FRANKLIN COVEY CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. | NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Franklin Covey Co. (hereafter referred to as we, us, our, or the Company) is a global company specializing in organizational performance improvement. We help individuals and organizations achieve results that require a change in human behavior and our mission is to "enable greatness in people and organizations everywhere." Our expertise is in the following seven areas: Leadership, Execution, Productivity, Trust, Sales Performance, Customer Loyalty, and Educational improvement. Our offerings are described in further detail at www.franklincovey.com and elsewhere in this report. We have some of the best-known offerings in the training industry, including a suite of individual-effectiveness and leadership-development training and products based on the best-selling books, The 7 Habits of Highly Effective People, The Speed of Trust, The Leader In Me, and The Four Disciplines of Execution, and proprietary content in the areas of Execution, Sales Performance, Productivity, Customer Loyalty, and Educational improvement. Through our organizational research and curriculum development efforts, we seek to consistently create, develop, and introduce new services and products that help individuals and organizations achieve their own great purposes.
Fiscal Year
Our fiscal year ends on August 31 of each year. During fiscal 2017, our Board of Directors approved a change to our fiscal quarter ending dates from a modified 52/53-week calendar in which quarterly periods ended on different dates from year to year, to the last day of the calendar month in each quarter. Beginning with the second quarter of fiscal 2017, our fiscal quarters now end on the last day of November, February, and May. Unless otherwise noted, references to fiscal years apply to the 12 months ended August 31 of the specified year.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and our wholly-owned subsidiaries, which consist of Franklin Development Corp., and our offices in Japan, China, the United Kingdom, and Australia. Intercompany balances and transactions are eliminated in consolidation.
Pervasiveness of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Cash and Cash Equivalents
Some of our cash is deposited with financial institutions located throughout the United States of America and at banks in foreign countries where we operate subsidiary offices, and at times may exceed insured limits. We consider all highly liquid debt instruments with a maturity date of three months or less to be cash equivalents. We did not hold a significant amount of investments that would be considered cash equivalent instruments at August 31, 2017 or 2016. Of our $8.9 million in cash at August 31, 2017, $7.3 million was held outside the U.S. by our foreign subsidiaries. We routinely repatriate cash from our foreign subsidiaries and consider cash generated from foreign activities a key component of our overall liquidity position.
Inventories
Inventories are stated at the lower of cost or market, cost being determined using the first-in, first-out method. Elements of cost in inventories generally include raw materials and direct labor. Cash flows from the sale of inventory are included in cash flows provided by operating activities in our consolidated statements of cash flows. Our inventories are comprised primarily of training materials, books, and related accessories, and consisted of the following (in thousands):
| | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
Finished goods | | $ | 3,306 | | | $ | 5,002 | |
Raw materials | | | 47 | | | | 40 | |
| | $ | 3,353 | | | $ | 5,042 | |
Provision is made to reduce excess and obsolete inventories to their estimated net realizable value. In assessing the valuation of inventories, we make judgments regarding future demand requirements and compare these estimates with current and committed inventory levels. Inventory requirements may change based on projected customer demand, training curriculum life-cycle changes, and other factors that could affect the valuation of our inventories.
During the third quarter of fiscal 2017, we decided to exit the publishing business in Japan (Note 13) and wrote off the majority of our book inventory located in Japan, which totaled $2.1 million.
Other Current Assets
Significant components of our other current assets were as follows (in thousands):
| | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
Deferred commissions | | $ | 6,150 | | | $ | 1,664 | |
Other current assets | | | 2,217 | | | | 1,737 | |
| | $ | 8,367 | | | $ | 3,401 | |
We defer commission expense on All Access Pass and other subscription sales and recognize the commission expense with the corresponding revenue.
Property and Equipment
Property and equipment are recorded at cost. Depreciation expense, which includes depreciation on our corporate campus that is accounted for as a financing obligation (Note 6), and the amortization of assets recorded under capital lease obligations, is calculated using the straight-line method over the lesser of the expected useful life of the asset or the contracted lease period. We generally use the following depreciable lives for our major classifications of property and equipment:
Description | Useful Lives |
Buildings | 20 years |
Machinery and equipment | 5–7 years |
Computer hardware and software | 3–5 years |
Furniture, fixtures, and leasehold improvements | 5–7 years |
Our property and equipment were comprised of the following (in thousands):
| | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
Land and improvements | | $ | 1,312 | | | $ | 1,312 | |
Buildings | | | 30,044 | | | | 32,201 | |
Machinery and equipment | | | 2,119 | | | | 2,279 | |
Computer hardware and software | | | 22,647 | | | | 18,552 | |
Furniture, fixtures, and leasehold | | | | | | | | |
improvements | | | 8,319 | | | | 9,292 | |
| | | 64,441 | | | | 63,636 | |
Less accumulated depreciation | | | (44,711 | ) | | | (47,553 | ) |
| | $ | 19,730 | | | $ | 16,083 | |
Leasehold improvements are amortized over the lesser of the useful economic life of the asset or the contracted lease period. We expense costs for repairs and maintenance as incurred. Gains and losses resulting from the sale of property and equipment are recorded in operating income (loss). During fiscal 2017, we capitalized $0.1 million of interest expense in connection with the installation of our new enterprise resource planning software system and the development of our new All Access Pass portal.
Impairment of Long-Lived Assets
Long-lived tangible assets and definite-lived intangible assets are reviewed for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. We use an estimate of undiscounted future net cash flows of the assets over the remaining useful lives in determining whether the carrying value of the assets is recoverable. If the carrying values of the assets exceed the anticipated future cash flows of the assets, we recognize an impairment loss equal to the difference between the carrying values of the assets and their estimated fair values. Impairment of long-lived assets is assessed at the lowest levels for which there are identifiable cash flows that are independent from other groups of assets. The evaluation of long-lived assets requires us to use estimates of future cash flows. If forecasts and assumptions used to support the realizability of our long-lived tangible and definite-lived intangible assets change in the future, significant impairment charges could result that would adversely affect our results of operations and financial condition. For more information regarding our impaired asset charges in fiscal 2015, refer to Note 12.
Indefinite-Lived Intangible Assets and Goodwill Impairment Testing
Intangible assets that are deemed to have an indefinite life and acquired goodwill are not amortized, but rather are tested for impairment on an annual basis or more often if events or circumstances indicate that a potential impairment exists. The Covey trade name intangible asset has been deemed to have an indefinite life. This intangible asset is tested for impairment using qualitative factors or the present value of estimated royalties on trade name related revenues, which consist primarily of training seminars and work sessions, international licensee sales, and related products. Based on the fiscal 2017 evaluation of the Covey trade name, we believe the fair value of the Covey trade name substantially exceeds its carrying value. No impairment charges were recorded against the Covey trade name during the fiscal years ended August 31, 2017, 2016, or 2015.
Goodwill is recorded when the purchase price for an acquisition exceeds the estimated fair value of the net tangible and identified intangible assets acquired. During August 2017, we adopted Accounting Standards Update (ASU) 2017-04, Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment. This guidance simplifies the subsequent measurement of goodwill and eliminates the two-step goodwill impairment test. Under the new guidance, an annual or interim goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and two-step goodwill impairment test.
We tested goodwill for impairment at August 31, 2017 at the reporting unit level using a quantitative approach. The goodwill impairment testing process involves determining whether the estimated fair value of the reporting unit exceeds its respective book value. If the fair value exceeds the book value, goodwill of that reporting unit is not impaired. If the book value exceeds the fair value, an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value. The estimated fair value of each reporting unit was calculated using a combination of the income approach (discounted cash flows) and the market approach (using market multiples derived from a set of companies with comparable market characteristics).
On an interim basis, we consider whether events or circumstances are present that may lead to the determination that goodwill may be impaired. If, based on events or changing circumstances, we determine it is more likely than not that the fair value of a reporting unit does not exceed its carrying value, we would be required to test goodwill for impairment.
Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions, and determination of appropriate market comparables. We base our fair value estimates on assumptions we believe to be reasonable, but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. In addition, we make certain judgments and assumptions in allocating shared assets and liabilities to determine the carrying values for each of our reporting units. The timing and frequency of our goodwill impairment tests are based on an ongoing assessment of events and circumstances that would indicate a possible impairment. Based on the results of our goodwill impairment testing during fiscal 2017, we determined that no impairment existed at either of August 31, 2017 or 2016, as each reporting unit's estimated fair value exceeded its carrying value. We will continue to monitor our goodwill and intangible assets for impairment and conduct formal tests when impairment indicators are present. For more information regarding our intangible assets and goodwill, refer to Note 4.
Capitalized Curriculum Development Costs
During the normal course of business, we develop training courses and related materials that we sell to our clients. Capitalized curriculum development costs include certain expenditures to develop course materials such as video segments, course manuals, and other related materials. Our capitalized curriculum development spending in fiscal 2017, which totaled $6.5 million, was primarily for offerings related to the All Access Pass, The Leader In Me, our Leadership content, and for various other offerings. Generally, curriculum costs are capitalized when there is a major revision to an existing course that requires a significant re-write of the course materials or curriculum. Costs incurred to maintain existing offerings are expensed when incurred. In addition, development costs incurred in the research and development of new curriculum and software products to be sold, leased, or otherwise marketed are expensed as incurred until economic and technological feasibility has been established.
Capitalized development costs are amortized over three- to five-year useful lives, which are based on numerous factors, including expected cycles of major changes to our content. Capitalized curriculum development costs are reported as a component of other long-term assets in our consolidated balance sheets and totaled $11.6 million and $8.9 million at August 31, 2017 and 2016. Amortization of capitalized curriculum development costs is reported as a component of cost of sales in the accompanying consolidated statements of operations.
Accrued Liabilities
Significant components of our accrued liabilities were as follows (in thousands):
AUGUST 31, | | 2017 | | | 2016 | |
Accrued compensation | | $ | 10,611 | | | $ | 8,810 | |
Other accrued liabilities | | | 12,006 | | | | 8,612 | |
| | $ | 22,617 | | | $ | 17,422 | |
We reclassified approximately $4,000 of income taxes payable at August 31, 2016 to accrued liabilities.
Contingent Consideration from Business Acquisitions
Acquisitions may include contingent consideration payments based on various future financial measures related to an acquired company. Contingent consideration is required to be recognized at fair value as of the acquisition date. We estimate the fair value of these liabilities based on financial projections of the acquired company and estimated probabilities of achievement. At each reporting date, the contingent consideration liabilities are revalued to estimated fair value and changes in fair value subsequent to the acquisition date are reflected in selling, general, and administrative expense in our consolidated statements of operations, and could have a material impact on our operating results. Changes in the fair value of contingent consideration liabilities may result from changes in discount periods or rates, changes in the timing and amount of earnings estimates, and changes in probability assumptions with respect to the likelihood of achieving various payment criteria.
Foreign Currency Translation and Transactions
The functional currencies of our foreign operations are the reported local currencies. Translation adjustments result from translating our foreign subsidiaries' financial statements into United States dollars. The balance sheet accounts of our foreign subsidiaries are translated into United States dollars using the exchange rate in effect at the balance sheet date. Revenues and expenses are translated using average exchange rates for each month during the fiscal year. The resulting translation differences are recorded as a component of accumulated other comprehensive income in shareholders' equity. Foreign currency transaction losses totaled $0.2 million, $0.3 million, and $1.1 million for the fiscal years ended August 31, 2017, 2016, and 2015, respectively, and are included as a component of selling, general, and administrative expenses in our consolidated statements of operations.
Sales Taxes
We collect sales tax on qualifying transactions with customers based upon applicable sales tax rates in various jurisdictions. We account for sales taxes collected using the net method; accordingly, we do not include sales taxes in net sales reported in our consolidated statements of operations.
Revenue Recognition
We recognize revenue when: 1) persuasive evidence of an arrangement exists, 2) delivery of the product has occurred or services have been rendered, 3) the price to the customer is fixed or determinable, and 4) collectability is reasonably assured. For training and service sales, these conditions are generally met upon presentation of the training seminar or delivery of the consulting services based upon daily rates. For most of our product sales, these conditions are met upon shipment of the product to the customer. At times, our customers may request access to our intellectual property for the flexibility to print certain training materials or to have access to certain training videos and other training aids at their convenience. For intellectual property license sales, the revenue recognition conditions are generally met at the later of delivery of the content to the client or the effective date of the arrangement.
Revenue recognition for multiple-element arrangements requires judgment to determine if multiple elements exist, whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements. A deliverable constitutes a separate unit of accounting when it has standalone value to our clients. We routinely enter into arrangements that can include various combinations of multiple training offerings, consulting services, and intellectual property licenses. The
timing of delivery and performance of the elements typically varies from contract to contract. Generally, these items qualify as separate units of accounting because they have value to the customer on a standalone basis.
When the Company's training and consulting arrangements contain multiple deliverables, consideration is allocated at the inception of the arrangement to all deliverables based on their relative selling prices at the beginning of the agreement, and revenue is recognized as each offering, consulting service, or intellectual property license is delivered. We use the following selling price hierarchy to determine the fair value to be used for allocating revenue to the elements: (i) vendor-specific objective evidence of fair value (VSOE), (ii) third-party evidence (TPE), and (iii) best estimate of selling price (BESP). Generally, VSOE is based on established pricing and discounting practices for the deliverables when sold separately. In determining VSOE, we require that a substantial majority of the selling prices fall within a narrow range. When VSOE cannot be established, judgment is applied with respect to whether a selling price can be established based on TPE, which is determined based on competitor prices for similar offerings when sold separately. Our products and services normally contain a significant level of differentiation such that the comparable pricing of services with similar functionality cannot be obtained. When we are unable to establish a selling price using VSOE or TPE, BESP is used in our allocation of arrangement consideration. BESPs are established as best estimates of what the selling price would be if the deliverables were sold regularly on a stand-alone basis. Our process for determining BESPs requires judgment and considers multiple factors, such as market conditions, type of customer, geographies, stage of product lifecycle, internal costs, and gross margin objectives. These factors may vary over time depending upon the unique facts and circumstances related to each deliverable. However, we do not expect the effect of changes in the selling price or method or assumptions used to determine selling price to have a significant effect on the allocation of arrangement consideration.
