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#Good afternoon everyone and thank you for participating in Heidrick & Struggles fourth quarter and 2016 conference call.
Joining me on today's call is our CEO, <UNK> <UNK>, and our Chief Financial Officer, Rich <UNK>.
During the call today we will be referring to supporting slides that are available on the IR home page of our website at Heidrick.com.
We encourage you to follow along or print them.
Today were going to be using several non-GAAP financial measures that we believe better explain some of our results.
A reconciliation between adjusted EBITDA and adjusted EBITDA margin is found on slides 12 and 27 in our supporting slides.
Throughout the course of our remarks will be making forward-looking statements.
As you please refer to the safe harbor language contained in our news release and on side one of our presentation.
The slide numbers that we're going to be referring to our shown in the bottom right-hand corner of each slide.
Now <UNK>, I'll turn the call over to you.
Thank you, <UNK>, and good afternoon, everyone.
Today we reported fourth quarter and 2016 results that reflect continued solid progress on our strategic initiatives and a return on the investments we made over the last year in growing our business.
Let me begin with a few remarks about the fourth quarter.
We saw positive momentum of our third-quarter continue, net revenue increased almost 11% year over year and grew 11% sequentially compared to the third quarter.
Executive Search delivered good growth up 6% year over year.
Leadership Consulting has become a more meaningful part of our overall business just under 10% of net revenue in the fourth quarter with a 28% operating margin.
As such you've seen from our press release that we are now reporting all three business lines as separate segments namely Executive Search, Leadership Consulting, and Culture Shaping.
The growth in consolidated net revenue helped drive [45%] year-over-year growth on operating income and a 31% increase in adjusted EBITDA in the fourth quarter.
Looking back at what we achieved for the full year of 2016, I'm pleased with many of our accomplishments.
A few that I would highlight include number one, net revenue grew 10% or $51 million in 2016, 12% in constant currency, and more than half of the revenue growth was organic.
Separately we acquired three companies, two that bolstered our Leadership Consulting capabilities and one in Search that improved our brand and positioning in Europe and specifically in the UK.
We also made significant progress on our strategy to develop a diversified portfolio of leadership advisory and culture solutions that permit us to partner more significantly with boards and senior executives to improve individual, team and organizational performance.
In fact, half of our top 10 clients utilize both our Search and Leadership Consulting services in 2016.
Two other comments, the strategic investments in people that we made over the last year through hiring and acquisitions have helped us build a larger, more stable, higher quality base of consultants which positions us for growth and profitability in our business going forward.
And lastly, operating income improved 3% and adjusted EBITDA grew 10% both good improvements given the investments this year.
With those quick highlights of the fourth-quarter in 2016 I'll now call over to Rich to go into more detail and then I'll come back in a few moments and give you additional and specific thoughts on where we want to go in 2017.
Thanks, <UNK>, and good afternoon, everyone.
I will begin with some additional details from the fourth-quarter results beginning on slides 3 and 4.
Fourth-quarter net revenue of $159.8 million was up 11% compared to last year's fourth quarter or 14% in constant currency.
It increased 11% sequentially compared to the third quarter.
Executive Search grew 6% year over year, all three regions contributed to the growth and every industry practice of group, except gold technology and services, achieved growth as well.
Leadership Consulting grew 117% driven mostly by the inclusion of three acquisitions we made over the last year, but also good organic growth as well.
Culture Shaping declined 10% year over year but increased 11% sequentially compared to the third quarter.
Referring to slide 5, we ended the quarter with 335 Executive Search partner and principal consultants, 22 Leadership Consulting partners and 17 Culture Shaping partner and principal consultants.
Looking at slide 6, salaries and employee benefits expense in the fourth quarter increased $7.6 million or 7%.
Fixed compensation expense increased $7 million and reflects compensation related to four acquisitions as well as the investments we made in new and existing talent for all of the businesses.
In periods of high investment the fixed portion of our compensation expense will tend to be higher due to the incentives and guarantees that are part of the consultant hiring process.
As a result of higher fixed compensation expense and an increase in the use of third-party consultants and contractors, whose costs are included in our general and administrative expenses, variable compensation increased slightly in the quarter.
Salaries and employee benefits expense was 70.1% of net revenue for the quarter compared to 72.3% in the 2015 fourth quarter.
Turning to Slide 7, general and administrative expenses increased 15% or $5.3 million to $40.1 million.
More than half of this increase or $3.6 million reflects G&A from acquisitions of Co Company, DSI, JCA Group and Philosophy IB, including the use of third-party consultants and contractors.
Excluding the G&A of these acquisitions our G&A expense increased 5% in the fourth quarter.
Now looking at slides 8 and 9, operating income increased 45% or $2.4 million.
