Heidrick & Struggles International, Inc. (NASDAQ:HSII) Q3 2023 Earnings Call Transcript

Heidrick & Struggles International, Inc. (NASDAQ:HSII) Q3 2023 Earnings Call Transcript October 25, 2023

Heidrick & Struggles International, Inc. beats earnings expectations. Reported EPS is $0.729, expectations were $0.68.

Operator: Good afternoon, ladies and gentlemen, and welcome to the Heidrick & Struggles Q3 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. And please be advised that this call is being recorded. After the speakers’ prepared remarks there will be a question-and-answer session. [Operator Instructions] Now at this time, I’d like to turn things over to Mr. Steve Horwitz, Interim Head of Investor Relations. Please go ahead, sir.

Steven Horwitz: Thank you, and welcome to our 2023 third quarter conference call. Before we begin, we’d like to congratulate VP of IR, Suzanne Rosenberg, on her newborn and a wonderful addition to our Heidrick family. While she is on maternity leave for the quarter and year-end, I will be serving as the Interim Head of IR, having been placed through the On-Demand Talent group. Moving on to the business of the day. Joining me on today’s call is our President and CEO, Krishnan Rajagopalan, and Chief Financial Officer, Mark Harris. We posted our accompanying slides on the IR homepage of our website at heidrick.com, and we encourage you to view these slides for additional context to our prepared remarks. Please note that in the materials presented today, we may refer to non-GAAP financial measures that we believe provide additional insight into our underlying results.

Reconciliations between these non-GAAP financial measures and the most comparable GAAP measures may be found in the earnings press release. Also, in our remarks, we may make certain forward-looking statements. We ask that you please refer to the Safe Harbor language also contained in today’s press release. Krishnan, I’ll now turn the call over to you.

Krishnan Rajagopalan: Thank you, Steve. Good afternoon, everyone, and thank you for joining us today. Before we turn to our results, I’d like to take a moment to acknowledge the terrorist attacks on Israel that occurred a few weeks ago and the tragic events continuing to unfold in Israel and Gaza. Our thoughts go out to the countless people whose lives have been lost and changed forever. As a firm, we condemn all acts of terror and violence and reject all forms of racism and hate. We continue to focus on ensuring the safety and well-being of our colleagues and supporting friends and families around the world who have been impacted by these devastating events. Now turning to our financial results. We’re very pleased with our third quarter results where we delivered $263 million of revenue, which was at the upper end of guidance and within $1 million from being the largest third quarter in our history.

Our revenue was 3% stronger than last year’s third quarter, a return to year-over-year growth. With our continued focus on robust profitability, we’re also proud to have achieved our 13th consecutive quarter of double-digit adjusted EBITDA margin. Our execution this quarter was impressive, especially given the uncertain macro environment in which we have been operating. Clearly, geopolitical risk has also meaningfully increased over the past few weeks, which will make our markets harder to navigate, but we’re prepared to do so just as we have in the past. It’s important to note, however, that while we’ve historically demonstrated our ability to execute in difficult environments, these factors, among many others, make it difficult for anyone to accurately predict exactly what business conditions will look like over the coming few quarters and beyond.

In response to current conditions, our clients are creating a wide range of scenario planning expectations based on a range of outcomes, as we are as well. With that as a backdrop, I want to be explicitly clear that regardless of how the economy moves in the short to medium term, we’ll remain relentlessly focused on executing our One Heidrick strategy. As I mentioned before, this strategy encompasses the two main areas we focus on with our clients as their global leadership adviser. First, we bring the best talent to their companies, whether it’s permanent executive-level talent or on-demand talent, and second, we help leadership and organizations to be more effective through our consulting and now our digital offering. In doing so, we are continuing our decades-long position as a global market leader within Executive Search while also investing in the diversification of our product offerings.

Alongside our Executive Search services, we have a clear set of diversified solutions, which includes offerings in On-Demand Talent, Heidrick Consulting and the relatively soon to be contributor, Heidrick Digital. These diversified solutions now represent nearly 25% of our revenues, providing higher growth potential for the broader Heidrick & Struggles Enterprise, while also beginning to lessen the impact of revenue cyclicality that have always existed within Executive Search. These diversified solutions also make us a stronger partner to our clients as we’re able to provide them with a more comprehensive suite of talent, leadership and human capital offerings. Critically, our diversified approach is more important than ever. Our clients’ talent and human capital needs are continuing to grow and evolve and at a much faster pace.

