Hudson Global Inc (HSON) 2005 Q4 法說會逐字稿

Good morning, my name is Whitney and I will be your conference operator. At this time, I'd like to welcome everyone to the Hudson Highland Group fourth quarter results conference call. On the call today we have Jon Chait, Chairman and CEO, Mary Jane Raymond, Executive Vice President and CFO, and David Kirby, Director of Investor Relations. [OPERATOR INSTRUCTIONS] Mr Kirby, you may begin your conference.

Thank you very much, operator. Good morning, everyone, and welcome to the Hudson Highland Group conference call for the fourth quarter of 2005.

Before we 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 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 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. These forward-looking statements speak only as of today. The Company assumes no obligation and expressly disclaims any obligation to review or confirm analyst's expectations or estimates, or to update any forward looking statements, whether as a result of new information, future events, or otherwise. With that, I will now turn the call over to Jon Chait.

Thank you very much, David. And thank you very much, ladies and gentlemen, for joining us today. As has been our custom on past calls, I'm going to begin with some comments on significant trends within our business. I will spend some time focusing on issues that we highlighted for your on our December call. I will then turn the call over to Mary Jane Raymond, our Executive Vice President and Chief Financial Officer, who will discuss the financial results and provide our guidance for 2006. After Mary Jane's comment, we will open the line for your questions. Before I start, I want to refer you to the press release and accompanying cables released yesterday, as well as our letter to shareholders that is available on the investor section of our website, www.hhgroup.com.

As many of you know, the fourth quarter is historically a strong period for companies in the recruitment history. As I'm sure you've seen by now in the press release that we issued yesterday afternoon, our own fourth quarter represented a solid performance for our Company, although some regional results were not as strong as we had initially expected. Importantly, though, HHGP reported increased profits and margins and we continue to make progress towards our goal of increasing our long-term profitability. While Mary Jane will go into more detail concerning our financial results, and particularly focus on the financial results for the fiscal year, let me note a few highlights for the fourth quarter. Consolidated revenue and gross margin both increased marginally in the quarter, while EBITDA increased much more substantially. That's a phenomenon that many of you have asked questions about over the last several quarters and I'm going to spend some time addressing in my remarks and throughout the rest of the conference.

Importantly, of the 8 million increase in constant currency gross margin during the quarter, 33% dropped to EBITDA. We call this operating leverage and this is one of the most important financial metrics, to our way of thinking, that you should think about in terms of analyzing our Company. The Company's target is to return 25 to 50% of the increased gross margin dollars to the EBITDA line. We were successful in the fourth quarter, since the leverage was 33%. Consolidated EBITDA in the quarter increased 45% on a reported basis and 54% in constant currency. EBITDA came in at 2% of revenue in the fourth quarter, compared to 1.4% for the same quarter in the prior year. The EBITDA margin is a key financial goal of our Company and we have continued to make progress there.

On a full year basis, EBITDA margin reached 2.1% and leverage, as I described earlier, reached 51% in constant currency. Although solid, fourth quarter EBITDA results were below our expectations. Our expectations for the fourth quarter were to be larger than the third quarter from an EBITDA standpoint. That's the normal seasonal pattern. In fact, normally, we would expect the fourth quarter EBITDA to be nearly equal to the second quarter. To explain this, I'd like to turn now to update you on the business issues and challenges that we highlighted in our December call. As we mentioned in that call, two regions reported EBITDA below expectations, Hudson, ANZ, or Australian and new Zealand, and Hudson North America. Let me turn first to Hudson ANZ. In Australia, we experienced a slowdown in the fourth quarter. In December we indicated that gross margin was down 1.6% through November in constant currency.

For the quarter gross margin decline 7%. The reason for the quarter's results were hiring freezes and slowing recruitment demand by large clients in the IT, telecom and financial services sector, in addition to fewer working days when compared to the prior year. The conditions in Australia and New Zealand are not unique to Hudson Highland Group. All competitors are also reporting the same trends. But we are more heavily weighted to Australia and New Zealand than any major international company in the industry. It is important to note that neither the macroeconomic data for Australia, nor our weekly internal data, are showing recessionary signals. Australia GDP is forecast by Westpac Bank, and a number of other economic forecasting models, to grow at 3% in 2006, up from 2.5% in 2005. However, variations in economic strength among the Australian states may have an impact on our business.

