Zhengdong Zhu – Chairman and CEO
Ping Wei – Chief Financial Officer
Ella Ji – Oppenheimer
Jeff Lee – Signal Hill
China Distance Education Holdings Limited (DL) Q2 2010 Earnings Call May 17, 2010 8:00 AM ET
Good evening. And thank you for standing by for the China Distance Education Holdings Limited Second Quarter Fiscal 2010 Earnings Conference Call. Today, you will hear from Mr. Zhengdong Zhu, Chairman and CEO of the company; and Ms. Ping Wei, the CFO. During the prepared remarks, all participants will be in listen-only mode. After that, the company management will be available to answer your questions.
Before we start, we would like to 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. Among other things, the outlook for second quarter of fiscal year 2010 and oral statements from management on this call, as well as the company's strategic and operational plans, 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 these and other risks is included in the company's annual report on Form 20-F 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 statements, except as required under applicable law.
As a reminder, this conference call is being recorded. A summarized presentation can be downloaded from the company's IR website and which we will refer to during the course of the call. In addition, a webcast of this conference call is available on the company's Investor Relations website at ir.cdeledu.com.
I will now turn the call over to Mr. Zhu to discuss the operational highlights. Mr. Zhu, please go ahead.
Thank you everyone for joining us on our second quarter fiscal 2010 results conference call. Our operating results were released earlier and available on the company's website as well as on newswire services.
As you would have seen from our results release, our total revenue came in below our estimated revenue guidance range for the second quarter.
The shortfall resulted mainly from a delay in the signing of a courseware production contract and an additional delay in cash collection for portion of our book sales, which were only recorded as revenue after the cash is collected. However, we expect this delay to be temporary and such revenues to be -- most likely be recorded in this fiscal year.
I would like to provide you with update on courseware production forecast, as this was one of* the reason that we missed our guidance.
In 2008, the company was unofficially invited to participate in National Primary and Secondary School Educational Resources Sharing Coalition Project, a government project whereby content provided by premier teachers for China are recorded and placed online, making them accessible to teachers and students alike from all over China especially those from remote areas. Since then, we have worked hard to diversify in [ph] both online network and the courses.
We understood from the uncertainties involved from the get go, but we believe that this program has a great potential to enhance China’s K-12 [ph] public education system and is a step towards modernizing the sharing of pedagogy backed practices among Chinese teachers and promoting equality in compulsory K9 [ph] education.
In addition, if this project is successfully rolled out, it will give us a big boost in our push into lucrative K-12 of the school market.
As such in the past two years, we made strategic investments into the project, and due to the uncertainties, all our direct costs and payments associated with the project has been expensed as occurred. In March, after all the effort we put in, we were asked to submit our official date to undertake the platform development and courseware production part of this project.
I’m happy to report that we have officially won the bid and we’ll soon sign a contract to become official part of this very important project.
In addition, we believe that what we have developed over the past two years now constitute a good portion of the work mandated. As such, soon after the completion of the official contract we expect to report sizable revenues.
Despite these two timing issues, our core business remains healthy. Our overall enrollment for the quarter grew slightly. This was partially due to the later timing of Chinese New Year.
In addition, the continued impact of the 2008 to 2009, half price promotion made same period last year a tough comparison. However, we experienced a solid demand across a number of verticals including accounting, continuous education, healthcare and construction engineering during the quarter.
More importantly, with only a few exceptions, we saw increase in growth momentum in virtually all our verticals after the Chinese new year holiday and particularly since March positioning us well for delivering of our annual operational target.
Let me now walk you through our operational development for the quarter in more detail.
Starting on slide five. Total course enrollment was about 204,400, a slight increase compared with the second quarter of 2009.
This was impacted by challenging year-over-year comparison due to the half-price promotion ended in the second quarter of fiscal 2009. But as I mentioned, we saw stronger growth across most of our core verticals with increasing momentum since March.
As a quick note, we will be referencing the half-price promotion which began in August 2008 and extended through February 2009 throughout the call as the half-price promotion.
Net revenue for the quarter increased 10.9% year-over-year to U.S. $7.5 million.
