Korn Ferry (KFY) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Korn/Ferry fourth quarter earnings release teleconference call. At this time all participants are in a listen-only mode. Later we will have a question and answer session and I'll give you instructions at that time. Should you require assistance while you're on this call, simply press zero and then star, and an operator will come onto your line to assist you.

As a reminder, this conference is being recorded, and it will also be replayed. You may stay on the line at the conclusion of the call for the replay information.

Before I turn the call over to the chairman and CEO, let me first read the precautionary statement to investors. Certain matters to be discussed during this conference call will constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the company believes the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurance that such expectations will be attained. Participants on this call are cautioned to consider the risks related to our assumptions and expectations and not to place undue reliance on such forward-looking statements.

With that, I will be turning the call now over to the chairman and CEO of Korn/Ferry, Mr. Paul Reilly. Please go ahead.

Good morning. And thank you for the opportunity for me to review the fourth quarter in our past fiscal year. You know, we have just kind of put to bed probably the most difficult 12 months in the history of the executive search business. First we had the dot-com explosion, the war on terrorism, and maybe the icing on the cake has been the many corporate issues and scandals that have hit the press recently. As a result of these three major events, this past year was just really devastating to the recruiting business. Maybe the silver lining on the bright side is we've seen the high end of our business pick up. A lot of demand for CEOs, CFOs, board members, and presidents, given the environment. But in the volume segment of our business, vice-presidents, senior vice-presidents, clients have gotten a little gun-shy and have been slow to fill positions and have put some positions on hold.

Although it is clear that, you know, our business in the global economy has stabilized, there are no clear signs that a recovery has really begun. A lot of people have asked me about my timing in joining a year ago and said, "You know, do you think your timing was bad?" I think in retrospect being here almost a year, the timing was perfect. You know, as a company we are able to move quickly in anticipation of this declining demand. We made some very tough decisions midway through the fiscal year that really prepared us for the flat market we find ourselves in right now. We are the first major search firm to aggressively reduce our workforce and to cut our overhead.

Over the past 12 months we cut over one-third of our global head count, closed many offices, shut down our job direct subsidiaries, co-located almost all of our Futurestep offices within Korn/Ferry locations, and consolidated our back-end functions such as finance, marketing, HR, and IT. As a result, we have cut a full 100 million plus out of our cost structure. And when the economy returns, rel reap the benefits. Our modeling shows that just with the 10% rise in revenue, our operating margins would hit 15%. We have also strengthened our balance sheet and put our financial house in order. I'm extremely pleased to announce that we're able to complete a private placement deal with Friedman, Fleischer and Lowe, which we announced last week. This is a very favorable deal for us in which FF and L thus invested $50 million: 40 million in convertible subordinated notes, and 10 million in convertible preferred stock.

As a result of the investments, we have paid down our bank debt, which was costing us prime plus 3.75%, and now sit with 100 million in cash and only 10 million in bank debt.

Our loan agreement with B of A is up in November, and we are ready to begin the process of renegotiating the loan now.

One thing to note on the deal with FSL is that there are no onerous terms. There are not any veto powers nor did they have the opportunity to reset the conversion price even under severe conditions. But more importantly, they are a great strategic investor, and I look forward to two of their partners serving on our board of directors.

After their announcement, eight of our 12-member board will be outsiders. It appears that the market likes this deal, too. On the day we announced, the Dow registered a triple-digit decline, and our two publicly traded competitors are each down while our stock was up 9%.

We established a deal with FFL for a number of reasons. To begin with, we wanted to resolve our loan agreement before November, and we wanted to lock in more favorable terms on debt given this market. Secondly, we wanted to establish a long- term strategy, the strategy we established back in December, and we wanted to continue to fund that strategy despite the near-term volatility in the marketplace. Our long-term goal is to be the global provider of a full range of human capital solutions. That means we both need to broaden the range of our product offerings and deepen the relationships we have with global clients.

We now have executive search, middle management search, management assessment, and executive coaching.

And in the past six months, we have begun building an infrastructure for true global account management and integrated account services, much like investment banks and accounting firms have done over the past ten years.

I also want to stress the psychological benefits of concluding this private placement. First, as an outside investor, they clearly endorse our strategy and our direction, which I think is important to all of us. From a fiscal point of view, we absolutely could have moved forward without this equity investment. We could have tightened our belts, reduced our long-term investments, and we would have had sufficient cash to meet our operating needs.

But this is not just a brick-and-mortar business. Our assets are very talented professionals, an incredible global network, a brand well known in the marketplace, and technology second to none. This cash infusion provides our people with the confidence to know that they can focus on their client and on the marketplace and not worry about the day-to-day fluctuations in the stock market, demands on cash flow, or our balance sheet. It will also aid us in our aggressive recruiting effort to continue to add market-leading producers to our organization.

