August
8,
2006
Ms.
Linda
Cvrkel
Branch
Chief
Securities
and Exchange Commission
Division
of Corporate Finance
Washington,
D.C. 20549-0305
| RE: | Franklin Covey Co. (the Company) | |
| Form 10-K for the year ended August 31, 2005 | ||
| File No. 1-11107 | ||
| Response to Commission Letter Dated July 24, 2006 |
Dear Ms. Cvrkel:
This
letter is written in response to the Staff’s review of the Company’s Form 10-K
for the year ended August 31, 2005 as outlined in the Commission’s letter dated
June 26, 2006 and subsequent letter dated July 24, 2006. The Company is
providing the following additional information regarding the inclusion of
outstanding management common stock loan shares in the denominator of the
Company’s basic EPS calculation. The information presented in this response is
designed to provide the Staff with additional information related to the
Company’s determination of the treatment of the management common stock loan
shares in its EPS calculations.
Notes
to the Financial Statements
Note
11. Management Common Stock Loan Program
| 1. |
We
note from your response to our prior comment 6 that you have included
the
outstanding shares held by management common stock loan participants
in
the denominator for purposes of calculating basic EPS because you
believe
that the modification from a full recourse to non-recourse stock
option
arrangement did not represent a change in the nature of the outstanding
shares associated with the management common stock loans. However,
paragraph 7 of SFAS No. 123 states “that the rights and obligations
embodied in a transfer of stock to an employee for consideration
of a
non-recourse note are substantially the same as the grant of a stock
option and the transaction shall be accounted for as such.” Furthermore,
footnote 4 of SFAS No. 123 goes on to further clarify that an entity
that
conditionally transfers an equity instrument to another party under
an
arrangement that permits that party to choose at a later date whether
to
deliver the consideration for it with no further obligation, the
equity
instrument is not issued until the issuing entity has received the
consideration (e.g. cash). In this regard, it appears that your treatment
does not comply with the guidance set forth in SFAS No. 123. Please
advise, or alternatively, you may revise your presentation of EPS
to
exclude the shares subject to the loan, given the shares should not
be
considered outstanding for presentation purposes or for the purpose
of
calculating basic EPS. To the extent that the revised earnings per
share
amounts are materially different from those reported in your Form
10-K for
the year ended August 31, 2005, we believe you should amend your
financial
statements to include the revised earnings per share amounts. If
you do
not believe the change to EPS is material, please provide us with
your
computations which support the basis for your
conclusion.
|
Response:
During fiscal 2000, certain of the Company’s management personnel borrowed funds
from an external lender, on a full-recourse basis, to acquire shares of the
Company’s common stock. Upon the closing of the loans, these shares were issued
to management stock loan participants and were considered owned and outstanding
consistent with other shares of outstanding common stock. Since the Company
originally accounted for the loans and the corresponding shares using a
loan-based accounting model that included guidance found in SAB 102, SFAS No.
114, and SFAS No. 5, the management loan shares were included in outstanding
shares for purposes of calculating basic earnings per share (EPS).
The
May
2004 modifications to the management common stock loans to delay payment to
a
later date and lower the interest rate caused the Company to reconsider its
accounting for the loans as full recourse loans, even though legally, the loans
remained full-recourse to the participants. In addition, as a result of these
modifications, participants are now allowed to surrender their loan program
shares at the due date as partial consideration or full consideration for the
loans should the value of the shares be sufficient to repay the principal and
accrued interest. Although the Company has not relinquished its legal recourse
rights and has received payment in full from several loan participants, the
modifications demonstrated actions taken by the Company that could be argued
as
contrary to those that a third-party lender might take. In considering the
accounting guidance to apply to the May 2004 modifications, the Company was
unable to find accounting literature that specifically addressed the situation.
