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UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 

 

 

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Form 10-K 

 

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         Franklin Covey Co.          

(Exact name of registrant as specified in its charter) 

  

 

 

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: 

 

 

Securities registered pursuant to Section 12(g) of the Act: 

None 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No ☑ 

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐    No ☑ 

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 and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.  (Check one): 

Large accelerated filer

£

Accelerated filer

☑

Non-accelerated filer

£

(Do not check if a smaller reporting company)

Smaller reporting company

£

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 Yes ☐   No ☑

As of February 28, 2017, the aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant was approximately $171.7 million, which was based upon the closing price of $17.95 per share as reported by the New York Stock Exchange.

As of October 31, 2017, the Registrant had 13,702,759 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Registrant's Definitive Proxy Statement for the Annual Meeting of Shareholders, which is scheduled to be held on January 26, 2018, are incorporated by reference in Part III of this Form 10-K.

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ITEM 1. BUSINESS

General Information

Our fiscal year ends on August 31 of each year.  Unless otherwise noted, references to fiscal years apply to the 12 months ended August 31 of the specified year.

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.

Recent Business Developments

During fiscal 2016, we introduced the All Access Pass (AAP), which allows our clients unlimited access to our content through an electronic portal.  We believe the All Access Pass is a revolutionary and innovative way to deliver content to clients of various sizes, including large, multinational organizations.  Clients may utilize complete offerings such as The 7 Habits of Highly Effective People and The 5 Choices to Extraordinary Productivity, or use individual concepts from any of our well-known offerings to create a custom solution to fit their organizational or individual training needs.  During fiscal 2017, we invested significant capital to further develop the AAP offering and increase its usefulness to our clients.  We are currently translating AAP materials into 15 additional languages and completing significant upgrades of the AAP portal.  These enhancements to the AAP are expected to be launched in fiscal 2018.

·

New China Offices –On September 1, 2016 we opened three new sales offices in China.  These offices are located in Beijing, Shanghai, and Guangzhou.  Subsequent to August 31, 2017, we opened another sales office in Shenzhen, China.  Our sales operations in China were previously managed by an independent licensee partner.

·

Acquisition of Robert Gregory Partners – In May 2017, we acquired the assets of Robert Gregory Partners, LLC (RGP), a corporate coaching firm with expertise in executive coaching, transition acceleration coaching, leadership development coaching, implementation coaching, and consulting.  We anticipate that RGP services and methodologies will become key offerings in our training and consulting business.

·

Acquisition of Jhana Education – In July 2017, we acquired the stock of Jhana Education (Jhana), a company that specializes in the creation and dissemination of relevant, bite-sized content and learning tools for leaders and managers.  We anticipate that the Jhana content and delivery methodologies acquired will become key features of our AAP offering.

 

·

License Rights for Intellectual Property – During fiscal 2017, we acquired the license rights for certain intellectual property owned by Higher Moment, LLC.  The intellectual property is in part based on works authored and developed by Dr. Clayton Christensen, a well-known author and lecturer, who is a member of our Board of Directors.  As we seek to expand offerings available on the AAP, we anticipate additional purchases or licenses of intellectual property in future periods.

1.

World Class Content – Rather than rely on "flavor of the month" training fads, our content is principle-centered and based on natural laws of human behavior and effectiveness.  Our content is designed to build new skillsets, establish new mindsets, and provide enabling toolsets.  When our content is applied consistently in an organization, we believe the culture of that organization will change to enable the organization to achieve its own great purposes.  Our content is well researched, subjected to numerous field beta tests, and improved through a proven development process.

2.

Breadth and Scalability of Delivery Options – We have a wide range of content delivery options, including: the All Access Pass and other intellectual property licensing arrangements, on-site training, training led through certified facilitators, on-line learning, blended learning, and organization-wide transformational processes, including consulting and coaching.

3.

Global Capability – We not only operate domestically with sales personnel in the United States and Canada, but we also deliver content through our directly owned international offices and international licensee partners who deliver our content in over 150 other countries and territories around the world.  This capability allows us to deliver content to a wide range of customers, from large, multinational corporations to smaller, local entities.

We hold ourselves responsible for and measure ourselves by our clients' achievement of transformational results.

Our content and offerings are designed to help our clients achieve their own great purposes through a variety of resources, including best-selling books and audio, innovative and widely recognized thought leadership, and multiple delivery and teaching methods.  These elements allow us to offer our clients training and consulting solutions that are designed to improve individual and organizational behaviors, deliver content that adapts to an organization's unique needs, and provide meaningful improvements in our clients' business performance.  Further information about our content and services can be found on our website at www.franklincovey.com.  However, the information contained in, or that can be accessed through, our website does not constitute any part of this Annual Report.

Segment Information

·	Direct Offices – This segment consists of our sales force that serves the United States and Canada; our international sales offices located in Japan, China, the United Kingdom, and Australia; and our public programs group.

·	Strategic Markets – This segment includes our government services office, the Sales Performance practice, the Customer Loyalty practice, and the "Global 50" group, which is specifically focused on sales to large, multi-national organizations.

·	Education practice – This segment is comprised of our domestic and international Education practice operations, which are centered on sales to educational institutions such as elementary schools, high schools, and colleges and universities.

·	International Licensees – This segment is primarily comprised of our international licensees' royalty revenues.

Industry Information

According to the Training magazine 2017 Training Industry Survey, the total size of the U.S. training industry is estimated to be $93.7 billion, which is a significant increase (32%) compared with the prior year.  One of our competitive advantages in this highly fragmented industry stems from our fully integrated principle-centered training offerings, measurement methodologies, and implementation tools to help organizations and individuals measurably improve their effectiveness.  This advantage allows us to deliver not only training to both corporations and individuals, but also to implement the training through the use of powerful behavior-changing tools with the capability to then measure the impact of the delivered content and solutions.

Clients

We have a relatively broad base of clients, which includes thousands of organizational, governmental, educational, and individual clients in both the United States and in other countries that are served through our directly owned operations.  We have thousands of additional organizational clients throughout the world, which are served through our global licensee partner network, and we believe that our content, in all its forms, delivers results that encourage strong client loyalty.  We are not dependent on a single client or industry group, and during the periods presented in this report, none of our clients were responsible for more than ten percent of our consolidated revenues.

Over our history, we have provided content, services, and products to 97 of the Fortune 100 companies and more than 75 percent of the Fortune 500 companies.  We also provide content and services to a number of U.S. and foreign governmental agencies, as well as numerous educational institutions.  Due to the nature of our business, we do not have a significant backlog of orders.  Nearly all of our deferred revenue is attributable to subscription services for which we recognize revenue over the lives of the corresponding agreements.

Competition

We operate in a highly competitive and rapidly changing global marketplace and compete with a variety of organizations that offer services comparable with those that we offer.  The nature of the competition in the performance improvement industry, however, is highly fragmented with few large competitors.  Based upon our fiscal 2017 consolidated sales of $185.3 million, we believe that we are a leading competitor in the performance skills and education market.  Other significant comparative companies in the performance improvement market are Development Dimensions International, CRA International, Inc., Learning Tree International Inc., GP Strategies Corp., FTI Consulting, Inc., American Management Association, Wilson Learning, Forum Corporation, The Hackett Group, and the Center for Creative Leadership.

We believe that the principal competitive factors in the industry in which we compete include the following:

·	Quality of offerings, services, and solutions

·	Skills and capabilities of people

·	Innovative training and consulting services combined with effective products

·	Ability to add value to client operations

·	Reputation and client references

·

Price

·	Availability of appropriate resources

·	Global reach and scale

·	Branding and name recognition in our marketplace

Given the relative ease of entry into the training market, the number of our competitors could increase, many of whom may imitate existing methods of distribution, or could offer similar content and programs at lower prices.  However, we believe that we have several areas of competitive differentiation in our industry.  We believe that our competitive advantages include: (1) the quality of our content, as indicated by our strong gross margins, branded content, and best-selling books; (2) the breadth of delivery options we are able to offer to customers for utilizing our content, including the All Access Pass, live presentations by our own training consultants, live presentations though Company certified client-employed facilitators, intellectual property licensing, web-based presentations, and film-based presentations; (3) our global reach, which allows truly multinational clients to scale our content uniformly across the globe, through our mix of direct offices and our global licensee network; and (4) the significant impact which our offerings can have on our clients' results.  Moreover, we believe that we are a market leader in the U.S. in leadership, execution, productivity, and individual effectiveness content.

Seasonality

Our fourth quarter of each fiscal year typically has higher sales and operating income than other fiscal quarters primarily due to increased revenues in our Education practice (when school administrators and faculty have professional development days) and to increased sales that typically occur during that quarter resulting from year-end incentive programs.  Overall, training sales are moderately seasonal because of the timing of corporate training, which is not typically scheduled as heavily during holiday and certain vacation periods.

We believe that the recognition of deferred revenue from All Access Pass sales over the lives of the underlying arrangements will reduce some of the seasonality in our financial statements as described above.  However, the underlying sales activity as described above will continue to produce some measure of seasonality in our financial statements in future periods.

Manufacturing and Distribution

We do not manufacture any of our products.  We purchase our training materials and related products from various vendors and suppliers located both domestically and internationally, and we are not dependent upon any one vendor for the production of our training and related materials as the raw materials for these products are readily available.  We currently believe that we have good relationships with our suppliers and contractors.  Our materials are primarily warehoused and distributed from an independent warehouse facility located in Des Moines, Iowa.

Trademarks, Copyrights, and Intellectual Property

Our success has resulted in part from our proprietary content, methodologies, and other intellectual property rights.  We seek to protect our intellectual property through a combination of trademarks, copyrights, and confidentiality agreements.  We claim rights for over 580 trademarks in the United States and foreign countries, and we have obtained registration in the United States and numerous foreign countries for many of our trademarks including FranklinCovey, The 7 Habits of Highly Effective People, The 4 Disciplines of Execution, and The 7 Habits.  We consider our trademarks and other proprietary rights to be important and material to our business.

We claim over 200 registered copyrights, and own sole or joint copyrights on our books, manuals, text and other printed information provided in our training programs, and other electronic media

 

products, including audio and video media.  We may license, rather than sell, facilitator workbooks and other seminar and training materials in order to protect our intellectual property rights therein.  We place trademark and copyright notices on our instructional, marketing, and advertising materials.  In order to maintain the proprietary nature of our product information, we enter into written confidentiality agreements with certain executives, product developers, sales professionals, training consultants, other employees, and licensees.

Employees

One of our most important assets is our people.  The diverse and global makeup of our workforce allows us to serve a variety of clients on a worldwide basis.  We are committed to attracting, developing, and retaining quality personnel and actively strive to reinforce our employees' commitment to our clients, and to our mission, vision, culture, and values through the creation of a motivational and rewarding work environment.

We currently have approximately 850 associates.  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 and grow our business.