Western Australia and Queensland, two regions that are smaller markets for us, are expected to show the fastest growth because of their dependence in natural resources. While New South Wales and Victoria, our largest markets where most of our professional business lines predominate, are expected to show slower growth. Turning the New Zealand, the slowdown in the economy is more significant there and more pronounced. But the contribution to our business is smaller than in Australia. New Zealand represents approximately 25% of Hudson ANZ gross margin in 2005. In December, we reported that business conditions were slower due to the general economic uncertainty, partially attributable to the reaction to a recent election. Since then it's become clear that the general economy is certainly slowing. GDP growth, again forecasted by Westpac Bank, is forecasted at 1.2% in 2006, down from 2.4% last year and 4.4% in 2004.

Considering these factors, we anticipate softness in Australia and New Zealand continuing into 2006, but within the context of a growing economy. Our management team in Australia took actions to mitigate the impact of labor market conditions on EBITDA in the fourth quarter, without impairing the revenue-producing capacity of the business. We will continue to take actions to improve productivity and profitability in that market on a long-term basis. We will also continue to look for opportunities to offset permanent recruitment volatility through other service segments and offerings. It's normal, in my experience, to encounter headwinds in different national economies during the course of a cycle. And it is seldom the case, notwithstanding the desires of analysts and shareholders, that all economies are growing robustly at the same time. This is an industry characterized by operating leverage and it would be unreasonable to expect us, or any other competitor, to maintain the same level of profitability in a slow down as in a buoyant period.

Still, we do not believe that this slowdown reflects a material shift in the demand patterns in the Australian New Zealand market or in any way indicates fundamental problems with our business model. Turning to Hudson North America, revenue grew at a healthy 20% with EBITDA up only 8%, significantly below our expectations. I want to comment on two aspects of the fourth quarter results that accounted for the lower level of operating leverage. First, temporary contract margin declined to 21.1% from 22% in the quarter. This decline is a result of higher benefit payments, higher Workers Comp expense and the resolution of certain customer issues. I want to give you some greater visibility on the customer issues in the financial solutions group that impacted margins in the fourth quarter, as we discussed on the December call. There were three discreet instances that were resolved in the fourth quarter. Two involved credits to customers that felt costs incurred were too high in relation to the engagement. And one involved a cost overrun on a fixed price contract. All of these have been resolved and we don't regard them as ongoing or indicative of a long-term issue.

Second, Hudson North American results were impacted by higher professional fees related to the installation of our new PeopleSoft bill pay system. Mary Jane is going to provide more details on the status of that project in her remarks. Just to put this in perspective, the total impact of these items in Hudson North America was a little over $1 million in the quarter, but that would have increased our leverage ratio from 8%, which was under expectations, to 25%, that would have been within our expected band. I would like to turn now to a regional review of operations. In Hudson North America, as I mentioned, revenue increased 20% and gross margin increased 19% in the fourth quarter, reflecting increases in the legal, financial solutions and engineering practice groups. Permanent recruitment in the quarter was up 36%. Financial solutions grew slightly over 13% in the quarter compared to the fourth quarter of 2005, and sequentially was roughly flat. On the full year basis, financial solutions grew 83%. Although the growth rate slowed in the fourth quarter, part of this was due to a tough comparison to the fourth quarter of 2004, which was the peak of SOX work.

We've invested in 2005 in expanding our capability in financial solutions, investing in additional people, methodology and structure. Our bill rate has increased to $100 per hour and, by implication, the level of our work has also increased. We are confident that this practice will be an important component of our future growth. There's no way to describe the results in our legal practice group in North America last year, except to say that it was a banner year. The year ended with the fourth quarter increase in revenues of 43%, capping a year of an increase of 75% to over 100 million of revenue for that practice group. Engineering, aerospace and defense also had a banner year. Engineering in the fourth quarter increased revenues by 200%, in part fueled by project worked indirectly from FEMA. But for the year as a whole, engineering revenues were also up nearly 100%.

