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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

Commission File No. 0-25837

HEIDRICK & STRUGGLES INTERNATIONAL, INC.

(Exact Name of Registrant as Specified in its Charter)

233 South Wacker Drive, Suite 4200, Chicago, Illinois 60606-6303

(Address of principal executive offices) (Zip Code)

(312) 496-1200

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  x  No  ¨

The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant on June 30, 2003 was approximately $222,576,416 based upon the closing market price of $12.62 on that date of a share of Common Stock as reported on the Nasdaq National Market. As of February 27, 2004, there were 18,359,783 shares of the Company’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 12, 2004, are incorporated by reference into Part III of this Form 10-K.

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HEIDRICK & STRUGGLES INTERNATIONAL, INC. AND SUBSIDIARIES

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PART I

ITEM 1. BUSINESS

Heidrick & Struggles International, Inc. (“Heidrick & Struggles”) is a premier provider of executive search and leadership consulting services. We help our clients build leadership teams by facilitating the recruitment, development and retention of personnel for their executive management positions. In addition to executive search, which includes interim executive placement, we provide other leadership services including executive assessment and, through an alliance, executive coaching.

Heidrick & Struggles and its predecessors have been in the executive search business for over 50 years. We provide our services to a broad range of clients through our worldwide network of 311 consultants located in major cities around the world. For many of our clients, our global access to and knowledge of markets and candidates is an important characteristic of our business. We provide our executive search services on a retained basis, recruiting senior executives who often earn more than $200,000 annually. Our clients include the following:

The executive search industry is highly fragmented, consisting of more than 4,000 executive search firms worldwide. Based on trade publication reports, we estimate that fewer than 10 executive search firms/alliances generated more than $100 million in worldwide revenue during 2003. Executive search firms are generally separated into two broad categories: retained search firms and contingency search firms. Retained executive search firms fulfill their clients’ senior leadership needs by identifying potentially qualified candidates and assisting clients in evaluating and assessing these candidates for positions typically with annual cash compensation of $150,000 and above. Retained executive search firms generally are compensated for their services whether or not the client employs a candidate identified by the search firm, and are generally retained on an exclusive basis. In contrast, contingency search firms usually focus primarily on positions with annual cash compensation of less than $150,000 and are compensated only upon successfully placing a recommended candidate. Executive search firms normally charge a fee for their services equal to approximately one-third of the first year’s total compensation for the position being filled.

We are a retained executive search firm. Our search process typically consists of the following steps:

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Over the past several years we have begun to expand our services beyond executive search. For several years, we have offered executive assessment services in Europe. In late 2000, we extended our executive assessment business to North America and other parts of the world. This service provides senior-level executives with assessments of the individuals and teams reporting to them. We formed an alliance in March 2002 with Lore International Institute, a global executive coaching and professional development firm. Together we market executive coaching and professional development services to current and prospective clients.

We reduced our focus on mid-level management search, with the completion of the integration of this business into our executive search business in January 2002.

Available Information

We maintain an Internet website at http://www.heidrick.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports are available free of charge on this site as soon as reasonably practicable after the reports are filed with or furnished to the Securities and Exchange Commission. We also post quarterly press releases on our financial results, investor presentations and other documents containing additional information related to our company on this site. Our Internet website and the information contained in or connected to our website are for informational purposes only and are not incorporated into this annual report on Form 10-K.

Organization

Our matrix structure, which is organized by geography and client services specialties, is designed to enable us to better understand our clients’ cultures, operations, business strategies and industries, thereby improving our ability to serve them.

Geographic Structure.    We provide executive-level search and leadership consulting to our clients worldwide through our offices in 27 countries. Major locations are managed by an Office Managing Partner, and staffed with consultants, associates, administrative assistants and other support staff. Administrative functions are centralized where possible, although certain support and research functions are situated regionally because of variations in local requirements.

We also have affiliates in five countries. We have no financial investment in these affiliates, but receive licensing fees from them for the use of our name and our databases.

Client Services.    Our market-facing activities are primarily structured around four groups: Board Services, Key Accounts, Industry Practices and Functional Specialties. The needs of each client are often served by one or more of these groups, as a combination of specialized skills are sometimes required to effectively serve the client.

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Certain markets have a significant concentration of companies within particular industry sectors. For example, our Financial Services practice has its largest concentration of consultants in New York and London, two of the largest financial centers in the world. Each industry practice is coordinated by a Practice Managing Partner who facilitates the group’s marketing activities.

Executive search consultants from each of our Client Services groups may work from any one of our offices around the world. For example, an executive search for a chief financial officer of a health care company located in the United Kingdom may involve a consultant in the United Kingdom with an existing relationship with the client, another executive search consultant in the United States with expertise in our Health Care practice and a third executive search consultant with expertise in chief financial officer recruiting. This same health care client may also engage us to perform skill-based assessments on each of its senior managers, which could require the expertise of a professional trained in this service. If the client company is designated a key account, all of our services will be coordinated by our account leader for that client.

Information by Geographic Segment

North America.  As of December 31, 2003, we had 146 executive search consultants in our North America segment, which includes the United States (except Miami) and Canada. Our North America segment generated approximately 54% of our worldwide net revenue in 2003. The largest offices in this segment in terms of net revenue are located in New York, San Francisco, Tysons Corner and Chicago.

Latin America.  As of December 31, 2003, we had 18 executive search consultants in our Latin America segment, which includes Mexico and the rest of Latin America, as well as Miami, which serves as the gateway office to the region. Approximately 3% of our worldwide net revenue in 2003 was generated in this segment.

Europe.  As of December 31, 2003, we had 114 executive search consultants in 14 European countries. Our Europe segment generated approximately 36% of our worldwide net revenue in 2003. Germany, the United Kingdom and France produced the highest levels of net revenue in this segment.

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Asia Pacific.  As of December 31, 2003, we had 33 executive search consultants in the Asia Pacific segment. This segment generated approximately 7% of our worldwide net revenue in 2003.

For financial information relating to each geographic segment, see Note 2, Segment Information, in the Notes to Consolidated Financial Statements.

Seasonality

Historically, in years that were not affected by significant economic change, there has been some seasonality in our business. As a percentage of total annual net revenue, the first and fourth quarters of the year are typically the lowest. On average, the variance between the highest and lowest net revenue quarters is approximately five percentage points.

Clients and Marketing

Our consultants market the firm’s executive search services through two principal means: targeted client calling and industry networking with clients and referral sources. These efforts are supported by our databases, which provide all our consultants with information as to contacts made by their colleagues with particular referral sources, candidates and clients. In addition, we benefit from a significant number of referrals generated by our reputation for high quality service and successfully completed assignments.

