Franklin Covey Co (FC) 2007 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to FranklinCovey Company's third-quarter 2007 earnings conference call. My name is Geena and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today's conference (OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded for replay purposes. I would now like to turn today's presentation over to your host, Mr. Richard Putnam, Vice President of Investor Relations. Please go ahead, sir.

Good morning shareholders and interested parties. We would like to welcome you to our FranklinCovey third quarter fiscal 2007 conference call and web cast. My name is Richard Putnam. You're currently in a listen-only mode to prevent background noise. We will give you instructions for asking questions at the end of Mr. Whitman's presentation. You will need to dial into the conference call in order to ask questions, and that number is 866-383-8108; the access code is 10957569.

I would like to introduce those that will be participating on this morning's conference call -- Mr. Bob Whitman, CEO and Chairman of the Board; Bill Bennett, President of our Organizational Solutions Business Unit; Sarah Merz, President of our Consumer Solutions Business Unit; and Steve Young, who is off-site but will be joining us via conference call this morning.

Before I turn the time over to Mr. Young to review the financials and in light of regulation FD, this presentation is being web cast and can be accessed at FranklinCovey.com. You would note that this presentation may contain forward-looking statements as defined in the Securities laws that are based upon certain assumptions and are subject to certain risks and uncertainties that could cause results to vary from management's current expectations. This first slide in the packet is a Safe Harbor statement that outlines some of those risks and uncertainties. We would encourage you to become familiar with those risks and uncertainties which are outlined in our Form 10-K filed with the SEC for the year ended August 31, 2006, and any subsequent 10-K, 10-Q and 8-K filings. Copies of all recent filings with the SEC and additional information about FranklinCovey are available at out web site, franklincovey.com.

Some of the numbers we will discuss this morning have not been audited by KPMG, the Company's external auditors. We assume no obligation to update the matters discussed in this call. It is also illegal to record this call without the Company's permission.

There are a number of slides that we will be reviewing this morning in discussing and discussing during the call and they can be accessed at our investor relations page at franklincovey.com.

I would now like to turn the time over to Mr. Young, CEO of Franklin Covey. Mr. Young?

Thank you, Richard. It's very nice to be with you this morning. I'm going to summarize our financial result for the third quarter before Bill and Sarah give more detail about the training and product business operations.

I am happy to report that our third quarter financial result of operating income was $3.8 million higher than last year. Those who were on the call last quarter would remember that, even though we were behind the prior year through our first half, we were optimistic about the third and fourth quarter and reported that we expected our financial result by the end of the year to be higher than last year. So I am pleased to report that through the third quarter, we have achieved that and we expect to maintain that in the fourth quarter. So again, in our third quarter, we're happy to report that our operating income, or income from operations, was $3.8 million higher than last year, and that gives us a result that is $2.2 million higher than the year before, year-to-date.

This result is created by several positive things. First of all, you'll notice that our sales overall have improved a little bit, both for the quarter and year-to-date. You will also notice that our gross profit percentage is significantly higher this quarter than it was for the same quarter last year, and it is also a bit higher year-to-date, compared to the gross profit percentage last year. This is a result of several things. You might also notice that our gross profit percentage for the quarter and for year-to-date is essentially the same number.

Our gross profit percentage is high because of our mix between our training and our product business, a mix shift toward training. There is also a mix shift, if you will, within the training business and within the product business, both of which have been positive and have increased this gross margin percentage compared to the prior year, which in the third quarter, also included a $0.5 million negative adjustment, if you will, related to our Mexico operation, as you remember. So we're very pleased with our gross profit percentage this quarter and pleased that our revenues, particularly in the OS -- in the training business OSBU have increased significantly compared to the prior year, and Bill will talk more about that.

So in my mind as we anticipated, it was a good quarter with respect to our operating income. I think you'll also notice on our financial statement that our tax expense and benefit that we have talked about each quarter this year continues to be an item that we should note. This year, our effective tax rate is what I would call a normal rate for us. It is -- our tax rate is a little bit high because of timing differences that we have, but it's the normal rate for us, compared to the tax expense and benefit last year, which was impacted significantly by the fact that we were consuming net operating loss carryforwards that had valuation allowances against them. So as you would notice in our year-to-date result last year, we had pre-tax income of more than $13 million, but only $300,000 of tax expense.

So, this year, I would term more our normal year. The prior-year comparison is accurate but unusual because of the nature of our net operating loss carryforward consumption.

Also, I would like to remind everyone that, even though it seems like quite some time ago, it was in the third quarter that we completed the redemption of our preferred stock, 37.3 million, plus accrued dividends. That means that our preferred stock dividend line, while having an amount of $300,000 in this quarter and $2.2 million year-to-date, that will be zero in future quarters due to the redemption of our preferred -- of the remainder of our preferred stock. In order to accommodate or allow us to complete that redemption, we entered into lines of credit totaling $25 million. At the end of the quarter, we had borrowed $17.8 million against those, that line of credit or those lines of credit.

So, I guess the summary of this quarter is that it's quite similar to what we expected for the quarter. We anticipated that we would have a good result. We have a good result being $3.8 million better than last year, our operating income line. We're pleased with the redemption of the preferred. We understand our income taxes, and in summary, in my mind, we had a good quarter.

So, I would turn the time over to Bill or Sara to talk in more details about the operation. Thank you.

Thank you, this is Bill Bennett, President of the OSBU. I appreciate the time to be with all of you today and to make a few comments about what has happened in the division, the quarter and year-to-date.

First of all, I would just like to mention how pleased we were with the results for the quarter. In Q3, we grew approximately 14% on the top line at a divisional level and that brings us now to 16% year-to-date. The bottom-line, an EBITDA level for Q3, we grew 313%. And while that number is wonderful, keep in mind that we had the unfavorable activity last year with Mexico which caused a very favorable year-over-year comp on the bottom-line. However, even extracting that, the impact of Mexico from last year's number, the bottom-line grew 175%. So strong bottom-line growth for the division. And that brings the bottom-line performance year-to-date in OSBU up to 48% growth year-over-year.

In addition, profit as a percent of revenue grew substantially for the quarter and maintains very strong growth on a year to date basis. And in our revenue-generating operations, we had both domestic and international growing at double-digit percentages at almost 12% domestically and 13.5% internationally, respectively.

Our third revenue-generating operation, which is the Sales Performance Group, SPG, was flat in the third quarter on revenue growth. However, on a year-to-date basis, they are up 30% after very strong Q1 and Q2 performances.

So, overall on a financial performance standpoint, we're very pleased with the quarter and our current year-to-date position. As you know from previous calls, this year and the last couple of years and for the next couple of years to come, the prime growth strategy for OSBU is driven off the first key bet of adding new revenue-generating people in the field, more client partners. The intention is to double the client-partner count that we started with in fiscal '05 by the time we get to fiscal '10. That bet is a substantial contributor, the primary contributor in fact, to the overall growth bet to the organization.

The second key bet is, while doing that, to keep the performance of our alumni CPs, or our salespeople that were in place, prior to the time we began this new hiring effort at an overall average basis growing at least 5% a year. And third, while holding the costs down across the rest of the division with the only exception of some substantial investments we've made over the last few years in innovation and developing new products.

So, turning to the momentum slide, you can see that report on each of those bets, but the net result of staying ahead on all those bets is that our momentum, our rolling 12-month momentum, or in other words sales booked versus what we have delivered, has continued to grow substantially, now about $8 million over prior year. That is a measure of course of the days, the value of the days we book and total value of contracts booked for delivery at a later time.

Specifically on the bets, on the next page, you can see the new client-partner performance to ramp, and that's on a this-year basis. Both domestically and internationally, we remain ahead of the ramp plan. The ramp plan is, I would say, a fairly aggressive plan. So we're very pleased to be able to stay above the five-year documented ramp rate that we're trying to (technical difficulty) and we're of course almost three full years into that at this point with our new people.

On an alumni basis, the client partners that were here prior to the hiring effort, we also have remained ahead of that plan. As I've said, that we wanted to stay at least on an average basis 5% year-over-year growth across that entire group, and we are running at about 11%. So that remains in place as well.

