Korn/Ferry's (KFY) CEO Gary Burnison on Q2 2017 Results - Earnings Call Transcript

About: Korn/Ferry International (KFY)
by: SA Transcripts

Korn/Ferry International (NYSE:KFY) Q2 2017 Results Earnings Conference Call December 7, 2016 7:30 AM ET


Gregg Kvochak - SVP, IR

Gary Burnison - CEO

Bob Rozek - EVP, CFO and Chief Corporate Officer


George Tong - Piper Jaffray

Tim McHugh - William Blair

Mark Marcon - RW Baird


Ladies and gentlemen, thank you for standing by. And welcome to Korn/Ferry Second Quarter Fiscal Year 2017 Conference Call. At this time, all participants are in a listen-only mode. Following the prepared remarks, we will conduct a question-and-answer session. 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 fiscal 2016 and in the other periodic reports filed by 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 reconciliations 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.

Gary Burnison

Okay. Thank you, Stacey. I’m joined here by Bob Rozek and Gregg Kvochak, and I’d say a very early good morning and season’s greetings.

Let me first comment on the quarter. I am 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 benefitted by the Hay Group transaction. And 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, this is absolutely going to be a game changer for our Company. This past quarter, Hay Group achieved a $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, and Bob and Greg will share a little bit about the profitability that we’re very, very pleased with.

Futurestep in the quarter continued to be a shining star, 14% up at constant currency. We’ve 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 has 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. And now 12 months into this, we’re a much more diversified, balanced firm. As I have 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 quarter’s EBITDA, this adjusted EBITDA of $63 million, I got to tell you to put that in perspective, it wasn’t that long ago that adjusted EBITDA for the full year was substantially less than that.

I am very, very pleased with our Company, with our colleagues around the world in terms of what we’ve -- 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 repositioned the Company, and they provided a platform to both shape and accelerate our growth in the years ahead.

And 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 2017, we’re 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’re going to focus on to drive share and to drive growth, because for us now, with the synergy stuff behind us, this has to be about growth.

With those six things, number one, we’ve got to more aggressively integrate our IP into our recruiting offerings. Two, we’ve 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 looks more like solutions and industries. 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 is an opportunity there to double that business if not triple it. Fifth, we have to proactively target high stake opportunities in which we’re going to impact client success. And finally, we’re going to continue a very systematic and pragmatic M&A strategy.

So with that, I’ll turn it over to Mr. Rozek.

Bob Rozek

Great. Thanks, Gary, and good afternoon, everyone. I’m going to start with a few key highlights from the quarter. First, Gary indicated our consolidated fee revenue was seasonally strong and grew to nearly $402 million that’s year-over-year improvement of 43%. Compared to the first quarter of fiscal 2017, 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.

Gary mentioned, Futurestep has now achieved double-digit fee revenue growth for 12 consecutive quarters. We’re especially proud of our earnings and profitability; they continued 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 is fully benefited from the recent restructuring and integration activity 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 fiscal 2017 from 15.6% in the third quarter of fiscal 2016.

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 we’ll 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 strong August and September followed by a weakening in October. At 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 benefitted 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 cost, 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 and bonuses, our investible 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 fiscal 2017, up $0.08 or 16% compared to the second quarter of fiscal 2016 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’ll now turn it over to Greg to review our operating segments in a little bit more detail.

Gregg Kvochak

Thanks Bob. Starting with our Executive Search segment, at actual exchange rates, consolidated fee revenue in the second quarter for 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 and 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 Asia Pacific region was down 7%. Fee revenue growth for our global specialty practices was 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 the contraction in our financial services, consumer goods, and life science and healthcare practices which were down 13%, 8% and 1% respectively.

Financial services accounted for 18% of all Executive Search fee revenue of 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 seven year-over-year and 13 sequentially. Annualized fee revenue production for consultants in the second quarter was $1.26 million, up 5% sequentially and the number of new search assignments opened 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 fiscal 2016, 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 of fiscal 2017 was 25% compared to 26% in the second quarter of fiscal 2016. Sequentially, adjusted EBITDA for Executive Search improved $7.3 million or 23% with 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 fiscal 2017 completed its third full quarter of integrating 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 fiscal 2017. 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 and integration activities initiated over the last several quarters and realized the benefit of such actions for the full quarter.

In the second fiscal quarter fiscal 2017, 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 in the second quarter was -- 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 fiscal 2017.

Bob Rozek

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 U.S. 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 and 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 lost 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 is probably about 12% or 13% less working days in the third quarter. And obviously when folks aren’t working, you are not booking revenues at that time.

With regards to Futurestep, as previously discussed, new business trends in the second quarter remained 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, there is 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 cost, 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, it’s about $3 million of the charge and that relates to four locations. Professional fees associated with the continuing and ongoing financial and operational system conversion and there will be about another $2 million. And then the remaining $4 million will be the ongoing retention bonuses that were repaid in connection with the Hay Group acquisition. When you include all of these costs, we estimate that the fiscal 2017 third quarter fully diluted earnings per share measured by U.S. GAAP will likely be in a range of $0.36 to $0.46.

