New Oriental Education & Technology Group (EDU) Q3 2022 Earnings Call Transcript

New Oriental Education & Technology Group (EDU -2.48%)
Q3 2022 Earnings Call
Apr 26, 2022, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good evening and thank you for standing by for New Oriental’s FY 2022 third quarter results earnings conference call. [Operator instructions]. I now like to turn the meeting over to your host for today’s conference, Ms. Sisi Zhao.

Sisi Zhao — Director of Investor Relations

Thank you. Hello everyone, and welcome to New Oriental’s third fiscal quarter 2022 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 Chief Financial Officer

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 calls, and we will 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 cost incurred from cancellation costs, closure of the schools and learning centers, and employee layoffs, as a result of governments policy introduced last year. This quarter was about turning over a new leaf with new and decisive endeavors, innovative business opportunities, as the company embarks on a fresh journey that strive to increase all along 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 view initiatives as we announced the latest set of financial results. Our key remaining business have shown remarkable resilience as 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 enterpreneurial spirits has come to the forefront of such time of the change. And we have been exploring new business opportunities, including non-academic tutoring, intelligent learning system and device, study tour and research camp, educational materials and digitalized smart study solutions, as well as exam prep courses designed for the students with junior college diplomas to obtain bachelor’s degrees. Now, I would like to spend some time to talk about this quarter performance across our remaining business lines and introducing our new initiatives in detail.

Our key remaining business got a promising trends breaking it down. The overseas test drive business recorded the revenue increase of about 8% in dollar terms, for the first nine months of this fiscal year. The overseas study consulting reported revenue increase of about 26% in dollar terms year over year for the first nine months of this year. The domestic test prep 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 students all around developments. I’m glad to share with you that these new initiatives have shown positive momentum. Firstly, [Inaudible] tutor business, which we have rolled out in over 60 existing cities, focused on cultivating students, innovative ability and comprehensive quality. We’re happy to see increased market penetration in both market that we have tapped into.

The top 10 cities in China have contributed more than 60% of the revenue of this business. Secondly, the intelligence learning system and device business is a service designed to provide a tailored digital learning experience for students, utilized our past teaching experience, data and technology to provide personalized and targeted learning and exercise content together with our teachers monitoring and accessing the learning curve our students as a backend system. The new educational service not only greatly improved students learning efficiency, but also cultivate students proactive learning habits. We have tested adoption in over 15 existing cities and are delighted to see improved the customer retention and scalability of this newly initiative.

The revenue contribution of these initiatives from the top 10 cities in China is over 65%. Meanwhile, the study tour and research camp business is an initiative that aims at offering students the opportunity to fully leverage their free time holidays to broaden the scope of knowledge and cultivate subject interest. We have conducted the study tours and the research camp 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 prospect 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, age, where remote learning becomes increasingly mainstream. In addition, New Oriental’s smart education business comprised smart teaching, smart hardware, science and technology innovation education, and other service, providing high-quality educational resources and comprehensive service for local governments, educational authorities, primary, secondary schools and kindergartens. The products and services relates to scientific enlightenment, our space feature and artificial intelligence, smart education business have presence in over 2,000 kindergartens and over 500 primary, secondary schools across the country.

Last, but not least, what other new initiative I would like to share is exam prep course designed for students with junior college diplomas to obtain bachelors degrees. It has become a very common goal among many associated degree holders in the country to progress further in their education ladder by applying to university, and we saw this gap in market is providing exam prep service to these diplomas and college students, who would require support in taking that leap forward to the university level. We’re piloting such courses in so
me higher tier cities now and plan to roll it out to more cities in the next fiscal year. During the last two fiscal quarters, we have been fully committed to comply in the government’s policy.

And as the 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 have underscored the importance of our industry leading OMO system, which have been one of the consistent 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 the COVID-19 outbreaks in certain part of China, where strong flexibility is required in migrating students between online and offline classes to minimize learning disruption. We continue to our efforts in developing and revamping our OMO teaching platform, and kept leveraging our education infrastructure and technology strength across our remaining key business and new initiatives to prove more advanced and diversified education service for customer for 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 actively seeking new market opportunities by leveraging existing infrastructure and the technology is shifting strategic focus and adjusting existing business lines and service offerings. On the other hand, Koolearn continued to expand the developments of existing college and institution business segments, as well as online education products and service offering. On the other hand, it’s implementing structural changes to meet the needs of the changing regulatory and educational environment by actively exploring new initiatives to broaden customer base and offerings.

