Franklin Covey (FC) Q3 2018 Earnings Conference Call Transcript

Franklin Covey (FC 1.09%)
Q3 2018 Earnings Conference Call
Jun. 27, 2018 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

[Operator instructions] Welcome to the Q3 2018 Franklin Covey earnings conference call. My name is Sheryl and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session.

[Operator. Instructions]. Please note that this conference is being recorded. I will now turn the call over to your host Derek Hatch. Sir, you may begin.

Derek Hatch -- Corporate Controller

Thank you, Sheryl. On behalf of Franklin Covey Company, I would like to welcome you to our third-quarter conference call to discuss our earnings this afternoon. Before we get started, I would like to remind everybody that this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management's current expectations and are subject to various risks and uncertainties including but not limited to the ability of the company to stabilize and grow revenues, the acceptance of and renewal rates for the All Access Pass, the ability of the company to hire productive sales professionals, general economic conditions, competition in the company's targeted marketplace, market acceptance of new products and services and marketing strategies, changes in the company's market share, changes in the size of the overall market for the company's product, changes in the training and spending policies of the company's clients, and other factors identified and discussed in the company's most recent annual report on Form 10-K and other periodic reports which are filed with the Securities and Exchange Commission. Many of these conditions are beyond our control or influence, any one of which may cause future results to differ materially from the company's current expectations. And there can be no assurance that the company's actual future performance will meet management's expectations.

These forward-looking statements are based upon management's current expectations and we undertake no obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of today's presentation, except as required by law. With that out of the way, I would like to turn the presentation over to Mr. Bob Whitman, our chairman and chief executive officer.

Bob Whitman -- Chairman and Chief Executive Officer

Thanks, Derek, and good afternoon to everyone. Hope you are well. We're happy to have the chance to talk with you today We're really pleased with the results for the third quarter. Over the last three years, we've consistently focused on four key objectives. These objectives outlined in Slide 3 are first, to achieve strong overall revenue growth and accelerating growth in the enterprise division.

Second, to achieve aggressive growth in the subscription-related business. Third, to expand our gross margins and finally, to continue to significantly increase the lifetime value of our customer and bill the clients for life. We're really pleased that in the third quarter and really through the three quarters here to date, we've made significant progress on each of these four objectives. I am just going to hit the bullet point on each. First, as you can see on Slide 4, first revenue growth was strong.

Revenue grew 15.3% in the third quarter and year to date is also growing 15.3%. So it's been consistent all year long. In addition to achieving strong overall revenue growth, one of our most important objectives has been to achieve robust growth in the enterprise division, our largest growth engine. Really pleased that revenue in the enterprise division grew 17.6% in the quarter and again 17.5% year to date and that invoiced sales amounts grew in the enterprise division grew 9.3% in the third quarter and have grown 8.9% year to date.

So we're delighted to return to high single-digit growth on the amount of invoiced sales in the enterprise division. Second, our subscription and related revenue growth were very strong. Our overall subscription and related revenue grew 43% in the third quarter and 47% year to date and subscription-related revenue in the enterprise division grew an even more significant 66% in the third quarter and 78% year to date. Third, our gross margin percentage continued to expand, reflecting the high margins associated with our subscription offerings. Our gross margin percent increased to 670 basis points in the third quarter to 69.2% compared to 62.5% in last year's third quarter and our gross margin dollars and gross profit increased 28% to $34.9 million. The same patterns have been going on year to date where our gross margin percentage has increased by 520 basis points year to date 69.4% and our gross margin dollars or gross profit has grown 24.6% to $100.5 million. Finally, the key factors, which are driving significant increases in our customer lifetime value were all very strong in the third quarter and have been strong year to date.

Our total number of paying subscribers increased 37% in the third quarter to 540,000. Our annual revenue retention continued to greater than 90% for the third quarter and year to date. Our sale of All Access Pass add-on services increased 50% year over year through the third quarter and a new factory retracking approximately 20% of our All Access Pass holders are now multiyear pass holders compared to only approximately 2% just a year ago and we expect this percentage to continue to increase. Our customers are really receiving tremendous benefit from the All Access Pass and related services. One recent example we are currently working with one of the largest tire manufacturers and retailers in the United States.

Two years ago this client initially purchased an All-Access Pass for 500 leaders in order to implement a single organizational initiative. This client achieved great success in year one and at renewal time expanded their pass from 500 leaders to 1500 leaders. They also purchased an additional 100 Franklin Covey delivered training days to help them implement their initiatives and they recently renewed their All Access Pass for an additional three years. The Franklin Covey implementation specialists are working with them and are helping them drive progress across four large separate organizationwide initiatives. So it's an exciting time for that client. It's an exciting time for implementation specialists and for us as you see the kind of value that the clients are receiving. We expect continued progress on these same four factors in the fourth quarter: revenue growth and accelerated growth in enterprise division, their subscription and related revenue growth, increase in their gross margins, and continued very high customer retention add-on sales, etc. As a consequence, we expect a very strong fourth quarter and full and strong full fiscal-year results.

In am going to now ask Steve Young to review our overall performance for the third quarter and year to date and then ask Paul Walker and Sean Covey to review performance highlights for the enterprise and education division specifically. Steve?

Steve Young -- Chief Financial Officer

Thank you, Bob and please good afternoon, everyone. I am happy to be able to share some numbers and add a little color to the numbers Bob talked about. We did have a strong third quarter. As Bob mentioned, our revenue grew 15.3%, both in the quarter and year to date and our total subscription and subscription-related revenue grew 43% in the third quarter and 47% year to date. Subscription and subscription-related revenue in the enterprise division grew at an even more rapid rate at 66% in the third quarter and 78% year to date. Deferred revenue billed on the balance sheet at the end of the third quarter was $34.5 million, a year-over-year increase of 46% or $10.9 million.

