Franklin Covey - Earnings Call - Q3 2019
June 27, 2019
Transcript
Speaker 0
Welcome to the Q3 twenty nineteen Franklin Covey Earnings Conference Call. My name is Daryl and I'll be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. During the question and answer session, if you have a question, please press star then one on your touch tone phone.
Please note that this conference is being recorded. I will now turn the call over to Mr. Derek Hatch. Mr. Hatch, you may begin.
Speaker 1
Thank you, Daryl. On behalf of the management of Franklin Covey, I would like to welcome everyone to our conference call this afternoon. Before we begin, I'd like to remind everybody 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 product 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 ks and other periodic reports filed with the Securities and Exchange Commission. Many of these conditions are beyond our influence or control, 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 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 current 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 Bob Whitman, our Chairman and Chief Executive Officer. Bob? Derek, thanks so much.
Speaker 2
Good afternoon everyone. We really appreciate you joining us today. Hope your summers are off to a good start. Those of you who live in places that are having summer, most of the country is not. We're really pleased with our third quarter results.
Pleased that they were strong and better than expected. Building on our robust year to date performance, we're on a great trajectory to achieve significant growth in adjusted EBITDA and cash flow in fiscal twenty nineteen. And we believe also establish the foundation for a very strong fiscal twenty twenty and in the coming years beyond. Specifically, as you can see in slide three, we've said that we expect to grow reported adjusted EBITDA in constant currency from 11,900,000.0 in fiscal twenty eighteen to between 18 and 22,000,000 in fiscal twenty nineteen, which represents 50 to 85% growth. And then to grow adjusted EBITDA to between 26 and 31,000,000 in fiscal twenty twenty, and between 35 and 40,000,000 in fiscal twenty one.
We've also talked about the sum of increased adjusted EBITDA plus the change in deferred getting in the range of 30 to 34 this year, the range of 38 to 42 next year, and 47 to 52 the following year. And importantly, net cash generated we expect to really, which is a very close cousin to cash flow from operating activities, to very closely track reported adjusted EBITDA and again be between eighteen and twenty two this year and 26 to 31 next year and 35 to 40 in fiscal twenty twenty one. So we have high expectations and our strong third quarter and year to date performance has moved us rapidly up the mountain toward meeting these objectives and has reinforced four key takeaways in the business that I'd like to just touch on. They're in slide four. First takeaway is that the better than expected results in the third quarter were broad based, both as to operation as well as across almost all the lines in the income statement, showing growth in sales, higher gross margins, lower operating SG and A as a percentage of sales, and much higher adjusted EBITDA and cash flow.
The combination of these factors drove a 45% flow through of increases in revenue to increases in adjusted EBITDA and an even higher flow through to increases in cash flow. Second takeaway is that these results continue to be driven by significant growth in our subscription and related sales business, and by the strategic and structural strength of our subscription based business model. We're selling new subscriptions and retaining substantially all of the subscription and related revenue we contract. This is creating high lifetime customer value, significantly increasing our visibility into future revenue. It's also strategically and structurally durable because we're solving important problems and people are buying passes, paying upfront, signing multi year agreements.
And so that continued strong. In the third quarter subscription and related sales grew 27% year over year. And year to date we're up 30%. Our total number of paying subscribers grew 34% compared to the same period last year. And in addition our key subscription metrics continue to place in the company of some of the very top subscription businesses.
Third takeaway is again, maybe an emphasis again on the flow through. The subscription models, high recurring revenue, strong and expanding gross margins, relatively fixed central costs, and low capital intensity are driving really compelling economics and flow through. This again is reflected in the high flow through of increases in revenue to increases in adjusted EBITDA and cash flow. And finally, takeaway four, these great metrics are creating compelling sales force expansion economics. These combination of factors is making it so our payback period for an investment in a new client partner is only about a year.
And with the huge headroom we have for sales force growth, we're really taking advantage of that opportunity. So far this year we've added 13 net new client partners through the third quarter. We've added a few since then. That brought our total through the end of the third quarter to $2.27. And we expect to add at least seven additional new client partners by the end of the fourth quarter for a net addition of at least 20 net for the year.
So with those takeaways let's take a deeper look into our third quarter results. As you can see, in the third quarter our revenue growth was strong and broad based. As you can see in slide six, revenue grew 11% in the third quarter. It's grown 10.5% year to date and 10% for the latest twelve months. Adjusted for changes in foreign exchange rates, revenue actually grew 12.3 in the third quarter and 11.7% year to date, with strong growth in both the enterprise and education divisions.
Our balance of billed and unbilled deferred revenue, all related to subscription sales, grew 28% in the quarter to 63,700,000.0. That's an increase of $14,100,000 compared to last year's third quarter. Our balance of billed deferred revenue grew 16% to $39,900,000 $40,000,000 compared to last year's third quarter. And our balance of unbilled deferred revenue grew 58 compared to last year's third quarter to $23,700,000 It's worth noting that in addition to this large and increasing balance of deferred revenue, we also have $11,000,000 in contractual annual minimum royalty payments for our international licensee partners, which further adds to our large and growing balance of annually recurring revenue. Our total contracted revenue grew 5% in the quarter, 6.5% year to date, and 4.5% for the latest twelve months after absorbing more than $2,000,000 of impact from foreign exchange and from the delay of the government contract.
In actuality the contracted revenue in the Enterprise Division was substantially higher than this and so it was in the Education Division that we were down some. But that really was reflective of some large contracts that were signed last year that repeated this year but where certain terms of the contract don't allow us to put those on as multi year agreements even though they are multi year agreements because they have some rights to modify those don't appear as unbilled deferred now. Our profitability and cash flow metrics also increased significantly. As you can see in slide seven, gross profit grew 13.6% in the quarter, has grown 11.2% year to date and 11.7% in the latest twelve months. Gross margin percent improved 163 basis points to 70.8.