The operating margin was 4.8% in the quarter.
From a segment perspective, Leadership Consulting's 28% operating margin was the main driver of the improvement in consolidated operating income.
Now I'll turn to the annual results which start on slide 18.
<UNK> hit on most of the 2016 highlights at the beginning of the call but I'm going to walk through some additional details that are not covered in the release.
2016 net revenue increased about 10% or $51.2 million to $582.4 million.
Salaries and employee benefits expense as shown on slide 20 increased 8% or $30.7 million.
Mostly attributable to the increase in fixed compensation expense.
Again, the increase in fixed compensation expense is related to the four recent acquisitions as well as new hires in the Search and Culture Shaping over the last year and a severance expense related to the repositioning of the Leadership Consulting business which we recorded in the first quarter.
Salaries and employee benefits expense was 68.7% of 2016 net revenue compared to 69.5% in 2015.
Turning to slide 21, general and administrative expenses increased 15% or $19.4 million in 2016.
$11.9 million or 61% of this increase reflects G&A expenses related to the four recent acquisitions including the use of third-party consultants for client work.
In addition, another $1.5 million related to the LC restructuring costs announced in the first quarter.
Our organic growth in G&A was just under 5% for the year driven mostly by higher technology related expenditures.
I want to take a moment to talk about our effective tax rate for both the quarter and the year with results reflected in slides 13 through 16 for the quarter and slides 28 through 31 for the year.
Our book effective tax rate is always been volatile due to the operating results and many of our foreign jurisdictions.
During the course of the year as results come in and we are often changing our tax credit accruals to reflect our best estimate of where our taxable income will ultimately end up.
We finished the year strong with most of the increase in regions where we have higher effective tax rates, in particular the US.
At the end of the third quarter we were estimating their effective tax rate for this year was going to be 48%.
However, as you've seen in our press release, our fourth-quarter book effective tax rate was 95% and for the year was 59%.
This was a result of several nonrecurring items.
One is that we took the opportunity to repatriate foreign dividends to the United States which increased our book tax expense.
We offset the majority of the tax liability from these dividends by utilizing foreign tax credits that were close to expiring.
We also had a couple of nonrecurring discrete tax items that took place in the quarter.
If adjusted for the impact of these items the adjusted book effective tax rate would've been 54% for the fourth quarter and 48% for 2016.
As we look ahead to 2017 we are currently estimated an effective tax rate of between 44% and 46% which would be more of the norm.
Now referring to slide 32, cash and cash equivalents at December 31, were $165 million compared to $190.5 million at December 31, 2015.
The primary drivers of the difference compared to 2015 reflect cash bonus ---+ higher cash bonus payments in early 2016 and approximately $30 million of acquisition payments made in 2016, and then retention and earn out payments made to Senn Delaney.
The Company's cash position builds throughout the year as we accrued bonuses which are paid early in the following year.
Earlier this month we paid approximately $12 million in variable compensation related to the portion of consultant bonuses that are deferred each year.
In March and April we will pay out an additional $128 million in variable compensation related to 2016 performance.
Now let me give you the guidance for the first quarter and <UNK> will talk more generally about the year.
Our Executive Search backlog is shown on slide 33 and monthly confirmation trends are shown on slide 34.
Other factors on which we base our forecast include: anticipated fees, the expectations for our Leadership Consulting, Culture Shaping assignments, the number of consultants and their productivity, the seasonality of the business, the current economic climate, and foreign currency exchange rates.
We are forecasting 2017 first quarter net revenue of between $140 million and $150 million.
Reported net revenue was $130.2 million in the first quarter of 2016.
With that, I'll turn the call back over to <UNK>.
Thanks, Rich.
By virtually every metric we further strengthen our business in 2016 building off our achievements in 2015.
I want to express my appreciation to all of my colleagues for the work they are doing to contribute to the success of Heidrick & Struggles.
First of all, we believe that market conditions are favorable for our business in 2017 as reflected in our first-quarter guidance.
The rapid pace of change and rising uncertainty has placed an even bigger premium on leadership.
Never before has talent, leadership, and culture meant so much to building and sustaining competitive advantage.
We still have much more to accomplish in helping our clients identify, attract, and develop talent and to provide their leaders with the analytics and insights to drive their organizations forward.
Internally, we still have work to do and driving more synergy among our three business lines and advancing our key account focus to bring the full power of Heidrick to our clients.
All that said, there will be two key components of our growth.
One is from our core Executive Search business, capitalizing on the investments we have made in consultant teams globally and the second is from Leadership Consulting and Culture Shaping.
There is good opportunity for Heidrick enabled by our brand to take a bigger share of the market for increasingly valuable advisory services.
