Brian Beckwith – President and Chief Executive Officer
Mike DeMarco – Chief Financial Officer
Sally Wallach – Epoch Financial
Peoples Educational Holdings, Inc. (OTCPK:PEDH) F4Q 2011 Earnings Call August 15, 2011 11:00 AM ET
Good day, ladies and gentlemen, and thank you for standing by. Welcome to Peoples Educational Holdings’ Earnings Conference Call. My name is Alicia and I’ll be your operator for 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 are represented by 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 results to differ materially from those indicated today. These risk factors include change 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 over the call to today’s host, Mr. Brian Beckwith. Please proceed, sir.
Good morning. I’m Brian Beckwith, President and CEO of Peoples Educational Holdings. Welcome to our F2011 Q4 and year-end earnings conference call. I’ll begin with a brief overview, and Mike DeMarco, our Chief Financial Officer, will discuss our financial results in more detail.
Our fiscal year ending May 31st, 2011, was challenging given the state of the economy and a resulting difficult market for K-12 instructional materials as state and local education budgets continued to be under significant pressure. Although revenue for the Q4 declined 7.7% compared to the prior year, we’re encouraged by the positive revenue trend of our Q1 and Q2 results. Revenue for the full year was $31.3 million, a decline of 10.4% from the prior year.
Despite the decline in revenue, we continue to manage the business well. We continue to carefully manage our operating expenses given the current fiscal environment while investing in new products for future growth with an emphasis on digital and blended print and digital products. While the state and local fiscal environments are still difficult, there are signs that state finances are beginning to stabilize. According to the National Association of State Budget Officers, 13 states and the District of Columbia have reported budget gaps in their 2011 budgets. In F2010 by contrast, 45 states experienced shortfalls relative to their original budgets. Two key states – California and New Jersey – have experienced revenue increases that were unanticipated. On the downside, Texas has experienced revenue challenges that began later in the economic cycle than was the case in most states.
There continues to be an enormous focus at every level on improving the quality of education in our country. For the first time, the majority of state governors and chief state school officers are collaborating across states to improve our education system. The introduction of Common Course State Standards, or CCSS, spearheaded by the National Governors’ Organization and the Council of Chief State School Officers, continues to gain momentum. However, state assessments based on these standards are not expected to be fully implemented until the 2014/2015 school year. In the meantime, the existing state accountability systems based on term standards will remain in place in most states.
At this stage, Texas, Virginia and Alaska have announced that they will not adopt the CCSS while Minnesota has announced that it will adopt only the English Language Arts standards. Texas has implemented new standards and will begin implementing a new test called [STAR] in the coming school year. While the changeover has significantly affected our revenues in Texas over the short term, we believe that the new STAR assessments coupled with the new upcoming high school end-of-course assessments required for graduation will represent significant growth opportunities for us in the second-largest state and what has historically been one of our strongest states.
States have the option, under the Common Course Standards, to add up to 15% in additional state-specific standards. Of the ten states for which we publish state-specific materials, two – Texas and Virginia – have stated that they will continue with unique standards; and five additional states have indicated that they will add state-specificity. As a result, we anticipate a relatively small impact on our ability to deliver state-specific products in the major states where we deem it to be economically efficient.
On the other hand, the introduction of Common Standards offers us the opportunity to expand rapidly into states where we have not had a significant presence to date. Most of these are smaller states and will not require state-specific editions, yet they will collectively represent close to 50% of the US K-12 student population. We will continue to create common core print and internet-delivered products which leverages our strong standards orientation. Our first print work texts focusing on the CCSS have been launched. Additionally we’re in the process of developing new versions of our internet-delivered assessment and practice products – Assess and Practice Path – also centered on the CCSS.
While our research shows that most states continue to teach their current standards and prepare for their existing tests, there will be a migration towards the Common Course Standards as the new assessments relative to these standards are designed and implemented. Our products, both print and digital, will continue to prepare students for their existing standards and assessments while they will also assist in the migration to the new standards and ultimately prepare students to achieve proficiency on the new assessments. Our focus is to offer schools and districts a blended product solution – print and digital – to meet their immediate needs, whether it’s their current state standards or the implementation of the new CCSS.
Given the increased rigor of the new Common Course State Standards relative to most states’ existing standards, we see increased opportunities for standards-based test preparation, intervention and test practice in the coming years. We’re enthused about our completely reorganized and expanded product development organization which now has the ability to deliver strong print, digital and blended solutions from our existing content as well as newly developed content in new opportunity areas such as end-of-course. We have taken primary control of our digital development from outside developers although we’ll continue to use outside resources to augment our highly capable internal staff.
