Image Shown: Korn Ferry put up tremendous performance in the quarter ended January 2022 and provided favorable near term guidance in conjunction with its fiscal third quarter earnings update. We include Korn Ferry in our Best Ideas Newsletter portfolio. Image Source: Korn Ferry – Third Quarter of Fiscal 2022 IR Earnings Presentation
By Callum Turcan
The global organizational consulting firm Korn Ferry (KFY) is included in the Best Ideas Newsletter portfolio and we continue to be huge fans of the name. Korn Ferry is a tremendous free cash flow generator with a stellar business model. The differentiated nature of its offerings provides Korn Ferry with ample pricing power, allowing it to preserve its margins in the face of major inflationary headwinds. Korn Ferry is supported by a nice net cash position and its underlying financial performance has been aggressively trending in the right direction.
Earnings Update
In recent years, Korn Ferry has placed a great emphasis on digitally delivering its services to boost productivity while keeping a lid on costs. So far, its efforts on this front appear to be panning out favorably. On March 9, Korn Ferry posted third quarter earnings for fiscal 2022 (period ended January 31, 2022) that beat both consensus top- and bottom-line estimates. Its GAAP revenue grew by 43% year-over-year to reach $685 million in the fiscal third quarter as Korn Ferry’s fee revenue hit a quarterly high of $681 million according to management (the remainder is represented by ‘reimbursed out-of-pocket engagement expenses’). Korn Ferry saw its fee revenue increase across all lines of its business.
Its ‘Executive Search’ and ‘RPO and Professional Search’ segments have been firing on all-cylinders of late. The number of engagements billed at its Executive Search and RPO and Profession Search segments were up 33% and 90% year-over-year, respectively, and their number of new engagements grew by 37% and 95% year-over-year, respectively, in the fiscal third quarter. Strong performance at these two segments highlights Korn Ferry’s ability to win over new business while delivering for its existing clients. The firm’s Executive Search segment posted 42% revenue growth and its RPO and Professional Search segment posted 97% revenue growth on a year-over-year basis in the fiscal third quarter.
Korn Ferry’s ‘Digital’ segment posted 19% year-over-year revenue growth in the fiscal third quarter, aided by 28% growth at its subscription and license fee revenue. Pivoting to its ‘Consulting’ segment, revenue here grew by 20% year-over-year in the fiscal third quarter. The offerings provided by its Consulting segment were in high demand with the number of hours worked by Korn Ferry’s consultant and execution staff growing by 14% year-over-year while Korn Ferry’s average bill rate grew by 5% in the fiscal third quarter, resulting in significant revenue growth. We appreciate Korn Ferry’s pricing power.
In the fiscal third quarter, Korn Ferry’s GAAP operating income rose by 94% year-over-year to reach $126 million as its GAAP operating margin expanded by ~480 basis points to reach 18.4%. Pricing power, economies of scale, productivity improvements, and efficiencies generated by digitally delivering its services are all having a powerful impact on Korn Ferry’s profitability.
Korn Ferry provides its services to entities operating across multiple end industries with industrial, life sciences and healthcare, technology, financial services, and consumer goods representing its most important markets. Expanding into new markets represents one of Korn Ferry’s longer term growth strategies. The firm can, and often does, utilize its strong financial position to organically fund acquisitions to help push into new end industries.
Image Shown: Korn Ferry caters to variety of end industries. Image Source: Korn Ferry – 10-Q SEC Filing covering the Third Quarter of Fiscal 2022
Financial Strength
Korn Ferry’s GAAP diluted EPS came in at $1.54 in the third quarter of fiscal 2022, up from $0.94 in the same period last fiscal year. The firm generated $189 million in free cash flow during the first three quarters of fiscal 2022 and spent $22 million covering its total payout obligations (‘dividends paid to shareholders’ plus ‘dividends paid to noncontrolling interest’) during this period along with another $29 million buying back its common stock. We are big fans of Korn Ferry’s cash flow profile as the firm runs an asset-light business that requires relatively modest capital expenditures to maintain a given level of revenues.
Korn Ferry also spent $91 million on acquisitions during the first three quarters of fiscal 2022 as bolt-on deals represent a core part of its capital allocation strategy. The company completed its acquisition of Lucas Group in November 2021 for $91 million in cash considerations. Acquiring Lucas Group is expected to bolster Korn Ferry’s professional search operations.
Furthermore, Korn Ferry announced it had acquired Patina Solutions Group in April 2022 which is expected to bolster its execution solutions expertise and be immediately accretive to Korn Ferry’s earnings. Terms of its deal for Patina Solutions Group was not readily disclosed. We appreciate Korn Ferry’s bolt-on acquisition strategy as the company has a solid track-record of effectively integrating new assets into company-wide operations.
