Korn Ferry (KFY) Earnings Call Transcript & Summary

Good afternoon, and welcome. I'm George Tong. I'm the business services analyst at Goldman, and I'm really pleased to be joined by Bob Rozek, CFO; and Mathias Herzog, Head of Korn Ferry's Digital business and President of the firm's Global Technology Practice. Bob and Mathias, thanks for joining us today.

Happy to be here.

Great. So let's start with strategy. Korn Ferry has diversified its business over the years well beyond executive search, and the business now includes consulting, digital solutions, interim search. Why is it an advantage to have all of these businesses within the portfolio?

Yes. Listen, I think that, to me, the key advantage of that is the ability to drive top line synergies across. So if you think about all of our core solution areas, George, we have org strategy, assessment, succession, talent acquisition, leadership professional and total rewards, right? And so as you're selling into your clients, there's such connective tissue between all those solution areas. And we're the only firm in the world that has all those core solution areas, right? So when we approach our clients, it's kind of one-stop shopping, common science, common language and so on, and the ability to sell across is very, very easy.

Yes. Makes sense and also certainly makes the business more macro-resilient.

It does. It does. Yes. If you go back to like the Great Recession, peak quarter, trough quarter, and we were predominantly exec search, at the time, we were down 51%. If you go back to COVID, which wasn't necessarily a recession but it behaved like one, and we were down 28 -- or 29% and the business mix had changed dramatically.

Right. And how would you describe the cyclicality of your various business lines? Which are more cyclical, which are least cyclical, which are in between?

Yes, I would say that the talent acquisition businesses, Exec Search, Pro Search, and RPO are probably the most cyclical. For RPO, we're actually seeing that for the first time this time. In the past, it hasn't been quite as cyclical. I would say consulting and digital are probably half as much as what you would see in the talent acquisition businesses. In digital, as we continue to grow the subscription and license base, you got to become less and less cyclical.

Makes sense. And I guess speaking of cyclicality, what do your more pro-cyclical businesses tell you about where we are in the cycle?

Good question. Listen, I think we're -- we've been waiting for this recession to happen for a long, long time. Really, what we're hearing now from our folks in the field is that the level of business activities are still pretty high. But what's happening now is clients are just taking longer and longer to sign engagements. We've had some clients, even outside the U.S., talk about we're not going to do anything until we see how the U.S. election resolves itself.

Now Mathias, he's responsible for leading the firm's digital business. This segment deploys and sells IP related to products around HR -- a country's, HR, technology and various functional cross-area lines of businesses. So can you talk a little bit more about the digital business, its strategy and its various unique assets?

Yes, happy to. Thanks for the question. So digital for us, it's essentially our HR tech business, where we have our products, our software applications, our solutions. It's about a $360 million, $370 million business today. 40% of that is subscription revenue. And we have products that address a wide range of talent use cases, everything from helping our clients at scale with the definition of what good looks like in a given role, and it's think about job profiles, job descriptions, job architectures and then other products that our customers use to assess, right, against what those definitions are also at scale. And so we have a variety of products in that portfolio that our customers subscribe to it over a term license.

Your longer-term growth target for the digital business is 10% to 15%. Right now, you're in the mid-single-digit range. When do you think the growth can get to your targeted growth range? And what are the catalysts?

Yes, it's a good question. I mean we're doing a number of things to the business, right, to get it on that trajectory. I think the foundation is really strong. The IP is really strong. The science in our products is really strong. There are really 4 growth levers that we're aggressively going after. First one is One Korn Ferry, right? We really want all of Korn ferry to lean in. There's a lot of synergies that come from working cross-lines of business, as Bob mentioned earlier, especially when we package our products together with consulting services, right? So really getting that engine going to another -- at another level is one of the focus areas. Second area of focus for us to get the growth trajectory to where we want it to be is sales productivity, right? So we have a dedicated commercial team focused on selling our products, selling those SaaS applications. And there are levers that we're pursuing around territory optimization, things that just lift the seller productivity, where I think we have a lot of room to drive momentum. A big one for us is the product investments and the product innovation itself, right? So a lot of the products that we have today, they exist as point solutions. And we, based on what our customers are telling us, see a lot of opportunity in bringing these products together into a comprehensive talent suite on one cloud platform, right, that drives increased consumption and adoption, which then translates into ARR growth, right? And the fourth area is another one where we're leaning in pretty heavily, which is working with partners, right, building a partner ecosystem, a common playbook in tech, right? So we're following that playbook, leaning in with organizations like Salesforce, right? So we have products that run on Salesforce, in conjunction with Salesforce, and then other partnerships that we are building specifically with a prominent HCM platforms where the in-app experiences that we're going to be providing -- we'll be providing here in short order creates further room for growth, right? So lots going on in the business. We do have the aspiration to double that business. And as we're looking to get to that scale, we're also going to shift the business mix, right, to increase the subscription revenue, right, in the business, because we really like that sticky ARR at high margins, and that's a key focus for us to get there as quickly as possible.

