Franklin Covey Co. — Q2 FY2014 Form 10-Q
Reporting period: Quarter and first two fiscal quarters ended March 1, 2014; comparisons are with periods ended March 2, 2013. Amounts below are in millions unless otherwise stated. Franklin Covey provides training and consulting services, related products, and leasing. Management described Q2 as the strongest second quarter ever for its current business.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | First half FY2014 | First half FY2013 |
|---|---|---|---|---|
| Revenue | $46.5 | $40.4 | $89.9 | $84.5 |
| Gross profit | $31.4 | $27.3 | $61.4 | $56.8 |
| Gross margin | 67.5% | 67.5% | 68.3% | 67.3% |
| Operating income | $3.9 | $3.3 | $7.4 | $8.5 |
| Net income | $2.0 | $1.6 | $3.7 | $4.5 |
| Diluted EPS | $0.12 | $0.08 | $0.22 | $0.23 |
Q2 revenue grew 15%, led by training and consulting services, up 16% to $43.7 million. First-half revenue rose 6%, while first-half net income declined about 18%. Q2 SG&A increased $3.0 million, largely from sales hiring, commissions, marketing for the 7 Habits program launch, and NinetyFive 5 acquisition costs. First-half operating expenses also included higher share-based compensation and amortization.
Cash flow and liquidity: First-half operating cash flow was $8.3 million, down from $10.2 million; investing cash outflow was $9.7 million, including $5.7 million in capitalized curriculum development and $2.3 million of NinetyFive 5 acquisition payments. Financing cash outflow was $3.6 million. Cash was $7.2 million at March 1, versus $12.3 million at August 31, 2013; working capital was $37.4 million. The company reported no line-of-credit borrowings and had a $10 million revolving facility expiring March 2016. The balance sheet showed $28.0 million of financing obligations, including current and long-term portions.
Material changes and business developments
- The February pre-launch of the re-created 7 Habits Signature Program contributed to Q2 growth, alongside gains in national account practices and Execution.
- First-half national account sales increased, including Sales Performance, Education, and Customer Loyalty. NinetyFive 5, acquired in fiscal 2013, contributed to Sales Performance growth.
- First-half international direct sales declined, principally due to Japan and foreign-exchange effects; the weaker yen reduced translated sales. Licensee royalty revenue increased.
- Government-services sales were affected by the prior-year-quarter government shutdown and related delays. Management expected some deferred business to recover in Q3 but noted renewal of a major government contract was not assured.
Outlook, risks, and unusual items
Management expected existing capital resources to support operations for at least 12 months, subject to sales, cost control, receivable collections, capital needs, and access to financing. It forecast fiscal 2014 capitalized curriculum spending of approximately $8.0 million, property and equipment purchases of $3.0 million, depreciation of $3.3 million, and amortization of $3.9 million. Management anticipated improved receivable collections in the second half and expected most Education practice growth in Q4. These are forward-looking expectations, not guarantees.
Receivables from FC Organizational Products (FCOP), in which the company owns 19.5%, totaled $5.0 million at March 1, including long-term amounts discounted at 15%. The company is not contractually required to advance funds, but collectability depends on FCOP’s future cash flows. The NinetyFive 5 contingent earnout liability was $3.5 million and is remeasured each reporting period. After quarter-end, the company paid a preliminary $3.5 million final CoveyLink earnout payment. First-half operating cash flow was also pressured by seasonal payments of accrued bonuses and commissions, higher tax payments, and slower-than-expected receivable collections. Currency movements, government contract timing and renewal, competition, and the success of new offerings are additional risks.
The company recorded a $0.6 million first-half reduction in the estimated NinetyFive 5 earnout liability, reducing SG&A. The effective tax rate was approximately 41% in the first half, versus 39% a year earlier; management expected about 40% for the first three quarters of FY2014. No material change in market risk was reported, and no foreign currency or interest-rate derivatives were used.
Important facts for investors to verify
- Whether the 7 Habits relaunch and new sales hires generate sustained revenue and profit growth after the launch-related costs.
- Whether delayed government-services sales recover and whether the major government contract is renewed or extended.
- Whether receivables collections improve, especially for government, Education, licensee, and longer-payment-term customers.
- FCOP’s ability to repay the $5.0 million receivable and the assumptions supporting its collectability and discount rate.
- The final amount and timing of NinetyFive 5 earnout payments, and the effect of the CoveyLink payment on cash and liquidity.
- Execution and returns on the planned $8.0 million curriculum investment, alongside the company’s cash needs, financing obligations, and credit-facility covenants.