UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





x Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934





For the
quarterly period ended August 31, 2009





 ̈ 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: 4,454,502 shares of Common Stock (par
value $0.02 per share) outstanding on October 2, 2009.










TABLE OF
CONTENTS





PagePART
      I. FINANCIAL
      INFORMATIONItem
      1:
                                          Financial
      Statements:Condensed
      Consolidated Balance Sheets as of August 31, 2009 (Unaudited) and May 31,
      2009 and August 31, 2008 (Unaudited)
                                          3Condensed
      Consolidated Statements of Income for the Three Months Ended August 31,
      2009 and 2008 (Unaudited)
                                          4Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended August
      31, 2009 and 2008 (Unaudited)
                                          5Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                                          6Item
      2:
                                          Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                          9Item
      4:
                                          Controls
      and Procedures
                                          16PART
      II. OTHER
      INFORMATIONItem
      1:
                                          Legal
      Proceedings
                                          17Item
      2:
                                          Unregistered
      Sales of Equity Securities and Use of Proceeds
                                          17Item
      3:
                                          Defaults
      Upon Senior Securities
                                          17Item
      4:
                                          Submission
      of Matters to a Vote of Security Holders
                                          17Item
      5:
                                          Other
      Information
                                          17Item
      6:
                                          Exhibits
                                          17SIGNATURES
                                          18EXHIBITS
                                          19





2




Part I


Financial
Information





Item
1. Financial Statements





PEOPLES
EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS





UNAUDITED
                                            
                                            
                                            
                                            
                                            
                                            UNAUDITED(In Thousands-Except Share Data)
                                            
                                            August 31, 2009
                                            
                                            
                                            May 31, 2009
                                            
                                            
                                            August 31, 2008ASSETSCurrent AssetsCash
      and Cash Equivalents
                                            
                                            $
                                            102
                                            
                                            
                                            $
                                            42
                                            
                                            
                                            $
                                            71Accounts
      Receivable Net of Allowances for Doubtful Accounts and
      Returns
                                            
                                            
                                            6,531
                                            
                                            
                                            
                                            2,842
                                            
                                            
                                            
                                            7,786Inventory
                                            
                                            
                                            3,887
                                            
                                            
                                            
                                            4,219
                                            
                                            
                                            
                                            3,946Prepaid
      Expenses and Other
                                            
                                            
                                            355
                                            
                                            
                                            
                                            323
                                            
                                            
                                            
                                            327Prepaid
      Marketing Expenses
                                            
                                            
                                            878
                                            
                                            
                                            
                                            862
                                            
                                            
                                            
                                            1,103Deferred
      Income Taxes
                                            
                                            
                                            827
                                            
                                            
                                            
                                            1,092
                                            
                                            
                                            
                                            802Total
      Current Assets
                                            
                                            
                                            12,580
                                            
                                            
                                            
                                            9,380
                                            
                                            
                                            
                                            14,035Equipment
      - At Cost, Less Accumulated Depreciation of $2,301, $2,241 and $2,070,
      respectively
                                            
                                            
                                            347
                                            
                                            
                                            
                                            387
                                            
                                            
                                            
                                            551Other AssetsDeferred
      Prepublication Costs, Net
                                            
                                            
                                            12,800
                                            
                                            
                                            
                                            13,466
                                            
                                            
                                            
                                            14,857Deferred
      Income Taxes
                                            
                                            
                                            412
                                            
                                            
                                            
                                            1,006
                                            
                                            
                                            
                                            976Trademarks,
      Net
                                            
                                            
                                            185
                                            
                                            
                                            
                                            170
                                            
                                            
                                            
                                            189Prepaid
      Expenses and Other
                                            
                                            
                                            250
                                            
                                            
                                            
                                            273
                                            
                                            
                                            
                                            299Prepaid
      Marketing Expenses
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            371Total
      Other Assets
                                            
                                            
                                            13,647
                                            
                                            
                                            
                                            14,915
                                            
                                            
                                            