Deferred revenue billed and unbilled at the end of the third quarter was $49.6 million, a year-over-year increase of $23.5 million, or 90%, compared to the $26.1 million in total deferred revenue balances, again billed and unbilled, that we had at the end of last year's third quarter. Gross margin, our gross margin increased 670 basis points to $69.2 million in the third quarter and our gross margin dollars increased $7.6 million, or 27.7%, to $34.9 million. Third, our adjusted EBITDA was $0.6 million higher than last year and also slightly higher than our guidance even after making significant growth investments that we've talked about. Finally, our total number of paid subscribers grew 37% year over year in the third quarter and grew 45% in the enterprise division. I'll now provide just some additional detail on these key metrics that we just talked about. Slide 6 shows the 15.3% growth in revenue in the quarter to $50.5 million, which is a growth of $6.7 million compared with the $43.8 million of what revenue we reported in the third quarter of last year. Our revenue has grown $19.2 million, the same 15.3% to $144.9 million, compared with the $125.7 million of revenue we generated through the third quarter last year. Our total subscription and subscription-related revenue across both the enterprise and education divisions grew 43% in the third quarter and 47% year to date.

Subscription and subscription-related revenues in our enterprise division grew at an even faster 66% in the third quarter and 78% year to date, of course, driven by All Access Pass and pass-related sales. Our total subscription and subscription-related revenue plus the change in deferred revenue build and unbilled increased to $115.2 million, an increase of $30.5 million or 36% over the last four quarters. As shown in Slide 7, over the latest 12 months, All Access pass holders purchased $16.3 million of add-on services, a growth of $5.4 million or 50% compared to the $10.9 million in add-on services purchases by pass holders in the same 12-month period last year. As shown in Slide 8, our number of paying subscribers across both our enterprise and education divisions increased to approximately 540,000 in the third quarter, an increase of 140,000 or 37% from the approximately 400,000 subscribers that we had at the end of last year's third quarter. In the enterprise division, as shown in Slide 9, the approximately 377,000 person subscriber base at the end of the third quarter was up 120,000 subscribers or 45% compared with the 260,000 paying subscribers that we had at the end of last year. In the education division as shown in Slide 10, we had approximately 161,000 paying subscribers at the end of this year's third quarter, a growth of approximately 25,000 subscribers or 20% compared with approximately 135,000 paying subscribers that we had at the end of the third quarter last year. The significant growth in subscription and related revenue was partially offset by expected declines in our now much smaller legacy facilitator and delivery channels. So now deferred revenue, as shown on Slide 11, our total deferred revenue balances billed and unbilled, increased to $49.6 million at the end of the third quarter, a growth of $23.5 million, or 90%, year over year from $26.1 million in last year's third quarter. Deferred revenue build on the balance sheet at the end of the third quarter increased to $34.5 million year-over-year growth of $10.9 million or 46% compared with the balance of $23.6 million in the last year's third quarter. This growth came even with invoiced amounts in the education division being $2.5 million lower than the original plan, impacted by the maturation of a generosity multiyear funding agreement from a major donor over the past several years has added to the hundreds of new self-funded schools we add each year. Now deferred revenue unbilled, unbilled deferred revenue representing a business that is contracted but unbilled and off the balance sheet ended the third quarter at $15.1 million up more than six-fold compared to the $2.5 million and unbilled deferred revenue balance that we had at the end of the third quarter of last year. Now our adjusted EBITDA, we had expected and given guidance that our third-quarter adjusted EBITDA would be as much as 500,000 higher than what we reported in last year's third quarter. We're pleased that our actual third-quarter adjusted EBITDA was 600,000 higher than last year and slightly better than our expectation and guidance. This increase in adjusted EBITDA in the third quarter was a result of several factors. Our year-over-year reported revenue growth of $6.7 million, or the 15.3% that we mentioned several times here to $50.5 million.

Our gross margin percentage increased 670 basis points in the third quarter to 69.2% as shown in Slide 12, combined with our strong revenue growth this resulted in our gross margin dollars increasing $7.6 million or 28% to $34.9 million, compared to the $27.3 million in last year's third quarter. Now this $7.6 million increase in gross margin was benefited from the non-repeat of a $1.8 million charge related to exiting the publishing business in Japan last year. Excluding that benefit, gross margin dollars still increased $5.8 million, more than covering our nearly $5.2 million in a planned increase to growth investments related in the $600.6 million increase in adjusted EBITDA in the quarter. Year to date through the third quarter, our revenue has grown $19.2 million or 15.3% to $144.9 million. Our gross margin has increased 519 basis points to $69.4 million from $64.2 million year to date and our gross margin dollars have increased $19.9 million, or 24.6%, to $100.5 million and our year-to-date adjusted EBITDA has increased by $3.7 million. So good quarter. Paul?

Paul Walker -- Executive Vice President, Global Sales and Delivery

All right. Thanks, Steve. Hello everyone. Happy to have the opportunity to just share a little bit about the enterprise division third quarter and give a little bit of an update on where we are then year to date. In the enterprise division, third-quarter revenue came in at $39.9 million, representing growth of $6 million, or 17.6%, compared with revenue of $33.9 million in last year's third quarter.

In the enterprise division, the gross margin increased a significant 949 basis points to 73.2%, up from 63.7% in last year's third quarter. This combination of higher revenues and a higher gross margin percentage increased the enterprise division's gross margin dollars by $7.6 million in the third quarter. As noted by Steve previously, this $7.6 million increase in gross margin benefited from the non-repeat of a $1.8 million charge last year related to exiting the publishing business in Japan. This growth in gross margin dollars more than offset the $3.9 million of additional All Access Pass related growth investments that we made in the enterprise division in the third quarter, resulting in reported EBITDA of $4.3 million and amounted $1.9 million or 79% higher than in the last year's third quarter. Year to date just an update there here, through the third quarter, the enterprise division's revenue has grown $16.9 million, or 17.5%, to $113.7 million, compared with $96.8 million year to date through this point last year. Our gross margin has increased 698 basis points to 73.4% up from 66.4% last year. This combination of significantly higher revenue in a significantly higher gross margin percentage has driven a significant increase in the enterprise division's EBITDA to $11.7 million year to date through the third quarter this year, growth of $6.7 million or 133%, compared with $5 million in adjusted EBITDA generated in the first three quarters last year. As Bob mentioned earlier, this growth is really being driven by the high acceptance in our clients embracing the All Access Pass. He shared a brief example of how this is playing out.

