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.

Stephen Sheldon Bradford Alan Evans - Heartland Advisors, Inc. Kevin D. McVeigh - Macquarie Research.

Please stand by. We're about to begin. Good morning. This is Heidrick & Struggles Second Quarter 2014 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 morning, everyone, and thank you for participating in Heidrick & Struggles Second Quarter 2014 Conference Call. Joining me on today's call is our CEO, Tracy Wolstencroft; and Rich Pehlke, the 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. Also in today's call, we'll be using terms adjusted EBITDA and adjusted EBITDA margins.

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 20 in our supporting slides.

Throughout the course of our remarks, we'll be making some 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 slides numbers that we'll be referring to are shown in the bottom right-hand corner in each slide.

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

Thanks, Julie, and good morning, everyone, and thank you for joining this morning's call. Our second quarter results reflect more encouraging signs of progress. Revenue growth was the biggest driver, up 12% year-over-year. Europe achieved its fifth sequential quarter of growth and was the biggest contributor to the quarter, up 34%.

Second quarter Executive Search confirmations and average revenue per search were both up year-over-year and sequentially. Productivity reached $1.6 million in revenue per consultant, the highest since the second quarter of 2008. And, importantly, we achieved another sequential increase in consultant headcount.

The improvement in adjusted EBITDA and operating income in the second quarter reflects the power of achieving greater scale in our business. Our reported 9.2% operating margin is the highest since the fourth quarter of 2009, but we need to increase it further. There's so much to be done to grow revenue and improve the flows to our bottom line.

To deliver consistent improvements in growth and profitability, we will leverage our capabilities and go to market as one integrated firm. I'll have more to say about that after Rich gives you a review of our results..

Thanks, Tracy, and good morning, everyone. I'll review some of the key financial and operational metrics and touch on some of the variances. Slides 2, 3 and 4 indicate what Tracy has already highlighted. Consolidated net revenue in the second quarter was $136.1 million, up 11.5% or a $14 million increase from last year's second quarter.

Executive Search and Leadership Consulting revenue grew about 9% year-over-year or approximately $10 million. Europe, shown on Slide 5, was the key driver of the year-over-year revenue growth in this segment, almost up $8 million, or $6 million on a constant currency basis.

The Financial Services, Industrial and Global Technology & Services practices were the key drivers of growth in this region. We ended the quarter with 89 consultants in Europe, the same as at the end of June last year. But an improvement in consultant productivity and an increase in the average revenue per search helped drive strong results.

Along with the revenue increase, Europe also achieved a significant improvement in operating income and operating margin. Revenue in the Americas region, which is shown on Slide 6, increased about 3% compared to last year's second quarter.

Good growth from the Consumer Markets and Global Technology & Services practices were partially offset by declines in the Industrial and Healthcare & Life Sciences practices. Consultant headcount was lower by 4 compared to last year, but productivity improved as did the average revenue per search.

Operating income was essentially the same as last year and the operating margin was 27.2%. As shown on Slide 7, revenue in Asia Pacific was flat compared to last year at $25.1 million. On a constant currency basis, revenue increased about 2%.

Growth in Global Technology and Services, Consumer Markets and Healthcare & Life Sciences practices were offset by a decline in the Industrial practice. Consultant headcount at the end of the second quarter was 87, the same as in last year's second quarter. Productivity was unchanged and the operating margin was the same, 11.7%.

Looking at the industry practices globally, on Slides 8 and 9, you'll see that the Consumer Markets, Financial Services and Global Technology & Services practices achieved double-digit growth, while the Industrial practice was down 6%. The decline in the Industrial practice was specific to the Americas and Asia Pacific regions.

Now looking at our Culture Shaping segment on Slide 10. Revenue increased 72% or just under $1 million. It was a very good quarter for Culture Shaping, but I will remind you of some of the additional context.

Our reported results this year did benefit from favorable comparisons due to deferred revenue that we were unable to recognize in 2013 from Senn Delaney as a result of purchase accounting, which was $1.5 million in last year's second quarter and only $166,000 in this year's second quarter.

But even taking that into account, the year-over-year increase of revenue was a very strong 37%. Also recall what we said in our discussion of the first quarter results, that because of the size of this business and the timing of project initiations, there could be some variability in quarterly results.

If you compare Culture Shaping results for the 6 months of 2014 against the first 6 months of 2013, and add back the unrecognizable revenue, Culture Shaping revenue growth was approximately 11%.

