This is the Heidrick & Struggles' First Quarter 2018 Quarterly Conference Call. This call is being recorded. It may not be reproduced or retransmitted without the company's consent. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be provided at that time.

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 2018 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’ve posted our first quarter slides on IR homepage of our website at heidrick.com and we encourage you to print them for additional context, but we won’t be referring to specific page numbers during our opening comments. 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 in a schedule at the end of the release and 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 our safe harbor language contained in our news release and on Slide 1 of our deck. And Krishnan, now I'll turn it over to you..

Julie, thank you. Good afternoon and thank you for joining our call. Last quarter we introduced Mark Harris as our incoming CFO following Rich Pehlke’s retirement. Mark, it is great to have you here today, now fully entrenched in your role.

As you’ve seen from our press release, we reported a strong first quarter, continuing on the positive momentum that we saw at year-end, both momentum in the market and momentum inside the firm. On almost every meaningful metric, we reported growth and improvement in year-over-year results. Consolidated net revenue increased 14%.

Executive Search revenue was up 17%. Operating income grew 98%. Operating margin improved to 8.2%, and diluted earnings per share was $0.53, compared to $0.03 in last year's first quarter. I’d like to thank our employees around the world for driving these strong first quarter results.

I’m quite proud of what we achieved financially while executing on a number of strategic and operational initiatives. We finished formerly integrating leadership consulting and culture shaping and launched a new business Heidrick Consulting.

We launched our digital client portal and our new IP-based assessment methodology and are now active with clients globally on both. And we continue to executing the restructuring that was announced in early January. Now, let me turn the call over to Mark to further discuss the financial results..

Thank you, Krishnan. And let me reaffirm what was just said, supplemented through financial analytics. At the conclusion it will be obvious. This was an outstanding first quarter for me to be a part of. Before I get into the results, I’ll discuss the impact of the new revenue recognition methodology, commonly referred to as ASC 606.

As we previously discussed on earnings calls, the adoption of the standard in the first quarter of 2018 increased our reported consolidated net revenue by $2.5 million, compared to the historical method of revenue recognition or 2% of first quarter’s net revenue.

The change in methodology mostly affected how we recognize revenue associated with upticks for Executive Search contract and for licenses related to our proprietary culture shaping tools, which we refer to as enterprise agreements.

It resulted in an increase in revenue in Executive Search of approximately $3.5 million in the quarter and a deferral of revenue in Heidrick Consulting of $1 million.

For the full-year, we are currently expecting the change in revenue recognition will not be material to our consolidated net revenue, but this is all subject to variability in the number, timing, and value of the Executive Search confirmations, as well as our clients use and renewals of our enterprise license agreements.

With that I’ll move on to our results. Consolidated net revenue was up $20 million or 14% year-over-year, driven by great results in the Executive Search, which was up 17% year-over-year to $146 million. All of the key search business KPIs drove these results.

For example, search confirmations were up 5% year-over-year with strong performance from financial services, global technology and services, and consumer markets practices. Productivity and average retainers also improved compared to last year's first quarter. From our segment reporting, you can see we achieved double-digit growth in all regions.

Americas was up 12%, Europe was up 36%, and Asia Pacific was up almost 13%. While Heidrick Consulting did see a revenue retraction of approximately $1.3 million in the first quarter of 2018, 1 million of this decline in revenue was due to the new revenue recognition deferral in the quarter.

Irrespective of the revenue decline, we are quite encouraged what we're seeing in Heidrick Consulting. They are showing steady improvements in the business, including an increase in their pipeline.

Salaries and employee benefits saw an increase of $14.2 million from the first quarter 2017, $12.2 million of which was related to an increase in variable compensation given the strong performance in search on a comparative basis. We also made some strategic additions to consulting headcount in the quarter.

We hired 14 new search consultants to the Heidrick & Struggles family and we promoted 13 internally to Executive Search principles. General and administrative expenses fell by almost 2% or $0.6 million year-over-year.