For example, rapid business transformations, including more recent AI-driven ones, are putting even more demands on leadership talent. Topics such as cybersecurity and sustainability are growing in importance for Boards and companies. And there’s a continued push-pull around leader and employee expectations and culture related to remote, hybrid and traditional workplace environments. As our clients navigate through these needs, we’re working closely with them, advising them on these issues and providing them with a set of integrated talent and human capital advisory services in ways that previously have not been available to them. Now turning to each of our businesses, beginning with Executive Search. There has been a modest slowdown, reflecting macro and portfolio mix changes within the verticals in which we operate.

While global technology services and financial services experienced some headwinds, all other practice groups grew year-over-year. Generally, the search business has been somewhat stabilized over the last few quarters, and our pricing remains strong. Demand has been more resilient with CEO, divisional CEO, supply chain, financial officers and Board of Director roles. Now as we talk about demand stabilization, we should keep in mind that in the last few years have included an abnormally low demand period during the pandemic, followed by an abnormally high demand environment as companies began to refocus on future leadership needs. To more effectively measure our progress, it makes sense to take a longer-term view and a more comprehensive look at the growth patterns.

From the beginning of 2017 until now, we have delivered a very respectable 7.5% compound annual growth rate. Additionally, the business has been meaningfully profitable, producing north of $50 million in adjusted EBITDA in 8 of the last 10 quarters, including nearly $52 million this quarter. This profitability is very important to us as it helps us drive investments in our diversified solutions. Turning to Diversified Solutions. In On-Demand Talent, we’re very excited that our strategic acquisition of Atreus continues to drive outsized growth, and we now have a larger presence in Europe as a result of the acquisition. Additionally, demand in the Americas is showing strength. As I mentioned last quarter, we realigned our sales efforts to more directly pursue target good market opportunities and this realignment has enabled us to focus on the large talent constraints impacting our clients in areas such as AI, HR, CFO and CISO roles.

For example, we’re seeing an increased number of opportunities and roles for AI business applications, for interim finance leaders, for event-driven strategic implementations and for leadership in uncertain situations, while the labor market remains very tight and we’re able to fill these interim positions effectively because of our expansive network of On-Demand Talent. At the same time, talent application volume is at the highest level ever. Diving deeper into the tight labor market, our ability to combine Executive Search and On-Demand Talent is one powerful illustration of our One Heidrick strategy where we’re providing our clients with an expanded set of complementary talent offerings. For example, if a company is rapidly expanding, they may have difficulty quickly filling all of their positions.

By partnering with us, while they’re working towards the placement of a permanent executive, they can also tap into our vast network of senior independent talent to fill vacant roles on an interim basis. In addition, there are numerous opportunities to help with high-priority project-related work. Another key component of our diversified solutions offering is the Heidrick Consulting segment. As a reminder, the focus of our consulting business is to help clients with leadership assessment and development; to help them align around purpose, culture and strategy; and to provide pragmatic DE&I solutions. This quarter, the consulting business achieved solid organic year-over-year growth and inorganic growth like the businessfourzero, or B4Z, business.

As I mentioned last quarter, our backlog was fairly encouraging, and that strength continued through the third quarter. We did see some of those projects that were on hold begin to flow through the business, and that execution has been a positive driver of our revenues. In addition to the nice growth of confirmations compared to last year, we increased our consultant head count from 72 to 90. This helped drive the meaningful revenue growth we achieved compared to last year through purpose-driven culture and leadership projects. As part of the One Heidrick strategy and similar to our On-Demand Talent business, the significant amount of these projects were referred by our search business. And finally, I’ll discuss Heidrick Digital. As we know, this business has the opportunity to be a large contributor to our diversified solutions, albeit further down the road.

We feel strongly that the opportunity for our digital offerings, especially Heidrick Navigator, will be significant. When companies take a systematic approach to viewing their talent, they can make better leadership decisions. Whether it’s in identifying leaders to promote internally, more effectively aligning leadership talent to business needs, retaining top talent or ensuring that diversity, equity and inclusion goals are being met, our offering enables companies to maximize the value of their human capital. To that end, we’re excited to share that we converted one of our first early access partners from our Heidrick Navigator pilot program into a 3-year subscription. This is great early proof-of-concept success measure. Looking ahead through 2024, we’ll be focused on our early adopters and we’re responding to their feedback with periodic opportunities to convert them into subscription clients.

