Earnings Call Transcript - EDU Q3 2022

Operator, Operator

Good evening and thank you for standing by for New Oriental’s FY 2022 Third Quarter Results Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. I now like to turn the meeting over to your host for today’s conference, Ms. Sisi Zhao.

Sisi Zhao, Host

Thank you. Hello everyone, and welcome to New Oriental’s third fiscal quarter 2021 earnings conference call. Our financial results for the periods were released earlier today and are available on the company’s website, as well as on newswire services. Today, you will hear from Stephen Yang, Executive President and Chief Financial Officer. After his prepared remarks, Stephen and I will be available to answer your questions. Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. New Oriental 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. In addition, a webcast of this conference call will be available on New Oriental’s Investor Relations website at investor.neworiental.org. I will now turn the call over to Mr. Yang. Stephen, please go ahead.

Stephen Yang, Executive President and CFO

Thank you, Sisi. Hello everyone, and thank you for joining us on the call. Before we begin, I would like to convey our sympathy to all the people who have been impacted by the pandemic and thank all the healthcare heroes and the local authorities for their hard work and commitment during this difficult time. It’s been a while since our last earnings conference call, and we would like to take the opportunity to extend our gratitude to those who have been supporting and believing in New Oriental. While our business in the previous quarters was perhaps characterized by the significant costs incurred from cancellation costs, closure of the schools and learning centers, and employee layoffs, as a result of government policy introduced last year, this quarter was about turning over a new leaf with new and decisive endeavors and innovative business opportunities as the company embarks on a fresh journey that strives to increase the overall development of students. Despite the challenges the company is facing during this restructuring phase, we’re pleased to see a promising trend in our key remaining businesses and positive momentum emerging across many of our review initiatives as we announced the latest set of financial results. Our key remaining businesses have shown remarkable resilience as the overseas test prep business and overseas study consulting business recorded a year-over-year revenue growth of about 8% and 26% respectively for the first nine months of the current fiscal year. In the same period, our adult and university student business has performed exceptionally and recorded a rapid growth of approximately 59% year-over-year. Simultaneously, our management teams have come to the forefront during this time of change and we have been exploring new business opportunities, including non-academic tutoring, intelligent learning systems and devices, study tours and research camps, educational materials, and digitalized smart study solutions, as well as exam prep courses designed for students with junior college diplomas to obtain bachelor's degrees. Now, I would like to spend some time discussing this quarter's performance across our remaining business lines and introducing our new initiatives in detail. Our key remaining business is showing promising trends; breaking it down, the overseas test prep business recorded a revenue increase of 8% in dollar terms for the first nine months of this fiscal year. The overseas study consulting reported a revenue increase of about 26% in dollar terms year-over-year for the first nine months of this year. The domestic business targeting adults and university students recorded a rapid growth of approximately 59% year-over-year for the first nine months of this year. As for our new business initiatives, we have launched five new initiatives in the past months, which mostly revolve around facilitating the overall development of students. I’m glad to share with you that these new initiatives have shown positive momentum. Firstly, our business, which we have rolled out in over 60 existing cities, focuses on cultivating students' innovative ability and comprehensive quality. We're happy to see increased market penetration in both markets that we have tapped into. The top 10 cities in China have contributed more than 60% of the revenue of this business. Secondly, the intelligent learning system and device business is a service designed to provide a tailored digital learning experience for students, utilizing our past teaching experience, data, and technology to provide personalized and targeted learning and exercise content together with assessing the learning curve of our students as a backend system. The new educational service not only greatly improved students' learning efficiency but also cultivated students' proactive learning habits. We have tested adoption in over 15 existing cities and are delighted to see improved customer retention and scalability of this newly initiated service. The revenue contribution of these initiatives from the top 10 cities in China is over 65%. Meanwhile, the study tour and research camp business aims to offer students the opportunity to fully leverage their free time during holidays to broaden their knowledge and cultivate subject