If there's anyone out there still clinging to the notion that the market is efficient, take a look at what happened to the stock of test-prep company Princeton Review
With the sole analyst following the firm predicting that Princeton would report $0.08 per share in profits, any efficient market worthy of the name would have torpedoed the stock upon learning that Princeton actually lost $0.09 per share on a 3% increase in revenues.
Worse than the numbers themselves, however, was what they say about the credibility of Princeton management. As you may recall, in May, CEO John Katzman told investors that: "Revenue is expected to be strong, [and] we expect to be profitable for the year." And yet, three quarters into this "expected to be profitable" year, sales are up only 7% (decent, but hardly "strong"), and profits are entirely absent. On the contrary, the firm is down $0.21 per share in losses year to date.
. went Mr. Market. Princeton's stock price hardly budged on the bad news. So what gives? Why the sudden, forgiving mood on Wall Street? Perhaps it's because Princeton pointed out that half of last week's loss wasn't really "lost" at all. Of the quarter's $2.4 million in red ink, $1.2 million came from "costs . in connection with several significant K-12 contracts in which [Princeton] expects to recognize related revenue of approximately $2.7 million during the 2006 fourth quarter." What's more, the firm's kindergarten through grade 12 division did post "strong" revenue growth in Q3, up 39% year over year. As did Princeton's admissions services unit, which was up 29%. (In the firm's flagship test prep business, in contrast, sales slid 6%, dragging down the overall results.)
Personally, I think Mr. Market called this one wrong. As I've said many times, the key problem at Princeton is that its "cost of revenue" continues to grow faster than those revenues themselves. In Q3, revenue grew 7%, while cost of revenue rose four times as fast. Even if you back out the $1.2 million in costs mentioned above, cost of revenue was up 18%.
Moreover, I don't expect to see improvement next quarter. While Princeton paints its anticipated $2.7 million in K-12 revenue next quarter as a good thing, I beg to differ. Assuming no additional costs are incurred next quarter, $2.7 million in revenue, costing $1.2 million to generate, yields a gross margin of 56%. And if you refer back to the table laid out in last week's Foolish Forecast, that's below-trend for Princeton. Long story short, things are getting worse, not better.
Princeton's not the only educational services company to report earnings recently. Educate
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Fool contributor Rich Smith does not own shares of any company named above.