Edited Transcript of DL earnings conference call or presentation 22-May-20 12:00pm GMT

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

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[Interpreted] If you will now refer to the presentation, I will begin on Slide 4 with an overview of our financial results.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [6]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [7]

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[Interpreted] In the second quarter of fiscal 2020, our revenue increased by 8.1% year-over-year, at the low end of our guidance range.

Second quarter revenue growth was driven by net revenue from online education services, which was up 19.9% year-over-year, primarily attributable to the robust revenue growth of our accounting vertical. Our socially responsive actions to support our students during the COVID-19 outbreak, which include offering both free and significantly discounted online courses had a dampening effect on our second quarter revenue growth and led to a 34.5% year-over-year decline in our cash receipts from online course registration in the second quarter.

Total enrollment for the quarter, however, nearly doubled compared to the year ago period due to the immense popularity of our high-quality, attractively-priced online courses. It is important to point out that our total enrollment metric includes only paid enrollments.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [8]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [9]

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[Interpreted] Take our Certified Public Accountant or CPA business, as an example. More than 40% of the students who enrolled in our CPA exam preparation courses during the period, when we offered free and significantly discounted courses, spent over 10 hours studying on our learning platform. This level of student engagement shows that students appreciate online learning as well as our courseware.

We look forward to providing these and other students with additional comprehensive, high-quality courses in the future.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [10]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [11]

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[Interpreted] I’d now like to turn to Beijing Ruida, a leading provider of exam preparation services for participants in China’s Legal Professional Qualification Examination.

Since our acquisition of Ruida a few years ago, we have been collaborating with Ruida in an effort to improve its online capabilities, including the production delivery and administration of online courses. These efforts have augmented Ruida’s core off-line courses and enable Ruida to offer students an effective blended online, off-line learning solution.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [12]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [13]

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[Interpreted] In response to COVID-19, however, Ruida suspended its off-line classes, yet was able to successfully migrate students to its online classes. Despite posting a high single-digit decline in revenue for the second quarter compared with the year ago period, Ruida’s online preparedness helped cushion the effect of the suspension of off-line classes.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [14]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [15]

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[Interpreted] We remain committed to a multipronged student acquisition strategy and continue to collaborate with influential e-commerce and social media platforms, such as Tmall, jd.com, Weibo and WeChat to promote our course offerings and strengthen our brand.

During the pandemic, we offered various featured courses and value-added services to provide students with highly sought-after learning opportunities and quickly attracted students across China to our online learning platform.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [16]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [17]

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[Interpreted] We have been continuously upgrading and introducing mobile-based educational products and services, such as mobile gains in popularity among both working professionals and students in their pursuit of learning.

As of March 31, 2020, China Distance Education offered 69 mobile apps, recorded cumulative downloads of 66 million, up from 63 million as of December 31, 2019. In the second quarter, daily traffic to our mobile website continued to increase with daily active users in our accounting, healthcare and engineering & construction verticals increasing by 44.3%, 24.9% and 127.6% year-over-year, respectively.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [18]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [19]

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[Interpreted] With the pandemic gradually being contained in China, I would like to share some COVID-19-related updates.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [20]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [21]

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[Interpreted] For the sake of the ongoing health and safety of our employees, we have maintained precautionary measures across our operations, such as remote work, staggered work schedules and more frequent disinfecting of our offices.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [22]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [23]

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[Interpreted] To support students impacted by COVID-19, CDEL offered certain free courses and courses with significant discounts toward the end of January, as I previously noted.

During April, as the spread of the pandemic slowed, we gradually began raising prices and ended the free and significantly-discounted pricing program at the end of April.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [24]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [25]

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

Thank you. Before I discuss the details of our second quarter financial performance, I want to provide a few highlights regarding the improvement in our profitability. The second fiscal quarter marks the fourth consecutive quarter of year-over-year improvement in our operating margins.

