Gain on Sale of Discontinued Operations

        Effective December 21, 2001, the Company sold Premier Agendas, Inc., a wholly owned subsidiary located in Bellingham, Washington, and Premier School Agendas Ltd., a wholly owned subsidiary organized in Ontario, Canada, (collectively, “Premier”) to School Specialty, Inc., a Wisconsin-based company that specializes in providing products and services to students and schools. Premier provided productivity and leadership solutions to the educational industry, including student and teacher planners. The sales price was $152.5 million in cash plus the retention of Premier’s working capital, which was received in the form of a $4.0 million promissory note from the purchaser, which bears interest at LIBOR plus two percent and is due and payable in June 2002. Additionally, the Company will receive $0.8 million of cash from Premier related to income tax payments. The Company also agreed not to sell student planners containing the Company’s “7 Habits” and “What Matters Most” content directly to schools and school districts in the K through 12 market subsequent to the closing. The Company recognized a pretax gain of $96.5 million ($60.8 million after tax) on the sale of Premier, which was recorded as a gain on the sale of discontinued operations in the accompanying consolidated condensed statements of operations for fiscal 2002. The actual pretax gain was greater than previously anticipated due to changes in the net assets of Premier, primarily from greater than anticipated cash transfers to the Company prior to closing.

Preferred Stock Dividends

        Preferred stock dividends increased over the prior year due to the issuance of additional shares of preferred stock as payment for accrued dividends. The Company may, at its option, pay accrued dividends with cash or additional shares of preferred stock until July 1, 2002. Subsequent to that date, preferred stock dividends must be paid in cash. Accrued preferred stock dividends for the quarter ended February 23, 2002 were subsequently paid with cash.

Six Months Ended February 23, 2002 Compared to the Six Months Ended February 24, 2001

Sales

        During the first six months of fiscal 2002, the Company’s sales have been adversely affected by the unfavorable performance of the United States economy, which was worsened by the September 11 terrorist attacks. Additionally, the Company believes that reduced training and supply budgets at its corporate clients, in an effort to reduce overall operating expenses, and reluctance of personnel to travel, were significant contributors to the overall decrease in sales, for both products and training programs. Product sales, which primarily consist of planners, binders, and handheld electronic planning devices, decreased $54.5 million, or 29 percent, compared to the prior year. The decrease in product sales is primarily due to decreased retail store sales, catalog/e-Commerce, and wholesale sales. Retail store sales declined primarily due to lower average sales dollars per transaction coupled with reduced traffic in the stores. Average sales dollars per transaction decreased due to a sharp decline in sales of handheld electronic planning devices and related accessories. Total handheld electronic device sales, the majority of which are made through the Company’s retail stores, decreased by $26.1 million, or 59 percent, compared to the prior year. Planner and binder sales also decreased 14 percent and 17 percent, respectively, compared to the prior year. As a result of these declines, comparable store sales decreased by 30 percent compared to the prior year. The sales performance from 22 additional stores partially offset the decline in comparable store sales resulting in a 23 percent overall decrease compared to the prior year. At February 23, 2002, the Company was operating 173 domestic retail stores compared to 151 stores at February 24, 2001. Catalog/e-Commerce sales declined due to reduced call volume in the Company’s catalog call center operations and reduced sales activity through the Company’s Internet web site at www.franklincovey.com. Sales from the Company’s historically strong fall catalog mailing, which was mailed just days prior to September 11 and the subsequent anthrax scares associated with the mail, declined significantly compared to the prior year. Subsequent holiday mailings also produced disappointing results and overall catalog sales declined 39 percent from the prior year. The Company attributes this decline to the combination of significantly reduced response rates from its catalog mailings, an overall decrease in handheld electronic product sales, and the reluctance of companies to reimburse employees for planners and other productivity tools due to budgetary constraints. Other consumer business unit product sales decreased due to reduced demand for the Company’s products through wholesale channels and from the sale or discontinuance of certain other small non-core entities. The Company offers a variety of training seminars and consulting services including productivity, leadership, and sales performance training. Training sales decreased primarily due to canceled and postponed programs during the first quarter and reduced attendance, for both on-site and public leadership and productivity programs. Public program sales also continued their downward trend from late fiscal 2001 and decreased overall compared to the prior year. Due to economic factors adversely affecting corporate budgeting and spending, future bookings of training seminars remains slower than expected, and the Company expects this trend to impact the remainder of fiscal 2002. International product and training sales decreased compared to the prior year primarily due to decreased sales in Canada, continental Europe, Mexico, and Japan. These decreases were partially offset by a slight sales increase in the United Kingdom and flat sales results from licensee operations. In addition, foreign currency exchange rates had an adverse affect totaling $1.0 million upon reported international sales during the six months ended February 23, 2002.

