Korn/Ferry International — Q1 FY2019 Form 10-Q Summary
Reporting period: Three months ended July 31, 2018, compared with the three months ended July 31, 2017. Korn/Ferry provides Executive Search, Advisory, RPO and Professional Search, and related talent-management products and services.
Business context and reporting period
- The company approved a “One Korn Ferry” plan in June 2018 to operate under a single master brand and sunset sub-brands including Hay Group, Futurestep and Lominger.
- Reportable segments were renamed Advisory and RPO & Professional Search; segment financial reporting was not otherwise changed.
- The company adopted ASC 606 using the modified retrospective method, increasing opening retained earnings by $6.7 million, net of tax.
Financial performance and liquidity
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Fee revenue | $465.6 million | $401.3 million | Up 16% |
| Total revenue | $478.4 million | $414.9 million | Up 15% |
| Operating income (loss) | $(55.1) million | $41.9 million | Declined $97.0 million |
| Net income (loss) attributable to Korn/Ferry | $(38.6) million | $29.0 million | Declined $67.6 million |
| Diluted earnings (loss) per share | $(0.70) | $0.51 | Declined |
| Adjusted EBITDA | $70.8 million | $60.4 million | Up 17% |
| Adjusted EBITDA margin on fee revenue | 15.2% | 15.0% | Up 0.2 percentage points |
| Operating margin on fee revenue | (11.8%) | 10.5% | Down 22.3 percentage points |
Fee revenue increased in all businesses: Executive Search rose 20% to $192.9 million, Advisory rose 9% to $195.4 million, and RPO & Professional Search rose 28% to $77.3 million. Executive Search operating income increased to $40.9 million, and RPO & Professional Search operating income increased to $11.6 million.
Advisory reported an $83.1 million operating loss, primarily because of the $106.6 million tradename write-off. Excluding that charge, Advisory operating margin was approximately 12% versus 11% in the prior-year quarter.
- Cash and cash equivalents: $365.7 million at July 31, 2018, down from $520.8 million at April 30, 2018.
- Cash, cash equivalents and marketable securities: $499.8 million, down from $657.9 million.
- Net cash used in operating activities: $117.5 million, compared with $109.6 million used in the prior-year quarter.
- Net cash used in investing activities: $6.6 million, including $13.2 million of capital expenditures.
- Net cash used in financing activities: $20.6 million, including $5.2 million of term-loan principal payments and $6.0 million of dividends.
- Working capital was $470.3 million, an increase of $14.5 million from April 30, 2018.
- Accounts receivable days outstanding increased from 58 to 65 days.
Debt, liquidity and capital allocation
- Term Facility outstanding was $233.7 million at July 31, 2018, compared with $238.9 million at April 30, 2018; maturity is June 15, 2021.
- No borrowings were outstanding under the revolving facility. Approximately $122.1 million remained available after standby letters of credit.
- The average term-loan interest rate was 3.24%, compared with 2.34% in the prior-year quarter. An interest-rate swap fixes the rate on approximately half of outstanding debt at 1.919%, excluding the credit spread.
- The company was in compliance with debt covenants. Dividends and repurchases are subject to a maximum pro forma leverage ratio of 2.50 to 1.00 and minimum domestic liquidity of $50.0 million.
- Management expects cash on hand, operating funds and available credit to meet anticipated needs for the next twelve months, but notes that economic deterioration could reduce demand and operating cash flow.
- The regular quarterly dividend remained $0.10 per share. A $0.10 dividend was declared on September 5, 2018, payable October 15, 2018.
Material changes, unusual items and outlook
- The $106.6 million non-cash impairment charge eliminated the carrying value of indefinite-lived Hay Group and Lominger tradenames after the company decided to discontinue those brands. The charge was recorded in general and administrative expenses and excluded from Adjusted EBITDA.
- Compensation and benefits expense increased 18% to $321.9 million, primarily due to higher performance-related bonuses, a 6% increase in average headcount, higher incentive compensation and greater use of contractors.
- General and administrative expense increased 189% to $168.7 million; excluding the tradename write-off, it was approximately 13% of fee revenue versus 15% reported in the prior-year quarter.
- Performance obligations for contracts longer than one year totaled $486.7 million at July 31, 2018. Management expects to recognize approximately $225.6 million in fiscal 2019, $137.3 million in fiscal 2020, $72.4 million in fiscal 2021 and $51.4 million thereafter. These amounts exclude contracts with initial terms of one year or less and are not a forecast of total future revenue.
- The company continues to evaluate alternatives for implementing the reorganization contemplated by the One Korn Ferry plan and may not use the previously described holding-company merger structure.
- A $40.0 million retention pool related to a prior acquisition had $23.5 million paid; the remaining balance was expected to be payable within 45 days after November 30, 2018.
- No material changes were reported to the risk factors in the fiscal 2018 Form 10-K, and no material adverse legal proceedings were disclosed.
Key investor verification points
- Verify whether the One Korn Ferry rebranding and organizational changes improve cross-selling and revenue growth without creating additional execution or retention costs.
- Track adjusted versus GAAP profitability and confirm that the $106.6 million tradename impairment is non-recurring.
- Monitor bonus payments, receivables collection, cash conversion and the company’s ability to sustain dividends while repaying debt.
- Review debt covenant headroom, leverage calculations and the availability of the revolving facility.
- Assess the sustainability of the 15.2% Adjusted EBITDA margin and whether revenue growth continues across all three operating segments.
- Monitor foreign exchange exposure, interest-rate sensitivity, tax-accounting estimates under the Tax Cuts and Jobs Act, and potential goodwill or intangible-asset impairment.