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Franklin Covey Company (NYSE:FC)

Q1 2014 Results Earnings Call

January 07, 2013, 05:00 PM ET

Executives

Robert A. Whitman – President and Chief Executive Officer

Stephen D. Young – Executive Vice President, Chief Financial Officer and Corporate Secretary

Shawn D. Moon – Executive Vice President, Global Sales and Delivery, Government Services and Education

M. Sean Merrill Covey – Executive Vice President Global Solutions and Partnerships, Education Practice Leader

Derek Hatch – Corporate Controller, Central Services, Finance.

Analysts

Joe Janssen – Barrington Research

Jeff Martin – ROTH Capital Partners

Marco Rodriguez – Stonegate Securities

Kevin Leary – Spitfire Capital

Sarkis Sherbetchyan – B. Riley & Co.

Operator

Welcome to the Q1 2014 Franklin Covey Company Earnings Conference Call. My name is Leslie and I will be your operator for today. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Mr. Derek Hatch, Corporate Controller. Mr. Hatch, you may begin.

Derek Hatch

Thank you. First of all everyone, happy New Year. We are excited to have you on our call this afternoon. On behalf of the company, I would like to welcome you to our first quarter earnings release call.

Before we get going this afternoon I would like to remind everyone that this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management’s current expectations and are subject to various risks and uncertainties, including but not limited to the ability of the company to stabilize and grow revenues, the ability of the company to hire productive sales professionals, general economic conditions, competition in the company’s targeted marketplace, market acceptance of new products or services and marketing strategies, changes in the company’s market share, changes in the size of the overall market for the company’s products, changes in the training and spending policies of the company’s clients and other factors identified and discussed in the company’s most recent annual report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission.

Many of these conditions are beyond our control or influence, any one of which may cause future results to differ materially from the company’s current expectations; and there can be no assurance that the company’s actual future performance will meet management’s expectations. These forward-looking statements are based on management’s current expectations and we undertake no obligations to update or revise these forward-looking statements to reflect events or circumstances after the date of today’s presentation, except as required by law.

With that out of the way, I’d like to turn the time over to Mr. Bob Whitman, our Chairman and Chief Executive Officer.

Robert A. Whitman

Thanks Derek. Hello everyone. We are delighted to have a chance to talk to you today. Let me start out with saying that having just reported our strongest fourth quarter and fiscal year ever in November, we were pleased really to be able to continue our momentum during the first quarter. While as I will discuss in a moment, we had expected the quarter to be even stronger, the revenue turned out to be the second strongest ever for the first quarter for our current business and exceeded really only by last year’s first quarter.

As you can see in slide three, over the past four years, while certain individual quarters have been stronger than others, we've achieved year-over-year trailing four quarters revenue growth for every quarter. And we are pleased that this trend continued in the first quarter, whereas you can see trailing four quarters revenue increased to $190.3 million from $175 million for the same period a year before.

Our four geographic U.S. direct offices, our education practice, our sales performance practice and our global licensee partner network operations, all posted their strongest first quarter revenue ever. Bookings for these same operations were also very strong during the quarter and as a result we had our largest pipeline booked days and awarded revenue ever for the end of the first quarter.

The strong performance in these operations was offset somewhat by the decline in revenue in our government services unit resulting from the shutdown and then slower than expected restart of the federal government. This resulted in a need to shift the revenue which had been booked for delivery in the first quarter into future quarters. With larger than anticipated negative foreign exchange impact in Japan also and our decision to increase our first quarter growth investments to ensure the continuation of the strong growth in the future, this resulted in our first quarter coming in lower than we had expected.

Fortunately, the full amount of the government contract which was not utilized in the first quarter is still available for booking into the second and third quarters and much of it has already been booked and is being delivered. With this and the expected positive future impact from our first quarter growth investments we feel confident about both the direction and momentum of the business and about our previously provided annual guidance range, which I’ll talk to in a minute.

I would like to just briefly first provide some further details on the factors which impacted our otherwise really positive results in Q1 first quarter and how we expect those factors to reverse or moderate in the coming quarters. Second then review the continued progress on our key growth initiatives including our sales force productivity and ramp up and our ongoing product development and practice initiatives including the pending launch of our recreated 7 Habits offering and then finally discuss the underpinnings of our confidence in our annual adjusted guidance range.

So first just maybe quickly review the future impact that we see and the factors which impacted our first quarter. First discuss government revenue. In September, we were awarded the third renewal of a larger federal government agency content and training contract. We immediately began scheduling the delivery of millions of dollars of training days under this contract for October and November. With the government shut down in October however, this agency along with most other parts of the government was forced to reschedule essentially all of the October training days into future quarters.

As of the first week of November we saw a significant number of government training days on the books for delivery in November and the expectation of booking additional training days for November. The time required to restart government operations however turned out to be much longer than either the government or we had expected; in fact, it wasn’t really finally fully authorized until the very last day of our quarter.

As a consequence, nearly all of the training days we had booked for November under the contract together with nearly all new governmental bookings were pushed into future months and quarters. As noted, the full amount of government revenue related to that contract was not realized in the first quarter, is available to be rescheduled and delivered in the second and third quarters and as noted, training under that contract for the second quarter is nearly completely scheduled now and being delivered and the excess is expected to be booked and delivered in the third quarter.

From a foreign exchange standpoint, approximately a year ago the value of the yen declined significantly relative to the U.S. dollar. This negatively impacted our operating results from last year’s second, third and fourth quarters and negatively impacted revenue in the first quarter by approximately a $1 million. While we expect foreign exchange weakness to continue to have an impact on our operations in future quarters, at the current exchange rate its impact will be significantly less than in the last four quarters. So we’re expecting some moderation of that going forward.

The third element expected in the first quarter is the magnitude of our growth investments. Over the past several years we’ve invested heavily in growth. As you know last year we invested more than $20 million in growth initiatives and we expect to continued investment approximately as follows: First, approximately 4% of our revenue or $7 million to $9 million a year will be invested in innovation and new product development. Second, an additional 3% to 4% of revenue or $6 million to $8 million a year is invested in practice, leadership and these client facing product applications.

Third, approximately $7 million to $9 million per year in marketing these thousand or so marketing events which we have that invite clients to come and experience the content and hear the premise and another $4 million to $5 million annually for the hiring of new client partners and related sales personnel and so in the previous years we’ve investing roughly about $18 million to $20 million. So our results were after having swallowed those investments.