Our multiple-element arrangements generally do not include performance, cancellation, termination, or refund-type provisions.
Our international strategy includes the use of licensees in countries where we do not have a wholly-owned direct office. Licensee companies are unrelated entities that have been granted a license to translate our content and offerings, adapt the content to the local culture, and sell our content in a specific country or region. Licensees are required to pay us royalties based upon a percentage of their sales to clients. We recognize royalty income each period based upon the sales information reported to us from our licensees. Licensee royalty revenues are included as a component of training sales and totaled $10.6 million, $14.4 million, and $13.7 million for the fiscal years ended August 31, 2017, 2016, and 2015. The decrease in international licensee royalties in fiscal 2017 was primarily due to the conversion of our licensee operations in China into direct offices.
Revenue is recognized as the net amount to be received after deducting estimated amounts for discounts and product returns.
Stock-Based Compensation
We record the compensation expense for all stock-based payments to employees and non-employees, including grants of stock options and the compensatory elements of our employee stock purchase plan, in our consolidated statements of operations based upon their fair values over the requisite service period. For more information on our stock-based compensation plans, refer to Note 11.
Shipping and Handling Fees and Costs
All shipping and handling fees billed to customers are recorded as a component of net sales. All costs incurred related to the shipping and handling of products are recorded in cost of sales.
Advertising Costs
Costs for advertising are expensed as incurred. Advertising costs included in selling, general, and administrative expenses totaled $6.4 million, $6.6 million, and $7.4 million for the fiscal years ended August 31, 2017, 2016, and 2015.
Income Taxes
Our income tax provision has been determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred income taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The income tax provision represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred income taxes result from differences between the financial and tax bases of our assets and liabilities and are adjusted for tax rates and tax laws when changes are enacted. A valuation allowance is provided against deferred income tax assets when it is more likely than not that all or some portion of the deferred income tax assets will not be realized. Interest and penalties related to uncertain tax positions are recognized as components of income tax benefit or expense in our consolidated statements of operations.
We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement.
We provide for income taxes, net of applicable foreign tax credits, on temporary differences in our investment in foreign subsidiaries, which consist primarily of unrepatriated earnings.
Comprehensive Income
Comprehensive income includes changes to equity accounts that were not the result of transactions with shareholders. Comprehensive income is comprised of net income or loss and other comprehensive income and loss items. Our other comprehensive income and losses generally consist of changes in the cumulative foreign currency translation adjustment, net of tax.
Accounting Pronouncements Issued and Adopted
In January 2017, the Financial Accounting Standards Board (FASB) issued ASU 2017-04, Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment. This guidance simplifies the subsequent measurement of goodwill and eliminates the two-step goodwill impairment test. Under the new guidance, an annual or interim goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value. The amendments also eliminate the
requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and two-step goodwill impairment test. The ASU is effective prospectively for fiscal years and interim periods within those years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We have elected, as permitted by the guidance, to early adopt ASU No. 2017-04 to be effective for our annual goodwill impairment testing at August 31, 2017. The adoption of this standard did not have a material effect on our consolidated goodwill balance at August 31, 2017.
Accounting Pronouncements Issued Not Yet Adopted
On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This new standard was issued in conjunction with the International Accounting Standards Board (IASB) and is designed to create a single, principles-based process by which all businesses calculate revenue. The core principle of this standard is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. The standard also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. The new standard replaces numerous individual, industry-specific revenue rules found in generally accepted accounting principles in the United States. We are required to adopt this standard on September 1, 2018, and apply the new guidance during interim periods within fiscal 2019. The new standard may be adopted using the "full retrospective" or "modified retrospective" approach. We are continuing to assess the impact of adopting ASU 2014-09 on our financial position, results of operations, and related disclosures, and we have not yet determined the method of adoption nor the full impact that the standard will have on our reported revenue or results of operations. We currently believe that the adoption of ASU No. 2014-09 will not significantly change the recognition of revenues associated with the delivery of onsite presentations and facilitator material sales. However, the recognition of revenues associated with intellectual property licenses, such as our All Access Pass, and other revenue streams may be more significantly impacted by the new standard. The Company will continue to assess the new standard along with industry trends and additional interpretive guidance, and it may adjust its implementation plan accordingly. We do not expect the adoption of ASU 2014-09 to have any impact on our operating cash flows.
In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing. The guidance in ASU 2016-10 clarifies aspects of Topic 606 related to identifying performance obligations and the licensing implementation guidance, while retaining the related core principles for those areas. The effective date and transition requirements for ASU 2016-10 are the same as the effective date and transition requirements for Topic 606 (ASU 2014-09) discussed above. As of August 31, 2017, we have not yet determined the full impact that ASU No. 2016-10 will have on our reported revenue or results of operations.
On February 25, 2016, the FASB issued ASU No. 2016-02, Leases. The new lease accounting standard is the result of a collaborative effort with the IASB (similar to the new revenue standard described above), although some differences remain between the two standards. This new standard will affect all entities that lease assets and will require lessees to recognize a lease liability and a right-of-use asset for all leases (except for short-term leases that have a duration of less than one year) as of the date on which the lessor makes the underlying asset available to the lessee. For lessors, accounting for leases is substantially the same as in prior periods. For public companies, the new lease standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for all entities. For leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, lessees and lessors must apply a modified retrospective transition approach. While we expect the adoption of this new standard will increase reported assets and liabilities, as of August 31, 2017, we have not yet determined the full impact that the adoption of ASU 2016-02 will have on our financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting. The guidance in ASU 2016-09 simplifies several aspects of the accounting for stock-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification of items on the statement of cash flows. ASU 2016-09 is effective for public companies' annual periods, including interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted subject to certain requirements, and the method of application (i.e., retrospective, modified retrospective or prospective) depends on the transaction area that is being amended. Following adoption, the primary impact on our consolidated financial statements will be the recognition of excess tax benefits in the provision for income taxes rather than additional paid-in capital, which will likely result in increased
volatility in the reported amounts of income tax benefit or expense and net income (loss). For example, during fiscal 2017, we recorded $0.2 million of excess income tax benefits to additional paid-in capital. If we would have early adopted ASU 2016-09, this amount would have been recorded as a component of our consolidated income tax benefit for fiscal 2017. As of August 31, 2017, we have not completed the full evaluation of the impact of ASU 2016-09 on our results of operations or cash flows.
Robert Gregory Partners, LLC
On May 15, 2017, we acquired the assets of Robert Gregory Partners, LLC (RGP), a Dublin, Ohio based corporate coaching firm, for $3.5 million in cash plus potential contingent consideration totaling $4.5 million. Robert Gregory Partners is a corporate coaching firm with expertise in executive coaching, transition acceleration coaching, leadership development coaching, implementation coaching, and consulting. We anticipate that RGP services and methodologies will become key offerings in our training and consulting business. The financial results of RGP have been included in our consolidated financial statements since the date of the acquisition.
The total purchase price consisted of the following (in thousands):
| | | |
Cash paid to RGP at closing | | $ | 3,500 | |
Fair value of contingent consideration | | | 1,413 | |
Total purchase price | | $ | 4,913 | |
The major classes of assets and liabilities to which we have allocated the preliminary purchase price were as follows (in thousands):
| | | |
Accounts receivable | | $ | 458 | |
Prepaid expenses | | | 136 | |
Intangible assets | | | 3,811 | |
Goodwill | | | 1,232 | |
Assets acquired | | | 5,637 | |
| | | | |
Accounts payable | | | (51 | ) |
Accrued expenses | | | (80 | ) |
Deferred revenues | | | (593 | ) |
Liabilities assumed | | | (724 | ) |
| | $ | 4,913 | |
The goodwill generated from the RGP acquisition was allocated to each of our operating segments. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of RGP's coaching methodologies into our services and offerings. All of the goodwill from the RGP acquisition is expected to be deductible for income tax purposes.
The payment of contingent consideration is based on the achievement of specified financial results and the delivery of "add-on coaching services" content that will be included in our All Access Pass offering. During the quarter ended August 31, 2017, we paid the former owners of RGP $0.5 million of the contingent consideration for delivery of the content that has been integrated into our AAP offering. Due to the timing of the $0.5 million payment for add-on coaching services, this amount was included in the investing activities section of the accompanying consolidated statement of cash flows for fiscal 2017. Refer to Note 10 for further information regarding the fair value of the contingent consideration liability resulting from the RGP acquisition.
Following are the details of the purchase price allocated to the intangible assets acquired (in thousands):
| | | | |
| | | | Weighted Average |
Description | | Amount | | Life |
Customer list | | $ | 2,249 | | 10 years |
Content | | | 461 | | 5 years |
Trade name | | | 341 | | 5 years |
Non-compete agreements | | | 328 | | 2 years |
Deferred contract revenue | | | 237 | | 2 years |
Coach relationships | | | 150 | | 10 years |
Acquired technology | | | 45 | | 3 years |
| | $ | 3,811 | | 8 years |
Our consolidated financial statements include $1.2 million of revenue and $0.4 million of income from operations, excluding amortization of intangible assets, attributable to RGP since the date of the acquisition. For the twelve months ended December 31, 2016, RGP had revenues of $3.3 million (unaudited) and operating income of $1.1 million (unaudited). The costs to acquire RGP totaled approximately $0.1 million and were expensed as components of selling, general, and administrative expense in our consolidated financial statements.
Jhana Education
On July 11, 2017, we acquired all of the outstanding stock of Jhana Education (Jhana), a San Francisco based company that specializes in the creation and dissemination of relevant, bite-sized content and learning tools for leaders and managers. We anticipate that the Jhana content and delivery methodologies acquired will become key features of our AAP offering. The purchase price was $3.5 million in cash plus up to $7.2 million of contingent consideration. The financial results of Jhana have been included in our consolidated financial statements since the date of the acquisition.
The total purchase price consisted of the following (in thousands):
| | | |
Cash paid to Jhana at closing | | $ | 3,525 | |
Fair value of contingent consideration | | | 6,052 | |
Total purchase price | | $ | 9,577 | |
The major classes of assets and liabilities to which we have allocated the preliminary purchase price were as follows (in thousands):
| | | |
Cash | | $ | 253 | |
Accounts receivable | | | 195 | |
Prepaid expenses and other current assets | | | 86 | |
Deferred tax asset | | | 3,138 | |
Intangible assets | | | 6,076 | |
Goodwill | | | 3,085 | |
Assets acquired | | | 12,833 | |
| | | | |
Accounts payable | | | (185 | ) |
Accrued expenses | | | (19 | ) |
Deferred tax liability | | | (2,257 | ) |
Deferred revenues | | | (795 | ) |
Liabilities assumed | | | (3,256 | ) |
| | $ | 9,577 | |
Following are the details of the purchase price allocated to the intangible assets acquired (in thousands):
| | | | |
| | | | Weighted Average |
Description | | Amount | | Life |
Content | | $ | 3,097 | | 5 years |
Acquired technology | | | 1,474 | | 3 years |
Customer list | | | 1,016 | | 5 years |
Trade name | | | 445 | | 5 years |
Non-compete agreements | | | 44 | | 3 years |
| | $ | 6,076 | | 5 years |
The goodwill from the Jhana acquisition was assigned to the Direct Offices, Strategic Markets, and International Licensee segments. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of Jhana's content and delivery methodologies into our services and offerings, especially in the All Access Pass. None of the goodwill from the Jhana acquisition is expected to be deductible for income tax purposes.
The first two contingent payments of $1.0 million each are expected to be paid during the first and second quarters of fiscal 2018 based on the specified measures in the acquisition agreement. The payment of the remaining $5.2 million of contingent consideration is based on Company revenues and AAP revenues over the measurement period, which ends in July 2026. Refer to Note 10 for further information regarding the fair value of contingent consideration resulting from the Jhana acquisition.
The acquisition of Jhana had an immaterial impact on our consolidated financial statements for the fiscal year ended August 31, 2017. For the year ending December 31, 2016, Jhana had revenues of $1.6 million (unaudited) and a loss before income taxes of $3.1 million (unaudited). The costs to acquire Jhana totaled approximately $0.1 million and were expensed as incurred. The acquisition costs were included in our selling, general, and administrative expenses.
Unaudited Pro Forma Information
The following are supplemental consolidated financial results of Franklin Covey Co. on an unaudited pro forma basis as if the acquisitions of RGP and Jhana had been completed on September 1, 2015 (in thousands, except per share amounts):
| | | | | | |
YEAR ENDED | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
Revenue | | $ | 187,745 | | | $ | 204,505 | |
Net income (loss) | | | (7,976 | ) | | | 4,863 | |
Diluted earnings (loss) per share | | | (0.58 | ) | | | 0.32 | |
These pro forma results were based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had we been a combined company during the periods presented, and are not necessarily indicative of our consolidated results of operations in future periods. The pro forma results include adjustments related to purchase accounting, primarily the amortization of intangible assets, interest expense, and inclusion of acquisition costs.
Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts represents our best estimate of the amount of probable credit losses in the existing accounts receivable balance, and we review the adequacy of the allowance for doubtful accounts on a
regular basis. We determine the allowance for doubtful accounts using historical write-off experience based on the age of the receivable balances and current economic conditions in general. Receivable balances past due over 90 days, which exceed a specified dollar amount, are reviewed individually for collectability. As we increase sales to governmental organizations, including school districts, and offer longer payment terms on certain contracts (which are still within our normal payment terms), our collection cycle may increase in future periods. If the risk of non-collection increases for such receivable balances, there may be additional charges to expense to increase the allowance for doubtful accounts.
