Executives
Dong Xu - Chairman and Chief Executive Officer
Rick Chen - Executive Vice President
Dora Li - Chief Financial Officer
Analysts
Adele Mao - Susquehanna International
Ako [Ph] - Oppenheimer
Noah Education Holdings Ltd. (NED) F2Q09 (Qtr End 12/31/08) Earnings Call February 18, 2009 8:00 PM ET
Operator
Welcome to the Noah Education, second quarter fiscal 2009 financial results conference call. At this time all participants are in a listen-only mode. Following managements prepared remarks there will be a Q-and-A session. As a reminder, this conference is being recorded on February 18, 2009.
Joining the conference today are Mr. Dong Xu, Chairman and CEO; Mr. Rick Chen, Executive Vice President; and Ms. Dora Li, Chief Financial Officer.
After the close of the U.S. markets on Tuesday, Noah issued a press release announcing its second quarter fiscal 2009 financial results, which is available on the company’s IR webpage at www.ir.noahedu.com.cn. This call is also being broadcast live over the internet and a copy of the presentation that will be used for today’s call is also available on our website.
Before management’s presentation, I would like to refer to the Safe Harbor statement in connection with today’s conference call. This call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including certain expectations and goals, which are subject to numerous assumptions, and risks.
Forward-looking statements involve known and unknown risks and uncertainties, many of which are beyond our control, which may cause actual results to differ materially from any future results or achievements implied by such forward-looking statements. The company’s actual results could differ materially from those contained in the risk factor section of company’s final prospectus or recent filings filed with the Securities and Exchange Commission.
Unless required by law, the company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
I would now like to turn the call over to Noah’s Chairman and CEO, Mr. Dong Xu. Sir, please go ahead.
Dong Xu - (Interpreted)
Thank you. Good morning and to some good evening. Thank you for joining the conference call today. I’m very pleased to report that we delivered another solid performance in a seasonally soft second quarter. At the same, we are driving efforts to make critical strategic alignment, both internally and externally, that are fundamentals of achieving long-term profitable growth and establishing ourselves as the leading provider of supplementary education services in China.
To-date we have made substantial progress towards this goal. Noah remains the market leader in the ELP space and we continue to gain traction in our other business lines, including after-school education services, the content development business and our online knowledge sharing platform.
Turning to slide four, at Noah we strive to offer the best supplemental education product and services to meet the needs of students aged five to 19. Our superior offerings combined with our ability to capitalize on favorable market dynamics will help drive growth in the near term.
There are several key market trends that we can leverage. First, Chinese students placed a high value on education shown by the sustainable demand for our ELP product, which speaks to our ability to weather economic storms better than most of other financial. Second, the nationally under-served five to nine year old market represents strong growth opportunities for our KLD product. In addition, the rural areas in China remain under penetrated and we see vast potential as we expand into these areas.
Moreover, the recent China education reform proposal affirms the government’s commitment to spend 4% of GDP in improving the education system, providing tail winds that will help drive our growth. One of the areas in the government proposed 12 year plan, focuses on improving the accessibility and quality of education in rural areas of China. Noah will benefit from a much larger addressable market and a front mover advantage in reaching these students through the realignment of the distribution channel, which brings me to our next slide.
Moving on to slide five, since our IPO, we have been assembling the fundamental building law to trade a strong, lien foundation, that will drive sustainable growth in the long term. We have undertaken a number of initiatives to strengthen Noah at its core.
On the operations front, we have launched our Enterprise Resource Planning system or ERP and Knowledge Management System or KMS, which will substantially improve our operating efficiency and optimize our management processes. We have also begun implementing our Sarbanes-Oxley compliance project and remain committed to adhering to the best practice standards as an NYSE listed company.
There were several key strategic initiatives initiated in the fiscal second quarter, as part of the realignment of our R&D team we've formed 18, specifically task with building a Learning Management System or LMS, which will enable our proprietary courseware content to be delivered over different platforms, including our own ELPs, the internet and mobile phones.
We also appointed Mr. Yi Liu, as our Vice President of Sales and Marketing to realign our distribution channel. This will be critical to our success in leveraging market opportunities and supporting our business expansion in the medium to long term. Rick will discuss these initiatives in more detail.
