Heidrick & Struggles International Inc (HSII) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Heidrick & Struggles Q1 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a Q&A session and instructions will begin at that time.

You may now begin your conference.

Good morning, everyone, and thank you for participating in our 2006 first quarter conference call and webcast. On today’s call from Heidrick & Struggles are Tom Friel, Chairman and CEO; Eileen Kamerick, CFO.

As a reminder, there are supporting slides that are available on our web site at heidrick.com to accompany our remarks today. As always, we advise you that this call may not be reproduced or retransmitted without our consent. Also, we’ll be making forward-looking statements in today’s call and ask that you please refer to our safe harbor language contained in our news release dated today May, 2, 2006, which was widely disseminated by the various newswires and other media this morning. The same safe harbor language is also on Slide 2 of our presentation.

With that, I’ll turn the call over to you, Tom.

Thank you, Julie, and good morning everybody. Thank you for joining us this morning. On the call today, I’ll go through some of the highlights of our first quarter and then Eileen Kamerick will review our first quarter results in a little more detail. Then I’ll come back to provide you with an update on our overall outlook for the remainder of 2006.

There were a number of achievements and great improvements that give us confidence today in reiterating our 2006 guidance. However, this quarter was a very good example of why we felt it was appropriate to move from quarterly guidance to annual guidance. There has not been a consistent trend to our quarterly revenue in the last 4 years and the first quarter has never been our strongest quarter over that period of time. This quarter is no exception. Any quarter’s revenue can be easily skewed by the timing of a few large searches or confirmation trends and this makes it hard to predict revenue, which also leads to difficulty in predicting margins on a quarterly basis. On an annual basis, most of this variability disappears and we have no reason to believe that this year will be any different.

So let me share some of the highlights of the quarter, as well as some of the factors that give us confidence in the year. If you were following along with the slides we posted on our web site, we are starting on slide marked Number 3 in the bottom right-hand corner.

Our net revenue of $101.5 million in the first quarter was up 2.9% year-over-year and would have been approximately $105 million using last year’s exchange rates. In Europe, net revenue of $35.4 million was the highest quarterly revenue since June of 2001. And in Asia-Pacific, net revenue of $10.3 million for the quarter was a record for that region. So 2 out of our 3 geographic regions, representing more than 45% of our global revenue, achieved record results.

Turning to Slide 4, first quarter confirmations were up 1% year-over-year, but were up almost 16% sequentially. February confirmations were higher than January levels and March confirmations were even higher yet. Actually, March was the highest month we’ve had in more than a year. These confirmation trends are very encouraging to us. We are seeing generally very good business momentum as we end the quarter and good confidence from our recruiters. As we’ve shown you in Slide 6, because revenue lags are signed confirmations, at this point, we have expectations for a stronger second quarter.

Looking at Slide 7, we are pleased to report that in line with our plan for 2006 we grew our consultant headcount by 18 in the first quarter to 333 worldwide, up from 315 at the end of last quarter. 13 of the 18 net adds were in the Americas and 5 were in Europe. We are very excited about these new hires, which represent a good mix of consultants from other premiere executive search firms as well as industry and functional experts from firms such as McKenzie, Ernst & Young, and Capgemini.

Our goal for 2006 remains the addition of at least 10% net new consultants from the end of 2005, with the bulk of these hires planned in the first half of 2006, so that we have the year to build their productivity. We are more than halfway towards meeting this goal and have candidates in the pipeline that we believe will allow us to get there.

Moving to Slide 8, consultant productivity remains a strong growth driver for us. Despite a year-over-year increase, as I mentioned, of 28 consultants, we maintain annualized revenue per consultant at $1.2 million U.S. dollars, which is exactly where we were last year in the first quarter. We are very encouraged also by the feedback on our new training, onboarding, and mentoring programs that Bonnie Gwin, President of the Americas, told you about last quarter, to bring our new and existing professionals to higher productivity more quickly while maintaining superior quality in their work.

On Slide 9, our first quarter operating income, excluding a change in restructuring estimates, was $8.6 million, up almost 35% over last year’s first quarter operating income. And turning to Slide 10, the first quarter operating margin, excluding this restructuring charge, was 8.5%, up significantly compared to where we were in last year’s first quarter at 6.5%. One thing to note, which Eileen will go into more detail about in a minute, is that our first quarter of fixed costs, specifically related to salary and benefits expense that are specifically in the first quarter, are higher and this typically affects first quarter margin by a few points.

With that quick overview of some of the key metrics that we use to monitor our business, I will now turn the call over to Eileen to give us more detail on the quarterly results. Eileen?

Thank you, Tom.

I would like to review some of the major components of the first quarter. Looking at Slide 11 at the top line, revenue before reimbursement, or net revenue, of $101.5 million increased 2.9% year-over-year and was up slightly from the fourth quarter. Had we used last year’s exchange rates, the revenue would have been approximately $105 million. The net increase in revenue deferral in the quarter was $1.8 million and the total balance sheet amount of deferred revenue is currently $17.4 million. Typically, the first quarter is not our strongest. In fact, it has been our lowest revenue quarter in each of the last 2 years. But as Tom mentioned, confirmations started picking up in February and were even stronger in March.

Reported operating income for the first quarter was $8.4 million, representing an 8.3% operating margin and a significant improvement over where we were last year at this time. Excluding restructuring charges related to a change in estimates for real estate costs, the operating margin would have been about 8.5%. Looking a little further at operating expenses, I’ll explain some of the key drivers in the quarter.

If you turn to Slide 12, we have added this slide to provide you with more detail into the largest component of our P&L - salaries and employee benefits expense. Salaries and employee benefits expense in the first quarter was $70.1 million, or 69.1% of revenue. This expense was up $2.2 million, or approximately 3% year-over-year, and 5% sequentially. These increases, which in part reflect 28 more consultants than we employed last year at this time and 18 more since the end of December 2005, were planned and did result in higher first quarter fixed salary costs.

