Earnings Call Transcript - EDU Q2 2023

Sisi Zhao, Host

Thank you. Hello, everyone and welcome to New Oriental's second fiscal quarter 2023 earnings conference call. Our financial results for the period were released earlier today and are available on the company's website as well as on Newswire services. Today, Stephen Yang, Executive President and Chief Financial Officer and I will share New Oriental's latest earnings results and business updates in detail with you. After that, 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'll now first turn the call over to Mr. Yang Stephen. Please go ahead.

Stephen Yang, CEO and CFO

Thank you, Sisi. Hello, everyone and thank you for joining us on the call. This second quarter is a successful phase of manifestation as we have turned over a new leaf in our business and embarked on an innovative journey for rich business opportunities since the beginning of fiscal year 2023. Before going into details of our financial performance for this quarter, I would like to take this opportunity to extend our gratitude to those who have been delivering and supporting New Oriental along the way. I'm delighted to share with you that after a year of restructuring process, New Oriental has successfully generated fruitful yields from our new business ventures, combined with our existing businesses and innovative business opportunities. Despite the seasonality of some of our major businesses, which has historically resulted in a slower period for every second quarter, it's immensely encouraging to see that we have achieved meaningful profitability and better-than-expected margins in the second quarter. We have achieved a non-GAAP operating margin of 2.6% for this quarter as compared to negative 112.0% in the same period of the prior fiscal year, which was characterized by several significant one-off expenses incurred from class cancellations, school closures, and employee layoffs. Our key remaining businesses have continued to demonstrate remarkable resilience. In particular, the overseas test prep business and overseas study consulting business have recorded a remarkable year-over-year revenue increase as global COVID restrictions ease and the overseas study market is recovering. Our solid profitability, strong-performing remaining business lines, and emerging new business initiatives in this quarter have again strengthened our confidence in pursuing innovative endeavors and profitable growth through the rest of the year. Now I would like to spend some time to talk about the quarter's performance across our remaining business lines and new initiatives. Our key remaining businesses have achieved promising trends, while our new initiatives have shown positive momentum. Breaking it down, the overseas test prep business recorded a revenue increase of 17% in dollar terms, or 30% in RMB terms year-over-year for the second quarter. The overseas study consulting business recorded a revenue increase of about 14% in dollar terms or 27% in RMB terms year-over-year for the second quarter. The adults and university students business recorded a revenue decrease of 9% in dollar terms or a 2% increase in RMB terms year-over-year for the second quarter. As for our new business initiatives, as mentioned in the past quarter, we have launched several new initiatives which mostly revolve around facilitating students' all-round development. I'm glad to share with you that these new initiatives have further exceeded our expectations by sustaining a positive momentum and generating meaningful profits for the company. Firstly, the non-academic tutoring business, which we have rolled out in over 60 cities, focuses on cultivating students' innovative ability and comprehensive quality. We're happy to see increased market penetration in both markets we have tapped into, especially higher-tier cities with a total of 477,000 enrollments recorded in this quarter. The top 10 cities in China have contributed about 60% of revenue for this business. Secondly, the intelligence learning system and device business is a service designed to provide a tailored digital learning experience for students. It utilizes our path to teaching experience, data, and technology to provide personalized targeted learning and exercise content. Our continuous investments in technology have fueled our comparative edge, which helps us navigate the chain of challenges from the last year. Together with our teachers monitoring and assessing the learning curve for students at the back-end system, this new innovative education service not only greatly improves students' learning efficiency but also cultivates students' proactive learning habits. We have tested its adoption in over 60 cities with 108,000 active paid users in this quarter and are delighted to see improved customer retention and scalability of this new business. The revenue contribution from the top 10 cities in China is around 60%. Last but not least, our smart education