Our revenue increase was driven primarily by growth from our accounting continuous education, healthcare and construction engineering courses, partially offset by relatively slow enrollment in the quarter for APQE and CPA courses. All in all, online courses revenue increased by 7%.
In addition, Xinlixiang, our recently acquired Gaokao retake and high-school supplementary tutoring program also helps to increase our revenue by 52.6% year-over-year to U.S. $1.2 million.
And of course, as mentioned earlier due to the timing of correction, our book revenue disappointed, turning in 7.1% lower than the same period of last year.
However, from an operational level, we saw strong momentum in our book business and unrecognized book revenue now stands at U.S. $3.5 million, representing a 57% increase in actual distribution revenue volume year-to-date from the year-ago period.
Slide seven shows some operational update on our key service areas.
Our accounting continuous education courses, which were not included in the half-price promotion continued to record strong growth in the quarter. With the enrollment growing 86% year-over-year compared to same quarter of fiscal 2009, total revenue increased by 99% in the quarter, partially also due to the large increase in enrollment value from Q1 of 2010.
Enrollment for Accounting Professional Qualification Exam or APQE, and the China CPA Tax Preparation decreased on a year-over-year basis, primarily as a result of the half-price promotion and later timing of Chinese New Year. However, enrollment for CPA have resumed strong growth momentum starting from March.
We saw substantial increases in ASP in most of our accounting courses with the exception of accounting continuous education courses, partly due to the half-price promotion of last year.
As a result, except for APQE, which registered a slight cash revenue decrease, all our accounting courses registered healthy cash revenue increases in the quarter, such revenues also accelerated in Q3.
All in all, demand from most of our online courses is healthy. The growth trend in March to April indicates that demand remains reasonably robust and as a result, we are confident that we are on track to achieve our expected around 30% annual revenue growth target.
Moving on slide eight, our self-taught higher education courses.
Enrollment for self-taught higher education for the quarter was close to 9,800, a 3% increase from the same period of last year.
We just announced that we have expanded our self-taught higher education study process (Technical Difficulty)
Excuse me, ladies and gentlemen, we are having technical difficulty. Your lines will remain on silent hold until the call resumes. You may resume the conference.
We just announced that we have extended our self-taught higher education study process long-term program into Zhejiang and Hainan provinces, which provide us the access to an additional 700,000 self-taught higher education examination takers.
We have been designated the official provider in Zhejiang province, and have begun to roll-out the program and have done a multi-year exclusive contract with Hainan province.
To date, we have extended the program into six provinces, which together allow us to access the market with a collective size of 3 million self-taught higher education examination takers. We are slowly but surely building critical mass in this area. While, we do not expect meaningful revenue contribution until later this fiscal year, we’re confident in the revenue potential of those programs once they are fully rolled out.
Let's turn to slide nine, about other non-accounting course offerings. Enrollment for healthcare courses increased by 44% year-over-year, while cash ASP also showed a 7% increase in the period.
We believe this is a good performance, reflecting our high quality services and student satisfaction, as well as our strength in building brand recognition and in replicating our success in non-accounting verticals.
Construction and engineering courses also continue to see strong momentum in enrollment, with a 134% growth year-over-year, driven by the continuous education contracts. Cash ASP also increased 15%, as compared to same quarter of last year.
Moving onto slide 10. As mentioned in the last quarter, we did not recognize annual revenue for Yucai in the quarter. Meanwhile we recorded a total cost and expenses of about U.S. $290,000, significantly lower than the U.S. $570,000 in costs and expenses for last quarter, as we temporarily cutback the business start-up training program.
Nevertheless, I'm pleased to report that the reorganization at Yucai is almost complete. A new management team has been in place for four months now. And all the normal operations of post reorganized Yucai has resumed by now.
Also, we resumed delivering the training courses in April. We expect to continue to heavily expand operations from this point on and resume recognizing revenue within this calendar year.
We still believe in the market potential of the entrepreneurship training program that is the core value of Yucai, as we continue to resume the training program and expand it into new cities.
Finally, I'm pleased to report that Xinlixiang, our newly acquired Gaokao retake and high school supplementary tutoring business continue to progress well. Again, Xinlixiang was profitable in the quarter, generating a similar level of revenue and profit as compared with last quarter.