Right. And sort of related to that, could you talk a little bit more about how clients are consuming KF Digital today? And how could that evolve in the future?

Yes. So the variety of ways, so the cloud products, the SaaS applications, I mean, they are sold as subscriptions, right? So most of them are term licenses. And so our customers can subscribe to those products. For many of these products, we have attached services, right? So I'll give you an example. I mentioned the Salesforce partnership, we have a an application that's called Korn Ferry Sell. That's focused on driving seller productivity, sales effectiveness, evergreen topics, right, for most organizations. When -- that product we built using the IP that we bought with the Miller Heiman acquisition, right? So it's productized IP that integrates seamlessly with Salesforce. But we also sell training, right, that goes with that, right? So we can train large sales forces on that methodology. We create then the stickiness for the adoption of that sales methodology through product, right? So we've put the software in place for that sales transformation and the sales productivity increases to really take hold, right? And so we provide those attached services, I would call them as well in conjunction with the software. Hey, Mathias, maybe talk a little bit about what you're doing in terms of the platform to make it easier for not just how they consume it or to consume at all?

Yes. Yes. So one of the things that we're addressing, also not uncommon for an organization that has multiple products, right, some of which came into Korn Ferry through acquisitions is they're at the point that we're at right now. They're more point solutions. So they bought as individual subscriptions. But when you connect the dots and you look at the use cases that these products address, they should be used in conjunction, right? So an example here is if a customer of ours uses our profile manager application to help them with their job architecture design or define what good looks like in a given role, like define job roles and job descriptions. We also have products that our customers can subscribe to then assess individuals, right, against the job profiles. And then we have products that can support our clients to act on the insights, the talent insights, that come out of these assessments. So coaching, a coaching platform, learning products, right? So think about ad tech, learning tech. And the direction of play that we're moving into is to bring all of these applications together so that then you drive a more connected use cases and wider adoption, right, and more consumption on all the products.

Yes. Today, it's a little clunky for clients. So you kind of log in, log out, log in, log out.

Yes. Yes. So this is -- think about single orchestration layer, single sign-on, common landing pages, those types of integration activities that we're pursuing.

Right. You mentioned the subscription revenue mix is around 40% within digital today. Where do you think that can go? And what are some of the products that can get you there?

Yes. So I think we have the products that we need to get us there. The product innovations that we're putting in are going to drive more consumption and active usage. The integration activities, bringing all these products on a common platform is going to contribute to the growth in that subscription business mix. I think, as targets, we're looking to grow that to about 60%, 65%, right? I think there's always going to be some product attached services, right, because we also do implementations of the products. There's the training services that we provide around these products. And that's important for us because it drives consumption. It drives stickiness, right? So I think there's always going to be a portion of the business that is services related, but we want to get that percentage of subscription revenue to about 65%.

Got it. Let's take a step back and talk about broader revenue trends. In the fiscal first quarter, you saw some additional signs of stabilization in some of your more pro-cyclical businesses, albeit off of depressed levels, so no positive inflection yet. Can you talk a little bit more about some of these trends in Exec Search and...

Yes. Well, Exec Search, we actually did see a little bit of positive inflection, right? We grew about 2%, maybe 2% in constant currency in the quarter. But in our Pro Search business, that was down like 7%, something like that, around 7% to 8%. And that was kind of flat year-over-year, the -- or quarter sequential, the decline in the business. We also saw our interim business was down about 17% year-over-year. And again, sequentially, it was roughly flat. So we are starting to see parts of talent acquisition flatten out. We saw a little bit of positive inflection in executive search. And then last one is RPO, and that business has been fairly flat for the past 2 or 3 quarters now. And we expect that -- when you think about what we guided to, we expect those businesses to roughly continue to be flat.

Right. Within Executive Search, are there certain geographies that are growing or performing stronger than others? And are there any reasons why some of the recent trends may deviate from historical performance?

