UNITED
        STATES


SECURITIES
      AND EXCHANGE COMMISSION


WASHINGTON,
      D.C. 20549





**FORM
      10-Q**





(Mark
      One)





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





For
      the
      quarterly period ended May 27, 2006





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





For
      the
      transition period from __________ to __________





Commission
      file no. 1-11107









**FRANKLIN
      COVEY CO.**


(Exact
      name of registrant as specified in its charter)




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






Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days.





Yes
            
            xNo
            
            o





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





Large
                accelerated filer
            o
            
            Accelerated
                filer
            o
            
            Non-accelerated
                filer
            x





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





Yes
            
            oNo
            
            x





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





19,887,747
      shares of Common Stock as of July 5, 2006







**Index**




**Page**Financial
              Statements
            -3-Note
              1 - Basis of Presentation
            -6-Note
              2 - Accounting for Stock-Based Compensation
            -7-Note
              3 - Inventories
            -10-Note
              4 - Intangible Assets
            -10-Note
              5 - Preferred Stock Redemptions and Purchases of Company Common
              Stock
            -10-Note
              6 - Income Tax Benefit
            -11-Note
              7 - Legal Settlement
            -11-Note
              8 - Comprehensive Income
            -11-Note
              9 - Earnings Per Share
            -12-Note
              10 - Segment Information
            -13-Note
              11 - Management Common Stock Loan Modifications
            -15-Results
              of Operations
            -16-Liquidity
              and Capital Resources
            -21-Use
              of Estimates and Critical Accounting Policies
            -24-New
              Accounting Pronouncements
            -24-Market
              Risk of Financial Instruments
            -26-Controls
              and Procedures
            -27-Safe
              Harbor Statement Under the Private Securities Litigation Reform Act
              of
              1995
            -27-Other
              Information
            -28-Exhibits
            -28-Signatures
            -29-







2


PART
      I.
      FINANCIAL INFORMATION


ITEM
      1.
FINANCIAL STATEMENTS




FRANKLIN
      COVEY CO.





CONDENSED
      CONSOLIDATED BALANCE SHEETS


(in
      thousands, except per share amounts)





May
                27,
              2006
            
            August
                31,
              2005(unaudited)ASSETSCurrent
                assets:Cash
                and cash equivalents
            
            $
            28,804
            
            $
            51,690Restricted
                cash
            
            
            -
            
            
            699Accounts
                receivable, less allowance for doubtfulaccounts
                of $1,155 and $1,425
            
            
            26,684
            
            
            22,399Inventories
            
            
            22,395
            
            
            20,975Other
                current assets
            
            
            9,106
            
            
            9,419Total
                current assets
            
            
            86,989
            
            
            105,182Property
                and equipment, net
            
            
            33,715
            
            
            35,277Intangible
                assets, net
            
            
            80,439
            
            
            83,348Other
                long-term assets
            
            
            10,714
            
            
            9,426$
            211,857
            
            $
            233,233LIABILITIES
                AND SHAREHOLDERS’ EQUITYCurrent
                liabilities:Current
                portion of long-term debt and financing obligation
            
            $
            576
            
            $
            1,088Accounts
                payable
            
            
            11,418
            
            
            13,704Income
                taxes payable
            
            
            1,490
            
            
            3,996Accrued
                liabilities
            
            
            33,660
            
            
            36,536Total
                current liabilities
            
            
            47,144
            
            
            55,324Long-term
                debt and financing obligation, less current portion
            
            
            33,707
            
            
            34,086Other
                liabilities
            
            
            1,186
            
            
            1,282Deferred
                income tax liability
            
            
            9,715
            
            
            9,715Total
                liabilities
            
            
            91,752
            
            
            100,407Shareholders’
                equity:Preferred
                stock - Series A, no par value; 4,000 shares authorized,1,494
                and 2,294 shares issued and outstanding; liquidation
                preferencetotaling
                $38,278 and $58,788
            
            
            37,345
            
            
            57,345Common
                stock - $0.05 par value; 40,000 shares authorized,27,056
                shares issued and outstanding
            
            
            1,353
            
            
            1,353Additional
                paid-in capital
            
            
            186,272
            
            
            190,760Common
                stock warrants
            
            
            7,611
            
            
            7,611Accumulated
                deficit
            
            
            (1,033
            )
            
            (14,498
            )Deferred
                compensation on unvested stock grants
            
            
            -
            
            
            (1,055
            )Accumulated
                other comprehensive income
            
            
            770
            
            
            556Treasury
                stock at cost, 6,897 and 6,465 shares
            
            
            (112,213
            )
            
            (109,246
            )Total
                shareholders’ equity
            
            
            120,105
            
            
            132,826$
            211,857
            
            $
            233,233




See
      notes
      to condensed consolidated financial statements.




3


FRANKLIN
      COVEY CO.





CONDENSED
      CONSOLIDATED INCOME STATEMENTS


(in
      thousands, except per share amounts)





Quarter
                Ended
            
            Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005
            
            May
                27,
              2006
            
            May
                28,
              2005(unaudited)
            
            (unaudited)Net
                sales:Products
            
            $
            32,184
            
            $
            35,217
            
            $
            126,428
            
            $
            134,443Training
                and consulting services
            
            
            31,098
            
            
            30,571
            
            
            87,538
            
            
            82,97263,282
            
            
            65,788
            
            
            213,966
            
            
            217,415Cost
                of sales:Products
            
            
            15,584
            
            
            16,908
            
            
            56,536
            
            
            61,297Training
                and consulting services
            
            
            11,406
            
            
            10,612
            
            
            28,558
            
            
            26,19826,990
            
            
            27,520
            
            
            85,094
            
            
            87,495Gross
                profit
            
            
            36,292
            
            
            38,268
            
            
            128,872
            
            
            129,920Selling,
                general, and administrative
            
            
            35,629
            
            
            36,095
            
            
            108,885
            
            
            110,964Depreciation
            
            
            1,134
            
            
            1,848
            
            
            3,763
            
            
            6,346Amortization
            
            
            908
            
            
            1,043
            
            
            2,911
            
            
            3,130Income
                (loss) from operations
            
            
            (1,379
            )
            
            (718
            )
            
            13,313
            
            
            9,480Interest
                income
            
            
            307
            
            
            310
            
            
            953
            
            
            592Interest
                expense
            
            
            (663
            )
            
            (29
            )
            
            (1,966
            )
            
            (95
            )Gain
                on disposal of investment in unconsolidated subsidiary
            
            
            -
            
            
            500
            
            
            -
            
            
            500Legal
                settlement
            
            
            -
            
            
            -
            
            
            873
            
            
            -Income
                (loss) before benefit for income taxes
            
            
            (1,735
            )
            
            63
            
            
            13,173
            
            
            10,477Income
                tax benefit
            
            
            2,754
            
            
            3,006
            
            
            292
            
            
            1,203Net
                income
            
            
            1,019
            
            
            3,069
            
            
            13,465
            
            
            11,680Preferred
                stock dividends
            
            
            (934
            )
            
            (2,184
            )
            
            (3,452
            )
            
            (6,551
            )Loss
                on recapitalization of preferred stock
            
            
            -
            
            
            (7,753
            )
            
            -
            
            
            (7,753
            )Net
                income (loss) available to common shareholders
            
            $
            85
            
            $
            (6,868
            )
            $
            10,013
            
            $
            (2,624
            )Net
                income (loss) available to common
              shareholders
                per share:Basic
            
            $
            .00
            
            $
            (.34
            )
            $
            .50
            
            $
            (.18
            )Diluted
            
            $
            .00
            
            $
            (.34
            )
            $
            .48
            
            $
            (.18
            )Weighted
                average number of common shares:Basic
            
            
            20,060
            
            
            19,922
            
            
            20,234
            
            
            19,847Diluted
            
            
            20,734
            
            
            19,922
            
            
            20,670
            
            
            19,847




See
      notes
      to condensed consolidated financial statements.


4


FRANKLIN
      COVEY CO.





CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS


(in
      thousands)


Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005(unaudited)Cash
                flows from operating activities:Net
                income
            
            $
            13,465
            
            $
            11,680Adjustments
                to reconcile net income to net cash provided by operatingactivities:Depreciation
                and amortization
            
            
            8,046
            
            
            11,082Restructuring
                cost reversal
            
            
            -
            
            
            (306
            )Stock-based
                compensation cost
            
            
            567
            
            
            729Compensation
                cost related to CEO common stock grant
            
            
            -
            
            
            404Gain
                on disposal of unconsolidated subsidiary
            
            
            -
            
            
            (500
            )Changes
                in assets and liabilities:Increase
                in accounts receivable, net
            
            
            (4,264
            )
            
            (6,095
            )Decrease
                (increase) in inventories
            
            
            (1,388
            )
            
            2,253Decrease
                in other assets
            
            
            856
            
            
            957Decrease
                in accounts payable and accrued liabilities
            
            
            (4,628
            )
            
            (5,450
            )Increase
                (decrease) in other long-term liabilities
            
            
            (192
            )
            
            470Increase
                (decrease) in income taxes payable
            
            
            (2,535
            )
            
            (1,547
            )Net
                cash provided by operating activities
            
            
            9,927
            
            
            13,677Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (3,318
            )
            
            (2,671
            )Purchases
                of short-term investments
            
            
            -
            
            
            (10,653
            )Sales
                of short-term investments
            
            
            -
            
            
            21,383Proceeds
                from sale of investment in unconsolidated subsidiary
            
            
            -
            
            
            500Curriculum
                development costs
            
            
            (1,812
            )
            
            (1,699
            )Net
                cash provided by (used for) investing activities
            
            
            (5,130
            )
            
            6,860Cash
                flows from financing activities:Principal
                payments on long-term debt and financing obligation
            
            
            (965
            )
            
            (87
            )Change
                in restricted cash
            
            
            699
            
            
            -Proceeds
                from sales of common stock from treasury
            
            
            333
            
            
            35Proceeds
                from management stock loan payments
            
            
            134
            
            
            840Redemption
                of preferred stock
            
            
            (20,000
            )
            
            -Purchase
                of treasury shares
            
            
            (3,982
            )
            
            (22
            )Payment
                of preferred stock dividends
            
            
            (3,952
            )
            
            (6,551
            )Net
                cash used for financing activities
            
            
            (27,733
            )
            
            (5,785
            )Effect
                of foreign exchange rates on cash and cash equivalents
            
            
            50
            
            
            (473
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            (22,886
            )
            
            14,279Cash
                and cash equivalents at beginning of the period
            
            
            51,690
            
            
            31,174Cash
                and cash equivalents at end of the period
            
            $
            28,804
            
            $
            45,453Supplemental
                disclosure of cash flow information:Cash
                paid for interest
            
            $
            2,001
            
            $
            79Cash
                paid for income taxes
            
            $
            2,284
            
            $
            770Non-cash
                investing and financing activities:Accrued
                preferred stock dividends
            
            $
            934
            
            $
            2,184Issuance
                of unvested common stock for compensation plans
            
            
            212
            
            
            720Loss
                on recapitalization of preferred stock
            
            
            -
            
            
            (7,753
            )Capital
                lease financing of property and equipment purchases
            
            
            109
            
            
            -


See
      notes
      to condensed consolidated financial statements.  5


FRANKLIN
      COVEY CO.





NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)




**NOTE
      1 - BASIS OF PRESENTATION**





Franklin
      Covey Co. (hereafter referred to as us, we, our, or the Company) provides
      integrated consulting, training, and performance enhancement solutions to
      organizations and individuals in strategy execution, productivity, leadership,
      sales force effectiveness, effective communications, and other areas. Each
      integrated solution may include components of training and consulting,
      assessment, and other application tools that are generally available in
      electronic or paper-based formats. Our products and services are available
      through professional consulting services, public seminars, retail stores,
      catalogs, and the Internet at www.franklincovey.com .
      Historically, the Company’s best-known offerings include the FranklinCovey
      PlannerTM, and a suite of new and updated individual-effectiveness and
      leadership-development training products based on the best-selling book, *The
      7
      Habits of Highly Effective People* .
      We also
      offer a range of training and assessment products to help organizations achieve
      superior results by focusing and executing on top priorities, building the
      capability of knowledge workers, and aligning business processes. These
      offerings include the popular workshop *FOCUS:
      Achieving Your Highest Priorities* TM, *The
      4
      Disciplines of Execution* TM, *The
      4
      Roles of Leadership* TM, *Building
      Business Acumen: What the CEO Wants You to Know* TM,
      the
      Advantage Series communication workshops, and the *Execution
      Quotient* ( *xQ* TM)
      organizational assessment tool.





The
      accompanying unaudited condensed consolidated financial statements reflect,
      in
      the opinion of management, all adjustments (which include only normal recurring
      adjustments, except as discussed below) necessary to present fairly the
      financial position and results of operations of the Company as of the dates
      and
      for the periods indicated. Certain information and footnote disclosures normally
      included in financial statements prepared in accordance with accounting
      principles generally accepted in the United States of America have been
      condensed or omitted pursuant to Securities and Exchange Commission (SEC) rules
      and regulations. The information included in this quarterly report on Form
      10-Q
      should be read in conjunction with the consolidated financial statements and
      related notes included in our Annual Report on Form 10-K for the fiscal year
      ended August 31, 2005.




During
        the quarter ended May 27, 2006, we determined that our Mexico subsidiary
        had
        misstated its financial results in prior periods by recording improper sales
        transactions and not recording all operating expenses in proper periods.
        We
        determined that the misstatements occurred during fiscal 2002 through fiscal
        2006 in various amounts. The Audit Committee engaged an independent legal
        firm
        to investigate the misstatements and they concluded that such misstatements
        were
        intentional. The Company determined that the impact of these misstatements
        was
        immaterial to previously issued financial statements and we recorded a $0.5 million
        decrease to international sales and a $0.5 million
        increase in selling, general, and administrative expenses during the quarter
        ended May 27, 2006 to correct these misstatements. We are currently in the
        process of taking actions as recommended by the investigators, which include
        enhancements to internal control over foreign operations.




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





The
      Company utilizes a modified 52/53-week fiscal year that ends on August 31 of
      each year. Corresponding quarterly periods generally consist of 13-week periods
      that ended on November 26, 2005, February 25, 2006, and May 27, 2006 during
      fiscal 2006. Under the modified 52/53-week fiscal year, the quarter and three
      quarters ended May 27, 2006 had the same number of business days as the
      corresponding periods of the prior fiscal year.





