Franklin Covey Co (FC) 2016 Q4 法說會逐字稿

完整原文

使用警語:中文譯文來源為 Google 翻譯,僅供參考,實際內容請以英文原文為主

  • Operator

  • Welcome to the fourth-quarter 2016 Franklin Covey earnings conference call. My name is Anna and I'll be your operator for today's call.

  • (Operator Instructions)

  • Please note that this conference is being recorded. I will now turn the call over to Derek Hatch, Corporate Controller. Please go ahead

  • - Corporate Controller, Central Services & Finance

  • Thank you Ann. Good afternoon everyone and on behalf of the Company, I'll like to welcome you to our fourth quarter and FY2016 earnings call this afternoon. Before we get started, I'd 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 Managements 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 products and 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 training and spending policy of the Company's clients, and other factors identified and discussed in the Company's most recent annual report on form 10K and other periodic reports filed with the Securities & 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. And there can be no assurance that the Company's actual future performance will meet management's expectations.

  • These forward-looking statements are based upon management's current expectations and we undertake no obligation to up date 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'd like to turn the time over to Mr. Bob Whitman our Chairman and Chief Executive Officer.

  • - Chairman & CEO

  • Thanks, Derek. Good afternoon everyone, we appreciate each of you joining us. We are happy to have the chance to talk with you today and I'd like to briefly discuss four things. First, talk about the continued significant growth of All Access Pass and how our key assumptions about how All Access Pass can affect and significantly increase the lifetime value of our customers we're playing out today.

  • Second, a review of progress results for the fourth-quarter and full-year both the reported basis and on and apples to apples pre-deferral basis. Third, just touch on five things which we believe will help to accelerate our growth in the coming quarters. Things we are excited about and we think you -- hopefully you will be as well. And finally, provide an update on our outlook and guidance for FY17.

  • Let me start out with on the -- talk about All Access Pass. As you can see on slide 3 we achieved significant All Access Pass growth, again, in fourth quarter. As you can see we invoiced $13.7 million in All Access Pass and All Access Pass related services representing significant growth compared to the $6 million in the third quarter, the $3.1 million in the second quarter and almost $400,000 in the first quarter.

  • The $13.7 million invoice in the fourth quarter was greater than all of the All Access Pass amounts invoiced for the first three quarters combined. We felt very good about the momentum then. For the full year we invoiced $23.2 million in All Access Pass and pass holder related service and products of which approximately $16 million was recognized as revenue in the year with $7.25 million being added to the balance sheet of deferred revenue at year end and with an embedded contribution for adjusted EBITDA in $7.5 million and approximately $6.2 million which we recognized in FY17.

  • Second point is, All Access's Pass is shared total amounts invoiced in the office's that have been selling it has also increased significantly. Results, as you can also say in slide 3, the second line from the bottom, All Access Passes share the total amounts invoice by these office's increased significantly over the past three quarters for those offices which are selling it which are primarily US direct offices, the English-speaking direct offices in the UK and Australia and our government group.

  • As shown, the amounts invoiced related to the All Access Pass increased from just 2% of amounts invoiced in the first-quarter when we were first just testing All Access Pass to 14% in the second-quarter to 26% in the third and 47% in the fourth quarter. For the year as a whole, All Access Pass related amounts invoiced accounted for approximately 24% of those offices' total amounts invoiced for the full year.

  • Third point about All Access Pass, is it's also been a key driver in the Company's' significant growth in overall intellectual property sales. As you can see on slide 4, the amount of high-margin, intellectual property that's been invoiced, including All Access Pass, single content intellectual property licenses in the sales of training manuals to client employee facilitators has also grown significantly since the introduction of the All Access Pass.

  • As you can see after a 7% decline in last year's first-quarter in total IP sales, year-over-year growth in total invoiced intellectual property was up 29.3% in the second quarter, 31% in the third quarter and up 27% in the fourth-quarter even against what is typically a very tough year over year comp for the fourth quarter. This growth in intellectual property related sales has been exciting and significant. In the last few quarters its also been offset by a multi-quarter decline in revenue from on-site training days delivered by our consultants and so the total impact of those intellectual property sales hasn't seen in the overall results.

  • However, with increasing amounts of add-on services being purchased by All Access Passholders, we expect that in the coming quarters these declines in on-site services will flatten and only turn positive and that then this great, terrific growth on the IP side will then become more prominent in driving growth.

  • Finally, as it relates to All Access Pass, as a result of All Access Pass we expect the lifetime value of our customers to increase significantly. We have said in the past that we expect that the All Access Pass would significantly increase the lifetime value of our customers as a result of: A) having a higher initial sale size; B) providing a natural path for selling more add-on services and training materials; and, C) having a high renewal rate. Our indications to date, although it's relatively early, are that each of these benefits is likely to be realized.

  • First, in terms of average spend, as you can see in slide 5, the average spend for customers who became All Access Passholders in FY16, is significantly higher than it was for the same customers in FY15 before they became All Access Passholders.

  • As shown, 264 clients who are active facilitator clients in FY15, became All Access Passholders in FY16. For the full-year 2015, these 264 clients spent $9.8 million, whereas in FY16 these same clients who are now All Access Passholders spent $14.5 million, an overall increase of 48%.

  • Second, so the average spend, we think, is proving to be higher in almost every case and that's just the starting point. Second, add-on services. Although the majority of All Access Passholders purchased the pass just a few months ago, cumulatively they've purchased $3.1 million of additional services and products through the end of October, an amount already equal approximately 13% of the original spend on their All Access Pass purchase.

  • We expect the purchase of services and products to continue to increase as we hold discovery days with each new All Access Passholder and as their usage of All Access Pass increases. So, that we think will add to the initial sales side will get even bigger is you add on additional services which is historically as we've sold facilitator materials there hasn't been a national path for going bigger because they just are now a facilitator who buys materials each year. Now we are in there with this pass, helping them figure out how to use it and then recognizing that for some of these uses, they want to have additional services and help from us.

  • Third then, renewal rate, is the third aspect of the lifetime value. Average spend add-on services and then the renewal rate we are just now reaching the first annual renewal dates for the first All Access Passholders who bought in last year's first quarter. Because this first group included only 19 purchasers, we tested it, the sample size is small.

  • In addition, this group did not benefit from the full services now provided by our passholders services group, which was just being formed at that time. Nevertheless this group of 19, 10 of this group have already renewed or upgraded, most ahead of their renewal date which is just now arriving. And having met with all these passholders, we fully expect that all but three, and maybe all but two of the remaining passholders set to renew before the end of the quarter for a total of 16 or 17 out of 19. So 84% if 16.

  • But we feel really good given -- about that again it's a small sample size. The indications are good but now that we are really well-organized with a whole passholder services team that is now well organized and focused on ensuring passholder delight, renewal, expansion to add-on services and with this group, there's an initial call that happens with a new passholder and their client partner in one of our All Access Pass implementation specialists within days of their purchase.

  • In this call the passholder typically plans out their first usage of their pass. In addition, within the first 30 days this is usually followed up by an onsight, what we call a discovery day, in which a team arrives on site, not with the purpose of selling or the intent of selling something new, but of making sure they understand the full jobs to be done which the customer has and meeting additional internal stakeholders who themselves begin to plan their own additional impact journeys.

  • And as a result of this process, the vast majority of passholders have already scheduled impact journeys which take them well beyond the first year and into the second or third year of their pass or even beyond. And based on their ongoing works with these clients we expect that the vast majority of All Access Passholders are likely to renew their passes, on or before their anniversary date.

  • So, we'll continue to report on that as the quarter's progress. Obviously the biggest renewals will start to come somewhat in the second quarter but really beginning in the third and fourth quarters of next year.

