NaaS Technology Inc (NAAS) 2018 Q3 法說會逐字稿

Good morning, and good evening, everyone. Welcome to RISE Education's Third Quarter 2018 Earnings Conference Call. (Operator Instructions) This call is also being broadcast live on the company's IR website. Joining us today are Mr. Yiding Sun, CEO; Ms. Jiandong Lu, COO; Ms. Chelsea Wang, CFO of RISE Education; and Jack Wang, Senior Associate of ICR. Following management's prepared remarks, we will conduct the question-and-answer 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 am now turning the call over to Mr. Yiding Sun, CEO of RISE Education. Please go ahead, sir.

(foreign language)

Thank you, sir. Hello, everyone. This is Jack Wang, and I will translate for Mr. Sun.

Before I start reviewing our third quarter results, please allow me to introduce our Chief Operating Officer, Ms. Jiandong Lu. Ms. Lu served as our independent director from our successful listing on the NASDAQ Global Select Market in October 2017, until being appointed as our Chief Operating Officer on September 28, 2018.

Prior to joining us, Ms. Lu was an investment banker with JPMorgan where she held several senior executive positions and gained tremendous management experience overseeing the daily operations of the business. I am confident that her capital market expertise, her management experience and her leadership will be a great asset for our future expansion.

Now I will turn the call over to Ms. Lu to speak on behalf of Mr. Sun. Please go ahead, ma'am.

Thank you, Jack. This is Ms. Jiandong Lu. I apologize for losing my voice. I'm now speaking on behalf of our CEO, Mr. Yiding Sun.

During the third quarter of 2018, we continued our strong growth trajectory. Our total revenues grew by 33.6% year-over-year to RMB 347.4 million. Our educational programs remained our primary growth driver, and revenue generated from educational programs grew by 32.8% year-over-year to RMB 270.3 million.

During the third quarter, we opened 38 new learning centers, including 4 self-owned learning centers and 34 franchised centers, bringing the total number of our learning centers to 345 in our total network, including 72 self-owned learning centers, 2 of which are from Edge, and 273 franchised centers. As a result, we have added a total of 42 classrooms in our self-owned learning centers. Our student's retention rate remained high at 71% during the third quarter.

As we continue to execute our growth strategy, we have encountered some challenges in the marketplace, including tightening regulations in the education sector, increasing competition, more stringent fire safety code on commercial buildings and softened consumer spending in the PRC.

Such challenges slowed down the growth rate of our student's enrollment compared to the same period of previous year, while the total student enrollment at our self-owned learning centers and online courses increased by 26% year-over-year to 14,702, including the enrollments for short-term courses. Despite these temporary challenges, we are confident that RISE Education is well positioned to continue to lead the Chinese junior ELT market and enjoy healthy growth in the foreseeable future.

First, in the first half of this year, the Chinese government issued a series of new regulations to reduce students' after-school workload. Such regulations targeted school-aged children and test-preparation tutoring services. Since about 75% of our students are preschool children and because our education courses are more geared towards building soft skills and capabilities instead of test preparation, we are less impacted by the tightened regulation.

However, as the industry adapts to the new regulations, many test prep-orientated service providers in China are now shifting their demographic focus from school-aged to preschool children. The intensifying competition in the ELT market has escalated the marketing channel cost during the quarter. We have also adjusted our promotion strategies by increasing our investments in marketing. The junior ELT market has a unique set of characteristics which makes it difficult to new entrants to grasp within a short period of time. RISE Education has over 10 years of successful operations, a premium and trusted brand and a large trusted repository of high quality course materials in China's junior ELT industry. Therefore, we do think the new regulations will have a material or lasting impact on RISE operations.

Second, local government agencies have recently imposed a more stringent fire safety code of commercial buildings. As our learning centers rent the premises at commercial buildings such as shopping malls, it has taken longer time for our landlords to meet the more stringent fire safety codes. Therefore, we are unable to open new learning centers as fast as we scheduled earlier this year. We are now more mindful of the fire safety standards when selecting our landlords but also working closely with our landlord to meet the requirements under the fire safety code as quickly as possible. As of now, the opening of our new learning centers has been slightly behind our original schedule, and we will be 2 centers short of what was originally planned by the end of 2018.