We’re excited that the feedback for Navigator has been universally positive. The success of the digital offering has also allowed us to target higher volume assessment engagements for Heidrick Consulting. Again, we’re still very early in our Heidrick Digital business journey, but we’re excited by some of our early successes. Now you’ve all heard me speak quite a bit today about the One Heidrick strategy and how all our businesses are strategically linked. Before we conclude, I’ll share a client example that illustrates how our different businesses work together to provide a more diversified comprehensive solution. This example is that of a large company that recently IPO-ed. Their goals were to drive expansion into new markets, accelerate the pace of change in innovation, transform their culture to pursue more strategic growth opportunities, reshape their leadership team and further globalize their business.

Our search team introduced the client to our consulting team to perform assessments on potential COO successors from within their organization. After conducting the assessment, they decided that they would continue their search externally with us. The comprehensive nature of our approach, coupled with our clear analysis, gave this client the confidence in our ability to be their leadership adviser and has led to a stronger partnership. We now have multiple projects in place with them to drive organization-wide culture change, executive team acceleration and CEO succession planning. This example really gets to the heart of what we are accomplishing with so many of our clients, which is to be their leadership adviser, guiding them to be a stronger company.

So in closing, we continue to be a market leader, and we’re relentlessly focused on our One Heidrick strategy, bringing clients the best permanent executive and on-demand talent and helping leadership be more effective through our consulting and digital offerings. Looking ahead, we will continue to develop our diversified solutions as we provide broader, more comprehensive offerings for talent and human capital challenges at the executive level. The fundamentals of the business are solid, and we’re excited by the opportunities in front of us. Finally, a big thank you to the Heidrick team for their continued hard work and incredible dedication to our clients. I would now like to turn the call over to Mark.

Mark Harris: Thank you, Krishnan, and good afternoon and evening to everyone on today’s call. Today, I will start off with a review of our third quarter results, which came in at the upper end of our guidance, demonstrating strong execution by our team in all business segments. As Krishnan mentioned, growth through our diversified solutions and continued strong profitability remain at the forefront of what we’re trying to accomplish for our shareholders in 2023 and beyond. Before I dive in the consolidated results for the quarter, I’d like to highlight some numbers associated with our diversified solutions. As Krishnan mentioned, this platform consists of our On-Demand Talent and Heidrick Consulting businesses and will soon include Heidrick Digital.

These businesses now represent nearly 25% of total revenue, a considerable change from the 9% when we embarked upon this journey in 2018. In fact, our diversified solutions quadrupled in that time, going from $63 million to $257 million on an annualized basis today or an annual growth rate of 32%. Our strategy will be to continue to invest in these businesses, and we expect they will become increasingly part of our bottom-line profitability. Moving on to this quarter’s results. On a consolidated basis, third quarter revenue was $263.2 million or 3.1% above revenue for the third quarter of 2022. More specifically, Executive Search revenue decreased 6.6% from Q3 2022 to $198.8 million. Looking at our regional performance compared to the prior quarters, we saw Americas Search revenue was down 8%, Europe was up 8% and Asia Pacific was down 22%.

This performance was in line with our expectations due to normal seasonality. Compared to last year’s third quarter, we saw a 5% reduction in confirmations. Consultant productivity on a trailing 12-month basis in the third quarter was $1.9 million and compares to $2.5 million in the trailing 12 months of the third quarter of 2022. This is right in the middle of the range we expect in a post-pandemic environment where technology has been enhanced, embraced and accepted by the market. Turning to On-Demand Talent. Revenue was $41.1 million, up 77% compared to the third quarter of 2022. As we have previously discussed, this growth was driven by the positive effects of our Atreus acquisition. Backing out the acquisition for a more comparative results, we saw our legacy On-Demand Talent business revenue fall by approximately 16% compared to the same period last year.

While we saw drops in wins, average project sizes and the number of extensions, this seemed consistent with the market. However, we are expecting to see strength in our markets in the short to medium term. Heidrick Consulting’s third quarter revenue grew 22% year-over-year to $23.3 million, partially due to the acquisition of B4Z. And even without their contributions, our legacy HC business was up nearly 10%. Our business is benefiting from the approach to invest in both organic and inorganic growth where 1 plus 1 equals 3 or greater. In addition to revenue growth, we delivered a 17% increase in confirmations from the previous quarter and we increased the number of consultants by 25% to 90, which we believe will have strong returns in the future.

Plus, we’re currently in the investment and scaling phase, and we look forward to delivering continued success with the combination of organic of the Heidrick Consulting business, along with future acquisitions that fit within our strategic vision. Turning to operating expenses. Including recent acquisitions, we saw salary and benefits increased 2.5% from the third quarter of 2022. Variable compensation decreased $13.5 million year-over-year due to a decrease in production. Fixed compensation increased $9.2 million over the third quarter of 2022 due to base salary and payroll taxes, the deferred compensation plan and other costs, partially offset by decreases in RSU amortization and retirement benefits. As a percentage of net revenue, salary and benefits were 63.5% versus 67.2% last year.