We classify receivable amounts as current or long-term based on expected payment and record long-term accounts receivable at their net present value. During the fourth quarter of fiscal 2015, we became aware of financial difficulties at a contracting partner from whom we receive payment for services rendered on a large federal government contract. Subsequent to August 31, 2015 we received a $1.8 million payment from this entity and entered into discussions to convert the remaining receivable, which totaled $2.9 million, into a note receivable. Based on expected payment terms as of August 31, 2015, we reclassified this amount to other current assets and other long-term assets on our consolidated balance sheets based on expected principal payments. During fiscal 2017, the note receivable terms were extended an additional two years. This note receivable continues to bear interest at 5.0 percent per year.
Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. We do not have any off-balance sheet credit exposure related to our customers nor do we generally require collateral or other security agreements from our customers.
Activity in our allowance for doubtful accounts was comprised of the following for the periods indicated (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Beginning balance | | $ | 1,579 | | | $ | 1,333 | | | $ | 918 | |
Charged to costs and expenses | | | 1,747 | | | | 2,022 | | | | 699 | |
Deductions | | | (1,016 | ) | | | (1,776 | ) | | | (284 | ) |
Ending balance | | $ | 2,310 | | | $ | 1,579 | | | $ | 1,333 | |
Deductions on the foregoing table represent the write-off of amounts deemed uncollectible during the fiscal year presented. Recoveries of amounts previously written off were insignificant for the periods presented.
4. | INTANGIBLE ASSETS AND GOODWILL |
Intangible Assets
Our intangible assets were comprised of the following (in thousands):
| | | | | | | | | |
| | Gross Carrying | | | Accumulated | | | Net Carrying | |
AUGUST 31, 2017 | | Amount | | | Amortization | | | Amount | |
Definite-lived intangible assets: | | | | | | | | | |
License rights | | $ | 27,750 | | | $ | (17,802 | ) | | $ | 9,948 | |
Acquired content | | | 62,094 | | | | (43,864 | ) | | | 18,230 | |
Customer lists | | | 20,092 | | | | (16,935 | ) | | | 3,157 | |
Acquired technology | | | 3,568 | | | | (2,136 | ) | | | 1,432 | |
Trade names | | | 2,036 | | | | (1,163 | ) | | | 873 | |
Non-compete agreements and other | | | 758 | | | | (104 | ) | | | 654 | |
| | | 116,298 | | | | (82,004 | ) | | | 34,294 | |
Indefinite-lived intangible asset: | | | | | | | | | | | | |
Covey trade name | | | 23,000 | | | | - | | | | 23,000 | |
| | $ | 139,298 | | | $ | (82,004 | ) | | $ | 57,294 | |
| | | | | | | | | | | | |
AUGUST 31, 2016 | | | | | | | | | | | | |
Definite-lived intangible assets: | | | | | | | | | | | | |
License rights | | $ | 27,000 | | | $ | (16,790 | ) | | $ | 10,210 | |
Acquired content | | | 58,564 | | | | (42,175 | ) | | | 16,389 | |
Customer lists | | | 16,827 | | | | (16,529 | ) | | | 298 | |
Acquired technology | | | 2,049 | | | | (2,049 | ) | | | - | |
Trade names | | | 1,250 | | �� | | (951 | ) | | | 299 | |
| | | 105,690 | | | | (78,494 | ) | | | 27,196 | |
Indefinite-lived intangible asset: | | | | | | | | | | | | |
Covey trade name | | | 23,000 | | | | - | | | | 23,000 | |
| | $ | 128,690 | | | $ | (78,494 | ) | | $ | 50,196 | |
Our intangible assets are amortized over the estimated useful life of the asset. The range of remaining estimated useful lives and weighted-average amortization period over which we are amortizing the major categories of definite-lived intangible assets at August 31, 2017 were as follows:
Category of Intangible Asset
| Range of Remaining Estimated Useful Lives
| Weighted Average Original Amortization Period
|
| | |
License rights | 5 to 9 years | 30 years |
Acquired content | 2 to 9 years | 25 years |
Customer lists | 1 to 10 years | 12 years |
Acquired technology | 3 years | 3 years |
Trade names | 1 to 5 years | 5 years |
Non-compete agreements and other | 1 to 10 years | 4 years |
Our aggregate amortization expense from definite-lived intangible assets totaled $3.5 million, $3.3 million, and $3.7 million for the fiscal years ended August 31, 2017, 2016, and 2015. Amortization expense from our intangible assets over the next five years is expected to be as follows (in thousands):
| | | |
YEAR ENDING | | | |
AUGUST 31, | | | |
2018 | | $ | 5,368 | |
2019 | | | 4,790 | |
2020 | | | 4,324 | |
2021 | | | 3,809 | |
2022 | | | 3,498 | |
Goodwill
Activity in our consolidated goodwill was as follows during fiscal 2017 and 2016 (in thousands):
| | | |
Balance at August 31, 2015 | | $ | 19,903 | |
Accumulated impairments | | | - | |
Balance at August 31, 2016 | | | 19,903 | |
Acquisition of RGP (Note 2) | | | 1,232 | |
Acquisition of Jhanna (Note 2) | | | 3,085 | |
Accumulated impairments | | | - | |
Balance at August 31, 2017 | | $ | 24,220 | |
We allocated the goodwill generated from our fiscal 2017 business acquisitions to our operating segments based on their relative fair values as shown below (in thousands):
| | | | | | | | | |
| | | | | Allocated | | | | |
AUGUST 31, | | 2016 | | | Goodwill | | | 2017 | |
Direct offices | | $ | 10,790 | | | $ | 2,592 | | | $ | 13,382 | |
Strategic markets | | | 2,930 | | | | 513 | | | | 3,443 | |
Education practice | | | 2,176 | | | | 154 | | | | 2,330 | |
International licensees | | | 4,007 | | | | 1,058 | | | | 5,065 | |
| | $ | 19,903 | | | $ | 4,317 | | | $ | 24,220 | |
5. | TERM LOANS PAYABLE AND REVOLVING LINE OF CREDIT |
During fiscal 2011, we entered into an amended and restated secured credit agreement (the Restated Credit Agreement) with our existing lender. The Restated Credit Agreement provides us with a revolving line of credit facility and the ability to borrow on other instruments, such as term loans. We generally renew the Restated Credit Agreement on a regular basis to maintain the long-term availability of this credit facility.
On May 24, 2016, we entered into the Fifth Modification Agreement to the Restated Credit Agreement. The primary purposes of the Fifth Modification Agreement were to (i) obtain a term loan for $15.0 million; (ii) increase the maximum principal amount of the revolving line of credit from $30.0 million to $40.0 million; (iii) extend the maturity date of the Restated Credit Agreement from March 31, 2018 to March 31, 2019; (iv) permit the Company to convert balances outstanding from time to time under the revolving line of credit to term loans; and (v) adjust the fixed charge coverage ratio from 1.40 to 1.15.
During fiscal 2017, we entered into the Sixth, Seventh, and Eighth Modification Agreements to the Restated Credit Agreement. The Sixth Modification and Eighth Modification agreements adjusted the definition of EBITDAR in the funded debt to EBITDAR and fixed charge coverage ratios applicable to our debt covenants to include the change in deferred revenue. The Seventh Modification Agreement extended the maturity date of the Restated Credit Agreement to March 31, 2020.
In connection with these Modification Agreements obtained during fiscal 2017 and 2016, we have entered into a security agreement, repayment guaranty agreements, and a pledge and security agreement. These agreements pledge substantially all of our assets located in the United States to the lender as collateral for borrowings under the Restated Credit Agreement and subsequent amendments.
The effective interest rate on our term loans and revolving line of credit was 3.1 percent at August 31, 2017 and 2.3 percent at August 31, 2016.
Term Loans Payable
In connection with the Fifth Modification Agreement, we obtained a $15.0 million term loan and have the ability to obtain additional term loans in increments of $5.0 million up to a maximum of $40.0 million. Each additional term loan reduces the amount available to borrow on the revolving line of credit facility on a dollar-for-dollar basis. We obtained a $5.0 million term loan during each of September 2016 and August 2017. Interest on the term loans is payable monthly at LIBOR plus 1.85 percent per annum and each term loan matures in three years. Interest is payable monthly and principal payments are due and payable on the first day of each January, April, July, and October. Principal payments are equal to the original amount of each term loan divided by 16 and any remaining principal at the maturity date is immediately payable or may be rolled into a new term loan. The proceeds from each term loan may be used for general corporate purposes and each term loan may be repaid sooner than the maturity date at our discretion. The following information applies to our term loans payable at August 31, 2017 (in thousands):
| | | | | | | | | |
| | Original Principal | | | Quarterly Principal | | | Outstanding | |
Maturity Date | | Amount | | | Payment Amount | | | Principal | |
May 24, 2019 | | $ | 15,000 | | | $ | 938 | | | $ | 10,313 | |
August 29, 2019 | | | 5,000 | | | | 313 | | | | 3,750 | |
August 29, 2020 | | | 5,000 | | | | 313 | | | | 5,000 | |
| | | | | | | | | | $ | 19,063 | |
Principal payments by fiscal year through the maturity dates of the term loans are as follows (in thousands):
YEAR ENDING | | | |
AUGUST 31, | | | |
2018 | | $ | 6,250 | |
2019 | | | 10,313 | |
2020 | | | 2,500 | |
| | $ | 19,063 | |
Revolving Line of Credit
The key terms and conditions of our revolving line of credit are as follows:
· | Available Credit – The maximum available credit was $40.0 million. The amount of available credit has been reduced to $30.0 million as of August 31, 2017 by the $5.0 million term loans (as discussed above) obtained during fiscal 2017.
|
· | Maturity Date – The maturity date of the Revolving Line of Credit is March 31, 2020.
|
· | Interest Rate – The effective interest rate continues to be LIBOR plus 1.85 percent per annum and the unused credit fee on the line of credit remains 0.25 percent per annum.
|
· | Financial Covenants – The Restated Credit Agreement requires us to be in compliance with specified financial covenants, including (a) a funded debt to EBITDAR (earnings before interest, taxes, depreciation, amortization, and rental expense) ratio of less than 3.00 to 1.00; (b) a fixed charge coverage ratio greater than 1.15 to 1.0; (c) an annual limit on capital expenditures (not including capitalized curriculum development) of $8.0 million; and (d) outstanding borrowings on the Revolving Line of Credit may not exceed 150 percent of consolidated accounts receivable.
|
In the event of noncompliance with these financial covenants and other defined events of default, the lender is entitled to certain remedies, including acceleration of the repayment of any amounts outstanding on the Restated Credit Agreement. At August 31, 2017, we believe that we were in compliance with the terms and covenants applicable to the Eighth Modification Agreement. We had $4.4 million outstanding on our revolving line of credit at August 31, 2017, and had no borrowings outstanding on August 31, 2016.
In connection with the sale and leaseback of our corporate headquarters facility located in Salt Lake City, Utah, we entered into a 20-year master lease agreement with the purchaser, an unrelated private investment group. The 20-year master lease agreement also contains six five-year renewal options that will allow us to maintain our operations at the current location for up to 50 years. Although the corporate headquarters facility was sold and the Company has no legal ownership of the property, under applicable accounting guidance we were prohibited from recording the transaction as a sale since we have subleased a significant portion of the property that was sold. Accordingly, we account for the sale as a financing transaction, which requires us to continue reporting the corporate headquarters facility as an asset and to record a financing obligation for the sale price.
The financing obligation on our corporate campus was comprised of the following (in thousands):
| | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
Financing obligation payable in | | | | | | |
monthly installments of $297 at | | | | | | |
August 31, 2017, including | | | | | | |
principal and interest, with two | | | | | | |
percent annual increases | | | | | | |
(imputed interest at 7.7%), | | | | | | |
through June 2025 | | $ | 22,943 | | | $ | 24,605 | |
Less current portion | | | (1,868 | ) | | | (1,662 | ) |
Total financing obligation, | | | | | | | | |
less current portion | | $ | 21,075 | | | $ | 22,943 | |
Future principal maturities of our financing obligation were as follows at August 31, 2017 (in thousands):
| | | |
YEAR ENDING | | | |
AUGUST 31, | | | |
2018 | | $ | 1,868 | |
2019 | | | 2,092 | |
2020 | | | 2,335 | |
2021 | | | 2,600 | |
2022 | | | 2,887 | |
Thereafter | | | 11,161 | |
| | $ | 22,943 | |
Our remaining future minimum payments under the financing obligation in the initial 20-year lease term are as follows (in thousands):
YEAR ENDING | | | |
AUGUST 31, | | | |
2018 | | $ | 3,579 | |
2019 | | | 3,651 | |
2020 | | | 3,724 | |
2021 | | | 3,798 | |
2022 | | | 3,874 | |
Thereafter | | | 11,283 | |
Total future minimum financing | | | | |
obligation payments | | | 29,909 | |
Less interest | | | (8,278 | ) |
Present value of future minimum | | | | |
financing obligation payments | | $ | 21,631 | |
The $1.3 million difference between the carrying value of the financing obligation and the present value of the future minimum financing obligation payments represents the carrying value of the land sold in the financing transaction, which is not depreciated. At the conclusion of the master lease agreement, the remaining financing obligation and carrying value of the land will be offset and written off of our consolidated financial statements.
Lease Expense
In the normal course of business, we lease office space and warehouse and distribution facilities under non-cancelable operating lease agreements. We rent office space, primarily for international and domestic regional sales administration offices, in commercial office complexes that are conducive to sales and administrative operations. We also rent warehousing and distribution facilities that are designed to provide secure storage and efficient distribution of our training products, books, and accessories. These operating lease agreements often contain renewal options that may be exercised at our discretion after the completion of the base rental term. In addition, many of the rental agreements provide for regular increases to the base rental rate at specified intervals, which usually occur on an annual basis. At August 31, 2017, we had operating leases with remaining terms ranging from less than one year to approximately eight years. The following table summarizes our future minimum lease payments under operating lease agreements at August 31, 2017 (in thousands):
| | | |
YEAR ENDING | | | |
AUGUST 31, | | | |
2018 | | $ | 866 | |
2019 | | | 321 | |
2020 | | | 84 | |
2021 | | | 84 | |
2022 | | | 84 | |
Thereafter | | | 268 | |
| | $ | 1,707 | |
We recognize lease expense on a straight-line basis over the life of the lease agreement. Contingent rent expense is recognized as it is incurred and was insignificant for the periods presented. Total rent expense recorded in selling, general, and administrative expense from operating lease agreements was $1.8 million, $2.2 million, and $2.3 million for the fiscal years ended August 31, 2017, 2016, and 2015.
