Brian Beckwith – President and CEO
Michael DeMarco – EVP and CFO
Sally Wallach – Epoch Financial
Peoples Educational Holdings, Inc. (OTCPK:PEDH) F2Q 2012 Earnings Call January 12, 2012 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 Candace [ph] and I’ll be your coordinator for today. (Operator instructions) As a reminder, ladies and gentlemen, this conference is being recorded for replay purposes.
Before we begin, the company has asked that the following statement be read. 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. It is my pleasure to introduce your host for today’s conference Mr. Brian Beckwith. Sir, you may proceed.
Good morning. I’m Brian Beckwith, President and CEO of Peoples Educational Holdings. Welcome to our fiscal year 2012 second quarter 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.
Net revenue for the quarter ending November 30, 2011, was $4.6 million, compared to $6.2 million during the same period in the prior year. Net revenue for the six months ended November 30, 2011 was $16.6 million, compared to $19.3 million during the same period in the prior year. Our decline in revenue for the six months ended November 30, 2011, continues to reflect challenges in the educational materials market as schools continue to react to budgetary shortfalls, and have been delaying or reducing orders, and in some cases not purchasing new materials for the classrooms.
These circumstances continue to have an adverse impact on our revenue. Although all three of our product groups experienced revenue declines, the Test Preparation, Assessment and Instruction product group accounted for $1.8 million of the decline. This is primarily a result of a decline in revenue generated out of Texas, and I will comment more specifically on this in a moment.
Net income for the six months was $2,000, compared to $471,000 in the prior year. However, non-GAAP net income, which excludes nonrecurring costs and adjusts for the difference between prepublication expenditures and amortization, increased $480,000 to $595,000.
Free cash flow, which is cash provided by operating activities reduced by expenditures for prepublication costs, equipment, and intangibles, for the six months was $1.4 million. As indicated, our Testing, Assessment and Instruction revenue decreased primarily due to a decline in Texas. Texas has implemented new standards and is in the midst of a change to new tests. While the changeover has significantly affected our revenues in Texas in the short term, we believe that the new STAAR, or State of Texas Assessments of Academic Readiness Assessments, coupled with the new upcoming high school End of Course of EOC assessments requires for graduation will create growth opportunities for us.
Under the newly revised graduation requirements, students will need to pass 12 EOC assessments over the next four years in order to graduate. We have released new and revised products for Texas focusing on the EOC and the new STAAR, and expect revenue to rebound over the next two quarters. Educators have only recently learnt that the new STAAR test will count towards Federal annual yearly progress requirements for this school year.
Texas is the second largest state and has historically been one of our strongest states with a strong brand recognition, and a highly capable and an enthusiastic sales team. Our Literacy group represents the smallest of our three product groups. These Literacy products are developed by other publishers, and [inaudible] by Peoples Educational primarily through independent sales representatives under our management.
Revenue for this group was off $619,000, compared to the first six months of the prior fiscal year due to a decline in the number of large opportunities that last year were funded primarily with ARRA, The American Recovery and Reinvestment Act funds. We are currently pursuing additional funding opportunities, including the recently released $180 million federal Striving Readers Comprehensive Literacy Program. We are also positioning this product and packages that align well with the goals to the Common Core Standards that are beginning to be implemented in most states.
Our College Preparation product group was off 3.3% compared to the first six months of the prior fiscal year. We are beginning to see pockets of growth in both print and digital versions of these products. These are primarily college level texts, e-books and class management systems that we sell into high school space, as exclusive distributors for two college publishers. We also developed proprietary supplemental materials for this market. We are pleased to see some stabilization in this market and believe that there continues to be opportunities for future growth.
The overall market for K-12 instruction materials has been extremely challenging over the past few years due to the decline in state and local funding. State and local fiscal environments are still difficult. According to the Center on Budget and Policy Priorities 37 states are providing less funding for students in local school districts in the 2011, 2012 [ph] school year than they provided last year. This school year is the primary year of the much talked about funding cliff in which additional Federal stimulus dollars have run out, but the economic recovery has not yet gained enough momentum to replace these funds.
Texas in particular has experienced revenue challenges that began later in the economic cycle than was the case in most states. While we believe that the market will continue to be challenging in the short term, we are pleased to see increased demand for our product in some of our key states, such as California and New Jersey.
We are focused on the eventual change over in most states to the Common Core State Standards over the next few years. We released our first CCSS instructional products earlier in the calendar year, and have now seen sales in 29 states. We continue to be encouraged by the favorable market response to these products. This expands our presence beyond the 10 core states that we were previously focused on.
Also, the enhanced rigor of the CCSS relative to existing state standards creates a favorable environment for our products, which are designed to improve student mastery. Our CCSS products have been an area of growth for us over the past six months. We are also enthused about continued enhancement of our new digital products, Measuring Up Insight and Measuring Up MyQuest. These products provide Internet-delivered formative assessment, highly engaging test practice and instruction relating specifically to the existing state standards in 10 states and to the CCSS as well for those schools in districts that are beginning to migrate to the new common standards.
