Korn Ferry Q3 FY2023 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Korn Ferry Third Quarter Fiscal Year 2023 Conference Call. As a reminder, this conference call 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 we 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 this presentation and in the periodic and other reports filed by the company with the SEC, including the company's annual report for fiscal year 2022 and the company's soon-to-be-filed quarterly report for the quarter ended January 31, 2023. Also, some of the comments today may reference non-GAAP financial measures such as constant currency amounts, EBITDA and adjusted EBITDA. Additional information concerning these measures, including reconciliations to the most directly comparable GAAP financial measure is contained in the financial presentation and earnings release relating to this call, both of which are posted in the Investor Relations section of the company's website at www.kornferry.com. With that, I'll turn the call over to Gary Burnison. Please go ahead, Gary.

Okay. Thanks, Greg, and good afternoon, everybody. Thanks for joining us. Number one, I'm very proud of our third quarter performance, particularly in light of the macroeconomic environment. Given our scale and the depth and breadth of our IP data and content, we are incredibly well positioned to enable our clients to navigate an economy in transition. Our strategy is working. We've built synergistic businesses around Executive Search that are generating more durable fee revenues. We're going to continue to prioritize investment in the larger, faster-growing, less cyclical markets that set our firm and our clients up for success. As an example, the recent addition of Salo now brings our Interim Services to be more than 10% of our firm's revenue on a pro forma basis. This wasn't even a business for us a year ago. And yes, this might be the most anticipated downturn ever, but this is also a transitory time. And like others in the past, it also brings opportunity. It's a proving ground for the efficiency of our strategy, the strength of our culture, the resilience of our colleagues, and the potency of the Korn Ferry brand. With that, Bob, I'll turn it over to you.

Great. Thanks, Gary, and good afternoon and good morning, everyone. Our results in the third quarter continue to provide proof that our growth strategy is working. For instance, we continue to demonstrate the ability to drive top-line synergies between our solutions. As an example, our recent acquisitions in the Interim space, which we believe provide real outsized opportunities for growth, have created almost 700 additional engagement wins resulting in an incremental $43 million in fee revenue since the third quarter of fiscal year '22 when we acquired the Lucas Group. And this is all through cross-sales between the acquired entities and legacy Korn Ferry. Cross-sells between our other lines of business and both our marquee and regional accounts continue to perform very well in the quarter. I recently celebrated my 11th year with Korn Ferry. One of the reasons why I joined the company was the growth strategy. It really resonated with me, and I believe more deeply in it today. We are relentlessly driving an integrated solutions-based go-to-market strategy, delivering unparalleled client excellence, extending the Korn Ferry brand, advancing Korn Ferry as the premier career destination, and we're pursuing transformational opportunities at the intersection of talent and strategy. This growth strategy served us well back in 2012 when I joined and continues to do so even more today. Let me turn the call over to Gregg, who will take you through some of the overall company financial highlights.

Okay. Thanks, Bob. Turning to our third quarter financial results. Fee revenue was $681 million for the quarter which was flat year-over-year and up 4% at constant currency. By line of business, fee revenue was mixed as demand in Executive Search and permanent placement professional search moderated from post-pandemic recovery highs while our Consulting, Digital, RPO, and Interim Solutions remained relatively stable. Measured year-over-year at constant currency, Consulting was up 4%, Digital was essentially flat, and RPO was up 9%. Including revenue from recently acquired businesses, Professional Search & Interim was up 33% at constant currency, while Executive Search was down 9%. In the third quarter, consolidated new business, excluding RPO, was up 5% year-over-year at constant currency and up approximately 1% at actual rates, with growth in all lines of business except Executive Search. In the third quarter, adjusted EBITDA was $96 million with an adjusted EBITDA margin of 14%, which was in line with our guidance. Earnings and profitability were impacted by an overall mix shift in fee revenue to lower-margin lines of business, investments in fee earner and execution capacity, and to a lesser extent, wage inflation. Adjusted fully diluted earnings per share in the third quarter were $1.01, which was down $0.58 or 36% year-over-year. Adjusted fully diluted earnings per share exclude an after-tax charge of $42 million or $0.80 per share related to the realignment of our workforce and the impairment of certain real estate assets. GAAP fully diluted earnings per share in the third quarter were $0.21. Our investable cash position remains strong, and our current capital deployment continues to be balanced. For all of fiscal '23, through the end of the third quarter, we repurchased approximately $80 million of our stock, paid cash dividends of approximately $25 million, deployed $99 million for business acquisitions, and funded about $48 million of capital expenditures, most of which was directed towards product development initiatives for our digital business. With that, I'll now turn the call over to Tiffany to review our operating segments in more detail.

