Heidrick & Struggles International Management Discusses Q1 2014 Results - Earnings Call Transcript

| About: Heidrick & (HSII)

Heidrick & Struggles International (NASDAQ:HSII)

Q1 2014 Earnings Call

April 29, 2014 10:00 am ET

Executives

Julie Creed - Vice President of Investor Relations and Director of Workplace Strategies

Tracy R. Wolstencroft - Chief Executive Officer, President and Director

Richard W. Pehlke - Chief Financial Officer and Executive Vice President

Analysts

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Stephen Sheldon

Kevin D. McVeigh - Macquarie Research

Kevin M. Steinke - Barrington Research Associates, Inc., Research Division

Operator

Good morning. This is the Heidrick & Struggles' First Quarter 2014 Conference Call. This call is being recorded. It may not be reproduced or retransmitted without the company's consent. [Operator Instructions] Now we will turn the call over to Julie Creed, Vice President of Investor Relations and Real Estate. Please go ahead.

Julie Creed

Good morning, everyone, and thank you for participating on our first quarter 2014 conference call. Joining on today's call is our CEO, Tracy Wolstencroft; and Rich Pehlke, Chief Financial Officer.

As a reminder, we'll be referring to some supporting slides that are available on our website at heidrick.com, and we encourage you to follow along or print them. As always, we advise you that this call may not be reproduced or retransmitted without our consent.

And in today's call, 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 19 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 in the bottom right-hand corner of each slide.

And Tracy, before I turn it over to you, I'm going to ask the operator to check into a lot of background noise that we're hearing on our end, a lot of feedback.

All right, Tracy, I'll turn it over to you and maybe Wes [ph] can check on that.

Tracy R. Wolstencroft

Thanks, Julie, and good morning. It's been just under 3 months since I joined Heidrick & Struggles. And as I said on our -- my first call back in February, my top priority is our people, getting to know them and working to establish and reestablish their confidence. In that context, I have traveled to our offices in Europe, Asia, Canada and throughout the United States to meet with employees and clients.

Each meeting reinforces an observation that I've had since my first days here. Our people are very committed to Heidrick & Struggles and to our clients. We have strong client relationships, and the opportunity is there to leverage and expand those relationships across all of our service lines. In general, economic conditions continue to show improvement. Now is the time to capitalize on the increasing confidence of Board of Directors and executive teams, who want to invest and grow.

Our first quarter was a step in the right direction. There were some encouraging signs of progress. Revenue grew 8% year-over-year. A good portion of this growth was driven by our European region, which achieved its fourth sequential quarter of growth. First quarter Executive Search confirmations were the highest in 3 years and consultant productivity increased year-over-year. And for the first time in 10 quarters, there was a sequential increase in consultant headcount.

There is still much to be done. These results also illuminate the work that is required to improve what flows to our bottom line. Delivering improved growth and profitability requires us to leverage our capabilities and to go to market as one integrated economy.

Let me turn it over to Rich to give you a review of our results, and then I'll come back with the summation of the priorities that we see going forward.

Richard W. Pehlke

Thanks, Tracy, and good morning, everyone. I'll review some of the key financial and operating metrics and explain select variances on those slides.

We begin looking at Slides 2, 3 and 4, where consolidated net revenue in the first quarter was $111.1 million, up 8% or $8 million from last year's first quarter. Executive Search and Leadership Consulting revenue grew about 7% year-over-year or approximately $7 million. Culture Shaping revenue increased 17% or just under $1 million.

Europe, shown on Slide 5, was the key driver of the year-over-year revenue growth in the quarter. This region was up almost $8 million; $7 million on a constant currency basis. We ended the quarter with 87 consultants in that region, up from 83 at the end of December, 3 fewer than March 31 of last year.

Virtually, every industry practice group in Europe contributed meaningfully to the year-over-year growth. Improvement in consultant productivity and an increase in the average revenue per search also helped drive the results. Along with revenue increase, Europe also achieved a significant improvement in operating income and operating margin.

On Slide 6, revenue in Asia Pacific increased 5% year-over-year or $1 million. Consultant headcount increased to 87, up from 84 at the end of the fourth quarter, and it's flat for the first quarter of last year. Consultant productivity improved slightly in this region. The Global Technology & Services practice was a key driver of growth, but Consumer Markets and Financial Services also contributed to the year-over-year progress.