More importantly, you'll see that the Culture Shaping segment achieved an operating margin of 14% in the second quarter, and 5% for the first 6 months, and it was accretive for both quarter and year-to-date periods. Referring to Slide 11. We ended the second quarter with 311 consultants.

Our year-to-date growth in consultant headcount largely reflects our hiring efforts to date as well as our annual promotion process. Developing our colleagues is as important to us as attracting new talent to the firm, and Heidrick has a long history of successfully promoting from within.

This year, our annual promotion cycle resulted in 15 of our best being promoted into the consultant ranks effective April 1. Turning to Slide 12. Second quarter annualized consultant productivity improved to $1.6 million compared to $1.5 million in the last year's second quarter.

The trailing 12-month consultant productivity is now running at $1.5 million. We do expect that -- we will see some variability in that metric when additional investments in consultants are made. But it was a good trend and we are pleased to see the results in the quarter.

As you can see on Slide 13 which is specific to Executive Search, search confirmations in the second quarter increased 3.5% year-over-year, and were the highest they've been in 11 quarters. Slide 14 shows the average revenue per search, $117,400 in the quarter and running at $115,100 on a trailing 12-month basis. Referring now to Slides 15 and 16.

Salary and employee benefits expense increased $9 million -- $9.1 million to $92.1 million, overall, representing 67.7% of net revenue. Variable compensation increased $9.5 million as a result of the higher revenue. Like in the first quarter, Europe's year-over-year growth in revenue was a key driver of this increase.

We were pleased to see that fixed compensation expense declined about $500,000 during the same period. Turning to Slide 17. General and administrative expenses declined $1.8 million, or 5% to $31.4 million, representing 23.1% of net revenue. The decrease came from a number of areas, but the largest decline was in Professional Services fees.

In the third quarter, we'll see additional G&A expense of approximately $2 million related to our Global Partners' meeting, which we held earlier this month in Chicago. Moving to Slides 18 through 22.

Adjusted EBITDA in the second quarter was $18.9 million compared to $11.9 million in the comparable quarter of last year, and the adjusted EBITDA margin was 13.9% compared to 9.7%. Operating income in the second quarter increased $12.5 million, and the operating margin improved to 9.2%.

The improvements mostly reflect the higher net revenue, helped by the decline in G&A expenses.

If you turn to Slides 23 and 24, we reported net income in the second quarter of $3.8 million and diluted earnings per share of $0.21, almost double what we reported in last year's second quarter, and this is despite an effective quarterly tax rate from a book standpoint of 70.3%.

These results highlight the positive effect that scale and revenue growth have on our bottom line. Looking at Slide 25. Cash and cash equivalents at June 30 increased to $123.4 million from $101.4 million at the end of March. Our debt position continues to decrease and it's down to $32.5 million at the end of June, from $34 million at March 30.

Cash provided by operating activities in the second quarter was $29.6 million compared to $20.6 million in last year's second quarter. Looking forward to the third quarter, our Executive Search backlog is shown on Slide 26, and monthly confirmation trends are shown on Slide 27.

We are forecasting third quarter net revenue of between $123 million and $133 million.

As always, the factors on which we base our forecast include our current backlog, monthly confirmation trends for executive search and leadership consulting, the anticipated fees, expectations for our Culture Shaping business, the number of consultants, the current economic client -- climate, excuse me, and the stable currency rates.

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

Thanks, Rich. Our people have been my top priority since I arrived here earlier this year. Strengthening our business begins through a combination of attracting great people and then investing in them through training, development, all along fostering collaboration, trust, teamwork and the ability to embrace change.

Earlier this month, 280 of our firm's leaders from 30 countries gathered for our biennial partners' meeting, this time in Chicago. By any measure, it was a very positive experience. The energy and the enthusiasm from everyone who attended was palpable.

The meeting also provided Heidrick the opportunity to expand our culture shaping initiative throughout the firm. We embarked on our own culture shaping journey in June, and since then, almost 100 of our partners and corporate leaders have participated in the initial phase.

By late fall, our intent is that all partners and principals and key corporate leaders will have completed this initial work. The reception to culture shaping has been equally very positive.

Not only are people excited about the opportunity to actively shape Heidrick & Struggles' culture, they're excited about the opportunity to learn, firsthand, the value of one of our company's core service offerings. Although our people have been my top priority, clients are at the center of our business.

Since joining the firm almost 6-months ago, I've now met with dozens of clients in order to personally understand our value proposition and how we can strengthen it. Quite simply, our clients want more from Heidrick. They want great search judgment, deeper assessment and more of a strategic relationship with us around succession.

