China Distance Education Holdings Limited (DL) Q2 2019 Earnings Call Transcript

China Distance Education Holdings Limited (DL)
Q2 2019 Earnings Call
May 16, 2019, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good evening. Thank you for joining us for the China Distance Education Holdings Limited second quarter fiscal year 2019 earnings conference call. On today's call are Mr. Zhengdong Zhu, Chairman and CEO and Mr. Marostica, Co-CFO. During management's prepared remarks, all participants will be in a listen-only mode. Following management's prepared remarks, we will open the call for questions.

Before we start, I remind listeners that this conference call contains forward-looking statements. These statements are made under the safe harbor provisions of the US Private Securities Litigation Reform Act of 1995.

The outlook for the third quarter and full fiscal year 2019, oral statements from management on this call, as well as the company's strategic and operational plans, in particular the anticipated benefits of strategic growth initiatives, including the promotion of the company's lifelong learning ecosystem, regular class test prep enrollment growth, cost control, and year over year improvement of operating margins, among other things may 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 this and other risks is included in the company's annual report in 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 call is being recorded. In addition, the presentation we will be referring to during the course of the call can be downloaded from the company's investor relations website. Further, a webcast of this conference call will also be available on the company's IR website at ir.cdeledu.com.

I will now turn the call over to Mr. Zhu. Mr. Zhu, please go ahead.

Zhengdong Zhu -- Co-Founder, Chairman of the Board and Chief Executive Officer

[Through Translator] Thank you, everyone for joining our second quarter fiscal year 2019 earnings conference call. Our operating results were distributed earlier via internet newswire services and are also posted on our website, where a slide presentation is available as well.

If you will now refer to the presentation, I will begin on slide four with an overview of our financial results.

In the second quarter of fiscal 2019, our net revenue increased by 30.3% year over year to $38.8 million, exceeding the high end of our guidance range. In what is typically our seasonally weakest quarter of the fiscal year in terms of revenue and profitability. The second quarter's better than expected revenue performance was attributable to the strong growth of our accounting vertical together with a significant increase of revenue from the sale of learning simulation software. Revenue from the legal vertical generated by Beijing Ruida also contributed to our second quarter revenue growth.

Cash receipts from online course registration grew by 29.8% year over year to $57 million. Second quarter cash receipts were buoyed by strong growth in cash receipts from our market-leading accounting vertical and more student enrollments in our longer duration premium and elite classes.

Total enrollments increased by 8.9% year over year during the second quarter, owing to strong growth in accounting and engineering and construction or E&C continuing education course enrollments.

This year, we have been successful in monetizing our longer duration classes, which offer our students more value-added services such as closers oversight from our tutors, employment guidance services, personalized learning reports, and longer study periods, among others. Such premium and elite classes are placed at relatively higher price points than our regular classes.

While our pivot to higher value longer duration classes has driven robust cash receipt growth in receipt quarters, we believe our relatively lower price, shorter duration regular classes as well as our free classes are important drivers of increased traffic to our course websites and help us further promote our higher value classes. And looking ahead to next year's test preparation season, in an effort to better serve our students, we have formed a team which is focused on enhancing our course websites with enriched content and improved website navigation.

As previously disclosed, we decided to voluntary de-list CDEL's controlled company, Zhengbao Yucai, from the New Third Board, China's over-the-counter stock exchange. This decision was due to a lack of both trading volume of Zhengbao Yucai's shares and fundraising opportunities. Zhengbao Yucai completed its voluntary de-listing from the New Third Board on April 22nd, 2019. We will continue to consolidate Zhengbao Yucai's financials in CDEL's consolidated financial statements.

Next, CDEL decided to acquire an additional 9% equity interest in Beijing Ruida, a leading provider of exam preparation services for participants in China's legal professional qualification examination. For a total consideration of 38.3 million RMB or $5.6 million, bringing the company's total equity interest in Beijing Ruida to 60%. The transaction is expected to close in the third quarter of fiscal 2019. In addition, Beijing Ruida reported revenue of approximately $4.5 million in the second quarter.

