Heidrick & Struggles International, Inc.

Good morning, everyone, and thanks for participating in our fourth quarter and 2011 conference call. Joining me on the call today are Kevin Kelly, Chief Executive Officer; and Rich Pehlke, our Chief Financial Officer.

As a reminder, we'll be referring to supporting slides that are available on our website at heidrick.com and we encourage you to follow along or print them.

As always, we advise you that this call may not be reproduced or retransmitted without our consent. In today's call, we'll be using the terms operating income and operating margin excluding restructuring charges and operating income and operating margin excluding impairment and restructuring charges.

These are non-GAAP financial measures we believe better explain some of our results. A reconciliation between GAAP and non-GAAP financial measures can be found on Slide 24 in our supporting slides and at the back of our release.

Also we'll be making forward-looking statements on today's call and ask that you please refer to the Safe Harbor language contained in our news release and on Slide 1 of our presentation. Our slide numbers refer to the slide numbers in the bottom right-hand corner of each Slide.

And now, I'll turn over the call to Kevin. Please start on page -- on Slide 2.

Thanks, Julie. Good morning, everyone, and thank you for joining us.

Today, we reported revenue of $528 million for 2011, a 7% increase year-over-year. With this recovery being slower and more uneven than the ones we've experienced in the past, we saw more volatility in our results from quarter-to-quarter.

At the same time, our full-year net revenue was at the midpoint of our guidance we provided at the start of 2011. On an operating basis, excluding impairment and restructuring charges, we improved the operating margin to 6%, having made especially good progress in controlling our cost structure.

We are very pleased with this outcome. It's a reflection of our strong client base, the quality of our people throughout the globe, as well as management's commitment to deliver growth to our shareholders over the long term.

We recognize that although we delivered solid revenue growth and margin improvement, 2011 did not come without costs. We took some aggressive actions in the fourth quarter in the form of a restructuring to better align our geographies with our clients and provide the capital necessary for targeted investments.

With that backdrop, let me highlight a few other key metrics of our business in 2011. The Americas region delivered the strongest performance with revenue up 12%, while Europe grew 4%.

Asia Pacific's revenue were down 1% compared to 2010 but against a tough year-over-year comparison. In 2010, revenue in this region grew 47% in part due to several large clients.

We believe that one of our competitive advantages is the deep industry knowledge our consultants are able to provide our clients.

On Slide 4, we provide you with a breakdown of our 2011 performance by practice and Slide 5 reflects our improved industry diversification. Every practice achieved year-over-year revenue growth in 2011, except the Financial Services practice, which declined 10% or approximately $15 million.

In the Americas, revenue from the Financial Services practice was up slightly. However, we saw declines in Asia Pacific, which was largely expected due to the high volume of work we generated in 2010.

The Financial Services practice also saw a decline in Europe, but this is more broad-based and largely a function of market conditions in that region.

From a functional practice perspective, I'll highlight the performance of our 2 largest practices, the financial officers' practice and the marketing sales and strategy officers' practice, which grew annual build fees 20% and 12%, respectively, compared to 2010. Our strategy is to extend Heidrick & Struggles' strong reputation as the leading search firm at the C-suite and board level to that of a Leadership Advisor, helping clients not only attract but also retain and develop leadership talent for their organizations.

On Slide 6, you'll see that revenues from Leadership Consulting Services increased 14% in 2011 to $45 million and represented 9% of total net revenue in the year, up from 8% a year ago.

Slide 7 shows we confirmed 4,274 searches last year, up 2% compared to 2010. And Slide 8 highlights the average revenue per search of $112,900, which increased by $4,400 in 2011.

Moving to Slide 9. We ended the quarter with 347 consultants, the same as at the end of last year but a decline of 39 compared to the end of the third quarter, reflecting the workforce reduction in October.

Globally, our voluntary turnover in 2012 was 9% and in line with an average year.

Productivity on Slide 10 is measured by annual net revenue for consultants, was $1.4 million in 2011 the same as in 2010 but based on 23 higher average consultants in the year. We believe that the combination of hires made in 2010 and 2011 who are now reaching higher productivity, and the reduction in force last year that included exiting underperforming consultants should help us achieve higher productivity levels in 2012.

