China Distance Education Holdings Limited (NYSE:DL)
Q3 2014 Earnings Conference Call
August 14, 2014 8:00 a.m. ET
Zhengdong Zhu – Co-Founder, Chairman and CEO
Ping Wei – CFO
Gene Munster – Piper Jaffray
Dionne Cheung – Quam Asset Management
Good evening and thank you for standing by for the China Distance Education Holdings Limited Fiscal Year 2014 Third Quarter Earnings Conference Call. Today’s call will feature commentary by Mr. Zhengdong Zhu, Chairman and CEO; and Ms. Ping Wei, CFO. During management’s prepared remarks, all participants will be in a listen-only mode. Following the conclusion of management’s preferred commentary we will open up the call for 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. The outlook of the fourth quarter and full year fiscal year 2014 and oral statements from management on this call, as well as the Company’s strategic and operational plans, in particular the company’s mobile strategies among other things, 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 statements. Further information regarding this and other risks is included in the company’s Annual Report on Form 20-F and in 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 is being recorded. A summarized presentation can be downloaded from the Company’s IR Web site 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 Web site at ir.cedledu.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 third quarter fiscal 2014 financial results conference call. Our operating results were released earlier and are available on the Company’s Web site as well as on the Newswire services.
I will begin on Slide 4 with the overview of our results.
In the third quarter of fiscal 2014, we continued to achieve strong growth in each of our core verticals; accounting, healthcare, and engineering and construction OE&C, registering revenue of $25 million, an increase of 36.6% year over year, exceeding the top end of our guidance. Our net income increased by 139.5% year over year to $5.3 million in the third quarter.
Our progress is also reflected in our operational data. In the third quarter of fiscal 2014, we achieved $26.2 million of cash receipts from online course registration, a year-over-year increase of 20.9%. Total course enrollments also increased 42.6% from the same quarter last year, reaching 925,000 in the third quarter of fiscal 2014.
We also generated net operating cash inflow of $17 million in the third quarter of fiscal 2014. Excluding the payback of $25 million that were temporarily held on behalf of certain of our selling shareholders in the company’s follow-on offering completed on March 2014. This compares to an inflow of $12.9 million in the prior year period. That increase was primarily due to the increased cash revenues and increased profitability we realized for the third quarter.
We attribute our strong operating performance to our continued commitment towards providing our students with our high quality results oriented course offerings along with a superior online learning experience enabled by our innovative learning technology as well as our comprehensive student learning services. This total solution enables our students to ensure afford class online learning experience and helps them achieve their educational success.
I would like to take some time now to discuss the exciting advances at our mobile learning initiative. We are the only company that offers stand-alone mobile learning total solutions that included audio-video courses, adaptive practice question banks, self-generated mock exams and comprehensive learning support.
We provide free mobile courses for students who have purchased our regular online courses. We also provide fee-based stand-alone mobile courses. This as a main mobile learning application which allows students to watch lectures, take notes, practice exercises and get viewing support on their mobile devices anytime anywhere.
We also provide adaptive question bank app with functionality of providing students adaptive exercise questions, learning read-out assessments or exam performance prediction and the user level specific mock exam. This gives students the opportunity to spend more time and efforts with their performance areas therefore enhancing the overall learning efficiency and effectiveness.
We saw very good reception of our stand-alone fee-charging mobile courses as evident by the over 31,000 cumulative-paid enrolments up to the end of this quarter of three accounting courses that we initiated in October 2013.
This accounted for about 8% of our total enrollments in CPA, elementary and intermediary level APQE test-prep courses enabling us to get a data to analyze our students’ mobile learning habits, their level of acceptance and overall activities providing us sufficient samples to objectively evaluate our students’ mobile learning progress and the results. This data also allows us to adapt our mobile courses to our students’ learning routine getting our mobile offerings and positioning us well for the growth chain of mobile dominated online learning.
In order to promote our stand-alone mobile courses, we temporarily give our students significant discounts. As a result, ASP for our mobile courses are significantly lower leading to a decrease in ASP for CPA and APQE courses for this year. However, we believe in the long-term strategy value of this initiative into mobile and its tremendous future growth potential.
