10-Q 1 d10q.htm FORM 10-Q Prepared by R.R. Donnelley Financial -- Form 10-Q
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 July 31, 2002 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
 
(I.R.S. Employer
of incorporation or organization)
 
Identification Number)
 
1800 Century Park East, Suite 900, 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  ¨
 
The number of shares outstanding of our common stock as of September 11, 2002 was 37,857,574.
 


Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
 
 
         
Page

PART I.    FINANCIAL INFORMATION
    
      
Item 1.
  
Financial Statements
    
           
       
3
           
       
4
           
       
5
           
       
6
           
Item 2.
     
12
           
Item 3.
     
18
           
PART II.    OTHER INFORMATION
    
      
Item 6.
     
19
           
  
20
      
  
21

2


Table of Contents
PART I.    FINANCIAL INFORMATION
 
Item 1.    Financial Statements
 
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
 
    
As of
July 31, 2002

    
As of
April 30, 2002

 
    
(unaudited)
        
ASSETS
                 
Cash and cash equivalents
  
$
58,792
 
  
$
66,128
 
Receivables due from clients, net of allowance for doubtful accounts of $7,963 and $7,767
  
 
55,153
 
  
 
54,960
 
Income tax and other receivables
  
 
13,935
 
  
 
30,140
 
Deferred income taxes
  
 
10,576
 
  
 
10,336
 
Prepaid expenses
  
 
11,108
 
  
 
10,331
 
    


  


Total current assets
  
 
149,564
 
  
 
171,895
 
    


  


Property and equipment, net
  
 
37,690
 
  
 
40,248
 
Cash surrender value of company owned life insurance policies, net of loans
  
 
52,449
 
  
 
53,048
 
Deferred income taxes
  
 
22,771
 
  
 
21,794
 
Goodwill
  
 
88,158
 
  
 
85,346
 
Other intangibles, net of accumulated amortization of $4,463 and $4,103
  
 
471
 
  
 
396
 
Deferred financing costs, investments in unconsolidated subsidiaries and other
  
 
8,529
 
  
 
4,847
 
    


  


Total assets
  
$
359,632
 
  
$
377,574
 
    


  


LIABILITIES AND SHAREHOLDERS’ EQUITY
                 
Notes payable and current maturities of long-term debt
  
$
7,902
 
  
$
12,818
 
Borrowings under credit facility
           
 
39,000
 
Accounts payable
  
 
8,352
 
  
 
8,319
 
Compensation and benefits
  
 
25,943
 
  
 
48,774
 
Other accrued liabilities
  
 
31,370
 
  
 
37,374
 
    


  


Total current liabilities
  
 
73,567
 
  
 
146,285
 
    


  


Deferred compensation and other retirement plans
  
 
46,489
 
  
 
44,806
 
Long-term debt
  
 
40,757
 
  
 
1,634
 
Other
  
 
7,247
 
  
 
5,552
 
    


  


Total liabilities
  
 
168,060
 
  
 
198,277
 
7.5% Convertible mandatorily redeemable preferred stock, net of unamortized discount and issuance costs, redemption value $10,100
  
 
8,964
 
        
Shareholders’ equity
                 
Common stock: $0.01 par value, 150,000 shares authorized, 38,597 and 38,587 shares issued and 37,871 and 37,869 shares outstanding
  
 
303,034
 
  
 
301,488
 
Retained earnings (deficit)
  
 
(103,561
)
  
 
(102,853
)
Unearned restricted stock compensation
  
 
(2,643
)
  
 
(2,988
)
Accumulated other comprehensive loss
  
 
(12,486
)
  
 
(14,101
)
    


  


Shareholders’ equity
  
 
184,344
 
  
 
181,546
 
Less: Notes receivable from shareholders
  
 
(1,736
)
  
 
(2,249
)
    


  


Total shareholders’ equity
  
 
182,608
 
  
 
179,297
 
    


  


Total liabilities and shareholders’ equity
  
$
359,632
 
  
$
377,574
 
    


  


 
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 July 31,

 
    
2002

    
2001

 
    
(unaudited)
 
Fee revenue
  
$
83,950
 
  
$
105,535
 
Reimbursed out-of-pocket expenses
  
 
5,838
 
  
 
7,921
 
    


  


Revenue
  
 
89,788
 
  
 
113,456
 
Compensation and benefits
  
 
59,508
 
  
 
75,153
 
General and administrative expenses
  
 
18,675
 
  
 
32,045
 
Out-of-pocket expenses
  
 
6,064
 
  
 
7,569
 
Depreciation and amortization
  
 
4,231
 
  
 
4,044
 
Goodwill impairment charges
           
 
40,181
 
Asset impairment and restructuring charges
           
 
9,247
 
Interest income and other income, net
  
 
972
 
  
 
865
 
Interest expense
  
 
2,656
 
  
 
1,548
 
    


  


Loss before provision for income taxes and equity in earnings of unconsolidated subsidiaries
  
 
(374
)
  
 
(55,466
)
Provision for (benefit from) income taxes
  
 
570
 
  
 
(8,081
)
Equity in earnings of unconsolidated subsidiaries
  
 
361
 
  
 
526
 
    


  


Net loss
  
$
(583
)
  
$
(46,859
)
    


  


Net loss attributed to common shares
  
$
(708
)
  
$
(46,859
)
    


  


Basic loss per common share
  
$
(0.02
)
  
$
(1.25
)
    


  


Basic weighted average common shares outstanding
  
 
37,701
 
  
 
37,555
 
    


  


Diluted loss per common share
  
$
(0.02
)
  
$
(1.25
)
    


  


Diluted weighted average common shares outstanding
  
 
37,701
 
  
 
37,555
 
    


  


 
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)
 
    
Three Months Ended July 31,

 
    
2002

    
2001

 
    
(unaudited)
 
Cash from operating activities:
                 
Net loss
  
$
(583
)
  
$
(46,859
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
                 
Depreciation
  
 
3,871
 
  
 