Yes. I would say if I go back to our fourth quarter last year and our first quarter this year and I look at new business, it's been very interesting. The fourth quarter, the first 2 months of the quarter were soft in Exec Search and then the last month was very strong. We saw Exec Search thing happen in the first quarter of this year. In fact, the North American business had an extremely strong month in the month of July. But I would -- I think as I look at the -- where we are with each of those areas, the one area that's really been a surprise for me all along is Europe, how well the executive search businesses continue to do there. They had ended up with a fairly strong first quarter. It came in as a strong part of our guide, and for Q2 as well. So that business has really held up. I think a lot of it is due to -- we have an extremely good management team in place there, and they actually function very well together as what I would call One Korn Ferry, right? So everybody is attached. We all know what we're doing, we're going to market in a combined basis. And so I think that's what's allowing us to enjoy some of the success that we are in Europe.

Got it. You're targeting consulting revenue growth in the 10% to 15% range, very similar to digital. What are some of the catalysts that can jump-start consulting growth from what currently is around the low single-digit range.

Yes, I would say there's probably a couple of things. One is it's kind of funny you think about the chaos that's going on in the world. And every time there is chaos or chaotic events that are out there, companies are trying to figure out how do I navigate, right? So that creates a tailwind for us. As I look at the consulting business today, our org strategy business is doing extremely well and it's a part of the business. We're actually helping clients think about the transformation of the workforce. Different work needs to get done, it needs to get done differently and so on. The one area I'm really excited about is our assessment business and using the assessments that Mathias talked about. Gary made a comment in one of our management meetings one day. He said, "Assessments are to Korn Ferry what hamburgers are to McDonald's." And you think about the assessment that drives development; it drives talent acquisition; it drives succession planning; and there are so many things that we do that feed up the assessment business that I think that's going to be one of our critical growth drivers going forward. Another area that I'm pretty excited about is leadership and professional development. So we've had two very large tech companies and one very large finance institution come to us over the past 18 months to say, "Hey, we love your coaches. We love your content. Will you take the next level of leadership in our firm and develop them for us?" And so you get 2-, 3-, 4-year contracts that are in the $15 million, $20 million range and you do that for folks. So I think those are going to be some of the -- as I look for some of the real drivers of growth in consulting.

Yes. Maybe building on that, right, because that also feeds into some of the synergies between the lines of business. But so as we're the assessment business for digital is a very high potential business for us as well. When we think about sort of what can operate as a catalyst for consumption of other products, right, it is assessment. Because once you have -- once you do assessments at scale, you identify talent gaps, right? You identify -- you need to do something about those assessment insights, right? And usually, what you end up doing with the insights of what organizations ought to be doing is you take action whether that's through development, interventions or coaching, right? And so there is a lot of synergies that happen when we do things, assessments at the top of the house, right? And organizations start to get exposure to the IP and to science that's embedded in the work that we do. And more often than not, the question comes up, well, this is great stuff, right, but can we scale this, right? And we have the talent suite lined up, right, to then provide that scaling using technology and using subscription services to really allow our customers to tap into all the science and the IP that we have.

And get the insights from. We've got a team right now that are really going after gaining insights from analytics. And just to give you an example. Gary who's on a call with the CEO of a very large health care company about 2 months ago, and you had this team go in and we've assessed a lot of their executives over time, and he went into the conversation with the whole sheet of insights. Did you know that your workforce look like this or relative to itself or relative to industries, and the CEO at the company is blown away by what Gary was able to tell about his workforce.

Right. Right. Now given both your digital and consulting businesses have, the 10% to 15% medium-term target, which of the 2 do you think will get there first and why?

And Bob, what's your favorite?

I would say -- and I'm not playing favorites because you're sitting there. But I would say digital will get there first. Yes, digital will get there first because you've got the ability to kind of sell without having to have people to execute. We're consulting -- you can sell all the work you want, if you don't have the capacity to deliver, you're not going to get the revenue. Where in digital, we'll sell licenses and you kind of make money while you sleep. I think digital has probably a better chance of getting there quicker.

Right. And I know digital was put together through a combination of multiple M&A pieces with different tech stacks. What are some of the things that you might have to do to integrate and normalize all of the tech stack together?

Yes. Well, that's what Mathias was talking about because right now, they're -- we're in the process of doing, but they're not -- and so as you go in, you do an assessment, right, and the assessment tells you you've got this gap in your skill set. So you log in and do the assessment, you log out and then you go over to our leadership development. You log in, right, and you log. So it's kind of clunky for people to consume those assets, whereas once Mathias is done this year, that will be a single sign-on. I go on, I do that and I get redirected right over to the -- to development activities.

