Executives
Zhengdong Zhu - Chairman and Chief Executive Officer
Ping Wei - Chief Financial Officer
Taylor Rafferty - Investor Relations
Analysts
Mark Marostica - Piper Jaffray
Catherine Leung - Citigroup
Echo He - Oppenheimer
China Distance Education Holdings, Ltd. (DL) F1Q09 Earnings Call February 17, 2009 8:00 AM ET
Operator
Good evening and thank you for standing by for the China Distance Education Holding Limited fiscal 2009 first quarter earnings conference call. Following an introduction and Safe Harbor statement by Taylor Rafferty, you will hear from Mr. Zhengdong Zhu, Chariman and CEO of the company and Ms. Ping Wei, the CFO. After the prepared remarks, management will be available to answer your questions.
Taylor Rafferty
Thank you everyone for joining us on our first quarter 2009 results conference call. Before we start we would like to remind listeners that this conference call contains forward-looking statements. The statements are made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. Among other things, the outlook for second quarter of fiscal year 2009 and oral statements from management on this call as well as the company’s strategic and operational plans and the new investment contain forward-looking statements.
Forward-looking statements involve inherent risk and uncertainties. A number of factors would 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 registration statement on Form F-1 and other documents of the company as filed with the Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statement except as required under applicable laws.
As a reminder, this conference call is being recorded. A webcast of this conference call and the presentation which we will refer to during the call is available for download on our investor relation website at ir.cdel.edu.com.
I will now turn the call over to Mr. Zhu to discuss the operations highlight.
Zhengdong Zhu
(Presentation in Mandarin - Translation below)
Thank you everyone for joining us on our fiscal 2009 first quarter results conference call Our operation results were released yesterday and are available on the company’s website as well as on newswire services.
I am pleased to report that on February 4, 2009, we successfully transferred the listing of our ADS’s from NYSE archive to the NYSE main board. This transfer allows our ADS to be listed and treated together with many highly regarded business names around the world on the same platform.
Our business follows a seasonal pattern primarily driven by test states with the majority of those states falling in our Q3 and Q4. As a result, the first quarter is typically our slowest quarter in terms of revenue and not profitable; however, we delivered strong results despite the normal seasonal pattern.
Enrollment for the first quarter of fiscal 2009 increased over 137% year over year to more than 341,000 and we recorded net revenue of $4.9 million representing a year over year increase of 171.2%. At the same time, we were able to achieve good improvement in margin levels.
There are two key factors that contributed to our results. First, we believe our performance in the case that we have not seen any slowdown in the demand for our online educational services. On the contrary, as the job market becomes more competitive in a softening economy, the demand for professional qualifications and certifications will likely increase as students want to better equip and differentiate themselves from the competition.
Second, we believe the steady growth in enrollment and revenue was also partly a result of students enrolling earlier to take advantage of our half-price promotion we held during the quarter, and to help leverage the benefits of the promotion to attract new students to study online and thereby gain further market share, we invested in the marketing campaign during the quarter in support of the half-price offer.
While we are the clear leader in the online professional education market, we believe there remain huge long-term growth opportunities in what is still a developing market. Therefore, we will continue investing in the business in support of our strategy and we believe we remain well positioned to capitalize on the robust growth opportunities in the online education market.
Now, let me provide you with some operational update on our key service areas. First, we continue to see robust enrollment growth for accounting courses, especially our traditional test preparation courses such as Accounting Professional Qualification Exam or APQE, CPA, and other exams. Enrollment for such courses saw an increase of 53% to 179,000 as compared to the first quarter of fiscal 2008. At the same time, we continue to penetrate the accredited provincial market for the continued education market. We are now accredited by 24 provinces and cities to provide accounting continued education courses and have achieved an overall enrollment of more than 100,000 for the first quarter. We expect enrollment for accounting continued education to fluctuate from quarter to quarter, but overall we expect this program to continue to grow in fiscal year 2009.
We also continue to make good progress on the self-taught higher education studying process monitoring program, one of our important mid to long-term growth areas. We can now offer virtually all courses to students in Tianjin, and we have already opened 80 modules for the study process monitoring program and we are still adding more courses. We expect enrollment for future quarters to continue to ramp up in Tianjin.
Last month, we announced our exclusive partnership with Beijing City University to provide self-taught higher education studying process monitoring programs for non-full-time students in Beijing. We believe the expansion of this program from Tianjin to Beijing which has more than double the number of students as Tianjin reflects the strength of our brand name and our position as an industry leader. We expect the Beijing program to begin generating meaningful revenue by the end of fiscal year 2009 or the beginning year of fiscal year 2010. We will continue to pursue opportunities with other provinces to further expand this program.
