Oct 29, 2013
Executives
Julie Creed - Vice President of Investor Relations and Director of Workplace Strategies Jory J. Marino - Interim Chief Executive Officer, Regional Managing Partner and Vice Chairman of Financial Services Practice Richard W.
Pehlke - Chief Financial Officer and Executive Vice President
Analysts
Stephen Sheldon Frank Atkins - SunTrust Robinson Humphrey, Inc., Research Division Kevin M. Steinke - Barrington Research Associates, Inc., Research Division Kevin D.
McVeigh - Macquarie Research
Operator
Good morning. This is Heidrick & Struggles Third Quarter 2013 Conference Call.
Please note that this call is being recorded and 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, ma'am.
Julie Creed
Good morning, everyone. And thank you for participating in Heidrick & Struggles 2013 Third Quarter Conference Call.
Joining me on today's call are Jory Marino, our interim Chief Executive Officer; and Rich Pehlke, Heidrick & Struggles' Chief Financial Officer. As a reminder, we'll be referring to 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. In today's call, we're going to be using terms -- the terms "adjusted EBITDA" and "adjusted EBITDA margin".
These are non-GAAP financial measures that we believe better explain some of our results. A reconciliation between GAAP and non-GAAP financial measures can be found on Page 3 and Page 7 of our press release and on Pages 3 and -- on Slides 3 and 30 in our supporting slides.
Throughout the course of our remarks, we'll be making forward-looking statements and ask that you please refer to the Safe Harbor language contained in our news release and on Slide 1 of our presentation. The slide numbers that we're going to be referring to are shown in the bottom right-hand corner of each slide.
And now, I'll turn the call over to you, Jory. Please start on Slide 2.
Jory J. Marino
Thanks, Julie. And good morning, everyone and thank you for joining today's call.
Over the course of the last 3 months, I've had the opportunity to connect with hundreds of employees around the globe. My goal has been to listen and learn: learn how we can better connect and make sure our people have what they need to serve our clients to the best of their ability.
It is clear that we have a very talented and experience group of professionals who are passionate about our firm and focused on delivering superior results to our clients as we help them build the best leadership teams in the world. We have an opportunity to build on this foundation and deliver more value to each of our constituencies.
As you saw in this morning's release, we reported third quarter net revenue of $119 million, up 1% year-over-year and down 3% compared to our second quarter. Revenue for the first 9 months of 2013 increased 1% compared to the first 9 months of 2012.
Adjusted EBITDA, as shown on the next 3 slides, was down 2% year-over-year, although up 15% compared to second quarter. Year-to-date for the 9-month period, adjusted EBITDA is down 2% and the adjusted EBITDA margin is 9.4%.
Improving profitability continues to be a key focus and we are pleased with the progress we have made over the course of this year on both adjusted EBITDA and adjusted EBITDA margin. This improvement is reflected in Slide 6.
The EBITDA improvement was one of the several positives in the third quarter. As you see on Slide 7, we continued to benefit from the additional Senn Delaney.
In addition to performing in line with our expectations from a revenue and margin perspective, the ability to speak the culture has allowed us to introduce a new dimension to our client conversations that will lead to deeper and longer-term relationships. As you'll see on Slide 8, Asia-Pacific and Europe also showed good progress.
In Asia-Pacific where Heidrick & Struggles holds a market-leading position, revenue grew 7% on a constant currency basis. And revenue in Europe is the highest in 5 quarters, up 12% year-over-year on a constant currency basis.
A result of improving market conditions and our focus on adding capabilities in the 3 key markets of the U.K., Germany and France. While we don't want to read too much into one quarter, we do believe that our European operations have begun stabilized.
Our service practices delivered mixed results, but Consumer Markets and Life Sciences were both up more than 10% year-over-year. And the average fee per Executive Search improved to $124,500 in the third quarter.
That said, consultant turnover continues to be higher than we would like, which impacts confirmation trends in the third quarter. In the Americas, the combination of voluntary and involuntary turnover impacted revenue, but at the same time, improved productivity.