Finally, I'd mention, from a cost standpoint, we've done a great job keeping the costs under control. We have -- that is evidenced certainly by the improvement of EBITDA as a percent of revenue, but also of continued performance on costs better than our budgeted plans. So our teams have been able to keep that slightly under the spend objective which has helped the overall model.

So we feel good about the performance. The key bets that we've put in place are functioning well. Probably the only other one I should mention for which we don't have a chart as I mentioned a second ago that this also includes investment over the last few years in new products. The new products that we've shipped are doing extremely well. The leadership offering is one of the best launches we've ever had in the new product and we have continued progress on some of the others. So overall, I think a strong picture for OSBU.

With that, I will turn it over to my colleague, Sarah Merz.

Thank you, Bill. Good morning, everyone. This is Sarah Merz, President of the Consumer Business Unit, and I'm happy to report to you the results of the third quarter for the CSBU. I'm going to address each of our channels in turn, starting with retail stores.

As many of you know, our retail chain is now composed of 87 stores and we, like many other specialty retailers, went into this year knowing that traffic was going to be the challenge, that traffic continues to be strong in the retail sector. So we placed three key bets for the year, two of which focused on the optimizing the customer interaction inside the store and one which was outreach to reach outside the four walls of the store. The key bets internally were that when the customer came in the store, a greater percentage of them would buy a complete planning solution as opposed to maybe just a refill for their planner and we set a mark that at least 13% of all transactions had to include a build-your-own system bundled sale.

In the third quarter, we achieved 14% build-your-own system as a percent of sales, so we hit that mark. The second key bet was that, when the customers came in the store, that we would engage with them on our FranklinCovey training, knowing that that made them a stickier customer, more enthusiastic about the methodology and increased the customer lifetime value. Our mark was to increase our public program workshop sales by 22%, and we are happy to report in the third quarter that those sales actually grew 118%.

The remaining bet is outreach, and the challenge here is to have our stores become more local sales centers and move outside of the store and spread the word about FranklinCovey to self-generate traffic. We are finding that about a quarter of the stores have done a great job of that and they are holding the line or growing the top line through their outreach initiatives, with about another quarter of the stores slightly below the line, but still doing quite a bit of outreach. And the challenge for us is to really now institutionalize what we're seeing a quarter of the stores do across the entire chain.

So that continues to be a key bet. It's an area that has a lot of focus and training and tracking and will likely be that for quite a while to come as traffic continues to be a challenge.

Retail stores in total did experience sales softness, but at the profitability line, they are running the same as last year, year-to-date, on EBITDA.

Moving on to Consumer Director, which is the combination of our call center and our e-commerce site, our strategy for many years has been to move from calls to clicks and drive people to the web site where there is 24-by-7 accessibility. We're seeing in Consumer Director that conversion rate has been a little bit softer than we had all anticipated and we're seeing a little bit of softness in user sessions. And so the challenge there has been to put initiatives in place not only on our user sessions or calls, but our conversion rate and our average ticket.

With that understanding, we have had several initiatives in place, some of which have moved the user sessions up and have increased the average ticket, and so the challenge will continue to be to push up the conversion rate which is such a sensitive but very powerful driver on the business.

One of the things that we're very happy to report is that our ability to take retail customer information and convert that to e-mails is becoming more and more of a reality every day as our outside direct marketing partners are able to match back customer data to current e-mail addresses. And so we are working very hard to gather the information from all of our customers and other channels so we can also converse with them in our consumer direct channels. So we're working on gathering new names with each week that passes and continuing to work on segmentation. We have a new outsource partner, [Epsilon], who is helping us with our e-mail segmentation capabilities and that is a critical element of increasing conversion rate. So that is Consumer Direct.

For Wholesale, Wholesale was one of the key bets for the year and it is on track. We're happy to report there is strong growth both at the top line and at the bottom line. In managing the wholesale business, we look both at the number of outlets that are carrying FranklinCovey product, and that has grown significantly over the last three to four years and the opportunity to find new outlets for FranklinCovey product. So we look at sales per existing and the growth of new outlets. We are delighted that our distribution partners report strong sell-through. They have strong forecast that has led to healthy orders to fill the pipeline and we are seeing, particularly with some of our new products, faster-than-anticipated turns. So we continue to do quite a bit of product innovation and have launched over the last few years and continue to support several new sub-brands of FranklinCovey, including 365 at Target and Day One at Wal-Mart. So Wholesale was a key bet and is continuing to generate the desired growth in top and bottom line.

Finally, International. International is an area that the CSBU has focused on really for the first time this past year in a more direct way, and with an area where there was softness for several years on the product side, and we are happy to report that that has leveled off. The performance year-over-year on the top and the bottom line has held and there are significant opportunities internationally that we're very enthusiastic about and are investing a lot of time and energy to pursue both in our direct offices as well as with our fairly extensive network of licensees worldwide. So we are working directly with the licensees to grow consumer businesses that will support the robust training businesses that already exist and we're looking at new distribution partner opportunities internationally as well.

So those are the four areas to update you all on in the CSBU, and we look forward to continued fiscal year.

Thanks, Sarah. This is Bob Whitman. I will really just open at the time here now for Q&A. I might just make a couple of comments prior to doing that.

First of all, express appreciation and admiration to Sarah and Bill for the way in which they are running their businesses. And I think the idea that these fundamental bets that we at least understand what they are, in most of them we are making progress. If we're not, there is such a focus on improving them that, as Sarah mentioned, even in this outreach initiative, we do have a good share of our stores that are getting it and others that are close and the rest that will. And they have done a great job at execution.

Maybe worthwhile noting that from their perspective on to the consumer side, these key bets about which Sarah spoke, these are ones that we feel good about our ability to execute on over the immediate term, and generally the idea that we can have these millions of customers come into our retail stores which some people worry about the investment sector, but they've been -- it's a profitable operation. It produces brand value business that then supports both our Consumer Direct and Wholesale operations, as well as the ability to distribute our brand internationally. And so we feel good about -- the key bet is of course this ability to get outreach sales that some of which in most retailers is not in the DNA. But as a Company, we have it in our DNA because the OSBU is all outbound direct selling. And certainly at this point, in this last quarter, there has been really significant store-by-store increases in outbound selling, almost a 60% increase in the average store outbound sales in the third quarter. And while some of our wholesale operations are in fact we believe hurting traffic in our retail locations, if we can make this outbound effort work, we then win on both sides. We get both the wholesale profitability and have a profitable retail operation as well.

The key overall initiative for growth being the new client partners and the productivity, our (inaudible) client partner, we had just wonderful salespeople and client partners and consultants who represent us out in the market. And I think a reflection of their capability as well as the efficacy of our offerings and solutions is driving the growth there.

Finally on the recap side, we are happy to [have] really completed one aspect of the recapitalization which we've been working on for the last several years. First, bifurcating the convertible preferred into the straight preferred and warrants, then retiring the warrants. And we've also purchased of course some common shares, but we're now in a position where going forward, we expect by calendar year end that we will have retired any outstanding amounts on our credit line, and we'll be in a position then where all excess cash to be applied to other investments to grow the Company or to repurchase shares.

I will now open the time -- I will turn it back to you, Richard, to give instructions about opening it for questions.

Geena will give us the instructions.

(OPERATOR INSTRUCTIONS). Russ Silvestri, Skiritai Capital.

I had a couple of questions. First of all, I was just curious -- why now on the preferred stock? While do you retire it now?

As opposed to later in the year, you mean, or not at all?

Exactly, not at all or later in the year.

Two things. One, the preferred has always had a coupon rate of 10%, and that coupon rate is of course paid in after-tax dollars because it's preferred dividend. So that is a relatively -- it was a great piece of capital to have to stabilize the Company and so forth, but it's relatively inexpensive. The second is that, our window for redeeming the preferred, if we were ever going to therefore get rid of the preferred dividend, that closes this December. And so the idea is, of course we think that you can get an immediate after-tax return of 10%, create -- get more of the cash flow of the Company going to common shareholders, and we needed to take advantage of it if we were going to do it this year so that we could have it done before December. We would then -- it would be close to prepayment for another five years.

Okay. And then, in terms of the interest you will be paying on the $17.8 million I guess debt looking at -- that's like a 6.4% I think I saw it in the Q?

Yes, but the 6.4% pre-tax, and so the after-tax cost of that is less than 4% compared with the after-tax of 10% for the preferred.

Right. So it's going to cost you like $1.1 million, $1.2 million a year kind of thing?

Yes, as I mentioned, we went into the line simply to retire all of the preferred, but we expect to be out of the line [herein]. So I think it's a short-term borrowing cost with a positive arbitrage in the short run and a hugely positive arbitrage in the long run.

Gotcha. And then also, in the Q, I noticed you sold your manufacturing plant and had a gain of $1.2 million?

Yes.

Where does that show up on your income statement? Does that just impact gross margin positively?

Bob, notice on income statement that it's a separate line item just above depreciation. It's a 1.227.

Okay, I see it over there on the far right, okay.

Yes, that's the gain.

But that's for the three quarters ended. Was that not recognized in this quarter?

It was in the Q2.

Alright, I was a little confused on that. And then, how many total headcount do you guys have in terms of salespeople?

There are different ways of adding that up. Bill can probably give you an exact number.

I'm more interested on the consulting side.

On the organizational side, domestically, we have around 74; internationally, we have about 40 in our direct top business. In our Sales Performance Group, we have another eight, and then through our licensee partners, in their operations, there are approximately another 200. So depending on how you count it, those are the different pieces.

Okay. Lastly, I'm not that familiar -- I've just started getting involved in the story. The EDS contract I noticed, it starts to go down in the future. When does that contract get negotiated?

We have a long-term agreement with EDS. We have a right to buy our way out of the contract that declines every year if we were to choose to do that, but we've recently renegotiated with EDS and they were very helpful in there, frankly. But recognizing that just a shift of our business toward the OSBU from the CSBU where originally, the contract was written -- where -- to support a much larger consumer operation. And so, there are three different contracts, as you probably know. One is the information -- the general IT contract, the second one is our call center contract and the third is our warehouse and distribution contract. And each of them has slightly different -- they have a different set of terms, and also a slightly different duration. But in general, we have -- these are long-term agreements. We have many years still remaining on them, and -- but as our business shifts, we don't weight to any specific point. We start having discussions, and then if anything changes, then hopefully we can work things through as have in the past with them.

Okay. So just if the retail sales will continue to be adversely impacted, you have the facility or an ability to reduce your basic cost with these folks?

Yes. We have fixed minimum cost as part of the contract, and so our ways of flexing the cost structure if something were -- if it were to need it, would be one of two. One would be just going in and negotiating, the other is to pay the termination payments necessary to exit the contracts if we thought we had a better alternative.

Okay, and just my last question. In terms of -- the consulting obviously is doing quite well, and I think in the Q, you guys mentioned some seasonality. I was, one, trying to get a flavor for that seasonality, but then also, any other macro drivers that -- ? You've obviously grown the sales force, but any other macro drivers, like whatever, economic or -- that you look at historically as reasonable indicators of how

Yes. I think, generally, first of all, on the second question, I think we are certainly not immune to the economy generally, and so looking at real GDP growth, etc., even though we hope to grow at five to six times that number, we are still affected by it. I guess our perspective is this. Of the approximately 103 -- just take domestically -- of the approximately 103,000 businesses in the U.S. with more than 100 employees, our penetration is actually -- despite our relatively strong brand, our penetration is less than 5%. Within the clients we have, we are not penetrated fully in many of those large organizations because many of our clients are big. So we see, in the face of any economic difficulty, if the efficacy to our solutions is hitting on the problems that the companies have, that we have plenty of room for growth. We also have only about 40% of the potential territory, sales territories, covered. Even with all of our hiring that we've been doing, only about 40% of the territories even domestically have a salesperson in place. So we think we can continue to grow in good times and bad. But certainly, the willingness of organizations to spend money on training on -- we have two sides in our consulting. We have kind of the historical training, which is kind of for the masses employees, and that is a key portion of our business. We think it's important to make those investments in good times and bad. But oftentimes, in bad economic times, those investments will be curtailed. On the other hand, the offerings which we've brought out in the last years, they're much more execution-oriented. Those tend I think to have probably very little flex in good times or bad, perhaps even in bad times having a little bit more urgency to figure out how to get costs and do other things. So we're hoping over time to build a business that's resilient in good times and bad. I say right now, the main idea is that we have a lot -- we're certainly far from saturated and we think we can continue to add salespeople in good times and bad and still grow.

And then the seasonality issue?

Seasonality -- actually, there's not that much. There are a couple of periods of weeks a couple times a year -- people tend not to do a heck of a lot of training obviously over the Christmas holidays. Also, in late summer, between July 20 and the end of August, you tend to have so many people on vacations and a lot of companies don't do big training events domestically. On the other hand, with our balance internationally, that is becoming much less of an issue too because the seasons are just different and the down periods are different. So we really don't see much.

As you look at the sales by quarter in OSBU, there really just is not that much difference. In fact, one of our strongest quarters of the year is our fourth quarter when you'd otherwise think that it would be off, but it's because we have a facilitator business where we have all of these licensed facilitators. And while they may not do a lot of training in the fourth quarter, they -- in the end of the fourth quarter, they often buy the manuals with which they will be training in the first quarter. So we don't see that much seasonality really and haven't had that much seasonality in the consulting and training side.

Okay, thank you.

[Tom Koch], [Turnaround] Capital.

I just had a couple of questions. Is there any update you can give? I think on the last call, you mentioned that there may be an OSBU contract announcement sometime in July.

I will just say, I don't think we'll be making an announcement, but that contract has -- we have been developing a product -- we signed a contract last fall, and the reason we won't be making an announcement is simply because of the client confidentiality. But I think we can say on this call that we entered into a contract, it was a multi-million dollar -- multi-million, multi-year contract that has kind of an annual renewal last October under which we were to build a new product, which is actually a product we're calling Seven Habits Interactive. It's an online interactive simulation version of the Seven Habits. It also includes what we call Blended Learning. It includes some standup training. And that product we've been developing all year and expect to deliver it here, as we mentioned in July. We had originally thought we may make an announcement of who the client was, but won't. But nevertheless, we can confirm that that contract did sign and we are now about to deliver on it. And so, we expect in the fourth quarter to receive revenue that will be somewhere close to $2 million from that contract, and it will be a pretty profitable contract.

And will you receive revenues quarterly from that, or is it just going to be kind of one quarter each year that you will see a benefit or an increase from that contract?

Assuming the renewal, and the nature of the organization with whom we're dealing is one where they have to -- their funds are allocated annually. And so, the idea would be this, would be kind of something that would be equal, more less equal every month. We also are having to spend all the money to develop it. We believe this will be a product that will be very, very good for about 70 to 110 big accounts where they can do a deep pervasive implementation. So we hope this will be something where the nature of their streams will be -- it will be a license fee, and they will be kind of recurring one-twelfth each month's kind of things that will give us some good stability and recurring revenue.

Okay, great. The other thing is -- is there any update on your thoughts or plans, as far as monetizing any of your foreign operations?

Yes, we can give an update. We have entered into letters of agreement now, letters of intent, to sell our Mexican and Brazilian operations to -- and we convert those to licensed operations. The purchasers are people with whom we have actually had business relationships in the past and feel very good about both of these. We can't announce that they have sold, and they haven't yet, but we are under a letter of agreement with both, letter of intent with both, and actually under contract with one. And we had hoped to close both of these by year end. The effect of the sale will be return of our capital, but by changing the business model, we'll have minimum royalty payments. Revenues will go down in those countries, and so it will make it harder in the next year in the sense that -- to have the same level of year-over-year top-line gains. But our minimum royalty payments, which are really essentially all closer to profit, will change the bottom line in those two countries by over $1 million just on the trailing. If it had been in place this year, we would have had $1 million more operating income than we had this year.

Any plans for any other ones?

No, we don't have any plans. We assessed all the different countries and I think we are fully committed in the other four direct offices in Japan, the UK, Australia and Canada, to maintaining our operations. We've done some work on the business models in a couple of those with our leaders there. We have also split the consumer operations which were historically part of the Canadian and UK and Australian operations, and those will now be -- being run by the Consumer Business Unit that was kind of insufficient. I mean, they had great people, but we just feel like bringing the full focus of our -- CSBU team will also have the advantage there. But over the course of this spring, we've assessed everyone. I would have thought going in actually, Tom, that there might have been another one that we would have sold, but actually the strength of our management teams and the strength of the business plans we saw, we came away believing that we were better off staying in.

Okay, great. And if I may, I have one question for Steve, was just -- I think your comments about the year-end target for operating income to be above '06. You are clearly there now, and will the trend continue in the fourth quarter? If you just had a flat quarter with last year, you would still be above that trend. But, do you expect this trend to continue?

We're not really making a protection about our fourth quarter, but I would say, we don't expect to slip any in the fourth quarter.

Tom, I think -- and Steve -- if your question -- because I think that's the same thing as saying, what Steve said could be true. If we were exactly zero with last year or just even with last year in the fourth quarter, we could still say we would be ahead for the year. That's your question, right Tom?

Yes.

And without giving a specific projection, we expect good gain for the fourth quarter also. We're not giving a specific number. We thought the third and fourth quarters would be -- both very good, and we still think that. We won't have the benefit of the non-repeated [with] Mexico. On a year-over-year basis, we had the Mexican problem last year. We would not have that benefit, but otherwise, there's nothing to suggest that we would not have otherwise something that's relatively similar in the fourth quarter. Does that confuse you, or is that helpful?

No, that's very helpful. I appreciate it. One last thing and I apologize, then I will get off. Did you say that you expect to pay the line down by the end of your fiscal year, calendar year?

Calendar. Because of the amount of capital that we tie up at this time of year, we invest a lot right now in working capital in building up the product for the CSBU, because a lot of this product is being shipped through wholesale channels or into our own stores to make sure that we're prepared for the high season. And so, this is a particularly working capital intensive period, but as we sell through that inventory, our biggest cash position of the year is at the end of December or end of January. So at the end of our calendar year, we should be out of the line.

But then, as you go into '08 calendar year, you may have to dip back into for working capital?

No, because I think our normal working capital wouldn't require that. And so, we would not -- we haven't had a borrowing line for years, as you know. And the only reason we have one now is just so that we could complete the purchase of the preferred. We would not anticipate -- we wouldn't have any working capital need for that line. We would have plenty of cash and cash flow to take care of any working capital needs. And so, any use of the line would be for other capital purposes.

Okay, great stuff. Thanks a lot.

John Lewis, Osmium Partners.

Just a couple of quick questions. I guess first off, Bob, I think I heard you right. Did you say that you believe you guys can grow about five times GDP?

Well, we hope that we can grow. If you look at the -- in previous web casts, we've provided kind of a schedule for what the new client partner ramp-up could mean for the Company, and we are kind of in year three now of that effort. But the new client partners average -- during their first five years, starting from 200,000 their first year and growing to stabilized number of above 1.1 million, have close to a 50% growth rate when we do that. So I think we would hope that we can, in this -- year-to-date, we have been growing the OSBU at -- I think it has been about 15% top line year to date. And, again, I wasn't trying to give a projection per se, but the point was, that we should be able to grow at some pretty significant multiple I would think of GDP, because even the productivity of our existing seasoned client partners is growing more than the real GDP. Yes, so just more --.

Got it. Okay, because I saw I guess in 2005, you had 137 client partners, you guys hope to double that to 270 in -- I guess in 2010. Do you anticipate about -- adding about 25 annualized, or is there -- how does the ramp-up look on that front?

I will let Bill respond directly.

The goal we run with is about 10 in domestic, 10 in international, and another three to five in sales performance (inaudible); so 20-plus on an annualized basis. And of course, we're also adding to replace whatever folks might leave the business over time.

Got it. And, Bill, on one of your three I guess big bets, one -- your third big bet was holding cost down. I guess, what does that exactly translate into I guess longer term, in terms of EBITDA margins, on international and domestic?

Well, maybe I can answer that relative to what the models look like. As an example, domestically, a sales office, when we think running at optimal level, it returns about 40% on the bottom line. And that's of course assuming that the only costs in that office are sales, sales management and sales support people. When you look at an international office where you carry the cost for the operating support that we carry here in headquarters, it isn't reflected in the domestic number; then you drop about another nine points or so. So you have maybe 8 -- 31%, 32% in an optimal office. Right now, the U.S. offices are running at somewhere about 36-ish, 37 or so. So we have another three- or four-point gain that we anticipate getting there as those offices improve. And we've got -- the international offices are changing the landscape radically. They have been as low as down in the single digits. We'll have them up into the teens and I hope to move that by the time we get to 2010, up to their optimum level in the low 30s. Does that help?

That is very helpful. I guess next, I was going to ask Sarah. I guess you guys have been running on the CSBU side at about $13.5 million in EBITDA for the last three years or so. There's obviously a ton of moving parts in the CSBU side of the business. I guess, do you have any kind of long-term -- if your big bets play out, do you have any kind of long-term objective in underlying growth of EBITDA on the CSBU side?

We do. We certainly will continue to invest in growing wholesale, and that is really a high margin business for us because so much of that is coming through as royalties that drop right down from the top to the bottom line. And we'll continue to expand distribution, both domestically and internationally. You know, we're really only at the beginning of the story on international for the CSBU. The offices, the four direct offices we're working, we're adding resources and capabilities. And, frankly, a lot of the process and operations that exist domestically and all of the work that we will do with the licensees would be new growth opportunity that would drop to the bottom line.

Okay, that's helpful. And then, Steve, in your 10-Q, you guys state that you're working on some cost reduction strategies. Can you give us an idea of kind of the timing and the magnitude of these potential reductions?

We're continuously working on cost reduction, on cost reduction strategy, and that comment is basically intended to say it's something that we're always looking at, always focused on, always working on, always having initiatives that are going -- that we are working on. But if you look over our past few years, you can see significant reductions in cost. We are not -- that statement is [an announcement] we have those types of initiatives in place that are going to really significantly reduce our cost in the future. It's a comment just notifying the shareholders and readers that it's something that we're always focused on and always, always, always working on. In light of the, as Bill was saying, adding 20 to 25 sales persons per year, that would obviously increase some of our cost, and other growth initiatives that we choose to invest in will increase our cost. And given that, we're just always focused on areas that we could reduce cost. But no big initiatives to announce or the impact of what those initiatives might be. It's just something we're always focused on very diligently in both business units.

John, I might just add that, what's really driving us in the overall cost structure and revenue side is to try to have a certain business model. Each one of the units in the Company that receives leadership now has a five-year plan that kind of has a business model for every cost center. So really, this idea is, for the overall business, while we're delighted that the business model has improved a lot and that this year, EBITDA to sales will be north of 8%, this year may be close to 9. We -- and operating income will be between 5 and 6 -- we -- our target is to have operating income to sales be at least 10% and EBITDA to sales be in the 14% range. So I think everybody has a model that builds up in our five-year plan of how we're going to get there. Obviously, that doesn't assure that we will go get there, but it kind of -- in some places, there are investments going on, but in most, there are continued efforts, whether it's IT or central staffing or attrition management where we really try to make sure that there's attrition that we try to find. The first question is, okay, now, how do we make sure we don't have to hire? And so there are 50 things going on that try to help our cost. At the same time we're investing in four big areas, hiring new salespeople, hiring consultants, investing in product development and investing in building kind of our sales training capability.

That's very helpful. I guess my last question is, just to make sure I heard you right. Did you say you guys -- I think you guys already said that you anticipate to have your line fully paid down by the end of the year, and it sounds like you guys would then be more aggressive in buying shares?

Yes. The first point, we do expect to have it paid down by the end of the calendar year, and then at that point, if we are meeting our numbers and so forth, the net result would be, we would be generating a lot of cash. We would not have preferred to pay or lines to pay down. And so I think at that point, you will have a whole different set of options for either -- on one hand, repurchasing shares; on the other hand, for making investment if we can find other ways to invest even higher rates of return that we'd do that. But right now, it's looking like that we would love to buy some shares when we're in that position.

Well congratulations. You guys are doing a great job, and thanks for having the call.

I would like to turn the presentation back over to Bob Whitman for any closing remarks.

Well, we just appreciate very much those of you who have joined, appreciate your questions and continued support. And we will just thank you and I think end the call at this time. Thanks very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.