Heidrick & Struggles International Inc (HSII) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Heidrick & Struggles third quarter 2010 conference. At this time all participants are in a listen-only mode. Later we will have a question-and-answer session and instructions will be at that time. (Operator Instructions). I would now like to introduce your host for today's conference, Ms. Julie Creed. You may begin.

Good morning, everyone, and thanks for participating on our third quarter conference call. Participating with me on the call today are Kevin Kelly, Chief Executive Officer, and Scott Krenz, the Chief Financial Officer. As a reminder we will be referring to supporting slides at our website at heidrick.com, and we encourage to you follow along or print them.

As always we advise you this call may not be reproduced or retransmitted without our consent. Also, we'll be making forward-looking statements and ask that you please refer to the Safe Harbor language contained in our news release and on slide one of our presentation.

And now I'll turn the call over to you, Kevin. Please start on slide two.

Thanks, Julie. Good morning, and thank you for joining today's call.

Before we get into the normal review of the numbers that we do on these calls, I would like to give you what I think are some of the headlines. First of all a strong quarter. Revenue of $126 million exceeded our expectations. And encouragingly October showed strong confirmation trends. The operating margin of 3.5% was acceptable, and had we not chosen for competitive reasons, which I will talk about in a second, to increase our variable compensation by $5 million in the quarter, operating margin would have also exceeded our guidance.

The second headline is the very strong performance of our Asia-Pacific business, where we are the market leader. For the first quarter ever, Asia-Pacific revenue exceeded that of Europe. Which leads me to my third headline. Europe did not perform well. Revenue was down 12% quarter over quarter, and the quarterly operating loss in this region was $1.4 million. A large part of the this relates to my fourth and final headline.

Turnover in the consultant ranks has higher than any of us would have liked ,and it is no secret in the industry that certain of our competitors have targeted us. They have gone to great lengths to pry our talent away. Tactics have included offering large sign-on bonuses, multi-year guarantees, and in many cases leadership rolls were offered. But I believe we've come through it with a stronger, more cohesive group of consultants, and our client service and results to date clearly demonstrated what an incredibly strong bench we have at Heidrick & Struggles.

We have been both proactive and responsive about retention and have been dealing with the issue in a multitude of ways. The first and obvious is looking at the competitiveness of our pay. We firmly believe that we are one of the most competitive compensation packages in the industry, and benchmarking analysis supports that. Where we feel we are not being competitive, we have taken action, and that is why we added this variable component to our consultant's compensation this quarter in addition to normal bonus accrual.

We have invested heavily in improving communication with consultants and better connecting them to leadership advisory strategy. The first global consultants meeting in three years and our custom education programs with Harvard and Duke fall into this category as well. We've also brought together several groups of consultants under an umbrella program we call Aspire to assure that our culture and our organization support our strategy and provide a working environment attractive to our workforce.

We have also been very active on the recruiting front, and numerically we will more or less offset our losses this year, and we continue to pursue our strategy of hiring mostly experienced search consultants from boutiques. All of our data supports this strategy as superior to hiring from other top-tier firms, where there is a significant upfront investment combined with the falloff in production resulting from a range in the environment seldom produces positive ROI. However, not just a numbers game. We believe the quality of the new hires supports Heinrich's position at the top of the executive search industry and our strategy in becoming a leadership advisor.

We are being equally aggressive in addressing the challenges we face in Europe. Our operations in Europe suffered disproportionately from the consultant turnover, and that has obviously been quite destructive to the business. So as one would expect, almost half of our new recruits are in the European region. But there is almost always a 12 to 18 month period for new hires to hit their stride. This is the time necessary for even experienced consultant to adapt new people, a new environment, and a new way of doing things.

The other major issue we've faced in Europe is it's just more difficult to address individual performance issues. This is the result of relatively inflexible work rules in many of the locations in which we operate. We are addressing this by focusing our leaders on the underperformers. The idea is to improve their performance through training, mentoring and coaching, and we've already begun to see positive results from this effort.

Finally evaluating the leadership to ensure we have the right leaders in place to maximize performance in this region. And now I'll hand it over to Julie to go over the numbers.

Thanks, Kevin. Starting on slide three, net revenue came in slightly ahead of expectations at $126.1 million, up 21.8% compared to last year's third quarter and same as the second quarter. The Americas and Asia-Pacific had great quarters.

From a practice perspective, the education and social enterprise practice up 42% year over year, financial services increased 38%, global technology and services was up 22%, and the industrial practice grew 21%. As you saw in our release, net revenue from leadership consulting services increased 33% year-over-over and 20% sequentially, representing 7.8% total net revenue in the quarter. These results continue to validate our strategy to become a leadership advisory firm.

Slide four is a view of our monthly confirmations, or signed contracts for executive search and leadership consulting projects. Monthly confirmations in 2010 continuing track ahead of 2009 levels, up 19% year to date compared to 2009, and have been ahead of our forecast this year. As Kevin mentioned, October was a good month, and we're very close to surpassing 2008 levels, something we've been looking forward to for a long time.

Slide five is a look at quarterly confirmation trends specific to executive search. Third quarter confirmations were 3% higher than last year's third quarter but were 6% lower than second quarter.