                                            16,692Total Assets
                                            
                                            $
                                            26,574
                                            
                                            
                                            $
                                            24,682
                                            
                                            
                                            $
                                            31,278LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent LiabilitiesCurrent
      Maturities of Long Term Obligations
                                            
                                            $
                                            2,023
                                            
                                            
                                            $
                                            2,034
                                            
                                            
                                            $
                                            2,043Accounts
      Payable
                                            
                                            
                                            7,829
                                            
                                            
                                            
                                            3,998
                                            
                                            
                                            
                                            10,387Accrued
      Compensation
                                            
                                            
                                            326
                                            
                                            
                                            
                                            170
                                            
                                            
                                            
                                            363Other
      Accrued Expenses
                                            
                                            
                                            1,040
                                            
                                            
                                            
                                            855
                                            
                                            
                                            
                                            360Deferred
      Revenue
                                            
                                            
                                            259
                                            
                                            
                                            
                                            278
                                            
                                            
                                            
                                            526Total
      Current Liabilities
                                            
                                            
                                            11,477
                                            
                                            
                                            
                                            7,335
                                            
                                            
                                            
                                            13,679Long
      Term Obligations, Less Current Maturities
                                            
                                            
                                            8,122
                                            
                                            
                                            
                                            11,854
                                            
                                            
                                            
                                            9,708Total Liabilities
                                            
                                            
                                            19,599
                                            
                                            
                                            
                                            19,189
                                            
                                            
                                            
                                            23,387Stockholders' EquityPreferred
      Stock, authorized 1,500,000 shares; none issuedCommon
      Stock, $0.02 par value; authorized 8,500,000 shares; issued:4,478,434,
      4,478,434 and 4,470,734  shares, respectively
                                            
                                            
                                            90
                                            
                                            
                                            
                                            90
                                            
                                            
                                            
                                            89Additional
      Paid In Capital
                                            
                                            
                                            8,080
                                            
                                            
                                            
                                            8,060
                                            
                                            
                                            
                                            8,024Accumulated
      Deficit
                                            
                                            
                                            (1,131
                                            )
                                            
                                            
                                            (2,593
                                            )
                                            
                                            
                                            (158
                                            )Treasury
      Stock - 16,232 shares, at cost
                                            
                                            
                                            (64
                                            )
                                            
                                            
                                            (64
                                            )
                                            
                                            
                                            (64
                                            )Total Stockholders' Equity
                                            
                                            
                                            6,975
                                            
                                            
                                            
                                            5,493
                                            
                                            
                                            
                                            7,891Total Liabilities and Stockholders'
      Equity
                                            
                                            $
                                            26,574
                                            
                                            
                                            $
                                            24,682
                                            
                                            
                                            $
                                            31,278





See Notes
to Condensed Consolidated Financial Statements





3




PEOPLES
EDUCATIONAL HOLDINGS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)





(In
Thousands, Except Per Share Data)





Three
      Months EndedAugust
      31,2009
                  
                  
                  2008Revenue,
      Net
                  
                  $
                  14,749
                  
                  
                  $
                  15,997Cost
      of RevenueDirect
      Costs
                  
                  
                  7,413
                  
                  
                  
                  8,407Prepublication
      Cost Amortization
                  
                  
                  1,400
                  
                  
                  
                  1,658Total
                  
                  
                  8,813
                  
                  
                  
                  10,065Gross
      Profit
                  
                  
                  5,936
                  
                  
                  
                  5,932Selling,
      General and Administrative Expenses
                  
                  
                  3,511
                  
                  
                  
                  3,590Income
      from Operations
                  
                  
                  2,425
                  
                  
                  
                  2,342Other
      Expenses, Net
                  
                  
                  10
                  
                  
                  
                  8Interest
      Expense
                  
                  
                  94
                  
                  
                  
                  228Income
      Before Income Taxes
                  
                  
                  2,321
                  
                  
                  