These products were developed internally through our development services team and are being taken to market by our new team of digitally focused sales reps headed by a national digital sales manager, as well as by our existing team of independent and company sales representatives.
We are excited by our new capabilities and feel that we are well prepared for future growth as the market moves increasingly towards the use of educational technology in the classroom.
I will now turn it over to Mike to discuss our financials in more detail. Mike?
Thank you Brian. Total revenue for the second quarter was $4.6 million, compared to $6.2 million in the prior year. Revenue results by product line are as follows
Test Preparation, Assessment and Instruction product line revenue was $2.8 million, a year-over-year decline of $1.2 million. As Brian mentioned earlier in the call, the decline was primarily in the state of Texas, which is in the process of transition to a new set of standards and tests. This impacted not only the revenue for the quarter, but also for the six months period.
College Preparation revenue for the quarter was $1.6 million, a year-over-year decline of $234,000, and Literacy revenue for the quarter was $198,000 compared to $371,000 in the prior year. our revenue from this product group for both the quarter and the six-month period was significantly affected by the decrease in federally funded literacy initiatives, specifically ARRA, which was a funding source commonly used by customers of this product.
Cost of revenue consists of two components
direct costs and prepublication cost 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 38.7% of revenue, a slight decline from 39.0% in the prior year.
Prepublication costs include expenses associated with producing new proprietary products. These costs are capitalized and are amortized depending upon the product over a three or five-year period. For the quarter we amortized $1.3 million of prepublication costs, which was $19,000 higher than the prior year. As a percentage of revenue however, it increased from 20.1% to 27.5%.
Selling and marketing expenses for the quarter were $1.8 million, a decrease of 21.4% from the prior year. The decrease is due to lower salary and related expenses, lower sample and marketing and promotional expenses, and the declining commission expense as a result of our lower revenue base. As a percentage of revenue the expense increase from 37.8% to 40.1% due to the lower revenue base.
General and administrative expense for the period were $1.0 million, a year-over-year decline of 4.2%.
Net loss for the quarter was $869,000, compared to $581,000 in the prior year, and net loss per share was $0.19, compared to $0.13 last year. Our results for the six months ending November 30, 2011 were as follows
Total revenue were $16.6 million compared to $19.3 million in the prior year. Testing, Assessment and Instruction revenue was $7.3 million, a decline of $1.8 million from the prior year. College Preparation revenue was $8.7 million, a year-over-year decline of $298,000, and Literacy revenue was $601,000, compared to $1.2 million in the prior year.
Cost of revenue as a percentage of revenue for the six-month period was 63.9%, up from 60.1% in the prior year. Within cost of revenue, direct costs were 48.1% of revenue compared to 47.0% for the prior year. The percentage increase is primarily due to revenue mix, as College preparation revenue for the period increased from 46.5% of total revenue in the prior year to 52.3% of total revenue in the current year.
College preparation direct costs are substantially higher than that of our other products. Prepublication cost amortization was $2.6 million, an increase of $92,000 -- as a percentage of revenue it increased from 13.1% to 15.8%.
Selling and marketing expenses for the period were $3.7 million, a decrease of 18% from the prior year. The decrease is due to a reduction in commission expense as a result of lower revenue, a decrease in salaries and related expenses, the timing of various promotional campaigns, and an overall decline in sample expense. The expense as a percentage of revenue for the six-month period was 22.5%, a decrease from 23.6% in the prior year.
General and administrative expenses for the period were $2.1 million, a year-over-year decrease of $135,000 and 6.1%. The decrease is primarily a result of overall cost containment initiatives, offset by a 62000 increase in stock-based compensation expense. Net income for the six-month period was essentially breakeven compared to net income of $471,000 and $0.11 per share in the prior year. Non-GAAP earnings, which is net income adjusted for non-recurring items and the difference between prepublication expenditures and amortization was $595,000, or $0.13 per share, compared to $115,000 and $0.03 per share in the prior year. The increase is primarily due to a $1.4 million year-over-year decline in prepublication expenditures, offset by a $469,000 decline in net income. Brian.
Thanks Mike. For the remainder of fiscal 2012, despite the still difficult economy, we will continue to focus on improvements in net income, non-GAAP net income and free cash flow, while reducing our outstanding debt. We will continue to invest in the long-term growth strategies, particularly in the area of enhanced digital offerings and the Common Core standards, as well as in enhancing the strength and capabilities of our sales force, and we’ll continue to take the steps necessary to minimize expenses and improve efficiencies given the economic climate.