Turning to slide six; while we continually look for ways to improve our operating structure, we also remain focused on delivering consistent business and financial results. We remained the industry leader in terms of both ELP sales and volumes. Sales of our core ELP products were strong, even during what is seasonally our softest quarter.
Our KLD products continued to be the key growth driver, achieving more than 34% quarter-over-quarter revenue growth. In fact, we released two new KLD products during the second quarter and early feedback has been very positive.
We continue to leverage our strong brand name, superior content development capabilities and comprehensive national sales and distribution network that enhances our market leadership. As promised, we have delivered a gross margin of more than 60% in the fiscal second quarter, which was attributable to our detailed retails and the completion of the one off inventory clean-up we initiated in the prior fiscal quarter. Moreover, Noah continues to seek additional opportunity to generate revenue and work towards our goal to become a leading provider of supplementary education services in China.
Let me now turn the call over to Dora, who will provide an overview of our finical performance. Dora.
Dora Li
Thank you. Hello everyone and my thanks to those joining us today. Let’s begin on slide eight. We are pleased to report a 10.6% increase in net revenue, as we generated RMB735.4 million in the fiscal second quarter, compared with RMB122.4 million in the second quarter of fiscal 2008.
With the completion of the clearing of the ELP and e-dictionary inventory, ELP sales remain Noah’s primary revenue generator especially as the KLD continues to gain momentum in the near term. ELP sales accounted for 98.7% of total sales in the fiscal second quarter at RMB133.6 million where KLD sales accounted for 27.3%, DLD accounted for 52.8% and e-dictionaries accounted for 18.6%.
Turning to slide nine, we have been prudent in controlling our cost, and by doing so, we have delivered solid gross margins in the second fiscal quarter. Cost of sales was RMB66.8 million during the second quarter of fiscal 2009. As percentage of net revenue, cost of sales decreased to 49.4% in the second quarter of fiscal 2009, compared with 53.3% in the comparable quarter last year.
Gross profit for the quarter increased by nearly 20% to RMB68.5 million, representing a gross margin of 50.6%; this compared with gross profit of RMB57.2 million and gross margin of 46.7% in the second quarter of fiscal 2008; more effect to maintain its gross margin about 50% in fiscal year 2009.
Slide ten; the total operating expenses increased by 16.5% to RMB72.6 million, representing 53.6% of net revenue for the fiscal second quarter. This compares with RMB62.3 million or 50.9% of net revenue in the second quarter of fiscal 2008. The increase was primarily attributable to operating expenses incurred as a public company, as well as our investment in sales and marketing and R&D to build our business.
Operating income for the quarter increased 43% to RMB9.3 million, representing an operating margin of 6.8%. This compares to operating income of RMB6.5 million and an operating margin of 5.3% in the corresponding period last year. The increase in operating income correlates directly with Noah’s 40% year-over-year increase in gross profit and increase in other operating income, related to the government subsidies granted to software companies. This was partially offset by the increase in total operating expenses in the second quarter of fiscal 2009.
Turning to slide 11, net income was RMB8.8 million, representing RMB0.24 per basic and diluted share for the second quarter of fiscal 2009. This compares with net income of RMB13.8 million and RMB0.4 and RMB0.38 per basic and diluted share respectively for the second quarter of fiscal 2008. This decrease in net income in the fiscal second quarter was primarily due to the decrease in interest income.
Interest income decreased by RMB7.2 million to RMB1.2 million in the fiscal second quarter versus RMB8.4 million in the year ago quarter, primarily due to the significant decrease in interest rates. Although this impacts our P&L statements, please be reminded that this is not reflective of any significant change in our operating performance.
Derivative loss in the second quarter of fiscal 2009 was RMB2.1 million, representing the change in fair value of warrant. Noah does not expect to be impacted by the change in fair value of warrant after the third quarter of fiscal 2009 as the warrants will expire after that quarter.
We recorded an investment income of RMB2.7 million in the fiscal second quarter. We want to remind investors that our investments are not linked to any derivative and they are guaranteed in principal and interest.
During the second quarter, we recorded RMB2.2 million in other non-operating loss, which was largely attributable to the end realized foreign exchange loss or inter company loans, due to the slight dollar appreciation during the fiscal second quarter. As we have stated on previous calls, we do not expect in the coming quarters to reach the same level of gains from foreign exchange as we have in the past.
