NaaS Technology Inc (NAAS) 2017 Q3 法說會逐字稿

Good morning and good evening, everyone. Welcome to RISE Education's Third Quarter 2017 Earnings Conference Call. (Operator Instructions) This call is also being broadcasted live on the company's IR website.

Joining us today are Mr. Yiding Sun, CEO of RISE Education; and Ms. Chelsea Wang, CFO of RISE Education. Following management's prepared remarks, we will conduct a Q&A session.

Before we begin, I refer you to the Safe Harbor statement in the company's earnings release, which also applies to the conference call today as management will make forward looking statements.

I will now turn the call over to Mr. Yiding Sun, CEO of RISE Education. Please go ahead, sir.

(Spoken in Chinese).

Thank you, Operator. Hello everyone. Welcome to our third quarter 2017 earnings conference call. This is Chelsea Wang, CFO of RISE Education. I will now speak on behalf of our CEO, Mr. Yiding Sun.

We're excited to conduct the very first earnings conference call following our IPO in October 2017. As the leading junior English Language Training or ELT service provider in China, we continue to benefit from robust market growth. According to Frost & Sullivan, gross billing in China's premium junior ELT market is expected to grow at a 23% CAGR from 2016 to RMB239.8 billion by 2021.

Such growth is mostly fueled by favorable government policies, rising disposable income and a strong cultural and a societal emphasis on English education. Our operating results have certainly reflected the strong market momentum. Our net new student enrollment per self-owned center per month achieved 35.7% by Q3, compared with the average of 33% per center per month during the first half of this year.

Q3 and the Q1 are typically strong quarters for student recruitment. Our new student enrollment in the third quarter of this year is even better than expected seasonal adjustment and is an evidence of our continuously strong growth momentum.

During Q3, we further expanded our learning center network by opening 2 self-owned and 11 franchise centers. As of September 30, 2017, we had 259 learning centers across 85 cities throughout China, among which 58 are self-owned and 201 are franchised. As our network grows in both size and the density, we believe that we will not only achieve better economies of scale, profit margins and brand recognition, but also further crystallize our competitive differentiation.

For self-owned centers, we continue to strengthen our leadership positions in the existing five cities of Beijing, Shanghai, Guangzhou, Shenzhen and Wuxi. To expand our opportunities for future growth, we plan to enter into the city of Foshan, which is approximately 30 kilometers away from Guangzhou and with a population of 8 million people. We target to open two self-owned centers in Foshan during the fourth quarter 2017 into 2018.

By expanding our self-owned learning center networks into the cities adjacent to the existing five locations, we should be able to leverage our current management resources and capabilities to achieve the rapid expansion with the higher success rate and at a lower cost than ever before.

For franchise centers, with the aim to improve quality control, we have been deploying our management information system called COS among our franchisees. Our COS systems unifies enrollment, billing, customer contact and many other functions in the daily operations of learning centers.

By the end of Q3 2017, we have brought more than 50% of our franchise learning centers into the COS system. Our goal is to bring all of our franchisees onto the system so that we can not only share our operational standards and development initiative with them, but also obtain complete and continuous visibility into the operations of our entire learning center network.

Besides expanding our networks in Q3, we have paid close attention to the changing dynamics of our competitive landscape and taken proactive actions to further strengthen our own competitive advantage.

First, we acknowledge that competition in the online junior ELT market is intensifying. We encountered competitive pressure not only from many offline players launching their own online offerings, but also from existing online ELT players entering the junior segment of the market. For us, online offerings have always been an integral component of our efforts to enhance student learning experience and outcome.

Back in 2015, we introduced our first online product called Rise Up. In May, 2017 we also launched another online product, Can-Talk. Through Can-Talk students aged six or above received one-on-one or small class lessons from native English-speaking teachers from North America who are certified by TESL or Teaching English to Speakers of Other Languages.

Can-Talk engages students in learning-focused discussions of popular culture topics and academic test-oriented topics and thereby enhance their conversational and academic language skills.

Because we can cross sell Can-Talk to our existing students, we don't need to spend much money to market it. We expect Can-Talk to attract more interest from our students in 2018, strengthen our position in the online market and support our overall revenue growth in the long-term.