Lease Income
We have subleased the majority of our corporate headquarters campus located in Salt Lake City, Utah to multiple, unrelated tenants as well as to FC Organizational Products (FCOP, refer to Note 18). We recognize sublease income on a straight-line basis over the life of the sublease agreement. The cost basis of our corporate campus was $34.1 million, which had a carrying value of $7.9 million at August 31, 2017. The following future minimum lease payments due to us from our sublease agreements at August 31, 2017 include lease income of approximately $0.7 million per year from FCOP. The majority of contracted lease income after fiscal 2021 is from FCOP (in thousands):
YEAR ENDING | | | |
AUGUST 31, | | | |
2018 | | $ | 3,648 | |
2019 | | | 3,359 | |
2020 | | | 3,448 | |
2021 | | | 1,814 | |
2022 | | | 638 | |
Thereafter | | | 1,767 | |
| | $ | 14,674 | |
Sublease revenue totaled $3.6 million, $4.4 million, and $4.4 million during the fiscal years ended August 31, 2017, 2016, and 2015.
8. | COMMITMENTS AND CONTINGENCIES |
Information Systems and Warehouse Outsourcing Contract
Prior to July 2016, we had an outsourcing contract with HP Enterprise Services to provide information technology system support and product warehousing and distribution services. Effective July 1, 2016, we entered into a new warehousing services agreement with an independent warehouse and distribution company to provide product kitting, warehousing, and order fulfillment services at a facility in Des Moines, Iowa. Under the terms of the new contract, we pay a fixed charge of $18,000 per month for account management services and variable charges for other warehousing services based on specified activities, including shipping charges. The warehouse charges may be increased each year of the contract based upon changes in the Employment Cost Index. The new warehousing and distribution contract expires on June 30, 2019.
During fiscal years 2017, 2016, and 2015, we expensed $2.6 million, $3.8 million, and $4.9 million for services provided under the terms of our warehouse and distribution outsourcing contract. The total amount expensed each year under these contracts include freight charges, which are billed to the Company based upon activity. Freight charges included in the warehouse and distribution outsourcing costs totaled $1.5 million, $1.8 million, and $1.9 million during the fiscal years ended August 31, 2017, 2016, and 2015. Because of the variable component of the agreement, our payments for warehouse and distribution services may fluctuate in future periods based upon sales and levels of specified activities.
Purchase Commitments
During the normal course of business, we issue purchase orders to various vendors for products and services. At August 31, 2017, we had open purchase commitments totaling $6.6 million for products and services to be delivered primarily in fiscal 2018. The increase over prior years is primarily due to commitments for enterprise risk planning software and AAP portal development activities. Other purchase commitments for materials, supplies, and other items incidental to the ordinary conduct of business were immaterial, both individually and in aggregate, to the Company's operations at August 31, 2017.
Letters of Credit
At August 31, 2017 and 2016, we had standby letters of credit totaling $0.1 million. These letters of credit were primarily required to secure commitments for certain insurance policies and expire in January 2018. No amounts were drawn on the letters of credit at either August 31, 2017 or August 31, 2016.
Legal Matters and Loss Contingencies
We are the subject of certain legal actions, which we consider routine to our business activities. At August 31, 2017, we believe that, after consultation with legal counsel, any potential liability to us under these other actions will not materially affect our financial position, liquidity, or results of operations.
Preferred Stock
We have 14.0 million shares of preferred stock authorized for issuance. At August 31, 2017 and 2016, no shares of preferred stock were issued or outstanding.
Treasury Stock
Open Market Purchases
On January 23, 2015, our Board of Directors approved a new plan to repurchase up to $10.0 million of the Company's outstanding common stock. All previously existing common stock repurchase plans were canceled and the new common share repurchase plan does not have an expiration date. On March 27, 2015, our Board of Directors increased the aggregate value of shares of Company common stock that may be purchased under the January 2015 plan to $40.0 million so long as we have either $10.0 million in cash and cash equivalents or have access to debt financing of at least $10.0 million. Through August 31, 2017, we have purchased 1,539,828 shares of our common stock for $26.8 million under the terms of this expanded common stock repurchase plan. The actual timing, number, and value of common shares repurchased under this plan will be determined at our discretion and will depend on a number of factors, including, among others, general market and business conditions, the trading price of our common shares, and applicable legal requirements. The Company has no obligation to repurchase any common shares under the authorization, and the repurchase plan may be suspended, discontinued, or modified at any time for any reason.
The cost of common stock purchased for treasury as shown on our consolidated statement of cash flows for the year ending August 31, 2017 includes the cost of 51,156 shares that were withheld for minimum statutory taxes on stock-based compensation awards issued to participants during the fiscal 2017. The withheld shares were valued at the market price on the date the shares were distributed to participants, which totaled $0.9 million. For the fiscal years ended August 31, 2016 and 2015, we withheld 2,260 shares and 17,935 shares for minimum statutory taxes on stock-based compensation awards, which had a total value of $38,000 and $0.3 million, respectively.
Fiscal 2016 Tender Offer
On December 8, 2015, we announced that our Board of Directors approved a modified Dutch auction tender offer for up to $35.0 million in value of shares of our common stock at a price within (and including) the range of $15.50 to $17.75 per share. The tender offer commenced on December 14, 2015, and expired at 11:59 p.m. Eastern time, on January 12, 2016. The tender offer was fully subscribed and we acquired 1,971,832 shares of our common stock at $17.75 per share. Including fees to complete the tender offer, the total cost of the tendered shares was $35.3 million, which was financed by existing cash and proceeds from our revolving line of credit facility. For further information regarding the terms and conditions of this completed tender offer, refer to information in the Tender Offer Statement on Schedule TO filed with Securities and Exchange Commission on December 14, 2015 and subsequent amendments thereto.
10. | FAIR VALUE OF FINANCIAL INSTRUMENTS |
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The accounting standards related to fair value measurements include a hierarchy for information and valuations used in measuring fair value that is broken down into the following three levels based on reliability:
· | Level 1 valuations are based on quoted prices in active markets for identical instruments that the Company can access at the measurement date. |
· | Level 2 valuations are based on inputs other than quoted prices included in Level 1 that are observable for the instrument, either directly or indirectly, for substantially the full term of the asset or liability including the following: |
a. | quoted prices for similar, but not identical, instruments in active markets; |
b. | quoted prices for identical or similar instruments in markets that are not active; |
c. | inputs other than quoted prices that are observable for the instrument; or |
d. | inputs that are derived principally from or corroborated by observable market data by correlation or other means. |
· | Level 3 valuations are based on information that is unobservable and significant to the overall fair value measurement. |
The book value of our financial instruments at August 31, 2017 and 2016 approximated their fair values. The assessment of the fair values of our financial instruments is based on a variety of factors and assumptions. Accordingly, the fair values may not represent the actual values of the financial instruments that could have been realized at August 31, 2017 or 2016, or that will be realized in the future, and do not include expenses that could be incurred in an actual sale or settlement. The following methods and assumptions were used to determine the fair values of our financial instruments, none of which were held for trading or speculative purposes:
Cash, Cash Equivalents, and Accounts Receivable – The carrying amounts of cash, cash equivalents, and accounts receivable approximate their fair values due to the liquidity and short-term maturity of these instruments.
Other Assets – Our other assets, including notes receivable, were recorded at the net realizable value of estimated future cash flows from these instruments.
Debt Obligations – At August 31, 2017, our debt obligations consisted of variable-rate term notes payable and borrowings on our variable-rate revolving line of credit. The term notes payable and revolving line of credit (Note 5) are negotiated components of our Restated Credit Agreement, which is renewed on a regular basis to maintain the long-term borrowing capability of the agreement. Accordingly, the applicable interest rates on the term loans and revolving line of credit are reflective of current market conditions, and the carrying value of term loan and revolving line of credit obligations therefore approximate their fair value.
Contingent Consideration Liabilities from Business Acquisitions
We have contingent consideration liabilities resulting from our business acquisitions. We measure the fair values of the contingent consideration liabilities at each reporting date based on various valuation models as described below. Changes to the fair value of the contingent consideration liabilities are recorded as components of our selling, general, and administrative expenses in the accompanying consolidated statements of operations in the period of adjustment.
Robert Gregory Partners – On May 15, 2017, we acquired the assets of RGP (Note 2). The purchase price included contingent consideration payments to the former owners of RGP of up to $4.5 million, based on the achievement of specified levels of earnings before interest, income taxes, depreciation, and amortization expense (EBITDA) and the delivery of "add-on coaching services content" for our AAP as set forth in the purchase agreement. The specified levels of EBITDA include measures for RGP coaching services plus earnings from add-on coaching services sold through the AAP. The fair value of the contingent consideration on the acquisition date was $1.4 million, of which $0.5 was paid during the fourth quarter for the successful delivery of the add-on coaching services content. The fair value of the RGP contingent liability is estimated using a Monte Carlo simulation method, which considers numerous potential financial outcomes using estimated variables such as expected revenues, growth rates, and a discount rate. This fair value measurement is considered a Level 3 measurement because we estimate revenues and corresponding expected growth rates each period. The following range of growth rates were used to calculate the initial fair value of the contingent consideration:
| | | | | | | | | |
| | Likely | | | Minimum | | | Maximum | |
RGP growth rate - Year 1 | | | 14.8 | % | | | (12.0 | )% | | | 35.0 | % |
RGP growth rate - Year 2 | | | 10.0 | % | | | (12.0 | )% | | | 35.0 | % |
RGP growth rate - Year 3 | | | 10.0 | % | | | (12.0 | )% | | | 35.0 | % |
| | | | | | | | | | | | |
Add-on services growth rate - Year 1 | | | 60.0 | % | | | (20.0 | )% | | | 130.0 | % |
Add-on services growth rate - Year 2 | | | 50.0 | % | | | (20.0 | )% | | | 130.0 | % |
Add-on services growth rate - Year 3 | | | 40.0 | % | | | (20.0 | )% | | | 130.0 | % |
At August 31, 2017, the estimated fair value of the RGP contingent consideration was $0.9 million, which was recorded as a component of other long-term assets.
Jhana Education – On July 11, 2017, we acquired the stock of Jhana Education (Note 2). The purchase price included potential contingent consideration of $7.2 million through the measurement period, which ends in July 2026. The first two payments of $1.0 million each are payable during the first half of fiscal 2018, based on specified dates and objectives. The payment of the remaining $5.2 million is based on a percentage of consolidated Company and total AAP sales. The fair value of the contingent consideration was calculated using a probability weighted expected return methodology, which is a Level 3 measurement because we estimate projected consolidated Company and AAP sales over the measurement period. Probabilities were applied to each potential sales outcome and the resulting values were discounted using a rate that considered Jhana's weighted average cost of capital and specific risk premiums associated with the potential contingent consideration. At August 31, 2017, the fair value of the contingent consideration was $6.1 million, with $2.7 million recorded in accrued liabilities and the remaining $3.4 million recorded in other long-term liabilities.
Ninety Five 5, LLC – In fiscal 2013, we acquired Ninety Five 5, LLC (NinetyFive5). The purchase price included contingent consideration payments to the former owners up to a maximum of $8.5 million, based on cumulative EBITDA as set forth in the purchase agreement. The contingent consideration measurement period ended on August 31, 2017. During the measurement period, we reassessed the fair value of the contingent consideration liability each period using the probability weighted expected return method. This fair value measurement is considered a Level 3 measurement because we estimated projected earnings during measurement period utilizing various potential pay-out scenarios. Probabilities were applied to each potential scenario and the resulting values were discounted using a rate that considered Ninety Five 5's weighted average cost of capital as well as a specific risk premium associated with the riskiness of the contingent consideration itself, the related projections, and the overall business.
Based on achieved EBITDA results through the first half of fiscal 2016, we paid the former owners of NinetyFive5 $2.2 million in the third quarter of fiscal 2016. No further contingent consideration payments were made or are expected to be made to the former owners of NinetyFive5 since the measurement period ended on August 31, 2017. During the fiscal
years ended August 31, 2017 and 2016, the NinetyFive5 contingent consideration liability was comprised of the following activity (in thousands):
| | | |
Contingent consideration liability at August 31, 2015 | | $ | 2,565 | |
Payment of first contingent consideration award | | | (2,167 | ) |
Increase in contingent consideration liability | | | 1,538 | |
Contingent consideration liability at August 31, 2016 | | | 1,936 | |
Decrease in contingent consideration liability | | | (1,936 | ) |
Contingent consideration liability at August 31, 2017 | | $ | - | |
11.STOCK-BASED COMPENSATION PLANS
Overview
We utilize various stock-based compensation plans as integral components of our overall compensation and associate retention strategy. Our shareholders have approved various stock incentive plans that permit us to grant performance awards, unvested share awards, stock options, and employee stock purchase plan (ESPP) shares. In addition, our Board of Directors and shareholders may, from time to time, approve fully vested stock awards. The Organization and Compensation Committee of the Board of Directors (the Compensation Committee) has responsibility for the approval and oversight of our stock-based compensation plans.
On January 23, 2015, our shareholders approved the 2015 Omnibus Incentive Plan (the 2015 Plan), which authorized an additional 1.0 million shares of common stock for issuance to employees and members of the Board of Directors as stock-based payments. We believe that the 2015 Plan will provide sufficient available shares to grant awards over the next several years, based on current expectations of grants in future periods. A more detailed description of the 2015 Plan is set forth in the Company's Proxy Statement filed with the SEC on December 22, 2014. At August 31, 2017, the 2015 Plan had approximately 494,000 shares available for future grants.
