Franklin Covey Co. (FC) Q3 2014 Earnings Report, Transcript and Summary

Welcome to the Third Quarter 2014 Franklin Covey Earnings Conference Call. My name is Lakiv, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Derek Hatch, Corporate Controller. Derek, you may begin.

Thank you. Good afternoon, ladies and gentlemen. On behalf of the company, I'd like to welcome you to our third quarter investor call this afternoon. Before we begin, I'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 the training and spending policies of the company’s clients, and other factors identified and discussed in the company’s most recent annual report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission. Many of these conditions 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 the events or circumstances after the date of today’s presentation, except as required by law. With that out of the way, we'd like to turn the time over to Mr. Bob Whitman, our Chairman and Chief Executive Officer. Bob?

Thanks, Derek. I'm happy to have a chance to talk with all of you today. I've enjoyed talking to a number of you over the last few days. And inasmuch as you all have had the press release and we've talked, today, I'd just like to maybe hit some headlines. I know we're competing with the World Cup game, and we'll understand if we hear cheering in the background. But we appreciate you joining us. I'd just like to briefly address 4 topics. Let me just hit on the results for the third quarter, give a little more detail on the shift of the -- the economic shift of the $2.4 million of revenue from Q3 to Q4, then give an update on our progress on the overall business plan and thesis of growing double digit and flowing through 30%, and then give our -- just review our outlook for Q4 and beyond. So I'll start with our third quarter results, which you've seen the detail of. I'll just hit some headlines. Third quarter for us was generally a very solid quarter in terms of revenue growth. As you can see on Slide 3, we achieved growth in all of our major channels, except for government services. Our direct geographic offices in the U.S. and Canada posted 7% growth for the quarter on top of 19% growth in the second quarter and had 12% growth for the trailing 4 quarters. But for the shift of revenue to the third quarter, most of which occurred in these offices, their growth would have been, of course, stronger. And we expect to be very strong in the fourth quarter, independent of the shift and in adding that shift to it to be even stronger. Second, our international direct offices achieved growth of 12% for the quarter. This has been an area of focus for us over the past years. And we were pleased that despite some foreign exchange challenges, these offices were still able to post significant growth. And this is something we're excited about. They are implementing the same marketing and go-to-market hiring plans, and we're starting to see that move the needle on the growth rate in international direct offices. Our international licensee operations grew 11%, reflecting ongoing efforts to employ the same hiring and marketing initiatives that are driving revenue in our direct offices. 7 Habits launched, which has gotten off to a strong start in our direct offices in the U.S. and U.K. and Australia, is just now starting in most of our international partner offices. So we look forward to accelerated growth in the fourth quarter and particularly in the first and second quarters of next year. Our National Account Practices grew 20% for the quarter, reflecting growth in each of our Education, Customer Loyalty and Sales Performance practices. And so the growth in all these areas, the main channels, were partially offset -- was partially offset by a $1.7 million decline in the Government Services area that was expected. The renewal of the large government contract, which had occurred in last year's third quarter, has been deferred until the fourth quarter of this year. Approximately $1 million of adjusted EBITDA contribution came from that renewal in last year's third quarter, which should not repeat in this year's third quarter. So overall, we felt very good about the growth. We'd like to see greater growth in the direct offices in the U.S., which we'll address, but which they've had in the past and which we are confident they'll have in the future. In terms of our practices, as shown on Slide 4, the Leadership, Education and Customer Loyalty practices achieved significant growth during the quarter: 35% for Leadership, 30% for Education, 39% for Customer Loyalty. Growth in the Leadership practice was driven by the launch of the re-created 7 Habits Signature 4.0 offering. And the extent of the focus on the launch of 7 Habits in the second and third quarter to establish this launch firmly among both our existing clients and new clients impacted the Productivity, Speed of Trust and Execution practices revenue during the second and third quarters as we essentially shut off those events just to allow full focus on getting 7 Habits established. Speed of Trust was down more than others during the quarter because in last year's third quarter, we had a big Speed of Trust tour, which generated exceptional revenues in that quarter. But we expect these practices to resume growth during the fourth quarter as we once again have ongoing marketing events in each of these practice areas. And we expect that by the first quarter, all of the practices will be back in full growth mode again. So that's kind of the summary of the results. Obviously, there will be plenty of time for questions and answers. The second topic I'd like to address, is just the shift of revenue from third quarter into the fourth quarter that we discussed in the press release. Despite the broad-based growth of the company overall, the company's revenue growth was somewhat less than we'd expected for the third quarter. As we've analyzed and re-analyzed almost all of that, more than 100% of it was due to approximately $2.4 million of revenue that we had expected to be recognized in the third quarter, which shifted and either has already been realized in the fourth quarter or is expected to be realized during the fourth quarter. This shift of revenue into the fourth quarter accounts for, as I mentioned, more than 100% of the variance in gross profit, adjusted EBITDA, operating income and net income compared to that which we'd expected for the quarter. Thankfully approximately $1 million of this revenue has already been recognized in June. The revenue shift fell into 2 basic categories: First, last minute delay in the signing of 2 specific contracts, which totaled approximately $600,000 in revenue, and because of their high intellectual property content, would have had an effect of about $0.5 million of adjusted EBITDA. The larger of those was signed in June, and the other contract is out for final signature now. The second component of that was the encouraging, but earlier-than-expected shift in the mix of new client prospects as compared to the company's existing client facilitators attending 7 Habits launch events during the third quarter compared to the second quarter. As we've noted, new clients typically have a somewhat longer average conversion period than do the company's existing client facilitators. And we believe that this increased mix of new clients and the decreased mix of existing client facilitators have resulted in the shift of approximately $1.8 million of 7 Habits revenue into the fourth quarter, which resulted in a commensurate increase in the company's prospective business pipeline for 7 Habits at the end of the third quarter. Let me just provide a little more detail on this shift of 7 Habits revenue. First, it might be worthwhile noting that overall, the revenue generated from the launch of the new 7 Habits offering has substantially exceeded expectations for second and third quarters. In our January conference call, we said that our expectation for the new offering was to generate $3 million to $4 million of new 7 Habits revenue in the second quarter, $4 million to $5 million in the third quarter and $5 million to $6 million in the fourth quarter. As noted in the press release, the actual new 7 Habits revenue for the first 2 quarters was approximately $11.2 million, exceeding the upper range of our expectations for those 2 quarters by more than $2 million. So the issue in the second quarter wasn't one of the -- of the launch not being as successful as we'd thought it would be overall; but was that based on the revenue, the $5.7 million of revenue generated in the second quarter, where we had thought we'd generate $3 million to $4 million, and the amount that have been generated from these launch events during the second quarter, we projected a similar result into the third