Franklin Covey Co (FC) 2019 Q3 法說會逐字稿

Welcome to the Q3 2019 Franklin Covey Earnings Conference Call.

My name is Daryl, 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 Mr. Derek Hatch.

Mr. Hatch, you may begin.

Thank you, Daryl.

On behalf of the management of Franklin Covey, I would like to welcome everyone to our conference call this afternoon.

Before we begin, I'd like to remind everybody 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 our 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 and 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 product -- 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 influence or -- and control, 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 future performance will meet management's expectations.

These forward-looking statements are based on management's current expectations, and we undertake no obligation to update or revise these forward-looking statements to reflect current 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 Bob Whitman, our Chairman and Chief Executive Officer.

Bob?

Derek, thanks so much.

All right.

Good afternoon, everyone.

We really appreciate you joining us today.

Hope your summers are up to a good start, those of you who live in places that are having summer, most of the country's not.

We're really pleased with our third quarter results, pleased they were strong and better than expected.

We're building on our robust year-to-date performance.

We're in a great trajectory to achieve significant growth and adjusted EBITDA and cash flow in fiscal '19 and we believe also establishes the foundation for a very strong fiscal 2020 and in the coming years beyond.

Specifically, as you've seen in Slide 3 and we've said that we expect to grow reported adjusted EBITDA in constant currency from $11.9 million in fiscal '18 to between $18 million and $22 million in fiscal '19, which represents 50% to 80% -- 85% growth, and then to grow adjusted EBITDA between $26 million and $31 million in fiscal '20 and between $35 million and $40 million in fiscal '21.

We've also talked about our -- some of the increased adjusted EBITDA plus the change in deferred getting in the range of $30 million to $34 million this year, in the range of $38 million to $42 million next year and $47 million to $52 million the following year.

And importantly, the net cash generated, we expect to really -- which is a very close cousin to cash flow from operating activities, to very closely track reported adjusted EBITDA and again be between $18 million and $22 million this year and $26 million to $31 million next year and $35 million to $40 million in fiscal '21.

So we have high expectations, and our strong third quarter and year-to-date performance has moved us rapidly up the mountain toward meeting these objectives and has reinforced 4 key takeaways in the business that I'd like to just touch on there in Slide 4.

First takeaway is that the better-than-expected results in the third quarter were broad-based both as to operation as well as across all -- most all of the lines in the income statement, showing growth in sales, higher gross margins, lower operating SG&A as a percentage of sales and much higher adjusted EBITDA and cash flow.

The combination of these factors drove a 45% flow-through of increases in revenue to increases in adjusted EBITDA and an even higher flow-through to increases in cash flow.

Second takeaway is that these results continue to be driven by significant growth in our subscription and related sales business and by the strategic and structural strength of our subscription-based business model.

We're selling new subscriptions and retaining substantially all of the subscription and related revenue we contract.

This is creating high lifetime customer value, significantly increasing our visibility into future revenue.

It's also strategically and structurally durable because we're solving important problems and people are buying passes, paying upfront, signing multiyear agreement.

And so that continued strong in the third quarter.

Subscription and related sales grew 27% year-over-year, and year-to-date we're up 30%.

Our total number of paying subscribers grew 34% compared to the same period last year.

And in addition, our key subscription metrics continue to place in the company of some of the very top subscription businesses.

Third takeaway is again maybe an emphasis again on the flow-through, our -- the models -- our subscription models, high recurring revenues, strong and expanding gross margins, relatively fixed central costs and low capital intensity are driving really compelling economics and flow-through.

This again is reflected in the high flow-through of increases in revenue to increases in adjusted EBITDA and cash flow.

And finally, takeaway 4, these great metrics are creating compelling sales force expansion economics.

This combination of factors is making it so our payback period for an investment in new client partner is only about a year.

And with the huge headroom we have for sales force growth, we're really taking advantage of that opportunity.

So far this year, we've added 13 net new client partners through the third quarter.

We've added a few since then.

That brought our total to -- through the end of the third quarter to 227, and we expect to add at least 7 additional new client partners by the end of the fourth quarter for a net addition of at least 20 net for the year.

So with those takeaways, let's take a deeper look into our third quarter results.

As you can see, in the third quarter, our revenue growth was strong and broad-based.

You can see in Slide 6, revenue grew 11% in the third quarter.

It's grown 10.5% year-to-date and 10% for the latest 12 months.

Adjusted for changes in foreign exchange rates, revenue actually grew 12.3% in the third quarter and 11% -- 11.7% year-to-date with strong growth in both the Enterprise and Education Divisions.

Our balance of billed and unbilled deferred revenue all related to subscription sales grew 28% in the quarter to $63.7 million.

That's an increase of $14.1 million compared to last year's third quarter.

Our balance of billed deferred revenue grew 16% to $39.9 million, $40 million compared to last year's third quarter, and our balance of unbilled deferred revenue grew 58% compared to last year's third quarter to $23.7 million.

It's worth noting that in addition to this large and increasing balance of deferred revenue, we also have $11 million in contractual annual minimum royalty payments for our international licensee partners, which further adds to our large and growing balance of annually recurring revenue.

Our total contracted revenue grew 5% in the quarter, 6.5% year-to-date and 4.5% for the latest 12 months after absorbing more than $2 million of impact from foreign exchange and from the delay of the government contract.

In actuality, the contracted revenue in Enterprise Division was substantially higher than this, and so it was in the Education Division that we were down some.

But that really was reflective of some large contracts that were signed last year that repeated this year but for certain terms of the contract don't allow us to put those on as multiyear agreements even though they are multiyear agreements because they have some rights to modify.

Those won't appear -- those don't appear as unbilled deferred now.

Our profitability and cash flow metrics also increased significantly.

As you can see in Slide 7, gross profit grew 13.6% in the quarter, has grown 11.2% year-to-date and 11.7% in the latest 12 months.

