Korn Ferry (KFY) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Korn/Ferry International conference call.

At this time, all participants are in a listen only mode.

Later, we will conduct a question-and-answer session.

As a reminder, this conference is being recorded.

Before I turn the call over to your host, Mr. Paul C. Reilly, Chairman and CEO, let me first read a cautionary statement to investors.

Certain matters to be discussed during this conference call will constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Although the Company believes the expectations reflected in such forward looking statements are based on reasonable assumptions, the Company can give no assurance that such expectations will be attained.

Participants on this call are cautioned to consider risks related to these assumptions and expectations and not to place undue reliance on such forward looking statements.

With that I will turn the call over to Mr. Reilly.

Please go ahead, Mr. Reilly.

Great, thank you, and good morning.

Thank you for joining us.

You know, this morning's been a long time coming.

I joined Korn/Ferry in July 2001 -- two months before September 11, five months before the collapse of Enron and Arthur Anderson and only nine months into the worst decline the recruitment market has ever seen.

I don't think any of us could have foreseen back then how long or how deep this recession would be.

The impact of global -- of the recession on the recruitment industry was severe and sustained.

The result was a shakeout in the marketplace -- probably 20 percent of the consultants in the industry have left the business.

A number of big names have exited and shut their doors.

But I believe the dark days are well behind us.

And that the industry and Korn/Ferry are entering a period of sustained growth.

So this morning it gives me great pleasure to announce that we posted a solid operating profit in the second quarter of the fiscal year and exceeded (indiscernible) consensus with earnings of 6 cents per share.

I'm also pleased to announce that we're forecasting positive EPS in Q3 as well.

There are really two key factors behind our Q2 performance.

First was the growth in revenue and this is really a revenue story in our core executive search business and second was Futurestep's positive cash flow and profitability.

For Q2, our fee revenue came in at about 76.6 million -- up 5.5 percent over the prior quarter.

The growth in revenue was primarily driven by North America, which is clearly showing signs of recovery.

When we add to include our Mexican operations Q2, we would have revenue of $40 -- 79.1 (ph) million which means from a run rate perspective we're back on track as the largest executive search firm.

In addition to revenue growth, I am particularly pleased with the profitability and the repositioning of our Futurestep operations.

When I joined the Company in 2001, Futurestep was losing well over $1 million a month.

I'm pleased to tell you that this past fiscal quarter Futurestep generated positive cash flow and posted its first operating profit since its inception.

I think it's a further validation of our strategy in a very very tough market.

As I said, this has been a long time coming and it's not been easy.

Our earnings improvement are the result of stringent cost cutting, relentless attention to client relationships, and a focused re-engineering of our business to fit the needs of the marketplace.

On the cost side, we reduced our global operating workforce from 2800 people to 1400 sublet over 400,000 square feet of office space and cut 260 million of expenses out of our system.

But you know that's really behind us.

This is about revenue.

At the same time, we've established global accounts programs, instituted account management training, altered our compensation system to foster better collaboration and deemphasized the transactional nature of our business and emphasized the relational nature of our business.

The ability to grow global accounts and cross sell a variety of services is still the key to the long-term growth in our business and we have not taken our eye off that ball, despite the severe economic downturn of the past 30 months.

Finally, we have reengineered our business to better meet client needs and to operate profitably.

The key change here has been at Futurestep.

Futurestep was conceived and launched as a dotcom business in a dotcom boom and we have evolved Futurestep business model in order to achieve profitability, scalability, and more importantly -- the clients love the service.

We have made great progress in this area by shifting our emphasis from individual services to projects, recruitment, contracts, and outsourcing to fill multiple positions for a single client.

On the Executive Search side, an important factor in turning the quarter has been our aggressive and successful recruitment program.

Since the start of our fiscal year -- just May 1 of this year -- we have now brought over 30 new partners to the firm.

These professionals are coming from our competition and from industry and they are producing immediate results and continuing to expand our brand and our capability.