Market conditions were improving around the world and we intend to capture more of this upside. Our management team is committed to executing the firm's Leadership Advisory strategy and we're aligned around the steps necessary to get there and to restore growth.
Our clients want a talent partner who can serve all of their leadership needs, and we believe our firm is well-positioned to be that partner. We hold the enviable position of serving leading global organizations throughout the world, and a significant amount of our work continues to be at the top of the market.
In fact, through the first 9 months of 2013, our CEO in Board Practice confirmed 40% more nonexecutive director engagements for Fortune 1000 clients versus 2012. And there's one 45% of known Fortune 500 CEO search and succession planning opportunities in 2013.
Before I turn the call over to Rich Pehlke , I would like to take a moment to thank all of my colleagues around the firm for their commitment to helping our clients to build best leadership teams in the world. Your efforts and contributions have not gone unnoticed.
With that, I'm going to turn over to Rich -- turn the call over to Rich who will provide further detail on the third quarter.
Richard W. Pehlke
Thanks, Jory, and good morning, everyone. Since Jory provided high-level overview of the quarter, I'd like to give you a bit more detail and a few line items on the financial statements.
Similar to the last 2 quarters, the year-over-year comparisons are affected by the acquisition of Senn Delaney, which was completed on December 31, 2012. In the third quarter, we recorded $6.6 million of revenue from Senn Delaney.
As you'll recall, we've been limited in the amount of pre-acquisition deferred revenue that we've been able to recognize related to Senn Delaney as a result of purchase accounting. This quarter, there was only about $340,000 that we're unable to recognize for accounting purposes.
We expect the remaining balance to run out in even smaller amounts over the next few quarters. Referring to Slides 14 and 15, salaries and employee benefits expense was $81.7 million, up $2 million or 3% compared to last year's third quarter.
Included in the quarter was $3 million of expense related to the separation agreement with the company's former CEO. Of the $2 million reported year-over-year increase in salaries and employee benefits, there was an increase in variable compensation of $3.2 million offset by a decrease in fixed compensation of $1.2 million.
The increase in variable compensation reflects increases in bonus accruals related to our consultant performance, some of whom are having record years. The decrease in fixed compensation was attributable to lower expenses, results of lower headcount, and decreases in guarantee and sign-on bonus expense.
Turning to Slide 16, general and administrative expenses increased $1.5 million year-over-year, or 5% to $29 million in the third quarter. There are several large items to point out in the G&A line.
Last year's third quarter included an expense of approximately $2.5 million related to our global partners' meeting. In this year's third quarter, we have $3.3 million of expenses related to the addition of Senn Delaney.
If you were to exclude these 2 items from G&A in both quarters, it would indicate that we've held the G&A expense run rate essentially flat in the core business. Moving to Slide 17 and 18, we reported net income in the quarter of $4.1 million and diluted earnings per share of $0.23.
The effective quarterly tax rate was 45.4% based on a full-year projected tax rate of approximately 68%. Up slightly from where we projected we'd be for the year at the end of the second quarter, which is 64%.
This is due to the projected mix of income worldwide. Now looking at Slide 19, Heidrick & Struggles' cash position remains strong and we have ample financial flexibility to continue to invest in and grow our business.
Cash and cash equivalents at September 30 were $132.8 million, and our cash position net of debt was $95.8 million. Recall that we build our cash position throughout the year as we accrue for bonuses which are paid in March of the following year.
While we're pleased with the trends and improvements we saw in the third quarter, the opportunity for growth is in front of us and there is work to be done. Our Executive Search backlog is shown on Slide 20, and monthly confirmation trends are shown on Slide 21.
While October confirmations aren't final, August and September confirmations trended slightly lower than we had expected, and that will impact fourth quarter performance to a degree. We're forecasting fourth quarter net revenue of between $100 million and $110 million.
The factors which we base our forecasts each quarter include our current backlog, confirmation trends for the Search and Leadership Consulting businesses, the anticipated fees associated with those businesses, expectations for Senn Delaney, the number of consultants and the current economic climate and stable currency rates. With that, I'll turn on the call back over to Jory.