If you turn to slide six, we ended the quarter with 343 consultants, down 22 compared to September 30, 2009, and flat sequentially compared to June 30. During the third quarter, 21 consultants left the firm, but 21 consultants joined the firm. 17 of these 21 hires are experienced in search or leadership consulting, and four were new to search. We've hired eight consultants who started in October or haven't even started yet.

Looking at slide seven, productivity, which we define as analyzed net revenue divided by average number of consultants during the quarter, improved to $1.5 million in the third quarter, compared to $1.1 million in last year's third quarter and $1.4 million in the second quarter. In fact, the Americas and Asia-Pacific region both achieved record levels of productivity in the quarter. Given the number of new hires we made to date, we are pleased with the gains, and yes, we believe there is still room to improve these numbers.

On slide eight, the average revenue per search improved again. For the 12 months ended September 30, the average revenue per search $106,500, an improvement compared to 2Q when it was $102,300.

Turning to slides nine and ten. Salaries and employ benefit expense increased by $21.1 million or 29.5% year over year. This increase reflects higher performance-related variable compensation, which increased $17.9 million compared to last year's third quarter. A majority of this increase as a result of higher bonus accruals related to higher net revenue and the mix of consultants who are generating that revenue. But as Kevin referred to early, the increase also reflects approximately $5 million in the quarter related to a variable component we added to the consultant's compensation in order to be more competitive in the market. The full year impact of this compensation component is approximately $8 million, so in the fourth quarter the expense will be about $2 million.

Fixed compensation, which includes fixed salaries and employee benefits as well as stock-based compensation expense, increased $2.3 million year over year. An increase in the cash component of $5 million relates to our restoration of the 5% salary reduction in place in 2009, a 6% increase in worldwide head count, and incentive awards issued in the second quarter. This increase was partially offset by year-over-over decline in stock-base compensation of $2.7 million, reflecting an increase in RSU forfeitures specific to the third quarter and a reduction in the RSUs granted in 2009 and 2010 compared to prior years, when a portion of consultants' bonuses was paid in the form of RSU.

Now turning to slide 11. General and administrative expenses increased $3.9 million or 13.6% from last year's third quarter. A number of expenses that we anticipated would start to drop off in the third quarter did that. For example, there was a $1.3 million decline in professional service fees related to Project Velocity, which is the process improvement project we have talked about for the last 15 months or so that was essentially completed in the third quarter. And premise-related costs and depreciation declined $1.9 million year over year as a result of favorable lease renewals and lease terminations.

However, there were other expenses in the third quarter, such as valuable training and development initiatives that we reinstated. Another year-over-over increase relates to the uncapitalized costs related to Project Latitude, which is our new search engine. Latitude will be both a competitive advantage and a significant productivity enhancement. It is a relationship manager, an information resource, and a very much improved search tool all in one very efficient application. But I'll let Scott talk about our expected cost savings going forward.

Moving to slide 12, I'll explain the restructuring charges. Of the $920,000 reported, we recorded reconstructing charges of $600,000 in the quarter related to restructuring of our global IT services delivery model. In September we began outsourcing the IT infrastructure in order to further reduce our overall cost and improve operational efficiencies. The other $300,000 of this charge represent additional charges related to two -- to our estimated remaining lease obligation on two previously restructured properties.

Turning to slide 13 and 14. Operating income in the quarter was $3.2 million, and the operating margin was 3.5%. Excluding restructuring charges, the operating margin would have been 4.2%.

Now if you look at the income statement for the nine-month period, or slide 15, there were a number of unusual items that I thought I'd review again quickly. Recall in the first quarter that we recorded other charges of $4.2 million. $3.2 million of the other charges related to our settlement of lease obligations for our former London office location, which was vacated in early 2010, and the other $1 million due to an unfavorable judgment in a lawsuit filed by a former European employee who left the firm in 2006.

Moving down, restructuring and impairment charges of $1.6 million for first nine months reflect the $920,000 I discussed earlier, plus about $700,000 of restructuring charges taken in 2Q that related to a subtenant who defaulted on a sublease on a previously restructured property.

And then moving down to other operating income of $1.1 million recorded in the second quarter. This reflects a fair value assessment of the potential future earn out payments under the purchase agreement for an acquisition we made in 2009 in Eastern Europe. The assessment indicated that there would not be any future earn out payments, and this resulted in $1.1 million adjustment.

So if we were to exclude these unusual items, our year-to-date operating income would have been $13 million for the first nine months, and the operating margin 3.5%. And now I'll turn the call over to you, Scott.

Thank you, Julie.

In looking at the third quarter numbers, I think there are probably three things which stand out. Salaries and benefits grew faster than revenue, G&A up $3.9 million compared to third quarter 2009, and the third quarter effective tax rate is unusually high.

Tackling these in order, Kevin already mentioned that in order to maintain our competitiveness in the market, we booked an additional $5 million in consultants' variable compensation expense in the third quarter. Absent this, salaries and benefits would have grown in line with revenue growth. It is worth notes that on a year-over-over basis we are still seeing the impact of the restoration of the 5% 2009 salary reductions and the 401(k) match, which was eliminated in 2009.

The G&A increase is more difficult to explain because it is not just one thing, and there are a number of items moving in both directions. First the promised reductions from Project Velocity and real estate are there. $1.3 million quarter over quarter improve from Velocity and $1.9 million improve from reduced real estate expense.

