Franklin Covey Co. (FC) Q1 2018 Earnings Report, Transcript and Summary

Welcome to the First Quarter 2018 Franklin Covey Earnings Conference Call. My name is Anna, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Derek Hatch. Please go ahead.

Thank you, Anna. Hello everyone, and Happy New Year. On behalf of Franklin Covey, I'd like to welcome you to our first quarter of fiscal 2018 earnings call this afternoon. And hope all of you are having a good year, and are avoiding the severe weather on the East Coast, the cyclone bomb. Before we get started this afternoon, 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 acceptance of and renewal rates for the All Access Pass, 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 the company's actual future performance will meet management's expectations. These forward-looking statements are based upon management's current expectations and we undertake no obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of today's presentation, except as required by law. In addition, I'd like to remind everyone that during the call we will be discussing GAAP and non-GAAP financial measures. Please refer to the reconciliation of these items as found in this presentation and in our earnings release for the first quarter. 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. Hello to everyone. Again, Happy New Year, and we're happy to have a chance to talk with you today. I hope that from our discussion today you'll glean five takeaways, those are shown on slide three. First, that our strong first quarter results reflect just a leading-edge of what we except to be an even more significant inflection in revenue and adjusted EBITDA growth and cash flow for fiscal '18 and beyond. Second that the continued growth in our deferred revenue balances provides significantly increased visibility and a strengthened foundation for accelerated future growth. Third, that the growth has been driven by success of the subscription business whose key metrics are extremely strong. Fourth, we expect -- we're at an inflection point where we expect significantly accelerated growth now in adjusted EBITDA, our adjusted EBITDA margins and free cash flow this year and the next years despite making significant growth investments. And finally that we believe -- there's increasing upside we believe for shareholders as most of the value of the subscription business is not yet reflected in the market cap we don't believe, and we'll just touch on each of those. I'd like to start with the first one, the results for the first quarter being the leading-edge of what we expect to be a significant inflection in results this year. Slide four provides some quick highlights on the key results for the first quarter. As shown, revenue grew 20.5%, subscription and subscription-related revenue grew 59%, the subscription and subscription-related revenue in the Enterprise Division grew even faster at 138% year-over-year. Our deferred revenue that was billed grew 23%. Our total deferred revenue, including billed and unbilled grew 52% year-over-year. Our adjusted EBITDA was $3.4 million higher than in last year's first quarter. Our net cash provided by operating activities was $5.2 million higher than last year's first quarter. And our number of paid subscribers through our subscription offerings grew 44%. And now I'd like to provide just a paragraph or two on each of these points. Starting out, you see on slide five, our reported revenue grew 20.5% in the first quarter, to $47.9 million, up from $39.8 million in the first quarter of fiscal 2017. You can see again that our total subscription and subscription-related revenue across both the Enterprise and Education Divisions grew even faster at 59%, partially muted by declines in our, now much smaller, legacy facilitator and onsite delivery channels. And that subscription and subscription-related revenue in our Enterprise Division alone grew even faster, at 138%. The engine felt strong in the Enterprise Division, revenue grew $7.7 million, which was 26%. So its total revenue was $37.5 million, up $7.7 million or 26% compared to last year. In the Education Division revenue grew $400,000 or 5%, to $9.2 million. Slide six, our total deferred revenue, billed and unbilled, grew 52% year-over-year in the first quarter, to $10.1 million, up from $6.6 million in the last year's first quarter. And as you can see, deferred revenue that was billed increased 23%, to $8.2 million from $6.6 million in last year's first quarter, and the deferred revenue that's unbilled was worked more and more on multi-year contracts was $1.9 million in the first quarter compared to none in the prior year's first quarter. Turning to slide seven, we're pleased that as shown on slide seven our adjusted EBITDA, of $600,000 for the first quarter, was $3.4 million higher than the negative $2.8 million in reported EBITDA we had in last year's first quarter, also $2.4 million higher than our guidance. Our guidance was for adjusted EBITDA in the first quarter to be approximately negative $1.8 million, which was $1 million higher than in last year's first quarter. We were really encouraged that the strength of All Access Pass' revenue in our Enterprise Division drove strong growth in revenue, and also significantly increased our gross margin percentage resulting in higher than expected adjusted EBITDA despite our significantly increased growth investments to cover implementation specialists, new portal, localization of content in 16 languages, content investments, et cetera. And just to refer you to slide 29 which is in the appendix just to give you a little more color on the performance. You should see there in the Enterprise Division first quarter revenue was $37.5 million, growth of $7.7 million or 26% compared to the $29.8 million in last year's first quarter. The Enterprise Division's gross margin increased 644 basis points to 72.1%, from 65.7% in last year's first quarter. And again, reflecting the high margins in our subscription business. The combination of higher revenues and higher gross margin drove a $4.8 million increase in EBITDA in the Enterprise Division to $4.5 million, compared to EBITDA of minus $300,000 in last year's first quarter. And this was after covering more than $1.5 million in increased growth investments as I mentioned before. So we felt great about the performance of Enterprise Division in the first quarter. As also shown in slide 29, as expected, the Education Division's adjusted EBITDA was $900,000 lower than last year's first quarter. That reflects both one, the staffing and marketing investments the Education Divisions make during the first and second quarters to be able to generate the contracts with hundreds of new schools which it recognizes in the fourth quarter where, as you know, substantially all of its annual EBITDA is generated. It also reflects the change in the structure of our Leader in Me subscription offering where we are now including several onsite delivery days as part of our Leader in Me offering instead of charging for these training days à la carte outside the Leader in Me membership. This results in revenue from these onsite days which were delivered in the first quarter and has normally been recognized in the first quarter, now being recognized over 12 months. Going back to slide eight, net cash provided by operating activities increased $5.2 million in the first quarter, from minus $3 million last year to positive $2.3 million this year. And then finally, on slide nine, our total number of paying subscribers across both our Enterprise and Education units increased to 475,000 in the first quarter. That represents an increase of 125,000 people or users or a 44% from the approximately 330,000 subscribers we had at the end of the first quarter in fiscal 2017. So we felt really good about the results and direction and momentum we had in the first quarter. Second point on the agenda is just the continued growth in our balances of deferred revenue are providing significantly increased visibility into and has strengthened foundation for achieving accelerated growth as we have more and more of that revenue already in place. As you can see in slid 10, our total balance deferred revenue billed and unbilled increased to $47.7 million in the first quarter. That represents a high percentage growth of 164% compared to $18.1 million in total deferred revenue balances billed and unbilled we had at the end of last year first quarter. As you can see, our balance to billed deferred increased to $31.8 million, which is growth of $15.7 or 97%, compared to $16.1 million we had in last year's first quarter. And our balance of unbilled deferred, which really began to grow in this last year's fourth quarter increased to $15.9 million in the first quarter, compared to $2 at the end of last year's first quarter. As noted, these significantly growing balances of deferred revenue provide increased revenue visibility and establishing the foundation for accelerated revenue growth well into fiscal 2019. And we expect actually to the extent of our visibility in the future we continue to increase in each of the coming quarters, one, just as the natural result of growth, and second, we will now begin to offer our subscription offering in our international direct offices in Japan and China here in the next few months. It will also occur in our licensee division, but that won't generate subscription revenue, per say, because they pay us on a royalty basis, because it will increase the visibility again from those offices. So that for us is an important objection that we continue to make progress again. Going to the third point, the growth is really being driven by our subscription business, whose growth and key metrics were really extremely strong in the first quarter and have been for some period of time. Over the past decade, many of you have been with us that long; we made three important shifts in our business and business model. As indicated in slide 11, each of these shifts resulted in meaningful increase in share value. Our final business model shift occurred in fiscal 2016. As you know, throughout all the earlier periods we typically sold our content solutions one course or one solution at a time, and often to one team at a time. However, as you know, two years ago, after a lot of study, we determined our strategic strengths of having best-in-class branded content. The most flexible content delivery options and the broadest and deepest sales and distribution capabilities put us in a unique position to offer our content and solutions through a subscription service model, software as a service model, but also as a subscription as countries in other sectors have done. As you know see on slide 12, Franklin Covey being in the organizational performance improvement and talent development space. We believe that offering our solution through the All Access Pass subscription offering would allow us to substantially expand the breadth and depth of our client impact, significantly increasing lifetime value of our customers, and potentially changing the basis for completion in our industry, and ultimately creating substantial value for our shareholders. Yes, there has been a bit of a transition. We appreciate your patience as we have been going through it, but I think the good news for us at least is we believe it's working and working well. Our growth and momentum in our subscription and subscription-related revenue was very strong in the first quarter, as were our subscription and software as a service quality metric. First, as shown on slide 13, for the latest 12 months, our -- across our both business, our subscription-related revenue and change in deferred revenue billed and unbilled increased to $107 million. That's growth of $37.4 million, or 54% compared to the $69.9 million in total subscription revenue we generated for the same 12-month period in last year's first quarter - for the trailing four quarters ending last year's first quarter. So that significant growth in the overall subscription revenue and subscription-related, and the change in deferred that just continue to build up momentum. Second as shown on slide 14, we've already talked about this, but I will give you a little more color on this. Our total number of paying subscribers across both our Education and Enterprise units increased to applications 475,000 in the first quarter. That's an increase of 125,000 or 44% from the approximately 330,000 subscribers we had at the end of first quarter in fiscal 2017. As you can see in slide 15, in the Enterprise Division, of our total 475,000 active subscribers; as