On May 31, 2017, our Board of Directors approved the 2017 Employee Stock Purchase Plan (the 2017 ESPP Plan). The 2017 ESPP Plan authorized a new tranche of 1,000,000 shares to be issued to ESPP participants and modernized some aspects of the ESPP (e.g., allowing for electronic communication with participants), but all other key terms and conditions of the 2017 ESPP Plan remain consistent with the prior plan (e.g., discount percentage, purchase date, etc.). We intend to submit the 2017 ESPP Plan to a vote of shareholders at our next annual shareholders' meeting, which is expected to be held in January 2018. At August 31, 2017, the 2017 ESPP Plan had approximately 987,000 shares remaining for purchase by plan participants.
The total compensation expense of our stock-based compensation plans was as follows (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Performance awards | | $ | 2,902 | | | $ | 2,492 | | | $ | 1,890 | |
Unvested stock awards | | | 500 | | | | 450 | | | | 400 | |
Fully vested stock awards | | | 135 | | | | 60 | | | | 125 | |
Compensation cost of the ESPP | | | 121 | | | | 119 | | | | 121 | |
| | $ | 3,658 | | | $ | 3,121 | | | $ | 2,536 | |
The compensation expense of our stock-based compensation plans was included in selling, general, and administrative expenses in the accompanying consolidated statements of operations, and no stock-based compensation was capitalized during fiscal years 2017, 2016, or 2015. During fiscal 2017, we issued 217,581 shares of our common stock from shares held in treasury for various stock-based compensation plans. Certain of our stock-based compensation plans allow recipients to have shares withheld from the award to pay minimum statutory tax liabilities. We withheld 51,156 shares of our common stock for minimum statutory taxes during fiscal 2017.
The following is a description of our stock-based compensation plans.
Performance Awards
Due to the significant change in our business resulting sales of the All Access Pass, on October 18, 2016, the Compensation Committee approved a modification to the fiscal 2012 through fiscal 2016 performance awards to include the change in deferred revenue, less certain costs, in adjusted earnings before interest, taxes, depreciation, and amortization (Adjusted EBITDA) in the vesting calculations. Our share price on October 18, 2016 was less than the share prices used to recognize stock-based compensation expense on the fiscal 2012 through fiscal 2015 performance awards and no incremental stock-based compensation expense was recognized from this modification for those awards. The incremental compensation expense recorded in fiscal 2017 as a result of this modification for the fiscal 2016 LTIP award was approximately $0.6 million.
In fiscal 2015, the Compensation Committee approved a modification to exclude the effects of foreign exchange on the measurement of performance criteria on the outstanding tranches of our long-term incentive plan (LTIP) awards. Accordingly, we calculated incremental compensation expense based upon the fair value of (closing price) our common stock on the modification date, which totaled $0.7 million. We recognized $0.5 million of the incremental compensation expense during fiscal 2015 for service provided in the current and previous fiscal years associated with the modification.
Each of the LTIP performance awards described below have a maximum life of six years and compensation expense is recognized as we determine it is probable that the shares will vest. Adjustments to compensation expense to reflect the timing of and the number of shares expected to be awarded are made on a cumulative basis at the date of the adjustment. Award tranches that have vested and shares distributed to participants are marked as "vested" in the tables below. Tranches that have met the performance criteria, but are awaiting Compensation Committee approval are marked as "criteria met," and tranches that have been determined to not be probable of vesting are marked as "not probable" in the tables below. The status for the tranches presented in the tables below is as of August 31, 2017.
Fiscal 2017 LTIP Award – On October 18, 2016, the Compensation Committee granted performance-based awards for our executive officers and members of senior management. A total of 183,381 shares may be earned by the participants based on six individual vesting conditions that are divided into two performance measures, trailing four-quarter Adjusted EBITDA and trailing four-quarter gross All Access Pass sales as shown below.
| | | | | | | | | | | | |
Adjusted EBITDA | | All Access Pass Sales |
Award | | | | | | | Award | | | | | |
Goal | | | Number of | | Tranche | | Goal | | | Number of | | Tranche |
(millions) | | | Shares | | Status | | (millions) | | | Shares | | Status |
$ | 36.7 | | | | 42,789 | | amortizing | | $ | 30.1 | | | | 18,338 | | vested |
$ | 41.8 | | | | 42,789 | | amortizing | | $ | 35.4 | | | | 18,338 | | vested |
$ | 47.7 | | | | 42,789 | | amortizing | | $ | 40.8 | | | | 18,338 | | vested |
| | | | | 128,367 | | | | | | | | | 55,014 | | |
Fiscal 2016 LTIP Award – On November 12, 2015, the Compensation Committee granted performance-based awards for our executive officers and members of senior management. A total of 231,276 shares may be awarded to the participants based on six individual vesting conditions that are divided into two performance measures, trailing four-quarter Adjusted EBITDA and increased sales of Organizational Development Suite (OD Suite) offerings as shown below. The OD Suite is defined as Leadership, Productivity, and Trust practice sales.
| | | | | | | | | | | | |
Adjusted EBITDA | | OD Suite Sales |
Award | | | | | | | Award | | | | | |
Goal | | | Number of | | Tranche | | Goal | | | Number of | | Tranche |
(millions) | | | Shares | | Status | | (millions) | | | Shares | | Status |
$ | 36.0 | | | | 53,964 | | amortizing | | $ | 107.0 | | | | 23,128 | | vested |
$ | 40.0 | | | | 53,964 | | amortizing | | $ | 116.0 | | | | 23,128 | | criteria met |
$ | 44.0 | | | | 53,964 | | amortizing | | $ | 125.0 | | | | 23,128 | | criteria met |
| | | | | 161,892 | | | | | | | | | 69,384 | | |
Fiscal 2015 LTIP Award – During fiscal 2015, the Compensation Committee granted a performance-based award for our executive officers and certain members of senior management. A total of 112,464 shares may be awarded to the participants based on six individual vesting conditions that are divided into two performance measures, trailing four-quarter Adjusted EBITDA and increased sales of OD Suite sales as shown below.
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Adjusted EBITDA | | OD Suite Sales |
Award | | | | | | | Award | | | | | |
Goal | | | Number of | | Tranche | | Goal | | | Number of | | Tranche |
(millions) | | | Shares | | Status | | (millions) | | | Shares | | Status |
$ | 39.6 | | | | 26,241 | | amortizing | | $ | 107.0 | | | | 11,247 | | vested |
$ | 45.5 | | | | 26,241 | | amortizing | | $ | 118.0 | | | | 11,247 | | criteria met |
$ | 52.3 | | | | 26,241 | | not probable | | $ | 130.0 | | | | 11,247 | | amortizing |
| | | | | 78,723 | | | | | | | | | 33,741 | | |
Fiscal 2014 LTIP Award – During the first quarter of fiscal 2014, the Compensation Committee granted performance-based equity awards for our executive officers. A total of 89,418 shares may be awarded to the participants based on six individual vesting conditions that are divided into two performance measures, trailing four-quarter Adjusted EBITDA and trailing four-quarter increased sales of courses related to The 7 Habits of Highly Effective People (the 7 Habits).
| | | | | | | | | | | | |
Adjusted EBITDA | | 7 Habits Increased Sales |
Award | | | | | | | Award | | | | | |
Goal | | | Number of | | Tranche | | Goal | | | Number of | | Tranche |
(millions) | | | Shares | | Status | | (millions) | | | Shares | | Status |
$ | 37.0 | | | | 20,864 | | vested | | $ | 5.0 | | | | 8,942 | | vested |
$ | 43.0 | | | | 20,864 | | amortizing | | $ | 10.0 | | | | 8,942 | | vested |
$ | 49.0 | | | | 20,864 | | not probable | | $ | 12.5 | | | | 8,942 | | criteria met |
| | | | | 62,592 | | | | | | | | | 26,826 | | |
Fiscal 2013 LTIP Award – During the first quarter of fiscal 2013, the Compensation Committee granted a performance-based equity award for the Chief Executive Officer (CEO), Chief Financial Officer (CFO), and the Chief People Officer (CPO). A total of 68,085 shares may be issued to the participants based on six individual vesting conditions that are divided into two performance measures, trailing four-quarter Adjusted EBITDA and Productivity Practice sales.
| | | | | | | | | | | | |
Adjusted EBITDA | | Productivity Practice Sales |
Award | | | | | | | Award | | | | | |
Goal | | | Number of | | Tranche | | Goal | | | Number of | | Tranche |
(millions) | | | Shares | | Status | | (millions) | | | Shares | | Status |
$ | 33.0 | | | | 15,887 | | vested | | $ | 23.5 | | | | 6,808 | | vested |
$ | 40.0 | | | | 15,887 | | amortizing | | $ | 26.5 | | | | 6,808 | | not probable |
$ | 47.0 | | | | 15,887 | | not probable | | $ | 29.5 | | | | 6,808 | | not probable |
| | | | | 47,661 | | | | | | | | | 20,424 | | |
Fiscal 2012 LTIP Award - During fiscal 2012, the Compensation Committee granted a performance-based equity award for the CEO, CFO, and CPO similar to the fiscal 2013 executive award described above. A total of 106,101 shares may be issued to the participants based on six individual vesting conditions that are divided into two performance measures, Adjusted EBITDA and Productivity Practice sales. The fiscal 2012 LTIP award measurement period ended on August 31, 2017.
| | | | | | | | | | | | |
Adjusted EBITDA | | Productivity Practice Sales |
Award | | | | | | | Award | | | | | |
Goal | | | Number of | | Tranche | | Goal | | | Number of | | Tranche |
(millions) | | | Shares | | Status | | (millions) | | | Shares | | Status |
$ | 26.0 | | | | 24,757 | | vested | | $ | 20.5 | | | | 10,610 | | vested |
$ | 33.0 | | | | 24,757 | | vested | | $ | 23.5 | | | | 10,610 | | vested |
$ | 40.0 | | | | 24,757 | | not vested | | $ | 26.5 | | | | 10,610 | | not vested |
| | | | | 74,271 | | | | | | | | | 31,830 | | |
Unvested Stock Awards
The annual Board of Director unvested stock award, which is administered under the terms of the Franklin Covey Co. 2015 Omnibus Incentive Plan, is designed to provide our non-employee directors, who are not eligible to participate in our employee stock purchase plan, an opportunity to obtain an interest in the Company through the acquisition of shares of our common stock. Each eligible director is entitled to receive a whole-share grant equal to $75,000 with a one-year vesting period, which is generally granted in January (following the Annual Shareholders' Meeting) of each year. Shares granted under the terms of this annual award are ineligible to be voted or participate in any common stock dividends until they are vested.
Under the terms of this program, we issued 29,834 shares, 25,032 shares, and 24,210 shares of our common stock to eligible members of the Board of Directors during the fiscal years ended August 31, 2017, 2016, and 2015. The fair value of shares awarded to the directors was $0.5 million in each of those years as calculated on the grant date of the awards. The corresponding compensation cost is recognized over the vesting period of the awards, which is one year. The cost of the common stock issued from treasury for these awards was $0.4 million in fiscal 2017, and $0.3 million in each of the fiscal years ended August 31, 2016 and 2015. The following information applies to our unvested stock awards for the fiscal year ended August 31, 2017:
| | | | | | |
| | | | | Weighted- | |
| | | | | Average Grant- | |
| | | | | Date Fair | |
| | Number of | | | Value Per | |
| | Shares | | | Share | |
Unvested stock awards at | | | | | | |
August 31, 2016 | | | 25,032 | | | $ | 17.98 | |
Granted | | | 29,834 | | | | 17.60 | |
Forfeited | | | - | | | | - | |
Vested | | | (25,032 | ) | | | 17.98 | |
Unvested stock awards at | | | | | | | | |
August 31, 2017 | | | 29,834 | | | $ | 17.60 | |
At August 31, 2017, there was $0.2 million of unrecognized compensation cost related to unvested stock awards, which is expected to be recognized over the remaining weighted-average vesting period of approximately four months. The total recognized tax benefit from unvested stock awards totaled $0.2 million for fiscal 2017 and $0.1 million for each of the fiscal years ended August 31, 2016 and 2015. The intrinsic value of our unvested stock awards at August 31, 2017 was $0.6 million.
Stock Options
We have an incentive stock option plan whereby options to purchase shares of our common stock may be issued to key employees at an exercise price not less than the fair market value of the Company's common stock on the date of grant. Information related to our stock option activity during the fiscal year ended August 31, 2017 is presented below:
| | | | | | | | | | | | |
| | | | | | | | Weighted | | | | |
| | | | | Weighted | | | Average | | | | |
| | | | | Avg. Exercise | | | Remaining | | | Aggregate | |
| | Number of | | | Price Per | | | Contractual | | | Intrinsic Value | |
| | Stock Options | | | Share | | | Life (Years) | | | (thousands) | |
Outstanding at August 31, 2016 | | | 631,250 | | | $ | 11.41 | | | | | | | |
Granted | | | - | | | | - | | | | | | | |
Exercised | | | (62,500 | ) | | | 9.00 | | | | | | | |
Forfeited | | | - | | | | - | | | | | | | |
Outstanding at August 31, 2017 | | | 568,750 | | | $ | 11.67 | | | | 2.8 | | | $ | 4,055 | |
| | | | | | | | | | | | | | | | |
Options vested and exercisable at | | | | | | | | | | | | | | | | |
August 31, 2017 | | | 568,750 | | | $ | 11.67 | | | | 2.8 | | | $ | 4,055 | |
During fiscal 2017, we had 62,500 stock options exercised on a net share basis, which had an aggregate intrinsic value of $0.5 million. At August 31, 2017, there was no remaining unrecognized compensation expense related to our stock options and no options were exercised during either fiscal 2016 or 2015.