                  2,106Income
      Tax Expense
                  
                  
                  859
                  
                  
                  
                  782Net
      Income
                  
                  $
                  1,462
                  
                  
                  $
                  1,324Net
      Income per Common Share:Basic
      and Diluted
                  
                  $
                  0.33
                  
                  
                  $
                  0.30Weighted-average
      Number of Common Shares Outstanding:Basic
      and Diluted
                  
                  
                  4,462
                  
                  
                  
                  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)
                            
                            Three
      Months EndedAugust
      31,2009
                            
                            
                            2008Cash
      Flows From Operating ActivitiesNet
      Income
                            
                            $
                            1,462
                            
                            
                            $
                            1,324Adjustments
      to Reconcile Net Income to Net Cash Provided
      by Operating ActivitiesDepreciation
                            
                            
                            60
                            
                            
                            
                            76Amortization
      of Prepublication Costs and Intangible Assets
                            
                            
                            1,403
                            
                            
                            
                            1,661Stock-Based
      Compensation
                            
                            
                            20
                            
                            
                            
                            11Market
      Value Adjustment of Interest Rate Swap
                            
                            
                            (39
                            )
                            
                            
                            (12
                            )Deferred
      Income Taxes
                            
                            
                            859
                            
                            
                            
                            782Changes
      in Operating Assets and LiabilitiesAccounts
      Receivable
                            
                            
                            (3,689
                            )
                            
                            
                            (4,122
                            )Inventory
                            
                            
                            332
                            
                            
                            
                            448Prepaid
      Expenses and Other
                            
                            
                            (9
                            )
                            
                            
                            41Prepaid
      Marketing Expenses
                            
                            
                            (16
                            )
                            
                            
                            (150
                            )Accounts
      Payable and Accrued Expenses
                            
                            
                            4,172
                            
                            
                            
                            5,610Deferred
      Revenue
                            
                            
                            (19
                            )
                            
                            
                            51Net
      Cash Provided By Operating Activities
                            
                            
                            4,536
                            
                            
                            
                            5,720Cash
      Flows From Investing ActivitiesPurchases
      of Equipment
                            
                            
                            (20
                            )
                            
                            
                            (61
                            )Expenditures
      for Intangibles
                            
                            
                            (18
                            )
                            
                            
                            (1
                            )Expenditures
      for Prepublication Costs
                            
                            
                            (734
                            )
                            
                            
                            (1,315
                            )Net
      Cash Used In Investing Activities
                            
                            
                            (772
                            )
                            
                            
                            (1,377
                            )Cash
      Flows From Financing ActivitiesNet
      Payments Under Line of Credit
                            
                            
                            (3,193
                            )
                            
                            
                            (3,815
                            )Principal
      Payments On Long-Term Debt
                            
                            
                            (511
                            )
                            
                            
                            (510
                            )Net
      Cash Used In Financing Activities
                            
                            
                            (3,704
                            )
                            
                            
                            (4,325
                            )Net
      Increase in Cash and Cash Equivalents
                            
                            
                            60
                            
                            
                            
                            18Cash
      and Cash EquivalentsBeginning
      of Period
                            
                            
                            42
                            
                            
                            
                            53End
      of Period
                            
                            $
                            102
                            
                            
                            $
                            71Supplemental
      Cash Flow InformationCash
      Payments for:Interest
                            
                            $
                            139
                            
                            
                            $
                            212




See Notes
to Condensed Consolidated Financial Statements




5





Peoples
Educational Holdings, Inc., and Subsidiary


Notes
to Condensed Consolidated Financial Statements (UNAUDITED)





NOTE
1 - Basis of Presentation


Nature of
business:Peoples
Educational Holdings, Inc. (PEH), through its wholly owned subsidiary, Peoples
Education, Inc. (PE), publishes and markets its own supplementary educational
textbooks and materials for the K –12 school market. The materials are
predominantly state-specific and standards-based, focused on state-required
tests.  PE distributes other publishers’ college textbooks and
supplements to the high school Advanced Placement market. In addition, PE also
publishes its own proprietary supplemental material for the Advanced Placement
market.  Marketing channels include direct and commission sales
representatives, telemarketing, direct mail, and catalogs. PE and PEH are
together referred to herein as the Company.





