NetDragon Websoft Holdings Limited (777) Earnings Call Transcript & Summary

Dear friends, good morning. Thank you for joining NetDragon's Websoft Holdings Limited today for our 2021 interim results presentation. [Foreign Language] Our presentation PPT will be broadcast on the live streaming platform. The PPT is also available for download on our company website at www.nd.com.cn, under the Investor Relations tab in IR website section. [Foreign Language] Before the start of our presentation, please allow me to introduce the management who are joining us today. [Foreign Language] Dr. Simon Leung, Group Vice Chairman and Executive Director; [Foreign Language] Mr. Ben Yam, Group CFO; [Foreign Language] Mr. Lin Chen, Group Senior VP, [Foreign Language]; Mr. Vin Riera, CEO of Promethean; [Foreign Language] Now let's pass our time to Dr. Simon Leung to host our presentation today. [Foreign Language]

Well, thank you. Good morning. As you can see my background is actually well in Hong Kong, a bit challenging. So I hope you guys get to your office safely. Well, thank you for joining our call this morning. How I wish we can meet you face to face, but with COVID, this is actually where we have to make do. [indiscernible] troubled over the last 1.5 years, which is very unusual. Happy to report we have a very, very strong finish for our -- with our first half in all sets of our businesses, gaming and education. If you look at all the matrix that we track, revenue is up, margin is up, cash is up, and [profit]is up. So the team will take you through all these. Let's take a look at our performance in the first half. Before we do that, let me introduce the team very quickly one more time. So I will talk about the highlights, a lot of people having conversation questions about China's new direction in terms of education, how it impact education business. I'll talk to that very quickly. Vin will talk through the education business. Vin actually, in addition to Promethean, he has also taken over the [Edmodo] responsibility. We see the market actually moving towards blended solutions. It is the right time to combine Edmodo and Promethean. So Vin is not only the CEO of Promethean, he is actually the CEO of the combined educational business. Lin Chen will talk about the gaming business and Ben will, of course, talk about the financials. But more exciting is actually talking about some of the shareholder enhancement value program that we're going to be rolling out in the second half, which is the most exciting part. That's coming at the set of very strong performance, we call it capital management. Okay. Let's move on to Slide #4. We talk about it, it's in the press release, but I will just repeat a couple of the numbers. 19% year-over-year revenue combined growth which is quite impressive. EBITDA is up quite a bit, 42%. Profit, both operating profit and net profit, are up. Net profit up 28%. If you take a look at operating profit, it's up 59%. Slide #5, really great highlights as the team will go through it. In gaming, we're back to double-digit growth, which is very good in the current environment. Another highlight is actually our overseas growth, which is 29%. In terms of education, continue to be very strong, of course, that will improve our bottom line. And amidst the corporate challenges, logistics and freight is actually a very big challenge for us, but I am have very happy to report the team has done a very good job in managing that and then also managing the cost for freight and logistics. A quick word on our country's strategy. We're continuing the rollout, we're picking up steam, continue to work on countries like Egypt to add to it, we designed an MOU at Thailand, we're going to pilot, it's actually an English learning, smart classroom capability. And then once that's completed, we're going to roll it out to the rest of the country. I just hope COVID is not going to be there to rain on our parade. And last but not least is our -- something that I'm very happy and excited about is we're going to be announcing a bunch of activities that's going to unlock the value of NetDragon. The reason we can do that is actually is back -- on the back of many quarters of strong financial performance. Okay. Turning the focus on China a little bit. The market gets very effective because of the change of education regulations. Overall margin is impacted. But I want to assure you guys that we are quite different from some of the other companies. So I'm going to spend a couple of minutes taking you through it and we can have more questions about it. We can go to Slide #7. The gist of this slide is actually to tell you, the new policy actually doesn't affect our business because we are not in the after-school children business. As a matter of fact, because of the change, it put a lot more focus into the classroom, putting the right infrastructure in the classroom, putting a lot of comments and also putting a lot of focus in developing the teachers, in turn, it will benefit the students is actually that is our strategy, which is better learning solutions. So the future of China education actually works very well with our strategy, which is a strategy we've been pushing since day 1, and we have never changed. So in a way, the market is coming to us. In the rest of the world, because of COVID, in China because of the new regulation and also COVID, [I have to say]. So let's go to Page 8. Because of that, we are very clear in what we're going to be doing in China. So we have experiment quite a number of products and strategy, is actually with the change of regulation, it is very clear to us our future belongs to the classroom and belongs to more like a 2G or 2B business. So what we're going to do is actually we're going to be focusing on a couple of strategies. As a result, we're going to be rightsizing our organization in China. With the rightsizing, we can save some money that will go to the bottom line. I think that's very good for the investors. So with that, on the back of education, I'm going to hand it over to Vin Riera and he's going to take you through both Promethean business and the Edmodo business. Vin?