  • So having a strong renewal rate can begin to drive accelerated revenue and profit growth in the second and third and fourth quarters. Where today, we are benefiting only from new sales in our traditional delivery channels, as we have this new sales and then add on renewals that are at both a higher renewal rate and on a much higher purchase price we expect this will begin to drive some additional revenue.

  • So the combination of having higher initial sales significant add-on sales of service and products and a high renewal rate, is expected to significantly increase the average lifetime value of our customers. And we're trying to follow the sales process so that rather than trying to rush into it that we're doing it -- methodically we are going in and making sure we understand what they are doing, expanding the passes, et cetera and we are really having some success at these.

  • If we add, in addition to $3 million of services, if we add pass expansions that have occurred and also pass upgrades, where they bought a smaller pass and then upgraded, we now actually have $5 million of add on services and expansion in this early stages. We're only -- of the 1,000 passholders, we have only had these discovery days with about 170 or so up-to-date, because they -- up until recently and that process has been established.

  • So we are excited about that potential for this. We will talk more about that in a few minutes.

  • Second, now we would like to just review the results for the fourth quarter and year. I'm going to turn the time over to Steve to lead that discussion. Steve thanks.

  • - CFO

  • Thank you Bob and thank you everyone for being on the call today. So over the past couple of years three factors have created some of the lumpiness in our reported results. Number one, the impact of foreign exchange. Two, the yearly changes in revenue related to a major government agency contract that we have talked about before. And, three, the shift toward having much larger amounts of deferred revenue related to amounts invoiced.

  • For example, in FY16, the non-repeated government agency contract reduced reported revenue by $6.6 million and adjusted EBITDA by $3.9 million. Number two, the foreign exchange fluctuations reduced reported revenue by $900,000 and adjusted EBITDA by $800,000. The impact of increases in deferred revenue during the year was greater than the sum of these two factors. Reducing reported revenue by $8.6 million and impacting adjusted EBITDA by $7.5 million.

  • For FY17, there won't be any year over year impact from the government agency contract because the contract was fulfilled in FY15 and generated no revenue or adjusted EBITDA in FY16 against which we need to compare. And while no one can predict FX changes, for the first time in years, we are starting the year in a position we are assuming year-end FX rates remain stable. There will be no gain or loss from FX in FY17 with the increase in the yen offset by the declines in the pound. So stay tuned. At least we're in a better position beginning this year than we have been in for years related to FX.

  • However, as just discussed, as a result of All Access Pass and other intellectual property licenses, we have been generating a significantly increased amount of very high margin deferred description revenue. And we expect this subscription type revenue to continue to grow both in total and as a percentage of the total amounts invoiced.

  • While the ultimate economics in cash flow from a contract invoice with a subscription component and one without it, are essentially the same and the cash flow is identical, as you know, the accounting methodology for such contracts results in only a portion of the amount invoiced with respect to that contract being recognized in the period in which it was sold, with the balance being amortized over the ensuing months.

  • And as much as a meaningfully high share of amounts invoiced was deferred in FY16, than in prior years, and because we believe that deferred revenue will continue to increase in the future, I would like to review our results from both an apples to apples, meaning amounts invoiced basis which considers amounts actually invoiced before splitting those amounts into recorded revenue and deferred revenue, and on an as reported basis after the economics of the invoice contract having been split between recognized revenue and deferred revenue.

  • Just a note regarding the amounts invoiced approach. Amounts invoiced is the actual amount billed to clients.

  • It is not the concept of contract value, sometimes utilized by subscription service companies where the total twelve-month value of contracts in place at the end of a period is counted as contract value. Rather amounts invoiced is the actual amount billed to customers where the cash has either already been received or a valid enforceable receivable is in place and will be recognized as revenue. Also note that in as much as the deferred revenue portion relates to intellectual property, it has an extremely high gross margin.

  • So now I'd like to briefly talk about the results for the fourth-quarter and for the year. As you can see in slide 6, in the fourth-quarter of FY16, amounts invoiced were $73.1 million, a $2.4 million increase compared to the $70.7 million of amounts invoiced in the fourth-quarter of FY15, an increase of 3.4%.

  • As a result of the significant year-over-year growth in All Access Pass in the fourth quarter, and an increase in the percentage of Leader in Me schools that renewed intellectual property coaching descriptions, which was an increase to 94% from 90% last year, the share of amounts invoiced, which was recorded as deferred revenue in the quarter, increased meaningfully.

  • In FY15, 93% of the amounts invoiced was recognized as revenue in the quarter. In FY16, however only 88.6% of the amounts invoiced was recognized as revenue in the quarter, with the balance, an amount of $8.3 million, reflected in a net increase in deferred revenue on the balance sheet.

  • So revenue -- deferred revenue. As shown on slide 7, in the fourth-quarter of FY16, the net increase in deferred revenue is $8.3 million, a 151% increase compared to the $3.3 million change in deferred revenue during the fourth-quarter of FY15.

  • For our gross margin in the fourth quarter of FY16, the gross margin profit percentage increased to 70.4% compared to 69% in the fourth quarter last year, even excluding the $8.3 million increase in extremely high gross margin percentage deferred revenue generated in that quarter. So we are pleased that the gross margin percentage could increase even after we are deferring such a significant amount of very high margin revenue.

  • Adjusted EBITDA. As shown in slide 7, reported adjusted EBITDA for the fourth quarter was $16.2 million with an additional $7.4 million of adjusted EBITDA contribution embedded in deferred revenue, compared to FY15 where reported adjusted EBITDA was $17.3 million with an additional $3.1 million embedded in deferred revenue.

  • As also shown on slide 7, in the fourth quarter, $7.4 million of the amount of adjusted EBITDA contribution generated in the quarter, remained embedded on the balance sheet at year end. This compares to only $3.1 million in the fourth quarter of last year. So we are pleased with the result in the fourth quarter, especially when you consider the amount recorded, and amount reflected on the balance sheet.

  • So for the full year, it's a similar story, or result, where we consider both the recorded amount and the deferred amount that's on the balance sheet. So in revenue, as you can see on slide 8, we invoiced $208.7 million in FY16. This represented a decrease of $3.7 million, or 1.7% compared to the $212.4 million invoiced in FY15. FY15 did include the $6.6 million in revenue from the large federal government agency contract fulfilled in 2015, and therefore generated no revenue in 2016.

  • For the rest of the business, other than this contract, we invoiced $205.8 million in 2015. In FY16 we invoiced $208.7 million, after absorbing $900,000 impact from foreign exchange, reflecting a $2.9 million increase compared to the $205.8 million invoiced for the rest of the business in FY15. So in revenue there were some growth, once you consider the rest of the business. So that's what was reflected in revenue.

  • However, shown also on slide 8, with the introduction and significant growth in All Access Pass during the year, and within the increased percentage of Leader in Me schools that renewed their intellectual property and coaching subscription in FY16, which again, was 94% versus 90%, similar to Q4.

  • The share of the amounts invoiced, which was recognized as revenue in the year, compared to the portion which was deferred, shifted. As shown on slide 8, in FY15, $209.9 million, or 98.8% of the amounts invoiced, was recognized in revenue in the year. In FY16, however, only $200.1 million or 95.9% of the $208.7 million amount invoiced during the quarter, was recognized in the year. The $208 million in the year recognized in the year, with an $8.6 million increase to amount of deferred revenue on the balance sheet.

  • So again very similar. The need to consider both reported amount and the deferred amount, when looking at what actually, we believe, went on during the quarter.

  • And again, this deferred amount shown on slide 8 in FY16, the deferred amount was $8.6 million increase, compared to a $2.5 million change in deferred revenue for the full-year before. A very important point that needs to be considered when reviewing all of our financial statements.

