Educational Development (NASDAQ:EDUC) Q2 2020 Earnings Call

0:01 Ladies and gentlemen, thank you for standing by and welcome to the Educational Development Second Quarter Fiscal Year 2020 Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference to your speaker today, and Mr. Randall White, Chief Executive Officer. Please go ahead, sir. Thank you very much. Welcome to all you on the phone here that have an interest in Education Development Corporation. We have an interesting quarter and what I'm going to do is actually introduce Heather Cobb, our Chief Sales and Marketing Officer.

0:47 She's on the call. are CFOs. So if you have questions for any of them specifically, you're welcome to do that also. So we have the full crew here at your disposal to ask any question you'd like. And with that, while you're thinking about that, I want to turn it over to Dan to actually talk about our earnings release. Thank you, Randall. For an earnings update, net revenues for the second quarter of fiscal 2020 were approximately $24.4 million. down 0.3 million or 1% from 24.7 million reported in the second quarter of fiscal 2019. Earnings before income taxes totaled approximately 1.4 million, a decrease of 0.6 million or 30% from approximately 2 million in the second quarter of fiscal 2019.

1:38 Pre-tax profit as a percentage in net revenues were 5.6% in the second quarter of fiscal 2020. as compared with 8.1% reported in the second quarter of fiscal 2019. Net earnings in the second quarter of fiscal 2020 total approximately one million, a decrease of 0.5 million or 33% from approximately 1.5 million in the second quarter of fiscal 2019. Earnings per share on a fully diluted basis decreased six cents a share or 33% from 18 cents a share reported in the second quarter of fiscal 2019. to 12 cents reported in the second quarter of fiscal 2020. This concludes the earnings results, and I'll pass the call back to Randall.

2:23 Okay. Thanks, Dan. Well, I think if you follow the stock very much, you know that the second quarter is historically the lowest net revenue quarter of the year for the UBAM division, and actually our second quarter started a little slower than last year. However, in anticipation of that or trying to overcome that, in July, we had a 30th anniversary special. We've actually been in the direct selling business for over 30 years, recognized by the Direct Selling Association as one for the last two years as one of the 100 top direct selling companies in the world. Very proud of that because it has come under some fire in the past. So in July, we thought we'd run a really nice July 30th anniversary recruiting special. We brought in over 10,000 new sales consultants in July.

3:15 Come in in July, it takes them sometimes a little while to get started, sometimes not. Some of them hit the ground running. But this increase in July caused August net revenues to be up over 8% of August a year ago. Very nice to see an uptick after a couple of months of not up. We like up better. And we expect this growth to continue during the fall ceiling season. We're very optimistic about what's happening there. Our publishing division sales, which are sales to retail stores, toy stores, bookstores, they increased just under 4% over last year's quarter two net earnings. And it's primarily due to the distribution we have. And we have some excellent projections we think can happen in that division.

4:06 We just have to place more emphasis on that. We do have a new person heading that division in this past eight, nine months, and we're very enthused about the progress she's making. It's an interesting concept. We have outside sales reps and we have inside sales reps on the phone. The concept of it is the outside reps go into a store and present our products. The problem is you're covering a lot of territory with a guy in a car. and so we supplement that with people here on the phone and the idea is that a sales rep can go into the store in Florida and get our products in the store and then we can supplement because they can only get in there once or twice a year with the territory they have and we supplement with our inside sales reps so we're very excited about our new person over that division that's working together with both of them to increase sales and we're optimistic about that.

4:55 The reasons, we have some other operations updates that we're pretty excited about and and I might let someone besides me talk a little bit about it that's a little closer to the ground on this. So I'm going to bring in Craig White. He's our Chief Information Officer, our Chief Operating Officer, and talk about some of the updates that we're doing that we think will have an impact on future growth. Craig? Thank you, Randall. Our IT department has been responsible for two major projects this year. The first of which is our consultant back office, which is where the salespeople can log in and get a 360-degree view of their business, be it sales, recruiting, basically anything about their business. And so this major upgrade that we're working on, number one, brings a mobile-friendly, mobile-responsive component to the back office so that they can conduct their business away from home.

