Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended October 31, 2004 or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 001-14505
KORN/FERRY INTERNATIONAL
(Exact name of registrant as specified in its charter)
| Delaware | 95-2623879 | |
(State of other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
1900 Avenue of the Stars, Suite 2600, Los Angeles, California 90067
(Address of principal executive offices) (Zip code)
(310) 552-1834
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
The number of shares outstanding of our common stock as of December 7, 2004 was 39,489,689.
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
2
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
As of October 31, 2004 | As of April 30, 2004 | |||||||
| (unaudited) | ||||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | 116,219 | $ | 108,102 | ||||
Marketable securities | 6,092 | — | ||||||
Receivables due from clients, net of allowance for doubtful accounts of $8,894 and $6,159 | 71,858 | 52,306 | ||||||
Income tax and other receivables | 6,743 | 5,812 | ||||||
Deferred income taxes | 9,320 | 9,320 | ||||||
Prepaid expenses | 11,938 | 10,128 | ||||||
Total current assets | 222,170 | 185,668 | ||||||
Property and equipment, net | 19,209 | 19,603 | ||||||
Cash surrender value of company owned life insurance policies, net of loans | 60,503 | 58,868 | ||||||
Deferred income taxes | 27,996 | 27,352 | ||||||
Goodwill | 101,945 | 98,481 | ||||||
Deferred financing costs, investments and other | 8,177 | 7,670 | ||||||
Total assets | $ | 440,000 | $ | 397,642 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Accounts payable | $ | 8,530 | $ | 8,676 | ||||
Income taxes payable | 10,569 | 2,956 | ||||||
Compensation and benefits payable | 56,076 | 60,957 | ||||||
Other accrued liabilities | 29,115 | 24,785 | ||||||
Total current liabilities | 104,290 | 97,374 | ||||||
Deferred compensation and other retirement plans | 56,676 | 53,018 | ||||||
Long-term debt | 44,852 | 44,400 | ||||||
Other | 8,649 | 11,456 | ||||||
7.5% Convertible mandatorily redeemable preferred stock, net of unamortized discount and issuance costs, redemption value $11,674 | 10,698 | 10,512 | ||||||
Total liabilities | 225,165 | 216,760 | ||||||
Stockholders’ equity | ||||||||
Common stock: $0.01 par value, 150,000 shares authorized, 40,223 and 39,363 shares issued and 39,074 and 38,170 shares outstanding | 318,782 | 307,003 | ||||||
Retained deficit | (104,123 | ) | (121,204 | ) | ||||
Unearned restricted stock compensation | (4,982 | ) | (2,341 | ) | ||||
Accumulated other comprehensive income (loss) | 5,932 | (1,596 | ) | |||||
Stockholders’ equity | 215,609 | 181,862 | ||||||
Less: Notes receivable from stockholders | (774 | ) | (980 | ) | ||||
Total stockholders’ equity | 214,835 | 180,882 | ||||||
Total liabilities and stockholders’ equity | $ | 440,000 | $ | 397,642 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
3
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended October 31, | Six Months Ended October 31, | ||||||||||||
| 2004 | 2003 | 2004 | 2003 | ||||||||||
| (unaudited) | (unaudited) | ||||||||||||
Fee revenue | $ | 108,505 | $ | 76,650 | $ | 211,313 | $ | 149,237 | |||||
Reimbursed out-of-pocket engagement expenses | 5,036 | 5,315 | 10,411 | 11,061 | |||||||||
Total revenue | 113,541 | 81,965 | 221,724 | 160,298 | |||||||||
Compensation and benefits | 69,009 | 51,355 | 133,885 | 102,673 | |||||||||
General and administrative expenses | 21,402 | 17,492 | 42,246 | 34,302 | |||||||||
Out-of-pocket engagement expenses | 5,520 | 5,460 | 11,158 | 11,256 | |||||||||
Depreciation and amortization | 2,140 | 2,500 | 4,382 | 5,287 | |||||||||
Restructuring charges | — | — | — | 8,526 | |||||||||
Total operating expenses | 98,071 | 76,807 | 191,671 | 162,044 | |||||||||
Operating income (loss) | 15,470 | 5,158 | 30,053 | (1,746 | ) | ||||||||
Interest and other income, net | 372 | 9 | 776 | 470 | |||||||||
Interest expense | 2,720 | 2,714 | 5,272 | 5,423 | |||||||||
Income (loss) before provision for income taxes and equity in earnings of unconsolidated subsidiaries | 13,122 | 2,453 | 25,557 | (6,699 | ) | ||||||||
Provision for income taxes | 4,905 | 475 | 9,391 | 931 | |||||||||
Equity in earnings of unconsolidated subsidiaries | 492 | 243 | 915 | 414 | |||||||||
Net income (loss) | $ | 8,709 | $ | 2,221 | $ | 17,081 | $ | (7,216 | ) | ||||
Basic earnings (loss) per common share | $ | 0.23 | $ | 0.06 | $ | 0.45 | $ | (0.19 | ) | ||||
Basic weighted average common shares outstanding | 38,399 | 37,491 | 38,100 | 37,457 | |||||||||
Diluted earnings (loss) per common share | $ | 0.21 | $ | 0.06 | $ | 0.40 | $ | (0.19 | ) | ||||
Diluted weighted average common shares outstanding | 46,262 | 39,669 | 46,349 | 37,457 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Six Months Ended October 31, | ||||||||
| 2004 | 2003 | |||||||
| (unaudited) | ||||||||
Cash from operating activities: | ||||||||
Net income (loss) | $ | 17,081 | $ | (7,216 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||
Depreciation and amortization | 4,382 | 5,287 | ||||||
Interest paid in kind and amortization of discount on convertible securities | 932 | 2,243 | ||||||
(Gain) loss on disposition of property and equipment | (5 | ) | 83 | |||||
Provision for doubtful accounts | 4,186 | 1,833 | ||||||
Gain on cash surrender value of life insurance policies | (2,200 | ) | (2,203 | ) | ||||
Deferred income taxes | (644 | ) | (1,026 | ) | ||||
Tax benefit from exercise of stock options | 1,783 | — | ||||||
Asset impairment charge | — | 464 | ||||||
Non-cash compensation arrangements | 2,077 | 1,391 | ||||||
Change in other assets and liabilities: | ||||||||
Deferred compensation | 2,492 | 2,801 | ||||||
Receivables | (25,008 | ) | 1,955 | |||||
Prepaid expenses | (1,810 | ) | 429 | |||||
Investment in unconsolidated subsidiaries | (82 | ) | 331 | |||||
Income taxes payable | 7,613 | — | ||||||
Accounts payable and accrued liabilities | (947 | ) | (16,287 | ) | ||||
Other | (3,672 | ) | (1,386 | ) | ||||
Net cash provided by (used in) operating activities | 6,178 | (11,301 | ) | |||||
Cash from investing activities: | ||||||||
Purchase of property and equipment | (2,787 | ) | (948 | ) | ||||
Purchase of marketable securities | (6,092 | ) | — | |||||
Business acquisitions | (419 | ) | — | |||||
Premiums on life insurance policies | (720 | ) | (1,127 | ) | ||||
Surrender of life insurance policies | — | 1,917 | ||||||
Proceeds from life insurance policy benefits | 339 | — | ||||||
Purchase of Futurestep minority shares | — | (570 | ) | |||||
Net cash used in investing activities | (9,679 | ) | (728 | ) | ||||
Cash from financing activities: | ||||||||
Payment of acquisition notes | — | (5,099 | ) | |||||
Payments on life insurance policy loans | (308 | ) | (1,574 | ) | ||||