Either by agreement with clients or for client relations purposes, executive search firms sometimes refrain from recruiting employees of a client, and possibly other entities affiliated with that client, for a specified period, generally not more than one year from the commencement of a search. We seek to mitigate the adverse effects of these blocking arrangements by strengthening our long-term relationships, thereby communicating our belief to prospective clients that we can conduct searches without these off-limit arrangements impeding the quality of our work.

No single client accounted for more than 3% of our net revenue in 2003, 2002 or 2001.

Information Management

We rely on technology to support our consultants and staff in the search process. Our technology infrastructure consists of internally developed databases containing candidate profiles and client records, coupled with online services and industry reference sources. We use technology to manage and share information on current and potential clients and candidates, to communicate to both internal and external constituencies and to support administrative functions. Over the past several years, we have invested in improving our systems. We intend to continue to invest in our own systems, focusing on our global search system and on our financial management and reporting systems.

Professional Staff and Employees

Our executive search professionals are categorized either as consultants or associates. Associates assist consultants by conducting research, making initial contact with candidates in some instances and performing other functions. As of December 31, 2003, we had 1,232 full-time equivalent employees, of whom 311 were executive search consultants, 310 were associates and 611 were other search, support and corporate staff.

During 2003, market conditions in Europe continued to weaken. In order to better align the size of our workforce with these market conditions, we reduced our workforce by 32 people, primarily in Europe, including 7 executive search consultants. The reduction represented approximately 2% of our global workforce. During

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2002, we reduced our global workforce by approximately 400 people, or 20%, including 112 executive and management search consultants, in order to better align the size of our employee base with market conditions. During 2001, we reduced our global workforce by 620 people, or 25%, including 136 executive and management search consultants, in order to adjust to weakening economic conditions.

In each of the past five years, no single consultant accounted for a material portion of our net revenues. We most frequently recruit our consultants from other executive search firms or, on occasion, from the industries represented by our practices. In the latter case, these are often seasoned executives who are entering the search profession as a second career, and who we train in our techniques and methodologies. We are not a party to any collective bargaining agreement, and we consider relations with our employees to be good.

Competition

The executive search industry is highly competitive. While we face competition to some degree from all firms in the industry, we believe our most direct competition comes from established global retained executive search firms that conduct searches primarily for the most senior-level positions within an organization. In particular, our competitors include Spencer Stuart & Associates, Egon Zehnder International, Russell Reynolds Associates, Inc. and Korn/Ferry International. To a lesser extent, we also face competition from smaller boutique or specialty firms that specialize in certain regional markets or industry segments. Each firm with which we compete is also a competitor in seeking to attract the most effective consultants.

The overall search industry has relatively few barriers to entry. Higher barriers exist, however, for firms like ours that focus primarily on conducting searches for executive-level positions. At this level, clients rely more heavily on a search firm’s reputation, global access and the experience level of its consultants. We believe that the segment of executive search in which we compete is more quality-sensitive than price-sensitive. As a result, we compete on the level of service we offer, reflected by our client services specialties and, ultimately, by the quality of our search results. We believe that our emphasis on senior-level executive search, the depth of experience of our search consultants and our global presence enable us to compete favorably with other executive search firms.

Competition in our other leadership consulting services, including executive assessment and coaching, is highly fragmented, with no universally recognized market leaders. Several of our primary competitors in executive search also offer such complementary services but those typically represent less than a majority percentage of their revenue.

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EXECUTIVE OFFICERS

Our executive officers as of March 1, 2004 are as follows:

There are no family relationships between any executive officer or director. The following information sets forth the business experience for at least the past five years for each of our executive officers as of March 1, 2004:

Thomas J. Friel has been our Chairman and Chief Executive Officer since June 2003. Previously, Mr. Friel was Chairman of the Technology Practice, Chairman of the Leadership Services Group and a Vice Chairman of Heidrick & Struggles from October 2001 to June 2003. Prior to that, Mr. Friel was President of Heidrick & Struggles Ventures from 1999 to 2001. Mr. Friel also served on our Board of Directors subsequent to our initial public offering in 1999 until 2002 when the Board transitioned to a majority of independent directors. He joined us in 1979.

Eduardo Antunovic has been our Regional Managing Partner, Southern Europe/Latin America since September 2002 and Managing Partner, Global Industry Practices since December 2003. Previously, Mr. Antunovic was Area Managing Partner of our Latin America region from 2001 to 2002; Regional Managing Partner of our offices in Argentina, Brazil, Chile and Peru from 1999 to 2001; and Office Managing Partner, Sao Paulo from 1997 to 1999. He joined us in 1996.

Jocelyn A. Dehnert has been our Regional Managing Partner, Northern Europe since September 2002. Previously, Dr. Dehnert was Regional Managing Partner, Asia Pacific from October 2001 to August 2002, and Managing Partner of our Financial Services Practice in Asia Pacific from January 2000 to October 2001. She became a Partner with us in November 1996. She joined us in 1995.

Fritz E. Freidinger has been our Chief Legal Officer and Corporate Secretary since January 2004. Previously, Mr. Freidinger had been our General Counsel and Corporate Secretary since joining us in December 2002. Prior to that, Mr. Freidinger was Vice President, Global General Counsel and Corporate Secretary of Jones Lang LaSalle Incorporated from 2001 to 2002. From 1997 to 2001, Mr. Freidinger was with Hagan & Associates, a law firm providing services to Jones Lang LaSalle and its clients.

Bonnie W. Gwin has been our Regional Managing Partner, North America since January 2004 and Managing Partner, Technology and Professional Services Practice since October 2002. Previously, Ms. Gwin was Managing Partner, North American Operations from February 2003 to December 2003; Managing Partner, Chicago, Cleveland, and Toronto from October 2001 to October 2002; Office Managing Partner, Cleveland from January 2001 to October 2001; and Partner in Charge of our Software specialty practice from October 2000 to February 2001. She joined us in 1997.

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L. Kevin Kelly has been our Regional Managing Partner, Asia Pacific since September 2002. Previously, Mr. Kelly was Office Managing Partner, Tokyo from February 2002 to September 2002. He joined us in 1997.

Jeff R. Scherb has been our Chief Technology and Operations Officer since January 2004. Previously, Mr. Scherb had been our Chief Information Officer since joining us in September 2002. Prior to that, Mr. Scherb was Senior Vice President and Chief Technology Officer of Tribune Company from 1996 to 2002. Mr. Scherb also was President of Tribune Interactive at Tribune Company from 1999 to 2000.

Scott W. Sherwood has been our Chief Talent and Human Resources Officer since joining us in January 2004. Prior to that, Mr. Sherwood was President of Scott Sherwood & Associates, Inc. from 1997 to 2004.

