Hudson Global Inc (HSON) 2004 Q4 法說會逐字稿

At this time I would like to welcome everyone to the Hudson Highland Group fourth-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) I will now turn the call over to Mr. David Kirby, Director of Investor Relations. Mr. Kirby, you may begin.

Good morning and welcome to the Hudson Highland Group earnings call for the fourth quarter of 2004. I'm David Kirby, Director of Investor Relations for Hudson Highland Group. Our call this morning will be led by Jon Chait, Chairman and Chief Executive Officer, and Rich Pehlke, Executive Vice President and Chief Financial Officer.

Before I begin I will read the Safe Harbor statement. Please be advised that except for historical information the statements made during the presentation constitute forward-looking statements under the applicable securities laws. Such forward-looking statements involve certain risks and uncertainties including statements regarding the Company's strategic direction, prospects and future results. Certain factors including factors outside of our control may cause actual results to differ materially from those contained in the forward-looking statements including economic and other conditions in the markets in which we operate; risks associated with acquisitions, competition, seasonality; and the other risks discussed in our filings made with the Securities and Exchange Commission.

I will now turn the call over to Jon Chait.

As has been our practice in the past, I will start our presentation by commenting on the trends and highlights of the quarter and then turn over to Rich to review the financial results in more detail. For purposes of my remarks, the profit level to which I refer generally is adjusted EBITDA as defined in the schedule to the press release which was distributed earlier today.

Our fourth-quarter operating results exceeded our guidance. While we didn't give specific guidance for the fourth quarter, we had indicated that full-year results might reach breakeven. In fact, we exceeded that result and reached profitability for the full year and a significant improvement over 2003.

Currency had an impact on all lines of our financial statements, but I want to draw your attention to the constant currency movements. In constant currency Q4 revenue increased 15 percent on a year-to-year basis, gross margin 18 percent and adjusted EBITDA reached 5.3 million compared to the 5.9 million reported. So on a bottom line basis currency had a relatively limited impact. In fact, comparing Q4 '04 to Q4 '03 in constant currency gross margin increased by over $18 million and EBITDA increased by $16 million reflecting very substantial leveraging of gross margin growth due to good expense management by our operating units.

Trends within the quarter were favorable. The group achieved a positive adjusted EBITDA in November, a 4-week month for our internal accounting purposes, followed by a strong performance in adjusted EBITDA in December, which is a 5-week month for our accounting purposes. But as many of you know, December included both the Thanksgiving and Christmas holidays. So it was a quarter that we thought had very positive aspects from a trend basis.

Operating leverage in Q4 was positive in all of our regions, meaning that the percentage of profitability increase was greater than the percentage of gross margin increase. Again, it's an indicator that expenses were well controlled by our operating management.

Highland Partners continued to benefit from the repositioning completed last year. Highland Partners recorded an adjusted EBITDA profit of nearly $1 million in Q4, 6 percent of revenues compared to a loss of nearly $2 million in the year ago quarter. Highland achieved profitability on essentially flat gross margin and a smaller number of partners. The North American, Canadian and Australian units continued to achieve excellent results in Highland Partners.

Looking at the trends as we look out to 2005 -- and Rich will discuss our guidance for 2005 in more detail -- revenue growth is being driven both secularly and cyclically in all of our operations. We see revenue and gross margin growth coming primarily from North America and Asia in 2005 with continued profitability in Australia, New Zealand and Highland Partners and with improving profitability in Hudson Europe.

In North America, as you may remember, we invested in new offices and headcount in 2003 and this paid off for us in 2004. We expect it to continue to pay off for us in 2005. 2004 the North American Hudson operations experienced strong profit growth in IT, legal and accounting and finance as well as engineering, aerospace and defense. Temp gross margins improved 160 basis points to 21.6 percent in 2004 reflecting both positive variance due to mix and improvement in underlying margins.

Similarly in Asia we experienced strong growth in the top line in 2004 and expect it to continue in 2005 and beyond. We expect to continue to leverage our gross margin growth in both markets.

With respect to our remaining markets, we expect to grow profitability in 2005 despite modest top line growth. Australia, New Zealand had significantly improved profits in 2004 and we expect steady profit growth in 2005. We also expect that Hudson Europe will provide good profit growth in 2005 as a result of modest growth in the UK economy, our largest market, as well as continued profit growth in continental Europe.