In addition, the active eBook application we built in our last quarter promoted into active learning environment. This application allows students to read cost material, take notes and practice exercises and questions. The cloud-based storage function enables our students to seamlessly well suited for any devices without losing track of their learning progress. More than that, this application connects our students with building support providing tailored help for each student.
So far our 51,000 students have activated over 100,000 eBooks that they obtained either through direct paying for the eBooks or through buying our print books which includes free eBooks. For the month of July alone over 60% of such students used eBooks online.
Our mobile platform includes a lot amount of free informative obligations providing general test logistics, exam information and exam registration guidance. In addition, we provide free social applications for students to share their test preparation experience, as we believe that the best marketing of our solutions will always come from our successful students.
By the end of July 2014, cumulative downloads for our mobile applications have reached 5.8 million.
We believe mobile is a next big growth opportunity for the company, which we will extend our market reach to a group of students that would not have otherwise had access to our online courses. We are continuing to build a content-rich comprehensive platform that gives students all the necessities for success and are continuing to capitalize all these trends by yielding out additional mobile offerings going forward.
Now let me walk you through our operating metrics in more detail, starting with our accounting vertical on Slide 6.
This year, CPA exams will be administered about one month earlier than last year, as such the enrollment peak season turned out to be about one month earlier as well. Therefore we saw strong enrolment growth in Q2 which makes a quarterly comparison for Q3 difficult. As a result enrollments for our online CPA course in the third quarter decreased by 5.9% year-over-year.
ASP for online CPA course in the quarter decreased by 6.2% year-over-year, mainly due to the lower ASP for the mobile courses and the changes in revenue mix. Online APQE enrollments in the third quarter increased by 4.6% year-over-year. This relatively low growth is due to the shift in enrollment peak seasons for elementary level APQE courses. ASP for online APQE courses decreased by 5.8% compared to the third quarter of fiscal 2013, also due to the popularity of our mobile courses and some lower ASP courses.
Other online accounting test preparation course enrollments in the third quarter increased by 9.8% year-over-year, while ASP increased slightly by 2.5% year-over-year. Enrollments for accounting continue education in the third quarter increased by 38.9%, 70.9% year-over-year, as we continued to expand our program rate and catch up in the delay enrollments from last year. ASP decreased slightly by 1.1% year-over-year.
Moving on to our non-accounting verticals on slide 7, the fast growth within our healthcare and E&C verticals also contributed to our strong performance in the third quarter of fiscal 2014. Online healthcare test preparation course enrollments in the third quarter increased by 58.4% year-over-year, again demonstrating the strong market demand for our high quality courses and services. In addition we believe this strong demand can be attributed to the endorsement of our courses by our students who often relate their experience and collect their experiences on colleagues and to their classmates.
ASP for online healthcare test preparation courses increased by 23.5% year-over-year, primarily driven by more healthcare professionals signing up for the high and premium courses to get access to our more comprehensive services. As a result our cash registration revenue for the third quarter increased significantly by 85.7% year-over-year.
Our online E&C verticals also delivered very strong results enrollments for E&C online test preparation courses increased by 37.8% year-over-year with a year-over-year increase of 1.6% in ASP. This resulted in 40% of cash registration revenue growth in the third quarter.
Enrollments for E&C Continue Education Courses in the third quarter grew by 241.3% year-over-year. This large increase was mainly a result of a significant portion of last year’s continued education enrollments were delayed to later quarters, upon finalization of our collaboration agreement with our partner. In other words it was an easy comparison quarter. ASP increased by 29% year-over-year from the same period last year, mainly due to relatively more enrollments in higher ASP courses.
We continue to see significant growth opportunities for our business in both of this large and fast growing vertical. Our penetration rate in the Healthcare Test Preparation market was only about 5% last year. Similarly penetration rates for the E&C vertical was only about 2% for 2013.
Moving to our online learning open platform, for the third quarter of fiscal 2014, total cash registration revenue exceeded $1.8 million for courses and services that are delivered with our open learning platform, or included a component of service commitment that requires us to deliver online real time interactive courses. The number of students who paid to obtain such courses or services is approximately 86,000 in the quarter.
