Heidrick & Struggles International Inc (HSII) Q1 2019 Earnings Call Transcript

Heidrick & Struggles International Inc (NASDAQ: HSII)Q1 2019 Earnings CallApril 29, 2019, 5:00 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day ladies and gentlemen and welcome to the Heidrick & Struggles 2019 First Quarter's Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder this call may be recorded.

I would now like to introduce your host for today's conference Ms. Julie Creed, Vice president of Investor Relations and Real Estate. You may begin.

Julie Creed -- Vice President, Real Estate & Investor Relations

Good afternoon everyone and thanks for participating on our 2019 first quarter conference call. Joining me on today's call is our President and CEO, Krishnan Rajagopalan and our Chief Financial Officer, Mark Harris. We posted our first quarter slides on the IR home page of our website at heidrick.com, and we encourage you to view them for additional context. But we won't be referring to specific page numbers during our opening comments.

In our opening comments and in our quarterly slides, we will refer to adjusted EBITDA and adjusted EBITDA margin. These are non-GAAP financial measures that we believe provide additional insight into our underlying results. A reconciliation between GAAP and non-GAAP financial measures can be found in the last schedule of our press release and in our supporting slides. Also in our remarks we'll be making forward-looking statements and ask that you please refer to the Safe Harbor language contained on our news release and on Slide 1 of our presentation.

And Krishnan, now I'll turn the call over to you.

Krishnan Rajagopalan -- President and Chief Executive Officer

Julie, thank you. Good afternoon everyone and thank you for joining our call. We're pleased to report another strong quarter of results continuing our positive momentum and capitalizing on market conditions that remained robust. With many thanks to our employees around the world, almost every financial and operational metric improved in the first quarter compared to last year's first quarter. Let me just highlight a few.

Net revenue increased 7% or 10% on a constant currency basis. Operating margin expanded 140 basis points to 9.6%. Diluted earnings per share improved to $0.62 from $0.53 in the last year's first quarter.

As many of you on this call know, over the last two years we've been on a journey to transform our business to become a trusted advisor offering distinctive data-driven and technology-enabled talent leadership and culture solutions that will accelerate our clients' performance. Our people, our values, and our purpose to help our clients change the world one leadership team at a time are at the core of all that we do. Reflecting our promotions, strategic hiring, and very low turnover, we ended the first quarter with 370 search consultants and 67 Heidrick Consulting consultants, the combined increase of 5% compared to the end of last year's first quarter.

We are very proud of our new class of diverse consultants promoted this year and will continue our internal training and professional development programs to support them, while also attracting new top talent to drive expansion into markets and practices where we see good opportunities for growth.

Executive Search continued to grow driven by increases in the number of consultants, search confirmations, productivity and an average revenue per search. We remain focused on working at the top of organizations and our account strategy is working. And we continue to drive strong collaboration between our Executive Search and Heidrick Consulting businesses to ensure we are bringing the very best of Heidrick to all our clients.

In Heidrick Consulting, we saw a small decline in net revenue on a constant currency basis for which there were several contributing factors none of which were material. I'm excited by a number of positive indicators in this business and confident in our growth strategy. For example, following the recent launch of our book Goliath's Revenge which talks about how established companies can thrive in the age of disruption, we had an increasing number of opportunities to introduce our clients to our digital acceleration offerings. We can advise them on how to attract the right types of leaders and talent in this new era of digital disruption and how to build a culture of continuous innovation.

The launch has led to a number of very productive conversations with our clients as well as several confirmed projects and a strong pipeline of consulting opportunities. Interests in our integrated offering of search and leadership consulting continues to grow. Last year we doubled the consulting revenue generated through the collaboration with search and we continue to gain traction in the market for our integrated offering, which just came together a year ago.