The biggest declines in G&A were related to lower intangible amortization, due to the impairments taken last year in the second and fourth quarters. The other two big contributors to the decline related to lower bad debt expense and a decline in external client services.

These savings were partially offset by increases in office occupancy cost and professional services fees. We have achieved a sizable improvement in operating income and operating margin in the first quarter of 2018. Operating income increased by $6.5 million and our operating margin nearly doubled to 8.2% from 4.7% margin in the first quarter of 2017.

Further, the effective tax rate in the first quarter fell to 21.3%, largely as a result of discrete events from the 2018 first quarter, including the benefits of the Tax Act, which benefited earnings by approximately $0.05.

Looking at our anticipated adjusted tax strategy, coupled with our internal forecast for the mix of income and applying the new tax rates, we believe our annual effective tax rate will be in the mid-30% rate by year-end, excluding one-time items. A good reduction from the adjusted 48.9% tax rate in 2017.

All of this led to one of our strongest first quarter earnings in the history of Heidrick & Struggles. Our net income increased to $10.2 million from $0.7 million in the first quarter of 2017. We delivered diluted earnings per share of $0.53 in the first quarter of 2018, an increase of $0.50 over the first quarter of 2017.

Let me wrap up by briefly discussing some of our balance sheet items.

Reflecting the payment of bonus in the first quarter, cash paid for the restructuring, as well as our acquisition in Denmark, you will see we ended the first quarter of 2018 with cash and cash equivalents of $73.4 million, compared to $68.3 million at the end of the 2017 first quarter.

Looking at our cash and cash equivalents net of debt, we ended the 2018 first quarter with $61.4 million, compared to $43.3 million at the end of last year's first quarter.

Finally, of the $73.4 million in cash and cash equivalents $65.8 million is readily available for operational use, while $7.6 million has more limited availability due to currency, tax, and other factors that make it less efficient to use at this time.

Similar to last year's first quarter, we borrowed $20 million for short-term working capital under our credit agreement and subsequently repaid $8 million in 2018 first quarter.

And while the $12 million outstanding is categorized as long-term debt because the credit agreement expires in 2020, we intend to repay this debt in the second quarter, subject to market conditions. Now let me give you guidance for the second quarter. Our Executive Search backlog remains strong when compared to other first quarters.

Given our monthly search confirmation trends and other factors for which we base our forecast, including anticipated fees, the expectations for Heidrick Consulting assignments, the number of consultants and their relative productivity, the seasonality of business, the anticipated economic climate, and the foreign currency exchange rates, we are forecasting 2018 second quarter net revenue of between $160 million and $170 million.

This compares to $152 million in net revenue in last year's second quarter. With that, I’ll turn the call back over to Krishnan who will give an update on our strategic priorities..

Thank you, Mark. We clearly have momentum in the market and in our firm and we’re delivering profitable growth. The market for Executive Search remains strong and we're seeing Heidrick Consulting start to bear fruit following the completion of the integration. On our last call, I mentioned we have four priorities for 2018 across the enterprise.

I’ll briefly update you on each one. The first priority is growth. Increasing the scale and impact of both our business segments. In search, we continue to strategically bring in new talent to the firm. In the first quarter, we added 27 consultants of which 13 were promotions to Principal consultants through our training and development programs.

We also completed our acquisition in Denmark in early January and the integration and subsequent performance has met all of our expectations. In Heidrick Consulting, we are scaling the business to increase our impact with clients building on the success of our platform accelerating performance.

We’re investing in new consulting expertise, new service offerings, and scalable tools and methodologies. Understanding that this is a business with longer sales cycle, and always starts slower in the first quarter we're pleased with the growing pipeline of client engagements.

Some of the services in high demand are leadership development, team effectiveness, and organizational transformation. And with the integration complete, we will return to strategic hiring, and added 1 consultant in the first quarter, and have hired 4 so far in the second quarter.

