Educational Development Corporation — Q1 FY2018 Form 10-Q
Business and period: The company sells Usborne and Kane Miller children’s books through Usborne Books & More (UBAM), its independent-consultant network, and a Publishing segment serving retail accounts. This report covers the three months ended May 31, 2017; comparisons are with the three months ended May 31, 2016. All amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net revenues | $26.93 million | $22.78 million |
| Gross margin | $19.51 million; 66.7% of revenue | $16.11 million; 70.7% of revenue based on reported figures |
| Operating expenses | $17.62 million | $15.26 million |
| Earnings before tax | $1.98 million | $1.00 million |
| Net earnings / diluted EPS | $1.23 million / $0.30 | $0.62 million / $0.15 |
| Operating cash flow | $(0.34) million | $(1.11) million |
| Cash and cash equivalents at period-end | $0.59 million | $0.93 million |
Net revenue increased 18.2%, while net earnings nearly doubled. The filing’s MD&A reports gross margin as 66.7% and 60.0%, respectively, but the prior-period percentage does not reconcile to the financial statements’ gross margin and net revenue; investors should verify the comparative margin. The financial statements show gross margin dollars rising 21.1%.
At May 31, current assets were $34.37 million and current liabilities were $24.66 million. Current debt included $5.56 million drawn on the revolving line and $0.90 million of current long-term debt. Long-term debt, net of current maturities, was $20.45 million. Total debt including the line of credit was approximately $26.90 million. The revolving facility had $1.44 million available under its $7.0 million limit. Cash declined $0.11 million from February 28.
Changes, drivers, and management commentary
- UBAM net revenue rose 20.1% to $24.81 million; average active consultants increased 24.3% to 25,600. UBAM operating income rose 36.9% to $4.38 million. Management attributed growth to consultant expansion and improved product costs, including volume discounts.
- Publishing net revenue was nearly flat at $2.12 million, while segment operating income fell 13.6% to $0.57 million. Management noted that Publishing sales are seasonal and typically lower in the first and fourth fiscal quarters.
- Operating cash flow remained negative despite higher earnings. The principal working-capital outflow was a $7.13 million decrease in accounts payable, primarily reflecting payments to suppliers for earlier inventory purchases. Inventory declined $4.52 million as management reduced excess stock built against sales forecasts that exceeded actual sales.
- Capital spending used $0.24 million in the quarter. The company had approximately $1.5 million of equipment purchase orders for distribution-center capacity improvements.
- Management said operating cash flow and the expanded bank facility were expected to meet FY2018 liquidity needs, with cash also intended for inventory and debt reduction. No earnings or revenue guidance was provided.
Debt, liquidity, risks, and notable items
- On June 15, 2017, after quarter-end, the company amended its bank agreement: the revolving limit increased from $7.0 million to $10.0 million and its termination date was extended to June 15, 2018. The limit may increase to $15.0 million subject to specified requirements and bank approval.
- The amendment also provided a $3.0 million advancing term-loan facility for planned shipping-capacity improvements. Advances accrue interest and are to convert to a term loan on December 9, 2017, amortizing over 36 months.
- The bank agreement requires financial ratios and restricts certain activities, including additional debt, capital expenditures, and dividends or stock repurchases. The filing says a covenant default occurred in Q4 FY2017 and was waived under a February 2017 amendment.
- Key risks described include recruiting and retaining consultants, forecasting demand and managing inventory, obtaining books with long supplier lead times, shipping orders without backlogs, and securing working-capital and capital-expenditure financing. Purchases are concentrated with an England-based publisher; purchases from that supplier were $1.9 million in the quarter versus $9.9 million a year earlier.
- UBAM sales are generally paid when ordered, and the company recognizes revenue when products ship. It reported $0.55 million of deferred revenue for prepaid orders shipped after quarter-end. Management cautioned that interim results may not predict full-year results because of seasonality.
- No dividends were declared for the quarter, compared with $0.09 per share in the prior-year quarter. The company reported effective disclosure controls and no material quarterly change in internal control over financial reporting. No legal proceedings were reported.
Important facts for investors to verify
- Reconcile the conflicting gross-margin percentages in MD&A with the financial statements and confirm the comparative-period margin.
- Track whether consultant growth translates into sustained sales and earnings, and whether Publishing performance improves during its seasonally stronger quarters.
- Assess working-capital conversion, especially accounts-payable movements, inventory levels, receivables reserves, and continued negative operating cash flow.
- Confirm compliance with bank covenants and the conditions for the higher revolving limit; monitor borrowings, interest costs, and the advancing term loan.
- Evaluate whether demand forecasts, supplier concentration and lead times, and planned distribution-capacity spending are consistent with actual sales and liquidity.