The following additional information applies to our stock options outstanding at August 31, 2017:
| | | | | | | | | | | | | | | | |
| | | | | | Weighted | | | | | | | | | | |
| | | Number | | | Average | | | | | | Options | | | | |
| | | Outstanding | | | Remaining | | | Weighted | | | Exercisable at | | | Weighted | |
| | | at August 31, | | | Contractual | | | Average | | | August 31, | | | Average | |
Exercise Prices | | | 2017 | | | Life (Years) | | | Exercise Price | | | 2017 | | | Exercise Price | |
$ | 9.00 | | | | 62,500 | | | | 3.4 | | | $ | 9.00 | | | | 62,500 | | | $ | 9.00 | |
$ | 10.00 | | | | 168,750 | | | | 2.8 | | | $ | 10.00 | | | | 168,750 | | | $ | 10.00 | |
$ | 12.00 | | | | 168,750 | | | | 2.8 | | | $ | 12.00 | | | | 168,750 | | | $ | 12.00 | |
$ | 14.00 | | | | 168,750 | | | | 2.8 | | | $ | 14.00 | | | | 168,750 | | | $ | 14.00 | |
| | | | | 568,750 | | | | | | | | | | | | 568,750 | | | | | |
Fully Vested Stock Awards
Client Partner and Consultant Award – During fiscal 2011, we implemented a new fully vested stock-based award program that is designed to reward our client partners and training consultants for exceptional long-term performance. The program grants shares of our common stock with a total value of $15,000 to each client partner who has sold over $20.0 million in cumulative sales or training consultant who has delivered over 1,500 days of training during their career. During fiscal 2017, nine individuals qualified for this award; four individuals qualified for this award in fiscal 2016; and five individuals earned this award in fiscal 2015.
In the fourth quarter of fiscal 2015, the Compensation Committee approved a fully vested award equal to $10,000 for each general manager or area director that achieved a specified sales goal. Five individuals achieved their sales goals and qualified for the award. This award was only for fourth quarter fiscal 2015 sales performance and no additional awards may be granted under the terms of this award.
Employee Stock Purchase Plan
We have an employee stock purchase plan that offers qualified employees the opportunity to purchase shares of our common stock at a price equal to 85 percent of the average fair market value of our common stock on the last trading day of each quarter. We issued a total of 43,199 shares, 49,375 shares, and 42,687 shares to ESPP participants during the fiscal years ended August 31, 2017, 2016, and 2015, which had a corresponding cost basis of $0.6 million, $0.7 million, and $0.6 million, respectively. We received cash proceeds for these shares from ESPP participants totaling $0.7 million in each of the fiscal years ended August 31, 2017, 2016, and 2015.
Our impaired asset charges during fiscal 2015 consisted of the following (in thousands):
Long-term receivables from FCOP | | $ | 541 | |
Capitalized curriculum | | | 414 | |
Investment cost method subsidiary | | | 220 | |
Prepaid expenses and other long-term assets | | | 127 | |
| | $ | 1,302 | |
The following is a description of the circumstances regarding the impairment of these long-lived assets.
Long-Term Receivables From FCOP – We determined that the operating agreements between the Company and FCOP allow us to collect reimbursement for certain rental expenses prior to the annual required distribution of earnings to FCOP's creditors. Such rents were previously treated as lower in priority and therefore, were considered long-term receivables. Although this determination improved our cash flows and collections of rents receivable from FCOP in the short term, it reduced the amount of cash we were expecting to receive from the required distribution of earnings to pay long-term receivable balances. After this determination was made, the present value of our previously recorded long-term receivables was more than the present value of expected corresponding cash flows. Accordingly, we recalculated our discount on the long-term receivables and impaired the remaining balance.
Capitalized Curriculum – During fiscal 2015, we determined that it would be beneficial to discontinue a component of one of our existing offerings and we received legal notice that another offering contained names trademarked by another entity. Since we currently offer a similar program, the decision was made to discontinue the offering rather than modify the curriculum as required by applicable trademark law. Accordingly, we impaired the remaining unamortized carrying value of these offerings. These items were classified as components of other long-term assets on our consolidated balance sheets.
Investment in Cost Method Subsidiary – In the fourth quarter of fiscal 2015, we became aware of financial difficulties at an entity in which we had an investment accounted for under the cost method. Based on discussions with management of the entity, we determined that the investment in this subsidiary would not be recoverable in future periods due to going concern considerations. Accordingly, we impaired the carrying value of the investment in this entity. The investment in this entity was previously classified as a component of other long-term assets in our consolidated balance sheets.
Prepaid Expenses and Other Long-Term Assets – In connection with a component of one of our offerings that was discontinued (as described above), we had prepaid royalties to an unrelated developer. Based on the decision to impair the content, we determined that the probability of receiving cash flows sufficient to recover the prepaid royalties was remote and we expensed the carrying value of these prepaid assets. Approximately $60,000 of this balance was previously included in other long-term assets.
13. | CONTRACT TERMINATION AND RESTRUCTURING COSTS |
Contract Termination Costs
During fiscal 2017, we entered into a new 10-year license agreement for Education practice content in a foreign country, with minimum required royalties payable to us totaling $16.1 million (at current exchange rates) over the life of the arrangement. Under a previously existing profit-sharing agreement, we would have been obligated to pay one-third of the new minimum royalty stream, or $5.4 million, plus one-third of any royalties in excess of the contractual minimums to the licensee that owns the rights for that country. In exchange for a $1.5 million payment, we terminated the previously existing profit-sharing agreement and we will not owe any further profit sharing-payments to the international licensee. For example, during fiscal 2017, we received $0.9 million of royalty revenues from this agreement. Under the previous profit sharing arrangement, we would have been required to pay $0.3 million to the licensee. Based on the guidance for contract termination costs, we expensed the $1.5 million payment during the second quarter of fiscal 2017.
Restructuring Costs
Fiscal 2017 Restructuring Costs
During the third quarter of fiscal 2017, we determined to exit the publishing business in Japan and restructured our U.S./Canada direct office operations in order to support new sales and renewals of the All Access Pass. We expensed $3.6 million related to these changes during fiscal 2017 as described below. The majority of these costs were attributable to our Direct Offices operating segment.
Exit Japan Publishing Business
Due to a change in strategy designed to focus resources and efforts on sales of the All Access Pass in Japan, and declining sales and profitability of the publishing business, we decided to exit the publishing business in Japan. As a result of this determination, we wrote off the majority of our book inventory located in Japan for $2.1 million, which was recorded as a component of product cost of sales in the accompanying consolidated statements of operations for fiscal 2017.
U.S./Canada Direct Office Restructuring
We restructured the operations of our U.S/Canada direct offices to create new smaller regional teams which are focused on selling the All Access Pass, helping clients strategically implement the AAP, and providing services to further develop long-term client relationships. Accordingly, we determined that our three remaining sales offices located in Atlanta, Georgia; Irvine, California; and Chicago, Illinois were unnecessary since most client partners work from home-based offices; restructured the operations of the Sales Performance and Winning Customer Loyalty Practices; and eliminated certain functions to reduce costs in future periods. The $1.5 million restructuring charge associated with these operational changes was comprised of the following (in thousands):
| | | |
Description | | Amount | |
Severance costs | | $ | 986 | |
Office closure costs | | | 496 | |
| | $ | 1,482 | |
As of August 31, 2017, all of the severance costs have been paid and the remaining office closure cost accrual totaled $0.5 million, which is included as a component of accrued liabilities on the accompanying consolidated balance sheet.
Fiscal 2016 Restructuring Costs
In the fourth quarter of fiscal 2016, we restructured the operations of certain of our domestic sales offices. The cost of this restructuring was $0.4 million and was primarily comprised of employee severance costs, which were paid in August and September 2016.
We also restructured the operations of our Australian direct office. The restructuring was designed to reduce ongoing operating costs by closing the sales offices in Brisbane, Sydney, and Melbourne, and by reducing headcount for administrative and certain sales support functions. Our remaining sales and support personnel in Australia now work from home offices, similar to many of our sales personnel located in the U.S. and Canada. The Australia office restructure cost $0.4 million and was primarily comprised of office closure costs, including remaining lease expense on the offices that were closed, and for employee severance costs. The severance costs included the restructuring charge totaled less than $40,000. As of August 31, 2017 substantially all of the remaining accrued restructuring costs were paid.
Fiscal 2015 Restructuring Costs
During the fourth quarter of fiscal 2015, we realigned our regional sales offices that serve the United States and Canada. As a result of this realignment, we closed our northeastern regional sales office located in Pennsylvania and created new geographic sales regions. In connection with this restructuring, we incurred costs related to involuntary severance and office closure costs. The restructuring charge taken during the fiscal year ended August 31, 2015 was comprised of the following (in thousands):
| | | |
Description | | Amount | |
Severance costs | | $ | 570 | |
Office closure costs | | | 17 | |
| | $ | 587 | |
The majority of these costs were paid prior to August 31, 2015 and there were no remaining costs from the fiscal 2015 restructuring accrued as of August 31, 2017.
14. | EMPLOYEE BENEFIT PLANS |
Profit Sharing Plans
We have defined contribution profit sharing plans for our employees that qualify under Section 401(k) of the Internal Revenue Code. These plans provide retirement benefits for employees meeting minimum age and service requirements. Qualified participants may contribute up to 75 percent of their gross wages, subject to certain limitations. These plans also provide for matching contributions to the participants that are paid by the Company. The matching contributions, which were expensed as incurred, totaled $1.9 million, $1.9 million, and $1.7 million during the fiscal years ended August 31, 2017, 2016, and 2015. We do not sponsor or participate in any defined-benefit pension plans.
Deferred Compensation Plan
We had a non-qualified deferred compensation (NQDC) plan that provided certain key officers and employees the ability to defer a portion of their compensation until a later date. Deferred compensation amounts used to pay benefits were held in a "rabbi trust," which invested in insurance contracts, various
mutual funds, and shares of our common stock as directed by the plan participants. However, due to legal changes resulting from the American Jobs Creation Act of 2004, we determined to cease compensation deferrals to the NQDC plan after December 31, 2004. Following the cessation of deferrals to the NQDC plan, the number of participants remaining in the plan declined steadily, and our Board of Directors decided to partially terminate the NQDC plan. Following this decision, all of the plan's assets were liquidated, the plan's liabilities were paid, and the only remaining items in the NQDC plan are shares of our common stock owned by the remaining plan participants. At August 31, 2017 and 2016, the cost basis of the shares of our common stock held by the rabbi trust was $0.4 million.
Our benefit (provision) for income taxes consisted of the following (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Current: | | | | | | | | | |
Federal | | $ | 69 | | | $ | (380 | ) | | $ | (220 | ) |
State | | | (71 | ) | | | (197 | ) | | | (208 | ) |
Foreign | | | (2,320 | ) | | | (2,553 | ) | | | (2,691 | ) |
| | | (2,322 | ) | | | (3,130 | ) | | | (3,119 | ) |
| | | | | | | | | | | | |
Deferred: | | | | | | | | | | | | |
Federal | | | (1,227 | ) | | | (1,584 | ) | | | (3,239 | ) |
State | | | (17 | ) | | | 70 | | | | (138 | ) |
Foreign | | | 468 | | | | 50 | | | | 200 | |
Operating loss carryforward | | | 6,964 | | | | - | | | | - | |
Valuation allowance | | | (129 | ) | | | (301 | ) | | | - | |
| | | 6,059 | | | | (1,765 | ) | | | (3,177 | ) |
| | $ | 3,737 | | | $ | (4,895 | ) | | $ | (6,296 | ) |
The allocation of our total income tax provision (benefit) is as follows (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Net income (loss) | | $ | 3,737 | | | $ | (4,895 | ) | | $ | (6,296 | ) |
Other comprehensive income | | | 37 | | | | 115 | | | | 52 | |
| | $ | 3,774 | | | $ | (4,780 | ) | | $ | (6,244 | ) |
Income (loss) before income taxes consisted of the following (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
United States | | $ | (10,126 | ) | | $ | 9,328 | | | $ | 15,073 | |
Foreign | | | (783 | ) | | | 2,583 | | | | 2,339 | |
| | $ | (10,909 | ) | | $ | 11,911 | | | $ | 17,412 | |
The differences between income taxes at the statutory federal income tax rate and the consolidated income tax rate reported in our consolidated statements of operations were as follows:
YEAR ENDED AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Federal statutory income tax rate | | | 35.0 | % | | | (35.0 | )% | | | (35.0 | )% |
State income taxes, net of federal effect | | | 2.3 | | | | (1.9 | ) | | | (2.3 | ) |
Valuation allowance | | | (1.2 | ) | | | (2.5 | ) | | | - | |
Foreign jurisdictions tax differential | | | (1.9 | ) | | | 0.6 | | | | (1.2 | ) |
Tax differential on income subject to both U.S. and foreign taxes | | | 0.4 | | | | (1.9 | ) | | | (0.5 | ) |
Effect of claiming foreign tax credits instead of deductions for prior years | | | - | | | | - | | | | 3.2 | |
Uncertain tax positions | | | 4.4 | | | | 0.4 | | | | 0.9 | |
Non-deductible executive compensation | | | (1.6 | ) | | | - | | | | (0.2 | ) |
Non-deductible meals and entertainment | | | (2.2 | ) | | | (1.6 | ) | | | (1.1 | ) |
Other | | | (0.9 | ) | | | 0.8 | | | | - | |
| | | 34.3 | % | | | (41.1 | )% | | | (36.2 | )% |
In prior fiscal years, we elected to take deductions on our U.S. federal income tax returns for foreign income taxes paid, rather than claiming foreign tax credits. During those years we either generated or used net operating loss carryforwards and were therefore unable to utilize foreign tax credits. In fiscal 2011, we began claiming foreign tax credits on our U.S. federal income tax returns. Although we could not utilize the credits we claimed for fiscal 2012 and fiscal 2011 in those respective years, we concluded it was more likely than not that these foreign tax credits will be utilized in the future.