I want to mention an exciting new initiative that we announced last week. Our disruptive innovators team. We call it a team, rather than a practice because their work cuts across all industries. We are beginning to work with innovative emerging companies at the cusp of rapid growth and market disruption.

These companies with great ambition help to change the world with the power of their ideas, they have important needs as they outgrow their start-up stages with plans to quickly scale up to $1 billion or more in revenue.

We can help these developing organizations succeed in their go-to market strategies by filling important talent gaps, advising on transformation and change management, and accelerating their growth and development. Our second priority in 2018 is to accelerate our cross-enterprise collaboration.

When we bring the full power of our people and services from both search and consulting to our clients, we can achieve the greatest impact with them and drive profitable growth for the firm. This is our biggest initiative as an enterprise as the major focus of the regional consulting conferences we’re hosting in the second quarter.

Since the beginning of the year, we’ve conducted five intensive training sessions on our Heidrick Consulting offerings for our search consultants, we have three more coming up over the next month.

In these sessions, consultants from both lines of business work together to identify promising opportunities to expand the breadth of our engagements with clients who only know us for one type of service. A pipeline of opportunities is emerging that we are tracking and focused on.

Our third priority is on driving a premium service experience for our clients that will further distinguish Heidrick from its competitors. As I mentioned earlier, we have rolled out our digital portal, which embeds our new proprietary assessment framework based on our accelerating performance methodology.

Over two-thirds of all new engagements to date have adopted this methodology and the feedback that we received from clients is outstanding. We view this as a competitive differentiator. And finally, our fourth priority is to further improve our cost structure.

While pleased with the first quarter improvements in operating income, margin, and EPS we continue to make cost management part of our culture and we will not lose this focus. I want to again thank our employees around the globe for their hard work this quarter. Two things that make this firm great are our people and our culture.

I truly believe we are creating new and unique opportunities to win in the market and our people are embracing this strategy. Everyone benefits. Clients, employees, the firm, and shareholders. Now, we’ll be happy to take your questions..

[Operator Instructions] And our first question will come from Tim McHugh from William Blair..

Yes, thanks.

First, can I just ask the small acquisition, how many consultants did that add during the quarter for you?.

Sure. It added seven consultants in the quarter, or six, sorry six consultants..

Okay.

So, can you talk about – I guess that plus the comment about 27 hires, and if I look at the reported metrics it is up 3 sequentially, so how was turnover relative to normal levels?.

Yes, it’s Krishnan here. Look, turnover is a little bit higher than it has been normal. We are clearly in a war for talent, but the trend line isn't that surprising to me, same as what I would say.

Over the last two years we really began to focus on performance management of the firm and if you look at the slide that you are referring to as well, I think in the first quarter deck you will see a gradual decrease there, in fact last quarter – last year in consulting headcount, much of it due to very deliberate performance management.

So, we're replaced that headcount with outstanding new consultants and we continue to do that. So, the headcount in one quarter is here as you are saying three higher than it was in the past in the previous quarter. And at the same time, we're promoting from within and what you will see is the productivity of the team has gone up as well.

So, it is exactly a lot of what we wanted in this case..

Okay.

And is the higher turnover, is that some facility that you mentioned the trend line from last year, do we see that throughout last year or is the trend, I guess the turnover increase here as you got into 2018?.

No, it was pretty gradual throughout the year, if you look at it, it was pretty consistent. So, the program that we had established. As I said, there is a war for talent that is out that. We happen to be also recipients of some great talent that is walking into Heidrick & Struggles each and every day..

And Tim first quarter tends to have changes just because when there's – when we pay out bonuses. We had three people retire after bonuses this year, we had two people who are just, they didn’t leave the firm, they just were reclassified out of consulting status, so that’s five there. So, it’s not….

Fair enough.

Two other numbers one, I guess one, what was the impact as I guess I was trying to get to executive search growth on a constant currency basis, I apologize if you gave that, but I didn’t catch it, and then secondly you mentioned regional consulting conferences happening in the second quarter in the past, it was more so when you would do one big conference, but that sometimes affected G&A, is that – do we need to think about that for the second quarter in terms of the cost of those events?.

