Heidrick & Struggles International Inc (HSII) 2005 Q3 法說會逐字稿

At this time I would like to turn the call over to Julie Creed, Vice-President of Investor Relations.

Good morning, everyone and thank you for participating on our 2005 third quarter conference call and webcast. On today's call from Heidrick & Struggles are Tom Friel, Chairman and CEO, Kevin Kelly, President of our Europe and Asia/Pacific regions, Eileen Kamerick, Chief Financial Officer and Todd Welu, Controller. As a reminder there are some supporting slides that are available on our website at www.heidrick.com to accompany today's comments. As always, we advise you that this call may not be reproduced or retransmitted without our consent. Also we will be making certain forward-looking statements on today's call and ask that you please refer to the Safe Harbor language contained in our news release dated today October 28, 2005 which was widely disseminated by the various wire services and other media this morning and this information is also on slide two of our presentation. At this point I will turn the call over to you, Tom.

Thank you, Julie and thank you all for joining us this morning. Let me begin by saying that we are quite pleased with our third quarter results. We think that this quarter validates on so many fronts the success of the strategy that we have been implementing for months including restructuring we did in the second quarter. With a new operating platform in place, record productivity and operating margins at all-time highs we can now finally focus most of our attention on growth.

If you are following along with the slides we posted on our website, we are starting on slide number three. I would like to highlight some of our accomplishments this quarter. Our net revenue of $109.6 million was up 19.6% year-over-year and 6% sequentially. This is the first time in the last six years that our third quarter revenue was higher than the second quarter. Our Americas' region had an excellent quarter as did Asia/Pacific. The financial services industry group also had an outstanding quarter and was a big factor in driving the higher than expected revenue in the quarter.

On slide 4, our third quarter operating income of $12.9 million includes $1.6 million of previously announced restructuring charges, which Todd Welu will detail later in the call. Excluding the restructuring charges, which we believe more appropriately reflects our core operations, operating income in the third quarter would have been $14.5 million, up more than 77% over last year and up almost 12% sequentially.

On slide five, excluding restructuring charges, the operating margin was 13.3%, up significantly compared to last year's operating margin of 8.9% and an improvement over last quarter's operating margin of 12.6%. Excluding the restructuring charges and the tax benefits that Eileen Kamerick will explain in more detail, our adjusted net income and diluted earnings per share more than doubled year-over-year.

Regarding some of our operational metrics, our consultant head count at the end of the third quarter was 306, essentially level compared to June despite the departure of eight consultants in the third quarter as part of the restructuring. Consultant result in head count was up about 4% year-over-year.

Moving to slide eight, consultant productivity was also a growth driver in the quarter. On an annualized basis, productivity rose to a record $1.4 million per consultant. We have many consultants producing at levels well in excess of this average and although strategic hiring is part of our growth strategy and always has been, and our headcount will grow, we certainly believe that there is opportunity for driving productivity further with our existing staff.

Also in the quarter, on September 16th, we announced a new $50 million stock repurchase program. Through two prior buy-back programs completed over the last four years, we have repurchased more than 2.8 million shares of common stock at an aggregate cost of approximately $61 million. Although we haven't purchased any shares under this new program yet, and no time limit has been set for completing it, we will keep you posted every quarter as we progress through the program. This repurchase is part of our ongoing commitment to enhanced shareholder value while still retaining adequate cash to grow our business and provide for contingencies and opportunities.

The restructuring that we discussed in detail on the second quarter call has been completed and has accomplished what we intended it to do. As you have seen from our third quarter results, overall Company and European operating margins were both up year-over-year. Going forward, we have now a much stronger operational base from which to grow. The continuing strength of this base is heavily driven by another great quarter in our Americas' region. Our most powerful engine which is headed by Bonnie Gwin, President of the Americas. We will have Bonnie join us in a subsequent quarterly call.

But as our operating performance in Europe was the key target of this restructuring, I now want to turn the call over to Kevin Kelly, President of the Europe and Asia/Pacific regions who joins us from London to update you on our operations and our market strategy there. Kevin, over to you.

Thank you, Tom. We are excited about the opportunities that we see to profitably grow our presence and business in Europe. As Tom said, the restructuring has given us the opportunity to step back with a better foundation and to build the business more profitably. We know that others in our industry have achieved mid to high teens operating margins in Europe and we see no reason why we can't get to comparable profitability levels over time.

As you have seen by our third quarter results, we managed both the top and bottom line very well. The London office, the largest in our Company, had a great quarter, as did the financial services and consumer industry groups. As I said last quarter, this is a full management team effort and our European consultants embraced the opportunity to be part of the growth that I know we can achieve. Restructurings are difficult, but it's been three months and I see our consultants as very enthusiastic, energized and reinvigorated.

Last quarter I shared with you the two initiatives we are focused on executing. First, in addition to growing the business in each country, we are focused on fostering and expanding cross border work for clients throughout Europe. This is a work in progress, but we've implemented a number of processes internally to help us facilitate our initiatives.

Our second initiative is the hiring of new consultants and investing in an energized team. As part of the restructuring, we have done an extensive review of our skillset in Europe both from a geographic and industry group perspective and identified very specific gaps that we want to fill. While our hiring strategy is three-fold, promotion from within, hiring experienced search consultants and hiring consultants that are new to search, we are particularly focused on hiring experienced industry experts or business professionals who are new to search. This is the approach that we took in Asia/Pacific with aggressive hiring more than a year ago and you are currently seeing in both the top and the bottom line. We firmly believe it's the correct strategy for Europe as well.

