Franklin Covey Co. — Form 10-Q Summary
Reporting period: Quarter and two quarters ended February 28, 2018; fiscal year ends August 31. Dollar amounts are in millions unless stated otherwise. The company provides performance-improvement content, training, consulting, and subscription offerings, including All Access Pass (AAP) and The Leader in Me.
Financial performance
| Metric | Q2 FY2018 | Q2 FY2017 | First half FY2018 | First half FY2017 |
|---|---|---|---|---|
| Net sales | $46.5 | $42.2 | $94.5 | $82.0 |
| Gross profit | $32.7 | $28.0 | $65.6 | $53.3 |
| Gross margin | 70.3% | 66.4% | 69.4% | 65.1% |
| Operating loss | $(5.1) | $(4.5) | $(8.4) | $(9.9) |
| Net loss | $(2.7) | $(3.3) | $(5.1) | $(7.3) |
| Net loss per diluted share | $(0.20) | $(0.24) | $(0.37) | $(0.53) |
| Adjusted EBITDA | $(0.7) | $(0.4) | $(0.1) | $(3.2) |
First-half revenue rose 15%, led by training and consulting services, up 16% to $90.9 million. Q2 sales increased 10%. Subscription and subscription-related revenue grew 55% in Q2; management attributed stronger gross margins mainly to the growing mix of higher-margin subscription revenue and lower publishing sales after exiting Japan’s publishing business. Operating expenses increased with investment in sales and implementation staff, advertising, ERP and acquired businesses. Q2 operating loss widened despite higher sales, while net loss narrowed partly with a larger income-tax benefit.
First-half cash provided by operating activities was $9.4 million, compared with $6.8 million a year earlier. Investing cash use was $7.6 million and financing cash use was $0.2 million. Cash increased to $10.8 million from $8.9 million at August 31, 2017. Cash paid for income taxes was $1.2 million; interest paid was $1.3 million.
Balance sheet, debt, and liquidity
At February 28, 2018, cash was $10.8 million, current assets were $76.4 million, and current liabilities were $72.5 million, leaving working capital of $3.9 million. Total liabilities were $116.6 million and shareholders’ equity was $80.4 million. The company reported $9.9 million drawn on its revolving credit line, $15.9 million of term loans, and a $22.0 million financing obligation for its corporate campus, including current portions.
Management reported $20.1 million available under its line of credit and stated it expected current resources, operating cash flows, and available borrowing to cover projected needs for at least the next 12 months. Of the cash balance, $9.7 million was held at foreign subsidiaries. The credit agreement has financial covenants, including leverage, fixed-charge coverage, capital-expenditure, and receivables requirements; management said the company was in compliance at quarter-end. The facility expires March 31, 2020.
Material changes and operating developments
- Deferred subscription revenue was $32.1 million, up 99% year over year; an additional $15.1 million of contracted, unbilled deferred revenue was not recorded on the balance sheet. Q2 included $14.4 million of new subscription contract billings and recognition of $13.7 million of previously deferred revenue.
- Segment sales increased 19% for Direct Offices and 10% for Education in the first half; International Licensees were essentially flat. Management cited education demand and international AAP adoption as growth opportunities.
- Q2 operating expenses included a $1.4 million year-over-year adverse change in acquisition contingent-consideration expense. First-half results also benefited from the absence of $1.5 million of prior-year contract-termination costs and prior-year contingent-liability credits.
- The company launched a new ERP system on December 1, 2017 and updated related financial controls. Management concluded disclosure controls were effective at quarter-end.
Outlook, risks, and unusual items
- Management expects fiscal 2018 depreciation of approximately $5.6 million, amortization of approximately $5.4 million, property and equipment purchases of approximately $7.5 million, and curriculum-development spending of approximately $5.0 million. AAP portal upgrades could increase capital spending.
- Management expected most Education sales growth to occur in the fourth fiscal quarter and anticipated that AAP availability in additional languages could support international sales and royalties. No quantified full-year revenue or earnings guidance is provided.
- The 2017 Tax Act generated a provisional $1.2 million Q2 income-tax benefit. The company may revise its provisional tax accounting, potentially materially. Management said a reliable annual effective tax rate was impracticable to estimate, in part because of uncertainty in the mix of subscription and other revenues.
- Adoption of the revenue-recognition standard was required beginning September 1, 2018; the full effect and adoption method were undetermined. Management said AAP and other license revenue could be more affected than onsite presentations and facilitator materials. The new lease standard was also expected to increase reported assets and liabilities, but its impact was not yet determined.
- Key risks include the subscription-model transition and revenue deferral, customer acceptance and renewals, competition, sales and collection trends, execution of technology investments, foreign-exchange movements, borrowing costs and covenant compliance, and data-security and privacy compliance. GDPR requirements were to apply beginning May 2018; the company expected to comply.
Important facts for investors to verify
- Whether subscription growth, renewals, deferred revenue, and unbilled contracted revenue convert into sustained recognized sales and cash generation.
- Whether rising operating expenses and acquisition-related costs moderate enough for improved gross margins to translate into operating profitability.
- Available borrowing capacity, covenant headroom, debt service, and the concentration of cash at foreign subsidiaries.
- The final effects of the 2017 Tax Act and the timing and impact of adopting the revenue and lease accounting standards.
- Whether planned ERP and AAP investments stay within expected budgets and deliver the anticipated operating and sales benefits.