We are pleased with the progress we made in our open learning platform, particularly in the early reception of our skills enhancement training courses and our online, offline combined textbook business. We will continue to explore and develop new business models and a revenue software that for utilizing our open learning platform.
This completes my update on business operation. I will now turn the call over to Wei Ping, our CFO to walk you through our financials.
Thank you, Mr. Zhu. As Mr. Zhu mentioned once again we delivered a revenue growth that exceeded the top end of our guidance range in the third quarter of fiscal 2014, reflecting the continued strong demand for our high quality quarter offerings.
Let’s turn to slide 10, to look at some of our key financial metrics. Total net revenue increased by 36.6% to $25 million in the third quarter of fiscal 2014 from $18.3 million in the third quarter of fiscal 2013. This increase was primarily due to higher revenue in accounting, healthcare, and E&C verticals.
Net revenue from online education services, books and reference materials and other sources contributed to 82.5%, 7% and 10.5% respectively of total net revenue for the third quarter of fiscal 2014. Net revenue from online education services increased by 40.2% to $20.6 million in the third quarter of fiscal 2014, from $14.7 million in the prior year period, mainly due to higher revenue from accounting, healthcare and E&C verticals.
Net revenue from books and reference materials increased by 27.9% to $1.7 million in the third quarter of fiscal 2014 from $1.4 million in the third quarter of 2013. Net revenue from other sources increased by 17.8% to $2.6 million in the third quarter of fiscal 2014 from $2.2 million in the third quarter of fiscal 2013. The increase was mainly due to higher revenue from our online text group, our in-person accounting professional training courses and course for production services. This increase was partially offset by a revenue decrease in business start-up training courses and other in-person training courses.
Cost of sales increased by 27.1% to $10.5 million in the third quarter of fiscal 2014 from $8.2 million in the third quarter of fiscal 2013. The increase in the cost of sales was mainly due to increased electric fees, salaries and related expenses, server lese fees and bandwidth costs, rental and related expenses and cost of books and reference materials.
Gross profit increased by 44.3% to $14.5 million in the third quarter of fiscal 2014 from $10.1 million in the prior year period. Gross margin increased to 58.1% in the quarter as compared to 55% in the same quarter of fiscal 2013 thanks to the scalability of our model.
Total operating expenses increased by 15% to $8.7 million in the third quarter of fiscal 2014, from $7.6 million in the prior year period. This increase was primarily due to higher marketing and promotional expenses, increased commissions to the company’s distributors, and increased salaries and related expenses.
Selling expenses increased by 22.5% to $6.3 million in the third quarter of fiscal 2014 from $5.1 million in the prior year period, primarily driven by increased commissions to the company’s online distributors and expansion of marketing and promotional activities and increased salaries and related expenses. G&A expenses were flat at $2.4 million in the third quarter of fiscal years 2014 and 2013.
Income tax expenses increased by 112.3% to $1.3 million in the third quarter of fiscal 2014 from $620,000 in the prior year period, primarily due to the increase in taxable income. Net income increased by 139.5% to $5.3 million in the third quarter of fiscal 2014 from $2.2 million in the prior year period, as we continue to achieve leverage in our model.
Now let’s turn to slide 11, to review our cash flow. Net operating cash outflow was $8 million in the third quarter of fiscal 2014 as compared to net operating cash inflow of $12.9 million in the prior year period, primarily as $17 million of cash generated from operating activities due to increased cash revenue and profitability in the quarter are offset by the pay back of $25 million of proceeds that the company temporarily held for its shareholders related to the company’s follow-on offering completed on March 17, 2014.
Cash and cash equivalents, term deposits, and restricted cash as of June 30, 2014, were $132.3 million, as compared with $140.8 million as of March 31, 2014. The decrease was primarily due to the payback of $25 million that had been held on behalf of certain selling shareholders, partially offset by the $70 million in cash generated from other operating activities during the fiscal third quarter.
This completes my financial overview. Now I will turn the call back to Mr. Zhu for concluding remarks on our strategy and business updates as well as financial guidance for the fourth quarter and fiscal year 2014. Mr. Zhu, please.
