Franklin Covey Co. — Form 10-Q Summary
Reporting period: Quarter and first three quarters of fiscal 2014 ended May 31, 2014; comparative income and cash-flow periods ended June 1, 2013. Balance-sheet comparisons are with August 31, 2013. Amounts below are in millions except per-share data.
Business context and results
Franklin Covey provides organizational and individual performance training, consulting, related products, and leasing. Management described the quarter as the strongest third-quarter sales performance for its current business, while noting that revenue growth was below expectations because some anticipated sales shifted to the fourth quarter.
| Metric | Quarter ended May 31, 2014 | Prior-year quarter | First three quarters 2014 | Prior-year first three quarters |
|---|---|---|---|---|
| Revenue | $47.1 | $44.9 | $137.1 | $129.4 |
| Gross profit | $29.9 | $29.4 | $91.3 | $86.3 |
| Gross margin | 63.4% | 65.6% | 66.6% | 66.7% |
| Operating income | $3.0 | $4.1 | $10.4 | $12.6 |
| Net income | $1.9 | $2.1 | $5.6 | $6.6 |
| Diluted earnings per share | $0.11 | $0.13 | $0.33 | $0.36 |
| Consolidated Adjusted EBITDA | $5.1 | $6.3 | $17.8 | $18.9 |
Quarterly revenue rose 5%, led by training and consulting services, which increased 5%; products increased 19%, while leasing was essentially flat. Nine-month revenue increased 6%, primarily reflecting service growth. Quarterly operating margin was approximately 6.4% versus 9.1%; nine-month operating margin was approximately 7.6% versus 9.7%. Lower quarterly gross margin and higher operating expenses more than offset revenue growth.
Cash flow, liquidity, and debt
- Operating cash flow for the first three quarters was $9.3 million, compared with $8.9 million a year earlier. Investing activities used $14.9 million, including $6.4 million of capitalized curriculum development, $2.3 million of property and equipment purchases, and acquisition-related payments. Financing activities used $1.3 million.
- Cash declined to $5.3 million at May 31 from $12.3 million at August 31, 2013. The company had $2.5 million drawn on its $10 million revolving credit facility, versus no borrowings at fiscal year-end. It reported $37.4 million of working capital.
- Current assets were $69.0 million and current liabilities were $31.6 million. The company also reported a $27.7 million financing obligation, including its corporate-campus lease obligation. It stated that it was in compliance with its credit-facility covenants.
- The credit facility expires in March 2016 and includes financial covenants and an $8 million capital-expenditure limit, excluding capitalized curriculum development. Management said existing resources should be adequate for at least the next 12 months, subject to business and collection risks.
Material changes, outlook, and risks
- Management said approximately $2.4 million of revenue expected in the quarter shifted to the fourth quarter: about $0.6 million related to delayed contract signing and about $1.8 million associated with a higher mix of prospective new clients attending 7 Habits Signature Program launch events. Approximately $1.0 million of the shifted revenue was recognized in June.
- Management expected a delayed large government contract renewal in the fourth quarter and cited an encouraging U.S./Canada pipeline. International licensee revenue and several national-account practices grew; government-services revenue declined. Management also expected most Education practice sales growth to occur in the fourth quarter. These are outlook statements, not formal earnings guidance.
- Quarterly gross margin fell to 63.4%, affected by higher amortization of capitalized curriculum costs, lower-margin Education coaching contracts, and the shift of some higher-margin revenue. SG&A rose $1.4 million year over year, mainly from sales hiring, commissions, marketing, and launch events.
- Management forecast fiscal 2014 capitalized curriculum spending of approximately $8.5 million, property and equipment purchases of $3.0 million, depreciation of $3.5 million, and intangible amortization of $4.0 million.
- The quarterly effective tax rate was about 20%, versus about 40% a year earlier, primarily because of tax benefits from the resolution of uncertain tax positions. The nine-month rate was about 35%. Management said the annual rate could change depending on whether prior-year returns are amended to claim foreign tax credits. A large foreign estimated tax payment was expected to be recovered in 2014.
- Unusual and acquisition-related items included a $3.5 million final CoveyLink earn-out payment, a $0.5 million Red Tree acquisition, and a $0.9 million nine-month reduction in the estimated NinetyFive 5 earn-out liability that reduced SG&A. The Red Tree sellers and CoveyLink former owners included relatives of named executive officers; Red Tree’s former owners are employed by the company.
- The company held a $5.6 million receivable from FC Organizational Products (FCOP), in which it owns 19.5%. It reported receiving $3.9 million from FCOP during the first three quarters. Collection timing and FCOP’s financial health remain relevant risks; the long-term receivable is discounted at 15%.
- Other risks cited include slower receivable collections, foreign-exchange impacts, competition, execution and acceptance of new offerings, uncertain contingent acquisition payments, and estimates underlying receivable, inventory, tax, goodwill, and intangible-asset valuations. The company reported no material changes in market risk and no use of foreign-currency or interest-rate derivatives.
Important facts for investors to verify
- Whether the delayed government contract renewal and shifted program revenue were realized in the fourth quarter, and how much of the stronger pipeline converted to sales.
- Whether gross margins recover as curriculum launch costs, contract mix, and delayed higher-margin sales change.
- Whether receivable collections improve as management expected, particularly government, Education, licensee, and FCOP balances.
- Whether cash use for curriculum investment and acquisitions remains consistent with management’s liquidity outlook and credit covenants.
- How the NinetyFive 5 contingent payment, tax-credit decisions, and any related-party exposures affect future earnings, cash flow, and disclosures.