Gross margin percent improved 163 basis points to 70.8%.

This has resulted from accelerated growth in subscription and related sales.

Our operating SG&A as a percentage of sales was -- is better, is down.

It improved 269 basis points in the third quarter coming in at 65.3% compared to 68% in last year's third quarter, and year-to-date we were 370 basis points better in terms of operating SG&A relative to sales.

It results in, of course, significant increase in adjusted EBITDA and cash flow.

Adjusted EBITDA increased $2.5 million in the quarter to $3.1 million from $600,000 in last year's third quarter.

Adjusted for changes in foreign exchange rates, adjusted EBITDA actually increased $2.8 million in the third quarter to $3.4 million.

Year-to-date through the third quarter, adjusted EBITDA in constant currency increased $8.1 million compared to only $0.5 million year-to-date through the third quarter last year, so up against 7.5 -- $7.6 million through the third quarter.

And for the latest 12 months in constant currency, adjusted EBITDA increased 70.9% to $19.5 million compared to $11.4 million in adjusted EBITDA for the same period last year.

Finally, net cash flow provided by operating activities, as you can see in Slide 37 in the appendix, increased to $18.6 million.

That's an increase of $10 million or 116% compared to $8.6 million through last year's third quarter.

So overall, we felt really good about the performance of the company, its broad-based nature both as to division, geography, delivery, modality, et cetera, also as it relates to the lines on the income statement and the cash flow statement.

Just looking at our segment results, I'll start with a review of the results for the Enterprise Division, just touching on some of the headlines there.

As you can see on Slide 8, the Enterprise Division, which accounted for approximately 75% of our total revenue in the third quarter, our revenue growth was broad-based with strong growth throughout the U.S. and Canada and in each of our international direct offices.

Revenue in our licensee division was down slightly to last year, reflecting the impact of foreign exchange and the conversion of the German licensee to a direct office in this last year also recognizes that they're in the process of learning to sell All Access Pass and doing a good job but there is some transition for them even though it doesn't affect our results because they pay us based on their invoiced revenue.

As you can see in Slide 8, in the Enterprise Division, revenue grew 8.8% in the quarter and has grown 9.8% year-to-date and 11.4% for the latest 12 months.

Adjusted for changes in foreign exchange, revenue grew 10.4% in the third quarter and has grown 11.2% year-to-date.

Our balance of billed and unbilled deferred revenue in the Enterprise Division grew 34% in the third quarter to $55.3 million, our balance of billed deferred revenue increasing 16.2% to $32.3 million and our balance of unbilled deferred revenue increasing 71% to $23 million, establishing the foundation for strong future growth as we sign these multiyear agreements that don't actually show up on our balance sheet but are contractual and are there and will move into billed and then into recognized revenue as they mature.

Our contracted revenue grew 7.1% in the third quarter and 9.5% year-to-date, 6% for the latest 12 months.

And again, this is not in constant currency, which would have made it 100 basis points or so higher, and we had 26% growth in contracted AAP and related sales.

Just touching on the Enterprise Division's profitability on the next slide, Slide 9. Gross profit increased 10.6% in the third quarter, 10% year-to-date and 13.2% in the latest 12 months.

Gross margin increased 117 basis points during the third quarter to 74.3%, and that occurred even with strong growth in sales of All Access Pass add-on support services, which have slightly lower margin.

The operating SG&A as a percentage of sales improved 256 basis points coming in at just 61% compared to 63.5% in last year's third quarter, and that ratio of operating SG&A [as a percentage of] to sales improved 293 basis points year-to-date.

Finally, adjusted EBITDA in the Enterprise Division increased to $5.8 million in third quarter, representing growth of 51% compared to last year's third quarter.

This reflected a flow-through of incremental revenue to incremental adjusted EBITDA of 56%.

In constant currency, adjusted EBITDA increased actually to $6.1 million, which was growth of 59%.

Year-to-date, through the third quarter, adjusted EBITDA in the Enterprise Division increased to $14.8 million.

That's 46.3% growth compared to $10.1 million year-to-date last year.

And again, adjusted for foreign exchange, adjusted EBITDA year-to-date increased actually to $15.6 million or growth of 54%.

Finally, for the latest 12 months, adjusted EBITDA has grown 46% to $23 million.

That's $7.3 million of growth compared to the same period last year.

And adjusted for foreign exchange, it grew 51% to $24 million, which is growth of 51%.

So the momentum in the Enterprise Division continues to be very strong, and we expect to generate significant amount of growth in invoiced and contracted revenue in the fourth quarter, which establishes a strong foundation for accelerated growth in fiscal 2020 as all of that deferred revenue, primarily deferred revenue, goes onto our balance sheet and is known to be -- will for sure be recognized next year.

Just quickly touching on the Education Division, which represented 22% of our total revenue in the quarter.

Revenue growth was strong, growing 20.1% in the quarter and has grown 13.5% year-to-date.

Revenue growth for the latest 12 months was 5.7%, but you'll remember that, that was reduced last year by the impact of the expiration of a large multiyear education foundation contract in last year's third quarter.

Excluding the impact of this large contract, latest 12-month revenue growth would have been 16.6%.

And adjusted for changes in foreign exchange, revenue grew 20.4% in the third quarter and 14.2% year-to-date.

Our balance of deferred revenue in Education Division grew 13.6% in the third quarter.

Again, the profitability in the Education Division was good and strong, strong improvements.

Gross profit increased 24.5% in the third quarter, has grown 16% year-to-date and 6.3% for the latest 12 months, the latest 12 months figure again reflecting the expiration of a large foundation contract last year.

Gross margin has improved to 61.7%, which is up 218 basis points over last year's third quarter.

We've done a great job on the operating SG&A as a percentage of sales, improving 594 basis points for the quarter coming in at 63.4% compared to 69.3% in last year's third quarter and there -- has improved 500 basis points year-to-date.

