Educational Development Corporation (EDUC) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Educational Development Corporation First Quarter 2018 Results Call. At this time all participants are in a listen only mode. [Operator Instructions] I'd now like to turn the conference over to Randall White, Chief Executive Officer. Please go ahead.

Hey, welcome, guys. Glad you could join us on the call today. We have some nice results to report. So I think we'll just start by turning over to Dan O'Keefe, our new CFO, to give you an update on the quarter, and then I'll come back and we'll have some more questions. Dan?

Thank you, Randall. Just a quick review of our financial performance for the quarter in comparison to the same quarter a year ago ended 5/31/2016. Revenue for our first quarter of fiscal year '18 was 26,930,800 compared to 22,784,200 a year ago or a growth of 4,146,600 or 18.2% growth for the quarter. Gross margin for the quarter was 19,506,000 compared to 16,110,400 for the same quarter a year ago or a growth of 3,395,600 or 21.1%. Our total selling and operating expenses for the quarter totaled 17,615,500 for the quarter compared with 15,261,100 for the same quarter last year, a growth of 2,354,400 or 15.4%. And earnings before taxes were 1,982,200 compared to 1,004,600 or a growth of 977,600 or 97.3% growth in earnings before taxes. Net earnings after taxes for the quarter were 1,225,300 for the quarter compared with last year's net earnings after taxes of 620,200, a growth of 605,100 or 97.6% growth over last year's same quarter. Earnings per share on a fully diluted basis for the quarter were $0.30 compared with the same quarter last year of $0.15, which was a $0.15 share growth from last year or 100% growth from last year. This concludes the summary of the earnings changes from the same quarter a year ago, and I will pass the call back over to Randall White, our CEO.

Thanks, Dan. As a note here, we also have in the room available for questions are Heather Cobb, our Vice President of UBAM division; and Craig White, who is our Vice President of Information Technology. Well, it's really nice to have those kind of earnings. I've been talking for a while that we've experienced explosive growth, and it's really nice to see the earnings start to follow. I have kind of been predicting that for quite some time, but it's really nice to actually see it in black and white. The growth, of course, is driven by our UBAM division, and it is continuing to grow in consultants, and that's primarily due to a couple of things. We think we have the best direct selling company in the country, and the demand for our products is seemingly insatiable. We went through a retail fall and weathered it because our products are superior. And, again, the leadership in that division, and overall, our impression is it's been incredible growth, nice to see it continuing. I tell you -- I'll tell you again, the headcount on consultants is a soft number because we know when they start. They sign an agreement, they pay us for a kit, but we don't know when they stop and we don't know if they stop. Sometimes, people stop for a while and keep going, start up again, but we go and make a sweep every month and it's only -- we only report active if they've been in action for the past six months. It doesn't mean they've gone because sometimes -- I mean, this is a volunteer army, and so they can come and go as they wish because it's all commission-based. But our consultant headcount increased to 27,600 at the end of May, and we have experienced a significant growth since the end of the quarter. In June, we decided to run a special to entice new consultants. We haven't done that in two years because we haven't needed to. We've struggled to just handle our growth so why try to increase that headcount, but we did because the fall was a little tough on people and people said, listen, give us something to be excited about. They call it a reason to ring. And so the regular kit was $75, which is not exactly life changing, but we put out a special, a little bit smaller kit, but it's for $50. And that, again, gave our consultants a reason to ring. They call up, say, oh my gosh, we haven't had a special in two years. You better do this now. And actually, we signed 6,330 new consultants in the month, 1,500 of them on the last day. It was quite an influx of new recruits. Now, again, why is our headcount not up that much? Because we sweep. Again, if you haven't sold anything, we don't count you as active. So the headcount didn't go up 6,000, it went up a couple of thousand. This growth, though, in headcount consultants is really exciting and gives us a lot of confidence as we go forward, that we can keep our growth going that, historically, we've experienced -- historically, in the last couple of years. Our first quarter really showed a significant increase in profits over prior quarters. Now I've been alluding to that for a while, that it's a struggle to go from $35 million to $100 million in two years and it takes a lot of different technology and we've installed it, and I wish you could plug like a light bulb or like a lamp. You plug it in and turn it on and it works. It doesn't. It's not quite that simple. I'm sure most of you guys know that. But it's a constant upgrade. It's a constant training issue. We had a meeting yesterday to work out things. But that technology that we've installed, we think, will put us in a position to do $200 million this year. I'm not forecasting $200 million. I'm just telling you, we're trying to put the base in place to be able to handle that kind of business. Now our -- the reason our profits increased, I alluded to it on the last call, the -- as you buy in volume, your cost goes down in [indiscernible] cost, because we're seeing significant reduction in our cost of goods because of the volume buying, and that's about half of it. The other half is the increased productivity and reduction in our cost in the operations and warehouse. So we're excited about that because those are sustainable, ongoing and we think will get better. We haven't really benefited entirely from the amount of technology that is put in place. Literally, it's a day by day improvement. And this past week, we made improvements on the way the products are shipped and the way they're picked and handled. So we have significant -- well, we have room for improvement, I think, significant, in earnings from the warehouse. So this 100% increase in our earnings in the quarter is not a fluke. There's no onetime that we've taken benefit from, so I think that we have things in place that will allow us to reach the volumes that we think will happen and do it efficiently. We're continuing to make these improvements and investments. It really is a challenge, guys, to handle this kind of volume of business, but we have some great partners. UPS is a great partner to us. They have people in here every week trying to help us because they're in every warehouse in America. And they'll see something, recommend something, then we go out and shop, so to speak, with vendors to find the most efficient way to install that for ourselves. And in one year, if you could just see what's happened in -- the difference in this place in one year, it's amazing. But again, you can't do things the same way that you did when you were doing $35 million, when you're trying to do $200 million. So we're excited about that. It's an ongoing basis. We have -- you probably noticed, we signed our agreement, a loan agreement extension, right, Dan, do you want to?

