Korn Ferry (KFY) 2006 Q2 法說會逐字稿

Welcome to the Korn/Ferry International second-quarter 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 statements made in the presentation today 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, investors are cautioned not to place undue reliance on such statements.

Actual results in future periods may differ materially from those currently expected or desired because of a number of risks and uncertainties which are beyond the Company's control.

Additional information concerning such risks and uncertainties can be found in the Company's annual report for fiscal 2005.

And with that I'll turn the call over to Mr. Reilly.

Please go ahead, sir.

Seasons greetings, good morning and thank you all for joining us.

This morning we're pleased to report the results of our second quarter for fiscal year 2006.

During the quarter fee revenue rose 3% sequentially, nearly 16% over the prior year at 125.8 million.

Business began accelerating as we transitioned out of the summer seasonality; it was marked by solid improvements in North America and Europe as well as continued expansion in Asia-Pacific.

Despite all the ongoing oil situations, fears of inflation, additional interest rate hikes, the mid- to executive-level human capital markets remain strong.

Over the quarter we made solid advances in each of our service offerings against our KF1 strategy.

Moreover, the backlog moving into the third quarter is up significantly and we expect business to continue to operate at solid levels for the remaining of the year.

Despite the natural disasters of late summer, the North American economy has remained remarkably healthy for human capital and talent remains a big need for our clients.

Last week's labor numbers of 215,000 new jobs added in the month of November illustrated the underlying strength of the U.S. economy.

In Europe the UK posted noteworthy performance in Q2.

I think it's also interesting to point out that Asia continues to experience prolonged and steady growth across the whole region.

As expected India and China continue to experience robust activity in all industries and Asia is a market where we continue our dominance.

Perhaps less obvious than some of the sectors in Asia, our business in Australia is up 45% over last quarter.

As we stated last quarter, we see significant growth opportunity for profitable growth in the $200 billion human capital market that we operate in and we said we are going to begin investing much more heavily in our future.

In executive search our goal is to be the leader in every region and every practice that we operate in.

To that end we have added 34 new partners over the last two quarters, 11 this quarter alone.

In Futurestep, although revenues were flat this quarter due to summer holidays particularly in Europe, we believe Futurestep has the opportunity to be a multi hundred million dollar player in this emerging RPO marketplace.

We have proven that it is a sustainable, profitable business and we are now investing for the future.

We have hired significantly and, on top of our recent openings in Shanghai, we have now opened Futurestep offices in Delhi and in Madrid.

We have signed our first global recruitment process outsourcing agreement and already have four assignments in China.

Turning to our leadership development solutions business, the pipeline remains strong.

We are confidence that our LDS offerings, which include management assessment, coaching and our proprietary online talent management application called Executive Center, continue -- can contribute not only to our top and bottom line, but enhance our relationships with our clients.

At the close of the quarter our cash balance had reached 188.5 million.

From this strong financial position we will maintain a prudent investment strategy in our various businesses in an effort to deliver above-average growth to the firm and create a broader positioning for Korn/Ferry as a provider of multiple solutions to our clients.

Beyond organic investments we have also continued to investigate the external market for alliances and acquisitions that meet our rigid criteria to help drive shareholder value.

Of course our primary objective is to stay focused on making our businesses profitable as we prudently invest for the future.

Looking forward, we will continue to aggressively roll out our strategy which we believe will strongly enhance shareholder value.

With the upcoming holidays we expect normal seasonality in the third quarter and then a strong close in the fourth quarter.

I would now like to turn our call over to Gary Burnison, our Chief Operating Officer and Chief Financial Officer.

Gary?

Thanks, Paul, and good morning, everyone.

We're happy to report that our recently completed second quarter was another quarter of growth for Korn/Ferry.

In fact, this quarter represents eight out of nine quarters of sequential growth in our business.

Despite the seasonal effects of the summer months, we finished strong with fee revenue growing 3% sequentially and nearly 16% year-over-year reaching almost 126 million.

Including Mexico fee revenue was over 129 million.

As we stated on our last earnings call, we continue to make key investments in all of our businesses -- executive recruiting, leadership development and Futurestep which we believe are essential to serve our clients' expanding talent management needs and to fuel long-term growth and enhance future profitability.

