KFY

Korn/Ferry International: Q2 2004 Financial Summary (Period Ended July 31, 2003)

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended July 31, 2003, for Korn/Ferry International, a global executive recruitment firm. The company operates two primary segments: Executive Recruitment and Futurestep (middle-management recruitment). The reporting period reflects ongoing restructuring efforts initiated in fiscal 2002 to address deteriorating economic conditions, reduce costs, and reposition the enterprise.

Key Financial Metrics

Liquidity: Cash used in operating activities was $22.1 million, compared to $6.8 million in the prior year. The company maintains a $30 million Senior Secured Revolving Credit Facility with no borrowings outstanding as of July 31, 2003.

Material Changes vs. Prior Period

• Revenue Decline: Fee revenue decreased 13.5% to $72.6 million, driven by a reduced number of engagements across all geographic regions due to the challenging economic environment. Executive recruitment revenue fell 13.5%, while Futurestep revenue declined 14.3%.
• Restructuring Charges: The company incurred $8.5 million in restructuring charges in the current quarter, compared to none in the prior year. This included $6.7 million for severance and benefits related to 162 staff reductions, $0.9 million for facilities, and other asset write-offs.
• Operating Performance: Operating loss widened to $6.9 million from a profit of $1.3 million. Excluding restructuring charges, adjusted operating income was $1.6 million, a slight improvement over the prior year's $1.3 million.
• Expense Reduction: Compensation and benefits expenses decreased 13.8% to $51.3 million, reflecting a 13% workforce reduction. General and administrative expenses fell 10.0% to $16.8 million.

Guidance, Outlook, and Risks

Management Commentary: Management continues to streamline infrastructure and improve organizational efficiencies. The focus remains on consolidating back-office functions, reducing corporate overhead, and preserving top talent. The company believes cash on hand, the credit facility, and funds from operations are sufficient to meet working capital and capital expenditure requirements.

Risks and Contingencies:

• Economic Sensitivity: Results are heavily dependent on the economic environment and client hiring activity.
• Restructuring Execution: Future cash outflows are expected for the remaining restructuring liability of $19.4 million, primarily severance and facility lease commitments.
• Debt Obligations: The company has $40.0 million in 7.5% Convertible Subordinated Notes and $10.0 million in Convertible Preferred Stock. Interest and dividends are payable semi-annually, with a portion payable in kind for the first two years.
• Foreign Currency: Global operations expose the company to foreign currency exchange fluctuations, though natural hedges are utilized.

Investor Verification Checklist

• Restructuring Liability: Verify the $19.4 million restructuring liability roll-forward and expected cash outflow timing (severance expected by Feb 2004; facility costs over 8 years).
• COLI Borrowings: Confirm the $67.6 million in borrowings against Company Owned Life Insurance policies and the associated variable interest rates.
• Convertible Securities: Review the terms of the $50 million in convertible debt and preferred stock, specifically the mandatory redemption date of June 13, 2010, and conversion price of $10.25 per share.
• Segment Performance: Analyze the divergence between North America (profitable) and Europe (loss-making due to restructuring and FX) within the Executive Recruitment segment.
• Stock-Based Compensation: Note that the company has not adopted SFAS No. 123 for expensing stock options; pro forma net loss would be $(14.3) million if fair-value accounting were applied.