In the healthcare segment, high season for enrollment is typically Q2 and Q3 of our fiscal year; however, we have expanded our course offerings in the healthcare segment go from 16-course offering in the first quarter of fiscal 2008 to 28 course offerings in the first quarter of fiscal 2009 and our enrollment for healthcare courses also doubled for the first quarter of fiscal 2009 to around 4300, up from 2200 for the corresponding period in 2008. We expect this segment will continue building momentum in the coming quarters.
We are the sole sponsor of the Ministry of Education’s ITAP contest and the exclusive online trainer for the contest. This program brought us about 36,000 enrollments during Q1 2009. We also paid a substantial sponsorship fee in the quarter which is part of the reason why our sales and marketing expense was high this quarter.
In addition, as we mentioned in the conference call last quarter, we launched premium classes for most of our subjects including accounting, healthcare, and legal in August 2009. The pricing of premium classes is somewhat of a halfway point between our regular and elite classes. The classes do not offer refund for students who do not pass the exams; however, students are entitled to re-register for the same course at a 50% discount for the next year. This strategy has proven successful and the cash enrollment revenue from the premium classes during the period was over 17% of total online education cash revenue. We will continue promoting this new set of classes in order to enhance our course offering and generate more revenue per enrollment.
Let me provide a brief update on our promotions. The half-price promotion campaign we launched last year was concluded on February 1, 2009, and prices for our courses have resumed normal levels. Over the promotional period, overall we did not see a significant drop in the average student payment while at the same time enrollments grew significantly.
To match the discount we also launched a major marketing campaign to promote our courses. This campaign coupled with the ITAP sponsorship and scholarships that we typically gave out at this time of the year and the increased commission paid to our online distribution agents due to higher sales volume resulted in much higher sales and marketing expenses.
To capitalize on the robust growth opportunities in the online education market, we expect to continue investing in business, infrastructure, and promotional activities. As such, we expect our selling expenses to largely remain in line in the ensuing quarters. Additionally, we are happy to report that we did not see a major dropout in enrollment momentum post the promotion campaign.
This completes my update on business operations. Let me now turn the call over to Wei Ping, our CFO, to walk you through our first quarter financials.
Ping Wei
Thank you Chairman Zhu and hello everyone. We have a PPT for this conference call at this time, so please turn to slide 11 of our presentation for the financial review. The fiscal first quarter is traditionally a seasonally slow quarter for our business, but nevertheless we were able to deliver a strong year-over-year growth for the quarter as we continued to see robust demand for our education services across most of our product lines.
Let me first recap our key financial matrix for the quarter. Total net revenues for the first quarter of fiscal 2009 were $4.9 million representing a year-over-year increase of 171.2% from $1.8 million of last year. Online educational services net revenues for the quarter were $4.4 million, an increase of 188% from the same period in 2008. The increase in online educational services net revenues were mainly due to strong course enrollment growth in various subject offerings such as accounting continued education, ITAP contest, and healthcare. Such increases were in part a result of the recognition of approximately $0.9 million of APQE elite cost revenue deferred from the fourth quarter of fiscal year 2008.
Our complementary business also recorded strong growth. Sales of books and reference materials grew to $0.3 million for the quarter from $0.2 million in Q1 2008. In addition, other revenues increased to $0.3 million and an increase of 121% over the same period in 2008. Other revenues primarily comprised of platform production and related services.
Cost of sales for the quarter was $2.5 million, an increase of 147.8% over the same period in 2008. Excluding share based compensation, cost of sales was $2.1 million, an increase of 103.7% over the same period last year. The increase in cost of sales was primarily due to increased lecture fees, course production, and tutoring service personnel cost as well as server maintenance fees due to the increased usage of online infrastructure by a larger number of course participants than the first quarter of 2008.
Gross profit for the first quarter was $2.4 million representing a 200.6% increase year over year. Excluding share-based compensation, non-GAAP gross profit was $2.9 million, a 256% increase year over year. Growth margin was 49.2% compared to 44.4% in the same period last year. Excluding share-based compensation, non-GAAP gross profit for the first quarter of fiscal year 2009 was 58.2% as compared to 44.4% in the same period last year. The significant expense in growth margin was primarily due to slower increase in cost of sales relative to the increase in the revenues which demonstrates the scalability of our business model.