Executive Officers

The executive officers of Franklin Covey Co. at August 31, 2017, were as follows:

Scott J. Miller, 49, was appointed as Executive Vice-President of Business Development and Marketing in March 2012.  Mr. Miller, who has been with Franklin Covey for nearly 19 years, previously served as Vice-President of Business Development and Marketing.  Mr. Miller's role as an Executive Vice-President caps 12 years on our front line, working with thousands of client facilitators across many markets and countries.  Prior to his appointment as Vice-President of Business Development and Marketing, Mr. Miller served as the general manager of our central regional sales office for six years.  Scott originally joined the Covey Leadership Center in 1996 as a client partner with the Education division.  Mr. Miller started his professional career with the Disney Development Company, the real estate development division of the Walt Disney Company, in 1992.  During his time with the Disney Development Company, Scott identified trends and industry best practices in community development, education, healthcare, architectural design, and technology.  Mr. Miller received a Bachelor of Arts in Organizational Communication from Rollins College in 1996.

Shawn D. Moon, 50, was the Executive Vice-President of Strategic Markets, where he was responsible for the Company's Government Sales, Sales Performance Practice, Customer Loyalty Practice, and Global 50 team.  Mr. Moon has been an Executive Officer since July 2010 and served previously as our Executive Vice-President of Global Sales and Delivery.  Mr. Moon has more than twenty-nine years of experience in sales and marketing, program development, and consulting services.  From November 2002 to June 2005, Shawn was a Principal with Mellon Financial Corporation where he was responsible for business development for their human resources outsourcing services.  Shawn also coordinated activities within the consulting and advisory community for Mellon Human Resources and Investor Solutions.  Prior to November 2002, he served as the Vice President of Business Development for our Training Process Outsourcing Group, managed vertical market sales for nine of our business units, and managed our eastern regional sales office.  Shawn received a Bachelor of Arts from Brigham Young University in English Literature and he is the author of the books, The Ultimate Competitive Advantage: Why Your People Make All the Difference and the 6 Practices You Need to Engage Them; and Talent Unleashed: Three Leadership Conversations for Tapping the Unlimited Potential of People.

 

In September 2017, Mr. Shawn D. Moon left his full-time role with the Company.  Mr. Moon will continue to be involved with the Company on a part-time consulting basis in connection with the implementation of certain key initiatives, including speaking at key thought leadership events, helping to launch new books, and other activities.

Paul S. Walker, 42, is a 17-year veteran of Franklin Covey Co.  On September 1, 2015, Mr. Walker was appointed Executive Vice-President of Global Sales and Delivery.  Mr. Walker began his career with Franklin Covey in 2000 in the role of business developer, was promoted to a Client Partner, and then to an Area Director.  In 2007, Mr. Walker became General Manager of the Company's central sales region, an 11-state area that also included Ontario, Canada.  Prior to working for Franklin Covey, Mr. Walker was a senior sales partner for Alexander's Digital Printing and a middle-market pilot coordinator with New York Life.  Mr. Walker graduated from Brigham Young University with a Bachelor of Arts in Communications.

Robert A. Whitman, 64, has served as Chairman of the Board of Directors since June 1999 and as President and Chief Executive Officer of the Company since January 2000.  Mr. Whitman previously served as a director of the Covey Leadership Center from 1994 to 1997.  Prior to joining us, Mr. Whitman served as President and Co‑Chief Executive Officer of The Hampstead Group from 1992 to 2000 and is a founding partner at Whitman Peterson.  Mr. Whitman received his Bachelor of Arts degree in Finance from the University of Utah and his MBA from the Harvard Business School.

Stephen D. Young, 64, joined FranklinCovey as Executive Vice President of Finance, was appointed Chief Accounting Officer and Controller in January 2001, Chief Financial Officer in November 2002, and Corporate Secretary in March 2005.  Prior to joining us, he served as Senior Vice-President of Finance, Chief Financial Officer, and director of international operations for Weider Nutrition for seven years; as Vice-President of Finance at First Health for ten years; and as an auditor at Fox and Company, a public accounting firm, for four years.  Mr. Young has more than 35 years of accounting and management experience and is a Certified Public Accountant.  Mr. Young was awarded a Bachelor of Science in Accounting from Brigham Young University.

 

Available Information

We regularly file reports with the 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 100 F Street, NE, 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, proxy and information statements, and other information that the Company files with the SEC 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 is reasonably practicable after we file or furnish these reports with the SEC.

 

 

 

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 we, us, our, the Company, and FranklinCovey) and subsidiaries.  This discussion and analysis should be read together with the accompanying consolidated financial statements and related notes contained in Item 8 of this Annual Report on Form 10-K (Form 10-K) and the Risk Factors discussed in Item 1A of this Form 10-K.  Forward-looking statements in this discussion are qualified by the cautionary statement under the heading "Safe Harbor Statement Under The Private Securities Litigation Reform Act Of 1995" contained later in Item 7 of this Form 10-K.

EXECUTIVE SUMMARY

General Overview

Franklin Covey Co. is a global company focused on individual and organizational performance improvement.  Our mission is to "enable greatness in people and organizations everywhere," and our worldwide resources are organized to help individuals and organizations achieve sustained superior performance through changes in human behavior.  We believe that our content and services create the connection between capabilities and results. Our expertise and offerings extend to seven crucial areas:  Leadership, Execution, Productivity, Trust, Sales Performance, Customer Loyalty, and Educational Improvement.  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 four important characteristics that distinguish us from our competitors.

1.

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.

2.

Transformational Impact and Reach – We hold ourselves responsible for and measure ourselves by our clients' achievement of transformational results.  Our commitment to achieving lasting impact extends to all of our clients—from CEOs to elementary school students, and from senior management to front-line workers in corporations, governmental, and educational environments.

3.

Breadth and Scalability of Delivery Options – We have a wide range of content delivery options, including: the All Access Pass and other 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.

4.

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, and the United Kingdom; and we contract with independent licensee partners who deliver our content and provide services in over 150 other countries and territories around the world.

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, Customer Loyalty, and Education.  We believe that our content helps individuals, teams, and entire organizations transform their results through achieving systematic, sustainable, and measurable changes in human behavior.  Our offerings are described in further detail at www.franklincovey.com.  The information contained in, or that can be accessed through, our website does not constitute a part of this annual report, and the descriptions found therein should not be viewed as a warranty or guarantee of results.

Our fiscal year ends on August 31, and unless otherwise indicated, fiscal 2017, fiscal 2016, and fiscal 2015 refer to the twelve-month periods ended August 31, 2017, 2016, 2015, and so forth.

Fiscal 2017 Business Development

Development of the All Access Pass

During mid-2016, we introduced the All Access Pass (AAP), which allows our clients unlimited access to our intellectual property through an electronic portal.  We believe the All Access Pass is a revolutionary and innovative way to deliver content to clients of various sizes, from large, multinational entities to smaller organizations that are seeking to improve their culture and results.  The All Access Pass allows our clients to: purchase unlimited access to our collection of best-in-class content to address their most important performance needs; assemble, integrate, and deliver that content through any of a broad combination of delivery modalities; have the help of our implementation specialists to design customized impact journeys; and do so at a very attractive price per person trained.  Clients may utilize complete offerings such as The 7 Habits of Highly Effective People and The 5 Choices to Extraordinary Productivity, or use individual concepts from any of our well-known offerings to create a custom solution to fit their organizational or individual training needs.  During fiscal 2017, we invested significant capital to further develop the AAP offering and increase its functionality and usefulness to our clients.  We are currently translating AAP materials into 15 languages and completing significant upgrades of the AAP portal.  These enhancements to the All Access Pass are expected to be launched in mid-fiscal 2018.

While we anticipated that the introduction of the AAP would be disruptive to our current business, especially during the transition to this new business model, we believe that the AAP will provide long-term benefits to our clients and to our financial results.  During the first quarter of fiscal 2017, we decided to allow new AAP agreements to receive updated content throughout the contracted period.  As a result of this decision, we are required to defer substantially all All Access Pass revenues at the inception of the arrangements and recognize the revenue over the lives of the corresponding contracts.  This decision had a significant impact on our fiscal 2017 financial statements, especially reported revenue, as we deferred significant AAP contract revenues.  However, we anticipate that the recognition of deferred AAP sales will benefit future periods and reduce seasonal revenue fluctuations.

Business Acquisitions

In May 2017, we acquired the assets of Robert Gregory Partners, LLC (RGP), a corporate coaching firm with expertise in executive coaching, transition acceleration coaching, leadership development coaching, implementation coaching, and consulting.  We recognized $1.2 million of sales from RGP in fiscal 2017, and we anticipate that RGP services and methodologies will become key offerings in our training and consulting business in future periods.

In July 2017, we acquired the stock of Jhana Education (Jhana), a company that specializes in the creation and dissemination of relevant, bite-sized content and learning tools for leaders and managers.  While our fiscal 2017 sales were not significantly impacted by the Jhana acquisition, we anticipate that the acquired Jhana content and delivery methodologies will become key features of our AAP offering.

 

New China Direct Offices

On September 1, 2016 we opened three new sales offices in China.  These offices are located in Beijing, Shanghai, and Guangzhou.  During fiscal 2017, we recognized $11.0 million in sales from these new offices and we expect to see growth in fiscal 2018 and beyond as we develop our business in the China marketplace.  Subsequent to August 31, 2017, we opened another sales office in Shenzhen, China.  Prior to fiscal 2017, our sales operations in China were managed by an independent licensee partner.

Acquisition of Intellectual Property License Rights

During fiscal 2017, we acquired the license rights for certain intellectual property owned by Higher Moment, LLC.  The intellectual property is in part based on works authored and developed by Dr. Clayton Christensen, a well-known author and lecturer, who is a member of our Board of Directors.  As we seek to expand the content and offerings available on the All Access Pass, we anticipate additional purchases of intellectual property licenses in future periods.

The following is a description of the impact that these developments had on our financial results for the fiscal year ended August 31, 2017.

Financial Overview

As previously mentioned, the decision to allow new AAP contracts to receive updated content over the lives of the arrangements had a significant impact on our fiscal 2017 financial results as we were required to defer substantially all AAP revenues at the inception of the contracts and recognize the revenue over the lives of the arrangements.  This change resulted in less recognized sales during fiscal 2017 compared with fiscal 2016 and increased deferred revenue on our balance sheet.  Since its introduction in the first quarter of fiscal 2016, AAP and AAP add-on amounts invoiced have grown steadily on a year-over-year basis, from $23.2 million in fiscal 2016 to $63.1 million in fiscal 2017, including unbilled deferred revenue from multi-year contracts as described below.  At times we may invoice our clients in advance of the renewal service period, and depending upon the timing of AAP expansions and upgrades, renewal invoices may occur in a different quarter than the original invoice.  We believe that the transition to the All Access Pass will provide significant future benefits to us as the average client sales size is expected to increase, the retention rate of our clients improves, the ability to reach additional customers expands, and clients realize greater value to their organizations through access to expanded content and purchase additional services and training materials.

However, the change to the AAP-focused business model has required a significant transition both operationally, as our sales force adapts its sales strategy, and from an accounting and reporting point of view.  Operationally, the AAP sales cycle is typically longer than previous transactional type sales for revenues such as facilitator and onsite contracts.  We believe this change reflects the strategic nature of the AAP sale and the need for additional approvals at our clients.  During fiscal 2017, we also restructured our sales force in the United States and Canada into teams that are designed to focus on the sale and support of AAP arrangements.