The
accompanying condensed consolidated financial statements have been prepared by
the Company without audit and in accordance with the 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 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 financial statements,
management has evaluated subsequent events through October 2, 2009. The
operating results for the three month period ended August 31, 2009, are not
necessarily indicative of the operating results to be expected for the full
fiscal year. Accordingly, these 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.





Management
is required to make certain estimates and assumptions which affect the amounts
of assets, liabilities, revenue and expenses we have reported and our disclosure
of contingent assets and liabilities at the date of the 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 allowances
for returns as of August 31, 2009, May 31, 2009 and August 31, 2008 were
approximately $803,000, $520,000 and $960,000, respectively. 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 statements of
income.  The Company recognizes subscription based revenue on its
Measuring Up e-Path® prorata over the life of the agreement.




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 review of all outstanding amounts on a
monthly basis.  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.





NOTE
3 – Basic and Diluted Per Share Amounts


Basic per
share amounts are computed, generally, by dividing net income by the weighted
average number of common shares outstanding.  Diluted per share
amounts assume the conversion, exercise or issuance of all potential common
stock instruments, unless their effect is anti-dilutive thereby reducing the
loss or increasing the income per common share.  In calculating
diluted weighted average shares and per share amounts, the Company included
stock options with exercise prices below average market prices, for the
respective reporting periods in which they were dilutive, using the treasury
stock method.  The number of additional shares was calculated by
assuming the outstanding stock options were exercised and that
the proceeds from such exercises were used to acquire common stock at the
average market price during the reporting period.  The weighted
average common shares outstanding included no shares of common stock equivalents
for the three months ended August 31, 2009 and 2008, as all outstanding option
shares are antidilutive.




6




Peoples
Educational Holdings, Inc., and Subsidiary
 Notes
to Condensed Consolidated Financial Statements (UNAUDITED)




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)August 31,
                    
                    
                    May 31,
                    
                    
                    August 31,2009
                    
                    
                    2009
                    
                    
                    2008Balances,
      Beginning
                    
                    $
                    13,466
                    
                    
                    $
                    15,200
                    
                    
                    $
                    15,200Prepublication
      Cost Additions
                    
                    
                    734
                    
                    
                    
                    4,821
                    
                    
                    
                    1,315Amortization
      Expense
                    
                    
                    (1,400
                    )
                    
                    
                    (6,555
                    )
                    
                    
                    (1,658
                    )Balances,
      Ending
                    
                    $
                    12,800
                    
                    
                    $
                    13,466
                    
                    
                    $
                    14,857





The
estimated future amortization expense over the next five years as related to the
above deferred prepublication costs is as follows:





For
      the remainder of fiscal 2010
                  
                  $
                  3,939For
      the year ended May 31, 2011
                  
                  
                  4,214For
      the year ended May 31, 2012
                  
                  
                  2,682For
      the year ended May 31, 2013
                  
                  
                  1,278For
      the year ended May 31, 2014 and thereafter
                  
                  
                  687$
                  12,800





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 over the current year and are expensed as they are
distributed.  Prepaid marketing expenses include samples, catalogs and
promotional materials.





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





(In Thousands)August 31,
                  
                  
                  May 31,
                  
                  
                  August 31,2009
                  
                  
                  2009
                  
                  
                  2008Total
      Prepaid Balance
                  
                  $
                  878
                  
                  
                  $
                  862
                  
                  
                  $
                  1,474Less
      current portion
                  
                  
                  878
                  
                  
                  
                  862
                  
                  
                  
                  1,103Long-term
      balance
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  371





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.





