Form 10Q 07-11-06 (3rd Quarter)
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 27, 2006

 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission file no. 1-11107
 
 
FRANKLIN COVEY CO.
(Exact name of registrant as specified in its charter)
 
Utah
(Stae of incorporation)
 
87-0401551
(I.R.S. employer identification number) 
 
2200 West Parkway Boulevard
Salt Lake City, Utah
(Address of principal exective offices)
 
 
 
84119-2099
(Zip Code) 
 
Registrant's telephone number,
Including area code 
 
 
 
(801) 817-1776
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes
 
x
No
 
o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer
 o
 
Accelerated filer
o
 
Non-accelerated filer
x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes
 
o
No
 
x

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock as of the latest practicable date:

19,887,747 shares of Common Stock as of July 5, 2006

 
Index
 
 
Page 
Financial Statements 
Note 1 - Basis of Presentation
Note 2 - Accounting for Stock-Based Compensation
Note 3 - Inventories
Note 4 - Intangible Assets
Note 5 - Preferred Stock Redemptions and Purchases of Company Common Stock
Note 6 - Income Tax Benefit
Note 7 - Legal Settlement
Note 8 - Comprehensive Income
Note 9 - Earnings Per Share
Note 10 - Segment Information
Note 11 - Management Common Stock Loan Modifications
Results of Operations
Liquidity and Capital Resources
Use of Estimates and Critical Accounting Policies
New Accounting Pronouncements
Market Risk of Financial Instruments
Controls and Procedures
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Other Information
Exhibits
Signatures
 

 
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
 
FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)

   
May 27,
2006
 
August 31,
2005
 
   
(unaudited)
 
ASSETS
         
Current assets:
             
Cash and cash equivalents
 
$
28,804
 
$
51,690
 
Restricted cash
   
-
   
699
 
Accounts receivable, less allowance for doubtful accounts of $1,155 and $1,425
   
26,684
   
22,399
 
Inventories
   
22,395
   
20,975
 
Other current assets
   
9,106
   
9,419
 
Total current assets
   
86,989
   
105,182
 
               
Property and equipment, net
   
33,715
   
35,277
 
Intangible assets, net
   
80,439
   
83,348
 
Other long-term assets
   
10,714
   
9,426
 
   
$
211,857
 
$
233,233
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
             
Current liabilities:
             
Current portion of long-term debt and financing obligation
 
$
576
 
$
1,088
 
Accounts payable
   
11,418
   
13,704
 
Income taxes payable
   
1,490
   
3,996
 
Accrued liabilities
   
33,660
   
36,536
 
Total current liabilities
   
47,144
   
55,324
 
               
Long-term debt and financing obligation, less current portion
   
33,707
   
34,086
 
Other liabilities
   
1,186
   
1,282
 
Deferred income tax liability
   
9,715
   
9,715
 
Total liabilities
   
91,752
   
100,407
 
               
Shareholders’ equity:
             
Preferred stock - Series A, no par value; 4,000 shares authorized, 1,494 and 2,294 shares issued and outstanding; liquidation preference totaling $38,278 and $58,788
   
37,345
   
57,345
 
Common stock - $0.05 par value; 40,000 shares authorized, 27,056 shares issued and outstanding
   
1,353
   
1,353
 
Additional paid-in capital
   
186,272
   
190,760
 
Common stock warrants
   
7,611
   
7,611
 
Accumulated deficit
   
(1,033
)
 
(14,498
)
Deferred compensation on unvested stock grants
   
-
   
(1,055
)
Accumulated other comprehensive income
   
770
   
556
 
Treasury stock at cost, 6,897 and 6,465 shares
   
(112,213
)
 
(109,246
)
Total shareholders’ equity
   
120,105
   
132,826
 
   
$
211,857
 
$
233,233
 
               
 
See notes to condensed consolidated financial statements.
 
3

FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)

   
Quarter Ended
 
Three Quarters Ended
 
                   
   
May 27,
2006
 
May 28,
2005
 
May 27,
2006
 
May 28,
2005
 
   
(unaudited)
 
(unaudited)
 
Net sales:
                 
Products
 
$
32,184
 
$
35,217
 
$
126,428
 
$
134,443
 
Training and consulting services
   
31,098
   
30,571
   
87,538
   
82,972
 
     
63,282
   
65,788
   
213,966
   
217,415
 
Cost of sales:
                         
Products
   
15,584
   
16,908
   
56,536
   
61,297
 
Training and consulting services
   
11,406
   
10,612
   
28,558
   
26,198
 
     
26,990
   
27,520
   
85,094
   
87,495
 
Gross profit
   
36,292
   
38,268
   
128,872
   
129,920
 
                           
Selling, general, and administrative
   
35,629
   
36,095
   
108,885
   
110,964
 
Depreciation
   
1,134
   
1,848
   
3,763
   
6,346
 
Amortization
   
908
   
1,043
   
2,911
   
3,130
 
Income (loss) from operations
   
(1,379
)
 
(718
)
 
13,313
   
9,480
 
                           
Interest income
   
307
   
310
   
953
   
592
 
Interest expense
   
(663
)
 
(29
)
 
(1,966
)
 
(95
)
Gain on disposal of investment in unconsolidated subsidiary
   
-
   
500
   
-
   
500
 
Legal settlement
   
-
   
-
   
873
   
-
 
Income (loss) before benefit for income taxes
   
(1,735
)
 
63
   
13,173
   
10,477
 
Income tax benefit
   
2,754
   
3,006
   
292
   
1,203
 
Net income
   
1,019
   
3,069
   
13,465
   
11,680
 
Preferred stock dividends
   
(934
)
 
(2,184
)
 
(3,452
)
 
(6,551
)
Loss on recapitalization of preferred stock
   
-
   
(7,753
)
 
-
   
(7,753
)
Net income (loss) available to common shareholders
 
$
85
 
$
(6,868
)
$
10,013
 
$
(2,624
)
                           
Net income (loss) available to common
shareholders per share:
                         
Basic
 
$
.00
 
$
(.34
)
$
.50
 
$
(.18
)
Diluted
 
$
.00
 
$
(.34
)
$
.48
 
$
(.18
)
                           
Weighted average number of common shares:
                         
Basic
   
20,060
   
19,922
   
20,234
   
19,847
 
Diluted
   
20,734
   
19,922
   
20,670
   
19,847
 
 
See notes to condensed consolidated financial statements.