Kevin already mentioned the large vestment we made in training and development programs at Harvard, Duke, and also the Project Aspire. Taken together, these amounted to approximately $2.5 million of year-over-year increase in expense. Project Latitude, the new search system, accounted for $1.5 million in additional spend in the quarter. This system will begin to roll out in the first quarter of 2011. Unusual legal fees and tax planning activities together accounted for another $1 million in spend in the quarter. Finally, bad debt expense up $400,000. These are larger numbers which comp for the increase.

As for the tax rate, early in the third quarter we engaged an outside advisor to do a thorough assessment of the tax function and processes. In the course of their review, they raised a question about the mechanics of calculating the quarterly effective tax rate. Although we have been using the same methodology since 2005, we concluded they were right. So in the third quarter we changed this calculation and recorded accumulative adjustment for the impact of the entire nine months of 2010, or about $2 million in taxes in the quarter. Ironically this change will result in an offsetting decrease in the fourth quarter tax rate. Our full year effective tax rate is unchanged.

We still estimate the full year effective tax rate to be between 48% and 55%. As we discussed last quarter, the relatively high rate is very much influenced by the unbenefited losses in several foreign jurisdictions, mostly in Europe, by the non-deductibility of some of the costs associated with vacating our former London office. Our long-term goal still remains an effective tax rate of approximately 40%. Now if you took out the change in methodology in the third quarter, the effective tax rate would have been approximately 40%. And the impact on EPS is significant. Without the change in methodology in the taxes, the EPS would have been $0.18 rather than the $0.07 that we reported.

Cash provided by operating activities in the third quarter was $31.4 million, compared to $12.1 million in the third quarter of 2009 and $23.7 million in the second quarter. We ended the quarter with $122.8 million in cash and cash equivalents, up from $92.6 million at the end of June and $75.3 million at the end of last year's third quarter. Accrued bonuses at the end of the third quarter were $86 million, the majority of which we expect to pay in March of 2011.

We expect positive operating cash flow in the fourth quarter and are projecting 2010 free cash flow between $17 million and $23 million. Free cash flow is net of accrued bonuses and capital expenditures. As I mentioned previously, capital expenditures this year have been unusually high, $23 million to $25 million, because of the fit-outs of new offices. Going forward we expect capital expenditures to return to their historical levels of 2% to 3% of revenue.

We ended the quarter with $121 million in accounts receivable. This is high for us, representing a DSO of 77 days. Bringing this down will be a focus in the fourth quarter. I'll remind everyone we pay bonuses to our consultants on collected, not invoiced, revenue, so every incentive to get the cash in. We have analyzed this carefully and concluded this does not represent a bad debt issue. People have been a bit distracted by the changes we've made to our internal processes. We completed the conversion to a single global financial system in September, so things are starting to get back to normal.

Looking forward, we believe our fourth quarter revenue will be between $120 million and $128 million. You can see on slide 20 that monthly confirmations have continued to be strong through October. Given third quarter results and our expectations for the fourth quarter, we are increasing the forecast of 2010 net revenue to $486 million to $494 million. We expect fourth quarter to again be led by Asia-Pacific and the Americas geographically, and by leadership consulting and the industrial practices globally.

Turning to slide 22, we are estimating a fourth quarter operating margin of 8% to 11%. Obviously whether we hit the high or low end will largely be determined by whether we hit the low or high end of fourth quarter expected revenue. We are maintaining full year operating guidance of 3% to 5%.

There are a number of factors going to contribute to a fourth quarter margin that is significantly higher than the third quarter margin. We have talked about this a couple of times, but third quarter was impacted by $5 million in additional variable compensation, added to be more competitive in the marketplace. For this compensation component, the impact to fourth quarter will be about $2 million, a $3 million improvement quarter over quarter.

Third quarter included $1 million in severance that we don't expect to repeat, and we have a seasonal decline in payroll expenses of about $500,000. We will realize additional benefit from the completion of Project Velocity, with $1 million of savings in the fourth quarter compared to the third quarter. We have fewer training and development programs scheduled for the fourth quarter. This will yield $400,000 of bottom line benefit. Finally, as we collect receivables in the run up to year end, we expect lower accounts receivable balances to help us reduce impact to bad debt.

One other note on real estate. Our year-to-date savings on real estate costs and depreciation is $3.3 million compared to the same period of 2009, and we expect that number to continue to improve.

And with that I'll throw it back to you, Kevin.

Thanks, Scott.

I'd like to spend a few minutes addressing one of our industry practice groups that extremely important to all of us, financial services. 34% of our revenue in the third quarter and 33% for the first nine months. We've made an excellent recovery from 2009, and for the first nine months it grew 61% compared to the same period of 2009. Heidrick & Struggles is known for expertise in this sector, and we are clearly the market leader. We have lots of clients who rely on the strength of the global network.

Some of you have voiced concerns about a falloff in recruiting in this sector over the next coming quarters. Due to regulatory controls related to risk management, capital adequacy, compensation and financial services sector, our clients are going through some secular transformations, but doesn't mean there will not be recruiting. It means that our clients will have different needs and recruiting in different areas. We are very well positioned to benefit either because of our strength in geographies, like Asia-Pacific or Russia or Latin America, and because of our product specialization in these areas that are interesting to banks as they adjust business models.