quarter, but the mix of participants shifted somewhat. Let me walk through a few slides that may provide some additional insight. Slide 5 shows that approximately the same -- in the first column, shows that approximately the same number of people registered for events in the second and third quarters. Because there were fewer events, a few less events in the third quarter, the actual number of registrants per event was essentially equal. Next, in the second column over, in both quarters, these events in both quarters generated approximately the same amount of revenue plus pipeline. We look at every event we have and have had for years, we look at how much revenue is generated in the quarter and how much pipeline, and we then have the metrics on what the pipeline conversion is. It's interesting that both in the second and third quarter, we generated about the same amount of revenue plus pipeline. So as you see in the third column, the actual revenue recognized in the third quarter was $4.1 million versus $5.7 million in the second quarter, which was $1.6 million less. But column 4 shows that, conversely, the pipeline that was generated in the third quarter was about $1.7 million or $1.8 million higher than it was in the third (sic) [second] quarter. And so the question is really what caused the shift since the overall activity and effectiveness of the events seemed to be quite similar. Slide 6 shows what we believe it is the primary reason, which is the shift of new customers versus existing customers. And as you see there, approximately -- in the third quarter, approximately 31% of our registrants were existing customers versus 69% new. And that shifted to where -- sorry, let me flip over. In Q2 -- I've got -- we'll reverse it -- new customers were 54%; existing, 46%; and that shifted to 69% new customers and 31% existing. And importantly, as part of that, there's a group of existing customers that's particularly important, which is those who were existing 7 Habits -- active 7 Habits facilitators as opposed to customers in other content. And that represented a much bigger share of the second quarter than it did in the third. 54% of those converted, and so the biggest impact was really the difference in the number of active 7 Habits facilitators attending in the third quarter compared to the second. Question, is there something -- is there something wrong with that? We think the answer is no, clearly no. As I noted, the overall revenue has come in much higher. Actually, 75% of all our active 7 Habits facilitators attended either in the second or third quarter, with a little over half in the second quarter, and the other 23% or 24% in the third. In both quarters, more than half of them converted, but that was the main thing. And so I think it was our -- in retrospect, knowing the strength -- or seeing the strength of conversion and the high percentage of the existing 7 Habits facilitators who had attended an event in the second quarter, the extrapolation of the results from that quarter into the third quarter was probably in error, although we didn't know that until all the dust settled and we were close to the end of the third quarter. So all in all, we think that's the difference. The pipeline, much of it is already converted. There's a very strong pipeline. We think that the combination of the strong pipeline that we have, together with fourth quarter incentives as we sunset the former 7.0 -- or the 3.0 7 Habits product will help the rest of them to convert. So we have a little over half of the -- a little over 40% of the active 7 Habits facilitators have already converted. We've gone through and done an analysis account by account. We think that's about half of what will convert and they'll be about 20% where because they have inventory of 3.0 or they've made big investments in translation of something in 3.0 or somebody is no longer in that position to teach in the immediate term, that about 20% won't convert now. So we expect that we'll convert about half of what we'll convert from our existing base. Excitingly for us, on the other hand, is the tremendous response we've had from new potential companies. And so the fact that we had fewer existing customers affected the quarter, but the extent of demand and the fact that these new customers are coming in, filling the events and purchasing in a relatively short period of time, although it was longer than the existing customers, is very encouraging. There are more than 10 million managers in the United States; only about 1,500 of them have we seen in the first -- in the second and third quarters. So we think this provides a very long runway for this offering as well as for Trust and otherwise. Let me just shift now to the third point, progress on our overall business plan and thesis. As you know, our basic business plan and thesis has been that our -- our goal has been to achieve growth at least 10% a year, with approximately 30% of incremental revenue flowing through the increases in adjusted EBITDA. I thought it might be useful, in response to also some questions I've received, just to give you an update on the overall progress. Slides 7 through 16 just provide a quick walk-through. I'll just take a few seconds per slide. Slide 7 shows that against this goal of achieving 10% annual growth in revenue, in fact, since 2009, the compounded average growth rate has been 11.6%. You can see that it's been lumpy in some years, where the government contract may have increased in 2011, increased that growth rate some and then the decline in that contract in '12 reduced it some. But overall, we've been able to meet the growth rate. But what we want to be able to do is meet that so it's not lumpy either. And so -- but that's been the base, the first point. As you can see in Slide 8, even though not every quarter is the same, on a rolling 4-quarter basis, each first quarter, each second quarter, each third and fourth has continued to have growth on the trailing 4-quarter basis. And we expect that to continue into the future. Slide 9 shows that our revenue per channel over the period of years has also grown well. Self-funded marketing and other, those are ones that won't change much. The other is the rent on our sale-leaseback facility. Self-funded marketing is just that. I mean, it's speeches and public programs and things that we've reduced our focus on. But our National Account Practices have grown extremely well. Our international licensee business has grown dramatically on a gross revenue. Our royalties grow at the same pace but off a smaller base. Our international direct offices have grown, and that's despite significant pressure on -- FX pressure over the last 2 years. Government Services has actually grown overall, but it's been up and down. And then our direct offices in the U.S. and Canada, without government, have grown substantially and have been a major growth engine. The things we've learned and done there are now being translated both in the international direct and our international licensee offices and National Account Practices. Slide 10 shows that practice-by-practice, our revenue growth has also been substantial. And we have these goals for these practices. And thankfully, we have -- basically, all those goals have been met to date, and we feel good about each practice. It does not mean we don't have challenges or things we think about every day and ways we can accelerate growth, but we feel fundamentally we've made good progress in each. Slide 11 shows that what has been driving this growth is kind of 2 things. One that you don't see on the slide, which is our focus on quality results for clients. It's our #1 objective as a company. And during the period of years, our recurring revenue, the repeat revenue from 1 year -- revenue from 1 year -- the clients that repeat in the next has gone from the high 60s to the low 90s. And that's been really important. It's also ultimately the thing that we're about as a company, it's the thing that will drive our -- it drives our mission and our revenue and profitability. The other thing that's driven it, though, is the increase in the size and productivity of our sales force. You can see in Slide 11, the sales force has increased from 101 to 169 at the end of the third quarter. And by the time of our sales kickoff training conference in end of September, we expect to be at that 180 goal. That means that really that by the time we reported last year -- we reported on the year in November, we had about 145 Client Partners. We've hired 24 since then. But really, since this actual year end, where we had 130 at the actual August 31, we've added 36 new Client Partners. So it's been a big hiring year. And what's been very exciting about it is with the addition of our sales management position with all of our marketing events, et