Jory J. Marino
Thanks, Rich. The last several months, we affirm that we have the right strategy, a solid service platform and world-class consultants.
We have all the necessary elements for success. However, we are also acutely aware that we must execute more effectively to deliver the results that our clients, employees and shareholders expect.
And that is what we are committed to do. Operator, at this time Rich and I would be more than happy to take questions.
Operator
[Operator Instructions] And we'll take our first question from Tim McHugh of William Blair.
Stephen Sheldon
This Stephen Sheldon, for Tim this morning. First, just want to ask what was the turnover during the quarter, and how much of that was voluntary versus involuntary?
And then also if we look over last year, has any vertical been hit harder than others in the context of the turnover? So yes, any color there would be appreciated.
Jory J. Marino
Total turnover for the quarter was 16; 13 of which was voluntary, and 3 of which was involuntary. The second part of your question, was any vertical hit more than another?
Our smallest vertical, oddly enough, which is our Education & Social Enterprise practice, was the hardest hit. But it also is the vertical that is a small piece of our business.
The only other verticals were plus-minus what we would've anticipated: Consumer was up by 11%, Life Sciences was up by 20%; ESE, as I mentioned a moment ago was down about 25%; and Industrial was down 20%. So, when you look at it, Financial Services was essentially flat.
It was off by just a fraction. And if you look at the 9 months, for Financial Services they were up 3%, which is indicative of the recovery that's been made year-to-date in that sector.
So, I don’t think there was any unusual hit in core industry practices other than the one I referenced, which was ESE.
Stephen Sheldon
Okay. And then I also want to ask a little more detail in what you're seeing in Europe.
Was the growth there due to the easier comp, or is there something more fundamental that's driving that? And then also, was there any notable change in Europe as you progress in the quarter?
Richard W. Pehlke
This is Rich, Stephen. I'm not sure if there's anything particularly worth calling out from the standpoint of change.
I think a couple of things drove it: number one, that some of the newer consultants that we've hired and added to our team have started to ramp up and be -- experience steadier production. Some of the losses that we had experienced a couple of years ago in Europe were pretty senior people, and it takes a little bit longer to get those people on board and up to speed.
So I think a combination of a little bit of better economic environment in Europe, as well as just some newer people getting up to speed have driven it. So we're encouraged by that.
I think Europe still remains a tough marketplace because of, as we've said many times, capital investment and the trends in capital investment in that business. But certainly, there are brighter spots, I think London is a brighter spot.
I think Germany improved a little bit in the quarter. We'd like to see France get a little bit stronger, but that's one that where there's a lot of sovereign impact relative to risk characteristics in that market just because of tax structure and some of the things going on there.
But overall, that's really been the nature. Europe will go, for us, largely driven by what happens in those 3 markets.
Jory J. Marino
The only thing I would add to that -- and this is Jory -- is as you may recall, at the beginning of this year, we appointed a new region leader in Europe. And frankly, with a little bit of focus, a little bit of tireless effort, we're starting to see some of the benefits of that leadership change, and that's been a big positive for us.
Stephen Sheldon
Okay. That's helpful.
And then last, the tax rate came in a little lower than we expected this quarter. How do you think we should model that moving forward?
Richard W. Pehlke
I wish I could give you a lot of clarity about the definitive. But as we've said many times, the nature of the revenue mix and the income mix varies all over the map, especially when we're impacted by our European operations.
So the more -- if we can get more income out of Europe, it's certainly going to help our tax rate a lot. And as you can see, as we've got some benefit from the stabilization and improvement in our international markets, that's going to help.
So right now, I don't think there's a dramatic change in the model in looking forward, but I'm hoping the current trends starts to stabilize.
Operator
And moving on, we'll go to next question from Tobey Sommer of SunTrust.
Frank Atkins - SunTrust Robinson Humphrey, Inc., Research Division
This is actually Frank, in for Tobey. A question on confirmations.
If we look at the monthly trends in August, September and October, you see a little bit of weakness there. Is that market-driven, or do you think that is related to the consultant headcount?