7


Peoples
Educational Holdings, Inc., and Subsidiary


Notes
to Condensed Consolidated Financial Statements (UNAUDITED)




·
            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 ranges 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 funded debt to EBITDA.  At August 31, 2009, $3.0
      million was outstanding under this facility and $7.0 million was available
      for borrowing.





·
            The
      term loan was originally 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
      $3.5 million of the $7 million outstanding.  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 funded debt to
      EBITDA ratio. After the three year period, the interest rate reverts back
      to a variable rate.





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





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 quarters ended August 31, 2009 and 2008 were approximately 37% and 40%,
respectively.





The
Company established a valuation allowance of $700,000 during fiscal year ending
May 31, 2009. As of
August 31, 2009, there has been no change to the valuation allowance which had
previously been provided in the amount of $700,000 related to the tax benefit of
our available federal and state Net Operating Losses (NOLs). 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.





NOTE
8 – Recently Issued Accounting Standards


In
May 2009, the FASB issued SFAS No. 165, “Subsequent Events”. The provisions
of SFAS No. 165  set forth the period after the balance sheet date
during which management should evaluate events or transactions that may have
occurred for potential recognition or disclosure in the financial statements,
the circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements and the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. It is effective for interim and annual
periods ending after June 15, 2009. The adoption of FAS 165 did not have a
material impact on the Company’s financial condition or results of
operation.


8




Peoples
Educational Holdings, Inc., and Subsidiary


Notes
to Condensed Consolidated Financial Statements (UNAUDITED)





In June
2009, the FASB issued FAS 167, Amendments to FASB Interpretation No. 46(R). FAS
167 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 FAS 167 to have an impact on the Company’s results
of operations, financial condition or cash flows.




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 market, (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
supplementary 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.




9





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 Product Revenue)
                
                
                43
                %
                
                
                22
                %
                
                
                15
                %
                
                
                20
                %





PRODUCT
OVERVIEW





We
develop and sell our own proprietary products and distribute other publishers’
products. Our products are organized in three product groups, Test Preparation,
Assessment, and Instruction, College Preparation and Literacy. The Test
Preparation, Assessment, and Instruction materials are almost exclusively
proprietary products; Literacy materials are exclusively distributed products
while the College Preparation materials are mainly distributed products
accompanied by a limited number of proprietary titles.





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 twelve
      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 e-Path®, a
      web-based assessment product developed in conjunction with Cisco Learning
      Systems, provides schools and districts the ability to provide formative
      classroom level assessments, which, in turn, allows for informed
      instruction relative to state standards. Measuring Up e-Path®
      delivers a detailed prescriptive instructional path for individual
      students tied into our instructional materials or to other products in use
      within a school or district. The strategy is to help educators assess a
      child’s strengths and weaknesses relative to the state standards and then
      provide a Personal Prescriptive Path®
      for remediation. The assessment data can be aggregated using
      NCLB-compliant reporting at the class, school and district level and can
      be used to drive not only student learning, but teacher professional
      development as well.





Instruction


·
            We
      have two product lines within this grouping: Focused Instruction and
      remedial, multicultural  and professional development 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, multicultural and professional development 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 though 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.





10




Literacy
Product Group





·
            In
      March 2009 we entered into exclusive sales and distribution agreements
      within the United States for specific products from three 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 August
31, 2009 vs. Three Months Ended August 31, 2008




(Amounts in Thousands - Except Per Share Data)
                    
                    Three Months Ended August 31,2009
                    
                    
                    2008RevenueTest
      Preparation, Assessment and Instruction
                    
                    $
                    6,267
                    
                    
                    
                    42.5
                    %
                    
                    $
                    6,651
                    
                    
                    
                    41.6
                    %College
      Preparation
                    
                    
                    7,621
                    
                    
                    
                    51.7
                    %
                    
                    
                    9,346
                    
                    
                    
                    58.4
                    %Literacy
                    
                    
                    861
                    
                    
                    
                    5.8
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %Total
      Revenue
                    
                    
                    14,749
                    
                    
                    