We made a decision last summer that we would commit to paying a minimum bonus plan for this fiscal year, and we have lived up to that commitment. Our consultants know that for fiscal year '02, they will be receiving a cash bonus that is somewhere between 50% as a minimum and higher for the bigger producers. We felt it was important to make this commitment to our consultants in this worst economic climate to keep them focused on the market.

I think taking this stand with our people will serve us well in the future.

We are now putting the finishing touches on a compensation plan for the coming year with Towers Parents, and while I can't provide any of the details of that plan on this call I can tell you that philosophically it's in direct alignment with our long-term strategy and focuses on the profitability of our business.

Our senior management team and I continue the task of transforming a culture molded by 30 years of a highly successful partnership into a public company that rewards global account management, cross- selling, cross-border sharing of assignments, and fiscal transparencies of public markets.

Compensation drives behavior. Behavior defines the culture. And culture defines the brand. Our new compensation program must reward performance, meaning build and collect, but it also must reward customer satisfaction, account management, teamwork, and the appearance of corporate values.

We will establish the clear metric for each of these soft areas as we roll out the plan and we'll transform our culture into the human capital firm of the future.

It will not happen overnight, but we are well underway, and actually despite this difficult 12 months, I am thrilled with the progress that we've made during horrendous economic times.

I'm employing to let Gary Burnison now take you through the financials butter I want to leave you with the message that we have made it through the toughest of times and I've never been more excited about what lies ahead. We've cut our costs, installed a new management team, developed a long- term strategy, and strengthened our balance sheet. Although the near-term economic environment is uncertain, we are in solid position to take advantage of the eventual economic upturn - rebound when it happens.

Next, I would like to introduce Gary Burnison, our new CFO. I think it is a testament to Gary, our finance team and our strong financial control culture that with a new CFO, this is Gary's 90th day, a new auditor, Ernst and Young in April, that we could close this new equity investment and report earnings on time. I will now turn the call over to Gary. Gary?

Thanks, Paul. Good morning. I'd like to go through a few highlights of the quarter before getting into the details of the quarter. We're pleased to report that the operating loss per share was 12 cents, which was in line with guidance, excluding nonrecurring charges of 8.9 million, or 23 cents a share. Five million of the 8.9 was previously announced and related to restructuring charges, mostly in Europe. And there was an additional four million noncash impairment charge.

More importantly, our core executive search business, on an EBITDA basis, doubled quarter over quarter to 6.2 million, or 7.6% EBITDA margin. As we announced last Friday, we closed a $50 million private placement with Friedman, Fleischer and Lowe, the San Francisco-based private equity firm. As Paul indicated, we're extremely pleased to have the firm - and, more specifically, Tully Friedman, Spencer Fleischer, and David Lowe - as strategic partners to you, our shareholders, and our management team. The private placement was 40 million of convertible subnotes and 10 million of convertible preferred stock. Both are convertible into common at a conversion price of 10.25 per share, and if converted, would represent about 11.4% of our outstanding common stock, or approximately 4.9 million shares. Point out that the convertible notes are tax deductible. In addition we issued warrants to purchase approximately 273,000 shares, common shares at an exercise price of $12 per share.

Upon completion of the offering and subsequent pay-down of bank debt, we'll have cash on hand of about $100 million, and remaining bank debt of 10 million, which I intend to pay in the next 30 days or so. The transaction has clearly fortified our balance sheet, more importantly, given us fantastic strategic partners and provides sufficient liquidity to satisfy our operating requirements.

Next I'd like to point out, as announced in our earnings release, we changed our method of accounting for our subsidiary in Mexico from the consolidation method to the equity method. Historically we've consolidated the results of the Mexico operations based on our effective control of the business. Even though our ownership and voting interests was slightly blow 50%, I want to put this in context that, one, this will not have any impact on EPS, cash flow, or equity, and it represents about 3% of our revenue.

Although we believe that in substance we control the business, we do not technically or legally have over 50% interest.

So prospectively, we'll deconsolidate the Mexico operations and pick up our share of the income from Mexico below the line is equity and earnings in unconsolidated subs.

As I said, this change won't affect the EPS, cash flow, or equity. It will have the effect of lowering revenue, EBITDA, and operating profits. We'll adjust our historical financials in this year's 10-K to reflect the change.

In Appendix A of the press release we've shown the impact of this change on selected line items historically, and let me point out an example of this. Our fourth quarter revenue on a consolidated basis would have been $93 million. With Mexico deconsolidated, the revenue is $90 million. Likewise, our fourth-quarter EBITDA would have been 3.3 million under the consolidated approach, 2.6 million under the new equity approach. Note that there's no impact to EPS.