Kevin J. Smith has been our Chief Financial Officer since joining us in January 2002. Prior to that, Mr. Smith was the Executive Vice President and Chief Financial Officer from 2000 to 2001 and the Senior Vice President and Chief Accounting Officer from 1998 to 2000 at True North Communications, Inc. From 1997 to 1998 he held various positions with Midcom Communications, Inc., including Executive Vice President and Chief Financial Officer, Chief Executive Officer, and consultant. In December 2003, we announced that Mr. Smith planned to leave our company on March 31, 2004. The search for his successor is currently underway.

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RISK FACTORS

In addition to other information in this Form 10-K, the following risk factors should be carefully considered in evaluating our business because such factors may have a significant impact on our business, operating results, cash flows and financial condition. As a result of the risks set forth below and elsewhere in this Form 10-K, and the risks discussed in our other Securities and Exchange Commission filings, actual results could differ materially from those projected in any forward-looking statements.

We depend on attracting and retaining qualified consultants.

Our success depends upon our ability to attract and retain consultants who possess the skills and experience necessary to fulfill our clients’ executive search needs. Our ability to hire and retain qualified consultants could be impaired by any diminution of our reputation, decrease in compensation levels relative to our competitors or restructuring of our compensation system or competitor hiring programs. If we cannot attract, hire and retain such consultants, our business, financial condition and results of operations may suffer.

We may not be able to prevent our consultants from taking our clients with them to another firm.

Our success depends upon the ability of our consultants to develop and maintain strong, long-term relationships with our clients. In many cases, one or two consultants have primary responsibility for a client relationship. When a consultant leaves one executive search firm and joins another, clients that have established relationships with the departing consultant may move their business to the consultant’s new employer. We may also lose clients if the departing consultant has widespread name recognition or a reputation as a specialist in executing searches in a specific industry or management function. Historically, we have not experienced significant revenue loss from this client portability. If we fail to limit departing consultants from moving business to another employer, our business, financial condition and results of operations may be adversely affected.

Our success depends on our ability to maintain our professional reputation and brand name.

We depend on our overall reputation and brand name recognition to secure new engagements and hire qualified consultants. Our success also depends on the individual reputations of our consultants. We obtain many of our new engagements from existing clients or from referrals by those clients. A client who is dissatisfied with our work can adversely affect our ability to secure new engagements. If any factor hurts our reputation, including poor performance, we may experience difficulties in competing successfully for both new engagements and qualified consultants. Failure to maintain our professional reputation and brand name could seriously harm our business, financial condition and results of operations.

Because our clients may restrict us from recruiting their employees we may be unable to fill existing executive search assignments.

Clients frequently require us to refrain from recruiting certain of their employees when conducting executive searches on behalf of other clients. These restrictions generally remain in effect for no more than one year following the commencement of an engagement. However, the specific duration and scope of the blocking arrangements depend on the length of the client relationship, the frequency with which the client engages us to perform searches, the number of assignments we have performed for the client and the potential for future business with the client.

If a prospective client believes that we are overly restricted by these blocking arrangements from recruiting the employees of our existing clients, these prospective clients may not engage us to perform their executive searches, and as a result, our business, financial condition and results of operations may suffer.

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We face aggressive competition.

The global executive search industry is extremely competitive and highly fragmented. We compete with other large global executive search firms and with smaller specialty firms. Specialty firms can focus on regional or functional markets or on particular industries. Some of our competitors possess greater resources, greater name recognition and longer operating histories than we do in particular markets or practice areas. There are limited barriers to entry into the search industry and new search firms continue to enter the market. Many executive search firms that have a smaller client base may be subject to fewer blocking arrangements. In addition, our significant clients or prospective clients may decide to perform executive searches using in-house personnel. Finally, during soft economic climates, competitors sometimes reduce their fees in order to attract clients and increase market share. Because we typically do not discount our fees, we may experience some loss of net revenue. We may not be able to continue to compete effectively with existing or potential competitors. Our inability to meet these competitive challenges could have an adverse impact on our business, financial condition and results of operations.

We rely heavily on information management systems.

Our success depends upon our ability to store, retrieve, process and manage substantial amounts of information. To achieve our goals, we must continue to improve and upgrade our information management systems. We may be unable to license, design and implement, in a cost-effective and timely manner, improved information systems that allow us to compete effectively. In addition, business process reengineering efforts may recommend a change in software platforms and programs. Such plans may result in an acceleration of depreciation expense over the shortened expected remaining life of the software. If we experience any interruptions or loss in our information processing capabilities, our business, financial condition and results of operations may suffer.

We face the risk of liability in the services we perform.

We are exposed to potential claims with respect to the executive search process and our other leadership consulting services. A client could assert a claim for violations of blocking arrangements, breaches of confidentiality agreements or malpractice. In addition, a candidate could assert an action against us. Possible claims include failure to maintain the confidentiality of the candidate’s employment search or for discrimination or other violations of the employment laws. In various countries, we are subject to data protection laws impacting the handling of candidate resumes and other data. We maintain professional liability insurance in amounts and coverage that we believe are adequate. However, we cannot guarantee that our insurance will cover all claims and that the coverage will be available at reasonable rates. Significant uninsured liabilities could have a negative impact on our business, financial condition and results of operations.

Our multinational operations may be adversely affected by social, political and economic risks.

We generate substantial revenue outside the United States. We offer our services through our offices in 27 countries around the world. We are exposed to the risk of changes in social, political and economic conditions inherent in international operations which could have a significant impact on our business, financial condition and results of operations. In particular, we conduct business in countries where the legal systems and trade practices are evolving. Commercial laws in these countries are often vague, arbitrary and inconsistently applied. Under these circumstances, it is difficult for us to determine at all times the exact requirements of such local laws. If we fail to comply with local laws, our business, financial condition and results of operations could suffer. In addition, the global nature of our operations poses challenges to our management, and financial and accounting systems. Failure to meet these challenges could seriously harm our business, financial condition and results of operations.

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We may not be able to align our cost structure with revenue.

The timing and strength of an economic recovery in the United States, Europe and other areas of the world continues to be unclear. It is difficult for us to forecast revenue generation with any degree of certainty, even in the near term, and to balance revenue with the required capacity. In 2003, 2002 and 2001, we took steps to reduce our workforce, consolidate and close offices and reduce other expenses. If we do not reduce our costs in proportion to demand for our services in a timely manner or if we reduce our workforce so that we are unable to service increased demand, our business, financial condition and results of operations could be adversely affected.

We may not be able to generate sufficient profits to realize our tax loss carryforwards.

In 2003, 2002 and 2001, we reported net losses, primarily due to restructuring activities necessary to align our cost structure with expected net revenue levels. The timing and strength of an economic recovery in the United States, Europe and other areas of the world continues to be unclear. During the fourth quarter of 2003, we recorded a full valuation allowance for our deferred tax assets for the U.S. and foreign operations which comprise the U.S. income tax entity. While we expect to be profitable in 2004 and beyond, there is no assurance that future taxable income will be sufficient to realize the benefit of tax loss carryforwards and other deferred tax assets. If after future assessments of the realizability of the deferred tax assets, we determine that a lesser allowance is required, we would record a reduction to the income tax expense and the valuation allowance in the period of such determination. If we are unable to generate taxable income in the long-term, our business, financial condition, results of operations and cash flow could suffer.

