Korn Ferry (KFY) 2004 Q3 法說會逐字稿

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

Before I turn the call over to your host Mr. Paul Reilly, Chairman and CEO, please first let me 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 obtained.

Participants on this call are cautioned to consider the risks related to the 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, sir.

Thank you, Dave.

Good morning and thank you guys for joining us this morning.

This morning I am pleased to report our second quarter of profitability, as well as a sequentially quarterly rise in revenue and our first year-over-year revenue increase since the third quarter of 2001.

Additionally, virtually every region and all the products, with the exception of South America, showed both revenue growth and profit.

Although new job growth worldwide has been sluggish and below most economists' expectations, at the highest levels of Executive Search, we are experiencing an uptick.

The overall economic rebound has manifested itself through fattening corporate profits, increased productivity, driven mainly by staff and overhead reductions.

Organizations generally remain skittish to hire unless they are absolutely certain that their current staff is operating at peak capacity and that their new employees are essential to meet market demand.

However, more and more companies are now focusing on bringing in people to generate revenue.

Furthermore, outsourcing to developing nations like China and India, have impacted job creation in the U.S., but in turn, has helped fuel demand for executives in growth markets such as Beijing, Shanghai and New Delhi.

At Korn/Ferry, over the past six months, our revenue was up almost 13 percent in our Chinese and India offices.

By all other indications, the economy primarily in North America is experiencing a healthy recovery, one in which is boosting production orders and overall expansion.

This expansion started showing up in our backlogs late summer, and we continued to build momentum.

We believe that as this continues, it will up the need for additional headcount.

We remain cautiously optimistic that our momentum will continue well into the summer months.

This morning I am pleased to announce that we posted a solid operating profit in the third quarter of this fiscal year, and I am also pleased to announce that we are forecasting positive EPS in quarter four as well.

Revenue growth continues, driven largely by North America.

When we include our Mexican operations, North America Q3 total revenues totals $83.5 million.

Not only are we witnessing recovery in the Executive Search business, but the progress being made at Futurestep is significant as well.

Quarter three marks the second profitable quarter in a row, as well as growth in the business.

The validation of the expanded Futurestep model is bearing out in the marketplace as Futurestep now provides clients with a wide variety of recruiting offerings.

Futurestep has experienced an increase in demand for its project base recruitment, on-site recruiting and fully outsourced interim recruiting.

We are confident that Futurestep will continue to play an increasing larger in our overall size and profitability.

Internally our efforts to recruit new and experienced partners to add to our great existing partners continues and remains strong in the third quarter.

Year-to-date we have recruited 40 new senior client partners and client partners.

As I mentioned on our last call, we have expanded our focus internationally in this quarter as well.

While the international economic recovery continues to lag behind that of North America, we will continue to strengthen our global team.

We are extremely excited about two new additions -- Bob Damon, as President of our North America operations, and Joseph Grisedieck, as Vice Chairman and a key member of our Board of Directors and CR Specialist teams.

Joe served two terms as CEO of Spencer Stuart (ph), and Bob was Vice Chairman and Head of U.S.

Operations and held several other leadership positions at Spencer Stuart.

These two seasoned veterans are sure to have an immediate and significant impact on our organization and symbolize our ongoing commitment to take share at the highest levels of Executive Search.

We are thrilled to have both of them as part of our team.

We are witnessing a dynamic change in brand perception by insiders within the industry.

As we began our recruitment efforts over 12 months ago, it was through focused dialogue and persuasion that we convinced new partners to join us.

Today it is a different story.

I believe that among senior consultants and candidates Korn/Ferry is becoming known as the place to be.

Our strategy is simply to be the premier career destination of today's top professionals.

For us, the focus remains on growing revenue, strengthening our strategic client relationships, taking share, and offering clients a diversified suite of solutions.

Our cost-cutting is over.

Our profitability has been restored.

As I stated last quarter, we still have capacity for growth within our current structure, and while we aggressively recruit new consultants, we will maintain a tight lid on operating costs and infrastructure.

We will spend time and resource for training and developing our employees with a focus on client service and quality delivery.