5:54 Secondly, one of the big things in the industry as far as IT is concerned is kind of what we say is the gamification of their business. So we'll be rolling out notifications on different things that are milestones and keystones in their business. So that's another exciting part to the back office. The second major project is our e-commerce site. And The main thing that we're doing for it is getting it to a version that is more mobile responsive and mobile friendly. Most people that look at our statistics would say that our conversion rate of customers to completing orders is pretty high already.

6:39 We hope with it going to a mobile responsive, mobile friendly type environment that we increase our conversion rate even further. It also has other features like more social media interaction and things like that. So we're very excited about those two projects. On a third note, we've recently entered into a partnership with PayPal to become our merchant service. PayPal brings a lot of exciting technology possibilities, so we're very excited to move forward with them and all those things those that will bring. I'd next like to pass it off to Heather Cobb, our Chief Sales and Marketing Officer.

7:28 Between sales and the operations update that Craig just provided, I just wanted to add that all of these operations updates and upgrades that we're doing are really, at the end of the day, providing more more options and a better experience for the end user. So for the back office, when the end user is our consultant, that it will be a better user experience. For our e-commerce site, when it comes to the customer, having the different options that PayPal provides, having it be mobile friendly, different things like that all will be on that focus that we're looking for, which is to improve that user experience.

8:14 Okay, well, let me add one more note to that. We have a pretty good rapport with the field sales force, and one night, Saturday night, about 2.30 in the morning, my phone dings me, wakes me up. and this lady says, seriously Randall, I've got to give up and go downstairs to place an order. And her point was with PayPal, you can do it on the phone. So we believe that this is going to be good for us for this to happen. Anyway, that lady thought it would. Our second quarter is typically the softest revenue quarter, as I mentioned before and consequently. because of UBAN, it's their slowest quarter. Some of the schools are out, and such expenses have a bigger impact on the bottom line in that quarter. Profitability declined in the quarter to the previous year. A couple of reasons. We are on accrual accounting here, in case anybody was wondering, but still, the size we're getting...

9:19 Things happen to us that we try to anticipate, and a couple of them are we have big events that we spend a lot of money on. As an example, we provide incentive travel for our field sales force. If they jump by and run fast, they can run a contest. We never know who's going to take them because we do the very best we can to make it a destination they want to go to, but we now have 35,000 thereabouts, by the way. Don't write that down because it changes every hour. But approximately $35,000, and we never know if they want to go to Dominican Republic or Alaskan Cruise. Well, we thought Dominican Republic was a nice place. We offer an alternative.

10:04 We figure about $2,200 per trip. And again, give or take. That's for the airfare and the person to be on that trip. And so we budget that. And then we offer an alternative. Sometimes the family... doesn't work out for them to go on the trip or what have you, and so they opt out, and we give them an opt out if they can take $2,000, basically a comparable amount of books, which they could, again, sell and benefit from the trip, or just $1,000 cash, and we never know. Well, Dominican Republic, for whatever reason, several opt outs, and we got a $350,000 refund from our trip accrual, which is our very best guess at the time. Well, Well, we're on accrual accounting. That has to be taken that month.

10:49 Well, it was that month a year ago, a $350,000 rebate from a trip, the people who'd earned it. Well, the next year, it's compared to the Alaskan cruise. Well, 525 people went on that. It was basically a million dollars, and we didn't have a rebate from that. By the way, that was all in our accrual system, and it didn't show up as any blip in the month of August. like it did the previous year. So these are things that happen. I hope I'm not complaining, whining about anything. It's just the way it works. I used to be an accountant, by the way, and I know how this all works. We also got a big tax refund a year ago in August from the state on a rebate of property taxes.

11:35 So these things that we really are not manipulated with, we don't know about, we take them at the time when we know about them, and that's the way they felt. We also have netting costs going up, and we're looking at things like that. And there's plenty more things to look at here to analyze our costs and try to be more profitable. I would point out that the pre-tax profit at 5.6 reflects the strength of our business model, even during the softest quarter of the year. While we're not just really excited about it. Still, we were profitable. Also, in that quarter, we used $400,000 of cash to re-purchase 60,000 shares in the quarter. I think we've announced that, that we're in a position of positive cash that we made from time to time.

