Franklin Covey Co (FC) 2014 Q3 法說會逐字稿

Welcome to the third quarter 2014 Franklin Covey earnings conference call. My name is Lakiba and I will be your operator for today's call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Derek Hatch, Corporate Controller. Derek, you may begin.

Thank you. Good afternoon ladies and gentlemen. On behalf of the Company, I would like to welcome you to our third-quarter investor call this afternoon.

Before we begin I like to remind everyone that this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management's current expectations and are subject to various risks and uncertainties including, but not limited to, the ability of the Company to stabilize or grow revenues; the ability of the company to hire productive sales professionals; general economic conditions; competition in the Company's targeted marketplace; market acceptance of new products or services and marketing strategies; changes in the Company's market share; changes in the size of the overall market for the Company's products; changes in the training and spending policies of the Company's clients; and other factors identified and discussed in the Company's most recent Annual Report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission.

Many of these conditions are beyond our control and influence, any one of which may cause future results to differ materially from the Company's current expectations. And there can be no assurance that the Company's actual future performance will meet management's expectations. These forward-looking statements are based on management's current expectations and we undertake no obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of today's presentation, except as required by law.

With that out of the way, we would like to turn the time over to Mr. Bob Whitman, our Chairman and Chief Executive Officer. Bob?

Thanks, Derek. I'm happy to have a chance to talk to some of you today, as I enjoyed talking with a number of you over the last few days. And inasmuch as you all have had the press release and we've talked, today I would just like to maybe hit some headlines.

I know we're competing with the World Cup game. We'll understand if we hear cheering in the background. But we appreciate you joining us.

I'd just like to briefly address for topics and just hit on the results for the third quarter, give a little more detail on the shift of -- the economic shift to the $2.4 million of revenue from Q3 to Q4. Then give an update on our progress on the overall business plan and thesis of growing double-digit and flowing through 30%, and then give our -- just review our outlook for Q4 and beyond.

So I'll start with third-quarter results which you have seen the detail of -- we'll just hit some headlines. Third quarter for us is generally a very solid quarter in terms of revenue growth. As you can see in slide 3, we achieved growth in all of our major channels except for government services.

Our direct geographic offices in the US and Canada posted 7% growth for the quarter on top of 19% growth in the second quarter and had 12% growth for the trailing four quarters. But for the shift of revenue to the third quarter, most of which occurred in these offices, their growth would have been of course stronger. We expect it to be very strong in the fourth quarter independent of the shift, and in adding that shift to it, to be even stronger.

Second, our international direct office achieved growth of 12% for the quarter. This has been an area of focus for us over the past years and we are pleased that despite some foreign-exchange challenges, these offices were still able to post significant growth -- and this is something we are excited about. They are implementing the same marketing and go-to-market hiring plans, and we are starting to see that move the needle on the growth rate in the international direct offices.

Our international licensee operations grew 11%, reflecting ongoing efforts to implement the same hiring and marketing initiatives that are driving revenue in our direct offices. The 7 Habits launch, which has gotten off to a strong start in our direct offices in the US and the UK and Australia, is just now starting in most of our international partner offices. So we look forward to accelerated growth in the fourth quarter and particularly in the first and second quarters of next year.

Our national account practices grew 20% for the quarter, reflecting growth in each of our education, customer loyalty, and sales performance practices. So the growth in all these areas -- main channels -- were partially offset by a $1.7 million decline in the government services area. It was expected -- the renewal of the large government contract which had occurred in last year's third quarter has been deferred into the fourth quarter of this year.

Approximately $1 million of adjusted EBITDA contribution came from that renewal in last year's third quarter, which should not repeat in this year's third quarter. So, overall, we felt very good about growth. We would like to have seen greater growth in the direct offices in US, which we'll address -- but which they have had in the past and we are confident they will have in the future.

In terms of our practice, which is shown on slide 4, the leadership, education, and customer loyalty practices achieved significant growth during the quarter -- 35% for leadership, 30% for education, 39% for customer loyalty. Growth in the leadership practice was driven by the launch of the re-created 7 Habits signature 4.0 offering. And the extent of the focus on the launch of 7 Habits in the second and third quarter to establish this launch firmly among both our existing clients and new clients impacted the Productivity, Speed of Trust, and Execution practices revenue during the second and third quarters as we essentially shut off those events just to allow full focus on getting 7 Habits established.

Speed of Trust was down more than others during the quarter because in last year's third quarter we had a big Speed of Trust tour, which generated exceptional revenues in that quarter. But we expect these practices to resume growth during the fourth quarter as we once again have ongoing marketing events in each of these practice areas. And we expect that by the first quarter, all of the practice will be back in full growth mode again.

So that's kind of the summary of the results. Obviously we will leave plenty of time for questions and answers. The second topic I would like to address is just the shift of revenue from third-quarter into the fourth quarter that we discussed in the press release.

Despite the broad-based growth of the Company, overall the Company's revenue growth was somewhat less than we had expected for the third quarter. We've analyzed and we analyzed almost all of that, and more than 100% of it is due to approximately $2.4 million of revenue that we had expected to be recognized in the third quarter which shifted, and either has already been realized in the fourth quarter, or is expected to be realized during the fourth quarter.

This shift of revenue into the fourth quarter accounts for, as I mentioned, more than 100% of the variance in gross profit, adjusted EBITDA, operating income and net income compared to that which we had expected for the quarter. Thankfully, approximately $1 million of this revenue has already been recognized in June.

The revenue shift fell into two basic categories. First, last minute delay in the signing of two specific contracts which totaled approximately $600,000 in revenue. And because of their high intellectual property content, would have had an effect of about $0.5 million of adjusted EBITDA. The largest of those was signed in June and the other contract is out for final signature now.

