Earnings Call Transcript - KFY Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Korn Ferry Second Quarter Fiscal Year 2020 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 call is being recorded for replay purposes. We have also made available in the Investor Relations section of our website a copy of the financial presentation that we will be reviewing with you today. Before I turn the call over to our host, Mr. Gary Burnison, let me first read a cautionary statement to investors. Certain statements made on 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 reports filed by the company with the SEC, including the company's Annual Report for fiscal year 2019. 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 direct 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. With that, I'll turn the call over to Mr. Burnison. Please go ahead, Mr. Burnison.

Gary Burnison, CEO

Okay, Jamie. Good afternoon, everybody, and seasons greetings. Thank you for joining us. Clearly, this has been an eventful year for Korn Ferry. On November 14, about a month ago, we celebrated our 50th anniversary, and it really capped an unprecedented moment in our history as the preeminent global consulting firm. Fee revenue in the quarter was up 1% in constant currency. We had an adjusted EBITDA margin of almost 16% and in the quarter, we continued to have a long-term balanced approach to capital deployment. We repurchased about $50 million of stock during the quarter in addition to our normal quarterly dividend. On November 1, we completed the acquisitions of Miller Heiman, Strategy Execution, and AchieveForum. Historically, we've only focused on a 10% subset of the $300 billion market for learning and development. With these acquisitions, we've added professional development and upskilling capabilities that combine with our current offerings in leadership development and that will leverage our digital platform, tapping a much bigger opportunity in learning, development, and outsourcing. The companies that have joined us now train more than 210,000 people a year. As I think about this calendar year and the past few years, the investments that we've made in our business and operations, including folding the firm under one brand with one unified team to handle all of our clients’ needs, have really set the foundation to accelerate our growth in the years ahead. The foundation of our go-forward strategy is around our intellectual property (IP). Arguably, we have the most comprehensive organizational and people databases in the world, and we have rewards data on more than 20 million professionals and over 20,000 companies. We've conducted almost 70 million assessments, and we have organizational benchmark data on 12,000 companies. We have 3,900 success profiles and 30,000 job titles. We've got rich IP. And certainly, last but not least, every business hour we put somebody in a job every three minutes. Building on this IP and the investments we've made, our growth levers going forward are really going to be anchored around six key activities. One is to continue to extend and reposition the Korn Ferry brand. The brand that is synonymous with enabling people and organizations to exceed their potential, creating opportunities for individuals and companies. Secondly, we will continue the path that we've systematically gone down around a programmatic go-to-market strategy. We've made investments around account planning and account management talent. At the end of the second quarter, we had more than 300 marquee and regional accounts, which represented about 30% of the revenue, and our long-term goal is to have those represent 40% to 45% of the portfolio. Third, we need to create scalable, repeatable, outcome-based solution sets. Fourth, we have to monetize this fabulous IP that we have, and that's the thinking behind a new business that we're going to break out separately this quarter, the third quarter, called KF Digital. Fifth, we will continue to pursue strategic acquisitions. Finally, we will be the premier career destination in the consulting world. The integration of these acquisitions is well underway. We expect the revenues from them will add another $120 million to $130 million of revenue and, combined with what was our legacy product business initially, creates a $400 million Korn Ferry Digital business. We would expect the adjusted EBITDA margin of the Korn Ferry Digital business after the synergies, which Bob will talk about, will be 27% to 30%. In this current quarter, in our third quarter, we're going to begin breaking out Digital in our segment reporting. We expect that this will contribute about $100 million of EBITDA, approximately a third of the company's annualized EBITDA run rate or approximately 19% of the company's annualized run rate net income. That's obviously very meaningful because that revenue stream is durable. The IP changes many people's lives, and it's really about knowledge transfer. As we look ahead, one word sums up the current economic environment: confusion. Part of this stem from the sociopolitical climate, whether it's social unrest, inequality, elections, Brexit, or trade skirmishes. The important thing is what do you do about it and how do you position your organization. I think we've been very transparent over the last few quarters, and we've taken a number of steps that we feel enable us to seize opportunity. Number one, we introduced this regional account program; two, we continued driving the marquee account program and aggressively recruited account leaders. We've talked about how we've been moderating headcount for some time. We've also shared with you our view around professional search, moving that more towards knowledge-based assignments. M&A, you know our track record there. I talked about the recent acquisitions we completed. Finally, we've laid plans here to monetize the Korn Ferry digital and technology platform that we're building. In markets like these, it's great companies that make their best moves. We have a history of seeking opportunity in more turbulent times, and as such, we've evolved into a broad-based consulting firm. Our offerings span way more than talent acquisition to organizational advisory services, learning and development assessments, succession, rewards, benefits, and more. Korn Ferry is a much more diversified and balanced firm. Based on the year-to-date quarter two results and the expected top-line contribution from the recent learning development acquisitions, almost two-thirds of our revenue is outside our historical executive search business. That includes almost $1 billion in revenue from four solution areas: organizational strategy, assessment, succession, learning development, and rewards and benefits. I believe that this diversification strategy is absolutely taking hold. As we enter another new year, we’re going to continue our strategy commitment to build the preeminent global organizational consultancy, helping our clients synchronize strategy, operations and their talent to drive superior performance. That’s what it’s all about for us. With that, I’m joined here by Bob and Gregg Kvochak. Bob, I’ll turn it over to you.

Bob Rozek, CFO

Great. Thanks, Gary, and good afternoon, everyone. Financial results for the second quarter of fiscal 2020 continue to highlight the strength of our business model and the impact that the diverse mix of products and solutions that we have really contributes to the growing durability of our revenue base. As Gary indicated, we’re operating in a confused economic environment driven by a whole host of factors, which accentuates the importance of our diversification strategy. Our consolidated fee revenue in the second quarter was $492.4 million, which was down less than 1% year-over-year at actual currency and up about 1% measured at constant currency. From a solution perspective, at constant currency, RPO and Pro Search continued to accelerate with fee revenue growth of 20%, while our advisory segment was down 1%, and Exec Search was down by 3%. We continue to diligently manage our cost base, which resulted in adjusted EBITDA of approximately $78 million and an adjusted EBITDA margin of 15.9%. Turning to new business trends, globally, new business in the second quarter for all of Korn Ferry was up about 11% over last year’s second quarter. Demand for RPO and Professional Search services continues to be strong, with total new business awards of approximately $150 million in the quarter, consisting of $32 million of new Professional Search assignments and $118 million of longer-term RPO contracts. Of the $118 million of RPO contracts, approximately $49 million are with new clients, or what we call new logos, and approximately $69 million are extensions and renewals with current clients. Second quarter RPO awards were broad-based geographically, with strong growth in the U.S., the UK, and China. At constant currency, our advisory new business was up about 1%, with particular strength in North America, which was up 5% year-over-year, while our Exec Search new business was down about 5% year-over-year. At the end of the second quarter, total cash and marketable securities were $609 million, which was up about $86 million compared to the second quarter of fiscal 2019. Excluding amounts reserved for deferred comp arrangements and for accrued bonuses, our investable cash balance at the end of the second quarter was about $346 million, which is up about $102 million year-over-year. We also had outstanding debt at the end of the second quarter of about $273 million. It should be noted that the second quarter's ending cash balance and outstanding debt balance both include an incremental $50 million drawn on our revolver to finance a portion of the recent acquisitions that Gary spoke about, in addition to our recent acquisition investments, consistent with our philosophy to maintain a balanced approach to capital allocation. In FY2020, through the second quarter, and including activity to date for the third quarter, we have now repurchased in open market transactions about 1.74 million shares, using total cash of approximately $66 million. Currently, we have about $184 million remaining on our authorization for share repurchases. And lastly, on December 4, the board declared a $0.10 per share dividend payable on January 15, 2020. Finally, adjusted diluted earnings per share in the second quarter were $0.81, down approximately $0.04 compared to the adjusted fully diluted earnings per share in the second quarter of fiscal 2019. This was mainly driven by a higher effective tax rate in this year’s second fiscal quarter, which is about 26.8% compared to 23.8% in the second quarter of fiscal 2019. I’m now going to turn the call over to Gregg, who will review our operating segments in a little bit more detail.

Gregg Kvochak, COO

Okay. Thanks, Bob. Growth for RPO and Professional Search continued at a high double-digit pace in the second quarter of fiscal 2020. In the second quarter, RPO and Professional Search generated $94.8 million of fee revenue, which was up 20% year-over-year measured at constant currency. All geographic regions grew in the second quarter. As Bob previously mentioned, in the second quarter, RPO and Professional Search new business was strong, the second highest quarter ever. Earnings and profitability for RPO and Professional Search also grew in the second quarter. EBITDA was $16.1 million, up $2.9 million or 22% year-over-year, and EBITDA margin improved year-over-year to 17%. Now turning to Advisory. In the second quarter, global Advisory fee revenue was $209.8 million, which was down 1% year-over-year measured at constant currency. In North America and Europe, Advisory fee revenue grew modestly year-over-year at constant currency, but was down in both Asia Pacific and Latin America. In the second quarter, EBITDA for Advisory was $36.9 million, with a 17.6% margin. Finally, for Executive Search, global fee revenue in the second quarter of fiscal 2020 was $187.8 million, which compared to year-over-year and measured at constant currency was down approximately 3%. The total number of dedicated Executive Search consultants worldwide at the end of the second quarter was 585, up 29 year-over-year and up 16 sequentially. Annualized fee revenue production per consultant in the second quarter was $1.3 million, and the number of new search assignments opened worldwide in the second quarter was 1,719, which was down approximately 2% year-over-year. EBITDA for Executive Search in the second quarter was $44 million with an EBITDA margin of 23.4%. Now going to turn the call back over to Bob to discuss the outlook for the third quarter of fiscal 2020.

Bob Rozek, CFO

Great. Thanks, Gregg. As Gary talked about, starting in fiscal 2020 Q3, we're going to be modifying our segment reporting and we'll be breaking what we call Advisory today into two separate reporting segments, KF Consulting and KF Digital. The new KF Digital segment will include our legacy products' financial results, as well as the financial results of our recently acquired companies, Miller Heiman Group, AchieveForum, and Strategy Execution. Over the past 18 months, we've invested in our digital business to digitize and harmonize a structure of our IP content and data, and we are building a technology platform for the efficient delivery of these assets directly to an end consumer or indirectly to a consulting engagement. These investments, when combined with the investments made in the recent acquisitions, really provide us with the opportunity to step back and look at the Advisory business and split it into our two new reporting segments. Furthermore, as we recently announced, we implemented a restructuring plan to rationalize the company's cost structure to realize efficiencies and operational improvements that these investments have enabled us to achieve. Now, the plan will impact the whole of our existing Advisory reporting segment; it includes the elimination of redundant positions and the consolidation of office space. As we previously announced, the costs associated with these actions are estimated to range from $20 million to $26 million, primarily paid in cash. We expect to recognize these charges beginning in Q3 of FY2020 and expect to conclude the actions early in Q1 of FY2021, with approximately $18 million to $22 million of the charges recognized in Q3 of FY2020. The annual cost savings in KF Digital associated with these actions are estimated to be $25 million to $30 million. As Gary indicated earlier, at the conclusion of the plan, the new KF Digital segment is expected to have a run rate adjusted EBITDA margin of 27% to 30%, in a run rate operating margin of 23% to 26%. From an overall Korn Ferry perspective, the acquisitions and the totality of our restructuring actions are expected to contribute $35 million to $40 million of incremental annual EBITDA, which translates to about $22 million to $25 million of incremental annual net income, and approximately $0.40 to $0.45 of incremental annual EPS. Our global consolidation backlog of undelivered work entering the fiscal third quarter, which is typically a seasonally slower quarter for us, is pretty solid. For the month of October, Korn Ferry consolidated new business was up 10% in constant currency. However, in November, new business for the whole of Korn Ferry was down about 5% in constant currency. Considering these factors, assuming worldwide economic conditions, financial markets, and foreign exchange rates remain as they are, we expect our consolidated fee revenue in the third quarter of fiscal 2020 to range from $490 million to $510 million. Of that amount, we expect about $30 million to come from the recent acquisitions. Additionally, we expect our consolidated diluted earnings per share, adjusted to exclude all the restructuring, integration and acquisition charges, to range from $0.70 to $0.78. Finally, our diluted earnings per share for Q3 of FY2020 measured under U.S. GAAP are expected to range from $0.35 to $0.52 per share. That concludes our prepared remarks, and we'd be glad to answer any questions you have.

Operator, Operator

Our first question is from Kevin McVeigh, Credit Suisse. Please proceed.

Kevin McVeigh, Analyst

Great, thanks so much. Hey, thank you folks. Lot of really good detail. Hey, Gary, given the digital initiatives, I wonder if you could give us a sense of how that impacts the core business. And I guess what I mean is, a lot of strategy today leverage kind of the digital strategy to kind of reinvigorate or enhance kind of the core revenue stream of the business, in this case the Search business. Any sense of the growth prospects for that business? And I guess, I mean, longer term obviously independent of where we are given some of the macro uncertainty.

Gregg Kvochak, COO

When considering the challenges faced by consulting firms, scaling human resources is a significant issue. We are establishing a foundation to scale our intellectual property. For any company or CEO, organizational performance hinges on leadership, strategy, purpose, accountability, and capability. The human element in this equation is crucial for a CEO's success. We have intellectual property that assists companies in identifying and accessing the right talent, structuring their organizations, facilitating learning and development, and determining workforce compensation. I genuinely believe our database is one of the most comprehensive sources of organizational and personnel data globally. Our objective is to positively impact more lives, amplify our influence, and enhance knowledge sharing since not every company wants large teams of consultants. We believe our intellectual property can facilitate knowledge transfer that enables organizations and their employees to reach their full potential, approaching it from a scaling viewpoint. We are beginning with a business projected at $400 million, which is expected to generate nearly $100 million in EBITDA. This segment is highly resilient. In terms of its relationship to our search business, I regard it as a valuable asset. Notably, we place individuals in jobs every three minutes, which is significant. If we can encourage more ongoing conversations with clients throughout the year, it will strengthen our organization and enhance the search business. In terms of market opportunities, we estimate our potential at $200 billion to $300 billion, while the Executive Search market itself is rather limited, amounting to about $5 billion to $8 billion. Although it’s a strong sector, it doesn’t represent a large fraction of our overall market potential. We have observed consistent referrals from consultants across our services. For instance, in the last quarter, 22% of our consulting business originated from the search segment.

Bob Rozek, CFO

And Kevin, this is Bob. I would just add one thing to what Gregg said.

Kevin McVeigh, Analyst

Hey, Bob.

Bob Rozek, CFO

The other thing is, I think the Exec Search business will benefit as a differentiator because the intellectual property, the data that Gary discussed that sits at the center of the organization, gets integrated into each of our solution areas, including Exec Search. The uniqueness allows the Exec Search community to integrate that into their offering and go to market in a differentiated way versus our competitors.

Operator, Operator

Our next question is from Mark Marcon from Baird. Please go ahead.

Mark Marcon, Analyst

Good afternoon. First on – when we take a look at the RPO and Professional Search, you're obviously doing tremendously well there. It seems to us like you're growing faster than the market. Can you talk a little bit about some of the key drivers you're seeing there and how much of the growth would you attribute to the market relative to your execution compared to others?

Gary Burnison, CEO

Yeah, I think we're out executing. I would say and Bob can add, I would, I say that it's number one, the One Korn Ferry approach has worked this last quarter, it varies by quarter. When you look at the referrals from, say Executive Search into RPO, it was 35%; in Professional Search, it was 50%. So number one, that is absolutely working. I think the biggest differentiator is the IP that Bob talked about. We've done a good job of integrating that IP holistically throughout the organization. I would say absolutely that it’s the IP, the one firm approach, and the quality of the work that we're doing. It’s obviously phenomenal. This kind of growth we're presenting here is stellar; there’s just no other way to describe it.

Bob Rozek, CFO

Yeah, listen Mark, I would echo what Gary just said. If you think about our – again the IP at the center of the organization. I grew up in a public accounting environment with specific lines of business. IP-rich but unique for tax, unique for audit. Our IP is ubiquitous across the whole of the organization. Everything that sits in that center fuels every line of business. Our RPO offering can incorporate successful profiles, interview questions, assessment protocols, and pay data. Other folks can't do that. That's why we’re winning.

Operator, Operator

Next question is from the line of George Tong with Goldman Sachs. Please go ahead.

George Tong, Analyst

Hi, thanks. Good morning or good afternoon. The Advisory business is splitting into KF Consulting and KF Digital. How would you distinguish the near and intermediate-term growth prospects of both of these businesses separately and what initiatives do you have to accelerate the growth of KF Consulting?

Gary Burnison, CEO

The KF Consulting business, the real opportunity is in the United States. We've been in the business 50 years and the Search business in North America is roughly $400 million a year. The Consulting business that we have has been much shorter, more like five years, and is already $200 million. Think of the search business at $400 million, the enormous market opportunity in consulting around organizational strategy, change management, and M&A; that is multiples larger. In the U.S., the market is big and our business is a couple of hundred million dollars annually. To accelerate that market, we'll be relentless with these marquee and regional accounts, put account teams against them, and be proactive and have a long game in mind. Secondly, we need to aggressively recruit and promote consultants into that organization. Moving this business over time to bigger and more impactful engagements is critical, which are anchored around business outcomes like M&A and culture change. The digital business requires a transformation from analog to digital. We’re putting in about $5 million or $6 million a quarter into the underlying platform because that will be the differentiator. Our IP is world-class and through these last three acquisitions, we focus on scale to impact thousands of lives.

Operator, Operator

Our next question is from the line of Marc Riddick with Sidoti. Please go ahead.

Marc Riddick, Analyst

Hi, good evening.

Gary Burnison, CEO

Good evening.

Marc Riddick, Analyst

Wanted to touch on now with the – and we’re certainly looking forward to making this part of the reporting and having access to that information going forward as you go through this part of the journey. But I wanted to discuss, where this puts you on your thoughts on M&A going forward. Does this end the prioritization that you currently have when you look at the overall company? Does this put you on the sidelines for a little while or how should we think about that going forward?

Gary Burnison, CEO

We’re never on the sideline. But the question is, do we actually throw the ball? We’re always in the market, so what I can’t answer is whether we’re actually going to pull the trigger on something. It depends on many factors. We have an enormous, fragmented market opportunity; no consultancy is solely focused on an organization’s strategy and its people. Korn Ferry will continue to grow organically and will make meaningful acquisitions. We’re always engaged but remain pragmatic and systematic in building out this strategy. We’re disciplined in our approach to pricing and culture, and we’re mindful that capital has an implied cost. We need to beat that cost of capital.

Bob Rozek, CFO

Yes. Marc, this is Bob. If you think about – you’ve to go back to when we did the Hay Group transaction in December of 2015, we were about $1 billion there. This transaction is way bigger with $120 million or $130 million in revenue. We fully expect integration to be quicker. We’ve taken steps, even though it just closed on November 1. I think you will see that this is going to be integrated much more rapidly.

Operator, Operator

And we have a question coming from the line of Mark Marcon from Baird. Please go ahead.

Mark Marcon, Analyst

All right, good afternoon. Can you talk a little bit more about Miller Heiman and what it’s – what it specifically will be adding? When we think about the $120 million to $130 million in revenue, what the margin profile is? If we can disaggregate what the contribution there is going to be relative to some of the restructuring efforts that you’re going to put in place, in terms of what that contribution would be? Just a lot to unpack there.

Gary Burnison, CEO

Let me provide a little context. We would expect based on the current environment that we would have a $400 million Korn Ferry Digital business. When you break that down, about $100 million would be around rewards where companies license our data. $120 million would be around assessments, succession, $60 million would be organizational strategy, and the remaining piece is $120 million around learning development, anchored primarily at the professional level and below. The Miller Heiman piece is a significant portion of that $120 million. It gives us rich IP and great people around how a company can drive growth, and in turbulent times, it’s even more important than when the wind's behind your back. It allows us to provide sales performance solutions that fit very well with our talent acquisition business. The synergy with parts of our talent acquisition business is significant.

Bob Rozek, CFO

I would also encourage you not to look at it as individual pieces. Similar to when we did the Hay Group transaction; we integrate these businesses as fast as possible. It's like creating a milkshake; once you hit blend, you can't pull it apart. Gary hit blend at 12:01 AM on November 1, and we're working as hard as we can to integrate not only the back offices but the go-to-market activities and folding these businesses into the one Korn Ferry model. We don't think of these as individual businesses anymore. After we get through everything we're doing, you should expect EBITDA margins in KF Consulting to be in the 12% to 15% range.

Operator, Operator

Next question is from Marc Riddick with Sidoti. Please go ahead.

Marc Riddick, Analyst

I did just want to ask a follow-up as to, I didn't know it's been a fairly short period of time, but I was wondering if there was any feedback that you've received from some of the marquee clients that you deal with and what their receptivity was to where you are from the transaction and some of the opportunities you see ahead.

Gary Burnison, CEO

We already secured a $1.5 million deal, a win together. The other two companies we bought have tremendous capability and tremendous people, particularly around broad-based professional development. Miller Heiman is a well-known brand. We have received positive feedback, both from clients and many consultants in our own organization who have gone through Miller Heiman training. In fact, we’re going to utilize it, as we do with all of our IP, on ourselves. The feedback has been good, and we have absolutely incorporated their teams into the Marquee and regional account program.

Operator, Operator

All right. The next question is from Mark Marcon from Baird. Please go ahead.

Mark Marcon, Analyst

Hey, Gary, we've been through multiple cycles together. You've got tremendous perspective in terms of talking to global leaders around the globe. From your perspective, do you think things from a macro perspective feel the same, better or worse today than they did say three months ago?

Gary Burnison, CEO

I think the ADP report on the job market was more right than wrong. There's more caution now on the part of CEOs than there was three months ago. Whether you put that on the December 12 election in Britain or all the other things that are happening, there is certainly more caution today than there was three months ago.

Operator, Operator

It appears there are no further questions in the queue right now, Mr. Burnison.

Gary Burnison, CEO

Okay. Thank you. For any company, successful strategy implementation is about execution and that's about getting the people and the organizational and cultural aspects right. That's what we do. We're more than talent acquisition, more than leadership development, more than rewards. We focus on making change happen, and we're going to make change happen in 2020. So, have a great holiday season and we'll talk to you, if not sooner, in the new calendar year. Thank you very much. Bye-bye.

Operator, Operator

Ladies and gentlemen, this conference call will be available for replay for one week, starting today at 7:00 PM Eastern Time, running through December 12 ending at Midnight. You may access the AT&T Executive playback service by dialing 866-207-1041 and entering the access code 9543885. International participants may dial 402-9708 or 0847. Additionally, the replay will be available for playback at the company's website in the Investor Relations section. That does conclude your conference for today. You may now disconnect.