Franklin Covey Co Q2 FY2025 Earnings Call

Good day, and thank you for standing by. Welcome to Franklin Covey Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to turn the conference over to Derek Hatch, Corporate Controller. Please go ahead.

Thank you. Hello, everyone, and thanks so much for joining us today. We appreciate having the opportunity to connect with you. As we get started, please remember 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 grow revenue, the acceptance of and renewal rates for our subscription offerings, including the All Access Pass and The Leader in Me memberships, the ability of the company to hire productive sales and other client-facing professionals, general economic conditions, competition in the company's targeted marketplace, market acceptance of new offerings 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 such as governmental contracting actions that are 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 except as required by law. With that out of the way, we'd like to turn the time over to Mr. Paul Walker, our Chief Executive Officer and President.

Thank you, Derek. Good afternoon, everyone. We're happy to have the opportunity to speak with you today and to share an update on the continued progress of the business. The current external economic environment is turbulent and uncertain. We're not entirely immune to what's going on in the broader economic and political environment. However, we are pleased, first, that the importance of the opportunities and challenges we help organizations achieve are mission critical to them and our business and business model are strong. Second, we're pleased with the traction we're already achieving in the implementation of our go-to-market transformation in our enterprise North America business is significant. And third, we're pleased that our education business continues to be strong. As a result, we continue to be confident in the actions we've undertaken to accelerate future revenue growth. And with this growth in revenue, we also expect to achieve significant growth in adjusted EBITDA and cash flow. Over the next few minutes, I'd like to briefly address the following questions you can see shown on Slide 4. The first question is, what are the areas in which we have been seeing some impact from the external environment? And I want to lay those out. Second, what are the key metrics that reflect both the continued underlying strength and durability of our business model and the significant traction we're already achieving in the implementation of our new go-to-market acceleration actions in our North America enterprise business? And then the third question I want to answer, lay out and answer, is what are the key factors that are driving the continued strength and growth in our education business? So let's get into each of these. First, what are the areas in which we've been seeing some impact from the external environment? While we feel good about progress across the vast majority of our business, we are experiencing direct and indirect impact from the actions being taken by the federal government and by the results in economic uncertainty. And while this impact is on the margin for our overall business, nevertheless, it is impacting our revenue growth in the year and is the primary reason why our results will be down this year compared to expectations. We're seeing the effect primarily in the areas you can see shown on Slide 5. The first is in our government business. Roughly 6% or $17 million of our total business is in some way tied to governmental entities such as the Department of Defense, Veterans Affairs, and state and local entities. Approximately $5 million in government revenue has already been cancelled or postponed as the federal government looks to cut spending in nearly every category. We expect government revenues to be down by at least $5 million this year compared to the low end of our original guidance. The second area in which we're seeing some impact from these same government actions and trade tensions is in our international direct and licensee operations. A significant portion of this impact is being felt in China, where the threat of escalating tariffs and other potential factors and political factors is causing a sensitivity by national and even local companies in China to being viewed as doing business with US firms. In a small number of cases we've also had clients in Europe and Canada postpone or cancel engagements either as a defensive or nationalistic response to the threat or the reality of tariff actions or as a response to the uncertainty of the economic conditions in their own country. While these pressures have not been widespread, they are having an impact on the margin, and we expect that they could result in our international revenues being down by as much as $4 million compared to the low end of our guidance this year. Third, we see the potential for some impact in our education business. To date, we've seen little measurable impact from concerns about the potential disruption of the Department of Education. I think it's important to note that almost all of our education revenue comes from state-level funding. We sell to schools and districts and not to the Department of Education. However, because the Department of Ed has historically provided approximately 14% of state-level education funding, we're mindful that uncertainty about potential federal level changes within the Department of Ed could cause some uncertainty at the state level, which could slow down schools' speed of decision-making this spring. We think this could have as much as a $3 million impact to education revenue. While we haven't yet experienced any real negative impact here, we are monitoring the situation closely. Looking out a little bit at the future ultimately, it appears that any funding changes at the federal level are likely to be reallocated to the state level and from there to the local schools and districts to which we sell, but short-term disruption is a possibility. Finally, these same government-related actions also have the potential to create some headwinds for some of our clients in the United States, and we think that this could create an approximately $3 million of additional impact here. So let me now speak to how this translates into our revised guidance for the year. First, I would just say that the objectives of our go-to-market transformation that we've talked about in the last few calls remain unchanged. Despite the on-the-margin interruptions in revenue in our government and international operations that I just described, the engines in our enterprise division in North America and in our education business remain strong and durable. Our go-to-market transformation is tracking a bit ahead of expectation, and I want to talk about that here in a minute. And our go-to-market transformation is expected to drive significant acceleration of our overall company revenue growth, moving us from single-digit to double-digit revenue growth in the coming years, and with a significant flow through this incremental revenue to increases in adjusted EBITDA and cash flow. With that said, due to the impacts of the government actions just outlined, we are adjusting our guidance for this fiscal year. As shown on Slide 6, last year we achieved revenue of $287.2 million, generating adjusted EBITDA of $55.3 million. Our original guidance for fiscal 2025 provided, but at the low end we would grow revenue by approximately $8 million and generate adjusted EBITDA of $40 million, with the reduction from the prior year reflecting the $16 million of incremental growth investments being made this year. Due to the impact of government actions we just discussed, we now expect revenue will come in between $275 million and $285 million, or $7 million or 2.5% lower than last year, and $15 million or 5% lower than the low end of our original guidance in constant currency. With this, we expect adjusted EBITDA to be between $30 million and $33 million, primarily reflecting the growth profit we expect to be lost related to the decline in revenue, again, related to the government actions previously discussed. While the $16 million of incremental growth investments were always going to have a direct impact on this year's adjusted EBITDA, we expected they would establish a solid foundation for accelerated future growth, and we still do. As noted, we're pleased with the traction we're getting, and both fully committed