We believe that fiscal 2018 will provide an inflection point in our financial operations when compared with fiscal 2017 results.  As we recognize previously deferred AAP sales, continue to realize a similar dollar value of AAP renewals, and attract new clients, we believe that our financial results will improve over fiscal 2017 results.  During the fourth quarter of fiscal 2017, we also introduced the opportunity for clients to purchase multi-year AAP contracts.  At August 31, 2017 we had $16.5 million of unbilled deferred revenue, which represents business that is contracted but unbilled and excluded from our balance sheet.  We believe that multi-year contractual arrangements will provide value to our clients and a more predictable revenue stream for the Company.

Including the factors noted above, our net sales in fiscal 2017 were $185.3 million compared with $200.1 million in fiscal 2016, and $209.9 million in fiscal 2015.  Deferred revenues on our balance sheet increased $20.7 million from August 31, 2016, to a total of $41.5 million at August 31, 2017.  Our fiscal 2017 fourth-quarter sales remained strong and totaled $59.5 million, which excludes a significant deferral of invoiced AAP contracts and multi-year contracts as described above.  The following table sets forth consolidated sales data by category and by our primary delivery channels (in thousands):

Our gross profit in fiscal 2017 totaled $122.7 million, compared with $135.2 million in the prior year.  The decrease in gross profit was primarily due to sales activity as described above, and our decision to exit the publishing business in Japan during the third quarter of fiscal 2017.  Our gross margin, which is gross profit as a percent of sales, was 66.2 percent compared with 67.6 percent in fiscal 2016.  Excluding the impact of the charge to exit the Japan publishing business, which totaled $2.1 million, our gross margin was 67.4 percent for the fiscal year ended August 31, 2017.

Our operating expenses increased $10.2 million compared with fiscal 2016, primarily due to a $7.6 million increase in selling, general, and administrative (SG&A) expenses; $1.5 million of contract termination costs; $0.7 million of increased restructuring costs; and $0.5 million of increased depreciation and amortization expense.  The increase in SG&A expenses was primarily related to opening three new sales offices in China; the addition of new sales and sales support personnel and increased travel to promote the AAP and new China offices; increased computer software costs primarily related the installation of a new enterprise resource planning (ERP) system; and increased non-cash stock-based compensation expense.  These increases were partially offset by a $1.9 million decrease in contingent consideration costs resulting from a prior period business acquisition.

As a result of the factors noted above, our loss from operations in fiscal 2017 was $(8.9) million, compared with income of $13.8 million in the prior year.  Pre-tax loss for fiscal 2017 was $(10.9) million compared with pre-tax income of $11.9 million in fiscal 2016.  Our effective income tax benefit rate was approximately 34 percent in fiscal 2017 compared with an income tax rate of approximately 41 percent in fiscal 2016.  Our income tax benefit was $3.7 million in fiscal 2017 compared with an income tax provision of $4.9 million in fiscal 2016.  Net loss for fiscal 2017 was $(7.2) million in fiscal 2017, or $(.52) per share, compared with $7.0 million of net income, or $.47 per diluted share, in fiscal 2016.

Further details regarding these items can be found in the comparative analysis of fiscal 2017 with fiscal 2016 as discussed within this management's discussion and analysis.

During fiscal 2017, we invested our available cash and proceeds from our secured credit facility to make substantial and significant investments in our business that we believe will drive results and provide benefits in future periods.  We invested $7.3 million of cash to acquire RGP and Jhana during the last half of fiscal 2017; we used $7.2 million of cash to purchase property and equipment, which was primarily comprised of software for our new ERP system and a significant upgrade to our AAP portal; and we invested $6.5 million in new curriculum development, including the translation of AAP content into 15 languages.  We currently anticipate that the new ERP system and upgraded AAP portal will be completed and placed into service in fiscal 2018.

 

Our liquidity position remained healthy during fiscal 2017 and we had $8.9 million of cash and cash equivalents at August 31, 2017, with $25.6 million of remaining credit available on our revolving credit facility, compared with $10.5 million of cash at August 31, 2016.  During fiscal 2017 we also converted $10.0 million of borrowings on our revolving credit facility into term loans.  At August 31, 2017, we had $19.1 million payable on term loans to the lender on our secured credit facility.

Our primary source of cash is our ongoing business operations.  Historically, we have funded our operations, business acquisitions, capital purchases, curriculum development, and share repurchases from our operating activities and from our long-term revolving line of credit facility.  Our positive cash flows over the past three years have enabled us to repurchase $63.4 million of our common stock since September 1, 2014, including a $35.0 million tender offer that was completed in January 2016.  We anticipate that cash flows from our operating activities, proceeds from our line of credit facility, and term-loan borrowing will be sufficient to support our operations for the foreseeable future.  For further information regarding our cash flows and liquidity refer to the Liquidity and Capital Resources discussion found later in this management's discussion and analysis.

Key Growth Objectives

We believe that our best-in-class content, combined with flexible delivery modalities and worldwide sales and distribution capabilities are the foundation for future growth at Franklin Covey.  Building on this foundation, we have identified the following key drivers of growth in fiscal 2018 and beyond:

·

New All Access Pass Sales and the Renewal of Existing Client Contracts – We are focused on sales of AAP contracts and have restructured our domestic sales force and sales support functions to more effectively sell and support the AAP.  We believe we are well positioned to expand sales of the All Access Pass in the United States and Canada and reach new clients.  The fiscal 2017 acquisition of Jhana Education is expected to attract new clients through its delivery of content in bite-sized modules.  We are currently in the process of translating AAP content into 15 new languages and expect to release the content and a new improved AAP portal in fiscal 2018.  These additional languages will allow us to launch the AAP at our offices in Japan and China, as well as with many of our licensee partners.

·

Education Segment Sales – Our Education segment has consistently grown over the past several years.  We intend to continue to invest in new content and additional sales personnel to reach out to new schools and retain existing schools.  We believe there are significant growth opportunities, both domestically and internationally, for our Education segment and its well-known The Leader in Me offering.

·

Growth of our Direct Office and International Licensee Channels – We are actively focused on growing the size and productivity of our direct office channel through expansion of our sales force to reach potential clients.  We believe that the structural changes made in fiscal 2017 will help us improve sales and lower costs in future periods.  In addition, we believe the acquisition of Robert Gregory Partners, LLC in fiscal 2017 will open new opportunities as we seek to expand our coaching business.  We are also actively seeking to expand the size and productivity of our international licensee partners through the development of additional content, such as the translated AAP offerings, and additional licensee support activities.

Another of our underlying strategic objectives is to consistently deliver quality results to our clients.  This concept is focused on ensuring that our content and offerings are best-in-class, and that they have a measurable, lasting impact on our clients' results.  We believe that measurable improvement in our clients' organizations is key to retaining current clients and to obtaining new sales opportunities.

 

Other key factors that influence our operating results include: the size and productivity of our sales force; the number and productivity of our international licensee operations; the number of organizations that are active customers; the number of people trained within those organizations; the continuation or renewal of existing services contracts, especially All Access Pass renewals; the availability of budgeted training spending at our clients and prospective clients, which, in certain content categories, can be significantly influenced by general economic conditions; and our ability to manage operating costs necessary to develop and provide meaningful training and related services and products to our clients.

RESULTS OF OPERATIONS

The following table sets forth, for the fiscal years indicated, the percentage of total sales represented by the line items through income or loss before income taxes in our consolidated statements of operations.  This table should be read in conjunction with the accompanying discussion and analysis, the consolidated financial statements, and the related notes to the consolidated financial statements.

FISCAL 2017 COMPARED WITH FISCAL 2016

Sales

We offer a variety of training courses, consulting services, and training-related products that are focused on solving organizational problems which require a change in human behavior.  Our training and consulting solutions are provided both domestically and internationally through the All Access Pass, our sales and delivery personnel, client facilitators, international licensees, and the internet on various web-based delivery platforms.  The following sales analysis for the fiscal year ended August 31, 2017 is based on activity through our operating segments as shown in the preceding comparative sales table.

 

Cost of Sales and Gross Profit

Gross profit consists of net sales less the cost of services provided or the cost of goods sold.  Our cost of sales includes the direct costs of delivering content onsite at client locations, including presenter costs, materials used in the production of training products and related assessments, assembly, manufacturing labor costs, and freight.  Gross profit may be affected by, among other things, the mix of practice solutions sold to clients, prices of materials, labor rates, changes in product discount levels, and freight costs.

Our cost of sales totaled $62.6 million in fiscal 2017 compared with $64.9 million in fiscal 2016.  Our gross profit for fiscal 2017 was $122.7 million compared with $135.2 million in fiscal 2016.  The decrease in gross profit during fiscal 2017 was primarily due to sales activity, as described above, and our decision to exit the publishing business in Japan and write off the majority of our book inventory.  Our gross margin for fiscal 2017 was 66.2 percent of sales compared with 67.6 percent in fiscal 2016.  Excluding the impact of the $2.1 million charge to exit the Japan publishing business, our gross margin was 67.4 percent for the fiscal year ended August 31, 2017.

Operating Expenses

Our operating expenses consisted of the following for the periods indicated (in thousands):

Selling, General and Administrative Expense – The increase in our SG&A expenses during fiscal 2017 was primarily due to 1) opening three new sales offices in China during the fiscal year, including $0.5 million of non-repeating start-up costs; 2) a $5.5 million increase in spending related to new sales and sales-related personnel, additional bonuses for sales associates related to multi-year deferred sales contracts, and increased travel to promote our new offices in China and the AAP; 3) a $1.9 million increase in computer costs primarily resulting from the installation of our new ERP system; and 4) a $0.5 million increase in non-cash stock-based compensation.  We continue to invest in new sales and sales-related personnel and had 221 client partners at August 31, 2017 compared with 204 client partners at August 31, 2016.  These increases were partially offset by a $3.5 million decrease from the change in estimated earn out payments to the former owners of NinetyFive 5, reduced warehousing and distribution expense, and cost savings in various other areas of our operations.

Contract Termination Costs – We entered into a new 10-year license agreement for Education practice content in a foreign country, with minimum required royalties payable to us that total $16.1 million (at current exchange rates) over the life of the arrangement.  Under a previously existing profit-sharing agreement, we would have been obligated to pay one-third of the royalty, or $5.4 million, to an international licensee partner that owns the rights in that country.  For a $1.5 million cash payment, we terminated the previously existing profit sharing arrangement and we will owe no further royalty payments to the licensee.  Based on the guidance for contract termination costs, we expensed the $1.5 million payment made during the second quarter.

Restructuring Costs – During the third quarter of fiscal 2017, we decided to exit the publishing business in Japan and we restructured our U.S./Canada direct office operations to transition to an AAP-focused business model.  We expensed $3.6 million related to these changes during fiscal 2017.  Due to a change in strategy designed to focus resources and efforts on sales of the All Access Pass in Japan, and declining sales and profitability of the publishing business, we decided to exit the publishing business in Japan.  As a result of this determination, we wrote off the majority of our book inventory located in Japan and expensed $2.1 million, which was recorded in cost of sales, as previously described.  We also restructured the operations of our U.S/Canada direct offices to create new smaller regional market teams that are focused on selling the All Access Pass.  Accordingly, we determined that our three remaining regional sales offices were unnecessary since most client partners work from home-based offices, we restructured the operations of the Sales Performance and Winning Customer Loyalty Practices, and we eliminated certain functions to reduce costs in future periods.  We expensed $1.5 million for these restructuring costs in fiscal 2017.

