China Distance Education Holdings Limited (NYSE: DL) Q2 2020 Earnings Call Transcript

China Distance Education Holdings Limited (DL) Q2 2020 earnings call dated May 22, 2020

Corporate Participants:

Zhengdong Zhu — Co-founder, Chairman of the Board and Chief Executive Officer

Mark Marostica — Co-Chief Financial Officer

Analyst:

Gregory Pendy — Sidoti — Analyst

Presentation:

Operator

Good evening and thank you for joining us for the China Distance Education Holdings Limited Second Quarter Fiscal Year 2020 Earnings Conference Call. On today’s call, we will have Mr. Zhengdong Zhu, Chairman and CEO, and Mr. Mark Marostica, co-CFO. During management’s prepared remarks, all participants will be in a listen-only mode. Following management’s prepared remarks, we will open the call for questions.

Before we start, we remind listeners that this conference call contains Forward-Looking Statements. These statements are made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. The outlook for the third quarter of fiscal year 2020, oral statements from management on this call, as well as the company’s strategic and operational plans in particular the impact of COVID-19 on our business, the solutions we adopt to address COVID-19, the revision of revenue guidance and balancing growth and profitability, as well as the anticipated benefits of strategic growth initiatives including the promotion of the company’s lifelong learning ecosystem among other things, may contain forward-looking statements. Forward-looking statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in any forward-looking statement. Further information regarding this and other risks is included in the company’s annual report on Form 20-F and in other documents that the company has filed with the Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statements except as required under applicable law.

As a reminder, this conference call is being recorded. In addition, the presentation, we will be referring to during the course of the call, can be downloaded from the company’s Investor Relations website. Further, a live and archived webcast of this conference call will also be available on the company’s IR website at ir.cdeledu.com.

I will now turn the call over to Mr. Zhu. Mr. Zhu, please go ahead.

Zhengdong Zhu — Co-founder, Chairman of the Board and Chief Executive Officer

[Foreign Speech]

Thank you everyone for joining our second quarter fiscal year 2020 earnings conference call. Our operating results were distributed earlier via Internet newswire services and are also posted on our website, where a slide presentation is available as well.

[Foreign Speech]

If you will now refer to the presentation, I will begin on Slide 4 with an overview of our financial results.

[Foreign Speech]

In the second quarter of fiscal 2020, our revenue increased by 8.1% year-over-year at the low end of our guidance range. Second quarter revenue growth was driven by net revenue from online education services, which was up 19.9% year-over-year, primarily attributable to the robust revenue growth of our accounting vertical. Our socially responsive actions to support our students during the COVID-19 outbreak, which included offering both free and significantly discounted online courses had a dampening effect on our second quarter revenue growth and led to a 34.5% year-over-year decline in our cash receipts from online course registration in the second quarter.

Total enrollment for the quarter, however, nearly doubled compared to the year ago period, due to the immense popularity of our high-quality attractively priced online courses. It is important to point out that our total enrollment metric includes only paid enrollments.

[Foreign Speech]

Take our certified public accountant or CPA business as an example. More than 40% of the students who enrolled in our CPA exam preparation courses during the period when we offered free and significantly discounted courses spent over 10 hours studying on our learning platform. This level of student engagement shows that students appreciate online learning as well as our courseware. We look forward to providing these and other students with additional comprehensive high-quality courses in the future.

[Foreign Speech]

I would now like to turn to Beijing Ruida, a leading provider of exam preparation services for participants in China’s legal professional qualification examination. Since our acquisition of Ruida a few years ago, we have been collaborating with Ruida in an effort to improve its online capabilities including the production, delivery and administration of online courses. These efforts have augmented Ruida’s core offline courses and enabled Ruida to offer students an effective blended online-offline learning solution.

[Foreign Speech]

In response to COVID-19 however, Ruida suspended its offline classes, yet was able to successfully migrate students to its online classes. Despite posting a high single-digit decline in revenue for the second quarter compared with the year ago period, Ruida’s online preparedness helped cushion the effect of the suspension of offline classes.

[Foreign Speech]

We remain committed to a multipronged student acquisition strategy and continue to collaborate with influential e-commerce and social media platforms such as Tmall, JD.com, Weibo and WeChat to promote our offerings and strengthen our brands. During the pandemic, we offered various featured courses and value-added services to provide students with highly sought after learning opportunities and quickly attracted students across China to our online learning platform.

[Foreign Speech]

We have been continuously upgrading and introducing mobile-based educational products and services such as mobile games and popularity among both working professionals and students in their pursuit of learning. As of March 31, 2020 China Distance Education offered 69 mobile apps and recorded cumulative downloads of 66 million up from 63 million as of December 31, 2019. In the second quarter, daily traffic to our mobile website continued to increase with daily active users in our accounting, healthcare, and engineering and construction verticals increasing by 44.3%, 24.9% and 127.6% year-over-year respectively.