For the remainder of my comments I'm going to focus on the - the discussion will be focused on the new presentation basis. In other words, with Mexico deconsolidated. Consolidated revenues for the fourth quarter of fiscal year 2002 were $90 million, which was essentially flat sequentially, down 38% compared to the same quarter in the prior year.

Revenues for 2002 were 394 million, compared to 636 million in fiscal 2001. That was down about 38% year over year.

As I indicated earlier, the consolidated net loss for the quarter excluding special charges was 4.3 million, or 12 cents per share, which was in line with our prior guidance for the fourth quarter.

Compared to a loss per share for the prior sequential quarter - in other words, our third quarter of fiscal 2002, fourth quarter loss showed an improvement of seven cents from a loss per share of 19 cents in the third quarter. This sequential improvement was due to lower GNA expense before depreciation, amortization, realized as a result of our restructuring initiatives and a lower tax provision.

As I talked about earlier, the fourth quarter results reflect total assets impairment and restructuring charge of 8.9 million, which is comprised of 4.9 million, mostly for the downsizing activities in Europe as planned and an additional four million noncash charge relating to the write- off of a nonstrategic investment which we believe is permanently impaired.

Accordingly, the consolidated net loss for the fourth quarter was 13.3 million, or a loss per share of 35 cents.

The balance sheet at the end of Q4 reflects 39 million of bank debt and approximately 66 million of cash. Happy to report that subsequent to quarter end, we received a tax refund of $17 1/2 million. After the $50 million private placement, which should result in about 46 million of net proceeds, and again paying the bank debt down to 10 million will have cash on hand of about $100 million, prior to the payment of approved bonuses in July of 2002.

The net accounts receivable at the end of Q4 was approximately 55 million, down from about 58 million at the end of Q3.

Let me review the business units in detail now starting with core executive search.

Revenues for executive search for the fourth quarter were 81 million, which is up about a million dollars on a sequential quarterly basis, ending the year with 347 million in core executive search revenue.

On a geographic basis, sequentially quarterly revenues increased 5% in North America, and 30% in Latin America, of course on a much smaller base with respect to Latin America, and decreased 8% in Europe and 3% in Asia-Pacific.

Fourth quarter EBITDA before nonrecurring charges was 6.2 million for our core search business, or an EBITDA margin of 7.6%, compared to EBITDA of 3.2 million for a margin of 4.1% for the prior sequential quarter. So you can see the EBITDA almost doubled sequentially.

Operating profits for Q4, again for the core executive search business, excluding special charges, were 2.7 million, for a margin of 3.4%, compared to a nominal operating profit in the prior sequential quarter.

The number of executive search consultants at quarter end was 443, with a reduction of 26 from the prior quarter, down 118 from the prior year.

Average fees per engagement remain relatively flat at 65,000 sequentially. The number of engagements also remained relatively flat on a sequential basis. However, our revenue per consultant increased about 7% sequentially, or an annualized fourth quarter run rate per consultant of about $720,000.

Futurestep revenues for the fourth quarter were 8.9 million. That compares to 9.7 million in Q3 of FY '02.

Fourth quarter EBITDA before charges for Futurestep was negative 3.6 million, compared to EBITDA loss of 2 million for the prior sequential quarter. That's primarily due to lower revenue in the quarter.

Let me now comment on our outlook. Although we believe there are indications of a stabilizing economic environment, the continuing global economic uncertainty continues to provide us with a challenging environment. As such, first quarter fiscal year 2003 revenue will likely be in the range of 81 to 86 million. And, by the way, on the old basis, if we would have consolidated Mexico, that's about 85 to 90 million.

And the operating results will be break-even to a loss per share of six cents.

Those conclude management's remarks. I'll now turn it over to Ken so he can begin taking your questions. Thank you.

Ladies and gentlemen, if you wish to ask a question, please depress the one on your touch-tone phone. You'll hear a tone indicating you've been placed in queue. You can remove yourself from queue at any time by depressing the pound key. And if you're on a speakerphone, for clarity's sake, please pick up your handset before you ask your question.

And the first question comes from Mark Allen from Sun Trust Robinson and Humphrey. Please go ahead.

Hey, good morning, guys. Nice job managing in a terrible environment. This question would deal with essentially a little bit more color in the high end business relative to volume price and mix, and you mentioned that the C-level searches were kind of picking up while kind of the level below that was not. Can you provide any kind of additional color, you know, relative to, you know, percent - how that mix is shifting around between the C-level and the other?