In the third quarter, we hired seven new consultants including for example, a former McKenzie consultant and a former Pricewaterhouse consultant both with extensive industry knowledge and contacts. Typically it takes new hires nine to twelve months to get fully up to speed but several of our new hires already have searches engaged. We have also aggressively -- we also have aggressive hiring plans for the next year to fill a balance of the gaps we have identified. Even with these hiring plans, however, we are focused on profitable growth.

This journey will not happen overnight. As you know, the U.K., France and Germany are the largest contributors to the European region. Our offices in the U.K. and France are running very smoothly. But Germany has always had profitability issues and still does. We are well aware of the issues, many of which are related to country specific employment regulations and believe that the restructuring and planned strategic hiring will be key elements to growth going forward.

I'm very pleased about what we have been able to achieve in the last quarter, and I'm even more excited about the opportunities I see working together with our colleagues in Europe and around the world to grow the European business further while providing the highest quality service to our clients.

Thanks for your time. Now I will turn the call over to Eileen who will give you more details about our results.

Thank you, Kevin. I'm going to go over the results and I will discuss some of the more significant line items and then Todd Welu, our Controller, will cover other income statement items and provide you with additional cash flow detail.

Looking at slide nine, at the top line, revenue before reimbursements or net revenue of 1.9 -- $109.6 million increased 19.6% year-over-year and 6% sequentially. There were three elements that helped drive the larger than expected revenue this quarter. First and foremost, all the regions turned in great results with America's revenue up almost 22% year-over-year and Asia/Pacific revenue up 25% year-over-year. As a subset of that, the financial services industry group had an outstanding quarter. Finally, the average fee per search increased 15% from the second quarter. Which is partially a function of the great results from the financial services industry group since the fee per search is typically somewhat higher for financial services searches.

When we talked to you on our last call at the beginning of August, we told you that we had very strong confirmations in June. But that they had tapered off in July. And we never expected that August, which is typically one of the slower months of the year, would have had good confirmations as well. In fact, as Tom pointed out, we haven't had a third quarter that is higher in revenue than a second quarter in the last six years. So we really do consider it quite a welcome surprise but untypical.

Now let me go right to the bottom line. We reported GAAP net income in the third quarter of $30.4 million and fully diluted earnings per share of $1.58. However, this was driven by a significant non-cash tax benefit in the quarter as a result of reversing a portion of the valuation allowance on certain of our U.S. deferred tax assets.

During the third quarter, based on the application of FAS statement 109, we determined that a significant portion of our U.S. deferred tax assets should be recognized due to our solid operating performance over the past few years and positive earnings trends. As a result, we recorded a net non-cash tax benefit of $18.1 million associated with the reversal of the valuation allowance. The valuation allowance against deferred tax assets was recorded as you may remember in fourth quarter 2003 during a period in which we had generated cumulative losses due to restructuring which brought into question the realizability of the deferred tax assets. In recent years, we began to generate book income on a consistent basis and projections show that we will continue to do so. Under FAS 109, the Company must continually evaluate the need for the valuation allowance and reduce or reverse the allowance when it is more likely than not that some or all of the associated benefits of the deferred tax assets will be utilized. In the current quarter, we concluded that it was more likely than not that a majority of our U.S. deferred tax assets would be realizable and recorded a net non-cash tax benefit of $18.1 million to reverse the valuation allowance on a significant portion of our deferred tax assets.

A valuation allowance will continue to remain on $6.8 million of U.S. deferred tax assets related to foreign tax credits and state net operating losses. In addition, we will retain a valuation allowance on a majority of our foreign deferred tax assets including foreign net operating losses. The valuation allowance on these assets will be reversed as we generate sufficient positive evidence that these assets will be realizable. Had we excluded the restructuring charges and the tax benefits associated with the reversal of the valuation allowance, adjusted net income would have been $14 million and diluted earnings per share would have been $0.73. Both more than double compared to adjusted 2004 third quarter net income and EPS, excluding the significant gain from the monetization of Google warrants in that quarter.

For the fourth quarter we estimate an effective tax rate between 15% to 20%. A portion of the valuation allowance that was anticipated to be realized in the fourth quarter was not included in the $18.1 million reversal noted earlier. The portion that was not released will be released in the fourth quarter and will have the effect of eliminating the federal tax provision on the projected fourth quarter income. We acknowledge that our tax situation has been challenging to understand. But we expect to return to a normalized tax rate of between 40 and 42% in 2006. Let me move on now to operating income and margin.

Year to date, for the first nine months of 2005 excluding the restructuring charges, operating income is at $33.9 million, representing a 10.9% operating margin. We are very pleased with this improvement. At the revenue levels we have been at the last two quarters, this is where you can see the operating leverage inherent in our business model. Of course, the restructuring and our expense controls have helped as well. We remain confident in our ability to reach a 10% operating margin for the year, excluding the restructuring charges.

Looking at our results from a regional perspective, please turn to slides 11, 12 and 13. In the Americas, net revenue of $65.2 million was up almost 22% year-over-year and almost 10% sequentially. The financial services industry group had an especially excellent quarter, but really every practice posted good growth in the quarter. Operating income was up 29% year-over-year. Operating margin was up to 22.3%. We still believe that there is room to improve the operating margin in the Americas by controlling and leveraging fixed costs as we successfully grow revenue and hire strategically.

Consultant head count at the end of September was 158 compared to 160 at the end of second quarter. In the second and third quarters, our managers were very focused on cost initiatives and the restructuring. But recently we dedicated resources to focus specifically on hiring and our consulting recruiting pipeline is noticeably stronger as a result.