And with that overview, I'll turn the call over to Rich.

Thanks, Kevin, and good morning, everyone. I'll begin my remarks with the discussion of the operating expenses.

Starting with Slides 11 and 12, salaries and employee benefits expense increased by $32 million or 10% year-over-year. In constant currencies, the increase was $21 million or 6%.

Fixed compensation expense, which includes equity compensation, accounted for $20 million of the increase, and is largely attributable to the year-over-year increase in employee headcount that we carried throughout most of 2011 until our workforce reduction in October. It also reflects merit increases that were implemented in early 2011.

Performance-related variable compensation accounted for the remaining $12 million increase, primarily as a result of the higher bonus accruals related to the growth in net revenue of 2011.

Turning to Slide 13. General and administrative expenses declined year-over-year by $7 million or 5%, and as a percentage of net revenue, declined to 23.4%.

In constant currencies, G&A expenses declined by $10 million or 8% in the year. We're very pleased with this reduction as it comes from tighter controls in a number of areas throughout the firm.

Lower professional fees, real estate expense, unbilled travel and entertainment expenses, and general and office and administrative expenses were 4 of the largest contributors to the decrease.

On Slide 14, you'll see we have reduced our rent expense by $7.9 million over the last 3 years. This is great progress towards the goal we set in 2009 for a reduction of $10 million in 5 years.

Turning to Slides 15 and 16. We produced operating income excluding the impairment and restructuring charges of $31.8 million in 2011, and our operating margin improved to 6%.

This compares favorably to 3.6% in 2010 and represents good progress. We did not achieve these results on an EPS basis, largely due to our effective tax rate.

As I have mentioned in previous calls, our taxes in 2011 reflect losses and charges that cannot be deducted for tax purposes on our book financials. The goodwill and intangible asset impairment in the third quarter is a good example as we did not have a tax basis in these assets.

Therefore, the impairment of goodwill did not generate any tax benefit for book purposes. In addition, there are a number of jurisdictions, primarily in Europe, where we have established valuation allowances against deferred tax benefits.

Not only does establishing the valuation allowance create a one-time deferred tax expense but allows us not to recognize current losses as checked [ph] by the bids [ph] in these jurisdictions. As a reminder, our reported tax rate is not our cash tax rate.

Although we reported a 128% negative effective tax rate for the year, we anticipate the effective cash tax rate to be approximately 40% in line with our 2010 corporate income tax filings experienced.

Looking at Slide 18. Net cash provided by our operating activities in 2011 was $44.8 million, compared to $84.3 million in 2010.

The year-over-year decline primarily reflects the decrease and the change in accrued bonuses, partially offset by the improvements we've made in managing working capital especially in the accounts receivable balance. We ended the quarter with $185.4 million in cash and cash equivalents, up from $135.5 million at the end of September and $181.1 million at the end of last year.

Those of you who are familiar with our bonus -- our business know that our cash position typically builds throughout the year, as we accrue for our variable compensation and deferred compensation, and the cycles of these payments occur in February, March and April of each year. Our fourth quarter cash position was favorably impacted by our improvement in the collection of our receivables but this was somewhat offset by cash payments we made related to the restructuring.

Looking at 2012, in February we paid out approximately $10 million of cash related to the portion of consultants' compensation that were deferred in 2008, 2009 and 2010. In March and April, we expect to pay approximately $109 million of variable compensation related to 2011 performance.

This compares to last year when we paid approximately $95 million related to 2010 performance. We also expect to pay approximately $8 million in 2012 related to the restructuring actions we took in the fourth quarter.

We expect CapEx to be in the range of $8 million to $11 million for the year, a decline compared to $18 million in 2011. Our proprietary search system is currently being piloted and our investment in developing the system will taper off by the summer.

We also perceive fewer new office build outs. As we have said previously, our global cash fees at any given time range between $40 million and $60 million.

One small housekeeping item to make note of. In 2012, we'll be moving to the operating responsibility for our Middle East region from Europe to Asia Pacific, and we'll be reporting our segmented results to reflect that change.