We may experience impairment of our goodwill and other intangible assets.

The timing and strength of an economic recovery in the United States, Europe and other areas of the world continues to be unclear. While current valuation estimates indicate that there has been no impairment of goodwill or other intangible assets, prolonged economic downturns could jeopardize the values assigned to goodwill and other intangible assets. If the carrying value of our reporting units’ goodwill exceeds its implied fair value, then we must record an impairment loss equal to the difference. If our operations do not generate sufficient earnings and cash flow in the long-term, our business, financial condition and results of operations could suffer.

Our ability to sublease or assign unused office space could affect our earnings and cash flows.

In 2002 and 2001, we consolidated and closed offices in order to reduce costs. This left us with a significant amount of unused office space with respect to which we are still required to make lease payments. At the time of the office closings we accrued the estimated costs associated with these actions. During 2003, we recorded restructuring expense of $22.2 million to increase accruals for unused office space, reflecting the expectation of longer vacancy periods due primarily to weakness in the real estate markets in which the leased properties are located. While we have made progress in securing subleases for several properties, at December 31, 2003, we had six office locations designated as unused real estate, representing approximately 106,000 square feet. The total remaining commitment related to these properties is $55.5 million of which $30.0 million has been accrued at December 31, 2003, net of estimated sublease income. Inherent in these accruals are estimates concerning vacancy periods and sublease income. If we are unable to sublease or assign this unused office space within the estimated time frame, or if we sublease or assign this office space for amounts less than we had anticipated, our business, financial condition, results of operations and cash flow could suffer.

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We have antitakeover provisions that make an acquisition of us difficult and expensive.

Antitakeover provisions in our Certificate of Incorporation, our Bylaws and the Delaware laws make it difficult and expensive for us to be acquired in a transaction which is not approved by our Board of Directors. Some of the provisions in our Certificate of Incorporation and Bylaws include:

These provisions could discourage an acquisition attempt or other transaction in which stockholders could receive a premium over the current market price for the common stock.

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ITEM 2. PROPERTIES

Our corporate office is located in Chicago, Illinois. We have offices in major metropolitan areas in 27 countries around the world. All of our offices are leased. We do not own any real estate. The aggregate square footage of office space under lease was approximately 820,000 as of December 31, 2003. These office leases call for future minimum lease payments of approximately $144.2 million and have terms that expire between 2004 and 2016, exclusive of renewal options that we can exercise. Approximately 127,000 square feet of office space has been sublet to third parties. See Risk Factors included in Item 1 of this Form 10-K for further information concerning unused office space.

ITEM 3. LEGAL PROCEEDINGS

We have contingent liabilities from various pending claims and litigation matters arising in the course of our business, some of which involve claims for damages that are substantial in amount. Some of these matters are covered by insurance. Although our ultimate liability in these matters cannot be determined, based upon information currently available, we believe the ultimate resolution of such claims and litigation will not have a material adverse effect on our financial condition, results of operations or liquidity.

In December 2002, Mt. Sinai Medical Center of Miami filed suit against us regarding a search for a chief executive officer we performed in 1998. The suit is pending in the U.S. District Court for the Southern District of Florida. We believe the claims made by Mt. Sinai have no merit and are vigorously defending against the claims. Following a failure to achieve a compromise in mediation, the judge in this case ruled on our motion to dismiss the claims and active discovery commenced. The judge dismissed all the claims made by Mt. Sinai other than a claim for a breach of the covenant of good faith and fair dealing. Most of the discovery in this matter was completed during the fourth quarter of 2003. During this period, Mt. Sinai clarified the damages it is seeking – (i) the fee paid for the chief executive officer search of $169,000, (ii) fees paid for other searches of approximately $500,000 and (iii) between $59 million and $75 million based primarily upon the operating loss incurred by Mt. Sinai in 2001, the chief executive officer’s last year at the hospital. We believe the claims made by Mt. Sinai are covered by our professional liability insurance policies with policy limits of $20.0 million. While there can be no assurance as to the outcome, we believe that the claims are without merit and, as such, will not have a material adverse effect on our financial position, results of operations or liquidity. The trial in the matter is expected to begin in July 2004.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the last quarter of 2003.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is listed on the Nasdaq National Market under the symbol “HSII.” The following table sets forth the high and low stock price per share of the common stock for the periods indicated, as reported on the Nasdaq National Market.

As of February 27, 2004, the last reported price on the Nasdaq National Market for our common stock was $21.27 per share and there were approximately 220 stockholders of record of the common stock.

We have never paid cash dividends on our common stock and do not presently anticipate paying any cash dividends on our common stock in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will be dependent upon our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors deemed relevant by the Board of Directors. Future indebtedness and loan facilities may also prohibit or restrict our ability to pay dividends and make distributions to our stockholders.

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ITEM 6. SELECTED FINANCIAL DATA

The selected financial data presented below have been derived from our audited consolidated financial statements. The data as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001 are derived from the audited historical consolidated financial statements which are included elsewhere in this Form 10-K. The data as of December 31, 2001, 2000 and 1999 and for the years ended December 31, 2000 and 1999 are derived from audited historical consolidated financial statements that are not included in this report. The data set forth are qualified in their entirety by, and should be read in conjunction with, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the audited consolidated financial statements, the notes thereto, and the other financial data and statistical information included in this Form 10-K.

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Notes to Selected Financial Data:

Upon a value event such as an initial public offering or an acquisition, the equity securities arising from the exercise of warrants are monetized, resulting in a realized gain, net of the consultants’ share of the gain and other costs. In 2003, 2002, 2001, 2000 and 1999, we recorded realized gains, net of the consultants’ share of the gain and other costs, of $0.7 million, $1.6 million, $1.0 million, $7.4 million and $0.8 million, respectively, related to the equity and warrant portfolio.

