Earnings Call Transcript - HURN Q2 2023

Operator, Operator

Good afternoon. And welcome to Huron Consulting Group's webcast to discuss the financial results for the Second Quarter of 2023. As a reminder, this conference call is being recorded. Before we begin, I would like to point all of you to the disclosure at the end of the company's news release for information about any forward-looking statements that may be made or discussed on this call. The news release is posted on Huron's website. Please review that information along with the filings with the SEC for a disclosure of factors that may impact subjects discussed in this afternoon's webcast. The company will be discussing one or more non-GAAP financial measures. Please look at the earnings release and on Huron's website for all of the disclosures required by the SEC, including reconciliations to the most comparable GAAP numbers. And now I would like to turn the call over to Mark Hussey, Chief Executive Officer and President of Huron Consulting Group. Mr. Hussey, please go ahead.

Mark Hussey, CEO

Good afternoon, and welcome to Huron Consulting Group's Second Quarter 2023 Earnings Call. With me today are John Kelly, our Chief Financial Officer; and Ronnie Dail, our Chief Operating Officer. We continue to drive strong organic growth in each of our three operating segments while expanding our company-wide operating margin, consistent with our growth strategy. Revenues in the second quarter of 2023 grew 27% over the prior year quarter, and for the first half of 2023, revenues grew 25% over the same period last year, reflective of the ongoing strength and demand for both our consulting and managed services and digital capabilities. Adjusted EBITDA margin increased to 130 basis points in the first half of 2023, compared with the same period in 2022. As we make solid progress toward a goal of expanding company-wide profitability, we are pleased that our performance has outpaced the financial objectives shared at a 2022 Investor Day. We remain confident in our ability to deliver above these goals in the years ahead. I'll now share some additional insights into our second quarter performance. In the healthcare segment, second quarter revenues grew 35% over the prior year quarter. The increase in revenues in the quarter was driven by strong demand for our performance improvement, financial advisory, and digital offerings. As the federal and state pandemic relief funding has waned, hospitals and health systems face ongoing financial and operational challenges. Many organizations have experienced workforce shortages, increased cost of labor and supplies, and increased competitive pressures in their markets, collectively leading to margin pressures and, in many cases, net operating losses. Healthcare organizations are focused on addressing these challenges and doing so in a manner that best positions them to stabilize near-term performance and enables them to achieve their broader strategic goals. The shifting mindset highlights the need to implement more immediate financial improvements while also designing strategies for new and long-term growth centered around the consumer. In responding to clients' needs to address both immediate and long-term improvements, we have significantly broadened our portfolio to create more balanced and diversified healthcare offerings. We've strengthened our industry expertise and expanded our portfolio of capabilities to solidify our position as the partner of choice for clients seeking to address both current and longer-term challenges and opportunities, which has also, in turn, expanded our addressable market in the healthcare industry. Let me bring this to life with a couple of examples. We're working with central health systems facing the exact pressures I just noted. These systems need to identify significant and sustainable financial improvement across their operations, sometimes ranging into hundreds of millions of dollars. Opportunities like these play to our strengths in core performance improvement, as we help transform their current operating models and capabilities across such areas as revenue cycle, workforce and supply chain, and clinical optimization. In addition to driving near-term efficiency gains, our clients are also focused on driving longer-term sustained improvement and growth to support their strategic goals. To support the second objective, we bring together our strategy and innovation, care transformation, financial advisory, and digital offerings to redesign the clients' operating and care delivery models in order to fundamentally strengthen the systems' underlying economics. Our competitive differentiation stems from our ability to assemble and deploy a talented team of healthcare experts integrated across a broad set of capabilities, and to work collaboratively to deliver the best solution possible for our clients. And that's at the heart of a new operating model. The second example of our work to improve performance in healthcare is an engagement in which we're using generative AI to drive efficiency in call center operations. Our digital team is implementing generative AI in conjunction with Salesforce to optimize and automate processes. These examples, though very different in their scope and implementation, aim to drive near-term and long-term sustained benefits to address financial and operational challenges. Our deep healthcare expertise and digital capabilities together enable us to design offerings that address a broad range of strategic and operational concerns of our healthcare clients. Turning now to education, education segment revenues grew 25% in the second quarter of 2023 over the prior year quarter, driven by broad-based demand across all our offerings in the segment. Our digital offerings in education improved 47% over the prior year quarter, while our strategy and operations and research offerings continue to perform well. While some college