Near term these investments have had only a marginal impact on profitability.

Quarter two operating earnings remain strong at 18.1 million or a 14.4% margin.

Additionally, bottom line FY '06 Q2 EPS was a solid $0.25 or 19% greater than the second quarter of FY '05.

Our cash balance improved over $26 million sequentially reaching almost 189 million.

The number of executive search consultants increased 11 to 432 while revenue per consultant was flat sequentially at an annualized rate of slightly over $1 million per consultant.

Today we're also announcing that our Board of Directors has approved the repurchase of up to $50 million of Korn/Ferry's stock.

The shares will be repurchased from time to time in open market transactions subject to market conditions and other factors.

This repurchase program will not affect Korn/Ferry's commitment to invest in our core businesses and other opportunities to fuel future growth.

Let me now review the business segment starting with executive recruiting where fee revenue was 109 million and up 3.3% sequentially and 14% year-over-year.

All regions were up sequentially as confirmations rebounded in the latter part of the quarter after a slow start due primarily to summer vacation seasonality in Europe and North America.

In North America fee revenue grew $1 million or 1.6% sequentially and nearly 13% year-over-year reaching 62.7 million.

In Europe fee revenue was 27.8 million, a 3% gain -- sequential gain and nearly a 17% improvement over the prior year.

Strengthening markets in the UK, Switzerland and Spain primarily drove Europe's sequential fee revenue gain.

Asia-Pacific's quarter two fee revenue improved to 14.7 million.

Australia, Greater China and India continue to be the markets driving growth in the Asia Pacific region.

South America fee revenue was 3.7 million and up 8.5% sequentially and up nearly 47% year-over-year.

The executive recruiting operating margin was 22.1% and up slightly sequentially.

Now turning to Futurestep, fee revenue was flat sequentially at 16.8 million due primarily to summer vacation seasonality in Europe.

Compared to the prior year Futurestep's quarter two fee revenue was up almost 30%.

Futurestep Asia-Pacific continued to grow improving $600,000 or nearly 19% sequentially.

Futurestep's operating earnings and margin slipped sequentially to 1.55 million and 8.7% respectively reflecting planned investments required to meet current and projected marketplace demand.

Let me now comment on our outlook.

Assuming constant FX rates and the anticipated effects of calendar year end seasonality we estimate quarter three fee revenue will be in the range of 125 to 130 million and EPS will likely range from $0.25 to $0.29 per share.

That concludes our remarks.

I'll now turn it over Leah (ph) so we can begin taking your questions.

(OPERATOR INSTRUCTIONS).

Kelly Flynn, UBS.

This is Andrew Fones for Kelly.

I had a question regarding the investments.

I was wondering if you could just give us more color on exactly where the investments have gone within Futurestep and elsewhere in your business.

And then a follow-up question.

If you could perhaps give us a sense regarding alliances and acquisitions, where you expect those to be -- where those may be?

Would it be executive search, leadership, Futurestep or are you looking at all of those businesses?

Our investments primarily in our business are people.

In Futurestep we've had a couple of office openings but we've hired, we've really ramped up the hiring.

This market is so robust that we're actually having to pick what work we'll take.

There's just a huge demand and we're just staffing up for that demand.

So a lot of it's people, some of it's office openings but our primary investment is people.

In terms of business acquisitions, I mean potentials; we're looking at all sectors but primarily in Futurestep and our LDS businesses.

We're looking at are there businesses that can help jump start -- kind of take us to the next level in those businesses where we've already had significant growth and success.

But we're very, very cautious in terms of it.

We understand the challenges of integration of acquisitions and we have high bars, but we are systematically looking at businesses that would fit.

If you look, as Paul said, it's mainly people and infrastructure in process.

If you look in the Futurestep business we're up in that 61 employees since the beginning of the fiscal year.

And in the executive search business we're up about net 50 or so employees and that's fairly broadly distributed throughout the entire world in terms of where we've added those colleagues to our businesses.

We did announce today a stock repurchase program.

We think at the end of this fiscal year we'll have $100 million of truly excess cash on our balance sheet.

We're going to return some of that to the shareholders.