And finally there, adjusted EBITDA increased $700,000 to negative $200,000 compared to negative $900,000 in last year's third quarter.

As you know, substantially, all the profitability of the Education Division occurs in our fiscal fourth quarter.

Year-to-date through the third quarter, adjusted EBITDA in Education Division is negative $1.4 million, is an improvement of about $1.5 million compared to last year, and so really feel very good about the staging of the Education business being up while they're generating also lots of pipeline and contractual revenue for the fourth quarter.

So that will -- is a long discussion on the results but that will take you through point 1. The other points are faster.

Takeaway 2 is that the strong results are being driven by the growth in our subscription business.

As we mentioned, growth in All Access Pass and related sales continue to be very strong in the third quarter and year-to-date.

As you can see in Slide 13, All Access Pass and related sales in the third quarter grew 26% to $20.4 million.

Year-to-date, All Access Pass and related has increased 36%, and that same metric for the latest 12 months is up 40%.

The balance of deferred revenue in the Enterprise Division grew 34% year-over-year in the third quarter, and the number of All Access Pass subscribers reached 406,000 at the end of the third quarter, which is an increase of 104,000 or 34% compared to our 303,000 paid subscribers 1 year ago.

Importantly, not only are we growing, but we're also growing in a way that is, we think, durable and sustainable and has some metrics that are very comparable to those of the best subscription companies.

Shown on Slide 14, some of these metrics include annual revenue retention of more than 90%; add-on services rate of more than 45%, which is highly correlated with high customer retention and expansion; a total revenue retention, which includes year-over-year same client subscription and services revenue, of just over 100%; relatively large initial purchase price, which reflects the relatively large size of the population, which All Access Pass is typically purchased, and this establishes the foundation for strong unit economics; our customer acquisition cost relative to initial purchase price is less than 1:1, and so that plus the fact you can ramp up salespeople and pay for them in a year gives a very strong reason to pursue the expansion of the sales force.

Then the expectation that we will achieve $100 million in annual recurring revenue somewhere between our fourth and fifth year is 4 to 5 years ahead of when many of the companies who have achieved that, have done so.

And as mentioned, we also have this other contractual recurring revenue of the minimum royalty payments for our licensee business.

So the combination of these things, we think it's great that we can grow and that we can grow in a way that is durable and quality and reflects the fact that our customers are really getting enormous value from the All Access Pass, the things they're doing.

This -- the fact that we're -- that they -- or when they renew, they're both expanding, oftentimes extending the term of their contract, shows they're getting real value.

In many cases, some of these clients might face headwinds in their particular industry or whatever they're choosing to consolidate and give us a higher and higher share of their business.

And the value proposition is very compelling.

To increase this client impact, we are committed to consistently adding content and capabilities to the All Access Pass.

As you can see on Slide 16, we've consistently added content and new capabilities.

We added 1,200 micro-learning articles, which are being added to all the time with the acquisition of Jhana.

And these articles are pushed out to leaders in our client populations weekly.

We added broad coaching capabilities with the acquisition of Robert Gregory group and created 4 new major courses that are now offered in all modalities, live and digital.

And it's continuing -- with the continuing theme of expanding into content categories that we think are very powerful, we're really pleased to announce that we've just signed an exclusive agreement with Liz Wiseman, a renowned author of the best-selling book, Multipliers, and one of the most sought-after speakers and teachers on leadership.

Liz is a researcher and executive adviser who teaches leadership to executives around the world and has been listed on the Thinkers50 ranking and named 1 of the top 10 leadership thinkers in the world.

Wiseman has conducted significant research in the field of leadership and collective intelligence, and Liz writes for the Harvard Business Review, Fortune and writing with other business and leadership journals.

We've entered into an initial term, 10-year agreement, which can be expanded multiple times beyond that, and we'll be developing together a powerful premier leadership development solution based on Multipliers to be included in Franklin Covey's All Access Pass.

We are really excited about this new partnership and are thrilled to be partners with Liz and with the entire Wiseman Group.

We'll be sending out a press release providing more information on this new partnership tomorrow morning.

So we continue to build the strategic durability by identifying those big, intractable problems that are based in scaled and lasting change in human behavior.

We also have structural durability that's driven by the fact that All Access Pass purchasers contract and pay for their subscription at least a full year in advance.

And second, as is shown in Slide 17, an increasing percentage of passholders are entering into multiyear contracts.

For the latest 12 months, 29% of passholder organization entered into multiyear contracts, up from 15% a year ago.

As illustrated in Slide 18, our goal is to simultaneously achieve a combination of top-tier growth and subscription and related sales, strong growth there to be in the top tier of these -- of the economic and customer metrics that we reviewed, then also top-tier rates of growth in adjusted EBITDA and cash flow.

That's a rare thing to be hitting on all 3 of them.

We believe that we are and we continue to do so.

And for us, achieving the intersection of these 3 factors reinforces this prospect of creating significant increases in value for our shareholders and for our clients.

A bullet point on takeaway 3, which is that our -- the model's high recurring revenue, strong gross margins and relatively fixed central costs and low capital intensity is driving compelling economics.

As you can see in Slide 20, the flow-through of incremental revenue to increases in adjusted EBITDA, which is, in other words, how much of the growth in revenue actually gets to the adjusted EBITDA line, has been very strong.

For the third quarter, 45%; year-to-date, 44%; in the latest 12 months, 35% of the incremental revenue has flowed through to increases in EBITDA.

And actually, the cash flow has grown a bit faster than that.

As we've noted, the final takeaway is that our -- the subscription metrics create compelling sales force growth economics.

We've recorded several times on the big opportunity we have there, but the fact that you can invest in a client -- new client partner who, over a period of years, you can see on 22 -- Slide 22, over the first 5 years, gets to a $1.3 million of revenue, generating very high gross margin revenue, fully pays for herself or himself in the first year, combined with a customer acquisition cost that also is less than 1:1 gives really compelling economics.