  • Gross profit, again, we are pleased that the gross profit percentage increase to 67.6%, compared to 65.8% last year. Even, again, as you consider that a $8.6 million increase in this high-gross margin deferred revenue that was generated but not recognized until next year.

  • Adjusted EBITDA, as also shown on slide 8, reported adjusted EBITDA for FY16 was $26.9 million, with a $7.5 million increase in adjusted EBITDA contribution embedded in deferred revenue on the balance sheet, compared to FY15, where we reported adjusted EBITDA of $31.9 million with an additional $1.9 million in adjusted EBITDA contribution embedded in deferred revenue on the balance sheet.

  • FY15's result, included a $3.9 million contribution to adjusted EBITDA from the large federal government agency that we have talked about. The contract that was fulfilled in 2015, and did not generate adjusted EBITDA in FY16. For the rest of the business, other than that contract, recognized adjusted EBITDA in FY15 was $28 million with $1.9 million of adjusted EBITDA contribution embedded in deferred revenue.

  • This reflects that, as with the revenue and gross profit, a significantly increased share of adjusted EBITDA contribution generated in the year was embedded in deferred revenue at the end of the fourth quarter. As shown also on slide 8, for the year $7.5 million of adjusted EBITDA contribution generated in the year, remained embedded on the balance sheet. This compares to $1.9 million in the prior year.

  • So, starting with $26.9 million in reported adjusted EBITDA, then considering the $7.5 million increase in adjusted EBITDA contribution embedded in deferred revenue at year end, and then adjusting for the $900,000 for the negative impact of foreign exchange, the total adjusted EBITDA generated during the course of the full-year, fell within our original guidance of $34 million to $36 million, even after allowing for an additional compensation expense that would have been occurred, had the adjusted EBITDA been recognized in the year.

  • So the last point on this is, our cash flow from operating activities was very strong for the year, indicative of the fact that the economics of the business follows amounts invoiced, and not the amounts recorded. As shown on slide 9, cash flow from operating activities for the year was $32.7 million, a 6.5% or 24.7% increase compared to the $26.2 million in cash flow from operating activities last year. This strong cash flow, again, indicates the fact that the economics of that business follows the amounts invoiced, for which we bill and collect, and not necessarily the amount we report.

  • So our liquidity remains strong, even after returning more than $43 million to shareholders in the form of stock buybacks during the year. We ended the year with only $5 million in net debt and a $35 million availability under our credit facility. So, Bob --

  • - Chairman & CEO

  • Thanks, Steve. Comprehensive review. We'll obviously be delighted to answer questions here in a moment.

  • One other note, is for the full-year, we were delighted that the sum of the amounts recognized, plus the increase in the amount deferred in the FX got us in the original range. If you look at where we -- and really, the entire difference between where we were in June, if you take the actuals for the first nine months, and then look at the amount that would have been for the fourth quarter, the approximately $3.5 million of additional deferred, we had thought, at that point, that we might have as much as $5 million increase in deferred revenue to get to the lower end of our guidance range of $31 million to $36 million.

  • And we ended up with a $8.3 million increase in deferred revenue, so with almost 90% -- 88% contribution after deferred commissions, et cetera. That if you take the first three quarters actual, and then add the fourth-quarter produced, versus what we thought, that the extra $3.3 million, of course, also gets you into the $31 million range, for the first three quarters as recorded in the last quarter adjusted for that.

  • Before we got to questions just want to touch on some things that we believe will help to accelerate our growth in the coming quarters. As you know, over the past couple years our growth rate has slowed. Some of this slowing was due to foreign exchange headwinds, and a non-repeat of the major government agency contract. But for reasons we discussed in previous quarters, our growth in our US direct offices has also been slow.

  • We believe that the following things can actually begin to accelerate growth in our direct offices in the coming quarters, and really for the company overall. Five bullet points.

  • First, growth from All Access Pass renewals, upgrades, expansions, and add-on services. We've already talked about that. We believe we are just now beginning to gain traction on what will prove to be an enormous opportunity for growth through passholder renewals, expansions, add-on services. What we have seen to-date with All Access Passes has just been new sales and add-on.

  • Assuming these renewals occur at a high rate, it doesn't affect first quarter very much, because it was only $300,000 of revenue, but as you move into the second, third, and fourth quarters where you could have -- for the revenues were $3 million, I mean the amounts invoiced were $3 million, $6 million, and then $13 million. Obviously, a renewal rate of 80% percent, or something like that in those quarters, would add a lot, and addition to new sales would start to really provide growth, and because a lot of that happened in the direct offices, it will support growth there.

  • In addition, because our sales approach and Passholder service approach, is focused not only on assuring high levels of Passholder satisfaction, but on identifying expanded customer populations and needs, there's a big opportunity for add-on services. I noted before, that during the last five months, basically we've sold more than $3 million of additional services and materials to Passholders, and more than an additional $2 million in Pass upgrades and expansions, by having these meetings. We've only had meetings with about 1/5 of those who purchased. I mean those were all scheduled but it's a new concept to these discovery days.

  • So we see a significant opportunity for continuing to expand revenue within existing accounts and we believe that we will have real impact on that in the coming quarters. It should begin to become apparent in this quarter, and the second and third quarters.

  • Second, we see significant headroom for continued growth in new All Access Pass sales. Even with the more than $23 million of invoiced All Access Pass and Pass-related amounts during FY16, most of which have occurred just in the last seven months of the year, we believe that we're just getting started and that we have lots of headroom for continued growth.

  • The potential for increasing new All Access Pass sales includes increased sales to our 3,100 active client organizations in our English-speaking direct offices. Despite the remarkable All Access Pass growth to-date, only 13% or 401 of these 3,075 active client organizations, have purchased an All Access Pass to date, leaving lots of room for growth. And we say that active clients are, these are ones that have bought something in the last couple of years, and that doesn't include all the others who, like -- I'm loyal to my dentist, I just haven't been there in maybe the last year or two. It doesn't mean I'm not loyal to him; when they have the need, they'll come back. But there's 3,075 who have been spending stuff in each of the last years, that most of whom still have not had a chance to purchase.

  • Second, increased sales to the more than 9,900 accounts that are assigned to our client partners, that are not yet actually doing business with us. Each client partner has a number of assigned accounts. Some of them of course, fit in that first category as being active clients, but a bigger portion fit in clients they are responsible for prospecting.

  • All Access Pass is opening a lot of new doors, and to date 178 of our All Access Pass sales have actually come from these 9,900 assigned accounts, who were otherwise not clients. But that's just less than 2% penetration, so we're really excited about the potential for growth in these accounts. These people get invited to events, they have lots and lots of face-to-face meetings with them, and this offering -- this way of delivering our content is resonating with those folks.

  • And then third opportunity for new sales, are increase sales and international direct in licensee partner offices. To-date, All Access Pass has not been available for sale in our non-English-speaking international direct offices, nor, with few exceptions, in our international licensing partner offices.

  • We believe there's an enormous opportunity for All Access Pass growth outside the US. To address this potential, we are currently in the process of translating and localizing the 16 most popular course and solution areas included in the All Access Pass, into all of the 14 major languages.

  • Supporting this expansion with an updated portal that meets all the international data-privacy standards, and we're also beginning to train client partners. That's already ongoing to get ready for the -- to the end of February. All Access Pass will then be available for sale most countries by March 1, and we expect that will be creating new wave of growth in the third and fourth quarters.

  • With All Access, it's always providing a real opportunity for global sales. This is an important initiative for us, because when a client goes in, and they understand they can buy all of our content for a designated population, and they can do it -- and they want that solution applied across the world, and we can do that because of our licensing network or our direct offices, and we now will be able to do it. We'll have the offering, all the offerings, also translated.

  • We think this will be an exciting thing. It takes a while to get new people selling, which is why we're training them now. We think this is an exciting opportunity which will start, really, in March 1.