Borrowings under life insurance policies | 1,593 | 1,421 | ||||||
Purchase of common stock | (2,341 | ) | (676 | ) | ||||
Proceeds from issuance of common stock upon exercise of employee stock options and in connection with an employee stock purchase plan | 8,729 | 126 | ||||||
Receipts on stockholders’ notes | 206 | 271 | ||||||
Net cash provided by (used in) financing activities | 7,879 | (5,531 | ) | |||||
Effect of exchange rate changes on cash flows | 3,739 | (722 | ) | |||||
Net increase (decrease) in cash and cash equivalents | 8,117 | (18,282 | ) | |||||
Cash and cash equivalents at beginning of the period | 108,102 | 82,685 | ||||||
Cash and cash equivalents at end of the period | $ | 116,219 | $ | 64,403 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
5
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
1. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements for the three and six months ended October 31, 2004 and 2003 include the accounts of Korn/Ferry International and all of its wholly and majority owned domestic and international subsidiaries (collectively, the “Company”). The consolidated financial statements are unaudited, but include all adjustments, consisting of normal recurring accruals and any other adjustments, that management considers necessary for a fair presentation of the results for these periods. These financial statements have been prepared consistently with the accounting policies described in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2004 (“Annual Report”) and should be read together with the Annual Report.
Critical Accounting Policies and Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. As a result, actual results could differ from these estimates. The most significant areas that require management judgment are revenue recognition, deferred compensation and the carrying values of goodwill and deferred income taxes.
Cash and Cash Equivalents
The Company considers cash equivalents to be only those investments which are highly liquid, readily convertible and mature within three months from the date of purchase.
Available for Sale Securities
The Company considers its investment portfolio and marketable securities available-for-sale as defined in SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” These investments are recorded at fair value in the accompanying balance sheet.
Stock Based Compensation
The Company accounts for its employee stock options under the recognition and measurement principles of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees and related interpretations” (APB 25). Under APB No. 25, no stock-based compensation is reflected in operations, as all options granted under the plans have an exercise price equal to the fair market value of the underlying common stock on the date of grant and the related number of shares granted is fixed at that point in time.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS No. 148”), effective for fiscal years ending after December 15, 2002. SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-based Compensation” (“SFAS No. 123”), to provide several alternatives for adopting the stock option expense provisions of SFAS No. 123, as well as additional required financial statement disclosures. SFAS No. 148 does not require companies to expense stock options in operations. The Company has not adopted the provisions of SFAS No. 123 for expensing stock based compensation; however, the Company adopted the additional disclosure provisions required by SFAS 148.
6
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(in thousands, except per share amounts)
The following table illustrates the effect on net income (loss) and earnings (loss) per share as if the Company had applied the fair value recognition provisions of SFAS No. 123:
Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Net income (loss), as reported | $ | 8,709 | $ | 2,221 | $ | 17,081 | $ | (7,216 | ) | |||||||
Stock-based employee compensation charges, net of related tax effects*: | ||||||||||||||||
Employee stock compensation expense included in net income (loss), as reported | 281 | 1,011 | 621 | 1,368 | ||||||||||||
Employee stock compensation expense determined under the fair-value based method | (1,757 | ) | (4,230 | ) | (3,911 | ) | (7,738 | ) | ||||||||
Net income (loss), as adjusted | $ | 7,233 | $ | (998 | ) | $ | 13,791 | $ | (13,586 | ) | ||||||
Interest expense on convertible securities, net of related tax effects* | 785 | 1,560 | ||||||||||||||
Net income adjusted for computation of diluted EPS, as adjusted | $ | 8,018 | $ | 15,351 | ||||||||||||
Basic EPS | ||||||||||||||||
As reported | $ | 0.23 | $ | 0.06 | $ | 0.45 | $ | (0.19 | ) | |||||||
Pro forma | $ | 0.19 | $ | (0.03 | ) | $ | 0.36 | $ | (0.36 | ) | ||||||
Diluted EPS | ||||||||||||||||
As reported | $ | 0.21 | $ | 0.06 | $ | 0.40 | $ | (0.19 | ) | |||||||
Pro forma | $ | 0.17 | $ | (0.03 | ) | $ | 0.33 | $ | (0.36 | ) | ||||||
| * | For Fiscal 2005 only |
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with a zero dividend rate. The following assumptions were used by the Company for options granted in the respective periods:
| Quarter Ended October 31 | ||||||
| 2004 | 2003 | |||||
Expected stock volatility | 63.1 | % | 63.5 | % | ||
Risk-free interest rate | 3.69 | % | 3.60 | % | ||
Expected option life (in years) | 4.50 | 4.50 | ||||
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options. The assumptions used in option valuation models are highly subjective, particularly the expected stock price volatility of the underlying stock. In management’s opinion, existing valuation models do not provide a reliable, single measure of the fair value of its employee stock options because changes in these subjective input assumptions can materially affect the fair value estimate. For purposes of pro forma disclosures, the estimated fair values of the options are amortized over the options’ vesting periods.
Common Stock
The Company issued 143,000 and 747,000 common shares relating to the exercise of stock options and 98,000 and 98,000 common shares in conjunction with the Company’s employee stock purchase plan in the three and six months ended October 31, 2004, respectively.
7
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(in thousands, except per share amounts)
Reclassifications
Certain prior year amounts have been reclassified to conform with the current year presentation.
New Accounting Pronouncements
In December 2003, the FASB issued FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities”, effective as of the first reporting period beginning after March 15, 2004. The impact upon adoption of this standard did not have a material impact on the results of the Company’s operations or the Company’s financial position.