Currently, we have one office in Middle East, in Dubai, and revenue attributable to this region was just under $3 million in 2011.

Slide 19 shows our quarterly search confirmations and Slide 20 shows our backlog. As is typical with our business, fourth quarter confirmations were lower than the third quarter, so backlog is lower going into the first quarter.

Fourth quarter confirmations fell off more than what we've seen historically, which was disappointing, but not totally unexpected due to the restructuring actions we took in October as well as conditions we've experienced in the financial services sector. In our monthly confirmations slide, in Slide 21, you'll see that January improved compared to December, and that February will be an improvement to January and on par with February of 2011.

As we noted in the release, current market conditions around the world and prevailing uncertainty continued to make it increasingly difficult to forecast our business. Today, we are a leaner company than we were last year at this time.

And because we expect volatility in the business and economic climate for some time to continue, we'll be cautious about hiring levels throughout 2012. We're currently forecasting net revenue of between $510 million and $540 million, which represents a mid- to high-single digit growth from our current base of consultants.

We do not expect any practice or region to be the single driver of our growth and to weigh on our growth. We are forecasting an improvement in operating margin, currently expecting between 7% and 9% overall, with the range mostly dependent on how revenue sorts out.

The restructuring last October is expected to produce annualized savings of $20 million to $25 million. While some of these savings will be selectively reinvested in the business, we will be very prudent about how and where we invest.

We'll continue to apply strong ROI governance to everything we do and any investment will be evaluated based on the impact on clients, consultant productivity, cash flow and margin improvement.

As for quarterly guidance, we have provided a forecast for net revenue in the first quarter of between $105 million and $115 million. Given the current volatility and market conditions and the general lumpiness of our quarterly results, our visibility of quarterly margins is too cloudy.

We believe it is more meaningful to share with you directionally where we are working to take company for the full year.

And with that, I'll turn it back over to Kevin.

Thank you, Rich. Before I turn my comments to 2012, I'd just like to note that I'm very proud of our overall performance in 2011.

Heidrick & Struggles ended the year in a much stronger operating and financial position than where we began. And as it relates to our business, we are feeling positive about our prospects for 2012.

That said, we fully recognize that our business is driven by larger macroeconomic conditions and therefore, we will continue to manage our cost aggressively, invest selectively to maintain our financial strength and flexibility. Serving our clients around the world is our number 1 priority, so we're building on our unparalleled executive search capabilities with Leadership Consulting Services to become a Leadership Advisory firm.

Our strategy is continuously reinforced by conversations we're having around the globe with our clients and other CEOs. It's no longer enough to have a strong management team in place, where the pressing need to ensure that the talent aligns with long-term business strategy.

To support the continued growth of our leadership consulting capabilities, in December, we hired Erik Coles [ph] and his global practice managing partner of leadership consulting. Erik brings relationships with many Fortune 500 companies and extensive experience having led several international leadership consulting firms throughout his career.

We're very confident that under his direction, we'll be able to continue to develop our leadership consulting capabilities, and expand our highly successful client relationships.

To be a Leadership Advisory firm, not only means growing our consulting capabilities but also continuing to expand our Search business. Our focus in 2012 will be to make some selective hires to fill very specific needs throughout the globe and to strengthen our practice verticals or geographical areas that align with economic growth.

These investments will be tied to increasing consultant productivity in support of our long-term margin targets. We believe that both profitability and productivity go hand-in-hand, so we're committed to ensuring our consultants have the best platform from which to succeed.

When we roll out Latitude, our propriety search database at the end of the second quarter, our consultants will have access to the state-of-the-art technology that will allow them to work more effectively with their clients. We're also introducing our path to partner program this year to strengthen our relationships and ensure our consultants have clearly defined professional development objectives.

We believe these types of investments, which are directed at ensuring we serve our clients well, will help continue to differentiate Heidrick & Struggles and allow us to reach our long-term objectives.

Before we open the call up to questions, I'd like to take a moment to thank our colleagues around the globe for all of their hard work in 2011. Without a doubt, we have the best people in the business, and we couldn't be more proud that they represent Heidrick & Struggles on a daily basis.