In summation, the performance of the Americas under the leadership of Bonnie Gwen continues to be consistently strong.

Let's talk about Europe next. Revenue of $34.3 million was up 14.4% year-over-year. And despite the restructuring in Europe last quarter, and a traditional summer slow down in this region. Revenue was down only $58,000 from second quarter levels. As expected as a result of the restructuring, operating income more than doubled year-over-year to $3.7 million. And the operating margin was 10.9%, compared to 3.8% in last year's third quarter and 3.5% last quarter. As Kevin mentioned, we still expect margins to get to mid to high teens, but it won't happen overnight. We need to balance profitable growth with strategic hires. Consultant head count in Europe at the end of September was 107, compared to 108 at the end of the second quarter.

Moving on to Asia, net revenue of $10.2 million in the quarter was up 25% over last year, and up 4.2% sequentially. What we are seeing in this region is the result of past hiring efforts and continued improvements in the productivity of our consultants in this region. Operating income and operating margin in the quarter both improved. Operating income was up almost 65% year-over-year. And the operating margin in the quarter was 26.1%. Largely driven by increased productivity. The consultant head count in Asia/Pacific region was 41 at the end of the quarter, compared to 39 at June 30th and a net increase of 6 compared to third quarter 2004. The Tokyo office in particular showed considerable strength in the quarter following its recruiting efforts over the last 12 months. And the China offices both continue to disem --- demonstrate solid growth and capacity for the future.

I will now turn the call over to our controller, Todd Welu, for more detail on the income statement and our cash flow expectations.

Thanks, Eileen. Going back to look at operating expenses in slides 14 and 15, you will see that salaries and employee benefits expense in the quarter was $71.3 million. Of this amount, $3.9 million was stock based compensation expense. We expect stock based compensation expense for the 2005 year to be approximately $14 million. Salaries and employee benefits expense is up $10.9 million on an absolute basis compared to the third quarter of last year. But down slightly as a percentage of revenue. The expense increase was the result of $9.3 million of higher bonus accruals related to higher net revenue levels, $2.3 million of higher stock based compensation, primarily as a result of the restricted stock units granted in the first quarter of 2005, and $1.2 million of higher fixed compensation. This expense increase was partially offset by a benefit of $1.9 million related to bonus payments paid with restricted stock which are recognized over the vesting period as discussed in detail last quarter.

The expected total 2005 benefit from the bonus payments paid with restricted stock should be approximately $6 million. Total bonus expense in the third quarter was approximately $26 million, for the year, total bonus expense is expected to be 86 to $90 million. Total corporate expenses were up approximately $600,000 from the third quarter of 2004, as a result of amortization expense of the corporate RSU grants in March and increased fees for professional services related to tax, legal and IT initiatives.

Looking at slide 16, reported restructuring charges came in less than we were expecting, approximately $1.6 million. Actual restructuring charges would have been about $3.1 million, but were offset by the reversal of $1 million for renegotiated space leased for one of our search offices and approximately $500,000 was reversed for severance. The applicable accounting rules require that we record restructuring charges when they are incurred rather than when we commit to a plan. Therefore, certain costs associated with restructuring initiatives that began in the 2005 second quarter will be recognized in subsequent quarters. However, we believe that any amount will be relatively small.

The improvements in results especially from our European operations reflect savings that are in line with what we expected for 2005, still approximately $8 million. And on an annualized basis, savings are expected to be between 14 and $15 million.

Now moving to slide 17 and 18. Cash flows and balance sheet items. Cash flows from operations was $38.3 million in the quarter and free cash flow, which we defined as cash flow from operations minus capital expenditures, was $37 million. Cash flow was up sequentially in the quarter, largely as a result of higher revenue. The cash, cash equivalents and short-term investments balance at September 30th was $193.9 million, compared to $153.7 million at the end of June and compared to $280.2 million at September 30th last year, which included $128.8 million in net proceeds from the sale of Google stock.

We are projecting a cash balance as of year end to be between 165 and $170 million after payout of the December bonus which we estimate will be about 50 to $55 million. This cash balance projection would vary depending on how much stock we repurchase in the fourth quarter. Capital expenditures for the year should still be between 5 and $6 million. As you know, our business generates a significant amount of cash and we have limited cash needs. We look at all viable options to increase shareholder value and review these options at every board meeting. Our first priority would to be invest cash in the business either to grow organically or through some selected acquisitions. As for acquisitions, our strategy or focus hasn't changed. We are always looking at and comparing potential acquisition candidates toward [deganic] investments in each of our regions, practices and in the area of leadership consulting.

Now, with that I will turn the call back over to Tom.

Thanks, Kevin, Eileen and Todd.

In summary for our prepared remarks, we believe that our operation and financial performance in the third quarter validates the strategy that we put in place shortly after I took the CEO role in mid-2003. We have made some tough decisions and it's taken some time for them to be reflected in operating results. But this quarter has shown that Heidrick & Struggles can and will grow profitably. Almost every metric we use to measure our performance has improved. We have also re-enforced our commitment to our shareholders to increase shareholder value and our two completed and one newly authorized share repurchase programs are reflective of that commitment.

As part of this, we also want to continue to ensure that our management and our employees are fully aligned with our outside shareholders. To demonstrate our commitment to that objective, we will be paying 10% of management and consultants bonuses in restricted stock this year.