With that I'm going to turn it over to Rich to go through the financial statements in more detail.

Good morning, everyone. I'll touch briefly on the subjects I normally cover on the call; first I'll start with currency. Jon mentioned some of the constant currency changes; I'll give you the currency impact for both Q4 and for the full year. Currency impacted revenue a positive 6 percent for the quarter; gross margin 6.5 percent; it increased expenses by 5.9 percent and, as Jon indicated, virtually had no impact on adjusted EBITDA which is our normal pattern that we've experienced. For the full year the currency impact was 8.6 percent positive on revenue; 8.5 percent on gross margin; 6.7 percent increase in expenses resulting in a positive contribution to EBITDA of 1.4 million for the full year.

Jon touched on the fact that our operations are controlling our expenses very well. Our non salary related expenses declined 23 million year-over-year and that takes into account the impact of currency on those expenses so the true year-over-year impact was significantly higher in light of the fact our salary related expenses increased 9 percent reflecting the growth in the business as evidenced by our 17 percent growth in gross margins.

We have confidence that we can continue to control the rate of growth in expenses overall as we continue to see growth in the business. Our fourth quarter did experience a small increase and growth in the salary-related costs beyond our normal trends largely due to a very strong finish of the year, some new hires in North America and in other growing areas of the business as well as some severance related costs as we continue to shape our management team worldwide.

In addition, I'd like to highlight that one of the areas we've been concentrating on, occupancy declined 23 percent year-over-year. So our efforts in reshaping our real estate portfolio globally have been paying off.

I want to comment briefly also on the fact that of the restructuring charges over the last 2 years we have been talking about adjusted EBITDA because of the M&I and reorg expenses that we've incurred as we've continued to reshape this business. In the fourth quarter we did record 1 million for restructuring and $4 million in total for the full year. All of these costs relate to real estate related transactions. You may recall in the third quarter a good portion of that number was because of the Toronto move that we affected in Highland Partners and in the fourth quarter virtually all of the expenses came out of Europe as we continued to reflect estimates for properties that we've exited or have sublet and finished deals on relative to the subleases of excess property.

We do not expect more charges in the restructuring lines as we go forward in the future. The only adjustments we would make to that line are to true up any estimates as we realize either subleases or related transactions to things that we've already booked. It's our expectation that any future changes in our operating portfolio of real estate or of management will flow through the operating line and will de-emphasize the need for having to distinguish between adjusted EBITDA and EBITDA in the future.

I want to comment also about another line in our expense -- on our income statement, depreciation. With all our focus on adjusted EBITDA we constantly get questions about our level of depreciation as people flow down to net income. Our depreciation has run much higher than normal CapEx levels for our Company over the past 2 years. This has been a result of accelerated depreciation on assets on our balance sheet related to the spin in 2003.

In '05 we expect the depreciation level to drop from the $20 million level that we reported today to about 17 million. This is due to some accelerated depreciation in Australia which will cause as a result of our move from Angel Place to new property in midyear and that will cause our run rate in depreciation to be about $1 million higher in the first two quarters of next year versus the final two quarters of the year.

We will continue to see the trend in depreciation go down in future years. I don't expect a significant change in our CapEx numbers. We still look for about a $10 to $12 million run rate in CapEx per year with an average useful life of our assets is about 3 to 4 years. So we continue to see depreciation expense move downward as we go forward.

Our tax line, we continue not to record high tax expense. We have estimated tax loss carry forwards and we currently estimate a gross value of about $335 million with an estimated deferred tax asset consequence of about $116 million. The predominant balance of that is in the U.S., the UK and Europe as well as Australia, and we expect that those loss carryovers will help us in the future with our cash flow as we continue to become profitable across our regions.

Our cash balance finished the year at $21 million, slightly lower than we expected at the end of the third quarter. The quality of our accounts receivable is excellent, bad debt expense has virtually not been a factor in our Company in 2004. We did experience some deterioration our working capital trends in Europe and we're addressing these as our DSO increased slightly there and that contributed to our slightly lower cash balance.