Examples include helping an Indian bank go global, a regional bank in Asia go global, a European bank go super-regional, and a mid-market US bank go global as well. We are also doing more with to worth with standalone advisory investment banking boutiques and with hedge funds more so than we have done in some time. And the positions range from senior management for these entities to bankers, sales people and traders across products and geographies.

I'd also like to remind you that this is something more than just a flat quarter compared to the third quarter in financial services, just because inherently there is seasonality. Our clients tend not to hire as many in the fourth quarter because that will dilute the bonus pool year end, and they'd get little return on their investments. I'd like to end the call as I did in July with Heidrick & Struggles commitment to the core values that make our brand synonymous with best in class, including client service, people, integrity, teamwork and respect. And I'd also like to thank our employees listening to the call for commitment and hard work, and I'd like to thank our investors and analysts for their continued support. And at this point we'd be happy to take any questions you may have. Thank you very much..

(Operator Instructions). And our first question comes from Tim McHugh. Your line is open.

Yes, can you give us a little more color on the additional bonus expense in the quarter? Was that -- just to be clear, was that a one-time retention type payment, was it some type of employment agreement, or was this a structural increase in the overall compensation level you're going -- you're gone to pay forward to consultants?

It probably is more of the latter. I mean, we have been monitoring the market, we've been monitoring what's been happening with our employee base and receiving a lot of feedback on that. And it was clear that in a certain area we were just not being competitive, and we decided that we would fund that. And it is within the context of the plan that exists, but it will be an ongoing expense. It's not a one-time thing.

Okay. So going from $5 million in Q3 to $2 million. Was the $5 million just catching up for the first part of the year?

Yes, it's $8 million for the year that we added for the year.

Okay.

And then we caught up through the first three quarters. So $5 million through the first three quarters and the remainder in the fourth quarter. And then we would expect similar amounts going forward.

You said that was with a particular sector or certain area? Can you elaborate on what area that is?

No, it was consultant compensation, okay? It related to our revenue producing consultants, but it was across the board there.

Okay. And then as you've -- you said you felt you were below market. Is the change designed to bring you in line with the market at a premium to try and recruit people? Were you --

Neither. Defining market in our industry is very difficult given that several of our competitors -- in fact, most of our competitors are private and are probably as guarded about compensation as we are in disclosing it to the marketplace. We felt, in fact, that we were competitive. We felt, in fact, that we have one of the best compensation packages in the entire industry. But given some of the recent feedback we've been getting, it was clear that people were focusing on certain aspect of it here, and that we needed to address that going forward. So I'm not sure -- and I don't think anybody can tell you whether or not this puts us at a premium or below. I think in general, though, we are pretty comfortable that we were and we remain competitive here, but we just wanted to take an issue off the table and not talk about it any more with our consultants, and so we did that.

Okay. And then one last would be the SG&A expenses. I think we talked before, you thought, given the -- you thought expenses would fall off quite a bit in the second half of the year, and then we'd be at a lower rate in 2011 than 2010. Without giving specific guidance, can you update us on kind of your thoughts on that, given the -- are the upticks in training and development type of costs going to offset the savings kind of permanently going forward such that we should expect SG&As to be more flat than necessarily down going forward? Or would you still expect SG&A to trend down from where we saw it in the first half of year and then in Q3 as well?

I still stand by the statements we made previously that we are bringing G&A down, and we are doing it over a period of time. The work we're doing, which has been completed now, in Velocity, the work we're doing in real estate, all of which are contributing to that. I think also contributing to it, which is a side benefit of Velocity, is much more insight into our business and much more timely reporting, which is allowing us to really stay on top of the expenses on a going forward basis.

This has been a strange year -- 2010, that is -- in that we've introduced a lot of change here. We've changed the way people do a lot of their day-to-day activities. Things like invoicing, things -- management reporting and stuff, and that was part of Velocity. We've introduced some changes in the compensation system, which I think were designed to tie people much more to the Firm as opposed to the individual. We've changed offices, we've put new technology in front of people, we've been rolling out a series of things in IT and making changes there.

And what you are seeing in that period of high change is a lot of effort has been put into training, into development, into connecting people with our strategy, and that's been seen in G&A. That general category is what has kept it from declining the way we would have thought. That's not an ongoing thing. We return in 2011, I hope, to a much more normal environment where these changes are behind us and people are used to it. And we get into a normal rhythm of things and expect to see the declines then -- well, we are begin to see them in the fourth quarter -- and that to carry through into next quarter.

Okay, thank you.

And our next question comes from Kelly Flynn. Your line is open.

Thanks. First couple of questions are actually follow-ups to the last one. Just on the G&A sequentially in Q4, you laid out all those items that are going to be different in Q4 versus Q3 that would explain the higher margin. I just want to be clear. Which will show up in G&A? Severance?

Let me go back to the list here.

I think you've got -- I mean, you've got $5 million in comp.

Well, comp will not.

Right.

The severance, it depends where it has, but I think largely not. Most of the severance was in comp. Payroll expenses will be in comp. Now the Velocity stuff is going to show up in G&A. The training and development will show up in G&A. Real estate shows up in G&A. So those are the big ones that fall into the G&A line.

Okay. So I wanted to go back to the Velocity stuff. You said basically you have $1.3 million in savings in Velocity?