And with that, I’ll conclude our prepared remarks and we would be glad to answer any questions you have.

Question-and-Answer Session


Thank you. [Operator Instructions] And our first question will go to George Tong with Piper Jaffray. Please go ahead.

George Tong

Hi, thanks. Good morning.

Gary Burnison

Hey, George.

George Tong

On a pro forma basis for Hay Group, if you assume -- you own Hay Group in the year ago period, it appears that revenue growth was negative in the fiscal 2Q. 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?

Bob Rozek

Yes. George, I think there is couple of things. 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 U.S., so currency does weigh on that. So, we would look at it as being more flattish. And 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 set, those initiatives have really helped 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 call that follow the money, but our first priority was to drive the synergies and make sure that the economics from the transaction pan [ph] out as we had communicate with our Board. So that was our first order of priority. Now, with the synergies essentially behind us, we’ve got a couple of office moves left. But with the rest of the synergies behind us, the focus right now is on a top-line growth, as Gary had indicated.

Gary Burnison

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 probably at today’s dollars kind of like 750 or 760, 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’re 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. So that’s -- 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.

George Tong

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

Gary Burnison

Well, November, in Europe, we had our best month of new business in probably two years. Asia was also incredibly strong. And when you look at North America, we did see a pause around October 2015 or so. We saw pause in kind of the level of new business. And as Bob indicated, that seem to pick-up a little bit after the election. So, overall, if you were to look at North America in November -- and 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%. So that’s another good sign.


For next question, we’ll go to Tim McHugh with William Blair. Please go ahead.

Tim McHugh

Hi, guys. 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. I guess 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 to use the cash flow from here?

Gary Burnison

Our Board -- we have this dialog. 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 a $150 million authorized to buy back stock which we have started to execute on.

Tim McHugh

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 I guess forward into calendar 2017 and 2018, what are the levers for profit margins from here I guess to drive further improvement or I guess would you caution against that and I guess how is that margin from here?

Gary Burnison

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

Bob Rozek

It was in the 16%, 18% range.

Gary Burnison

So, I would still kind of look at that as more typical math. 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 a $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’ve got the largest data base 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. So, 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.

Tim McHugh

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?

Gary Burnison

Yes. I would say, Tim, if you go back to the long-term targets we have in our deck when we go out and enroll with you, if you look at search in the 20% to 25% range, we are kind of right in the sweet spot on that right now. I would say in Futurestep, got that business at about 15% margin right now; there is probably room, a little bit room on the upside. We think the long-term range is 14% to 16% there. So, I think there is a little bit of room on the Futurestep side for some margin expansion.

Tim McHugh

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

Gary Burnison

Yes. We’re actually going through a detailed evaluation of that right now. Tim, remember, we’ve got two opportunities to bring cash back, or I’d just 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. And then, we also have, as you recall, when we did the Hay Group transaction, the way we were able to structure, if we’ve got about $200 million, what we call a valve to get money back to the U.S. on a tax efficient basis. So, the combination of those to gives 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. So, we’re going through evaluating. As we look at where our cash sits, what we’ve done is we looked at cash on a country-by-country basis. We’ve identified those areas where even if there is a relief from a U.S. tax perspective, there is a high withholding tax cost; we’ve carved those out. We’re looking at locations where there is other potential restrictions on getting cash out of the country. So, we’re in the process to define it. But I’d say there is probably $65 million to $70 million that we have an opportunity to bring back at this point in time.


We’ll go to line of Mark Marcon with RW Baird. Please go ahead.

Unidentified Analyst

Hi. This is Craig [ph] dialing in for Mark. Thanks for taking my question. Just wondering on the North America Search side, how have the conversations and tone of the conversations with clients changed post election? I know you said you’ve seen a tick-up in new business. But I mean, have the conversations become to change just given what the potential for policy is going into 2017?

Gary Burnison

Well, 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’ll see if that turns into increasing levels of business in early calendar 2017.

Unidentified Analyst

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

Gary Burnison

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 early 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% to 16% of the portfolio, we’ve 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. So, 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.

Unidentified Analyst

Okay, great. And lastly with Futurestep, you mentioned that the pipeline remains pretty strong and robust. What is the average length of assignments that you are seeing now, if we could just get a sense of kind of the new awards? And when we 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?

Gregg Kvochak

This is Gregg Kvochak. Yes, most of the new orders in the current quarter for Futurestep are new logos, 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.


And it appears there are no further questions, Mr. Burnison.

Gary Burnison

Okay. Well, listen, I thank you for joining us very early in the morning. You know there is no doubt that the role the people play and leadership play in driving a client’s organizational performance. I can assure you that we’ve never been better positioned to drive client success and reshape the future of work than today.

So with that, again, I would say happy holidays, merry Christmas. Thank you for joining us and we’ll talk to you next time.


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 14th ending at midnight. You may access by AT&T Executive Playback Service by dialing 18004756701 and entering the access code of 407777. International participants dial 3203653844. 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.