Thanks, Gregg. Starting with KF Digital, global fee revenue in the third quarter was $85 million, which was down 6% year-over-year and approximately flat at constant currency. Digital subscription and license fee revenue in the third quarter was $30 million, which was approximately 31% of fee revenue for the quarter. Global new business for KF Digital was $109 million, with $39 million or 35% of the total subscription and license sales. Earnings and profitability in the quarter were impacted by investment in product development initiatives and a slight uptick in SG&A. For Consulting, fee revenue in the third quarter grew to $162 million, which was flat year-over-year and up approximately 4% at constant currency. Fee revenue growth was strongest in organizational strategy, which grew 12% versus the prior year. Additionally, global new business for Consulting in the third quarter was up 9% year-over-year at constant currency. The Professional Search & Interim business new business increased 30% in the third quarter versus last year, driven by double-digit strength in North America, aided by the current year acquisitions. Total fee revenue was $118 million, up $28 million or 31% over the same time period. Breaking down the quarter, growth in the interim business was sufficient to offset the expected deceleration in the permanent placement portion of the segment. Interim Services fee revenue grew to $53 million from $15 million in the same quarter of the prior year, driven in part by the recent acquisitions of Patina and ICS. Permanent placement fee revenue declined by $10 million to $65 million year-over-year, down 13% at actual and down 11% at constant currency. Moving on to recruitment process outsourcing, new business for the third quarter was $44 million, and total revenue under contract at the end of the quarter was approximately $837 million. Fee revenue totaled $104 million, which was up $5 million or 5% year-over-year and up approximately 9% at constant currency. The pipeline remains strong as RPO continues to win new business by offering a differentiated tech-enabled solution across a variety of markets and industries. The volume from these new wins offset some of the volume moderation seen over the last few quarters, positioning the RPO business for strong growth despite the moderation in the base. Finally, global fee revenue for Executive Search in the third quarter was $212 million and as expected, experienced a year-over-year decline of 9% at constant currency compared to the high growth rate enjoyed during the pandemic recovery last year. Growth in EMEA was offset by slower demand in North America and APAC. Global new business in the third quarter for Executive Search was down 13% year-over-year and down approximately 10% at constant currency. I will now turn the call back over to Bob to discuss our outlook for the fourth quarter of fiscal '23.

Great. Thanks, Tiffany. Now assuming no new major pandemic-related lockdowns or further changes in worldwide geopolitical conditions, economic conditions, financial markets, and foreign exchange rates, we expect fee revenue in the fourth quarter of fiscal '23 to range from $690 million to $710 million. Our adjusted EBITDA margin to be approximately 14%, and our consolidated adjusted diluted earnings per share to range from $0.97 to $1.05. Finally, we expect our GAAP diluted earnings per share in the fourth quarter to range from $0.89 to $0.98. Now in closing, we continue to believe strongly that our differentiated and diversified offerings and solutions, the organizational consultancy we have built will ensure our clients find solutions for their organizational and talent challenges for both the near term as well as in the long term. With that, we would be glad to answer any questions you may have.

Your first question comes from the line of George Tong from Goldman Sachs.

Can you discuss how new business trends performed in the month of February? And if you have any insight as well into the month of early March?

Bob, do you want to do that?

Sure. Yes. Our new business trends in February when we closed out the month, George, the new business came in right where we expected it to be and actually it was up about 7%, excluding RPO, it was up about 7% year-over-year. RPO had another really good month this month. They did close to $45 million in new business in the month of February. For March, it's too early to really talk about it as we have only 3 or 4 days in now. So there's really not much to say as the new business comes in, at times, it tends to come more towards the end of the month. So it would probably be too premature to give you any insight into March yet.

Okay, got it. That's helpful. And then, Digital side...

Yes, I was going to say the other thing I would add is the patterns that we're seeing in the month of February were exactly what we saw in the third quarter by line of business.

