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 August 31, 2010





 ̈
            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  ̈          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 September 24, 2010









TABLE OF
CONTENTS





PagePART
      I.
                  FINANCIAL
      INFORMATIONItem
      1:
                  Financial
      Statements:Condensed
      Consolidated Balance Sheets as of August 31, 2010 (Unaudited) and May 31,
      2010 and August 31, 2009 (Unaudited)
                  
                  
                  3Condensed
      Consolidated Statements of Income for the Three Months Ended August 31,
      2010 and 2009 (Unaudited)
                  
                  
                  4Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended August
      31, 2010 and 2009 (Unaudited)
                  
                  
                  5Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                  
                  
                  6Item
      2:
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  
                  
                  10Item
      4:
                  Controls
      and Procedures
                  
                  
                  16PART
      II.
                  OTHER
      INFORMATIONItem
      1:
                  Legal
      Proceedings
                  
                  
                  17Item
      2:
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  
                  
                  17Item
      3:
                  Defaults
      Upon Senior Securities
                  
                  
                  17Item
      5:
                  Other
      Information
                  
                  
                  17Item
      6:
                  Exhibits
                  
                  
                  17SIGNATURES
                  
                  
                  18EXHIBITS
                  
                  
                  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)
                                              
                                              August 31, 2010
                                              
                                              
                                              May 31, 2010
                                              
                                              
                                              August 31, 2009ASSETSCurrent AssetsCash
      and Cash Equivalents
                                              
                                              $
                                              209
                                              
                                              
                                              $
                                              110
                                              
                                              
                                              $
                                              102Accounts
      Receivable, Net of Allowances for Doubtful Accounts and
      Returns
                                              
                                              
                                              5,728
                                              
                                              
                                              
                                              2,990
                                              
                                              
                                              
                                              6,531Inventory,
      Net
                                              
                                              
                                              3,565
                                              
                                              
                                              
                                              3,591
                                              
                                              
                                              
                                              3,887Prepaid
      Expenses and Other
                                              
                                              
                                              309
                                              
                                              
                                              
                                              264
                                              
                                              
                                              
                                              355Prepaid
      Marketing Expenses
                                              
                                              
                                              788
                                              
                                              
                                              
                                              642
                                              
                                              
                                              
                                              878Deferred
      Income Taxes
                                              
                                              
                                              692
                                              
                                              
                                              
                                              833
                                              
                                              
                                              
                                              827Total
      Current Assets
                                              
                                              
                                              11,291
                                              
                                              
                                              
                                              8,430
                                              
                                              
                                              
                                              12,580Equipment
      - At Cost, Less Accumulated Depreciation of $2,486, $2,444 and $2,301,
      respectively
                                              
                                              
                                              236
                                              
                                              
                                              
                                              249
                                              
                                              
                                              
                                              347Other AssetsDeferred
      Prepublication Costs, Net
                                              
                                              
                                              13,064
                                              
                                              
                                              
                                              12,864
                                              
                                              
                                              
                                              12,800Deferred
      Income Taxes
                                              
                                              
                                              -
                                              
                                              
                                              
                                              477
                                              
                                              
                                              
                                              412Trademarks,
      Net
                                              
                                              
                                              224
                                              
                                              
                                              
                                              189
                                              
                                              
                                              
                                              185Prepaid
      Expenses and Other
                                              
                                              
                                              149
                                              
                                              
                                              
                                              167
                                              
                                              
                                              
                                              250Total
      Other Assets
                                              
                                              
                                              13,437
                                              
                                              
                                              
                                              13,697
                                              
                                              
                                              
                                              13,647Total Assets
                                              
                                              $
                                              24,964
                                              
                                              
                                              $
                                              22,376
                                              
                                              
                                              $
                                              26,574LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent LiabilitiesCurrent
      Maturities of Long Term Obligations
                                              
                                              $
                                              2,000
                                              
                                              
                                              $
                                              2,000
                                              
                                              
                                              $
                                              2,023Accounts
      Payable
                                              
                                              
                                              8,857
                                              
                                              
                                              
                                              4,904
                                              
                                              
                                              
                                              7,829Accrued
      Compensation
                                              
                                              
                                              346
                                              
                                              
                                              
                                              153
                                              
                                              
                                              