cetera, we've both hit our -- Client Partners are both hitting or exceeding ramp, and we've also lost very, very few. And so the retention rate has also gone up, so this has been a key thing. Slide 12 says that also to be able to build that to capacity, to be hiring 30-plus Client Partners a year has taken some real investment. Slide 12 shows the investments in just the field support practice, the practice support and central sales and licensee support. And so that's gone from $11 million a year in 2011 to $18 million in 2013. We've said in previous calls that we expect to be able to hold the line or maybe even reduce this slightly. And you can see that for 2014, these investments have flattened out. We might have a small decrease next year. But the point is that certainly, adding to these investments, on one hand, has made it more difficult to -- has tightened the spread and the flow-through in quarters, but now reaching the point, where we in fact, are hiring and ramping up more salespeople, that also now on the flattened investments will allow us -- investment plan will allow us to flow through a lot more. The next slide shows also that in order to support the -- Slide 13 shows that in order to support the hiring and ramping up of salespeople and to increase the number of face-to-face hours we're spending with the client, in 2013, the left bars, we added 22 new Client Partners but we added 2 support people -- 45 support people for the 22. And for one 12-month period, it was as high as 3:1. This year, it's closer to 1:1. You see 32 net hires, and 37 support positions. We expect that will go to a little less than 1:1 in 2015 and beyond. And so again, this flow-through will help us. The other thing that helps a lot is the fact that when you step up, when you increase the number of new hires from 20 to 30, there's an enormous increase in investment. I mean, the 30 people have a net investment of $3 million in their -- have a $3 million payroll their first year plus marketing and other things. It is largely offset but not completely offset, but it does compress the margins. In the second year of those people's tenure, however, they each had about $300,000 of revenue, with no increase in costs. And so you have an extra $9 million of revenue generating almost 70% gross margin. And since we expected them flatlining for the next few years about 30 net new hires a year, that incremental increase, again, should reduce. And so the flow-through, if you go to Slide 14 -- I'm sorry. One page before this. Let's go to Slide 14. The payoff for doing this if we can succeed is shown on page -- or Slide 14, where if we can hire 30 net new Client Partners a year, by the fifth year, you've got an extra $117 million of revenue. Flowing through, we expect at about 30% and yet only 1 of the 5 classes is ramped up, dividing [ph] the fifth year. The others are still in ramp, suggesting that there's initial additional growth available embedded in that sales force. As there is right now, in our 169, there are almost 100 of them, they're still in some form of ramp up. And so we expect now significant flow-through of incremental revenue from the existing people who are ramping up, from the new people who are ramping up, but with flat-to-down central support costs and much reduced incremental field support costs. Page 15, Slide 15 shows the flow-through. We've had revenue growth on the top of about -- on average, it's been 11.6% over the last 4 years compounded. In 2013, it was 12%. You can see that also the flow-through goal of about 30%, actually we've exceeded that over the last 4 years, but not in the last couple. So we've had 41% -- 42% flow-through of incremental revenue to incremental EBITDA. Our goal has been 30%. But in '13, when we're making all these incremental investments as well as the investments in the launch of 7 Habits, that dropped to 21.2%. We expect to move forward in the fourth quarter to have a flow-through of well north of 30% in the fourth quarter. And moving into the next year, it will -- we will quite confidently count on 30% initial flow-through. I might note that the flow-through, of course, in '13 and '12, to some extent, but '13, was impacted meaningfully by the devaluation of the yen and by the deduction in the size of the government contract that costs us almost $4 million of EBITDA. And so our goal is knowing that the core business is strong and then growing well, we have had some of these issues that make some quarters lumpy. We expect with the hiring of the salespeople, we'll get to the point where our core business can offset any potholes that we have in foreign currency or the government thing and that we can be growing top line 10% plus organically and flowing through. Slide 16 kind of shows how that's gone. So I hope that review is useful. We'll certainly look forward to answering your questions. Finally, in terms of the outlook, maybe just for the outlook, I'll just summarize on the strategic initiatives that the size of the company's direct sales forces continue to expand. You've seen that. Productivity continues to meet or exceed our expectations. Our licensee partner network continues to expand. The number of international licensee partners has now increased to 52, including our Education licensee partners, and that will expand further. The company's repeating revenue continues to be high, with our focus on quality results as our #1 objective. More than 90% of the revenue generated by clients in the trailing 4-quarter period ended a year ago, repeated in this year's fourth quarter -- last -- latest 4 quarters. And that the launch of the re-created 7 Habits signature product is ahead of pace. Finally, in terms of outlook, the booking momentum continues to be strong. You saw the press release. Our corporate pipeline of booked days and awarded revenue increased by 7% to more than $36 million, which represents our largest ever corporate pipeline for the end of the third quarter. Interestingly, as predictive as the corporate pipeline typically is of future revenue growth, it turns out that at the end of the third quarter, it's not as predictive of the fourth because such a high percentage of our revenue in the fourth quarter comes from facilitator sales, and which means that the pipeline as a percentage of the total pipeline only include booked days and contractual revenue. And so we feel pretty good about the momentum of the facilitator business and expect that will -- our growth will exceed 7% in the fourth quarter. The corporate and education booked day momentum was strong, increasing 13% during the quarter. The overall perspective business pipelines, which do include the facilitator sales, reached the highest levels ever for the end of the third quarter. And so we feel very good about the pace and momentum. The outlook, given the strength of the various pipelines, the strong booking momentum, the expectation, hope for renewal of the large government agency contract in the fourth quarter and our expectation of significant sales growth in the fourth quarter. Otherwise, it makes us confident that our fiscal fourth quarter will be our strongest ever, both the top line and bottom line that we're well positioned for continued and accelerated growth in fiscal 2015 and beyond. To allow for some uncertainty related to the timing and award of the government contract and to provide additional conservatism, we're expecting or we've revised our annual guidance down 3% with the range to be between $34 million and $37 million. So I'll just close and say we're pleased with our continued progress in each of the areas. We appreciate your support. I'd say we've never really felt more excited or confident about the business. When we had our kickoff meeting in the fall, after having made a lot of progress over the last years, we said we're here not to celebrate having reached the summit, but having reached base camp of a new whole mountain, which is the rapid expansion phase. We've spent all this money investing in infrastructure, doing all the things we've had to do to get to where we are, at the same time, thankfully growing revenue and profitability. But we really feel now that almost all our time now was spent on this question of hiring and ramping up 30 new Client Partners a year and making sure the flow-through is there. So at this point, I'll turn the time over to Derek Hatch to just review some key metrics. I should note -- I think many of you know that Steve Young, a year -- a week ago was all of a sudden taken to the hospital for an emergency surgery that's not life threatening, but it's painful, and his recovery has been a little slower. But he's in good spirits and good health. We expect him to be back in the office next week, but he's not here to do that today. And so, Derek, we'll turn the time to you.