Great. Thank you. Good morning, everybody. I want to start by talking about the strong market demand that has been driven by COVID. COVID pushed the Education segment into finding solutions for blended learning, and that really led to an inelastic demand for our education products within our portfolio. We see that the interactive classroom technology is a core part of blended learning. During the last 18 months, schools all over the globe bought more one-to-one devices. They bought more software programs. They looked at different ways of educating students in a blended learning environment. And our interactive front-of-class technology is at the absolute core of that. And the demand for the higher-end technologies to support the blended learning solutions is evidenced in the results, and I'll share that with you shortly. There's also a huge opportunity because there's a relatively low penetration of interactive devices globally. About 1/3 of the classrooms have interactive displays on a global basis, that still means that we have significant opportunity, not only to continue to replace legacy technologies in more mature markets, but also go -- continue to go after the emerging markets and win the business and gain new share. And then the last point on the overall strong market demand is that this is the new normal of learning. The solutions that we're seeing that are being put in place around the globe are not short-term fixes for the next year or 2. It's considered the new normal and how schools are going to continue to operate not only from a face-to-face classroom setting, but also how they're going to operate in a blended learning environment. So we have a very strong belief that blended learning is driving the demand today. It's also the future of our business. From a market growth outlook, you'll see that the market grew between 2020 to 2021, it's estimated to grow 20%. We're obviously participating in that growth, and we also see growth continuing on to 2022. Next slide, please. So some of the drivers that are helping with the growth of Promethean is our brand equity. I talked about this on every earnings call, but Promethean has been in the education segment for over 20 years. We're well known. We are well respected. We have a following of teachers and administrators and IT professionals around the globe. And that brand equity really helps open doors for us. The second thing is that we have a premium product, but we price it and configure it specifically for education. There are so many different use cases for interactive devices. We chose to focus our development and R&D efforts on front-of-classroom technologies and use cases and how they're used within schools or even within Ministries of Education in some of the emerging markets. We have a unique blended learning focus. We're very conscious of how our products are used in the classroom and how they are used in a traditional way where you have students in front of you, but also where we need where you need to connect cameras where you have to run different types of software in order to engage the students remotely. And then the final point is we're able to cover the territory that we're able to cover because of our -- the great relationship we have with our channel around the globe. We're always building out and looking for white spaces that we could better cover with deeper -- with new channel relationships and making sure that as opportunities present themselves that we're there and we're competing for those opportunities. We take our relationship with our channel very seriously and we invest in our channel to ensure that not only that we're successful, but they're also successful as well. And the result of this is we've been able to expand our market share. So globally, excluding China, in the second half of 2020, we're at 21%, first half of 2021, we're at 24.5%. And then in our top 3 markets, which are the biggest markets that we have outside of our emerging markets, we gained share in the U.S., U.K. and Germany, respectively. Next slide, please. So we have had both significant revenue and volume growth. Revenue growth on a half-over-half basis was 21%, on a year-over-year basis, 35.6%. The same thing goes for volume growth. The market grew 6%, where Promethean grew 21.5%. So we're seeing growth both in our number of units within the market and also top line revenue. Next slide, please. And then we continue to focus on operational excellence. Simon talked about this a little bit during his speech -- during his first set of comments. But the supply chain and logistics have been extremely challenging for all businesses. And we've put a lot of focus on how we can continue to operate efficiently, operate cost effectively and make sure that we have products in our channel and with our distributors to be installed in schools. The first thing that you'll see here is that from a product mix standpoint, our ASP went up year-over-year. There's a couple of factors for that. The first is with blended learning solutions, schools are really looking to put in our higher-end product, our higher-end products. It's a faster product. It has more computing capability. It works effortlessly in a blended learning environment. It's not that our lower-end product doesn't work, but in a blended learning solution, but the higher end product certainly works effortlessly. It's also worth mentioning that there are significant funding streams in place globally that are fueling ad tech spending. And when there's money to spend, schools are looking for solutions that are sustainable solutions, not only for this year but for the next few years. Gross margin went up, and again, back to our discipline on cost, making sure that we're planning appropriately for inventory and managing our supply chain and logistics down to every last penny to make sure that we're extracting the value that we need to out of that and then passing that along to our customers as well. And then from an operational efficiency standpoint, OpEx as a percent of revenue went down from 27.2% to 23.6%. And with that said, I'm going to turn it over to Lin to talk about gaming.