This has resulted from accelerated growth in subscription and related sales. Our operating SG and A as a percentage of sales is better, it's down. It improved two sixty nine basis points in the third quarter, coming in at 65.3% compared to sixty eight percent in last year's third quarter. Year to date, we're three seventy basis points better in terms of operating SG and A relative to sales. The result's been of course a significant increase in adjusted EBITDA and cash flow.
Adjusted EBITDA increased $2,500,000 in the quarter to $3,100,000 from $600,000 in last year's third quarter. Adjusted for changes in foreign exchange rates, adjusted EBITDA actually increased $2,800,000 in the third quarter to $3,400,000 Year to date through the third quarter adjusted EBITDA in constant currency increased 8,100,000.0 compared to only half a million dollars year to date through the third quarter last year. So up again $7,600,000 through the third quarter. And for the latest twelve months in constant currency adjusted EBITDA increased 70.9 to $19,500,000 compared to $11,400,000 in adjusted EBITDA for the same period last year. Finally, net cash flow provided by operating activities, as you can see in slide 37 in the appendix, increased 18,600,000.0.
That's an increase of 10,000,000 or 116% compared to 8,600,000.0 through last year's third quarter. So overall we felt really good about the performance of the company, its broad based nature both as to division, geography, delivery modality, etcetera, also as it relates to the lines on the income statement and the cash flow statement. Just looking at our segment results, I'll start with a review of the results for the Enterprise Division just touching on some of the headlines there. As you can see on slide eight, the Enterprise Division which accounted for approximately 75% of our total revenue in the third quarter, our revenue growth was broad based with strong growth throughout The US and Canada and in each of our international direct offices. Revenue in our licensee division was down slightly to last year, reflecting the impact of foreign exchange and the conversion of the German licensee to a direct office in this last year.
It also recognizes that they're in the process of learning to sell All Access Pass and doing a good job, but there's some transition for them even though it doesn't affect our results because they pay us based on their invoice revenue. As you can see on slide eight, the Enterprise division revenue grew 8.8% in the quarter and has grown 9.8% year to date, and 11.4% for the latest twelve months. Adjusted for changes in foreign exchange, revenue grew 10.4% in the third quarter and has grown 11.2% year to date. Our balance of billed and unbilled deferred revenue in the Enterprise division grew 34% in the third quarter to $55,300,000 with our balance of billed deferred revenue increasing 16.2% to $32,300,000 and our balance of unbilled deferred revenue increasing 71% to $23,000,000 establishing the foundation for strong future growth as we sign these multi year agreements that don't actually show up on our balance sheet but are contractual and are there and will move into billed and then into recognized revenue as they mature. Contracted revenue grew 7.1% in the third quarter and 9.5% year to date, 6% for the latest twelve months.
And again this is not in constant currency which would have made it 100 basis points or so higher. We had 26% growth in contracted AEP and related sales. Just touching on the Enterprise Division's profitability on the next slide, slide nine. Gross profit increased 10.6% in the third quarter, 10% year to date, and 13.2% in the latest twelve months. Gross margin increased 117 basis points during the third quarter to 74.3%.
That occurred even with strong growth in sales of All Access Pass add on support services, which have a slightly lower margin. The operating SG and A as a percentage of sales improved two fifty six basis points, coming in at just 61% compared to 63.5% in last year's third quarter. And that ratio of operating SG and A to sales improved two ninety three basis points year to date. Finally, EBITDA in the Enterprise division increased to $5,800,000 in the third quarter, representing growth of 51% compared to last year's third quarter. This reflected a flow through of incremental revenue to incremental adjusted EBITDA of 56%.
In constant currency, adjusted EBITDA increased actually to $6,100,000 which was growth of 59%. Year to date, through the third quarter adjusted EBITDA in the Enterprise division increased to $14,800,000 that's 46.3% growth compared to $10,100,000 year to date last year. Again adjusted for foreign exchange adjusted EBITDA year to date increased actually to 15,600,000.0 or growth of 54%. Finally, for the latest twelve months adjusted EBITDA has grown 46% to 23,000,000, that's $7,300,000 of growth compared to the same period last year. Adjusted for foreign exchange it grew 51% to 24,000,000, which is growth of 51%.
So the momentum in the Enterprise division continues to be very strong. We expect to generate a significant amount of growth in invoiced and contracted revenue in the fourth quarter, which establishes a strong foundation for accelerated growth in fiscal twenty twenty as all of that deferred revenue, primarily deferred revenue goes onto our balance sheet and is known to be, will for sure be recognized next year. Quickly touching on the education division, which represented 22% of our total revenue in the quarter. Revenue growth was strong, growing 20.1% in the quarter. It has grown 13.5% year to date.
Revenue growth for the latest twelve months was 5.7%, but you'll remember that that was reduced last year by the impact of the expiration of a large multi year education foundation contract in last year's third quarter. Excluding the impact of this large contract, latest twelve month revenue growth would have been 16.6%. Adjusted for changes in foreign exchange revenue grew 20.4% in the third quarter and 14.2% year to date. Our balance of deferred revenue in the Education Division grew 13.6% in the third quarter. Again, the profitability in the Education Division was good and strong, strong improvements.
Gross profit increased 24.5% in the third quarter, has grown 16% year to date and 6.3% for the latest twelve months. The latest twelve months figure again reflecting the expiration of the large foundation contract last year. Gross margin has improved to 61.7%, which is up two eighteen basis points over last year's third quarter. They've done a great job on the operating SG and A as a percentage of sales, improving five ninety four basis points for the quarter coming in at 63.4% compared to 69.3% in last year's third quarter, and it's improved 500 basis points year to date. Finally, their adjusted EBITDA increased 700,000 to negative 200,000 compared to negative 900,000 in last year's third quarter.