I will grab that for you Tim, so let me answer your first question, which is in regard to constant FX growth, search as you know came in at 17.1% within a constant currency it would have been about 13%. So again, there was definitely some FX movement.

And then the second question in regards to the conferences et cetera, we amortized that over the period at which we do it. So, I don't think you're going to be seeing Q2 any real noise as pertained to the conferences it'll be pretty flat in terms of the way we accrue that have expanded it..

Okay. Great. Thank you..

Of course..

Our next question will come from Tobey Sommer with SunTrust..

On thanks.

What are your plans for internal consulting headcount over the balance of the year?.

Let me take that. It is Krishnan here. Look, we continue to invest in hiring in a very strategic basis both in Executive Search and in Heidrick Consulting, and we are very, very careful in doing that and we're looking for the best talent that we can get so expect for us to continue to grow there..

So, you are expecting growth, are there any parameters you can put around that?.

Look, I don't think the growth in headcount is going to get at the level that we have had it in the past from an external hiring perspective of where we’ve hired 30, 40 people, so we won't be doing that. So, it will be a little bit less than that is what I would saying. We have got a great internal talent pipeline that we continue to develop.

So, we're very confident in that as well..

There is 30 or 40 that you are referencing is that, are those net prior hiring numbers or gross? Just trying to make sure I’m referencing the right historical figures?.

Yes. I think we used to hire about 40 gross, I would say..

Thanks.

How do you think about productivity here, the average revenue per consultant whether it’s in this quarter or the prior one at historically elevated levels, how much more do you think you have in terms of capacity of your existing staff?.

I think there is probably a little bit more on top of that as we bring in – as we are changing our leverage model and we're bringing in more principles, that number is not going to spike because the principles will generally be less productive, so in our model we're bringing in more principles these days..

Okay.

Is that 100,000, 200,000, how do you frame the opportunity for increased productivity?.

It’s Mark, let me kind of jump in. First of all, what Krishnan said was absolutely right, second comment would be, it is a function of mix too, right? So, what kind of searches we are doing at the time et cetera, it is also I would say, a third is a function of the market, which is why you're seeing the upward trend.

As we all know we have been on a long economic recovery cycle et cetera, so we would expect to see exactly what we are seeing in terms of the upward trend.

Our comment would be the pace of the trend will continue as the growth of the economy continues as the changes that we're watching in terms of the searches that we are doing et cetera that would be a constant growth if you will, but at some point clearly it is going to plateau itself if you will and that is very difficult for us to make an assessment without really understanding kind of where the macro is going to take us to..

Okay. How about, I missed a figure, I was wondering if you could repeat the sort of spendable cash figure that you mentioned in your prepared remarks, I apologize my pen wasn't quite fast enough..

That's okay, my team is flashing me to slow down, so it’s my fault not yours. So, the answer is, let me kind of flip back, okay, here we go, what I gave was, out of the 73.4 million 65.8 would be what I would deem readily available, and then I would say the other 7.6, which is the Delta between that and the 73.4 it is just a little bit more limited.

I wanted to be clearing that statement, the cash is there, and we can certainly use it, but if you don't need to touch it and until we get it kind of more efficient through currency, tax, et cetera it is just one of those that has little more leakage than I would like to do, so that is why we call it kind of less than available, I don't want to say unavailable..

Sure. Understood.

In the 65.8, that’s a clean number without bonus accruals that need to be subtracted or anything like that?.

Well it is as of the end of the period. So, as of March that was the cash balance. We still have, as you know, payments, we get some tax payments on those bonus accruals that go out typically in the second quarter….

I was kind of aiming for what a net number is for spendable cash, ex the other items that might need to draw on that million [ph]?.

It's all spendable. Bonuses are accrued, but that's all spendable..