In the first quarter, fixed compensation was slightly higher than first quarter 2005, representing approximately 70% of salaries and benefits expense, with 30% being variable. Much of this increase is due to the higher consultant headcount as a result of salaries and benefits for the new consultant and, as Tom mentioned, as with most professional services firms. Fixed costs for items like social security, as well as our 401K match, are highest in our first quarter. Total stock-based compensation expense was $4.9 million compared to the first quarter 2005 when it was $1.7 million. The most significant components of this large increase are related to an increase in RSUs awarded last year. About $800,000 of expense is related to the equity components of the 2005 bonus program and $2.8 million relates to service-based equity awards given to retain our key consultants.

Please recall that we made a change in our compensation plan in last year’s second quarter. Under that program between 10% and 20% of consultants and management bonuses, depending on the individual’s level of responsibility, are awarded in RSUs. This change was designed to increase consultant stock ownership in the Company in order to align their interests with those of the shareholders, principally through restricted stock unit awards. The Company has made a conscious decision to use RSUs as a means of building long-term stock ownership within the consultant base.

Since the accounting for RSUs awarded is part of our consultant’s bonus can be confusing, allow me to elaborate. RSUs are earned in the bonus year but awarded in equity grants in March of the following year and then continue to vest ratably over the next 3 years. Compensation expense related to these RSUs is recognized over the entirety of the bonus and service period. Our new bonus program resulted in a deferral of $2.1 million of compensation expense during first quarter 2006 compared to the same period in 2005, the last quarter before our compensation program change became effective and when all of the cash bonus expense was being recognized.

This expense decreased was offset by 2 items. One, the $800,000 worth of equity-based compensation expense previously mentioned, related to bonuses earned in 2005 and paid in equity for which expense is being recognized over the entire bonus and service vesting period. And second, $1.1 million of stock-based compensation expense for bonuses earned and expensed in the first quarter 2006 that will be granted in the form of RSUs in first quarter 2007. As a reminder, our 2006 bonus accruals are based on our full-year expectations for revenue and profitability, despite only having 1 quarter of actual results.

Stock option expense amounted to $600,000 for the quarter. The annual stock option expense for 2006 will be approximately $2.3 million, less than our original estimate of $3 million. The increase related to expensing stock options was partially offset by a one-time benefit of $400,000, related to recognizing the cumulative effect of forfeitures calculated in accordance with 123R.

Moving on to G&A expenses in the quarter, this line item decreased to $22.7 million, or 22.4% of revenue, from $24.3 million, or 24.6% in the same quarter last year. We continue to closely manage G&A.

We reported net income in the first quarter of $5.9 million and fully diluted earnings per share of $0.30. These results reflect a first quarter tax rate of 44.2%. The principal reason for the slightly higher first quarter tax rate reflects a one-time non-cash charge associated with the Company’s ability and election to use more tax efficient foreign tax credits versus deductions for foreign taxes paid. While slightly unfavorable to our first quarter tax rate, this election is expected to result in a lower effective and cash tax rate for the year. For the full year, we expect an effective tax rate of approximately 40%.

As part of our $50 million share repurchase program announced last September, we repurchased just over 480,000 shares in the first quarter at an average price of $34.49 per share, for a total of $16.6 million. Because our ability to repurchase was restricted to March, due to our trading blackout period, the effect on our diluted weighted average common shares outstanding in the first quarter was minimal. And the effect on diluted earnings per share in the first quarter was less than 1%. We have about $24 million remaining under the current authorized share repurchase program.

Moving to Slides 13 and 14, cash flows and balance sheet items, net cash used in operating activities was $35.3 million in the quarter and free cash flow, which we define as cash flow from operations, net of CapEx, was a use of $35.7 million. Cash flow in the first quarter was down sequentially from the fourth quarter after paying out approximately $46 million of our 2005 cash bonuses. The cash, cash equivalents, and short-terms investments balance as of March 31st was $158.4 million, reflecting the March bonus payment and share repurchases. For 2006, we’re still expecting to generate free cash flow after bonuses of between $50 and $60 million. We have consolidated interim and final bonus payments for our consultants to one payment in first quarter 2007, which will result in a one-time increase to cash flow in the fourth quarter of 2006.

We continuously look at all options that will maximize our ability to increase shareholder value and we review this at every board meeting. Our current cash strategy includes investments in our business; for example, to improve productivity or marketing to win more searches and share repurchase programs. In addition, we review and analyze alternatives for returning cash to shareholders as well as potential acquisitions that would be accretive and would allow us to fill some very specific geographical or functional gaps and/or allow us to expand our services.

Now, let me give you a quick overview on regional results. Please turn to the Americas results on Slide 15. Net revenue of $55.8 million in the quarter was up 2.2% year-over-year but down 6.3% sequentially. Year-over-year, the consumer, financial services, and technology industry groups saw the strongest revenue growth. January confirmations started out fairly weak in the Americas, down year-over-year and flat sequentially with December confirmations. February confirmations were higher than January but still down compared to last year’s February. And in March, confirmations really picked up. They were the highest of any month in the last 12 months.

Operating income was $9.8 million, up 10.4% year-over-year but down from $11.2 million in the fourth quarter. The quarterly downward pressure we’re seeing on operating margins in the Americas is largely a function of costs associated with the additional consultants we’ve hired in this region, specifically in the last 2 quarters.

Consultant headcount at the end of March was 178, up by 21 people, or 13%, compared to last year at this time, and up by 13 people just since the end of the December. As you know, this hiring was part of our 2006 strategic plan and we’re confident that the investment will enable us to deliver on our annual revenue and operating margin guidance for the Company.

Now, for Europe’s results, please turn to Slide 16. We are very pleased with the year-over-year and sequential improvements in European results in the first quarter. First quarter revenue of $35.4 million was up 3.8% year-over-year and up 12.1% sequentially. On a constant currency basis, revenue would have been up 13.8% year-over-year or approximately $38.8 million.

Our offices in the U.K., France, and Italy all delivered very strong year-over-year and sequential revenue and operating income growth. Our German offices also showed meaningful improvements in operating income year-over-year and substantial improvements in revenue and operating income sequentially. Year-over-year, growth in the financial services and technology industry groups help drive revenue growth.

First quarter operating income and operating margins both reflect strong year-over-year and sequential improvements but we continue to seek to leverage maximum benefit from the restructuring we took in last year’s second quarter, while at the same time driving productivity and higher revenue growth.

Consultant headcount at the end of March was 113, up 5 from the end of December. Strategic hiring remains a key focus in Europe. Our strategy is to hire individuals who have the right practice background for the industry or functional gaps we’re looking to fill and who are Pan European in focus and attitude.