Thanks, Bob. Believe me, right now, nobody misses Steve more than I do at this moment. So let me take you through this stuff, some other information really quickly to round out the income statement. As you can see, most of the metrics on this page didn't change significantly from the prior quarter. Depreciation is expected to be $3.5 million for the year, up a little bit compared with the prior year. That's due to primarily some computer hardware we added in the first quarter. So we still feel pretty good about -- and some expected computer software in the fourth quarter. Amortization is expected to be $4 million for the year versus $3.2 million. That's primarily -- the decrease there is primarily due to the acquisition last year of NinetyFive 5. Now that, that was done in the third quarter of fiscal 2013, we're really on apples-to-apples basis there with our amortization expense. If you don't see it, it was essentially flat compared to the prior year. Our net interest expense and discount, no change there from our prior expectations, down a little bit from the prior year, primarily due to change in accreted interest on FCOP receivables. Effective tax rate. Our tax rate for the quarter, as you might have noticed, was 20%. That's a bit under what we would normally expect. That was primarily due to some -- what we call uncertain tax positions. Those are tax assets that we're not allowed to take on our returns because they're not rock solid or not achieving as a high enough probability that they can be maintained if they were questioned. The statute of limitations ran out on those -- or being able to take those assets. We were able to take those assets during the quarter, which reduced our effective rate during the quarter to 20%, which is not indicative for our year, obviously. We were 35% for the first 3 quarters of 2014, which was about where we -- kind of where we thought or a little over than where we thought we were. However, we do know that there will be some information coming in, in the fourth quarter that our tax department is accumulating to see if it will be beneficial for us to take some deferred tax credits and amend some prior year returns, like we did last year, to reduce our effective rate. Share-based compensation, $3.6 million last year, expected to be about $3.4 million this year. CapEx, those are purchase of property and equipment. We're expecting that to total about $3.0 million for the year, up a little bit. Most of that increase occurred in our first quarter as we purchased a new -- some new computer networking hardware here at our headquarters facility. Capitalized curriculum, you see a big change there, up to $8.5 million compared to $3.2 million in the prior year. We expect $8.5 million. Most of that growth is primarily due to the rework and the significant recreation of the 7 Habits, our signature program that you've already heard about. Our share count lastly, up to 16.9 million, which reflects we're up about 100,000 shares from last quarter. And that reflects the vesting of about 90,000 shares of performance-based stock award and 9,000 shares that were issued to participants in our Employee Stock Purchase Plan. So we expect 16.9 million to be about where we end the year. Barring any unforeseen vestings or other things, we think that, that share count should probably be pretty close to where it will be at August 31. With that, we'll turn the time over to questions and back to Bob.