Total operating expenses for the first quarter of fiscal 2009 was $3.4 million, a year-over-year increase of 257.9% and a 49.8% sequential increase. Excluding share-based compensation, operating expenses were $2.9 million, an increase of 207.7% year over year and a 67.3% sequential increase. The increase in selling expenses was primarily due to a major marketing campaign, the ITAP sponsorship and the increase to revenue generated through our online distributors. The increase in G&A was primarily resulted from the audit and focal advisory service costs associated with being a US listed public company. Income tax benefit for the first quarter of fiscal 2009 was $0.2 million as compared with an expense of $4000 in the same period of 2008.
We have obtained preliminary approval of high tax status for income tax purpose, but have not received the final paperwork. So, to be conservative, we used 25% tax rate for the current quarter, but we maintained our expected effective tax rate for the fiscal year at 13%. Net loss was $0.5 million for the first quarter of fiscal 2009 compared to net income of $19,000 the same time last year. Excluding share-based compensation, non-GAAP net income for the fiscal first quarter was $0.4 million as compared to $19,000 the same period last year.
Now, let us move to slide 12, which shows the details on our balance sheet. Net operating cash flow for the first quarter of fiscal 2009 was $0.6 million, a decrease of 68.2% over the same period last year which was resulted primarily due to the increase in accounts receivables balance. Cash and cash equivalents as of December 31, 2008, decreased to $64.4 million from $66.2 million as of September 30, 2008. This decrease was mainly due to payment of capital expenditure for the purchase of equipment and intangible assets, initial public offering expenses, and the repurchase of our ADS’s from the open market in the amount of $1 million, $0.9 million, and $0.5 million respectively. Such decrease was partially offset by the $0.6 million of operating cash flow generated in the quarter. Deferred revenue and refundable fee balance was $9.7 million, a 46.3% increase from the balance of $6.6 million for the first quarter of fiscal 2008.
This completes my financial overview. Now, I will turn the call back to Mr. Zhu, our CEO, for the final remarks on market and business outlook as well as financial guidance for the second quarter of fiscal 2009.
Zhengdong Zhu
(Presentation in Mandarin - Translation below)
We are pleased with our performance for the quarter and we believe it represents clear proof of our growth strategy which is shown on slide 14. For 2009, we will continue to execute our integrated strategy.
The expansion of the self-taught learning program from Tianjin to Beijing is a clear demonstration of the scalability and resourceability of our business model. We believe it also demonstrates our ability to execute our growth strategy to expand existing business lines while continuing to grow organically by increasing enrollment in existing course offerings. We anticipate self-taught programs to become a key medium to long-term growth driver.
In addition, I am delighted to inform you that we just signed a new investment contract yesterday to expand our business into provision of business startup practical training. The agreement was entered into by our affiliated company, Beijing-Chapin Hi-Tech Company and Beijing-In Lung UPEI Education Consulting Company Limited, a leading provider of business startup training in China. Under the agreement, Beijing-Chapin will invest RND 36 million to acquire from UPEI all of its existing operating assets and businesses. After the completion of such acquisition, Beijing-Chapin will hold 60% of the equity interest in the new company. The new program will target university students, the unemployed, and any individuals who are interested in learning to start up business. The transaction will allow us to pursue business opportunities in the employment practical training area and we believe recent softening of economy will bring in more opportunities in this base. Furthermore, Chinese government strongly encourages the provision of such practical training to promote employment opportunities in the country.
Looking ahead, we believe economic softness in China and a more competitive job market will provide us with new opportunities as students increasingly look to leading industry players, like China Distance Education. To capitalize on this opportunity, we will continue to invest in and grow the business in step with the needs and interest of our students. We believe all these factors will allow us to continue to enjoy steady growth in fiscal 2009.
As such looking to our guidance on slide 16, due to the normal seasonal pattern the fiscal second quarter is typically stronger than the first quarter and we expect to generate total net revenue in the range of $6.8 million to $7.7 million. This represents the company’s current and preliminary deal, which is subject to change.
Thank for your time and we would be happy to take your questions.
Question and Answer Session
Operator
(Operator Instructions). The first question comes from Mark Marostica of Piper Jaffray.
Mark Marostica - Piper Jaffray
Nice work on the quarter. A few questions for you; the first one I want to ask is about the deferred revenue this quarter up quite significantly. When we look at that close to $10 million figure, how much of that will drop into Q2, the March quarter, and how much of the March quarter guidance is new revenue and perhaps if you could just talk about how you are tracking quarter to date so far on the second quarter.