Next, please turn to Slide 17 and we’ll discuss the Asia-Pacific region. The Asia-Pacific region turned in a record quarter with $10.3 million in revenue. On a constant currency basis, based on last year’s exchange rates, revenue would have been almost $11 million. Offices across the region performed well, but revenue growth was driven by especially strong performance from our Hong Kong office, with good growth in the financial services industry group - Melbourne, with great growth in the industrial group, and in India and in China, where robust economies continue to drive good demand for our services.

Operating income and operating margin were both up year-over-year, largely driven by increased productivity. Towards the end of last year, the Asia-Pacific region embarked on a hiring strategy to build consultant headcount from the mid-30s level, where it had been for several years, to around 40, and is now at 42 at the end of March. The costs associated with new hires are a primary reason why the margin fell slightly in the first quarter compared to fourth quarter levels.

With that review, I’ll turn the call back to Tom.

Thanks very much, Eileen.

So, to summarize, we are generally very optimistic about the year ahead, despite some normal first quarter softness in revenue, because of the milestones we hit and the improvements we’ve made in the quarter. Current confirmation trends and our operational initiatives give us high confidence at this time to reiterate our expectations to achieve consolidated net revenue of between $445 million and $465 million, representing growth over 2005 net revenue of between 8% and 13%.

Further, based on these net revenue levels, we expect our 2006 full-year operating margin to improve to approximately 12%, excluding the changes to estimates for prior restructurings. This margin hurdle takes into account several additional costs we will also incur in 2006, including our continued focus on strategic hiring; incremental stock-based compensation expense that we did not have last year; a worldwide partners meeting in the fourth quarter, which we believe is instrumental in fostering the success of all of the initiatives we’ve been sharing with your regarding training, mentoring, and driving revenue in key accounts and new services; and some increase in our marketing programs to drive revenue.

So with that overview of the quarter and of 2006, we’d like to open it now for your questions.

[Operator instructions.] Tobey Sommer, SunTrust Robinson Humphrey

This is Mike Vincent for Tobey this morning. A couple of quick questions. First off, on the addition of new recruiters, could you tell us kind of what the breakdown is among those kind of by -- from other recruiting firms or industry or maybe internal promotion?

It’s actually a mix of all of those. We’ve got in the 18, about a third, 6 are experienced from other search firms, and 12 would be new to search, either promoted from within our ranks or hired from the outside in industry. And that actually, as it turns out, is relatively consistent with our overall goals, which are to stay balanced, about a third, in each of those categories. It doesn’t always work out that way exactly, as some of these hires are opportunistic, but this quarter it worked out pretty much that way.

And then a follow-up to that on the productivity that you’re seeing from the recruiters that are hired without experience. What’s kind of been your experience during this business cycle as far as, do they tend to perform kind of once they get ramped up at the productivity levels of the overall recruiters or they can be kind of lagging a little bit?

Well, actually, we’ve been very successful through a lot of our training and mentoring and integration programs to shorten the cycle, which, historically, was 2 to 3 years to get somebody new to the business fully up to speed. We’re getting that down to 12 to 18 months in many cases, even with people with no experience. With experience, industry recruiters, that goes a lot quicker. Among our top producers worldwide in this quarter, and actually each of the last few quarters, we’re finding in the top 10 players consultants that have been with us in some cases less than a year, and that’s actually very gratifying. So I think it reflects a couple of things. One, it reflects the quality of the hiring because these are excellent people that are joining us. And I think it’s impacted in a positive way by the training and mentoring programs that accelerate the time to full productivity. So we’re actually pretty confident that we have the right formula to how to get this done and to keep doing it on this basis.

And our revenue per consultant stayed at $1.2 million, which is where it was at this quarter last year and also fourth quarter of 2005. So even with pretty significant additional headcount we’ve been able to maintain our productivity.

And then you had a chart in your slides that shows productivity kind of last year tick up from kind of in the second and third quarter. Considering the new hires, would you expect it to kind of hold steady this year, as opposed to an uptick like that? Or do you think it’s possible to improve a little bit as the quarter progresses here?

I mean, I think there is certainly an opportunity to improve productivity and we expect that as the year goes on.

Matt Litfin, William Blair

What was the dollar amount for the margin effect of the first quarter seasonal factors that you mentioned?

Well, we don’t break those down, but we certainly had higher salary and benefits expense than we would have expected, Matt. So, I mean, certainly the fixed costs of new consultants and the fact that we had some up front costs in terms of hiring and then, obviously, what we mentioned, which is the full balance of both people, social security accruals, and a 401K match. All of those would conspire to sort of -- may have a margin effect of at least a couple of points.

Okay. Can you talk to how confirmations have trended in April relative to those March levels that you mentioned?

Sure. We’re still seeing very good momentum in April. So we see the market as continuing to be strong.

Okay, thanks. And, Tom, a final question for you. I’m interested in why you said that this quarter is proof that going to annual guidance was a good move? I mean, even giving you guys the benefit of the doubt that you had a sense that first quarter was going to be seasonally weaker than the rest of the year, why would you not want to communicate that knowledge to avoid the volatility in your stock that we’re seeing today?

Well, number one, one of the things that we said I think last year is while the first quarter has, historically, not been a strong one, the ability to predict the performance of a given quarter isn’t very good. And we’ve had different quarters be first and last over the course of the last 2 or 3 years. We wouldn’t have had any particular visibility into what the first quarter would turn out to be. If we had had that visibility, we would have shared it. But we’re not able to really able to forecast that on a quarter-to-quarter basis. I think a perfect example of this quarter, if this quarter had been offset a month, it would have been a completely different story because February, March, April looks a lot different than January, February, March. But that might be completely different a quarter or 2 from now.

And the other thing is, Matt, I mean, we’ve been talking for some time with our board about moving to annual guidance. We think it’s a better corporate governance discipline to look at the mid-term to longer-term trends in the business. We manage this business on an annual basis. We certainly phase our spending on an annual basis. All of our consultants are focused on producing annual numbers. So for all of those reasons, it makes more sense in terms of managing the business. Not to take your eye off near-term results, but to really be focused on mid-term and longer-term building shareholder value.

