Earnings Call Transcript - EDU Q2 2024

Operator, Operator

Good evening and thank you for standing by for New Oriental's FY 2024 Second 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 would 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 second fiscal quarter 2024 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 neorental.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 pleasure to announce that New Oriental has delivered a set of fruitful financial results that have surpassed our expectations this quarter. Our diverse business lines have embarked on a healthy recovery and anchored stable top line performance, while the enduring momentum of our new business has made a meaningful contribution to the company's revenue and continues to pave the way for further acceleration. New Oriental's bottom line performance has achieved promising growth with operating margin and non-GAAP operating margin reaching 2.5% and 5.9% for this quarter, respectively. Thanks to our unwavering efforts to improve our operational efficiency and cost control, as well as the combined efforts of our restructured business model, we used fewer resources and streamlined our cost structure. Encouraged by the company's sustainable profitability, resilient business lines, and fostering new business, we are committed to maintaining a healthy market share growth and creating sustainable value for customers and shareholders in the long term. Now, I'd like to spend some time discussing the quarter's performance across our remaining business lines and new initiatives. Our key remaining businesses have depicted a positive trend, while the new initiatives secured positive momentum. Breaking it down, the overseas test prep business recorded a revenue increase of 47% in dollar terms or 50% in RMB terms year-over-year for this quarter. The overseas study consulting business recorded a revenue increase of about 32% in dollar terms or 35% in RMB terms year-over-year for this quarter. The adults and university students business recorded a revenue increase of 43% in dollar terms or 46% increase in RMB terms year-over-year for this quarter. As mentioned in the past quarters, we have launched multipronged new initiatives, which mostly revolve around facilitating students' overall development. They have continued to prosper with consistent growth, delivering meaningful profits to the company. Firstly, the non-academic tutoring courses, which we have offered in around 60 existing cities, focus on cultivating students' innovative ability and comprehensive quality. The markets we have tapped into have recorded elevated penetration, especially in higher-tier cities with a total of approximately 786,000 student enrollments recorded in this quarter. The top 10 cities in China contribute over 60% of the revenue of this business. Secondly, the intelligent learning system and devices business, a service designed to provide a tailored digital learning experience for students to enhance learning efficiency has been adopted in around 60 existing cities. We have observed an enhanced customer retention rate and scalability of this new initiative. Approximately 181,000 active paid users were reported in this fiscal quarter. The revenue contribution of these initiatives from the top 10 cities in China is around 55%. Our smart education business, educational materials, and digitalized smart study solutions have continued to contribute materially to the overall results. In summary, our new educational business initiatives reported a revenue increase of about 68% in dollar terms or 72% increase in RMB terms year-over-year for this fiscal quarter. In addition, as mentioned in the last quarter, we have inaugurated a newly integrated tourism-related business line as one of our innovative ventures tailored with diverse offerings of cultural trips, study tours in China and overseas as well as camp education. New Oriental's cultural tourism business shares the spirit to provide premium quality travel experiences that are infused with joy from cultural exchange, knowledge sharing, and personal fulfillment. Within this new business line, our study tour and research camp business for students of K-12 and university age anchored encouraging growth this quarter, thanks to a strong post-COVID recovery of demand and resumed traveling. We have conducted study tours and research camps in over 50 cities across the country with the Top 10 cities in China offering over 55% revenue share of this new initiative. We have also piloted a number of top-notch tourism offerings to expand our reach to all age groups, including middle-aged and elderly individuals across 17 featured provinces. As we are still at a preliminary stage of planning, testing, and evaluating the viability of the business in selected regions, we will keep you posted should there be timely updates. With regard to our OMO system, we have persisted in revamping our platform and leveraged our educational infrastructure and technological edge on remaining key businesses and new business with a vision to provide advanced, diversified education services to customers of all ages. During this reporting period, a total of $28.7 million has been invested in our OMO teaching platform, which equips us with the flexibility to maintain unrivaled service to students continuously. During the reporting period, East Buy has attained strong growth momentum through a series of new initiatives aimed to foster the development of its private label products and upgrades in customer service. A comprehensive detailed optimization of product quality has been conducted, and East Buy has made remarkable breakthroughs in supply chain integration, boosting its private label products to a total of 264 SKUs. Furthermore, nationwide broadcast events across provinces were launched with consistent support from local cultural and tourism authorities. East Buy also began introducing cultural tourism products and includes a century-long history, culture, geographies, and folklore into their live streaming and e-commerce broadcasts, presenting lively introductions of historical monuments, tourism attractions, and local specialties to their audience. We look forward to witnessing the continued growth of East Buy and its positive reception within the community. Regarding the Company's latest financial position, I'm confident to share that the company is in a healthy financial status with cash and cash equivalents, term deposits, and short-term investments totaling approximately $4.8 billion. On July 26, 2022, the Company's Board of Directors authorized a share repurchase of up to $500 million of the Company's ADS or common shares during the period from July 28, 2022, through May 31, 2023. The Company's Board of Directors further authorized the company to extend its share repurchase program launched in July 2022 by 12 months through May 31, 2024. As of January 23, 2024, the company repurchased an aggregate of approximately six million ADS for approximately $194.2 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

