- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended February 29, 2012

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. 000-50916

Peoples Educational Holdings, Inc.

(Exact name of registrant as specified in its charter)

Delaware		41-1368898
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

299 Market Street, Saddle Brook, NJ 07663

(Address of principal executive offices) (Zip Code)

(201) 712-0090

(Registrant’s telephone number, including area code)

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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such file). Yes x No ¨

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

Large accelerated filer ¨ Accelerated filer ¨

Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the Issuer's classes of common stock, as of the latest practical date: 4,465,202 shares of Common Stock (par value $0.02 per share) outstanding on March 30, 2012.

TABLE OF CONTENTS

Page

PART I.	FINANCIAL INFORMATION

Item 1:	Financial Statements:

	Condensed Consolidated Balance Sheets as of February 29, 2012 (Unaudited) and May 31, 2011 and February 28, 2011 (Unaudited)	3
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended February 29, 2012 and February 28, 2011 (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended February 29, 2012 and February 28, 2011 (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6

Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10

Item 4:	Controls and Procedures	18


PART II.	OTHER INFORMATION

Item 1:	Legal Proceedings	19

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	19

Item 3:	Defaults Upon Senior Securities	19


Item 5:	Other Information	19

Item 6:	Exhibits	19

SIGNATURES		20

EXHIBITS		21

Part I

Financial Information

Item 1. Financial Statements

PEOPLES EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS

	UNAUDITED						UNAUDITED
(In Thousands-Except Share Data)	February 29, 2012			May 31, 2011			February 28, 2011
ASSETS

Current Assets
Cash and Cash Equivalents	$	940		$	18		$	33
Accounts Receivable, Net of Allowances for
Doubtful Accounts and Returns		1,302			2,745			2,204
Inventory, Net		2,958			3,196			3,554
Prepaid Expenses and Other		327			322			390
Prepaid Marketing Expenses		565			505			710
Deferred Income Taxes (Note 8)		1,062			1,136			900
Total Current Assets		7,154			7,922			7,791

Equipment - At Cost, Less Accumulated Depreciation
of $2,561, $2,515 and $2,551, respectively		291			314			308

Other Assets
Deferred Prepublication Costs, Net		10,780			12,269			13,095
Deferred Income Taxes (Note 8)		860			501			502
Trademarks, Net		284			255			232
Prepaid Expenses and Other		76			108			114
Total Other Assets		12,000			13,133			13,943

Total Assets	$	19,445		$	21,369		$	22,042

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities
Current Maturities of Long Term Obligations	$	2,000		$	2,000		$	2,000
Line of Credit		9,000			-			-
Accounts Payable		2,749			4,340			4,004
Accrued Compensation		436			394			391
Other Accrued Expenses		518			520			506
Deferred Revenue		467			438			508
Total Current Liabilities		15,170			7,692			7,409

Long Term Obligations, Less Current Maturities		-			8,234			8,810

Total Liabilities		15,170			15,926			16,219

Commitments and Contingencies

Stockholders' Equity
Preferred Stock, authorized 1,500,000 shares; none issued		-			-			-
Common Stock, $0.02 par value; authorized 8,500,000 shares; issued:
4,481,434 shares for all periods reported		90			90			90
Additional Paid In Capital		8,433			8,305			8,294
Accumulated Deficit		(4,184	)		(2,888	)		(2,497	)
Treasury Stock - 16,232 shares, at cost		(64	)		(64	)		(64	)
Total Stockholders' Equity		4,275			5,443			5,823

Total Liabilities and Stockholders' Equity	$	19,445		$	21,369		$	22,042

See Notes to Condensed Consolidated Financial Statements

PEOPLES EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In Thousands, Except Per Share Data)


	Three Months Ended						Nine Months Ended
	February						February

		2012			2011			2012			2011

Revenue, Net	$	3,638		$	5,126		$	20,256		$	24,430

Cost of Revenue
Direct Costs		1,235			1,496			9,227			10,561
Prepublication Cost Amortization		1,216			1,385			3,841			3,918
Total		2,451			2,881			13,068			14,479

Gross Profit		1,187			2,245			7,188			9,951

Selling, General and Administrative Expenses		2,683			3,162			8,509			9,945

Income (Loss) from Operations		(1,496	)		(917	)		(1,321	)		6

Other Expenses, Net		9			5			32			22
Interest Expense		79			71			228			230

Loss Before Income Taxes		(1,584	)		(993	)		(1,581	)		(246	)

Income Tax Benefit (Note 8)		(286	)		(368	)		(285	)		(91	)

Net Loss	$	(1,298	)	$	(625	)	$	(1,296	)	$	(155	)

Net Loss per Common Share:
Basic and Diluted	$	(0.29	)	$	(0.14	)	$	(0.29	)	$	(0.03	)

Weighted-average Number of
Common Shares Outstanding:
Basic and Diluted		4,465			4,465			4,465			4,465

