Earnings Call Transcript - FC Q2 2023

Operator, Operator

Good day and thank you for standing by. Welcome to the Second Quarter 2023 Franklin Covey 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 hand the conference over to your speaker today, Derek Hatch, Corporate Controller.

Derek Hatch, Corporate Controller

Thank you. Good afternoon, everyone. On behalf of Franklin Covey, I want to welcome you to our earnings call for the second quarter of fiscal 2023, and I hope that you and your families are enjoying some nice warm spring weather today as well. Before we begin, we'd like to remind everybody 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 acceptance of renewal rates of our subscription offerings, including the All Access Pass and Leader in Me memberships, the duration and recovery from the COVID-19 pandemic, the ability of the company to hire productive sales 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 marketing and 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 the company's actual future performance will meet management's expectations. These forward-looking statements are based upon 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, I'd like to turn the time over to Mr. Paul Walker, our Chief Executive Officer. Paul?

Paul Walker, CEO

Thank you, Derek. Hello, everyone. Thanks for joining us today. I too hope you're doing well. I'm joined here today by Steve Young, our CFO; Jen Colosimo, President of our Enterprise Division; Sean Covey, President of our Education Division and several members of our executive team. We're happy to have Colleen Dom here, our Head of Operations as well. We're also happy to have Bob Whitman, our Executive Chairman, with us. In the midst of an increasingly uncertain economic environment, we are pleased to report that our second quarter revenue was $61.8 million or 9% higher than the prior year. In constant currency, our second quarter revenue grew approximately 11% to $62.7 million, even after lower than anticipated sales in China and the decrease in rental income, which combined made up an additional $1.1 million of impact. We're also pleased to report that adjusted EBITDA for the quarter was $8.2 million. In constant currency, adjusted EBITDA for the quarter was $8.4 million and would have been even higher if not for China and the absence of the rental income. The current economic environment obviously continues to be a challenging one for both companies and investors. Everyone is hiking in deeper snow now than they were even 90 days ago. Based on the strength of the quarter and year-to-date results and our confidence in the strength of our pipelines, even in this environment, we're pleased to be able to reiterate our full-year adjusted EBITDA guidance in constant currency of between $47 million and $49 million. As to revenue, compared to our estimate at the beginning of the year of $294 million, we expect revenue to be impacted by approximately $3.5 million due to FX, an additional $2.5 million because of slower than expected recovery of sales in China and Japan, and by an additional $4 million to reflect the expected impact of the deeper snow through which our clients are now hiking. Importantly, as you know, Franklin Covey's strategy, business model, and approach were really developed and refined with times like these in mind. Specifically, five key elements of Franklin Covey's strategy and business model were each designed to allow us to take advantage of opportunities while building in resilience and enabling us to achieve strong growth in revenue, adjusted EBITDA, and cash flow even in challenging economic circumstances. The individual and collective strength of these five strategic elements, which you can see shown in Slide 4, is being reflected in our second quarter year-to-date and latest 12-month results. These five elements of our strategy and business model are as follows: The first is that we've chosen to help clients address challenges that are mission critical and extremely durable. As you know, we help organizations and schools achieve results that require the collective action of significant numbers of people. These kinds of challenges are mission critical and extremely durable, and they don't become less important or easier when the external environment becomes more difficult, in fact quite the opposite. As a result, many of what are