The company exited January 2022 with $1.1 billion in cash, cash equivalents, current marketable securities, and noncurrent marketable securities on hand stacked up against no short-term debt and $0.4 billion in long-term debt on the books. However, a large portion of its cash-like position is effectively reserved for bonuses and deferred compensation. When removing those liabilities from the picture, Korn Ferry viewed its “investable cash” position sitting near $0.6 billion at the end of the fiscal third quarter, indicating the company still has a net cash balance.
Image Shown: Korn Ferry had a nice net cash position on hand at the end of January 2022. Image Source: Korn Ferry – Third Quarter of Fiscal 2022 IR Earnings Presentation
Outlook and Management Commentary
The company provided favorable guidance for the fourth quarter of fiscal 2022 during its fiscal third quarter earnings update. Korn Ferry forecasts that it will generate $670-$690 million in fee revenue, diluted EPS of $1.44-$1.60, and non-GAAP adjusted diluted EPS of $1.49-$1.63 in the fiscal fourth quarter. At the midpoint of guidance and on a year-over-year basis, that would represent 22% fee revenue growth, 26% diluted EPS growth, and 29% adjusted EPS growth if realized. We appreciate Korn Ferry’s confidence in its near term performance.
During Korn Ferry’s fiscal third quarter earnings call, management had this to say on the firm’s business strategy (emphasis added):
“Elements of our strategy include driving a top-down go-to-market approach based on our marquee regional accounts, which year-to-date represent about 37% of our portfolio. This not only facilitates growth and enduring partnerships, but is also key to more scalable and durable revenues. For example, on a year-to-date basis, about 28% of our revenue is driven by cross referrals within our firm, up several million dollars sequentially, which demonstrates the effectiveness of our go-to-market strategy.
We also believe there’s substantial market opportunity with our talent acquisition and interim businesses, particularly given the acceleration of the nomadic labor market. And looking at our digital and consulting businesses, we’ll continue to innovate, marrying Korn Ferry’s capabilities with tomorrow’s opportunities from organizational transformation, to sales effectiveness and accelerated revenue growth to M&A and ESG. We’re going to continue to further push to monetize our IP and continue to move more of our digital business to a subscription offering.” — Gary Burnison, CEO of Korn Ferry
Building up better relationships with its marquee regional accounts and supporting cross-selling efforts while pushing more of its digital business towards subscription offerings should support Korn Ferry’s financial performance over the long run as its revenue streams become “stickier.” Management noted that Korn Ferry started off the fiscal fourth quarter on extremely strong footing during the firm’s fiscal third quarter earnings call:
“Backlog exiting the third quarter was strong as was February new business. February generally is the shortest month in the year in terms of working days. However, this February was actually our eighth best new business month ever excluding RPO. And if you include RPO, it was actually our best new business month ever.” — Bob Rozek, CFO, EVP, and VP CCO of Korn Ferry
Korn Ferry suspended its business in Russia in the wake of the Russian invasion of Ukraine in February 2022, which could hinder its near term financial performance along the margins. Geopolitical tensions in Europe represent a major hurdle for Korn Ferry, though the firm remains confident it can steer itself through the storm with its growth runway intact.
Concluding Thoughts
Korn Ferry’s underlying business is performing quite well, and its financials remain rock-solid. The company is a tremendous free cash flow generator backed up by a nice net cash position. Korn Ferry possesses ample pricing power and has a highly scalable business model, with strong demand for its offerings underpinning its bright near term growth outlook. Robust revenue growth and meaningful operating margin expansion represents a powerful combination that supports our expectations Korn Ferry’s free cash flows will swell higher over the coming fiscal years.
Our fair value estimate for Korn Ferry sits at $84 per share, well above where shares of KFY are trading at as of this writing. We continue to like the company in our Best Ideas Newsletter portfolio. Shares of KFY yield a modest ~0.8% as of this writing and its payout offers investors incremental dividend growth upside as well.
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Callum Turcan owns shares of DIS, META, GOOG, VRTX, and XLE and is long DIS and META call options. Apple Inc (AAPL), Cisco Systems Inc (CSCO) and Microsoft Corporation (MSFT) are all included in both Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Alphabet Inc (GOOG) Class C shares, Meta Platforms Inc (META), Korn Ferry (KFY), PayPal Holdings Inc (PYPL) and Visa Inc (V) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation (ORCL) and Qualcomm Inc (QCOM) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. ASML Holding NV (ASML), Meta Platforms, Oracle, and Taiwan Semiconductor Manufacturing Company Limited (TSM) are all included in Valuentum’s simulated ESG Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.