Now I'd like to go through the financials for this quarter. Operating costs and expenses for the quarter were $848.3 million, representing a 32.4% increase year-over-year. Non-GAAP operating costs and expenses for the quarter, which exclude share-based compensation expenses, were $818.7 million, representing a 31.6% increase year-over-year. The increase was primarily due to the costs and expenses related to the substantial growth in East Buy's private-label products and live-streaming e-commerce business. Cost of revenue increased by 25.7% year-over-year to $422.6 million. Selling and marketing expenses increased by 62.2% year-over-year to $155 million. General and administrative expenses for the quarter increased by 29.6% year-over-year to $270.7 million. Non-GAAP G&A expenses, which exclude share-based compensation expenses, were $256.1 million, representing a 34.2% increase year-over-year. Total share-based compensation expenses, which were allocated to related operating cost expenses, increased by 57.3% to $29.6 million in the second fiscal quarter of 2024. Operating income was $21.3 million, compared to a loss of $2.5 million in the same period of the prior fiscal year. Non-GAAP income from operations for the quarter was $50.9 million, representing a 212.2% increase year-over-year. Net income attributable to New Oriental for the quarter was $30.1 million, representing a 4007.4% increase year-over-year. Basic and diluted net income per ADS attributable to New Oriental were $0.18 and $0.18, respectively. Non-GAAP net income attributable to New Oriental for the quarter was $50.2 million, representing an 182.6% increase year-over-year. Non-GAAP basic and diluted net income per ADS attributable to New Oriental were $0.30 and $0.29, respectively. Net cash flow generated from operations for the second fiscal quarter of 2024 was approximately $300.6 million and capital expenditure for the quarter was $43.4 million. Turning to the balance sheet. As of November 30, 2023, New Oriental had cash and cash equivalents of $1,942.6 million. In addition, the company had $1,324.1 million in term deposits and $1,571.2 million in short-term investments. New Oriental's deferred revenue, which represents cash collected upfront from customers and related revenue that will be recognized as the services or goods are delivered, at the end of the second quarter of fiscal year 2024 was $1,645 million, an increase of 44.4%, as compared to $1,139.1 million at the end of the second fiscal quarter of 2023. Now I'll hand over to Stephen to go through our outlook and guidance.

Stephen Yang, Executive President and CFO

As we enter the new quarter, we look forward to delivering student growth and ongoing margin expansion, building on the blend of our brand advantage, roots in history, influential teaching and content resources, and solid foundation. We're also committed to working diligently, adhering to the latest guidance from the Chinese authorities on enhancing the nation's education levels to strengthen its leading position to further unveil our possibilities across all business lines and creative endeavors. With regard to the learning center and classroom space, we plan to increase our capacity moderately by about 20% year-over-year. We will keep monitoring the pace and scale of new openings according to the local operations and our financial results in this fiscal year. The groundwork we have laid and the progress we have made thus far have fueled our optimism for the future. We remain dedicated to achieving margin expansion throughout the whole year. In the coming quarter, we expect total net revenue to be in the range of $1,070.9 million to $1,093.5 million, representing a year-over-year increase in the range of 42% to 45%. To conclude, we're delighted to share our latest set of results with all of you. We are confident in our ability to drive our business toward an even more positive trajectory and enhance profitability throughout the remainder of fiscal year 2024. While we cultivate new endeavors to build upon our capabilities, we will also devote resources to the research and application of new technologies such as AI and ChatGPT into our educational and product offerings to uplift our strengths and pursue further growth and operating efficiency. At the same time, we will continue to seek guidance from and cooperate with government authorities in various provinces in China in alignment with their efforts to comply with relevant policies, guidelines, 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 2024 Q2 summary. At this point, I'd like to open the floor for questions. Operator, please open the call for this. Thank you.

Operator, Operator

Thank you. The question-and-answer session of this conference call will begin shortly. Our first question comes from Felix Liu from UBS. Please go ahead, Felix.

Felix Liu, Analyst

Hi. Good evening, Stephen and Sisi. Congratulations again on the strong set of results. My question is on your very good third quarter guidance of over 40% revenue growth. Could you give us a rough breakdown of what's driving that strong growth? Thank you.

Stephen Yang, Executive President and CFO

Okay. Thank you, Felix. I think we will provide the top line guidance this quarter as we did in previous quarters. So as for the revenue guidance for Q3, I think we are still taking a conservative approach in giving the Q3 growth guidance, which will be in the range of 42% to 45% in dollar terms year-over-year, given the strong demand in the education sector and growth momentum we have seen so far in this fiscal year. So we're quite confident about the whole year's revenue growth; it will be better than we originally expected, especially in the coming Q3. For all the business lines, the overseas-related business on the demand side, we have seen very strong demand for overseas test prep and the consulting business. And on the supply side, we have seen some players disappear from the market during the COVID period. That means we're facing less competition in the market. Regarding the other revenue contributor, the new businesses, we believe the encouraging performance in Q2 proves that we are heading in the right direction. We believe this business will be able to maintain excellent top-line growth in Q3. That's why we provide the guidance of top-line growth of 42% to 45%. Sisi, do you want to add to the breakdown?

Sisi Zhao, Host

Yes. Actually, the revenue contribution from key business lines is pretty consistent this year, very similar to last quarter, like the overseas-related business contributes around 20% to 21% of total revenue; domestic prep is about 2% to 3%. The K-12 newly developed educational initiatives for K-9 and some remaining tutoring business for high school together contribute over 41% to 42% of total revenue. The key drivers are performing very well, and we are seeing a continued trend for all the key business lines as well.

Stephen Yang, Executive President and CFO

Thank you, Felix.

Felix Liu, Analyst

Okay. Thank you. Very clear. Congratulations on the results.

Stephen Yang, Executive President and CFO

Thank you again.

Operator, Operator

Thank you. Our next question comes from the line of Yiwen Zhang from China Renaissance. Please ask your question, Yiwen.

Yiwen Zhang, Analyst

Hey, good evening, management, and thanks for taking my question. Congrats on another strong quarterly result. So my question is about our learning center expansion. You mentioned about a 20% capacity growth for the whole year. If I calculate correctly, that actually implies second half net ads would slow down a bit. Could you discuss what our consideration is there given the very strong demand? Thank you.

Stephen Yang, Executive President and CFO

Yes. This quarter, we added around 7% new capacity. At this time last quarter, we guided the capacity expansion to be somewhere around 15% to 20%. This time we will raise the expansion guidance to around 20%. I think we will open a reasonable amount of the new learning centers, while some in the new classroom areas or some existing learning centers will be expanded in the second half of the year. Most of the new openings will be in the cities with better top-line and bottom-line performance. We will keep monitoring the pace and scale of the new openings according to the operation and financial results in the second half of the year. Maybe in the next quarter or just in Q4, I think we will share with you about our new decisions regarding learning center expansion, and we may raise it again. Thank you.

Yiwen Zhang, Analyst

Yes. Okay. Thank you.

Operator, Operator

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

Lucy Yu, Analyst

Hi, Stephen. This is Lucy from BofA. A follow-up on an earlier question about expansion. We have seen very strong demand on the ground. Many of my friends are trying to enroll in a learning center, but I was told it's already full even while under reservations at the moment. So I'm wondering what the bottleneck is for us to expand faster at the moment. Is it teacher recruitment, finding the right location, or obtaining licenses? What is the bottleneck preventing us from expanding even faster? Thank you.

Stephen Yang, Executive President and CFO

Yes, thank you, Lucy. The reason we give the learning center expansion guidance of about 20% is that we have the OMO system, and the OMO model allows us to take in more students into existing classrooms and learning centers. So the OMO model helps us a lot. Education is typically a long-term business. We care more about the top-line growth and bottom-line growth, which means margin expansion. We don’t want to grow the business too fast. The top-line growth, as I said, we have already guided 45% top-line growth in Q3 and we also focus on margin expansion. So it’s about finding a balance between top-line and bottom-line growth, Lucy.

Lucy Yu, Analyst

Thank you, Stephen. Just to follow up, you mean the OMO model. I know it's adopted for high school, but for non-curricular training, are we also using OMO at the moment?

Stephen Yang, Executive President and CFO

Yes.

Lucy Yu, Analyst

So what's the percentage of online versus offline at the moment?

Stephen Yang, Executive President and CFO

Yes, for some non-academic courses and the overseas test prep, even for some college students' business, we use the OMO model for all of these businesses.

Sisi Zhao, Host

And also the intelligent learning devices, which is also one that we don't require too many new locations.

Lucy Yu, Analyst

I see. Thank you so much.

Stephen Yang, Executive President and CFO

Thank you, Lucy.

Operator, Operator

Thank you, Lucy. Our next question comes from the line of Timothy Zhao from Goldman Sachs. Please ask your question, Timothy.

Timothy Zhao, Analyst

Thank you. Hi, Stephen. Hi, Sisi. This is Timothy from Goldman. My question is on the margins. I saw this quarter the non-GAAP operating margin expanded by around 3.3 percentage points. Just wondering if you could provide any color in terms of breakdown because, on the other hand, I think for East Buy, there was some pressure on the margin. Just wondering if we exclude the margin impact from East Buy, what kind of margin expansion we are seeing for the core business? And then after this quarter, how do we think about the full-year operating margin guidance? Thank you.

Stephen Yang, Executive President and CFO

Okay. Yes, let us start with the quarter margin analysis. Even though, as you said, East Buy saw margin drag this quarter, we still achieved non-GAAP operating margin expansion by 330 basis points. The margin increase was primarily driven by the following reasons. Number one is the improving utilization rates of our facilities and the teaching resources which increased the learning center margins on average. This means we have lower fixed costs and expenses compared to last year. Number two is the new business margin is around 19% to 20%. We just started the new business two years ago, which means the ramping-up pace is much faster than we expected. The remaining businesses, such as the overseas-related sector and the college segment generated higher margins compared to last year. In Q2, if we exclude East Buy's impact, the non-GAAP margins for education increased significantly. As we head into Q3 with operating leverage and higher utilization control, we expect to see continuous margin expansion even in Q3 and Q4. Therefore, in the second half of the year, you will observe margin expansion in the education business.

Timothy Zhao, Analyst

Thank you, Stephen and Sisi. This is very helpful.

Stephen Yang, Executive President and CFO

Thank you.

Operator, Operator

Thank you, Tim. Our next question comes from the line of Tian Hou from T.H. Capital. Please ask your question, Tian.

Tian Hou, Analyst

Hi, Sisi, Stephen. Congratulations on the good quarter. I have actually two questions; one is, how is the culture and tourism business conducted? How do you record revenue from that? That's number one. Number two, can you break down the result and guidance into different segments for both revenues and margin profiles? Thank you.

Stephen Yang, Executive President and CFO

Thank you, Tian. I will take the question about the tourism business. As mentioned in the last quarter, we have started the tourism business as one of our innovative ventures. This tourism business includes our well-grounded study tour and research camp business for the students, as well as our new tourism business that serves the middle-aged and senior people. We employ many teachers, and I believe our new tourism business will utilize our strengths in knowledge sharing. Additionally, we have abundant sales channels including Dongfang, JingYuan, and online and offline channels in New Oriental. During this quarter, we piloted a number of tourism offerings to reach all age groups. The top-line growth is very good this quarter because last year we faced negative impacts from COVID. We set up the New Oriental Cultural Tourism Group, which has 100% subsidiaries in all cities. We report revenue from the education and tourism businesses separately in our financial statements. Our goal is to be the leading cultural tourism company in China, providing the best service to customers. I hope the tourism business will contribute more revenues and profits to the group moving forward.

Tian Hou, Analyst

That's good. Yes.

Sisi Zhao, Host

Yes, Tian, regarding your second question on the guidance breakdown, as I mentioned earlier, for overseas-related business, for Q3, the distribution is similar to the previous quarter, about 21% to 22%. The domestic test prep is about 2% to 3%. The K-12, including the new educational initiatives for K-9 and also remaining high school business together contribute over 40% of total revenue. So that's the key business line mix.

Tian Hou, Analyst

Thank you. Thank you.

Stephen Yang, Executive President and CFO

Thank you, Tian.

Operator, Operator

Our next question comes from Candice Chen from Daiwa. Please go ahead, Candice.

Candice Chen, Analyst

Great. Hi, Sisi and Stephen, congratulations on a very strong quarter and also the revenue guidance. My question is on the margins for the longer term. I think you just mentioned that for the new education businesses, we are looking at around 19% to 20% operating margin, which is impressive compared to what you mentioned in previous quarters. I wonder, in the longer term, in the next two to three years, what should we expect for this new education business in terms of operating margins? Also, for the overseas test prep business, what kind of margin should we expect given the strong demand out of the revenue here? Thank you.

Stephen Yang, Executive President and CFO

Yes, we started the new education business two years ago, and in this quarter, the margin of this business is roughly 19%. Going forward, I think the margin will be over 20%. That means we will expand the margin of this business in the second half of this year, and even in the new year, fiscal year '25, we expect the margin of the education business overall to expand. This is due to lower fixed costs, higher utilization of learning centers, and cost control. I believe both the existing and new businesses will expand their margins. Therefore, in the second half of this fiscal year and in fiscal year '25, I think we will witness margin expansion.

Candice Chen, Analyst

Great. Another question is about our cash. I think we have almost $5 billion in cash right now. In terms of shareholder returns, what are we going to do with the cash in the following years?

Stephen Yang, Executive President and CFO

Yes. We announced a $400 million share buyback program, and so far we have completed $194 million. I think we will buy back shares from the open market going forward. Historically, we have paid several special dividends and conducted share buybacks multiple times. In our next round, we may choose dividend payouts again along with share buybacks.

Candice Chen, Analyst

Okay. Good to hear. Thank you, Stephen.

Stephen Yang, Executive President and CFO

Thank you.

Operator, Operator

Thank you, Candice. Our next follow-up question comes from Felix Liu at UBS. Please go ahead, Felix.

Felix Liu, Analyst

Hi. Good evening, Stephen and Sisi. I have a follow-up question on competition. You mentioned that the supply-demand dynamics of the sector are very strong. Do you see any risk in competition intensifying? Do you see smaller players also ramping up capacity expansions? If not, what is happening in that regard? Thank you.

Stephen Yang, Executive President and CFO

You know, Felix, we have seen many competitors disappear from the market in the past two to three years. Especially, we are facing less competition in both the K-12 business and the overseas-related business, as well as the college business. Going forward, we expect the competitive environment to stabilize.

Felix Liu, Analyst

Okay. Got it. Thank you.

Operator, Operator

Thank you, Felix. Our next follow-up question comes from Timothy Zhao from Goldman Sachs. Please go ahead, Tim.

Timothy Zhao, Analyst

Hi, Sisi. Hi, Stephen. Just a follow-up question on the intelligent learning system and devices. I saw the number of active users for the past quarter is actually quite similar to the summer semester. Just wondering if you can share some color in terms of the seasonality of these business lines and what is the profitability we are seeing. How should we think about Q-on-Q growth into the third quarter and fourth quarter? That would be very helpful.

Sisi Zhao, Host

Yes, actually, the intelligent learning devices business is developing well. The growth is strong, and we are not seeing a very seasonal pattern for this business, quite similar to previous tutoring businesses, especially for middle school students. This year, the year-over-year increase in users is very high. We have also prepared many new devices to cater to customer needs. The key growth drivers are new customers, and we are also expanding into more subjects for existing customers. This product is helping kids enhance their self-study abilities even without teacher's instruction, using the device while benefiting from our distinctive content embedded in it. So this is a good solution after the policy changes and restructuring. We are confident in the development of this new product. Additionally, profitability is currently showing margins similar to our tutoring business, primarily for elementary school students, and we are seeing potentials for this learning device business. The margin potential is strong as we leverage our teacher resources and avoid high costs on new learning center openings.

Timothy Zhao, Analyst

That's clear. Thank you, Sisi.

Operator, Operator

Thank you, Tim. Our next follow-up question comes from the line of Tian Hou from T.H. Capital. Please go ahead, Tian.

Tian Hou, Analyst

Yes, Sisi and Stephen, just a follow-up question related to the seasonality. I'm not quite sure what the seasonality under the current business structure is. Could you provide some insight?

Stephen Yang, Executive President and CFO

Yes, the seasonality has become more stable than many years ago, but Q2 is still the lowest season. The strongest season is Q1, followed by Q3 and Q4, while Q2 remains the lowest season.

Tian Hou, Analyst

Does the margin also follow the same trend?

Stephen Yang, Executive President and CFO

I think so, yes. You look at the margin. In Q2, the non-GAAP Op margin is roughly 5.9%. I believe the margin in Q3 will definitely be higher than in Q2.

Tian Hou, Analyst

Okay. Got it. Thank you. Thank you.

Operator, Operator

Thanks, Tian. We are now approaching the end of the conference call. I'll turn the call over to New Oriental's Executive President and CFO, Mr. 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. That concludes today's conference call. Thank you for participating. You may now disconnect.