In addition to these ongoing investments while our sales force is paid on commission, each client partner receives a monthly draw against their commissions equal to approximate 67% of his or her anticipated commissions for the coming year based on the new sales goals that they are given and accept for that year. So with significant revenue growth we have achieved each year sales goals for our client and partners have also increased each year and with these increased goals, they receive increased draw amounts which are expensed in the quarter and which are not usually availed as they are little behind in the early quarters and they are ahead in the later quarters.

A substantial portion of all these investments I mentioned our budget as a percentage of forecasted annual revenue and our first quarter is typically not our larger revenue quarter, first quarter typically bears a larger than proportionate share of incremental investments. The flow-through of incremental revenue increases in each subsequent quarter and as you can see in slide four, a significant portion of our EBITDA for the year, a much more significant portion occurs in each of the subsequent quarters that just [follow] these investments.

This pattern has been extenuated with the growth of our education practice or almost half of its revenue occurs in our first quarter which is the summer when teachers and administrators of other school are available for training. One last note on this we invested even more in growth in this year’s first quarter than normal because of the large class of new client partners we hired right after year end. Second, because of the increased draws against commission [deriving] from our very strong growth in fiscal ’13 and particularly the fourth quarter.

Third, accelerated product development investments associated with our pending end of second quarter launch of our recreated 7 Habits of Highly Effective People leadership offering. And fourth, the decision which we made to hold a worldwide training conference at the beginning of this quarter, first quarter to make sure that everybody throughout the world was aligned around the execution of this year’s plan and off to a strong start.

These combined investments added more than a $1.5 million in year-over-year cost during the first quarter and we expect to recognize significant incremental revenue as a result of these investments in future quarters which should also increase -- result in increased sales flow-through for the rest of the year.

Finally during the fourth quarter at least from our relatively large tenant in our multi-tenant office campus expired and therefore we had no leasing revenue in the first quarter. This space is now being re-leased for a minimum of five years and nearly a 100% of the space in our office campus now under lease is with good credit tenants for the next few years.

The time required to sign and initiate the new lease resulted in about a 270,000 negative year-over-year impact on adjusted EBITDA in the first quarter and as a result of the new lease, the sequential positive impact in our second quarter and future quarters will be the same, about $270,000 for the quarter.

So just to summarize, the government revenue that got pushed off was the major reason for us missing the expectations we had and thankfully all of that revenue is still -- all of the un-booked revenue is still available for booking and now has been booked in second quarter, has been booked into the third quarter and delivered.

The yen will have and other foreign exchange will continue to have an impact, but we think less and with significant growth investments that we’ve made, we think are essential to continue our growth and they are paying off now and will continue to paying off throughout the year and the lease -- resigning of the lease will give us about $270,000 a quarter of increased adjusted EBITDA.

Now I would like to bring you up-to-date, so that’s kind of a summary of things that affected the quarter, I’d now like to bring you up-to-date on our progress on our major growth initiatives. As you know the basic premise for our growth is that we want to maintain the best-in-class content and solutions, ones that really have a seismic impact on our clients and cause them to buy and buy more and then get this in their cultures and repeat that revenue every year. And then second is to build worldwide selling and delivery organization that can scale across the world.

I’ll start with a brief report on our sales -- on the second one of those initiatives which is our sales force growth and productivity and just hit five bullet points. The first is that the size of our sales force continues to increase. Our number of client partners increase was 120 in fiscal 2012 to 147 client partners at the end of the first quarter.

Of these 147 client partner, approximately half are still in the ramp-up period and this is a great benefit for us because these client partners generate both -- generate substantial current revenue, while creating significant embedded future growth potential as they complete their ramp-up over the next few years. We’ve added 27 net new sales people since the beginning of fiscal ’13, so that’s basically in five quarters, and five behind.

We have -- as noted in previous reports our goal is to add approximately 30 net new client partners this year and every year. We want to make up also for the five, we didn’t hire last year and we’ve a detailed office by office plan for meeting this goal this year and for each over the next several years.

As you can see in slide five, adding new sales people and having them ramp up according to plan, provides us with the real opportunity to accelerate our growth, which is shown in this slide, that we’re hiring a net new 30 client partners a year and having them ramp up according to the schedule which they’ve exceeded in the past means that by year five, just hiring 30 a year, there is an extra $117 million of revenue and yet you only have one class, Class I in that slide that’s fully ramped up and so this is critical initiative for us. We’ve put a lot of effort into it over the years and this is paying big dividends.

Second, our new client partners are ramping up somewhat ahead of plan. As you can see in Slide six, during fiscal ’13 revenue from our client partners in ramp up again exceeded expectation with these ramping client partners generating $41.3 million in revenue compared with our target of $34.7 million. With the addition of our new sales manager positions in fiscal ’13, has exclusive focuses to help new client partners ramp up, we made exceptional and accelerated progress in both the ramp up and retention of new client partners in fiscal ’13. This trend continued for the trailing four quarters period with our ramping client partners’ revenue continuing to be somewhat above our projected ramp rate.

Third, the productivity of our fully ramped client partners continues to increase. From fiscal 2004 through fiscal ’13, our average revenue per season to client partners, ramped-up client partner increased from little over $800,000 to more than $1.7 million, which was a compounded average growth rate in productivity of 8%, which has somewhat exceeded our originally targeted productivity growth expectation we set in 2005.

During fiscal ’13, the productivity of fully ramped client partners increased 7% and for the trailing four quarters, their productivity continued to increase. Our retention rate for fully ramped client partners has also been very strong. In fiscal 2005, we established a goal of having an annual retention rate of approximately 95% for these fully ramped client partners and our actual retention rate has been very close to that at 94.5% in each year.

Fourth, the productivity of our global licensee partners also continues to increase. As shown in Slide seven the gross revenue of our global licensee partners on which we earn royalties of approximately 15% has increased from around $29 million in 2004 to a little over $80 million in fiscal ’13. Our royalties from these global licensee partners increased commensurately from $4.5 million in fiscal 2004 to $12.9 million in fiscal ’13. Our royalty of new license revenue from licensees continued to increase in fiscal ’13 growing 9.5% and this growth continued for the trailing four quarters for royalty and new license revenue from licensees grew 13.4%.

Finally the success of our sales growth and productivity initiatives has driven the growth of our non-government direct offices in the U.S. and of our national account practices. As you can see in Slide eight, over the past three years, revenue in our non-government U.S. direct offices increased $25.5 million from $54 million to almost $80 million, which is a compounded average growth rate of 13.7% reflecting these ongoing investments in growing our sales force. As also shown in Slide eight, during the same period, revenue in our national account practice which include our education sales performance and customer loyalty practices grew $15.3 million from $19.4 million to almost $35 million a compounded average growth rate of 21.3%.

This growth continued for the trailing four quarters for revenue and our non-government direct offices grew $12.7 million or 14% and as shown in Slide nine, revenue in our national account practices grew $11.7 million for the latest four quarter or 42%. We expect to achieve -- continue to achieve significant growth in both our direct offices and national account practices again in fiscal 2014 and for the rest of the quarters in ’14.

So I’ll give just a really brief overview of our progress, on our quality results for clients’ objectives, as we call it, the quality of our solutions and our delivery. We’ve made significant progress on our quality objective over the past years and this progress continued during the first quarter and for the trailing four quarters. We measure progress in this objective along several dimensions, [which of note] are high revenue renewal rates, pricing power of our offerings and the growth of our various practices.

First, revenue renewal rates, our revenue renewal rate remained very high in fiscal 2013 with approximately 90% of our revenue from fiscal ’12 repeating in fiscal ’13. And for the trailing four quarters again, approximately 90% of our revenue from the same period last year repeated in those trailing four quarters.

Second, pricing power; the quality of our best-in-class branded solutions continues to provide us with pricing power across all of our various delivery modalities. As a result, as shown in Slide 10, our gross margins increased steadily over the past years and quarters. This trend continued in the first quarter and for the trailing four quarters with our gross margin increasing to 68% from 66.1% in the first quarter of fiscal 2013.

Third and final, the growth of our practices as shown in Slide 11, since 2005 each of our seven practice areas has grown significantly. And as you can see in Slide 12, during the trialing four quarters, we achieved significant revenue growth across almost all of our practice areas, with education growing 56%; execution, 29%; sales performance, 26%, including that position of the NinetyFive 5; trust growing 23%; productivity, 11% and customer royalty, 6%.

Revenue in our leadership practice decreased 17% from the trailing four quarters reflecting both the emphasis on our trust practice. It’s client and leadership practice revenue related to the expected decline in revenue from the large government agency contract and the focus of our leadership practice among the refinement and pending launch of the recreated 7 Habits of Highly Effective People offering beginning at the end of this year’s fiscal second quarter which of course we are in.

This is one of the most important product recreations ever for us. Just one that -- with all of the success we’ve had with new product launches and we’ve been forcing as you see from the growth of all these practices we’ve had success. In each stage these have been primarily in the past these have been primarily launches, they are U.S. based with the exception of the productivity offering which was global. But there is no offering that’s more global than 7 Habits of Highly Effective People. So this launch for us represents an opportunity to have a truly global launch and something that can have a big impact.

And I am going to ask Sean Covey and Shawn Moon to discuss this new offering and the worldwide marketing launch initiatives associated with it in just a moment. We expect launch of this new offering to drive strong growth in the leadership practice revenues during the second half of fiscal ’13 -- ’14 and beyond.

Finally, our outlook; each of our key momentum indicators continues to be very positive. And the momentum in our business continues to be both strong and broad-based. As you can see in slide 13 our pipeline of book days and awarded revenue which is a measure of business already booked or awarded in our five direct offices in U.S. including our normal government business but excluding large government contracts, and in Canada, our national account practices grew $3.3 million to $31.5 million at the end of the first quarter. This reflects a 12% year-over-year increase compared with the $28.2 million pipeline we had at the end of the first quarter of fiscal 2013 and represents our largest ever first quarter pipeline awarded revenue and booked days.

The government contract pipeline of booked days and awarded revenue which is specific to this one contract declined $2.2 million, is 39%. This decline is related mostly to a change in the contractual front time frame for this contact to five months instead of 12 months which resulted from the sequestration of the government last year. And so we expect that later in this year we’ll add a significant amount of pipeline when the renewal comes up again. We hope to add -- we hope to win the renewal again, add substantial new pipeline business there.

Our prospective business pipeline is also really strong. And this is a measure of the amount of potential new revenue currently being discussed with some both existing and potential clients has increase significantly during the quarter compared with last year and reached record levels in all of our U.S. geographic offices, our direct offices in Japan, Australia and UK and then our national account practices.

These perspective business pipeline are staged earlier in the business process than the actual contractual pipeline that we discussed that historically have been very strong predictors of the likely strength of our future bookings and revenue. In fact the conversion of this large prospective business pipeline at the end of the first quarter has already begun to translate to significant new contractual bookings and revenue in our second quarter.

So overall we are very encouraged by the momentum we are continuing to see in the business, and the continued growth in the size and productivity of our direct sales forces, the growth of our international and global licensee partner operations and despite the shifts in revenue during the first quarter of our government business by the overall momentum and trajectory of our business as a consequence we reaffirm our fiscal 2014 full year adjusted EBITDA guidance range of between $35 million and $37 million.

I’d like to just make two notes and then just turn the time over to Shawn. First is that as you think about the shift of revenue from the first quarter almost all of the government revenue which shifted out of the first quarter will be recognized in the third quarter since much of our second quarter bookings alludes to that contract that are already in place. So we started booking not only in place October, November also got it in place with the second quarter, the first quarter shifted and we didn’t had room in the second quarter, it will move into the third quarter. We already had strong second quarter that’s the first point.

The second is because we are confident that our strategy, direction of momentum we are going to continue to make significant growth investments in new sales people, marketing, product development every quarter. As a consequence of revenue shifts earlier as it did in the fourth quarter we picked up some revenue from the first quarter or later as happened in the first quarter it can have an impact on an individual quarter without effecting your confidence or performance for the year.

So with that I just like to again express the appreciation each of you could join us today. We’ll have a longer than normal opportunity for question and answer. I am just now going to Sean Covey to provide a brief overview of the efforts to recreate the 7 Habits and then Shawn Moon can provide an overview of our significant worldwide launch activities. Sean?

M. Sean Merrill Covey

Okay. Hello everyone this is Sean Covey. Good to be with you. I’ll just give a quick overview of what’s happening in product development. I’ve been in product development now overseeing it for the last 20 year at Franklin Covey and so I am very excited to come out with the new 7 Habit signature program and its family of products. We coined this re-creation because it's much bigger than an upgrade as we significantly do and we expect to see great results from this. It will come out in March and we think that we are going to see impact on this over the couple of years in a big way.

So a little bit of context about this product. This is a three day program and this is our single largest best-selling products in the world that we have right now. Internationally it accounts for about 50% of the products that they sell. So it’s even bigger internationally because the other packages haven’t, not grown as much there as of yet. It's a three day program as I mentioned. We also have one day version of it and so forth and it's meant to help individuals become more effective as well as helping keep innovations and improve their performance by improving their cultures.

To put in perspective as well we’ve done over the last 20 years about 1 billion in sales of this solution. So this is a very big new thing for us. Consistently we find that this program is ranked amongst the highest if not the highest of all the programs that our clients teach. We win awards with it consistently. You could argue there is no official statistics kept on this you could argue this is really the most successfully leadership development program ever created and it's been about eight years since we last upgraded the program and so we are excited about this.

In the last two years we’ve been working on this. We started by gathering a lot of feedback from clients around the world we asked them what’s working what’s not, what could make this better. We did a lot of research around it. We’ve been working on this for about two years and spent millions of dollars to try to perfect it. We’ve done a lot of beta tests around the globe to try to make it better and get input and feedback to make sure it's really and truly a global product. So from all this feedback that we gathered we implemented this and we’ve created we think an extraordinary offerings and a family of offerings for that matter.

What’s new and improved about it? Well, two things stand out. One, the big picture on this is, impact, we really wanted to take this from the idea of taking a leadership development course to really living it and applying it to helping transform individuals as well as really making it different at the team level and at the organizational level.

So as part of this we’ve developed a companion product with this that we’re calling leader implementation. It’s all around helping organizations that really want to have cultural impact take the 7 Habits and institutionalize it by certifying all of their managers and leaders on how to apply the 7 Habits at the team level, how to model it, how to coach around it, how to improve performance, how to get effective feedback and give effective feedback.

So the whole idea is really applying and institutionalizing this. As part of this we went around the world and found several organizations that have literally transformed their companies using the 7 Habits as a key tool and we highlight these companies and show how they have done it and how they can do it better at their own companies. We have a lot of technology in this new workshop, we have a new Living The 7 Habits app that you can download that will track your progress, that will give you daily reminders and tips. There is a great contract; a 49 day contract you can take that is a regimen on how to apply the 7 Habits over these 49 days.

There are many new video illustrations inside the program. We use video a lot because it helps create a center line that is replicable so the clients can teach this and we do the train the trainer programs. We offer a lot of videos so clients can great impacts in their teaching, in their efforts. We have many new videos inside the program, great new illustrations. We have got one new video for example on the London Royal Valley and how they create such great shows and students again and again and how they do it.

We’ve got videos on the orchestra. In South America, they have created instruments out of a landfill and how the community went about doing this and the way it transformed their community and we have got many new videos and illustrations to back up all the key teachings that we have in this program.

Finally, we have a lot of new skill and drill. This is one of the areas of feedback that we heard from our clients that people wanted more practice less theory and so we’ve really shifted the emphasis from theory to practice, more coaching, more role playing, more skill and drill. So when you package all of this together we think this is a real big recreation as we call it or upgrade and as I mentioned before, I’ve been in this role for quite some time and Franklin Covey is known for producing best-in-class solutions and we have reputation for always having the top products in the category and I believe this is the finest offering we’ve ever created over the last 20 years and this has been evolution because we’ve gotten better and better at product developments and I think we’ve been able to apply all of those the learning and skills to create something extraordinary.

So this, as I mentioned, will be coming out in March just in a couple of months from now and we’re excited about the impact.

Robert A. Whitman

Thank you Sean and Shawn Moon if you want to talk about, briefly talk about how this worldwide launch is going to roll out through starting now and through the end of February, and just preceding launch.

Shawn D. Moon

I would be happy to, thanks Bob. So first of all, I would like to say that the field is remaining focused on the -- what we call the sales go-to-market strategy which really is targeted around face-to-face meetings and our ongoing marketing events and our sales management and task substitution that is associated with all of that and that really has been the catalyst behind the continued growth of our pipeline. We’re excited about that and we are maintaining our focus of that. And as part of this, we are in the middle. In fact, I am calling you from frozen Chicago right now because we’re in the middle of our pre-launch to all of our sales staff meeting region-by-region team-by-team introducing them to this new product and offering and sales strategies around all of this.

We are in the process of launching globally 7 Habits marketing events in 250 cities around the world. All of those will take place over the next nine months. In that tour we’re calling a tour and we’ll showcase the solution to about 20,000 individuals, influencers and decision makers. And the goal is to certify north of a 1,000 facilitators through this process by August 31st. We also anticipate that, that will build a pipeline in excess of $20 million on this product alone.

We’re very excited about that we have -- we are doing this in this quarter. We are starting this process where we have about 60 cities between U.S., UK and Australia and so we’re starting this process now and we’ll -- our goal is to certify somewhere north of 480 facilitators in this quarter, in this product. This is the process and methodology that has been very successful in the past, in previous launches and we’re taking that model that has worked not just in the U.S., in Canada and UK and Australia in this quarter which we are doing but applying that worldwide over the next nine months.

I just have to report on the level of the excitement that we’re seeing from the field. We are very, very enthusiastic about this new offering. As Sean mentioned we believe this is the finest offering that Franklin Covey has produced and the sales force is very, very enthusiastic about it. We’re only half way through by the end of the week we’ll complete that process.

And we’re having a region-by-region opportunity to create specific strategies. We implemented before the holiday a goal to fill about 400 to 700 seats in these first 60 events. We’re very pleased to -- the momentum there we are currently at 1,200 registration for those events. So we’re tracking a little bit ahead of the game, very exciting start and we believe that this will have not just significant impact this quarter, but on our year overall; so very enthusiastic about it.

Robert A. Whitman

Thanks Shawn. I think at this point, we’ll open up for questions. And Steve Young and all of our senior management team should be ready to respond to anything you have.

Question-and-Answer Session

Operator

Thank you. We’ll now begin the question-and-answer session. (Operator Instructions) Our first question is from Alex Paris of Barrington Research. Please go ahead.

Joe Janssen – Barrington Research

Yeah, thanks for taking my question. This is Joe actually for Alex. And Shawn let me welcome you to Chicago it’s pretty cold here.

Shawn D. Moon

It’s delightful.

Joe Janssen – Barrington Research

Let me just focus on a couple of modeling questions. Bob, I just wanted to try get this right. I appreciate all your commentary around the quarter versus expectations. I think it’s explaining with the large government contract etcetera. Just so I am getting this right, that the impact of the contract which pushed to Q3, FX, I think you have one more quarter of where it impact you and it's somewhat, call it normalizes in Q3 and beyond. And the loss of revenues from the lease is going to reverse next quarter and beyond. Is that right?

Robert A. Whitman

Yes, yeah, this quarter, yeah that we are in right now.

Joe Janssen – Barrington Research

And then I am just curious, in your press release you mentioned other postponed government work and I think you’ve kind of alluded to it in the prepared remarks and that’s dependent, the resolution of that’s dependent, I guess uncertainty is still going on in government operations. How big of an impact is that exactly?

Robert A. Whitman

I will let maybe Shawn Moon, if you like to respond to that, it would be great.

Shawn D. Moon

So, when the -- two parts to that, Joe. The government, the large contract that we had, that first one expired at the end August 31 and expected renewal of that was September didn’t renew until October which we were thrilled with, because we can condense our delivery and when that -- with the government shutdown that just put that off. We ended up delivering exactly one day, the very last day of November and we anticipated $1 million.

So that as Bob talked about, that was the impact of that particular contract, but the sequestration and the shut-down of the government really brought our entire government business to a halt. It wasn’t even the people wouldn’t purchase from us, there was such skittishness with our buyers that they wouldn’t even meet with us. There was such uncertainly and it’s a different sales environment in the government to begin with, that even after the government came back online, it didn’t mean that all of their strategies and plans and everything just picked up right where they left off. In fact it took them a good six weeks to get back into gear.

And so it was a very frustrating time from a government perspective. We are very pleased that a budget has been passed and that we -- we are seeing momentum and good meetings and lots of interest. We anticipate this new offering that has always played well and been a strong offering for the government, we expect it will have a continued level of interest there. And so the momentum has really -- has started back up again. But it did take the wind out of the sales for that particular buying group for more than just the nine days that the government was shut down.

Robert A. Whitman

With the budget in place now, Joe though it starting to thaw and I think people now recognize and they know what they have to deal with. Just also may be Joe just refining one response on the yen related impact, the major devaluation occurred at the end of December last year and it had a big impact on the whole year. I mean almost $3 million or little more than $3 million of revenue was lost and say half of that in EBITDA as a result of the yen.

Thankfully we are now anniversaring that starting in January, so now the incremental impact should be less but the end result will decline a little further which affected us in November as well. And so we think it will still have a negative impact in at least at the current exchange rate will have a negative impact just will be -- may be half of the impact we had last year so it will feel better.

Joe what’s…

Joe Janssen – Barrington Research

And to a lesser degree Q2 and then somewhat normalized in Q3, okay.

Robert A. Whitman

Joe I want to comment on the government business if I’d like.

Joe Janssen – Barrington Research

Sure, go ahead.

Robert A. Whitman

While their shutdown was really devastating to that particular team in the first quarter, it may have actually been one of the better things that happened in the longer term because of the pressure that was put on our leaders to actually pass a budget and not just kick the can down to really 30 days or 45 days as what they’ve historically done. So the fact that we now have a budget in place for two years, there is still some uncertainty and we still have some issues there, but the pressure that was applied in the first quarter and hurt us in the first quarter actually helps us down the road.

Joe Janssen – Barrington Research

Okay, great. And then one last question I’ll turn back in queue. The net new 17 CPs hired that was in Q1 right?

Robert A. Whitman

Yes.

Joe Janssen – Barrington Research

And then just refresh my memory, how does that compare from Q1 of last year and then secondly I guess given you are more than 50% of where your goals, any reason why you couldn’t go above? Is there any limiting factor that wouldn’t allow you to go to say 40%, I know this is a high number or even 50% is…

Robert A. Whitman

Let me say that what happened is that if we reported in November some of our hiring occurred right towards year-end for last year as well and so between the hiring we did in last fiscal year is it turned out we wanted to hire right before the big sales training conference and so a lot of those people fell in. So that is really more of last year’s number than this and we were behind a little bit on that. And so we tend to hiring classes so the next big group of people will be hired between now and mid-year and the remainder between mid-year and the end of the year.

So I think for us, we wanted to hire net 35 new people this year, but the 17, most of those really account as part of last year’s hires because they were hired immediately following the end of the fiscal year.

Joe Janssen – Barrington Research

Right, the net 35 encompasses five from the previous quarter.

Robert A. Whitman

Yeah, picking up the five we missed last year, which was just timing issue, somebody accepts an offer and then there has been a lot of moves and they can’t take the assignment and things happen.

Joe Janssen – Barrington Research

That’s good. Thank you for taking my questions.

Robert A. Whitman

Thanks Joe. Keep going.

Operator

Our next question is from Jeff Martin with ROTH Capital. Please go ahead.

Jeff Martin – ROTH Capital Partners

Thanks, good afternoon guys.

Robert A. Whitman

Hi, Jeff. How are you?

Jeff Martin – ROTH Capital Partners

I am good, how are you?

Robert A. Whitman

I am okay.

Jeff Martin – ROTH Capital Partners

Could you give us some insight into what you think the sales cycle will be for the new 7 Habits offerings? In other words, I am trying to get at when will we really start to see the impact from that on the revenue side and what kind of growth do you expect at our leadership as a result over the coming year?

Robert A. Whitman

Here is fundamentally what will happen is we think Jeff is this. Shawn noted it will start in March; actually it will start February 22nd. So what we are doing right now is building these events, these first 60 events will happen between now and the end of February, mid-February actually and this is primarily a lot of our existing 7 Habits facilitators.

In last year’s second quarter we had a project management launch and some other facilitator initiatives. We’ve pulled off on anything but this and so we’d expect to do somewhere between $3 million and $4 million of revenue in 7 Habits in this quarter primarily through our existing facilitators and that would represent growth say of $1 million in that particular channel -- facilitator channel for this quarter.

By year end we would think that we’d have certainly with say $3 million to $4 million in the second quarter, that number will be probably $4 million to $5 million in the third quarter and even little more than that in the fourth quarter. And so we’d expect that the year-over-year growth in the product line will be north of $5 million in the back half of the year with the thought that it will be about -- it is at about $10 million next year and so with that, the other factor will continue to grow on their own.

These multi-year launches the idea is to launch these things so that then they are growth business without having to have big launches. We’ve just held up on this one for a few years to make sure that we -- that when we launch, it really could be a global product. But that’s the kind of impact just $5 million of incremental this year, $10 million incremental next year and a truly global success is our goal.

Jeff Martin – ROTH Capital Partners

Okay. And with the other practices, are you running the same number of events as last year and more events. How are you keeping an eye on the ball with some of the other practices that are going on?

Robert A. Whitman

It’s a great question. Every Monday morning we review the pace of these events. And what we’re doing is we’ll hold probably about 9% more events this year than last year but what’s happening because we have a lot of new sales people and because a lot of marketing programs we will tend to put more people into these programs and it will benefit more sales people and so a single event, multiple sales people can bring their clients to it and have the effects. So we think we can get the kind of as you’ve seen in our U.S. direct offices we’ve had mid-teens growth over the last years.

We think we can achieve that again this year, on top without 15% increase in events. It will account for about third of our pipeline the rest is just ongoing face-to-face calls. So it plays an important role but not the exclusive role in our go-to-market strategy.

Jeff Martin – ROTH Capital Partners

Okay. And then in Q1 your international license revenue was up a little bit but definitely a slow growth than you have seen in the trailing four quarters. Do you think that’s part of the reflection of people holding back waiting for the 7 Habits update and should -- and also what are your expectations for international license as a result of this re-launch? I would imagine that they’re pretty optimistic?

Robert A. Whitman

Yeah we have Sean Covey, he oversees that?

M. Sean Merrill Covey

Okay, hi. So I am not real worried about this 1% growth in the first quarter because last year we had a large contract in Brazil that was in advance, that didn’t repeat this year, around 2 million and so that will flow through over that couple of years. But if you take that out we grew at about 8%. If you take out foreign exchange impact we grew at about 10%. So we feel like the operational health of the licensing network as a whole is pretty strong at 10% for the quarter if you take out a few factors. So I am not, I don’t feel like there has been any significant bump at all in the ongoing performance of the licensees.

And in terms of the product launch it will have a big impact and it will take a little longer than you asked because we’ll launch this as Bob mentioned at the end of February, globally in English, and so India and Singapore and South Africa will get it in English and immediately it will have some impact but the majority of the countries speak other languages. And will take us three to six months to localize and translate the product.

So I think we’ll see some impact this year and a lot more next year. It will be higher leverage because again half of their sales are The 7 Habit. They know how to sell it well, they are in love with it, The 7 Habits, this is where they began and so I think the impacts are going to be significant and I am very encouraged by that. I think it won’t be as impactful this year as it will in the U.S.

Robert A. Whitman

Jeff you asked -- these questions are very insightful, just because of -- I think for us our planning process around product launches et cetera is exactly you are suggesting. We want to make sure that every practice is growing double-digits every year in perpetuity. Part of that is the product redevelopment and investment we have ongoing. So there will be new additions, module, things that people have to bring out to strengthen the solutions every year, part of the event strategy and part of the growth of the sales force and to reach that kind of integrated plan with the between the channels and the practice and they work together to accomplishing objectives.

Jeff Martin – ROTH Capital Partners

And then one thing Bob I wanted to ask you is you talked about getting more involved with the international license partners. That’s something I think you didn’t address in your commentary. I was just curious if you can give an update on how the progress is coming along and where you think you are versus where you are wanting to be?

Robert A. Whitman

Great. Yeah and Sean why don’t you take the first shot at it?

M. Sean Merrill Covey

Yes, sure. Yeah, so what we’re trying to do as I mentioned that’s the strength and the weakness right, the 7 Habits is half of the business internationally that’s great and yet, you’ve got to grow your practices that’s the big opportunity one of our biggest growth opportunities. So what we’re doing is, we’re taking it practice by practice and inside the practice, we’re creating global practice leaders, okay. So like in execution we now have for the first time, somebody that is part of the practice that’s focused solely on the partners international licensee and we’re going to do it instead of trying to boil the ocean, we’re going to focus this year on five of our largest partners, who are ready for, to launch and grow execution.

We’ll start there, spend most of our efforts trying to get those five down and in the next year we’ll take on another five and that’s the plan for each of the practices. So execution is beginning this, we will do the case. Education is also doing the same thing, we’re going to be over time doing the sales performance. With the launch of 7 Habits, we will have a lot of focus internationally. So this is the plan. We start getting double digit growth in each of the practices internationally by expanding the practice support so you’ve to focus internationally. And again this is one of the ways we are going to grow to our $200 million target by 2020.

Robert A. Whitman

And licensing…

M. Sean Merrill Covey

And gross licensing revenue. So…

Jeff Martin – ROTH Capital Partners

Okay.

Robert A. Whitman

Have you got response to that Jeff?

Jeff Martin – ROTH Capital Partners

Yeah, that’s helpful. Thanks. And then not to monopolize the Q&A but if I could ask one more question Bob on NinetyFive 5, could you give us kind of progress report, I was real surprised to see how we’re working on consideration, given it’s fairly recent acquisition?

Robert A. Whitman

See first of all, we feel very good about the acquisition and the pipeline is significant. They had a good first quarter, we expect they will have a strong second and third and fourth quarter. So I think from that standpoint we feel good about it. We had set some targets for the practice earlier on as part of their earn out that said, we had our base earn out payments based on the business plan that we signed up on. We also had some accelerated payments slate of our own if we -- it came right out of the box and not recover off the bulk, they ultimately make it earn some of those latter ones but I think it’s started off strong but not strong… it started off in line with what we had thought it would, but not at the ring the bell kind of level and so maybe Steve can speak to that.

But fundamentally the practice feels really good. We met with their whole practice here recently a month or so ago, the whole practice team, they’ve got a lot of strategic business going, they have won five new contracts they have a potential to be truly significant. They increased their forecast several times this last quarter and so we feel like they are getting their feet underneath them. I would say, that they and we were more optimistic about the first three months, the next three months we are on track and now they are starting to move a little bit ahead of kind of what our expectations are, so I don’t know Steve, if you want to add anything to it.

Stephen D. Young

Bob, I just agree with what you said. We came out of the gate in a good position, not quite the ring the bell position, the $500,000 bring back is a valuation of the entire remaining earn-out. So that is driven to a great extent by how you come out of the gate as opposed to so much on how we believe it’s going to earn-out. So in the new accounting, as you know, we have to value the entire remaining earn-out potential at the end of each quarter and that’s where that 500,000 -- well, it’s actually a P&L benefit from looking at the value of the remaining earn-out.

Robert A. Whitman

But that’s 500,000 against potential earn-out and 12 or so million and so we’re really -- our guarantee payments we are re-evaluating them and they may not get all the way to 12 but it’s going to be good.

Stephen D. Young

Yeah.

Jeff Martin – ROTH Capital Partners

Okay. So a bit of aggressive earn-out initially and it’s performing to your expectations.

Robert A. Whitman

Yeah. So just one last comment, I think it’s more of the integration of the offerings the two offerings were made to fit together but they have never been sold together. And we know that it takes a long time to sell it, sell any new offerings and I think that’s all that really happened on it.

M. Sean Merrill Covey

Yeah we do had new to speak and Shawn you could speak we have some new -- in this practice feeling exciting that things really we’ve never really had a facilitator license facilitator base selling this product even though it makes so much sense in a sales force to have sales leadership and sales can be trained. We never productized the offering that was more consultative then product type. And so we have really spent -- we’ll have three modules by the end of this quarter. We have one up and going now, two more modules in the first form in middle of that will be delivered this quarter. And we think this will give a new base for providing existing clients with tools for implementation as well as an alternative delivery method w which you know in rest of our business delivers 45 million of revenue a year none of it’s self performing. So we are really very excited about it and so like we are now the interactions of it.

Shawn D. Moon

And Bob if I can just comment that if there is an accomplishment in the first part of this integration that is most were of celebrating is the fact that we were able to complete one of the facilitator modules that we’re selling and getting great traction on and as Bob mentioned in the coming six weeks or so we’ll have two additional one’s. So that really represents offerings that has never been productized in this way, that coupled with the electronic tools really revolutionize it's how we r able to go to market like this so we are very excited about that.

Jeff Martin – ROTH Capital Partners

Great thanks for the detail, appreciated guys.

Operator

And our next question comes from Marco Rodriguez of Stonegate Securities. Please go ahead.

Marco Rodriguez – Stonegate Securities

Good afternoon guys. Thank you for questions. Hey, most of my questions have actually been asked and answered, just a couple real quick follow up to just a clarification. On the government business I heard a couple of different numbers were the impact of since I heard a $2 million impact in prepared remarks, and then I think I heard Shawn say a million as well. I am just trying to quantify what was the negative impact in the quarter for the government business?

Robert A. Whitman

A million and a half. No, it just happens to be -- that’s the number.

Marco Rodriguez – Stonegate Securities

Okay that’s perfect and so that million and a half you are expecting to book the vast majority let's call 80% plus in Q3 did I get that correctly?

Robert A. Whitman

Yeah most well yeah the portion is got pushed out and the majority of that will go in Q3, let me step back the total size of contracts just over $5 million on the last day of the quarter they purchased intellectual property for us and it’s a little over a million and then the rest of the contract then was not -- none of that was delivered and so the rest of that covered roughly $4 million, 3.8 million will be delivered in second and third quarters.

Marco Rodriguez – Stonegate Securities

Okay. But you are going to have an extra million and half in Q3 that what didn’t show off in Q1 correct?

Robert A. Whitman

Yeah.

Marco Rodriguez – Stonegate Securities

Got it, okay. And then in terms of the ForEx impact just kind of looking again at your prepared remarks in the press release. It looks like maybe I misinterpreted the ForEx impact was about a million higher than you are expecting?

Robert A. Whitman

The impact in the first quarter of the foreign exchange was about a $1 million but from November 1st when we forecasted would be flat to slightly down. We’ve had with another $150,000 or so our bottom line impact from foreign exchange during the quarter. So the primary things with the push off with government but we also had the 150,000 or so of bottom line impact for FX incrementally in the first quarter.

So total impact is million on revenue, bottom lines for the quarter, was that’s got $300,000 or $400,000 for the total quarter. So it's a 400,000 for the quarter Marco total FX impact with the incremental from November 1st of the ending more than a $160,000 range.

Marco Rodriguez – Stonegate Securities

Okay got it, thanks a lot guys.

Robert A. Whitman

Thank you very much, Marco.

Operator

Our next question is from Kevin Leary with Spitfire Capital. Please go ahead.

Kevin Leary – Spitfire Capital

Good afternoon, everybody. First question is on international direct. Even if I add back the $1 million or so that was FX related revenue is still down call it $1 million. I know there has been some talk about the new dealership offering coming out. And I am just wondering is all of that decline waiting to unleash the new leadership offering or is there anything else underlying dragging down that growth?

Robert A. Whitman

Shawn you want to respond first?

Shawn D. Moon

Yeah there is a couple of things. The new leadership offering is one thing. Second we had significant opportunities, that we actually moved forward into the fourth quarter of last year and that was something that had may be a disproportionate impact in those offices then some of the direct offices in U.S. and Canada.

And we had a leadership change in our UK operations as well and that was one that was a little bit disrupted but very pleased with the direction of the new leader, so a combination of those things.

Robert A. Whitman

Going forward, the impact of 7 Habits launch will be more profoundly positive in those options because historically that’s been the majority of what they’ve sold, in Japan starting in June when the translations completed immediately. In the UK and Australia we expect the impact in this quarter.

We had about, we were down some hopefully it was -- been working on big deals sometimes they ship late and sometimes they ship early in this case two deals, two particular deals in Japan with that $140,000 moving into the fourth quarter.

Kevin Leary – Spitfire Capital

Got it. And I think I heard earlier that about 50% of licensee revenue is leadership. Is it kind of equivalent international direct or is it a different ratio?

Robert A. Whitman

It is equivalent, may be a little higher.

Shawn D. Moon

Yeah may be a little higher particularly in Japan where it’s higher than that.

Kevin Leary – Spitfire Capital

Got it, okay. And then second question just balance sheet related may be for Steve. Looking at cash it declined about $10 million during the quarter and it looks like most of that is a reduction in accrued liabilities. Can you just kind of bridge me through the fourth quarter of last year the first quarter of this year and what drove to the pay down what those different accounts for?

Stephen D. Young

Sure. There is several impacts in cash only back up just a little bit. The primary reduction is related to the payment of our year-end commissions and bonuses. So all of the executive team as an example is paid an annual bonus the same as in many companies so at year-end that’s accrued and it’s all paid in the first quarter. So since last year was a good year than those are reasonable amounts. Additionally, since our Q4 results were -- sales results were good the amount of our accrued commission at the end of the year are higher than any other month and so those are paid in the first quarter.

So if those types of payments. Additionally impacting our cash balance we paid $1 million in acquisition payment related to NinetyFive 5 because of our 7 Habits work. We had $2.7 million of capitalized development payments which is a high amount for quarter very valuable et cetera but it’s higher than the normal quarter of capitalized development.

And then because we allowed the net exercise of share based compensation awards that vested, we actually paid just over $3 million in the purchase if you will have of shares because of share-based compensation award. So the combination of all of those things impacted our cash balance.

Kevin Leary – Spitfire Capital

Great, that’s helpful. Thank you. And then lastly the new lease that was signed the new sub lease that was signed is that at a similar rate so once you guys get back to a run rate lease revenue will it be similar to what you’ve seen in the past?

Stephen D. Young

Yes, it is about at the same rate…

Kevin Leary – Spitfire Capital

Okay, understood. Okay, great. Thanks for taking my questions.

Robert A. Whitman

I might just add on this -- let me just add on this cash point. The other thing that impacts our cash balance any period is obviously our receivable balance. And just note for everybody that our receivable balance well high at the end of the quarter we believe is - the information we have -- $9 million at the end of quarter.

Operator

Our next question is from Sarkis Sherbetchyan with B. Riley & Co. Please go ahead.

Sarkis Sherbetchyan – B. Riley & Co.

Thank you. Most my questions have been answered, one quick clarification. So our overall sales in Q1 generally consistent with your internal expectations or were there some surprises beyond the government shutdown that impacted the results. Thank you.

Robert A. Whitman

Yes, generally they were in line with our expectations with the exception of some of the -- you work on these larger deals and as we mentioned last quarter’s call there is about a million and half or so of large deals between Japan and U.S. that got moved end of the quarter, but otherwise our booking pace and everything was as expected and so really with the exception of the international direct offices which we’ve spoken about, change of the booking, the revenue everything else was really on-track with expectations in the first quarter, in some cases somewhat ahead.

Sarkis Sherbetchyan – B. Riley & Co.

Okay, that’s helpful and then one housekeeping item. Is it possible to break out the cost of goods sold by line item that will be pretty helpful?

Stephen D. Young

By line item…

Robert A. Whitman

Yes we are going to Derek Hatch will answer.

Derek Hatch

So you are talking for trading and consulting services products in leasing?

Sarkis Sherbetchyan – B. Riley & Co.

Yes.

Derek Hatch

Yes cost of goods sold for training and consulting services were $12.414 million; products was $506,000 and leasing was $467,000 that’s a total $13.387 million with gross profit of (inaudible) for the quarter.

Sarkis Sherbetchyan – B. Riley & Co.

Thank you so much, that’s helpful.

Operator

Our next question is from Johnny Wilkerson, private investor. Please go ahead.

Unidentified Analyst

Yes, thanks for taking my questions and I was hearing your commentary for Q4. There was considerable discussion about the education practice and specifically the role of the Lead in Me program in that. Could you talk a little bit about how that impacted the Q1 and how you see that going forward for the balance of the year?

Robert A. Whitman

I will let Sean do that.

M. Sean Merrill Covey

Sure yes, so few years ago we grew the education practice was at 40%, last fiscal year we grew at 65%. First quarter of this year grew at 24% and then so the growth continued strong and we have a large -- the thing is encouraging as we are giving large and larger contracts with that district level we’ve been talking to some leaders at the state level education leaders of the state level. So we have over 2,000 leader in these schools now and about 1,800 in United States and the other 200 at outside.

We have major growth initiatives going on in the several foreign countries like Brazil and this year we’re focused on getting a large education partner established in China. So the momentum is strong and we continue to hire we’ve gone from like six sales people to over 20 now. And so we expect good solid growth and don’t see anything slowing down at all in our growth in our potential there. We have for example an opportunity with one large district in a real big metro area that could be about 200 schools that we would implement just over a few months period, we are negotiating our contract right now.

But because again we focus on quality always first and because of that focus for example in New York City we started with just a handful of schools, it went really well with them and so now the New York City district is very interested in doing more with us and so we’ll continue to focus on quality, on getting research done that’s a big area of focus now and also we do a lot of fund raising or fund matching with chambers of commerce with foundations and so forth. Because businesses are very interested in education and there is a lot of money out there looking for something that works and we feel like we’ve got something that does work and so we are pleased with the progress.

Robert A. Whitman

Yes does that help and any other questions on that?

Unidentified Analyst

Yes, just one additional question that I understand that within that program the signature Habits program is part of that, will the new offering now be included in that and will there be some effort to re-up those who have participated in the old program recently or how will that play out?

Robert A. Whitman

Yes, the 7 Habits signature program is a key component of the Leader in Me process. One of about six items that go into it and it will be incorporated. So the new 7 Habits to be part of the Leader in Me and we’ll be launching that right along with the rest of the country.

So we’re excited about that and it will help improve the program and we think keep the acceleration of growth strong for education.

Unidentified Analyst

Thank you.

Robert A. Whitman

Just one thing, the -- rapidly education grows the more pressure puts on the early quarters financially too because half of the revenue from education comes in the fourth quarter. And you have the draws to sales people, the new recruitment sales people, the R&D investment et cetera that tends to contribute less to the bottom line in the early quarters and hugely than the later quarters and so we’re excited about it. It does create a little bit of ink around the first quarter too from the profitability standpoint.

Operator

And I show no further questions at this time.

M. Sean Merrill Covey

We would like to thank everyone and thanks for staying on a little longer to answer -- to ask these questions. We appreciate your continued support and look forward to talking to you again in April looking forward. Thanks so much.

Operator

Thank you ladies and gentlemen, this concludes today’s conference. Thank you for participation and you may now disconnect.

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