Franklin Covey Co. — Q3 FY2019 Form 10-Q
Reporting period: Quarter and three quarters ended May 31, 2019. Fiscal year ends August 31. Financial amounts below are in millions unless stated otherwise; interim statements are unaudited.
Business context
Franklin Covey sells organizational training, consulting, content and education solutions. Its strategy centers on subscription offerings, including All Access Pass (AAP) and The Leader in Me, alongside training, products and international licensing. The company reported Direct Offices, International Licensees and Education Practice segments.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | First 9 months FY2019 | First 9 months FY2018 |
|---|---|---|---|---|
| Net sales | $56.0 | $50.5 | $160.2 | $144.9 |
| Gross profit | $39.7 | $34.9 | $111.8 | $100.5 |
| Gross margin | 70.8% | 69.2% | 69.8% | 69.4% |
| Operating loss | $(1.9) | $(2.6) | $(6.1) | $(11.0) |
| Net loss | $(2.0) | $(2.5) | $(6.9) | $(7.7) |
| Loss per share, basic and diluted | $(0.14) | $(0.18) | $(0.49) | $(0.55) |
| Adjusted EBITDA, non-GAAP | $3.1 | $0.6 | $7.2 | $0.5 |
Quarterly sales grew 11% (12% excluding unfavorable foreign exchange); nine-month sales grew about 11%. Q3 subscription and subscription-related revenue grew 27%. Quarterly operating loss improved despite higher SG&A and depreciation; higher sales and gross margin contributed. Adjusted EBITDA is a company-defined non-GAAP measure.
For the first nine months, operating cash flow was $18.6 versus $8.6 in the prior year. Investing cash use was $4.8, including $3.0 of property and equipment purchases and $1.8 of curriculum development. Financing cash use was $13.2, chiefly from reducing revolver borrowings and scheduled principal payments. Cash increased $0.7 to $10.9.
Balance sheet and liquidity at May 31, 2019
- Cash: $10.9, of which $9.5 was held at foreign subsidiaries; accounts receivable: $52.1.
- Current assets were $79.1 and current liabilities $82.4, a $3.3 working-capital deficit. Deferred revenue was $45.2 current on the balance sheet; the note reports total deferred revenue of $48.7 including long-term amounts.
- Revolver borrowings were $4.1, with $25.9 available. Term notes totaled about $8.1 and the campus financing obligation about $19.5. The company said it complied with credit covenants.
- Credit terms include funded debt to EBITDAR below 3.0x, fixed-charge coverage above 1.15x, and an $8.0 annual capital-expenditure limit excluding capitalized curriculum development.
Material changes and unusual items
- Revenue growth reflected subscription sales, increased onsite presentations and Education revenue, partly offset by lower legacy facilitator and international licensee revenue. Foreign exchange reduced Q3 sales by $0.6 and operating results by $0.3.
- ASC 606 adoption on September 1, 2018 changed the timing of certain international license fees and affected comparisons. It reduced Q3 sales by about $0.2, but increased nine-month reported sales by $1.4 and improved nine-month net loss by $1.6. Adoption reduced opening retained earnings by $3.1 after tax; prior-year comparisons were not restated.
- The company acquired its Germany, Switzerland and Austria licensee in December 2018 for total consideration of $1.0, including $0.8 of forgiven receivables. Since acquisition, the operation contributed $1.1 of sales and a $0.3 operating loss. About $0.8 of additional severance, legal and related costs were expected to be expensed.
- Q3 SG&A included a $1.1 increase in contingent consideration liabilities, mainly following an amendment to the Robert Gregory Partners acquisition agreement. Nine-month results also included $0.5 of licensee-transition costs.
- Education Practice Adjusted EBITDA remained negative at $(0.2) for Q3 and $(1.4) for nine months, though both improved year over year. The expiration of a charitable foundation funding commitment reduced nine-month Education revenue by $0.6 and gross profit by about $0.4.
Outlook, commentary and risks
- Management said the subscription transition was progressing well and expected most Education sales growth in the fourth fiscal quarter, consistent with historical seasonality. The filing does not provide a specific full-year revenue or earnings forecast.
- Management estimated FY2019 property and equipment purchases of about $4.9, curriculum-development spending of $3.1, depreciation of $6.5 and amortization of $5.0.
- The company expected existing resources to be adequate for at least 12 months, while noting liquidity depends on sales, economic conditions, cost control and receivable collections. It may use additional financing if needed; availability and terms are not assured.
- Variable-rate term loans and revolver borrowings carried an effective rate of 4.3%. A one-percentage-point rate increase was estimated to add about $0.1 of interest expense over 12 months. Other disclosed risks include foreign exchange, competition, subscription acceptance and renewals, and execution of growth plans.
- ASC 842 lease accounting was due to be adopted September 1, 2019 and was expected to increase reported assets and liabilities; the full impact had not yet been determined.
Important facts for investors to verify
- Whether subscription growth, renewals and remaining performance obligations convert into recognized revenue and cash flow; $63.7 of remaining performance obligations was reported, about 75% expected to be recognized within 12 months.
- How much of the operating cash-flow improvement reflects sustainable performance versus working-capital movements, including collections of receivables and changes in deferred revenue.
- Progress and profitability of the newly owned GSA operations, and the final acquisition-related costs and contingent consideration obligations.
- Fourth-quarter Education seasonality, the effect of the expired funding commitment, and the segment’s path toward positive operating contribution.
- The eventual balance-sheet effect of ASC 842 and continued compliance with credit covenants and repurchase-plan conditions.