As you know, substantially all the profitability of the Education Division occurs in our fiscal fourth quarter. Year to date through the third quarter adjusted EBITDA in Education Division is negative 1.4 is an improvement of 1,500,000 compared to last year. So really feel very good about the staging of the Education business being up while they're generating also lots of pipeline and contractual revenue for the fourth quarter. So that was a long discussion on the results, that'll take you through point one, the other points faster. Takeaway two is that the strong results are being driven by the growth in our subscription business.
We mentioned, growth in All Pass and related sales continued to be very strong in the third quarter and year to date. As you can see in slide 13, all access pass and related sales in the third quarter grew 26% to $20,400,000 Year to date all access pass and related has increased to 36% and that same metric for the latest twelve months is up 40%. The balance of deferred revenue in the Enterprise Division grew 34% year over year in the third quarter. And the number of All Access Pass subscribers reached 406,000 at the end of the third quarter, which is an increase of 104,000 or 34% compared to our 303,000 paid subscribers one year ago. Importantly, not only are we growing, but we're also growing in a way that is durable and sustainable and has some metrics that are very comparable to those of the best subscription companies.
Shown on slide 14, some of these metrics include annual revenue retention of more than 90%, add on services rate of more than 45%, which is highly correlated with high customer retention and expansion, a total revenue retention, which includes year over year same client subscription and services revenue of just over 100%. Relatively large initial purchase price which reflects the relatively large size of the population for which All Access Pass is typically purchased and this establishes the foundation for strong unit economics. Our customer acquisition costs relative to initial purchase price is less than one to one. So that plus the fact that you can ramp up salespeople and pay for them in a year gives a very strong reason to pursue the expansion of the sales force. Then the expectation that we will achieve $100,000,000 in annual recurring revenue somewhere between our fourth and fifth year is four to five years ahead of when many of the companies who have achieved that have done so.
And as I mentioned we also have this other contractual recurring revenue of the minimum royalty payments from our licensee business. So the combination of these things we think is great that we can grow and we can grow in a way that is durable quality and reflects the fact that our customers are really getting enormous value from the All Access Pass and the things they're doing. The fact that when they renew they're both expanding, often times extending the term of their contract shows they're getting real value. In many cases some of these clients might face headwinds in their particular industry or whatever they're choosing to consolidate and give us a higher and higher share of their business. And the value proposition is very compelling.
To increase this client impact we are committed to consistently adding content and capabilities to the All Access Pass. As you can see on slide 16 we've consistently added content and new capabilities. We added 1,200 micro learning articles which are being added to all the time with the acquisition of Jhana and these articles were pushed out to leaders in our client populations weekly. We added broad coaching capabilities with the acquisition of Robert Gregory Group and created four new major courses that are now offered in all modalities, live and digital. In this continuing theme of expanding into content categories that we think are very powerful, we're really pleased to announce that we've just signed an exclusive agreement with Liz Wiseman, the renowned author of the bestselling book Multipliers and one of the most sought after speakers and teachers on leadership.
Liz is a researcher and executive advisor who teaches leadership to executives around the world and has been listed on the Thinkers50 ranking and named one of the top 10 leadership thinkers in the world. Wiseman has conducted significant research in the field of leadership and collective intelligence, and Liz writes for the Harvard Business Review, Fortune, and a variety of other business and leadership journals. We've entered into an initial term ten year agreement, which can be expanded multiple times beyond that. And we'll be developing together a powerful premier leadership development solution based on multipliers to be included in Franklin Covey's All Access Pass. We are really excited about this new partnership and are thrilled to be partners with Liz and with the entire Weisman Group.
We'll be sending out a press release providing more information on this new partnership tomorrow morning. So we continue to build the strategic durability by identifying those big intractable problems that are based in scaled and lasting change in human behavior. We also have structural durability that's driven by the fact that All Access Pass purchasers contract and pay for their subscription at least a full year in advance. And second, as shown in slide 17, an increasing percentage of pass holders are entering into multi year contracts. For the latest twelve months 29% of pass holder organizations entered into multi year contracts, up from 15% a year ago.
Illustrated in slide 18, our goal is to simultaneously achieve the combination of top tier growth in subscription and related sales. Strong growth there to be in the top tier of the economic and customer metrics that we reviewed. And also top tier rates of growth in adjusted EBITDA and cash flow. That's a rare thing to be hitting on all three of them. We believe that we are and that we can continue to do so.
And for us achieving the intersection of these three factors reinforces this prospect of creating significant increases in value for our shareholders and for our clients. A bullet point on takeaway three, which is that the model's high recurring revenue, strong gross margins, and relatively fixed central costs, and low capital intensity is driving compelling economics. As you can see in slide 20, the flow through of incremental revenue to increases in adjusted EBITDA, which is in other words how much the growth in revenue actually gets to the adjusted EBITDA line, has been very strong. For the third quarter, 45% year to date, 44% in the latest twelve months, 35% of the incremental revenue has flowed through the increases in EBITDA. And actually the cash flow has grown a bit faster than that.
As we've noted, the final takeaway is that the subscription metrics create compelling sales force growth economics. We've reported several times on the big opportunity we have there. But the fact that you can invest in a client new client partner who over a period of years, you can see on slide 22, over the first five years gets to $1,300,000 of revenue, generating very high gross margin revenue, fully pays for herself or himself in the first year, combined with customer acquisition cost that also is less than one:one, gives really compelling economics. We are taking advantage of that. As we mentioned, we have added 13 net new client partners through the third quarter.
We've added a few since then toward our expectation that we'll meet at least the 20 net new client partners that we said we would at the start of the year by the end of the summer. Over the next three years we expect to add at least 75 net new client partners to our base of two thirty four. So in conclusion, again, the takeaways, I know you've already gotten, but on slide 23. Broad based results in the third quarter that were higher than expected, that have established the foundation for and already put us in the that kind of growth, we've already grown by the amount we expect it to for the year in our guidance. That this is being driven by the continued strength of the subscription related sales model.
