Korn/Ferry Floating on Cash

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Hard on the heels of Friday's report that the U.S. enjoyed strong jobs growth in February, headhunting firm Korn/Ferry (NYSE: KFY) delivered its own good news yesterday. Third-quarter revenues grew strongly at 42% over Q3 2003, accelerating from the year-to-date revenue increase of 40%. (Favorable exchange rates from operations abroad accounted for just more than 10% of the total increase.) All of this revenue growth translated into a 130% jump in profits per diluted share for the quarter and lengthened this fiscal year's lead over the first nine months of last year, when the company lost $0.09 per share. To date, Korn/Ferry has racked up earnings per share of $0.62 and is trending toward the low-to-mid $0.80s for the year if profits continue growing at their current run rate.

Generally improving job markets accounted for the company's success only in part. Much more important was Korn/Ferry's ability to tighten up its operational efficiency, yielding operating margins for the year to date of 14.4% versus last year's anemic 2% (for the first nine months; for the year, Korn/Ferry increased this margin to 4.2% as it turned profitable in the last quarter of fiscal 2004).

So far, the story sounds pretty good. And now let's take a look at the number that Fools love best: free cash flow. In Korn/Ferry's case, this number is even more significant than with most companies, because historically, Korn/Ferry's GAAP earnings greatly understate the firm's true cash profitability (in fact, over the past several years, 2001 was the only year in which the two numbers were essentially equal). Because the company failed to provide a cash flow statement along with yesterday's earnings release, we cannot be certain of its exact free cash flow. And cash generation in the first six months was pretty weak, with the company generating only $3.4 million. Judging from the latest balance sheet, however, this changed in the fiscal third quarter. Cash and equivalents in the company's coffers grew by $48.8 million over the past nine months, suggesting robust cash generation in the quarter just ended.

Judging from the above, it's pretty clear that Korn/Ferry is performing well as a business. In order for the company to make itself a decent investment, though, there's one final thing that still needs doing. Over the past year, Korn/Ferry's basic share count has increased 7%, its diluted share count by 25%. Until management returns the lid to the stock options cookie jar, I'd hesitate to invest in this stock, no matter how good its profits.

Fool contributor Rich Smith has no position, short or long, in Korn/Ferry.