I’ll just add one further comment, Matt, just to make one point real clear, is that the move to annual guidance, when we made it, had absolutely nothing to do with what we thought the performance would be in this particular first quarter. So, I mean, it had to do much more completely with the notion that running our business on an annual basis is predictable and is much more sensible, as Eileen just mentioned.

Mark Marcon, Robert W. Baird

In terms of the March confirms, how much were they up relative to the prior year?

Well, we usually don’t give specifics on year-over-year in terms of a month, but we certainly saw a market increase in terms of year-over-year in March. This quarter was really very backend loaded, which is why you had a revenue deferral as well, because our revenue really came in pretty heavily in the back half of the month. But the increase year-over-year was significant.

Why do you think the dynamic occurred where the quarter ended up being as back-end loaded? Is it due to your exposure in financial services and there are record bonuses in the financial services industry this year? What drove that?

That’s a very insightful comment. It is one thing that we looked at in terms of trying to ascertain if that was true. I mean a third of our business is financial services. And you are exactly right, Mark, I mean, they had record bonuses and, obviously, people are going to stay for those bonuses. So there certainly could be that effect. Some of it is just what Tom referred to. This is a lumpy business and it’s difficult to forecast even a month ahead. But I certainly think that’s one element of what could be happening, certainly in financial services but in other businesses as well where people are staying to pick up their bonuses and so you see sort of movement in the back half of the first quarter rather than the front half.

So the round of musical chairs started later this year.

Yeah.

Okay. Anything in particular in terms of your own consultants, consultant capacity in terms of established consultants, anything along those lines that were a constraining factor in the first quarter of this year that might carry on throughout the balance of the year?

No. We do not have capacity constraints. And, as Tom has mentioned before, although last year we were annualizing it at revenue per consultant of $1.3 million, which is an all-time high, we certainly believe that we have the means of pushing that higher, either in terms of productivity measures or people doing more searches. So we don’t think that we’re constrained and, obviously, with the new consultants we’ve brought on, we’ve created new capacity. So those limitations are really not an issue for us.

With regards to the partners meeting that you are going to have in the fourth quarter, how much is that going to cost? My recollection was it was $2 to $3 million the last time you had one.

Yes, that’s about right. And that will be spread not entirely in the fourth quarter. That’s the majority of the expense will be that, but it will be in the third and fourth quarters.

And then just what sort of things, we know you are not giving quarterly guidance, but in order to avoid this sort of volatility, what are some of the things that we should take into consideration when we think about modeling the second quarter? Are there any special expenses? Anything that might end up changing? How should we think about things?

Well, we’ve given you the sense of where we see the market and sort of the confirmations going into that quarter. We don’t have any extraordinary expenses that we foresee right now.

But from that perspective, your operating margins sequentially, if your revenues are increasing in every single -- if your revenues are going to increase sequentially in every market, you should see a sequential improvement with regards to operating margins. Is that correct?

Well, we would expect to have a full year operating margin at 12%. Obviously, we were lower than that in the first quarter, so one would expect that the sequential operating margin beyond that would be higher.

Clint Fendley, Wachovia

Tom, can you discuss the turnover trend that you’ve seen with your consultants post your bonus payment here? And also, if you could discuss your rationale for moving to the one single bonus payment?

Sure. Well, first off, the consultant turnover this year was extremely low. The risk of turnover in any professional service firm that pays an annual bonus at one time or more than one time, as we do, is highest right after those bonus payment periods. So there is some effect on that in the market, particularly as movement occurs in professional service firms and both with our competitors and with some of our clients. So the period of highest risk for us for consultant turnover, voluntary, is March/April/May, and we’re largely through that with minimal turnover by historic standards. I think in the month of April we lost 1 consultant. Typically, we would look to keep that below 5% and we’re very much below that now, which says most of our new hires become net new hires because there is very little loss. So that’s not something that’s worrying us at this point.

The other question related to moving to a single bonus payment from 2. Historically, we had made a deposit in the neighborhood of 50% of the bonus payment in December and followed with a settling up final payment at the end of February or the first week or so of March. This proved to be difficult for 2 things. One is an enormous strain on the financial staff and the HR staffs and the management of the Company to go through this exercise twice within 2 months. Secondly, we decided best practice would require us to move to closing the books, settling up, determining what our bonus pools are, and then dividing them appropriately among all of the people, not just our consulting staff but our non-consulting staff that participates in these pools. And do that at one time. The fact that we have included now over the last 2 years RSUs as a percentage of cash compensation makes this calculation even more complicated, has more pieces to it, requires more administration, and it just -- by all accounts, and our internal management and teams have supported this, to do that right and communicate it correctly, simply required that we do it once. And so we decided to consolidate all of that into one cycle, close the year, do the evaluations, assess what we have to work with in terms of bonus pools globally, divide them up, and write the checks the first week of March generally.

And as a public Company, we think it’s appropriate. We are, obviously, compensating people based on revenue and profitability. And to do so appropriately, you need full-year final results. So all of those really argue for really having one bonus payment when you finalize the year.

A final question here. Tom, can you provide some details on the type of marketing programs that you have planned for the remainder of the year? Thank you.

Sure. We have some marketing programs that are global, some that are regional, and some that are local, and it’s a combination of all of these and the money is being budgeted quite carefully. We’ve actually, historically, spent a fair amount of money on marketing, but we haven’t had coordination of it as tightly as we think is appropriate. So we’ve pulled a lot of the control of marketing programs and marketing dollars back to a central point or a regional point. Much of it is in support and much of our money will be in support of our major initiatives around working at the top - CEO dinners, CEO-focused publications, outreach to boards. We have a couple of new relationships; one with Directors and Boards magazine that is kicked off with great effect.

We are hosting a series of newly launched CEO and director events - some dinners and some other forum events with outside speakers in various markets of the world. We’ve just, in fact, concluded a series of those over the last 2 or 3 weeks in the major headquarters capitals of Asia and a couple in Latin America. We have a cycle of those in Europe coming up. We have improved some of our internal and external marketing communications documents. We’ve actually released in our current Annual Report, which we released about a week ago, the 2005 Annual Report, included for the first time a major emphasis on the partner relationships with some of our global clients and featuring them in some of our public materials, which we like and which they like and they participated with us in developing that.