I'll just share another brief one here. We're working with a large global consumer packaged goods company right now and we began working with them a little over a year ago and they bought an initial All Access Pass for 100 leaders and our client partner implementation specials began working with them and with the client, they identified a population of 2,000 leaders that needed to be developed more broadly and that is where you see the depth and the breadth and the richness of the All Access Pass come together because we have got our content in 16 languages now. We've got Jhana, we've got Robert Gregory Coaching Services, the digitized content that we have in addition to the traditional blockbuster branded instructor-led courses. We've worked with this client now to develop 21 unique Impact Journeys and those impact journeys are being deployed in multiple countries across 2,000 leaders today and recently the client just signed for another two years. And Impact Journey just quickly on that, this is really at the crux of what we're now able to help clients with that, that we weren't able to do it for All Access Pass. Traditionally a client would engage us and we might deliver A training program and that program might have a pre or post assessment but it was primarily built around a one or two or three-day experience. When we assembled the All Access Pass and as I mentioned earlier, we added the pieces like Jhana and the ability to push content and we digitized all of this content. We translated the languages and we created coaching services.

Now that same participant goes through an expanded journey that might be anywhere from a few weeks to a few months and in the process of that, that more immersive experience, we can really help the client change the behavior or build the capability is the better way to say it, of that leader to drive the outcomes the organization wants and so this one example the client is actually designed with us 21 of those journeys to meet the various needs for these 2,000 leaders. I've got literally hundreds of customers like this who were really pleased to be serving now and the All Access Pass is becoming an indispensable part of what they're doing and obviously, it's changed the basis for our relationship with them. As Bob noted, we're really pleased by the enterprise division 17.6% reported revenue growth in the third quarter and also that the enterprise division achieved growth of 9.3% in invoiced sales amounts, which is shown on Slide 15. We expect the enterprise division to also have a strong fourth quarter adding to its performance gains for this year. And now I'll turn it over to Sean.

Sean Covey -- Executive Vice President, Global Solutions and Partnerships

All right. Thanks, Paul. Hi everybody. This is Sean and I'm excited to give you a quick update on education and how we are doing there.

So on Slide 13 on the education division, the reported revenue of $9.2 million in the third quarter reflects year-over-year growth of $0.6 million, or 7.4%. The education division the adjusted EBITDA in the third quarter was a negative $0.7 million, which was less than last year's third-quarter EBITDA of $0.3 million and this reflects the staffing and marketing investments that the education division makes during the first, second and third quarters so that we can generate contracts and deliver in the fourth quarter. With the hundreds of new schools, this revenue is primarily recognized in the fourth quarter and as a reminder, in the fourth quarter, this is the quarter in which the education division generates about half of our annual revenue and virtually all of our annual EBITDA comes from the fourth quarter. Year to date through the third quarter, revenue for education has grown by $2.2 million, or 9%, to $27.4. So I am excited to share some other good developments in education. I am pleased to share that the Leader in Me, which is our primary model that we're selling. So our whole school-improvement model is now in over 4,000 schools and in over 50 countries and we're very excited to see it expanding around the globe through a partnership network similar to what we've created on the corporate side. For example, we now have over 300 leaders in these schools in Brazil through our partner there.

Just recently in the last couple of months, we entered China through several new partners, each owning pieces of China and we feel like this is going to bring on hundreds of new schools in the coming years in China. During the third quarter also, we signed up a new partner in Pakistan and with that, we got just recently 300 new Leader in Me schools starting up in Pakistan. So we're very pleased to see this global expansion and feel like that's one of the best opportunities we have for education. We're also excited about the Leader in Me expanding into the high school market. I am going to tell this year, the Leader in Me has primarily been available only for the elementary market and a little bit into the middle market but not much but based on high demand from districts who are doing a lot of Leader in Me with elementary schools and who want it in the upper levels, we've opened it up to high school this year and we're pleased that over 100 high schools will be joining the Leader in Me community this summer and we expect high schools to be a major source of growth for us in the coming years because with high school will come more expertise with middle schools. So basically doubles the size of our market opportunity from just the primary grades to the secondary market. I am also thrilled to now for this past week the Leader in Me was endorsed by an organization named CASEL, which stands for the collaborative academic social-emotional learning and the CASEL is a leading authority in the K-12 market for everything related to academic and social-emotional learning, and their endorsement is based on us meeting several standards, including the quality and breadth of our curriculum and then, most importantly, sufficient and valid empirical peer-reviewed research. Their endorsement basically states that we're a highly recommended provider in the K-12 market and that we have evidence to back it up.

We now have over 30 independent university studies that validate the positive impact of Leader in Me upon such measures as improved attendance, fewer behavioral problems in students, increased teacher and student engagement, increased academic achievement and the development of vital skills in student such as responsibility and goal-setting, resilience, problem-solving, public speaking, and communication. As we look to the fourth quarter, our contracting pays for new schools is strong and for the year, we plan to bring on about over 500 new schools in the U.S. and Canada. We also expect more than 90% of our current 2,400 Leader in Me school in the U.S. and Canada to renew their subscriptions, which is consistent with past years. We've always been around 90% or little higher.

As a consequence, we expect to achieve growth in both revenue and EBITDA in the education division in the fourth quarter. So I'll turn back to you, Bob.