you can see in slide 15, 330,000 of them are in our Enterprise Division, almost all of which are past subscribers. This 330,000 subscriber base is up 125,000 subscribers, or 61% compared to the 205,000 subscribers we had at the end of last year's first quarter. So with that, growth continues to be very strong. In the Education Division as shown in slide 16, our growth was 15% during the year, which is again very solid growth, we had 150,000 subscribers at the end of this year first quarter, which is growth of 20,000 subscribers or 15% compared to the approximately 130,000 subscribers we had at the end of the first quarter of fiscal 2017, as it relates to growth of our subscription-related business. Third, as you can see in slide 17, like Gartner subscribers purchased nearly $0.50 of add-on services for every $1 in subscription revenue; our passholders are also purchasing significant amounts of add-on services to help them achieve their organizational objective. In the first quarter, passholder purchases of add-on services increased substantially. As you can see in slide 17, All Access Passholders purchased $3.6 million of add-on implementation services. That's growth of $1.5 million, a big percentage, compared to their purchases of $2.1 million of add-on services, last year's first quarter. And for the trailing 12 months, All Access Passholders purchased $14.9 million of add-on services, which is growth of $11.1 million or almost tripling, compared to $3.8 million of add-on services purchases by passholders for the same 12-month period ending in last year's first quarter. One last comment there about our growth and the strength of our subscription business is, we are also pleased with some of our subscription businesses key indicators placed among what are considered best-in-class SaaS companies. Recently one of our shareholders was nice enough to send us a copy of an independent study of SaaS companies, which included data on all 56 of the publicly-traded SaaS companies. Twelve of these companies were considered best-in-class based on their achievement of all three of the factors shown in slide 18, which -- the percentage year-over-year revenue growth being at least 25%, the subscription and subscription-related, the gross margins in their SaaS business being at least 70%, and what they call growth efficiency, a combination of the growth rate of 25%, and their free cash flow yield, which was at least 5% on top of the 25%. And that made the best-in-class grew at least in the study. As you can see in slide 19, we were encouraged that as indicated there, our SaaS business is also achieving these three best-in-class SaaS standards, even though we are early on, our subscription and subscription-related growth is been well in excess of 30%, of course of a smaller base, our gross margins are north of 70%, and our growth efficiency, the combination of the gross margin and our cash yield even with all investments has put us at least in that space. And so, we are trying therefore not only generate revenue, but has quality of the revenue sustained the revenues, sustained at high margins, high add-on services, high revenue retention. As you can see on slide 20, the combination for us of having a higher initial sales size, revenue retention of more than 90%, plus the add-on purchase of implementation services is driving significantly increased life time value for our customers. Our customer of course you know, about 40% of our All Access Pass customers were previously facilitated or coming from our facilitator client. So, an example of how that's changed for them in the traditional facilitator business, the initial sale may have been around $15,000; it's a pretty close average actually of the 263 clients who had purchased All Access Passes through at the end of last year, their average purchase had been $15,000, their highest purchase and facilitator over three years is $15,000, whereas the initial purchase price for their All Access Pass was $28,000. Over three years, studying that group of people, they'd spent an average of around $32,000 rounding. And now with the renewal rate and the add-on services, we would expect over the same three-year period substantially hire something in the range of $89,000. Differences for us, this idea of building clients for life, where we acquire new clients, we go in and work with them to make sure they're getting real value out of the offering, expanding their populations, expanding the number of Solutions they're utilizing, adding on services where it's useful to them, and then renewing and continuing that virtuous cycle, we believe, is a great way to do business. It's been a great thing for our customers, a really great thing for them as they find us as real strategic partner. It's been great for our clients and for our employees and for our associates here because they're doing really important work in getting the chance to what they always wanted to do is go deeper and more pervasive. And we believe that it's also an exciting time to be a shareholder for Franklin Covey as well. Fourth point on the overall agenda is that we believe we are in a significant inflection point, where we now expect to achieve accelerated revenue growth, increasing gross margins, and increasing flow-through to adjusted EBITDA and cash flow. And we recognized that our transition to a subscription model would be disruptive. It's shown in slide 21. On the left-hand side of the chart, we knew our transition would involve subscription accounting. And over that period of time last year, the portion of the given contracts value, it is recognized upfront at the time still have declined significantly. This transition also disrupts our legacy facilitator and onsite business model. However, as noted on right-hand side, this has also significantly increased our lifetime customer value, increasing our gross margins, we expect will have significant impact on our EBITDA margins, it is also increasing our visibility as you can see at the end of the first quarter we had $47.7 million balance, a very high margin deferred revenue, which will be recognized as revenue and income in fiscal '18 and into fiscal '19. We have now reached an inflection point for under any of a wide variety of revenue growth scenarios, we expect to achieve strong revenue growth, increasing gross margins, and significantly increasing flow-through to adjusted EBITDA and cash flow. To share some at least sensitivity which may be helpful to some of you who that's - look for that visibility. As shown in the slide 22, we assume we meet our 14% revenue guidance this year. And then our EBITDA ends up in the middle of the range, say to $12.5 million, this says after having done that, if the growth rate would have dropped then to 7%, the scenario one where we hit this year's numbers, but then the growth rate drops to 7% thereafter, where scenario two, where we have 14% this year and the revenue growth continues; it go to 15% a year, and just to get two different views. Under scenario one, revenue would still grow to $226.8 million in 2019, to $242.7 million in '20. I think on the slide it skips over to 21, but $259.7% million in fiscal 2021 and to $278 million in fiscal 2022. The contribution produced by the operating units by the Enterprise and Education Divisions will be the midpoint of our range this year on EBITDA, their contribution toward that will be $28.5 million in EBITDA contribution in fiscal '18. That would be expected to grow to $43 million in 2019 to $56 million in 2020. Again, we are skipping $68 million in 2021 and to $81.7 million in '22. The reported adjusted EBITDA after achieving $12.5 million, which is of course the midpoint of our guidance range this year, because we just use that midpoint, reported adjusted EBITDA would be expected to increase to $26 million in '19 to $37.4 million in 2020 to $49 million in 2021 and to $61 million in '22. And cash flow would actually grow little faster after having cash flow of $25.7 million in fiscal '18. Cash flow as defined here would be expected to increase to approximately $38 million in fiscal '19 to $45.4 million in fiscal '20 to $55.6 million in 2021 and to $67 million in 2022 even after making significant ongoing investments. You can read the scenario two, but let me just hit some headlines here. Under scenario two, if after achieving our revenue guidance of 14% in fiscal '18 revenue then grew 15% a year thereafter, you can see the revenue would get to $371 million in fiscal '22, Division level adjusted EBITDA contribution would get to $109 million by then. Reported adjusted EBITDA would go from $29 million to $46 million to $65 million to $88 million. And cash flow from $25 million in '18 would go to $41 million, $54 million in 2020 to $72 million in '21 and to $95 million in 2022, again, even after making significant ongoing investments. For those of you who would like to play with the numbers there, there are additional sensitivity scenario shown in slide 27, which might help you as you try to just look at other data points, but we are excited, whatever the exact numbers are, we're excited to be at this inflection point where we expect to achieve strong revenue growth increasing gross margins and significantly increase flow-through to adjusted EBITDA in cash flows moving forward. Final point on our takeaway agenda is number five. Just to say that notwithstanding the revenue momentum, the substantially increased visibility, the dramatic growth in the SaaS business, and being at new inflection point, we believe that very little of the expected value of our subscription business we've talked about just now with the cash flows are likely to be, most of which are driven by the subscription business, we believe that very little of that is reflected in the current market capitalization, you know, because -- and we think that's good news for shareholders who are getting lot of the values based on the legacy businesses that continue to generate EBITDA and will continue, like our Education business, which again is increasing from subscription, we're just looking at the enterprise business alone. We've got several units that generates significantly EBITDA contribution; Education, which is continuing to grow well over the years, and we expect will continue to grow well. Our licensee division, which is part of the enterprise that has separate business model generates significant amount of contribution. The offices outside like China and Japan who haven't yet began the subscription, and then just remaining contribution from our legacy business. When you add those up using some reasonable multiple of those and subtracting that from our roughly $300 million market cap, I think the conclusion is that compared to best-in-class SaaS companies that are trading in multiple revenue of four to 10 times, we're not saying, "We should," but depending on your math and what multiplies you might be trading at half a point, at half times revenue or whatever, we think as this becomes more and more visible, the success of the ongoing efforts on the transition, you know, at some point that will begin, at least as a chance that will begin to become recognized as well. So, and with these numbers that we provided on the previous slide that showed potential cash flows, I think discounted cash flow analysis would also suggest valuation disconnect potentially, which we hope is to the benefit of all shareholders. So in conclusion, just going back to our five takeaways, our first quarter results we think are reflective of the even more significant inflection in revenue and adjusted EBITDA growth we expect for the full year. We are happy to be at that point. We've been talking about getting there and believe we're now approaching that on the middle of it. Second, our significantly increasing balances and deferred revenue are providing significantly extended visibility and strengthening the foundation for accelerated future growth. Third, our actual and expected growth in revenue and adjusted EBITDA is being driven by the SaaS business, whose business is dramatically the key metric strong. The inflection -- the economic inflection point we're hitting is expected to drive significant growth at all levels, and particularly in free cash flow despite growth investments. And while we are hitting the inflection point we think that there's very little of that value being baked into our current market cap, and therefore giving everybody who is on this call a chance to benefit from the recognition of this. At this time, I would just turn the time over to Steve to review our guidance, and we'll open it for questions.

