Good afternoon. This is Heidrick & Struggles’ Third 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 on how to ask questions. Now I would like to turn the conference over to Julie Creed, Vice President of Investor Relations and Real Estate. Please go ahead, ma’am..

Good afternoon, everyone, and thank you for participating in Heidrick & Struggles 2018 third 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 third quarter slides on the 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. In our opening remarks, or in our quarterly slides, we refer to 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 our release and in our supporting slides.

Also, in our remarks, we’ll be making forward-looking statements and ask you please refer to the Safe Harbor language contained in our news release and on Slide 1 of our presentation. And now, Krishnan, I’ll turn the call over to you..

Julie, thank you. Good afternoon, and thank you for joining our call. As you’ve seen from our press release, we reported another great quarter, our second consecutive quarter of record net revenue and our 13th sequential quarter with year-over-year revenue growth. Equally as important to us, we reported continued improvements in profitability.

Some highlights to share. Quarterly net revenue was a record $187.6 million, up 17% year-over-year and up 3% sequentially. Through the first nine months of the year, consolidated net revenue is up 17% as well. Executive search revenue grew 19% in the quarter, driven by all three regions and all industry practices.

Year-to-date, executive search revenue was up 20%. We achieved another company record for executive search productivity in the quarter at $2 million per consultant and on a trailing 12-month basis, productivity is at $1.8 million per consultant.

We further reduced G&A expenses resulting in the lowest quarterly run rate as a percentage of net revenue since going public. On a trailing 12-month basis, G&A expenses are now running at 20% of net revenue. The third quarter operating margin of 11% is the highest quarterly operating margin in the last 10 years.

And finally, net income more than doubled to $16.5 million compared to last year’s third quarter and diluted earnings per share nearly doubled to $0.85, compared to $0.43 in last year’s third quarter. I could not be prouder of our employees accomplishments. They’ve enabled us to report such strong results again this quarter and year-to-date.

We’re living our values, especially to win as one firm and achieving our strategic operational and financial goals. I’m excited about our momentum and the potential of our company looking forward. Now, let me turn the call over to Mark to further discuss the financial results..

Thank you, Krishnan, and good afternoon to everyone on the call. Thank you for joining us today. As Krishnan mentioned, third quarter net revenue was $187.6 million, up $27.8 million, or 17% compared to last year’s third quarter, and a new quarterly record for Heidrick & Struggles net revenue.

Although third quarter revenue can often be slower than the second quarter, mainly attributable to summer vacations, our third quarter revenue grew 3% sequentially from the second quarter. As you can see, revenue came in 4% higher than the high-end of the guidance we gave at the end of the second quarter.

This was a function of all search revenue drivers exceeding expectations. Search confirmations increased 14% year-over-year; average revenue per search increased 4.5%; upticks increased 7%, although more in line with our expectations; and productivity had a new record of $2 million per consultant compared to $1.6 million in last year’s third quarter.

Every region achieved double-digit growth and every industry practice group contributed to the revenue growth. All of this resulted in higher than expected search revenue in the third quarter, up 19%, or $27.9 million. Turning to Heidrick Consulting.

Revenue was $15.5 million in the third quarter, essentially flat compared to the same quarter a year ago. However, revenue would have increased 5% year-over-year, if not for this year’s adoption of ASC 606 that impacted our revenue recognition methodology for enterprise license agreements.

Enterprise license agreements are now recognized over five years, compared to one year, thus reducing net revenue in the quarter by approximately $900,000, or $2.7 million year-to-date. Salary and employee benefits increased $25.4 million or 23% from the third quarter 2017.

$9.3 million of the increase was related to fixed compensation, primarily related to higher costs for talent as we continue to invest in our future.

The other $16.1 million of the increase was related to variable compensation associated with the strong performance in search, which unlocked more of our variable bonus due to consultants hitting higher tiers earlier.

Although salaries and benefits as a percentage of revenue increased in the third quarter of this year, we don’t expect the usual fourth quarter increase that we have seen in the last several years, given the variable compensation tiers unlocked earlier. For the fourth consecutive quarter, general and administrative expenses declined year-over-year.