interest. We have conducted study tours and research camps in over 50 cities across the country. The revenue contribution of these initiatives from the top 10 cities in China is over 55%. We're also very excited about the prospects of the educational material and digitalized smart study solutions, a self-learning system leveraging advanced technology that enables students to have complete control over the pace and flexibility of learning, especially where remote learning becomes increasingly mainstream. In addition, New Oriental’s Smart Education Business comprises smart hardware, science and technology innovation education, and other services, providing high-quality educational resources and comprehensive services for local governments, educational authorities, primary and secondary schools, and kindergartens. The products and services related to this smart education business have presence in over 2,000 kindergartens and over 500 primary and secondary schools across the country. Last but not least, the exam prep course designed for students with junior college diplomas to obtain bachelor's degrees has become a very common goal among many associated degree holders in the country. We have observed that this market is providing them prep services as these diploma and college students require support in taking the leap forward to the university level. We're piloting such courses in some higher-tier cities now and plan to roll them out to more cities in the next fiscal year. During the last two fiscal quarters, we have been fully committed to complying with the government's policy, and as a result, the total number of schools and learning centers was reduced to 847 by the end of this fiscal quarter. The significant change in our structure emphasizes the importance of our industry-leading OMO system, which has been one of the consistencies during the company's resurgence phase, as we remain committed to investing in the R&D of the technology. The OMO has been instrumental during the restructuring process as well as during the COVID-19 outbreaks in certain parts of China, where strong flexibility is required in migrating students between online and offline classes to minimize learning disruption. We continue our efforts in developing and revamping our OMO teaching platform and keep leveraging our education infrastructure and technology strength across our remaining key business and new initiatives to provide more advanced and diversified educational services for customers of all ages. We invested $27 million in the quarter and $129 million in the first three quarters of this fiscal year to improve and maintain our OMO teaching platform, which ensured that our high-quality service to students during the pandemic is uncompromised. Regarding the performance of our pure online platform, Koolearn, in light of the changing landscape of the education industry in China, Koolearn has been seeking new market opportunities by leveraging existing infrastructure and technology to shift its strategic focus and adjust existing business lines and service offerings. Koolearn has continued to expand the development of existing college and institution business segments, as well as online education products and service offerings. On the other hand, it is implementing structural changes to meet the needs of the changing regulatory and educational environment by actively exploring new initiatives to broaden its customer base and offerings. Some of the new initiatives that Koolearn has been exploring include live stream marketing of traditional Chinese culture and high-quality agriculture and other products from different regions of China, seeking institutional cooperation, and developing new intelligent learning innovations. After the introduction of the government policy on after-school tutoring last year, which has undoubtedly had a direct impact on our business, we have received many inquiries and concerns from investors over the company's financial position. As a company with a long-standing heritage, we have always ensured that we are prepared to weather changes in the market, which reflects in our ability to maintain a strong cash position throughout the entire process. By the end of the quarter, our cash and cash equivalents, term deposits, and short-term investments totaled approximately $4.4 billion. In the second and third quarter of this fiscal year, the company incurred considerable costs from the termination of its lease agreements in relation to the closure of learning centers and employee layoffs. We believe that the costs generated during the restructuring phase are temporary as they are non-recurring losses. With the process of school closures now largely completed, it signals that the company has now entered a stage of starting afresh, exploring new opportunities with greater flexibility and strong cash flows. We're confident in the sustainable profitability of the older remaining key businesses, as well as the growth and profit potential of our new initiatives. The company's management team will continue to work together to seek profitable growth. We believe our continued commitment to high-quality service and operational efficiency will generate more value for our customers, society, and shareholders over the long term. Now, I will turn the call over to Sisi Zhao to go through our key financials. Sisi?