And as Paul said, at the same time we're looking for ways to jump start the talent management businesses in both -- at the middle management level, Futurestep, and our leadership development business.

Two quick questions on your comments.

The two office openings, where were they?

And then the 100 million of excess cash, is that after the share buyback or before?

The Futurestep openings were -- we opened up in Delhi and Madrid in November.

So those are the two most recent Futurestep office openings.

But we've opened in Shanghai and we'll have further expansion.

The interesting thing is we almost enter those markets with a backlog of business.

So there's huge demand and we're opening as prudently as we can get the businesses up and running.

And the 100 million is before and, again, it's a quite conservative look at the balance sheet; it assumes no debt at all and it assumes a level of working capital plus some rainy day money as well.

And that would be after the bonus payment?

Yes.

What was the accrued bonus in the quarter?

For the quarter it was about $22.5 million and for the first six months it's about 46.

Okay.

And finally, seasonality, you said you expected normal seasonality in Q3.

Can you just give us a sense of what you see as being normal seasonality?

The problem is we never know what's going to happen in December.

December is usually a down month -- and in North America and Europe with Chinese new year February always -- I mean January has a small blip in Asia.

So we've had strong Decembers before, but two out of three Decembers are usually off because of the holidays.

And if you look where the holidays fall this year, they're longer weeks, so very often we'll get some off'ish (ph).

But I think we've built those numbers into our guidance.

Okay, thanks.

Clint Fendley, Wachovia.

Good morning, guys, and congratulations on the quarter.

I wondered if you could provide some color on what you're seen from a vertical industry perspective.

All of the verticals -- if you look almost year-over-year, the leading growth has been in financial services, industrial -- which has been a strong one, and consumer.

They continue to be kind of the strong ones.

Life sciences has been steadily strong.

There hasn't even been a recession since I've been here in 2001 in the life science business.

So you're seeing financial service growth year-over-year being very strong.

And the surprising one that had been lagging in the last few quarters and over the last year is industrial has really picked up across the business.

Are there anywhere you've seen some weakness in the latest quarter?

Not really weakness; technology has been slower and it's just been I think really because of the hardware side of the business a slower market recovery.

Although it's positive it's certainly slower than the rest of the segments.

And on Futurestep I wondered if you could -- and in the past you've indicated that you expect this unit to grow 25 to 30%.

I wondered if you could just talk about how you still look towards that growth and you balance that with your investments and the margin impact that you're going to have on that growth relative to your investments?

I think we've proven that Futurestep can be -- I remember when I first got here people wondered if Futurestep could make money and I think we've shown that it can have margins competitive with the search business.

The issue is if we want this business which will easily -- just because of the market will grow significantly, do we want to just follow the market and keep the margins or do we really want to take share with decent margins?

And what we've done is we've started to invest more heavily in it and we think it's going to have a huge payoff.

We got ranked by one of the magazines as one of the top ten RPO outsourcers and we only deal in the middle management space and they're ranking us against staffing firms with much broader -- I mean this in terms of number of employees -- much broader businesses.

So we have a great position.

We expect over time we'll get more competition and we want to grow that business faster than the market growth at 25% so we're going to start investing in it.

Yes, it's taken a couple points off the margin short-term, but we think it's the right thing to do for a while -- I mean as long as the market stays robust.

All we have to do is turn down the spigot (ph) to get the margins, but we think the prudent thing is to grow it.

And final question.

You indicated that most of your investments are related to human capital.

Can you talk about them in marketing perspective on Futurestep what your plans are there (technical difficulty) coming new year?

We just finished a strategic planning cycle and we're going to up really our stake in the marketing and positioning of Futurestep.

And again, in this business it's not always dollars.

It's just getting the message out to clients, getting it more focused.

We've had an awful lot of successes with global RPO engagements now and one of the problems is honestly, and the reason we're recruiting so heavily is keeping up with demand.

So there's a balance here.

We don't want such a flood of business we can't service it either so we've been balancing very, very high-growth with trying to build for the future and we will continue to raise the bar in all of our businesses.

I don't want anyone to think we're not focused on executive search either.

We expect it to be a solid double-digit growth business with high margins and we're investing in every region.

