Peoples Educational Holdings, Inc. F2Q09 (Qtr End 11/30/08) Earnings Call Transcript

Peoples Educational Holdings, Inc. (PEDH)

F2Q09 (Qtr End 11/30/08) Earnings Call Transcript

January 12, 2009 5:00 pm ET

Executives

Brian Beckwith – President and CEO

Mike DeMarco – EVP and CFO

Analysts

Sally Wallick – Dutton Associates

Presentation

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Peoples Educational Holdings Earnings Conference Call. My name is Anton, and I will be your operator today. (Operator instructions) As a reminder, ladies and gentlemen, this conference is being recorded.

Before we begin, the company has asked me to read the following statement. Today's presentation by management contains forward-looking statements within the meaning of the Securities Exchange Act of 1934. These forward-looking statements represent the Company's present expectations or beliefs concerning future events.

The company cautions that such statements are necessarily based on certain assumptions, which are subject to risks and uncertainties, which could cause actual results to differ materially from those indicated today. These risk factors include changes in general economic conditions, local and state levels of educational spending, changes in demand from customers, variations in the mix of products sold, the impact of competitive products and pricing, and the company's ability to respond to rapidly changing technologies. Further information on these risk factors is included in the company's filings with the Securities and Exchange Commission.

I would now like to hand the call over to the host for today's call, Brian Beckwith.

Brian Beckwith

Good afternoon. I am Brian Beckwith, president and CEO of Peoples Educational Holdings. Welcome to our second quarter fiscal year 2009 earnings conference call. I will begin with a brief overview of operations and results for our major product line groupings, and Mike DeMarco, our Chief Financial Officer, will discuss our financial results in more detail.

While Mike will go into more detail, I do want to touch on a few key points. Our revenue for the quarter ended 11/30/08 was $8.3 million, a decrease of approximately 3% from the same period in the prior year. For the six months ended November 30, 2008, revenue was $24.3 million, a decrease of approximately 4%. Revenue from testing, assessment and instruction was down 8% from the prior year six-month period, while college preparation revenue was essentially flat with the prior year.

According to the Association of American Publishers, AAP, market conditions in the supplemental segment of the educational publishing industry continue to be challenging. Supplemental revenue was off 8.4% for the six months ended November 30, 2008, compared to the same period in the prior year. While educational budgets tend to be the last to be cut during times of state and local fiscal stress, they are not immune. According to recent reports in the National Association of State Budget Officers website, 41 states faced budget shortfalls in fiscal year 2009 which began July 1, 2008, in most states. Yet despite softness in supplemental material sales, our internal analysis of publicly available information in the test preparation and assessment segment of the supplemental market indicates that this specific part of the market is continuing to grow and we expect it to fare better than more general instruction materials during the downturn in state and local spending.

Peoples Education grew at a steady pace through the last state fiscal crisis in the years 2002 through 2004. We feel that the current fiscal problems may have moderated our growth but we’ve continued to gain share in the overall supplemental market and feel that we will be well positioned when funding improves.

Focused Instruction product line revenue was up 7.5% on a year over year basis for the first six months of our fiscal year in the face of a supplemental market in which many competitors are faced with significantly declining revenues. Late in the first quarter of this year in time for the new school year, we’ve published Turbo Math for the middle school grades six through eight. We now have Turbo Math product for grades three through eight. In addition, based on requests from educators, we also released an additional earlier grade called AB for the Keep On Reading Science! series. We now offer six Focused Instruction series, each of which comes with free online assessment delivered by our e-Path platform.

We plan to continue to invest in the development of new Focused Instruction products and to offer them in combination through intervention programs at the district level. We are pleased with the reception of our newly created intervention programs in reading and math, including intervention kits with customized pacing guides developed from our growing line of Focused Instruction products.

Having invested in the development of a strong standards based content database and test preparation license and assessment, we feel that we are well positioned to leverage that content into new states as well as new segments of the test preparation market such as Measuring Up Express, our new lower cost, less comprehensive series, in a timely and efficient manner. This leveraging of existing content extends the digital instruction as well which I will touch on in a moment.

On the electronic product front, our user friendly yet highly capable online assessment diagnostic system, e-Path, was critical to our success with last year’s California adoption. Developed in conjunction with the Cisco Learning Institute, e-Path has begun to experience significant growth in our other major states. In two major districts in Texas, we’ve begun to offer digital instruction, which students can access as a direct result of the work with the e-Path assessment system. We believe that providing digital instruction standards based as well as assessment will be key part of our strategy over the next several years as the market continues to move towards electronic preparation and instruction for state tests.