Depreciation – Depreciation expense increased primarily due to the acquisition of assets in fiscal 2017.  Based on property and equipment acquisitions during fiscal 2017 and expected capital additions during fiscal 2018, including the completion of the installation of a new ERP system and new All Access Pass portal, we expect depreciation expense will total approximately $5.5 million in fiscal 2018.

Amortization – Our consolidated amortization expense increased compared with the prior year primarily due to the fiscal 2017 acquisitions of Robert Gregory Partners, LLC and Jhana Education, and the amortization of acquired intangible assets.  Based on current carrying amounts of intangible assets and remaining estimated useful lives, we anticipate amortization expense from intangible assets will total $5.4 million in fiscal 2018.

Income Taxes

Our effective income tax benefit rate for the fiscal year ended August 31, 2017 was approximately 34 percent compared with an effective income tax expense rate of approximately 41 percent in fiscal 2016.  Our effective benefit rate in fiscal 2017 was increased by $0.5 million in previously unrecognized tax benefits, but was reduced by recording additional valuation allowance against the deferred tax assets of a foreign subsidiary, disallowed travel and entertainment expenses, and disallowed executive compensation.  In fiscal 2016, our effective income tax rate was increased primarily due to a $0.3 million valuation allowance against the deferred tax assets of a foreign subsidiary with recent and substantial taxable losses combined with disallowed travel and entertainment expenses.

During fiscal 2017, we paid $2.6 million in cash for income taxes, primarily to foreign jurisdictions.  We expect to recover a significant portion of our 2017 tax payments as we utilize foreign tax credit carryforwards in the future.  Over the next four to six years, we expect that our total cash paid for income taxes will be less than our total income tax provision as we utilize carryforwards of net operating losses and foreign tax credits.

FISCAL 2016 COMPARED WITH FISCAL 2015

Sales

The following sales analysis for fiscal 2016 compared with fiscal 2015 is based on activity through our operating segments as described in the fiscal 2017 sales analysis, and as shown in the preceding comparative sales table.

Direct Offices – As previously mentioned, we introduced the AAP in our domestic direct offices in late January 2016.  The AAP was well received by existing and new clients and we invoiced $19.4 million of new AAP contracts during fiscal 2016 through our direct offices, including $10.7 million in the fourth quarter.  However, in accordance with applicable revenue recognition guidance, we deferred $6.2 million (net of amounts previously deferred and subsequently recognized during fiscal 2016) of revenue that was primarily recognized in fiscal 2017 over the lives of the respective contracts.  While sales of new AAP contracts grew significantly in the fourth quarter compared with previous quarters of fiscal 2016, our onsite presentation sales declined compared with the prior year.  Our international direct office sales declined by $1.7 million during the fiscal year, primarily due to decreased demand for certain programs in these offices and $0.2 million of unfavorable foreign exchange rates, primarily during the first half of fiscal 2016.

Strategic Markets – The $7.2 million decrease in sales was primarily due to the renewal of a $6.6 million government contract in fiscal 2015, which did not repeat in fiscal 2016 due to administrative changes at the federal agency that resulted in the contract not being opened for renewal bids, and a $2.7 million decrease in Customer Loyalty practice sales.  Partially offsetting these decreases were $1.0 million of sales from our Global 50 group, $0.7 million of increased government services sales (excluding the impact of the government contract that was not renewed), and $0.3 million of increased revenue from the Sales Performance practice.  Our Customer Loyalty practice sales decreased primarily due to the termination of a contract with a large, multi-unit retailer.  Sales Performance practice sales increased due to new contracts obtained primarily during the first half of fiscal 2016.

Education Practice – We continue to see increased demand for The Leader in Me program in many school districts in the United States as well as in some international locations, which contributed to a $7.2 million, or 22 percent, increase in Education practice revenues compared with the prior year.  At August 31, 2016 over 3,000 schools around the world were using The Leader in Me curriculum.  Sales of subscription services during the previous fiscal year also improved sales during fiscal 2016 as we recognized a portion of the revenue that was deferred in previous periods.

International Licensees – Our international licensee royalties increased $0.5 million as certain of our licensee partners' sales increased compared with the prior year.  Licensee sales during the fiscal year ended August 31, 2016 were reduced by $0.6 million due to foreign exchange rate fluctuations as the U.S. dollar strengthened during the year.

Corporate and other – During fiscal 2016, corporate and other sales decreased primarily due to a $0.4 million decrease in shipping and handling revenues and a $0.2 million decrease in book and audio revenues from royalties on publications.

Gross Profit

Our gross profit for fiscal 2016 was $135.2 million compared with $138.1 million in fiscal 2015.  The decrease in gross profit was primarily due to sales activity during fiscal 2016 as previously described.  Our gross margin for fiscal 2016 increased to 67.6 percent of sales compared with 65.8 percent in fiscal 2015.  The improvement in gross margin was primarily due to a change in the mix of sales, which produced increased intellectual property sales, including All Access Pass sales, decreased onsite presentations, increased international licensee royalty revenues, and decreased costs associated with our online offerings as we restructured our online program operations during the first quarter of fiscal 2016.

Operating Expenses

Our operating expenses consisted of the following for the periods indicated (in thousands):

Selling, General and Administrative Expense – The increase in our SG&A expenses during fiscal 2016 was primarily due to 1) a $2.0 million increase in associate costs, primarily due to new sales and sales-related personnel; 2) a $1.5 million increase in the contingent consideration liability associated with the acquisition of NinetyFive 5; 3) a $1.4 million increase in software costs primarily related to our new ERP system; 4) a $1.1 million increase in bad debt expense resulting primarily from the write off of an Education practice contract and receivables from a large retailer that declared bankruptcy, plus other increases to the allowance for doubtful accounts throughout the fiscal year; and 5) a $0.6 million increase in non-cash stock-based compensation.  We had 204 client partners at August 31, 2016 compared with 180 client partners at the end of fiscal 2015.  A significant improvement in Sales Performance practice EBITDA during the first half of fiscal 2016 increased the probability of a second $2.2 million contingent consideration payment to the former owners of NinetyFive 5, which led to the significant increase in expense during fiscal 2016.  Partially offsetting these increases were $0.8 million of decreased foreign exchange losses, $0.8 million of reduced advertising and promotional expenses, and cost savings in various other areas of our operations.

Impaired Assets – During fiscal 2015, we impaired $1.3 million of long-term assets, which consisted of $0.6 million of capitalized curriculum that was discontinued (and related prepaid royalties), $0.5 million of long-term receivables from FC Organizational Products (FCOP), and an investment in an unconsolidated subsidiary totaling $0.2 million.  We determined that we will receive payment from FCOP for certain rent expenses earlier than previously estimated.  While this determination improves cash flows from FCOP in the short term, the present value of our share of cash distributions to cover remaining long-term receivables was reduced and was less than the present value of the receivables previously recorded and accordingly, we recalculated the discount on the long-term receivables and impaired the difference.  During the fourth quarter of fiscal 2015, we became aware of financial difficulties at an unconsolidated subsidiary in which we previously invested $0.2 million.  Based on this information, we determined that the carrying value of this investment would not be recoverable and we wrote off the investment.  We previously accounted for this investment using the cost method based on our insignificant ownership and influence in the entity.

Restructuring Costs – In the fourth quarter of fiscal 2016, we restructured the operations of certain of our domestic sales offices to reduce ongoing operational costs.  The cost of this restructuring was $0.4 million and was primarily comprised of employee severance costs, which were paid in August and September 2016.

During fiscal 2016 we also restructured the operations of our Australian direct office.  The restructuring was designed to reduce ongoing operating costs by closing the sales offices in Brisbane, Sydney, and Melbourne, and by reducing headcount for administrative functions.  Our remaining sales and support personnel in Australia now work from home offices, as do most of our sales personnel located in the U.S.

 

and Canada.  The $0.4 million charge recorded during the second quarter of fiscal 2016 was primarily for office closure costs, including remaining lease expense on the offices that were closed, and for employee severance costs.

Depreciation – Depreciation expense decreased due to certain assets becoming fully depreciated during fiscal 2016.

Amortization – Our consolidated amortization expense decreased compared with the prior year due to the amortization of previously acquired intangibles, some of which are amortized more heavily early in their estimated useful lives.

Income Taxes

Our effective tax rate for the fiscal year ended August 31, 2016 was approximately 41 percent compared with approximately 36 percent in fiscal 2015.

Our effective tax rate increased primarily due to the fiscal 2015 recognition of benefits from claiming foreign tax credits instead of foreign tax deductions for fiscal 2008 through fiscal 2010.  In fiscal 2015 we finalized the calculations of the impact of amending previously filed federal income tax returns to realize foreign tax credits previously treated as expired under the tax positions taken in the original returns.  The income tax benefit recognized from these foreign tax credits totaled $0.6 million in fiscal 2015.  As of August 31, 2015, we have amended all available prior year returns to claim foreign tax credits instead of tax deductions.  In fiscal 2016, we also recorded a valuation allowance of $0.3 million against the deferred tax assets of a foreign subsidiary with recent and substantial taxable losses.

Discount on Related Party Receivable

We record receivables from FCOP for reimbursement of certain operating costs, office space rent, and for working capital and other advances that we make, even though we are not contractually required to make advances or absorb the losses of FCOP.  Based on expected payment, some of these receivables are recorded as long-term receivables and are required to be recorded at net present value.  We have discounted the long-term portion of the FCOP receivables based on forecasted repayments at a discount rate of 15 percent, which was the estimated risk-adjusted borrowing rate of FCOP.

During fiscal 2015, we adjusted the discount and carrying value of our receivables from FCOP as described above in the section entitled "Impaired Assets."  The corresponding adjustment to the discount on our long-term receivables from FCOP totaled $0.4 million.

QUARTERLY RESULTS

The following tables set forth selected unaudited quarterly consolidated financial data for the fiscal years ended August 31, 2017 and 2016.  The quarterly consolidated financial data reflects, in the opinion of management, all normal and recurring adjustments necessary to fairly present the results of operations for such periods.  Results of any one or more quarters are not necessarily indicative of continuing trends (in thousands, except for per-share amounts).

 

Our fourth quarter of each fiscal year has higher sales and operating income than other fiscal quarters primarily due to increased revenues in our Education practice (when school administrators and faculty have professional development days) and to increased AAP and facilitator sales that typically occur during that quarter resulting from year-end incentive programs.  Overall, training sales are moderately seasonal because of the timing of corporate training, which is not typically scheduled as heavily during holiday and certain vacation periods.  Quarterly fluctuations may also be affected by other factors including the introduction of new offerings, business acquisitions, the addition of new organizational customers, and the elimination of underperforming offerings.