3,936
 
Amortization of intangible assets
  
 
360
 
  
 
107
 
Amortization of note payable discount
  
 
84
 
  
 
139
 
Interest, dividends and amortization on convertible debt and preferred stock
  
 
446
 
        
Loss on disposition of property and equipment
  
 
138
 
  
 
72
 
Unrealized loss on marketable securities and other assets
  
 
290
 
        
Provision for doubtful accounts
  
 
2,056
 
  
 
3,510
 
Cash surrender value (gains) losses and benefits in excess of premiums paid
  
 
(197
)
        
Deferred income tax provision (benefit)
  
 
(977
)
  
 
(7,844
)
Tax benefit from exercise of stock options
           
 
188
 
Asset impairment charge
           
 
46,445
 
Restructuring charge
           
 
1,618
 
Restricted stock compensation
  
 
346
 
  
 
101
 
Change in other assets and liabilities, net of acquisitions:
                 
Deferred compensation
  
 
1,683
 
  
 
1,931
 
Receivables
  
 
14,624
 
  
 
11,663
 
Prepaid expenses
  
 
(777
)
  
 
(1,020
)
Investment in unconsolidated subsidiaries
  
 
(511
)
  
 
(795
)
Income taxes
  
 
(124
)
  
 
(12,683
)
Accounts payable and accrued liabilities
  
 
(28,781
)
  
 
(85,563
)
Other
  
 
1,292
 
  
 
676
 
    


  


Net cash used in operating activities
  
 
(6,760
)
  
 
(84,378
)
    


  


Cash from investing activities:
                 
Purchase of property and equipment
  
 
(190
)
  
 
(5,088
)
Sale of marketable securities
           
 
13,008
 
Premiums on life insurance, net of benefits received
  
 
(2,379
)
  
 
(2,483
)
    


  


Net cash (used in) provided by investing activities
  
 
(2,569
)
  
 
5,437
 
    


  


Cash from financing activities:
                 
Issuance of convertible debt, preferred stock and warrants, net
  
 
45,722
 
        
Net (repayments) borrowings on credit line
  
 
(39,000
)
  
 
52,000
 
Payment of shareholder acquisition notes
  
 
(4,656
)
  
 
(2,926
)
Net borrowings under life insurance policies
  
 
2,507
 
  
 
2,488
 
Purchase of common stock and payment on related notes
  
 
(65
)
  
 
(457
)
Issuance of common stock and receipts on shareholders’ notes
  
 
513
 
  
 
2,251
 
    


  


Net cash provided by financing activities
  
 
5,021
 
  
 
53,356
 
    


  


Effect of exchange rate changes on cash flows
  
 
(3,028
)
  
 
(548
)
    


  


Net decrease in cash and cash equivalents
  
 
(7,336
)
  
 
(26,133
)
Cash and cash equivalents at beginning of the period
  
 
66,128
 
  
 
85,661
 
    


  


Cash and cash equivalents at end of the period
  
$
58,792
 
  
$
59,528
 
    


  


 
The accompanying notes are an integral part of these consolidated financial statements.

5


Table of Contents
KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(in thousands, except per share amounts)
 
1.    Summary of Significant Accounting Policies
 
Basis of Presentation
 
The consolidated financial statements for the three months ended July 31, 2002 and 2001 include the accounts of Korn/Ferry International (“KFY”), 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, which 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, 2002 (“Annual Report”) and should be read together with the Annual Report.
 
In fiscal 2002, the Company determined that its investment in subsidiaries in Mexico should be accounted for using the equity method of accounting under accounting principles generally accepted in the United States (“GAAP”). Previously, the Company consolidated the accounts of its subsidiaries in Mexico, in which KFY believes it has effective control but owns less than 50% of the shareholder voting interest. While the Company believes that this presentation reflected the way in which these subsidiaries are managed and operate, the legal structure of these entities requires the use of the equity method of accounting under GAAP. This legal structure was established in 1977, which at that time, limited foreign investment. Accordingly, the accompanying consolidated financial statements for fiscal 2002 have been restated to comply with GAAP and reflect the operations of the Mexico subsidiaries under the equity method of accounting. The restatement to properly apply the equity method of accounting for the Mexico subsidiaries had no impact on net income, EPS or cash flow but did reduce previously reported revenue and expenses.
 
Critical Accounting Policies and Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 deferred income taxes.
 
Reclassifications
 
Certain prior year amounts have been reclassified to conform with the current year presentation.
 
New Accounting Pronouncements
 
Effective as of May 1, 2002, the Company adopted Emerging Issues Task Force Issue No. 01-14 (“EITF No. 01-14”), “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred”. EITF No. 01-14 requires the classification of reimbursements received for “out-of-pocket” expenses as revenue and the related expenses incurred as expense on the statement of operations. Historically, the Company followed this practice for “out-of-pocket” expenses incurred by the Company and its consultants. Candidate “out-of-pocket” expenses, primarily travel, however, were netted in revenue as a reduction in the amounts billed to clients. The Company is the primary obligor and at risk for client reimbursement of the candidate “out-of-pocket” expenses and accordingly, prior period results reflect the reclassification of candidate “out-of-pocket” expenses previously netted in revenue to expense. Although revenue and expense increased as a result of the reclassification, there was no impact on operating profit, net income, EPS or cash flow.
 
Effective as of May 1, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. This statement replaces SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived assets to be Disposed Of”. The adoption of SFAS No. 144 did not have an impact on the Company’s financial statements for the three months ended July 31, 2002.

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Table of Contents

KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)

In July 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement requires that a liability for costs associated with an exit or disposal activity, including certain restructuring costs, be recognized and measured initially at fair value when the liability is incurred. Previously, these liabilities were recognized at the date an entity committed to a plan and measurement at fair value was not required. This statement is effective prospectively for exit and disposal activities initiated after December 31, 2002 with earlier application encouraged. The Company does not believe that the adoption of this statement will have a significant impact on the Company’s financial position or results of operations.
 