In 2003, the unrealized losses, net of the consultants’ share of the losses and other costs, were less than $0.1 million, related to the equity and warrant portfolio. In 2002 and 2001, we recorded unrealized losses, net of the consultants’ share of the losses and other costs, of $3.0 million and $4.7 million, respectively, related to the equity and warrant portfolio.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as other sections of this annual report on Form 10-K contain forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. The forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry in which we operate and management’s beliefs and assumptions. Forward-looking statements may be identified by the use of words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions. Forward-looking statements are not guarantees of future performance and involve certain known and unknown risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from what is expressed, forecasted or implied in the forward-looking statements. Factors that may affect the outcome of the forward-looking statements include, among other things, our ability to attract and retain qualified executive search consultants; the condition of the economies in the United States, Europe, or elsewhere; social or political instability in markets where we operate; price competition; our ability to achieve the planned cost savings from our cost reduction initiatives; our ability to sublease or assign unused office space; our ability to realize our tax loss carryforwards; an impairment of our goodwill and other intangible assets; and delays in the development and/or implementation of new technology and systems. For more information on the factors that could affect the outcome of forward-looking statements, see Risk Factors in Item 1 of this Form 10-K. We caution the reader that the list of factors may not be exhaustive. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Executive Overview

Our Business

We are a premier provider of executive search and leadership consulting services. We help our clients build leadership teams by facilitating the recruitment, assessment and development of personnel for their executive management positions. In addition to executive search for permanent and interim placements, we provide other leadership services, including executive assessment, and, through an alliance, executive coaching. We provide our services to a broad range of clients through our worldwide network of 311 consultants located in 27 countries throughout the world. Our executive search services are provided on a retained basis. Revenue before reimbursements of out-of-pocket expenses (“net revenue”) consists of retainers and indirect expenses billed to clients. Typically, we are paid a retainer for our executive search services equal to approximately one-third of the estimated first year compensation for the position to be filled. In addition, if the actual compensation of a placed candidate exceeds the estimated compensation, we often will be authorized to bill the client for one-third of the excess. Indirect expenses are calculated as a percentage of the retainer with certain dollar limits per search.

Historical Perspective

During 1999 and 2000, the executive search industry experienced a dramatic increase in demand for its services in virtually all markets based on increased competition for executive talent, the need for executives with diverse and global leadership skills, and the proliferation of Internet and e-commerce businesses. Our rate of growth in net revenue during this period exceeded both the industry trend and our historical average because of the need for management at start-up companies, the creation of new e-commerce positions at more established companies and the growth in the financial services industry. We responded to these trends by increasing the number of consultants and the number of offices from which we served our clients. In 2000, we added more than 100 consultants, including consultants experienced in executive search and employees from other disciplines who were new to the search profession, in anticipation of a continuation of increased demand. Also, in response to the demand for Internet-enhanced mid-level search, in March 1999, we launched our mid-level recruiting business as a separate subsidiary called LeadersOnline.

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The slowdown in the United States economy that began early in 2001, especially in the financial services and technology sectors, followed by a slowdown in other geographic markets, created an environment where the previous trends began to reverse. Commencing in June 2001, when we anticipated a decrease in net revenue compared to 2000, we took steps to reduce our cost base by reducing our workforce while retaining capacity to meet additional demand when the economy recovered. In October 2001, we announced further reductions in our workforce and consolidated or eliminated office space.

The initiatives related to these announcements, including the integration of LeadersOnline into our Executive Search business, were completed during the 2002 first quarter.

In 2002, the worldwide economies, and the demand for executive search services, continued to weaken. Even after taking into account the workforce reductions and office consolidations and closings that occurred since June 2001, at the then-current and anticipated net revenue levels, we determined that we had substantial excess search team capacity. In addition, the cost structure in Europe continued to be too high for its net revenue level. As a result, in October 2002, we announced further reductions in our workforce and additional office consolidations and closings.

2003 Overview

In 2003, continued global economic weakness and geopolitical tensions adversely impacted the business environment and, consequently, the demand for our services. Net revenue in 2003 was $317.9 million, a decrease of 9.3%, from $350.7 million in 2002, as a soft economy for much of the year adversely affected our results. Excluding the positive impact of exchange rate changes, net revenue decreased approximately 14% in 2003 compared to 2002.

This year also saw changes in our company’s senior management with the resignations of our Chief Executive Officer, Mr. Piers Marmion, our President and Chief Operating Officer, Mr. David Anderson and our Chief Financial Officer, Mr. Kevin J. Smith. We recorded charges of $6.1 million for these separations. In addition to these separation charges, we recorded $2.8 million of other severance expense, primarily in Europe and North America.

During 2003, we recorded restructuring charges of $29.4 million, consisting of $3.9 million of severance expense, primarily in Europe, $3.3 million of expense for goodwill and other intangible asset impairment, primarily related to a wholly-owned subsidiary in Finland which is expected to be converted to a licensee, and $22.2 million of expense to increase accruals for unused office space, reflecting the expectation of longer vacancy periods due primarily to weakness in the real estate markets in which the leased properties are located. Due to these restructuring charges, we did not expect to achieve certain long-term profitability targets established in 2002 and therefore reversed $1.3 million of accruals related to our Performance Share Program that had been recorded as of December 31, 2002.

Our 2003 income tax provision includes a non-cash income tax expense of $57.9 million, recorded in the fourth quarter of 2003, to provide a full valuation allowance against our net deferred tax assets for the U.S. and foreign operations which comprise the U.S. income tax entity. In assessing the need for a valuation allowance, we considered all positive and negative evidence, including scheduled reversals of deferred tax liabilities, tax-planning strategies, projected future taxable income and recent financial performance. In 2003, 2002 and 2001, we reported net losses, primarily due to restructuring activities necessary to align our cost structure with expected net revenue levels. Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Based upon the provisions of SFAS No. 109, we recorded a full valuation allowance against our net deferred tax assets.

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Despite these significant expenses recorded in 2003 and the decline in net revenue, we believe that our cost structure is better aligned with anticipated net revenue levels, primarily as a result of the restructuring and cost reduction initiatives which have occurred over the past three years. We ended the year with a cash balance of $119.3 million, an increase of $9.1 million, compared to $110.2 million at December 31, 2002. Also, in December 2003, we secured a $60.0 million revolving credit facility.

2004 Outlook

For 2004, we currently anticipate that net revenue will grow at a rate in the mid-single digits. This performance assumes that the worldwide economy will continue to strengthen. At that level of net revenue growth, we would expect to generate operating margins in the 5 percent to 6 percent range.

We receive warrants for equity securities in our client companies, in addition to our cash fee, for services rendered on some searches. Upon a value event such as an initial public offering or an acquisition, the equity securities arising from the exercise of the warrants are monetized, resulting in a realized gain, net of the consultants’ share of the gain and other costs. In 2003, 2002 and 2001, we recorded realized gains, net of the consultants’ share of the gain and other costs, of $0.7 million, $1.6 million, $1.0 million, respectively, related to the equity and warrant portfolio. With improvements in economic conditions, it is possible, although not certain, that we could realize gains which are significant to our reported earnings in the future.

Results of Operations

We operate our executive search and complementary leadership services in four geographic regions: North America, which includes the United States (except Miami) and Canada; Latin America, which includes Mexico and the rest of Latin America, as well as Miami, which serves as our gateway office to the region; Europe; and Asia Pacific.