In March 2004, the FASB issued an Exposure Draft, “Share-Based Payment - An Amendment of FASB Statements No. 123 and 95” (“Proposed SFAS 123R”). The Proposed SFAS 123R may be effective for interim or annual periods beginning after June 15, 2005 and would eliminate the ability to account for share-based compensation transactions using APB 25. The Company would be required to recognize compensation expense, using a fair-value based method, for stock options and employee stock purchase plans.
2. Basic and Diluted Earnings (Loss) Per Share
Basic earnings (loss) per common share (“basic EPS”) was computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted earnings (loss) per common share (“diluted EPS”) reflects the potential dilution that would occur if all in-the-money outstanding options or other contracts to issue common stock were exercised or converted and was computed by dividing adjusted net income (loss), after assumed conversion of subordinated notes and preferred stock, by the weighted average number of common shares outstanding plus dilutive common equivalent shares. The following is a reconciliation of the numerator and denominator (shares in thousands) used in the computation of basic and diluted EPS:
| Three Months Ended October 31, | Six Months Ended October 31, | ||||||||||||
| 2004 | 2003 | 2004 | 2003 | ||||||||||
Net income (loss) (Numerator): | |||||||||||||
Net income (loss) for basic EPS | $ | 8,709 | $ | 2,221 | $ | 17,081 | $ | (7,216 | ) | ||||
Interest expense on convertible securities, net of related tax effects | 785 | 254 | 1,560 | ||||||||||
Net income for diluted EPS | $ | 9,494 | $ | 2,475 | $ | 18,641 | |||||||
Shares (Denominator): | |||||||||||||
Weighted average shares for basic EPS | 38,399 | 37,491 | 38,100 | 37,457 | |||||||||
Effect of convertible subordinated notes | 4,470 | 4,470 | |||||||||||
convertible preferred stock | 1,117 | 1,067 | 1,118 | ||||||||||
warrants | 274 | 274 | |||||||||||
restricted stock | 110 | 43 | 139 | ||||||||||
stock options | 1,888 | 1,064 | 2,242 | ||||||||||
employee stock purchase plan | 4 | 4 | 6 | ||||||||||
Adjusted weighted average shares for diluted EPS | 46,262 | 39,669 | 46,349 | 37,457 | |||||||||
Basic earnings (loss) per share | $ | 0.23 | $ | 0.06 | $ | 0.45 | $ | (0.19 | ) | ||||
Diluted earnings (loss) per share | $ | 0.21 | $ | 0.06 | $ | 0.40 | $ | (0.19 | ) | ||||
8
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(in thousands, except per share amounts)
Assumed exercises or conversions have been excluded in computing the diluted earnings per share when their inclusion would be anti-dilutive. If the assumed exercises of convertible notes, preferred stock and in-the-money options and warrants had been used, the fully diluted shares outstanding for the six months ended October 31, 2003 would have been 39,288.
3. Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of net income (loss) and all changes to stockholders’ equity, except those changes resulting from investments by owners (changes in paid in capital) and distributions to owners (dividends).
Total comprehensive income (loss) is as follows:
| Three Months Ended October 31, | Six Months Ended October 31, | ||||||||||||
| 2004 | 2003 | 2004 | 2003 | ||||||||||
Net income (loss) | $ | 8,709 | $ | 2,221 | $ | 17,081 | $ | (7,216 | ) | ||||
Foreign currency translation adjustment | 5,741 | 2,056 | 6,388 | 1,392 | |||||||||
Unrealized gain on marketable securities, net of related tax effects | 1,140 | — | 1,140 | — | |||||||||
Comprehensive income (loss) | $ | 15,590 | $ | 4,277 | $ | 24,609 | $ | (5,824 | ) | ||||
The accumulated other comprehensive income of $4.8 million and $1.1 million at October 31, 2004 is comprised of foreign currency translation adjustments and unrealized gains on marketable securities, respectively.
4. Deferred Compensation, Retirement Plans and Pension Plan
The Company has a defined benefit pension plan, referred to as the Worldwide Executive Benefit Plans covering all of the Company’s employees in the United States and certain employees in foreign countries. The components of net periodic benefit cost are as follows:
Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Components of net periodic benefit costs: | ||||||||||||||||
Service cost | $ | — | $ | 24 | $ | — | $ | 48 | ||||||||
Interest cost | 50 | 53 | 100 | 106 | ||||||||||||
Amortization of actuarial loss | (38 | ) | (36 | ) | (76 | ) | (72 | ) | ||||||||
Net periodic benefit cost | $ | 12 | $ | 41 | $ | 24 | $ | 82 | ||||||||
The Company also established several deferred compensation plans for vice-presidents that provide defined benefit payments to participants based on the deferral of current compensation subject to vesting and retirement or termination provisions. The components of net periodic benefit cost are as follows:
Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||
Components of net periodic benefit costs: | ||||||||||||
Service cost | $ | 786 | $ | 661 | $ | 1,572 | $ | 1,322 | ||||
Interest cost | 813 | 778 | 1,626 | 1,566 | ||||||||
Amortization of actuarial gain | 100 | 185 | 200 | 370 | ||||||||
Net periodic benefit cost | $ | 1,699 | $ | 1,624 | $ | 3,398 | $ | 3,258 | ||||
In January 2004, the Company implemented the Executive Capital Accumulation Plan (“ECAP”). ECAP is intended to provide certain employees an opportunity to defer salary and/or bonus on a pre-tax basis, or make an after-tax contribution. The Company made a $4.0 million ECAP contribution in the three and six months ended October 31, 2004 that vests over a 3 year period. The Company’s fiscal year 2006 ECAP contribution is discretionary and is based on the Company’s profitability and results of operations.
9
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(in thousands, except per share amounts)
5. Restructuring Charges
Based on deteriorating economic conditions in fiscal 2002, the Company began a series of restructuring initiatives to address its cost structure and to reposition the enterprise to gain market share and take advantage of any potential economic up-trend. These business realignment initiatives reduced the Company’s work force by nearly 30%, or over 850 employees.
Operating results include restructuring charges related to the following business segments in the six months ended October 31, 2003:
| Restructuring | ||||||||||
| Severance | Facilities | Total | ||||||||
Executive recruitment | ||||||||||
North America | $ | 455 | $ | (191 | ) | $ | 264 | |||
Europe | 4,405 | 505 | 4,910 | |||||||
Asia Pacific | 160 | — | 160 | |||||||
South America | 58 | — | 58 | |||||||
Total executive recruitment | 5,078 | 314 | 5,392 | |||||||
Futurestep | 1,474 | 1,508 | 2,982 | |||||||
Corporate | 152 | — | 152 | |||||||
Total | $ | 6,704 | $ | 1,822 | $ | 8,526 | ||||
Executive recruitment severance of $5.1 million included 112 employees terminated. The $0.3 million of facilities restructuring charge is net of a $0.8 million favorable adjustment related to previously reported restructured properties as a result of subleases signed at better terms than originally anticipated. The facilities restructuring charge primarily relates to lease termination costs, net of estimated sublease income, for excess space in three executive recruitment offices and included $0.2 million related to the write-down of fixed assets and $0.3 million of other restructuring charges.