In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not believe that the adoption of this statement will have a significant impact on the Company’s financial position or results of operations.
 
2.    Basic and Diluted Earnings (Loss) Per Share
 
Basic earnings (loss) per common share (“basic EPS”) was computed by dividing net loss attributed to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common and common equivalent share (“diluted EPS”) reflects the potential dilution that would occur if the outstanding options or other contracts to issue common stock were exercised or converted and was computed by dividing the net loss by the weighted average number of shares of common stock outstanding and dilutive common equivalent shares. Following is a reconciliation of the numerator (loss) and denominator (shares in thousands) used in the computation of basic and diluted EPS:
 
    
Three months ended July 31,

 
    
2002

    
2001

 
    
Loss

    
Weighted
Average
Shares

  
Per
Share
Amount

    
Loss

    
Weighted
Average
Shares

  
Per
Share
Amount

 
Basic EPS
                                             
Net loss
  
$
(583
)
                
$
(46,859
)
             
Convertible preferred stock dividend
  
 
(125
)
                                    
    


                


             
Loss attributed to common shareholders
  
$
(708
)
  
37,701
  
$
(0.02
)
  
$
(46,859
)
  
37,555
  
$
(1.25
)
                  


                


Effect of dilutive securities
                                             
Shareholder common stock purchase commitments
                                             
Convertible debt
                                             
Convertible preferred stock
                                             
Stock options
                                             
    


  
           


  
        
Diluted EPS
                                             
Loss attributed to common shareholders plus assumed conversions
  
$
(708
)
  
37,701
  
$
(0.02
)
  
$
(46,859
)
  
37,555
  
$
(1.25
)
    


  
  


  


  
  


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Table of Contents

KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
 
NOTES TO 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 there is a net loss for the period because their inclusion would reduce the loss per share or be anti-dilutive. If the assumed exercises or conversions had been used, the fully diluted shares outstanding for the three months ended July 31, 2002 would have been 37,718.
 
3.    Comprehensive Income (Loss)
 
Comprehensive income (loss) is comprised of net income (loss) and all changes to shareholders’ 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 July 31,

 
    
2002

    
2001

 
Net loss
  
$
(583
)
  
$
(46,859
)
Foreign currency translation adjustment
  
 
1,616
 
  
 
(1,073
)
Reclassification adjustment for losses realized in net income (loss), net of tax benefit of $2,145
           
 
2,962
 
    


  


Comprehensive income (loss)
  
$
1,033
 
  
$
(44,970
)
    


  


 
Due to certain restructuring activities taken by the Company, as discussed in Note 4, the extended decline in the stock market and other factors, the Company believed that the loss in value related to certain equity securities was no longer temporary in nature and reclassified the loss of $2,962, net of a tax benefit of $2,145, included in other comprehensive income (loss) at April 30, 2001 to net income (loss) in the three months ended July 31, 2001 resulting in a pretax charge of $5,107. In addition, the Company recognized a holding loss on these securities of $1,157 arising in the three months ended July 31, 2001. The total pretax charge related to the recognized loss on this investment of $6,264 was included in the asset impairment charge for the three months ended July 31, 2001.
 
In the three months ended July 31, 2002, the Company recognized unrealized holding losses related to this investment of $313 included in other income.
 
The accumulated other comprehensive loss of $12,485 at July 31, 2002 is comprised of foreign currency translation adjustments.
 
4.    Asset Impairment and Restructuring Charges
 
Based on deteriorating economic conditions encountered in the first quarter of fiscal 2002, the Company developed a series of business realignment initiatives announced in August 2001. The immediate goals of these initiatives were to reduce losses, preserve top employees and maintain high standards of client service. These initiatives resulted in a total charge against earnings in the first and second quarters of fiscal 2002 of $84.2 million. In addition, the Company implemented restructuring initiatives in the fourth quarter of fiscal 2002 primarily related to executive recruitment in Europe and Futurestep resulting in a charge of $8.9 million. These charges reflect costs associated with a reduction in the work force of nearly 30%, or over 750 employees; consolidation of many of the back-office functions for Futurestep and Korn/Ferry; wind down of JobDirect operations and write-down of other related assets and goodwill.
 
Operating results for the three months ended July 31, 2001 include asset impairment and restructuring charges related to the following business segments:

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Table of Contents

KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)

 
    
Asset Impairment

    
Restructuring

    
    
Goodwill

  
Other

    
Severance

  
Total

Executive recruitment
                             
North America
  
$
11,230
  
$
 
    
 
984
  
$
12,214
Europe
                  
 
1,778
  
 
1,778
Asia/Pacific
                  
 
57
  
 
57
Futurestep
         
 
6,264
    
 
164
  
 
6,428
JobDirect
  
 
28,951
                  
 
28,951
    

  

    

  

Total
  
$
40,181
  
$
6,264
    
$
2,983
  
$
49,428
    

  

    

  

 
The goodwill impairment charge recognized in the first quarter of fiscal 2002 was based on an analysis of future undiscounted cashflows that indicated that goodwill was impaired. The charge represents the excess of the carrying value over fair value, based on a discounted cashflow method. The other asset impairment charge is primarily related to property and equipment and other investments. The restructuring charge for severance resulted from actions approved by senior management in response to a decline in revenue in the first two months of fiscal 2002 that did not require board approval.
 
A summary of the asset impairment and restructuring charges recognized in the second and fourth quarters of fiscal 2002 follows:
 
    
Asset Impairment

  
Restructuring

    
    
Goodwill

  
Other

  
Severance

  
Facilities

  
Total

Executive recruitment
                                  
North America
  
$
2,745
  
$
711
  
$
8,089
  
$
5,490
  
$
17,035
Europe
                
 
3,055
  
 
2,517
  
 
5,572
Asia/Pacific
         
 
15
  
 
1,704
  
 
70
  
 
1,789
Futurestep
         
 
6,694
  
 
2,428
  
 
6,872
  
 
15,994
JobDirect
         
 
1,369
  
 
843
  
 
1,173
  
 
3,385
    

  

  

  

  

Total
  
$
2,745
  
$
8,789
  
$
16,119
  
$
16,122
  
$
43,775
    

  

  

  

  

 
The facilities restructuring charge is comprised primarily of lease termination costs, net of estimated sublease income, for excess space and includes $1,952 related to the write-off of unamortized leasehold improvements.
 