We are in the process of developing enhanced digital instructional capabilities and while we’ve had some delays in the development process, we intend to implement pilot lessons in two states during the fourth quarter of fiscal 2009. If these pilots are successful, we will finalize the development of a digital differentiated instruction product and test market this product in two of our key states. The instruction will be driven by our e-Path assessment system, which is designed to identify weaknesses relative to the state standards in specific grades and subject areas, including English language arts, math and science. We are also currently upgrading our customer interface and report presentation package for each e-Path, which will make e-Path even more user-friendly.

I will now turn it over to Mike to discuss our financials in more detail. Mike?

Mike DeMarco

Thank you, Brian.

Revenue for the second quarter ended November 30 was $8.3 million, which represents a 2.6% decrease from the prior year. Test preparation assessment and instruction revenue was $6.1 million, a decrease of 6.3%, and college prep revenue was $2.2 million, which represents a 9.2% increase. Cost of revenue consists of two components, direct costs and prepublication cost amortization. The expense as a percentage of revenue was 57.9%, up from 55.6% last year. Direct costs consists of three components

one, product cost, which includes paper, printing and binding and pre-press cost for proprietary products and product purchases for nonproprietary products; two, royalties on proprietary products; and three, warehousing and shipping costs on all products.

Direct cost as a percentage of revenue was 37.5%, a 1.8 percentage point increase from the prior year. This increase is due to revenue mix as college preparation revenue for the period increased from 23.6% to 26.4% of total revenue. College preparation direct costs are substantially higher than out of testing, assessment and instruction products as the majority of the college preparation revenue is derived from nonproprietary products.

Prepublication costs include the onetime cost associated with developing and producing new or revised proprietary products. Prepublication costs are capitalized and expensed on a straight-line basis over a three or five year period based upon the product. For the quarter, we amortized $1.7 million of prepublication cost which was consistent with the prior year.

Marketing and selling expenses decreased $587,000 or 18.6% from the prior year. As a percentage of revenue, it decreased six percentage points to 31.1%. General and administrative expenses remained consistent with the prior year. Our operating loss for the quarter was $146,000, an improvement of 306,000 and 67.7% as compared to the prior year. Interest expense was $208,000, a decrease of $146,000. During the period, we recognized $37,000 of noncash interest expense related to the market rate adjustment of our swap agreement. The balance of the year over year fluctuation is primarily due to lower average outstanding debt. Net loss for the quarter was $220,000, which represents an improvement of 47.9% over the prior year. On a per share basis, the loss was $0.05 compared to a loss of $0.09 last year.

Our year-to-date six month results are as follows. Revenue was $24.3 million, a decrease of 4.3%. Test preparation assessment and instruction revenue decreased 8% to $12.8 million, and college prep revenue was $11.5 million which is flat with the prior year. Cost of revenue as a percentage of revenue was 61.2%, an increase of 1.5 percentage points compared to the prior year. Direct costs as a percentage of revenue was 47.4%, an increase of 1.1 percentage points. This increase is primarily due to revenue mix as college preparation revenue increased from 45.4% to 47.5% of total revenue.

Prepublication cost amortization was $3.4 million consistent with the price year. Marketing and selling expenses decreased $1.3 million to $4.8 million; as a percentage of revenue, the expense decreased from 24% to 19.8%. Administrative expenses increased 5.5% to $2.4 million, primarily due to higher accounting fees and severance payments associated with headcount reductions. Operating income for the six-month period was $2.2 million, an increase of $316,000 and 16.8%.

Interest expense decreased $305,000 to $437,000. During the six-month period, we recognized $25,000 of noncash interest expense due to the market rate adjustment of our swap agreement. The balance of the year over year fluctuation is primarily due to lower average outstanding debt. The net income for the period was $1.1 million, an improvement of $362,000 and 48.9% from the prior year. Basic and diluted earnings per common share was $0.25 compared to basic and diluted earnings of $0.17 and $0.16 respectively in the prior year.