And we are taking advantage of that.

As we mentioned, we have added 13 net new client partners through the third quarter, we have added a few since then toward our expectation that we will meet at least the 20 net new client partners that we said we would at the start of the year by the end of the summer.

And over the next 3 years, we expect to add at least 75 net new client partners to our base of 234.

So in conclusion, again, the takeaways -- I know you've already gotten but on Slide 23.

The broad-based results in the third quarter that were higher than expected, that have established the foundation for and already put us in the -- even with that kind of growth, we've already grown by the amount we expected to for the year in our guidance.

But this is being driven by the continued strength of the subscription-related sales model that the high flow-through that we forecasted that we're grateful it is happening and we expect to be a very high growth -- achieve very high rates of growth in both the EBITDA and cash flow this year and in coming years and that we have a great unit expansion opportunity with sales force, which we're taking full advantage of with our new sales school with our 5 recruiters and with many other things we're doing to make sure we take advantage of this.

We appreciate your support, really appreciate the efforts of our approximately 1,000 associates throughout the world.

We're really excited about our opportunities, about the trajectory we're on to achieve significant growth this year and in the years ahead that I would just say it's an exciting and great time to be at Franklin Covey.

I think it's a great and exciting time to be a client of Franklin Covey.

Hopefully, it's also a good time -- exciting time to be an owner at Franklin Covey.

So with that, I'll now turn the time over to Steve Young, our CFO, to review our outlook and guidance for the balance of the year.

Steve?

Okay.

Thank you, Bob.

Good afternoon, everyone.

Our specific guidance for fiscal '19, as you know, was that in constant currency, adjusted EBITDA would increase from $11.9 million in fiscal 2018 to a range of between $18 million and $22 million in FY '19, representing a year-over-year growth of between 50% and 85%.

We reaffirm this guidance.

We are really pleased that in constant currency, adjusted EBITDA, as Bob said, has increased from -- increased $7.6 million year-to-date through the third quarter.

We are experiencing very strong momentum in the business.

As a result, we expect to retain the $7.6 million of year-to-date adjusted EBITDA growth and even add a bit to it in the fourth quarter, putting our full year adjusted EBITDA essentially right in the middle of our guidance range of $18 million to $22 million, representing year-over-year growth in adjusted EBITDA of approximately 65% to 68%.

Specifically, we expect year-over-year adjusted EBITDA to increase by up to $500,000 in the fourth quarter and this in spite of the fact that almost all of our growth in invoiced revenue in the fourth quarter is expected to be subscription sales whose revenue will be recognized over time but whose cost for marketing or for hiring new client partners, as you know, will be expensed in the fourth quarter.

And a second reason that the adoption of the new Topic 606 accounting standard will cost us approximately $1.3 million of adjusted EBITDA in the fourth quarter this year compared to our fourth quarter of last year.

So to conclude, we're really excited about our results year-to-date by the expected strength of the fourth quarter and by the significant momentum of the business overall.

As a result of this momentum and our strong business model, we not only expect to achieve our guidance for the year but establish a foundation for very strong results in the future.

Thank you, Bob.

Thanks, Steve.

At this point, we'll just open it to -- for questions.

We'll ask our operator to open the line, thanks.

(Operator Instructions) And we do have a question from Alex Paris.

This is Chris Howe sitting in for Alex.

Just sorting through my thoughts and notes here.

You've mentioned previously about the multiyear contracts trending to 50% over time.

And on the last call, I believe you mentioned the 7-year contract.

As we think of the length of these contracts, can you characterize or break down the mix that you're seeing as you push forward these efforts to accrue more multiyear contracts over time?

Sure.

Thanks.

I'll ask Paul Walker to talk to...

Chris, yes.

So as we mentioned, we're -- in the last 12 months, multiyear contracts have increased to now 29% of our contracts are multiyear.

And of course, we're interested in having each at one of be a -- for as many years as possible.

And you remember accurately the one we talked about last time, that was up to 7 years.

We're seeing a number of these multiyear contracts are not just for 2 years now but are increasingly becoming 3-year contracts.

I'm not sure that the clients will do -- how many clients will do 7 years.

We'll try for that.

But we're really pleased with the momentum.

You saw in that slide that Bob showed a minute ago, it was 1% of our contracts 2 years ago, 15%, and now it's up to 29%, and we continue to work that.

I think what happens is, one, our sales force becomes more comfortable with positioning that right out of the gate; and two, as we're now into our second and third and approaching fourth year renewal cycles with some of these clients, we're now so embedded with them that it makes a lot of sense.

The things we're talking about, the journeys were on with them just will have a multiyear aspect to them.

And so it makes sense for the client to save a little bit by going multiyear and just to enter into that longer-term commitment with us.

So we expect that to keep growing.

Okay.

That's great.

And then some more questions here.

You mentioned the rep last time that's solely targeting multiyear agreements.

As you move forward in this transition of the sales force, is that their main focus now?

Or is there still -- are there still other people on the sales force that are not focused on multiyear agreement or they're focused on both, I should say?

I'll stay with that.

This is Paul again.

So our sales force is exclusively focused -- first of all, it's important to note, they're exclusive focused on selling All Access Pass in the Enterprise Division.

So all we sell is the All Access Pass and the related services that go along with it.

There are -- some of our client partners still have a bit of traditional business that either they're still trying to convert over or those clients will just stay traditional clients of ours.

But essentially, all of the time and energy and effort is on selling All Access Pass.

Within that context, we attempt to position multiyear every time we can.

And there are some clients that -- if it's their first time becoming a client of ours.

The timing is not right for them to make that kind of commitment.

They'll try us out for a year and they might come back at their first renewal period.

