Franklin Covey Co (FC) 2015 Q2 法說會逐字稿

Welcome to the Q2 2015 Franklin Covey earnings conference call.

My name is Adrian, and I will be your operator for today's call.

(Operator Instructions) Please note this conference is being recorded.

I'll now turn to call over to Derek Hatch.

Derek Hatch, you may begin.

Thank you.

On behalf of Franklin Covey Companies, welcome to our call this afternoon to discuss our financial results for the quarter ended February 28, 2015.

Before we begin, we would like to remind everyone 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 and 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 or influence, any one of which may cause future results to differ materially from the Company's current expectations.

There can be no assurance that the Company's future -- 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 CEO.

Thanks, Derek.

I'd like to welcome everyone to the call.

Appreciate your joining.

The second quarter was characterized by four things.

Strong overall revenue levels against the big comp quarter last year.

Second, foreign-exchange movement which impacted both revenue and adjusted EBITDA during the quarter.

Third, large net investments in new client partners and supporting marketing activities which have already helped to drive a 12% increase in the size of our perspective business pipelines for Q3 and Q4.

And fourth and finally, nearly $40 million increase in our liquidity, with an increase in our authority to use it and our intent to use it to help create shareholder value.

The second quarter also established a foundation for what we expect to be significant growth in both revenue and profitability during the balance of the year and beyond.

So I would just like to now provide a brief overview and description of the results for the year.

First, talk about revenue.

Our $46.3 million in revenue represented actually a strong revenue quarter for us.

In fact, we achieved our second-best revenue ever for the second quarter for our current business.

Excluding the approximately $1.2 million reduction in revenue related to foreign exchange, our revenue would have been $47.5 million, and that would have been our strongest second quarter ever.

Although revenue was strong, it was flat to last year, due both to foreign-exchange charges and to the fact that we were up against a very comp from last year's second quarter where total Company revenue grew 15%, driven by the very successful launch of our re-created 7 Habits offering in that quarter.

We felt good about the revenue performance for the quarter on a broad base.

We generated our highest-ever second quarter revenue in our education practice, which was up 14%.

Sales performance practice, which was up 30% in the UK, which was up 10%.

Shown in slide 3 in local currency, revenue in our direct office in Japan grew 10%, as did the UK, and our gross revenue and our international licensing partner operations also grew 14%.

Second, talked about adjusted EBITDA.

Adjusted EBITDA for the quarter was $2.8 million lower than last year's very strong second quarter in which adjusted EBITDA grew 19%, again, driven by the success of the launch of the 7 Habits offering.

More than 100% of the impact to adjusted EBITDA for the quarter was attributable to the following two factors.

First, the impact of changes in foreign exchange resulted in a $900,000 reduction in adjusted EBITDA for the quarter.

As noted, foreign exchange charges reduced revenue from our non-US operations by $1.2 million during the second quarter, resulting in this $900,000 reduction in adjusted EBITDA.

Again, as you can see in slide 3, our international direct offices and international licensee partner operations had strong growth in the second quarter in their local currencies, and our international direct offices posted revenue growth of 8% combining the 10% in Japan and the UK and the slight reduction in Australia -- the slight decline in Australia.

Licensee operations grew 14%.

Year to date through the second quarter, changes in foreign exchange reduced reported revenues by $2 million and adjusted EBITDA by $1.6 million.

Current exchange rates, we expect the effective changes in foreign exchange to reduce reported revenue from our non-US operations during the back half of the year by approximately $3.3 million and reduce adjusted EBITDA by approximately an additional $1.2 million.

So for the year as a whole, including charges already occurred, we expect the effects of foreign exchange to reduce reported revenue by approximately $5.3 million and adjusted EBITDA by $2.8 million.

The second factor affecting -- aside from FX, all the rest of the change in year-over-year decline in EBITDA is attributable to the four direct offices in the US.

They -- their EBITDA contribution during the quarter was approximately $2.25 million lower than in last year's second quarter as a result really of two factors.

It was first a tough comp against which they were competing.

And second, significant increases in the growth and investments in the quarter, and I'll just note each of those.

First, lower direct office revenue.

Approximately $900,000 of the decrease in adjusted EBITDA contribution from these direct offices was due to lower revenues compared to last year's second quarter in which revenue in these offices grew 18%, driven by the strength of launch of the re-created 7 Habits.

We feel very good about these offices; they have been, are, and will continue to be powerful growth engines for the Company.

As you can see in slide 4, these 4 offices have achieved significant and consistent revenue growth over a number of years.

Over a four-year period, their compounded average revenue growth has been 12.6%; over the 2012 to 2014 period has been 13.7%.

These offices are very strong.

We expect their revenue and EBITDA contribution to increase significantly in the third and fourth quarters and for the year as a whole, and be positioned for even more aggressive growth going forward as they have continued to add -- they have been one of the largest adders of the client partners, and we have been investing behind supporting those client partners.

So part of the decline in revenue, the rest was the increasing growth in investments in those offices.

As you know and as you can see in slide 5, the significant portion of our annual adjusted EBITDA is typically generated in our fiscal third and fourth quarters.

This is driven by two factors.

First, a disproportionate share of our revenue income is generated in our third and fourth fiscal quarters.

This is driven by the fact that the education business generally -- typically generates more than half of its annual revenue in the summer months when school administrators and faculty are in recess and available for training.

This is also impacted by growth in our corporate business, where we have historically offered biggest promotion to our thousands of client-employed facilitators to purchase new training materials in August, which is the end of our fiscal year.

And so we have this buy-10, get-one-free offer which people build toward during the course of the year, and they tend to reorder a disproportionate amount of their materials during this promotional period.

The second factor -- so one part of the equation is that you've got more of our revenue that occurs in the back half.

The second factor impacting the seasonality of our EBITDA is that while a disproportionate share of the revenue occurs in the third and fourth quarters, a disproportionate share of our growth investments occur in the first and second quarters.