                    100.0
                    %
                    
                    
                    15,997
                    
                    
                    
                    100.0
                    %Cost
      of RevenueDirect
      Costs
                    
                    
                    7,413
                    
                    
                    
                    50.3
                    %
                    
                    
                    8,407
                    
                    
                    
                    52.6
                    %Prepublication
      Cost Amortization
                    
                    
                    1,400
                    
                    
                    
                    9.5
                    %
                    
                    
                    1,658
                    
                    
                    
                    10.4
                    %Total
      Cost Of Revenue
                    
                    
                    8,813
                    
                    
                    
                    59.8
                    %
                    
                    
                    10,065
                    
                    
                    
                    62.9
                    %Gross
      Profit
                    
                    
                    5,936
                    
                    
                    
                    40.2
                    %
                    
                    
                    5,932
                    
                    
                    
                    37.1
                    %Selling,
      General and Administrative ExpensesMarketing
      and Selling
                    
                    
                    2,283
                    
                    
                    
                    15.5
                    %
                    
                    
                    2,246
                    
                    
                    
                    14.0
                    %General
      and Administrative
                    
                    
                    1,228
                    
                    
                    
                    8.3
                    %
                    
                    
                    1,344
                    
                    
                    
                    8.4
                    %Total
      Selling, General and Administrative Expenses
                    
                    
                    3,511
                    
                    
                    
                    23.8
                    %
                    
                    
                    3,590
                    
                    
                    
                    22.4
                    %Operating
      Income
                    
                    
                    2,425
                    
                    
                    
                    16.4
                    %
                    
                    
                    2,342
                    
                    
                    
                    14.6
                    %Other
      Expenses, Net
                    
                    
                    10
                    
                    
                    
                    0.1
                    %
                    
                    
                    8
                    
                    
                    
                    0.1
                    %Interest
      Expense
                    
                    
                    94
                    
                    
                    
                    0.6
                    %
                    
                    
                    228
                    
                    
                    
                    1.4
                    %Income
      Before Taxes
                    
                    
                    2,321
                    
                    
                    
                    15.7
                    %
                    
                    
                    2,106
                    
                    
                    
                    13.2
                    %Income
      Tax Expense
                    
                    
                    859
                    
                    
                    
                    5.8
                    %
                    
                    
                    782
                    
                    
                    
                    4.9
                    %Net
      Income
                    
                    $
                    1,462
                    
                    
                    
                    9.9
                    %
                    
                    $
                    1,324
                    
                    
                    
                    8.3
                    %Net
      Income per Common Share:Basic
      and Diluted
                    
                    $
                    0.33
                    
                    
                    
                    
                    
                    
                    $
                    0.30




Overview





The
quarter ended August 31, 2009 was a challenging one. Due to economic conditions
and the current status of state and federal economies, many schools are reacting
to budgetary pressures and have been holding back or delaying
orders.  These circumstances have had an adverse impact on our revenue
for the period.  Net revenue for the quarter was $14.7 million, a
decline of 7.8% from the same period in the prior year.  Test
Preparation, Assessment, and Instruction revenue decreased 5.8% on a
year-over-year basis while College Preparation revenue decreased 18.5%. Revenue
from our new Literacy product offering was $861,000 for the quarter. Despite the
overall shortfall in revenue, we were able to offset the revenue decline by
reducing expenses, resulting in net income for the quarter of $1.5 million, an
increase of 10.4% over the prior year.  Basic and diluted earnings per
common share for the quarter were $0.33, compared to $0.30 for the same period
last year.


12




REVENUE





Test Preparation,
Assessment, and Instruction





Revenue
for this product group for the quarter was $6.3 million, compared to $6.7
million during the same period in the prior year. Test Preparation and
Assessment revenue for the quarter was $5.3 million, a decrease of 7.2% from the
prior year, while Instruction revenue was $1.0 million, an increase of 2.5% on a
year-over-year basis.





College
Preparation





College
Preparation revenue for the quarter was $7.6 million, compared to $9.3 million
during the same period in the prior year.  Total revenue within this
group, was down 18.5%, primarily due to the current economic conditions, as
schools are holding back or delaying purchase orders. Revenue from the sale of
products offered from the two major college publishers was $7.2 million,
compared to $8.8 million for the prior year.  Revenue for this product
group is extremely seasonal; as historically over 60% of the annual revenue is
derived in the three months ended August 31.





Literacy





Revenue
for this product group, which was started in March 2009, was $861,000 for the
quarter. We feel that these new products allow us to enter a market niche for
which we previously did not have a product offering. We anticipate growing the
number of products within this group initially through additional distribution
agreements and in the future by in-house development.




COST OF REVENUE





Cost of
Revenue for the quarter was $8.8 million (59.8% of revenue) compared to $10.1
million (62.9% 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, binding, and
prepress costs for proprietary products and product purchases for nonproprietary
products, (2) royalties and (3) warehousing and shipping costs.





·
            Direct
      costs as a percentage of revenue were 50.3% for the quarter compared to
      52.5% during the same period in the prior year.  The percentage
      decrease is due to revenue mix, as College Preparation revenue decreased
      from 58.4% of the total revenue in the prior year, to 51.7% in the current
      year.  College Preparation direct costs are substantially higher
      than the direct cost of our other
products.





·
            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, which decreased from $1.7 million in the prior year due to lower
      spending levels over the past two fiscal
years.





13




MARKETING
AND SELLING





Marketing
and Selling expenses for the quarter were $2.3 million, representing an increase
of $37,000 from the same period in the prior year. As a percentage of revenue,
the expense increased from 14.0% in the prior year to 15.5% in the current
period. Marketing expenses within this category increased $80,000 for the
quarter primarily due to expenses associated with our Literacy product line
which did not exist in the prior year.   Selling expenses within
this category decreased $44,000 for the quarter compared to the prior year, but
increased as a percentage of revenue from 11.4% in the prior year to 12.1% for
the current year due to the revenue decline.





GENERAL
AND ADMINISTRATIVE





General
and administrative expenses decreased $116,000 or 8.6% for the quarter compared
to the same period in the prior year as we continue to maintain tight control
over expenses.





INTEREST
EXPENSE





Interest
expense for the quarter was $94,000, compared to $228,000 for the same period in
the prior year.  The change primarily is due to 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
quarter was $39,000 of income, compared to $12,000 of income during the same
period in the prior year.





LIQUIDITY AND CAPITAL
RESOURCES





Net cash
provided by operating activities for the quarter ended August 31, 2009 was $4.5
million.  Cash was primarily provided by our net income before
depreciation, amortization and deferred income taxes, as well as a decrease in
inventory and an increase in accounts payable and accrued expenses, offset by an
increase in accounts receivable. Accounts receivable and accounts payable
increased, while inventory decreased, due to the cyclical nature of our
revenues.





Net cash
used in investing activities was $0.8 million, consisting primarily of
prepublication cost expenditures of $0.7 million.  Prepublication
expenditures for the quarter decreased $0.6 million, or 44% compared to the same
period in 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 $3.7 million, consisting of $3.2 million of net
payments on our revolving line of credit and $0.5 million of payments on our
term loan and capital lease obligations.





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.





·
            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 ranges 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
      our total funded debt to EBITDA.  At August 31, 2009, $3.0
      million was outstanding under this facility, and $7.0 million was
      available for borrowing.





·
            The
      term loan was originally 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
      $3.5 million of the $7 million outstanding at August 31,
      2009.  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 the three year period, 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 quarter ended
      August 31, 2009, we have recorded a credit to interest expense of
      $39,000.





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.


14




We use
our cash and borrowing availability under our financing arrangements, together
with cash generated from operations, to meet our cash needs.  We
believe that our borrowing capacity together with our existing sources of cash
will be sufficient to meet our anticipated cash needs for the balance of the
fiscal year.  We intend to continue investing in prepublication costs
for our proprietary products, using cash generated from operations, and
borrowings under financing arrangements.  As we develop more products,
additional investments in inventory will be required.