to these investments and confident they will do exactly what they were expected to do, which is to accelerate our growth. We, of course, did not anticipate the impact of the government actions, but are taking quick action to reduce our cost structure in government, in our international operations, and other areas of our business. We expect these actions will partially offset some of the government-related impact and result in an even higher percentage of incremental revenue flowing through to adjusted EBITDA next year. Therefore, we expect this will be an approximate one-year step back and that next year, adjusted EBITDA will be back to approaching where we thought it would be this year. We'll provide specific fiscal 2026 revenue and adjusted EBITDA guidance in November, which has been our pattern. So, having talked about the external environment and our updated guidance for the year, I'd now like to turn to a different topic, which is to address the strength we're seeing across the majority of our business right now. Despite the potential near-term impact in the areas just discussed, the strategic strength of our overall business and our business model continues to be evident. We're also pleased with the significant early traction, as I mentioned, that we're achieving in our new go-to-market in our enterprise North America. I'd like to first address the strength of our strategic position and business model. Our strategic strength derives from the importance of the opportunities and challenges we help organizations address. Opportunities and challenges which are very durable for clients in good times and in more challenging times. This strategic strength and the strength of our business model continue to be reflected in the following metrics in our North America enterprise business, as you can see shown on Slide 7. First, our revenue continues to renew at high rates. Apart from the government action related headwinds we've addressed. A majority of our clients continue to expand and renew even amid a more uncertain environment. This strong retention is driven in part by our clients' continued interest in expanding the duration of their contracts with us to ensure the ongoing achievement of their critical objectives. At the end of the second quarter, 61% of our subscription revenue is under a multi-year contract, equaling the high percentage we have achieved at this same point last year. Second, our clients continue to expand with us. Over time, the average revenue per All Access Pass client has expanded significantly from $39,000 to more than $85,000, reflecting both the growth of the populations being served within our clients and the expansion of incremental offerings that they purchase. The third area of strength is that our clients are continuing to purchase significant amounts of services to help them achieve their mission critical objectives. Despite the uncertainty, it is significant that excluding our government business, in our business in the United States and Canada, our advanced bookings for new services have increased 5% year-to-date over the same period last year. This reflects our clients' commitments to achieving a performance outcome. Importantly, this momentum in bookings will translate into increases in services revenue in the coming quarters. Fourth, we're pleased with the indicators of significant traction we're already achieving in the implementation of our new go-to-market acceleration in our enterprise business in North America. And I'd like to talk about this here just for a couple of minutes. This is an initiative into which, as previously discussed, we've invested an incremental $16 million this year. It's been just 90 days since we launched our transition, and the traction and early results we're seeing are very encouraging. The focus of our go-to-market transition is on achieving significant increases in two key outcomes which will drive our accelerated growth. The first objective is to significantly increase our new logo sales, and this is off to a very good start. We won more new logos in the second quarter, both in terms of dollars generated and number of clients than in any of the last five quarters, and we expect another strong quarter ahead in Q3. We exceeded our new logo plan by more than 50% in the second quarter. While we did not start the transition until the second quarter, we're pacing to achieve approximately 40% growth in new logo sales for the year. Importantly, we've also had a higher purchase of services by new All Access Pass clients this past quarter than we've seen in previous quarters. I'm going to come back and touch on that in just a second. Our second objective is to increase our expansion within existing client organizations. This is also off to a strong start. The second quarter was a strong quarter in terms of client expansions, and we beat our planned expansion target by 8%. Underpinning the strength of this early traction are two important factors. First, that our new go-to-market organizational structure is fully aligned, fully staffed, and working. Every role is filled, and we've added top-tier talent and critical roles to go along with the already tremendous talent we had in place. All 44 of our new logo salespeople are in place today. 42 of the 44 were in place by December 1. And the other two, so all 44 were in place by February 1, which is a full month ahead of what our planned staffing plan indicated. 21 of the 24 brand new new logo hunting salespeople closed business in the second quarter. 21 of 24 closed business in the second quarter, which is their first quarter. That's an unprecedented ramp speed for us. And our new logo pipeline exceeded plan by 30%. And our conversion rates were 300 basis points above our targeted conversion rates in the second quarter. The second factor underpinning our traction and momentum is that the important investments we've been making into content, technology, and delivery capabilities over the past years are enabling us to serve even more clients more broadly and more effectively than ever before. As I mentioned a minute ago, we're also seeing a strong attachment rate of services to new logo wins. And this is a bit of a shift for us. We're intentionally driving this with these new logo sellers. And this is not only increasing deal size, but we anticipate it will also boost client retention as our clients who buy services renew at higher rates. I'd like to share a quick win story from the second quarter that highlights the win of a new logo that also had more of these services attached. We closed a large hospital system in the Midwest for $253,000 in annual contract value. This is a very nice new logo win for us. And this contract had a $144,000 All Access Pass subscription with $109,000 in services attached to that subscription. The deal began with interest from the hospital system CEO and he'd asked for a single keynote on the speed of trust and we quickly expanded that initial interest into a rollout that covered a few hundred of their leaders to instill trust across teams and within patients in each of their hospitals. This deal was closed in just 44 days by one of our new logo sellers who was new in role. It was her third month in seat. Finally, I'd like to as I touched briefly on a minute ago, just discuss for a second the ongoing strength we're seeing in our education business. As shown on Slide 8, education revenue grew 3% in the second quarter and is up 7% year-to-date. Importantly, year-to-date invoiced amounts in education are up 13%, positioning us well for the seasonally stronger second half. We're seeing strong demand for Leader in Me driven by success in delivering the outcomes that educators, parents, and communities care about, such as leadership development, student engagement, and character building. This strong demand is fueling our transition from selling initially to individual schools to selling to entire districts. And we now, in a handful of cases, are serving statewide contracts. We're pleased there are now 7,800 Leader in Me schools around the world, and we're just getting started in growing that number to even larger heights. So we feel quite good about the progress that’s being made with the transformation of our North America operation. We feel good about the continued momentum in education. And with that, I'd like to turn the time over to Steve and ask Steve to share a little bit more detail on our financial results, also share a little bit of specific Q3 guidance.