Specifically, let me highlight the goals for each of our three businesses in the year forward.
First an Executive Search.
We intend to build on our momentum.
Key to our growth objectives is improving the productivity of the consultant hires we made in 2016 and a new class in 2017 consultant promotions.
Reflecting are well-established development and training program we promoted a record 28 people into the Search consultant ranks as principles effective January 1.
We also promoted six from principle to partner.
As with new hires, we will invest in developing the new principal consultants to assure they're highly successful with support throughout the organization at every level.
We want to continue to grow our market share of the Americas and in Europe.
In Europe in particular, we will continue to integrate the JCA acquisition and drive more focus and growth at the CO and Board level.
Our focus in Asia will be to maintain share and look for opportunities to drive improved profitability as we focus on higher value searches.
Globally, we will continue to hire selectively, targeting specific practice, functional, or geographical gaps but are not planning the same level of hiring that was accomplished in 2016.
And growing our key account base which was also an important part of our growth story in 2016, we will continue in 2017 with a further emphasis across service line collaboration.
For Leadership Consulting, our goal is to continue to scale the business to increase our impact with clients.
We made significant strides in 2016.
We developed a consulting platform which we call, Accelerating Performance.
It is designed to help clients move their businesses forward with both speed and agility in an increasingly unpredictable operating environment.
Our methodology behind Accelerating Performance based on more than four years of research was launched last month at a CEO panel in Davos at the World Economic Forum.
This year we look to further integrate our advisory presence globally, investing in consultant expertise, new service offerings, and scalable tools, and methodologies.
Expect to see an increase in revenue and profitability as we progress the integration of the three acquisitions and continue to grow the business.
Overall, we believe we are building an LC business that has higher growth characteristics in Search and upon achieving scale will have returns that are no less.
Third, Culture Shaping.
Our Culture Shaping business fits prominently into our growth strategy.
Both as an important source of revenue and earnings growth but also with a fundamental part of our client offering that is critical to maximizing our client impact.
2016 was a year of significant investment in Culture Shaping.
Specifically in new consultants who will help us capitalize on what we have today as well as drive incremental new growth going forward.
The scale of the investment made in Culture Shaping in 2016 when not recur in 2017.
We expect to see a much higher operating margin contribution from this business segment in the low to mid teens.
Assuming revenue growth accelerates, the mix of enterprise revenue and consulting revenue remains balanced and with investment in retention cost being less of a factor, by 2018 we expect the margin should exceed 20% returning to historical levels.
Overall, across our business we are making good progress.
We are delivering on our strategy to deepen and expand our presence of clients at the top and to offer more services as a trusted and valued advisor.
Balancing our investments in the growth of each of our businesses with shareholder returns will require our continued focus and outstanding operational execution.
Let me pause there and Rich and I will be delighted to take your questions.
Stephen I will take that and let <UNK> add to it.
It is not---+ in businesses like Leadership Consulting just like in Culture Shaping we might see some little bit of lumpiness, it won't necessarily always be a sustained run rate.
I don't think it is far off in terms of the size of the business that we are looking at going forward.
Certainly will be in incumbent upon our ability to continue to add consultants as well as support resources to fulfil client engagements.
We do like the progress of what we have seen in the fourth quarter as the Leadership Consulting business has come together and certainly it started to show the momentum of building the business that we have the looking to build for some time now.
What was the second part of the question.
That's a tough one because I would say a lot of it is driven by the fact of the newer businesses and the newer consultants that have come in through the course of both.
Remember Co Company wasn't a new acquisition this year, it came in late in 2015 much ---+ it drove a lot because, Colin came as part of Co Company, it drove a lot of the revenue.
Certainly there was a decent contribution from DSI and a small amount from PIV because that came in the latter part of the year.
I would add what you see happening in the fourth quarter is ---+ you clearly see the contributions coming from acquisitions that happened in 2016, DSI in the PIV.
But you also seeing the content that we built which I referenced around Accelerating Performance and you see that being flexed in the marketplace.
That Accelerating Performance is really new IP for us, it is based on market research along with what we look at as the best-performing companies across the Footsie 500.
You really saw all so all that coming together in the fourth quarter of 2016, it may be a bit on the high side but the direction is the right statement to take from it.
I think what we generally say, is if you follow the geopolitical headlines over the last couple of weeks or couple of months you could find reasons to pause in terms of what that impact might be in the economy.
We just don't see it in the economy.
We certainly don't see in the United States.
We don't see it.
If we see it anywhere we see it in, maybe a tad more in Asia but even there we had increased growth in the fourth quarter.
Europe, there's all sorts of reason to reflect or concern yourself with the noise, but it just hasn't shown up in the economy yet.