The second component of that was the encouraging but earlier than expected shift in the mix of new client prospects as compared to the Company's existing client facilitators attending 7 Habits launch events during the third quarter compared to the second quarter. As we have noted, new clients have typically have a somewhat longer average conversion period than do the Company's existing client facilitators, and we believe that this increased mix of new clients and the decreased mix of existing client facilitators resulted in this shift of approximately $1.8 million of 7 Habits revenue into the fourth quarter, which resulted in a commensurate increase in the Company's prospective business pipeline for 7 Habits at the end of the third quarter.

Let me just provide a little more detail on this shift of 7 Habits revenue. First, it might be worthwhile noting that, overall, the revenue generated from the launch of the new 7 Habits offering has substantially exceeded expectations for the second and third quarters. In our January conference call, we said that our expectations for the new offering was to generate $3 million to $4 million of new 7 Habits revenue in the second quarter, $4 million to $5 million in the third quarter, and $5 million to $6 million in the fourth quarter.

As noted in the press release, the actual new 7 Habits revenue for the first two quarters is approximately $11.2 million, exceeding the upper range of our expectations for those two quarters by more than $2 million. So the issue in the second quarter wasn't one of the launch not been successful as we thought it would be overall, but it was that based on the revenue, the $5.7 million of revenue generated in the second quarter, where we had thought we would get and generate $3 million to $4 million, an amount that had been generated from these launch events during the second quarter, we projected a similar result into the third quarter. But the mix of participants shifted somewhat.

Let me walk-through a few slides that may provide some additional insight. Slide 5 shows that approximately the same in the first column, shows that approximately the same number of people registered for events in the second and third quarters.

Because there are fewer events -- a few less events in the third quarter, the actual number of registrants per event was essentially equal.

Next, in the second column over, in both quarters -- these events in both quarters generated approximately the same amount of revenue plus pipeline. When we look at every event we have and have had for years, we look at how much revenue was generated in the quarter and how much pipeline, and we then have the metrics on what the pipeline conversion is.

It's interesting that both in the second and third quarter we generated about the same amount of revenue plus pipeline. So, as you see in the third column, the actual revenue recognized in the third quarter was $4.1 million versus $5.7 million in the second quarter, which is $1.6 million less.

Column 4 shows that conversely, the pipeline that was generated in the third quarter was about $1.7 million or $1.8 million higher than it was in the third quarter. And so the question is really what caused the shift? , since the overall activity and effectiveness of the event seemed to be quite similar.

Slide 6 shows what we believe is the primary reason, which was the shift of new customers versus existing customers. And as you see there in approximately -- in the third quarter, approximately 31% of our registrants were existing customers versus 6% to 9% new. And that shifted to where -- sorry, let me flip over. In Q2 I've got -- reverse it -- new customers were 54%; existing, 46%. And that shifted to 69% new customers and 31% existing.

And you know, importantly, as part of that there is a group of existing customers that's particularly important, which is those that are existing -- active 7 Habits facilitators as opposed to customers in other content. And that represented a much bigger share of the second quarter than it did in the third. 54% of those converted. And so, the biggest impact was really the difference in the number of active 7 Habits facilitators attending in the third quarter compared to the second.

The question is, is there something wrong with that? We think the answer is no; clearly, no. As I noted, the overall revenue has come in much higher. Actually 75% of all of our active 7 Habits facilitators attended either in the second or third quarter, with a little over half in the second quarter and the other 23% or 24% in the third. In both quarters more than half of them converted, but that was the main thing.

So I think it was our -- in retrospect -- knowing the strength or seeing the strength of conversion, and the high percentage of the existing 7 Habits facilitators who had attended an event in the second quarter. The extrapolation of the results from that quarter into the third quarter was probably an error, although we didn't know that until all the dust settled and we were close to the end of the third quarter.

So, all in all, we think that the difference -- the pipeline, and much of it has already converted -- there's a very strong pipeline. And we think the combination of strong pipeline that we have together with fourth-quarter incentives as we sunset the former 3.0, 7 Habits product, will help the rest of them to convert. So we have a little over half -- a little over 40% of the active 7 Habits facilitators have already converted.

We've gone through and done analysis account by account. We think that's about half of what will convert. And it will be about 20% where, because they had inventory of 3.0, or they've made investments in translation or something in 3.0, or somebody is no longer in that position to teach in the immediate term, that about 20% won't convert now. So we expect we've convert about half of what will convert in our existing base.

Excitingly for us, on the other hand, is the tremendous response we've had from new potential companies. So the fact that we had fewer existing customers protected the quarter. But the extent of demand and the fact that these new customers are coming in, filling the events, and purchasing in a relatively short period of time -- although it's longer than the existing customers -- is very encouraging. There are more than 10 million managers in the United States; only about 1500 of them have we seen in the second and third quarter. So we think this provides a very long runway for this offering as well as for Trust and otherwise.

Let me just shift now to the third point -- progress on our overall business plan and thesis. As you know, our basic business plan and thesis has been that -- our goal has been to achieve growth of at least 10% the year with approximately 30% of incremental revenue flowing through to increases in adjusted EBITDA. I thought it might be useful in response to also some questions I've received just to give you an update on the overall progress.

Slides 7 through 16 just provide a quick walk-through -- I'll just take a few seconds per slide. Slide 7 shows that against this goal of achieving 10% annual growth in revenue, in fact since 2009, the compounded average growth rate has been 11.6%. You can see that it's been lumpy some years where the government contract may have increased in 2011 -- increased that growth rate some, and then the decline in that contract in 2012 reduced it some. But overall we've been able to meet the growth rate.

What we want to be able to do is meet that so it's not lumpy, either. So -- but that's been the basis for the first point.

As you can see, in slide 8, even though not every quarter is the same on a rolling fourth-quarter basis, each first quarter, each second quarter, each third and fourth continue to have growth on a trailing four-quarter basis. We expect that to continue into the future.