Futurestep severance of $1.5 million included 43 employees terminated. Facilities restructuring costs of $1.5 million relates to five Futurestep Europe offices that were closed as employees co-located with executive recruitment offices and included $0.2 million related to the write-down of related fixed assets and $0.2 million of other restructuring charges.
Corporate severance of $0.1 million included 7 employees terminated.
A roll-forward of the restructuring liability at October 31, 2004 is as follows:
| Restructuring | ||||||||||||
| Severance | Facilities | Total | ||||||||||
Liability as of April 30, 2004 | $ | 847 | $ | 9,891 | $ | 10,738 | ||||||
Payments | (237 | ) | (1,646 | ) | (1,883 | ) | ||||||
Liability as of October 31, 2004 | $ | 610 | $ | 8,245 | $ | 8,855 | ||||||
The severance accrual includes amounts paid monthly and are expected to be paid in full by December 2004. The accrued liability for facilities costs relates to commitments under operating leases, net of estimated sublease income, of which $5.9 million is included in other long-term liabilities, paid over the next seven years.
10
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(in thousands, except per share amounts)
6. Mandatorily Redeemable Convertible Securities
In June 2002, the Company issued 7.5% Convertible Subordinated Notes in an aggregate principal amount of $40.0 million and 10,000 shares of 7.5% Convertible Series A Preferred Stock at an aggregate purchase price of $10.0 million. The notes and preferred stock have priority over common stockholders. The notes and preferred stock are convertible into shares of the Company’s common stock at $10.19 per share, as amended in December 2003. The Company also issued warrants to purchase 274,207 shares, as amended, of its common stock at an exercise price of $11.94, as amended. The warrants expire in 2012. The warrants were recorded at fair value resulting in discounts on the Notes and Preferred Stock (together “the securities”) of $1.2 million and $0.3 million, respectively, and are amortized over the life of the securities. In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, ” effective at the beginning of the first interim period after June 15, 2003. This Statement requires that mandatorily redeemable instruments be classified as liabilities. The Company adopted this Statement in the first quarter of fiscal 2004 and classified its preferred stock as a liability.
The securities may be redeemed at the option of the purchasers after June 13, 2008, the sixth anniversary of the closing date, at a price equal to 101% of the issuance price plus all accrued interest and dividends. The securities are mandatorily redeemable if still outstanding on June 13, 2010, at a price equal to 101% of the issuance price plus accrued interest and dividends. From the third to the sixth year, the securities are subject to optional redemption by the Company at 200% to 250% of the then outstanding principal balance provided certain minimum price targets for the Company’s common stock are not achieved.
Interest and dividends are payable semi-annually with 1% payable in cash and 6.5% payable in additional Notes and Preferred Stock for the first two year period from the date of issuance. Thereafter, interest and dividends are payable in either additional securities or cash at the option of the Company. The Company also incurred issuance costs of $4.3 million that have been deferred and are being amortized over the life of the securities as interest expense with respect to $3.4 million allocated to the Notes and $0.9 million allocated to the Preferred Stock.
7. Business Segments
The Company operates in two global business segments in the retained recruitment industry, executive recruitment and Futurestep. These segments are distinguished primarily by the candidates’ level of compensation. The executive recruitment business segment is managed by geographic regional leaders. Revenue from leadership development solutions and other consulting engagements is included in executive recruitment. Futurestep’s worldwide operations are managed by the Chief Executive Officer of Futurestep. The geographic regional leaders and the Chief Executive Officer of Futurestep report directly to the Chief Executive Officer of the Company.
A summary of the Company’s results of operations for the three and six months ended October 31, 2004 and 2003 by business segment are as follows:
| Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||
Fee revenue: | ||||||||||||
Executive recruitment: | ||||||||||||
North America | $ | 55,657 | $ | 40,615 | $ | 107,313 | $ | 77,022 | ||||
Europe | 23,837 | 17,860 | 48,655 | 36,015 | ||||||||
Asia Pacific | 13,554 | 8,314 | 26,056 | 16,321 | ||||||||
South America | 2,497 | 2,380 | 4,604 | 4,301 | ||||||||
Total executive recruitment | 95,545 | 69,169 | 186,628 | 133,659 | ||||||||
Futurestep | 12,960 | 7,481 | 24,685 | 15,578 | ||||||||
Total fee revenue | $ | 108,505 | $ | 76,650 | $ | 211,313 | $ | 149,237 | ||||
11
Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(in thousands, except per share amounts)
| Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Total revenue: | ||||||||||||||||
North America | $ | 58,493 | $ | 43,802 | $ | 113,438 | $ | 83,610 | ||||||||
Europe | 24,798 | 18,638 | 50,395 | 37,810 | ||||||||||||
Asia Pacific | 13,871 | 8,593 | 26,694 | 16,954 | ||||||||||||
South America | 2,628 | 2,503 | 4,827 | 4,519 | ||||||||||||
Total executive recruitment | 99,790 | 73,536 | 195,354 | 142,893 | ||||||||||||
Futurestep | 13,751 | 8,429 | 26,370 | 17,405 | ||||||||||||
Total revenue | $ | 113,541 | $ | 81,965 | $ | 221,724 | $ | 160,298 | ||||||||
| Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Operating income (loss) before restructuring charges | ||||||||||||||||
Executive recruitment: | ||||||||||||||||
North America | $ | 11,956 | $ | 8,260 | $ | 24,056 | $ | 14,338 | ||||||||
Europe | 4,022 | 324 | 8,583 | 347 | ||||||||||||
Asia Pacific | 3,064 | 217 | 5,262 | 976 | ||||||||||||
South America | 272 | 350 | 552 | 400 | ||||||||||||
Total executive recruitment | 19,314 | 9,151 | 38,453 | 16,061 | ||||||||||||
Futurestep | 2,383 | 479 | 4,293 | (70 | ) | |||||||||||
Corporate | (6,227 | ) | (4,472 | ) | (12,693 | ) | (9,211 | ) | ||||||||
Operating income before restructuring charges | 15,470 | 5,158 | 30,053 | 6,780 | ||||||||||||
Restructuring charges (Note 5) | — | — | — | (8,526 | ) | |||||||||||
Total operating income (loss) | $ | 15,470 | $ | 5,158 | $ | 30,053 | $ | (1,746 | ) | |||||||
12
Table of Contents
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-looking Statements
This quarterly report on Form 10-Q may contain certain statements that we believe are, or may be considered to be, “forward-looking” statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally can be identified by use of statements that include phrases such as “believe”, “expect”, “anticipate”, “intend”, “plan”, “foresee”, “may”, “will”, “estimates”, “potential”, “continue” or other similar words or phrases. Similarly, statements that describe our objectives, plans or goals also are forward-looking statements. All of these forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from those contemplated by the relevant forward-looking statement. The principal risk factors that could cause actual performance and future actions to differ materially from the forward-looking statements include, but are not limited to, dependence on attracting and retaining qualified and experienced consultants, portability of client relationships, local political or economic developments in or affecting countries where we have operations, ability to manage growth, restrictions imposed by off-limits agreements, competition, risks related to the growth and results of Futurestep, reliance on information processing systems, and employment liability risk. Readers are urged to consider these factors carefully in evaluating the forward-looking statements. The forward-looking statements included in this Form 10-Q are made only as of the date of this report and we undertake no obligation to publicly update these forward-looking statements to reflect subsequent events or circumstances.
