Franklin Covey Co. 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended May 30, 2009, and the three quarters ended May 30, 2009. Franklin Covey Co. provides integrated consulting, training, and performance solutions. The reporting period reflects a significant structural change: the sale of the Consumer Solutions Business Unit (CSBU) in the fourth quarter of fiscal 2008. Consequently, the company's operations now focus primarily on the Organizational Solutions Business Unit (OSBU), delivering training and consulting services to organizations, while product sales are limited to specific international markets.
Key Financial Metrics
| Metric (in thousands) | Q3 2009 | Q3 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Net Sales | $30,645 | $59,061 | $95,629 | $207,763 |
| Gross Profit | $18,935 | $35,968 | $59,315 | $128,762 |
| Gross Margin | 61.8% | 60.9% | 62.0% | 62.0% |
| Operating Income (Loss) | $(1,233) | $(823) | $(5,331) | $10,836 |
| Net Income (Loss) | $(5,053) | $(1,482) | $(6,255) | $3,557 |
| Cash and Equivalents | $1,216 | $4,853 | $1,216 | $4,853 |
| Working Capital | $(3,282) | $5,253 | $(3,282) | $5,253 |
| Line of Credit Outstanding | $16,050 | $0 | $16,050 | $0 |
Note: Working capital is calculated as Current Assets ($39,903) minus Current Liabilities ($43,185) for May 30, 2009.
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 48% in the quarter and 54% year-to-date compared to the prior year. This is primarily due to the divestiture of the CSBU, which accounted for the majority of product sales. Training and consulting services sales also declined 18% due to economic conditions and reduced public seminar activity.
- Profitability Shift: The company reported a net loss of $5.1 million for the quarter and $6.3 million year-to-date, compared to a net loss of $1.5 million and net income of $3.6 million in the prior year periods. A $2.9 million income tax provision in the current quarter significantly impacted the net loss, reversing benefits recorded in prior quarters.
- Liquidity Position: Cash and cash equivalents dropped from $15.9 million at the end of fiscal 2008 to $1.2 million. The company utilized cash proceeds from the CSBU sale to fund a $28.3 million tender offer for its own stock. To maintain liquidity, the company drew $16.1 million on its line of credit.
- Segment Performance: The OSBU Domestic segment sales decreased 19%, while International sales decreased 20%. The CSBU segment reported zero sales as it was sold.
Guidance, Outlook, and Risks
- Outlook: Management expects continued economic deterioration to impact sales but believes cost-control measures and restructuring will improve operations. The company anticipates existing capital resources will be adequate for the next 12 months.
- Debt Covenants: Subsequent to the quarter end, the company entered a second modification agreement on its line of credit. Borrowing capacity is scheduled to decrease from $20 million (June 30) to $13.5 million (November 30). The interest rate increased to LIBOR plus 2.0%. Compliance with financial covenants (funded debt to earnings, fixed charge coverage) is required to avoid default.
- Contingencies: The company holds a $6.2 million receivable from Franklin Covey Products, LLC (the buyer of the CSBU), consisting of working capital settlements and reimbursable costs. Failure to collect this amount would have a significant adverse effect on cash flows.
- Internal Controls: The company disclosed material weaknesses in internal controls at its Japan subsidiary regarding revenue recognition and inventory reserves. Remediation efforts are underway, but disclosure controls were deemed ineffective as of the period end.
- Acquisition: The company acquired CoveyLink Worldwide, LLC for approximately $1.2 million, adding $1.8 million in net sales year-to-date.
Investor Verification Checklist
- Receivable Collectibility: Verify the status of the $6.2 million receivable from Franklin Covey Products, LLC, as this is a critical liquidity driver.
- Debt Compliance: Monitor compliance with the modified line of credit covenants, specifically the funded debt to earnings ratio, given the reduced borrowing capacity and increased interest rates.
- Japan Subsidiary Controls: Confirm the effectiveness of remediation efforts regarding the material weaknesses in revenue recognition and inventory valuation at the Japan subsidiary.
- Cost Reduction Efficacy: Assess whether the restructuring plan and cost-saving initiatives are sufficient to offset the revenue decline from the CSBU sale and the broader economic downturn.
- Tax Provision Volatility: Review the methodology for the income tax provision, which resulted in a significant charge in the current quarter despite a pre-tax loss.