But I also will point out the strong growth in our business did have some impact as well. We were able to fund -- and it speaks to the quality of our balance sheet that we were able to fund a $49 million increase in our accounts receivable and only a $23 million increase in our accruals and still have minimal impact on the cash line. I think that speaks to the strength of our balance sheet and the effect of our working capital management and our treasury management worldwide.

Our guidance -- our long-term goal, as Jon and I have stated repeatedly, is to achieve sustainable EBITDA margins of about 7 to 10 percent. We believe we will continue to progress ratably toward that goal over the next 2 years. We've indicated in our release today that we expect to achieve EBITDA margins of about 1.5 to 2 percent in '05 and increase again to the 3.5 to 4 percent range in '06.

We also spoke about the trends for the first quarter, the guidance of the first quarter of next year. We've said often that the first quarter of our fiscal year always tends to be our weakest. The reason for this is our high concentration of permanent placement business which tends to be a lower in the early part of the year as well as seasonal holidays in our A-Pac region which tend also to be lower at this time of the year. And we have indicated that our EBITDA for the first quarter may not reach the breakeven level for Q1 '05.

I will point out that this is not a reflection of any change in trend within our operations. Our current operating trends, in fact, are consistent with our expectations. We are expecting considerable improvement in operating performance year-over-year at the end of Q1 and that's keeping in mind the fact that we reported an $11 million adjusted EBITDA loss in Q1 of '04.

The last thing I'll comment on is Sarbanes-Oxley. Hudson Highland expects to issue a report concluding the internal control over our financial reporting was effective as of December 31, 2004. Our external auditor is currently completing all their final testing at work, and to date no issue has been raised to management that would indicate that there would be any change in our report. We're very satisfied with the work that's been done across our Company to make this happen. We're pleased with the effort of our team and with the various resources we've put in place to help us reach this goal, a very important goal. And we're very pleased with the outcome.

And so with that I think Jon and I would be happy to take any questions.

(OPERATOR INSTRUCTIONS) Randy Mehl, Robert W. Baird.

I wanted to follow-up on some comments that you made about Europe, Jon. It seems like you were profitable in the quarter but you're still sort of teetering with breakeven levels. And I'm wondering what needs to happen for there to be a definitive positive trend toward profitability there? Are you still making moves operationally?

Let me take the question in two parts, Randy, and thank you. First of all, Europe from our standpoint is really two different markets. The UK, which is by far our largest market in Europe, has had a reasonable economic environment in which it operates and has been consistently profitable and is growing profitability. We expect it to continue to grow profitability in 2005.

In continental Europe the economies have been much more mixed, as I'm sure you know, and there's been much slower growth throughout continental Europe. That has been in effect a drag on our results in continental Europe. Nevertheless we achieved profitability in both Belgium and the Netherlands which are important markets for us. We have made some changes in terms of reducing our cost structure and we've made some management changes in some of our European markets. Those are reported within our fourth-quarter results. Those changes we think will be positive for the Company in the future, but obviously we took the charges in the fourth quarter.

I think our business in continental Europe is largely a permanent recruitment business. Again, as I think you know better than everybody, permanent recruitment is particularly a function of the economic environment and it's -- conventional wisdom indicates it's a middle cycle to late cycle mover in terms of the economy. So what has to happen in continental Europe is a better economy for us to do really, really well.

Having said all that, one of the things I said in my remarks was we expect our European operations to report better earnings results in 2005 and that does come from a cost reduction standpoint in particular. Our expectation in 2005 is even without an economic recovery in continental Europe we will report better bottom-line results.

The performance within the Americas and in Asia has been very good including in the fourth quarter. I'm wondering what kind of revenue growth assumption are you using when you look at those '05 and '06 EBITDA margin targets? I know they've been dependent on revenue levels.

When it comes to specific targets I'll turn it over to Rich because he likes to talk about those specific numbers.

We're not going to give specific revenue guidance, Randy. Specifically what we've done is to point our guidance towards operating margins because the revenue growth rates in our markets are different. Certainly we're expecting higher revenue growth by degree in North America than we are anywhere else in our regions with maybe the exception of Asia. And as Jon pointed out earlier, some of our other regions are going to be more productive in the more modest revenue growth assumptions.

