Edited Transcript of DL earnings conference call or presentation 18-Mar-20 12:00pm GMT

Total enrollment for the quarter exceeded 1.3 million, up 2% year-over-year. Notably, in the first quarter of fiscal 2020, we are pleased to see a significant acceleration in enrollment growth in our regular relatively shorter duration accounting exam preparation courses. Enrollment growth in this course category had been lagging for the past several quarters. We, therefore, redoubled our efforts to attract students to our platform who prefer to study with us for a relatively shorter period of time compared with our longer duration courses.

Aside from our solid first quarter performance, I’m pleased to announce our Board of Directors has approved a special cash dividend of $0.145 per ordinary share or $0.58 per ADS on outstanding shares distributed to shareholders as of record as of the close of trading on March 31, 2020. We are proud of our strong cash-generating ability and believe returning capital to shareholders through our dividend is an effective use of capital to maximize long-term shareholder value.

I will now provide updates on our key growth strategies. In our 20-year operating history, we have built a strong and self-reinforcing business model with a comprehensive lifelong learning ecosystem. In our accounting vertical, for example, we have built a comprehensive suite of services to address the needs of both students and enterprise clients. On the student front, we have established a full-service portfolio that fulfills the diverse learning needs of our students. Our accounting ecosystem provides students professional certification exam preparation, continuing education services, practical accounting training, employment guidance services, job internship arrangement services, as well as our leading collection of proprietary accounting books and reference materials. In addition, for our enterprise clients, we offer tax advisory and consulting as well as accounting and related advisory services.

The integration of our service offerings has enabled our accounting ecosystem to offer attractive value propositions to working professionals, college students and businesses. The welcome reception of our services across students and enterprises in the marketplace is evidenced by our sustained top line growth. Importantly, the achievements of our accounting vertical serve as a blueprint to replicate and propel growth in our engineering & construction, legal and other verticals.

To attract students to our comprehensive lifelong learning ecosystem, we have implemented a multipronged student acquisition strategy by engaging with influential e-commerce and social media platforms, such as Tmall, JD.com, Weibo and WeChat, in an effort to extend our outreach and broaden our student audience.

At the same time, we have developed and launched a variety of learning modalities, including pre-recorded online audio/video courseware, mobile learning, live streaming as well as our in-person instructor-led course offerings. We offer our students multiple learning modalities to appeal to the varying learning styles and preferences across our student base, so as to provide each student with the optimal learning approach to acquire knowledge and sharpen their professional skills with the goal of helping our students advance in their careers.

Our live-streamed courses are well suited for students who desire a technology-based learning solution but prefer a live course setting and greater interaction with a lecturer. We currently offer livestreaming of certain popular exam preparation courses, which are attracting a growing audience of students. In the first quarter of fiscal 2020, enrollments in our live-streamed courses doubled year-over-year. In addition, we will hold livestreaming events on social media platforms regularly to help elevate our brand, showcase our lectures and further drive course enrollments.

Turning to mobile, we have been consistently upgrading and enriching our mobile educational products and services to better resonate with our tech-savvy students, embedding new features and functions into our mobile apps to deliver a more engaging learning experience. As of December 31, 2019, China Distance Education offered 69 mobile apps and recorded cumulative downloads of 63 million, up from 60.9 million as of September 30, 2019. In the first quarter, daily traffic to our mobile website continued to increase with daily active users in our accounting, healthcare and engineering and construction verticals, increasing by 9.9%, 11% and 41% year-over-year, respectively.

Now I would like to share some updates regarding the COVID-19 outbreak. First, I would like to extend my heartfelt thanks to the medical professionals and individuals on the frontline who are fighting against the outbreak. Our thoughts are with those who have been impacted. During the epidemic, the ongoing health and safety of our employees remain paramount, and we have enacted several precautionary measures across our operations, including remote work and staggered work schedules.