$1.3 million in Q3, and then an additional $1 million in Q4.

So it will be an incremental million in Q4?

Yes.

And the $1.9 million that you mentioned. Was that real estate?

That's real estate, and again that's Q3. And then that will continue on into Q4 and probably increase a bit, because we continue to streamline our footprint, reduce our real estate footprint.

So is it $1 million or $2 million lower, the G&A, you think, in the fourth quarter?

I really haven't looked at that, but yes, $1 million, $1.5 million. Yes, it's probably more like $2 million. Yes, $2 million, maybe a little higher than $2 million.

Okay, great. And then also just a follow-up just on the variable comp. First of all, could you talk a little bit just qualitatively about how this works? What are you doing there? If they perform well, they're getting more? I mean, is it across the board? I mean, can you -- I know for competitive reasons you don't --

Yes, I hate to be mysterious about this, and I really do apologize to everybody. We try to be a little circumspect with our comp plans, simply because everybody is doing to us what we do to them. Which is when you hire a new person you talk to them. You always try to figure out what the other players are paying and how, because that's the only intelligence you have out there, because people tend to be -- most of them tend to be private.

This particular issue really relates more to clarity than anything else. One of the things that we have promised our consultant population is that we would provide them as much clarity in what they're going to be paid as we can. In this issue was an issue of -- it was a discretionary issue, and we decided in the interest of clarity we just wanted to take it off the table and fund it and make it clear it to people that this amount was there, and it is not something they had to wait until year end and guess whether it was going to be there or not be there. And so it was a matter of just making things a little clearer to our consultant population and giving them more certainty around what they are looking at.

Now in general the comp plan for consultants -- now I'm talking consultants, because it is very different for support people here -- but for consultants is based largely on their production and the amount of money they bring in the door. Although there is a fairly large component of it which is related to a complete assessment of, broadly, speaking Firm behaviors; mentoring, team building, development of business, that sort of thing. But by and large it still relates back to their personal production modified by, as I said the behaviors we talked about and modified by firm performance at the end of the day. So it is relatively straight forward.

This one piece was just an added distraction, because it was a piece where a decision would be made typically at the end of the year. People were asking questions about it. We went back and said, given everything else here and the way the plan is structured, it didn't make any sense to have those questions still out there, so we just funded it and said it's done, take that off the table, we don't have to talk about that any more.

Okay. And then related to the same topic, variable comp, and think you said in answering the last question that you thought it was going to be similar levels in fiscal 2011? Does that mean similar levels meaning $8 million?

For this particular piece, yes, although it will flex a little bit depending on just the number of consultants who are there. Largely speaking it will be the same level going forward, because this piece was a very -- was a discretionary piece and wasn't necessarily s closely tied to production as the rest of it. We just wanted, as I said, in the interest of providing more certainty and clarity to the consultant population, we wanted to take the issue off the table. At the end of the year we would have made the decision to fund it anyhow. We just decided to take it off the table in the third quarter and get the noise out of the system.

Okay. Do you think you'll get leverage on the salary and benefits line in fiscal 2011?

Leverage? We should, because it relates back to productivity, and we've done really well in 2010 in consultant productivity. We've reached levels which are consistent with 2008. Our goals are higher than that. This is something Kevin has mentioned repeatedly, and it's very -- and the reason he mentions it repeatedly is it is very important to Kevin, and it's a key driver here that we continue to improve our productivity. So our plans going forward are to continue to drive that number up. We've publicly said we that we are aiming for a number that is up around $2 million ultimately. We're at $1.5 million right now, and we'd expect to find some station in between next year and that continued improvement, which is a long-winded way of saying that, yes, we expect leverage on that compensation line.

But -- I mean, conceptually, if the economy is getting better, wouldn't it seem like your competitors will get even more aggressive about recruiting your people and paying them more? Why wouldn't you continue to have to increase your comp as a percentage?

Well, there's two sides to this. There's our side, and it's something which we haven't enjoyed, that's for certain. But I think we've discovered two things. One, that we have an incredibly strong bench and probably do -- my opinion, our opinion -- the best job in the industry developing people internally. We'll continue to focus on doing that. The other side of this is that the people going away -- I mean, this is an economic decision, and in many cases we've looked at it and decided this doesn't make sense economically. Well, unless the people recruiting on the other side have unlimited pocketbooks, eventually they reach a point it impact them as well. So you have to look at the balance on this. This looks -- my -- and again take this is my opinion -- but it looks to be a one-time run on the bank here, and the other side is going to run out of steam here if they're not already running out of steam, because it is just very costly to do this.

I mean, Kevin mentioned earlier in his remarks that we focus our hiring activity on boutiques and on consulting companies and on the industry. And although we've done a couple of hires on the tier one firms, we tend to shy away from it. They are a very expensive proposition. They require multi-years guarantees, huge upfront signing bonuses. There's a lot of risk you take on board when you do that, and we have consciously and very -- with a lot of focus this year, not followed that path.

What's happening to us are people are hiring tier one people, and they are seeing and we watching them go with large multi-year guarantees, with large sign-on bonuses, with all of the things which we are trying to avoid because we know from our experience it has a large impact on your bottom line eventually, and it really has other impacts. It destabilizes the rest of your consultant population. Why is Joe getting a guarantee, and I'm not. It causes a lot of disruption internally, and so eventually -- it's not a one-way street and eventually it has got to reach a balance here, and I think that balance is going to come fairly quickly.