The
      results of operations for the quarter and three quarters ended May 27, 2006
      are
      not necessarily indicative of results expected for the entire fiscal year ending
      August 31, 2006.





Certain
      reclassifications have been made to the fiscal 2005 financial statements to
      conform with the current period presentation.


Return
      to Index


6


**NOTE
      2 - ACCOUNTING FOR STOCK-BASED
      COMPENSATION**





On
      September 1, 2005, the Company adopted the provisions of Statement of Financial
      Accounting Standards No. 123 (Revised 2004), *Share-Based
      Payment* (SFAS
      No.
      123R), which is a revision of SFAS No. 123, *Accounting
      for Stock-Based Compensation* .
      Statement 123R supersedes Accounting Principles Board (APB) Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      and
      amends SFAS No. 95, *Statement
      of Cash Flows* .
      Statement No. 123R requires all share based-payments to employees, including
      grants of stock options and the compensatory elements of employee stock purchase
      plans, to be recognized in the income statement based upon their fair
      values.





We
      previously accounted for our stock-based compensation using the intrinsic method
      as defined in APB Opinion No. 25 and accordingly, prior to September 1, 2005
      we
      did not recognize any expense for our employee stock purchase plan or incentive
      stock option plan in our consolidated financial statements. We used the modified
      prospective transition method to adopt the provisions of SFAS No. 123R. Under
      this method, unvested awards at the date of adoption as well as awards that
      are
      granted, modified, or settled after the date of adoption will be measured and
      accounted for in accordance with Statement 123R. Based upon our analysis of
      the
      requirements of SFAS No. 123R, we reclassified our unamortized deferred
      compensation related to the issuance of unvested common stock awards that was
      reported in the equity section of our balance sheet to additional paid-in
      capital. The following table presents the stock-based compensation expense
      included in our selling, general, and administrative expenses for the quarter
      and three quarters ended May 27, 2006 and the pro forma stock-based compensation
      amounts that would have been included in our income statements for the
      comparable periods of the prior year had stock-based compensation expense been
      determined in accordance with the fair value method prescribed by SFAS No.
      123
      and SFAS No. 148, *Accounting
      for Stock-Based Compensation: An Amendment of FASB Statement No.
      123* (in
      thousands):





Quarter
                Ended
            
            Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005
            
            May
                27,
              2006
            
            May
                28,
              2005Compensation
                cost of stock options
            
            $
            2
            
            $
            4(1)
            
            $
            6
            
            $
            2,103(1)Discount
                on employee stock purchase plan
            
            
            9
            
            
            -
            
            
            24
            
            
            4(1)Compensation
                cost of unvested stock awards
            
            
            321
            
            
            344
            
            
            537
            
            
            722Compensation
                cost of stock option agreement modifications
            
            
            -
            
            
            108(1)
            
            
            -
            
            
            108(1)Compensation
                cost of fully vested stock award
            
            
            -
            
            
            -
            
            
            -
            
            
            404Total
                stock-based compensation
            
            $
            332
            
            $
            456
            
            $
            567
            
            $
            3,341Net
                loss attributable to common shareholders, as reported
            
            
            
            
            $
            (6,868
            )
            
            
            
            $
            (2,624
            )Fair
                value of stock-based compensation excluded from net loss, net of
                tax
            
            
            
            
            
            (112
            )
            
            
            
            
            (2,215
            )Net
                income available to common shareholders, pro forma
            
            
            
            
            $
            (6,980
            )
            
            
            
            $
            (4,839
            )Basic
                and diluted earnings per share, as reported
            
            
            
            
            $
            (.34
            )
            
            
            
            $
            (.18
            )Basic
                and diluted earnings per share, pro forma
            
            
            
            
            $
            (.35
            )
            
            
            
            $
            (.29
            )





(1)
            Based
                upon the intrinsic method as defined in APB Opinion No. 25, this
                amount
                was excluded from operating expenses and net income prior to the
                adoption
                of SFAS No. 123(R) on September 1,
                2005.




7




The
      following is a description of activity in our stock-based compensation plans
      for
      the quarter and three quarters ended May 27, 2006.





**Stock
      Options**





The
      Company has an incentive stock option plan whereby options to purchase shares
      of
      our common stock are issued to key employees at an exercise price not less
      than
      the fair market value of the Company’s common stock on the date of grant. The
      term, not to exceed ten years, and exercise period of each incentive stock
      option awarded under the plan are determined by a committee appointed by our
      Board of Directors. During the three quarters ended May 27, 2006 we did not
      grant any new stock options and the remaining unamortized service cost on
      previously granted stock options is insignificant in aggregate. The intrinsic
      value of stock options exercised during the three quarters ended May 27, 2006
      was less than $0.1 million.
      The fair market value of options that vested during the quarter was zero and
      for
      the three quarters ended May 27, 2006 was approximately $6,000 .
      The
      Company generally issues shares of common stock for the exercise of stock
      options from shares held in treasury.





A
      summary
      of our stock option activity for the three quarters ended May 27, 2006 is as
      follows (in thousands, except share amounts):





Number
                of Stock Options
            
            Weighted
                Avg. Exercise PriceOutstanding
                at August 31, 2005
            
            
            2,285,884
            
            
            12.40Granted
            
            
            -
            
            
            -Exercised
            
            
            (35,537
            )
            
            5.50Forfeited
            
            
            (90,375
            )
            
            15.84Outstanding
                at May 27, 2006
            
            
            2,159,972
            
            
            12.37





The
      following additional information applies to our stock options outstanding at
      May
      27, 2006:





Range
                of
              Exercise
                Prices
            
            Number
                Outstanding at May 27, 2006
            
            Weighted
                Average Remaining Contractual Life (Years)
            
            Weighted
                Average Exercise Price
            
            Options
                Exercisable at May 27, 2006
            
            Weighted
                Average Exercise Price$1.70
                - $7.00
            
            
            232,912
            
            
            3.8
            
            $
            5.30
            
            
            207,912
            
            $
            5.73$7.75
                - $9.69
            
            
            316,500
            
            
            3.3
            
            
            9.19
            
            
            316,500
            
            
            9.19$14.00
                - $14.00
            
            
            1,602,000
            
            
            4.3
            
            
            14.00
            
            
            1,602,000
            
            
            14.00$17.69
                - $21.50
            
            
            8,560
            
            
            1.6
            
            
            17.82
            
            
            8,560
            
            
            17.82





The
      intrinsic value of our outstanding in-the-money options was $0.7 million
      and the intrinsic value of our exercisable in-the-money options was $0.5 million
      at May 27, 2006.





The
      Company did not issue any stock options to vendors or other non-employees during
      the three quarters ended May 27, 2006.





**Employee
      Stock Purchase Plan**





The
      Company has an employee stock purchase plan that offers qualified employees
      the
      opportunity to purchase shares of our common stock at a price equal to 85
      percent of the average fair market value of the Company’s common stock on the
      last trading day of the calendar month in each fiscal quarter. Based upon SFAS
      No. 123R, we determined that the discount offered to employees is compensatory
      and the amount is therefore expensed each quarter. A total of 7,546 and 21,920 shares
      were issued under this plan in the quarter and three quarters ended May 27,
      2006, respectively.


Return
      to Index


8


**Unvested
      Stock Awards**





***Employee
      Awards*** **-** During
      fiscal 2006 and in prior periods, we have granted unvested stock awards to
      certain employees as long-term incentives. The following is a brief description
      of these unvested stock awards that have been granted to employees.





**Awards
      Granted in Fiscal 2005 and Prior Periods -** These
      awards cliff vest five years from the grant date or on an accelerated basis
      if
      we achieve specified earnings levels. The compensation cost of these unvested
      stock awards was based on the fair value of the shares on the grant date and
      is
      expensed on a straight-line basis over the vesting (service) period of the
      awards. The recognition of compensation cost will be accelerated when we believe
      that it is probable that we will achieve the specified earnings thresholds
      and
      the shares will vest. We did not accelerate the vesting of any of these awards
      during the three quarters ended May 27, 2006.





**Fiscal
      2006 Long-Term Incentive Plan -** On
      January 20, 2006, the Company’s shareholders approved a stock-based long-term
      incentive plan (the LTIP) that permits the grant of unvested share awards of
      common stock to certain employees as directed by the Compensation Committee
      of
      the Board of Directors. The LTIP share awards granted during fiscal 2006 cliff
      vest on August
      31, 2008 ,
      which
      is the completion of a three-year performance period. The number of shares
      that
      are finally awarded to LTIP participants is variable and is based entirely
      upon
      the achievement of a combination of performance objectives related to sales
      growth and operating income during the three-year performance period. The
      Compensation Committee initially granted awards for 377,665 shares
      (target award) of common stock; the number of shares finally awarded will range
      from zero shares, if a minimum level of performance is not achieved, to 200
      percent of the target award, if specifically defined performance criteria is
      achieved during the three-year performance period.





The
      LTIP
      shares were valued at $6.60 per
      share, which was the closing price of our common stock on the grant date. The
      corresponding compensation cost of the award, based upon the target award number
      of shares, totaled $2.5 million,
      which is being expensed over the service period of the award. Due to the
      variable number of shares that may be issued under the LTIP, we reevaluate
      the
      LTIP on a quarterly basis and adjust the number of shares expected to be awarded
      based upon financial results of the Company as compared to 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 date
      of adjustment based upon the probable number of shares to be awarded. There
      was
      no adjustment to the number of shares expected to be issued under the LTIP
      during the three quarters ended May 27, 2006. The total compensation cost of
      the
      LTIP is equal to the number of shares finally issued multiplied by $6.60 per
      share, the fair value of the common shares determined at the grant
      date.





***Board
      of Director Awards*** - During
      January 2006, the Company’s shareholders also approved changes to our
      non-employee directors’ stock incentive plan (the Directors’ Plan). The
      Directors’ plan was designed to provide non-employee directors of the Company,
      who are ineligible to participate in our employee stock incentive plan, an
      opportunity to acquire an interest in the Company through the acquisition of
      shares of common stock. Under the previous provisions of the Directors’ Plan,
      each non-employee director received an annual unvested stock award with a value
      (based on the trading price of the Company’s common stock on the date of the
      award) equal to $27,500. The primary modification to the Directors’ plan
      approved by the shareholders changes the annual unvested stock grant to 4,500
      shares of common stock rather than the dollar value previously defined in the
      plan. The amendment also eliminates the limitation on the maximum dollar value
      of all awards made under the Directors’ Plan in any given year.





During
      the three quarters ended May 27, 2006, we granted 27,000 shares
      of unvested stock to members of our Board of Directors under the Directors’
Plan. The compensation cost of the Board of Director award was $0.2 million
      and was calculated at $7.84 per
      share, which was the fair value of the Company’s common stock on the grant date.
      The common stock issued to the Board of Directors was previously recorded as
      treasury stock and had a cost basis of $0.5 million.
      The difference between the compensation cost of the award and the cost of the
      shares issued was recorded to additional paid-in capital.





A
      summary
      of our unvested stock award activity for the three quarters ended May 27, 2006
      is as follows (in thousands, except share amounts):





Number
                of Unvested Shares
            
            Compensation
                CostOutstanding
                shares and unamortized compensation cost at August 31,
                2005
            
            
            409,295
            
            $
            1,055Granted
            
            
            -
            
            
            -Vested
            
            
            -
            
            
            -Amortization
                of compensation
            
            
            n/a
            
            
            (68
            )Outstanding
                shares and unamortized compensation cost at November 26,
                2005
            
            
            409,295
            
            
            987Granted
            
            
            377,665
            
            
            2,493Vested
            
            
            -
            
            
            -Amortization
                of compensation
            
            
            n/a
            
            
            (148
            )Outstanding
                shares and unamortized compensation cost at February 25,
                2006
            
            
            786,960
            
            $
            3,332Granted
            
            
            27,000
            
            
            211Vested
            
            
            -
            
            
            -Amortization
                of compensation
            
            
            n/a
            
            
            (321
            )Outstanding
                shares and unamortized compensation cost at May 27, 2006
            
            
            813,960
            
            $
            3,222





The
      intrinsic value of our unvested stock awards (both employee and Board of
      Director awards) was $6.5 million,
      which was based upon our closing stock price of $7.99 per
      share on May 27, 2006.




9


**NOTE
      3 - INVENTORIES**





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





May
                27,
              2006
            
            August
                31,
              2005Finished
                goods
            
            $
            19,408
            
            $
            18,161Work
                in process
            
            
            299
            
            
            825Raw
                materials
            
            
            2,688
            
            
            1,989$
            22,395
            
            $
            20,975




**NOTE
      4 - INTANGIBLE ASSETS**





The
      Company’s intangible assets were comprised of the following (in
      thousands):





***May
                27, 2006***
            
            Gross
                Carrying Amount
            
            Accumulated
                Amortization
            
            Net
                Carrying Amount*Definite-lived
                intangible assets:*License
                rights
            
            $
            27,000
            
            $
            (7,183
            )
            $
            19,817Curriculum
            
            
            58,233
            
            
            (26,442
            )
            
            31,791Customer
                lists
            
            
            18,774
            
            
            (12,943
            )
            
            5,831Trade
                names
            
            
            1,277
            
            
            (1,277
            )
            
            -105,284
            
            
            (47,845
            )
            
            57,439*Indefinite-lived
                intangible asset:*Covey
                trade name
            
            
            23,000
            
            
            -
            
            
            23,000Balance
                at May 27, 2006
            
            $
            128,284
            
            $
            (47,845
            )
            $
            80,439***August
                31, 2005****Definite-lived
                intangible assets:*License
                rights
            
            $
            27,000
            
            $
            (6,480
            )
            $
            20,520Curriculum
            
            
            58,232
            
            
            (25,146
            )
            
            33,086Customer
                lists
            
            
            18,774
            
            
            (12,032
            )
            
            6,742Trade
                names
            
            
            1,277
            
            
            (1,277
            )
            
            -105,283
            
            
            (44,935
            )
            
            60,348*Indefinite-lived
                intangible asset:*Covey
                trade name
            
            
            23,000
            
            
            -
            
            
            23,000Balance
                at August 31, 2005
            
            $
            128,283
            
            $
            (44,935
            )
            $
            83,348





The
      Company’s aggregate amortization expense totaled $0.9 million
      for the quarter ended May 27, 2006 and $1.0 million
      during the quarter ended May 28, 2005. For the three quarters ended May 27,
      2006
      our total amortization expense was $2.9 million
      compared to $3.1 million
      for the three quarters ended May 28, 2005.