We certainly are seeking to achieve margin expansion and we certainly saw it more in the EBITDA side than the operating income side this year because of the acquisition accounting.
We were a bit more pleased with that but certainly---+ and we knew that this would be a year of investment largely driven by what we did in LC in terms of one of our more profitable business virtually turning that to into almost a breakeven business for the current year and expect that to turn around next year so we should see some margin expansion there.
I think from a standpoint the margin expansion will come if we can continue to hold or increase the size of the Search business because we are operating at a better level now for our expense base.
Second of all, it will also continue, it will be incumbent upon us to continue to grow the Leadership Consulting business as well as return LC back to profitability and the pace in which that happens will certainly be a big factor in driving margin growth.
I'll make to overall comments <UNK>, one is what you are seeing is the investment in the consultants we've had over the past 18 months start to generate that return.
That's why you see those numbers holding.
We feel good about having productivity in the $1.6 million range even with all the hiring that we have done.
You have a sense for---+ you don't always get that return without some time on the investment side and we are starting to see that return.
On the principal side we just have a strong amount of confidence in the principles in the firm as well as the principals to be that are being groomed in the firm and we want to balance our hiring between the experienced partner level and the principal side for a whole bunch of reasons.
We see---+ you saw it at the margin a little bit more investment by us in 2016 at that principal reason because of the confidence we have.
Sure, I think overall and I will have Rich pick this up but overall the reason to segment is frankly just transparency.
Transparency to you but frankly, also transparency within Heidrick.
We want people who are managing the business to feel accountable for it, to feel connected very directly with it, but also aware of how the other businesses are doing.
I'd say transparency and accountability were the main drivers certainly for investors but also frankly, within Heidrick.
<UNK>, what I would add to that too is we pretty much at this point in time have almost three relatively distinct business models now that we are managing with clear management teams within the business that have now come up to a different level of scale.
It became the right time to pull LC out of the Search business and give that transparency the [traits] refer to as well as more directly coincide with how we are managing the business.
I will take a moment also to go back to your first question just to make sure because you mentioned about the flattish headcount.
We are up in headcount relative to both total employees and consultants.
Part of one of the challenges and opportunities we have, that relates even back to the first question on margin expansion, is that we have to balance that continued investment in people to support the growth of the business and talent is still at a premium in our industry.
Try and drive that leverage across the business while we are supporting a higher amount of headcount.
In part it is due to the fact we use different leverage models in each of the businesses as well because in LC we are much more of a consultative partner with a lot of operating leverage underneath.
In Culture Shaping that is a slightly different leverage model as well and then Search is a little bit more of what we have been used to in the past which is a little bit more of a one-to-one-to-one ratio across our business.
Three very distinct businesses, lots of dynamics going on relative to the headcount, trying to shrink the overall G&A operating base as we continue to grow these businesses and at the same time take some of those savings and reinvest them back into technology to try and hopefully grow the productivity of the business.
The trade-off that we hope to happen over time there is that if we can continue to build the support ranks of the LC business we're going to need those types of people to actually fulfill the jobs ---+ the assignments we have from our clients.
The opportunity for margin expansion there is to get a better return because the cost of labor will be cheaper if we bring it in-house over time.
We are paying a premium to use outside consultants.
While we are comfortable doing it as we grow the business and as we deploy the IT we have in LC and Leadership Consulting, we are (inaudible) and our increasing the ranks at the principal and more general levels in LC for exactly that reason that you are asking.
And <UNK>, I have one other thing that the $11.9 million also includes general ongoing G&A, it's not all just third-party contractors and consultants.
We are not going to be able to give you a specific number on that not because we do want to but you understand we're not going to be able to do that.
I would say in general and this goes back to the earlier question as well about why we breaking out these business, we're breaking them out because we have confidence in our ability to break them out.
We have confidence in the growth in LC, it is an area of the firm that we are looking to grow for the reasons we described in terms of margin opportunity, as well as what it does to add value to our client.
I think the way you can view it is we are looking to grow all these businesses and we invested in all three of them in 2016 in a meaningful way.
Just the math, just the numbers means you are going to see more growth at the Leadership Consulting and Consulting level on a percentage basis.
We're going to want to grow those businesses meaningfully, is the way I would say.
We are going to want to continue to achieve scale for all the complementary margin reasons as well as just footprint and impact we can have on the Search business into acquiring talent.
What you see happening at Heidrick is we want to help companies both acquire the talent but then as that talent comes in-house how can we improve their performance, how can we improve it to our Leadership Consulting IP and platform and how can we do it with respect to Culture Shaping.
Okay.
Operator, thank you very much.
All of our business participants, thank you as well and we will leave it there.
Have a good rest of the day.