Okay. Thank you, Bob. Happy New Year everyone. For guidance, so as you remember our guidance for the year is that we expect net sales to increase from $185 million to approximately $212 million, a 14% increase. We expect deferred revenue on our balance sheet to increase by more than $15 million, a 36% increase. And we expect adjusted EBITDA to increase from $7.7 million to a range of $10 million to $15 million for the year. Our positive Q1 result gives us increased confidence in this annual guidance. As Bob mentioned, we are pleased to report that adjusted EBITDA for the quarter was $2.4 million higher than our guidance. This improvement compared to guidance is primarily due to an increase in add-on AAP sales and facilitator sales in the quarter, combined with the expected increase in recorded AAP sales and high gross margins. So we're pleased with the quarter. At the beginning of this year, we expected our Q1 and Q3 adjusted EBITDA results to be somewhat higher than last year. We expected our Q2 result to be somewhat less than last year, maybe as much as $1 million and we expected our Q4 result to be significantly higher than last year. We still have those same expectations in light of the fact that Q1 was quite good compared to our guidance. So Q2, we expect a higher dollar amount of contracts to be signed in Q2 than in Q1, maybe a $3 million higher amount of contracts signed, and are pleased than an increased amount of those contracts is expected to be related to the continuing growth of our subscription business. This expected mix shift in sales toward the subscription business compared to Q1 is expected to cause the reported sales result in Q2 to be less than Q1, maybe by 3%. And so, our guidance for Q2 is therefore that adjusted EBITDA is expected to fall between a negative $500,000 and a negative $1.5 million for the quarter, again as we expected at the beginning of the year. So we're pleased with our first quarter result. We're pleased with where we expect to be at midpoint of the year compared to what we were thinking at the beginning of the year. And while we have confidence in our guidance because we're still in a significant transition of our business toward a subscription model, changes including a significant change in the mix of sales between subscription and non-subscription could still result in us reporting results that are different than our current expectations. So, Bob, let's look at guidance.