                                              326Other
      Accrued Expenses
                                              
                                              
                                              585
                                              
                                              
                                              
                                              527
                                              
                                              
                                              
                                              1,040Deferred
      Revenue
                                              
                                              
                                              441
                                              
                                              
                                              
                                              404
                                              
                                              
                                              
                                              259Total
      Current Liabilities
                                              
                                              
                                              12,229
                                              
                                              
                                              
                                              7,988
                                              
                                              
                                              
                                              11,477Long
      Term Obligations, Less Current Maturities
                                              
                                              
                                              5,845
                                              
                                              
                                              
                                              8,584
                                              
                                              
                                              
                                              8,122Total Liabilities
                                              
                                              
                                              18,074
                                              
                                              
                                              
                                              16,572
                                              
                                              
                                              
                                              19,599Commitments and
    ContingenciesStockholders' EquityPreferred
      Stock, authorized 1,500,000 shares; none issued
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Common
      Stock, $0.02 par value; authorized 8,500,000 shares; issued: 4,481,434
      shares as of August 31, 2010 and 4,478,434 shares, as of May 31, 2010 and
      August 31, 2009
                                              
                                              
                                              90
                                              
                                              
                                              
                                              90
                                              
                                              
                                              
                                              90Additional
      Paid In Capital
                                              
                                              
                                              8,154
                                              
                                              
                                              
                                              8,120
                                              
                                              
                                              
                                              8,080Accumulated
      Deficit
                                              
                                              
                                              (1,290
                                              )
                                              
                                              
                                              (2,342
                                              )
                                              
                                              
                                              (1,131
                                              )Treasury
      Stock - 16,232 shares, at cost
                                              
                                              
                                              (64
                                              )
                                              
                                              
                                              (64
                                              )
                                              
                                              
                                              (64
                                              )Total Stockholders' Equity
                                              
                                              
                                              6,890
                                              
                                              
                                              
                                              5,804
                                              
                                              
                                              
                                              6,975Total Liabilities and Stockholders'
      Equity
                                              
                                              $
                                              24,964
                                              
                                              
                                              $
                                              22,376
                                              
                                              
                                              $
                                              26,574





See Notes
to Condensed Consolidated Financial Statements.




3




PEOPLES
EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)





(In
Thousands, Except Per Share Data)





Three Months EndedAugust 31,2010
                        
                        
                        2009Revenue,
      Net
                        
                        $
                        13,148
                        
                        
                        $
                        14,749Cost
      of RevenueDirect
      Costs
                        
                        
                        6,666
                        
                        
                        
                        7,413Prepublication
      Cost Amortization
                        
                        
                        1,294
                        
                        
                        
                        1,400Total
                        
                        
                        7,960
                        
                        
                        
                        8,813Gross
      Profit
                        
                        
                        5,188
                        
                        
                        
                        5,936Selling,
      General and Administrative Expenses
                        
                        
                        3,409
                        
                        
                        
                        3,511Income
      from Operations
                        
                        
                        1,779
                        
                        
                        
                        2,425Other
      Expenses, Net
                        
                        
                        8
                        
                        
                        
                        10Interest
      Expense
                        
                        
                        101
                        
                        
                        
                        94Income
      Before Income Taxes
                        
                        
                        1,670
                        
                        
                        
                        2,321Income
      Tax Expense
                        
                        
                        618
                        
                        
                        
                        859Net
      Income
                        
                        $
                        1,052
                        
                        
                        $
                        1,462Net
      Income per Common Share:Basic
      and Diluted
                        
                        $
                        0.24
                        
                        
                        $
                        0.33Weighted-average
      Number ofCommon Shares Outstanding:Basic
      and Diluted
                        
                        
                        4,464
                        
                        
                        
                        4,462





See Notes
to Condensed Consolidated Financial Statements.