Any thoughts on this -- on trends on a monthly basis?
Richard W. Pehlke
This is Rich. I think, a little bit with -- I think we've actually sensed that the market has picked up a little bit.
And I think that some of our's related to a little bit more of confirmation trends related to consultant activity in the short-term. So, I think a slightly larger impact in turnover versus market for us.
Frank Atkins - SunTrust Robinson Humphrey, Inc., Research Division
Okay. And then we got the headcount as of the end of the quarter, I believe, was 308.
Has that changed as of now?
Richard W. Pehlke
Well, we don't comment on the individual fluctuations on any given week day or month. I mean, the reality is people -- we always have net impacts in and out.
We'll be hiring some people. Some people may leave.
So until we get in the next quarter, we won't talk about that.
Frank Atkins - SunTrust Robinson Humphrey, Inc., Research Division
Okay, great. And then I guess in the guidance, revenue guidance, what are you forecasting for Leadership Consulting and how is that area progressing?
Richard W. Pehlke
I think Leadership Consulting business is it's currently scaled in our business today. It's still relatively flattish.
And the amount of impact is considered to be pretty stable in terms of overall contribution. I think we're a little bit disappointed we haven't invested heavier in that business.
And we're looking for ways currently to boost that up a little bit more, because I think we've got very good consultants, but we're still limited in their capacity and we haven't scaled that business effectively enough. So we've got to get a little bit better at that to get a stronger financial contribution.
Very pleased with what I'm seeing with Senn Delaney relative to their contribution, both in terms of revenue and operating margin. And in our Search business, we continue to see some consultants having exceptional years and doing very well, and there's still a population of our consultants that we need to help and mentor up a little bit in terms of their production rates that can improve overall productivity.
Jory J. Marino
This is Jory. Just to add to that, as you may recall, from the -- our last earnings call where we talked about the things we're going to focus in on, clearly, scale in our Leadership Consulting platform is a key driver.
Being able to provide, not only the high-level custom solutions and -- that our clients looking for from us, but also to provide some scale and more technology-based solutions on a go-forward basis. And then the second driver was around focusing our core search business.
And so we haven't loss focus on that, and those are the 2 themes that you'll continue to see us driving towards.
Frank Atkins - SunTrust Robinson Humphrey, Inc., Research Division
Okay. And if I could sneak 1 or 2 quick ones in there.
What's bonus accrual as it stands right now? And then coming a little bit on the hiring environment, has anything changed from the competitive landscape from your competitors, or where these folks are being hired from?
Or your thinking in terms of the hiring process?
Richard W. Pehlke
Well, I think from a hiring perspective -- I'll deal with the last question first. We tend -- I think as I look back in the recent quarters, it's been about a 50-50 split of people that we've brought with either industry experience that are newer to search versus people who are established search.
We look for qualification based upon their ability to do business development, talk the language of the industry. Relative to the vertical, they may come in, have good business acumen and have the ability to relate to clients and people very well.
So, I think we'd like to tilt that a little bit more towards experienced search because there's a faster ramp up time, but that can change from quarter-to-quarter.
Julie Creed
And your first question, Frank, there's a slide in our deck we give each quarter, Slide #15. We don’t provide the actual dollar bonus accrual.
But if you use the variable and bonus related expense in that slide, Slide 15, that's the best proxy that we provide every quarter.
Operator
And we'll go next to a question from Kevin Steinke of Barrington research.
Kevin M. Steinke - Barrington Research Associates, Inc., Research Division
I was wondering if you spent any time drilling into the -- down into the reasons behind the consultant turnover, or if the turnover you felt was more of an isolated incident in the quarter. You said it was related to your smallest practice.
So any color on that would be helpful.
Richard W. Pehlke
Yes, so there's a couple of things. As we think about it, people do leave for a variety of reasons, so I don't know that we have any themes that have emerged in people who decide to leave the firm.
We look at people who we're attracting to the firm as well, and there, we're seeing some themes. And so, if you think about our brand value in terms of the work the current people do, you've heard a little bit about, of course, some of our wins on both a percentage basis, on an actual basis, in both our Board and CEO practice.