12:25 and David O'Keefe. We have continued our trend of declaring dividends, 5 cents during the quarter, which is equivalent to 10 before the split, so we're paying out the equivalent of 40 cents, but now 20 cents for the year. We expected growth and our practice of paying quarterly dividends coupled with our share repurchase program continues to make us believe that our shares are still a little bit undervalued. But don't let me guess on what's going to happen in the stock market because I didn't think this report was the best we ever put out and the stock went up, so what do I know? I know that this is solid business and the entire direct selling industry has come under attack for unethical practices. I can assure you on this phone call, I have no hesitation to tell you there's not one thing unethical or illegal about the program we run. I tell everybody at any meeting I have, if you've got any concern about anything we are doing that's not ethical or illegal, you come tell me and I'll fix it because we don't know about that.

13:31 We're a very straightforward direct selling. The reason we're in direct selling is because When we started this program, we didn't have a way to get the very best products in the world into the marketplace. And you see the results of the direct selling now. We sold $100 million, from $25 million up to $118 million, because of being able to present the product to someone. And that's the way we think it's been the most effective, is trying to buy shelf space. What do you have to do in the retail market today? So it's been very effective for us. We have nothing to do with anybody in the industry who's paying people to sign it. It's not us. We're completely honest. If anybody wants to ask a question, you just jump right in here. But we've been hurt a little bit by being painted by the same brush, and it's not us. We've been doing this for 30 years and never had a complaint.

14:21 So with all of that conversation, probably more than you want to know, Is there anybody who has one possible question or something I didn't cover ad nauseum? I'm sorry. Joelle, we are ready to turn the call over for questions from anybody that's on the call that would like to ask a question. Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. to withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Mike Hughes with SGF Capital. Your line is now open.

15:06 Good afternoon. Thanks for taking my questions. First one, in the current quarter, the November quarter and then, you know, the Feb quarter also, were there any one-time benefits I'm not sure off-cuff Thank you for having me. And how should we think about incremental operating margins, meaning for each incremental dollar in revenue, how much should fall to the bottom line prior to taxes?

16:15 Well, the problem with incremental profit is the UBAM is reported with the major portion of their expense is below the line in sales and commission. And so you've got, as opposed to the retail division, it's recorded as a discount above the line. We record gross sales for a $10 book. The average discount to a store is 50%. So we show a gross sale of $10, which we don't get. We get the $5 after discount, and then cost of goods. In the U-band division, we actually get the $10 for the book, and then we have expenses after that. So when you talk about incremental profit, the fastest growing and largest division is U-band, where the bigger portion of their expenses is below the line. Thank you very much.

17:34 How much of that would drive to the operating income line? That's the question in the UBAM business. Okay. All right. Let me go back to that model again that you know about. A $10 book at retail shows up in the financial statements as a $10 gross sale. And then you drop down to the bottom line. And basically the model is this, 25% cost of goods, 25% for this company to operate, and 50% marketing costs. whether it is a discount to retail store or the economic model of UBAM. So the answer I think you're looking for is in a sale of a $10 book, we roughly have about $2.50 for us to run this business, pay the employees, have profit left over to pay the shareholders.

18:23 So incremental revenue in UBAM is more of a 25% contribution as opposed to publishing, which is a 50%. Did I confuse you? No, I think I followed. I appreciate that. And then the consultant count at the end of August, I think you put in the press release, was 35,000. Did you say on today's call that that's the number currently as of today also? No, I didn't say that. I said I hate to use that number because it changes hourly. We know when someone signs up. We don't know when they stop. because they don't call and tell us, I stopped. You look back in over six months and say, well, I guess they're gone. And we revise that number periodically to be accurate.