The high flow through that we forecast we're grateful it is happening and we expect to achieve very high rates of growth in both EBITDA and cash flow this year and in coming years. And that we have a great unit expansion with Salesforce which we're taking full advantage of with our new sales school, with our five recruiters, and with many other things we're doing to make sure we take advantage of this. We appreciate your support. We really appreciate the efforts of our approximately 1,000 associates throughout the world. We're really excited about our opportunities and about the trajectory we're on to achieve significant growth this year and in the years ahead.
I would just say it's an exciting and great time to be at Franklin Covey. I think it's an exciting time to be a client of Franklin Covey. Hopefully it's also a good time, an exciting time to be an owner at Franklin Covey. So with that I'll now turn the time over to Steve Young, our CFO, to review our outlook and guidance for the balance of the year. Steve?
Speaker 3
Okay, thank you Bob. Good afternoon everyone. Our specific guidance for fiscal twenty nineteen as you know was that in constant currency adjusted EBITDA would increase from $11,900,000 in fiscal twenty eighteen to a range of between $18,000,000 and $22,000,000 in FY 2019, representing a year over year growth of between 5085%. We reaffirm this guidance. We're really pleased that in constant currency adjusted EBITDA, as Bob said, has increased $7,600,000 year to date through the third quarter.
We are experiencing very strong momentum in the business. As a result, we expect to retain this $7,600,000 of year to date adjusted EBITDA growth and even add a bit to it in the fourth quarter, putting our full year adjusted EBITDA essentially right in the middle of our guidance range of 18,000,000 to $22,000,000 representing year over year growth in adjusted EBITDA of approximately 65% to 68%. Specifically, we expect year over year adjusted EBITDA to increase by up to $500,000 in the fourth quarter. And this in spite of the fact that almost all of our growth in invoice revenue in the fourth quarter is expected to be subscription sales whose revenue will be recognized over time but whose cost for marketing or for hiring new client partners as you know will be expensed in the fourth quarter. And a second reason that the adoption of the new Topic six zero six accounting standard will cost us approximately $1,300,000 of adjusted EBITDA in the fourth quarter this year compared to our fourth quarter of last year.
So to conclude, we're really excited about our results year to date by the expected strength of the fourth quarter and by the significant momentum of the business overall. As a result of this momentum and our strong business model, we not only expect to achieve our guidance for the year but establish a foundation for very strong results in the future. So thank you, Bob.
Speaker 2
Thanks Steve. At this point let's open it for questions. I'll ask our operator to open the line. Thanks.
Speaker 0
And I'm standing by for questions. We do have a question from Alex Paris. Go ahead with your question, Alex.
Speaker 4
This is Chris Howe sitting in for Alex. Good afternoon, everyone.
Speaker 2
Hey, Chris. How are you?
Speaker 4
I'm good. Sorting through my thoughts and notes here.
Speaker 5
You've mentioned
Speaker 4
previously about the multiyear contracts trending to 50% over time. And on the last call, I believe you mentioned a seven year contract. As we think of the length of these contracts, can you characterize or break down the mix that you're seeing as you push forward these efforts to accrue more multiyear contracts over time?
Speaker 2
Sure, thanks. I'll ask Paul Walker to talk to you.
Speaker 6
Hi, Chris.
Speaker 7
Yes, so
Speaker 6
as we mentioned, in the last twelve months, multiyear contracts have increased to now 29% of our contracts are multiyear. And of course, we're interested in having each one of those be for as many years as possible. And you remember accurately the one we talked about last time that was up to seven years. We're seeing a number of these multiyear contracts. They're not just for two years now, but are increasingly becoming three year contracts.
Not sure that clients will do how many clients will do seven years. We'll try for that. But but we are we're really pleased with the momentum. You saw on that slide that Bob showed a minute ago, it was 1% of our contracts two years ago, 15%, and now it's up to 29%, and we continue to to work that. I think what happens is is one, our Salesforce becomes more comfortable with positioning that right out of the gates, and two, as we're now into our second and third and approaching fourth year renewal cycles of some of these clients, we're now so embedded with them that it makes a lot of sense.
The things we're talking about, the journeys we're on with them just will have a multiyear aspect to them. And so it makes sense for the client to to save a little bit by going multiyear and and just to to to enter into that longer term commitment with us. So we expect that to keep growing.
Speaker 4
Okay. That's great. And then some more questions here. You mentioned the rep last time that's solely targeting multiyear agreements. As you move forward in this transition of the sales force, is that their main focus now?
Or is there still are there still other people on the sales force that are not focused on multiyear agreements? Or they're focused on both, I should say.
Speaker 6
I'll I'll stay with that. This is Paul again. So so our Salesforce is exclusively focused first of all, it's important to note, they're exclusively focused on selling all access paths in the enterprise division. So that so all we sell is the all access path and the related services that go along with it. There are some some of our client partners that still have a bit of traditional business that either they're still trying to convert over or those clients will just stay traditional clients of ours.
Essentially all of the time and energy and effort is on selling All Access Pass. Within that context, we attempt to position multi year every time we can. And and there are some clients that if it's their first time becoming a client of ours, that that the timing is not right for them to make that kind of commitment. They'll they'll try this out for a year, and they might come back at their first renewal period. And at that point, they might go multi year with us.
But But yes, everybody's selling All Access Pass and we are trying to position multi year everywhere we can.
Speaker 2
Chris, just one other note. This is Bob. The nature of the problems we're helping clients solve when they really get into it, as Paul mentioned, they recognize that if they're going to try to transform and get lasting behavioral change in the way that their sales force engages clients, say at a major consulting firm or a major technology firm, they recognize that both the journey of getting all the salespeople across that and then maintaining that with coaching and ongoing tools, this is going be a multi year journey. It's a journey that's worth it because they know what the payback is going to be. If you're trying to get 190,000 frontline employees to do better and do something better or different every day so it'll drive guest satisfaction, that's an initiative that they're going to be on forever.