See Notes to Condensed Consolidated Financial Statements

PEOPLES EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)	Nine Months Ended
	February
	2012			2011
Cash Flows From Operating Activities
Net Loss	$	(1,296	)	$	(155	)
Adjustments to Reconcile Net Loss to Net Cash
Provided by Operating Activities
Depreciation		102			107
Amortization of Prepublication Costs and Intangible Assets		3,858			3,936
Stock-Based Compensation		128			170
Market Value Adjustment of Interest Rate Swap		(11	)		15
Deferred Income Taxes		(285	)		(92	)
Changes in Assets and Liabilities
Accounts Receivable		1,444			786
Inventory		238			37
Prepaid Expenses and Other		27			(73	)
Prepaid Marketing Expenses		(60	)		(68	)
Accounts Payable and Accrued Expenses		(1,551	)		(683	)
Deferred Revenue		29			104
Net Cash Provided By Operating Activities		2,623			4,084

Cash Flows From Investing Activities
Purchases of Equipment		(81	)		(166	)
Expenditures for Intangibles		(45	)		(61	)
Expenditures for Prepublication Costs		(2,352	)		(4,149	)
Net Cash Used In Investing Activities		(2,478	)		(4,376	)

Cash Flows From Financing Activities
Net Borrowings Under Line of Credit		2,277			1,711
Exercise of Stock Options		-			4
Principal Payments On Long-Term Debt		(1,500	)		(1,500	)
Net Cash Provided By Financing Activities		777			215

Net Increase (Decrease) in Cash and Cash Equivalents		922			(77	)

Cash and Cash Equivalents
Beginning of Period		18			110
End of Period	$	940		$	33

Supplemental Cash Flow Information
Cash Payments for:
Interest	$	243		$	217


See Notes to Condensed Consolidated Financial Statements

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

NOTE 1 – Nature of Business and Basis of Presentation

Nature of business: Peoples Educational Holdings, Inc. (PEH), through its wholly owned subsidiary, Peoples Education, Inc. (PE), publishes and markets its own supplementary educational textbooks and digital programs for K-12 school market. The materials are predominantly state specific and standards-based, focused on state-required tests, offering instruction, practice, and formative assessment tools in both print and digital formats. PE publishes its own proprietary materials, and distributes on an exclusive basis for other publishers, college textbooks and supplements to the high school Advanced Placement*, (*Advanced Placement is a registered trademark of the College Board) honors and college preparation market. PE also distributes for three publishers supplemental literacy materials for grades K–8. Marketing channels include direct and commission sales representatives, telemarketing, direct mail, and catalogs. PE and PEH are together referred to herein as the “Company”.

Basis of Presentation: The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission and instructions to Form 10-Q for interim financial information and therefore do not include all information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These unaudited condensed consolidated financial statements contain, in the opinion of management, all adjustments (consisting of normal accruals and other recurring adjustments) necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows for the periods presented. The operating results for the three and nine month periods ended February 29, 2012 are not necessarily indicative of the operating results to be expected for the full fiscal year. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the year ended May 31, 2011.

Use of Estimates: Management is required to make certain estimates and assumptions which affect the amounts of assets, liabilities, revenue and expenses that the Company has reported and the disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements. Actual results could differ materially from these estimates and assumptions.

Concentration of Credit Risk: The Company maintains its cash and cash equivalents primarily with major financial institutions. One such account did exceed the FDIC limit as of February 29, 2012.

NOTE 2 – Revenue Recognition and Accounts Receivable

Revenue is recognized when products are shipped, the customer takes title and assumes risk of loss, and collection of related receivable is probable. The Company recognizes subscription based revenue on its digital products prorata over the life of the subscription agreement. The allowances for returns were as follows:

February 29, 2012		$	48,000
February 28, 2011		$	150,000

This allowance is recorded at the time of revenue recognition, if the right of return exists, and is recorded as a reduction of revenue and accounts receivable. The Company recognizes shipping and handling revenues as part of revenue, and shipping and handling expenses as part of cost of revenue on the consolidated statements of operations.

In November 2011, the Company entered into a new agreement with one of its college publishers. Under the new agreement, the Company will continue to perform all the same functions as it did under the previous agreement, including all sales, marketing and administration functions. However, the college publisher will now invoice the customers directly and remit to the Company the difference between the revenue and the cost associated with that revenue. The Company has established a reserve for returns on this revenue which is reflected as a reduction from accounts receivable.

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

The Company provides credit to its customers determined on a customer-by-customer basis. Trade receivables are carried at original invoice amount less an estimate made for doubtful accounts based on a monthly review of all outstanding amounts. Management determines the allowance for doubtful accounts after reviewing individual customer accounts as well as considering both historical and expected credit loss experience. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received. The allowance for doubtful accounts was $10,000 as of February 29, 2012, May 31, 2011 and February 28, 2011.

NOTE 3 – Basic and Diluted Per Share Amounts

Basic per share amounts are computed, generally, by dividing net (loss) by the weighted average number of common shares outstanding. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock instruments, unless their effect is anti-dilutive thereby reducing the loss or increasing the income per common share. Due to the net losses for the three and nine months ended February 29, 2012 and February 28, 2011, diluted shares were the same as basic shares since the effect of options and warrants would have been anti-dilutive.

