KFY

Korn/Ferry International: Q3 2003 Financial Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended January 31, 2003, and the nine-month period ended on the same date. Korn/Ferry International operates in two primary global segments: Executive Recruitment and Futurestep (middle-management recruitment). The company is navigating a global economic downturn, continuing cost-reduction and restructuring initiatives initiated in fiscal 2002 to reduce losses and preserve top talent.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Fee revenue decreased 13% ($11.2 million) for the quarter and 18% ($52.4 million) for the nine-month period compared to the prior year. This decline was driven by reduced hiring activity across all geographic regions and business lines.
• Profitability Improvement: Despite revenue declines, the company narrowed its operating loss significantly. Operating income improved from a loss of $3.5 million in the prior quarter to a profit of $0.2 million. For the nine months, the operating loss narrowed from $95.0 million to $14.4 million.
• Restructuring Charges: The company incurred $16.3 million in asset impairment and restructuring charges for the nine months ended January 31, 2003. This is a significant reduction from the $84.3 million charged in the same period of the prior year. The current charges relate to severance for approximately 130 employees and facility consolidation.
• Cost Reduction: Compensation and benefits expenses decreased 14% for the quarter and 19% for the nine months, reflecting a workforce reduction of approximately 16% in executive recruitment and 35% in Futurestep over the last 12 months.
• Cash Flow: Operating cash flow turned positive, providing $8.7 million for the nine months, compared to a use of $78.6 million in the prior year. This improvement was driven by a $19.4 million reduction in receivables and lower net losses.

Guidance, Outlook, and Risks

Management Commentary: Management attributes the revenue decline to the continued weakness in the global economy. However, they highlight that cost-saving initiatives are yielding results, with adjusted operating income (excluding restructuring charges) improving to $1.8 million for the nine-month period compared to a loss of $10.8 million in the prior year.

Liquidity and Capital Resources:

• The company obtained a $30 million Senior Secured Revolving Credit Facility in February 2003 to support working capital needs.
• In June 2002, the company issued $40 million in 7.5% Convertible Subordinated Notes and $10 million in Convertible Preferred Stock.
• Management believes cash on hand, the new credit facility, and funds from operations are sufficient for foreseeable requirements.

Risks and Contingencies:

• Economic Sensitivity: Results are heavily dependent on global economic conditions and client hiring activity.
• Restructuring Execution: Ongoing facility closures and workforce reductions carry execution risks.
• Debt Covenants: The new credit facility requires the company to meet specific financial condition covenants on a quarterly basis.
• Foreign Currency: Global operations expose the company to foreign currency exchange fluctuations, though natural hedges are utilized.

Investor Verification Checklist

• Revenue Trends: Verify if the 13-18% revenue decline is stabilizing or accelerating in subsequent quarters.
• Restructuring Completion: Confirm the timeline for the completion of facility closures and the final cost of the $16.3 million restructuring charge.
• Credit Facility Utilization: Monitor the utilization of the new $30 million revolving credit facility and compliance with financial covenants.
• Segment Performance: Review the specific performance of the Futurestep segment, which continues to report significant operating losses despite cost cuts.
• Debt Obligations: Assess the impact of the 7.5% convertible debt and preferred stock on future cash flows and potential dilution.