The following presentation of management’s discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements included in this Form 10-Q.
Executive Summary
We are a leading provider of recruitment and leadership development services with the broadest global presence in the recruitment industry. Our services include executive recruitment, middle-management recruitment (through Futurestep), leadership development solutions and executive coaching. Over half of the executive recruitment searches we performed in fiscal 2004 were for board level, chief executive and other senior executive positions and our 3,608 clients included approximately 42% of the Fortune 500 companies. We have established strong client loyalty; more than 79% of the executive recruitment assignments we performed in fiscal 2004 were on behalf of clients for whom we had conducted previous assignments over the last three fiscal years.
To reach our objective of expanding our position as a leading provider of recruitment and leadership development services, our strategic objectives include broadening our product and service offering, improving coordination in global recruiting and increasing operational efficiencies, expanding our market reach and presence through technology and assessment solutions and leveraging our leadership and brand name in executive recruitment. We will continue to develop new products and services, refine our technology and aggressively market our proven global recruitment expertise.
In our second quarter of fiscal 2005, fee revenue increased 42% over last year to $108.5 million with increases across all regions. Operating income improved $10.3 million to $15.5 million in the current quarter. Futurestep revenues increased 73% to $13.0 million from $7.5 million in the prior year with increases across all regions. Futurestep’s operating income increased to $2.4 million from $0.5 million in the prior year.
Critical Accounting Policies
The following discussion and analysis of our financial condition and operating results are based on our unaudited condensed consolidated financial statements. Preparation of this Form 10-Q requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results may differ from those estimates and assumptions. In preparing our financial statements and accounting for the underlying transactions and balances, we apply our accounting policies as disclosed in our Notes to Unaudited Condensed Consolidated Financial Statements. We consider the policies related to revenue recognition,
13
Table of Contents
deferred compensation and the carrying values of goodwill and deferred income taxes as critical to an understanding of our financial statements because their application places the most significant demands on management’s judgment. Specific risks for these critical accounting policies are described in our Fiscal 2004 Annual Report on Form 10-K.
Results of Operations
The following table summarizes the results of our operations for the three and six months ended October 31, 2004 and 2003 as a percentage of fee revenue:
| Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||
Fee revenue | 100 | % | 100 | % | 100 | % | 100 | % | ||||
Reimbursed out-of-pocket engagement expenses | 5 | 7 | 5 | 7 | ||||||||
Total revenue | 105 | % | 107 | % | 105 | % | 107 | % | ||||
Compensation and benefits | 64 | 67 | 63 | 69 | ||||||||
General and administrative expenses | 20 | 23 | 20 | 23 | ||||||||
Out-of-pocket engagement expenses | 5 | 7 | 5 | 7 | ||||||||
Depreciation and amortization | 2 | 3 | 2 | 3 | ||||||||
Restructuring charges | 0 | 0 | 0 | 6 | ||||||||
Operating income (loss) | 14 | 7 | 14 | (1 | ) | |||||||
Net income (loss) | 8 | 3 | 8 | (5 | ) | |||||||
The following tables summarize the results of our operations by business segment. Operating income (loss) is calculated as a percentage of fee revenue.
Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||
| Dollars | % | Dollars | % | Dollars | % | Dollars | % | |||||||||||||||||||||
Fee revenue | ||||||||||||||||||||||||||||
Executive recruitment: | ||||||||||||||||||||||||||||
North America | $ | 55,657 | 51 | % | $ | 40,615 | 53 | % | $ | 107,313 | 51 | % | $ | 77,022 | 52 | % | ||||||||||||
Europe | 23,837 | 22 | 17,860 | 23 | 48,655 | 23 | 36,015 | 24 | ||||||||||||||||||||
Asia Pacific | 13,554 | 13 | 8,314 | 11 | 26,056 | 12 | 16,321 | 11 | ||||||||||||||||||||
South America | 2,497 | 2 | 2,380 | 3 | 4,604 | 2 | 4,301 | 3 | ||||||||||||||||||||
Total executive recruitment | 95,545 | 88 | 69,169 | 90 | 186,628 | 88 | 133,659 | 90 | ||||||||||||||||||||
Futurestep | 12,960 | 12 | 7,481 | 10 | 24,685 | 12 | 15,578 | 10 | ||||||||||||||||||||
Total fee revenue | 108,505 | 100 | % | 76,650 | 100 | % | 211,313 | 100 | % | 149,237 | 100 | % | ||||||||||||||||
Reimbursed out-of-pocket engagement expenses | 5,036 | 5,315 | 10,411 | 11,061 | ||||||||||||||||||||||||
Total revenue | $ | 113,541 | $ | 81,965 | $ | 221,724 | $ | 160,298 | ||||||||||||||||||||
Three Months Ended October 31, | Six Months Ended October 31, | |||||||||||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||
| Dollars | % | Dollars | % | Dollars | % | Dollars | % | |||||||||||||||||||||
Operating income (loss) | ||||||||||||||||||||||||||||
Executive recruitment: | ||||||||||||||||||||||||||||
North America | $ | 11,956 | 21 | % | $ | 8,260 | 20 | % | $ | 24,056 | 22 | % | $ | 14,074 | 18 | % | ||||||||||||
Europe | 4,022 | 17 | 324 | 2 | 8,583 | 18 | (4,563 | ) | (13 | ) | ||||||||||||||||||
Asia Pacific | 3,064 | 23 | 217 | 3 | 5,262 | 20 | 816 | 5 | ||||||||||||||||||||
South America | 272 | 11 | 350 | 15 | 552 | 12 | 342 | 8 | ||||||||||||||||||||
Total executive recruitment | 19,314 | 20 | 9,151 | 13 | 38,453 | 21 | 10,669 | 8 | ||||||||||||||||||||
Futurestep | 2,383 | 18 | 479 | 6 | 4,293 | 17 | (3,052 | ) | (20 | ) | ||||||||||||||||||
Corporate | (6,227 | ) | (4,472 | ) | (12,693 | ) | (9,363 | ) | ||||||||||||||||||||
Total operating income (loss) | $ | 15,470 | 14 | % | $ | 5,158 | 7 | % | $ | 30,053 | 14 | % | $ | (1,746 | ) | (1 | )% | |||||||||||
14
Table of Contents
Three Months Ended October 31, 2004 Compared to Three Months Ended October 31, 2003
Fee Revenue.Fee revenue increased $31.9 million, or 42%, to $108.5 million in the three months ended October 31, 2004 compared to $76.7 million in the three months ended October 31, 2003. The increase in fee revenue is attributable to an increase in the number of new engagements opened and increased average fees. Exchange rates favorably impacted fee revenues by $3.0 million in the current quarter.
