Franklin Covey Co (FC) 2018 Q1 法說會逐字稿

Welcome to the First Quarter 2018 Franklin Covey Earnings Conference Call.

My name is Anna, and I will 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.

Please go ahead.

Thank you, Anna.

Hello, everyone, and happy new year.

On behalf of Franklin Covey, I'd like to welcome you to our first quarter of fiscal 2018 earnings call this afternoon.

I hope all of you are having a good year and are avoiding the severe weather on the East Coast, the cyclone bomb.

Before we get started then this afternoon, 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 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 acceptance of and renewal rates for the All Access Pass; 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 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 update or revise these forward-looking statements to reflect events or circumstances after the date of today's presentation, except as required by law.

In addition, I'd like to remind everyone that during the call, we will be discussing GAAP and non-GAAP financial measures.

Please refer to the reconciliation of these items as found in this presentation and in our earnings release for the first quarter.

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

Bob?

Thanks, Derek.

Hello to everyone, again happy new year, and we're happy to have the chance to talk with you today.

I hope that from our discussion today, you'll glean 5 takeaways.

Those are shown on Slide 3: first, that our strong first quarter results reflect just the leading edge of what we expect to be an even more significant inflection in revenue and adjusted EBITDA growth and cash flow for fiscal '18 and beyond;

second, that the continued growth in our deferred revenue balances provide significantly increased visibility and a strengthened foundation for accelerated future growth;

third, that the growth is being driven by success of the subscription business, whose key metrics are extremely strong;

fourth, we expect we're in an inflection point where we expect significantly accelerated growth now in adjusted EBITDA, our adjusted EBITDA margins and free cash flow this year and the next years' despite making significant growth investments;

and finally, that we believe that there is an increase -- there's increasing upside, we believe, for shareholders as most of the value of the subscription business is not yet reflected in the market cap, we don't believe, and we'll just touch on each of those.

I'd like to start with the first one, our -- the results for the first quarter being the leading edge of what we expect to be a significant inflection in results this year.

Slide 4 provides some quick highlights on the key results for the first quarter.

As shown, revenue grew 20.5%.

Subscription and subscription-related revenue grew 59%.

The subscription and subscription-related revenue in the Enterprise Division grew even faster at 138% year-over-year.

Our deferred revenue that we -- was billed grew 23%.

Our total deferred revenue, including billed and unbilled, grew 52% year-over-year.

The adjusted -- our adjusted EBITDA was $3.4 million higher than in last year's first quarter.

Our net cash provided by operating activities was $5.2 million higher than last year's first quarter, and our number of paid subscribers through our subscription offerings grew 44%.

I'd now like to provide just a paragraph or 2 on each of these points.

Starting out, you see on Slide 5, is our reported revenue.

Our reported revenue grew 20.5% in the first quarter to $47.9 million, up from $39.8 million in the first quarter of fiscal 2017.

You can see again that our total subscription and subscription-related revenue across both the Enterprise and Education Divisions grew even faster at 59%, partially muted by declines in our now much smaller legacy facilitator and on-site delivery channels; and that subscription and subscription-related revenue in our Enterprise Division alone grew even faster at 138%, a good strong -- the engine felt strong.

In the Enterprise Division, revenue grew $7.7 million, which was 26%.

So it's -- total revenue was $37.5 million, up $7.7 million or 26% compared to last year.

In the Education Division, revenue grew $400,000 or 5% to $9.2 million.

Slide 6. Our total deferred revenue, billed and unbilled, grew 52% year-over-year in the first quarter to $10.1 million, up from $6.6 million in last year's first quarter.

As you can see, deferred revenue that's billed increased 23% to $8.2 million from $6.6 million in last year's first quarter, and the deferred revenue that's unbilled as we work more and more on multiyear contracts was $1.9 million in the first quarter compared to none in the prior year's first quarter.

Turning to Slide 7. We're pleased that as shown on Slide 7, our adjusted EBITDA of $600,000 for the first quarter was $3.4 million higher than the negative $2.8 million in reported EBITDA we had in last year's first quarter, also $2.4 million higher than our guidance.

Our guidance was for adjusted EBITDA in the first quarter to be approximately negative $1.8 million, which was an amount -- $1 million higher than in last year's first quarter.

We are really encouraged that the strength of All Access Pass's revenue in our Enterprise Division drove strong growth in revenue, and significantly -- also and significantly increased our gross margin percentage, resulting in higher-than-expected adjusted EBITDA despite our significantly increased growth investments to cover implementation specialists, new portal, localization of content in 16 languages, content investments, et cetera.

Just to refer you to the Slide 29, which is in the Appendix, just to give you a little more color on the performance, you should see there in the Enterprise Division, first quarter revenue was $37.5 million, growth of $7.7 million or 26% compared to the $29.8 million in last year's first quarter.

The Enterprise Division's gross margin increased 644 basis points to 72.1% from 65.7% in last year's first quarter, again reflecting the high margins in our subscription business.

The combination of higher revenues and higher gross margin drove a $4.8 million increase in EBITDA in the Enterprise Division to $4.5 million compared to EBITDA of minus $300,000 in last year's first quarter.

And this was after covering more than $1.5 million in increased growth investments, as I mentioned before, so we felt great about the performance of Enterprise Division in the first quarter.

As also shown on Slide 29, as expected, the Education Division's adjusted EBITDA was $900,000 lower than in last year's first quarter.

That reflects both, one, the staffing and marketing investments the Education Division makes during the first and second quarters to be able to generate the contracts with hundreds of new schools, which it recognized in the fourth quarter where, as you know, substantially all of its EBITDA, annual EBITDA, is generated; it also reflects a change in the structure of our Leader in Me subscription offering where we are now including several on-site delivery days as part of our Leader in Me offering instead of charging for these training days a la carte outside the Leader in Me membership.

This results in revenue from these on-site days, which were delivered in the first quarter and is normally being recognized in the first quarter, now being recognized over 12 months.