Longer term, we see tremendous growth opportunities for the executive search and leadership consulting professions and we plan to capitalize on these opportunities aggressively. Demographic trends, increased regulatory requirements, heightened focus on corporate governance, shorter CEO and senior officer tenures, and a limited global talent pool are just a few of the factors that will continue to drive the need for executive recruiting, director searches and consulting, and leadership consulting for many years to come.

Quarter to quarter, our revenue and margins may move up and down. But long term this is a growth business. That is why we are stepping up our recruiting efforts to meet this demand and to grow our market share worldwide. We have been working very hard to improve our business model so that we can grow while still producing better bottom line results.

To reflect the strong results in the third quarter, we are increasing our 2005 guidance for consolidated net revenue to be in the range of $409 million to $414 million, implying fourth quarter net revenue of between 97 and $102 million. At those net revenue levels, we would expect to achieve our goal for an operating margin of approximately 10% for the year, excluding any restructuring charges, and operating income of between 8 and $10 million for the fourth quarter. In the fourth quarter we know that executive recruiting typically slows during the holidays given budget cycles and bonus schedules. So with that said, we expect a good fourth quarter but not a sequential increase in revenue growth.

As stated in the release, we are well into our 2006 global budget and forecasting meetings. And we will provide guidance for 2006 when we release fourth quarter results. But we strongly believe that the initiatives we are working on to grow the Company and the steps we have taken this year to improve our cost structure will provide us with top line growth and increased operating profit leverage as we head into 2006.

With that, we will open the call up for questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Michel Morin from Merrill Lynch.

Hi. Yes. Good morning. I was wondering if, Eileen, you touched on the valuation allowance. I was wondering if you could remind us how much is left in the valuation allowance?

Yes, Michel. We are now down to a $25 million valuation allowance that will be on the balance sheet at this point.

And that includes the U.S. portion?

No that amount does not include the U.S. portion. That was the amount at the end of December. It will be left on the balance sheet after we have uncovered a piece of the valuation allowance associated with fourth quarter taxable income.

And then if you're guiding to a 40% or 40 to 42% rate in '06 and you have done this reversal here. There is another little bit coming up in 4Q --- or Q4, when we think about '06 in terms of the cash taxes, can you give us a bit of indication what you are expecting there?

At this point our tax rate should be commensurate with our cash tax rate. We have opportunities in the future to use our net operating losses in Europe to reduce our taxes there, but we are not forecasting the use of those in 2006, Michel. It's further out but we look at opportunities going forward to reduce our taxes through tax planning. Most specifically to use those deferred tax assets that we still have on the books and the net operating losses in Europe but we don't anticipate that will affect our tax rate in 2006.

And then separate question in terms of the guidance for Q4, last year it seems like you had a very nice sequential pickup from Q3 to Q4, doesn't seem like you are expecting the same kind of trend. Was it something unique about last year that really influenced the numbers there?

Michel, this is Tom. This is probably a good place to make a comment about the difficulty of forecasting revenues tightly quarter to quarter in our business. On an annual basis these things smooth out. As we saw last year we had a particularly strong fourth quarter and a less strong third quarter. This year we've had an extremely strong third quarter and some of that may impact revenues in the fourth quarter. We are expecting a good fourth quarter, but I think some of this is simply the timing of assignments that come in near the end of a quarter that could be the last two weeks of one quarter and first two weeks of the next quarter that impact quarter to quarter results substantially but don't tend to have much impact on annual results because most of our clients' hiring and planning is on an annual cycle, not on a quarterly cycle.

Right. Okay. And then the fee for search that was provided, what was that number in terms of year on year growth?

Quarter over quarter? I don't have that in front of me but I will give that to you but it was up second quarter by about 15% to an average now of just over 100,000. And that number will move quarter to quarter, Michel, but it was up -- so we did get a pick up from pricing.

And that would be true on a year on year basis as well?

We will get that number for you.

Great. Thanks very much.

Our next question comes from Ty Govatos of CL King.

How are you and congratulations. May you have many more like this.

Thank you, Ty.

The SG&A depending on how you calculate it was either up or flat sequentially. Could you explain why it wasn't down given the restructuring and more importantly could you flesh out what kind of SG&A expenses you expect in the quarter --- fourth quarter given your guidance.

Hi, Ty, this is Todd. We certainly don't expect that -- we expect the SG&A should be relatively consistent in the fourth quarter with what we saw in the third quarter as well. And as far as the year-over-year down, clearly, with that additional increase in revenue, I think you have to look at it as a percentage basis and not just on the raw dollars as well. Yes, the dollars were up but on a percentage basis it's way down. I think we look at it in that way. In the absolute way.

Okay. One more. If I looked at that 1.6 million restructuring. Where was that? Was that in gross profits? Was it in the G&A?

The results of the restructuring?

Yes.

Well, the restructuring, if you remember what we said about the restructuring time, most of it was in people cost so you will see it in the cost and benefits line. There was a little bit in property, but 80% of the benefit that we were receiving we expected to be as a result of the severance actions that we took rather than any property actions that we took.

Additionally, Ty, the $1.6 million is on its own line and the restructuring as well and, of course, is factored into our operating income that we state this quarter.

Okay. Thanks an awful lot. And again, great quarter.

I wanted to go back to Michel Morin's question on a year-over-year basis the fee per search was also up about 15%.

Our next question comes from Matt Litfin from William Blair & Company.

Good morning, let me add my own congratulations. Question on stock based compensation; do you see any reason why that might be any less next year than it has been this year? Or are you expecting that 3 to $4 million that you said in the press release you had this quarter to persist into next year?