Let's just open it for your questions now, and operator, if you can set that, that would be great.

[Operator Instructions] And our first question is going to come from Joe Janssen from Barrington Research.

First, let me just focus on the government contract that was pushed from Q3 to Q4. I mean, what gives you confidence that's going to be renewed in the current quarter?

Yes, we don't have absolute confidence, which is why we expanded the range to allow for that. We've been informed that their intention is to have it rebid during the quarter. They would like to begin training by the end of the quarter, but I think it is uncertain, just as all things in the government seem to be in the last few years. So we've been told to get ready for the bid. We have our request for -- our RFP response prepared. Assuming they follow through on their plans, their stated plans, we would expect to submit it immediately and hopefully have it be awarded, but we're not absolutely certain.

Okay. And then with guidance, it sounds since you lowered it by $1 million on the lower end, a function of this government contract, my question is, assuming the government contract got pushed into Q1, but given the current trends and what you're seeing in the current quarter, the original guidance of $35 million to $37 million, I mean, is that still within reach?

Yes, I mean, the government contract itself could have an impact of, say, $1.8 million on EBITDA in the quarter. And so the fact that we reduced the guidance range by $1 million says that to be conservative otherwise just because not everything happens as you think, we have a plan internally to try to make sure we get into the range with or without a government contract. Everybody's working against that plan. And if everything came in as planned, we would still end up in the original range to allow for the government and any slip, anything that might happen just on the margin, that's the reason for the range.

Okay. And then a margin question here. Given the flow-through characteristics that you've talked about, investment spend easing a bit as we go forward. Maybe a few years ago, we were all looking for that 18%. I think that's within striking distance, obviously. If you're looking 3 to 5 years, given the flow-through characteristics, maybe help me think my -- or reset my expectations. Low 20s, kind of mid-20s, it looks like the business, given the characteristics, could very easily do 100 basis points improvement on an annual basis. I mean, am I far off there?

Well, I mean, I think the math is right, Joe, in terms of the -- if we're able to flow-through 30% of incremental revenue to incremental EBITDA, obviously, it would tend to keep moving up. What we've said in the past is that we would try to -- our goal would be to accelerate growth. If we could accelerate -- if we could maintain really good EBITDA margins and accelerate growth, we'd choose that. But right now, we don't feel like we're holding back on investment anyway. As you've seen, we've hired -- we've been investing in everything we can invest in, that we can feel we can manage. And so I think it's likely we'd continue to creep up some until we -- but I think we didn't say, "Hey, we figured out we can hire 40 Client Partners a year instead of 30," then that would again flatten out for a few years. And then I think if we could figure how to keep upping that every year, it would probably keep it flatter. But otherwise, I think if you stated 30 a year, obviously, over time you'd absorb that and start to -- it would keep moving toward 30.

Okay. And then, just -- I heard Derek's comments regarding the tax benefit in Q4. Just for my modeling purpose, should we just assume a 41% tax rate?

For Q4? Yes, right now, go ahead and model that in. We really do think it will be a little lower than that. But until we get that information in the quarter and our tax department guys can run the information through to determine whether or not to take those deferred taxes international foreign [ph] tax credits, we won't know that until really the end of the fourth quarter. So I think for modeling purposes, 40%, 41% would be a good rate.

And then our next question is going to come from Tim McHugh from William Blair.

I guess just 2 questions. One, I guess -- you've talked about the Leadership program's producing, I guess, at a higher level than you thought. But how do you think about the impact, I guess, on the other programs in terms of client, your sales people focusing on that? Because, I guess, separate from even the issue for this quarter, I guess, my impression is overall sales aren't drastically different than you would expect. So is there just a greater, I guess, distraction or shift in focus amongst the sales force or is it kind of consistent with what you would have expected?

Let me just to get one point of context to it, if that's okay. There are certain sales team -- we have different sales forces. There's one sales force that sells primarily Leadership, Trust and Productivity. And so there, if you have a big launch of one thing, where they're trying to fill the next extraordinary number of events in 1 quarter, it does tend in that quarter to offset somewhat. But what you're doing is, as you build the base of clients from doing that and you launch a product and deep into a number of organizations and they repeat revenue at 90%, they can then drop back in subsequent quarters and have a more steady fluence. So really, almost all the growth in the last year has occurred in that -- for that sales force has include -- has occurred in Productivity and Trust and those products have moved from -- moved up significantly, grown their revenue very significantly over the years. And they're now established brands and products that can expand domestically and internationally. 7 Habits was already established, but had not been relaunched. So we just felt it was worth -- it is basically driven -- the metrics are driven by the number of events you have and the number of attendees. And we just decided during the second and third quarters not to hold a lot of those other events just to -- we've done a lot in the past and just make sure that there's sufficient focus on 7 Habits. But going forward, you'll have a blend of events that will allow each product line to grow by 10% or 12% a year. We'd expect all of the practice to grow in line with our overall growth and there wouldn't be a particular dislocation, if that's responsive.

Yes, a little bit. I guess, I mean, I guess, I understand this -- that, that group's selling the same products, and Productivity and Speed of Trust grew a lot last year. But I guess what I'm trying to understand is that the better-than-expected results in Leadership, is that really, I guess, an above average outcome or is that a shift in focus amongst the sales force from one product to the other that's having a negative impact on the other ones? And I guess the net impact of if you look at the sales force, maybe just focused on that collection, while Leadership is above average, is the overall sales productivity of that group above average or is it just a shift in focus, I guess?

Yes, fine. So versus expectation, it's better than expected because we expected to not have those -- you schedule those events way out and we knew that the other 2 practices would decline. So relative expectation is better. And so -- on the question is the whole company a lot better off than it would have been had you not launched? In the short run, I think, yes, a little bit better. It's not dramatically better than it would have been if we just continued to push the other products. But we think establishing thousands of new licensed facilitators in 7 Habits who will be teaching, who will be able -- who will go out and spread this in their organizations, will be a very good thing for us long term. And so, I don't know if that...

That's helpful, yes.

In the quarter, it tends to one -- last year's third quarter, we had a big push on Speed of Trust. And we did that for a couple of years before, but it was a $2.5 million product that's now almost a $20 million product and has been growing well. But every few years, you do a new big tour that allows you to attract new customers. Same with 5 Choices when it replaced that focus. So I think -- we do think -- I think your point, your insight on that is correct, that if we were to add 20 new offerings to the sales force, at some point, you'll just be trading one off versus the other. But these products don't all address the same problem or job to be done. I mean, Trust, it can be -- I mean, Trust is a great thing and so is Leadership and so is Productivity. And so to that extent, they could be interchangeable. But really the way in which we sell them, the targeted audience for Productivity is different in the -- even though it's all HR related training people. I mean, Productivity is focused on organizations with lots of high-value decisions where you have big sales forces and things like that, where making good choice of how to spend your time has a particularly big impact. Speed of Trust is particularly effective and targeted on organizations who have gone through a major realignment or a merger acquisition where there's lot -- it may not be a foundation for Trust. 7 Habits is focused on building a foundation for winning culture. So it's not the same problem you're trying to solve, but it's the same sales force selling it. And if we can establish ourselves in all 3 problem areas, they're all big and, in fact, with problems each of which can grow. And that sales force then can increase their productivity, and it can be a net positive for doing it.