Secondly, we understand that the speed of new product launch has been accelerating and that consumers are now constantly bombarded with new product offerings. Parents face increasing difficulty in choosing among a variety of new products and thus they gravitate towards those products with well-known brands and clear value propositions.

Our RISE brand name is already well-known as the pioneer of subject-based learning in China, and we have further augmented our brand recognition by extending our Rise Up product to cover middle school students. We are now in the process of introducing high school curriculums into Rise Up and expect to launch Rise Up for high school in 2018.

In addition, during Q3, we signed a definitive agreement to acquire The Edge Learning Centers, a leading Hong Kong-based firm specializing in admission consulting to overseas boarding school and college. We believe that The Edge will be a natural extension of our current course and product offerings. The acquisition is expected to close in Q4 2017.

In summary, we have made solid progress during the third quarter of 2017 in terms of network expansion, competitive positioning, quality control and product enrichment. Going forward, we strive to continue to strengthen our competitiveness and solidify our market leadership by targeting the premium segment of the junior ELT market, leveraging our innovative subject-based learning course offerings and focusing on delivering uniform quality of service across our entire learning center network.

With that, I will turn the call to our CFO, Chelsea Wang for financial updates.

Hello, everyone. This is Chelsea Wang again. Before I start to discuss the details of our Q3 2017 financial results, I would like to reiterate that in terms of the seasonality, Q3 and the Q1 are typically strong quarters for student recruitment. During the third quarter of this year, we had an increase in collection of pre-paid tuition and fees along with a growing student enrollment. Although we paused our courses for two weeks in Q3 2017 to accommodate the summer holiday, it only deferred our revenue recognition. In addition, IPO and one-off professional expenses of RMB9.3 million have reduced the net income in the third quarter of 2017.

Now let me turn to our Q3 financial results. Please note that all numbers are denominated in RMB.

Our total revenue increased by 28.3% year over year to RMB260 million in Q3 2017 from 202.7 million in Q3 2016. On the nine-month basis, revenue increased by 34.6% year over year to RMB697.1 million. This increase was primarily attributable to an increase of RMB146.1 million in revenues from educational programs which include Rise Start, Rise On and Rise Up.

Revenues from educational programs increased by 26.4% year over year to RMB203.6 million for the quarter and by 33.6% year over year to RMB581.4 million on a nine-month basis. Such growth was primarily driven by an increase in student enrollment at our self-owned learning centers.

In the first nine months of 2017, total student enrollment increased by 38.5% year over year to 38,193. Our student retention rate improved to 70% by the end of September which is much higher than the industry average of 41%, according to Frost & Sullivan.

Year over year revenue growth from our educational programs hit its lowest point of this year in Q3, mainly because this year we decided not to make up the two weeks courses that were missed in order to accommodate the summer holiday in the third quarter. During previous years, we made up for these missed courses by adding extra courses right after the break. But it was found that doing so was difficult for students and their parents. This year, we will instead lengthen each course and the revenue for these missed courses will be recognized later. Despite the above effect in Q3 this year our revenues from educational programs still grew by 26.4% year over year because of the strong growth in our student enrollment.

Going into the fourth quarter, we expect such seasonality to dissipate and our revenue growth to recover.

Revenues from our franchise learning centers grow by 44.9% year over year to RMB31 million in Q3. Such increase was mainly driven by an increase in the recurring franchisee fees from existing franchise learning centers as well as initial fees from new and renewed franchised learning centers.

During Q3 of 2017, we added four new franchise partners and a net of 11 franchised learning centers.

Other revenues increased by 25.3% year over year to RMB25.5 million in Q3 2017, primarily due to an increase in revenues from our overseas study tour business.

Cost of revenues increased by 25.1% year over year to RMB126.8 million during Q3 2017, primarily driven by two factors -- one, an increase in teachers' compensation as a result of more teaching hours; and two, higher rental costs as a result of opening new self-owned learning centers. Because our cost of revenues grow at a lower pace than our total revenue growth, our gross margin expanded to 51.2% in Q3 2017 from 50% in Q3 last year.

Total GAAP operating expenses grow by 33.3% year over year to RMB89.8 million in Q3 2017. Adjusted operating expenses grow only by 19.5% year over year to RMB80.5 million during the quarter. Adjusted operating expenses excluded RMB9.3 million IPO and one-off professional expenses.