Executive Recruitment – Executive Recruitment fee revenue increased $26.4 million, or 38%, due to an increase in the number of new engagements opened as well as an increase in average fees. North America fee revenue increased $15.0 million, or 37% in the current quarter primarily due to an increase of 26% in the number of billed engagements. Europe reported fee revenue of $23.8 million, an increase of $6.0 million, or 33%, compared to the same period last year. The increase in fee revenue was driven by an increase of 8% in the number of billed engagements and an increase in average fees. Exchange rates favorably impacted Europe fee revenue by $2.1 million in the current quarter. Asia Pacific fee revenue increased $5.2 million, or 63%, to $13.6 million compared to the same period last year due to an increase of 26% in the number of new engagements opened, an increase of 32% in the number of billed engagements, as well as an increase in average fees. South America reported fee revenue of $2.5 million, an increase of $0.1 million, or 5%, compared to the same period last year.
Futurestep - Fee revenue increased $5.5 million, or 73%, to $13.0 million in the three months ended October 31, 2004 compared to $7.5 million in the three months ended October 31, 2003. The increase in fee revenue, reflected across all regions, is due to our continued strategic emphasis on outsourced recruiting solutions. Exchange rates favorably impacted Futurestep fee revenue by $0.6 million in the current quarter.
Compensation and Benefits.Compensation and benefits expense increased $17.7 million, or 34%, to $69.0 million in the three months ended October 31, 2004 compared to $51.4 million in the three months ended October 31, 2003. The increase in compensation and benefits expense reflects an increase in bonus expense as a result of increased profitability, an increase in existing employees’ salary base as well as an increase due to new consultants hired. Exchange rates impacted compensation and benefits unfavorably by $1.7 million. Executive recruitment compensation and benefits costs of $57.4 million increased $13.4 million, or 30%, compared to last year due to an increase in the number of consultants and bonus expense. Exchange rates impacted executive recruitment compensation and benefits expense unfavorably by $1.4 million in the current quarter. Executive recruitment compensation and benefits expense, as a percentage of fee revenue, decreased to 60% from 64% in the prior year, as a result of increased productivity by our consultants. Futurestep compensation and benefits expense increased $3.0 million, or 59%, to $8.2 million from $5.2 million in the prior year due to increases in execution resources and bonus expense. Futurestep compensation and benefits expense, as a percentage of fee revenue, decreased to 63% from 69% in the prior year. Corporate compensation and benefits expense increased $1.2 million, or 55%, to $3.4 million in the current quarter, reflecting an increase in bonus expense as well as decreased returns on investments related to our Company Owned Life Insurance (“COLI”) policies.
General and Administrative Expenses.General and administrative expenses increased $3.9 million, or 22%, to $21.4 million in the three months ended October 31, 2004 compared to $17.5 million in the same period last year. Exchange rates unfavorably impacted general and administrative expenses by $0.5 million in the current quarter. In executive recruitment, general and administrative expenses increased $2.7 million, or 19%, due to increases in bad debt expenses, professional fees and costs associated with the global partner meeting that occurred in October 2004. Executive recruitment general and administrative expenses, as a percentage of fee revenue, decreased to 17% from 20% in the prior year, as a result of our efforts in controlling costs. Futurestep general and administrative expenses, as a percentage of fee revenue, decreased to 16% from 19% in the prior year. Corporate general and administrative expenses increased $0.6 million, or 27%, to $2.7 million in the current quarter primarily due to increased professional fees.
Out-of-Pocket Engagement Expenses.Out-of-pocket engagement expenses are comprised of expenses incurred by candidates and our consultants that are generally billed to clients. Out-of-pocket engagement expenses of $5.5 million remained fairly consistent with the prior year. As a percentage of fee revenue, out-of-pocket engagement expenses decreased to 5% from 7% in the prior year.
15
Table of Contents
Depreciation and Amortization Expenses.Depreciation and amortization expense of $2.1 million in the three months ended October 31, 2004 decreased $0.4 million, or 14%, from the prior year as fixed assets became fully depreciated in the latter half of fiscal 2004.
Operating Income (Loss.)Operating income increased $10.2 million to $15.5 million in the current quarter compared to $5.2 million in the prior year.
Executive recruitment operating income increased $10.2 million to $19.3 million in the three months ended October 31, 2004 compared to $9.2 million in the three months ended October 31, 2003. The increase in executive recruitment operating income is a result of the increase in revenue offset by increases in compensation and bonus expense, bad debt expenses, professional fees and costs associated with our global partner meeting. Executive recruitment operating income, as a percentage of fee revenue, increased to 20% in the current quarter from 13% in the same period last year.
Futurestep operating income improved $1.9 million to $2.4 million in the three months ended October 31, 2004 from $0.5 million in the three months ended October 31, 2003. The improvement in Futurestep operating income reflects the increase in revenue in the current quarter offset by an increase in compensation and bonus expense.
Interest Income and Other Income, Net.Interest income and other income, net includes interest income of $0.4 and $0.2 million in the three months ended October 31, 2004 and 2003, respectively.
Interest Expense.Interest expense, primarily related to the borrowings under COLI policies and our convertible securities, was $2.7 million in the current quarter, consistent with prior year.
Provision for Income Taxes.The provision for income taxes was $4.9 million in the three months ended October 31, 2004 compared to $0.5 million in the same period last year. The provision for income taxes in the current year reflects a 37.4% effective tax rate. The provision for income taxes in the prior year reflects foreign income tax expense as a result of pretax income in certain foreign subsidiaries.