Third, our business has been partially affected by the softened consumer spending amidst in the escalating trade war. However, the impact of the trade war has been mostly on discretionary spending such as overseas travel and new vehicle purchases. In contrast, Chinese parents have always regarded their children's education as a nondiscretionary investment. Industry studies have also shown that among all subjects, spending on English education is the most resilient to economic downturns, more so than spending on math, science and other subjects. Above all, we believe consumers tend to focus more their efforts on the brands that they trust amidst the market uncertainties.

On August 25, we successfully concluded the seventh RISE Cup competition. During the final round, 50 finalists out of more than 55,000 registered participants showcased soft skills, including communication, collaboration, teamwork and leadership to the audience of more than 2,000 people. This year's RISE Cup was a tremendous success, setting a new record in the company's history. This achievement demonstrates our significant brand influence as well as the recognition and the trust from our customers. In a recent survey conducted by DDC, an international STEM program provider, RISE is ranked as the #1 brand among the top 10 ELT providers in China based on our course curriculum, class style, education materials, teacher background and quality of service.

Our well-known brand has also manifested in our consistently high student retention rate. Our student retention rate remained high at above 70%, that is to say our students typically stay with RISE for a long time, in many cases, a minimum of 3 years once the students are enrolled into our educational program. With our ability to retain students and cross-sell our new programs, we believe the long lifetime value of our students is actually increasing, despite our increased upfront investment in student acquisition.

The high student retention rate has been one of our key competitive advantages. Even so, we are constantly working to further improve it. In an environment where competition and regulation intensify day by day, we focus our attention on further enhancing our consumer service and improving our management efficiency while expanding our business through building our learning platform such as Homeschool Connectand [After-School Homework] will enable to closely monitor our student's learning outcomes and to further improve our communications with parents in order to improve our customer satisfaction.

We are also reinforcing our teachers' training and optimizing our teachers' compensation structure to raise teacher satisfaction and to lower our teachers' turnover rate. At the same time, we are improving our operations system and our accounting management systems in order to improve our management efficiency and better control our operational risks. We'll use technology to empower our educational services, our teachers and our operations. As one of our growth strategies, we continue to evaluate our franchised centers for consolidation. I'm very pleased to report that recently, we signed an agreement with our existing franchise partner in Shijiazhuang, pursuant to which, we will purchase from her 51% of equity interest in all the 5 learning centers in Shijiazhuang. These 5 learning centers have approximately 3,500 students in total.

Shijiazhuang is a very attractive market for us as RISE is already the #1 junior ELT provider in the Shijiazhuang market in terms of market share. We see continued opportunities to increase student enrollment as well as the course prices. We believe this is a testament to RISE's ability to continue to roll up existing franchised centers. In addition to franchised center acquisition, we are evaluating other potential acquisition opportunities, which may be complementary to our service offering, student demographics and teaching philosophy.

Looking forward, we believe that the market demand for junior English teaching training will remain strong because of Chinese parents' unwavering commitment to their children's education. In order to fully capitalize on such market opportunities, we will continue investing in sales and marketing to attract the new students while enhancing our services to retain existing students.

Our strong profitability, positive cash flow and sufficient cash reserve afford us with ample firepower to invest for our long-term and sustainable success. To demonstrate our strong conviction towards our long-term success, we have put a plan in place to buy back up to USD 30 million worth of ADS during the next 12 months. We believe our core competencies will enable us to thrive in any market condition.

This concludes the remarks of our CEO, Mr. Yiding Sun. I will now turn the call over to our CFO, Ms. Chelsea Wang, to go through our financial highlights. Chelsea, please go ahead.

Thank you, Jiandong, and hello, everyone. Before I begin, please note that all numbers stated are in RMB terms.

In the third quarter of 2018, our total revenues increased by 33.6% year-over-year to CNY 347.4 million from CNY 260 million in the same period last year. The increase was driven by a 32.8% year-over-year increase in revenues from our educational programs, which increased to CNY 270.3 million in the third quarter of 2018. Such growth was primarily attributable to our industry leading retention rate which increased to 71% this quarter from 70% in the same period last year. The strong expansion of our self-owned learning center network also contributed to our strong financial performance this quarter.