This is driven by two factors.

First, as you can see in slide 6 and I think as you know, investments in new client partners, which are generally higher as a class in the fall, typically do not turn positive until the third and fourth quarters.

So we invest in them.

We have a net investment during the first two quarters, and then they begin to contribute to EBITDA later on.

Second, as you can see in slide 7, marketing events also don't generate a huge amount of revenue in the quarter in which they are held because they -- unless it's held on the very first day of the quarter.

So on average if it's held in the middle of quarter, not that high a percentage of the total revenue that will come from that event will actually show up in the quarter.

It will be in subsequent quarters.

And while it's not a long term over which it comes, nevertheless it tends not to be in the early quarters.

So these two factors build the foundation for revenue in the third fourth quarters but themselves cost money.

So the significant growth in our business overall and the growth of the education practice in particular has increased the size of our investments in client partners and marketing events in the first two quarters of each fiscal year to ensure that we prepare to reap the harvest in the third and fourth quarters.

We have a lot of confidence in these investments; they are ones we've been making for years.

We are not confused about what an investment in an event generates.

We analyze it every week and we talk about it every Monday morning at 8:30.

We are also very confident about our investments in client partners, which we reported on over the years.

But nevertheless, the bigger we get and the more of that revenue that is in the back half, the bigger the front-half investments.

I mentioned we did a lot of investing in the second quarter -- $1.4 million of the year-over-year decline in EBITDA from the four US direct offices related to the 13 net new client partners added in these four offices compared to last year's second quarter to a 48% increase in the number of marketing events which we held during the second quarter.

And to a special investment we made in the second quarter to support an unprecedented face-to-face meeting effort where we had more than 2,000 face-to-face meetings and connected with nearly 3,000 of our client facilitators during the second quarter to make sure they knew they were appreciated, to let them know what was going to be going on this year, and to prepare them to be ready to buy and plan their purchases in the third and fourth quarters.

Because of the success of this initiative, we plan to do a similar face-to-face initiative in Q4 just to make sure that everything is set for the fourth quarter.

As I mentioned, these investments are already paying off.

Our new client partners are ramping up and will start contributing to adjusted EBITDA in the third and fourth quarters.

Our investments in this significantly increased number of marketing events and the support of the face-to-face calling effort during the second quarter has already driven a 12% increase in our third- and fourth-quarter pipelines with more to come.

And as a result of our activity, we've also certified an additional 950 client-employed facilitators compared to this time last year.

So on top of our base of thousands and thousands of facilitators, we've added another 950.

And these new facilitators will be in a position as they are trained and so forth to be ready to purchase materials and begin training in the fourth quarter.

So we are looking forward to big things from these offices in the third and fourth quarters as these pipelines begin to be converted to increases in revenue.

For us, it really wasn't a choice not to make the investments because we knew -- we were confident of the harvest if we make the investments, and if we don't we are confident the harvest would be short of what we wanted it to be.

Third topic, briefly, our fundamental debts over our arching debts we believe are still very much on track.

As you know, we have three key growth and value-creation objectives.

One, to grow revenue by approximately 10% a year.

Second, to have approximately 25% to 30% of our increases in revenue flow through to increases in adjusted EBITDA, which of course over time has increased our adjusted EBITDA margins.

And, three, to utilize our strong balance sheet to help to accelerate shareholder value creation.

We continue to be committed to these initiatives and really are pleased with the progress we have continued to make against them.

Let me just touch on them briefly.

In terms of achieving revenue growth of 10%, our past revenue growth actually has been strong.

We expect to continue to achieve strong revenue growth in the future.

Even after more than $2.7 million in negative foreign-exchange impact, revenue growth for the latest 12 months has been 7% net of foreign exchange.

On a broader basis, our overall -- as you can see on slide 8, our overall revenue growth over the past years has been strong.

You can see in slide 8 it's not only been 10% or more in most years, but it also in most four -- for the trailing 12 months ended at the end of almost every quarter.

Since we have had good, consistent growth, we've had FX issues, we've had government shutdown and sequestration issues, et cetera.

But notwithstanding those, we feel good about the ability to grow organically at around 10% or more a year.

We've made the investments in the numbers of client partners that should drive that, and so we are feeling good about that one.

This growth has been underpinned, as you know, by three primary factors.

First, the hiring and ramp-up and productivity of client partners.

We currently have 177 client partners.

We are now hiring groups of client partners in classes who all begin at the same time, so this number of 177 is essentially the same number that we had at the end of the first quarter where we are now getting ready for the big ramp-up of hiring for the fall.

Following this pattern, we expect to add at least an additional net 23 client partners by year end or immediately thereafter so that they can attend our September sales academy.

Second driver has been the growth in the productivity of our international licensee partner network.

As shown in slide 9, our international licensee partners' gross revenues have grown from approximately $23 million in fiscal 2005 to approximately $90 million in fiscal 2014.

The royalties which we receive from them, which represent approximately 15% of their gross revenues, have grown from just over $4 million in fiscal 2005 to $14 million in fiscal 2014.

So the compounded average growth rate, again, has been north of 10% for the licensees.

The third driver has been the growth of our practices.

As you can see in slide 10, each of our practices has really grown a lot since this base year when we started these initiatives in 2005.

As you can see in slide 11, most for the trailing 12-month period have had good, solid growth.

And Speed of Trust was down a little bit.

There is a big tour going on now around the Speed of Trust in the third and fourth quarters.

Execution has also been down a little bit, and this primarily impacted some very large accounts that have now matured, and there are still clients that aren't spending exactly the amount they did before.

Our pipeline is growing to fill that.

So that's kind of our first objective on revenue growth.

We feel like all three of these facts will continue to drive the productivity, ramp-up of the client partners, the growth of our licensee network, and the continued growth of our practices.