We’re also enthusiastic about our rapidly-developing digital sales capabilities. We now have a dedicated team of seven experienced digital sales personnel including a highly-experienced national digital sales manager. This group will work closely with our existing sales force in order to extend the solutions we can provide to educators and leverage our existing brand and customer relationship strengths. I’ll now turn it over to Mike to discuss our financials in more detail. Mike?
Thank you, Brian. Total revenue for Q4 was $6.8 million compared to $7.4 million in the prior year. Test preparation assessment and instruction product line revenue was $4.2 million – a year-over-year decline of $474,000. College preparation revenue was $1.9 million, a year-over-year decline of $100,000; while literacy revenue was $711,000 compared to $719,000 in the prior year.
Cost of revenue as a percentage of revenue for the quarter was 58.8%, up slightly from 58.3%. Cost of revenue consists of two components: direct costs and pre-publication costs amortization. Direct costs, which consists of product costs for our print products, web hosting fees for our digital products, royalties, warehousing and shipping costs, was 37.7% of revenue, a year-over-year decline of 3.2 percentage points. This fluctuation is due to product revenue mix and a $105,000 decline in the inventory reserve expense. Pre-publication costs include expenses associated with producing new products. These costs are capitalized and are amortized depending on the product over a three- or five-year period. For the quarter, we amortized $1.4 million of pre-publication costs which was $154,000 higher than the prior year. As a percentage of revenue, it increased 3.7 percentage points to 21.1%.
Selling expenses for the quarter were $1.6 million or 23.6% of revenue compared to $1.5 million or 20.5% of revenue last year. The increase is due to higher sales infrastructure costs offset by lower commission expense. Marketing expenses for the period were $702,000, a decrease of 2% from the prior year. General and administrative expenses for the period were $1 million, a year-over-year decline of 3%. Net loss for the quarter was $391,000 compared to $106,000 in the prior year, and net loss per share was $0.09 compared to $0.02 last year.
The results for the full year, twelve months ending May 31st, 2011, were as follows: total revenue was $31.3 million compared to $34.9 million in the prior year; testing assessment and instruction product line revenue was $17.4 million, a decline of $2.8 million from last year. College preparation revenue was $11.6 million, a year-over-year decline of $500,000; and literacy revenue was $2.2 million, a year-over-year decline of $328,000. Cost of revenue as a percentage of revenue for the twelve-month period was 59.2% up from 58.3% in the prior year. Within cost of revenue, direct costs were 42% of revenue compared to 42.9% in the prior year. The improvement is due to the decline in the inventory reserve expense offset by slightly higher product costs due to product revenue mix.
Pre-publication cost amortization was $5.4 million consistent with the prior year, but increased as a percentage of revenue from 15.4% to 17.2%. Selling and marketing expenses for the year were $8.9 million, a decline of $475,000 and 5% from the prior year. Marketing expenses accounted for $448,000 of the total reduction and this was primarily due to lower product sampling and decreased internet expenses. General and administrative expenses for the year were $4.4 million, a year-over-year decrease of $81,000 and 2%. The decrease is primarily a result of overall cost containment initiatives offset by an increase of $121,000 in stock based compensation expense.
Net loss for the year was $546,000 or $0.12 per share compared to net income of $251,000 and $0.06 per share in the prior year. Net income, which is net income adjusted for non-recurring items and the difference between pre-publication expenditures and amortization was a loss of $164,000 or $0.04 per share compared to income of $534,000 or $0.12 per share in the prior year. The decline is primarily due to the year-over-year decline in net income and the market value fluctuation of our term loan swap agreement. Free cash flow for the year was $265,000 compared to $3.2 million in the prior year. The year-over-year decline in free cash flow is a result of the $2.8 million decrease in net cash provided by operations consisting primarily of fluctuations in net income, deferred taxes and accounts payable, and accrued expenses. Brian?
Thanks, Mike. Early next month we’ll be re-launching our existing suite of digital products with new user-friendly interfaces and strong new functionality under our well known flagship Measuring Up brand name. These products will continue to be sold under the subscription as a service, or SAAS, business model. This model is becoming increasingly accepted in the educational instructional marketplace, and we believe that over time a substantial portion of our business will migrate to this model.