now our largest client relationships were first established during and immediately after the great financial crisis. A key metric showing the ongoing desire of potential clients to address these challenges and their trust in selecting us as their partner is our ability to win new clients or new logos, in both good and more challenging times. We're pleased that our contracted new logo revenue in the second quarter year-to-date and for the latest 12 months has remained very strong. A second key element of our strategic strength is the effectiveness of our solutions in helping clients address these challenges. This builds tremendous client commitment and loyalty, which in turn results in achieving strong growth in subscription and subscription services revenue, having a significant percent of clients who enter into multi-year contracts, achieving strong levels of contracted revenue and high levels of revenue retention, and having clients purchase significant amounts of services to help them achieve their objectives. We are pleased that, even in the current economic environment, all four of these metrics remained strong in the second quarter, year-to-date, and for the latest 12-month periods. First, subscription revenue remained strong in the second quarter year-to-date and for the latest 12 months. As shown in Slide 6, total company subscription and subscription services revenue grew 15% in the second quarter, has grown 18% year-to-date, and 22% for the latest 12 months, with All Access Pass subscription and subscription services revenue growing 11% in the second quarter, which was on top of 29% growth in the second quarter of last year, 15% year-to-date, which was on top of 28% growth year-to-date, through the second quarter of last year, and 22% in the latest 12 months. In our education business, Leader in Me subscription and subscription services revenue grew 30% in the second quarter, 27% year-to-date, and 23% in the latest 12-month period. Second, as shown in Slide 7, the percent of our North America All Access Pass subscription contract value represented by multi-year contracts of at least two years has increased significantly, from 47% in last year's second quarter to 55% in this year's second quarter. This reflects our clients' long-term commitment to address their big opportunities and challenges utilizing our solutions. Third, we also achieved strong levels of invoice revenue and high revenue retention. Again, we're pleased with the significant levels of revenue that we contracted during the second quarter and in the year-to-date and latest 12-month periods. As shown in Slide 8, invoice revenue in the Education Division grew 30% or $1.8 million in the second quarter, 29% year-to-date, and 19% for the latest 12 months, and our balance of deferred education revenue increased $3.1 million or 18% to $20.2 million. Our balance of billed and unbilled deferred revenue at the end of the quarter was $145.8 million, reflecting growth of $26.5 million or 22% versus last year. This growth in unbilled deferred increases visibility and predictability into future revenue and provides a meaningful tailwind for growth in our invoiced amounts in the coming quarters. The individual and collective power of these five key elements has been very evident in the strength of our business over the past years and in our continuing strength in the second quarter, year-to-date, and latest 12-month periods. We're pleased that even after investing $25 million of excess liquidity for stock repurchases in the last four quarters, we ended the second quarter with $55.1 million in cash and with our full $15 million revolving credit facility undrawn. During the second quarter, our Board of Directors both replenished our stock repurchase authorization and increased it to $50 million. In addition, subsequent to the end of the quarter, we entered into a new credit facility, at an attractive rate that increases our revolving credit amount from $15 million to $62.5 million, providing us with significant flexibility for both repurchasing stock and making strategic acquisitions. As a result of this ongoing strength, we expect to generate adjusted EBITDA between $47 million and $49 million in constant currency in fiscal '23 and in constant currency to be able to achieve our targets of $57 million in adjusted EBITDA in fiscal '24 and $67 million in fiscal '25.