We'd also like to thank our shareholders for their support and acknowledge we're committed to delivering the long-term value that you expect.

Thanks again for taking the time to join us this morning. And at this time, Rich and I would be happy to take any questions that you all may have.

This is actually Derek Sbrogna for Kevin McVeigh. I'm just wondering if you guys can pry a little more detail on what your guidance implies by each year at the 3 regions?

Well, sure. We don't give guidance by a specific region.

We give it by total company. So clearly, I think given the nature of the restructuring efforts we took in the fall, you can tell that we are still cautious about the European global economy and the economies within certain countries.

The volatility that we've experienced there, in terms of all of the sovereign risk and political risk that exist in that region of the world has caused us to pull back geographically a little bit in that region, I think, in a prudent way. Nevertheless, we've also got a number of up-and-coming consultants in that region, that I think will give a very positive contribution to the business.

U.S. still remains the largest portion of our business and Asia Pacific, which was one of the regions that was hit a lot by the financial services sector in 2011.

I think it's certainly going to be one where we're going to continue to invest because of the growth in the economies in the countries that we see. So we're still looking for balance geographically.

I think we're looking for diversification geographically but that's as far as we'll go in terms of specific direction.

Got it. That's very helpful.

And just one kind of housekeeping question. You guys, you'd talked about the normalized tax rate of 40%.

Was that a 2011 number or is that looking forward for 2012 and...

It was a 2011 number in terms of the cash tax rate and we expect it to be about the same. That was for 2010 as well.

It's what we expect the 2011 payments to be in effect as well.

Got it. And then that'll be the same for 2012?

For 2012, I would expect it to be in that range. I mean, what's going to dictate that over time is how we make money and where we make money.

I mean, as I mentioned in the call, our balance sheet is very conservative because we have a number of valuation allowances. And so we take a lot of attention to where we want to have costs and where we want to drive profitability because we could have the opportunity to improve that over time as we grow certain sectors of our business.

This is actually Matt Hill in for Tim McHugh. My first question is -- previously, you guys had talked about shifting your focus from managing the business on a practice level to more of a regional focus, thinking that would drive some cost savings and possibly improve margins.

So I was wondering if we can get an update of how far along that is and kind of what you're seeing so far?

Yes, this is Rich. I'll start with that.

The practice focus that we have in our business is largely one that helps drive the revenue and economic opportunity and the hiring practices of our consultants across the globe. But one of the things that we've taken a hard look at, in the end of 2011, was to make sure that we didn't lose sight of managing the cost in our region and office basis.

And I think we've made some improvements there. I think one of the reasons we saw a little slippage in margin over the last 18 months was the fact that in driving the practices, and focusing so hard on practices, that you can lose sight of your cost base and -- which is much easier and much more appropriate to manage on an office-by-office and country-by-country basis.

So we balance that. There's always a fine line.

But clearly, we work very closely with our regional leaders and our practice leaders in all those -- across matrix environment to make sure that we're taking advantage of all the economic opportunity and business opportunity we can, but still having a very strong discipline about cost. And I think you started to see that play out in the last 2 quarters of 2011.

Okay. And then one more on -- just kind of an update on financial services.

What you're seeing and hearing from some of the clients out there, and then maybe on a regional basis to that?

Sure, Matt. It's Kevin.

Financial services has been kind of a small [ph] -- just 3 plus years and I think anyone can pick up a newspaper without seeing that there's some challenges still that remain in financial services. Having said that, there are still areas of growth in financial services and there's still a number of international banks and investment banks that continue to expand.

And we've been very well served in helping some of these banks expand not only in the North America but other parts of Europe and Asia and Latin America as well. What you're also seeing the market as a shift towards -- and in compensation towards more equity.

That's impacted some of these fees that we've seen out there where we used to get the first year's fee based on cash, net cash compensation. So there's been a little bit impact there.

But as I look forward in 2012, what we're hearing, and I just met a number of executives in the financial services industry that they expect their business to pick up in the second and third quarter of the year. And after bonus time, we'll see probably some greater activity in the financial services sector.

Continued growth in Asia Pacific, you'll see it's probably fairly flat in North America and there are still opportunities in Europe as well.