And you always have new frontline people. You need to keep it going. And so the very nature of what we do use for multiyear contracts is just as Paul said, in the initial year they don't know the extent to which they're going to be engaged in these big journeys. Once they get engaged, it's a very straightforward thing to say, well, look, You gotta match the contract term to what you're trying to get done, and you can save a little in the way during the way. So
Speaker 4
Thank you for the color. I I have many questions here, but one more, if
Speaker 6
I may. Sure.
Speaker 4
As you continue to move towards 2021 and you talked about the higher levels of net cash that are going to be generated, with this additional cash and as you see more of this deferred revenue being recognized, how do you anticipate allocating this cash to investments, repurchases and or acquisitions? And in regard to Jonah and Robert Gregory, are there others that present viable candidates for integration into Franklin Covey?
Speaker 2
Thanks. Our priorities for the utilization cash are kind of in this order. First of all, is investing in the recurring needs of the existing business. Just the ongoing investment in keeping all the content fresh, our portals and everything that go on. And that's the first priority.
That's well within our budget to do that. But it's an ongoing investment we make every year. The second is the ability to take steps that would grow the business, whether it's new content, could be an add on acquisition, it could be the acceleration right now in the growth of the sales force, which takes some additional capital. And those things all have such a very high payback when you get a 100% return in the first year, as we said, hiring a new salesperson or whatever. That's our second utilization.
The third is that we have utilized a lot of the excess cash flow beyond those two for years in repurchasing shares. Some have asked why we haven't been active in repurchasing shares in the last quarters. And really, if we haven't if we're not active repurchasing shares in a quarter, it's due to one of three things. Either one, we're making additional investments in the business, which last year we did. We made incremental investments in our new ERP system, in our portal acquisitions and so forth.
We made substantial cash acquisitions. So one would be that, that we just had unusual requirements in the business. That has not historically been the case. We historically spent about 4% of our revenue in innovation and product development. With the All Access Pass we've moved that up now to 7% a year.
But we usually live within that budget. But if we're not buying it could be that we're investing buying stock it's because we're investing in other parts of the business. The second is that it may be the time of year where your cash in our late part of our fiscal year, because our fourth quarter is so generally significant in terms of revenue, and particularly so in education, We invest a lot of money in working capital to fund all those sales in the fourth quarter. Usually, so sometimes it's just that we don't have a lot of excess cash if we're not buying. A third could be honestly, that we may be involved in something or having discussions about something which could be material to the business and significant enough that we're precluded from buying.
But otherwise, anytime we think we can earn at least a 20% IRR by investing in our stock, which we have continued to believe is what we can do, we do that. And we expect in this coming year that we'll have the cash available and the inclination and expectation of doing so. Is that helpful?
Speaker 4
Yes, it is. I have more, but I'll jump back in
Speaker 2
the queue. Okay. Thanks.
Speaker 4
Thank you for taking my questions.
Speaker 2
We're happy. We look forward to talking to you if you'd like to get those other questions answered. Thanks.
Speaker 0
And our next question comes from Tim McHugh. Tim, you can go ahead with your question.
Speaker 2
Hi, Tim.
Speaker 8
Good afternoon. It's actually, Trevor Romeo on for Tim.
Speaker 2
Hi, Trevor. How are you?
Speaker 8
I'm well. How about yourself?
Speaker 2
Great, thanks.
Speaker 8
Yes. So first question here. So part of your growth strategy involves growing the client partner headcount. Just wanted to ask, you know, in the current labor market, how difficult is it for you to find qualified people for those roles? And then along with that, how is your retention trending among the client partner group?
Speaker 2
Great. I'm going ask Todd Davis who heads our people services and who has these five recruitment professionals working with them every day. Todd, would you respond to that?
Speaker 9
Yeah, thanks. Pleased to join you. So it's a great question. It's part of the key strategy. So we have, as Bob mentioned, we have a very seasoned recruiting staff, particularly for our industry.
And so while to your point the labor market is certainly becoming more challenging, we have found, quite frankly, with the All Access Pass model, more than before, while they're not knocking at the door, we're finding much more interest from seasoned salespeople client partners as we call them who are interested in our company for two primary reasons. There are others, but the two primary reasons are the the subscription based model where they can actually go in and and and have the the the business model so they can actually make a difference. We can make a difference within the client organization. And then also, and then also, I just lost my train of thought. The two reasons are the model and then the investment that Bob was talking about.
Just the significant investment and not not talking ill of any of our competitors or that, but they're so pleased to be with an organization that is making the financial investment in our offerings and in our solutions. Those are the two that come top of mind as we're talking to the candidates and interviewing quite frankly day, this recruiting team is pulling together some phenomenal candidates. So yes, has become more difficult and we're finding with the direction that the company's headed, we are becoming more attractive for those salespeople that are in our industry.
Speaker 2
Paul, on the retention question, do you wanna address that? Yeah.
Speaker 6
So so we we have we think we have pretty pretty good retention quite good retention, actually, especially given where the labor market is right now. And there's a lot of reasons to to to join other companies. We have long tenure here. Frank and Covey, fact, when people join us and they come to our sales academies, we run this five week sales academy. Two of the weeks are in person here in Salt Lake at our headquarters.
That's something we've been doing this year that's making a tremendous difference. So people come in and they do a tour around our campus and they get to know some of their peers out there, their fellow client partners. And one of the common refrains is you you have people that have been here a long time. And and they say that in a really good way and we feel like that is a really good thing. And so we're we do everything we can to retain them, especially the ones we want to retain.
We feel good about where we are there. And as Todd mentioned, we're hiring a lot of great people right now.
Speaker 2
And I think just in terms of specific metrics, we need to hire about 31 client partners to retain 20 over time. And so, you know, and that's feel like that's a very good retention rate in a business that is heavily commissioned sales where they have to go out and win. And and that, you know, that that third that you lose happens over time. But we're grateful also that our client partners that we do retain are ramping according to and a little bit ahead of the schedule that we've established for them. We keep adding new schools and tools and marketing efforts and other things to help them succeed.
And I think we've got a great group of people who've been here for many, many, many years. And We were meeting not long ago where we went through some of our senior salespeople and some of our top selling people, all of whom had been here more than twelve years. We have good retention. Once you get through the ramp, you tend never to leave. Thanks.
Okay,
Speaker 8
great. That's very helpful. And then second question, you had some nice gross margin improvement come through on a year over year basis this quarter. I know you hadn't necessarily seen that in the past couple of quarters despite pretty strong revenue growth. Could you just kind of talk through the drivers of the gross margin improvement other than revenue growth that helped this quarter?
Speaker 2
Yes. I mean, the first factor is just mix. So as we have more and more subscription revenue as a percentage, we'll get that. It was offset in the first couple of quarters this year somewhat by we had such a significant expansion in our services revenue, our addition of services, which we think is important, moving that up to now 47% on top, it helped down the gross margin expansion a little bit. Given the same mix of services and subscriptions, you'll tend to have some, just the mix shift change will add to the margins.
I think that's the primary thing. We also have had annual price increases for the All Access Pass. And that, most of that flows through to the increment. While it doesn't apply to the entire population because people can avoid it if they'll sign multi year agreements or they can do it by signing up, expanding their population or whatever else. And we want them to do those things.
We give them those incentives because our focus is on we want revenue per client to grow. And if we give up a little bit on the revenue per seat to get revenue per client that's something that's in our favor. But beyond that I think it's primarily that there is some price increase for all new sales and for anybody who doesn't take advantage of those, so a combination of that and the mix shift continues to nudge the gross margin upward, offset partially by certain increases in service sales. And so any given quarter, you might, you know, be flat or whatever. We don't expect to go backwards on this.
Speaker 8
Okay. Great. That's all I had for now. So thank you guys very
Speaker 2
much for your Great questions.
Speaker 0
Our next question comes from Jeff Martin. Jeff, you can go ahead with your question.
Speaker 7
Thanks. Good afternoon, guys.
Speaker 2
Hi, Jeff.
Speaker 7
Wanted to touch on the international license partners and also the international offices. Specifically, I wondered how the direct office in China has fared, if that's growing nicely. And then on the international license side specifically, are they all selling all access pass? Where are they in that process? And do you expect some growth acceleration there?
Speaker 2
I'd like Paul to respond to that.
Speaker 6
Sure. Hi, Jeff. I'll start with the international direct offices. They had, as Bob mentioned a few minutes ago, really a nice Q3. Every office was up in the third quarter.
All of the offices are doing well for the year, and we expect that they'll continue to do well in the fourth quarter. As you know, in our English speaking offices, so in The UK and Australia, they've been selling All Access Pass now as long as we have here in The US. And the the majority of their business is now All Access Pass. They're seeing very similar retention metrics, add on services metrics, multi year metrics, etcetera. China China is actually doing very well also.
They had a great quarter. They are not yet selling All Access Pass. They will start in the fall. We've been working our technology team's been working, doing a great job getting a portal stood up inside China. We do service some clients in China, so we're able to sell global deals and and and service clients in China.
But really to do this in a big way in China, we need to have our All Access Pass portal and everything in China to provide good, consistent, steady access for people there. So China's doing well, and All Access Pass will start in the fall. Japan has just come online in the last few months now with All Access Pass. They've sold some, that that business is starting to grow for them. And so we expect that they'll follow a similar trajectory as we have in our English speaking countries.
And then as you know, earlier this year, we we assume the license in Germany, Switzerland, and Austria. And they're selling All Access Pass as well. They got on board as our licensee partners did a little over a year ago. And that business had a nice quarter also. It's now being led and managed out of The UK by our leader there.
So we feel really good about international direct. Half those offices are selling All Access Pass almost exclusively, the other in China and Japan are coming online. The licensees are actually doing pretty well as well. They're up a little bit for the year. They'll be up for the year when it's all said and done.
They were a little bit off, as Bob mentioned, in the third quarter, primarily due to foreign exchange and the conversion of Germany becoming a direct office. And they were down you know, they're still in the middle of this conversion themselves. So we we were about a year late in supporting them with the All Access Pass. And so this is kind of their their first full year, if you will, selling it. Actually, they're doing they're doing quite well.
We think it'll be a good driver of growth for them. They still just pay us, of course, royalties on their sales. But theoretically, this will this should help them drive their business more quickly than they have in the past just like it it is for us, and that should translate into higher royalties for us. Just of note, we had one of our partners last year, about this time, sold a a thousand person pass, and they just got the renewal on it late last week. And so that's that's kind of because that's an exciting thing to see.
Same play happening in our direct operations, translating and happening just the exact same way in our licensee operations, we you know, they'll continue to get better and better better at as well.
Speaker 7
Okay. That's helpful. Thanks. I wanted to ask, as it pertains to client partner additions, what's the balance of mix in terms of ads in North America versus international markets?
Speaker 6
It's about sixtyforty, 60 US, 40 outside The US. I think that's an opportunity where we will, should, and will get more aggressive in our international offices. You know, we've got China now and and that that now that having been part of in Germany as well, we've got some big economies there that are now that we've got them in and they're they're part of our direct operations, China now for a few years has been in Germany just recently, and we get those businesses running exactly how we run them in the other parts of the world where we're direct. There's an opportunity to add a lot of headcount there, and I think we will. But but for this upcoming year, the mix is about sixty forty in what we expect to hire and and probably will be fifty fifty for quite a while.
We got we got a lot of headroom everywhere.