And at that point, it might go multiyear with us.

But yes, everybody is selling All Access Pass and we are trying to position multiyear everywhere we can.

Chris, just wanted to note -- this is Bob.

The nature of the problems we're helping clients solve, when they really get into it, as Paul mentioned, they recognize that if they're going to try to transform and get lasting behavioral change in the way that their sales force engages clients, say, the major consulting firm or a major technology firm, they recognize that both the journey of getting all the salespeople across that and then maintaining that with coaching and ongoing tools, this is going to be a multiyear journey.

And it is a journey that's worth it because they know what the payback is going to be.

If you're trying to get 190,000 frontline employees to do better and do something better or different every day so it will drive guest satisfaction, that's an initiative that they're going to be on forever.

And you always have new frontline people.

You need to keep it going.

And so the very nature of what we do (technical difficulty) used for multiyear contracts is just as Paul said, in the initial year, they don't know the extent to which they're going to be engaged in these big journeys.

Once they get engaged, it's a very straightforward thing, they say look -- you ought to match the contract terms to what you're trying to get done and you can save a little in the way -- during the way.

So...

I have many questions here, but one more, if I may.

Sure.

As you continue to move towards 2021 and you talked about the higher levels of net cash that are going to be generated, with this additional cash and as you see more of this deferred revenue being recognized, how do you anticipate allocating this cash to investments, repurchases and/or acquisitions?

And in regards to Jhana and Robert Gregory, are there others that present viable candidates for integration into Franklin Covey?

Thanks.

Our priorities for the utilization of cash are kind of in this order, first of all, is investing in the recurring needs of the existing business and just the ongoing investment and keeping all the content fresh, our portals and everything that go on.

And that's the first priority.

That's well within our budget to do that, but it's an ongoing investment we make every year.

The second is the ability to take the steps that would grow the business, whether it's new content, could be an add-on acquisition.

It could be the acceleration right now in the growth of the sales force, which takes some additional capital.

And those things will all have such a very high payback when you get 100% return in the first year, as we said, hiring a new salesperson or whatever.

That's our second utilization.

The third is that we have utilized a lot of the excess cash flow beyond those 2 for years and repurchasing shares.

Some have asked why we haven't been active in repurchasing shares in the last quarters.

And really, if we haven't -- if we're not active in repurchasing shares in a quarter, it's due to 1 of 3 things.

Either one, we're making additional investments in the business, which last year we did.

We made incremental investments in our new ERP system, in our portal acquisitions and so forth.

We made substantial cash acquisitions.

So one would be that -- that we just had -- we had unusual requirements in the business.

That has not historically been the case.

We historically spend about 4% of our revenue in innovation and product development.

With the All Access Pass, we've moved that up now to 7% a year, but we usually live within that budget.

But if we're not buying, it could be that we've been investing, buying stock.

It's because we've been investing in other parts of the business.

So second is that it may be the time of the year where your cash -- in our late part of our fiscal year because our fourth quarter is so generally significant in terms of revenue and particularly so in Education.

We invest a lot of money and working capital in -- to fund all those sales in the fourth quarter and usually -- so sometimes, it's just that we don't have a lot of excess cash if we're not buying.

Third could be, honestly, that we may be involved in something -- or having discussions about something which could be material to the business and significant enough that we're precluded from buying.

But otherwise, any time we think we can earn at least a 20% IRR by investing in our stock, which we have continued to believe is what we can do, we do that.

And we expect in this coming year that we'll have the cash available and the inclination and expectation of doing so.

Is that helpful?

Yes, it is.

I have more but I'll jump back in the queue.

Okay.

Thank you.

We're happy -- we'll look forward to talking to you if you'd like to get those other questions answered.

And our next question comes from Tim McHugh.

It's actually Trevor Romeo on for Tim.

So first question here, so part of your growth strategy involves growing the client partner head count.

Just wanted to ask, in the current labor market, how difficult is it for you to find qualified people for those roles?

And then along with that, how's your retention trending among the client partner group?

Great.

I'm going to ask Todd Davis, who heads our people services and who has these 5 recruitment professionals working with him every day.

Todd, would you respond to that?

Yes.

Thanks.

I'm pleased to join you.

So it's a great question.

That's part of the key strategy.

So we have -- as Bob mentioned, we have a very seasoned recruiting staff particularly for our industry.

And so while -- to your point, the labor market is certainly becoming more challenging.

We have found, quite frankly, with the All Access Pass model, more than before while they're not knocking at the door, we're finding much more interest from seasoned salespeople client partners, as we call them, who are interested in our company for 2 primary reasons -- there are others but the 2 primary reasons are the subscription-based model where they can actually go in and have the business model so they can actually make a difference, we can make a difference within the client organization.

And then also, I just lost my train of thought -- the 2 reasons were -- are the model and then the investment that Bob was talking about, just the significant investment and not talking ill of any of our competitors with that, but they're so pleased to be with an organization that is making the financial investment in our offerings and in our solutions.

So those are the 2 that come top of mind as we're talking to the candidates and interviewing, quite frankly, every day.

This recruiting team is pulling together some phenomenal candidates.

So yes, it is -- it has become more difficult and we're finding with the direction of the company is headed, we are becoming more attractive for those salespeople that are in our industry.

Paul, and the retention question, do you want to address that?

Yes.

So we have -- we think we have pretty good retention -- quite good retention, actually, especially given where the labor market is right now.

And there's a lot of reasons to join with a company who have long tenure here at Franklin Covey.

In fact, when people joined us and they come to our Sales Academies, we run this 5-week Sales Academy.

Two of the weeks are in person here at -- in Salt Lake at our headquarters.

That's something we've been doing this year that's making a tremendous difference.

So people come in and they do a tour around our campus, and they get to know some of their peers or their fellow client partners and one of the common refrain is, "You have people that have been here a long time," and they say that in a really good way.

