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Business Context and Reporting Period

Company: Franklin Covey Co.
Filing Type: Form 10-K (Annual Report)
Fiscal Year End: August 31, 2005
Business Overview: FranklinCovey provides integrated learning and performance solutions, including training, consulting, and productivity tools (e.g., The 7 Habits of Highly Effective People, FranklinCovey Planning System). The company operates through two segments: the Consumer and Small Business Unit (CSBU) and the Organizational Solutions Business Unit (OSBU). Operations are global, with direct offices in six countries and licensed operations in 67 countries.

Key Financial Metrics (Fiscal 2005)

Note: Financial data for 2004 and prior periods has been restated due to errors in deferred income tax calculations (see Material Changes).

Material Changes vs. Prior Period

• Revenue Growth: Total sales increased by $8.1 million (3%) to $283.5 million, marking the first year-over-year sales increase in several years. This was driven by an $18.1 million increase in training and consulting services, partially offset by a $10.0 million decline in product sales.
• Profitability Turnaround: The company returned to profitability, reporting operating income of $8.9 million compared to an operating loss of $9.1 million in 2004. Net income improved from a loss of $10.2 million to income of $10.2 million.
• Segment Performance:
  • OSBU: Sales increased 19% to $130.2 million, driven by growth in both domestic and international training.
  • CSBU: Sales decreased 8% to $153.4 million, primarily due to the closure of 30 underperforming retail stores and declining technology product sales.
• Restatement: The company restated prior period financials to correct inaccurate deferred tax calculations related to indefinite-lived intangibles. This adjustment increased the reported net loss for fiscal 2002 by $8.1 million and adjusted balance sheet liabilities for 2003 and 2004.
• Capital Structure: Completed a preferred stock recapitalization, recording a $7.8 million non-cash loss. Used proceeds from the sale of its corporate headquarters to redeem $30.0 million of preferred stock, reducing annual dividend obligations by $3.0 million.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management continues to focus on increasing sales, improving gross margins, and reducing operating costs to achieve consistently profitable operations. The company anticipates closing additional retail stores in fiscal 2006.
• Unusual Items:
  • Preferred Stock Recapitalization: A $7.8 million loss was recorded due to the revaluation of preferred stock and issuance of warrants.
  • Legal Settlement: Received $1.7 million in cash from a legal settlement against World Marketing Alliance, Inc., though the gain is deferred pending the resolution of an appeal.
  • Corporate Headquarters Sale: Sold and leased back the corporate campus for $33.8 million (net proceeds $32.4 million). Accounted for as a financing obligation rather than a sale due to sublease arrangements.
• Risks and Contingencies:
  • Internal Controls: Management identified a material weakness in internal controls over financial reporting related to income tax accounting, necessitating the restatement.
  • SEC Investigation: The company is cooperating with an SEC investigation regarding its management stock loan program and a withdrawn tender offer.
  • Intangible Assets: Significant intangible asset balances ($83.3 million) could be impaired if cash flows decline.
  • Outsourcing: Reliance on Electronic Data Systems (EDS) for warehousing, distribution, and IT services involves long-term contractual obligations totaling approximately $257 million.

Investor Verification Checklist

• Restatement Impact: Verify the specific adjustments made to deferred tax liabilities and retained earnings in the restated 2004 and 2003 balance sheets.
• Preferred Stock Redemption: Confirm the timeline and funding source for the remaining preferred stock redemptions, as the company seeks shareholder approval to extend the redemption period.
• Internal Control Remediation: Review the company's plan to remediate the material weakness in income tax accounting controls identified in Item 9A.
• Store Closure Strategy: Assess the impact of continued retail store closures on CSBU revenue and the associated exit costs.
• Management Stock Loans: Evaluate the collectibility of the management common stock loan program, which is accounted for as non-recourse stock compensation.
• EDS Contract: Review the terms of the long-term outsourcing agreement with EDS and the potential penalties for early termination.