Slide 9 shows that our revenue per channel over the period of years has also grown well. Self-funded marketing and other -- those are ones that won't change much. The other is the rent on our sale leaseback facilities -- self-funded marketing is just that. It's speeches and public programs and things that we reduced our focus on there.

But our national account practices have grown extremely well. Our international licensee business has grown dramatically on a gross revenue. Our royalties grow at the same pace, but off a smaller base. Our international direct offices have grown and that's despite significant pressure on -- FX pressure over the last two years.

Government Services has actually grown overall but it's been up and down. And then our direct offices in the US and Canada without government have grown substantially and have been a major growth engine. The things we have learned and done there are now being translated both into international direct and our international licensee offices and national account practices.

Slide 10 shows that practice by practice, our revenue growth has also been substantial. We have these goals for these practices and basically all those goals have been met to date. And we feel good about each practice. It doesn't mean we don't have challenges or things we think about every day, ways we can accelerate growth, but we feel fundamentally we've made good progress in each.

Slide 11 shows that in driving this growth there is kind of two things. One that you don't see on this slide, which is our focus on quality results for clients. It's our number-one objective as a Company.

And during this period of years, our recurring revenue -- the repeat revenue from one year -- the revenue from when you are the -- clients that repeat in the next has gone from the high 60s to the low 90s. That's been really important. It's also ultimately the thing we are about as a Company. It's the thing that drives our mission and our revenue and profitability.

The other thing that's driven it, though, is the increase in the size and productivity of our salesforce. You can see on slide 11, the salesforce has increased from 101 to 169 at the end of the third quarter. And by the time of our sales kickoff training conference at the end of September, we expect to be at that 180 goal.

That means that by the time we reported last year on the year in November, we had about 145 client partners. We have hired 24 since then, but really since the actual year-end where we had 130 at the actual August 31, we've added 36 new client partners, so it's been a big hiring year.

And what's been very exciting about it is with the addition of our sales management position, with all of our marketing events, etc. we've -- our client partners are both hitting or exceeding ramp, so we've also lost very, very few. So the retention rate has also gone up. So this has been a key thing.

Slide 12 said that also to be able to build the capacity to be hiring 30+ client partners a year has taken some real investment. Slide 12 shows the investments in just the field support practice, practice support, and central sales and licensee support. So that's gone from $11 million a year in 2011 to $18 million in 2013.

We've said in previous call that we expect to be able to hold the line or maybe even reduce this slightly. As you can see that for 2014 these investments have flattened out. We might have a small decrease next year. But the point is certainly adding to these investments on one hand has made it more difficult to -- has tightened the spread and the flow through in quarters, but now reaching the point where we are in fact hiring and ramping up more salespeople -- that also, now on a flattened investment, will allow us -- investment plan will allow us to flow through a lot more.

The next slide shows also that -- slide 13 shows that in order to support the hiring and ramping up of salespeople, and to increase the number of face-to-face hours we are spending with the client, in 2013, the left bars, we added 22 new client partners. But we added two support people -- 45 -- support people for the 22. And for one 12-month period it was as high as 3 to 1. This year it's closer to 1 to 1 -- you see 32 net hires and 37 support positions. We expect that will go to a little less than 1 to 1 in 2015 and beyond. So, again, this flow through will help us.

The other thing that helps a lot is the fact that when you step up -- when you increase the number of new hires from 20 to 30, there is an enormous increase in investment. The 30 people have a net investment of $3 million payroll their first year, plus marketing and other things. It's largely offset, but not completely offset, but it does compress the margins.

In the second year of those people's tenure, however, they each add about $300,000 of revenue with no increase in cost. So you have an extra $9 million of revenue generating almost 70% gross margin. And since we expect to then flatline for the next few years -- about 30 net new hires a year, that incremental increase again should reduce.

So the flow through if you go to slide 14 -- let's go to slide 14. The payoff for doing this if we can succeed is shown on slide 14, where if we can hire 30 net new client partners a year, by the fifth year you've got an extra $117 million of revenue flowing through, we expect, at about 30%, and yet only one of the five classes has ramped up in the fifth year. The others are still in ramp, suggesting that there is an additional growth available embedded in that salesforce, as there is right now in our 169, there are almost 100 of them that are still in some form of ramp up.

So we expect now significant flow-through of incremental revenue from the existing people who are ramping up, from the new people who are ramping up, but with flat to down central support costs and much reduced incremental field support costs.

Page 15 -- slide 15 shows the flow-through. We've had revenue growth on the top of about -- on average it's been 11.6% over the last four years compounded. In 2013 it was 12%.

Also, the flow-through goal about 30% has actually exceeded that over the last four years but not in the last couple. So we've had 41%, 42% flow-through of incremental revenue to incremental EBITDA. Our goal has been 30%.

But in 2013 where we were making all these incremental investments, as well as the investments in the launch of 7 Habits, that dropped to 21.2%. We expect to move forward in the fourth quarter to have flow-through well north of 30% in the fourth quarter. And moving into next year, it will be quite confidently -- count on 30% or so flow-through.

I might note that the flow-through of course in 2013 -- and 2012 to some extent, but 2013 was impacted meaningfully by the devaluation of the yen and by the reduction in the size of the government contract that cost us almost $4 million of EBITDA. So our goal is, knowing that the core business strong and going well, we have had some of these issues that made some quarters lumpy.

We expect, with the hiring of the salespeople people, get to the point where our core business can offset any potholes that we have in foreign-currency or government things. And that we can be growing top line 10%-plus organically and flowing through.

Slide 16 kind of shows how that's going. Hopefully that review is useful and we are most certainly looking forward to answering your questions.

Finally, in terms of the outlook, maybe just for the outlook I'll just summarize on the strategic initiatives. The size of the Company's direct sales forces continue to expand. You have seen that. Productivity continues to meet or exceed our expectations.