And the point -- where we are in our history as a company still is making sure that we execute regardless of the stream of revenue that we have. I think we're going to be in a position to capture operating margin whether the growth is modest or better than modest. But certainly from the degree we expect stronger growth in North America versus other regions in the world.

But as I look at how you're leaving '04 and starting '05, it seems like certainly something north of 10 percent would be assumed for constant currency growth. Is that fair to say?

That would be your estimate wouldn't it? You're trying to get me to give you an estimate and I'm not going to give you one.

Okay. Then one final question. As it relates to the trends in January, you didn't speak to January I don't think. How did January start out?

I think I did kind of speak to it in that the fact that related to our first-quarter guidance we've seen nothing in our operating trends that we have not either expected or that would indicate that anything has changed materially as we carry forward into the new year.

Okay.

But keep in mind, our January tends to be lower in pure volume than most of the months in our year because of the fact of the seasonality and the geographic breakdown of our business.

Understood. Thank you very much. I appreciate that.

Ty Govatos, C.L. King.

I'm having a problem when I look at your SG&A next year. Can we assume it's going to run at the fourth-quarter rate? It seems like the fourth quarter was inflated by a couple of items.

Look at the fourth quarter in constant currency. Make sure you make the adjustment for currency.

So maybe closer to 125 million a quarter next year. Is there anything else that would boost that item up?

If you're talking total SG&A including payroll related costs. The one thing that should (multiple speakers), our expenses should grow at a rate lower than our revenue growth but it will move because of salary related costs. As our business grows we would expect that line of expense to grow up but not as much because it will be a combination if our business continues to grow of some new hires as well as increased commissions for existing people because we're a commission based organization. So there should be operating leverage on increases and gross margin, but if the expenses increases it should come in the area of salary and related, not in G&A.

There would be modest increases in G&A as we go forward, but they'll be offset by some things coming down. I expect professional services, for example, to come down because of Sarbanes-Oxley work tapering off. I expect continued -- the improvement in the occupancy to flow through as we go forward in the year. So some things will offset. So the G&A line should be -- will not be the driver of any increase. So I think your overall assumption isn't too far off.

Okay. And what did you tell Randy your revenue growth expectations are for next year?

Thank you, I told him to call you.

One more. You said CapEx of about 10 to 12 going forward?

That's correct.

Okay, that's what I needed.

And that's been about what we've had. I just wanted to help people rationalize the trend in depreciation because I know people have been trying to get the bottom-line numbers and we've had slightly higher depreciation in part because of the spin. Keep in mind, we made an acquisition this year that put some assets on the balance sheet that increased our depreciation with JMT as well as the fact that the counting for moving out of the Australian lease bumps our depreciation up a little bit in the first two quarters of next year.

Okay. Thanks an awful lot.

Kevin Steinke, William Blair and Co.

It's Matt Litfin. Really two questions. A quick one for you, Rich. What was the trend in North American temp gross margin excluding the lower margin engineering staffing piece of that?

Excluding the lower margin piece it's been solidly in the mid to high 20s.

And is that on an uptrend or a downtrend or how would you characterize the (multiple speakers)?

It's been an uptrend and that's been in the increase in accounting finance as well as an improvement in the IT business -- as well as our legal business which has been growing very dramatically.

One follow-up I just thought of on that. How much of the finance and accounting staffing strength in North America would you attribute to Sarbanes-Oxley and how do you view that over the next few quarters?

There's no question Sarbanes-Oxley related work has made a significant contribution to the business and maybe could be as much as around half of the increase in the accounting and finance business. But I think the good thing about the way our people have approached it is we've been approaching it more on a solutions base which is not as much project based. And I think a lot of our work has been the type that has some sustainability to it in terms of customer relationships. Having said that, we know our North American people have been very cautious not to overestimate the impact of Sarbanes-Oxley work in the coming year and we're making sure that it's not a reason for the business to not grow.

And then one for Jon if I might. What are you seeing on the people front, Jon, in terms of maybe employee turnover at the branch level as well as how you view where you are in the process of getting the right people in place at the manager level -- country manager even branch manager levels?

