Korn Ferry (KFY) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to Korn/Ferry's second-quarter FY17 conference call.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

We have also made available in the investor relations section of our website at kornferry.com a copy of the financial presentation that we will be reviewing with you today. Before I turn the call over to your host, Mr. Gary Burnison, let me first read a cautionary statement to investors.

Certain statements made in the call today such as those relating to future performance, plans and goals 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 release relating to the presentation in the Company's annual report for FY16, and in the other periodic reports filed in the Company with the SEC.

Also, some of the comments today may reference non-GAAP financial measures such as adjusted fee revenue, constant currency amounts, EBITDA, and adjusted EBITDA. Additional information concerning these measures, include reconciliation to the most directly comparable GAAP financial measure, is contained in the financial presentation and earnings release relating to the call, both of which are posted on the investor relations section of the Company's website at www.kornferry.com.

With that, I'll turn the call over to Mr. Burnison. Please go ahead, Mr. Burnison.

Okay. Thank you, Stacy. I'm joined here by Bob Rozek and Gregg Kvochak. And I'd say a very early good morning and seasons greetings.

Let me first comment on the quarter. I'm especially proud of our performance during the quarter, particularly given the uncertainty that surrounded the world late summer. All of our reporting segments were up sequentially.

Overall, we generated $402 million of fee revenue, which on a constant currency basis is an all-time high. That represents 43% year-over-year growth and that's obviously benefited by the Hay Group transaction. The profitability was very strong with diluted EPS of $0.59. EBITDA for the quarter was $63 million. Both of those, obviously, are on an adjusted basis. Our EBITDA margin was almost 16%.

It was a little over a year ago that we announced the closing of the Hay Group acquisition. And as I mentioned at that time, I was excited about the opportunity and the opportunities that it would bring to our firm. And I can tell you now, a year and four days later, that this is absolutely going to be a game changer for our Company.

This past quarter, Hay Group achieved $189 million of revenue and now represents almost 50% of the Company. October was the best month of new business for Hay since our ownership. Bob and Greg will share a little bit about the profitability that we are very, very pleased with. Futurestep in the quarter continued to be a shining star, 14% up at constant currency.

We have achieved double-digit fee revenue growth for about 12 consecutive quarters now and it was a very good quarter in terms of new wins. Search, on a constant currency basis, was up about 1.5%. More importantly it was up 8% sequentially and now with Hay Group, we've got even deeper IP and analytics to give clients an advantage in driving superior business results through people and that's going to absolutely benefit the entire enterprise but certainly our Search business.

Again, reflecting back on this year, this is been a historic year for us. I would argue in our 70 plus year history that this has been the most transformative year. We've unified two great organizations to create the preeminent advisor for an organization and its people. Now 12 months into this, we are a much more diversified balanced firm.

As I had mentioned, about half of our revenue mix now comes from organizational and talent advisory solutions and the other half comes, obviously, from our talent acquisition solutions. And this quarters EBITDA, this adjusted EBITDA of $63 million, I got to tell you, to put that in perspective, it was not that long ago that adjusted EBITDA for the full year was substantially less than that.

I'm very, very pleased with our Company, with our colleagues around the world in terms of what we've pulled off. The synergies and the investments that we've made this calendar year, they've not only enhanced our performance but I really, deeply believe that they have strategically reposition the Company.

And they've provided a platform to both shape and accelerate our growth in the years ahead. Today we are a firm that can help clients drive business results both through organizational and people performance. And that's anchored in six global solutions: strategy execution and org design, talent strategy and work design, assessment and succession, executive search and recruitment, leadership development, and finally, rewards and benefits.

So as we are now at the end of another calendar year and looking into [2007], we are going to continue our strategic commitment in building a world-class people and organizational advisory firm. And over this next calendar year, we've got six priorities that we are going to focus on to drive share and to drive growth. Because for us now, with this synergy stuff behind us, this has to be, this has to be about growth.

But those six things, number one, we have got to more aggressively integrate our IP into our recruiting offerings. Two, we have got to link our solutions for greater client impact. An example would be linking together our assessment with our development offerings.

Three, we've got to actualize our solution orientation for growth and scale and we've got to continue to move from Search/Futurestep/Hay Group to something that more looks like solutions and industries. And so for example, we have to scale our org design capabilities, our leadership development opportunity, and our rewards and benefits offerings. And so we're going to continue to make targeted investments in those areas.

Four, we have to drive more repeatable and leverageable revenue through our global productized services business. Today that's about $250 million of the $1.6 billion and I think there's an opportunity there to double that business, if not triple it.

Fifth, we have to proactively target high stake opportunities in which we are going to impact client success. And finally, we are going to continue a very systematic and pragmatic M&A strategy. With that, I will turn it over to Mr. Rozek.

Great. Thanks, Gary, and good morning, everyone. I'm going to start with a few key highlights from the quarter. First, as Gary indicated, our consolidated fee revenue was seasonally strong and grew to nearly $402 million. That's a year-over-year improvement of 43%.

Compared to the first quarter of FY17, our consolidated fee revenue grew 6% with growth coming from all three lines of business. Sequentially, fee revenue growth in the second quarter was strongest for North American Executive Search and the Hay Group, both of which grew at 13.3% and 6% respectively. Futurestep also continued its impressive growth in the second quarter with $56.8 million of fee revenue and that was up 14% year-over-year at constant currency and 12.5% in actual dollars.

As Gary mentioned, Futurestep has now achieved double-digit fee revenue growth for 12 consecutive quarters. We're especially proud of our earnings and profitability as they continue to improve in the second quarter. Our consolidated adjusted EBITDA grew to a record $63.3 million with an adjusted EBITDA margin of 15.7%.

Additionally, the profitability of the Hay Group improved for the third consecutive quarter and that was driven by both seasonally strong fee revenue and a cost base which has fully benefited from the recent restructuring in integration activities that we completed in the prior quarters. The Hay Group's adjusted EBITDA margin has now grown to 18.7% in the second quarter of FY17 from 15.6% in the third quarter of FY16.

Finally, starting in the second quarter, as part of our balanced approach to capital deployment, we began the open market purchase of our shares. To date, we have purchased approximately 521,000 shares or about 1% of our outstanding share base. We currently have approximately $139 million remaining on the authorization previously approved by our Board and will use that in connection with future repurchases of our shares.

Now turning to new business trends. First, for Executive Search, on a global basis, monthly new business trends in the second quarter were mixed. We saw a strong August and September followed by a weakening in October. Actual foreign exchange rates global Executive Search new business in the second quarter was down approximately 3% year-over-year but up approximately 7% sequentially.

On a unit basis, the number of newly confirmed Executive Search assignments were flat when measured year-over-year and up approximately 3% sequentially. For the Hay Group, new business awards were seasonally strong, reaching nearly $193 million with a very strong month of new business in October. Finally, Futurestep was awarded nearly $75 million of new business in the second quarter, which was an all-time high.

As previously highlighted, in the second quarter, we achieved a record level of adjusted EBITDA as our operations benefited from both strong fee revenue in addition to the lower cost base. At $63.3 million, our adjusted EBITDA in the second quarter was up $17.2 million or 37% year-over-year and $6.9 million or 12% sequentially.

Consistent with prior quarters, our adjusted EBITDA in the second quarter excludes certain items, approximately $5.8 million of retention bonuses and integration costs, both of which relate to the Hay Group acquisition. At the end of the second quarter, our total cash and marketable securities were $390 million, excluding cash and marketable securities reserved for deferred compensation of bonuses, our investable cash balance at the end of the second quarter was approximately $155 million.

We had outstanding debt at the end of the quarter of approximately $266 million and that primarily relates to the Hay Group acquisition which we closed last December. And finally, our adjusted fully diluted earnings per share were a record $0.59 in the second quarter of FY17, up $0.08 or 16% compared to the second quarter of FY16 and up $0.07 or 13% on a sequential basis. On a GAAP basis, fully diluted earnings per share for the second quarter were $0.52.

With that, I will now turn it over to Gregg to review our operating segments in a little bit more detail.

Thanks, Bob. Start with our Executive Search segment, at actual exchange rates, consolidated fee revenue in the second quarter for our Executive Search segment was $156.2 million, flat year-over-year and up $9.8 million or 6.7% sequentially. When adjusted to a constant currency basis of measurement, consolidated fee revenue in the second quarter for our Executive Search segment was up approximately $2.4 million or 1.5% year-over-year at approximately $11 million or 7.6% sequentially.

Regionally, growth rates in the second quarter were mixed. Compared year-over-year at actual exchange rates, North America was flat, Europe was down 5% but up 2% at constant currency and the Asia-Pacific region was down 7%. Fee revenue growth for our global specialty practices were also mixed in the second quarter.

Compared to the second quarter a year ago, growth in our industrial practice, up 12%, and the technology practice, up 3%, was offset by a contraction in our financial services, consumer goods, and life sciences and healthcare practices, which were down 13%, 8%, and 1% respectively. Financial services accounted for 18% of all Executive Search fee revenue second quarter, which was down 260 basis points year-over-year.

The total number of dedicated Executive Search consultants worldwide at the end of the second quarter was 501, up 7 year-over-year and 13 sequentially. Annualized fee revenue production per consultant in the second quarter was $1.26 million, up 5% sequentially and the number of new search assignments open worldwide in the second quarter, excluding Mexico, was 1,401, which was flat year-over-year.

Adjusted EBITDA for Executive Search in the second quarter was $39 million, which was down $1.6 million or 4% compared to the second quarter of FY16, due primarily to the change in market-driven losses recorded in the quarter on the assets backing our deferred compensation programs.

The adjusted EBITDA margin for Executive Search in the second quarter FY17 was 25% compared to 26% in the second quarter of FY16. Sequentially, adjusted EBITDA for Executive Search improved $7.3 million or 23% with a 340 basis point improvement in margin, driven primarily by stronger fee revenue in North America.

Now turning to the Hay Group segment, which in the second quarter of FY17 completed its third full quarter of integrated operations. Fee revenue for the Hay Group segment was seasonally strong in the second quarter, reaching $188.8 million, an increase of $115 million year-over-year and an increase of $10.7 million or 6% compared to the adjusted fee revenue recorded in the first quarter of FY17.

The profitability of the Hay Group was also up sharply in the quarter. As previously stated, the Hay Group segment has been the main beneficiary of the restructuring integration activities initiated over the last several quarters and realize the benefit of such actions for the full quarter.

In the second fiscal quarter of FY17, the Hay Group achieved $35.3 million of adjusted EBITDA with an adjusted EBITDA margin of 18.7%. This was the third consecutive quarter of margin improvement for the Hay Group.

Finally, turning to Futurestep, which continues to be our fastest-growing segment for the firm, in the second quarter Futurestep generated $56.8 million of fee revenue, which was up 12.5% year-over-year, and at constant currency, was up nearly 14%. On a regional basis, year-over-year, measured at actual exchange rates, growth was broad based with North America up 10%, Europe up 1% but up 11% at constant currency, and Asia-Pacific was up 29%.

Futurestep's earnings also continued to ramp. EBITDA in the second quarter was $8.4 million, which was up $945,000 or over 13% year-over-year. Futurestep's EBITDA margin in the second quarter was 14.9%, which was up 10 basis points year-over-year. Now I'll turn the call back over to Bob to discuss our outlook for the third quarter of FY17.

Great. Thanks, Gregg. As previously discussed, our new business activity exiting the second quarter was mixed. We saw a very strong August and September and then new business globally in Executive Search softened in October leading up to the US election. To start the third quarter, up through the date of the election, global November new business remained slow, but after the date of the election, we saw new business ramp up in both North America and in Europe.

Globally, total new business in November finished up 2% year-over-year. If historical patterns remain consistent with prior years, December new business is expected to be seasonally weaker. It should be followed by a stronger January.

For the Hay Group, fiscal third quarter is typically a seasonally weaker quarter for both new business as well as revenue as time off during the year-end holidays results in both less time with clients to conclude the backlog of open assignments, as well as the release of fewer new assignments. When you compare FY17 Q2 to FY17 Q3, there's probably about 12% or 13% less working days in the third quarter and obviously when folks aren't working, you're not booking revenues at that time.

With regards to Futurestep, as previously discussed, new business trends in the second quarter remain strong and we continue to see a strong and robust pipeline of new opportunities. Our FY17 Q2 cost base enjoyed a full quarter of savings from the actions that we've taken in prior quarters.

As previously disclosed, other than some further real estate consolidation and there's not too much of that left at this point, the majority of our restructuring and integration actions are substantially complete. And while we remain diligent on costs, we do not expect the material flow-through of incremental future savings to earnings at this point.

Taking all of this into consideration and assuming worldwide economic conditions, financial markets, foreign exchange rates remain steady, we expect our consolidated fee revenue in the third quarter to range from $370 million to $390 million and our consolidated adjusted diluted earnings per share to range from $0.48 to $0.56. Finally, related to the ongoing integration of the Hay Group, in the third quarter, we will incur additional restructuring and integration charges ranging from approximately $8.2 million to $9.4 million.

These charges relate to the further consolidation of our global real estate footprint. That's about $3 million of the charge and that relates to four locations. Professional fees associated with the continuing and ongoing financial and operational systems conversions, that will be about another $2 million.

And then the remaining $4 million will be the ongoing retention bonuses that were paid in connection with the Hay Group acquisition. When you include all of these costs, we estimate that the FY17 third-quarter fully diluted earnings per share measured by US GAAP will likely be in the range of $0.36 to $0.46.

With that, I will conclude our prepared remarks and we would be glad to answer any questions you have.

Thank you, ladies and gentlemen.

(Operator Instructions)

George Tong, Piper Jaffray.

Thanks. Good morning. On a pro forma basis for Hay Group, if you assume you owned Hay Group in the year-ago period, it appears that revenue growth was negative in the fiscal Q2. Can you discuss some of the factors that might have impacted pro forma Hay Group revenue growth in the quarter and initiatives that you have in place to accelerate revenue growth for Hay Group?

Yes, George, I think there's a couple things. I think, as we look at it, we would say that the revenues year-over-year are flattish because I think currency with, remember, a lot of the Hay Group is outside the US. So currency does weigh on that. So we would look at it as being more flattish.

As Gary indicated, when we step back and think about that transaction and the impact it's going to have on this organization, we are really, really excited about what the future holds. And as we look at that business, some of the things that Gary talked about in terms of our focus areas, our go-to-market activities, the work we're doing around solution sets, those initiatives will really help to drive the growth that we would expect to see out of the Hay Group business on a go-forward basis.

When we bought the business, George, our first priority, we called it follow the money, but our first priority was to drive the synergies and make sure that the economics from the transaction penciled out as we had communicated with our Board. So that was our first order of priority. Now, with the synergies essentially behind us, we got a couple of office moves left, but with the rest of the synergies behind us, the focus right now is on the top-line growth, as Gary had indicated.

I would follow up, George, that, at the end of the day, for any CEO, strategy is all about execution and that's all about people. And so, our plan is to own that space, to define a new space around an organization and its people and Hay Group, now, we have almost 4,000 people in that business. We have scale. We essentially have an $800 million business.

A year ago, in September, when I announced this, I said pro forma we had an $800 million business combining our LTC with our Hay Group business. You adjust that for currency and you're probably, at today's dollars, kind of like $750 million or $760 million and that's where the business is. But the priority is certainly around growth.

And what we have to do there is, really, number one, we've got to look to that global productized services business that we have and drive more scalable growth there. Secondly, we are going to invest in our solutions around org design, around leadership development, around rewards and benefits. That will lead to growth.

And finally, we've got to link our solutions together. Whether it is assessment and development or whether it is compensation and search, we have to tie those together to have a holistic solution for clients. And so those are the specific things that we are doing to drive growth. And then finally, we are very aggressively upgrading talent in the entire enterprise, but particularly within the Hay Group.

Very helpful. As it relates to Executive Search, you had indicated that new business is ramping coming out of the second quarter. Can you elaborate on the trends that you're seeing in North America and EMEA in Exec Search?

Well, November, in Europe, we had our best month of new business in probably two years. Asia was also incredibly strong. When you look at North America, we did see a pause around October 15 or so. We saw a pause in the level of new business and, as Bob indicated, that seemed to pick up a little bit after the election.

Overall, if you were to look at North America in November, the level of new business was essentially, it was almost flat with a year ago, which was a very strong month. And the other thing that's encouraging is that we've seen an uptick in energy. And energy is, today, about 6% of the portfolio. And prior to the transaction, energy was about 7%. It went down to 3%, 3.5%. That's another good sign.

Got it. Thank you.

Tim McHugh, William Blair.

Thanks. First, I guess, one of the things you mentioned was M&A as one of the priorities and you also bought back stock this quarter. How are you thinking about -- are you more comfortable with holding debt and being a bit more aggressive? Is there anything that's changed how you're thinking about the balance sheet or wanting to use the cash flow from here?

You know, our Board, we have this dialogue. Our priorities are, number one, to invest the cash in the business. Certainly, with interest rates what they are, there is a unique opportunity to lock in a more efficient capital structure that we've done over the last year and we continue to look at. But our priorities really haven't changed.

One, to invest in the business. Two, to put a reasonable dividend level to our shareholders, and three, we have $150 million authorized to buy back stock, which we have started to execute on.

Okay. And I guess you talked a little bit about the synergies you've realized at this point from the Hay acquisition. As we think forward into calendar 2017 and 2018, what are the levers for profit margins from here to drive further improvement? Or, I guess, would you caution against that? How do you feel about margins from here?

I mean, look, 19% is an incredibly strong EBITDA margin for that business. And I think when we did the transaction, Bob, you had indicated, what was our target margin?

It was in the 16% to 18% range.

I would still look at that as more typical. Now, the scalability and the profitability of that business is going to be greatly impacted by our ability to scale and grow our productized services business. So, today, of a run rate of $1.6 billion, half of that is in the Hay Group. When you look at the $800 million, about $250 million of it is around IP that we license to clients.

For example, we have got the largest database on compensation anywhere in the world. We license that to our clients. I look at that business and say we should triple that business. That, obviously, has a much higher profitability profile associated with it than, say, a typical consulting assignment.

The real answer to your question. I think it's more reasonable to target what Bob had indicated, 16% to 18%, because this has to be about growth. But secondly, the real question there is to what extent are we going to be able to drive hyper-growth through our products business which touch a lot of people's lives?

Okay. And what about just for the other segments, then, as we think about the margins? I guess I was trying to also think about the overall Company at this point. Is there room for leverage in Futurestep at this point and Executive Search?

Yes. I would say, Tim, if you go back to the long-term targets we have. And in fact, when we go out on the road with you, if you look at Search in the 20% to 25% range, we were kind of right in the sweet spot on that right now. I would say in Futurestep, everyone's got that business at about a 15% margin right now. There's probably room, a little bit of room on the upside. We think the long-term range is 14% to 16% there. I think there's a little bit of room on the Futurestep side versus a margin expansion.

Okay. And lastly just one numbers question. Given the election, the offshore cash, can you give us any thoughts on potential for repatriation and how much could you reasonably bring back if there were some sort of change in the taxes?

Yes. We are actually going through a detailed evaluation of that right now. Remember, we have got two opportunities to bring cash back, or I should say, one opportunity and one potential opportunity. So, depending on what the administration does from a relief perspective on repatriation, we would obviously look to take advantage of that.

Then we also have, as you recall, when we did the Hay Group transaction, the way we were able to structure it, we have got about a $200 million, what we call a valve, to get money back to the US on a tax-efficient basis. So the combination of those two give us ample opportunity to bring dollars back. If you look at where we're at right now, I would say we've got probably somewhere in the neighborhood of $65 million to $70 million that we can potentially bring back. That's what we're going through and evaluating.

As we look at where our cash sits, what we've done is we've looked at cash on a country-by-country basis. We've identified those areas where, even if there's a relief from a US tax perspective, there's a high withholding tax cost. We've carved those out.

We are looking at locations where there's other potential restrictions on getting cash out of the country. We are in the process of defining it, but I'd say there's probably $65 million to $70 million that we'd have an opportunity to bring back at this point in time.

Okay. Thank you.

Mark Marcon, R. W. Baird.

Hello. This is Craig filling in for Mark. Things for taking my question. Just wondering on the North America Search side, how have the conversations or the tone of the conversations with clients changed post election? I know you said you've seen a tick-up in new business, but have the conversations maybe changed just given what the potential for policy is going into 2017?

I think there is certainly -- it's hard to generalize, but I would say that the conversation is certainly more optimistic than it was in May and June. No doubt about that. Now, we will see if that turns into increasing levels of business in early calendar 2017.

Okay. And, going into the specific verticals there, just financial services, I know that was, we saw that contract this past quarter. But obviously, the environment there is getting better with rates going up. So, I mean, have you seen an improvement from that vertical?

November was, in terms of new business in financial services, was certainly better than say what we saw in the second quarter. But, remember, when you look at our firm, we purposefully repositioned our portfolio many years ago and really today, 30% of the firm is driven by our industrial business. And so with the conversations around infrastructure with the agreement that was reached around oil, those should bode well for us in 2017.

Financial services is about 15%, 16% of the portfolio. We have got a fabulous business there. One of the big opportunities there is within our insurance segment, where I think we can even have greater impact. It's obviously been challenged, but it was good to see November, that that was better than what we've seen over the last few months.

Okay. Great. And lastly with Futurestep, you mentioned that the pipeline remains pretty strong and robust. What is the average length on assignments that you are seeing now? If we could just get a sense of kind of the new awards and when you think about the incremental revenue you're getting there, I mean, if we think about the split, how much of that is coming from new business wins versus your expanding relationships with clients that you already have?

Greg, this is Gregg Kvochak. Yes, most of the new orders in the current quarter for Futurestep are new logo, so new clients. And then to answer your second question, the average duration of an RPO assignment is approximately three years and that's been pretty consistent for a number of quarters.

All right. Great. Thanks a lot.

It appears there are no further questions. Mr. Burnison.

Okay. Well, listen. I thank you for joining us very early in the morning. There's no doubt that the role of the people and leadership play in driving a client's organizational performance. I can assure you that we've never been better positioned to drive clients' success and reshape the future of work than today. With that, again, I would say Happy Holidays, Merry Christmas, thank you for joining us and we'll talk to you next time.

Thank you, ladies and gentlemen. This conference will be available for replay for one week starting today at 9:30 AM eastern standard time running through the day, December 14, ending at midnight. You may access the AT&T executive playback service by dialing 1-800-475-6701 and entering the access code of 407777.

International participants 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. That does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.