Peoples Educational (PEDH) 10-Q 2008 Q4 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended November 30, 2008

[  ] 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 o

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 o	Accelerated filer o
Non-accelerated filer o (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 o No x

Indicate the number of shares outstanding of each of the Issuer's classes of common stock, as of the latest practical date: 4,454,502 shares of Common Stock (par value $0.02 per share) outstanding on January 7, 2009.

TABLE OF CONTENTS

		Page
PART I.	FINANCIAL INFORMATION
Item 1:	Financial Statements:
	Condensed Consolidated Balance Sheets as of November 30, 2008 (Unaudited) and May 31, 2008 and November 30, 2007 (Unaudited)	3
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended November 30, 2008 and 2007 (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended November 30, 2008 and 2007 (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
Item 4(T):	Controls and Procedures	16
PART II.	OTHER INFORMATION
Item 1:	Legal Proceedings	17
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	17
Item 3:	Defaults Upon Senior Securities	17
Item 4:	Submission of Matters to a Vote of Security Holders	17
Item 5:	Other Information	17
Item 6:	Exhibits	17
SIGNATURES		18
EXHIBITS		19

2

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)	November 30, 2008			May 31, 2008			November 30, 2007
ASSETS
Current Assets
Cash and Cash Equivalents	$	36		$	53		$	172
Accounts Receivable Net of Allowances for
Doubtful Accounts and Returns		2,816			3,664			2,726
Inventory		4,009			4,394			4,769
Prepaid Expenses and Other		401			404			443
Prepaid Marketing Expenses		1,096			829			753
Deferred Income Taxes		661			1,024			1,119
Total Current Assets		9,019			10,368			9,982
Equipment - At Cost, Less Accumulated Depreciation
of $2,142, $1,994 and $1,843, respectively		511			566			634
Other Assets
Deferred Prepublication Costs, Net		14,588			15,200			16,555
Deferred Income Taxes		1,250			1,536			534
Trademarks, Net		192			191			170
Prepaid Expenses and Other		272			263			324
Prepaid Marketing Expenses		247			495			765
Total Other Assets		16,549			17,685			18,348
Total Assets	$	26,079		$	28,619		$	28,964
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current Maturities of Long Term Obligations	$	2,044		$	2,042		$	1,570
Accounts Payable		6,980			4,906			6,406
Accrued Compensation		155			247			178
Other Accrued Expenses		276			347			401
Deferred Revenue		486			475			656
Total Current Liabilities		9,941			8,017			9,211
Long Term Obligations, Less Current Maturities		8,458			14,046			11,715
Total Liabilities		18,399			22,063			20,926
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: 4,470,734 shares for all periods		89			89			89
Additional Paid In Capital		8,034			8,013			7,980
Retained Earnings (Accumulated Deficit)		(379	)		(1,482	)		33
Treasury Stock - 16,232 shares for all periods, at cost		(64	)		(64	)		(64	)
Total Stockholders' Equity		7,680			6,556			8,038
Total Liabilities and Stockholders' Equity	$	26,079		$	28,619		$	28,964
See Notes to Condensed Consolidated Financial Statements

3

PEOPLES EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In Thousands, Except Per Share Data)
	Three Months Ended						Six Months Ended
	November 30,						November 30,
	2008			2007			2008		2007
Revenue, Net	$	8,279		$	8,502		$	24,276	$	25,369
Cost of Revenue
Direct Costs		3,102			3,036			11,509		11,739
Prepublication Cost Amortization		1,694			1,692			3,352		3,395
Total		4,796			4,728			14,861		15,134
Gross Profit		3,483			3,774			9,415		10,235
Selling, General and Administrative Expenses		3,629			4,226			7,219		8,355
Income (Loss) from Operations		(146	)		(452	)		2,196		1,880
Other Expenses, Net		9			12			17		24
Interest Expense		208			354			437		742
Income (Loss) Before Income Taxes		(363	)		(818	)		1,742		1,114
Income Tax Expense (Benefit)		(143	)		(396	)		639		373
Net Income (Loss)	$	(220	)	$	(422	)	$	1,103	$	741
Net Income (Loss) per Common Share:
Basic	$	(0.05	)	$	(0.09	)	$	0.25	$	0.17
Diluted	$	(0.05	)	$	(0.09	)	$	0.25	$	0.16
Weighted-average Number of
Common Shares Outstanding:
Basic		4,455			4,443			4,455		4,434
Diluted		4,455			4,443			4,455		4,491
See Notes to Condensed Consolidated Financial Statements