I was wondering if you could give us kind of the main contributors of what will be an improved operating margin compared to last year despite the fact that kind of at least based on annual revenue guidance, revenue looks to be kind of more or less flattish?

Sure, Tobey. This is Rich, I'll start on that.

I think the biggest driver is a couple of things. Number 1, we've made a few refinements in our expense management and cost base and we're going to continue to give that intention.

But I think the number 1 area is really where we've -- the actions we took in the restructuring and where we reset our footprint, if you will, geographically, and also to match kind of our client needs. We have taken a significant amount of fixed compensation out of our cost base.

And it's one of the areas that we're going to continue to put a very stringent control on, only from the standpoint that we wanted to be as variable as possible over time, so that it really -- we make sure that we're paying our best people. It works better for retention.

It also drives productivity. And so -- and it also helps us manage the overall return on investment.

So the biggest majority of the cost savings really came out of the fixed compensation line. And we'll come out of that line in 2012.

That being said, we are going to be selective about how we hire. We are still going to continue to address market needs and we have the funds to do so.

I feel very good about the strength of both the cash position as well as the balance sheet that we have more than ample resources that we -- it should be -- start to see investment levels pick up by our clients. We'll be in a great position to address those, both with our current base of consultants and to fill out any growth needs that we may have in certain geographies.

But that's really where the bulk of the savings will come.

My second question has to do with driving increased productivity kind of as measured by the annualized revenue per consultant. How do you look at -- first of all, do you expect to be able to increase it this year?

And if so, how could you, how do you expect to do that if financial services may be a little bit more modest because of the increased equity component?

Sure. In a couple of things, as Rich mentioned, we went through our restructuring last year and we took out a number of underperformers in the organization, number 1.

Number 2, we did a lot of recruiting. So over the last 18 months and as we have analyzed how long it takes individuals to get up to speed, it's anywhere from 12 to 18 months.

So what we've seen over the course of the last 3 or 4 months is we have a lot of hires that we made at the end of 2010, 2011 really start to ramp up. So it's a combination of those as well.

And one thing that -- to remember with financial services is, even though investment bankers or bankers get paid a decent sum of money, we've always had caps in place. And even though somebody may have made $1.5 million, $2 million, we still had a cap of $400,000 or $500,000, so the impact wasn't as great as we've seen.

Plus we have a great group of people in financial services and they're very entrepreneurial. And one thing to mention is we've also seen new areas of growth in financial services and back-office infrastructure, technology, legal and compliance and risk.

So we've seen -- we're seeing growth in that area and quite frankly, given the state of the financial services, market risk and compliance is huge and compensation in those areas is still fairly high. So between the restructuring, between our development of people, between the time it takes to get up to speed in areas of growth in financial services, not to mention industrial and consumer goods and technology, we believe we can continue to increase and increase productivity this year.

Okay. So you do expect to increase it.

But Kevin, you mentioned the equity component -- I mean, financial services is increasing. Are you just citing it anecdotally but saying it does not impact the financial performance of the firm within that segment?

It depends and it's case cut by case basis. I mean, there's way to restructure fees where it doesn't impact it, and we've been working with clients to make sure that we're paid fairly for compensation that's given.

We've seen some firms do it for years. Some may do it longer term but they've all -- investment banks have always had a deferred element be it 30% or 40% for some of the larger investment banks.

But for this year, some have increased it more. But what I'm saying is that, yes, it should impact it somewhat, but given the entrepreneurial spirit of our Financial Services practice and the talent that we have in that sector, they are engaging with their clients to figure out how we can maintain the fee levels that we have historically.

Okay. And my last question, just wanted to get some color around how you're thinking about your consultant headcount this year, if you have plans to increase it on a net basis or at this point, you're thinking kind of more stable numbers?

Well, I think currently, I think by the time we're at the end of the year, you might see a stable to a very slight increase in terms of headcounts. And a lot of that will be driven by promotions as Kevin indicated.

We have a number of people in our pipeline that are up and coming. So it certainly could be organic growth in a number of consultants.

