Educational Development Corporation — Form 10-Q
Reporting period: Third quarter and nine months ended November 30, 2016. The company sells children’s books through EDC Publishing, a wholesale operation, and Usborne Books & More (UBAM), a direct-sales network. Results are subject to product-sales seasonality.
Financial performance
| Metric | Three months ended Nov. 30, 2016 | Year-over-year | Nine months ended Nov. 30, 2016 | Year-over-year |
|---|---|---|---|---|
| Net revenue | $30.7 million | +25.7% | $79.4 million | +70.1% |
| Gross margin | $22.4 million; 72.9% | 69.8% in 2015 | $56.9 million; 71.6% | 66.7% in 2015 |
| Income before taxes | $2.04 million | $2.03 million in 2015 | $3.57 million | $3.60 million in 2015 |
| Net earnings | $1.27 million; $0.31 per share | $1.26 million; $0.31 per share | $2.21 million; $0.54 per share | $2.23 million; $0.55 per share |
| Operating cash flow | Not presented for the quarter | $(0.17) million | $9.41 million provided in 2015 |
Quarterly revenue growth produced little change in pretax or net earnings. For the nine-month period, revenue increased sharply but net earnings edged down; net margin declined to 2.8% from 4.8%. Operating expenses rose faster than revenue year over year, including operating and selling, commissions, and general and administrative costs.
Balance sheet, debt, and liquidity
- At November 30, cash was $1.0 million, current assets were $42.2 million, and current liabilities were $56.3 million, implying negative working capital of approximately $14.1 million and a current ratio of about 0.75.
- Net inventory was $34.2 million current plus $0.3 million non-current, compared with $17.5 million and $0.2 million, respectively, at February 29. Management linked the inventory build to sales demand.
- Total debt was approximately $24.7 million: $21.8 million in term debt and $2.9 million drawn on the revolving facility. Because the company was in breach of its debt-to-worth covenant and had not received a waiver, all term debt was classified as current. Management expected a waiver.
- The revolving facility was $7.0 million, with $4.12 million available at quarter end; the company subsequently used the remaining availability. On January 9, 2017, CEO Randall White advanced $350,000 for operating costs; repayment was expected during January.
- Nine-month investing cash outflow was $2.12 million, principally capital expenditures. Financing provided $2.09 million, including $4.0 million of term-loan proceeds, offset in part by dividends, debt repayments, and line-of-credit payments.
Material changes and management commentary
- UBAM drove growth: nine-month segment revenue increased to $72.1 million from $37.7 million. Active consultants rose 63% to about 28,100. Growth reflected fundraiser, internet, and home-party sales; quarterly school and library sales fell 42%.
- EDC Publishing’s nine-month revenue fell to $7.2 million from $8.9 million, which management attributed largely to shipping delays as UBAM growth strained capacity. Publishing shipments improved in the third quarter after capital improvements, and management expected improvement to continue through the fiscal year.
- Cash from operations was pressured by a $16.8 million increase in inventory and other working-capital needs. Deferred revenue increased to $9.6 million from $2.9 million at February 29; approximately $9.45 million related to sales orders shipped in December after quarter end. Related prepaid commissions were $2.08 million.
- Purchases from an England-based publishing company were $29.9 million of the $43.7 million total inventory purchases during the nine months, indicating supplier concentration.
- The UBAM direct-sales order system launched September 1 took longer than expected to implement. The company had capitalized $808,400, with a remaining book value of $788,200; an impairment could result if the system cannot meet program needs.
Risks, contingencies, and outlook
- Covenant and liquidity risk: The bank waiver had not been received as of the filing. The covenant breach triggered current classification of $21.8 million of term debt; subsequent use of all revolving availability and the CEO advance underscore cash constraints.
- Control weakness: Management identified a material weakness in controls over deferred revenue and cash, including inability to quantify deferred revenue and reconcile cash accurately and promptly. Remediation was in progress and expected before fiscal year-end 2017; management said these controls were ineffective at November 30.
- Management provided no numerical earnings or revenue guidance. It said EDC Publishing sales were expected to improve as shipping times returned toward historical levels. The filing cautions that interim results may not indicate full-year results because of seasonality.
- The company declared a $0.09-per-share dividend, paid December 16, 2016. Legal proceedings were reported as not applicable.
Important facts for investors to verify
- Whether the lender granted a waiver of the debt covenant breach, and the current classification, maturity, and terms of the term debt.
- Current cash, borrowing availability, repayment of the CEO’s $350,000 advance, and the company’s ability to fund seasonal inventory and operating needs.
- Whether the deferred-revenue and cash control weakness was remediated as planned, and whether subsequent filings report any further control or reporting issues.
- Whether the UBAM order system became fully functional and whether any impairment was recorded.
- Whether inventory levels, post-quarter shipments, and EDC Publishing’s shipping recovery translated into sustained cash generation and earnings.