Despite the fact that the new job market growth remains sluggish, we are encouraged by the increasing demand for senior level positions we have been experiencing this fiscal year.

Based on our momentum, current backlog and an accelerating of confidence from our clients we will close fiscal year 2004 strong and look forward to even greater things in 2005.

While no one can predict when the (inaudible) will truly return to a full swing, one thing is for certain.

When it does return, it will do so with a fury, and Korn/Ferry will be there each step of the way.

I would like to turn it over to Gary Burnison, our Chief Operating Officer and Chief Financial Officer at this time for a more detailed financial review.

Gary?

Thanks, Paul.

Good morning everyone.

We have good news to share.

We are profitable, recruiting new colleagues into the firm, and the balance sheet is absolutely solid.

Quarters two and three are the first consecutive quarters with both revenue improvement and positive EPS since the first two quarters of FY '01, which really means the summer and fall of the year 2000.

Now for a few highlights for the third quarter.

EPS was 10 cents, and fee revenue was 81.4 million.

As Paul said, with our fine Mexico operations, that number would be almost 84 million.

Fee revenue grew almost 5 million or 6 percent sequentially over the second quarter. 2 million of this was due to FX with no impact on the bottom-line.

The improvement was driven primarily by the strong backlog entering the quarter, related to the improvement in fall confirmations, as well as a better-than-expected January.

EBITDA or cash flow was up 1.1 million or 15 percent sequentially to 8.8 million, while operating earnings also approved 1.1 million or 21 percent to 6.3 million.

All profit improvements are the result of a combination of higher revenue and a relatively stable cost base at constant FX rates.

As of January 31st, our cash balance was almost 77 million or 12.5 million higher than at the end of the second quarter.

We are happy to report we have no outstanding borrowings on our line of credit.

Third-quarter Accounts Receivable was almost $52 million.

The total number of Executive Search consultants is 386, which is stable with with the first quarter despite the fact that as Paul indicated that we have brought 40 outstanding partners into this firm this fiscal year.

Now let me review the business segments in detail, starting with executive recruiting.

Third-quarter executive recruiting fee revenue grew 3.6 million or 5.2 percent sequentially.

Without the impact of FX, fee revenue grew $2 million.

This improvement in revenue was due primarily to North America as Paul indicated.

North American third quarter fee revenue improved 1.5 million or 3.7 percent to 42.1 million.

This is the second consecutive quarter of fee revenue growth in North America.

In Europe, fee revenue improved 2 million sequentially or 800,000 without the impact of FX.

Asia-Pacific was up 600,000 sequentially or 200,000 without the impact of FX.

Latin America third-quarter fee revenue was down slightly sequentially.

Overall third-quarter executive recruiting operating earnings were 11.4 million and improved 2.2 million or 24 percent percent versus the second quarter.

Likewise, executive recruiting EBITDA or cash flow was 13.4 million and 2.2 million or 20 percent better than the second quarter.

All executive recruiting regions showed sequential profit improvement in the third quarter, accept Latin America which was breakeven.

Excluding corporate allocations, Executive Search operating and EBITDA margins surged to 15.6 percent and 18.5 percent respectively, and we are happy to say they are at their highest level in two and half years.

As stated earlier, the number of executive recruiting consultants at the end of the third quarter was approximately 386, and it is stable with the beginning of the fiscal year, but consultant productivity is up 12 percent from the first quarter to an annualized revenue run-rate of 750,000 per consultant.

Now turning to Futurestep.

Futurestep fee revenue continued to improve in the third quarter.

Third-quarter fee revenue was 8.5 million and 1.1 million or 14 percent higher than the second quarter.

Excluding the impact of favorable FX rates, Futurestep fee revenue grew 700,000 or 9 percent sequentially.

All Futurestep fee regions contributed to the improved revenue in the quarter.

Futurestep North American fee revenue continued to trend upward.

The third quarter is the fifth consecutive quarter of improved revenue in North America.

Futurestep remained in the black for the second consecutive quarter as third quarter profits continued to expand.

Futurestep's third-quarter operating earnings improved to 600,000, while EBITDA improved 900,000.

Futurestep's third-quarter operating and EBITDA margins are now at 7.3 and 10.7 percent respectively.