In terms of the business model, our long-term objective has been to have approximately 25% to 30% of incremental revenue flow through to increases in adjusted EBITDA.

Slide 12 shows how that's been going.

As you can see slide 12, from 2011 through fiscal 2014, revenue increased $44.4 million and adjusted EBITDA increased $13.2 million, reflecting flow-through of approximately -- it was 29.7% flow-through incremental EBITDA to incremental revenue.

This was after absorbing the impact of foreign exchange, government sequestration, shutdowns etc.

Fiscal 2014 alone flow-through was 21%, reflecting both some increased investment and sales support and the impact of foreign exchange and the decline in the government revenue relating to a major contract that year.

So there will be impacts from time to time from foreign exchange and other factors.

But having already made our significant infrastructure investments in 2013 and 2014, we believe the incremental revenue on a constant currency basis will be in that 25% to 30% -- maybe a little bit less than that when you have big FX charges.

But otherwise, we still believe we can flow through.

Finally, on accelerating value creation through the use of our strong balance sheet, I'm going to really, Steve, maybe just turn the time to you to discuss that if you don't mind.

Thank you, Bob.

Good afternoon, everyone.

I am pleased to be with you.

So as you know, over the past years in addition to the increased earnings, capital transactions have played an important role in the Company's progress.

Slide 13 actually shows some of the things that we have done including the sale of Premier, sale leaseback of campus and so forth.

So I think we've shown a willingness to complete these types of transactions.

To give us the flexibility that we need currently to hopefully benefit shareholders from the strength of our balance sheet and our liquidity, we are happy to announce that we've increased the size of our revolving credit line from $10 million to $30 million and also obtained bank approval to additionally borrow up to $20 million more under a two-year term loan.

Our Board of Directors also increased the amount of our share repurchase authorization from $10 million to $40 million.

Note that we also ended the quarter with approximately $18.6 million of cash, and we had more than $12 million of cash flow from operations during the quarter.

So we have $18 million of cash significant availability in our revolving line in this potential term loan that we currently have no balance outstanding on either of those.

So a combination of the increased cash, the increased borrowing capacity, and the increased authorization to buy shares gives us the ability, we believe, to use our balance sheet strength to benefit shareholders, including through the repurchase of outstanding shares.

And outstanding shares including the potential to repurchase Knowledge Capital shares, all or part of those shares that could become available.

In Q2, we did purchase some shares under the repurchase authorization that we had in place.

So we are quite excited about -- we spent about $1.6 million, about 89,000 shares.

So we are excited about the authorization and the borrow capacity and the ability that it gives us to benefit shareholders by being proactive in using the strength of our balance sheet and our liquidity position.

Thanks, Bob.

Thank you, Steve.

Let me just finish up here in terms of our outlook to say that we are very encouraged by the momentum we are continuing to see in the business, by the continued growth in the size and productivity of our direct sales forces, the growth in our international licensee partner operations, and our practices and by the overall momentum and trajectory of the business.

Our key momentum indicators continue to be very positive, and this momentum is both strong and broad-based.

Our prospective business pipeline, as I mentioned, continues to be strong and growing.

As noted about a minute ago, the size of our prospective pipelines for our four direct offices for the third and fourth quarters have already increased 12% just on the foundation of events we've had already.

And those tend to continue to build as the client partners follow up on these events.

We are experiencing similar growth in the pipelines of most of our other operations.

So we feel very good about the momentum of the business.

When we established our adjusted EBITDA guidance range for the year of $37 million to $40 million, it was with the expectation that we as a team would be targeting the high end of that range.

This continues to be our objective.

And, parenthetically, that's what drives the compensation for our executive team and others.

That net number isn't changing because of FX or anything else; that continues to be our objective.

We believe that absent the effects of foreign exchange our operations would track toward the high end of that range for the year.

With the ongoing impact of foreign exchange, however, we expect to absorb approximately $2.8 million of negative impact to adjusted EBITDA, which we had not anticipated.

So despite this nearly $3 million foreign-exchange hit, because of our confidence in the strength of the business otherwise for the second half of fiscal 2015 and some large transactions in which we've been working and are very hopeful about, we are only reducing our fiscal 2015 adjusted guidance -- EBITDA guidance range by $1 million to between $36 million and $39 million, not by the $3 million that FX effect is -- hopefully that expresses our confidence in the foundation of the business.

So with that, Steve, you had other things you were going to talk about today?

With that, we will turn it over to you all for questions.

Look forward to answering.

(Operator Instructions) Joe Janssen, Barrington Research.

FX aside, if I hear you correct, it sounds like the momentum, things are continuing to move in a positive direction.

Let me focus on the marketing side of this.

Given the big push in terms of the actual number of events you had in Q2 relative to where the pipeline is at today, Bob, are you -- maybe talk about the early results?

Are you pleased maybe compared to what maybe your original expectations were going into the quarter?

Given -- I think you had -- on your last quarterly call, you gave a slide where you were doing almost a 100% increase of what you did last year.

So I'm just kind of getting a peek at how that's going.

Thanks, Joe.

For the last four years we've been running a lot of these events and have kept pretty darn good records on them to find out what each event produces and how quickly.

So I think we feel confident about what comes out of these events.

So the events we held this quarter -- it wasn't with trepidation that we increased the number of events.

It was actually with real commitment and a determination that we would find a way to hold a number of events because we know what should come out of them.

So I think the pipelines that are coming out, early expectations are on track or maybe a little ahead of what we would have thought.

The event mix has some impact on that, Joe.

When we have events that are more 7 Habits or productivity oriented, the conversion cycle -- the average sales tends to be a little lower because people -- it's more often than not, a licensed facilitator who is buying enough manuals for a class.

So the average order size tends to be a little smaller, but the curve of the pipeline is faster.

When we do more execution, sales performance, and trust events, there tend to be a higher percentage of those events that become larger strategic -- they are all strategic -- but tend to be engagements where we might be delivering some of the content ourselves.

So the mix has something to do with it.

But I'd say overall our understanding of the numbers, we think, is good, and the results have been good.

So we are continuing on with a very strong event schedule every quarter thereafter.

So the jump quarter to quarter won't be the same as when we had this big starting the engine and priming the pumps, which we had in the second quarter, doubling the events.

Where this quarter, it will be much more just we will continue to build pipeline from the second-quarter events and have a similar number of events in the third and fourth quarters.

But we feel confident about that.

Another thing I think that is important is that we now -- we haven't talked much about this because it is in our overall client-partner ramp numbers, we have 23 client partners now who really don't own a territory.

The holy grail for us over the years has been to say, there are more than 15 million managers in the United States alone, and a lot of those managers have enough budget that they could buy a $6,000 or $7,000 course to take their team through whether or not their entire organization was going to commit to a bigger engagement.

Over the last three years as we have launched 5 Choices, Trust, and 7 Habits have learned that there are actually a lot of those people who are not existing clients that might otherwise be assigned to -- in the 100 clients their average client partner has that will come in and make a decision.

So we have now 20-plus salespeople who we haven't given any accounts to.

Historically, we'd give them a few accounts to get them started where they are just going cold turkey with good supervision.

And it's early on, but we are very confident their ramp is going to be there.

They are already generating revenue.

So between the events for those folks plus our normal events, we are really encouraged and have the pedal down on continuing this.

Is that responsive to your question?

It does.

So nothing has changed.

Back half of the year, you expect the flow-through obviously to go higher, given your guidance.

Again, FX aside.

Just the execution risk gets a little higher in the back half of the year just given the early first-half results and adjusted EBITDA.

Hiring expectations the back half -- your kind of stated goal has been a net 30 CPs; you've now got 20.

Just so I don't get too far ahead of myself, another 10, is that kind of what we are looking at?

You are not going to go too much above and beyond that target number, are you?

We expect to hire another 23 by August 31.

But we won't be hiring them a lot ahead of that, either.

We are going to start sales academy -- Sean -- second week of September.

Sean, you will be hiring not until the fall?

June or July.

(Inaudible) June or July.

So the 23 net new hires between now and the end of the year will get us in the 200s by the beginning of the year.

I imagine there will also be some additional hires that we don't know about right now.

But right now there's some programmed hires.

We have 23 that are programmed by region, by date, by type of client partner that we are going to hire.

We will continue to focus on that.

But I think the idea of net 30 a year continues to be the goal.

And if we were a little over 200, we would be a little below net 30 for the 12 months ended August 31.

My guess is by November, though, we will be in the ZIP Code of that.

And we are hiring for specific cities and the mentoring coverage, et cetera, affects a little bit the hiring we did.

We reported in January that we had hired net 31 for the 12 months -- the prior months.

So we remain committed to the initiative at the same scale.

Okay.

Thank you.

Tim McHugh, William Blair.

Hi.

This is Sam actually filling in for Tim.

Just a question on incremental margins.

Maybe just kind of what -- just get a sense of what your expectations are for the full year.

The EBITDA margin -- if we take this range of 36 to 39 expanded range, and we said that revenue -- we thought revenue growth was going to be 10%, but it would be down -- so 10% growth would represent about $20 million of revenue.

We said it will do about $5 million less than that because of FX, and that would be $15 million of revenue growth, in the middle of the range from 34.4 to 37.5 or something -- we would have roughly 25% EBITDA flow-through from incremental revenue.

Does that make sense?

I was doing the math -- it's approximately that.

And obviously FX hitting is reducing that a little bit below what it would've been.

But fundamentally, it's kind of still in that range.

Okay.

Sure.

And then another follow-up question, so when you establish the 30 net new client partners per year, what was the -- maybe just kind of like a reminder as far as why 30 and maybe not why tie that to a different metric like prospective business pipeline or events or anything else like that?

So that's a great question.

We started off -- we know what the economics of the new client partner are, so that's our unit of measure.

So for us, it's kind of like opening stores.

How many new stores are we going to be opening?

So we went from 6 to 10 to 13 to 18 to 22, and then we thought we could make the jump to 30.

But the idea behind that is that if we hire 30 net new client partners a year, we can grow our field operations within a couple of years of doing that.

If we can do that for another couple of years, all of our direct offices that have these client partners will be at a revenue rate where they can grow at 12% or 13% a year, year after year, with that kind of revenue growth, with that kind of client partner growth.

So for us, we were looking at what the potential was, what we could handle.

And when we think we can have more than 1,000 client partners, the question we are often asked is why isn't it more than 30?

But I think at 30, we feel like for the next couple or three years, that's a good level where we can mentor them, we can make sure they are successful, we won't have any degradation in quality, and so that's kind of where we set it.

But behind that are the lead metrics -- exactly what you are talking about.

So we had the lead metrics that drive that client partner revenue of the number of events they have, the number of leads per event.

We expect, for example, these new client partners that are focused just on these events that I mentioned to Joe, where they don't have assigned accounts.

They just take the new clients that come in.

We expect them to generate four new certification equivalents, we call them, so that's around $6,000 sales, their first 90 days.

Then $8,000 their second.

Then $12,000 every quarter thereafter while retaining 90% of the revenue from their previous ones.

So there's a set of metrics, and the events for them are two-thirds of the game.

For our other client partners and the more strategic, big-account client partners, they use events selectively.

So we kind of have the ankle-bones-connected-to-the-leg-bones-connected-to-the-hip-bones strategy which says, okay, if we want those people to ramp up according to the schedule that we've established, what kind of lead flow do they have to have?

How much new pipeline do they need to add every single week?

Where does the pipeline come from?

So we have a lot of math behind it.

But the unit of measure is kind of like same-store sales and increasing the number of stores open, so to speak, and having the number of client partners.

Okay.

Great.

Thank you.

Jeff Martin, ROTH Capital Partners.

Bob, I know you have for a while have been tracking face time with clients.

And that is not a new initiative, but it's an emphasized initiative.

Was just curious if there -- it sounds to me like in the quarter there was a particular emphasis on that.

Was just curious if there was something that led up to that or if that is a normal course of business.

I'll let Sean respond.

Hi, Jeff.

Good to talk with you.

So there's a couple of responses.

We really do emphasize the face-to-face hours that the client partner achieved.

This is something that I check on with my team every single week.

It's one of our lead indicators.

And at the individual client partner, we have what we call plan-and-review sessions where they have an hour every week with their respective sales managers to go over a few key indicators in the pipeline of big deals and stuff like that.

This is the first thing that they review, and it's tracked, and there's a lot of coaching and mentoring and right along that happened with all of that.

So that's a long way of saying we really do focus on the face-to-face hours and as we are going into the quarter knowing that we had last year's 7 Habits launched as part of -- we pulled that forward into February from March.

We had a specific emphasis on pipeline building that would come from these face-to-face hours.

We developed a very powerful, we believe, face-to-face kit.

They gave a very specific agenda for these face-to-face meetings.

And so the first answer is, no, it's part of our standard course.

And the second answer is, yes, we had a special emphasis on it and will continue to do that as we move forward into the fourth quarter and the first quarter.

And it yielded a very impressive pipeline from these face-to-face hours.

This is a very important metric to us, and we actually over-achieved our expectation in the second quarter and established it was good for the pipeline.

Is that responsive?

Yes.

That's helpful.

And then, Bob, your EBITDA guidance -- your updated guidance, if you adjust for the FX, it actually implies that you are increasing it by a couple of million.

Was just curious if I'm thinking about that correctly.

I think you've got the math right.

I think what we are seeing is that when we laid out the initial guidance for getting FX, we did not budget or plan for any large individual transactions because they are just hard to predict, and they are always hard to predict.

But because we have a pipeline of those big transactions in which we are involved across a number of practices, we feel right now that there is a likelihood given -- it's not hundreds or anything, but a dozen or so good-sized -- really good-sized deals.

We feel that we'll get our share of those -- are likely to get our share of those, and that's giving us some more optimism above what the normal run rate would be.

Obviously if we didn't get any of those, we'd be back toward the lower end of that.

But that's the thinking behind it is that FX, we know kind of where it will hit us at least at current exchange rates.

We are feeling a little stronger about the likely revenue in the coming quarters.

Joe mentioned -- of course, the more back-end loaded -- in one sense, it looks like there's a lot more execution risk and there probably is.

But in another sense, you take what Sean Covey is building in the education practice -- by this time, their schedule is filling up very rapidly for the late third and fourth quarter.

So the execution risk in education -- you can speak more on this, Sean, if you like -- has moved from sales execution risk more to delivery execution risk in the fourth quarter.

Same thing for us -- in the rest of the organization, there's more execution risk on filling the pipeline in the first half of the year.

There's more execution risk on delivering on that pipeline in the back half.

Both have their unique challenges, but, given the two, I'd rather be on the delivery side of that bet than the other.

So we feel like, of course, there's risk.

And you hate to be back-end loaded, but at least the back-end loading is off a different kind of a bet than it is on the filling pipeline.

Sean, do you want to add anything?

Yes, sure.

So just on education since it's so fourth-quarter backloaded, let me just share with you what's happening with our -- these are the key predictive measures that we have.

Second half of the year -- I can just share those with you.

Our main one is our contracted revenue.

So it's revenue under contract right now.

For the third and fourth quarters, it is up 21%.

Most of that is in the fourth quarter; it's up 48% in the fourth quarter.

Another key measure is our pipeline of proposals sent.

This is the dollar value of proposals that we are waiting to hear back from.

Now, those are up 61% over last year.

The number of large deals in our pipeline is stronger than it's ever been.

So that's way up over last year.

And then the fourth one is -- are core sustainment revenues.

So when our sustainment revenue as opposed to new school revenue.

New school revenue is when a school implements The Leader in Me solution, there is a couple of years of implementation.

Then after that, there is the sustainment revenue.

It's coaching.

It's keeping the solution alive and well inside the school.

A lot of materials and so forth.

That's a key measure for us as well, and that's up 148%.

So we feel good about the second half of the year in education.

Okay.

That's real helpful.

Thank you.

And then I wanted to ask you about the chain advisor is up 950 over the last 12 months.

How does that compare to the past couple of years?

Is there anything specific driving that?

I would apparently think it's 7 Habits, but I'm just curious if there's anything else.

Exactly.

We have these kind of two sides.

We look at our solutions in kind of two camps.

We call some modular solutions where people buy a course or content or whatever.

They don't have to buy a whole solution.

They don't have to buy a whole rollout.

These solutions are typically sold to the HR suite, decision makers who are tasked with building the capabilities of their organization.

We have these other integrated solutions that are really focused on specific outcomes where a line leader, or a line leader together with a very performance-oriented HR partner, is trying to get results.

That's like an execution sales performance, Leader in Me, customer loyalty, et cetera.

And so we have -- during a period of years when we were launching Leader in Me, execution and sales performance, a disproportionate amount of our new sales -- because a disproportion of our events and lead generation was coming on the side towards these integrated solutions.

And we now have about $70 million of our revenue is a company that comes from these integrated solutions that didn't exist at all five or six years ago.

But in the cycle of product development, what's happened is it had been four or five years since we had redone all of our core courses that were on the modular side in the more HR-oriented things like productivity, Trust, and 7 Habits.