4

PEOPLES EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)	Six Months Ended
	November 30,
	2008			2007
Cash Flows From Operating Activities
Net Income	$	1,103		$	741
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities
Depreciation		148			151
Amortization of Prepublication Costs and Intangible Assets		3,357			3,412
Stock-Based Compensation		21			17
Market Value Adjustment of Interest Rate Swap		25			136
Deferred Income Taxes		649			373
Changes in Assets and Liabilities
Accounts Receivable		848			1,235
Inventory		385			501
Prepaid Expenses and Other		(6	)		(63	)
Prepaid Marketing Expenses		(19	)		156
Accounts Payable and Accrued Expenses		1,911			(329	)
Deferred Revenue		11			329
Net Cash Provided By Operating Activities		8,433			6,659
Cash Flows From Investing Activities
Purchases of Equipment		(93	)		(88	)
Expenditures for Intangibles		(6	)		(46	)
Expenditures for Prepublication Costs		(2,740	)		(2,770	)
Net Cash Used In Investing Activities		(2,839	)		(2,904	)
Cash Flows From Financing Activities
Net Payments Under Line of Credit		(4,591	)		(3,669	)
Proceeds From the Exercise of Stock Options		-			88
Principal Payments On Long-Term Debt		(1,020	)		(100	)
Net Cash Used In Financing Activities		(5,611	)		(3,681	)
Net Increase (Decrease) in Cash and Cash Equivalents		(17	)		74
Cash and Cash Equivalents
Beginning of Period		53			98
End of Period	$	36		$	172
Supplemental Cash Flow Information
Cash Payments for:
Interest	$	410		$	633
See Notes to Condensed Consolidated Financial Statements

5

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

NOTE 1 - Basis of Presentation

Nature of business:Peoples Educational Holdings, Inc. (PEH), through its wholly owned subsidiary, Peoples Education, Inc. (PE), formerly known as The Peoples Publishing Group, Inc., publishes and markets its own supplementary educational textbooks and materials for the K –12 school market. The materials are predominantly state-specific and standards-based, focused on state-required tests.  PE distributes other publisher’s college textbooks and supplements to the high school Advanced Placement market. In addition, PE also publishes its own proprietary supplemental material for the Advanced Placement market.  Marketing channels include direct and commission sales representatives, telemarketing, direct mail, and catalogs. PE and PEH are together referred to herein as the Company.

The accompanying condensed consolidated financial statements have been prepared by the Company without audit and in accordance with the instructions to Form 10-Q and therefore do not include all information and disclosures necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. These 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 six month periods ended November 30, 2008, are not necessarily indicative of the operating results to be expected for the full fiscal year. Accordingly, these 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, 2008.

Management is required to make certain estimates and assumptions which affect the amounts of assets, liabilities, revenue and expenses we have reported and our disclosure of contingent assets and liabilities at the date of the financial statements.  Actual results could differ materially from these estimates and assumptions.

Reclassifications: Certain amounts on the consolidated balance sheet as of November 30, 2007 have been reclassified, with no effect on net earnings or stockholders equity, to be consistent with classifications adopted as of May 31, 2008.

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 allowances for returns as of November 30, 2008, May 31, 2008 and November 30, 2007 were approximately $776,000, $528,000 and $675,000, respectively. 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 net revenue, and shipping and handling expenses as part of cost of revenue on the consolidated statements of operations.  The Company recognizes subscription based revenue on its Measuring Up e-Path® prorata over the life of the agreement.

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 review of all outstanding amounts on a monthly basis.  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 $40,000 at November 30, 2008, May 31, 2008 and November 30, 2007.

6

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

NOTE 3 – Basic and Diluted Per Share Amounts

Basic per share amounts are computed, generally, by dividing net income or 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 Company’s net losses for the three months ended November 30, 2008 and 2007, -0- shares and 70,313 shares respectively were excluded from the diluted shares calculation as their impact was antidilutive.  The dilutive effect of these additional shares for the six months ended November 30, 2008 and 2007 was to increase the weighted average common shares outstanding by -0- shares and 57,161 shares respectively.