This completes my update on business operations. Let me now turn the call over to Wei Ping, our CFO, to walk you through our second quarter of fiscal 2010 financials.
Thank you, Chairman Zhu, and hello, everyone. It's a pleasure to be here tonight. As I have a bit of problem with my voice, I'm going to ask [Lily] to help me go through the prepared remarks. And I will be available together with Zhengdon Zhu to answer your questions.
And now, I'm going to turn the call back to Lily.
Okay. Turning on slide 12. We believe this quarter's performance highlights our continuous focus on executing cost and expense control. We continue to balance our growth initiatives with stringent cost controls to ensure the delivery of sustainable and profitable long-term growth. We will continue to employ stringent cost control to drive further margin expansion and profitable growth.
Let me now recap our key financial metrics for the quarter. Total net revenue for the second quarter of fiscal 2010 was U.S. $7.5 million, a year-over-year increase of 10.9% from U.S. $6.8 million in the second quarter of fiscal 2009.
Online education services net revenue for the quarter were U.S. $5.8 million, a 7% year-over-year increase. Despite the challenging comparison due to the half-price promotion, the year-over-year improvement was driven by the increased enrollment in accounting continuous education, healthcare and construction engineering courses, together with the higher average selling price of most [ph] of our verticals.
Revenue from books and reference materials declined by 7.1% to U.S. $0.5 million for the quarter, as a result of the delayed cash collection from our distributors.
Other revenue, primarily comprised with magazine content production services, in-person training courses and related services, and Gaokao retake courses offered by the newly acquired Xinlixiang, increased by 52.6% year-over-year to U.S. $1.2 million for the quarter, mostly driven by the contribution from Xinlixiang.
Cost of sales for the quarter was U.S. $3.7 million, an increase of 6.7% over the same period of 2009. Excluding share-based compensation non-GAAP, cost of sales was U.S. $3.3 million, an increase of 15% over the same period last year.
The year-over-year increase in cost of sales was mainly due to the increased rental and other costs for the new Gaokao retake courses offered by Xinlixiang.
Gross profit for the quarter was U.S. $3.8 million, representing 15.3% year-over-year increase. Excluding share-based compensation, non-GAAP gross profit was U.S. $4.2 million, representing a 7.2% year-over-year increase.
Gross margin was 50.8%, compared to the 48.8% in same quarter last year. Excluding share-based compensation, the non-GAAP gross margin was 55.4%, compared to 57.4% in the same period of 2009.
The decrease in non-GAAP gross margin was primarily a result of costs incurred by Yucai, and increased rental and facility expenses as we expanded our rental space and facilities to accommodate the new Gaokao retake courses and information technology courses, and the decrease in share-based compensation in the second quarter of fiscal 2010, compared to the same period of last year.
Total operating expenses for the quarter was U.S. $3.7 million, a year-over-year increase of 12.5% and a sequential decline of 10.1%. Excluding share-based compensation, non-GAAP operating expenses were U.S. $3.2 million, an increase of 14.7% year-over-year and a sequential drop of 7.5%.
Selling expenses were U.S. $1.7 million, a 5.7% increase year-over-year and a 16.2% decrease quarter-over-quarter. Excluding share-based compensation, non-GAAP, selling expense were U.S. $1.6 million, a 6.3% increase year-over-year and a 16% decrease quarter-over-quarter as we continued to exercise stringent cost controls.
For the fiscal third quarter, we expect our selling expenses to increase sizably from the year ago period, as a fiscal third quarter is an important promotion time for both CPA courses and the Gaokao retake undertake tutoring program for the summer.
General and administrative expenses were U.S. $2 million in the second quarter of fiscal 2010, representing a 19% year-over-year increase and a 4.2% sequential decrease. Excluding share-based compensation charge, non-GAAP, general and administrative expenses were U.S. $1.6 million, an increase of 24.3% [ph] year-over-year and 2.8% sequential increase.
The increase in general and administrative expenses was primarily due to higher office expenses and professional fees. This quarter, we recorded an income tax expense of U.S. $800000, compared with tax expense of U.S. $230,000 in the same period of last year.
