Korn Ferry — Form 10-Q Summary
Business context and reporting period
Korn Ferry is a global organizational consulting firm operating through Executive Search, Korn Ferry Advisory, and Korn Ferry RPO & Professional Search, plus Corporate activities. This filing covers the three and nine months ended January 31, 2019, compared with the corresponding periods ended January 31, 2018. Effective January 1, 2019, the company adopted the Korn Ferry master brand and discontinued sub-brands including Hay Group, Lominger, and Futurestep.
Financial performance and liquidity
| Metric | Three months ended Jan. 31, 2019 | Three months ended Jan. 31, 2018 | Nine months ended Jan. 31, 2019 | Nine months ended Jan. 31, 2018 |
|---|
| Fee revenue | $474.5 million | $447.6 million | $1,435.3 million | $1,291.9 million |
| Total revenue | $486.2 million | $460.8 million | $1,471.3 million | $1,331.2 million |
| Operating income | $62.7 million | $49.8 million | $78.6 million | $144.2 million |
| Net income attributable to Korn Ferry | $45.0 million | $27.2 million | $52.4 million | $92.6 million |
| Diluted EPS | $0.80 | $0.48 | $0.92 | $1.63 |
| Adjusted EBITDA | $77.7 million | $71.4 million | $228.8 million | $202.4 million |
- Third-quarter fee revenue increased 6%; nine-month fee revenue increased 11%. Foreign exchange reduced fee revenue by $16.6 million in the quarter and $27.8 million year to date.
- Third-quarter operating margin was 13.2% of fee revenue versus 11.1% in the prior-year quarter. Nine-month operating margin declined to 5.5% from 11.2%, primarily because of the tradename impairment.
- Third-quarter net income attributable to Korn Ferry margin was 9.5% of fee revenue versus 6.1%. The nine-month margin declined to 3.6% from 7.2%.
- Adjusted EBITDA margin was approximately 16% in both comparable third quarters and nine-month periods.
- Nine-month operating cash flow was $101.0 million versus $59.6 million. Investing cash flow used $59.5 million, including $36.9 million for property and equipment and $34.6 million of company-owned life insurance premiums. Financing cash flow used $57.8 million.
- Cash and cash equivalents were $489.5 million at January 31, 2019, compared with $520.8 million at April 30, 2018. Cash, cash equivalents, and marketable securities totaled $622.9 million versus $657.9 million.
- Working capital increased to $530.7 million from $455.8 million. Client receivables increased to $421.8 million, and days sales outstanding increased from 58 to 71 days.
- Long-term debt was $222.7 million at January 31, 2019, with no current portion reported. The company had $226.9 million outstanding under a new revolving facility and $420.2 million of remaining availability.
- The new five-year, $650.0 million senior secured revolving facility matures December 19, 2023. The company was in compliance with its debt covenants.
Segment performance and material changes
| Segment | Q3 2019 fee revenue | Q3 change | Q3 operating income | Nine-month fee revenue | Nine-month change |
|---|
| Executive Search | $193.4 million | Up 7% | $44.7 million | $584.0 million | Up 13% |
| Advisory | $201.5 million | Up 2% | $29.3 million | $614.0 million | Up 6% |
| RPO & Professional Search | $79.6 million | Up 15% | $12.2 million | $237.4 million | Up 21% |
- Quarterly growth was broad-based. Executive Search benefited from higher engagement volume and average fees; RPO & Professional Search had the fastest growth. EMEA Executive Search fee revenue declined 2% in the quarter, while North America increased 11%.
- Quarterly compensation and benefits expense increased 4%, partly due to an 8% increase in average headcount. RPO & Professional Search headcount increased 25% in the quarter and 26% year to date to support revenue growth.
- Nine-month compensation and benefits expense increased 11%, including a $47.2 million increase in performance-related bonus expense.
- The company recorded a $106.6 million non-cash impairment charge in the nine months ended January 31, 2019 for Hay Group and Lominger tradenames made obsolete by the rebranding plan. No such charge occurred in the third quarter.
- Nine-month Advisory operating income changed from $72.5 million of income to a $24.4 million loss because of the tradename impairment. Excluding the impairment, Advisory operating margin was approximately 13%, consistent with the prior period.
- The company adopted ASC 606 using the modified retrospective method on May 1, 2018, increasing opening retained earnings by $6.7 million net of tax. Comparative periods were not restated.
- The effective tax rate was 25.4% in the third quarter versus 49.1% in the prior-year quarter, and 20.8% for the nine months versus 36.7%. The comparison was affected by the Tax Cuts and Jobs Act and discrete tax benefits.
Outlook, risks, contingencies, and unusual items
- Management expects cash on hand, operating cash flow, and available credit capacity to satisfy anticipated working capital, capital expenditures, debt service, dividends, and other requirements for the next twelve months.
- The company declared a $0.10-per-share dividend on March 6, 2019 and approved an approximately $200 million increase to its repurchase authorization, leaving approximately $250 million of capacity. Dividends and repurchases remain subject to board discretion, financial conditions, and credit agreement restrictions.
- Management identified risks from economic and labor-market conditions, demand changes caused by automation, consultant recruitment and retention, client and brand relationships, rebranding execution and costs, foreign currency, competition, cybersecurity and data privacy, intellectual property, regulatory developments, acquisitions, seasonality, and goodwill or intangible-asset impairment.
- A 10% change in relevant foreign exchange rates could produce an estimated $10.3 million gain or loss based on exposures at January 31, 2019. A 100-basis-point increase in LIBOR would increase interest expense by approximately $0.6 million for the quarter and $1.8 million for the nine months.
- The company used an interest-rate swap with a January 31, 2019 notional amount of $110.0 million to hedge part of its variable-rate debt. It also uses foreign currency forward contracts for selected exposures.
- The filing reports no material legal proceedings, no material changes to previously disclosed risk factors, and no off-balance-sheet arrangements. Management stated that internal controls were effective and that no material control changes occurred during the quarter.
- Remaining performance obligations for contracts with expected durations greater than one year totaled $528.9 million at January 31, 2019; approximately $104.4 million was expected to be recognized in fiscal 2019.
Investor verification checklist
- Verify whether revenue growth, especially in RPO & Professional Search and Executive Search, is sustained after adjusting for foreign exchange and changing economic conditions.
- Assess the effect of the new brand architecture on client demand, retention, intellectual property monetization, and future impairment risk.
- Monitor receivable days, collections, bonus payments, and operating cash conversion.
- Review leverage, covenant headroom, variable interest exposure, and the company’s use of the revolving facility and company-owned life insurance borrowings.
- Separate recurring operating performance from the $106.6 million non-cash tradename impairment and other adjustments used in Adjusted EBITDA.
- Confirm the timing and execution of planned dividends and share repurchases, including the credit agreement’s 3.25-to-1.00 leverage and $50 million domestic-liquidity conditions.