Speaker 2
We think also, Jeff, at this point, one of the strongest assets we have as a company, most important parts of the company, is the leadership group we have, and particularly those who had these 16 offices or areas of the world in our direct offices. We had our quarterly leadership meeting two weeks ago. And this is a group of seasoned people who on average have been with us sixteen years who manage their 10 to $15,000,000 responsibility in the world. And this is an impressive great group. When you look at the four metrics for which they're responsible, every one of them is living within the minimum acceptable level.
Others have specialties where they're on the high end. But this is a group of people who knows how to run a team and we'll be able to add, you know, these new client partners are being added to those teams now. We've also put some other new roles which are kind of player coaches that are carrying a quota but also helping to do this. So I think we're better positioned now than we've ever been to be able to feel really confident about adding a lot of new client partners in the coming years because each of them can take one or two a year and that allows you to grow quite rapidly. That's a big important that's a real importance.
Speaker 7
Okay. Great. And then my last question is around new content and how quickly that becomes a revenue growth driver. And it makes a lot of sense as you're bundling everything into one path that additional content is going to have a lot more value more quickly than under the old model. I was just curious, as you bring on new content, what kind of ramp do you expect to see out of that versus what you've historically had under the old model?
Speaker 2
Yeah, under the old model of course we were able to look specifically to a piece of content and know exactly the revenue it generated because we sold it separately as you know. Now when it enters as part of the All Access Pass, it's really the value proposition that is the total ecosystem that we have. So the primary ways in which we see impact are one, we may have already had high retention. We already do have high retention. So it's hard to say that it went up a lot.
But where it comes is that there are new jobs to be done, new impact journeys this allows us to have that allow us to go deeper into an organization. And so if we pick the right content areas and we pick the right problems, we've seen, for example, Jhana. The usage of Jhana is across the system. About two thirds of our All Access Pass holders utilize it. And when they utilize it, they utilize it frequently.
It's really pervasive. And so we can see that usage. Our coaching business has gone up a lot. We had something new like this content from this partnership with Liz Wiseman. We expect it to be reflected, one, our retention rates will stay high and maybe expand.
We'll be able to continue to do price increases that will allow us to do things. Third, people will sign more multi year agreements because that's one of the things behind the moving toward 50% is they'll be on impact journeys that we know they want to be on. And we have the content and solutions to do it. So a combination of those factors. We do it within a specific budget, but we don't look specifically to the economics of that other than that's part of our 7% spend to add new content.
But we're very precise about doing so on jobs that we know need to be done thinking it will affect the whole ecosystem.
Speaker 7
Is That's that helpful. I appreciate it. Thanks guys.
Speaker 2
Thanks Jeff.
Speaker 0
And our next question comes from Marco Rodriguez. Marco you can go ahead with your question.
Speaker 10
Good afternoon guys. Hey thanks for taking my questions.
Speaker 2
Thank you.
Speaker 10
Most of my questions have been asked and answered. So I just have a couple of real quick I guess housekeeping items. In terms of your guidance specifically on the CapEx and Cap D spend for fiscal twenty nineteen. It looks like those numbers kind of have come down here since the last guidance. Can you just talk a little bit about that?
Speaker 3
Yes. A lot of our spend on CapEx and Cap D is down in this quarter and year to date, just representing when capitalized projects have been completed and when certain CapEx projects have been completed. So that isn't the fundamental change in the amount that we Marco that we plan to spend in those areas. We've just had less spending year to date than we thought we would have, which means that we'll make up a little bit of that in the fourth quarter perhaps and going into next year. That's one reason this year is down.
And then the second reason, as Bob mentioned, is in the past we're doing a large ERP project and doing the initial development of our portal, both of which were capitalized. So we had higher spending in the past on those items. We have an amount that we plan to spend each year going forward and it just so happens that the timing of projects makes our year to date this year a little bit lower than would be a standard run rate.
Speaker 10
Okay. I think I understand what you're saying there. But I was mostly referring to the fact that the guidance range for the full fiscal year seemed to have come down versus the prior guidance in Q2 and the beginning of the year. So that's just timing?
Speaker 3
Yes. Our view of what we're going to spend on CapEx and Cap D is unchanged from what we talked about. But as you know, when we have these large capitalized development projects, etcetera, point at which those are capitalized is when we are spending obviously those monies on the capitalization and that there are swings in that development. But the swings don't in this case don't represent a fundamental change in how much we plan to spend in capitalized development or capitalized spending on the portal.
Speaker 10
Got it. And then in terms of the balance sheet, just the cash you guys have on there right now, just taking a look at what you've reported here year to date for cash flow from ops and what you had spent here for CapEx and Cap D, cash is pretty flat from the beginning of the year. So I'm assuming you've been paying down, per your credit agreements. Has anything else been accelerated to pay that down? Or are there other expenditures that are happening on cash flow from financing that has kind of kept things level there?
Speaker 1
No. Not necessarily. A fair amount of our cash on our balance sheet is tied up in some foreign operations that we can't repatriate. And we're, otherwise, we would have paid the line of credit down even farther than we have. And stuff, we're always looking to repatriate cash as quickly as we can to put it to use to reduce interest expense and to use things use it for things in investing activities or financing activities so that we don't have to borrow against our line.
But a lot of our cash and the reason why the cash is really kinda flat even though we have paid paid down our line significantly since the beginning of the year and made our term loan payments is just simply because we can't repatriate it fast enough with local laws and their local needs to pay annual income tax payments and things like that.
Speaker 10
Got it. And then last quick question. Just maybe, Bob, if you can talk a little bit about an M and A landscape, any sort of things you might be looking at in terms of specialized content or things you think that might be somewhat interesting going forward?
Speaker 2
Yeah, thanks Marco. For us, we always have a lot of what we put in the business development initiatives. For us, fewer of them are acquisitions of companies than they are possibly acquisitions of content or capabilities. In some cases, as you know, with John and Robert Gregory we did. Most of what we're looking at is either expanding some kind of a capability that won't be a big branded thing.