Steve. This time I would just open it up for questions. Thanks a lot. Is our Operator there?

Thank you. [Operator Instructions] And we have a question from Alex Paris from Barrington Research. Please go ahead.

Good afternoon gentlemen. This is Chris Howe sitting in for Alex.

Hi, Chris. How are you?

I'm doing great. I have two questions here just to start off. First, any additional color on the large intellectual property contracts as far as maybe the magnitude, how it came about, and what's unique about this contract? And then my second question was in regard to the tremendous paid subscriber growth that you had of up 44%. Perhaps as much as you can share, how is this going in the quarter in regard to the Enterprise and Education segments? And any insight into how it may look for the year? Thank you.

So, in the first question, we talked about the one large Enterprise -- we have a client that's a large professional services firm that's been a client for maybe 15 years who, recognizing the value of the past and such, just signed a multiyear contract during this quarter. And so I think that there's nothing new other than this in terms of the relationship, it's just that this client now seeing the advantages of having a multiyear relationship that's contractual upfront, and the ability to do a lot more things with them provided that -- I don't know, Paul, if you want to give any other color on that?

No, that's right on, Bob.

Is that responsive to your question, I mean, that's all it is. It's just a client who has typically signed up for this year by year decided to sign a multiyear contract to deepen the work that we're doing since we have good commitments of what we're going to do together. As it relates to the subscription growth, maybe I could just refer you to slide -- in terms of -- let me just see if the question was -- was the question about the growth in the quarter itself, and how that broke out between Enterprise and Education, or did I miss the question. I apologize.

I was more seeking out what your expectations are for the full-year in regard to that metrics.

Okay.

Perhaps any additional color that's not in the slides.