Bob Whitman -- Chairman and Chief Executive Officer

Thanks so much Steve and Paul and Sean and as you can hear there are a lot of exciting things going on in the company and the flywheel continues to turn and quarter by quarter we just see the momentum continue to build based on driven by the impact we are having with customers, the ability to retain those customers, expand their relationships with us and expand our sales force and reach around the world. Finally, I'll just talk about making a note about our business model inflection point. We've now reached an inflection point we're under any of a wide variety of revenue growth scenarios. We expect to achieve strong revenue growth, increasing gross margins and then significantly increasing and accelerating flow-through of revenue to increases in adjusted EBITDA and cash flow. Underpinning this inflection is the powerful interplay among four key factors that are outlined in Slide 14. There is first, the positive and widening gap between the growth in our subscription-related revenue and the decline or the winding out of our legacy facilitator and on-site business. As you can see illustratively in figure 8, as you can see that 14, during the initial transition to All Access Pass in 2017, the significant rapid growth to our subscription-related revenue was largely offset by declines in revenue in the revenue for our legacy facilitator and on-site delivery channels even though only less than half the initial sales were made to those clients.

Nevertheless, it interrupted that channel. However in fiscal 2018, '19 and beyond, there is a positive gap growing between the growth of our subscription-related business and the decline in our increasingly smaller legacy facilitator and on-site business. That positive space is expected to continue to grow as the legacy business gets smaller and smaller and as we continue to achieve accelerated growth in the subscription side. So that's one driver of inflection. The second is the positive relationship between the growth of revenue and the lack of growth of our cost, the relative flatness of our cost increases in the future. In fiscal '19 and beyond, our incremental investments in new content, portals, localization as I said, will continue but be relatively small incrementally compared to fiscal '18's elevated levels. In addition, our central and central support costs are expected to remain essentially flat.

As a result as indicated in figures B in Slide 14, in fiscal '19 and beyond, a significantly higher portion of our increases in revenue and gross margin are expected to flow through the increases in adjusted EBITDA and cash flow. To just give you an example in '18 in fiscal '18, we expect revenue to grow approximately $27 million with a contribution to EBITDA, which is immediately obvious of about 40% of that incremental growth or an extra $11 million of EBITDA contribution being generated from those sales. In fiscal '18 however, because of the very significant increases in investments for implementation specialists, localization of content in the 15 languages, the new portal, the ERP system and other investments that we've made that won't have that same increment next year, of that $11 million increase in EBITDA contribution, about say $3.7 million or so will flow through to increase in EBITDA at least around the middle of our guidance range. In fiscal '19 however, if we were to achieve similar growth of $27 million, incremental growth of $27 million, a very large portion of the approximately $11 million or 40% incremental contribution from those sales would be expected to flow through the increases in adjusted EBITDA and cash flows. So that's a second important inflection point. The third factor is the relationship between the growth in revenue and the growth in adjusted EBITDA and that's just driven incrementally by the high margins that we have in the highly variable selling costs as we've just indicated, that as revenue grows aside from the not being central fixed cost, there is very high flow through because you have primarily commission sales force with high gross margins and that will drive it. And finally the relationship between the growth in adjusted EBITDA and the growth in pre-tax cash flow as illustrated in figure D in fiscal '19 and beyond, cash flow is expected to grow even more rapidly than reported revenue. This is due to the fact that the accounting for our subscription sales spreads recognition of the subscription revenue over the term of the contract even though most all of our subscription revenues build up from the time it's contracted. The accounting recognition of deferred revenue, therefore, significantly lags the collection of the cash and as a result, cash flow growth is expected to be even more rapid than the reported revenue going forward particularly with the reduced investment. So the interplay of all these key factors is expected to grow significant growth as we move forward also in the fourth quarter. So just in conclusion, ending where we started, summarizing the points already made in Slide 3, we've achieved strong revenue growth and an accelerated revenue growth in the enterprise division and we expect that to continue. We also expect strong revenue growth in the education division in the fourth quarter.

Second, our subscription-related momentum continues to be very strong, both in the enterprise and education divisions. Third, our gross margins continue to expand and we expect that will continue as the mix shift toward subscriptions continues. And fourth, each of those factors is driving a significantly increased customer lifetime value, which is forming a base for growth and retain more than 90% of our previous revenue and adding on services to increase its tremendous base for accelerated growth, which as we just pointed out we expect there will be a lot more flow through of that incremental growth as we move forward and that we are really on the cusp of that both in the fourth quarter and beyond. So with that point, I'll just turn the time to Steve to discuss our guidance and then we'll open it for questions.

Steve Young -- Chief Financial Officer

OK. Thanks, Bob. So our year to date adjusted EBITDA as we mentioned is $3.7 million higher than last year. So we know the math and are pleased that if our fourth quarter adjusted EBITDA result was the same as last year's $10.9 million, then adjusted EBITDA would $11.4 million for the year. Within our guidance range of $10 million to $15 million, we do expect Q4 adjusted EBITDA to be as much as last year with increases in sales and gross margin at least covering our increased growth investment.

Therefore, we affirm our original guidance of $10 million to $15 million and as you see if we have the same as last year, would be $11.4 million. We also mentioned for many of you I think would be interested in some of the schedules in the appendix. We put additional information there that we believe would be helpful to those of you who are analyzing the company and building models and those kinds of things. So we would encourage you to look at the schedules there where we intend to give you the information that you need to complete your analysis. So thank you.

Bob Whitman -- Chairman and Chief Executive Officer

Thanks, Steve. We will now ask the operator to open this up for questions. 

Questions and Answers:

Operator

Thank you. We'll now begin the question-and-answer session. [Operator. Instructions].

And our first question comes from Jeff Martin from Roth Capital Partners. Jeff, your line is open.

Jeff Martin -- Roth Capital Partners -- Analyst

Thanks. Good afternoon.

Bob Whitman -- Chairman and Chief Executive Officer

Hi, Jeff.

Jeff Martin -- Roth Capital Partners -- Analyst

Hi, Bob and Steve. How are you?

Bob Whitman -- Chairman and Chief Executive Officer

Great. How are you doing?

Jeff Martin -- Roth Capital Partners -- Analyst

Doing well. Thanks. Bob, could you give us an update on direct offices both domestically and internationally?

Bob Whitman -- Chairman and Chief Executive Officer

Yes. Paul?

Paul Walker -- Executive Vice President, Global Sales and Delivery

Yes, for the direct offices, make up the vast majority of the enterprise division update that we gave but they're doing well. They had a good third quarter.