Let me - I don't think we have the exact numbers with us. You know, obviously there is a lot fewer CEOs than there are VPs and SVPs. So even though that makes up, it's still a small percentage of the overall business. The good news is often from our standpoint is those changes usually result in the next level of changes. What we're seeing, though, is still a very, very cautious environment where people are slow to let go the position so, you know, the activity is there but people are just not making that next round of hires. You're seeing a very stable, you know, we're under cost pricing pressures, we've always been all year, but the pricing has held very firm, we've held it very firm, and the market has respected that, and so I think what you're seeing is a flat volume and a flat C-level right now, and given the environment, we don't see, you know, short-term a lot of change. It's very, very uncertain.

You're saying your fee percentage per search, you're holding that. Is there any delta on the compensation levels, you know, if you go kind of position by position, is there still inflation in wages?

You know, I don't think -

Compensation.

You know, I don't think we're seeing as much. Obviously at the high level there's still a lot of competition for people. But, you know, I'd say overall it's still pretty flattish and the fee structure is pretty flattish right now in this environment.

Is the - is the environment in your opinion, are you guys seeing more I guess what would be called forced turnover, you know, as a function of the economy, companies making changes due to performance issues?

You know, I think, you know, we all read - I mean I think one of the perils of being in my job is, you know, you get rated on how the company does. Part of that may be management, part of that may be the environment. So we're clearly seeing more turnover there than we have in the past, in looking for people that - you know - you know, to make the next step. But again, you know, if you look at total number of searches, those number of searches are insignificant compared to the rest of the market. They're more exciting, they're interesting, but the volume business that really is the heart of the business is the second- level business where there's many more positions.

And your sense is there is pent-up demand because people are just sitting on that now?

Oh, yeah, it's very clear, if you talk to the consultants in the marketplace, and we've seen this now for throughout this calendar year, although they've let more searches go beginning the first of the year, there are an awful lot of people that want to fill positions, and because of the economy and uncertainty as you watch the stock market, they're just very slow to fill them.

Thank you, and good luck next year.

Yeah. And one additional comment that's interested me. If you look over the last three recessions, what you've generally seen is the first, you know, year is a slightly down year. This has been unusual, this recession. Then a flat year. And then, you know, the last three recessions it's been, you know, pretty big recovery about 30% jump in our business. And my guess is, you know, we're going to slug out through the recession however long it lasts and then it will pop back up. I just don't know when that is. We don't have indications at this point that that recovery is underway.

Okay. Thank you.

Our next question comes from the line of David Billick at Morgan Stanley. Please go ahead.

Good morning. You guys mentioned a little bit about bonus compensation this year. Can you give us some color in terms of, one, how do you determine what's kind of like the metrics you use to determine an executive recruiter's bonus, and then separately, in terms of the aggregate, what you expect the total bonus payments to be in July in terms of cash and how much in terms of equity.

We have, David, I think it was end of last year that we expected about $45 million of bonuses in cash, and that number still holds. That's our expectation of the payment in July. This year under our cash bonus system, most of that was - the cash portion was really determined under a build and collect schedule, that is how much did you bill and bring into the company. The options portion is based on, you know, other factors such as not just build and collect, but teamwork, collaboration, value, contribution to the enterprise. Because of our stock swap that we did this year, we will not be issuing options until September, late September because of the - you know, the six-month and a day rule for stock swap. So we are still working with our compensation committee to finalize kind of that option payment. We're still looking at it.

Great. In terms of Futurestep, maybe if you could just discuss a little bit more. It seems that the sequential decline in revenue was less than the sequential decline in the operating profits. Could you talk a little bit about what's going on there and how Futurestep has either met or not met your expectations thus far?

Yeah, let me, David - it's Gary - let me just talk, on the sequential change, there were some - several ones, I would call them one-time items that were recorded in the fourth quarter that made that comparison that you're talking about. You know, revenue was down, you know, bye-bye seven or $800,000 sequentially. But as you pointed out, EBITDA was probably down, you know, a million and a half or so. Probably half of that was due to the revenue drop, but there were some one-time items in there.

I think that, you know, we've undergone a significant change with Bob McNabb running Americas and Asia-Pacific. You know, Bob was CEO of course (unintelligible) a hundred- million-dollar business, and Bob has been doing a great job of revamping our business in the Americas, and just, you know, an almost impossible market today. Executive search is tough, but middle management search is really a tough business right now and he's made great progress both in the revenue growth and restructuring the business.

Europe is a concern. I mean Europe is still going through some of the sort-out, although the executive search business has been surprisingly steady to us over these past few months, middle matting has been hit pretty hard and I think you'll see a decline in our European based business and therefore why we went through the restructuring that we did last quarter.

