believe is the right client strategy, we will do them.

Clearly when we do these acquisitions, we're making investments that, at least in our case to date, are going to take longer to show that return versus the quick mathematical pop that can come from buying back shares. But we think is the more enduring return over time and complementary to our business that really, again, starts with search and starts with the access and the permission that search has in the board room and in the C-Suite.

I'll stop there and see if that addresses your thoughts.

It does. Very helpful. Any thoughts on trying to preliminary conversations into 2017?

That's interesting, because your kind of commentary on the July/August pause and then reacceleration in September is really being echoed. Do you expect that to kind of follow through over the balance of Q4 and then into 2017 as well?

Tough question for us to ask. I would just say this. As challenging as it is to have two slow months like July and August, we had a whole lot -- before I prefer having this conversation with you with September and October with positive momentum and July and August strong and September and October weak.

Where that continues, we've given -- the best we can tell you is the forecast that Rich described with regard to revenues. Beyond that into 2017, we are right in the middle of our planning process right now as it relates to 2017 for the balance of this year. It's obviously something we are very, very focused on.

Overall economic headlines are not the most positive and robust. That said, what you see happening in the capital markets is generally asymmetric with that. And so we are like everyone else, trying to figure out how to balance those big macro headlines with the conversations that we are having with our companies, where we see them investing, how they are investing.

You only have to look at what's happening in the market in the last month or so, whether you look this week to AT&T/Time Warner, whether you look to Bayer and Monsanto. There is a lot of interest out there in trying to figure out how to grow businesses. And if they decide that doing it organically is going to take too long, there's some robustness in that merger marker right now which is quite interesting. And that obviously speaks to confidence.

No doubt. One last one on the numbers. You talked about a step-up in temporary help expansion professional fees. What drove that?

There's a couple of things. We've got a couple of initiatives going on inside the Company, number one, where we needed some temporary help, which is we are implementing new HR information system across the business, which was badly needed.

The system that we had is outdated and couldn't even be upgraded anymore. And we are a people company. And so we are going to a cloud-based system. We needed some outside expertise with people with specific skills that needed to come in and help us with that implementation. That expense hit this quarter and may hit another quarter or two, just as we finish that implementation.

That hit us both in the professional services line as well as in the temporary help line. In addition we have some hiring fees of just people that we've been adding to the mix in specialty areas, especially that are outside the core of our normal search business, where we actually have to use recruiters, et cetera, to fill out the specialties, as well.

So these were small items individually. In the aggregate I'm talking about probably close to somewhere around $400,000 to $500,000. Again, small numbers move our needle a lot.

And that's after-tax rates, that $400,000 to $500,000?

Those are pretax.

Pretax, okay. Thanks so much.

Sure.

Kevin Steinke, Barrington Research.

Good afternoon. It sounds like you're going to continue to be quite aggressive on adding leadership consultants and people on the Culture Shaping side. But you also talked about opportunistic hiring on the Search side to fill in certain pockets. And you highlighted JCA as one example of that, also adding people through acquisition. Just wondering when you look at the Search side how many pockets you still see to you fill in as you rebuild the consultant base, either by geography or industry or any other way you'd like to characterize it?

I'd say Kevin, we are a big step up from where we were two years ago, number one. Two is, in the spirit of the questions that have been asked, we -- just about overall economic environment, we don't want to get ahead of ourselves with regard to that and we want to balance that with where we see opportunities to hire talent that are attracted to what Heidrick is building right now.

There are definitely pockets in each industry where we can selectively hire. But I wouldn't say that we are -- we are nowhere near where we were two-plus years ago where we had huge gaps. I would say right now we are approaching where we can be opportunistic, we're going to do that as opposed to where we absolutely have to go higher.

Kevin, there's one thing I would add to that conversation is, it's more quality than quantity. But if you think about the just general needs of the business, and we've said this many times. In an environment in Executive Search, it's one of the reasons why we believe the portfolio mix has to continues to evolve as well.

Growth in Search is hard to come by. And so it does -- and one of the big drivers of that is the number of people you have in the market who are good. And so we always are looking for the right talents and places to add the talent that makes sense for the business and are of the caliber and the right culture fit with our people because search is the engine of the business.

Kevin, I'll just add one other part, which is we are also very committed and have been to promoting from within. So there is a whole group of people who are moving up the experience curve. We will be looking at another year where we will make promotions to partner, where we will make promotions to principles.

It's too soon to get into anything other than just stating that in concept. But we continue to be very focused on that internal promotion path as a way for our people to advance, but also as a way to fill those opportunities in the marketplace. In a perfect world we would get to a place where we can promote more from within than what we have to do on the outside and keep outside just very opportunistic.

Okay. Yes, that's really helpful commentary.

Tracy, I think in your prepared comments you talked about the G&A expense levels maybe being one area where you fell a little bit short, although a lot of that also sounded like it is driven by your own activities to grow the business in terms of making acquisitions, and also just the mix shift of the business to leadership consulting where you are using third-party contractors. So is there an opportunity to streamline some of that G&A post these acquisitions?