Bob Whitman -- Chairman and Chief Executive Officer

In fact, the growth of the direct offices was a little higher than the licensee were relatively flat in the quarter. So the growth rate would have a couple hundred basis points higher in the enterprise division but for the licensees, all the rest of the relates to the direct keep going.

Paul Walker -- Executive Vice President, Global Sales and Delivery

Yes and just another note or two that we commented on the past, so All Access Pass is going well. It's been sold in the US and Canada, of course, the U.K., Australia. It's now that we've finished the translation, it's up and running in Japan and we're starting to sell there and we're kind of on the cusp of doing so in China and expect to do that in the first part of next fiscal year as all start selling in China. I don't know if Jeff helpful or if you have some specific questions.

Jeff Martin -- Roth Capital Partners -- Analyst

I guess that just leaves Australia then right.

Paul Walker -- Executive Vice President, Global Sales and Delivery

So the U.K., Australia, the US and Canada are all selling All Access Pass. Doing well with that. We are pleased with the revenue retention that we're seeing and Bob mentioned the services that are being sold, it's kind of uniform across all of the offices in terms of the performance related to All Access Pass.

Jeff Martin -- Roth Capital Partners -- Analyst

OK. And then and Bob last quarter you mentioned the decline in the legacy on-site and related would be about $7 million to $8 million this year. Just looking for an update if that's tracking to that...

Bob Whitman -- Chairman and Chief Executive Officer

Yes that's tracking Jeff, our guess is by the end of the year it will be exerted about a $7 million drag on growth that will be smaller again next year and the following year. So the break is coming off year by year as that business gets smaller and it will be a smaller drag this year and smaller drag again next year.

Jeff Martin -- Roth Capital Partners -- Analyst

OK. And then you also mentioned I think three new content programs last quarter. Could you speak generally to the new company or the content strategy and then specifically to some of those newer programs?

Bob Whitman -- Chairman and Chief Executive Officer

Yes just speaking to this strategy, yes thanks Jeff, just speaking to this strategy, long ago, we made 17 years ago we made the commitment to not only build in fact to develop capabilities in people but to connect those capabilities to specific outcomes and like sales performance or customer loyalty or execution of a major initiative and today over a third of all of our revenues relate to a circumstance for our client actually is engaging us to help drive home a specific outcome. So our content strategy is then across three things. One, we'll continue to be strong in building individual capabilities, particular personal and interpersonal capabilities there.Second, we want to build particular strong capabilities around two groups of leaders. One group is the first level leader, the first is really which is really the connection between the company's strategy and its customers and that's an increase, it's always been important but it's increasingly important as layers have been taken away above those managers and they are now doing jobs that require their managing teams virtually and their sectors.

So that's a big effort for us.We had Jhana there. We have a new course focused on that one, we call the six clinical practices for leading a team. We have a new book coming out in that same area. Everyone deserves a great manager.

We put additional resources there. Another level is for the senior level manager who is responsible not only for leading a team but leading a team of teams, leading in multiple teams and so leading leaders of teams and we have a new offering there called the four essential rules of leaders.We also have an integrated solution that combines trust and execution for those people. We're taking the Jhana capability that exists that was primarily focused for the first level managers and adding that capability with weekly feeds for senior-level managers in education ultimately also for individuals to be effective.So everybody will be getting their ultimately getting there Jhana weekly but for a specific job to be done and we're then trying to just and then we're also focusing on that connection between capability and outcomes and we already have execution.We're tying it very tightly to offerings like customer loyalty, manufacturing sales performance things like that and a strong broader offering on accountability throughout an organization. So that's our map.

Is that helpful?

Jeff Martin -- Roth Capital Partners -- Analyst

It is. It is. And then the last question if I hop off here, your growth strategy longer-term how do you envision it in terms of sources of growth in terms of new content versus adding salespeople versus growing with existing pass holders. How do you envision that over the intermediate and longer term?

Bob Whitman -- Chairman and Chief Executive Officer

Yes leaving out the decline of legacy business, so you usually have the pure growth of vehicles. If we can just retain revenue of more than 90% of the previous customers and add on 30% to 40% of that on sales, we already are in growth land each year just from retention and add-on sales.The driving of new cast sales though and so that's important, driving a new past sales and growth beyond that involves the growth of the sales force in two components. The first is the ramp-up of people we already have. We have $40 million of revenue potential if we didn't hire another salesperson just ramping those people up that we already have who are in their first or second or third year of the five-year ramp just continuing to ramp those should add $40 million of revenue over the next couple years.And then we've never stopped on the issue of growing sales force although if you look at our number, you would say we had in the last year because we haven't grown the net sales force very much but that really mask what's been happening, three years ago, we had hired about 25 salespeople just to handle all of our events and so facilitators there.When we moved to All Access Pass, we decided that group of people just wasn't geared to do the kind of strategic selling.

And so while we've hired and retained a bunch of new people, we had also lost that group of 25 by choice and by design but we continue that strategy and so I think as you go forward, the addition of new salespeople ensuring the ramp of a new salespeople, the growth of our licensees that's kind of the distribution growth.The retention of new customers, of existing customers and add-on sales, could continue without a lot of new content but we want to build the strategic viability and importance of what we're doing by adding a few key pieces of content each year that strengthen our major strategic modes.

Jeff Martin -- Roth Capital Partners -- Analyst

OK, that's helpful. Thanks very much.

Bob Whitman -- Chairman and Chief Executive Officer

Thanks, Jeff.

Operator

Our next question comes from Marco Rodriguez from Stonegate Capital. Marco your line is open.

Bob Whitman -- Chairman and Chief Executive Officer

Hi, Marco.

Marco Rodriguez -- Stonegate Capital -- Analyst

Hey, guys. How are you?

Bob Whitman -- Chairman and Chief Executive Officer

Great. How are you doing?