Sisi Zhao, Host

Okay. Now, I'd like to walk you through the other key financial details for the quarter. Operating cost and expenses for the quarter were $755.3 million, representing a 30.6% decrease year-over-year. Non-GAAP operating costs and expenses for the quarter, which excludes share-based compensation, are $725.3 million, representing a 32.5% decrease year-over-year. The decrease was primarily due to the reduction in facilities and the number of staff as a result of the restructuring in the last two quarters. Cost of revenue decreased by 30.9% year-over-year to $372.7 million. Selling and marketing expenses decreased by 40% year-over-year to $93.7 million. G&A expenses for the quarter decreased by 26.6% year-over-year to $288.8 million. Non-GAAP G&A expenses, which exclude share-based compensation, were $259.6 million, representing a 32.3% decrease year-over-year. Total share-based expenses, which were allocated to related operating costs and expenses, increased by 107.8% to $30 million in the quarter. The increase is due to the grants of restricted share units of the company to employees and directors in May 2021 with graded vesting over three years. Operating loss was $141.2 million, compared to an income of $101.5 million in the same period of the prior fiscal year. Non-GAAP loss from operations for the quarter was $111.2 million, compared to an income of $115.9 million in the same period of last fiscal year. Net loss attributable to New Oriental for the quarter was $122.4 million, compared to an income of $151.3 million in the same period of last year. Basic and diluted net loss per ADS attributable to New Oriental were $0.72 and $0.72, respectively. Non-GAAP net loss attributable to New Oriental for the quarter was $95.5 million, compared to an income of $163.2 million in the same period of last year. Non-GAAP basic and diluted net loss per ADS attributable to New Oriental were $0.56 and $0.56, respectively. Net operating cash outflow for the quarter was approximately $235 million and CapEx for the quarter was $37.4 million. Turning to the balance sheet, as of February 28, 2022, New Oriental had cash and cash equivalents of $1,466.8 million. In addition, the company had $915.1 million in term deposits and $2,028.1 million in short-term investments. New Oriental's deferred revenue balance, which is cash collected from registered students for the courses and recognized proportionally as revenue as the instructions are delivered, at the end of the quarter was $971.3 million, a decrease of 47.9% as compared to last year as of the end of the third quarter of fiscal year 2021. The decrease is primarily due to the cessation of the K-9 academic after-school tutoring services in order to comply with the government policy in China. Now, I’ll hand over to Stephen to go through our outlook and guidance.

Stephen Yang, Executive President and CFO

Looking ahead into the next quarter of fiscal year 2022, having adopted measures in response to the latest policies and regulations, we now have a clearer picture of the recovery trends of the company's near-term financial performance and are prepared for a new beginning as we identify new and profitable market opportunities for the long run. As the stage of closure of the schools and learning centers nears its end, we’re left with a relatively small portion of the lease terminations to be executed in the coming months. The non-recurring one-off costs related to the closure were already accrued in the first half of the current fiscal year. In the meantime, our strong performing key remaining businesses are all profitable and will continue to serve as a solid foundation for business performance, providing us with the fuel to explore new possibilities in the markets. Our strategic focus and investment approach going forward aim at expanding our new initiatives, which will be key growth engines for our business. We're confident about the future success of these services as they echo the current trends in the market, with the likes of non-academic tutoring and study tours targeting the facilitation of the overall development of students, which is a general goal that the industry is striving to achieve. Meanwhile, intelligent learning systems and devices, and digitalized smart study solutions are offering students a personalized digital and remote learning experience, which is a trending theme in the enabled and post-pandemic education industry. It will take time for these new businesses to come to full fruition, but as we saw in this quarter, the encouraging growth trajectory they have already been showing proves that we are heading in the right direction. We're confident that these businesses will start to contribute meaningful revenue from the next fiscal year onwards. We would like to note that our guidance is taking into consideration of the recent pandemic development in Shanghai and some other small cities that are still in lockdown. These cities have inevitably impacted our local business operations. Student recruitment is where we experienced some disruption, as students and customers were unable to access our service centers to attend courses. Though the overall impact on the business has been limited, thanks to our OMO system, which enabled us to swiftly migrate students from offline to online classes, avoiding much of the learning disruption. We also don't expect the disruptions in Shanghai and some other small cities to have a significant effect on our overall revenue growth, as we have a presence across many cities in China. Although the pandemic situation in China remains fluid, our operational infrastructure, led by the OMO system, has demonstrated strength and flexibility in the past couple of years, weathering disruptions, while our staff across the country have gained experience in preparing for and responding to COVID operations. Therefore, we're confident that any future outbreaks in other cities will only have a limited impact on our business. Our experience stands the test of time. One of the strengths of New Oriental is the experience and legacy we have built over the years, which has proven to be the differentiating factor between us and other players during challenging periods. Leveraging our experience and brand recognition, as well as our very healthy cash balance that has been maintained during a very difficult time, we have great confidence that the overall business will turn profitable again in the near future. To conclude, we’re now taking all kinds of operational actions to promote our key remaining businesses and investing in the new initiatives, which will be the new growth engines that accelerate our recovery. At the same time, we will continue to seek guidance from and cooperate with government authorities in various provinces in China in connection with its efforts to comply with the relevant policies, guidelines, and any related implementation rules, regulations, and measures, and further adjust our business operations as required. With our investments in different strategies, we’re optimistic about brighter prospects for our business. We believe this new company structure following the restructuring phase will bring us fruitful returns in the long run. I must mention that these expectations reflect our considerations of the latest regulatory measures and the pandemic situation, as well as our current and permanent view, which is subject to change. At this point, I would like to open the floor for questions. Operator, please open the call for this.

Operator, Operator

Thank you. Our first question comes from Felix Liu from UBS. Please ask your question.

Felix Liu, Analyst

Thank you management for taking my question. I’m very pleased to see the resilience you have shown during the tough restructuring due to the external environment. My first question is on the restructuring progress. So, you mentioned that most of the restructuring is almost finished. May I know if the number of learning centers you have by the end of Q3 will be more or less sustainable into the future, or do you expect more closures in the upcoming months? My second question is regarding the accounting of the restructuring costs. Unfortunately, I noticed that you have turned this quarter. Could you please elaborate on how much of the cost this quarter is related to the one-off restructuring and how much will be ongoing? Any color on the outlook of your new initiative would also be much appreciated. Thank you.

Stephen Yang, Executive President and CFO

Thank you, Felix. Regarding your first question about learning centers, at the end of the last fiscal year, we had a total of 1,669 learning centers. By this quarter's end, we have 847 learning centers. We plan to close down some additional learning centers. Therefore, we expect the number of learning centers to decrease to between 650 to 700 by the end of this fiscal year. Regarding the one-off costs associated with the learning center closures and utility layoffs, we have already accrued most of these costs in the first half of this year. Yes, you saw the losses in this quarter, but I believe this is mainly due to new investments in the new initiatives for the future. However, we believe that these new initiatives, such as the intelligent learning systems and devices, or some like the exam prep for college students to obtain their bachelor’s degrees, are worthy investments as they will start to generate profits in the near future. We are optimistic that in the next fiscal year we will start to see profitability, as our domestic test prep and overseas consulting businesses are already profitable. We believe that new businesses will also be profitable, and we have an optimistic margin profile in the upcoming fiscal year.

Operator, Operator

Thank you. Our next question comes from DS Kim from J.P. Morgan. Please ask your question.

DS Kim, Analyst

Hi Stephen. Hi Sisi, thanks for resuming the results call and hope you are safe and well in Beijing. I actually have a couple of questions, but out of consideration for time, I will stick to one question here and try to ask again later. In terms of the revenues in the third quarter, could you provide details on how much of that third quarter revenue happened in December versus January and February of this year? In relation to that, how much was the new initiatives you mentioned, like the non-academic intelligent learning systems, contributing to the revenue in the third quarter?

Stephen Yang, Executive President and CFO

For revenue contribution in this quarter, the December revenue was slightly higher than the revenue of January and February since we closed down the K-9 business by the end of last calendar year. In December, we did have some of the K-9 tutoring courses that reported revenue. As for the new business, which we just launched a couple of months ago, it's quite new but has been growing very fast. The new business, including the non-academic courses and new services related to the intelligent learning system, will contribute more revenue in the next year. I believe the new business will constitute over 20% of the revenue contribution next year, and we are already seeing rapid growth.

Operator, Operator

Thank you. Our next question comes from an unidentified analyst from Morgan Stanley. Please ask your question.

Unidentified Analyst, Analyst

Thank you, management. My question is also related to the new business. Is there any operational data that you could share, for example, regarding the retention rate for the new non-academic courses? Additionally, how do you see the competition in this area? Thank you.

Stephen Yang, Executive President and CFO

We started our new business a couple of months ago, and it has developed very quickly. We have noticed that student retention rates are climbing higher and higher. In major cities, we are seeing that student retention rates for our new courses are close to the retention rates of our academic courses from last year, which is good news for us. In terms of competition, while the competition is still present, we believe that it is lessening due to the overall market environment changes. We have seen many of our competitors leave the market, so competition is not a problem for us.

Operator, Operator

Thank you. The next question comes from an unidentified analyst. Please ask your question.

Unidentified Analyst, Analyst

Hello, Sisi and Stephen, thank you for taking my question. I would like to ask about the recovery of the overseas and domestic test prep businesses, especially given the easing of border control in other countries. At the same time, I have noticed that the domestic test prep business has shown strong revenue growth. Overall, for the next fiscal year, how do you foresee the revenue growth of the test prep businesses, and what kind of developments have been made in the domestic test prep over the past year to achieve such strong growth?

Stephen Yang, Executive President and CFO

Despite being in the restructuring phase, we are happy to report that both the domestic and overseas test prep businesses have experienced significant growth in the past couple of months. The overseas test prep and consulting business had a total revenue increase of about 15% year-over-year, with 8% growth in the overseas test prep and 26% growth in consulting for the first nine months of this year. We know that the pandemic is still affecting some countries, including China, but many students continue to enroll in overseas test prep classes. Most of these students are high school and college students making future plans, so they are unlikely to change their intentions. I believe that humanity can overcome the coronavirus, and I'm confident that our overseas test prep and consulting business will see meaningful growth in the upcoming fiscal year. The domestic test prep market is booming as more university and college students opt to take the Chinese GRE exam. We are well-positioned to dominate this business. For the last two years, we have prepared internally by organizing our Chinese GRE department, adult English, and moving talent from the K-12 business to bolster our domestic test prep. I firmly believe that our domestic test prep will continue to grow rapidly and yield more profit for New Oriental.

Operator, Operator

Thank you. Our next question comes from Lucy Yu from Bank of America. Please ask your question.

Lucy Yu, Analyst

Thank you, Stephen for taking my question. My question pertains to the margins of the remaining businesses, which you mentioned are profitable. Could you share the profitability metrics for those remaining businesses? Additionally, you mentioned that the new business will become profitable next fiscal year. What are the expected margins for those new businesses in the upcoming year? Thank you.

Stephen Yang, Executive President and CFO

The remaining businesses, specifically in overseas test prep and other areas, typically have margins between 15% to 20%, while the domestic test prep margins are around 10%. The new businesses have shown lower margins initially, but I believe that next year they will turn profitable. Theoretically, the margins for new businesses could reach around 20%, making them a strong addition to our portfolio.

Operator, Operator

Thank you. Our next question comes from Liping Zhao from CICC. Please ask your question.

Liping Zhao, Analyst

Thanks, Stephen and Sisi for taking my question. I’m glad to see that you have made progress on some new initiatives. Could you tell us which of these initiatives will most likely be the future key revenue contributors? What are EDU’s competitive advantages in that direction? Thank you.

Stephen Yang, Executive President and CFO

We have several new business opportunities, including five key new initiatives. The first focuses on innovative tutoring, aimed at improving students' innovative abilities and overall quality through programming, design, presentation skills, art, sports, and more. This has grown rapidly as students have more free time due to reduced pressure from the double deduction policy. Parents are keen to support their children’s development. Secondly, we launched an intelligent learning system and device that utilizes our past teaching experience and data analytics. This system promotes self-study among students, leading to positive reception from both students and parents. These two initiatives—the tutoring programs and the intelligent learning systems—are expected to be major contributors to our revenue going forward. Again, thank you for joining us today. If you have any further questions, please do not hesitate to contact me or any of our investor relations representatives. Thank you.

Operator, Operator

Thank you. This concludes our conference for today. Thank you for participating. You may all disconnect.