Selling and marketing expenses increased to RMB45 million in Q3 2017 from RMB30.4 million in Q3 last year. As a percentage of total revenue, selling and marketing expenses increased to 17.3% in Q3 this year from 15% in Q3 last year, mostly because we increased the sales and the marketing spending to expand our network of self-owned learning centers and recruit more students. Going forward, we plan to invest further in marketing and branding building, while closely monitoring the return on investment of our sales and marketing dollars.

General and administrative expenses increased by 21.2% to RMB44.8 million in Q3 2017 as compared with RMB36.9 million in Q3 last year, mostly due to IPO and one-off professional expenses. As a percentage of total revenue, G&A expenses decreased to 17.2% in Q3 this year from 18.2% in Q3 last year.

Adjusted EBITDA, which excludes the RMB9.3 million IPO and one-off professional expenses increased by 31% year over year to RMB64.8 million in Q3 2017 from RMB49.5 million in Q3 last year.

Adjusted EBITDA margin was 24.9% in the quarter as compared with 24.4% in the same period last year.

Adjusted net income grew by 33.3% to RMB35.9 million in Q3 this year from RMB26.9 million in Q3 last year. Adjusted net income excludes IPO and one-off professional expenses. Adjusted EPS was RMB0.39 in Q3 2017 as compared to 0.27 in Q3 last year.

GAAP net income in Q3 2017 was RMB26.6 million as compared with RMB26.9 million in Q3 last year. Net margin in Q3 2017 was 10.2% as compared with 13.3% in the same period of 2016.

GAAP net income per share in Q3 2017 was RMB0.3 as compared with RMB0.27 in Q3 last year. The decline in our GAAP net income and net margin were mostly attributable to an increase in our interest expenses, which was RMB5.7 million in Q3 2017 as compared with RMB1 million in Q3 2016. The higher interest expense is caused by a combination of longer interest period and an expanded loan principal to USD110 million in September 2017 from USD55 million in September, 2016.

The loan proceeds were used to pay out dividends to our shareholders, Bain Capital. In addition, we believe taking on a bank loan to establish our credit history will help us to get access to additional capital for growth if needed in the future. The bank loan also showed the company's financial discipline, stability and proper governance. We expect our leverage ratio to go below 2 by the end of 2018.

Turning to our balance sheet, as of September 30th, 2017 we had RMB764.3 million of cash and cash equivalents, restricted cash and short-term investment as compared with RMB656.7 million as of December 31, 2016. As of September 30, 2017, our deferred revenue and customer advances balance increased to [RMB800.7] (corrected by company after the call) million from RMB786.2 million at the end of June 2017 and RMB601.3 million at the end of 2016, representing a 33.1% growth over the balance at the end of 2016. Deferred revenue and customer advances mainly consisted of up-front tuition and fees from students that will be converted proportionally into revenues as we deliver our courses.

Now, let me provide you our guidance. Going into the fourth quarter of 2017, we expect our total revenue to be between RMB260 million and RMB270 million, representing a year over year growth of approximately 34.5% to 39.7%. And as we disclosed in IPO prospectus, we will incur IPO-related expenses, a Bain Capital consulting termination fee and share-based compensation for previous years in Q4 2017.

Nonetheless, we expect adjusted EBITDA margin in Q4 2017 to remain at approximately the same level as during the first nine months of 2017. This forecast reflects our current and preliminary review on the market and operational conditions which are subject to change.

This concludes our prepared remarks. Operator, we would now like to open up the call for questions from our audience. For those who would like to ask a question, please state your question in Chinese first and then in English. Operator, please proceed.

(Operator Instructions) Our first question comes from the line of Zhong Sheng from Morgan Stanley. Please ask your question.

(Spoken in Chinese). Subject to the guidance the enrollment for new learning centers (Spoken in Chinese). Thank you very much for the question. So, the first question is outlook guidance for the enrollment and the new learning centers members in Q4 and next year?