Our hiring plan for Heidrick Consulting is on track, including two new partners in Germany who will give us a much more meaningful presence in that market, a new team that's starting to gain traction in Asia and others. We remain focused on our four key initiatives in order to build on our progress, gain market share and increase shareholder value. These initiatives are to increase the scale and impact of our two businesses, increase cross-enterprise collaboration, drive a premium service experience for our clients and maintain a focus on cost containment initiatives. We are expanding our value proposition and strengthening our overall positioning as a trusted leadership advisor that can provide a wide range of executive talent and human capital solutions.

For example, as emerging technologies such as blockchain, machine learning, and robotics continue to reshape the business landscape for all of our clients, we need to stay ahead of their talent needs. To do that we have consultants working in several specialty areas including artificial intelligence and data analytics, cybersecurity, digital innovation and the Internet of Things. This month we launched a new specialty practice called blockchain and distributed ledger technology to help companies find the right talent for exploring the impacts and applications of these types of technologies to transfer assets or conduct transactions across the Internet and peer-to-peer networks.

In addition, some of you may recall that last year we introduced our Disruptive Innovators Team. These consultants advise early stage companies on the cusp of rapid growth about filling key leadership and talent gaps to help them accelerate their development. This team operates across all of our practices and regions in both Search and Heidrick Consulting, and I am pleased to report that we are now actively working with some very prominent unicorns in each of our major geographies.

I'm especially looking forward to our global consultants' meeting next month. This is an important event that brings us together to align as one firm and enables cross-enterprise collaboration between Search and Consulting. The meeting is a great opportunity to share the latest developments related to our own data-driven tech-enabled solutions and to dive deeper into how we can better serve our clients. We will use our time together to explore what is next on the horizon for our industry, how we can accelerate the pace of innovation within our firm and how we can fuel our future opportunities for growth. Thank you again to our teams around the world on a great quarter and a great start to 2019.

Now let me turn the call over to Mark to elaborate on the quarter.

Mark Harris -- Chief Financial Officer

Thank you, Krishnan. Good afternoon to everyone on the call today. We thank you for joining us. As Krishnan mentioned earlier, we achieved net revenue of $171.6 million, another historical achievement for a first quarter here at Heidrick & Struggles. This was an increase of 7.2% year-over-year or an increase of 10% on a constant currency basis and in line with the guidance we provided at the end of February. The year-over-year and the first quarter was driven by Executive Search where we saw an increase in revenue of $12.5 million or 8.6% to $158.3 million. Almost without exception, the first quarter is our seasonally slowest quarter. So we're very pleased with how we started 2019.

The Americas region had a strong growth of 15% which wasn't surprising given the first quarter GDP growth reported on Friday. Asia Pacific grew 7%, but on a constant currency basis it actually grew 12% with strong performance from our Australia, Japan, India, Middle East and Singapore offices. Europe declined 6%. However, on a constant currency basis Europe actually grew 1%. While Brexit remains a challenge and has impacted our financial services practice in the UK, the strength of our other European operations such as Belgium, the Netherlands, Switzerland and Spain allowed us to maintain confirmations and revenue comparable to the first quarter of 2018. As you can see the revenue decline in Europe was mainly attributable to currency devaluation. In summary, on a constant currency basis Search revenue increased by 11%.

Salary and employee benefits were up $9.4 million or 8.4% from 2018's first quarter, but in line with our revenue growth. $4.5 million of the increase was related to fixed compensation primarily due to talent acquisition and retention as well as inflation adjustments we made in the first quarter. The other $4.9 million was related to variable compensation associated with the growth in Search revenue. For the sixth consecutive quarter general and administrative expenses improved year-over-year. G&A was $34.4 million, down 3.3% or approximately $1.2 million.

There were savings in a number of areas but the biggest improvement was in professional service expenses. In lieu of last year's regional and practice meetings, we will have our global consultant meeting in the second quarter of 2019. We expect incremental G&A expense of approximately $500,000 pertaining to this meeting.