We extended our line of credit with MidFirst, our lender, primary lender, and also executed an advancing term loan to help us finance the capital improvements that we're making this second quarter, and actually, we started in the first quarter with capital improvements to our warehouse to increase our operational capacity -- daily shipping capacity.

So they were out a couple of weeks ago, and I think there were no questions. They were very pleased with what they saw. It's nice to have good relationship with the banks where you can, as you go, if you need to draw funds, that they're available. So they increased our line and also a separate line, as Dan mentioned, just for technology, and that would be a separate line. So we now have the funding capacity to do what we want. It was a little touch and go a couple of months ago, three months ago and -- but the extra profitability certainly helps. Everyone likes to see more profit if they're going to loan you money. So we're very happy with the results. It seems all along. We're now getting back to more of a historical profit level that we had when we had a nice small, controlled operation. We're getting back to that again. We've had problems with -- we just put in four software programs, and that was very ambitious and we survived it all. And we're now tweaking them and pulling them together, and we're really excited about where we're headed in the next few months. We recently hosted 650 people a week in Disney, and we paid for everything. We paid for the airfare, the hotel, food allowance and the Disney passes. 488 people earned it, but when some people don't take it and take cash and then some take their family along, but 650 people, which is pretty amazing for a small company like this. We're really growing and you're seeing travel is one way we do that. Our next trip is to Punta Cana, and we're really scratching our heads about trying to forecast what that will look like next summer and how many people will earn it, and literally, there could be 1,000 or more. So it's a really unusual business. We have a great demand for our products. Our products just keep getting better. I'm really happy about that, that the products, every quarter, we get new products that drive the sales, and so I think in the [indiscernible] division, that's very important that you have viable products, and we also have very modestly posh products. So the future of the organization looks very strong. And the most exciting thing for me is to see the profit go up. Sales have been there, but now the profit is. So with that, if I haven't covered every single thing anybody wants to know, you are welcome to ask me a question.

[Operator Instructions] And our first question comes from Paul Carter of Adaptable Capital Market Management. Your line is now open.

So you increased your active consultant count from like 25,800 at the end of February to 27,600, I think, at the end of May, so like an 1,800 net increase. Can you say how many active consultants were added in the quarter and then how many were kind of lost realizing it's kind of a fuzzy number?

In which period now do we want to talk about?

Just during the quarter.

Dan?

I don't have those numbers readily handy, Paul, but as Randall was saying, we had some growth in our headcount during the quarter. We measure our consultant count each month by looking at the number of consultants that have made a sale force in the last six months. And so we're constantly having new consultant adds, and then consultants go stale for a period of time and then become inactive and not part of our active consultant counts. So there is some turnover every month. Some months are positive and some months aren't, but we had growth overall for the quarter. And as Randall talked about, we had a consultant kit special in June, which yielded over 6,000 new consultants for the month of June. So we had a lot of good growth in June with new consultants, and that also had a positive impact on our existing consultants, right, Heather?

Absolutely. And I think the thing to remember here is, just as a rule in the direct selling world, there are always consultants that are coming and going and that they tend to be almost equal numbers. It's said in various areas of the direct selling world that you always have 1/3 coming, 1/3 staying and 1/3 going. So any of the numbers that we're looking at, as you even admitted, are fluid numbers. So because of the way that we define active compared to the way that other direct selling companies define active, they are very interesting numbers to look at.