Our overall U.S. taxable income and foreign source income for fiscal 2014 and 2013 were sufficient to utilize all of the foreign tax credits generated during those fiscal years, plus additional credits generated in prior years. Accordingly, we amended our U.S. federal income tax returns from fiscal 2003 through fiscal 2010 to claim foreign tax credits instead of foreign tax deductions. In fiscal 2015, we finalized the calculations of the impact of amending previously filed federal income tax returns to realize foreign tax credits previously treated as expired under the tax positions taken in the original returns. The income tax benefit recognized from these foreign tax credits totaled $0.6 million in fiscal 2015.
We recognized tax benefits from deductions for stock-based compensation in excess of the corresponding expense recorded for financial statement purposes. Instead of reducing our income tax expense for these benefits, we recorded $0.2 million and $0.1 million for the fiscal years ending August 31, 2017 and 2015. Tax expense related to stock-based compensation recorded in additional paid-in capital for fiscal 2016 was insignificant. Following the adoption of ASU 2016-09 in fiscal 2018, the benefits and deductions resulting from stock-based compensation in excess of the corresponding book expense will be recorded as a component of our income tax provision or benefit for the period.
The significant components of our deferred tax assets and liabilities were comprised of the following (in thousands):
| | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
Deferred income tax assets: | | | | | | |
Net operating loss carryforward | | $ | 10,310 | | | $ | - | |
Sale and financing of corporate | | | | | | | | |
headquarters | | | 8,420 | | | | 9,013 | |
Foreign income tax credit | | | | | | | | |
carryforward | | | 4,382 | | | | 2,784 | |
Stock-based compensation | | | 2,954 | | | | 2,674 | |
Inventory and bad debt reserves | | | 1,643 | | | | 1,147 | |
Bonus and other accruals | | | 1,574 | | | | 1,017 | |
Deferred revenue | | | 510 | | | | 405 | |
Other | | | 337 | | | | 617 | |
Total deferred income tax assets | | | 30,130 | | | | 17,657 | |
Less: valuation allowance | | | (612 | ) | | | (301 | ) |
Net deferred income tax assets | | | 29,518 | | | | 17,356 | |
| | | | | | | | |
Deferred income tax liabilities: | | | | | | | | |
Intangibles step-ups – indefinite lived | | | (8,539 | ) | | | (8,528 | ) |
Intangibles step-ups – definite lived | | | (7,607 | ) | | | (6,003 | ) |
Intangible asset impairment and | | | | | | | | |
amortization | | | (4,875 | ) | | | (4,505 | ) |
Property and equipment depreciation | | | (4,960 | ) | | | (3,367 | ) |
Deferred commissions | | | (2,195 | ) | | | - | |
Unremitted earnings of foreign | | | | | | | | |
subsidiaries | | | (492 | ) | | | (574 | ) |
Other | | | (236 | ) | | | (399 | ) |
Total deferred income tax liabilities | | | (28,904 | ) | | | (23,376 | ) |
Net deferred income taxes | | $ | 614 | | | $ | (6,020 | ) |
Deferred income tax amounts are recorded as follows in our consolidated balance sheets (in thousands):
| | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
Other long-term assets | | $ | 1,647 | | | $ | 650 | |
Long-term liabilities | | | (1,033 | ) | | | (6,670 | ) |
Net deferred income tax liability | | $ | 614 | | | $ | (6,020 | ) |
As of August 31, 2016, we had utilized all of our U.S. federal net operating loss carryforwards. However, we incurred a federal net operating loss of $17.5 million in fiscal 2017 and acquired a federal net operating loss carryforward of $7.7 million in connection with the purchase of the stock of Jhana Education (Note 2) in fiscal 2017. Our U.S. federal net operating loss carryforwards were comprised of the following at August 31, 2017 (in thousands):
| | | | | Loss | | | Loss | | | Operating | |
Loss Carryforward | Loss Carryforward | | | | | Deductions | | | Deductions | | | Loss Carried | |
for Year Ended | Expires August 31, | | Amount | | | in Prior Years | | | in Current Year | | | Forward | |
December 31, 2012 | 2031 | | $ | 243 | | | $ | - | | | $ | - | | | $ | 243 | |
December 31, 2013 | 2032 | | | 553 | | | | - | | | | - | | | | 553 | |
December 31, 2014 | 2033 | | | 1,285 | | | | - | | | | - | | | | 1,285 | |
December 31, 2015 | 2034 | | | 1,491 | | | | - | | | | - | | | | 1,491 | |
December 31, 2016 | 2035 | | | 3,052 | | | | - | | | | - | | | | 3,052 | |
July 15, 2017 | 2036 | | | 1,117 | | | | - | | | | - | | | | 1,117 | |
Acquired NOL | | | | 7,741 | | | | - | | | | - | | | | 7,741 | |
August 31, 2017 | 2037 | | | 17,500 | | | | - | | | | - | | | | 17,500 | |
| | | $ | 25,241 | | | $ | - | | | $ | - | | | $ | 25,241 | |
We have U.S. state net operating loss carryforwards generated in fiscal 2009 and before in various jurisdictions that expire primarily between September 1, 2017 and August 31, 2029. The U.S. state net operating loss carryforwards generated in fiscal 2017 primarily expire on August 31, 2037. The state net operating loss carryforwards acquired through the purchase of Jhana Education stock expire between August 31, 2031 and August 31, 2036.
Our U.S. foreign income tax credit carryforwards were comprised of the following at August 31, 2017 (in thousands):
| | | | | | | | | | | | | |
Credit Generated in | | | | | | Credits Used | | | Credits Used | | | Credits | |
Fiscal Year Ended | Credit Expires | | Credits | | | in Prior | | | in Fiscal | | | Carried | |
August 31, | August 31, | | Generated | | | Years | | | 2017 | | | Forward | |
2011 | 2021 | | $ | 3,445 | | | $ | (859 | ) | | $ | - | | | $ | 2,586 | |
2012 | 2022 | | | 2,563 | | | | (2,563 | ) | | | - | | | | - | |
2013 | 2023 | | | 2,815 | | | | (2,815 | ) | | | - | | | | - | |
2014 | 2024 | | | 1,378 | | | | (1,378 | ) | | | - | | | | - | |
2015 | 2025 | | | 1,422 | | | | (1,422 | ) | | | - | | | | - | |
2016 | 2026 | | | 1,569 | | | | (1,569 | ) | | | - | | | | - | |
2017 | 2027 | | | 1,796 | | | | - | | | | - | | | | 1,796 | |
| | | $ | 14,988 | | | $ | (10,606 | ) | | $ | - | | | $ | 4,382 | |
During the year ended August 31, 2016, we determined it was more likely than not that deferred tax assets of a foreign subsidiary would not be realized. Accordingly, we recorded a $0.3 million valuation allowance against these deferred tax assets in fiscal 2016. During fiscal 2017, we increased this valuation allowance by $0.1 million to $0.4 million, which reduced our income tax benefit for the year by $0.1 million.
We acquired federal and state net operating loss carryforwards in connection with the purchase of Jhana Education stock during fiscal 2017. Section 382 of the Internal Revenue Code limits our ability to use these acquired losses. Accordingly, we recorded valuation allowances in the amount of $0.2 million against the related deferred tax assets. Our income tax benefit for fiscal 2017 was unaffected by this valuation allowance.
We have determined that projected future taxable income is adequate to allow for realization of all deferred tax assets, except for the assets subject to the valuation allowances. We considered sources of taxable income, including future reversals of taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, and reasonable, practical tax-planning strategies to generate additional taxable income. Based on the factors described above, we concluded that realization of our deferred tax assets, except those subject to the valuation allowance as described above, is more likely than not at August 31, 2017.
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Beginning balance | | $ | 3,024 | | | $ | 3,115 | | | $ | 3,491 | |
Additions based on tax positions | | | | | | | | | | | | |
related to the current year | | | 10 | | | | 199 | | | | 244 | |
Additions for tax positions in | | | | | | | | | | | | |
prior years | | | 85 | | | | 3 | | | | 144 | |
Reductions for tax positions of prior | | | | | | | | | | | | |
years resulting from the lapse of | | | | | | | | | | | | |
applicable statute of limitations | | | (634 | ) | | | (212 | ) | | | (339 | ) |
Other reductions for tax positions of | | | | | | | | | | | | |
prior years | | | (126 | ) | | | (81 | ) | | | (425 | ) |
Ending balance | | $ | 2,359 | | | $ | 3,024 | | | $ | 3,115 | |
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $1.6 million at August 31, 2017, and $2.1 million at August 31, 2016. Included in the ending balance of gross unrecognized tax benefits at August 31, 2017 is $2.4 million related to individual states' net operating loss carryforwards. Interest and penalties related to uncertain tax positions are recognized as components of income tax expense. The net accruals and reversals of interest and penalties increased or decreased our income tax expense by an insignificant amount in each of fiscal 2017, fiscal 2016 and fiscal 2015. The balance of interest and penalties included in other liabilities on our consolidated balance sheets at August 31, 2017 and 2016 was $0.3 million at each date.
During the next 12 months, we expect a decrease in unrecognized tax benefits totaling $0.2 million relating to state net operating loss deductions upon the lapse of the applicable statute of limitations.
We file United States federal income tax returns as well as income tax returns in various states and foreign jurisdictions. The tax years that remain subject to examinations for our major tax jurisdictions are shown below.
2010-2017 | Canada and Australia |
2012-2017 | Japan and the United Kingdom |
2013-2017 | United States – state and local income tax |
2014-2017 | United States – federal income tax |
2016-2017 | China |
2017 | Singapore |
16. | EARNINGS (LOSS) PER SHARE |
The following is a reconciliation from basic earnings (loss) per share (EPS) to diluted EPS (in thousands, except per-share amounts).
| | | | | | | | | |
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Numerator for basic and | | | | | | | | | |
diluted earnings per share: | | | | | | | | | |
Net income (loss) | | $ | (7,172 | ) | | $ | 7,016 | | | $ | 11,116 | |
| | | | | | | | | | | | |
Denominator for basic and | | | | | | | | | | | | |
diluted earnings per share: | | | | | | | | | | | | |
Basic weighted average shares | | | | | | | | | | | | |
outstanding | | | 13,819 | | | | 14,944 | | | | 16,742 | |
Effect of dilutive securities: | | | | | | | | | | | | |
Stock options and other | | | | | | | | | | | | |
stock-based awards | | | - | | | | 132 | | | | 181 | |
Diluted weighted average shares | | | | | | | | | | | | |
outstanding | | | 13,819 | | | | 15,076 | | | | 16,923 | |
| | | | | | | | | | | | |
EPS Calculations: | | | | | | | | | | | | |
Net income (loss) per share: | | | | | | | | | | | | |
Basic | | $ | (0.52 | ) | | $ | 0.47 | | | $ | 0.66 | |
Diluted | | | (0.52 | ) | | | 0.47 | | | | 0.66 | |
Since we incurred a net loss for the fiscal year ended August 31, 2017, no potentially dilutive securities were included in the calculation of our earnings per share because the inclusion of these securities would be antidilutive. The number of dilutive securities that would have been included at August 31, 2017 would have been approximately 0.2 million shares. Other securities, including performance stock-based compensation instruments, may have a dilutive effect on our EPS calculation in future periods if our financial results reach specified targets (Note 11).
Reportable Segments
Our revenues are primarily obtained from the sale of training and consulting services and related products. During fiscal 2017, we managed our business based on the following four operating segments:
· | Direct Offices – This division includes our geographic sales offices that serve the United States and Canada; our international sales offices located in Japan, China, the United Kingdom, and Australia; and our public programs group.
|
· | Strategic Markets – This division includes our government services office, the Sales Performance practice, the Customer Loyalty practice, and the "Global 50" group, which is specifically focused on sales to large, multi-national organizations.
|
· | Education practice – This division includes our domestic and international Education practice operations, which are centered on sales to educational institutions.
|
· | International Licensees – This division is primarily comprised of our international licensees' royalty revenues.
|
We have determined that the Company's chief operating decision maker is the CEO, and the primary measurement tool used in business unit performance analysis is Adjusted EBITDA, which may not be calculated as similarly titled amounts calculated by other companies. For reporting purposes, our consolidated Adjusted EBITDA can be calculated as our income or loss from operations excluding stock-based compensation, contract termination costs, restructuring charges, depreciation expense, amortization expense, and certain other items such as impaired asset charges and adjustments for changes in the fair value of contingent consideration liabilities from business acquisitions.
Our operations are not capital intensive and we do not own any manufacturing facilities or equipment. Accordingly, we do not allocate assets to the divisions for analysis purposes. Interest expense and interest income are primarily generated at the corporate level and are not allocated. Income taxes are likewise calculated and paid on a corporate level (except for entities that operate in foreign jurisdictions) and are not allocated for analysis purposes.