Included in accrued liabilities at July 31, 2002 is $670 of severance restructuring costs and $9,266 of facilities restructuring costs. The severance accrual includes amounts paid monthly and are expected to be paid in full by October 31, 2002. The accrued liability for facilities costs primarily relates to lease payments, net of sublease income, that will be paid over the next two to ten years. During the three months ended July 31, 2002, the Company paid $1,509 of accrued severance costs and $1,133 of accrued facilities costs.
 
5.    Mandatorily Redeemable Convertible Securities
 
In June 2002, the Company issued 7.5% Convertible Subordinated Notes in an aggregate principal amount of $40.0 million, 10,000 shares of 7.5% Convertible Series A Preferred Stock at an aggregate purchase price of $10.0 million and warrants to purchase 272,727 shares of its Common Stock at an exercise price of $12.00. 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, that are amortized over the life of the securities.
 
        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 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 provided certain minimum price targets for our common stock are achieved.

9


Table of Contents

KORN/FERRY INTERNATIONAL AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)

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 will be amortized using the effective interest method over the life of securities as interest expense with respect to $3.4 million allocated to the Notes and as a charge against capital with respect to $0.9 million allocated to the Preferred Stock. The $0.9 million charge will be accreted to dividends over the life of the Preferred Stock.
 
6.    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 method used to identify candidates and the candidates’ level of compensation. The executive recruitment business segment is managed by geographic regions. Futurestep’s worldwide operations are managed by an operating group comprised of a president of operations for North America and Asia and a president of operations for Europe. The regional leaders and this operating group report directly to the Chief Executive Officer of the Company.
 
A summary of the Company’s operations (excluding interest income and other income, and interest expense) by business segment follows:
 
    
Three months ended July 31,

    
2002

  
2001

Fee revenue:
             
Executive recruitment:
             
North America
  
$
42,163
  
$
49,822
Europe
  
 
22,164
  
 
27,364
Asia/Pacific
  
 
8,072
  
 
11,003
South America
  
 
2,107
  
 
2,901
Futurestep
  
 
9,444
  
 
13,565
JobDirect
         
 
880
    

  

Total fee revenue
  
 
83,950
  
 
105,535
    

  

Reimbursed out-of-pocket expenses
  
 
5,838
  
 
7,921
    

  

Total revenue
  
$
89,788
  
$
113,456
    

  

 
 
    
Three months ended July 31,

 
    
2002

    
2001

 
Operating profit (loss) before asset impairment and restructuring charges
                 
Executive recruitment:
                 
North America
  
$
3,024
 
  
$
669
 
Europe
  
 
1,322
 
  
 
1,171
 
Asia/Pacific
  
 
(1,164
)
  
 
428
 
South America
  
 
(558
)
  
 
(646
)
Futurestep
  
 
(1,314
)
  
 
(3,744
)
JobDirect
           
 
(3,233
)
    


  


Subtotal operating profit (loss) before asset impairment and restructuring charges
  
 
1,310
 
  
 
(5,355
)
Asset impairment and restructuring charges (Note 4)
           
 
(49,428
)
    


  


Total operating profit (loss)
  
$
1,310
 
  
$
(54,783
)
    


  


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KORN/FERRY INTERNATIONAL AND SUBSUDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)

7.    Summarized Fiscal 2002 Quarterly and Annual Revenue
 
Following are the fiscal 2002 second, third, and fourth quarter and annual results that reflect the restatement to report the Company’s investment in its Mexico subsidiaries under the equity method and reclassification to report reimbursed out-of-pocket expenses “gross” as revenue and expense as discussed in Note 1:
 
    
Restated Fiscal 2002 quarters ended,

  
Restated
Year ended
April 30, 2002

    
October 31

  
January 31

    
April 30

  
Fee revenue:
                             
Executive recruitment
                             
North America
  
$
51,118
  
$
46,156
 
  
$
48,426
  
$
195,522
Europe
  
 
25,221
  
 
20,952
 
  
 
18,561
  
 
92,098
Asia/Pacific
  
 
9,543
  
 
8,655
 
  
 
8,345
  
 
37,546
South America
  
 
2,769
  
 
2,210
 
  
 
2,914
  
 
10,794
Futurestep
  
 
10,086
  
 
8,742
 
  
 
7,686
  
 
40,079
JobDirect
  
 
523
  
 
(17
)
         
 
1,386
    

  


  

  

Total fee revenue
  
 
99,260
  
 
86,698
 
  
 
85,932
  
 
377,425
Reimbursed out-of-pocket expenses
  
 
8,159
  
 
6,078
 
  
 
7,152
  
 
29,310
    

  


  

  

Total revenue
  
$
107,419
  
$
92,776
 
  
$
93,084
  
$
406,735
    

  


  

  

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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.
 
Overview
 
We are the world’s leading recruitment firm with the broadest global presence in the recruitment industry. Our services include executive recruitment, middle-management recruitment (through Futurestep), strategic management assessment and executive coaching. As of April 30, 2002, we had approximately 443 executive recruitment consultants and 81 Futurestep consultants based in nearly 90 offices across 36 countries. Our clients are many of the world’s largest and most prestigious public and private companies, middle-market and emerging growth companies as well as government and not-for-profit organizations. Over half of the executive recruitment searches we performed in fiscal 2002 were for board level, chief executive and other senior executive positions and our 3,908 clients included approximately 35% of the Fortune 500 companies. We have established strong client loyalty; more than 81% of the executive recruitment assignments we performed in fiscal 2002 were on behalf of clients for whom we had conducted multiple assignments over the last three fiscal years.
 