Equity in Earnings of Unconsolidated Subsidiaries.Equity in earnings of unconsolidated subsidiaries is comprised of our less than 50% shareholder interest in our Mexican subsidiaries. We report our interest in earnings or loss of the Mexican subsidiaries on the equity basis as a one line adjustment to net income (loss). Equity in earnings was $0.5 million in the current quarter compared to $0.2 million the same period last year.
Six Months Ended October 31, 2004 Compared to Six Months Ended October 31, 2003
Fee Revenue.Fee revenue increased $62.1 million, or 42%, to $211.3 million in the six months ended October 31, 2004 compared to $149.2 million in the six months ended October 31, 2003. The increase in fee revenue is attributable to an increase in the number of new engagements opened across all regions. Exchange rates favorably impacted fee revenues by $7.2 million.
Executive Recruitment – Executive recruitment fee revenue increased $53.0 million, or 40%, due to an increase in the number of new engagements opened as well as an increase in average fees. North America fee revenue increased $30.3 million, or 39%, to $107.3 million due to a 25% increase in the number of new engagements opened. Europe reported fee revenue of $48.7 million, an increase of $12.6 million, or 35%, compared to the same period last year driven by an increase of 10% in the number of new engagements opened as well as an increase in average fees. Exchange rates favorably impacted Europe fee revenue by $3.8 million. Asia Pacific fee revenue increased $9.7 million, or 60%, to $26.1 million compared to the same period last year due to an increase of 22% in the number of new engagements opened as well as an increase in average fees. South America reported fee revenue of $4.6 million, an increase of $0.3 million, or 7%, compared to the same period last year.
Futurestep - Fee revenue increased $9.1 million, or 58%, to $24.7 million in the six months ended October 31, 2004 compared to $15.6 million in the six months ended October 31, 2003. The increase in fee revenue is due primarily to our continued strategic emphasis on outsourced recruiting solutions. Exchange rates favorably affected Futurestep revenue by $2.7 million.
16
Table of Contents
Compensation and Benefits.Compensation and benefits expense increased $31.2 million, or 30%, to $133.9 million in the six months ended October 31, 2004 compared to $102.7 million in the six months ended October 31, 2003. The increase in compensation and benefits expense reflects an increase in bonus expense as a result of increased profitability, an increase in existing employees’ salary base as well as an increase due to new consultants hired. Exchange rates impacted compensation and benefits unfavorably by $3.3 million. Executive recruitment compensation and benefits costs of $111.2 million increased $24.4 million, or 28%, compared to last year due to an increase in the number of consultants and bonus expense. Exchange rates impacted executive recruitment compensation and benefits expense unfavorably by $2.7 million. Executive recruitment compensation and benefits expense, as a percentage of fee revenue, decreased to 60% from 65% in the prior year, as a result of an increase in productivity by our consultants. Futurestep compensation and benefits expense increased $4.3 million, or 39%, to $15.3 million from $11.0 million in the prior year due to increases in execution resources and bonus expense. Exchange rates impacted Futurestep compensation and benefits expense unfavorably by $0.6 million. Futurestep compensation and benefits expense, as a percentage of fee revenue, decreased to 62% from 71% in the prior year. Corporate compensation and benefits expense increased $2.5 million, or 52%, to $7.4 million, reflecting an increase in bonus expense and compensation associated with executive benefits.
General and Administrative Expenses.General and administrative expenses increased $7.9 million, or 23%, to $42.2 million for the six months ended October 31, 2004 compared to $34.3 million in the same period last year. Exchange rates unfavorably impacted general and administrative expenses by $2.4 million. In executive recruitment, general and administrative expenses increased $6.2 million, or 23%, due to increases in bad debt expenses, professional fees and costs associated with the global partner meeting that occurred in October 2004. Executive recruitment general and administrative expenses, as a percentage of fee revenue, decreased to 18% from 20% in the prior year, as a result of our efforts in controlling costs. Futurestep general and administrative expenses increased by $0.7 million, or 20%, to $4.2 million. Futurestep general and administrative expenses, as a percentage of fee revenue, decreased to 17% from 23% in the prior year. Corporate general and administrative expenses increased $1.0 million, or 26%, to $5.1 million primarily due to increased professional fees.
Out-of-Pocket Engagement Expenses.Out-of-pocket engagement expenses are comprised of expenses incurred by candidates and our consultants that are generally billed to clients. Out-of-pocket engagement expenses of $11.2 remained fairly constant with the prior year. As a percentage of fee revenue, out-of-pocket engagement expenses decreased to 5% from 7% in the prior year.
Depreciation and Amortization Expenses.Depreciation and amortization expense of $4.4 million in the six months ended October 31, 2004 decreased $0.9 million, or 17%, from the prior year as fixed assets became fully depreciated in fiscal 2004.
Operating Income (Loss).Operating income increased $23.3 million to $30.1 million in the current quarter compared to $6.8 million in the prior year. Prior year operating profit includes $8.5 million of restructuring expenses.
Executive recruitment operating income increased $22.4 million to $38.5 million in the six months ended October 31, 2004 compared to $16.1 million in the six months ended October 31, 2003. Prior year operating income includes $5.4 million of restructuring expense. The increase in executive recruitment operating income is a result of the increase in revenue offset by increases in compensation and bonus expense, bad debt expenses, professional fees and costs associated with our global partner meeting. Executive recruitment operating income, as a percentage of fee revenue, increased to 21% in the current quarter from 12% in the same period last year.
Futurestep operating income improved $4.4 million to $4.3 million in the six months ended October 31, 2004 from an operating loss of $0.1 million in the six months ended October 31, 2003. Prior year operating loss included $3.0 million of restructuring charges. The improvement in Futurestep operating income is due to the increase in revenues offset by an increase in compensation and bonus expense.
Interest Income and Other Income, Net.Interest income and other income, net includes interest income of $0.7 and $0.5 million in the six months ended October 31, 2004 and 2003, respectively.
Interest Expense.Interest expense, primarily related to the borrowings under COLI policies and our convertible securities, was $5.3 million, a slight decrease from the prior year.
17
Table of Contents
Provision for Income Taxes.The provision for income taxes was $9.4 million in the six months ended October 31, 2004 compared to $0.9 million in the same period last year. The provision for income taxes in the current year reflects a 36.7% effective tax rate. Although we reported a pretax loss in the prior year, certain foreign subsidiaries reported pretax income resulting in foreign income tax expenses.
Equity in Earnings of Unconsolidated Subsidiaries.Equity in earnings of unconsolidated subsidiaries is comprised of our less than 50% shareholder interest in our Mexican subsidiaries. We report our interest in earnings or loss of the Mexican subsidiaries on the equity basis as a one line adjustment to net income (loss). Equity in earnings was $0.9 million compared to $0.4 million the same period last year.
