NaaS Technology Inc. (NAAS) Q2 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the RISE Education Second Quarter 2019 Earnings Call. [Operator Instructions] I must advise you that this conference is being recorded today, Friday, the 16th of August 2019. I would now like to hand the conference over to your first speaker today. Ms. Mei Li. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and welcome to RISE Education's Second Quarter 2019 Earnings Conference Call. Today, you will hear from Mr. Sun Yiding CEO, who will give you an overview of the company's strategy and recent developments, followed by Ms. Lu Jiandong, our COO and CFO, who will go over our financial results in more detail. Before we proceed, I would like to remind you that this discussion may contain certain forward looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. To understand the factors that could cause results to materially differ from those in the forward-looking statements, please refer to our Form 20-F filed with the SEC on April 19, 2019. We do not assume any obligation to update any forward-looking statements, except as required under applicable law. At this point, I'd like to turn the call over to Mr. Sun Yiding. Please go ahead.

[Foreign Language]

Thank you. I will read through Mr. Sun's prepared remarks. I'm pleased with our performance during the quarter and the adaptability of our team as we continue to enhance our operations in a rapidly changing environment. Revenues came in at RMB 367.1 million, an increase of 22.3% year-over-year. Adjusted EBITDA margin came in higher than our expectations at 24.2% during the quarter. This result demonstrated the effectiveness of our continued efforts to drive strong revenue growth while generating healthy margins. The student enrollment we disclose are composed of registration of new students and the retention of existing ones. Total student enrollments during the quarter were 10,106. But this number isn't directly comparable to the same period of last year. This is primarily because on a city-by-city basis, we are not allowed to charge our students to pay tuition fees for the next level of course until they complete the existing one. We have quickly adjusted our sales strategy to accommodate to the new tuition fee collection schedule, which breaks down our standard quarter into 3 or 4 installments throughout the period since the new collection schedules began being implemented in December 2018 in Beijing and Wuxi. Additionally, we have been gradually canceling full-day courses primarily in Beijing to comply with the implementation of local government requirements. Our quarterly retention rate remained stable and increased slightly to 72% compared with 71% during the same period of last year. This highlights the strong trust parents continue to place in us and the student stickiness to our high-quality courses. In the coming quarters, we will continue to work to improve our effectiveness in growing new student enrollments and consolidating our high retention rate. We continue to execute the expansion plan for our learning center network. We remain on track to add 11 new self-owned learning centers and 50 to 60 franchised learning centers throughout the year. During the quarter, we added 2 self-owned learning centers with a total of 173 classrooms. The new learning centers are located in Beijing and Foshan and we added 11 franchised learning centers in Hangzhou, Hefei, Kunming, Nanchang, Zhanjiang, Changchun, Zhongshan and Ganzhou. We will consolidate the Shijiazhuang franchise business in the third quarter of 2019, which will add 7 learning centers to our self-owned learning center network. We are currently also in talks with a number of potential acquisition targets, which I look forward to updating you when appropriate. Rise now has a nationwide franchise network of 328 learning centers in 126 cities. Selective acquisition of our franchise learning centers will accelerate our business growth and cement RISE footprint nationwide. In July, we made a minority investment in New York City Kids Club or NYC Kids Club, a respected early childhood education brand. This investment represents one of our many initiatives to extend our business lines and expand our reach to potential students at an earlier stage. Operating in a sector that benefits from the favorable government policies, NYC Kids Club now has over 140 self-owned and franchised learning centers in China. With over 80% of their classes taught in English, we believe our courses are an easy fit for parents who want to continue their kids' education in English as they grow older. Our beginner courses can easily be integrated with NYC Kids Club's early education courses and