  • So we talked about two; one, growth in expansion sales existing All Access Pass holders; two, new sales of All Access Passes to people who aren't our clients, or who are; third, this expansion in direct and licensing partner offices, and we think those will all help.

  • Next is growth in China. Over the past 12 years our operations in China have been operated by a highly-valued licensing partner. During that time, the business grew steadily to over $10 million in revenue, paying us $1.5 million of license fees. And those selling our solutions established relations with a number of key multi-national companies, local Chinese companies -- many of whom, themselves, are very large, and state owned enterprises. Two years ago, the term of that license ended.

  • Given the importance of China in the world, and the large number -- large number of our US clients who have operations there, together with our desire to make sure that the full range of our solutions is available in the market, where previously just certain courses, we ultimately made the decision not to renew our license, but to go direct.

  • With the cooperation of our partner, we agreed on a mutually-beneficial two-year transition plan, that would allow our partner to continue to receive income during the transition period, and would allow us to make a smooth transition of both employees and clients to Franklin Covey. We hired the previous leader of our licensing partner's business in China, with our partners approval, as the leader of these offices during the transition.

  • And we are delighted to say, that substantially all the employees who had been working in our business and remained with us, as a result, as of September 1, we are now operating -- or have been operating, three direct offices in China; in Beijing, Shanghai, and Guangzhou. We believe we can make a great impact in China, and are excited about our offices, and the people and clients there. A number of us recently were in China to participate in some very well-executed special thought leadership events, in Beijing and Shanghai, to formally introduce our new direct operations to, literally, hundreds of organizations.

  • We were thrilled with the strength of our team there, with the stature of their clients. We had a lunch that included some really big US names, that were there: Johnson & Johnson, Mary Kay, other big organizations, but also some large Chinese companies. Our team there is off to a great start. The events were very well received and has already resulted in numerous new opportunities -- sales opportunities.

  • We expect this transition, from being a licensee that produced $1.5 million to $2 million of royalties -- we'll pick up revenue, it will help our top-line growth, we'll pickup probably, $7 million or so, of revenue this year.

  • In terms of EBITDA the contribution probably won't be a lot extra in this first year, because last year, under the license agreement, they had an extraordinarily high payment that was due. So the increase in profitability won't be as much in the first year, but thereafter, it's larger than it would have been, and we expect it to grow from there.

  • As I mentioned, also, the next area of growth-- fourth, growth in our international education licensing partners. The education division continued to grow well in FY16, achieving 15% growth in the fourth quarter, and 22% growth for the year. After a flattish year last year, got right back to growing as they have done for years, and they added 500 new Leader in Me schools during the fiscal year.

  • Perhaps most importantly, their focus over the past many years on helping schools achieve quality outcomes is really paying off. This year we retained 94% of the schools that are part of the Leader in Me network of schools; which is really remarkable. It was high last year, at 90%. That increase of 4% was meaningful, in terms of the amount of deferred revenue that was generated and added to our deferred revenue for the quarter.

  • We believe that the opportunity to grow The Leader in Me, is as strong outside of the United States as it is within. Of our 3000 schools, about 900 currently lay outside the US. And just recently, we signed a contract with SOMOS education, one of the largest education providers in Brazil, to bring The Leader in Me to both private and public Brazilian schools. This is a 10-year contract, which guarantees us a minimum of $15 million in royalties over that period of time. That's really important from an impact standpoint as well.

  • We expect to continue to sign more of these large multi-year contracts outside the US, with licensees in education specifically, which is evidence of the relevance our education solutions, whether at home or abroad.

  • Finally, the final way of leveraging our growth, and this has been one that's ongoing. One of our key on-going growth initiatives, as you can see in slide 10, is additional ramp-up of new client partners. As you can see, as of August 31, we had 204 client partners, an increase of 24 compared to the 180 we had at the end of FY15.

  • This increase of 24 client partners represents a13% increase to our overall sales force. Since 2012 -- a little less than the 30 that we targeted, but we made some decisions with the transition of leadership in a couple of our regions this year, that have made sense, to let them get the new managing directors onboard. And so this 24 met our objective, as it was revised mid-year.

  • During FY17, we expect to hire an additional net 30 client partners. The plans are in place, and that would bring our client partner count to 234 by year-end, and that net addition in the 234 does not include the 10 client partners that we have in China.

  • With that, Steve, I'll just turn thing back to you, to review our outlook and guidance, and then we will go to questions and answers.

  • - CFO

  • Okay, a little bit on guidance. So based upon the success of the All Access Pass, we've decided to modify our offerings and business practices to make the All Access Pass experience even better for our customers. These future changes could include; adding content from thought leaders outside the company; localizing content, including additional assessments; and developing webcasts for our Passholders.

  • These future changes in offerings and business practices will result in a much larger portion of our invoiced amounts being deferred over the term of the underlying contracts and agreements. Meaning, that our deferred revenue on the balance sheet is expected to grow significantly in FY17.

  • For guidance this year, we need to consider both the expected amount of reported adjusted EBITDA, and the expected change in deferred revenue, less applicable costs, as recorded on the balance sheet. And I know from talking to many of you, that are very familiar with this concept.

  • In FY16, as you remember, we reported $26.9 million of adjusted EBITDA and an increase in deferred revenue, less applicable costs of $7.5 million, as we have seen on slide 8. The sum of these two numbers is $34.4 million.

  • While we do not know the mix of deferred sales versus recorded sales in FY17, we do expect that the sum of these two numbers will grow from $34.4 million in FY16 to between $35 million and $38 million pre- FX, in FY17. As I said before, we expect the amount of reported EBITDA in FY17 to potentially decrease, and maybe significantly, and the amount of deferred revenue on the balance sheet to increase significantly.

  • As to how this amount is likely to spread throughout the year, as always, our first-quarter includes significant investments in new hires, and this year will also include investments in localization and training necessary to launch All Access Pass globally, at the end of the second quarter. Reflecting these investments, the results for first quarter, could be $1 million or $1.5 million lower than last year, with year-over-year growth beginning in the second-quarter, and beyond.

  • So a last point. Last year in FY16, our All Access Pass invoiced amounts were $21.5 million, plus services. Of the $21.5 million, we deferred $9 million. In FY17, with that same invoiced amount, we would defer the total $21.5 million.

  • Additionally, we might make changes in the business that would require us to defer a portion of our facilitator sales. So, as you would expect, we are holding ourselves to a commitment of growing our invoiced amount, as we have always talked about. It's just, it is impossible right now for us to predict accurately, the amount of those increased sales that will be deferred. So, Bob, that's --

  • - Chairman & CEO

  • So let's just open it up for questions.

  • - CFO

  • Why don't we open it for questions.

  • - Chairman & CEO

  • Thanks, Steve, and let's just open up for questions.

  • Operator

  • (Operator Instructions)

  • Tim McHugh, William Blair.

  • - Analyst

  • Hi, just two questions: One, given you described about the complexity in the Business, do you have a plan or goal you would care to share, as it relates to cash flow or free cash flow? I think you are getting there with all the other things, but wondering if that's just a better way to look at it? And secondly -- ?

  • - Chairman & CEO

  • I didn't mean to interrupt you. I was just saying to Steve -- I think that's actually a really good suggestion and one that would be good. I think it's something we should do and will do. That's a really good thing because the cash flow is -- I think your insight is great. So, yes.

  • - CFO

  • We don't have an exact number right now.

  • - Chairman & CEO

  • We don't today, but we can do that and we will send it out.

  • - Analyst

  • Okay. The mid-point, if we do all the adjustments and look at it -- EBITDA adjusted for invoice -- it's kind of a high single-digit growth rate maybe at the mid-point? Given all you described about the positive trends as it relates to this, are there some offsets in there that -- why not better than that? What are the pros and cons holding that back as you think through to next year?