Marco Rodriguez -- Stonegate Capital -- Analyst

Doing really wel, thanks. Real quick question here. Shifting over to the leader in the education division and maybe if you can talk a little bit about the same in expansions on a year over year, also on a year-to-date basis, some fairly significant growth rates and I know you talk to the fact that you've been adding and making some investments there.

Was there any other sort of one-off type expenses or very large expenses that are not repeatable or are those types of run-rate numbers now?

Steve Young -- Chief Financial Officer

So our basic SG&A expenses and the increases, yeah, those are we do this every year where we make a lot of client partner investments, marketing investments, other infrastructure investments that help us get ready for the fourth quarter, which is when we bring out all the new schools and do most of the training during the summer months. So those are expenses that we think will pay off in the fourth quarter and will pay off and in coming years as well. So those aren't one-time expenses. These are infrastructure, These are bodies. These are people.

They are not just one-time things that will go away. So we have that infrastructure in place but we think it's going to give us necessary to bring on 500 plus new schools in the fourth quarter as well as all the retention of the 2500 schools that we have right now.

Bob Whitman -- Chairman and Chief Executive Officer

Marco the one investment though that was made this year that won't incrementally increase is the one in research that really backed up you the CASEL certification and so forth. We made the determination that it was such an important thing in the education of peer-reviewed research and to make sure that we had a fertile field for doing that research. And so we upped our investment by almost $800,000 this last year. That level won't go down a lot next year and we think we can retain that but you won't have an incremental gain. That was a big jump this year for us that won't be incrementally repeated each year whereas the other ones will.

Marco Rodriguez -- Stonegate Capital -- Analyst

Gotcha. OK. And you mentioned in your prepared remarks on the education side that The Leader in Me, you're starting to kind of move that into the high school market and thereby kind of I guess doubling the market opportunity for you guys, if you can talk a little bit about how that sort of started and how you started to make your way into the high school market? And then if you could maybe talk a little bit about what might need to be changed in terms of delivery of the contact because I'm assuming that it's a little bit different to communicate with a team versus I am not sure you could.

Bob Whitman -- Chairman and Chief Executive Officer

Yes sure. Yes, so it is. We actually started in the high school market years ago, when we were much smaller. So we got some experience with working with them but the Leader in Me started in elementary.

We've gotten really good at it. We understand that market really well and what happens if you're selling to districts ultimately and these districts will bring on if they have 20 schools, they'll bring on two elementary Leader in Me schools. They have great success with it. They like it. They go into the middle school and into the high schools and they start saying will hey, we really like this.

We like what we've done. We would like to continue this. And so there has been a lot of pressure through the years and for five years in a row, we've said no, not this year and we've got so much growth opportunity with elementary, let's just stick with it but finally there has been so much pressure from districts to develop a middle school and a high school solution that we decided that now is the time. So we spent the last two years developing the high school solution.

We set the money on it already and we're launching it right now. We made a lot of adjustments. There are some things that work in Leader in Me in elementary that didn't work in high school. Because we had maybe 20 schools beta testing for the last four years, we kind of figured out what's working and what's not. So we made some adjustments.

It's more classroom based. We have some really good curriculum around college and career success in readiness around leadership skills. It goes a lot deeper than we do at the elementary level and it really prepares them for college and the workforce. So we think that there's a lot of money in high schools. There's a lot of opportunities.

95% of our business is K-6 right now. You add 7 to 12, we really think the market opportunity doubled. So this is our first year into it and we think we will get 100 schools, which is about double what we were expecting next year, and we think we can get 250 and we could see that grow really fast over the next five to seven years.

Marco Rodriguez -- Stonegate Capital -- Analyst

Got it. And do you have the capacity on the sales, five sales head side to deliver that or do you have to add additional people for that sort of a growth expectation?

Bob Whitman -- Chairman and Chief Executive Officer

I think the sales side will be similar to what it's been. We'll just keep adding 8 to 10 new salespeople a year. We're not going to divide the sales group between high school and primary and secondary because they're selling to districts right and they want to keep that relationship. So we think that we'll have and we'll continue to have our same salespeople selling both ways. This year we had a few of them that really cracked the code on it and they basically kind of did the same amount of new schools on the elementary side and added a lot of high schools on top of that. We'll watch it closely.

If it comes a time where we need to divide the two we well but we don't think it's the way to go at this point but yes, we think we have the capacity to deliver good growth next year in both markets with our current strategy around salespeople.

Marco Rodriguez -- Stonegate Capital -- Analyst

Understood. And shifting gears here, Bob, maybe if you could just talk a little bit more here on the shift in the business model? Obviously, it's taken a little bit of time but the numbers are starting to show the grand scheme if you will but during this time we've had some changes in terms of the way you were structuring that business model and how sales were going to be made to the end customer. Do you feel as if now you are kind of settled on the formula as far as how to deliver everything content wise and sales wise or there are other initiatives maybe that you might be thinking about in the back of your mind that that might improve things or accelerating down the road?

Bob Whitman -- Chairman and Chief Executive Officer

Thanks, Marco. I am going to let Paul respond firstly.

Paul Walker -- Executive Vice President, Global Sales and Delivery

Just a couple of comments Marco, good question. I think the short answer is yes, I think that we have a strategy we believe in. We think things have filled out to use your word there, for example, the first couple years trying to figure out what was the right support model for these All Access pass holding clients relative to implementation specialists. And we toyed around with a hybrid model that you think some of our delivery can form who delivered by day and kind of were supporting clients by night almost and we've now centered in half of this past little over a year now have been using a full-time team for that. It's working really well and so that's just one example of probably it doesn't whereas we encounter new things that to figure out how to fall for those but today primarily we have sales force that's very talented increasing in their skill and capability to go position a subscription-type sales that's renewable asset that once they've sold that, they are in there working with the client to look for expansion opportunities. We now know how to work through the renewal cycle and the procurement cycle. These things were new to us when we first started that having to have a contract for everything versus just a simple order for our facilitator purchase and so I do think for us the key will be keeping the revenue retention high, which we're doing, continuing to focus on some of these new service opportunities like coaching. We're just scratching the surface with what we can do with the Robert Gregory coaching content is growing rapidly but just scratching the surface there and so it will be adding client partners and then going deeper within the accounts we have and driving new sales, I think.