Turning to our mobile platform, as of March 31st, 2019, China Distance Education offered 68 mobile apps and recorded cumulative downloads of 54 million, up from 48.8 million as of December 31st, 2018. In the second 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 41.9%, 10.9%, and 43.6% year over year, respectively.

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.

Mark Marostica -- Co-Chief Financial Officer

Thank you. Before I discuss the details of our second quarter financial performance, I want to touch on a few items related to our profitability and operating margin outlook. We believe our second quarter fiscal 2019 marks and important inflection point in terms of profitability. Our second quarter gross margins expanded year over year, which is the first quarter in over two years where we've seen gross margin expansion and both second quarter salaries and related expenses and rental and related expenses grew at a slower pace than revenue growth for the first time in the last six quarters.

Our efforts to balance growth through profitability are beginning to bear fruit. Excluded in the operating results of Beijing Ruida and $1.7 million in amortization expenses of intangibles arising from the acquisition of Beijing Ruida, our second quarter fiscal 2019 operating margin would have improved by 436 basis points year over year, underscoring the improving profitability of CDEL's core business.

This would mark the first quarter in the last nine quarters where we've seen year over year operating margin expansion, again, excluding the operating results of Beijing Ruida and the amortization expenses of intangibles attributable to Beijing Ruida. Of note, we began consolidating Beijing Ruida into our consolidated financial statements in the fourth quarter of fiscal 2018.

Looking ahead, we expect our operating margins will expand year over year in both our third and fourth quarters of fiscal 2019, based on our expectation of healthy revenue growth and diligent expense control. Enrollments in our online accounting test preparation courses were down 21.8% year over year in the second quarter, primarily due to declines in certified public account or CPA enrollments as well as accounting professional qualification exam or APQE enrollments.

That said, our accounting premium class test preparation enrollments were up almost 600% year over year in the second quarter and drove accounting test prep cash receipts growth of 47.8% year over year in the quarter. Enrollments in our accounting continuing education courses increased by approximately 180% year over year in the second quarter of fiscal 2019, primarily due to a resumption of accounting continuing education in certain jurisdictions.

Total online accounting test preparation ASPs increased by 89% year over year in our second quarter as ASPs increased significantly in our CPA at APQE courses. These ASP increases were mainly due to increased student enrollments in our longer duration premium classes. Enrollments in our online healthcare test preparation courses in the second quarter of fiscal 2019 decreased by 20.9% year over year, primarily due to enrollment declines in our medical practitioner and physician assistant test preparation courses.

ASPs for our healthcare test preparation courses increased by 24.6% year over year in the second quarter, mainly due to overall ASP increases and in particular our longer duration premium classes.

Enrollments in our online engineering and construction or E&C test preparation courses decreased by 9.8% year over year in the second quarter, primarily due to enrollment declines in our associate and constructor test preparation courses. Enrollments in our E&C continuing education courses, however, increased by 52.5% year over year in the second quarter.

ASPs for our E&C test preparation courses in the second quarter increased by 30.5% year over year, primarily due to overall ASP increases of our longer duration premium classes. The ASPs for E&C continuing education courses decreased by 32.1% year over year in the second quarter.

The significant year over year increase in our second quarter E&C continuing education enrollments and corresponding year over year decline in E&C continuing education ESPs were primarily due to a policy change implemented by the E&C professional certification authorities whereby students are now allowed to purchase continuing education services from multiple providers in order to fulfill their continuing education requirements instead of from a single provider, as was the case previously.

Let's now turn to slide ten to 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 39.9% in the second quarter of fiscal year 2019, compared with 37.3% in the second quarter of fiscal year 2018. The year over year expansion in gross margin was primarily due to decreased salaries and related expenses and better leverage on lecture fees and rental and related expenses, partially offset by expenses associated with Beijing Ruida, including amortization expenses of intangibles arising from the acquisition of Beijing Ruida.

Non-GAAP selling expenses increased by 65.9% to $13.8 million in the second quarter of fiscal year 2019 from $8.3 million in the prior year period. Driven primarily by increases in advertising and promotional expenses, salaries, and related expenses, commissions to our agents, and other miscellaneous selling expenses as well as expenses associated with Beijing Ruida.

Non-GAAP general and administrative expenses increased by 15.5% to $6.1 million in the second quarter of fiscal year 2019 from $5.3 million in the prior year period, mainly due to an increase in salaries and related expenses and expenses associated with Beijing Ruida.

Overall, the non-GAAP operating loss for the second quarter of fiscal year 2019 was $3.6 million compared with non-GAAP operating loss of $2.4 million in the prior year period. Income tax benefit was $1.3 million in the second quarter of fiscal year 2019 compared to income tax benefit of $1.4 million in the prior year period, primarily due to a lower than estimated effective tax rate, applied in fiscal year 2019 compared with the prior year period. Non-GAAP net loss was $3.4 million in the second quarter of fiscal year 2019 paired with non-GAAP net loss of $2.7 million in the prior year period.

Now, let's turn to slide 11 to review our cash flow. Net operating cash inflow increased by 128.8% to $16.5 million in the second quarter of fiscal 2019 from $7.2 million in the prior year period. The operating cash inflow was mainly attributable to the increase in deferred revenue generated from our professional education services segment. The operating cash inflow was partially offset by the increase in accounts receivable, pre-payments, and other current assets, and the decrease in accrued expenses and other liabilities, income tax payable, deferred tax liabilities, and amount due in related party.

Cash and cash equivalence, restricted cash, and short-term investments as of March 31st, 2019 increased by 17.7% to $130.1 million from $110.5 million as of December 31st, 2018, mainly due to the operating cash inflow generated in the second quarter of fiscal year 2019, partially offset by capital expenditures of $1.7 million.

This completes my financial overview. I will now return the call to Mr. Zhu for concluding remarks as well as financial guidance for both the third quarter and for fiscal year 2019. Mr. Zhu, please.

Zhengdong Zhu -- Co-Founder, Chairman of the Board and Chief Executive Officer

[Through Translator] Thank you, Mark. Overall, we're pleased with our progress in the first half of fiscal year 2019 as we've generated healthy growth of cash receipts from online course registration while effectively controlling our cost structure, setting the stage for improved profitability in the quarters ahead.

Our steadfast efforts to broaden our lifelong learning ecosystem have enabled us to build a well-diversified business model with multiple revenue streams across four key industry verticals, including accounting, healthcare, engineering and construction, and legal. We've also deepened our service offering within our industry verticals, particularly in our market-leading accounting ecosystem. We now offer exam preparation services for high-stakes professional certification exams with multiple class types and learning modalities tailored to individual learning styles and preferences.

Our continuing education ensures students maintain the professional certifications in good standing. Our practical accounting training courses bundled with employment guidance services better prepare students to start their careers. We also offer career enhancement skills training for working professionals, college-focused accounting learning simulation software for enhanced self-learning experience, as well as accounting services for corporate clients.

We remain committed to delivering high-quality courseware and educational services to our students to help them advance in their careers while integrating best of breed learning technologies into our educational solutions. Our focus on optimizing the integration of learning and technology will ultimately pave the way for future growth and strengthen our leadership position in China's education industry.

As China's trusted leader in online professional education, our vision has remained consistent over the years, which is to cultivate online learning as a lifestyle, while striving to position China distance education as our students' pre-eminent learning partner on their lifelong learning journey.

We are confident in the long-term value we can bring to investors. We continue to expect to generate non-GAAP operating income growth in fiscal 2019 with improved non-GAAP operating margins, while we focus growth with a keen focus on prudent cost control. And we are pleased to report that we are seeing continued strong growth momentum and cash receipts from online course registration, which increased by approximately 30% year over year on a constant currency basis during the third quarter fiscal 2019 through the end of last week.

Turning to guidance, for the third quarter of fiscal year 2019, the company expects to generate total net revenue in the range of $61.6 million to $64 million, representing year over year growth of approximately 30% to 35%.

For the fiscal year 2019, the company expects to generate total net revenues in the range of $210 million to $218.3 million, representing year over year growth of approximately 26% to 31%. The company's prior year fiscal year 2019 full year total net revenue guidance range was $208.3 million to $216.7 million.

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

Questions and Answers:

Operator

Ladies and gentlemen, for the benefit of all the callers participating in today's call, if you wish to ask your question to management in Chinese, please also immediately restate your question in English. We will now begin the question and answer session. If you wish to ask a question, please press *1 on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press the # key. Please note that there may be a short pause as the questions are being collated. We thank you for your patience.

Your first question comes from the line of Mr. Greg Pendy from Sidoti. Your line is open.

Greg Pendy -- Sidoti -- Analyst

Thanks for taking my questions. I just wanted to know -- I think first off, if you could expand a little bit, you said the resumption of continuing education, you said it was a headwind last year in the prior quarter. Can you just give us a little bit more color on what's going on there? Is it throughout China, certain provinces, and why it might be coming back?

Mark Marostica -- Co-Chief Financial Officer

Sure. In the wake of the cancellation of the accounting certificate examination, there was certainly a lull and inconsistent enrollment results for accounting continuing education for several quarters. We saw that certainly in our results. What we have been seeing recently is a resumption by certain jurisdictions across China in providing accounting continuing education services and promoting those services. So, in fact, we saw a pretty substantial increase in our accounting continuing education course enrollment in the quarter as a result of this resumption.

I would also add to your question the note on engineering and construction continuing education enrollment, which also surged in the quarter for a different reason, on the back of a policy change which allows students to fulfill their continuing education requirement using multiple providers versus a single provider, as was the case previously.

Greg Pendy -- Sidoti -- Analyst

Then on the cost outlook, can you give us an update on where you are in terms of rent? I believe you had elevated rent this quarter. But is that something that you've exited some space on a going forward basis?

Mark Marostica -- Co-Chief Financial Officer

Yes. We are beginning to enjoy some improved leverage on rental and related expenses. You may recall that a year ago with our renting the Anhui Qiao location. We doubled up on rent expense during the period. We were making lease hold improvements to Anhui Qiao, which are behind us for the most part, at this point.

As we mentioned in our prepared remarks, we're now seeing some nice leverage on rental and related expenses as we've anniversaried the Anhui Qiao initial rent expense as well as exiting some space in our headquarter building, namely the second floor and part of our first floor as well as the second floor of our Haidian location. So, this is something we had talked about on prior calls that we were planning to do.

For these reasons, as we go forward in the third quarter, current quarter, and fourth quarter and beyond, we should see improved leverage on rental non-related expenses. In fact, looking at the overall expense outlook for the company in the second half of the fiscal year, we do expect continued year over year gross margin expansion and leverage on G&A spending, as we saw in the second quarter.

We do expect year over year selling expense growth to moderate in Q3 compared to Q2, with some leverage on selling expenses coming back in Q4 due to the fact that we're now able to capitalize and amortize certain aging commissions over the service period, which was not the case in Q4 of fiscal 2018. All in all, Greg, we do expect 51 to 100 basis points of operating margin expansion in fiscal 2019.

Greg Pendy -- Sidoti -- Analyst

Then just one more if I can -- you had a 51% stake in Beijing Ruida. You decided to increase it. Can you give us the big picture on any thoughts on what was behind the decision to go? I know you had the option to go up to 60%, but any color on the longer-term strategy behind Beijing Ruida and any thoughts on what you've learned in terms of your current ownership?

Mark Marostica -- Co-Chief Financial Officer

Sure. I'd like to highlight three key reasons. First, upping our equity stake in Beijing Ruida underscores the importance of Ruida to our overall business strategy. Ruida has clearly moved us squarely into a fourth vertical, legal education, which helps diversify our business model. Secondly, we like Ruida's high quality content, leading lecturers, and market positioning. Third, we believe the returns on investor capital with respect to Ruida will be attractive over the next several years.

Greg Pendy -- Sidoti -- Analyst

That's helpful. Thanks a lot, guys.

Operator

Once again, if you wish to ask a question, please press *1 on your telephone keypad and wait for your name to be announced. There are no further questions at this time. I would now like to turn the call back to the management for closing remarks.

Mark Marostica -- Co-Chief Financial Officer

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.

Operator

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

Duration: 33 minutes

Call participants:

Zhengdong Zhu -- Co-Founder, Chairman of the Board and Chief Executive Officer

Mark Marostica -- Co-Chief Financial Officer

Greg Pendy -- Sidoti -- Analyst

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