Franklin Covey Co. — Form 10-Q Summary
Reporting period: Third quarter and first three quarters of fiscal 2013, ended June 1, 2013; comparisons are to the quarter and first three quarters ended May 26, 2012. Amounts below are in millions unless noted.
Business context and results
Franklin Covey provides organizational training, consulting, related products, and licensing. Management called the quarter the strongest third quarter under its current business model, citing broad sales growth and higher net income. The company reports as one operating segment.
| Metric | Q3 FY2013 | Q3 FY2012 | First 3 quarters FY2013 | First 3 quarters FY2012 |
|---|---|---|---|---|
| Revenue | $44.9 | $41.3 | $129.4 | $119.4 |
| Gross profit / margin | $29.4 / 65.6% | $26.1 / 63.3% | $86.3 / 66.7% | $77.7 / 65.0% |
| Operating income | $4.1 | $3.4 | $12.6 | $9.9 |
| Income before taxes | $3.5 | $2.8 | $10.9 | $8.0 |
| Net income | $2.1 | $1.6 | $6.6 | $4.4 |
| Diluted EPS | $0.13 | $0.09 | $0.36 | $0.24 |
Q3 revenue rose 9%, operating income 20%, and net income 31%. Nine-month revenue increased 8% and net income increased about 49%. Q3 service and consulting revenue grew 11%, while product revenue fell 38%; leasing revenue rose 37%. Growth included U.S./Canada direct sales, national accounts, facilitator sales, and intellectual-property licensing. International direct revenue declined 8% in the quarter, partly because of yen depreciation. Gross-margin improvement reflected a richer mix of higher-margin facilitator, license, and royalty revenue.
SG&A increased $2.2 million in Q3, mainly from sales-related staffing and commissions, advertising, and travel; lower share-based compensation partly offset the increase. For the first three quarters, SG&A rose $5.8 million, slightly faster than revenue. Nine-month adjusted EBITDA, a non-GAAP measure, was $18.9 million versus $17.4 million.
Cash flow, liquidity, and obligations
- Operating cash flow: $8.9 million for the first three quarters, versus $8.7 million; higher earnings were partly offset by payments reducing accrued liabilities and accounts payable.
- Investing and financing cash flow: Investing used $6.8 million, including acquisition spending, curriculum development, capital expenditures, and a CoveyLink earnout. Financing used $3.8 million, including $2.7 million of principal payments and $1.4 million for treasury-share purchases.
- Cash and working capital: Cash was $8.9 million at June 1, down from $11.0 million at August 31, 2012; net working capital was $28.8 million, up from $27.5 million. $3.9 million of cash was held by foreign subsidiaries.
- Debt and credit: No borrowings were outstanding on the $10 million revolving facility. The bank term note had $0.8 million remaining. The separate corporate-campus financing obligation totaled approximately $28.8 million. The credit facility was extended to March 31, 2016, bears interest at LIBOR plus 2.50%, and has financial covenants; the company reported compliance.
- Cash outlook: Management expected existing resources to support operations for at least 12 months and expected cash taxes to remain below tax expense while foreign tax credit carryforwards and other deferred tax assets are used, currently expected through fiscal 2015.
Material changes, outlook, and risks
- NinetyFive 5 acquisition: Acquired substantially all assets on March 11, 2013 to expand Sales Performance offerings. Initial consideration was $4.2 million, payable in installments, plus contingent earnouts up to $8.5 million based on cumulative EBITDA. At quarter-end, $3.1 million of the initial price remained payable. The purchase allocation was preliminary; acquired identifiable intangibles totaled $4.0 million and goodwill was $4.7 million. The acquisition had an immaterial effect on reported-period results; management expected it to benefit future periods.
- Other unusual items: The company paid $2.2 million for the fourth of five potential CoveyLink earnouts; a former owner is the brother of a named executive officer. Management stock-loan shares were transferred into treasury after the program’s breakeven price was reached, substantially reducing the share count used in Q3 EPS. Warrants with an $8 exercise price expired in March 2013.
- Near-term business outlook: Management said its U.S./Canada regional sales pipeline remained strong and expected continued growth there, and anticipated higher international licensee royalties. It warned that government-services sales in Q4 FY2013 would be adversely affected by the timing of a large contract renewal, now scheduled for Q1 FY2014. Management also expected fiscal 2013 depreciation of approximately $3.0 million and amortization of $3.2 million.
- Related-party exposure: The company held approximately $7.1 million receivable from FC Organizational Products (FCOP), in which it owns 19.5%. Long-term receivables are discounted at 15%; collectability depends on FCOP’s future cash flows. The company says it is not required to advance funds, but may do so. FCOP’s inability to pay could adversely affect liquidity and results.
- Other risks and commitments: Risks include sales trends, economic conditions, competition and new offerings, foreign-exchange movements, receivable collection, and execution of strategic initiatives. Contractual obligations totaled approximately $81.4 million, including long-term campus lease payments and up to $8.5 million of NinetyFive 5 contingent earnouts; actual earnout payments may differ. The company also disclosed potential impairment risks tied to estimates and assumptions.
Important facts for investors to verify
- Whether revenue growth and improved gross margin persist, particularly as product sales and self-funded marketing declined.
- How the government contract renewal timing affects Q4 FY2013 and Q1 FY2014 results.
- Whether NinetyFive 5 meets EBITDA earnout thresholds and delivers the expected sales and integration benefits; confirm the final purchase-price allocation.
- FCOP’s repayment performance and the recoverability of the $7.1 million related-party receivable.
- Liquidity after acquisition payments, earnouts, share repurchases, and scheduled debt and financing-obligation payments; monitor compliance with credit covenants.
- Management’s cash-tax expectations and the timing of foreign tax credit carryforward utilization.