Professional education is our focus of growth area of Chinese government as the number of internet users in China continues to grow along with the popularity of internet enabled tablets and smartphone, the delivery of professional education continues to evolve to be more online and a mobile based. We believe this sustainable long term trend will continue to fuel our growth.
As a leading online education company with over 14 years of operating history and the comprehensive and integrated online and mobile learning platform, we will continue to look for innovations and breakthroughs with our online learning platform, particularly our mobile learning solution. Our mission remains to be building speedy [ph] as a life-long online education partner for working professionals and others in China to fulfil their educational needs.
Going forward we are confident that we will continue to grow our business at a healthy pace, expand our leadership position and increase our market share in the online professional education market, by leveraging our rich high quality content and comprehensive services with our leading online and mobile learning platform.
Turning to our financial outlook, for the fourth quarter of fiscal 2014, the company expects to generate total net revenue in the range of $32.4 million to $38.6 million, representing year-over-year growth of approximately 20% to 24%.
For the 2014 fiscal year, the company is again raising its guidance. The total net revenue to the range of $94.3 million to $95.5 million, representing year-over-year growth of approximately 32% to 34%. The company’s fiscal 2014 full year total net revenue guidance range was $90.6 million to $94.2 million.
That concludes my prepared remarks. Thank you for your time. Operator, we are now happy to take questions.
We will now begin the question-and-answer session. (Operator instructions). Your first question comes from the line of Gene Munster from Piper Jaffray. Your line is open, please go ahead.
Gene Munster – Piper Jaffray
Good evening and congratulations. You talked a little bit about mobile and the opportunity and specifically some of the impact that’s its having on engagement, usage and ASPs. It’s pretty clear that this is the way the future and that’s the engagement piece to it. How should we think about the impact on ASPs over the next 1, 2, and maybe 6 quarters, kind of maybe think about it over throughout 2015? Do we start to see a rebound? And more specifically how do you think about pricing of mobile? Its seems that your being more aggressive to promote adoption and you have a timetable of when you may be changing some of that pricings, thank you.
Gene, the answer from Mr. Zhu is that the positioning of our fee based mobile classes is to actually extend our market range to those students who have not used our regular internet courses or they don’t have access to our regular internet courses. In other words, the introduction of our mobile courses actually extended our regional market range. Out of the study, 1000 page students, 56% are new students. You average those students in those two subjects for our mobile courses. Regarding to the design of our fee based mobile courses, those mobile courses are designed around individual knowledge point with the length of audio radio calls about ten minutes and in total our total length of our audio radio course is around 25 hours.
Actually we are now planning to address our ASP in the fee based mobile learning applications, with the aim to attract more students to enrol – more new students to enrol for our mobile courses.
In terms of the ASP expectation over the next few quarters as we are already through the heavy enrollment season, what I’m seeing is that the mobile enrollment has come down quite significantly to just a few thousand in the current quarter. So the ASP impact for Q4 should be smaller.
Now going forward on a yearly basis, the price of our mobile course is typically are about two-thirds of our regular class and now this year we actually has some significant promotions like discounts. So as a result we achieved a price was actually less than expected price of 50% of the listed price and that shouldn’t happen on a sort of regular basis going forward. So going forward first of all this year on the three subjects already 10% of total enrollment, I think as sort of incremental increase to sort of to overall percentage of total enrollments. The increase will be slower going forward. Therefore impact on ASP will be lower and secondly the ASP for the mobile portion itself going forward will be higher than this year as well.
So the short answer to your question Gene, going forward the impact of ASP on mobile portion to the overall ASPs, I think it will be much smaller. This year actually the mobile portion brought down the ASPs for APQE and CPA, actually by about 800 basis points or 8% I would say. Originally the – we expect a 10% ASP increase, the net result would be only 2% of increase due to the impact of the mobile. But going forward, it actually should be a positive because we don’t have this promotion and we wouldn’t have this promotion anymore. I hope that will answer.