Or is it just also a function of growing into that expense base with the acquired businesses? Or how would you see maybe G&A levels, either as on an absolute basis or as a percent of revenue improving going forward?

Yes. Kevin, I'm going to jump in on this just because a little more detailed maybe then Tracy would have at his fingertips. But it's a great question.

It's something that we'll probably be getting even more clarity to as we get to year end and in the next year, because the mix -- and I think you said it embedded in your question. The mix of our business is changing. And some of the nature of the G&A we are experiencing is changing. I'll give you an example.

Most of our G&A, which is non-people in our vocabulary right now and we may give further clarity on this in future income statement presentations. But most of our G&A -- all of our G& A is the non-people related expenses. Most of ours falls really in four lines right now that are really material to the business.

Number One is our occupancy expense across our business, which is just basically the existence of our offices. That's been almost a flat expense for a long period of time.

The second one is our professional services where we engage the help of people outside the Company to either assist us or do critical things that we need done. One example on the corporate side, obviously, is things like audit fees and tax work, et cetera, and throughout our various geographies.

Internally we use professional services fee for things like I talked about, technology implementation, marketing support and expense. We've got some tremendous marketing initiatives going on right now with our leadership consulting business that are extremely going to be well done, well received, client impacting where we are using the help of some outside people to help get that done.

The third major line is the outside contractor expense. I think really that is really much more of a cost of sales type of expense that really probably doesn't belong in G&A. And we are looking at that for longer term presentation, because that's really temporary help to fulfill consulting engagements, just because we haven't been able to leverage up the team fast enough.

And so it's hurting our margin in two ways. Number one, it's making G&A look bigger. And number two, it's a higher cost than if we had our own people. As Tracy mentioned, over time as we scale that business more appropriately, the cost of that leveraged support will go down. And it will not be a G&A expense, it will really be a cost of services expense.

And then the final thing is the travel and entertainment and business development expense. This is one of the fine lines we always walk, because we encourage our people to be in touch with clients. We want them out there market-facing, talking the business, getting knowledgeable about all three lines of business, and having deeper conversation with clients.

That's part of the strategy. And that actually -- and we saw a little blip in that, again, not huge dollars. It happens to be large dollars in our income statement presentation because the numbers are kind of small. But we're talking about like an increase of about $0.5 million Companywide for the quarter.

And so it's those types of things that are what's driving the G&A increase. The other thing I would say is that relative to the folding in of the acquisitions, a lot of the acquisition G&A cost was those outside contractors, and that will have clarity over time. The balance of that, things like earn-out and intangible amortization, that will wane off over time because of the timing of the acquisitions and we must accrue for the earn-outs. And so as we become an acquirer, if we continue to acquire, you'll still see that be. If we don't do that many acquisitions, that expense will wane over time and it will not be a sustainable expense.

And then the third thing is regular G&A. We are all four acquisitions combined, we probably have an aggregate of about just over $1.2 million -- just about $1.2 million of combined expense for the four businesses in the quarter. Some of that will go away.

There are some of the smaller companies we are in the process of integrating them now onto our platform, and their back office will go away. These are not big back offices, so there's not millions and millions of dollars of operating synergies. For the most part it's relatively small. But we are going to make anything that we can go away as quickly as possible. And a lot of that could trail off by the end of the year.

Kevin, the reason I highlighted it is when you are a Company of our size, you obviously have to watch scale. Small dollars can be big percentages. So when we see that, it's my way of flagging to you and to the broader investment community that when we see a number move with those kind of percentages, we focus on it. We don't just look at the hard dollar and dismiss it to scale.

We focus, okay, how can we make this better? That's why I raised it, because we want you to know that we are focused on it and ideally we want to bring that number down.

Okay, yes. Fair enough. That makes sense.

I guess on the contractor portion of G&A costs, as you said, Rich, as you scale the business that will diminish or go into cost of services, although I guess should we think about that being part of the G&A for at least a few quarters going forward as you are going through this transition and kind of scaling up Leadership Consulting?

It's going to be part of the income statement whether or not it's in G&A or some other line of presentation. That's what I don't know yet, Kevin.

But it certainly going to be there because I don't think we can hire fast enough. And I'm not sure we want to hire that fast. I'd rather have the leverage support trail the growth of the business development people a little bit.

We have an excellent network of professionals who are very flexible. And as we build this business it's almost in our best interest to be flexible on that instead of building hard costs into the business. We're trying to balance that with the work that we have. And as that business grows, we are going to continue to monitor it.

All right. All right, great. And then on Culture Shaping, you talked about energy clients having an impact on them. Just wondering, I mean, is that related to oil price fall out? How significant is energy as a portion of their clients or revenue for Culture Shaping?

In this particular case it's more related to a couple of situations that, one, is certainly oil price decline. The other is more from an M&A point of view, and what the client is really allowed to do from a regulatory point of view.