IT in the fourth quarter was down 12%. However, IT EBITDA for the quarter was at 9.9% of revenue, so it remains a very healthy, profitable practice group for us. For the fiscal year, IT revenue was up 4%. As we mentioned in prior calls, our IT business has been impacted through the year by the decline in a specific customer account. I'm certain that the management team will adapt and has adapted to the decline in this account by adding additional business in other accounts. This is a very profitable business, as I mentioned, and we have a management team that's very bottom-line focused. Excluding the one account that I mentioned, the IT business grew 7% in the fourth quarter and 24% for the year. Hudson Europe continued a strong profit recovery and positive mix shift led by the U.K.. This market very much exemplifies the impact of the mix shift that you see in our consolidated results. Hudson European revenues decreased 2% with gross margin flat. However, EBITDA increased to 3.6 million compared to barely a bare profitability in the same period in the prior year.

EBITDA increased to 3% of revenues in the fourth quarter, again compared to bare profitability in the prior year, although the prior year was impacted by nonrecurring expenses. The U.K. was the leader in our European operations with EBITDA up 40% and EBITDA margin reaching 4.5% of revenues, compared to 3.1% in the same quarter of '04. Hudson Asia had another strong quarter, particularly in Singapore and Hong Kong, and reported EBITDA at a level of 16% of revenues in the quarter. Highland Partners also had a strong quarter with revenues up 5% and reaching an EBITDA level of 10% of revenues. I want to just close my remarks with some strategic observations. The softness that we experienced in the fourth quarter in Australia/New Zealand in no way deters us from our overriding objective of increasing margins from our core practice groups and making sure that we have the appropriate business mix to produce increased, sustainable profitability, as measured by higher EBITDA as a percent of revenue.

There is nothing that suggests a material shift in the market or the need for us to fundamentally rethink our business model. I think our fourth quarter results support this, as consolidated EBITDA grew 45%. In the coming year, we will continue our strategic focus on expanding our core high-growth, high-margin professional business lines, increasing the proportion of revenues attributable to temporary recruitment and project solutions to offset the volatility of permanent recruitment and leveraging our human capital solution service offerings to deliver greater value to our clients that further distinguish us from competition. With that, I'm going to end my formal remarks and turn it over to Mary Jane for a review of the fourth quarter and fiscal year 2005 results, as well as our guidance for 2006. Mary Jane.

Thank you, Jon, and good morning to everyone. I'm pleased to be joining you today and I look forward to meeting many of you in the weeks to come. To begin the discussion of the financial highlights, let me actually break with precedent and start with the bottom of the P&L statement to reveal some good news that we have here. That is that for the full year 2005, the Hudson Highland Group moved from a net loss to a net profit, with a net income of $5.3 million. The Company has turned an important corner, to begin generating positive earnings that will allow us to continue to invest in the core business that will enhance our strategy of long-term, sustained profitability. Returning to the top of the P&L, the revenue grew 12% on a constant currency basis for the year 2005, with constant currency revenue gains in each of our key geographic markets. For the fourth quarter, constant currency revenues grew 6%, supported by gains in our two largest markets, Hudson North America and Hudson Europe. Our full year gross margin increased 13% on a constant currency basis and our gross margin percentage increased from 37.4 in 2004 to 37.6 in 2005.

For the quarter, the constant currency gross margin increased 6% and our gross margin percentage was flat to prior year, at 37.4 in 2005 compared to 37.5 in 2004. Along with our net income, EBITDA turned positive this year and the EBITDA margin, one of our key metrics for profitability progress, ended the year at 2.1%. We met our guidance that the EBITDA would meet or exceed 2% for fiscal year 2005. For the quarter, as Jon mentioned earlier, the EBITDA increased a strong 45% on a year-over-year basis and increased from 1.4% in the fourth quarter of 2004 to 2% in the fourth quarter of 2005. The net income, as I mentioned, on a consolidated basis is $5.3 million, including depreciation and amortization expense of 18.4 and tax expense of $5 million. The basic and diluted EPS were $0.24 and $0.22 respectively, up from a net loss in 2004 of 26.8 or $1.38 on a basic and diluted share basis. For Q4, net income was 2.8 million, diluted EPS was $0.12 and $0.11 respectively, up from a net loss in Q4 '04 of $1.3 million or $0.07 a share. Let me comment on a few specific aspects of our performance this year.

