We traveled with the management team of Franklin Covey this week. We continue to have a more bullish view of the medium- to long-term prospects for the stock than its near-term prospects. While strong growth in the education business and a catch-up of some delayed revenue should help the company’s fiscal fourth-quarter results, the company’s guidance for the fourth quarter (which ends at the end of August) still appears somewhat challenging unless Franklin Covey renews its contract with the federal government (which we do not believe has happened yet).
The fiscal fourth-quarter estimates are achievable (particularly at the revenue line), but they are certainly not a slam-dunk, and it is hard to see much upside potential. Still, we are optimistic about the company’s earnings growth potential over the next few years. After investing in the company’s sales support function and the size of its salesforce during the last few years, Franklin Covey appears poised to perhaps see an acceleration in its revenue growth and an increase in its incremental profit margin. As described later in this note, our analysis of the growth of the company’s salesforce and incremental margins suggests that EBITDA growth could be 25% or so for the next few years.
We are projecting 15% EBITDA growth for the next two fiscal years, as we have not yet seen the company’s revenue growth rate and incremental margin pick up (partly due to a variety of headwinds this year). With the stock trading at 8 times our fiscal 2015 adjusted EBITDA estimate, we believe it is reasonably attractive if EBITDA growth is in the double digits during the next few years, let alone if the pace of growth improves. Therefore, while we are a little cautious about the company’s fourth-quarter results, we continue to like the stock over the medium to long term.
The one area of the business that management sounds the most optimistic about right now is its education practice, which accounts for 15% of revenue. This practice has grown 20% year-to-date (including 30% growth last quarter) and grew 64% last fiscal year. A little more than half of the annual revenue for this practice comes in the fiscal fourth quarter, so this will be an important contributor to the fiscal fourth-quarter results. While the growth of this business has been explosive during the last five years, the company’s penetration remains very low at primary (K-6) schools in the United States. Management noted that clients are starting to ask strongly that Franklin Covey develop a similar program for middle schools.
It also is seeing some growing interest internationally, including in emerging markets where the number of schools is much bigger than in the United States. We also believe a fair amount of the salesforce growth is being dedicated to this practice. We thus expect revenue growth in this practice to remain above average during the new few years. If the education practice grows at 20%-25%, it will become the largest practice at the company within four to five years.