Our licensee partner network continues to expand. The number of international licensee partners has now increased to 52, including our education licensee partners, and it will expand further. The company's repeating revenue continues to be high, with our focus on quality results -- our number one objective of more than 90% of the revenue generated by clients in the trailing four-quarter period ended a year ago, repeated in this year's last -- latest four quarters. And the launch of the re-created the 7 Habits signature product is ahead of pace.

Finally, in terms of outlook, the booking momentum continues to be strong. You saw the press release. Our corporate pipeline of booked days and awarded revenue increased by 7% to more than $36 million, which represents our largest-ever corporate pipeline for the end of the third quarter.

Interestingly, as predicted, the corporate pipeline typically is a future revenue growth. It turns out that at the end of the third quarter it's not as predictive of the fourth, because such a high percentage of our revenue in the fourth quarter comes from facilitator sales, and which means that the pipeline as a percentage of the total pipeline only includes booked days and contractual revenue. And so we feel very good about the momentum of the facilitator business, and expect that will -- our growth will exceed 7% in the fourth quarter.

The corporate and education booked day momentum was strong, increasing 13% during the quarter. The overall prospective business pipelines, which do include facilitator sales, reached the highest levels ever for the end of the third quarter. So we feel very good about the pace and momentum.

The outlook, given the strength of various pipelines, the strong booking momentum, the expectation -- hope for the renewal of a large government agency contract in the fourth quarter and our expectation of significant sales growth in the fourth quarter. Otherwise, it makes us confident that our fiscal fourth-quarter will be our strongest ever, both at top line and bottom line, and that we are well-positioned for continued and accelerated growth in fiscal 2015 and beyond.

To allow for some uncertainty related to the timing and award of the government contract, and provide additional conservatism, we are expecting -- we revised our annual guidance down 3%. We will arrange to be between $34 million and $37 million. So I will just close and say that we are pleased with our continued progress in each of the areas. We appreciate your support.

I'd say we've never really felt more excited or confident about the business. When we had our kickoff meeting in the fall, after having made a lot of progress over the last years, we said we are here not to celebrate having reached the summit, but having reached base camp of a whole new mountain, which is the rapid expansion phase.

We've spent all this money investing in infrastructure, doing all the things we had to do to get to where we are, and at the same time thankfully growing revenue and profitability. But we really feel now that almost all of our time now is spent on this question of hiring and ramping up 30 new client partners a year and making sure the flow-through is there.

So at this point I'll try the time over to Derek Hatch to just review some key metrics. I should note, I think many of you know that Steve Young, a week ago, was all of a sudden taken to the hospital for an emergency surgery that is not life-threatening, but is painful. And his recovery has been a little slower. But he's in good spirits and good health.

We expect him to be back in office next week. But he's not here to do that today and so Derek, we'll turn the time to you.

Thank you, Bob. Believe me, right now nobody misses Steve more than I do at this moment. So let me take you through just some other information really quickly to round out the income statement.

As you can see, most of the metrics on this page didn't change significantly from the prior quarter. Depreciation is expected to be $3.5 million for the year; up a little bit compared with the prior year. That is due primarily to some computer hardware we added in the first quarter. So we still feel pretty good about -- and some expected computer software in the fourth quarter.

Amortization is expected to be $4 million for the year versus $3.2 million. That's primarily due to the acquisition last year of NinetyFive 5. Now that that was done in the third quarter of fiscal 2013, we are really on an apples-to-apples basis there with our amortization expense. If you don't see it, it was essentially flat compared to the prior year.

Our net interest expense and discount -- no change there from prior expectations; down a little bit from the prior year, primarily due to change in accreted interest on FCOP receivables.

Effective tax rate -- our tax rate for the quarter, as you might have noticed, was 20%. That's a bit under what we would normally expect. That was primarily due to some -- what we call uncertain tax positions. Those are tax assets we are not allowed to take on our returns because they are not rock solid -- not achieving a high enough probability that they can be maintained if they were questioned. The statute of limitations ran out on those, our being able to take those assets. We were able to take those assets during the quarter, which reduced our effective rate during the quarter to 20%, which is not indicative for our year obviously.

We were 35% for the first three quarters of 2014, which was about where we -- kind of where we thought, a little lower than where we thought we were. However, we do know that there will be some information coming in, in the fourth quarter, that our tax department is accumulating to see if it will be beneficial for us to take some deferred tax credits and amend some prior year returns like we did last year, to reduce our effect rate.

Share-based compensation $3.6 million last year; expected to be about $3.4 million this year. CapEx -- those are purchases of property and equipment -- we are expecting that to total about $3.0 million for the year, up a little bit. Most of that increase occurred in our first quarter as we purchased some new computer networking hardware here at our headquarters facility.

Capitalized curriculum -- you see big change there; up to $8.5 million compared to $3.2 million in the prior year. We expect $8.5 million -- most of that growth is primarily due to the rework or in the significant recreation of the 7 Habits signature program that you have already heard about.

Our share count, lastly, up to 16.9 million which reflects -- we were up about 100,000 shares from last quarter. That reflects divesting of about 90,000 shares of a performance-based award and 9000 shares that were issued to the participants in our employee stock purchase plan. So we expect 16.9 million to be about where we end the year, barring any unforeseen vestings or other things. And we think that that share count should be pretty close to where we will be at August 31.

With that, I'll turn the time over to questions and back to Bob.

Absolutely. Let's just open it for questions now. So, operator, you can set that up if you could.

Okay, great. (Operator Instructions). Joe Janssen, Barrington Research.

First, let me just focus on the government contract that was pushed from Q3 to Q4. What gives you confidence that's going to be renewed in the current quarter?

