NaaS Technology Inc. (NAAS) Q4 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the RISE Education Fourth Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] I must advise you that this conference is being recorded today, Friday 16 of March of 2018. I would now like to hand the conference over to your first speaker today, CEO of RISE Education, Mr. Yiding Sun. 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. Management will make forward-looking statements. Thank you. Please go ahead.

[Foreign Language] Hello, everyone. We are pleased to conclude fiscal year 2017 with solid financial and operational performance in the fourth quarter. This reflects our commitment to the quality education and to delivering the best English learning experience to our students. Continuing our strong growth momentum from the last quarter, we achieved a 48.8% year-over-year increase in revenues and a 99.0% year-over-year increase in adjusted EBITDA in the fourth quarter of 2017. New student enrollment continued its healthy growth trajectory and reached 33.6 for self-owned center per month during the full year of 2017, up from 30.6 during the full year of 2016. Meanwhile, our high student retention ratio remains stable at 70% for the full year of 2017, up from 67% for the full year of 2016 and above the industry average at 41%, according to Frost & Sullivan. Our industry leading high student retention rate is a testament to our superior quality of service, high customer satisfaction and strong customer loyalty. On the expansion front, we continued to experience rising demand for junior English Learning Training or ELT services throughout China. As a result, we accelerated our pace of expansion in our self-owned learning center network in both tier 1 and lower tier cities. In 2017, we added a net of 10 self-owned learning centers, of which 6 were added during the fourth quarter. We now have a cumulative 2269 learning centers across 86 cities in China and one in Singapore [indiscernible] 64 self-owned and 206 franchised centers includes two self-owned centers and one franchised center of the Edge. During the previous earnings call, we announced our plan to expand to the city of Foshan, which is approximately 30 kilometers away from Guangzhou and contains a population of 8 million. As planned, we successfully launched our first self-owned learning center in Foshan in December 2017. In 2018, we plan to open 13 to 15 more self-owned learning centers throughout China, up from 10 in 2017. With the acquisition of the Edge learning centers in 2017, we added two self-owned centers in Hong Kong and one franchised center in Singapore. In anticipation of a future market demand, we remain committed to our expansion plans, both in our learning center network and the faculty and closely monitor the operations of newly opened centers. Now, I would like to move on to our franchised centers. In the fourth quarter, we added five franchised centers, including one franchised center of the Edge. Now, let me explain how we maintain quality and commercial success. First, to reinforce a uniform in high standard of class room teaching across all centers, we routinely monitor each franchised center for customer satisfaction and provide a mandatory annual and a periodic training to all teachers. Secondly, to bring the underperforming franchisees up to par and to calculate our high success rate among new franchisees, we regularly offer coaching sessions and share with them our insights in how to successfully manage daily operations and reach profitability. Third, to help improve the operation of our franchised centers and our management over them, we have successfully implemented our COS operating system to 90% of our franchisees by end of the year 2017. To more closely align franchisees’ interest with our own, we introduced an initiative during the previous quarter to acquire selected franchised centers and bring them into our self-owned networks. We are currently in discussion with several candidates. Now, I would like to give an update on new developments in our educational products. We continued our unwavering focus on providing uniformly high quality of education, services across our entire education network. In December 2017, we upgraded the Rise Up courseware with in depth cooperation with the high schools and the Universities of the United States. Level 3 and level 4 of our new high school courseware were launched. The new courseware is discussion based and project based, blending both online and offline offerings. It’s designed to help students seamlessly reach American high school level status so that they can be strong candidates for US universities. We expect the extended course offering to help us grow high school enrolment overtime. Now, we have extended our service offerings to the entire K-12 student groups covering students aged 3 to 18, both online and offline. The development of Can-Talk, which offers one-on-one or small-class lessons online delivered by certified native English speaking teachers is on track and we are encouraged by its operations and enrolment results so far. Going forward, we will continue to broaden and optimize our online course offering and accelerate the pace of our new courseware development. We plan to launch another two levels of courses in the next month. Finally, our branding influences further expanded by our traditional nationwide branding events in 2017. We organized our 6th annual Rise Up. We have more than 49,000 students from our self-owned learning centers and our franchised learning centers participated in the group based tournament. During the final competition of 2017, over 1.5 million video views were achieved across key online video platforms. So competitions are designed to encourage creativity, creative thinking and the presentation skills in our students as well as ability to put their ideas into practice. We also hosted our 8th Rise Star Forest Guardian Contest with our partner, WildAid, an environmental organization that focuses on reducing the demand for wildlife products. Up to now, over 46,000 students have joined the contest and also making their videos on social media platforms as compared with 32,000 in 2016. The number has been rising as registration continues. Our successful marketing and branding events not only accelerate our new student enrolment growth, but also strengthens the value of our brand. As a result, we are able to negotiate better terms with commercial real estate developers to rent prime locations for our new learning centers. Overall, we achieved solid progress in 2017. Our market is propelled by the rising demand for junior ELT services. Going forward, we would strive to maintain the steady expansion pace and the healthy economic metrics of our central network. We are confident that with our brand equity, sound business model and the development strategies, we will be able to solidify our leadership position in the junior ELT market in China. This concludes the prepared remarks of our CEO, Mr. Yiding Sun. I will now turn the call over to our CFO, Ms. Chelsea Wang, to go over our financial highlights. Chelsea, please go ahead.