business, which comprises smart teaching, smart hardware, science, technology, and innovation education, serves local governments, education authorities, schools, and kindergartens. Our educational material utilizes the smart study solutions and the self-learning system, leveraging advanced technology, enabling students to have complete control over the pace of their learning in an age where remote learning becomes increasingly mainstream. We also offer exam prep courses designed for students with junior college diplomas to obtain bachelor's degrees. The above-mentioned business has been gaining wide traction and has contributed to the overall growth of the company, attaining instrumental profit since the last quarter. Coming to our OMO system, we continuously invest in developing and revamping our OMO teaching platform and have leveraged our educational infrastructure and technology strength over the remaining businesses and new initiatives to provide more advanced and diversified education services to our customers for all ages. Our OMO system has been a core support to our business, especially as some of the strict social control measures were implemented in the past months. We have invested a total of $21 million in the quarter in our OMO teaching platform, which gives us the flexibility to continue offering high-quality services to students during the pandemic. Now I would like to give you all an update on Koolearn's latest performance. In the first half of this fiscal year, Koolearn has achieved incremental breakthroughs in both business operations and financial performance. This significant progress was made as a result of Koolearn's strategic transformation from focusing on online education to livestreaming e-commerce. In 2021, Koolearn expanded its livestreaming e-commerce business and established Dongfang Zhenxuan, which has since become a well-known platform for promoting healthy, top-quality, and cost-effective products to the public. The platform has formed a part of a tight supply chain management and after-sales service system that strictly abides by a set of relevant laws and regulations. Leveraging our deep understanding of customer needs, Dongfang Zhenxuan continues to expand its product selection and SKUs through proactive cooperation with third parties, coupled with the development of our Dongfang Zhenxuan private labeled products. The platform's business developments have gratefully benefited from the maturity of China's social infrastructure and the contributions and support from the community. To summarize, Koolearn has shown significant growth and profitability; for the first six months of this fiscal year, Koolearn recorded revenue of nearly RMB 2,080.1 million, representing a 590.2% increase from revenues from continuing operations of RMB 301.4 million in the same period of the prior fiscal year. Koolearn recorded RMB 585.3 million of net profits, a 638.5% increase from the net loss from the continuing operation of RMB 108.7 million in the same period of the prior fiscal year. In the first six months of the fiscal year, the gross profit of Koolearn reached around RMB 982.5 million, accounting for 47.2% in terms of the GP margin. As we continuously map the platform's strategic transformation, the fast-growing Dongfang Zhenxuan is also committed to giving back to customers and the community. Since its launch, Dongfang Zhenxuan has stood firm not to charge commissions from customers or any fees and has always taken close reference to industry standards, focusing on its partnerships, the most beneficial long-term collaboration with various parties, to maximize benefits to customers. Dongfang Zhenxuan also ensures to attain cost-effective performance as one of its development principles. On one hand, Dongfang Zhenxuan focuses on enhancing product capability while continuing to establish its cultural content. On the other hand, Dongfang Zhenxuan has also organized diverse outdoor livestreaming activities to promote special agriculture products and contribute to cultural tourism. Through its unyielding aspiration to create value in related industries, Dongfang Zhenxuan has successfully received in return meaningful revenues and a loyal customer base during the reporting period. With regard to the company's latest financial position, I'm confident to share with you that the company is in a healthy financial status with cash and cash equivalents, term deposits, and short-term investments totaling approximately $4.2 billion. On July 26, 2022, the company and the Board of Directors authorized a share repurchase of up to $400 million of the company's ADS or common shares during the period from July 28, 2022, through May 31, 2023. As of January 16, 2023, the company repurchased aggregate of approximately 3.1 million ADS for approximately $79 million from the open market under the share repurchase program. Now I'll turn the call over to Sisi to share with you about the key financials.