We want to be number one in every region in the world and we're not today.

We have a solid position everywhere and we're one in a lot of markets.

So we believe that all these businesses are positive cash flow, they all have good margins and we can invest in all of them and continue to push for growth and continue to move in a more solid market position.

Thank you.

Michel Morin, Merrill Lynch.

Good morning.

A couple questions.

First, you talk about the hiring that's been done and if I've got the numbers right I think you said you've added 34 new partners in search in the first six months, of the fiscal year that is, and 11 in the quarter.

Can you talk about retention and if there's been any change there?

Are you simply just doing a better job of attracting new people or is it a combination of both you're keeping more people?

And then secondly, in terms of Futurestep, could you remind us where you are in terms of number of offices now and kind of your expected time to break even on some of these new offices?

Thank you.

In terms of the new hires and the retention, we've actually been very blessed in four years here.

The retention has been outstanding.

We've got a world-class team all over the world and we've been able to attract and add to that team.

We've brought in probably 110 to 115 partners over the last 25 to 26 months.

At the same time we've promoted people from within.

So the retention has been absolutely outstanding.

In terms of the Futurestep offices around the world, don't quote me on this, but I think it's about 21 or so if I'm not mistaken.

Okay.

And then in terms of time to break even on the new offices, how do think about that or how should we think about that?

It's brick and mortar and it's people.

We would obviously think that we are bringing in very, very talented people and as a result break even would be in a matter of months.

It's not a very -- there's just not a lot of investment per se that needs to be made other than brick and mortar and people.

Right, okay.

And then just going back on your retention comment, recognizing that you've been very happy, you were very pleased with the results.

Has there been any change in the last year or so in terms of the retention or has it been just pretty consistent?

It has been very, very consistent.

We have most of our involuntary resignations, there's been very few.

You also have normal -- people leaving for retirements you have, but we've been at really I think for this business historic lows in a long time for the last three years.

We don't take it for granted; we've got great people, we know our competitors are calling them every day and I think it's up to us to show we're the best environment to be in and the best firm to be with and we work on it very hard.

And actually if I may add another question on the buyback.

How should we think about how you would think about executing that?

Is this something that you think you'd be in the market pretty consistently buying back stock?

Or is it something where you want to have the approval in your pocket so that when there's some opportune time you can be active in the market?

How should we think about that?

You're always opportunistic, right?

The reality -- you this, Michel, we were going to have a lot -- this business generates a lot of free cash flow.

We're very fortunate from that perspective.

And we've always been struggling with the balance in terms of first and foremost trying to invest in our businesses which I think we've done and proven to you that we can do and do it profitably.

But secondly, we have an obligation to create positive EVA and in that regard we are going to return some money to our shareholders.

Great, thank you.

Mark Marcon, Robert W. Baird.

Good morning and nice quarter especially given all the investments.

I was wondering if you could comment a little bit -- you had mentioned early on in the commentary that conditions improved as the quarter went along.

I was wondering if you could give us just a little bit more color above and beyond that.

Did it pick up right away in August and then did it continue to build in September and October?

Julys for whatever reason was down for us in terms of new business and I think it was down for a lot of the folks in the executive recruiting industry.

August was definitely better than July and it's steadily improved.

November was a reasonable month in terms of new business, slightly better than October.

This month, Mark, this is really a seasonal month and my expectation would be that it would be down from November.

So it sounds like August was better than July and September was better than August and October was better than -- so sequentially improvement all the way through November and of course December ends up being a tough one to call just because of the holidays.

Right.

Okay, great.

And then January is typically a pretty strong month?

We hope so.

In terms of the Futurestep investments, is there any way that you can quantify the number of people that you've added?

Since the beginning of the fiscal year, Mark, we've put on I believe it's about 61 net employees in our Futurestep business.

That brings you to roughly --?

A little bit over 400, Mark.

Okay.

So that's a fairly significant ramp.

And then you mentioned that you've got a number of engagements, for engagements in China, one global.

I'm assuming that those haven't really kicked in as yet in terms of contributing to revenues or is that a correct assumption?

And if so, when would they start kicking in?

They're just starting and I think that the significance much more than the dollars, although some of them are nice, but some of them are big contracts.

