KORN FERRY quarterly report, Q3 FY2014

Korn/Ferry International Form 10-Q Summary

Business context and reporting period

This filing covers the fiscal third quarter and nine months ended January 31, 2014, compared with the periods ended January 31, 2013. Korn/Ferry provides executive recruitment, Leadership & Talent Consulting (LTC), and Futurestep recruitment process outsourcing and professional recruitment services through 87 offices in 37 countries.

The filing reflects the continuing integration of PDI Ninth House and Global Novations, acquired during fiscal 2013. Management’s fiscal 2014 strategy emphasizes cross-selling and integration of service lines, growth in LTC and RPO, technology and process improvements, disciplined acquisitions, and development of new products and services.

Financial performance and liquidity

Metric	Three months ended Jan. 31, 2014	Three months ended Jan. 31, 2013	Nine months ended Jan. 31, 2014	Nine months ended Jan. 31, 2013
Fee revenue	$242.2 million	$202.0 million	$708.6 million	$584.9 million
Total revenue	$250.9 million	$210.3 million	$734.8 million	$611.1 million
Operating income	$27.3 million	$8.7 million	$67.1 million	$28.5 million
Net income	$21.3 million	$9.5 million	$51.5 million	$21.1 million
Diluted EPS	$0.43	$0.20	$1.05	$0.44
Adjusted EBITDA	$35.2 million	$25.2 million	$103.8 million	$70.0 million

Fee-revenue operating margin increased to 11.3% from 4.3% in the quarter and to 9.5% from 4.9% for the nine-month period. Net income margin increased to 8.8% from 4.7% in the quarter and to 7.3% from 3.6% year to date. Adjusted EBITDA margin was approximately 14.5% in the quarter and 14.6% year to date, compared with 12.5% and 12.0%, respectively, in the prior-year periods.

Quarterly fee revenue increased 20%; excluding the PDI acquisition, management reported 12% growth. Nine-month fee revenue increased 21%; excluding prior-year acquisitions, management reported a $51.8 million increase.
Quarterly segment fee revenue was $144.0 million for Executive Recruitment, $62.2 million for LTC, and $35.9 million for Futurestep. LTC grew 51%, including the PDI contribution, and Futurestep grew 18%.
Nine-month segment fee revenue was $420.7 million for Executive Recruitment, $188.4 million for LTC, and $99.5 million for Futurestep.
Operating cash flow was $33.1 million for the nine months, versus cash used of $2.2 million in the prior-year period. Capital expenditures were $17.3 million, and investing cash outflow was $9.3 million.
Cash and cash equivalents were $247.8 million at January 31, 2014, compared with $224.1 million at April 30, 2013. Total cash, cash equivalents, and marketable securities were $377.2 million, compared with $366.0 million.
Working capital increased by $66.2 million. Client receivable days outstanding increased from 59 to 70 days, consistent with historical experience according to management.
The company had no borrowings under its $75 million senior unsecured revolving credit facility. Standby letters of credit totaled $2.8 million under the facility plus $0.2 million with other financial institutions.
The company had $73.3 million of primarily variable-rate borrowings against company-owned life insurance policies; the related net cash surrender value was $93.7 million.
Deferred compensation liabilities totaled $168.6 million. Mutual funds held in trust for related obligations had a fair value of $115.1 million, while vested and unvested obligations totaled $116.4 million.

Material changes versus the prior comparable period

Growth occurred across all Executive Recruitment regions and all three operating segments. Executive Recruitment engagements billed increased 11% in the quarter and 7% year to date.
Executive Recruitment operating margin rose to 22.0% from 16.6% in the quarter and to 20.9% from 14.1% year to date.
LTC moved from a $2.8 million operating loss in the prior-year quarter to $5.7 million of operating income; its year-to-date operating margin increased to 9.0% from 7.1%.
Futurestep revenue benefited from larger RPO contracts and increased non-executive recruitment, although its quarterly operating margin declined to 10.9% from 12.3%.
Compensation and benefits increased 16% in the quarter and 19% year to date, driven primarily by higher performance bonuses, salaries, and headcount.
General and administrative expense declined as a percentage of fee revenue to 15.4% from 17.8% in the quarter and to 15.9% from 17.6% year to date.
Restructuring charges fell to zero in the quarter from $4.4 million and to $3.7 million year to date from $19.9 million, as PDI integration and cost-rationalization activity progressed.
Other income declined in the quarter to $1.1 million from $3.3 million, primarily reflecting lower gains on mutual funds supporting deferred compensation obligations. Year-to-date other income increased to $7.8 million from $3.8 million.
The effective tax rate was 24% in the quarter and 31% year to date, compared with 24% and 36%, respectively, in the prior-year periods. The current-year rate benefited from the conclusion of an IRS examination and a greater proportion of income earned in lower-tax jurisdictions.

Guidance, outlook, risks, contingencies, and unusual items

The filing does not provide specific quantitative revenue, earnings, or margin guidance. Management believes cash on hand and operating cash flow will be sufficient for anticipated working capital, capital expenditures, and general corporate requirements over the next twelve months.

Fiscal 2014 priorities include continued integration of prior-year acquisitions, expansion of LTC and RPO, technology investment, new product development, and disciplined acquisitions.
The company paid $15.0 million of contingent consideration to PDI selling stockholders after achievement of specified expense-synergy goals.
The company recorded $4.5 million of compensation expense for an employment dispute during the nine months; the matter was settled and no related liability remained at January 31, 2014.
Restructuring liabilities totaled $3.7 million at January 31, 2014, primarily for facility obligations, with certain facilities costs payable over the next four years.
Key risks include economic and labor-market weakness, demand volatility and seasonality, foreign currency movements, competition, consultant retention, client relationship portability, off-limits restrictions, legal and employment liability, cybersecurity and systems disruption, intellectual property protection, acquisition integration, goodwill and intangible-asset impairment, deferred-tax-asset recoverability, and changes in accounting estimates.
Foreign currency translation reduced accumulated other comprehensive income by $8.4 million year to date. Management estimated that a 15%, 25%, or 35% movement in specified currencies could produce approximately $2.7 million, $4.5 million, or $6.3 million of exchange gain or loss, respectively, for the quarter based on outstanding balances.
The company reported no material litigation expected to adversely affect its business, financial position, or results of operations, no material changes to previously disclosed risk factors, and no off-balance-sheet arrangements.

Important facts for investors to verify

Separate organic growth from acquisition-related growth, particularly in LTC and consolidated fee revenue.
Whether improved operating margins are sustainable after restructuring benefits decline and performance-based compensation rises.
Collection trends and aging of client receivables following the increase in days sales outstanding to 70 days.
The remaining cash requirements and completion timeline for PDI integration, restructuring, and contingent obligations.
The distinction between unrestricted liquidity and assets held in trust for deferred compensation obligations.
Exposure to foreign currency movements, variable-rate COLI borrowings, and future interest-rate changes.
Results of the fiscal 2014 annual goodwill and indefinite-lived intangible-asset impairment tests, which were scheduled for the fourth quarter.
Compliance with the revolving-credit agreement’s financial covenants and $50 million domestic liquidity requirement.