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 February 28, 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: 4,462,202 shares of Common Stock (par
value $0.02 per share) outstanding on April 2, 2010.





TABLE OF
CONTENTS





PagePART
      I.
                    FINANCIAL
      INFORMATIONItem
      1:
                    Financial
      Statements:Condensed
      Consolidated Balance Sheets as of February 28, 2010 (Unaudited) and May
      31, 2009 and February 28, 2009 (Unaudited)
                    3Condensed
      Consolidated Statements of Operations for the Three and Nine Months Ended
      February 28, 2010 and 2009 (Unaudited)
                    4Condensed
      Consolidated Statements of Cash Flows for the Nine Months Ended February
      28, 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
                    18PART
      II.
                    OTHER
      INFORMATIONItem
      1:
                    Legal
      Proceedings
                    19Item
      2:
                    Unregistered
      Sales of Equity Securities and Use of Proceeds
                    19Item
      3:
                    Defaults
      Upon Senior Securities
                    19Item 4:
                    Submission
      of Matters to a Vote of Security Holders
                    19Item
      5:
                    Other
      Information
                    19Item
      6:
                    Exhibits
                    19SIGNATURES
                    20EXHIBITS
                    21


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)
                                          
                                          February
      28, 2010
                                          
                                          
                                          May
      31, 2009
                                          
                                          
                                          February
      28, 2009ASSETSCurrent AssetsCash
      and Cash Equivalents
                                          
                                          $
                                          95
                                          
                                          
                                          $
                                          42
                                          
                                          
                                          $
                                          33Accounts
      Receivable, Net of Allowances for Doubtful Accounts and
      Returns
                                          
                                          
                                          2,261
                                          
                                          
                                          
                                          2,842
                                          
                                          
                                          
                                          1,706Inventory,
      Net
                                          
                                          
                                          3,980
                                          
                                          
                                          
                                          4,219
                                          
                                          
                                          
                                          3,941Prepaid
      Expenses and Other
                                          
                                          
                                          357
                                          
                                          
                                          
                                          323
                                          
                                          
                                          
                                          370Prepaid
      Marketing Expenses
                                          
                                          
                                          443
                                          
                                          
                                          
                                          862
                                          
                                          
                                          
                                          964Deferred
      Income Taxes
                                          
                                          
                                          938
                                          
                                          
                                          
                                          1,092
                                          
                                          
                                          
                                          661Total
      Current Assets
                                          
                                          
                                          8,074
                                          
                                          
                                          
                                          9,380
                                          
                                          
                                          
                                          7,675Equipment
      - At Cost, Less Accumulated Depreciation of $2,405, $2,241 and $2,215,
      respectively
                                          
                                          
                                          272
                                          
                                          
                                          
                                          387
                                          
                                          
                                          
                                          446Other AssetsDeferred
      Prepublication Costs, Net
                                          
                                          
                                          11,991
                                          
                                          
                                          
                                          13,466
                                          
                                          
                                          
                                          13,826Deferred
      Income Taxes
                                          
                                          
                                          212
                                          
                                          
                                          
                                          1,006
                                          
                                          
                                          
                                          1,796Trademarks,
      Net
                                          
                                          
                                          189
                                          
                                          
                                          
                                          170
                                          
                                          
                                          
                                          191Prepaid
      Expenses and Other
                                          
                                          
                                          185
                                          
                                          
                                          
                                          273
                                          
                                          
                                          
                                          376Prepaid
      Marketing Expenses
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          123Total
      Other Assets
                                          
                                          
                                          12,577
                                          
                                          
                                          
                                          14,915
                                          
                                          
                                          
                                          16,312Total Assets
                                          
                                          $
                                          20,923
                                          
                                          
                                          $
                                          24,682
                                          
                                          
                                          $
                                          24,433LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent LiabilitiesCurrent
      Maturities of Long Term Obligations
                                          
                                          $
                                          2,000
                                          
                                          
                                          $
                                          2,034
                                          
                                          
                                          $
                                          2,045Accounts
      Payable
                                          
                                          
                                          3,322
                                          
                                          
                                          
                                          3,998
                                          
                                          
                                          
                                          2,830Accrued
      Compensation
                                          
                                          
                                          241
                                          
                                          
                                          
                                          170
                                          
                                          
                                          
                                          232Other
      Accrued Expenses
                                          
                                          
                                          444
                                          
                                          
                                          
                                          855
                                          
                                          
                                          
                                          294Deferred
      Revenue
                                          
                                          
                                          546
                                          
                                          
                                          
                                          278
                                          
                                          
                                          
                                          403Total
      Current Liabilities
                                          
                                          
                                          6,553
                                          
                                          
                                          
                                          7,335
                                          
                                          
                                          