They're coming to Korn/Ferry because of the strength of our brand, they want to join a winning team and more importantly they believe in our strategy, our business model and our culture.

Most of the new partners have come in North America, now we're turning our attention on the recruitment efforts internationally especially Europe.

This past quarter has been marked by a number of significant successes in the marketplace.

In October, we signed a major deal with Futurestep to recruit accountants (indiscernible) the SEC.

This is one of the largest contracts that Futurestep or that Korn/Ferry has ever signed.

We continue to win on large CEO searches including our recent placement at Freddie Mac of their new chairman and CEO.

I think it is important to emphasize that for us the cost cutting is over.

We will not take any charges in this past quarter.

I do not anticipate any charges in the coming quarter.

Our challenge, now, is about growth and growing profitability profitably and scaling our business for the long-term future.

We still have capacity for growth within our current structure and while we are aggressively recruiting new consultants we will maintain a tight lid on operating cost and infrastructure.

We will continue, however, to invest in training and in developing complementary products and services for our clients.

This obviously, fundamentally, we're bullish about the human capital sector for the long-term.

Despite the tough markets for the past three years, the demographics are still overwhelmingly in favor and the war on talent is very real.

With increased demand and a declining supply, and adding to the fact that even in our last survey 56 percent of executives say they expect to change jobs in the next year, there will be unprecedented demand when this recovery returns for executive recruitment.

As this confidence evolves, the market for senior executives will continue to strengthen.

Although we're totally optimistic and bullish on the future, we are forecasting another profitable quarter for Q3, so revenue will be impacted by the seasonality of December and January.

And I think although we're long-term very bullish on the business I think short-term -- with the seasons and knowing this economy is still in the recovery phase -- we will continue to be cautious.

We remain optimistic in North America but cautious on Europe particularly in key markets like Germany where economic issues still impact the business.

In Asia, we have had a strong quarter especially in Australia and China, where we're well positioned against our competition.

Before I turn the call over to Gary Burnison for a more detailed financial review, I want to note that last month we promoted Gary to Chief Operating Officer.

This is in recognition of the phenomenal job he has done in guiding us through a very tough market and restoring our balance sheet to its current state of health.

Congratulations, Gary, and take it away.

Thanks, Paul, and good morning, everyone.

The message is simple -- we've returned to profitability and the top line grew in this quarter sequentially.

Why?

Because of the outstanding partners and colleagues we have around the world.

It's that simple.

EPS for the second quarter was 6 cents and with the first quarter of positive earnings since the fourth quarter of our fiscal year '01.

This represents an 8 cent improvement over the first quarter's adjusted loss per share of 2 cents.

Second quarter operating earnings were 5.2 million and improved 3.5 million compared to the first quarter's adjusted operating earnings of 1.6 million.

Second quarter EBITDA or cash flow was also up sharply to 7.7 million or a 10 percent margin.

Additionally, Futurestep operating earnings in EBITDA improved to 500 and 700,000, respectively, and as Paul said that's the first time of profitability in Futurestep's five-year history.

The profit improvements were due to the efforts, as I said earlier, of our partners and colleagues around the world, our go to market and recruiting strategies and our relentless focus on efficiency and world-class client service.

Second quarter fee revenue was 76.7 million and was up 4.1 or 6 percent sequentially over the first quarter.

The sequential second quarter fee revenue growth was particularly strong in North America where revenue was up 4.2 million or 11.4 percent.

As of October 31st, our worldwide cash balance was 64.4 million or a 10.5 million increase over the first quarter.

We have new outstanding borrowings on our line of credit.

Our second quarter net accounts receivable balance was 49.9 million, almost $50 million and the total number of executive search consultants worldwide was 385.

Let me now review the business segments in a little bit more detail starting with our core business executive recruiting.

Second quarter executive recruiting fee revenue was 69.2 million and was up 4.7 million or 7.2 percent versus the first quarter.

North America's second quarter fee revenue improved to 40.6 million or 11.5 percent over the first quarter.