business officers feel confident in their financial stability, their institutions over the next 10 years have concerns over their near-term financial outlook, largely due to enrollment declines, reduced net tuition revenue, and an expense base that is increasing faster than revenues. Our education clients are not only focused on their near-term challenges, but they're also committed to establishing a strong foundation to achieve their long-term strategic goals. Similar to healthcare, the confluence of these factors underscores the need to drive near-term improvements while establishing sustainable long-term strategies. Let me use a couple of examples to highlight the impact that deep industry expertise and a broad set of capabilities have on our higher education clients. As a first example, we've been engaged by a university to support the execution of their strategic plan. We are collaborating with them to identify opportunities that will drive growth and financial and operational improvements to create capacity to invest in high-priority areas within the plan. Our scope at the university is broad, spanning administration, research, facilities, technology, and more. To illustrate this, let me highlight three of these areas. Within the research enterprise, we're helping this institution define a research strategy and administrative operations. Within the technology function, we're executing a data and analytics strategy aimed at driving greater value and insights across the entire institution. Finally, together with the academic units, we're working with academic affairs to empower academic leaders with greater access to data, advising on new offerings and capabilities to support the institution's growth goals. Our strategy, operations, and research teams have done a remarkable job collaborating with clients, leading to additional opportunities to expand their efforts into new areas within the university, including their intercollegiate athletics program. Our second example highlights the power of our combined consulting and digital offerings, where two clients were seeking to create an agile operational foundation to support future growth focused on enabling and positive engaging student experiences as a competitive advantage. Huron was hired to help execute a digital transformation to establish a process-driven, technology-enabled organization across this multi-campus institution. Our strategy and operations, research, and digital teams are all collaborating to lay a new operational foundation for the university, enhancing their ability to recruit students, faculty, and staff, and creating an agile and flexible foundation to help them achieve their future strategic goals. Together, our deep industry expertise and strong reputation, coupled with the broad array of offerings in a collaborative, nimble culture, solidify our strong competitive position, helping institutions address the challenging landscape within higher education. In the second quarter of 2023, turning to commercial, our commercial segment revenues grew 10% over the prior year quarter, driven by strong demand for our distressed financial advisory offerings and digital offerings, partially offset by a decline in our strategy and innovation offerings. Demand for our distressed financial advisory offerings remains strong given the continued impact of higher interest rates, challenging capital markets, increasing costs, and expanding competitive pressures. Healthcare companies are executing digital transformations to address some of the same pressures, with advanced and agile technology capabilities and strong data and analytics infrastructures helping bend cost curves, enabling better and faster decision-making to improve how organizations engage with their customers. Growth in our commercial segment has increased the classification in our portfolio and markets, driving new avenues for growth and expanding our addressable market. We believe that a broad portfolio of digital, financial advisory, and strategy and innovation offerings, coupled with deepening industry expertise, will continue to be a solid foundation for growth in the segment. Finally, let me turn to our outlook for the year. As our press release indicates, we are increasing and narrowing our annual revenue guidance to $1.3 billion to $1.34 billion, an increase of $70 million at the midpoint. We continue to expect our adjusted EBITDA margin to be in the range of 12% to 12.5% of revenues while raising our full-year adjusted diluted earnings per share to a range of $4.35 to $4.65, which is an increase of $0.50 per share at the midpoint. Our first-half results demonstrate the continued demand for our services and products, and the power of a collaborative culture and new operating model. In summary, we're pleased with the first-half performance, and we expect the underlying demand across our segments to continue as reflected in our updated revenue and earnings guidance. I reiterate our commitment to our shareholders as we remain focused on advancing our growth strategy. Our strong relationships, industry expertise, and broad array of offerings in healthcare and education, along with a $0.5 billion digital capability, which today represents about 45% of our total company revenues, provides a strong foundation from which to address the myriad of challenges our clients face today, and position them for future success. We will also continue to drive new avenues of growth for our business as we expand upon our portfolio of offerings and further strengthen our industry expertise. While we are still in the early stages of the strategic journey described in our 2022 Investor Day, we've demonstrated our ability to accelerate growth across the business over the last six quarters. We remain confident in our ability to meet or exceed our medium-term financial objectives. Now, let me turn it over to John for a more detailed discussion of financial results.