And we have beefed up our marketing staff by hiring 2 or 3 additional professionals and incurring slightly increased use of some favorite outside professionals to help us with some of these programs. And to cover some of that, we have pulled back some marginal programs that we didn’t think were as effective as some of these central ones were, so we contributed some of that funding to some of these new programs, which I think are much more aligned with our strategic options and are actually proving to be much more effective in terms of -- in some cases, spending more money, but with higher impact.

David Steinberg, Goldman Sachs

Question was regarding the G&A expenses. They were down 6% year-over-year, and I think your prepared comments said something to the effect you were going to continue to be diligent in terms of looking at ways of reducing expenses. Factoring in the fact that you have $2 to $3 million in the back half of the year for the partner’s meeting, I’m trying to understand how we should be thinking about G&A expenses through the remainder of the year. Is that something where we can continue to see 6% year-over-year improvement or should we be thinking of it in terms of a percent of revenue? What goes in there and how should we be thinking about fixed versus variable components of that? You did a great job of breaking down the salary. I’m curious to drill down in G&A.

Yes. On G&A, I really think it’s most productive to think of it in terms of a percentage of revenue. And as we’ve stated, as we grow, it’s difficult to keep that absolutely flat nominally; but as a percentage, we’re committed to try to keep it in the low 20s on an annual basis. Obviously, some of the spending, for example, for the worldwide partner meeting, you will see that move up for a quarter, but on an annual basis, our real focus is on keeping that in the low 20s in terms of a percentage of revenue.

And in terms of fixed versus sort of a variable, one major component of that that’s variable is our non-rebillable travel. I mean, we’re a global Company and in terms of business development and also just what we need to do to run the firm, there is a fair amount of travel that goes on. We’ve had a renewed focus on keeping that down. On the fixed basis, we’re seeing the benefits of our restructuring actions that we took, so our operating lease expense is lower. So I think on the fixed portion of it, some of what you’re seeing is the flow-through from last year when we took some actions regarding real estate and brought that cost down.

Wonderful. One quick follow-up. In terms of the restructuring charges, they were low in the quarter at $176,000. Just curious when we’ll see them go away entirely?

Well, the issue is under the new accounting rules. New being in the last couple of years. The reason why you still see a flow-through on that line is that if there is any change in estimates, and in this instance, this is actually a change of estimate on operating expenses for a property that was restructured in 2003, that has to flow through the restructuring line. Previously, you could put all of that in one major restructuring charge. But the way the rules work now, if there is a true-up of any estimates regarding a sublease or operating expenses, that does have to go through the restructuring line. We don’t anticipate that that would be significant, but we do have properties under restructuring. And so you could see a change in estimates in any given quarter, but it should be relatively low. And we have no new restructuring program and no intent to take a restructuring. So understand that’s just a change in estimates, it’s not actually restructuring actions taken.

Fine. Thank you.

Michael Morin, Merrill Lynch

Tom, I just want to make sure I understood your comment about the plans to continue to hire on the consultants. Did I hear you correctly in saying that kind of the recent pace is kind of what you would look to continue to do in the first half and then perhaps slow that down a bit in the second half?

We would -- that is correct. And we would like to get -- we’ve got hiring targets for the year. We would ideally like to get those accomplished by the end of the first half, because that gives us the maximum amount of time to see the productivity of the new hires by year-end. However, if the productivity continues and we believe we can increase the hiring beyond the 10% target, as long as we can continue to grow productivity faster than headcount, we’ll continue to do that. So we may well revise upward the hiring targets in this maybe third quarter, assuming the performance of the people we’ve hired in the first and second quarter is ramping up at the rate that we expect it to, and so far the indications of that is that it will. So we’re very optimistic that we now have the right programs in place to make sure we’re hiring the right people, that the misfires or mis-hires will be quite low as a percentage of the people that we bring on, and that we will be able to bring these people up to speed to reasonable productivity quite quickly.

Okay. And then in terms of the financial impact of these new hires on the margin, I guess what I was hoping to understand a bit better is what is really driving that? Are we talking about some one-time expenses related to the initial hiring or are we really talking about the added ongoing salary burden of people who are not yet productive? I don’t know if that’s clear in terms of what I’m looking for, but basically is it -- how much of that might be one-time related?

Well, some of it, and Eileen will have a comment on it as well I think, some of it is both. There is typically one-time expense associated with starting up a new consultant, particularly if we start up a new partner team, which could, in fact, involve 1 or 2 people beyond the individual that we hire in terms of support roles. Often a partner team for us is 2, 3, maybe 4 people. And so there is some initial investment in non-revenue-producing people as well as revenue-producing people when we bring a senior person onboard or promote one.

There can be some front-end costs associated with that that’s not recovered - signing bonuses and things that are one-time events to move people out of somewhere and bring them in here. And then the biggest real load is how quickly will this individual ramp up and intersect into earned variable compensation over and above whatever fixed compensation we pay them at the time we bring them in. Often that’s not in the first year; it’s more like the second year. So that’s a hiring investment in the first year that we’re working on making as short as possible. But, clearly, we won’t get the top talent that we want unless we’re willing to make some investment in bringing them over and getting them up to speed. And we just have to balance that fairly carefully and make sure that in the aggregate it’s covered by productivity elsewhere.

Eileen, any further comments on that?

Let me give you a little bit of color on that as well. In terms of just, if you go to Slide 12, our salary and employee benefits expense is up year-over-year $1 million. So there is a fixed cost component that isn’t covered and has a margin effect because you’re getting people up to speed. But in addition to that, there are a couple of points of margin that are just first quarter one-time expenses that should be less pronounced through the rest of the year. So part of it is dependent upon the additional costs that we’re incurring for having new people is their salary and benefits expense, which we have every reason to believe that as they become more productive they’ll come up and over that and be able to contribute to the margin. And then in first quarter, as I mentioned, there are some expenses that are just front-end loaded that will be less recurring throughout the year.

So when you have these, like, one-time signing bonuses, that does not get included in your salary and employment benefits line?

Yes, it does.

It does, okay.

Yeah.

All right. And then I just want to clarify, on that Slide 12, your -- well, first of all, thanks for providing this line, it’s very helpful, 2006 RSU bonus accruals. I just wanted to clarify that that is what accrues in ’06 but is actually related to the ’05 bonus?