I mean it's an engineering lift, right? So we -- so in the digital organization, we have north of 400 engineers now, right? So they are working on that platform integration, right, and really bringing these applications together for a seamless user experience. There's also data integration work that needs to happen, right? So think about the massive amount of data that we have, right, the example that we'd like to give, right? We have done over 100 million assessments against what good looks like in a given role. That's massive amounts of proprietary data, pair that with all the pay data that we have, right, from our paid subscription business, the path that we're on is essentially bring all those data assets together, integrate the applications on one technology platform, right? And then we're off to the races. So it's an engineering lift.

Got it. Korn Ferry is also in the RPO business. Can you briefly talk about what the RPO business is for those that might not be familiar?

Sure. So to me, RPO is recruiting at scale. So companies will come to us and say, "Hey, we're going to hire," pick a number, "5,000, 7,000 people over the course of the next year, and we want to outsource that function to you, Korn Ferry." For us today, that's roughly about a $400 million business. It's grown nicely. Prior to the pandemic right now, it's kind of flat. They're doing about 90 -- roughly $90 million of business a quarter. It's been up as high as $114 million, I think, at one point. But once we get past the current environment that we're in and things look better and we start to see the base of our clients elevating their talent requirements, and we'll get back to normal levels. And if you simply were to take all the contracts we have in place today and bring them back to their original contract value versus the depressed levels that we're at, that would add about another $50 million, $55 million in fee revenue. The other thing that we've seen over the course of the past year in that business, George, is if I go back to '22 and '23, we had roughly $600 million of new business both of those years and 70% of that was a new client. So we call it a new logo. 30% was renewal. We had such success with new clients as those things are coming to the end of the term, what we're seeing now is a lot more renewals. We've seen that during FY '24 and we saw it in Q1. But we do expect that to flip back to, I would say, probably 50-50 going forward and we'll be well above the current levels of new business that we're at today.

Got it. That's helpful. Typically, the RPO business is going to be driven by new business wins that can be lumpy and then ongoing hiring volumes or base volumes from existing clients. Where are you seeing most, I guess, sensitivity to cyclical trends? Is it the base performance? Or is it the new client wins?

I would say it's probably the base performance. We had this phenomenon we talked about a couple of earnings calls ago, Gary referred to as labor hording where companies weren't downsizing their recruiting organizations. They were hanging on to people and rather than giving volumes to us, they were keeping it. And the reason why they did that was if you go back to the pandemic recovery, the slope of that curve was really, really steep. And at one point, there's even an article in a journal that talked about the hardest job to recruit for as a recruiter. And so companies were kind of hanging on. We're not seeing it as much anymore. So I think right now, it's really just the base and as the world gets better, that base recovers.

Got it. Interim search is a relatively new business for Korn Ferry. Revenues are currently declining double digits. Can you talk about how Korn Ferry's interim business is different or better than other temp staffers out there?

I would say there's probably 2 things as I think about our business that's different and/or better. So one, if you look at like a Robert Half or a Manpower, they provide staffing at virtually all levels of an organization where our interim business mirrors our executive search and professional search. So we do see suite down to professional levels. We don't go anywhere below that in an organization. That's one. I think second is if you think about creating cross-line of business referrals and synergies, as a search partner, it's really easy for me to understand what interim is, right? And even if I get an opportunity to do a search, I can very easily say, hey, let me get you an interim body until I find your perm higher, right? And so we're seeing that the level of activity between the lines of business for the newly acquired interim business has picked up a bit.

If you sort of dive into the interim search business, are there certain pockets either end markets or geographies that are experiencing more pressure than others?

Right now, we're feeling a bit more pressure in finance and accounting. If you went back to Q3, Q4 of last year, it was more in IT. I think the -- we bought a business called Patina, and they do C-suite. That business has stayed relatively consistent. The other thing is, right now, our business is heavily concentrated in the U.S. So opportunities for us are obviously to expand into Europe, Asia and so on.

Right. One of the key advantages of having a diversified business model is cross-selling. Can you talk about what your rate of cross-line of referral activity is right now and where it can go to over time?

Yes. Right now, we're hovering somewhere close to 27%, maybe a little bit below that level. We've had it up as high as 29%. And where it dropped down was one going through the bad or challenging economic times. The RPO business was one where we had a lot of cross-line of business referral activity. And as those volumes came down, that impacted us. And then by buying the interim businesses, it takes a while to ramp those up. And so we had a sort of a denominator/numerator effect going on. My gut is once we get through the current environment and things get better, we should be 30% plus on our cross-line of business activities. We've actually -- we have a referral program that we put in place. And this year, we actually sweetened it a bit, and we opened it up to more parts of the business. So virtually everybody in the company now that refers a piece of work in outside of their line of business gets compensated for it. We moved the award up from 10% of the value of the engagement to 12.5%.