4
FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
   
Three Quarters Ended
 
   
May 27,
2006
 
May 28,
2005
 
   
(unaudited)
 
Cash flows from operating activities:
         
Net income
 
$
13,465
 
$
11,680
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation and amortization
   
8,046
   
11,082
 
Restructuring cost reversal
   
-
   
(306
)
Stock-based compensation cost
   
567
   
729
 
Compensation cost related to CEO common stock grant
   
-
   
404
 
Gain on disposal of unconsolidated subsidiary
   
-
   
(500
)
Changes in assets and liabilities:
             
Increase in accounts receivable, net
   
(4,264
)
 
(6,095
)
Decrease (increase) in inventories
   
(1,388
)
 
2,253
 
Decrease in other assets
   
856
   
957
 
Decrease in accounts payable and accrued liabilities
   
(4,628
)
 
(5,450
)
Increase (decrease) in other long-term liabilities
   
(192
)
 
470
 
Increase (decrease) in income taxes payable
   
(2,535
)
 
(1,547
)
Net cash provided by operating activities
   
9,927
   
13,677
 
               
Cash flows from investing activities:
             
Purchases of property and equipment
   
(3,318
)
 
(2,671
)
Purchases of short-term investments
   
-
   
(10,653
)
Sales of short-term investments
   
-
   
21,383
 
Proceeds from sale of investment in unconsolidated subsidiary
   
-
   
500
 
Curriculum development costs
   
(1,812
)
 
(1,699
)
Net cash provided by (used for) investing activities
   
(5,130
)
 
6,860
 
               
Cash flows from financing activities:
             
Principal payments on long-term debt and financing obligation
   
(965
)
 
(87
)
Change in restricted cash
   
699
   
-
 
Proceeds from sales of common stock from treasury
   
333
   
35
 
Proceeds from management stock loan payments
   
134
   
840
 
Redemption of preferred stock
   
(20,000
)
 
-
 
Purchase of treasury shares
   
(3,982
)
 
(22
)
Payment of preferred stock dividends
   
(3,952
)
 
(6,551
)
Net cash used for financing activities
   
(27,733
)
 
(5,785
)
               
Effect of foreign exchange rates on cash and cash equivalents
   
50
   
(473
)
Net increase (decrease) in cash and cash equivalents
   
(22,886
)
 
14,279
 
Cash and cash equivalents at beginning of the period
   
51,690
   
31,174
 
Cash and cash equivalents at end of the period
 
$
28,804
 
$
45,453
 
               
Supplemental disclosure of cash flow information:
             
Cash paid for interest
 
$
2,001
 
$
79
 
Cash paid for income taxes
 
$
2,284
 
$
770
 
               
Non-cash investing and financing activities:
             
Accrued preferred stock dividends
 
$
934
 
$
2,184
 
Issuance of unvested common stock for compensation plans
   
212
   
720
 
Loss on recapitalization of preferred stock
    -    
(7,753
)
Capital lease financing of property and equipment purchases
   
109
   
-
 
See notes to condensed consolidated financial statements.
5

FRANKLIN COVEY CO.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
NOTE 1 - BASIS OF PRESENTATION

Franklin Covey Co. (hereafter referred to as us, we, our, or the Company) provides integrated consulting, training, and performance enhancement solutions to organizations and individuals in strategy execution, productivity, leadership, sales force effectiveness, effective communications, and other areas. Each integrated solution may include components of training and consulting, assessment, and other application tools that are generally available in electronic or paper-based formats. Our products and services are available through professional consulting services, public seminars, retail stores, catalogs, and the Internet at www.franklincovey.com. Historically, the Company’s best-known offerings include the FranklinCovey Planner™, and a suite of new and updated individual-effectiveness and leadership-development training products based on the best-selling book, The 7 Habits of Highly Effective People. We also offer a range of training and assessment products to help organizations achieve superior results by focusing and executing on top priorities, building the capability of knowledge workers, and aligning business processes. These offerings include the popular workshop FOCUS: Achieving Your Highest Priorities™, The 4 Disciplines of Execution™, The 4 Roles of Leadership™, Building Business Acumen: What the CEO Wants You to Know™, the Advantage Series communication workshops, and the Execution Quotient (xQ™) organizational assessment tool.

The accompanying unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments, except as discussed below) necessary to present fairly the financial position and results of operations of the Company as of the dates and for the periods indicated. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to Securities and Exchange Commission (SEC) rules and regulations. The information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended August 31, 2005.
 
During the quarter ended May 27, 2006, we determined that our Mexico subsidiary had misstated its financial results in prior periods by recording improper sales transactions and not recording all operating expenses in proper periods. We determined that the misstatements occurred during fiscal 2002 through fiscal 2006 in various amounts. The Audit Committee engaged an independent legal firm to investigate the misstatements and they concluded that such misstatements were intentional. The Company determined that the impact of these misstatements was immaterial to previously issued financial statements and we recorded a $0.5 million decrease to international sales and a $0.5 million increase in selling, general, and administrative expenses during the quarter ended May 27, 2006 to correct these misstatements. We are currently in the process of taking actions as recommended by the investigators, which include enhancements to internal control over foreign operations.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management 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.

The Company utilizes a modified 52/53-week fiscal year that ends on August 31 of each year. Corresponding quarterly periods generally consist of 13-week periods that ended on November 26, 2005, February 25, 2006, and May 27, 2006 during fiscal 2006. Under the modified 52/53-week fiscal year, the quarter and three quarters ended May 27, 2006 had the same number of business days as the corresponding periods of the prior fiscal year.

The results of operations for the quarter and three quarters ended May 27, 2006 are not necessarily indicative of results expected for the entire fiscal year ending August 31, 2006.

Certain reclassifications have been made to the fiscal 2005 financial statements to conform with the current period presentation.
Return to Index
6

NOTE 2 - ACCOUNTING FOR STOCK-BASED COMPENSATION

On September 1, 2005, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. Statement 123R supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. Statement No. 123R requires all share based-payments to employees, including grants of stock options and the compensatory elements of employee stock purchase plans, to be recognized in the income statement based upon their fair values.

We previously accounted for our stock-based compensation using the intrinsic method as defined in APB Opinion No. 25 and accordingly, prior to September 1, 2005 we did not recognize any expense for our employee stock purchase plan or incentive stock option plan in our consolidated financial statements. We used the modified prospective transition method to adopt the provisions of SFAS No. 123R. Under this method, unvested awards at the date of adoption as well as awards that are granted, modified, or settled after the date of adoption will be measured and accounted for in accordance with Statement 123R. Based upon our analysis of the requirements of SFAS No. 123R, we reclassified our unamortized deferred compensation related to the issuance of unvested common stock awards that was reported in the equity section of our balance sheet to additional paid-in capital. The following table presents the stock-based compensation expense included in our selling, general, and administrative expenses for the quarter and three quarters ended May 27, 2006 and the pro forma stock-based compensation amounts that would have been included in our income statements for the comparable periods of the prior year had stock-based compensation expense been determined in accordance with the fair value method prescribed by SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation: An Amendment of FASB Statement No. 123 (in thousands):

   
Quarter Ended
 
Three Quarters Ended
 
   
May 27,
2006
 
May 28,
2005
 
May 27,
2006
 
May 28,
2005
 
Compensation cost of stock options
 
$
2
 
$
4(1)
 
$
6
 
$
2,103(1)
 
Discount on employee stock purchase plan
   
9
   
-
   
24
   
4(1)
 
Compensation cost of unvested stock awards
   
321
   
344
   
537
   
722
 
Compensation cost of stock option agreement modifications
   
-
   
108(1)
 
 
-
   
108(1)
 
Compensation cost of fully vested stock award
   
-
   
-
   
-
   
404
 
Total stock-based compensation
 
$
332
 
$
456
 
$
567
 
$
3,341
 
                           
Net loss attributable to common shareholders, as reported
       
$
(6,868
)
     
$
(2,624
)
Fair value of stock-based compensation excluded from net loss, net of tax
         
(112
)
       
(2,215
)
Net income available to common shareholders, pro forma
       
$
(6,980
)
     
$
(4,839
)
                           
Basic and diluted earnings per share, as reported
       
$
(.34
)
     
$
(.18
)
                           
Basic and diluted earnings per share, pro forma
       
$
(.35
)
     
$
(.29
)

 
(1)
Based upon the intrinsic method as defined in APB Opinion No. 25, this amount was excluded from operating expenses and net income prior to the adoption of SFAS No. 123(R) on September 1, 2005.
 
7
 
The following is a description of activity in our stock-based compensation plans for the quarter and three quarters ended May 27, 2006.

Stock Options

The Company has an incentive stock option plan whereby options to purchase shares of our common stock are 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. The term, not to exceed ten years, and exercise period of each incentive stock option awarded under the plan are determined by a committee appointed by our Board of Directors. During the three quarters ended May 27, 2006 we did not grant any new stock options and the remaining unamortized service cost on previously granted stock options is insignificant in aggregate. The intrinsic value of stock options exercised during the three quarters ended May 27, 2006 was less than $0.1 million. The fair market value of options that vested during the quarter was zero and for the three quarters ended May 27, 2006 was approximately $6,000. The Company generally issues shares of common stock for the exercise of stock options from shares held in treasury.

A summary of our stock option activity for the three quarters ended May 27, 2006 is as follows (in thousands, except share amounts):

   
 
Number of Stock Options
 
Weighted Avg. Exercise Price
 
 
Outstanding at August 31, 2005
   
2,285,884
   
12.40
 
Granted
   
-
   
-
 
Exercised
   
(35,537
)
 
5.50
 
Forfeited
   
(90,375
)
 
15.84
 
Outstanding at May 27, 2006
   
2,159,972
   
12.37
 

The following additional information applies to our stock options outstanding at May 27, 2006:

 
Range of
Exercise Prices
 
 
 
Number Outstanding at May 27, 2006
 
Weighted Average Remaining Contractual Life (Years)
 
 
 
Weighted Average Exercise Price
 
 
 
Options Exercisable at May 27, 2006
 
 
 
Weighted Average Exercise Price
 
 
$1.70 - $7.00
   
232,912
   
3.8
 
$
5.30
   
207,912
 
$
5.73
 
$7.75 - $9.69
   
316,500
   
3.3
   
9.19
   
316,500
   
9.19
 
$14.00 - $14.00
   
1,602,000
   
4.3
   
14.00
   
1,602,000
   
14.00
 
$17.69 - $21.50
   
8,560
   
1.6
   
17.82
   
8,560
   
17.82
 

The intrinsic value of our outstanding in-the-money options was $0.7 million and the intrinsic value of our exercisable in-the-money options was $0.5 million at May 27, 2006.

The Company did not issue any stock options to vendors or other non-employees during the three quarters ended May 27, 2006.

Employee Stock Purchase Plan

The Company has 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 the Company’s common stock on the last trading day of the calendar month in each fiscal quarter. Based upon SFAS No. 123R, we determined that the discount offered to employees is compensatory and the amount is therefore expensed each quarter. A total of 7,546 and 21,920 shares were issued under this plan in the quarter and three quarters ended May 27, 2006, respectively.
Return to Index
8

Unvested Stock Awards

Employee Awards - During fiscal 2006 and in prior periods, we have granted unvested stock awards to certain employees as long-term incentives. The following is a brief description of these unvested stock awards that have been granted to employees.

Awards Granted in Fiscal 2005 and Prior Periods - These awards cliff vest five years from the grant date or on an accelerated basis if we achieve specified earnings levels. The compensation cost of these unvested stock awards was based on the fair value of the shares on the grant date and is expensed on a straight-line basis over the vesting (service) period of the awards. The recognition of compensation cost will be accelerated when we believe that it is probable that we will achieve the specified earnings thresholds and the shares will vest. We did not accelerate the vesting of any of these awards during the three quarters ended May 27, 2006.

Fiscal 2006 Long-Term Incentive Plan - On January 20, 2006, the Company’s shareholders approved a stock-based long-term incentive plan (the LTIP) that permits the grant of unvested share awards of common stock to certain employees as directed by the Compensation Committee of the Board of Directors. The LTIP share awards granted during fiscal 2006 cliff vest on August 31, 2008, which is the completion of a three-year performance period. The number of shares that are finally awarded to LTIP participants is variable and is based entirely upon the achievement of a combination of performance objectives related to sales growth and operating income during the three-year performance period. The Compensation Committee initially granted awards for 377,665 shares (target award) of common stock; the number of shares finally awarded will range from zero shares, if a minimum level of performance is not achieved, to 200 percent of the target award, if specifically defined performance criteria is achieved during the three-year performance period.

The LTIP shares were valued at $6.60 per share, which was the closing price of our common stock on the grant date. The corresponding compensation cost of the award, based upon the target award number of shares, totaled $2.5 million, which is being expensed over the service period of the award. Due to the variable number of shares that may be issued under the LTIP, we reevaluate the LTIP on a quarterly basis and adjust the number of shares expected to be awarded based upon financial results of the Company as compared to the performance goals set for the award. Adjustments to the number of shares awarded, and to the corresponding compensation expense, are made on a cumulative basis at the date of adjustment based upon the probable number of shares to be awarded. There was no adjustment to the number of shares expected to be issued under the LTIP during the three quarters ended May 27, 2006. The total compensation cost of the LTIP is equal to the number of shares finally issued multiplied by $6.60 per share, the fair value of the common shares determined at the grant date.

Board of Director Awards - During January 2006, the Company’s shareholders also approved changes to our non-employee directors’ stock incentive plan (the Directors’ Plan). The Directors’ plan was designed to provide non-employee directors of the Company, who are ineligible to participate in our employee stock incentive plan, an opportunity to acquire an interest in the Company through the acquisition of shares of common stock. Under the previous provisions of the Directors’ Plan, each non-employee director received an annual unvested stock award with a value (based on the trading price of the Company’s common stock on the date of the award) equal to $27,500. The primary modification to the Directors’ plan approved by the shareholders changes the annual unvested stock grant to 4,500 shares of common stock rather than the dollar value previously defined in the plan. The amendment also eliminates the limitation on the maximum dollar value of all awards made under the Directors’ Plan in any given year.

During the three quarters ended May 27, 2006, we granted 27,000 shares of unvested stock to members of our Board of Directors under the Directors’ Plan. The compensation cost of the Board of Director award was $0.2 million and was calculated at $7.84 per share, which was the fair value of the Company’s common stock on the grant date. The common stock issued to the Board of Directors was previously recorded as treasury stock and had a cost basis of $0.5 million. The difference between the compensation cost of the award and the cost of the shares issued was recorded to additional paid-in capital.

A summary of our unvested stock award activity for the three quarters ended May 27, 2006 is as follows (in thousands, except share amounts):

   
Number of Unvested Shares
 
 
Compensation Cost
 
Outstanding shares and unamortized compensation cost at August 31, 2005
   
409,295
 
$
1,055
 
Granted
   
-
   
-
 
Vested
   
-
   
-
 
Amortization of compensation
   
n/a
   
(68
)
Outstanding shares and unamortized compensation cost at November 26, 2005
   
409,295
   
987
 
Granted
   
377,665
   
2,493
 
Vested
   
-
   
-
 
Amortization of compensation
   
n/a
   
(148
)
Outstanding shares and unamortized compensation cost at February 25, 2006
   
786,960
 
$
3,332
 
Granted
   
27,000
   
211
 
Vested
   
-
   
-
 
Amortization of compensation
   
n/a
   
(321
)
Outstanding shares and unamortized compensation cost at May 27, 2006
   
813,960
 
$
3,222
 

The intrinsic value of our unvested stock awards (both employee and Board of Director awards) was $6.5 million, which was based upon our closing stock price of $7.99 per share on May 27, 2006.
 
9
NOTE 3 - INVENTORIES

Inventories are stated at the lower of cost or market, cost being determined using the first-in, first-out method, and were comprised of the following (in thousands):

   
May 27,
2006
 
August 31,
2005
 
           
Finished goods
 
$
19,408
 
$
18,161
 
Work in process
   
299
   
825
 
Raw materials
   
2,688
   
1,989
 
               
   
$
22,395
 
$
20,975
 
 

NOTE 4 - INTANGIBLE ASSETS

The Company’s intangible assets were comprised of the following (in thousands):

 
May 27, 2006
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Definite-lived intangible assets:
                   
License rights
 
$
27,000
 
$
(7,183
)
$
19,817
 
Curriculum
   
58,233
   
(26,442
)
 
31,791
 
Customer lists
   
18,774
   
(12,943
)
 
5,831
 
Trade names
   
1,277
   
(1,277
)
 
-
 
     
105,284
   
(47,845
)
 
57,439
 
                     
Indefinite-lived intangible asset:
                   
Covey trade name
   
23,000
   
-
   
23,000
 
Balance at May 27, 2006
 
$
128,284
 
$
(47,845
)
$
80,439
 
                     
August 31, 2005
                   
Definite-lived intangible assets:
                   
License rights
 
$
27,000
 
$
(6,480
)
$
20,520
 
Curriculum
   
58,232
   
(25,146
)
 
33,086
 
Customer lists
   
18,774
   
(12,032
)
 
6,742
 
Trade names
   
1,277
   
(1,277
)
 
-
 
     
105,283
   
(44,935
)
 
60,348
 
                     
Indefinite-lived intangible asset:
                   
Covey trade name
   
23,000
   
-
   
23,000
 
Balance at August 31, 2005
 
$
128,283
 
$
(44,935
)
$
83,348
 

The Company’s aggregate amortization expense totaled $0.9 million for the quarter ended May 27, 2006 and $1.0 million during the quarter ended May 28, 2005. For the three quarters ended May 27, 2006 our total amortization expense was $2.9 million compared to $3.1 million for the three quarters ended May 28, 2005.

NOTE 5 - PREFERRED STOCK REDEMPTIONS AND PURCHASES OF COMPANY COMMON STOCK
 
Preferred Stock Redemptions

During the three quarters ended May 27, 2006 we have redeemed $20.0 million, or approximately 800,000 shares of preferred stock. Since the recapitalization of our preferred stock in March 2005, we have redeemed a total of $50.0 million, or approximately 2.0 million shares, of our outstanding Series A preferred stock. These preferred stock redemptions have reduced the Company’s preferred dividend obligation by $5.0 million per year.

At our Annual Meeting of Shareholders held in January 2006, we obtained shareholder approval of an amendment to our articles of incorporation that extends the period during which we have the right to redeem outstanding shares of preferred stock at 100 percent of its liquidation preference. The amendment extends the current redemption deadline from March 8, 2006 to December 31, 2006 and also provides the right to extend the redemption period for an additional year to December 31, 2007, if another $10.0 million of preferred stock is redeemed before December 31, 2006. During February 2006 we redeemed the preferred stock necessary to satisfy the additional extension provision and the Company can redeem preferred stock at the liquidation preference through December 31, 2007.

Common Stock Purchases

During January 2006, our Board of Directors authorized the purchase of up to $10.0 million of our currently outstanding common stock. The purchases will be made at the Company’s discretion at prevailing market prices and will be subject to customary regulatory requirements and considerations. The Company does not have a timetable for the purchase of these common shares and the authorization by the Board of Directors does not have an expiration date. During the quarter ended May 27, 2006, we purchased 275,300 shares of our common stock for $2.4 million. Through the three quarters ended May 27, 2006 we have purchased 485,500 shares of our common stock under the terms of this newly authorized plan for $3.9 million.
Return to Index
10
NOTE 6 - INCOME TAX BENEFIT

The Company recorded income tax benefits totaling $2.8 million during the quarter ended May 27, 2006 and $3.0 million during the quarter ended May 28, 2005. We regularly evaluate our United States federal and various state and foreign jurisdiction income tax exposures and record reserves against tax exposures based upon the probability that the tax exposure would be sustained by various tax jurisdictions. We recognize the benefits of the tax exposure items in the financial statements, that is, the reserve is reversed when it becomes probable that the tax position will be sustained. To assess the probability of sustaining a tax position, the Company considers all available positive evidence. In many instances, sufficient positive evidence may not be available until the expiration of the statute of limitations for assessment by tax authorities, at which time the entire benefit will be recognized as a discrete item in the applicable period. The income tax benefits recorded during the quarters ended May 27, 2006 and May 28, 2005 resulted primarily from the expiration of the statute of limitations for various tax exposures, which was partially offset by income taxes incurred by our profitable foreign subsidiaries and foreign income taxes on payments received from foreign licensees.

During the periods ended May 27, 2006 and May 28, 2005, we were unable to offset our tax liabilities in foreign jurisdictions with our domestic operating loss carryforwards. In addition, a history of significant operating losses has precluded us from demonstrating that it is more likely than not that the benefits of domestic operating loss carryforwards, together with the benefits of other deferred income tax assets will be realized. Accordingly, we have recorded valuation allowances on the majority of our domestic deferred income tax assets. However, as operating results continue to improve and taxable income continues to increase, we are accumulating positive evidence which may allow us to reverse these valuation allowances on the deferred income tax assets in a future period.
 
NOTE 7 - LEGAL SETTLEMENT

In fiscal 2002, we filed legal action against World Marketing Alliance, Inc., a Georgia corporation (WMA), and World Financial Group, Inc., a Delaware corporation and purchaser of substantially all assets of WMA, for breach of contract. The case proceeded to trial and the jury rendered a verdict in our favor and against WMA on November 1, 2004 for the entire unpaid contract amount of approximately $1.1 million. In addition to the verdict, we recovered legal fees totaling $0.3 million and pre- and post-judgment interest of $0.3 million from WMA. During our fiscal quarter ended May 28, 2005, we received payment in cash from WMA for the total verdict amount, including legal fees and interest. However, shortly after paying the verdict amount, WMA appealed the jury decision to the 10th Circuit Court of Appeals and we recorded receipt of the verdict amount plus legal fees and interest with a corresponding increase to accrued liabilities and deferred the gain until the case was finally resolved. On December 30, 2005, the Company entered into a settlement agreement with WMA. Under the terms of the settlement agreement, WMA agreed to dismiss its appeal. As a result of this settlement agreement and dismissal of WMA’s appeal, we recorded a $0.9 million gain from the legal settlement and a $0.3 million reduction in selling, general, and administrative expenses during the second quarter of fiscal 2006.
 
NOTE 8 - COMPREHENSIVE INCOME

Comprehensive income is based on net income and includes charges and credits to equity accounts that are not the result of transactions with shareholders. Comprehensive income for the Company was calculated as follows (in thousands):

   
Quarter Ended
 
Three Quarters Ended
 
   
May 27,
2006
 
May 28,
2005
 
May 27,
2006
 
May 28,
2005
 
Net income
 
$
1,019
 
$
3,069
 
$
13,465
 
$
11,680
 
Other comprehensive income (loss) items:
                         
Adjustment for fair value of foreign currency hedge derivatives
   
-
   
-
   
-
   
(318
)
Foreign currency translation adjustments
   
434
   
(455
)
 
214
   
(52
)
Comprehensive income
 
$
1,453
 
$
2,614
 
$
13,679
 
$
11,310
 
 
11
NOTE 9 - EARNINGS PER SHARE

Basic earnings per common share (EPS) is calculated by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net income available to common shareholders by the weighted-average number of common shares outstanding plus the assumed exercise of all dilutive securities using the treasury stock method or the “as converted” method, as appropriate. Following the preferred stock recapitalization that was completed in March 2005, our preferred stock is no longer convertible into common stock or entitled to participate in dividends payable to holders of common stock. Accordingly, we no longer use the two-class method of calculating EPS as defined in SFAS No. 128, Earnings Per Share, and EITF Issue 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128, for periods after February 26, 2005.

The following table sets forth the computation of basic and diluted EPS for the periods indicated (in thousands, except per share amounts):

   
Quarter Ended
 
Three Quarters Ended
 
   
May 27,
2006
 
May 28,
2005
 
May 27,
2006
 
May 28,
2005
 
Net income
 
$
1,019
 
$
3,069
 
$
13,465
 
$
11,680
 
Non-convertible preferred stock dividends
   
(934
)
 
(2,184
)
 
(3,452
)
 
(2,184
)
Convertible preferred stock dividends
   
-
   
-
   
-
   
(4,367
)
Loss on recapitalization of preferred stock
   
-
   
(7,753
)
 
-
   
(7,753
)
Net income (loss) available to common shareholders
 
$
85
 
$
(6,868
)
$
10,013
 
$
(2,624
)
                           
Convertible preferred stock dividends
 
$
-
 
$
-
 
$
-
 
$
4,367
 
Weighted average preferred shares on an as converted basis
   
-
   
-
   
-
   
6,239
 
Distributed EPS - preferred
 
$
-
 
$
-
 
$
-
 
$
.70
 
                           
Undistributed income (loss) through February 26, 2005
 
$
-
 
$
(6,868
)
$
-
 
$
4,244
 
Preferred ownership on an as converted basis
   
-
   
-
   
-
   
24
%
Preferred shareholders interest in undistributed income
   
-
   
-
   
-
   
1,019
 
Weighted average preferred shares on an as converted basis
   
-
         
-
   
6,239
 
Undistributed EPS - preferred
 
$
-
 
$
-
 
$
-
 
$
.16
 
                           
Undistributed income (loss)
 
$
85
 
$
(6,868
)
$
10,013
 
$
4,244
 
Common stock ownership
   
100
%
 
100
%
 
100
%
 
76
%
Common shareholder interest in undistributed income (loss)
   
85
   
-
   
10,013
   
3,225
 
Undistributed loss for the quarter ended May 28, 2005
   
-
   
(6,868
)
 
-
   
(6,868
)
Common shareholder interest in undistributed loss
 
$
85
 
$
(6,868
)
$
10,013
 
$
(3,643
)
Weighted average common shares outstanding - Basic
   
20,060
   
19,922
   
20,234
   
19,847
 
Effect of dilutive securities(1):
                         
Stock options
   
75
   
-
   
55
   
-
 
Unvested stock awards
   
403
   
-
   
315
   
-
 
Common stock warrants
   
196
   
-
   
66
   
-
 
Weighted average common shares outstanding - Diluted
   
20,734
   
19,922
   
20,670
   
19,847
 
                           
Basic EPS - Common
 
$
.00
 
$
(.34
)
$
.50
 
$
(.18
)
Diluted EPS - Common
 
$
.00
 
$
(.34
)
$
.48
 
$
(.18
)

(1)For the quarter and three quarters ended May 28, 2005, conversion of common share equivalents is not assumed because such conversion would be anti-dilutive.

At May 27, 2006, we had approximately 1.8 million stock options outstanding which were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the Company’s common shares. At May 28, 2005, we had approximately 2.3 million stock options that were not considered in our calculation of diluted EPS that may have a dilutive effect on the Company’s EPS calculation in future periods.
Return to Index
12

NOTE 10 - SEGMENT INFORMATION

The Company has two segments: the Consumer and Small Business Unit (CSBU) and the Organizational Solutions Business Unit (OSBU). The following is a description of our segments, their primary operating components, and their significant business activities:

Consumer and Small Business Unit - This business unit is primarily focused on sales to individual customers and small business organizations and includes the results of our domestic retail stores, consumer direct operations (catalog, eCommerce, and public seminars programs), wholesale operations, and other related distribution channels, including government product sales and domestic printing and publishing sales. The CSBU results of operations also include the financial results of our paper planner manufacturing operations. Although CSBU sales primarily consist of products such as planners, binders, software, and handheld electronic planning devices, virtually any component of our leadership, productivity, and strategy execution solutions may be purchased through our CSBU channels.

Organizational Solutions Business Unit - The OSBU is primarily responsible for the development, marketing, sale, and delivery of strategic execution, productivity, leadership, sales force performance, and communication training and consulting solutions directly to organizational clients, including other companies, the government, and educational institutions. The OSBU includes the financial results of our domestic sales force and our international operations. The domestic sales force is responsible for the sale and delivery of our training and consulting services in the United States. Our international sales group includes the financial results of our directly owned foreign offices and royalty revenues from licensees.

The Company’s chief operating decision maker is the CEO, and each of the segments has a president who reports directly to the CEO. The primary measurement tool used in business unit performance analysis is earnings before interest, taxes, depreciation, and amortization (EBITDA), which may not be calculated as similarly titled amounts calculated by other companies. For segment reporting purposes, the Company’s consolidated EBITDA can be calculated as its income from operations excluding depreciation and amortization charges.

In the normal course of business, the Company may make structural and cost allocation revisions to its segment information to reflect new reporting responsibilities within the organization. During the first quarter of fiscal 2006, we transferred our public seminar programs from the domestic unit of OSBU to the consumer direct channel in CSBU. We also transferred the operations of certain corporate departments, such as Franklin Covey travel and accounts payable, to the operating segments. All prior period segment information has been revised to conform to the most recent classifications and organizational changes. The Company accounts for its segment information on the same basis as the accompanying condensed consolidated financial statements.
 
13
SEGMENT INFORMATION
(in thousands)
                     
 
Quarter Ended
May 27, 2006
 
Sales to External Customers
 
 
 
Gross Profit
 
 
 
EBITDA
 
 
 
Depreciation
 
 
 
Amortization
 
Consumer and Small Business Unit:
                     
Retail
 
$
11,493
 
$
6,347
 
$
(1,018
)
$
274
 
$
-
 
Consumer direct
   
12,504
   
7,479
   
5,509
   
16
   
-
 
Wholesale
   
6,920
   
3,632
   
3,447
   
-
   
-
 
Other CSBU
   
1,168
   
119
   
(6,870
)
 
300
   
-
 
Total CSBU
   
32,085
   
17,577
   
1,068
   
590
   
-
 
                                 
Organizational Solutions Business Unit:
                               
Domestic
   
17,807
   
10,879
   
639
   
85
   
902
 
International
   
13,390
   
7,836
   
415
   
289
   
6
 
Total OSBU
   
31,197
   
18,715
   
1,054
   
374
   
908
 
Total operating segments
   
63,282
   
36,292
   
2,122
   
964
   
908
 
Corporate and eliminations
   
-
   
-
   
(1,459
)
 
170
   
-
 
Consolidated
 
$
63,282
 
$
36,292
 
$
663
 
$
1,134
 
$
908
 
                                 
Quarter Ended
May 28, 2005
                               
Consumer and Small Business Unit:
                               
Retail
 
$
13,443
 
$
7,392
 
$
(1,083
)
$
614
 
$
-
 
Consumer direct
   
12,144
   
7,153
   
3,876
   
23
   
-
 
Wholesale
   
7,627
   
3,459
   
3,292
   
-
   
-
 
Other CSBU
   
792
   
(39
)
 
(5,925
)
 
650
   
86
 
Total CSBU
   
34,006
   
17,965
   
160
   
1,287
   
86
 
                                 
Organizational Solutions Business Unit:
                               
Domestic
   
18,736
   
11,629
   
2,313
   
74
   
954
 
International
   
13,046
   
8,674
   
2,744
   
331
   
2
 
Total OSBU
   
31,782
   
20,303
   
5,057
   
405
   
956
 
Total operating segments
   
65,788
   
38,268
   
5,217
   
1,692
   
1,042
 
Corporate and eliminations
   
-
   
-
   
(3,044
)
 
156
   
1
 
Consolidated
 
$
65,788
 
$
38,268
 
$
2,173
 
$
1,848
 
$
1,043
 
                                 
Three Quarters Ended
May 27, 2006
                               
Consumer and Small Business Unit:
                               
Retail
 
$
50,001
 
$
29,359
 
$
4,404
 
$
1,056
 
$
-
 
Consumer direct
   
50,291
   
30,311
   
23,992
   
43
   
-
 
Wholesale
   
17,148
   
8,680
   
8,142
   
-
   
-
 
Other CSBU
   
3,622
   
630
   
(22,525
)
 
957
   
57
 
Total CSBU
   
121,062
   
68,980
   
14,013
   
2,056
   
57
 
                                 
Organizational Solutions Business Unit:
                               
Domestic
   
49,423
   
31,677
   
2,985
   
249
   
2,845
 
International
   
43,481
   
28,215
   
8,320
   
940
   
9
 
Total OSBU
   
92,904
   
59,892
   
11,305
   
1,189
   
2,854
 
Total operating segments
   
213,966
   
128,872
   
25,318
   
3,245
   
2,911
 
Corporate and eliminations
   
-
   
-
   
(5,331
)
 
518
   
-
 
Consolidated
 
$
213,966
 
$
128,872
 
$
19,987
 
$
3,763
 
$
2,911
 
                                 
Three Quarters Ended
May 28, 2005
                               
Consumer and Small Business Unit:
                               
Retail
 
$
59,886
 
$
34,369
 
$
5,453
 
$
2,136
 
$
-
 
Consumer direct
   
49,390
   
29,455
   
19,274
   
517
   
-
 
Wholesale
   
16,107
   
7,536
   
6,995
   
-
   
-
 
Other CSBU
   
2,542
   
(1,289
)
 
(20,416
)
 
2,016
   
258
 
Total CSBU
   
127,925
   
70,071
   
11,306
   
4,669
   
258
 
                                 
Organizational Solutions Business Unit:
                               
Domestic
   
48,303
   
31,756
   
5,293
   
228
   
2,862
 
International
   
41,187
   
28,093
   
9,903
   
994
   
5
 
Total OSBU
   
89,490
   
59,849
   
15,196
   
1,222
   
2,867
 
Total operating segments
   
217,415
   
129,920
   
26,502
   
5,891
   
3,125
 
Corporate and eliminations
   
-
   
-
   
(7,546
)
 
455
   
5
 
Consolidated
 
$
217,415
 
$
129,920
 
$
18,956
 
$
6,346
 
$
3,130
 
14

A reconciliation of operating segment EBITDA to consolidated income before taxes is provided below (in thousands):

   
Quarter Ended
 
Three Quarters Ended
 
   
May 27,
2006
 
May 28,
2005
 
May 27,
2006
 
May 28,
2005
 
Reportable segment EBITDA
 
$
2,122
 
$
5,217
 
$
25,318
 
$
26,502
 
Restructuring cost reversal
   
-
   
-
   
-
   
306
 
Corporate expenses
   
(1,459
)
 
(3,044
)
 
(5,331
)
 
(7,852
)
Consolidated EBITDA
   
663
   
2,173
   
19,987
   
18,956
 
Depreciation
   
(1,134
)
 
(1,848
)
 
(3,763
)
 
(6,346
)
Amortization
   
(908
)
 
(1,043
)
 
(2,911
)
 
(3,130
)
Income (loss) from operations
   
(1,379
)
 
(718
)
 
13,313
   
9,480
 
Interest income
   
307
   
310
   
953
   
592
 
Interest expense
   
(663
)
 
(29
)
 
(1,966
)
 
(95
)
Recovery of investment in unconsolidated subsidiary
   
-
   
500
   
-
   
500
 
Legal settlement
   
-
   
-
   
873
   
-
 
Income (loss) before income tax benefit
 
$
(1,735
)
$
63
 
$
13,173
 
$
10,477
 
 
NOTE 11 - MANAGEMENT COMMON STOCK LOAN MODIFICATIONS

During the quarter ended May 27, 2006, the Company offered participants in its management common stock loan program the opportunity to formally modify the terms of their loans in exchange for placing their shares of common stock obtained through the loan program in an escrow account that allows the Company to have a security interest in the loan program shares. The key modifications to the management common stock loans for the participants accepting the offer are as follows:

 
·
Modification of Promissory Note - The management stock loan due date will be changed to be the earlier of (a) March 30, 2013, or (b) the date on which the Company’s stock closes, as reported by the exchange or market that is the principal market for our common stock, at or above the price per share such that the value of the shares acquired by the participants under the program is equal to the principal and accrued interest on the participants’ promissory notes (Breakeven Date). The interest rate on the loans will increase from 3.16 percent compounded annually to 4.72 percent compounded annually.

 
·
Redemption of Management Loan Program Shares - The Company will have the right to redeem the shares on the due date in satisfaction of the promissory notes as follows:

 
(a)
On the Breakeven Date, the Company has the right to purchase and redeem from the loan participants the number of loan program shares necessary to satisfy the participant’s obligation under the promissory note. The redemption price for each such loan program share will be equal to the closing price of our common stock on the Breakeven Date.
  (b) If the Company’s stock has not closed at or above the breakeven price on or before March 30, 2013, the Company has the right to purchase and redeem from the participants all of their loan program shares at the closing price on that date as partial payment on the participant’s obligation. 
 
Loan program participants may choose whether or not to place their loan program shares in the escrow account and accept the modification agreement. If a loan participant declines the offer to modify their management stock loan, their loan will continue to have the same terms and conditions that were previously approved in May 2004 by the Company’s Board of Directors and their loans will be due at the earlier of March 30, 2008 or the Breakeven Date. The Company believes that the new modifications improve its ability to collect the shares purchased by participants through establishing a security interest in the shares and facilitates redemption of the loan program shares from participants on the due date. Consistent with the May 2004 modifications, participants will be unable to realize a gain on the loan program shares unless they pay cash to satisfy the promissory note obligation prior to the due date.

Due to the loan program modifications that were approved in May 2004, we currently account for the management common stock loans as stock option arrangements. Under the provisions of SFAS No. 123R, which we adopted on September 1, 2005, additional compensation expense will be recognized only if the Company takes action that constitutes a modification that increases the fair value of the arrangements. Since these new modifications do not increase the fair value of the arrangements, no compensation expense was recognized.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Management’s discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based upon management’s current expectations and are subject to various uncertainties and changes in circumstances. Important factors that could cause actual results to differ materially from those described in forward-looking statements are set forth below under the heading Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995.

The Company suggests that the following discussion and analysis be read in conjunction with the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended August 31, 2005.
 
RESULTS OF OPERATIONS

Overview

Our third fiscal quarter, which includes the months of March, April, and May, has historically reflected seasonally lower product sales, but generally stronger training and consulting service sales compared to our first two fiscal quarters. As a result of these seasonal product sales factors, our third fiscal quarter has typically not been as profitable as other quarters of our fiscal year. For the quarter ended May 27, 2006, our loss from operations increased to $1.4 million compared to $0.7 million in the prior year and our after-tax net income declined to $1.0 million compared to $3.1 million in the comparable quarter of the prior year. However, due to significantly reduced preferred dividends resulting from preferred stock redemptions, and a $7.8 million loss recognized on the recapitalization of our preferred stock in fiscal 2005, our income available to common shareholders improved to $0.1 million compared to a $6.9 million loss recognized in the corresponding quarter of fiscal 2005.

The primary factors that influenced our operating results for the quarter ended May 27, 2006 were as follows:

 
·
Sales - Product sales declined $3.0 million due to fewer retail stores being open during the quarter, reduced wholesale sales, and reduced technology and specialty product sales. Partially offsetting these declines were improved “core” product sales performance, including planners, binders, totes, and other planning tools and accessories. Training and consulting services sales increased $0.5 million primarily due to increased international sales and improved The 7 Habits of Highly Effective People training program sales, which were partially offset by decreased sales effectiveness training sales. As a result of these factors, our total sales decreased by $2.5 million, or 4 percent, compared to the corresponding quarter of the prior year.

 
·
Gross Profit - When compared to the prior year, our gross profit declined due to decreased sales. Our gross margin, which is gross profit in terms of a percentage of sales, declined to 57.3 percent compared to 58.2 percent in the prior year. The decrease was primarily due to increased costs for our annual Symposium conference events that were held during the quarter.

 
·
Operating Costs - Our operating costs declined by $1.3 million compared to the prior year, which was the result of selling, general, and administrative expense decreases totaling $0.5 million, a $0.7 million decrease in depreciation expense, and a $0.1 million decrease in amortization expense.
 
 
·
Income Tax Benefit - During the quarter ended May 27, 2006, we recognized income tax benefits totaling $2.8 million compared to income tax benefits of $3.0 million in fiscal 2005. The tax benefits recorded during these quarters were primarily the result of the expiration of the statute of limitations for various tax exposures, which were partially offset by income taxes incurred by our profitable foreign subsidiaries and foreign income taxes on payments received from foreign licensees.

 
·
Preferred Stock Dividends - Due to preferred stock redemptions in fiscal 2005 and the first two quarters of fiscal 2006 totaling $50.0 million, our preferred stock dividends decreased by $1.3 million compared to the corresponding quarter of fiscal 2005.

 
·
Correction of Foreign Subsidiary Misstatements - During the quarter ended May 27, 2006, we determined that our Mexico subsidiary had misstated its financial results in prior periods by recording improper sales transactions and not recording all operating expenses in proper periods. We determined that the misstatements occurred during fiscal 2002 through fiscal 2006 in various amounts. The Audit Committee engaged an independent legal firm to investigate the misstatements and they concluded that such misstatements were intentional. We are in the process of taking actions as recommended by the investigators, which include enhancements to internal control over foreign operations. The Company determined that the impact of these misstatements was immaterial to previously issued financial statements and we recorded a $0.5 million decrease to international sales and a $0.5 million increase in selling, general, and administrative expenses during the quarter ended May 27, 2006 to correct these misstatements.

Further details regarding these factors and their impact on our operating results and liquidity are provided throughout the following management’s discussion and analysis.

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Quarter Ended May 27, 2006 Compared to the Quarter Ended May 28, 2005