For more information on our quarterly results of operations, refer to our quarterly reports filed on Form 10-Q as filed with the SEC.  Our quarterly reports for the periods indicated are available free of charge at www.sec.gov.

LIQUIDITY AND CAPITAL RESOURCES

Introduction

During fiscal 2017, we used our cash provided by operating activities and a portion of the available capital from our secured credit facility to make substantial and significant investments in our business that we believe will provide benefits in future periods.  We spent $7.3 million of cash to acquire the businesses of Robert Gregory Partners, LLC, and Jhana Education during the last half of fiscal 2017.  We used $7.2 million of cash for purchases of property and equipment in fiscal 2017, primarily for software and hardware related to our new ERP system and significantly upgraded All Access Pass portal.  The new ERP system and AAP portal are expected to be completed and launched during fiscal 2018.  We also spent $6.5 million of cash to develop additional offerings primarily related to the AAP, including the translation of AAP materials into additional languages, and The Leader in Me courses offered through our Education

 

segment.   In addition to these uses of cash for investing activities, we also spent $5.4 million to purchase shares of our common stock on both the open market and from shares withheld on vested stock-based incentive awards.  For further information on these investments in our business during fiscal 2017, refer to the discussions under "Cash Flows from Investing Activities" and "Cash Flows from Financing Activities" found later in this analysis of liquidity and capital resources.

Our cash balance at August 31, 2017 was $8.9 million, with $25.6 million of available credit on our secured credit agreement, compared with $10.5 million of cash at August 31, 2016.  During fiscal 2017 we also converted $10.0 million of borrowings on our secured credit facility into term loans.  At August 31, 2017, we had $19.1 million payable on term loans to the lender on our secured credit facility.

Our net working capital (current assets less current liabilities) was $11.2 million at August 31, 2017 compared with $35.7 million at August 31, 2016.  The reduction in our net working capital was primarily due to a $20.7 million increase in deferred revenues resulting primarily from increased AAP sales, and borrowings used in fiscal 2017 to invest in our business as described above.  Of our $8.9 million in cash at August 31, 2017, $7.3 million was held outside the U.S. by our foreign subsidiaries.  We routinely repatriate cash from our foreign subsidiaries and consider cash generated from foreign activities a key component of our overall liquidity position.  Our primary sources of liquidity are cash flows from the sale of services in the normal course of business and available proceeds from our secured credit facility.  Our primary uses of liquidity include payments for operating activities, capital expenditures (including curriculum development), acquisition of businesses and intellectual property licenses, purchases of our common stock, working capital expansion, and debt payments.

The following table summarizes our cash flows from operating, investing, and financing activities for the past three years (in thousands):

Modifications to the Amended and Restated Credit Agreement

On May 24, 2016, we entered into the Fifth Modification Agreement to our existing amended and restated secured credit agreement (the Restated Credit Agreement) with our existing lender.  The primary purposes of the Fifth Modification Agreement were to (i) obtain a term loan from the lender for $15.0 million (the Term Loan); (ii) increase the maximum principal amount of the revolving line of credit from $30.0 million to $40.0 million; (iii) extend the maturity date of the Restated Credit Agreement from March 31, 2018 to March 31, 2019; (iv) permit us to convert balances outstanding from time to time under the revolving line of credit to term loans; and (v) adjust the fixed charge coverage ratio from 1.40 to 1.15.  During fiscal 2017, we entered into the Sixth, Seventh, and Eighth Modification Agreements to the Restated Credit Agreement.  The Sixth Modification and Eighth Modification agreements adjusted the definition of EBITDAR in the funded debt to EBITDAR and fixed charge coverage ratios applicable to our debt covenants to include the change in deferred revenue.  The Seventh Modification Agreement extended the maturity date of the Restated Credit Agreement to March 31, 2020.

The amount of available credit on our revolving credit line is reduced by amounts converted to term loans.  Term loans are due three years from the inception of each new loan.  Principal payments on our term loans are due quarterly and are equal to the original amount of each term loan divided by 16.  Any remaining principal at the maturity date is immediately payable or may be rolled into a new term loan.  Interest is charged at the same rate as the revolving line of credit and is payable monthly.  As a result of the $10.0 million of term loans obtained during fiscal 2017, our maximum available credit on the revolving line of credit is $30.0 million (less amounts borrowed) at August 31, 2017.

 

The various modification agreements preserve existing debt covenants that include (i) a funded debt to EBITDAR ratio of less than 3.0 to 1.0; (ii) a fixed charge coverage ratio greater than 1.15 to 1.0; (iii) an annual limit on capital expenditures (excluding capitalized curriculum development) of $8.0 million; and (iv) outstanding borrowings on the revolving line of credit may not exceed 150 percent of consolidated accounts receivable.  The other key terms and conditions of the various modification agreements are substantially the same as those defined in the Restated Credit Agreement, except as described above.  We believe that we were in compliance with the financial covenants and other terms applicable to the Restated Credit Agreement at August 31, 2017.

In addition to our revolving line of credit facility and term loan obligations, we have a long-term lease on our corporate campus that is accounted for as a financing obligation.  For further information on our operating lease obligations, which are not currently recorded on our consolidated balance sheet, refer to the notes to our consolidated financial statements as presented in Item 8 of this report on Form 10-K.

The following discussion is a description of the primary factors affecting our cash flows and their effects upon our liquidity and capital resources during the fiscal year ended August 31, 2017.

Cash Flows from Operating Activities

Our primary source of cash from operating activities was the sale of services and products to our customers in the normal course of business.  The primary uses of cash for operating activities were payments for selling, general, and administrative expenses, payments for direct costs necessary to conduct training programs, payments to suppliers for materials used in training manuals sold, and to fund working capital needs.  Our cash provided by operating activities was $17.4 million for the fiscal year ended August 31, 2017 compared with $32.7 million in fiscal 2016.  The decline was primarily attributable to decreased operating income when compared with the prior year.  Our operating income during fiscal 2017 was significantly reduced by the deferral of All Access Pass sales and costs associated with the transition to an AAP-focused business model.  Following the transition period to the AAP focused business model, we anticipate that cash flows from operating activities will improve and return to levels consistent with prior years.

Cash Flows from Investing Activities and Capital Expenditures

Our cash used for investing activities during fiscal 2017 totaled $21.7 million.  Our primary uses of cash for investing activities included purchases of property and equipment, the acquisition of businesses, and spending on curriculum development, including the acquisition of intellectual property rights.

Our purchases of property and equipment totaled $7.2 million, and consisted primarily of computer software and hardware.  We are currently in the process of implementing new ERP software and developing a significantly improved AAP portal.  Both of these projects are expected to be completed in fiscal 2018.  We currently anticipate that our purchases of property and equipment will total approximately $5.0 million in fiscal 2018.

In the third quarter of fiscal 2017, we acquired Robert Gregory Partners, LLC, a corporate coaching firm, for $3.5 million in cash plus up to $4.5 million of contingent consideration.  We paid the first contingent consideration payment, which totaled $0.5 million, during the fourth quarter of fiscal 2017.  This payment was classified as a component of cash flows from investing activities due to short-term timing of the payment.  During the fourth quarter of fiscal 2017, we acquired Jhana Education for $3.3 million in cash (net of cash acquired) plus up to $7.2 million of contingent consideration.  Jhana Education specializes in the creation and dissemination of relevant, bite-sized content and learning tools for leaders and managers.  For further information regarding our business acquisitions during fiscal 2017, refer to the notes to our consolidated financial statements in Item 8 of this report on Form 10-K.

 

Throughout fiscal 2017 we spent $6.5 million on various offerings, which was primarily for All Access Pass content, including the translation of AAP items into 15 additional languages; new development and offerings related to The Leader in Me; and for various other offerings and content.  Our anticipated spending for capitalized curriculum in fiscal 2018 is expected to be approximately $6.4 million.  During fiscal 2018, we expect to continue to make investments in our All Access Pass offerings, The Leader in Me, and in various other courses.

During fiscal 2017, we acquired the license rights to certain intellectual property owned by Higher Moment, LLC for $0.8 million.  The intellectual property is in part based on works authored and developed by Dr. Clayton Christensen, a well-known author and lecturer, who is a member of our Board of Directors.  Acquisitions of other businesses and intellectual property licenses in future periods will increase our use of cash for investing activities.

Cash Flows from Financing Activities

During fiscal 2017, our net cash provided by financing activities totaled $3.1 million.  Our primary sources of cash from financing activities during fiscal 2017 were $10.0 million borrowed on term notes payable, including a $5.0 term loan obtained in August 2017, $4.4 million of borrowings from our revolving line of credit, and $0.7 million of proceeds from participants in our employee stock purchase plan.  Our primary uses of cash for financing activities were $5.4 million spent on purchases of our common stock, including shares withheld for minimum statutory taxes on stock-based compensation awards, $5.0 million used to repay term loans payable, and $1.7 million used to pay the financing obligation on our corporate campus.

On January 23, 2015, our Board of Directors approved a new plan to repurchase up to $10.0 million of the Company's outstanding common stock.  All previously existing common stock repurchase plans were canceled and the new common share repurchase plan does not have an expiration date.  On March 27, 2015, our Board of Directors increased the aggregate value of shares of Company common stock that may be purchased under the January 2015 plan to $40.0 million so long as we have either $10.0 million in cash and cash equivalents or have access to debt financing of at least $10.0 million.  Under the terms of this expanded common stock repurchase plan, we have purchased 1,539,828 shares of our common stock for $26.8 million through August 31, 2017.  Since September 1, 2014, we have returned $63.4 million of cash to our shareholders through the purchase of our shares by means of a $35.0 million tender offer, open market purchases, and from shares withheld for minimum statutory taxes on stock-based compensation awards.  Future purchases of our common stock will increase the amount of cash used for financing activities in those periods.

During fiscal 2017, we completed the acquisitions of Robert Gregory Partners and Jhana Education as previously described.  Each of these acquisitions have contingent consideration that may be earned by their former owners based on specified performance criteria.  As the operations of these acquisitions reach the specified milestones for required contingent payments, our uses of cash for financing activities will increase.

Sources of Liquidity

We expect to meet our projected capital expenditures, service our existing financing obligation, and meet other working capital requirements during fiscal 2018 from current cash balances, future cash flows from operating activities, and available borrowings on our secured credit facility.  Going forward, we will continue to incur costs necessary for the day-to-day operation and potential growth of the business and may use our available revolving line of credit and other financing alternatives, if necessary, for these expenditures.  Our Restated Credit Agreement expires in March 2020 and we expect to renew the Restated Credit Agreement on a regular basis to maintain the long-term borrowing capacity of this credit facility.  At August 31, 2017, we had $25.6 million of borrowing capacity on our Restated Credit Agreement.  Additional potential sources of liquidity available to us include factoring receivables, issuance of additional equity, or issuance of debt from public or private sources.  If necessary, we will evaluate all of these options and select one or more of them depending on overall capital needs and the associated cost of capital.