Got you. Most of your cross-selling typically happens among your larger customers, your marquee and your regional accounts. Can you talk about what revenue mix your marquee and regional accounts represent and how fast those accounts are growing?

Yes. I would say, right now, we have 350 accounts that we classify as marquee and regional. Just to give you some perspective, today, we have roughly, say, 14,000 clients. We have a lot of clients that buy one-off type things. So if you carve those out, we're probably somewhere 9,000 to 10,000 what I consider real clients. And so 350 of those are the marketing and regional accounts. They generate 37% of our revenue, so obviously a large portion. Over 60% of those accounts use more than one line of business. And what we found over time is when you sell more than one line of business into a client, the revenue opportunities are 4 to 5x greater than just a monoline client.

Right. Makes sense. I'm going to pause there for a moment to see if there are any questions from the audience. Okay. Let's turn to margins. So your guidance points to roughly 250 bps of year-over-year margin expansion in fiscal 2Q. What's driving that significant amount of margin expansion? And how sustainable is it?

Yes. So I would say that, right now, if you go to the midpoint of our guidance, it's 16.5%. It's a 250 basis point improvement. It's definitely sustainable. We've done a lot in terms of managing our cost base. So if we look at our real estate, for example, we've taken out about 35% of our footprint because we just don't need people that aren't going in an office like they used to. When you look at our -- before the pandemic, our travel business development budget, we'd spend $10 million or $11 million a quarter. Today, it's about $5 million, right, because there's so much stuff happened virtually. So we've been driving enormous productivity into our workforce, and we're closely managing costs going forward. In fact, we are so confident in our ability to continue at this level. We took our dividend up in Q2 last year, 83% in that quarter, and then we actually bumped up again at year-end. So today, our EBITDA this quarter did about $111 million. I would say if you look at our share buybacks and our dividends on an annual basis, it's probably $170 million to $180 million combined. And we're very confident that we'll be able to continue at that level.

Some of your newer business ventures like interim search carry lower margin profiles, how much of a revenue benefit would you need to see from these businesses for you to get comfortable with the margin profile?

I think we're comfortable with it today because you have to look at the company as a portfolio, right? So if we get Mathias growing at the rate that we expect him to grow, that's a 30% margin, right? So we're going to get some pluses and minuses when talent acquisition bounces back. Exec Search is somewhere between 25%, 27%. Pro Search is probably closer to 28% to 30%, right? So as the mix moves and evolves, we're not particularly concerned about the interim business coming in. And quite honestly, when you buy those businesses, they're doing about an 8% EBITDA margin. They're pretty poorly managed, really underinvested, and we're plug-and-play so we have a platform that's common systems, common processes, controls across the globe. So we literally pick the business up and plug it in. And so we're able to get a lot of cost synergies out just by doing that. In fact, when we take a deal to our Board, we never like juice up the revenues. We keep revenue fairly conservative, and we're able to make the math work just on the cost takeouts.

Right. In the fiscal quarter 2Q, your margin guidance, like you said, is 16.5%. What is your longer-term target for EBITDA margins? And how do you bridge that gap?

Yes. Well, right now, we're within the -- in the range. We talk about our long-term targets in the 16% to 18% range. And again, a lot of that is going to depend at any one point in time what the revenue mix looks like, right, if we double or triple down and interim will push it down towards the lower end, if digital pops back down and the acquisition pops back, it will push it up towards the upper end. My gut is we're staying at 16% to 18%. But if we really get the digital business where we want it to be, we could blow through the top end of that.

Got it. And then lastly, capital allocation. What are your current capital allocation priorities? And if you're looking at M&A, where do you see the most opportunity?

Sure. So our -- we've always followed sort of a balanced approach to capital. Our priority is always going to be to put that money back into the business first, right? So that's hiring talent, teams. It's investing back into the other stuff that Mathias is doing in digital with CapEx, and then it's doing M&A work. And we do generate a lot of cash. So we're always going to be above and beyond what we can consume internally. And so that's when we put the dividend and the buybacks into place. I would say from an opportunistic perspective, I mean, Gary would love to do a strategy firm, but there's just not a lot of assets out there. So I don't think we'll -- you'll see us do that. I think the opportunities in my book are going to be more in the leadership and professional development space potentially as well as to continue investing in the interim space. The interim space, it's a massive market, right, worth $300 million. So we look at it from a growth perspective, it's been just a huge opportunity for us.

Great. Well, Bob, Mathias, thank you so much for the time and insights.

Very good. Thanks very much.

Pleased to meet you, and thanks to the management team.

Thanks, everybody.