I think our turnover -- particularly looking at North America where turnover has been a problem over the last say 18 months -- turnover in '04 has improved the marketplace. We've cut our turnover and I think we're at a rate where I would say we're at a normalized rate. We actually -- in our business, as I think you know, Matt, some turnover is good because it's a performance driven business and so some turnover is good.

And I'd say we're actually in far better shape today than we have been in any time since the spin. So in terms of country managers, I think we're pretty much there. As I said, we've made some changes in Europe this year and changes in Europe are very expensive. So a single change in Europe is monumentally more expensive than a change anywhere else in almost any other place in the world. But I think we're where we need to be in terms of our country level management.

Great. Thank you.

David Cohen, Midwood Capital.

I know this is going to require some adjustment for currency which I didn't record all the details when you touched on it earlier. But if I look at sort of a sequential growth in revenue I come up with like $29 million and I look at a sequential growth in SG&A I come up with about $8.5 million. That's about 30 cents on the incremental revenue dollar that is absorbed by SG&A. Is that what we should expect or how should we be adjusting that? What's the contribution -- I'm trying to get at the contribution from the incremental revenue dollar?

I am not sure I totally followed all of your question, but I guess --.

Well, I'm just looking at Q3. Q3 did $315 million, Q4 344, so call it $30 million of increased revenue on a sequential basis, and your SG&A went up $8.5 million. So rounding, you have 30 cents on the incremental revenue dollar was absorbed by SG&A. Is that how we should think about the business going forward?

Well, I think I need to focus you more on the incremental gross margin as well as the incremental SG&A. I spoke to that a little bit in my comments, because I think if I take your sequential -- if I take a look at the sequential gross margin, I'm not sure exactly what the number was, but it probably was impacted a little bit by direct costs. We probably didn't have as much incremental leverage as we would have liked coming out of that growth fall to the bottom line. And I mentioned that in my comments because we did spike up in salary and related costs due to some increases in commissions, some new hires and some severance costs that Jon indicated relative to some country management that impacted the fourth quarter. I think you are focused on the right thing. And as we go forward, as the revenue and gross margin grows, we are looking for operating leverage to fall through on incremental dollars. And it could be safely within the 25 to 50 percent range that it wouldn't be out of line. Now, a lot of that will --.

I'm sorry, say that again, the 25 --.

25 to 50 percent range of incremental dollars, depending upon --.

-- incremental gross profit dollars?

Yes, depending upon how the business comes in. It depends on if it comes in through permanent placement, it depends upon if it comes through in temp.

Right, I was just sort of mentally keeping the mix constant.

Right, but in general, that is where we look for the operating leverage. So as we go forward and exactly what that percentage will be, we are not totally sure, but we are positioning ourselves to expect that that operating leverage should continue to happen, and that is what will drive up the operating margins. We continue to need to invest in the business. As the operations continue to improve, we will do that measurably so that we can control it, so that we deliver bottom-line results as well as continue to put ourselves in a position to grow.

If you did keep mix constant, what is sort of the weighted average commission dollar that your producers are getting on an incremental gross margin dollar?

It varies all over the world. It varies geographically as well as service --.

I mean, let's deal with averages, because for us to see how the business is going to ramp up and how much operating leverage we are going to get.

At the peak, for example, just to give you a magnitude of how much it can vary, just in commission dollars at the very peak of the highest earnings search partner, you might lose 50 percent to 55 percent. When you start talking about temp and permanent placement, it's probably lower than that.

I think Rich gave you a very meaningful number. I just draw your attention to David. He said if you take the incremental gross margin dollars, and he said 25 to 50 percent would fall to incremental EBITDA, I think you should think about that pretty carefully.

But that didn't happen if we look sequentially, Q3 you had --.

We told you that. And just another thing to bear in mind, our business, one of the things that we talk about quite a bit is year-on-year comparisons. So quarter-on-quarter, year-on-year. Our business is a little bit different from other people's in the industry, and that is that sequential growth. I mean, you can draw your own conclusions about anything you want, but just to tell you the facts. Sequential analysis is somewhat difficult, because there is a dramatic seasonality that runs through our business. So comparing Q3 to Q4 in our business is like an apple and an orange; they're both round but they are both different. Europe in Q3 is a pretty slow place, and if you look at Europe as a percentage of our gross margin, you can do the math faster than I can; it's a big number. So that is one issue.