**NOTE
      5 -****PREFERRED STOCK REDEMPTIONS AND
      PURCHASES OF
      COMPANY COMMON STOCK**




**Preferred
      Stock Redemptions**





During
      the three quarters ended May 27, 2006 we have redeemed $20.0 million,
      or approximately 800,000 shares
      of preferred stock. Since the recapitalization of our preferred stock in March
      2005, we have redeemed a total of $50.0 million,
      or approximately 2.0 million
      shares, of our outstanding Series A preferred stock. These preferred stock
      redemptions have reduced the Company’s preferred dividend obligation by $5.0 million
      per year.





At
      our
      Annual Meeting of Shareholders held in January 2006, we obtained shareholder
      approval of an amendment to our articles of incorporation that extends the
      period during which we have the right to redeem outstanding shares of preferred
      stock at 100 percent of its liquidation preference. The amendment extends the
      current redemption deadline from March 8, 2006 to December 31, 2006 and also
      provides the right to extend the redemption period for an additional year to
      December 31, 2007, if another $10.0 million of preferred stock is redeemed
      before December 31, 2006. During February 2006 we redeemed the preferred stock
      necessary to satisfy the additional extension provision and the Company can
      redeem preferred stock at the liquidation preference through December 31,
      2007.





**Common
      Stock Purchases**





During
      January 2006, our Board of Directors authorized the purchase of up to $10.0 million
      of our currently outstanding common stock. The purchases will be made at the
      Company’s discretion at prevailing market prices and will be subject to
      customary regulatory requirements and considerations. The Company does not
      have
      a timetable for the purchase of these common shares and the authorization by
      the
      Board of Directors does not have an expiration date. During the quarter ended
      May 27, 2006, we purchased 275,300 shares
      of our common stock for $2.4 million.
      Through the three quarters ended May 27, 2006 we have purchased 485,500 shares
      of our common stock under the terms of this newly authorized plan for $3.9 million.


Return
      to Index


10


**NOTE
      6 - INCOME TAX BENEFIT**





The
      Company recorded income tax benefits totaling $2.8 million
      during the quarter ended May 27, 2006 and $3.0 million
      during the quarter ended May 28, 2005. We regularly evaluate our United States
      federal and various state and foreign jurisdiction income tax exposures and
      record reserves against tax exposures based upon the probability that the tax
      exposure would be sustained by various tax jurisdictions. We recognize the
      benefits of the tax exposure items in the financial statements, that is, the
      reserve is reversed when it becomes probable that the tax position will be
      sustained. To assess the probability of sustaining a tax position, the Company
      considers all available positive evidence. In many instances, sufficient
      positive evidence may not be available until the expiration of the statute
      of
      limitations for assessment by tax authorities, at which time the entire benefit
      will be recognized as a discrete item in the applicable period. The income
      tax
      benefits recorded during the quarters ended May 27, 2006 and May 28, 2005
      resulted primarily from the expiration of the statute of
      limitations for various tax exposures, which was partially offset by income
      taxes incurred by our profitable foreign subsidiaries and foreign income taxes
      on payments received from foreign licensees.





During
      the periods ended May 27, 2006 and May 28, 2005, we were unable to offset our
      tax liabilities in foreign jurisdictions with our domestic operating loss
      carryforwards. In addition, a history of significant operating losses has
      precluded us from demonstrating that it is more likely than not that the
      benefits of domestic operating loss carryforwards, together with the benefits
      of
      other deferred income tax assets will be realized. Accordingly, we have recorded
      valuation allowances on the majority of our domestic deferred income tax assets.
      However, as operating results continue to improve and taxable income continues
      to increase, we are accumulating positive evidence which may allow us to reverse
      these valuation allowances on the deferred income tax assets in a future
      period.




**NOTE
      7 - LEGAL SETTLEMENT**





In
      fiscal
      2002, we filed legal action against World Marketing Alliance, Inc., a Georgia
      corporation (WMA), and World Financial Group, Inc., a Delaware corporation
      and
      purchaser of substantially all assets of WMA, for breach of contract. The case
      proceeded to trial and the jury rendered a verdict in our favor and against
      WMA
      on November 1, 2004 for the entire unpaid contract amount of approximately $1.1 million.
      In addition to the verdict, we recovered legal fees totaling $0.3 million
      and pre- and post-judgment interest of $0.3 million from WMA. During our fiscal
      quarter ended May 28, 2005, we received payment in cash from WMA for the total
      verdict amount, including legal fees and interest. However, shortly after paying
      the verdict amount, WMA appealed the jury decision to the 10th Circuit Court
      of
      Appeals and we recorded receipt of the verdict amount plus legal fees and
      interest with a corresponding increase to accrued liabilities and deferred
      the
      gain until the case was finally resolved. On December 30, 2005, the Company
      entered into a settlement agreement with WMA. Under the terms of the settlement
      agreement, WMA agreed to dismiss its appeal. As a result of this settlement
      agreement and dismissal of WMA’s appeal, we recorded a $0.9 million
      gain from the legal settlement and a $0.3 million
      reduction in selling, general, and administrative expenses during the second
      quarter of fiscal 2006.




**NOTE
      8 - COMPREHENSIVE INCOME**





Comprehensive
      income is based on net income and includes charges and credits to equity
      accounts that are not the result of transactions with shareholders.
      Comprehensive income for the Company was calculated as follows (in
      thousands):





Quarter
                Ended
            
            Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005
            
            May
                27,
              2006
            
            May
                28,
              2005Net
                income
            
            $
            1,019
            
            $
            3,069
            
            $
            13,465
            
            $
            11,680Other
                comprehensive income (loss) items:Adjustment
                for fair value of foreign currency hedge derivatives
            
            
            -
            
            
            -
            
            
            -
            
            
            (318
            )Foreign
                currency translation adjustments
            
            
            434
            
            
            (455
            )
            
            214
            
            
            (52
            )Comprehensive
                income
            
            $
            1,453
            
            $
            2,614
            
            $
            13,679
            
            $
            11,310




11


**NOTE
      9 - EARNINGS PER SHARE**





Basic
      earnings per common share (EPS) is calculated by dividing net income available
      to common shareholders by the weighted-average number of common shares
      outstanding for the period. Diluted EPS is calculated by dividing net income
      available to common shareholders by the weighted-average number of common shares
      outstanding plus the assumed exercise of all dilutive securities using the
      treasury stock method or the “as converted” method, as appropriate. Following
      the preferred stock recapitalization that was completed in March 2005, our
      preferred stock is no longer convertible into common stock or entitled to
      participate in dividends payable to holders of common stock. Accordingly, we
      no
      longer use the two-class method of calculating EPS as defined in SFAS No. 128, *Earnings
      Per Share* ,
      and
      EITF Issue 03-6, *Participating
      Securities and the Two-Class Method under FASB Statement No.
      128* ,
      for
      periods after February 26, 2005.





The
      following table sets forth the computation of basic and diluted EPS for the
      periods indicated (in thousands, except per share amounts):





Quarter
                Ended
            
            Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005
            
            May
                27,
              2006
            
            May
                28,
              2005Net
                income
            
            $
            1,019
            
            $
            3,069
            
            $
            13,465
            
            $
            11,680Non-convertible
                preferred stock dividends
            
            
            (934
            )
            
            (2,184
            )
            
            (3,452
            )
            
            (2,184
            )Convertible
                preferred stock dividends
            
            
            -
            
            
            -
            
            
            -
            
            
            (4,367
            )Loss
                on recapitalization of preferred stock
            
            
            -
            
            
            (7,753
            )
            
            -
            
            
            (7,753
            )Net
                income (loss) available to common shareholders
            
            $
            85
            
            $
            (6,868
            )
            $
            10,013
            
            $
            (2,624
            )Convertible
                preferred stock dividends
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            4,367Weighted
                average preferred shares on an as converted basis
            
            
            -
            
            
            -
            
            
            -
            
            
            6,239Distributed
                EPS - preferred
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            .70Undistributed
                income (loss) through February 26, 2005
            
            $
            -
            
            $
            (6,868
            )
            $
            -
            
            $
            4,244Preferred
                ownership on an as converted basis
            
            
            -
            
            
            -
            
            
            -
            
            
            24
            %Preferred
                shareholders interest in undistributed income
            
            
            -
            
            
            -
            
            
            -
            
            
            1,019Weighted
                average preferred shares on an as converted basis
            
            
            -
            
            
            
            
            
            -
            
            
            6,239Undistributed
                EPS - preferred
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            .16Undistributed
                income (loss)
            
            $
            85
            
            $
            (6,868
            )
            $
            10,013
            
            $
            4,244Common
                stock ownership
            
            
            100
            %
            
            100
            %
            
            100
            %
            
            76
            %Common
                shareholder interest in undistributed income (loss)
            
            
            85
            
            
            -
            
            
            10,013
            
            
            3,225Undistributed
                loss for the quarter ended May 28, 2005
            
            
            -
            
            
            (6,868
            )
            
            -
            
            
            (6,868
            )Common
                shareholder interest in undistributed loss
            
            $
            85
            
            $
            (6,868
            )
            $
            10,013
            
            $
            (3,643
            )Weighted
                average common shares outstanding - Basic
            
            
            20,060
            
            
            19,922
            
            
            20,234
            
            
            19,847Effect
                of dilutive securities(1):Stock
                options
            
            
            75
            
            
            -
            
            
            55
            
            
            -Unvested
                stock awards
            
            
            403
            
            
            -
            
            
            315
            
            
            -Common
                stock warrants
            
            
            196
            
            
            -
            
            
            66
            
            
            -Weighted
                average common shares outstanding - Diluted
            
            
            20,734
            
            
            19,922
            
            
            20,670
            
            
            19,847Basic
                EPS - Common
            
            $
            .00
            
            $
            (.34
            )
            $
            .50
            
            $
            (.18
            )Diluted
                EPS - Common
            
            $
            .00
            
            $
            (.34
            )
            $
            .48
            
            $
            (.18
            )





(1) For
      the
      quarter and three quarters ended May 28, 2005, conversion of common share
      equivalents is not assumed because such conversion would be
      anti-dilutive.





At
      May
      27, 2006, we had approximately 1.8 million
      stock options outstanding which were not included in the computation of diluted
      EPS because the options’ exercise prices were greater than the average market
      price of the Company’s common shares. At May 28, 2005, we had approximately 2.3 million
      stock options that were not considered in our calculation of diluted EPS that
      may have a dilutive effect on the Company’s EPS calculation in future
      periods.


Return
      to Index


12


**NOTE
      10 - SEGMENT INFORMATION**





The
      Company has two segments: the Consumer and Small Business Unit (CSBU) and the
      Organizational Solutions Business Unit (OSBU). The following is a description
      of
      our segments, their primary operating components, and their significant business
      activities:





***Consumer
      and Small Business Unit -*** This
      business unit is primarily focused on sales to individual customers and small
      business organizations and includes the results of our domestic retail stores,
      consumer direct operations (catalog, eCommerce, and public seminars programs),
      wholesale operations, and other related distribution channels, including
      government product sales and domestic printing and publishing sales. The CSBU
      results of operations also include the financial results of our paper planner
      manufacturing operations. Although CSBU sales primarily consist of products
      such
      as planners, binders, software, and handheld electronic planning devices,
      virtually any component of our leadership, productivity, and strategy execution
      solutions may be purchased through our CSBU channels.





***Organizational
      Solutions Business Unit -*** The
      OSBU
      is primarily responsible for the development, marketing, sale, and delivery
      of
      strategic execution, productivity, leadership, sales force performance, and
      communication training and consulting solutions directly to organizational
      clients, including other companies, the government, and educational
      institutions. The OSBU includes the financial results of our domestic sales
      force and our international operations. The domestic sales force is responsible
      for the sale and delivery of our training and consulting services in the United
      States. Our international sales group includes the financial results of our
      directly owned foreign offices and royalty revenues from licensees.





The
      Company’s chief operating decision maker is the CEO, and each of the segments
      has a president who reports directly to the CEO. The primary measurement tool
      used in business unit performance analysis is earnings before interest, taxes,
      depreciation, and amortization (EBITDA), which may not be calculated as
      similarly titled amounts calculated by other companies. For segment reporting
      purposes, the Company’s consolidated EBITDA can be calculated as its income from
      operations excluding depreciation and amortization charges.





In
      the
      normal course of business, the Company may make structural and cost allocation
      revisions to its segment information to reflect new reporting responsibilities
      within the organization. During the first quarter of fiscal 2006, we transferred
      our public seminar programs from the domestic unit of OSBU to the consumer
      direct channel in CSBU. We also transferred the operations of certain corporate
      departments, such as Franklin Covey travel and accounts payable, to the
      operating segments. All prior period segment information has been revised to
      conform to the most recent classifications and organizational changes. The
      Company accounts for its segment information on the same basis as the
      accompanying condensed consolidated financial statements.