No. Let me walk down that line, the equity compensation expense, the slide you have. The 2005 bonus RSUs, those were actually RSUs that were awarded in March 2006 that were related to 2005 bonus. And then the bottom line that says 2006 RSU bonus accruals, that’s an accrual in the first quarter for 2006 bonus that is earned but will be paid in 2007 in RSUs.

Right. Okay. Even though none of that has really vested yet.

Exactly. I mean, because you’re earning it, as I said in the script, you are earning it in the year that you received the bonus and then they vest ratably over the next 3 years. The actual period of the expense is the year in which you earn the bonus and then through the time that you receive the RSUs and they vest. So it’s actually around 51 months.

Matt Litfin, William

Yes, I had a follow-up on that last question there on the intra-quarter bonus payment to consultants. My understanding was that 10% of the ’05 bonuses were in stock or RSUs. Can you tell us what price that that equity was granted or has that equity grant, has it been priced at this point or is it yet to be priced?

No, it’s been priced, but let me explain how that works. The consultants have a bonus, let’s say $100,000, and the number of RSUs you received is based on a date -- the opening and closing average of the stock, which in this instance was $32.96 on I believe March 3rd, which was a date set by the board. You take the amount of bonus that the individual is to receive and divide the value of the RSUs into that to determine how many RSUs they’ve received. They also receive a 10% premium on that amount.

The actual taxable and conversion rate of the RSU will be the price on the day the RSU vests and retraunches over the following 3 years. So the initial price, if you will, determines the number of RSUs that the individual gets on that conversion from earned bonus to RSUs, but that will not then be the price of the RSUs at the time they vest or on which they’ve been taxed. That will be the price subsequently and it will be multiple price of 3 anyway over the 3 vesting traunches because these bonus RSUs are all 3-year one third, one third, one third RSUs.

Great, that’s helpful. And so the actual amount would be, I guess, 10% on top of the 10%. So it would be $101 compared to a bonus last year of $100. Is that the way to think about it?

That’s correct. Converted into RSUs on that date and then, hopefully, we would hope that assuming an increasing stock price the value would be more than $110, but, obviously, it could be less, depending on the price of the stock on the annual best dates, 1, 2, and 3 years subsequent.

Kelly Flynn, UBS

This is Andrew Fones for Kelly Flynn. I was wondering if I could take you back to Slide 5 for a moment. I think you mentioned that confirmation trends, the momentum there remains strong in April. I was wondering if you could just kind of help me understand where we would totally expect April to kind of plot on that chart. Would it be around the level of March or are we seeing kind of continued improvement in the March level?

We’re seeing momentum. We haven’t given you that because, obviously, we’re not giving guidance for the second quarter, but we are seeing similar kind of trends in April.

Sorry. And by similar trend, you mean we continue to see an increase in the level of confirmation?

Well, we’re seeing a kind of level of business activity that’s commensurate with March.

Okay, thanks. And you gave details, kind of guidance, of how confirmations trended in the Americas. I was wondering if you were able to give us a sense of how confirmations trended through Q1 in both Europe and Asia also.

Well, in general, in Europe, confirmations were fairly strong, as they were in Asia. We didn’t see the same lumpiness through the quarter in either of those regions that we saw in the U.S.

Okay.

So January was not as strong in all of the regions as February and March and there was acceleration for all 3 regions, but the kind of significant back-end loading of confirmations was more pronounced in the Americas than the other 2 regions.

We had a strong April in all 3 regions, particularly given that the Easter holiday was in April and sometimes has a negative impact. It did not appear to this year. So even given that, April is a strong month.

Okay. Can you point at all to, perhaps, what caused the relatively weaker confirmation numbers? By the chart here, it looks like November, December, and January and then since then the improvement. I guess, looking back last year, we saw some seasonality from December to January, but this year looks a little different.

Well, I think the essence of that question is the essence of the move to annual guidance because we can’t predict these things on a quarterly basis very well and it seems like on an annual basis, if the work isn’t there in one quarter it’s there in the next quarter. And most of the seasonality, which if it were true seasonality, would be a lot easier to model, but it’s not true seasonality in that the strongest month or the strongest quarter from one year doesn’t repeat on a predictable pattern year-on-year. That’s true seasonality. We just see, I think, in our business that there is just lumpiness and unpredictability in terms of these trends. Try as we do to see patterns, they just don’t seem to be there when you cut it down to as close as months or even quarters. But when you take a broader view, it rounds out the ups and downs and makes things much more reasonable to look to. And so, particularly given that our clients run their business, their hiring cycles are annual, their compensation cycles are annual, our hiring compensation cycles are annual, our budget cycles are annual, our cost management cycles are annual, it’s just everything sorts out much better on a calendar year basis.

To add for a minute, we’ve given you this slide last quarter as well, but the slide on 23 just gives you a sense of it. There is no particular pattern. I do think that in the Americas we saw a weakness, particularly in part because people were waiting after very good years in many industries to pick up bonuses before they moved. But that’s our best estimate of what was happening in the quarter, and, obviously, we’ve seen that rebound in March and in April.

Okay, thank you. That’s really helpful. On the margin side, I don’t mean to beat a dead horse, but I think that you said that basically your plan was to hire at least kind of 10% additional headcount. That would be about 31 people. You brought 18 on in Q1, so obviously you are very front-end loaded in terms of your hiring. You said that that had an impact I think of about 2 points. So it’s my estimate on that that would be about an impact of about $2 million. Can you tell us is that the one-time cost that you referred to as a recruiting and onboarding cost or is that overall including [indiscernible] and so forth?

Well, first of all, we said there were some front-end costs that just had to do with being a professional services firm, which we had some expenses in terms of setting up the year. It’s not just salary and benefits expense, it’s beginning of the year marketing expense, it’s other items that kind of have that downward pressure on the margin. So there certainly was -- there was $1 million of increase in salaries and employee benefits year-over-year. And we also had, as I mentioned, things like 401K match and FICA, which make a difference in the first quarter margins. But that was all planned. Our intent was to try to get as many of the hires in in the fourth quarter and in the first quarter of this year so that we set up the revenue growth for the year. So having said that, we certainly think that we’re going to be able to reach the full-year 12% margin. Our first quarter is not, in terms of margin or in revenue, our strongest quarter, and a lot of it is because our business-building activity and spending goes on in the first quarter.

