Form 10-K 11-14-2006
 
 

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

 
Form 10-K
 

 
 
þ
 
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED AUGUST 31, 2006
 
   
 OR
 
o
 
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSISTION PERIOD FROM ___ TO ___ 
 
 
         Franklin Covey Co.        
(Exact name of registrant as specified in its charter)
 
 
 
 Utah
 
 1-11107
 
 87-0401551
 (State or other jurisdiction of incorporation)
 
 (Commission File No.)
 
 (IRS Employer Commission File No.)
 
 
2200 West Parkway Boulevard
Salt Lake City, Utah 84119-2331
(Address of principal executive offices, including zip code)
 
Registrant's telephone number, including area code: (801) 817-1776
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 Title of Each Class
 
 Name of Each Exchange on Which Registered
 Common Stock, $.05 Par Value
 
 New York Stock Exchange
 
Securities registered pursuant ot Section 12(g) of the Act:
 
Series A Preferred Stock, no par value
Title of Class
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes oNo þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o    No þ
 
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 preceeding 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 þ   No o
 
Indicate by check mark if disclosure of delinquent filers pursuant ot Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See deifinition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.  (Check one):
oLarge accelerated filer þAccelerated filer oNon-accelerated filer 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o    No þ
 
As of February 24, 2006, the aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant was approximately $126.3 million.
 
As of November 1, 2006, the Registrant had 19,678,591 shares of Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Parts of the Registrant's Definitive Proxy Statement for the Annual Meeting of Shareholders, which is scheduled to be held on January 19, 2007, are incorporated by reference in Part III of this Form 10-K.
 
 
 
FRANKLIN COVEY CO.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
AUGUST 31, 2006
 
Table of Contents
 
 
 
 
Part I.  
  Item 1.  Business  
  Item 1A. Risk Factors  
  Item 1B. Unresolved Staff Comments  
  Item 2. Properties  
  Item 3. Legal Proceedings  
  Item 4. Submission of Matters to a Vot of Security Holers   
     
Part II.    
  Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities  
  Item 6. Selected Financial Data  
  Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations  
  Item 7A. Quantitative and Qualitative Disclosures About Market Risk  
  Item 8.  Financial Statements and Supplementary Data  
  Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures  
  Item 9A. Controls and Procedures  
  Item 9B.  Other Information  
   
Part III.      
  Item 10. Directors and Executive Officers of the Registrant  
  Item 11. Executive Compensation  
  Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters  
  Item 13. Certain Relationships and Related Transactions  
  Item 14. Principal Accountant Fees and Services  
       
Part IV.      
  Item 15.  Exhibits and Financial Statement Schedules  
       
       
  Signatures     
  Exhibit 21 Franklin Covey Co. Subsidiaries  
  Exhibit 23 Consent of Independent Registered Public Accounting Firm  
  Exhibit 31.1
Rule 13a-14(a) Certification of the Chief Executive Officer
 
  Exhibit 31.2
Rule 13a-14(a) Certification of the Chief Financial Officer
 
  Exhibit 32
Section 1350 Certifications
 
  Exhibit 99.1
Report of KPMG LLP, Independent Registered Public Accounting Firm, on Consolidated Financial Statement Schedule for the years ended August 31, 2006, 2005, and 2004
 
  Exhibit 99.2 Financial Statement Schedule II - Valuation and Qualifying Accounts and Reserves  
 
 
PART I

ITEM 1.
Business


General
 
Franklin Covey Co. (the Company, we, us, our or FranklinCovey) influences organizations, families and individuals the world over by helping them achieve their own great purposes through teaching the principles and practices of effectiveness and by providing reinforcement tools like the FranklinCovey Planning System. Nearly 1,500 FranklinCovey associates world-wide delivered timeless and universal curriculum and effectiveness tools to more than five million customers in fiscal 2006. We strive to excel in this endeavor because we believe that:

 
l
People are inherently capable, aspire to greatness, and have the power to choose.
 
 
l
Principles are timeless and universal and are the foundation to lasting effectiveness.
 
 
l
Leadership is a choice, built inside out on a foundation of character. Great leaders unleash the collective talent and passion of people toward the right goal.
 
 
l
Habits of effectiveness come only from the committed use of integrated processes and tools.
 
 
l
Sustained superior performance requires a balance of performance and performance capability (P/PC Balance®) - a focus on achieving results and building capability.
 

The Opportunity
 

Corporations, organizations and individuals cumulatively purchased more than $13 billion1  in 2006 and estimated to purchase more than $15 billion in 2007 professional performance training curricula, books, tapes, CD’s and other tools in an effort to improve their effectiveness and productivity. The training industry is divided into two segments - IT training and performance skills training. The performance skills training segment of the industry represented an estimated $7 billion in sales in 2006 and is expected to grow to nearly $9 billion in 2007 through sales of hundreds of different curricula, delivered to both corporations and individual customers. In addition to training, the performance skills industry includes a number of measurement methodologies and integrated implementation tools. The measurement methodologies include return on investment analysis and behavior modification measurement. Implementation tools are designed to increase learning retention and increase behavior modification. Many companies in the industry specialize in only one or two of these areas.
____________________________
1 Simba Information, Corporate Training Market 2006: Forecast and Analysis. (2006)
 
FranklinCovey is engaged in the performance skills industry. FranklinCovey’s competitive advantage in this highly fragmented industry stems from our fully integrating training curricula, measurement methodologies and implementation tool offerings to help individuals and organizations measurably improve their effectiveness. This advantage allows FranklinCovey to deliver not only training to both corporations and individuals, but also to implement the training through the use of powerful behavior changing tools and then measure the impact of that training.
 
In fiscal 2006, we provided products and services to 90 of the Fortune 100 companies and more than 75 percent of the Fortune 500 companies. We also provide products and services to a number of U.S. and foreign governmental agencies, including the U.S. Department of Defense, as well as numerous educational institutions. We provide training curricula, measurement services and implementation tools internationally, either through directly operated offices, or through licensed providers. At August 31, 2006, we had direct operations in Australia, Brazil, Canada, Japan, Mexico and the United Kingdom. We also had licensed operations in 75 countries and licensed rights in more than 130 countries. More than 450,000 individuals were trained during the fiscal year ended August 31, 2006.
 
Unless the context requires otherwise, all references to the Company, we, us, our or to FranklinCovey herein refer to Franklin Covey Co. and each of its operating divisions and subsidiaries. The Company's principal executive offices are located at 2200 West Parkway Boulevard, Salt Lake City, Utah 84119-2331 and our telephone number is (801) 817-1776.
 
FranklinCovey Products
 
An important principle taught in our productivity training is to have a single personal productivity system and to have all of one’s information in that system. Based upon that principle, we developed the FranklinCovey Planning System with the original Franklin Planner as one of the basic tools for implementing the principles of our time management system. The Franklin Planner consists of paper-based FranklinCovey Planning Pages, a binder in which to carry it, weekly, monthly and annual calendars as well as personal management sections. We offer a broad line of renewal planning pages, forms and binders in various sizes and styles. The FranklinCovey Planning System broadened as we developed additional planning tools to address the needs of more technology oriented workers as well as those who require both greater mobility and ready access to large quantities of data. For those clients who use digital or electronic productivity systems, we offer a wide variety of electronic solutions incorporating the same planning methodology.
 
FrankinCovey Planning Pages. Paper planning pages are available for the FranklinCovey Planning System in various sizes and styles and consist of daily or weekly formats, with Appointment Schedules, Prioritized Daily Task Lists, Monthly Calendars, Daily Notes, and personal management pages for an entire year. FranklinCovey Planning Pages are offered in a number of designs to appeal to various customer segments. The Starter Pack, which includes personal management tabs and pages, a guide to using the planner, a pagefinder and weekly compass cards, combined with a storage binder, completes the basic FranklinCovey Planning System.
 
Binders. To further customize the FranklinCovey Planning System, we offer binders and business cases (briefcases, portfolios, business totes, messenger bags, etc.) in a variety of materials, styles and sizes. These materials include high quality leathers, fabrics, synthetic materials and vinyl in a variety of color and design options. Binder styles include zipper closures, snap closures, and open formats with pocket configurations to accommodate credit cards, business cards, checkbooks, electronic devices and writing instruments. Most of the leather items are proprietary FranklinCovey designs. However, we also offer products from leading manufacturers such as Kenneth Cole.
 
Electronic Solutions. We offer our time and life management methodology in an electronic format within a complete Personal Information Management (“PIM”) system through the FranklinCovey PlanPlusÔ Software offerings. The software application can be used in conjunction with planning pages, electronic handheld organizers or used as a stand-alone planning and information management system. The FranklinCovey PlanPlus Software permits users to generate and print data on FranklinCovey Planning Pages that can be inserted directly into the FranklinCovey Planner. The program operates in the Windows® 95, 98, 2000, NT and XP operating systems. The FranklinCovey PlanPlus Software includes all necessary software, related tutorials and reference manuals. FranklinCovey PlanPlusÔ Software is also intended for our corporate clients that have already standardized on MicrosoftÒ for group scheduling, but wish to make the FranklinCovey Planning System available to their employees without creating the need to support two separate systems. As this kind of extension proves its value in the market, the FranklinCovey Planning Software extension model may be expanded to other platforms.
 
We are an OEM provider of the PalmOneÔ handheld devices, which has become another successful planning tool for which we provide FranklinCovey Planning Software and sell through our FranklinCovey channels. In an effort to combine the functionality of paper and the capabilities of the PalmÒ, we introduced products that can add paper-based planning to these electronic planners as well as binders and carrying cases specific to the PalmOneÔ product line. We have also expanded the handheld line to include other electronic organizers with the FranklinCovey Planning Software such as the iPAQÔ Pocket PC from Hewlett-Packard® and the TrioÔ by Handspring®, now part of PalmOneÔ.
 
We also provide The 7 Habits of Highly Effective People® training course in online and CD-ROM versions. This edition delivers the content from the 3-day classroom workshop in a flexible self-paced version via the Internet or CD-ROM that is available when and where employees need it. The Online Edition is presented in a multi-media format with video segments, voiceovers, a learning journal, interactive exercises, and other techniques. Included with the course is a 360-Degree profile and e-Coaching to help participants gain a broader perspective of their strengths and weaknesses and to help them implement the training to improve their skills.
 
The FranklinCovey Planning System is also available for the Tablet PC through FranklinCovey PlanPlus for Windows XP software. The software was developed in cooperation with Agilix Labs and includes the following features: screen views similar to the paper-based FranklinCovey Planner, natural handwriting interface, the full FranklinCovey Planning System with appointment scheduling, prioritized daily and master tasks and daily notes, digital note-taking and synchronization with Outlook Exchange and an e-Binder concept allowing for the collection of all important documents into one place.
 
Personal Development and Accessory Products. To supplement our principal products, we offer a number of accessories and related products, including third-party books, videotapes and audio cassettes focused on time management, leadership, personal improvement and other topics. We also market a variety of content-based personal development products. These products include books, audio learning systems such as multi-tape, CDs and workbook sets, CD-ROM software products, calendars and other specialty name brand items. We offer numerous accessory forms through our Forms Wizard software, which allows customization of our more popular forms, including check registers, spreadsheets, stationery, mileage logs, maps, menu planners, shopping lists and other information management and project planning forms. Our accessory products and forms are generally available in all the FranklinCovey Planner sizes.
 
Books. The principles we teach in our curriculum have also been published in book, audiotape and CD formats. Books to which the Company holds copyrights include The 7 Habits of Highly Effective People®, Principle-Centered Leadership, First Things First, The 7 Habits of Highly Effective Families, Nature of Leadership, Living the 7 Habits, and the latest book, The 8th Habit: From Effectiveness to Greatness all by Stephen R. Covey, The 10 Natural Laws of Time and Life Management, What Matters Most and The Modern Gladiator by Hyrum W. Smith, The Power Principle by Blaine Lee, The 7 Habits of Highly Effective Teens by Sean Covey and Business Think by Dave Marcum and Steve Smith. These books, as well as audiotape and CD audio versions of many of these products, and the products mentioned above are sold through general retail channels, as well as through our own catalog, our e-commerce Internet site at www.franklincovey.com and our retail stores.

Training and Consulting Services
 
We offer training and consulting services for organizations through a combination of assessment instruments, including the xQ (Execution QuotientÔ) Profile and the 7 Habits Profile, and training courses including FOCUS: Achieving Your Highest Priorities; The 4 Disciplines of Execution™; The 4 Roles of Leadership™; and The 7 Habits of Highly Effective PeopleÒ. We measure the impact of training investments for our clients through pre- and post- assessment profiles and return on investment analysis. These services are marketed and delivered world-wide through our Organizational Solutions Business Unit (OSBU), which consists of consultants, selected through a competitive and demanding process, and sales professionals.
 
Training and Education Programs. We offer a range of training programs designed to measurably improve the effectiveness of individuals and organizations. Our programs are oriented to address personal, interpersonal, managerial and organizational needs. In addition, we believe that our learning process provides an engaging and behavior-changing experience, which frequently generates additional business. During fiscal year 2006, more than 450,000 individuals were trained using the Company’s curricula in its single and multiple-day workshops and seminars. We also offer assessment tools to help organizational clients determine the effectiveness of implementing company goals. The xQ Survey is an exclusive FranklinCovey assessment tool that gathers information, from an employee perspective, on how well organizational goals are understood and are being carried out. The survey questions, administered through a Web-based system, probe for details to uncover underlying focus and teamwork barriers or issues.
 
Our single-day FOCUS: Achieving Your Highest Priorities workshop teaches productivity skills integrated with a planning system to help individuals clarify, focus on, and execute their highest priorities, both personally and professionally. This seminar is conducted by our training consultants for employees of clients and in public seminars throughout the United States and in many foreign countries. The single-day The 4 Disciplines of Execution workshop helps managers identify the highest priorities for their teams and then lead those teams to execute tasks day-after-day.
 