Net income was U.S. $0.2 million for the second quarter of fiscal 2010, compared to net income of U.S. $0.3 million in the same quarter last year. Excluding share-based compensation, non-GAAP net income for the quarter was U.S. $1.1 million, compared to the net income of U.S. $1.4 million in the corresponding quarter in 2009.
Slide 12 shows the details of our balance sheet and cash flow numbers. Net operating cash outflow for the quarter was U.S. $2.6 million, comparing to a net cash inflow of U.S. $1 million in the same period of last year.
This was primarily due to the placement of U.S. $2.8 million restricted cash into a court appointed restricted bank account relating to Yucai legal arbitration that we initiated to recover the acquisition consideration pay to a previous owner of Yucai. The increase in prepayment of book printing and other deferred costs also contributed to the decrease.
As of March 31, 2010, deferred revenue and refundable fee balance was U.S. $12.4 million, a increase of 4.2% from the balance of U.S. $11.9 million for the first quarter of fiscal 2010 and 29.2% increase from the second quarter of fiscal 2009.
Cash and cash equivalents, term deposits and restricted cash as of March 31, 2010 was U.S. $57 million, a slight decrease from U.S. $57.3 million as of December 31, 2009, as we continued to buyback shares as part of our share repurchase program.
This completes the financial overview. I will now turn the call back to Mr. Zhu for the final remarks on strategy and business update, as well as, financial guidance for the third quarter of fiscal 2010.
In conclusion, we faced a number of challenges which impacted our results for the quarter. However, we remain confident in our outlook for the remainder of the year and beyond, based on a number of factors.
First, we are seeing positive signs in the momentum of our core online education courses, namely, accounting, healthcare and construction engineering, underpinning our confidence in the continued strong demand for our courses.
Second, Xinlixiang, our new Gaokao retake and a primary secondary school supplementary education had delivered in line with our expectations.
Third, we expect the delayed revenue from courseware production is most likely to be recorded in this fiscal year. And finally, we continue to expand the market for our self-taught higher education. They process [ph] long-term program, which we believe will be a key growth driver over the medium-term. As a result, we believe our business is well positioned to deliver growth in our seasonally stronger second half of the year.
Our revenue guidance for the third quarter of fiscal 2010, we expect our revenue to come in between U.S. $10.3 million to U.S. $11.3 million, as compared to the net revenues of U.S. $8.3 million in the third quarter of fiscal 2009. This represents the company’s current and preliminary view which is subject to change.
Thank you for your time. We’d now be happy to take your questions.
(Operator Instructions) And your first question comes from Ella Ji with Oppenheimer.
Ella Ji – Oppenheimer
My first question, I want to clarify that in your next quarter’s revenue guidance, have you included any revenue from the courseware production contract that was delayed in this quarter?
Ella, this is Ping Wei. For next quarter’s guidance -- thanks for the question by the way, our next quarter’s guidance, we actually did not look at sort of specifically what should be included, what should be excluded. In general, we provide a relatively conservative guidance and discounting basically the probability of both the courseware production revenue potential as well as the Yucai revenue potential.
However, basically the short answer to your question is it’s partly considered, but the range as to provide the cushion and sort of possible discount for the kind of revenues. We talked about the rate of courseware production and the Yucai’s, sort of, training course revenue.
Ella Ji – Oppenheimer
Okay. Okay, thanks for that. And you mentioned that you remained comfortable to achieve a 30% annual revenue growth for this fiscal year. Now my rough calculation shows that, it suggests the fourth quarter, in the fourth quarter, you would have to grow 50% in the fourth quarter to achieve annual growth rate in the service. Could you talk about how much is organic growth in your existing online education business and how much would be the contribution from your new growth drivers? Thank you.
That’s a very good question. In fact, Ella, Zhu said around 30% and so I think, he sort of more provide that from operational highlight level. As you know, we do not actually provide sort of annual revenue guidance. We only guide next quarter and we are comfortable with the $10.3 million to $11.3 million of revenue guidance for next quarter. Looking to full year, I think we’ve talked about 30% -- around 30% or 20% to 30% kind of revenue growth all out and we don’t see any sort of signs that we will make us to adjust the expectation for the year yet.