NOTE 4 – Deferred Prepublication Costs

Deferred prepublication (product development) costs are recorded at their original cost and amortized over a three or five-year period, based on the estimated lives of the related publications. The net carrying value of the deferred prepublication costs is periodically reviewed and compared to an estimate of future undiscounted cash flows. If future undiscounted cash flows are not sufficient to support the net carrying value of the asset, an impairment charge will be recognized. At February 29, 2012 and February 28, 2011 the Company had an allowance of $137,000, reducing prepublication costs to their estimated net realizable value.

The activity in deferred prepublication costs is as follows for the periods presented:

(In Thousands)
	Three Months Ended						Nine Months Ended
	February						February
	2012			2011			2012			2011
Balances, Beginning	$	11,319		$	13,445		$	12,269		$	12,864
Prepublication Cost Additions		677			1,035			2,352			4,149
Amortization Expense		(1,216	)		(1,385	)		(3,841	)		(3,918	)
Balances, Ending	$	10,780		$	13,095		$	10,780		$	13,095

The estimated future amortization expense over the next five years as related to the above deferred prepublication costs is as follows:

(In Thousands)

Remainder of fiscal year ending May 31, 2012	$	1,145
Year ending May 31, 2013		4,066
Year ending May 31, 2014		2,748
Year ending May 31, 2015		1,770
Year ending May 31, 2016 and thereafter		1,051
	$	10,780

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

The future estimated expense amount is expected to increase as the Company continues its investments in product development.

NOTE 5 – Prepaid Marketing Expense

The costs of catalogs and promotional materials that have not been completed or delivered to customers are carried as a prepaid expense until the actual date of completion and mailing. Prepaid samples consist of materials that will be distributed to educators and are expensed as they are distributed. Prepaid marketing expenses include samples, catalogs and promotional materials.

NOTE 6 – Financing Arrangements

The Company has a revolving line of credit and a term loan with Sovereign Bank. Amounts borrowed under the agreement are secured by substantially all of the assets of the Company.

The revolving line of credit provides for advances up to $10.0 million. On August 10, 2011, we entered into an amendment of our credit agreement with Sovereign Bank which extends the maturity date of the revolving line of credit from March 1, 2012 to December 31, 2012, increases the interest rate by 0.75% for both the revolving line of credit and the term loan over the interest range in the original agreements, reduces the maximum amount of advances under the revolving line of credit to $9.0 million on March 1, 2012 and provides for an additional 0.25% interest rate increase effective July 1, 2012. At February 29, 2012, $9.0 million was outstanding under this facility.

The term loan was originally for $10.0 million and matures in December 2012. At February 29, 2012, $2.0 million remained outstanding under the term loan.

On June 3, 2010, we entered into a swap agreement for $3.0 million, which expired in February 2012. The change in the fair value of the interest rate swap is recognized as an adjustment to interest expense during each reporting period. For the nine months ended February 29, 2012, we recorded interest income of $11,000 relating to the swap.

The credit agreement contains certain financial covenants, calculated on a consolidated basis for the Company and its subsidiary, which, among other things, impose a maximum ratio of total funded debt to EBITDA, a minimum fixed charge coverage ratio and a restriction on the payment of common stock dividends. At February 29, 2012, we were in compliance with each of these covenants except the covenant relating to the maximum ratio of total funded debt to EBITDA. On April 5, 2012, the lender waived our non-compliance with this covenant.

NOTE 7 – Liquidity and Capital Resources

The Company has incurred losses of approximately $1,296,000 and $155,000 for the nine months ended February 29, 2012 and February 28, 2011 , respectively. At February 29, 2012, the Company had cash and cash equivalents of approximately $940,000, a working capital deficit of approximately $8,016,000 and an accumulated deficit of approximately $4,184,000.

Our existing credit facility (see Note 6) with Sovereign Bank expires on December 31, 2012 and we are currently exploring new financing opportunities. If we are unable to secure a new credit facility or generate sufficient cash flow from operations to service our commitments, we will be required to adopt alternatives, such as seeking equity capital in order to fund our current liabilities, operations and product development initiatives. There can be no assurance that such actions will be available in general or on terms acceptable to the Company.

NOTE 8 – Income Taxes

During the quarter ended February 29, 2012, the Company increased its valuation allowance by $300,000, resulting in a $1.0 million valuation allowance against its $2.9 million deferred tax asset as of February 29, 2012. The allowance reflects the Company's assessment of its ability to realize the benefit of the deferred tax asset. The Company made this determination after weighing both negative and

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

positive evidence in accordance with FASB ASC Topic 740, "Income Taxes" ("ASC 740"), which requires that the deferred tax asset be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax asset will not be realized in a future period. The evidence weighed included a historical two-year cumulative loss related to earnings before taxes in addition to an assessment of sources of taxable income, availability of tax planning strategies, and future projections of earnings. The Company will continue to maintain a valuation allowance against its deferred tax asset until the Company believes it is more likely than not that these assets will be realized in the future. If sufficient positive evidence arises in the future indicating that all or a portion of the deferred tax asset meets the more-likely-than-not standard under ASC 740, the valuation allowance would be reversed accordingly.