Gross Margin

        The Company’s overall gross margin for the six months ended February 23, 2002, decreased to 55.6 percent of sales, compared to 57.8 percent in the prior year. The decline in gross margin was due to a number of factors, including increased deep discounting on handheld electronic products, changes in the product mix, increased manufacturing costs, and backorders on certain planner products, which adversely affected product cost of sales. The impact of fixed delivery costs for public seminars, reduced sales of high-margin training kits and accessories, the sale of new low-margin customized training products, and participant cancellations at the Company’s annual symposium event reduced training and service gross margins during the six months ended February 23, 2002. Gross margin for product sales decreased to 52.1 percent compared to 54.2 percent in the prior year. Due to reduced demand for handheld electronic products, additional discounting was required to slow declining sales of these products, especially during the seasonally heavy shopping season in November and December of 2001. The Company has also experienced a shift in its product mix toward lower-margin binders and planners. Additionally, smaller production runs for planners and related forms resulted in higher per-unit costs due to the loss of printing volume efficiencies. In addition, the Company experienced a shortage of certain planner products during the second quarter due to production problems at a third party supplier. The shipping of those backordered products required more expensive overnight carriers in order to maintain high customer service standards. These increased shipping costs could not entirely be passed on to consumers. Training and service gross margin decreased to 63.9 percent compared to 67.7 percent in the prior year. Seminar costs, as a percentage of revenue, increased due to overall lower attendance at public seminar events held during the year and the cancellation and postponement of numerous seminars due to travel restrictions resulting from the September 11 terrorist attacks, which primarily affected the first quarter. Certain components of public training program costs are fixed, such as site fees, equipment rentals, and presenter costs. With a decline in the average number of participants per public training seminar, the fixed costs for the seminar resulted in lower gross margins for the event. In addition, some costs incurred for canceled seminars were not entirely refundable. Reduced seminar attendance also resulted in decreased sales of higher-margin training kits and related accessories. The Company provided a new customized training product that had significantly lower margins than the majority of other training kits, products, and accessories. Due to travel restrictions and safety concerns following the events of September 11, many customers declined to attend the Company’s annual symposium conference, which resulted in a reduced gross margin for that event. As part of its efforts to improve operational results, the Company is actively seeking to reduce product and seminar costs in order to improve overall gross margins.

Operating Expenses

        Selling, general, and administrative (“SG&A”) expenses increased $1.4 million, to 61.4 percent of sales, compared to 44.2 percent of sales in the first six months of the prior year. The increase in SG&A expenses was primarily due to severance costs resulting from headcount reduction efforts, increased consulting and product development costs, increased retail store operations, costs associated with the implementation of the Electronic Data Systems (“EDS”) outsourcing contract, and expenses incurred to upgrade the Company’s Oracle based information systems. These increases were partially offset by decreased associate costs, reduced travel and entertainment expenses, and reduced spending in various areas of the Company in response to cost reduction initiatives. The Company has implemented numerous initiatives to reduce operating expenses, including headcount reductions in various areas of the Company. As a result of these efforts, the Company incurred and expensed $2.9 million of severance and related costs during the six months ended February 23, 2002. During fiscal 2002, the Company expensed approximately $2.8 million of development costs related to certain projects that are expected be non-recurring in nature. As previously mentioned, the Company is operating 22 additional stores compared to the prior year and has realized increased operating costs, including pre-opening costs for new stores opened during the fiscal year. During fiscal 2001, the Company entered into a long-term outsourcing agreement with EDS to provide warehousing, distribution, information systems, and call center operations. In addition to base charges for services provided, the Company has incurred transition costs necessary to operate under the terms of the agreement. However, the Company believes that over the life of the contract, significant cost savings will be realized in these outsourced areas. The Company is currently in the process of upgrading its Oracle information system applications and has expensed $1.0 million of external consulting costs related to the software installation that do not qualify for capitalization. The Company has initiated numerous cost reduction initiatives and believes that its efforts will reduce recurring operational SG&A costs throughout the remainder of fiscal 2002 and in future periods.

        During the six months ended February 23, 2002, the Company increased its reserve with respect to its management common stock loan program by a total of $18.5 million. Refer to the discussion under “Operating Expenses” for the quarter ended February 23, 2002 for further information regarding the charges to the management common stock loan reserve. In addition, the Company recognized an impairment charge of $4.5 million related to a note receivable from the sale of a subsidiary, obsolete computer software costs, and software development costs for a line of new planner products. Refer to the discussion under “Operating Expenses” for the quarter ended February 23, 2002. The Company did not have similar charges during the six months ended February 24, 2001.