Asia-Pacific grew 300,000 over the first quarter to 8.3 million while South America grew 400,000 to 2.4 million -- again, those numbers do not include our outstanding operation in Mexico.

Europe's second quarter fee revenue was down slightly -- only about 300,000 versus the first quarter to 17.9 million.

Overall, executive recruiting's second quarter operating earnings grew 32 percent sequentially to 9.2 million or a 13.2 percent margin.

Likewise executive recruiting EBITDA improved 24 percent sequentially to 11.2 million or a 16.2 percent margin.

All of our executive recruiting regions -- except for Asia-Pacific -- showed profit improvement in the second quarter.

Profits improved the greatest in North America where operating earnings were up 2.2 million or 36 percent sequentially.

And EBITDA was up 2.2 million or 31 percent sequentially.

As stated earlier, the number of search assignments grew 19 percent over the first quarter to 1,375.

Again primarily due to a spike in confirmed new business in North America in the month of October.

Now to Futurestep.

Second quarter fee revenue was 7.5 million, down slightly about 600,000 versus the first quarter.

The overall decline was primarily due to the seasonality in Europe but also due to the closing of several operations in Europe as part of our first quarter restructuring and tightening of that business model.

The decline in Europe fee revenue was partially offset by improved fee revenue in North America.

Second-quarter Futurestep fee revenue in North America grew 800,000 or 38 percent versus the first quarter.

Futurestep Asia-Pacific remained relatively flat in the second quarter.

For Futurestep, however, despite the overall decline in fee revenue, profitability was up sharply in the second quarter.

Operating earnings in EBITDA improved to 500,000 and 700,000 respectively.

This represents a sequential improvement of $1 million in operating earnings and a 800,000 improvement in EBITDA or cash flow versus the first quarter of adjusted results (ph).

The profit improvements were results of our strategy and our unrelentless -- relentless (ph) focus on cost-cutting.

Now let me comment on our third-quarter outlook.

Although activity has improved in the last few months, especially in North America, year end holiday seasonality will temper fee revenue growth in the third-quarter.

We will, however, remain profitable.

We estimate third-quarter fee revenue to be in the range of 72 to 78 million and EPS to be positive a penny to 8 cents.

Those conclude our remarks and now I'll turn it over to the operators so we can begin taking your questions.

Thank you.

[Operator Instructions].

Mark Marcon with Wachovia Securities.

Congratulations -- it has been a long time coming.

Wondering, with regards to North America, how do you feel about the margins in terms of the sustainability?

Mark, it's Paul Reilly.

I will speak and let Gary jump in.

First, we feel very comfortable about that.

We've always said this is a high margin business.

We will continue as revenue grows to improve the margins in North America.

We've gotten -- we've got -- we still got capacity in the system.

It's funny after bringing on new client partners, we haven't added support under it, we still have capacity and I think, actually, our issue is timing as the revenue grows and this recovery matures in North America, margins should continue to improve.

Gary, I don't know if you want to add to that.

No, I completely agree with that.

I think we will -- as this revenue picks up we will continue to see an expansion to market (indiscernible).

Where could the margins go to in North America?

Well, when we look at it on a segment basis, if you talk about -- if you talk about operating margins without, again, without corporate overhead -- you know as I look back in the history of Korn/Ferry and I exclude the Telecom and Internet time, those margins were quite high in the 30s and that, again, that is without -- without and that is important to note -- corporate overhead.

But I think there is a fair amount of improvement we can make there.

And as Paul said we still believe we have capacity.

We've added -- as Paul said -- over 30 partners since May 1st, substantial portion of those were in North America.

And we really haven't added much to the staff.

We still believe there is a lot of leverage in the business.

How much -- you keep talking about the excess capacity -- where do you think you could take (indiscernible) without adding any additional consultants?

We're going to continue add world-class people to (indiscernible) like we did and we will continue to aggressively do that and retain our best people.

If you look, overall, we think we have anywhere from 25 to 33 percent capacity.

So we believe that we could increase revenue by that proportion of amount.

