Going into Wednesday's earnings exam, investors weren't particularly optimistic about Princeton Revue's (NASDAQ:REVU) chances. Indeed, the past couple of months have seen the test-prep specialist lose about 20% of its value. But the damage wasn't as bad as shareholders had feared.

The company booked $34 million in revenue for the quarter, and the GAAP loss came in at $0.05 per share -- a $0.02-per-share loss, if you back out $0.03 per share in restructuring charges. Result: The stock lost no ground on the day of the announcement, and it's up 4% one day later.

The big picture
If you recall from our pre-earnings-release Foolish Forecast, we noted that Princeton had set itself two primary objectives in restoring profitability. First, it needed to grow revenues. Second, it needed to reduce costs.

On revenues, we saw strong growth in the two smallest segments, K-12 and Admissions, mitigate anemic growth in its flagship Test Prep division. Thus, the company appears to have a decent handle on objective No. 1. Let's instead dig into the costs side of the equation.

Cost of services rose 33% year over year for the quarter, and 24% year over year for the first half of 2006. Compare that to the 14% quarterly sales growth and the 9% growth year to date, and I think it tells you two things. First, gross margins continue to deteriorate at Princeton, at an accelerating pace. Second, no matter how fast the business can grow its sales of services, the cost of those services continues to rise even faster. That's not a good trend.

Things look better a bit farther down the income statement, however. Operating costs grew just 6% for the quarter, versus nearly 7% for the first half. That tells us that management is doing an admirable job of keeping its costs of operations in check, even if it has not yet achieved its goal of actually reducing them.

Where to focus
Princeton's stock has lost 10% of its value over the last year. If you intend to bet on a turnaround, here are three key places to look for evidence that it will succeed:

  • Revenues: Grade B+. Princeton outperformed on this score this quarter.
  • Operating costs. Grade B-. It still isn't "reducing" its costs, but it's getting there.
  • Cost of services: Grade F. The company must improve here or suffer continuing margin declines, hampering its chances of earning decent (or any) profits in the future.

Watch these metrics like a hawk.

Competitors:

  • Washington Post (NYSE:WPO)
  • Reed Elsevier (NASDAQ:ENL)
  • McGraw-Hill (NYSE:MHP)
  • Educate (NASDAQ:EEEE)

Customers:

  • Plato Learning (NASDAQ:TUTR)

Now that you know what we found at Princeton, review what were looking for in the first place with our "Foolish Forecast: Princeton's Q2 Preview."

Which educational powerhouse is paying off for Tom Gardner and Bill Mann's Motley Fool Hidden Gems ? Find out with a free 30-day trial subscription.

Fool contributor Rich Smith does not own shares of any company named above.