G&A was $33.1 million, down 11%, or $4.2 million. As a percentage of net revenue, G&A was 17.6%, the lowest since we’ve been publicly traded.

There were savings realized in a number of areas, but the largest declines were in internal meetings and travel, a reduction in the use of external third-party consultants, lower IT communication costs and lower bad debt expense. Turning to operating income.

We saw the third quarter operating income increased to $20.6 million, with an operating margin of 11%, the highest in 10 years. Last quarter, we added a slide in the deck, Slide 10, which shows our trailing 12-month operating margin that removes the quarter-to-quarter variability.

The numbers are adjusted for restructurings and impairments, but the slide shows the progress we’re making to drive increasing profitability. This trend is very important to us and a key metric for evaluating our performance.

Finally, net income in the third quarter more than doubled to $16.5 million and diluted earnings was $0.85 per share, with an effective tax rate of 29%. We believe our annual effective tax rate for 2018 will be in the low 30% range, a material reduction from the adjusted 48.9% tax rate in 2017. This was achieved through a combination of the U.S.

Tax Reform Act, better tax planning overseas and improved performance of the firm. Now, I’ll turn to our balance sheet. We ended the third quarter with cash and cash equivalents of $164.2 million compared to $105.7 million at the end of 2017’s third quarter.

Further, of the $164 million in cash and cash equivalents, $153 million, or 93% is available for operating use, while $11 million has more limited availability due to currency, tax, and other factors that make it less efficient to use at this time.

I’m pleased to announce that we’ve executed a new credit agreement that takes advantage of favorable market conditions, thereby lowering our costs and extending our term. It was led by Bank of America Merrill Lynch and SunTrust Robinson Humphrey supported further by HSBC Bank.

This agreement provides us with a senior unsecured revolving credit facility in an aggregate amount of $175 million that expires in October 2023. This was increased to match the growth of our business today and expected growth in the future.

The new credit facility provides us with total financial flexibility to continue to invest in our business and pursue our strategy. While today, there is no imminent need for the facilities capacity, this gives Heidrick financial security if and when we needed.

I’d like to thank all of our banks who participated in this facility who was a great achievement for Heidrick & Struggles. Now, let me give you guidance for the fourth quarter.

As a reminder, our guidance is based on the seasonality of search confirmation trends in the first quarter; search backlog at the end of the third quarter, which is increased from the second quarter; our expectations for Heidrick Consulting assignments; anticipated fees; the number of consultants and their productivity; and the anticipated economic climate.

We expect that 2018 fourth quarter net revenue will be in the range of $170 million to $180 million, which would be a record fourth quarter for Heidrick & Struggles. In summary, we delivered another outstanding quarter and continued our pace of growth from the first-half of the year.

Our business continues to benefit from the overall market strength and we believe we are winning more than our fair share of it. We will continue to focus on strong execution, prudent investments, long-term planning, and adding value to our clients.

With that, I’ll turn the call back over to Krishnan, who’ll give us an update on our strategic priorities..

number one, growth and increasing the scale and impact of both our business segments; number two, cross-enterprise collaboration between search and consulting; number three, delivering a premium experience to our clients; and number four, improving our cost structure to deliver increasing profitability.

I’m pleased with the progress we’re making with all these initiatives, and you can see that they’re having – that they have positively impacted our performance. We’ve significantly grown our search business this year and we did this with fewer, but more productive consultants and their teams.

We continue to look opportunistically to hire new consultants, strategically driving expansion into markets and practices where we see good opportunities for growth. As you have seen, we didn’t hire aggressively at the consultant level as we have in the past years.

Instead, we placed greater emphasis on internal training and development programs for our consultant support teams. In January, we will announce our annual consultant promotion. I believe that this approach to growing our search business goes hand in hand with all four initiatives.

In Heidrick Consulting, we continue to build the business that we launched at the beginning of the year now with the integration behind us fully expect to gain traction over the next 12 months. We’ve hired several partners and principals in the first-half of 2018, but in the second-half we will add more principals than partners.

Principals are not reflected in our consultant headcount, but are equally important to growing this business. We are pleased with the increase in cross-selling initiatives and the growing pipeline of client engagements, especially those that resulted from a collaboration with search.