David, I'll point out one other thing, too. In terms of the restructuring for the fourth, we had mentioned it's about $5 million. Two and a half of that was for severance and two and a half was for facilities, and if you look at the reduction in employees in total, it's about 150 employees, 90 of those were in executive search, mostly Europe, but 60 were in Futurestep.

Hmm. Thanks a lot.

Thanks, David.

And the next question comes from the line of Mark Marcone as Wachovia Securities. Please go ahead.

Trying to, you know, take a look at your future guidance in terms of, you know, revenues of 81 to 86 million going forward, and I'm assuming that what you would probably expect is that you're going to have - would you expect that kind of the same sort of trends would hold, in other words, you know, that maybe we see another decline in Europe, maybe North America core stays kind of flat, continue to see a decline in Futurestep, you know, and I decline in Asia-Pac. I'm just trying to from a regional perspective can you give us a little color in terms of expectations.

I think that, Mark, that obviously predicting the global economic world right now is tough for anybody. We probably at the beginning of the year had expectations of a little quicker pickup in North America but we have found in this quarter for it to be a little flattish. So, you know, given the feeling in the market overall, we see it kind of flattish, although, you know, there's hope that it will pick up later in the year, but who knows. So we're - although we're looking for some pickup later, we are managing, from a cost standpoint, from a business standpoint, to a flat revenue.

Europe has been a surprise to us. Honestly, we did expect some further decline in the executive search business, just based on the economy, but it's been holding very well, and its confirmations, contracts have been doing surprisingly well. Futurestep has been a concern for us in Europe and shows some softening. Asia has been pretty flattish, you know, really most of the year and continues to be. It's a tough environment. We've got great market position, and they seem to be doing well. And obviously, you know, we've done what - Latin America, Mexico's done very well, but obviously South America has been a troubled economic environment. It's just not a very big part of our business, but there are some countries there where it's hard to do any business right now, so that's kind of the global picture, and I just think that given the uncertainty we're just trying not to be too aggressive in our expectations of what could happen.

Okay. But I mean if - was generally about right in terms of, you know, what I mentioned before in terms of how we might - you know, obviously we've got to kind of model this out by region and if we had to that maybe, you know, assuming that North America would be flat and, you know, Europe might be doubt and Futurestep might be down and Asia-Pac might be down just a teeny bit would probably be the best way to go, or...?

Well, it's Gary. It's Gary. I think that one thing is that in our fourth quarter, North America just had a fantastic quarter. They were up a couple million dollars -

Right.

- sequentially. You know, it's - you know, part of the that could have been, you know, kind of going into a new year, pent-up demand. You know, it's possible that that, you know, could go down a little bit. And, you know, the rest I would say is just relatively - relatively flattish. I will say that Europe, you know, in May was - you know, had a pretty good - had a pretty good month.

Mark, I think that everybody coming through the cycle, it's just hard to predict. We've been predicting, you know - I think that the one trend is that Futurestep in Europe will be down. Everything else has looked - you know, our outlook is relatively flattish plus or minus.

Okay. I'd like - I'd like to ask a really positive question, but first I'd - could you give us kind of the monthly sequential, you know, kind of how the trends went by month across the quarter?

It's very hard because the - you know, you get -

I know it's bumpy. I'm just trying to discover -

It's very bumpy. You get a big bump in January and you get a big off certain times of year, and then we had, you know, with an April close, the first two weeks of May are slower, but there's obviously people rush to close business at the end of the year. So I mean the indications I think for seven weeks going forward aren't much, but for the past quarter, what would you say, it's been pretty level, actually.

I would say if you look at our conformations in March, you know, in May, the first couple weeks of June, just look at our weekly conformations, you know, they're pretty much running at the same level that they were in, you know, April. In terms of the monthly, I don't have that breakout here in front of me.

Okay. I was interested in what you said before about early - you know, you've obviously done an exceptional job in terms of rationalizing the costs under really tough circumstances, and you mentioned that, you know, potentially if you could get a 10% increase in revenues, if I heard this right, that you - you could potentially end up with 15% operating margins? Is that right? And then if that's the case, is that off of your current run rate, or off of what you're doing - what you did on an annualized basis? In other words, would it be, you know, 10% increase off of an annualized run rate off of the fourth quarter of 90 million o would it be off of your annual production this past year?

This is a very revenue sensitive business, as I think all service businesses are. You know, it's - it's hard to cut costs, you know, in any business, but do you it, but the truth is we're very leveraged from an operating standpoint. If you look at revenue per consultant, I mean we have 30% plus capacity just based on a existing consultant not even hitting our high historic levels, both in terms of number searches per consultant and revenue per consultant. So, yes, if you look at just our run rate now, 10% increase in revenue would deliver 15% operating margins on a consolidated basis. So the leverage is there, we've been over it a million times. we've looked at it three or four ways and we come up with the same answer. There's huge leverage in the business but, you know, to get a 10% increase we've either got to steal great market share or get a little help from the economy.