Franchise revenues increased by 15% year-over-year to CNY 35.6 million in the third quarter of 2018 despite the impact on revenue due to the adoption of ASC 606. The increase is primarily attributable to the steady growth of recurring franchise fees, an increase in the number of franchised learning centers, which totaled 273 as of the end of September 2018 compared to 201 by the end of September 2017.

Other revenues increased to CNY 41.5 million in the third quarter of 2018, up 63% year-over-year from CNY 25.5 million in the same period last year, primarily due to the revenue contributions from The Edge and our study tour programs.

Gross profit for the third quarter of 2018 increased by 37.8% year-over-year to CNY 183.5 million. Gross margin improved to 52.8% during the third quarter of 2018 compared with 51.2% in the same period last year.

Selling and marketing expenses for the third quarter of 2018 were CNY 77.5 million or 22.3% of total revenue compared with CNY 45 million or 17.3% of our total revenues in the same period last year. The growth of our selling and marketing expenses was mainly driven by the increases in our marketing channel expenses as we expanded our network of self-owned learning centers and increased our student enrollment.

General and administrative expenses for the third quarter of 2018 were CNY 57.8 million or 15.6% of total revenues compared with CNY 44.8 million or 17.2% of our total revenues in the same period last year. The increase in our general and administrative expenses was primarily due to higher personnel costs and office expenses as a result of our business expansion.

Our operating income for the third quarter of 2018 increased by 11% year-over-year to CNY 48.2 million. Operating margin for the third quarter of 2018 decreased to 13.9% from 16.7% in the same period last year mainly due to the increase in our selling and marketing expenses.

Our non-GAAP operating income for the third quarter of 2018 was CNY 50.6 million, and our non-GAAP operating margin for the third quarter of 2018 was 14.6%.

Adjusted EBITDA for the third quarter of 2018 remained stable at CNY 64.8 million compared with the same period last year. Adjusted EBITDA margin decreased to 18.7% from 24.9% in the same period last year, mainly due to the increase in our sales and marketing expenses.

Net income attributable to RISE for the third quarter of 2018 increased by 9.9% year-over-year to CNY 32.9 million from CNY 29.9 million in the same period last year. Non-GAAP net income attributable to RISE was CNY 35.3 million, and non-GAAP net margin was 10.2% for the third quarter of 2018.

Basic and diluted net income attributable to RISE per ADS were both CNY 0.57 for the third quarter of 2018. Basic and diluted non-GAAP net income attributable to RISE per ADS was CNY 0.62 and CNY 0.61, respectively, for the third quarter of 2018.

Turning to our cash flow in the balance sheet. We generated CNY 74.7 million positive cash flow from operating activities for the third quarter of 2018 compared with CNY 75.5 million in the same period of the prior year. The slight decrease was mainly attributable to an increase in operational costs and rental deposit as we opened more new self-owned learning centers. As of September 30, 2018, we had cash, cash equivalents, restricted cash, short-term investments and loan receivable of RMB 1,299.6 million compared with RMB 1,084.9 million as of December 31, 2017.

As of September 30, 2018, total deferred revenue and the customer advances balance increased by 27.1% to CNY 1.03 billion from CNY 812.8 million at the end of 2017. This increase was primarily driven by higher pre-paid tuition and fees from our rising level of student enrollment, partially offset by recognized revenue as our courses were delivered.

Now let me provide you with our guidance. For the fourth quarter of 2018, we expect our total revenues to be between CNY 345 million and CNY 350 million, representing a year-over-year growth of approximately 28%. At the same time, please note that with our plans to increase our marketing spending, we expect our full year EBITDA margins, adjusted EBITDA margins to be between 22.5% to 23.5%. This forecast reflects our current and preliminary view on the markets and operational conditions which are subject to change.

This concludes our 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) Your first question comes from Melissa Chen from China Renaissance.

(foreign language) I will translate for myself. So I'm calling on behalf of Nicky Ge, our analyst. We have 2 questions actually. So first of all, about the regulation. So I'm just wondering whether the regulation tone -- or the government tone has changed so far, specifically on the most recent regulatory change from the General State Council. And the second question is about the sales and marketing. So as mentioned here before, the total guidance for the sales and marketing expense is going to be stable compared to last year. So I'm wondering, will there be any change about the guidance? And what's our guidance for next year?