We're going to watch it carefully. I think it's really important to mention that I think we're taking slightly more stringent and focused approach on performance management.

So I think the numbers of consultants, while it may not be growing much I think, the quality of what we have in our firm will be much greater.

Last question. Spendable cash as of next month or April, by my math with your bonus accrual in the severance pay out, it's about $65 million or $70 million, is that about right?

It could be. It's -- a lot is going to be dependent upon how we manage the working capital over the next 30 or 45 days.

You're absolutely right. As we said on previous calls, our cash balance, some of our cash is restricted in countries and is somewhat logistically difficult to move around.

So at the right jurisdictions, we do have a considerable amount of outflows coming in the next 60 days between restructuring and bonus payments. I'm not afraid to use my credit line if I would have to, in the short term, just to balance that to avoid moving money unnecessarily or at high cost.

But we're just going to wait and see. We're just managing that very tightly.

But I don't foresee that as any kind of a long-term issue over 2012.

I had a question about the leadership consulting business. You said overall you're going to be cautious on hiring this year.

But first of all, I was wondering if the hiring environment for leadership consulting still is competitive and if you plan to continue to add there in 2012?

Yes, one of our -- Kevin, this is Kevin. Just one of our key focal points for 2012 is the scaling the leadership consulting business.

And that's one of the high priorities. We've brought Eric in, in December, and we will look to invest in that area.

We're seeing a lot of client demand not only here in the United States, but globally, Europe, Latin America and Asia Pacific. So we will continue to recruit in that area and look to how we can scale that business given the demand we're seeing in the marketplace.

And how do you feel about the overall progress of integration between search and leadership consulting at this point?

I think it's worked very well. We may -- I think you may have been on the call that we mentioned before.

We find that the retention rates of our clients jumped significantly. And our fees are much higher as well when we have an integrated approach to leadership consulting.

And I can tell you, from just seeing a number of clients across the globe that they're really delighted with the service offering that we have, whether it's on the succession planning, assessment or development front. And so at this point in time, the integration is going well.

The biggest challenge we have and as I mentioned that the focal point is delivering for our clients because of the demand out there and how we can scale the business at a much faster pace.

Another follow-up question. Kevin, where do you see social networking now impacting the business?

I'm interested in your thoughts as far as it being a tool. But also I'm curious if at the margin kind of on the lowest end of where the firm operates, if you're seeing it as a competitor as well?

One thing to -- Tobey, it's a great question and I think you know we've been focusing on these technologies for a number of years at Heidrick & Struggles and to make sure that there isn't a risk of disintermediation and how do we embrace these technologies and really help our consultants as well. What we've seen in this area is, yes, there is a number of Web 2.0 technologies out there and we actually use them.

And we're probably the first to admit that it really helps us in terms of delivering at a much faster pace to our clients and it really cuts down the front end of the research phase that we have to go through every time we execute the search. But something to bear in mind and I've asked this to a number of clients over the last year.

One of the strengths we have as a firm is not just putting a resume in front of somebody or using technology to shot a resume at somebody. It's really assessing and developing these candidates to make sure that they stick at an organization for a long period of time.

And we used this statistic frequently, that 40% of senior executives don't last 18 months in an organization and a lot of that has to do with the fact that culturally, they may not fit in and that can be missed if you just pass a resume on in terms of technology. So it's the assessment process that we go through that really differentiates us from these competitors.

And to put it in perspective for you, I was seeing a client recently. And to your point, they have hired a number of people internally to use these technologies, LinkedIn specifically.

But if you, and I'm referring to a specific technology client, they advertised on LinkedIn for a one position and ended up with 1,700 resumes. Now when you get 1,700 resumes, it takes a lot of time and effort to sift through them and you're not going to get the quality control that we provide as the executive search and leadership consulting firm to the assessment process that I just mentioned.

Could there be potential down the road for disintermediation? Absolutely.

Is that why we're focusing on looking at different business units and lines here at Heidrick & Struggles? Absolutely.

But right now, we're embracing the technology and we hope to provide the best technology we can to our consultants so they can deliver for our clients.

Well, I will thank you, everybody, for joining the call today and appreciate your support and I hope you have a great day.