That provides a nice, attractive platform for us and a nice, attractive platform of where people to -- want to come to. In terms of the materiality of the departures, they've have been all over the lot.
Some of them have been the individuals who were not performing up to what we believe our standards should be, and they self-select out. And there was 1 or 2 cases where we would have preferred not to lose the person, but we did.
But at the same time, we've also attracted in the quarter 9 very good hires, both here and abroad.
Julie Creed
And Kevin, if I could just clarify something you said, just to make sure everyone on the call. When Jory was referring to industry practice growth rate, he was referring to revenue growth rate and increases and decreases, and not consultant turnover in those practices.
Jory J. Marino
Yes. That's exactly right, and I should have mentioned that as well.
But thank you for that catch, Julie.
Kevin M. Steinke - Barrington Research Associates, Inc., Research Division
Okay. No, thanks for clarifying that.
So do you continue the heightened focus on performance management? And do you think that's maybe led to some departures at maybe people who are performing at the lower end of the ranges?
Or any commentary there?
Richard W. Pehlke
Yes. Kevin, this is Rich.
Just to add, look, I think it's most heightened issue that we spend most of our times discussing because it's so critical to our business. We are a people-oriented business, 70% of our revenue goes into the computation of our people.
And people drive our business and, obviously, our client facing. So we look at everything from, as Jory indicated, the people we hire, to the tools we provide them, to the training and support and how we make sure support gets to doing great work across the firm.
And at some places, we do it better than others, and we just got to continually get better. Obviously, the turnover is higher than we would expect.
And this is a business that is going through a lot of constructive change. From the standpoint of just technology changes every day, the demand of clients changes every day, and we've just got to keep a better pace with it and making sure our people are as well-equipped as possible to deal with it.
And so, it comes back to making sure that we do everything from not just the profile of people we hire, but also engaging in people, making sure they're successful on the platform. Performance management sometimes gets too often skewed to thinking that you want to drive people out of the firm.
And the reality is it's all about making people successful in the firm. And that starts at the front line.
People they interact with everyday and continues down through everything that we invested and try and give them support. So it's got to be a complete effort.
And we, as leadership, take it very seriously.
Jory J. Marino
Yes, just to build on that last point, if I think about the 2 things that are, clearly, the most important to us on a go-forward basis. And frankly, over the past 60 years, the firm has been our clients and our people.
Great clients and great people make a great business, and the results generally follow. So when I think about performance, I think about managing performance, not performance managing.
You want to -- we want to create a winning team, we want to create a winning culture, and the focus for all of us on the leadership team, as evidenced by the fact that we invested in a new CHRO, Head of HR, a couple of months back, and we are working through a whole host of programmatic shifts to ensure that our people are the best-trained with the best tools and that this is a -- and that we, indeed, have a great place for them to build a career. So people and clients are the big drivers for me, and for the leadership team, we, at the firm.
And we have great people and great clients, and we continue to win, we'll have great results. And that probably, is obvious to everybody on this call.
But it certainly -- you got to live -- you got to walk that talk, and you got to live it everyday.
Kevin M. Steinke - Barrington Research Associates, Inc., Research Division
All right, great. Thanks for that helpful commentary.
And I had one last question. In your last couple of press releases, earnings releases, you've called out decreases in guarantee and sign-on bonus expense.
Is there a reason for a decline in fixed compensation expense. I was wondering if there is something -- a conscious effort going on there to reduce sign-on bonuses or guarantees, or if that's just a result of hiring trends?
Or am I reading too much into that?
Richard W. Pehlke
No, you're not reading too much into it, Kevin. It's a couple of things.
Number one, I think there has been a constructive change in the way we've structured some hiring packages which have helped that somewhat, and sometimes, candidly, in years past, it was an abused element of our hiring process. Having said that, I wish it was a little bit stronger because I wish we were hiring more.
We've got to do a better job of filling that pipeline. It is not a restriction.
It's something that we take in a case-by-case basis, so I can tell you that we have never had a hiring freeze. We have not instituted a hiring freeze.