Okay, just one last quick question. What's the bottom line on what tax rate we should be using in the fourth quarter? I mean there probably isn't one, but is it 38%?

Well, it's probably, if fourth quarter runs similar to third quarter, it's probably going to be around 20%. If we normalize it -- if we normalize this quarter, it would have been about 40%. People are pointing at numbers at me. Here I'm trying to do math in my head, and they're doing very scientific about this, which is why they get frustrated with me. It looks like the fourth quarter forecast is somewhere around just south of 40%.

Sorry, the 48% to 55% you're saying for the full year, does that assume the higher tax rate in the third quarter?

Yes, it does.

Okay, we can figure it out from that. Thank you.

The next question comes from Tobey Sommer. Your line is open.

Thanks. Quick follow-up on the tax rate. So the tax rate guidance assumes the GAAP tax rate in the proceeding -- in the previous three quarters, or does it assume some pro forma rate?

No, it's GAAP. Just reported.

Okay. Question for you. Broadly speaking, we've had shifts in compensation. Earlier questioners have gone through those. Could you update us on your view for margin potential in the expansionary economic period for the Firm?

Yes, we've talked about this before, and I think we generally stick to the same thought process. And that is, as we start moving into the mid $500 million roughly speaking in revenue that we start getting into the double digit range. And I've said that on previous calls, and I think the numbers are still the same. That we would start targeting moving into the double digit operating income margin range as we move into the around $550 million type of revenue.

Is there any way you could be more specific than a double digit range? Because that's a 10 percentage point range there.

Yes, well, I think one could guess the lower end of double digits as we get into the mid $500 million and then ramping up from there. We will be much more specific when we do year-end. We are in the midst right now of completing our annual operating plan for 2011, and that's why we haven't mentioned anything about 2011 right now. But when we come forward and talk about 2011, I think we'll be much more specific about margins and what we think going forward. But to clarify my comment, when I said getting the double digits, getting that 10% to 11% range.

Okay. And then curious about Europe, where the margins are a little lower now, and that's influencing also I guess the tax rate. These hires that you've on-boarded in the recent quarter and in October appear to be skewed a little bit to address some of that European attrition. Is there an expectation that margins will improve headed out of this year into next year, and would that influence the tax rate for next year? Thanks.

Yes and yes. We definitely expect marginals in Europe to improve as both -- just the general business atmosphere there improves, but also as we address some of the hiring and departures over there. The issue -- and we have mentioned this before. In the United States, it's this one huge market, 50% of our business, and if somebody leaves in San Francisco or Dallas or something, it's easy to cover out of New York or Chicago. That's not the case in Europe. If somebody leaves in one of the smaller countries, it will be difficult for somebody out of London to cover or France to cover because of language and culture and stuff. So it is a different mosaic to manage. And we've been filling in those gaps, and the hiring has been designed to fill in the gaps and get the thing back on track.

And it's those smaller countries that we've lost then have thrown off the losses, which have caused the tax issue. So we should address both of those issues going forward next year, and should see margins recover in Europe as well as that will have an impact on the tax rate as well as we move toward our target of 40%. In addition to that, we are undertaking or have been undertaking for the past several months here a series of tax-planning activities, which are also expected to be put in place over the next two or three years, which are aimed at getting us to roughly that 40% range.

Okay. Thank you, that was helpful. Is there incremental carry over of cost savings for Velocity in 2011?

Oh, yes. That's an ongoing thing. We have put targets out there, largely speaking from not -- from Velocity and a couple of associated projects around IT and like, we have stated before that we expect to get $10 million out of that, which is an ongoing annuity. And we are still hanging in there with that. We are making a lot of improvements around the Company in terms of all the G&A and overhead processes, and then still on track for roughly $10 million of ongoing improvements in real estate as well. Those have both been successful projects.

And I'll point out not just a cost reduction exercise. I can, with a fair amount of pride, say that the team here over the last two years has done an extraordinary job, and we have better insights into our business, provide better reporting to people, provide more timely reporting, have better mechanisms to manage the business than we've had in the past, and a lot of that is to do with Velocity and the changes we've made there.

So we're not just getting cost savings in that specific G&A area, but I also think it's allowing us to do a lot of things. And as an example, we were talking about productivity. It gives us much more insight into that issue of productivity, the levers you need to pull, and how we'll improve it going forward. So we are in a much better position just as a management team, but we're also going to have ongoing savings, and those are annuities. Those will go on forever. And we continue to look for improvements, in fact, in all those areas.

Okay, last question for me. Are there any incremental expense kind of reinstatements similar to the 401(k) match or something like that, or is that behind us in 2010? I'm just trying to get a sense of what identifiable operating margin improvement we could get with additional revenue in 2011 as a result of maybe not having more of these reinstated?

No, we should find -- we've had tough year-over-over comparisons this year in areas like fixed compensation and compensation in general because of the reinstatement of those items. Going into 2011 we do not have similar issues which come back . To my knowledge, no major changes planned to the benefit structure or the comp structure, so the year-over-over comparisons should be much more understandable between 2010 and 2011, and really we are talking now about something which I think tracks more directly revenue

Thank you very much.