Thank you, May and hello, everyone. Before I begin please note that all numbers stated are in RMB terms. In addition, as we stated in IPO prospectus, we incurred IPO related expenses and one-off expenses of 81.8 million in the fourth quarter of 2017 and that such expenses were one-off in nature. Also, upon our IPO, our employee ESOP plan became vested. And as a result, we recognized share-based compensation expenses of 95.3 million during the quarter to reflect the accumulated impact of such expenses in our pre-IPO period. Those items have reduced net income in the fourth quarter and full year of 2017 by 156.6 million and 175.9 million, considering income tax expense impact respectively. Now, let me turn to our Q4 financial results. Our total revenues increased by 40.8% year-over-year to 272.2 million from 193.3 million in the fourth quarter 2016. This increase was primarily driven by an increase of 66.7 million in revenues from educational programs. On a full year basis, our total revenues increased by 36.3% year-over-year to 969.3 million. Revenue from educational programs increased by 36.4% year-over-year to 249.7 million for the quarter and by 34.4% year-over-year to 831.1 million for the full year of 2017. This growth was primarily driven by an increase in student enrolment at our self-owned learning centers and the price increase. In the full year of 2017, total student enrollments from educational programs increased by 36.7% year-over-year to 49,451. Our student retention rate increased to 70% by the end of 2017 from 67% in 2016, which is also much higher than the industry average of 41%, according to Frost & Sullivan. Revenue from our franchised learning centers grew by 59.9% year-over-year to 17 million in Q4, 2017. This increase was mainly driven by an increase in recurring franchise fees from existing franchised learning centers as well as initial and the renewal franchise fees from new and renewed franchise learning centers. In the quarter, we added a net of four franchised learning centers. Other revenues increased to 5.4 million in Q4 2017 from 0.2 million in Q4, 2016, primarily due to an increase in revenues from The Edge, the newly acquired company located in Hong Kong. Cost of revenues increased by 39.9% year-over-year to 129.3 million during Q4, 2017, primarily driven by three factors. First, 17.1 million of cumulative share-based compensation expenses allocated to related cost of revenues. Two, an increase in teachers’ compensation as a result of more teaching hours. And three, higher total rental costs as a result of opening new self-owned learning centers. Because our cost of revenues grow at a slower pace than our total revenue growth, our adjusted gross profit for Q4 2017 was 159.9 million, up 58.6% year-over-year. Adjusted margins expanded to 58.8% in Q4 2017 from 52.2% in the same period last year. Total operating expenses for the fourth quarter of 2017 increased by 184.6 million or 211.8%, to 271.7 million as compared with 87.1 million in the same period of the prior year. Excluding the impact of IPO-related expenses, one-off expenses and the share-based compensation expenses, non-GAAP operating expenses for the fourth quarter of 2017 was 111.6 million. Selling and marketing expenses increased to 61.7 million in Q4 2017 from 44.3 million in the same period of last year. Non-GAAP operating expenses, excluding 9 million share-based compensation expenses, increased to 52.7 million. As a percentage of total revenues, non-GAAP selling and marketing expenses decreased to 19.3% in the fourth quarter of 2017 from 22.9% in the same period of 2016, mainly due to the better sales conversion rate and better brand awareness. General and administrative expenses increased to 210 million in Q4 2017, mostly due to 69.2 million in share-based compensation expenses and 81.8 million in IPO-related expenses and one-off expenses. As a percentage of total revenues, non-GAAP G&A expenses for the full year of 2017 reduced by 50 basis points to 21.7% from 22.2% in 2016. Now, let me go through our adjusted financial metrics. Adjusted EBITDA increased by 99% year-over-year to 68.1 million in Q4 2017 from 34.2 million in Q4 last year. Adjusted EBITDA margin increased to 25% in the quarter from 17.7% in the same period last year. Non-GAAP operating income grew by 253.6% year-over-year to 48.3 million in Q4 2017. Adjusted operating margin expanded to 17.7% in the quarter from 7.1% in the same period last year. Non-GAAP net income grew to 28.6 million in Q4 this year from 5.7 million in Q4 last year. Diluted non-GAAP EPS was 0.26 per ordinary share in Q4 2017 as compared with 0.08 for the same period last year. Turning to our cash flow and balance sheet, we generated 19 million positive cash flow from operating activities during Q4 this year. As of December 31, 2017, we had 1.1 billion of cash and cash equivalents, restricted cash and short-term investments as compared with 656.7 million as of December 31, 2016. As of December 31, 2017, our deferred revenue and customer advances balance increased to 812.8 million from 601.3 million at the end of 2016, representing a 35.2% growth over the balance at the end of 2016. Deferred revenue and customer advances mainly consisted of upfront tuition fees from students that will be recognized proportionally as revenues as we deliver our courses. Now, let me provide you our guidance. For the first quarter of 2018, we expect our total revenues to be between 255 million and 265 million, representing a year-over-year growth of approximately 21% to 26%. We expect adjusted EBITDA margins in Q1 2018 to be between 22% to 25%. This forecast reflects our current and preliminary views 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 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 the line of Natalie Wu from CICC.