[Foreign Language]

[Foreign Language] Hello, everyone. This is Ben, and let's get right into our financials for the first half. Okay. So first, on our income statement, our revenue growth was close to 19%, with gaming and education both performing exceptionally well. Our gaming revenue growth continued from the momentum we saw in the second half of last year with a 12% growth. And our education business recorded one of our strongest performances in recent years with 23.7% growth on the back of 2 main drivers, one is overall market growth; and the second one is the fact that we've been increasing our market share, as Vin pointed out earlier. We're also seeing benefits from the -- from operating leverage as we continue to scale our top line while we manage our business with cost discipline. So as you can see here, all our SG&A expenses as a percentage of revenue have all gone down compared to prior year. And as a result, we're seeing 28% increase in net profit, a 42% increase in EBITDA and 26% increase in non-GAAP profits. And in the meantime, we continue to maintain our very strong financial position as our net cash amounts to over $4 billion. Next slide, please. On to the segmental financials. First on the education business. Our overall gross margin increased by 5.5 percentage points, and that's largely driven by Promethean's gross margin enhancement. And it's also worthwhile to point out that our core segmental loss for the education business continued to trend down as I kind of guided earlier. As you can see, going from $377 million last year to $266 million. And going into the second half, we do expect the education loss to continue to narrow. And then on to the gaming business, again, we saw double-digit growth on the back of both in terms of both top line and bottom line, on the back of relatively stable operating expenses. Next slide, please. Okay. So the next part of this presentation is shareholder value enhancement, and we are very excited to be announcing these measures. And the goal here is really -- we're aiming to initiate these new capital measures to maximize capital return to our shareholders while allowing us to continue to invest in the future. Next slide. So first to tee it up. NetDragon has been consistently growing our profitability and also our cash flow in the past several years, as many investors would know who follow us for many years. And in the meantime, we've also been generating growing free cash flow, as you can see here. So in 2020, our free cash flow was close to $1 billion. And in the coming years, we are fully confident that our free cash flow will continue to grow. Next slide. And as we increase our earnings and free cash flow in the past several years, we've also been consistently increasing our cash return to shareholders via dividend and also share buyback. In 2020, we returned a total of $355 million in terms of Hong Kong dollars to our shareholders, which increased by over 50% from 2019 and also represented 37% of our net earnings. Next slide. And to break down the cash returns further. First, we can talk about dividends. As you can see, within declaring increasing dividends in the past several years, and we're also pleased to say that we're going to increase our interim dividend by 60% to $0.40 per share. Next slide. And then in terms of the stock buyback, our Board has organized a committed stock repurchase program whereby we expect to buyback our stock up to USD 300 million over the next 3 years. And this is really a follow-through on our long-term commitment to maximize the value for our shareholders. We believe that given the level of our stock price at the moment and the fact that we've been consistently growing our business, our net profits and cash flow, in the past many years, this is a very optimal timing to initiate a stock buyback program of this scale. And on top of that, our decision to commit to the stock buyback program really -- and also increasing our cash dividend, really underscore our confidence in the long-term business outlook and also our future cash generation abilities. So we're going to implement this buyback program while maintaining a very strong balance sheet and also liquidity profile. And we also expect that we're going to return in the next 3 years, a substantial portion of our free cash flow through a combination of this stock buyback and also dividends. And again, I would also like to emphasize that while we implement this program, we're going to continue to maintain very strong kind of net cash position as I -- at the end of the first half, our net cash is over $4 billion, and that will enable us to be able to capitalize on our strategic and also acquisition opportunities going forward. And with that, I'm going to pass the stage back to Simon, who's going to take us over take us over the outlook.

