Franklin Covey Co. — Q2 FY2016 Form 10-Q
Reporting period: Quarter and first two quarters ended February 27, 2016; comparative periods ended February 28, 2015. Figures below are in millions of dollars except per-share data. The company provides training, consulting, related products, and licensing services focused on individual and organizational performance.
Financial performance
| Metric | Q2 FY2016 | Q2 FY2015 | First half FY2016 | First half FY2015 |
|---|---|---|---|---|
| Revenue | $45.3 | $46.3 | $90.5 | $94.2 |
| Gross profit / margin | $29.9 / 65.9% | $30.0 / 64.8% | $59.9 / 66.2% | $61.2 / 65.0% |
| Operating income (loss) | $(0.3) | $1.2 | $1.5 | $4.8 |
| Net income (loss) | $(0.4) | $0.4 | $0.3 | $2.3 |
| Diluted EPS | $(0.03) | $0.02 | $0.02 | $0.13 |
| Adjusted EBITDA (non-GAAP) | $4.4 | $3.8 | $8.9 | $9.7 |
Quarterly revenue fell 2%; first-half revenue fell 4%. Training and consulting revenue declined 3% in Q2 and 4% in the first half. Gross profit was nearly flat in Q2 and lower year over year in the first half, while gross margin improved in both periods, which management attributed to sales mix, intellectual-property offerings, facilitator sales, and lower online-program costs.
Q2 operating expenses increased $1.3 million, including a $1.2 million increase in the NinetyFive 5 contingent earn-out liability, $0.5 million more share-based compensation, and $0.4 million of restructuring charges. Foreign exchange reduced Q2 sales by $0.5 million and operating income by $0.6 million; first-half impacts were $1.5 million and $1.2 million, respectively.
First-half operating cash flow was $16.8 million, versus $12.2 million a year earlier. Investing cash use was $2.2 million; financing cash use was $25.7 million, primarily reflecting the share tender offer. Cash ended at $5.3 million, down from $16.2 million at August 31, 2015. Net working capital was $37.7 million, versus $55.8 million.
At February 27, 2016, the company had $10.1 million drawn on its $30.0 million revolving credit facility and approximately $25.4 million in financing obligations, including the campus financing obligation. The credit facility expires in March 2018. The company reported covenant compliance at period-end.
Material changes and business developments
- The new All Access Pass (AAP), launched in U.S. and Canadian regional offices in late January, generated $2.9 million of contracted sales; $1.1 million was deferred for recognition over contract lives. Management reported encouraging initial acceptance and a strengthening potential-sales pipeline.
- Strategic Markets revenue fell 16% in Q2 and 22% in the first half, largely because a federal contract that contributed $1.7 million in Q2 2015 ($4.4 million in the first half) did not recur, and Customer Loyalty sales weakened. The federal contract might not reopen for bids during FY2016.
- Education Practice revenue increased 29% in Q2 and 32% in the first half, supported by demand for The Leader in Me and recognition of previously deferred subscription revenue. Management expects most annual Education sales growth in the fourth fiscal quarter.
- Direct Offices revenue declined 4% in Q2 and 6% in the first half. Management cited weak western-region demand, including lower oil-and-gas client training spending, timing of public-program contracts, and foreign exchange. International Licensees declined 8% in Q2; excluding currency effects, first-half licensee sales rose 4%.
- The company repurchased 1,971,832 shares in a fully subscribed modified Dutch auction tender at $17.75 per share. Total cost, including fees, was $35.3 million, funded with existing cash and credit-line borrowings.
Outlook, risks and unusual items
- Management said existing capital resources should be adequate for at least the next 12 months, relying on cash, operating cash flow, and the credit facility. It cautioned that liquidity depends on sales, cost control, capital spending, and receivable collections, and that alternative financing may not be available on acceptable terms.
- FY2016 estimates included approximately $7.0 million of property and equipment purchases, $4.2 million of curriculum development spending, $4.0 million of depreciation, and $3.3 million of amortization. ERP replacement could change capital spending from the estimate.
- Management expected to pay the first $2.2 million NinetyFive 5 earn-out payment in Q3 FY2016; further payments may be due in FY2017. The earn-out fair-value liability was $3.9 million at quarter-end, after a $1.2 million quarterly increase recorded in SG&A.
- An Australian direct-office restructuring closed offices in Brisbane, Sydney, and Melbourne and reduced administrative and sales-support headcount. The quarter included $0.4 million of costs; $0.3 million remained accrued at period-end. The action is intended to reduce ongoing costs.
- Risks include foreign-exchange pressure, slower collections from government and education customers and licensees, reduced oil-and-gas client spending, uncertainty over the federal contract, and execution of AAP. The filing identifies cyber-attack and data-security exposure associated with the internet-based AAP platform.
- The company had not determined the impact or adoption method for the pending revenue-recognition standard, or the full financial-statement impact of the new lease standard; it expected the latter to increase reported assets and liabilities. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether AAP sales and deferred revenue convert into recognized revenue, renewals, and sustainable customer demand.
- Progress on replacing the lost federal contract and rebuilding Strategic Markets and Customer Loyalty sales.
- Receivable collection trends, particularly for government and education customers, licensees, and contracts with longer payment terms.
- Liquidity and covenant headroom after the tender offer, including the impact of planned capital spending and expected earn-out payments.
- Whether Education Practice growth, including fourth-quarter seasonality, offsets weakness elsewhere, and whether currency effects persist.
- The eventual effects and transition requirements of the new revenue and lease accounting standards.