KFY

Korn/Ferry International: Q1 2008 Financial Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended July 31, 2007 (First Quarter of Fiscal Year 2008). Korn/Ferry International is a global provider of talent management solutions, operating primarily through two segments: Executive Recruitment (senior-level search) and Futurestep (middle-management and outsourced recruiting). The company reported strong growth across all geographic regions, driven by an increase in the number of engagements billed and higher average fees.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Fee revenue increased 21% ($32.6 million) year-over-year. This was driven by an 11% increase in the number of engagements billed and higher average fees. Exchange rates provided a favorable impact of $6.2 million.
• Segment Performance:
  • Executive Recruitment: Revenue rose 21% to $159.8 million. Operating income increased 22% to $32.7 million. Growth was broad-based, with EMEA up 31% and Asia Pacific up 24%.
  • Futurestep: Revenue rose 26% to $25.6 million, driven by a strategic shift toward larger outsourced recruiting solutions. Operating income doubled to $2.1 million.
• Expense Increases: Operating expenses rose $30.3 million. Compensation and benefits increased 18% due to a 20% increase in global headcount (656 new employees). General and administrative expenses rose 30%, partly due to increased bad debt expense ($1.2 million) and premise costs.
• Cash Flow: Net cash used in operating activities was $73.4 million, compared to $47.1 million in the prior year. This outflow was primarily due to a significant reduction in accrued compensation liabilities (payment of deferred compensation) and an increase in receivables.

Guidance, Outlook, and Risks

• Strategic Focus: Management plans to increase market share and enhance cross-selling of multi-product strategies, specifically Recruitment Process Outsourcing (RPO) and Leadership Development Solutions (LDS).
• Acquisitions: The company continues a disciplined acquisition strategy. Recent contributions included the Lominger Entities (acquired in Q2 FY2007) and The Newman Group (contributing to Futurestep growth).
• Liquidity: The company has no long-term debt and no outstanding balance on its credit facility. Management believes cash on hand and funds from operations are sufficient for working capital and capital expenditure needs.
• Risks: Key risks include dependence on retaining qualified consultants, portability of client relationships, and foreign currency fluctuations. The company noted a $0.3 million foreign currency loss in the quarter. There were no material changes to risk factors from the previous annual report.
• Accounting Changes: The company adopted FIN 48 (Accounting for Uncertainty in Income Taxes) on May 1, 2007, resulting in a $3.5 million reduction to retained earnings.

Investor Verification Checklist

• Cash Flow vs. Net Income: Verify the sustainability of operations given the $73.4 million cash outflow from operations despite $17.1 million in net income. The outflow is largely due to the timing of deferred compensation payments.
• Headcount Efficiency: Monitor if the 20% increase in headcount continues to drive revenue growth or if it pressures margins in future quarters.
• Bad Debt Exposure: Review the $1.2 million increase in bad debt expense and the allowance for doubtful accounts ($11.6 million) to assess credit risk in the current economic environment.
• Stock Repurchases: Note the company repurchased approximately 545,000 shares under public programs during the quarter, reducing the remaining authorized buyback value to $36.6 million.
• Foreign Currency Sensitivity: Assess the impact of a strengthening U.S. dollar, as a 15% appreciation could result in a $2.4 million exchange loss based on current balances.