Going back to Slide 8. Net cash provided by operating activities increased $5.2 million in the first quarter from minus $3 million last year to positive $2.3 million this year.

And then finally, on Slide 9, our total number of paying subscribers across both our Enterprise and Education units increased to 475,000 in the first quarter.

That represents an increase of 125,000 people or users or 44% from the approximately 330,000 subscribers we had at the end of the first quarter in fiscal 2017.

So we felt really good about the results and direction and momentum we had in the first quarter.

A second point on the agenda is the -- just the continued growth in our balances of deferred revenue are providing significantly increased visibility into, and a strengthened foundation for, achieving accelerated growth as we have more and more of that revenue already in place.

As you can see on Slide 10, our total balance of deferred revenue, billed and unbilled, increased to $47.7 million in the first quarter.

That represents a high percentage growth, 164%, compared to the $18.1 million in total deferred revenue balances, billed and unbilled, we had at the end of last year's first quarter.

As you can see, our balance of billed deferred increased to $31.8 million, which is growth of $15.7 million or 97% compared to the $16.1 million we had in last year's first quarter.

And our balance of unbilled deferred, which really began to grow in this -- last year's fourth quarter, increased to $15.9 million in the first quarter compared to $2 million at the end of last year's first quarter.

As noted, these significantly growing balances of deferred revenue is providing increased revenue visibility and establishing the foundation for accelerated revenue growth well into fiscal 2019.

And we expect, actually, that the extent of our visibility in the future will continue to increase in each of the coming quarters, one, just as the natural result of growth; and second, we'll now begin to offer our subscription offerings in our international direct offices in Japan and China here in the next few months.

It will also occur in our licensee division, but that won't generate subscription revenue per se because they pay us on a royalty basis, but it will increase the visibility again from those offices.

So that for us is an important objective that we continue to make progress again.

Going to the third point, that our -- the growth is really being driven by our subscription business whose growth and key metrics were really extremely strong in the first quarter and have been for some period of time.

Over the past decade -- many of you have been with us that long -- we made 3 important shifts in our business and business model.

As indicated in Slide 11, each of these shifts has ultimately resulted in meaningful increase in share value.

Our final business model shift occurred in fiscal 2016.

As you know, throughout all the earlier periods, we typically sold our content and solutions one course or one solution at a time and often to one team at a time.

However, as you know, 2 years ago, after a lot of study, we determined that our strategic strengths of having best-in-class branded content, the most flexible content delivery options, and the broadest and deepest sales and distribution capabilities put us in a unique position to offer our content and solution through a Subscription as a Service model -- Software as a Service model, but also as a subscription, as companies and other sectors have done, that you can see on Slide 12, Franklin Covey being in the organizational performance improvement and talent development space.

We believe that offering our solutions through the All Access Pass subscription offering would allow us to substantially expand the breadth and depth of our client impact, significantly increasing lifetime value of our customers and potentially changing the basis for competition in our industry and ultimately creating substantial value for our shareholders.

There's been a bit of a transition; we appreciate your patience as we've been going through it.

But I think the good news, for us at least, is we believe that it's working and working well.

Our growth and momentum in our subscription and subscription-related revenue was very strong in the first quarter as were our subscription -- or Software as a Service quality metrics.

First, as shown in Slide 13, for the latest 12 months, our -- across our -- both business, our subscription and subscription-related revenue and change in deferred revenue, billed and unbilled, increased to $107 million.

That's growth of $37.4 million or 54% compared to the $69.9 million in total subscription revenue we generated for the same 12-month period in last year's first quarter -- for the trailing 4 quarters ending last year's first quarter.

So that significant growth in the overall subscription revenue and subscription-related and the change in deferred just is continuing to build up momentum.

Second, as shown on Slide 14, we've already talked about this, but I'll give you a little more color on this.

Our total number of paying subscribers across both our Education and Enterprise units increased to approximately 475,000 in the first quarter.

That's as an increase of 125,000 or 44% from the approximately 330,000 subscribers we had at the end of the first quarter in fiscal '17.

As you can see in Slide 15, in the Enterprise Division, of our total 475,000 active subscribers, as you can see in Slide 15, 330,000 of them are in our Enterprise Division, almost all of which are All Access Pass subscribers.

This 330,000-person subscriber base is up 125,000 subscribers or 61% compared to the 205,000 subscribers we had at the end of last year's first quarter.

So with that, growth continues to be very strong.

And then the Education Division, as shown in Slide 16, our growth was 15% during the year, which is again very solid growth.

We had 150,000 subscribers at the end of this year's first quarter, which is growth of 20,000 subscribers or 15% compared to the approximately 130,000 subscribers we had at the end of the first quarter of fiscal 2017.

As it relates to growth of our subscription-related business, third, as you can see in Slide 17, like Gartner, the subscribers purchase nearly $0.50 of add-on services for every $1 in subscription revenue.

Our Pass holders were also purchasing significant amounts of add-on services to help them achieve their organizational objectives.

In the first quarter, Pass holder purchase of add-on services increased substantially.

And as you can see in Slide 17, All Access Pass holders purchased $3.6 million of add-on implementation services.

That's growth of $1.5 million, a big percentage compared to their purchase of $2.1 million of add-on services in last year's first quarter.

And for the trailing 12 months, the All Access Pass holders purchased $14.9 million of add-on services, which is growth of $11.1 million or almost tripling compared to the $3.8 million of add-on services purchased by Pass holders for the same 12-month period ending in last year's first quarter.

One last comment then about our -- the growth and the strength of the subscription business is, we're also pleased that some of the -- some of our subscription business's key indicators place it among what are considered best-in-class SaaS companies.

Recently, one of our shareholders was nice enough to send us a copy of an independent study of SaaS companies, which included data on all 56 of the publicly traded SaaS companies.