make for an easy transition. NYC Kids Club's educational philosophy, geographic markets, operational model and product mix are highly complementary with ours and will create significant opportunities for us to cross-sell our courses. Having completed our investments, our focus now is on developing efficient approaches to acquiring students above the age of 3 and converting them into long-term RISE students. I'm excited about the enormous potential this strategic partnership brings to our business, and I look forward to working closely with them. While not our primary focus, we will continue to carefully assess any investment opportunity that arises to expand or diversify our business in a meaningful way. We continue to invest in our core competitiveness. In addition to content development to expand product offerings and strengthen our competitive advantage, we began upgrading our demo course for K1 students, the first major entry-level course we offer, during the second quarter with new high-tech tools to make kids more interactive and engaging when they enter our classroom for the first time and make the demo course more attractive to prospective students. We also continue to roll out new updates for RISE plus, our in-house developed online platform that offers after-class learning experience and facilitates parent supervision and provides an efficient communication between our teachers, parents and the students. RISE Plus now offers short course learning modules that cater to students' unique learning patterns and include phonics and logical thinking courses for younger students as well as courses to improve English language comprehension and test preparation for middle and high school students. On the people side, we introduced a new incentives for sales staff in June 2019 and are in the final preparation to roll out additional performance-based rewards for teachers in September. These rewards and incentives were designed to improve teacher retention, drive new student acquisition, increase retention of existing students and improve efficiency going forward. These rewards have immediately reduced sales staff turnover and improved our employee morale. Incentive-related expenses are expected to be around RMB17 million for full year 2019. We believe that by reducing teacher turnover rates and increasing employee efficiency, we will eventually benefit from this investment in our staff. We will soon complete the eighth RISE Cup competition which is an annual nationwide English language project competition we host as part of our marketing and branding efforts, where student participants are encouraged to complete certain assignments through teamwork in a fun manner. Over 61,000 students from our self-owned and franchised learning centers have signed up this year, an increase of 11% over last year. The event received extensive media coverage from outlets such as Tencent News, NeaEase News, Youth.cn and the YNET. Our annual RISE Cup event is a chance for students to demonstrate the progress that they have made with our courses and provides us with an opportunity to showcase our educational philosophy to potential customers and increase word-of-mouth referral. We continue to invest in marketing channels in a controlled and targeted manner to further increase new student enrollments. We rigorously evaluate all online and off-line marketing channels on a frequent basis to rapidly adjust them when needed and ensure they are targeted, effective and have the proper amount of resources allocated. We will continue to work hard on developing new online and offline marketing opportunities that generate a solid return on investment and increase our conversion rates. In conclusion, I'm pleased with the efforts we made during the quarter. Our focus is on building this business for the long term, and our strategy is ideally positioning us to do so. We will continue to solidify our leading position in the market by devoting resources towards expanding our geographic network, accelerating and diversifying our businesses through strategic investments and acquisitions, strengthening the reach and influence of our highly-respected brands and leveraging technology to enhance product offerings and operational efficiency. We offer a unique value proposition to both parents and students with our unwavering focus on improving the learning experience. I am confident we will capture substantial growth opportunities that this sector continues to generate and deliver long-term value for our shareholders. This concludes the remarks of our CEO, Mr. Sun Yiding. I will now turn the call over to our COO and CFO, Ms. Lu Jiandong, to go through our financial highlights. Ms. Lu, please go ahead.