Thank you, Paul. Good afternoon, everyone. It's a pleasure to be with you today. You'll find on Slides 9 through 12 and in the appendix, the second quarter financial details I've typically shared verbally on these calls. But today I'll take the time to highlight a few encouraging trends we're seeing in the business that continue to support our confidence moving forward. First a few high-level financial results. The second quarter revenue was $59.6 million or $60.1 million in constant currency, slightly below the $61.3 million we achieved in Q2 last year, with more than all of the difference reflecting the impact of the government-related cancellations in the last 60 days. Adjusted EBITDA for the quarter was $2.1 million, or $2.6 million in constant currency, landing at the top end of our expectations despite the government disruptions. Gross margin and SG&A were in line with projections, including the second quarter share of our $16 million in incremental growth investments in North America. We feel good about the results given the cancelled government revenue and the related shortfall in international sales, and it being the first quarter of our go-to-market transformation Paul just described. Second, I'd like to highlight that we're seeing continued strength in the number and value of multi-year contracts being signed. In fact, additions to unbilled deferred revenue, which reflects multi-year contracts secured but not yet invoiced, was up 10% in the second quarter and is also up 10% for the first half of this year compared to the first half last year. This momentum is also evident in our All Access Pass contracts in North America. As at the end of Q2, the percentage of All Access Pass contracts that are multi-year was a strong 55%. And as Paul mentioned, the percentage of our subscription revenue associated with this multi-year agreement was also a strong 61%. These results reflect our clients' long-term commitment and belief in the value and strategic impact of our solutions. In the midst of a more challenging macroeconomic environment, we're also pleased that the vast majority of our clients are renewing their contracts, expanding their usage, and expressing confidence in the work we're doing together. This gives us continued confidence in both the future trajectory of the business and the early returns we're seeing from our go-to-market transformation. Third, as Paul mentioned, our services booking rate in the United States and Canada, excluding government, is up 5% year-over-year. This is a strong indicator that we're not only landing new clients, but that we are a trusted partner in delivering solutions that drive real outcomes and lasting value. Fourth, we're seeing good momentum in our education business, particularly in the number of large state and district level opportunities we're actively pursuing. This pipeline strength, together with the base of 7,800 schools, gives us confidence in the demand for the kind of outcomes our Leader in Me solution delivers and provides confidence in continued growth as we move through the second half of the year, which is historically education's strongest period. Finally, our business continues to produce strong, reliable cash flow, and today we still have more than $100 million in liquidity. We've continued to use this strength to return value to shareholders. From 2022 to today, we have invested approximately $105 million or 83% of free cash flow to purchase 2.6 million shares. In the first half of this year, we've invested $14.7 million to purchase 397,000 shares. We expect to continue allocating excess cash toward accelerating growth, M&A activities, and share purchases. We remain committed to being a disciplined steward of capital while staying focused on driving long-term value creation. Now just a little bit more on guidance. As Paul shared earlier, our revenue guidance for the year is to be between $275 million and $285 million, with adjusted EBITDA between $30 million and $33 million, both in constant currency. Our guidance for the third quarter is that, revenue will be between $67 million and $71 million, and adjusted EBITDA will be between $4 million and $6.5 million, reflecting both the expected continued revenue disruption from government-related activities impacting our direct government, international education, and other revenues, as well as the third quarter's portion of our growth investments. So, Paul, back to you.