The significance is we just opened in the summer in Shanghai and we have four RPO engagements which talks about how you open an office and you're off and running.

Spain we just opened and they got their first one the same month.

And then on the global one the significance is that we've had a lot of RPO but most of them have been all regional.

We actually had a company that signed us to provide simultaneously around the world.

We think we're the only firm in our space that can do that.

So to land the first one is a good sign, but any one in themselves wouldn't be the significant revenue driver for the Company, although some of them are pretty good deals.

Great.

And then your operating margins in core executive search are up nicely on a year-over-year basis despite the significant investment in people.

Should we think of those new adds to this fiscal year, are they up and productive as of yet or is the productivity from them still to come and so therefore maybe the margins can go up even higher?

Some are and some aren't.

It typically takes 12 months, it could be as long as 18 months.

Having said that I've seen people hit the ground running, Mark, but it definitely takes time to train and assimilate and all that.

Our annualized revenue per consultant right now is about $1 million globally.

We think that number globally should look more like 1.2 million'ish.

So you could read in there that there's capacity.

At the same time, Mark, we really do see an opportunity to dominate this business and we are going to continue to add people to our firm here.

I just one to say our investment -- our criteria, especially at the partner level, is extremely high.

There isn't a partner that's joined this is firm that I haven't personally interviewed.

I think Gary about virtually -- there might have been -- they're virtually the same much less in going through our system.

So with the criteria we've still set a high benchmarks.

But I think our industry actually does.

We've had fortunately/unfortunately we have good competitors.

We're in a good industry.

But we're very, very focused on not just adding bodies.

We're adding very, very quality people and that's why I think you see the results you've seen over the last few years; it's not just headcount, it's high quality people who aren't only productive but fit the values that we're building in this organization.

And then fee for search was up 10.4%.

What are you seeing there?

Is that just a continued shift away from options to cash comp, recognition of better talent is scarcer and so we've got to pay more, or are you getting any upticks?

How's that progressing?

Well, it's a combination of a lot of things.

Our average fee, when you look at it, tends to be a little bit lower than some of our competitors, but our network is much more broad and diversified and so the average fee levels in other parts of the world are significantly less than they are here in the United States.

Just as an example, Latin America and Asia.

Absolutely.

But I think it reflects two things, Mark.

I think it reflects the fact that we are moving the brand up-stream slowly over time in the executive search business.

And secondly, it's a reflection of wage pressure as well as a movement towards more cash and less equity from the .com days.

Great.

Thank you.

Tobey Sommer, SunTrust Robinson Humphrey.

This is actually Mike Fitz (ph) in for Tobey this morning.

On the first question, could you just comment a little bit maybe on what you're seeing since the end of the quarter in the European markets both for Futurestep as well as maybe for search?

You mean in November?

Or November, since the end of the quarter.

Again, I think that it's so hard to read in to four weeks.

The -- overall in Europe the month of November was good in terms of new business.

Germany continues to be a challenge as you would expect.

But overall November, like in other parts of the world, was as good as October in terms of new business.

A question on Futurestep.

Do you have any evidence that you could point at that would show that there's more search revenue coming out of the relationships?

I know in the past you said that the one benefit in Futurestep is the relationship building which could lead to more search revenue down the road.

Is there anything you could point at to show some of that is going on?

It's interesting because we do track referrals back and forth, but at the beginning our LDS and Futurestep businesses were very dependent on search referrals.

That shifted.

Their brands alone are growing, but we've had very significant searches referred out of both our leadership development and Futurestep searches and they grow.

And they grow because our relationships grow.

And the clients see us as Korn/Ferry and different services and if they trust the relationship when opportunities come up they trust us to do other things.

So yes, I can't say it's a huge part of our revenue today but it's a growing system, it's a referral system and our partners work much more closely together than they ever have.

We obviously can't say client names, but one comes to mind where we've done probably 15 to 20 searches over the last two years and we just finished our 85th Futurestep placement for that client.

So we definitely see that in our business.

And then on the search side, do you anticipate to continue adding recruiters at the same pace when they become available or are you more approaching a point where there's enough capacity to maybe slowdown on that?

