Earnings Call Transcript - KFY Q1 2024

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Korn Ferry First Quarter Fiscal Year 2024 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 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 statement 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 2023 and the Company’s soon to be filed quarterly report for the quarter ended July 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 kornferry.com. With that, I’ll turn the call over to Mr. Burnison. Please go ahead, Mr. Burnison.

Gary Burnison, CEO

Okay. Thank you, Greg, and good afternoon, everybody, and thanks for joining us. Our team is going to get into the numbers in a second, but I first want to say how incredibly proud I am of our firm, of our colleagues. And our diversification strategy is the right one. It continues to positively influence our results. I would point out that clearly the market demand for permanent placement talent acquisition has softened from post-pandemic highs, but the rest of the portfolio has performed absolutely as designed. Our consulting and digital businesses have never been more meaningful, especially when you think about tomorrow’s economy, which will face continued demographic shortages and skill shifts all over the globe. As I step back and assess the landscape, it seems that much of the business world is undergoing a multi-quarter cyclical reset, not only in how we work but also in navigating an interest rate environment we haven’t seen in almost two decades. This transitory period is likely to bring about significant change and more importantly, opportunity for Korn Ferry, and we’re ready to seize that opportunity with a three-point strategy: number one, optimize; two, innovate; and three, consolidate. Bob will delve into that a little more in his remarks. While we’re not where we used to be, we are clearly on the road to where we want to be — the firm that enables people and organizations to achieve more. Bob, I’ll hand it over to you.

Bob Rozek, CFO

Great. Thanks Gary. Good afternoon or good morning, depending on where you’re calling in from. I echo Gary’s comments in that we’re pleased with the results from the first quarter of the fiscal year, as our earnings and profitability remain sequentially stable despite the challenging macroeconomic backdrop and a seasonally slower fee revenue quarter. As I step back and put the quarter in context, I’m also pleased that our results are a clear demonstration that we continue to execute our strategy successfully. We’ve built a company with a portfolio of core and integrated human capital solutions that are both highly relevant in today’s world, as well as synergistic in terms of top line impact. In an environment where other employment services companies are experiencing downward pressure on their top line, our fee revenue was essentially flat year-over-year as client demand around solutions such as workforce transformation, assessment succession, and interim contract labor offset the expected moderation in permanent placement talent acquisition. You heard Gary speak about our strategic focus moving forward — optimize, innovate, and consolidate. Let’s start with optimize. We will continue to drive productivity by leveraging our cost base. In fact, if you take Q1 of FY24 and compare it to Q3 of FY20, which was the last quarter before the pandemic, our fee revenue per employee is up 18%. We will also continue to pursue opportunities in faster-growing economies, with governments driving economic infrastructure and human capital initiatives, with our marquee and regional accounts, and with cross-line business referrals. Now turning to innovate, we will be at the forefront of talent and organizational data ensuring that our IP is fit-for-purpose for the foreseeable future. We are going to continue to leverage new technologies, such as generative AI, to drive greater client impact. We will invest to monetize our intellectual property through our digital business and increase our emphasis and investment in our expansive and proprietary data. Lastly, let’s discuss consolidate, where our efforts will focus on investing in strategically aligned, less cyclical, faster-growing, and larger addressable markets. We plan to enhance our global executive and professional interim business, expand our capabilities in leadership and professional development, and continue to explore opportunities in strategic and operational consulting. Now with that, let me turn it over to Gregg, who will take you through some overall company financial highlights.

Gregg Kvochak, CFO

Thanks, Bob. In the first quarter, global fee revenue was $699 million, flat year-over-year at actual foreign exchange rates and at constant currency. Fee revenue continued to moderate from post-pandemic highs in our permanent placement talent acquisition businesses but was offset by stable revenue from consulting and digital, along with revenue from our recent investments in interim services. By line of business measured year-over-year at constant currency, fee revenue was down 12% for executive search, down 21% for professional search permanent placement, and down 16% for RPO. In contrast, fee revenue growth measured year-over-year at constant currency was up 1% for consulting, up 5% for digital, and aided by our recent acquisitions of ICS and Salo, fee revenue for interim services was up $59 million. Consolidated new business in the first quarter, excluding RPO, was up 1% year-over-year at actual rates and up 2% at constant currency. Consistent with fee revenue, new business in the first quarter moderated most in executive search and permanent placement professional search. Earnings and profitability measured year-over-year also moderated in the first quarter. Adjusted EBITDA in the first quarter was $96 million with an adjusted EBITDA margin of 13.7%. Consistent with recent quarters, earnings and profitability in the first quarter were impacted by the mix shift in fee revenue by line of business, investments in headcount to preserve fee-generating and execution capacity, and product development initiatives specifically for digital. Additionally, it should be noted that adjusted EBITDA in the first quarter was essentially flat sequentially, with a 30 basis-point improvement in margin, driven primarily by cost control measures implemented over the last two quarters. Finally, our adjusted fully diluted earnings per share in the first quarter were $0.99, down $0.51 or 34% year-over-year. Adjusted fully diluted earnings per share exclude approximately $6 million or $0.10 per share of restructuring, integration, and acquisition costs, primarily related to our acquisitions, as well as an incremental reduction in our real estate footprint. Our investable cash position at the end of the first quarter was $481 million. In the first quarter, we deployed $34 million of cash, including $4 million for share repurchases, $8 million for dividends, $13 million for capital expenditures, and $9 million for debt service. Now, I will turn the call over to Tiffany to review our operating segments in more detail.

Tiffany Louder, CFO

Thanks, Gregg. Starting with KF Digital, global fee revenue in the first quarter was $88 million, which was up 5% year-over-year at actual and at constant currency. Digital subscription and license fee revenue in the first quarter was $33 million, approximately 37% of fee revenue for the quarter. The increase was primarily due to our strategy to transition from point sale solutions to longer-term subscription and license sales, along with an increase in assessment tools as the technology industry began investing again with a focus on leadership development. Global new business for KF Digital was $93 million, with $32 million or 34% of that total tied to subscription and license sales. For consulting, fee revenue in the first quarter was $168 million, which was up approximately 1% at both actual and constant currency. Fee revenue growth was strongest in assessment and succession, which increased 10% year-over-year. Average hourly bill rates continued to climb, now close to $400 an hour, which is up over $30 an hour from just one year ago. Additionally, global new business for consulting in the first quarter was up 7% year-over-year at constant currency with double-digit growth in EMEA and Latin America. The professional search and interim business increased 29% at constant currency in the first quarter compared to last year, driven by strong performance in North America and aided by this year’s acquisitions. Total fee revenue was $142 million, up $43 million or 44% over the same time period. Breaking down the quarter, growth in the interim business was more than enough to offset the moderation in the permanent placement portion of the segment. Interim services fee revenue grew to $84 million from $25 million in the same quarter of the prior year, driven primarily by the recent acquisitions. Permanent placement fee revenue declined by $16 million to $58 million year-over-year, down 22% at actual and down 21% at constant currency. Moving on to recruitment process outsourcing, new business for the first quarter was $48 million, and total revenue under contract at the end of the quarter was approximately $680 million. Fee revenue totaled $96 million, which was down $18 million or 16% year-over-year and down approximately 16% at constant currency. Fee revenue was impacted by a moderation in hiring volume in the base and backlog. We see the slowdown as transitory and believe RPO is well-positioned to benefit when hiring returns to more normalized levels in the base and the larger, more recent wins begin converting to fee revenue. Although quarterly new business can be choppy at times, the pipeline remains strong as RPO continues to win new business, with a differentiated service offering in the marketplace, including our new data-driven recruiting technology, Nimble, that leverages our unique data, IP, and talent management expertise. Finally, global fee revenue for executive search in the first quarter was $205 million, experiencing a year-over-year decline of 12% at constant currency compared to the high growth rates seen during the pandemic recovery in the first quarter of last year. New business in the first quarter for executive search was down 14% year-over-year at actual and constant currency. I will now turn the call back over to Bob to discuss our outlook for the second quarter of fiscal '24.

Bob Rozek, CFO

Great. Thanks, Tiffany. 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 second quarter of fiscal ‘24 to range from $675 million to $695 million, our adjusted EBITDA margin to be 13.5% to 14%, and our consolidated adjusted diluted earnings per share to range from $0.91 to $1.1. Finally, we expect our GAAP diluted earnings per share to range from $0.85 to $0.97. In closing, we have amassed a unique collection of intellectual property, data, content, and science aligned to help companies solve their business and human capital issues. With these assets, we will continue to partner with clients, helping them build long-term talent strategies that balance company growth with the needs of employees. With our synergistic assets, which touch every aspect of an employee’s engagement with their employer, we are well-positioned to continue driving top line growth. No business issue or problem has ever been solved without the involvement of people, and that’s exactly where we come in — working through and with people to help individuals and organizations exceed their potential every day. With that, we would be glad to answer any questions you may have.

Operator, Operator

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

George Tong, Analyst

In the past, you’ve provided data on cross-selling interim search across your various segments. Can you provide an update on cross-selling and include traction with business lines beyond interim, particularly within your marquee and regional accounts?

Gary Burnison, CEO

It continues to be very, very good. Overall for the platform, number one, the global marquee and regional accounts represent almost 40% of the portfolio. When you look at the cross referrals, they typically range between 25% to 30% in any quarter. Cross-referral percentages are higher into RPO and professional search for sure. When you see cross-referrals into digital, it’s about 35% or so. Overall, this trend continues to demonstrate that the strategy is working, providing us with more reasons to engage with clients. This remains a significant opportunity for the firm.

George Tong, Analyst

That’s helpful. And then within your RPO business, new business fell approximately 68% year-over-year to $48 million in the fiscal first quarter. Can you talk a little bit about what you are seeing within RPO, and when you would expect new business trends to improve?

Gary Burnison, CEO

One of the broader trends occurring is what I consider a multi-quarter cyclical reset identifying what I term as labor hoarding. Not long ago, 3.5 years ago, companies were forced to take drastic measures during COVID. Soon after, there was a huge uplift in demand, followed by what’s now referred to as the great resignation. During that period, recruiters were particularly difficult to recruit, leading companies to build robust HR staffs. Consequently, I believe we are witnessing in-sourcing rather than downsizing. Despite a strong pipeline, factors like in-sourcing and labor hoarding are significantly affecting our RPO business. New business trends tend to be quite lumpy. Over the past two years, we averaged about $600 million in new business, but I expect it to reach $100 million to $150 million in the second quarter. While it may not hit $600 million this year, I feel confident it could reach about $525 million to $550 million. However, there are no doubts that labor hoarding is having an impact on RPO.

Bob Rozek, CFO

And Gary, this is Bob. Just to add some context, when we discuss new business, we always mention it without RPO because of the uneven nature of that business. It’s crucial to not look at a single quarter in isolation. If you go back to last year in FY23, it was $150 million in Q1, $290 million in Q2, $44 million in Q3, and $115 million in Q4. Hence, you don't see a smooth linear pattern in RPO as you do in the other segments, so it is necessary to consider this when evaluating RPO.

Operator, Operator

Your next question comes from the line of Mark Marcon from Baird. Please go ahead.

Mark Marcon, Analyst

Gary, you talked about the reset lasting a few quarters, particularly in the context of adapting to higher interest rates. Aside from labor hoarding, what other factors are you assessing? And how might you take advantage of these trends?

Gary Burnison, CEO

Our consulting business is ideally positioned to take advantage of the changes occurring. Companies will need to execute strategies similar to ours; they must optimize resources, innovate, or consolidate. This environment has generated new consulting wins focused on optimization, reorganization, and restructuring. Companies are adapting, though we have yet to see a significant impact from higher carry costs due to interest rates. People's consumer savings, particularly in the U.S., have lasted much longer than anticipated. Organizations are now realizing they can only raise prices to a certain point, marking a shift in strategies concerning organizational structures, talent, and overall human capital.

Mark Marcon, Analyst

In your conversations with business leaders at marquee accounts, what’s your sense of how long this reset might last?

Gary Burnison, CEO

Sentiments vary across the board. The outlook is decidedly optimistic in some segments, while others remain pessimistic. The overarching trend is that for decades, the world has grown accustomed to low interest and cheap money, which we are resetting to a more historic norm. Companies will have to respond to this new environment. I think we are likely to remain in this landscape for a few more quarters. Despite the steady labor force, the demographic challenges facing Western economies will present long-term opportunities for us. Concepts like flexibility in work, and longer life expectancies leading to more valuable contributions, indicate that the interim business should become a billion-dollar enterprise for Korn Ferry. This market opportunity, particularly in targeted skill areas, is key for our continued growth.

Mark Marcon, Analyst

Considering the interim business, could you share the organic growth rates for your recent acquisitions, such as Salo? How does the organic side look?

Gary Burnison, CEO

Focusing on new business over the trailing four months, organic growth for interim services is down about 6%, while in dollar terms, it's down approximately 2%. This indicates that the organic side has maintained stability despite current conditions.

Mark Marcon, Analyst

Has the situation worsened, or has it remained steady month-to-month?

Gary Burnison, CEO

No, it’s been stable. Similar to the executive search, the trailing four months have consistently shown a 13-14% decline in new business. In contrast, consulting has experienced a 14% increase during the same timeframe. This reinforces the effectiveness of our strategy.

Bob Rozek, CFO

Just to add, the interim business aligns more closely with IT trends than with executive or financial areas.

Mark Marcon, Analyst

Executive search seems relatively resilient in EMEA. Can you shed light on that resilience against the backdrop of challenges such as a potential recession in Germany?

Gary Burnison, CEO

EMEA has varied performance. While some areas thrive, others are facing challenges, such as Germany. Our global marquee and regional account strategy, reinforced by our investments, validates the portfolio’s strength in EMEA. Labor markets haven’t expanded, and ongoing skill shortages remain significant despite the observed labor hoarding, thus supporting growth in EMEA.

Bob Rozek, CFO

On the margins side, we've been undergoing workforce rebalancing. It involves an ongoing assessment of staffing levels across sectors. Adjusting headcounts in Europe carries higher costs than in other regions, reflecting in our margins.

Mark Marcon, Analyst

Given the persistent environment challenges, do you think the current margins are at the bottom end of your projected range? Could there be further downside?

Gary Burnison, CEO

That's a challenging inquiry. Several wildcards remain, including China’s current situation as a major manufacturing hub, the energy impacts related to the war in Ukraine, and changes in Middle East oil production. The reset process we are in will stretch over several quarters, compelling enterprises to optimize, reorganize, and adjust to this new global situation. Demographic shortages also remain a pressing reality. In brief, executive search and professional search will plateau and continue adapting, with consulting and digital outperforming alongside strong prospects in interim services.

Operator, Operator

Your next question comes from the line of Trevor Romeo. Please go ahead.

Trevor Romeo, Analyst

Could you break down your expectations for guidance across each of the segments? Seasonal trends usually indicate an uptick in Q2. Which segments might deviate from those normal patterns?

Gary Burnison, CEO

Bob, please elaborate.

Bob Rozek, CFO

Sure, Trevor. As Gary mentioned, we are observing a plateau in the permanent placement portion of our businesses. For guidance, we see the consulting segment typically rising in Q2, and we anticipate slight growth in this area. Digital should also see a mild increase. Conversely, the interim segment may remain flat or slightly decline, especially in the IT vertical. Overall, our midpoint guidance suggests flat growth across the board, indicating stability despite varying trajectories across segments.

Trevor Romeo, Analyst

On the consulting side, I was encouraged to see solid performance and new business trends. Can you discuss the drivers within each area of consulting?

Gary Burnison, CEO

I attribute success to companies needing to adapt to the reset trend we observe. Government initiatives like the Infrastructure Act in the U.S. notably drive consulting engagements. We're witnessing an increase in integrated consulting efforts, emphasizing our strong data capabilities across compensation and benefits, providing suitable opportunities for monetizing our IP.

Operator, Operator

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

Tobey Sommer, Analyst

Regarding interim services, is the current weakness predominantly a sequential decline or is it attributed to conditions earlier in the year? What type of year-over-year trends are we seeing?

Bob Rozek, CFO

The decline on the interim side results partially from a significant contract with a defined life, which has concluded. The deceleration rate we're currently observing indicates improvement. Based on current insights, we anticipate stability going forward past the Q1 to Q2 transitional period.

Tobey Sommer, Analyst

Previous downturns were often followed by rapid recoveries. However, today seems more like a normalization phase. What kind of growth might we expect in a scenario where the economy maintains a soft landing without a significant increase in unemployment?

Gary Burnison, CEO

We must consider Korn Ferry's long-term CAGR. If I recall correctly, our 10- and 20-year growth rates are about 12% to 14%. Looking forward, I think it's reasonable to expect an upward trajectory, especially since we are better positioned than we were a decade ago. Additionally, we are innovating in the flexibility labor market. Over 18 months, we've established a $350 million business that could easily evolve into a billion-dollar segment. Our consulting arm presents untapped multibillion-dollar market opportunities. Evidence points to our successful go-to-market approach, with strong cross-referrals and a comprehensive account strategy.

Tobey Sommer, Analyst

As you pursue the interim business towards $1 billion, how does that impact your overall addressable market? Do you have insights into TAM sizes typically reported for F&A or IT?

Gary Burnison, CEO

Quantifying that exact figure is intricate. Nevertheless, I believe we need to focus on the upper end of the market where we can leverage revenue synergy and cross-referrals effectively. I estimate Korn Ferry’s total addressable market at around $250 billion to $300 billion. A significant segment encompasses training and development, where we remain visibly underrepresented. Additionally, sectors in staffing are crucial as we stay concentrated on higher-end services. Although the interim business largely operates within the U.S., exploring additional geographical opportunities is essential.

Tobey Sommer, Analyst

Regarding in-sourcing impacting RPO, how do you foresee that evolving? Is it a broader reaction correlated with labor dynamics influenced by the great resignation, or could it affect other facets of your business?

Gary Burnison, CEO

The in-sourcing phenomenon primarily impacts RPO. During the great resignation, talent acquisition professionals were notably hard to find, leading to a rise in built-in HR capacity in companies. As a result, organizations are filling reduced demand from internal resources. This pattern shows no imminent changes for the RPO market. Despite a good pipeline, labor hoarding poses challenges. I anticipate that new business may reach about $525 million this year, though not the previous $600 million. This reflects a direct response to current in-sourcing trends.

Operator, Operator

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

Gary Burnison, CEO

Thank you for joining us today. We look forward to speaking with you again soon. Goodbye.

Operator, Operator

Ladies and gentlemen, this conference call will be available for replay for one week starting today at 3:00 p.m. Eastern Time running through September 14, 2023. You may access the playback service by dialing 866-207-1041 and entering the access code 3900121. International participants may dial 402-970-0847. Additionally, the replay will be available for playback at the Company’s investor relations section on their website. That concludes your conference for today. Thank you for your participation and using this service.