Now let me comment on the outlook for the fourth quarter.

Assuming relatively stable foreign currency exchange rates, we estimate that fourth-quarter fee revenue will be in the range of 81 to 85 million and that EPS will be in the range of 10 cents to 16 cents.

This concludes our remarks.

Dave, I will turn it over to you so we can begin taking questions.

Thank you.

(OPERATOR INSTRUCTIONS).

Bob Layvik (ph), CSB Securities.

Futurestep has continued strong growth and success.

I wonder if you can just give us a little color on the changes you have made there, what industries it is in, and then looking forward, what kind of margins can Futurestep achieve?

Let me answer the first part.

First, I think the big changes after my arrival was just bringing a leadership team headed by Bob McNabb, who is CEO of a $750 million public company, so someone who understands both the staffing and recruiting model and who is able to really blend and change the product mix.

The product mix of Futurestep is now basically an outsourced recruiting or project recruiting model.

Over half of their revenue now is coming from projects versus single recruiting, and that is growing in all regions of the world.

So the product is very focused.

We measure client satisfaction on every search, both an Executive Search and Futurestep.

Futurestep has reached the same profitability, the same satisfaction stores as our Executive Search which we think is outstanding.

In fact, in January, we had a record number of placements in the history of the company even at half the revenue of what they used to be.

It is just a whole different operation today.

It is an outsourced recruiter.

It is project-oriented.

The quality is high.

The delivery is high, and even in this tough market, they are experiencing growth in all three regions and they will continue to.

I think in terms of what Paul said, we have an outstanding team, and the team is working fabulously with our management assessment team, with our coaching team, and with our Executive Search partners, better than we ever have.

In terms of the margins, the normalized margins in terms of what this business can do, we think it can do 14 or 15 percent operating margins, and that is what we are targeting over the long-term.

Great.

Thank you very much.

One other quick question.

You mentioned you still have capacity if you will from your Executive Search base.

When would you think you would run into constraints on growth and start adding more to your base, your 385?

Well, we are going to continue to recruit talented people into this firm, and we are going to retain the colleagues and partners that we have.

There is no question about that.

We still do have capacity worldwide within the business.

That capacity is probably 25 or 30 percent or so right now.

So if we look out for the next couple of quarters, I cannot see a significant increase in resourcing levels.

But we clearly have capacity.

We have eliminated almost $250 million of costs in and out of the firm, and it is quite scalable now.

The capacity, we clearly have capacity at the partner level, and we are picking up -- filling that up.

We are feeling some stretch at some of the support levels, and we will strategically add where necessary.

But we are in a very much of a cost control productivity game, too.

But the first thing is we keep the quality high, so we have got this I think very well-managed.

Great.

Thank you very much.

Randy Mail (ph), Robert W. Baird.

Good morning and congratulations Paul and Gary for strong results.

I wanted to pursue a couple of things.

First of all, the recent trends in North America and Europe, if you can elaborate on those?

And then maybe -- the quarter seemed very strong in Europe just given conditions there.

I am wondering if there is something or some more color you can add to what happened there and how sustainable that might be?

Our outlook honestly is that we are pretty optimistic about North America.

We started seeing a pickup in late summer, and a little bit of trail-off in the holidays, but less than we thought.

January was strong, and February was even better after this reporting period.

So we think there is a sustainable trend in North America.

Europe, we are a little more cautious on.

We had -- the UK overall has been strong, although it had a month of a little softness.

The continent, we have been concerned primarily with Germany and France where I think there is still some structural over-employment due to labor laws.

But they actually did a little better than we thought, so it is hard to predict.

We are cautious about the economic conditions on the continent, particularly France and Germany, and I think we are cautiously optimistic about the continued growth of North America, and where that balances out is hard to predict.

So when you look at firm search activity in January and February, you did see some nice momentum?

November and December, as you know, are holiday months, and as you would expect, the level of new business in those months declined from September and October.

And as you would expect, January was better than those levels and February was better than January.

Europe, however, I think continues, as Paul said, to be quite challenging for all businesses.

Okay.

Thank you very much.

I appreciate it.

Mark Marcon, Wachovia.

