Franklin Covey Co. (FC) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Franklin Covey Earnings Conference Call. My name is Jeff, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Derek Hatch, Corporate Controller. And you have the floor, sir.

Thank you, Jeff. On behalf of Franklin Covey, I'd like welcome everybody to our investor call this afternoon to discuss the financial results through the quarter ended February 25, 2012. However, before we get started, like to remind everybody that this presentation will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management’s current expectations and are subject to various risks and uncertainties including, but not limited to, the ability of the company to stabilize and grow revenues; the ability of the company to hire productive sales professionals; general economic conditions; competition in the company’s targeted marketplace; market acceptance of new products or services and marketing strategies; changes in the company’s market share; changes in the size of the overall market for the company’s products; changes in the training and spending policies of the company’s clients; and other factors identified and discussed in the company’s most recent annual report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission. Many of these conditions are beyond our control or influence, any one of which may cause future results to differ materially from the company’s current expectations, and there can be no assurance that the company’s actual future performance will meet management’s expectations. These forward-looking statements are based on management’s current expectations, and we undertake no obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of today’s presentation. With that said, we’d like to turn the presentation over to our Chief Executive Officer and Chairman of the Board, Mr. Bob Whitman.

Thanks, Derek. Hello, everyone, we appreciate you all joining us today and having so many of you join us today as well. We assume that you all saw the press release. We’re delighted to report that we had a very strong second quarter, actually the strongest second quarter ever for our current business. We continue to feel very good about the business, about our momentum, and our outlook for the year and beyond. We’re also feeling confident about the prospects for continued growth in each of our channels and practice areas and about the expected trajectory of our business over the next several years. So today I’m going to keep my remarks relatively brief to allow plenty of time for questions you might have. I’d like to just touch on 3 topics: First, the headlines regarding the financial performance of the business during the second quarter; second, our momentum and outlook for the year and what we see as a very positive trajectory for the business and our growth and earnings potential for this year and next several years; and finally, our announced $10 million common stock repurchase program. So starting with the headlines about our second quarter’s results. First headline is our free cash flow and – or at least our net cash generated and cash flow from operations were extremely strong during the quarter and for the trailing 4 quarters. Our net cash generated, which is -- there’s an exhibit that shows the calculation of that, grew 48% during the second quarter to $4.1 million, up from $2.8 million in the second quarter of 2011. And as you can see in Slide 3, for the trailing 4 quarters ended February 25, our net cash generated increased to $16.9 million, which is an increase of $2.2 million, or 15%,…

Thanks, Bob. Just to follow up on a couple comments regarding the financial statements. As Bob mentioned, we had a very good quarter, which produced some nice results in our income statement. Through increased sales and good gross margins flowing through to increased adjusted EBITDA, which then of course rolled through to improved pre-tax earnings and then to net income. We were also happy to have our income tax rate stay generally consistent for the second quarter in a row, right around 46%. That’s a significant improvement over our prior-year percentages, which were as high as 64% for this quarter last year. Once again, it’s due to the same general conditions that we have with permanent differences, and if you have any questions regarding the impact of income taxes, please give me a call. I’d be happy to explain them to you. But all these improvements, as Bob mentioned, led to improved cash flow from operations, which has really served to strengthen our financial position. Our balance sheet is in great shape. At the end of the quarter, we had $8.2 million in cash and cash equivalents. Working capital increased to $22.2 million compared with $16.7 million at August 31, 2011. We have no balances outstanding on our line of credit facility. We’re on time making our payments, of course, with our term loan that we have, and we owe about $4 million left on that. We also recently renewed our line of credit facility with our lender, and extended that due date out, the maturity out, until the end of March 2013. So as a result of all of those things, our balance sheet is in fantastic shape. We don’t see any significant issues or impairments coming down the road, and our financial position looks very, very strong. As…

Thanks, Derek. I think at this point I'll just turn the time to the operator to tell us how to start the question-and-answer period.

[Operator Instructions] Our first question comes from the line of Joe Janssen with Barrington Research.

I’ll start with the sensitivity analysis that you presented on Slide 7. I appreciate the color. And just for clarification, that -- assuming the different variables, is that incorporating your additional sales force that you plan to hire over the next 2 years? Or is that looking at it kind of in arrears?

Well, that’s a good question. I mean this is just showing what would happen if we grew it. I included a slide at the back, Joe, and maybe ask Shawn Moon, who heads our direct sales forces, I think Slide 10. Maybe, Shawn, why don’t you just respond to it. I think there’s a slide in the deck.

Yes, would refer you to Slide 10, the growth opportunity sales force addition slide. And there are really 2 factors in the productivity of our sales force as we see moving forward. First is increasing the productivity of our existing salespeople, or what we call our client partners. And then the second is actually increasing the number of client partners. So in this slide, you can see that the typical expected ramp rate for the new salespeople hired. For every 10 net salespeople that we bring on in a given year, we call this our class, right, our net investment for that year, including those…

Is this Slide 9?

Slide 9, I’m sorry. You can see that the ramp rate for those folks, and we’ve factored in those that hire but don’t make it, so we have that included, the investment required for that is about $600,000 in the first year. You can see there in year 2 that typically we cover all of the year 1 investment plus an additional $1 million. And then by year 5, each class of 10 net new hires should generate about $13 million in revenue and contribute more than $5.5 million, almost $6 million, in additional EBITDA contribution. Then on Slide 10, you can see that we’ve been hiring a class of new client partners each year over the past few years, and we have client partners who are in different stages of the ramp. So we felt as a consequence, it’s probably worth noting that even without hiring, and I think this speaks to your question, Joe, additional salespeople, just with those that we have, we could increase revenue by $44 million. That’s almost the same amount of revenue increase outlined in Slide 7 without adding new people. And this would come with substantial flow through, since we don’t have an incremental investment with the new people. So in addition to continuing our ramp with our existing classes of client partner, we have also increased the number of our new client partners over the past few years. In 2011, we hired 14 net new client partners. In FY 2012, we’ve already hired an additional 18 new client partners. And we expect to be able to increase our hiring to 30 a year, and then onto 40 a year, over the next several years.