All prior period segment information has been revised to conform to our current organizational structure, assigned responsibilities, and primary internal reports. We account for our segment information on the same basis as the accompanying consolidated financial statements.
| | | | | | | | | |
| | Sales to | | | | | | | |
Fiscal Year Ended | | External | | | | | | Adjusted | |
August 31, 2017 | | Customers | | | Gross Profit | | | EBITDA | |
| | | | | | | | | |
Direct offices | | $ | 96,662 | | | $ | 65,950 | | | $ | 6,134 | |
Strategic markets | | | 22,974 | | | | 13,601 | | | | (2,005 | ) |
Education practice | | | 44,122 | | | | 27,916 | | | | 6,043 | |
International licensees | | | 13,571 | | | | 10,483 | | | | 6,005 | |
Total | | | 177,329 | | | | 117,950 | | | | 16,177 | |
Corporate and eliminations | | | 7,927 | | | | 4,717 | | | | (8,478 | ) |
Consolidated | | $ | 185,256 | | | $ | 122,667 | | | $ | 7,699 | |
| | | | | | | | | | | | |
Fiscal Year Ended | | | | | | | | | | | | |
August 31, 2016 | | | | | | | | | | | | |
| | | | | | | | | | | | |
Direct offices | | $ | 103,605 | | | $ | 74,632 | | | $ | 17,791 | |
Strategic markets | | | 29,819 | | | | 18,791 | | | | 3,559 | |
Education practice | | | 40,844 | | | | 24,513 | | | | 4,787 | |
International licensees | | | 17,113 | | | | 13,152 | | | | 8,646 | |
Total | | | 191,381 | | | | 131,088 | | | | 34,783 | |
Corporate and eliminations | | | 8,674 | | | | 4,066 | | | | (7,889 | ) |
Consolidated | | $ | 200,055 | | | $ | 135,154 | | | $ | 26,894 | |
| | | | | | | | | | | | |
Fiscal Year Ended | | | | | | | | | | | | |
August 31, 2015 | | | | | | | | | | | | |
| | | | | | | | | | | | |
Direct offices | | $ | 113,087 | | | $ | 81,057 | | | $ | 18,801 | |
Strategic markets | | | 37,039 | | | | 21,680 | | | | 8,418 | |
Education practice | | | 33,681 | | | | 19,350 | | | | 3,084 | |
International licensees | | | 16,547 | | | | 12,343 | | | | 6,645 | |
Total | | | 200,354 | | | | 134,430 | | | | 36,948 | |
Corporate and eliminations | | | 9,587 | | | | 3,659 | | | | (5,090 | ) |
Consolidated | | $ | 209,941 | | | $ | 138,089 | | | $ | 31,858 | |
A reconciliation of Adjusted EBITDA to consolidated net income (loss) is provided below (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
Enterprise Adjusted EBITDA | | $ | 16,177 | | | $ | 34,783 | | | $ | 36,948 | |
Corporate expenses | | | (8,478 | ) | | | (7,889 | ) | | | (5,090 | ) |
Consolidated Adjusted EBITDA | | | 7,699 | | | | 26,894 | | | | 31,858 | |
Stock-based compensation | | | (3,658 | ) | | | (3,121 | ) | | | (2,536 | ) |
Reduction (increase) in | | | | | | | | | | | | |
contingent consideration liability | | | 1,936 | | | | (1,538 | ) | | | (35 | ) |
Costs to exit Japan publishing business | | | (2,107 | ) | | | - | | | | - | |
Contract termination costs | | | (1,500 | ) | | | - | | | | - | |
Restructuring costs | | | (1,482 | ) | | | (776 | ) | | | (587 | ) |
ERP system implementation costs | | | (1,404 | ) | | | (448 | ) | | | - | |
China office start-up costs | | | (505 | ) | | | (222 | ) | | | - | |
Business acquisition costs | | | (442 | ) | | | - | | | | - | |
Impaired assets | | | - | | | | - | | | | (1,302 | ) |
Depreciation | | | (3,879 | ) | | | (3,677 | ) | | | (4,142 | ) |
Amortization | | | (3,538 | ) | | | (3,263 | ) | | | (3,727 | ) |
Income (loss) from operations | | | (8,880 | ) | | | 13,849 | | | | 19,529 | |
Interest income | | | 379 | | | | 325 | | | | 383 | |
Interest expense | | | (2,408 | ) | | | (2,263 | ) | | | (2,137 | ) |
Discount on related party receivable | | | - | | | | - | | | | (363 | ) |
Income (loss) before income taxes | | | (10,909 | ) | | | 11,911 | | | | 17,412 | |
Benefit (provision) for income taxes | | | 3,737 | | | | (4,895 | ) | | | (6,296 | ) |
Net income (loss) | | $ | (7,172 | ) | | $ | 7,016 | | | $ | 11,116 | |
Geographic Information
Our revenues are derived primarily from the United States. However, we also operate wholly owned offices or contract with licensees to provide our services in various countries throughout the world. Our consolidated revenues were derived from the following countries/regions (in thousands):
| | | | | | | | | |
YEAR ENDED | | | | | | | | | |
AUGUST 31, | | 2017 | | | 2016 | | | 2015 | |
United States | | $ | 137,219 | | | $ | 155,153 | | | $ | 162,594 | |
Japan | | | 14,482 | | | | 14,997 | | | | 14,446 | |
China | | | 11,552 | | | | 3,884 | | | | 2,424 | |
United Kingdom | | | 4,754 | | | | 7,716 | | | | 8,997 | |
Canada | | | 4,372 | | | | 4,357 | | | | 6,460 | |
Australia | | | 2,704 | | | | 3,404 | | | | 3,774 | |
Western Europe | | | 1,679 | | | | 1,503 | | | | 1,364 | |
Thailand | | | 1,147 | | | | 1,226 | | | | 1,055 | |
Denmark/Scandinavia | | | 775 | | | | 863 | | | | 729 | |
Mexico/Central America | | | 751 | | | | 917 | | | | 974 | |
Middle East | | | 723 | | | | 584 | | | | 670 | |
Singapore | | | 722 | | | | 1,143 | | | | 1,397 | |
India | | | 701 | | | | 677 | | | | 708 | |
Central/Eastern Europe | | | 638 | | | | 644 | | | | 492 | |
Indonesia | | | 614 | | | | 579 | | | | 651 | |
Brazil | | | 410 | | | | 319 | | | | 321 | |
Malaysia | | | 364 | | | | 384 | | | | 511 | |
The Philippines | | | 324 | | | | 332 | | | | 327 | |
Others | | | 1,325 | | | | 1,373 | | | | 2,047 | |
| | $ | 185,256 | | | $ | 200,055 | | | $ | 209,941 | |
At August 31, 2017, we had wholly owned direct offices in Australia, China, Japan, and the United Kingdom. Our China direct offices opened on September 1, 2016. Our long-lived assets, excluding intangible assets, goodwill, and the long-term portion of the related party receivable were held in the following locations for the periods indicated (in thousands):
| | | | | | |
AUGUST 31, | | 2017 | | | 2016 | |
United States/Canada | | $ | 33,146 | | | $ | 27,288 | |
Japan | | | 2,350 | | | | 2,045 | |
Australia | | | 466 | | | | 349 | |
China | | | 301 | | | | - | |
United Kingdom | | | 240 | | | | 114 | |
Singapore | | | 152 | | | | - | |
| | $ | 36,655 | | | $ | 29,796 | |
Inter-segment sales were immaterial and were eliminated in consolidation.
18. | RELATED PARTY TRANSACTIONS |
Knowledge Capital Investment Group
Knowledge Capital Investment Group (Knowledge Capital) held a warrant to purchase 5.9 million shares of our common stock, exercised its warrant at various dates according to the terms of a fiscal 2011 exercise agreement, and received a total of 2.2 million shares of our common stock from shares held in treasury. Two members of our Board of Directors, including our CEO, have an equity interest in Knowledge Capital.
Pursuant to a fiscal 2011 warrant exercise agreement with Knowledge Capital, we filed a registration statement with the SEC on Form S-3 to register shares held by Knowledge Capital. This registration statement was declared effective on January 26, 2015. On May 20, 2015, Knowledge Capital sold 400,000 shares of our common stock on the open market and we did not purchase any of these shares. At each of August 31, 2017 and 2016, Knowledge Capital held 2.8 million shares of our common stock.
FC Organizational Products
During the fourth quarter of fiscal 2008, we joined with Peterson Partners to create a new company, FC Organizational Products, LLC. This new company purchased substantially all of the assets of our consumer solutions business unit with the objective of expanding the worldwide sales of FCOP as governed by a comprehensive license agreement between us and FCOP. On the date of the sale closing, we invested approximately $1.8 million to purchase a 19.5 percent voting interest in FCOP, and made a $1.0 million priority capital contribution with a 10 percent return. At the time of the transaction, we determined that FCOP was not a variable interest entity.
As a result of FCOP's structure as a limited liability company with separate owner capital accounts, we determined that our investment in FCOP is more than minor and that we are required to account for our investment in FCOP using the equity method of accounting. We have not recorded our share of FCOP's losses in the accompanying consolidated statements of operations because we have impaired and written off investment balances, as defined within the applicable accounting guidance, in previous periods in excess of our share of FCOP's losses through August 31, 2017.
Based on changes to FCOP's debt agreements and certain other factors in fiscal 2012, we reconsidered whether FCOP was a variable interest entity as defined under FASC 810, and determined that FCOP was a variable interest entity. Although the changes to the debt agreements did not modify the governing documents of FCOP, the changes were substantial enough to raise doubts regarding the sufficiency of FCOP's equity investment at risk. We further determined that we are not the primary beneficiary of FCOP because we do not have the ability to direct the activities that most significantly impact FCOP's economic performance, which primarily consist of the day-to-day sale of planning products and related accessories, and we do not have an obligation to absorb losses or the right to receive benefits from FCOP that could potentially be significant. Our voting rights and management board representation approximate our ownership interest and we are unable to exercise control through voting interests or through other means.
The operations of FCOP are primarily financed by the sale of planning products and accessories, and our primary exposure related to FCOP is from amounts owed to us by FCOP. We receive reimbursement from FCOP for certain operating costs and rental payments for the office space that FCOP occupies.
We classify our receivables from FCOP based upon expected payment. Long-term receivable balances are discounted at 15 percent, which was the estimated risk-adjusted borrowing rate of FCOP. This rate was based on a variety of factors including, but not limited to, current market interest rates for various qualities of comparable debt, discussions with FCOP's lenders, and an evaluation of the realizability of FCOP's future cash flows. In fiscal 2013, we began to accrete this long-term receivable and the majority of our interest income from fiscal 2015 through fiscal 2017 is attributable to the accretion of interest on long-term receivables.
During fiscal 2015, we determined that we will receive payment from FCOP for certain rent expenses earlier than previously estimated and we recognized additional leasing revenues from FCOP totaling $0.2 million due to the change in the priority of the payment of these items. Although we were able to record additional leasing revenues and our cash flows on current related party receivables will improve in the short term, the present value of our share of cash distributions to cover remaining long-term receivables was reduced and was less than the present value of the receivables previously recorded and accordingly, the Company recalculated its discount on the long-term receivables and impaired the remaining balance, which totaled $0.5 million.
At August 31, 2017 and 2016, we had $1.7 million (net of $0.7 million discount) and $3.2 million (net of $0.8 million discount) receivable from FCOP, which have been classified in current assets and long-term assets in our consolidated balance sheets based on expected payment dates. We also owed FCOP approximately $9,000 and $0.1 million at August 31, 2017 and 2016, respectively, for items purchased in the ordinary course of business. These liabilities were classified in accounts payable in the accompanying consolidated balance sheets.
CoveyLink Acquisition and Contractual Payments
During fiscal 2009, we acquired the assets of CoveyLink Worldwide, LLC (CoveyLink). CoveyLink conducts training and provides consulting based upon the book The Speed of Trust by Stephen M.R. Covey, who is the brother of one of our executive officers.
We accounted for the acquisition of CoveyLink using the guidance found in Statement of Financial Accounting Standards No. 141, Business Combinations. The previous owners of CoveyLink were entitled to earn annual contingent payments based upon earnings growth during the five years following the acquisition. During fiscal 2015, we completed a review of the contingent consideration payments and determined that we owed the former owners of CoveyLink an additional $0.3 million for performance during the measurement period. We do not anticipate any further payments related to the acquisition of CoveyLink. The annual contingent payments were classified as goodwill in our consolidated balance sheets under the accounting guidance applicable at the time of the acquisition.
Prior to the acquisition date, CoveyLink had granted us a non-exclusive license for content related to The Speed of Trust book and related training courses for which we paid CoveyLink specified royalties. As part
of the CoveyLink acquisition, an amended and restated license for intellectual property was signed that granted us an exclusive, perpetual, worldwide, transferable, royalty-bearing license to use, reproduce, display, distribute, sell, prepare derivative works of, and perform the licensed material in any format or medium and through any market or distribution channel. We are required to pay the brother of one of our executive officers royalties for the use of certain intellectual property developed by him. The amount expensed for these royalties totaled $1.5 million, $1.4 million, and $1.4 million during the fiscal years ended August 31, 2017, 2016, and 2015. As part of the acquisition of CoveyLink, we signed an amended license agreement as well as a speaker services agreement. Based on the provisions of the speakers' services agreement, we pay the brother of one of our executive officers a portion of the speaking revenues received for his presentations. We expensed $1.2 million, $1.3 million, and $1.0 million for payment on these presentations during fiscal years 2017, 2016 and 2015. We had $0.7 million accrued for these royalties and speaking fees at each of August 31, 2017 and 2016, which were included as components of accrued liabilities in our consolidated balance sheets.
Acquired License Rights for Intellectual Property
During the third quarter of fiscal 2017, we acquired the license rights for certain intellectual property owned by Higher Moment, LLC for $0.8 million. The intellectual property is in part based on works authored and developed by Dr. Clayton Christensen, a well-known author and lecturer, who is a member of our Board of Directors. However, Dr. Christensen does not have an ownership interest in Higher Moment, LLC. The initial license period is five years and the agreement may be renewed for successive five-year periods for $0.8 million at each renewal date. The agreement may be terminated by either party at any time, but if we choose to terminate the agreement prior to the third renewal date, we are required to pay $0.3 million to Higher Moment, LLC.
Other Related Party Transactions
We pay an executive officer of the Company a percentage of the royalty proceeds received from the sales of certain books authored by him in addition to his annual salary. During the fiscal years ended August 31, 2017, 2016, and 2015, we expensed $0.2 million, $0.3 million, and $0.2 million for these royalties, and we had $0.1 million and $0.2 million accrued at August 31, 2017 and 2016 as payable under the terms of these arrangements. These amounts are included as a component of accrued liabilities in our consolidated balance sheets.
We pay the estate of the late Dr. Stephen R. Covey a percentage of the royalty proceeds received from the sale of certain books that were authored by him. We expensed $0.1 million in each of fiscal 2016 and fiscal 2015 for royalties under these agreements. At August 31, 2016, we had $0.2 million accrued for payment to the estate of the former Vice-Chairman under these royalty agreements. Amounts payable to the estate of Dr. Stephen R. Covey are included as components of accrued liabilities in our consolidated balance sheets.