One thing that I think is of note here, when we were a smaller company at the $35 million level, larger companies could dangle a carrot in front of our consultants, and that's all you make. But what's happening with our growth, we have people who are making outstanding amounts, and by the way, it's a formula and we hope they make $1 million because the formula, we -- the profits are the same to us. So we have people now can say that they made $25,000 in a month, other people make wild allegations and yada, yada, fine, but I'll tell you, when we can tell someone that you can work from your home, be around your family, make your family first and have excellent high quality educational products to sell at a reasonable price and make $20,000 in a month, it's not hard to recruit people. So -- what's happened to the 6,000 has probably woken up 2,000 to 3,000 more who kind of, you know, had a little rough day or something and -- but they get a new recruit, it's like a shot of adrenaline. And so we've asked late back and forth saying, Oh my gosh, we can't get a flood of orders like we did last fall and not be able to handle it. So it's a double edged sword here. We're at the warehouse and, oh my gosh, get this stuff all installed because it's coming, and we think that is the case. There's just nothing more exciting to a consultant than to have another consultant join because it reinforces what they're doing.

Okay, that's helpful. And then your inventory is down to about $30 million or was down about $30 million at the end of the quarter. And then you stated in your Q that you expect cash flow from operations to be used this year to increase inventory. Do you have a rough idea of where you think your inventory position will grow to by the end of the year?

Yes. It came down because we had forecast sales of around $125 million to $150 million and had inventory added to do that. Well, when we weren't able because we just couldn't get it out the door, it showed our inventory out of balance with our sales. So the inventory got reduced on a natural basis of selling out what we already had before we got to reorder.

The key, Paul, and I'll jump in here, one of the key things, as Randall said, is making sure that we have the right inventory for the number of orders coming in the door. When we think that -- if we're going to grow the way we've been growing in the past, we see inventory growing, we're very hesitant to put out projections as a small company. Putting out earnings projections and inventory projections is one that we're really, as a management team, not wanting to do. We don't see a large -- so -- we're very hesitant to give you a number [Indiscernible] but we don't see a large investment of inventory. We see it being more in line with what the sales were in prior years. So if you go back to sales volumes 2, 3, 4 years ago and what the inventory volumes were as a percentage, it's going to be more in line with those. Then the issue we had in 2000 -- at the end of 2000 in fiscal '17 when we actually had a much -- a jump in inventory, as Randall said, we worked that off now over the last -- well, the last part of fiscal '17 and now the first part of '18, we've worked off the majority of any excess inventory.

Yes. And there's a couple of factors working there. One, reducing the inventory down, but you reach an economic quantity that we are in now where if your sales double, your inventory doesn't double, you just order it a little more often. When you get to 100,000 print runs, you don't need to print 200,000. You just do it twice a year or -- so your inventory doesn't really grow as fast as your sales do when you reach this level, and we've reached it. We've reached the level now in inventory, in sales where people are finding us. We just signed a new contract with a very well-known writer in England who also has an adventure TV show, and that was quite a coup because when you grow like this, people want to be a part of it. So they bring products to us weekly, and we can take our pick about which ones we decide to publish. So -- but anyway, the point is inventory will not grow at the same rate as sales does because we reach economic levels every order.

[Operator Instructions] And our next question comes from Jon Jung of Trailhead Asset Management. Your line is now open.

I wonder if you could give us a little bit more information about what's happened with the order entry in sales commission system. The software that was installed last year during the Christmas holidays didn't work very well and went back to the old system. Is that correct?

Yes, that's basically correct. It was installed September, and we dis-installed it in January, I think, Craig?

February 1st.

