Franklin Covey Company

Hello, and welcome to the third quarter 2020 FranklinCovey earnings conference call. My name is Michelle, and I will be the operator for today's conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and during the question-and-answer session, if you have a question, please press star, then 1 on your touchtone phone. Please note that this conference is being recorded. I will now turn the call over to the Corporate Controller, Derek Hatch. Sir, you may begin.

Thanks, Michelle. On behalf of Franklin Covey, I would like to welcome everyone to our conference call this afternoon to discuss our third quarter fiscal 2020 results. Before we get started, I would like to remind everyone that this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management's current expectations and are subject to various risks and uncertainties, including but not limited to the ability of the company to stabilize and grow revenue, the duration and the intensity of the COVID-19 pandemic and the corresponding recovery from the pandemic, the acceptance of and renewal rates for the all-access pass, the ability of the company to hire 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, including the effects of the COVID-19 pandemic, 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 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. Bob Whitman, our Chairman and Chief Executive Officer. Bob?

Good, Derek, thanks so much. Thanks to everyone for joining us today. We're really happy to have a chance to talk with you. Hope each of you is doing well and that each of you is well. Obviously, the 90 or so days since we last reported have been some of the most noteworthy in recent history, both nationally and globally. And while many of us have been through a lot in the past, none of us has lived through a time quite like this. As a result, all of us, whether individuals, schools, or companies, are dealing with uncertainties we've never faced before. Despite these challenges, however, we're grateful actually that our rate of progress has strengthened, as we'll talk about today, that many areas have been actually quite a bit stronger than we might have guessed. We believe this reflects our compelling strategy, our strong operations, and in some cases, the relative firming up of the snow that we talked about in last call. in a number of areas. As we'll address later, the rate of our progress leads us to expect that we will resume being a very high EBITDA growth, high cash flow growth company as we have been in the past quarters as we've moved beyond this period. I'd like to jump right in and start out by reviewing our results for the third quarter. We entered, just in context, we entered fiscal 2020 with strong momentum. having seen revenue grow 15.6 million or 7.5% in 2019, and having seen adjusted EBITDA increase 8.7 million or 73%. We expected this momentum to continue, is being driven by the things that we knew it should be driven by, and even accelerate in 2020. As a result, we expected revenue growth in the high single digits, meaning $18 to $20 million, with adjusted EBITDA and cash flow expected to increase between 35 and 50 percent for the year to between 27 and 32 million. Consistent with this plan and the expectation for 2020, just as a reference point, as slide three, through the second quarter ended February, we had thankfully had very strong year-to-date results. Year-to-date revenue had been up 7.8 percent, subscription and related revenue had grown 22% to all excess past, and related revenue had grown 25. Adjusted EBITDA had already increased 4.9 million, or 118%, and cash flow from operating activities had increased 4 million, or 30%, to 17.4 million. That meant that the latest 12 months through the second quarter, adjusted EBITDA had increased 9.4 million, or 59%, reaching 25.5 million for the latest 12 months, really almost getting us into the lower end of the range expected by our full year fiscal 2020 guidance of 27 to 32 million. And that was our two historically strongest quarters still ahead of us. With that performance, we entered the third quarter with the expectation of achieving actually the high end of this year's adjusted net cash generated range. I give you that background only to say that we were grateful to start, you know, that we were on track, had been on track, that we entered this time strong strategically, operationally, and financially with significant liquidity. However, in April, when we reported on these results, the external environment obviously was one of significant and constantly changing uncertainties. How would COVID-19 virus and its related stay-at-home restrictions impact society at large? How would it affect individuals, businesses, and schools? And obviously, really, much of this uncertainty remains. These factors had a significant impact on our business in the third quarter. As you can see in slide four, our revenue for the third quarter was $37.1 million. That was down 18.9 million compared to 56 million in last year's third quarter. As we'll discuss in further detail, more than 100% of this decline in revenue resulted from the need to reschedule coaching and training engagements that had been scheduled onsite at client locations and which then were not possible to deliver due to stay-at-home restrictions. Actually, the majority of this decline occurred in our international operations. where our offices in China and Japan and in