The second issue is Q4, as much as we try to do everything on 4 ratable quarters, Q4 we end up truing up a lot of bonuses for the year, and that has an impact on our sequential analysis. So the way we look at the business is year-on-year because that gives you roughly, not entirely perfect, but roughly a fair comparison in terms of various growth rates. The third thing is sequentially you have to look at it in constant currency, because currency has a material impact, particularly if you want to pull out one line of the financial statement. It has a material impact on any particular line you look at, other than EBITDA.

Randy Mehl, Robert W. Baird.

I had a couple follow-ups here. One is, in the fourth-quarter you had another drop in -- or I shouldn't say another -- a drop in corporate cost that was quite significant. I am wondering what a realistic level is going forward?

I just want to make sure which number are you looking at, Randy?

Looking at the 7.5 million down from 8.5 million in the third quarter.

Right. I think as we go forward, that number is pretty close. It is probably going to be in that 7.5 to 8 range still, at least through '05.

Okay. In Asia-Pac, there was quite a bit of improvement in the fourth quarter. You had several quarters of constant currency declines, revenue declines, and that reversed in the fourth quarter and the profitability was very good. Just wondering was there a change? I think the environment has been pretty good there for a while now. Was there a change in the operating model?

Yes, there has been a big change in the operating model, in that it partially reflects the change in the accounting because of the restructuring of the real estate, as well as the productivity from some of the cost reductions and moves that they have made to their cost structure. So we are seeing increased productivity out of that region, as well as lower occupancy cost and the benefit of taking down some of the cost relative to the move, and the way the accounting for that flows through. But overall, I think it speaks to the efforts that they have made in a very constructive way to lower their operating cost and increase their marginal profitability.

Okay, so as you look at the Hudson Asia unit going forward, I mean it sounds like we should expect growth next year and margins to improve. Is that fair to say?

Just to make sure we have the vocabulary right, for reporting purposes we report on a unit called Asia-Pac. And sometimes when Rich and I talk, we talk internal vocabulary which is divided into A and Zed (ph) and Asia. They make up Asia-Pac. Looking at those two operations, A and Zed is growing at a tremendous year in terms of profitability growth on a relatively modest top-line growth in local currency. In Asia, which was a much smaller unit, but we had a tremendous year on both top-line growth and profitability growth. We would expect the trend in Asia to continue, continued good top-line growth, continued good profitability growth. In A and Zed, because we are seeing relatively modest top-line growth -- it is a very advanced economic cycle. Typical of advanced economic cycles, as I know you know, top-line growth is more modest. We are not going to get the explosive profitability growth that we had in '04, but we very much expect to see profitability growth, and my adjective was steady, in line with the market.

Okay, great. Thank you, I appreciate it.

Evan Steen with Eos.

A question that nobody has focused on, but you guys have talked about for a long time, and that is the long-term goal of 7 to 10 percent. Could you just give me some metrics on how you get there, whether it is leveraging the SG&A once you have it in place and having the revenue grow; whether it is perhaps a change in the mix between permanent placement as we move out over the next 3 years? I'm just trying to get your vision of how you get from where you are going to head to next year towards that long-term goal.

It's a combination of two things. One thing, the big part of that movement is as we grow our gross margin is to maintain our operating leverage, so that we grow our gross margin and we grow our EBITDA faster than we grow our expenses. So that was what Rich was talking about where he said we ought to be able to leverage 25 to 50 percent of gross margin growth down into EBITDA. If you play that out mathematically on either end of his range, you get there over a period of time. At the same time, we are continuing this kind of chip-away. For the last 18 months we have been chopping away at expenses, and we are at the point where there isn't anything to chop. So there are some chips that we can still chip away at in terms of expenses, and we continue to do that. We expect to see a little bit in '05, but not monumental amounts.

And I assume everything you are referring to is internal; there is no assumed acquisitions or anything like that?

Correct.