It’s all spendable. It’s all cash and legal spend. That’s in the market..

Okay. From a longer-term perspective just want to ask a strategic one, and I’ll get back in the queue.

How do you, what kind of revenue mix in margin profile do you want and expect the business to have over the medium or long-term?.

Revenue mix margin profile ….

What kind of EBITDA margins do you think you have and what’s the mix between search and consulting?.

It’s Krishnan here. So, let me just at least take you to – at the top level, look, we need to scale up our Heidrick Consulting offering, and we think it leads to double in size if not go a little bit greater than that, so that is what we are trying to target from a growth perspective in the long-term.

So, those kinds of, as to the impact of that on the financials, as we continue to evolve that I think we will have some greater clarity on the impact that that’s going to have, but size wise and mix wise that’s what I would say..

Right. And to answer your question on point, in the first Q we had adjusted EBITDA margin of about 11.5%, which was up from 8.8% in Q1 last year.

So, like operating income margin where we have been talking about both are increasing in the right direction of what we are trying to achieve and I think to kind of jump on what Krishnan had said, the guidance, excuse me, the thoughts we would have is that 11.5% would continue as we focus on our cost as we focus on the business both in Consulting and Search.

Our goal is to maintain the growth..

Did 1Q reflect the entire cost savings initiatives or is there some sort of incremental carryover impact that benefits 2Q or the remaining quarters of 2018?.

Sure.

So, the answer is, as Krishnan pointed out we're still very much in the process of the announced restructuring that we did in January of this year, so we’re going through completion, my comment would be all of which would probably complete itself within the end of the second quarter and then Q3 and Q4 will be more pure without that noise, within the P&L.

So, it is still very much a work-in-progress because we knew it was going to take, again due to the jurisdictions that we are in, some time to ensure that we did the appropriate restructuring in terms of the announcements in getting up the P&L..

Is there any way to numerically ballpark how much hit the quarter versus how much is yet to come?.

No, I think the only way that I will make the comment is the $11 million to $13 million that we gave in terms of the annualized savings is still very much the goal that we have in terms of what we think financially it would be, and it is a little difficult again because kind of for two reasons, number one as you know, cash is fungible with growth, becomes onboarding, becomes other things, so it does get a little bit noise associated to it, and as we rightly say, the second comment would be because we are in the midst of it.

It is difficult in terms of what is quantifiable in Q1 versus Q2 in onward and upward through Q3 and Q4, but I would tell you we are certainly more than two thirds of the way through the process in Q1 and then there would be the rest of it to do sort of speak in Q2..

Okay. Thanks..

Sure..

[Operator Instructions] Our next question will come from Kevin Steinke with Barrington Research..

Good afternoon..

Hi Kevin..

So, I wanted to follow-up on the discussion about the restructuring savings there, you mentioned four new Heidrick Consulting consultants added thus far in the second quarter.

So, are we, does that represent just beginning of you beginning to reinvest those savings as you talked about on the last call wanting to reinvest a good portion of those savings?.

Look, I think it represents an opportunity for us in the market to be able to grow Heidrick Consulting at the right place and right time. So, it is difficult to find the best consultants and we are Heidrick & Struggles but we look very, very hard for that type of talent and that was afforded to us.

So, we are trying to balance that with the program here at. And if we don't see the best people available we won’t make those hires..

Okay.

You also talked about seeing a good pickup in the Heidrick Consulting pipeline, I don't know if you could talk a little bit more about maybe the size of the projects you are seeing, if that is any change from what you have seen in the past and may be a projected timing of some of this new business might start to flow through to your results?.

I think – so the pipeline as you know, in Heidrick Consulting we announced the new Heidrick Consulting at the beginning of this year, we started to develop and working on that pipeline so to speak.

We have an economic objective of what we are trying to achieve and my comments on statement was the pipeline was looking good was really coming from the fact that the traction that we have has been very good and at least to this point strong.