13
 SEGMENT
        INFORMATION


(in
                thousands)*Quarter
                Ended*
              *May
                27, 2006*
            
            Sales
                to External Customers
            
            Gross
                Profit
            
            EBITDA
            
            Depreciation
            
            Amortization**Consumer
                and Small Business Unit:**Retail
            
            $
            11,493
            
            $
            6,347
            
            $
            (1,018
            )
            $
            274
            
            $
            -Consumer
                direct
            
            
            12,504
            
            
            7,479
            
            
            5,509
            
            
            16
            
            
            -Wholesale
            
            
            6,920
            
            
            3,632
            
            
            3,447
            
            
            -
            
            
            -Other
                CSBU
            
            
            1,168
            
            
            119
            
            
            (6,870
            )
            
            300
            
            
            -Total
                CSBU
            
            
            32,085
            
            
            17,577
            
            
            1,068
            
            
            590
            
            
            -**Organizational
                Solutions Business Unit:**Domestic
            
            
            17,807
            
            
            10,879
            
            
            639
            
            
            85
            
            
            902International
            
            
            13,390
            
            
            7,836
            
            
            415
            
            
            289
            
            
            6Total
                OSBU
            
            
            31,197
            
            
            18,715
            
            
            1,054
            
            
            374
            
            
            908Total
                operating segments
            
            
            63,282
            
            
            36,292
            
            
            2,122
            
            
            964
            
            
            908Corporate
                and eliminations
            
            
            -
            
            
            -
            
            
            (1,459
            )
            
            170
            
            
            -Consolidated
            
            $
            63,282
            
            $
            36,292
            
            $
            663
            
            $
            1,134
            
            $
            908*Quarter
                Ended*
              *May
                28, 2005***Consumer
                and Small Business Unit:**Retail
            
            $
            13,443
            
            $
            7,392
            
            $
            (1,083
            )
            $
            614
            
            $
            -Consumer
                direct
            
            
            12,144
            
            
            7,153
            
            
            3,876
            
            
            23
            
            
            -Wholesale
            
            
            7,627
            
            
            3,459
            
            
            3,292
            
            
            -
            
            
            -Other
                CSBU
            
            
            792
            
            
            (39
            )
            
            (5,925
            )
            
            650
            
            
            86Total
                CSBU
            
            
            34,006
            
            
            17,965
            
            
            160
            
            
            1,287
            
            
            86**Organizational
                Solutions Business Unit:**Domestic
            
            
            18,736
            
            
            11,629
            
            
            2,313
            
            
            74
            
            
            954International
            
            
            13,046
            
            
            8,674
            
            
            2,744
            
            
            331
            
            
            2Total
                OSBU
            
            
            31,782
            
            
            20,303
            
            
            5,057
            
            
            405
            
            
            956Total
                operating segments
            
            
            65,788
            
            
            38,268
            
            
            5,217
            
            
            1,692
            
            
            1,042Corporate
                and eliminations
            
            
            -
            
            
            -
            
            
            (3,044
            )
            
            156
            
            
            1Consolidated
            
            $
            65,788
            
            $
            38,268
            
            $
            2,173
            
            $
            1,848
            
            $
            1,043*Three
                Quarters Ended*
              *May
                27, 2006***Consumer
                and Small Business Unit:**Retail
            
            $
            50,001
            
            $
            29,359
            
            $
            4,404
            
            $
            1,056
            
            $
            -Consumer
                direct
            
            
            50,291
            
            
            30,311
            
            
            23,992
            
            
            43
            
            
            -Wholesale
            
            
            17,148
            
            
            8,680
            
            
            8,142
            
            
            -
            
            
            -Other
                CSBU
            
            
            3,622
            
            
            630
            
            
            (22,525
            )
            
            957
            
            
            57Total
                CSBU
            
            
            121,062
            
            
            68,980
            
            
            14,013
            
            
            2,056
            
            
            57**Organizational
                Solutions Business Unit:**Domestic
            
            
            49,423
            
            
            31,677
            
            
            2,985
            
            
            249
            
            
            2,845International
            
            
            43,481
            
            
            28,215
            
            
            8,320
            
            
            940
            
            
            9Total
                OSBU
            
            
            92,904
            
            
            59,892
            
            
            11,305
            
            
            1,189
            
            
            2,854Total
                operating segments
            
            
            213,966
            
            
            128,872
            
            
            25,318
            
            
            3,245
            
            
            2,911Corporate
                and eliminations
            
            
            -
            
            
            -
            
            
            (5,331
            )
            
            518
            
            
            -Consolidated
            
            $
            213,966
            
            $
            128,872
            
            $
            19,987
            
            $
            3,763
            
            $
            2,911*Three
                Quarters Ended*
              *May
                28, 2005***Consumer
                and Small Business Unit:**Retail
            
            $
            59,886
            
            $
            34,369
            
            $
            5,453
            
            $
            2,136
            
            $
            -Consumer
                direct
            
            
            49,390
            
            
            29,455
            
            
            19,274
            
            
            517
            
            
            -Wholesale
            
            
            16,107
            
            
            7,536
            
            
            6,995
            
            
            -
            
            
            -Other
                CSBU
            
            
            2,542
            
            
            (1,289
            )
            
            (20,416
            )
            
            2,016
            
            
            258Total
                CSBU
            
            
            127,925
            
            
            70,071
            
            
            11,306
            
            
            4,669
            
            
            258**Organizational
                Solutions Business Unit:**Domestic
            
            
            48,303
            
            
            31,756
            
            
            5,293
            
            
            228
            
            
            2,862International
            
            
            41,187
            
            
            28,093
            
            
            9,903
            
            
            994
            
            
            5Total
                OSBU
            
            
            89,490
            
            
            59,849
            
            
            15,196
            
            
            1,222
            
            
            2,867Total
                operating segments
            
            
            217,415
            
            
            129,920
            
            
            26,502
            
            
            5,891
            
            
            3,125Corporate
                and eliminations
            
            
            -
            
            
            -
            
            
            (7,546
            )
            
            455
            
            
            5Consolidated
            
            $
            217,415
            
            $
            129,920
            
            $
            18,956
            
            $
            6,346
            
            $
            3,130


14


A
      reconciliation of operating segment EBITDA to consolidated income before taxes
      is provided below (in thousands):





Quarter
                Ended
            
            Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005
            
            May
                27,
              2006
            
            May
                28,
              2005Reportable
                segment EBITDA
            
            $
            2,122
            
            $
            5,217
            
            $
            25,318
            
            $
            26,502Restructuring
                cost reversal
            
            
            -
            
            
            -
            
            
            -
            
            
            306Corporate
                expenses
            
            
            (1,459
            )
            
            (3,044
            )
            
            (5,331
            )
            
            (7,852
            )Consolidated
                EBITDA
            
            
            663
            
            
            2,173
            
            
            19,987
            
            
            18,956Depreciation
            
            
            (1,134
            )
            
            (1,848
            )
            
            (3,763
            )
            
            (6,346
            )Amortization
            
            
            (908
            )
            
            (1,043
            )
            
            (2,911
            )
            
            (3,130
            )Income
                (loss) from operations
            
            
            (1,379
            )
            
            (718
            )
            
            13,313
            
            
            9,480Interest
                income
            
            
            307
            
            
            310
            
            
            953
            
            
            592Interest
                expense
            
            
            (663
            )
            
            (29
            )
            
            (1,966
            )
            
            (95
            )Recovery
                of investment in unconsolidated subsidiary
            
            
            -
            
            
            500
            
            
            -
            
            
            500Legal
                settlement
            
            
            -
            
            
            -
            
            
            873
            
            
            -Income
                (loss) before income tax benefit
            
            $
            (1,735
            )
            $
            63
            
            $
            13,173
            
            $
            10,477




**NOTE
      11 - MANAGEMENT COMMON STOCK LOAN
      MODIFICATIONS**





During
      the quarter ended May 27, 2006, the Company offered participants in its
      management common stock loan program the opportunity to formally modify the
      terms of their loans in exchange for placing their shares of common stock
      obtained through the loan program in an escrow account that allows the Company
      to have a security interest in the loan program shares. The key modifications
      to
      the management common stock loans for the participants accepting the offer
      are
      as follows:





·
            **Modification
                of Promissory Note -**The
                management stock loan due date will be changed to be the earlier
                of (a)
                March 30, 2013, or (b) the date on which the Company’s stock closes, as
                reported by the exchange or market that is the principal market for
                our
                common stock, at or above the price per share such that the value
                of the
                shares acquired by the participants under the program is equal to
                the
                principal and accrued interest on the participants’ promissory notes
                (Breakeven Date). The interest rate on the loans will increase from
                3.16
                percent compounded annually to 4.72 percent compounded
                annually.





·
            **Redemption
                of Management Loan Program Shares -**The
                Company will have the right to redeem the shares on the due date
                in
                satisfaction of the promissory notes as
                follows:





(a)
            On
                the Breakeven Date, the Company has the right to purchase and redeem
                from
                the loan participants the number of loan program shares necessary
                to
                satisfy the participant’s obligation under the promissory note. The
                redemption price for each such loan program share will be equal to
                the
                closing price of our common stock on the Breakeven
                Date. (b)
            If the Company’s stock has not closed at or above the
              breakeven price on or before March 30, 2013, the Company has the right
              to
              purchase and redeem from the participants all of their loan program
              shares
              at the closing price on that date as partial payment on the participant’s
              obligation.




Loan
      program participants may choose whether or not to place their loan program
      shares in the escrow account and accept the modification agreement. If a loan
      participant declines the offer to modify their management stock loan, their
      loan
      will continue to have the same terms and conditions that were previously
      approved in May 2004 by the Company’s Board of Directors and their loans will be
      due at the earlier of March 30, 2008 or the Breakeven Date. The Company believes
      that the new modifications improve its ability to collect the shares purchased
      by participants through establishing a security interest in the shares and
      facilitates redemption of the loan program shares from participants on the
      due
      date. Consistent with the May 2004 modifications, participants will be unable
      to
      realize a gain on the loan program shares unless they pay cash to satisfy the
      promissory note obligation prior to the due date.





Due
      to
      the loan program modifications that were approved in May 2004, we currently
      account for the management common stock loans as stock option arrangements.
      Under the provisions of SFAS No. 123R, which we adopted on September 1, 2005,
      additional compensation expense will be recognized only if the Company takes
      action that constitutes a modification that increases the fair value of the
      arrangements. Since these new modifications do not increase the fair value
      of
      the arrangements, no compensation expense was recognized.


Return
      to Index


15


ITEM
      2.  MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS




Management’s
      discussion and analysis contains forward-looking statements within the meaning
      of the Private Securities Litigation Reform Act of 1995. These statements are
      based upon management’s current expectations and are subject to various
      uncertainties and changes in circumstances. Important factors that could cause
      actual results to differ materially from those described in forward-looking
      statements are set forth below under the heading Safe Harbor Statement Under
      the
      Private Securities Litigation Reform Act of 1995.





The
      Company suggests that the following discussion and analysis be read in
      conjunction with the Consolidated Financial Statements and Management’s
      Discussion and Analysis of Financial Condition and Results of Operations
      included in our Annual Report on Form 10-K for the year ended August 31,
      2005.




**RESULTS
      OF OPERATIONS**





**Overview**





Our
      third
      fiscal quarter, which includes the months of March, April, and May, has
      historically reflected seasonally lower product sales, but generally stronger
      training and consulting service sales compared to our first two fiscal quarters.
      As a result of these seasonal product sales factors, our third fiscal quarter
      has typically not been as profitable as other quarters of our fiscal year.
      For
      the quarter ended May 27, 2006, our loss from operations increased to $1.4 million
      compared to $0.7 million
      in the prior year and our after-tax net income declined to $1.0 million
      compared to $3.1 million
      in the comparable quarter of the prior year. However, due to significantly
      reduced preferred dividends resulting from preferred stock redemptions, and
      a
      $7.8 million loss recognized on the recapitalization of our preferred stock
      in
      fiscal 2005, our income available to common shareholders improved to $0.1 million
      compared to a $6.9 million
      loss recognized in the corresponding quarter of fiscal 2005.





The
      primary factors that influenced our operating results for the quarter ended
      May
      27, 2006 were as follows:





·
            ***Sales*****-**Product
                sales declined$3.0million due to fewer retail stores being open during the quarter,
                reduced
                wholesale sales, and reduced technology and specialty product sales.
                Partially offsetting these declines were improved “core” product sales
                performance, including planners, binders, totes, and other planning
                tools
                and accessories. Training and consulting services sales increased$0.5million primarily due to increased international sales and improved*The
                7 Habits of Highly Effective People*training
                program sales, which were partially offset by decreased sales
                effectiveness training sales. As a result of these factors, our total
                sales decreased by$2.5million, or4percent, compared to the corresponding quarter of the prior
                year.





·
            ***Gross
                Profit***-
                When compared to the prior year, our gross profit declined due to
                decreased sales. Our gross margin, which is gross profit in terms
                of a
                percentage of sales, declined to57.3percent compared to58.2percent in the prior year. The decrease was primarily due to increased
                costs for our annual Symposium conference events that were held during
                the
                quarter.





·
            ***Operating
                Costs***-
                Our operating costs declined by$1.3million compared to the prior year, which was the result of selling,
                general, and administrative expense decreases totaling$0.5million, a$0.7million decrease in depreciation expense, and a$0.1million decrease in amortization
                expense.




·
            ***Income
                Tax Benefit***-
                During the quarter ended May 27, 2006, we recognized income tax benefits
                totaling$2.8million compared to income tax benefits of$3.0million in fiscal 2005. The tax benefits recorded during these quarters
                were primarily the result of the expiration of the statute of limitations
                for various tax exposures, which were partially offset by income
                taxes
                incurred by our profitable foreign subsidiaries and foreign income
                taxes
                on payments received from foreign
                licensees.





·
            ***Preferred
                Stock Dividends***-
                Due to preferred stock redemptions in fiscal 2005 and the first two
                quarters of fiscal 2006 totaling$50.0million, our preferred stock dividends decreased by$1.3million compared to the corresponding quarter of fiscal
                2005.





·
            ***Correction
                of Foreign Subsidiary Misstatements***-
                During the quarter ended May 27, 2006, we determined that our Mexico
                subsidiary had misstated its financial results in prior periods by
                recording improper sales transactions and not recording all operating
                expenses in proper periods. We determined that the misstatements
                occurred
                during fiscal 2002 through fiscal 2006 in various amounts. The Audit
                Committee engaged an independent legal firm to investigate the
                misstatements and they concluded that such misstatements were intentional.
                We are in the process of taking actions as recommended by the
                investigators, which include enhancements to internal control over
                foreign
                operations. The Company determined that the impact of these misstatements
                was immaterial to previously issued financial statements and we recorded
                a$0.5million decrease to international sales and a$0.5million increase in selling, general, and administrative expenses
                during
                the quarter ended May 27, 2006 to correct these
                misstatements.





Further
      details regarding these factors and their impact on our operating results and
      liquidity are provided throughout the following management’s discussion and
      analysis.