Okay, that's helpful. And then, the government business, I guess, if we assume -- just assume that if you didn't get the contract renewal, I guess how big is it at this point, such that, as we think towards next year if it's even a meaningful issue anymore?

No. It is still meaningful, but not so much on a year-over-year basis if we -- so on a total basis in this fiscal year, assuming we didn't get it, it would have produced around $6 million of revenue during the quarter. It didn't produce anything during the first quarter to speak of until the very last day. We then had about $5 million in second and third quarter, in the early part of the third quarter, and it'd be nothing in fourth. And so $7 million of revenue, it'd probably have -- if we didn't get anything, if we didn't renew at all, it might have something like net, net $2.5 million impact on EBITDA in 2014. But it's actually, on a year-over-year basis, had more of an effect than that -- I mean, in 2015. It's had more of an effect on that in 2014 because of the decline. So I'd say it's something that it would be great if we got it. If we don't, we intend to build and expect to grow the noncontract government business and all the rest of them, and our expectations would remain unchanged so it would actually probably take some lumpiness out, but we're hopeful of getting it renewed at some point.

And then our next question is going to come from Marco Rodriguez out of Stonegate Securities.

Yes, I was wondering if you could do -- provide a little update here on NinetyFive 5, the acquisition there. It seems like you might be kind of underperforming there. Any kind of update you can provide?

Sure. I'll say maybe 3 different data points. Number one, the primary reason for the acquisition of NinetyFive 5, and the economics of the foundational acquisition was that we were about to spend $1.5 million on developing a tool set which they already had developed. It was complementary to our content. And that we -- they also had a book of business. And so the initial price that we paid at $4 million, in our minds paid for the product development we would have done -- do on our own, plus the existing pipeline of business. So that's one metric in terms of we priced it, so there wasn't any way we could end up upside down on the actual investment. And with it, we got some tremendous new clients, a great team and then maybe a critical mass in the business. But as it relates to -- so then second, there was the expectation of what would be required to get the earn-out to have earn-out more than $4 million? And that was set in a very aggressive growth level, which isn't a normal growth level, but we basically agreed with the team that if they could achieve certain really, really stretch objectives, they could achieve that and they're not now achieving it. The third metric is what do we really expect, and it's a little less -- and we're -- our performance has been a little less than we expected in terms of growth. I think it's driven, not by the quality of the content we got or the quality of the customers, but by the fact that neither our own sales force in Sales Performance practice, nor NinetyFive 5's -- or I should say both of them are very, very good at big deal, they're whale hunting and getting big deals, and keeping them and expanding them. What neither of us had was a front-end pipeline sales force that's out there making the 400 hours of face-to-face calls every year on smaller accounts that you can then feed into the big deal people who can do it. And so I think we have been a little disappointed that we didn't get around that faster. But we have now taken that on, and we'll be adding 10 or 11 -- Shawn [ph]? 11 salespeople. And we're going to have the salespeople, the front-end loading people, hired in our geographic regions that already know how to hire and ramp up salespeople. We feel we're very confident about the ability to do that and figure instead of trying to test that out in a new environment inside the National Account Practices, let's just do it in our regions. And then as those people develop the accounts that have the potential to become bigger, then the existing salespeople in the practice will grow, but -- so I think it's fair to say that the aggressive sales growth on which the reserve was -- or the accounting was done to allow for a big earn-out, that's unlikely to happen. But at the same time, we feel very good about the talent we have, about the plan we have. I'd expect a year from now that on this call, you will have seen good, solid growth in the sales performance practice.

Got it. Understood. And then, in terms of the 7 Habits launch, it seems like it's done fairly well here, above expectations here in the U.S. Any sort of update you can provide on pushing that out to the international licensees?

Yes. Sean Covey would you like to just address the rollout? And then, Scott Miller talk about what's on the docket for these coming months?

Sure. Sure, this is Sean. Yes, so internationally, we're just starting because we had to localize. So we've got it in the top 9 key languages now, and so the -- we've just begun the launch in the last month. And we have about 125 different events going on. The initial response has been extraordinarily positive across the board because one of the key things we did to the new 7 Habits 4.0 is we made it international, a lot more diversity. We filmed a lot of the new films in different locations around the world. So it's being received very, very well across the board by clients. So we're excited by that. And some of our first events like we held one in Singapore, we had 250 people in attendance. We got 80 certifications out of it, went very well. So we're just at the very beginning. We have a plan to try to get 1,000 people certified by the end of August in the new 7 Habits 4.0, and this -- we'll hit it hard for the next couple of months. And so we'll get some impact from the fourth quarter, but most of it will come next year, in the first and second quarter. Internationally, we think it will be very impactful just because it's about 50% of our sales is in the single product. And so the leverage of that is tremendous. So from a product standpoint, it's being very well received. From a marketing standpoint, we're just beginning on the front end of the launch. And but -- it's very positive thus far. Scott, what would you add about...

That's great, Sean. And Scott Miller, just maybe talk for a minute about what's planned in the coming months.