First of all currency. Currency had a relatively minimal impact on the reported results for the full year. For the quarter, currency hurt the reported revenue and gross margin by about 3 percentage points and EBITDA was affected by about 8 points due to currency in the quarter. In terms of expenses and leverage, for the full year our expenses increased 7% on a constant currency basis, lower than the 12% constant currency revenue growth. In terms of leverage, the portion of the additional gross margin that's realized in the EBITDA, our constant currency leverage, as Jon mentioned before, was 51% for the year and 33% for the quarter. Just to reiterate Jon's point from earlier, leverage is a particularly important metric for us, as it measures the increase in the efficiency of our operations. To spend a minute on the expenses in Q4, let me comment that our office and general expenses, on a constant currency basis, will be up 14%, reflecting higher cost to implement PeopleSoft, which I'll discuss in a minute, as well as a full quarter of the consolidated expenses for Balance and higher occupancy costs in some locations.

With respect to our expenses for the PeopleSoft implementation in the U.S., as most of you know, anytime a new system is put in place, it is not uncommon for implementation issues to arise. As we said in the third quarter of 2005, we experienced some delays in billing that caused us to exit the third quarter with higher billed and unbilled receivables. During the fourth quarter, we addressed the associated customer issues resulting in about $600,000 of customer credits. Additional expenses in the fourth quarter, totaling about $660,000 over our budge, resulted from continuing consulting fees related to the system's installation. While some of these consulting costs will continue into the first half of 2006, we believe that we've now fully addressed the billing timeliness issues and expect, with continued careful monitoring and refinement of the system over the next several quarters, to reap the benefits of a more robust support system for the North America market.

Turning to depreciation and amortization, this expense, as I mentioned before, was $18.4 million for the year 2005. It includes the amortization of intangibles from the Balance acquisition and is roughly in line with our estimate that we gave in the third quarter of $18 million. Our capital spending was 1.7 million in the fourth quarter and roughly $10 million for the year. As a note for 2006, we expect the depreciation and amortization to be a bit higher, in the range of 21 to $22 million, due to a full year of amortization of the Balance intangible assets and depreciation for the PeopleSoft capital expenditure. We expect that our capital expenditures for 2006 will be in the 10 to $12 million range. Turning to taxes, we had a tax credit in the fourth quarter of 2005 of roughly $300,000. This is due to two factors. First of all, we had an income shift between regions where we don't pay tax and those, primarily Australia, where we do pay tax. Secondly, the finalization of our 2004 Australian tax return resulted in a small reduction to last year's tax accrual. These items together caused our tax provision to become a tax credit in this quarter. For the full year, our tax rate was 48.7%.

Our estimated tax loss carriedforward has a gross value of 268 million at year-end, with an estimated deferred tax asset of $98 million, about 70 million of which is in the U.S. and 28 of which is in the U.K. and Europe. Turning to some of our key balance sheet metrics, we finished the quarter with $34.1 million in cash and receivables of $232 million. The receivable base was down $9 million from the third quarter on strong collections in the fourth quarter. The quality of our receivable base remains very good and bad debt expense is not a major factor for us. Our DSO improved two days from the third quarter to 56 days in the fourth quarter, as we made progress on the collection of receivables that were delayed from the third quarter due to the PeopleSoft issues. We continue to see strong collections in the first quarter, but I would say that we still have room to improve in this area, particularly in North America.

Our short-term debt outstanding at the end of the year was $30.1 million, which, on an aggregate basis, is typically used to fund our receivables growth as the Company grows. Our credit facility is $75 million, which we consider to be seasonably adequate to fund our needs. Let me turn now to the guidance for 2006. The details of our guidance are in the press release, which you have read. As Jon discussed, some of the issues that surfaced in the fourth quarter of 2005 are expected to carryover, to some degree, into Q1,2006, causing, in our expectations, Q1 to be lower than prior year. To provide some perspective on Q1, '06, let me say that we expect Q1 to be positive at the EBITDA level. In addition, our guidance includes the expenses for stock options, which for the first quarter of '06 we expect to be about $1.6 million. If you deduct the impact of stock options from the prior year's result of Q1 at the EBITDA level of 2.8, you can easily see the range that we expect to fall into. Again, keep in mind that Q1 is historically the lowest profit-generating quarter of the year. And we are anticipating a continuation of the business conditions in the Asia/Pacific region.