Steve Young, CFO

Thank you, Paul. Good afternoon, everyone. It's nice to be with you. As Paul said, I'd like to start by sharing some headlines regarding our revenue. As Paul mentioned, as you can also see in Slide 18, our revenue growth in the second quarter continued to be strong, with revenue increasing 9% to $61.8 million compared to $56.6 million in last year's second quarter. In constant currency, our revenue grew an even more rapid 11%, even after lower than anticipated sales in China and a decrease in rental income, which combined made up an additional $1.1 million impact. Our subscription and subscription services revenue grew even more rapidly. As shown in Slide 18, total subscription and subscription services revenue grew 15% in the second quarter, 18% year-to-date, and 22% in the last 12-month period, with All Access Pass subscription and subscription revenue growing 11% in the second quarter, on top of 29% growth last year and growing 15% year-to-date. Our strong and increasing liquidity adds Franklin Covey optionality, as we continue to invest in our business, evaluate potential acquisition opportunities, and continue to look at ways to further enhance shareholder value.

Paul Walker, CEO

Thank you, Steve. Thanks for taking us through that. Maybe just stepping back for just a minute before we move to guidance and outlook. In this environment, we're often asked a couple of questions. First, whether organizations and schools are still engaging us on major behavioral change initiatives? And second, how we're thinking about the ongoing growth of our revenue-generating client-facing roles including client partners? The answer to the first question is an emphatic yes. While it's true that some organizations are hunkering down as occurred during the early stages of the pandemic, many others see this as a critical time to strengthen their organizations by putting extraordinary focus on major strategic objectives. Last week, we convened a group of Chief Human Resource Officers and Chief Learning Officers from 17 of the largest companies in the country. Collectively, they employ more than 2 million people. We spent the entire day discussing the areas in which they and their CEOs are most focused, and how they are organizing to drive collective action on their most important objectives. Over and over, we heard these leaders discuss the high correlation between leadership capability and financial performance, the importance of culture, and the power of focusing and aligning organizations to improve execution. Franklin Covey is the trusted partner to our clients in each of these areas. As shown on Slide 23, I'd like to briefly touch on a few recent client wins that illustrate the positive momentum we're seeing across the majority of our client base right now. First is the recent new client win with a large organization engaging us on a major sales transformation initiative that will touch more than 5,000 of their sales professionals around the world. This is a five-year All Access Pass contract. A second is a large multinational information technology consultancy, whose All Access Pass actually expired six months ago, resulting in a non-renewal at that time due to uncertainty in the economy. However, in the second quarter just ended, we won this client back for a new three-year contract with significant subscription services attached. A third is a large transportation company that expanded their All Access Pass seats from 1,500 to 9,000 in the second quarter, allowing us to help them address their entire leadership population globally. And also importantly in our Education Division, the team has successfully pivoted from selling Leader in Me, not only to individual schools but also to entire districts and states. We won our second state-funded contract and have closed district-wide sales with more than twice the number of districts this year than we had at the same point last year.

Steve Young, CFO

Thank you again, Paul. Driven by the continued strength, strategic durability, and future visibility provided by our All Access Pass and Leader in Me membership subscriptions, which due to their high revenue retention, high lifetime customer value, and their attractiveness to new customers have resulted in accelerated growth over the past year, we are affirming our previously announced guidance that adjusted EBITDA for fiscal 2023 will increase to between $47 million and $49 million in constant currency, compared with the $42.2 million in adjusted EBITDA achieved in fiscal 2022. We expect to achieve this growth even after continuing to make increased investments to add new client partners, other personnel, and investments in delivery portals and content, while absorbing potentially challenging macroeconomic circumstances. This guidance also assumes that China and Japan will begin their post-COVID-19 recovery in the second half of the year and includes the loss of approximately $1.4 million of adjusted EBITDA related to the loss in Q2 of a large tenant at our corporate campus.

Paul Walker, CEO

Thank you, Steve. We feel great about our continued momentum and are looking forward to accelerating growth. And with that, I think we ought to open up to your questions.

Operator, Operator

Thank you. Our first question comes from Nehal Chokshi with Northland Capital Markets. You may proceed.

Nehal Chokshi, Analyst

Thank you. Hey. Just a little clarification on the EBITDA guidance. The slides are classifying on a constant currency basis. In the quarter ago period, that did not specify on a constant currency basis. So, are we going from an as is to a constant currency outlook here?

Steve Young, CFO

Fair question. Specially, I think we've always tried to give our guidance in constant currency, and so that was probably a miss on our part in the slide last quarter.

Nehal Chokshi, Analyst

Okay. Excellent. And I think what you guys are trying to communicate here is that over the last three months, you have seen incremental headwinds to EBITDA and you're absorbing those incremental headwinds. Can you quantify exactly those incremental headwinds on an EBITDA basis as opposed to a revenue basis that you have already provided?

Paul Walker, CEO

We haven't specified a figure related to how the revenue headwinds impact adjusted EBITDA, but any additional revenue, whether it's $2 million, $3 million, or $4 million, would significantly contribute to adjusted EBITDA at a high flow-through rate.

Nehal Chokshi, Analyst

Got it. Okay. Great. Two other quick questions here. So, bookings in the quarter are up only 2% year-over-year, although, the All Access Pass invoicing was up 5% year-over-year. That's versus the mid-teens prior four quarters and 23% in the November quarter. So, a pretty significant deceleration in your bookings, what's the narrative behind that deceleration there?

Paul Walker, CEO

Yeah. It's a good question. So, stepping back for just a second, as we looked at the quarter and as we talked about just a minute ago, there are a number of positives happening in the quarter relative to bookings. We had a number of clients who renewed and expanded their All Access Pass, which was greater in the second quarter than it was a year ago. So it wasn't that we had more clients signing multiyear contracts this year than did a year ago. So we felt great about that. New logo sales continue to be strong in the quarter for the year-to-date and for the latest 12 months. Those were all positives. We mentioned that while the same percentage of clients who don’t renew in any given quarter didn’t renew, there were some larger clients in there who didn’t renew this quarter, and that weighed to the point where it almost mostly offset the gains on the other side. So that’s what happened in the quarter. There were really positive things, but we had those clients who, while the same percentage didn’t renew in a typical quarter, some of them were larger and reflective of more headwinds for them.

Nehal Chokshi, Analyst

Okay. And my last question is, can you explain to me what you guys mean by deeper snow?

Paul Walker, CEO

So, in Utah, it sounds a little funny. Snow is like crazy in Utah. We were trying to think of what would be a good metaphor, so if a year ago and by the way, a year ago, it wasn't like the economy was all roses either. We’re starting to see some concern and maybe a little bit of pullback, but we’re seeing a little bit more of that now from our clients where if there was not a lot of snow on the ground a year ago, there is a bit more snow now. While the same unit of effort doesn’t yield the same mild high per day for some of our clients, as they face a little bit more headwind, that does have some spillover back into us. And I think we saw that with those clients who, while about the same percent of clients don’t renew in a typical quarter, some of them are larger reflective of that deeper snow for them, which impacts us.

Nehal Chokshi, Analyst

Okay. Thank you. I’ll save the floor here.

Paul Walker, CEO

Thanks, Nehal.

Operator, Operator

Thank you. Our next question comes from Jeff Martin with ROTH MKM. You may proceed.

Jeff Martin, Analyst

Thanks. Good evening, everyone. I appreciate all the detailed information; it's very useful. I'd like to explore the industry mix a bit more and ask if you've noticed any specific trends among your major industry categories, such as manufacturing, financial services, government, and technology, in relation to client renewals. Is there a noticeable pattern within these larger segments, even though none is significantly dominant?

Paul Walker, CEO

Yes, that's a great question. I'll make a quick comment and then have Jen Colosimo provide more details. In short, it doesn't vary much by industry. Jen, you can go ahead.

Jen Colosimo, President of Enterprise Division

Thank you for the question, Jeff. The simplest way to answer that is no. We are not seeing a trend by industry. The best way I could explain it is based on the challenges that we address with our clients, particularly regarding leadership culture and executing on strategy. Many of our clients are reinvesting in that, even if they may have a smaller workforce. As we look at it, as you might expect in this economy, decision-making often moves up. We have clients that are making that economic case, and we have some that are delaying decision-making. So, it’s frankly just an uncertain environment where many things that Paul mentioned are happening. In fact, the same percentage is renewing, and to your question, even within industry, we just had a few larger revenue amounts that did not renew, and we hope to win them back.

Paul Walker, CEO

Yes, Jeff, it's good to hear. We did note that government revenue declined, which slightly impacted our results in North America for the quarter. This sector has been somewhat weaker, but I don't anticipate this will be a long-term trend. It's primarily related to one specific agency.

Jeff Martin, Analyst

Okay. And then I was intrigued by your wording where clients were quote not able to renew rather than chose not to renew. Is there something in particular that stands out and led you to phrase the statement that way?

Paul Walker, CEO

No. Trying to remember where I said that. Oftentimes, when clients don’t renew, they're very committed to us and what they're trying to achieve. If you were in those discussions, you’d hear them say, 'We’re not able to do this for this reason at this moment, but this is not going to be a long-term permanent situation.' So it's just sometimes where the environment for the client causes some difficulty.

Jeff Martin, Analyst

Okay. Well, let me just add a second part to that question. It's noticeable that your unbilled deferred revenue growth far outpaced your deferred subscription build in the quarter. That suggests the longer-term contracts are overwhelmingly outpacing the shorter-term contracts. That says your more loyal, higher-value clients are renewing at multi-year and past expansion levels relative to maybe some of the shorter-term clients. Could you comment on some of the shorter-term clients? Are those traditionally your more valued clients or is there much of a difference?

Paul Walker, CEO

Great. I think we’ve been pleased with the continued steady growth in clients wanting to enter into multiyear contracts. Typically, it will be upon the renewal of their first year or even their second year where they step across and add years. The nature of the problems we’re solving typically requires longer-term commitments. We see that in clients generally deciding to make the commitment to multiyear more and more, and we certainly saw that in the second quarter. To extent there is greater churn, we see that with those clients coming out of their first year. But those mature cohorts show very little churn.

Jeff Martin, Analyst

Great. In the last couple of quarters, you've mentioned an acceleration in revenue growth. Given the current environment, that growth might take a pause. Could you share your level of confidence and whether there have been any shifts or changes regarding your earlier targets of reaching mid-teens and eventually upper teens revenue growth once the economy stabilizes?

Paul Walker, CEO

Great. Our business model generates significant increases in adjusted EBITDA and cash flow, independent of whether we get to the mid-teens and then all the way to the high-teens. The timing of when we get there might be a little bit more elongated. But we’re still very excited and pleased with what we’re seeing in the way the subscription businesses are behaving in both divisions.

David Storms, Analyst

Perfect. Thanks for taking my call.

Paul Walker, CEO

Hi, Dave.

David Storms, Analyst

My first question is coming from Slide 16. Paul, you had mentioned the deeper snow that a lot of your clients are seeing. Would we expect that average annual client spend to be greater than the $77,000 going forward still, or will that number come down as clients pare back the scope of what they're asking from you guys?

Paul Walker, CEO

Great question. So that has increased quite significantly over the years. We would expect that number to continue to increase. More clients are expanding, and we still saw growth in services in the prior year. So those factors show that, that number would continue to inch up.

Steve Young, CFO

The decrease can be driven significantly by the fact that a lot of our costs are either fixed or grow at a rate slower than our revenue growth. Areas that are not client-facing, like central overhead, are expected to grow at a rate lower than revenue for quite some time.

David Storms, Analyst

Do you have a target on what new number of new client partners would look like by the end of the year?

Paul Walker, CEO

I don’t have a specific number today, but we expect to add a significant number of client partners between now and the end of the year. We want to ensure we get the best talent and provide them with the right support to be successful.

Samir Patel, Analyst

How do you think about capital allocation over the next few years? Is the facility a nice to have in case or is there actually something you kind of intend to use it for?

Paul Walker, CEO

First of all, thank you to Derek Hatch for getting all of that put in place. We didn’t just go for an increase in our credit facility to have comfort; we expect to generate a lot of cash. We think there’s an opportunity to be potentially more inquisitive in this environment. We have a great organic growth story, and at the same time, there could be some opportunities for exciting accelerants to what we’re doing and that liquidity provides us the flexibility to act on those opportunities.

Steve Young, CFO

Those will be on our 8-K tomorrow. The 8-K is coming out tomorrow on that. It's a varying amount depending on our covenants. We expect to start at SOFR plus 150.

Samir Patel, Analyst

Thank you, guys.

Paul Walker, CEO

Thanks, Samir.

Operator, Operator

Thank you. This concludes the Q&A session. I’d now like to turn the call back over to Paul for any closing remarks.

Paul Walker, CEO

Thank you, and thanks for your time today. We appreciate you tuning in. Thanks for your great questions, and we look forward to talking to you again soon. Have a good evening.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.