[Foreign Language] I will translate myself in English. Thanks for taking my question and I basically have two questions. First one is regarding the competitive landscape for the online education currently. It would be great if management can share with us about the competitive landscape change recently comes by online players, especially those chased by private market. Any target about the operation metrics for your online endeavors this year would be great. Second one is regarding the upcoming upgrade in your curriculum for junior students. So just wondering how is the acceptance so far and if we look at the period enrolment till now, how should we think about the effects that could be brought by this upgrade? And also just want to get a sense about the current thoughts about the price increase plan in this year and also in the future? Thank you.

[Foreign Language] Let me translate for Mr. Sun. To answer your first question, as you correctly mentioned, there are many online English tutoring providers in the market. We have been expanding in this segment and also transforming and developing the projects. For right education, we have always put emphasis and focus on online products. Since 2015, we have launched online products across Rise Up for all the age group students, so that students can learn English in their junior spare times. Rise Up, since its launch, has received positive feedback from the parents and we do see positive investments in both our revenue and student enrolment. Chelsea will later give you some guidance on numbers. Secondly, last year, as we mentioned, during last earnings call, RISE also launched a product called Can-Talk, target students in age group of 7 to 8 years old and this is an extension to our current offline product and so that students can learn with defined contact as a supplement to their offline curriculum and studies. Based on the feedback from parents in the last quarter, we also see very, very positive feedback and we do see a lot of further growth in this product. Furthermore, for the online product, with this, it’s most useful for older students, where they grow in age, they can learn by themselves, however for small age group students in 3 to 6 years old, with the [indiscernible]. We also want to emphasize that the right curriculum is not only focused on English language skills. We also focus on other soft skills like presentation, leadership skills, team work, therefore, personal interaction offline curriculum is also very important to ensure we have achieved learning outcome.

Okay. Let me add on revenue contributions. So for Rise Up, so far, it’s about 1% of our total revenues, but we expect a higher growth in year 2018.

[Foreign Language] To answer your second question about the program upgrade, actually since 2015, we have always been upgrading our products annually and in the past, we have received positive feedback from the parents and the key focus of our product upgrade is to move some of the offline hours to online hours and supplement with online products such as online library and many other learning tools, for example, [indiscernible]. And this upgrade also is moving from offline to online, we also changed our offline curriculum to make more content. As I mentioned, the parents seem to be very positive to the upgrade and we received quite good feedback from them.