I'm very pleased to report that our operating income in the first quarter of 2019 increased 25% to $16.4 million. Further, operating margin expanded to 9.6% from 8.2% in last year's first quarter. These improvements in profitability were driven by a combination of revenue growth and cost containment efforts as well as improvement in productivity, some of which we believe is the direct results of the increasing adoption rate of our technology platforms.

Finally, we achieved net income of $12.1 million in the first quarter of 2019, an increase of 19% compared to last year's net income of $10.2 million. Diluted earnings per share also improved to $0.62 compared to $0.53 we had last year. We're very pleased with the bottom line gains, especially given the effective tax rate in the first quarter was 35.9%. Last year's first quarter tax rate was 21.3% but had the benefit of several discrete items in that quarter. For the full-year 2019, we are expecting an effective tax rate in the low 30% range.

Now let's turn to the balance sheet. First you'll see three new line items related to our adoption of ASC 842, the new accounting standard impacting the treatment of our leases. Additional information about our adoption is provided in our 10-Q financial statements footnote six. As you will see there is no impact to cash and cash equivalents, the income statement or shareholders' equity. Second, at the end of the first quarter, we nearly doubled our cash and cash equivalents to $114.4 million compared to $61.4 million net cash at the end of last year's first quarter, a great start to 2019. As a result of our strong operating cash flows, we did not need to borrow to fund our working capital needs as we had done in the past two years.

Finally, I'm also pleased to announce that we will be paying a $0.15 per share cash dividend in May. As a reminder, last quarter we increased our quarterly cash dividend to $0.15 per share from $0.13.

Looking at the second quarter, we expect that net revenue will be in the range of $172 million to $182 million, compared to $183.1 million in last year's second quarter. It is important to remind you that last year's second quarter net revenue was a record, up 20% year-over-year. The midpoint of our guidance in last year's second quarter was $165 million and we beat that by $18 million mainly driven by an unusually high amount of unforeseen upticks. We have not assumed that level of upticks in our guidance for this year's second quarter and we expect to meet our guidance with our core business.

In summary, we delivered another outstanding quarter and we have every intention of continuing our momentum. We will maintain our discipline with regard to balancing investment for future growth and always continue to be cost conscious.

With that, we'll be happy to take your questions. Katherine, we're ready to take the questions now.

Questions and Answers:

Operator

Thank you. (Operator Instructions) And our first question comes from Kevin McVeigh with Credit Suisse. Your line is open.

Kevin McVeigh -- Credit Suisse -- Analyst

Great, Thanks very much. Hey, your thoughts on Europe, just it sounds like a lot of the kind of headline was more currency. Are we in -- because it sounds like there has been some optimism kind of in some of the earlier cycle indicators. Any thoughts around that just in general and then just thoughts on kind of client engagements and the tonality of the clients, particularly in Europe?

Krishnan Rajagopalan -- President and Chief Executive Officer

Yeah, Kevin, thanks for your questions. Krishnan here.

Kevin McVeigh -- Credit Suisse -- Analyst

Hey, Krishnan.

Krishnan Rajagopalan -- President and Chief Executive Officer

Look, I think that in Europe I mean if you look at confirmations for us, we're seeing a good story there, OK. So it's balanced out, it's different than it was before where we had most of our confirmations coming out of the UK. We've got a balanced story across Europe now. So I think that's the good news that we see and that's sort of, if you were to talk just in general about Europe, I think that's the sentiment that's out there. So we're feeling good about that. There is different flavors in each of the different countries and there's great client engagement as well. So we're not seeing a lack of client engagement. It's just the mix has varied a little bit now from where we were about a year ago.

Kevin McVeigh -- Credit Suisse -- Analyst

Got it. And then just on the upticks in terms of Q2, are you assuming any in there or is it just at not the same pace as Q2 of last year? And then can you just remind us is that margin incrementally much higher than the core or how should we think about that from an EBITDA perspective?