NOTE 4 – Deferred Prepublication Costs

Deferred prepublication costs are capitalized and amortized over a three or five-year period (the estimated lives of the related publications) using the straight-line method beginning on the in-stock date of the publication.  The activity in deferred prepublication costs and the balances as of November 30, 2008 and November 30, 2007 are as follows:

(In Thousands)
	Three Months Ended						Six Months Ended
	November 30,						November 30,
	2008			2007			2008			2007
Balances, Beginning	$	14,857		$	17,080		$	15,200		$	17,180
Prepublication Cost Additions		1,425			1,167			2,740			2,770
Amortization Expense		(1,694	)		(1,692	)		(3,352	)		(3,395	)
Balances, Ending	$	14,588		$	16,555		$	14,588		$	16,555

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

For the remainder of fiscal 2009	$	3,112
For the year ended May 31, 2010		5,045
For the year ended May 31, 2011		3,498
For the year ended May 31, 2012		2,027
For the year ended May 31, 2013 and thereafter		906
	$	14,588

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 over the next two years and are expensed as they are distributed.  Prepaid marketing expenses include samples, catalogs and promotional materials.

Prepaid marketing expenses are presented in the balance sheets as follows:

(In Thousands)
	November 30,		May 31,		November 30,
	2008		2008		2007
Total Prepaid Balance	$	1,343	$	1,324	$	1,518
Less current portion		1,096		829		753
Long-term balance	$	247	$	495	$	765

7

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

The estimated recognition of prepaid marketing expense is expected to be as follows:

(In Thousands)
For the remainder of fiscal 2009	$	848
For the year ended May 31, 2010		495

NOTE 6 – Financing Arrangements

The Company has a $20 million credit agreement with Sovereign Bank.  Amounts borrowed under the agreement are secured by substantially all of the assets of the Company.   The agreement provides for a $10 million revolving line of credit and a $10 million term loan as follows:

· The revolving line of credit provides for advances up to $10 million and expires in March 2012.  The interest rate on the revolving line of credit is in a range from LIBOR plus 2.0% to LIBOR plus 2.25%, or prime to prime plus 0.5%, with the exact interest rate based on the ratio of the Company’s total funded debt to EBITDA.  At November 30, 2008, $1.8 million was outstanding under this facility, and $8.2 million was available for borrowing.

· The term loan is for $10 million and matures in December 2012.  The term loan provides for payments of interest only for the first twelve months and for 20 equal quarterly payments of principal and interest which began on March 31, 2008.  The term loan bears interest at the same rate as the revolving line of credit for $4.25 million of the $8.5 million outstanding.  The Company entered into a swap agreement to fix the interest rate on the balance of the term loan for three years at a rate of 5.3% plus an interest spread of 2.00% to 2.25% based upon our total funded debt to EBITDA ratio. After the three-year period, the interest rate reverts back to a variable rate.  The change in the fair value of the interest rate swap is recognized as interest expense or income during each reporting period.  For the three and six month periods ended November 30, 2008, the Company recorded $37,000 and $25,000 of interest expense as a result of the mark-to-market interest rate adjustment.

In May 2008, the Company entered into a $1.5 million letter of credit agreement with Sovereign Bank.  The interest rate on the letter of credit is LIBOR plus 2.5%, or prime rate plus 0.5%.  Amounts borrowed under the agreement are secured by substantially all of the assets of the Company. At November 30, 2008, no amounts were outstanding under this agreement. This agreement was terminated in December 2008.

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, and a minimum fixed charge coverage ratio.  These financial covenants also restrict the payment of dividends on the Company’s common stock.

NOTE 7 – Income Taxes

On a quarterly basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision based on the anticipated rate. As the year progresses, we refine our estimate based on the facts and circumstances by each tax jurisdiction. The effective tax rate for the six months ended November 30, 2008 and 2007 were approximately 37% and 33%, respectively.

We are subject to income taxes in the U.S. federal jurisdiction and various state jurisdictions.  Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply.  With few exceptions, we are no longer subject to U.S. federal, state or local income tax examinations by tax authorities for the years before 2004.  We are not currently under examination by any taxing jurisdiction.

8

Peoples Educational Holdings, Inc., and Subsidiary

Notes to Condensed Consolidated Financial Statements (UNAUDITED)

NOTE 8 – Recently Issued Accounting Standards

Effective June 1, 2008, we adopted FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”) for financial instruments. SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair

value measurements. The adoption of SFAS 157 did not have any impact to our financial statements. SFAS 157 will become effective for non-financial measurements for the Company on June 1, 2009 and is not expected to have a significant impact on the Company’s financial position or results of operations.

Effective June 1, 2008, we adopted FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS No. 159 gives entities the option to measure eligible financial assets and financial liabilities at fair value on an instrument by instrument basis,

that are otherwise not permitted to be accounted for at fair value under other accounting standards. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability. Subsequent changes in fair value must be recorded in earnings. SFAS 159 became

effective with no impact to the Company’s financial position or results of operations.

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 our business and our 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 our ability to respond thereto, (4) the impact of competitive products and pricing, (5) federal, state and local levels of educational spending, (6) our ability to retain qualified personnel, (7) our ability to retain its distribution agreements in the College Preparation market, (8) the sufficiency of our copyright protection, and (9) our 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 we achieve may differ materially from any forward-looking statements due to such risks and uncertainties. We undertake 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 us in this report, including the discussion set forth below, and in our 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 our business and results of operations.

SEASONALITY

Each of our product lines has its own seasonality. The average revenue percentage by product line and in total by quarter for the last two full fiscal years 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		28%		25%		21%		26%
College Preparation		65%		14%		6%		15%
Total Revenue		41%		21%		16%		22%

9

PRODUCT OVERVIEW

We develop and sell our own proprietary products and distribute other publishers’ products. Our products are organized in two product groups, one designated as Test Preparation, Assessment, and Instruction, and the other as College Preparation. The Test Preparation, Assessment, and Instruction materials are almost exclusively proprietary products, while the College Preparation materials are mainly distributed products accompanied by a limited number of proprietary titles.

Test Preparation, Assessment, and Instruction Product Group

Test Preparation, Assessment

· We create and sell print and web-based materials 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 twelve states. MeasuringUp® 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.

· Measuring Up e-Path®, a web-based assessment product developed in conjunction with Cisco Learning Systems, provides schools and districts the ability to provide formative classroom level assessments, which, in turn, allows for informed instruction relative to state standards. Measuring Up e-Path® delivers a detailed prescriptive instructional path for individual students tied into our instructional materials or to other products in use within a school or district. The strategy is to help educators assess a child’s strengths and weaknesses relative to the state standards and then provide a Personal Prescriptive Path® for remediation. The assessment data can be aggregated using NCLB-compliant reporting at the class, school and district level and can be used to drive not only student learning, but teacher professional development as well.

Instruction

· We have two product lines within this grouping: Focused Instruction and remedial, multicultural  and professional development related materials. Focused Instruction materials provide standards–based, state-specific supplemental instruction on 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.  We continue to sell our backlist remedial, multicultural and professional development materials, but 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 though billed directly by the college publishers.  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.

10

RESULTS OF OPERATIONS

Three Months Ended November 30, 2008 vs. Three Months Ended November 30, 2007

(Amounts in Thousands - Except Per Share Data)	Three Months Ended November 30,
	2008			2007
Revenue
Test Preparation, Assessment and Instruction	$	6,090	73.6%	$	6,498	76.4%
College Preparation		2,189	26.4%		2,004	23.6%
Total Revenue		8,279	100.0%		8,502	100.0%
Cost of Revenue
Direct Costs		3,102	37.5%		3,036	35.7%
Prepublication Cost Amortization		1,694	20.5%		1,692	19.9%
Total Cost Of Revenue		4,796	58.0%		4,728	55.6%
Gross Profit		3,483	42.0%		3,774	44.4%
Selling, General and Administrative Expenses
Marketing and Selling		2,571	31.1%		3,158	37.1%
General and Administrative		1,058	12.8%		1,068	12.6%
Total Selling, General and Administrative Expenses		3,629	43.9%		4,226	49.7%
Operating Loss		(146)	-1.9%		(452)	-5.3%
Other Expenses, Net		9	0.1%		12	0.1%
Interest Expense		208	2.5%		354	4.2%
Loss Before Taxes		(363)	-4.5%		(818)	-9.6%
Income Tax Benefit		(143)	-1.7%		(396)	-4.6%
Net Loss	$	(220)	-2.8%	$	(422)	-5.0%
Net Loss per Common Share:
Basic and Diluted	$	(0.05)		$	(0.09)

Overview

Net revenue for the three months ended November 30, 2008 was $8.3 million, compared to $8.5 million during the same period in the prior year. Test Preparation, Assessment, and Instruction revenue decreased 6.3%, and College Preparation revenue increased 9.2% for the quarter as compared to the same period in the prior year.  Net loss for the quarter was $220,000, a $202,000 and 47.9% improvement over the prior year.  Basic and diluted loss per common share were ($0.05) for the quarter, compared to ($0.09) for the same period last year.