12 of these companies were considered best-in-class based on their achievement of all 3 of the factors shown in Slide 18, which are year-over-year -- the percentage of year-over-year revenue growth being at least 25% of the subscription and subscription-related; their gross margins in their SaaS business being at least 70%; and what they call growth efficiency, a combination of the growth rate of 25% and their free cash flow yield, which was at least 5% on top of the 25%.

And that made the best-in-class group, at least in this study.

As you can see in Slide 19, we were encouraged that, as indicated there, our SaaS business is also achieving these 3 best-in-class SaaS standards.

Even though we're early on, our subscription and subscription-related growth has been well in excess of 30%, of course, off a smaller base.

Our gross margins are north of 70%.

And our growth efficiency, the combination of the gross margin and our cash yield, even with all the investments, has put us at least in that place.

And so we're trying to, therefore, not only build something that generates revenue, but has quality of the revenue, sustained -- the revenue is sustained at high margins, high add-on services, high revenue retention.

As you can see on Slide 20, the combination for us of having a higher initial sale size, revenue retention of more than 90%, plus the add-on purchase of implementation services is driving significantly increased lifetime value for our customers -- of our customers.

Our customers, of course -- about 40% of our All Access Pass customers were previously facilitator -- coming from our facilitator clients.

And so an example of how that's changed for them, in the traditional facilitator business, the initial sale may have been around $15,000.

It's a pretty close average actually of the 263 clients who had purchased All Access Passes through the end of last year, their average purchase had been $15,000.

Their highest purchase as a facilitator over 3 years is $15,000, whereas the initial purchase price of -- for their All Access Pass was $28,000.

Over 3 years studying that group of people, they had spent an average of around $32,000 rounding.

And now with the renewal rate and the add-on services, we'd expect over that same 3-year period substantially higher, something in the range of $89,000 difference.

And so for us, this idea of building clients for life where we acquire new clients, we go in and work with them to make sure they're getting real value out of the offering, expanding their populations, expanding the number of solutions they're utilizing, adding on services where it's useful to them and then renewing and continuing that virtuous cycle, we believe, is a great way to do business.

It's been a great thing for our customers, a really great thing for them that they find us as their real strategic partner.

It's been great for our clients and for our employees and for our associates here because they're doing really important work and getting the chance to do what they've always wanted to do is to go deeper and more pervasive.

And we believe that it's also an exciting time to be a shareholder at Franklin Covey as well.

Fourth point on the overall agenda is that we believe we're at a significant inflection point where we now expect to achieve accelerated revenue growth, increasing gross margins and increasing flow through to adjusted EBITDA and cash flow.

And we recognize that our transition to a subscription model would be disruptive.

As shown in Slide 21, on the left-hand side of the chart, we knew our transition would involve subscription accounting.

And over that period of time, the last 2 years, the portion of a given contract's value that is recognized upfront at the time of sale has declined significantly.

This transition has also disrupted our legacy facilitator and on-site business model.

However, as noted on the right-hand side, this has also significantly increased our lifetime customer value.

It's increasing our gross margins, we expect to ultimately have significant impact on our EBITDA margins.

It's also increasing our visibility.

As you can see, at the end of the first quarter, we had $47.7 million balance, a very high margin deferred revenue, which will be recognized as revenue and income in fiscal '18 and into fiscal '19.

We've now reached an inflection point where under any of a wide variety of revenue growth scenarios, we expect to achieve strong revenue growth, increasing gross margins and significantly increasing flow-through to adjusted EBITDA and cash flow.

And I'll share some at least some sensitivity that may be helpful to some of you who have asked for that visibility.

As shown on Slide 22, assuming we meet our 14% revenue guidance this year and then our EBITDA ends up in the middle of the range, say, at $12.5 million, this says after having done that, if the growth rate were to drop then to 7% under the scenario 1 where we hit it -- this year's numbers, but then the growth rate drops to 7% thereafter; or scenario 2 where we hit 14% this year and the revenue growth continues or goes to 15% a year, just to get 2 different views.

Under scenario 1, revenue would still grow to $226.8 million in 2019, to $242.7 million in '20.

I think on the slide, it skips over '21, but $259.7 million in fiscal 2021 and to $278 million in fiscal 2022.

The contribution produced by the operating units, by the Enterprise and Education divisions, will be -- the midpoint of our range this year on EBITDA, their contribution toward that would be $28.5 million in EBITDA contribution in fiscal '18.

That would be expected to grow to $43 million in 2019 to $55 million -- $56 million in 2020.

Again, skipping that year, $68 million in 2021 and to $81.7 million in '22.

The reported adjusted EBITDA after achieving $12.5 million, which is, of course, the midpoint of our guidance range this year, so we'd just use that as the midpoint, our reported adjusted EBITDA would be expected to increase to $26 million in '19, to $37.4 million in 2020, to $49 million in 2021 and to $61 million in '22.

And cash flow would actually grow a little faster.

After having cash flow of $25.7 million in fiscal '18, in -- cash flow, as defined here, would be expected to increase to approximately $38 million in fiscal '19, to $45.4 million in fiscal '20, to $55.6 million in 2021 and to $67 million in 2022, even after making significant ongoing investments.

Now you can read the scenario 2, but let me just hit some headlines here.

If -- under scenario 2, if after achieving our revenue guidance of 14% in fiscal '18, revenue then grew at 15% a year thereafter, you can see that revenue would get to $371 million in fiscal '22, division-level adjusted EBITDA contribution would get to $109 million by then, reported adjusted EBITDA would go from $29 million to $46 million to $65 million to $88 million, and cash flow from $25 million in '18 would go to $41 million, to $54 million in 2020, to $72 million in '21 and to $95 million in 2022, again even after making significant ongoing investments.

For those of you who'd like to play with the numbers there are additional sensitivity scenarios shown on Slide 27 that might help you as you try to just look at other data points.

But we're excited.

Whatever the exact numbers are, we're excited to be at this inflection point where we expect to achieve strong revenue growth, increasing gross margins and significantly increasing flow-through to adjusted EBITDA and cash flow as we move forward.