Mark Harris -- Chief Financial Officer

Sure. Let me try to help you out with that. So if you remember when we talked about in Q2 last year we had a very unusual amount of upticks that come in. Typically it's somewhere between 10% and 15% of our revenue was in upticks and it was clearly on the high end if not past the high end. My comment would be we only assume our normal upticks as we have to under the accounting rules. As you know under the new revenue recognition accounting rules that we had to implement last year there is a certain volume of upticks based on historical perspective we have to book. We're just not assuming the indulgence, if you will, that we had in Q2 last year, the overshoot that we saw kind of come in and we tried to explain.

Kevin McVeigh -- Credit Suisse -- Analyst

Got it. And then just from a margin perspective, Mark, is that higher or would it be pretty consistent with the kind of normal?

Mark Harris -- Chief Financial Officer

It would be higher than the normal margin you see in the financial statements, because the only thing -- your fixed is already covered, so now it's just really kind of the incremental bonus dollars that would be associated with the uptick would obviously come out as an expense but it would have nothing else. G&A and everything has already been covered off. So if you look at it that way then, yes, technically it'd be much higher than normal.

Kevin McVeigh -- Credit Suisse -- Analyst

Awesome. (ph) Thank you.

Krishnan Rajagopalan -- President and Chief Executive Officer

Sure.

Operator

Thank you. And our next question comes from Tim McHugh with William Blair. Your line is open.

Trevor Romeo -- William Blair & Company -- Analyst

Hi. Good afternoon. This is actually Trevor Romeo in for Tim. Thank you for taking the call. First just wanted to follow up on the upticks. Was there also a high amount of upticks in Q3 and 4 of last year? And if so, how much of an impact would that potentially have on the second half?

Mark Harris -- Chief Financial Officer

I don't remember the actual amount. In Q3 there was, again, slightly above average in terms of the uptick. So it wasn't as pervasive (ph) as it was in the second quarter. In Q4 it was very much normalized. So it was what we expected to come in, was generally what came in. So that was the way that I remember it.

Trevor Romeo -- William Blair & Company -- Analyst

Okay. Got it. Thanks. And then, so on Heidrick Consulting, you called out the end of the several large projects in Europe. Just any sense of maybe how large those projects were and whether you see those projects being replaced quickly or is $13 million revenue kind of closer to the run rate going forward for that segment?

Krishnan Rajagopalan -- President and Chief Executive Officer

Yeah. It's Krishnan here. Look I don't think those sides of those projects were material. I think basically we were off by, If you adjust for currency, by say $600,000 or so and that's two projects, I am going to call it, that are booked either on the 31st or the 1st. And that's really what explains the difference for us with Heidrick Consulting.

Trevor Romeo -- William Blair & Company -- Analyst

Okay. Thanks that's helpful. And maybe just one more if I could, it looks like the number of confirmations for the Search segment were down a little bit year-over-year in March. Was there anything unusual as the quarter progressed there and can you give any indication maybe on how confirmations are trending thus far into April?

Mark Harris -- Chief Financial Officer

We take the trend in April, if you will, into the guidance that we give. So the only thing I would tell you is that the confirmations, the volume confirmations came in within expectations. So we're very happy about that. And April, obviously given the guidance that we've given, is similar. So it's about as much light as I can shed in terms of the April result.

Trevor Romeo -- William Blair & Company -- Analyst

Okay. Got it. That's helpful. Thank you.

Operator

Thank you. (Operator Instructions) And we have a question from Tobey Sommer with SunTrust. Your line is open.

Tobey Sommer -- SunTrust Robinson Humphrey -- Analyst

Thank you. I was wondering if you could give us an update on your plans to expand your consulting and non-search businesses. There was a notable transaction in the space which one of the private players moved that direction as well. So I'm just kind of curious how your plans are progressing and how you plan it differentiated if many of the multinationals kind of have some exposure outside of Search how you'll be able to differentiate yourself? Thanks.