Since the beginning of the year, the central and local governments have put in place a series of proactive measures to reduce the spread of COVID-19, such as postponing the return to school, and mandating online course delivery for schools across the country. CDEL, as a leading provider of online professional education in China, was selected as one of the key dedicated online education services providers by China’s Ministry of Education to facilitate online class delivery and higher education institutions across China during the epidemic. Our participation in this program demonstrates our reputation as a leader in online education as well as our best-of-breed educational content and technological strength.

Beyond the cooperation with government agencies, CDEL took prompt action toward the end of January to support students in severely affected regions by offering free online courses covering popular professional examination categories to students in Hubei province, the epicenter of the endemic. Outside of Hubei, CDEL began offering students certain online exam preparation courses at significant discounts. Online education is a safe and contactless instructional delivery method that offers easy access to educational content for all with Internet access. At this challenging time, we will utilize our extensive experience in online education to help students across China.

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

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [3]

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Thank you. Before I discuss the details of our first quarter financial performance, I want to provide a few highlights regarding the improvement in our profitability.

In the first quarter of fiscal 2020, we delivered non-GAAP gross profit growth of 51.4% year-over-year, with a non-GAAP gross margin of 50.2%, up significantly from non-GAAP gross margin of 40% in the year-ago period. We recorded non-GAAP operating income of $2.6 million for the quarter compared with an operating loss in the prior year period. Please note that non-GAAP figures noted in our earnings release and discussed on this call exclude share-based compensation expenses. We attribute the improvement in our operating profitability to healthy top-line performance and effective execution of certain expense control measures, including strict headcount and office space control, and leverage of our cost structure, which have been a key focus of the company for the last several quarters.

Now let me summarize some of our key operating metrics on Slides 6 and 7. Enrollments in our online accounting test preparation courses were up 5.1% year-over-year in the first quarter, primarily due to increases in Accounting Professional Qualification Exam or APQE enrollments. In the first quarter of fiscal 2020, enrollments in our accounting continuing education courses were relatively flat compared with the year-ago period. Total online accounting test preparation ASPs increased by 11.5% year-over-year in the first quarter as ASPs increased significantly in our CPA test preparation courses, mainly due to changes in product mix. The ASPs for our accounting continuing education courses increased by 3.6% year-over-year in the first quarter.

Enrollments in our online healthcare test preparation courses in the first quarter of fiscal 2020 increased by 3.4% year-over-year. ASPs for our healthcare test preparation courses decreased by 5.8% year-over-year in the first quarter, mainly due to changes in product mix.

Enrollments in our online engineering & construction, or E&C test preparation courses, increased by 27.8% year-over-year in the first quarter, primarily due to strong enrollment growth in our first level constructor and cost valuator courses. Enrollments in our E&C continuing education courses increased by 47.2% year-over-year in the first quarter, primarily due to seasonality. ASPs for our E&C test preparation courses in the first quarter increased by 9.1% year-over-year, primarily due to changes in product mix. The ASPs for E&C continuing education courses decreased by 3.9% year-over-year in the first quarter.

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

Non-GAAP gross margin was 50.2% in the first quarter of fiscal 2020 compared to 40% in the first quarter of fiscal year ’19 — 2019. The year-over-year expansion in gross margin was primarily due to decreased salaries and related expenses, as well as decreased rental and related expenses.

Non-GAAP selling expenses increased by 32.4% to $19.2 million in the first quarter of fiscal year 2020 from $14.5 million in the prior year period, driven primarily by increases in advertising and promotional expenses, commissions to agents, salaries and related expenses and rental and related expenses.

Non-GAAP general and administrative expenses decreased by 13.9% to $5 million in the first quarter of fiscal year 2020 from $5.9 million in the prior year period. The decrease was mainly due to the lower provision for doubtful debts compared with the prior year period. Overall, non-GAAP operating income for the first quarter of fiscal year 2020 was $2.6 million compared with non-GAAP operating loss of $1.7 million in the prior year period.

In the first quarter of fiscal year 2020, we recorded a noncash foreign currency exchange loss of $2.5 million, mainly related to loans from our PRC subsidiaries to our offshore holding company, due to the appreciation of Renminbi against the U.S. dollar from September 30, 2019 to December 31, 2019. We recorded a noncash foreign currency exchange gain of $76,000 in the prior year period.