Based on deteriorating economic conditions in late fiscal 2001, we began developing a series of restructuring initiatives in the quarter ended July 31, 2001, to address our cost structure and to reposition the enterprise to gain market share and take full advantage of the eventual economic recovery. Our immediate goals were to reduce losses, preserve our top producers and maintain our high standards of client service. In August 2001, we announced these business realignment initiatives designed to reduce expenses in response to the current economic environment and to reposition our company to take advantage of the increase in the demand for recruitment services when the economy improves. In addition, we implemented additional business realignment initiatives in the fourth quarter of fiscal 2002 primarily to further downsize our operations in Europe and further streamline our Futurestep operations.
 
The total charge related to these initiatives of $93.1 million resulted in charges against earnings in the first, second and fourth quarters of fiscal 2002 of $49.4 million, $34.8 million and $8.9 million, respectively. The charge reflects costs associated with a decision to reduce the workforce by approximately 30%, or over 750 employees; consolidate all back-office functions for Futurestep and Korn/Ferry; exit the college recruitment market and write-down related assets and goodwill.
 
In June 2002, we announced a change in our method of accounting for our ownership interests in our Mexico subsidiaries, which have been part of Korn/Ferry since 1977. Previously, based on our effective economic and management control of these subsidiaries, we had consolidated their operating results with a deduction for the other shareholders’ interest after tax. We now present our economic interests in the after tax operating results of the Mexico subsidiaries as a single line item, “equity in earnings of unconsolidated subsidiaries”, on our consolidated financial statements. This presentation reflects our less than 50% voting interest in the common stock of these entities. There

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was no impact on operating profit, net income, EPS or cash flow as a result of this change; however, revenue and expenses were reduced.
 
Critical Accounting Policies
 
The following discussion and analysis of our financial condition and operating results are based on our 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 period. 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 Consolidated Financial Statements. We consider the policies related to revenue recognition, deferred compensation 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 2002 Annual Report on Form 10-K.
 
New Accounting Pronouncements
 
In November 2001, the Financial Accounting Standards Board (“FASB”) issued Topic No. D-13, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred” that requires presentation of reimbursements received for “out-of-pocket” expenses as revenue and the related expenses as expense in the statement of operations. This topic will be issued as Emerging Issues Task Force Issue No. 01-14 (EITF No. 01-14), is effective for reporting periods beginning after December 15, 2001 and requires prior period results to be reclassified to conform to the new presentation. As discussed in Note 1 to the Consolidated Financial Statements, we implemented this guidance effective May 1, 2002. Accordingly, prior year results reflect the reclassification of “out-of-pocket” expenses, primarily candidate travel expenses, previously reported as a reduction in revenue, to expense. There was no impact on operating profit, net income, EPS or cash flow as a result of the reclassification.
 
The following table illustrates the impact of this reclassification on reported revenue:
 
    
Q1’02

  
Q2’02

  
Q3’02

  
Q4’02

  
Q1’03

    
(dollars in thousands)
    
Revenue
  
$
113,456
  
$
107,419
  
$
92,776
  
$
93,084
  
$
89,788
Less: reimbursed candidate out-of-pocket expenses
  
 
3,919
  
 
2,930
  
 
3,005
  
 
2,990
  
 
2,630
    

  

  

  

  

Net revenue, historical presentation
  
 
109,537
  
 
104,489
  
 
89,771
  
 
90,094
  
 
87,158
Less: reimbursed company and consultant out-of-pocket expenses
  
 
4,002
  
 
5,229
  
 
3,073
  
 
4,162
  
 
3,208
    

  

  

  

  

Fee revenue
  
$
105,535
  
$
99,260
  
$
86,698
  
$
85,932
  
$
83,950
    

  

  

  

  

 
Results of Operations
 
The following table summarizes the results of our operations with Mexico on an equity basis for the three months ended July 31, 2002 and 2001 as a percentage of fee revenue:
 
      
Three months ended July 31,

 
      
2002

      
2001*

 
Total revenue
    
107
%
    
107
%
Fee revenue
    
100
 
    
100
 
Compensation and benefits
    
71
 
    
71
 
General and administrative expenses
    
22
 
    
30
 
Out-of-pocket expenses
    
7
 
    
7
 
Depreciation and amortization
    
5
 
    
4
 
Asset impairment and restructuring charges
             
47
 
Operating profit (loss)
    
2
 
    
(52
)
Net loss
    
(1
)
    
(44
)

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Table of Contents

*
 
Operating loss, excluding impairment and restructuring charges, as a percentage of fee revenue for the three months ended July 31, 2001, is 5%. On this same basis, net loss as a percentage of fee revenue is 2% for the three months ended July 31, 2001.
 
The continued weakness in the global economy has resulted in decreases in fee revenue in all of our business lines and geographic regions compared to the same period last year:
 
Executive recruitment fee revenue declined in all geographic regions in the three months ended July 31, 2002 compared to the same period last year. The decline is due primarily to the economic slowdown in the United States and Europe that contributed to a decline in executive recruitment fee revenue of $7.7 million, or 15%, in North America and $5.2 million, or 19%, in Europe for the current year three month period compared to the same three month period in the prior year. Even though fee revenue declined, operating profit increased $1.0 million to $2.6 million in the current three month period from $1.6 million in the prior year first quarter. This increase reflects an increase in North America of $2.4 million, primarily attributable to the benefits of our fiscal 2002 cost savings initiatives offset by a decrease in Asia/Pacific of $1.6 million to an operating loss of $1.2 million due primarily to the relatively smaller decrease in costs compared to fee revenue.
 
Futurestep fee revenue declined $4.1 million, or 30%, for the three months ended July 31, 2002 compared to $13.6 million in the prior year first quarter and reflects a decline in all geographic regions primarily attributed to the weakness in the global economy. As in executive recruitment, the lower cost structure resulting from our fiscal 2002 restructuring initiatives more than offset the decline in fee revenue resulting in a decrease in the operating loss of $2.4 million to $1.3 million for the current three month period.
 