The growth in Europe and Asia Pacific was partially offset by the Americas region, where revenue declined about 3% or approximately $2 million. Productivity in the Americas improved substantially. The Consumer Markets, Financial Services and Global Technology & Services practices achieved year-over-year growth. However, these improvements were not quite strong enough to offset the decline in consultant headcount. We ended the quarter with 129 consultants, down from 148 a year ago.

Looking at the industry practices globally, on Slides 8 and 9, you'll see the 3 of the 4 largest industry practice groups achieved double-digit year-over-year growth in revenue: Consumer Markets, Global Technology and Financial Services. What was encouraging is that we experienced revenue growth in each of the 3 regions in all of these practices as well.

Tracy touched on consultant headcount earlier. Referring to Slide 10, we started 2014 with 293 Search and Leadership consultants. We ended the first quarter with 303 consultants as a result of our hiring efforts so far this year. Developing our colleagues is as important to us as attracting new talent to the firm, and Heidrick has a long history of promoting and developing from within. This year, our annual promotion cycle resulted in 15 of our best being promoted to principal consultants effective April 1, and that number will be reflected in the second quarter.

Turning to Slide 11. Q1 annualized consultant productivity was $1.4 million compared to $1.2 million in the last year's first quarter. The trailing 12 months consultant productivity has shown stability and is trending upwards from $1.4 million.

As you can see on Slide 12, which is specific to Executive Search, search confirmations in the first quarter increased 8.5% year-over-year and were higher than in the 2012 first quarter as well. So as Tracy mentioned, the best start we've had in 3 years.

Slide 13 shows the variability in revenue per search from quarter-to-quarter. And we provide you with the average revenue per search on a trailing 12 months basis where you can see that it has held steady over the last few quarters at about $113,000.

I mentioned earlier that reported revenue from Culture Shaping increased almost $1 million in the year's first quarter, but this doesn't fully explain the results. You may recall that in last year's first quarter, we were unable to recognize $2 million of pre-acquisition deferred revenue because of the purchase accounting adjustments. So if you take into account the unrecognized revenue in both quarters, the comparable results of the business would reflect a slight decline in Culture Shaping. Because of the size of this business and the timing of project initiations, which are driven largely by our clients' activity, we will likely continue to see variability in quarterly results from this business.

Referring now to Slides 14 and 15, salaries and employee benefits expense was $75.9 million, representing 68.3% of net revenue. Year-over-year salaries and employee benefits expense increased $4.4 million or 6.2%. Of the $4.4 million, variable compensation, mostly related to bonus accruals, was up $7.5 million. Europe's revenue growth was a key driver of this increase. Last year this time, there was virtually no accrual for Europe in the first quarter. Fixed compensation expense declined $3 million, mostly related to the lower headcount compared to last year.

Turning to Slide 16. General and administrative expenses increased $3.3 million or 10.7% to $34.4 million, representing 31% of net revenue. Three items account for most of this increase. One is higher-than-normal legal and professional services fees, most of which were project-specific and not expected to recur. The second is a onetime state franchise tax matter. And the third is a year-over-year increase in unbillable travel-related expenses related to an increase in new business development and training activity. We should see our run rate for expenses be lower than the first quarter for the remainder of the year.

Moving to Slide 17, 18 and 19. Adjusted EBITDA in the first quarter was $6 million compared to $6.6 million in the comparable quarter of last year. And the adjusted EBITDA margin was 5.4% compared to 6.5%. The decline mostly relates to the higher G&A expenses I just referred to.

On Slide 24, our cash position remains strong, and we have the financial flexibility to continue to invest and grow the business. Cash and cash equivalents at March 31 were $101.4 million or $67.5 million net of our debt. Reflecting the payment of bonuses in the first quarter, cash used in operating activities was $74.9 million compared to $69.1 million used in last year's first quarter.

Our cash position builds throughout the year as we accrue for bonuses which are paid out in the spring of the following year. We paid out approximately $89 million in February and March related to variable or deferred bonus payments. And this month, we'll pay approximately another $7 million related to payroll taxes.

Looking at the second quarter, our Executive Search backlog is shown on Slide 25, and monthly confirmation trends are shown on Slide 26. We are forecasting first quarter net revenue of between $120 million and $130 million. As always, the factors on which we base our forecast include our current backlog, confirmation trends for Executive Search and Leadership Consulting, as well as the anticipated fees, the expectations for our Culture Shaping services, the number of consultants, the current economic climate and stable currency rates.