We believe that our existing cash and cash equivalents, cash generated by operating activities, and availability of external funds as described above, will be sufficient for us to maintain our operations in the foreseeable future.  However, our ability to maintain adequate capital for our operations in the future is dependent upon a number of factors, including sales trends, macroeconomic activity, our ability to contain costs, levels of capital expenditures, collection of accounts receivable, and other factors.  Some of the factors that influence our operations are not within our control, such as general economic conditions and the introduction of new offerings or technology by our competitors.  We will continue to monitor our liquidity position and may pursue additional financing alternatives, as described above, to maintain sufficient resources for future growth and capital requirements.  However, there can be no assurance such financing alternatives will be available to us on acceptable terms, or at all.

Contractual Obligations

We have not structured any special purpose entities, or participated in any commodity trading activities, which would expose us to potential undisclosed liabilities or create adverse consequences to our liquidity.  Required contractual payments primarily consist of lease payments resulting from the sale of our corporate campus (financing obligation); repayment of term loans payable; expected contingent consideration payments from business acquisitions; short-term purchase obligations for inventory items and other products and services used in the ordinary course of business; minimum operating lease payments primarily for leased office space; and minimum payments for outsourced warehousing and distribution service charges.  At August 31, 2017, our expected payments on these obligations over the next five fiscal years and thereafter are as follows (in thousands):

(1)	Payment amounts shown include interest at 3.1 percent, which is the current rate on our Term Loan and revolving credit obligations.

(2)

The payment of contingent consideration from business acquisitions is based on current estimates and projections.  We reassess the fair value of estimated contingent consideration payments each quarter based on information available.  The actual payment of contingent consideration amounts may differ in amount and timing from those shown in the table.

(3)	Our required minimum payments for warehousing services contains an annual escalation based upon changes in the Employment Cost Index, the impact of which is not estimated in the above table.  The warehousing services contract expires in June 2019.

Our contractual obligations presented above exclude unrecognized tax benefits of $2.4 million for which we cannot make a reasonably reliable estimate of the amount and period of payment.  For further information regarding our unrecognized tax benefits, refer to the notes to our consolidated financial statements as presented in Part II, Item 8 of this report on Form 10-K.

 

USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America.  The significant accounting policies that we used to prepare our consolidated financial statements are outlined primarily in Note 1 to the consolidated financial statements, which are presented in Part II, Item 8 of this Annual Report on Form 10-K.  Some of those accounting policies require us to make assumptions and use judgments that may affect the amounts reported in our consolidated financial statements.  Management regularly evaluates its estimates and assumptions and bases those estimates and assumptions on historical experience, factors that are believed to be reasonable under the circumstances, and requirements under accounting principles generally accepted in the United States of America.  Actual results may differ from these estimates under different assumptions or conditions, including changes in economic and political conditions and other circumstances that are not in our control, but which may have an impact on these estimates and our actual financial results.

The following items require the most significant judgment and often involve complex estimates:

Revenue Recognition

We derive revenues primarily from the following sources:

·	Training and Consulting Services – We provide training and consulting services to both organizations and individuals in leadership, productivity, strategic execution, trust, sales force performance, customer loyalty, and communication effectiveness skills.

·	Products – We sell books, audio media, and other related products.

We recognize revenue when: 1) persuasive evidence of an arrangement exists, 2) delivery of product has occurred or services have been rendered, 3) the price to the customer is fixed or determinable, and 4) collectability is reasonably assured.  For training and service sales, these conditions are generally met upon presentation of the training seminar or delivery of the consulting services based upon daily rates.  For most of our product sales, these conditions are met upon shipment of the product to the customer.  At times, our customers may request access to our intellectual property for the flexibility to print certain training materials or to have access to certain training videos and other training aids at their convenience.  For intellectual property license sales, the revenue recognition conditions are generally met at the later of delivery of the content to the client or the effective date of the arrangement.

Revenue recognition for multiple-element arrangements requires judgment to determine if multiple elements exist, whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements.  A deliverable constitutes a separate unit of accounting when it has standalone value to our clients.  We routinely enter into arrangements that can include various combinations of multiple training offerings, consulting services, and intellectual property licenses.  The timing of delivery and performance of the elements typically varies from contract to contract.  Generally, these items qualify as separate units of accounting because they have value to the customer on a standalone basis.

When the Company's training and consulting arrangements contain multiple deliverables, consideration is allocated at the inception of the arrangement to all deliverables based on their relative selling prices at the beginning of the agreement, and revenue is recognized as each curriculum, consulting service, or intellectual property license is delivered.  We use the following selling price hierarchy to determine the fair value to be used for allocating revenue to the elements: (i) vendor-specific objective evidence of fair

 

value (VSOE), (ii) third-party evidence (TPE), and (iii) best estimate of selling price (BESP).  Generally, VSOE is based on established pricing and discounting practices for the deliverables when sold separately.  In determining VSOE, we require that a substantial majority of the selling prices fall within a narrow range.  When VSOE cannot be established, judgment is applied with respect to whether a selling price can be established based on TPE, which is determined based on competitor prices for similar offerings when sold separately.  Our products and services normally contain a significant level of differentiation such that the comparable pricing of services with similar functionality cannot be obtained.  When we are unable to establish a selling price using VSOE or TPE, BESP is used in our allocation of arrangement consideration.  BESPs are established as best estimates of what the selling price would be if the deliverables were sold regularly on a stand-alone basis.  Our process for determining BESPs requires judgment and considers multiple factors, such as market conditions, type of customer, geographies, stage of product lifecycle, internal costs, and gross margin objectives.  These factors may vary over time depending upon the unique facts and circumstances related to each deliverable.  However, we do not expect the effect of changes in the selling price or method or assumptions used to determine selling price to have a significant effect on the allocation of arrangement consideration.

Our multiple-element arrangements generally do not include performance, cancellation, termination, or refund-type provisions.

Our international strategy includes the use of independent licensees in countries where we do not have a wholly owned operation.  Licensee companies are unrelated entities that have been granted a license to translate our content, adapt the content to the local culture, and sell our offerings and products 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 period based upon the sales information reported to us from our licensees.  International royalty revenue is reported as a component of training and consulting service sales in our consolidated statements of operations.

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

Stock-Based Compensation

Our shareholders have approved performance-based long-term incentive plans (LTIPs) that provide for grants of stock-based performance awards to certain managerial personnel and executive management as directed by the Organization and Compensation Committee of the Board of Directors.  The number of common shares that are vested and issued to LTIP participants is variable and is based upon the achievement of specified performance objectives during defined performance periods.  Due to the variable number of common shares that may be issued under the LTIP, we reevaluate our LTIP grants on a quarterly basis and adjust the expected vesting dates and number of shares expected to be awarded based upon actual and estimated financial results of the Company compared with the performance goals set for the award.  Adjustments to the number of shares awarded, and to the corresponding compensation expense, are made on a cumulative basis at the adjustment date based upon the estimated probable number of common shares to be awarded.

The analysis of our LTIP awards contains uncertainties because we are required to make assumptions and judgments about the timing and eventual number of shares that will vest in each LTIP grant.  The assumptions and judgments that are essential to the analysis include forecasted sales and operating income levels during the LTIP service periods.  These forecasted amounts may be difficult to predict over the life of the LTIP awards due to changes in our business, such as from the introduction of the All Access Pass and its impact on reported financial results.  These business changes may also leave some previously approved performance measures obsolete or unattainable.  The evaluation of LTIP performance awards and the corresponding use of estimated amounts may produce additional volatility in our consolidated financial statements as we record cumulative adjustments to the estimated service periods and number of common shares to be awarded under the LTIP grants as described above.

 

 

Accounts Receivable Valuation

Trade accounts receivable are recorded at the invoiced amount and do not bear interest.  Our allowance for doubtful accounts calculations contain uncertainties because the calculations require us to make assumptions and judgments regarding the collectability of customer accounts, which may be influenced by a number of factors that are not within our control, such as the financial health of each customer.  We regularly review the collectability assumptions of our allowance for doubtful accounts calculation and compare them against historical collections.  Adjustments to the assumptions may either increase or decrease our total allowance for doubtful accounts.  For example, a 10 percent increase to our allowance for doubtful accounts at August 31, 2017 would increase our reported loss from operations by approximately $0.2 million.

For further information regarding the calculation of our allowance for doubtful accounts, refer to the notes to our financial statements as presented in Item 8 of this report on Form 10-K.

Related Party Receivable

At August 31, 2017, we had receivables from FCOP, an entity in which we own 19.5 percent, for reimbursement of certain operating costs and for working capital and other advances, even though we are not obligated to provide advances to, or fund the losses of FCOP.  We make use of estimates to account for these receivables, including estimates of the collectability of amounts receivable from FCOP in future periods and, based upon the timing of estimated collections, we were required to classify a portion of the receivable to long-term.  In accordance with applicable accounting guidance, we are required to discount the long-term portion of the receivable to its net present value using an estimated effective borrowing rate for FCOP.

We estimated the effective risk-adjusted borrowing rate to discount the long-term portion of the receivable at 15 percent, which was recorded as a discount on a related party receivable in our consolidated statements of operations in certain periods.  Our estimate of the effective borrowing rate required us to estimate a variety of factors, including the availability of debt financing for FCOP, projected borrowing rates for comparable debt, and the timing and realizability of projected cash flows from FCOP.  These estimates were based on information known at the time of the preparation of these financial statements.  A change in the assumptions and factors used, including estimated interest rates, may change the amount of discount taken.

Our assessments regarding the collectability of the FCOP receivable require us to make assumptions and judgments regarding the financial health of FCOP and are dependent on projected financial information for FCOP in future periods.  Such financial information contains inherent uncertainties, and is subject to factors that are not within our control.  Failure to receive projected cash flows from FCOP in future periods may result in adverse consequences to our liquidity, financial position, and results of operations.  For instance, changes in expected cash flows during fiscal 2015 resulted in impaired asset charges and increased discount expense during that fiscal year.

For further information regarding our investment in FCOP, refer to the notes to our financial statements as presented in Item 8 of this report on Form 10-K.

Inventory Valuation

Our inventories are primarily comprised of training materials and related accessories.  Inventories are reduced to their fair market value through the use of inventory valuation reserves, which are recorded during the normal course of business.  Our inventory valuation calculations contain uncertainties because the calculations require us to make assumptions and judgments regarding a number of factors, including future inventory demand requirements and pricing strategies.  During the evaluation process we consider historical sales patterns and current sales trends, but these may not be indicative of future inventory losses.  While we have not made material changes to our inventory valuation methodology during the past three years, our inventory requirements may change based on projected customer demand, technological and product life cycle changes, longer or shorter than expected usage periods, and other

 

factors that could affect the valuation of our inventories.  If our estimates regarding consumer demand and other factors are inaccurate, we may be exposed to losses that may have an adverse impact upon our financial position and results of operations.  For example, a 10 percent increase to our inventory valuation reserves at August 31, 2017 would increase our reported loss from operations by $0.1 million.

Due to a change in strategy designed to focus resources and efforts on sales of the All Access Pass in Japan, and declining sales and profitability of the publishing business, in the third quarter of fiscal 2017 we decided to exit the publishing business in Japan.  As a result of this determination, we wrote off the majority of our book inventory located in Japan for $2.1 million, which was recorded as a component of product cost of sales in the accompanying consolidated statements of operations for fiscal 2017.