16


Quarter
      Ended May 27, 2006 Compared to the Quarter Ended May 28, 2005





**Sales**





The
      following table sets forth sales data by category and for our operating segments
      (in thousands):





Quarter
                Ended
            
            Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005
            
            Percent
                Change
            
            May
                27,
              2006
            
            May
                28,
              2005
            
            Percent
                Change*Sales
                by Category:*Products
            
            $
            32,184
            
            $
            35,217
            
            
            (9)
            
            $
            126,428
            
            $
            134,443
            
            
            (6)Training
                and consulting services
            
            
            31,098
            
            
            30,571
            
            
            2
            
            
            87,538
            
            
            82,972
            
            
            6$
            63,282
            
            $
            65,788
            
            
            (4)
            
            $
            213,966
            
            $
            217,415
            
            
            (2)*Consumer
                and Small Business Unit:*Retail
                Stores
            
            $
            11,493
            
            $
            13,443
            
            
            (15)
            
            $
            50,001
            
            $
            59,886
            
            
            (17)Consumer
                Direct
            
            
            12,504
            
            
            12,144
            
            
            3
            
            
            50,291
            
            
            49,390
            
            
            2Wholesale
            
            
            6,920
            
            
            7,627
            
            
            (9)
            
            
            17,148
            
            
            16,107
            
            
            6Other
                CSBU
            
            
            1,168
            
            
            792
            
            
            47
            
            
            3,622
            
            
            2,542
            
            
            4232,085
            
            
            34,006
            
            
            (6)
            
            
            121,062
            
            
            127,925
            
            
            (5)*Organizational
                Solutions Business Unit:*Domestic
            
            
            17,807
            
            
            18,736
            
            
            (5)
            
            
            49,423
            
            
            48,303
            
            
            2International
            
            
            13,390
            
            
            13,046
            
            
            3
            
            
            43,481
            
            
            41,187
            
            
            631,197
            
            
            31,782
            
            
            (2)
            
            
            92,904
            
            
            89,490
            
            
            4Total
                Sales
            
            $
            63,282
            
            $
            65,788
            
            
            (4)
            
            $
            213,966
            
            $
            217,415
            
            
            (2)




***Product
      Sales*** **-** Overall
      product sales, which primarily consist of planners, binders, software, and
      handheld electronic planning devices that are primarily sold through our
      Consumer and Small Business Unit (CSBU) channels, declined $3.0 million,
      or 9 percent,
      compared to the prior year. The decline in product sales was primarily due
      to
      the following performance in our CSBU channels:





·
            **Retail
                Stores**-
                The$2.0million decline in retail sales was due to fewer stores, which had
                a$2.0million impact on sales, and reduced demand for technology and specialty
                products, which totaled$0.3million. Partially offsetting these declines were increased “core” product
                (e.g. planners, binders, and totes) sales, which improved$0.3million, compared to the prior year. At May 27, 2006, we were operating93retail stores compared to112stores at May 28, 2005. Comparable store (stores which were open
                during
                the comparable periods) sales wereflatcompared
                to the same quarter of the prior
                year.





·
            **Consumer
                Direct**-
                Sales through our consumer direct channels (catalog, eCommerce, and
                public
                seminars) increased primarily due to increased public seminar sales
                and
                the transition of clients from closed retail stores to consumer direct
                channels.





·
            **Wholesale**-
                Sales through our wholesale channel, which includes sales to office
                superstores and other retail chains, decreased$0.7million primarily due to reduced demand for our products through
                these
                channels during the quarter.





·
            **Other
                CSBU**-
                Other CSBU sales consist primarily of domestic printing and publishing
                sales and building sublease revenues. The increase in other CSBU
                sales was
                primarily due to increased sublease revenue. During fiscal 2005,
                we began
                subleasing a substantial portion of our corporate
                headquarters.




17


***Training
      and Consulting Services*** **-** We
      offer
      a variety of training courses, training related products, and consulting
      services focused on productivity, leadership, strategy execution, sales force
      performance, and effective communications training programs that are provided
      both domestically and internationally through the Organizational Solutions
      Business Unit (OSBU). Our overall training and consulting service sales
      increased $0.5 million,
      or 2 percent,
      compared to the same quarter of the prior year. Training and consulting service
      sales performance during the quarter was primarily attributable to the following
      factors in our OSBU divisions:





·
            **Domestic*****-***Our
                domestic training sales declined by$0.9million, or5percent, primarily due to a$0.6million decrease in our sales effectiveness training sales and a$0.5million decrease in seminar presentations by Dr. Stephen R. Covey.
                Decreased sales effectiveness training was primarily due to reduced
                demand
                for this curriculum during the quarter. Training seminars presented
                by Dr.
                Covey were favorably influenced in the prior year by the release
                of*The
                8**th**Habit*book
                and the demand for these presentations did not continue at the same
                level
                in fiscal 2006. These declines were partially offset by increased
                sales of
                other training courses, especially those related to our*The
                7 Habits of Highly Effective People*training courses. In addition, training manual sales increased by$0.5million and the number of training and consulting days delivered
                increased
                by12percent
                over the prior year.





·
            **International*****-***International sales increased$0.3million, or3percent, compared to the prior year. The increase was the result
                of
                increased licensee royalty revenues and increased sales at our directly
                owned offices in Canada, Australia, and Brazil. Partially offsetting
                these
                sales increases were the correction of misstatements at our Mexico
                subsidiary and the translation of foreign sales to United States
                dollars.
                During the quarter ended May 27, 2006, we determined that our Mexico
                subsidiary misstated its financial results in prior periods by recording
                improper sales transactions and not recording all operating expenses
                in
                proper periods. We determined that the misstatements occurred during
                fiscal 2002 through fiscal 2006 in various amounts. The correction
                of
                these misstatements, which primarily occurred in prior fiscal years,
                resulted in a$0.5million decrease in international sales. The translation of foreign
                sales
                to United States dollars resulted in a$0.3million unfavorable impact to our consolidated sales as certain foreign
                currencies, particularly the Japanese Yen, weakened against the United
                States dollar during much of the quarter ended May 27,
                2006.





**Gross
      Profit**





Gross
      profit consists of net sales less the cost of goods sold or the cost of services
      provided. Our overall gross margin, which is gross profit stated in terms of
      a
      percentage of sales, declined to 57.3 percent,
      compared to 58.2 percent
      in the comparable quarter of fiscal 2005. The decline was primarily attributable
      to increased training and consulting services costs from our Symposium
      conference events held during the quarter. Our gross margin on product sales
      decreased slightly to 51.6 percent
      compared to 52.0 percent
      in fiscal 2005.





For
      the
      quarter ended May 27, 2006, our training and consulting services gross margin
      declined to 63.3 percent
      compared to 65.3 percent
      in the prior year. The decrease in gross margin during the quarter was primarily
      attributable to increased direct costs associated with our annual Symposium
      conferences that were held at various locations in the United States and in
      the
      United Kingdom, and increased cost of sales at certain international locations.
      These decreases were partially offset by increased sales of certain higher
      margin training and consulting sales.





**Operating
      Expenses**





***Selling,
      General and Administrative*** **-** Our
      selling, general, and administrative (“SG&A”) expenses decreased $0.5 million,
      or 1 percent,
      compared to the prior year. The decline in SG&A expenses was primarily due
      to reduced retail store costs resulting from fewer stores and the favorable
      results of initiatives to reduce overall operating costs. Our retail store
      costs
      decreased $1.1 million
      due to store closures that occurred in prior periods. In addition to these
      decreases, we continue to implement strategies designed to reduce our overall
      operating costs. Our cost-reduction efforts have included retail store closures,
      headcount reductions, and other measures designed to focus our resources on
      critical activities and projects related to growth opportunities. The favorable
      impact of these efforts resulted in reduced SG&A expenses in many areas of
      the Company during the quarter ended May 27, 2006.





Partially
      offsetting these expense reductions were costs related to our investment in
      various growth initiatives, the correction of misstatements in a foreign
      subsidiary, and increased accounting and consulting fees primarily associated
      with compliance with Section 404 of the Sarbanes-Oxley Act of 2002. During
      fiscal 2005 and 2006 we began numerous initiatives designed to produce business
      growth in future periods. These initiatives included hiring additional sales
      people in both OSBU and CSBU, increased advertising and marketing programs,
      additional curriculum and product development, and increased spending on sales
      effectiveness training. Due to the time necessary to implement these growth
      strategies, including training new sales personnel and effectively rolling
      out
      new training offerings and products, these growth initiatives may not add
      material benefits to our fiscal 2006 operating results. However, we believe
      that
      these investments in additional sales personnel, increased marketing, and new
      consulting, training, and product offerings will allow us to increase our sales
      and improve our operating performance in future periods. During the quarter
      ended May 27, 2006, we determined that our subsidiary in Mexico misstated its
      financial results in prior periods by recording improper sales transactions
      and
      not recording all operating expenses in proper periods. We determined that
      the
      misstatements occurred during fiscal 2002 through fiscal 2006 in various
      amounts. We corrected these misstatements during the quarter ended May 27,
      2006
      and recorded a $0.5 million
      charge to SG&A expenses. We are currently in the process of becoming
      compliant with the internal control requirements found in Section 404 of the
      Sarbanes-Oxley Act of 2002. During the quarter ended May 27, 2006, we recorded $0.3 million
      of additional accounting and consulting fees related to our compliance
      efforts.





We
      regularly assess the operating performance of our retail stores, including
      previous operating performance trends and projected future profitability. During
      this assessment process, judgments are made as to whether under-performing
      or
      unprofitable stores should be closed. As a result of this evaluation process,
      we
      closed 6 retail
      store locations during the quarter ended May 27, 2006 and have closed 2 additional retail locations subsequent to the end of the quarter. We incurred
      and expensed $0.1 million
      of costs related to closed stores during each of the quarters ended May 27,
      2006
      and May 28, 2005. The costs associated with closing retail stores are typically
      comprised of charges related to vacating the premises, which may include a
      provision for the remaining term on the lease, and severance and other personnel
      costs, which are included as a component of SG&A expenses. We may continue
      to incur store closing expenses in future periods if we determine to close
      additional retail locations.


Return
      to Index


18


***Depreciation
      and Amortization*** **-** Depreciation
      expense decreased $0.7 million,
      or 39 percent,
      compared to the third quarter of fiscal 2005 primarily due to the full
      depreciation or disposal of certain property and equipment (including retail
      stores) and the effects of significantly reduced capital expenditures during
      preceding fiscal years. Based upon these events and current capital spending
      trends, we expect that depreciation expense will continue to decline during
      the
      remainder of fiscal 2006 as compared to prior periods.





Amortization
      expense from definite-lived intangible assets totaled $0.9 million
      for the quarter ended May 27, 2006 compared to $1.0 million
      in the prior year. We expect intangible asset amortization expense to decline
      compared to the prior year since certain intangible assets became fully
      amortized during fiscal 2006.





**Other
      Income and Expense Items**





***Interest
      Expense*** *-* Our
      interest expense increased $0.6 million
      primarily due to the sale of our corporate headquarters facility and the
      resulting interest component of our lease payments to the landlord. We are
      accounting for the lease on the corporate facility as a financing obligation,
      which is accounted for similar to long-term debt.





**Income
      Taxes**





During
      the quarter ended May 27, 2006, we recognized income tax benefits totaling $2.8 million
      compared to $3.0 million
      in fiscal 2005. The income tax benefits reported in these periods primarily
      resulted from the expiration of the statute of limitations for various
      tax exposures, which were partially offset by income taxes incurred by our
      profitable foreign subsidiaries and foreign income taxes on payments received
      from foreign licensees.





We
      were
      unable to offset our tax liabilities in foreign jurisdictions with our domestic
      operating loss carryforwards. In addition, our history of significant operating
      losses has precluded us from demonstrating that it is more likely than not
      that
      the benefits of domestic operating loss carryforwards, together with the
      benefits of other deferred income tax assets will be realized. Accordingly,
      we
      have recorded valuation allowances on the majority of our domestic deferred
      income tax assets at May 27, 2006. As our operating results continue to improve
      and our taxable income continues to increase, we are accumulating positive
      evidence which may allow the Company to reverse these valuation allowances
      on
      our deferred income tax assets in a future period.





**Loss
      on Recapitalization of Preferred Stock**





We
      completed our preferred stock recapitalization during the quarter ended May
      28,
      2005. Due to the significant modifications to our preferred stock, we believe
      that previously outstanding preferred stock was replaced with new classes of
      preferred stock and common stock warrants. As a result, the new preferred stock
      was recorded at its fair value on the date of modification, which was determined
      to be equal to the liquidation preference of $25 per share. The difference
      between the aggregate fair value of the consideration given (the new Series
      A
      preferred stock and the common stock warrants) and the carrying value of the
      previously existing Series A preferred stock, which totaled $7.8 million, was
      reported as a loss on recapitalization of preferred stock, which decreased
      net
      income attributable to common shareholders in the quarter ended May 28,
      2005.





Three
      Quarters Ended May 27, 2006 Compared to the Three Quarters Ended May 28,
      2005





**Sales**





***Product
      Sales*** **-** Overall
      product sales, which primarily consist of planners, binders, software, and
      handheld electronic planning devices that are primarily sold through our
      Consumer and Small Business Unit (CSBU) channels, declined $8.0 million,
      or 6 percent,
      compared to the prior year. The decline in product sales was primarily due
      to
      the following performance in our CSBU channels:





·
            **Retail
                Stores**-
                Retail sales declined$9.9million compared to the prior year. The decrease was due to fewer
                stores,
                which had a$10.3million impact on sales, and reduced demand for technology and specialty
                products, which totaled$1.4million. Partially offsetting these declines were increased “core” product
                sales. Improved core product sales trends were reflected in a1percent increase in comparable store sales compared to the prior
                year.





·
            **Consumer
                Direct**-
                Year-to-date sales through our consumer direct channels (catalog,
                eCommerce, and public seminars) remained relatively consistent with
                the
                prior year and increased slightly due to increased public seminar
                sales
                and the transition of clients from closed retail stores to consumer
                direct
                channels.





·
            **Wholesale**-
                Sales through our wholesale channel increased$1.0million primarily due to the timing of product sales to these entities
                and
                increased demand from wholesale channel
                customers.





·
            **Other
                CSBU**-
                Other CSBU sales consist primarily of domestic printing and publishing
                sales and building sublease revenues. The increase in other CSBU
                revenues
                was primarily due to increased sublease revenue compared to the prior
                year.





19


***Training
      and Consulting Services*** **-** Our
      overall training and consulting service sales increased by $4.6 million,
      or 6 percent,
      compared to the same period of the prior year. The improvement in training
      and
      consulting service sales was primarily attributable to the following sales
      performance during the first three quarters of fiscal 2006 in our OSBU
      divisions:





·
            **Domestic*****-***Our
                domestic training sales increased by$1.1million, or2percent, compared to fiscal 2005. The increase was primarily due
                to
                improved sales of training courses related to our refreshed*The
                7 Habits of Highly Effective People*curriculum. Increased sales of these programs were partially offset
                by
                decreased sales effectiveness training sales. Training manual sales
                increased by$2.6million and the number of training and consulting days delivered
                increased
                by8percent over the prior year.





