Jul 14, 2008
Executives
Derek Hatch – Corporate Controller Bob Whitman – Chief Executive Officer Stephen Young – Chief Financial Officer Bill Bennett – President Organizational Solutions Business Unit
Analysts
Kevin Henehan – KMH Capital Advisors John Lewis – Osmium Partners Julian Allen – Spirit Capital Tom Coach – Turnaround Capital
Operator
Welcome to the Q3 2008 Franklin Covey Co. earnings conference call.
(Operator instructions) I would now like to turn the presentation over to your host for today’s call, Derek Hatch, Corporate Controller of Franklin Covey Co.
Derek Hatch
Before we begin, I’d like to read our necessary safe harbor regarding forward-looking statements and remind everyone that this presentation contains forward-looking statements that are necessarily based on certain assumptions and are subject to certain risks and uncertainties including the ability of the company to stabilize and grow revenues, hire productive sales professionals, general economic conditions, competition in the company’s targeted marketplace, market acceptance of new products or services and marketing strategies, increases or decreases in the company’s market share, growth or contraction of the overall market for the products offered by the company and its competitors, changes in the training and spending policies of the company’s clients and other factors identified and discussed in the company’s fiscal 2007 10-K report and subsequent 10-Q and 8-K reports filed with the Securities and Exchange Commission. Many of these conditions are beyond our control or influence.
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 expectations as of the date hereof and are subject to the outcome of various factors, including those listed above, any one of which may cause future results to differ materially from the company’s current expectations.
That having been said, I’d like to turn our discussion at this point over to Bob Whitman, our Chief Executive Officer.
Bob Whitman
I would like to talk about three things this morning and then open it up for questions. First is our performance for the third quarter, and obviously it is not one of our stronger quarters from a reporting standpoint, and we will talk about the underlying factors for this.
However, I’ll just say it upfront that we don’t believe it is reflective of any fundamental weakness in our organizational operations. Just slightly more than 100% of the decline in profitability is related to the product’s business, and within in that, at least a significant factor was the timing of the change in our wholesale distribution partner.
As you look at Slide 5, you will see there are momentum and a revenue momentum in terms of bookings. Advanced bookings have actually been good and accelerated somewhat during the quarter.
On Slide 6, you will see that the ramp-up rates for our new client partners continues to be on track, and on Slide 7, the productivity of our alumni client partners also has been good, and in fact despite what isn’t a robust economy, generally about maybe a little over two-thirds of our client partners are ahead at this point year-over-year, and we expect to exit the fourth quarter from an operating standpoint to be stronger than the third quarter and be a pretty strong quarter, so we’ll go into more detail on that. The second thing we want to talk about is a review of the transaction, and all of you or most of you have read that we completed the closing of the transaction much sooner than we had originally anticipated, and that is now done, and we talk about the implications for that.
Third, we want to talk about, just briefly note, the plans for the previously talked about tender offer and confirm out intentions as relates to that, so with that just as an introduction, we’ll obviously get into the detail now and answer any questions. I’m going to turn the time over to Steve Young, our chief financial officer for anything he likes to talk about in relevance to those three things.
Steve Young
I’m pleased to be here this morning to be able to talk about our quarter and the transaction that has taken place and the other matters that Bob mentioned. First of all let me mention related to our quarter filing, if we look at the income statement, we’ll notice first that sales were down $5.4 million.
Bob mentioned that a portion of this, a major portion in fact, more than the total is due to a decrease in product sales of $5.7 million and an increase in training sales of $0.3 million. Product sale did decrease due to the timing of the transition of the wholesale business to a new distributor, as Bob mentioned, some due to the impact of closed stores and also due to traffic decreases in the retail and consumer direct business.
Bill will talk more about the training sales revenue and business in a minute, so I won’t go into that detail. You will notice that our margin decreased slightly compared to prior year, primarily due to an increase in the amortization of development cost, but still a good gross margin.
Our SG&A decreased somewhat compared to last year. We disclosed that there are some non-repeating benefits and some non-repeating costs in this quarter that tend to be offsetting, a little bit of an improvement just considering those items, so SG&A is down a little bit.
We consider that to be good, and we continue to focus on SG&A, and after this transaction, we’ll be focusing even more on rightsizing or adjusting, if you will, the remaining Franklin Covey Co. You’ll notice looking at our earnings or loss per share that our weighted average number of shares used is $16.1 million even though we have $19.6 million outstanding.
The reason for this is we are obligated to remove the management loan shares that are held in escrow when we record a net loss. This is an accounting treatment not often seen but one that is applicable to us due to the nature of our management loan program and the fact that those shares are held in escrow by the company.
Those 3.5 million shares are not removed for the earnings per share calculation when we have earnings. So I know that’s a quick review of the income statement.
Bill will talk more about the training side of the business in just a minute and give more details about what’s going on there which is important. Now if we look just a little bit at the transaction that just took place, I’m excited about this.
I think that the transaction is good for both companies, and that if it’s good for both companies, it’s going to be good for the employees and hopefully the shareholders. I’m excited and pleased about what has taken place.
To date, after the CSBU sale is closed on Monday, effective July 5, we have received the $32 million cash representing the initial purchase price. We have invested $1,755,000 to acquire a 19.5% voting interest in the new company.
That 19.5% voting interest is a little bit less than 16% interest in the earnings of the new company. We have also made a $1 million preferred contribution to the new company that bears a 10% priority return.
This preferred contribution will paid back over time as there is available cash in the new company which is a defined term, so we don’t anticipate that within the next year, but after that, we anticipate that $1 million will be repaid. Also as a part of the transaction we have entered into a working capital note that will be adjusted over the next 60 days and then paid to us.
It will become due in January 2009. This working capital note represents the sum of two numbers.
One is the amount by which working capital actually transferred to the new company exceeds $10.1 million, and the other part of the note is to reflect actual reimbursable cost that we have paid and then will be reimbursed by the buyer. I know that you are very sophisticated financial people on the phone.
If we calculate this working capital note as of the May numbers that have been disclosed, it’ll total approximately $3 million, but our expected amount is $5.5 million. Please understand as I said earlier that that amount will adjust over the next 60 days as we actually close the books.
As we actually accumulate all of the reimbursable costs and get final numbers, that could change materially, but that is our estimated amount at the current time, so we are very pleased about how all that has gone. We’ll account for our 19% interest in the company using the equity method.