This is particularly noteworthy given the challenges we faced during the COVID-19 outbreak. In the second fiscal quarter, despite the negative impact to our top line growth from the COVID-19 pandemic, our non-GAAP gross profit grew 38.4% year-over-year, with impressive non-GAAP gross margin expansion to 51.1% compared with 39.9% in the year ago period. And we achieved non-GAAP operating income of $2 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.

The improvement in our operating profitability was primarily due to modest top line growth coupled with effective execution of certain expense control measures, including strict headcount and office space control, coupled with stronger leverage of our cost structure. These measures have been a key focus of the company for the last several quarters.

Now let me summarize some of our key operating metrics on Slide 6 and 7. Overall, enrollments in online test preparation courses of our 4 main verticals including accounting, healthcare, engineering & construction and legal grew significantly in the second quarter, up approximately 300% year-over-year.

In contrast, ASPs for these online test preparation courses declined, primarily due to the popularity of the discounted test preparation courses that we offered during the quarter in response to the COVID-19 outbreak. Enrollments in our online accounting test preparation courses were up 351% year-over-year in the second quarter, primarily driven by the growth of our Accounting Professional Qualification Exam or APQE course enrollments, Certified Public Accountant or CPA course enrollment and tax adviser course enrollments.

Second quarter enrollments in our accounting continuing education courses decreased by 38.4% compared with the year ago period. Likewise, total online accounting test preparation ASPs decreased by 86.7% year-over-year in the second quarter. The ASPs for our accounting continuing education courses increased by 56.7% year-over-year in the second quarter.

Enrollments in our online healthcare test preparation courses in the second quarter of fiscal 2020 increased by 155% year-over-year, while ASPs for our healthcare test preparation courses decreased by 74.5% year-over-year. Enrollments in our online engineering & construction or E&C test preparation courses increased by 481% year-over-year in the second quarter. ASPs for our E&C test preparation courses in the second quarter decreased by 91.4% year-over-year.

Enrollments in our E&C continuing education courses increased by 29.8% year-over-year in the second quarter. ASPs for E&C continuing education courses were relatively flat year-over-year in the second 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 and encourage listeners to refer to our earnings press release and financial filings for further details.

Non-GAAP gross margin was 51.1% in the second quarter of fiscal year 2020 compared with 39.9% in the second quarter of fiscal year 2019. The year-over-year expansion in gross margin was primarily due to decreased salaries and related expenses as well as decreased costs of purchases related to the sale of learning simulation software, rental and related expenses and lecture fees.

Non-GAAP selling expenses increased by 10.5% to $15.3 million in the second quarter of fiscal year 2020 from $13.8 million in the prior year period, driven primarily by increases in advertising and promotional expenses commissioned to agents and rental and related expenses, partially offset by a decrease in salaries and related expenses.

Non-GAAP general and administrative expenses decreased by 10.7% to $5.4 million in the second quarter of fiscal year 2020 from $6.1 million in the prior year period. The decrease was mainly due to lower salaries and related expenses. Overall, non-GAAP operating income for the second quarter of fiscal year 2020 was $2 million compared with non-GAAP operating loss of $3.6 million in the prior year period.

In the second quarter of fiscal 2020, we recorded a noncash foreign currency exchange gain of $1.6 million, mainly related to loans from our PRC subsidiaries to our offshore holding company due to the depreciation of the renminbi against the U.S. dollar from December 31, 2019 to March 31, 2020. We recorded a noncash foreign currency exchange loss of $2.2 million in the prior year period.

Income tax expenses were approximately $700,000 in the second quarter of fiscal year 2020 compared with income tax benefit of $1.3 million in the prior year period, primarily due to taxable income in the second quarter of fiscal 2020.

Non-GAAP net income attributable to CDEL was $5 million in the second quarter of fiscal year 2020 compared with non-GAAP net loss attributable to CDEL of $3.4 million in the prior year period.