The following tables summarize the results of our operations by business segment with Mexico on an equity basis. As a result of our change in accounting for our Mexico operations, we have renamed our Latin America segment South America. The South America business segment excludes Mexico fee revenue of $3,591 and $4,714 and operating profit of $1,509 and $2,233 in the three months ended July 31, 2002 and 2001, respectively. The operating margin is calculated based on fee revenue.
 
    
Three Months Ended July 31,

 
    
2002

    
2001

 
    
Dollars

  
%

    
Dollars

  
%

 
    
(dollars in thousands)
 
Fee revenue
                           
Executive recruitment:
                           
North America
  
$
42,163
  
50
%
  
$
49,822
  
47
%
Europe
  
 
22,164
  
26
 
  
 
27,364
  
26
 
Asia/Pacific
  
 
8,072
  
10
 
  
 
11,003
  
10
 
South America
  
 
2,107
  
3
 
  
 
2,901
  
3
 
Futurestep
  
 
9,444
  
11
 
  
 
13,565
  
13
 
JobDirect
                
 
880
  
1
 
    

  

  

  

Total fee revenue
  
 
83,950
  
100
%
  
 
105,535
  
100
%
    

  

  

  

Reimbursed out-of-pocket expenses
  
 
5,838
         
 
7,921
      
    

         

      
Total revenue
  
$
89,788
         
$
113,456
      
    

         

      

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Three Months Ended July 31,

 
    
2002

    
2001

 
    
Dollars

    
Margin

    
Dollars

    
Margin

 
    
(dollars in thousands)
 
Operating profit (loss) before asset impairment and restructuring charges
                               
Executive recruitment:
                               
North America
  
$
3,024
 
  
7
%
  
$
669
 
  
1
%
Europe
  
 
1,322
 
  
6
 
  
 
1,171
 
  
4
 
Asia/Pacific
  
 
(1,164
)
  
(14
)
  
 
428
 
  
4
 
South America
  
 
(558
)
  
(26
)
  
 
(646
)
  
(22
)
Futurestep
  
 
(1,314
)
  
(14
)
  
 
(3,744
)
  
(28
)
JobDirect
                  
 
(3,233
)
      
    


  

  


  

Subtotal
  
 
1,310
 
  
2
 
  
 
(5,355
)
  
(5
)
Asset impairment and restructuring charges
                  
 
(49,428
)
  
(47
)
    


  

  


  

Total operating profit (loss)
  
$
1,310
 
  
2
%
  
$
(54,783
)
  
(52
)%
    


  

  


  

 
The asset impairment and restructuring charges for the three months ended July 31, 2001 included: $12,214 in North America, $1,778 in Europe, $57 in Asia/Pacific, $6,428 in Futurestep and $28,951 in JobDirect.
 
In the following comparative analysis, all calculations are based on dollars in thousands.
 
Three Months Ended July 31, 2002 Compared to Three Months Ended July 31, 2001
 
Fee Revenue.    Fee revenue decreased $21.6 million, or 20%, to $83.9 million for the three months ended July 31, 2002 from $105.5 million for the three months ended July 31, 2001. The decrease in revenue was primarily the result of a decrease in demand reflecting continued weakness in the global economy experienced throughout fiscal 2002.
 
Executive Recruitment—All geographic regions reported lower fee revenue in the three months ended July 31, 2002 compared to the comparable period in the prior year. North America experienced the largest decline in fee revenue of $7.7 million, or 15%, to $42.2 million in the first fiscal quarter of 2003, due primarily to a decrease in demand while average fees remained constant. Europe reported fee revenue of $22.2 million, a decline of $5.2 million, or 19%, compared to the prior year driven primarily by a decrease in the number of engagements while average fees increased slightly. The decline in volume in Europe in the current year first quarter compared to the prior year first quarter was partially offset by the favorable impact of exchange rate fluctuations on translation into U.S. dollars of approximately 7%. Asia/Pacific fee revenue declined $2.9 million, or 27%, to $8.1 million primarily due to a decrease in demand across the region with minimal impact from local currency translation in this period. South America reported fee revenue of $2.1 million, a decline of $0.8 million, or 27%, compared to the prior year first quarter, primarily due to the unfavorable impact of exchange rate fluctuations in Brazil.
 
Futurestep—Fee revenue decreased $4.1 million, or 30%, to $9.4 million in the three months ended July 31, 2002 from $13.6 million in the three months ended July 31, 2001 across all geographic regions. Of the total decrease in fee revenue, North America declined $1.4 million, or 41%, Europe declined $2.0 million, or 24%, and Asia/Pacific declined $0.7 million, or 38%. The decrease includes the favorable impact from translation of local currency revenue into U.S. dollars of approximately $0.7 million.
 
JobDirect—In fiscal 2002, we decided to reduce our investment in the college recruitment market in the first quarter and ultimately exit this market in the third quarter. In the three months ended July 31, 2001, we recognized impairment charges of $29.0 million representing substantially all of the unamortized goodwill resulting from our acquisition of JobDirect in July 2000.
 
Compensation and Benefits.    Compensation and benefits expense decreased $15.6 million, or 21%, to $59.5 million in fiscal 2003 from $75.1 million in fiscal 2002. The decrease in executive recruitment compensation and benefits costs of $10.0 million quarter over quarter reflects a 30% reduction in our workforce in the last half of fiscal 2002. Executive recruitment compensation and benefits expense as a percentage of fee revenue increased to 71% in the three months ended July 31, 2002 from 69% in the comparable period in fiscal 2002. Futurestep compensation and benefits expense declined $3.8 million, or 37%, to $6.5 million in the current three month period compared to the prior year quarter reflecting a 46% decrease in the number of employees for the last half of the current year, largely in the

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United States. As a percentage of fee revenue, Futurestep compensation and benefits expense was 69% in the current three month period an improvement of 7% compared to 76% in the prior year comparable quarter.
 