Income tax benefit was $34,000 in the first quarter of fiscal year 2020, compared with income tax expenses of $1 million in the prior year period, primarily due to the taxable loss in the first quarter of fiscal 2020.

Non-GAAP net loss attributable to CDEL was $1.2 million in the first quarter of fiscal year 2020, compared with non-GAAP net income attributable to CDEL of $2.4 million in the prior year period. That said, it is important to point out that we recorded a $6.9 million gain on the previously announced disposal of 60% equity interest in the Tax School Program in the first quarter of fiscal year 2019 and fair value change of the remaining 40% equity interest.

Now let’s turn to Slide 11 to review our cash flow. Net operating cash flow — excuse me, net operating cash inflow decreased by 15% — 15.6% to $22.5 million in the first quarter of fiscal 2020 from $26.6 million in the prior year period. The operating cash inflow was mainly attributable to net income before noncash items generated in the first quarter of fiscal 2020. The decrease in accounts receivable and the increase in accrued expenses and other liabilities, deferred revenue, and refundable fees also contributed to the operating cash inflow. The operating cash inflow was partially offset by the increase in inventories, prepayments and other current assets and the decrease of lease liability, income tax payable and deferred tax liabilities. Cash and cash equivalents, term deposits, restricted cash and short-term investments as of December 31, 2019, increased by 13.5% to $145.9 million from $128.5 million as of September 30, 2019, mainly due to the operating cash inflow generated in the first quarter of fiscal 2020. The sale proceeds of approximately $800,000 from the disposal of an investment also contributed to the increase in cash. The increase was partially offset by the repayment of offshore loans of $11 million and capital expenditures of approximately $900,000.

This completes my financial overview. Next, I would like to provide color regarding the potential impact of the COVID-19 outbreak on our financial performance over the next few quarters.

At the present time, we have not received notification from professional examination administration authorities regarding any changes or delays to the timing of key examinations. We provide exam preparation services for students registered for these examinations, most of which are typically scheduled in September or October of each year. In the event of any delay in exam timing, however, it is important to note that the corresponding cash receipts from online course registration, which we have received, would not be forsaken. Instead, such cash receipts will be recognized ratably over a longer period, in sync with the respective exam date for the examined question.

As a result of our swift response to the COVID-19 outbreak, enrollments in our online exam preparation courses, including discounted and free enrollments, have increased dramatically since the end of January 2020. This development demonstrates our commitment to our students across China as well as our ability to scale our online learning platform and serve a significantly larger student audience. In the meantime, we expect the COVID-19 outbreak will have a near-term negative impact on both our cash receipts from online course registration and GAAP revenue as a result of our proactive measures to support our students across China. That said, we are encouraged by the appeal of our online learning solutions across our student base, particularly in the current environment and remain very confident with respect to the long-term viability of our business model.

I will now return the call to Mr. Zhu for concluding remarks as well as financial guidance for both the second quarter and fiscal year 2020. Mr. Zhu, please.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [4]

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Thank you, Mark.

[Interpreted] We achieved a positive start for fiscal 2020, delivering solid revenue growth and improved operating profit in the first quarter, while posting healthy growth of cash receipts from online course registration. As we look further into 2020 and beyond, we will remain true to our core vision of cultivating online learning as a lifestyle, with a commitment to serving as China’s foremost lifelong, comprehensive online education partner for working professionals and others in China to fulfill their educational needs.

Since January, we’ve confronted an evolving situation in the wake of the COVID-19 outbreak and its disruption to China’s macro economy. Containment measures, including extended holidays, travel restrictions, delayed resumption of enterprise production and operating activities after Chinese New Year have put a suspension on the return to normal daily life for nearly all across China. As the outbreak endures, macro uncertainties remain, and we anticipate consumer spending generally will remain cautious. During this challenging period, CDEL will continue to be proactive in supporting the virus containment effort and leading by example in course social responsibility.