And we feel like that is a really good thing.

And so we're -- we do everything we can to retain them, especially the ones we want to retain.

We feel good about where we are there, and as Todd mentioned, is -- we're hiring a lot of great people right now.

And I think just in terms of specific metrics, we need to hire about 31 client partners to retain 20 over time.

And so -- and that's -- we feel that's a very good retention rate in a business that is heavily commissioned sales where they have to go out and win.

And that 10, that third that you lose happens over time, but we're grateful.

So that our client partners that we do retain are ramping according to and a little bit ahead of the schedule that we've established for them.

We keep adding new schools and tools and marketing efforts and other things to help them succeed.

And we've got a great group of people who've been here for many, many, many years.

And we're meeting not long ago where we went through some of our senior salespeople.

And some of top-selling people, all of whom had been here more than 12 years.

And so we have good retention.

Once you get through the ramp, you tend never to leave.

So -- thanks.

Okay.

Great.

That's very helpful.

And then second question, you had some nice gross margin improvement come through on a year-over-year basis this quarter.

I know you hadn't necessarily seen that in the past couple of quarters despite pretty strong revenue growth.

So could you just kind of talk through the drivers of the gross margin improvement other than revenue growth that helped this quarter?

Yes.

I mean the first factor is just mix.

So as we have more and more subscription revenue as a percentage, we'll get that.

It was offset in the first couple of quarters this year somewhat by we had such a significant expansion in our services revenue, addition of services, which we think is important that -- moving that up to now 47% on top.

It held down the gross margin expansion a little bit.

Given the same mix of services and subscriptions, you'll tend to have some -- just the mix shift change will add to the margins.

And I think that's the primary thing.

We also have had annual price increases for the All Access Pass and that -- most of that flows through to the increment.

And while it doesn't apply to the entire population because people can avoid it if they'll sign multiyear agreements or they can do it by signing up, expanding their population or whatever else, despite -- and we want them to do those things.

We give them those incentives because our focus is we want revenue per client to grow.

And if we give up a little bit on the revenue per seat to get revenue per client, that's something that's in our favor.

But beyond that, I think it's primarily that the rest -- there is some price increase for all new sales and for anybody who doesn't take advantage of those or a combination of that, and the mix shift continues to nudge the gross margin upward, offset partially by certain increases in service sales.

And so any given quarter, you might be flat or whatever.

We don't expect to go backwards on this.

And our next question comes from Jeff Martin.

I wanted to touch on the international license partners and also the international offices.

Specifically, I want to touch on the direct office in China has fared, if that's growing nicely.

And then on the international license side specifically, are they all selling All Access Pass?

Where are they in that process?

And do you expect some growth acceleration there?

I'll invite Paul to respond to that.

Sure.

Jeff, so I'll start with the international direct offices.

They had, as Bob mentioned a few minutes ago, really a nice Q3.

Every office was up in the third quarter.

All of the offices are doing well for the year, and we expect that they'll continue to do well in the fourth quarter.

As you know, in our English-speaking offices, so in the U.K. and Australia, they've been selling All Access Pass now essentially as long as we have here in the U.S. And the majority of their business is now All Access Pass, are seeing very similar retention metrics, add-on services metrics, multiyear metrics, et cetera.

China is actually doing very well also.

They had a great quarter.

They are not yet selling All Access Pass.

They will start in the fall.

We've been working -- our technology team has been working, doing a great job getting a portal stood up inside China.

We do service some clients in China.

So we're able to sell global deals and then service clients in China.

But really, to do this in a big way in China, we need to have our All Access Pass portal and everything in China to provide good, consistent, steady access for people there.

So China is doing well and the All Access Pass will start in the fall.

Japan has just come online in the last few months now with All Access Pass.

They had sold some, and that business is starting to grow for them.

And so we expect that they'll follow a similar trajectory as we have in our English-speaking countries.

And then as you know earlier this year, we assumed the license in Germany, Switzerland and Austria, and they're selling All Access Pass as well.

They got onboard as our licensee partners did a little over a year ago.

And that business had a nice quarter also.

It's now being led and managed out of the U.K. by our leader there.

So we feel really good about international direct, and half of those offices are selling All Access Pass almost exclusively and the other -- and China and Japan are coming online.

The licensees are actually doing pretty well as well.

They're up a little bit for the year.

They'll be up for the year when it's all said and done.

They were a little bit off, as Bob mentioned, in the third quarter primarily due to foreign exchange and the conversion of Germany becoming a direct office.

And they were down -- they're still in the middle of this conversion themselves.

So we were about a year late in supporting them with the All Access Pass.

And so this is kind of their first full year, if you will, selling it.

Actually, they're doing quite well.

We think it will be a good driver of growth for them.

They still just pay us, of course, royalties on their sales, but theoretically, this will -- this should help them drive their business more quickly than they have in the past just like it is for us, and that should translate into higher royalty for us.

Just of note, we had -- one of our partners, last year, about this time, sold 1,000-person pass and they just got the renewal on it late last week.

And so that's kind of -- that's an exciting thing to see.

And the same play happening in our direct operations, translating and happening just the exact same way in our licensee operations and we -- they'll continue to get better and better at it as well.

Okay.

That's helpful.

I wanted to ask, as it pertains to the client partner additions, what's the balance of mix in terms of adds in North America versus international markets?

It's about 60-40, 60 U.S., 40 outside the U.S. I think that's an opportunity where we will -- should and will get more aggressive in our international offices.

We've got China now and that now having been part of -- and Germany as well.

We've got some big economies there that are -- now that we've got them in and they're part of our direct operations, China now for a few years has been and Germany just recently.

And we get those businesses running exactly how we run them.

In the other parts of the world where we're direct, there's an opportunity to add a lot of head count there and I think we will.

But for this upcoming year, the mix is about 60-40 in what we expect to hire and probably will be 50-50 for quite a while.