General and Administrative Expenses.    General and administrative expenses decreased $13.3 million, or 42%, to $18.7 million in the first fiscal quarter of 2003 from $32.0 million in the first fiscal quarter of 2002. In executive recruitment, general and administrative expenses decreased $8.6 million, or 36%. The largest decline was in facilities and office costs resulting from the restructuring initiatives implemented in fiscal 2002. Futurestep general and administrative expenses decreased $2.7 million, or 47%, mainly due to reduced office costs, professional fees and advertising expenses that are also primarily attributable to the fiscal 2002 restructuring. As a percentage of fee revenue, general and administrative expenses in executive recruitment, decreased to 21% in the current year first fiscal quarter from 27% in the comparable period in fiscal 2002. Futurestep general and administrative expenses as a percentage of fee revenue decreased to 33% in the current year first fiscal quarter from 43% in the comparable period in the prior year.
 
Out-of-Pocket Expenses.    Out-of-pocket expenses are comprised of engagement related expenses incurred by candidates and our consultants that are generally billed to clients. Historically, we have netted candidate out-of-pocket expenses against revenue and reported consultant out-of-pocket expenses as general and administrative expenses. We adopted EITF No. 01-14 effective May 1, 2002, which requires the classification of out-of-pocket expenses, “gross” on the statement of operations as revenue when billed and expense when incurred. Accordingly, candidate out-of-pocket expenses reported as a reduction in revenue in prior periods were reclassified from revenue to out-of-pocket expenses to reflect this new presentation.
 
Out-of-pocket expenses of $6.1 million in the current three month period decreased $1.5 million, or 20%, from $7.6 million in the same period last year. As a percentage of fee revenue, out-of-pocket expenses remained constant at 7% in both three month periods.
 
Operating Profit.    Operating profit was $1.3 million in the current year first fiscal quarter compared to a loss of $54.8 million in the prior year first fiscal quarter. Excluding the asset impairment and restructuring charges in the three months ended July 31, 2001 of $49.4 million, operating profit increased $6.7 million from a loss of $5.4 million in the same quarter last year. Executive recruitment operating profit, on this same basis, increased to $2.6 million, or 4% of fee revenue, from $1.6 million, or 2% of fee revenue, in the three months ended July 31, 2001. This increase was driven primarily by North America with improvement of $2.4 million that reflects the benefits of the reduced cost structure and efficiencies resulting from the fiscal 2002 restructuring initiatives that more than offset the decline in revenue and resulted in an increase in the operating margin of over 5%. The increase in North America was partially offset by a decline in Asia/Pacific of $1.6 million to a loss of $1.2 million in the current three month period.
 
Futurestep operating losses, excluding asset impairment and restructuring charges in the prior year first fiscal quarter, improved by $2.4 million, or 65%, reflecting the reduced compensation and benefits costs and general and administrative expenses discussed above. The operating loss was reduced to 14% of fee revenue in the current three month period from 28% of fee revenue in the same quarter last year and reflects the larger percentage decrease in costs compared to revenue.
 
Interest Income and Other Income, Net.    Interest income and other income, net includes interest income of $0.4 million and $0.8 million for the three months ended July 31, 2002 and 2001, respectively. The decrease in interest income of $0.4 million is due primarily to a lower average cash balance compared to the prior year. The increase in other income is due primarily to an increase in recognized foreign exchange gains of $0.6 million on a U.S. dollar investment in Brazil and a decrease in losses on the disposal of property of $0.1 million in the current three month period compared to the prior year three month period.
 
Interest Expense.    Interest expense increased $1.1 million in the current fiscal quarter, to $2.6 million from $1.5 million in the prior fiscal quarter, primarily due to an increase in average borrowings under the line of credit, the higher effective interest rate in the second quarter of fiscal 2002 and interest on convertible debt from June 13, 2002.
 
Provision for (Benefit from) Income Taxes.    The provision for income taxes was $0.6 million in the current three month period compared to a benefit of $8.1 million in the prior year three month period. Although we reported a pretax loss in the current quarter, some of our foreign subsidiaries reported pretax income resulting in foreign income tax expense. The effective tax rate was 15% for the three months ended July 31, 2001 primarily due to non-deductible asset impairment charges.
 
Equity in Earnings of Unconsolidated Subsidiaries.    Equity in earnings of unconsolidated subsidiaries is comprised of our less than 50% shareholder interest in our Mexico subsidiaries. In fiscal 2002, we changed the presentation of

16


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our investment in Mexico from the consolidation method to the equity method. Under the equity method, we report our interest in the earnings or loss of the Mexico subsidiaries as a one line adjustment to net income. Previously, we reported all of the revenue and expenses of these subsidiaries offset by a one line adjustment for the other shareholders’ interests. Equity in earnings was $0.4 million in the current three month period and $0.5 million in the prior three month period.
 
Liquidity and Capital Resources
 
In June 2002, we closed a $50.0 million private placement with Friedman, Fleischer & Lowe, a San Francisco based private equity firm, comprised of $40.0 million 7.5% Convertible Subordinated Notes; $10.0 million 7.5% Convertible Preferred Stock and warrants to purchase 272,727 shares of our common stock at an exercise price of $12 per share. Interest and dividends are payable semi-annually in either additional Notes and Preferred Stock or cash, at our option, except for the first two years from the date of issuance during which 1% must be paid in cash. The Notes and Preferred Stock are convertible into shares of our common stock at $10.25 per share which if converted would represent approximately 4.9 million shares or 11.4% of our outstanding common stock.
 
In the first half of fiscal 2002, we were in default under our credit agreement with Bank of America. In March 2002, we reached an agreement to amend our credit facility from $100.0 million to $45.0 million, to waive prior defaults, to secure it by certain assets and to amend our financial covenants to make compliance more achievable going forward. The financial covenants include a minimum fixed charge coverage ratio, a maximum leverage ratio, a quick ratio and other customary events of default. The amended agreement required payment of a fee of $1.0 million at inception. We paid additional fees of $0.5 million in June 2002 and the remaining fees of $1.0 million were waived upon completion of the private placement. In June 2002, the credit facility commitment was reduced from $45.0 million to $31.2 million. There were no outstanding borrowings under the facility at July 31, 2002. Outstanding credit facility borrowings bear interest at Prime plus 3.75% under the amended agreement. We are seeking to refinance or replace this facility before its maturity in November 2002.
 