Total revenue consists of revenue before reimbursements of out-of-pocket expenses (“net revenue”) and reimbursements of out-of-pocket expenses. Net revenue consists primarily of retainers and indirect expenses billed to clients. Reimbursements of out-of-pocket expenses are characterized as revenue in accordance with Emerging Issues Task Force (“EITF”) Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred.” Related reimbursable expenses are also shown separately within operating expenses.

For segment purposes, the reimbursements of out-of-pocket expenses are reported on a separate line, and therefore do not affect the analysis of net revenue by geographic region. The presentation required by EITF Issue No. 01-14 has no impact on the consolidated operating income (loss) or on the operating income (loss) of the geographic regions.

We believe that analyzing trends in net revenue and analyzing operating expenses as a percentage of net revenue more appropriately reflects our core operations.

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The following table summarizes the results of operations for the periods indicated:

The following table sets forth, for the periods indicated, our selected statements of operations data as a percentage of revenue before reimbursements (net revenue):

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2003 Compared to 2002

Total revenue.  Consolidated total revenue decreased $36.2 million, or 9.6%, to $340.6 million in 2003 from $376.8 million in 2002. The decline in total revenue was due primarily to the decline in revenue before reimbursements (net revenue).

Revenue before reimbursements (net revenue).  Consolidated net revenue decreased $32.8 million, or 9.3%, to $317.9 million in 2003 from $350.7 million in 2002. Excluding the $17.9 million positive impact of exchange rate changes, net revenue declined approximately 14%. We believe information regarding changes in net revenue excluding the impact of exchange rate changes is helpful in providing an understanding of the volume of business activity. Most of our practices experienced declines in net revenue. In 2003, the number of confirmed executive searches decreased 5% to 3,757 from 3,973 in 2002. We believe this decrease reflects the impact of the continuing weak global economic conditions.

Net revenue in North America was $172.0 million in 2003, a decrease of $22.2 million, or 11.4%, from $194.2 million in 2002. Most of the practices experienced declines in net revenue with the most significant declines in the Technology and Financial Services practices. In Latin America, net revenue was $11.2 million in 2003, an increase of $0.2 million, or 2.0%, from $11.0 million in 2002, reflecting increases in the Financial Services and Professional Services practices, despite the loss of net revenue from operations that were converted to licensees in 2002. Net revenue in Europe was $113.0 million in 2003, a decrease of $11.4 million, or 9.1%, from $124.4 million in 2002. Excluding a positive impact of $16.5 million due to exchange rate changes, Europe’s net revenue decreased by approximately 22% from 2002. The decline in net revenue is attributable to general economic weakness, particularly in the Financial Services and Industrial practices, and the loss of net revenue from unprofitable operations that were converted to licensees or shut down during 2002. In Asia Pacific, net revenue was $21.6 million in 2003, an increase of $0.5 million, or 2.6%, from $21.1 million in 2002. Excluding a positive impact of $1.3 million due to exchange rate changes, Asia Pacific’s net revenue was $20.3 million, a decrease of approximately 3% compared to 2002. Increases in the Industrial and Consumer practices were more than offset by declines in the Technology and other practices.

Salaries and employee benefits.  Consolidated salaries and employee benefits expense decreased $18.8 million, or 7.8%, to $223.5 million in 2003 from $242.3 million in 2002. Salaries and employee benefits expense in 2003 includes $6.1 million of expense related to the separation agreements of the former Chief Executive Officer, the former President and Chief Operating Officer and the Chief Financial Officer, approximately $2.8 million of other severance-related expenses, primarily in Europe and North America, partially offset by a $0.9 million reduction in employee benefit expense accruals and a benefit of $1.3 million from the reversal of accruals recorded in 2002 for the Performance Share Program. Excluding these items, which we believe more appropriately reflects our core operations, consolidated salaries and employee benefits expense would have been $216.8 million in 2003, a decrease of $25.5 million, or 10.5%, compared to $242.3 million in 2002. The decrease was primarily attributable to $35.8 million of lower fixed costs as a result of the elimination of approximately 400 positions since March 2002, partially offset by $10.3 million of additional performance-related compensation expense for executive search consultants and support staff. The average number of executive search consultants in 2003 was 328, a decrease of 16%, compared to an average of 391 in 2002.

As a percentage of net revenue, salaries and employee benefits expense increased to 70.3% in 2003 from 69.1% in 2002. Excluding the $8.9 million of severance-related expenses, the $0.9 million reduction of employee benefit accruals and the $1.3 million of benefit resulting from the reversal of accruals related to the Performance Share Program, which we believe more appropriately reflects our core operations, salaries and employee benefits expense as a percentage of net revenue would have been 68.2% in 2003 compared to 69.1% in 2002. The decrease as a percentage of net revenue is primarily due to lower fixed salaries and employee benefits expense in relation to the net revenue levels, partially offset by a greater percentage of net revenue accrued for performance-based compensation.

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General and administrative expenses.    Consolidated general and administrative expenses decreased $19.6 million, or 18.4%, to $87.3 million in 2003 from $106.9 million in 2002. This decrease was due to $11.5 million of lower discretionary spending, a reduction in bad debt expense of $2.8 million and $5.3 million of cost savings in rent, depreciation and other infrastructure expenses, primarily related to the consolidation and closing of offices and lower systems-related spending.

As a percentage of net revenue, general and administrative expenses decreased to 27.4% in 2003 from 30.5% in 2002.

2003 and 2002 Restructuring charges.    In 2003, we recorded restructuring charges of $29.4 million. In 2002, we recorded restructuring charges of $48.5 million. The following table summarizes the workforce reductions as well as the restructuring charges recorded in each year:

The restructuring charges of $29.4 million recorded in 2003 include severance and other employee-related costs of $3.9 million related to reductions in our workforce, primarily in Europe, expense of $22.2 million to increase accruals for leased properties that had been identified as excess in previous office consolidation charges and $3.3 million of expense for impairment of goodwill and other intangible assets related primarily to a wholly-owned subsidiary in Finland which is expected to be converted to a licensee. The workforce reductions, which occurred during the fourth quarter of 2003, affected 32 people, primarily in Europe, and included 7 executive search consultants. The accruals for excess real estate were increased to reflect the expectation of longer vacancy periods due primarily to weakness in the real estate markets in which the leased properties are located. The restructuring charges by segment are as follows: North America $7.0 million; Europe $22.1 million; and Corporate $0.3 million. Of the $29.4 million of restructuring charges recorded in 2003, approximately $25.8 million represents cash charges.