(foreign language)

Let me answer Mr. Sun's answer to your question. Your first question is in regard to the policies issued by the government recently on the kindergartens. I would say the policy is not related to our business. Although we focus on the age group between 3 to 6 demographics, we provide only after-school English training. So although we see some fluctuation in the market, I will say it has nothing to do with our business.

Okay, let me answer your second question. So regarding the sales and the marketing expense as a percentage of revenue, it will be increased by 2% compared with the year 2017. As we explained in second quarter earnings release call, we decided to invest the marketing spending to drive more student enrollment. So it is a long-term strategy. We believe we will reach our return on earnings -- return on investment in the future. Thank you.

Your next question comes from Alex Xie from Credit Suisse.

(foreign language) So I'll translate the questions for myself. Firstly, I would like to ask management about our short-term courses. What are the enrollment numbers for short-term courses online and offline? And secondly, I'd like to ask about our margin guidance. Is the margin guidance more due to regulation pressure or competition pressure? What lines are mostly affected? And my third question is about regulation for the 3 months prepayments. I have seen many news about regulation checks on the rule in the -- by the local governments and how RISE is going to respond to such new regulation?

(foreign language)

Thank you very much for your question. Let me first answer your first question with regard to our short-term courses. I will just say that we have made pretty good progress on this program. It is the first time for RISE to launch summer short-term courses, and we have recruited a total of approximately 4,000 students. Some of them are from RISE programs and some of them are from outside of RISE. And we tried to convert some of the outside students to enroll into RISE educational programs. I will just say that this first time effort has been pretty much paid off reasonably well. It's going to help us to recruit -- continue to recruit students from the market.

(foreign language)

Okay, with regard to your question on the impact of the new policy on RISE operations, I will then analyze it from the following aspects. It's true that since the announcement of the State Council Number 80 Circular, which regulates the overall education industry, RISE, itself, started -- worked very hard to comply with whatever is required by the new policies. As a matter of fact, the new policy targets to further regulate the market and to improve the overall education service. I will just say that it is in line with the RISE Education objective and education philosophy. With regard to the 3-month charge, I think that in our franchised learning centers like in Suzhou and Zhejiang, the implementation efforts is really, from the government, is very serious. We can also see Beijing government also started to investigate the learning centers -- I mean, the overall market, and just has started to put it on top agenda, government agenda. In response to the policy of charging customers no more than 3 months, on one hand, we improved our IT systems to make it compliant with government policies. In terms of the business operation, since our curriculum is 1 year mostly, so we sign the contract with our customers, sign a 1-year contract with our customers. The payment is just divided in 3 installments to make sure each installment covers no more than 3 months. The second policy is about the fire safety code. As I stated in my speech, it is becoming increasingly rigid, which has somewhat delayed our efforts in opening new learning centers. Therefore, we are very mindful of the more rigid fire safety code and when we select the landlords, first to make sure that the landlords are in for compliance so that it won't affect so much our speed of opening new stores. And to be very honest, it's true, it has, as I've stated, our speed of opening new learning centers is slightly behind our schedule. The third policy with regard to the teacher certificate, well, I would say, since the IPO of RISE on NASDAQ, we have made increased efforts to comply with regulations -- various regulations. We put compliance as top of our agenda. In general, I will say the policy impact on RISE's business is insignificant.

(foreign language)

So last, I want to emphasize, all these policies has impact obviously in short term, but in the long run, I don't think it's going to be a lasting or material. I don't think it's going to be a material or a lasting impact on our operations.

(foreign language) A quick follow-up about teaching licenses. In my understanding, RISE is not -- it is not mandatory for RISE teachers to have teaching licenses because RISE is not a test-oriented teaching provider. Has RISE already received some instructions from the government to obtain teaching licenses? And how much of RISE teachers have obtained such licenses?

(foreign language)

Thank you, Alex. You're right, we are not a test-oriented, subject-based education institution. So far, we haven't got any notice from the government requiring our students to have the certificate in order to start their education in classrooms. However, we have set a very high bar for ourselves in order to comply with government policies and also improve the quality of teaching. We have restructured our teachers' compensation. Part of that is to reward the teachers who get a teacher certificate. So it's a measure of encouragement of our teachers to take -- of course, take the test and to get the certificate.