John Kelly, CFO

Thank you, Mark. And good afternoon, everyone. Before we begin, please note that I will be discussing non-GAAP financial measures such as EBITDA, adjusted EBITDA, adjusted net income, adjusted EPS, and free cash flow. Our press release, 10-Q, and investor relations page on the Huron website have reconciliations of these non-GAAP measures to the most comparable GAAP measures, along with a discussion of why management uses these non-GAAP measures and why management believes they provide useful information to investors regarding our financial condition and operating results. Now I’ll share some of the key financial results for the quarter. Revenues for the second quarter of 2023 were $346.8 million, up 26.9% from $273.3 million in the same quarter of 2022, achieving another record of quarterly revenues as we continue to execute our growth strategy. The increase in revenues in the quarter was driven by organic growth across all three of our operating segments. From a capability perspective, consulting and managed services revenues grew 33.4% and digital revenues grew 19.2% when compared to the same quarter in 2022, respectively. Net income was $24.7 million, or $1.27 per diluted share, compared to net income of $13.9 million, or $0.76 per diluted share in the second quarter of 2022. Our effective income tax rate in the second quarter of 2023 was 29.4% compared to 36% in the same prior year period. Our effective tax rate from Q2 of 2023 was less favorable than the statutory rate, inclusive of state income taxes, primarily due to certain nondeductible expense items, partially offset by the tax benefit of non-taxing gains on investments used to fund our deferred compensation liability. Adjusted EBITDA was $48.5 million or 14% of the revenues in Q2 2023 compared to $33.2 million, or 12.2% of revenues in Q2 2022. The increase in adjusted EBITDA in the quarter was primarily attributable to the rise in segment operating income, reflecting continued progress toward our goal of mid-teen adjusted EBITDA margins by 2025. Adjusted net income was $27 million in the second quarter of 2023 compared to $17.5 million in the second quarter of 2022. Adjusted diluted earnings per share were $1.38 in Q2 2023, compared to $0.83 in the prior year quarter, an increase of 66% year-over-year. Now, I'll make a few comments about the performance of each of our operating segments. The healthcare segment generated 50% of total company revenues during the second quarter of 2023. This segment posted revenues of $173.8 million, up $45.3 million, or 35.3% from the second quarter of 2022. The increase in revenue reflects continued strong demand for our performance improvement, financial advisory, digital, and revenue cycle managed services offerings, demonstrating broad-based demand across our portfolio of healthcare offerings. As a reminder, in accordance with US GAAP, we recognize performance-based fees on our healthcare performance improvement projects as we deliver on those projects using a percentage of completion methodology and our best estimate of the total performance-based fees that we expect to earn on each project, which are typically based on a portion of the recurring financial benefits that we expect to generate for our clients. To the extent that our estimate of those clients' financial benefits changes in a given period due to our performance, we adjust the amount of revenue recognized under our contract for the amount that we ultimately expect to bill to our clients. Our second quarter healthcare consulting and managed services revenues included approximately $16 million in favorable adjustments related to several performance-based fee contracts where our teams delivered financial benefits for our clients that exceeded our previous expectations. The ability to deliver financial benefits for our clients that exceed expectations to generate incremental revenues for Huron presents an ongoing opportunity for our healthcare performance improvement business and demonstrates the strength of our business model. However, the timing and magnitude of such favorable revenue adjustments can vary from quarter to quarter. Operating income margin for healthcare was 28.3% for Q2 in 2023 compared to 23.6% for the same quarter in 2022. This