19:09 And I've said this many times, and I'm not trying to fool anybody. Again, we know exact day they sign up. But if you look back in six months and haven't sold anything, we take them off the active count. And it may look like something. That's what it is. of the 10,000. I'm going to put Craig on the spot here. We had 10,000 people in July. How many of them have sold in July, August, or September? Well, I haven't looked at that since last week, but I think it's in the neighborhood of 7,000 have sold something, and those 7,000 have sold roughly $6 million. Okay. So 7,000 have sold $6 million. 3,000 have sold nothing. but also remember of the 10,000 recruits in July, back by August, they'd recruited another 1,000 people. So that number keeps, that's the way the business works.

20:06 You have people coming and going. I've heard in the industry you've got a third coming, a third going, and a third here. So we constantly have to keep new people because people look at this and they go, oh, my gosh, it's getting rich quick. No, it's not. No, it's not. You have to work. There's no free lunch here. and some people do and they get that kit. They're so excited to get started and they just don't quite ever get started. But that's okay because we don't lose any money on the kit. And if we put 3,000 kits out there and they never sell anything, they've got a really nice box of books and someone comes over and says, oh my gosh, these are nice books. So we don't feel like we're losing any money on the 3,000 because if it's 6 or 7,000, we've already sold 6 million. I hope that helps you a little bit. Right, I understand.

20:51 Two more questions for you. You referenced, I guess you imply the month of August revenue was up 8% year over year, at least in the UBAM division. And then you go on to say that that growth continued into the fall selling season. I assume you're referring to the month of September? Well, we were here for the whole month of September, I'll tell you that. Right, right, but in the press room. Oh, here's an old woman over here. Don't be giving out any, Ernie, don't be giving out future stuff. Well, I'm telling you, what I said was we expected to continue into the fall selling season, and I wouldn't say that if it was down. Okay. Is there any reason to believe that the early part of the quarter was an easier comparison, meaning it gets more challenging as we move into later October, November, so the growth might not continue? No.

21:42 Thank you. Thank you. Thank you. Facebook made some changes that made it a little bit more challenging to hold. I think you refer to it as online house parties. Have your consultants at this point assimilated to that change? And more importantly, do you expect any additional changes or anything on the horizon with Facebook? Great question, Mike. This is Heather. I addressed this briefly in I believe it was the last call as well.

22:33 You know, Facebook being what it is, It's hard to say whether we can anticipate any more changes or not. I would say if you were hedging your bets, the answer is probably going to be yes. They're changing things all the time. I will tell you that the joy of our consultant base and especially our leader base is that they've faced these challenges before. And while that first one we felt a little harder, it took a little bit longer to overcome, they're quite creative when it comes to coming up with workable solutions for any of the changes that they may see on Facebook or any other platform as that may be. And so while I'm saying yes, we do anticipate that Facebook will be changing something at some point, I will also say that I don't know that the impact will be dramatic because our field sales force is so good at overcoming those challenges.

23:29 It is a constant challenge, Joe. Okay. Thank you very much. I appreciate your time. I'm going to tell you something else. What? I'm going to tell you something else. You didn't ask this. Our controller here in the company has been with us about a year and a half, two years. About a year and a half, two years. Very straightforward, honest accountant. And he decided he wanted to know more about direct selling because you hear a lot of negative stuff. So he talked to his wife in signing up as a consultant. I'm not sure I even knew about it at the time. And she... was very interesting. She experienced the very same thing that other people in the field do. After a couple weeks, she said, I don't know if I can do this. I don't like to call my friends. I'm not a salesperson.

24:16 And he said, give it a shot. Come on. Don't give up so easy. And I'm paraphrasing here. The truth is somewhere in here. And so she stayed with it, and he encouraged her to find out how the business works from the inside of the company, which I thought was pretty insightful because I didn't encourage him to do that. Well, at the end of the year, she walked across the stage as one of the top sales leaders in the country with over $30,000. And so I'm thinking, if an accountant's wife can sell that, gosh, just do the math on 30,000 times 30,000. What is that? A lot. Just a little personal note about one of our key members and staff that had his wife join to investigate the company, if you want to call it that, and see how it worked from the inside.