The effective tax rate for the three months ended February 29, 2012 reflects a benefit of 18.1%, as compared to a benefit of 37.1% for the three months ended February 28, 2011. The effective tax rate for the nine months ended February 29, 2012 reflects a benefit of 18.0%, as compared to a benefit of 37.0% for the nine months ended February 28, 2011.

The effective tax rate during the three and nine months ended February 29, 2012 reflects the impact of a $300,000 charge related to an additional valuation allowance established by the company.

NOTE 9 – Recently Issued Accounting Standards

In October 2009, the FASB issued FASB Accounting Standards Update (“FASB ASU”) No. 09-13, “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (a consensus of the FASB Emerging Issues Task Force)” (“FASB ASU 09-13”). FASB ASU 09-13 updates the existing multiple-element arrangement guidance currently in FASB ASC 605-25 (“Revenue Recognition-Multiple-Element Arrangements”). This new guidance eliminates the requirement that all undelivered elements have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to the items that have already been delivered. Further, companies will be required to allocate revenue in arrangements involving multiple deliverables based on the estimated selling price of each deliverable, even though such deliverables are not sold separately by either the company itself or other vendors. This new guidance also significantly expands the disclosures required for multiple-element revenue arrangements. The revised guidance was effective for the first annual period beginning on or after June 15, 2010. The adoption of FASB ASU 09-13 did not have an impact on the Company’s consolidated financial position, results of operations and cash flows.

NOTE 10 – Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC Topic 718 by recognizing the fair value of stock-based compensation in the statement of operations. The fair value of the Company’s stock option awards are estimated using a Black-Scholes option valuation model. This model requires the input of highly subjective assumptions and elections including expected stock price volatility and the estimated life of each award. In addition, the calculation of compensation costs requires that the Company estimate the number of awards that will be forfeited during the vesting period. The fair value of stock-based awards is amortized over the vesting period of the award.

For the nine months ended February 29, 2012 and February 28, 2011, stock-based compensation expense was approximately $128,000 and $170,000, respectively.

As of February 29, 2012, there was approximately $308,000 of total unrecognized compensation cost related to unvested stock-based compensation awards granted under the equity compensation plan which will be amortized over the weighted average remaining requisite service period. Such amount does not include the effect of future grants of equity compensation, if any. Of the $308,000 unrecognized compensation cost, the Company expects to recognize approximately 14% of the total in the balance of fiscal 2012, 50% in fiscal 2013, 35% in fiscal 2014, and 1% in fiscal 2015.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

FORWARD–LOOKING STATEMENTS

This Form 10-Q contains “forward-looking statements” (as defined in section 21E of the Securities Exchange Act of 1934) regarding the Company and its markets. These forward-looking statements involve a number of risks and uncertainties, including (1) changes in demand from customers, (2) changes in product or customer mix or revenues and in the level of operating expenses, (3) rapidly changing technologies and the Company's ability to respond thereto, (4) the impact of competitive products and pricing, (5) federal, state and local levels of educational spending, (6) the Company's ability to retain qualified personnel, (7) the Company’s ability to retain its distribution agreements in the College Preparation and Literacy markets, (8) the sufficiency of the Company’s copyright protection, and (9) the Company’s ability to continue to rely on the services of a third-party warehouse, and other factors disclosed below and throughout this report. The actual results that the Company achieves may differ materially from any forward-looking statements due to such risks and uncertainties. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Readers are urged to carefully review and consider the various disclosures made by the Company in this report, including the discussion set forth below, and in the Company's other reports filed with the Securities and Exchange Commission from time to time that attempt to advise interested parties of the risks and factors that may affect the Company's business and results of operations.

SEASONALITY

The supplemental school publishing business is seasonal, cycling around the school year that runs from September through May. Typically, the major marketing campaigns, including mailings of new catalogs and focused sales efforts, begin in September when schools reopen. This is the period when sample books are provided free-of-charge for review to teachers for their purchase consideration . General marketing efforts, including additional sales and marketing campaigns, catalog mailings, and complimentary copies, continue throughout the school year.

Each of our product lines has its own seasonality. The average revenue percentage over the past two fiscal years by quarter is summarized in the table below.


	Jun - Aug			Sep - Nov			Dec - Feb			Mar - May
	1st Quarter			2nd Quarter			3rd Quarter			4th Quarter
Test Preparation, Assessment, and Instruction		30	%		24	%		22	%		24	%
College Preparation		62	%		16	%		5	%		17	%
Literacy		36	%		16	%		18	%		30	%
Total Revenue		42	%		20	%		16	%		22	%

PRODUCT OVERVIEW

We are a leading publisher and distributor of supplemental instructional materials for the kindergarten through high school sector. We design and produce materials in both print and digital formats, with a growing emphasis on Internet-based delivery. Our materials are predominantly state-specific and standards-based, focused on state-required tests. We also distribute college preparation products developed internally, and by other publishers, and literacy products developed by other publishers.

We operate as one business segment, with three product groups.

Test Preparation, Assessment, and Instruction Product Group

Test Preparation, Assessment

•

We create and sell print and digital products targeted to grades 1-12 to help students prepare for state proficiency tests. The Measuring Up ^® Test Preparation and Assessment print products are sold in eleven states. Measuring Up ^® is positioned as standards-based, state customized instruction and classroom assessment, designed to be an integral part of a school’s instructional program throughout the school year. In addition, we also have Common Core Standards test preparation products which can be used on a national basis.