quarter-over-quarter increase in margin was primarily due to revenue growth outpacing the increase in salaries and related expenses for our revenue-generating professionals, although partially offset by increases in contractor expenses and project costs as a percentage of revenues. The education segment generated 32% of total company revenues during the second quarter of 2023. The education segment posted revenues of $110.7 million, up $22.5 million, or 25.5% from the second quarter of 2022. The increase in revenues in the quarter was driven by demand across a broad portfolio of offerings and segments. Our digital capability in education grew 47% year-over-year, reflecting continued demand for our digital, technology, and analytics services and product offerings. Our strategy, operations, and research offerings also continued their growth trajectory in the second quarter of 2023. Operating income margin for education was 24.8% for Q2 2023, compared to 24.6% in the same quarter of 2022. The commercial segment generated 18% of total company revenues during the second quarter of 2023, and posted revenues of $63.3 million, up $5.7 million, or 10% in the second quarter of 2022. The quarter-over-quarter increase in revenue is primarily attributable to strong demand for our distressed financial advisory offerings and our digital offerings, partially offset by declines in our strategy offerings. Operating income margin for the commercial segment was 16.8% for Q2 2023 compared to 21% for the same quarter in 2022. The quarter-over-quarter decrease was primarily driven by the increase in performance bonus expense for our revenue-generating professionals as a percentage of revenues based on our updated expectations for full-year performance. Corporate expenses not allocated at the segment level were $42.9 million in Q2 2023 compared to $29.9 million in Q2 2022. Unallocated corporate expenses in the second quarter of 2023 included $1.4 million of expenses related to the increase in the liability of our deferred compensation plan, which is offset by the investment gain in the assets used to fund that plan, reflected in other income expense. Unallocated corporate expenses in the second quarter of 2022 reflected a $4.9 million reduction in expenses related to the deferred compensation plan. Excluding the impact of the deferred compensation plan in both periods, unallocated corporate expenses increased $6.7 million, primarily due to increased compensation costs for our support personnel. Excluding the impact of the deferred compensation plan, unallocated corporate SG&A decreased as a percentage of revenues to 12% in the second quarter of 2023, compared to 12.7% in the same period of 2022. Now turning to the balance sheet and cash flows, we finished the quarter with total debt of $395 million, consisting entirely of our senior bank debt, with cash of $16.6 million, resulting in net debt of $378.4 million. Our revenue ratio defined in our senior bank agreement was 2.2x of adjusted EBITDA as of both June 30, 2023, and June 30, 2022. Cash flow generated by operations in the second quarter of 2023 was $78.2 million, representing a record for the second quarter of the year. We used $8.2 million of our cash to invest in capital expenditures, inclusive of internally developed software costs, resulting in free cash flow of $70 million. We used $15.4 million of our cash to repurchase approximately 194,000 shares during the quarter. DSO came in at 77 days for the second quarter of 2023, compared to 83 days in the first quarter of 2023, and 81 days for the second quarter of 2022. Finally, let me turn to our expectations and guidance for 2023. As Mark noted, we are raising our full-year 2023 revenue guidance to be in the range of $1.3 billion to $1.34 billion. The increase in our revenue guidance primarily reflects strong momentum across our business. In addition, we are maintaining our adjusted EBITDA guidance range of 12% to 12.5% of revenues and raising and narrowing our full-year adjusted non-GAAP diluted earnings per share guidance to the range of $4.35 to $4.65. We now expect our full-year free cash flow to be in the range of $100 million to $120 million. Finally, we expect our full-year effective tax rate to be in a range of 28% to 30%.

