Franklin Covey Co. (FC) Q2 2014 Earnings Report, Transcript and Summary

Welcome to the Q2 2014 Franklin Covey Co. Earnings Conference Call. My name is Eric. I'll be your operator for today's call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the call over to Derek Hatch. Mr. Hatch, you may begin.

Thank you, Eric. On behalf of Franklin Covey, I'd like to welcome everyone to our investor call this afternoon to discuss our second quarter for fiscal 2014. Before we begin, we'd 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 revenues, the ability of the company to hire productive sales professionals, general economic conditions, competition in the company’s targeted marketplace, market acceptance of new products or services and marketing strategies, changes in the company’s market share, changes in the size of the overall market for the company’s products, changes in training and spending policies of the company’s clients and other factors identified and discussed in the company’s most recent annual report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission. Many of these conditions are beyond our control or influence, any one of which may cause future results to differ materially from the company’s current expectations. And there can be no assurance that the company’s actual future performance will meet management’s expectations. These forward-looking statements are based on management’s current expectations, and we undertake no obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of today’s presentation 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.

Thanks, Derek. We'd like to welcome everyone to our second quarter conference call. We appreciate all of you joining us. We're really very pleased with our second quarter financial results that we released earlier today. And I want to give you some headlines about those. At the outset of our call today, I thought it might be helpful to just highlight, first, the progress we continue to make on each of the 3 overarching objectives, which we've discussed in the past, which refers to deliver quarterly results for our clients. That is the central, most important thing, it drives everything else; second, to increase the size and productivity of our sales and delivery forces worldwide on an ongoing basis; and third, to consistently grow both top and bottom line. As you can see on Slide 3, where those objectives are laid out, we're pleased that we made good progress over the years -- over the past years on each of those objectives. And we continued that in the second quarter and for the trailing 4-quarter periods. And you can see on the slide, our renewal in terms of delivering quality results for our clients, our revenue renewal rates have been and continue to be approximately 90%, a little above that, actually. We have best-in-class, branded solutions, which were the central focus of our efforts. We have the best-in-class content, continue to provide pricing power and drive increases in gross margin. Our average revenue per client continues to increase. And so that's -- we have a lot of measures of actual customer satisfaction central to -- these are a few metrics that we measured on which we hold ourselves accountable for progress every quarter. In terms of increase in the size and productivity of our sales and delivery forces worldwide, we're on track to grow the sales force from -- to 120 -- 180 Client Partners by the end of the year. They're 120 at the start of the fiscal '13, 147 at the start of -- just after the start of this year. And our Client Partner ramp rates continue to meet or exceed the model. And as you can see on revenue and adjusted EBITDA and the other financial metrics we'll go into more detail that we've had continued growth there. So I'd like to briefly share some quarterly and trailing 12 months' -- trailing 4 quarters' highlights for each of these imperatives. Let me begin in reverse order with objective 3, the financial results, and about consistently growing both our top and bottom line. As you can see in Slide 4, in the fiscal second quarter and for the trailing 4 quarters, our revenue growth accelerated in the second quarter with revenue growing 15% to $46.5 million and growing 11.1% to $196.4 million for the trailing 4 quarters. Effective in that, actually, is around $3.5 million of additional growth we would have had but for foreign currency adjustments, and so we feel now that the revenue is growing well and there's a good engine behind that. Our adjusted EBITDA grew 19% to $6.6 million in the second quarter and 12% to $31.4 million for the trailing 4 quarters. Our adjusted EBITDA margin improved to 14.2% in the second quarter and to 16% for the trailing 4 quarters. Income from operations grew almost 20%, 19.9%, to $3.9 million in the second quarter and grew 4.3% to $20.5 million for the trailing 4 quarters. Net income grew 23.8% to $2 million in the second quarter and grew 42.2% to $13.5 million for the trailing 4 quarters. And finally, diluted net income per share grew significantly, increasing 50% in the second quarter from $0.08 per share to $0.12 per share. As you can see in Slide 5, with the second quarter strong results, we're glad that we're able to continue to achieve -- this chart is kind of a rolling 4 quarters results in each quarter. We're glad to continue to achieve trailing 4 quarters revenue growth in each quarter trend, which has continued over the past 4 years, as you can see. So in terms of the objective 3, consistently growing top and bottom line, we're grateful to be on track for that, and we'll talk about this in a few minutes. But we expect to continue to be able to achieve this ongoing revenue and profitability. On the second objective, which is increasing the size and productivity of our sales and delivery forces worldwide, during the second quarter, we also continued to make significant progress on this objective. First, the productivity of our existing Client Partners continued to increase. They increased by approximately -- and we expect it will be at least 8% for this year, which is consistent with our targeted productivity growth expectations for this group. We're on track, and our total Client Partner count reached 180 by the end of the year, as I noted in the headlines. And we're completed -- committed to add at least 30 net new Client Partners this year and every year. We expect the ramp-up of these new Client Partners will continue to meet or exceed our model, exceed it meaningfully by the addition of this new sales manager role, which we added to our mentoring structure last year. It's working extremely well. We're having a positive impact both on new Client Partner ramp rate and on new Client Partner retention. And we've made significant investments to build the infrastructure to be able to get this ramp going. And for us now, though, the good news is that in coming quarters, the incremental investments we will need to make are much smaller than they've been. And so we will expect beginning in the fourth quarter particularly and in future quarters to have a lot more flow-through on incremental revenue than we've had in the last couple of years since we've been making all these investments. Nevertheless, we're glad to have been able to grow top and bottom line meaningfully while making these investments. Our marketing capabilities have also increased significantly and are really helping to accelerate our sales force ramp-up and build our pipelines. Driven by -- as you can see on Slide 6, driven by the productivity of our Client Partners and the [indiscernible] industry's go-to-market efforts, we achieved growth in all of our major channels during the quarter. In our direct offices in the U.S. and Canada, including government, revenue grew 15.3% to $24.2 million in the second quarter and 8% to $99.3 million for the trailing 4 quarters. That 4 quarters' growth rate, although good, was muted, as you know, by the decline in government revenues related to last year's tough environment, sequestration, government shutdown, et cetera. With budgets in place, we expect that the government business, while maybe not robust, will at least be contributing to our growth in the future. In our international direct offices in the U.K., Japan and Australia, revenue grew 3% to $70 million in the second quarter with growth in the U.K. and Australia partially offset by a decline in revenue in Japan, which -- and primarily, the Japan decline was primarily a result of year-over-year declines in the yen. We're excited, really, in the quarter that the U.K. and Australia offices had really good growth. And there's been a lot of work done by Shawn Moon and Scott Miller and our teams to help build the infrastructure in those countries, and it's starting to really bear fruit. We expect in Japan, where our 7 Habits of Highly Effective People, which is a major product line, that the launch which will occur there beginning in the fourth quarter will also have a real impact there as it gets translated and ready to go. Our licensing revenue grew 8.7% to $3.9 million in the second quarter and 5.3% to $15.8 million for the trailing 4 quarters with our royalties growing faster than our overall revenues and the product revenues will be flatter. And then finally, revenue in our national account practices grew 37.4% to $8.4 million in the second quarter and grew 48% to $42 million for the trailing 4 quarters. Finally, in terms of the report on these objectives, objective 1, delivering quality results for our clients. Over the years, we've also made significant progress on this central objective of central importance. This progress continued during the first quarter and for the trailing 4 quarters. As you know, the central element ensuring that the clients get the results they desire is the quality of our content and offerings and the way in which they are delivered. And this quality and efficacy is driven by the significant ongoing investments we've made in R&D and solutions development under the direction of our very strong practice leaders and strong practice teams. In the second quarter, we were very pleased we've had a very successful prelaunch of our recreated 7 Habits of Highly Effective People leadership solution. The actual launch began March 1 in the new quarter. That prelaunch has gone very well. In a few minutes, I'm going to ask Sean Covey, Shawn Moon and Scott Miller to provide more detail about this new solution, and that will be their primary focus. But just to get a brief overview, we had a 170-city -- we have a 170-city launch planned for the third and fourth quarters. We did about 60 events in the prelaunch phase in just 1 month. And we had indicated in our first quarter conference call that we would feel that our prelaunch was very successful if we were able to achieve between $3 million and $4 million in revenue in the new solution during the second quarter. We were very pleased to have exceeded this target during the second quarter, generating more than $5 million of revenue from the new 7 Habits offering, actually a little more than $5.5 million. As expected and as shown in Slide 7, the relaunch of 7 Habits also drove significant growth in our Leadership practice revenues