Yes, I mean, for us of what we had a significant growth in the first quarter, we had, as you see, 44% for the quarter. It was actually even more dramatic in the Enterprise business. And so I think we expect, on slide 15, you saw that the Enterprise business was up 61%. This is an apples-to-apples because both of our first quarters which tend to be smaller. But I think this kind of year-over-year growth in total subscribers, something being in the 40%-plus growth of subscribers for the year is something we'd expect would be on trajectory with what our expectations are for the continued growth of the subscription side. So we think that that would put us well over 500,000 subscribers for the year.

Okay, thank you. That's helpful.

Okay, thanks.

And we have a question from Tim McHugh from William Blair. Please go ahead.

Hi, good afternoon. This is actually Trevor Romeo in for Tim today. Thanks for taking the questions.

Hi, Trevor.

Hi. So first of all, I guess thanks for the details about the guidance. But I just wanted to dive in a little bit further there. The revenue growth being 20% in the first quarter, the guidance implies closer to 12% to 13% growth the next three quarters, if my math is right. So I know the comp in the first quarter is a bit easier. Is there any reason to think that underlying growth might be a little slower the rest of the year or anything unusual about the first quarter that helped? Anything you'd call out there?

Yes, I think it's just really the issue is just the mix growth because we expect most of the growth to be occurring -- we expect really significant growth in the number of contracts we're going to be signing. Because they're mostly subscription contracts the portion of those, that big increase in contracts being signed, that'll be actually recognized in the year, as we get further and further in the year, even though we're signing more and more contracts, less and less of that revenue gets recognized. So it's primarily the expectation that Steve mentioned. We expect in the second quarter to have a higher mix of subscription than we did in the first. And we expect that to grow also in the third and fourth quarters for just smaller amounts will be there. And so I think it's just that. If you're looking at the volume of new contracts being sold, it wouldn't drop off. But because of that we're happy to have that little bit of cushion on the first quarter. But hardly anything that we sell in the fourth quarter will show up in the fourth quarter if it's subscription.

Okay, got it.

That response -- yes.

Yes, I think that that makes sense. And then one other one, I know that the deferred revenue was up quite a bit on a year-over-year basis, but if I'm looking at this right it looks like it maybe was actually down a bit sequentially from the fourth quarter. Is that just kind of similarly realizing some of the deferred revenue from the previous balance or normal seasonal effects, or anything there?

Yes, I think that is the normal seasonal effect of just having such a significant amount of deferred revenue on the balance sheet at the end of the year that's generated significantly in the fourth quarter in both the Education Division and the Enterprise Division. And then in both cases it's simply that that's such a large amount that more of it is flowing into revenue than is being sold and generated in that quarter. So, it's true seasonality based upon the pattern of our sales. And we'll reverse a little bit each quarter to where the fourth quarter is where we have a significant increase in the deferred revenue on the balance sheet.

Okay.

I was reading recently, I guess, Salesforce.com which we'd all like to be like. It has a similar thing where its fourth quarter is so big that it has a negative sequential change in deferred revenue even though positive year-over-year. And this is the most dramatic comparison because fourth quarter is by far our biggest and first quarter is by far our smallest. And so that's exactly what's happening.

Okay, right. That makes sense. Maybe one more follow-up, could you describe the magnitude of what acquisitions have added to revenue. And also, just following up on the earlier question about the intellectual property contract, I don't know if you guys didn't want to disclose, but could you go over the magnitude of that contract as well as possible. Thanks.

Sure. So, the two questions.

I was talking - in the quarter we had something like a million dollars from one of the acquisitions, and the other one is kind of…

A million of revenue.

Of revenue, included in the past, and so it's hard to pull out exactly what the incremental amount would be, but say it's a few hundred thousand additional of incremental from that. So I would say it's a little bit between $1 million and $2 million, in that range in the quarter, $1.3 million in the quarter.

And then as to this multiyear contract, maybe some context. You may recall that in the fourth quarter we signed $16.5 million of contracts that were unbilled in that quarter. And that reflected people who, on average -- All Access Pass holders who on averaged the duration of their contract by six months, and increased their population size by 14%. So this is something you're going to see quarter, by quarter, by quarter. It's not that this change is not exclusive to this one contract. Actually it includes several contracts. So I would just -- so there's one contract that simply, something you're see a lot of I think quarter-by-quarter in increasing amounts and a lot in the fourth quarter, where clients who have an existing pass for one year decide that they -- the impact jury, we call it, they were on is going to take multiple years to get done, and who decided to go ahead and sign a multiple year contract to do so. So again, this one particular client is just one of -- there were 320 of them in the fourth quarter who did it. There were a dozen or so in this first quarter that we just called out. I think in our disclosure there was one larger one. But this is just an ongoing process. But I'd be happy to answer more questions. We don't use client names, but it's a large professional services firm, as I mentioned, has a 15-year relationship, has been buying stuff from us every year just decided that with the subscription model it would make sense to do it -- sign a multiyear agreement. Is that helpful at all?

Yes. No, that's very helpful. Thank you for the clarifications there. Happy New Year guys.

Thank you.

And we have a question from Marco Rodriguez from Stonegate Capital. Please go ahead.

Hi, good afternoon guys. Thanks for taking my questions.

Thank you, Marco.

I just wanted to get some clarification on that last question, the answers there. The incremental or the acquisition revenue that you guys recognized in Q1 '17 -- or excuse me, Q1 '18 was $1 million to $1.3 million, did I hear that correctly?

Yes.

Okay, perfect. And then I'm not sure if I caught this, but the question asking about the IP contract -- the large IP contract, can you quantify the revenue amount that was recognized in this quarter?

$500,000.

$900,000.

$900,000. Sorry about that.

Okay. And then out of curiosity here, the gross margin came in a little bit higher than I was expecting here. Was there a significant impact with the IP contract that maybe had that 68%-69% gross margin a little bit higher than was expected? And if not, if you can kind of help us understand how you're thinking about the gross margin cadence because obviously that number is significantly higher than what you guys normally report in a Q1?

Yes, IP contracts typically don't have much cost of sales attached to them. We typically give them access to our intellectual property via desk or some other means. This was not in All Access Pass type deals, so the whole amount was recognized upfront. But there's very little, typically, cost of sales associated with a straight up intellectual property deal like that. And then, plus the recognition of the highly -- of the deferred amounts that come in, that's high margin enough, that really those two items really significantly pushed our margin up for the quarter.

Yes. And the largest piece of that would be the mix of revenue with this one contract added in. So we expect -- have expected our margins to improve as we go in more and more toward All Access Pass sales. And so there was a little bit of benefit from this contract, but we expect them to be good high margins anyway.

Got you. And then you guys had talked a little bit, at least in your prepared remarks, about having some increased costs here for sales and sales-related people, especially on the education side. If you can maybe talk a little bit about -- were these additional heads or support people, and sort of what your expectations are as you go through the year here.

Sure. Hi, this is Sean. In terms of education, what we typically do is hire -- at the start of the year we hire a lot of sales people, sales assistants. We also hire a lot of coaches so we can deliver on the fourth quarter when we bring in all the new schools. So we're typically hiring around 30 or 40 people early on in the year that shows up in the first quarter, a lot of it in second quarter, so we can bring on, what we're hoping to do is, about a thousand schools this summer internationally and domestically. So I don't know if that's responsive to your question, but we have to hire now to deliver on the year later. That's why the first quarter has come in -- the lower EBITDA amount in Education.

Got you. Okay, and so most of the spending on that, that's permanent spending fixed costs, if you will, that we should be seeing going forward?

Yes, much of it. Some of it is variable, like the coaching is variable based on the number of schools that we have and maintain. Much of it is -- about half of it is fixed, about half of it is variable.

Got you. Okay, and then in that SG&A line, Paul, just last quick question here, were there any extraordinary expenses that were kind of one-time in nature in terms of spending, or is that kind of a good number from which to model going forward?

Probably the most dramatic one that had the biggest impact on the quarter was last year we took around a $1 million credit. We didn't take it. We had to take it as we adjusted the fair value of a contingent earn-out liability. So we were forced to push a credit through as we reduced that liability there, was almost $1 million. This year, in particular, we've had a $176,000 increase to a fair value. That created a $1.2 million difference between last year and this year in our SG&A. But right now it looks, as far as like oddities in the current year as far as a run rate, I don't know that there are any unusual items that would cause the run rate to be significantly different from Q1 than in the other quarters.

I don't either.

And Marco, just maybe in terms of background for others who may have the question -- actually there's been several questions on the impact of this one contract. So I probably should've given more background on it, because we wouldn't have thought that was very much of a factor. Because I think the main thing, on slide 29, is that in the Enterprise Division sales grew $7.7 million for the quarter. We would've had revenue from this client in the quarter, a normal thing anyway. And so the incremental impact of this one client might've been a little on that, but I think main story here is that we sold -- all of our intellectual property has very high margins. So these All Access Pass sales, by their very nature, had very high gross margins. And so that's -- was different. And so the difference in gross margin that was generated, as you can see the year-over-year change in gross margin of $7.5 million, there was of course some positive contribution from that contract. But it's not a material factor in the overall performance of the Enterprise business, so…

Got it. Appreciate your guys' time.

Thanks.

And we have a question from Kevin Liu from B. Riley FBR. Please go ahead.

Hi. Good afternoon.

Hi, Kevin.

First question I wanted to ask was just in terms of some of the longer duration contracts you're signing up, are those largely from customers who have already been on All Access Pass, and are now renewing with the increased populations, et cetera? Or is it also a function of going out and trying to secure new sales at longer durations.

Yes, most of it is upon renewal, even though we'd love to sell multiple-year contracts upfront, and do have some of them. The vast majority of those are sold. Paul, I don't know if you want to give some color or commentary on that?

Yes, it's exactly right, Kevin. We're seeing an increase overall of multiyear agreement. The majority of the increase is coming from those who are renewing after their first year once they've had a chance to -- a lot of organizations they apply the All Access Pass for a couple two or three hundred users in their population, because we've identified with them some job they're trying to get done. And then the benefit for us and for them is that we get in there and start working with them within the first 30 days of them holding that pass to try to identify adjacent populations and additional stakeholders. And so, over the course of that first contract year we're uncovering more opportunity with them inside that organization. So that by the time we get to renewal there's more need to identify, and there's the basis for a larger path expansion at the time of that renewal. So I think we're probably always going to see clients ready to go multiyear more at renewal time, although our sales people are starting to figure out how to sell multiyear deals at the time of the first sale as well.

Got it, that's helpful. And then just on the education practice, Bob, you mentioned a little bit annoying for the some of the onsite delivery days. Was that something that just started recently or has that been kind of a contributing factor going back further. And how much in revenues would've been recognized if you were still charging à la carte.

Sean?

Sure. No, this is new. We just switched it last year. So it's really - is hitting this year for the first time -- this is the first, first quarter this is hitting us. And we would have probably done another $1.5 million in revenue, give or take, of onsite days that were put into the membership subscription package which are now recognized over $1.12 million. So I would say about in that range.

Thank you. Okay, it's all I had for now, and congrats on the --

And it would be about the same for the second quarter as well, about the same amount.

Thanks, Kevin.

And we have a question from Patrick Retzer from Retzer Capital. Please go ahead.

Good afternoon gentlemen.

Hi, Pat.

So, congratulations on a great quarter. Clearly you've hit it out of the park on all the metrics, so thank you for that. And you're presentation was excellent so, again, we appreciate that. The one thing you haven't touched on that I saw, I've long been a fan of your consistent stock buybacks as a way to shrink the market cap as all the other metrics grow. And obviously you had a short window because of the calendar and your fiscal year on buying back stock. But could you talk about if you bought any back in the fiscal fourth quarter, and what your outlook is on that going forward.

Sure. Thanks, Pat. Steve, do you want to?

Sure. I think our strategy is the same as we've talked about for quite some time, is that as we would use excess cash to buy stock, and we even, as you know, a year or so ago, went into our credit line a little bit to do a tender offer. So we still have the same strategy of buying back stock, and we plan to do that in this particular quarter. Like you say, it was a small window. And we are using a fairly significant amount of cash related to the development of our ERP system, our new portal, and the localization of our content. So we were using enough cash that we did not buy in the open market this quarter, but we did however spent about $2 million in the equivalent of buying shares allowing individuals to net exercise on stock awards. So you will see in the cash flow statement when you look at it that we used $2 million this quarter, but weren't really as aggressive as we might, as we have been in the past, and not as aggressive as we might be in the future, based upon the thing we have going on right now that are using cash.

Okay, I appreciate that. And keep up the good work.

Thanks, Pat very much.

And we have a question from Samir Patel from Askeladden Capital. Please go ahead.

Hey, guys. Any color on how renewal rates are tracking for All Access Pass?

Yes, I think we continue to say that our revenue retention has been north of 90%, and it continues to -- we'll continue at that level. To give an official thing, I guess once a year, we audit quality, but in terms of the -- it's obviously more than that when you include these multiyear contracts, but I am just saying on an annually recurring revenue basis, we feel good about the continued revenue retention rate. We are doing a lot in that regard of course. We made the investments, sort of being reflected here and implementation specialist. In the fourth quarter we had this huge numbers of passes to renew, and that gave us some challenges in terms of getting all of them renewed in time, that we feel good about now with -- where we are, and we think we can continue north of 90% on revenue retention.

Got you. And as far as the content licensing that you had discussed a few quarters ago, any updates there, or is there anything that you are continuing to look at, any other add-on services like Robert Gregory or Jonah that you are looking to add, or are you kind of steady state there?

No, we -- in terms of services, we are trying to build out the services, which Robert Gregory relating to the acquisition and some other add-on services because our clients are finding plenty of ways and needs that they have in addition to our normal delivery. On the content acquisitions, we are continuing to work on licenses of content that we expect in the next few months to be announced and a couple of other significant licensing deal.

Great. And as far as slide 22 and slide 27, where you sort of talking about the long-term outlook for the business, can you just give me some color on what would lead to one scenario versus the other? I mean, do you think it's mostly driven by retention rate, it's mostly driven by this ramp of you buying partners, I mean what do you think drives either of those scenarios?

Yes, I mean the key metrics that we kind of in the middle of that, if we could retain -- we retain at least 90% of our revenue. So, $25 billion to $30 billion of new passes a year, and add-on services of around 25% of the total pass revenue that would put you kind of in the middle of that, you know, between those two points, and we have -- we believe those are things, we ought to do, but I think those are the key drivers of it. And so, we had independent efforts on each of those three. Paul, I don't know if you want to give you any other context, but those are the three factors that drive it.

Yes I agree with Bob. For us doing, all three of those and increasingly figuring out how to go, more new passes we can sell obviously, the more there is in those future years we need to renew and the larger the base is and that's [technical difficulty]

Yes.

Got it.

And then, Samir, the other thing which you have a good handle on, I know is the number. One of the other inflections that is less obvious, but it's helping drive the inflection is that we have all these sales people we already hired, who are in the middle of their ramp. And during the ramp period, their growth tends to be a little faster, but half of our client partners are still in one stage of the ramp or another, which is accelerated growth. And that can help drive it up. And addition of new sales people also, which we expect during this year to be back up into the mid-20s, if not higher, in additions of new client partners. So I think combination of those factors retain the business you have, adding on services, adding new passes, just on the productivity of the existing sales forces as they ramp up and adding new sales people to it. I think the other thing will effect, you know, have an impact on that growth rate also is the ability for China and Japan to begin selling All Access Pass this spring. And that would again help to build the foundation going forward.

Got you. And as far as incremental margins, it seems to me like you actually would have seen something close to 40% incremental adjusted EBIDTA margin this quarter, if not for the growth investment. I know part of that was due to the intellectual property license and a couple of those other factors you mentioned, but in general do you still feel confident about the 3% plus incremental adjusted EBIDTA?

Yes, I think that's our target to be around 30% incremental EBIDTA margin on revenue growth.

Great, thanks.

Thanks so much.

And we have a question from Travis Wiedower from Wiedower Capital. Please go ahead.

Hey guys, thanks for taking my question.

Thanks, Travis. Thank you.

You guys had historically been a very high tax payer. So I would love to hear some comments on the tax reform, especially with respect to what you expect your effective rate to be going forward, and if that lower rate effects any of our future investments or anything like that?

Well, as you know, we are in the middle of that evaluation right now, and we expect an improved tax rate to -- effective rate this year or maybe 28%, 29% compared to the 40%, 41% we might otherwise expect. And that's a blended rate for this year since the transition to the new taxes midyear. And so, our statutory rate, we think right now would be in the 21% range. We don't know exactly how that converts to an effective rate. We are in the middle of that analysis now, but it will be positive to us and low 20% rate somewhere. And yes, that will effect what we do, since we are a company that generates cash already and have a better tax rate then we might buy another share.

Okay. So, it sounds like, after I noted this year has a little bit of blended factor in there, so maybe 2019 looking forward is probably in the low to mid 20s of effective tax rate, is kind of what you are expecting?

That's what I think right now. And as you know, and would imagine, we are in the middle of that analysis right now. So, I can't declare that as a final answer, but that's what we are seeing, yes.

Okay. Well, that's all I have. I appreciate it and congrats on a good quarter.

Thanks very much. Thanks for your good questions.

And we have a question from John Lewis from Osmium. Please go ahead.

Hey, guys.

Hey, John.

Fantastic results. And your presentation is an A+. So thank you for such a great presentation today.

Thanks very much.

Just a couple of quick questions; you said that in the coming months without tipping your hand, you think you would possibly add new content license partners. Would that be an existing categories or new categories?

That's a great question. I think we are trying -- we got -- today of course we have three basic categories of content. One is around individual effectiveness -- individual and personnel effectiveness. The second is in leadership and leadership development. And the third is the things that connect the two. Connect those capabilities to outcomes, like our execution practice et cetera. I think we will be doing -- we will be making development investments in the third, you know, in terms of the connecting capabilities to results, we will be doing some development, new content development in that regard. We'll be introducing a new course that we've had developed, it will be launched at the end of this month in the leadership area. And then the major focus for us though is in leadership. These new license contracts will likely to be primarily in the leadership area where we are already strong and would like to fill in some holes.

Got it. I had a little connectivity issue, you might have covered this, but if not, could you give color on what the expectations for client partners are for ramp rates on All Access Pass, like, what do you -- now that this model has gained more traction, what is the expectation -- and ramp rate for different years for your client partners, but for a client partner that's been with you for five years, what is the expectation in terms of number of seats sold per year?

Yes. Paul, do you want to take that? Thanks, John.

Yes. That's great question. So taking an example of client partners that's been with us five years, their new seats that are going to sell are going to come from two categories or three categories. Really one will be expansion of existing passes that they sold in the last couple of years. The second would be selling to a brand new logo, that's been -- it's assigned to them has not yet purchased the pass. And then the third would be converting somebody from one of our older channels or old facilitator channel or old onsite channel over to the All Access Pass as a way of doing business with us. And so, we are expecting that each client partner and somewhat to sell much more than this, but they're going to sell a couple hundred thousand of that, of that new subscription business a year on top of the renewals, and the other expansion that they would otherwise have. And of course, an example of client partners that's been here five or six years, need to sell lot more of that just looking at their goal. So we are moving them aggressively in that direction. We are doing a lot of training and development right now helping them. As we talked in the last call, it's a bit of a different sale, it's a different procurement process, where I think learned our way through that over the past couple of years, and we have pretty high expectations for each of our client partners. And so far, they have done a great job of growing into those.

That's helpful. Just a little more clarification, so basically what you're saying is if I'm a client partner and you had the old model, you could kind of go to an install base and sell three million box or two million box worth of product a year or services a year with 90% renewal rates, you expect them to go out and actually penetrate a much deeper level of the market in the each successive year, is that right?

We do. We do exactly to retain what they had sold in the prior years at least 90%. And then go out and continue to penetrate further. Now for those that have been around little bit of time, what's happening in their business to sell to a degree, which Bob and Steve had talked about on this call and their prior calls is they are cannibalizing their existing revenue you know, because we haven't converted all of that old business yet, but we are very much in the mode of not just kind of camping and living on the business we have. They have got aggressive growth goals to go find new logos and sign-up new clients.

Okay, that's helpful. My last question is this just you said you're going to release the new All Access Pass in, I think 16 countries, is that all in Q calendar year of Q1?

No, it will be in calendar Q3 I believe, right, at this point. So it will be starting in April. In April, we will be -- all the countries in the world basically will be able to start selling All Access Pass. It will take them a while to get up to speed. And of course, we will get it all loaded in. But the launch will be in the third quarter. And then of course it will continue as those people ramp up. So, it will -- it will take years, but starting this year.

Yes, right. So it will be Q2 calendar year?

Yes.

Q2 calendar year.

I think you asked it correctly, I was just thinking fiscal calendar, you're right.

Got it. Okay, great, very helpful. Yes, tremendous work, thank you very much and good luck.

Thanks, John.

And we have a question from Samir Patel from Askeladden Capital. Please go ahead.

Yes, just to go back to slides 22 and 27, I was trying to bridge you cash flow number. And it looks to me like you've already burdened that with your capital expenditures. So that's basically unlevered free cash flow before interest and before tax, right? So to get from that cash flow number to free cash flow and basically just have to subtract interest and then burden that with whatever tax rate I think is appropriate?

Yes, I think that's right.

Okay. There is no other - so I mean, other than like restructuring or any sort of other one-time items, I mean that's your unlevered free tax free cash flow?

Yes, that would include, like you said, any of those unusual items or acquisitions, or those kinds of things, but yes, I agree with what you said.

Okay, just wanted to make sure. Thanks, Steve.

Thank you.

And we have no further questions at this time. I'll like to turn the call over to Mr. Bob Whitman for closing remarks.

Great. I just want to thank everyone for being on the call today, particularly thank each of you for your help, advice, and guidance through this process. And we feel like you know, for us this is a really exciting time, I think because as I said, it's exciting for our customers. When you recognize that more than 300 of our passes, we decided it was valuable enough for them in the fourth quarter to say that multiyear extended term agreements. That was an exciting thing for us. We tested it kind of in that quarter. But we will be doing that going forward. So I think for our associates, it's really an exciting time to be doing such great work, and doing so much more -- those are kinds of things people wanted to do here and do - to have these engagements for people calling up and saying, "We have got a new problem. Can you come and help me save it up, or solve it?" And we think our shareholders have been doing a little long suffering during the year, during the transition, but we have been growing. But we expect to continue to execute and to meet our guidance for year. We appreciate your support, and look forward to talking soon. Thanks.

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