We've got a lot of headroom everywhere.

And we think also, Jeff, at this point, one of the real -- one of the strongest assets we have as a company, most important parts of the company, is the leadership group we have and particularly those who head these 16 offices or areas of the world in our direct offices.

We had our quarterly leadership meeting 2 weeks ago.

And this is a group of seasoned people who, on average, have been with us 16 years, who manage their $10 million to $15 million responsibility in the world.

And this is an impressive, great group.

When you look at the 4 metrics for which they're responsible, every one of them is living within the minimum acceptable level.

Others have specialties where they're on the high end.

This is a group of people who knows how to run a team, and we'll be able to add -- these new client partners are being added to those teams now.

We've also put some other new roles, which are kind of player/coaches that are carrying quota but also helping to do this.

So I think we're better positioned now than we've ever been to be able to feel really confident about adding a lot of new client partners in the coming years because each of them can take 1 or 2 a year, and that allows you to grow quite rapidly.

So that's a big -- that's of real importance.

Okay.

Great.

And then my last question is around new content and how quickly that becomes a revenue growth driver.

And it makes a lot of sense as you're bundling everything into one pass that additional content is going to have a lot more value more quickly than under the old model.

Was just curious, as you bring on new content, what kind of ramp do you expect to see out of that versus what you've historically had under the old model?

Under the old model, of course, we were able to look specifically to a piece of content and know exactly the revenue it generated because we sold it separately, as you know.

Now when it enters as part of the All Access Pass, it's really the value proposition that is the total ecosystem that we have.

And so the primary ways in which we see impact are, one, I mean we may have already had a high retention.

We already do have high retention.

So it's hard to say that went up a lot.

But where it comes is there are new jobs to be done, new impact journey this allows us to have.

It allows us to go deeper into an organization.

And so if we pick the right content areas, we pick the right problems, we see -- we've seen, for example, Jhana, the usage of Jhana is where -- is across the system.

About 2/3 of our All Access passholders utilize it.

And when they utilize it, they utilize it frequently.

Mostly they -- it's really pervasive.

And so we can see that usage.

Our coaching business has gone up a lot, and we add something new like this content from this partnership with Liz Wiseman.

We expect to be reflected, one, that our retention rates will stay high and maybe expand.

We'll be able to continue to do price increases that will allow us to do things.

Third, people will sign more multiyear agreements because that's one of the things behind the moving towards 50%.

It's -- they'll be on impact journeys that we know they want to be on, and we have the content and solutions to do it.

So a combination of those factors.

We do it within a specific budget, but we don't look specifically to the economics of that other than that's part of our 7% spend to add new content.

But we're very precise about doing so on jobs that we know need to be done, thinking it will affect the whole ecosystem.

Is that helpful?

That's helpful.

And our next question comes from Marco Rodriguez.

Most of my questions have been asked and answered.

So I just have a couple of real quick, I guess, housekeeping items.

In terms of your guidance, specifically on the CapEx and cap D spend for fiscal '19, looks like those numbers kind of have come down here since the last guidance.

Can you just talk a little bit about that?

Yes.

A lot of our spend on CapEx and cap D is down in this quarter and year-to-date, just representing when capitalized projects have been completed and when certain CapEx projects have been completed.

So that is in the fundamental change in the amount that we -- Marco, that we plan to spend in those areas.

We are -- we just had less spending year-to-date than we thought we would have, which means that we'll make up a little bit of that in the fourth quarter perhaps and going into next year.

That's one reason this year is down.

And then the second reason, as Bob mentioned, is in the past, we were doing a large ERP project and doing the initial development of our portal, both of which were capitalized.

So we had higher spending in the past on those items.

We have an amount that we plan to spend each year going forward, and it just so happens that the timing of projects makes our year-to-date this year a little bit lower than would be a standard run rate.

Okay.

I think I understand what you're saying there, but I was mostly referring to the fact that the guidance range for the full fiscal year seem to have come down versus the prior guidance in Q2 and the beginning of the year.

So that's just timing?

Yes.

Yes.

Our view of what we're going to spend on CapEx and cap D is unchanged from what we've talked about.

But as you know, when we have these large, capitalized development projects, et cetera, the point at which those are capitalized is when we are spending, obviously, those monies on the capitalization, and that there are swings in that development, but the swings don't -- in this case, don't represent a fundamental change in how much we plan to spend in capitalized development or capitalized spending on the portal.

Got it.

And then in terms of the balance sheet, just the cash that you guys have on there right now, just taking a look at what you've reported here year-to-date for cash flow from ops and what you had spent here for CapEx and cap D. Cash is pretty flat from the beginning of the year.

So I'm assuming you've been paying down per your credit agreements.

Has anything else been accelerated to pay that down?

Or are there other expenditures that are happening on the cash flow from financing that has kind of kept things level there?

No, not necessarily.

A fair amount of our cash in our balance sheet is tied up in some foreign operations that we can't repatriate.

Where otherwise, we would have paid the line of credit down even farther than we have and stuff we're always looking to repatriate cash as quickly as we can to put it to use to reduce interest expense and to use things -- use it for things and investing activities or financing activities so that we don't have to borrow against our line.

But a lot of our cash and the reason why the cash is really kind of flat even though we have paid down our line significantly since the beginning of the year and made our term loan payments.

Is just simply because we can't repatriate it fast enough with local laws and their local needs to pay annual income tax payments and things like that.

Got it.

And then last quick question.

Just maybe Bob, if you can talk a little bit about the M&A landscape, any sort of things you might be looking at in terms of specialized content or things you think that might be somewhat interesting going forward?

Yes.

Thanks, Marco.

I mean for us, we always have a lot of what we've put in the business development initiatives.

For us, fewer of them are acquisitions of companies than they are possibly acquisitions of content or capability.