Operator, Operator

I would now like to open the call for questions.

Tobey Sommer, Analyst

Thank you. I wanted to ask a question about the organic runway in broad terms. Do you feel like you've got all the pieces of your business to continue to drive organic growth and bridge it? Because you've been de-leveraging for a number of years, which makes your stock kind of riskless cash deployment or at least less risky. I'm wondering if there's potential for you to pivot and start to spend money on acquisitions over the near term.

Mark Hussey, CEO

Tobey, it’s Mark. You're breaking up a little bit. I think we got the question about whether we have the organic platform today to continue growth without deploying large amounts of capital in M&A. And the answer is yes, the portfolio—if you look back at what's happened to our business over the last 10 years, we have diversified our healthcare portfolio to be far more balanced between performance improvement and other solutions like digital, financial advisory, and strategy. Our education business has grown to a nice level of scale from what it was over that period of time. We expanded into areas in the commercial markets in conjunction with digital acquisition platforms that included many small acquisitions, which got us to this very large platform we have today. There are what I would characterize as opportunistic pieces for us to deploy. But I don't think that we see any major gaps in the platform as we see it right now.

Tobey Sommer, Analyst

Thanks. Do you think that would be more on the IT side, getting skills for specific emerging software that are experiencing rapid adoption, or more for functional areas?

Mark Hussey, CEO

Tobey, I think it will be a combination of both. I think it will probably lean more toward digital, because those actually work hand-in-hand, especially when we model our work collaboratively as a team in those markets, enabling the advisory side of the business. It could be a little bit more on the pure advisory side, but largely, I would say it likely will have a digital flair, and probably focus on some of the edge solutions in industries wherein we are not currently established to help us gain a foothold and facilitate expansion to be relevant in those particular markets. So I think that'll probably lean towards digital solutions, irrespective of the industry as a general statement, but it’s absolutely going to have an industry focus on it as well.

Tobey Sommer, Analyst

Last question for me, we’ve heard from some professional services firms that employee retention year-to-date has improved pretty significantly, and in some cases, it seems to be dampening operating leverage. That's not evident in your case, but I wanted to see if the improved employee retention is evident even though dampening operating leverage is still visible.

John Kelly, CFO

Tobey, this is John. Yes, our retention has certainly improved over the course of the year. I think our attrition rate at this point is on a trajectory to be lower than even the historical norms that we had prior to the pandemic. But in our case, given the pipeline, backlog, and growth we’re seeing in our business, this is great news for us in terms of really having the talent that we need to deploy on our projects. If we were to have a higher attrition rate, that just means we would need to be more aggressive in the market to bring people in because of the demand we're seeing right now across the business.

Operator, Operator

Our next question comes from the line of Andrew Nicholas with William Blair and Co.

Andrew Nicholas, Analyst

Hi, good afternoon. Thanks for taking my questions. I wanted to ask first on the margin guidance. Obviously, really, really strong second quarter, and a second-quarter EBITDA margin that was well above the full-year guide. Just kind of curious what in the second half makes you a bit more conservative on EBITDA margins? And maybe wrapped within that question is a question regarding headcount growth and hiring expectations in the back half of the year.

John Kelly, CFO

Sure, Andrew. We're very pleased with our progress on the margin thus far this year. I think it's a reflection of a number of initiatives that we've had within the company to improve our pricing, increase our utilization, enhance our deployment of global resources, and really the continued scaling of our corporate SG&A. The performance-based fees recognized in the healthcare performance improvement business also helped with margins during the quarter. That said, we're pleased with the growth rates we've achieved so far this year and the evolving pipeline that we see looking into 2024. With this in mind, we think it's likely that we'll continue to build out a resource pool in the back half of the year with an eye on 2024. This may create some additional pressure on second-half margins because there's typically a ramp to productivity for new consultants. We are very comfortable with our guidance range and the margins. From our perspective, we see the potential based on the initiatives I described to push upside there, but we're balancing that by probably being a little conservative with the guidance, recognizing that at the rate of our growth, we are likely still going to be in the market adding talent, and there tends to be a little bit of a ramp as we're building up resources.

Andrew Nicholas, Analyst

That's helpful. Thank you. I wanted to ask about the India initiative, which I know is a key part of your margin targets. I think last quarter, there was a little bit of pressure in digital utilization. That's picked up nicely sequentially. If you could give an update on progress and utilization within that part of your business, the global support staff.

John Kelly, CFO

We are indeed seeing significant progress there, Andrew. As we discussed in prior calls, we intentionally built up our resource pool in the back half of last year in India, really to diversify our global talent and ensure that we had the capacity to serve our clients, particularly in areas of digital growth. Along with that build-up came some utilization pressure as we trained those resources to be ready for deployment. Our expectation for the year was that utilization would ramp up sequentially each quarter, which is what we're observing. We ended up with digital utilization at 74.7% for the quarter, which is a composite that we’re looking at from a geographic perspective, which is nearing 80% in North America, and then within India, we're ramping up to 65% this quarter, reflecting some nice sequential improvement for us.