Your next question comes from Felix Liu from UBS.

(foreign language) Let me translate myself. So the quarter's GPM is a bright spot. The rental percentage as a percentage of sales is declining year-on-year. But given the higher standards on fire safety, is this low level of rental expenses sustainable in the mid to long term? And second question, can management provide some breakdown on the Can-Talk enrollment and the enrollment from RISE Start? And my third question is that, we know the company ran a lot of promotion in the summer, and the summer, we recorded 4,000 short-term enrollment. So if we exclude that, long-term enrollment is largely flat year-on-year. So how does management think of this going forward?

(foreign language)

Thank you for your question. Let me answer your first and the third question and leave the second one to Chelsea. In expanding our business, we actually impose pretty strict control on the rental expenses, as you can see reflected in our gross margin. As you mentioned that fire safety code implementation has becoming increasingly rigid, stringent. It's not going to affect our rentals, but more of the approval process since most of our learning centers are located in the shopping malls which basically are in compliance with the fire safety code meet the governmental requirement. However, in opening new learning centers, the approval process has already been extended. Part of the reason is the regulator for fire safety has been transferred from the armed police to emergency management department. So in process of the transition, many application has been slowed down. So that effect of the speed of getting approvals, as a result, it affects the opening of -- the speed of opening up our new learning centers.

(foreign language)

On your third question, we have good reservation. We started our summer courses this summer on a pilot basis, which turned out to be a good success. We managed to convert some outside students to enroll into RISE educational program. So we'll continue our tryout for our programs to be launched in summer and also winter vacation as a new channel of recruiting new students. We do feel the increasing competition in our market, and I would say the market is more crowded than before. However, RISE does not rely on a single marketing channel to enroll students, and we also changed our marketing strategy and also promotion strategy and to develop the new channels to recruit more students in the future.

Yes, so for online business, actually, the RISE online business includes Rise Up and Can-Talk. Can-Talk is a new product launched in the middle of last year. So by the end of September this year, around maybe 13% of our new enrollments come from online business. It was just -- we're seeing far below the 10% last year.

And any color on the enrollment contribution from RISE Start, our core business?

So you mean RISE Start? So for Rise Start is our core business. Yes, for the new enrollments, we've maintained about maybe 60%, 60% to 61%.

Your next question comes from Sheng Zhong from Morgan Stanley.

(foreign language) So I'll translate myself. Considering all these pressure from the competition and the regulation, so what the management's outlook for the growth plan in next year?

(foreign language)

Thank you very much, Sheng Zhong. So let me answer your question in the following 2 aspects. That currently, our regulatory environment where government policies cause uncertainties in the market as a whole, we have somewhat modified our growth strategy for next year. We're going to adopt a prudent growth strategy. However, we believe the uncertainties caused by government policies and also the increasing competition from -- the increasing competition will be short term. Generally, the market demand is -- remains strong and resilient, and we believe the market will recover. In terms of the prudent growth -- to be more specific on our prudent growth strategy, we are going to slow down the pace of opening up our self-owned learning centers. However, this can be compensated -- made up for by our efforts in acquiring of franchised learning centers. Acquisition of Shijiazhuang is a good example. Shijiazhuang franchisee has a good reputation, has good market share in Shijiazhuang. It is an attractive market. It is also located close to Beijing and easy to manage by our head office. So acquisition of franchised partners will be one of our key growth strategies next year. In expanding our operations in a prudent manner next year, we also will focus on the services. Our objective is to focus our brand building word-of-mouth by the parents to further increase our enrollment. So we actually -- the focus of our next year will be our services. The service we'll target to our customers. And as I have mentioned that we are building -- the parent communications will improve. Through our platform, we increase our communications with the parents so as to improve the customer satisfaction. We also tried to reinforce training management of our teachers so that they can have a better -- well, to improve the teacher satisfaction and to lower the turnover rate. Meanwhile, we are going to improve our ITC systems as well. We're going to improve our operating systems, COS, as well as accounting systems and to further improve our management efficiency.

Thank you for the questions. Ladies and gentlemen, we have reached the end of our conference call. Thank you for participating. You may all disconnect.