Non GAAP net income which adjusted net income for the difference between pre-publication expenditures and amortization and adjust for non-recurring items was $1.5 million, an improvement of $300,000. Basic non-GAAP EPS was $0.33, an improvement of $0.06 per share. Our liquidity continues to be strong. On November 30, 2008, we had $1 million outstanding on our revolving line of credit and we are paying down our $8.5 million term loan at a rate of $500,000 per quarter.

Free cash flow for the six months ending the November 30th was $5.6 million, an increase of $1.8 million from the prior year. And additionally during the six months ended November 30th, we reduced our line of credit by $4.6 million from year-end and paid down our term loan $1 million. Brian?

Brian Beckwith

Thanks, Mike.

I would like to close our prepared remarks with a few comments on Peoples Education’s outlook for fiscal year 2009. In fiscal year 2008, we achieved modest revenue growth with substantial improvements in non-GAAP net income and free cash flow through operating efficiencies and process improvements. We expect this trend to continue for fiscal 2009. In fiscal 2009, despite the difficult market, we will continue to focus on substantial improvements in net income, non-GAAP net income and free cash flow, while continuing to reduce our outstanding debt.

While continuing with long-term growth strategies, we have taken the necessary steps to minimize expenses and improve our efficiencies given the current economic climate. In December 2008, we reduced the headcount, terminating 13 non-product development employees, the majority of which were administrative in nature. In addition during the same time period, we were able to eliminate 12 positions within the product development group, as we continue our efforts to streamline our processes and increase the use of outsourcing. The changes made will allow us to increase productivity, maintaining a core group of development personnel that will enable us to scale seasonally and react on a more timely basis for the needs of our customers.

In light of our second quarter earnings results and our revenue expectations for the balance of the year, we are reducing the fiscal 2009 financial guidance that we first provided in August. We now project revenue to be between $37 million and $39 million, net income from a breakeven to $200,000 positive, and non-GAAP net income to be between $500,000 and $800,000. In addition, we expect positive free cash flow to range between $1 million and $1.5 million for the full fiscal year.

Thank you for listening to our prepared remarks. We would now like to open it up for questions if any from our listening audience.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Sally Wallick with Dutton Associates. Please proceed with your question.

Sally Wallick – Dutton Associates

Hi, Brian. Hi, Mike. A few questions, a couple related to revenues. First of all, it looks like college prep revenue was relatively strong in the second quarter, what’s the reason for that?

Mike DeMarco

Sally, I think that was really just primarily timing of orders. If you look at it for the six month period, it was basically flat with last year. So there was nothing out of the ordinary that occurred in the second quarter. It was really just the timing as compared to it coming in the first quarter versus the second quarter.

Sally Wallick – Dutton Associates

Okay.

Brian Beckwith

And the first quarter is the larger quarter growing out perhaps, so it is weighted towards it more.

Mike DeMarco

Exactly.

Sally Wallick – Dutton Associates

Yes, okay. And second question is on the electronics revenue, do you have a year over year number for that for the second quarter? Did it slow down? It looked like maybe it did, but I'm not sure about that.

Mike DeMarco

Yes, on a six-month basis, as Brian said, it is up about 7%. Just looking at it on a pure second quarter basis, it did go down slightly as compared to the prior year, but nothing extremely material.

Sally Wallick – Dutton Associates

Okay. And what would the reason be for that, because that, it seems to me, has been a very strong area for you in previous quarters?

Mike DeMarco

Sure. I think the biggest driving force on that is in California in the prior year, if you recall that we had the Casey [ph] packages, and those have done very well. That was a combination of books and electronics. Well, that special funding has expired, so we are not seeing as much business on those packages as we had previously, that we are still selling those particular books, but we are also selling the lower grades and those still have the electronics component built in.

Sally Wallick – Dutton Associates

Okay. And then a couple questions related to cost. You mentioned having eliminated a number of positions and, Mike, I think you mentioned that there were some severance in the second quarter. Did the severance related to eliminating those positions fall in the second quarter or will there be…?

Mike DeMarco

No. Actually the severance that I had mentioned in my discussion really related to severances that had taken place in the first quarter, during the first quarter. We consolidated some of our production and editorial team that was at a different location and consolidated it internally into New Jersey. So those expenses really hit in the first quarter but the one I was talking about, the six-months, that is where I talked about it. If you look at the admin expenses for the second quarter, they were pretty much flat with where they were last year.

Sally Wallick – Dutton Associates

Okay. So severance…

Mike DeMarco

The severance on the headcount reduction that Brian had mentioned, that actually happened in December. So we will see some of – so we will see those expenses hitting in the third quarter.