General and administrative expenses increased to $37.6 million or 14.3% of net revenue compared to 12.6% of net revenue in the third quarter of 2022. The increase is due to intangible amortization and accretion costs from acquisitions, office occupancy costs and marketing, partially offset by a decrease in other costs. Last, we remain focused on progressing the development of Heidrick Navigator and our other digital assets through R&D spending. R&D spend for the third quarter was $5.6 million or 2.1% of net revenue versus $5.4 million or 2.1% of net revenue in the third quarter of 2022. Overall, the spending is consistent with prior quarters. As we continue to incorporate M&A activity into our business, we must also record noncash charges related to purchase accounting.

Therefore, in terms of underlying profitability, and consistent with comments we made in the previous quarter, we view adjusted EBITDA as the best proxy of our operating performance of the business, and we’ll use this going forward, as we’re doing internally. In the third quarter, adjusted EBITDA was $32.3 million compared to $33.3 million in the third quarter of 2022. As Krishnan mentioned, we recorded our 13th consecutive double-digit adjusted EBITDA margin at 12.3%, which compares to 13% last year. On a segment basis, Executive Search remains very profitable, even with the decrease in revenue, with an adjusted EBITDA of $51.9 million compared to $51.5 million in the third quarter of 2022 or a margin of 26.1% compared to 24.2%, respectively.

On-Demand Talent recorded an adjusted EBITDA loss of $0.6 million versus a gain of $0.2 million in the third quarter of 2022. However, as we’ve discussed, we expect EBITDA margins to continue to be negligible while we both reposition ourselves in the market and invest in people and technology to capture more of this expanding market. Finally, Heidrick Consulting posted an adjusted EBITDA loss of $2.2 million compared to a $1.4 million loss in the same quarter last year as we continue to invest in the business to build scale. Finally, adjusted net income for the quarter was $15 million and adjusted diluted earnings per share was $0.73, which is down from the $20.5 million in adjusted diluted EPS of $1 in the same quarter last year due to the factors just discussed.

Now I’ll turn to the balance sheet. At the end of the third quarter, our cash and marketable securities increased sequentially by $95 million to $334 million from the previous quarter but was down to $122 million by the same quarter last year. The year-over-year decrease is due to our acquisition of BTG, B4Z, Atreus and Executive Search expansions in Finland, South Africa and South America. Taking a closer look at how we prioritize the uses of cash, we first take care of our current operations and then we believe our next greatest returns will come from reinvesting our cash and inorganic opportunities that accelerate our strategy and are accretive to our shareholders, bottom-line. When we believe we have discretionary cash that isn’t needed for the previous mentioned priorities, we will then review our dividend policy followed by potential stock repurchases.

Moving forward, while there is pressure on corporate spending in the market, we’re still seeing good demand signals and strong fundamentals across our business lines. Therefore, we expect the fourth quarter to be strong compared to last year, allowing us to finish another year north of the $1 billion in revenue. That said, turning to our fourth quarter 2023 revenue guidance, we expect to range between $240 million and $260 million. As I mentioned last quarter, we’ll continue to leverage our leading Executive Search business and grow our diversified solutions segment as they carry different macro risks, which tend to be less cyclical and more predictable. While they generally carry lower margins versus Executive Search and, therefore, will put pressure on our enterprise EBITDA margins, I would point out that they are expected to grow aggregate dollars in both EBITDA and bottom-line, which is expected to expand our EPS in the future.

With that, Krishnan and I will be glad to take your questions.

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Q&A Session

Operator: Thank you, Mr. Harris. [Operator Instructions] We’ll take our first question this afternoon from Kevin Steinke at Barrington Research.

Kevin Steinke: Good afternoon, Krishnan and Mark. I want to start out by asking about your comment about a moderate slowdown in Executive Search. This is something, I guess, you’ve mentioned on the last couple of calls. But I just was wondering if that comment was meant to indicate that things have slowed down meaningfully since your second quarter call, or is it kind of as it was several months ago in terms of the overall pace of the demand environment in search.

Krishnan Rajagopalan: Yes. Kevin, thanks. Yes, look, I would say that we have been in a choppy environment for a bit of time, and it kind of feels the same to us, though, there are many more macro things we’re talking about today than we were even a month ago. So we think it’s a choppy environment. We think talent is constrained still in this choppy environment. Decision-making is a little bit slower than what we’ve seen in the past. But I don’t want to say that it’s worse than in the second quarter. It sort of feels the same to me and it feels like it’s going to continue a little bit as well.