11

REVENUE

Test Preparation, Assessment, and Instruction

Test Preparation, Assessment, and Instruction revenue for the quarter was $6.1 million, compared to $6.5 million during the same period in the prior year. Due to the current state of the economy, many schools are reacting to budgetary pressures and have been holding back or delaying orders.  These circumstances have had an adverse impact on our revenue for the period.

College Preparation

College Preparation revenue for the quarter was $2.2 million, compared to $2.0 million during the same period in the prior year.   Revenue from the sale of products offered from the two major college publishers, which represents over 90% of the revenue within this product group, increased 11% compared to the prior year, primarily due to the timing of the orders.  Revenue from other distribution agreements and from our proprietary products decreased 11% from the prior year.

COST OF REVENUE

Cost of Revenue for the three months ended November 30, 2008 was $4.8 million (58.0% of revenue) compared to $4.7 million (55.6% 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, binding, and prepress costs for proprietary products and product purchases for nonproprietary products, (2) royalties on proprietary products, and (3) warehousing and shipping costs for all products.

· Direct costs as a percentage of revenue were 37.5% for the quarter ended November 30, 2008 compared to 35.7% during the same period in the prior year.  The percentage increase is due to revenue mix, as College Preparation revenue for the quarter increased from 23.6% of the total revenue in the prior year, to 26.4% in the current year.  College Preparation direct costs are substantially higher than the direct cost of Testing, Assessment and Instruction, as the majority of College Preparation revenue consists of non-proprietary products.

· Prepublication costs include one-time expenses associated with developing and producing new or revised proprietary products.  It includes all editorial expenses, writing, page design and makeup, art and other permissions, prepress, and any other costs incurred up to the print/bind stage of the books.  Prepublication costs are capitalized and expensed on a straight-line basis over a three- or five-year period, based upon the product’s estimated useful life cycle.  For the three months ended November 30, 2008 we amortized $1.7 million of prepublication costs, which was consistent with the same period in the prior year.

MARKETING AND SELLING

Marketing and Selling expenses decreased by $587,000 compared to the prior year. The expense as a percent of revenue decreased from 37.1% in the prior year to 31.1% in the current period due to revenue mix, and overall expense reductions.

Marketing expense within this category decreased $300,000 for the quarter primarily due to a decrease in exhibit, catalog and promotional expenses.   Selling expenses within this category decreased $287,000 from the prior year and decreased as a percentage of revenue from 22.4% in the prior year to 19.5% in the current year due to expenses associated with the revenue mix and overall cost containment efforts.

GENERAL AND ADMINISTRATIVE

General and administrative expenses remained consistent with the same period in the prior year.

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INTEREST EXPENSE

Interest expense for the quarter was $208,000, compared to $354,000 for the same period in the prior year.  The change is primarily due to lower average outstanding debt on a year-over-year basis and a $99,000 reduction in the mark-to-market interest rate adjustment on the swap portion of our term loan.

Six Months Ended November 30, 2008 vs. Six Months Ended November 30, 2007

(Amounts in Thousands - Except Per Share Data)	Six Months Ended November 30,
	2008			2007
Revenue
Test Preparation, Assessment and Instruction	$	12,741	52.5%	$	13,844	54.6%
College Preparation		11,535	47.5%		11,525	45.4%
Total Revenue		24,276	100.0%		25,369	100.0%
Cost of Revenue
Direct Costs		11,509	47.4%		11,739	46.3%
Prepublication Cost Amortization		3,352	13.8%		3,395	13.4%
Total Cost Of Revenue		14,861	61.2%		15,134	59.7%
Gross Profit		9,415	38.8%		10,235	40.3%
Selling, General and Administrative Expenses
Marketing and Selling		4,817	19.8%		6,078	24.0%
General and Administrative		2,402	9.9%		2,277	9.0%
Total Selling, General and Administrative Expenses		7,219	29.7%		8,355	33.0%
Operating Income		2,196	9.1%		1,880	7.3%
Other Expenses, Net		17	0.1%		24	0.1%
Interest Expense		437	1.8%		742	2.9%
Income Before Taxes		1,742	7.2%		1,114	4.3%
Income Tax Expense		639	2.6%		373	1.5%
Net Income	$	1,103	4.6%	$	741	2.8%
Net Income per Common Share:
Basic	$	0.25		$	0.17
Diluted	$	0.25		$	0.16