To meet our client’s needs, we must deliver a seamless solution set that brings together an integrated platform of search, leadership consulting and culture shaping across all our geographies and industries. We will not only help our clients find the right leaders, we'll work to ensure their success.

In closing, our people, our clients and our brand are the core strengths we will leverage to grow this company and improve profitability.

I challenged everyone at our partner's meeting to feel a sense of urgency about what needs to be done and I encouraged them to be energized by the incredible opportunity to return to and exceed the financial performance of our very best years. Let me pause and say Rich and I will be happy to take any of your questions. Doug, back to you..

[Operator Instructions] We will now take a question from Tim McHugh from William Blair..

It's Stephen Sheldon in for Tim. First, it looks like you had another sequential increase in headcount, about 8 this quarter.

So I was curious, how many consultants you hired in the quarter, and then how many left, whether voluntarily or involuntarily?.

This is Julie. Started the quarter at 303, hired 13, promoted 15, and 20 left for a variety of reasons, including voluntary and involuntary..

Okay, great.

And then I was hoping you could give some more color on what drove the improvement in the Culture Shaping business, and how sustainable you would view that improvement, specifically should we be expecting the absolute revenue achieved in the quarter to be fairly sustainable going forward?.

Yes, good morning, Steve. This is Rich. As I indicated in my remarks, we're going to see variability in that business a little bit from quarter-to-quarter, because much of the revenue recognition relates to how projects initiate with the clients. So we're right on track with where we thought it would be, quite frankly, on a year-to-date basis.

And with the pipeline that we see for the year, we had a little ground to make up from the early part of the year and some of that was made up in the second quarter, so it was a very encouraging second quarter.

And as Tracy indicated in his remarks as well, we're very bullish on that offering relative to its integration, both into Heidrick, as well as its standalone prospects. It's a hot topic in the leadership area. A lot of our clients are talking about culture and its impact on their leadership and on their effectiveness as organizations.

And we think we're extremely well-positioned and we have a very strong belief in the business..

Okay, great. And then just one last one.

I was just curious what kind of approximate operating margin and tax rate you'd expect for the third quarter?.

Well, we don't forecast margin and tax rate, we only give guidance on the revenue levels. As we've said all along, our target for this business has been to drive operating and profit margins into the double digits. We saw good improvement in that in the second quarter.

It’s -- just a reminder again, that our operating margin will trail our EBITDA margin over the course of the periods that we deal with the earnout from the Senn Delaney acquisition, which is why we disclosed both because the EBITDA margin more closely relates to our cash flow and true cash impact on the earnings level of the business.

So clearly, our margin is driven right now by the power of scale, as we indicated. And if we continue to have run rates like we saw in the second quarter, I'm optimistic..

[Operator Instructions] And we'll now take a question from Brad Evans with Heartland..

Tracy, as you highlighted, you've been here for 6 months now and I just would love for you to maybe just to amplify a little bit on as you are in your seat, where are you ahead of plan, and where might should be, maybe, perhaps, a little bit behind plan in the first -- for the first 6 months of your tenure, if anywhere?.

Thanks, Brad, for the question. A couple of thoughts on that. As you know, the primary focus, as I referenced this morning, is on our people. And very close to that, obviously, is our clients who are at the center of what we do.

So the way I think about our progress, is I look at our people, I look at are we building our consultant ranks? And are we rebuilding it with the right people, and where we need to? Are we -- as Julie referenced, are we asking some folks that it's time? And so there's nothing more important, Brad, than building and rebuilding our consultant ranks, so we can interact with the client.

I'd say secondly, there's still much work to be done there. As everyone on this phone call knows, Heidrick lost consultants in the last couple of years, and we're not going to make all that up in a couple of quarters. And so we view this as a positive march, but we view it as one that's going to take some time.

So I don't know whether or not I characterize that behind or ahead, but I would consider it forward. And then lastly, I would say, as you can see in the quarter, Europe has done well. The United States has done solid.

Asia has been relatively flat, and I think that talks about just how competitive the environment is in Asia, but it also says there's opportunity there to grow our consultant ranks, which we're focused on..

Okay.

In terms of people, the consultant base, are you where you thought you would have been? Or relative to your early expectations in terms of your ability to grow the consultant base? Or where do you stand today versus where you thought you'd be maybe when you first where onboard in to the organization?.

Yes, I don't -- I can't give you the exact number, what I can tell you is, what I'm focused on is growing the base, but also growing the quality of the offering we present to our clients. And so going back to an earlier question, and I referenced our -- clearly, our most important offering is what we do around core search.