It’s difficult to again, we want to be a little bit competitive sensitive to giving out too much information as it relates to Heidrick Consulting. I would tell you that you hit on an excellent point, which is when are we going to see the revenue and my answer would be how long is a piece of string.

And I mean that from the standpoint of the new revenue recognition standard has so many difficulties before you kind of get through and that’s why I mentioned we had a $1 million deferral in Heidrick Consulting in terms of the new revenue recognition standard is becoming, it is almost a respect of how much you build, it is just a standard, which terms in terms make you evaluate of your – the way you need to recognize it.

So, hard for me to answer especially with 606, but I would imagine you will start to see that progress again in Q3 and Q2 as the pipeline really starts to show itself to the P&L..

We are beginning to see a lot of green shoots, as I call them, they have come up as a result of the collaboration that we’re driving across between search and between consulting, I can give you a couple of examples of some of the things that we're beginning to see.

Many companies are now beginning to call pivot towards growth and as they do that the CEOs have put in place a strategy, but they realize that the strategy requires a significant change and upgrade not in leadership skills and often culture as well, and this is leading to work for us both in the leadership development and culture shaping buckets that we see, I will give you an example, energy sector, company that was pivoting again from cost containment to more of a growth strategy, the new CEO quickly realized the culture needed to change, and through our established relationships and search we are able to open the door and we have a very large culture shaping project that has been launched over there.

Second areas of growth that we are seeing is, for example with the PE firms. They are realizing that they need to get their hands around the talent equation in their investments, far sooner than later.

So, we are involved with PE firms now and in their portfolio companies across the full deal cycle, sort of with a pre-due diligence model on talent and post due diligence on talent and culture and search and everything that we do. They sort of have an M&A playbook and we’re part of that M&A playbook as what I would say.

So, teams and tools are being engaged on every deal that they consider and these are the kinds of things that we're trying to drive across the enterprise..

Okay, it’s helpful.

You just mentioned kind of a pivot to growth among your client base, how dramatic of the pivot is that that you are seeing and I’m just kind of curious if that is a little bit surprising that pivot is just happening now given where we are and the economic cycle, so I guess any comments on there would be helpful?.

Look, I mean, I think we have seen a steady growth, I think when I say pivot to growth it is sort of the recognition that human capital is a big asset as part of that growth, so the pivotal growth happens and there is strategy and a whole bunch of other things that companies do and I think the human capital equation is what is really over the last couple of quarters beginning to come through in that growth agenda for these companies..

Okay.

Could you just touch a little bit more on the client portal that you talked about the launch of that and also the opportunities to make your relationships perhaps most sticky through that portal?.

Sure.

So, we talked about this a little bit before, but just to go quick deeper, so we have rolled out and when we think about it, it is not just a client portal, which it is, but it sort of wraps our proprietary assessment framework around it that we take our accelerating performance framework, which has inside of it, what we call the drive factors for performance and embeds it inside there, and it is quite sticky.

I think there is a large opportunity here, our global clients like one standardized approach they like one way of being able to conduct their business. The IP behind it is quite strong as well. So, it stands at test as well. So, I think it represents a real opportunity for competitive differentiation for us..

Okay, great.

Just one last question here on the numbers, was the HRMC tax settlement, was that, is that included in the 8.8% adjusted EBITDA margin that you reported for 1Q 2017?.

Yes..

Okay. Alright great. Thanks for taking my questions..

[Operator Instructions] We have no further questions at this time. I would like to turn the call back over to Heidrick & Struggles for closing remarks..

Great. This is Krishnan. Thank you. Let me close by offering a few quick summary thoughts. Number one, we're very excited about the progress we are making. Number two, as you can tell, we have a talented and motivated team at Heidrick & Struggles that is driving results.

And number three, as we focus on the remainder of the year, we will continue to drive profitable growth by driving collaboration to support the growth of both Consulting and Search and by continuing to drive the implementation of IP and technology enabled solutions. Thank you very much for joining our call today..

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