Earnings Call Transcript - EDU Q3 2023

Operator, Operator

Good evening and thank you for standing by for New Oriental’s FY 2023 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’d now like to turn the meeting over to your host for today’s conference, Ms. Sisi Zhao. Thank you. Please go ahead.

Sisi Zhao, Host

Hello, everyone. And welcome to New Oriental’s third 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 view 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 first 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. It’s our great pleasure to announce that upon the completion of the restructuring process and the introduction of our new businesses, we have managed to deliver a set of remarkable financial results this quarter, with both topline and bottomline beating expectations. These results are bolstered by the macro trends of economic recovery as the pandemic subsides, business activities resume, and people regain their confidence in consumption, while we observe the demand for our products and services gradually increasing. We have also achieved a GAAP operating margin and non-GAAP operating margin of 8.8% and 11.7%, respectively, for this year. Our key remaining business has continued to demonstrate solid recovery. In particular, our overseas test prep and overseas study consulting business have performed exceptionally and recorded continuous year-over-year revenue increments, thanks to the strong COVID recovery across the globe. Our restructured business model, streamlined cost structure, coupled with the emerging new business, have not only helped us yield better than expected margins in this fiscal quarter but also effectively diversify our business and enable us to offset certain historical seasonality. As we head into the fourth quarter, our solid profitability, strong performance of remaining business lines, and emerging new business initiatives in this quarter reaffirm our belief in sustaining healthy growth of our market share and pursuing innovative endeavors as we continuously seek the encouraging environment of recovery. Now, I’d like to spend some time to talk about our performance across our many business lines and new initiatives in detail. Our key remaining business has a promising trend, and the new initiatives have shown positive momentum. Breaking it down, the overseas test prep business recorded a revenue increase of 13% in dollar terms or 23% in RMB terms year-over-year for this quarter. The overseas test prep business increased by 5% in dollar terms, or 13% in the RMB terms year-over-year for this quarter. The adults and university students’ business recorded a revenue decrease of 3% in dollar terms or 5% increase in RMB terms year-over-year for this quarter. As mentioned in previous quarters, we have also launched several new initiatives, which mostly revolve around facilitating students' development. I am glad to share that these new initiatives have continued to exceed our expectations by sustaining positive momentum and generating meaningful profits for the Group. Further, the non-academic tutoring courses that we have offered focus on cultivating students' skills, with 218,000 student enrollments recorded this quarter. The top 10 cities in China have contributed about 60% of the revenue from this business. Secondly, the intelligent learning system and device business is a service designed to provide a tailored digital learning experience for students. It utilizes our teaching experience, data, and technology to offer personalized targeted learning and exercise content. Our continuous investments in technology have fueled our competitive edge, driving our navigation amidst the challenges from the past year. We have tested its adoption in around 60 existing cities, with 108,000 active paid users 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%. Meanwhile, the study tour and research camp business is an initiative aimed at offering students of K12 and university ages the opportunity to fully leverage their free time, broaden their knowledge, and cultivate subject interest. We have conducted the study tour and research camps in over 50 cities across the country, with revenue contribution from the top 10 cities in China being over 55%. Last but not least, our smart education business, which comprises smart teaching, smart hardware, science, technology and innovation education, and other services, serves local governments, education authorities, schools, and kindergartens. Our educational material utilizes smart study solutions, the self-learning system, which leverages advanced technology to enable students to have complete control over the pace and flexibility of the learning process, especially as 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 gained wide traction and contributes to the overall growth of the company, attaining instrumental profits since the last quarter. Regarding our OMO system, we continued our efforts in developing and revamping the platform, capturing leverage from our educational infrastructure and technological strength across all our remaining key businesses and the new business to provide more advanced and diversified educational services for our customers. During the reporting period, we invested $26.8 million in the quarter to further improve and maintain our OMO teaching platform. Now, I would like to give you all an update on East Buy’s latest performance. During the reporting period, East Buy has proven itself as a successful business model with instrumental breakthroughs in both business operations and financial performance. The business has continued to offer a remarkable contribution to the company’s overall revenue and profit growth. East Buy continues to invest substantial resources in improving product quality and variety under its private label Fun Too and its customer-centric strategy during the reporting period. East Buy remains rigorous in applying stringent standards in supplier selection to only source products of top quality while safeguards collaborations with SF Express and the JD Group to continuously refine the delivery process and service. To distinguish itself from conventional live streams, East Buy also upholds its unique feature of integrating intelligent dissemination alongside product sales, aiming to foster nationwide cultural and knowledge sharing. The series of East Buy’s in-person live-streaming and participation in cultural documentaries and exhibitions have not only increased traffic to East Buy’s platform and boosted sales but also elevated audience engagement and awareness of the preservation of Chinese cultural resources. It’s inspiring to see that East Buy has grown significantly since its inception, becoming a well-known platform for promoting healthy, top-quality, cost-effective products and developing a loyal customer base, while also appreciating the country’s cultural assets for the betterment of the community. Regarding the company’s latest financial position, I am confident to share that the company is in a healthy financial status, with cash, cash equivalents, term deposits, and short-term investments totaling approximately $4.3 billion. On July 26, 2022, the Company’s 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 April 18, 2023, the company repurchased approximately 5.1 million ADS for approximately $157.6 million from the open market under the share repurchase program. Now, I will turn the call over to Sisi to share with you about the key financials.

Sisi Zhao, Host

Okay. I’d like to walk you through the other key financial details for this quarter. Operating cost and expenses for the quarter were $687.7 million, representing a 9% decrease year-over-year. Non-GAAP operating cost and expenses for the quarter, which exclude share-based compensation expenses, were $666.3 million, representing an 8.1% decrease year-over-year. The decrease was primarily due to the reduction of facilities and staff as a result of downsizing in fiscal year 2022. Cost of revenue decreased by 0.9% year-over-year to $369.6 million. Selling and marketing expenses increased by 9.5% year-over-year to $102.6 million. G&A expenses for the quarter decreased by 25.4% year-over-year to $215.5 million. Non-GAAP G&A expenses which exclude share-based compensation expenses were $194.5 million, representing a 25.1% decrease year-over-year. Total share-based compensation expenses, which were allocated to related operating costs and expenses decreased by 28.6% to $21.4 million in the third fiscal quarter of 2023. Operating income was $66.5 million, representing a 147.1% increase year-over-year. Non-GAAP operating income for the quarter was $87.9 million, representing a 179% increase year-over-year. Net income attributable to New Oriental for the quarter was $81.6 million, representing a 166.7% increase year-over-year. Basic and diluted net income per ADS attributable to New Oriental were $0.49 and $0.48, respectively. Non-GAAP net income attributable to New Oriental for the quarter was $95.4 million, representing a 199.9% increase year-over-year. Non-GAAP basic and diluted net income per ADS attributable to New Oriental were $0.57 and $0.56, respectively. Net operating cash flow for the third fiscal quarter of 2023 was approximately $190.5 million, and capital expenditure for the quarter was $49.2 million. Turning to the balance sheet. As of February 28, 2023, New Oriental had cash and cash equivalents of $1,329.5 million. In addition, the company had $1,413.5 million in term deposits and $1,568.1 million in short-term investments. New Oriental’s deferred revenue balance, which is the cash collected from registered students for courses and recognized proportionally as revenue as classes are delivered at the end of the third fiscal quarter of 2023 was $1,163.2 million, an increase of 19.8% compared to $971.3 million at the end of the third fiscal quarter of fiscal year 2022. Now, I will hand over to Stephen to go through our outlook and guidance.

Stephen Yang, Executive President and CFO

Looking ahead to the fourth quarter, which has historically been one of our seasonal peak quarters, our key remaining businesses are in the process of recovery with the opportunity to further increase market share as the pandemic subsides. As you know, the company remains tireless in seeking new opportunities with greater flexibility and strong cash flows, and we are confident in embarking on a journey that ensures sustainable growth. For our new businesses, the encouraging performances they have achieved in previous quarters prove that we are heading in the right direction. We firmly believe that this business will sustain healthy growth and generate meaningful profits for the company in the fourth quarter and going forward. Regarding the learning centers and classroom space, we are planning to moderately increase our capacity, by which we expect to open a small number of new learning centers and expand classroom areas of some existing learning centers in a few major cities. In summary, we expect total net revenue in the fourth quarter of fiscal year 2023, March 1, 2023 to May 31, 2023, to be in the range of $801.8 million to $822.7 million, representing a year-over-year increase in the range of 53% to 57%. As profitability recorded year-to-date has reaffirmed our success and dedication in turning a new page, we are also confident in achieving a satisfactory operating profit level in the full year of fiscal year 2023. To conclude, we are now taking multipronged operational excellence to accelerate our recovery and anchor sustainable growth. Simultaneously, we will cautiously research and unveil the potential in new market opportunities and try to apply new technologies such as AI and ChatGPT into our education and product offerings, with a vision to uplift our innovative capability in pursuit of profitable growth and increasing operating efficiency. We stay committed to seek guidance from cooperation with the government authorities in alignment with these efforts to comply with the relevant policies, 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 the current and preliminary view, which is subject to change. This is the end of our fiscal year 2023 Q3 summary. At this point, I would like to open the floor for questions. Operator, please open the call for this. Thank you.

Operator, Operator

Thank you. Our first question comes from Felix Liu from UBS. Please go ahead, Felix.

Felix Liu, Analyst

Hi. Good evening, Stephen and Sisi. Congratulations on the very strong results. My question is on your forward-looking guidance for the fourth quarter. I know the year-on-year growth outlook is very impressive. May I know what the key drivers or the good performing business segments are driving the fourth quarter growth? And if we look slightly beyond the next quarter for the next fiscal year, what are the business segments that you expect the fastest growth in FY 2024? Thank you.

Stephen Yang, Executive President and CFO

Okay. Thank you, Felix. I think we remain confident and optimistic about the business performance in Q4 and the new fiscal year 2024. Firstly, I think the macro trend of economic recovery as the pandemic subsides, where we are seeing people rebuild their confidence in consumption, and we are also seeing the demand for our products and services gradually increasing. Regarding the different business lines, the remaining businesses such as the overseas-related business on the demand side, we have seen strong demand for overseas test prep and consulting business. On the supply side, we have seen some players disappear from the market, which means we are facing less competition. That’s why we are optimistic about the overseas-related business going forward. As for our new business, the encouraging performance in Q3 and the previous quarters show that we are heading in the right direction. We believe that this business will be able to maintain very strong topline growth and generate more profit for the company. That’s why we projected very strong topline growth in Q4 to be in the range of 53% to 57% in dollar terms. If you convert it into RMB terms, it would be much higher. Bottomline wise, we are confident in achieving greater operating profit in Q4 and the new year. Next year, I believe the key growth driver will be the new business. We started the new business, such as non-academic courses, about 15-16 months ago, and it has grown very quickly this year, and I also believe it will have very high growth rates next year. Sisi, do you want to add something?

Sisi Zhao, Host

Just one thing, if you look at Q4’s guidance, historically, last year, Q4 was the very first quarter that we did not have K9 academic tutoring, so that’s why the growth rate compares to previous quarters is higher.

Stephen Yang, Executive President and CFO

Thank you, Felix.

Operator, Operator

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

Lucy Yu, Analyst

Hi, Stephen and Sisi. This is Lucy from BAM. I have one question on Tung-Jung Hsieh. Looking at the minority interest, it seems that the net profits for Tung-Jung Hsieh have decreased Q-on-Q. Could you please elaborate on the reason behind that and how should we think about the earnings contribution from Tung-Jung Hsieh going forward? Thank you.

Stephen Yang, Executive President and CFO

I think during this quarter, East Buy has proven itself as a successful business model, contributing remarkably to the company’s overall revenue and profit margin. This quarter, East Buy continues to invest substantial resources in improving product quality and collaborates with JD and SF Express to provide better delivery services. Therefore, they have invested some money. However, I can’t provide details of the margin analysis or profit analysis due to compliance. I believe next quarter, the Tung-Jung Hsieh management, East Buy management will share more detailed information with you. Thank you, Lucy.

Lucy Yu, Analyst

Understood. Thank you, Stephen.

Stephen Yang, Executive President and CFO

Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Candis Chan from Daiwa. Please ask your question, Candis.

Candis Chan, Analyst

Great and hi, Stephen and Sisi. Thank you for taking my question and congratulations on the very strong set of results. My question is related to the new businesses. Firstly, may I know the rough breakdown of our new initiatives revenue? Secondly, about the longer-term business direction going forward, as we see that our business has become more diversified, not only has East Buy done very well, even for New Oriental live team channels, we also see a very decent GMP trend. I mean, founder, you and Michael also talked about entering into cultural tourism as well. I am just wondering what the key development areas for New Oriental will be in the following years. Do we have any plans to enter into the learning device market or explore other new areas? Thank you.

Sisi Zhao, Host

As for the new initiatives with educational nature, the biggest revenue contributor is the non-academic tutoring. We are using our existing teaching resources and developing the content quickly while leveraging our existing channels to attract students. This year is primarily focused on developing this new type of initiative, and we are seeing strong demand along with positive retention, and our operating data shows encouraging trends, leading us to be confident about this business's continued growth and meaningful revenue contributions, alongside good profitability. The second largest education-centered new initiative is the intelligent learning device business. This offers a way for students to do self-study using our technology and access our teaching systems via hardware solutions, which has garnered significant interest from our customers. We are also utilizing existing channels, including local schools and learning centers, to roll out these new products, reporting satisfactory retention and renewal of tuition fees. This business is also expected to contribute significantly to revenue and profitability. The other new initiatives are also showing potential, despite facing challenges during the pandemic last year, but we remain confident about their future as we can tap into high demand from local markets. We are committed to developing all these new initiatives, aiming for them to all become meaningful contributors to revenue and profit.

Stephen Yang, Executive President and CFO

Let me answer your last question about the cultural tourism. Some of you may have read online that Michael stated we are considering expanding the cultural tourism business, which indeed holds significant potential in the country. As you know, we have a lot of teachers, some of whom are star teachers. I believe that by leveraging our educators' expertise in general studies, cultural studies, and history, we could offer unique cultural tourism experiences that combine education and entertainment for all ages, including children, college students, and seniors. Additionally, we may leverage our distribution channels, like Tung-Jung Hsieh, East Buy, and our various online streaming channels, as well as numerous schools and learning centers, to distribute this new business. However, we are currently at an early planning and evaluation stage for this venture. We will keep you updated if we have any further developments. Thank you.

Candis Chan, Analyst

That’s very clear. Thank you.

Operator, Operator

Thank you. Our next question comes from Linda Huang from Macquarie. Please go ahead, Linda.

Linda Huang, Analyst

Hi, management. This is Linda from Macquarie. My question is quite simple. My two questions are regarding our cash situation. I still see that we keep accumulating cash, and our operating cash flow generation is quite strong. Regarding the share buyback, have we considered other methods such as a special dividend to return to shareholders? That would be the first question. The second question relates to our non-academic tutoring business. Sisi just mentioned that we are observing a very good retention rate. What is the retention rate now, and how does it compare to the previous regulatory period? Thank you.

Stephen Yang, Executive President and CFO

Thank you, Linda. As you know, we announced a $400 million share buyback program last year. To date, we have utilized approximately $157 million in repurchasing shares from the open market. Our decision is based on evaluating our stock's performance. Historically, we have sometimes opted for share buybacks and at other times for special dividends. Thus, next year’s decision will depend on the Board of Directors' considerations. Regarding retention rates for non-academic courses, I can tell you that the retention rate for children's courses is over 70% this quarter, indicating a significant improvement. For the intelligent learning system devices, the renewal rates have surpassed 60% already. Thank you, Linda.

Linda Huang, Analyst

Thank you very much.

Operator, Operator

Thank you. Next, we have a follow-up question from the line of Candis Chan from Daiwa. Please go ahead, Candis.

Candis Chan, Analyst

Great. Hi, Sisi and Stephen. I just wanted to follow up on profitability because you mentioned that for new businesses, they are now contributing very strong revenue and also good profitability. Can you share a bit more on the margins of the new businesses, particularly for the non-academic tutoring or the intelligent system devices? Thank you.

Stephen Yang, Executive President and CFO

Yeah. I think the overall margin for new businesses is over 10% already. We launched these businesses just 15-16 months ago, so it's quite recent. We are cautious about new investments in these areas, allowing us to reach profitability more quickly. We anticipate that the margins for new businesses will continue to rise in Q4 and in the upcoming year. Was that clear?

Candis Chan, Analyst

Yes. That’s very helpful.

Stephen Yang, Executive President and CFO

Thank you.

Operator, Operator

Thank you. Our next follow-up question comes from the line of Felix Liu from UBS. Please ask your question, Felix.

Felix Liu, Analyst

Thank you, management, for taking my question again. I just wanted to follow up on the market landscape of non-academic tutoring. I know we have most of our revenue coming from the top 10 cities. Where do you see the biggest growth opportunity ahead? Do you think it's more about ramping up our market share in existing top cities, or do you see a lot of opportunity in other cities, especially lower-tier cities, for non-academic tutoring? Thank you.

Stephen Yang, Executive President and CFO

I think, as I said, we are observing less competition in the childcare business. We are gaining market share in both top-tier and lower-tier cities. Moving forward, nearly all cities will experience growth. Sisi, do you want to add?

Sisi Zhao, Host

Currently, we see that top 10 cities contribute over 60% of overall revenue for this category. Growth will come from both expanding in existing major cities and developing markets in lower-tier cities, where demand for non-academic tutoring is growing strong. We are leveraging our existing educational infrastructure in around 70-80 cities, where we have schools and learning centers. This positions us well to capitalize on the high demand for this type of service.

Felix Liu, Analyst

Okay. Got it. Thank you.

Stephen Yang, Executive President and CFO

Thank you.

Operator, Operator

Thank you. We are nearing the end of the conference call. I will now hand it over to New Oriental’s Executive President and CFO, Stephen Yang, for his closing remarks.

Stephen Yang, Executive President and CFO

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 today’s conference call. Thank you for participating. You may now disconnect.