Final point on our takeaway agenda is number five.

There is -- just to say that notwithstanding the revenue momentum, the substantially increased visibility, the dramatic growth in the SaaS business and their being at an inflection point, we believe that very little of the expected value of our subscription business we've talked about just now with what the cash flows are likely to be, most of which are driven by the subscription business, we believe that very little of that is reflected in the current market capitalization because -- and we think that's good news for shareholders who are getting -- where a lot of the value is based on the legacy businesses that continue to generate EBITDA and will continue, like our Education business, which again is increasingly from subscription.

But just looking at the Enterprise business alone, we've got several units that generate significant EBITDA contribution.

Education, which has continued to grow well over the years and we expect will continue to grow well; our licensee division, which is part of Enterprise but has a separate business model, generates significant amounts of contribution; the ops outside in the -- like China and Japan, who haven't yet begun the subscription; and then just the remaining contribution from our legacy business.

When you add those up using some reasonable multiple of those and subtracting that from our roughly $300 million market cap, I think the conclusion is that compared to best-in-class SaaS companies that are trading in a multiple of revenue of 4 to 10x, we're not saying we should, but depending on your math and what multiples, we might be trading at 0.5 point, 0.5x revenue or whatever.

And therefore, we think that as this becomes more and more visible, the success of the ongoing efforts on the transition that, at some point, that will begin to -- at least there's a chance that will begin to become recognized as well.

So -- and with these numbers that we provided on the previous slide that showed potential cash flows, I think a discounted cash flow analysis would also suggest the valuation disconnect potential, which we hope is to the benefit of all shareholders.

So in conclusion, just going back to our 5 takeaways, our first quarter results, we think, are reflective of an even more significant inflection in revenue and adjusted EBITDA growth we expect for the full year.

We're happy to be at that point.

We've been talking about getting there and believe we're now approaching that, or in the middle of it.

Second, our significantly increasing balances of deferred revenue are providing significantly extended visibility into and strengthening the foundation for accelerated future growth.

Third, our actual and expected growth in revenue and adjusted EBITDA is being driven by the success of our SaaS business whose growth is dramatic and the key metrics strong.

The inflection -- the economic inflection point we're hitting is expected to drive significant growth at all levels and particularly in free cash flow despite growth investments.

And while we are hitting the inflection point, we think that there's very little of that value being baked into our current market cap and, therefore, giving us a chance to -- giving everybody who's on this call a chance to benefit from the recognition of this.

At this time, I would just turn the time over to Steve to review our guidance, then we'll open up for questions.

Okay, thank you, Bob.

Happy new year, everyone.

For guidance.

So as you remember, our guidance for the year is that we expect net sales to increase from $185 million to approximately $212 million, a 14% increase.

We expect deferred revenue on our balance sheet to increase by more than $15 million, a 36% increase.

And we expect adjusted EBITDA to increase from $7.7 million to a range of $10 million to $15 million for the year.

Our positive Q1 result gives us increased confidence in this annual guidance.

As Bob mentioned, we are pleased to report that adjusted EBITDA for the quarter was $2.4 million higher than our guidance.

This improvement compared to guidance is primarily due to an increase in add-on AAP sales and facilitator sales in the quarter combined with the expected increase in recorded AAP sales and high gross margins.

So we're pleased with the quarter.

At the beginning of this year, we expected our Q1 and Q3 adjusted EBITDA results to be somewhat higher than last year.

We expected our Q2 result would be somewhat less than last year, maybe as much as $1 million.

And we expected our Q4 result to be significantly higher than last year.

We still have those same expectations in light of the fact that Q1 was quite good compared to our guidance.

So Q2.

We expect a higher dollar amount of contracts to be signed in Q2 than in Q1, maybe a $3 million higher amount of contracts signed; and are pleased that an increased amount of those contracts is expected to be related to the continuing growth of our subscription business.

This expected mix shift in sales toward the subscription business compared to Q1, is expected to cause the reported sales result in Q2 to be less than Q1, maybe by 3%.

And so our guidance for Q2 is, therefore, that adjusted EBITDA is expected to fall between a negative $500,000 and a negative $1.5 million for the quarter, again as we expected it to be -- as we expected at the beginning of the year.

So we're pleased with our first quarter result.

We're pleased with where we'll be at -- where we expect to be at the midpoint of the year compared to what we were thinking at the beginning of the year.

And while a lot of our confidence -- while we have confidence in our guidance, because we're still in a significant transition of our business toward a subscription model, changes, including a significant change in the mix of sales between subscription and nonsubscription, could still result in us reporting results that are different than our current expectations.

So Bob, that's a look at guidance.

At this time, we would just open it up for questions.

Thanks a lot.

(Operator Instructions) We have a question from Alex Paris from Barrington Research.

This is Chris Howe sitting in for Alex.

I had 2 questions here just to start off.

First, any additional color on the large intellectual property contract as far as maybe the magnitude, how it came about and what's unique about this contract?

And then my second question was in regard to the tremendous paid subscriber growth that you had of up 44%.

Perhaps, as much as you can share, how is this going in the quarter in regard to the Enterprise and Education segments?

And any insight into how it may look for the year?

So on the first question, we've talked about one large enterprise -- we have a client that's a large professional services firm that's been a client for maybe 15 years who, recognizing the value of the Pass and such, just signed a multiyear contract during this quarter.

And so I think that there's nothing new other than this -- I mean, in terms of the relationship, it's just that this client now is seeing the advantages of having a multiyear relationship that's contractual upfront will -- and the ability to do a lot more things with them, provided that.

I don't know, Paul, if you want to give any other color on that.

No, that's right on, Bob.

Does that respond to your question on ed?

So that's how it is.

It's just a client, who is typically signed up for this year by year, decided to sign a multiyear contract to deepen the work that we're going since we have good commitments from what we're going to do together.

As it relates to the subscription growth, maybe I can just refer you to slide -- in terms of -- let me just say -- see if the question was how much of it was the -- your -- was the question about the growth in the quarter itself and how that broke out between Enterprise and Education?

Or did I miss the question?

I apologize.

I was more seeking out what your expectations are for the full year in regard to that metric, and perhaps any additional color that's not in the slides.

Yes, I mean, for us, while we had a significant growth in the first quarter, we had, as you see, 44% for the quarter, it was actually even more dramatic in the Enterprise business.

And so I think we expect, on Slide 15, you saw that the Enterprise business was up 61%.

This is an -- this is an apples-to-apples because both are -- our first quarters tend to be smaller.

But I think this kind of year-over-year growth in total subscribers, something being in the 40%-plus growth of subscribers for the year, is something we'd expect to be on trajectory with what our expectations are for the continued growth of the subscription side.

So we think that, that would put us at well over 0.5 million subscribers for the year.

And we have a question from Tim McHugh from William Blair.

This is actually Trevor Romeo, in for Tim today.

So first of all, I guess, thanks for the details about the guidance, but I just want to dive in a little bit further there.

The revenue growth being 20% in the first quarter, the guidance implies closer to 12% to 13% growth the next 3 quarters, if my math is right.

And so I know the comp in the first quarter is a bit easier.

But is there any reason to think that underlying growth might be a little slower the rest of the year, or anything unusual about the first quarter that helped?

Anything you'd call out there?

Yes, I think it's just that, really, the issue is just the mix growth.

Because we expect most of the growth to be occurring, we expect really significant growth in the number of contracts we're going to be signing.

But because they're mostly subscription contracts, the portion of those -- that big increase in contracts being signed will actually be recognized in the year.

As we get further and further in the year, even though we're signing more and more contracts, less and less of that revenue gets recognized.

So it's primarily the expectation that, as Steve mentioned, we expect in the second quarter to have a higher mix of subscription than we did in the first.

And we expect that to grow also in the third and fourth quarters for just smaller amounts would be there.

And so I think it's just that.

We expect -- if you're looking at the volume of new contracts being sold, it wouldn't drop off.

But because of that, we're happy to have that little bit of cushion on the first quarter.

But hardly anything that we saw in the fourth quarter will show up in the fourth quarter if it's subscription.

Okay, got it.

Got it.

Does that respond to -- yes.

Yes, I think that makes sense.

And then, one other one.

I know that the deferred revenue was up quite a bit on a year-over-year basis.

But if I'm looking at this right, it looks like maybe it was actually down a bit sequentially from the fourth quarter.

Is that just kind of similarly realizing some of the deferred revenue from the previous balance or normal seasonal effects or anything there?

Yes, I think that is the normal seasonal effect of just having such a significant amount of deferred revenue on the balance sheet at the end of the year that's generated significantly in the fourth quarter in both the Education division and the Enterprise division.

And then in both cases, it's simply that, that's such a large amount, the more of it is flowing into revenue than is being sold and generated in that quarter.

So it's true seasonality based upon the pattern of our sales and will reverse a little bit each quarter, to where the fourth quarter is where we have a significant increase in the deferred revenue on the balance sheet.

Yes.

I was reading recently, I guess, Salesforce.com, which we'd love -- we'd all like to be like, it has a similar thing where its fourth quarter is so big that it has a negative sequential change in deferred revenue, even though positive year-over-year.

And we -- this is the most dramatic comparison because fourth quarter is by far our biggest and first quarter is by far our smallest.

So that's exactly what's happening.

Okay, right.

That makes sense.

Maybe one more follow-up.

Could you describe the magnitude of what acquisitions have added to revenue?

And also, just following up on the earlier question about the intellectual property contract, I don't know if you guys were -- didn't want to disclose, but could you go over the magnitude of that contract as well, if possible?

Sure.

So the 2 questions.

Yes, I was talking to the (inaudible).

In the quarter, we had something like $1 million from one of the acquisitions and the other one was kind of...

$1 million of revenue.

Of revenue.

Yes.

Included in the past and so it's hard to pull out exactly what the incremental amount would be, but say it's a few hundred thousand additional of incremental from that.

So I would say, it's a little bit between $1 million and $2 million in that range in the quarter -- or $1.3 million in the quarter.

Yes.

And this multiyear contract, maybe some context, you may recall that in the fourth quarter we signed $16.5 million of contracts that were unbilled in that quarter.

And that reflected people who on average -- existing All Access Pass holders, who on average increased their -- the duration of their contract by 6 months and increased their population size by 14%.

So this is something you're going to see quarter by quarter by quarter.

It's not -- this change is not exclusive to this one contract, actually, it includes several contracts.

So I would just -- so this one contract is simply something you'll see a lot of, I think, quarter by quarter in increasing amounts and a lot in the fourth quarter where clients who have an existing Pass for 1 year decide that they -- the impact journey, we call it, they're on is going to take multiple years to get done and who decide to go ahead and sign a multiple-year contract to do so.

So again, it is one particular client.

It's just one of -- there were 320 of them in the fourth quarter who did it.

There were a dozen or so in this first quarter that we just called out.

I think in our disclosure there was one larger one.

But this just an ongoing process, but I'd be happy to answer any more questions.

We don't use client names, but it's a large professional services firm as I mentioned, has a 15-year relationship, has been buying stuff from us every year, just decided that with the subscription model it would make sense to do it, sign a multiyear agreement.

Yes.

Is that helpful at all?

Yes, that's very helpful.

And we have a question from Marco Rodriguez from Stonegate Capital.

I just want to get some clarification on that last question, the answers there.

The incremental or the acquisition revenue that you guys recognized in Q1 '17 -- or excuse me, Q1 '18, was $1 million to $1.3 million?

Did I hear that correctly?

Yes.

Okay, perfect.

And then I'm not sure if I caught this, but the question asking about the IP contract, the large IP contract, can you quantify the revenue amount that was recognized in this quarter?

$500,000.

$900,000.

Oh, $900,000.

Certainly.

Okay.

And then out of curiosity here, the gross margin came in a little bit higher than I was expecting here.

Was there a significant impact with the IP contract that maybe had that 68%, 69% gross margin a little bit higher than was expected?

And if not, if you can kind of help us understand how you're thinking about the gross margin cadence because that, obviously that number is significantly higher than what you guys normally report in a Q1.

Yes, IP contracts typically don't have much cost of sales attached to them.

We typically give them access to our intellectual property via a disc or some other means.

This was not an All Access Pass type deal, so the whole amount was recognized upfront.

But there's very little typically cost of sales associated with a straight-up intellectual property deal like that, and then -- plus the recognition of the highly -- the deferred comp of the deferred amounts that come in, that's high margin enough, that really those 2 items really significantly pushed our margin up for the quarter.

Yes.

And the largest piece of that would be the mix of revenue with this one contract added in.

So we expect -- have expected our margins to improve as we go in more toward All Access Pass sales.

And so there was a little bit of benefit from this contract, but we expect them to be good high margins anyway.

Got you.

And then, you guys had talked a little bit, at least in your prepared remarks, about having some increased costs here for sales and sales-related people, especially on the Education side.

If you can maybe talk a little bit about, were these additional heads or support people, and sort of what your expectations are as you kind of go through the year here?

Sure.

Hi, this is Shawn.

In terms of Education, what we typically do is hire -- at the start of the year, we hire a lot of salespeople, sales assistants, we also hire a lot of coaches so we can deliver on the fourth quarter when we bring on all the new schools.

So we're typically hiring around 30 or 40 people early on in the year, that shows up in the first quarter, a lot of it in the second quarter.

So we can bring on what we're hoping to do is about 1,000 schools this summer internationally and domestically.

So I don't know if that's responsive to your question, but we have to hire now to deliver on the year later.

That's why the first quarter has come in the lower EBITDA amount in Education.

Got you, okay.

And so most of the spending, and that's permanent spending, fixed cost, if you will, that we should be seeing going forward.

Yes, much of it is.

Some of it is variable, like the coaching is variable based on the number of schools that we have and maintain.

Much of it is -- about half of it is fixed, about half of it is variable.

Got you.

Okay.

And then in that SG&A line -- I apologize, last quick question here.

Were there any extraordinary expenses that were kind of one-time in nature in terms of spending?

Or is that kind of a good number from which to model going forward?

Probably the most dramatic one that had the biggest impact on the quarter was, last year, we took around a $1 million credit.

We didn't take it; we had to take it as we adjusted the fair value of a contingent earn-out liability, so we were forced to push a credit through as we reduce that liability.

That was almost $1 million.

This year, in particular, we had a $176,000 increase to a fair value.

That created a $1.2 million difference between last year and this year in our SG&A.

But right now, it looks as far as like oddities in the current year as far as a run-rate, I don't know that there are any unusual items that would cause the run-rate to be significantly different from Q1 than in the other quarters.

I don't either.

And Marco, just maybe in terms of background for others who may have the question.

I think there's been several questions on the impact of this one contract.

So I think -- we thought we probably should have given more background of it because we wouldn't have thought that was very much of a factor because I think the main thing on Slide 29 is that in the Enterprise division, sales grew $7.7 million for the quarter.

We would have had revenue from this client in the quarter in a normal thing anyway.

And so the incremental impact of this one client might have been a little bit on that.

But I think the main story here is that we sold -- all of our intellectual property has very high margins.

I mean, so this All Access Pass sales, by their very nature, have very high gross margins, and so that's not what's different.

And so the difference in gross margin that was generated, as you can see the year-over-year change in gross margin of $7.5 million, there was of course some positive contribution from that contract, but it's not a material factor in the overall performance of the Enterprise business.

And we have a question from Kevin Liu from B. Riley FBR.

First question I wanted to ask was just in terms of some of the longer-duration contracts you're signing up, are those largely from customers who have already been on All Access Pass and are now renewing with the increased populations, et cetera?

Or is it also a function of going out and trying to secure new sales at longer durations?

Yes.

Most of it is upon renewal, even though you'd love to sell multiple-year contracts upfront and do have some -- the vast majority of those are sold.

Paul, I don't know if you want to give some color commentary on that.

Yes.

It's exactly right, Kevin.

We were seeing an increase overall of multiyear agreements.

The majority of the increase is coming from those who have -- who are renewing after their first year.

Once they've had a chance to -- some organizations, they'll buy the All Access Pass for a couple of 200 or 300 users in their population because we've identified with them some jobs they're trying to get done, and then the benefit for us and for them is that we get in there and start working with them within the first 30 days of them holding that pass to try to identify adjacent populations and additional stakeholders.

And so over the course of that first contract year, we're uncovering more opportunity with them inside that organization so that by the time we get to renewal there's more need that's been identified, there's the basis for a larger pass expansion at the time of that renewal.

So I think we're probably always going to see clients ready to go multiyear more at renewal time, although our salespeople are starting to figure out how to sell multiyear deals at the time of the first sale as well.

Got it, that's helpful.

And then just on the Education practice, Bob, you mentioned a little bit of bundling for some of the on-site delivery days.

Was that something that just started recently?

Or has that been kind of a contributing factor going back further?

And how much in revenues would have been recognized if you were still kind of charging a la carte?

Shawn.

Sure.

No, this is new.

We just switched it last year so it's really -- it's hitting this year for the first time.

This is the first, first quarter this is hitting us.

And we would have probably done another $1.5 million in revenue, give or take, of on-site days that were put into the membership subscription package which are now recognized over $1.12 million.

About in that range.

Got it.

Great.

That's all I had for now and congrats...

And will be about the same for the second quarter as well, about the same amount.

Thanks, Kevin.

And we have a question from Patrick Retzer from Retzer Capital.

So congratulations on a great quarter.

Clearly, you've hit it out of the park on all the metrics, so thank you for that.

And your presentation is excellent, so again, we appreciate that.

The one thing you haven't touched on that I saw, I've long been a fan of your consistent stock buybacks as a way to shrink the market cap as all the other metrics grow.

And obviously you had a short window because of the calendar and your fiscal year on buying back stock, but could you talk about if you bought any back in the fiscal fourth quarter and what your outlook is on that going forward?

Sure.

Thanks, Pat.

Steve, do you want...

Sure.

Our -- I think our strategy is the same as we've talked about for quite some time -- is that we'd use excess cash to buy stock and we even, as you know, a year or so ago, went into a credit line a little bit to do a tender offer.

So we still have the same strategy of buying back stock and we plan to do that.

In this particular quarter, like you say, it was a small window and we're using a fairly significant amount of cash related to the development of our ERP system, our new portal and the localization of our content.

So we were using enough cash that we did not buy in the open market this quarter.

But we did, however, spend about $2 million in the equivalent of buying shares, allowing individuals to net exercise on stock awards.

So you'll see in the cash flow statement when you look at it that we used $2 million this quarter, but weren't really as aggressive as we might -- as we've been in the past or as aggressive as we might be in the future based upon the things we have going on right now that are using cash.

Okay, well, I appreciate that and keep up the good work.

Thanks, Pat, very much.

And we have a question from Samir Patel from Askeladden Capital.

Any color on how renewal rates are tracking for All Access Pass?

Yes, I think we've continued to say that our revenue retention has been north of 90% and it continues to -- we'll continue at that level.

We give an official thing, I guess, once a year where we audit quality.

But in terms of the -- it's obviously more than that when you include these multiyear contracts.

But I'm just saying on an annual -- annually recurring revenue basis, we feel good about the continued revenue retention rate.

We're doing a lot in that regard, of course.

We've made the investments that are being reflected here in implementation specialists.

We had -- in the fourth quarter, we had a huge number of passes to renew and that gave us some challenges in terms of getting them all renewed in time that we feel good about now with where we are and I think we can continue north of 90% on revenue retention.

Got you.

And as far as the content licensing that you had discussed a few quarters ago, any updates there?

Is there anything that you're continuing to look at?

Any other add-on services, like Robert Gregory or Jhana that you're looking to add or are you kind of steady state there?

We -- in terms of services, we're trying to build out the services with Robert Gregory, relating to the acquisition and some other add-on services because our clients are finding ways and needs that they have, in addition to our normal delivery.

On the content acquisitions, we are continuing to work on licenses of content, et cetera.

We expect in the next few months to be announcing a couple of other significant licensing deals.

Great.

And as far as Slide 22 and Slide 27 where you're sort of talking about the long-term outlook for the business, can you just give me some color on what would lead to one scenario versus the other?

I mean, do you think it's mostly driven by retention rate?

Is it mostly driven by this ramp of new client partners?

I mean, what do you think drives either of those scenarios?

Yes.

I mean, the key metrics that we're pretty kind of in the middle of that is we could retain revenue -- we could retain at least 90% of our revenue, sell $25 million to $30 million of new passes a year and add-on services of around 25% of the total pass revenue.

That would put you kind of in the middle of that, between those 2 points, and we have been -- we believe those are things we ought to do.

But I think those are the key drivers of it, and so we've got independent efforts on each of those 3. Paul, I don't know if you want to give any other context, but those are the 3 factors that drive this.

Yes, I agree, Bob.

Those are the 3. And I think the same.

For us, doing all 3 of those and increasingly figuring out how to go ahead.

The more new passes we can sell, obviously the more there is in those future years if they need to renew.

And the larger the base is, and that's a great growth also.

Yes.

And then, Samir, the other thing which you have a good handle on I know is the number.

One of the other inflections that is less obvious, but it's helping drive the inflection is that we have all these salespeople we've already hired who were in the middle of their ramp.

And during the ramp period, their growth tends to be a little faster.

But about half of this -- half of our client partners are still in one stage of the ramp or another, which has accelerated growth, and that can help drive it up and addition of new salespeople also which we expect during this year to be back up into the mid-20s, if not higher in additions of new client partners.

So I think combination of those factors retain the business you have, adding on services, adding new passes just on the productivity of the existing sales forces they ramp up and adding new sales force -- salespeople to it.

I think the other thing that will affect, will have an impact on that growth rate also is the ability of -- for China and Japan to begin selling All Access Pass this spring and that will again help to build the foundation going forward.

Got you.

And as far as incremental margins, it seems to me like you actually would have done something close to 40% incremental adjusted EBITDA margins this quarter, if not for the growth investments.

And I know part of that was due to the intellectual property license and a couple of those other factors you mentioned.

But in general, do you still feel confident about the (inaudible) 30%-plus incremental adjusted EBITDA?

Yes.

I mean, I think that's our target, to around 30% incremental EBITDA margins on revenue growth.

And we have a question from Travis Wiedower from Wiedower Capital.

You guys have historically been a very high taxpayer, so I'd love to hear some comments on the tax reform, especially with respect to what you expect your effective rate to be going forward and if that lower rate affects any of your future investments or anything like that.

Well, as you know, we're in the middle of that evaluation right now and we expect an improved tax rate to an effective rate this year of maybe 28%, 29% compared to the 40%, 41% that we might otherwise expect.

And that's a blended rate for this year since the transition to the new taxes midyear.

And so our statutory rate we think, right now, would be in the 21% range.

We don't know exactly how that convert to an effective rate.

We're in the middle of that analysis now, but it will be positive to us and a low 20% rate somewhere.

And yes, that will affect what we do since we're a company that generates cash already and have a better tax rate, then we might buy another share.

Okay.

So it sounds like after I noted this year has a little bit of a blended factor in there, so maybe 2019 looking forward is probably in the low to mid-20s of effective tax rate.