We've got to do a better job of meeting our plans in terms of building our practices in our region -- regional presence at the right level with the right people, and money is not standing in the way of that.
Jory J. Marino
Having said that, we also want to -- I'm sorry. Kevin, let me just try and jump in for a quick second here.
Having said that, we also want to be sensible in terms of the type of people we hired. We want to hire people that want to be here.
We want to hire them for the right reasons. And of course, we're going to do all the things necessary to ensure that they are appropriately on board it both professionally and financially.
It's easy to buy people, I suppose, and you get sort of all kinds of money to buy talent. And it's been done in your industry over the years, and as you probably saw last week, I guess, Morgan Stanley and Bank of America called a truce on that in some level and we're seeing that broker hires, guarantees and all of that are changing as well.
So I think it's around the value proposition. At the same time, every firm, ours included, want to be sensible as we bring people on-board, and again, onboard them both professionally and onboard them financially appropriately, so that we indeed attract the talent that we need to have to grow the platform.
Operator
[Operator Instructions] And we'll go next to Kevin McVeigh of Macquarie.
Kevin D. McVeigh - Macquarie Research
Great. I wonder if you could give us a sense in terms of the revenue on Q4, what type of margin assumptions they have dialed in there between $100 million and $110 million.
And if you said this, I apologize, but just the tax rate associated with that, number one. And then number two, Rich, as you think about the business longer-term, I mean, you painted almost $620 million of revenue.
And here, if you annualize at that kind of current run rate, you're at $420 million. Pretty deep into the recovery, I mean, how are you thinking about peak earnings in this next up cycle and the components of that from a margin perspective as well?
Richard W. Pehlke
You asked a lot of forward-looking questions that I am not going to answer. But let me try and give you a little bit more color to try and direct you a little bit without going where I can't go.
First of all, I don’t give margin guidance, and we don't do any margin guidance. But let me speak to what I think we have been able to accomplish over the last few quarters.
That while we've seen the business not maybe stabilized at a level of revenue that I'd like to see in terms of our scale, I think the company has done a very good job of maintaining healthier margins than we've experienced in the past. So through a combination of things we've done over the last couple of years to stabilize our G&A expense rate, et cetera, I think those things are coming into fruition, and our people have been a great job of managing expense across the business, both in corporate and out in the field.
Having said that, we're still scaled to be a larger business, which really addresses the second part of your question. And we had anticipated being a larger business coming into this year.
And we have had a net turnover issue that's slightly higher than what would've expected. And some of that -- some of the issue in that revenue shortfall that disappoints us is that it's a combination both of turnover, as well as some performance issues that could be better.
It's unfair to just paint a broad brush because we have people that are performing very well in this market. We have seen uptick in the market.
And I'm not sure -- the cycle is at a late stage. Quite frankly, where we participate, some of our markets are a little bit more early stage than others.
I think, as I said in my commentary, I think the possibility for growth still remains here, and we've got to make sure that we capitalize it the best we can and put ourselves in the best possible position. As for the tax rate comment, as I checked my notes on what you asked about, the one thing I'll just go back to is that I think we are slightly positive -- positively impacted by the book tax rate this quarter.
Again, our book tax rate tends to be a little bit higher than we -- than our effective cash tax rate because of the European issues. And again, if we get a little bit more improvement in that business, over time, that's going to certainly help that.
We -- from a cash perspective, we're preserving the ability to use our foreign tax credits and some of those preferred tax assets, so should we continue to make progress in those markets, it generates a lot of cash flow opportunities and profitability opportunities.
Operator
[Operator Instructions] And there are no further questions on the queue at this time.
Jory J. Marino
If there are no other questions, I want to thank everybody for your participation this morning. For our colleagues around the globe, I want to again give a shout out and thank everyone for all that you do for this firm and will continue to do for this firm, and all of you should know that your leadership is behind you.
Have a great day everyone. Enjoy the rest of your day.
Julie Creed
Thank you.
Operator
Again, that does conclude the call. We would like to thank everyone for their participation today.