And Mark, if you look, as you go through the history even excluding the dotcom days you know if you look at number assignments or revenue per professional or any measure there's still a good 25 percent in the system.

Great and in terms of the tax rate where do you think that's going to go -- going forward?

Well I would -- we don't provide guidance out that far but I would say that for the next couple of quarters I would use the levels that we've been running at for the last few quarters.

We certainly have some tax planning strategies for working on and I would feel very comfortable for the next couple of quarters using what we've been providing for.

So like the 19 percent level that we saw this quarter?

Yeah.

And is there any additional -- I know you've been doing a lot of work in Europe in terms of improving things there from a cost structure perspective and certainly bore fruit this quarter.

Are the expense levels in Europe now at a level that is going to be sustained or were there some improvements that occurred mid quarter that still haven't shown through?

No, I would say that a lot of those did show in this quarter.

Like, with all of our businesses across the world, we will have a relentless focus on cost and quality and it's not singled out in Europe.

And we will just continue that focus.

Hey, Mark, as I said it's a fundamental shift.

When I first got here we were the first costcutters and I think in the industry got a lot of criticism, we were laying people off before anybody else.

I think as a result of that, we're done.

We're sure there's always things you can improve trimming you can do here and there but I think we've been ahead of the curve.

We're right size.

This is to us about revenue and recruitment gain and our view is how do we keep focused on big clients and how do we add additional people to fill holes or to bolster the business?

And if you look at Europe you know that's where I'm spending a lot of my recruitment in the last few months hasn't been really U.S. focus -- it's on Europe now and we're in a revenue gain (ph) as far as we're concerned not a cost gain anymore.

We will continue to manage and hold them down but we're out of the cost-cutting business.

And then, I've got lots of questions but let me ask one, and then I'll all hop off and comeback.

Bonus accrual -- can you give us what that number was for this quarter and what it is year-to-date?

$18 million year-to-date, 12 percent of revenue, 10 million or so in the quarter.

Mark Allen with SunTrust Robinson Humphrey.

Congratulations on turning the corner.

My question, Paul, would be kind of qualitative -- looking for a little more color on the pickup in North America.

Is there any way to kind of characterize how much of that is new customers versus old customers that are doing more hiring?

How much of it is new positions versus the release of some pentup demand?

First let me tell you, I get a lot of questions about about industry segments and if you look at the growth during the downturn that we've had significantly has been in our health-care -- both services and provider segments and they've continued to grow but I think when you look at the rebound you saw the industries that were down in everything.

Every industry grew this quarter, every single one.

But where we saw some return on the two most depressed markets is we're seeing a good rebound in financial services which has clearly been down and a double-digit return in technology.

And I think when you look at the mix of clients that's across the board, there are existing clients that are hiring, and we have some existing clients that not hiring as much.

They're new clients -- a lot of them are in our global or regional accounts so it's pretty broad based.

I think that during the recovery and in the depth of the recession you saw most of the recruiting being replacements.

Today you are seeing more new positions being added, more depth being added.

A lot of people have talked about the jobless recovery but I think if you talk to people that work for Korn/Ferry or work for any of our clients what we've done in the last two years is doubled up everyone's jobs and there's no doubt that if there is a revenue momentum in North America people have to hire.

I mean, they've just got people maxed out.

In fact, the interesting thing is our executive survey two weeks ago of the 3,000 executives we surveyed 56 percent say they plan to change jobs because they're tired where they are.

So I think once -- as this recovery continues, you're going to see some broad-based recruitment by most companies.

That was going to be my next question, Paul, just kind of follow on with that.

Do you guys have any data going back to the really strong years?

How much of your assignment demand -- how much of that was related to newly created positions versus the situation where you had turnover?

Someone has an open slot.

Just trying to ask the question, how significant do you think an uptick in turnover will be to your demand?

I don't have that data.

I will tell you that if the huge job boom in recruitment was during the dotcom days which created a lot of velocity because dotcoms were taking people out of companies and they had to replace them.