Valuation of Indefinite-Lived Intangible Assets and Goodwill

Intangible assets that are deemed to have an indefinite life and goodwill balances are not amortized, but rather are tested for impairment on an annual basis, or more often if events or circumstances indicate that a potential impairment exists.  The Covey trade name intangible asset originated from the merger with the Covey Leadership Center in 1997 and has been deemed to have an indefinite life.  This intangible asset is quantitatively tested for impairment using the present value of estimated royalties on trade name related revenues, which consist primarily of training seminars, and related products, and international licensee royalties.

Goodwill is recorded when the purchase price for an acquisition exceeds the estimated fair value of the net tangible and identified intangible assets acquired.  During August 2017, we adopted Accounting Standards Update (ASU) 2017-04, Intangibles—Goodwill and Other:  Simplifying the Test for Goodwill Impairment.  This guidance simplifies the subsequent measurement of goodwill and eliminates the two-step goodwill impairment test.  Under the new guidance, an annual or interim goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value.  The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and two-step goodwill impairment test.

We tested goodwill for impairment at August 31, 2017 at the reporting unit level using a quantitative approach.  The goodwill impairment testing process involves determining whether the estimated fair value of the reporting unit exceeds its respective book value.  If the fair value exceeds the book value, goodwill of that reporting unit is not impaired.  If the book value exceeds the fair value, an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value.  The estimated fair value of each reporting unit was calculated using a combination of the income approach (discounted cash flows) and the market approach (using market multiples derived from a set of companies with comparable market characteristics).  The estimated fair values of the reporting units from these approaches were weighted in the determination of the total fair value.

On an interim basis, we consider whether events or circumstances are present that may lead to the determination that goodwill may be impaired.  These circumstances include, but are not limited to, the following:

·	significant underperformance relative to historical or projected future operating results;

·	significant change in the manner of our use of acquired assets or the strategy for the overall business;

·	significant change in prevailing interest rates;

·	significant negative industry or economic trend;

·	significant change in market capitalization relative to book value; and/or

·	significant negative change in market multiples of the comparable company set.

 

If, based on events or changing circumstances, we determine it is more likely than not that the fair value of a reporting unit does not exceed its carrying value, we would be required to test goodwill for impairment.

Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions.  These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions, and determination of appropriate market comparables.  We base our fair value estimates on assumptions we believe to be reasonable, but that are unpredictable and inherently uncertain.  Actual future results may differ from those estimates.  In addition, we make certain judgments and assumptions in allocating shared assets and liabilities to determine the carrying values for each of our reporting units.  The timing and frequency of our goodwill impairment tests are based on an ongoing assessment of events and circumstances that would indicate a possible impairment.  Based on the results of our goodwill impairment testing during fiscal 2017, we determined that no impairment existed at August 31, 2017, as each reportable operating segment's estimated fair value exceeded its carrying value.  We will continue to monitor our goodwill and intangible assets for impairment and conduct formal tests when impairment indicators are present.

Acquisitions and Contingent Consideration Liabilities

We record acquisitions resulting in the consolidation of an enterprise using the purchase method of accounting.  Under this method, the acquiring company records the assets acquired, including intangible assets that can be identified and named, and liabilities assumed based on their estimated fair values at the date of acquisition.  The purchase price in excess of the fair value of the assets acquired and liabilities assumed is recorded as goodwill.  If the assets acquired, net of liabilities assumed, are greater than the purchase price paid, then a bargain purchase has occurred and the company will recognize the gain immediately in earnings.  Among other sources of relevant information, we use independent appraisals or other valuations to assist in determining the estimated fair values of the assets and liabilities.  Various assumptions are used in the determination of these estimated fair values including discount rates, market and volume growth rates, product or service selling prices, cost structures, royalty rates, and other prospective financial information.

Additionally, we are required us to reassess the fair value of contingent consideration liabilities resulting from business acquisitions at each reporting period.  Although subsequent changes to the contingent consideration liabilities do not affect the goodwill generated from the acquisition transaction, the valuation of expected contingent consideration often requires us to estimate future sales and profitability.  These estimates require the use of numerous assumptions, many of which may change frequently and lead to increased or decreased operating income in future periods.  For instance, during fiscal 2017 we recorded $1.9 million of decreases to the fair value of the contingent consideration liability related to a business acquisition from a previous period, which resulted in a corresponding decrease in selling, general, and administrative expenses.

Impairment of Long-Lived Assets

Long-lived tangible assets and definite-lived intangible assets are reviewed for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.  We use an estimate of undiscounted future net cash flows of the assets over their remaining useful lives in determining whether the carrying value of the assets is recoverable.  If the carrying values of the assets exceed the anticipated future cash flows of the assets, we calculate an impairment loss.  The impairment loss calculation compares the carrying value of the asset to the asset's estimated fair value, which may be based upon discounted cash flows over the estimated remaining useful life of the asset.  If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis, which is then depreciated or amortized over the remaining useful life of the asset.  Impairment of long-lived assets is assessed at the lowest levels for which there are identifiable cash flows that are independent from other groups of assets.

 

Our impairment evaluation calculations contain uncertainties because they require us to make assumptions and apply judgment in order to estimate future cash flows, forecast the useful lives of the assets, and select a discount rate that reflects the risk inherent in future cash flows.  Although we have not made any material recent changes to our long-lived assets impairment assessment methodology, if forecasts and assumptions used to support the carrying value of our long-lived tangible and definite-lived intangible assets change in the future, significant impairment charges could result that would adversely affect our results of operations and financial condition.

Income Taxes

We regularly evaluate our United States federal and various state and foreign jurisdiction income tax exposures.  We account for certain aspects of our income tax provision using the provisions of FASC 740-10-05, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon final settlement.  The provisions of FASC 740-10-05 also provide guidance on de-recognition, classification, interest, and penalties on income taxes, accounting for income taxes in interim periods, and require increased disclosure of various income tax items.  Taxes and penalties are components of our overall income tax provision.

We record previously unrecognized tax benefits in the financial statements when it becomes more likely than not (greater than a 50 percent likelihood) that the tax position will be sustained.  To assess the probability of sustaining a tax position, we consider all available evidence.  In many instances, sufficient positive evidence may not be available until the expiration of the statute of limitations for audits by taxing jurisdictions, at which time the entire benefit will be recognized as a discrete item in the applicable period.

Our unrecognized tax benefits result from uncertain tax positions about which we are required to make assumptions and apply judgment to estimate the exposures associated with our various tax filing positions.  The calculation of our income tax provision or benefit, as applicable, requires estimates of future taxable income or losses.  During the course of the fiscal year, these estimates are compared to actual financial results and adjustments may be made to our tax provision or benefit to reflect these revised estimates.  Our effective income tax rate is also affected by changes in tax law and the results of tax audits by various jurisdictions.  Although we believe that our judgments and estimates discussed herein are reasonable, actual results could differ, and we could be exposed to losses or gains that could be material.

We establish valuation allowances for deferred tax assets when we estimate it is more likely than not that the tax assets will not be realized.  The determination of whether valuation allowances are needed on our deferred income tax assets contains uncertainties because we must project future income, including the use of tax-planning strategies, by individual tax jurisdictions.  Changes in industry and economic conditions and the competitive environment may impact the accuracy of our projections.  We regularly assess the likelihood that our deferred tax assets will be realized and determine if adjustments to our valuation allowance are necessary.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENT

In January 2017, the Financial Accounting Standards Board (FASB) issued ASU 2017-04, Intangibles—Goodwill and Other:  Simplifying the Test for Goodwill Impairment.  This guidance simplifies the subsequent measurement of goodwill and eliminates the two-step goodwill impairment test.  Under the new guidance, an annual or interim goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value.  The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and two-step goodwill impairment test.  The ASU is effective prospectively for fiscal years and interim periods within those years beginning after December 15, 2019.  Early adoption is permitted

 

for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  We have elected, as permitted by the guidance, to early adopt ASU No. 2017-04 of August 31, 2017 to be effective for our annual goodwill impairment testing.  The adoption of this standard did not have a material effect on our consolidated goodwill balance at August 31, 2017.

ACCOUNTING PRONOUNCEMENTS ISSUED NOT YET ADOPTED

In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing.  The guidance in ASU 2016-10 clarifies aspects of Topic 606 related to identifying performance obligations and the licensing implementation guidance, while retaining the related core principles for those areas.  The effective date and transition requirements for ASU 2016-10 are the same as the effective date and transition requirements for Topic 606 (ASU 2014-09) discussed above.  As of August 31, 2017, we have not yet determined the full impact that ASU No. 2016-10 will have on our reported revenue or results of operations.

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.  Early adoption is permitted for all entities.  For leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, lessees and lessors must apply a modified retrospective transition approach.  While we expect the adoption of this new standard will increase reported assets and liabilities, as of August 31, 2017, we have not yet determined the full impact that the adoption of ASU 2016-02 will have on our financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting.  The guidance in ASU 2016-09 simplifies several aspects of the accounting for stock-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification of items on the statement of cash flows.  ASU 2016-09 is effective for public companies' annual periods, including interim periods within those fiscal years, beginning after December 15, 2016.  Early adoption is permitted subject to certain requirements, and the method of application (i.e., retrospective, modified retrospective or prospective) depends on the transaction area that is being amended.  Following adoption, the primary impact on our consolidated financial statements will be the recognition of excess tax benefits in the provision for income taxes rather than additional paid-in capital, which will likely result in increased volatility in the reported amounts of income tax expense and net income.  For example, during fiscal

 

2017 we recorded $0.2 million of excess income tax benefits to additional paid-in capital.  If we would have early adopted ASU 2016-09, this amount would have been recorded as a component of our consolidated income tax benefit for fiscal 2017.  As of August 31, 2017, we have not completed the full evaluation of the impact of ASU 2016-09 on our results of operations or cash flows.

REGULATORY COMPLIANCE

We are registered in states in which we do business that have a sales tax and we collect and remit sales or use tax on sales made in these jurisdictions.  Compliance with environmental laws and regulations has not had a material effect on our operations.