25:05 I'm very proud of that because she had great results, but also I'd buy a book from her. Okay, next question. Do you have any more, Mike? I don't. I appreciate your time. Thank you. You bet. Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. Our next question comes from Edward Norson with a private investor. Your line is now open. Randall, I have a general question with all this talk about tariffs. I understand the books are made in England. Is there any additional cost involved with that, the new tariffs on the EU? Well, we're in, you may know if you keep track of it as much as we do, we monitor daily basically through our publisher in California, Kane Miller, because we do most of our own printing there. So we're monitoring it, and there's tariffs that they say are being imposed. What's the situation right now?

26:04 So to kind of elaborate a little bit, Edward, where we're at right now, we've been, our product codes have been exempt from the tariffs initially through the first couple of phases, but right now we're set for tariffs to start in mid-December. And there'll be a reprieve for a few weeks for people that have orders that are in production and things like that. But we were set for tariffs back in June as well, and then we got a reprieve kind of at the last minute. So we're set for tariffs on products coming from China, and a bulk of our products are produced in China, about 70% of them. We're set for those tariffs to come in into play in December.

26:52 Now, having said that, Edward, we do have some mitigating factors. We do carry a large amount of inventory on hand. And this is probably going to be one of the few times that anybody says, well, it's great that you've got almost the equivalent of a whole year's supply of inventory on hand. But that is, you know, it's a function of our business. It takes sometimes six to eight months between the time that you order a product, and the time that you receive it in your warehouse and can actually sell it. So because of that lead time, we do have to carry a large amount of inventory. And because of that large amount of inventory, we'll have somewhat of a strategic buffer until the industry can react to it.

27:38 And of course, we'll react to it similar to what the industry will do. So what he's also saying is that not only will it affect us, but it will affect everybody who's a competitor. and Dan O'Keefe. and it's prepaid and we don't have the book, it's a mess to get that money back to them. So we may have a lot of inventory, but it meets our business model. So we'll see how that all works out, but that's a good question, Ed.

28:27 I have another question also. Dan, could you give me an estimate of your capital expenditures for the upcoming fiscal year? We don't really, Ed, we don't really project or announce capital expenditures. What we can tell you, you know, we go through a process with our board where we put together our forecast for each year and including our capital expenditures. We've had some significant capital expenditures in the past as we've been upgrading our warehouse operation system. But, you know, with our latest upgrades, we're not forecasting any significant Capital Additions in the warehouse. Our IT projects, while we really have a confidence in the impact it will have with the sales and with our sales force, it's not very significant when it comes to the capital expenditure.

29:25 We're pretty much a low CapEx company. The warehouse is set. The CapEx, like you said, the public company software upgrades. There may be some costs in these new things we're doing here. But traditionally, we're a very low CapEx company to run our business. I see. I do have one more question for you, Randall. Are there any plans? Do you have any plans in the future with the older building? Yeah. Glad you asked that because I was just over there today. What we've done is we've leased the entire front third of that building out, who have renovated it. And man, it looks a whole lot better than we were over there, although I did complain that they tore my office out.

30:10 But we've leased every bit of space that's available. And what we didn't lease is what we are using for inventory. We are using that building. But the front half, the office space, has been leased out to people who've done a very nice job of refurbishing it and much better than we were in it. So that's, we're bringing it in. What will be our annualized revenue on that? About $140,000 annualized. We'll annualize around $140,000 of revenue on a go-forward basis. Sorry we didn't do that sooner. It just didn't seem, when we were going like crazy, that's what we were... and David Chancewell. Let's do something with that building and we have. That's about $150,000 of additional revenue.

31:01 We'll probably find some place for it. That's great. Thank you. Okay. All right. We told you everything you possibly want to know today. Is that true? No more questions? Guys, thank you very much. I feel very bullish. I feel very strong about where we are today. I think we've got a good and the management team here, and I think our prospects are good. Part of our issue has been the industry itself has been attacked very significantly, but I tell you, I can assure you guys, it has nothing to do with us, and while it's called serious reverberations around that direct selling industry, it has nothing whatsoever to do with our business model. So with that, I wish you a happy Thanksgiving, and thanks for being on the call.

31:50 and Joel, we'll turn the call over to you. Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.