KORN FERRY quarterly report, Q1 FY2018

Korn/Ferry International — Fiscal 2018 First Quarter 10-Q Summary

Business Context and Reporting Period

Korn/Ferry provides executive search, talent and leadership consulting, recruitment process outsourcing, professional recruitment, and related talent-management products. The filing covers the three months ended July 31, 2017, compared with the three months ended July 31, 2016. The primary business segments were Executive Search, Hay Group, and Futurestep.

Financial Performance and Liquidity

Metric	Q1 FY2018	Q1 FY2017	Change
Fee revenue	$401.3 million	$375.6 million	Up 7%
Total revenue	$414.9 million	$392.9 million	Up 6%
Operating income	$40.7 million	$4.5 million	Up $36.2 million
Net income attributable to Korn/Ferry	$29.0 million	$3.2 million	Up $25.8 million
Diluted EPS	$0.51	$0.06	Up $0.45
Adjusted EBITDA	$59.4 million	$56.4 million	Up $3.0 million
Net cash used in operating activities	$109.6 million	$135.7 million	Improved by $26.1 million

Operating margin was 10.2% of fee revenue, compared with 1.2% in the prior-year quarter. Net income attributable to Korn/Ferry was 7.2% of fee revenue, compared with 0.9%.
Adjusted EBITDA margin remained approximately 15% of adjusted fee revenue in both periods.
Fee revenue increased in Executive Search to $161.2 million, Hay Group to $179.5 million, and Futurestep to $60.6 million. Executive Search represented the largest year-over-year growth contributor, while Futurestep increased 11%.
Cash, cash equivalents, and marketable securities totaled $408.3 million at July 31, 2017, down from $530.8 million at April 30, 2017. The decline primarily reflected annual bonus payments, sign-on and retention payments, capital expenditures, dividends, debt repayment, and share repurchases.
Cash and cash equivalents were $282.0 million at July 31, 2017. Working capital was $407.1 million. Management stated that available liquidity and expected operating funds should be sufficient for the next twelve months.
Operating cash flow was negative because of seasonal working-capital uses, including bonus payments and increases in client receivables. Days sales outstanding increased from 61 days to 69 days.

Debt, Capital Allocation, and Other Financial Items

Term loan debt outstanding was $254.4 million at July 31, 2017, compared with $259.5 million at April 30, 2017. The term facility and revolving facility mature June 15, 2021.
No borrowings were outstanding under the $125 million revolving credit facility. The company was in compliance with its debt covenants.
The average term-loan interest rate was 2.34%. An interest-rate swap fixed the rate on approximately half of outstanding debt at 1.919%, excluding the credit spread.
The company paid $5.8 million of dividends and repurchased approximately $4.0 million of common stock during the quarter. The quarterly dividend was $0.10 per share; a further $0.10 per-share dividend was declared on September 5, 2017.
The company had $117.2 million remaining under its authorized share-repurchase program at July 31, 2017.
Marketable securities held in trust for deferred-compensation obligations had a fair value of $126.3 million and supported vested obligations of $116.2 million.

Material Changes Versus the Prior Comparable Period

Profitability improved substantially primarily because restructuring charges fell to $0.3 million from $24.5 million in the prior-year quarter. The prior-year charges largely related to severance and facility consolidation following the Hay Group acquisition.
Hay Group moved from a $7.7 million operating loss to $19.1 million of operating income, driven mainly by the reduction in restructuring charges and modest revenue growth.
Executive Search operating income increased to $32.8 million from $26.9 million, with margin rising to 20.4% from 18.4%.
Futurestep operating income increased to $8.2 million from $7.5 million, while its margin remained approximately 14%.
Compensation and benefits expense increased 4% to $274.0 million, primarily because of higher average headcount, partially offset by lower integration costs.
General and administrative expense increased 5% to $58.3 million, including higher foreign-exchange losses, premises and office costs, business-development expense, and bad-debt expense.
Foreign currency translation produced a $16.2 million comprehensive-income benefit, compared with a $13.3 million loss in the prior-year quarter.
Adjusted EBITDA increased only 5% despite the sharp GAAP operating-income improvement, and adjusted EBITDA margin remained flat because higher revenue was substantially offset by increased compensation and general and administrative costs.

Guidance, Outlook, Risks, and Unusual Items

The filing does not provide a specific quantitative earnings or revenue forecast. Management expects current cash, operating funds, and credit availability to support working capital, capital expenditures, debt repayment, retention-pool obligations, dividends, and share repurchases over the next twelve months.
A $40 million Legacy Hay retention pool remained an obligation; $9.0 million had been paid in fiscal 2017, with the remaining amount scheduled in installments after November 30, 2017 and November 30, 2018, subject to applicable conditions.
Management continued integrating Legacy Hay through facility consolidation. The restructuring liability was $10.3 million at July 31, 2017.
Key risks include demand sensitivity to economic and labor-market conditions, automation, attracting and retaining consultants, competition, client-relationship portability, off-limits restrictions, currency fluctuations, cybersecurity and data-privacy requirements, legal and regulatory exposure, acquisition integration, goodwill and intangible-asset impairment, consultant utilization and billing rates, seasonality, and the ability to maintain the cost structure.
A 10% change in the value of the currencies to which the company is exposed could result in an estimated foreign-exchange gain or loss of approximately $8.5 million. A 100-basis-point increase in LIBOR would have increased quarterly interest expense by approximately $0.7 million.
The company adopted share-based-payment accounting amendments on May 1, 2017. The filing states that the primary effect was to recognize excess tax benefits in income-tax expense rather than equity; the forfeiture-policy election had no financial-statement impact.
The company is evaluating the future revenue-recognition standard and expects most contracts to continue recognizing revenue over time, but the ultimate impact and adoption method were not yet finalized.
Management reported no material litigation, no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and effective disclosure controls.

Important Facts for Investors to Verify

Whether the strong GAAP margin improvement is sustained after the remaining Hay integration and facility-consolidation activities are completed.
Future fee-revenue growth, engagement volumes, average fees per engagement, consultant headcount, and utilization across Executive Search, Hay Group, and Futurestep.
Conversion of revenue and earnings into operating cash flow after seasonal bonus payments and elevated receivables.
Debt amortization, leverage-covenant headroom, variable-rate exposure, and the impact of the interest-rate swap.
The timing and amount of remaining Legacy Hay retention-pool payments and restructuring obligations.
The effect of foreign-exchange movements, particularly on revenue, operating expenses, accumulated other comprehensive income, and cash held overseas.
The sustainability of the $0.10 quarterly dividend and share repurchases under the credit agreement’s leverage and liquidity conditions.
The eventual financial-statement impact and adoption approach for the new revenue-recognition and lease-accounting standards.