As the K-12 market continues to evolve in response to state and federal initiatives as well as to technological innovation, there’s a strong and growing trend toward incorporating student performance as determined by a variety of assessments into teacher and administrative evaluations, which has an impact on advancement, pay and tenure. Given our ability through assessment and strong instruction to create and implement a personal prescriptive path, or P3, for each student, and thereby improve individual student performance, we feel we’re well-positioned to prosper in the coming years. Our organic growth potential is strong and we’ll continue to pursue potential partnerships and add on acquisitions with a focus on test preparation, formative assessment and practice for state tests.
Thank you for listening to our prepared remarks. We’d now like to open it up to questions, if any, from our listening audience.
(Operator Instructions.) Your first question comes from the line of Sally Wallach from Epoch Financial. Please proceed.
Sally Wallach – Epoch Financial
Hi, Brian, hi Mike. Just a few quick questions: first of all I was intrigued by your comments about the digital products. Can you talk a little bit about how that part of your business has been performing? And I don’t believe you’re breaking that out as a share of the total business but if you could give us even a little color on that I’d be curious to know how that’s been changing over time.
Sure. Right now, Sally, it’s still a relatively small portion of our testing assessment and instruction revenue. It’s probably about 5% of the total but it is growing. I mean we had a spike on our digital products about two years ago with a large adoption in California which did not repeat, but we did see some nice growth in there, and I think – Brian, I don’t know if you want to touch a little more on the digital sales effort – but we definitely see this as an area that is going to be increasing pretty significantly in the future.
Yeah, for the first time we really have a dedicated sales group with an experienced manager who we just brought onboard a couple months ago, and you know, we’re putting in place the systems and the reporting; and with our new development capabilities we now have a fully professional in-house dedicated digital development capability which we didn’t have in the past. And that is coming together very nicely and we’re very excited about it. Coming back to school we’ll be re-launching our products under the Measuring Up brand, which is our flagship and which we haven’t been using on the digital side; and we’ll continue to augment the functionality throughout the school year using our new internal capabilities. So we’re excited about it and so is the sales team we have in place. We’ll also continue to use our existing sales force which is large to feed leads and continue to assist in the selling of the digital products, but now we have a group that’s just purely focused on digital sales.
Sally Wallach – Epoch Financial
Okay, and I think you said in your comments that you now have seven sales reps who focus only on digital, and it sounds like that’s a fairly new effort so that’s not something that would have really affected last year in any way.
Yeah, that’s a new effort, having them under one management structure and we’re incentivizing the existing sales force as well in order to feed them leads and customer relationships. So yeah, this is a new effort and we’re enthused about it. There’s a lot of energy there.
Sally Wallach – Epoch Financial
Okay, great. And then you mentioned in Texas the new STAR test, and I believe you said that in the near term ahead, the transition had a slight negative effect but should be positive long-term. Can you talk about the timing of that – how that transition happens and how you think that could affect your business?
Sure, and that’s something that we’ve experienced in other states as well, as old standards are replaced and as previous tests are replaced. And Texas has come out with new standards and they’re being implemented, and we do have instructional materials that we’ve developed that relate to those new standards. But the specific test items for the new tests have not been released yet although there are some broad blueprints. And we’re known for our high degree of specificity, so until we get those test items we can’t put out the level of quality of material that we need in order to really succeed in the marketplace. But those will be coming out this fall. For the first time they’re going to be field testing the new STAR assessment in the early part of next year. We do have some of what we call STAR-ready assessments, so they’re close to what the new assessment will be but they don’t have quite the level of specificity that ultimately we will have. So as we get more information and as the product improves we think we’ll be able to regain quite a bit of the revenue that we’ve seen fall as they transition to the new tests.
Sally Wallach – Epoch Financial
Okay. And then finally you mentioned the rollout of the digital product suite, but are there any other important new products coming out in this fiscal year?
Yeah, the other one I would mention is the Texas end-of-course. Texas is moving to specific end-of-course assessments for specific courses such as biology, etc., and they will be counting towards graduation requirements. That’s a new initiative on the part of Texas and so we’ll be launching a series of end-of-course test preparation materials and they’ll be hybrid print/digital products; and they will be coming out beginning this fall for Texas. So we think that’s going to be a big opportunity area for us as well.
Sally Wallach – Epoch Financial
Okay, great. Thanks a lot.
Thank you, we appreciate it.
(Operator instructions.) At this time you have no further questions. This does conclude the question-and-answer portion of the call. I will now hand the call over to Brian Beckwith for closing remarks. Please proceed, sir.
Okay, thank you for your participation today. We appreciate your support and your continued interest in Peoples Education. Have a great day. Thank you.