We don't have absolute confidence, which is why we expanded the range to allow for that. We've been informed their intention is to have it rebid during the quarter -- that they would like to begin training by the end of the quarter. But I think it is uncertain, just as all things in the government seem to be in the last few years.

So we've been told to get ready for the bid. We have our request for our RFP response prepared. Assuming they follow through on their plans, their stated plans, we would expect to submit it immediately and hopefully have it be awarded. But we are not absolutely certain.

Okay. And then with guidance, it sounds like -- since you lowered it by $1 million in the lower end, being a function of this government contract -- my question is, assuming the government contract got pushed into Q1, but given the current trends and what you're seeing in the current quarter -- the original guidance of 35% to 37%, is that still within reach?

Yes. The government contract itself could have an impact of, say, $1.8 million on EBITDA in the quarter. So the fact that we reduced the guidance range by $1 million says that -- and to be conservative otherwise, just because not everything happens as you think.

We have a plan internally to try to make sure we get into the range with or without the government contract. Everybody is working against that plan, and if everything came into its plan, we would still end up in the original range to allow for the government and anything that might happen -- just on the margin -- that's the reason for the range.

Okay. And then a margin question here. Given the flow-through characteristics that you've talked about -- investment spend easing a bit as we go forward, maybe a few years ago we were all looking for that 18%. I think that's within striking distance, obviously.

You know, if you are looking 3 to 5 years, given the flow-through characteristics maybe help me reset my expectations. You know, low 20s, mid 20s; it looks like the business, given the characteristics could very easily do 100 basis points improvement on an annual basis. Am I far off there?

I think the math is right, Joe, in terms of if we are able to flow through 30% of incremental revenue to incremental EBITDA, obviously it would tend to keep moving up. What we've said in the past is that we -- our goal would be to accelerate growth. If we could maintain really good EBITDA margins and accelerate growth, we would choose that. But right now, we don't feel like we are holding back on investment anyway.

As you've seen, we've hired -- we've been investing everything we can invest in that we feel that we can manage. So I think it's likely it would continue to creep up some until we -- and I think if we then said, hey, we figured out we can hire 40 client partners a year instead of 30, then that would again flatten out for a few years. And if we could figure out how to keep upping that every year, it would probably keep it flatter. But otherwise I think if you stated 30 a year, obviously over time you would absorb that and start to -- keep moving toward 30.

Okay. And then I heard Derek's comments regarding the tax benefit in Q4. Just for my modeling purpose, can we just assume a 41% tax rate?

For Q4? Yes. Right now go ahead and model that in. We really do think it will be a little lower than that. But until we get that information in a quarter and our tax department guys can run the information through to determine whether or not to take those deferred taxes international for tax credits, we won't really know that until really the end of the fourth quarter. So I think for modeling purposes, 40%, 41% would be a good rate.

All right guys. Good quarter.

Thanks, Joe. Thanks very much.

Tim McHugh, William Blair.

Thanks. I guess just two questions. One, you talked about the leadership programs producing at a higher level than you thought. How do you think about the impact on the other programs in terms of client and salespeople focusing on that, because separate from even the issue for this quarter, I guess my impression is overall sales are not drastically different than you would expect.

So is it just a greater distraction or shift in focus amongst the salesforce? Or is it kind of consistent with what you would have expected?

Let me just give one point of context, Tim, if it's okay. There are certain sales -- we have different sales forces. There's one salesforce that sells primarily Leadership, Trust, and Productivity. So, there, if you have a big launch of one thing where they are trying to fill the next extraordinary number of events in one quarter, it does tend in that quarter to offset somewhat.

But what you're doing is you build a base of clients from doing that, and you launch a product deep into a number of organizations and they repeat revenue at 90%. They can then drop back in subsequent quarters and have a more steady flow.

So, really, almost all the growth in the last year for that salesforce has occurred in Productivity and Trust. And those products have moved up significantly -- grown their revenue very significantly over the years, and are now established brands and products that can expand domestically, internationally. 7 Habits was already established, but had not been relaunched. So we just felt it was worth -- it has basically driven -- the metrics are driven by the number of events you have and the number of attendees. We just decided during the second and third quarters not to hold a lot of those other events. We have done a lot in the past, and just make sure there's sufficient focus on 7 Habits.

But going forward, you will have a blend of events that will allow each product line to grow by 10% to 12% year. We'd expect all of the practice to grow in line with overall growth and there wouldn't be a particular dislocation -- if that's responsive.

Yes. A little bit, I mean I guess I understand that that group is selling the same products and Productivity and Speed of Trust grew a lot last year. But I guess what I'm trying to understand is the better-than-expected results in Leadership. Is that really I guess an above-average outcome, or is that a shift in focus amongst the salesforce from one product to the other that's having a negative impact on the other ones?

The net impact of if you look at the salesforce and maybe just focused on that collection -- while Leadership is above average, is the overall sales per productivity of that group above average? Or is it just a shift in focus, I guess?

So let's break out -- versus expectation, it's better than expected because we expected to not have those -- you know, you schedule those events way out and we knew that the other two practices would decline. So relative expectation is better.

On the question, is the whole Company a lot better off than it would've been had you not launched, in the short run I think yes, a little bit better. It's not dramatically better than it would've been if we just continued to push the other products. But we think establishing thousands of new license facilitators in 7 Habits who would be teaching, who will be able -- who will go out and spread this in their organizations will be a very good thing for us long-term.

And so (multiple speakers) -- in the quarter it tends to -- last year's third quarter we had a big push on Speed of Trust. And we did that for a couple years before, but it was a $2.5 million product that is now almost a $20 million product and has been growing well. But every few years you do a new big tour that allows you to attract new customers; the same with 5 Choices, when it replaced FOCUS.

So I think your insight on that is correct. If we were to add 20 new offerings to the sales force, at some point you would just be trading one off versus the other. But these products don't all address the same problem or job to be done.