Turning to slide 12; for the first six months of fiscal 2009, net revenue was RMB337.5 million compared with RMB369.9 million for the six months ended December 31, 2007. Net revenue from DLD sales was RMB206.9 million for the six months ended December 31, 2008, compared with RMB284.6 million in the six months ended December 31, 2007.
The decrease in DLD sales impacting overall net revenue in the first six months of fiscal 2009 was largely attributable to the clearing of Noah’s inventory and the consequent higher proportion of discounted sales of outdated DLD products, during the fiscal first quarter.
Net revenue from KLD products was RMB64.4 million for the first half of fiscal 2009. E-dictionary product sales totaled RMB61.4 million, compared with RMB81.8 million in the first half of fiscal 2008.
Gross profit was RMB169.7 million and represented a gross margin of 50.3% in the first six months of fiscal 2009. This compares with gross profit of RMB181.4 million and a gross margin of 49% in the corresponding period last year. The year-over-year decrease in gross profits was due to the discounted sales of our ageing DLD product in the first three months of fiscal 2009.
Total operating expenses for the first six months of fiscal 2009, were RMB168.4 million, compared with RMB150.1 million for the comparable period in 2008, primarily attributable to the increase in research and development expenses and general and administrative expenses incurred from increased content development costs and our recent RMB (Inaudible), as well as the legal and other consulting fees as a result of being a public company.
Operating income was RMB25.7 million for the first six month period ended December
31, 2008, representing a 55.1% decrease, compared with RMB57.2 million in the same period of 2007. Operating margin for the six months period ended December 31, 2008 was 7.6% versus 15.5% for the same six month period in 2007. The decrease in operating income and margin was primarily due to the aforementioned factors impacting revenue and operating expenses.
The net income for the first half of fiscal 2009 was RMB44.7 million or RMB1.2 and RMB1.19 per basic and diluted share respectively. This compares with net income of RMB58.3 million or RMB1.69 and RMB1.63 per basic and diluted shares respectively, for the first half of fiscal 2008.
As you can see on slide 13, our cash, cash equivalents and short-term investments remains strong with RMB1.03 billion at the end of December 31, 2008. The onetime dividend payment of RMB137.5 million announced in the previous quarter was paid out in January 2009 and it will be reflected on our balance sheet in the third quarter.
Let me update you on our share repurchase program announced last year. As of January 30, 2009 we have purchased approximately 2.4 million ADS at an average purchase price of $3.68, for a total of US $8.9 million. Currently, the company has a total of US $1.1 million left, ended the previously announced share repurchase program. We will continue purchasing shares during the timeframe authorized by the board and as defined by SEC regulations.
Moving to slide 14, looking ahead to the fourth quarter of fiscal 2009, based on our current estimates, we expect net revenue for the third quarter of fiscal 2009 to be in the range of RMB205 million to RMB210 million, which represents an increase of 11% to 14% year-over-year. We assure you that our business is still well positioned for growth and that our efforts are not equity linked or hide-away risky investments that may put us in an unhealthy position.
With that said, I’d now like to turn the call over to Rick, to update you on some of our operational initiatives.
Rick Chen
Thank you, Dora. I would like to give you additional details of some of the initiatives that Mr. Xu mentioned earlier and then we’ll be happy to take your questions. Let’s continue on slide 16. As discussed we are in a process of strengthening our internal infrastructure to drive future growth.
On the operation side, we launched our Enterprise Resource Planning system or ERP and Knowledge Management System or KMS at the end of December 2008. The investments in both systems will generate substantial cost savings in the long run and will substantially improve the operational efficiency of the company.
Lastly, the implementation of our Sarbanes-Oxley compliance project, initiated in the first quarter of 2009, will also bring our internal control levels up to the par with other NYSE listed companies.
In an effort to capitalize our long running content development efforts, we have formed a dedicated team to develop our Learning Management System, based on the standards and specifications of the Shareable Content Object Reference Model or the SCORM, which is endorsed by the China Ministry of Education and widely used by other Learning Management System companies.
By establishing such a system, Noah will be able to leverage their vast amount of courseware titles that we have created which stands at 43,000 at the end of December 2008, and associated learning materials to create business opportunities going forward. With the scalability and manageability and reliability of the LMS system, we can offer the content via various platforms such as our ELP products, internet, mobile phones and other devices going forward.
Another critical aspect of the company is our nationwide sales and distribution network. Over the years, Noah has achieved a great deal of success through this vibrant network. However, in order for us to meet the new challenges and capitalize on the opportunities ahead of us, it is vital for us to enhance the efficacy of our channels and to expand our reach.
During the quarter, we have brought in a seasoned sales veteran from Lenova to be in-charge of this important task of channel realignment. We expect this realignment process to last a couple of quarters and should better serve our long-term growth objectives.
Turning to slide 17; while building our solid foundation, we are gaining momentum in our complementary business lines. Our Access Noah program currently serves as our primary out reach program, putting our brand name and products in the hands of 1000s of students and teachers nationwide. Our Access Noah in-school program will play an important role as we continue to build towards -- becoming the leading provider of supplemental education services in China.
In the fiscal second quarter, we were able to establish exclusive partnerships with additional 80 schools, bringing our total partnership to 900 schools across China. These partnerships have allowed us to work directly with students and teachers and obtain feedbacks on our products and services. We continue to raise brand awareness among students and teachers across primary and secondary schools in China and we’re working towards our goal of becoming the education brand to serve the five to 19 year old age group.
As for our Access Noah Online program, we successfully launched our official website in December 2008. This Web 2.0 portal is an online learning community for both students and teachers, enabling them to share knowledge and exchange messages in chat rooms and message boards. It also features personal and in-class profile pages, an area that foster increased interaction between teachers and students.
Our numbers of registered users have expanded to approximately 740,000 at the end of December 2008, compared to the 700,000 users we reported at the end of September 2008. The Access Noah In-school and Online programs combine to create a powerful marketing initiative that will help us to expand our brand awareness in schools and in homes across China.
Furthermore, we continued our active discussion with potential acquisition targets in After-School Education Service segment. During the fiscal second quarter, our seven after-school tutoring centers generated about RMB0.98 million compared to RMB0.26 million in the prior year quarter.
Moving on to the slide 18, before we open the call to questions, let me remind you of the key objectives of our growth strategy. Our ultimate goal is to become the leading provider of supplemental education services and products, offering electronic learning products, content development, online community and after-school educational services.
We’ll do so through four primary initiatives. First, deepening penetration in the ELP market by improving our content and service offering; second, expanding our distribution network and enhancing our brand recognition; third, diversifying and expanding to a full spectrum of supplemental education services; and fourth, selectively pursue strategic acquisition opportunities. Given our solid growth of our core business and sound balance sheet, we are well positioned to take advantage of opportunities ahead of us.
Thank you and we’ll now open up the call for questions.
Question-and-Answer Session
Operator
(Operator Instructions) You have a question from the line of Adele Mao from Susquehanna International; please proceed.
Adele Mao - Susquehanna International
Hi, it’s Adele Mao from Susquehanna and I have several questions. First I’d like to discuss revenue visibility into the current quarter. Could you just comment on DLD, KLD trends that you are seeing, prior to Chinese New Year, in the beginning of new semester and what assumptions you’ve baked in, in order to reach your target for the second half of the quarter?
Dora Li
Hi Adele, this is Dora. So, basically we have given out our forecast for the fiscal first quarter between RMB205 million to RMB210 million, and representing a 11% to 14% increase. And in terms of our growth for our DLD and KLD e-dictionary, we have mentioned in our press release. We are expecting our KLD business to continue to gain momentum and our DLD business will also gain momentum in the Q3 quarter which is usually a big season and our e-dictionary will remain at or near the current level.
Adele Mao - Susquehanna International
Now, could you also comment on the ASP trends versus the last year?
Dora Li
Well, in terms of our ASP, we are expecting the DLD to remain at the same or current levels, and we are expecting the KLD line, with the rolling out of new product. We are expecting the KLD ASP will slightly increase versus the previous quarter and e-dictionary will be still in the low-end side.
Adele Mao - Susquehanna International
Okay, that’s helpful. You did not provide net income guidance this quarter, is there a particular reason for that?
Dora Li
As you can see, we are feeding on cash, cash equivalent and short-term investment with the balance of US$151 million and our net income was impacted by interest income, investment income as well as the foreign exchange gain and loss. So, the fluctuation in interest rates and the foreign exchange rates will impact our net income. So, under current economic climate, we’ll just continue to provide the net income guidance, but we want to repeat that our fundamental operation is sound and healthy.
Adele Mao - Susquehanna International
Okay, that’s fair. My last question related to LMS that you mentioned. My understanding is that this will allow the company to distribute the content database through various platforms, including internet and mobile phones and you said in the press release, with the objective to generate revenue in the medium-to-long-term.
Can you just help me understand the business model towards generating revenue off the Learning Management System? Is it the proprietary content that you will be selling or you are bundling your content with another hardware like say a cell phone?
Rick Chen
Adele, this is Rick. Basically, the objective of the creation of the Learning Management System is first of all to help us manage the existing content portfolio we have. We have come to realization that it is important for us to make our content both secured and scalable under the current system.
So, this is really the first objective of creating this Learning Management System and on top of that, we have come to realization that by developing the content within the learning system using the industry standards, we’ll be able to offer this content via various platforms such as mobile phones and devices and we have initiated discussions with other service providers over the last couple of months to test out the market.
To be frank with you, we’ve rushed to the final business models. We have not come to the finalization of that, but we have been in active discussions with other service providers and those feedbacks were very well received.
Adele Mao - Susquehanna International
Okay, but if your content will be available through mobile phones, and then why would students buy DLDs, I mean to a certain extent, do you expect the DLD volume to be cannibalized, if one day I mean the Educational Content is actually made available through cell phones?
Rick Chen
Well, there are two different types of content. One, is the proprietary content, which we believe will be best used and served through our hardware and software combination, because of the piracy issue in China, and there is also other standard content that are widely used by students and teachers, but it’s not easily accessible. So we wanted to really divide the content into two categories and be able to offer different type of content to different service providers.
Adele Mao - Susquehanna International
Okay and you say service providers, does that mean handset makers or carriers or…?
Rick Chen
Yes, it could be the handset makers and it could be the carriers and I think in going forward, we want our content to be the best content in the supplemental education market in China. And by creating the standards and by creating the content based on these standards, we’ll be able to be ahead of the game, by offering these content to service providers who will need to open-up the education market for their respective customers.
Adele Mao - Susquehanna International
I see, okay that’s helpful. Thank you very much.
Rick Chen
Thanks.
Operator
(Operator Instruction) Your next question comes from the line of Paul Keung from Oppenheimer, please proceed.
Ako – Oppenheimer
Hi this is Ako [Ph]. My question is could you talk about the addressable market of KLD product in comparison with the DLD product?
Rick Chen
Ako hi, this is Rick. The addressable market of KLD is about $90 million between the age from five to nine in China and this market is historically being way underserved. There has not been a particular product that meets the needs and wants of this particular age group in terms of learning. So, the launch of the KLD product-line not just by Noah, but also by other companies has greatly narrowed the demand gap among these young kids.
Ako – Oppenheimer
And also if you add affordability, would that reduce this $90 million to about one tenth of it?
Rick Chen
Well, first of all, you have to come to realize that the price point for the KLD product is about half of the DLD product. So, in terms of affordability, it will make the KLD product much more affordable than the DLD product in the second tier or third tier cities in China or even in the country side. So, the affordability issue is something that’s less relevant in the KLD market than in the DLD market.
Ako – Oppenheimer
Okay, so you just mentioned some competitors and what’s your competitive position right now, on KLD product?
Rick Chen
We have launched the KLD product in August of last year and before us, there are a few players that have got into this market and some of them have been in this KLD market for the last couple of years. We consider there are a couple of primary competitors in this market for us. One is Bubugao, BBK and the other one is Touchelong [Ph] which who has been in this market for the last couple of years. So, we are sort of a late mover into this market, but we have gained accretive attraction over the last couple of quarters.
Ako – Oppenheimer
Okay, and then can you also talk about this KLD current gross margin and the future gross margin target?
Rick Chen
The current margin for the KLD is around 42% to 43% and going forward, I think we expect that margin to improve to be around 45%.
Ako – Oppenheimer
Okay, I got you. Thank you so much, that’s all.
Operator
(Operator Instructions) At this time, there are no further questions. I would now like to turn the call over to management for closing remarks.
Rick Chen
Thank you everyone. On behalf of the management team, I would like to thank everyone for joining us today and for your support. We are committed into building shareholder value by executing on our strategy and we look forward to keeping you updated of our progress. If you have any questions, please feel free to call either Mr. Xu Dong, Dora or me. Thank you and have a good day or good night.
Operator
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day
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