[Foreign Speech]

With the pandemic gradually being contained in China, I would like to share some COVID-19-related updates.

[Foreign Speech]

For the sake of the ongoing health and safety of our employees, we have maintained precautionary measures across our operations such as remote work, staggered work schedules and more frequent disinfecting of our offices.

[Foreign Speech]

To support students impacted by COVID-19, CDEL offered certain free courses and courses with significant discounts toward the end of January as I previously noted. During April, as the spread of the pandemic slowed, we gradually began raising prices and ended the free and significantly discounted pricing program at the end of April.

[Foreign Speech]

This concludes my update on our business operations and strategy. I will now turn the call over to Mark, our co-CFO, to walk through key operating metrics and financials.

Mark Marostica — Co-Chief Financial Officer

Thank you. Before I discuss the details of our second quarter financial performance, I want to provide a few highlights regarding the improvement in our profitability. The second fiscal quarter marks the fourth consecutive quarter of year-over-year improvement in our operating margins. This is particularly noteworthy, given the challenges we faced during the COVID-19 outbreaks. In the second fiscal quarter, despite the negative impact to our top line growth from the COVID-19 pandemic, our non-GAAP gross profit grew 38.4% year-over-year with impressive non-GAAP gross margin expansion to 51.1% compared with 39.9% in the year ago period and we achieved non-GAAP operating income of $2 million for the quarter compared with an operating loss in the prior-year period.

Please note that non-GAAP figures, noted in our earnings release and discussed on this call, exclude share-based compensation expenses.

The improvement in our operating profitability was primarily due to modest top line growth coupled with effective execution of certain expense control measures, including strict headcount and office space control coupled with stronger leverage of our cost structure. These measures have been a key focus of the Company for the last several quarters.

Now, let me summarize some of our key operating metrics on Slide 6 and 7. Overall, enrollments in online test preparation courses of our four main verticals, including accounting, healthcare, engineering and construction, and legal grew significantly in the second quarter, up approximately 300% year-over-year. In contrast, ASPs for these online test preparation courses declined, primarily due to the popularity of the discounted test preparation courses that we offered during the quarter in response to the COVID-19 outbreak.

Enrollments in our online accounting test preparation courses were up 351% year-over-year in the second quarter, primarily driven by the growth of our accounting professional qualification exam or APQE course enrollments, certified public accountant or CPA course enrollment and tax advisor course enrollments. Second quarter enrollments in our accounting continuing education courses decreased by 38.4% compared with the year ago period. Likewise, total online accounting test preparation ASPs decreased by 86.7% year-over-year in the second quarter. The ASPs for our accounting Continuing Education courses increased by 56.7% year-over-year in the second quarter.

Enrollments in our online healthcare test preparation courses in the second quarter of fiscal 2020 increased by 155% year-over-year, while ASPs for our healthcare test preparation courses decreased by 74.5% year-over-year. Enrollments in our online engineering and construction or E&C test preparation courses increased by 481% year-over-year in the second quarter. ASPs for our E&C test preparation courses in the second quarter decreased by 91.4% year-over-year. Enrollments in our E&C continuing education courses increased by 29.8% year-over-year in the second quarter. ASPs for E&C continuing education courses were relatively flat year-over-year in the second quarter.

Now, let’s look at some of our financial metrics. To be mindful of the length of our earnings call, I will focus on key financial highlights and encourage listeners to refer to our earnings press release and financial filings for further details.

Non-GAAP gross margin was 51.1% in the second quarter of fiscal year 2020 compared with 39.9% in the second quarter of fiscal year 2019. The year-over-year expansion in gross margin was primarily due to decreased salaries and related expenses, as well as decreased costs of purchases related to the sale of learning simulation software, rental and related expenses and lecture fees.

Non-GAAP selling expenses increased by 10.5% to $15.3 million in the second quarter of fiscal year 2020 from $13.8 million in the prior-year period, driven primarily by increases in advertising and promotional expenses, commissions to agents and rental and related expenses, partially offset by a decrease in salaries and related expenses. Non-GAAP general and administrative expenses decreased by 10.7% to $5.4 million in the second quarter of fiscal year 2020 from $6.1 million in the prior-year period. The decrease was mainly due to lower salaries and related expenses.

Overall, non-GAAP operating income for the second quarter of fiscal year 2020 was $2 million compared with non-GAAP operating loss of $3.6 million in the prior-year period. In the second quarter of fiscal 2020, we recorded a non-cash foreign currency exchange gain of $1.6 million, mainly related to loans from our PRC subsidiaries to our offshore holding company due to the depreciation of the renminbi against the U.S. dollar from December 31, 2019 to March 31, 2020. We recorded a non-cash foreign currency exchange loss of $2.2 million in the prior-year period. Income tax expenses were approximately $700,000 in the second quarter of fiscal year 2020 compared with income tax benefit of $1.3 million in the prior-year period, primarily due to taxable income in the second quarter of fiscal 2020.

Non-GAAP net income attributable to CDEL was $5 million in the second quarter of fiscal year 2020, compared with non-GAAP net loss attributable to CDEL of $3.4 million in the prior-year period.

Now, let’s turn to Slide 11 to review our cash flow. Net operating cash inflow decreased by 28.7% to $11.7 million in the second quarter of fiscal 2020 from $16.5 million in the prior-year period. The operating cash inflow is mainly attributable to net income before non-cash items generated in the second quarter of fiscal 2020. The decrease in pre-payments and other assets to the other current assets, the increase in accrued expenses and other liabilities, and the decrease and increase in amount due from and to related parties respectively also contributed to the operating cash inflow. The operating cash inflow is partially offset by the increase in inventories and the decrease in deferred tax liabilities.

Cash and cash equivalents, term deposits, restricted cash and short-term investments as of March 31, 2020 decreased by 10.8% to $130.2 million from $145.9 million as of December 31, 2019, mainly due to the repayment of offshore loans of $20.4 million, the repayment of an onshore loan of $1.1 million, the payment of an investment of approximately $700,000 and capital expenditures of approximately $1.2 million. The decrease was partially offset by the operating cash inflow generated in the second quarter of fiscal 2020.

This completes my financial overview. Next, I would like to provide additional color regarding the potential impact of COVID-19 on our financial performance over the next few quarters. To date, we have received notifications from professional examination administrative authorities regarding postponement of a number of examinations, which were previously scheduled during May and June, including elementary APQE, nurse qualification, health qualification, and associate constructor examination. There has been no further guidance from examination administration authorities at this time regarding when these particular examinations will be held. Consequently, our third fiscal quarter and potentially our fourth fiscal quarter GAAP revenue will be negatively impacted as the corresponding cash receipts from these courses related to these examinations will be recognized ratably over a longer expected service period.

I will now return the call to Mr. Zhu for concluding remarks as well as financial guidance for the third quarter. Mr. Zhu, please.

Zhengdong Zhu — Co-founder, Chairman of the Board and Chief Executive Officer

Thank you, Mark.

[Foreign Speech]

The COVID-19 pandemic has created numerous challenges for society, our student community and our firm. That said, the true metal of a company is measured by its response to such challenges. As we’ve discussed, our response to the pandemic has been swift and resolute, centered on keeping our employees safe, and supporting our students during these difficult times. The free and significantly discounted exam preparation courses, we offered to students during the COVID-19 outbreak, have negatively impacted our revenue and cash receipts growth. At the same time, we have substantially increased our reach to a broader student audience that is attracted to our high-quality courses and continues to be keen on both enhancing knowledge through professional certification and career development.

[Foreign Speech]

During our second fiscal quarter, we reached an important milestone of 20 years of operating history in China’s online education industry. During the past 20 years, we have faced many challenges, yet continued to thrive by being socially responsible, by being committed to serving our students with best-of-breed content and value-added services, and by responding to students’ various learning styles and preferences through multiple learning modalities, including pre-recorded audio, visual, mobile and live streaming courses. Our comprehensive lifelong learning ecosystem has evolved as well, now covering four key industry verticals including accounting, healthcare, engineering and construction, and legal. And our business has proven to be resilient.

[Foreign Speech]

Let me wrap up by saying that when we look back on this extremely challenging time of COVID-19, we expect this period will be viewed as a watershed moment for online education in China’s education industry. Online education is a safe and contactless instructional delivery method that offers easy access to educational content for all with Internet access and a popular learning modality for students to continue learning during this difficult time.

[Foreign Speech]

As a pioneer in online professional education, we believe in the long-term growth prospects of China’s online education industry and are well prepared to serve a growing student demographic. We are dedicated to consistently delivering knowledge to a broad student constituency, extending convenience, flexibility and engagement to their learning experience. Meanwhile, we will continue to integrate cutting-edge technologies into our educational solutions and diversify our core offerings to fulfill the needs of our students at different stages of their study and career development. With our 20-year track record and an unwavering commitment to education, we have proven to be the premier partner of choice for students in their journey of lifelong learning.

[Foreign Speech]

Turning to guidance. For the third quarter of fiscal year 2020, the company expects to generate total net revenue in the range of $50.6 million to $53.7 million, representing a year-over-year decline in the range of approximately 18% to 13% respectively.