Hi, Matt. This is Todd. The answer to that question is, yes, we would expect that it would persist. There would be no reason to think that we would change our stock based compensation strategy as we move forward. And the plans are to continue to do that.

Question for Kevin, on this big surge in the Q3 operating margin in Europe, obviously we heard your comments that you think that you can improve that further over time. Did you get a full quarter of the post restructuring benefits in Europe? Or is there still some flow through that could push the operating margin up into Q4 and that's kind of the normalized post restructuring operating margin?

Let me respond to that, Matt, to give you some sense of it. Not in the G&A line. We didn’t get all of that because an awful lot of the actions taken, the property actions were not until late in the quarter which is why you see a little bit of this restructuring flowing through in third quarter; we didn't take it all in the second quarter. So there may be some uplift there.

Going forward, what Kevin talked about and he can speak to this as well, obviously, is that we're going to have to balance driving margin there with hiring very strategically. There are some benefits that did not flow through this quarter because they were undertaken on the property side late in third quarter. And Kevin, I don't know if you want to comment further on that.

I think you are right, Eileen. The biggest challenge we have next year is making sure that we get the right people in, as I mentioned earlier, to fill the many gaps we have in Europe while at the same time focusing on profitability. And Tom spoke earlier about growing -- we are entering an era of growth as well. We need to add great people across the globe, particularly in Europe and we are taking a hard look at our cost at the same time. So it's a lot about growth, a lot about getting great people on board while at the same time looking at the profitability.

Okay. Eileen, can I confirm something that I think you said earlier. I want to make sure I understood it. Given the deferred income taxes that you have now and tax shields, you don't expect any of that to help you out in '06? And you expect to pay a 40% plus cash tax rate as well as a book tax rate on the totality of your income?

Yes, and that is consistent with what we were saying the last several quarters; when the valuation allowance was reversed, we expected to be at a tax rate that's commensurate with most public professional services firms which is somewhere between 40 and 42%. We are undertaking tax planning to utilize the deferred tax assets and particularly our NOLs in Europe. But at this time we do not see that affecting that tax rate. If we get better visibility or have some additional planning opportunities around the tax rate, we will update you. At this point our best estimate based on advice from our tax advisers and the work that we have done is that our cash and book tax rate for next year will be 40 to 42%.

Okay. One more if I might, Tom, I think you mentioned earlier, I think you said you need to keep an adequate cash. Can you update us as to how much cash you now think that is?

Matt, let me respond to that first. We said in the past it's about 50 to $60 million. And one of the things that we haven't referenced is that some of that cash that we talk about a 50 to $60 million balance includes some cash in certain countries that we can't necessarily access and move to other countries. So there is a certain portion of that cash balance that is restricted. Given that and given the need to have some cushion for contingencies and opportunities we're comfortable with something around the $50 million level.

I would only add that as you have seen, we are not reluctant to return excess cash to shareholders. We announced two previous programs and actually more important than announcing them we completed them and we've announced a third one now which we expect to complete. This is something that we pay attention to every time. I know there are some that might think that we could be more aggressive there. But this is something that we review every board meeting and every quarter. And while we maybe tend to be a little on the conservative side in terms of returning that cash, if it's excess, we will return it.

Thanks for those comments.

Our next question comes from Kelly Flynn from UBS.

Yes, hi, this is Andrew Fones for Kelly. I wanted to ask a question on Europe. It appears that looking at your results in the prior two years, 2003 and 2004, that you have seen about a 90% sequential decline in revenue in those years on average. This year revenues are flat sequentially in Europe. Could you perhaps comment on what you think drove the relatively strong quarter there?

Kevin, I think the background to that that Kevin will tell you is all of the practices were up strongly but particularly financial services.

Absolutely. What we did, Andrew, last couple of years, particularly in Europe, is focused on strengthening all practices but in particular financial services. What you are seeing now is the hard work and effort of most of the consultants across the region of financial services plus if I throw in there the U.K. office; I mentioned earlier they had a phenomenal quarter and they have. And a lot I attribute to the fact that last year they focused on recruiting as well and filling in a lot of gaps --- or holes we had in the business here in London. I think it's a combination of both.

I would simply add one more comment and that is a key part of our strategy over the last two years has been to continue to link our consultants around the world to drive revenue through our largest global accounts and to dramatically increase the amount of revenue that we are generating from some of our key crown jewel global accounts.

We have seen consistent increase in that and as these are global, the performance of these global accounts drives revenue in all three regions including Europe. And some of the both the recent and we certainly hope future revenue increases in Europe will be influenced not just by the practices and our hiring to fill gaps as Kevin has quite rightly pointed out. But by the increasing collaboration within these major global accounts which are critical for us.

Do you have any further [inaudible] countries outside of the U.K.?

We don't tend to comment a lot about individual country performance. Kevin, you may want to add a comment here, but I think the key drivers in Europe, if you are talking about countries outside of the U.K. in Europe, Germany, the U.K. and France are the three big drivers of our European performance.

And as Kevin has said, our performance in Europe this year and the U.K. has been outstanding and France has been very good and Germany is still struggling a little bit because -- partly because there was a major focus of our restructuring there and that was the country that was hit the hardest and will probably recover last. Kevin, you may want to add to that.

What I would like to add, Tom, and you pointed out this earlier with Mike who runs our global account program, we've systematically, Andrew, gone through country by country and our global 150 accounts and where we are missing revenue we made sure those consultants covering those industry sectors were connected with the individuals around the globe who could help them drive and penetrate accounts in a much broader and deeper basis. I think that's starting to work. I think that the connectivity, as I mentioned before, one of the key objectives I have is, hand European cross border work and we're starting to see the results of that. We are engaging colleagues across countries. We are engaging colleagues across the oceans as well. And it's starting to show. We still have a way to go but I'm excited about the opportunity and I'm very optimistic about next year as well.