But because of that access to the client, we also have an opportunity to expand that conversation around the components of leadership consulting, which we talked a lot about in our conference, in the importance of assessment and succession and then, obviously, culture shaping, as Rich described.

So I view it as -- I don't have a specific consultant number, if that's what you're looking for. What I do have is the positive trend, and also expanding the quality of our conversation with the client to, obviously, include Search but also embrace the other services that we have around leadership consulting and culture shaping..

But it sounds like you'd be disappointed if you weren't able to continue to grow the consultant base into the back half of 2014?.

We're certainly looking to grow it..

Okay, that's helpful. And in terms of just -- if you don't mind amplifying as well, as in -- what you're hearing from you clients in terms of the demand cadence.

I guess, what -- as you look to the back half across the various geos that you participate in, what has you optimistic and what has you cautious in terms of the demand cadence that you're hearing from your global customers?.

one is they're very focused on talent, and looking to bring in great talent wherever they can; at the same time, the economy is showing some positive signs here and you can see that in the numbers. I think everyone is cautiously optimistic that, that will continue.

And I'd say on Asia, we would look to -- we would look for only more growth there, but I'd also say that Asia is an extremely competitive marketplace..

So thank you for that amplification.

The guidance for the third quarter is pretty positive, and can you just help us understand how, just -- not on a granular level but at a high level, how you arrived at that guidance in light of -- juxtaposed against the July confirmation number? Do you expect that number to pop back up in August? Is that -- Are you seeing leading indicators that would imply that we start to bend that curve back to a higher trajectory?.

Yes, let me ask Rich just to walk through how we came up with that..

Yes, Brad, I'll speak a little bit to that. As I mentioned, there's a number of factors that go into the components of developing the guidance and how we model it.

One thing we saw, that we've seen so far in 2014 is we've seeing a little bit of difference in some of our areas of business where we've seen acceleration of what we would call normal cycles.

In the Financial Services practice for example, where we see some relationship with core customers that usually kind of timeout a little bit later in the fall, have accelerated in time and kind of come forward a little it earlier in the year.

And we actually benefited in a little bit of that in the second quarter, because we closed some more activity and actually had very good upticks contributing to our revenue recognition. Some of that impacts the ability of the timing of our revenue recognition as we look through the quarter, so -- and how it plays through.

We did, as indicated in our slides, our July confirmations are probably trending a little lower than maybe we would've thought on average for the year. But we've already factored that into the guidance outlook into the Q3.

Some of that is driven by the fact we did take our partners out of the market for a couple of days in our Chicago meeting, as well as some of the activity we saw that flowed into the second quarter this year. Overall, we really -- we try and keep our finger on the pulse where our people are active, where our practices are active.

And as Tracy indicated, pretty much on a global basis, our people are highly engaged at client activity. But again, it's still a market where we see some variability in timing, some transactions take a little longer than others.

We'd like to bring our overall cycle on our search down a little bit in terms of days of completion, that's a still a very active goal of ours. And we take that all into consideration.

But at the end of the day, between the combination of the culture shaping and our current trend in the business and our higher productivity, we think it supports the forecast we've given for the quarter..

And just one last question.

If I recall correctly, there's about $23 million available on the share repurchase plan? Is that correct?.

I don't have the current number in my fingertips..

I have it..

We'll see if we can find it. It seems a little -- I thought that was high....

Yes..

I guess just -- as you're looking for that number, I guess, the question around that is, with the company's valuation, roughly around 5 -- a little less than 5x 2014 EBITDA.

I'm just curious, Tracy, from your perspective, with -- how the balance sheet is currently positioned, would a $10 million or $20 million share repurchase program meaningfully derail your strategy from a -- either an internal investment opportunity or external?.

Brad, the way I'd answer that is, I'd say what we're highly focused on right now is investing in our people and investing in scalable solutions that allow them to bring the highest value to our client space. Those priorities dominate right now.

And as we discussed, while I take your point about valuation, our #1 focus with respect to investing is around people and solutions for our clients. And through that, we think value will express itself in the marketplace..

I agree with you but I would just -- the only push back I would have for you is that of the holistic approach to capital allocation that includes returning capital to shareholders.

In light of some of that in certain -- in light of some of the negative misperceptions around the company, so that -- so shareholders are rewarded as well as the investment you're making in our producers which is obviously very, very important.