  • - CFO

  • Well, one thing is -- the plain English version is, one concept is you want to give us a little bit of room to hit within our number, considering things that we can't now envision. There's a possibility, like in the past, that something will happen that we don't envision right now that would cause us to go down a little bit. The bottom end of our range, we believe, is a little bit conservative.

  • So as we go forward, there are several things going on. One is that we will have an increase in costs related to the additional sales people that we have hired and the bonuses we would incur from hitting our numbers.

  • Going the other way, we had a pretty big write-off of a receivable last year that we do not expect to repeat in the current year. So that would be a positive. We expect China to be a positive.

  • So as far as a headwind, if you will, that would keep the number down, it would be related to cost, really developing and accelerating this All Access Pass, adding the 30 salespeople and the annualization of the 24 we hired last year, and the bonuses that would be related to us hitting our numbers.

  • - Chairman & CEO

  • As usual, Tim, your insights are correct. The numbers to which we are being held, and which we are holding our people to, would be to put us at the very high end or above the top end of that range. We are just trying to give some flexibility since this is new and we've got some investments to make; although they're not huge, they are still meaningful.

  • - Analyst

  • Okay. Fair enough. If we are trying to just -- the profitability of deferred revenue, when we look at the increase in deferred revenue, is the ratio you are describing for Q4 the right way you would tell us we can think about that in the future?

  • - CFO

  • Yes.

  • - Chairman & CEO

  • Yes.

  • - Analyst

  • Okay.

  • - Chairman & CEO

  • That really includes the deferred commissions that relate to that. Even though we paid a commission, there's a deferred commission expense and a little bit of cost of sale. On the IP, it's really -- .

  • - CFO

  • We pay our salespeople at the time that they actually complete the transaction with the customer and we have a valid receivable. So as we defer the revenue, we also list a portion of that commission as essentially prepaid commission. So the flow-through will be 85% to 88% flow-through when that deferred revenue hits the P&L next year.

  • - Chairman & CEO

  • And you'll be able to track it on the balance sheet, because it will either be in deferred revenue or in --.

  • - CFO

  • You probably noticed that we broke out separately on the balance sheet deferred revenue, just so it would be easier for somebody to track that piece of it.

  • - Chairman & CEO

  • And the expenses.

  • - CFO

  • And then the expenses are in our prepaid expenses, but you can consider that to be 85% to 88%.

  • - Analyst

  • Okay. Thank you.

  • Operator

  • Jeff Martin, ROTH Capital Partners.

  • - Analyst

  • Thanks. Hi, Bob. Hi, Steve. Good afternoon. Question on the -- may have to defer $21 million on a similar amount from FY16? I'm curious on what may affect that? You say you may have to versus you will have to. And second part of the question is, why would you have to defer the whole thing in FY17 versus a much smaller portion of that in FY16?

  • - Chairman & CEO

  • Steve, do you want to go ahead first?

  • - CFO

  • First of all, when we say defer, defer the amount, you defer the amount over the term of the contract. So we were to begin, anytime we would have a sale, we would begin recording that revenue, [once that's a] year of contract, 1/12 every month over the life of the contract, rather than taking the deferred revenue at the end.

  • And the things that I mentioned, things like adding content to -- make available for our new customers, and making localized content available and allowing what we sell to them in the future to change, that's what changes the accounting such that we would not be allowed to record a portion up front and defer a portion like we did last year. We just need to defer the entire amount and record it over the period of the contract.

  • - Analyst

  • Right. I guess I'm just curious why the percentage would shift that much more next year versus this year?

  • - Chairman & CEO

  • Here's the idea, Jeff. If you break our -- if you break the way that we can account for revenue into four groups, which I think at least how I'm thinking about it going forward. One is intellectual property. Two is portals -- portal services and things. Third is services, and fourth is products.

  • As we have introduced All Access Pass -- and historically, if we sold a manual to a facilitator, that whole thing, if it's a $200 manual, it's been treated of course as a product sale because it's fully delivered at that time. We could choose -- if that's what we continue to do in the future, that group matures over the years and we convert that group over the next two or three years, ultimately it would go into All Access Pass.

  • What we did with All Access Pass is to split that $200 manual into the IP portion and into the manual. And now I would buy it for 100 people, I would be paying $170 a person, say, $17,000 for the intellectual property, and they can buy manuals or not. Because some people in Silicon Valley or other places may just want the content delivered on their iPad or whatever else, and never buy a manual.

  • So we've already separated, in All Access Pass, the IP from the actual physical manual. And with the IP, we've added a bunch of richness to it. In addition to the actual manual or the content, that is now digital or they can print out, but it's digital -- we give them -- they can intersperse the training, they can include our insights, modules, our digital assets. We have outlined hundreds of different ways in which people can take our content, interspersing digital content with it.

  • So one idea is, let's only give that value to All Access Pass holders, and when they buy the IP, and if they choose to buy a manual. It's only if you buy the Pass that you can get the benefit of those other ways of adding to the value and the impact of the training.

  • But then on the other hand, we hate to put our client partners and our clients [in the pay] -- so if they're not in a position to buy the Pass, why if they buy $200 a manual, why won't we break it up so they can either buy the manual or not, buy the IP and just do it on their iPad. And if they want to, to intersperse the learning with these very digital assets.

  • The reason why it would go -- I mean, depending on their choices, we could either have a slow transition over a period of years, just keep our manuals the same, and as those convert, eventually over two or three or four years we would convert it. The other is, we think there's a real competitive advantage to saying: Hey, look, if it's IP, it's IP.

  • So in those manuals that we sold, $8 million of facilitator manuals in the fourth quarter, if we split that between IP and manual, we could move the whole thing in one year, one. The transition would all occur in one year because the IP portion would be deferred, then in 2018 it would come back. The real point isn't an accounting point. We think it gives us a competitive advantage.

  • Steve's just pointing out, depending on those choices, if we said everything that's IP, whether in the form of a manual or All Access Pass, that portion of it was going to be treated as subscription revenue. So we have the flexibility to add all this value to those being trained. All portals, which were already 1/12, were there.

  • Then services as delivered, and manuals as delivered, two things would happen. One, it would be a huge increase in deferred revenue in one year. It would also be over in one year. But it would also then, from a competitive standpoint, say that other people can only sell a manual because -- that we compete.

  • Other people can't sell an All Access Pass; they sell one course. Other people have to sell their course with a manual because they don't dare do subscription. And we can say: Hey, listen, look at all the richness we can bring to it.

  • To the extent we make those decisions to have all people get those additional services, it would force the accounting, it would also make a big impact in one year on the reported. The cash flow wouldn't change, and we'd be across the bridge a lot faster. Is that responsive?

  • - Analyst

  • Yes, that's helpful. On the client-partner side, could you give a high-level sense of how these client partners' sales approach are shifting? How are they managing the traditional side of the Franklin Covey business versus the All Access Pass side? That would be helpful. Thanks.

  • - Chairman & CEO

  • Great, thanks. I'll ask Paul Walker to respond to that.

  • - EVP of Direct Offices Division

  • Sure. Thanks, Bob. Couple of thoughts: First of all, as far as converting, we hope that, as time goes on here, all of our clients will want to become Pass holders. That's certainly the goal we have is that as we engage with them now, that we are talking to them about the value and the benefit. Because there are great value, great benefits and value to them to convert over.

  • How it's changing the way client partners work day in and day out -- one of the things we're focusing heavily on is just making sure that as we go in and call on our clients, we are really identifying what's the real job they are hiring us to do, ensuring we are connected clearly to a strong business case that affects lots of people. It's a big initiative going on inside the Organization, because we know that not only will increase the size of the initial Pass and connect us to something that really has legs to it, but it also increases our chances to go in, and improves our odds of going in and having this discovery day Bob talked about earlier where we can expand the population, expand the size of the Pass, and expand the number of jobs we can help that client with on the back end.