Sally Wallick – Dutton Associates

Okay. And to what extent did that contribute to lowering guidance? I'm just wondering how meaningful that…

Mike DeMarco

It is not a – I mean it is not an immaterial number, but I think the guidance lowering was primarily due to the market conditions that we're seeing, the lower revenues that we are expecting. That was the main reason for changing the guidance and the earnings that would result as a result of those lower revenue numbers.

Brian Beckwith

Yes, we…

Mike DeMarco

The severance is, it really is not a huge dollar amount.

Brian Beckwith

We just felt we had to be more conservative with our revenues given the environment that we're seeing out there, both the state and then going down to the local level, which of course impacts on the school budgets.

Sally Wallick – Dutton Associates

Yes, okay. And could you update us on new product development activities right now for the second half and going into the new fiscal year?

Brian Beckwith

Yes. I think in general terms, without being too specific about the states which we tend not to do for competitive reasons, we have a few initiatives going on. I mean first of all, we had mentioned Measuring Up Express. So we are growing out into at least one new state with Measuring Up Express and are adding some additional titles in another state. We are doing some fill in grades in existing states. We're not entering any new states in the second half of the fiscal year. So that's pretty much our print plan.

We do have new states that are on the boards and we are doing research on. We expect that new states will be part of our plan next year although we haven't made a final determination on our pre-prep plan for next year, but all of the product that we are creating on the print side is for existing states.

Then on the electronic side, I mentioned our initiative to develop a more enhanced digital instruction product, and that is a big initiative for us, and a significant one, in which the students will be able to go directly from our e-Path standards-based assessment to standards-based instruction which is instruction which is derived from our books but is interactive in nature. So it has some enhanced qualities that uses the technology. And that’s a pretty big new product initiative for us.

We are piloting that as I said in a couple of state we believe in the fourth quarter now. We do have some sample lessons at this stage and we're looking hard at all levels of the electronic piece of test preparation and standards-based instruction. There are, just like in the print test prep market, where there are various levels Measuring Up, our traditional

Measuring Up being very high level, very rigorous product. Similarly on electronics side, there are rigorous products and there are less rigorous newer quick test prep type products.

So we're looking at development potential at all those levels and doing quite a bit of research on that. We are well positioned because of the investment that we’ve made in e-Path to customize it to each customers’ needs. So we're working on filling out that portfolio of solutions.

Sally Wallick – Dutton Associates

And Brian, on the enhanced digital instruction product that you are working on now, why was that delayed? What happened there?

Brian Beckwith

Yes, most of the delay that – well, I guess, it was twofold. I mean, one, it is a complex – building any software and doing it right is a complex process. So I was not surprised by the delay because our focus was on doing it right and getting it out there in a form that was in good shape and ready for the market. So we did not push time ahead of quality, number one.

Number two, the conversion of our legacy product, of our print product into electronic formats has required a little bit more work than we had anticipated when we started the program. That will not be a problem with product that we are creating now going forward because we are developing it to be platform independent. So that content that we are creating from here forward will be digital ready. But some of our older products, we had to go through some conversions to make them uniform and that required an additional step which slowed us down. Those were the primary elements.

Sally Wallick – Dutton Associates

Okay. The rollout or the anticipated rollout is pilot tested in a couple of days by the end of this year, and then what happens next year?

Brian Beckwith

And assuming those pilots go well, then those same states are the ones we would roll into while simultaneously building it out for additional states. We have not determined how many additional states at this stage.

Sally Wallick – Dutton Associates

Okay. But if we are on this call a year from now, well assuming all goes well, we will probably be talking about incremental revenue from this product in at least those two states?

Brian Beckwith

Yes, that is our plan.

Sally Wallick – Dutton Associates

Okay, great.

Brian Beckwith

That’s right.

Sally Wallick – Dutton Associates

Okay, thanks a lot.

Mike DeMarco

All right, Sally. Thank you.

Brian Beckwith

Thank you.

Operator

(Operator instructions) And there are no further questions at this time.

Brian Beckwith

Okay. Thank you for your participation today. We appreciate your support and your continued interest in Peoples Education. We ask that you have a good evening until we speak again. Thank you.

Operator

Thank you for your participation in today's conference call. This concludes the presentation. You may now disconnect.

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