Korn Ferry (KFY) 2007 Q2 法說會逐字稿

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, 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 assumption, 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 2006.

With that, I will turn the conference over to Mr. Reilly.

Please go ahead, Mr. Reilly.

Thank you.

Good morning, everyone.

Thanks for joining us today.

Now, we've reached our mid-point for fiscal '07, and I am proud and encouraged about the progress we're making here at Korn/Ferry against our one-Company strategy.

For the long-term, the underlying economic expansion, as well as the shift in demographics, continue to propel our business.

Over the short-term we are confident that a back drop of stellar corporate profitability and record margins in particular will drive the second half of the fiscal year.

Although Thomas Friedman in his recent books said the world is flat, from our perspective the world looks up everywhere.

It is not only our executive search business which continues to experience significant growth, but rather our entire portfolio of talented management solutions and in every region of the world.

With that said, I am pleased to report that Korn/Ferry generated $156 million in fee revenue during the second quarter, up 24% from last year.

Profitability improved in the first quarter to $21.1 million in operating earnings, which represents a 24% increase in EPS year-over-year at $0.31.

Or really, on an apples-to-apples basis, without stock option expense, a 32% increase in profitability.

Despite the normal seasonality we usually see this time of year, strong confirmations and search help lead the quarter.

But certainly of note, is the fact that Futurestep, our management and outsource recruiting business, achieved record revenue of $20.6 million in the second quarter.

Futurestep has now posted 12 straight quarters of sequential revenue growth.

I will provide a brief update on our business segments now.

Beginning with executive search, our business has performed well through the first half of the year.

We have been very focused on client facing activities, developing our people and continuing to go recruit new consultants in order to be able to take additional market share and grow our business.

As a result, through the first two quarters, all regions fee revenues were up over 20% with Asia Pacific experiencing the largest year-over-year improvement of a little over 30%.

Additionally, annualized revenue per consultant continues to rise and is currently on track for $1.12 million per consultant.

While all of our industry groups are up, there are certain subsectors that continue to show prolonged and steady growth.

In financial services, commercial and investment banking, asset management, wealth management, specifically in North America and Asia then very, very vibrant.

Within our industrial markets the big movers are energy and industrial products, sectors especially within Europe and North America.

IT and professional services and communications have risen sharply this quarter, as well as primarily driven by activity in North America and Europe.

In the middle market, Futurestep had a terrific quarter led by strong performance in all regions.

The business generated quarterly revenues of $20.6 million with a 9% operating margin.

A combination of large RPO projects, as well as individual mid-level searches, continues to fuel our growth in the middle market.

Futurestep RPO, managed services and interim solutions business have continued strong growth, particularly in North America.

As I've said in the past, we believe that increasingly companies will turn to fewer partners to fill multiple human capital needs.

We also believe that the Korn/Ferry brand provides permission and paves the way for our firm to broaden its suite of services.

Both of these beliefs continue to bear out in the marketplace as our non-search related offerings steadily gain traction with our clients.

In addition to a very positive quarter at Futurestep, our leadership development solutions also gained significant momentum in quarter two.

Our LDS group, which now offers executive compensation, talent development, merger integration, succession planning and a host of other HR consultive services, is now on a quarterly run rate of nearly $10 million.

Our confirmed pipeline and high potential prospects are very strong, and we're very optimistic about the performance of our LDS group in the coming quarters.

We have made significant investment in organic growth of our LDS team recruiting world class consultants around the globe.

Over the past quarter we've also been very focused on the integration of the recent acquisition of Lominger.

So far, the integration is proceeding quickly and smoothly.

The first step of the process has been to merge Lominger's assessment methodologies together with Korn/Ferry's to create a best-in-class offering.

This mapping exercise was accomplished in October.

The Lominger transition team is now in the process of training all Korn/Ferry's leadership consultants.

As the LDS consultants are trained, they will be able to accompany Korn/Ferry search consultants on a client call to introduce the Lominger solutions.

With the holiday seasonality beginning to set in across the world at year end, we are reasonably optimistic for the third quarter and very optimistic about our year end as our fourth quarter is our traditional strong quarter in our business.

We are forecasting the third quarter to be in the range of $150 to $158 million with a slight improvement in profitability.

With the strong backlog of confirmations going into the quarter, we expect business to be influenced by the year end holidays, as typically it is.

The October 7, Economist ran a cover story entitled "The Search For Talent" and devoted almost the entire issue to the topic of the global workforce and the incredible dearth of available workers.

As I mentioned our global partnership meeting recently, although the rest of the world has just begun to realize this long-term phenomena, which lies before us, we have been predicting this trend since 2001.

Everything we have done since then has been focusing on positioning Korn/Ferry as the partner to help clients tackle these enormous talent management challenges.

Although there is still much to be done, we have built a unique business model and aggressively recruited to staff our businesses with the best consultants in their respective fields.

With the power and the permission that the Korn/Ferry brand offers, along with the unyielding focus on our global partnership, our management team and Stewart's, Korn/Ferry is in the midst of great transformation for the benefit of its clients, its employees and shareholders.

Despite the upcoming seasonality, our business remains strong.

In the months ahead, we will continue to focus on our strategy, unlock synergies and drive the integration and aggressively pursue additional strategic opportunities to ignite growth and scalability.

And with that, I would like the turn the call over to our COO and CFO, Gary Burnison.

Thanks, Paul, and good morning.

We're pleased to report another quarter of growth for Korn/Ferry and more importantly, it's been profitable growth.

In the quarter the EPS increased 32% over the prior year excluding the impact of FAS 123-R.

Fee revenue increased 24% year-over-year and has now grown sequentially in 13 of the last 14 quarters.

Including Mexico, second quarter fee revenue was nearly $160 million.

In the second quarter, we continued to make measured investments in people and processes, targeted at transforming Korn/Ferry into a diversified HR solutions firm, while striving to improve operating profitability.

Second quarter consolidated operating margin improved 30 basis points sequentially reaching 13.6%.

Excluding the impact of FAS 123-R, year-over-year operating earnings improved nearly $4.5 million or 25%, with operating margin improving 10 basis points to 14.5%.

Our second quarter worldwide cash balance improved almost to $230 million.

Through October 31, approximately $32 million remains of the combined $75 million stock repurchase funds authored and announced in December of 2005 and June of 2006.

Early in the second quarter on August 8, as previously announced, we completed the acquisition of Lominger, the gold standard in leadership development.

As we indicated, bottom line profits also remain strong.

EPS was $0.31, a $0.06 or 24% improvement versus the second quarter of FY '06.

And as we plan, Lominger added about $0.01 to our results during the quarter.

Now let me review the business segments, starting with executive recruiting where second quarter fee revenue was approximately $135 million and up 24% year-over-year.

Second quarter fee revenue improved the most in North America, increasing almost 28% year-over-year.

Fee revenue in Europe was up 18%, and Asia Pacific finished another strong quarter with fee revenue of $18.3 million, which was up almost 25% year-on-year.

Operating earnings for executive recruiting were almost $27 million for a 19.7% margin.

And without the stock option expense the margin was 20.7%.

As previously mentioned, second quarter ending consultant count was up 12 sequentially to 478, with revenue per consultant of approximately $1.1 million.

As Paul indicated, Futurestep fee revenue improved to $20.6 million and was up $3.8 million or 22.4% year-over-year.

Futurestep has now grown in 12 consecutive quarters.

Sequentially, fee revenue grew 8.5% in the Asia Pacific region.

With North America and Europe flat to slightly down due primarily to summer vacation seasonality.

Sequential profitability also improved, with Futurestep reporting $1.8 million of operating earnings or a 9% margin versus operating earnings of $1 million or a 5.1% margin in our first quarter.

Let me now comment on our FY '07 third quarter outlook.

Assuming constant FX rates, and factoring the effect of year end holiday seasonality, we estimate third quarter fee revenue will likely range from $150 million to $158 million.

And diluted EPS will likely range from $0.29 to $0.33 per share.

That concludes our remarks.

I will now turn it over to Shannon so that we can begin taking your questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Mark Marcon from Baird.

Congratulations on another great quarter.

Thank you, Mark.

I'm wondering, where do you think we are as to where capacity could go?

How much extra capacity have you built?

And then given the economic cross currents that is currently have, with some people being concerned about us going into a potentially a cyclical downturn or at least the question comes up.

How does that impact your future investment in new consultants?

How do you think about that?

Mark, let me deal with the second half first.

And I will let Gary talk about capacity a little bit.

We see the economy in our business as extremely robust.

We're -- two things I think really impact our business.

One is, net hiring which the economy even though it has slowed a little bit over last year, is still strong.

But even more important is velocity, is that every time someone changes jobs there is a vacancy that has to be filled.

And the white collar -- the college degree unemployment less than 2% now, there is just a shortage everywhere.

And that trend is going to just get more pronounced over the next few years. 50% the Fortune 500 executives are retirement age.

There is going to be changes, there is going to be a shortage of people.

And even in a moderate economy, I think our business is so well positioned for the next 10 years that, sure, a huge impact could get it, but all we see is signs of strengthening all over.

Even this year, as everyone says the economy has moderated, look at our results and our industry, our competitors have done well, too.

I think we have done a little better.

But I just don't see that falling off for us.

And the other thing is even in a cyclical downturn where we're well positioned to be profitable, maybe we can't hit the margins we hit today, but I think we still have pretty strong results.

So we're optimistic and we're going to continue to add to our workforce.

We're recruiting partners in all of our businesses.

We expect them all to grow, in some of our businesses we have more demand than we have capacity to deliver like in Futurestep where we continue to grow.

So we remain optimistic over the foreseeable future.

With regards to capacity, I think there is some capacity.

I will let Gary handle that one.

Well, Mark, the life blood of a services firm is bringing in talented people and we are continuing to do that as Paul indicated.

You have to be mindful of where you may be in a cycle.

The last labor cycle at least in the United States lasted 10 years, which was substantially longer than previously, which has averaged about five years.

But we continue to bring talent into the firm.

And in terms of capacity, what a lot of people don't focus on is the fact that our average fee has climbed up rather nicely over the last eight quarters or so and that hasn't been by accident.

We've continued to develop a more consultative workforce.

We have brought in now almost 200 partners over about 41 months. 50% of those partners come out of search. 50% of them come out of other industries.

By and large, the workforce is looking for consultative than it has ever been.

But our average fees are still substantially less than some of our competitors.

Now, part of that is due to the fact that we have a very, very broad geographic footprint.

In Asia Pacific, we're dominant.

In Latin America, we're dominant.

The average fees in those country and is regions are obviously substantially smaller.

But there is capacity from that perspective.

And our average fee this quarter was about $80,000 globally and that's up from, say, $65,000 eight quarters ago.

So clearly, there is capacity there and it is something that we continue to go at strategically.

So, if you would look at the whole system, how much -- if you didn't add any more consultants at this point, how much capacity would you have, do you think?

Obviously it is going to vary geography and by practice group, but --?

Absolutely.

Listen, Mark, our revenue per partner is $1.1 million or so.

Right.

Globally, and you look at some other competitors and they're at a $1.4 million.

You just have to make a determination, is Korn/Ferry going to be successful to continue to move its brand upstream and continue to move the average fees up.

Okay.

Great.

And then lastly, with regards to Futurestep, great progress there.

Where do you think the margins get to over the short-term?

I know that the focus is really more on expanding the service and increasing revenue and I know the longer term target.

But over the next 12 to 15 months where would you say margins can get to or is this a good place to plan for on a go-forward basis?

It is probably a good place to plan for.

We really again, the market opportunity there overall is a $15 to $20 billion market.

Clients do not have great choices there in terms of global execution at the middle management level.

We're very bullish on the opportunity but we continue to invest in infrastructure and process to create repeatable processes so we can scale that business because we do think it is a multi-$100 million opportunity for us.

Could there be 200 or 300 basis points up over where we are or down?

Sure.

But I think, Mark, this is probably a pretty good level.

Great.

Thank you very much and congratulations again.

Thank you, Mark.

Our next question is from Clint Fendley with Davenport.

Good morning.

I wondered, first question, on the average fees, how much of the uptick you have seen in those is attributable to the strength that you have seen in your financial services practice?

And as you look back at the consultants you have added to your business, has it been skewed towards the financial services area?

Well, no.

It has been fairly broad-based actually.

Financial services is an area that we could actually -- there is more opportunity for Korn/Ferry there compared to some of our competitors.

In the last quarter financial services was about 23% of our business.

You can look at a couple other firms, and it is 33% of our business.

We've got a great franchise but it is clearly an opportunity for us.

So, no, it was not driven solely by financial services.

It has been fairly broad across the different markets we operate in.

So today, you wouldn't really say that you've been gaining tremendous amount of share in that area, then?

Well, we would like to think that we're gaining share.

We've recruited people in, but it is a very vibrant part of the economy as you know.

And given the pay levels and the like, it is an area that we want to increase our market share.

I'd say we're not losing share.

Whether we're gaining share, the market is so robust right now, it would be hard to tell.

It is just a very robust market and an area we're focused on continuing to grow.

Okay.

Gary, switching to Europe, I wondered if you could comment on the driver behind the 370 sequential basis point increase that we saw in margins and how sustainable you feel that might be in the near term?

Well, the margins do bounce around from quarter to quarter.

If you look back historically over the last four to eight quarters, the margins have bounced from 15% to 20%.

And we do think that the margin that we've achieved here in the second quarter that we should be able to duplicate that at least over the next quarter on two.

But yes, it tends to -- it's a bit lumpy and it tends to bounce around from quarter to quarter.

Okay.

And final question here, obviously, very strong results across most all geographies.

I wondered you could comment on South America?

Obviously, a small part of your business but is that a seasonal effect here or is there something else going on?

We think it is a seasonal effect.

And what the numbers don't include here, because we don't consolidate it, is Mexico.

And with Mexico, our business in Latin America is dominant and thriving.

Hopefully, in the next quarter, we'll be able to rebound in South America.

Okay.

Thank you.

Our next question is from Mike Carney with Aperion.

Good morning.

Good quarter again.

Thank you.

First, Gary, on the G&A line, you mentioned an increased other expense, and that was a little higher than I expected.

What is that?

Yes, in the quarter, Mike, we had some meetings.

We had our partners meeting.

And I think what you'll see this next quarter if you look in our second quarter, the one we just completed, you'll notice that the comp and benefit ratio was a little bit lower than it has been historically and G&A ratio was higher than it's been.

I think you will see those switch a little bit in our third quarter to what it's looked like over the last four or five quarters.

Your partners meeting is always in the second quarter, isn't it?

We stagger it.

Every other year we have a global meeting, and the other year we have regional meetings.

It is usually second and third quarters.

And this year we actually had a global meeting, so we brought 450 people together in Montreal.

And with that we did a number of other work shops and trainings and client initiatives.

Okay.

Then just quickly back to the capacity and hiring, it is still running 10% net new consultants.

Is it reasonable that percentage growth is going to drop in coming quarters?

Well, we've never published what we're doing.

We go at it both from a top down and a bottom up in terms of how we add talent to our own workforce.

We're very, very mindful in terms of the quality of people that we bring in.

And that we're going to continue to attract talent to this firm, particularly as we diversify and create more solutions for our clients outside of executive recruiting.

We haven't historically published any kind of goals nor do we really look at it that way, Mike.

Certainly, it is more strategic.

On the -- in terms of if we just look at the current 10% rate, did you say the mix is 50% outside hiring and 50% promotions, is that what you said, Gary?

No, no, if you just look, particularly over the last 40, 41 months, it has been -- the workforce in terms of consultants has been 50% outside of executive search in terms of their past work experiences and 50% from the search industry.

Okay.

And then on the LDS side you've added a lot of people there but the productivity is fairly high.

If you don't hire anyone else on the LDS, just assuming you didn't, what's the capacity or productivity?

Is it substantial from this level?

Yes.

It is pretty significant, Mike.

We now have about 50 partners, excluding our Lominger colleagues.

We have 50 partners in the leadership development business and it is quite significant.

It is probably double if you look at those partners.

Are those consultants going to have higher productivity than an executive recruitment consultant like a McKenzie partner or is it going to be about the same as an executive search consultant?

Yes, it should look like a typical partner in the services business.

Our executive recruiting business we look at it that way and we look at our leadership development business in much the same way.

It is a consulting business, so you are looking at rate per hour, revenue per partner and utilization.

Do you think it will be higher than what a typical executive recruiter would do or --?

No.

I think it will probably be about the same.

We would like to see it as about $1.4 million or so per partner.

That would be ideal.

All right.

There is a little bit more lag time in that business.

It is a new business for us, we're rolling it up, but we're extremely pleased with the quality of people that have joined us and also with how well they've done in the start-up.

That's a business that takes a little while to even for an experienced person to really build their business, a little bit more lead time.

But we're very happy with the progress to date.

And your typical LDS consultant that's doing different types of consulting work, he or she would not be selling -- I mean, they would be selling but really wouldn't be doing the organizational consulting from Lominger, right?

Those are more specific types of services?

Well, we actually started two days ago, we're training, integrating the Lominger business into Korn/Ferry, and it is actually quite exciting.

We are going to re-engineer our search process, incorporating the Lominger development tools and competency.

We're going to continue to go down behavioral interviewing.

So, we're going to do some great things in our search business.

And in terms of our leadership development business, two days ago we actually -- we started a training of our leadership development consultants on the Lominger product suite, which is 58 products.

So, we're actually very excited about that.

And Mike, we have started that training and we would hope to think that over time that our leadership folks will be very knowledgeable in those products and with the Lominger associates can deliver world class consulting capabilities.

Okay.

And last question, Paul, you mentioned I believe that you mentioned in executive recruitment energy and industrial products, did that have the highest growth in the quarter?

Is that why you mentioned that stream?

It is really financial services and industrial have been our two biggest winning sectors, yes.

And that subsector has been extremely strong for us on a year-over-year basis.

Sequentially, technology really picked up.

That's been probably the biggest sequential quarter on quarter growth.

But if you look year-over-year in steadiness, industrial and financial services have been great, which has given us -- that's why we're kind of optimistic.

This isn't just a financial services run up.

If you look year-on-year, all five sectors have done extremely well.

Healthcare is the only one that's fairly double-digit, about 11%, but it never had a recession.

It is very steady and we're a market leader there.

Everything else is 20% plus kind of growth rates, and it is across the board for us.

In terms of the RPO wins recently, what industries are -- I know you mentioned growth across all regions, but what industries are you getting wins there?

Retail has been the big winner this quarter.

We're getting -- we probably started kind of in banking and technology.

And then if you look at the first big wins for Futurestep, the last quarter certainly retail has been a big pick up for us and has a lot of promise.

And are there -- on the RPO side, are those companies that are all global companies or are there mid-market companies mixed in there, too?

Well, most of the big RPO's have been global companies.

And it is interesting that we're getting -- the start of those RPO assignments were regional assignments for global or regional companies.

The last few have been global assignments starting off in regions.

So, we have some very, very large clients now that started using us in one country for a global processor and now we're expanding.

We have one client we started in North America, we're now in Canada, we're in China and we're continuing to expand their RPO across the world.

So, we're really excited about that business.

Okay.

Thanks.

Take care.

Our next question is from the line of Michael Morin with Merrill Lynch.

Please go ahead.

Good morning.

I was a bit late jumping on, so I might have missed this.

But on Lominger, did you by any chance break out its contribution in the quarter in terms of revenues and EBIT?

And am I correct in thinking that that was all included in the North American segment?

You are absolutely correct.

It was about $3.5 million, Michael, and it added about $0.01.

Exactly what we said it would do.

$3.5, that's on the top line?

Yes.

And then profitability, has that -- that's pretty consistent with where it was when you acquired it?

Absolutely.

How is that growing organically and is there any seasonality that we should be aware of there?

I don't think so.

If you look at the historical [kegger] on the Lominger business since 1991, it is about 14% or so.

And we're doing some exciting things with it.

We have a big opportunity internationally and we've got a huge opportunity to really infuse it into our search business and into our clients to improve their development of their own workforce.

In the short-term it is going to take a little time to integrate it.

But we're expecting good growth from it but we think it can really explode once we get our integration there.

And is the integration kind of slowing the growth relative to where it has been historically?

No.

I think we can exponentially increase growth after the integration but we've got to -- we can maintain the growth in the short-term but in the longer term we're really excited about what it can do.

Yes, we're just approaching this very pragmatically and very thoroughly.

And many acquisitions don't work because they're not carefully thought out in terms of integration and we're just trying to be very pragmatic about it.

And then the buybacks, was there any activity this quarter?

No.

There was no activity.

We have $32 million left on our combined $75 million buyback programs that we announced starting back last December.

Okay.

And then in terms of healthcare, I think you mentioned that it is the one that is barely growing double-digits but you didn't really see a recession in that segment.

Is it fair -- would you characterize that segment as being maybe a bit counter cyclical by any chance and sequentially, are you seeing any change in trend there at all?

It has been very steady.

I don't -- I think the issue with healthcare is counter cyclical in this way is that the demographics are just overwhelming the healthcare system and that's not going to change.

The aging of the population, the demand for drugs and healthcare, and the shortage of people in the economy in general, I just don't see that slowing down at all.

And even in 2001 when everything seemed like it was being cut in half, healthcare was growing about a little over double-digits then, too and it's continued to.

Yes, that's right.

We've seen consistent growth year-over-year and it's about 14%, and that's what we've seen over the last several years.

And remind how big that segment is again?

It is about overall, with our life sciences business, it is about 14% or 15% of our business, something like that.

And is it predominantly U.S. focused?

You would really have to bifurcate it.

On the service side, that's primarily U.S. but it is a global business and it kind of matches the overall geographic mix of the rest of our business.

Great, thanks very much.

Thank you.

It appears there are no further questions Mr. Reilly.

Great.

Well, thank you.

We're proud of the quarter we had and we're working on the next one and very optimistic about the trends.

Just a reminder, the third quarter because of the year end holidays, is always a little tougher quarter for us to predict and December is usually a slower month as people take year end holidays.

But overall, business looks in great shape, backlog is good, the economy is moving forward.

So, we're very very optimistic for the year.

So, thank you and we'll talk to you again after the middle of next quarter.

Ladies and gentlemen, this conference call will be available for replay for one week starting today at 12:30 p.m.

Eastern and running through December 13 at midnight.

You may access the AT&T executive playback service by dialing 800-475-6701 and entering the access code 850501.

International participants may dial 320-365-3844.

Additionally, the replay will be available for playback at the Company's Website, www.kornferry.com in the Investor Relations section.

Thank you for your participation.

That does conclude our conference for today.

You may now disconnect.