Like a hotel has to renovate soft goods every three to four years, hard goods five to seven, and lobbies and public areas seven to eight, we just in the normal cycle -- because we did those things first in 2003 through 2005, it was time for those to recycle.

So I think what's driven this is, Jeff, is that, one, we've just gotten better at it.

And second, because in the last three or four years we've re-launched productivity, Trust, and 7 Habits -- and 7 Habits, now managers coming up and so forth -- there's just been a higher volume of products that are bought by people where these front-line facilitation by their own certified facilitators has been the primary mode of delivery.

So at this point, we think the two will balance out, and probably the growth won't be quite as rapid on that side.

It will be a little more rapid on the integrated solutions side, and there will be a balanced portfolio.

So we would still both think that we'll add 800 to 1,000 new certified facilitators a year just because of the pace that's behind it.

I think that's what's been driving the unusually high number of new facilitators over the last couple of years.

Okay.

Great.

And then last question, does your expanded credit facility prohibit you from using that capital to repurchase shares, or can you use it?

No, it specifically allows that.

Go ahead, Steve.

Yes, it does allow.

Yes.

We use the whole $30 million of credit facility plus the $20 million term loan facility for the repurchase of shares on top of our $18 million.

So it was put in place to give us all the options -- provide all the options to us.

There's no restrictions on that.

It also allows us to do other things.

We can do other things, obviously.

We could use the whole thing to repurchase shares.

Specifically it allows all of that.

Thanks, guys.

Good luck in the second half.

Marco Rodriguez, Stonegate Capital Partners.

I wanted to follow up on the last question on the credit facility.

Just kind of want to get a little bit better of a sense as far as what was driving your guys' thinking in playing there?

I understand obviously you upped the share repurchase, but just kind of give us a sense as far as what else you might be thinking about.

I would say that primarily we are thinking of just having the capacity to react to current circumstances related to share price or other things or the overhang of Knowledge Capital shares and just the scenario that we find ourselves in, specifically to give us the ability to repurchase shares.

So it gives us other abilities also, but I think that that was the driving factor.

I mean, that was just the driving factor.

Understood.

And then next question, in regard to the international licensees, can you maybe provide us a little bit of an update as far as where they are in their ramp on the newly released 7 Habits?

And then also maybe if you can give us some more color in terms of where they might be in their stage, if you will, in terms of rolling out that same CP ramp and marketing strategy that you guys have been using for the last few years?

Yes, sure.

Okay.

So in terms of just recapping where they stand right now for the year, and then I'll talk about 7 Habits and the ramp thing -- but we are in a healthy spot.

If you factor in FX, factor out the negative FX exchange, we are growing at 14% this year.

We have -- I'm very encouraged by the new practices and the growth of the new practices internationally.

Again, 66% of our revenue is coming from leadership only, so there is so much open field here.

Education internationally is up 68%, Trust is up 43%, and sales performance is up 15%.

So on the 7 Habits itself, I would say we are halfway through that.

It is -- we still have a lot of work to do.

For example, this last month we were launching it in India for the first time, hard.

And so I think there's still a lot.

I think some of the growth we are starting to experience right now, this 14% growth, the gross dollar level is part of that.

And so I still think we are going to receive benefit for the second half of the year and probably some for next year as well, just because it takes time to get these products localized and to get the machine going.

So I think that's and an encouraging thing.

I think secondly on the hire and ramp plan, or CPs, it's almost like everything is delayed by a year and a half or two years on everything we are doing.

All of our best practices with face-to-face hours, hiring and ramping CPs, marketing events -- it just takes more time and more energy.

And, again, you've got the language factors.

So I think we are a little behind the US, and, again, I think this is a really good thing to look forward to as we -- as these best practices begin to get called out.

So we are now tracking face-to-face hours across-the-board; tracking weekly with all of our partners, all 54 of them.

We are tracking pipeline.

We are tracking hiring and ramping CPs.

So I'm excited by this, and I think it's one of the key reasons why we've got a lot of future pent-up growth.

Between practices -- new practices coming on board, I think there's a lot of opportunity there.

Getting these systems like the hire-and-ramp process in place.

There's a lot of opportunity there.

And I just the fact that we are still pretty small -- most of these partners are $1 million to $5 million to $6 million in size.

And so I think there's a lot of low-hanging fruit still left in these countries.

It's harder to grow once you are much bigger, but at this stage I think you can grow faster.

So I feel like the prospects are positive.

Got it.

And just for clarification there, when you mention that they are about a year or so behind, that's just the normal cycle that you have between when you guys implement something versus them.

Not necessarily you are behind the schedule that you guys have planned out in terms of trying to implement that.

Is that correct?

Yes.

It just takes longer.

You've got distance to travel and you've got language.

Mark, we also started later because we are asking -- the investments necessary to get this started -- for them to hire new client partners, to hire marketing resources, start holding events, have sales trainers, higher practice leaders, et cetera, those investments, we don't with integrity want to ask them to do something that we haven't proven ourselves.

So until we felt that we were really confident and we could share -- which we share all the metrics to these events.

We show them exactly what kind of lists are mailed, et cetera.

But the first two years, we were still learning that, and we couldn't with integrity ask them to step up and make a bet that we weren't yet sure about ourselves.

The same on hiring and ramp-up.

So, yes, you've got it.

We didn't even start asking them to do it for two years after.

We've been at it five or six years.

We didn't even ask them to get going.

And even then, as Sean said, we picked eight or nine key countries in which to get started in certain practices.

So, yes, it's just the natural flow of this, but we feel really excited about it.

And our last Redwood meeting, which includes the top 10 licensing partners along with our own direct offices, we went around and spent a whole afternoon identifying the number of new client partners that everybody was going to hire in the countries as well as in our own offices, and the aspirations were very similar.

There are a lot more countries than we have offices.

But if you take it across the range of the licensees, they had nearly as many new client partners in their sites to hire as we did ours.