Okay. Let me answer your first question. Regarding the new enrollments for the fourth quarter, just let me give you the comments for the third quarter year to date. Our new enrollments per center per month is about [35.7]. So, for the whole year, we do think we can keep this momentum. And for the new centers -- for the whole year, we expect to open to achieve maybe 63 to 65 self-owned learning centers for this year.

Thank you. So, for next year, how many we expect the new learning centers we will have?

Yes, for next year, we expect to have 20 to 25 more new centers increase next year, so that means it's about maybe 12 to 15 new centers next year.

Yes, I see. Thank you. And so the second question is, I see that we have a really strong guidance on the EBITDA margin and non-GAAP EBITDA margin in the fourth quarter. So, given that we have -- we will have some new -- I think we will have five to seven new learning centers, can you please guide us through how we achieve the margin expansion? Thank you.

Okay. So, let me answer you this question. As look forward, there is still a lot of factors -- I mean the additional [levers] for margin improvement. I think the first one is student retention -- student retention. So, for the year-to-date -- September year-to-date, our student retention rate is 70%. That means, if we keep this percentage retention rate, it can lead to increasing student enrollment and the decreasing customer acquisition cost. That is the first one.

And for the second one, we can always improving our utilization and the maturing of existing centers which will lead rental costs as a percentage of revenues to further decline. And third is that we also can improve our operating efficiency which will lead to a decrease of our SG&A as a percentage of revenue.

Yes. Thank you very much. That's very helpful. And second question is about the sales and marketing expense in this quarter, this has been some -- as a percentage of revenue, there is an improved increase. So, I'm wondering if it's about the seasonality, about some promotional or some branding activities? So, if we look at next quarter -- fourth quarter and the full year, how do we see the trend?

Yes. So let me explain to you, for our sales and marketing expenses, it comprises several [parts]. One is general branding expenses. The second part is marketing expense, including both online and offline portions. And the third portion is selling expenses. So, for the whole year, we think we can keep very stable percentage of revenue as maybe 17% to 18%.

For Rise, I think we have very cost-efficient customer acquisition strategies because we have access to a number of offline and online marketing channels and also approximately 30% of our new enrollments come from our word of mouth -- the channel and also combined with our retention rate of 70%. So, that means our -- sales and marketing expense is very effective.

So, for the third quarter, it's a little bit higher than before because we want to recruit more student enrollment in this quarter to maintain a high achievement in the future.

Understand, thank you. So, my last question is you said that you signed a definitive agreement to acquire The Edge Learning Center. So, can you please give us more color about this acquisition? Like what the valuation, how you want to consolidate this business with our current business? Thank you.

Yes. I think the core business of Edge is admission consulting for overseas boarding school and college. So, the main purpose of this acquisition is to expand our current course and product offerings. Compared with our existing business, the deal size is very small. So, yes, the value of this acquisition is EBITDA multiple below 10 times.

(Operator Instructions) Our next question comes from the line of Thomas Chong from Credit Suisse. Please ask your question.

(Spoken in Chinese). I have three questions. The first question is about our M&A strategy. Is there any specific project that you want to (inaudible) next year? And my second question is about the fourth quarter guidance. We have the EBIDTA margin, but how about the [non-GAAP] net margin? Is there any color? And my third question is about is there any incremental expenses that we need to incur for providing better security for the students? Thanks.

(interpreted) Let me translate for Mr. Sun. For our next year's M&A strategy, the company, as disclosed in the IPO prospectus, will focus on franchise partner acquisitions. We already started the screening of some potential partners to acquire and by doing so, we believe we can fully expand our student base and also increase the company's growth in the future. (Spoken in Chinese).

Okay. For the non-GAAP margin, the color of fourth quarter, we think we can maintain a percentage of maybe 10% to 12%.

(interpreted) To answer your question about whether the safety requirement will increase our cost, we would like to share with you a few key points. The safety is not only about installed hardware but also about management of the company. First of all, during the teacher and the staff recruitments, we not only review on their academic capabilities, we also review their ethical standards by doing reference check, it's the first one.

The second one, we have a routine and periodical training for all the teachers and our staff, including Code of Ethics and Code of Conduct. We also have periodic training on safety.

On the third point, on daily operation -- for daily operations, we already have CCTV installed in our learning centers, so we don't think we need to install additional ones -- incur additional costs since we already have those equivalents. And on a weekly basis, we do review all these videos to make sure we meet the safety and [healthy] requirements.

On the fourth point, we do have a dedicated team comprised of supervisors from the branch office and other supervisors to do periodic checks in the learning centers to make sure they comply with all our requirements.

Lastly, all the school centers, we have -- we have insurance coverage to make sure there's no additional cost happens. I hope this answers your question.

Thank you. Our next question comes from the line of [Wayne Wong] from HSBC. Please ask your question.

(Spoken in Chinese). I have two quick questions. So, the first question is regarding to the future expansion strategy regarding to the self-owned and franchise learning center, maybe across different regions in China. And the second question is regarding to the current revenue contribution from the online product and do we have any like future budget and investment plan for the online product? Thank you very much.

(interpreted) For the growth of our learning network, as you probably noticed, the self-owned center, the revenue makes up the majority of our revenue and in the future, the self-owned centers still our key focus. We are going to expand self-owned learning networks through both opening new centers in 15 cities as well as expansion into new locations as we mentioned in the earnings release call. In the future, the speed of opening new centers will be around a 25% year over year. That translates into around 12 centers to 15 centers each year.

And for the franchise business, we also see the potential in this part because there are huge demands in the non-tier-one cities. In the future, we plan to open 30% to 50% -- 30 to 50 franchise centers in the next few years each year.

And regarding your second question, we just launched our online business in 2015. So, it's still a new business. The revenue contribution compared with our total revenue is not very significant.

(interpreted) (Inaudible) further comments on the online business, first of all, the company has always been pay attention to the online way of delivering our education services. A few years ago, the company started to research and develop its new online product called Rise Up. Rise Up is the U.S. middle school curriculum and majority of the curriculum is delivered online with a small offline element. By this way of blended learning, we believe it enhanced the learning result.

Also in May 2017, the company launched a new product called Can-Talk. This is one-on-one foreign teacher English training online product. And they aimed for older age group students focusing on oral English practice with foreign teachers. We do see a great interest from our parents on this product. And going forward, we believe Can-Talk can attract additional interest from our existing customers and can become a sizeable business for RISE Education.

Thank you. Our next question comes from the line of Ivy Luo from Macquarie. Please ask your question.

(Spoken in Chinese). I have three questions here. So, the first one is regarding the margin improvement as we mentioned that utilization rate has been increasing which is like decreasing our rental costs. So just wondering what utilization right now of both our self-owned centers and the franchise-modeled centers? And my second question is regarding the -- our self-owned learning centers, just want to know like what's the CapEx for us to establish each learning center? And my third question is regarding the franchised model, as we charge a recurring percentage franchise fee, I'm wondering what's the percentage at the current level, and if as we see the franchise revenue has been increasing, is there some part of it actually coming from the rising percentage? Thank you.

Okay. Let me answer your questions. The first one is about our utilization. Our current average utilization is about 50%. For mature centers, it's [above] 80%.

And your second question is about our retention rate. Again, by the end of September, our student retention rate is 70%. It's very high, compared with our market average, which is about 41%. And in the future, we even keep this kind of a student retention rate, we still can -- I mean achieve more students -- student enrollment in the future. It's your second question.

And for your third question, is CapEx investment of our new center, it's about RMB2.5 million to RMB3 million per center.

And the fourth one is about our franchise revenue. Our franchise revenue comprises three parts. The first one is up-front fee, up-front fee when we signed franchise agreement with our franchise -- with our franchise partners and when we renew the franchise agreement with them. The second one is a recurring franchise fee, which is a pre-agreed share of tuition, the fees collected by franchise partners. The third one is the revenue from the course materials we sell to the franchise partners. Three parts -- and, for the second part, the recurring one is the biggest one, which is about 80% of our total franchise revenues.

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

The question is you're talking about improving the retention rate. So, I wonder what the current renewal rate of the student enrollment? Also, for your current growth, how much does it come from ARPU increase, how much comes from the enrollment growth? That's the question. (Spoken in Chinese).

Okay. Let me answer your questions. Your first question is about retention rate. I think our -- as we mentioned before, our student retention rate is about 70%.