Overview

Net revenue for the six months ended November 30, 2008 was $24.3 million, a decrease of 4.3% from the  prior year.  Test Preparation, Assessment, and Instruction revenue decreased 8% from the prior year, while College Preparation revenue remained consistent with prior year.  Net income for the six month period was $1.1 million, an increase of 48.9% over the prior year.  Basic and diluted earnings per common share were $0.25, compared to a basic and diluted earnings of $0.17 and $0.16 respectively, for the same period last year.

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REVENUE

Test Preparation, Assessment, and Instruction

Revenue for this product group for the six months ended November 30, 2008 was $12.7 million, an 8% decrease compared to the prior year. Due to the current state of the economy, many schools are reacting to budgetary pressures and have been holding back or delaying orders.  These circumstances have had an adverse impact on our revenue for the period.

College Preparation

College Preparation revenue for the six months ended November 30, 2008 was $11.5 million, which was consistent with the same period in the prior year.  Revenue from the sale of products offered from the two major college publishers, which represents over 90% of the total revenue within this product, was $11.0 million, which remained consistent with the same period in the prior year.  Revenue from other distribution agreements and from our proprietary products increased 14% from the prior year  Revenue for this product group is extremely seasonal; as historically over 79% of the annual revenue is derived in the six months ended November 30, 2008.

COST OF REVENUE

Cost of Revenue for the six months ended November 30, 2008 was $14.9 million (61.2% of revenue) compared to $15.1 million (59.7% 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, binding, and prepress costs for proprietary products and product purchases for nonproprietary products, (2) royalties on proprietary products, and (3) warehousing and shipping costs for all products.

· Direct costs as a percentage of revenue were 47.4% compared to 46.3% in the prior year.  The percentage increase is due to revenue mix, as College Preparation revenue for the period increased from 45.4% of the total revenue in the prior year, to 47.5% in the current year.  College Preparation direct costs are substantially higher than the direct cost of Testing, Assessment and Instruction, as the majority of College Preparation revenue consists of non-proprietary products.

· Prepublication costs include one-time expenses associated with developing and producing new or revised proprietary products.  It includes all editorial expenses, writing, page design and makeup, art and other permissions, prepress, and any other costs incurred up to the print/bind stage of the books.  Prepublication costs are capitalized and expensed on a straight-line basis over a three- or five-year period, based upon the product’s estimated useful life cycle.  For the six months ended November 30, 2008 we amortized $3.4 million of prepublication costs, which was consistent with the prior year.

MARKETING AND SELLING

Marketing and Selling expenses decreased by $1.3 million on a year-over-year basis. As a percent of revenue, the expense decreased from 24.0% to 19.8% in the current year due to revenue mix and overall expense reductions.

Marketing expense within this category decreased $471,000 for the period primarily due to a decrease in sampling, exhibit, catalog and promotional expenses.  Selling expenses within this category decreased $791,000 from the prior year due to expenses associated with the revenue mix and overall cost containment efforts. As a percentage of revenue, the selling expenses decreased from 16.7% in the prior year to 14.2%.

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GENERAL AND ADMINISTRATIVE

General and administrative expenses increased $125,000 or 5.5% compared to the prior year.  This fluctuation is due to higher accounting fees and severance payments associated with headcount reductions.

INTEREST EXPENSE

Interest expense for the six months ended November 30, 2008 was $437,000, a decrease of $305,000 compared to the same period in the prior year.  The change is due to lower average outstanding debt on a year-over-year basis and a decrease of $111,000 in the mark-to-market interest rate adjustment related to the swap portion of our term loan.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities for the six months ended November 30, 2008 was $8.4 million.  Cash was primarily provided by our net income before depreciation, amortization and deferred income taxes, as well as decreases in accounts receivable and inventory and an increase in accounts payable.

Net cash used in investing activities was $2.8 million, consisting primarily of prepublication cost expenditures of $2.7 million.  Prepublication expenditures for the six months ended November 30, 2008 were consistent with the prior year.