  • So we're focusing really heavily with the client partners on really getting back to some of the basics. Selling, in a very strategic way, larger deals, more transformational deals. As Bob mentioned, increasing the initial size of the deal and it's also increasing the amount of revenue we are doing with these clients post initial Pass sale.

  • - Chairman & CEO

  • And I think, Jeff, it's changing -- we are in the past, when we were in the more product launch mode, we talked about this in the past. When we were there, we were doing a lot of more promotional things where we had a big initiative. We're getting a new product pushed out.

  • This is much more day to day, make your 10 hours a week of sales calls. In those 10 hours a week of face-to-face meetings, you're going to have a number of meetings with people who just bought Passes. The discovery days you'll have new meetings with people who just attended. And your day ought to look pretty much the same quarter after quarter, year over year.

  • While that will mean that, okay, if last year's first quarter we did a promotion or something, a big push on one product, you'll lose that for the first year that you do year over year. It will then create something where this big pipeline is growing all the time, and they will add a lot more sales on. That's what's happening -- something north of 70% of our opportunities that are in Salesforce.com right now, are related in one way or another to All Access Pass.

  • It's just the nature, once they go in there, even if somebody says they just want to train in one course, you are going to say, fine, we can turn the other buttons off so you don't see anything else. But it's still the most economical and flexible way to implement that one course is accessing the content through an All Access Pass, where you can have all these other digital assets to help you out. And by the way, if during the year you decide to do something else, you've already got it. And we can help you find value.

  • So it's really changing the whole sales approach to something that is not promotional. It's happened where, as we talked before, the average opportunity size went down with these product-oriented facilitator sales. The average opportunity has gone way up. The sales cycle is a little longer, just because you have to sign a contract, but the deals are so much bigger and the pathway to doing something meaningful is there. So we think the trade-off is going to really pay off.

  • - Analyst

  • Reaching a level of $12 million in the fourth quarter, your fourth quarter into the launch, seems to be indicative of success in this area. Do you expect a continued ramp at the pace we have been seeing? Are we going to get to $20 million a quarter? Is that unreasonable to think?

  • - Chairman & CEO

  • In fact, I really appreciate you raising that. As you know, our fourth quarter is historically the time when we sell most of our IP. And so that's the big facilitator quarter, and as a consequence, it was the big quarter of conversion.

  • I think if we add something like $4 million to $5 million, maybe $5 million to $6 million of invoiced amounts per quarter until we come up against the renewals -- it's our first quarter. I think if we got something between $5 million and $6 million of new sales, that would be a good thing, given our normal seasonality of when the sales cycle for people.

  • The second quarter you pick that up again, it's a similar amount, $5 million to $6 million of invoiced amount, and you start to pick up a percentage of the renewal. I think it's more like that. I think the year over year will be impressive, but the sequential will follow our seasonality for a while, and then hopefully over time the seasonality will just get less.

  • - Analyst

  • Great. Thanks for your time.

  • Operator

  • Marco Rodriguez, Stonegate Capital Markets.

  • - Analyst

  • Good evening, guys. Thank you for taking my questions here. A bit of a follow-up on the All Access Pass here: I know in the past you described that business or that service or how you'd like to describe it as kind of incremental revenue generation for Franklin Covey. And it sounds like obviously it's been doing very well and you are changing some of the services that you are adding in there. Should we characterize that business as still incremental revenues? Or are you seeing perhaps some existing clients switching the way they are buying from you?

  • - Chairman & CEO

  • Thanks, Marco. Number one, the first thing is it will convert. We only want to cannibalize all of our existing clients. Because the average sale size for our facilitator clients -- I say average, but this is the mean across 2,000 of them is around $8,500 a year they spend in the year they spend the most, and over three years they spend about twice that amount.

  • So the typical facilitator is loyal and buying every year, but they might buy at a different time, or they might skip. Over three years, they generate $15,000 of revenue.

  • For us with All Access Pass, the initial sales side, the initial sale has averaged about $28,000 in the initial sale. We are getting about 20% of that amount, even in this early stage, of increased either services or expansions or upgrades on those Passes. And then hoping for an 80% renewal rate.

  • Over those same three years, rather than getting $16,000, we are thinking in terms of having more like $60,000 or $65,000. Number one, we really want to get all of our existing customers across the bridge, and yet, like I say, to date only about 12% or 13% of those people have gotten across the bridge. So we have a lot of headroom to get that done, but that's number one.

  • And everyone that we convert, they have that advantage. That's a major objective. But we don't want to do it as a promotion or something. We just want to go out there and have the discussions, and meet them where they are, and over the next two or three years, get them all across.

  • To your second point, though, really a significant portion of our sales, more than half, have come from people who aren't active clients. Either they are somebody who were once a client and no longer want to train in that way, but see this as a new way of doing things, or from this list of the 9,900 assigned accounts who are not yet customers. This is giving a whole new way of going to market with them, because many times they don't want to buy a course; they've got a big learning and development group that actually wants the content to weave into other things they are already doing. They want to add concepts or lessons from what we do, and our film libraries, et cetera, into the stuff they already do as an organization to enrich it. That's a whole new way of engaging with us.

  • More than half of the sales have occurred with clients who were not active clients. Those who are, like we said, we hope will dramatically increase the lifetime value of those who were clients. We think this approach is really targeted at a job to be done that every person out there who has any responsibility for performance improvement is in our target. We really see it both ways, and we expect lots of headroom in both.

  • - Analyst

  • Thank you on that answer there. So you also addressed changing, or rather updating the All Access Pass with additional languages, and launching that overseas. I don't know if I missed that, but was there a timeline associated with that?

  • - Chairman & CEO

  • Yes, I apologize. I wasn't very clear. We will have that localization work done by the end of February, so we can launch across the world March 1.

  • Those people are now going through -- Paul was down in Phoenix yesterday for the review of all the training materials and the training process for all those people. Shawn and his team, tomorrow morning we have a call with all the partners to get them ready for this. They actually have a weekly call on this, but I'm on it tomorrow.

  • We expect them to be ready to go March 1 to get selling this, so that by the end of the third quarter or the start of the fourth quarter, we ought to start to see some traction, given the sales cycle internationally. Also in the offices in Japan, and now China, we have a similar timeline.

  • - Analyst

  • Got you. And last quick question, in regard to your outlook here, you use this word, a transition period where then future results will be a little bit more predictable for you guys on a quarter-to-quarter basis, what have you. Can you help define what that transition period is, timeline-wise? Are we talking next year, three years, five years?

  • - Chairman & CEO

  • Yes, and that's great. It ties a little bit to Jeff's question as well. Let's say we went all the way, and starting tomorrow, every sale we make this year that we made last year, we do with these additional services so that the IP portion is 1/12, that the portals are already 1/12, and then services and products are sold on that.

  • That way, if we did that immediately, then the transition, other than the mix between services and products and IP, at least all the IP and portals would have transitioned in one year. Because everything we sell, whether it's a Pass or it's an individual course, where we are splitting the IP from the manual and having them buy the manual separately, we would get it done more quickly.

  • Our idea -- number one, because our customer, we can then have this strategic advantage with them. But number two, to get across the bridge quickly. We want this transition period to be as short as possible. And if we go to that immediately, then that shortens the time, so that over the two years you get across the bridge instead of over three or four.

  • - CFO

  • Totally agree, Bob. Just want to make the point that we are not just deciding here what accounting to use. We are deciding what business practices to implement, and that will drive the accounting. So we are not just deciding to change our accounting and what we have done.