Regarding the expensing of stock options, FAS 123R as its called, as I mentioned, beginning in the first quarter of '06 the Company will begin to record this expense as required. Based on the current information, we expect the impact to be about 16 in the first quarter and about $4.9 million for the entire year. This compares to the yearly cost for 2005 of $4.5 million. Lastly, I'll just note that today's guidance does not include any anticipated future transactions. We do expect to continue to evaluate the strategic alternatives for our business units and these transactions may have an impact on our revenue, EBITDA, and EPS. With those remarks, I'd like to open the line for questions.

Operator, I think we're ready for questions now.

[OPERATOR INSTRUCTIONS] Your first question comes from Jeff Silber with Harris Nesbitt.

Thank you very much. I was wondering if we could get a little bit more color on the first quarter guidance on the revenue line. You gave us a lot of good guidance for 2006 by region. If we can get something similar for the first quarter, I think that would be helpful.

Mary Jane, I'll let you take a stab at that.

First of all, as you know, we don't give guidance by quarter, but I think with respect to the revenue, as we indicated, we do expect to see some of the softness that we experienced in Q4 continue into the first quarter and have built the guidance for the year accordingly and set the EBITDA expectations accordingly.

All right. On the stock-based compensation side, is that pretax or after tax?

Pretax.

Okay and then on the tax rate, and I know it's difficult to forecast, but the guidance that you're implying, what tax rate should we be using for both the first quarter and the full year?

Well, we're not going to give guidance per se at the tax line. I think that what we see as the exiting rate coming out of 2005 is something more normal to what you should expect to see than what we saw in the third quarter of 2005.

Okay. Great. Now, in terms of the way the Company gets information from abroad, I know there's been some investor concern about the delay or how long it takes, sometimes, to get some bottom-line information from the various regions, specifically in Australia and New Zealand. I was wondering if you could address those concerns and if any changes have been made over the past few months.

I'm actually not sure what you're talking about, Jeff, because I think we get bottom-line information in the ordinary course of business. As you know, we have -- first of all, we have a system of top-line, weekly information that we get from all of our regions. And bottom-line, I would say we close quarters, close months rather, pretty quickly, ten days after the end of the month. As you know, Jeff, we can't always share that information with the financial community because of regulation FD. But I would say that's not an issue. Do you have some -- what's your basis of thinking it is an issue?

I can't say -- maybe it was somebody else that went out with this information in terms of some delays in getting some information, which is why when you had given the EBITDA guidance at the end of October and then seven weeks later changed it, that may have been one of the reasons, maybe that was just a misinformation that was placed out there, but I know I've gotten some questions on that so far.

Let me just address that, because I think there's -- sometimes there is an issue about visibility. There's no question that on October, David, was it October 25th?

26th.

26th we had our third quarter release and we increased our guidance and on December 22nd we reduced our guidance. I'm sure a number of investors were asking what happened. And the nature of our business is that we do not have a lot of visibility forward and that's particularly exacerbated by the fact that 55% of our gross margin is attributable to permanent recruitment. And permanent recruitment is not only volatile, as you already know, but even within a month 40% or more of gross margin in a month comes in the last week of the month, which is typical for permanent recruitment. It makes visibility difficult for us, compounded by, frankly, what was a cycle. You can call it a mini cycle, or a cycle, but the slowdown, which is not atypical, occurred fairly rapidly and in permanent recruitment it occurs very rapidly. I think that the lack of visibility, frankly, for someone like you, Jeff, who's been around this industry quite some time, is not a new story. But that's the background on the the October and December guidance changes.

Okay, great. One more quick one and I'll let somebody else jump on. Just one more clarification on the guidance for the year. The Hudson Europe revenue growth at 0 to 5%, is that including the impact of the Balance acquisition?

Yes.

Yes.

Okay, great, thanks.

Thanks, Jeff.

Your next question comes from Mark Marcon with R.W.

It's R.W. Baird. Good morning, everybody.

Hi, Mark.

How are you. We'll give you credit that it's RW Baird..

In terms of the guidance that you're looking at, in terms of the EBITDA guidance, could you characterize how you would think the North America and European margins will trend?

Well, I think our general way of thinking about this would be that European margins are trending up. That was -- obviously, we had a huge increase in 2005 for the year as a whole. We reached 3%, I believe, for the year as a whole in Europe. And we believe that consistent with the general strategy of shifting the mix to higher margin business, that that trend will continue in 2006. The U.S. is a different story, Hudson North America is a different story, it's a story that's a growth story. We had good growth in 2005. We expect to have growth in 2006 and, accordingly, that that would drive a further margin increase.