·
            **International*****-***International sales increased$2.3million, or6percent, compared to the prior year. The increase was the result
                of
                improved sales performance at our directly owned offices in Canada
                and
                Japan, and increased licensee royalty revenues. These increases were
                partially offset by the translation of foreign sales, which resulted
                in a$1.1million unfavorable impact to our consolidated sales as certain foreign
                currencies, particularly in Japan, weakened against the United States
                dollar during the three quarters ended May 27,
                2006.




**Gross
      Profit**





Gross
      profit consists of net sales less the cost of goods sold or the cost of services
      provided. Our overall gross margin, which is gross profit stated in terms of
      a
      percentage of sales, improved slightly for the three quarters ended May 27,
      2006
      to 60.2 percent
      of sales, compared to 59.8 percent
      in the comparable period of fiscal 2005. The improvement in our overall gross
      margin was primarily due to increased training sales as a percent of total
      sales
      and favorable product sales mix changes. Training and consulting service sales,
      which typically have higher gross margins than our product sales, increased
      to 41 percent
      of total sales in fiscal 2006 compared to 38 percent
      in the prior year.





Our
      gross
      margin on product sales improved to 55.3 percent
      compared to 54.4 percent
      and was primarily due to a favorable shift in our product mix as sales of
      higher-margin paper products and binders increased as a percent of total sales,
      while sales of lower-margin technology and specialty products continue to
      decline, and to better inventory management practices during fiscal
      2006.





Training
      and consulting services gross margin, as a percent of sales, declined slightly
      to 67.4 percent
      compared to 68.4 percent
      in fiscal 2005 primarily due to higher costs associated with our Symposium
      conferences which were held during the quarter ended May 27, 2006 and increased
      cost of sales in certain international locations.





**Operating
      Expenses**





***Selling,
      General and Administrative*** **-** Our
      SG&A expenses decreased $2.1 million,
      or 2 percent,
      compared to the prior year. The decrease in SG&A expenses was primarily due
      to reduced retail store costs resulting from fewer stores and the favorable
      results of initiatives to reduce overall operating costs. Our retail store
      costs
      decreased $3.6 million
      primarily due to store closures that occurred in prior periods. We also
      recovered $0.3 million
      of legal costs from the WMA settlement during the quarter ended February 25,
      2006. In addition to these decreases, we continue to implement strategies
      designed to reduce our overall operating costs. The favorable impact of these
      efforts has resulted in reduced SG&A expenses in many areas of the Company
      during the three quarters ended May 27, 2006. These cost reductions were
      partially offset by increased spending on growth initiatives (refer to
      discussion below), $0.7 million
      of increased travel expenses resulting from additional employee training and
      sales leadership events, $0.4 million
      of increased accounting fees primarily related to compliance with section 404
      of
      the Sarbanes-Oxley Act of 2002, and the correction of misstated operating
      expenses at our Mexico subsidiary totaling $0.5 million.





During
      fiscal 2006, we have invested in various initiatives intended to grow our
      business in future periods. These initiatives included hiring additional sales
      people in both OSBU and CSBU, increased advertising and marketing programs,
      additional curriculum and product development, and increased spending on sales
      effectiveness training. Due to the time necessary to implement these growth
      strategies, including training new sales personnel and effectively rolling
      out
      new training offerings and products, these growth initiatives may not add
      material benefits to our fiscal 2006 operating results. However, we believe
      that
      these investments in additional sales personnel, increased marketing, and new
      consulting, training, and product offerings will allow us to increase our sales
      and improve our operating performance in future periods.





We
      regularly assess the operating performance of our retail stores, including
      previous operating performance trends and projected future profitability. As
      a
      result of this evaluation process, we closed 14 retail
      stores during the three quarters ended May 27, 2006 and have closed 2 additional retail locations subsequent to May 27, 2006. We incurred and expensed $0.4 million
      of costs related to store closure activities compared to $0.8 million
      for store closure costs in the same period of the prior year. We may continue
      to
      incur store closing expenses in future periods if we determine to close
      additional retail locations.





During
      the second quarter of fiscal 2006 our shareholders approved a long-term
      incentive plan (LTIP) that permits the grant of unvested share awards of common
      stock to certain employees. These LTIP share awards granted during fiscal 2006
      cliff vest on August 31, 2008, which is the completion of a three-year
      performance period. The number of shares that are finally awarded to
      participants is variable and is based entirely upon the achievement of a
      combination of performance objectives related to sales growth and operating
      income during the three-year performance period. The award was initially for 377,665 shares
      (target award) of common stock. The award shares were valued at $6.60 per
      share, and the corresponding initial compensation cost totaled $2.5 million.
      However, the number of shares that will ultimately vest under the LTIP will
      vary
      depending on whether the performance criteria are met or exceeded. The award
      will be reviewed quarterly and the value may be adjusted, depending on the
      performance of the Company compared to the award criteria. The compensation
      cost
      of the award is being expensed over the three-year service period of the award.
      As a result, the award will increase our SG&A expense during the vesting
      period.





On
      September 1, 2005, we adopted the provisions of Statement of Financial
      Accounting Standards No. 123 (Revised 2004), *Share-Based
      Payment* (SFAS
      No.
      123R), which is a revision of SFAS No. 123, *Accounting
      for Stock-Based Compensation* .
      Statement No. 123R requires all share based-payments to employees, including
      grants of stock options and the compensatory elements of employee stock purchase
      plans, to be recognized in the income statement based upon their fair values.
      Although the additional compensation expense resulting from the adoption of
      SFAS
      No. 123R was immaterial to the three quarters ended May 27, 2006, our operating
      expenses may be unfavorably affected in future periods if we grant additional
      stock options or participation in our employee stock purchase program
      increases.





20


***Depreciation
      and Amortization*** **-** Depreciation
      expense decreased $2.6 million,
      or 41 percent,
      compared to the first three quarters of fiscal 2005 primarily due to the full
      depreciation or disposal of certain property and equipment and the effects
      of
      significantly reduced capital expenditures during preceding fiscal years. Based
      upon these events and current capital spending trends, we expect that
      depreciation expense will continue to decline during the remainder of fiscal
      2006 as compared to prior periods.





Amortization
      expense on definite-lived intangible assets totaled $2.9 million
      for the three quarters ended May 27, 2006 compared to $3.1 million
      in the prior year. We expect intangible asset amortization expense to total
      $3.8
      million in fiscal 2006.





**Other
      Income and Expense Items**





***Interest
      Income*** *-* Our
      interest income increased $0.4 million
      primarily due to increased interest rates and higher average cash balances
      in
      our interest-bearing cash accounts.





***Interest
      Expense*** *-* Our
      interest expense increased $1.9 million
      primarily due to the sale of our corporate headquarters facility and the
      resulting interest component of our lease payments to the landlord.





***Legal
      Settlement*** **-** In
      fiscal
      2002, we filed legal action against World Marketing Alliance, Inc., a Georgia
      corporation (WMA), and World Financial Group, Inc., a Delaware corporation
      and
      purchaser of substantially all assets of WMA, for breach of contract. The case
      proceeded to trial and the jury rendered a verdict in our favor and against
      WMA
      for the entire unpaid contract amount of approximately $1.1 million.
      In addition to the verdict, we recovered legal fees totaling $0.3 million
      and pre- and post-judgment interest of $0.3 million
      from WMA. We received payment in cash from WMA for the total verdict amount,
      including legal fees and interest. However, shortly after paying the verdict
      amount, WMA appealed the jury decision to the 10th Circuit Court of Appeals
      and
      we recorded receipt of the verdict amount plus legal fees and interest with
      a
      corresponding increase to accrued liabilities and deferred the gain until the
      case was finally resolved. On December 30, 2005, we entered into a settlement
      agreement with WMA. Under the terms of the settlement agreement, WMA agreed
      to
      dismiss its appeal. As a result of this settlement agreement and dismissal
      of
      WMA’s appeal, we recorded a $0.9 million
      gain from the legal settlement.





**Income
      Taxes**





For
      the
      three quarters ended May 27, 2006 we recorded an income tax benefit of $0.3 million,
      compared to a benefit of $1.2 million
      for the same period of the prior year. These tax benefits resulted primarily
      from the expiration of the statute of limitations for various tax
      exposures, which were partially offset by income taxes incurred by our
      profitable foreign subsidiaries and foreign income taxes on payments received
      from foreign licensees. During the second quarter of fiscal 2006 we also
      received a $0.6 million
      tax assessment from a foreign jurisdiction, further offsetting the tax benefits
      for the period.





We
      were
      unable to offset our tax liabilities in foreign jurisdictions with our domestic
      operating loss carryforwards. In addition, our history of significant operating
      losses has precluded us from demonstrating that it is more likely than not
      that
      the benefits of domestic operating loss carryforwards, together with the
      benefits of other deferred income tax assets will be realized. Accordingly,
      we
      have recorded valuation allowances on the majority of our domestic deferred
      income tax assets at May 27, 2006. As our operating results continue to improve
      and our taxable income continues to increase, we are accumulating positive
      evidence which may allow the Company to reverse these valuation allowances
      on
      our deferred income tax assets in a future period.




**LIQUIDITY
      AND CAPITAL RESOURCES**





Historically,
      our primary sources of capital have been net cash provided by operating
      activities, line-of-credit financing, long-term borrowings, asset sales, and
      the
      issuance of preferred and common stock. We currently rely primarily upon cash
      flows from operating activities and cash on hand to maintain adequate liquidity
      and working capital levels. Our third fiscal quarter, which includes our
      seasonally low-product sales months, has historically produced near break-even
      operating results and does not generally produce significant cash flows from
      operating activities. At May 27, 2006, we had $28.8 million
      of cash and cash equivalents compared to $51.7 million
      at August 31, 2005. Our net working capital (current assets less current
      liabilities) decreased to $39.8 million
      at May 27, 2006 compared to $49.9 million
      at August 31, 2005.





During
      the first three quarters of fiscal 2006, one of our primary uses of cash has
      been the redemption of Series A preferred stock. During this period, we have
      redeemed a total of $20.0 million,
      or approximately 800,000 shares, of our outstanding preferred stock. Since
      the
      fiscal 2005 sale of our corporate headquarters facility, we have redeemed $50.0 million
      of preferred stock which has reduced our preferred stock dividend obligation
      by $5.0 million
      per year. However, in connection with the sale of our corporate campus, which
      provided proceeds of $32.4 million,
      we incurred a long-term financing obligation for the purchase price. The annual
      payments on the financing obligation are approximately $3.0 million
      per year for the first five years with two percent annual increases thereafter.
      The Company believes that its strategy related to the sale of the corporate
      campus and subsequent redemptions of preferred stock will improve overall cash
      flows in future periods. In addition to preferred stock redemptions, we also
      obtained authorization from the Board of Directors to purchase up to $10.0 million
      of our common stock. During the three quarters ended May 27, 2006, we have
      purchased 485,500 shares
      of common stock for $3.9 million
      under the terms of this recently approved program to purchase common shares.
      We
      currently anticipate that additional preferred stock redemptions and common
      stock purchases will occur in future periods if our cash flows from operating
      activities continue to improve.





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
      three quarters ended May 27, 2006.


Return
      to Index


21


**Cash
      Flows From Operating Activities**





During
      the three quarters ended May 27, 2006, our net cash provided by operating
      activities totaled $9.9 million
      compared to $13.7 million
      for the same period of the prior year. Our primary source of cash from operating
      activities was the sale of goods and services to our customers in the normal
      course of business. The primary uses of cash for operating activities were
      payments to suppliers for materials used in products sold, payments for direct
      costs necessary to conduct training programs, and payments for selling, general,
      and administrative expenses. Cash used for changes in working capital during
      the
      first three quarters of fiscal 2006 was primarily related to 1) payments made
      to
      reduce accrued liabilities and accounts payable from seasonally high August
      31
      balances; 2) increased accounts receivable balances; and 3) purchases of
      additional inventories. We believe that our continued efforts to optimize
      working capital balances, combined with existing and planned sales growth
      programs and cost-cutting initiatives, will improve our cash flows from
      operating activities in future periods. However, the success of these efforts,
      and their eventual contribution to our cash flows, is dependent upon numerous
      factors, many of which are not within our control.





**Cash
      Flows From Investing Activities and Capital Expenditures**





Net
      cash
      used for investing activities totaled $5.1 million
      for the three quarters ended May 27, 2006. Our primary uses of cash for
      investing activities were the purchase of property and equipment, which
      consisted primarily of computer hardware and software and totaled $3.3 million,
      and further investment in curriculum development, primarily related to new
      and
      refreshed training courses based primarily on *The
      7
      Habits of Highly Effective People* ,
      which
      totaled $1.8 million.





**Cash
      Flows From Financing Activities**





Net
      cash
      used for financing activities during the three quarters ended May 27, 2006
      totaled $27.7 million.
      Our primary uses of cash for financing activities during this period were the
      redemption of $20.0 million,
      or approximately 800,000 shares, of Series A preferred stock, payment of
      preferred stock dividends totaling $4.0 million
      (which included accrued dividends on redeemed shares through the date of
      redemption), and purchases of our common stock totaling $4.0 million.
      We also used restricted cash, generated from a portion of the proceeds of the
      corporate headquarters sale totaling $0.7 million
      to repay the mortgage, including a $0.1 million
      prepayment penalty, on one of the buildings that was sold in the campus sale
      transaction that was completed in fiscal 2005.





**Contractual
      Obligations**





The
      Company has not structured any special purpose or variable interest entities,
      or
      participated in any commodity trading activities, which would expose us to
      potential liabilities or create adverse consequences to our liquidity. During
      the quarter ended May 27, 2006 we amended our outsourcing agreement with
      Electronic Data Systems Corporation (EDS). One of the key provisions of this
      amendment is reduced required minimum annual payments for information systems
      support. Although we may pay more than the minimum required payments due to
      actual usage and other factors, the contractually required minimum annual
      payments were reduced by a total of $84.2 million
      over the life of the outsourcing agreement, which extends through June 30,
      2016.
      The following table has been revised to reflect the decreased minimum required
      annual payments to EDS for outsourcing services as well as the impact of fiscal
      2006 preferred stock redemptions, totaling $20.0 million,
      on projected dividend payments and monitoring fees paid to a preferred stock
      investor. Contractual obligations in other captions presented have not changed
      materially from those disclosed in our fiscal 2005 report on Form 10-K and
      were
      not revised (in thousands).