In October 2001, we announced company-wide cost reduction initiatives to better align costs with the expected net revenue levels. During the first quarter of 2002, we recorded $23.2 million of restructuring charges related to these announced initiatives. The actions, which occurred during the first quarter of 2002, affected 166 people, including 51 executive search and management search consultants. The remainder was search and corporate support staff. Over two-thirds of the layoffs were in North America, 20% were in Europe, and the rest were in Latin America and Asia Pacific. The 2002 first quarter restructuring charges include severance and other employee-related costs of $10.4 million and costs related to the consolidation and closing of offices of $12.8 million. By segment, the restructuring charges recorded in the first quarter of 2002 are as follows: North America

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$13.3 million; Latin America $0.1 million; Europe $7.0 million; Asia Pacific $0.3 million; and Corporate $2.5 million. Of the $23.2 million of restructuring charges recorded in the 2002 first quarter, approximately $15.2 million represents cash charges. No restructuring charges were recorded in the second or third quarters of 2002.

In October 2002, we announced additional reductions in our workforce and the consolidation and closing of offices, recording a charge of $25.4 million. The actions affected 236 employees, of which 156 were in Europe. Of the reductions, 61 were executive and management search consultants and the remainder was support staff. Of the $25.4 million restructuring charge, $12.2 million was for severance and related costs, $10.6 million was facilities-related and $2.6 million was for the write-off of goodwill, intangible assets and software. By segment, the restructuring charges recorded in the fourth quarter of 2002 are as follows: North America $6.4 million; Latin America $0.5 million; Europe $17.7 million; Asia Pacific $0.4 million; and Corporate $0.4 million.

Of the $25.4 million of restructuring charges recorded in the 2002 fourth quarter, approximately $20.9 million represents cash charges.

Approximately $45.8 million of the 2003 and 2002 restructuring charges remained unpaid as of December 31, 2003. The majority of the amounts remaining to be paid relate to real estate leases. Cash disbursements lag the charges because charges related to disposing of leases are recorded currently, while the cash spending for each affected lease will continue until sub-leasing, or negotiations with the lessor to terminate the lease, are completed. Based on current estimates, approximately $18.1 million is expected to be paid in 2004, with the remaining $27.7 million payable in years subsequent to 2004.

Operating loss.  Our consolidated operating loss was $22.3 million in 2003, a decrease of $24.8 million compared to the operating loss of $47.1 million in 2002. The following table summarizes our consolidated operating loss for the years ended December 31, 2003 and 2002, respectively:

The decrease in the consolidated operating loss was primarily due to lower restructuring charges and improved profitability in the geographic regions.

In North America, operating income in 2003 increased $2.3 million to $36.0 million from $33.7 million in 2002. The decline of $22.2 million in North America’s net revenue was offset by $18.0 million of lower fixed salaries and employee benefits expense, including a benefit from the forfeiture of certain restricted stock units and a reduction of accruals for employee benefits expense, a benefit of $0.6 million related to the reversal of accruals for the Performance Share Program which were recorded in 2002 and $9.5 million of lower discretionary spending and lower facilities-related expenses. Most of the cost savings are attributable to the reductions in workforce, and the consolidation and closing of offices, that have occurred since the 2002 first quarter. The cost reductions were offset by a $3.6 million increase in performance-based compensation expense for executive search consultants and support staff.

In Latin America, operating income was $0.9 million in 2003 compared to an operating loss of $2.8 million in 2002. The operating loss in 2002 included $1.7 million of costs associated with converting certain wholly- owned subsidiaries to licensees and an adjustment for value-added taxes.

In Europe, the operating loss was $3.8 million in 2003, an increase of $0.6 million, compared to an operating loss of $3.2 million in 2002. The operating loss in 2003 includes approximately $2.0 million of

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severance-related expenses. Excluding these severance-related expenses, which we believe more appropriately reflects our core operations, Europe’s operating loss in 2003 would have been $1.9 million, a decrease of $1.3 million, compared to the $3.2 million operating loss in 2002. The decline in net revenue of $11.4 million was offset by $10.4 million of lower fixed salaries and employee benefits expense, a reduction in bad debt expense of $2.7 million, $2.8 million of lower discretionary spending and approximately $2.2 million of lower systems-related spending. These cost savings reflect the reductions in workforce and cost reduction initiatives which have occurred since the first quarter of 2002. These cost savings were partially offset by a $5.4 million increase in performance-based compensation expense for executive search consultants and support staff.

In Asia Pacific, operating income in 2003 was $2.3 million, an increase of $0.8 million, compared to operating income of $1.5 million in 2002. The increase was attributable to the increase in net revenue of $0.5 million and lower fixed salaries and employee benefits expense.

Unallocated corporate expenses increased $0.4 million, or 1.4%, to $28.2 million in 2003 from $27.8 million in 2002. Corporate expenses in 2003 include $6.1 million of severance-related expenses for the separation agreements of three executives. Excluding these severance expenses, which we believe more appropriately reflects our core operations, unallocated corporate expenses would have been $22.1 million, a decrease of $5.7 million, or 20.5%, compared to 2002. This decline in corporate expenses reflects $3.2 million of lower salaries and employee benefits expense and $3.8 million of lower systems-related spending and operating expenses, partially offset by $1.3 million of higher infrastructure-related costs.

Restructuring charges were $29.4 million in 2003 compared to $48.5 million in 2002. The restructuring charges are explained in the preceding section captioned, 2003 and 2002 Restructuring charges.

Net non-operating income (expense).   The following table presents the components of our net non-operating income (expense) for 2003 and 2002, respectively:

Interest income in 2003 was approximately $1.7 million compared to $2.0 million in 2002. The decline is primarily due to lower returns on invested cash balances.

We receive warrants for equity securities in our client companies, in addition to our cash fee, for services rendered on some searches. The warrants are recorded at fair value. Some of the warrants in our portfolio meet the definition of a derivative instrument under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and its subsequent amendments. In accordance with SFAS No. 133, subsequent changes in the fair value of these derivative instruments are recorded in the Consolidated Statements of Operations rather than as a component of accumulated other comprehensive income. Warrants which do not meet the definition of

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a derivative instrument are regularly reviewed for declines in value. Upon a value event such as an initial public offering or an acquisition, the equity securities arising from the exercise of the warrants are monetized, resulting in a realized gain, net of the consultants’ share of the gain and other costs.

During 2003, we recognized $0.7 million of realized gains and less than $0.1 million of unrealized losses, net of the consultants’ share of the gains (losses) and other costs, related to our equity and warrant portfolio. During 2002, we recognized $1.6 million of realized gains and $3.0 million of unrealized losses, net of the consultants’ share of the gains (losses) and other costs, related to our equity and warrant portfolio. With improvements in economic conditions, it is possible, although not certain, that we could realize gains which are significant to our reported earnings in the future.

The write-down of the long-term investment of $5.0 million in 2002 resulted from the write-down of the remainder of our investment in ETF Group. ETF Group is a Europe-based venture capital firm that helps emerging companies expand into international markets.

Net other non-operating expense was $1.7 million in 2003 compared to $0.1 million in 2002. Other non-operating expense consists primarily of exchange gains and losses on intercompany balances which are denominated in currencies other than the functional currency and which are not considered permanent in nature.