As we approach the end of our second quarter of fiscal 2020 and look ahead to the beginning of the second half of our fiscal year, we’ve acknowledged that the situation remains fluid, yet we are committed to being vigilant and steadfast in caring for our stakeholders. For our students, we intend to continue providing best-of-breed courseware and high-quality value-added services. We are requiring remote work for most of our employees, while limiting the number of in-office employees and disinfecting the office areas to keep them safe. Overall, we are able to continue our operations in the current environment and our business remains on solid footing.

Anticipating the day when we all look back on this time and reflect on the lessons learned, we expect this period will be viewed as a pivotal point of growth for online education in China’s education industry. As a pioneer in online professional education, we believe in the long-term growth prospects of China’s online education industry and are well prepared to serve a growing student demographic. We are dedicated to consistently delivering knowledge to a broad student constituency, extending convenience, flexibility and engagement to their learning experience. In the meanwhile, we’ll continue to integrate cutting-edge technologies into our educational solutions and diversify our course offerings to fulfill the needs of our students at different stages of their study and career development. With our 20-year track record and an unwavering commitment to education, we have proven to be the premier partner of choice for students in their journey of lifelong learning.

Turning to guidance, for the second quarter of fiscal year 2020, the company expects to generate total net revenue in the range of $41.9 million to $43.8 million, representing year-over-year growth of approximately 8% to 13%.

For the fiscal year 2020, the company expects to generate total net revenues in the range of $239.4 million to $250 million, representing year-over-year growth of approximately 13% to 18%.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have the first question from the line of Greg Pendy.

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Gregory R. Pendy, Sidoti & Company, LLC – Consumer Analyst [2]

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My first question is just on the gross margins. I know they’ve expanded for several quarters right now. Just trying to get a gauge. I think from your 10 asset, it looks like you did see a headcount reduction and then also, you had some dual rent last year, which I assume is beyond you. So just trying to get a sense of what is the run rate on the cost structure going forward. Do you think the cost cuts are done and now the leverage is going to come mainly from revenue growth? Just trying to get a sense of how to think about gross margins in 2020.

And also, I think last call, you kind of mentioned for the year, you were maybe guiding around 55%. Is that still the case?

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [3]

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First of all, with gross margins, as you saw in the first quarter, we saw a considerable improvement based on leverage of not only salaries and related expenses, but also rent and related expenses. We expect to see gross margins continue to improve throughout the year on a year-over-year basis as we benefit from a very well-honed cost structure in that regard. A couple of points, too, you may want to recall, we disposed of our tax school in December of 2019 quarter. And because of that disposal, we are able to reduce headcount accordingly and we’ve been enjoying a lower headcount basis as a result. And we intend to keep our headcount rather stable for the balance of the year.

Regarding rent, as you mentioned, we did have dual spaces last year, both in Beijing and Haidian headquarters and at Anhui Qiao, our newest office location. And we’ve migrated staff throughout last fiscal year to the new office location in Anhui Qiao, which comes with lower rental expenses. So we’ve been enjoying rental expense reduction in the current quarter — or quarter we just reported as well as the current quarter. And we’ll anniversary that move in the third quarter, which is our June quarter. So net-net, we do believe we will see continued gross margin expansion this year. And the figure you mentioned around mid-50s is, I think, a viable figure for us in terms of how the model will play out for the full fiscal year.

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Gregory R. Pendy, Sidoti & Company, LLC – Consumer Analyst [4]

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And just one more question, I think, on the dividend. I think this is your eighth dividend as a public company, a special dividend. Is this going to be the typical bridge loan structure? Should we expect from the payout perspective on the — and from a balance sheet perspective, just to see the restricted cash go up and how it typically flows through?

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [5]

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Yes, Greg, exactly. In this case, we are able to take advantage of the dividend bridge loan structure as we have several times in the past, where we’re able to avail ourselves of an offshore loan and then have matching funds onshore, and they will be deemed restricted cash on the balance sheet.