•

Measuring Up Live™, is a suite of two online products designed to meet unique needs of individual schools and school districts. Measuring Up Insight™, formerly ePath Assess™, is a customized formative assessment and progress monitoring program that allows educators to make data-driven decisions. Measuring Up MyQuest™, formerly Practice Path™, offers a student driven approach to skills practice and instruction that is standards customized. The Measuring Up Live™ suite of tools provides educators with online options to best meet the needs of their students and teachers, while providing specific state and common core standards content for assessment and instruction.

Instruction

•

The primary products within this group are our Focused Instruction materials. Focused Instruction materials provide standards–based, state-specific supplemental instruction in particular subject areas such as reading comprehension, mathematics problem solving, and vocabulary development. Essential to this strategy is the market alignment of the Focused Instruction and Test Preparation and Assessment products so that both product lines are suitable for sale to an identical customer base with an identical sales force. Also included within this product group are our backlist remedial and multicultural products which we continue to sell; however we are not investing in new development for these products

College Preparation Product Group

We have the exclusive U.S. high school distribution rights for college textbooks and related instruction materials published by two major college publishers. In addition to these distributed products, we also publish our own proprietary products for the college preparation market. The college preparation products that we offer are utilized in a wide range of Advanced Placement, honors, electives and other high-level high school courses. Distribution revenue consists of direct billings to customers, as well as commissions earned on sales generated by our marketing efforts, but billed by other parties. Such sales, for which the commission rate varies, include purchases by schools through online bookstores and sales derived as a result of purchases made through state adoption contracts.

In November 2011, we entered into a new agreement with one of our college publishers. Under the new agreement, we will continue to perform all the same functions as we did under the previous agreement, including all sales, marketing and administration functions. However, the college publisher will now invoice the customers directly and remit to us the difference between the revenue and the costs associated with that revenue. We have established a reserve for returns on this revenue which is reflected as a reduction from accounts receivable.

Literacy Product Group

Our Literacy products are developed by other publishers and we have the U.S. distribution rights. These products are competitively positioned in the supplemental reading market for grades K-8 for districts that are looking for literacy resources to enhance or fill gaps in their existing programs. Products within this group include an extensive selection of leveled reading materials; high-interest engaging resources for striving readers; series that integrate reading, science, and social studies; and selections and strategies for students who are in the process of learning English.

RESULTS OF OPERATIONS

Three Months Ended February 29, 2012 vs. Three Months Ended February 28, 2011

(Amounts in Thousands - Except Per Share Data)	Three Months Ended February
	2012					2011
Revenue
Test Preparation, Assessment and Instruction	$	2,902		79.8	%	$	4,107		80.1	%
College Preparation		605		16.6	%		713		13.9	%
Literacy		131		3.6	%		306		6.0	%
Total Revenue		3,638		100.0	%		5,126		100.0	%

Cost of Revenue
Direct Costs		1,235		33.9	%		1,496		29.2	%
Prepublication Cost Amortization		1,216		33.4	%		1,385		27.0	%
Total Cost Of Revenue		2,451		67.4	%		2,881		56.2	%

Gross Profit		1,187		32.6	%		2,245		43.8	%

Selling, General and Administrative Expenses
Marketing and Selling		1,672		46.0	%		1,995		38.9	%
General and Administrative		1,011		27.8	%		1,167		22.8	%
Total Selling, General and Administrative Expenses		2,683		73.7	%		3,162		61.7	%

Operating Loss		(1,496	)	-41.1	%		(917	)	-17.9	%

Other Expenses, Net		9		0.2	%		5		0.1	%
Interest Expense		79		2.2	%		71		1.4	%
Loss Before Income Tax Benefit		(1,584	)	-43.5	%		(993	)	-19.4	%

Income Tax Benefit (Note 8)		(286	)	-7.9	%		(368	)	-7.2	%

Net Loss	$	(1,298	)	-35.7	%	$	(625	)	-12.2	%


Net Loss per Common Share:
Basic and Diluted	$	(0.29	)			$	(0.14	)

Overview

Revenue continues to be impacted by the reaction of schools to budgetary pressures. Revenue for the quarter was $3.6 million, a decline of $1.5 million from the prior year. The year-over-year decline was primarily in the Testing, Assessment and Instruction product line. Net loss for the quarter, which includes a $300,000 deferred tax valuation allowance, was $1.3 million, an increase of $672,000 from the prior year.

REVENUE

Test Preparation, Assessment, and Instruction

Revenue for this product group for the quarter was $2.9 million, compared to $4.1 million during the same period in the prior year. Test Preparation and Assessment revenue for the quarter was $2.7 million, a decrease of $1.0 million from the prior year, while Instruction revenue was $218,000, a decline of $171,000 compared to the prior year. The revenue shortfall is primarily due to a decline in one of the states in which we publish state-specific materials. This state is in the process of transitioning to new standards and new tests and during such transitions, schools and districts have historically reduced their expenditures until the transition is complete. Although this change has had a short-term impact on our revenue, it creates future opportunities as educators are in need of products supporting these new standards and test. We have recently released materials for the End of Course (EOC) exit exams in this state. This is the first year these EOC tests will count and there is a significant amount of attention from educators to prepare students for these tests. The initial feedback from the market on our EOC products has been favorable.

