Edgar Filing: FRANKLIN COVEY CO

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended February 28, 2019

[ ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission file no. 1-11107

FRANKLIN COVEY CO.

(Exact name of registrant as specified in its charter)

Utah (State of incorporation)		87-0401551 (I.R.S. employer identification number)
2200 West Parkway Boulevard Salt Lake City, Utah (Address of principal executive offices)		84119-2099 (Zip Code)
Registrant’s telephone number, Including area code		(801) 817-1776

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 preceding 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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	Smaller reporting company	☒
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock as of the latest practicable date:

13,963,616 shares of Common Stock as of March 31, 2019

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per-share amounts)


	February 28,			August 31,
	2019			2018
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	13,108		$	10,153
Accounts receivable, less allowance for doubtful accounts of $4,185 and $3,555		50,591			71,914
Inventories		2,840			3,160
Income taxes receivable		-			179
Prepaid expenses and other current assets		12,879			14,757
Total current assets		79,418			100,163

Property and equipment, net		19,725			21,401
Intangible assets, net		50,146			51,934
Goodwill		24,220			24,220
Deferred income tax assets		5,652			3,222
Other long-term assets		11,015			12,935
	$	190,176		$	213,875

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of term notes payable	$	7,813		$	10,313
Current portion of financing obligation		2,211			2,092
Accounts payable		7,933			9,790
Income taxes payable		107			-
Deferred revenue		45,209			51,888
Accrued liabilities		16,074			20,761
Total current liabilities		79,347			94,844

Line of credit		8,376			11,337
Term notes payable, less current portion		1,875			2,500
Financing obligation, less current portion		17,844			18,983
Other liabilities		7,490			5,501
Deferred income tax liabilities		210			210
Total liabilities		115,142			133,375

Shareholders’ equity:
Common stock, $.05 par value; 40,000 shares authorized, 27,056 shares issued		1,353			1,353
Additional paid-in capital		212,960			211,280
Retained earnings		55,552			63,569
Accumulated other comprehensive income		470			341
Treasury stock at cost, 13,109 shares and 13,159 shares		(195,301	)		(196,043	)
Total shareholders’ equity		75,034			80,500
	$	190,176		$	213,875

See notes to condensed consolidated financial statements

FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND STATEMENTS OF COMPREHENSIVE LOSS

(in thousands, except per-share amounts)


	Quarter Ended						Two Quarters Ended
	February 28,			February 28,			February 28,			February 28,
	2019			2018			2019			2018
	(unaudited)						(unaudited)

Net sales	$	50,356		$	46,547		$	104,185		$	94,479
Cost of sales		14,990			13,803			32,037			28,867
Gross profit		35,366			32,744			72,148			65,612

Selling, general, and administrative		35,925			35,097			70,568			68,921
Depreciation		1,697			1,379			3,251			2,280
Amortization		1,300			1,395			2,538			2,791
Loss from operations		(3,556	)		(5,127	)		(4,209	)		(8,380	)

Interest income		9			25			22			59
Interest expense		(623	)		(692	)		(1,255	)		(1,240	)
Discount accretion on related party receivable		243			29			258			56
Loss before income taxes		(3,927	)		(5,765	)		(5,184	)		(9,505	)
Income tax benefit		410			3,025			310			4,373
Net loss	$	(3,517	)	$	(2,740	)	$	(4,874	)	$	(5,132	)

Net loss per share:
Basic and diluted	$	(0.25	)	$	(0.20	)	$	(0.35	)	$	(0.37	)

Weighted average number of common shares:
Basic and diluted		13,937			13,867			13,927			13,796


COMPREHENSIVE LOSS
Net loss	$	(3,517	)	$	(2,740	)	$	(4,874	)	$	(5,132	)
Foreign currency translation adjustments,
net of income tax benefit (provision)
of $(11), $(136), $0, and $(94)		438			429			129			352
Comprehensive loss	$	(3,079	)	$	(2,311	)	$	(4,745	)	$	(4,780	)

See notes to condensed consolidated financial statements

FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)


	Two Quarters Ended
	February 28,			February 28,
	2019			2018
	(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(4,874	)	$	(5,132	)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization		5,789			5,071
Amortization of capitalized curriculum costs		2,856			2,560
Stock-based compensation expense		1,989			1,736
Deferred income taxes		(1,402	)		(5,358	)
Change in fair value of contingent consideration liabilities		76			652
Changes in assets and liabilities, net of effect of acquired business:
Decrease in accounts receivable, net		21,197			17,911
Decrease (increase) in inventories		402			(157	)
Decrease in prepaid expenses and other assets		2,425			1,144
Decrease in accounts payable and accrued liabilities		(6,298	)		(2,310	)
Decrease in deferred revenue		(8,842	)		(5,388	)
Increase (decrease) in income taxes payable/receivable		214			(288	)
Decrease in other long-term liabilities		(182	)		(1,074	)
Net cash provided by operating activities		13,350			9,367

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment		(2,195	)		(4,288	)
Curriculum development costs		(1,256	)		(2,185	)
Acquisition of business, net of cash acquired		(32	)		(1,108	)
Net cash used for investing activities		(3,483	)		(7,581	)

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from line of credit borrowings		46,032			47,047
Payments on line of credit borrowings		(48,993	)		(41,505	)
Principal payments on term notes payable		(3,125	)		(3,125	)
Principal payments on financing obligation		(1,020	)		(910	)
Purchases of common stock for treasury		(12	)		(2,005	)
Payment of contingent consideration liabilities		(301	)		(44	)
Proceeds from sales of common stock held in treasury		444			348
Net cash used for financing activities		(6,975	)		(194	)
Effect of foreign currency exchange rates on cash and cash equivalents		63			244
Net increase in cash and cash equivalents		2,955			1,836
Cash and cash equivalents at the beginning of the period		10,153			8,924
Cash and cash equivalents at the end of the period	$	13,108		$	10,760

Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	831		$	1,156
Cash paid for interest		1,276			1,274

Non-cash investing and financing activities:
Purchases of property and equipment financed by accounts payable	$	369		$	233
Consideration for business acquisition from liabilities of acquiree		798			-

See notes to condensed consolidated financial statements

FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(in thousands and unaudited)


											Accumulated
	Common		Common		Additional						Other			Treasury			Treasury
	Stock		Stock		Paid-In			Retained			Comprehensive			Stock			Stock
	Shares		Amount		Capital			Earnings			Income			Shares			Amount

Balance at August 31, 2018		27,056	$	1,353	$	211,280		$	63,569		$	341			(13,159	)	$	(196,043	)
Issuance of common stock
from treasury						64									11			166
Purchase of treasury shares																		(7	)
Stock-based compensation						946
Cumulative translation
adjustments												(309	)
Cumulative effect of
accounting change									(3,143	)
Net loss									(1,357	)
Balance at November 30, 2018		27,056		1,353		212,290			59,069			32			(13,148	)		(195,884	)

Issuance of common stock
from treasury						53									11			162
Purchase of treasury shares																		(5	)
Stock-based compensation						1,043
Restricted stock award						(426	)								28			426
Cumulative translation
adjustments												438
Net loss									(3,517	)
Balance at February 28, 2019		27,056	$	1,353	$	212,960		$	55,552		$	470			(13,109	)	$	(195,301	)

See notes to condensed consolidated financial statements

FRANKLIN COVEY CO.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY – PRIOR FISCAL YEAR

(in thousands and unaudited)


											Accumulated
	Common		Common		Additional						Other			Treasury			Treasury
	Stock		Stock		Paid-In			Retained			Comprehensive			Stock			Stock
	Shares		Amount		Capital			Earnings			Income			Shares			Amount

Balance at August 31, 2017		27,056	$	1,353	$	212,484		$	69,456		$	667			(13,414	)	$	(198,895	)
Issuance of common stock
from treasury						(3,600	)								256			3,758
Purchase of treasury shares															(103	)		(1,968	)
Stock-based compensation						956
Cumulative translation
adjustments												(77	)
Net loss									(2,392	)
Balance at November 30, 2017		27,056		1,353		209,840			67,064			590			(13,261	)		(197,105	)

Issuance of common stock
from treasury						(264	)								61			456
Purchase of treasury shares															(2	)		(38	)
Stock-based compensation						779
Restricted stock award						(348	)								23			348
Cumulative translation
adjustments												429
Net loss									(2,740	)
Balance at February 28, 2018		27,056	$	1,353	$	210,007		$	64,324		$	1,019			(13,179	)	$	(196,339	)

See notes to condensed consolidated financial statements

FRANKLIN COVEY CO.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1 – BASIS OF PRESENTATION

General

Franklin Covey Co. (hereafter referred to as us, we, our, or the Company) is a global company focused on organizational performance improvement. Our mission is to “enable greatness in people and organizations everywhere,” and our global structure is designed to help individuals and organizations achieve sustained superior performance through changes in human behavior. We are fundamentally a content and solutions company, and we believe that our offerings and services create the connection between capabilities and results. Our expertise extends to seven crucial areas: Leadership, Execution, Productivity, Trust, Educational Improvement, Sales Performance, and Customer Loyalty. We believe that our clients are able to utilize our content to create cultures whose hallmarks are high-performing, collaborative individuals, led by effective, trust-building leaders who execute with excellence and deliver measurably improved results for all of their key stakeholders.

In the training and consulting marketplace, we believe there are three important characteristics that distinguish us from our competitors.

World Class Content – Our content is principle-centered and based on natural laws of human behavior and effectiveness. When our content is applied consistently in an organization, we believe the culture of that organization will change to enable the organization to achieve their own great purposes. Our content is designed to build new skillsets, establish new mindsets, and provide enabling toolsets to our clients.

Breadth and Scalability of Delivery Options – We have a wide range of content delivery options, including: subscription offerings, which includes the All Access Pass (available in multiple languages), The Leader in Me membership, and other subscription offerings; intellectual property licenses; on-site training; training led through certified facilitators; on-line learning; blended learning; and organization-wide transformational processes, including consulting and coaching.

Global Capability – We have sales professionals in the United States and Canada who serve clients in the private sector and in governmental organizations; wholly-owned subsidiaries in Australia, China, Japan, the United Kingdom and new subsidiaries in Germany, Switzerland, and Austria; and we contract with licensee partners who deliver our content and provide related services in over 150 other countries and territories around the world.

We are committed to, and measure ourselves by, our clients’ achievement of transformational results.

We have some of the best-known offerings in the training industry, including a suite of individual-effectiveness and leadership-development training content based on the best-selling books, The 7 Habits of Highly Effective People, The Speed of Trust, and The 4 Disciplines of Execution, and proprietary content in the areas of Execution, Sales Performance, Productivity, Educational Improvement, and Customer Loyalty. Our offerings are described in further detail at www.franklincovey.com. The information posted on our website is not incorporated into this report.

The accompanying unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position and results of operations of the Company as of the dates and for the periods indicated. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to Securities and Exchange Commission (SEC) rules and regulations. The information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and related notes included in our annual report on Form 10-K for the fiscal year ended August 31, 2018.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Our fiscal year ends on August 31 of each year and our fiscal quarters end on the last day of November, February, and May of each year.

The results of operations for the quarter and two quarters ended February 28, 2019 are not necessarily indicative of results expected for the entire fiscal year ending August 31, 2019, or for any future periods.

Accounting Pronouncements Issued and Adopted

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). This new standard was issued in conjunction with the International Accounting Standards Board (IASB) and is designed to create a single, principles-based process by which all businesses calculate revenue. The core principle of this standard is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. The new standard replaces numerous individual, industry-specific revenue rules found in generally accepted accounting principles in the United States. We adopted ASU No. 2014-09 on September 1, 2018 using the “modified retrospective” approach. Under this transition method, we applied the new standard to contracts that were not completed as of the adoption date and recognized a cumulative effect adjustment which reduced our retained earnings by $4.1 million ($3.1 million, net of tax) on September 1, 2018, which primarily consisted of initial licensing fees on international locations. The comparative prior period information has not been restated and continues to be presented according to accounting standards for revenue recognition in effect during the periods presented.

The primary impact of ASU No. 2014-09 on our revenue recognition policies is a change in the way we account for our initial license fee associated with licensing an international location. The Company previously recorded the non-refundable initial license fee from licensing an international location as revenue at the time the license period begins if all other revenue requirements had been met. However, under Topic 606, the Company will recognize revenue on the upfront fees over the duration of the contract.

Under Topic 606, we will account for the All Access Pass (AAP) as a single performance obligation and recognize the associated transaction price on a straight-line basis over the term of the underlying contract. This determination was reached after considering that our web-based functionality and content, in combination with our intellectual property, each represent inputs that transform into a combined output that represents the intended outcome of the AAP, which is to provide a continuously accessible, customized, and dynamic learning and development solution only accessible through the AAP platform.

We do not expect the accounting for fulfillment costs or costs incurred to obtain a contract to be materially affected in any period due to the adoption of ASU 2014-09. While we do not believe the adoption of ASU 2014-09 will materially impact our annual financial statements, the change in the timing of revenue recognition of certain contracts could result in significant quarter-to-quarter fluctuations in revenue. See Note 2 for further details regarding our revenue recognition accounting policies under Topic 606.

The cumulative after-tax effects of the changes made to our consolidated balance sheet from the adoption of Topic 606 were as follows (in thousands):


	August 31,		ASC 606			September 1,
	2018		Adjustments			2018
Assets:
Other current assets	$	10,893	$	109		$	11,002
Deferred income tax assets		3,222		1,005			4,227

Liabilities and Shareholders' Equity:
Deferred revenue		51,888		2,008			53,896
Other liabilities		5,501		2,249			7,750
Retained earnings		63,569		(3,143	)		60,426

The following line items in our condensed consolidated statement of operations were impacted by the adoption of the new standard for the quarter ended February 28, 2019 (in thousands, except per-share data):


	February 28,			February 28,
	2019			2019			Impact of
	As Reported			Without ASC 606			ASC 606
Revenue	$	50,356		$	49,895		$	461
Cost of sales		14,990			14,990			-
Selling, general, and administrative		35,925			35,914			11
Income tax benefit		410			517			(107	)
Net loss		(3,517	)		(3,860	)		343

Net loss per share:
Basic and diluted	$	(0.25	)	$	(0.28	)

The following line items in our condensed consolidated statements of operations were impacted by the adoption of Topic 606 for the two quarters ended February 28, 2019 (in thousands, except per-share data):


	Two Quarters			Two Quarters
	Ended February 28,			Ended February 28,
	2019			2019			Impact of
	As Reported			Without ASC 606			ASC 606
Revenue	$	104,185		$	102,653		$	1,532
Cost of sales		32,037			32,037			-
Selling, general, and administrative		70,568			70,486			82
Income tax benefit		310			652			(342	)
Net loss		(4,874	)		(5,982	)		1,108

Net loss per share:
Basic and diluted	$	(0.35	)	$	(0.43	)

Selected condensed consolidated balance sheet line items as of February 28, 2019, which were impacted by the adoption of the new standard, are as follows (in thousands):

	February 28,		February 28,
	2019		2019		Impact of
	As Reported		Without ASC 606		ASC 606
Assets:
Prepaid expenses and other current assets	$	12,879	$	12,853	$	26
Deferred income tax assets		5,652		4,989		663
Total assets		190,176		189,487		689

Liabilities and Shareholders' Equity:
Deferred revenue		45,209		44,262		947
Other liabilities		7,490		5,712		1,778
Retained earnings		55,552		57,588		(2,036	)
Total liabilities and shareholders' equity		190,176		189,487		689

The adoption of ASC Topic 606 did not have a material impact on our cash flows from operating, investing, or financing activities.

Accounting Pronouncements Issued Not Yet Adopted

On February 25, 2016, the FASB issued ASU No. 2016-02, Leases. The new lease accounting standard is the result of a collaborative effort with the IASB (similar to the new revenue standard described above), although some differences remain between the two standards. This new standard will affect all entities that lease assets and will require lessees to recognize a lease liability and a right-of-use asset for all leases (except for short-term leases that have a duration of less than one year) as of the date on which the lessor makes the underlying asset available to the lessee. For lessors, accounting for leases is substantially the same as in prior periods. For public companies, the new lease standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted for all entities. We expect to adopt the provisions of ASU 2016-02 on September 1, 2019, and we may elect to apply the new standard on a prospective basis. At February 28, 2019, our leases primarily consist of the lease on our corporate campus, which is accounted for as a financing obligation on our consolidated balance sheets and operating leases for office and warehousing space. We expect the adoption of this new standard will increase our reported assets and liabilities since we will record the lease obligation and a corresponding right of use asset on our balance sheet for leases that are currently accounted for as operating leases. However, as of February 28, 2019, we have not yet elected the transition method or determined the full impact that the adoption of ASU 2016-02 will have on our consolidated financial statements.

NOTE 2 – REVENUE RECOGNITION

We account for revenue in accordance with ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which was adopted on September 1, 2018 using the modified retrospective method (Note 1). We earn revenue from contracts with customers primarily through the delivery of our All Access Pass and The Leader in Me subscription offerings, through the delivery of training days and training course materials, and through the licensing of rights to sell our content into geographic locations where the Company does not maintain a direct office. We also earn revenues from leasing arrangements that are not accounted for under Topic 606. Returns and refunds are generally immaterial, and we do not have any significant warranty obligations.

Under Topic 606, we recognize revenue upon the transfer of control of promised products and services to customers in an amount equal to the consideration the Company expects to receive in exchange for those products or services. Although rare, if the consideration promised in a contract includes variable amounts, we evaluate the estimate of variable consideration to determine whether the estimate needs to be constrained. We include the variable consideration in the transaction price only to the extent that it is probable a significant reversal of the amount of cumulative revenue recognized will not occur.

We determine the amount of revenue to be recognized through application of the following steps:

·	Identification of the contract with a customer

·	Identification of the performance obligations in the contract

·	Determination of the transaction price

·	Allocation of the transaction price to the performance obligations in the contract

·	Recognition of revenue when the Company satisfies the performance obligations

Taxes assessed by a government authority that are collected from a customer are excluded from net revenue.

Subscription and Support Revenues

Subscription revenues primarily relate to the Company’s All Access Pass and The Leader in Me subscription offerings. We have determined that it is most appropriate to account for the AAP subscription as single performance obligation and recognize the associated transaction price ratably over the term of the underlying contract beginning on the commencement date of each contract, which is the date the Company’s platforms and resources are made available to the customer. This determination was reached after considering that our web-based functionality and content, in combination with our intellectual property, each represent inputs that transform into a combined output that represents the intended outcome of the AAP, which is to provide a continuously accessible, customized, and dynamic learning and development solution only accessible through the AAP platform.

We typically invoice our customers annually upon execution of the contract or subsequent renewals. Amounts that have been invoiced are recorded in accounts receivable and in unearned revenue or revenue, depending on whether transfer of control has occurred.

Training Days and Product Sales

We deliver Company-led training days from our offerings, such as The 7 Habits of Highly Effect People, at a customer’s location based upon a daily consultant rate and a set price for training materials. These revenues are recognized as the training days occur and the services are performed. Customers also have the option to purchase training materials and present our offerings through internal facilitators and not through the use of a Franklin Covey consultant. Revenue is recognized from these product sales when the materials are shipped. Shipping revenues associated with product sales are recorded in revenue with the corresponding shipping cost being recorded as a component of cost of sales.

Geographic Location License Rights

Our international strategy includes the use of licensees in countries where we do not have a wholly-owned direct office. Licensee companies are unrelated entities that have been granted a license to translate our content and offerings, adapt the content to the local culture, and sell our content in a specific country or region. Licensees are required to pay us royalties based upon a percentage of their sales to clients. We recognize royalty income each reporting period based upon the sales information reported to us from our licensees. When sales information is not received from a particular licensee at the end of a reporting period, the Company estimates the amount of royalties to be received for the period that is being reported based upon prior forecasts and historical performance. These estimated royalties are recorded as revenue and are adjusted, if necessary, in the subsequent period.

The primary impact of ASU No. 2014-09 on our financial statements is a change in the way we account for the initial license fee associated with licensing an international location. The Company previously recorded the non-refundable initial license fee from licensing an international location as revenue at the time the license period began if all other revenue requirements had been met. However, under Topic 606, we recognize revenue on the upfront fees over the term of the initial contract.

Contracts with Multiple Performance Obligations

We enter into contracts that often include multiple performance obligations. A performance obligation is a promise in a contract to transfer products or services that are distinct, or that are distinct within the context of the contract. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when the performance obligation is satisfied. Determining whether products and services meet the distinct criteria that should be accounted for separately or combined as one unit of accounting requires significant judgment.

When determining whether goods and services meet the distinct criteria we consider various factors for each agreement including the availability of the services and the nature of the offerings and services. We allocate the transaction price to each performance obligation on a relative standalone selling price (SSP) basis. Significant judgment is required to determine the SSP for each distinct performance obligation. The SSP is the price which the Company would sell a promised product or service separately to a customer. In determining the SSP, we consider the size and volume of transactions, the geographic location, price lists, historical sales, and contract prices. We may modify our pricing from time-to-time in the future, which could result in changes to the SSP.

Contract Balances

As described above, subscription revenue is generally recognized ratably over the term of the underlying contract beginning on the commencement date of each contract. The timing of when these contracts are invoiced, cash is collected, and revenue is recognized impacts our accounts receivable and deferred revenue accounts. We generally bill our clients in advance for subscription offerings or within the month that the training and products are delivered. As such, consideration

due to the Company for work performed is included in accounts receivable and we do not have a significant amount of contract assets. Our receivables are generally collected within 30 to 120 days but typically no longer than 12 months. Deferred revenue primarily consists of billings or payments received in advance of revenue being recognized from our subscription offerings. Furthermore, our clients, to expend funds in a particular budget cycle, may prepay for services or products which are also a component of our consolidated deferred revenue. Our deferred revenue totaled $48.4 million at February 28, 2019 and $52.9 million at August 31, 2018, of which $3.2 million and $1.0 million were classified as components of other long-term liabilities at February 28, 2019 and August 31, 2018, respectively. The amount of deferred revenue that was generated from subscription offerings totaled $39.6 million at February 28, 2019 and $48.4 million at August 31, 2018. During the quarter and two quarters ended February 28, 2019, we recognized $14.0 million and $30.1 million of previously deferred subscription revenue.

Remaining Performance Obligations

When possible, we enter into multi-year non-cancellable contracts which are invoiced either upon execution of the contract or at the beginning of each annual contract period. Topic 606 introduced the concept of remaining transaction price which represents contracted revenue that has not yet been recognized, including unearned revenue and unbilled amounts that will be recognized as revenue in future periods. Transaction price is influenced by factors such as seasonality, the average length of the contract term, and the ability of the Company to continue to enter multi-year non-cancellable contracts. At February 28, 2019 we had $64.5 million of remaining performance obligations, including the amount of deferred revenue related to our subscription offerings, of which approximately 75 percent will be recognized over the next 12 months.

Costs Capitalized to Obtain Contracts

We capitalize the incremental costs of obtaining non-cancellable subscription revenue, primarily from the All Access Pass and The Leader in Me subscription offerings. These incremental costs consist of sales commissions paid to our direct sales force and include the associated payroll taxes and fringe benefits. As the same commission rates are paid annually when the customer renews their contract, the capitalized commission costs are amortized ratably on an annual basis. At February 28, 2019 the Company has capitalized $6.2 million of direct sales force commissions, which are included as a component of other current assets on our condensed consolidated balance sheet. During the quarter and two quarters ended February 28, 2019, we capitalized $2.3 million and $3.8 million of costs to obtain revenue contracts and amortized $2.2 million and $4.8 million to selling, general, and administrative expense, respectively.

Refer to Note 9 (Segment Information) to these condensed consolidated financial statements for our disaggregated revenue information.

NOTE 3 – ACQUISITION OF GERMANY, SWITZERLAND, AND AUSTRIA LICENSEE

On December 5, 2018, we purchased all of the equity of Leadership Institut GmbH, a Munich, Germany based company with wholly owned subsidiary companies in Switzerland and Austria. Leadership Institut GmbH previously operated as an independent licensee that provided our training and products to Germany, Switzerland, and Austria (GSA). We intend to transition the GSA licensee operation to a directly owned office similar to the fiscal 2017 transition of the licensee operation in China. The purchase price was $0.2 million in cash, plus $0.8 million in forgiveness of liabilities owed to the Company from the pre-existing relationship at the purchase date. There is no contingent consideration obligations or other additional consideration associated with the purchase of the former GSA licensee. We accounted for the acquisition of Leadership Institut Gmbh as a business combination in the second quarter of fiscal 2019. We also expect to

incur additional costs for severance, legal, and other related acquisition expenses. These additional costs are expected to total approximately $0.8 million and will be expensed as incurred in selling, general, and administrative expense. The acquisition of the GSA licensee will provide us with the opportunity to operate a directly owned office in one of the world’s largest economic markets and is expected to provide significant future growth opportunities. The total purchase price consisted of the following (in thousands):


Cash paid at closing	$	159
Accounts receivable from GSA licensee		798
Total purchase price	$	957

The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows (in thousands):


Cash acquired	$	127
Accounts receivable, net		564
Inventories, net		80
Prepaid and other current assets		45
Intangible assets		741
Property and equipment		27
Other long-term assets		11
Assets acquired		1,595
Accounts payable		(208	)
Accrued liabilities		(383	)
Income taxes payable		(47	)
Liabilities assumed		(638	)
	$	957

The preliminary allocation of the purchase price to the intangible assets acquired was as follows (in thousands):


			Weighted Average
Description	Amount		Life
Reacquisition of license rights	$	360	3 years
Localized content		202	3 years
Customer relationships		179	3 years
	$	741

We have included the financial results of the former GSA licensee in our financial results since the date of acquisition. For the quarter ended February 28, 2019, the new direct office that serves the GSA region had $0.5 million of sales and a $0.2 million operating loss. During the second quarter of the prior year, we recognized $0.1 million of royalty revenue from the GSA licensee. For the twelve months ended August 31, 2018, the former GSA licensee had $3.3 million of sales and a $1.3 million pre-tax tax loss.

NOTE 4 – INVENTORIES

Inventories are stated at the lower of cost or net realizable value, cost being determined using the first-in, first-out method, and were comprised of the following (in thousands):


	February 28,		August 31,
	2019		2018
Finished goods	$	2,818	$	3,130
Raw materials		22		30
	$	2,840	$	3,160

NOTE 5 – FAIR VALUE OF FINANCIAL INSTRUMENTS

At February 28, 2019, the carrying value of our financial instruments approximated their fair values. The fair values of our contingent consideration liabilities from business acquisitions are considered “level 3” measurements because we use various estimates in the valuation models to project the timing and amount of future contingent payments. The valuation models described in our annual report on Form 10-K for the fiscal year ended August 31, 2018 were utilized during the current period (with updated estimates) to arrive at the estimated fair values of the contingent consideration liabilities on the reporting date. The fair value of the contingent consideration liabilities from the acquisitions of Robert Gregory Partners (RGP) and Jhana Education (Jhana) changed as follows during the two quarters ended February 28, 2019 (in thousands):


	Balance at		Change in					Balance at
	August 31, 2018		Fair Value		Payments			February 28, 2019
RGP Acquisition	$	606	$	9	$	-		$	615
Jhana Acquisition		3,942		67		(301	)		3,708
	$	4,548	$	76	$	(301	)	$	4,323

Approximately $1.0 million of the Jhana contingent consideration liability was recorded as a component of accrued liabilities on our condensed consolidated balance sheet at February 28, 2019. The remainder of our contingent consideration liabilities are classified as other long-term liabilities. Adjustments to the fair value of our contingent consideration liabilities are included in selling, general, and administrative expense in the accompanying condensed consolidated statements of operations.

NOTE 6 – STOCK-BASED COMPENSATION

The cost of our stock-based compensation plans is included in selling, general, and administrative expense in the accompanying condensed consolidated statements of operations. Our stock-based compensation expense was comprised of the following for the periods presented (in thousands):


	Quarter Ended				Two Quarters Ended
	February 28,		February 28,		February 28,		February 28,
	2019		2018		2019		2018
Long-term incentive awards	$	824	$	582	$	1,557	$	1,373
Restricted stock awards		175		160		350		292
Employee stock purchase plan		44		37		82		71
	$	1,043	$	779	$	1,989	$	1,736

During the quarter and two quarters ended February 28, 2019, we issued 39,803 shares and 50,932 shares of our common stock under various stock-based compensation arrangements. Our stock-based compensation plans allow shares to be withheld to cover statutory income taxes if so elected by the award recipient. During the quarter ended February 28, 2019, we withheld 241 shares of our common stock for statutory taxes on stock-based compensation arrangements. The following is a description of the developments in our stock-based compensation plans during the quarter and two quarters ended February 28, 2019.

Fiscal 2019 Restricted Stock Award

Our annual restricted stock award granted to non-employee members of the Board of Directors is administered under the terms of the 2019 Franklin Covey Co. Omnibus Incentive Plan, and is designed to provide our non-employee directors, who are not eligible to participate in our employee stock purchase plan, an opportunity to obtain an interest in the Company through the acquisition of shares of our common stock. The annual award is granted in January (following the annual shareholders’ meeting) of each year. For the fiscal 2019 award, each eligible director received a whole-share grant equal to $100,000 with a one-year vesting period. Our restricted stock award activity during the two quarters ended February 28, 2019 consisted of the following:


				Weighted-Average
				Grant Date
	Number of			Fair Value
	Shares			Per Share
Restricted stock awards at
August 31, 2018		23,338		$	30.00
Granted		28,525			24.54
Forfeited		-			-
Vested		(23,338	)		30.00
Restricted stock awards at
February 28, 2019		28,525		$	24.54

At February 28, 2019, there was $0.6 million of unrecognized compensation expense remaining on the fiscal 2019 Board of Director restricted share award.

Fiscal 2019 Time-Based Award

On January 25, 2019, the Organization and Compensation Committee (the Compensation Committee) of the Board of Directors approved a new incentive plan award for the Chief Executive Officer, Chief Financial Officer, and Chief People Officer that has a two-year time-based vesting (service) condition. A total of 11,915 shares were issued to the participants in connection with this award. The fair value of this award was calculated by multiplying the number of shares times the closing price of the Company’s common stock on the grant date, which was $24.54 per share. The fair value of this award totals $0.3 million, which will be expensed evenly over the two-year service period.

Fiscal 2019 Long-Term Incentive Plan Award

On October 1, 2018, the Compensation Committee of the Board of Directors granted a new long-term incentive plan (LTIP) award to our executive officers and members of senior management. The fiscal 2019 LTIP award is similar to the fiscal 2018 LTIP award and has three tranches, one of which has a time-based vesting condition and two of which have performance-based vesting conditions as described below:

Time-Based Award Shares – Twenty-five percent of the 2019 LTIP award shares vest to participants after three years of service. The total number of shares that may be earned by participants after three years of service is 36,470 shares. The number of shares awarded in this tranche is not variable and will not fluctuate based on financial measures.

Performance-Based Award Shares – The remaining two tranches of the 2019 LTIP award are based on fiscal 2021 qualified adjusted earnings before interest, taxes, depreciation, and amortization (Adjusted EBITDA) and fiscal 2021 subscription service sales, respectively. The number of shares that will vest to participants for these two tranches is variable and may be 50 percent of the award (minimum award threshold) up to 200 percent of the participant’s award (maximum threshold). The number of shares that may be earned for achieving 100 percent of the performance-based objectives (target award threshold) totals 109,409 shares. The maximum number of shares that may be awarded in connection with the performance-based tranches of the 2019 LTIP totals 218,818 shares.

The fiscal 2019 LTIP has a three-year life and expires on August 31, 2021.

Compensation expense recognized during the quarter and two quarters ended February 28, 2019, for long-term incentive plan awards in the table above includes expense related to awards granted in previous periods for which the performance conditions we believe are probable of being achieved.

Employee Stock Purchase Plan

We have an employee stock purchase plan (ESPP) that offers qualified employees the opportunity to purchase shares of our common stock at a price equal to 85 percent of the average fair market value of our common stock on the last trading day of each fiscal quarter. During the quarter and two quarters ended February 28, 2019, we issued 10,730 shares and 21,218 shares of our common stock to participants in the ESPP.

NOTE 7 – INCOME TAXES

The Tax Cut and Jobs Act (the 2017 Tax Act) was signed into law on December 22, 2017. The 2017 Tax Act significantly revises the U.S. corporate income tax code by, among other things, lowering the statutory corporate tax rate from 35 percent to 21 percent; eliminating certain deductions; imposing a mandatory one-time transition tax, or deemed repatriation tax, on accumulated earnings of foreign subsidiaries as of 2017 that were previously tax deferred; introducing new tax regimes; and changing how foreign earnings are subject to U.S. tax.

Since we have an August 31 fiscal year end, the lower corporate income tax rate was phased in, resulting in a U.S. statutory federal rate of 25.7 percent during fiscal 2018 and a 21 percent rate for fiscal 2019 and subsequent fiscal years. Other provisions of the 2017 Tax Act, which were not effective for us in fiscal 2018, are now effective for fiscal 2019 and future years, including limitations on the deductibility of interest and executive compensation as well as anti-deferral provisions on Global Intangible Low-Taxed Income (GILTI).

We recorded an income tax benefit of $0.3 million for the two quarters ended February 28, 2019 on a pre-tax loss of $5.2 million, resulting in an effective tax benefit rate of 6.0 percent. Our effective benefit rate was adversely affected by GILTI tax expense, non-deductible expenses, and effective foreign tax rates which are significantly higher than the U.S. statutory rate. We recorded GILTI tax expense totaling $0.3 million during the first two quarters of fiscal 2019, based on the earnings of our foreign subsidiaries. Net operating loss carryforwards prevented us from using foreign tax credits against this tax. Unlike regular foreign tax credits, we permanently forego any unused foreign tax credits applicable to GILTI.

NOTE 8 – LOSS PER SHARE

The following schedule shows the calculation of loss per share for the periods presented (in thousands, except per-share amounts).


	Quarter Ended						Two Quarters Ended
	February 28,			February 28,			February 28,			February 28,
	2019			2018			2019			2018
Numerator for basic and
diluted loss per share:
Net loss	$	(3,517	)	$	(2,740	)	$	(4,874	)	$	(5,132	)

Denominator for basic and
diluted loss per share:
Basic weighted average shares
outstanding		13,937			13,867			13,927			13,796
Effect of dilutive securities:
Stock options and other
stock-based awards		-			-			-			-
Diluted weighted average
shares outstanding		13,937			13,867			13,927			13,796

EPS Calculations:
Net loss per share:
Basic and diluted	$	(0.25	)	$	(0.20	)	$	(0.35	)	$	(0.37	)

Since we incurred a net loss for the quarter and two quarters ended February 28, 2019, no potentially dilutive securities are included in the calculations of diluted loss per share because such effect would be anti-dilutive. The number of dilutive stock options and other stock-based awards for the quarter ended February 28, 2019 would have been approximately 214,000 shares.

NOTE 9 – SEGMENT INFORMATION

Segment Information

Our sales are primarily comprised of training and consulting services. Our internal reporting and operating structure is currently organized around two divisions. The Enterprise Division, which consists of our Direct Office and International Licensee segments and the Education Division, which is comprised of our Education practice. Based on the applicable guidance, our operations are now comprised of three reportable segments and a corporate services group. The following is a brief description of our reportable segments:

Direct Offices – Our Direct Office segment has a depth of expertise in helping organizations solve problems that require changes in human behavior, including leadership, productivity, execution, trust, and sales performance. We have a variety of principle-based offerings that help build winning and profitable cultures. This segment includes our sales personnel that serve the United States and Canada; our international sales offices located in Japan, China, the United Kingdom, Australia, and our new offices in Germany, Switzerland, and Austria; our government services sales channel; and our public programs operations.

Education Practice – Centered around the principles found in The Leader in Me, the Education practice is dedicated to helping educational institutions build a culture that will produce great results. We believe these results are manifested by increases in student performance, improved school culture, decreased disciplinary issues, and increased teacher engagement and parental involvement. This segment includes our domestic and international Education practice operations, which are focused on sales to educational institutions such as elementary schools, high schools, and colleges and universities.

International Licensees – Our independently owned international licensees provide our offerings and services in countries where we do not have a directly-owned office. These licensee partners allow us to expand the reach of our services to large multinational organizations as well as smaller organizations in their countries. This segment’s results are primarily comprised of royalty revenues received from these licensees.

·	Corporate and Other – Our corporate and other information includes leasing operations, shipping and handling revenues, and certain corporate administrative expenses.

We determined that the Company’s chief operating decision maker is the Chief Executive Officer (CEO), and the primary measurement tool used in business unit performance analysis is Adjusted EBITDA, which may not be calculated as similarly titled amounts disclosed by other companies. Adjusted EBITDA is a non-GAAP financial measure. For reporting purposes, our consolidated Adjusted EBITDA may be calculated as our income or loss from operations excluding stock-based compensation, depreciation expense, amortization expense, and certain other charges such as adjustments for changes in the fair value of contingent liabilities from business acquisitions. The Company references this non-GAAP financial measure in its decision making because it provides supplemental information that facilitates consistent internal comparisons to the historical operating performance of prior periods and we believe it provides investors with greater transparency to evaluate operational activities and financial results.

Our operations are not capital intensive and we do not own any manufacturing facilities or equipment. Accordingly, we do not allocate assets to the reportable segments for analysis purposes. Interest expense and interest income are primarily generated at the corporate level and are not allocated. Income taxes are likewise calculated and paid on a corporate level (except for entities that operate in foreign jurisdictions) and are not allocated for analysis purposes.

We account for the following segment information on the same basis as the accompanying condensed consolidated financial statements (in thousands).

	Sales to
Quarter Ended	External				Adjusted
February 28, 2019	Customers		Gross Profit		EBITDA

Enterprise Division:
Direct offices	$	36,414	$	27,294	$	2,543
International licensees		2,906		2,221		1,218
		39,320		29,515		3,761
Education practice		9,698		5,429		(909	)
Corporate and eliminations		1,338		422		(1,888	)
Consolidated	$	50,356	$	35,366	$	964

Quarter Ended
February 28, 2018

Enterprise Division:
Direct offices	$	33,275	$	24,881	$	1,331
International licensees		3,046		2,364		1,162
		36,321		27,245		2,493
Education practice		9,007		5,163		(1,151	)
Corporate and eliminations		1,219		336		(2,010	)
Consolidated	$	46,547	$	32,744	$	(668	)

Two Quarters Ended
February 28, 2019

Enterprise Division:
Direct offices	$	74,885	$	54,364	$	6,183
International licensees		6,583		5,084		2,846
		81,468		59,448		9,029
Education practice		20,044		11,822		(1,174	)
Corporate and eliminations		2,673		878		(3,722	)
Consolidated	$	104,185	$	72,148	$	4,133

Two Quarters Ended
February 28, 2018

Enterprise Division:
Direct offices	$	67,471	$	49,442	$	3,723
International licensees		6,366		4,866		2,572
		73,837		54,308		6,295
Education practice		18,183		10,593		(1,993	)
Corporate and eliminations		2,459		711		(4,368	)
Consolidated	$	94,479	$	65,612	$	(66	)

A reconciliation of our consolidated Adjusted EBITDA to consolidated net loss is provided below (in thousands).


	Quarter Ended						Two Quarters Ended
	February 28,			February 28,			February 28,			February 28,
	2019			2018			2019			2018
Segment Adjusted EBITDA	$	2,852		$	1,342		$	7,855		$	4,302
Corporate expenses		(1,888	)		(2,010	)		(3,722	)		(4,368	)
Consolidated Adjusted EBITDA		964			(668	)		4,133			(66	)
Stock-based compensation expense		(1,043	)		(779	)		(1,989	)		(1,736	)
Increase in contingent consideration liabilities		(52	)		(477	)		(76	)		(652	)
Licensee transition costs		(428	)		-			(488	)		-
ERP system implementation costs		-			(429	)		-			(855	)
Depreciation		(1,697	)		(1,379	)		(3,251	)		(2,280	)
Amortization		(1,300	)		(1,395	)		(2,538	)		(2,791	)
Loss from operations		(3,556	)		(5,127	)		(4,209	)		(8,380	)
Interest income		9			25			22			59
Interest expense		(623	)		(692	)		(1,255	)		(1,240