Krishnan Rajagopalan -- President and Chief Executive Officer

Sure. Yeah. It's Krishnan here. Look, so we have strong growth plans for Heidrick Consulting, number one, let me just start there, where we're not only expanding the offerings as we talked about with digital acceleration and a few other things that we're doing in that practice but we're hiring into Heidrick Consulting as well. So we've got strong ambitions there to continue to grow that practice. I won't specifically comment on the acquisition that you're talking about just beyond what's available in the open market on that, OK, because it's under legal restrictions that often occur with these types of things. But let me just say that I think that the human capital space, one, is a big space and a fast-growing space as well. Number two, I don't think those assets were the perfect assets for Heidrick. we've got a very strong culture offering and it wouldn't have complemented that offering. And then just looking at the publicly available information, it just plays at a lower level than where we aspire to play if you do the math on revenue and people et cetera. So we want to aim -- continue to aim at the top in terms of what we're continuing to look at in the marketplace and where the valuations are right we're ready to be prepared to have conversations on that and that's the way we look at it. And so I know it's a big space and so I don't think that playing in a lower segment is going to impact Heidrick's business.

Tobey Sommer -- SunTrust Robinson Humphrey -- Analyst

Okay. Thank you. In the Executive Search business what sort of senior revenue generating headcount growth should we anticipate this year? And then I was wondering if you could also comment on the trends in financial services down a little bit in the quarter but wondering what your client partners focused on that area are telling me about demand as you work your way through the rest of '19?

Mark Harris -- Chief Financial Officer

Just repeat the first question and I'll get to that. I got the financial services. I think you had two questions, oh, head count, yeah. (multiple speakers)

Tobey Sommer -- SunTrust Robinson Humphrey -- Analyst

Head count -- head count growth, yeah.

Mark Harris -- Chief Financial Officer

Yeah, look, so I think consistent with what I've said before, look, we're not trying to grow headcount inside of Search at the rates that we had historically. We've got a very, very strong pipeline of talent. We've promoted 24 people to be consultants. This year (ph) 28 people I believe to be -- 24 people to be consultants this year which is terrific. And so that's the primary focus. We will do strategic hiring around that. We'll continue to do that in growth areas but it's not going to be at the levels that you've seen for Heidrick in the past in terms of that.

And your second question was --?

Julie Creed -- Vice President, Real Estate & Investor Relations

Financial services.

Mark Harris -- Chief Financial Officer

Yeah, second question on financial services, we're clearly seeing as you saw in the numbers the financial services marketplace was a little bit slower in Europe in particular, OK. So that's where we're feeling the effects of financial services right now. In other markets it appears to be holding up. I think in general decisions are taking a little bit longer than they have in the past. But having said that there is some positive news in the market as we read each and every day. So we're optimistic about that as well. So it was really Europe financial services for us.

Tobey Sommer -- SunTrust Robinson Humphrey -- Analyst

Thank you very much.

Operator

Thank you. And I'm showing no further questions at this time I'd like to turn the call back to management for any closing remarks.

Krishnan Rajagopalan -- President and Chief Executive Officer

Thank you again for joining us. We're quite pleased that the market remains robust despite the usual quarter-to-quarter and geographic variability. We're going to continue to work hard to grow Heidrick Consulting and further our overall business transformation. I want to again thank our teams around the world for their tremendous efforts. We'll look forward to talking with you again in July. In the meantime, we're going to be doing some road shows in New York and in Boston in May and June. Please reach out to us if you've got any questions. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.

Duration: 25 minutes

Call participants:

Julie Creed -- Vice President, Real Estate & Investor Relations

Krishnan Rajagopalan -- President and Chief Executive Officer

Mark Harris -- Chief Financial Officer

Kevin McVeigh -- Credit Suisse -- Analyst

Trevor Romeo -- William Blair & Company -- Analyst

Tobey Sommer -- SunTrust Robinson Humphrey -- Analyst

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