Korn/Ferry International — Fiscal 2016 Third Quarter Form 10-Q
Reporting period: Three and nine months ended January 31, 2016, compared with the corresponding periods ended January 31, 2015. The filing is the fiscal 2016 third-quarter report, despite the request metadata referring to “2015 Q3.” Korn/Ferry provides executive recruitment, Hay Group talent and leadership consulting, and Futurestep recruitment process outsourcing and professional search services.
Financial performance and liquidity
| Metric | Three months ended January 31, 2016 | Three months ended January 31, 2015 | Nine months ended January 31, 2016 | Nine months ended January 31, 2015 |
|---|---|---|---|---|
| Fee revenue | $344.2 million | $249.5 million | $892.2 million | $756.4 million |
| Total revenue | $358.9 million | $258.9 million | $929.6 million | $783.9 million |
| Operating income (loss) | $(14.1) million | $32.9 million | $47.9 million | $85.9 million |
| Net income (loss) | $(16.0) million | $22.9 million | $25.1 million | $62.9 million |
| Diluted earnings (loss) per share | $(0.30) | $0.46 | $0.48 | $1.25 |
| Adjusted EBITDA | $47.7 million | $39.1 million | $135.4 million | $121.0 million |
Margins: Consolidated operating margin was negative 4.1% of fee revenue in the quarter and 5.4% for the nine-month period, compared with 13.2% and 11.4%, respectively, in the prior-year periods. Adjusted EBITDA margin was 13.6% in the quarter and 15.1% for the nine months, compared with 15.7% and 16.0%, respectively.
- Quarterly fee revenue increased 38%, with $71.9 million contributed by Legacy Hay. Excluding Legacy Hay, fee revenue increased 9% and was adversely affected by $19.6 million of foreign-exchange translation.
- Nine-month fee revenue increased 18%; excluding Legacy Hay, it increased 8%, while foreign exchange reduced revenue by $52.3 million.
- Quarterly operating loss included $30.6 million of restructuring charges, $21.1 million of integration and acquisition costs, and a $5.9 million deferred-revenue adjustment related to the acquisition.
- Other loss was $7.1 million in the quarter and $9.8 million for the nine months, primarily reflecting declines in the fair value of trading securities held for deferred compensation obligations.
Cash flow, debt and liquidity
- Cash used in operating activities was $17.4 million for the nine months, compared with $18.1 million provided in the prior-year period.
- Cash used in investing activities was $267.3 million, including $252.6 million paid for Legacy Hay and $17.7 million of capital expenditures.
- Cash provided by financing activities was $132.2 million, including $150.0 million of term-loan proceeds, offset by $2.5 million of principal repayment and $16.1 million of dividends.
- Cash and cash equivalents were $207.3 million at January 31, 2016, compared with $380.8 million at April 30, 2015. Cash plus marketable securities totaled $343.3 million versus $525.4 million.
- Marketable securities of $135.9 million were primarily held in trust for deferred compensation obligations of $133.0 million and therefore were not fully available for general corporate use.
- The term loan had $147.5 million outstanding at January 31, 2016, with an average interest rate of 1.56% for the quarter. No borrowings were outstanding under the $100 million revolving facility.
- The credit agreement matures September 23, 2020, requires minimum Adjusted EBITDA and maximum leverage compliance, and requires $50 million of domestic liquidity for certain acquisitions, dividends and repurchases. The company reported compliance with its debt covenants.
- Management stated that available cash, operating funds and other liquidity should meet expected working capital, capital expenditures, debt service, Legacy Hay retention obligations and dividends for the next twelve months.
Material changes versus the prior comparable period
- On December 1, 2015, Korn/Ferry acquired Legacy Hay for $470.5 million, consisting of $252.6 million in cash and 5.9 million common shares valued at $217.9 million. The preliminary allocation included $326.7 million of goodwill and $198.7 million of intangible assets.
- Legacy Hay contributed $71.9 million of quarterly fee revenue and $8.6 million of Adjusted EBITDA, but generated a $29.2 million operating loss in the quarter, including integration costs and restructuring charges.
- Hay Group quarterly fee revenue increased 118% to $140.5 million, primarily from Legacy Hay; its operating loss was $21.6 million versus prior-year operating income of $8.6 million.
- Executive Recruitment quarterly fee revenue increased 8% to $154.7 million and operating income increased to $34.6 million from $33.6 million. Futurestep fee revenue increased 18% to $49.0 million and operating income increased to $6.6 million.
- For the nine months, Executive Recruitment operating income rose to $108.7 million from $87.7 million, while Futurestep operating income rose to $19.7 million from $14.4 million. Hay Group reported a $6.3 million operating loss versus $19.8 million of operating income.
- Accounts receivable increased materially following the acquisition and higher days sales outstanding, from 58 days at April 30, 2015 to 69 days at January 31, 2016.
- The company declared and paid quarterly dividends of $0.10 per share and declared another $0.10 per share dividend after quarter-end. Future dividends remain subject to board discretion and debt covenant requirements.
Outlook, risks and unusual items
- Management’s strategy emphasizes integration of the multi-service platform, expanded intellectual property and technology, and growth in consulting, assessment, recruitment process outsourcing and related services.
- A $40 million Legacy Hay employee retention pool remains outstanding; up to $5 million is payable within one year, with the balance scheduled in 2017 and 2018.
- The company recorded a $21.3 million restructuring liability at January 31, 2016, primarily for severance and facility consolidation.
- Following a February 2016 Venezuelan currency devaluation, management expects an estimated pretax charge of $9 million to $12 million, or $0.11 to $0.14 of diluted EPS, in the fourth quarter of fiscal 2016.
- Key risks include Legacy Hay integration, indebtedness and covenant compliance, foreign currency exposure, economic and labor-market conditions, client and consultant retention, competition, cybersecurity, technology dependence, goodwill and intangible-asset impairment, deferred-tax-asset recoverability, and marketable-securities volatility.
- The company had no material litigation expected by management to adversely affect its financial position or results. Disclosure controls were deemed effective, and no material changes to internal control were reported.
Investor verification checklist
- Verify the final purchase-price allocation for Legacy Hay, including goodwill, intangible assets, deferred taxes and any measurement-period adjustments.
- Track whether Legacy Hay achieves sustainable profitability after the reported restructuring and integration costs.
- Reconcile unrestricted domestic liquidity with deferred-compensation trust assets and assess compliance with the $50 million liquidity requirement.
- Monitor term-loan amortization, leverage ratios, variable-rate exposure and the scheduled $7.8 million quarterly installments beginning April 1, 2016.
- Assess working-capital conversion, receivables growth and the increase in days sales outstanding.
- Confirm the magnitude and timing of the projected Venezuela charge and continuing foreign-exchange effects.
- Evaluate whether recurring Adjusted EBITDA performance supports dividends, retention payments and debt service; Adjusted EBITDA is a non-GAAP measure and is not a substitute for GAAP earnings or cash flow.