You have done a lot of work figuring out where the holes are. Can you talk at all to the hiring plans, perhaps try to quantify that both for Europe and across the whole Company?

Let me jump in first on that and I will take the global view and then Kevin can comment to EMEA. We have indicated that two things, one, that we are going to grow. We grow really in two ways. We grow by increasing our consultant head count and we grow by increasing our consultant productivity. It's our ---- our history has been that we focused a little more on productivity over the last year than on consultant growth. But we think the time now is to shift that somewhat.

Having said that, if we grow our consultant head count less than we grow our revenue, then productivity by definition continues to increase and that's been our history and that's our goal. Overall, we have indicated that we would expect consultant head count --- net consultant head count globally to grow in 10% or so range. Next year that will be 30, 35 net consultants in addition; we have some turnover of people leaving both voluntarily and through the restructuring. But through this period we are still hiring. We have got some fairly targeted but aggressive hiring plans in Europe that Kevin and his team have in place. Plus we also have aggressive targeting hiring plans for both the Americas under Bonnie Gwin's leadership and in Asia. Kevin, you may want to comment specifically on the European piece of that.

Sure. Andrew, what we have done is I came from a budget meeting the last couple of days in Paris and we sat down there as a leadership team in Europe and said, okay, historically we've gone to each office at this time of year and we want to grow by X the next year or X-plus 20%. What we decided to do this year is say, okay, if we will look at this PanEuropean strategy we have in terms of more connectivity and we break it out by practice and by function, where are the holes? So we are overlapping the office with the functions and the practices and that was pretty telling in terms of where the gaps are in the region and now we have a task force in place and recruiting group in place to actually go out and help fill those gaps --- gaps, pardon me.

Okay. Thanks. And if I could ask one last question. I also thought that the Q4 guidance seems to allow for a great deal of kind of seasonal slow down in the fourth quarter. As you look at the confirmation trend, was there anything that gave you concern? You mentioned confirmations in August are up strongly. Can you comment on September and October?

In the third quarter, Andrew, the confirmations are up 3% year-over-year, but sequentially they are down. So, yes, I mean we had a very big fourth quarter last year, it was our second largest quarter which is untypical. So, we have a more difficult comp to go against. And in general, if you talk to people who do hiring in major corporations, fourth quarter is not traditionally the point at which they are focused on hiring. They are focused more on building budgets and opening up those budgets to start hiring in first and second quarter. So, as you see this industry recover, it's a little difficult to determine exactly how seasonal trends will play out, but our sense of the confirmation trend and just our sense of where fourth quarter typically will come in in terms of revenue gives us reason to believe that we will have a revenue that is within the range that we guided you to.

Okay. Thanks, guys.

Our next question comes from Mark Marcon from Baird.

Hi, it's Mark Marcon from R.W. Baird. First of all, congratulations, great progress for the whole team getting operating margins up. With regards to Andrew's last question in terms of the confirms, you mentioned that the confirms were down 3% sequentially in the third--

No, no. Let me correct you. They were up year-over-year 3%. They are down somewhat from third quarter.

They are down somewhat from third quarter -- you mean in the fourth quarter – in October they are down relative --

I'm sorry, from second quarter to the same time.

From second quarter to third quarter. Down somewhat. Is that a function of what happened in July?

Well, it's difficult for us and I know that all of the analysts and people who follow our stock try to use confirmations as a means of ascertaining what's happening and what will happen with revenue. It would be speculation on my part to say to you why are confirmations down compared to what we saw happening before we went into the last quarter. At this point, we are trying to give you our best estimate of revenue based on where the trends are headed.

I appreciate that. But it sounds like the confirms were down in July and then picked up in August and September.

Yes.

And continues through October.

Well, again, they are down sequentially, so if you look at -- as we move into the fourth quarter, I think we told you this was now in August that at the end of June we saw very strong confirms. That end of June compared to end of September is not as robust. Is that helpful?

Yes.

Okay.

Great. And then with regards to financial services, that seems like a recurring theme. Do you happen to have the percentage of revenues that was derived from financial services during the second quarter?

In the second quarter it was approximately 33%. And that's commensurate really with our annual. But we didn't expect the incremental piece of financial services revenue that came in.

Were there any big international or global projects that you did in financial services and what areas of financial services specifically were strong?

The ---- overall the practice is strong. There was not a particular project or two that unduly influenced these totals. This was broad based support in the financial services sector which has had a strong year in the industry.

I think if we look back historically while this year we’ve had outstanding performance in the financial services sector, which we very much appreciate and those partners are doing great and working very hard, there have been years when we have been driven as a firm by other sectors including the technology sector three or four years ago which was our major sector. I think the balance that we have now across the major industry sectors of technology, financial, industrial, health care, life sciences, consumer, and several others give us great strength to take advantage of short-term trends in these sectors up or down and still stay balanced.

We were, I think, much more balanced across our sectors than we would have been even three or four years ago and that gives us great comfort for the future and we want to make sure we maintain that balance. Obviously continued strength in the financial services sector, we hope for it. And if it continues to be strong that will help us and others. But we were also getting strong performance out of some of our other sectors as well.

Great. And then, with regards to the fee per search, nice increase there. You mentioned that the strong performance in financial services contributed, are you seeing an increase in fee per search across your other practice areas? Or was it isolated to financial services?