There might be a little less absolute drill on making sure it gets done, but not much less.

Yes.

And we just hired a new dedicated marketing director to help us run the play with marketing events across the board, which I think is going to help a lot.

I just got back from the Middle East and our partners there.

And it was really encouraging to hear about -- we had four client partners, and now we have seven.

And we had two in this country, and now we have three.

We have four here, now we have six.

So the hiring bug is catching.

Got it.

Thanks a lot, guys.

Appreciate it.

Kevin Liu, B. Riley & Co.

Just a couple of quick follow-ups to guidance questions from earlier.

I guess you are now incorporating some of the large deals, and I know you alluded to some of those last quarter as well.

But in terms of the decision to factor them into the guidance now, maybe talk about where they are in terms of the stage of the sales cycle and why you have increased confidence so close?

And then also just whether these deals are spread pretty broadly across your different practice areas or concentrated in any particular areas.

So the confidence comes from -- you asked exactly the right question: what stage of the sales process are they in?

If it's just a prospect you think would be a great something, that doesn't make our list.

We have a group of accounts where there's been a proposal made, where there has been a solution discussed and it's being worked on for long periods of time.

We always have a pipeline of these.

These are just the ones that we think are going to have the chance of maturing.

Now, almost all of these that we are thinking about have a specific solution that's been discussed, a specific proposal that is in the hands of the client.

In most cases, there is ongoing discussion about the implementation.

In many cases, there are pilots being run to test how it's going.

So, again, we are not -- in our numbers, it is not like we've got millions and millions of dollars in these big deals in our thinking.

But I think maybe $1 million or so of EBITDA related to deals that in aggregate add up to $6 million or $7 million in prospects.

So it's just stuff that's far enough down the road that it starts to feel like some of those will make it into the year, and that's why we are feeling like we don't need to reserve for the whole FX.

Understood.

And then just going back to the second quarter, obviously revenues were fairly flattish, and you talked about a number of factors there.

The gross margin was a bit lower, and I know there were some issues with things like underutilization and the like in the prior quarter.

I'm just wondering what sort of factors kept the gross margin from holding steady if not increasing in this current Q2.

Yes, I think three things, Kevin.

One, the under-absorption you talked about -- so the margins improved somewhat from the first quarter, so that was good.

It improved 170 basis points or so from the first quarter, I believe, in terms of the year-over-year difference -- the difference in the second quarter versus the difference in the first.

We still have in education in Japan -- and in Japan, the under-absorption of consultants and delivery capacity that will come into play and reverse itself in the third and fourth quarters as those quarters get bigger.

Second is the amortization related to the development of the 7 Habits offering last year is fixed at about $500,000 a year.

But it affects gross margin more in the first two quarters because we actually had the product completed into the second quarter last year.

So now in future quarters, it was already affecting last year's margin, but in this year there is a $0.5 million in each of those quarters.

And the third is a slightly different mix of sales in this quarter.

We have in education a higher percentage of revenue from these coaching contracts that are in fact lower margin.

And because of the launch of 7 Habits last year, which had about 83% gross margin associated with it, the fact that you had a couple of million more revenue in the four direct offices, this meant you had a couple million more at that higher margin.

So as the three factors that -- how does that play out in third and fourth quarters?

The reversal of the absorption in education in India -- in Japan -- will just reverse.

We've got those costs, they just will charge to a very, very high margin in those quarters.

On the 7 Habits amortization, we are already now anniversaried on that, so the incremental impact will both be smaller in Q3 and Q4.

And as a percentage of sales, which will be bigger, it will be a smaller impact.

And then on the mix, typically our fourth quarter has a very high mix of facilitator sales, as we mentioned.

That's why on the corporate side there's a bulge in the fourth quarter.

So we think those margins will come back into line, generally.

On pure percentages, as you develop new products, even though we also get new pricing power, on a revenue -- on a contribution -- gross margin dollars of contribution per sale, we have increases.

But in terms of absolute percentages, if you increase the cost of sales by 8% or $8.00 and you don't increase the price by double, you would have a slight erosion in the margin.

But we think that that's minimal, and that the other factors are the driving factors on margin.

Thank you.

That's helpful.

Jamie DeYoung, Goudy Park Capital.

Congratulations on good results in a tough FX environment.

I just had a couple of questions.

I want to turn to page 9 on the slide deck.

So international licensees business has tripled over the last 10 years.

You grew double digits again this past quarter.

Can you tell us what the EBITDA margin was on $15.8 million of royalty revenue that you have had over the last 12 months?

Generally we have a model set for every operation in the Company that knows exactly what it's supposed to be.

For them, their cost of delivering this is about 15% of revenue.

So, again, that low margin -- there's fixed cost, but today it's about 85% of incremental revenue flows through for licensees.

It wasn't that way, of course, when it's smaller, and that doesn't include all of our investments in product development and so forth which aren't actually charged against it.

So we have practice leaders that are charged against that, et cetera, so it's not a true profitability contribution.

But looking at it the way we do, incremental revenue relative to incremental cost, it flows through at about 85%.

So one way to look at the businesses, your base consulting practice business is really being valued at 4 or 5 times EBITDA when you put a much higher double-digit multiple on the licensee business.

So when you look at other businesses that you are comped against -- GPX, et cetera, that trade at 11 times EBITDA with no royalty revenue, it seems -- the business seems to be grossly undervalued.

So that's just one observation.

Another point -- if we just look out on the business, you've gone done a good job keeping the share count down.

Now with the extended line of credit and the strong free cash flow, is it fair to say over the next two years, exiting next year and growing operating free cash flow, another $20 million next year, that you would be in a position to try to take $2 million out of the share count?

I think we would have the capacity to do that for sure.

You have said just right, and you always have a very good handle on this.

Let's just say that we end the year without buying, and we end the year with a little north of $20 million of cash, and that we generate another $20 million of cash each of the next two years, say, after-tax cash flow.