We will receive a tax distribution to cover our tax liability each year, and our presentation going forward for this transaction is not discontinued operations treatment, so again even though it’s a significant portion of the business, we will not reflect discontinued operations. That means as we go forward, revenue as an example in the first quarter of next year will be significantly less than the first quarter of last year because products revenue is not included, so we are not obligated but we’ll want to show the impact of this sale on those numbers, but just wanted you to be aware that will be the accounting treatment going forward.
Additionally, please remember as a result of the transaction that if the EBITDA of the new company exceeds $13 million, then we’ll receive the 30% royalty on that excess up to a cap of $1,250,000 of royalty per year. On last thing relating to this transaction is that resulting from this sale, we have a modification in our credit facilities.
Our $25 million facility is now with one lender rather than two. Our interest rate has increased from LIBOR plus 1.1 to LIBOR plus 1.5, and our line of credit must be reduced from $25 million to $15 million by the end of June next year.
So again just very pleased about the transaction and the work that’s gone on in the last few weeks to close this transaction. It has been very exciting to see it all come together.
Looking at our balance sheet, as a result of this transaction, you’ll note at the end of third quarter, we show assets and liabilities and equity held for sale. This means the CSBU assets and liabilities are summarized on those lines in the financial statement and excluded from their normal classification.
Inventory as an example shows a balance of $7 million. This is the amount that excludes the CSBU inventory, so if you look at our balance sheet, you’ll see that the assets of operations held for sale total $30.8 million.
Our liabilities held for sale as of quarter end total $10.4 million, and our other comprehensive loss held for sale totals $0.6 million. In those balances, the $30.8 million of assets held for sale is just over $5 million of receivables, just over $14 million of inventory, and about $3 million of other current assets for total current assets of $22.5 million, and fixed assets of $8.3 million.
On the liability side, those liabilities held for sale are accounts payable of just over $4 million and accrued liabilities of just over $6 million. We know that using the third quarter numbers, there are many who’ll attempt to calculate our gain on sale, and so please remember that the balances as of the third quarter, the assets held for sale, that is not the transaction balance sheet.
The transaction balance sheet is as of the end of June, not as of May or end of our third quarter, but as you run the calculation, you’ll see that our working capital as of May was more than the required $10.1 million. But that isn’t the exact number that we’ll have when we close, so if you attempt to calculate the gain, you’ll need to know that our estimated closing cost that we used pro forma information is $2.4 million, and if you use that, you should calculate a book gain on the sale of approximately $10.6 million, and please remember all the disclaimers that we have not closed our books yet.
This transaction was just effective less than a week ago. We have not closed our books yet.
We do not have an exact gain on sale, and so that number is subject to modification and could even be material, even though that is our anticipated number. It’s also I think very important to note that even though we have a fairly significant book gain because of the nature of our book to tax differences, this transaction will result in a tax loss of a few million dollars, so I think that’s an important thing to remember, so if you cut through all it and look at the assets held for sale and all the different things excluding all of that, you’ll calculate that our accounts receivables were up a little.
Our inventories were down a fair amount. Our accounts payable and accrued liabilities were also down a fair amount in this quarter compared to year-end, so I hope that’s enough information about the balance sheet, the income statement, and the deal.
A little bit of comment about our pro forma information. Later today, consistent with SEC rules, we will file an 8-K that includes a summary of this sale transaction, and we’ll also include pro forma financial schedules.
It’ll show a pro forma balance sheet as of May, a pro forma income statement for FY07, and a pro forma income statement for the three quarters reported of FY08. If you’re interested to look at that pro forma information, I think it lays out quite clearly the impact of CSBU going out of the company, and it’ll show that as of FY07, the operating income attributed to CSBU was approximately $11 million, just a little bit under, and for the three quarters of FY08, the operating income was just a little bit over $6 million.
Please look at those schedules again to get more detail and what you’ll notice is the way these schedules were performed is the pro forma information includes the revenues, the gross margin, and the SG&A directly attributable to the CSBU and also includes an allocation of certain expenses like audit cost and tax and other things. In our financial statements as we mentioned for last year, of course, those items will be included in our numbers and will not go with the new company.
I don’t know if that’s clear about the pro forma information, but I hope that it is, and we are happy to talk more about our pro forma information once those schedules are filed today, and we have a chance to review those.
Bob Whitman
Steve, I might just add, as it relates to the transaction, just stepping back from it, I’m sure everybody still remembers the discussion from May when we announced that there were three primary thoughts behind the transaction and also behind this transaction versus alternative things that we could have done. There have been an awful lot of things.
The first is the strategic reason for it, and the surprising things for most people is to recognize that the products business continues to actually be a very strong business. That in terms of number of planners sold, it’s a surprise for most people to recognize that the actual number of planners sold has increased since ‘99, not decreased, but the number that are sold through our own channels, of course through a strategic choice, has declined significantly.
The overlap because of our growth of our training business in areas other than just in time management and individual effectiveness which continue to be strong and grow but which are a percentage of business, there’s only about a 12% overlap between the training that we do and time management training which would actually drive the product sales. Even with growth in that business over the next year, as we expect that to go down to 5% or 4%, and so strategically we felt that for us we ought to be focusing our efforts as a company on the training, consulting businesses, and all the things around that, put all our capital behind that and all of our focus there, and so strategically there was a reason for.
Second, we felt that given that strategic direction, which is a continuation of really defining the core business and exiting everything that isn’t that, and we’ve clearly defined that as our consulting and training business. Second was that we felt that this transaction represented what is the net present value of the business as we forecasted it out.
While there are, we think, good opportunities for growth, that’ll require investment and effort, and as a public company for the next few years as that restructuring and transition continues to occur, it would be a difficult thing for people to understand because it’ll continue, the top line revenue will go down as the distribution shift to third party continues, and because it’s not fundamental to the ongoing training business, we felt that if we can get the fair value, the net present value of the cash flows upfront, that would be a great thing to do. Third, we felt that there might be some opportunity to repurchase shares which we’ll talk about later, and while we getting the net present value of our expected cash flows or got the net present value of our expected cash shows, we would have a chance for reinvestment, and fourth the expectation will be that over time a company that’s focused on this non-capital intensive training business that’s been growing and growing nicely, both on the top and bottom line, would be easier to understand, one, and number two would be in a peer group that would have a higher multiple.
The thing that Steve mentioned obviously on one hand, you are losing somewhere at least for the first nine months on our pro forma base is $7 million or so of operating income, and we talked on the May call that the real plan for us is, there are cost reductions that will be allowed by this, but there will also just business model improvements that will continue, and we expect good growth in coming years in the organizational business still, reflected by a momentum index, etc., and so our real idea was that by the time the dust settles on this transaction, we get through a year of operations that we can be back to a point where the basic income that we had with the CSBU, we can have without the CSBU and with reduced number of shares outstanding, so just want to remind people of the philosophical underpinnings and strategic underpinnings of the transaction.
Steve Young
As a last point, let me just mention a little bit specifically about our fourth quarter. We expect that our fourth quarter operations to be good and up from the prior year.
So that’s good. That’s the underlying operations of the business we think in the fourth quarter are going to be good.
Of course, in the fourth quarter is when record this transaction that has just completed, and the earnings and operations of the CSBU, the products business for the months of July and August will not be included in our fourth quarter numbers other than our 15.6% interest in those earnings that will reflect as earnings of an unconsolidated sub. We expect it to be a good quarter and then in a quarter we’ll have those revenues excluded and also in the fourth quarter, we’ll include any of the expenses and costs and payments related to the transaction that would not be allowed to be accounted for against the gain on the sale.
A part of those expenses that’ll be incurred relate to our RSAs and our LTIP awards that are outstanding and which management of both OSBU and CSBU has participated in, so we have restricted stock awards, we have LTIP programs, we have good results that have been recorded in past years. We have results expected in the future.
Those RSAs and LTIPs have terms and conditions that are related to future operations of the company. Of course, the future operations of the company are significantly impacted by the sale of this CSBU, so the compensation committee and management concluded a reasonable and fair settlement of those RSAs and LTIPs, and related matters would be recorded in the fourth quarter, so RSAs will be vested, the LTIPs programs will essentially be eliminated and will be in a position to go forward, and we will record a reasonable settlement for those things in the fourth quarter, so if you add the amount of earnings at CSBU that would not be recorded and that, as I call it, a reasonable settlement for the RSAs and the LTIPs and the transaction that has taken place, etc., then it will be a few million dollars of cost, approximately $4 million of cost in the fourth quarter that either wouldn’t have been recognized on the cost side or would have been recorded on the revenue side, and so that’ll mask a little bit the overall good fourth quarter that we are planning have.
Bob Whitman
.
Stephen Young
Yes, and we’ll also have the gain which we calculated to be a book gain of approximately $10.6 million that is subject to adjustment.
Bob Whitman
Steve, you might want to note why you talked about 15.6% of the earnings versus 19.5% of the earnings in products.
Stephen Young
Our voting interest in the new company is a 19.5% interest. Management of the new company has an opportunity to vest participation in earnings.
Their anticipated vesting in their share of the earnings would reduce our participation in the earnings to approximately 15.6% if they were to fully invest, which means that that management participation is just in the earning and does not also represent a voting interest. Bob, does that sound like enough on that?
Bob Whitman
I think so.
Stephen Young
On the tender offer, I think the only thing to update there is that we are planning still to proceed with the Dutch auction tender offer that we have talked about and announced before and disclosed, and when that tender offer is actually launched in the next short period of time, then we’ll of course at that time disclose the range and the amount of proceeds that will be used in that Dutch auction, so I think the keyword there is simply that we are planning to proceed with what we have previously disclosed and announced, and so with that I’m very pleased to turn the time over to Bill Bennett, the President of the Organizational Solutions Business Unit.
Bill Bennett
I appreciate the opportunity to tell you a little bit about our Q3. Steve has also already mentioned that we had extremely modest growth in the third quarter, and as Bob opened the call, he said this wasn’t one of our best quarters.
We were somewhat disappointed in our quarter. However, before I go into detail to explain the background on that, let me just point out as we had each quarter up here, just remind you of the conversion both Brazil and Mexico.
Brazil and Mexico were formerly direct opposites reporting revenue. As of the first of this fiscal year, they become licensees reporting only royalty to us, creating a rather dramatic revenue reduction on a year-over-year basis for this year, but that business model has also yielded an increase in profit for us, so it’s been a good decision, but if you take Brazil and Mexico out of the analysis so that you have an apples to apples comparison for both years, that would add $1.3 million more to the year-over-year revenue growth for the OSBU, so keep that in mind as we go through here.
We break down this business into our big three channel and then our other channels so that we can keep our focus up on the core lines of our business and pay attention to the health of those. The big three are made up of our domestic direct sales offices, our international direct sales offices, and our licensee offices, and they cover each one of those.
On the domestic side, we have divided the United States into seven regions, five of those seven regions grew in Q3. Two of the seven did not, and the net of that together resulted in a slight decline in sales year-over-year for the domestic direct offices.
However, it’s important to point out that even in the two offices that declined, the declines there were isolated to a few territories. In case of one of the regions, it is the one region in the United States in which we have substantial construction business which is isolated into two territories and obviously those two sales people have felt the hit quite directly from the what’s going on in that sector of the economy.
Outside of those territories, the rest of the region performed well, but those happened to be some of our most experienced client partners with larger territories, so it had a big impact there. In the case of the other region, the decline, again it was isolated to really one territory.
It was underperforming year-over-year while rest of the territories performed well, so I don’t want to imply that we are not concerned about it, but I think the first step of analysis is to take a look at what’s happening on broad base, and on the broad basis, we are growing, and Bob already pointed out that two-thirds of our sales people are running ahead of last year, several of whom will have the best years they have ever had this year. As you take one level deeper look at domestic direct offices and take a look at their drivers, our facilitator revenue was up 7% year-over-year which we were happy with.
The onsite business was not up, and this is where we really felt the pain of the particular places where we were down. We started the quarter with actually a very healthy inventory of days to be delivered, but during the course of the quarter, we received, as we always do, but perhaps slightly more than average day cancellations on those days we delivered as well as a slower booking pace in both the months of April and May.
We watched these booked day inventories quite carefully. It’s a great bellwether of the business, so obviously we were a little concerned in watching that.
Upon inspection, I’ll tell you what we think happened. We had a huge focus in Q3 on a new facilitator product launch in leadership modules.
That drew quite a bit of attention on the sales course over to that which is causing them to make contact with our facilitators in the field, and we think that caused us the majority of the issues that hit these booked days. If that assumption is correct, then we should have seen an increase in booked days as we came into fourth quarter.
We did. The month of June was a spectacular increase, in fact it was our second biggest booking month this year, almost 30% growth over prior years on our booked days, so that bank of booked days is refilling rapidly, and we feel as we look forward to the rest of Q4 and into Q1, we feel very confident about that, so on those two drivers, I think they are fairly good indicators of what’s going on.
We also watch, our course, our new client partners. You’ll see this in one of your charts, and Bob brought attention to it, but we keep our eye on the growth rate on our new CPs, and they remain at or above our targeted revenue growth rates around the world.
In further year to date domestic direct officers are up about 6% over prior year. In the fourth quarter just to give you one look forward, we had a very large deal in the fourth quarter of last of $1.9 million deal that will not repeat.
Despite that, we are still forecasting growth in the domestic direct offices for Q4, so we feel very good about that outlook. The second of the big three is the international direct offices.
We had about 10% growth in Q3, and there was some spectacular growth, Canada almost 40%, Australia at that point 3%. Our largest office, Japan, grew but was fairly modest at a little over 3%.
We had a very large deal that typically comes in Q3, and this year came in for various reasons in Q2, so that’s adjusted the two quarters in Japan. Looking forward into Q4, Japan is looking to have a great fourth quarter there too, so we think we are very much on track in that place.
Year to date, overall in our direct offices, we are well into double-digit growth over prior year.
Bob Whitman
You probably should mention that portion of that growth of course comes from the foreign exchange.
Bill Bennett
It does, and so we did benefit in this particular quarter from the exchange rate. Adjusting for exchange rate, we still grew, and so that obviously has added to it.
This is one of the quarters where it’s given, and we benefited from that, but we still had growth in those cases. Finally, the third of the four channels that we keep our eye on is licensing business, and we had almost 14% growth for the quarter, and we are tracking almost 20% growth for year in those businesses, so your net-net on the three big channels amounted to a little over about 3% increase in sales which obviously coursed down by what I already described in domestic, but I have already mentioned what we are feeling about Q4.
Quick summary of the remaining channels, the remaining parts of the business which are also important to us but tend to be more on the periphery as indicators of our future business is our sales performance group which sells our sales training, our public programs group, our audio and book sales, and our professional speaking business which is of course almost entirely Stephen Covey. Publics are off and other companies in that industry are off as well.
The bright spot there is that we had done quite well. I think Bob has mentioned in prior calls without our web based, our live webinar that we have been teaching in fact has been so successful, that we have five more webinar style courses coming out over the next few months, and our publics business is going to be shifting to put a tremendous emphasis on that style of delivery, and that is just from top to bottom a great business model.
Our sales performance group started off the year quite far below last year. They have been climbing all year.
They were a little bit behind in Q3, and we anticipate them showing a flat to maybe modest growth in Q4 and continuing growth into the next year, so we feel that’s going in the right direction. Audio and book is just very cyclical.
When we publish a book, it goes up right away and then there’s an echo effect as the audios which are typically derivatives of the book follow behind. We didn’t publish anything, so the business is down.
We will be publishing next year, and the business will go up. Finally, Stephen R’s speaking circuit has actually grown quite well.
It doesn’t drop much to the bottom line because of the way we structured that business, but it does create huge awareness for the company, so obviously when Stephen is out there and attracting crowds, it’s good for us all. So, the last two notes I will make, just two positive items of note.
Our customer loyalty practice is quite new. We’re not really ready to report, I think, on how that’s going overall, but we would tell you that the early start and the momentum is outstanding.
We’re quite excited about that, and our upcoming release for grade schools called the Leader in Me is going to be coming. This is probably one of the most beta-tested programs we’ve ever come out with, and the early returns on those beta tests are excellent, and I think that we are going to have a great run with that as well.
Bob Whitman
At this point, I’ll turn the time to our host to tell us how to move us into Q&A mode.
Operator
(Operator Instructions) Your first question comes from Kevin Henehan - KMH Capital Advisors.
Kevin Henehan – KMH Capital Advisors
I saw in your previous release, not today but maybe a week ago, you were saying that the tender offer would commence in the fourth fiscal quarter of 2008, which I believe ends August 31, but a lot of people may not realize your fiscal year, so if you can clarify any color on that. So that would mean that the tender offer would commence over the next few weeks or at least 6 weeks.
Bob Whitman
We would expect that in the next couple of weeks. I would think that 10 to 14 days would be the start.
Kevin Henehan – KMH Capital Advisors
And the size, you haven’t commented exactly.
Bob Whitman
Our general thoughts are just what they were before. We will use the net proceeds from the transaction to do that, so we don’t know exact number.
We don’t get to be quite that precise. The net proceeds as Steve said will be somewhere in the $28 million range.
Operator
Your next question comes from John Lewis - Osmium Partners.
John Lewis – Osmium Partners
What were the bookings up in June?
Bill Bennett
Almost 30%, in fact 29%.
John Lewis – Osmium Partners
On Slide 5, I believe it shows a pretty hefty ramp. It looks right around April.
I think that was the launch of Great Leaders, Great Teams, Great Results. Is that what really drove that spike up in the April-May time period?
Bob Whitman
What it really was, John, is that the thing we’re comping against in the third quarter actually which also contributes to the flatter year-over-year performance is that last year was our big launch of the new leadership offering to which you referred. This year, we refer the momentum to bookings where a lot of those aren’t recognized in revenue until later.
In connection with our customer loyalty business, we entered into a couple of big contracts during that April period, the revenue for which will come in the future. But I think that was really more of a factor in this spike, and as Bill said, the 7% increase facilitator sales related to the sales of these leadership modules.
We are counting on a new product where historically we’ve been course-centric. We’ve started strategically moving more and more towards resource-based offerings.
These are taking courses and breaking them down into modules where these are a couple of hours to 4-hour modules, where as a part of a management meeting or whatever else, you can just do a part of the course where you don’t actually have to consume the whole thing. We’ll be actually going further on that and breaking it down into the molecular level or even to principles that you can use in one of your staff meetings, where on the web you can get a teach about things like that.
We’re starting to launch that, so together with entry into these new contracts on the customer loyalty practice were the primary reason for that spike.
John Lewis – Osmium Partners
Just so I understand, if I were to take the ’07 number in June on your momentum index on Slide 5, you said it was up 30%, so would I take 30% on $63 million, and your momentum index would be up to around $80 million?
Bob Whitman
We probably haven’t done a good job in the past of describing the factors that make up that momentum index. Maybe it would be a good time to do so now.
The momentum includes three things. One is the booked days, and that makes up about half of our total business.
So it’s the actual days that we book for delivery on site at a customer site. A second thing it includes is facilitator sales, which are actually recognized right when they are sold, these are manuals and things, and the third, which we call other revenue, involves large deals that might be intellectual property or other things.
Those are the three things that we have bookings on. So, to Bill’s point, the 50% portion of the business is onsite revenue, and it changes in different months, but let’s just use that as the number.
That 50% was up 30% in June, and that’s the thing to which Bill was referring. Bill, you may want to add color or commentary on that.
John Lewis – Osmium Partners
Given the weak overall economy, what in your mind is really having you swim up the stream so to speak on the training side here?
Bob Whitman
Maybe three things, as I see it, and Bill, please, you have a very granular perspective every day, but we’ve got a couple industries frankly that are in full-out recession, the home-building industry and construction industry and even the defence department because of the cost of funding the war, etc. For them, all discretionary spending has been cut, and that reflects in a few territories.
It’s not broad based. Nevertheless, we had some large deals.
We think those businesses, the construction industry, that’s going to be tough for a while, whereas the Department of Defence interestingly has shifted where historically they cut their discretionary spending on things that affect our individual effects on these leadership offerings. At the same time, the advanced bookings we have on the execution-related business have actually been quite exciting in the Department of Defence as well.
So I think the combination of those sectors will be down and the construction sector will be down, I am sure, for the next year or two, but I think the defence business will come back this year for us. So that’s one area.
I think you then have specific other industries or companies that don’t seem to be very broad-based, but where they have themselves decided to cut discretionary spending, and it hits you where it hits you. But as Bill said, while it’s muted maybe the growth of certain of our client partners, some of the client partners who actually had that happen to them still have to figure out how to avoid it, but you will have some of that hit that we didn’t have so much in the past.
The third place where it shows up is in cancellation rates, where people book things and then pull them off the books. And there we watch that very carefully.
In 2001, the nature of the slowdown was different in its makeup, but also our offerings were very different where we were completely just selling training offerings and no execution related stuff. Our cancellation rates went up into the mid 20s for things that were already on the books.
So we watch that very carefully, and really, the pattern, with the exception of those few accounts, isn’t very different right now. So we think that the business is more resilient.
I think the challenge is making sure our value propositions are really hitting on business outcomes. We’ve been working on that for a number of years, and I think that’s helping us a lot.
We thankfully have not had many companies who just have said outright we’re not training, but they are very anxious of course to understand the economic payback. Things like our customer loyalty and execution related offerings, even our leadership offerings, and interestingly even time-management where there is a direct payback where people can see it; those tend to be easier value propositions more so than others.
Overall, it’s not a robust economy, but we haven’t thus far seen any broad-based thing as reflected by the fact that two-thirds of our sales people are ahead.
Bill Bennett
Bob briefly mentioned ’01. One of the real lesions we learned in ’01 was when we took a real hit in that economic turn is when we had gone out and sold directly into the HR department on a transactional basis.
People love us; we have a great reputation, but when our course goes into a company as one of their catalogue offerings, that business gets swept away pretty fast when there’s a crunch in the business, and what learned is that we weren’t doing enough value-oriented selling over time in our solutions to business problems. We had just fallen, I think, on our laurels and a victim of our success, so really ever since that decline, we have focused the last several years.
We’ve invested in one of our top people leading our sales training. We’ve taught all of our CPs.
We’ve stressed to our existing CPs the idea of tying to a business problem. We’ve done that, which is where we banking and we’re doing in most places now.
You tend to keep your fingers crossed, but you tend to be pretty resilient. In fact, in some cases, as a company tightens up, they increase their focus on the things that they think are going to make a difference to their bottom-line and we’ve done the job right we stay in place.
Operator
Your next question comes from of Julian Allen - Spirit Capital.
Julian Allen – Spirit Capital
Back in May in the original discussion of the sale of the CSBU business, I believe that you referenced approximately $10 million in savings due to the reduced complexity and that that savings would be shared across the two businesses. Can you give us some color on whether that quantity has changed, and therefore what time period we might expect to see that reduction occurring?
Bob Whitman
In May, just as you said, independent of the transaction actually back last December, we had identified about $10 million cost reductions a little less than half of which would happen in the CSBU, a little more than half of which would happen in the OSBU. We believe the size of that is still right, and I think we talked a little bit about the make of that in May, and we had already taken a number of steps, but really, since then, if anything, we’ve solidified pieces of that as we negotiated or reconfirmed elements of that.
I think overall part of the pro forma we had for the sale of the CSBU included about $4.3 million of cost reductions and business model improvements. We feel that we’re right on that numbers.
Actually, it is going to take a little less capital. Those things that we identified for the OSBU and central operations, which were a little over $5 million, are firming up or have already been accomplished.
We are still thinking that on the remaining company side, its somewhere north of $5 million. It doesn’t all happen exactly on fiscal years.
For the example, our IT savings, which we think, will be a little more than $7 million a year will kick in when we get the new systems in place, which we have identified and are in process of doing. They are not big, big system changes, but nevertheless, it won’t happening exactly on the first of the year, but the annualized impact of these cost savings are really the same magnitude or maybe a little bit more.
Julian Allen – Spirit Capital
When you publish the performance of the business, it is the ongoing business that primarily comprises the SBU unit that will immediately enjoy the benefit that portion of its overhead that will be covered by the OSBU and then furthermore over time should enjoy some further cost reductions as some of these initiatives kick in.
Stephen Young
The pro forma information for CSBU will include certain amount of allocations, I believe they said earlier like audit expenses, tax expenses, etc., so it is the portion of our earnings that are being pulled out, and yes, the savings of $10 million that we’ve talked about, the portion attributed to them would be future savings and also when Bob talked about the dust settling over the next year or so and us getting back to a point then, our savings are anticipated in that dust settling comment also. Does that answer the question?
Julian Allen – Spirit Capital
You discussed the backlog in inventory of booked dates. Can you give us a sense if after a very strong June of nearly up 30% bookings, would that leave your backlog as of early July roughly in line with where it was last year, is it up or is it down, just to help us quantify some of the effects of some industries up and some down, some regions up and others down?
Bill Bennett
I think at this point time, July is a little off of last year. August is getting to be up about where it was last year, and I expect that to continue to improve.
One data point that might be useful to you is that when we book days, probably 75% of them fall between one month out and 4 months out for delivery. You’ve got 7-8% that fall inside the month that the booking happens and then the remainder can spread all the way up to a year around, and that shapes according to a lot of different things, but on the average, that’s about where they run.
So, you’ve got a quarter plus, sometimes, impact from an increase or decrease in days, so I suspect we are in our fiscal July and July will continue to improve. I’ll be happy if July comes in flat with last year.
I think August will be up, and it bodes well for Q1.
Bob Whitman
Beyond just booked days, as I mentioned, there are also these other large contracts that don’t reflect as much in booked days, as they are intellectual property or contractual things. Those will also begin to contribute in the fourth quarter and then ramp up in the first and second quarter.
Also as far as facilitator revenue, the fourth quarter is historically our biggest time for that, so again the three of those make up the momentum that you asked the specific question about, just booked days, which is normally half the business because some of these large contracts. It’s a little bit less probably in the fourth quarter.
Operator
Your next question comes from Thomas Coach - Turnaround Capital.
Tom Coach – Turnaround Capital
I just had a follow-up question to the last discussion here on these booked days. How do the cancellation rates play into that?
Are you saying you see some visibility as far as strength there, but then you also in the previous part of this whole conversation talked about having some higher cancellations or cancellations that come in?
Bob Whitman
The booked days are net of those, net of anything we know about, so the big accounts that have cancelled, so they’ve already been netted out, and so, I hope I didn’t misspeak. Our cancellation rate, with the exception of a couple of accounts, it is really about where it’s always been.
We haven’t seen any increase in that, so we don’t have an expectation at this point based on looking at every month very carefully that beyond these two or three accounts that there’s any statistical shift toward higher cancellation rate, so we don’t anticipate much difference.
Tom Coach – Turnaround Capital
Bob, what changed then? When we were back in the beginning of the year and you talked about how a weaker beginning of the year followed by a stronger second half, and this last quarter I don’t think fell into that fairway.
What changed? If cancellations didn’t change, why are your numbers not up more like you thought they were going to be?
I am just trying to understand and question the visibility that you really have a forward basis.
Bob Whitman
Let’s talk about visibility first. I think it’s an important point.
I think Bill tends to say it’s not that we have enormous visibility beyond a certain number of months. Again, to take three things, the booked days as Bill mentioned tend to be delivered within four months, so that we have good visibility on for about four months at a time.
In the facilitator business, actually we have a day’s visibility. We know the general patterns and we know what’s in the pipeline, but really in terms of once it comes on; it’s booked when it’s sold, and the third is the larger contracts that come in and go out.
So I’d say from my perspective, the news of the second and third quarters was that overall the booking pace was flatter than we had thought. In December and January, we had the two largest booking months I think in history.
I think December was the largest booking month in history and then January followed with a huge booking month. February was flatter.
March was really significant, and then it flattened a lot in April and May. Our question is how much of that was the economy related and how much of it was something else related, but it was lower, and the first quarter was also soft, but we have already talked about that.
So that effects were there for the next three or four months and there was an anticipation, which may have been a little unrealistic as, you look at it. We had a very successful launch of these new modules.
There was a big push on that in the third quarter, which they were focused on some of these modules, I think there was less focus on the booked days as Bill talked about, which hits you for two or three months. But it was very successful relative to some of our expectations, but not really what they were forecasted in terms of what they thought they could do, so that was a little flatter.
The combination of those two factors leaves you into effectively the third quarter, and in the fourth quarter, because you had flatter bookings in the third quarter that leaves you a little softer in the fourth quarter as well. We’ll benefit on the other hand from some of the larger contracts that are independent of booked days because they are more contractual intellectual property-related things, which we didn’t get any of to speak of in the third quarter, but the revenue will start to be recognized here in the fourth quarter to partially offset.
I would just say that primarily the booked days being flatter in the third quarter than we had thought and the launch of the modules being more modest than had been forecasted by our teams at that time that we felt very strongly about, those are the two factors, I think.
Bill Bennett
Yes. I would agree.
Tom Coach – Turnaround Capital
In the earnings release, there is a comment here that talks about the declining gross margin primarily due to increased amortization of capitalized development cost and increased sales of low-margin specialized seminar events. Do those two items pertain to the OSBU side or the CSBU side?
Bob Whitman
The OSBU side, here’s what they are. Let me talk about the second one.
In the third quarter, I think this also by the way had an impact, maybe insignificant as it relates to the flattening of the booking pace in ’08 in the second and third quarter. Historically, we had these big symposium events in the spring.
They took a ton of time for our sales force. We lost money on them.
They were not small, $300,000 to $500,000 a year on those, but they were the large client events where you would have Jack Welch and other people come and speak and put on a big thing. We felt strongly that the effort, while it generated revenue in later quarter, was one that also disconnected our sales force sometimes from just selling the value propositions they were always trying to promote.
This year, we went to something that we touched the previous year. We had 26 or 27 of these, what we call greatness summits.
They just don’t have very much associated with them. It took a lot less time from our sales force than these bigger events.
Each one of them just responsibility for their own city, but there is not much margin in those, and because we did so many of them, that margin had an impact. It doesn’t repeat in further quarters.
It’s just relative to that quarter. I think Bill thinks that perhaps even though we believe they had been successful and resulted in bookings that they did in June and other months that we’re sapping a little bit too much of our sales force strength, but it’s non-repeating.
As it relates to the amortization though, as we have invested in things like the 7 Habits Interactive and in other offerings that have these big resource-based components, you have straight line amortization of those capitalized development costs, which hits your margins when you haven’t yet been generating revenue or as much revenue from those. You have a straight-line amortization, but the sales you hope are not straight line, you hope that they build.
In connection with 7 Habits Interactive and other customer loyalty offering, we had capitalized development costs that we immediately began to amortize on a straight line basis, but the ramp up of those revenues occurs over a longer period of time. For both of those reasons, the gross margins which have increased very steadily for years, we expect those margins to be able to hold and perhaps improve a little bit in the future, but this last quarter and this quarter, the amortization expenses together with these close to zero margin promotional events where we get revenue but no profit have hit that.
Tom Coach – Turnaround Capital
I was going to ask one other numbers question to see if this ties in anymore with this, but you do have some pro forma information on the Q here, and if I take the EBITDA from OSBU, for this quarter, it was 12.2% versus what I calculated to be about 16.4% in the quarter a year ago. Are these the same issues we’re talking about?
Bob Whitman
We just talked about two things that affected that. Another thing that affected it was that last year the launches of some of the new things created some additional gross margin that we were comping against, but fundamentally, it’s those two areas.
Tom Coach – Turnaround Capital
On a consolidated basis, the EBITDA for the 9 months for the OSBU business is relatively flat with where it was last year. I didn’t hear anything on an EBITDA basis, but on a top line basis, you’re talking about expectations in the fourth quarter for growth.
Does that mean that EBITDA could be expected to be higher as well? I know you talked about some of these one-time costs and expenses related to the deal, but if you took those as below the line items, when we’re talking about just the core operations, what’s your expectation there?
Bob Whitman
Cooperation would grow, but for those one-time costs. One thing that’s challenging in the fourth quarter on a comp basis is that last year in the fourth quarter we had a $1.8-million sale which was to a big client in one of the industries that I talked about that did not repeat this year.
You had very high margins, about $1.3 million or so of margin. Even with that, without these one-time specials that you could argue are below the line, we still would expect bottomline growth even absorbing that.
That’s what we think.
Tom Coach – Turnaround Capital
I think on the last call you touched on this a little bit. So we can take this run rate of this EBITDA level that we’re at and everybody makes their assumptions on where that’s going, and then add on top of that over the next 12 months, you’re hoping what I heard was to get something close to 50% of the $10 million savings that would be on the OSBU side that will show up gradually over the next 12 months?
Bob Whitman
Yes. Probably, that’ll be a little bit more than that, Tom, but I think the IT portion will be the one that will be phased in.
A lot of the others will occur more rapidly, so I would think we’d probably get 75% of that $5 million into the fiscal year, if that’s what you’re asking.
Tom Coach – Turnaround Capital
75% you think will show up by the end.
Bob Whitman
Will happen in the next fiscal year, and then if you take that plus what we expect will be growth in the big three channels, and a significant thing really for our operations for next year just as you think about is that this year to date even though the three small channels, the public programs, the sales performance group, and books and audio, even though their upside is relatively limited as it relates to the total side of the business, their downside has been significant this year. On a year-over-year basis, I don’t think this will be exact, but it’s somewhere around $2.5 million of EBITDA.
That’s the year-over-year decline in EBITDA just in those three channels, so if next year we were to stabilize those three, so that we didn’t lose any further ground and we think in every base we won’t lose further ground and that actually we’ll get some growth, you pick up $2.5 million in the business model next year, say that number or some number close to that just if you didn’t have it. With everything else being equal, for next year, you ought to be able to pick up these cost savings plus the non-repeated declines and that would at help you in those areas, and then what happens on the top line growth in the big three, of course the last 15 minutes of questions is bookings pace and other things, and I think realistically the flatter bookings in the third quarter will affect us in the fourth quarter, even though not so much that we won’t be able to grow still, it’s still flatter than we had originally thought.
If we’re able to continue strong bookings along with these new big contracts, then in the first and second quarters, we’ll start to build, but even without growth in those, we should have improvement as a consequence of the cost reductions and the hopefully non-repeat of the declines in those three small channels.
Stephen Young
Tom, one additional thing, when you look at the pro forma information today and look particularly at the business being sold versus the CSBU segment information, you’ll see and recall what we’ve said in the past. It isn’t exactly the segment that’s being sold, so to look at our segment information, the CSBU column, the business being sold is a bit more profitable than the CSBU segment.
Bob Whitman
Because of internal allocations of costs that get redone by about $1.3, Tom.
Stephen Young
I think that will be important for everybody to look at that pro forma information and if you want to compare it back to the segment information.
Operator
Your next question comes from John Lewis - Osmium Partners.
John Lewis – Osmium Partners
You are going to file a pro forma statement with the SEC tonight. What is your current headcount on client partners?
If you could give me that, that’s great.
Bill Bennett
We’ve got approximately 70 right now in the US. We’ve got about 50 to 55 or so in the international direct offices, and then throughout the licensees the counts won’t be exact because sometimes these people have multiple jobs in some of the licensee offices, but there’s another 100+ probably, maybe 150 or so, in those offices scattered about the world, and we’ve been trying some different things too there.
We’ve been starting to build more of little teams as time has gone by and so you have a good mentoring environment for junior client partners coming up through the ranks.
John Lewis – Osmium Partners
In your Q, you say you have licensed operations in 87 countries and you have licensed rights in more than 140 countries. Can you just clarify?
I think I get it, but what’s the difference there?
Bill Bennett
The licensed operations would refer to the actual brick and mortar people on the ground located in specific countries. The larger number of countries where we can sell are those places in which we are selling.
Bob Whitman
In other words, somebody may have gotten right to a turf where they haven’t yet been fully able to develop and they’re fixed on one country of three in which they have rights.
John Lewis – Osmium Partners
Now that you’re more of a pure play focused obviously on OSBU, what opportunities are there? I know you’re in some very, very tiny countries.
It must be licensed right, but 87 countries in terms of licensed operations, where are some of the countries where you are in? I know we talked in the past about China and India, and you think you’re barely scratching the surface.
Can you just give us a big picture of outside company-owned operations to franchised, where are the big international opportunities where you’d like to have franchises push the pedal a little more aggressively?
Bob Whitman
If you look at the world and say 6 billion people, the direct offices both domestically and internationally that we have, the ones that are really our own owned and operated offices cover less than 500 million of those people, although they’re in some great industrial countries. Nevertheless, it’s Japan, the UK, Canada, and Australia along with the US, so a lot of the big growth opportunities both South America, China, India, Russia and elsewhere really through our licensee partners, and so while historically there was probably a time when that was viewed as hey it’s nice that they can do some business there, hope they win, they’re paying us a net amount, and I’m sure that was never the mentality, but you could easily say out of sight, out of mind.
But today, if we’re going to really grow and take advantage of all the opportunities we have for growth, we have to really help those people build their business, so in places like China and India, our licensee partner in India has doubled its business every single year, has opened 9 or 10 offices in different places in India, and is barely scratching the surface, and yet running as fast as they can. In China, they’ve opened several offices and are moving rapidly.
For us as we go forward, the real idea is to look and say in terms of actual offices, we’ve got to be looking at our domestic, internal direct, and licensee offices in a very similar way as it relates to holding ourselves accountable for the growing against opportunities and helping them to grow, providing resources, and training people to help them internationally. This year, we added a very strong individual from the US whose full responsibility is to help licensee partners on sales training and so forth, and we’ll build those teams.
I think if we are agnostic as to whether we own or operate through licensee, the things that we provide in terms of great offerings, great sales process, great ability to develop consultants, and much better marketing support, e-commerce support, etc., web-based offerings and things, as we make those scalable across the world, we’re going to be…in the past when we launched products, if we launched it in the US and then a year to 18 months later, they would come up having to spend their own money to develop this, but from now on, we’ll introduce everything in 7 key languages, so that a big percentage of our people can move. I think through a combination of helping people to grow, there may be opportunities in the future even to invest capital to help them grow in certain areas of the world, adding country heads which will mean just go in there and try to help multiple franchisees or licensees within a given market.
If we’re really going to grow significantly in the world, we’ve got to help these people more systematically than we have in the past. Thankfully, they’re such great partners that they’ve grown very well on their own.
In a place like Scandinavia, it isn’t a high-growth economy; nevertheless, we’ve a very high growth business and high growth team there and in other areas of the world.
John Lewis – Osmium Partners
Can you give any color on what your targeted SG&A would be on the OSBU, central and combined?
Stephen Young
For going forward, I don’t have that number.
John Lewis – Osmium Partners
We’ll see what happens on the pro forma tonight.
Bob Whitman
We’re holding ourselves to a business model, John. I think if you think of a business model, we’re targeting, as we talked about in the last call, for the remaining business, by the time the dust settles, we want to be in double-digit business model in terms of the EBITDA to sales and certainly operating income of more 10%.
You can figure out given our gross margins where our selling costs have to be to get that.
Operator
You have a follow-up question from Thomas Coach - Turnaround Capital.
Tom Coach – Turnaround Capital
I was just wondering given that now you’re going to be in a less capital-intensive business, what do you intend on a go-forward basis to be doing. It looks like you’ll be generating a significant amount of cash flow on a cash flow basis.
I know you’ve got NOLs. I know you have to pay some foreign taxes.
You’ve got interest expense, and you’ve got some development costs, but should be a lot of CapEx involved. Now that you’re emerging as this new entity with only the one business segment and significant cash flows, how would you describe what the strategy is as to reinvest those in growth, are there any acquisitions to do, or would it be a return of those profits to shareholders?
Bob Whitman
I think probably the rank order, at least in my mind, Tom, would be as follows. One, we want to make sure we’re investing sufficiently to build the foundation of offerings and capabilities and sales training and other things that are necessary to really allow the growth to really expand around the world because you’ve got so much opportunity.
Now, we’ve been making those investments, so I don’t know that that reflects a big increase in spending in particular either in SG&A or capital, but there’ll be ongoing investments there that will have the very highest returns on capital. The next opportunity would be in the acquisitions area, but I for us those will probably tend to be smaller opportunities because we’ve got a strategy and a set of offerings and a perspective on the problems that we’ve chosen to solve.
It doesn’t mean that others don’t have great offerings. It might be the acquisition of rights to a book or distributions rights.
It’ll be great if we had some big acquisition opportunities. There might be some, but what we’re really saying is as we play out these solution areas in which we play that there are other people who have great things as part of an offering which may be acquired in small pieces or by a practice or whatever, but I don’t think you’ll be spending a ton of capital there.
A third area would be in actually helping licensee partners as they get strapped for cash by taking an interest in some of those operations. It’s not a stated objective, but I think that could be an interesting one in some of these high-growth markets.
If we can be helpful to our partners in helping them grow with capital, that would be a place to put it, but beyond that in one or another returning to shareholders either through continued repurchasing of stock or dividend could be in the picture, so I think that’ll become clearer. Additionally, there is this $28 million or so that would be spent on the repurchase of shares now if we were able to get the shares.
We expect, as you said, to generate a lot of cash, and so those are our priorities. Right now, as we see it, we think that even lower on the scale where you’ll be doing things where you’ll be returning it to shareholders in some way.
Tom Coach – Turnaround Capital
Right, and you talked about expectation of getting, it was $3 to $5 million-ish I think from the working capital down the road as well, right? That’s additional cash that comes in.
Bob Whitman
Right.
Tom Coach – Turnaround Capital
A dividend program would be great.
Bob Whitman
Like I said, we’ll be looking for the upper part of the chart, but right now, expecting that we’ll probably be on the lower part of the chart.
Operator
There are no questions in the queue.
Bob Whitman
Thank you very much for joining. We appreciate it.
Obviously, for the last quarter and this next quarter, the financials are going to be a little messy with all the transactions and everything else, but fundamentally we’ve all in these calls for years talked about what you’re going to do with the consumer business, when you’re going to repurchase shares, hopefully these actions have been responsive to those questions. We’ve been thinking about it for years, trying to get it done for years obviously.
Among the various efforts are recapitalizing the preferred gave us the flexibility to repurchase that, which we’ve now completed, the sale of CSBU, the repurchase of stock, and perhaps some ongoing purchase of stock going forward. As it relates to the capital side of the business and the strategic side restructuring, we think largely this multi-year process that we’ve been going through has yielded us a company that is clean, able to grow, not very capital intensive, and relatively focused with some opportunities around the world.
Our team has done a great job in operations. Bill, Steve, and Sarah have done a really wonderful job in turning their businesses around and getting them to grow, and we’re happy to continue to be partners with Sarah and with Peterson Partners in the products business, but I think as we focus solely on this new business, in the next couple of quarter, I think maybe flatness resulting from some softer booking as we’ve had in the past, but we think we can grow the bottom line and top line well.
We think our fundamental bets are good, and as I said, our goal is to despite maybe the difficulty of understanding exactly what is going on in any specific quarter or the dust settling point, really our objective is to be back at about the same level of profitability in approximately the next year or so, without the CSBU as we were with it and with a lot fewer shares outstanding. So hopefully these steps are ones that will help us to focus strategically as well as benefit the shareholders long term, and we sure appreciate all your interest and support in this.
Thanks very much. Hope you all have a good weekend.