We believe that cash on hand and funds from operations will be sufficient to meet our anticipated working capital, capital expenditures and general corporate requirements for the foreseeable future.
 
Cash used in operating activities was $6.8 million in the current three month period and $84.4 million in the same period last year. Our largest cash requirement in the first fiscal quarter is generally the payment of the prior year accrued bonus. In the current three month period, the payment of accrued bonuses for fiscal 2002 was partially offset by an income tax refund of $17.6 million. In the prior year first fiscal quarter, cash used in operating activities was due primarily to the payment of bonuses.
 
Cash used in investing activities was $2.6 million, for the current three month period compared to cash provided of $5.4 million for the three months ended July 31, 2001. In the three months ended July 31, 2002, cash used in investing activities was primarily for premiums on company owned life insurance, or COLI, policies of $2.4 million. In the prior year three month period, cash provided by investing activities included proceeds from the sale of marketable securities of $13.0 million offset by $5.1 million for purchases of property and equipment and $2.5 million for COLI premiums. The COLI premiums were funded through borrowings under these life insurance policies in both the current and prior year three month periods.
 
Capital expenditures consist primarily of systems hardware and software costs, upgrades to information systems and leasehold improvements. The decrease in the current three month period of $4.9 million compared to the same period last year reflects reduced spending in line with our cost saving initiatives.
 
Cash provided by financing activities was $5.0 million and $53.4 million during the three months ended July 31, 2002 and 2001, respectively. In the current three month period, we received net proceeds of approximately $45.7 million from the issuance convertible securities and paid the net outstanding borrowings of $39.0 million on our credit facility. In the prior year three month period, we borrowed $52.0 million on our credit line, primary for the payment of fiscal 2001 bonuses.
 
Total outstanding borrowings under COLI policies were $60.6 million and $50.4 million as of July 31, 2002 and 2001, respectively. Generally, we borrow under our COLI policies to pay 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 $113.1 million and $104.8 million at July 31, 2002 and 2001, respectively.

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Recently Issued Accounting Standards
 
In July 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement requires that a liability for costs associated with an exit or disposal activity, including certain restructuring costs, be recognized and measured initially at fair value only when the liability is incurred. Previously these liabilities were recognized at the date an entity committed to a plan and measurement at fair value was not required. This statement is effective prospectively for exit and disposal activities initiated after December 31, 2002 with earlier application encouraged. The Company does not believe that the adoption of this statement will have a significant impact on the Company’s financial position or results of operations.
 
In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. We do not believe that the adoption of this statement will have a significant impact on the Company’s financial position or results of operations.
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk
 
As a result of its 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.    Generally, financial results of 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.
 
Financial results of foreign subsidiaries in countries with highly inflationary economies are measured in U.S. dollars. The financial statements of these subsidiaries are translated using a combination of current and historical rates of exchange and any translation adjustments are included in determining net income.
 
Historically, we have not realized any significant translation gains or losses on transactions involving U.S. dollars and other currencies. This is primarily due to natural hedges of revenue and expenses in the functional currencies of the countries in which our offices are located and investment of excess cash balances in U.S. dollar denominated accounts. In the three months ended July 31, 2002, we recognized foreign currency gains, after income taxes, of $ 1.7 million, primarily related to our operations in Europe and South America, and during the three months ended July 31, 2001, we recognized foreign currency losses, after income taxes, of $0.2 million, primarily related to our Europe and South America operations. Realization of translation gains or losses due to the translation of intercompany payables denominated in U.S. dollars is mitigated through the timing of repayment of these intercompany borrowings.
 
Interest Rate Risk.    We primarily manage our exposure to fluctuations in interest rates through our regular financing activities that generally are short term and provide for variable market rates. Currently, we have all of our investments in interest bearing money market accounts at market rates. As of July 31, 2002, we had no borrowings outstanding on our revolving line of credit. The revolving line of credit bears interest at Prime plus 3.75%. We had $60.6 million of borrowings against the cash surrender value of COLI contracts at July 31, 2002, bearing interest primarily at variable rates payable at least annually.
 
Notes payable due to shareholders at July 31, 2002 of $7.7 million and $1.5 million due in fiscal 2003 and 2004, respectively, resulted from business acquisitions in fiscal 2000 and 2001 and bear interest at rates ranging from 6.5% to 7.0%. 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 outstanding on June 13, 2010. Interest is payable in either cash or additional securities at our option except for 1% payable in cash for the first two years.

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PART II.    OTHER INFORMATION
 
Item 6.    Exhibits and Reports on Form 8-K
 
(a)  Exhibits
 
None.
 
(b)  Reports on Form 8-K
 
Current report event, dated June 13, 2002, (Items 5 and 7) was filed with the SEC on June 18, 2002.

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SIGNATURE
 
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
By:
 
/s/    GARY D. BURNISON        

   
Gary D. Burnison
Executive Vice President and Chief Financial Officer
 
Date:  September 13, 2002

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CERTIFICATIONS
 
I, Paul C. Reilly, certify that:
 
1.  I have reviewed this quarterly report on Form 10-Q of Korn/Ferry International;
 
2.  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; and
 
3.  Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.
 
By:
 
/s/    PAUL C. REILLY        

   
Paul C. Reilly
Chairman and Chief Executive Officer
 
Date:  September 13, 2002
 
I, Gary D. Burnison, certify that:
 
1.  I have reviewed this quarterly report on Form 10-Q of Korn/Ferry International;
 
2.  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; and
 
3.  Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.
 
By:
 
/s/    GARY D. BURNISON        

   
Gary D. Burnison
Chief Financial Officer and Executive Vice President
 
Date:  September 13, 2002

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