                                          5,804Long
      Term Obligations, Less Current Maturities
                                          
                                          
                                          8,475
                                          
                                          
                                          
                                          11,854
                                          
                                          
                                          
                                          11,885Total Liabilities
                                          
                                          
                                          15,028
                                          
                                          
                                          
                                          19,189
                                          
                                          
                                          
                                          17,689Commitments and
    ContingenciesStockholders' EquityPreferred
      Stock, authorized 1,500,000 shares; none issuedCommon
      Stock, $0.02 par value; authorized 8,500,000 shares; issued: 4,478,434
      shares, for all periods
                                          
                                          
                                          90
                                          
                                          
                                          
                                          90
                                          
                                          
                                          
                                          90Additional
      Paid In Capital
                                          
                                          
                                          8,105
                                          
                                          
                                          
                                          8,060
                                          
                                          
                                          
                                          8,042Accumulated
      Deficit
                                          
                                          
                                          (2,236
                                          )
                                          
                                          
                                          (2,593
                                          )
                                          
                                          
                                          (1,324
                                          )Treasury
      Stock - 16,232 shares, at cost
                                          
                                          
                                          (64
                                          )
                                          
                                          
                                          (64
                                          )
                                          
                                          
                                          (64
                                          )Total Stockholders' Equity
                                          
                                          
                                          5,895
                                          
                                          
                                          
                                          5,493
                                          
                                          
                                          
                                          6,744Total Liabilities and Stockholders'
      Equity
                                          
                                          $
                                          20,923
                                          
                                          
                                          $
                                          24,682
                                          
                                          
                                          $
                                          24,433





See Notes
to Condensed Consolidated Financial Statements.


3





PEOPLES
EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)





(In
Thousands, Except Per Share Data)





Three
      Months Ended
                  
                  
                  Nine
      Months EndedFebruary
      28,
                  
                  
                  February
      28,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Revenue,
      Net
                  
                  $
                  5,450
                  
                  
                  $
                  5,204
                  
                  
                  $
                  27,504
                  
                  
                  $
                  29,481Cost
      of RevenueDirect
      Costs
                  
                  
                  1,809
                  
                  
                  
                  1,733
                  
                  
                  
                  11,950
                  
                  
                  
                  13,242Prepublication
      Cost Amortization
                  
                  
                  1,364
                  
                  
                  
                  1,688
                  
                  
                  
                  4,092
                  
                  
                  
                  5,040Total
                  
                  
                  3,173
                  
                  
                  
                  3,421
                  
                  
                  
                  16,042
                  
                  
                  
                  18,282Gross
      Profit
                  
                  
                  2,277
                  
                  
                  
                  1,783
                  
                  
                  
                  11,462
                  
                  
                  
                  11,199Selling,
      General and Administrative Expenses
                  
                  
                  3,398
                  
                  
                  
                  3,146
                  
                  
                  
                  10,548
                  
                  
                  
                  10,366Income
      (Loss) from Operations
                  
                  
                  (1,121
                  )
                  
                  
                  (1,363
                  )
                  
                  
                  914
                  
                  
                  
                  833Other
      Expenses, Net
                  
                  
                  11
                  
                  
                  
                  2
                  
                  
                  
                  25
                  
                  
                  
                  18Interest
      Expense
                  
                  
                  46
                  
                  
                  
                  126
                  
                  
                  
                  206
                  
                  
                  
                  564Income
      (Loss) Before Income Taxes
                  
                  
                  (1,178
                  )
                  
                  
                  (1,491
                  )
                  
                  
                  683
                  
                  
                  
                  251Income
      Tax Expense (Benefit)
                  
                  
                  (377
                  )
                  
                  
                  (546
                  )
                  
                  
                  326
                  
                  
                  
                  93Net
      Income (Loss)
                  
                  $
                  (801
                  )
                  
                  $
                  (945
                  )
                  
                  $
                  357
                  
                  
                  $
                  158Net
      Income (Loss) per Common Share:Basic
                  
                  $
                  (0.18
                  )
                  
                  $
                  (0.21
                  )
                  
                  $
                  0.08
                  
                  
                  $
                  0.04Diluted
                  
                  $
                  (0.18
                  )
                  
                  $
                  (0.21
                  )
                  
                  $
                  0.08
                  
                  
                  $
                  0.04Weighted-average
      Number of Common Shares Outstanding:Basic
                  
                  
                  4,462
                  
                  
                  
                  4,457
                  
                  
                  
                  4,462
                  
                  
                  
                  4,455Diluted
                  
                  
                  4,462
                  
                  
                  
                  4,457
                  
                  
                  
                  4,465
                  
                  
                  
                  4,455





See Notes
to Condensed Consolidated Financial Statements.