  • What we're talking about is if we're going to allow our customers to have different services over the time of their contract, that requires us to go subscription. It's the business practice that's driving the accounting.

  • - Analyst

  • Thanks a lot, guys, for your time.

  • - Chairman & CEO

  • Did that answer that, Marco? We are thinking the business practices are going to change, so it's on the short side of that possible transition, not the long side.

  • Operator

  • Kevin Liu, B. Riley & Company.

  • - Analyst

  • Hi. Good afternoon. Just in terms of the Q4, in which the amounts for All Access Pass, could you just talk about whether any of those were multi-year in nature or those were all 12 months or less?

  • - Chairman & CEO

  • Yes, the nature of the contract generally has been a one-year contract and it's automatically renewable, if they don't let us know within 90 days. They have all been one-year contracts.

  • Actually in recent days we've had requests, as we get in there with people saying: Gosh, I have already plotted out what I'm going to be doing for the next three years. I'd rather not have to worry about a price increase and changes, et cetera. We were reticent to do that because the way the offering was structured, the one-year made sense because we couldn't give them additional content that they didn't buy in the original Pass. Because a portion of it was recorded as IP up front, and only the digital assets were recognized over time.

  • As we make the decision that, wait a second, we can get lots of these multi-year contracts if we tell them that whatever content we develop or come up with in the meantime, whatever changes in the portal we do, they'll get the benefit from it. It's been restricted, not because they weren't willing; they were already plotting out two- and three-year impact journeys. It was that we didn't -- we couldn't promise them that they'd get the benefits of upgrades in our offering. That is part of what we've been talking about.

  • If we say, we're going to do what's right for the customer, we're going to give a competitive advantage. We're going to be able to tell them, in addition to the courses, we're going to have really premium webcasts that help you get additional value. We are going to add -- anything you buy, you get the new content. If we add a new course, you will get it.

  • Two things will happen: One, it will drive the transition faster, but also it will, we think, drive more of these multi-year contracts because people are already thinking in longer terms. Our business practice was forcing them to look shorter. Does that make sense?

  • - Analyst

  • Yes, understood. More generally on that, in terms of how you are invoicing today, are you primarily billing on a monthly or quarterly basis, or are you actually billing a full year up front?

  • - Chairman & CEO

  • We bill up front; they pay on normal terms. I think that's reflected in the cash flow. Cash flow is $33 million, which is just billed invoice. By the time we are recognizing it, we've had the cash for a long time.

  • - Analyst

  • Great. Just lastly for me: Certainly over the course of FY16, you returned quite a bit of capital to shareholders. While you do have some upticks in some of the product development costs for next year, just curious whether you'd expect to continue to return a significant amount of your free cash flow to shareholders?

  • - CFO

  • I doubt it will be $43 million, but yes, we will continue to generate cash and we expect to do something with cash and expect that will include purchasing shares opportunistically.

  • - Analyst

  • All right. Thanks for taking the questions.

  • Operator

  • Alex Paris, Barrington Research.

  • - Analyst

  • This is Chris Howe sitting in for Alex Paris. Most of my questions have been asked, but I did have a few left over. You mentioned the discovery days with current AAP partners is still ongoing? I was just wondering, at what point do you think you will have visited the majority of the existing AAP partners?

  • - Chairman & CEO

  • That's a great question. Every Tuesday morning we ask the whole team that question and have a review of it. We did 90 new discovery days in the last two weeks, and there is -- the idea is we want these done. We want them all done by year end, calendar year end. We won't get them all done with the holidays, but our guess is over the next 90 days or so, we will have those discovery days.

  • Not all of it is us, by the way. Some people just can't get their team together until after Christmas.

  • The idea going forward is the call within two days, the initial call where they had this hour-plus planning session and the discovery day within 30, and that's the standard. All of that data is now in. We track red, yellow, green. It's green if it's being held within 30 days.

  • We just didn't think of the discovery day until -- we didn't come up with that as the best way to do it until we tested it for a few months. I think it will be probably into, well into the second quarter, say by end of January or so by the time all those that were in at year end will have had the discovery day.

  • One thing we did for a lot of these Pass holders, not recognizing that we wouldn't have that, is some of them have a little longer time, so they had a 14-month contract or something, so they didn't lose. If they couldn't get things planned in time, they would still get a full year's value this first year.

  • - Analyst

  • And just a follow-up on that: Of the ones that you have had the chance to visit thus far, what percentage have converted or upgraded to additional services? And maybe you can share some additional thoughts on some of the early successes you have had during the discovery process?

  • - Chairman & CEO

  • Great. So first of all, Paul, do you want to talk about some of the successes they've had in the discovery process --?

  • - EVP of Direct Offices Division

  • These discovery days that we hold -- they are anywhere from a few hours to an entire day, and sometimes we will do a couple different sessions with the same client. The idea is, if you can imagine, we might have sold the Pass to the head of learning and development, a Chief Learning Officer, and he or she purchased the Pass for a specific purpose, say a leadership development initiative. But they've now invited us in to come to this discovery day, and around that table might be the head of sales, might be an operational lead, it might be somebody else running another part of the business. And we are sharing with them how we partner with organizations like theirs, and outlining how they might be able to leverage the Pass, and oftentimes that does lead then to additional sales.

  • I would say about a third of our clients that we've done discovery days with are actually adding on additional seats, additional services. One example, we had a client in Texas that bought the Pass for a leadership development initiative. They came back into the discovery day, and they invited their head of sales to come. And the head of sales purchased, for his population, that actually doubled the size of the original Pass and then added on 12 consulting days. It took what was initially around a $40,000 sale, and it took it up to $120,000 or so engagement over the first year. That's just kind of at a high level of how it works and what we are seeing.

  • - Chairman & CEO

  • Mathematically, we have sold about $5 million of add-on services, expansions, upgrades or products in these first 100 plus discovery days. I don't know that if we do 800 more we will get $40 million, but I'm saying I think the idea is we think about a third of them will do something new, initially.

  • This discovery day process is not a one-time thing. We expect to visit every quarter to update. And so we think there's a whole other way -- I mean, the number of the large deals we have now, and large opportunities, is like 20 times the number we had last year at this time because people see now how they can use this to do things they never would have considered.

  • We go in and when we tell them, look, you can do this yourself or you can (inaudible) continue you can get us to help you a little bit upfront and certify your people, or we can do it for you. Once you give them the option of not hiring you, then they raise their hand and say I'd like some help. And that's where historically we just never did that. We sold them the manuals and said go at it.

  • I think there's a lot of opportunity. I'll have to give you more examples; if you'd like to call, we can go over 10 client examples specifically what happened, if that's helpful.

  • - Analyst

  • No, thank you for the additional color. It's been very helpful. And we will follow up.

  • - Chairman & CEO

  • I'd offer that, by the way, to anyone -- if anybody has some specific questions and want to see how this really works, we are happy to be completely transparent on -- we will pick 20 at random. You can pick numbers one, five, seven, nine and whatever, and we will just tell you exactly what happened in the discovery days and what came from it. If you want to get a better sense, we can schedule an hour sometime and do that, and we'd be happy to do so.

  • Operator

  • Samir Patel, Askeladden Capital Management.

  • - Analyst

  • Fantastic to see all the momentum on All Access Pass. My primary question is basically Tim's question, which I guess I'll ask a slightly different way. Just to reiterate, it sounds like you have all this fantastic momentum, you're getting clients spending a lot more money, you are re-engaging clients who maybe weren't active in recent years.

  • And yet your adjusted EBITDA guidance, when you add back the deferred revenue portion, is still not quite as high as I would've expected for 2017. I guess that's because of some of the investments you're making and the transitions.

  • So when you look out to 2018, when some of those one-time investments are in the books, and you also have the renewals on top of the new business that you are signing up, I know it's early, but would it be unreasonable to expect your adjusted EBITDA plus deferred revenue number to be in excess of $40 million?

