Franklin Covey Co. — Q2 FY2017 Form 10-Q
Reporting period: Quarter and first two quarters ended February 28, 2017; comparison periods ended February 27, 2016. Franklin Covey provides performance-improvement training, consulting, content and related products. Amounts below are in USD millions unless stated otherwise.
Financial results
| Metric | Q2 FY2017 | Q2 FY2016 | First half FY2017 | First half FY2016 |
|---|---|---|---|---|
| Net sales | $42.2 | $45.3 | $82.0 | $90.5 |
| Gross profit | $28.0 | $29.9 | $53.3 | $59.9 |
| Gross margin | 66.4% | 65.9% | 65.1% | 66.2% |
| Operating income (loss) | $(4.5) | $(0.3) | $(9.9) | $1.5 |
| Net income (loss) | $(3.3) | $(0.4) | $(7.3) | $0.3 |
| Basic and diluted EPS | $(0.24) | $(0.03) | $(0.53) | $0.02 |
| Operating cash flow | Not separately presented | Not separately presented | $6.8 | $16.8 |
First-half investing cash outflow was $6.3 million, including $3.9 million for property and equipment and $2.3 million for curriculum development. Financing activities provided $0.2 million. Cash increased $0.2 million from fiscal year-end to $10.7 million.
At February 28, cash was $10.7 million, current assets $72.2 million and current liabilities $49.9 million, giving working capital of $22.4 million. Term notes totaled $16.6 million; the campus financing obligation was $23.8 million. There were no revolving-credit borrowings, and up to $35.0 million was available on the revolver. The company reported compliance with credit covenants. Total liabilities were $86.8 million.
Changes and drivers
- Sales declined 7% in Q2 and 9% in the first half. Training and consulting services were down 5% and 9%, respectively; product and leasing sales also decreased.
- The All Access Pass (AAP) transition is a major factor: Q2 AAP contract billings were $7.8 million, versus $3.1 million a year earlier; first-half billings were $12.8 million, plus $5.5 million of related services and products. Most AAP contract revenue is deferred and recognized over the contract term, weighing on current reported revenue.
- Education Practice sales grew 15% in Q2 and 11% in the first half, supported by demand for The Leader in Me. Strategic Markets and international licensee sales declined; the China licensee transition to company-operated offices also reduced royalty revenue.
- Q2 gross margin improved slightly, but first-half margin fell 1.1 percentage points. SG&A and other operating costs rose, reflecting salesforce investment, China offices, AAP promotion, stock compensation and ERP work.
- Q2 results included a $1.5 million charge to terminate an international licensee profit-sharing agreement. The company also reversed $0.9 million of contingent earn-out expense in Q2 and $1.9 million for the first half; the related liability was reduced to zero.
Outlook, liquidity and risks
- Management expects AAP revenue deferrals and the operational transition to continue affecting FY2017 results; it expects deferred AAP revenue to benefit future periods and reduce seasonal revenue fluctuations. AAP content translation into 16 languages was expected to be completed and launched in late FY2017.
- Management anticipated FY2017 property-and-equipment spending of about $5.4 million, curriculum-development spending of $8.0 million, depreciation of $3.9 million and amortization of $2.9 million. ERP replacement could change capital spending.
- The company expects Education Practice growth, with much of the usual annual growth occurring in Q4, and said new China offices were meeting expectations. It anticipates lower licensee royalties in FY2017 after the China transition.
- Management stated available resources should support operations for at least 12 months. Liquidity depends on sales, cost control, capital spending and collection of receivables. Collections remained slower than expected for government and Education customers, licensees and certain service contracts; the allowance for doubtful accounts increased.
- After quarter-end, the company reorganized its U.S. salesforce and closed domestic sales offices. It may incur office-closure and severance costs, expected to be finalized in Q3.
- Credit facilities contain leverage, fixed-charge coverage, capital-spending and borrowing limits. The February amendment adjusted the fixed-charge coverage calculation to include 85% of changes in deferred revenue. Management warned financing alternatives may not be available on acceptable terms.
- Other uncertainties include AAP sales and renewals, contract timing, competition, foreign exchange, revenue recognition under pending accounting standards, and collection of the $3.0 million receivable from FC Organizational Products. The company received $0.7 million from FCOP during Q2 and a further $1.4 million after quarter-end.
Important facts for investors to verify
- Whether AAP billings convert into renewals and recognized revenue at a pace sufficient to offset lower traditional and onsite sales.
- Cash conversion and receivables quality, including the timing of government, Education, licensee and FCOP collections.
- Progress and final costs of the U.S. sales-office reorganization, China expansion and ERP replacement.
- Compliance with credit covenants, debt repayment requirements and the availability of the revolver as operating results fluctuate.
- The effects of upcoming revenue-recognition and other accounting standards on reported revenue, earnings and balance-sheet amounts.