However, as our business move along, if we see sort of signs that we have typically achieving the original planned gross target then we will let you know [ph]. So I guess that’s the best I can sort of, shed light on the Q4 or fiscal year performance.
Ella Ji – Oppenheimer
Right. Thank you. My -- and then for your self-taught higher education, can you update us with -- like for example you rolled out in Jiangsu and Yunnan province last quarter. Could you update us with the progress in the two provinces?
Right. Actually, Jiangsu has top scored [ph] actually for two quarters. So the final exam will be the July 2010 exam for both basically so the test trials for six months and then they will need to access the result. So at this movement, the trial is still going on and it should be concluded somewhere during the summer or around September. And we will have a much better sort of an update for our investors at that time.
In terms of Zhejiang, we are finalizing the plan and then it should be rolled out fairly soon. And this year, new province, actually I would like to add this on the two new provinces though we just sort of make progress, fairly quick progress. One is Hainan, we’ve already started a test trial project as well in Hainan and same thing we’ve done actually in a larger scale. So that’s why we talked about we’re very comfortable with the size of our revenue contribution towards the later half of this year.
Ella Ji – Oppenheimer
Great. Good to know. Thank you very much.
You’re very welcome. Thank you, Ella.
Your next question comes from Jeff Lee with Signal Hill.
Jeff Lee – Signal Hill
Hi, thank you. Good evening. I want to follow-up on self-taught a little bit. I guess these trials that you mentioned what means to happen before you can get more significant growth from self-taught in new provinces. And assuming there is some sort of positive result to these trials then what’s the next step?
Right now, the trial program typically is limited number of courses to limited number of schools and limited number of student base. The trial result, once the results are evaluated, the sort of classic next step or typical next step will be to open up as many courses as possible to the general self study population with Zhejiang province.
So that’s basically at current sort of test trial basis there’s only a few thousand students per quarter for a few subjects. Once we are into the full -- sort of full-fledged kind of enrollment phase, it should be addressable market of about 3 million students and basically virtually all the courses we are with the critical mass and whereby we can offer the study process monitoring program. So that’s a significant difference actually.
Jeff Lee – Signal Hill
And what are the dates that all these trials are being conducted on? I mean you mentioned the two provinces already, what about the other provinces?
Zhejiang, right now, is actually on voluntary enrollment basis. We don’t have much limitations. But it’s actually -- with Zhejiang, we are a little bit in sort of passive. We are taking the lead from our partner locally. So we need to work with our partner more to sort of push the program forward. In terms of Jiangsu, the trial program should complete sometime in August. Same thing with the few other provinces and Beijing has still same status as we talked before. There is no progress there.
However, at the same time, I do believe we are working actually also with the few provinces that we have not signed a contract with, so technically these other few provinces also under test trial period. So you can see that the test trial period for quite a new provinces more or less all complete around like September to November kind of timeframe. So that’s why we hope that by end of this year with the sizable enrollment -- or sizable enrollment ramp-up.
Jeff Lee – Signal Hill
So given that timeframe, is it likely that significant revenue wouldn’t come from self-taught until next fiscal year?
We’re actually still hoping that the final quarter of this year will see a fairly decent revenue contribution. But we will have to wait and see.
Jeff Lee – Signal Hill
Okay. I want to ask you about your (inaudible)? How much revenue did they contribute in the quarter? I mean did you have any plan for expansion there or considering any additional K-12 acquisitions?
Right. The revenue contribution for the quarter is about U.S. $600,000 and the profit contribution is about $150,000. It’s fairly stable for last quarter and this quarter and we expect similar contribution for the next quarter as well. Because they enroll students once a year, once the students are in, we have revenue more or less locked up for from September to June.
Now, in terms of our trend on the K-12 vertical, the (inaudible) about the sort of primary school coalition program, that is more or less official by now. So it’s going to be one of our key focus for the next, while on the K-12 vertical. Because that project while we keep on talking about the one million potential courseware recording revenue, totaled project budget for CDEL is actually a bit over U.S. $2 million.