Fiscal
            
            Fiscal
            
            Fiscal
            
            Fiscal
            
            FiscalContractual
                Obligations
            
            2006
            
            2007
            
            2008
            
            2009
            
            2010
            
            Thereafter
            
            TotalMinimum
                required payments to EDS for outsourcing services
            
            $
            19,825
            
            $
            17,217
            
            $
            15,901
            
            $
            15,927
            
            $
            15,577
            
            $
            88,531
            
            $
            172,978Required
                payments on corporate campus financing obligation
            
            
            3,045
            
            
            3,045
            
            
            3,045
            
            
            3,045
            
            
            3,055
            
            
            53,072
            
            
            68,307Minimum
                operating lease payments
            
            
            8,509
            
            
            6,204
            
            
            5,346
            
            
            4,225
            
            
            3,148
            
            
            7,718
            
            
            35,150Preferred
                stock dividend payments
            
            
            4,385
            
            
            3,735
            
            
            3,735
            
            
            3,735
            
            
            3,735
            
            
            -
            
            
            19,325Debt
                payments
            
            
            866
            
            
            160
            
            
            155
            
            
            148
            
            
            143
            
            
            554
            
            
            2,026Contractual
                computer hardware and software purchases
            
            
            1,334
            
            
            680
            
            
            797
            
            
            1,072
            
            
            1,334
            
            
            6,059
            
            
            11,276Monitoring
                fees paid to a preferred stock investor
            
            
            195
            
            
            166
            
            
            166
            
            
            166
            
            
            166
            
            
            -
            
            
            859Total
                expected contractual
              obligation
                payments
            
            $
            38,159
            
            $
            31,207
            
            $
            29,145
            
            $
            28,318
            
            $
            27,158
            
            $
            155,934
            
            $
            309,921




22


**Other
      Items**





***Management
      Common Stock Loan Program*** **-** The
      Company is the creditor for a loan program that provided the capital to allow
      certain management personnel the opportunity to purchase shares of our common
      stock. In May 2004, our Board of Directors approved modifications to the terms
      of the management stock loans. While these changes had significant implications
      for most management stock loan program participants, the Company did not
      formally amend or modify the stock loan program notes. Rather, the Company
      chose
      to forego certain of its rights under the terms of the loans in order to
      potentially improve the participant’s ability to pay, and the Company’s ability
      to collect, the outstanding balances of the loans. Based upon guidance found
      in
      EITF Issue 00-23, *Issues
      Related to the Accounting for Stock Compensation under APB Opinion No. 25 and
      FASB Interpretation No. 44* ,
      and
      EITF Issue 95-16, *Accounting
      for Stock Compensation Agreements with Employer Loan Features under APB Opinion
      No. 25* ,
      we
      determined that the management common stock loans should be accounted for as
      non-recourse stock compensation instruments due to the modifications approved
      in
      May 2004 and their effects to the Company and the loan participants. While
      this
      accounting treatment does not alter the legal rights associated with the loans
      to the employees, the modifications to the terms of the loans were deemed
      significant enough to adopt the non-recourse accounting model as described
      in
      EITF 00-23. As a result of the May 2004 modifications and this accounting
      treatment, the remaining carrying value of the notes and interest receivable
      related to the notes, which totaled $7.6 million,
      was reduced to zero with a corresponding reduction in additional paid-in
      capital.





We
      currently account for the management common stock loans as equity-classified
      stock option arrangements. Under the provisions of SFAS No. 123R, which we
      adopted on September 1, 2005, additional compensation expense will be recognized
      only if the Company takes action that constitutes a modification which increases
      the fair value of the arrangements. During the quarter ended May 27, 2006,
      the
      Company offered management stock loan participants the opportunity to formally
      modify the terms of their stock loans in exchange for placing stock loan shares
      in an escrow account controlled by the Company. Under terms of the new
      modifications, the management stock loan due date will be changed to be the
      earlier of (a) March 30, 2013, or (b) the date on which the Company’s stock
      closes, as reported by the exchange or market that is the principal market
      for
      our common stock, at or above the price per share such that the value of the
      shares acquired by the participant equals the principal and accrued interest
      on
      the participant’s promissory note (the Breakeven Price). The modifications give
      the Company the right to redeem the stock on the due date of the promissory
      note. In addition, the interest rate on the loans will increase from 3.16
      percent compounded annually to 4.72 percent compounded annually. Since these
      new
      modifications do not increase the fair value of the arrangements, we did not
      recognize any additional compensation expense.





As
      a
      result of these loan program modifications, the Company hopes to increase the
      total value received from loan participants; however, the inability of the
      Company to collect all, or a portion, of these receivables could have an adverse
      impact upon our financial position and future cash flows compared to full
      collection of the loans.





***Availability
      of Future Capital Resources*** **-** Going
      forward, we will continue to incur costs necessary for the operation of the
      business. We anticipate using cash on hand, cash provided by operating
      activities, on the condition that we can continue generating positive cash
      flows
      from operations, and other financing alternatives, if necessary, for these
      expenditures. We anticipate that our existing capital resources should be
      adequate to enable us to maintain our operations for at least the upcoming
      twelve months. However, our ability to maintain adequate capital for our
      operations in the future is dependent upon a number of factors, including sales
      trends, 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 economic conditions and
      the
      introduction of new technology and products by our competitors. We will continue
      to monitor our liquidity position and may pursue additional financing
      alternatives, if required, to maintain sufficient resources for future operating
      and capital requirements. However, there can be no assurance such financing
      alternatives will be available to us on acceptable terms.




23


**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 polices that we used to prepare our consolidated financial statements
      are outlined in Note 1 to the consolidated financial statements, which are
      presented in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal
      year ended August 31, 2005. Some of those accounting policies require us to
      make
      estimates and assumptions that 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 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 significant judgment and often involve complex
      estimates:





**Revenue
      Recognition**





We
      derive
      revenues primarily from the following sources:





·
            ***Products***-
                We sell planners, binders, planner accessories, handheld electronic
                devices, and other related products that are primarily sold through
                our
                CSBU channels.





·
            ***Training
                and Consulting Services***-
                We provide training and consulting services to both organizations
                and
                individuals in strategic execution, leadership, productivity, goal
                alignment, sales force performance, and communication effectiveness
                skills. These training programs and services are primarily sold through
                our OSBU channels.





The
      Company recognizes revenue when: 1) persuasive evidence of an agreement exists,
      2) delivery of product has occurred or services have been rendered, 3) the
      price
      to the customer is fixed and determinable, and 4) collectibility is reasonably
      assured. For product sales, these conditions are generally met upon shipment
      of
      the product to the customer or by completion of the sale transaction in a retail
      store. For training and consulting service sales, these conditions are generally
      met upon presentation of the training seminar or delivery of the consulting
      services.





Some
      of
      our training and consulting contracts contain multiple deliverable elements
      that
      include training along with other products and services. In accordance with
      EITF
      Issue No. 00-21, *Accounting
      for Revenue Arrangements with Multiple Deliverables* ,
      sales
      arrangements with multiple deliverables are divided into separate units of
      accounting if the deliverables in the sales contract meet the following
      criteria: 1) the delivered training or product has value to the client on a
      standalone basis; 2) there is objective and reliable evidence of the fair value
      of undelivered items; and 3) delivery of any undelivered item is probable.
      The
      overall contract consideration is allocated among the separate units of
      accounting based upon their fair values, with the amount allocated to the
      delivered item being limited to the amount that is not contingent upon the
      delivery of additional items or meeting other specified performance conditions.
      If the fair value of all undelivered elements exits, but fair value does not
      exist for one or more delivered elements, the residual method is used. Under
      the
      residual method, the amount of consideration allocated to the delivered items
      equals the total contract consideration less the aggregate fair value of the
      undelivered items. Fair value of the undelivered items is based upon the normal
      pricing practices for the Company’s existing training programs, consulting
      services, and other products, which are generally the prices of the items when
      sold separately.





Revenue
      is recognized on software sales in accordance with Statement of Position (SOP)
      97-2, *Software
      Revenue Recognition* as
      amended by SOP 98-09. SOP 97-2, as amended, generally requires revenue earned
      on
      software arrangements involving multiple elements such as software products
      and
      support to be allocated to each element based on the relative fair value of
      the
      elements based on vendor specific objective evidence (VSOE). The majority of
      the
      Company’s software sales have elements, including a license and post contract
      customer support (PCS). Currently the Company does not have VSOE for either
      the
      license or support elements of its software sales. Accordingly, revenue is
      deferred until the only undelivered element is PCS and the total arrangement
      fee
      is recognized ratably over the support period.





Our
      international strategy includes the use of licensees in countries where we
      do
      not have a directly-owned operation. Licensee companies are unrelated entities
      that have been granted a license to translate the Company’s content and
      curriculum, adapt the content and curriculum to the local culture, and sell
      the
      Company’s training seminars and products in a specific country or region.
      Licensees are required to pay us royalties based upon a percentage of the
      licensee’s sales. The Company recognizes royalty income each period based upon
      the sales information reported to the Company from the licensee.





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




**Stock-Based
        Compensation**
 
 Effective
        September 1, 2005, we adopted the fair value recognition provisions of SFAS
        No.
        123R, using the modified prospective transition method, and therefore have
        not
        restated prior periods’ financial results. Under this method, we recognize
        compensation expense for all share-based payments granted after September
        1,
        2006 and prior to but not yet vested as of September 1, 2006, in accordance
        with
        SFAS No. 123R. Prior to the adoption of SFAS No. 123R, we accounted for
        share-based payments under APB No. 25, and therefore we generally recognized
        compensation expense from stock options only when we granted options with
        an
        exercise price below the market price on the date of grant or made modifications
        to stock option terms which increased the fair value of the award.
 
 During
        fiscal 2006, we granted unvested stock-based compensation awards to certain
        employees in a Board of Director approved long-term incentive plan (LTIP).
        The
        LTIP share awards granted during fiscal 2006 cliff vest on August 31, 2008,
        which is the completion of a three-year performance period. The number of
        shares
        that are finally awarded to LTIP participants is variable and is based entirely
        upon the achievement of a combination of performance objectives related to
        sales
        growth and operating income during the three-year performance period. Due
        to the
        variable number of shares that may be issued under the LTIP, we reevaluate
        the
        LTIP on a quarterly basis and adjust the number of shares expected to be
        awarded
        based upon financial results of the Company as compared to the performance
        goals
        set for the award. Adjustments to the number of shares awarded, and to the
        corresponding compensation expense, are based upon estimated future performance
        and are made on a cumulative basis at the date of adjustment based upon the
        probable number of shares to be awarded. Actual results could differ from
        estimates made during the service, or vesting, period. The total compensation
        cost of the 2006 LTIP grant will be equal to the number of shares finally
        issued
        multiplied by $6.60 per share, the fair value of the common shares determined
        at
        the grant date.
 
 We
        estimate the value of our stock option awards on the date of grant using
        the
        Black-Scholes option pricing model. However, at May 27, 2006 the remaining
        cost
        associated with our unvested stock options was insignificant.


**Accounts
      Receivable Valuation**





Trade
      accounts receivable are recorded at the invoiced amount and do not bear
      interest. The allowance for doubtful accounts represents our best estimate
      of
      the amount of probable credit losses in the existing accounts receivable
      balance. We determine the allowance for doubtful accounts based upon historical
      write-off experience and current economic conditions and we review the adequacy
      of our allowance for doubtful accounts on a regular basis. Receivable balances
      past due over 90 days, which exceed a specified dollar amount, are reviewed
      individually for collectibility. Account balances are charged off against the
      allowance after all means of collection have been exhausted and the probability
      for recovery is considered remote. We do not have any off-balance sheet credit
      exposure related to our customers.


Return
      to Index


24


**Inventory
      Valuation**





Inventories
      are stated at the lower of cost or market with cost determined using the
      first-in, first-out method. Our inventories are comprised primarily of dated
      calendar products and other non-dated products such as binders, handheld
      electronic devices, stationery, training products, and other accessories.
      Provision is made to reduce excess and obsolete inventories to their estimated
      net realizable value. In assessing the realization of inventories, we make
      judgments regarding future demand requirements and compare these assessments
      with current and committed inventory levels. 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.





**Indefinite-Lived
      Intangible Assets**





Intangible
      assets that are deemed to have an indefinite life 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 has been deemed to have an indefinite life. This intangible
      asset is assigned to the OSBU and is tested for impairment using the present
      value of estimated royalties on trade name related revenues, which consist
      primarily of training seminars, international licensee royalties, and related
      products. If forecasts and assumptions used to support the realizability of
      our
      indefinite-lived intangible asset change in the future, significant impairment
      charges could result that would adversely affect our results of operations
      and
      financial condition.





**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 the 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 recognize an impairment loss equal to the difference between the
      carrying values of the assets and their estimated fair values. 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. The
      evaluation of long-lived assets requires us to use estimates of future cash
      flows. If forecasts and assumptions used to support the realizability 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**





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
      history of significant operating losses has historically precluded us from
      demonstrating that it is more likely than not that the related benefits from
      deferred income tax deductions and foreign tax carryforwards will be realized.
      Accordingly, we recorded valuation allowances on the majority of our deferred
      income tax assets. As our operating results continue to improve and our taxable
      income continues to increase, we are accumulating positive evidence which may
      allow the Company to reverse all, or a portion of, our valuation allowances.
      We
      will continue to evaluate both positive and negative evidence and when it
      becomes more likely than not that all or a portion of our deferred tax assets
      will be realizable, we will reduce our valuation allowance. The decision to
      increase or decrease our valuation allowances requires significant judgment,
      including estimates of future income that may or may not be
      realized.




**NEW
      ACCOUNTING PRONOUNCEMENTS**





In
      March
      2005, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
      (FIN) No. 47, *Accounting
      For Conditional Asset Retirement Obligations - an Interpretation of FASB
      Statement No. 143* .
      This
      interpretation clarifies that the term *conditional
      asset retirement obligation* as used
      in SFAS No. 143, *Accounting
      for Asset Retirement Obligations* ,
      refers
      to a legal obligation to perform an asset retirement activity in which the
      timing and (or) method of settlement are conditional on a future event that
      may
      or may not be within the control of the Company. Thus, the timing and (or)
      method of settlement may be conditional on a future event. Accordingly, we
      will
      be required to recognize a liability for the fair value of a conditional asset
      retirement obligation if the fair value of the liability can be reasonably
      estimated. The fair value of a liability for the conditional asset retirement
      obligation should be recognized when incurred - generally upon acquisition,
      construction, development, and (or) through the normal operation of the asset.
      The effective date for FIN No. 47 is no later than the end of fiscal years
      ending after December 15, 2005, which is August 31, 2006 for the Company. As
      of
      May 27, 2006, we do not believe that the adoption of FIN No. 47 will have a
      material impact on our consolidated financial statements.