Does it relate to -- you mentioned professional fees for the people soft implementation with the credits, that issue is behind. Are you going to see the same magnitude of professional fees, or is that going to decline materially in the first half?

I wouldn't expect to it to decline materially in the first half. Certainly, we had fees both to install the system and then the fees as we noted in the fourth quarter. My sense is that we'll see them roughly about that level probably for the first half.

Okay. And then with regards to Europe, how is Balance going, what sort of contributions did you get in the fourth quarter and how should we think about the organic revenue growth for the Hudson Europe for next year?

I'll start on the Balance side and then turn it over to Mary Jane or David to talk about revenue growth number. Balance has done very well. Very much in -- our expectations were high and they very much have satisfied those expectations in every way. So, from a financial standpoint, we certainly will reap the benefit of including the Balance operations in our consolidated operations for the first eight and a half months that we did not have in 2005. So that will be a benefit. But very much they performed very well, the management team there is a delight to work with. So far, we're extremely happy with that.

Jon, can you mention what the revenue contribution was?

I don't know that we've given out specific details about the Balance acquisition, so I defer to my colleagues.

That's correct, it's a good contributor. I can break it out. In terms of go forward, Mark, for 2006, Europe is definitely an execution of our strategy. We've guided constant currency numbers and revenue for the year, zero to 5% growth, and we have signaled the last two quarters that top-line growth has been pretty flat to down a little bit, but we've been expanding the gross margins. Gross margin has been growing a little bit faster than that, as we continue to shed low margin contracts and focus on higher margin operations. That's certainly the strategy for 2006 and the acquisition of Balance falls into that strategy as we'll be working in higher margin areas and temporary contracting, particularly in continental Europe, through Balance.

What's the area where you're seeing a bit of a decline on an organic basis in Europe? Is it shifting out of the lower margin IT, temporary business? Is that the primary area where you're seeing a little bit of softness?

Well, I would not characterize it as softness. The primary where we're seeing a big mix shift is in the U.K., first of all. In the U.K., which is about 55% of European gross margin, and that's the market in which we have the largest temporary contract business in Europe. And it's a market where we are definitely undergoing a very significant mix shift that's been very successful, financially, so far, shifting out of low margin business. Some of it is in IT,absolutely. I think that's a story you've probably heard from some other competitors that you talk to, as well as a few other practice groups. And we are repositioning ourselves to be a higher margin provider in the IT sector and also in other practice groups.

In any given quarter, the challenge for us is that it's easy to fire the business and the day you fire the business, you entirely lose that segment of the revenue associated with it, but obviously, a much smaller piece of EBITDA. And in the best of circumstances, you can replace it with other business, but making that trade means that your revenues are at zero. And that's what's impacting our top-line. We're not very concerned about that, and I know you know this, Mark, we're really focused on driving profitability. It comes back to, sometimes, what I call the simple-minded analysis of Hudson Highland, which was when I joined the Company we had revenues of 1.250 billion, roughly, and we had losses on an operating basis. And my strategy has been to make that original 1.2 billion, and they are not red dollars or green dollars, so this is a metaphor, make that original 1.2 billion profitable rather than just trying to grow our way out of it. So that's really the process that we've been going through for the past two years. We expect '06 to be a similar year in a number of the markets.

Great. That would seem to imply that the gross margins in Europe should continue to increase, yet, obviously, terrific progress in the fourth quarter.

The gross margin line is a line that's a tough one for us because as temporary help becomes the more important part of our mix, which again is one of our strategies, the gross margin at the temporary line, even in the best of circumstances, is 30%, 35%. And the gross margin permanent recruitment is 95 to 100%. So, I know it sounds paradoxical to financial analysts, but in a way, having our gross margins stable, even down, would be fine with us if it was being driven by the increase in temporary project solutions. So we, again, obviously we look at the gross margin line, but we look a lot more carefully at the EBITDA line.

So the operating expenses were basically [INAUDIBLE] a little bit?

Yes, absolutely. That's a good point, also, as we talk about shifting out of the low margin business, there are operating expenses that we can make more efficient because, by definition, doing a lot more volume requires more people, more admin, et cetera. So we can continue to make our operations more efficient by focusing on high margin business as well.

Great. Thank you very much.

Thanks, mark.