Is that 10% off of the 90 million or 10% off of what you did during the year?

It would be 10 - 10% off the - you know, off the 90 million with Mexico 93 million, something like that.

Okay. Great. Thank you.

If there are any further questions, now is the time to press one. We have a question that is coming from the line of Kelly Flynn at UBS Warburg. Please go ahead.

Thanks. Could you give more detail about what you're seeing across various industries, with particular interest in financial services and technology?

Yeah, Kelly, I would say that, you know, first, the growth industry for us, and probably for everyone, has been health care and not-for-profits. I wish it was a bigger part of our business, but those businesses have been very, very robust and continue to show kind of high resiliency in this market. Quarter by quarter sequentially, actually financial services and consumer markets showed pretty good increases. I am concerned, you know, the kind of double-digit increase quarter on quarter. Obviously I think the financial services market, especially when you take in investment banking and corporate finance is still a very iffy market. I mean you get some hires and you get layoffs and you hear people saying they're not hiring. So I'm very cautious on that segment. But the consumer piece seems to be solid, the strictly piece was off slightly but it had done better last year than the other segments had. But, you know, just the retail and consumer part has done well. You know, technology is just tough. It was - it was about flat quarter on quarter, slightly down, but it's just - you know, it was battered last year and don't see huge signs of recovery there yet.

Okay. Also, just to sort of follow up to that, do you have any - based on your observation from historical patterns, do you have any views on which of the industries that you just spoke to are likely to show pickup first? I guess excluding health care.

You know - yeah, I think this economy has surprised everybody. You wouldn't expect consumer to be doing well in a recession, but obviously it's done both from an economic standpoint. From a business standpoint it's done well. Health care shouldn't be a surprise. You know, people get sick, and do - you know, use health care services no matter what the economy is, so we should expect that. I obviously believe that, you know, probably the industry that's had the biggest swings historically for us has been financial services. It's been an industry that cuts very quickly and hires very quickly. And, you know, I think the technology recovery is going to be, you know, slower, but I think those are two industries that, once they hit whatever that return point end will hire aggressively, but I think it will be kind of slow until they feel like there's a return. And that's why we're being cautious in the outlook.

Okay. And then a different question for the Q1 guidance. Can you give us some indication as to whether or not that assumes basically constant head count?

Whether it seems what, Kelly?

Constant. Where does it stand for consultant count? Does it assume approximately the same that you ended with?

Yeah. That's - that's correct.

Okay. And then also on that issue it seems that you said your consultant count on average was down 26 through the quarter, but that didn't foot with the number that you gave in your press release last time, which was 493. Can we assume that that difference relates all to Mexico?

Yeah.

Okay. Okay, great. Thanks a lot.

Thanks, Kelly. We continue, too, I mean for the audience, if you look at our business, we really sized it, 1998 calendar year roughly we were this size, our support staff, our, you know, corporate everything is about size for that revenue run rate. But we do have more consultants than we had then. So we clearly have the capacity with an economic upturn to handle the business. Although we have fewer consultants we've been very aggressive, you know, both counseling the people that we felt weren't long-term players and retaining the people, you know, that we thought were. And so we still have capacity.

And are you through, Ms. Flynn?

Yes, I'm done, thanks.

Thanks, Kelly.

Our next question comes from the line of Stefan Mixtu at Tight Place Capital. Please go ahead.

Hi. Good morning. A couple questions. Just back to this upside, you know, the earnings leverage on the turn, what is that - what does that imply about kind of where you're - are your break-even costs now about somewhere around this kind of mid-eighties million per quarter? Is that kind of the cash cost of running the business now?

Well, I mean if you - if you look, if you were to assume that if you exclude bonus for a second, and if you were just to take all the other costs, you know, our fixed cost structure there is, you know, probably around, you know, 73, 75 million, something like that, excluding depreciation and amortization.

Okay. And then excluding any kind of bonus accrual, you're saying?

Yeah. Yeah, that's exactly right.

Okay. And a piece of that is - is in - Is Futurestep still really standing on its own, or is that - is that more - is it the revenue just separately reported but the infrastructure more consolidated, or integrated?

A little bit of both. I mean we do treat the revenue and directly charge expenses as directly charged to Futurestep and the company, but we do have a shared services agreement for infrastructure where they pay their, you know, kind of fair share of the general infrastructure costs and any specific items that they have that are unique to their business.

Okay. And is there - do you have some time frame by which you think Futurestep can get to break even and then eventual profitability?