I think that we have the opportunity and we don't have quotas, we have goals, but it's all up to people, not filling quotas.

We have strategic fills that we need in certain markets.

We have desks (ph) that we need in certain markets and we've been aggressive in places like India where we've been a market leader.

We doubled the number of partners in this last year in China where we've been a dominant player, we significantly added a number of partners because we think there's market growth.

We will continue in certain markets in Europe strategically to find certain high-level people to fill what we think are areas to go up market and in other markets we'll continue to add people where they need be.

So a lot of the hires have been strategic and there are some that are opportunistic, you just find a great player you had to the team.

So recruiting -- obviously the beginning of this year has been a high number so it's probably higher than normal, but we continue to plan to add to recruitment.

Just a follow-up on that.

Were most of the hires this year or I guess the majority of them international?

No.

Okay.

They're from all over.

Honestly it is a good spread with our business.

Okay, thank you.

Joel Jolson, JMP.

Congratulations on the quarter.

I know after your last call you were a little bit nervous about it.

It looks like you delivered again, so great job and thanks for doing the buyback for us; we were looking for that.

I just had -- conceptually should I be thinking about your company now as a couple of different businesses?

One is the executive search that you're a dominant player in that's generating a very significant amount of cash and the other being Futurestep there that basically you're continuing to invest heavily in to take advantage of one of the more exciting market opportunities in business services?

Is that the right way for me to think about it?

Yes and no I think.

First, this is a great core business and I wish we easily dominated search everywhere because it's a very profitable business.

Unfortunately our competitors make us work for it.

But it's a long-term, very cash positive, very high relationship business that we continue to expect to grow.

I do think that if you look at the strategy from an internal point of view it's how do you develop human capital talent management to help organizations solve all their people problems.

So there are relationships between the businesses in terms of synergies from a client point of view.

From an outside point of view there's no doubt that future step has a huge growth potential because it's operating in a $30 billion market that's a startup that's very fragmented and we're bringing some process to.

So we have huge growth potential and we think under stable growth rates as high margin.

But again, we think there's a balance between -- it's easy to grow at 20% and love the margins.

We think there's an opportunity to gain market share and we're going to balance investment and profitability.

We're keeping -- we're not buying business in the market.

Even though margins were down this quarter, honestly what happened is at the deal level the deals are as profitable as before, we're just investing in the infrastructure to grow faster.

I guess -- and I think you guys are doing exactly the right thing.

My only question about that -- and obviously the search business is a really good business, but it's a little bit more of a mature business, right?

Yes, it is.

So finally, I guess what's the end game with the strategy from your point of view here?

Because basically, if you look at the public comps for a business like Futurestep they're a multiple of where the overall company is selling at?

Is there a strategy do monetize that at some point?

We have not talked about that publicly.

The market opportunity is huge.

We need to scale the business.

We need to put in infrastructure and process.

We need to add people.

Customers do not have a solution, a great solution in the middle management area.

There's nobody you can turn to that's global that can pull off what I think we are going to pull off.

And ultimately how that's reflected in terms of valuation, we'll just have to see.

I think that over time that not only will our clients gravitate to the strategy and the different service offerings, but I think longer-term shareholders will too.

(multiple speakers) I think you guys are doing a great job and just keep it up.

Thank you.

Thank you.

Mr. Riley, we have no further questions.

You may continue.

Thank you all very much.

We are coming off -- I hope you get the message that in this quarter that margins were down slightly because of investment only.

It's a great business and I think there are times instead of -- how do you jump start the growth and really in the future take advantage of what we think is a burgeoning market?

So we're investing prudently.

I think we'll continue to generate good returns, but we will invest for the future.

Thank you for your faith in us and we'll talk to you next quarter.

Ladies and gentlemen, this conference call will be available for replay for one week starting today at 12:30 PM Eastern standard time and running through the date of December 15th at midnight.

You may access the AT&T executive playback service by dialing 1-800-475-6701 and enter the access code of 805-765.

International participants may dial 320-365-3844.

Additionally, the replay will be available for playback at the Company's website of www.Korn/Ferry.com in the Investor Relations section.

And that does conclude your conference for today.

Thank you for your participation and for using AT&T executive teleconference.

You may now disconnect.