KFY

Korn/Ferry International: Q2 Fiscal 2008 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report on Form 10-Q for Korn/Ferry International, a global provider of executive recruitment, outsourced recruiting (Futurestep), and leadership development solutions. The report covers the quarterly period ended October 31, 2007 (the second quarter of fiscal year 2008) and the six months ended on that date. The company operates in two primary segments: Executive Recruitment and Futurestep.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Fee revenue increased 26% in Q2 and 24% YTD compared to the prior year. This was driven by an 11% increase in the number of engagements billed and significant increases in average fees across all regions.
• Segment Performance:
  • Executive Recruitment: Fee revenue grew 25% in Q2. North America, EMEA, and Asia Pacific all reported double-digit growth. The Lominger Entities acquisition contributed $2.6 million to Q2 revenue.
  • Futurestep: Fee revenue grew 30% in Q2, driven by a strategic shift toward larger outsourced recruiting solutions, resulting in higher average fees.
• Expense Increases: Operating expenses rose significantly due to a 22% increase in global headcount (including an 81% increase in Futurestep consultants) and higher variable compensation awards. Compensation and benefits expenses increased 28% in Q2.
• Cash Flow: Net cash used in operating activities was $43.4 million for the six months ended Oct 31, 2007, compared to $13.7 million in the prior year period. This was primarily due to a $56.8 million increase in accounts payable and accrued liabilities (timing of payments) and a $44.6 million increase in receivables.
• Stock Repurchases: The company repurchased approximately 2.0 million shares of common stock during the quarter, utilizing the full $125 million authorized under previous programs. On November 2, 2007, the Board approved an additional $50 million repurchase program.

Guidance, Outlook, and Risks

• 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).
• Liquidity: The company maintains strong liquidity with $166.9 million in cash and no long-term debt. Management believes existing resources are sufficient for working capital and capital expenditure needs.
• Market Risks:
  • Currency: The company is exposed to foreign currency fluctuations. A 15% strengthening of the U.S. dollar against major currencies could result in an exchange loss of approximately $2.0 million based on outstanding balances.
  • Competition & Talent: Risks include dependence on retaining qualified consultants and competition in the recruitment industry.
• Accounting Changes: The company adopted FIN 48 (Accounting for Uncertainty in Income Taxes) in May 2007, resulting in a $3.5 million reduction to retained earnings. As of Oct 31, 2007, gross unrecognized tax benefits were $10.7 million.

Investor Verification Checklist

• Headcount vs. Revenue Efficiency: Verify if the 22% increase in global headcount and 81% increase in Futurestep consultants will yield sustainable margin improvements as the new hires ramp up.
• Operating Cash Flow: Monitor the significant use of cash in operating activities ($43.4M outflow YTD) to ensure it is a timing issue related to receivables/payables rather than a structural cash burn.
• Stock Repurchase Impact: Confirm the execution of the newly approved $50 million share repurchase program and its impact on diluted EPS.
• Futurestep Margins: Review Futurestep's operating margin, which declined to 6% in Q2 from 9% in the prior year, to assess the profitability of the aggressive expansion strategy.
• Acquisition Integration: Assess the ongoing contribution of the Lominger Entities to the Executive Recruitment segment's growth.