We’re projecting full year revenue to be between $30 million and $32 million, net income to be at a break-even level, non-GAAP income to be between $400,000 and $600,000, and free cash flow to be between $1.4 million and $1.6 million.
Thank you for listening to our prepared remarks. We’d now like to open it up for questions if any from our listening audience.
(Operator instructions) Our first question will come from the line of Sally Wallach with Epoch Financial. You may proceed.
Sally Wallach – Epoch Financial
Good morning. Hi Brian, hi Mike.
Hi. Good morning Sally.
Good morning Sally.
Sally Wallach – Epoch Financial
Just a couple of questions, based on the guidance you provided, it looks like you are expecting revenue to improve in the second half, just wondered if you could provide a little more color on that. Is that mainly because that you expect an improvement in Texas or are there other factors that come in to play in that projection?
Yes, go ahead Mike. You want to touch on that.
Sure. Texas is one part of it Sally that we are expecting to have an increase there not only on the state-specific testing product as a result of the STAAR tests having to count towards the federal AYP, but also on the End of Course products that Brian had touched on that those were introduced just over the last couple of months.
It seems to be a very hot topic in Texas right now. There is a lot of anxiety as it relates to the tests and that translates into good news for us as far as having the products out there to meet their needs. So, I think Texas is a large part of it that we're also seeing some very good opportunities in California pretty much across the board, and then the last area is the digital products that with the enhancements that we've made over the last 12 months that we are expecting to see some movement on that in the second half of the year also. So it's really a combination of those three. Is there anything you want to add?
That is the primary element. You've covered it.
Sally Wallach – Epoch Financial
Okay, and in Texas given the expectation that you'll see a pickup in business there in the second half, is it reasonable to then expect that you would enter the New Year with some momentum, in other words this is perhaps just the beginning of some rebound in that business?
Yes, that is a reasonable expectation. We will continue to develop new products for the Texas market. It is in our plans, and we'll continue to really focus on additional End of Course exams as they come out. They're starting with four this year, but we'll continue to roll out new tests each year, and as more and more is known about the STAAR tests, we're able to better hone in on and meet with a high level of specificity the needs of preparing for and improving the performance on that test. So, yes, we see continued growth in our opportunities and access [ph].
Sally Wallach – Epoch Financial
Okay. And also, with regard to the Common Core Standards, how do you see that progressing in terms of a roll out to the various states over, say, the next 12 to 24 months?
Well, we've put in place sales people that we previously did not have in place in order to sell Common Core products. In some cases they sell other products as well. But these are people who have digital capabilities as well as print capabilities. That's how we're getting the sales in the additional states beyond our traditional core states.
We've now seen sales in 29 states for our Common Core products. So, you know, as the states begin to emphasize more and more, the transition towards the Common Core Standards, we believe that we'll see a significant pickup in sales in those states. Virginia and Texas have opted not to go with the Common Core Standards, and so we will remain focused on their specific standards. The implementation schedule on those -- on the Common Core Sally, it does vary by state pretty significantly, and also states in many cases are doing partial implementations, where they are implementing portions of it over a specific time period. So it is not the same. There is not one implementation schedule, and therefore all the states, they all have their own implementation schedules at this point.
Yes, that is correct. Additionally, as part of the Common Core criteria, they are able to modify the standards and change up to 15% of them, or add to them, augment them, and we're beginning to see that in some of the major states. So that we feel is going to be an opportunity for us as those changes and additions become clear, we are in a position to react very quickly to give them a high level of state specificity.
So, we will have products certainly in the larger states that are very specific to those states and have the Common Core elements, but also have the elements which they've decided to change or augment.
Sally Wallach – Epoch Financial
Okay, sounds good. And then finally, with regard to your digital product, is that a growing share of revenue at this point, and if you were to look out, say, two to three years, where do you see that going? Do you expect it to be a significantly larger share of your business in that period of time?
In answer to the second part of the question, yes, we are anticipating it is going to be a much larger percentage of our total business going out. For the first six months, that was actually a segment that within Testing, Assessment and Instruction, and that actually did have a year-over-year growth.
But it's still off of a relatively small base, but that we are seeing more and more of a movement from print to digital, and more of a combined solution, both print and digital solutions. So, yes, we are expecting some pretty significant growth in the digital product in the foreseeable future.
Yes, I don't have a percentage for you, but yes, three or four years out we believe that it will be a significant portion of our revenues. In the mid-term what we're seeing is that there's more and more demand for blended solutions that combine both print and digital, and we're exploring that trend.
Sally Wallach – Epoch Financial
Okay, great. Thank you so much.
(Operator instructions) This concludes the question-and-answer portion of today's conference. I will turn the call back to Mr. Beckwith for closing remarks. Sir?
Yes, thank you for your participation today. We appreciate your support and your continued interest in Peoples Education. Have a great day. Thank you.
Thank you, sir, and thank you for your participation. You may now disconnect. Have a great day.