Sisi Zhao, Host

Okay. Now I'd like to walk you through the other key financial details for this quarter. Operating cost and expenses for the quarter were $640.7 million, representing a 55.1% decrease year-over-year. Non-GAAP operating costs and expenses for the quarter, which exclude share-based compensation expenses, were $621.9 million, representing a 55.4% decrease year-over-year. The decrease was primarily due to the reduction of facilities and number of staff as a result of the downsizing in the fiscal year 2022. Cost of revenue decreased by 31.6% year-over-year to $336.2 million. Selling and marketing expenses decreased by 15% year-over-year to $95.5 million. G&A expenses for the quarter decreased by 74.6% year-over-year to $209 million. Non-GAAP G&A expenses, which exclude share-based compensation expenses, were at $190.9 million, representing a 75.7% decrease year-over-year. Total share-based compensation expenses, which were allocated to related operating costs and expenses decreased by 39.5% to $18.8 million in the second fiscal quarter of 2023. Operating loss was $2.5 million compared to a loss of $768.1 million in the same period of the prior fiscal year. Non-GAAP income from operations for the quarter was $16.3 million compared to a loss of $737.1 million in the same period of the prior fiscal year. Net income attributable to New Oriental for the quarter was $0.7 million compared to the loss of $936.5 million in the same period of the last fiscal year. Basic and diluted net income per ADS attributable to New Oriental were $0 and $0 respectively. Non-GAAP net income attributable to New Oriental for the quarter was $17.8 million compared to the loss of $901.6 million in the same period of last year. Non-GAAP basic and diluted net loss per ADS attributable to New Oriental was $0.11 and $0.10 respectively. Net cash flow generated from operations for the second fiscal quarter of 2023 was approximately $173.7 million and capital expenditure for the quarter was $11.4 million. Turning to the balance sheet. As of November 30, 2022, New Oriental had cash and cash equivalents of $1,029.9 million. In addition, the company has $1,033.2 million in term deposits and $2,145.7 million in short-term investments. New Oriental's deferred revenue balance, which is cash collected from registered students for courses and recognized proportionally as revenue as instruction was delivered at the end of the second quarter of fiscal year 2023, was $1,139.1 million, an increase of 6.9% as compared to $1,065.8 million at the end of the second quarter of fiscal year 2022. Now, I'll hand over to Stephen again to go through our outlook and guidance with you.

Stephen Yang, CEO and CFO

Thank you, Sisi. Looking ahead into the rest of fiscal year 2023 with the restructuring process largely completed and our new businesses in their early stages, we expect our school network and geographic coverage to stabilize. The company remains tireless in seeking new opportunities with greater flexibility and strong cash flows. We're confident in the sustainable profitability of all our remaining key businesses, as well as the growth and prospects of our new initiatives. For our new businesses, as we observed in the first half of this fiscal year, the encouraging performance that these businesses have achieved proves that we are heading in the right direction and we firmly believe that business will be able to maintain an upward growth trajectory and generate meaningful profits for the company in fiscal year 2023. As for the evolving pandemic development in China, since late November 2022 many cities are experiencing certain levels of disruption in business operations. Although we're expecting a negative impact on our financials in the coming one or two quarters, we remain confident and optimistic that the overall impact will be temporary and manageable. Hence, we expect total net revenue in the third quarter of the fiscal year 2023 to be in the range of $702.8 million to $719.8 million, representing a year-over-year increase in the range of 14% to 17%. The projected increase in revenue in our assumptions of the currency RMB is expected to be in the range of 24% to 27%. As the profitability we recorded in this fiscal quarter has reaffirmed our success and dedication in turning a new page and generating profits for the rest of the year, bottom-line wise, we're confident in achieving greater operating profit in the full year of fiscal year 2023. To conclude, we're now taking multipronged operational actions to promote our key remaining businesses while we're cautiously investing in new initiatives, which will remain new growth engines that accelerate our recovery and pursuit of profitable growth. At the same time, we will continue to seek guidance from and cooperate with government authorities in various provinces in China, in alignment with the efforts to comply with the relevant policies and regulations as well as to further adjust our business operations as required. I must say that these expectations and forecasts reflect our considerations of the latest regulatory measures, as well as our current and preliminary view which is subject to change. This is the end of our fiscal year 2023 Q2 summary. At this point, I would like to open the floor for questions. Operator, please open the call for this.

Operator, Operator

Our first question comes from Felix Liu from UBS.

Felix Liu, Analyst

Congratulations on the topline as well as the guidance. My question is on the COVID impact. I know that COVID has come pretty viciously in December but now we're past the peak. So I'm just wondering how has COVID impacted our February quarter. If there is any quantifiable metric that will be very helpful. And my second question is, what's the expectation of our various businesses from here? If you were to rank the fastest to more stable business, how would you rank your various business segments?

Stephen Yang, CEO and CFO

Thank you, Felix. Regarding the evolving pandemic situation in China since last December, I understand the previous peak. Many cities have experienced some impact on our businesses. However, based on our current assessment, the net effect is minor, and we remain confident and optimistic that the overall consequences of the pandemic will be temporary and manageable. Additionally, our guidance for Q3 is very strong, and the revenue outlook across different business lines looks favorable. Can you please repeat the second question?

Felix Liu, Analyst

Yes. So maybe for Q3 and for the whole year which are the business lines that you think will grow the fastest and which are the ones that are more stable?

Stephen Yang, CEO and CFO

We have two types of business. The first is our traditional business, while the second includes our overseas-related operations, such as overseas test preparation and consulting, which account for 24% or 25% of our total revenue for the year. We faced challenges last year, but this year, we are witnessing significant revenue growth, particularly over the past two quarters. We also launched a new business segment within schools in November 2020, and it has shown remarkable growth in just one year. This segment ranks first in revenue growth among all our business lines. Additionally, we are seeing promising results from Dongfang Zhenxuan, which shared its first-half performance today, and the numbers reflect strong growth. Therefore, the new businesses in the EDU sector, particularly the K-12 schools and Dongfang Zhenxuan, are our top performers.

Unidentified Analyst, Analyst

So congrats on the profitable status for this quarter. And my question is, since COVID restrictions have been lifted in China, do we expect higher growth rates of our new business line in the next quarter and also in the next fiscal year? And is there any new opportunities within our new initiatives business?

Stephen Yang, CEO and CFO

Yes, for the new business, yes, as we saw in this quarter and last quarter, the encouraging performance proves that we are heading in the right direction and we firmly believe that the new business will be able to maintain upward growth in Q3, Q4, and the next fiscal year, what I mean is fiscal year 2024. And we started the new business last year but I think we ramped up the new business very quickly. And as good news for us, is that the margin for the new business in this quarter is already over 10%. So think about that. We started this business last year and it took us about 2 to 3 quarters to get to breakeven point and then we made it profitable. So it sounds very good. And I think we are on the right track, and I think management of New Oriental will pay more efforts where it creates more opportunities, business opportunities to develop the new businesses, such as in Dongfang Zhenxuan and our new business this year. And so we will do more to create more in the future.

Sisi Zhao, Host

Yes. Actually the new pandemic situation with the gradual opening up after these recent developments of the new situation, I think, probably we can see more opportunities in certain kinds of new initiatives such as the study tours and research camping business that we mentioned 1 to 2 quarters ago as one of the new initiatives. But as the pandemic situation happened after 1 to 2 quarters, we did not have a very good chance to rollout business domestically. But with the new situation, we have confidence that there are more opportunities for this business to perform better.

Lucy Yu, Analyst

Congratulations on a profitable quarter. Could you please give us some color on the revenue breakdown this quarter and as well as the margin profile for different business lines? I know, Stephen, you already mentioned the new business is 10% OP margin. How about the rest?

Sisi Zhao, Host

Yes, for the reported quarter, the overseas-related business including the overseas test prep and consulting contributed roughly about 21% of total revenue and the domestic test lab, the adults university students' business contributed roughly about 6%, and the school business, including our remaining high school business and also the new initiatives for younger students, together contributed roughly over 40% of total revenue. The rest are Koolearn and some other businesses. So that's the rough contribution, yes.

Stephen Yang, CEO and CFO

Lucy, I just want to share with you the margins by different business lines. The overseas-related business, overseas test lab combined with the consulting business, the margin for the whole year, fiscal year 2023, will be around 10% to 15% margin. What I'm saying is that the margin is before the corporate overhead. And the adults and the university study business, I think the margin profile, I think the business will be breakeven this year. And the school business, including the remaining business and new initiatives, as Sisi said contributed 45% of total revenue. The margin should be somewhere around 20% to 25% or a little bit higher. So the others, this is the big others, including the Koolearn, Dongfang Zhenxuan, and others, I think, if you follow the numbers, the Koolearn's first-half year report, I think you will see more color on the margin profile of the Koolearn and the others, Lucy.

Lucy Yu, Analyst

Just one follow-up. Could you also talk about Y-o-Y growth for different business lines in this quarter?

Stephen Yang, CEO and CFO

Year-over-year, I think the revenue contributions.

Sisi Zhao, Host

Yes, we talked about it in the prepared remarks. So for this quarter, like in U.S. dollar terms, the overseas test prep business increased by roughly 17%. Actually, for RMB terms, you should add another 10% to 15% more. The university students' business is stable and in U.S. dollar terms it is negative 8% but RMB terms is positive. And the school business actually increased because of the new initiatives. And also Koolearn and other business increased a lot.

Candis Chan, Analyst

Congratulations on the very strong set of results and also on the strong guidance for next quarter. My first question is related to the third-quarter revenue guidance and also the profitability that we are aiming for. So firstly, can you give us a rough breakdown of revenue for the third quarter and also in terms of the operating margin, how should we look at it for the third quarter, given the strong revenue?

Stephen Yang, CEO and CFO

In the Q3 forecast, the overseas-related business, test lab, and consulting business are expected to contribute 24% to 25% of total revenue. The business focused on adults and university students will account for 2% of the revenue due to COVID. The school business, which includes traditional activities, remaining operations, and new initiatives, is projected to contribute 43% to 44% of total revenue. The remaining 30% will come from Koolearn, Dongfang Zhenxuan, and other ventures such as books and additional businesses. Regarding the margin profile, we observed a significant increase in both gross profit and operating margins in Q2 compared to last year, primarily driven by volume. Last year's Q2 had considerable one-off costs associated with class cancellations, learning center closures, and staff layoffs, whereas this quarter and throughout this fiscal year, we have not faced these one-off costs. Additionally, the reduction in learning centers has led to lower fixed costs, improving margins per center. New businesses are also showing margins exceeding 10% this year, which is encouraging, along with the recovery of the remaining business, including overseas-related operations, which typically have a higher margin than last year. Moreover, Dongfang Zhenxuan and Koolearn, particularly the streaming e-commerce segment, are experiencing higher margins, positively impacting the overall group margin. Looking ahead, we believe these factors will continue to drive higher profits and improve margins year-over-year, making us optimistic about the margin profile for the entire fiscal year 2023.

Candis Chan, Analyst

So my second question is related to the regulations. Recently in late December, we saw new documents about the non-academic tutoring activities. So do we see an impact on our business overall, like in terms of pricing and also the expansion?

Stephen Yang, CEO and CFO

Actually, since the government has issued the policy last year, I think we have the authority to explore new business directions and follow all of the central and local government authorities' rules. And so, yes, you mentioned that the new rules in last October, last year, I think there will be no material impacts on our business.

Felix Liu, Analyst

Stephen, this is Felix. And my follow-up question is on your learning center network. I know that you opened 2 centers in this quarter. So I think that's a good step forward, although a small step. Could you share some color on your expansion outlook from here maybe this year and next year?

Stephen Yang, CEO and CFO

Okay. I think in the rest of this fiscal year, I think we have no big plan to set-up new learning centers. I think the learning center number will be stabilized because we made a loss on the OMO system in the past years and we moved a lot of costs from the offline to online, saving costs in those areas. And we changed from the traditional business, classroom areas to the new businesses. So this is the internal change. And next year, we do hope we'll open more learning centers. But so far, since it's too early to say how many learning centers we set up for the new year because we have not finished the new year budget. I think I want to share with you the new learning center expansion plan next quarter earnings call.

Unidentified Analyst, Analyst

My question is about the ratio of teachers to students. Could you share some color on the teacher to student ratio on each learning service segment? And do you have more plans to recruit more teachers in the next 2 years?

Stephen Yang, CEO and CFO

I can't share with you the teachers' number. By the end of this quarter, we have 26,000 teachers in total. And because we started a new business just last year, I think it's too early to calculate the teachers to student ratio. I think maybe next quarter, we'll be in the new year, we'll disclose the ratio. And yes, I think we are hiring new teachers because you know we started new businesses. And for some non-academic courses or the other new businesses, we do need to hire more teachers. But the key is, we don't want to hire indiscriminately. We can't move above the elevation and efficiency of the whole company, so I think we believe we will keep the higher utilization and the higher efficiency for the whole company in the future.

D.S. Kim, Analyst

Congrats on a strong result. I actually just have 1 quick follow-up question on all your comments regarding margins. Can I ask how much of corporate overhead costs shall we expect at this stage, i.e., I remember corporate overhead used to be like high single digit-ish revenue pre double reduction policy like 2 years back. So given the much smaller or reasonably smaller revenue base now, I'm wondering how much overhead we should model and expect for this year either as a percentage of revenue or dollar term would be appreciated.

Stephen Yang, CEO and CFO

Yes, I think since last year, we cut off some fixed costs and expenses in the headquarters. So I think the headquarters expenses as a percentage of the total revenue will be stabilized and roughly at 6% to 7% of total revenue; this is the total expense from the headquarters.

D.S. Kim, Analyst

That's very impressive and a greater margin guidance. If I may follow up again on all your comments on the expansion plan, I don't want to ask too much about the number of learning centers but may I check for non-subject tutoring classes. Where do we see incremental demand opportunity say top-tier cities, top 10 cities versus the rest of the nation? Do you see stronger demand, and where do you think we would open more stores and more centers in terms of geographical exposure?

Stephen Yang, CEO and CFO

I think the new business developments in the top-tier cities are a little bit better than in the lower-tier cities, and this is what we have seen in the past quarters. But I do believe even in some lower-tier cities, they will catch up because they start with the business; it's a little bit slower than the top-tier cities. And so, almost everywhere we're seeing business opportunities for non-academic courses, almost everywhere. And yes, that's all. Capacity, as I said, now we don't have the capacity expansion plan and we just want to keep the same learning center numbers moving next quarter or even for the end of this fiscal year. Next year, maybe we'll expand; we will extend some new learning centers. But so far, we haven't finished next year's budget. I will share with you the numbers next quarter.

Unidentified Analyst, Analyst

Stephen, I have a follow-up question. I noticed that there is a significant increase in non-academic tutoring enrollment in Q2. Would you like to specify the driver behind? And do we have any target for the enrollments during the whole year?

Stephen Yang, CEO and CFO

I think the market is always there. And we do have the famous brands and we do have the teachers. And yes, we started this business just a year ago, so you saw the numbers. The exciting news for us is that the profitability of the new business is exciting; it's much better than we expected. And for the new business, I don't believe in the rest of this fiscal year, the new business, the revenue growth will be accelerated again. And even for next year, fiscal year 2024, I believe the revenue growth of the new business will be high, yes. So we're optimistic about the non-academic courses business.

Sisi Zhao, Host

Yes. And by the way, the non-academic tutoring business, according to our experience over the last several quarters, we think that its seasonality is not that apparent as some other test prep business. So every quarter, probably the enrollments will be relatively stable if we do the Q-on-Q comparison. And also as new business development in all the local cities, you can probably see strong momentum; as we have seen that Q2's growth or enrollment trends are also similar or even better than Q1.

Unidentified Analyst, Analyst

Just 1 more follow-up question. Do we have any color on the retention rate for each segment?

Stephen Yang, CEO and CFO

I think the retention rate is related to the traditional K-12 business. We closed on the K-9 business last year. But for new businesses like non-academic courses, we just follow up; we just trace the retention rate. The good news for us is that we are seeing the retention rate is getting higher and higher. And for example, as for the non-academic courses, the retention rate now is between 65% to 70%. We just started the new business, and the retention rate now is better than we expected. We believe the retention rate will get higher going forward. And overseas test prep and the university students' business?

Sisi Zhao, Host

One-off.

Stephen Yang, CEO and CFO

Yes, that's roughly, it's one-off.

Sisi Zhao, Host

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.