  • - Chairman & CEO

  • I think that's right, it wouldn't be. We'd be expecting it.

  • - Analyst

  • Sure. Basically, your fundamental underlying business growth is actually higher than the adjusted EBITDA growth. You're just reinvesting some of it. Then you'll see a significant acceleration from 2017 to 2018?

  • - Chairman & CEO

  • That's true. And the other thing I didn't think of exactly when Tim raised the question, one of the other reasons is, we have had, for the last few quarters, for more than a year, maybe seven quarters, we've had a decline in the services side of the Business, the on-site delivery days. And we think these add-on Pass sales, et cetera, and these add-on services are going to reverse that.

  • These were independent of the Pass. Things where people used to just hire you independently, and now you have to do it through the Pass, so it's declined some. I think part of our conservatism is to say, we believe, whether it's this quarter or next quarter or the next quarter, that's going to turn with all these new services and offset that. But otherwise, we do have a negative headwind on on-site days that's pushing against us. That's part of our conservatism.

  • We actually believe we're going to solve it. If so, then we really are on the very conservative edge. If it takes us longer to solve it than we think, than we hope, it might take us a little longer.

  • Once we get that solved, I think your point is exactly right. The investments aren't -- our investments aren't massive. We're not talking about investing $5 million and $6 million and $7 million of expense in these things. These are incremental, a couple of million dollars of extra marketing and development expense, so forth.

  • So the real issue is, can we overcome some of the trends we have had that have offset this growth? And can we do it quickly enough that it all gets in this year? Or is it something we know we're going to solve but it takes longer. So I think that's just the conservatism. As I mentioned, all of us have plans to do better, and the next year certainly ought to be in that range.

  • - Analyst

  • Sure. Good thing you brought that up, because that was going to be my little follow-up, which is, I'm not sure I completely understand those dynamics around the on-site days? Clearly there's increasing demand from your clients for your products. That's pretty clear from the All Access Pass uptake. Can you just explain in a little more depth exactly what's been going on with those on-site days, the Pass, I think you mentioned seven quarters, and why you expect that to reverse?

  • - Chairman & CEO

  • Yes. The on-site days typically occur in one of two circumstances. One is where it's a brand-new client who doesn't know exactly what they're going to try to do and, therefore, they don't want to invest in certifying teachers inside their own company. So it's kind of a first-time engagement, where we are in there, and they come in and look at training and have us deliver it for them. That's not what's been affected. That still happens.

  • They say, oh gosh, that Pass sounds like a great idea, but I just need a course tomorrow or a week after tomorrow. That's a good way of getting to know us, after which they say, this was great. We then tell them about the Pass and that they can get those same services at a slight discount if they buy the Pass.

  • The second one, where this really resides is that there are some big engagements that drive a lot of service revenue but which haven't been as sticky. The execution is a very sticky solution. In the implementation, we have lots of services up front where a $90,000 track that somebody buys to take 25 managers through a track to get them certified and how to lead an execution engagement. Out of the $20 million we do in the execution practice, only about $12 million of that is on the intellectual property side and $12 million is on the services side.

  • And so as we have provided more content for execution, where people can do some of this on their own, two things happen. One, the populations are growing a lot, of people who are involved in the execution solution. But in the initial phases of them buying, rather than having to buy services in order to do it and having to commit to this big, heavier process, they can do it another way. And so it's primarily in a couple of categories like that in trust implementations where part of it's focused with the sales force learning to sell All Access. There's been less focus on selling that a little bit.

  • But it's more that if the client now is engaging us and buying the intellectual property, in that period before they start implementing the solutions between the purchase, et cetera, they just haven't been buying services. That's the main area that's been affected is these larger implementations. But we think it's just -- and we can track them, and think it's pretty much short term because those new buyers now are in fact are signing up for new services as we get in there on the discovery days.

  • What we should see, whether this quarter or next quarter, is a flattening in the decline, and then a starting back to turn it. We also have -- we have a new execution offering that I think will help drive it, but that's the circumstance that's been driving it. It's a combination, and it's really these bigger engagements, where now the core content is being delivered to the All Access Pass, rather than being simultaneous, and the services are coming second. I don't know if that is helpful at all.

  • - Analyst

  • Yes, that's great color. Have you dimensionalized that with a number, as far as how big that headwind is or has been?

  • - Chairman & CEO

  • Yes, we have. In the third and fourth quarters, the headwind in the US direct offices was about $2 million a quarter. Now, the margins are lower. The impact has been about $1.2 million, so let's say 60% gross margin because it includes services. There's some travel associated with it that has no margin where they reimburse us for travel.

  • So it's hit us negatively about $1.2 million in the US direct offices in the third and fourth quarters. In the first quarter, my guess is it will be similar. On a year-over-year basis, it will be probably similar, around a couple million dollars. But it would have been -- and in each case, in the fourth quarter it would've been more, like it was in the third quarter, but it's being offset by these new services.

  • So as those get delivered, booking them is one thing, delivering them might be 90 days later. We have some visibility into the idea that by -- into the second quarter it should start -- it should flatten and start to turn by the third quarter. And then we think it will be -- the amount of headwind will reduce every quarter after that.

  • So maybe a year from now we have no headwind hopefully or somewhere in that range, and at least we are flat. On a year-over-year basis we would be growing, but we'd get that $2 million back through additional services.

  • - Analyst

  • Okay. Got it. And one final thing: I know that one of the things we talked about previously was how you were looking to expand your sales focus from your traditional benchmark, the Marriotts and Exxon Mobils, the big companies of the world, to maybe more of the middle market, maybe smaller companies? But it sounds like right now you have plenty of stuff on your hands, just as far as getting existing clients onto All Access Pass. Is that still your next leg of growth after you get through that?

  • - Chairman & CEO

  • First of all, most of our clients actually are in the middle market. Most of them are not Fortune 500 companies. We do business with Fortune 500, but it's not a deep penetration.

  • We actually typically would have a deeper penetration with the thousands of 5,000-person employers. That's a really great spot for us, and we have lots of business in the 200 to 500. So I think with us, the thing that All Access -- it's been an issue of going in -- if what you were primarily selling was a course, a specific course or content area, even in a big company you weren't penetrating very deeply because they were figuring which group was going to go through it. You are actually, now we are able to get more penetration in both.

  • So really our strategy is to -- we've organized so that the salesperson, their collection of 60, 70, or 80 signed accounts with whom they might be doing business with 20% of those today or 30%, and the others are prospects, is actually a pretty good mix of middle market, big accounts, and even smaller accounts with 200 or so employees. The allocation of accounts is across markets; the approach is going to be the same though to go into those accounts and figure what jobs they're trying to get done and have the All Access Pass be the methodology for delivering on it. So I think our go to market is really already across those. We don't go to small business, per se, and less than 200 hasn't been a target for us. But otherwise our mix is pretty much the entire -- it would be helpful, maybe we'll just take note, and in future conference call we could give you a mix of how that mix, what that mix looks like between large and medium and small accounts.

  • - Analyst

  • It's getting late here, so thanks. But incidentally, Bob, I'm sure your dentist would like to remind you that if you're really a loyal customer, you'll go in for a checkup every six months so you don't need a root canal (laughter). I'm sure he'd like you to know that.

  • - Chairman & CEO

  • Sorry, we kept everybody so long, but really appreciate all the great questions.

  • Operator

  • We have no further questions at this time. I would like to turn the call over to Bob for closing remarks.

  • - Chairman & CEO

  • Great, thank all of you so much for joining. We look forward to talking with you if you'd like to catch up, and thanks so much. We are very encouraged about what's going on, and appreciate your support and thoughtfulness. Thanks.

  • Operator

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