The question is a market question, honestly. I think the break-even is now in the mid-forties. And again, there's leverage in the model. You know, Bob McNabb has been - done a great job with changing the model into really doing what I would call your bulk hiring or outsourcing of middle management hiring. But, you know, there is - he's made great progress. We've signed a lot of pretty large contracts, and there are a lot of them that are kind of agreed to and on hold. And I think he needs a little bit of market help. So I think the question on timing is when does the market return, because we've taken the costs out of the business.

Right. Okay. And then in terms of the - you know, you said about 45 million of cash payments for bonuses in July and earlier you had said that you're targeting about a 50% cash payout of bonuses, does that imply, then, you'll be issuing options, you know, if the stocks hit at these levels, you'd be issuing somewhere around five million options in September to cover the equity portion of the bonuses?

There's no way we'd ever considering issuing five million in options. Let me answer the first part of your question first is that the bonus plan basically said that under our typical build and collect schedule, that you earn a bonus. We would pay at the low end 50% of that bonus in cash, but the truth is, if you don't earn, you know - if you don't deliver north of 700,000 in revenue, the bonus is essentially zero in the calculation anyway. Our top producers were guaranteed an increasing percentage up to 100% full payout, which - which a single producer hit this year. So on average it's much more than 50%. No, we have separated the cash from the options fees. We are not using options to make up the shortfall in the cash feeds at all. The option feeds is still under the old formula.

Okay. So what's the rest of the bonus, then? In other words, if the 45 million is - maybe I'm misunderstanding, but if the 45 million is targeted at a 50% payout, you're saying the rest of that bonus either wouldn't - isn't - the consultant is not entitled to it because they didn't hit a, you know, prescribed level, or - you know what I'm saying? What's the rest of the bonus, then? How is it satisfied?

The cash - this is - our old system is very complex, and I'm happy to go into it but we're also getting away from the revenue system in place.

Okay.

But under the old schedule it said that you were entitled to a claim on a bonus pool. You didn't absolutely get paid no matter what, based on profit, that if you generated X-dollars of revenue, that you were entitled to X-dollars of payment against a bonus pool. That bonus pool could be higher and they got more or that bonus pool could be less and they got less. What we said this year because of the uncertain market and want to go retain our top producers is we wanted to set a schedule that said at the low end we would pay you 50% of your cash bonus which was basically 70% of your total compensation -

Okay.

- and up to a hundred percent, and that 30% of the compensation was in stock options. We are not making up that shortfall in the bonus pool. We're saying that, you know, because there was no bonus pool, and there were no profits, you do not get those bonuses. And it's no different than our competitors have done.

I see what you're saying. Okay. Do you have some sense of how many options you have to issue, then, in September to satisfy any obligations under the bonus pool?

No, we're still working on that but it's not anywhere near the number you're seeking.

Okay. And then lastly, did you go back historically and find, when was the last time that revenue per consultant was this dismal, and, you know, what does that kind of imply as to where we are in the cycle?

First, apples to apples. First, compared to the other people in the industry, we count our prepartners principals as consultants. Most firms only count their partners. So first, if you look apples to apples and compared us, we have many more people we classify as consultants versus our competitors. So that's number one. We use a principal category which is a prepartner, we count them as consultants because they do have revenue goals in their numbers which is half of what their consultants - the partners make. At the peak that number was near a million dollars a consultant. That was our best year ever. Now, again, versus our competitors, that's probably a million four or some number like that on an apples-on-apples basis. So, depending on what you want to compare it to, let's make sure we have the right denominator.

Okay, that's fair.

Okay? But apples to apples, we're about 700 and change versus a million at the peak, and I would say that if you go back through history it's always been in the eight-plus range. This is - this is the worst year for us, at least that I know of.

So you probably go - got to go back more than a decade or something to get to these levels?

Yeah, I think you have to go back - I think you could go back 30 years since the beginning of this business and never see a decline like this, ever. So I mean this has just been an unusual event.

Okay. All right. Well, good luck on the turn.

Thanks.

Next we go to the line of Dan Ditler as Lehman Brothers. Go ahead.

Yes. Do you have any planned further restructuring or asset impairment charges for the first quarter of fiscal 2003?

No, we see no restructuring, and we see no impairment charges. We've been pretty aggressive in writing things down as we see any potential impairment. And again, this impairment was a noncash item.

Great. Thank you very much.

And we have a follow-up question from Mark Marcone as Wachovia Securities. Go ahead.

Futurestep, what percentage of that is - is Europe? In other words, how much of Futurestep's revenues come from Europe at this point?

Yeah. Quite a bit, Mark. If you look in the fourth quarter, we did about $9 million of revenue in Futurestep, you know, about seven of it was from Europe.