I do want to point out something that I did mention on the last call regarding our debt situation. And you may recall, at that point, on our last call, we talked about our goal over 2020 to reduce our debt exposure and pay down the various loans in place. You can see in the current — or in the first quarter, we’ve paid down loans in total of approximately $11 million, leaving $27.7 million of borrowings on the balance sheet. We fully intend to extinguish that debt during 2020. So there’s no change to our plans. Having said that, you are correct in your assessment in terms of how we are funding the current dividend, which, in total, will be about $19.6 million. We value very much the opportunity to maximize shareholder value by returning cash to shareholders, and we happen to be in a very healthy cash position with the cash generated in the past quarter as well. So nonetheless, that’s where we sit on the dividend front.

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Operator [6]

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We have the next question from the line of CiCi Liu.

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CiCi Liu, CVC Capital [7]

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So I basically have a more current epidemic-related question. Well, we noticed that in face of the COVID-19 epidemic, you actually launched a series of marketing campaigns and advertisements with extremely low prices that to — probably to just attract your target audience and to funnel in. I just want to get a general sense of how does this — I mean, may shed us some light to your first quarter performance, how the conversion, et cetera? How — does this campaign — well, will we expect it to continue in the future?

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [8]

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Yes, a very good observation. Certainly, our response to the COVID-19 outbreak has been swift, and a big part of that response was making our courses available at very attractive price points to our students. We talked on the call already about free courses for students in the epicenter of the epidemic, Hubei province, and then heavily discounted courses for students outside of Hubei, as you pointed out. So having said that, we view this as an important feature of our corporate responsibility and our response to the outbreak in supporting our students across China. Certainly, as of this point, we’re still in the midst of the outbreak. The very pricing that you pointed toward is still in place, and we have made no announcement as to any alterations to that, but we’ll certainly inform others once that changes.

The effect of this has been certainly quite positive with regards to enrollments. We’ve seen enrollment soar in the period after the end of January when we launched the promotional pricing, if you will. And that has been, I think, evidenced by a very strong commitment on our part to our students, plus students gravitating to our platform in this very challenging time. So I think it’s a net positive for us. So that’s how we see things playing out.

The downside effect, of course, and we’ve talked about it already, is the downwardly revised revenue guidance as a result of our actions on the corporate social responsibility front. Does that answer your question?

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CiCi Liu, CVC Capital [9]

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Yes, partly. And I’m just wondering if there’s possibly, can be a kind of silver lining to the current situation that you may bring more enrollment, that you will be able to upsell in the future? And do you see if there’s a possibility that you can convert those new enrollments?

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [10]

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I think at the present time a silver lining is a tough word to use. This is a serious time for all of us, and we’re focused on supporting our students. But when we get beyond this and look back, I think that what we’ll see during this period of time is this notion that online education will be elevated. Certainly, the spotlight is on online education right now, and many students who otherwise would not choose to study online are looking at that as a viable alternative. And we think that going forward, this will be a pivotal point for the online education industry because of that. Students will now seek this out as a very viable alternative to a traditional instructor-led learning. So having said that, I do think that we may be in a position where we’re introducing our solutions to students who haven’t used us in the past and who will appreciate the service levels, and will look back and be potential students in the future for us.

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CiCi Liu, CVC Capital [11]

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Okay. So is that possible we can just have some sense of what the enrollment number looks like?

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [12]

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Well, to give you a sense, in the period, since the end of January through last week, approximately, we’ve seen about 350,000 to 400,000 paid enrollments attracted to our discounted courses, as you mentioned. Obviously, a very high number when you consider that’s only a very short period of time of about 6 weeks. On the free enrollment front, in Hubei province, we’re looking at over 2 million — well over 2 million enrollments.

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CiCi Liu, CVC Capital [13]

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2 million.

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [14]

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In excess of 2 million, as of this time. Yes.

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Operator [15]

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As there are no further questions at this time, I would like to turn the call back to management for closing remarks.

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [16]

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Thank you, operator. On behalf of the management team, we thank you for joining us today, and we look forward to updating you on our progress. Stay safe, everyone.

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Operator [17]

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Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]