College Preparation

College Preparation revenue for the quarter was $605,000, compared to $713,000 during the same period in the prior year. Revenue for this product group is extremely seasonal; historically approximately 5% of the annual revenue is derived during the three months ended February 29. Revenue from the sale of products offered from the two major college publishers was $564,000, a decline of $85,000 from the prior year. Revenue from our proprietary products was $41,000, a decrease of $15,000 from the prior year.

Literacy

Revenue for this group was $131,000 for the quarter, compared to $306,000 during the same period in the prior year. Revenue from this product group was affected significantly due to a decrease in federally funded literacy initiatives, specifically ARRA funding (American Recovery and Reinvestment Act of 2009) which was a funding source utilized by customers.

COST OF REVENUE

Cost of revenue for the quarter was $2.5 million (67.4% of revenue) compared to $2.9 million (56.2% of revenue) during the same period in the prior year.

Cost of revenue consists of two components: direct costs and amortization of prepublication costs.

Direct costs consist of (1) product cost, which includes paper, printing, and binding for proprietary print products and product purchases for nonproprietary products, (2) web-hosting fees for our digital products, (3) royalties on proprietary products, and (4) warehousing and shipping costs for all non-digital products.

Direct costs as a percentage of revenue for the quarter were 33.9%, as compared to 29.2% during the same period in the prior year. The percentage increase is primarily due to revenue mix, as College Preparation revenue for the period increased from 13.9% of the total revenue in the prior year, to 16.6% in the current year. College Preparation direct costs are substantially higher than those of our other products.

Prepublication costs include one-time expenses associated with developing and producing new or revised proprietary products. It includes all development expenses, including but not limited to writing, design, art, permissions, and any other costs incurred up to the release date of the product in print and/or digital format. Prepublication costs are capitalized and expensed on a straight-line basis over a three- or five-year period, based upon the product. We believe our amortization policy is in line with industry practice. For the quarter, amortization expense was $1.2 million of prepublication costs, a decrease of $169,000 from the prior year. As a percentage of revenue the expense increased from 27.0% to 33.4%.

MARKETING AND SELLING

Selling and marketing expenses for the quarter were $1.7 million, a decrease of 16.2% from the prior year. The decrease is due to lower salary and related expenses, lower marketing promotional expenses, and a decline in commission expense as a result of decreased revenue.

GENERAL AND ADMINISTRATIVE

General and administrative expenses for the quarter were $1.0 million, a decrease of 13.4% compared to the prior year. The decrease is due to active cost management.

INTEREST EXPENSE

Interest expense for the quarter was $79,000, compared to $71,000 for the same period in the prior year. The change is primarily due to an increase in the average interest rate, offset by the change in the fair-value of our swap agreement. Included in interest expense for the quarter was $3,000 of income, compared to $1,000 of income during the same period in the prior year.

Nine Months Ended February 29, 2012 vs. Nine Months Ended February 28, 2011

(Amounts in Thousands - Except Per Share Data)	Nine Months Ended February,
	2012					2011
Revenue
Test Preparation, Assessment and Instruction	$	10,233		50.5	%	$	13,207		54.1	%
College Preparation		9,291		45.9	%		9,697		39.7	%
Literacy		732		3.6	%		1,526		6.2	%
Total Revenue		20,256		100.0	%		24,430		100.0	%

Cost of Revenue
Direct Costs		9,227		45.6	%		10,561		43.2	%
Prepublication Cost Amortization		3,841		19.0	%		3,918		16.0	%
Total Cost Of Revenue		13,068		64.5	%		14,479		59.3	%

Gross Profit		7,188		35.5	%		9,951		40.7	%

Selling, General and Administrative Expenses
Marketing and Selling		5,411		26.7	%		6,555		26.8	%
General and Administrative		3,098		15.3	%		3,390		13.9	%
Total Selling, General and Administrative Expenses		8,509		42.0	%		9,945		40.7	%

Operating Income (Loss)		(1,321	)	-6.5	%		6		0.0	%

Other Expenses, Net		32		0.2	%		22		0.1	%
Interest Expense		228		1.1	%		230		0.9	%
Net Loss Before Income Tax Benefit		(1,581	)	-7.8	%		(246	)	-1.0	%

Income Tax Benefit (Note 8)		(285	)	-1.4	%		(91	)	-0.4	%

Net Loss	$	(1,296	)	-6.4	%	$	(155	)	-0.6	%


Net Loss per Common Share:
Basic and Diluted	$	(0.29	)			$	(0.03	)

Overview

The supplemental education material market continues to be challenging as schools are reacting to budgetary shortfalls and have been delaying or reducing orders, and in some instances not purchasing new materials for the classrooms. These circumstances continue to have an adverse impact on our revenue. Net revenue for the nine month period ended February 29, 2012 was $20.3 million, a decline of 17.1% from the same period in the prior year. Revenue was below the prior year for all three product groups.