many of our licensees were closed due to strict stay-at-home orders for much of the quarter. As we'll discuss in a minute, we have been able to rebook many of these engagements live online. We ultimately expect to retain and really not lose the vast majority of the revenue that required rebooking. On the other hand, as we'll discuss in more detail in a minute also, our subscription revenue proved to be extremely durable even in the middle of the pandemic. And so I think, you know, taking those two points, almost all of the, more than 100% of the impact was as a result of not being able to carry out live training and consulting events, which thankfully we've been able to reschedule the bulk of live online. And thankfully the other part of our business, the subscription side, which doesn't, the, the, activities of which really don't affect the quarter because they're just put on the balance sheet for subscription accounting, actually retained strength. We'll talk about that more in a minute. Our gross margin remains strong, even increased 146 basis points to 72.3% in the quarter. Also, as you can see, increased 214 basis points year-to-date and 131 basis points for the latest 12 months. And these increases reflect the increased share of revenue related to high-margin subscription sales. Third, SG&A, we have a highly variable and performance-tied cost structure that was designed to flex meaningfully to provide a significant offset if there were at any time an offset to revenue and gross margin in a downturn, and it did. As shown, operating SG&A declined $6.1 million in the quarter, offsetting 48% of the $12.8 million decline in gross profit in the quarter related to the need to reschedule these onsite engagements. Fourth, adjusted EBITDA declined $6.7 million in the third quarter, reflecting that the $12.8 million decline in gross profit was meaningfully offset by that decline in operating SG&A. And finally, cash flow from operating activities remained strong through the quarter, at $18.7 million. Stepping back from this, I'd like to address four key takeaways that I hope you'll find useful as we unpack these numbers and provide some important insights. Takeaway one, noted, is more than 100 percent of the decline in revenue and adjusted EBITDA in the third quarter resulted from this need to reschedule revenue due to the worldwide stay-at-home restrictions. As noted, the majority of this related to our international operations whose offices were closed during much of the quarter and who do not yet have substantial subscription businesses to cushion them. Thanks to our immediate shift to delivering coaching and training live online, a capability we developed over the past 10 years, we've scheduled a significant portion of the engagements which had to be rescheduled. And actually, our booking pace for coaching and training services gained very strong traction and accelerated since early May. And so we believe that the area of biggest impact in the quarter, that of having to reschedule, was well on the way to being addressed. Our booking pace, as we'll talk about more in the last six weeks or eight weeks, has now regained the same levels we had last year in the U.S. and Canada. And so we believe that in coming quarters, uh, you know, those, you know, that impact will, uh, will address itself. We continue to have weakness in China and Japan, although both are, are, are increasing or improving for Q4 as well as among our licensee partners. So the biggest challenge we believe is on the way to getting addressed. Second is that our subscription business has been strong and durable, even in the middle of the pandemic. The rapid growth of our subscription business obviously has driven our accelerated growth in cash flow over the past several years. And even in the third quarter, subscription revenue grew significantly and contracted and invoice subscription revenue also continued very strong throughout the third quarter and has accelerated further in June. Third takeaway is that this strength in the middle of the storm is not just by happenstance. It is based on deep strategic and operational roots, including the importance of the challenges which we're helping our clients address. Those haven't gone away in these times. The flexibility of our offerings across a wide range of modalities allows us to shift immediately to where more than 80% of our new bookings are live online now, and we're converting a bunch of the old days there. And third, the strength of our business model, which flexed on the downside and which has high flow through on the upside. Finally, we'll give some outlook as to what we expect going forward. We do expect to emerge from this period and be able to resume our aggressive march up the mountain of achieving high rates of growth and adjusted EBITDA and cash flow. And we believe we're establishing now the foundation for doing that. So I'd like to just address each of these key takeaways so you have some more context. First, the idea that more than all of the decline related to these are need to rebook. More than 10 years ago, just after SARS actually, we were concerned about it. We met and allocated significant resources developing very strong live online coaching and training delivery capabilities. Not many other people were. You had pure digital. and you had pure live on-site, we felt like, you know, really you need to be able to deliver this content. We need to be able