INFLATION AND CHANGING PRICES

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

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain written and oral statements made by us in this report are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934 as amended (the Exchange Act).  Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain words such as "believe," "anticipate," "expect," "estimate," "project," or words or phrases of similar meaning.  In our reports and filings we may make forward-looking statements regarding our expectations about future reported revenues and operating results, future sales growth, the expected completion of our new ERP system and new AAP portal, the expected introduction of new or refreshed offerings, including additions to the All Access Pass and improvements to our Education segment, future training and consulting sales activity, the impact of multi-year contracts for the All Access Pass, renewal of existing contracts, the release and success of new publications, the expected growth of our business in China, anticipated expenses, the adequacy of existing capital resources, projected cost reduction and strategic initiatives, expected levels of depreciation and amortization expense, expectations regarding tangible and intangible asset valuations, the seasonality of future sales, the seasonal fluctuations in cash used for and provided by operating activities, future compliance with the terms and conditions of our Restated Credit Agreement, the ability to borrow on, and renew, our Restated Credit Agreement, expectations regarding income tax expenses as well as tax assets and credits and the amount of cash expected to be paid for income taxes, estimated capital expenditures, and cash flow estimates used to determine the fair value of long-lived assets.  These, and other forward-looking statements, are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements.  These risks and uncertainties are disclosed from time to time in reports filed by us with the SEC, including reports on Forms 8-K, 10-Q, and 10-K.  Such risks and uncertainties include, but are not limited to, the matters discussed in Item 1A of this annual report on Form 10-K for the fiscal year ended August 31, 2017, entitled "Risk Factors."  In addition, such risks and uncertainties may include unanticipated developments in any one or more of the following areas:  unanticipated costs or capital expenditures; delays or unanticipated outcomes relating to our strategic plans; dependence on existing products or services; the rate and consumer acceptance of new product introductions, including the new AAP portal; foreign currency exchange rates; competition; the number and nature of customers and their product orders, including changes in the timing or mix of product or training orders; pricing of our products and services and those of competitors; adverse publicity; adverse effects on certain licensee's performance due to civil unrest in some of the countries where our licensees operate; and other factors which may adversely affect our business.

 

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

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

Forward-looking statements are based on management's expectations as of the date made, and the Company does not undertake any responsibility to update any of these statements in the future except as required by law.  Actual future performance and results will differ and may differ materially from that contained in or suggested by forward-looking statements as a result of the factors set forth in this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in our filings with the SEC.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk of Financial Instruments

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

Foreign Exchange Sensitivity

Due to the global nature of our operations, we are subject to risks associated with transactions that are denominated in currencies other than the United States dollar, as well as the effects of translating amounts denominated in foreign currencies to United States dollars as a normal part of the reporting process.  The objective of our foreign currency risk management activities is to reduce foreign currency risk in the consolidated financial statements.  In order to manage foreign currency risks, we may make limited use of foreign currency forward contracts and other foreign currency related derivative instruments.  However, we did not utilize any foreign currency forward or related derivative contracts during fiscal 2017, fiscal 2016, or fiscal 2015.

Interest Rate Sensitivity

Our long-term liabilities primarily consist of term loans payable obtained from the lender on our Restated Credit Agreement, a long-term lease agreement (financing obligation) associated with the sale of our corporate headquarters facility, amounts borrowed on our revolving credit facility, deferred income taxes,

 

and contingent consideration payments resulting from our business acquisitions.  Our overall interest rate sensitivity is primarily influenced by any amounts borrowed on term loans or on our revolving line of credit facility, and the prevailing interest rate on these instruments.  The effective interest rate on the term loans and our revolving line of credit facility was 3.1 percent at August 31, 2017, and we may incur additional expense if interest rates increase in future periods.  For example, a one percent increase in the interest rate on our term loans and the amount outstanding on our revolving credit facility at August 31, 2017 would result in approximately $0.2 million of additional interest expense in fiscal 2018.  Our financing obligation has a payment structure equivalent to a long-term leasing arrangement with a fixed interest rate of 7.7 percent.

During the fiscal years ended August 31, 2017, 2016, and 2015, we were not party to any interest rate swap agreements or similar derivative instruments.

 

 

 

 

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AUGUST 31,		2017				2016
In thousands, except per-share data
ASSETS
Current assets:
Cash and cash equivalents		$	8,924			$	10,456
Accounts receivable, less allowance for doubtful accounts of $2,310 and $1,579			66,343				65,960
Receivable from related party			1,020				1,933
Inventories			3,353				5,042
Income taxes receivable			259				-
Prepaid expenses			3,569				2,949
Other current assets			8,367				3,401
Total current assets			91,835				89,741
Property and equipment, net			19,730				16,083
Intangible assets, net			57,294				50,196
Goodwill			24,220				19,903
Long-term receivable from related party			727				1,235
Other long-term assets			16,925				13,713
		$	210,731			$	190,871
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of financing obligation		$	1,868			$	1,662
Current portion of term notes payable			6,250				3,750
Accounts payable			9,119				10,376
Deferred revenue			40,772				20,847
Accrued liabilities			22,617				17,422
Total current liabilities			80,626				54,057
Line of credit			4,377				-
Financing obligation, less current portion			21,075				22,943
Term notes payable, less current portion			12,813				10,313
Other liabilities			5,742				3,173
Deferred income tax liabilities			1,033				6,670
Total liabilities			125,666				97,156
Commitments and contingencies (Notes 7 and 8)
Shareholders' equity:
Common stock, $.05 par value; 40,000 shares authorized, 27,056 shares issued			1,353				1,353
Additional paid-in capital			212,484				211,203
Retained earnings			69,456				76,628
Accumulated other comprehensive income			667				1,222
Treasury stock at cost, 13,414 shares and 13,332 shares			(198,895	)			(196,691	)
Total shareholders' equity			85,065				93,715
		$	210,731			$	190,871

YEAR ENDED AUGUST 31,		2017				2016				2015
In thousands, except per-share amounts
Net sales:
Training and consulting services		$	177,816			$	189,661			$	198,695
Products			3,881				6,009				6,885
Leasing			3,559				4,385				4,361
			185,256				200,055				209,941
Cost of sales:
Training and consulting services			56,557				59,158				66,370
Products			3,990				3,206				3,306
Leasing			2,042				2,537				2,176
			62,589				64,901				71,852
Gross profit			122,667				135,154				138,089
Selling, general, and administrative			121,148				113,589				108,802
Impaired assets			-				-				1,302
Contract termination costs			1,500				-				-
Restructuring costs			1,482				776				587
Depreciation			3,879				3,677				4,142
Amortization			3,538				3,263				3,727
Income (loss) from operations			(8,880	)			13,849				19,529
Interest income			379				325				383
Interest expense			(2,408	)			(2,263	)			(2,137	)
Discount on related-party receivables			-				-				(363	)
Income (loss) before income taxes			(10,909	)			11,911				17,412
Benefit (provision) for income taxes			3,737				(4,895	)			(6,296	)
Net income (loss)		$	(7,172	)		$	7,016			$	11,116
Net income (loss) per share:
Basic and diluted		$	(0.52	)		$	0.47			$	0.66
Weighted average number of common shares:
Basic			13,819				14,944				16,742
Diluted			13,819				15,076				16,923
COMPREHENSIVE INCOME (LOSS):
Net income (loss)		$	(7,172	)		$	7,016			$	11,116
Foreign currency translation adjustments, net of income
tax benefit of $37, $115, and $52			(555	)			1,030				(1,259	)
Comprehensive income (loss)		$	(7,727	)		$	8,046			$	9,857

YEAR ENDED AUGUST 31,		2017				2016				2015
In thousands
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(7,172	)		$	7,016			$	11,116
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization			7,443				6,943				7,875
Amortization of capitalized curriculum development costs			3,745				3,865				4,093
Deferred income taxes			(5,594	)			1,854				3,665
Stock-based compensation expense			3,658				3,121				2,536
Impairment of assets			-				-				1,302
Excess tax expense (benefit) from stock-based compensation			(168	)			52				(137	)
Increase (decrease) in contingent consideration liabilities			(1,936	)			1,538				35
Changes in assets and liabilities, net of effect of acquired businesses:
Decrease (increase) in accounts receivable, net			164				(576	)			(4,355	)
Decrease (increase) in inventories			1,583				(908	)			2,239
Decrease in receivable from related party			1,421				820				620
Increase in prepaid expenses and other assets			(4,861	)			(1,119	)			(2,010	)
Increase (decrease) in accounts payable and accrued liabilities			676				2,264				(5,654	)
Increase in deferred revenue			19,142				8,112				2,481
Increase (decrease) in income taxes payable/receivable			(249	)			(316	)			2,548
Decrease in other liabilities			(495	)			(1	)			(164	)
Net cash provided by operating activities			17,357				32,665				26,190
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment			(7,187	)			(3,993	)			(2,446	)
Capitalized curriculum development costs			(6,466	)			(2,236	)			(2,166	)
Acquisition of businesses, net of cash acquired			(7,272	)			-				(262	)
Acquisition of license rights			(750	)			-				-
Net cash used for investing activities			(21,675	)			(6,229	)			(4,874	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from line of credit borrowings			34,320				46,454				-
Payments on line of credit borrowings			(29,943	)			(46,454	)			-
Proceeds from term notes payable financing			10,000				15,000				-
Principal payments on term notes payable			(5,000	)			(937	)			-
Principal payments on financing obligation			(1,662	)			(1,472	)			(1,302	)
Purchases of common stock for treasury			(5,431	)			(43,586	)			(14,427	)
Payment of contingent consideration liability			-				(2,167	)			-
Income tax benefit (expense) recorded in paid-in capital			168				(52	)			137
Proceeds from sales of common stock held in treasury			682				679				689
Net cash provided by (used for) financing activities			3,134				(32,535	)			(14,903	)
Effect of foreign currency exchange rates on cash and cash equivalents			(348	)			321				(662	)
Net increase (decrease) in cash and cash equivalents			(1,532	)			(5,778	)			5,751
Cash and cash equivalents at beginning of the year			10,456				16,234				10,483
Cash and cash equivalents at end of the year		$	8,924			$	10,456			$	16,234
Supplemental disclosure of cash flow information:
Cash paid for income taxes		$	2,562			$	3,410			$	2,383
Cash paid for interest			2,314				2,231				2,130
Non-cash investing and financing activities:
Purchases of property and equipment financed by accounts payable		$	697			$	334			$	134

																		Accumulated
																		Other
		Common				Common				Additional				Retained				Comprehensive				Treasury				Treasury
		Stock Shares				Stock Amount				Paid-In Capital				Earnings				Income				Stock Shares				Stock Amount
In thousands
Balance at August 31, 2014			27,056			$	1,353			$	207,148			$	58,496			$	1,451				(10,266	)		$	(141,734	)
Issuance of common stock from
treasury											(847	)											111				1,536
Purchase of treasury shares																							(778	)			(14,427	)
Unvested share award											(336	)											24				336
Stock-based compensation											2,536
Cumulative translation
adjustments																			(1,259	)
Tax benefits recorded in
paid-in capital											137
Other											(3	)															3
Net income															11,116
Balance at August 31, 2015			27,056				1,353				208,635				69,612				192				(10,909	)			(154,286	)
Issuance of common stock from
treasury											(143	)											57				823
Purchase of treasury shares																							(2,505	)			(43,586	)
Unvested share award											(356	)											25				356
Stock-based compensation											3,121
Cumulative translation
adjustments																			1,030
Tax expense recorded in
paid-in capital											(52	)
Other											(2	)															2
Net income															7,016
Balance at August 31, 2016			27,056				1,353				211,203				76,628				1,222				(13,332	)			(196,691	)
Issuance of common stock from
treasury											(2,103	)											188				2,785
Purchase of treasury shares																							(300	)			(5,431	)
Unvested share award											(442	)											30				442
Stock-based compensation											3,658
Cumulative translation
adjustments																			(555	)
Tax benefit recorded in
paid-in capital											168
Other
Net loss															(7,172	)
Balance at August 31, 2017			27,056			$	1,353			$	212,484			$	69,456			$	667				(13,414	)		$	(198,895	)