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

Tracy R. Wolstencroft

Thanks, Rich. The #1 focus you heard from me last quarter remains the same. Strengthening our business begins with the priority we place on our people. We're working to ensure that we have the very best consultants and that they have the platform to provide clients unparalleled service and value as their trusted advisors. We must foster collaboration, trust, teamwork and the ability to embrace change. This starts with attracting great people and investing in them through training, developing and mentoring.

With our people and the clients they serve as our top priority, there are 3 actions that need to happen more consistently and with scale to accelerate growth at Heidrick. One, collaborate across the regions and practices; two, collaborate between Search, Leadership Consulting and Culture Shaping; and three, ensure that the best ideas of our people are reaching our clients.

To be clear, clients are the center of our business. To meet their needs, we must seamlessly bring together our regional and practice expertise and provide an integrated service offering. It is also how we will increase revenue and profitability. One example of how this can work to meet the changing dynamics of the marketplace is our recent placement of the President and CEO of a large nonprofit in the United States. We differentiated our firm by going beyond our capabilities to present not only a qualified slate of candidates but provided an assessment of the cultural fit of each candidate. Interestingly, the search committee didn't just want to know if the candidate would fit their culture. They also wanted to know what kind of cultural change the candidates could bring to and develop at the organization. As culture increasingly becomes more closely linked to an organization's long-term success, our Search, leadership Consulting and Culture Shaping capabilities provide a uniquely integrated value proposition. It's the kind of integrated leadership expertise that I know our firm can increasingly provide to our global clients.

To further underscore the importance of our client focus and to further increase consultant accountability and collaboration, I've asked Jory Marino to be Head of Global Markets and Krishnan Rajagopalan be the Head of Global Practices. They highlight the importance of our client coverage matrix, namely, both geographic and industry practice. Jory previously led the Americas region and served as the Interim CEO. He will oversee the performance of our 3 geographic regions.

Krishnan has led our Global Technology & Services practice for the last 5 years. He will have responsibility for all the industry and functional practice groups. Together, they will drive our holistic, one-firm approach that brings the best of our firm to our clients in every case. Developing deeper, more strategic relationships will help us deliver profitable results for both our clients and our firm.

A separate growth initiative will be to expand the reach of our CEO and Board of Directors practice. Heidrick is known for the work that we do at the top of leading organizations. When we succeed at the CEO and board level, our brand impact in the market is greatest and has the potential to help us everywhere in our business. The goal is to establish deep, senior relationships across our client base to enhance the brand value of every practice, every region and every service line in which we are engaged.

Our people, the work we do with our clients and the brand that results are the core attributes we need to leverage to grow and increase profitability.

We pause there and open it up to questions for Rich and myself.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Tobey Sommer of SunTrust.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Wanted to ask my first question about the employee retention or attrition. In the initial response to the bonus payout then, what has that been like? And are there any changes to compensation, either format or payout, that you're evaluating on a go-forward basis?

Tracy R. Wolstencroft

Tobey, it's Tracy. The -- first of all, on consultant headcount, we're encouraged by the comments that I made with regard to this being the first time in a number of quarters that we've seen a sequential increase in consultants, number one. Number two, the compensation as we referenced in the first quarter was one that we felt hit the mark in terms of rewarding our consultants and employees for year of 2013, which had a number of challenges, and yet through that, the productivity of those consultants increased. And for the moment, there is no change with respect to any thoughts going forward on how we assess compensation. More work to do on that.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Okay. What were the gross hires and promotions and losses of consultants in the quarter?

Julie Creed

Tobey, this is Julie. We -- in the quarter, we hired 21 people. And 11 people left for a variety of reasons.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Okay, perfect. I wanted to ask about Financial Services, which was up in the quarter. And historically, the demand for that has been a little bit better kind of around this period of the year or maybe in the next couple of months. What's your -- the outlook for Financial Services in 2Q and beyond?