Thanks, Steve. Thanks for taking us through that. And we'll now invite the operator to open the line for questions as we do. Just, one again, thank everybody for being here today and look forward to answering your questions.

Thank you. Our first question will come from Alex Paris of Barrington Research. Your line is open.

Hi guys, thanks for taking my questions.

Good to talk to you today.

Yep, same here. I guess we'll start with the external impacts, and tariff-related and so on. I think I understand it. There's direct federal government agencies in our business. There's impact on your international business because of the response to the increased tariff talk from this end and there is an expected impact on your education business as well. So focusing first on the federal government, I think you said in your preferred comments that it's 6% or $17 million is government revenue on a full-year basis, DOD, VA, and then state and local, is that correct?

Yes, but the majority of it being federal, yes.

Okay, that's what I was going to ask. The majority is federal. And you called out DOD and VA, are there any other agencies that we should be aware of?

Yes, so we do work with US AID, has been an agency we've had a long relationship with in the past. We've done stuff with Health and Human Services. We've had a nice government business for a long time doing work across a number. We do work with the Treasury and work with Congress in the past. So it's been fairly broad over the years, Alex.

Got you. And then you mentioned that the entire decline in revenue year-over-year was attributed to cancelled government contracts and their related impact on your other businesses.

Yes, that's right.

Particularly the impact was reflected in Q2 of the cancellation just in the last 60 days.

Got you. All right. And then on the education, and obviously there's nothing you can do about that. Are there hopes to win the business back in the future? Certainly your guidance assumes that you don't win it back this year.