Liquidity and Capital Resources
Cash provided by operating activities was $6.2 million for the six months ended October 31, 2004 compared to cash used in operating activities of $11.3 million for the same period last year. The increase in operating cash in the current period compared to the same period last year is primarily due to the increase in net income and taxes payable partially offset with the increase in receivables.
Cash used in investing activities was $9.7 million for the six months ended October 31, 2004 and $0.7 million in the same period last year. In the six months ended October 31, 2004 we invested $6.1 million in marketable securities in conjunction with our ECAP program. Capital expenditures for the six months ended October 31, 2004 and 2003 were $2.8 million and $0.9 million, respectively. Capital expenditures primarily consist of systems hardware and software costs and leasehold improvements.
Cash provided by financing activities was $7.9 million for the six months ended October 31, 2004 compared to cash used in financing activities of $5.5 million in the six months ended October 31, 2003. In the current period, we received $1.6 million from borrowings under our COLI policies and issued $8.7 million of common stock, which is offset by $2.3 million in purchases of common stock. In the same period last year, we made payments of $5.1 million on acquisition notes.
Total outstanding borrowings under our COLI policies was $58.9 million and $65.7 million as of October 31, 2004 and 2003, respectively. Generally, we borrow under our COLI policies to pay related premiums. Such borrowings do not require principal payments, bear interest at primarily variable rates and are secured by the cash surrender value of the life insurance policies of $119.4 million and $119.7 million as of October 31, 2004 and 2003, respectively.
In the six months ended October 31, 2004, we issued an additional $1.5 million of 7.5% Convertible Subordinated Notes in lieu of cash interest and $0.4 million of 7.5% Convertible Series A Preferred Stock in lieu of cash dividends. As of October 31, 2004, we had approximately $46.7 million outstanding in aggregate principal amount of 7.5% Convertible Subordinated Notes due in June 2010 and 7.5% Convertible Series A Preferred Stock with an aggregate liquidation preference of $11.7 million.
We have a $30.0 million Senior Secured Revolving Credit Facility. The total amount available for borrowing is limited based on certain accounts receivable balances. The credit facility is secured by substantially all of our assets including certain accounts receivable balances and guarantees by and pledges a portion of the capital stock of our significant subsidiaries. We are required to meet certain financial condition covenants on a quarterly basis. As of October 31, 2004, we had no outstanding borrowings on our credit facility.
We believe that cash on hand, borrowings available under our credit facility and funds from operations will be sufficient to meet our anticipated working capital, debt service requirements, capital expenditures and general corporate requirements. However, adverse changes in our revenue could require us to further cut costs or obtain financing to meet our cash needs.
18
Table of Contents
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements and have not entered into any transactions involving unconsolidated, limited purpose entities.
Recently Issued Accounting Standards
In December 2003, the FASB issued FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities”, effective as of the first reporting period beginning after March 15, 2004. The impact upon adoption of this standard did not have a material impact on the results of our operations or financial position.
In March 2004, the FASB issued an Exposure Draft, “Share-Based Payment - An Amendment of FASB Statements No. 123 and 95” (“Proposed SFAS 123R.”) The Proposed SFAS 123R may be effective for interim or annual periods beginning after June 15, 2005 and would eliminate the ability to account for share-based compensation transactions using APB 25. We would be required to recognize compensation expense, using a fair-value based method, for stock options and employee stock purchase plans.
Item 3.Quantitative and Qualitative Disclosures About Market Risk
As a result of our global operating activities, we are exposed to certain market risks, including foreign currency exchange fluctuations, fluctuations in interest rates and variability in interest rate spread relationships. We manage our exposure to these risks in the normal course of our business as described below. We have not utilized financial instruments for trading or other speculative purposes, nor do we trade in derivative financial instruments.
Foreign Currency Risk
Substantially all our foreign subsidiaries are measured in their local currencies. Assets and liabilities are translated into U.S. dollars at the rates of exchange in effect at the end of each year and revenue and expenses are translated at average rates of exchange during the year. Resulting translation adjustments are reported as a component of comprehensive income on our Statement of Stockholders’ Equity. We recognized $0.2 million and $0.7 million of transaction adjustments in the three and six months ended October 31, 2004, respectively.
Historically, we have not realized significant foreign currency gains or losses on transactions denominated in foreign currencies. In the three and six months ended October 31, 2004, we recognized foreign currency losses, after income taxes, of $0.1 million and $0.5 million, respectively, primarily related to our Europe operations on our Statement of Operations.
Our primary exposure to exchange losses is based on outstanding inter-company loan balances denominated in U.S. dollars. If the U.S. dollar strengthened 15%, 25% and 35% against Pounds Sterling and the Euro, the Company would recognize an exchange loss of $1.0 million, $1.7 million and $2.4 million, respectively, based on outstanding balances at October 31, 2004.
Interest Rate Risk
We primarily manage our exposure to fluctuations in interest rates in part through our regular financing activities, which generally are short term and provide for variable market rates. As of October 31, 2004, we had no outstanding balance on our credit facility. We have $58.9 million of borrowings against the cash surrender value of COLI contracts as of October 31, 2004 bearing interest primarily at variable rates. The risk of fluctuations in these variable rates is minimized by a corresponding adjustment to our borrowed funds crediting rate on the cash surrender value on our COLI contracts.
In June 2002, we issued $40.0 million of 7.5% Convertible Debt and $10.0 million of 7.5% Convertible Preferred Stock that is mandatorily redeemable by us if still outstanding on June 13, 2010.
19
Table of Contents
Item 4.Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
Based on their evaluation of our disclosure controls and procedures conducted as of the end of the period covered by this quarterly report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) are effective.
(b) Changes in Internal Control over Financial Reporting.
There were no changes in our internal control over financial reporting or that have materially affected or are reasonably likely to materially affect our internal control over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses.
20
Table of Contents
| Exhibit Number | Description of Exhibit | |
| 3.1 | Certificate of Incorporation of the Company, filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q, dated December 15, 1999, and incorporated herein by reference. | |
| 3.2 | Certificate of Designations of 7.5% Convertible Preferred Stock, filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K, dated June 18, 2002, and incorporated herein by reference. | |
| 3.3 | Amended and Restated Bylaws of the Company, filed as Exhibit 3.3 to the Company’s Annual Report on Form 10-K, dated July 29, 2002, and incorporated herein by reference. | |
| 31.1 | Chief Executive Officer Certification pursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Chief Financial Officer Certification pursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Chief Executive Officer and Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350. | |
21
Table of Contents
Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
KORN/FERRY INTERNATIONAL | ||||
Date: December 10, 2004 | By: | /s/ GARY D. BURNISON | ||
Gary D. Burnison | ||||
Chief Operating Officer and | ||||
Chief Financial Officer | ||||
22