        Depreciation expense increased by $5.3 million compared to the prior year, primarily due to the purchase of computer hardware and software, the acceleration of depreciation on certain computer software that will be replaced during the Company’s third fiscal quarter, and the addition of leasehold improvements in new and remodeled retail stores. Amortization expense decreased by $3.9 million, primarily due to the adoption of SFAS No. 142, which prohibits goodwill amortization and requires the Company to adopt a fair value approach to goodwill and indefinite-lived intangible assets. As a result of adopting the provisions of SFAS No. 142, the Company wrote off all recorded goodwill associated with its consumer business unit and organizations business unit on its balance sheet as of September 1, 2001. Goodwill and intangible assets assigned to the education business unit, which consisted primarily of Premier, were not required to be written down since the fair values of that business unit’s assets exceeded their book values at the measurement date. The corresponding charge resulting from the adoption of SFAS No. 142 was recorded as a cumulative effect of accounting change in the accompanying consolidated condensed statement of operations for the six months ended February 23, 2002 and totaled $61.4 million after applicable tax benefit.

Equity in Earnings of Unconsolidated Subsidiary

        The Company incurred an aggregate impairment charge of $16.3 million for the six months ended February 23, 2002, with respect to its investment in Franklin Covey Coaching LLC, an unconsolidated subsidiary. The remaining investment balance on the accompanying condensed consolidated balance sheet at February 23, 2002 represents the fair value of expected remaining cash disbursements and the expected return of tangible assets upon termination of the joint venture agreement. As further information becomes available, including coaching program financial results and negotiations with AMS, additional adjustments to the Company’s investment in Franklin Covey Coaching LLC may become necessary. As of February 23, 2002, the Company’s remaining net investment in Franklin Covey Coaching LLC totaled $1.2 million.

Interest Income and Expense

        Interest income and expense was impacted by the sale of Premier that occurred during the Company’s second fiscal quarter ended February 23, 2002. On December 21, 2001, the Company used a portion of the proceeds from the sale of Premier to repay and terminate the Company’s existing term loan and line of credit agreement. Interest income increased $1.5 million over the prior year primarily as a result of increased cash balances from the sale of Premier, combined with interest income recognized from the participants of the management stock loan program. The participants are obligated to repay the interest to the Company when the loans mature in March 2005. Beginning with the third quarter of fiscal 2002, the Company will no longer accrue interest on the management stock loan program notes receivable. Interest expense decreased $0.4 million compared to the prior year primarily due to lower debt balances during the quarter ended February 23, 2002. Due to these decreased debt balances, the Company expects interest expense to be less than reported in prior comparable periods, throughout the remainder of fiscal 2002.

Other Income

        During the quarter ended February 23, 2002, the Company sold a building located in Chandler, Arizona, that previously housed the operations of the government products group. The gain on the sale of the building was $0.6 million and was recorded as other income in the accompanying condensed consolidated statement of operations for fiscal 2002.

Gain on Sale of Discontinued Operations

        Effective December 21, 2001, the Company sold Premier to School Specialty, Inc., a Wisconsin-based company that specializes in providing products and services to students and schools. Premier provided productivity and leadership solutions to the educational industry, including student and teacher planners. The sales price was $152.5 million in cash plus the retention of Premier’s working capital, which was received in the form of a $4.0 million promissory note from the purchaser, which bears interest at LIBOR plus two percent and is due and payable in June 2002. Additionally, the Company will receive $0.8 million of cash from Premier related to income tax payments. The Company recognized a pretax gain of $96.5 million ($60.8 million after tax) on the sale of Premier, which was recorded as a gain on the sale of discontinued operations in the accompanying consolidated condensed statements of operations for fiscal 2002. The actual pretax gain was greater than previously anticipated due to changes in the net assets of Premier, primarily from greater than anticipated cash transfers to the Company prior to closing.

Cumulative Effect of Accounting Change

        Effective September 1, 2001, the Company adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.” The provisions of SFAS No. 142 prohibit the amortization of goodwill and indefinite-lived intangible assets and require such assets to be tested for impairment and to be written down to fair value, if necessary. In order to assess the value of its goodwill and indefinite-lived intangibles as of September 1, 2001, the Company engaged an independent valuation firm. The valuation process assigned the Company’s assets and liabilities to its operating business units and then provided a fair market value of those assets using a discounted cash flow model that also considered factors such as market capitalization and appraised values of certain assets. Based upon the results of the valuation testing, the Company wrote off all of the goodwill assigned to the organizations and consumer business units, plus a portion of the Covey trade name intangible asset, which has an indefinite life. The write-off totaled $61.4 million after applicable tax benefits and was retroactively recorded in the Company’s first fiscal quarter as required by the guidelines of SFAS No. 142. Goodwill and intangible assets assigned to the education business unit, which consisted primarily of Premier, were not required to be written down since the fair value of that business unit’s assets exceeded their book value at the measurement date. Remaining intangible assets, with a net book value of $102.7 million, were primarily generated from the merger with Covey Leadership Center and are assigned to the organizations business unit.

Preferred Stock Dividends

        Preferred stock dividends increased over the prior year due to the issuance of additional shares of preferred stock as payment for accrued dividends. The Company may, at its option, pay accrued dividends with cash or additional shares of preferred stock until July 1, 2002. Subsequent to that date, preferred stock dividends must be paid in cash. Through February 23, 2002, preferred dividend payments have been made with additional shares of preferred stock. Accrued preferred stock dividends for the quarter ended February 23, 2002 were subsequently paid with cash.

LIQUIDITY AND CAPITAL RESOURCES

        Historically, the Company’s primary sources of capital have been net cash provided by operating activities, long-term borrowings, line of credit financing, and the issuance of preferred and common stock. Working capital requirements have also been financed through short-term borrowing and line-of-credit financing.

        Net cash provided by operating activities for the six months ended February 23, 2002 was $12.6 million compared to $48.0 million for the six months ended February 24, 2001. The decrease in operating cash flows was primarily due to reduced net income resulting from declining sales during fiscal 2002. The Company anticipates that cash flows from operating activities will continue to be adversely affected by unfavorable sales performance during the remainder of fiscal 2002. Non-cash adjustments to the Company’s results of operations during fiscal 2002 included increases to the provision for losses on the management stock loan program totaling $18.5 million, a $16.3 million impairment charge on the Company’s investment in Franklin Covey Coaching LLC, $20.1 million of depreciation and amortization charges, and a $4.5 million impairment of other assets. Consistent with comparable periods of the prior year, the primary source of cash from operating activities was the collection of accounts receivable, primarily from Premier, which records seasonally high sales during the Company’s fourth fiscal quarter. The primary use of cash was the payment of accounts payable and accrued liabilities, also primarily attributable to the seasonal nature of Premier’s operations. Additionally, due to losses generated by continuing operations recorded during the first six months of fiscal 2002, the Company recognized income tax benefits that were offset, in part, by the income tax liabilities resulting from the sale of Premier.

        Net cash provided by investing activities totaled $143.1 million during the first six months of fiscal 2002 compared to $18.3 million of net cash used for investing activities in the prior year. During the quarter ended February 23, 2002, the Company sold Premier, a wholly owned subsidiary that provided productivity and learning solutions to the educational industry. The sales price was $152.5 million in cash plus the retention of Premier’s working capital, which was received in the form of a $4.0 million promissory note from the purchaser, which bears interest at LIBOR plus two percent and is due and payable in June 2002. The Company will also receive $0.8 million from Premier related to income tax payments. During the six months ended February 23, 2002 the Company used $6.9 million of cash to purchase computer hardware and software, leasehold improvements in new stores, and other property and equipment. The Company reduced its purchases of property and equipment from $16.1 million during comparable periods in the prior year and plans to continue to reduce capital expenditures until sales performance and related cash flows improve. The Company also received $2.3 million of cash proceeds from the sale of a building located in Chandler, Arizona.

        Net cash used for financing activities during the six months ended February 23, 2002 was $109.4 million compared to $31.3 million in the first six months of the prior year. The primary use of financing cash during fiscal 2002 was the payment of outstanding term loan and line of credit debt balances. On December 21, 2001, the Company used $92.3 million of the proceeds from the sale of Premier to pay all amounts outstanding on its existing term loan and line of credit agreements. As a result of this prepayment, the existing line of credit agreement was terminated. Following payment and termination of its lines of credit, the Company’s remaining debt balances primarily consist of long-term mortgages on certain buildings and property. In addition to repaying its term note and line of credit, the Company was required to settle an outstanding interest rate swap agreement it had entered into as a part of the debt facility for $4.9 million in cash. Accrued preferred dividends totaling $2.2 million at February 23, 2002 were subsequently paid in cash during the Company’s third fiscal quarter. Previous dividends paid during fiscal 2002 were paid with additional shares of preferred stock.

        The Company has not engaged in off-balance sheet arrangements, structured any special purpose entities, or participated in any commodity trading activities, which would expose the Company to potential undisclosed liabilities or create adverse consequences to its liquidity. Required contractual payments consist primarily of payments to Electronic Data Systems (“EDS”) for outsourcing services related to information systems, warehousing and distribution, and call center operations; rent expense for retail store space; and mortgage payments on certain buildings and property. These obligations are described in further detail in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2001.

        On November 26, 2001, the Company filed a tender offer statement with the Securities and Exchange Commission, which was subsequently amended on December 24, 2001, to purchase up to 7,333,333 shares of its common stock at a purchase price of $6.00 per share. The Company reserved the right in the tender offer document, upon providing appropriate notice, to extend the date of the tender offer or change the number of shares or the price at which the Company was willing to tender. The Company also reserved the right to terminate the tender offer (a) if changes occurred in the economy that could in the Company’s reasonable judgment have a material adverse effect on the Company’s business, operations, or prospects or (b) if any change occurred in the Company’s business, financial condition, assets, income, operations, or prospects that in the Company’s reasonable judgment has or may have a material adverse consequence to the Company. The Company terminated the tender offer on January 22, 2002 (See Note 13 for further discussion regarding cancellation of the tender offer). Termination of the tender offer allowed the Company to maintain a strong balance sheet, minimize debt, and maintain cash balances, which the Company believes will be sufficient to meet its necessary working capital requirements.

        Going forward, the Company will continue to incur costs necessary to develop products and curriculum, to deploy sales initiatives, to enhance electronic commerce channels, to pay preferred stock dividends, and other costs related to implement strategies necessary for the operation of the business. Cash provided by the sale of Premier, operations, and other financing alternatives will be used for these expenditures. Management anticipates that its existing capital resources will be sufficient to enable the Company to maintain its current level of operations for the foreseeable future. The Company also continues to pursue additional financing alternatives, including new lines of credit, as it positions itself for the future.

"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of 1995

        With the exception of historical information (information relating to the Company’s financial condition and results of operations at historical dates or for historical periods), the matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere are forward-looking statements that necessarily are based on certain assumptions and are subject to risks and uncertainties. Such uncertainties include, but are not limited to, unanticipated developments in any one or more of the following areas: decreased sales and profitability due to the sale of Premier, decreased sales as a result of adverse economic conditions, management of costs in connection with reduced sales, unanticipated costs, delays or outcomes relating to the Company’s restructuring plans, availability of financing sources, failure to collect employee notes receivable, realizability of long-lived assets, dependence on certain products or services, the rate and consumer acceptance of new product introductions, competition, the number and nature of customers and their product orders, pricing, pending and threatened litigation, and other risk factors which may be detailed from time to time in the Company’s press releases, reports to shareholders, and in filings with the SEC.

        While the Company has a broad customer base, it is subject to variables over which it has no direct control such as innovations in competing products, the general transition from paper-based products to electronic or Internet based products, changing corporate policies on the part of the Company’s customers, competition from others in the industry, and the effects of terrorist activities on the United States economy. In addition, the Company is subject to changes in costs of supplies necessary to produce its products and distribution of those products. The Company’s business is subject to seasonal variations and is also subject to currency risks associated with sales occurring in countries other than the United States. Sales outside the United States potentially present additional risks such as the potential for political, social, and economic instability.

        The market price of the Company’s common stock has been and may remain volatile. In addition, the stock markets in general have recently experienced increased volatility. Factors such as quarter-to-quarter variations in revenues and earnings or the failure of the Company to meet analysts’ expectations could have a significant impact on the market price of the Company’s common stock. In addition, the price of the common stock can change for reasons unrelated to the performance of the Company.

        These forward-looking statements are based on management’s expectations as of the date hereof, and the Company does not undertake any responsibility to update any of these statements in the future. Actual future performance and results will differ and may differ materially from that contained in or suggested by these forward-looking statements as a result of the factors set forth in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the business risks described in the Company’s Annual Report on Form 10-K for the year ended August 31, 2001, and other risks, foreseen or unforeseen.

                                          Notional Amount in        Notional Amount in
           Contract Description            Foreign Currency            U.S. Dollars
        -----------------------------    ----------------------    -----------------------

        Japanese Yen                               590,000              $      4,770
        Australian Dollars                           2,755                     1,381
        Mexican Pesos                               14,620                     1,535
                                                                        ------------
                                                                        $      7,686
                                                                        ============

                                          Notional Amount in        Notional Amount in
           Contract Description            Foreign Currency            U.S. Dollars
        -----------------------------    ----------------------    -----------------------
        Japanese Yen                               590,000              $      4,770
        Australian Dollars                           2,755                     1,381
        Mexican Pesos                               14,620                     1,535
                                                                        ------------
                                                                        $      7,686
                                                                        ============