We also deliver multiple-day workshops, primarily in the leadership area. Included in these offerings is the three-day 7 Habits workshop based upon the material presented in The 7 Habits of Highly Effective People®. The 7 Habits workshop provides the foundation for continued client relationships and the content and application tools are designed to be delivered deep into the client’s organization. Additionally, a three-day 4 Roles of Leadership course is offered, which focuses on the managerial aspects of client needs. FranklinCovey Leadership Week consists of a five-day session focused on materials from FranklinCovey's The 7 Habits of Highly Effective People® and The 4 Roles of Leadership courses. FranklinCovey Leadership Week is reserved for supervisory level management of our corporate clients. As a part of the week's agenda, executive participants plan and design strategies to successfully implement key organizational goals or initiatives.
 
In addition to providing consultants and presenters, we also train and certify client facilitators to teach selected FranklinCovey workshops within their organizations. We believe client-facilitated training is important to our fundamental strategy of creating pervasive on-going client impact and revenue streams. After having been certified, client facilitators can purchase manuals, profiles, planners and other products to conduct training workshops within their organization, generally without repeating the sales process. This creates programs which have an on-going impact on our customers and which generate annuity-type revenues. This is aided by the fact that curriculum content in one course leads the client to additional participation in other Company courses. Since 1988, we have trained more than 20,000 client facilitators. Client facilitators are certified only after graduating from one of our certification workshops and completing post-course certification requirements.
 
In April 2002, we introduced The 7 Habits of Highly Effective People® training course in online and CD-ROM versions. The need for reaching more employees faster and more inexpensively are the key drivers behind the growth of e-learning in the marketplace. The 7 Habits Online Edition addresses that need, offering a flexible alternative to classroom training.

Segment Information
 
To help us fulfill our mission of enabling greatness in people and organizations everywhere, we have organized our business in two segments: (1) the Consumer Solutions Business Unit (CSBU) designed to reach individual consumers; and (2) the Organizational Solutions Business Unit (OSBU) designed to serve organizational clients. The following table sets forth, for the periods indicated, the Company's revenue from external customers for each of its operating segments (in thousands):

   
2006
 
2005
 
2004
 
Consumer Solutions Business Unit
                   
Retail Stores
 
$
62,440
 
$
74,331
 
$
87,922
 
Consumer Direct
   
63,681
   
62,873
   
60,091
 
Wholesale
   
19,783
   
19,691
   
21,081
 
Other
   
4,910
   
3,757
   
2,007
 
Total CSBU
   
150,814
   
160,652
   
171,101
 
 
Organizational Solutions Business Unit
                   
Domestic
   
71,108
   
68,816
   
56,015
 
International
   
56,701
   
54,074
   
48,318
 
Total OSBU
   
127,809
   
122,890
   
104,333
 
 
Total
 
$
278,623
 
$
283,542
 
$
275,434
 


We market products and services to organizations, schools and individuals both domestically and internationally through FranklinCovey retail stores, our consumer direct channel (which includes catalog operations, our Internet website at www.franklincovey.com and public seminar programs), our organizational and educational sales forces and other distribution channels. Our quarterly results of operations reflect seasonal trends that are primarily the result of customers who renew their FranklinCovey Planners on a calendar year basis.  Domestic training sales are moderately seasonal because of the timing of corporate training, which is not typically scheduled as heavily during holiday and vacation periods.  Additional financial information related to our operating segments, as well as geographical information can be found in the notes to our consolidated financial statements (Note 18).

Consumer Solutions Business Unit
 
We sell FranklinCovey products and other productivity tools to individual consumers through our company-owned retail stores, through FranklinCovey consumer direct channels, and through selected wholesale channels.
 
Retail Stores. Beginning in late 1985, we began a retail strategy by opening retail stores in areas of high client density. The initial stores were generally located in close proximity to corporate clients. We revised our strategy by locating retail stores in high-traffic retail centers, primarily large shopping centers and malls, to serve existing clients and to attract increased numbers of walk-in clients. Our retail stores average approximately 1,900 square feet. Our retail strategy focuses on reinforcing the training experience with high client service and consultative sales of planning tools. We believe this approach ensures longer-term usage and satisfaction with the FranklinCovey Planning System.
 
We believe that our retail stores have an upscale image consistent with our marketing strategy. Products are attractively presented and displayed with an emphasis on integration of related products and accessories. Our retail sales associates have been trained to teach the FranklinCovey Planning System, using the various tools and electronic handheld devices and software we offer, enabling them to assist and advise clients in the selection and use of our products.
 
Retail store employees have also been engaged to proactively market to small businesses in the cities where they are located. Their marketing efforts include calling upon small (fewer than 100 employees) businesses to offer productivity tools and training.  This out-bound selling effort has helped to stabilize declining revenues in the retail channel and provided access to FranklinCovey training and products to a business segment not traditionally marketed to through the Company’s sales force.
 
At August 31, 2006, FranklinCovey had 89 domestic retail stores located in 33 states. We closed 16 retail stores in the United States during fiscal year 2006. These closures were primarily comprised of under-performing stores. The Company anticipates that it may close additional stores in fiscal year 2007.
 
Consumer Direct. Our Consumer Direct channel consists of sales through catalog call-in operations, Internet sales operations and public seminar programs. We periodically mail catalogs to our clients, including a fall catalog, holiday catalogs, spring and summer catalogs timed to coincide with planner renewals. Catalogs may be targeted to specific geographic areas or user groups as appropriate. Catalogs are typically printed in full color with an attractive selling presentation highlighting product benefits and features. We also market the FranklinCovey Planning System through our e-commerce Internet site at www.franklincovey.com. Customers may order catalogs and other marketing materials as well as the Company’s product line through this Internet portal.
 
During fiscal 2001, we entered into a long-term contract with Electronic Data Systems (EDS) of Dallas, Texas, to provide a large part of our customer relationship management in servicing our Consumer Direct customers through our catalog and e-commerce operations. We use EDS to maintain a client service department, which clients may call toll-free, from 6:00 a.m. to 7:00 p.m. MST, Monday through Friday, to inquire about a product or to place an order. Through a computerized order entry system, client representatives have access to client preferences, prior orders, billings, shipments and other information on a real-time basis. Each of the more than 65 customer service representatives has the authority to immediately solve client service problems. The integrated relationship management system provided by EDS allows orders from our customers to be processed through its warehousing and distribution systems. Client information stored within the order entry system is also used for additional purposes, including target marketing of specific products to existing clients. We believe that the order entry system helps assure client satisfaction through both rapid delivery and accurate order shipment.
 
Our Consumer Direct channel includes public seminar sales. Public seminars are planned and coordinated with training consultants by a staff of marketing and administrative personnel at the Company's corporate offices. The seminars are delivered by our training consultants in more than 100 major metropolitan cities throughout the United States. These seminars provide training for organizations and the general public and are also used as a marketing tool for attracting corporate and other institutional clients. Corporate training directors are often invited to attend public seminars to preview the seminar content prior to engaging FranklinCovey to train in-house employees. Smaller institutional clients often enroll their employees in public seminars when a private seminar is not cost effective.
 
Wholesale. We have an alliance with MeadWestvaco to sell our products through the contract stationer channel. MeadWestvaco distributes our products to contract stationer businesses such as Office Express, Office Depot, Office Max and Staples, which sell office products through catalog order entry systems to businesses and organizations. MeadWestvaco also represents FranklinCovey in the office superstore category by wholesaling the FranklinCovey Planning System to Staples, Office Depot and OfficeMax and represents us with Target Stores, for which we designed a specialty line of paper planning products branded under the “365 by FranklinCovey” under-brand label which is sold exclusively in their stores. We also have a similar distribution agreement with Heritage Industries in which they sell select products into Sam’s, Costco, Office Depot, Office Max and Staples stores and an under-brand label “DayOne by FranklinCovey” product line that is sold through WalMart stores. 
 
Other.  Other sales included sales of printing services by FranklinCovey Printing, a wholly-owned subsidiary, miscellaneous licensing rights of FranklinCovey products and brands to various marketing customers, and sub-lease revenues from third-party tenants. 

Organizational Solutions Business Unit 
 
Domestic Training. We sell effectiveness and productivity solutions to organizations and schools through our own direct sales forces. We then deliver training services to organizations, schools and individuals in one of four ways:

 
1.
 
FranklinCovey consultants provide on-site consulting or training classes for organizations and schools. In these situations, our consultant can tailor the curriculum to our client’s specific business and objectives.
 
 
2.
 
We conduct public seminars in 130 cities throughout the United States, where organizations can send their employees in smaller numbers. These public seminars are also marketed directly to individuals through our catalog, e-commerce web-site, retail stores, and by direct mail.
 
 
3.
 
Our programs are also designed to be facilitated by licensed professional trainers and managers in client organizations, reducing dependence on our professional presenters, and creating continuing revenue through royalties and as participant materials are purchased for trainees by these facilitators.
 
 
4.
 
We also offer The 7 Habits of Highly Effective People® training course in online and CD-ROM formats. This self-paced e-learning alternative provides the flexibility that many organizations need to meet the needs of various groups, managers or supervisors who may be unable to attend extended classroom training and executives who need a series of working sessions over several weeks.
 
FranklinCovey's domestic training operations are organized in geographic regional sales teams in order to assure that both the consultant and the client sales professional participate in the development of new business and the assessment of client needs. Consultants are then entrusted with the actual delivery of content, seminars, processes and other solutions. Consultants follow up with client service teams, working with them to develop lasting client impact and ongoing business opportunities.
 
We employ 103 sales professionals and business developers located in six major metropolitan areas throughout the United States who sell integrated offerings to institutional clients. We also employ an additional 49 sales professionals and business developers outside of the United States in six countries. Our sales professionals have selling experience prior to employment by the Company and are trained and evaluated in their respective sales territories. Sales professionals typically call upon persons responsible for corporate employee training, such as corporate training directors or human resource officers. Increasingly, sales professionals also call upon line leaders. Our sales professionals work closely with training consultants in their territories to schedule and tailor seminars and workshops to meet specific objectives of institutional clients.  
 
FranklinCovey currently employs 109 training consultants in major metropolitan areas of the United States, with an additional 26 training consultants outside of the United States. Our training consultants are selected from a large number of experienced applicants. These consultants generally have several years of training and/or consulting experience and are known for their excellent presentation skills. Once selected, the training consultant goes through a rigorous training program including multiple live presentations. The training program ultimately results in the Company's certification of the consultant.
 
We also provide The 7 Habits of Highly Effective Teens as a workshop or as a year-long curriculum to schools and school districts and other organizations working with youth. Based on The 7 Habits of Highly Effective Teens book, it helps to teach students and teachers studying skills, learning habits, and interpersonal development. In December 2001, we sold the stock of Premier Agendas, a wholly owned subsidiary that previously delivered our products and services to schools, to School Specialty. Pursuant to a license from FranklinCovey, Premier Agendas is expected to continue to expose over 20 million K-12 students to FranklinCovey’s world-renowned 7 Habits content. We retained the educator leadership and effectiveness training portion of Premier’s business.  
 
International Sales. We provide products, training and printing services internationally through Company-owned and licensed operations. We have Company-owned operations and offices in Australia, Brazil, Canada, Japan, Mexico and the United Kingdom. We also have licensed operations in Argentina, Austria, Bahamas, Bahrain, Bangladesh, Belgium, Bermuda, Bulgaria, Chile, China, Colombia, Costa Rica, Croatia, Czech Republic, Denmark, Dominican Republic, Ecuador, Egypt, El Salvador, Estonia, Finland, France, Germany, Greece, Greenland, Guatemala, Honduras, Hong Kong, Hungary, India, Iceland, Indonesia, Israel, Italy, Jordan, Kuwait, Latvia, Lebanon, Lithuania, Luxembourg, Malaysia, Nepal, Netherlands, Netherland Antilles, Nicaragua, Nigeria, Norway, Panama, Paraguay, Peru, Philippines, Poland, Portugal, Puerto Rico, Russia, Saudi Arabia, Singapore, Slovak Republic, Slovenia, South Africa, South Korea, Spain, Sri Lanka, Sweden, Switzerland, Taiwan, Thailand, Trinidad/Tobago, Turkey, UAE, Ukraine, Uruguay, Venezuela, Vietnam and West Indies. There are also licensee retail operations in Hong Kong and South Korea. Our seven most popular books, The 7 Habits of Highly Effective People, Principle-Centered Leadership, The 10 Natural Laws of Time and Life Management, First Things First, The Power Principle, The 7 Habits of Highly Effective Families and The 7 Habits of Highly Effective Teens are currently published in multiple languages. Financial information about our foreign operations is contained in Note 18 to our consolidated financial statements.
 
Strategic Distribution Alliances 
 
We have created strategic alliances with third-party organizations in an effort to develop effective distribution of our products and services. The principal distribution alliances currently maintained by FranklinCovey are: Simon & Schuster and Saint Martin’s Press in publishing books for the Company; Nightingale-Conant to market and distribute audio and video tapes of the Company's book titles; MeadWestvaco to market and distribute selected FranklinCovey Planners and accessories through the At-A-Glance catalog office supply channels and in the office superstores channel; PalmOneÔ to serve as the official training organization for its PalmOneÔ products; Agilix Labs in development of the PlanPlus Software; Microsoft in conjunction with PlanPlus marketing; and Heritage Travelware. Ltd. to market and distribute selected FranklinCovey products to Sams Club, Costco and WalMart.
 
Clients
 
We have a relatively broad base of institutional and individual clients. We have more than 2,000 institutional clients consisting of corporations, governmental agencies, educational institutions and other organizations. We believe our products, workshops and seminars encourage strong client loyalty. Employees in each of our distribution channels focus on providing timely and courteous responses to client requests and inquiries. Institutional clients may choose to receive assistance in designing and developing customized forms, tabs, pagefinders and binders necessary to satisfy specific needs. As a result of the nature of FranklinCovey’s business and distribution channels, the Company does not have, nor has it had, a significant backlog of firm orders.
 