Kevin Steinke: Okay. That’s good to hear. Thanks. And you did mention on the consulting side of the business that some projects that had been delayed have started up. Maybe could you just talk about the rationale from the client side to start up those projects? Or what might have been the impetus to move forward that might have gotten them past the hurdles that they had been kind of concerned about before?

Krishnan Rajagopalan: Yes. Look, I would say the majority of those hurdles look like trying to prioritize their own business in the first and second quarter as clearly wanting to go on particularly culture and leadership journeys with us but getting their priorities together, getting their teams together. And so they signed up for the project work, thinking that they could kick it off, and I think they felt far more comfortable about where their own teams were and what their priorities were to be able to engage with us on these projects. I think it’s nothing more than that but just how do you prioritize.

Kevin Steinke: Okay. Great. Thank you. And you mentioned again there the realignment in the On-Demand Talent sales effort. I know it’s still early days, but any indications early on of some of the benefits of that realignment or what you would hope to accomplish going forward with that initiative.

Krishnan Rajagopalan: Super. Yes. Look, we definitely feel we’re beginning to see green shoots from that initiative. So we’ve got a lot of metrics in place that we look at, the number of conversations people are having, opportunity pipelines, et cetera. And those have all pointed way up now from where they were in the middle, so we’re feeling good about that. We’re able to bring sales and the talent side of the equation together a little bit closer. We’ve got a couple of very targeted projects as well on initiatives that we see out there where talent is scarce and we’ve got opportunity. We call them our greenhouse projects. AI would be one of them, and we’re seeing nice momentum in there as well, to be able to put part-time or interim people in place on those kinds of projects. So that’s why we’re feeling pretty good about that sales realignment.

Kevin Steinke: Okay. Thank you. And I also wanted to ask about digital, and congratulations on converting one of the pilot programs to a per year subscription. Just I don’t know if you can give any sense about how you look to establish subscription prices. I mean, is that completely fixed? Is there any variation based on volume or usage? Or I guess, any insight in just kind of the pricing model that you could provide.

Mark Harris: Sure. Let me give it a try, Kevin. So I think the first one is, there’ll be the typical upfront fee, if you will, for installing and making sure that everything kind of goes at the outset of putting everything in place. Then you would have a subscription fee. That’s really based off the user count. And there’s two different elements to that. The first one, obviously, is the number of users that you have. Obviously, the more, the per pricing would come down. And the other thing that we do is, we do benchmark that off some other SaaS companies to see what the pricing and the market really is in terms of a fair value of what we charge for it. So we kind of get our nods, if you will, from the market as well as the upfront fee in order to put everything kind of in place.

So it’s a combo. You can figure that again, typically, whatever we put in place would more or less have a 2- or 3-year runway in front of it in terms of how we would build the business and expectations of how we build that business.

Kevin Steinke: Okay. Perfect. That’s helpful. And just lastly, I wanted to ask about the acquisition pipeline. You mentioned there that acquisitions continue to be a top priority for capital allocation. Maybe what you’re seeing in this environment and if the pipeline has changed at all just based on the macro-outlook.

Mark Harris: The only thing you see on the pipeline is that the pipeline always continues to be quite strong. I mean just to be clear, the first priority is always internal — our organic operations. And we still believe that we’ve got things to do in terms of technology development for On-Demand Talent, Heidrick Consulting, some event there, et cetera. So please don’t underestimate the fact that we are spending money rightfully on what we currently hold today in inorganic as kind of the second priority. On the second priority of inorganic, pipeline is strong. Still, some things are probably outside our reach in terms of pricing structure, et cetera. And I don’t believe really what we’ve seen — even though we’ve seen an increase in interest rates, I think I saw somewhere where they said credit cards were at 28% in credit card interest rates.

That hasn’t really impacted a lot of the financings that I would have expected to see as of yet in terms of people going back, trying to get their Series G and H on, so to speak. So that will most likely, I think, start to come to focus in Q4, Q1 and Q2 next year. And I think then real valuations probably come within striking distance of where we think we can be accretive to our shareholders. So that’s kind of the way that we see it.

Kevin Steinke: Okay. Thanks for all the color. I will turn it over.

Operator: Thank you. We go next now to Tobey Sommer at Truist Securities.

Tobey Sommer: I was wondering if you could help bridge us to profitability in some of the smaller businesses that you’re investing in and managing for growth given the market opportunity that you see. I think investors kind of want to understand what that looks like and need more information to construct a vision of sort of what the company’s future financial profile will be.