Your next question comes from Mike Carney with Aperion Group.

Good morning. I would first like to say, thanks for the lot of details that you provided in the release yesterday. That leads to less questions and we don't have to guess on what happened. On my questions, first, in Hudson U.S., outside of the issues related to some of the direct cause in the PeopleSoft problems, it seemed like a pretty good quarter comparatively to other professional staffing providers, and --

We thought so.

Yet you talked about on the December call that there was some pricing issues. But I can't see that from my 10,000 foot view.

I think I mentioned, first of all and I'll ask Mary Jane to comment on this, but I think I mentioned in the December call that if it was just the North American issues, we wouldn't have brought them up on the call at all. What happened was in today's regulatory world, the advice we got was is if we make an announcement and we talk about anything, we have to talk about everything. And I tried to indicate, obviously unsuccessfully, because you're not the only person that's noticed that, unsuccessfully that I did not regard them as major issues, but on the other hand, in the interest of full disclosure, there were issues. And Mary Jane, perhaps just want to take a minute to talk about those and maybe put some numbers on them.

I think, notwithstanding John's comment that in December we meant to be as complete in our disclosure as we thought we should be, with respect to North America in the fourth quarter, I think we did talk about that despite the fact we were seeing some pressure at the margin level, we didn't necessarily think it was an industry issue. What it was, as we experienced it here and Jon described earlier, was certain pushback from clients on a few number of issues with respect to certain services we were providing, whether they thought they were being priced at the right level, they had an understanding of the cost, et cetera. And so as we came in and resolved those during the fourth quarter, it was in round numbers about $600,000 or so. It wasn't a large number, but it was for us in December, when we talked to you, a big enough number to make a difference and to cause us to, as I said, be as open about what we were seeing as possible.

Okay. It seems like the first quarter has rebounded from kind of a lesser, robust fourth quarter in the U.S. I know Hudson Highland has a less diversified business than other competitors, but is -- are you benefiting from that also?

I think the way we see it is the current trends are consistent with our guidance.

Okay. Also in North America, Jon, if you could speak to this, it seems like the turnover continues to be probably higher than competition in the U.S. in my research, some of it is probably because you've expanded so much in the U.S. But if the turnover declined, obviously, that would help profits.

Boy, you've got some good research, Mike, but we don't perceive turnover as a problem in the U.S. We perceive it as a problem, maybe, in a few other geographies, but the U.S. turnover actually has come way down from where it was a year and a half ago. And I would say it's actually a level now where -- I wouldn't ever say you're happy with turnover, but it's not on our screen as a big issue. We always want to retain good employees, of course, but we don't perceive it as an issue, really, in the U.S.

Okay. Thanks. And then turning to ANZ, it looks like December was clearly very bad, but obviously, if it's hiring freezes it's not really a long-term issue if the economy is not -- if it's not really an economic issue. So from my 10,000 foot view, again, it looks like that basically your people in ANZ are making the same amount of money they made last year, but they're producing less. So when you say you're taking steps in ANZ to mitigate the profitability decline, does that mean you're not looking to get rid of revenue producers unless it's a longer term trend, these hiring freezes.

Exactly right. That's exactly the balance. You've hit it on the head, Mike. That's exactly the balance we strive for. And our management team is going a great job, which is if we're convinced it's, which we are at the moment, that it's not a long-term trend, it's not a fundamental shift in the market, we're not in a real recessionary downdraft, then we don't think it makes sense to get rid of revenue producers. We do all the other things that you can do in terms of discretionary spending management to maximize profitability given the conditions.

But obviously over the longer term, I guess, those revenue producers aren't going to make the same amount of money they would have if they were producing a lot more?

Yes, that's right.

Certainly.

Absolutely right.

And then last question is on the guidance. Mary Jane, you've talked about 2.5 to 3.5% for '06 EBITDA, obviously everyone is focused on that. Are you trying to make about a 1% guidance from here on out? Or are you 90 to 95% comfortable that you can get into that range, because it's such a wide range at this point, 15 or $16 million worth of EBITDA. I seem to think that why would you even provide guidance if it's that large, because, obviously, you can understand that the price of the stock and the fact that you would -- trying to reach your 7 to 10% goal there's a big significance between 2.5% or 3.5%.