I would just expand on what Sean said. So we have -- we're about 1/3 of the way through the international tour. We will end the first launch of this tour with over 300 events worldwide, like Sean said, in Singapore. This week, we have events going on in Hong Kong, Beijing, Shanghai. They're all averaging 240, 260 people coming to preview. The North American average was between 70 and 100 previews. So our international events are, in many cases, they're working what are otherwise very robust events in North America. So we have some large events in big cities. But internationally, the events are proving to be phenomenal. I think another exciting progress is that this facility or channel has not typically [ph] been very robust international. Most of our certified facilitators come from our English-speaking direct offices. And our virtual certification process, which is now done all online, is now being translated into other languages. So we're going live with our Spanish version of our virtual certification, which will allow 15, 20 countries to begin to very efficiently and effectively certify facilitators, so I think we're going to see this tour gain enormous traction. Sean mentioned, our goal is 1,000 certifications from 7 Habits. And out of about 8 cities, we already have 160 certifications, so the momentum is very encouraging.

Got it. And last quick question, just a follow up on the tax question earlier for modeling purposes. I understand if you guys do take those benefits on the taxes. Can you give us a sense as far as how low that tax rate can go in Q4?

Yes, that's a tough question just simply because if you look at how much we did last year, it's really dependent on a bunch of variables. It could be as low -- we could end up similar with last year's rates or even as, I think, from talking to our Vice President of tax, even 1% lower. So I would guess that the best scenario would be what it was last year in the fourth quarter. I'm sorry, I don't know have that percentage right here with me, but they would probably end us up being -- end up being around a 26% to 27%, maybe even 25%, effective rate for the entire year.

And then our next question is going to come from Jeff Martin out of Roth Capital Partners.

Could you -- thanks for all the detail on the seminars for the recreated 7 Habits. Was curious as to your conversion rates, we're all looking at the conversion rates for the existing clients, what kind of conversion are you seeing for the new clients and how does that compare to some of your other content practices?

Yes, the conversion rate, obviously, the simple number is that in the quarter, for the quarter, about 7% of those who attend as a new client convert in the quarter for the quarter, and it ends there. And then, there's a similar amount that converts in the following quarter. And then, of course, then you got a pipeline that's still out there for many months that people continue to work. It may not be in the time in their organization. So overall, what we've learned from the other products is that out of every event that we have, that doesn't include existing clients, may end up generating about $70,000 or $80,000 of business over time in the next 12 to 14 months. And so that translates into an effective conversion rate somewhere around 30%, Jeff, I mean, effectively over time. And so, some of it happens right upfront; other amounts are spread over time.

Okay, that's helpful. And then, how should we look at the growth in Leadership over the next 2 to 3 years? I mean, you're going to have a lot of events really running through probably, what, end of the year, first half of next year? How should we look at the growth rate in Leadership, and what kind of level do you think that, that can get up to on a run rate basis?

Well, at a minimum, we'd expect Leadership to be growing along with the pace of the company, generally about 10% or 12%. But I think it will be somewhat elevated probably for the next 12 months. Even in the U.S., it will be elevated just because you'll still have this big pipeline that's going to be generated quarter after quarter. And so, it will get a disproportionate share. If we're doing, say, 800 events next year, Scott, how many of them will be -- in the 800 in the U.S., how many of them will be 7 Habits events next year?

About 200.

Yes. So it will get 1/4 of the attention where historically it's had no event. So it will grow disproportionately. And so if we have, say, 10% or 12% growth as a company, you'd probably have 15% to 16% growth from 7 Habits in the U.S. It will be faster than that, I expect, in our direct offices. Particularly Japan is a big office for us and a significant portion of its sales come historically from 7 Habits. So we should have, again, accelerated growth in Japan and, as Sean said, in the -- among the international licensee partners. So I think, overall, it will be mid-teens or better growth overall, probably in the next year. And -- but the others ought to all do pretty well, too.

Okay. And then, we didn't cover much on Education. That's continuing to grow at a very healthy pace. Do you expect that to remain at an elevated growth rate for quite a while still?

Sean, do you want to address that?

Sure, sure. Yes, Education's growth has been strong and steady. And we -- fourth quarter, we expect it to be in the 30%, 40% range; for the year about the same, and I see this carrying on for the foreseeable future. We've yet to -- I mean if you look at where the Leader in these schools are, we'll add about 500 this year to the network, giving us about 2,000. And a lot of it -- I mean it's disproportionate in the Southeast where it began, where the first schools began. And then, we've kind of gone, migrated toward the Northeast. We're pretty lightly populated in the West, all the intermountain states, California, Oregon, along the coast, Washington, very few schools, so we've done very little -- done very little there, and the opportunity is right there. So our focus is on -- continues to be quality results for the schools, reducing behavior problems, helping with teacher engagement, parental support and engagement, as well as improving academics in some cases. And we just find we're getting better, our quality's getting better every year. We still feel like we have a long way to go, but it's getting better and that drives growth more than anything else. For example, in New York City, we have a few schools up and going in the Big District there with 500 schools. And because they've done so well, we're now looking at an opportunity to go to hundreds of schools in New York City. So we're going to just continue to focus on quality. We find that it is the key marketing tool for us. The Leader in e-book is also a key marketing tool, and that will be -- the second edition of that book will be coming out in August. We think that will drive some growth as well. So kind of a long answer to your short question, but yes, I think we can expect Education to continue to grow at the same rate as it has the last 3 or 4 years.

And then our next question is going to come from Kevin Liu out of B. Riley & Co.

Just regarding the facilitator visibility that you might have for Q4. I know you mentioned it's generally a big quarter there. But given that you guys had a lot of strength there with kind of the early buys in Q2, and that did seem to pull in some revenues from the third quarter here, I mean how confident are you that you can continue to see the usual step-up that you would typically see in the fourth quarter?