About six.

About six, I'm sorry. Then the other million was Asia. And so if you look, it's six - six Europe, a million of Asia, and a couple million bucks for North America.

Okay. And do you anticipate at some point that the Europe portion is going to stabilize, or...? You didn't sound very optimistic.

No, I - we absolutely do. I mean it's an economic cycle. If we didn't think it would we'd have a different view of the business. But, you know, obviously the middle management has been hit. I just don't know - I think we're going to see not a, you know, eclipse in Europe but I think we're going to see some downward drifting over the next few months.

Okay. And then Mexico, does it fit into Latin America or North America?

Latin America.

Latin America?

Yes.

And would you be so kind as to at some point in the future provide us - you did a great job with regards to the Appendix A, you know, for the overall deal. Would you be able to give us those numbers for - on a quarterly basis going back from Mexico, or for Latin America?

We will obvious when will we file, you know, to reclassify the whole - you know, historically so you'll have all that information, but we'll be able to give it to you.

Okay. Thank you very much.

And next we go to the line of Seth Rosen at Imminent Capital. Please go ahead.

Hi, guys. I've got two margin questions. The first is just a clarification of what you said before. I wanted to make sure I understood. I thought you said that based on the 90 million of revenue, if you had a 10% revenue increase, you'd see 15% margins. I think that implies over 100% incremental margins, so I must be doing something wrong there. And then the second question on margins was you mentioned you have thirty%-plus capacity, if you will, for the consultants. I'm wondering, you know, if you get back to, you know, maybe 90 to a hundred percent capacity, given the aggressive cost cutting, what you think EBITDA margins for the company would be in that type of environment.

Let me answer your - your first question in terms of the incremental change. You know, the marginal payout on the increase in revenue would be very small, so, you know, again, which is 93 million, which is the old basis, you know, you're talking a revenue increase of $10 million. Substantially all of that would fall to the bottom line. Secondly is that we went through this restructuring in our fourth quarter, and that is going to produce, you know, annualized savings this year of probably almost $10 million. And so, you know, just those two alone you can easily see how you get there.

Okay.

I'm sorry. What was your -

Just the long-term margins if you get - given the aggressive cost cutting, if you get back to, you know, a more normalized revenue consultant - revenue per consultant that implies 90 to 100% capacity utilization, what type of operating margins or EBITDA margins you think the business should be able to do.

Well, you can see, I mean right with that example of a 10% increase, there is just, you know, we've got a lot of muscle, got a lot of talented people in this organization. I don't see any reason why we can't be 15 to 20% operating margins.

Okay. Great. Thanks.

And next we go to the line of David Billick at Morgan Stanley. Go ahead.

Hi, guys. It looks like you've done a lot of work of people looking at history and people getting at capacity issues and growth coming out. Even in the second half of the nineties that searches per consultant rose pretty rapidly partly due to the Internet boom as search per consultant went from 15 per year to 18 from 1997 to 2000 down to 16 in 2001 and about 11 in fiscal 2002. Given that there were - I guess there were some complaints about the quality of service people we're getting kind of towards the end of the boom. When you're talking about capacity, what do you think is a normal level of searches per consultant that can be done per year on average? Long question. I hope it made sense.

No, I think one is it's going to vary by region. In North America it's going to be less. Some other parts where they do - where the fees are less but do you more searches. But overall in the system, you're absolutely - we have done a lot of modeling and have looked extensively at the business say in the summer of '98, before the - if you want to call it a bubble. And we realistically think that, you know, system-wide we should be able to be, you know, around 15 engagements, you know, 16 engagements per consultant. We don't see why - why we couldn't do that. Obviously now that varies from region to region. North America would be less than that, other parts of the world would be slightly higher.

Thanks. That's a big help for modeling purposes.

Yeah, and Dave, you know, from - what we've done is we've gone back and normalized years, too. We've look at '97, '98, '99, 2000 before things have boomed up where there was more steady state business. And those numbers of searches per consultant hold, we're not looking for, you know, just 15 searches at 65,000 average fee gets you to the million dollars, which is a very profitable level, so you don't need record numbers to be a very strong business.

Great. Thank you.

Once again, press one if you have a question.

I think we're at the top of our time line, so if there's one more question, Kim, we can take.

Okay, there is no one in queue now.

Okay. Well, great. We'll just make a closing comment, then. You know, obviously I think we've managed our costs very tough in this market. We're optimistic about our future, but it's a very cautious environment, so we're going to manage our costs tough, keep our people motivated and focused and, you know, we're going to have to wait for this economic return and do what we can to take market share during this downturn. So with that I thank you for your time and, Kim, I'll turn it back to you for the replay.

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