Gene Munster – Piper Jaffray
Got it. Yeah, that’s helpful. One follow-up thing is that you mentioned that the mobile adaption is not at the same pace as it was at the beginning of the June quarter. Is that number going to just fluctuate quarter-to-quarter or is that kind of a few thousand additions, more or less the run rate that we should think about?
It fluctuates from quarter-to-quarter, but in terms of the annual sort of percentage of mobile students as percentage of total of students, it should be increasing sort of slower, because already we showed 10% already in one year and unless we reach sort of 20% or even more next year, this will already be a slower sort of increase, right.
Gene Munster – Piper Jaffray
Yeah, that’s helpful. Thank you very much.
Thank you, Gene.
Your next question comes from the line of Ella Ji from Oppenheimer. Your line is open. Please go ahead.
Hi, good evening. Thank you for taking my questions. This is Fiona on behalf of Ella and congratulations on the strong quarter. I have two questions today. Firstly we saw some news yesterday about a cancellation of the certified tax agent registration which is [Foreign Language]. So we were just wondering should we expect any impact on your tax related courses from this cancellation, any color would be helpful, thank you.
Actually you may refer to this news with a new regulation of number 37 released a few days ago. Actually the association of Study 5 has currently released interpretation of this regulation. Which means that this regulation number 37 is not cancelling the CPA exam or this designation. It is repositioning actually from the profession, of the profession. From the government permits this profession to a more self-regulated profession. Which means the exam will be repositioned from the permit exam – permit base exam to qualification assessment based exams.
The further explanation of the association of CPA is actually that association is speeding the registration progress, which means to further reform the transition of the CPA from profession government permit base to the qualification assessment base. In fact in China our profession vertical requires more and more professionals, which means there is a great growth future for professional educations going forward. In other words, we are more than well positioned to make more growth potential.
Okay, thank you. That’s good to hear. And my second question is that can you give us some color on your annual dividend for this year? Last year you had $0.60, so just wondering how should we expect the trend this year? Thank you.
Okay. Fiona, I’ll take your question directly. Our board passed a resolution actually, if I do not remember wrong, about two years ago. Basically establishing a dividend policy for the company, we are going to each year access our sort of cash generated from operating activity and we will actually permit to pay back all the excess cash generated from operations to our shareholders via dividend of all the other means.
Now in terms of the exact dividend level, I think the board will sort of approve that, so we don’t really have a say in that, but I can give you idea of what kind of dividend level you can expect. First of all, let’s look back to fiscal 2013. On 2013, we generated a free cash flow of about $30 million and we sort of have an internal definition of cash earning. We define cash earning at non-GAAP revenue. Our non-GAAP earnings sort of passed the deferred revenue refundable fee increase in a year. For that number, fiscal 2013 would be around $21 million and in 2013 we actually declared a dividend of $0.60 per ADR that represents about total of $21 million of dividend payoff.
Now moving onto this year numbers, so far we have already generated about $35 million of free cash flow in the three quarters. Now bear in mind Q4 even though is our heaviest revenue quarter, it’s actually a relatively low cash flowing quarter. So conservatively, we generated a few million more of free cash flow in fourth quarter. That will give you an annual sort of free cash flow number anywhere between $35 million and $40 million and possibly a cash earning number like sort of probably more than $30 million. So I guess you can sort of more or less calculate the kind of dividend level again expect based on those numbers. Hope that they help, Fiona?
Yes, that’s very helpful. So thank you. That’s all my questions.
It looks like there are no further questions? Are there?
Sorry for the interruption. Your next question comes from the line of Harry Hee – and Tony Yang [ph] from Tokyo Industry. Your line is open. Please go ahead.
Okay. Thank you for taking my question. [Foreign Language]
Okay, Harry. Hi. Let me translate those questions into English, okay. First of all, it’s a margin-- the reason behind the margin expansion. Okay, what’s the driver behind the margin expansion? Second is the breakeven points for healthcare and E&C courses. The third question is regarding to the fee charge of mobile courses, the expected revenue contribution for the next one or two years from mobile courses. The final question is regarding to the use of follow-on proceeds. [Foreign Language]
Okay. I will answer this question at least that the question is related to numbers. First of all, margin expansion in Q3 is primarily because of the scalability of all model. As you can see, we actually are still seeing pretty relatively sort of fast hostel revenue and selling expense increase but because revenue grows faster and for G&A there is no need to increase that at all. So that gave us just margin expansion, not really any sort of significant other reasons. Now in terms of revenue distribution of accounting versus healthcare versus E&C verticals and the breakeven points, last year accounting accounted for about 56% of our total revenue, healthcare about 13%, E&C about 7%.