to do it, get the same net promoter scores that we were getting. And so we've tested this a lot and done a lot of this training. More than 190 of our consultants across both divisions have the capability to deliver our coaching, training, and impact journeys on both our own proprietary Adobe-supported platform called LiveClick, as well as on all the other major live platforms and live online platforms, including Zoom, Microsoft Teams, WebEx, and GoToMeeting. Our consultants are expert at facilitating and delivering live online, and actually they earn the same high 70s net promoter scores with their live online delivery that they achieve when delivering live onsite at client locations, and actually have a little higher rating on the question, how likely is it that you would recommend your instructor You know, it's in the 80s, you know, mid-80s anyway, but it's actually a point higher with live online. So for years we had believed that with the quality of our content and our consultants and our digital support tools, this live online capability would ultimately become a unique competitive advantage, both relative to traditional live on-site only providers and actually also to digital only providers. Vision of this, though, and despite our capabilities, clients actually typically continue to choose to have these coaching and consulting engagements done live on-site at their business or school locations. Lester of this is that in the U.S. and Canada in last year's third quarter, we started the quarter with 659, and this is in the enterprise business, 659 coaching and training engagements already on the books. and added an additional 920 engagements for delivery in the third quarter, ending the quarter with almost 1,600 coaching and training engagements. Essentially, all of them were for live onsite delivery at client locations. Similarly, we began this year's third quarter with 884 coaching and training engagements on the books, which was 34% higher than last year's third quarter, and again, Almost all of these engagements were scheduled live on site at client or school locations. However, as we all know, pandemic related concerns and stay at home restrictions made this onsite delivery virtually impossible during most of the third quarter. This meant that substantially all of this third quarter revenue had to either be rescheduled live online and typically not into the same quarter since many companies and schools were just trying to get their bearings during the third quarter. In addition, given the uncertainty as to when offices might reopen, an uncertainty which obviously continues, the pace of new bookings of coaching and training engagements was also much lower throughout March and April as many organizations figured they'd be back in their offices by May or June and they'd just go ahead and do it live on site then. But as that started to become more clear, they've converted a substantial number of those to live online. These same factors had actually an outsized impact on our offices in China and Japan, which were closed for long periods of time during these countries, multiple lockdowns since these areas traditionally had done very little live online or digital training and didn't have a large base of all access pass subscription revenue to provide revenue stability. We knew that our international licensee partners experienced similar challenges than they have. And so the amount of revenue that was involved in these onsite engagements that had to be rescheduled was very substantial, totaling approximately $30 million across the company. Last year, it would have been $30 million plus this year. As I mentioned, because of our investments in developing strong live online delivery capability, we moved immediately to provide many live online client demos daily. All day long, teams were showing feedback clients how it could work. They were surprised by how engaging it was. Many of our training engagements, therefore, that we lost have already been rescheduled or are in the process of being rescheduled. And we expect that a significant majority of these onsite engagements which have been postponed will ultimately be rescheduled and not lost and not displace other revenue. However, finally, even with our rapid response, more than $20 million of the revenue of that over $30 million had to be rescheduled. It just wasn't possible to deliver it. And that represented more than 100% of the company's total decline in revenue in the quarter. And as mentioned, an unusual amount of that occurred in our international offices. It's shown in slide eight. You get an idea of the mix of this. Whereas our international operations, you can see they're accounted for 29% of our revenue in the third quarter of fiscal 2019. These operations accounted for 5.3 million of lost contribution in this year's third quarters. This is kind of looking at the EBITDA impact. By contrast, our U.S.-Canadian operations, which accounted for 56% of our total enterprise division revenue in last year's third quarter, accounted for only 1.4 million of reduced contribution. And this, again, is a reflection of the strong subscription orientation in the US and Canada and among our English-speaking international offices and the earlier stages of subscription development in China and Japan. We're pleased I mentioned that the booking momentum for new coaching and training engagements, has increased significantly and 80% of those new bookings are now live online. And it's really accelerated over the past two months and is surprisingly now tracking ahead of our booking pace at the same time last year. As you can see in slide 9, just to give you some visibility on this, you can see the pickup of the booking of new coaching and training delivery engagements beginning in mid-April. As shown, since then bookings have accelerated. As a result, in the U.S. and Canada, we are now back to booking levels nearly equal to those being achieved last year at this time. Also, on the same slide 9, you can see that our mix of delivery on new bookings has shifted to approximately 80% live online now, and so we're getting the same pace of bookings almost as we had last year at this time, despite ongoing uncertainty, and people are very willingly doing it live online, and we think this is important. In addition to improving coaching and training at e-booking pace, as you can see on slide 10, we're also very encouraged by the pace of additions to our overall advanced stage pipelines. And this consists of both invoice revenue and deals which are, in our calculations, very, very highly likely to close, either 85% to 95%, depending if it's A or B status. trend began pacing ahead of prior year, starting in mid-May and his accelerated pace has continued through July today. And so, so the things that are not recognized in our third quarter, the things that are recognized really didn't have very much to do with the quarter itself or what was generated in the quarter. We had deferred revenue already on the, on the balance sheet that was coming in. We knew, and we had all these bookings that then couldn't be delivered. on site and that's really the story of the third quarter. However, the important thing for us looking forward is that the activities and booking pace on things that when booked really go on the balance sheet and don't have an impact much in the third or fourth quarters that build the foundation for next year thankfully have been strong. Second major takeaway is related to this subscription business. which again didn't have much impact at all in the quarter except for the deferred revenue piece, but has an important impact on the future. This is the area in which we expected to feel the least impact from the current pandemic. We have an $84 million pure subscription business excluding add-on services. And you can see in slide 12, our subscription revenue has grown from just $19.6 million in 2016 to $80.9 million for the latest 12 months to this year's second quarter, with All Access Pass subscription revenue growing from $11.9 to $58 million, and Leader & Me subscription revenue growing from $7.6 million in 2016 to $22.5 million. This subscription business has been characterized by rapid growth, strong gross margins, high revenue retention rates, and a very strong lifetime customer value. and has been a key driver behind the accelerated growth and adjusted EBITDA and cash flow we have achieved over the past several years. This strong growth and strong economics, together with the low customer acquisition cost to lifetime customer value, has caused some of you to let us know that you believe that this part of the business alone, which represents about 40% of our revenue and has been increasing by about 800 basis points a year, is worth at least five times its revenue. greater than 400 million just this portion of the business alone which has been durable and we're not making it stating opinion on it but we believe that is a very robust business importantly has shown our total subscription revenue as as well as both leader and me revenue continue to grow in the third quarter and you can see increase to 84 million for the training 12 months uh latest 12 months through the third quarter uh and so this was strong 18 growth in the quarter itself. I'll just give you some quick bullet point data on the subscription business. First, our billed and unbilled deferred revenue. We expected that 100% of the 22-plus million deferred revenue that was scheduled to be recognized in the third quarter would be recognized, and all of it was. You can see that's broken into billed deferred revenue as shown in slide 13. We had $47.9 million of billed deferred revenue on the books at the end of the second quarter, which is $8.4 million or 21% higher than at the end of the second quarter a year ago. Of this amount, we expected to get the full $22.3 million that was scheduled to be recognized. And as we did, as a result, our revenue in the third quarter increased 18%, subscription revenue increased. With all excess past subscription revenue growing slightly higher, 19%, and leader in May growing 14%. You see the unbilled deferred revenue also on slide 13, where we had a balance of $34.8 million of unbilled deferred revenue at the end of the second year related primarily to multi-year contracts. And that number was 39% or $9.8 million higher than the $25 million balance we had at the same time last year. Again, we expected that substantially all of this that was supposed to be invoiced in the quarter would be invoiced, and all of it was. We had concerns that the pace of decision-making in the midst of all this would be held up, that that would affect potentially renewals and new past sales. As you can see, however, in slide 14, our renewals historically have been very strong. In every case over the last nine quarters, the latest 12 months, revenue retention percentage has exceeded 90%. We had expected our revenue retention rate during the third quarter, however, would likely be lower due to just all the disruption. And while we weren't sure what to expect, we are very pleased that despite the difficult and unusual business environment, our All Access Pass revenue retention rate was actually higher than 80% for the third quarter. And with this strong performance, our latest 12-month revenue retention actually exceeded 90% again for the 10th straight quarter. Subsequent to the end of the quarter, we've actually had a couple of other accounts come in that were delayed and weren't counted in the quarter that actually boost that revenue retention a bit higher. Second, you know, we were concerned that the invoice sales of all access passes to new organizations or new logos would be impacted. But again, it has continued to be strong. As you can see in slide 15, the sale of all access passes to new logos continued strong during the quarter, coming in at 92% of the level achieved in last year's Q3 in US and Canada. And the sale of all access pass passes to new logos was even stronger in June. And as a result, as you can see also on slide 15, as a result, the sale of all access passes to new logo companies for the four months March through June came in right at 100 percent of the level achieved for the same period last year. Third, the pace at which all access pass holders entered into multiyear contracts has also been strong. Well, it might have been reasonable to expect that fewer All Access Pass holders would enter into or renew multi-year contracts during the third quarter with all the uncertainty. As you can see in slide 16, the dollar amount of multi-year All Access Pass contracts actually increased a little bit to $3.9 million from $3.5 million in last year's third quarter. And our balance of unbilled deferred revenue increased to $33.4 million. from 23.7 million at the end of last year. As a result, the combination of maintaining high revenue retention and entering to new logo sales, our invoice subscription revenue in total was 86 percent of the amount we invoiced in the prior year. It was 11.8 million versus 13.7 last year, and again, If you look through June on things that renewed just a little late, that gap closes even further. In the education division, approximately historically 88% of LeaderME schools in the US and Canada have renewed their LeaderME subscription membership in a given year. The vast majority of these renewals have occurred during our fiscal third and fourth quarters, matching schools' budget cycles, and so this year it's right in the middle of the storm. With more than 2,700 leader in these schools to renew, it might not have been unreasonable again to assume that the renewal rate would drop substantially. As you can see in slide 17, the tremendous disruption in schools in March when schools and their administrators were scrambling to teach live online and ensure that those who depended on school meals could still pick them up, etc., resulted in us starting April with 967 Leader in these schools having renewed or committed to renew their subscription membership, and that number was 434 or 31% fewer than at the same time in fiscal 2019. However, our education team has been working around the clock, and they've really made up very substantial ground since then. As of yesterday, July 8th, this number had increased to 1,994 retained schools that either already signed contracts or are awaiting return of a contract to which they've committed. And that's now just 141 schools or 8% behind where we were at this time last year. At present, we expect that the school renewal rate will again end up at greater than 80%, reflecting these schools' strong commitment to the Leader in Me program. Finally, as the expected sale of Leader in Me memberships to new schools, expected that would be impacted by the very challenging current environment that it has been. As shown in slide 18 through July 8, 280 new schools had purchased or are awaiting signed contracts on purchase of new Leader in Me memberships. This represents approximately 65% of the number of new Leader in Me schools we had contracted. at the same time last year. However, based on our current pipeline and taking into account the initial significant disruption marks and the fact that it kind of moved everything back about six weeks, we expect that the pace of sale of new school memberships will increase and reach approximately 400 by the end of the fourth quarter. That's a number that 75 percent of the number achieved last year and a number we would feel very good about. In fact, we viewed it as a very strong indication of the significant value schools place on the Leader in Me that during the difficult period since March 1, more than 1,200 schools have renewed their Leader in Me memberships with all they had going on, and 130 of these new schools have become Leader in Me schools. So I'm really pleased that our subscription business remains so durable, even in these times, and that the primary impact on our business, which has been the inability to deliver training and coaching, is on the way to being addressed because of our significant success with live online training. So I'll just quickly turn the time over to Paul Walker to discuss our third takeaway that related to the factors which are underpinning the strategic durability of the subscription business. Paul?