(Mandarin Translation of above question)
Zhengdong Zhu
(Response in Mandarin - Translation below)
Based on our current analysis, we expect over $3 million of deferred revenue on the balance sheet as at the end of the quarter to be converted into the Q2 2009 revenue, but in Q2 2009, we probably will also accumulate new deferred revenue as well.
Mark Marostica - Piper Jaffray
Okay. Could you make a comment just in terms of how you feel the quarter is tracking, maybe relative to last year so far and half way to the quarter, but you did mention with the half-price promotion having ended at the beginning of the month, it sounded like enrollment trends are still very strong.
Ping Wei
At the moment, we are quite comfortable with our guidance. What we see in addition to the Q1 deferred revenue balance that will be recognized in the quarter, the cash enrollments over the six weeks’ time we seen is actually pretty strong as well, which we expect to generate around $2 million US dollar revenue in the same quarter. So, generally speaking we should be pretty comfortable with our guidance.
Mark Marostica - Piper Jaffray
Chairman Zhu also mentioned the accounting continued education, which is very strong this quarter; tends to fluctuate. I wonder what that may portend for Q2 and maybe just talk about the general seasonality of accounting continuing education.
(Mandarin Translation of above question)
Zhengdong Zhu
(Response in Mandarin - Translation below)
In terms of accounting continued education seasonality, usually for the first physical quarter and even the second due to the Chinese New Year and the long government holidays, the enrollment is affected a bit, but usually by third quarter it will pick up.
Ping Wei
Mark, just a bit of additional color on this. Fiscal first quarter is typically strong while fiscal second quarter because there is a Chinese New Year in there will be as far as we have seen so far as relatively light and slow. We do expect it to pick up towards the second half of the fiscal year.
Mark Marostica - Piper Jaffray
Moving onto the self-taught business and obviously Tianjin now fully operational, I guess to have the same question with Beijing; when do you think that relationship will become fully operational and generate meaningful revenue, and then perhaps if you can comment on any other self-taught fields that may be in the pipeline and when do you think those might come to fruition.
(Mandarin Translation of above question)
Zhengdong Zhu
(Response in Mandarin - Translation below)
In terms of self-taught project program in Beijing, we have already signed an agreement but we still are finding the detailed terms. We would expect to see some meaningful contribution by the last quarter, fourth quarter of fiscal 2009 or the first quarter in 2010. As our program in Tianjin gained success and expanding the program to Beijing, and with our strong promotion effort of this program, we will expect to see great results in more provinces and cities very soon.
Ping Wei
Mark, just to add a bit more on the Beijing side, Beijing we have the complete agreement. Right now it is working with the government authorities on the specifics of how this program should work in Beijing. So our partners and us are working together on this.
Mark Marostica - Piper Jaffray
Okay. One last question and I will turn it over. I am curious how much one-time or nonrecurring selling expenses were incurred in the first quarter. I am just trying to get a sense for how to model selling expense going forward given that you had some non-recurring items, it looked like, in that line item this quarter.
Ping Wei
Why don’t I give you an idea of the composition of the Q1 selling expenses. In the Q1 selling expenses, they are about $200,000; that’s actually the commission to the online agent which you probably will continue to see ramp up as more revenues come from online distribution network, but that has to do with our revenue recognition policy basically full amount of the students enrollment coming from online distribution agent will be recorded as revenue. So, as a result their percentage of commission will flow to sales and marketing and we actually would like to have that part go further up. Other than that the ITAP sponsorship, about $150,000, is a once year. So you won’t see that in the next quarter. Having talked about the specifics of this quarter, the Chairman also mentioned earlier and in general our sales and marketing in future quarters will be in line with what we saw in the first quarter, and on annual basis we do not see a dramatic uptick in our sales and marketing expenses from our expected or budgeted amount.
Mark Marostica - Piper Jaffray
So, just taking that into consideration, should we just assume that the amount that you posted this quarter, I think it was $1.3 million, that should be what we should be modeling, in and around that.
Ping Wei
Yes, I would say taking out a share-based compensation of about $100,000 in the quarter, the base number probably will be that level for the remaining of the year give or take probably $100,000 in up and down fluctuation.
Operator
Your next question comes from Catherine Leung of Citigroup.
Catherine Leung - Citigroup
My question is on the Tianjin continual assessment program. Has this been ramping overall in line with your expectations and is there anything that the company can do to accelerate the growth in this program now that all the subjects are effectively being offered under this program. Secondly on the acquisition, could you please discuss more of the rationale and benefits of this cooperation with In Lung UPEI?
(Mandarin Translation of above question)
Zhengdong Zhu
(Response in Mandarin - Translation below)
I believe the policy is very beneficial for the students, but it takes time for the students to really trust and getting to know the new system and applying to the policy. In terms of the government regulation, the self-taught higher education’s main office, they actually opened up this market step by step. We actually implemented the program in three different phases. In phase 1, basically we only opened three basic classes, and for the phase 2 which was during the Olympics, where we were waiting for some approval at that time. For the third phase, their classes opened, but we did not do much promotion during that period. Now it is in the phase 4, which is targeting April 2009 test date, we have opened, and all classes have overall all useful gear and now we are able to offer a total of 95 different courses to the student in Tianjin. Now we will fully leverage this policy and we will market and promote our program in full gear.
Ping Wei
Basically utilizing our course platform, that is the (inaudible) and also when students are coming to register in person, we tell them about the program on the site.
Zhengdong Zhu
(Response in Mandarin - Translation below)
So we’re very confident in the mid to long-term growth of self-taught education program.
Ping Wei
Okay. Catherine, I would like to also give you a bit of light on the numbers as well. When Tianjin opened up all the subjects to us in the mid of October, from October actually to mid of December, that is when students start to enroll for the exam of January, we only had about 100 enrolments in total and post January exam to date, which is still before we start to actively promote the course when the students register for the exams of April, over this short period of time we already see post exam enrolment of around 1000 students, which is certainly dramatic if you look at the comparison, but still for the April exam the heavy enrolment will come somewhere in March, so we should have a much better idea of the traction we have gained in March as well.
Zhengdong Zhu
(Response in Mandarin - Translation below)
For In Lung, their program is targeted for the students and the unemployed to provide training or improve their ability to start up business. The great synergy between the two companies we will actively promote this program to the university students. I believe the combination of the online and offline programs will provide great growth opportunities in the future. Currently, this program is offline face-to-face program. In the future when we extend that to the online programs we will believe the synergy will be even more and then the effect will be even greater. This program also receives great government encouragement in terms of monitoring events, encouragements, etc., the purpose is to promote employment and increase employment level across the country. After the acquisition we will principally use their regional management team and will not use up too much CDEL’s management time.
Ping Wei
I will add a bit more to this. I just mentioned that with the government support and encouragement, actually for the new company, it will have more than 20 projects approved and signed with the Government whereby the Government will actually provide payments to train students to become young entrepreneurs and start their own business, so they are not actively on the market looking for work that is not there, and secondarily from a financial perspective, we actually expect this project to generate net income in the first year and so in that sense we expect the project to be accretive to EPS.
Operator
Your next question comes from Echo He of Oppenheimer.
Echo He - Oppenheimer
Could you talk some about the market and what the market penetrations is at current stage and your future growth; is it because of a higher market penetration or because of market consolidation?
(Mandarin Translation of above question)
Zhengdong Zhu
(Response in Mandarin)
Echo He - Oppenheimer
Let’s talk about APQE and CPA and accounts orders based on the financial sector.
(Mandarin Translation of above question)
Zhengdong Zhu
(Response in Mandarin)
Ping Wei
We think it’s a combination of both; the purpose of our marketing campaign in the quarter so as to increase penetration, basically attract new students to us as well as to consolidate on more market share that is already there in the online market, but at the moment it is hard to quantify how much market share we have gained and how deeper the penetration we have obtained.
Echo He - Oppenheimer
Is it a similar situation to other areas like self-education and others?
Ping Wei
Self-education in health care is a bit different in that than both of these businesses we are actually nurturing the market, so market penetration is very, very low at the moment and so the primary goal will be to penetrate the market. And on the accounting side, we take right now already around 70% of online market share and we think that will actually slightly go up even though we cannot quantify the percentage that has gone up.
Echo He - Oppenheimer
Okay. The second question is about the future trend of your cost of revenues; the cost of service as in the cost of intangible goods and both.
Ping Wei
Only cost of tangible books the margin should be relatively stable at around 50% that is basic how we price our product. Now, on the online course revenues, one thing for sure is this year or next year our revenue growth will typically be faster than the sort of cost of revenue increase. So at the moment we maintain our objective or our view that our margin level of fiscal year 2009 should go back to our margin level of fiscal of 2007.
Operator
There are no further questions at this time. Please continue.
Ping Wei
Thank you all again very much for joining us today, and we look forward to updating you on our progress in the near future. Thank you. That concludes our call today.
Operator
Thank you very much. That concludes our conference for the day. Thank you for participating. You may now disconnect.
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