Got it. That's helpful. Switching gears to the digital business. Revenue growth there moderated from 15% year-over-year growth in fiscal 2Q at roughly flat constant currency this quarter, fiscal 3Q. Can you elaborate on the reasons behind this change in growth and when you expect the reacceleration in growth and what the drivers will be for growth acceleration?

Well, I think there are a couple of short-term drivers and then there are some medium- to long-term drivers. The medium- to long-term drivers revolve around our success with our tech platform that we're building. And that is a set of IP that is anchored around developing technologies using our developmental library of competencies and the like. So that's one factor that will increase the medium to long term. The second is to the extent that we're successful at bringing in partners within our ecosystem to distribute our IP. The third thing I would mention is that when you look at our sales force within the digital channel, you have to remember that almost 30% of the sales force is relatively new in the last, call it, 6 to 9 months. And so it naturally takes time for those people to ramp up. And I'd also point out a shift that we made going back a couple of years, but really 1.5 years ago, is moving that business to a SaaS model. And so when you look at that and you go back, say, a year, 1.5 years ago, the subscription backlog was probably revenue under contract of about $300 million. Now it's moved up to about $350 million. And so there's been a massive shift that we've made over the last 2 to 3 years in that business from immediately recognizing revenue to creating a more sustainable business model. So you don't necessarily see that in the revenue, but there's a major, major transformation happening. And then, the final thing I'd say is that, obviously, it's an environment where everybody is watching costs. And we saw it in this last quarter in the digital business from some of our technology clients cutting back on some of the things that they were getting from us, particularly around assessment. So I think those are the factors that I would look to on both a short and medium to long-term basis.

Your next question comes from the line of Tobey Sommer from Truist Securities.

This is Jasper Bibb on for Tobey. Just two quick clarification questions on the guidance. First is the 4Q guidance, does it reflect the full impact of the restructuring program on margin? And then secondly, how much incremental revenue from Salo is in the guidance?

Bob, why don't you handle the incremental cost? And we're expecting for Salo in the quarter about $30 million of incremental revenue in the fourth quarter.

Yes. And then in terms of the guidance, we executed the plan that we talked about on the last earnings call. We spent between taking out positions and reducing our real estate footprint. We spent approximately $51 million. We're going to get somewhere in the $50 million to $55 million range for savings. But what we're also forecasting for the fourth quarter is continued moderation in what I would call the executive search in the professional search permanent placement business. And that, as you know, is high yielding in terms of the EBITDA margin for us. And so as that continues to decline, that will consume some of the savings. We're also reinvesting back into the business in terms of fee earners and delivery capacity to meet our client demand, as well as we're going to continue to accelerate the investments that we're making into Digital. And so those will net out. And then as the permanent placement portion of the business reaches its trough and starts to recover, we'll see the margins start to pop up and come back again.

That makes sense. And then on the search consultant productivity, down to $1.4 million this quarter, pretty much in line with pre-COVID levels. If demand continues to soften in that segment, how should we think about managing to a productivity threshold versus keeping capacity for an eventual cyclical rebound?

Well, right now, we're positioned to maintain capacity. And when you look at our consulting business, our digital business, and in the search business, our view is to hold capacity. It really depends on what happens here with the economy. But the $1.4 million, obviously, if demand falls, that will likely decline. But my orientation right now is to maintain capacity.

Got it. Last one for me. I was hoping you could speak to your long-term EBITDA margin targets. I still think those are feasible and how should we think about the increased interim exposure via your recent acquisitions, perhaps changing the long-term gross margin profile of the business as part of that.

Yes, it's a great question. I think it—number one, look, this was a business that didn't exist. During the pandemic, we looked around and said how is the world going to change and professionals wanting more flexibility in their life. With an aging baby boomer population, maybe people that didn't want to work full-time but still want to contribute in meaningful ways to society. We very purposefully said let's go into this market. We've taken that now from basically 0 to a run rate now of about $320 million, $330 million in 18 months. This will definitely be a $1 billion business for us. There is no question about it. Now as we do that and we address these bigger markets that have proven to be less cyclical than, say, the legacy business of Executive Search, the margin profile is going to change. There's no doubt about it. And Bob, you can describe the quantitative impact of that. But if we get this business to $1 billion, which we think we can, and everything else were the same—which is not going to stay the same—but if it did, you're probably talking 200 to 300 basis points of margin shift. But we really are excited about this. We are seeing incredible levels of cross referrals, creating deeper meaning and deeper impact with clients. We believe that overall, much like the strategy when I started, this is my 84th earnings call, and I remember day 1, the entire business was essentially executive search, and now executive search today is just 31% of the company. What we have demonstrated now is we are building a platform with more client impact that changes more people's lives and enables people and organizations to thrive. It also provides a more stable company for shareholders. You can see it in the numbers and the new business over the last several months, barring some sort of economic disaster. But Bob, maybe you could comment on the quantitative aspect of the margin.

Sure. So Jasper, when we buy these businesses, they generally come with about, I would say, around an 8% EBITDA margin. Our goal as we go through the integration, as you know, we've built a company that’s kind of plug and play. So we're able to achieve cost synergies fairly easily just by plugging the acquired companies into our network. Our goal is to take those margins up to the 12% to 15% range over time. As Gary alluded to, the trade-off in margin for us is the opportunity for growth and the stability that those revenue streams bring to the organization.

Your next question comes from the line of Marc Riddick from Sidoti.

So I was wondering if you could talk a little bit about some of the changes in particular demand drivers. I'm specifically talking about trends that you’ve noticed over the last few months that have sort of changed or shifted, whether it’s from a standpoint of some of the things that were driving demand over the last couple of years. Are there any particular areas that have sort of picked up that we haven't been talking about or thinking about, or maybe some things that have waned a bit beyond recessionary impact?

Well, industrial has certainly been a bright spot and that's been a change. When I look year-over-year, industrial is up about 10%. So that's certainly good, considering it's almost 30% of the company's portfolio. Clearly, going back to August of last summer, with the move by central banks, particularly the Fed to become more hawkish, companies are clearly looking at their costs. There was this massive upswing after the pandemic in terms of hiring, and naturally that has moderated, which is exactly what we've seen. We've seen moderation in the perm parts of our recruiting business. Wage growth is still at elevated levels, around 6% to 7%. People that are changing jobs are not getting what they were getting coming out of the pandemic; it is more like a 15% uptick in wages. So that moderation is likely to continue on the perm side, especially given recent comments by the Fed. The RPO business continues to hold up incredibly well. We have seen some degradation in the base business, nominally, but we've also picked up substantial wins in industrial and healthcare. When you look at consulting and digital, on a constant currency basis, Consulting was up 9%, and new business in digital was up 6%. It is playing out exactly as our strategy was designed; the strategy is working.

That's really helpful. I was curious if you were starting to see a bit of a pickup in business travel and more face-to-face activity and being in front of clients again. It seems like it's kind of back and forth a bit. I was wondering if you have any thoughts on that; are clients doing face-to-face with you more? Do you see more of a pickup in travel and entertainment going forward? How should we think about that?

Well, the genie is out of the bottle. I think all of us enjoy the flexibility that, unfortunately, the pandemic brought about. When this whole thing started, I said, travel and all of this, how you're entertained, how you consume, how you produce, it's going to be about 50% of what it was. Now it's not even at the 50% level of what it was, clearly. Yes, we are seeing a desire for sure—there is no substitute for being in-person with another human being—but it is not at all like it was before. This is a generational change. That could take 5 to 10 years to truly play out. Yes, there has been an increase over the last few months, but nothing close to what it once was. And then with China setting aside the geopolitical aspect, we’ll see what happens with China, which has had a significant drag on multinational companies and in the Asia Pacific region, along with our business. It could be as much as $40 million to $50 million a year for us.

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

Okay. We appreciate everybody taking the time to listen. First and foremost, I want to thank our colleagues all around the world for just an incredible performance. Thanks to Bob, Gregg, and Tiffany, and we'll talk to you next time. See you. Bye-bye.

Ladies and gentlemen, this conference will be available for replay for 1 week starting today at 3:00 p.m. Eastern Time running through the day March 15, 2023, ending at midnight. You may access the AT&T executive playback service by dialing 866-207-1041 and entering the access code 703-7839. International participants may dial 402-970-0847. Additionally, the replay will be available for playback at the company's website. That does conclude your conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.