Mark Hussey, CEO

Andrew, it’s Mark. I'm going to add a couple of things to what John said. Utilization is one part of the story, but another part is the breadth of what we're doing across every service line within India. Notably, in the last quarter, we hired a country leader in Singapore, which will be served predominantly out of the India capabilities that we possess today. So it is a great platform for us to expand. We have done very well in that market, with clients and the channel pulling us into there. We feel very confident in our ability to continue leveraging that not only as a source of margin expansion but also to help drive revenue growth.

Operator, Operator

Our next question comes from the line of Bill Sutherland of the Benchmark Company.

Bill Sutherland, Analyst

Thanks and congrats on a terrific quarter, guys. In healthcare, John, did you mention the growth that you had in digital on the healthcare side?

John Kelly, CFO

It was 10% for the quarter, Bill.

Bill Sutherland, Analyst

Okay. And is the education so strong, just because there's this insatiable need for cloud migration in the universities?

Mark Hussey, CEO

Yes, Bill, this is Mark. There is indeed a long-term cloud conversion happening to replace decades-old investments and systems, which creates the opportunity for them to leverage new technologies to help grow their business through applications like CRM systems such as Salesforce. Data analytics also presents tremendous opportunities to bring digital solutions broadly across the entire higher education landscape, as well as healthcare.

Bill Sutherland, Analyst

In terms of your growth guidance for the year, should we think about hiring being in line with that? Are you going to be hiring potentially a little ahead of that growth?

John Kelly, CFO

In the base case, Bill, I think of hiring generally being in line with revenue. However, if we continue to have a strong pipeline for the back half of the year into next year, and as projects continue to convert, there is potential for us to hire even more aggressively than that. Overall, I would think of it as being generally in line with revenue in the back half of the year.

Bill Sutherland, Analyst

Finally, regarding the commercial side, how are you thinking about the expansion into serving additional industries? Historically, you had strength in financial services and energy, but what industries are you looking to expand into more significantly, and are you making progress on that front?

Mark Hussey, CEO

Kevin, it's Mark. The answer is yes. We have strength in financial services and energy utilities. The third one is more broad and is doing well for us, primarily in the industrial market, which encompasses various companies. Our model's power lies in our capacity to bring capability solutions into industries where we have that combination of expertise along both the vertical and horizontal dimensions. As we continue to grow there, that's where, back to an earlier question on M&A, you'll see us continuing to utilize not only tuck-ins but organic hiring to solidify our positioning in that particular market. Historically, a decade ago, this was a very low single-digit percentage of our business. Over time, as we've expanded our digital capabilities to strengthen both healthcare and education, it has naturally preferred us into much broader markets in ways that are very naturally accretive to our expansion and growth.

Operator, Operator

We have a follow-up question from the line of Tobey Sommer of Truist Securities.

Tobey Sommer, Analyst

Thanks for the follow-up. I wanted to ask you questions about your relatively small restructuring business. What's the outlook there? The capital markets seem to be looking for a soft landing, and I think Chairman Powell said yesterday that the Fed is no longer modeling a recession. What's your mindset there?

Mark Hussey, CEO

Tobey, right now, I'd say there will continue to be strong demand for a while. While interest rate increases and a slowdown in absolute terms are in play, you have capital markets that, in prior periods, were due to financial solutions restructuring in this environment. Now you often need an operating solution to fit the circumstances. The complexity of that plays well to the strengths we have in that particular market, and we see that continuing for some period of time. The senior lending market is not really supportive of many of these situations right now. The non-regulated market is quite expensive, so I foresee continued pressure in the next 12-18 months. Thank you for spending time with us this afternoon. We look forward to speaking with you again in November when we announce our third-quarter results. Have a good evening.

Operator, Operator

That concludes today's conference call. Thank you everyone for your participation.