Is that kind of what you're getting at?

That's what I think right now.

And as you know and would imagine, we're in the middle of that analysis right now.

So I can't declare that as a final answer, but that's what we're seeing, yes.

Okay.

That's all I have.

I appreciate it and congrats on a good quarter.

Thanks very much.

Thanks for the good question.

And we have a question from John Lewis from Osmium.

Hey, guys.

Fantastic results, and your presentation is an A+, so thank you for such a great presentation today.

Thanks very much.

Just a couple of quick questions.

You said that in the coming months, without tipping your hand, you think you would possibly add new content license partners.

Would that be an existing categories or new categories?

That's a great question.

I think we're trying -- we got -- today, of course, we have 3 basic categories of content.

One is around individual effectiveness versus individual and interpersonal effectiveness.

The second is in leadership and leadership development.

Then the third is these things that connect the 2, connect those capabilities to outcomes, like our Execution practice, et cetera.

I think we'll be doing -- we'll be making develop investments in the third in terms of the connecting capabilities to results.

We'll be doing some development of new content development in that regard.

We'll be introducing a new course that we have developed.

It will be launched at the end of this month in the leadership area.

And then the major focus for us, though, is in leadership.

These new license contracts are likely to be primarily in the leadership area where we are already strong and we'd like to fill in some holes.

Got it.

I had a little connectivity issue, you might have covered this, but if not, could you give color on what the expectations for client partners are for ramp rates on All Access Pass?

Like what do you -- now that this model has gained more traction, what is the expectation?

I know there's kind of cap rate for different years for your client partners, but for a client partner that's been with you for 5 years, what is the expectation in terms of number of seats sold per year?

Yes.

Paul, do you want to get it?

Or Shawn?

Yes.

So taking the example of a client partner that's been with us 5 years, they -- their new seats are going sell, they're going to come from 2 categories -- or 3 categories, really.

One will be expansion of existing passes that they sold in the last couple of years.

A second would be selling to a brand-new logo.

That's been -- that's assigned to them that has not yet purchased a pass.

And then the third would be converting somebody from one of our older channels, our old facilitator channel or old on-site channel over to the All Access Pass as a way of doing business with us.

And so we're expecting that each client partner and somewhat sell much more than this, but they're going to sell a couple of hundred thousand of that new subscription business a year, on top of the renewals and the other expansion that they would otherwise have.

And of course, and the example of a client partner that's been here 5 or 6 years, we need to sell a lot more of that, just to hit their goal.

So we're moving them aggressively in that direction.

We're doing a lot of training and development right now, helping them.

As we talked in the last call, it's a bit of a different sale.

It's a different procurement process where we've, I think, learned our way through that over the past couple of years and we have pretty high expectations for each of our client partners.

And so far, they're doing a great job of growing into those.

That's helpful.

Just a little more clarification.

So basically, what you're saying is, if I'm a client partner and I -- and you had the old model you could kind of go to you in install base and sell $3 million or $2 million worth of product a year -- or services a year.

With 90% of renewal rates, you expect them to go out and actually penetrate a much deeper level of the market in year -- in each successive year.

Is that right?

We do.

We do expect them to retain what they had sold in the prior years at least 90% and then go out and continue to penetrate further.

Now for those that have been around a little bit of time, what's happening in their business, still to a degree, which Bob and Stephen talked about on this call and in prior calls, is they are cannibalizing their existing revenue still because we haven't converted all of that old business yet.

But we're very much in the mode of not just kind of camping and living on the business we have.

They've got aggressive growth goals to go find new logos and sign up new clients.

Okay, that's helpful.

My last question is just, you said you're going to release the new All Access Pass in, I think, 16 countries.

Is that all in calendar year Q1?

No, it will be in calendar Q3, I believe, right, at this point.

It will be starting in April.

In April, we'll be -- all the countries in the world basically will be able to start selling All Access Pass.

It will take them a while to get up to speed, and of course we won't be able to get it all loaded in.

But the launch will be in the third quarter and then of course we will continue as those people ramp up.

So it will (inaudible) could take a year, but starting this year.

Yes?

Yes, right.

So that'll be Q2 calendar year?

Yes.

Oh, sorry...

Q2 calendar year.

Let me add.

I think you asked it correctly.

I just -- I was just thinking fiscal calendar.

You're right.

And we have a question from Samir Patel from Askeladden Capital.

Yes, just to go back to Slide 22 and 27, I was trying to bridge your cash flow number, and it looks to me like you've already burdened that with your capital expenditure.

So that's basically unlevered free cash flow before interest and before tax, if it's right.

So to get from that cash flow number to free cash flow, I basically just have to subtract interest and then burden it with whatever tax rate, I think, is appropriate.

Yes, I think that's right.

Okay, there's no other -- so I mean, other than like restructuring or any sort of other onetime items, I mean that's your unlevered pretax free cash flow?

Yes, that would include, like you said, any of those unusual items or acquisitions or those kinds of things.

But yes, I agree with what you said.

And we have no further questions at this time.

I will like to turn the call over to Mr. Bob Whitman for closing remarks.

Great.

I just want to thank everyone for being on the call today, particularly thank each of you for your help, advice and guidance through this process, and we feel like, for us, this is a really exciting time.

I think, as I said, it's exciting for our customers.

When you recognize that more than 300 of our passes decided it was valuable enough for them in the fourth quarter to sign a multiyear extended term agreement, that was an exciting thing for us.

We tested it kind of in that quarter.

But we'll be doing that.

We're excited for our associates.

It's really an exciting time to be doing such great work and doing so much more.

For me, this is the kind of thing that people wanted to do here and do -- they have these engagements where people are just calling them up and say, "We had a new problem, can you come and help me size it up or to solve it?" And we think our shareholders have been a little long-suffering during the transition where we haven't grown, but we expect to continue to execute and to meet our guidance for the year.

We appreciate your support, and we look forward to talking soon.

Thanks.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.