And then a final question, your current share account, I think you bought back 490,000 shares in the quarter.

Yes.

Is that around $19 million at this point?

Yes.

Mike Carney, Aperion Group

Appreciate all the new details. In terms of hiring, one more time, are there any primary practice groups that you’re really keying in on?

Yes, there are. They vary somewhat by region. We have a very focused hiring plan. Although, I mean, we’re recruiters by nature, so you always tend to be opportunistic if there is somebody that we find and we think fits our partner profile and that we can make them available, we would likely to do that. But at the same time, we’ve got some industry softness in some areas where we need some talent. Life sciences generally is one of those. It’s a high-growth industry that we’re very focused on. There are elements of financial services where we still have some room to grow. There are elements of the global energy and oil and gas business, which are currently strong, where we need some more help. There are a couple of geographies in the world where consumer and high-end retail, we could add a couple of people, and just by our strength there are places in the industrial and the technology practice where we have some holes that we would like to fill. So it isn’t in only one area; it’s a sprinkling of key people across various industry functions around the world.

Okay, good. Thanks, Tom. And it looks like financial services if the big part of the growth and would you say that you’re trying to, I assume, grow the -- obviously, it’s a little bit more cyclical area, but you’re trying to grow the other practice groups as much as you’re trying to grow the financial services?

We certainly want a balance in terms of our portfolio. We’ve been very successful in financial services. One of the reasons why is we did a major acquisition several years ago that gave us a presence in financial services and allowed us to build a base in that particular niche. And it’s been a very good business for us and continues to be so, but we think that there are other areas that we can grow to balance that out.

And we want to make sure, if you will, that we’re able to take advantage of the hot sectors when there are hot sectors. This firm was very heavily weighted to technology in the late ‘90s and early 2000s. And that shift has moved somewhat to financial services in the last 2 or 3 years. It could be another sector that could become dominant over the next 2 or 3 years. It’s one of the reasons why we want to make sure that we stay balanced and that we have industry-leading consultants and enough depth to cover increasing demand across all of the major sectors. In a perfect world, we’d be perfectly balanced across all of the international and industry sectors and geographies. But, obviously, the world isn’t perfect, so we try to achieve as much balance as we can but recognize that industries go up and down and we’re at much less risk if we have a balanced group of partners that can adapt as market conditions change. And I think we’re in pretty good shape there now.

And we also focus on functional practice. Our CFO practice, in particular, has been a real growth area for us. And that expertise, the kind of conjunction of industry expertise and functional expertise is a very effective way to go to market.

And in the hiring in the first quarter, would you say that the majority of those hires had started in the first part of the quarter or did it take until the last part of the quarter to get the majority of hires started?

It’s really ratably across the quarter. There is no particular trend. It’s not front-end loaded, it’s not backend loaded, it’s pretty much evenly spread.

All right. And, Eileen, obviously, you’ve already talked about you’re well on your way to getting to the 10% new hires. So if you’re not looking like you’re going to achieve 12% margin, would that mean that you would be willing to get rid of some of the unproductive hires quicker or would you let that ride out until maybe a more normalized out into ’07?

Well, first of all, we’ve just hired people after a period where we’ve had some pressure from you and from shareholders that we needed to grow our consultant base. We’ve done so very thoughtfully. Senior management spent a lot of time making sure that we hire the right people and giving them the resources and onboarding tools to be successful. We expect that it takes people a period of time to get fully up to speed, but we’ve seen some of our new consultants in the last year or so rise to the top of the ranks in terms of what they can achieve. So it would not be our first step to, in fact, reduce our headcount in terms of consultants but to make sure that they succeed. And we have very strategic plans in place to do that.

Obviously, our bonuses are paid -- are limited to some extent by our profitability, so that’s a self-regulating mechanism. So the real focus on driving revenue and also driving profitability is impounded into our compensation plans as well.

Okay. And one last question on the -- again, on the restricted stock expense. The total expense is still only the restricted stock issuance dollar amount over the vesting period, correct?

Yeah.

So you’re just really breaking, in that good table you give us, you’re really breaking that out into different parts of or different years of when you had issued that stock.

Yeah. I mean, well, it’s not even just issuing it. The reality is that you earn a bonus over a period of time.

Or, I’m sorry, earning. Correct.

Yeah, you earn it and then it just -- that’s over a period of time. That expense is actually 51 months in total. So it’s the year in which you earn the bonus, then the RSUs are granted to you in March, and then they vest over the next 3 years. So over that entire period there is compensating expense associated with the earning of the bonus that’s paid in RSUs and then the vesting of the RSUs. And the reason for that is if the person leaves that they can -- they would, in fact, forfeit those RSUs. So along with aligning people within our business who are revenue drivers with shareholders it’s also a retention mechanism.

In addition, we give out equity that is not just equity associated with earning a bonus, but, in fact, awards of restricted stock to retain our best people. Now, those vest and are expensed just over the 3-year period. You receive it as a consultant and it vests over 3 years. So that’s a little different. That it’s just a 3-year vest and expense period.

Right. But there’s been no change in the financial reporting related to RSUs, except for the cumulative effect that you mentioned. Is that correct?

That’s exactly right. I mean, that’s required under 123R. The only changes in accounting that are taking place in the first quarter as a result of 123R, one, we’re expensing stock options, as everyone knows, and secondly there is a forfeiture that has to be calculated, its accumulative effects. But we’ve always expensed RSUs. As you know, that’s equity that always had to be accounted for and expensed, unlike options, until recently.

Right. And so the prior year’s RSUs that you granted was the 1.6, or the expense would have been just that 1.6 in 2005 on that table?

In 2005, the first line, 2005 bonus RSUs that were, in fact, awarded in March 2006 is $800,000. So in 2005, if you’re trying to compare, it was just 1.6. I can take you through this offline as well.

I got it. Thanks.

We try to make it as [voices overlap] as possible. Okay.

Mark Marcon, Robert W. Baird

With regards to the 10% increase in terms of the total number of consultants, how would we think about that geographically in terms of where it’s going to end up impacting?

We expect some additional, a couple of additional, consultants in Asia. And then it would be fairly evenly balanced between Europe and the Americas.