So -- well, first of all, we feel very confident that we will. Over the years, we've trained our existing client base that we have 1 big promotion each year which is that you buy 10 manuals, you get 1 free. And so a lot of our customers just know that they're going to be ordering in the fourth quarter. And so the facilitator sales in the second quarter were almost all driven by 7 Habits. And so in 7 Habits alone, as I mentioned, we think about half of those who will convert haven't converted this year. So we expect -- so the sum of second and third quarter could easily happen in the fourth or sliding fourth into the first. But all the other [indiscernible] really had no focus in the last couple of quarters. But we feel good and, of course, it's not just a general feeling. We have these reviews every day and we look at the size of the pipelines and opportunities. We spent the morning, this morning, going through several offices and looking. Their pipelines are a bit -- it looks to us right now that the pipelines in each offering area are elevated significantly; that they're good reasons for people to buy; that the current partners are out there talking to them early. And so in a normal year, we'd have about 1/3 of our facilitator revenue occur in the fourth quarter. And so, if any given year, you're going to do close to -- let's just say, you're going to do $48 million or something of facilitator revenue in North America, you'd have had -- you'd have $16 million in the last quarter versus $32 million across 3 quarters. And so we expect it to have a similar pattern in this fourth quarter. You don't have total visibility on the actual sale because it's not contracted, as I mentioned, but you still know what percentage of your pipeline of opportunity is likely to convert. And we have such a good relationship with so many of our clients with this 90% renewal that really, it's usually a question of how much, what their training needs are for the next year. It's not so much a question will they -- do they need to repurchase. They're committed to the offering, they're training new people. They're just trying to get a handle on the number of people they're going to need to train next year and they're making sure they understand the motivation of doing it in the last quarter. Is that helpful?

Yes, that's definitely helpful. And then just with respect to the International business, I mean, you guys were already growing double digits this past quarter. It sounds like the ramp up and launch of 7 Habits internationally is going well. Is it fair to assume that you guys expect to continue growing the International business double digits, both for the licensees and the direct office from here on out?

Yes, we stated in the licensees that we expect -- we've grown about 11.5% -- 11.8% compounded for the last 7 years and we have this stretch goal to say we want to get to $200 million of gross revenues for about $85 million -- have their gross revenues get to $200 million by 2020. We -- everything that the team is doing there led by Sean Covey in that area is pointed toward that. And in international direct offices, Shawn Moon, do you want to just speak to that?

Yes. Our expectation for the international direct offices is to say we have the same kind of growth expectations in those offices that we have in our domestic offices. We are encouraged by the fact that, for instance, in Japan, the office sells more 7 Habits than any other single office and has yet to launch the 7 Habits because of translation, but it's actually doing that now. We've had our first couple of events in Japan and they have been filled to bursting in the venues and have been received very, very well. So we're excited about that. In the U.K., where we have launched the 7 Habits, we're back-to-back on 2 of our very largest quarters ever. And the fourth quarter is looking strong in the U.K. and Australia is the same. In fact, one of the large deals that we expect in third quarter and closed just to the first couple of days of the fourth quarter, as Bob mentioned, the shift of the revenue was in our Australia office, the single large deal they've had there. So we're encouraged by the growth momentum there and expect that to continue. Our expectations again are the same for those offices that we have in the U.S. and Canadian offices.

And you might talk to the hiring that you're doing?

Yes, the hiring -- yes, thank you, Bob. The hiring expectations there are the same elsewhere. And so we have identified our target hiring thresholds and they are clipping along at that pace. And so they are -- we are -- the phrase we use is "they're running the play." And we are running the play, which includes all of the marketing events and all of the other launches that have said that we have including the hiring and ramping of Client Partners. So we are on pace there.

Great, and just one last question for me. Any color you can add on kind of the SG&A line here for Q4? I know typically there seems to be a seasonal spike. Can we just look back at the magnitude on either an absolute or a percentage basis last year to assume the Q4 number for this year?

Sure, here's Derek Hatch.

Yes. We would expect -- to be there's -- to be an increase primarily due to the increase to the [indiscernible] sales at [indiscernible] because increased sales, we would expect some increased commissions on those increased sales. And actually it was the driver -- at least the last few years, that's been the primary driver of our SG&A increases in the fourth quarter. We would expect that to occur again. So I would say even on an absolute dollar basis, it's hard to project. But based on sales, I would say, it would probably be up maybe another $1 million or $2 million versus last year.

We expect that [ph] -- even with that, Kevin, as you know, the strategic -- the detailed model, but we'd expect very significant flow-through of incremental revenue to incremental EBITDA in the fourth quarter.

And our next question is going to come from Matthew Berry from Lane Five Capital.

You mentioned in the last 10-Q, the longer-than-expected collections time for government education and licensee accounts and expected some improvement in the third quarter, I think, which didn't seem to materialize. So there's still -- it looks like maybe $8 million to $10 million of cash locked up, which is like a 3% buyback or more than a whole year's worth of practice development costs or 40 to 50 new hire costs. So could you just touch on what is actually causing those delays, the underlying causes of those accounts?

Well, primarily, we did see a little bit of improvement in the fourth -- in the third quarter, but like you said, not a lot. A lot of that stuff is simply due to the timing, the payment cycle on some of these clients. The government typically tends not to pay quite as fast. They will pay. Their stuff doesn't move quite as quickly. And we have had some relatively large deals that have gone through and sometimes those guys have gone to a little bit longer payment terms. And so we do believe that there is some capital locked up in our receivables. We hope to get to that, get the DSO down and days sales outstanding down and get the cash in the door. But you're right on your analysis as far as there's probably $7 million or $8 million of receivables locked up in a little bit longer terms than we would like. We definitely have all hands on deck to try to collect those.

And it's not an indication of anything we need to be concerned about at this point? I mean, you haven't made any provisions against them or anything like that?

No. Yes, our write-offs are virtually 0 for the entire year, so we're not providing for a lot of write-offs or anything like this. We believe they're all still collectible.

And we have no additional questions at this time.

All right. Great. I would just like to thank everyone for your participation today, for staying on a little bit longer. Appreciate that. We're looking forward to talking at the end of the fourth quarter. And obviously we're in the middle of a lot going on here in the fourth quarter. So thanks again for your support, look forward to talking to you soon. Thanks.

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