Competition
 
Training. Competition in the performance skills organizational training and education industry is highly fragmented with few large competitors. We estimate that the industry represents more than $6 billion in annual revenues and that the largest traditional organizational training firms have sales in the $100 million to $400 million range. Based upon FranklinCovey's fiscal 2006 organizational sales of approximately $130 million, we believe we are a leading competitor in the organizational training and education market. Other significant competitors in the training market are Development Dimensions International, Institute for International Research (IIR) (formerly Achieve Global and Zenger Miller), Organizational Dynamics Inc., Provant, Forum Corporation, EPS Solutions and the Center for Creative Leadership.
 
Products. The paper-based time management and personal organization products market is intensely competitive and subject to rapid change. FranklinCovey competes directly with other companies that manufacture and market calendars, planners, personal organizers, appointment books, diaries and related products through retail, mail order and other sales channels. In this market, several competitors have strong name recognition. We believe our principal competitors include DayTimer, At-A-Glance and Day Runner. We also compete with companies that market substitutes for paper-based products, such as electronic organizers, software, PIM’s and handheld computers. Many FranklinCovey competitors, particularly those providing electronic organizers, software-based management systems, and hand-held computers, have access to marketing, product development, financial and other resources significantly in excess of those available to FranklinCovey. An emerging potential source of competition is the appearance of calendars and event-planning services available at no charge on the Web. There is no indication that the current level of features has proven to be attractive to the traditional planner customer as a stand-alone service, but as these products evolve and improve, they could pose a competitive threat.
 
Given the relative ease of entry in FranklinCovey's product and training markets, the number of competitors could increase, many of whom may imitate existing methods of distribution, products and seminars, or offer similar products and seminars at lower prices. Some of these companies may have greater financial and other resources than us. We believe that the FranklinCovey Planning System and related products compete primarily on the basis of user appeal, client loyalty, design, product breadth, quality, price, functionality and client service. We also believe that the FranklinCovey Planning System has obtained market acceptance primarily as a result of the concepts embodied in it, the high quality of materials, innovative design, our attention to client service, and the strong loyalty and referrals of our existing clients. We believe that our integration of training services with products has become a competitive advantage. Moreover, we believe that we are a market leader in the United States among a small number of integrated providers of productivity and time management products and services. Increased competition from existing and future competitors could, however, have a material adverse effect on our sales and profitability.

Manufacturing and Distribution
 
The manufacturing operations of FranklinCovey consist primarily of printing, collating, assembling and packaging components used in connection with our paper product lines. We operate our central manufacturing services out of Salt Lake City, Utah. We have also developed partner printers, both domestically and internationally, who can meet our quality standards, thereby facilitating efficient delivery of product in a global market. We believe this has positioned us for greater flexibility and growth capacity. Automated production, assembly and material handling equipment are used in the manufacturing process to ensure consistent quality of production materials and to control costs and maintain efficiencies. By operating in this fashion, we have gained greater control of production costs, schedules and quality control of printed materials.
 
During fiscal 2001, we entered into a long-term contract with EDS to provide warehousing and distribution services for our product line. EDS maintains a facility at the Company’s headquarters as well as at other locations throughout North America.
 
Binders used for our products are produced from either leather, simulated leather, fabrics or other synthetic materials. These binders are produced by multiple product suppliers. We currently enjoy good relations with our suppliers and vendors and do not anticipate any difficulty in obtaining the required binders and materials needed for our business. We have implemented special procedures to ensure a high standard of quality for binders, most of which are manufactured by suppliers in the United States, Europe, Canada, Korea, Mexico and China.
 
We also purchase numerous accessories, including pens, books, videotapes, calculators and other products, from various suppliers for resale to our clients. These items are manufactured by a variety of outside contractors located in the United States and abroad. We do not believe that we are materially dependent on any one or more of such contractors and consider our relationships with such suppliers to be good.

Research and Development
 
FranklinCovey believes that the development of new products and curricula are important to maintaining its competitive position. Our products and services are conceived, designed and developed through the collaboration of our internal innovations group and external partner organizations. We focus our product design efforts on both improving our existing products and developing new products. We intend to continue to employ a customer focused design approach to provide innovative products and curricula that respond to and anticipate customer needs for functionality, productivity and effectiveness.

We expense in the same year incurred part of the costs to develop new curricula and products.  Curriculim costs are only capitalized when a course is developed that will result in significant future benefits or when there is a major revision to a course or course materials.  Our research and development expenditures totaled $2.3 million, $2.2 million, and $3.6 million in fiscal years 2006, 2005, and 2004, respectively, and capitalized curriculum costs totaled $4.0 million, $2.2 million and $1.0 million, respectively, for the same years.

Trademarks, Copyrights and Intellectual Property
 
We seek to protect our intellectual property through a combination of trademarks, copyrights and confidentiality agreements. We claim rights for 128 trademarks in the United States and have obtained registration in the United States and many foreign countries for many of our trademarks, including FranklinCovey, The 7 Habits of Highly Effective People, Principle-Centered Leadership, The 4 Disciplines of Execution, FranklinCovey Planner, PlanPlus, The 7 Habits and The 8th Habit. We consider our trademarks and other proprietary rights to be important and material to our business. Each of the marks set forth in italics above is a registered mark or a mark for which protection is claimed.
 
We own sole or joint copyrights on our planning systems, books, manuals, text and other printed information provided in our training seminars, the programs contained within FranklinCovey Planner Software and its instructional materials, and our software and electronic products, including audio tapes and video tapes. We license, rather than sell, all facilitator workbooks and other seminar and training materials in order to protect our intellectual property rights therein. FranklinCovey places trademark and copyright notices on its instructional, marketing and advertising materials. In order to maintain the proprietary nature of our product information, FranklinCovey enters into written confidentiality agreements with certain executives, product developers, sales professionals, training consultants, other employees and licensees. Although we believe the protective measures with respect to our proprietary rights are important, there can be no assurance that such measures will provide significant protection from competitors.

Employees

As of August 31, 2006, FranklinCovey had 1,237 full and part-time associates, including 539 in sales, marketing and training; 343 in customer service and retail; 113 in production operations and distribution; and 242 in administration and support staff. During fiscal 2002, the Company outsourced a significant part of its information technology services, customer service, distribution and warehousing operations to EDS. A number of the Company’s former employees involved in these operations are now employed by EDS to provide those services to FranklinCovey. None of our associates are represented by a union or other collective bargaining group. Management believes that its relations with its associates are good and we do not currently foresee a shortage in qualified personnel needed to operate our business.
 
Available Information
 
The Company's principal executive offices are located at 2200 West Parkway Boulevard, Salt Lake City, Utah 84119-2331 and our telephone number is (801) 817-1776.
 
We regularly file reports with the Securities and Exchange Commission (SEC). These reports include, but are not limited to, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and security transaction reports on Forms 3, 4, or 5. The public may read and copy any materials that the Company files with the SEC at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains electronic versions of the Company’s reports on its website at www.sec.gov.
 
The Company makes our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and other reports filed or furnished with the SEC available to the public, free of charge, through our website at www.franklincovey.com. These reports are provided through our website as soon as reasonably practicable after we file or furnish these reports with the SEC.
 
 
ITEM 1A. Risk Factors
 
Our business environment, current domestic and international economic conditions, and other specific risks may affect our future business decisions and financial performance. The matters discussed below may cause our future results to differ from past results or those described in forward-looking statements and could have a material adverse effect on our business, financial condition, liquidity, results of operations, and stock price, and should be considered in evaluating the Company.

The following list of potential risks to the Company is not exhaustive. Additional business risks and uncertainties that are not presently known to us or that are not currently believed to be material may also harm our business operations and financial results.

We operate in highly competitive industries

The training and consulting industry and planner product industry are highly competitive with relatively easy entry. Competitors continually introduce new programs and products that may compete directly with our offerings. Larger and better capitalized competitors may have superior abilities to compete for clients and skilled professionals. In addition, one or more of our competitors may develop and implement training courses or methodologies that may adversely affect our ability to sell our methodologies to new clients.

We have experienced net losses in recent fiscal years and we may not be able to maintain consistent profitability

Although we reported net income in fiscal 2006, we have experienced significant net losses in recent years. While we continue to implement initiatives designed to increase our sales, reduce costs, and otherwise improve our operating results, and have recognized significant improvements in recent years, we cannot assure you that we will return to consistently profitable operations.

During previous years we have faced numerous challenges that have affected our operating results. Specifically, we have experienced, and may continue to experience the following:
 
·
Declining traffic in our retail stores and consumer direct channel
 
·
Increased risk of excess and obsolete inventories
 
·
Operating expenses that, as a percentage of sales, have exceeded our desired business model
 
·
Costs associated with exiting unprofitable or underperforming retail stores
 
In addition, if we are unable to maintain profitable operations we may be required to reestablish valuation allowances on our deferred tax assets if it becomes more likely than not that we would not be able to realize the benefits of those assets. The reestablishment of deferred tax assets would have an unfavorable impact upon our reported net income.

If we do not achieve the appropriate cost structure our profitability could decrease

Our future success and profitability depend in part on our ability to achieve the appropriate cost structure and be efficient in the highly competitive training, consulting, and planner industries. We are currently developing and implementing profit-enhancing initiatives and business models that impact our operations and are designed to improve our profitability. Our recent initiatives have included exiting non-core businesses, recapitalization of our preferred stock, asset sales, headcount reductions, and other internal initiatives designed to reduce our operating costs. If we do not achieve targeted business model cost levels and manage costs and processes to achieve additional efficiencies, our competitiveness and profitability could decrease.

Our results of operations are materially affected by economic conditions, levels of business activity, and other changes experienced by our clients

Uncertain economic conditions continue to affect many of our clients’ businesses and their budgets for training, consulting, and related products. Such economic conditions and budgeted spending are influenced by a wide range of factors that are beyond our control and that we have no comparative advantage in forecasting. These conditions include:

 
·
The overall demand for training, consulting, and our related products
 
·
Conditions and trends in the training and consulting industry
 
·
General economic and business conditions
 
·
General political developments, such as the war on terrorism, and their impacts upon our business both domestically and internationally
 
·
Natural or man-made disasters

In addition, our business tends to lag behind economic cycles and, consequently, the benefits of any economic recovery may take longer for us to realize than other segments of the economy. Future deterioration of economic conditions, particularly in the United States, could increase these effects on our business.

Our product sales may continue to decline and result in changes to our profitability

In recent years, our product sales have declined. These product sales, which are primarily delivered through our retail stores, consumer direct channels (catalog call center, eCommerce and public seminar programs), wholesale, and government product channels, have historically been very profitable for us. However, due to recent sales declines, we have reevaluated our product business and have taken steps to restore its profitability. These initiatives have included hiring an additional sales force based at certain retail stores, retail store closures, active efforts to transition catalog customers to our eCommerce site, outsourcing our government products channel, and increasing our business through wholesale channels. However, these initiatives may also result in decreased gross margins on our product sales if lower-margin wholesale sales increase. If product sales continue to decline or gross margins decline, our product sales strategies may not be adequate to return our product delivery channels to past profitability levels.

We may not be able to compensate for lower sales or unexpected cash outlays with cost reductions significant enough to generate positive net income

Although we have initiated cost-cutting efforts that have included headcount reductions, retail store closures, consolidation of administrative office space, and changes in our advertising and marketing strategy, if we are not able to prevent further sales declines or achieve our growth objectives, we will need to further reduce our costs. An unintended consequence of additional cost reductions may be reduced sales. If we are not able to effectively reduce our costs and expenses commensurate with, or at the same pace as, any further deterioration in our sales, we may not be able to generate positive net income or cash flows from operations. Although we have experienced improved cash flows from operations during fiscal 2006 and 2005 compared to recent periods, an inability to maintain or continue to increase cash flows from operations may have an adverse impact upon our liquidity and ability to operate the business. For example, we may not be able to obtain additional financing or raise additional capital on terms that would be acceptable to us.

Our global operations pose complex management, foreign currency, legal, tax, and economic risks, which we may not adequately address

We have Company-owned offices in Australia, Brazil, Canada, Japan, Mexico, and the United Kingdom. We also have licensed operations in numerous other foreign countries. As a result of these foreign operations and their growing impact upon our results of operations, we are subject to a number of risks, including:

 
·
Restrictions on the movement of cash
 
·
Burdens of complying with a wide variety of national and local laws
 
·
The absence in some jurisdictions of effective laws to protect our intellectual property rights
 
·
Political instability
 
·
Currency exchange rate fluctuations
 
·
Longer payment cycles
 
·
Price controls or restrictions on exchange of foreign currencies

While we are not currently aware of any of the foregoing conditions materially adversely affecting our operations, these conditions, which are outside of our control, could change at any time.

We may experience foreign currency gains and losses

Our sales outside of the United States totaled $56.7 million, or 20 percent of total sales, in fiscal 2006. As our international operations continue to grow and become a larger component of our overall financial results, our revenues and operating results may be adversely affected when the dollar strengthens relative to other currencies and may be positively affected when the dollar weakens. In order to manage a portion of our foreign currency risk, we make limited use of foreign currency derivative contracts to hedge certain transactions and translation exposure. There can be no guarantee that our foreign currency risk management strategy will be effective in reducing the risks associated with foreign currency transactions and translation.

Our profitability will suffer if we are not able to maintain our pricing and utilization rates and control our costs

Our profit margin on training services is largely a function of the rates we are able to recover for our services and the utilization, or chargeability, of our trainers, client partners, and consultants. Accordingly, if we are unable to maintain sufficient pricing for our services or an appropriate utilization rate for our training professionals without corresponding cost reductions, our profit margin and overall profitability will suffer. The rates that we are able to recover for our services are affected by a number of factors, including:

 
·
Our clients’ perceptions of our ability to add value through our programs and products
 
·
Competition
 
·
General economic conditions
 
·
Introduction of new programs or services by us or our competitors
 
·
Our ability to accurately estimate, attain, and sustain engagement sales, margins, and cash flows over longer contract periods 
 
Our utilization rates are also affected by a number of factors, including:
 
·
Seasonal trends, primarily as a result of scheduled training
 
·
Our ability to forecast demand for our products and services and thereby maintain an appropriate headcount in our employee base
 
·
Our ability to manage attrition
 
Our training program profitability is also a function of our ability to control costs and improve our efficiency in the delivery of our services. Our cost-cutting initiatives, which focus on reducing both fixed and variable costs, may not be sufficient to deal with downward pressure on pricing or utilization rates. As we introduce new programs and seek to increase the number of our training professionals, we may not be able to manage a significantly larger and more diverse workforce, control our costs, or improve our efficiency.

Our new training programs and products may not be widely accepted in the marketplace

In an effort to improve our sales performance, we have made significant investments in new training and consulting offerings. Additionally, we have invested in our existing programs in order to refresh these programs and keep them relevant in the marketplace, including certain programs based on the newly revised The 7 Habits of Highly Effective People curriculum. Although we believe that our intellectual property is highly regarded in the marketplace, the demand for these new programs and products is still emerging. If our clients’ demand for these new programs and products does not develop as we expect, or if our sales and marketing strategies for these programs are not effective, our financial results could be adversely impacted and we may need to significantly change our business strategy.

If we are unable to attract, retain, and motivate high-quality employees, we will not be able to compete effectively and will not be able to grow our business

Due to our reliance on customer satisfaction, our overall success and ability to grow are dependent, in part, on our ability to hire, retain, and motivate sufficient numbers of talented people with the necessary skills needed to serve clients and grow our business. The inability to attract qualified employees in sufficient numbers to meet particular demands or the loss of a significant number of our employees could have a serious adverse effect on us, including our ability to obtain and successfully complete important client engagements and thus maintain or increase our sales.

We continue to offer a variable component of compensation, the payment of which is dependent upon our sales performance and profitability. We adjust our compensation levels and have adopted different methods of compensation in order to attract and retain appropriate numbers of employees with the necessary skills to serve our clients and grow our business. We may also use equity-based performance incentives as a component of our executives’ compensation, which may affect amounts of cash compensation. Variations in any of these areas of compensation may adversely impact our operating performance.

Our strategy of outsourcing certain functions and operations may fail to reduce our costs for these services

We have an outsourcing contract with Electronic Data Systems (EDS) to provide warehousing, distribution, information systems, and call center operations. Under terms of the outsourcing contract and its addendums, EDS operates the Company’s primary call center, provides warehousing and distribution services, and supports our various information systems. Due to the nature of outsourced operations, we are unable to exercise the same level of control over outsourced functions and the actions of EDS employees in outsourced roles as our own employees. As a result, the inherent risks associated with these outsourced areas of operation may be increased.

Certain components of the outsourcing agreement contain minimum activity levels that we must meet or we will be required to pay penalty charges. If these activity levels are not achieved, we may not realize anticipated benefits from the EDS outsourcing agreement in these areas.

Our outsourcing contracts with EDS contain early termination provisions that we may exercise under certain conditions. However, in order to exercise the early termination provisions, we would have to pay specified penalties to EDS depending upon the circumstances of the contract termination.

We have significant intangible asset balances that may be impaired if cash flows from related activities decline

At August 31, 2006 we had $79.5 million of intangible assets, which were primarily generated from the fiscal 1997 merger with the Covey Leadership Center. These intangible assets are evaluated for impairment based upon cash flows (definite-lived intangible assets) and estimated royalties from revenue streams (indefinite-lived intangible assets). Although our current sales and cash flows are sufficient to support the carrying basis of these intangibles, if our sales and corresponding cash flows decline, we may be faced with significant asset impairment charges.

Our future quarterly operating results are subject to factors that can cause fluctuations in our stock price

Historically, our stock price has experienced significant volatility. We expect that our stock price may continue to experience volatility in the future due to a variety of potential factors that may include the following:

 
·
Fluctuations in our quarterly results of operations and cash flows
 
·
Variations between our actual financial results and market expectations
 
·
Changes in our key balances, such as cash and cash equivalents
 
·
Currency exchange rate fluctuations
 
·
Unexpected asset impairment charges
 
·
Lack of analyst coverage

In addition, the stock market has experienced substantial price and volume fluctuations over the past several years that has had some impact upon our stock and other stock issues in the market. These factors, as well as general investor concerns regarding the credibility of corporate financial statements and the accounting profession, may have a material adverse effect upon our stock in the future.

We may need additional capital in the future, and this capital may not be available to us on favorable terms

We may need to raise additional funds through public or private debt offerings or equity financings in order to:

 
·
Develop new services, programs, or products
 
·
Take advantage of opportunities, including expansion of the business
 
·
Respond to competitive pressures
 
We may be unable to obtain the necessary capital on terms or conditions that are favorable to us.

We are the creditor for a management common stock loan program that may not be fully collectible

We are the creditor for a loan program that provided the capital to allow certain management personnel the opportunity to purchase shares of our common stock. For further information regarding our management common stock loan program, refer to Note 9 to our consolidated financial statements as found in Item 8 of this Annual Report on Form 10-K. The inability of the Company to collect all, or a portion, of these receivables could have an adverse impact upon our financial position and future cash flows compared to full collection of the loans.

We may have exposure to additional tax liabilities

As a multinational company, we are subject to income taxes as well as non-income based taxes, in both the United States and various foreign tax jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and other tax liabilities. In the normal course of a global business, there are many intercompany transactions and calculations where the ultimate tax determination is uncertain. As a result, we are regularly under audit by tax authorities. Although we believe that our tax estimates are reasonable, we cannot assure you that the final determination of tax audits will not be different from what is reflected in our historical income tax provisions and accruals.

We are also subject to non-income taxes, such as payroll, sales, use, value-added, and property taxes in both the United States and various foreign jurisdictions. We are regularly under audit by tax authorities with respect to these non-income taxes and may have exposure to additional non-income tax liabilities.

We may elect to use our cash to redeem shares of preferred stock or purchase shares of our common stock, which may decrease our ability to respond to adverse changes

Our outstanding preferred stock bears a cumulative dividend equal to 10 percent per annum. Through August 31, 2006 we have redeemed $50.0 million of our outstanding preferred stock and during fiscal 2006 we amended the terms of our preferred stock recapitalization that was completed in fiscal 2005 to extend the period during which we can redeem preferred stock at an amount equal to the liquidation preference. We anticipate that we may redeem additional shares of preferred stock in the future to the extent that we believe sufficient cash is available to do so. Any such preferred stock redemptions will reduce our cash on hand and may reduce our ability to adequately respond to any future adverse changes in our business and operations, whether anticipated or unanticipated.

A natural or man-made disaster could have a material adverse effect on the Company’s business

We have products and training materials manufactured at numerous sites located around the world. However, a significant portion of our products are manufactured and shipped from facilities located in Salt Lake City, Utah. In the event that these facilities were severely damaged or destroyed as a result of a natural or man-made disaster, we would be forced to rely solely on third-party manufacturers. Such an event could have a material adverse impact on our business prospects, results of operations, and financial condition.
 
 
ITEM 1B.
Unresolved Staff Comments

Pursuant to a review of the Company’s Form 10-K for the fiscal year ended August 31, 2005, we received a comment letter from the Securities and Exchange Commission (SEC) Staff related to various issues. During fiscal 2006 we resolved all of the comments on this letter except for a matter regarding the treatment of management common stock loan shares in the calculation of earnings per share (EPS) following the fiscal 2004 and fiscal 2006 modifications to the loans. We have sent a response to the SEC Staff and have had ongoing discussions regarding this matter. The Company believes that it has properly accounted for the EPS effects of changes to the management stock loan program but the matter is subject to further review and comment by the SEC. For further information regarding the treatment of management stock loan shares in the calculation of EPS, refer to Note 17 to our consolidated financial statements in Item 8 of this report on Form 10-K.

 
ITEM 2.
Properties

FranklinCovey’s principal business operations and executive offices are located in Salt Lake City, Utah. The following is a summary of our owned and leased properties. Our corporate headquarters lease is accounted for as a financing arrangement and all other facility lease agreements are accounted for as operating leases. Our lease agreements expire at various dates through the year 2025.

Corporate Facilities
Corporate Headquarters and Administrative Offices:
Salt Lake City, Utah (7 buildings) - all leased

Organizational Solutions Business Unit
Regional Sales Offices:
United States (7 locations) - all leased

International Administrative/Sales Offices:
Canada (1 location) - owned
Latin/South America (3 locations) - all leased
Asia Pacific (4 locations) - all leased
Europe (1 location) - leased

International Distribution Facilities:
Canada (1 location) - owned
Latin America (1 location) - leased
Asia Pacific (3 locations) - all leased
Europe (1 location) - leased

Consumer Solutions Business Unit
Retail Stores:
United States (89 locations in 33 states) - all leased

Manufacturing Facilities:
Salt Lake City, Utah (1 location) - for sale

A significant portion of our corporate headquarters campus is subleased to several unrelated entities.

We consider our existing facilities to be in good condition and suitable for our current and anticipated level of operations in the upcoming fiscal year. Significant developments related to our properties during fiscal 2006 consisted of the following:

 
·
In August 2006, we initiated a plan to reconfigure our printing operations in order to lower manufacturing costs, increase operational efficiency, and improve our ability to provide printing services for other entities. As a result of this plan, we are moving our printing operation a short distance from its existing location to our corporate headquarters campus and we are in the process of selling the existing manufacturing facility. We are also selling certain printing presses at the existing location and plan to replace these presses with new presses at the new location. Other existing presses will be moved to the new location as part of the reconfiguration plan. Because of the disruption of printing activity resulting from the move, the Company has developed a supply strategy to maintain adequate inventories of printed material while the reconfiguration plan is completed.
 
 
·
During fiscal 2006, we closed 16 domestic retail store locations and may close additional retail locations during fiscal 2007.
 

ITEM 3.
Legal Proceedings


During fiscal 2002, we received a subpoena from the Securities and Exchange Commission (SEC) seeking documents and information relating to our management stock loan program and previously announced, and withdrawn, tender offer. We provided the documents and information requested by the SEC, including the testimonies of our Chief Executive Officer, Chief Financial Officer, and other key employees. During February 2006, we received notification from the SEC that the investigation was terminated without a recommendation for enforcement action.

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 in the quarter ended February 25, 2006. We also recorded a $0.3 million reduction in selling, general and, administrative expenses for recovered legal expenses.

In August 2005, EpicRealm Licensing (EpicRealm) filed an action against the Company for patent infringement. The action alleges that FranklinCovey infringed upon two of EpicRealm’s patents directed to managing dynamic web page requests from clients to a web server that in turn uses a page server to generate a dynamic web page from content retrieved from a data source. The Company denies the patent infringement and believes that the EpicRealm claims are invalid. This litigation is currently in the discovery phase and the Company intends to vigorously defend this matter.

The Company is also the subject of certain other legal actions, which we consider routine to our business activities. At August 31, 2006, we believe that, after consultation with legal counsel, any potential liability to the Company under such actions will not materially affect our financial position, liquidity, or results of operations.


ITEM 4.
Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of security holders during the fourth quarter of our fiscal year ended August 31, 2006.


PART II

ITEM 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
 
FranklinCovey’s common stock is listed and traded on the New York Stock Exchange (NYSE) under the symbol “FC.” The following table sets forth, for the periods indicated, the high and low sale prices for our common stock, as reported on the NYSE Composite Tape, for the fiscal years ended August 31, 2006 and 2005.

   
High
 
Low
 
Fiscal Year Ended August 31, 2006:
             
Fourth Quarter
 
$
8.37
 
$
5.16
 
Third Quarter
   
9.79
   
7.00
 
Second Quarter
   
7.79
   
6.00
 
First Quarter
   
7.35
   
6.42
 
               
Fiscal Year Ended August 31, 2005:
             
Fourth Quarter
 
$
8.10
 
$
5.80
 
Third Quarter
   
7.13
   
2.22
 
Second Quarter
   
2.80
   
1.65
 
First Quarter
   
1.98
   
1.61
 

We did not pay or declare dividends on our common stock during the fiscal years ended August 31, 2006 and 2005. We currently anticipate that we will retain all available funds to redeem outstanding preferred stock, purchase shares of our common stock, and to finance our future growth and business opportunities and we do not intend to pay cash dividends on our common stock in the foreseeable future. However, we are obligated to pay cash dividends, which accrue at 10 percent per year, on our outstanding shares of Series A preferred stock.

As of November 1, 2006, the Company had 19,678,591 shares of its common stock outstanding, which was held by 424 shareholders of record.

The following table summarizes Company purchases of our preferred and common stock during the fiscal quarter ended August 31, 2006:


 
Period
 
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs
(in thousands)
 
Common Shares:
                 
May 28, 2006 to July 1, 2006
   
-
 
$
-
   
none
   $
6,073
 
                           
July 2, 2006 to July 29, 2006
   
50,700
   
6.65
   
50,700
   
5,735
 
                           
July 30, 2006 to August 31, 2006
   
145,100
   
5.85
   
145,100
   
4,887
(1) 
                           
Total Common Shares
   
195,800
 
$
6.06
   
195,800
 
 
 
 
                           
Total Preferred Shares
   
none
   
none
             
____________________________
(1) In January 2006, our Board of Directors approved the purchase of up to $10.0 million of our outstanding common stock. All previous authorized common stock purchase plans were canceled. Following the approval of this stock purchase plan, we purchased a total of 681,300 shares of common stock for $5.1 million during fiscal 2006.
 

ITEM 6.
Selected Financial Data

The selected consolidated financial data presented below should be read in conjunction with the consolidated financial statements of Franklin Covey and the related footnotes as found in Item 8 of this report on Form 10-K.

During fiscal 2002, we sold the operations of Premier Agendas and discontinued our on-line planning service offered at franklinplanner.com. Accordingly, the information set forth in the table below has been restated to reflect Premier Agendas and franklinplanner.com as discontinued operations.

August 31,
 
2006
 
2005
 
2004
 
2003
 
2002
 
In thousands, except per share data
                     
                       
Income Statement Data:
                               
Net sales
 
$
278,623
 
$
283,542
 
$
275,434
 
$
307,160
 
$
332,998
 
Income (loss) from operations
   
14,046
   
8,443
   
(9,064
)
 
(47,665
)
 
(122,573
)
Net income (loss) from continuing operations before income taxes
   
13,631
   
9,101
   
(8,801
)
 
(47,790
)
 
(122,179
)
Income tax benefit (provision)(1)
   
14,942
   
1,085
   
(1,349
)
 
2,537
   
32,122
 
Net income (loss) from continuing operations(1)
   
28,573
   
10,186
   
(10,150
)
 
(45,253
)
 
(90,057
)
Cumulative effect of accounting change, net of income taxes
   
-
   
-
   
-
   
-
   
(75,928
)
Net income (loss) available to common shareholders(1)
   
24,188
   
(5,837
)
 
(18,885
)
 
(53,988
)
 
(117,399
)
                                 
Earnings (loss) per share:
                               
Basic
 
$
1.20
 
$
(.34
)
$
(.96
)
$
(2.69
)
$
(5.90
)
Diluted
 
$
1.18
 
$
(.34
)
$
(.96
)
$
(2.69
)
$
(5.90
)
                                 
Balance Sheet Data:
                               
Total current assets
 
$
87,120
 
$
105,182
 
$
92,229
 
$
110,057
 
$
124,345
 
Other long-term assets
   
12,249
   
9,051
   
7,305
   
10,472
   
11,474
 
Total assets
   
216,559
   
233,233
   
227,625
   
262,146
   
308,344
 
                                 
Long-term obligations of continuing operations
   
35,347
   
46,171
   
13,067
   
15,743
   
15,231
 
Total liabilities
   
83,210
   
100,407
   
69,146
   
84,479
   
81,922
 
                                 
Preferred stock
   
37,345
   
57,345
   
87,203
   
87,203
   
87,203
 
Shareholders’ equity
   
133,349
   
132,826
   
158,479
   
177,667
   
226,422
 
__________________________
 
(1)
Net income in fiscal 2006 includes the impact of deferred tax asset valuation allowance reversals totaling $20.4 million.
 
 
ITEM 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
INTRODUCTION

The following management’s discussion and analysis is intended to provide a summary of the principal factors affecting the results of operations, liquidity and capital resources, contractual obligations, and the critical accounting policies of Franklin Covey Co. (also referred to as the Company, we, us, our, and FranklinCovey, unless otherwise indicated) and subsidiaries. This discussion and analysis should be read together with our consolidated financial statements and related notes, which contain additional information regarding the accounting policies and estimates underlying the Company’s financial statements. Our consolidated financial statements and related notes are presented in Item 8 of this report on Form 10-K.

FranklinCovey seeks to improve the effectiveness of organizations and individuals and is a worldwide leader in providing integrated learning and performance solutions to organizations and individuals that are designed to enhance strategic execution, productivity, leadership, sales force performance, effective communications, and other skills. Each performance solution may include products and services that encompass training and consulting, assessment, and various application tools that are generally available in electronic or paper-based formats. Our products and services are available through professional consulting services, public workshops, retail stores, catalogs, and the Internet at www.franklincovey.com. Historically, our best-known offerings include the FranklinCovey Planner™, and a suite of 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.

Our fiscal year ends on August 31, and unless otherwise indicated, fiscal 2006, fiscal 2005, and fiscal 2004, refers to the twelve-month periods ended August 31, 2006, 2005, and 2004.

Key factors that influence our operating results include the number of organizations that are active customers; the number of people trained within those organizations; the sale of personal productivity tools (including FranklinCovey Planners, personal, binders, electronic planning devices, and other related products); the availability of budgeted training spending at our clients and prospective clients, which is significantly influenced by general economic conditions; and our ability to manage operating costs necessary to develop and provide meaningful training and products to our clients.

RESULTS OF OPERATIONS

Overview

Our operating results in fiscal 2006 reflected year-over-year improvement compared to fiscal 2005. Despite a slight decrease in overall sales, due primarily to closed retail stores, we reported income from operations of $14.0 million in fiscal 2006 compared to $8.4 million in fiscal 2005. For the fiscal year ended August 31, 2006, we reported net income (before preferred dividends) of $28.6 million, compared to $10.2 million in fiscal 2005. Our fiscal 2006 net income includes the reversal of valuation allowances on our deferred income tax assets that favorably impacted our reported income taxes by $20.4 million. The primary factors that influenced our financial results for the fiscal year ended August 31, 2006 were as follows:

 
·
Sales Performance - Our consolidated sales decreased $4.9 million compared to the prior year. The decrease in sales was due to an $11.0 million decline in product sales that was primarily the result of closed retail stores. Our training and consulting services sales increased by $6.1 million compared to fiscal 2005, which was attributable to improvements in both domestic and international delivery channels. The improvement in training and consulting services sales was primarily due to increased sales of our recently refreshed The 7 Habits of Highly Effective People training courses.
 
 
·
Decreased Operating Costs - Our operating costs decreased by $6.9 million compared to fiscal 2005. Reduced operating expenses were due to a $3.6 million reduction in selling, general, and administrative expenses, a $3.0 million decrease in depreciation expense, and a $0.3 million decline in amortization expense. Consistent with prior years, we continue to seek for and implement strategies that will enable us to reduce our operating costs in order to improve our profitability.
 
 
·
Income Tax Benefit - Due to improved operating performance and the expected availability of future taxable amounts, we concluded that it was more likely than not that the benefits of certain deferred income tax assets would be realized. As a result, we reversed the valuation allowances on those domestic net deferred income tax assets during the fourth quarter of fiscal 2006. The reversal of the valuation allowances had a $20.4 million favorable impact on our reported fiscal 2006 income taxes.
 
 
·
Preferred Stock Redemptions - During fiscal 2006, we redeemed $20.0 million, or 0.8 million shares, of our Series A preferred stock. Since the fiscal 2005 preferred stock recapitalization, we have redeemed a total of $50.0 million, or 2.0 million shares, of our preferred stock. These preferred stock redemptions have reduced our dividend obligation by $5.0 million per year.


Although we achieved improved financial results in fiscal 2006 and recognized improvements in other financial trends, we have not yet attained our targeted business model and we are therefore continuing our efforts to increase sales, improve gross margins, and reduce operating costs in order to achieve consistently profitable operations in future periods. Further details regarding our operating results and liquidity are provided throughout the following management’s discussion and analysis.

The following table sets forth, for the fiscal years indicated, the percentage of total sales represented by the line items through income (loss) before income taxes in our consolidated income statements:

YEAR ENDED AUGUST 31,
 
 
2006
 
 
2005
 
 
2004
 
Product sales
   
56.1
%
 
59.0
%
 
64.3
%
Training and consulting services sales
   
43.9
   
41.0
   
35.7
 
Total sales
   
100.0
   
100.0
   
100.0
 
                     
Product cost of sales
   
25.3
   
27.2
   
31.1
 
Training and consulting services cost of sales
   
14.6
   
13.3
   
12.3
 
Total cost of sales
   
39.9
   
40.5
   
43.4
 
Gross profit
   
60.1
   
59.5
   
56.6
 
                     
Selling, general and administrative
   
52.0
   
52.3
   
54.1
 
Depreciation
   
1.7
   
2.7
   
4.3
 
Amortization
   
1.4
   
1.5
   
1.5
 
Total operating expenses
   
55.1
   
56.5
   
59.9
 
Income (loss) from operations
   
5.0
   
3.0
   
(3.3
)
                     
Interest income
   
0.5
   
0.3
   
0.1
 
Interest expense
   
(0.9
)
 
(0.3
)
     
Recovery from legal settlement
   
0.3
             
Gain on disposal of investment in unconsolidated subsidiary
         
0.2
       
Income (loss) before income taxes
   
4.9
%
 
3.2
%
 
(3.2
)%

Segment Review

We have two reporting segments: the Consumer Solutions Business Unit (CSBU) and the Organizational Solutions Business Unit (OSBU). The following is a brief description of these segments and their primary operating activities.

Consumer Solutions Business Unit - This business unit is primarily focused on sales to individual customers and includes the results of the Company’s retail stores, consumer direct (includes catalog, eCommerce, and public seminar training) operations, wholesale, and other related distribution channels, including government sales, and office superstores. 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 the Company’s leadership and productivity solutions can be purchased through CSBU channels.

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

The following table sets forth sales data by category and for our operating segments for the periods indicated. For further information regarding our reporting segments and geographic information, refer to Note 18 to our consolidated financial statements as found in Item 8 of this report on Form 10-K (in thousands).

 
 
YEAR ENDED AUGUST 31,
 
 
 
 
2006
 
Percent change from prior year
 
 
 
 
2005
 
Percent change from prior year
 
 
 
 
2004
 
Sales by Category:
                               
Products
 
$
156,205
   
(7)
 
$
167,179
   
(6)
 
$
177,184
 
Training and consulting services
   
122,418
   
5
   
116,363
   
18
   
98,250
 
   
$
278,623
   
(2)
 
$
283,542
   
3
 
$
275,434
 
                                 
Consumer Solutions Business Unit:
                               
Retail stores
 
$
62,440
   
(16)
 
$
74,331
   
(16)
 
$
87,922
 
Consumer direct
   
63,681
   
1
   
62,873
   
5
   
60,091
 
Wholesale
   
19,783
   
-
   
19,691
   
(7)
 
 
21,081
 
Other CSBU
   
4,910
   
31
   
3,757
   
87
   
2,007
 
     
150,814
   
(6)
 
 
160,652
   
(6)
 
 
171,101
 
Organizational Solutions Business Unit:
                               
Domestic
   
71,108
   
3
   
68,816
   
23
   
56,015
 
International
   
56,701
   
5
   
54,074
   
12
   
48,318
 
     
127,809
   
4
   
122,890
   
18
   
104,333
 
Total net sales
 
$
278,623
   
(2)
 
$
283,542
   
3
 
$
275,434
 


FISCAL 2006 COMPARED TO FISCAL 2005

Sales

Product Sales - Our overall product sales, which primarily consist of planners, binders, software, handheld electronic planning devices, and publishing, which are primarily sold through our CSBU channels, declined $11.0 million compared to fiscal 2005. The decline in overall product sales was primarily due to decreased retail store sales resulting from store closures that occurred during fiscal 2006 and 2005. The following is a description of sales performance in our CSBU delivery channels during the year ended August 31, 2006:
 
 
·
Retail Sales - The decline in retail sales was primarily due to store closures, which had a $12.5 million unfavorable impact on our retail store sales in fiscal 2006. Our retail stores also sold $1.7 million less technology and specialty products when compared to the prior year, primarily due to declining demand for electronic handheld planning products. Although store closures and reduced technology and specialty product sales caused total retail sales to decline compared to the prior year, we recognized a 1 percent improvement in year-over-year comparable store (stores which were open during the comparable periods) sales in fiscal 2006 as sales of “core” products (e.g. planners, binders, totes, and accessories) increased compared to the prior year. At August 31, 2006, we were operating 89 domestic retail locations compared to 105 locations at August 31, 2005.
 
 
·
Consumer Direct - Sales through our consumer direct segment (eCommerce, catalog, and public seminars) increased primarily due to increased public seminar sales and increased sales of core products. Increased public seminar sales was the result of additional seminars held during fiscal 2006 and an increase in the number of participants attending these programs.
 
 
·
Wholesale Sales - Sales through our wholesale channel, which includes sales to office superstores and other retail chains, were essentially flat compared to the prior year.
 
 
·
Other CSBU Sales - Other CSBU sales primarily consist of domestic printing and publishing sales and building sublease revenues. The increase in other CSBU sales was primarily attributable to increased sublease income from additional sublease contracts obtained during fiscal 2006. We have subleased a substantial portion of our corporate headquarters in Salt Lake City, Utah and have recognized $1.9 million of sublease revenue during fiscal 2006, compared to $1.1 million in fiscal 2005.
 
Training and Consulting Services Sales - We offer a variety of training and consulting services and related products that are focused on assisting individuals and organizations to become measurably more effective. Our training and consulting services include programs in productivity, leadership, strategy execution, sales force performance, and effective communications that are delivered both domestically and internationally through the OSBU. Our overall training and consulting service sales totaled $122.4 million in fiscal 2006, an increase of $6.1 million compared to the prior year. The improvement in training sales was reflected in both domestic and international training program and consulting sales. Our domestic sales performance improved in nearly all sales regions and was primarily attributable to increased sales of the refreshed The 7 Habits of Highly Effective People training course and the expansion of our sales force. Domestic sales also increased $0.7 million as a result of additional Symposium conferences that were held during the third and fourth quarter of fiscal 2006. These sales increases were partially offset by reduced sales force performance training, due to decreased demand in fiscal 2006, and decreased sales from seminars presented by Dr. Stephen R. Covey. In fiscal 2005, Dr. Covey presented more seminars to coincide with the publication of his new book, The 8th Habit.

International sales improved by $2.6 million, primarily due to increased sales at our directly owned operations in Japan, Canada, and Brazil, as well as increased licensee royalty revenues. International sales improvements from these sources were partially offset by decreased sales in the United Kingdom and Mexico, unfavorable currency translation rates, and the correction of misstatements at our Mexico subsidiary. During fiscal 2006, certain foreign currencies, particularly the Japanese Yen, weakened against the United States dollar, which had an unfavorable impact on reported sales. The unfavorable impact of currency translation on reported international sales totaled $1.0 million for the fiscal year ended August 31, 2006. During the third quarter of fiscal 2006, we determined that our Mexico subsidiary 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 correction of these misstatements, which primarily occurred in prior fiscal years, resulted in a $0.5 million decrease in international sales in fiscal 2006.

Gross Profit

Gross profit consists of net sales less the cost of goods sold or the cost of services provided. Our cost of sales includes materials used in the production of planners and related products, assembly and manufacturing labor costs, direct costs of conducting seminars, freight, and certain other overhead costs. Gross profit may be affected by, among other things, prices of materials, labor rates, product sales mix, changes in product discount levels, production efficiency, and freight costs.

We record the costs associated with operating our retail stores, call center, and Internet site as part of our consolidated selling, general, and administrative expenses. Therefore, our consolidated gross profit may not be comparable with the gross profit of other retailers that include similar costs in their cost of sales.

Our overall gross margin, which is gross profit stated in terms of a percentage of sales, improved to 60.1 percent in fiscal 2006, compared to 59.5 percent in the prior year. The gross margin improvement was primarily attributable to improved margins on product sales, which was partially offset by declining margins on our training and consulting sales. Our gross margin on product sales improved to 54.9 percent compared to 53.9 percent in fiscal 2005. The improvement in product sales gross margin was primarily due to improved inventory management processes, which reduced obsolescence, scrap, and other related charges, and changes in our product mix as sales of lower margin technology and specialty products continued to decline while sales of higher margin core products increased compared to the prior year.

Our overall gross margin on training and consulting services declined to 66.7 percent of sales compared to 67.5 percent in the prior year. The decrease in training and consulting services gross margin was primarily attributable to increased sales of lower-margin Symposium conferences and decreased sales of higher-margin sales performance training products during fiscal 2006. These unfavorable gross margin items were partially offset by decreased sales of lower-margin seminars presented by Dr. Covey in the fiscal year.

Operating Expenses

Selling, General and Administrative - Our consolidated selling, general, and administrative (SG&A) expenses decreased $3.6 million compared to the prior year. The decrease in SG&A expenses was primarily due to reduced retail store costs resulting from operating fewer stores, reductions in executive severance costs, reduced stock-based compensation costs, and the favorable results of initiatives to reduce overall operating costs. Our retail store SG&A expenses decreased $5.1 million primarily due to store closures that occurred during fiscal 2006 and in prior periods (refer to discussion below). During fiscal 2005 we incurred and expensed $0.9 million of severance costs to our former general counsel and we did not incur any similar executive severance charges in fiscal 2006. Our stock-based compensation costs declined $0.4 million due to a fully vested stock award granted to the CEO and accelerated vesting on unvested stock awards during fiscal 2005. The overall decrease in stock-based compensation cost was partially offset by expense related to our long-term incentive plan (see discussion below) during fiscal 2006. In addition to these decreases, we continue to implement strategies designed to reduce our overall operating costs. The favorable impact of these efforts has resulted in reduced SG&A expenses in many areas of the Company during the fiscal year ended August 31, 2006. These cost reductions were partially offset by additional spending on growth initiatives (see discussion below) that resulted in increased travel expenses resulting from further employee training and sales leadership events, which totaled $1.3 million, and increased OSBU associate costs totaling $1.1 million resulting primarily from hiring additional sales personnel. We also corrected misstated operating expenses at our Mexico subsidiary, which had a $0.5 million unfavorable impact on our SG&A expenses in fiscal 2006.

During fiscal 2006, we have invested in various initiatives intended to grow our business in future periods. These initiatives included hiring additional sales people, increased advertising and marketing programs, additional curriculum and product development, and increased spending on sales effectiveness training. Due to the time necessary to implement these growth strategies, including training new sales personnel and effectively rolling out new training offerings and products, these growth initiatives did not add material benefits to our fiscal 2006 operating results. However, we believe that these investments in additional sales personnel, increased marketing, and new consulting, training, and product offerings may increase our sales and improve our operating performance in future periods.

We regularly assess the operating performance of our retail stores, including previous operating performance trends and projected future profitability. During this assessment process, judgments are made as to whether under-performing or unprofitable stores should be closed. As a result of this evaluation process, we closed 16 stores during fiscal 2006. The costs associated with closing retail stores are typically comprised of charges related to vacating the premises, which may include a provision for the remaining term on the lease, and severance and other personnel costs. These store closure costs totaled $0.5 million in fiscal 2006 compared to $1.0 million in fiscal 2005, when we closed 30 retail locations. Store closure costs are expensed as incurred and were included as a component of our SG&A expense. Based upon our continuing analyses of retail store performance, we may close additional retail stores and may continue to incur costs associated with closing these stores in future periods.

During fiscal 2006 our shareholders approved a long-term incentive plan (LTIP) that permits the grant of annual unvested share awards of common stock to certain employees. These 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 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 award was initially for 377,665 shares (target award) of common stock. The award shares were valued at $6.60 per share, and the corresponding initial compensation cost totaled $2.5 million. However, the number of shares that will ultimately vest under the LTIP will vary depending on whether the performance criteria are met or exceeded. The award will be reviewed quarterly and the value may be adjusted, depending on the performance of the Company compared to the award criteria. Based upon fiscal 2006 financial performance and estimated performance through the remaining service period, the number of performance awards granted during fiscal 2006 was reduced during the fourth quarter of fiscal 2006 to 337,588 shares, which resulted in a cumulative adjustment to our fiscal 2006 operating results of $0.1 million. The compensation cost of the award is being expensed over the three-year service period of the award and increased our stock-based compensation cost in fiscal 2006 by $0.5 million. The continued amortization of the fiscal 2006 award and any future LTIP grants may increase our SG&A expense during the vesting period.

On September 1, 2005, we adopted the provisions of SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. 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. Although the additional compensation expense resulting from the adoption of SFAS No. 123R was immaterial to our fiscal year ended August 31, 2006, our operating expenses may be unfavorably affected in future periods if we grant additional stock options or participation in our employee stock purchase program increases.

Depreciation and Amortization - Depreciation expense decreased $3.0 million, or 39 percent, compared to fiscal 2005 primarily due to the full depreciation or disposal of certain property and equipment and the effects of significantly reduced capital expenditures during preceding fiscal years. Based upon current capital spending levels, we do not expect depreciation expense to continue to decline during fiscal 2007 to the same extent that it declined in fiscal 2006 when compared to prior periods.

Amortization expense on definite-lived intangible assets totaled $3.8 million for fiscal 2006 compared to $4.2 million in the prior year. The decline was due to the full amortization of certain intangible assets during fiscal 2006 and in prior periods. During fiscal 2006, we reduced the remaining estimated useful life of customer lists acquired in the merger with the Covey Leadership Center based upon expected future sales from these customers. This change in accounting estimate increased our amortization expense in fiscal 2006 by $0.6 million. We expect intangible asset amortization expense to total $3.6 million in fiscal 2007.

Other Income and Expense Items

Interest Income - Our interest income increased $0.4 million primarily due to increased interest rates on our interest-bearing cash accounts.

Interest Expense - Our interest expense increased $1.8 million primarily due to the sale of our corporate headquarters facility and the resulting interest component of the financing obligation in our lease payments to the landlord.

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 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. 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, we 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.

Income Taxes

The increase in our income tax benefit in fiscal 2006 was due to the reversal of the majority of our valuation allowances on our deferred income tax assets, which totaled $20.4 million. The fiscal 2006 income tax benefit was partially offset by taxes withheld on royalties from foreign licensees and taxes paid in foreign jurisdictions by our profitable directly owned foreign operations. The income tax benefit in fiscal 2005 was primarily due to the reversal of accruals related to the resolution of certain tax matters and was partially offset by taxes withheld on royalties from foreign licensees and taxes paid in foreign jurisdictions resulting from profitable foreign operations.

Our effective tax rate has been unusual in recent years, including fiscal 2006, due to the effect of operating losses and changes in valuation allowances. Absent extraordinary, unforeseen events, we expect our effective income tax rate for fiscal 2007 and future years to be approximately 55 percent, primarily due to the effect of permanent book versus tax differences and income from foreign licensees. However, the utilization of domestic loss carryforwards will minimize cash outflows related to domestic income taxes.


FISCAL 2005 COMPARED TO FISCAL 2004

Sales

Product Sales - Our overall product sales, which are primarily sold through our CSBU channels, declined $10.0 million compared to fiscal 2004. The decline in product sales was primarily due to decreased sales in our retail and wholesale delivery channels, with the majority of the decline in product sales occurring in our first quarter of fiscal 2005. The following is a description of sales performance in our CSBU delivery channels during the fiscal 2005:
 
   ·
Retail Sales - The decline in retail sales was due to the impact of fewer stores, which represented $10.7 million of the total $13.6 million decline, and reduced technology and spacialty product sales, which totaled $5.5 million.  During fiscal 2004, we closed 18 retail store locations and we closed 30 additional stores during fiscal 2005.  At August 31, 2005, we were operating 105 retail stores compared to 135 stores at August 31, 2004.  Overall product sales trends were reflected in a four percent decline in year-over-year comparable store sales.  Declining technology and specialty product sales were partially offset by increased "core" product sales during fiscal 2005.  
 
 
·
Consumer Direct - Sales through our consumer direct channels (eCommerce, catalog, and public seminars) increased primarily due to increased public seminar sales, which totaled $2.3 million, and increased core product sales.
 
 
·
Wholesale Sales - Sales through our wholesale channel, which includes sales to office superstores and other retail chains, decreased primarily due to a shift from contract stationer revenue channels to royalty based retail channels. As a result of this change our sales decreased, but our gross margin contribution through this channel remained consistent with the prior year.
 
   · Other CSBU Sales - Other CSBU sales primarily consist of domestic printing and publishing sales and building sublease revenues. The increase in other CSBU sales was primarily attributable to increased sublease income. We have subleased a substantial portion of our corporate headquarters in Salt Lake City, Utah and have recognized $1.1 million of sublease revenue during fiscal 2005, compared to $0.2 million in fiscal 2004.
 
Training and Consulting Services Sales - Our overall training and consulting service sales increased by $18.1 million, or 18 percent, compared to the prior year. The improvement in training sales was reflected in both domestic and international training program and consulting sales. Our domestic sales performance improved in nearly all sales regions and was primarily attributable to increased client facilitated sales of the enhanced The 7 Habits of Highly Effective People training course, increased sales performance group sales, and improved sales of our The 4 Disciplines of Leadership and xQ offerings.

International sales improved by $5.8 million, or 12 percent primarily due to increased sales in Japan, Mexico, Brazil, the United Kingdom, increased licensee royalty revenues, and the translation of foreign sales amounts as foreign currencies strengthened against the United States dollar during much of fiscal 2005. The favorable impact of currency translation on reported international revenues totaled $1.7 million for the fiscal year ended August 31, 2005. These increases were partially offset by decreased sales performance at our Canadian operations.

Gross Profit

Our overall gross margin improved to 59.5 percent of sales, compared to 56.6 percent in fiscal 2004. This overall gross margin improvement is consistent with quarterly gross margin trends during fiscal 2005 and was primarily due to increased training and consulting sales as a percent of total sales, favorable product mix changes, lower product costs, and improved margins on our training and consulting service sales. Training and consulting service sales, which typically have higher gross margins than our product sales, increased to 41 percent of total sales during fiscal 2005 compared to 36 percent in the prior year.

Our gross margin on product sales improved to 53.9 percent compared to 51.6 percent in fiscal 2004. The improvement was primarily due to a favorable shift in our product mix as sales of higher-margin paper products and binders increased as a percent of total sales, while sales of lower-margin technology and specialty products continued to decline. Additionally, the overall margin on paper and binder sales has improved through focused cost reduction efforts, and improved inventory management.

Training and related consulting services gross margin, as a percent of sales for these services, improved to 67.5 percent compared to 65.6 percent in fiscal 2004. The improvement in our training and consulting services gross margin was primarily due to a continued shift in training sales mix toward higher-margin courses and offerings, reduced costs for training materials, such as participant manuals and related items, and overall lower costs associated with training sales.

Operating Expenses

Selling, General, and Administrative - Our selling, general, and administrative (SG&A) expenses decreased $0.6 million and improved as a percent of sales to 52.3 percent, compared to 54.1 percent in fiscal 2004. Declining SG&A expenses were the direct result of initiatives specifically designed to reduce our overall operating costs and is consistent with operating expense trends during the previous two fiscal years. Our cost-reduction efforts have included retail store closures, headcount reductions, consolidation of corporate office space, and other measures designed to focus our resources on critical activities and projects. These efforts were partially offset by increased commission expenses related to increased training sales, severance costs associated with a former executive officer, expenses related to the cancellation of the CEO’s compensation agreement, additional costs associated with the preferred stock recapitalization, investments in new products, and costs of hiring new sales force personnel. The primary effects of our cost-cutting initiatives were reflected in reduced rent and utilities expenses of $3.2 million and reductions in other SG&A expenses, such as outsourcing and development costs, that totaled $1.4 million compared to the prior year. We also reduced our store closure costs by $1.3 million (refer to discussion below) as many of the leases on stores that were closed expired during fiscal 2005 and did not require additional costs to exit the leases. These improvements were partially offset by $2.7 million of increased associate costs and $1.7 million of additional advertising and promotion spending.

We regularly assess the operating performance of our retail stores, including previous operating performance trends and projected future profitability. During this assessment process, judgments are made as to whether under-performing or unprofitable stores should be closed. As a result of this evaluation process, we closed 30 stores during fiscal 2005. Retail store closure costs totaled $1.0 million during fiscal 2005 compared to $2.3 million in fiscal 2004, when we closed 18 store locations.

During fiscal 1999, our Board of Directors approved a plan to restructure our operations, which included an initiative to formally exit leased office space located in Provo, Utah. During fiscal 2005, we exercised an option, available under our master lease agreement, to purchase, and simultaneously sell, the office facility to the current tenant. The negotiated purchase price with the landlord was $14.0 million and the tenant agreed to purchase the property for $12.5 million. These prices were within the range of estimated fair values of the buildings as determined by an independent appraisal obtained by the Company. We paid the difference between the sale and purchase prices, plus other closing costs, which were included as a component of the restructuring plan accrual. After completion of the sale transaction, the remaining fiscal 1999 restructuring costs, which totaled $0.3 million, were credited to SG&A expense in our consolidated statement of operations.
 
Depreciation - Depreciation expense decreased $4.0 million, or 34 percent, compared to fiscal 2004 primarily due to the full depreciation or disposal of certain property and equipment balances, primarily computer software and hardware, and the effects of significantly reduced capital expenditures during preceding fiscal years.

Interest Income and Interest Expense

Interest Income - Our interest income increased $0.5 million compared to fiscal 2004 primarily due to increased cash balances and higher interest rates on our interest-bearing cash accounts.

Interest Expense - Our interest expense increased $0.6 million primarily due to the sale of our corporate headquarters facility and the resulting interest component of our lease payments to the landlord. We are accounting for the lease on the corporate facility as a financing obligation, which is accounted for similar to long-term debt.
 
Gain on Disposal of Investment in Unconsolidated Subsidiary
 
During fiscal 2003, we purchased approximately 20 percent of the capital stock (subsequently diluted to approximately 12 percent ownership) of Agilix Labs, Inc. (Agilix), for cash payments totaling $1.0 million. Agilix is a development stage enterprise that develops software applications, including the majority of our software applications that are available for sale to external customers. Although we continue to sell software developed by Agilix, uncertainties in Agilix’s business plan developed during our fiscal quarter ended March 1, 2003 and their potential adverse effects on Agilix’s operations and future cash flows were significant. As a result of this assessment, we determined that our ability to recover the investment in Agilix was remote. Accordingly, we impaired and expensed our remaining investment in Agilix of $0.9 million during the quarter ended March 1, 2003. During the quarter ended May 28, 2005, certain affiliates of Agilix purchased the shares of capital stock held by us for $0.5 million in cash, which was reported as a gain on disposal of an investment in unconsolidated subsidiary.
 
Income Taxes

The income tax benefit for fiscal 2005 resulted primarily from reversal of accruals related to the resolution of certain tax matters. This tax benefit was partially offset by taxes payable by foreign affiliates and taxes withheld on royalties from foreign licensees. The income tax provision for fiscal 2004 was primarily attributable to taxes payable by foreign affiliates and taxes withheld on royalties from foreign licensees. These foreign taxes were partially offset by the reversal of accruals related to the resolution of certain tax matters.

As of August 31, 2005 and 2004, given our recent history of significant operating losses, we had provided a valuation allowance against the majority of our deferred income tax assets. As of August 31, 2005 and 2004, we had net deferred tax liabilities of $6.9 million and $7.3 million, respectively. Our foreign deferred tax assets of $0.9 million and $0.8 million at August 31, 2005 and 2004 primarily relate to our operations in Japan. The net domestic deferred tax liability of $7.8 million at August 31, 2005 and the $8.1 million deferred liability at August 31, 2004 primarily relate to the step-up of indefinite-lived intangibles.

Loss on Recapitalization of Preferred Stock

We completed our preferred stock recapitalization during the quarter ended May 28, 2005. Due to the significant modifications to our preferred stock, we determined that our previously outstanding preferred stock was replaced with new classes of preferred stock and common stock warrants. As a result, the new preferred stock was recorded at its fair value on the date of modification, which was determined to be equal to the liquidation preference of $25 per share. The difference between the aggregate fair value of the consideration given (the new Series A preferred stock and the common stock warrants) and the carrying value of the previously existing Series A preferred stock, which totaled $7.8 million, was reported as a loss on recapitalization of preferred stock, which decreased net income available to common shareholders in the quarter ended May 28, 2005. Subsequent to May 28, 2005, we used $30.0 million of the proceeds from the June 2005 sale of our corporate headquarters facility to redeem shares of preferred stock under terms of the recapitalization plan.


QUARTERLY RESULTS

The following tables set forth selected unaudited quarterly consolidated financial data for fiscal 2006 and fiscal 2005. The quarterly consolidated financial data reflects, in the opinion of management, all adjustments necessary to fairly present the results of operations for such periods. Results of any one or more quarters are not necessarily indicative of continuing trends.

Quarterly Financial Information:

YEAR ENDED AUGUST 31, 2006
                 
   
November
26
 
February
25
 
May
27
 
August
31
 
In thousands, except per share amounts
                 
Net sales
 
$
72,351
 
$
78,333
 
$
63,282
 
$
64,657
 
Gross profit
   
44,406
   
48,173
   
36,292
   
38,514
 
Selling, general, and administrative expense
   
37,767
   
35,488
   
35,629
   
35,863
 
Depreciation
   
1,408
   
1,221
   
1,134
   
1,016
 
Amortization
   
1,095
   
908
   
908
   
902
 
Income (loss) from operations
   
4,136
   
10,556
   
(1,379
)
 
733
 
Income (loss) before income taxes
   
3,823
   
11,085
   
(1,735
)
 
458
 
Net income
   
3,233
   
9,213
   
1,019
   
15,108
 
Preferred stock dividends
   
(1,379
)
 
(1,139
)
 
(934
)
 
(933
)
Income available to common shareholders
   
1,854
   
8,074
   
85
   
14,175
 
                           
Earnings (loss) per share available to common shareholders:
                         
Basic
 
$
.09
 
$
.40
 
$
.00
 
$
.71
 
Diluted
 
$
.09
 
$
.39
 
$
.00
 
$
.70
 
                           
                           
YEAR ENDED AUGUST 31, 2005
                         
 
 
 
November
27 
   
February
26
   
May
28
   
August
31
 
In thousands, except per share amounts
                         
Net sales
 
$
69,104
 
$
82,523
 
$
65,788
 
$
66,128
 
Gross profit
   
41,435
   
50,217
   
38,268
   
38,775
 
Selling, general, and administrative expense
   
35,930
   
38,939
   
36,095
   
37,341
 
Depreciation
   
2,178
   
2,320
   
1,848
   
1,428
 
Amortization
   
1,043
   
1,043
   
1,043
   
1,044
 
Income (loss) from operations
   
2,284
   
7,915
   
(718
)
 
(1,038
)
Income (loss) before income taxes
   
2,364
   
8,051
   
63
   
(1,377
)
Net income (loss)
   
1,526
   
7,086
   
3,069
   
(1,495
)
Preferred stock dividends
   
(2,184
)
 
(2,184
)
 
(2,184
)
 
(1,718
)
Loss on recapitalization of preferred stock
   
-
   
-
   
(7,753
)
 
-
 
Income (loss) attributable to common shareholders
   
(658
)
 
4,902
   
(6,868
)
 
(3,213
)
                           
Basic and diluted loss per share attributable to common shareholders
 
$
(.03
)
$
.19
 
$
(.34
)
$
(.16
)

Our quarterly results of operations reflect seasonal trends that are primarily the result of customers who renew their FranklinCovey Planners on a calendar year basis. Domestic training sales are moderately seasonal because of the timing of corporate training, which is not typically scheduled as heavily during holiday and vacation periods.

During the fourth quarter of fiscal 2006, we reversed valuation allowances on certain deferred income tax assets which had a $20.4 million favorable impact on our net income and net income available to common shareholders for that period.

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 have taken actions as recommended by the investigators to prevent future misstatements, which include enhancements to internal control over foreign operations.

Quarterly fluctuations may also be affected by other factors including the introduction of new products or training seminars, the addition of new institutional customers, the timing of large corporate orders, the elimination of unprofitable products or training services, and the closure of retail stores.


LIQUIDITY AND CAPITAL RESOURCES

Historically, our primary sources of capital have been net cash provided by operating activities, line-of-credit financing, long-term borrowings, asset sales, and the issuance of preferred and common stock. We currently rely primarily upon cash flows from operating activities and cash on hand to maintain adequate liquidity and working capital levels. At August 31, 2006 we had $30.6 million of cash and cash equivalents compared to $51.7 million at August 31, 2005. Our net working capital (current assets less current liabilities) decreased to $38.7 million at August 31, 2006 compared to $49.9 million at August 31, 2005, primarily due to reduced cash and cash equivalents.

The following discussion is a description of the primary factors affecting our cash flows and their effects upon our liquidity and capital resources during the fiscal year ended August 31, 2006.

Cash Flows from Operating Activities

During fiscal 2006 our net cash provided by operating activities was $17.0 million compared to $22.3 million in fiscal 2005. Our primary source of cash from operating activities was the sale of goods and services to our customers in the normal course of business. The primary uses of cash for operating activities were payments to suppliers for materials used in products sold, payments for direct costs necessary to conduct training programs, and payments for selling, general, and administrative expenses. Our cash flows from operating activities were unfavorably affected by decreased sales compared to fiscal 2005, although we recognized cash flow improvements from operating activities through reduced selling, general, and administrative expenses and corresponding reduced cash payments for costs and expenses related to generating revenues, which was reflected by improved income from operations.

Our cash flows generated from improved operating results was offset by cash used for working capital items. During fiscal 2006, our primary uses of cash for operating activities were related to reducing accrued liability and accounts payable balances, payment of income taxes in jurisdictions where we were unable to utilize existing loss carryforwards, and the impact of increased accounts receivable that were primarily the result of increased sales in our OSBU during the fourth quarter of fiscal 2006. We believe that efforts to optimize working capital balances combined with existing and planned efforts to increase sales, including sales of new products and services, and cost-cutting initiatives, will improve our cash flows from operating activities in future periods. However, the success of these efforts is dependent upon numerous factors, many of which are not within our control.

Cash Flows from Investing Activities and Capital Expenditures

Net cash used for investing activities totaled $8.3 million for the fiscal year ended August 31, 2006. Our primary uses of investing cash were the purchases of property and equipment totaling $4.4 million and $4.0 million spent in curriculum development. Property and equipment purchases consisted primarily of computer hardware, software, and leasehold improvements for subleased areas of our corporate campus and in certain of our retail stores. During fiscal 2006, we invested in curriculum development primarily related to new leadership and strategy execution offerings.

During fiscal 2007, we expect to spend $10.5 million on purchases of property and equipment and $3.1 million on curriculum development activities. The increase in capital spending on property and equipment is primarily due to the purchase of new printing presses and equipment in connection with the reconfiguration of our printing operations. However, actual capital spending is based upon a variety of factors and may differ from these estimates.

Cash Flows from Financing Activities

Net cash used for financing activities during fiscal 2006 totaled $29.9 million. Our primary uses of cash for financing activities were redemptions of preferred stock totaling $20.0 million, purchases of common stock totaling $5.2 million, preferred dividend payments totaling $4.9 million, and principal payments on our long-term debt and financing arrangement totaling $1.1 million. Since we recapitalized our preferred stock in fiscal 2005, we have redeemed $50.0 million, or 2.0 million shares, of our outstanding preferred stock. These redemptions have reduced our preferred dividend obligation and corresponding financing cash outflows by $5.0 million per year. We anticipate making additional preferred stock redemptions under the terms of our recapitalization plan in future periods.

Contractual Obligations

The Company has not structured any special purpose or variable interest entities, or participated in any commodity trading activities, which would expose us to potential undisclosed liabilities or create adverse consequences to our liquidity. Required contractual payments primarily consist of payments to EDS for outsourcing services related to information systems, warehousing and distribution, and call center operations; payments on a financing obligation resulting from the sale of our corporate campus; minimum rent payments for retail store and sales office space; cash payments for Series A preferred stock dividends; mortgage payments on certain buildings and property; cash payments for new printing services equipment; short-term purchase obligations for inventory items; and monitoring fees paid to a Series A preferred stock investor. Our expected payments on these obligations over the next five fiscal years and thereafter are as follows (in thousands):

   
Fiscal
 
Fiscal
 
Fiscal
 
Fiscal
 
Fiscal
         
Contractual Obligations
 
2007
 
2008
 
2009
 
2010
 
2011
 
Thereafter
 
Total
 
                               
Minimum required payments to EDS for outsourcing services
 
$
17,217
 
$
15,901
 
$
15,927
 
$
15,577
 
$
15,298
 
$
73,233
 
$
153,153
 
Required payments on corporate campus financing obligation
   
3,045
   
3,045
   
3,045
   
3,055
   
3,115
   
49,957
   
65,262
 
Minimum operating lease payments
   
8,475
   
7,228
   
5,564
   
4,012
   
2,402
   
6,013
   
33,694
 
Preferred stock dividend payments(1)
   
3,734
   
3,734
   
3,734
   
3,734
   
3,734
   
-
   
18,670
 
Debt payments(2)
   
176
   
168
   
160
   
153
   
145
   
435
   
1,237
 
Contractual computer hardware purchases(3)
   
535
   
483
   
556
   
587
   
525
   
3,192
   
5,878
 
Payments for new printing services equipment(4)
   
3,137
   
-
   
-
   
-
   
-
   
-
   
3,137
 
Purchase obligations
   
10,523
   
-
   
-
   
-
   
-
   
-
   
10,523
 
Monitoring fees paid to a preferred stock investor(1)
   
166
   
166
   
166
   
166
   
166
   
-
   
830
 
Total expected contractual obligation payments
 
$
47,008
 
$
30,725
 
$
29,152
 
$
27,284
 
$
25,385
 
$
132,830
 
$
292,384
 
_____________________________
 
 
(1)
Amount reflects $37.3 million of outstanding preferred stock. The amount of cash dividends and monitoring fees that we are obligated to pay will decline as shares of preferred stock are redeemed.

 
(2)
The Company’s variable rate debt payments include interest payments at 7.0%, which was the applicable interest rate at September 29, 2006.

 
(3)
We are contractually obligated by our EDS outsourcing agreement to purchase the necessary computer hardware to keep such equipment up to current specifications. Amounts shown are estimated capital purchases of computer hardward under terms of the EDS outsourcing agreement and its amendments.

 
(4)
In August 2006, we signed contracts to purchase new printing equipment for $3.1 million in cash as part of a plan to reconfigure our printing services operation. The payments are due at specified times during fiscal 2007 that coincide with the installation and successful operation of the new equipment.

Other Items

The Company is the creditor for a loan program that provided the capital to allow certain management personnel the opportunity to purchase shares of our common stock. For further information regarding our management common stock loan program, refer to Note 9 in our consolidated financial statements. The inability of the Company to collect all, or a portion, of these receivables could have an adverse impact upon our financial position and future cash flows compared to full collection of the loans.

Going forward, we will continue to incur costs necessary for the operation and potential growth of the business. We anticipate using cash on hand, cash provided by operating activities on the condition that we can continue to improve our cash flows generated from operating activities, and other financing alternatives, if necessary, for these expenditures. We anticipate that our existing capital resources should be adequate to enable us to maintain our operations for at least the upcoming twelve months. However, our ability to maintain adequate capital for our operations in the future is dependent upon a number of factors, including sales trends, our ability to contain costs, redemptions of preferred stock, purchases of our common stock, levels of capital expenditures, collection of accounts receivable, and other factors. Some of the factors that influence our operations are not within our control, such as economic conditions and the introduction of new technology and products by our competitors. We will continue to monitor our liquidity position and may pursue additional financing alternatives, if required, to maintain sufficient resources for future growth and capital requirements. However, there can be no assurance such financing alternatives will be available to us on acceptable terms.
 
USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America. The significant accounting polices that we used to prepare our consolidated financial statements are outlined in Note 1 to the consolidated financial statements, which are presented in Part II, Item 8 of this Annual Report on Form 10-K. Some of those accounting policies require us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements. Management regularly evaluates its estimates and assumptions and bases those estimates and assumptions on historical experience, factors that are believed to be reasonable under the circumstances, and requirements under accounting principles generally accepted in the United States of America. Actual results may differ from these estimates under different assumptions or conditions, including changes in economic conditions and other circumstances that are not in our control, but which may have an impact on these estimates and our actual financial results.

The following items require the most significant judgment and often involve complex estimates:

Revenue Recognition

We derive revenues primarily from the following sources:

 
·
Products - We sell planners, binders, planner accessories, handheld electronic devices, and other related products that are primarily sold through our CSBU channels.
 
 
·
Training and Consulting Services - We provide training and consulting services to both organizations and individuals in strategic execution, leadership, productivity, goal alignment, sales force performance, and communication effectiveness skills. These training programs and services are primarily sold through our OSBU channels.


The Company recognizes revenue when: 1) persuasive evidence of an agreement exists, 2) delivery of product has occurred or services have been rendered, 3) the price to the customer is fixed and determinable, and 4) collectibility is reasonably assured. For product sales, these conditions are generally met upon shipment of the product to the customer or by completion of the sale transaction in a retail store. For training and service sales, these conditions are generally met upon presentation of the training seminar or delivery of the consulting services.

Some of our training and consulting contracts contain multiple deliverable elements that include training along with other products and services. In accordance with Emerging Issues Task Force (EITF) Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, sales arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the sales contract meet the following criteria: 1) the delivered training or product has value to the client on a standalone basis; 2) there is objective and reliable evidence of the fair value of undelivered items; and 3) delivery of any undelivered item is probable. The overall contract consideration is allocated among the separate units of accounting based upon their fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions. If the fair value of all undelivered elements exits, but fair value does not exist for one or more delivered elements, the residual method is used. Under the residual method, the amount of consideration allocated to the delivered items equals the total contract consideration less the aggregate fair value of the undelivered items. Fair value of the undelivered items is based upon the normal pricing practices for the Company’s existing training programs, consulting services, and other products, which are generally the prices of the items when sold separately.

Revenue is recognized on software sales in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition as amended by SOP 98-09. SOP 97-2, as amended, generally requires revenue earned on software arrangements involving multiple elements such as software products and support to be allocated to each element based on the relative fair value of the elements based on vendor specific objective evidence (VSOE). The majority of the Company’s software sales have elements, including a license and post contract customer support (PCS). Currently the Company does not have VSOE for either the license or support elements of its software sales. Accordingly, revenue is deferred until the only undelivered element is PCS and the total arrangement fee is recognized ratably over the support period.

Our international strategy includes the use of licensees in countries where we do not have a directly-owned operation. Licensee companies are unrelated entities that have been granted a license to translate the Company’s content and curriculum, adapt the content and curriculum to the local culture, and sell the Company’s training seminars and products in a specific country or region. Licensees are required to pay us royalties based upon a percentage of the licensee’s sales. The Company recognizes royalty income each period based upon the sales information reported to the Company from the licensee.

Revenue is recognized as the net amount to be received after deducting estimated amounts for discounts and product returns.

Share-Based Compensation

Effective September 1, 2005, we adopted the fair value recognition provisions of SFAS No. 123R, using the modified prospective transition method, and therefore have not restated prior periods’ financial results. Under this method, we recognize compensation expense for all share-based payments granted after September 1, 2006 and prior to but not yet vested as of September 1, 2006, in accordance with SFAS No. 123R. Prior to the adoption of SFAS No. 123R, we accounted for share-based payments under APB No. 25, and accordingly, we generally recognized compensation expense from stock options only when we granted options with an exercise price below the market price on the date of grant or made modifications to stock option terms which increased the fair value of the award.

During fiscal 2006, we granted performance based compensation awards to certain employees in a Board of Director approved long-term incentive plan (LTIP). These performance based share awards grant each participant the right to receive a certain number of shares of common stock based upon the achievement of specified financial goals at the end of a predetermined performance period. The LTIP 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 (fiscal 2008 sales compared to fiscal 2005 sales) and cumulative operating income during the performance period. 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 based upon estimated future performance and are made on a cumulative basis at the date of adjustment based upon the probable number of shares to be awarded. Actual results could differ from estimates made during the service, or vesting, period. The Compensation Committee initially granted awards for 377,665 shares (target award) of common stock and 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 minimum sales growth necessary for participants to receive any shares under the LTIP is 7.5 percent and the minimum cumulative operating income is $36.2 million. The percentage of target shares awarded is based upon the combination of these factors as shown below:

Sales Growth
Percent of Target Shares Awarded
30.0%
115%
135%
150%
175%
200%
22.5%
90%
110%
125%
150%
175%
15.0%
65%
85%
100%
125%
150%
11.8 %
50%
70%
85%
110%
135%
7.5%
30%
50%
65%
90%
115%
 
$36.20
$56.80
$72.30
$108.50
$144.60
 
Cumulative Operating Income (millions)

Based upon fiscal 2006 financial performance and estimated performance through the remaining service period, the number of performance awards granted during fiscal 2006 was reduced at August 31, 2006 to 337,588 shares, which resulted in a cumulative adjustment to our fiscal 2006 operating results of $0.1 million. The compensation cost of the LTIP grant was $0.5 million in fiscal 2006 and the total compensation cost of the LTIP will be equal to the number of shares finally issued multiplied by $6.60 per share, which was the fair value of the common shares determined at the grant date.

We estimate the value of our stock option awards on the date of grant using the Black-Scholes option pricing model. However, the Company did not grant any stock options in fiscal years 2006 or 2005 and at August 31, 2006 the remaining cost associated with our unvested stock options was insignificant.

Accounts Receivable Valuation

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts represents our best estimate of the amount of probable credit losses in the existing accounts receivable balance. We determine the allowance for doubtful accounts based upon historical write-off experience and current economic conditions and we review the adequacy of our allowance for doubtful accounts on a regular basis. Receivable balances past due over 90 days, which exceed a specified dollar amount, are reviewed individually for collectibility. Account balances are charged off against the allowance after all means of collection have been exhausted and the probability for recovery is considered remote. We do not have any off-balance sheet credit exposure related to our customers.

Inventory Valuation

Inventories are stated at the lower of cost or market with cost determined using the first-in, first-out method. Our inventories are comprised primarily of dated calendar products and other non-dated products such as binders, handheld electronic devices, stationery, training products, and other accessories. Provision is made to reduce excess and obsolete inventories to their estimated net realizable value. In assessing the realization of inventories, we make judgments regarding future demand requirements and compare these assessments with current and committed inventory levels. Inventory requirements may change based on projected customer demand, technological and product life cycle changes, longer or shorter than expected usage periods, and other factors that could affect the valuation of our inventories.

Indefinite-Lived Intangible Assets

Intangible assets that are deemed to have an indefinite life are not amortized, but rather are tested for impairment on an annual basis, or more often if events or circumstances indicate that a potential impairment exists. The Covey trade name intangible asset has been deemed to have an indefinite life. This intangible asset is assigned to the OSBU and is tested for impairment using the present value of estimated royalties on trade name related revenues, which consist primarily of training seminars, international licensee royalties, and related products. If forecasts and assumptions used to support the realizability of our indefinite-lived intangible asset change in the future, significant impairment charges could result that would adversely affect our results of operations and financial condition. Based upon our fiscal 2006 evaluation, our trade-name related revenues and licensee royalties would have to suffer significant reductions before we would be required to impair the Covey trade name.

Impairment of Long-Lived Assets

Long-lived tangible assets and definite-lived intangible assets are reviewed for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. We use an estimate of undiscounted future net cash flows of the assets over the remaining useful lives in determining whether the carrying value of the assets is recoverable. If the carrying values of the assets exceed the anticipated future cash flows of the assets, we recognize an impairment loss equal to the difference between the carrying values of the assets and their estimated fair values. Impairment of long-lived assets is assessed at the lowest levels for which there are identifiable cash flows that are independent from other groups of assets. The evaluation of long-lived assets requires us to use estimates of future cash flows. If forecasts and assumptions used to support the realizability of our long-lived tangible and definite-lived intangible assets change in the future, significant impairment charges could result that would adversely affect our results of operations and financial condition.

Income Taxes

The Company regularly evaluates United States federal and various state and foreign jurisdiction income tax exposures. The tax benefits of tax exposure items are not recognized in the provision for income taxes unless it is probable that the benefits will be sustained, without regard to the likelihood of tax examination. A tax exposure reserve represents the difference between the recognition of benefits related to exposure items for income tax reporting purposes and financial reporting purposes. The tax exposure reserve is classified as a component of the current income taxes payable account. The Company adds interest and penalties, if applicable, each period to the reserve which is recorded as a component of the overall income tax provision.

The Company recognizes 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 will not be available until the expiration of the statute of limitations for Internal Revenue Service audits, at which time the entire benefit will be recognized as a discrete item in the applicable period.

The calculation of our income tax provision or benefit, as applicable, requires estimates of future taxable income or losses. During the course of the fiscal year, these estimates are compared to actual financial results and adjustments may be made to our tax provision or benefit to reflect these revised estimates.

The Company continually assesses the need for valuation allowances against its deferred income tax assets, considering recent profitability, known trends and events, and expected future transactions. For several years prior to the year ended August 31, 2006, our history of significant operating losses precluded us from demonstrating that it was more likely than not that the related benefits from deferred income tax deductions and foreign tax carryforwards would be realized. Accordingly, we recorded valuation allowances on the majority of our deferred income tax assets.

In fiscal 2006 we reversed the majority of these valuation allowances. Due to improved operating performance, business models, and expectations regarding future taxable income, the Company has concluded 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. Thus, we reversed the valuation allowances on certain of our domestic deferred income tax assets, except for $2.2 million related to foreign tax credits.


NEW ACCOUNTING PRONOUNCEMENTS

Error Corrections - In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3. Statement No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle and applies to all voluntary changes in accounting principle. This statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of an accounting change. Further, SFAS No. 154 requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of shareholders’ equity) for the period that is being reported in an income statement. This statement also carries forward, without change, the guidance in APB Opinion No. 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. Statement No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and will thus be effective for our fiscal year beginning September 1, 2006.
 
Sales Tax Presentation - In June 2006, the EITF reached a consensus on Issue No. 06-03, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). This consensus provides that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer on either a gross basis (included in revenues and costs) or on a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. The provisions of EITF 06-03 become effective for interim and annual reporting periods beginning after December 15, 2006. The Company is currently evaluating the impact of adopting EITF 06-03 on the presentation of our consolidated financial statements.

Uncertain Tax Positions - In July 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109. This interpretation prescribes a consistent recognition threshold and measurement standard, as well as criteria for subsequently recognizing, derecognizing, and measuring tax positions for financial statement purposes. This interpretation also requires expanded disclosure with respect to the uncertainties as they relate to income tax accounting and is effective for fiscal years beginning after December 15, 2006. The Company will adopt the provisions of FIN No. 48 no later than September 1, 2007 (fiscal 2008). We are currently in the process of evaluating the impact of FIN No. 48 on our financial statements. The cumulative effect from the adoption of FIN No. 48, if any, will be an adjustment to beginning retained earnings in the year of adoption.
 
Evaluation of Misstatements - In September 2006, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which provides the Staff’s views regarding the process of quantifying financial statement misstatements, such as assessing both the carryover and reversing effects of prior year misstatements on the current year financial statements. The evaluation requirement