So I think -- first of all nothing happens unless people start hiring.

That's the essence of any economic recovery.

So that's the No. 1 driver and I think that anyone should look at as they look at our business.

But having said that job turnover has probably been at a low for years -- for a decade in that there is a lot of pent-up demand from people that're looking to change jobs.

So first you're going to see recruiting going up because people are hiring.

When that starts happening, when there are more jobs available, what is going to further fuel that will be turnover as people change jobs.

So that's -- although we're really really bullish on recovery, the question is when and when does that cycle start?

It's a clear trend that's started.

We just don't know what the velocity is yet.

And final question is, really, I guess, just between yourselves and the other public competitor (indiscernible), you guys have decided to stick it out in the middle market area.

And I was wondering what are your thoughts going forward, what -- are there implications between the two companies in terms of competitive strategy, profitability, implications -- given the difference in the strategies?

First, we have a number of good competitors in the high-ended search.

That's where we compete.

We're a high level search firm.

And Hydrec (ph) is obviously a good company but we don't benchmark against them.

They are a good firm but, honestly, I think we do have different strategies and in any business whether you take financial services or consulting or you have a lot of good competitors, they have different strategies.

We're very focused on our middle management business, I think we're doing it different than anybody else.

It is clearly not a middle management recruiting business.

This is a project management and outsourcing business.

We've brought in leadership with experience.

Our head of that business has run $750 million staffing firm as a CEO.

I mean and also has been in the recruitment space so I think our business model's different to everyone else's and time tells who is going to be successful in their business model.

So we're just focused on doing our business right and we're not really trying to benchmark what other folks are doing.

I can tell you -- executive recruitment's been off.

Where people cut first was middle management and, in spite of that, we're getting growth in that business.

We're getting major new contracts and in an upmarket I am sure we will do much better.

Most of the revenue decline you saw on Futurestep is because we closed businesses in Europe.

We started in the U.S. and Asia -- having a very focused strategy.

We've moved that focused strategy over to Europe.

We've got great leadership with -- in Europe with Didier (indiscernible) France (ph) and I'm sure we will pull off strategy there.

Because he's already done it in France and we're going to do it in the rest of Europe.

So I don't know how to make comparisons of others.

I would absolutely agree with Paul.

Our strategy is a multi-product offering strategy.

And in the Executive Search side of the business, our fees in the United States are very very high.

And we operate at the high-end and we are going to continue that focus.

But what we're trying to do is to add value to clients and bring more than one offering to just Executive Search and so with the Futurestep business it is really an outsourced type project management recruiting solution that happens to be catered at the middle management level.

But that's not the strategy.

The strategy of this firm is a multi-product strategy, led by our core business and will always be our core business -- our high-end Executive Search business.

I appreciate that, guys, and good luck in the second half.

Thanks.

Kelly Flynn with UBS.

And one moment please.

One moment, please.

Ladies and gentlemen, we're currently experiencing technical difficulties.

One moment.

Apologies, Mr. Allen, your line is still open if you wish to ask additional questions.

Paul, can you hear me?

Yes, we can.

Throw one more in.

You know, you mentioned you'd been adding net now to the consultant headcount.

So does that mean you bottomed on your headcount back in the spring of this calendar year?

Well, if you look at our partners as we define them, our consultants for the quarter we ended at about 385.

At the end of April or so, it was 400.

And so, we have, obviously, we've continued to cancel out people.

We did a restructuring in the first quarter and we've added people.

Which I think is normal in any course of business.

You continue to manage -- you manage people, figure out who's fitting the strategy, who's making it, who's not and adding people to do it.

So, I think the difference is that we've become a very aggressive recruiter but it's not just anybody.

We turned away people who are doing very well in this business.

We're only recruiting people that fit our strategy, the culture that we're building in our new organization going forward, and so it's a very very focused recruiting.

And we will continue doing that.

Need to add people to our (indiscernible) group of outstanding people we have here.

Did we answer your question?

Hello?

Call on another line?

We should call back in.

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