4





PEOPLES
EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)





(In
      Thousands)
                    
                    Nine
      Months EndedFebruary
      28,2010
                    
                    
                    2009Cash
      Flows From Operating ActivitiesNet
      Income
                    
                    $
                    357
                    
                    
                    $
                    158Adjustments
      to Reconcile Net Income to Net Cash Provided by Operating
      ActivitiesDepreciation
                    
                    
                    164
                    
                    
                    
                    221Amortization
      of Prepublication Costs and Intangible Assets
                    
                    
                    4,104
                    
                    
                    
                    5,048Stock-Based
      Compensation
                    
                    
                    45
                    
                    
                    
                    30Market
      Value Adjustment of Interest Rate Swap
                    
                    
                    (117
                    )
                    
                    
                    36Deferred
      Income Taxes
                    
                    
                    948
                    
                    
                    
                    103Changes
      in Assets and LiabilitiesAccounts
      Receivable
                    
                    
                    581
                    
                    
                    
                    1,958Inventory
                    
                    
                    239
                    
                    
                    
                    453Prepaid
      Expenses and Other
                    
                    
                    54
                    
                    
                    
                    (79
                    )Prepaid
      Marketing Expenses
                    
                    
                    419
                    
                    
                    
                    237Accounts
      Payable and Accrued Expenses
                    
                    
                    (1,016
                    )
                    
                    
                    (2,144
                    )Deferred
      Revenue
                    
                    
                    268
                    
                    
                    
                    (72
                    )Net
      Cash Provided By Operating Activities
                    
                    
                    6,046
                    
                    
                    
                    5,949Cash
      Flows From Investing ActivitiesPurchases
      of Equipment
                    
                    
                    (49
                    )
                    
                    
                    (101
                    )Expenditures
      for Intangibles
                    
                    
                    (31
                    )
                    
                    
                    (8
                    )Expenditures
      for Prepublication Costs
                    
                    
                    (2,617
                    )
                    
                    
                    (3,666
                    )Net
      Cash Used In Investing Activities
                    
                    
                    (2,697
                    )
                    
                    
                    (3,775
                    )Cash
      Flows From Financing ActivitiesNet
      Payments Under Line of Credit
                    
                    
                    (1,762
                    )
                    
                    
                    (663
                    )Principal
      Payments On Long-Term Debt
                    
                    
                    (1,534
                    )
                    
                    
                    (1,531
                    )Net
      Cash Used In Financing Activities
                    
                    
                    (3,296
                    )
                    
                    
                    (2,194
                    )Net
      Increase (Decrease) in Cash and Cash Equivalents
                    
                    
                    53
                    
                    
                    
                    (20
                    )Cash
      and Cash EquivalentsBeginning
      of Period
                    
                    
                    42
                    
                    
                    
                    53End
      of Period
                    
                    $
                    95
                    
                    
                    $
                    33Supplemental
      Cash Flow InformationCash
      Payments for:Interest
                    
                    $
                    382
                    
                    
                    $
                    581





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
electronic 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.  In preparing the
accompanying unaudited condensed consolidated financial statements, management
has evaluated subsequent events through April 8, 2010, the date of the issuance
of these financial statements. The operating results for the three and nine
month periods ended February 28, 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 for the year ended May 31,
2009.





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:





February
      28, 2010
                    
                    $
                    619,000May
      31, 2009
                    
                    $
                    520,000February
      28, 2009
                    
                    $
                    625,000





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 operations.




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 was
$40,000 for all periods presented.


6


Peoples
Educational Holdings, Inc., and Subsidiary


Notes
to Condensed Consolidated Financial Statements (UNAUDITED)





NOTE 3 – Basic and Diluted Per
Share Amounts


Basic per
share amounts are computed, generally, by dividing net income or loss by the
weighted average number of common shares outstanding.  Diluted per
share amounts assume the conversion, exercise or issuance of all potential
common stock instruments, unless their effect is anti-dilutive thereby reducing
the loss or increasing the income per common share.  Due to the net
losses for the three months ended February 28, 2010 and 2009, diluted shares
were the same as basic shares since the effect of options and warrants would
have been anti-dilutive. The dilutive effect of these additional shares for the
nine months ended February 28, 2010 and 2009 was to increase the weighted
average common shares outstanding by 2,558 and 222 shares,
respectively.