Richard W. Pehlke

Tobey, this is Rich. Financial Services remains one of our largest and most important practices. The area where we're seeing a lot of good activity is in the asset management and risk areas, which are broader than just maybe servicing the large banks, where you see a lot more volatility in headcount. We've had some very creative efforts within the practice to drive growth and opportunity in these areas. So we're -- it's a much more balanced approach. I think we have a good outlook for the industry overall or for the sector overall. I don't think it'll lead the practices in terms of its growth rate. I think we're probably thinking that maybe there might be higher growth in areas like Technology. But it certainly, as we indicated, is one of the 3 big factors that contributed to the quarter.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Okay. My last question is about Culture Shaping and I'll get back in the queue. Do you feel like you have the appropriate scale to compete and do work for your clients in that area now or you need to invest a little bit more? And secondly, do you have a sense for whether sort of private competitors that are out there in the global arena have invested as much as you or maybe you have a leg up on them in this regard?

Tracy R. Wolstencroft

Tobey, on Culture Shaping, we don't believe that we need to go outside and invest more. What we do need to do is invest more internally. What I mean by that is to more forcefully integrate the Culture Shaping offering that we have and connect it to our existing clients as well as perspective ones. But in terms of any need to go outside, we don't see that.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Relative to the competitors and what their offerings are in this regard, does this distinguish your nature of project?

Tracy R. Wolstencroft

It's a good question. Having Culture Shaping at Heidrick is a distinguishing characteristic of the firm. The broader question about the competition and the number of players that are out there. As you know, it's a highly, highly fragmented sector. And so it is not easy to look at a -- from my old days to look at – a proverbial [indiscernible] table of Culture Shaping firms 1 through 5 and see how we marked. What we know is from the dialogue and the [indiscernible] we have with clients and the number that we're having, that what we have offers a dimension that they don't see in many other places.

Richard W. Pehlke

Yes, Tobey, if I could build on that a little bit. The last point that Tracy touched on is very important. From the standpoint of that, one of the things that distinguished our offering is the fact that we can integrate into the human resource sorting systems of our clients with some of the technology that we have. So it's not only of a high-end, a very consultative effort that starts at the top, but it works down very thoroughly within large-scale organizations and can be -- become part of their ongoing efforts in learning and tied right to their human resources. And that establishes the long relationships with clients. So it's a very unique offering and one that's been very successful.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Let me just refine the question a bit. I was kind of referring specifically to your large Executive Search competitors as opposed to Culture Shaping competitors. So is this aspect of your offering, Culture Shaping, a distinguishing feature that those other large Executive Search players, primarily the private ones, offer or not?

Tracy R. Wolstencroft

The short answer, Tobey, is yes. We think it's distinguishing to have the Culture Shaping experience of Senn Delaney part of Heidrick.

Operator

The next question comes from Tim McHugh of William Blair.

Stephen Sheldon

It's Stephen Sheldon for Tim. First, you talked about some variability in the Culture Shaping business, but you're still down some sequentially. Is there any seasonality impact in the first quarter or -- and how should we think about the seasonality of that business moving forward through 2014?

Richard W. Pehlke

Yes. In some cases, there is -- seasonality might not be quite the right word, but it certainly is a -- as I mentioned in my comments, it's very impacted by client behavior and how they go about doing the process of some of the work with our consultants and with our teams. A great example that probably slightly impacted our run rate this year is the fact that, for example, one of our major verticals is health care, and there's been a lot of issues going on in the healthcare space relative to Obama Care and how companies are doing with it. And so if you think about it from a client standpoint, clearly, looking at their roadmap, about where they're going with their business might impact ways in which they work on the development of their organizations. Having said that, that doesn't mean the work goes away, but it certainly could impact the timing of when work starts and when work finishes. And how they go to then -- they progress to the next stage because usually, when you experience our activities, new culture in period of 1 to 3 stages in terms of the type of work that's done with the client. The technology and the more integrated -- down in the organizations that the later stage and that's a little bit more of the newer type stream, the ones that are more variable are in the first and second stages where you're working with the top teams of the organization. And that's clearly driven by when the client wants to start the work.

Stephen Sheldon

Okay, that's helpful. On the G&A, the expense side. How -- you talked about the 3 kind of nonrecurring items. How big of a -- how big were those items in the quarter?

Richard W. Pehlke

Yes. There was a little disappointing to me, and it probably cost us couple of million dollars at least. The franchise tax matter was about $800,000. And the level of nonrecurring expenses were close to $1.5 million in terms of the Professional Services. I think our run rate will come down back to where in -- I think at the end of the day, we're going to get closer to where we expected G&A to be, if not drive a little more out of the business. But in a business our scale and sometimes when some of these metrics come in, and a great example is the franchise tax matter, we are notified by the state of that at the end of the quarter, and all of the sudden, we had an $800,000 impact and it's meaningful. So we're going to appeal that and -- but we still recorded the liability, and we’ll-- whatever happens over time, we'll finalize it through the financials. But I really see that the run rate should average and weigh down a little bit by a couple of million dollars.

Stephen Sheldon

Okay. And then last one, if I could. In the Americas, just kind of curious how demand kind of progressed through the quarter into the first quarter, second quarter in April? Any notable change there?

Tracy R. Wolstencroft

Yes. So in Americas, the numbers, as you saw, consultant headcount of 19 year-over-year at this point and yet productivity up. And that productivity speaks to the demand in the marketplace. It also speaks to the way that we are targeting more sharply our client base. So clearly, we are looking to rebuild where we have lost some consultants. We're looking to invest more. But we've been able to take the group that we have and through their increased productivity to deliver strong results.

Operator

The next question comes from Ty Govatos [ph] of TG Research.

Unknown Analyst

Rich, a couple of things. On the backlogs, when you look at those, does it indicate that the Americas, despite the decline in headcounts, will rebound?

Richard W. Pehlke

As Tracy has just indicated, I think it definitely does. In this quarter, we experienced a little bit higher level of deferred revenue in terms of just the way several of our confirmations were flowing in some of the business activities, so I feel very good about the range I gave for the second quarter. But I think it really speaks to the fact that Americas is still our strongest region and our largest region. And as Tracy indicated, when you think about the fact that year-over-year, we were down in headcount but almost made it all up in productivity is a pretty strong sign.

Unknown Analyst

It is. You said 10 promotions will show up in the second Q consultant count?

Richard W. Pehlke

15, 15.

Unknown Analyst

15. And the tax rate, any ideas for the year? Still in about 50%.

Richard W. Pehlke

Yes, the annual rate is probably around -- the annual rate is around 50%. You're spot on. Obviously, because of the way our income flows, not rate of return, through the year, it's unusually high in the first quarter.

Operator

And our next question comes from Kevin McVeigh of Macquarie.

Kevin D. McVeigh - Macquarie Research

I apologize if you had mentioned this, I jumped on late. You saw real much rebound in Europe and kind of last quarter, I think we were thinking that you couldn’t really count on the economy. Was there anything specific that drove that? And how should we think about that over the balance of the year?

Richard W. Pehlke

Sure, Kevin, it's Rich. A couple of things. I think there was a little bit of rebound in the economy in terms of -- I think the business climate is better. I don't think it's robust, but it certainly is better. And certainly, we saw impact of it in 2 of our -- especially in 2 of our areas, U.K. and Germany, which was refreshing to see. I think there is another factor in that we've seen a nice rebound by a couple of our consultants who maybe have had tough periods when the economy slowed down. But even more importantly, that was an area that you will recall, a couple of years ago, got hit hard by attrition and some of the people we've hired, they really stepped up and filled voids and done a nice job of leveraging the brand and building a nice run rate of business. So we've seen an improvement slowly building and finally breaking through a little bit in this quarter, and we're encouraged that we can keep the momentum going, but it's nice to see.

Operator

At this time, we have one question remaining in queue. [Operator Instructions] We will take our next question from Kevin Steinke of Barrington Research.

Kevin M. Steinke - Barrington Research Associates, Inc., Research Division

I was -- you referred to a separate growth initiative to expand the board and CEO practice. Do you feel like that's something you can do with resources you have in-house? Or is that going to be a targeted focus of your hiring efforts going forward?

Tracy R. Wolstencroft

Kevin, the short answer is both. There is more we can do to target, not only existing clients, but new ones. There is more we can do with our client base to cross the service offerings that we have across core Search, Leadership Consulting and Culture Shaping. And then there are some -- there is talent out there in the marketplace away from Heidrick that we're interested in having a dialogue with who we can bring into our CEO and board practice. So it's both.

Kevin M. Steinke - Barrington Research Associates, Inc., Research Division

Okay. Do you think that it changes the kind of the metrics in terms of what you'll have to pay out to bring people in? Or does -- should that just fit into your model now in terms of salary and employee benefits expense?

Richard W. Pehlke

I think if fits into the model.

Operator

It appears there are no further questions at this time.

Tracy R. Wolstencroft

Okay. Thank you, thank you very much. We look forward to talking to you in the quarter.

Julie Creed

Thank you.

Operator

Thank you, and that does conclude today's conference call.

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