Yes, yes. So staying on government for a second, our guidance and our view right now is that we don't win that back this year. I don't see a scenario where that happens. And so, what we're doing, one of the things we're doing is, we're just taking a look at that government business and saying, okay, over the next bit of time here, assuming the trajectory of what's happening within the government doesn't change, how do we structure that business so that we can be as profitable there as possible on less revenue. That's an action we're taking immediately. Longer term, as things settle down, I mean a big part of what we do as a company is we help organizations become more efficient, get more out of their people, do more with less. We have a whole set of offerings, as you know, around execution. There could be an opportunity to get back in and help on some of those things. Right now, the environment is such that there's not a lot of appetite to buy anything new in the government, but I think that we'll see as we go into next year whether that looks different, but at the moment, that's how we see it.

Got you. Thank you. And then on the education side, 86% of funding comes from state and local governments. Only a small component, 14% comes from the federal government overall, I'm not saying your revenue. And that would be things like Title I and individuals with disabilities. What percentage of your education division revenue comes from the Department of Education?

The Department of Education is not a client for us and they provide 14% of the state's budget, which is allocated towards programs like Title I. We do not sell to them and have never had a relationship with the Department of Education. Any cuts to that agency will not affect us. Based on our observations, we believe that funding from the Department of Education to the states will continue, possibly coming from a different agency as efforts are made to reduce the Department of Education. In the long term, we do not foresee this creating a funding challenge for us. We want to emphasize that there may be minor disruptions in our third and fourth quarters, which is when schools typically decide to implement Leader in Me. Historically, the second half of the year has been our strongest period. Therefore, the uncertainty surrounding the shift in funding from the federal government to the states could potentially affect the timing of those decisions. School board meetings are crucial for those decisions, and if a meeting is missed, it might delay the process. Currently, we are not observing widespread issues, but we wanted to point out that there might be a potential impact of a few million dollars. Overall, the business is performing well and we expect it to continue, but we want to acknowledge the risk that exists.

Just a couple more. So if I understand it correctly, some of these internal impacts are kind of masking the success and the traction and the trajectory resulting from your North American enterprise sales force restructuring. Just to be clear, I think in Q1, of that $16 million incremental investment, I think you spent a little bit less than $3 million in the first quarter, and I think you were expecting to spend a little bit more than $4 million in the second quarter, and then $4.5 million in each Q3 and Q4 to get us to $16 million. Are we still pretty much on that schedule in terms of incremental spending?

We are right on schedule. I can see Steve agrees. The investments we've made are on track. The team is in place, and the projections you mentioned of around $3 million increasing to $4 million and then to $4.5 million are already with us. This is a deliberate decision on our part; we are pleased with the early momentum and traction we are starting to see. Although we are only 90 days in, we are happy with the progress and do not want to reduce spending in this area. We believe this is the key driver for the company’s growth that we have discussed and are excited about. While we may make some cuts elsewhere, we intend to maintain our focus here. We are quite satisfied with our early results.

Great. And then the last couple would be regarding guidance. So you kind of spelled out the guidance there in the delta from previous guidance and year-over-year. You gave third quarter guidance so we have implied guidance for the fourth quarter. In the text of the press release, you said that the company expects this to be a one-year step back, and the company suggested EBITDA will approach original 2025 expectations in 2026. So that suggests there's been a reduction in expectations in 2026 given these external factors. And then what does that do to 2027 and 2028? Because you had given long-term guidance through 2028 previously.

Yes, that's a great question. We will provide an update in November as we observe the next couple of quarters. I want to add two more points regarding your question. First, we anticipate an acceleration in our invoicing growth in the latter half of this year. Also, when we assess costs unrelated to our growth, we expect that even with modest revenue growth next year, we will see a good flow-through given the significant investments made this year and the reduced incremental investments we will need to make next year. Additionally, the cost measures we implement in the latter half of this year will contribute to this positive flow-through next year. We're aiming to return to the flow-through levels that you are used to. This sets us up to get back to where we would have landed this year concerning adjusted EBITDA. In terms of our long-term revenue and adjusted EBITDA outlook, we will provide a comprehensive update in November. Fundamentally, we believe strongly in the demand for our offerings; our clients need what we provide, and we have robust strength in the business. The transformations happening in our North America enterprise operation, along with our long-standing momentum in education, give us confidence that revenue growth will accelerate over time. This should lead to increased adjusted EBITDA and cash flow, and we still maintain that underlying thesis. As we gain more clarity, we will share further details about the timing and extent of this growth. But we remain on a positive trajectory.

Okay, got you. And then lastly, I guess, again, the positive effects are somewhat masked by the external impacts. I think you said on the last conference call the things we should look for in terms of milestones would be the size of the pipeline that's where it would show up first, growth in invoiced sales that's where we'd see it second. I think it was down still in Q2. I realize we are only 90 days in. And then ultimately reported revenues. One of you could just give comment on those three milestones or a little additional color.

We saw significant growth in our pipelines, exceeding our target by about 30% in the second quarter. Our close rate was better than expected. Regarding new logos, we evaluated whether our marketing team could generate more leads and if our sales team could qualify and close those opportunities. In the second quarter, we exceeded our expectations in these areas. On the expansion side, we successfully grew our existing client base, beating our expansion plan by 8%. This was achieved despite some challenges with contracts and governmental factors in North America. Even with headwinds in the quarter, the leading indicators for January, February, and March looked positive. We are eager to provide updates as we approach the third and fourth quarters.

And has there been any impact on the commercial side of the business within enterprise, like extended sales cycles due to uncertainty, tariffs, recession worries, things like that?

I believe we're observing some uncertainty internationally, especially since three of the countries where we operate have held snap elections in the past 90 days. This has led to prolonged decision-making, which we've incorporated into our updated guidance. Additionally, we're anticipating some challenges in the U.S., including a potential impact of about $3 million. While we haven't encountered much of this yet, we're expecting to see some effects.

And that's in guidance.

That's in guidance, yes.

Okay, great. Well, thank you. I'll get back into the queue. Appreciate your answer to my questions.

Thanks, Alex.

Thank you. One moment for the next question please. And our next question will be coming from the line of Jeff Martin of ROTH Capital Markets. Your line is open.

Hi Jeff.

Thanks. Good afternoon, Paul and Steve. Hope you're well.

You too. Good to talk to you.

So Paul, I was just curious if you could clarify the $17 million government-related revenue, 6% of revenue. Does that include non-government organizations that are influenced by government agencies? Or is that a commemoration, or are you seeing any impact there?

Yes, the $17 million is governmental agency direct. The $17 million is direct. The broader, as far as government representing a good share of the GDP and how that spills over to companies who do a lot of work with the government, et cetera, et cetera. That's what we're trying to point to in the $3 million or so of impact we might see in the U.S. And just the presumption and expectation that there will be some of that this year that will be up against the back half of the year.

Yep. Okay. And then I was just curious if you could characterize the project starts among your clients who are subscription purchasers. Are those largely starting on time? Are they starting to infuse some delays related to uncertainties? Need to focus on other areas of the business, the impact of tariffs, etc.?

As we mentioned, in the second quarter, we actually had a better new logo quarter. For us, when we bring on a new client and sell a new logo, their subscription begins immediately, and the first year subscription clock starts. We have not noticed any slowdown in project starts at this point.

Okay, that's encouraging. And then if the economy does roll into a recession here, I know in the past you've spoken about the durability of the subscription model. Obviously, moving the multi-year contracts helps, but how do you see that in terms of potential impact on new logos? I know you just had a really strong first 90 days under the new go-to-market strategy, but just was curious if you have the same level of conviction if the economy does roll into a recession here.

Yes. You've pointed out two key aspects. First, our subscription business is advantageous during economic downturns, as approximately 55% of our contracts are multi-year agreements lasting two years or longer. This also accounts for 61% of our subscription revenue, which provides a bridging effect and stability during uncertain times. In previous downturns, we experienced a few quarters of uncertainty, and the multi-year contracts give us built-in durability. Furthermore, many of our clients on multi-year contracts are also in their first year, which adds to our resilience. Regarding new clients, I was pleased with our performance in the second quarter despite some external challenges. Currently, our pipelines and early indicators for Q3 suggest that we are poised for another strong quarter in acquiring new clients. We remain optimistic about these prospects. Our sales team is strategically focused on solutions like four disciplines of execution and sales performance solutions, which are essential for clients aiming to grow their businesses. We’re encouraged by our findings from Q2 and the positive early indicators for Q3 concerning new client acquisitions.

Okay. And then last for me is, your guidance suggests an adjusted EBITDA in Q4 of approximately $14 million to $16 million. I’m curious about your level of confidence regarding what could lead to exceeding that number or what challenges you might anticipate that could impact it.

Hi, Jeff. Since only a portion of subscription sales is recorded as actual revenue, the fourth quarter is particularly affected by the services we deliver and the number of coaching days, especially in education. One key point Paul made regarding the fourth quarter is that we don't foresee any significant disruptions impacting our education days. While we recognize the potential for disruption, we don't expect it to occur. Additionally, if some of the anticipated disruptions don’t materialize, the demand for those delivery days, services, and content could improve our projections as companies proceed with their needs.

I think that's a great point, Steve. Regarding the factors contributing to our new guidance, we have already experienced some lost business from the government segment. Other factors are more about our projections for the future and what we believe might occur. We are constantly working to exceed those expectations. For the international segment, we anticipate being down as much as $4 million compared to our plan this year. No one will be satisfied if we only meet the number we announced today. We are striving to achieve better results than what we presented, and that is certainly our goal.

That's helpful. Thank you for the time.

Thanks Jeff.

Thank you. One moment for the next question. And our next question will be coming from the line of Dave Storms of Stonegate. Your line is open.

Hi Dave.

Good afternoon. Thank you for taking my questions. I wanted to start by asking, given the external environment, if there’s any possibility or interest in focusing more internally, particularly on product development and enhancing AI capabilities or similar internal projects.

We have a strong product development plan that includes integrating AI into our products, which we are already implementing. We’ve mentioned this previously. Internally, we have the chance to improve our operations, making them more efficient and streamlined, and AI can certainly assist with that. I noted that we are reducing our EBITDA guidance mainly due to a decline in revenue while choosing not to cut the $16 million in growth investments. We will explore opportunities that do not affect our future business growth and seek ways to enhance our efficiency, a practice we have maintained for years and will continue to pursue.

Understood. Very helpful. Thank you. And then just looking at some of your go-to-market strategy, kind of outpacing goals, it does look like, as you mentioned, the new logos is up 150% over goals, where the expanders is up, call it, like 108%. Looking past the market uncertainty, do you see a point where you will need to hire more expanders faster than landers? And I guess kind of how are you thinking about the balance between those two roles?

It's a great question. Looking at the long term, we've effectively expanded client accounts after landing new clients. We've increased the average revenue from around $39,000 to just over $85,000, and we anticipate that trend will continue. Even if this growth doesn't accelerate significantly, bringing in more new clients will drive substantial growth. In the upcoming years, we expect to see an increase in client acquisitions and to continue growing in that area. We have about 16 million potential clients to target, including small and medium-sized businesses, so there’s a significant market for our content and solutions. There remains plenty of room for growth in client acquisition. Our account executives are actively seeking new business, and we plan to maintain that effort. While we will also need to enhance our expansion efforts as we succeed, we don’t anticipate needing to hire additional expanders this year due to the current capacity available. Over time, we will expand that team, but the growth in the expansion area may proceed at a slower pace compared to new client acquisition. Our customer success organization and implementation strategists will assist by managing some account duties, allowing expanders to concentrate on maximizing usage of our solutions within existing accounts. Both acquisition and expansion will grow, but we expect the client acquisition team to outpace growth in the expansion team. Consequently, we should improve our efficiency with existing clients since our cost structure in that area will remain relatively stable. It's important to note that previously, expanders were responsible for acquiring new business as well, but now their primary focus is on managing and expanding existing clients. This change allows us to increase the number of accounts managed by each expander without hindering expansion efforts.

That's all very helpful. Thank you.

Thanks, Dave.

Thank you. One moment for the next question. And our next question will be coming from the line of Nehal Chokshi of Northland Capital Markets. Your line is open.

Hello, Nahal.

Yes, hello. Hey, thank you for the questions. Congrats on the strong land and expand metrics within the quarter. Clearly the big topic though is the fiscal year revenue reduction. On Slide 5, you did have a line item here of $3 million additional impact in the year. I didn't hear any color on what that additional impact is. Could you repeat it if you already did talk about it?

Sorry. Yes, it's just the spillover of the government actions, tariff-related news, things like that that will create, we expect, some headwinds for our clients here in the U.S. And just the presumption and expectation that there will be some of that this year that will be up against the back half of the year.

Okay. So the way I kind of understand this guidance, Paul, is that, $9 million has been realized already and $6 million is being anticipated.

Yes. The $5 million has been realized, the $4 million isn't fully realized yet. It's the expectation of what we think happens across the year in international. And then education and the additional headwinds. So it's laying out the $15 million. But the $5 million is lost business already in the federal government. The others are just kind of our view into what we think could happen here in the future. And again, we'll try to do better than that, certainly.

Great. Okay. All right. Moving on to the EBITDA guidance. The EBITDA guidance has reduced 70% from the low end of the revenue cut, while the high end of the EBITDA cut is only reduced 50% from the revenue cut. This means that the amount of flow-through is less as we approach the more extreme end of the new guidance range. Why is that?

So Neha, yes, so the…

The amount of guidance cuts is smaller as we approach the lower end of the new revenue and EBITDA ranges. That's what I meant to say. Sorry.

Yes, Nehal. We see the same as you do, and that is, we clearly identified that the numbers, the difference that we're talking about is related to the low end of the guidance versus the full guidance. And if we did the calculation based upon the high end of the guidance, it would be a different level of impact. So we're agreeing with exactly with what you said. And we did the comparison to the low end of the ranges just because clearly identifying it is when anybody wanted to do the calculation based upon the high end, all the numbers are available to easily do that. But we see it the same way you see it Nehal.

Okay. And what I was trying to say was that, the low end of the new guidance range relative to the high end of the new guidance range for the EBITDA cut is not as severe as a percentage of your revenue cut as it is for the high end. And so, you're expecting not as much of a profitability impact as you get to a more extreme revenue cut scenario here. That was the question. Not which baseline to utilize.

Yeah, Nahal, if I'm understanding correctly, I think the thing included there is we're including an anticipation of having some reasonable controls of our SG&A. So those SG&A adjustments to adjusted EBITDA are the same, or they're talking about the low end or the high end of the range. It's the same number rather than a proportional adjustment based upon the change in revenue. And I think that's what's changing the different percentage. Does that make sense?

That makes a lot of sense. Yep, that makes 100% sense. Okay. And then it looks like in the quarter, you did have negative free cash flow. What's the driver of that?

There are several factors affecting our free cash flow, which is significantly lower than last year. One major factor is that we paid over $6 million in taxes this year, which we hadn’t typically done in the past. We had indicated for some time that these tax payments were coming due to the expiration of our net operating loss carryforwards and foreign tax credits. As a result, we saw an increase in cash paid for taxes. Additionally, last year we received a substantial amount of customer deposits that bolstered our cash flows, but these are irregular. This is due to the fact that customers seldom prepay for their services, but in education, especially at the state and district levels, if cash is available, they may make significant prepayments. This has had a notable impact on our cash flow, with about a $7 million difference in the deposits we received. Net income is another contributing factor. Thus, the primary influences on cash flow include the company's profitability, customer deposits, and our tax payments.

Okay. That's really helpful. And then, clearly you guys are signaling high confidence in the business fundamentals by deploying about $8 million in buybacks during the quarter. Can you give us a sense as to whether or not you will continue to do so, given where the stock is indicating here?

Nahal, as you know, we never really say exactly what we're going to do, but we do look at the share price and we have shown a willingness to buy back shares. So I think that's an indication that our strategy going forward will be similar to the past. And that is we hope in any scenario to be actually generating positive cash flow even at these reduced levels. And if we can have meaningful acquisition activity that will really increase the value of the company over a longer term, then we'll look seriously at that. And then amid all of that, we'll obviously look at the share price and other factors that we can see and the cash that we have available and look at buying back shares.

Okay. What's your degree of confidence that the remaining EBITDA that you expect to generate for this year will generate positive free cash flow?

I believe we will achieve positive free cash flow. Although we do not provide estimates, we anticipate that even with our reduced forecasts, we will maintain positive free cash flow for the year.

For the full fiscal year, or are you talking about for fiscal 2H 2025?

For the full year and some additions to the first half in the second half. Maybe not that much, but still some free cash flow for the year and most likely a little bit in the second half.

Great. Thank you very much.

Even given these numbers.

Thanks, Nahal.

Thank you. And that does conclude today's Q&A session. I would like to go ahead and turn the call back over to Paul for closing remarks. Please go ahead, Paul.

Thank you. Thanks again, everyone, for joining today. It's great to be with you and to share an update on where the business is. We're pleased with what's happening in our go-to-market transformation and also what's happening in our education business and look forward to talking to you again in a quarter. Have a great afternoon.

Thank you all for joining today's conference call. You may now disconnect.