Good morning and congratulations.

I was wondering, the bonus accrual for the quarter was that about 10.5 million?

No.

It was about 11.2 million for the quarter.

Okay.

And how much do you think you are going to end up paying out?

The balance sheet continues to improve nicely?

When we get towards the end of the fiscal year and going into the first quarter of fiscal '05, what would you anticipate paying out?

I think, number one, it depends on the profitability of the fourth quarter.

Our bonus pool is driven by our consultants. (inaudible) their production that stakes out the profitability of the region of the company, so the fourth quarter is going to say a lot.

If you come out towards the midpoint of your range roughly speaking, I am just trying to get an assessment in terms of where cash would end up?

As (inaudible) said, that is a creative and different way to answer the question.

But I will tell you that if we pay bonuses in the summertime and I would expect that after bonus payment, the balance sheet will be very healthy, and the cash balance will be in the mid-50s.

Okay.

Terrific.

Can you talk a little bit about the confirmation trends that you are seeing?

Just what we said before.

I think that we are seeing them across -- North America continues to have an upward confirmation trend.

So February was definitely better than January?

Yes, February was better than January.

And in Europe, I would say it is flattish, although January and February were not bad at all.

But I think it's hard to predict in that market, and we are seeing a slight increase in Asia, but again on the overall numbers, it is probably not a big impact.

Our Mexican operation is doing fabulous.

Latin America has been the one that has been flattish, but I would say overall America is clearly an upward trend.

Asia is showing some trending.

Europe is a question for us because of France and Germany.

Everyone I talk to cannot quite figure it out, so it is not just us.

That is more of a question mark, but they tend to be working hard at it and performed fairly well so far, but the economy concerns us there.

In North America, are you seeing it across all verticals, or is it concentrated in a few?

I would say if you look at verticals, healthcare continues.

All through this recession, Healthcare has been great, and it continues to grow even coming out of the recession in North America.

Probably the areas of the biggest pickup is in financial services which continues to improve from a low and is probably almost three quarters now sequential improvement.

Financial services, retail, we are seeing a pickup in the retail business, too.

So those are the primary drivers.

Technology is flattish, but if you broke it out, the software side or BC side of the business is up.

The hardware and telecommunication side is not, so you almost have to look within sectors of sectors, so.

Can you give us a feel for where you think the margins could go in North America and Europe?

What would the targets be?

In terms of margins, if you speak to operating margins without overhead (multiple speakers), in this quarter in North America, the margin was about 22 or 23 percent, something like that.

And we would expect that as the economy continues to add jobs given the team that we have and the reductions in the expense base that that margin can grow to, say, 27, 28 percent.

That is what we are targeting.

That is obviously very optimistic, but that is what we are targeting.

And in Europe when things normalize?

Well, I think there, I think quite honestly I do believe that for the next two or three quarters that Europe is going to be quite challenging.

I do think in any kind of normalized operating environment the margins in Europe will be less than in North America.

And if those margins were 20 percent or so, I think we would be happy.

Great and then lastly you made great progress in terms of corporate overhead.

Do you think a kind of 6.3 percent rate for the year is a normalized rate going forward, or can we even get more improvement there?

No.

I don't think we can get more improvement.

The corporate support groups around the world are a third of the size today than when we started here two and half years ago.

We have a fabulous world-class corporate team working harder than they have ever worked.

We have looked at all of our processes and the like, and we are going to continue to improve upon them.

But I think it would be very very tough.

We are very lean and mean throughout the wild.

I want to reiterate that.

We've got a great team.

I think our overhead on any comparison is lower.

We are lean and mean, and I don't want our guys getting any meaner, so.

Thank you.

Kelly Flynn, UBS.

Congratulations, guys. (technical difficulty).

I had a couple of questions.

I was wondering if you could give us a sense of the size of your operations in India and China perhaps as a percentage of the Asia-Pacific business?

We typically have not broken that about.

If you look as a percentage of the Asia-Pacific business off the top of my head, and this is just off the top of my head, I think it is around 15 percent or so give or take.

Again, I am not throwing up any data in front me.

We have got fabulous teams.