Trust is a great thing. So is Leadership and so is Productivity. And so, to that extent, they can be interchangeable. But really the way in which we sell them, the targeted audience for Productivity is different -- even though it's all HR related training people. Productivity is focused on an organization with lots of high-value decisions, big sales forces and things like that, where making a good choice about how to spend your time has a particularly big impact.

Speed of Trust is particularly effective and targeted on organizations that have gone through a major realignment or merger-acquisitions where there may not be a foundation for trust. 7 Habits is focused on building a foundation for a winning culture. So it's not the same problem you are trying to solve.

But, it's the same sales force selling it. If we can establish ourselves in all three problem areas, they are all big intractable problems, each of which can grow. And that salesforce can then increase their productivity and it can be a net positive for doing it.

Okay. That's helpful. And then the government business I guess if we assume -- just to assume if you didn't get the contract renewal, I guess, how big is it at this point, such that as we think towards next year if it's even a meaningful issue anymore?

Yes. It is still meaningful, but not so much on a year-over-year basis. So, on a total basis in this fiscal year, assuming we didn't get it, would have produced around $6 million of revenue during the quarter -- didn't produce anything during the first quarter to speak of until the very last day. We then had about $5 million in second and third quarter, in the early part of third quarter, and there would be nothing in fourth.

And so, $7 million of revenue it would probably have -- if we didn't get anything -- if it didn't renew at all, it might have had something like a net-net $2.5 million impact on EBITDA in 2014. But it's actually, on a year-over-year basis, had more of an effect than that -- I mean, 2015 -- it's had more of an effect on that in 2014 because of the decline.

So I'd say it's something that would be great if we got it. If we don't, we intend to build and expect to grow the noncontract government business and all the rest of them, and our expectations will remain unchanged. So it would actually probably take some lumpiness out, but we are hopeful of getting it renewed at some point.

Okay. Thank you.

Thanks, Tim.

Marco Rodriguez, Stonegate Securities.

Good afternoon guys. Thank you for taking my questions. I was wondering if you could provide a little update here on NinetyFive 5, the acquisition there. It seems like you might be kind of underperforming there. Any kind of update you can provide?

Sure. Yes, I'll tell you maybe three different data points. Number one, the primary reason for the acquisition of NinetyFive 5 and the economics of the foundational acquisition was that we were about to spend $1.5 million on developing a toolset which they had already developed. It was complementary to our content.

And they also had a book of business. And so, the initial price that we paid of $4 million, in our minds, paid for the product development we would've had to do on our own plus the existing pipeline of business. So that's one metric in terms of we priced it so there wasn't any way we could end up upside down on the actual investment. And with it, we got some tremendous new clients, a great team, and maybe a critical mass in the business.

But as it relates to -- then, second, there was the expectation of what would be required to get the earnout -- to have earnout more than $4 million. And that was set in a very aggressive growth level, which isn't a normal growth level. But we basically agreed that the team that if they could achieve certain really, really stretched objectives they could achieve that, and they are not now achieving that.

The third metric is, what do we really expect, and our performance has been a little bit less than we expected in terms of growth. I think it's driven not by the quality of the content we got or the quality of the customer, but by the fact that neither our own sales force in sales performance practice nor NinetyFive 5's -- I should say both of them are very, very good at big deal -- they are whale hunting and getting big deals and keeping them and expanding them.

What neither of us had was a front end pipeline sales force that out there making the 400 hours of face-to-face calls every year on smaller accounts that you can then feed into the big deal people who can do it. So I think we have been a little bit disappointed that we didn't get around that faster. But we have now taken that on, and will be adding 10 or 11, Sean, 11 salespeople. We are going to have the salespeople -- the front end loading people hired in our geographic regions that already know how to hire and ramp up salespeople.

We feel we are very confident about the ability to do that, and figure instead of trying to test that out in a new environment inside the national account practice, let's just do it in our regions. And then as those people develop accounts that have the potential to become bigger, then the existing salespeople in the practice will grow.

So I think it's fair to say that the aggressive sales growth on which the reserves -- or the accounting was done to allow for a big earnout -- that's unlikely to happen. But at the same time we feel very good about the talent we have, about the plan we have. I'd expect a year from now that on this call you will have seen good solid growth in the sales performance practice.

Got it. Understood. And in terms of the 7 Habits launch, it seems like it's done fairly well here, above expectations here in the US. Any sort of update you could provide on pushing that out to the international licensees?

Yes. Sean Covey, would you like just to address the rollout and then Scott Miller can talk about what's on the docket for these coming months.

Sure. This is Sean. Yes, so internationally, we are just starting because we had to localize, you know. So we've got it in the top nine key languages now. So we've just begun the launch in the last month and we have about 125 different events going on.

The initial response has been extraordinarily positive across the board. One of the key things we did for the new 7 Habits 4.0 is we made it international -- a lot more diversity. We filmed a lot of the new films in different locations around the world.

So it's being received very, very well across the board by our clients. We are excited by that and some of our first events, like we held one in Singapore. We had 250 people in attendance. We got 80 certifications out of it. It went very well. So we are just in the very beginning.

We have a plan to try to get 1000 people certified by the end of August in the new 7 Habits 4.0. And this will -- we'll hit it hard for the next couple of months, so we will get some impact in the fourth quarter. But also it will come next year in the first and second quarter.

Internationally we think it will be very impactful, just because it's about 50% of our sales is in this single product. And so the leverage of that is tremendous. So, from a product standpoint, it's being very well received. From a marketing standpoint we are just beginning on the front end of the launch. But it's very positive thus far. Scott, what would you add?

Scott Miller, just maybe talk for a minute about what's planned in the coming months.

I would just expand on what Sean said. So we are about a third of the way through the international tour. We will end the first launch of this tour with over 300 events worldwide.