4




PEOPLES
EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)





(In Thousands)
                    
                    Three Months EndedAugust 31,2010
                    
                    
                    2009Cash
      Flows From Operating ActivitiesNet
      Income
                    
                    $
                    1,052
                    
                    
                    $
                    1,462Adjustments
      to Reconcile Net Income to Net Cash Provided by Operating
      ActivitiesDepreciation
                    
                    
                    42
                    
                    
                    
                    60Amortization
      of Prepublication Costs and Intangible Assets
                    
                    
                    1,301
                    
                    
                    
                    1,403Stock-Based
      Compensation
                    
                    
                    30
                    
                    
                    
                    20Market
      Value Adjustment of Interest Rate Swap
                    
                    
                    23
                    
                    
                    
                    (39
                    )Deferred
      Income Taxes
                    
                    
                    618
                    
                    
                    
                    859Changes
      in Assets and LiabilitiesAccounts
      Receivable
                    
                    
                    (2,738
                    )
                    
                    
                    (3,689
                    )Inventory
                    
                    
                    26
                    
                    
                    
                    332Prepaid
      Expenses and Other
                    
                    
                    (27
                    )
                    
                    
                    (9
                    )Prepaid
      Marketing Expenses
                    
                    
                    (146
                    )
                    
                    
                    (16
                    )Accounts
      Payable and Accrued Expenses
                    
                    
                    4,204
                    
                    
                    
                    4,172Deferred
      Revenue
                    
                    
                    37
                    
                    
                    
                    (19
                    )Net
      Cash Provided By Operating Activities
                    
                    
                    4,422
                    
                    
                    
                    4,536Cash
      Flows From Investing ActivitiesPurchases
      of Equipment
                    
                    
                    (29
                    )
                    
                    
                    (20
                    )Expenditures
      for Intangibles
                    
                    
                    (42
                    )
                    
                    
                    (18
                    )Expenditures
      for Prepublication Costs
                    
                    
                    (1,494
                    )
                    
                    
                    (734
                    )Net
      Cash Used In Investing Activities
                    
                    
                    (1,565
                    )
                    
                    
                    (772
                    )Cash
      Flows From Financing ActivitiesNet
      Payments Under Line of Credit
                    
                    
                    (2,262
                    )
                    
                    
                    (3,193
                    )Exercise
      of Stock Options
                    
                    
                    4
                    
                    
                    
                    -Principal
      Payments On Long-Term Debt
                    
                    
                    (500
                    )
                    
                    
                    (511
                    )Net
      Cash Used In Financing Activities
                    
                    
                    (2,758
                    )
                    
                    
                    (3,704
                    )Net
      Increase in Cash and Cash Equivalents
                    
                    
                    99
                    
                    
                    
                    60Cash
      and Cash EquivalentsBeginning
      of Period
                    
                    
                    110
                    
                    
                    
                    42End
      of Period
                    
                    $
                    209
                    
                    
                    $
                    102Supplemental
      Cash Flow InformationCash
      Payments for:Interest
                    
                    $
                    66
                    
                    
                    $
                    139





See Notes
to Condensed Consolidated Financial Statements.




5




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), is a leading publisher and distributor
of supplemental instructional materials for the kindergarten through high school
sector (K-12).  PE designs and produces materials in both print and
digital format, with a growing emphasis on Internet-based delivery. The
materials are predominantly state-specific and standards-based, focused on
state-required tests.  PE also distributes college preparation
products developed internally and by other publishers and literacy products
developed by other publishers.  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 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 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 month period ended August 31, 2010 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/A for the year ended May 31,
2010.





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 condensed consolidated financial statements.  Actual
results could differ materially from these estimates and
assumptions.





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 electronic products prorata over
the life of the subscription agreement. The allowances for returns were as
follows:





August
      31, 2010
                    
                    $
                    431,000May
      31, 2010
                    
                    $
                    153,000August
      31, 2009
                    
                    $
                    803,000





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 income.




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 as of
August 31, 2010, May 31, 2010 and August 31, 2009 were $10,000, $10,000 and
$40,000, respectively.




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 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.  In calculating
diluted weighted average shares and per share amounts, the Company included
stock options with exercise prices below average market prices, for the
respective reporting periods in which they were dilutive, using the treasury
stock method.  The number of additional shares was calculated by
assuming the outstanding stock options were exercised and that
the proceeds from such exercises were used to acquire common stock at the
average market price during the reporting period.  The weighted
average common shares outstanding included 324 and 0 shares of common stock
equivalents for the three months ended August 31, 2010 and 2009,
respectively.





NOTE 4– Deferred
Prepublication Costs


Deferred
prepublication (Product Development) 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 is as
follows for the periods presented:





(In
Thousands)





August 31,
                    
                    
                    May 31,
                    
                    
                    August 31,2010
                    
                    
                    2010
                    
                    
                    2009Balances,
      Beginning
                    
                    $
                    12,864
                    
                    
                    $
                    13,466
                    
                    
                    $
                    13,466Prepublication
      Cost Additions
                    
                    
                    1,494
                    
                    
                    
                    4,782
                    
                    
                    
                    734Amortization
      Expense
                    
                    
                    (1,294
                    )
                    
                    
                    (5,384
                    )
                    
                    
                    (1,400
                    )Balances,
      Ending
                    
                    $
                    13,064
                    
                    
                    $
                    12,864
                    
                    
                    $
                    12,800





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, 2011
                  
                  $
                  3,707Year
      ending May 31, 2012
                  
                  
                  4,054Year
      ending May 31, 2013
                  
                  
                  2,531Year
      ending May 31, 2014
                  
                  
                  1,523Year
      ending May 31, 2015 and thereafter
                  
                  
                  1,249$
                  13,064





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.




7




Peoples
Educational Holdings, Inc., and Subsidiary


Notes
to Condensed Consolidated Financial Statements (UNAUDITED)





The
prepaid marketing expenses are presented in the balance sheets as
follows:





August
      31, 2010
                  
                  $
                  788,000May
      31, 2010
                  
                  $
                  642,000August
      31, 2009
                  
                  $
                  878,000





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. The average interest rates for the
      reporting periods ending August 31, 2010, May 31, 2010 and August 31, 2009
      were 2.5% for all periods.  At August 31, 2010, $2.8 million was
      outstanding under this facility, and $7.2 million was available for
      borrowing.





·
            The
      term loan is for $10 million and matures in December 2012.  The
      term loan provides 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 $2.3 million
      of the $5 million outstanding at August 31, 2010.  In May 2007,
      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 the Company’s total funded
      debt to EBITDA ratio. This swap agreement expired on May 31, 2010. On June
      3, 2010, the Company entered into a new swap agreement for $3 million,
      expiring in February 2012, fixing the interest rate at 1.25% plus an
      interest spread of 2.00% to 2.25% based upon the Company’s total funded
      debt to EBITDA ratio. 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 three months ended August 31, 2010,
      the Company recorded interest expense of $23,000 relating to the
      swap.





The
credit agreement contains certain financial covenants, calculated on a
consolidated basis for the Company, 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. The Company is in compliance with all
covenants at August 31, 2010.





NOTE 7 – Income
Taxes


On a
quarterly basis, the Company estimates what the effective tax rate will be for
the full fiscal year and records a quarterly income tax provision based on the
anticipated rate. As the year progresses, the Company refines the estimate based
on the facts and circumstances by each tax jurisdiction. The effective tax rates
for the three months ended August 31, 2010 and 2009 were approximately
37%.





The
Company established a valuation allowance of $700,000 during the fiscal year
ended May 31, 2009. As of
August 31, 2010, there has been no change to the valuation
allowance.


8




Peoples
Educational Holdings, Inc., and Subsidiary


Notes
to Condensed Consolidated Financial Statements (UNAUDITED)





The
carrying value of the net deferred tax asset assumes that the Company will be
able to generate sufficient taxable income in the future. The Company performs 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.





On
November 6, 2009, H.R. 3548, the Worker, Homeownership, and Business Assistance
Act of 2009 (the “Act”) was enacted. Although the Act deals principally with the
extension of unemployment benefits and mortgage relief, it also extends to all
businesses the five-year net operating loss carryback previously
available only to small businesses. The Act provides that a business of any size
may elect to carryback net operating losses incurred in 2008 or 2009 (but not
both) for three, four or five years. After
considering the fiscal 2008 federal income tax return filed with the IRS and the
expected fiscal 2009 net operating losses, the Company determined that it had a
carryback of approximately $1.9 million of tax-basis net operating losses from
fiscal 2008, which resulted in a refund of approximately $635,000. During the
third quarter of fiscal 2010, the Company filed Form 1120X with the IRS and
received the refund in February 2010.  The Company’s deferred tax
asset was reduced by the refund amount.





NOTE 8 – Recently Issued
Accounting Standards


In June
2009, the FASB updated its guidance in ASC 810 (formerly SFAS No. 167,
Amendments to FASB
Interpretation No. 46(R)). ASC 810 is intended to address (1) the effects
on certain provisions of FASB Interpretation No. 46 (revised December
2003),Consolidation of
Variable Interest Entities, as a result of the elimination of the
qualifying special-purpose entity concept in FAS 166, and (2) constituent
concerns about the application of certain key provisions of Interpretation
46(R), including those in which the accounting and disclosures under the
Interpretation do not always provide timely and useful information about an
enterprise’s involvement in a variable interest entity. This statement must be
applied as of the beginning of each reporting entity’s first annual
reporting period that begins after November 15, 2009. The Company does not
expect the adoption of ASC 810 to have an impact on the Company’s
consolidated financial position, results of operations and cash
flows.





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 will be
effective for the first annual period beginning on or after June 15, 2010. The
Company does not expect the adoption of FASB ASU 09-13 to have an impact on
the Company’s consolidated financial position, results of operations and cash
flows.





In
January 2010, the FASB issued FASB ASU No. 2010-06, “Fair Value Measurements and
Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements”
(“ASU 2010-06”). This update requires additional disclosures about (1) the
different classes of assets and liabilities measured at fair value, (2) the
valuation techniques and inputs used, (3) the activity in Level 3 fair value
measurements, and (4) the transfers between Levels 1, 2, and 3 fair value
measurements. ASU 2010-06 is effective for interim and annual reporting periods
beginning after December 15, 2009. The Company has complied with the additional
disclosures required by this standard. The adoption of this standard had no
impact on the Company’s consolidated financial position, results of operations
and cash flows.




9




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 revenue percentage for
fiscal 2010 by quarter is summarized in the table below.





Jun - Aug
                
                
                Sep - Nov
                
                
                Dec - Feb
                
                
                Mar - May1st Quarter
                
                
                2nd Quarter
                
                
                3rd Quarter
                
                
                4th QuarterTest
      Preparation, Assessment, and Instruction
                
                31%
                
                
                24%
                
                
                22%
                
                
                23%College
      Preparation
                
                63%
                
                
                16%
                
                
                4%
                
                
                17%Literacy
                
                33%
                
                
                16%
                
                
                23%
                
                
                28%Total
      Revenue
                
                42%
                
                
                21%
                
                
                16%
                
                
                21%





PRODUCT
OVERVIEW





We are a
leading publisher and distributor of supplemental instructional materials for
the kindergarten through high school sector (K-12).  We design and
produce materials in both print and digital formats, with a growing emphasis on
Internet-based delivery. The 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.




10





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. 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.





·
            ePath
      KnowledgeTM, is a suite of online tools designed to meet unique needs of
      schools and districts. Our first offering, ePath Assess TM, formerly
      Measuring Up e-Path®
      was developed in conjunction with Cisco Learning Systems.  ePath
      AssessTM provides formative assessment and ongoing progress-monitoring that
      allows educators to make data-driven decisions. ePath DiscoveryTM delivers
      immediate online standards-based instructional intervention for students.
      Lastly, Practice PathTM provides an easy-to-use student-based interface for
      online standards and test-based skill building and practice. The ePath
      KnowledgeTM suite of tools provides educators with online options to best
      meet the needs of their students and teachers, while providing state
      customized content for assessment and
  instruction.





Instruction


·
            We
      have two product lines within this group: Focused Instruction and remedial
      and multicultural related 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.  We
      continue to sell our backlist remedial and multicultural 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, but 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.





Literacy
Product Group





In March
2009, we entered into exclusive sales and distribution agreements within the
United States for specific products with three publishers. These materials
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.




11




RESULTS
OF OPERATIONS





Three Months Ended August
31, 2010 vs. Three Months Ended August 31, 2009




(Amounts in Thousands - Except Per Share Data)
                  
                  Three Months Ended August 31,2010
                  
                  
                  2009RevenueTest
      Preparation, Assessment and Instruction
                  
                  $
                  5,121
                  
                  
                  38.9%
                  
                  
                  $
                  6,267
                  
                  
                  42.5%College
      Preparation
                  
                  
                  7,177
                  
                  
                  54.6%
                  
                  
                  
                  7,621
                  
                  
                  51.7%Literacy
                  
                  
                  850
                  
                  
                  6.5%
                  
                  
                  
                  861
                  
                  
                  5.8%Total
      Revenue
                  
                  
                  13,148
                  
                  
                  100.0%
                  
                  
                  
                  14,749
                  
                  
                  100.0%Cost
      of RevenueDirect
      Costs
                  
                  
                  6,666
                  
                  
                  50.7%
                  
                  
                  
                  7,413
                  
                  
                  50.3%Prepublication
      Cost Amortization
                  
                  
                  1,294
                  
                  
                  9.8%
                  
                  
                  
                  1,400
                  
                  
                  9.5%Total
      Cost Of Revenue
                  
                  
                  7,960
                  
                  
                  60.5%
                  
                  
                  
                  8,813
                  
                  
                  59.8%Gross
      Profit
                  
                  
                  5,188
                  
                  
                  39.5%
                  
                  
                  
                  5,936
                  
                  
                  40.2%Selling,
      General and Administrative ExpensesMarketing
      and Selling
                  
                  
                  2,231
                  
                  
                  17.0%
                  
                  
                  
                  2,283
                  
                  
                  15.5%General
      and Administrative
                  
                  
                  1,178
                  
                  
                  9.0%
                  
                  
                  
                  1,228
                  
                  
                  8.3%Total
      Selling, General and Administrative Expenses
                  
                  
                  3,409
                  
                  
                  25.9%
                  
                  
                  
                  3,511
                  
                  
                  23.8%Operating
      Income
                  
                  
                  1,779
                  
                  
                  13.5%
                  
                  
                  
                  2,425
                  
                  
                  16.4%Other
      Expenses, Net
                  
                  
                  8
                  
                  
                  0.1%
                  
                  
                  
                  10
                  
                  
                  0.1%Interest
      Expense
                  
                  
                  101
                  
                  
                  0.8%
                  
                  
                  
                  94
                  
                  
                  0.6%Income
      Before Income Tax Expense
                  
                  
                  1,670
                  
                  
                  12.7%
                  
                  
                  
                  2,321
                  
                  
                  15.7%Income
      Tax Expense
                  
                  
                  618
                  
                  
                  4.7%
                  
                  
                  
                  859
                  
                  
                  5.8%Net
      Income
                  
                  $
                  1,052
                  
                  
                  8.0%
                  
                  
                  $
                  1,462
                  
                  
                  9.9%Net
      Income per Common Share:Basic
      and Diluted
                  
                  $
                  0.24
                  
                  
                  
                  
                  
                  $
                  0.33





Overview





The K-12
supplemental market continues to be impacted by the state and local economy
budget cuts.  Due to economic conditions and the current status of
state and federal economies, 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 as total revenue for
the quarter was $13.1 million, a decrease of 10.9% from the same period in the
prior year. Test Preparation, Assessment, and Instruction product group revenue
decreased 18.3% on a year-over-year basis, College Preparation product group
revenue decreased 5.8% and revenue generated by our Literacy product group
decreased by 1.3%. Net income for the quarter was $1.1 million, as compared to
$1.5 million in the prior year.  Basic and diluted income per common
share for the quarter were $0.24, compared to $0.33 for the same period last
year.




12




REVENUE





Test Preparation,
Assessment, and Instruction





Revenue
for this product group for the quarter was $5.1 million, compared to $6.3
million during the same period in the prior year.Test Preparation and
Assessment revenue for the quarter was $4.5 million, a decrease of 13.2% from
the prior year, while Instruction revenue was $0.6 million, compared to $1.0
million in the prior year.





College
Preparation





College
Preparation revenue for the quarter was $7.2 million, compared to $7.6 million
during the same period in the prior year.   Revenue from the sale
of products offered from the two major college publishers was $6.9 million, a
decline of 4.8% from the prior year.  Revenue from our proprietary
products and other distribution products was $277,000, a decrease of $95,000
from the prior year. Revenue for this product group is extremely seasonal;
historically approximately 63% of the annual revenue is derived during the three
months ended August 31.





Literacy





This
product group was launched in March 2009, and generated $850,000 of revenue,
compared to $861,000 during the same period in the prior year.In November 2009, we
expanded our product offering by adding two new series from one of our existing
literacy publishers.  In addition, we anticipate growing the number of
products within this group, initially through additional distribution
agreements, and in the future by in-house development.





COST OF REVENUE





Cost of
revenue for the quarter was $8.0 million (60.5% of revenue) compared to $8.8
million (59.8% 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 50.7%, as compared
      to 50.3% during the same period in the prior year. The increase is due to
      the revenue mix.





·
            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. We believe our amortization policy is in line with industry
      practice.  For the quarter, we amortized $1.3 million of
      prepublication costs, a decrease of $0.1 million from the prior
      year.





MARKETING
AND SELLING





Marketing
and selling expenses for the quarter were $2.2 million, a decrease of 2.3% from
the prior year. The expense as a percent of revenue increased from 15.5% in the
prior year to 17.0% in the current period due to a year-over-year decline in
revenue.





Marketing
expenses within this category increased $75,000 for the quarter.  Of
the total increase $60,000 relates to the timing of catalog expenses and the
balance of the increase was general marketing costs.   Selling
expenses within this category decreased $127,000 from the prior year primarily
due to the revenue mix. As a percentage of revenue, the expense increased from
12.1% in the prior year to 12.6%, primarily due to the revenue mix.




13




GENERAL
AND ADMINISTRATIVE





General
and administrative expenses for the quarter were $1.2 million, a decrease of
4.1% compared to the prior year.  The decrease is due to overall cost
containment efforts.





INTEREST
EXPENSE





Interest
expense for the quarter was $101,000, compared to $94,000 for the same period in
the prior year.  The change is due to lower average outstanding debt
on a year-over-year basis offset by a decline in the fair-value of our swap
agreement.  Included in interest expense for the quarter was $23,000
of expense, compared to $39,000 of income during the same period in the prior
year.





LIQUIDITY AND CAPITAL
RESOURCES





Net cash
provided by operating activities for the three months ended August 31, 2010 was
$4.4 million.  Cash was primarily provided by our net income before
depreciation, amortization and deferred income taxes, as well as increases in
accounts payable and accrued expenses offset by an increase in accounts
receivable.





Net cash
used in investing activities was $1.6 million, consisting primarily of
prepublication expenditures of $1.5 million.  Prepublication
expenditures for the period were $0.8 million higher than the prior year. The
increase in expenditures is primarily related to timing, as we expect the full
year expenditures to be comparable to the prior year expenditures of $4.8
million.





Net cash
used in financing activities was $2.8 million, consisting of $2.3 million of net
payments on our revolving line of credit and $0.5 million of payments on our
term loan.





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. The average interest rates for the
      reporting periods ending August 31, 2010, May 31, 2010 and August 31, 2009
      were 2.5% for all periods. At August 31, 2010, $2.8 million was
      outstanding under this facility, and $7.2 million was available for
      borrowing.





·
            The
      term loan is for $10 million and matures in December 2012.  The
      term loan provides 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 $2.3 million
      of the $5 million outstanding at August 31, 2010.  In May 2007,
      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 the Company’s total funded
      debt to EBITDA ratio. This swap agreement expired on May 31, 2010. On June
      3, 2010, the Company entered into a new swap agreement for $3 million,
      expiring in February 2012, fixing the interest rate at 1.25% plus an
      interest spread of 2.00% to 2.25% based upon the Company’s total funded
      debt to EBITDA ratio. 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 three months ended August 31, 2010,
      the Company recorded interest expense of $23,000 relating to the
      swap.





The
credit agreement contains certain financial covenants, calculated on a
consolidated basis for the Company, 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.




14


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.





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, 2010 Form 10-K/A.  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 August
31, 2010, we had a returns valuation allowance of $431,000.  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 electronic 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 August 31, 2010, 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 August 31, 2010 and is believed to be adequate
for any exposure to loss.





Allowance
for Excess and Slow-Moving Inventory


We
continuously monitor our 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 $955,000 at
August 31, 2010 is believed to be adequate to cover potential inventory loss
exposure.




15




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. As of
May 31, 2009, a valuation allowance has been provided in the amount of $700,000
related to the tax benefit of our available federal and state Net Operating
Losses. 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.





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.




16




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 August 31, 2010, 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
August 31, 2010.  At August 31, 2010, 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





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.




17




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:October
      8, 2010
                  
                  PEOPLES
      EDUCATIONAL HOLDINGS, INC.By: /s/ Brian T.
BeckwithBrian
      T. BeckwithPresident
      and Chief Executive
Officer




18