In fact, we brought those teams over to the United States over the last six or seven weeks meeting with clients and potential clients, and we have really got a world-class team there.

But I would say that is the percentage, 15 percent.

Could be a little higher.

It is a developing market, but it is developing quickly.

Our Executive Search is the new product.

We are the first foreign license in both those markets.

We have been in Shanghai seven and eight years, and Beijing seven and eight years respectively to develop those markets, and it is really in the last year or two that you are seeing a development in the executive recruiting market.

Could you give us a sense of roughly how many recruits you have over there?

The number of recruiters if you talked about partners, partner level colleagues, I would say it is probably around 15 or so, something like that, again, give or take.

I am just trying to count off the top of my head, but it is in that ballpark.

No.

Thanks.

That is real helpful.

The second question I guess was, I was wondering if you could give us cash from operations and CapEx in Q3?

CapEx was very very small.

It will continue to be small.

What I mean by small is that if you look out the next twelve months, I would expect that our capital expenditures would be something around $4 or $5 million for the whole year.

For the quarter, the CapEx was I think 300,000 or 400,000, something like that, very insignificant.

We have -- the biggest capital expenditures for our business are people and brick-and-mortar, and we operate in every location around the world that you would want to be.

We have capacity in our existing real estate.

We will do some things on the technology side over the next 12 or 15 months, but it will be relatively insignificant.

And so your cash flow from operations in the quarter?

Our cash flow from operations, if you look at -- what I go to is I look at EBITDA.

That is not a true cash flow because of the changes in working capital on the balance sheet.

But EBITDA for the quarter was almost $9 million.

Okay.

Thanks, guys.

Ty Gavatos (ph), CL King.

How are you?

A nitpicky question.

Do you have the bonus accruals for the second quarter?

You mean the bonus expense for the second poor?

Yes.

Yes, absolutely.

It was about $10 million for the second quarter.

Okay and a more esoteric question.

Paul, before you said when the business comes back, it will come back with a fury.

I don't want to put you on the spot, but if we look out 18 months from now, do you think the business can get back to in a full recovery double-digit gains year-to-year?

Absolutely.

We are going through in the Western world the demographic shifts that have not been seen.

There are going to be 15 million retirees this decade replaced by 30 million Generation Xers.

The population is going to go from 10 percent retired in 2000 to 19 percent, and the big whole is going to be in that 45 to 50-year-old group, which is where we are getting a lot of our executive management firms.

I think the (inaudible) is just starting, and I don't know when it returns and people start hiring like crazy, but I firmly believe that in the Western world there is going to be a huge shortage of people.

And then if you go over to Asia and the developing markets in India and China, (inaudible) people are there, and there is well-educated people, but the need for experienced businesspeople is huge and cannot be met by internal sources.

So I don't know when this returns, when the economies get heated up globally, but I think it's going to make the '90s in terms of the need for people look like nothing in the next decade.

Now you are going to ask me if that starts six months from now, a year from now, 18 months --

No.

I will let you off the book on that one.

I have no idea.

But demographically this is a great business and one of the things that attracted me here even two and half years ago during the recession.

Okay.

It has been very helpful.

Thank you very much.

(OPERATOR INSTRUCTIONS).

Mark Marcon, Wachovia.

A follow-up question.

Can you expand a little bit on the roles of Bob and Joe?

Obviously very high-profile hires for people who know the industry.

Are they going to be revenue producers, or are they going to be primarily in management?

What do you see them adding to the picture here?

One thing about Korn/Ferry all of us are in revenue production jobs.

I think when you are in a service client organization, unless you're working with clients, you don't have credibility.

So for myself to Gary, even though we may spend more time in management than others, we spend time in the market.

So Bob and Joe's roles will be the same.

Joe will have more of a prime role.

As Vice Chairman, he will be an advisor to me and to others because of his experience in this business.

But he will also initially really focus on working with our CEO and board practice as a member to help continue to expand it and grow it.

Our leaders have done a good job, and I think Joe will add some extra firepower and experience and market savvy.

He is just a great human being.

Bob has got more management work.

But Korn/Ferry management is market management.

It is motivating people, focusing on winning client work.

We've got a great finance staff.

I have had some people say, well, we don't have enough management.

Here we have great management.

Our cost management.

We have got a great finance team, and we want Bob focused on the market and people and recruiting, and he has a PNL, but he's got great support from our finance group.

But Bob's job will be to drive North America with his PNL.

But at Korn/Ferry, that is a lot of market work.

But we've got plenty of people to help on the cost side.

Do you think that completes the management team for you, or could we potentially see some additional additions?

Yes.

You know we are looking -- we are actually looking at a couple of slots the organization knows about.

I think it completes our work here in North American.

We have one or two verticals that we are talking to people about coming in to push them.

In Europe, I have been spending a lot of time with our European team.

Now that Bob is here, I will and we will go through the same exercise to figure out the leadership structure there.

But the good thing is we converted -- everyone believes in what we are doing and understands in what we are doing, and we will find the right people to drive it, whether it is internal or external.

So you will probably see one or two, but nothing I would say that you would say is dramatic.

Then you also mentioned in the release that you are seeing increased acceptance of your global client strategy.

I am wondering if you can elaborate on that.

I think the part of this that is interesting is training clients.

This is not an industry that is really historically where clients have gone to a preferred provider or sole source relationship.

It is one where we have had to educate clients on the value of it.

What value can we bring?

Our global account strategy has worked well in a tough marketplace, and we continue to roll it out and add more clients to it everyday.

We have a training session in North American next month we are going expand to 10 more clients, 12 clients, and we continue to incrementally build as we train people, get the organization to understand it and make sure we have the capacity to deliver, so.

That is a long-term goal.

It is a shift with our industry, and it is a shift on the client side.

So I think we are aggressively trying to lead the way in that, and we have had great success.

We still have got a long way to go.

Is there a metric that you are targeting in terms of percentage from top 100 accounts or anything along those lines that you can tell us what you are targeting and where you are currently?

I can tell my old firm -- there is so much of our business in this business it is also local clients and local delivery in countries that we were able to take global account revenue from 8 percent to 20 percent of our revenue globally, and we thought that was a big success.

Although the metrics are different here, I think we are looking for that kind of seachange, and we are learning as we rollout.

This will be a business where you are never going to get 80 percent of your accounts in solid just account relationships.

That is not this industry.

Just like investment banking does not get half its revenue from a certain set of accounts.

But we are moving more and more into that direction, and hopefully we can make it more and more sustainable.

Are there any pricing implications of that?

No.

Actually the pricing implications are probably fairly favorable for both.

What has happened with global accounts is clients who commit and give us certain revenue targets get some rights, but they are not significant.

On the other hand for us, it reduces marketing costs and increases, more importantly, client satisfaction and intimacy, so it is a big win-win.

So I would say that even if you looked at the average fees on our global accounts, they have been very strong because we have seemed to be able to penetrate the topside of those top clients and working at the highest level.

, Great.

The last couple of questions are more model-driven.

Can you give us a target in terms of what we should model in for the tax rate for the next year and the following year?

I would model in a full effective rate of, say, 42 percent.

42 percent for next year?

Yes.

What about the share count?

Obviously you have got those converts out.

It looks like at this price level they come into effect.

What should we look for --

This is (inaudible) speaking.

For the year, next year about 45.7 million shares fully diluted.

45.7?

Yes.

Great.

Super.

Thank you very much.

It appears there are no further questions, Mr. Reilly.

Great.

Well, we would like to thank you all just for participating today.

Although we are obviously proud of the results this quarter, our feeling here is we are just starting.

So we have got a good base to grow on, and we are going to continue to push.

There is a lot of hard work ahead of us.

Economic uncertainty is not out of our global economy right now, so we continue to manage costs.

But we keep focusing on revenue, and we will continue recruiting exceptional people into our organization, as well as cherishing the people we have.

We have got a very very good group of people here, and the nice thing is the people recruiting are blending in very well with our existing group.

So we will continue on the mission working hard, and we will update you next quarter.

Thanks for attending.

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Once again, here is Mr. Reilly.

All right.

Thanks, Dave.

Thank you.

Ladies and gentlemen, that does conclude our conference for today.

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