[Foreign Speech]

For fiscal year 2020, the company has decided to withdraw its previous revenue guidance in consideration of uncertainties related to the impact of COVID-19, including the postponement of certain professional certification examinations, the schedule of reopening of the schools and the schedule of resumption of provision of offline training courses among others.

[Foreign Speech]

This concludes my prepared remarks. Thank you for your time. Operator, we are now happy to take questions.

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin the question-and-answer session.

[Operator Instruction]

Your first question comes from the line of Greg, Sidoti. Please ask your question.

Gregory Pendy — Sidoti — Analyst

Hey guys, thanks for taking my questions. First of all, I guess, just can you talk a little bit about the gross margin outlook and how to think about that going forward with the sort of pull-forward in demand. I think we are already anniversarying some of the rationalization on the real estate side, given the move last year. Is there anything left on that? How should we be thinking about the gross margin?

Mark Marostica — Co-Chief Financial Officer

Yes. Thank you, Greg, for your question. Regarding gross margin, you can see that we have been quite successful in controlling our costs, particularly salary and related rental and related lecture fees. We maintained our headcount very steady and very stable and we continue to expect to do so, and we’ve been controlling our rent expense. In fact, in May, we have exited our leases of the third and fourth floors of our Haidian headquarter building in favor of a more reasonable rental expense at our MHL location. So, we continue to expect some savings on the rental side going forward.

Having said that, when we look to the third quarter, given the revenue decline expectation, we do expect a modest gross margin — gross margins to come down a little bit compared to the year ago period given that revenue reduction. But keep in mind, COVID-19 is the reason for the revenue reduction and it represents a near-term jolt for the company. The long-term business fundamentals, as you can see over the last four quarters, a very nice operating margin expansion, are very much intact that we expect to resume a track of continuing to grow our profitability in the future quarters and years ahead as we get beyond COVID-19.

Gregory Pendy — Sidoti — Analyst

Great. That’s helpful. And then, can we just move down to the SG&A side, how should we be thinking about the marketing, just given expectations going forward? And then, also on, maybe, commission to the agents?

Mark Marostica — Co-Chief Financial Officer

Sure. In terms of selling and marketing expense, I mean, that is certainly one area where given the expected revenue decline in the third quarter, we can continue to look for opportunities to rationalize those expenses given the cash receipts’ reality. And so, we will continue to manage those expenses effectively as we have done so in this most recent quarter. On the G&A side, we continued to manage those expenses very carefully as well. So, net net, I think when you look at the third quarter, we are likely in a position to still be profitable, but very slightly profitable, I think, on an operating basis, given the expected revenue decline in the third quarter.

Gregory Pendy — Sidoti — Analyst

Great. That’s helpful. And then, just one more. Can you just talk big picture about maybe the price elasticity? I know this was an unexpected event, but we kind of went through some discounting and prior to that you had momentum sort of on the REIT and premium side. So, how should we be thinking about sort of the price elasticity of courses right now as we kind of come out of the discounting of that?

Mark Marostica — Co-Chief Financial Officer

Sure, sure. As you mentioned Greg, during the discounting event that we undertook, given our social responsive action to offer these free and significantly discounted courses, we experienced a surge in paid enrollments for exam preparation courses during the quarter, around a million exam prep students, which is a very powerful number. At the same time, our cash receipts suffered. Now, during the month of April, we gradually began increasing prices as the COVID-19 pandemic subsided. And so, we start May with having that pricing program of heavily discounted courses and free courses sunsetted. So, now as we look at our results in May, it’s pretty clear that the same dynamics in terms of weakness on the cash receipts side are continuing and we believe that’s clearly a result of the idea that the company absorbs a good portion, a bulk of its purchasing power if you will from students and enrollments for exam prep courses, during the period of time that the Company offered the special discounted pricing program. So, that in some ways is certainly discoloring what otherwise would be considered price elasticity of demand that you referred to.

I do believe that as we get beyond COVID-19 and return to a more normal operating environment, that price elasticity will return. In other words, normal enrollment growth will follow normal pricing. And so, that should revert back to what you would expect to be the case. But given the effect of COVID-19 and the dramatic surge in enrollments in the second quarter, that’s certainly having a continued dampening effect on our cash receipts in the first half of the third quarter.

Gregory Pendy — Sidoti — Analyst

That’s helpful. Thanks a lot.

Mark Marostica — Co-Chief Financial Officer

Thank you, Greg.

Operator, next question? Hello, operator, are there any further questions?

Well, if there are no further questions at this time, I would like to wrap up the call. On behalf of the management team, we thank you for joining us today and we do look forward to updating you on our progress. Thank you.