Are you done hiring for fiscal 2012?

No.

Is 20 still the number?

Yes, we’ll probably go a little ahead of that, wouldn’t you think, Shawn?

Yes.

I mean we’ve got some needs that we’ll probably get filled. It'll probably go a little north of that.

Yes, there’s so much leverage in both these priorities, Joe, the ability to increase the productivity of our existing folks and the ability, in that context, to continue to add, as we have outlined before. Really this is my highest priority.

Yes, so hopefully that’s a response to your question. Maybe it was a long answer to a short question, but Shawn, I think, did a particularly good job of it. Shawn, thanks. It was just to say that the numbers that are in that sensitivity chart, if we just ramp up the people we have, we could get, I think that would -- if my math’s right, we’d get to $204 million of that $208 million of revenue. So there’d be $4 million shy if you didn’t hire anybody. But given that we are hiring and accelerating that, we would hope there's some upside.

Are you seeing any more efficiency in that? I remember a year ago those numbers looked a bit different in terms of the ramp of the salespeople. Are you still seeing some improvements in efficiency and…

We are. Shawn, maybe you want to speak to that too. Revenue per sales person on the ramp.

Yes, we are. Salesperson is going – has gone -- continues to go up from about $800,000 in 2004 to about $1.15 in 2011. And that’s up from 2010. There is some increased efficiency, yes.

Well, and Shawn, you might just speak to what the objectives are for the ramp rate, also, which is a little bit faster than what is shown on Slide 9, I believe.

Yes, the ramp rate is -- we’re hoping to trim a full year off of the ramp rate where before it’s taken them 5 years to get up to $1.1 million, our minimum expectation, now, of client partner, is to get up to $1.4 million. We have client partners that do well above that, but the $1.4 million is a number we think is attainable. And so that's – and there are several things that are going into that, but we’re seeing our pathway to that number.

Okay. Just I know I’ve been on for a while, 2 quick questions. Just regards the guidance, given the performance you’ve had in Q1 and Q2, seems the momentum is moving forward, guidance seems -- I know you’ve guided to the higher end of guidance now, but am I expecting anything? Should I be looking at anything in Q3, Q4?

Yes, I think just as I mentioned, I mean last year we a huge – we had 35% revenue growth in the third quarter and more than 100% EBITDA growth. So I think basically our view is we've got -- at the high end we’d be increasing EBITDA for the year around $5 million. We’ve done about half of that in the first 2 quarters. As I mentioned, the third quarter --we expect to grow in the third and fourth quarter, but would expect the third to be – the growth in the third, given that very tough comp, to be less than in the fourth. And it may be appropriate, at the end of the third quarter, to adjust our guidance further. But I think, trying to give us some direction at this point, that, that would be – in light of – you recall, Joe, that we had a – year-over-year, because of the first quarter decline in that government contract, which had been planned, we're up a little – it's up against a tougher comp, because you’ve got to make up for that $4.5 million and grow, but we feel confident we can move toward that upper end.

And just one last question, make it quick on my end. Update on India with schools and Leader in Me?

Yes, so the first -- we’ve begun with the first 20 schools, which is the first group that we have contract, and it’s underway. And we’re building the team up there so they can handle more. But domestically, in the U.S. operations, we continue to expand, and are now more than 750 schools that are Leader in Me schools. We’re now in the first 20 in India and I think as we’ve said, there are around 120,000 K-6 schools in North America. There are 746,000 K-8 schools, they have a little different format, but in India. So there’s a huge opportunity just in that one -- the expansion of the practice into India. And that’s maybe indicative that frankly, as we’ve said before, among our licensees, typically our international licensee partners, today our licensees are only in a couple of our different content categories. As we can take these new practices in, even in the existing licensees there’s a big opportunity both for organic growth but also adding these new practices. And this is one example of it.

[Operator instructions.] Up next we have Bill Gibson with Legend Merchant.

I’d like to zero in on probably your smallest practice, which is customer loyalty. It was growing at a pretty good clip, but it seems like it’s starting to lag a little. What’s going on there? What are the challenges?

I think generally, I’ll answer it 2 ways. One, we’ve actually had really good growth, continued growth, and they’ve added a lot of new clients. One of their larger clients has modified their offering of what they’re doing internally. It includes part of what we were doing before, and so the principal slowdown there has just been the reduction in that one contract. But all of the customers they’ve ever worked with are still customers. They’ve added 7 or 8 new customers this year. Some are in the pilot phase. Others are in rollout. But I’d expect that once we get over this little couple of quarter comparison with this one contract size reduction, that we expect to continue to see that grow.

Ladies and gentlemen, that'll conclude the question and answer portion for our call today. I’d now like to turn the presentation back over to Mr. Bob Whitman for closing remarks.

Great. Well, we just appreciate everyone being on the call with us today. Appreciate your continued support and guidance. And again, we feel very good about the quarter and about the momentum. And we’ll look forward to seeing many of you in the coming weeks and to reporting on third quarter. So thanks very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.