Another question I had was with regard to the balance sheet and cash, and I saw for this quarter this is the first time you took on a little bit of debt over the past quarter or two. Using what you've projected next year, obviously you'd be cash flow positive, but could you just speak about how that interplays with these accrued restructuring costs that are still fairly substantial on the balance sheet? I'm not sure what the timing of those is. Actually, obviously, the current ones are going to be done within the next 12 months and (indiscernible) ones will be longer. But I guess what I am asking is, simplistically a year out from now given what you projected, could you sort of give us a flavor for what you think the free cash flow after everything is, and that means taxes, growth in receivables, payment (indiscernible)?

I will let Rich deal with the specific numbers. I get to deal with the generality. One thing to bear in mind, in case your analysis -- I tell people this all the time. If your analysis is based on free cash flow, just bear in mind that temporary recruitment businesses tend to be consumers of cash as receivables build up in positive economic cycles. Now, temporary recruitment right now is only a third of our business or something like a third of our business, but our strategic goal is to increase that as a percentage of our business. As it increases, it will be a further call on cash. So that is the conceptual thing to keep in mind.

With that, I will let Rich talk about how the math might work.

A couple of things happened in the math here. Number 1, next year will still be a challenging year for us from a cash perspective because we do expect growth, and we do have to take care of some of the obligations that you pointed out. Next year is kind of the last year of the more heavy reorg payments that we have got pending from the pre-spin and post-spin related activities, which will actually be somewhere in the neighborhood of 7 to $8 million worth of cash payments over the course of the year, as well as our normal cash outflows which will include things like working capital, CapEx, etc.

So we also believe that the growth of the business over time will generate a fair amount of cash flow, albeit we tend to pay our people a little faster than we collect our receivables. So where Jon pointed to the fact that as we grow our business, the balance sheet dynamics get a little tricky, and we have to be on top of our game to manage it. That is one of the reasons we have the credit facility. The credit facility, as I have pointed out many times, gives us the flexibility to manage the spikes in working capital that on a monthly basis I can tell you can just about be equal to variations equal to our current cash balance. We will have days when in a single day, we would have VAT tax payments from the UK, commissions, payroll, all fall on the same day. It is the nature of the business, and it has to be managed in that way.

So we tend to have heavy outflows at the beginning of a quarter and we tend to build cash through the end of the quarter. That has been the continual pattern over the last two years. So I expect sitting here today that probably we would have a negative cash outflow year-over-year somewhere between 5 and $10 million as much, depending on the nature of the business and how the business progresses. I think we can more than manage that situation. I think the very fact, as I pointed out in my comments, of how we've managed the changes in our balance sheets as well as our current obligations, our receivables have never been healthier. We don't allow bad receivables to accumulate on our balance sheet.

We have improved our collection process and our credit policies globally. We are addressing our working capital issues in Europe, and I think we are going to make good progress on that in '05. So I have a high degree of confidence that it is all manageable, but it clearly will be a factor in '05, just because of the continued reorg payments.

David Cohen with Midwood Capital.

Just a quick question about what the provision for income taxes is representative of?

It is largely state; some country or federal tax payments and state tax payments related to income.

Okay. Do you not have NOLs to offset that?

Well, you don't always have NOLs in all places at all times, and especially not for state and some local taxes, no.

Okay, thanks.

We use the carryforwards whenever we can, believe me.

Mike Carney with Stephens.

Jumping back and forth, but congratulations on where you are at now from where you were. Just a couple questions. I think, Jon, did you say 21.6 temp gross margins?

In North America.

What was the total worldwide temp?

I will have to get it for you in a minute.

Total company was closer to about 17.9.

The reason I focused on North America is that -- and I know you know this, Mike -- strategically, it is the market we have said is critical to our growth strategy. It is a market where we are experiencing growth, and I wanted to reassure all of our investors that not only are we experiencing growth on the top line which was, I think, pretty spectacular for the quarter, we are seeing it in margins as well which demonstrates that we are growing in our high-margin businesses. As Rich mentioned, if you exclude our one lower margin business from that, I think we have a pretty attractive gross margin mix in North America.

The only other place -- well, the other two places that we do temporary contracting business is the UK and Australia. Both are good markets. Both, however, are markets in which temporary margins in general are lower. So that is why our -- if you look at our overall temp margin around 18 percent, slightly under 18 percent, it is less than our North American margin. We think the North American margin is particularly important for people to focus on, because that is the future of our business in terms of growth.