More broadly, the energy space, whether it be in our industrial area or whether it be in Cultural Shaping, is one that we are keeping a close eye on because of what's happening to overall energy prices and how that's moving the needle. We are seeing it both ways.

We are seeing a drop-off in activity on one hand. On the other hand, we see where there is greater concentrated focus on, do we have the right leadership at the top? Do we have the right leadership around the board room? And, therefore, there's an opportunity for a conversation with Heidrick that may not have happened, except for the fact that energy prices dropped and how are they positioning for the future.

It's a balance. Particularly on Culture Shaping it got hit because of a couple situations. I would not conclude that's an overall trend for them. More specific to these situations.

Okay, okay. Fair enough. That leads to my next question on Culture Shaping, is that -- you talked about some margin goals for that business in 2017 and 2018, margins scaling up over the next couple of years. I guess presumably you'd be having to assume some decent growth for that business to get to those margins. I don't know if you want to elaborate on --

Let me start and I'll all turn to Rich. The most important way to think about Culture Shaping in 2016 is this is a year of investment in talent that is guiding us through the continuing transition from the legacy team and legacy leadership that Senn Delaney has in place with where that business is going.

So there's five new people, as we described, in the beginning of the year that's come into the business. So there's a certain ramp-up time that each of those five have in terms of making their impact in the marketplace, as well as the impact that comes from the enhanced metric and training they are getting from the legacy partners who otherwise would be in the market full-time. And so it's the confluence of both of those that's hitting the margins this year.

What you see us saying with respect to margins going forward is more of a return to normal as that new talent becomes productive, as -- and as we believe the overall narrative around Culture Shaping continues to be strong in the broader world out there. And just pause and see if Rich would add to that.

Look, I think that's well said. I think from the standpoint of how the margins improve going forward, there's a couple things, because the construct behind some of the investments we made were not only investing in some new people, which are now in our run rate, but also in making sure that some of the legacy people were in a mentoring role rather than a pure business development role to make sure that the transaction happened as smoothly as possible and as effectively as possible.

Some of those investments, a lot of them trimmed down significantly after this year, and then a couple tail into next year. And so we do have history with this Company. You saw the legacy types of returns that could return on its EBITDA during the first three years of the business. We expect it to get back to close to those type of margins in the future, but at the same time, giving up maybe a little bit of that margin to fuel more revenue growth than just status quo. That's the balance we are talking about, Kevin.

Okay. Yes, thanks a lot. That makes sense. Thanks for taking my questions.

No problem. Thank you.

Tobey Sommer, SunTrust.

Thanks. I'm curious. Are the other large and substantial private executive search firms investing similarly into consulting services?

They are doing it in, and my answer, Tobey, is really is anecdotal, right, from what we see in the marketplace as opposed to anything that's happening on the inside. We certainly see, with the conversation around executive search, is looking to be expanded with regard to, once you are in what other advice can be given to clients?

We're doing it the way we have described. We see others participating in different ways. Exactly how much that is, is at the same speed, is a greater speed, is it a lesser speed, how are they doing it? Don't know.

So for a later date. How is Heidrick differentiating itself versus those other substantial competitors, if this is being drawn out by customers asking for more? Which makes sense? How is your approach creating a differentiated offering versus those other (multiple speakers) firms?

I think the one you touched on, which is what we are hearing from clients, and when I say what we are hearing, what we are hearing as we are out there engaging with them on the content that we are developing. And some of the most important content, which I reference is this theme of accelerating performance, which is really working with clients to answer the question not only who is the right person, if you will, the talent and leadership selection business search, but why are they the best and how can we make them better?

In the context of accelerating performance, we are looking at the client, both at the individual leader level, at the team around that leader, and then in selecting this around the entire organization. That is the essence of what accelerating performance is about at the individual talent and organization level. And we've developed a series of tools, and we've developed a methodology, which is embedding in that accelerating performances. There's a white paper that's out there. You will see a book very shortly with respect to this as well.

So we have invested in it. And we are engaging with clients in it. This why I made the reference that where we are seeing that dialogue with the client, either independent of Search or coupled with Search or coupled with Senn Delaney, we are experiencing some very high quality conversations and some very high quality assignments. And our task now is to work through how do we scale that globally in a smart way with respect to what do our clients need and how do we think about that trade-off of speed and capital?

Thank you very much.

With no further questions in the queue, I would like to turn the call back over to management for any additional or closing remarks.

I just want to thank everyone. I'll just close by saying that as you can see from our remarks, 2016 is a big investment year for Heidrick across all three of our businesses, Executive Search, Leadership Consulting, and Culture Shaping. And what you see in this quarter, but also what you see over the past nine months, is how that investment has been made, but also how the returns in the business have kept pace at the same time. So thank you for your questions, as always. We'll leave it there and we'll look forward to speaking with you again shortly. Thanks.

This does conclude today's conference. We thank you for your participation. You may now disconnect.