Some of the new initiatives that Koolearn have been exploring, including live-stream marketing of the traditional Chinese culture and high quality agriculture and other products from different place of our region in China, seeking institutional cooperation and developing new intelligent learning innovations. After the introduction of the [Inaudible] in the government policy on after-school tutoring last year, which has no doubt posted direct impact to our business. We have received many inquiries and concerns from investors over the company’s financial position. As a company with long-standing heritage, we have always made sure that we are prepared for and capable in weathering changes in the market and that reflects in our ability to maintain strong cash position throughout the whole — the process.

By the end of the quarter, our cash and cash equivalents term deposit and short-term investments totaled approximately $4.4 billion. In the second and third quarter of this fiscal year, the company incurred considerable cost from the termination of its leasing agreements in relation to the closure of the learning centers and the employee layoffs. We believe that this cost generated during the restructuring phase are temporary as they are nonrecurring losses. With the process of school closure and now largely completed, it signals that the company has now entered a stage of this — starting fresh, exploring new opportunities with greater flexibility and strong cash flows.

We’re confident that in the sustainable profitability of the older remaining key business, 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 values to our customers, society, and shareholders over the long term. Now, I will turn the call over to Sisi to go through our key financials. Sisi?

Sisi Zhao — Director of Investor Relations

OK. 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 or $725.3 million, representing a 32.5% decrease year over year.

The decrease was primarily due to the reduction of facilities and 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 32.3% decrease year over year. Total share based compensation — 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 flow — cash outflow for the quarter was approximately $235 million and capex for the quarter were $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 investment.

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 the same at 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 Chief Financial Officer

Looking ahead into the next quarter of fiscal year 2022, having adopted measures in response to the latest policies and regulations, we now have clearer picture about 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 a stage of the closure of the schools and learning centers nearing its end, we’re left with relatively small portion of the lease terminations to be executed in the coming months. The non-recurring one off costs relates to the closure were already accrued in the first half of the current fiscal year. In the meantime, our strong performing key remaining business are all profitable and will continue to serve as a solid foundation for the business performance, as will provide us with a fuel to explore new possibilities in the markets.

Our strategic focus and investments approach going forward aim at expan
ding our new initiatives, which will be nurtured into key gross engines for our business. We’re confident about the future success of this in the service as they echo with the current trends in the market. With the likes of the non-academic tutoring and study tour and research camp targeting the facilitation of the overall development of students, which is to generate — which is a general goal that the industry is striving to achieve. Meanwhile, intelligent learning system and device and digitalized smart study solutions are offering students digital, personalized, and remote learning experience, which has a trending team in the current teaching, enabled, and post-pandemic education industry.

It will take time for this new business to come to full fruition. But as we saw in this quarter, the encouraging growth trajectory that they have already been showing proof that we are heading toward the right direction. And we’re confident that the business will be starting to contribute meaningful revenue from the next fiscal year onwards. We would like to know that our guidance is taking into consideration of the recent pandemic development in Shanghai and some other small cities are still locked down, these cities, since March has inevitably impacted our business operation locally.

Student recruitment is where we experienced some disruption, as students and customers were unable to access our service centers to send out full courses. Though the overall impact on the business has been limited, thanks to our OMO system, which enable us to swiftly migrate students from offline to online classes, avoiding much of the learning disruption. We also don’t expect the disruption in Shanghai and some other small cities will have significant effect on our overall revenue growth as we have a widespread presence across many cities in China. Although the pandemic situation in China remains fluid, our operation infrastructure led by the OMO system has shown a strength in flexibility in the past couple of years to weather disruptions, while our staff across the country have got the experience to prepare for and respond to the COVID operations.

Therefore, we’re confident that our future — that any future outbreaks in other cities will only have limited impact on our business. Experience stands the test of time. One of the strengths of New Oriental’s is the experience and legacy we have built over the years. And this has proven to be the depreciation differentiation between us and other players during the challenging and period.

Leveraging our experience and brand recognition, as well as the very healthy cash balance that has been enhanced 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 business and investing in the new initiatives, which will be the new growth engine that accelerates our recovery. At the same time, we will continue to see guidance from and cooperate with the government authorities in various province in China in connection with its efforts to comply with the relevant policies, guidelines, and any related implementation rules, regulations and measures, and to further adjust our business operations as required.

With our investments in different strategies, we’re optimistic on brighter prospects of our business. We believe new company structure falling in the restructuring phase will bring us fruit-full returns in the long-run. I must have mentioned that these expectations reflects our considerations of the latest regulatory measures and 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 these.

Questions & Answers:

Operator

Thank you. [Operator instructions]. Our first question comes from Felix Liu from UBS. Please ask your question.

Felix Liu — UBS — Analyst

Thank you management for taking my question and I’m very pleased to see the resilience you have shown and the tough restructuring due to the external environment. My first question is on the restructuring progress. So you mentioned that most of the restructuring are almost finished. So may I know the learning center that you have by end of the Q3 will be more or less sustainable into the future, or do you expect more closures in the upcoming months? And my second part of the question is on the accounting of the restructuring costs.

Unfortunately, I noticed that you have turned this loss making in this quarter. So may I know how much of the cost this quarter is related to the one-off restructuring and how much will be ongoing? And maybe any color on the unique mix of your new initiative will be much appreciated? Thank you.

Stephen Yang — Executive President and Chief Financial Officer

Thank you, Felix. Your first question about learning center. In the last of fiscal year end, we had the 1,669 learning centers in total. And in this quarter end, we have five — we have 847 learning centers.

And we plan to close down some of the learners centers. So, we expect the learning center number will be decreased to 600 — 650 to 700 in this fiscal year-end. So this is my answer for the learning centers numbers of your question. And yes, we’re in the restructuring phase and I think the one-off cost relates to the learning center close down and the utility lay-off were already accrued in the first half of this year.

So that means we have already recorded most of the one-time cost into the first half of this year. Yes, you saw the last in this quarter, but I think mainly due to the new investments for the new initiatives for the future. So but I think it’s worthy because we started to fight, the new council of business, better than [Inaudible] children like the intelligent learning system and devices [Inaudible] study tour camps were some like the exams for the college students to get their bachelor’s degree. So those new initiatives need our new investment to buildup the good future.

And so now we are in a new investment phase, but we do believe those new initiatives will make profitable in the near — will make profit in your future. So I think we do believe in the next fiscal year where near future, we can be profitable because first of all, our — the [Inaudible] business, domestic test prep, the adult English, and the domestic test prep, and the overseas consulting business, all the large business are profitable, and we do believe the new business would be profitable. So I think the margin profile will be optimistic in the coming new fiscal year, Felix.

Operator

Thank you. [Operator instructions]. Our next question comes from DS Kim from J.P. Morgan.

Please ask your question.

DS Kim — J.P. Morgan — 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 because of the reminder, I would ask one question here. And I will try to ask again later.

In terms of the revenues in third quarter, if you look into the details, number one, how much of that third quarter revenue happened in December versus Jan, Feb of this year? And in relation to that, how much of the — roughly how much was the new initiative dose that you mentioned like non-academic intelligent learning systems and whatnot? How big was it, the revenue contribution in the third quarter?

Stephen Yang — Executive President and Chief Financial Officer

OK. For the revenue contribution in this quarter, I think the December revenue, it’s a little bit higher than the revenue of the January, February, because we closed down the K-9 business by the end of last calendar year. So in December, we did have some — the K-9, the tutoring courses and so
would report revenue. So yes.

And the new business, the non-academic courses, it’s quite new. We just launched the business, the non-academic courses, couple of months ago. And now it’s a little bit small, but it’s grown very fast. So, the new business what — including the non-academic courses and some likely the new service related to the intelligent learning system, I think we will contribute more revenue in next year.

So, I believe the new business will contribute over 20% of the revenue contribution next the year. So you saw the growth is extremely high.

Operator

Thank you. Our next question comes from Elsie Sheng from Morgan Stanley. Please ask your question.

Elsie Sheng — Morgan Stanley — Analyst

Thank you, management. My question is also related to the new business. So is there any operation data that you could share? For example like the retention rate for the — like the new non-academic courses, and also how do see the competition in this area? Thank you.

Stephen Yang — Executive President and Chief Financial Officer

Actually, we started with new business a couple of months ago, but has developed very quickly and we have seen, you know the student retention rates are guiding higher and higher. So in some new — the main cities, we were seeing the student retention rates are in non-academic courses is close to the retention rates that we the — of the academic courses last year. So it’s a good result for — good news for us. And yes, I know the revenue contribution is small, but the growth is very fast.

And the second [Technical Difficulty] of the competition. I think the competition, you know the competition is still there, but in the — upon the whole market environment changes, so I do believe the competition will become less, because we have seen a lot of our competitors will disappear from the markets. So the competition is not a problem for us. Thank you.

Operator

Thank you. The next question comes from Candis Chan from Daiwa. Please ask your question.

Candis Chan — Daiwa Capital Markets — Analyst

Hello, Sisi and Stephen, thank you for taking my question and I would like to ask about the recovery of the overseas and domestic test prep businesses so far because of the easing of cross border control in other countries. And at the same time, I also noticed that the domestic test prep business has — revenue growth looks very strong. So overall for next fiscal year, how does this business — test prep business revenue growth will look like? And what kind of development for the domestic test prep has been done over the past year to achieve that strong growth? Thank you.

Stephen Yang — Executive President and Chief Financial Officer

Yes, great question. Yes, despite we are in the restructuring phase, but we’re happy to see the domestic test prep business and oversea related business with very fast in the last couple of months. And oversea test prep and consulting business, the revenue increase is about — totally it’s about 15% year over year, oversea test prep 8%, and consulting business 26% in the first nine months of this year. And yes, we know the pandemic still in some other countries even in China.

But actually, what we’re seeing some students still enroll our the oversea test prep classes because for most of our — the oversea test prep the students are the high school students and college student. And they made the decision to study abroad someday, so they don’t have to change their decision. So and I do believe the human beings can beat the coronavirus. So I do believe our oversea test — the oversea test prep business and consulting business will be broad in a meaningful rate in the coming new year in fiscal year 2023. And the domestic test prep, there’s a news recently in China, more and more the university and college students choose to take the Chinese GRE, the like Chinese exam.

So I think the market is booming. And I think we are one of the dominator of this part of the business. And since two years ago, internally, we arranged internal solution of the Chinese GRE department, the English and the master test prep. And we moved some talent people from the K-12 business to the domestic test prep. So I think we prepared for the new — for this market for like just for the last two to three years.

So I do believe the mass test prep will grow very fast and will generate more and more the profit for New Oriental. Thank you.

Operator

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

Lucy Yu — Bank of America Merrill Lynch — Analyst

Thank you, Stephen for taking my question. My question is more on the modern side. You mentioned the remaining business is profitable. So can you share us the profitability of those remaining business? And for the new business, you also mentioned it will turn profitable next fiscal year.

So what are the expectation of the margins for those new business in upcoming year? Thank you.

Stephen Yang — Executive President and Chief Financial Officer

OK. The [Inaudible] business, the overseas test prep and consulting business, typically the margin is the 15% to 20%. And domestic test prep the margin is about to — is around 10%. And the new business we suffered a little bit loss, but I do believe next year will be profitable for the new business.

And I do believe theoretically the merge of new business will together like the 20% somewhere. And so it’s a good business.

Operator

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

Liping Zhao — CICC — Analyst

Thanks, Stephen and Sisi, for taking my question. So, glad to see that you have made progress in some new initiatives. So may I know which one will most likely be the future key revenue contributor? And what’s EDU’s competitive advantage in that direction? Thank you.

Stephen Yang — Executive President and Chief Financial Officer

Yes. We’re exploring new business opportunities including like the five the new business. So the — firstly, non-academic tutoring focus on helping the students to improve their innovative ability and comprehensive quality and such as level programming, level design, present scale, our exposure to grow very fast because since the double deduction new policy last year, we’re seeing that the students have more time during the weekend, during the holidays. So — and the parents love to see their kids to improve their OP comprehensive ability and so this is number one. Number two, we launched the intelligent learning system and device, utilize our past teaching experience and data technologies to help the students to do this like the like the self study by them self.

I think the system help them a lot and the students and parents love the new product. And so those two are the products the non-academic courses and the intelligent learning system devices will contribute more revenue going forward.

Operator

Alright. Thank you. We’re now approaching the end of the conference call. I will now turn the call back to New Oriental’s executive president and CFO, Stephen Yang, for his closing remarks.

Stephen Yang — Executive President and Chief Financial Officer

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 relation representatives. Thank you.

Operator

[Operator signoff]

Duration: 42 minutes

Call participants:

Sisi Zhao — Director of Investor Relations

Stephen Yang — Executive Preside
nt and Chief Financial Officer

Felix Liu — UBS — Analyst

DS Kim — J.P. Morgan — Analyst

Elsie Sheng — Morgan Stanley — Analyst

Candis Chan — Daiwa Capital Markets — Analyst

Lucy Yu — Bank of America Merrill Lynch — Analyst

Liping Zhao — CICC — Analyst

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