Now our internal projection is healthcare probably will account for about 20 or even more percent of our total revenue for this year simply because it’s growing so fast. It’s like today it’s growing around 80 or even higher percent in cash revenue. E&C probably will break 10% contribution so that’s itself pretty significant threshold for us as well sort of this year. Accounting even though is still growing fairly healthily probably will drop contributing to only about 50% of our overall revenue for this year. We do not track vertical specific breakdown points or sort of profitability of each vertical because each vertical actually share the same online platform share a lot of infrastructure support and share all the in-house sort of services and technology sort of a team. As such we only look at sort of breakeven margin for direct cost. We believe usually for any given vertical 10,000 students will be the breakeven point. After that incremental margin is actually pretty high at about 70% on EBIT level. So those are the first two questions.
And the number four question relates to our follow-on offerings, the incomes of expense. The U.S. GAAP actually requires a company to offset the expenses from the offerings against the proceeds of the offerings and only record the net proceeds as sort of increase to equity. So we do not need to amortize or bring it to P&L any offerings or expenses. That’s the first question. And secondly, incomes of use of proceeds. We don’t have operational need for cash still. So whatever cash we brought from that offering, we either used it for sort of strategic acquisition alliances opportunities or really we just don’t have a use for it because we typically enjoy an active working capital and as you heard from us earlier we actually paid dividends every year. So specifically potential acquisitions and allowances opportunities, we keep on exploring those and we keep on sort of affecting various sort of acquisition and sort of M&A opportunities, but we have been and we will always continue to be very conservative in assessing acquisition targets. So whether we will evaluate … essentially make a deal or acquire businesses it really depends on whether those potential targets can actually meet our quality standards, financial metrics, etc. But in general, otherwise, we’ll look at supplementary or sort of kind of complementary acquisitions and we will make sure it will accretive to our existing shareholders. I hope that will answer the three questions you have. Now I will turn the call back to Mr. Zhu to address the sort of the mobile question.
Okay. Currently, the revenue from fee-based mobile courses comes less than 1% of our total revenue. While we expect the contribution from the fee-based mobile courses will contribute about 5% to 10% of our total revenue going forward. But what we want to emphasize and what we’re focused on is actually through the using of mobile applications we can relate to a larger size of students can bring great influence for this learner to accept more online-based learning.
(Operator Instructions). Your next question comes from the line of Dionne Cheung from Quam Asset Management. Your line is open. Please go ahead.
Dionne Cheung – Quam Asset Management
Good evening, the management. My question is related to selling expenses because in Q3 this year we saw quite strong operating leverage on selling expenses and in previous year we looked at selling expenses usually declined on a quarter-and-quarter basis in Q4. So how should we expect the selling expenses for Q4 this year? Thank you.
Okay. Thanks for asking the question. In terms of selling expense, you should expect the same trend. Basically, Q4 selling expense should be lower than Q3 simply because Q2 and Q3 are our heavy promotion and enrolment seasons and Q4 is even though heavy revenue quarter, it’s actually typically from promotional activities and enrolments that happened earlier.
Dionne Cheung – Quam Asset Management
Okay. So maybe the seller expense as a percentage to sales, ratio will drop to 18th level right through this year. Am I correct?
Yeah. It will be. It will drop down to a level that’s similar to sort of last year in terms of percentage of revenue. Yes.
Dionne Cheung – Quam Asset Management
Thank you very much. That’s all my question. Thank you.
It appears there are no further questions at this time. I’d now turn the call back over to management for any additional or closing remarks.
Thank you. On behalf of the management team, we would like to thank you again for joining us today and we look forward to updating you on our progress next quarter. Thank you all.
Thank you. That does conclude our conference for today. Thank you for participating. You may all disconnect.
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