Although we reduced expenses on a year-over-year basis, these reductions were not able to offset the decline in revenue, resulting in a net loss for the nine month period of $1.3 million, compared to $155,000 in the prior year. The net loss of $1.3 million includes a $300,000 deferred tax valuation allowance. Basic and diluted net loss per common share for the period was $(0.29) compared to $(0.03) in the prior year.

REVENUE

Test Preparation, Assessment, and Instruction

Revenue for this product group for the nine months ended February 29, 2012 was $10.2 million, a decline of 22.5% compared to the prior year. Test Preparation and Assessment revenue for the period was $9.2 million, a 22.2% decline from the prior year while Instruction revenue was $1.0 million, a decrease of 25.3% on a year-over-year basis. The revenue shortfall for the nine months ended February 29, 2012, as it was for the quarter, was primarily related to the revenue decline in one state in which we offer state-specific product. This state is in the process of transitioning to new standards and new tests and during such transitions, schools and districts have historically reduced their expenditures until the transition is complete. Although this change has had a short-term impact on our revenue, it creates future opportunities as educators are in need of products supporting these new standards and tests. We have recently released materials for the End of Course (EOC) exit exams in this state. This is the first year these EOC tests will count and there is a significant amount of attention from educators to prepare students for these tests. The initial feedback from the market on our EOC products has been favorable.

College Preparation

College Preparation revenue for the nine month period was $9.3 million, compared to $9.7 million during the same period in the prior year. Revenue from the sale of products offered from the two major college publishers, which represents more than 90% of the total revenue within this product group, was $8.8 million, a decline of 4.7% compared to the prior year. Revenue from proprietary products was $503,000, an increase of 11.5% from the prior year.

Literacy

Revenue for this product group for the nine month period was $732,000, a year-over-year decline of 52.0%. Revenue from this product group was greatly affected by the decrease in federally funded literacy initiatives, specifically ARRA funding (American Recovery and Reinvestment Act of 2009) which was a funding source utilized by customers.

COST OF REVENUE

Cost of revenue for the nine month period was $13.1 million (64.5% of revenue) compared to $14.5 million (59.3% of revenue) during the same period in the prior year.

Cost of revenue consists of two components: direct costs and amortization of prepublication costs.

Direct costs as a percentage of revenue increased from 43.2% in the prior year to 45.6% in the current year. The percentage increase is primarily due to revenue mix, as College Preparation revenue for the period increased from 39.7% of the total revenue in the prior year, to 45.9% in the current year. College Preparation direct costs are substantially higher than those of our other products.

Prepublication costs include one-time expenses associated with developing and producing new or revised proprietary products. It includes all development expenses, including but not limited to writing, design, art, permissions, and any other costs incurred up to the release date of the product in print and/or digital format. Prepublication costs are capitalized and expensed on a straight-line basis over a three- or five-year period, based upon the product. We believe our amortization policy is in line with industry practice. For the period, we amortized $3.8 million of prepublication costs, a year-over-year decrease of 2.0%.

MARKETING AND SELLING

Selling and marketing expenses for the period were $5.4 million, a decrease of 17.5% from the prior year. The decrease is due to a reduction in commission expense as a result of lower revenue, a decrease in salary and related expenses, the timing of various promotional campaigns and an overall decline in sample expense. The expense as a percent of revenue remained consistent for the nine months at 26.7%, as compared to the prior year.

GENERAL AND ADMINISTRATIVE

General and administrative expenses for the period were $3.1 million, a decrease of 8.6% from the prior year, due to active cost management.

INTEREST EXPENSE

Interest expense for the period was $228,000, compared to $230,000 for the same period in the prior year. The change is primarily due to an increase in the average outstanding debt and interest rate, offset by the change in the fair-value of our swap agreement, which for the current nine month period was $11,000 of income, compared to $15,000 of expense in the prior year.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities for the nine months ended February 29, 2012 was $2.6 million. Cash was primarily provided by our net income before depreciation, amortization and stock-based compensation expense, as well as a decrease in accounts receivable, and inventory offset by a decrease in accounts payable and accrued expenses.

Net cash used in investing activities was $2.5 million, consisting primarily of prepublication expenditures of $2.4 million. Prepublication expenditures for the period were $1.8 million lower than the prior year. The decrease in expenditures is partially related to timing of expenditures; however we expect full year expenditures to be approximately $1.0 million less than the prior year expenditures of $4.8 million.

Net cash provided by financing activities was $777,000, consisting of $2.3 million of net borrowings on our revolving line of credit and a reduction of $1.5 million on our term loan.

The Company incurred losses of approximately $1,296,000 and $155,000 for the nine months ended February 29, 2012 and February 28, 2011 , respectively. At February 29, 2012, the Company had cash and cash equivalents of approximately $940,000, a working capital deficit of approximately $8,016,000 and an accumulated deficit of approximately $4,184,000.

We have a revolving line of credit and a term loan with Sovereign Bank. Amounts borrowed under the agreement are secured by substantially all of the assets of the Company.

The term loan was originally for $10.0 million and matures in December 2012. At February 29, 2012, $2.0 million remained outstanding under the term loan.