Yeah, the 18 that we hired, I think we covered that earlier.

Right.

In that 18, was 13 in the Americas and 5 in Europe. We had none in Asia in that because we had some hiring in Asia in the fourth quarter. I would think that if you look at that, they will roughly be in that balance I think more or less the same balance as the relative size of the region. So you’d probably think in terms of two-thirds in the Americas and one-third in Asia and Europe, plus or minus a little bit at the margin. We don’t try to track it quite that close. Asia may actually have a little higher growth over the rest of the year, but it’s on fairly small numbers.

And then with regards to Asia, you mentioned some of the countries that were strong. Were there any countries that were weak?

The only country where we’ve had a little bit of softness is Japan. And Japan goes up and down through the years. I think the other countries, including Australia, particular strength in India and China. Korea is strong. Hong Kong is strong. Singapore is strong. India and China, where we’re building a very substantial business, is quite strong. And really the only point of weakness currently at the start of the year would be Japan.

Did their confirm trends pick up?

Their confirm trends picked up and also Kevin Kelly recently spent some time in the Tokyo market talking to consultants there. So we’re very focused on addressing that issue.

Great. And then with regards to the 12% operating margin goal, you made nice year-over-year progress in your major geographies. How should we think about that 12% splitting out across the different geographies from a yearly perspective?

Well, we don’t really give margin guidance on a geographical basis, but, obviously, we’ve seen some margin expansion in Europe, which we expect that that margin expansion will hold or continue. And Asia, it has, obviously, expanded their margin over the last 2 years and is now trending in the mid-20s. We expect to see over the year some margin expansion from where we are now in the Americas.

And with regards to the hiring of new consultants, just to be clear on this, are you giving the new consultants guarantees? I know you’re giving them a signing bonus, but are there guarantees that are associated as well?

No, not always. It’s dependent upon the individual circumstances when we hire someone.

So in certain circumstances you are and in certain circumstances you’re not.

I mean, we try not in general to give people guarantees. And typically those are guarantees that are amortized over a period of time, because if they leave or if there is a sign-on bonus and people leave, obviously, they have an obligation to pay it back to us. It’s just a question of what the circumstances are of the person we’re recruiting, whether or not they are leaving something behind, whether or not if they are a searcher, they are midway through a year and they’re leaving a bonus behind. But, in general, we have very much a meritocracy and a system whereby people are paid for what they produce. We give people the time once they’re new consultants here to make it and all the resources to do that. And our people typically respond very favorably to that. And as I said before, some of the consultants we’ve hired in the last year are in our top 10 or 20 consultants that are doing extremely well. So I think we’ve been very successful at onboarding and providing people the resources to be successful.

We actually, we do this for a living and we have some of our best recruiters working for us on recruiting talent for us. So, generally, whatever, if there are guarantees, they are short-term duration, they are below maximum expectations, and rarely do they actually kick in because most of the new hires, if we’ve hired right, perform well above any guaranteed levels and cover that back quickly. That is not a big risk for us in terms of the P&L or the margin.

That’s good to hear. I mean, obviously, during the, perhaps, downturn, that was one of the big issues. Glad to hear that you’re controlling that.

With regards to -- what are you seeing -- I guess 2 final questions. What are you seeing in terms of salary increases for the people that are being recruited and how do you think that is going to play out through the year? And then secondly, what are you seeing in terms of your win rates for some of the higher profile searches?

When you were talking about salary increases, were you referring to salary increases for our recruiters or for placements in the market that we’re handling for clients?

Placements.

Well, we do get some uplift on that as inflation and other factors drive up the compensation of the candidates that we place, but that’s always been the case and that helps us some because in most cases we’re operating on a fixed or near fixed percentage of that compensation. I think any trends in terms of executive compensation going up, and they are, it’s good for us. In essence, it’s a price increase in our business that we don’t have to drive to our clients. The market does that.

As far as the other comment about the previous comments about in the last downturn, those were actually not guarantees that caused some people to go what we call underwater. It’s, basically, people that would not be earning their big salaries and would be in the negative variable compensation situation. Every year there are a few of those, including new hires, and maybe a handful of other people. It’s very manageable if the numbers are small and only kicks in if it’s very large.

I think the final question had to do with win rates on high-profile searches and it’s a very competitive market sector. We’ve had some very high-profile wins this year, particularly in big searches at the top of the market. We’ve had some losses in that sector too. Some of our major competitors who are good, we know they’re good. There is some fiercely contested work. I think we continue to have what we think is a high win rate, but we’re not satisfied unless we win them all. And, obviously, we don’t. And when we don’t win one that we would like to win it’s a disappointment for us, but overall we feel very confident that we have the right teams to do high-profile searches. We’re engaged in a number of them right now. We’re competing for a few more that we’ll hopefully be able to report on in the near future.

I think with that call, I’d like to close the conference call today with actually 2 quick final comments. First of all, I’d like to reiterate that Heidrick & Struggles is a growth business and we benefit from the need for senior executive management and board talent for leading companies in all parts of the world and we’re well-positioned to serve that need. Our results today demonstrate that again.

We’re particularly pleased, and I wanted to point this out as we close, with the performance this quarter of our business and our teams, particularly in Europe and in Asia-Pacific. In Europe, after several tough years and a difficult restructuring last years, it’s very rewarding to see the team exceeding both prior year performance and our own internal budgets for revenue, but more particularly for margin, which has been a focus of our efforts in Europe over the last 2 years. We expect that to continue and that’s a very good thing for our global performance. And in Asia-Pacific, revenue in the first quarter, which is typically not our strongest quarter, is an all-time record. Congratulations to our teams in Asia for achieving that.

And as I close, I’d also like to thank all of our consultant teams around the world and our corporate employees in Chicago and in elsewhere worldwide for their dedication and performance and their support, as we have made and largely completed the decisions that have been necessary to restructure this business over the last 2 years. We’re focused now on running our business and using our capital in order to strengthen our competitive position. Our hiring successes in the quarter and our progress towards our full-year goals are good examples of this.

We firmly believe that we are very well-positioned now for continuing and profitable growth for the foreseeable future. We look forward to sharing that with you in subsequent calls and we thank you for your support and your participation in the call today. Thank you very much.

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect.