UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
 
x
 
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) FO THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED AUGUST 31, 2005
 
   
 OR
 
o
 
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSISTION PERIOD FROM ___ TO ___ 
 
FC Logo
 
         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 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 x  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 an accelerated filer (as defined in Rule 12b-2 of the Act).  YES o  NO x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  YES o  NO x
 
As of February 25, 2005, the aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant was $40,623,127.
 
As of November 7, 2005, the Registrant had 20,744,725 shares of Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Parts of the Registrant's Proxy Statement for the Registrant's Annual Meeting of Shareholders, which is scheduled to be held on January 20, 2006, are incorporated by reference in Part III of this Form 10-K.
 
 

 
INDEX TO FORM 10-K
 
 
Table of Contents
 
PART I
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
 
 
 
 
     
PART II
 
 
 
 
 
 
 
     
    (b)   Restatement
     
     
     
     
     
     
     
     
     
     
 

 
 
     (a)    Business Environment and Risk
 

 
 
     
     
     
     
     
 
         1.  Nature of Operations and Summary of Significant Accounting Policies
         2.  Restatement
         3.  Stock-Based Compensation
         4.  Property and Equipment
         5.  Intangible Assets
         6.  Long-Term Debt and Financing Obligation
         7.  Lease Obligations
         8.  Commitments and Contingencies
         9.  Preferred Stock Recapitalization
         10.  Shareholders' Equity
         11.  Management Common Stock Loan Program
         12.  Financial Instruments
         13.  Impairment of and Gain on Disposal of Investment in Unconsolidated Subsidiary
         14.  Employee Benefit Plans
         15.  Restructuring and Store Closure Costs
         16.  Income Taxes
         17.  Earnings Per Common Share
         18.  Segment Information
         19.  CEO Compensation Agreement
         20.  Executive Separation Agreement
         21.  Related Party Transactions
         22.  Subsequent Event
 
 
 
 
 
 
 
 
PART III
 
 
 
 
 
 
 
 
 
 
 
PART IV
 
 
 
SIGNATURES
 
 

 
 
PART I

Item 1.
 
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 2005. 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 BalanceÒ) - a focus on achieving results and building capability.
 
The Opportunity
 
Corporations, organizations and individuals cumulatively purchase more than $10 billion a year in professional performance training curricula, books, tapes, CD’s and other tools in an effort to improve their effectiveness and productivity. The $10 billion training industry is roughly divided into two segments - IT training and performance skills training. After several years of lackluster industry results, performance skills training is estimated1  to grow 10% in 2005 compared to an estimated 4% growth rate in IT training. The performance skills training segment of the industry has 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.
 
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 2005, 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, 2005, we had direct operations in Australia, Brazil, Canada, Japan, Mexico and the United Kingdom. We also had licensed operations in 67 countries and licensed rights in 129 countries. Approximately 400,000 individuals were trained during the fiscal year ended August 31, 2005.
 
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.

1 Simba Information, Corporate Training Market 2005: Forecast and Analysis. (2005)
 
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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 more than 100 retail stores.
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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 2005, approximately 400,000 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 and Small 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):

   
2005
 
2004
 
2003
 
Consumer and Small Business Unit
                   
Retail Stores
 
$
74,331
 
$
87,922
 
$
112,054
 
Consumer Direct
   
55,575
   
55,059
   
56,177
 
Wholesale
   
19,691
   
21,081
   
16,915
 
Other
   
3,757
   
2,007
   
7,020
 
Total CSBU
   
153,354
   
166,069
   
192,166
 
Organizational Solutions Business Unit
                   
Domestic
   
76,114
   
61,047
   
74,306
 
International
   
54,074
   
48,318
   
40,688
 
Total OSBU
   
130,188
   
109,365
   
114,994
 
Total
 
$
283,542
 
$
275,434
 
$
307,160
 
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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 and our Internet website, www.franklincovey.com), our organizational and educational sales forces and other distribution channels. 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 and Small 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, 2005, FranklinCovey had 105 domestic retail stores located in 33 states and the District of Columbia. We closed 30 retail stores in the United States during fiscal year 2005. These closures were comprised of under-performing and unprofitable stores. The Company anticipates that it will close additional stores in fiscal year 2006.
 
Consumer Direct. Our Consumer Direct channel consists of sales through catalog call-in operations and Internet sales operations. 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 91 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.
 
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 and Costco stores and an under-brand label “DayOne by FranklinCovey” product line that is sold through WalMart stores.
 
Other. Other sales include sales of printing services by FranklinCovey Printing, a wholly-owned subsidiary, and miscellaneous licensing rights of FranklinCovey products and brands to various marketing customers. Sub-lease revenues from third-party tenants are also contained in the Other revenue category. Beginning in fiscal 2006, the marketing and administration of public seminars will be managed under the CSBU and sales reported as “Other CSBU” 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.
 
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 more than 151 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 89 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 48 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 84 training consultants in major metropolitan areas of the United States, with an additional 51 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 Teensas 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, Aruba, Austria, Bahamas, Bahrain Belgium, Bermuda, Bulgaria, China, Colombia, Costa Rica, Croatia, Czech Republic, Denmark, Dominican Republic, Egypt, El Salvador, Estonia, Finland, France, Germany, Greece, Greenland, Honduras, Hong Kong, Hungary, India, Indonesia, Israel, Italy, Jordan, Kuwait, Latvia, Lebanon, Lithuania, Luxembourg, Malaysia, The Netherlands, The Netherlands Antilles, Nicaragua, Nigeria, Norway, Panama, 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, Venezuela, Vietnam and The 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.
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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; Lumacore to promote and facilitate Dr. Covey's personal appearances and teleconferences; 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; distribution agreements with Hewlett Packard and Acer in connection with the Tablet PC; Agilix Labs in development of the PlanPlus Software; Microsoft in conjunction with the Tablet PC training and PlanPlus marketing; and Heritage Industries 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 2005 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, tapestry or vinyl materials. These binders are produced by multiple and alternative 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.
 
Our research and development expenditures totaled $2.2 million, $3.6 million, and $4.9 million in fiscal years 2005, 2004, and 2003 respectively.

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 147 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, 2005, FranklinCovey had 1,333 full and part-time associates, including 416 in sales, marketing and training; 515 in customer service and retail; 140 in production operations and distribution; and 262 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 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 450 Fifth Street, NW, 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.
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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 Offices:
Canada (1 location)
Latin America (3 locations) - all leased
Asia Pacific (2 locations) - both leased
Europe (1 location) - leased

International Distribution Facilities:
Canada (1 location)
Latin America (1 location) - leased
Asia Pacific (2 locations) - both leased
Europe (1 location) - leased

Consumer and Small Business Unit
Retail Stores:
United States (105 locations) - all leased

Manufacturing Facilities:
United States (1 location)
 
We consider our existing facilities sufficient for our current and anticipated level of operations in the upcoming fiscal year. Our manufacturing facility, which produces the majority of our printed paper products, operates at near capacity. Other significant developments related to our properties during fiscal 2005 consisted of the following:

 l
In June 2005, we completed the sale and leaseback of our corporate headquarters facility, located in Salt Lake City, Utah. The sale price was $33.8 million in cash and after deducting customary closing costs, including commissions and payment of the remaining mortgage on one of the buildings, we received net proceeds totaling $32.4 million. In connection with the transaction, we entered into a 20-year master lease agreement with the purchaser, an unrelated private investment group. The master lease agreement also contains six five-year options to renew the master lease agreement, thus allowing us to maintain our operations at the current location for up to 50 years.
 
 l
In November 2004, we simultaneously exercised our option to purchase the corporate facilities leased in Provo, Utah and sold these facilities to the tenant currently occupying that property. For further information regarding this transaction, refer to Note 15 to our consolidated financial statements.
 
 l
During fiscal 2005, we closed 30 domestic retail store locations and may close additional retail locations during fiscal 2006.
 
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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 have provided the documents and information requested by the SEC, including the testimonies of our Chief Executive Officer, Chief Financial Officer, and other key employees. The Company has cooperated, and will continue to fully cooperate, in providing requested information to the SEC. The SEC and the Company are currently engaged in discussions with respect to a potential resolution of this matter.
 
In fiscal 2002, we brought legal action against World Marketing Alliance, Inc., a Georgia corporation (WMA) and World Financial Group, Inc., a Delaware corporation and the purchaser of substantially all assets of WMA, for breach of contract. The case proceeded to jury trial commencing October 25, 2004. 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. The Company received payment in cash for the legal settlement during the quarter ended May 28, 2005. However, shortly after paying the legal settlement, WMA appealed the jury decision to the 10th Circuit Court of Appeals.  As a result of the appeal, we recorded the cash received and a corresponding increase to accrued liabilities, and will not recognize the gain for the legal settlement until the case is completely resolved.
 
The Company is also the subject of certain legal actions, which we consider routine to our business activities. At August 31, 2005, 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.
 
 
No matters were submitted to a vote of security holders during the fourth quarter of our fiscal year ended August 31, 2005.
 
PART II
 
 
Item 5. Market for the Registrant's Common Equity, Related Shareholder 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, 2005 and 2004.
 
   
High
 
Low
 
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
 
               
Fiscal Year Ended August 31, 2004:
             
Fourth Quarter
 
$
2.75
 
$
1.70
 
Third Quarter
   
2.86
   
2.05
 
Second Quarter
   
3.25
   
1.50
 
First Quarter
   
1.86
   
1.15
 
 
We did not pay or declare dividends on our common stock during the fiscal year years ended August 31, 2005 and 2004. We currently anticipate that we will retain all available funds to redeem outstanding preferred 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 and pay cash dividends on our outstanding shares of Series A preferred stock.
 
As of November 7, 2005, the Company had 20,744,725 shares of its common stock outstanding, which was held by approximately 328 shareholders of record.
 
The following table summarizes Company purchases of our preferred and common stock during the fiscal quarter ended August 31, 2005 (in thousands, except per share amounts):

 
 
 
 
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 Number of Shares That May Yet Be Purchased Under the Plans or Programs
 
 
Common Shares:
                 
May 29, 2005 to July 2, 2005
   
10(1)
 
$
6.86
   
none
   
n/a
 
                           
July 3, 2005 to July 30, 2005
   
-
   
-
   
none
   
n/a
 
                           
July 31, 2005 to August 31, 2005
   
1(3)
 
 
7.15
   
none
   
n/a
 
                           
Total Common Shares
   
11
 
$
6.89
         
426(4)
 
                           
Total Preferred Shares
   
1,200(2)
 
$
25.00
             
 

 
(1)
These shares of common stock were purchased in open market transactions for exclusive distribution to participants in our employee stock purchase program.
 
(2)
Amount represents the redemption of $30.0 million of preferred stock held by Knowledge Capital during the period July 3, 2005 to July 30, 2005 as provided by our fiscal 2005 preferred stock recapitalization. Subsequent to August 31, 2005, we redeemed an additional $10.0 million, or approximately 400,000 shares of preferred stock.
 
(3)
These shares of common stock were purchased in open market transactions for participants in the Company’s non-qualified deferred compensation plan by the plan administrator.
 
(4)
In previous fiscal years, our Board of Directors approved various plans for the purchase of up to 8,000,000 shares of our common stock. As of November 25, 2000, the Company had purchased 7,705,000 shares of common stock under these board-authorized purchase plans. On December 1, 2000, the Board of Directors approved an additional plan to acquire up to $8.0 million of our common stock. To date, we have purchased $7.1 million of our common stock under the terms of the December 2000 Board approved purchase plan. The maximum number of shares that may yet be purchased under the plans was calculated for the December 2000 plan by dividing the remaining approved dollars by $7.00, which was the closing price of the Company’s common stock on August 31, 2005. These shares were added to the remaining shares from the Company’s other Board-approved plans to arrive at the maximum amount that may be purchased as of August 31, 2005. No shares of our common stock were purchased during the fiscal quarter ended August 31, 2005 under terms of any Board authorized purchase plan.
 
Item 6.
 
Financial Highlights
 
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 2005, we determined that due to inaccurate deferred income tax calculations, our consolidated financial statements contained an error. The selected consolidated financial data has been derived from our consolidated financial statements and has been restated to reflect adjustments described in Note 2 to those consolidated financial statements.  This restatement affects our fiscal 2002 income statement data and our fiscal 2004, 2003, 2002, and 2001 balance sheet data as presented below.  There was no impact in any year due to this restatement on net cash provided by operating, investing, or financing activities on our consolidated statements of cash flows.
 
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,
 
2005
 
2004
 
2003
 
2002
 
2001
 
 
In thousands, except per share data
     
 
Restated
 
Restated
 
Restated
 
As Previously
Reported
 
Restated
 
                           
Income Statement Data
                                     
Net sales
 
$
283,542
 
$
275,434
 
$
307,160
 
$
332,998
 
$
332,998
 
$
439,781
 
Income (loss) from operations
   
8,943
   
(9,064
)
 
(47,665
)
 
(122,573
)
 
(122,573
)
 
(14,793
)
Net income (loss) from continuing operations before income taxes
   
9,101
   
(8,801
)
 
(47,790
)
 
(122,179
)
 
(122,179
)
 
(17,196
)
Income tax benefit (provision)
   
1,085
   
(1,349
)
 
2,537
   
32,122
   
25,713
   
4,000
 
Net income (loss) from continuing operations
   
10,186
   
(10,150
)
 
(45,253
)
 
(90,057
)
 
(96,466
)
 
(13,196
)
Cumulative effect of accounting change, net of income taxes
                     
(75,928
)
 
(61,386
)
     
Net loss attributable to common shareholders
   
(5,837
)
 
(18,885
)
 
(53,988
)
 
(117,399
)
 
(109,266
)
 
(19,236
)
Basic and diluted loss per share
   
(.34
)
 
(.96
)
 
(2.69
)
 
(5.90
)
 
(5.49
)
 
(.95
)
                                       
Balance Sheet Data
                                     
Total current assets
 
$
105,182
 
$
92,229
 
$
110,057
 
$
124,345
 
$
120,739
 
$
226,911
 
Other long-term assets
   
9,426
   
7,305
   
10,472
   
11,474
   
11,474
   
14,369
 
Total assets
   
233,233
   
227,625
   
262,146
   
308,344
   
304,738
   
551,022
 
                                       
Deferred income tax liabilities
   
9,715
   
10,047
   
10,538
   
11,739
   
-
   
41,326
 
Long-term obligations of continuing operations
   
46,171
   
13,067
   
15,743
   
15,231
   
3,492
   
146,138
 
Total liabilities
   
100,407
   
69,146
   
84,479
   
81,922
   
70,183
   
241,140
 
                                       
Shareholders’ equity
   
132,826
   
158,479
   
177,667
   
226,422
   
234,555
   
309,882
 
 
 
 

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 new and updated individual-effectiveness and leadership-development training products based on the best-selling book The 7 Habits of Highly Effective People. We also offer a range of training and assessment products to help organizations achieve superior results by focusing and executing on top priorities, building the capability of knowledge workers, and aligning business processes. These offerings include the popular workshop FOCUS: Achieving Your Highest Priorities™, The 4 Disciplines of Execution™, The 4 Roles of Leadership™, Building Business Acumen: What the CEO Wants You to Know™, the Advantage Series communication workshops, and the Execution Quotient (xQ™) organizational assessment tool.

Our fiscal year ends on August 31, and unless otherwise indicated, fiscal 2005, fiscal 2004, and fiscal 2003, refers to the twelve-month periods ended August 31, 2005, 2004, and 2003.

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 digital assistants or “PDAs”, binders, 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 provide training and products to our clients.



During the fiscal 2005 year-end closing process, the Company determined that its previously issued consolidated balance sheet for the year ended August 31, 2004 and consolidated statements of shareholders' equity for the three years in the period ended August 31, 2004 needed to be restated to correct an inaccurate deferred tax calculation that affected our statement of operations for the fiscal year ended August 31, 2002.  The Company identified that, historically, the deferred income tax liability for the basis difference on indefinite-lived intangibles calculated upon the adoption of SFAS No. 142, Goodwill and Other Intangibles, was incorrectly offset against deferred income tax assets.  The deferred tax liability relating to this basis difference was assumed to reverse against the deferred tax asset, which resulted in the Company not providing a sufficient valuation allowance against the deferred tax assets.  Since this deferred tax liability relates to indefinite-lived assets, it was not correct to net the deferred tax assets and liabilities.
 
In addition, the Company determined that it should have recognized a deferred tax liability and a corresponding increase to goodwill related to the acquisition of intangible assets in a prior period. The additional goodwill should have been expensed in the cumulative effect of the accounting change resulting from the adoption of SFAS No. 142 because all goodwill was considered impaired at the date that we adopted SFAS No. 142, and the additional deferred income tax liability should have been utilized to reduce the deferred tax valuation allowance.

These inaccurate deferred tax calculations impacted the consolidated statement of operations for fiscal 2002 by increasing the income tax benefit, and by decreasing the loss from continuing operations, by $6.4 million, and by increasing the charge resulting from the cumulative effect of accounting change related to the adoption of SFAS No. 142 by $14.5 million. The net effect of these errors increases the reported $109.3 million net loss attributable to common shareholders in fiscal 2002 by $8.1 million, to $117.4 million.

For periods subsequent to fiscal 2002, these errors only affected our consolidated balance sheets through the impact of increased net deferred tax liabilities and decreased retained earnings. There was no impact in any year due to this restatement on net cash provided by operating, investing, or financing activities on the consolidated statements of cash flows.
 
The following discussion in this Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects the effects of this restatement where applicable.


Overview

Our operating results in fiscal 2005 showed significant year-over-year improvement in nearly every area, including increased sales, improved gross margins, and lower operating costs. For the fiscal year ended August 31, 2005, we reported net income (before preferred dividends and loss on preferred stock recapitalization) of $10.2 million, compared to a net loss of $10.2 million in the prior year. Our operating income for the year ended August 31, 2005 improved by $18.0 million as we recognized operating income of $8.9 million compared to an operating loss of $9.1 million in fiscal 2004. The primary factors that influenced our financial results for the fiscal year ended August 31, 2005 were as follows:

 l
Sales Performance - Our total sales increased by $8.1 million, which represented the first increase in year-over-year sales performance in several years. The increase in total sales was due to improved training and consulting services sales, which increased $18.1 million compared to fiscal 2004. Increased training and consulting sales was attributable to improvements in both domestic and international delivery channels. During fiscal 2005 we also completed significant enhancements to our successful and well-known The 7 Habits of Highly Effective People training course and related products. We believe that our refreshed course materials and related products, in combination with our new training offerings, will contribute to continuing improvements in our training and consulting sales performance.
 
Product sales decreased by $10.0 million, which was primarily due to the impact of closed retail stores and declining technology and specialty product sales compared to the prior year.
 
 l
Gross Margin Improvement - Our gross margin improved compared to the prior year primarily due to increased training and consulting sales as a percent of total sales, favorable product and training program mix changes, reduced product costs, and lower overall costs in delivering our training and consulting service sales.
 
 l
Decreased Operating Costs - Our operating costs decreased by $5.1 million, primarily due to reduced depreciation and reduced selling, general, and administrative expenses. 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.
 
 l
Improved Cash Flows from Operations - Our cash flows from operations improved to $22.3 million compared to $12.1 million in fiscal 2004 and $5.8 million in fiscal 2003. We were able to improve our cash flows from operations primarily through improved operating results and continued reductions of on-hand inventories. As a result of these and other factors, we were able to increase our cash and cash equivalents balance to $51.7 million at August 31, 2005.
 
 l
Completion of the Preferred Stock Recapitalization - During fiscal 2005, we completed a preferred stock recapitalization that allows the Company to redeem shares of preferred stock. Although we recorded a $7.8 million non-cash loss resulting from the revaluation of our preferred stock and valuation of the newly issued common stock warrants, we were able to use a portion of the proceeds from the sale of our corporate headquarters to redeem $30.0 million, or 1.2 million shares, of preferred stock in fiscal 2005. This redemption will save $3.0 million annually in preferred dividends. Subsequent to August 31, 2005, we redeemed an additional $10.0 million of preferred stock, which will save additional dividend costs in future periods.
 

Although we achieved improved financial results in fiscal 2005 and saw improvements in many other related 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. 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 statements of operations:

YEAR ENDED
AUGUST 31,
 
 
2005
 
 
2004
 
 
2003
 
Product sales
   
59.0
%
 
64.3
%
 
65.8
%
Training and consulting services sales
   
41.0
   
35.7
   
34.2
 
Total sales
   
100.0
   
100.0
   
100.0
 
                     
Product cost of sales
   
27.2
   
31.1
   
33.3
 
Training and consulting services cost of sales
   
13.3
   
12.3
   
11.2
 
Total cost of sales
   
40.5
   
43.4
   
44.5
 
Gross margin
   
59.5
   
56.6
   
55.5
 
                     
Selling, general and administrative
   
52.3
   
54.1
   
60.0
 
Impairment of and (gain) on disposal of investment in unconsolidated subsidiary
   
(0.2
)
        0.2  
Provision for losses on management stock loans
               
1.3
 
Recovery of investment in unconsolidated subsidiary
               
(0.5
)
Depreciation
   
2.7
   
4.3
   
8.6
 
Amortization
   
1.5
   
1.5
   
1.4
 
Total operating expenses
   
56.3
   
59.9
   
71.0
 
Income (loss) from operations
   
3.2
   
(3.3
)
 
(15.5
)
                     
Interest income
   
0.3
   
0.1
   
0.2
 
Interest expense
   
(0.3
)
       
(0.1
)
Other expense, net
               
(0.1
)
Income (loss) before income taxes
   
3.2
%
 
(3.2
)%
 
(15.5
)%

Segment Review

We have two reporting segments: the Consumer and Small 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 and Small Business Unit - This business unit is primarily focused on sales to individual customers and small business organizations and includes the results of the Company’s retail stores, catalog and eCommerce 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. During fiscal 2005, we began an initiative to increase both training and product sales to small businesses through our CSBU channels with the addition of a small business sales force and other initiatives designed especially for small business clients.

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 segment sales data for the years indicated. For further information regarding our reporting segments and geographic information, refer to Note 18 to our consolidated financial statements (in thousands).

YEAR ENDED
AUGUST 31,
 
 
2005
 
 
2004
 
 
2003
 
Consumer and Small Business Unit:
             
Retail stores
 
$
74,331
 
$
87,922
 
$
112,054
 
Consumer direct
   
55,575
   
55,059
   
56,177
 
Wholesale
   
19,691
   
21,081
   
16,915
 
Other CSBU
   
3,757
   
2,007
   
7,020
 
     
153,354
   
166,069
   
192,166
 
Organizational Solutions Business Unit:
                   
Domestic
   
76,114
   
61,047
   
74,306
 
International
   
54,074
   
48,318
   
40,688
 
     
130,188
   
109,365
   
114,994
 
Total net sales
 
$
283,542
 
$
275,434
 
$
307,160
 


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 $10.0 million, or six percent, 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 year ended August 31, 2005:

 l
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 specialty 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 (stores which were open during the comparable periods) sales. Declining technology and specialty product sales were partially offset by increased “core” product (e.g. planners, binders, and totes) sales during fiscal 2005.
 
 l
Consumer Direct - Sales through our consumer direct channels (catalog and eCommerce) were generally consistent with the prior year and the slight increase was primarily due to increased core product sales compared to the prior year.
 
 l
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.
 
 l
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, which has been classified as other CSBU sales.
 


Training and Consulting Services Sales - We offer a variety of training solutions, training related products, and consulting services focused on productivity, leadership, strategy execution, sales force performance, and effective communications training programs that are provided both domestically and internationally through the Organizational Solutions Business Unit (OSBU). Our overall training and consulting service sales increased by $18.1 million, or 18 percent, compared to the same period of 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 Margin

Gross margin consists of sales less cost of sales. 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 margin 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 consolidated selling, general, and administrative expenses. Therefore, our consolidated gross margin may not be comparable with the gross margin of other retailers that include similar costs in their cost of sales.

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. 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 $1.0 million during fiscal 2005 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 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.

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.

Depreciation and Amortization - 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. Based upon these events and current capital spending trends, we expect that depreciation expense will continue to decline compared to prior periods.

Amortization expense on definite-lived intangible assets totaled $4.2 million for the fiscal years ended August 31, 2005 and 2004. We expect intangible asset amortization expense to total $3.8 million in fiscal 2006 as certain intangible assets become fully amortized in fiscal 2006.

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.
 
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 restated $8.1 million deferred liability at August 31, 2004 primarily relate to the step-up of indefinite-lived intangibles. For further information concerning deferred tax items, including the restatement of prior period deferred tax liabilities, refer to Notes 2 and 16 to our consolidated financial statements.

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 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 attributable 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.

Subsequent to August 31, 2005, we redeemed an additional $10.0 million of preferred stock and announced that we intend to seek shareholder approval to amend our articles of incorporation to extend the period during which we have the right to redeem the outstanding preferred stock at 100 percent of the liquidation preference. The amendment would extend the current redemption deadline from March 8, 2006 to December 31, 2006 and would also provide the right to extend the redemption period for an additional year to December 31, 2007, if another $10.0 million of preferred stock is redeemed before December 31, 2006.



Sales

Product Sales - Our product sales, which are primarily delivered through our CSBU channels, declined $25.0 million, or 12 percent, compared to the prior year. The decline in product sales compared to fiscal 2003 was primarily attributable to the following sales performance at our various CSBU channels.

Retail sales decreased $24.1 million, or 22 percent, compared to fiscal 2003. The decline in retail sales was primarily attributable to the following:

 l
$14.3 million of the retail sales decrease is the result of the closure of retail stores. The Company closed 18 stores in fiscal 2004 in addition to 22 domestic and 10 international stores that were closed in fiscal 2003. These store closures were primarily comprised of unprofitable stores and stores located in markets where we had multiple retail operations.
 
 l
$8.4 million of the retail store decrease was the result of declining comparable store technology sales, which include handheld electronic devices, or PDAs, and related products. Comparable stores are retail locations which have been open for the full year in the periods reported. Technology sales decreased as competition increased from office product superstores and discounters. Sales of core products remained relatively flat, decreasing less than one percent compared to fiscal 2003.
 

At August 31, 2004, we were operating 135 retail stores compared to 153 stores at August 31, 2003.

Consumer direct (includes catalog and eCommerce operations) sales decreased $1.1 million, or two percent, compared with fiscal 2003. The primary factors affecting consumer direct sales were as follows:

 l
Technology sales, including handheld electronic devices and PDAs, through this channel decreased $1.5 million.
 
 l
The total number of orders placed through the consumer direct channel decreased five percent from the prior year.
 
 
During 2004, our wholesale sales increased $4.2 million, or 25 percent, as we expanded our product offerings in office superstores and discount stores. Offsetting this increase were decreased other CSBU sales, which are comprised primarily of government product and external printing sales, and declined by $5.0 million compared to the prior year. During fiscal 2004, we outsourced the sale and distribution of our products through government channels to a well-established office products distributor. Accordingly, we now only recognize royalty income from the distributor rather than the net sale and corresponding costs related to those sales.

Training and Consulting Services Sales - Our overall training and consulting service sales declined $6.7 million, or six percent, compared to the prior year. Decreased training sales were primarily due to decreased domestic training sales which experienced a slow start in fiscal 2004. Of the $13.3 million decline in domestic training sales, $10.0 million occurred during the first two quarters of fiscal 2004 and was primarily attributable to decreased client-facilitated leadership programs. Decreased leadership training was partially offset by increased productivity training and sales from our new program, The 4 Disciplines of Execution and related xQ sales. However, our training and consulting business improved significantly during late fiscal 2004, especially in the fourth quarter.

International sales, which represented 44 percent of our OSBU segment sales in fiscal 2004, increased by $7.6 million, or 19 percent compared to the prior year. International sales growth was led by our two largest international offices, located in Japan and the United Kingdom, which experienced growth rates of 25 percent and 23 percent during fiscal 2004. Currency conversion also favorably impacted international results through translation of foreign sales to U.S. dollars. Excluding the impact of foreign currency exchange fluctuations, international sales grew 10 percent compared to fiscal 2003.

Gross Margin

For fiscal 2004, our overall gross margin improved to 56.6 percent of sales compared to 55.5 percent in fiscal 2003. The improvement in our overall gross margin was primarily due to increased margins from product sales and an increase in training and service sales as a percent of total sales. Increased gross margin on product sales was primarily due to a favorable shift in our product mix away from technology and specialty products to higher-margin paper and binder products. Paper product sales, including forms and tabs, combined with binder product sales, increased as a percentage of total sales to 61 percent in fiscal 2004 compared to 58 percent in fiscal 2003. Our gross margins on paper and binder products also increased as a result of specific cost reduction initiatives.

Training solution and related services gross margin, as a percent of sales, decreased to 65.6 percent compared to 67.2 percent the prior year. The decline in our training gross margin during the year was primarily due to the delivery of certain higher-cost programs that are part of a longer-term marketing strategy. These activities include: custom programs for certain strategic clients, multiple domestic symposium events, and a series of international events that also had lower gross margins than our other training programs. These factors were partially offset by ongoing initiatives designed to reduce overall training program delivery costs that continue to have a favorable impact on our training and services gross margin.

Operating Expenses

Selling, General, and Administrative - Our selling, general, and administrative (SG&A) expenses for fiscal 2004 decreased $35.2 million, or 19 percent, compared to the prior year. Declining SG&A expenses were the direct result of initiatives specifically designed to reduce our overall operating costs and were consistent with SG&A 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. The primary effects of these cost-cutting initiatives were reflected in associate expense reductions totaling $18.1 million, advertising and promotional expense reductions totaling $7.7 million, reduced rent and utilities charges totaling $5.1 million, and reductions in other SG&A expenses, such as outsourcing and development costs, that totaled $5.1 million compared to the prior year. Partially offsetting these cost reduction efforts were $2.3 million of additional expenses related to retail store closures, as discussed below.

We regularly assess the operating performance of our retail stores, which includes assessment of previous operating performance trends and projected future profitability. As a result of this evaluation process, we decided to close certain stores during fiscal 2004 and fiscal 2003. During fiscal 2004, we closed 18 retail stores and incurred additional expenses related to certain store closures that occurred during fiscal 2003. These store closure costs totaled $2.3 million during fiscal 2004 and were reported as a component of our SG&A expense.

Provision for Losses on Management Common Stock Program - Prior to May 2004, we utilized a systematic methodology for determining the level of loan loss reserves that were appropriate for the management common stock loan program. Based upon this systematic methodology, we recorded a $3.9 million increase to the loan loss reserve during fiscal 2003.

As a result of modifications to the terms of the management stock loans that were approved in May 2004 and their effects on the Company and loan participants (refer to Note 11 to our consolidated financial statements for further information), we determined that the management common stock loans should be accounted for as non-recourse stock compensation instruments. While this accounting treatment does not alter the legal rights associated with the loans to the participants, the modifications to the terms of the loans were deemed significant enough to adopt the non-recourse accounting model. As a result of this accounting treatment, the remaining carrying value of the notes and interest receivable related to financing common stock purchases by related parties, which totaled $7.6 million prior to the accounting change, was reduced to zero with a corresponding reduction in additional paid-in capital.

We currently account for the non-recourse stock loans as variable stock option instruments. Under the provisions of SFAS No. 123R, which we will adopt on September 1, 2005, additional compensation expense will only be recognized on the loans if the Company takes action on the loans that in effect constitutes a modification of an option. Although we do not anticipate significant further compensation expense related to the management stock loans, this accounting treatment precludes us from recovering the amounts expensed as additions to the loan loss reserve, totaling $29.7 million, which were recognized in prior periods.

The inability of the Company to collect all, or a portion, of these management stock loan receivables could have an adverse impact upon our financial position and future cash flows compared to full collection of the loans.

Depreciation and Amortization - Depreciation expense decreased $14.6 million, or 55 percent, compared to fiscal 2003 primarily due to the full depreciation or disposal of certain computer hardware and software assets, the prior year impairment of retail store assets, which totaled $5.0 million, and the effects of significantly reduced capital expenditures during preceding fiscal years.

Amortization expense on definite-lived intangible assets totaled $4.2 million during fiscal 2004 compared to $4.4 million in the prior year. The reduction in our amortization expense was due to the full amortization of certain definite-lived intangible assets.

Income Taxes

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. The income tax benefit for fiscal 2003 was primarily attributable to reversal of accruals related to the resolution of certain tax matters and a foreign income tax benefit related to our Japan operations.


The following tables set forth selected unaudited quarterly consolidated financial data for fiscal 2005 and fiscal 2004. 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, 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 margin
   
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
   
(218
)
 
(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 income (loss) per share attributable to common shareholders
 
$
(.03
)
$
.19
 
$
(.34
)
$
(.16
)
                           
                           
YEAR ENDED AUGUST 31, 2004
                         
 
 
 
November 29 
   
February 28
   
May 29
   
August 31
 
In thousands, except per share amounts
                         
                           
Net sales
 
$
75,031
 
$
78,715
 
$
61,248
 
$
60,440
 
Gross margin
   
42,755
   
44,784
   
32,767
   
35,495
 
Selling, general, and administrative expense
   
40,245
   
39,569
   
35,234
   
33,870
 
Depreciation
   
3,591
   
3,222
   
2,509
   
2,452
 
Amortization
   
1,043
   
1,043
   
1,043
   
1,044
 
Income (loss) from operations
   
(2,124
)
 
950
   
(6,019
)
 
(1,871
)
Income (loss) before income taxes
   
(2,150
)
 
1,035
   
(5,961
)
 
(1,725
)
Net income (loss)
   
(3,180
)
 
232
   
(5,149
)
 
(2,053
)
Preferred stock dividends
   
(2,184
)
 
(2,184
)
 
(2,184
)
 
(2,183
)
Loss attributable to common shareholders
   
(5,364
)
 
(1,952
)
 
(7,333
)
 
(4,236
)
                           
Basic and diluted loss per share attributable to common shareholders
 
$
(.27
)
$
(.10
)
$
(.37
)
$
(.21
)
                           
 
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 2005, we reclassified certain overhead costs that were included in cost of sales to selling, general, and administrative expense. The quarterly information included above was adjusted to reflect the quarterly impact of this reclassification. Amounts reclassified from cost of sales to selling, general, administrative expense consisted of the following (in thousands):

 
QUARTER ENDED
 
Fiscal
2005
 
Fiscal
2004
 
               
November
 
$
276
 
$
229
 
February
   
152
   
159
 
May
   
148
   
106
 
August
   
145
   
167
 
Total reclassified
 
$
721
 
$
661
 

During the fourth quarter of fiscal 2004, we recorded an adjustment to properly record shares of Company stock held by our non-qualified deferred compensation plan. This correction resulted in a $0.6 million favorable adjustment to our SG&A expense during the fourth quarter of our fiscal year ended August 31, 2004.

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.


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, 2005 we had $51.7 million of cash, cash equivalents, and short-term investments compared to $41.9 million at August 31, 2004. Our net working capital (current assets less current liabilities) increased to $49.9 million at August 31, 2005 compared to $36.0 million at August 31, 2004.

During fiscal 2005, we completed the sale of our corporate headquarters located in Salt Lake City, Utah and received net proceeds totaling $32.4 million. We used a portion of the proceeds from the sale of the campus to redeem $30.0 million of preferred stock, and we anticipate that additional redemptions in future periods will occur if our cash flows from operating activities continue to improve. However, in connection with the sale of our corporate campus we incurred a long-term financing obligation for the purchase price. The annual payments on the financing obligation are approximately $3.0 million per year for the first five years with two percent annual increases thereafter.

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, 2005.

Cash Flows from Operating Activities

During fiscal 2005 our net cash provided by operating activities improved to $22.3 million compared to $12.1 million in fiscal 2004. 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 favorably affected by increased sales compared to fiscal 2004 and we recognized cash flow improvements from operating activities through reduced cash payments for costs and expenses related to generating these revenues, which was reflected by improved gross margins and income from operations. We also received $1.7 million in cash from a legal settlement rendered in our favor.
 
During fiscal 2005, our primary uses of cash for operating activities were related to increased accounts receivable that was primarily due to increased sales in our OSBU during the fourth quarter of fiscal 2005 and payment of income taxes on international royalty revenue and on the sale of our corporate headquarters. Partially offsetting these uses of cash were improved cash flows from reduced inventory balances. In addition to the impact of closed stores, we have actively sought to improve our inventory levels through better management of on-hand inventories, especially for electronic devices. 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 provided by investing activities totaled $4.9 million for the fiscal year ended August 31, 2005. Our primary sources of investing cash were the sale of $21.4 million of short-term investments and $0.5 million of proceeds received from the sale of our investment in an unconsolidated subsidiary. These cash inflows were partially offset by purchases of short-term marketable securities totaling $10.7 million and the purchase of $4.2 million of property and equipment, which consisted primarily of tenant improvements on subleased areas of our corporate campus, computer hardware, software, and leasehold improvements in certain of our retail stores.  During fiscal 2005, we also invested $2.2 million in curriculum development, primarily related to our refreshed The 7 Habits of Highly Effective People training course.

Cash Flows from Financing Activities

Net cash used for financing activities during fiscal 2005 totaled $6.0 million. As mentioned above, we completed the sale of our corporate campus in Salt Lake City, Utah during the fourth quarter of fiscal 2005 and received net proceeds totaling $32.4 million. The proceeds from the sale of our corporate campus was a financing activity.  As a result of this transaction we will use cash in future periods to repay the financing obligation through our monthly lease payment (refer to the discussion under “Contractual Obligations” below). We used a portion of the proceeds from the sale of the corporate campus to redeem $30.0 million of preferred stock at its liquidation preference under the terms of our recapitalization agreement. This redemption will reduce our ongoing cash outflows for preferred dividends by $3.0 million per year. During fiscal 2005, we paid $9.0 million for preferred dividends, which included accrued dividends on the 1.2 million shares of preferred stock that were redeemed. We anticipate making additional preferred stock redemptions under the terms of our recapitalization plan if our cash flows from operating activities continue to improve.

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 the 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; 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
 
2006
 
2007
 
2008
 
2009
 
2010
 
Thereafter
 
Total
 
                                             
Minimum required payments to EDS for outsourcing services
 
$
23,918
 
$
22,591
 
$
22,829
 
$
23,076
 
$
23,330
 
$
141,467
 
$
257,211
 
Required payments on corporate campus financing obligation
   
3,045
   
3,045
   
3,045
   
3,045
   
3,055
   
53,072
   
68,307
 
Minimum operating lease payments
   
8,509
   
6,204
   
5,346
   
4,225
   
3,148
   
7,718
   
35,150
 
Preferred stock dividend payments(2)
   
4,930
   
4,734
   
4,734
   
4,734
   
4,734
   
-
   
23,866
 
Debt payments(1)
   
866
   
160
   
155
   
148
   
143
   
554
   
2,026
 
Contractual computer hardware and software purchases(3)
   
1,334
   
680
   
797
   
1,072
   
1,334
   
6,059
   
11,276
 
Monitoring fees paid to a preferred stock investor(2)
   
219
   
210
   
210
   
210
   
210
   
-
   
1,059
 
Total expected contractual obligation payments
 
$
42,821
 
$
37,624
 
$
37,116
 
$
36,510
 
$
35,954
 
$
208,870
 
$
398,895
 

 
(1)
The Company’s variable rate debt payments include interest payments at 5.5%, which was the applicable interest rate at September 30, 2005.
 
(2)
Amount reflects the $10.0 million preferred stock redemption that occurred subsequent to August 31, 2005 and will decline if we determine to make future redemptions of our preferred stock.
 
(3)
We are contractually obligated by our EDS outsourcing agreement to purchase the necessary computer hardware and software to keep such equipment up to current specifications. Amounts shown are estimated capital purchases of computer hardware and software under terms of the EDS outsourcing agreement and its amendments.
 
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 11 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, 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.


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:

 l
Products - We sell planners, binders, planner accessories, handheld electronic devices, and other related products that are primarily sold through our CSBU channels.
 
 l
Training and 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.

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

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.

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 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.

Our history of significant operating losses precludes us from demonstrating that it is more likely than not that the related benefits from deferred income tax deductions and foreign tax carryforwards will be realized. Accordingly, we recorded valuation allowances on the majority of our deferred income tax assets. These valuation allowances are based on estimates of future taxable income or losses that may or may not be realized.


Equity-Based Payments - In December 2004, the Financial Accounting Standards Board (FASB) approved Statement No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. Statement 123R supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. Generally, this new statement follows the approach previously defined in SFAS No. 123. However, SFAS 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. Pro forma disclosure is no longer an alternative.

We previously accounted for our stock-based compensation using the intrinsic method as defined in APB Opinion No. 25 and accordingly, we have not recognized any expense for our stock option plans or employee stock purchase plan in our consolidated financial statements. Statement No. 123R is effective for interim or annual periods beginning after June 15, 2005, and will thus be effective for our first quarter of fiscal 2006. Upon adoption, we intend to use the modified prospective transition method. Under this method, awards that are granted, modified, or settled after the date of adoption will be measured and accounted for in accordance with Statement 123R. Based upon our analysis of the requirements of SFAS No. 123R, our employee stock purchase plan will become a compensatory plan in fiscal 2006. However, due to current participation levels in the employee stock purchase plan and remaining levels of unvested stock option compensation expense, we do not believe that the adoption SFAS No. 123R will have a material impact upon our results of operations until we grant additional stock option awards or until participation in our employee stock purchase plan significantly increases. However, the transition to SFAS No. 123R will require us to reclassify our unamortized deferred compensation reported in the equity section of our balance sheet to additional paid-in capital.

For further information regarding our share-based compensation, refer to Note 3 to our consolidated financial statements.

Inventory Costs - In November 2004, the FASB approved Statement No. 151, Inventory Costs an Amendment of ARB No. 43, Chapter 4. Statement No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and requires that those items be recognized as a current period expense regardless of whether they meet the criteria of “so abnormal.” This statement also requires that allocation of fixed production overheads to the costs of conversion be based upon the normal capacity of the production facilities. This statement is effective for interim or annual periods beginning after June 15, 2005 and will thus be effective for our first quarter of fiscal 2006. We do not believe that the new accounting requirements of SFAS No. 151 will have a material impact on our financial statements.

Nonmonetary Exchange Transactions - In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement No. 153 amends APB Opinion No. 29, which is based upon the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged, by eliminating the exception to fair value accounting for nonmonetary exchanges of similar productive assets and replacing it with a general exception to fair value accounting for nonmonetary exchanges that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Statement No. 153 is effective for nonmonetary asset exchanges occurring in periods beginning after June 15, 2005. We do not believe that the requirements of this statement will have a material impact upon our financial statements.



The Company is registered in states in which we do business that have a sales tax and collects and remits sales or use tax on retail sales made through its stores and catalog sales. Compliance with environmental laws and regulations has not had a material effect on our operations.



Inflation has not had a material effect on our operations. However, future inflation may have an impact on the price of materials used in the production of planners and related products, including paper and leather materials. We may not be able to pass on such increased costs to our customers.



Certain written and oral statements made by the Company or our representatives in this report, other reports, filings with the Securities and Exchange Commission, press releases, conferences, Internet webcasts, or otherwise, are “forward-looking statements” within the meaning of the Private Securities Litigation reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain words such as “believe,” “anticipate,” “expect,” “estimate,” “project,” or words or phrases of similar meaning. Forward-looking statements are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. These risks and uncertainties are disclosed from time to time in reports filed by us with the SEC, including reports on Forms 8-K, 10-Q, and 10-K. Such risks and uncertainties include, but are not limited to, the matters discussed under “Business Environment and Risk” below. In addition, such risks and uncertainties may include unanticipated developments in any one or more of the following areas: unanticipated costs or capital expenditures; difficulties encountered by EDS in operating and maintaining our information systems and controls, including without limitation, the systems related to demand and supply planning, inventory control, and order fulfillment; delays or unanticipated outcomes relating to our strategic plans; dependence on existing products or services; the rate and consumer acceptance of new product introductions; competition; the number and nature of customers and their product orders, including changes in the timing or mix of product or training orders; pricing of our products and services and those of competitors; adverse publicity; and other factors which may adversely affect our business.

The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors may emerge and it is not possible for our management to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any single factor, or combination of factors, may cause actual results to differ materially from those contained in forward-looking statements. Given these risks and uncertainties, investors should not rely on forward-looking statements as a prediction of actual results.

The market price of our common stock has been and may remain volatile. In addition, the stock markets in general have experienced increased volatility. Factors such as quarter-to-quarter variations in revenues and earnings or losses and our failure to meet expectations could have a significant impact on the market price of our common stock. In addition, the price of our common stock can change for reasons unrelated to our performance. Due to our low market capitalization, the price of our common stock may also be affected by conditions such as a lack of analyst coverage and fewer potential investors.

Forward-looking statements are based on management’s expectations as of the date made, 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 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 and elsewhere in our filings with the SEC.
 
 
Market Risk of Financial Instruments

The Company is exposed to financial instrument market risk primarily through fluctuations in foreign currency exchange rates and interest rates. To manage risks associated with foreign currency exchange and interest rates, we make limited use of derivative financial instruments. Derivatives are financial instruments that derive their value from one or more underlying financial instruments. As a matter of policy, our derivative instruments are entered into for periods consistent with the related underlying exposures and do not constitute positions that are independent of those exposures. In addition, we do not enter into derivative contracts for trading or speculative purposes, nor are we party to any leveraged derivative instrument. The notional amounts of derivatives do not represent actual amounts exchanged by the parties to the instrument, and, thus, are not a measure of exposure to us through our use of derivatives. Additionally, we enter into derivative agreements only with highly rated counterparties and we do not expect to incur any losses resulting from non-performance by other parties.

Foreign Exchange Sensitivity - Due to the global nature of our operations, we are subject to risks associated with transactions that are denominated in currencies other than the United States dollar, as well as the effects of translating amounts denominated in foreign currencies to United States dollars as a normal part of the reporting process. The objective of our foreign currency risk management activities is to reduce foreign currency risk in the consolidated financial statements. In order to manage foreign currency risks, we make limited use of foreign currency forward contracts and other foreign currency related derivative instruments. Although we cannot eliminate all aspects of our foreign currency risk, we believe that our strategy, which includes the use of derivative instruments, can reduce the impacts of foreign currency related issues on our consolidated financial statements. The following is a description of our use of foreign currency derivative instruments.

Foreign Currency Forward Contracts - During the fiscal years ended August 31, 2005, 2004, and 2003, we utilized foreign currency forward contracts to manage the volatility of certain intercompany financing transactions and other transactions that are denominated in foreign currencies. Because these contracts do not meet specific hedge accounting requirements, gains and losses on these contracts, which expire on a quarterly basis, are recognized currently and are used to offset a portion of the gains or losses of the related accounts. The gains and losses on these contracts were recorded as a component of SG&A expense in our consolidated statements of operations and resulted in the following net losses for the periods indicated (in thousands):

YEAR ENDED AUGUST 31,
 
2005
 
2004
 
2003
 
                     
Losses on foreign exchange contracts
 
$
(437
)
$
(641
)
$
(501
)
Gains on foreign exchange contracts
   
127
   
227
   
38
 
Net losses on foreign exchange contracts
 
$
(310
)
$
(414
)
$
(463
)

At August 31, 2005, the fair value of these contracts, which was determined using the estimated amount at which contracts could be settled based upon forward market exchange rates, was insignificant. The notional amounts of our foreign currency sell contracts that did not qualify for hedge accounting were as follows at August 31, 2005 (in thousands):

 
Contract Description
 
Notional Amount in Foreign Currency
 
Notional Amount in U.S. Dollars
 
               
Japanese Yen
   
273,000
 
$
2,458
 
Australian Dollars
   
1,333
   
1,018
 
Mexican Pesos
   
9,400
   
846
 

Net Investment Hedges - During fiscal 2005 and 2004, we entered into foreign currency forward contracts that were designed to manage foreign currency risks related to the value of our net investment in directly-owned operations located in Canada, Japan, and the United Kingdom. These three offices comprise the majority of our net investment in foreign operations. These foreign currency forward instruments qualified for hedge accounting and corresponding gains and losses were recorded as a component of accumulated other comprehensive income in our consolidated balance sheet. During fiscal 2005 and 2004, we recognized the following net losses on our net investment hedging contracts (in thousands):

YEAR ENDED AUGUST 31,
 
2005
 
2004
 
               
Losses on net investment hedge contracts
 
$
(384
)
$
(337
)
Gains on net investment hedge contracts
   
66
   
130
 
Net losses on investment hedge contracts
 
$
(318
)
$
(207
)

As of August 31, 2005, we had settled our net investment hedge contracts and we had none outstanding. However, we may continue to utilize net investment hedge contracts in future periods as a component of our overall foreign currency risk strategy.

Interest Rate Sensitivity - The Company is exposed to fluctuations in U.S. interest rates primarily as a result of the cash and cash equivalents that we hold. Following the sale of our building in June 2005, our debt balances consist of the financing obligation from the sale of the corporate campus, one fixed-rate long-term mortgage, and one variable-rate mortgage on certain of our buildings and property. The financing obligation has a payment structure equivalent to a lease arrangement with an interest rate of 7.7 percent. Our fixed-rate debt has a 9.9 percent interest rate and was paid in full during September 2005 and our variable-rate mortgage has interest at the Canadian Prime Rate (5.5 percent at August 31, 2005) and requires payments through January 2015.

During the fiscal years ended August 31, 2005, 2004, and 2003, we were not party to any interest rate swap agreements or similar derivative instruments.
 
 
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.

We have experienced significant declines in sales and corresponding net losses in recent fiscal years and we may not be able to return to consistent profitability
 
Although our sales increased in fiscal 2005 compared to fiscal 2004, we have experienced significant sales declines in recent years. Our sales during fiscal 2005 were $283.5 million compared to $275.4 million in fiscal 2004 and $307.2 million in fiscal 2003. While our net income (before preferred dividends and recapitalization loss) has improved to $10.2 million in fiscal 2005, declining sales have also had a corresponding adverse impact upon our operating results during recent fiscal years and we have reported net losses totaling $10.2 million in fiscal 2004 and $45.3 million in fiscal 2003. We continue to implement initiatives designed to increase our sales and improve our operating results, and have recognized significant improvements in recent years, however, we cannot assure that we will return to consistently profitable operations.
 
In addition to declining sales, we have faced numerous challenges that have affected our operating results in recent years. Specifically, we have experienced, and may continue to experience the following:

 l
Declining traffic in our retail stores and consumer direct channel
 l
Increased risk of excess and obsolete inventories
 l
Operating expenses that, as a percentage of sales, have exceeded our desired business model
 l
Costs associated with exiting unprofitable retail stores


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:

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

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 revenue 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 2005 and 2004, 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.
 
We are unable to predict the exact amount of cost reductions required for us to generate increased cash flows from operations because we cannot accurately predict the amount of our future sales. Our future sales performance depends, in part, on future economic and market conditions, which are not within our control.

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:

 l
Restrictions on the movement of cash
 l
Burdens of complying with a wide variety of national and local laws
 l
The absence in some jurisdictions of effective laws to protect our intellectual property rights
 l
Political instability
 l
Currency exchange rate fluctuations
 l
Longer payment cycles
 l
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 operate in a highly competitive industry
 
The training and consulting industry is highly competitive with a relatively easy entry. Competitors continually introduce new programs and products that may compete directly with our offerings. Larger and better capitalized competitors may have enhanced 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.

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:

 l
Our clients’ perceptions of our ability to add value through our programs and products
 l
Competition
 l
General economic conditions
 l
Introduction of new programs or services by us or our competitors
 l
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:

 l
Seasonal trends, primarily as a result of scheduled training
 l
Our ability to forecast demand for our products and services and thereby maintain an appropriate headcount in our employee base
 l
Our ability to manage attrition
 
Our profitability is also a function of our ability to control costs and improve our efficiency in the delivery of our products and 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 such as the “4 Disciplines of Execution.” Additionally, we have invested in our existing programs in order to refresh these programs and keep them relevant in the marketplace, including the newly revised The 7 Habits of Highly Effective People curriculum. We expect that these new programs, combined with new product offerings, will contribute to future growth in our revenue. 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 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.