And our next question comes from Mark Marcon. Your line is open.

Good morning. I wanted to stay on Tobey's line of questioning. First of all, with regards to Europe, how should we think about that for next year? How long will it take to get that to normal margins?

Mark, it's Kevin. I'll start with the new recruits. We invested and seen a lot of white space and areas over the course of the last six to nine months. As we evaluated the business, we looked at looked at some of the emerging markets, we looked at gaps we had in industry sectors, and we've done a lot of recruiting and we're still recruiting in those areas. And as I think Scott mentioned before, you have a 12 to 18 month gap, if you will, in which consultants take the time to get up to speed.

I think secondly, Europe has lagged a little going into the recession and has lagged come out. We mentioned earlier -- I think Julie mentioned earlier we've sequential growth and confirmations September, October now. Hopefully we'll see that trend continue. We've seen anecdotally business come in over the course of the last few weeks as well across all industry sectors, so we're pretty positive with Europe picking up going into next year, and would hope that with opportunities in Germany, with France continuing to pick up, with the UK coming back as well, that we'll see margins creeping up going into 2011.

What -- I mean, we're coming off of what appears -- it looks like you're kind of going to be at break-even for this year in Europe, assuming that there's an improvement in the fourth quarter. So I guess what I'm wondering are we thinking we could have a huge improvement? How do the -- because you did say that it takes 12-18 months for the people to ramp up. And a lot of them have come on.

So, to answer your question, I would say obviously we will continue to invest in Europe, and I would see an increase next year and a continued drive to get back up to the numbers we were before, which is mid to high teens before Corporate allocations in terms margins. Secondly, I would see that we'll continue to invest in recruiting there, and this will be an ongoing process. We'd like to get it back up to the end of revenue levels and margin levels in 2007 and 2008 and believe we can get there over the next couple of years.

Okay. So in a next couple of years --

At the same time, having -- I was going to say, at the same, having just spent time in Asia and in Europe, you also see a fundamental shift in terms of talent moving to the Asia-Pacific region, and so we have to get the balance right in terms of investing.

And then can you discuss financial services? Really appreciate the color, Kevin, you brought up at the beginning. How much of financial services are in the Americas and Europe in terms of that -- 34% of your total revenue is in financial services, and of that, how much of that is in Americas and Europe?

I would say -- it's interesting, Mark, because that's a challenging internally as well as probably externally. Because, for example, the large Indian bank we are working with now who is looking to expand globally. We have consultants working on that, and not only North America but Asia and Europe as well. And the way we allocate that revenue depends on where the individual is sitting. So right now roughly we have the bulk of our revenue based in North America, but simultaneously you see Asia-Pacific right now really getting a lot of headwind in terms of the revenue in financial services, as you see a lot of these international banks, particularly Japanese banks, Chinese, Korean, et cetera look to expand in the -- look to expand internationally.

So I guess the short version is when an Indian bank is expanding into North America, we account for that revenue there, not necessarily in Asia-Pacific. So the bulk had been in North America, but we see a fundamental shift of that revenue now move overseas.

All right. And, Kevin, I mean, given your experience in the sector, I mean, you read the same things that we all see. I guess the other way of asking the question is, of that 34%, how much do you think are in areas where you would think there's going to be -- there's potential challenges or have been signals things will slow down as opposed to areas still picking up? Or how would you think that growth for next year in financial services will proceed, assuming constant currencies?

Mark, it's an interesting year, because historically we've focused on investment banking and asset wealth management, et cetera. And you've seen a shift to not only helping boutiques that I mentioned, US-based boutiques expand internationally, but also the foreign, whether it's a Russian bank, Indian bank, et cetera, expand internationally. We've moved into a lot of different areas vis-a-vis financial services, particularly as it relates to the back office, infrastructure side of the business, which has been critical as well. So we all see and read the newspapers in terms of investment banking, but hasn't been the bulk of our recruiting this year. It's been more on the across the board, and we have a broad and wide portfolio when it comes to our financial services practice. And I think that trend will continue next year -- going into next year.

So you're saying financial services should grow next year?

At this point in time confident the financial services will continue to grow. You may see it fall off in one or two sectors, and maybe investment banking, if you will, given the activity that is happening out there -- the lack of activity, I should say -- will fall off a bit, but we'll see -- continue to see international expansion as well as build up in the infrastructure side.

Great. And can you discuss the turnover issues? It sounds like you made adjustments to the compensation plan. What's the feedback now. Should -- it would appear that turnover would slow down in the fourth quarter just because we're in front of bonus season for consultants as well as people in financial services. But then as we go into next year post bonus, is it your sense that morale is at a level that and things have been set so that we should see more normal attrition rates?

I would. If you look at the -- going back three or four years, we've been to 8% to 10%. This year we are a little higher, 14% to 15%. But, Mark, we're really focused on a performance-driven culture, and I personally -- and our leadership team, Scott, et cetera -- are comfortable with an attrition rate around 10%. A lot of that will be managed by us.

I think what you don't see -- and I'm out here. I'm in Asia right now. I was in Europe a few weeks ago. I've been in numerous offices -- is that we have a great group of people, and part of the investment that we made in Harvard and Duke is investing in training and development toward our leadership strategy -- leadership advisory strategy. And a piece that many don't see is that we have -- the competitive nature in all of us would love to go out and recruit from our competitors. In fact, I was in Europe, I got a call from one of our competitors who is poaching from us and said would you take ten of our consultants over to Heidrick & Struggles. Part of you says, yes, l would love to do that, but on the other hand, it's not good for us, it's not good for our consultants, and it's not good for our shareholders.