In most instances, the accounting literature applied to the exercise of existing
stock options for full-recourse notes, which would suggest a compensation
element in the accounting model. In the Company’s situation, the loan program
was never intended to be a compensation arrangement, but rather a mechanism
to
allow employees to purchase an equity ownership in the Company. Due to the
lack
of specific accounting literature for these modifications, the Company, by
analogy, utilized the guidance found in Issue 50 of EITF 00-23, which addresses
changes from full-recourse notes issued with stock option arrangements to
non-recourse notes issued with stock option arrangements. Based upon this
guidance, the Company determined that it was proper to adopt the non-recourse
stock option model rather than continue with a loan-based accounting model,
even
though the loans remain full recourse to the participants and despite the fact
that the intent of the loan program was not compensatory. As further evidence
that the awards were not intended to be compensatory, one of the May 2004
modifications provides that once the market value of the Company’s common stock
equals the principal and accrued interest on the loans, participants can no
longer delay repayment on the loans. As a result, the loan participants are
essentially prevented from receiving compensation income from the loan shares
and the Company is virtually assured of never incurring any compensation cost
related to the loans.
Although
the stock option accounting model was adopted, the underlying nature of the
issued management loan shares did not change. Because the shares of stock were
actually issued to loan participants as registered shares, the shares were
entitled to vote, entitled to participate in common dividends, and the Company
could not control the holder’s transferability of the shares nor hold the shares
as collateral for the note. The Company considered these characteristics of
the
outstanding shares to be key differences from the guidance found in EITF 00-23
related to loans issued in connection with stock options, which may never be
exercised and the issuer therefore effectively maintains control of the shares.
As a result, the Company used its judgment and determined that the loan shares
should remain outstanding (rather than recorded as treasury stock) and in Basic
EPS, which was more representative of their voting rights, income participation
rights, and the Company’s inability to control the shares.
The
Company believed that this treatment was consistent with the guidance in
paragraph 7 of SFAS No. 123 related to the rights and obligations of the Company
and the loan participants. As the underlying shares were actually issued and
were out of the Company’s control, the Company believes that these circumstances
warranted different treatment than a transfer of stock to an employee for
consideration of a non-recourse note in which the issuer maintains control
of
the shares until the note is paid and the shares are actually issued and become
outstanding for purposes of calculating EPS. Additionally, these modifications
do not permit the surrender of the shares as full consideration on the note
with
no further obligation as described in footnote 4 of SFAS No. 123. The management
stock loan participants remain obligated to repay the loans in full and can
only
apply the market value of the shares surrendered as a reduction of the loan.
If
at the due date a participant chooses to surrender shares, and the fair value
of
the shares is insufficient to repay the loan in full, the participant remains
obligated to repay the balance owed on the note. Therefore, the Company does
not
believe that this is a conditional transfer of shares as defined in SFAS No.
123.
However,
during the third quarter of fiscal 2006, the Company determined that it wanted
to have an increased level of control over the loan program shares if the
participants choose to repay their loans by surrendering shares. As a result,
the Company offered loan participants additional modifications to the loan
terms, including another extension of the due date, in consideration for the
delivery of participant shares (either loan program shares or other shares
owned
by the participant) into an escrow account. At the end of the offer period,
the
majority of the loan participants accepted this offer and their shares have
been
transferred to the escrow account. Because the Company will now have significant
control over the transferability of these shares, the Company acknowledges
the
Staff’s comments and will consider these shares to be contingently issued and
will exclude them from the Basic EPS calculation beginning in the Company’s
fourth quarter of fiscal 2006.
Hopefully
the supplemental information presented above is fully responsive to the Staff’s
comment regarding the inclusion of management stock loan shares in the
calculation of Basic EPS. Although the topic of this response is complex and
involved significant professional judgment, the Company believes that the
accounting treatment described above best represents the substance of the
transaction and is in compliance with United States GAAP. The accounting
for Company’s management stock loan program has been the subject of continuing
dialogue and consultations with KPMG’s national Department of Professional
Practice, who agrees with the accounting conclusions reached by the Company.
Please contact me with any further questions that you may have regarding these
matters.
| Sincerely, | ||
| |
|
|
| /s/ STEPHEN D. YOUNG | ||
|
Stephen D. Young Chief
Financial Officer
|
||