So we are 100% support of that, but I think there's a dual track that the balance sheet does afford, and I think it's appropriate in light of where the company's valued. So thanks for that and good luck..

Thanks, Brad, and the confirmation, you're right, it's about $22 million that's available on the share repurchase program..

Doug are there any other questions in the queue?.

Yes. We have a question from Kevin McVeigh with Macquarie..

It looks like you have some real nice leverage on the SG&A line in Q2. And I know you're not giving kind of a formal guidance for Q3 but should we expect the same type of benefit? I mean obviously, last year you picked up 300 basis point sequentially.

But Q2 to Q3, I'm not suggesting 300, but should we be modeling continued improvement on that one?.

You know, we've done -- if you go back and look historically, Kevin, thanks for the question. We've done a pretty stringent job of trying to hold the line on the G&A line across the company.

And if you look at our segment results versus our overall income statement results, you see that the corporate part of that G&A line usually hovers around 9% to 11% of revenue, maybe the last few periods. And I kind of use that as a guideline, quite frankly, I really try and keep it around the 9% to 10% if I can.

And our people do a very good job, both in the field as well as corporate side of that. There's a lot of factors that drive it. We occasionally will get blips.

If you remember the first quarter, we had a couple of items that, for timing purposes, et cetera, and professional services, and a state tax matter that came into the quarter that blipped our G&A up about $2 million, $2 million to $3 million.

As I indicated in my remarks for Q3, we'll absorb the expenses from our partners meeting, which is going to be about $2 million. Now -- we're going to try to offset some of that, but that was -- candidly, that was investment worth making. And so, we may see a slightly higher rate in the quarter.

But I do not expect going forward, that you're going to see much of a material movement in that G&A line, up or down.

We're just going to try and hold it as steady as possible, absorb inflationary increases and services and people, and try and make that up through productivity and by continuing to leverage technology and continuing to improve our processes wherever we can. But I -- what it also shows is the power of the leverage.

If we get our revenue back up to where we've always talked about, where we want to keep productivity in the $1.5 million or higher range on our consultant base, we drive pretty good operating leverages as we move through the year. And that's where we'd like to see..

Got it.

And are you pretty comfortable in terms of the office footprint at this point? Or is there some incremental opportunity or -- on just office location?.

Every lease that comes up, we take the opportunity. We're actually working on now -- one right now in one of our larger offices in Chicago where we going to -- we hope to take some cost out in the very near future as our lease is coming up and we're doing our renewals. So we take every opportunity we can to do that.

Julie actually has a second job in our real estate area and does a fantastic job there, along with all our folks in the various offices. So I'm pretty comfortable, again, with our real estate footprint and the cost of our real estate and I'm very pleased that the work that our people do out in the field to help us with that effort..

Got it.

And then just, Tracy, as you think about hires going forward, what type of candidate, from a tenure perspective, are you thinking about and are there any particular verticals you're focused on?.

So I'll -- Kevin, I'll the answer in 2 ways. One is the verticals, Industrials and Life Sciences is where we're looking to invest, and in particular, I'd say more in the senior ranks.

But I would also say that parallel to that is junior people who we think have talent, not necessarily who have a background in Search, but we think have the abilities to drive Search business over time, who we can develop, who we can train and we can mentor. As we referenced, that has been an important talent pool for us over time.

And keeping that going is something we're very committed to. So I'd say it's on both sides, both at the junior level and at the senior level, and I'd call out Industrials and Life Sciences..

Got it. And then just the overall environment, it definitely seems like, obviously, the labor market's been firming up.

Are you seeing that vis-à-vis, the salaries your clients are willing to pay? Has there been any kind of meaningful uptick in that, relative to the last couple of years?.

This is Rich. I'll jump in on that. As we talk to our people, both regionally as well as by practice, the war for talent is pretty active right now.

So the good news about playing at the high end of the spectrum is that it's less a conversation about wages or pay, it's more about is it the right talent and is this somebody who can or will help me be successful from a client perspective. So as we've indicated in some of our metrics relative to our fee levels, that hasn't been a big concern at all.

We obviously operate in different markets. Wage and pay levels in some of our developing markets are, obviously, lower than some of the more developed markets. But at the end of the day, the averages speak for themselves and say the war for talent is still pretty active..

And it appears we have no further questions at this time..

Okay. Thank you, all, for being with us this morning. We are -- we're working very hard on your behalf. We appreciate your questions, both on this call, but also throughout the quarter. And we will, no doubt, be talking with each of you soon. Thank you..

This concludes today's conference. Thank you for participation..