Bob Whitman -- Chairman and Chief Executive Officer

Marco just one other comment is that this probably isn't obvious but we don't have any salespeople that weren't running the play and this is a great credit to our leadership. We had 17 managing directors who lead the direct sales forces and they're really, it's not like we got part of the sales force still selling the old way in part new. Everybody is selling the new thing. That transition is they're across the bridge on that and so it seems like now it's not like we ask ourselves every day how we can do something better. It's not like we think we have everything figured out but we do have something just delivering consistent increases in new past sales, retention, add-on sales, and our counter meetings are always it's been on the things we're not doing well but that is not structural anymore.

We are across the bridge on organizationally now. It's just performance.

Marco Rodriguez -- Stonegate Capital -- Analyst

Understood. Thanks a lot, guys. I appreciate your time.

Bob Whitman -- Chairman and Chief Executive Officer

Thank you so much.

Operator

Our next question comes from Kevin Liu from B. Riley. Kevin, your line is open.

Bob Whitman -- Chairman and Chief Executive Officer

Hi Kevin.

Kevin Liu -- B. Riley & Company -- Analyst

Hi. Good afternoon. First I just wanted to clarify something I thought I heard on the call. Did you guys say that the invoice amount in education missed by $2.5 million relative to plan and if so, could you kind of elaborate on some of those causes?

Steve Young -- Chief Financial Officer

We did. We're saying through the third quarter, we were $2.5 million behind the plan in the education group. I'll let Sean speak to that. He thinks he is going to make up a portion of that if not all in the fourth quarter but you can just address that Sean.

Sean Covey -- Executive Vice President, Global Solutions and Partnerships

Yes, we've had a couple things. One is, we've had a large multiyear funding agreement from a major donor that's helped sponsor new schools as corporation really believe in what we're doing and that was six-year agreement and that's basically it's come to an end and that's hurting us. We thought that we perhaps could get that renewed. They're probably going to wait a year or two before they start up again. So that was kind of unexpected and that's about as down some.

Also just as a reminder about 50% of our revenue and over 60% of our contracted revenue happens in the fourth quarter. So much of the year depends upon how we do in the fourth quarter. We feel pretty good about our growth prospects in the fourth. So --

Bob Whitman -- Chairman and Chief Executive Officer

We can address that Kevin. We can speak more but I think basically we just want to make clear that we were down a little bit versus our plan. We were up on plan generally overall and our gross margins are so much higher. Then EBITDA-wise, we are well ahead. Gross revenue education has been off versus plan a little bit year to date primarily because of the reason I've spoken to.

Kevin Liu -- B. Riley & Company -- Analyst

Yes, no that's helpful context. And then the other question I had was just around facilitator sales. Could you just remind me how much it's down year to date and as you look to Q4 I would imagine that's always been kind of the more pronounced period for facilitator sales? How should we think about those sales trends kind of shifting over to AAP subscription invoicing?

Bob Whitman -- Chairman and Chief Executive Officer

What's in our plan, last year we were down to about $14 million of facilitator sales in the U.S. offices. We expected that would be down about 45% this year, just a combination of people transitioning and just some of that business is always episodic, and not repeating each year. We were down a little less than that and my guess is that we will end up the year at somewhere around $9 million of facilitator sales. So we're not counting, Paul, on a huge, a big fourth quarter in facilitator. We normally had a promotion, it'll be smaller this year.

Just in the sales, it's almost distraction for the sales force to focus on that, but we do have a team in the side sales partners that are working on this. Paul, I don't know if you want to add something.

Paul Walker -- Executive Vice President, Global Sales and Delivery

No, we expect it will be down in the fourth quarter like we expect it to be down throughout the year and so --

Bob Whitman -- Chairman and Chief Executive Officer

It might be a little better than that.

Paul Walker -- Executive Vice President, Global Sales and Delivery

Might be a little better, yes.

Kevin Liu -- B. Riley & Company -- Analyst

Maybe asking the question a little bit differently, and because Q4 used to be so big for facilitator sales, do you guys have any sort of enhanced promotions or anything to that effect to help drive conversely a bigger benefit to your AAP invoicing activity?

Paul Walker -- Executive Vice President, Global Sales and Delivery

Yes, we've got, we do a number of little things to that point, initiatives that we have going on internally that we use with our clients to drive for example expansion revenue within our current pass holders. And so the client I spoke about earlier and my example expanded from a 100% pass to a 2,000-person pass. So they added 1,900 users. Not everybody has 1,900 users but we are constantly in there working with clients to try to expand what they're doing.

That certainly gives us benefit inside a given quarter. The heavy focus on selling new logos that benefits us in a quarter and then in the fourth quarter there are a lot of passes to renew from prior years selling activity.

Bob Whitman -- Chairman and Chief Executive Officer

As you know Kevin, these activities no longer affect the quarter very much. So we have the expenses associated within the quarter and the revenue gets puts on those started deferred balances. So very little of that effort will actually affect the quarter rather than on the expense side but it does drive longer-term contracts, etc., that will benefit net year.

Kevin Liu -- B. Riley & Company -- Analyst

All right, understood and appreciate you taking the questions.

Bob Whitman -- Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Trevor Romeo from William Blair. Trevor, your line is open.

Bob Whitman -- Chairman and Chief Executive Officer

Hi, Trevor. How are you?

Trevor Romeo -- William Blair -- Analyst

Good. How are you?

Bob Whitman -- Chairman and Chief Executive Officer

Great.

Trevor Romeo -- William Blair -- Analyst

Yes, it's Trevor in for Tim today. Thanks for taking the questions. Yes, so I guess if I understood the comment in the prepared remarks correctly, it sounded like adjusted EBITDA in the fourth quarter would be similar to the level in the fourth quarter last year. And I would've expected it to be maybe up a bit given the strong revenue growth that you guys have been seeing lately. So could you maybe just talk about what's driving that? Is it really only just a result of the investments you're making or is there anything else going on there?

Steve Young -- Chief Financial Officer

The only other thing that's going on there that would be cost-related is that our pattern of recognizing annual bonuses and commissions is skewed significantly toward the fourth quarter because that's when I call profit and since the annual bonuses are driven primarily by profit or the change in profit, we have a fairly significant increase in compensation in the fourth quarter just related to commissions and bonuses. And then we've talked a lot about the investments we've made in the year. A portion of those investments will be made in the fourth quarter and so we expect it will be a good fourth quarter and you look at the numbers in the fourth quarter is a very profitable and good fourth quarter. So our comment is partially reflecting the fact that last year's fourth quarter was so good and we expect an equally good fourth quarter this year and the pattern will most likely be revenue being good, our gross margin being up and our SG&A being up because of the investments we're making and what we just talked about, again still resulting in a great quarter that's probably consistent with last year and maybe a little bit more.

Bob Whitman -- Chairman and Chief Executive Officer

And Trevor just following up also on Kevin's question about the fourth quarter, obviously on the amount of business that we contract or invoice during the fourth quarter just a much smaller percentage of it shows up in the quarter even though you have all the expenses and so as a consequence this huge lumpiness that we always had in the fourth quarter will become less and less so as we add more of this deferred revenue.

Trevor Romeo -- William Blair -- Analyst

OK. Got it. Understood, thanks. And then just what kind of operating cash flow do you expect to generate this year and I guess just generally with the subscription model gaining some more traction, what sort of I guess cash flow conversion ratio do you see for the business going forward?

Steve Young -- Chief Financial Officer

Yes, it's Steve here. Historically, let's just say cash flow relative to adjusted EBITDA -- of course and if you add back the balance of the increase in deferred revenue toward our cash flow -- historically our cash flow has really been tracked at very high, very close to our adjusted EBITDA because you add to it the amortization of capitalized development cost that's already deducted from purchase of gross margin and then subtracting the capex and such to get to our cash flow. And so it's usually pretax been maybe $3 million or $4 million less than our adjusted EBITDA or the adjusted EBITDA plus the change in deferred and so the contribution issue will actually be similar to that. It's just that we may in a very similar way, the cash we're generating will be very strong this year and our investments this year with the incremental investment in implementation specialists, the $3.5 million for the localization of content in 16 languages, $4 million of portal cost, $5 million investment in the ERP system, etc., we invested those in things that we won't have to invest in again next year that at least won't have to increase next year. And on a cash basis form actually be investing in a lot of those next year but so the cash generation will be high about $4 million less than the sum of adjusted EBITDA plus the change in deferred and our investments were also higher this year. And one other point, Bob, is certainly that part of the reason the incremental increase in cash is so high compared to the incremental increase in adjusted EBITDA is that our balance sheet consumes less than 20% about 15% of that incremental adjusted EBITDA is consumed on the balance sheet by an increase in receivables. So it makes a very high flow-through of cash available for the capital investment that Bob talked about.

Trevor Romeo -- William Blair -- Analyst

OK, great. Thank you, guys, very much for the detail.

Bob Whitman -- Chairman and Chief Executive Officer

Thanks for the great questions.

Operator

And our final question comes from Patrick Retzer from Retzer Capital. Patrick, your line is open.

Patrick Retzer -- Retzer Capital Management LLC -- Analyst

Good afternoon, gentlemen. Congratulations on another great quarter.

Bob Whitman -- Chairman and Chief Executive Officer

Thanks, Pat.

Patrick Retzer -- Retzer Capital Management LLC -- Analyst

So you just got done talking about cash and cash flow. Bob, a year ago you made a couple of significant acquisitions. Since then understandably you've been pretty quiet on the stock buyback front, even though historically you've been very aggressive there. Can you comment on the outlook for buying stock back here in the foreseeable future?

Steve Young -- Chief Financial Officer

Sure. Yes, I think your analysis is exactly right. In this past year and a little bit before, we made a couple of acquisitions. We invested in the new portal, localization of the content, a new ERP system. So our capital spending was planned and it was significantly higher than it has been in other years. And at the same time, we are having the transition to the All Access Pass that we're making the growth in investment there. So as Bob talked about, the incremental flow through to cash of the incremental increase in adjusted EBITDA will generate and the decrease amount that we allocate to capital spending will mean that we'll have excess cash again in the near future and what we have normally done is if there is no acquisition or something like that is to buy back shares. So we're still the same people with the same overall capital strategies and intend to buy back shares with excess cash.

Patrick Retzer -- Retzer Capital Management LLC -- Analyst

OK, that sounds good. That's all I had. Keep up the good work and thanks for your effort.

Bob Whitman -- Chairman and Chief Executive Officer

Thanks, Pat. We appreciate your support. Any other questions?

Operator

At this time, we show no further questions in queue.

Bob Whitman -- Chairman and Chief Executive Officer

All right. We'll then just conclude by again thanking each of you for joining us during the call today. Maybe moreover thank you so much for your tremendous focus you've had over this transition over the last couple of years, being willing to invest the time and the analysis which wasn't easy and really learning the business, understanding what drives it. We're grateful that we're now showing there is all those factors are headed in the right direction and hopefully it makes it a little easier to follow us but we really appreciate everyone sticking in there through this transition and we look forward to now to hopefully rewarding everybody. So thanks very much.

Operator

[Operator signoff]

Duration: 70 minutes

Call Participants:

Derek Hatch -- Corporate Controller

Bob Whitman -- Chairman and Chief Executive Officer

Steve Young -- Chief Financial Officer

Paul Walker -- Executive Vice President, Global Sales and Delivery

Sean Covey -- Executive Vice President, Global Solutions and Partnerships

Jeff Martin -- Roth Capital Partners -- Analyst

Marco Rodriguez -- Stonegate Capital -- Analyst

Kevin Liu -- B. Riley & Company -- Analyst

Trevor Romeo -- William Blair -- Analyst

Patrick Retzer -- Retzer Capital Management LLC -- Analyst

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