Let me give you an example of the kind of collaboration we’re starting to see more of. A large multinational energy client set very high goals.

The client wanted to accelerate the team performance against the new strategy, increase employee engagement, build a high-performance culture, advance the organizational effectiveness and integration of an acquisition and become an employer of choice. The introduction to Heidrick Consulting came from a search colleague and we competed against a few.

We’ve now been working with this client leadership team over the last six months on a team journey, coupled with deep leadership development for the executive team and high potential leaders with a focus on laying the foundation of culture by activating the values of the company.

What makes these kinds of assignments so impactful for Heidrick is that multiple consultant teams are working with the client on a number of leadership initiatives, generating higher fees over a longer period of time, and all with a common goal of accelerating the performance of the leaders, teams and organization.

I also want to reiterate the importance of our initiative to deliver a premium experience to our clients. It’s worth emphasizing the importance of this initiative, because we believe it is differentiating us with clients and it is improving the efficiency of search.

The Heidrick Way, how we assess candidates capture data and communicate with our clients globally has been the foundation of this premium service experience. As adoption of the Heidrick Way continues to increase, we’re beginning to see real benefits.

In standardizing our assessment methodology globally and providing a deeper assessment of candidate, we are amassing a formidable collection of leadership data points. By analyzing this data, we can now provide our clients with aggregated market-level talent insights.

For example, what leadership capabilities define a high-performing CFO, as well as the search specific information they need to make hiring decisions. Through our online client portal, Heidrick Connect, our clients are accessing up-to-date candidate information for searches across all regions, across all assignments any time.

Heidrick Connect is also allowing our search teams to operate more efficiently due to seamless capture and sharing of information and insights. Building on these initiatives and our achievements this year, we are already looking out to 2021, a path we call Heidrick Rising.

Our vision and our strategy have not changed, to become the premier leadership advisory firm working on the most critical, C-suite and Board leadership issues.

Our vision is to be the trusted advisor that combines distinctive, data-driven and technology-enabled talent, leadership and culture solutions to accelerate the performance of the world’s most influential organizations.

Our strategy to achieve that vision is through the global delivery of a premium diversified portfolio of advisory solutions that empower Boards of Directors and senior executives to leverage top talent and transform their organizations. To get there, we’ll do the following.

Broaden our capabilities and service offerings to clients; go-to-market as one firm with an integrated value proposition; a distinctive suite of capabilities that maximize leader, team and organizational performance; and deliver superior leadership solutions through unique differentiated client experience, positioning the firm as a data-driven premium and technology-enabled advisor.

I want to again thank our employees around the globe for their hard work this year. We look forward to finishing the year strong and are excited about the future. Now we’d be happy to take your questions..

Thank you. At this time, we’ll open the floor for questions. [Operator Instructions] And our first question comes from Tim McHugh with William Blair..

Hi. This is actually Trevor Romeo on for Tim. Thanks for taking my call. First question just on consultant productivity for the search business. It continues to go higher and hit record levels as you mentioned. Do you think productivity is getting the point where it can’t go much higher, or do you think this level is sustainable? And also is the U.S.

productivity level different than it is internationally?.

Yes, it’s Krishnan here, and thank you for your question. I – let me start that and Mark can maybe add to that. As I mentioned even on our last call, our productivity number is a very heady number. I’m really proud of the team for what we’ve been able to do, and we really need to kind of peer back to why we’ve been able to do that.

We’ve got more searches at the top than we have had in the past, and we’re implementing our Heidrick Way, which allows us to deliver more on searches. I tend to think about it on a trailing 12-month basis.

So when we look at it over the last 12 months, we’re about $1.8 million, and that’s a number that I kind of sort of think about as being in the right range of where we should be. Our model is going to be to promote from within. We’ve got a big emphasis on that. It’s part of our people strategy.

And when that occurs, you will see a dip in the numbers before it goes back up as we absorb new people into the model as well. So, I’d be quite happy to maintain this number as we grow this business..

Yes, the only comment that I would add in there is that part of the productivity that you’re seeing here is because of the implementation of our technology in the Heidrick Way, which is something that we’ve been very focused on since the beginning of the year and even before that.