The other thing is, Rich, just trying to get an impact from SOX expense internally. And if I were to assume that you paid $3 million for Sarbanes-Oxley in 2004, is that cut in half in 2005, or what is the estimate there?

I think that could potentially be an accurate reflection of what could happen to those related costs. Keep in mind the one thing about Sarbanes-Oxley is that you have to keep it going. And one of the things we had to do in our company was establish the control environment that did not exist in many places. Now we have to institutionalize it in terms of making sure that the tests that you conduct are continual as you go forward in your business. I think that should be much less of a job than we had to do in '04, but there still will be work related to it. And so that is probably not a bad estimate in terms of what would happen there. I think we factored that into the comments that I made earlier about G&A.

Just finally on Highland Partners, the productivity there that you saw in the fourth quarter, is that continuing to be as strong as it has been? Was it higher? I'm trying to get a sense for the number of consultants.

It is marginally improving.

Continues to improve?

Yes, marginally.

They have done a very good job of -- we're not adding a lot to that business in terms of heads, but they've done a great job of raising their productivity and their profitability, and have done exactly what we have asked them to do.

Yes. I think Highland, as you can look from our data that we released today, Highland Europe which is really Highland UK has been the greatest struggle for us. And I think we feel pretty confident that '05 is going to be a better year for them. It is still a small business, but it is going to be a better year, and I think the productivity numbers will look much better.

Right. I have seen that the searches seem to be pretty high-quality lately. If you can get 4 or $5 million in EBITDA which is kind of the run rate from Highland Partners, is that good enough or are you looking to grow the business?

No. I would say that that is a very reasonable way to look at the business. We want to grow the business, but we are not anxious to add tremendous growth by adding lots of people. That is not our strategy. Our strategy is to have a very high-quality boutique business, and I think perhaps you have had a chance to talk to David and Rich. I think that the searches that we sign up match up with anybody's. The quality of the searches that we perform is excellent. Productivity in Australia and North America has been excellent. We are coming up now with some really significant improvements in the UK. But our strategy is to have it a nice profitable boutique business that provides leads for us, and we are seeing some success in that area in new client organizations.

Have you been able to -- has there been any cross-selling at all between Highland Partners and Hudson?

Yes, absolutely. Absolutely. So we are pretty happy with where Highland stands at this point.

The last thing is, Rich, on the release it says corporate and other. Does that include the Hudson developmental?

Yes.

Thank you.

Matt Litfin and Kevin Steinke with William Blair & Co.

I guess this is probably the longest Hudson Highland call I can remember, so I'll keep it quick. I was going to ask about the shareholder rights plan that was announced this morning. I guess it makes more sense when I realized just now that your tax yield is half of your market cap and that a profitable company might be interested in that. But just maybe perhaps you could just give us some of your own thoughts on why you implemented that and what the thinking was there?

Well, I think you have touched on one of the elements of it, but just overall I think it reflects the fact that management and the Board are confident in the future of the Company, and we want to make sure that as we go forward that all the proper governance things are in place; that our future gets decided by our management and our Board, and it's just that simple. And making sure that just because of circumstances either in our short tenure as a company or in the marketplace, that no one tries to take advantage of that. So it is a pretty basic step, and I think it is the right thing to do as both a director and as management.

Thanks, Rich.

Operator, we have time for one more question if there is one.

Actually, sir, we have no further questions of this time. I was going to give it back to you for closing remarks.

David?

Thank you for joining the Hudson Highland Group fourth-quarter earnings call. If there are any further questions, please feel free to contact Rich Pehlke or me, David Kirby, at any time. You can reach Rich at 212-351-7285, and you can reach me at 212-351-7216. This call has been recorded and will be available after 1 PM today by calling 1-800-642-1687, followed by the passcode 3355299. For calls outside the United States, please dial 1-706-645-9291, followed by the passcode 3355299. The call will remain archived for the next 7 days at those numbers, and it will be available on our website, HHGroup.com under the Investor Relations section. Thank you and have a great day.

Ladies and gentlemen, this does conclude today's Hudson Highland fourth-quarter earnings conference call. You may now disconnect.