Like Sean said, in Singapore; this week, we have events going on in Hong Kong, Beijing, Shanghai -- they are all averaging 240, 260 people coming to preview. The North American average was between 70 and 100 previews. So our international events are in many cases dwarfing what are otherwise very robust events in North America.

So we had some large events in big cities, but internationally the events are proving to be phenomenal.

I think another exciting progress is that this facilitator channel has not typically been a very robust international. Most of our certified facilitators come from our English speaking direct offices. And our virtual certification process, which is now done all online, is now being translated into other languages. So we're going live with our Spanish version of our virtual certification which will allow 15, 20 countries to begin to very efficiently and effectively certify facilitators. So I think we are going to see this tour gain enormous traction.

Sean mentioned our goal is 1000 certifications from 7 Habits. And out of about eight cities, we already have 160 certifications. So the momentum is very encouraging.

Got it. And last quick question -- just a follow-up on the tax question earlier for modeling purposes, I understand if you guys do take those benefits on the taxes, can you give me a sense of how low that tax rate could go in Q4?

Yes. That's a tough question, just simply because if you look at how much we did last year, it's very dependent on a bunch of variables. It could be as low -- we could end up somewhere with last year's rates or even a -- I think tied into our vice president tax, even a percent lower. So I would guess that the best scenario would be what it was last year in the fourth quarter. I'm sorry; don't have that percentage right here with me. But they will probably end up being around 26%, 27% -- maybe even 25% effective rate for the entire year.

Got it. That's helpful. Thank you, guys.

Jeff Martin, ROTH Capital Partners.

Thanks for all the detail on the seminars for the recreated 7 Habits. I was curious; as you hear the conversion rates -- we are looking at the conversion rates for the existing clients, what kind of conversion are you seeing for the new clients? And how does that compare to some of your other content practices?

Yes. The conversion rate -- I'll just say the simple number is that in the quarter, for the quarter, about 7% of those who attend that are new clients convert in the quarter for the quarter in events there. And there's a similar amount that converts in the following quarter. And then, of course, then you've got a pipeline to go out there for many months that people continue to work. It may not be the time in their organization.

So, overall, what we've learned from the other products is that out of every event that we have that doesn't include existing clients, you end up generating about $70,000 or $80,000 of business over time in the next 12 to 14 months. So that translates into an effective conversion rate somewhere around 30% effectively over time. So, some of it happens right up front. Other amounts are spread over time.

Okay. That's helpful. And then how should we look at the growth in Leadership over the next two to three years? I mean you are going to have a lot of events really running through probably the end of the year, first half of next year. How should we look at the growth rate in Leadership? And what kind of level do you think that can get up to on a run rate basis?

Well at a minimum we expect Leadership to grow to be growing along the pace of the Company generally at 10% for 12%. But I think it will be somewhat elevated probably for the next 12 months. Even in the US it will be elevated just because you still have this big pipeline that's going to be generated, quarter after quarter. And so it will get a disproportionate share.

If we're doing say 800 events next year, Scott, how many of them will be -- in the 800 in the US, how many will be 7 Habits against next year?

Probably 200.

So it will get a quarter of the attention where historically it's had no events. So it will grow disproportionately. And so if we have, say 10% to 12% growth as a Company, you'd probably have 15% to 16% growth for 7 Habits in the US.

It will be faster than that, I expect, in our direct offices, particularly Japan is a big office for us and a significant portion of its sales come historically from 7 Habits. So we should have, again, accelerated growth in Japan, as Sean said, among the international licensee partners. So I think overall it will be midteens or better growth overall, probably in the next year. And -- but the others ought to all do pretty well, too.

Okay. We didn't cover much on education. That's continuing to grow at a very healthy pace. Do you expect that to remain at an elevated growth rate for quite a while still?

Sean, do you want to address that?

Sure. Sure. Yes. Education's growth has been strong and steady. Fourth-quarter we expect it to be in the 30%, 40% range for the year -- about the same. And I see this carrying on for the foreseeable future.

We have yet to -- I mean, if you look at where the Leader in Me schools are, we will add about 500 this year to the network, getting us to about 2000. And a lot of it -- I mean it's disproportionate in the Southeast where it began, where the first schools began. And then we have kind of gone and migrated to the Northeast.

We are pretty lightly populated in the West. All the inner Mountain states -- California, Oregon, along the coast, Washington -- very few schools, so we've done very little there and the opportunity is ripe there.

So our focus continues to be on quality results for the schools, reducing behavior problems, helping with teacher engagement, parental support and engagement as well as improving academics in some cases. And we just find we are getting better -- our quality is getting better every year. We still feel like we have a long way to go, but it's getting better and that drives growth more than anything else.

For example, in New York City, we have a few schools up and going in the big district there with 500 schools. And because they have done so well, we are now looking at an opportunity to go to 100 new schools in New York City. So we are going to just continue to focus on quality. We find that it is the key marketing tool for us.

The Leader in Me book is also a key marketing tool and that will be the second edition of that book. It will be coming out in August. We think that will drive some growth as well. So, kind of a long answer to your short question, but, yes, I think we can expect education to continue to grow at the same rate as it has the last three or four years.

Okay. Appreciate that. And I just want say, Bob, thanks for all the details. Very helpful.

Thanks much, Jeff.

Kevin Liu, B. Riley.

Good afternoon. Just regarding the facilitator visibility that you might have for Q4, I know you mentioned it's generally a big quarter there. But given that you guys had a lot of strength there with kind of the early buys in Q2 and that did seem to pull in some revenues from the third quarter here, how confident are you that you can continue to see the useful step out that you would typically see in the fourth quarter?

First of all, we feel very confident that we will. Over the years we've trained our existing client base that we have one big promotion each year which is if you buy 10 manuals you get one free. So a lot of our customers just know they are going to be ordering in the fourth quarter.