And again, I think, Krishnan is absolutely spot on at the $1.8 million over the long term is exactly what we currently see it to be, but as we continue that evolution, we’ll continue to update you on the same..

And, Trevor, I’ll answer your other question about, does it vary from – by region? It does. Mostly that’s a function of salaries. And in India, for example, are different in salaries than New York City. So the fee per search is higher in the United States, but it has increased in all regions..

Got it. That’s very helpful. Thanks. Maybe just a follow-up on search. I think, last quarter, you mentioned that you thought the search business was growing faster than the market.

Is that, I guess, do you still maintain that view?.

Yes. The data is hard to come by. I mean, you see some of it in your own research. I think, we are keeping pace and I think that we are actually ahead of pace in gaining share with large global clients.

So, our sense is that, we typically don’t know until some annual reports will come out more towards the middle of next year, but it’s – that’s our sense. If we look back historically, the last couple of years, we see a trend line that Heidrick is gaining share..

Okay, great. And then maybe just one more.

I think, from the chart on Slide 17, it looks like confirmation trends in September, maybe were a little bit weaker than the prior few months? Could you maybe just comment on how trends progressed throughout the quarter, and maybe what you’re seeing in the beginning of October so far?.

Sure. Why don’t I try to answer both of those for you. So, I think, the first one is, when we take a look at August, which you’ll notice is an unusual uptick in search confirmation, so that was very surprising to us, given the holidays, where both Europe and the U.S., especially take a lot of holidays in August.

Yes, we saw that number grow from July, so that was very surprising to us. I think, what you’re seeing in September is that kind of coming back down to its more normalized level.

So again, like we tell you about quarterly, it’s hard to look at it on a quarter-by-quarter basis, because we like to look at things on the trailing 12 to give you a real indication of trend. My comment would be is, I wouldn’t focus too much on September, just the general trend in terms of what we saw in Q3 being so closely related to that of Q2.

And as you know from our seasonality, Q2 is a very strong quarter seasonally for our business. Q3 typically comes in a little bit lighter, and Q4 obviously is the lightest quarter of the quarters that we have, which kind of answers your second question.

What I will tell you, I can’t give – what we’re seeing in terms of October is, it is still continuing the strength in the markets, that we saw the strength kind of coming in and across on, it’s all embedded into the guidance number.

So again, I would say, the $170 million to $180 million guidance that we gave you on the revenue side has embedded that number as well so..

Okay, great. Thanks very much for the detail..

Sure..

Thank you. And our next question comes from Tobey Sommer with SunTrust..

Thanks. To start out if you could elaborate a little bit, give us some more color on how you achieved the G&A expense level in the quarter, if there’s anything kind of one-time-ish there, or should we think of this as some sort of a sustainable level? Thank you..

No, that’s a great question, Tobey, and thank you for throwing it out there. My comment is the following. In Q3, you saw a 17.6% of revenue, that is unusually low and something that, again, I think, is very difficult to achieve on a quarter-by-quarter basis.

I would say, an expected trend line of your G&A should be somewhere around 20% plus or minus depending what part of the cycle you’re in. We do believe that is achievable.

And I think, what you’ll see again, as you compare kind of a Q3 this year to a Q3 last year, there’s just difference in timings in terms of certain G&A expenses maybe hit earlier last year versus when they hit this year. But I would tell you in terms of what I would expect in on the future trailing 12 months, if I can use that, would be around 20%.

I think, that’s the right long-term vision you have on G&A..

Thanks.

And then, could you elaborate a little bit more on something that was mentioned in prepared remarks about how you hit certain payout thresholds and that there won’t necessarily be the same recent historical trend, where 4Q margin dips? Could you talk about that a little more?.

Yes. So – which you normally see on a – and when you look at kind of the seasonality, we’re again, anywhere from 4% to 5% as a percentage of revenue would increase in Q4. It’s usually when the tiers get more unlocked and we usually wait until we get towards the end of the year when you see it.

And I think what you’ve seen in the first nine months of this year, again, Q2 being the highest on a quarterly record revenue that we had prior to Q3 and our Q3 come in, it’s new – the – has the new record, if you will, for the performance past. Clearly, we believe it’s going to be a record year in terms of 2018.