Net cash used in financing activities was $5.6 million, consisting of $4.6 million of net payments on our revolving line of credit and payments on our term loan and capital leases.

We have a $20 million credit agreement with Sovereign Bank.  Amounts borrowed under the agreement are secured by substantially all of the assets of the Company.  The agreement provides for a $10 million revolving line of credit and a $10 million term loan as follows:

· The revolving line of credit provides for advances up to $10 million and expires in March 2012.  The interest rate on the revolving line of credit is in a range from LIBOR plus 2.0% to LIBOR plus 2.25%, or prime to prime plus 0.5%, with the exact interest rate based on the ratio of the Company’s total funded debt to EBITDA.  At November 30, 2008, $1.8 million was outstanding under this facility, and $8.2 million was available for borrowing.

· The term loan is for $10 million and matures in December 2012.  The term loan provided for payments of interest only for the first twelve months and for 20 equal quarterly payments of principal and interest which began on March 31, 2008.  The term loan bears interest at the same rate as the revolving line of credit for $4.25 million of the $8.5 million outstanding.  We entered into a swap agreement to fix the interest rate on the balance of the term loan for three years at a rate of 5.3% plus an interest spread of 2.00% to 2.25% based upon our total funded debt to EBITDA ratio. After the three-year period, the interest rate reverts back to a variable rate.  The change in the fair value of the interest rate swap is recognized as interest expense or income during each reporting period.  For the six month period ended November 30, 2008, we have recorded $25,000 of interest expense as a result of the mark-to-market interest rate adjustment.

In May 2008, we entered into a $1.5 million letter of credit agreement with Sovereign Bank.  The interest rate on the letter of credit is LIBOR plus 2.5%, or prime rate plus 0.5%.  Amounts borrowed under the agreement are secured by substantially all of the assets of the Company. At November 30, 2008, no amounts were outstanding under this agreement. This agreement was terminated in December 2008.

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, and a minimum fixed charge coverage ratio.  These financial covenants restrict the payment of dividends on the Company’s common stock.

We use our cash and borrowing availability under our financing arrangements, together with cash generated from operations, to meet our cash needs.  We believe that our borrowing capacity together with our existing sources of cash will be sufficient to meet our anticipated cash needs for the balance of the fiscal year.  We intend to continue investing in prepublication costs for our proprietary products, using cash generated from operations, and borrowings under financing arrangements.  As we develop more products, additional investments in inventory will be required.

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OFF-BALANCE SHEET ARRANGEMENTS

None.

CRITICAL ACCOUNTING ESTIMATES

The Company’s significant accounting policies are summarized in the footnotes to our financial statements included in our May 31, 2008 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:

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 November 30, 2008, we had a valuation allowance against this asset of $159,000.  If future net undiscounted cash flows are not sufficient to realize the net carrying value of the asset, an impairment charge will be recognized.

Allowance for Excess and Slow-Moving Inventory

The Company continuously monitors its inventory on hand 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 $502,000 at November 30, 2008 is believed to be adequate to cover potential inventory loss exposure.

Income Taxes

The carrying value of the Company’s net deferred tax assets assumes that the Company will be able to generate sufficient taxable income in the United States, based on estimates and assumptions. The Company records a valuation allowance to reduce the carrying value of its net deferred tax asset to the amount that is more likely than not to be realized based on management’s estimates of future levels of taxable income. In the event the Company were to determine that it would not be able to realize its deferred tax assets in the future, an adjustment to the deferred tax asset would decrease net income in the period such determination is made. On a quarterly basis, the Company evaluates the realizability of its deferred tax assets and assesses the requirements for a valuation allowance.

Item 4(T).  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.

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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 November 30, 2008, we did not issue any securities without registration under the Securities Act of 1933.

In October 2005, our Board of Directors had 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 November 30, 2008.  At November 30, 2008, 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 4.  Submission of Matters to a Vote of Security Holders

None.

Item 5.  Other Information

None.

Item 6.  Exhibits

Exhibit 31.1 CEO Certification pursuant to Rule 13a-14(a).

Exhibit 31.2	CFO Certification pursuant to Rule 13a-14(a).
Exhibit 32	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.

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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.

Dated: January 13, 2009	PEOPLES EDUCATIONAL HOLDINGS, INC.
	By: /s/ Brian T. Beckwith
	Brian T. Beckwith
	President and Chief Executive Officer

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