Business Context and Reporting Period
Company: Franklin Covey Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 28, 2011 (Third Quarter of Fiscal 2011)
Business Overview: Franklin Covey is a global provider of execution, leadership, and personal-effectiveness training. The company operates through regional sales offices in the U.S., government services, wholly-owned subsidiaries in Australia, Japan, and the U.K., and licensee partners in over 140 countries. Key offerings include training based on "The 7 Habits of Highly Effective People" and "The 4 Disciplines of Execution."
Key Financial Metrics
| Metric (in thousands) | Q3 2011 | Q3 2010 | YTD 3Q 2011 | YTD 3Q 2010 |
|---|---|---|---|---|
| Net Sales | $40,897 | $30,496 | $115,791 | $92,173 |
| Gross Profit | $25,781 | $19,204 | $73,968 | $59,122 |
| Gross Margin | 63.0% | 63.0% | 63.9% | 64.1% |
| Operating Income | $2,859 | ($170) | $7,794 | $122 |
| Net Income | $724 | $135 | $1,823 | $2 |
| Diluted EPS | $0.04 | $0.01 | $0.11 | $0.00 |
| Cash & Equivalents | $1,129 | $3,484 | $1,129 | $2,210 |
| Operating Cash Flow (YTD) | $6,213 (vs $5,491 prior YTD) | |||
| Total Debt (Current + Long Term) | $39,304 (Line of Credit: $7,093; Term Loan: $2,281; Financing Obligation: $29,735) |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated sales increased 34% ($10.4 million) in Q3 and 26% ($23.6 million) year-to-date compared to the prior year. Growth was broad-based across U.S./Canada, international direct offices, and licensee royalties.
- Profitability Turnaround: The company returned to profitability, reporting operating income of $2.9 million in Q3 2011 compared to an operating loss of $0.2 million in Q3 2010. This marks the fourth consecutive quarter of improved sales and operating income.
- Government Services: Sales through the government services group increased significantly ($3.6 million in Q3, $11.8 million YTD) due to federal contracts obtained in late fiscal 2010. However, these sales have not yet been collected, contributing to a rise in accounts receivable.
- Japan Operations: Despite a two-week office closure due to the March 2011 earthquake and tsunami, Japan sales increased due to publishing sales and favorable currency translation, though training sales remained flat.
- Expense Management: Selling, General, and Administrative (SG&A) expenses increased $3.5 million in Q3, primarily due to commissions and bonuses tied to improved performance. However, SG&A as a percentage of sales declined to 51.4% from 57.5%.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management reports a strong booking pace and a pipeline of awarded revenue higher than the prior year. They anticipate education practice sales will increase in the fourth quarter. The company expects to maintain operations for at least the next 12 months using existing capital resources.
- Unusual Items:
- Earnout Payment: The company paid $5.4 million in March 2011 as the second of five contingent payments for the acquisition of CoveyLink Worldwide, LLC. This is classified as goodwill.
- Income Taxes: The effective tax rate was approximately 67-69% for the quarter and YTD, significantly higher than statutory rates due to foreign withholding taxes and taxable interest on management stock loans. Cash paid for taxes ($1.3 million YTD) was significantly lower than the provision ($4.0 million) due to the use of net operating loss carryforwards.
- Risks and Contingencies:
- Liquidity: Cash balances decreased to $1.1 million. The company relies on a $10 million revolving line of credit and a new $5 million term loan. Compliance with financial covenants (e.g., funded debt to EBITDAR ratio) is required.
- Government Funding: Future sales from government contracts may be adversely affected if U.S. federal spending legislation is not approved timely.
- External Events: Lingering effects of the Japan earthquake and civil unrest in licensee countries (e.g., Egypt) pose risks to future sales.
- Secondary Liability: The company remains secondarily liable for retail store leases assigned to a subsidiary (FCOP) following a prior asset sale.
Investor Verification Checklist
- Cash Collection: Verify the collection of the $2.2 million in government receivables mentioned as received subsequent to May 28, 2011, and the timing of the remaining balance.
- Debt Covenants: Confirm continued compliance with the Restated Credit Agreement covenants, specifically the funded debt to EBITDAR ratio and minimum net worth requirements.
- Japan Recovery: Monitor the impact of the March 2011 earthquake on future training and consulting sales in Japan, as the company anticipates lingering adverse effects.
- Tax Rate Normalization: Track the utilization of domestic net operating loss carryforwards to determine when the effective tax rate may normalize to statutory levels.
- Goodwill Valuation: Review the valuation of goodwill and indefinite-lived intangible assets (Covey trade name) given the company's low market capitalization and the potential for impairment if share prices decline further.