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Executives

Derek Hatch – Corporate Controller

Robert A. Whitman – President & Chief Executive Officer

Shawn D. Moon – Executive Vice President

Analysts

Joe Janssen - Barrington Research

Bill Gibson - Legend Merchant

Franklin Covey (FC) Q4 2011 Earnings Call March 29, 2012 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2012 Franklin Covey earnings conference call. [Operator instructions.] I would now like to turn the conference over to your host for today, Mr. Derek Hatch, corporate controller. And you have the floor sir.

Derek Hatch

Thank you operator. On behalf of Franklin Covey, I’d to welcome everybody to our investor call this afternoon to discuss the financial results through the quarter ended February 25, 2012. However, before we get started, I’d like to remind everybody that this presentation will contain 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 obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of today’s presentation.

With that said, we’d like to turn the presentation over to our chief executive officer and chairman of the board, Mr. Bob Whitman.

Robert Whitman

Thanks Derek. Hello everyone, we appreciate you all joining us today and having so many of you join us today as well. We assume that you all saw the press release. We’re delighted to report that we had a very strong second quarter, actually the strongest second quarter ever for our current business.

We continue to feel very good about the business, about our momentum, and our outlook for the year and beyond. We’re also feeling confident about the prospects for continued growth in each of our channels and practice areas and about the expected trajectory of our business over the next several years.

Today I’m going to keep my remarks relatively brief to allow plenty of time for questions you might have. I’d like to just touch on three topics. First, the headlines regarding the financial performance of the business during the second quarter. Second, our momentum and outlook for the year and what we see as a very positive trajectory for the business and our growth and earnings potential for this year and the next several years. And finally, our announced $10 million common stock repurchase program.

So starting with the headlines about our second quarter’s results, first headline is our free cash flow and at least our net cash generated and cash flow from operations were extremely strong during the quarter and for the trailing four quarters. Our net cash generated - there’s an exhibit that shows the calculation of that - grew 48% during the second quarter to $4.1 million, up from $2.8 million in the second quarter of 2011.

And as you can see in the slide three, for the trailing four quarters ended February 25, our net cash generated increased to $16.9 million, which is an increase of $2.2 million, or 15%, compared with $14.7 million in trailing four quarters cash flow generated in the same period a year ago. This represents net cash generated per outstanding share of approximately $0.95.

Our cash flows from operating activities was also very strong. It was $8.6 million for the second quarter. It was unusually high. Our second quarter is typically higher than other quarters due the timing and receipt of our government receivables cash and other cash.

As you can also see, for the trailing four quarters, our cash flows from operating activities increased to $16.5 million, which is an increase of $5 million, or 43%, compared with the $11.5 million in the trailing four quarters cash flow that we had from operating activities a year ago. This strong cash flow allowed us to fully repay the outstanding balance on our credit facility, invest in key growth initiatives, and still increase our quarter end cash balances to $8.2 million.

The second headline is a high and increasing percentage of revenue flowed through to increases in adjusted EBITDA, income from operations, and net income. As you can see in slide four, adjusted EBITDA increased 46.9% for the second quarter to $5.3 million, up $1.7 million from the $3.6 million in adjusted EBITDA we achieved in the second quarter of fiscal 2011.

This also made the second quarter’s adjusted EBITDA our best second quarter ever for the business, and we were particularly pleased with it in as much as we were up against a very tough comp quarter from last year where adjusted EBITDA increased $1.6 million, or 78% compared to the second quarter of 2010. So for us that was a good mark to exceed and to exceed it so much.

For the trailing four quarters ended February 25, our adjusted EBITDA increased to $23.5 million, or approximately $1.33 per outstanding share, which is an increase of $5.3 million, or 29%, compared with the $18.2 million we generated in the trailing four quarters for the same period a year ago. So again, for us, a key metric, adjusted EBITDA, we felt really good about not only the quarter but the trailing four quarters. Continues to track well.

Our income from operations increased obviously even more, 86.9% for the second quarter to $2.8 million, up from $1.5 million in the second quarter of fiscal 11. Our operating income for the trailing four quarters ended February 25 increased to $12.7 million, which was an increase of 46%, or $4 million compared with the $8.7 million we generated a year ago.

And finally, net income was up a lot. It almost quadrupled to $1.2 million, or $0.06 a share, from $300,000, or $0.02 in the second quarter of 2011. This reflected both the strong but also an improvement in our effective tax rate.

So for the trailing four quarters, net income increased to $6.5 million, an increase of $5.8 million compared to the $700,000 in the trailing four quarters net income for the same period a year ago. So the leverage of the operating model I think is being reflected well in the flow-through from increased revenue, and having it flow all the way through.

Third headline is our adjusted EBITDA margin also expanded significantly in the second quarter, showing that flow-through. Our adjusted EBITDA to sales margin increased to 13.8% in the second quarter, up from 10.2% in the second quarter of 2011. For the trailing four quarters, that ratio increased to 14.4% from 12.1% for the trailing four quarters a year ago. So we expect future revenue growth and with the continued high flow-through we expect our adjusted EBITDA to sales margin will increase to approximately 18% over the next couple of years.

Final headline is that we were pleased to achieve strong and really very broad-based revenue growth during the second quarter. I’ll give just a little detail on that. Our revenue during the second quarter increased to $38.6 million, which is a $3.1 million, or 9% increase in revenue, all of which was organic. This made, again, the second quarter’s revenue the highest ever for any second quarter.

For the trailing four quarters, our revenue was $164 million, up 9.3%, or $14 million, compared with $150 million last year. And as I said, it was very broad-based. In our direct offices in the U.S., including our government region, revenue was essentially flat for the quarter, and up 3% for the trailing 12 months. That is, as you will recall, after a significant decline over the last 12 months in the government side.

Excluding our government services region, we had a planned decline in revenue in that related to the maturation of this large government contract. But the other direct office in the U.S. and Canada had revenue growth of 4% on top of a tough year over year comp where we had revenue growth of 17% last year. And for the trailing four quarters, these offices have grown 12%

In our national account practices, revenue grew 24% in the second quarter, and is up 29% for the trailing 12 months, obviously on a smaller base. Our international licensee partner offices, revenue grew 14% for the second quarter. It was up 17% for the trailing four quarters, and this growth was very broad-based across our licensee partners, two-thirds of them, and reflects our continued penetration in China, Singapore, and other major emerging markets.

In our international direct offices, revenue grew 14% for the quarter, and up 9% for the trailing 12 months, and we were really pleased with the strong revenues out of our Japan operations. So that’s kind of the end of the headlines, but we’re very pleased and encouraged by these results, and feel this continues the momentum we’ve been seeing over the last 12 quarters really.

Second, I’d like to make a few comments about our momentum and outlook for the year. The momentum in our business continues to be very strong and broad-based. I’ll give you just four little bullet points.

One, our pipeline of book days and order revenue, which as you know is the actual business booked to awarded, was $29.3 million at the end of the second quarter, reflecting a small year over year decline in our government pipeline. Thankfully it was a pretty small one. And then our growth in our pipeline of corporate business. So our corporate pipeline is the largest ever for any quarterly period at this point, and we expect that would flow through in the coming quarters.

Our second metric is this thing that we introduced last time. We have always measured it, but we introduced it to you all last quarter. It’s called our prospective business pipeline, which is business that we’re discussing with our clients and proposing, etc. And for our five direct sales offices in North America and our direct offices in the U.K., Japan, and Australia, our pipeline of business that we’re discussing clients was up very significantly for the period ending the quarter.

And that has already started to flow through in March, which is the first month of our third quarter. To date, at least through yesterday, our bookings were up for the month more than 40% compared to last March, and last March was a good quarter for us.

Finally, maybe just a word about the power of this operating model, which I think is becoming evident in the flow through. If you look at slide seven, you know we’ve said that we expect to be able to continue to achieve strong organic revenue growth in the future, in the range on average of at least low double-digit levels.

We’re pleased that our organic revenue growth over the past few years has actually been higher than this. We’ve also said that we expect between 30% and 40% of this increased revenue should flow through to increases in adjusted EBITDA. And again, we’re encouraged that the revenue flow through in the second quarter and over the past two years has also been higher than this.

But with these kinds of economics, as we get future revenue growth, it should drive aggressive growth in adjusted EBITDA, earnings, cash flow, while significantly expanding our adjusted EBITDA margins.

And last quarter’s webcast we used a slide which is shown here in seven - a version of it was used last time - which provided a model of how this kind of growth and flow through could translate into gains in profitability and cash flow in the future. We also, in this one, included - and this is about 2.5 years from now - these results would be four fiscal 2013 - under a range of different scenarios. This one is a little different. We also included for that year the net cash - under our definition of net cash generated - what the cash flow would be as well.

And so as you’ll see in slide seven, assuming that we achieve, say, a 10% compounded average growth rate in revenue over the next 2.5 years, and that 35% of that increase in revenue flowed through to adjusted EBITDA, our adjusted EBITDA would be expected to increase to between $38 million and $40 million, or to approximately, depending on the exact share count at that time, $2.25 to $2.50 per share at that time, representing a compounded annual growth rate in adjusted EBITDA of approximately 22%.

And obviously the percentage growth in operating income and net income would be even greater, as is shown. The cash flow would also be substantial, and so if you take that 10% and 35% as a middle point of the chart, in that year you’d expect to generate approximately $28 million of cash flow.

And so partially we’re sharing this data just so you can kind of see what we see as the basic operating model for the business, and I think you’re already seeing it in the results. But the range of possible outcomes - this shouldn’t be considered as formal guidance, but we’re trying to give this insight as to what the earnings and cash flow potential is and because we’re committed to achieving these kinds of results.

So finally, on this point, with the strength of our second quarter performance, and the momentum we’re continuing to see in the business, as reflected in these pipelines and our bookings, we now expect this year’s performance will be toward the higher end of our previously announced adjusted EBITDA guidance range of $24 million to $26 million, noting that we had extremely strong performance in last year’s third quarter, where we achieved revenue growth of 34% and adjusted EBITDA growth of 158%. We would expect greater growth in the fourth quarter than in the third quarter, but growth in both quarters.

Finally, I’d like to make a few comments about our announced authorization to repurchase up to $10 million of our common stock. As noted, we had very strong cash flow in the second quarter, and as we mentioned, there was $8.6 million in cash flow from operating activities - and for the trailing four quarters, $16.5 million in cash flows from operating activities. And as shown in that previous exhibit, we expect our operations to generate significant amounts of additional cash flow over the next 12 months and in the coming years.

In November, I shared our thinking about our retention of cash, and said that we had determined to build up our cash balances to $15 million while maintaining $10 million of availability under our credit facility before deciding what to do with the excess cash. And two, that it would likely be somewhere around the second quarter of next year, toward the end of the calendar year, before we expected to achieve that level of liquidity.

In light of our very strong operating performance in the second quarter year to date and for the trailing four quarters, the continued momentum we’re seeing in our business, the expected continued strength of our business and cash flow in the coming quarters and years, and the reduced uncertainty in the external environment, we recently made two decisions.

One was to lower our liquidity threshold to $10 million of cash, and we’re going to keep our $10 million of available under our credit line open. And second, to utilize the cash in excess of that $10 million to fund an authorized $10 million share repurchase program. So given the expected strength of our business and cash flows, we would expect to begin purchasing shares under this share repurchase program sometime later in this quarter or early next quarter.

So in conclusion, our organic growth and revenue was very broad-based across all of our major practices for the last 12 months also, and all major channels. The flow through was great with this adjusted EBITDA growth of 47% for the quarter, and 29% for the trailing 12 months. Cash flow was good, the margins expanded. So we’re pleased with the results and momentum of our business, expect to be able to continue to do both strong top and bottom line growth in fiscal 2012 and beyond.

So just want to thank each of you for your continuing support and guidance. I’m going to now turn the time over to Derek Hatch, our corporate controller, for some brief remarks. Normally I’m turning it over to Steve Young, our CFO, but last week Steve had knee replacement surgery. He’s doing very well, but will be out of the office, but on the phone and email, for the next couple of weeks.

So I’m now going to turn the time over to Derek.

Derek Hatch

Thanks Bob. Just to follow up on a couple comments regarding the financial statements, as Bob mentioned, we had a very good quarter, which produced some nice results in our income statement through increased sales and good gross margins flowing through to increased adjusted EBITDA, which then of course rolled through to improved pre-tax earnings and then to net income.

We were also happy to have our income tax rate stay generally consistent for the second quarter in a row, right around 46%. That’s a significant improvement over our prior year percentages, which were as high as 64% for this quarter last year. Once again, it’s due to the same general conditions that we have with permanent differences, and if you have any questions regarding the impact of income taxes, please give me a call. I’d be happy to explain them to you.

All these improvements, as Bob mentioned, led to improved cash flow from operations, which has really served to strengthen our financial position. Our balance sheet is in great shape. At the end of the quarter, we had $8.2 million in cash and cash equivalents. Working capital increased to $22.2 million compared with $16.7 million at August 31, 2011.

We have no balances outstanding on our line of credit facility. We’re on time making our payments, of course, with our term loan that we have, and we owe about $4 million left on that. We also recently renewed our line of credit facility with our lender, and extended that due date out - the maturity out - until the end of March 2013.

So as a result of all of those things, our balance sheet is in fantastic shape. We don’t see any significant issues or impairments coming down the road, and our financial position looks very, very strong.

As Bob mentioned, our cash flows were very good, and have been good over the trailing four quarters. Our cash flows from operating activities for the two quarters ended February 25, 2012 were $9.2 million compared to $8.3 million in fiscal 2011 for the same period. A large part of that was due, as Bob mentioned, to the receipt of cash and to the improved operating results.

We’ve been able to keep our cash flows used for investing activities in check, and we’ve spent $1.7 million for capitalized curriculums and development activities and $1.0 million for purchases of property and equipment, which are primarily computer hardware and software items.

Our cash used for financing activities totaled about $1.3 million. $1.5 million of that was used to pay down principal on our financing obligation and on our term loan. And they were partially offset by cash received from participants in our employee stock purchase plan.

But overall, we had, thanks to good, strong financial results for the quarter and for fiscal 2012 thus far, two quarters in, great cash flows and you can see the improvements and the increases all the way through our financial statements for the period ended February 25, 2012.

Hopefully that was helpful. If you have any questions in Steve’s absence, please feel free to give me a call. Derek Hatch, the controller. I’d be happy to answer any questions you might have regarding our financial statements.

With that said, I’d like to turn the time back over to Bob Whitman to continue the discussion.

Robert Whitman

Thanks Derek. I think at this point we’ll just turn the time to the operator to tell us how to start the question and answer period.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question comes from the line of Joe Janssen with Barrington Research. Please proceed.

Joe Janssen - Barrington Research

I’ll start with the sensitivity analysis that you presented on slide seven. I appreciate the color. Just for clarification, assuming the different variables, is that incorporating your additional sales force that you plan to hire over the next two years? Or is that looking kind of in arrears?

Robert Whitman

Well, that’s a good question. This is just showing what would happen if we grew it. I included a slide at the back, Joe, and maybe I’ll ask Shawn Moon, who heads our direct sales forces - Shawn, why don’t you just respond to it. I think there’s a slide in the deck.

Shawn Moon

I would refer you to slide 10, and the growth opportunities sales force addition slide. And there are really two factors in the productivity of our sales force as we see moving forward. First is increasing the productivity of our existing sales people, or what we call our client partners. And the second is actually increasing the number of client partners. So in this slide, you can see that the typical expected ramp rate for the new sales people hired. For every 10 net sales people that we bring on in a given year - we call this our class - our net investment for that year …

Joe Janssen - Barrington Research

Is this slide nine?

Shawn Moon

Slide nine, I’m sorry. You can see that the ramp rate for those folks - and we’ve factored in those that hire but don’t make it, so we have that included - the investment required for that is about $600,000 in the first year. You can see there in year two that typically we cover all of the year-one investment plus an additional $1 million. And then by year five, each class of 10 net new hires should generate about $13 million in revenue and contribute more than $5.5 million, almost $6 million, in additional EBITDA contribution.

Then on slide 10, you can see that we’ve been hiring a class of new client partners each year over the past few years, and we have client partners who are in different stages of the ramp. So we felt as a consequence that it’s probably worth noting that even without hiring - and I think this speaks to your question Joe - additional sales people, just with those that we have, we could increase revenue by $44 million.

That’s almost the same amount of revenue increase outlined in slide seven without adding new people. And this would come with substantial flow through, since we don’t have an incremental investment with the new people.

So in addition to continuing our ramp with our existing classes of client partner, we have also increased the number of our new client partners over the past few years. In 2011 we hired 14 net new client partners. In FY 2012 we’ve already hired an additional 18 new client partners. And we expect to be able to increase our hiring to 30 a year, and then on to 40 a year, over the next several years.

Joe Janssen - Barrington Research

Are you done hiring for fiscal 2012?

Shawn Moon

No.

Joe Janssen - Barrington Research

Is 20 still the number?

Robert Whitman

We’ll probably go a little ahead of that, wouldn’t you think, Shawn?

Shawn Moon

Yeah.

Robert Whitman

We’ve got some needs that we’ll probably get filled. It will probably go a little north of that.

Shawn Moon

There’s so much leverage in both these priorities, Joe. The ability to increase the productivity of our existing folks and the ability, in that context, to continue to add, as we have outlined before. Really this is my highest priority.

Robert Whitman

So hopefully that’s a response to your question. Maybe it was a long answer to a short question, but Shawn did a particularly good job of it. Shawn, thanks. Just to say that the numbers that are in that sensitivity chart, if we just ramp up the people we have, if my math’s right, we’d get to $204 million of that $208 million of revenue. So we’d be $4 million shy. If you didn’t hire anybody. But given that we are hiring and accelerating that, we would hope there was some upside.

Joe Janssen - Barrington Research

Are you seeing any more efficiency in that? I remember a year ago those numbers looked a bit different in terms of the ramp of the sales people. Are you still seeing some improvements in efficiency?

Robert Whitman

We are. Shawn, maybe you want to speak to that too. Revenue per sales person on the ramp.

Shawn Moon

Revenue per sales person continues to go up from about $800,000 in 2004 to about $1.15 in 2011. And that’s up from 2010. There is some increased efficiency, yes.

Robert Whitman

And Shawn, you might just speak to what the objectives are for the ramp rate, also, which is a little bit faster than what is shown on slide nine.

Shawn Moon

Yeah, we’re hoping to trim a full year off the ramp rate. Where before it’s taken them five years to get up to $1.1 million, our minimum expectation, now, of client partner, is to get up to $1.4 million. We have client partners that do well above that, but the $1.4 million is a number we think is attainable. And there are several things that are going into that, but we’re seeing our pathway to that number.

Joe Janssen - Barrington Research

Okay. I know I’ve been on for a while, but two quick questions. Just regarding guidance, given the performance you’ve had in Q1 and Q2. Seems like the momentum is moving forward. I know you’ve guided to the higher end of guidance, but am I expecting anything? Should I be looking at anything in Q3 and Q4?

Robert Whitman

I think just as I mentioned, last year we had 35% revenue growth in the third quarter and more than 100% EBITDA growth. So I think basically our view is at the high end we’d be increasing EBITDA for the year around $5 million.

We’ve done about half of that in the first two quarters. As I mentioned, we expect to grow in the third and fourth quarter, but would expect the growth in the third, given that very tough comp, to be less than in the fourth. It may be appropriate, at the end of the third quarter, to adjust our guidance further.

You’ll recall year over year, because of the first quarter decline in that government contract, which had been planned, we were up against a tougher comp, because you’ve got to make up for that $4.5 million and grow, but we feel confident we can move toward that upper end.

Joe Janssen - Barrington Research

And just one last question. I’ll make it quick on my end. Update on India with schools and Leader in Me?

Robert Whitman

We’ve begun with the first 20 schools, which is the first group that we have contract, and it’s underway. And we’re building the team up there so they can handle more. But domestically, in the U.S. operations, we continue to expand, and we’re now more than 750 schools that are Leader in Me schools. We’re now in the first 20 in India and I think as we’ve said there are around 120,000 K-6 schools in North America. There are 746,000 K-8 schools in India.

So there’s a huge opportunity just in the expansion of the practice into India. And that’s maybe indicative that frankly, as we’ve said before, among our licensees, typically our international licensee partners - today our licensees are only in a couple of our different content categories. As we can take these new practices in, even in the existing licensees there’s a big opportunity both for organic growth but also adding these new practices. And this is one example of it.

Operator

[Operator instructions.] Up next we have Bill Gibson with Legend Merchant. Please proceed.

Bill Gibson - Legend Merchant

I’d like to zero in on probably your smallest practice, which is customer loyalty. It was growing at a pretty good clip, but it seems like it’s starting to lag a little. What’s going on there? What are the challenges?

Robert Whitman

I think generally I’ll answer it two ways. One, we’ve actually had really good growth, continued growth, and they’ve added a lot of new clients. One of their larger clients has modified their offering of what they’re doing internally. It includes part of what we were doing before, and so the principal slowdown there has just been the reduction in that one contract. But all of the customers they’ve ever worked with are still customers. They’ve added seven or eight new customers this year. Some are in the pilot phase. Others are in rollout. But I’d expect that once we get over this little couple of quarter comparison with this one size reduction, that we expect to see that continue to grow.

Operator

Ladies and gentlemen, that will conclude the question and answer portion for our call today. I’d now like to turn the presentation back over to Mr. Bob Whitman for closing remarks.

Robert Whitman

Great. We appreciate everyone being on the call with us today. Appreciate your continue support and guidance. And again, we feel very good about the quarter and about the momentum. And we’ll look forward to seeing many of you in the coming weeks and to reporting on third quarter. Thanks very much.

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