Thank you, Mei. Hello, everyone. Now I would like to go through our financial highlights for the second quarter of 2019. Before I begin, please note that all numbers are stated in RMB. In the second quarter of 2019, our total revenues increased by 22.3% year-over-year to RMB 367.1 million. This was mainly driven by a 22.8% year-over-year increase in revenues from our educational programs to RMB 324.9 million. The increase in revenues from our educational programs was primarily attributable to an increase in the number of students in class for our regular courses, operated by self-owned learning centers and increase in prices for our regular courses. The number of our self-owned learning centers increased to 80 as of June 30, 2019 from 68 as of June 30 of last year. We added 173 classrooms as of June 30, 2019, compared to the same period last year. Franchise revenues increased by 19.9% year-over-year to RMB 39.8 million in the second quarter of 2019. The increase was primarily attributable to an increase in one-time franchise fees and recurring franchise fees associated with an increase in the number of franchised learning centers from 2013 [ph], as of June 30, 2018, to 328 as of June 30, 2019. Other revenues for the second quarter of 2019 decreased by 5.3% year-over-year to RMB 2.4 million. Cost of revenues for the second quarter of 2019 increased to RMB 160.4 million by 17.2% compared to the same period of last year. Non-GAAP cost of revenues for the second quarter of 2019 increased by 16.2% to RMB 155.2 million. The increase was primarily due to an increase in rental costs associated with our expanding operations and personnel costs associated with an increase in teacher headcount and total teaching hours at our self-owned learning centers. We expect incentive-related teacher costs to be approximately RMB13 million throughout the second half of the year. Gross profit for the second quarter of 2019 increased by 26.5% year-over-year to RMB206.6 million. Gross margin improved to 56.3% during the second quarter of 2019 compared with 54.4% in the same period last year. Selling and marketing expenses for the second quarter of 2019 was RMB70.7 million, an increase of 41% year-over-year from RMB50.2 million. The increase was primarily due to an increase in the marketing channel expenses and personnel costs associated with our expanding network of self-owned learning centers. Non-GAAP selling and marketing expenses during the same period of 2019 increased by 43.2% year-over-year to RMB69.8 million. As a percentage of revenue, non-GAAP selling and marketing expenses remained well under control coming in at 19%, an increase from 16.2% during the same period last year, in line with our expectations and below levels we saw during the second quarter of last year when selling and marketing investments accelerated. We're investing in selling and marketing now to drive new student enrollment going forward, which will result in a short term pressure but will drive long-term growth. Non-GAAP selling and marketing expenses as a percentage of revenue for full year 2019 is expected to increase by roughly 1% over 2018. We expect incentive-related expenses for sales staff to be approximately RMB4 million in the second half of the year. General and administrative expenses for the second quarter of 2019 were RMB92.6 million, an increase of 66.8% year-over-year from RMB55.5 million. The increase was mainly attributable to increased share-based compensation expenses associated with new option grants, an increase in personnel costs associated with our expanding business and additional professional fees related to acquisition and strategy development. Non-GAAP general administrative expenses for the second quarter of 2019 increased by 22.2% year-over-year to RMB65.3 million. Our operating income for the second quarter of 2019 was RMB43.3 million. Excluding the impact of share-based compensation expenses and amortization of certain intangible assets acquired as part of the 2013 acquisition, non-GAAP operating income for the second quarter of 2019 increased by 19% year-over-year to RMB76.8 million. Non-GAAP operating margin in the second quarter of 2019 was 20.9% compared to 21.5% for the same period last year. Adjusted EBITDA during the second quarter of 2019 was RMB89 million, an increase of 17.8% from RMB75.5 million in the same period last year. Our adjusted EBITDA margin was 24.2% in the second quarter of 2019 compared with 25.1% for the same period last year. Adjusted EBITDA during the second quarter of 2019 was RMB89 million, an increase of 17.8% from RMB75.5 million in the same period last year. Our adjusted EBITDA margin was 24.2% in the second quarter of 2019 compared with 25.1% a year ago. We will continue to invest in our core assets to strengthen our long-term growth trajectory. This includes the approved new salary structure and incentive scheme for teachers and sales staff. This is expected to reduce full year 2019 adjusted EBITDA margin by approximately 1%. As these investments take hold and efficiency improves, we expect this impact to be short-term and to positively contribute to our long-term margins. Income tax expenses for the second quarter of 2019 was RMB19.2 million compared with RMB15.7 million in the same period of last year. The increase was mainly due to a non-deductible share-based compensation expenses recognized during the second quarter of 2019. Net income attributable to RISE for the second quarter of 2019 was RMB21.2 million, a decrease of 50.3% year-over-year. Non-GAAP net income attributable to RISE for the second quarter of 2019 was RMB54.8 million, an increase of 10.4% year-over-year. Non-GAAP net margin attributable to RISE was 14.9% for the quarter compared with 16.5% in the same period last year. Basic and diluted net income attributable to RISE per ADS were both RMB0.37 for the second quarter of 2019. Basic and diluted non-GAAP net income attributable to RISE per ADS were RMB0.97 and RMB0.95, respectively, for the second quarter of 2019. Turning to our cash flow performance. We generated RMB129.2 million negative cash flow from operating activities during the second quarter of 2019 compared with positive RMB34.4 million in the same period of the prior year. The decrease was mainly attributable to the change in the tuition collection schedule to comply with certain regulatory requirements. As of June 30, 2019, the company had combined cash and cash equivalents, restricted cash, short-term investments and loans to a related party of RMB1,134.7 million compared with RMB1,316.8 million as of December 31, 2018. As of June 30, 2019, total deferred revenue and customer advances were RMB830.7 million, representing a decrease of 20% from RMB1,038.8 million as of December 31, 2018. The decrease was primarily due to the change in tuition collection schedule. Now let me provide you with our 2019 guidance. For the third quarter of 2019, we expect our total revenues to be in the range of RMB 410 million to RMB 417 million, representing a year-over-year growth of approximately 18% to 20%. This estimate takes into consideration the impact of the canceled full day courses in highly regulated districts and the impact of following changes to the collection schedule for tuition to comply with the implementation of local government requirements. The temporary impact has not affected our long-term growth strategy. The forecast reflects our current and preliminary view 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 go ahead.

