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Franklin Covey Co. 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended May 27, 2006, and the three quarters ended May 27, 2006. Franklin Covey Co. provides integrated consulting, training, and performance enhancement solutions, including the "7 Habits of Highly Effective People" curriculum. The company operates through two primary segments: the Consumer and Small Business Unit (CSBU) and the Organizational Solutions Business Unit (OSBU).

Key Financial Metrics

Debt and Liquidity: Total long-term debt and financing obligations were $33.7 million as of May 27, 2006. Net working capital decreased to $39.8 million from $49.9 million at the end of the prior fiscal year.

Material Changes vs. Prior Period

• Revenue Decline: Total sales decreased 4% in Q3 and 2% YTD. Product sales declined 9% in Q3 due to fewer retail stores (93 open vs. 112 prior year) and reduced wholesale demand. Training and consulting services sales increased 2% in Q3, driven by international growth and "7 Habits" program sales.
• Profitability: Operating loss widened to $1.4 million in Q3 from $0.7 million in the prior year, primarily due to lower sales and increased costs for Symposium conference events. However, net income available to common shareholders improved significantly to $0.1 million from a $6.9 million loss in the prior year, largely due to reduced preferred stock dividends and the absence of a $7.8 million recapitalization loss recorded in the prior year.
• Cost Reductions: SG&A expenses decreased $0.5 million in Q3 due to retail store closures and cost-cutting initiatives. Depreciation expense dropped 39% due to the full depreciation or disposal of assets.
• Legal Settlement: The company recorded a $0.9 million gain from a legal settlement with World Marketing Alliance, Inc. in the YTD period, resolving a breach of contract case.

Guidance, Risks, and Unusual Items

• Internal Control Material Weakness: Management identified a material weakness in internal controls related to international operations. An investigation revealed intentional misstatements by the Mexico subsidiary regarding sales and expenses from fiscal 2002 through 2006. The company recorded a $0.5 million decrease in sales and a $0.5 million increase in SG&A to correct these errors in Q3. Personnel changes and enhanced oversight are being implemented.
• Preferred Stock Redemptions: The company redeemed $20.0 million of Series A preferred stock YTD, reducing annual dividend obligations by $5.0 million. Shareholders approved an extension of the redemption period to December 31, 2007.
• Stock Repurchases: The Board authorized a $10.0 million common stock repurchase plan. The company purchased 485,500 shares for $3.9 million YTD.
• Outlook: Management expects depreciation to continue declining. They anticipate that investments in sales personnel and new products will improve future performance, though benefits may not be realized in fiscal 2006. The company believes existing capital resources are adequate for the next 12 months.

Investor Verification Checklist

• Verify the status of remediation efforts regarding the material weakness in internal controls at the Mexico subsidiary.
• Monitor the impact of continued retail store closures on product sales and SG&A expenses.
• Track the progress of preferred stock redemptions and the resulting reduction in dividend obligations.
• Assess the effectiveness of new growth initiatives in the Organizational Solutions Business Unit (OSBU) to offset product sales declines.
• Review the company's ability to reverse valuation allowances on deferred income tax assets as taxable income increases.