Thank you, Sun and Chelsea. Just a very quick follow-up, about the online courses, you mentioned that the revenue contribution currently is like 1%. So what’s your contribution regarding the enrollment and also if you can share with us about the retention rate so far that you have noticed for that program. And also for this year, if you wanted to develop those kind of endeavors aggressively, just want to hear about the marketing expenses related with that that you’re preparing to in fact for that online courses program. [Foreign Language] Hello

Okay. Sorry. Let me answer your question. So first, the question about the student enrollment for the Rise Up. So, the total contribution is also around maybe 1%. So for the revenue contribution, it’s about 1% to 2%. So that is your first question. And for second question, it’s about retention rate for the online product. I want to say that for our overall retention rate in year 2017 was 70%. So, much higher than the industry average. Regarding our products, I want to emphasize that most of our Rise Start and Rise On, offline products and for Rise Up, we adopt blended approach for this kind of product. That means, we combined online and offline portions and saw that encouraging. So there is no big difference on students renewal rate among those products. And for the new product, Can-Talk, it’s a pure online complementary product focused on listening our English. It is still a new product and we’re still tracking its renewal rate now.

Yes. And about the marketing expenses related with that?

I think we have overall marketing strategy for all products and for online portion, we don’t have specifically, I mean, more additional marketing strategy for online so far.

Your next question comes from the line of Sheng Zhong from Morgan Stanley.

[Foreign Language] So I have three questions. The first one is about the [indiscernible]. So can you give us a breakdown of the 2017 new learning centers by business and what the guidance of 2018? The second one is about enrolment growth. We noted that in the second half of 2017, the student enrolment growth, year-on-year growth was a little slower than the first half, [indiscernible] could be a reason, because from the price hike in the April and there are some go ahead in the second quarter, but except for that, is there any other reasons? The third question is about the regulation impact. The government announced that the private school will be in the same admission processes platform with private school and what the impact on -- and what the impact will be to the young children’s education service in the management’s views?

[Foreign Language] Thank you for your question. So in 2017, we opened 10 new centers and the centers opened in Beijing, Shanghai, Guangzhou, Shenzhen as well as Foshan. Foshan is the first -- the new city we first entered December last year. In terms of new centers growth in 2018, in terms of percentage, we have a targeted growth, the number of self-learning centers by 20% to 25%. In terms of numbers, it means 13 new centers to 15 new centers. And the centers will be opened in Beijing, Shanghai, Guangzhou, Shenzhen as well as Foshan. In terms of new center openings, it’s definitely higher growth rate compared with last year.

Okay. Let me answer your second question. So I think we kept a very good momentum on student enrollments in year 2017. The number of student enrollments increased to 49,451 by the end of last year. As we disclosed in the third quarter earnings release, the numbers of students by the end of September of year 2017 was 38,193. So very fast. That means in Q4, we also had more than 30% growth year-over-year. As a reminder, I want to emphasize that the semesters typically start in Q1 and Q3 and therefore those two quarters are peak seasons for student enrollment. Consequently, the student enrollment is weaker in Q2 and Q4 by comparison.

[Foreign Language] To answer your third question, as you mentioned, the new policy just came out. We have been closely monitoring the program implementation from the regulatory authorities. Overall, we are happy to be the continued reform in the education sector and the RISE is a company that always paid a great attention to regulatory requirements and comply with the relevant regulation. With regard to the new policy, our interpretation is that the key intention of the policy is to reduce further students into other school tutoring which is basically related to the public school curriculum and the preparation. RISE Education, as we repeatedly emphasized during the IPO and communication, we provide a skill based and [indiscernible] tutoring. Our curriculum design is based on the [indiscernible]. In addition to academic development, our courses put a great emphasis on personal development and social development, which includes self-confidence, creativity, and curiosity, project management and communication skills, leadership and team work, et cetera, et cetera. Our teaching philosophy and the curriculum are also designed to promote the holistic development of our student. Based on above understanding, we expect the new policy to bring slightly positive impact to the company in the longer-term.

[Operator Instructions] Your next question comes from the line of Thomas Chung from Credit Suisse.

[Foreign Language] My first question is about the record new contribution from tier 1 cities like Beijing, Shanghai, Guangzhou, and Shenzhen. And my second question is about the price hike for this year and my third question is about the EBITDA margin trend and finally is about the headcounts for this year versus ’17?

Okay. Let me answer your questions. So your first question is about the revenue contribution from the tier 1 cities. First of all, I think 90% of our total revenues come from the educational programs originally from the tier 1 cities and in the tier 1 cities, Beijing is still the biggest proportion, which is more than 60%. And for your second question, it’s about our ASP, price increase strategy. As we communicated before, every year, we have around maybe 3% to 5% price increase. So, we will keep the same. And for your third question, it’s about our EBITDA margin. In year 2017, our adjusted EBITDA is 25%. I think in the future, I think we can keep this kind of level towards year 2018. And for your last question, it’s about the number of employees. So by the end of year 2015, we had totally 2245 employees and in year 2017, our number of employees increased to 2754 employees, which is in line with our business growth. That is all my answers to your questions.

How we should think about this year in terms of the headcount increase?

Okay. For this year, I think it’s also I think the same. It depends on our business growth, especially for the revenue growth, we need more teachers to, I mean, support the revenue growth, to support the revenue growth. And for the G&A high count, we will keep almost stable.

[Operator Instructions] Your next question comes from the line of Wayne Wang from HSBC.

[Foreign Language] So thank you management for taking my questions. So what’s like the operating plan for the Edge in 2018 and what will be the synergy with Edge and our core business? How many learning centers Edge currently have and what’s our plan for 2018. And also it seems our operating cash flow is a little volatile in the past two quarters. So is there any seasonality reason for that phenomenon? Can management add more color on that would be very helpful?

[Foreign Language] Thanks for your question. We closed the Edge acquisition by the end of 2017. So Edge has two learning, self-owned learning centers in Hong Kong and one franchised learning center in Singapore. In the future, the company will continue to expand franchised centers in Southeast Asia countries as well as self-owned learning centers in Hong Kong. Regarding the synergy between Edge and RISE Education, Edge has a strong competitive advantage for the old age students. For RISE, as you could know, we have students in Rise Up age group. We do see a lot of synergy for the late age group, have the demand for consulting projects and program. For the second question, we will turn it to Chelsea.

Okay. Regarding the operating cash flow, it mostly depends on our student enrolments, the number of student enrolments. As we expand before, there is some enrolment, for example, the Q1 and Q3 are peak seasons for student enrolment as the new semesters are started in the two quarters. That’s why. Yeah.

Your next question comes from the line of [indiscernible] from 86Research.

[Foreign Language] Okay. I’ll translate in English. Thanks for taking my question. Two questions. First one is on the M&A strategy for franchised learning centers and second one is could management update the revenue distribution from the directly owned learning center by age group? Thank you.

[Foreign Language] To answer your first question regarding franchise partners acquisition, as we mentioned earlier, we have a plan to acquire franchise partners who have performed well. How we define perform well is they have future growth potential as well they have the potential to further improve their operation based on our self-owned centers. Currently, we have a couple of franchise partners in discussion with a possible acquisition and we will update you later when we have more concrete progress. And franchise partners is the strategic move for RISE is because the landscape and to the positive future growth. Yes. And for the second question, I would defer to Chelsea?

Okay. For the revenue contribution, the breakdown by product, I can share with you that so far, around maybe 56, around 56% of our in class students are from Rise Start and also maybe about 40% to 42% are from Rise On and other 1% or 2% from Rise Up. So, the revenue, the contribution ratio is similar to the in class student ratio.

Your next question comes from the line of Nicky Ge from China Renaissance.

[Foreign Language] My first question is about our Can-Talk. I wonder what is optimal penetration for our Can-Talk in terms of X percentage of our offline students and what’s the impact on the margins going forward? And the second question is our utilization rate of our cash flow. Thank you.

[Foreign Language] First to answer your question on online product, Can-Talk, Can-Talk was launched in 2017 and since that, we’ve seen good progress in terms of student recruitment, especially in the 7 years old group. So this year, we also have the plan to further upgrade Can-Talk to higher levels, targeting older age group. So far, the Can-Talk is only open to the students in the RISE student base. In the future, we also have the plan to open this program to non-RISE students. So we do see further growth opportunities. To answer your second question, for the existing students, we do offer them more and more products, so that besides offline curriculum, we also offer them online products like we talked online library and Can-Talk. So we also overseas study tools and added supplements products to offer to students. So at RISE, we have very loyal customer base and we have a lot of demand on different products and curriculum, but also have the plan to increase our R&D to further satisfy our customer’s demand. And for question three, I defer to Chelsea.

Okay. In terms of class room utilization rate, we measure it by the ratio of in class students divided by full capacity office centers in the year. So for a typical center, you are only content to around maybe 9 to 10 class rooms and the average capacity of a class room is about 110 students per year based on our current course arrangement. So the full capacity of a typical center is about 900 to 1000 students per year. And I want to say that average utilization rate is highly impacted by the number of new centers. So far, for our mature centers the average utilization in last year is about maybe 75% to 80%.

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