I mean, I think in general what we are seeing, Mark, is that there is an increased focus on cash compensation for executives as there's further scrutiny on equity compensation and there are some inflationary pressures being brought to bear on what is now a more demanding and tighter labor market for senior and mid level executives. So in general, again, this will jump around quarter to quarter given mix and other issues. But we see that as an upward trend that we will have the advantage of.

And then, Tom, you mentioned capacity and productivity at the beginning of your comments. Can you give us a sense for on average where you think the productivity level can go to?

Well, we have increased the consultant productivity in this quarter on an annualized basis as we said to 1.4 million. That's very close to an all-time record. But it's our sense that there is still given that is substantial room to increase that further. I mean, 1.5 we believe is easily achievable. We actually have many consultants that are operating significantly above 2 million. And so some of this is the balance of new research with more senior experienced hires and keeping that in balance.

But we don't think and I know there has been some concern about whether we are reaching the limits of productivity increase. We don't think we are at or close to the limit on average, although some of our individuals -- some of our partners probably are, but there is still plenty of capacity in the system. One of the things that we are working hard to do over the next quarter or two is make sure that we have a better system of matching the capacity where we have it with the needs where we have it. And some of that is enhanced by greatly increased teaming which is easier in our large global accounts to team senior revenue producing consultants with more Junior consultants who have the ability to execute projects and will work in teams. That is another positive element of the -- both the major account program and the strong focus on working in teams which Kevin mentioned in Europe but which applies equally around the world.

The other thing is, Mark, we are really focused on trying to use technology as a means of giving consultants the tools to drive productivity. For example we have a knowledge management center in India where we can produce very high quality research at a relatively reasonable cost and the means by which we drive tools like that into the consultant work force will allow them to work more intelligently and more productively. And as you can see, a lot of the productivity has been the driver behind our margin growth. And even as we grow with consultant headcount we want to not lose focus on productivity because we think there is real opportunity there.

Great. And in terms of the growth that you are experiencing, do you think that is an industry-wide trend that things have gotten better generally? Or is it just you gaining market share?

It's difficult to say in a market as fragmented as this that we are gaining market share. We certainly feel as if the major search firms have an advantage at the moment in terms of the regulatory focus on how executives are chosen. So that there is to some degree a flight to quality to the major firms on big searches, very visible, fortune 1000 searches. That having been said, it is a highly fragmented industry so it's difficult for me to be precise with you about whether or not we are gaining share. I do think that the market conditions generally for executive search are very good. And we're confident that we're certainly holding our own and competing well against our major competitors.

Great. And final question for Kevin. Kevin, what do you need to do in Germany going forward in order to --- to optimize the operations over there?

Kevin, this is Tom. Just a quick comment on that one and then I will throw it back to Kevin. I think that the situation in Germany really isn't any different than the situation anywhere else. It's just to make sure that we have the right consultant team and the right infrastructure supporting them and we link them in tightly with our global strategy and our global major account program and I think some of the changes that we made have made have --- over the last quarter have helped that and, Kevin, you may want to comment further on some more specific plans which apply to Germany but also apply to everywhere else.

Sure. I mean, one of the things that's great about this firm is the support mechanism, both within the region and around the globe. And to Tom's point, what we have seen and there is basically three things we need to do. One is recruit and make sure that the gaps that we have in Germany we fill in with the appropriate people. Two, is to engage our German partners and consultants in general with their peers across the region. And three, is really engage them in the top 150 accounts and that's where we spent a lot of time. Again, I worked with Bonnie and with our other colleagues in Asia/Pacific and I've worked with Mike Franzino and the rest of the operating committee in the firm each week on how we can integrate not only Germany but the rest of the offices in Europe with the rest of the organization and we were starting to see results about that. So I think those three things are what we are focusing on right now.

Great. Congratulations. I got more questions but I will follow-up off-line. Thank you.

Our next question is from Tobey Sommer from SunTrust Robinson.

Hi, this is Mike in for Tobey. Couple quick questions. First kind of a follow-up on the productivity question. Are you saying kind of the upside that you see in the productivity coming maybe from the focus on the top customers or somewhere else?

This is Tom. That is exactly where we see it. And I think the strategy for Heidrick & Struggles that we put in place a little over two years ago has really three main pieces to it. We talked about them before.

Number one, drive our work at the top. The high end CEO work and we continue to do extremely well there relative to all of our competitors. Those searches are small in number but they set the brand and they help establish our credibility.

The second is broaden the service offering which we are doing through the leadership services group which is having a good year is still small relative to the total but the broad base consulting services headed by Vince Perro who heads that group for us and is doing a great job.

And third is bringing all of that together in the large accounts. And Mike Franzino heads our large account global group working with Kevin and Bonnie in the regions and it's really critical for us in the future to continue to drive work in these largest global accounts. Our fees, our average fees are higher there --- our consultant productivity is better there. We know the clients better. They know us better. We get searches started quicker and get them finished quicker. And our consultants get to know these clients. Everything good comes from that.

The performance in these global accounts is higher in productivity. And pretty much every other metric that we measure. And so that's going to continue to be the driver. That work is also much easier for us to maintain relationships frankly against our competitors; as we serve these clients well, they stick with us. And, so we're going to continue to drive down those three strategic paths. And, if we do that, we are confident that productivity will increase. Typically it increases specifically because of those strategic initiatives.

Okay. You mentioned that the leadership services, could you break down what the percent of revenue was from that area?

On an annualized basis our leadership services business is about 3 or 4% of our total revenue.