Sticking to our strategy and what's working historically of developing people internally while simultaneously making sure we get the best from consulting firms and boutiques is something that we're going to adhere to and we're sticking to, and we are proud of that. Simultaneously, we don't want to go out and add a number of consultants from our competitors because it would disrupt the culture we have spent so much time building.

Secondly, I would also add that we just brought a consultant who left four months ago back today, and we have a number of consultants who have left who say the grass isn't always greener, we'd love to come back. In some cases we are looking at bringing them back. In other cases it just isn't going to work, because Scott mentioned earlier, we have a great bench, a deep bench, and some of our best producers this year are principle consultants who stepped up and really taken the reins over from others who left the firm, and it wouldn't be fair to them. So one of the benefits of our Firm and our talent development program is we give opportunities to a number of people.

So I guess the long version is that we'll continue to execute our strategy and recruiting strategy and growing the business that way. We'll continue to look at gaps across the globe and leveraging our bench internally. We've moved a number of consultants to different geographies, which is something that great organizations do, and we aspire to be -- continue to be a great organization, and we'll continue to do that. So we are comfortable where we are. Yes, it's bad when you lose people and lose good colleagues. Yet we're going to continue driving toward our strategy of leadership advisory and bringing on great people and developing others.

Great. And on a very positive note, Asia-Pac exceeded prior peak revenue at this point, and growth there has been terrific. I was wondering if you could talk a little bit about how you're sitting from a capacity perspective in Asia-Pac, and how we should think about the growth prospects there or the challenges of managing that?

I would say the challenges would be for us recruiting. Recruiting again from -- it is a very disparate industry and fragmented industry. You have a lot of boutiques, and so we are looking at recruiting in certain industry sectors across places like India, like China, even here, Australia and Singapore, et cetera, to fill in industry gaps. So the biggest challenge we have is really adding leadership advisory consulting capacity, adding industry expertise. And we are in the process of recruiting out here. There is a lot of white space.

Simultaneously, it's -- and I just mentioned a few minutes ago, Mark, we're also looking at moving individuals from both Europe and North America to fill in the gaps and have them provide connectivity to help us with European companies expanding over here and American companies simultaneously able to handle gap in capacity in terms of these Asian companies expanding oversees is something top of mind, too.

We see -- you see it in the investment banking world. You mentioned investment banking earlier. You have a lot of investment banking firms moving senior executives to Asia right now to help with the expansion, and we're looking to do the same to keep up with the demand from clients. I mean, the biggest challenge I think we have is keeping up with the demand of our clients at the senior level end of the spectrum. So it is something that is I think near and dear to all of our hearts, making sure we get the right people on board, that we can grow with our clients, and we can also leverage Heidrick & Struggles global network and provide great expertise and service to them, both as these companies expand in Europe and North America as well.

Thanks for the color.

I'm conscientious of the time. It's been an hour, so, operator, we'll take one more call from the next caller, and if there is anyone else that didn't get queued up, feel free to call us after the call.

And our last is from Kelly Flynn. Your line is open.

Sorry to come on again, but just two quick ones. Can you talk a little bit about the other income? I mean, that's -- I think they're seasonality, but that's jumping around a lot? What do we expect for Q4 and even next year?

Other income, if I'm wrong, that was driven by the adjustment and earn out of the acquisition in Europe that we made. So it's more of an accounting artifact, and the answer is that it's jumping around because it's not predictable, and I don't expect there to be a lot of activity there going forward.

Kelly, are you looking at the nine months results? The line item called other operating income, or other net non-operating income?

Hold on. No, it's other non-operating. Non-operating.

Other net non-operating.

Okay. That's a different line. Okay. That's principally FX, right?

On intercompany loans.

Yes, so that's principally driven by foreign exchange variations, and your guess is as good as mine on what's going to happen to foreign exchange next year.

Okay. And then going back to the tax rate. I mean, if you use what you said in the press release, and you keep everything else GAAP for the first nine months, to me it turns out to 35% in the fourth quarter, but you said 20% in your remarks.

No, no. I was doing some -- I think 35% is closer to what it is. 35%, 38%, in there is what we are predicting.

Okay, great. Thanks a lot.

And, Kelly?

Yes?

There was -- the reason it jumped around in this second quarter that -- the other net non-operating income. I mean, it's usually pretty steady like this quarter, but representing gains and losses on cash and intercompany balances. But what you saw in the second quarter was $1.1 million in there that was unusual, that represented an accumulative adjustment for the accounting of our minority interests associated with our operations China. So that was definitely a special event to 2Q, but normally exchange gains and losses on intercompany balances.

Okay, great. Thank you.

Okay, operator, I think that's -- thank you very much. I think that's all the calls we'll take for now. Again, if anyone didn't get a chance to ask questions, we are around. Just give us a call.

Yes, either call Julie Creed or Scott Krenz or myself, and we'll continue the conversation.

And thank you for your time. Have a great day.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the conference, and you may now disconnect. Everyone, have a wonderful day.