Well, thank you, Ben. I can see some of you are still looking at Page 37 doing a lot of math, right, between the $300 million and the $600 million. So I'll -- have fun on that one. So kidding aside, I'm going to [indiscernible] on outlook. If you kind of look at for the rest of the year, I think Lin Chen has done a very good job in articulating where we're going. So we continue to grow our gaming business, especially with the new game that is being launched in the second half. On the education side, I just have to say, we are very confident that we're going to end the year on a very high note. One of the reason is actually we have very strong backlog going into the second half of the year on the back of a high-growth first half. Very good news. I talked about it in our last meeting here, we believe our stock is actually quite undervalued. So our focus is to unlock the value of the company. Ben talked about a buyback, talked about increasing the dividend. On the dividend side, we basically are very confident that we'll continue that trend on the back of our good performance and good cash generation. I think one big one is actually is to unlock the value is to think about the spinning off of our education business. So we don't comment that planning. Actually, we started the process already. We'll update you in due course. Again, at the end of the day, we also executed our stockpile debt plan in a very thoughtful way. This is another way to unlock the value and also return the value back to the shareholder in addition to our dividend. So with that, thank you for your patience. I hope you are okay with our performance in the first half. Looking forward to talking to you about our second half in about 6 months' time. With that, I'm going to open up to Q&A. Thank you.

Thank you, Dr. Leung and management. Now it's time for our Q&A section. [Operator Instructions] [Foreign Language] We would like to welcome questions in both English and Chinese. [Foreign Language] Let's welcome our first question. So we have a question from the webcast platform. Can you please talk about the margin and the cash flow outlook of Promethean next year? Is there any room or further improvement on margins? And do you see inflation put pressure on materials?

Vin, do you want to take that? That's a [indiscernible] question, but we're not going to talk about the [indiscernible].

That's okay. Yes. Yes, we're not going to give any guidance for next year, but...

Yes, so I think next year [indiscernible] right now. So we're not going to talk about that now.

So either one of you take that question. So yes.

Vin, do you want to take that first? But the rest of the...

Yes, let me go first. Okay. So we still have issues, we still have issues in the supply chain that we're managing very closely. We're continually looking to source components to make sure that we have it ahead of when we need it. There's still challenges in logistics. There's still challenges in the supply chain. I'm optimistic that I think it's going to get better, but I don't think it's going to get better in the near term. I think it's -- we're going to continue to work through some of the challenges. And as we get into next year, I hope to be more forthcoming about some of the improvements that we're seeing when we talk again in 6 months. But between now and the next 6 months, I don't see major changes in the supply chain.

