10-K 1 form10k_112905.htm 2005 FORM 10K
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
 
 
 
PART I
 
PART II
 
 
 
 
 
 
 
         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
 
 
 
 
 
 
PART I

Item 1.
 
 
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)
 
 
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.
 
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.

 
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
  
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 Teens™ as a workshop or as a year-long curriculum to schools and school districts and other organizations working with youth. Based on The 7 Habits of Highly Effective Teens book, it helps to teach students and teachers studying skills, learning habits, and interpersonal development. In December 2001, we sold the stock of Premier Agendas, a wholly owned subsidiary that previously delivered our products and services to schools, to School Specialty. Pursuant to a license from FranklinCovey, Premier Agendas is expected to continue to expose over 20 million K-12 students to FranklinCovey’s world-renowned 7 Habits content. We retained the educator leadership and effectiveness training portion of Premier’s business.  
 
International Sales. We provide products, training and printing services internationally through Company-owned and licensed operations. We have Company-owned operations and offices in Australia, Brazil, Canada, Japan, Mexico and the United Kingdom. We also have licensed operations in Argentina, 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.
 
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.
 
 
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.
 
 
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.

 
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.

 
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.

 
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.


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.
 

 
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.
 
 
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.
 
 
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
 
 
 
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.
 
 
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