Income taxes.  In 2003, we had a pre-tax loss of $21.8 million and recorded income tax expense of $58.8 million. The 2003 income tax provision includes a non-cash income tax expense of $57.9 million, recorded in the fourth quarter of 2003, to provide a full valuation allowance against the net deferred tax assets for the U.S. and foreign operations which comprise the U.S. income tax entity. Judgment is required in developing our income tax provision, including the determination of deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. In assessing the need for a valuation allowance, we considered all positive and negative evidence, including scheduled reversals of deferred tax liabilities, tax-planning strategies, projected future taxable income and recent financial performance. In 2003, 2002 and 2001, we reported net losses, primarily due to restructuring activities necessary to align our cost structure with expected net revenue levels. SFAS No. 109, “Accounting for Income Taxes,” states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Based upon the provisions of SFAS No. 109, we recorded, in the fourth quarter of 2003, a full valuation allowance against our net deferred tax assets.

The income tax expense recorded in 2003 also includes an expense of $4.3 million, recorded in the first half of 2003, to reduce certain deferred tax assets, representing the excess of expense for accounting purposes over the deduction for tax purposes, required to be recorded upon the vesting of restricted stock units. In prior years, a portion of executive search consultant and management compensation was granted in restricted stock units at the then-average market price of approximately $39 per share. This price served as the basis for the compensation expense and the related tax benefit and deferred tax asset. The restricted stock units vested in 2003 at an average market price of approximately $12 per share. As this share price serves as the basis for the current tax deduction, we will realize a smaller tax benefit than initially recorded. Accordingly, we adjusted the deferred tax asset to reflect the lower tax benefit.

In 2002, we had a pre-tax loss of $51.7 million and an income tax benefit of $11.5 million. The effective tax benefit rate in 2002 was 22.2%, reflecting valuation allowances related to the recoverability of foreign tax credits, foreign net operating losses and other tax-related allowances. In addition, the income tax benefit in 2002 is reduced by approximately $0.8 million of additional provision for income taxes in certain Latin American subsidiaries. The income tax provision and related current and deferred tax balances are more fully described in Note 6, Income Taxes, in the Notes to Consolidated Financial Statements.

We anticipate that the effective tax rate will continue to fluctuate in the future due to the mix of earnings and profits in the jurisdictions in which we operate. In 2004, we anticipate that we will generate a loss for U.S. income tax purposes, due primarily to the timing of tax deductions related to our restructuring charges, and

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therefore do not anticipate recording or paying any U.S. income tax in 2004. We will however continue to record and pay income tax expense for certain of our foreign operations. While the Company expects to be profitable in 2004 and beyond, there is no assurance that future taxable income will be sufficient to realize the benefit of the deferred tax assets. If after future assessments of the realizability of the deferred tax assets, we determine a lesser allowance is required, we would record a reduction to the income tax expense and the valuation allowance in the period of such determination.

2002 Compared to 2001

Total revenue.  Consolidated total revenue decreased $110.8 million, or 22.7%, to $376.8 million in 2003 from $487.6 million in 2002. The decline in total revenue was due primarily to the decline in revenue before reimbursements (net revenue).

Revenue before reimbursements (net revenue).   Consolidated net revenue decreased $104.8 million, or 23.0%, to $350.7 million in 2002 compared to $455.5 million in 2001. Excluding the effect of exchange rate changes of $5.5 million, net revenue declined approximately 24%. We believe information regarding changes in net revenue excluding the impact of exchange rate fluctuations is helpful in providing an understanding of the volume of business activity. The decline was due to decreased demand for our executive search services across most industries and disciplines, especially in our Technology and Financial Services practices. The number of confirmed executive searches decreased 20% from 2001. We believe this decrease reflects the impact of the global economic slowdown.

Net revenue in North America was $194.2 million in 2002, a decrease of $63.9 million, or 24.8%, from $258.1 million in 2001. Increases in our Consumer and Professional Services practices were more than offset by declines in our Technology and Financial Services practices. In Latin America, net revenue decreased $3.5 million, or 24.2%, to $11.0 million in 2002 from $14.5 million in 2001, as the region felt the effects of weak U.S. and local economies and political turmoil in some countries. Most of the practices reported declines. Net revenue in Europe decreased $31.3 million, or 20.1%, to $124.4 million in 2002 from $155.7 million in 2001. Excluding the impact of exchange rate changes of $5.2 million, Europe’s net revenue declined approximately 24%. Most practices experienced declines in net revenue from 2001 to 2002. In Asia Pacific, net revenue was $21.1 million in 2002, a decrease of $6.1 million, or 22.5%, from $27.2 million in 2001. Excluding the impact of exchange rate changes of $0.3 million, Asia Pacific’s net revenue decreased approximately 24% compared to 2001. Increases in the region’s Professional Services and Higher Education/Nonprofit practices were more than offset by declines in the Financial Services, Technology, and other practices.

Salaries and employee benefits.  Consolidated salaries and employee benefits expense decreased $60.5 million, or 20.0%, to $242.3 million in 2002 from $302.8 million in 2001. The decrease was primarily attributable to $23.2 million of lower accruals for performance-based compensation, related in part to the lower net revenue, and $37.3 million of lower fixed costs as a result of the elimination of more than 1,000 positions, or approximately 40% of our workforce, since June 2001. As a percentage of net revenue, salaries and employee benefits expense increased to 69.1% in 2002 from 66.5% in 2001. This increase as a percentage of net revenue was primarily due to the impact of lower net revenue against our fixed salaries and employee benefits expense, partially offset by a lower percentage of net revenue being accrued for performance-based compensation for executive search consultants, management and support staff. The average number of executive search consultants in 2002 was 391, a decrease of 23%, compared to an average of 507 in 2001.

General and administrative expenses.  Consolidated general and administrative expenses decreased $50.5 million, or 32.1%, to $106.9 million in 2002 from $157.4 million in 2001. This decrease was due to $21.3 million of lower discretionary spending, $18.6 million of lower bad debt expense, and $8.1 million of lower infrastructure expense and other cost savings primarily from the consolidation and closing of offices. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” we did not record goodwill amortization in 2002. In 2001, general and administrative expenses included $2.5 million of goodwill amortization. As a percentage of net revenue, general and administrative expenses decreased to 30.5% in 2002 from 34.6% in 2001.

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2002 and 2001 Restructuring charges.  In 2002, we recorded restructuring charges of $48.5 million related to reductions in our workforce and the consolidation and closing of offices. In 2001, we recorded restructuring charges of $53.2 million related to reductions in our workforce, the consolidation and closing of offices, and the settlement of a former Chief Executive Officer’s contract upon his retirement. The following table summarizes the workforce reductions as well as the restructuring charges related to the announced initiatives: