Korn Ferry (KFY) Q3 2023 Earnings Call Transcript

Korn Ferry (NYSE:KFY) Q3 2023 Earnings Call dated Mar. 08, 2023.

Corporate Participants:

Gary Burnison — Chief Executive Officer

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Gregg Kvochak — Senior Vice President of Investor Relations

Tiffany Williams — Director of DE&I, RPO

Analysts:

George Tong — Goldman Sachs Group, Inc. — Analyst

Jasper Bibb — Truist Financial Corporation — Analyst

Marc Riddick — Sidoti & Company, LLC — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Korn Ferry Third Quarter Fiscal Year 2023 Conference Call. [Operator Instructions] 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.

Gary Burnison — Chief Executive Officer

Hey, thanks, Gregg, 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 and 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 in economy and 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 yeah, 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.

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Great. Thanks, Gary, and good afternoon or good morning, everyone. Our results in the third quarter continues 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 provides real outsized opportunities for growth, they have created almost 700 additional engagement wins resulting in an incremental $43 million in fee revenue since the third quarter of fiscal year ’22 and when we acquired the Lucas Group, and this is all through cross sales between the acquired entities and legacy Korn Ferry.

Cross sales between our other lines of business and our both our marquee and regional accounts, both continue to also perform very well in the quarter. I recently celebrated my 11th year with Korn Ferry, and 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 it continues to do so and even more today.

Let me turn the call over to Greg, who will take you through some of the company — overall company financial highlights.

Gregg Kvochak — Senior Vice President of Investor Relations

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 and 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 excludes 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 investible cash position remain strong and our current capital deployment continue 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.

Tiffany Williams — Director of DE&I, RPO

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 tied to subscription and license sales.

Earnings and profitability in the quarter were impacted by investments and 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 digital strategy, which grew 12% versus prior year. Additionally, global new business for consulting in the third quarter was up 9% year-over-year at constant currency.

The Professional Search and 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 more than enough to offset the expected deceleration in the permanent placement portion of the segment. Interim services fee revenue grew to $53 million from $50 million in the same quarter of the prior year, driven in part by the recent acquisitions of Patina and ICF.

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 the report 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 and the moderation in the base of it.

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 rates 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.

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Great. Thank you, 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 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 in 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 will be glad to answer any questions you may have.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from the line of George Tong from Goldman Sachs. Please go ahead.

George Tong — Goldman Sachs Group, Inc. — Analyst

Hi. Thanks. Good morning.

Gary Burnison — Chief Executive Officer

Hey, George.

George Tong — Goldman Sachs Group, Inc. — Analyst

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

Gary Burnison — Chief Executive Officer

Bob, you want to do that?

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Sure. Yeah. Our new business trends in February when we close out the month, George, the new business came in right where we expected it to be and actually was up about 7% excluding RPO, it was up about 7% year-over-year. RPO had another good, really good month, this month. They did close to $45 million in new business in the month of February. I’d say for March, it’s too early to really talk about, was already got three or four days and now, so there’s really not much to say. The way that new business comes in at times, it tends to come more towards the end of the month, so it would be probably too premature to give you any insight into March yet.

George Tong — Goldman Sachs Group, Inc. — Analyst

Okay. Got it. That’s helpful. And then…

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Hey, George…

George Tong — Goldman Sachs Group, Inc. — Analyst

On the digital side…

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Yeah. I was just saying, we added the patterns that we’re seeing in the month of February were exactly what we saw in the third quarter by line of business.

George Tong — Goldman Sachs Group, Inc. — Analyst

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

Gary Burnison — Chief Executive Officer

Well, I think the — there’s a couple of short-term drivers and then there’s 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 technologists 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, new in the last call it six to nine months. And so it naturally takes time for those people to ramp up. And I’d also point out a shift that we may — going back a couple of years, but really a year and a half ago is moving that business to a SaaS model. And so, we when you look at and you go back say a year, year and a half ago, the subscription backlog was probably revenue under contract was kind of $300 million, now it’s moved up to about $350 million. And so there has been a massive shift that we’ve made over the last two to three 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 is 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 assured and medium to long-term basis.

George Tong — Goldman Sachs Group, Inc. — Analyst

Very helpful. Thank you.

Operator

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

Jasper Bibb — Truist Financial Corporation — Analyst

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

Gary Burnison — Chief Executive Officer

Bob, why don’t you handle the incremental cost? And we’re…

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Sure.

Gary Burnison — Chief Executive Officer

For say low in the quarter about $30 million of incremental revenue in the fourth quarter.

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

Yeah. And then in terms of the guidance, we executed the plan that we talked about on the last earnings call. We spent in between taking out positions in real 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 saves. But what we’re also forecasting for the fourth quarter is continued moderation, what I would call the exact search in the Professional Search perm placement business and 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. Then we’re also reinvesting back into the business in terms of fee earners and delivery capacity to meet our clients’ demand as well as we’re going to continue to accelerate the investments that we made in — that we’re making into digital. And so those will net out. And then as the perm placement portion of the business, troughs out and then it starts to recover. We’ll see the margins start to come pop-up and come back again.

Jasper Bibb — Truist Financial Corporation — Analyst

Thanks. 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?

Gary Burnison — Chief Executive Officer

Well, right now we’re positioned to maintain capacity. And when you look at our consulting business, our digital business and in the Search businesses where our view is to hold capacity. And so it really depends on what happens here with the economy but the $1.4 million, obviously if demand falls out that will likely decline, but my orientation right now is to maintain capacity.

Jasper Bibb — Truist Financial Corporation — Analyst

Got it. Last one from 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, maybe changing the long-term gross margin profile of the business as part of that?

Gary Burnison — Chief Executive Officer

Yeah. It’s a great question. I think, number one, look, this was a business that didn’t exist. And so during the pandemic, we looked around and said, how is the world going to change and it [Technical Issues] Professionals wanting more flexibility in their life and 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. And so, we very purposely said let’s go into this market and we’ve taken that now from basically 0 to a run-rate now of about $320 million, $330 million in the span of 18 months. This will be for sure $1 billion business for us. There’s no question about it. Now, as we do that and we address these bigger markets that I think have proven over time to be less cyclical than say the legacy business of Executive Search, the margin profile is going to change, there is no doubt about it. And I can have Bob — 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 to stay the same, which is not going to stay the same, but if it did, you’re probably talking 200 basis points to 300 basis points I would think of a margin shift. But we just — we are really are excited about this. We are seeing incredible levels of cross referrals, of ways to create deeper meaning, deeper impact with clients. And so I do think that overall, much like the strategy, when I started, I mean, this is my 84th earnings call. And going back to day one, the entire business was essentially Executive Search and now Executive Search today is 31% of the company. And I think what we’ve demonstrated now is we’ve — we’re building a platform that has more client impact that changes more people’s lives, that enables people and organizations to be more there, and it also provides a much more stable company for our shareholders. And you can just see it in the numbers and you can see it in the new business over the last several months in terms of what’s happening, barring some sort of economic disaster. But Bob, maybe you could comment on the quantitative has factored the margin.

Robert Rozek — Chief Financial Officer, Exec. VP Chief Corporate Officer

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

Jasper Bibb — Truist Financial Corporation — Analyst

Appreciate the detail there. Thanks for taking the questions, guys.

Operator

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

Marc Riddick — Sidoti & Company, LLC — Analyst

Hey, there. Good morning.

Gary Burnison — Chief Executive Officer

Hey, Marc.

Marc Riddick — Sidoti & Company, LLC — Analyst

So I was wondering if you talk a little bit about some of the — if there were any changes in particular demand drivers, and I’m specifically talking about particular trends that you’ve noticed maybe over the last few months that have sort of changed or shifted whether it’s from a — from the 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 maybe we haven’t been talking about or thinking about or maybe some things that are waiting to bid beyond recessionary impact?

Gary Burnison — Chief Executive Officer

Well, industrial has certainly been a bright spot and that’s been a change. When I look year-over-year, industrial was up about 10%, so that’s crtainly — that’s good, considering it’s almost 30%, the company’s portfolio. Clearly, going back to August of last summer, at the end of last summer, with the move by central banks and particularly the Fed to become more hawkish. Companies are clearly looking at their cost and so there was this massive upswing after the pandemic in terms of hiring. And as you would expect that is moderated and that’s exactly what we’ve seen. So we’ve seen a moderation in the perm parts of our — we’re creating business. Wage growth is still at elevated levels, it’s probably 6%, 7%. People that are jumping jobs are not getting what they were getting coming out of the pandemic. It’s more like a 15% uptick in wages. And so that clearly has moderated and I would expect that that moderation is going to continue on the perm side, particularly given the comments yesterday, the day before by the Fed. The RPO business has like it always has, I mean it’s held up incredibly, incredibly well and yes, we’ve seen some degradation of the base business, that’s kind of a nominal amount. Going back to last fall, it was around the technology sector but we’ve also picked up some just enormous wins both in the industrial area and health care. Then you look at the consulting and digital business in the quarter on a constant currency basis. Consulting was up 9% new business and digital was up 6%. So it’s basically — I mean, it’s kind of — it’s really playing out as the strategy was designed, I mean the strategy is absolutely working.

Marc Riddick — Sidoti & Company, LLC — Analyst

That’s really helpful. Thank you. And then I was sort of curious about — it seems as though we were starting to see a bit of a pickup in business travel and then maybe starting to see a little bit more face-to-face activity, and being in front of clients again. But I would say, it seems as though it’s kind of — now that might be the recessionary impacts, but that’s kind of been back and forth a little bit. I was wondering if you maybe had any thoughts as to maybe what you’re seeing if your clients are during the face-to-face with you a little bit more? Do you see more of a pickup in travel, entertainment going forward or how should we be thinking about that?

Gary Burnison — Chief Executive Officer

Well, if the genie is out of the bottle? And so I think that all of us enjoy the flexibility that unfortunately, the pandemic brought about. And so — and this whole thing started I said three years ago, I said this thing, travel all the stuff it’s to be fixed, how you’re entertain, how you consume, how you produce. It’s going to be about 50% of what it was. Now, it’s not 50% of what it was and so, clearly, yes, we are seeing a desire for sure. There is no substitute for being in person with another human being but it’s not even at the 50% level of what it was. And I think that’s a generational change. I mean, that could take five to 10 years to truly play out. So it’s clearly increased over the last several months but nothing at all like it was. We’ll see with “China” setting aside the geopolitical, I’ll start — we’ll see what happens with China. It’s only been two, three, four weeks since “it’s opened up.” China has had an enormous drag on not only multinational companies and in the Asia Pacific region but it also on our business. It’s been, as you would expect, it’s been a drag on the top-line. It could be as much as $40 million to $50 million a year for us.

Marc Riddick — Sidoti & Company, LLC — Analyst

Thank you. I appreciate it.

Operator

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

Gary Burnison — Chief Executive Officer

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

Operator

Ladies and gentlemen, this conference will be available for replay for one week starting today at 3 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 7037839. International participants may dial 402-970-0847. Additionally, the replay will be available for playback at the company’s website. [Operator Closing Remarks]