We use our cash and borrowing availability under our financing arrangements, together with cash generated from operations, to meet our cash needs. We intend to continue investing in prepublication costs for our proprietary products, using cash generated from operations, and borrowings under financing arrangements.

Our existing credit facility with Sovereign Bank expires on December 31, 2012 and we are currently exploring new financing opportunities. If we are unable to secure a new credit facility or generate sufficient cash flow from operations to service our commitments, we will be required to adopt alternatives, such as seeking equity capital in order to fund our current liabilities, operations and product development initiatives. There can be no assurance that such actions will be available in general or on terms acceptable to the Company.

OFF-BALANCE SHEET ARRANGEMENTS

None.

CRITICAL ACCOUNTING ESTIMATES

Our significant accounting policies are summarized in the footnotes to our financial statements included in our May 31, 2011 Form 10-K. Some of our accounting policies require management to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. These judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. Actual results may differ from these estimates under different assumptions and conditions. Certain of the most critical estimates that require significant judgment are as follows:

Revenue Recognition and Allowance for Returns

Revenue is recognized when products are shipped, the customer takes title and assumes risk of loss, and collection of the related receivable is probable. On February 29, 2012, we had a returns valuation allowance of $48,000. The allowance is recorded at the time of revenue recognition, if the right of return exists, and is recorded as a reduction of accounts receivable. This allowance is estimated by management based on our historical rate of returns. We recognize shipping and handling revenues as part of revenue, and shipping and handling expenses as part of cost of revenue on the statements of operations. Subscription based revenue on our digital products is recognized prorata over the life of the subscription agreement.

Deferred Prepublication Costs

Deferred prepublication costs are recorded at their original cost and amortized over a three or five-year period, based on the estimated lives of the related publications. The net carrying value of the deferred prepublication costs is periodically reviewed and compared to an estimate of future net undiscounted cash flows. On February 29, 2012, we had an allowance against this asset of $137,000. If future net undiscounted cash flows are not sufficient to realize the net carrying value of the asset, an impairment charge may be necessary.

Allowance for Doubtful Accounts

Credit to our customers is determined on a customer-by-customer basis. Trade receivables are carried at original invoice amount less an estimate made for the doubtful receivables based on a monthly review of all outstanding amounts. We determine the allowance for doubtful accounts after reviewing individual customer accounts as well as considering both historical and expected credit loss experience. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received. The allowance for doubtful accounts was $10,000 at February 29, 2012 and is believed to be adequate for any exposure to loss.

Allowance for Excess and Slow-Moving Inventory

We continuously monitor our inventory for salability. This monitoring includes review of historical sales experience, projected sales activity by title, and any planned changes to a title that are known by management. Any slow-moving or non-salable inventory identified is reserved or written down at that time. The reserve of $783,000 at February 29, 2012 is believed to be adequate to cover potential inventory loss exposure.

Income Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statements carrying amounts and the tax basis of assets and liabilities. We provide a valuation allowance for deferred tax assets if we determine, based on the weight of available evidence, that it is more likely than not that some or all of the deferred tax assets will not be realized. A valuation allowance had originally been established in the amount of $700,000 related to the tax benefit of our available federal and state net operating losses. As of February 29, 2012 the financial statements reflect the impact of an additional $300,000 charge to the valuation allowance due to a historical two-year cumulative loss related to earnings before taxes. The carrying value of the net deferred tax asset assumes that we will be able to generate sufficient taxable income in the future. We perform a comprehensive tax review quarterly, and if future levels of taxable income are not sufficient or fail to materialize in the near term, management will adjust the valuation allowance accordingly.

Stock-Based Compensation Expense

We recognize compensation expense based on the grant-date fair value of the awards. Compensation expense for stock options is recognized over the vesting period of the award. The grant-date fair value of the stock options is determined using the Black-Scholes option-pricing model, using assumptions determined by management to be appropriate. For the nine months ended February 29, 2012, stock-based compensation expense was approximately $128,000.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934 (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”).

The purpose of this evaluation is to determine if, as of the Evaluation Date, our disclosure controls and procedures were operating effectively such that the information relating to the Company, required to be disclosed in our Securities and Exchange Commissions (“SEC”) reports (i) was recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were operating effectively.

Changes in Internal Control over Financial Reporting

During the fiscal quarter covered by this report, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

None.

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

During the three months ended February 29, 2012, we did not issue any securities without registration under the Securities Act of 1933.

In October 2005, our Board of Directors approved a share repurchase program, permitting us to repurchase up to 100,000 shares of our common stock. We did not repurchase any shares during the three months ended February 29, 2012. At February 29, 2012, 83,768 shares remained that could be purchased under the plan or programs. No share repurchase plan or program expired, or was terminated, during the period covered by this report.

Item 3. Defaults Upon Senior Securities

None.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit31.1

CEO Certification pursuant to Rule 13a-14(a).

Exhibit31.2

CFO Certification pursuant to Rule 13a-14(a).

Exhibit32

Certification of the CEO and the CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Exhibit101

Financial statements from the Quarterly Report on Form 10-Q of the Company for the quarter ended February 29, 2012, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.*

*Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings.

SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized.