Korn/Ferry International 10-Q Summary
Business context and reporting period
Korn/Ferry International provides executive search, organizational advisory services and products, professional search, and recruitment process outsourcing. The filing covers the quarter and six months ended October 31, 2018, the second quarter of fiscal 2019, with comparisons to the corresponding periods ended October 31, 2017.
The company approved a “One Korn Ferry” plan to consolidate sub-brands, including Hay Group, Futurestep and Lominger, under the Korn Ferry name. The legal name change was scheduled to become effective January 1, 2019. The segments were renamed Advisory and RPO & Professional Search, while Executive Search remained unchanged.
Key financial metrics
| Metric | Three months ended Oct. 31, 2018 | Year-over-year change | Six months ended Oct. 31, 2018 | Year-over-year change |
|---|---|---|---|---|
| Fee revenue | $495.2 million | Up 12% | $960.8 million | Up 14% |
| Total revenue | $506.8 million | Up 11% | $985.2 million | Up 13% |
| Operating income | $71.0 million | Up 35% | $15.9 million | Down $78.5 million |
| Net income attributable to Korn/Ferry | $46.0 million | Up $9.7 million | $7.4 million | Down $58.0 million |
| Diluted EPS | $0.81 | Up from $0.64 | $0.13 | Down from $1.15 |
| Adjusted EBITDA | $80.3 million | Up 14% | $151.1 million | Up 15% |
| Adjusted EBITDA margin on fee revenue | 16.2% | Up from 15.9% | 15.7% | Up from 15.5% |
Quarterly operating margin was 14.3% of fee revenue versus 11.8% in the prior-year quarter. Six-month operating margin was 1.7% versus 11.2%, primarily because of a $106.6 million non-cash tradename write-off.
- Quarterly segment fee revenue: Executive Search $197.6 million, Advisory $217.1 million, and RPO & Professional Search $80.5 million.
- Six-month segment fee revenue: Executive Search $390.6 million, Advisory $412.5 million, and RPO & Professional Search $157.8 million.
- Quarterly segment operating income: Executive Search $51.5 million, Advisory $29.4 million, and RPO & Professional Search $12.5 million, offset by Corporate expenses of $22.4 million.
- Cash flow: Operating activities used $32.2 million during the six months, compared with $56.2 million used in the prior-year period. Investing activities used $53.4 million and financing activities used $27.4 million.
- Liquidity: Cash and cash equivalents were $387.7 million; total cash, cash equivalents and marketable securities were $523.3 million at October 31, 2018, down from $657.9 million at April 30, 2018. Working capital was $466.1 million.
- Debt: Term loan principal outstanding was $226.9 million, down from $238.9 million at April 30, 2018. No revolver borrowings were outstanding, and $122.1 million was available under the revolver after letters of credit.
- Dividends and repurchases: The company declared quarterly dividends of $0.10 per share and repurchased $22.7 million of common stock during the six months. Approximately $65.4 million remained available under the repurchase program.
Material changes versus the prior comparable period
- Fee revenue grew across all three businesses. Quarterly growth was strongest in RPO & Professional Search at 21%, followed by Executive Search at 12% and Advisory at 9%.
- Executive Search operating margin increased to 26.0% from 20.0% for the quarter; Advisory increased to 13.6% from 13.2%; and RPO & Professional Search increased to 15.6% from 14.2%.
- Compensation and benefits increased 12% in the quarter and 15% for the six-month period, driven by higher performance bonuses, headcount growth, commissions, incentive amortization and contractor costs.
- Six-month general and administrative expense increased 94% to $226.5 million, primarily from the $106.6 million tradename impairment associated with discontinuing the Hay Group and Lominger brands. Excluding the write-off, general and administrative expense as a percentage of fee revenue declined to 12% from 14%.
- Other income of $3.4 million in the prior-year quarter became other loss of $4.6 million, primarily because of declines in the fair value of marketable securities. For the six-month period, other income of $6.8 million became a $0.1 million loss.
- Foreign currency translation losses reduced accumulated other comprehensive equity by $27.3 million during the six months, contributing to accumulated other comprehensive loss of $68.6 million at October 31, 2018.
- The company adopted ASC 606 using the modified retrospective method, increasing opening retained earnings by $6.7 million net of tax. Management stated that the adoption’s impact on reported revenue was immaterial.
Outlook, commentary, risks and unusual items
Management stated that cash on hand, operating funds and other liquidity should be sufficient for anticipated working capital, capital expenditures, debt repayment, retention-pool obligations, dividends and share repurchases over the next twelve months. The filing does not provide quantitative earnings or revenue guidance.
- The company expects to pay the remaining balance of a prior-acquisition employee retention pool, approximately $16.5 million, within 45 days after November 30, 2018.
- The senior secured credit agreement requires a pro forma leverage ratio no greater than 2.50 to 1.00 and domestic liquidity of at least $50.0 million for permitted dividends, repurchases and acquisitions. The company was in compliance with its debt covenants at October 31, 2018.
- The company’s term loan and revolver mature June 15, 2021. A swap fixes the interest rate on approximately half of outstanding debt at 1.919%, excluding the credit spread. Management estimated that a 100-basis-point increase in LIBOR would increase interest expense by approximately $0.6 million for the quarter and $1.2 million for the six months.
- Principal risks include demand sensitivity to economic conditions, automation, competition, consultant retention, client and brand relationships, currency fluctuations, cybersecurity and data privacy, legal and regulatory exposure, integration and rebranding execution, impairment of goodwill or intangible assets, tax-law developments, and seasonality.
- The company was evaluating alternative structures for implementing the planned holding-company reorganization and stated that it might not use the previously disclosed KF Merger structure.
- The filing reported no material legal proceedings, no material changes to previously disclosed risk factors, and no off-balance-sheet arrangements. Disclosure controls were assessed as effective.
Facts investors should verify
- Whether the One Korn Ferry rebranding and January 1, 2019 legal name change were completed as planned, including the treatment of discontinued sub-brands.
- The sustainability of revenue growth and segment margins after excluding the one-time tradename impairment.
- Cash conversion, receivables collection and the increase in days sales outstanding from 58 to 66 days.
- Debt repayment, leverage covenant compliance, variable-rate exposure and the $16.5 million estimated remaining retention-pool payment.
- The effect of deferred compensation obligations, COLI policy loans, foreign exchange movements and marketable-securities volatility on liquidity and earnings.
- Final tax accounting under the Tax Cuts and Jobs Act, including GILTI, FDII, BEAT, executive compensation limitations and interest limitations.
- The effect of the planned lease-accounting adoption beginning May 1, 2019, which management expects to increase reported assets and liabilities.