In some cases, as you know, with Jhana and Robert Gregory we did, the more -- the most important we're looking at is either expanding some kind of a capability that won't be a big branded thing.

It will just add a new capability like micro-learning with Jhana or assessments or things like that.

And so many of the things we're looking at are things that will increase the usage of All Access Pass or expand the ways in which people can get value from the All Access Pass.

And so a number of those will probably be just license agreement where it won't turn out to be a real M&A activity.

It will be in the form of license.

Occasionally, we'll do something big in the content area like with Liz Wiseman.

That's not a major effort on our part but it will -- we have a couple of those kinds of things that we're working on.

But more of the things are capabilities, things that allow usage -- to increase usage.

But we do have Boyd Roberts, who's here in the room and heads our business development effort, and he's got lots on his plate of things that we're looking at.

But we, again, think most of these will follow within our normal 7% spend, 7% of revenue spend each year.

And that's how that really we're organized to do [then responsive].

And our next question comes from Zach Cummins.

So in terms of the Education segment, can you talk about what really drove the strength here in Q3?

And what are really the expectations for growth in that segment as we move into kind of FY '20 and beyond?

Yes.

I'll turn the time over to Sean Covey and let him respond.

Yes.

Sure.

Zach, yes, so third quarter, we had a really strong third quarter.

Some of it was we had a lot of new contracts we signed with schools this year.

We're confident -- we feel good about our fourth quarter because we feel like we're going to bring in about 50 to 100 new schools over last year.

So that shows up -- some of that shows up in the third quarter.

These are new schools that we got signed in the third.

Our retention also is stronger than last year.

We think -- our retention has always been pretty high in the about 86% to 90% range.

And we feel like this year, it will be at least that good, if not 1 to 2 percentage points better.

That showed up in the third quarter as well.

So it was -- we also did a lot of material sales, okay?

So when Leader in Me schools sign on, we have additional material they can buy.

And we did a really good job of that in the third quarter.

And these are like leadership guides for students.

And they were extremely high margin as well, and that helped the gross margin in the third quarter.

So that came in stronger than expected and we put a real focus on that.

We find our -- we've updated these over the last year and we're finding that schools like these a lot.

So a combination of those things helped in the third.

And then again, the fourth, we feel pretty good about it because we've got a stronger pipeline so far.

The invoiced revenue and final stage pipeline revenue for the fourth quarter were up over last year by about $1.5 million already, again, new schools, 50 to 100.

So far, we're about 46 over last year at the same point.

And then the retention.

We also have a lot of -- this year, we feel good as well because we have a lot of late opportunities that we didn't have last year.

We still have some big deals out there that could close or not close or go into next year, which will either help this year or next year, yes.

So for the fourth, we feel good about it.

Long term, we feel really good about our prospects because -- for a few reasons.

One is the district opportunities, selling -- that's one of our big areas of focus next year is to sell more to districts and less direct to schools.

In the past, it's been more of the opposite.

But we're getting good with districts.

And we're only in 815 of the 15,000 in the U.S. -- 15,000 districts.

So we fell like that's a big opportunity.

The international opportunity continues to do really well.

We just opened up in China.

I was there last month.

We have 9 partners.

We licensed pretty much the whole country.

We have 30 Leader in Me schools.

We think we could get to a couple hundred next year.

That's going to help us a lot.

The international opportunity is really strong.

Higher education opportunity continues to grow.

That helped our gross margin as well.

If it becomes a higher percentage of our total sales, it's higher margin.

We feel the growth opportunity there is really good.

And I think finally, just the thing that's, I guess, most compelling about our -- the future opportunity in education is just the impact we find we're making.

We've got great research showing the efficacy of Leader in Me and how it's increasing attendance and decreasing behavioral problems and helping test scores in different areas.

And that is -- that's the key.

That's the word of mouth and that spreads really well.

It helps increase our penetration of districts and so forth.

So kind of a long answer to your question, but that's how we're feeling right now.

No.

I really appreciate all the color.

And just one more question from me.

Bob, I guess in terms of attachment rates for add-on services with your All Access Pass offering, do you anticipate that this is something that can be sustainable as customers start to go in the year 2, 3 or 4 of their contracts?

Are these add-on services something that are going to be recurring in nature and something that these clients will consider buying on an annual basis?

Yes.

I think that's been one of the most important factors -- and I didn't probably emphasize it enough is one of the most encouraging things is that our same client retention rate of revenue, including their pass and their services we're retaining just over 100% of that.

And so I think what's happening is people -- actually, the services increase as we're -- as people get down the road on this because they recognize they're entrusting us with -- and our content with more challenging and important problems, ones where they really do need to get the behavior changed.

And so yes, Paul, if you want to add anything to that.

But the services, we believe, are very durable.

I don't know -- we don't know how high up is.

But at least at the current levels, we think on a rolling 12-month pace, we should be able to maintain what we're doing.

And then as clients get into their third and fourth and fifth years, it's because they're working on things that are important.

And so to an earlier question about the M&A pipeline, I think, that Marco asked, some of the things we're doing is not M&A, but it's adding new services and designing new services to exactly meet the needs of people so when they go through and train a bunch of managers, there's coaching built into the process.

So I think right now, it's been very durable and expanding.

And to the extent we're good at selling and servicing clients, we think it will continue to be strong and expanding.

So.

And we have no more questions at this time.

Okay.

Great.

We'll just conclude and thank each of you for joining today.

Again, as I mentioned, it's a very exciting time to be part of Franklin Covey.

It's a time when really to see the impact that we're having in clients and see the recognition of that by revenue retention, new sales, et cetera.

It's really encouraging and we look forward to talking with many of you in the coming days and weeks.

If you have additional questions, happy to respond.

And we look forward to a strong fourth quarter and to getting a chance to have this formal discussion in November.

Thank you so much.

And thank you.

Ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may now disconnect.