It'll just add a new capability like microlearning with Jonna or assessments or things like that. So many of the things we're looking at are things that will increase the usage of All Access Pass or expand the ways in which people can get value from All Access Pass. And so a number of those will probably be just license agreements where it won't turn out to be a real M and A activity. It will be in the form of licenses. Occasionally we'll do something big in the content area like with Liz Wiseman.
That's not a major effort on our part, we have a couple of those kinds of things that we're working on. More of the things are capabilities, things that allow usage, to increase usage. But we do have Boyd Roberts who's here in the room and heads our business development effort. He's got lots on his plate of things that we're looking at, but we again think most of these will follow within our normal 7% spend, 7% of revenue spend each year, and that's how they're really organized to do it. Is that responsive?
Speaker 10
Got it. Yeah, understood. Thanks a lot, guys. Appreciate your time.
Speaker 2
Thank you, Marco.
Speaker 0
And our next question comes from Zach Cummins. Zach, you can go ahead with your question.
Speaker 11
Great. Thanks. Good afternoon.
Speaker 2
Hi, Zach.
Speaker 11
So in terms of the Education segment, can you talk about what really drove the strength here in Q3? And what are really the expectations for growth in that segment as we move into kind of FY 2020 and beyond?
Speaker 2
Yes, I'll turn the time over to Shaun Kevey and let's move on.
Speaker 5
Yes, sure. Hi, how are doing, Zach? Yeah, so third quarter we had a really strong third quarter. Some of it was we had a lot of new contracts we signed with schools. This year we're confident we feel good about our fourth quarter because we feel like we're going to bring in about 50 to 100 new schools over last year.
That shows up. Some of that shows up in the third quarter. These are new schools that we got signed in the third. Our retention also is stronger than last year. We think our retention's always been pretty high in the about 86% to 90% range.
And we feel like this year will be at least that good, if not one to two percentage points better. That showed up in the third quarter as well. We also did a lot of material sales. So when Leader in Me schools sign on, we have additional materials they can buy. And we did a really good job of that in the third quarter.
And these are like leadership guides for students. And they were extremely high margin as well, and that helped the gross margin in the third quarter. So that came in stronger than expected, and we put a real focus on that. We've updated these over the last year, and we're finding that schools like these a lot. A combination of those things helped in the third.
And then again, the fourth, we feel pretty good about it because we've got a stronger pipeline so far. The invoice revenue and final stage pipeline revenue for the fourth quarter were up over last year by about one and a half million already. Again, new schools, 50 to 100. So far we're about 46 over last year, the same point. And then the retention.
We also have a lot of This year we feel good as well because we have a lot of late opportunities that we didn't have last year. We still have some big deals out there that could close or not close or go into next year, which will either help this year or next year. Yeah, so for the fourth we feel good about it. Long term, we feel really good about our prospects because for a few reasons. One is the district opportunity selling, that's one of our big areas of focus next year is to sell more to districts and less direct to schools.
In the past it's been more of the opposite. But we're getting good with districts and we're only in 115 of the 15,000 in The US, 15,000 districts. So we feel like that's a big opportunity. The international opportunity continues to do really well. We just opened up in China.
I was there last month. We have nine partners. We've licensed pretty much the whole country. We have 30 Leader in Me schools. We think we could get to a couple 100 next year.
That's gonna help us a lot. The international opportunity is really strong. Higher education opportunity continues to grow. That helped our gross margin as well. If it becomes a higher percentage of our total sales, it's higher margin.
We feel the growth opportunity there is really good. And I think finally just the thing that's I guess most compelling about the future opportunity in education is just the impact we find we're making. We've got great research showing the efficacy of Leader in Me and how it's increasing attendance and decreasing behavior problems and helping test scores in different areas. And, that's the key. That's the word-of-mouth in that spreads really well.
It helps increase, you know, our penetration of districts and so forth. So kind of a long answer to your question, but that's how we're feeling right now.
Speaker 11
No. I really appreciate all the color. Thank you for that. And just one more question for me. Bob, I guess in terms of attachment rates for add on services with your All Access Pass offering, do you anticipate that this is something that can be sustainable as customers start to go into year two, three or four of their contracts?
Are these add on services something that are going to be recurring in nature and something that these clients will consider buying on an annual basis?
Speaker 2
Yeah, think that's been one of the most important factors, and I didn't probably emphasize it enough, is one of the most encouraging things is that our same client retention rate of revenue including their PASS their services were retaining just over 100% of that. And so I think what's happening is people actually the services increase as people get down the road on this because they recognize they're entrusting us and our content with more challenging and important problems. Ones where they really do need to get the behavior change. So yeah, don't And know, Paula, if you want add anything to that. But the services, we believe are very durable.
We don't know how high up is, but at least at the current levels we think on a rolling twelve month basis we should be able to maintain what we're doing and that as clients get into their third and fourth and fifth years, it's because they're working on things that are important. So to an earlier question about the M and A pipeline, I think that Marco asked, Some of the things we're doing is not M and A, but it's adding new services and designing new services to exactly meet the needs of people. So when they go through and train a bunch of managers there's coaching built in to the process. So I think right now it's been very durable and expanding. And to the extent we're good at selling and servicing clients, we think it will continue to be strong and expanding.
Speaker 11
Great, that's really helpful. Well, thanks again for that and best of luck as you head into Q4.
Speaker 2
Thanks very much. Zach, other questions?
Speaker 0
And we have no more questions at this time.
Speaker 2
Okay, great. Well, we'll just conclude and thank each of you for joining today. Again, as I mentioned, this is a very exciting time to be part of Franklin Covey. It's a time when really to see the impact that we're having in clients and see the recognition of that by revenue retention, new sales, etcetera. It's really encouraging.
We look forward to talking with many of you in the coming days and weeks. If you have additional questions happy to respond. And we look forward to a strong fourth quarter and to getting a chance to have this formal discussion in November. Thank you so much.
Speaker 0
And thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect. Hi.