KFY

Korn/Ferry International: Q1 Fiscal 2009 Summary (Ended July 31, 2008)

Business Context and Reporting Period

This Form 10-Q covers the three-month period ended July 31, 2008 (Q1 Fiscal 2009). Korn/Ferry International is a global provider of talent management solutions, operating primarily through two segments: Executive Recruitment and Futurestep (middle-management and outsourced recruitment). The company serves approximately 5,120 clients, including nearly half of the Fortune 500.

Key Financial Metrics

Note: Operating margin decreased to 11.5% of fee revenue from 13.5% in the prior year. Net cash used in operating activities was $88.9 million, primarily due to a significant reduction in accrued compensation liabilities.

Material Changes vs. Prior Period

• Revenue Growth: Fee revenue increased 11% ($20.3 million) driven by a 9% increase in the number of engagements billed and higher average fees. Growth was broad-based, with significant increases in North America (+7.6%), EMEA (+15.4%), and South America (+49.0%). Asia Pacific was the only region to decline (-5.7%) due to fewer engagements.
• Profitability Pressure: Despite revenue growth, operating income declined 5.2% ($1.3 million). This was caused by a 15.5% increase in compensation and benefits expenses ($19.1 million), driven by a 6% increase in global headcount and higher profitability-based awards.
• Segment Performance: Executive Recruitment operating income fell 3.1% to $31.7 million. Futurestep operating income rose 37% to $2.9 million, benefiting from revenue growth outpacing expense increases.
• Cash Flow: Net cash used in operating activities increased to $88.9 million from $73.4 million. This was largely due to the payment of accrued compensation and benefits, which decreased by approximately $92.6 million on the balance sheet.

Outlook, Risks, and Unusual Items

• Auction Rate Securities (ARS): The company holds $18.9 million (fair value $17.8 million) in auction rate securities. Due to global credit market liquidity issues, auctions for these securities have failed. The company classifies these as noncurrent and believes the decline in fair value is temporary. However, liquidity is diminished, and recovery of principal may be delayed until 2010-2012 or maturity.
• Subsequent Event: As of August 8, 2008, the company received notification of a proposed settlement where a third-party institution would repurchase $13.6 million of the company's ARS holdings at par value between 2010 and 2012. If finalized, this would reverse $0.8 million of unrealized losses.
• Strategic Focus: Management plans to focus on increasing market share, cross-selling multi-product strategies, and expanding Recruitment Process Outsourcing (RPO) and Leadership Development Solutions (LDS).
• Stock Repurchases: The company repurchased 127,607 shares during the quarter under a $50 million program approved in November 2007. Approximately $43.6 million remains available for repurchase.

Investor Verification Checklist

• ARS Liquidity Risk: Verify the status of the proposed settlement regarding the $18.9 million in auction rate securities and the potential timeline for liquidity recovery.
• Compensation Leverage: Monitor the ratio of compensation expenses to fee revenue, which rose to 69.1% in Q1 2008 from 66.4% in Q1 2007, impacting operating margins.
• Asia Pacific Trends: Investigate the 11% decline in engagements billed in the Asia Pacific region to determine if this is a temporary fluctuation or a structural shift.
• Cash Flow Volatility: Review the significant cash outflow for compensation payments to ensure future working capital requirements are met without external financing.