And the second question is about our growth, the revenue growth. This is the ASP increase. I think there are several factors that impact our revenue growth. For example, the growth of student enrollment, ASP increase and also the course arrangement of total course hours -- or total course hours. So, currently, most of our revenue increase will come from the increase on student enrollment.

Thank you. Our next question comes from the line of Nicky Ge from China Renaissance. As a reminder, please state your question in Chinese, then in English. (Inaudible), you can now ask your question. Thank you.

(Spoken in Chinese). My first question is about our revenue contribution from the top-tier cities and could management also elaborate on the revenue growth from the top-tier cities as well? And the second question is about the competition of pure online education versus our approach of online and offline combination. Thank you.

So, let me answer your first question. Regarding the revenue contribution, Beijing is the biggest city, which is about maybe between 65% and 70%. And Shanghai is the second one, which is about maybe 10 to 15%. And for Guangzhou and Shenzhen, it's below 10% for each.

(interpreted) To answer your question about how RISE online product is different from others, here's my comments. Most of the online offerings from our competitors focus on oral English practice for daily communication purpose. The online product of RISE Education differs from competitors in a few key aspects.

First, all our online offerings embrace the subject English teaching philosophy, follow a systematic and a complete curriculum rather than some random topics for pure oral English practices. Second, we combine the best of online and offline teaching by using a blended approach. We believe it enhanced the learning outcome. Third, our online flagship product, Rise Up, has a U.S. middle school curriculum. Students who finish this program can get credits from our U.S. cooperative schools. There are more than 100 of such cooperative schools in the U.S.

The students can also get exempted from taking TOEFL test in their application to these schools. During summer this year, we have around 100 students graduating from Rise Up program, 80% of students received offers from U.S. cooperative schools and around 30% of them even received a scholarship. So, these three key aspects I mentioned illustrated how RISE online offerings differ from others. I hope this answers your question.

Thank you. Our last question comes from the line of Liu Yilun from Anacole. Please ask your question.

(Spoken in Chinese). So, to briefly summarize my questions in four, the first one is unit economics on Can-Talk. The second one is on a little bit more elaboration on the business of the study tour. And the third one is on the G&A, why the recurring portion of the G&A has been substantially lower than the previous two quarters. And the fourth one is on tax rate, which has been a little bit higher than normal. So that will summarize all my four questions.

(interpreted) To answer your first question, we launched Can-Talk product this year. It's a one-on-one curriculum. We do see a lot of demand from current customers, especially in the existing student base. We plan to fully expand this product next year.

In terms of profitability, the key cost elements of this product is variable cost to teachers and we do not incur additional marketing costs because currently we cross sell this product to existing students. The margin is similar to our another online product called Rise Up.

For the overseas study tour, the positioning of this product is complementary to our in the classroom curriculum. And to emphasize, our overseas study tour is not pure travel program. We do let our students sit into our cooperating school classes so that they can experience how the students in the U.S. study. They can also make the decision whether they [truly] want to go abroad or not.

For overseas study tour, we normally can charge a much higher price to customers and this year we have around 700 students enrolled in the summer program. In terms of margin, our margin is similar to market standards. We also want to point out this is not high margin business for RISE Education. It's also a more complementary product for the existing curriculum.

Okay. Let me answer you, the third question. Our G&A expenses consist of personnel expense related to management and other employees and also some fees paid to professional parties and also rental expenses for administrative facilities. So, it's not affected by seasonality, I think.

For the nine-month period, as a percentage of revenue, the G&A expenses was about 17.3%. We do think we can have some improvement on that because we can improve our operating efficiency each year. So, if you look at the number by the end of last year, it's about 20.8%, and for the whole year we think we can have some improvement on it. And also for the next year, we also can have some improvement.

And for the tax rate, again, it is also because we have some -- one of IPO-related expense this quarter and also maybe in next quarter. It will impact our tax rate because most of our IPO-related expense happened overseas, I mean on the offshore entities. So, without this cannot impact -- we do have some [ETR] improvement year over year. By the end of last year, it's about maybe 33%. But for this year, we do think we can have some improvement on it.

Thank you. We are at end of today's conference. I would like to hand the call back to management for closing remarks. Please go ahead.

Okay. Thank you all for joining us today. We look forward to speaking with you in the coming quarters.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may all disconnect.