for the second quarter. As successful as our prelaunch activities for 7 Habits turned out to be, and obviously, we'll go into detail on that, the success of this launch importantly did not detract from the success of our other practices. As you can see in Slide 7, with the exception of our Trust practice, which has grown significantly over the last 4 quarters, each of our practices had its largest second quarter ever despite the fact that we were in the middle of launching 7 Habits on a pretty aggressive basis. As shown in the Leadership practice, second quarter revenues grew $3.2 million or 38%, while for the trailing 4 quarters, revenues declined 4%, reflecting the fact that we hadn't launched the Leadership practice and the decline in the government contract, which was heavily leadership related. With the ongoing worldwide launch of the recreated 7 Habits and with the pending recreation of each of our other primary leadership solutions over the next 2 years, we expect that our leadership practice should now grow strongly in the coming quarters and years as our other practices have over the past years. Our Education practice's second quarter revenues grew $0.5 million or 13.8%, with revenue for the trailing 4 quarters growing 47.3%. We expect very strong growth in the third and particularly in the fourth quarter in the Education practice, where as you know, almost 1/2 of the year's revenue is delivered in the fourth quarter. Our Productivity practice revenues grew 3.5% in the second quarter, and for the trailing 4 quarters, it's grown 7%. Execution practice revenues grew 7.3% in the second quarter and with revenue for the trailing 4 quarters growing 20.2%. The Trust practice second quarter revenues, I noted, were down 6%, but for the 4 quarters or the trailing 4 quarters, they've grown 13.4%. The Sales Performance practice grew 71% for the quarter, and for the trailing 4 quarters, it grew 54%, partially reflecting the acquisition of NinetyFive 5 1 year ago. And that's now -- the anniversary is here, so in future quarters, we'll be reporting on an apples-to-apples basis. Customer Loyalty practice revenues in the second quarter grew 32%, and for the trailing 4 quarters, 14.2%. In future quarters, we plan to transition to a new format for reporting on our practices. You can see that on Slide 8. And the primary adjustment between -- difference between 7 and 8 is that in 7, we report our practice revenues only in our direct offices and national account practices with the licensing royalty showing as a separate line item. The new format takes that licensing royalty revenue and allocates it to the appropriate practice and we think that's a better worldwide view of what's going on with the practices. Finally, I'll just say that, as I noted up front, our revenue renewal rates remain high at over 90%. Our gross margins continue to be strong, having grown, as you can see on Slide 9, are growing some of the last 12 months from 66.8% to 68%. In terms of our outlook, each of our key momentum indicators continues to be very positive. Momentum in the business continues to be both strong and very broad-based. As you can see in Slide 10, our pipeline of booked days and awarded revenue, which, as you know, is a measure of business already booked or awarded in our 5 direct offices in the U.S., including normal government business but excluding large government contract, also includes our business in Canada and our national account practices, grew $3.5 million during the quarter to $36.6 million. This reflects a 22% year-over-year increase in the corporate pipeline compared with the $29.2 million we had at the end of the second quarter of fiscal 2013, and maybe that's our largest second quarter pipeline ever. The government contract pipeline declined $2.9 million compared to 1 year ago, and that's really just a function almost entirely related to change in the contractual timeframe from this major government contract. It will only reflect the remaining amounts on a given contract, and since this is a stub period contract, which, as we reported in the first quarter, is recognized now almost all in the second quarter. We've left some revenue in the third, and then that -- we expect the government contracts will now be rebid in the start of the fourth quarter rather than the end of the third quarter, as it's normally been. Our prospective business pipeline, which is a measure of the amount of new potential revenue being discussed, are also at record levels really everywhere. They're staged earlier than the pipeline of booked days and awarded revenues. We may have already begun to transfer into significant, new contractual bookings and revenue in our third quarter. So we're very encouraged by the momentum we're continuing to see in the business, by the continued growth in the size and productivity of our direct sales forces, by the growth in our international licensee partner operations and by the overall momentum and trajectory of our business. As a consequence, we're pleased to reaffirm our fiscal 2014 full year adjusted EBITDA guidance range of between $35 million and $37 million and are looking forward to fiscal 2014 being another outstanding year for Franklin Covey. But maybe just a note, in terms of the direction and guidance, our confidence in our strategy, direction and momentum and such that we continue to make ongoing investments and we've reviewed that. As I noted earlier, however, to build up the infrastructure to be able to hire and ramp up 30 Client Partners from 12 and 15 and 18, we added sales managers to this marketing infrastructure. We added lots of sales support people, event scheduling people, regional practice leaders, et cetera. And that was expensive. It's compressed our flow-through over the last 6 quarters. And it's not that our flow-through hasn't been okay. Our margin -- our EBITDA margins still increased. And we expect, as I noted earlier, that these investments -- when we get through the third quarter, we will be continuing to make big investments in the launch of the -- worldwide launch activities related to 7 Habits, that we'll be in the position where our flow-through will increase significantly, our incremental investments will be much less than the related growth of sales and that we'll start to see that flow-through come back to what we had in prior years. We're glad we made these investments. We wouldn't be able to grow like we're growing. But it's a -- [indiscernible] and some of the quarters are being targeted [indiscernible]. So just in terms of looking at the next few quarters, given our expectation that the renewal of the government contract will not be rewarded until the fourth quarter, where it's normally in our third quarter numbers, and the significant investments associated with the relaunch of our 7 Habits solution and the staffing for the delivery of what we expect a little more than half of the year's total Education practice revenue in the fourth quarter, we're having to build up the staff to be able to deliver that much revenue. And we still expect -- we expect to grow the top line in our third quarter and fourth quarters, but the EBITDA will be somewhat muted in our third quarter. And so we'd expect to grow EBITDA compared to last year but relatively modestly. And we would expect the result of the adjusted EBITDA line to be somewhere flat to slightly up from where it was, the $6.6 million in Q2. We then expect to generate really significant growth in adjusted EBITDA in the fourth quarter, driven by strong increases in revenue and our Education practice where, as I noted, approximately 50% of the annual revenue and more than 80% of annual EBITDA accrues in the fourth quarter by our normal increase in fourth quarter facilitator sales, which always occurs in August, as we have our one big promotion for the year. And we also expect the possible renewal of this large government contract and other increases in our government business during the fourth quarter. And so we can do the math like you can, but it's a big number in the fourth quarter, but this is one that we feel confident will occur. I'd now like to turn the time over to Sean Covey, Shawn Moon and Scott Miller to talk about the launch of 7 Habits. Before doing so, however, I'd like to briefly highlight -- as you know, the significant increase in our profitability and thankfully our stock price during the past year resulted in 3 important events: one, the extinguishment of the management stock loan program, which simplified our balance sheet and eliminated this overhang; and secondly, the exercise of all the outstanding warrants that's made it easier to calculate what the real number of shares is. And important for a lot of the people inside the company, the vesting of the previous 2 tranches of what we call the Ringing the Bell Awards. As it relates to Ringing the Bell Stock Awards, you'll recall that in fiscal 2011, we established a contingent stock award program for approximately 25 of our senior leaders and managers excluding myself but including our other executive officers and our general managers, practice leaders and other key contributors. But very, very few of them had ever had any equity in the company and they'd been here and contributed meaningfully. We made it so the full vesting of these contingent awards depended on the market value of the stock, roughly doubling to at least $17 per share within 3 years for the first tranche, to $18.05 for the second tranche, should been -- it was issued 1 year later, and to $22.05 by July of 2016 for the third tranche, which was issued 2 years later. As noted, we were pleased with the first 2 tranches the award vested in the past 12 months. As part of the award, we agreed to allow executive officers and others to sell some of their Ringing the Bell share to pay taxes, fund their children's education, pay down their mortgages, et cetera, despite the fact that their shares vested months ago and no executive officers sold any of those shares. I just wanted you to know that with our strong performance during the second quarter, our confidence in meeting our guidance range for the year and the fact that people's taxes are due next week, we support the fact that 3 of the executive officers will be selling a relatively small amount of stock in the average of the -- less -- they will be slightly less than 8,000 shares in the coming days. And one of our directors, who has been a director for 18 years, plans to sell a few shares to -- some shares for estate planning purposes. We're thrilled with the performance of the company and the stocks [indiscernible] great contributions. I just wanted you to have the context for these modest sales, which you may see reported in the coming days and understand that it's part of the planning program from years ago. None of the other executive officers are selling any, and we're thrilled that people will have that chance to -- having the company changing contribution that there can be some life-changing results from that. I'd like to again thank you for your attendance today and for your guidance, support and confidence throughout the years. And now I'll turn the time over to Sean Covey and then Shawn and Scott. Thanks so much.

All right. Good afternoon, everyone. This is Sean Covey. Good to be with you. And I'm very excited to share that in February, we completed and launched the new 7 Habits of Highly Effective People Signature Program. And thus far, we've got early reviews in, and our clients are telling us that we have a big blockbuster on our hands. We're very excited about this. So about 2 years ago, our innovation team and our Leadership practice began in earnest to recreate The 7 Habits program. Our main objective was to reposition The 7 Habits as an essential foundation for making cultural change, cultural improvements inside of an organization rather than just having a great training product. We also felt like we needed to update and refresh the product since it's been about 7 years old since we last worked on it. The 7 Habits, as you know, represents a huge opportunity for us. It's our biggest and best-selling brand. It represents about 20% of our revenue in the United States and about 50% of our revenue outside -- in every country outside the United States. This is a project we can scale rapidly. Every office in the world currently sells The 7 Habits, not just the new one, but has been selling 7 Habits in the past. And this is where we have our largest base of certified client facilitators, all of whom will want to teach this new program and are currently being certified to teach it. And we also believe that The 7 Habits and its impacts are just beginning. There's a whole new generation of people that have never experienced the 7 Habits. And if you haven't read it, in the new foreword that was written by Jim Collins, the new 7 Habits 25th anniversary edition book, he says at the end of this foreword, "The 7 Habits is 25 years young, off to a good start indeed." And we believe the same. It's taken us about 2 years to redo this product. We went through a long and rigorous process. We gathered feedback from clients all around the world. And then we casted dozens of prototypes again and again until we felt like we got the solution just right. Some of the significant improvements to the product include a beautiful, elegant and modern-looking feel. All the materials and the packaging are redone and they're stunning. We moved the focus of the program from taking The 7 Habits course of going through training to Living the 7 Habits to living the principles and the practices after a person has gone through the course. To that end, we did our best to preserve the heart of The 7 Habits while updating everything about it. There is a lot more focus on skill development, a lot of skill and drill on different practices that we teach. The course contains 34 new and revised videos. This allows us to create a consistent quality teach with any facilitator that is teaching this, whether it's our own facilitator or a consultant, a licensed facilitator in another company or a principal of a school. It creates a great center line. We've also developed a new companion mobile app, which will be available through iTunes or Google Play. You can go download it right now. It's called Living the 7 Habits. And this new app is designed to be a companion to participants following the training. For example, before doing a performance review, a manager might look at the app for advice on how to give effective feedback. Or you can use the app to help you plan your upcoming week or to develop a personal mission statement. It has a lot of great features about it. In addition, to help establish The 7 Habits as a cultural operating system for an organization, we've developed a new companion one-day program, which we call The 7 Habits Leader Implementation. And this training, what it does is it equips leaders on how to coach their teams to higher performance using The 7 Habits. It's based on best practices from leading organizations around the world who use The 7 Habits or have used it in the past to build high-performance cultures. And we believe this companion product is a game changer and will lead to many more and larger strategic implementations because it takes it to a whole new level inside an organization. Our own consultants and our clients are giving great reviews about the new product. I just wanted to give you a couple of examples of some of the feedback we've been hearing. So we had a key player from a multibillion-dollar company in Denmark recently go to our program. In 30 years, this person had gone through many different leadership training programs and went to ours for the first time. And this is what he wrote us. He said, "It is so nice to finally see a program where everything is so professional, the videos, the workbook, the card. Everyone in our company should attend this course." So he was so impacted by the program himself that they decided instead of teaching it just to a few groups inside the company, to take it to the entire company and to roll it out to thousands of employees. We had another client go through the program. And he said "I have to admit that this is the best course or workshop I have ever attended. It is simply outstanding." And finally, from another client, he wrote us during the middle of the program. He said "Hey, we're right in the middle of the new 7 Habits 4.0 program, and I absolutely love it. It wasn't a small improvement. It was a quantum leap improvement." So those are the kinds of things that we've been hearing. We're very pleased because you work long and hard to get a product just right. And you never quite know what's going to happen, but so far, the results are extraordinary. And we're very pleased with what our clients are saying and also how it's attracting a lot of new clients. So -- and in our company, we've always had a reputation for creating the best-in-class offerings. And our innovation team -- we as a company as a whole really believe this is the finest thing that we've ever built. As well, we're excited to announce that with every purchase of The 7 Habits Participant Kit, anywhere in the world, that Franklin Covey is going to be donating a 7 Habits student workbook to a needy student somewhere in the world. And the idea basically is to give an underprivileged student the principles of the life skills that they need that are contained in The 7 Habits. And this will result in hundreds of thousands of needy children every year learning The 7 Habits. We're very excited about this -- our corporate contribution we're going to be making here. So I will now turn the time over to my friend and colleague, Shawn Moon, to talk about the launch of The 7 Habits that we just spoke about.

Thank you, Sean. Good afternoon, everybody. As Bob mentioned, we are very pleased with the performance of the direct offices in the second quarter where all categories of offices grew. And we're also very pleased, as Sean just reviewed, with the second quarter 7 Habits prelaunch results. Big kudos to Sean Covey and his entire innovations team. As Sean mentioned, the new product is very impressive. And the feedback that we received from the market has been overwhelmingly positive. The look and feel of the materials is world-class. The content, the work process, and the tools associated with The 7 Habits experience are all being exceptionally well received. As I mentioned, I believe, during our first quarter call, we held 60 kickoff events as part of the prelaunch of this product across the U.S., Canada, U.K. and Australia. In fact, I had the privilege of meeting some of you at these events, and it was great to have you participate with us. The event consisted of a morning overview session where we provided a business case and the content preview. And then following the morning session, we conducted afternoon facilitator certification sessions. So this same-day certification event was a new process for us. We're very pleased with how it turned out. These sessions resulted in hundreds of 7 Habits certifications across the world, new 7 Habits certifications. Also pleased that approximately 50% of the total -- about the 3,200 total overview attendees came from organizations that have not been implementing The 7 Habits, which resulted in about 20% of the total certifications from all of the prelaunch efforts. To have this many new organizations move this quickly, meaning in the quarter for the quarter, is an encouraging data point. Over 25% of the total event attendees certified to teach the content in their organizations, and that surpasses any prior overview event of any content. While we don't anticipate that same conversion rate percentage in the coming quarter, the power of The 7 Habits brand is clearly still a draw. And many of the organizations are moving forward with this content without prior experience with it. Our offices in the U.K. and Australia, as Bob mentioned, do not have the same facilitator base account. So we were interested to see how this smart strategy will play out in these offices, and we were very pleased that as these offices ran the same play as the U.S. and Canadian counterparts, they achieved a very strong growth in their facilitator business. So as a result of these prelaunch efforts, we achieved more than $5 million in revenue for the quarter with more than $4 million in the prospective business pipeline. And this translates to nearly 30,000 new participants or what will eventually be lives impacted, which is also something that we take a look at. So we're very pleased with those efforts. And now I'd like to turn the time over Scott Miller, our Chief Marketing Officer, who's going to talk about what we will do with The 7 Habits launch in the third quarter and the fourth quarter. Scott?

Thank you, Shawn. Good afternoon, everybody. Following on the successes that Shawn mentioned in our Q2 60-city prelaunch, we now move into the beginning phases of our multi-quarter global launch, which we'll endure for several years to come. Perhaps some of you on the phone recall that 2 years ago, we launched our new productivity solution named The 5 Choices to Extraordinary Productivity also in a global launch. We hosted about 177 cities in that launch campaign and continue now to have about 100 live events annually in that content, similar to other contents as well. Similarly, we've begun this 170-city world tour with the new 7 Habits solution. In fact, it actually grows every day. We're up to about 190 cities now. But our marketing journals [ph] say 170. So I'll stick with that. We anticipate that by the end of August, including the cities in which we held events during January and February in the prelaunch, we will expose north of 15,000 targeted buyers to The 7 Habits offer. These 170 events span the globe in nearly every major city and some second tier cities, including Vancouver, São Paulo, Moscow, Nairobi and New Delhi. In fact, the world tour began this week with events in Buffalo, New York, Jakarta and Dubai. And today, we have events in Irvine, California and Schaumburg, Illinois. Our early reports show that robust registrations continued worldwide with 170 attending yesterday in Jakarta and over 100 in Dubai. Also, each evening, we host a recap call with all of those involved in that day's events, reviewing logistics, successes, improvements and pipeline to ensure 100% quality experience for all of our clients, both current and prospective. We're also immensely encouraged with the effectiveness of our targeted main acquisition strategy, our multi-faceted messaging and marketing efforts and our daily registrations for the global tour. And as you would expect, materials are translated and localized for each event and country. However, the presentation delivery is held to a very tight center line. So we may change where we market the event, but the actual experience for the client, regardless of where you're attending, is exactly the same based on our practice in perfection of that message. We also continue to complement the live event tour with additional marketing effort, including live weekly webcast for those who can attend a live event near them, strategic placement of books and other promotional material to key decision makers. In essence, we tend to target several dozen local buyers and leaders in an event area and drop off and hand-deliver books and invitations for them to join us and other messaging opportunity to achieve a 100% conversion of potential current clients to the solution and aggressively recruit new prospects that will match our target market and value proposition. To that point, as Shawn mentioned, who of you have already attended, we invite any of you who'd like to preview the solution to visit our home page, franklincovey.com. And in the bottom left-hand corner, there's a green button. You can actually see the breadth of the tour and register for an event in a city probably near you. So as a recap, we've experienced an exceptionally strong start with the prelaunch of 7 Habits. We're now in the midst of a global tour with events being hosted nearly every business day for the coming 5 months, and we will continue to target prospective clients to showcase this solution in the coming quarters and years ahead.

Thanks, Scott and Sean and Shawn. Just one last comment, as we're going to open it up for questions, is that the idea here is that while we're launching 7 Habits, it's really the only practice area, leadership, where we haven't been having these events. We've talked for years about the marketing events, which we have. And we're not having any fewer execution events or education events or customer loyalty events. We may have had fewer trust events in this quarter. But in general, all of those practices got once -- at one time that are continuing to run. And so this has been the only practice area where we haven't done this, where we felt like we had to really recreate the product before we did it. Now every practice, it will move forward. We obviously expect accelerated growth in this practice in the coming years but that we expect the others to grow as well. So at this point, I'll open it for questions and let our operator tell you how to do that.[Operator Instructions] Our first question comes from Tim McHugh.

This is actually Matt Hill in for Tim McHugh this afternoon. My first question had to do with the gross margins, nice revenue growth, 15%. The gross margins kind of held flat. Did they have -- I know with the rollout of 7 Habits, there was some promotional pricing going on there and just kind of trying to understand if that had any impact. And then going forward, as the rollout continues, how that's going to kind of flow through?

Right. A couple of things. First of all, as you see on a rolling basis, that we've been able to continue the gross margin growth. Because as you were saying, there's some promotional pricing for existing clients that allows them to come in -- allowed them in the prelaunch phase to come in at discounts, similar to discount to kind of hold the line or a small increase relative to what they've been paying to get them to come across. Also, the cost of goods sold is higher and certainly, the production materials early on, you're not hitting the outsource in -- that you'll be doing in various countries around the world to get the material costs down that wasn't able to occur in the prelaunch phase. And so we were expecting, in the 7 Habits product specifically, that we would have improving margins. The price now -- now that we're in the launch phase, the price is higher. When we get through the first 2 quarters, we'll go higher still, and we think this -- the quality of what we've done will demand a higher price. At the same time, the price will be going up. Our costs will be going down. We also have in our cost of goods sold a lot of the consultant costs and so forth associated with this product. And so, all those things probably muted than what others would expect from the kind of revenue growth we had. We'd normally have a little bit more margin increase.

Okay. And then also in the government sector, I think the press release mentioned sales were kind of flat there. I'm just wondering how the contracting environment is going now. I think, just hearing some early rumblings from some of the other government consulting or contractors that came in a little bit slower or the ramp-up is a little bit slower than they were expecting. So I was just wondering what you're hearing on that end.

I'll let Shawn Moon respond to the second half of that question. On the first half, as expected, as you know in the first quarter, we received almost no revenue from the contract, which we had been awarded in September due to the government shutdown and the slowness of the start-up as it related to training in another sense. As expected, we knew what the revenue was likely to be in the first quarter so the revenue there -- or in the second quarter, we knew what that was. It was already booked by the end of our first quarter largely, and the first quarter revenue moved into the third. And as I mentioned, the leadership revenue side, as it relates to specific contract, was as expected and basically is known. As you mentioned, that particular contract will -- we believe, will be up for renewal here at the start of the fourth quarter. In terms of the general environment, Shawn, why don't you speak to that?

Yes, just very quickly. Matt, we are actually really encouraged by the level of activity. And I think that the rumbling that you have heard matched our experience. If there's a little bit of slowness in the government ticking up even after the budget was established, it was a really complex environment. But that said, the level of activity that we are seeing now is encouraging to us. It is -- it's a bit of a breath of fresh air, quite frankly, given the environment that we've had over the last -- the toxic environment you had over the last 2 years, and so we're starting to see some movement that is encouraging to us.

That's great. And then just one other quick question -- numbers question. Did -- was the sales force additions, the 23, was that the year-to-date number? Fiscal year-to-date?

No, let me just tell you kind of where we are. We added -- the total number at the end of our second quarter is 155. For the bunch of others that have been selected that are not yet on board, as we mentioned, we expect to reach the 180 number by the end of the year. We'll be adding Shawn in the education...

7.

7 here the next month. And we've got -- all the others kind of slotted, and we have 2 others that will be joining us next week. And so 1 month from now, we'll have an extra 10. We've added 8, Matt, in -- since we reported in November. And so we have our slots done. So we'll -- sorry, for the numbers we're choosing, but we'll go from 147 at the -- that we reported in November to 180 by year end.

Our next question comes from Jeff Martin.

Bob, could you give us a little detail on the rebounding markets in the U.K. and Australia and maybe characterize what your expectation is for Japan and what may be the factor impacting there aside from currency, if there is one?

Yes. Again, I'll ask -- I maybe can get a comment on this, Shawn, to give more detail on it. But the challenge we've had in our international direct office hasn't been anything specific to them has been more our busy-ness getting our -- the U.S. direct office [ph] and international account practices running the play, as we call it. There were all the infrastructure in place, proving it out before we had offices who were further away from us and harder to manage, yet it's been happening over the last 1.5 years is piece by piece. It's all in the same infrastructure, marketing having a -- the train the trainer looking for licensed facilitator approach there and starting to run the place. And so, Shawn, you might want to just speak what you've been doing and Scott had been doing to get them ready and what you're doing to get Japan ready for the launch of 7 Habits in June.

Yes. It's just as Bob said, we are -- the phrase we use is running the play, and as we have now run the play in those 2 countries, we -- the results that we achieved are really encouraging, 23% plus, almost 24% growth in Australia and almost 32% in U.K. in the last quarter. And that really is a function of the 7 Habits launch and running the events, giving quite the experience and giving them the opportunity to buy with this facilitator model. Our clients always buy from us in 2 ways: one, they have an experience with the content; and two, they have a relationship with our people. And so as a result of these events we provide both. Our focus continues to be on face-to-face meetings and we track and measure those activities. And these events that will give them -- give our clients the opportunity to have both that intellectual and also the emotional experience with the content, with the business case to show that here's why we would bring this into our organization, and it's working. The certification that we had in both countries were in excess of what we thought they would be going into the quarter and a lot of great momentum. These 2 countries have not historically had a big facilitator base, and so we don't have the same critical mass to draw upon at the end of the quarter, at the end of the year or whatever, to do -- work with our facilitators. And so this gives us the opportunity to really begin that in earnest, and to have the kind of results we had in the quarter were encouraging. So now to Japan, the story there is very much the same. It is to do the same thing. And we are launching, of course -- we launched here in English and then the translation that's required. It takes a little bit of time, and we built that into our plan. But we will be launching 7 Habits in Japan in June, July and August. As an office, the Japan office actually sells more 7 Habits revenue than any of our other offices. And so we really believe that with this new offering, we have a great opportunity there. We continue to fight that foreign exchange but in local currency, they're growing and growing nicely and so we're going to push that.

Jeff, did you also ask the question about FX impact or not?

No, I was just saying -- I was just looking to characterize Japan, if you excluded FX. And it sounds like it's growing so...

Yes, it is. And just on FX, the FX impacts, while still negative, is much less severe. In the first quarter, we had more than $1 million of revenue impact of FX that dropped to about $600,000 in the second quarter. And we, at least at current rates, we will drop to a couple of hundred thousand dollars in each of the coming quarters and, of course, no one knows exactly where the currency will be. But at current rates, it will be -- it will moderate a lot. Last year, we had over $3 million for the year, and it will be much less than that this year so...

Okay. And then, Bob, could you touch on the content development plans on more of an intermediate to longer-term outlook? 7 Habits has obviously been the key focus lately, and I applaud you for illustrating the launch and the early success and enthusiasm you have there for 7 Habits. But could you kind of lay the groundwork or the landscape for how we should think about content development in terms of...

Yes. In fact, I'll have Shawn try to give you more detail. Let me just give an introductory comment on it. As you know, we invest 4% of revenue every year in R&D, we say in pure product development. In addition to that, we've been investing around 3%, and it will start -- that will start to flatten and decline in the practice leadership area. And we'll keep investing there. It'll be as a percentage of sale. It will -- we won't be increasing that. But what happens every year is that we have a multiyear development plan because these projects take multiple years. And each practice has -- wants to have their thing done every single year, and so there's a process where we go through and vet what's going to happen. There's a normal refresh of every product, like we'll be in hotel every 5 or 6 years. You're redoing events and things and every year, you're doing everything. There's a maintenance program, but in terms of actual new development, that there's a whole -- there's a process that we go through and cut the $20 million of requests down to the $10 million or $8 million that we're really going to do. Shawn, why don't you give -- Shawn and Covey, as you know, has been in this area really for a decade -- more than a decade and has been pretty involved in every aspect. Shawn, do you want to add to that?

Yes. Well, just as Bob said, there's always a lot more than we have time and money to do, which is a good thing because we feel like we've got 20 years of great new ideas that could be developed and sold. The focus going forward -- like this year, the big focus was on the 7 Habits. And next year, we're going to work also on leadership as a whole, as a whole category. This is a huge area. This is where we're best known, and we have several products, one called Great Leaders, another called 7 Habits for Managers and others that we're going to be working on in the near future. And those are also big product lines. We'll also be working on the Sales Performance Group, Helping Clients Succeed product line. As we -- after we acquired Ninety Five 5, we saw a great opportunity to create several modules around selling that can be scaled across the globe. So we're going to be working on those, as well.

Okay. And Shawn, just to that point, you don't know this but yesterday, we were on the call. We don't name the client. But we introduced just 3 weeks ago the sales module and a large client, a really large international global firm, saw the materials, spontaneously ordered 1,000 sets of materials for their sales force yesterday. So that's the kind of thing that happens in the private sector.

Yes. The Sales Performance, we only -- we have 3 modules done and there's 5 more. There's a lot of room for growth there. Education will continue. We've got a lot of development plans for education, for The Leader in Me to continue to refine it. And then in the technology front, everything we do with 7 Habits, we want to put into every possible format. And so, well, there are webinar versions of the 7 Habits now, but we're creating also self-paced versions that you can take online and so forth. There'll always be a lot of technology and platforms being built. I'd say the main thrust over the next year or so is going to be on continuing to build out the leadership practice, which is our largest practice.

I'll say one last thing about that. As you know, the hardest thing, I think, in life and in business is to know our focus. And there's so many good ideas that -- and so our -- we have a process we're going through that is quite rigorous. We don't want to get involved, as we say, in the thick of thin things. You can think of a lot of things to do but you might not have the distribution capability or the sales capability or marketing or the market might be small and so we -- what we do is that gets through a process that goes on for a couple of months, starting now and ending in July. We're going to make all the decisions with the practice leaders and with the general managers and try to make sure that everything we're doing leverage -- either open some new area or leverage these things where we have and so a lot of the things get left on the side that are great ideas and they stay in the inventory of potentially good ideas for the future to allow us to focus on the things to make [indiscernible] now so...

And our next question comes from Marco Rodriguez.

I wanted to circle back around on the client partners here. It looks like I met 10 you've hired year-to-date and obviously, you said you guys are pretty comfortable and on track to get to the 180 for the end of the fiscal year. Just kind of looking for some color of whether or not this first half of the year is a little slower than you guys were expecting on the ramp.

It is, and let me just give you a perspective. We hired a lot of -- and the number of hires in this year is a lot bigger than that because, as we noted in our first quarter, we -- because we had our launch -- our sales launch in mid-September, we had a lot of people come on then and so really, we had -- and I think we've had 23 hires actually in this fiscal year. It's just that 7 -- we count -- when we reported in November, we gave the number 147. And we expect it to get to 180 by the end. So we've had a lot of activity in the first half of the year. A lot of these people that are really good, they don't give you -- when you hire them, they're not leaving their job that second. They have to make a transition. So we have -- with the 8 net since November, we have, as I mentioned, a big group. Shawn has got 7. We've got another 2. So we've got another 9 and then 4 others in the regions, in the U.S. Internationally, we got the same thing. We just went over the -- we had our -- we had what we call the Redwood Council meeting we've had in the last week in February. We go through a schedule office by office, month by month and location by location. And the pipeline, we have additional recruiters that are on board as part of this infrastructure. So we -- we're on track to where we thought we'd be. We always go to that meeting ready to be -- not be happy about somebody that didn't quite get there and try to see what we could do to help them and when they got through with the report, we kind of smile and say "I guess we don't have anything to talk about. You're on track. You got the pipelines filled". So we feel good about our ability to get to 180, which -- we've said we'd hire 30 last year. We only got to 25. We said in our call in the fall where we expect to make up that 5 and hire another 30, getting us in the range of 180. 180 would get us 30 plus 3, so chances are we'll probably get to 182, either at year end or within the couple of weeks after year end. But we think we're on track.

And how does the 155 CPs that you have right now, how does that break up in terms of the ones that are on the ramp and versus alumni?

This will be a rough answer, but we can get the specific answer. It's -- and happy to do so. But approximately, 1/2 of all the sales people are still in the ramp. So we'd have 70 or 80 of the client partners around the world that are in the ramp. Because we've hired so many in recent years. I guess, in a short way, you could answer, we had 25 last year, 22 the year before, 18 the year before and 13 and 11. So that's the number, 11, 13, 18, 22 and 25 is the numbers that are still in their 5-year ramp.

Got it. And then in terms of the support infrastructure that you guys have built over the years here, can you talk a little bit more in general or some more color around the sales managers? Any sort of tweaks that you may have been making here in the last year, any kind of hurdle that you've needed to overcome? Any sort of turnover metrics for the sales managers would be appreciated.

I'll let Shawn speak to you in just a second. Let me just show the concept of this infrastructure. The average -- our average client partner that's ramped up at least 5 years, it's when they passed -- they've gone through the ramp. The average or the mean client partner did $1.7 million last year. The median is like $1.6 million. So that $1.7 million, they're spending a little over 400 hours face to face with clients now. There used to be 250. They're now spending about 400 hours. That means when they are in front of the clients, they're -- they generate revenue of more than $4,000 now when they are face to face with clients. We know that is a key metric for us. The problem with getting that -- to move that number up and get them to spend 10 hours per week face to face with clients from the old 2 and 2.5 to 3 hours per week or 4 -- at 1 and 4 and 4.5 is that if you haven't been making all of your own appointments, doing all their stuff, that restricts it. And so for us, it's more than -- with more than $4,000 per hour of revenue and 70% of that more than $2,800 per hour in gross margin and yet you are unwilling to invest toward an $18 per hour person to help fill those appointments. The same issue is with sales management. And so for us, the fundamental thing we've done is to try to do what we call cast [ph] substitution, is things that others can do, which will increase our cost structure some but allowed more flow-through of these $4,000 per hour face-to-face meetings has been the focus on that. And then the sales management function was to make sure we had a dedicated group who didn't also have their own sales territory. We used to do player coaches but the idea was looks like people who are just coaches, helping these people get up. And the things we've learned, Shawn, why don't you speak to those?

And we may have talked about some of this, but we're pleased that we don't have any turnover in that group, and we have a very strong group. And we have general managers saying -- as they look at their years ahead, looking at forecast and growth plans over 3 to 5 years, wanting to actually accelerate the acquisitions of sales managers because it allows them to hire more people quicker, knowing and believing that the more we get the [indiscernible] parts on board and up to speed, the quicker we are able to hit our target. So no turnover there, and we really are excited about this. We're all -- we're excited about the performance. I would say, just to reiterate what Bob said, one of the key areas of focus of these sales managers has and track every single week is the face-to-face meeting. And some of the client partners, when they come on board, not really knowing the full extent of what we offer, Franklin Covey might be a little bit apprehensive to go meet face to face with clients. But what we have learned is that you got to have both the quality and the quantity of these meetings. And if you don't ever have the quantity, you will you never have the quality. And so we really do manage to that -- indicated we want people out face to face with clients. And as I said earlier, people buy from Franklin Covey when they an experience with the content [ph], and they have that critical relationship. And that's how that relationship is built. So managing to the face to face is one of the key learnings. And other key learning is the weekly accountability around the pipeline. So we take a look at our conversion rates and if we need x amount of revenue by x month, then we know we have to have x time some factor of pipeline that goes into the funnel, and this is perspective business pipeline, in order to achieve the revenue target. So every single week, these sales managers are looking at their face-to-face hours. They're also looking at their pipeline -- perspective business pipeline generation. So those are really important things, the process that we engage in that is just really critical. And I can't emphasize this enough, it's what we call the plan-and-review sessions. And that's where -- it's one on one every single week for 30 minutes to 90 minutes, reviewing the pipeline, reviewing the activities, reviewing the meetings coming up, talking about the clear-the-path issues, what resources does -- can a sales manager and the organization bring to bear to help the client partner in a particular meeting or a client pursued or some development activity or whatever. And so those plan-and-review sessions, those weekly one-on-one self-management sessions, it sounds like basic blocking and tackling and ideas. But it is the critical activity that needs to happen. Then finally, we are refining constantly our ramp-up process. We have an LMS that attracts individual usage. We have particular module that we ask every single client partner to go through by week. What do we need to have done this by week -- by day 30, you need to have done this. By 3 months, you need to have done this. And so that's something that is also reviewed in the plan-and-review sessions and is monitored on a macro level to make sure that everyone is getting the same center line of ramp-up and getting up to speed content reviews, practice reviews, those sorts of things.

Got it. And one last quick question, if I might. You mentioned that there'll be some -- an incremental cost reduction in the second half of the year based on I guess a little less spending on the infrastructure. I wonder if you could kind of quantify that.

Yes, and maybe -- what we say is the pace of increase has been slow. So [indiscernible]. We're not cutting back resources that we have now but the addition of new resources. So the percentage of sales that support costs will have gone down this year. In the last 12 months, a little bit. They'll go down more in the coming years. So we were targeting, as we've said in the past, to get to 18% EBITDA with sales margins and we think we can do that in the coming quarters.

And we do have another question from Kevin Liu.

Just some -- couple of questions along the prelaunch of the 7 habits program. First of all, with the $5 million plus in revenues you've already generated, could you give us a rough idea of what percentage of those revenues comes from just attendance at the events or certification versus content you're selling to those attendees?

Yes, we -- the amount of revenue from the actual attendance, the event is small. I mean, I'd say that it might be in the range of a couple of hundred thousand dollars across all 60 events. I mean, while there is a nominal charge to come, if you're an existing client, you get it waived and so forth. So it's there to -- so that people can come. It's really almost all something they bought.

Understood. And then so the $4 million in pipeline that you guys get out of these events, is that just referring to the amount of content you feel you can sell to the new certified facilitators or is there some other angle to that?

No, that's in addition. So the $5 million plus that we sold is the sale, and that's not included in our pipelines. The pipeline is business that we're just discussing with people. It has nothing to do with any clients that bought. So it's all new and new content -- new sales.

Understood. And it seems like at these earlier events, you've been successful in kind of getting north of 100 attendees per event. Is that kind of your expectation across the majority of these 170 or 190 cities you're targeting? And what has been kind of that certified facilitator conversion rate you've seen historically?

Yes. So it depends -- obviously, in some larger cities, these events are larger. But consider it a good average between 50 and 75 is a good attendance at these events. And that's kind of what we target. When it gets bigger than that, honestly, it sounds like it's a good thing. Often, it's not because you don't have sufficient number of sales to really sit down and work through things. And so we try to keep it in a ratio to the number of client partners that will be there. And so in some cases, you might have one city where we've just one client partner covering it, and you don't even want 60 or 70 there. You might want 35 or 40, but it has to really be great people. For example, Provo, Utah, we had an event with, Shawn, how many people?

We had 21 people, and we ended up having like 13 certifications.

13 sales out of the 20 -- so the sales people prepare. So for us, it's -- there's more behind the math. The broad answer will be 50 to 75 would be a great range. I know we're past our time. Are there other questions? We're delighted to continue to answer questions if you all are...

We do have another question in queue from Joe Janssen.

I know we're late in the call here, so I'll keep it short. I just wanted a couple of modeling questions here. On share count, you kind of alluded to this in your prepared remarks about certain directors having stock invested. You expected a few to be out in the market selling. I'm assuming others will not. I've noticed in your last page of the presentation, the last bullet there, you kind of made a comment on share count. Because of investing, you expected it to increase significantly. Could you just help me from a modeling perspective, what I should be thinking of in terms of the impact on a go-forward basis?

Okay, thanks. Steve?

Joe, as far as the outstanding shares, of course, the ones that are going to be traded just go from outstanding the one individual to outstanding to another. So the increase for the modeling in our share count will just be related to, as an example, when the third tranche of the ring-the-bell vets, we will issue new shares and when we do our ESPP plan every year, which is about 50,000 to 60,000 shares per year. That will increase. That's why in our model, we just increased about 100,000 from the number we had last time.

Okay. That's reasonable. It just sounds like...

These are big increases.

A relative term. And then, I just -- I was taking notes when you were talking about this in your prepared remarks just so I get it right. You expected, I think, adjusted EBITDA in Q3 to be kind of flat on a year-over-year basis and with all of it coming in Q4 in terms of to get to your guidance.

Yes, just slightly different, Joe. I'd say it will be up to last year, probably flat to slightly up from the second quarter.

Second quarter. Okay. And then, Bob, just one last question, share buybacks. I mean, there seems to be optimism on the call. You guys have done impressive results in '13. You're off to a good track in '14. I know investment spend is going to kind of tick down here, as we get into the back half of the year. Maybe just your thoughts on share buybacks.

Yes. We continue to feel -- we'd like to be out in the market buying. As you know, we've had -- the usage of cash has been product development, the acquisition we've made -- just recently in March, made our last payment on the Speed of Trust acquisition. We completed now our fixed payment obligation on Ninety Five 5. And so we're now in a position where our outflows for things other than just normal working capital will be significantly less than they've been. And so from our standpoint, we'd be delighted as our cash balances build back after these events. So we have to be in the market and my guess is just given the way the cash flows and the size of the sales in the fourth quarter, that takes a lot of capital to fund the receivables from the kind of increased sales that we're expecting in the fourth -- third and fourth quarters. And so as you know, the way it goes, probably towards the end of the calendar year would be when you'd expect to be starting to build up cash again and most likely in time back in the market so... Are there any other parting questions? We're delighted, of course. Those who didn't get a chance to ask the questions, who -- to take those individually offline. Also happy, of course, to stay here and answer any others that you might have while you eat your dinner. All right. If there aren't any others, we -- thanks very much for being with us today and for your ongoing support and guidance. I appreciate you very much. I'd like to express appreciation to the whole Franklin Covey team worldwide. This has been really remarkable this year. Everybody pulled together over these years and also in the preparation of this launch. Thanks so much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.