Yes, February 1st. So yes, we went back to our old system. And so what we've done, and on hindsight, maybe should have done it anyway, we -- our system works, and it's a basic system. And what we're doing is enhancing it, and again, maybe we should have done that, gone with another -- what we thought was a better system, has turned out that it wasn't. No direct -- two direct selling companies are alike, Jon. That's a problem. And even though the company was well-respected, as far as we knew, in a direct selling industry, they never could quite handle or adjust to our company. As an example, we allow consultants to have consignment, and no other direct selling company does. But the reason we do that is because if you want to go in and compete with the Scholastic Book Fair with $15,000, the salesperson doesn't have that kind of resources to do that, so we put it out on consignment. And we don't get it all back. There is some loss in that. But by and large, we think that generates $5 million to $10 million worth of revenue. The same thing on weekend booths, people will have $5,000 worth of inventory, and so we monitor that. And again, it's not a sale until it's been reconciled and they pay for it. So if we send somebody $10,000 worth of inventory, that's not a sale. But when they do sell it and send us in the reconciliation in cash, we consider that goes into revenue. But the company wasn't able to ever figure that out because nobody else has done that before. And they never could figure out our payroll system, I don't know why, because I think we have one of the most simple compensation programs in the industry. So at one point, we had to pull the plug and went back to our own. And while we had some hitches back and forth, had some equipment failures, by and large, today, we're very encouraged that it's working pretty smooth. The biggest problem now is integrating technology to get our shipping back to the first class level where everything's shipped in two to three days, but now, it's a couple of weeks. But we feel like within a week, that we'll have that down to, again, about five days because we're shipping about 2,000 orders a day more than we're receiving. So software encompasses the whole gamut of the direct selling division. We took it back. It's back on our system and it's working, and we'll put the enhancements in and be better off.

Okay. How much consignment inventory do you have out in your sales force now that's not booked as a sale?

Okay. Dan, give me the [indiscernible] closer. I could guess, but...

It's right under $1 million.

Now $1 million is our cost. You've got retail and the difference is, a $10 book -- a $10 retail book, we're going to have in our cost around $2.50. So we have -- when he's talking about your $1 million, $1,250,000 that's at our cost, which is about $5 million at retail. And we set up a reserve for that. I think last year, we wrote off about $100,000, and that may seem like a lot, but boy, it puts you in a whole marketplace that you cannot be in without floor planning this inventory for people who want to do large events, large book fairs, large booths, large things. And so we're the only company in the direct selling industry who does that, but it's a key part of our revenue growth. And the write-off is, again, like accounts receivable. You don't get our accounts receivable back either, so that's why he said reserve that for it.

Jon, just to be clear, in the Q, in the MD&A section in the Q, we outlined our consignment inventory at the end of the quarter was 950,100 at May 31 of this year, and it was 1,140,000 at February 28 of this year. So it declined 200,000 between February and May. And then we also have consignment inventory that we basically converted into a receivable. If the consultant becomes inactive, we convert that consignment inventory into a receivable, and that was 438,100 at the end of May. And just from an overview perspective, to give you some -- a picture of it, not every one of our 30,000 consultants that we have, and that's not a firm number, guys, not every one of the 27,600 consultants at the end of May have consignment inventory. In fact, only about 15% of our consultants actually receive consignment inventory. And of those -- of that 15% that received consignment inventory, about 90% of them have less than $1,000 in consignment inventory value. So a lot of times, as Randall said, it's about giving them enough inventory that they can go to a book fair and have a display. It's enough inventory so they can go into a school or into a public event and have a booth that is filled with enough inventory that they can actually be able to sell it at the fair or at the school or at the event, collect revenue and then reconcile that at the end of the event and recognize the revenue at that point.

I understand. And another subject, can you give me any update on any changes in your lease, your sublease and the property that you own behind the existing buildings?

Well, there is. Those guys, I love those guys. They're the sweetest, had a meeting with them yesterday. They're doing another $6 million upgrade. Thank you, guys. I appreciate it. So this is -- I mentioned this before. Before they're finished, they're going to invest about $12 million minimal in upgrading the facility that we own. They put a new roof on the building. They -- we've entered into a lease. We're going to -- we have a bunch of space that we're not utilizing right now, and it's not leasable to anyone because it doesn't have an outside entrance. But they want to lease that back from us while they're doing the renovation of their building. So we've got a little extra income that we'll be recognizing for 1.5 years or so as they go through and renovate every inch of that building, which it increases our value. We don't get to take it or anything. It's just unrealized equity. But it's there, so they spent a lot of money and are continuing to do so to enhance our building. And entered -- we entered into a lease now to lease them back about 24,000 -- just 24,000 plus, about -- yes, 24,000 to 30,000 square feet of office space while they put their people in while they're renovating their building.

Okay. How about the vacant land behind your property, are you doing anything with that?

We're eyeing it because if, in the event that sales would continue on the way they have, 100% growth, we're going to need that building. We still maintain 100,000 -- 103,000 square foot building of our former primary location, and it's full. It's about 12 blocks away, but still convenient. At some point in time, if profits and cash flow generate enough, that we would like to consolidate the locations into one, sell that building and build on this one. But that's out there. No more scaring anybody. That's not -- there aren't any plans for that. That's just an idea. The reason we don't want to sell it now, because we think we might need it in the future.

[Operator Instructions] And that concludes our question-and-answer session for today. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.