[Operator Instructions] Your first question comes from the line of Alex Xie from Crédit Suisse.

So I understand that you have mentioned the enrollment is not completely comparable to the last year. But then maybe I'll ask in a different way. So what are our expectations, say, for the full year growth, organic growth, in this year? And also, what measures have we taken, say, to accelerate our student enrollment growth and meet challenging market conditions?

Okay. Alex, again, please state your questions in Chinese, please.

[Foreign Language]

[Foreign Language]

First, let me answer your first question. Yes, after we changed the collection schedule for tuition fees to comply with government requirements, we see in the sector, a lot of educational players that have seen the impact. But right now, we feel that we have already adjusted our operation to the normal pace and our operation activities are back to normal. We think that competition in the sector persists always but the regulation increased the entry barrier of the sector, which benefits the healthy growth of the whole sector. And for some time, we have already seen some smaller players who do not have good qualifications and teachers who do not meet the requirement of the qualification and a teacher certificate they are out of the market right now. So we feel that gradually the competition in this sector is eased. And second point is, right now, we are trying to improve our operation, and we are also working, we're putting more efforts to improve our service. As I mentioned previously that 2019 is a year of our service. Our goal is to improve our product offering and service in this year. We hope that our efforts will continue to improve the sales lead conversion rate and improve the word of mouth referral for our business. And third point is we also work out plans to improve the compensation packages for our sales team and the teacher team. As I mentioned in the prepared remarks, we continue to increase the teacher morale, and we hope that those efforts will help us to increase the teacher retention rate and also the student retention rate and also improve the conversion rate of our new students.

[Foreign Language] So I had a follow-up for CFO. What are expectations for the revenue and also bottom line contribution from the consolidation of Shijiazhuang learning centers?

Thank you, Alex, for your question. On the Shijiazhuang, our auditors is still in the final stage of reviewing their accounts. As a private company, there are lots of things to do in order to address some compliance issues such as social security, taxes that need to be paid and also tax payable to the government. So in terms of the top line, we would expect for the second half of this year it's likely to be roughly 1.5% of contribution to our top line for the second half of this year.

Your next question comes from the line of Felix Liu from UBS.

[Foreign Language] Let me translate myself. I have 2 questions. One is on the follow-up question on the salary structure. Could the management break down what the changes are and the margin impact for this year and next year? And my second question is on the operating costs. We see a pretty fast growth in selling, marketing and G&A expenses for the quarter. So may I know the reasons behind as well as the surge in share-based compensation? Thank you.

[Foreign Language]

[Foreign Language] Let me translate the CEO's answer. First of all, the first one is right now to comply with the government requirements, we need more teacher to comply with the teacher certificate requirement. So when we do the recruitment when we recruit the new teachers, actually, we increased the requirement. We hope most of the teachers can come with the teacher certificate as naturally the salary level increased a little bit. And second is we still feel that the teacher asset is very important for our business operation. And we hope to solidify the teacher team. So in order to improve the retention and the decreased the turnover rate of our teacher team and improve the satisfaction of our students and the parents and to improve their learning experience accordingly, we increased the compensation package of all of our teachers. One part is for the base salary. We improved the base salary to keep up with the market level. And the second is we also increased the incentive. We added some incentive, basically depends on how many classes the teacher can teach. So this is basically to improve the teacher efficiency, improve the teacher-student ratio which will benefit to our profitability. For the investment, the amount of the investment in the second half, we probably will invest RMB13 million. We already budgeted RMB13 million for the incentive-related expenses of our teachers. And for the sales team, the related expenses is RMB4 million from June to December. So if we annualize the expense for 2020, the teacher-related incentive cost will be RMB47 million to RMB48 million and the sales team-related incentives will be RMB8 million. We will budget those expenses into when we start our annual budget process for next year.

Felix, let me address your question on sales and marketing and administrative costs. I think for sales and marketing expenses, as we have explained in our first quarter earnings release, the margin impact will be around 1% as compared to last year. As of now, we are in very good control of expenses for developing new marketing channels as well as the control over the personnel costs in the sales and marketing team. So that is entirely in line with our expectations. There's a pretty dramatic increase in the administrative cost. It's primarily due to a grant of new option scheme in the second quarter. So the total non-cash stock option-based compensation amounts to RMB27 million in the second quarter. So if you take a close look at the change of our general and administrative costs in the second quarter, which was RMB92 million as compared to RMB55 million last year, it's an increase of RMB37 million. So RMB27 million is the stock option related expenses and RMB10 million is actually the result of the increase in our professional fees, the fees paid to developing our blueprint and also professional fees in association with our acquisition initiatives. So the increase in the professional fees will be a onetime hit in the second quarter.

Your next question comes from the line of Alex Liu from China Renaissance.

[Foreign Language] I'll translate myself. My first question is on the promotion. So we still witnessed a very severe industry-wide education promotion war. I'm just wondering is there any spillover effect from this sector dynamic? And second question is on the regulations, now that we see the regulation impact cooling down on the entire sector, do we see a positive benefit from some small player quitting out of the market?

[Foreign Language]

Let me translate the first question for you. We already see the regulation is directing to the online course business. And during summer time, some other players who engage in the online business, they have a lot of the promotion activities. Well for RISE, the summer is not the peak season for us to acquire new students. Normally, we will offer these summer short-term courses to just as options for our students. And also, we hope to convert some new students to our regular classes after the summer time. And we hope to direct our business operation to be consistent with the government requirements. As a result, we are, RISE voluntarily reduced the number of short-term courses we offered in this summer time. As a result, we do not see many student enrollment from this type of courses this year. And we believe that our peak season will start from the end of August into September. This is typically the good time for us to do promotions and do promotion marketing to acquire the new students.

[Foreign Language]

For the regulatory environment, we can break this into as online and off-line sector. For the online sector, in the past several months that we have seen, the government continuously strengthen the supervision of online education players or the online education business, including the requirements of collection of tuition fees, no more than 3 months. And the teacher certificate, foreign teacher certificate, qualification of the learning centers, and other compliance issues. As we see more and more restrictions into this education sector, this is a good signal. It means that the government is trying to direct parents' attention to the bigger brand names who is good at the quality, who pay attention to the quality control, who can offer the better quality of teachers and products. So we feel this is a good opportunity for those good brand names to consolidate this education sector. This impact should continue in 2 years. This will benefit our business. We also read through the policy that the government require all the players to finish adaptation of their business to the new requirements before June 30, 2020. The strengthening of the government's supervisions, actually, it's good for the healthy growth of this sector. We see those players, they began to pay more attention to the quality control, the content offering and the investments in product development. Some smaller players who do not meet the requirement of the government in terms of teacher certificate, the qualification of the learning centers, they will be hit by the policy impact, the cash collection will be seriously affected. But for the organizations, for the compliant organizations like RISE, that we generate rich cash, so there's no burden for us. I think for RISE, the big impact comes from the new collection schedule as well for the tuition fees. But this will only have some short-term impact to us because we have a rich cash. We operated our business for more than 10 years as well. We can easily adapt ourselves into the environment.

Our last question comes from the line of Crystal Li from China Merchant Securities.

[Foreign Language] So let me translate for myself. The first question is that in terms of policy impact, do you feel it's hard to hire teachers with license or is there a shortage of qualified teachers? And the second question is that you just mentioned that the cancel of full day courses and I wonder, what's the contribution of this kind of courses to the revenue. And also, could you give me more color on your pricing strategy and the full year learning center outlook?

Let me answer your question on the full-day course impact on our full year revenue. As a matter of fact, currently only 3 districts in Beijing have been highly regulated. So we are forced to close and cancel all the full day courses in Haidian and Fengtai and Daxing major 3 districts. For the operation of all the other learning centers, it currently remains unaffected. In terms of the number of students for the 3 districts as of the end of June 30, amounted to a total of 107,000 students. And 210 students actually requested for a refund, and that impacted our second quarter revenue about RMB1.5 million. For the rest of the students, we actually changed their course and their class type into either half day course or they need to come to the school twice a week instead of staying in the school for a full day. So that also kind of impacts the pace of the revenue recognition. Basically, we can only recognize the half of the revenues for those students who change their class type from full day to half day or 3-hour & 3-hour class types. So altogether, for those 1,500 students, the reduction in the revenue recognition for the second quarter is close to RMB 5 million. So all together for the second quarter, it's about RMB 7 million. So by looking at the full year impact, roughly it's 30,000 in total. From July 1, in Beijing, we will not offer the full day course anymore. So we'll start to enroll those students into our regular courses. So that's about the full-day course impact on revenue. So I will have our CEO to answer the other 2 questions.

[Foreign Language]

Let me firstly translate the certificate question. After the government required the teachers to get a certificate, we began to direct our business to comply with the government requirement. When we recruit the new teachers, we would like to recruit more teachers who have already obtained the teacher certificate. We also will encourage our existing teachers to take those exams. We give them incentive to take the exam and obtain the certificate. So that right now, majority of our teachers have already obtained the teacher certificate, and we believe that we are compliant with government requirement for most of our learning centers. And the second question about the expansion plan in 2020. We feel that, currently, we see implementation of the government requirements in many local cities. So the government will require the private children business to make their learning centers fully compliant with the new requirement in terms of the fire protection assessment. So we feel that some smaller players, probably they will feel some burden to get good locations. But for bigger brand names, we do not see that pressure. And after the whole industry's entry barrier increased, we feel for RISE that we can accelerate our expansion in the next year. We believe we are confident that as a leading brand name in this junior ELT market, RISE can capture the substantial potential of this market and to make our business to generate a sustainable revenue growth in the long-term. Okay, operator. Let's move to the next question.

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

[Foreign Language] I'll translate myself. So first question is enrollment breakdown to the regular and the non-regular classes in second quarter of last year. And the second question is company made a lot of effort to extend the students' age, and I want to understand what the progress is now. Thank you.

[Foreign Language] So I'll answer your first question. In terms of the total enrollment released last year, the gross number was 13,735 that's in my data book, maybe slightly different from the earnings release, you can refer back. So the breakdown shall be 8352 students for our regular courses in our self-owned learning centers and 685 students are online students and 4698 students for the short-term courses. And there is no student enrollment for Edge second quarter of last year.

[Foreign Language]

Let me translate this question. Right now, most of our students are still age 3 to age 6. But we already take measures to improve or to increase the number of students, number of older students. For example we already incorporated more online portion into our courses for Level S1 to try to reduce the time the kids have to come to the learning center or spent in traffic. We are also upgrading the courses of Level S1 to Level S5. And in the future, we will also include a Level S6 into this upgrading. We hope our new content can better reflect kids' needs of different age to make their learning outcome better than before. And also, we are operating the RISE plus functions. We try to offer more after-class experience on that application so that kids can make use of their spare time at home to get a better and easier learning experience. Those are the major measures right now we are working at to increase the number of older students to try to diversify our student demographics. Thank you very much.

Ladies and gentlemen, this does conclude our conference for today. Thank you for participating. You may now all disconnect.