Franklin Covey Co. — Q1 FY2017 Form 10-Q
Business context and period: Franklin Covey provides performance-improvement training, consulting, intellectual-property licensing, and related products. The unaudited quarter ended November 26, 2016; the comparable quarter ended November 28, 2015. The company notes that its first quarter is typically an investment period and that most earnings are traditionally recognized in the third and fourth quarters.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Net sales | $39.8 million | $45.2 million |
| Gross profit / gross margin | $25.3 million / 63.6% | $30.1 million / 66.5% |
| Operating income (loss) | $(5.4) million | $1.8 million |
| Net income (loss) | $(4.0) million; $(0.29) per share | $0.8 million; $0.05 per share |
| Operating cash flow | $(2.9) million | $7.1 million |
- Sales fell 12% year over year. Training and consulting revenue was $38.1 million, down 12%; product revenue was $0.8 million, down 9%; leasing revenue was $0.9 million, down 20%.
- SG&A increased $2.6 million to $29.1 million, while total operating expenses increased $2.4 million to $30.7 million. Reported consolidated Adjusted EBITDA was $(2.8) million, versus $4.5 million a year earlier.
- Cash and cash equivalents were $7.9 million at November 26, 2016, down from $10.5 million at August 31, 2016; net working capital was $32.5 million. The filing says substantially all cash was held at foreign subsidiaries.
- Term notes payable totaled $17.8 million, including $5.0 million current and $12.8 million long-term. The corporate-campus financing obligation totaled $24.2 million, including $1.7 million current and $22.5 million long-term. There were no revolver borrowings; up to $35.0 million was available under the revolving line.
- Investing cash outflow was $2.7 million, including $2.0 million of property and equipment purchases and $0.7 million of curriculum development. Financing cash inflow was $3.5 million, including a new $5.0 million term loan.
Changes and operating drivers
- The All Access Pass (AAP) transition materially affected reported revenue: the company invoiced $5.0 million of AAP contracts in the quarter, compared with $0.4 million a year earlier, and deferred substantially all new AAP contract revenue over contract lives. Management said the transition would significantly affect FY2017 results, with deferred sales expected to benefit future periods.
- Domestic regional office revenue declined amid the AAP transition and lower on-site delivery. Strategic Markets revenue fell 34%, partly because of delayed contracting for large Sales Performance opportunities and completed Customer Loyalty contracts. International licensee revenue fell 24%, including the loss of China royalties after conversion to a direct office.
- New China direct offices generated $3.0 million of sales. Education Practice revenue increased 7% to $8.7 million, supported by demand for The Leader in Me program.
- Gross margin was lower due to deferred revenue, fixed Education coach and curriculum costs, lower royalty revenue, discounted on-site presentations for AAP clients, and sales mix.
- Higher SG&A reflected China office costs, increased bad-debt expense, ERP replacement costs, higher stock compensation, and travel and promotional spending. The quarter included $0.5 million of non-recurring China start-up costs. The company also recorded a $1.0 million reduction in the NinetyFive 5 earn-out liability, which reduced SG&A.
Outlook, risks, and contingencies
- Management expected China offices to perform favorably, new sales personnel to support FY2017 sales as they ramp, and Education Practice growth to continue, with much of its growth typically occurring in the fourth quarter. A large UK contract was expected to renew later in FY2017.
- Management estimated FY2017 depreciation of approximately $3.9 million, amortization of $2.9 million, property and equipment purchases of $5.4 million, and curriculum-development spending of $8.0 million. ERP replacement spending could differ from expectations.
- The company expected available resources to support operations for at least 12 months, relying on cash, operating cash flow, and potential revolver borrowings. This outlook depends on sales, cost control, capital spending, and receivable collections; alternative financing may not be available on acceptable terms.
- Management cited slower collections, including from government and Education clients and licensees, longer payment terms, and increased collection risk; the allowance for doubtful accounts increased. Operating cash flow was also affected by lower operating results and seasonal payments of accrued liabilities and accounts payable.
- The credit agreement requires a funded debt-to-EBITDAR ratio below 3.0, fixed-charge coverage above 1.15, and other restrictions. Management reported compliance at quarter-end. The term loans carried an effective rate of LIBOR plus 1.85%; the company estimated a 1 percentage-point increase in rates on outstanding borrowings would add about $0.2 million of annual interest expense.
- A potential additional NinetyFive 5 earn-out payment depends on performance thresholds; the recorded liability was $0.9 million, and the timing and amount of any further payment were uncertain. The company also reported a $3.4 million receivable from FC Organizational Products, net of discount.
- Other risks include AAP sales-cycle and revenue-recognition effects, competition, economic conditions, foreign exchange, execution of the ERP replacement, and the timing and mix of customer contracts. The company had not yet determined the full impacts of pending revenue, lease, and stock-compensation accounting standards.
Important facts for investors to verify
- Whether AAP contract sales and deferred revenue convert into recognized revenue as management expects, and how the transition affects FY2017 margins and cash flow.
- Whether receivable collections improve and whether higher doubtful-account provisions or customer payment delays persist.
- Progress and costs of the ERP replacement, China office expansion, and sales-force ramp-up, alongside the stated FY2017 spending estimates.
- Compliance with credit covenants, available revolver capacity, scheduled term-loan repayments, and the company’s ability to maintain liquidity.
- Actual Education Practice growth, UK contract renewal, licensee trends, and any NinetyFive 5 earn-out obligation.