And another question hitting on the productivity, could you -- what percentage of consultants are running at that 2 million or so run rate?

We really don't track that specifically, but we know if we look at our top tier consultants that we have many people who are annualizing well above that average. Obviously it's an average. So we've got a fair number of people who are well ahead of that.

And then one more question kind of on --- we saw a nice improvement on the margins in Europe and you mentioned that you could possibly get that up in the mid teens. Do you know what kind of time frame that is and maybe what you are expecting out of the group in the fourth quarter?

I wouldn't expect that we would see dramatic improvement in the European margins. This is pretty significant given that we have gone from about a 3.5% operating margin to almost 11. Let me step back for a minute and just say in general we don't give guidance on a quarterly basis or even on an annual basis region by region. And also on a region-wide basis and on a Companywide basis we really run this business on an annual basis. We have to approve for bonuses on an annual basis. We have to think about how we will manage the firm on an annual basis. So, you will see even in a very established business, like the Americas, the region will have --- or, that region will have margins that will move depending on revenue levels and we can't perfectly phase spending. So I know that is a challenge the analysts who follow us would like to create absolutely precise models. But unfortunately this is a business that doesn't have stair step revenue growth because of the seasonality of the business. And you will see margins move around a bit in terms of what happens in each region in each quarter.

Having said that, and I know Kevin will want to add color to this, we really are focused on balancing growing Europe and the opportunities that Kevin sees. And managing that profitably so that we can hold on to the margin that we created as a result of the restructuring and really move forward so that Europe looks more like our other two regions. There may be impediments in terms of getting to the really high margin, operating margin levels that you have in Asia and North America or in the Americas. But certainly we can close that gap more. But that will be a balancing exercise over the year. Kevin, I don't know if you want to add to that as well.

No, I think that --- just to add one quick thing if I look at our key objectives over the next 12 to 18 months one is connectivity with our partners in the firm and doing more PanEuropean work. And the challenge we have now again is filling the gaps that I mentioned throughout the region while at the same time making sure that we watch our profitability. So that's what we are really going to focus on over the next 12 months.

Great. Thank you.

Our next question is a follow-up question from Matt Litfin from William Blair.

Hi, as excited as we all are this call might be getting little long in the tooth, so I will follow up off-line. Thanks.

Thanks, Matt.

Thanks, Matt

Our next question is a follow-up question from Mark Marcon from Bob Baird.

Just one last question, with regards to the holiday season. Certainly appreciate that in terms of the impact sequentially, is there anything else that besides the normal holiday period that would drive revenues down sequentially? In other words, are there any major producers that might be leaving the firm or were there any sort of like big engagements that just came to an end that will --

No Mark. This is Eileen. No. There is nothing like that. Let me go back to our guidance is 97 to 102 for next quarter. We performed at a little over 98 last year. That was an extraordinarily big quarter and we’ve seen that in fourth quarters the last two years. Again, I could try to speculate what's happening in the hiring environment that all of the sudden we see a rush of business when typically in the fourth quarter you would not expect that. Again, anyone who sat inside a corporation and think about how companies think about hiring. That's just not a time where companies are focused on hiring.

So that range is indicative of what we see in confirmations at the end of September which as I said is less robust than what we saw at the end of June. And the fact that we have reasonably high comparability standard to meet, but that range of 97 to 102 is what we're comfortable with and we think it's indicative of the trends that we're seeing in the business. That having been said we are very focused on keeping everyone's mind on driving revenue for the fourth quarter. In fact, we had a conference call with a major leaders, Mike Franzino who is running the practices in accounts, Kevin, Bonnie, and Vince Perro, to talk specifically about continuing that revenue drive through the fourth quarter and to remain focused.

This is Tom. One quick comment there. I think this is a good indication of the difficulty of making some of these forecasts on a quarterly basis that tend to smooth out pretty reasonably on an annual basis. I mean, if we look back through the guidance for 2005 for the full year, we are right on it. And we feel very comfortable with that. And the quarters in between can sometimes frustrate you a little bit because you will get one that's a little bigger than you expected and another one that's a little lower than you expected, and I know for all of you and for us, that is tricky because it makes modeling the business difficult.

But if you back off occasionally and look at it on an annual basis, these quarter to quarter aberrations tend to smooth out pretty dramatically because we run the business on an annual cycle and our clients run their hiring and their recruiting planning on an annual cycle. And oftentimes it's almost random on their part when they get around to launching searches that have been approved in an annual budgeting cycle. They could fall in one quarter one time and another quarter the next time. Again, we will do the absolute best that we can to give you the best information we can on a quarter to quarter basis. But we also want to make sure that we stay focused on the objective in terms of how we run the business which is really on an annual basis.

And I think what you see now, Mark, is that we have right sized our operating models so that our cost structure is set to a very conservative level. What you see in the operating margin this quarter is when we do get incremental revenue it converts at very high levels and drives the operating margin.

Great, thank you.

There are no further questions at this time. I'd now like to turn the presentation back over to Tom Friel for any concluding comment

In the interest of time and we've run over a little bit the scheduled time today, I would like to close our call with two very quick comments. First of all, we remain and we are very pleased with our current performance and our long-term prospects which both are better than they have ever been.

And second, I want to thank our partners and colleagues and our leadership team and all of our staff worldwide. And I want to thank our clients worldwide who have made this strong performance this quarter possible. Thank you all for your interest in Heidrick & Struggles and thank you for participating in our call today. Good-bye.

That concludes today's presentation; you may now disconnect.