Now let’s turn to Slide 11 to review our cash flow. Net operating cash inflow decreased by 28.7% to $11.7 million in the second quarter of fiscal 2020 from $16.5 million in the prior year period. The operating cash inflow is mainly attributable to net income before noncash items generated in the second quarter of fiscal 2020.

The decrease in prepayments and other current assets, the increase in accrued expenses and other liabilities, and the decrease and increase in amount due from, and to related parties, respectively, also contributed to the operating cash inflow. The operating cash inflow is partially offset by the increase in inventories and the decrease in deferred tax liabilities.

Cash and cash equivalents, term deposits, restricted cash and short-term investments as of March 31, 2020 decreased by 10.8% to $130.2 million from $145.9 million as of December 31, 2019, mainly due to the repayment of offshore loans of $20.4 million, the repayment of an onshore loan of $1.1 million, the payment of an investment of approximately $700,000 and capital expenditures of approximately $1.2 million.

The decrease was partially offset by the operating cash inflow generated in the second quarter of fiscal 2020.

This completes my financial overview.

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

To date, we have received notifications from professional examination and administrative authorities regarding postponement of a number of examinations, which were previously scheduled during May and June, including elementary APQE, nurse qualification, health qualification and associate constructor examinations.

There has been no further guidance from examination administration authorities at this time regarding when these particular examinations will be held. Consequently, our third fiscal quarter and potentially our fourth fiscal quarter GAAP revenue will be negatively impacted as the corresponding cash receipts from these courses related to these examinations will be recognized ratably over a longer expected service period.

I will now return the call to Mr. Zhu for concluding remarks as well as financial guidance for the third quarter. Mr. Zhu, please?

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [26]

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Thank you, Mark. (foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [27]

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[Interpreted] The COVID-19 pandemic has created numerous challenges for society, our student community and our firm. That said, the true mettle of a company is measured by its response to such challenges. As we’ve discussed, our response to the pandemic has been swift and resolute, centered on keeping our employees safe and supporting our students during these difficult times.

The free and significantly discounted exam preparation courses we offered to students during the COVID-19 outbreak have negatively impacted our revenue and cash receipts growth.

At the same time, we have substantially increased our reach to a broader student audience that is attracted to our high-quality courses and continues to be keen on both enhancing knowledge through professional certification and career development.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [28]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [29]

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[Interpreted] During our second fiscal quarter, we reached an important milestone of 20 years of operating history in China’s online education industry. During the past 20 years, we have faced many challenges, yet continue to thrive by being socially responsible, by being committed to serving our students with best-of-breed content and value-added services and by responding to students’ various learning styles and preferences through multiple learning modalities, including prerecorded audio-visual, mobile and live streaming courses.

Our comprehensive lifelong learning ecosystem has evolved as well, now covering 4 key industry verticals, including accounting, healthcare, engineering & construction and legal, and our business has proven to be resilient.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [30]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [31]

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[Interpreted] Let me wrap up by saying that when we look back on this extremely challenging time with COVID-19, we expect this period will be viewed as a watershed moment for online education in China’s education industry.

Online education is a safe and contactless instructional delivery method that offers easy access to educational content for all with Internet access and a popular learning modality for students to continue learning during this difficult time.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [32]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [33]

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[Interpreted] 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.

Meanwhile, we will continue to integrate cutting-edge technologies into our educational solutions and diversify our core 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.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [34]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [35]

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[Interpreted] Turning to guidance.

For the third quarter of fiscal year 2020, the company expects to generate total net revenue in the range of $50.6 million to $53.7 million, representing a year-over-year decline in the range of approximately 18% to 13%, respectively.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [36]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [37]

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[Interpreted] For fiscal year 2020, the company has decided to withdraw its previous revenue guidance in consideration of uncertainties related to the impact of COVID-19, including the postponement of certain professional certification examinations, the schedule of reopening of schools and the schedule of resumption of provision of off-line training courses, among others.

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Zhengdong Zhu, China Distance Education Holdings Limited – Co-Founder, Chairman of the Board of Directors & CEO [38]

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(foreign language)

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [39]

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[Interpreted] 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) Your first question comes from line of Greg, Sidoti.

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

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First of all, I guess, just can you talk a little bit about the gross margin outlook? And how to think about that going forward with the sort of pull forward in demand? I think we’re already anniversarying some of the rationalization on the real estate side, given the move last year. Is there anything left on that? How should we be thinking about the gross margin?

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

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Yes. Thank you, Greg, for your question. Yes, regarding gross margin, you can see that we’ve been quite successful in controlling our costs, particularly salary and related, rental and related lecture fees. We maintained our headcount very steady and very stable. We continue to expect to do so, and we’ve been controlling our rent expense.

In fact, in May, we’ve exited our leases of the third and fourth floors of our Haidian headquarter building in favor of more reasonable rental expense at our Anhui Qiao location. So we continue to expect some savings on the rental side going forward.

Having said that, when we look to the third quarter, given the revenue decline expectation, we do expect modest gross margins to come down a little bit compared to the year ago period, given that revenue reduction. But keep in mind, COVID-19 is the reason for the revenue reduction, and it represents a near-term jolt for the company. The long-term business fundamentals, as you can see over the last 4 quarters, a very nice operating margin expansion are very much intact. We expect to resume a track of continuing to grow our profitability in the future quarters and years ahead as we get beyond COVID-19.

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

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Great. That’s helpful. And then can we just move down to the SG&A side? How should we be thinking about the marketing just given expectations going forward? And then also maybe commissions to agents?

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

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Sure. In terms of selling and marketing expense, I mean, that’s certainly one area where, given the expected revenue decline in the third quarter, we can continue to look for opportunities to rationalize those expenses given the cash receipts reality. And so we will continue to manage those expenses effectively as we have done so in this most recent quarter.

On the G&A side, we continue to manage those expenses very carefully as well. So net-net, I think, when you look at the third quarter, we’re likely in a position to still be profitable, but very slightly profitable, I think, on an operating basis, given the expected revenue decline in the third quarter.

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Gregory R. Pendy, Sidoti & Company, LLC – Consumer Analyst [6]

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Great. That’s helpful. And then just one more. Can you just talk big picture about maybe the price elasticity? I know this was an unexpected event, but we kind of went through some discounting. And prior to that, you had momentum sort of on the elite and premium side. So how should we be thinking about sort of the price elasticity of courses right now as we kind of come out of the discounting of that?

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Mark A. Marostica, China Distance Education Holdings Limited – Co-CFO [7]

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Sure, sure. As you mentioned, Greg, during the discounting event that we undertook, given our social responsive action to offer these free and significantly discounted courses, we experienced a surge in paid enrollments for exam preparation courses during the quarter, around 1 million exam prep students, which is a very powerful number.

At the same time, our cash receipts suffered. Now during the month of April, we gradually began increasing prices as the COVID-19 pandemic subsided. And so we start May with having that pricing program of heavily discount courses and free courses sunset it.

So now as we look at our results in May, it’s pretty clear that the same dynamics in terms of weakness on the cash receipt side are continuing. And we believe that’s clearly a result of the idea that the company absorbed a good portion at the bulk of its purchasing power, if you will, from students and enrollments for exam prep courses, during the period of time that the company offered the special discounted pricing program.

So that, in some ways, is certainly discoloring what would otherwise be considered price elasticity of demand that you referred to. I do believe that as we get beyond COVID-19 and return to a more normal operating environment, that price elasticity will return. In other words, normal enrollment growth will follow normal pricing. And so that should revert back to what you would expect to be the case.

But given the effect of COVID-19 and the dramatic surge in enrollments in the second quarter, that’s certainly having a continued dampening effect on our cash receipts in the first half of the third quarter.

Operator, next question?

Hello, operator, are there any further questions?

Well, if there are no further questions at this time, I would like to wrap up the call. On behalf of the management team, we thank you for joining us today, and we do look forward to updating you on our progress. Thank you.

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