OFF-BALANCE
SHEET ARRANGEMENTS





None.





CRITICAL
ACCOUNTING POLICIES AND SIGNIFICANT ESTIMATES





The
Company’s 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
policies that require significant judgment are as follows:





Revenue
Recognition and Allowance for Returns


Revenue
is recognized when products are shipped, the customer takes title and assumes
risk of loss, and collection of the related receivable is probable. On August
31, 2009, we had a returns valuation allowance of $803,000.  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 Measuring Up e-Path® products is recognized
prorata over the life of the agreement.





Deferred
Prepublication Costs


Deferred
prepublication costs are recorded at their original cost and amortized over a
three or five-year period, based on the estimated lives of the related
publications.  The net carrying value of the deferred prepublication
costs is periodically reviewed and compared to an estimate of future net
undiscounted cash flows.  On August 31, 2009, 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 review of all outstanding amounts on a monthly basis. 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 August 31, 2009 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 $689,000 at
August 31, 2009 is believed to be adequate to cover potential inventory loss
exposure.




15





Income
Taxes


We
recognize deferred tax assets and liabilities based on the differences between
the financial statements carrying amounts and the tax basis of assets and
liabilities. We provide a valuation allowance for deferred tax assets if we
determine, based on the weight of available evidence, that it is more likely
than not that some or all of the deferred tax assets will not be realized. As of
May 31, 2009, a valuation allowance has been provided in the amount of $700,000
related to the tax benefit of our available federal and state Net Operating
Losses (NOLs). The carrying value of the net deferred tax asset assumes that we
will be able to generate sufficient taxable income in the future. We perform a
comprehensive tax review quarterly and if future levels of taxable income are
not sufficient or fail to materialize in the near term, management will adjust
the valuation allowance accordingly.





Item
4.  Controls and Procedures





Evaluation
of Disclosure Controls and Procedures


Under the
supervision and with the participation of our Chief Executive Officer and our
Chief Financial Officer, we conducted an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange
Act of 1934 (the “Exchange Act”)), as of the end of the period covered by this
Quarterly Report on Form 10-Q (the “Evaluation Date”).




The
purpose of this evaluation is to determine if, as of the Evaluation Date, our
disclosure controls and procedures were operating effectively such that the
information relating to the Company, required to be disclosed in our Securities
and Exchange Commissions (“SEC”) reports (i) was recorded, processed,
summarized and reported within the time periods specified in SEC rules and
forms, and (ii) was accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required
disclosures.




Based on
this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that, as of the Evaluation Date, our disclosure controls and
procedures were operating effectively.





Changes
in Internal Control over Financial Reporting


During
the fiscal quarter covered by this report, there has been no change in our
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.





16





PART
II


OTHER
INFORMATION





Item
1.  Legal Proceedings





None.





Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds





During
the three months ended August 31, 2009, we did not issue any securities without
registration under the Securities Act of 1933.





In
      October 2005, our Board of Directors approved a share repurchase program,
      permitting us to repurchase up to 100,000 shares of our common
      stock.  We did not repurchase any shares during the three months
      ended August 31, 2009.  At August 31, 2009, 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





None.





Item
5.  Other Information





None.





Item
6.  Exhibits





Exhibit
      31.1
            CEO
      Certification pursuant to Rule
13a-14(a).





Exhibit
      31.2
            CFO
      Certification pursuant to Rule
13a-14(a).





Exhibit
      32
            Certification
      of the CEO and the CFO pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.





17





SIGNATURES





In
accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.





Dated:   October
      6, 2009
                      PEOPLES
      EDUCATIONAL HOLDINGS, INC.By: /s/ Brian T. BeckwithBrian
      T. BeckwithPresident
      and Chief Executive
Officer


18