And in addition to $U.S. 1 million or U.S. $2 million, a few other pieces of the K-12 strategy includes one, the actual online courses that would are generate revenue for us, which we are actually sort of we are still working on the model. We want to rollout a product model that’s actually definitely at the cutting edge of this than sort of business segment and also sort of pass to parents and kids. And at the same time, the Gaokao retake school in the K-12 office school tutoring (inaudible) even though Xinlixiang is doing well. It’s sort of dip of our toe in the water and we don’t actually expect Xinlixiang to expand dramatically in the next year.
In addition, whether we plan on acquiring new businesses similar in nature as compared to Xinlixiang, I would say, at this moment we are not really that aggressively seeking acquisition targets. But it’s part of our growth strategy, it’s part of our K-12 growth initiatives. So we continue to look for targets.
Jeff Lee – Signal Hill
Okay. You mentioned working on the models for actual online courses that would generate revenue. What sort of timeframe are your plans there?
We’ve always talked about sort of by end of this calendar year and we don’t see any changes in the timeline.
Jeff Lee – Signal Hill
Okay. And one about Yucai, you mentioned you expect to generate revenue during this year, dividend issues you have in the past quarters generating revenue. What gives you confident that you will be able to clock revenue?
That’s great question again, Jeff. Yucai, actually when we reported last quarter, it was actually -- it was still a tough time for us, we’ve replaced the management. We’ve done a lot of things to sort of make sure the business going to be healthy long-term -- for the long-term. We really like the project and the project as we expected having a great potential. Now, why we are confident at this moment that would generate revenue, this fiscal year given all the provinces, we have resumed the training in the cities that were sort of -- that we reconnected, even though we did not do any training in January to March timeframe.
In addition, we actually (inaudible) and human resources and social securities actually sort of jointly worked with us to work with local labor department to sort of further promote our program. They have officially started to do so and as a result, it’s much smoother profit now for us to review courses in existing province, cities as well as expanding to new cities.
So we are more or less back on track on providing the business start up training to the student base that we discussed in prior quarters. And with the program now reinitiated, resumed we are much more comfortable and with the new management team in place executing on the delivery and working with the ministry of labor and minister of finance on the collection side much more comfortable with what Yucai can achieve going forward.
Jeff Lee – Signal Hill
Okay. Great. Thank you. And last question, in your press release, you referred to accelerating enrolment growth beginning in March. Was there significant increase in your March spend that gives you more confidence going forward?
The short answer is, yes. The increase is actually quite significant. But I don’t you want to draw conclusion on the number but I can -- but what I can say is based on the cash enrollment numbers I’ve seen for March, April and the two weeks in May, our cash revenue actually increased in the neighborhood of 50%. But then like I say don’t build your expectation based on that number, it’s actually a fairly high number even for us.
Jeff Lee – Signal Hill
Okay. Great. Thank you very much.
You’re very welcome, Jeff.
(Operator Instructions) And you have a follow-up question from Ella Ji with Oppenheimer.
Ella Ji – Oppenheimer
Hi, it’s me again. Just want to follow-up -- just want to ask you about your potential use of cash balances on your balance sheet. Will you consider potential share repurchase or dividend, or what’s the focus of your main cash use? Thank you.
Ella, that’s a great question. We still have about U.S. $57 million of the cash on balance sheet. Right now, we don’t have it used for in operations as we continue to generate cash flow from operation activities. And incomes from share repurchase, we have an active repurchase program in place, sort of approved by the board. The overall repurchase plan is still U.S. $10 million, we’ve used up over U.S. $4 million.
So it’s still on, it’s active. At this moment, we don’t have dividend plans. We still look to acquire businesses that complements or supplements our current growth strategies and as we continue build on shareholder values for our shareholder. So in short-term, we don’t plan on dividing cash back to shareholders. We will continue to buyback shares and we hope to be able to deploy our capital that entrusted our investors to ask to sort of to deliver incremental sort of earnings to our shareholders.
Ella Ji – Oppenheimer
Thank you very much.
Okay. Thank you, Ella. And if there are no other questions, on behalf of the management team of CDE, we’d like to thank you again for joining us today. And we look forward to updating you on our progress in the near future. Thank you.
That concludes today’s conference. Thank you for your participation. You many now disconnect.
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