You would have $60 million of cash and $40 million of credit facility, and that's net of our invest -- that cash flow is net of our normal investment in growing salespeople, content, et cetera.

So I think we certainly have the capacity to do that, and we are trying to put ourselves in the position to do that.

Great.

So whether Knowledge Capital comes out this quarter or in five or six quarters, it really doesn't matter.

So if you model this thing out, if you are successful in taking the shares out and growing EBITDA in that 13%, 15%, you would be in a position then to do potentially $3.00 in adjusted EBITDA if you can get the share count down next year.

And then if you can continue to grow the free cash flow and take another $1 million out the next year, fiscal year 2017, you are going to be in a position to do $3.50 plus in adjusted EBITDA and you can decide what multiple you want to put on it.

But is that a right way to kind of look at where you are going?

There is no real change to ultimately getting to $50 million in adjusted EBITDA for fiscal year 2017.

That still remains kind of the longer-term goal.

Is that right?

Yes.

Our goal continues to be -- forgetting FX for a second -- to get, we said, in the next two or three years to get in the $50 million range.

So whether it's two years or three years with FX and other things, getting in that range continues to be the goal.

It's what drives the long-term incentives for most everybody in the Company is getting to those kind of numbers.

And putting ourselves in the position to also reduce the share count certainly directionally could have the effect that you are talking about.

At the same time, we can continue to flow through -- if we can flow through the incremental revenue to EBITDA, our operating margins would also continue to increase.

So we've got objectives around each of those things.

Okay.

Keep up the great work.

Appreciate the commentary.

Thanks so much.

Tim McHugh, William Blair.

Hi.

I joined a little late, but I have just a few quick questions I wanted to follow up on.

Thanks, Tim.

How are you?

Good.

How are you doing?

Good.

Thanks.

On currency, just to be clear, the kind of $3 million impact cited in the press release, is that since you last gave guidance, or is that the full-year impact?

In other words, I assume your guidance last quarter when you were talking $37 million to $40 million included a couple million dollars of impact already.

Exactly.

So for the full year, we think we will have $5.3 million of revenue impact and $2.8 million of EBITDA impact.

At the time we gave the guidance, we thought there would be about $1 million of FX in that -- just under about $900,000 or so of FX effect on adjusted EBITDA, and now it's a couple of million dollars more than that.

Okay.

So the different -- so $2.8 million versus $900,000, previously?

Yes.

It's a $2 million hit from what we thought previously, but you only brought it down by $1 million.

So it's a $1 million (inaudible), I guess, in terms of adding in the big projects (multiple speakers)?

That's right.

And when we think about the even bigger projects, it's the same sales force, right, that's selling it.

So is this just a replacement for other, I guess, smaller projects that these guys usually would have been working on?

Or is that part of why that explains some of the back-end-loaded nature -- these are longer sales cycle projects, or is it really a separate bucket of focus for the sales force?

It's typically a different -- it's largely a separate bucket of focus.

We have around 20 client partners that we view as large-account client partners.

In fact, we are having a meeting here in two weeks with those 20.

So it's a different group -- where we've got these three groups, Tim.

We've got a group of these we call area client partners that just do events day in and day out, and they just get those.

We have another group that has between 70 and 100 accounts assigned to them that is moving down so that they can focus on a narrow group.

But we also have this group of 20 who does a disproportionate amount of their business with a relatively small number of accounts.

So it's really not -- these folks aren't holding a lot of events.

They might occasionally put one of these large accounts into events, which they do.

They are helpful, but it's a separate group that is working on these larger accounts.

And again, they don't -- the fact that they work on larger accounts doesn't mean they fit into this category of a truly large account.

But from this basis, they are doing bigger deals.

There occasionally comes a big worldwide or nationwide kind of opportunity, and that's what we are talking about.

I think Kevin asked and I forgot to respond -- Kevin, I apologize.

These are spread across higher education, government, sales performance, execution, and Trust and government.

So there's a pretty good diversity of things.

Also among the licensees, there are a couple of larger ones where there could be some large transactions within existing licensees and also the possibility of a couple of new countries where we could have a sale to become a license.

So it's relatively broad-based.

It's not taking time away from the things that other people will be doing in the fourth quarter.

Typically, it's a different group of folks.

And are these licensed sales, or it's an ongoing relationship or a bigger relationship you are creating where the impact will be even bigger as we go into the following fiscal year?

Sean, do you want to respond?

Hi, Tim.

It includes both.

They are -- typically these large deals typically includes a licensed sale.

But in almost every case where we have a licensed sale, it represents a long tail to it; it has an ongoing relationship.

Just so it makes sense how that works.

So these aren't typically sales where you just license the content to somebody and they go off.

What they are doing is because they are committed to a big rollout of the solution, we price it to say, look, if you are going to do -- if you are going to roll this out across 10,000 managers, what you ought to do is buy a license right because you can get the price down per manager and then just buy content on top of it.

So it tends to be a statement that they have now made the decision to go big and go pervasive inside their organization.

And a license is just a part of an overall structure that we do as part of a bigger sale.

Occasionally, you will have somebody who just buys a license right to all the content within their entire organization.

That tends to actually be a smaller sale, but when they are large, it tends to include both sides.

Does that make sense?

Yes, that's helpful.

Okay.

Thank you.

I will now turn the call to Bill -- Bob Whitman for final remarks.

Thanks very much.

I'll introduce my brother Bill here and then close (laughter).

We appreciate very much everyone being part of the call today.

We appreciate the time and effort each of you invest to understand what it is we are doing and ask such great questions.

We are excited about where we are and where we expect to go in the coming quarters and years, and appreciate your support.

Thanks so much.

Thank you ladies and gentlemen.

This concludes today's conference.

Thank you for participating, and you may now disconnect.