I just do like to add a comment on that one. So in terms of margin, the freight cost is only a part of it, right? So the team is actually working very hard on not only on the freight charges but also on the cost of the product. And also is actually on product mix and also on ASP. So again, if I can remind you of one of the charts that Vin showed, our ASP is up -- actually our gross margin is actually up. So it's a combination of things that increased gross margin. I can assure you, Vin and his team are laser focused on improving it. So are there room to improve? The answer is yes, but there will be a lot of hard work. But I think the team can do it. What's the cash flow question again?

Yes. The cash flow question is the -- okay. So the cash flow outlook and the margin outlook, and we have -- do you have further improvement on the margin? And also, would there be any [ inflight ] pressure for the material?

I think we are mixing the question a big time. So we answer the Promethean question on margin and everything. Ben is going to answer the overall cash flow issue because that's both gaming and education. So Ben.

Yes. So in terms of the cash flow, let me talk about cash flow from an overall perspective. So as you can see, cash flow is directly related to kind of revenue growth, right? And as we look into the second half of this year, I think we'll be looking at sequential revenue growth. We're very confident, as Simon -- without mentioning the outlook, and also we're going to keep costs under control. So with that, we are very confident that we're going to be able to continue to increase our cash flow, both in terms of operating cash flow and also free cash flow in the second half of the year. So that will be the cash flow question.

Yes.

Thank you very much. [Operator Instructions] [Foreign Language] So our next question also comes from our online platform. It's a question about our educational business. Management mentioned that the spin-off -- the spin-off of our education business is on the way. So can you please share a little bit more about the detail plan, timetable or any progress?

No, we commenced the planning. So I also said in my presentation, maybe I didn't make it clear. We'll update everybody in due course.

Thank you very much. Next, we have a question from [indiscernible] [Foreign Language]

[indiscernible]

[Foreign Language]

[Foreign Language]

[Foreign Language] Our next question is about our educational business. Our investor, Okada, would like to know about that. For our Egyptian business, when will the pop-up classroom be starting -- like launching at -- in big scale?

That's the only question?

Yes, that's the question.

Okay, I'll take it [indiscernible]. Actually, we have done some pilots. Unfortunately, with COVID is actually not under control. So that is actually being put on hold at the moment. There's a whole series of other activities going on, working with the Egyptian government. So the answer to your question is actually, we do not know at this point. But I can rest assure you that as soon as COVID is like under control in Egypt, they will come back and look at how to roll out the pop-up classroom.

Thank you very much, Simon. Our next question comes from [indiscernible]. [Foreign Language]

Okay. I'm going to take the first 2 and then Lin Chen can talk about the third one. [Foreign Language]

Yes. Okay. [Foreign Language]

Thank you. [Foreign Language] [Operator Instructions] [Foreign Language] Our next question comes from [indiscernible]. With the fast growth in education business, would there be a chance that the overall gross profit margin may go down? Is the company comfortable with this? Or what would the company do to improve the overall margin?

Honestly,I don't know how to answer that question. The gross margin, in our case, is a complicated issue, right? So I mean because the different businesses. But our track record shows you we are doing very, very well in terms of gross margin. So again, I'll remind you to take a look at our slide before ASP up, cost is under control so our margin is up. The reason I laughed a little bit is actually because we have so many different businesses. So -- but the overall trend for our business in education is actually -- is moving towards a mix of software and hardware. So -- and services, right, because of that -- is actually -- I would expect the margin will improve because of the [indiscernible] mix. Because typically in software and services, your margin is actually higher than the hardware. But that doesn't mean that our hardware margin will go down. So it's not our goal to drive the margin down, right? So I have to be very clear. Our goal is to improve our margin. We improve it by operating in excellence and also working on businesses that will give us a higher gross margin. Right, Vin?

Exactly. Yes. Well said.

Thank you very much. [Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language] Operator?

[Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language] China Galaxy [indiscernible]. She would like to know that when will the monetization of Edmodo kick off? Is there any target on Edmodo's revenues scale into 2021 and 2022?

The -- actually, Vin, do you want to take it or do you want me to take it? Go ahead.

Yes, happy to take it. So we are in a couple of different areas on the monetization of Edmodo. The first is working on a product specific to ministries of education and country-wide rollouts. We've got a couple underway and a couple of discussions that are underway, and we're building pipeline there. The other thing that we're looking to do is monetize the community that we have and do so in a meaningful way. We have some product releases that are going to come out next year that are going to help us monetize the business. So we have a couple of different initiatives underway to monetize that business in that community.

And for the record, actually, we are monetizing some of it, but we will scale it next year. That's what the message from Vin.

Yes.

Thank you very much. Our next question came -- comes from [ Ken Yu ]. On the education business, what is the approximate gross margin headwinds today from U.S. and China trade tariffs? Will this -- while it's very difficult to forecast policy changes, is it possible that policy environment may improve in the future? So just curious that -- what would be -- what the policy in the future be beneficial to us or if anything, that will be beneficial to us from the operating environment?

The question is asking us to look at a crystal ball. So I'll pass it on to Vin. So Vin [indiscernible] in reading the crystal ball than I am.

I don't know if I have a crystal ball. What I will say is that we have seen -- relative to tariffs here in the U.S., we have seen our product being exempt from some of the highest tariff levels in the U.S., and I view that as a very positive sign. And I see no signs of that changing. That being said, I don't have insight into what future policies can be, but we certainly have not been harmed in any way incrementally from any tariffs that we've had to pay in the past.

But I would like to add, I look at this slightly differently on this one because the fact that if you look at our gross margin, it is actually improving. So it actually that means Vin and his team are handling the tariff issue quite very well. If there are any changes in terms of getting rid of the tariff, there's only upside force, right? So -- and personally, I don't foresee any increase in tariff. So I think we are in a pretty safe territory in terms of our costs.

Thank you very much. Due to the time limit, we would like to welcome our last 2 questions. [Foreign Language] Our next question comes from [ Ken Yu ] as well. How do you think about our dividend policy going forward and its growth potential? Should investors expect dividends to grow at a similar pace as our free cash flow?

Well, as I said, we don't expect our dividend to go backwards, let's do it this way. I mean, we said it before, it is our commitment to return a lot of these value back to the shareholders. And to do that is -- dividend is only one of them in many ways. Share buyback is another one. So that we can't commit to anything, but we don't foresee that going backwards.

Thank you very much. Our last question. [Foreign Language]

Lin Chen?

[Foreign Language]

Thank you, Lin Chen. [Foreign Language]

Well, first of all, thank you for your time this morning. I hope you are happy with our report. A couple of key points I'd like to remind everybody is actually the first one is actually, when you look at our businesses, both gaming and education, we are a global business. We're not a China along business. We're very proud of our market position in China, but at the same time, I think it's good we have diversity. So we are kind of -- we will -- it's actually -- I think the market is not rewarding us in terms of our global business. So we work very hard to change that perception. The other point I want to make is actually, if you look at the commitment we've made in unlocking the value and then returning the value back to our shareholders between dividends, buybacks and also committing to spin off the company, that means we are very confident in our business going forward. Our buyback program is not a 1-year program. It's actually we are very clear that it's a 3-year program, while we're maintaining the right cash position to allow us to do something strategic. So that tells you a little bit about the confidence of the team with our businesses, both gaming and education going forward. With that, we'll continue to work very hard to make you guys happy. And then with that, thank you for your time, and I'm sure you have more questions, feel free to come to us with more questions. Thank you so much.

Thank you very much, Dr. Leung. Thank you, Ben, Lin Chen and Vin. This successfully concludes our presentation today. Once again, I would like to thank you all for joining us. If you would like to communicate with the management further, please contact us for 1-on-1 weekend arrangement. Thank you, and we wish you all have a great day. [Foreign Language]