In
      May
      2005, the FASB issued SFAS No. 154, *Accounting
      Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB
      Statement No. 3* .
      Statement No. 154 changes the requirements for the accounting for and reporting
      of a change in accounting principle and applies to all voluntary changes in
      accounting principle. This statement requires retrospective application to
      prior
      periods’ financial statements of changes in accounting principle, unless it is
      impracticable to determine either the period-specific effects or the cumulative
      effect of an accounting change. Further, SFAS No. 154 requires that the new
      accounting principle be applied to the balances of assets and liabilities as
      of
      the beginning of the earliest period for which retrospective application is
      practicable and that a corresponding adjustment be made to the opening balance
      of retained earnings (or other appropriate components of shareholders’ equity)
      for that period that is being reported in an income statement. This statement
      also carries forward, without change, the guidance in APB Opinion No. 20 for
      reporting the correction of an error in previously issued financial statements
      and a change in accounting estimate. Statement No. 154 is effective for
      accounting changes and corrections of errors made in fiscal years beginning
      after December 15, 2005 and will thus be effective for our fiscal year beginning
      September 1, 2006.




25


ITEM
      3.
      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





**MARKET
      RISK OF FINANCIAL INSTRUMENTS**





The
      primary financial instrument risks to which the Company is exposed are
      fluctuations in foreign currency exchange rates and interest rates. To manage
      risks associated with foreign currency exchange and interest rates, we 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
      Currency Sensitivity**





Due
      to
      the global nature of the Company’s operations, we are subject to risks
      associated with transactions that are denominated in currencies other than
      the
      United States dollar, which creates exposure to foreign currency exchange risk.
      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 make limited use of foreign currency forward
      contracts and other foreign currency related derivative instruments. Although
      we
      cannot eliminate all aspects of our foreign currency risk, we believe that
      our
      strategy, which includes the use of derivative instruments, can reduce the
      impacts of foreign currency related issues on our consolidated financial
      statements.





During
      the quarter and three quarters ended May 27, 2006, we utilized foreign currency
      forward contracts to manage the volatility of certain intercompany financing
      transactions and other transactions that are denominated in foreign currencies.
      Because these contracts do not meet specific hedge accounting requirements,
      gains and losses on these contracts, which expire on a quarterly basis, are
      recognized currently and are used to offset a portion of the gains or losses
      of
      the related accounts. The gains and losses on these contracts were recorded
      as a
      component of SG&A expense in the Company’s consolidated statements of
      operations and resulted in the following net gains or losses for the periods
      indicated (in thousands):





Quarter
                Ended
            
            Three
                Quarters EndedMay
                27,
              2006
            
            May
                28,
              2005
            
            May
                27,
              2006
            
            May
                28,
              2005Losses
                on foreign exchange contracts
            
            $
            (208
            )
            $
            (31
            )
            $
            (276
            )
            $
            (384
            )Gains
                on foreign exchange contracts
            
            
            33
            
            
            53
            
            
            256
            
            
            56Net
                gain (loss) on foreign exchange contracts
            
            $
            (175
            )
            $
            22
            
            $
            (20
            )
            $
            (328
            )





At
      May
      27, 2006, the fair value of these contracts, which was determined using the
      estimated amount at which contracts could be settled based upon forward market
      exchange rates, was insignificant. The notional amounts of our foreign currency
      sell contracts that did not qualify for hedge accounting were as follows at
      May
      27, 2006 (in thousands):





Contract
                Description
            
            Notional
                Amount in Foreign Currency
            
            Notional
                Amount in U.S. DollarsJapanese
                Yen
            
            
            322,000
            
            $
            2,901Australian
                Dollars
            
            
            1,536
            
            
            1,159Mexican
                Pesos
            
            
            10,900
            
            
            951





During
      the three quarters ended May 28, 2005, we also entered into foreign currency
      forward contracts that were designed to manage foreign currency risks related
      to
      the value of our net investment in foreign operations located in Canada, Japan,
      and the United Kingdom. These foreign currency forward instruments, which
      expired on a monthly basis, qualified for hedge accounting and corresponding
      gains and losses were recorded as a component of other comprehensive income
      in
      our consolidated balance sheet. During the three quarters ended May 28, 2005,
      we
      recorded losses totaling $0.3 million
      from these contracts.





During
      the quarter ended May 27, 2006, we did not utilize net investment contracts
      or
      other derivative contracts that qualified for hedge accounting. However, the
      Company may utilize net investment hedge contracts in future periods as a
      component of its overall foreign currency risk strategy.





**Interest
      Rate Sensitivity**





The
      Company is exposed to fluctuations in U.S. interest rates primarily as a result
      of the cash and cash equivalents that we hold. Our debt balances consist
      primarily of a financing obligation associated with the sale of our corporate
      headquarters facility and a long-term mortgage on certain of our buildings
      and
      property. As such, we do not have significant exposure or additional liability
      due to interest rate sensitivity and we were not party to any interest rate
      swap
      or other interest related derivative instruments during the quarter ended May
      27, 2006.


Return
      to Index


26


ITEM
      4. CONTROLS AND PROCEDURES





During
      the quarter ended May 27, 2006, we determined that our Mexico subsidiary had
      misstated its financial results in prior periods by recording improper sales
      transactions and not recording all operating expenses in proper periods. We
      determined that the misstatements occurred during fiscal 2002 through fiscal
      2006 in various amounts. The Audit Committee engaged an independent legal firm
      to investigate the misstatements and they concluded that such misstatements
      were
      intentional. The Company determined that the impact of these misstatements
      was
      immaterial to previously issued financial statements and we recorded a $0.5 million
      decrease to international sales and a $0.5 million
      increase in selling, general, and administrative expenses during the quarter
      ended May 27, 2006 to correct these misstatements. In light of these
      misstatements at our Mexico subsidiary, management has concluded that, as of
      May
      27, 2006, a material weakness in the Company’s internal control over financial
      reporting existed related to international operations.  Specifically,
      we determined that we did not have adequate oversight of the accounting policies
      and procedures of our international locations.




**Evaluation
      of Disclosure Controls and Procedures**





We
      maintain disclosure controls and procedures that are designed to ensure that
      information required to be disclosed in the Company’s Exchange Act reports is
      recorded, processed, summarized and reported within the time periods specified
      in the Securities and Exchange Commission’s rules and forms and that such
      information is accumulated and communicated to our management, including the
      Chief Executive Officer and the Chief Financial Officer, as appropriate, to
      allow for timely decisions regarding required disclosure. In designing and
      evaluating the disclosure controls and procedures, management recognizes that
      any controls and procedures, no matter how well designed and operated, can
      provide only reasonable assurance of achieving the desired control objectives,
      and management is required to apply its judgment in evaluating the cost-benefit
      relationship of possible controls and procedures.





As
      required by Rule 13a-15(b) under the Exchange Act, we conducted an evaluation,
      under the supervision and with the participation of our management, including
      the Chief Executive Officer and the Chief Financial Officer, of the
      effectiveness and the design and operation of our disclosure controls and
      procedures as of the end of the period covered by this report, and included
      consideration of the material weakness related to income taxes disclosed in
      our
      Form 10-K for the fiscal year ended August 31, 2005. Based on this evaluation,
      and as a result of the material weakness in our internal control over financial
      reporting related to our international operations, the Chief Executive Officer
      and the Chief Financial Officer have concluded that our disclosure controls
      and
      procedures were not effective as of May 27, 2006.





**Changes
      in Internal Control Over Financial Reporting**





In
      order
      to remediate the aforementioned material weakness, certain personnel at our
      Mexico subsidiary have been terminated, and management is in the process of
      implementing new processes and internal controls over financial reporting
      including by aligning international accounting oversight with qualified
      personnel in the United States, expanding the contents of our monthly
      international reporting package, conducting more in-depth financial reviews
      for
      each country, increasing the frequency of on-site reviews and testing of
      internal controls, implementing of a training program for foreign accounting
      personnel, and changing the reporting structure so that international financial
      professionals report directly to a financial professional in the United States.
      We are also in the process of documenting processes and controls in the foreign
      locations to improve the quality of international financial accounting and
      reporting at all of our foreign subsidiary locations.





Other
      than as described above, there has been no change in the Company’s internal
      control over financial reporting during the fiscal quarter ended May 27, 2006
      that has materially affected, or is reasonably likely to materially affect,
      our
      internal control over financial reporting.




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





Certain
      written and oral statements made by the Company or our representatives in this
      report, other reports, filings with the Securities and Exchange Commission,
      press releases, conferences, Internet webcasts, or otherwise, 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. 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. 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 under
      Business Environment and Risk in our annual report on Form 10-K for the fiscal
      year ended August 31, 2005, which are incorporated herein by this reference.
      In
      addition, such risks and uncertainties may include unanticipated developments
      in
      any one or more of the following areas: demand for our products and services,
      which depends to some extent on general economic conditions, so that we can
      avoid future declines in revenues; the ability of our products and services
      to
      successfully compete with alternative solutions and the products and services
      offered by others; unanticipated costs or capital expenditures; cost savings
      from the outsourcing of our information systems and controls, including without
      limitation, the systems related to demand and supply planning, inventory
      control, and order fulfillment; delays or unanticipated outcomes relating to
      the
      Company’s strategic plans; dependence on existing products or services; the rate
      and consumer acceptance of new product introductions; 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; 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. Factors
      such
      as quarter-to-quarter variations in revenues and earnings or losses or 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 low market capitalization
      and
      share price, 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. 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.


27


PART
      II.  OTHER INFORMATION





Item
      1A. Risk
      Factors





The
      Company is providing the following information regarding changes that have
      occurred to previously disclosed risk factors from our Form 10-K for the fiscal
      year ended August 31, 2005:





***Our
      strategy of outsourcing certain functions and operations may fail to reduce
      our
      costs for these services*** *-* We
      have
      an outsourcing contract with Electronic Data Systems (EDS) to provide
      warehousing, distribution, information systems, and call center operations.
      Under terms of the outsourcing contract and its addendums, EDS operates the
      Company’s primary call center, provides warehousing and distribution services,
      and supports our various information services. Certain components of the
      outsourcing agreement contain minimum activity levels that we must meet or
      we
      will be required to pay penalty charges. During the quarter ended May 27, 2006,
      we amended our outsourcing agreement with EDS. One of the key provisions of
      this
      amendment is reduced required minimum annual payments for information systems
      support. Although we may pay more than the minimum required payments due to
      actual usage and other factors, the contractually required minimum annual
      payments were reduced by a total of $84.2 million
      over the life of the outsourcing agreement, which extends through June 30,
      2016.
      The Company believes that the reduced minimum charges will reduce our risk
      of
      penalty charges and that we will be able to realize benefits from the
      outsourcing agreement.





***We
      may elect to use our cash to redeem shares of preferred stock, which may
      decrease our ability to respond to adverse changes*** - Our
      outstanding preferred stock bears a cumulative dividend equal to 10 percent
      per
      annum. During fiscal 2005, we utilized a portion of the proceeds from the sale
      of our corporate headquarters to redeem $30.0 million of our preferred stock.
      Subsequent to August 31, 2005, we redeemed an additional $10.0 million of
      preferred stock and we proposed an amendment to the terms of our preferred
      stock
      recapitalization that was completed in fiscal 2005 to extend the period during
      which we can redeem preferred stock at an amount equal to the liquidation
      preference. We obtained shareholder approval of the amendment during the second
      quarter of fiscal 2006 and redeemed an additional $10.0 million of preferred
      stock in connection with this amendment to extend the redemption period to
      December 31, 2007. We anticipate that we may redeem additional shares of
      preferred stock in the future to the extent that we believe sufficient cash
      is
      available to do so. Additional preferred stock redemptions will reduce our
      cash
      on hand and may reduce our ability to adequately respond to any future adverse
      changes in our business and operations, whether anticipated or
      unanticipated.




Item
      2.   Unregistered
      Sales of Equity Securities and Use of Proceeds





The
      Company acquired the following securities during the quarter ended May 27,
      2006:





Period
            
            Total
                Number of Shares Purchased
            
            Average
                Price Paid Per Share
            
            Total
                Number of Shares Purchased as Part of Publicly Announced Plans or
                Programs
            
            Maximum
                Number of Shares That May Yet Be Purchased Under the Plans or
                ProgramsCommon
                Shares:February
                26, 2006 to April 1, 2006
            
            
            -
            
            $
            -
            
            
            none
            
            
            n/aApril
                2, 2006 to April 29, 2006
            
            
            144,200
            
            
            8.97
            
            
            144,200
            
            
            n/aApril
                30, 2006 to May 27, 2006
            
            
            131,100
            
            
            8.17
            
            
            131,100
            
            
            n/aTotal
                Common Shares
            
            
            275,300
            
            $
            8.59
            
            
            
            
            
            760,057(1)Total
                Preferred Shares
            
            
            none
            
            
            none





(1)  In
      January 2006, the Company’s Board of Directors approved the purchase of up to $10.0 million
      of our outstanding common stock. All previous authorized common stock purchase
      plans were canceled. Since the approval of this stock purchase plan, we have
      purchased 485,500 shares
      of common stock for $3.9 million.
      The maximum number of shares that may yet be purchased under this plan was
      calculated by dividing the remaining approved dollars by $7.99 ,
      which
      was the closing price of the Company’s common stock on May 26, 2006 (the last
      trading day of the fiscal quarter).




Item
      6.   Exhibits





(A)
            Exhibits:





10.1
            Amendment
                No. 6 to the Agreement for Information Technology Services between
                each of
                Franklin Covey Co., Electronic Data Systems Corporation, and EDS
                Information Services L.L.C. dated April 1, 2006 and incorporated
                herein by
                reference to Exhibit 99.1 to the Current Report on Form 8-K filed
                with the
                Commission on April 5, 2006.





31
            Rule
                13a-14(a) Certifications of the CEO and
                CFO.





32
            Section
                1350 Certifications of the CEO and
                CFO.


28





SIGNATURES





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.





FRANKLIN
                COVEY CO.Date:
            July
                11, 2006
            
            By:
            /s/
                ROBERT A. WHITMANRobert
                A. WhitmanChief
                Executive OfficerDate:
            July
                11, 2006
            
            By:
            /s/
                STEPHEN D. YOUNGStephen
                D. YoungChief
                Financial Officer


Return
      to
      Index





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