All that done is that more revenue, I don’t want to use the word upfront, but earlier than we had anticipated and what that will do with the tiers in the way that we set them at the end of last year is unlocking those earlier. So there is climbing up to tier ladder, if you will.

So instead of having that spike in Q4 that you would normally expect to see, our view is, it’s going to be relatively flat in Q4. So it’s not going to usually have it because of what happened in Q3 and the amount of revenue that we saw coming through..

Okay. That helps. Thank you..

Sure..

Do you envision any changes to sort of the leverage ratio and the proportion of kind of the ratio between most senior consultants and the more junior ones who support them such that you’re kind of able to achieve a higher annualized revenue per consultant than in the past?.

Well, so again, what I would tell you is, it’s a combination, right? So one of the items we’ve been working on for a little bit of time, right, is the Heidrick Way, is to focus on our technology platform in order to enable people to be more scalable. So I can’t talk about one, because they’re both embedded in the other.

The other comment, which I think you’ve rightly hit on is what we call the leverage model and how we’re trying to change, again, the cost at the top and trying to make sure that we have a leverage team, at cetera, and we’re really trying to work to ship that.

I think, you’re seeing that come through, excuse me, not just in the salary and benefits, you see it come through in the G&A and you see it come through in the productivity. So it’s something that we’re continuing to work on and something that again, that Krishnan will speak to in terms of where we think we can take it to..

Yes. We are – we’ve got metrics in place for our more senior consultants and those are in positions with larger accounts to, we think about a metric called self-sufficiency. So this basically looks at how much work they’re able to generate and pass to others as well? So we’re encouraging that in the metric systems that we’ve got.

So I fully do expect to see that we’ll have a better leverage model between our more senior partners and others as well..

Thank you. Just a couple of numbers questions for me and I’ll get back in the queue.

What’s the bonus accrual year-to-date or alternatively the sort of spendable cash out of the $164 million that you have today?.

Sure. So what we talked about, I think, you’re asking in terms of the cash and cash equivalents that’s available for operating use, in the prepared remarks, we said it was about $153 million, or about 93% of the $164 million.

Excuse me, the $11 million was more limited availability due to kind of the tax currency and other factors that make it more difficult to move up and out, so to speak. In terms of the actual bonus accrual, it’s not a number that we typically give.

But I would tell you that, again, it’s – from a scaling point of view, it’s entirely consistent, if you will, as a percentage of our revenue, et cetera, in terms of how that’s kind of working its way to the balance sheet..

Okay. And then last one for me. I know we’re not in 2019 yet.

But do you have any kind of preliminary view on a range for the tax rate out into next year?.

No is the answer to the question, because we’re still going through our whole budgetary cycle in terms of which offices are performing, et cetera. What I will tell you is similar market conditions, I wouldn’t expect that tax rate to change. I would still believe low-30s to mid-30s would be where we would end up.

I think, this year, will be – we’ve talked about it in the low-30s and that’s really around the specifics of the cash flow that we’re seeing..

Thank you very much..

Sure..

Thank you. [Operator Instructions] Our next question comes from Kevin Steinke with Barrington Research..

Afternoon. Following up on the discussion about G&A expense levels, something you’ve called out the past couple of quarters here is a reduction in the use of external third-party consultants. And if I recall, you had talked about wanting to reduce the use of those third-party consultants in Heidrick Consulting.

So maybe just talk about that a little bit more, are you adding more internally and thus lowering their cost and kind of what’s the outlook for that as you move forward, can you reduce that even further?.

No, no problem. So in terms of the external cost, again, consulting is one component, we’ll touch on that one, which is – our expectation is to continue to scale that through internal performance and less reliance on external third -party consultants. I would also tell you that we are doing that at the corporate level.

You’ve seen the fact that we’ve made, for example, a change in auditors from third-party consultants that we feel are more aligned economically to the growth strategy that we have in mind. We did the same thing in legal. We’ve done the same thing in other parts of our business. So it’s really a global initiative.

It’s not strictly related to Heidrick Consulting, which is all really, like I always tell everybody, the pennies add up to the savings and that’s really what you’re seeing coming through..