So, the facilitator sales in the second quarter was almost all driven by 7 Habits. So with 7 Habits alone, as I mentioned, about half of those who will convert have converted this year. So we expect that some of second and third quarter could easily happen in the fourth or sliding fourth into the third.

But all the other content categories really have no focus in the last couple of quarters, so we feel good, and of course it's not just a general feeling. We have these reviews every day and we look at the size of the pipelines and opportunities. We spent the morning this morning going through several offices and looking at their pipelines.

It looks to us right now the pipelines in each offering area are elevated significantly, that there are good reasons for people to buy, that these client partners are out there talking to them early.

And so, in a normal year, we have about a third of our facilitator revenue occur in the fourth quarter. And so if, in a given year, you are going to do close to -- let's just say you are going to do $48 million or something of facilitator revenue in North America, you would have $16 million in the last quarter versus $32 million across three quarters. So we expected to have a similar pattern in the fourth quarter.

You don't have total visibility on the actual sale because it's not contracted, as I mentioned. But you still know what percentage of your pipeline of opportunities is likely to convert. And we have such a good relationship with so many of our clients with this 90% renewal that really it's usually a question of how much -- what their training needs are for the next year. It's not so much a question, will they -- do they need to repurchase?

They are committed to the offering. They are training new people. It's just trying to get a handle on the number of people they are going to need to train next year and making sure that they understand the motivation of doing it in the last quarter. Is that helpful?

Yes. That's definitely helpful. And then with respect to the international business, you guys were already growing double digits this past quarter. It seems like the ramp up and launch of 7 Habits internationally is going well. And is it fair to assume that you guys expect to continue growing the international business double digits both for the licensees and the direct office from here on out?

Yes. We stated to the licensees that we expect 11.8% compounded for the last seven years and we have this stretch goal to say we want to get to $200 million in gross revenues -- have their gross revenues get to $200 million by 2020. We -- everything that the team is doing there, led by Sean Covey -- in that area is pointed to that. International direct offices, Sean, do you want to just speak to that?

Our expectation for international direct office is the same. We have the same kind of growth expectations in those offices that we have in our domestic offices. We are encouraged by the fact that, for instance in Japan, the offices sell more 7 Habits than any other single office and has yet to launch the 7 Habits because of translation but is actually doing that now. We've had our first couple events in Japan and they have been filled to bursting in the venues and have been received very, very well. So we are excited about that.

In the UK where we have launched the 7 Habits we are back to back on two of our very largest quarters ever. And the fourth quarter is looking strong in the UK and Australia is the same. In fact one of the large deals that they expect in third quarter and closed just to the first couple of days in the fourth quarter, as Bob mentioned, this shift in the revenue was in our Australia offices, the single large deal they have had there.

So we are encouraged by the growth momentum there and expect that to continue. Our expectations again are the same for those offices that we have in the US and Canadian offices.

And you might talk to the hiring they're doing.

Yes. The hiring expectations there are the same as elsewhere. So we have identified our target hiring thresholds and they are clipping along at that pace. And so they are -- the phrase we used is, they are running the play. And we are running play which includes all of the marketing events and all of the other launches etc. that we have -- including the hiring and ramping of client partners. So we are on pace there.

Great. And just one last question for me -- any color you can add on kind of the SG&A line here for Q4. I know typically there seems to be a seasonal spike. Can we just look back at the magnitude on either an absolute or a percentage basis last year to assume the Q4 number for this year?

Sure. Over here, Derek.

Yes. We would expect there to be an increase primarily due to the increase we are expecting for sales (inaudible). With those increased sales we expect increased commissions on those increased sales. And that's usually the driver; over the last few years that's been the primary driver of our SG&A increases in the fourth quarter.

We would expect that to occur at the end. So I would say even on an absolute dollar basis, it's hard to project. Based on sales and say it would probably be up maybe another million or two versus last year.

Thanks a lot.

Even with that, Kevin, as you know if you have a detailed model, but we expect very significant flow-through of incremental revenue to incremental EBITDA in the fourth quarter.

Thank you.

Matthew Berry, Lane Five Capital.

Hello. You mentioned in the last 10-Q the longer than expected collections time for government, education and licensee accounts and expected some improvement in third-quarter I think which didn't seem to materialize. So there is still -- it looks like maybe $8 million to $10 million of cash locked up, which is like a 3% buyback or more than a whole year's worth of practice development costs or 40 to 50 new hire costs. So could you just touch on what is actually causing those delays -- the underlying causes at those accounts?

Well, primarily, we did see a little bit of improvement in the third quarter but, like you said, not a lot. A lot of that stuff was simply due to the timing -- the payment cycle on some of these clients. The government typically tends not to pay quite as fast. They will pay -- their stuff doesn't move quite as quickly.

And we have had some relatively large deals that have gone through, and sometimes those guys have gone to a little bit longer payment terms. So we do believe that there is some capital locked up in our receivables. We hope to get to that, get the DSO down and days sales outstanding down, and get the cash in the door.

But you are right on your analysis as far as there is probably $7 million or $8 million of receivables locked up in little bit longer terms than we would like. We definitely have all hands on deck to try to collect those.

So it's not an indication of anything really we need to be concerned about at this point? I mean, you haven't made any provisions against them or anything like that?

Our write-offs are virtually zero for the entire year. So we are not provided for a lot of write-offs or anything like that. We believe they are all still collectible.

Okay. Thank you. I just wanted to check. Thank you very much.

And we have no additional questions at this time.

All right. Great. We would just like to thank everyone for your participation today, for staying on a little bit longer. We appreciate that. We are looking forward to talking at the end of the fourth quarter. Obviously we are in the middle of a lot going on here in the fourth quarter.

Thanks again for your support. We look forward to talking to you soon. Thanks.

Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.