We do understand that the range is wider than it has been. We set the guidance where we actually, prudently and in our judgment think it should be for this year, considering some of the items that we're dealing with in different geographies. So what we strove to do in setting the guidance was, as we talked about both on the December call and then in follow up meetings, just reiterating the same message, we wanted the guidance to actually encompass the range of situations we thought we could see with the time to actually take the appropriate actions to deal with those. We are, nonetheless, confident that we are on the track to achieve and stay on the 7 to 9, 7 to 10% profitability strategy that we have. And 2.5 still is an improvement over where we left 2005.

Okay, thanks.

Your next question comes from Matt Litfin with William Blair and Company.

Hi, good morning.

Hi, Matt.

What was cash flow from operations in the fourth quarter?

Cash flow from operations in the fourth quarter was a use of cash of $5.5 million.

Okay. And does the new EBITDA guidance include or exclude the stock-based compensation that you mentioned?

It does include it.

Okay. Follow-up question on Jeff's PeopleSoft question, do you expect to rollout PeopleSoft beyond the U.S. and if so, when?

No, we don't expect to roll it out beyond the U.S., or at least I should say, we don't have a plan to roll it out beyond the U.S. We are not believers in the nirvana of a global system because there is such large differences between our various markets in terms of size and scope and service offerings, et cetera. So we address each of the regions differently. So we won't be -- right now we don't have a plan to do it.

Okay, thanks, Jon. Can you address the first quarter guidance being down, but the full year guidance being up? Is that 100% based on your views of ANZ coming out of this soft patch or are there other factors that be be identified?

I wold say, this is Mary Jane, I would say that the first quarter guidance is largely driven by the ANZ issues. There's no other specific issues of large consequence. That's the main driver. Again, I just want to remind you that Q1 is a pretty small quarter in the industry, but certainly also for us, so relatively small numbers will make a difference.

And particularly small given the stock option expense.

Exactly.

Right. Last question has to do with the acquisition pipeline, what's in there and is there anything that's near to medium term?

We're always talking to people and I think, Matt, you know our strategy is first of all not to do -- we're not in the business of doing big deals, that's not the way we see building the Company. So for us a transaction like Balance is a relatively big deal. We are probably more thinking about deals the size of the JMT deal, first of all, so that size range. And we are -- I would say we're continuously talking to people. We don't have anything right now that's on the verge of being announced, but I'm not sure if I would characterize it as medium or long-term, that would be difficult to do.

Jon, if I may follow-up on that, ask it a different way. If you were to do acquisitions, what geographies or service lines do you find most attractive at this point?

Well, I think a good guide, Matt, is to look at the two places we've done them. Coincidentally, one is, certainly, in the U.S. Essentially the way we think about it is we're happy with our U.S. business. We don't feel we have to make an acquisition. But when the opportunity presents itself with the right people at the right pricing structure, if there's an opportunity to effectively expand our geography, or even enhance our geography, we would be interested in doing so. The JMT acquisition, as an example, got us into both the Denver market, that we were not in at all, and we had barely opened an office in Minneapolis, I don't think we had done much more than turn on the lights. And those have turned out to be excellent operations for us.

And then in Europe, particularly in continental Europe, we're very interested in finding additional project solutions for contracting opportunities. Balance was, again, a perfect example. The Netherlands is an important market in the industry, even though I know it's a small country. And we continue to look in those areas as an opportunity. We also look and think about the U.K. market to enhance our high margin business in the U.K. And that would be the third, I would say, area of focus. But, I would say that's sort of the priority in my mind.

Okay, thanks, Jon.

You're welcome.

[OPERATOR INSTRUCTIONS] There are no further questions. Mr. Chait, are there any closing remarks?

Certainly, operator. This is David Kirby. Thank you, everyone, for joining the Hudson Highland Group fourth quarter conference call. If you do have further questions, please feel free to contact Mary Jane Raymond or myself at any time. You can reach Mary Jane at 212-351-7232 and you can reach me at 212 351-7216. The call today has been recorded and will be available later today by calling 800-642-1687 followed by the pass code 4778139. For calls outside the U.S., please dial 706-645-9291, followed by the same pass code. The archived call will remain available for the next seven days at those numbers. Today's webcast will also be available on the investor section of our website, hhgroup.com. Thank you very much and have a great day.

This concludes today's Hudson Highland Group fourth quarter results conference call. You may now disconnect.