Okay. Okay, got it. And when you talked about the vision for 2021, you mentioned one of the goals was to broaden your service offerings.

Just wondering how much you think acquisitions might play into that, as you think about broadening your service offerings, maybe what the pipeline looks like? How aggressive are you looking, especially in light of the expanded credit agreement that you announced?.

Yes, Krishnan here. Thank you for that question. We continue to talk with all kinds of companies who are approaching us as well. This is a very vibrant human capital marketplace today, particularly with emphasis on technology and tools and things that companies are working on. So there are lots of conversations that are regularly going on.

Now, we have to be very careful with those things that fit our strategic purpose and our alignments. So we’re very, very careful on that. And we will be looking at those opportunities and we will continue to have those conversations before we proceed. So it’s definitely a part of our agenda..

And I would just add on to that what Krishnan said. So I think, the alignment is absolutely the first component. The second one is valuations, which I think as you know in this market right now, they’re pretty frothy. So our view generally is, we’re not going to see a lot of attractive opportunities.

In terms of answering last part of your question on the facility side, we have absolutely, right, nothing is spoken on that facility. There’s no intent behind the renewal. It’s simply, because the market conditions were there and it made a lot of sense.

It’s now cheaper than it was before, and we’ve extended the runway to 2023, which was important just in case we hit some bumps in the road. But even though we have that facility, our goal is still to be very focused on sticking to what we believe is important before we ever consider any type of acquisition and be very disciplined about it..

Okay, that’s helpful. You talked about how the executive search headcount is. It’s remained relatively flat the last few quarters here. You’re doing more with less, producing more with the consultant base you have. Yes, I noticed you had that press release about 10 days ago announcing 14 consultants added in search.

Is that just kind of an aggregate of what you’ve added throughout the year and just announcing?.

Yes..

Yes.

Okay, that’s not – we shouldn’t expect kind of a spike up over the next couple of quarters because of an announcement, is it fair?.

Yes. Look, I think, we think about number one, that was an aggregation of several months worth of hiring that we had been doing. So look, we’ve been focusing a lot on performance management, on training and development, implementing the Heidrick Way and using that as opportunities to improve our productivity.

We’ve been replacing headcount with outstanding new consultants that fit our model better. And at the same time, we’ve been promoting from inside the firm. And what you’ll see over time is, we’re going to continue to do that. So in January, we will be promoting more people.

So we kind of try to think about it as net new consultants between all of the things that are going on, not simply just hiring. Hiring will be a part of our program. It probably isn’t going to be as aggressive as it was historically, because we think we’ve got a great pipeline of internal talent that we can count on as well.

But you will see hiring from Heidrick in the future as well..

Okay.

Could you expand to on the comment about adding more principals than partners in Heidrick Consulting, I think, as you move over the next couple of quarters, what – what’s the objective there?.

Yes. So inside of consulting model as well, there’s a bit of a leverage there between partners and between principals and being able to – we’ve got lots of opportunities now we need to close on and deliver, and we feel that we need to have the best delivery resources available.

Those principals are also the key element, not only in delivering, but in selling work. So it’s a very important position for us to get the best talents in, because they’re our future partners. And most of those principals we’re hiring will be within one to two years partners inside of Heidrick Consulting.

So there’s a focus on not only on partner hiring, but on principal hiring as well going on inside of Heidrick Consulting..

Okay. Just lastly one numbers question here. There was other income item of a little over $2 million.

If there’s anything to call out as – in terms of what that was or just curious about what that number entailed?.

Yes. So basically, a while ago, we had a – an equity position pertaining to a search we did many, many years before the company went public and we exercised our warrant position on it. So that that’s really what was driving that number..

Okay, perfect. Thanks for taking the questions..

Sure..

Welcome..

Thank you. And we have no further questions in the queue at this time.

Are there any closing remarks from our speakers today?.

Yep. Thank you very much. I’ll be brief here and let me just summarize. We are very excited about the future. We’re looking forward to closing out this year strong and finishing with a record 2018. So I just want to say thank you to our employees and thank you all for joining us on our call today..

Ladies and gentlemen, this concludes today’s presentation. You may now disconnect..