NOTE 4– Deferred
Prepublication Costs


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





(In
Thousands)





Three
      Months Ended
                    
                    
                    Nine
      Months EndedFebruary
      28,
                    
                    
                    February
      28,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Balances,
      Beginning
                    
                    $
                    12,233
                    
                    
                    $
                    14,588
                    
                    
                    $
                    13,466
                    
                    
                    $
                    15,200Prepublication
      Cost Additions
                    
                    
                    1,122
                    
                    
                    
                    926
                    
                    
                    
                    2,617
                    
                    
                    
                    3,666Amortization
      Expense
                    
                    
                    (1,364
                    )
                    
                    
                    (1,688
                    )
                    
                    
                    (4,092
                    )
                    
                    
                    (5,040
                    )Balances,
      Ending
                    
                    $
                    11,991
                    
                    
                    $
                    13,826
                    
                    
                    $
                    11,991
                    
                    
                    $
                    13,826





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, 2010
                    
                    $
                    1,301Year
      ending May 31, 2011
                    
                    
                    4,731Year
      ending May 31, 2012
                    
                    
                    3,136Year
      ending May 31, 2013
                    
                    
                    1,657Year
      ending May 31, 2014 and thereafter
                    
                    
                    1,166$
                    11,991


The
future estimated expense amount is expected to increase as the Company continues
its investments in additional prepublication costs.





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)





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





(In
      Thousands)February
      28,
                  
                  
                  May
      31,
                  
                  
                  February
      28,2010
                  
                  
                  2009
                  
                  
                  2009Total
      Prepaid Balance
                  
                  $
                  443
                  
                  
                  $
                  862
                  
                  
                  $
                  1,087Less
      current portion
                  
                  
                  443
                  
                  
                  
                  862
                  
                  
                  
                  964Long-term
      balance
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  123





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 February 28, 2010, May 31, 2009 and February 28,
      2009 were 3.8%, 3.5% and 2.5%, respectively.  At February 28,
      2010, $4.4 million was outstanding under this facility, and $5.6 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 $3.0 million
      of the $6.0 million outstanding at February 28, 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. After May 31, 2010, the interest rate reverts back
      to a variable rate. 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 nine months ended February 28, 2010, The
      Company recorded a credit to interest expense of
  $117,000.





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 February 28, 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 and nine months ended February 28, 2010 and 2009 were
approximately 37% for all periods.





The
Company established a valuation allowance of $700,000 during the fiscal year
ended May 31, 2009. As of
February 28, 2010, there has been no change to the valuation allowance
which had previously been provided related to the tax benefit of our available
federal and state Net Operating Losses.


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
May 2009, the Financial Accounting Standards Board (“FASB”) updated its
guidance in ASC 855 (formerly SFAS No. 165) regarding subsequent events,
establishing principles and requirements for subsequent events. In particular,
ASC 855 sets forth the period after the balance sheet date during which
management shall evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements, the circumstances under
which an entity shall recognize events or transactions occurring after the
balance sheet date in its financial statements, and the disclosures that an
entity shall make about events or transactions that occurred after the balance
sheet date. This updated guidance is effective for interim periods ending after
June 15, 2009. The adoption of ASC 855 did not have a material impact on
the Company’s financial condition or results of operation.





In June
2009, the FASB approved the “FASB Accounting Standards Codification”
(“Codification”) as the single source of authoritative, nongovernmental, U.S.
Generally Accepted Accounting Principles (“GAAP”) to be launched on July 1,
2009.  The Codification does not change current U.S. GAAP or how the
Company accounts for its transactions or the nature of related disclosures made;
instead it is intended to simplify user access to all authoritative U.S. GAAP by
providing all the authoritative literature related to a particular topic in one
place.  All existing accounting standard documents will be superseded,
and all other accounting literature not included in the Codification will be
considered non-authoritative.  The Codification is effective for
interim and annual periods ending after September 15, 2009.  The
Codification is effective for the Company beginning with the quarter ended
November 30, 2009 and did not have an impact on its financial condition or
results of operations.





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 results
of operations, financial condition or cash flows.


9


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 is currently evaluating the impact FASB ASU 09-13 will have on our
consolidated financial statements.





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. 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. Excluding the Literacy product line
which was launched in March 2009, the average revenue percentage over the past
two full fiscal years 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
                
                
                29%
                
                
                
                26%
                
                
                
                21%
                
                
                
                24%College
      Preparation
                
                
                66%
                
                
                
                15%
                
                
                
                6%
                
                
                
                13%Total
      Revenue (excluding Literacy revenue)
                
                
                43%
                
                
                
                22%
                
                
                
                15%
                
                
                
                20%




10


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 electronic format, 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.





Test
Preparation, Assessment, and Instruction Product Group





Test Preparation,
Assessment


·
            We
      create and sell print and web-based materials targeted to grades 1-12 to
      help students prepare for state proficiency tests. The Measuring Up®Test Preparation and Assessment print products are sold in 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.





·
            Measuring
      up ePath, a web-based assessment product developed in conjunction with
      Cisco Learning Systems, has been rebranded and is now called ePath Assess
      and is part of a multi-product suite called ePath Knowledge.  ePath
      Knowledge®is
      a series of three, state customized online tools designed to meet unique
      needs of schools and districts.  ePath Assess provides formative
      assessment and ongoing progress-monitoring that allows educators to make
      data-driven decisions. ePath Discovery delivers immediate online
      standards-based instructional intervention for students.  Lastly,
      Practice Path provides an easy-to-use student-based interface for online
      standards and test-based skill building and practice.  The ePath
      Knowledge 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 on particular
      subject areas such as reading comprehension, mathematics problem solving,
      and vocabulary development.  Essential to this strategy is the
      market alignment of the Focused Instruction and Test Preparation and
      Assessment products so that both product lines are suitable for sale to an
      identical customer base with an identical sales force.  We
      continue to sell our backlist remedial 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 literacy publishers. These
material 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 February
28, 2010 vs. Three Months Ended February 28, 2009




(Amounts
      in Thousands - Except Per Share Data)
                    
                    Three
      Months Ended February 28,2010
                    
                    
                    2009RevenueTest
      Preparation, Assessment and Instruction
                    
                    $
                    4,350
                    
                    
                    
                    79.8%
                    
                    
                    $
                    4,398
                    
                    
                    
                    84.5%College
      Preparation
                    
                    
                    521
                    
                    
                    
                    9.6%
                    
                    
                    
                    806
                    
                    
                    
                    15.5%Literacy
                    
                    
                    579
                    
                    
                    
                    10.6%
                    
                    
                    
                    -
                    
                    
                    
                    0.0%Total
      Revenue
                    
                    
                    5,450
                    
                    
                    
                    100.0%
                    
                    
                    
                    5,204
                    
                    
                    
                    100.0%Cost
      of RevenueDirect
      Costs
                    
                    
                    1,809
                    
                    
                    
                    33.2%
                    
                    
                    
                    1,733
                    
                    
                    
                    33.3%Prepublication
      Cost Amortization
                    
                    
                    1,364
                    
                    
                    
                    25.0%
                    
                    
                    
                    1,688
                    
                    
                    
                    32.4%Total
      Cost Of Revenue
                    
                    
                    3,173
                    
                    
                    
                    58.2%
                    
                    
                    
                    3,421
                    
                    
                    
                    65.7%Gross
      Profit
                    
                    
                    2,277
                    
                    
                    
                    41.8%
                    
                    
                    
                    1,783
                    
                    
                    
                    34.3%Selling,
      General and Administrative ExpensesMarketing
      and Selling
                    
                    
                    2,330
                    
                    
                    
                    42.8%
                    
                    
                    
                    2,061
                    
                    
                    
                    39.6%General
      and Administrative
                    
                    
                    1,068
                    
                    
                    
                    19.6%
                    
                    
                    
                    1,085
                    
                    
                    
                    20.8%Total
      Selling, General and Administrative Expenses
                    
                    
                    3,398
                    
                    
                    
                    62.3%
                    
                    
                    
                    3,146
                    
                    
                    
                    60.5%Operating
      Loss
                    
                    
                    (1,121
                    )
                    
                    
                    -20.6%
                    
                    
                    
                    (1,363
                    )
                    
                    
                    -26.2%Other
      Expenses, Net
                    
                    
                    11
                    
                    
                    
                    0.2%
                    
                    
                    
                    2
                    
                    
                    
                    0.0%Interest
      Expense
                    
                    
                    46
                    
                    
                    
                    0.8%
                    
                    
                    
                    126
                    
                    
                    
                    2.4%Loss
      Before Income Tax Benefit
                    
                    
                    (1,178
                    )
                    
                    
                    -21.6%
                    
                    
                    
                    (1,491
                    )
                    
                    
                    -28.7%Income
      Tax Benefit
                    
                    
                    (377
                    )
                    
                    
                    -6.9%
                    
                    
                    
                    (546
                    )
                    
                    
                    -10.5%Net
      Loss
                    
                    $
                    (801
                    )
                    
                    
                    -14.7%
                    
                    
                    $
                    (945
                    )
                    
                    
                    -18.2%Net
      Loss per Common Share:Basic
      and Diluted
                    
                    $
                    (0.18
                    )
                    
                    
                    
                    
                    
                    $
                    (0.21
                    )





Overview





Net
revenue for the quarter was $5.5 million, an increase of 4.7% from the same
period in the prior year.  Test Preparation, Assessment, and
Instruction revenue decreased 1.1% on a year-over-year basis while College
Preparation revenue decreased 35.4%. Revenue for the quarter, generated by our
new Literacy product group was $579,000. Net loss for the quarter was $801,000,
as compared to $945,000 in the prior year.  Basic and diluted loss per
common share for the quarter were ($0.18), compared to ($0.21) for the same
period last year.


12


REVENUE





Test Preparation,
Assessment, and Instruction





Revenue
for this product group for the quarter was $4.4 million, for both the current
and prior year. Test Preparation and Assessment revenue for the quarter was $3.9
million, an increase of 5.2% from the prior year, while Instruction revenue was
$0.4 million, a year-over-year decline of $0.2 million.





College
Preparation





College
Preparation revenue for the quarter was $0.5 million, compared to $0.8 million
during the same period in the prior year.   Revenue from the sale
of products offered from the two major college publishers was $.4 million, a
decline of 38.9% from the prior year.  Revenue from our proprietary
products and other distribution agreements was $73,000, an increase of 5.5% from
the prior year. Revenue for this product group is extremely seasonal;
historically approximately 6% of the annual revenue is derived in the
period.





Literacy





Revenue
for this product group, which was launched in March 2009, was $579,000 for the
quarter. These new products allow us to enter a market niche for which we
previously did not have a product offering. 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 $3.2 million (58.2% of revenue) compared to $3.4
million (65.7% of revenue) during the same period in the prior
year.





Cost of
revenue consists of two components: direct costs and amortization of
prepublication costs.


Direct
costs consist of (1) product cost, which includes paper, printing, and binding
for proprietary print products and product purchases for nonproprietary
products, (2) web-hosting fees for our electronic products, (3) royalties on
proprietary products, and (4) warehousing and shipping costs for all
non-electronic products.





·
            Direct
      costs as a percentage of revenue for the quarter were 33.2%, which was
      comparable to the prior year percentage of
  33.3%.





·
            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 $1.4 million of
      prepublication costs, a decrease of $0.3 million and 19.2% from the prior
      year as a result of lower spending levels over the past three fiscal
      years.





MARKETING
AND SELLING





Marketing
and selling expenses for the quarter were $2.3 million, an increase of $0.3
million and 13.1% from the prior year. The expense as a percent of revenue
increased from 39.6% in the prior year to 42.8% in the current
period.





Marketing
expenses within this category increased $104,000 for the quarter, primarily due
to expenses associated with the Literacy product group which did not exist in
the prior year.   Selling expenses within this category increased
$166,000 from the prior year primarily due to expenses attributed to our
Literacy product group. As a percentage of revenue, the expense increased from
23.8% in the prior year to 25.7%, primarily due to expenses associated with the
Literacy revenue.




13




GENERAL
AND ADMINISTRATIVE





General
and administrative expenses for the quarter were $1.1 million, a decrease of
1.6% on a year-over-year basis.  The decrease is due to overall cost
containment efforts.





INTEREST
EXPENSE





Interest
expense for the quarter was $46,000, compared to $126,000 for the same period in
the prior year.  The change is due to lower average outstanding debt
on a year-over-year basis and lower interest rates.  Included in
interest expense was the fair value adjustment for our swap agreement, which for
the quarter was $38,000 of income, compared to $11,000 of expense during the
same period in the prior year.





Nine Months Ended February
28, 2010 vs. Nine Months Ended February 28, 2009




(Amounts
      in Thousands - Except Per Share Data)
                  
                  Nine
      Months Ended February 28,2010
                  
                  
                  2009RevenueTest
      Preparation, Assessment and Instruction
                  
                  $
                  15,523
                  
                  
                  
                  56.4%
                  
                  
                  $
                  17,140
                  
                  
                  
                  58.1%College
      Preparation
                  
                  
                  10,135
                  
                  
                  
                  36.8%
                  
                  
                  
                  12,341
                  
                  
                  
                  41.9%Literacy
                  
                  
                  1,846
                  
                  
                  
                  6.7%
                  
                  
                  
                  -
                  
                  
                  
                  0.0%Total
      Revenue
                  
                  
                  27,504
                  
                  
                  
                  100.0%
                  
                  
                  
                  29,481
                  
                  
                  
                  100.0%Cost
      of RevenueDirect
      Costs
                  
                  
                  11,950
                  
                  
                  
                  43.4%
                  
                  
                  
                  13,242
                  
                  
                  
                  44.9%Prepublication
      Cost Amortization
                  
                  
                  4,092
                  
                  
                  
                  14.9%
                  
                  
                  
                  5,040
                  
                  
                  
                  17.1%Total
      Cost Of Revenue
                  
                  
                  16,042
                  
                  
                  
                  58.3%
                  
                  
                  
                  18,282
                  
                  
                  
                  62.0%Gross
      Profit
                  
                  
                  11,462
                  
                  
                  
                  41.7%
                  
                  
                  
                  11,199
                  
                  
                  
                  38.0%Selling,
      General and Administrative ExpensesMarketing
      and Selling
                  
                  
                  7,109
                  
                  
                  
                  25.8%
                  
                  
                  
                  6,879
                  
                  
                  
                  23.3%General
      and Administrative
                  
                  
                  3,439
                  
                  
                  
                  12.5%
                  
                  
                  
                  3,487
                  
                  
                  
                  11.8%Total
      Selling, General and Administrative Expenses
                  
                  
                  10,548
                  
                  
                  
                  38.4%
                  
                  
                  
                  10,366
                  
                  
                  
                  35.2%Operating
      Income
                  
                  
                  914
                  
                  
                  
                  3.3%
                  
                  
                  
                  833
                  
                  
                  
                  2.8%Other
      Expenses, Net
                  
                  
                  25
                  
                  
                  
                  0.1%
                  
                  
                  
                  18
                  
                  
                  
                  0.1%Interest
      Expense
                  
                  
                  206
                  
                  
                  
                  0.7%
                  
                  
                  
                  564
                  
                  
                  
                  1.9%Income
      Before Income Tax Expense
                  
                  
                  683
                  
                  
                  
                  2.5%
                  
                  
                  
                  251
                  
                  
                  
                  0.9%Income
      Tax Expense
                  
                  
                  326
                  
                  
                  
                  1.2%
                  
                  
                  
                  93
                  
                  
                  
                  0.3%Net
      Income
                  
                  $
                  357
                  
                  
                  
                  1.3%
                  
                  
                  $
                  158
                  
                  
                  
                  0.5%Net
      Income per Common Share:Basic  and
      Diluted
                  
                  $
                  0.08
                  
                  
                  
                  
                  
                  
                  $
                  0.04




14




Overview





Year to
date net revenue declined 6.7% on a year-over-year basis due to an overall
decline in educational spending, as a result of state and local budgetary
issues.    Test Preparation, Assessment, and Instruction
revenue decreased 9.4% while College Preparation revenue decreased 17.9%. These
declines were offset by $1.8 million of revenue generated by our new Literacy
product offering. Despite the overall shortfall in revenue, we were able to
offset the revenue decline by reducing expenses, resulting in net income for the
period of $357,000, an improvement of $200,000 and 126% over the prior
year.  Basic and diluted earnings per common share for the period were
$0.08, compared to $0.04 in the prior year.





REVENUE





Test Preparation,
Assessment, and Instruction





Revenue
for this product group for the nine months ended February 28, 2010 was $15.5
million, a decline of 9.4% compared to the prior year. Test Preparation and
Assessment revenue for the period was $13.6 million, an 8% decline from the
prior year while Instruction revenue was $1.9 million, a year-over-year decrease
of $0.4 million.





College
Preparation





College
Preparation revenue for the nine month period was $10.1 million, compared to
$12.3 million during the same period in the prior year.  Revenue from
the sale of products offered from the two major college publishers, which
represents more than 90% of the total revenue within this product group, was
$9.5 million, a decline of 18.0% compared to the prior year. Revenue from other
distribution agreements and from our proprietary products was $0.6 million, a
decline of $0.1 million, from the prior year.





Literacy





Revenue
for this product group, which was launched in March 2009, was $1.8 million for
the period. These new products allow us to enter a market niche for which we
previously did not have a product offering. In November 2009, we expanded our
product offering by adding two new series from one of our existing literacy
publishers. We expect to continue growing this product group by adding new
products, initially through additional distribution agreements, and in the
future by in-house development.




COST OF REVENUE





Cost of
revenue for the period was $16.0 million (58.3% of revenue) compared to $18.3
million (62.0% 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 electronic products, (3) royalties on
proprietary products, and (4) warehousing and shipping costs for all
non-electronic products.





·
            Direct
      costs as a percentage of revenue declined from 44.9% in the prior year to
      43.4% in the current year.  The percentage decrease is primarily
      due to revenue mix, as College Preparation revenue for the period
      decreased from 41.9% of the total revenue in the prior year to 36.8% in
      the current year.  College Preparation direct costs are
      substantially higher than the direct cost of our other
      products.




15




·
            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 period, we amortized $4.1 million of prepublication
      costs, a year-over-year decline of $0.9 million due to lower spending
      levels over the past three fiscal
years.





MARKETING
AND SELLING





Marketing
and selling expenses for the period were $7.1 million compared to $6.9 million
during the same period in the prior year. As a percent of revenue, the expense
increased from 23.3% in the prior year to 25.8% in the current
year.





Marketing
expenses within this category increased $259,000 for the period primarily due to
expenses associated with the Literacy product group which did not exist in the
prior year.  Selling expenses within this category decreased $28,000
from the prior year, primarily due to the revenue mix.  As a
percentage of revenue, selling expenses increased from 15.9% in the prior year
to 16.9% due primarily to revenue mix.





GENERAL
AND ADMINISTRATIVE





General
and administrative expenses for the period were $3.4 million, a decrease of 1.4%
over the prior year. The decrease is due to overall cost containment
efforts.





INTEREST
EXPENSE





Interest
expense for the period was $206,000, a decrease of $358,000 compared to the same
period in the prior year.  The decrease is due to lower interest rates
and lower average outstanding debt on a year-over-year
basis.  Included in interest expense was the fair value adjustment for
our swap agreement, which for the period was $117,000 of income, compared to
$36,000 of expense during the same period in the prior year.





LIQUIDITY AND CAPITAL
RESOURCES





Net cash
provided by operating activities for the nine months ended February 28, 2010 was
$6.0 million.  Cash was primarily provided by our net income before
depreciation, amortization and deferred income taxes, as well as decreases in
accounts receivable, inventory and prepaid marketing expenses and an increase in
deferred revenue offset by a decrease in accounts payable and accrued
expenses.





Net cash
used in investing activities was $2.7 million, consisting primarily of
prepublication expenditures of $2.6 million.  Prepublication
expenditures for the period were $1.1 million lower than the prior year. The
decrease 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 $3.3 million, consisting of $1.8 million of net
payments on our revolving line of credit and $1.5 million of payments on our
term loan and capital leases.





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





16





·
            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 February 28, 2010, May 31, 2009 and
      February 28, 2009 were 3.8%, 3.5% and 2.5%, respectively.  At
      February 28, 2010, $4.4 million was outstanding under this facility, and
      $5.6 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 $3.0 million
      of the $6.0 million outstanding at February 28, 2010.  In May
      2007, we entered into a swap agreement to fix the interest rate on a
      portion of the balance of the term loan for three years at a rate of 5.3%
      plus an interest spread of 2.00% to 2.25% based upon our funded debt to
      EBITDA ratio. After May 31, 2010, the interest rate reverts back to a
      variable rate.  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 nine months ended February 28, 2010,
      we have recorded a credit to interest expense of
  $117,000.





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.





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, 2009 Form 10-K.  Some of our
accounting policies require management to exercise significant judgment in
selecting the appropriate assumptions for calculating financial estimates. These
judgments are subject to an inherent degree of uncertainty.  These
judgments are based on our historical experience, known trends in our industry,
terms of existing contracts and other information from outside sources, as
appropriate.  Actual results may differ from these estimates under
different assumptions and conditions.  Certain of the most critical
estimates that require significant judgment are as follows:





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 February
28, 2010, we had a returns valuation allowance of $619,000.  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.




17




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 February 28, 2010, we had an allowance
against this asset of $159,000.  If future net undiscounted cash flows
are not sufficient to realize the net carrying value of the asset, an impairment
charge 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 $40,000 at February 28, 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 $880,000 at
February 28, 2010 is believed to be adequate to cover potential inventory loss
exposure.





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.




18





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 February 28, 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
February 28, 2010.  At February 28, 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
4.  Submission of Matters to a Vote of Security Holders





On
January 14, 2010, the Company held its Annual Meeting of
Stockholders.  At the meeting, the following persons were elected to
the Company's Board of Directors:





Votes
                    For
                  
                  
                  Votes
                    WithheldG.
      Thomas Ahern
                  
                  
                  3,125,608
                  
                  
                  
                  250Brian
      T. Beckwith
                  
                  
                  3,125,608
                  
                  
                  
                  250John
      C. Bergstrom
                  
                  
                  3,125,608
                  
                  
                  
                  250Richard
      J. Casabonne
                  
                  
                  3,125,608
                  
                  
                  
                  250Anton
      J. Christianson
                  
                  
                  3,125,608
                  
                  
                  
                  250James
      P. Dolan
                  
                  
                  3,125,608
                  
                  
                  
                  250Diane
      M. Miller
                  
                  
                  3,125,608
                  
                  
                  
                  250James
      J. Peoples
                  
                  
                  3,125,608
                  
                  
                  
                  250





The
appointment of Rothstein Kass & Company P.C., as the Company’s independent
registered public accounting firm for the fiscal year ending May 31, 2010, was
ratified by the stockholders, with 3,487,626 votes for, 5,500 votes against, and
5,058 votes abstaining.





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.




19





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:  April
      8, 2010
                PEOPLES
      EDUCATIONAL HOLDINGS,
INC.





By: /s/ Brian T.
BeckwithBrian
      T. BeckwithPresident
      and Chief Executive Officer





20