NaaS Technology Inc. (NAAS) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the RISE Education Third Quarter 2019 Earnings Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ms. Mei Li. Thank you. Please go ahead.

Thank you, Operator. Hello, everyone, and welcome to RISE Education's Third Quarter 2019 Earnings Conference Call. Today, you will hear from Mr. Sun Yiding, CEO, who will give an overview of the company's strategy and recent developments; followed by Ms. Lu Jiandong, CFO and COO, who will go over our financial results in more detail. Before we proceed, I would like to remind you that today's 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 our 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.

Thank you, everyone, for joining us today. I will read through Mr. Sun's prepared remarks for him in English. I'm delighted to report a solid quarter of growth across our businesses. In face of the challenges posed by the regulatory environment and macroeconomic headwinds, revenues for the quarter increased by 18.4% year-over-year to CNY 411.1 million. Adjusted EBITDA increased by 37.1% year-over-year to CNY 88.9 million, and adjusted EBITDA margin expanded by 290 basis points to 21.6% from 18.7% for the same period of last year. Before I review our performance, I'd like to remind you that starting from this quarter, all of our operational and financial results includes Shijiazhuang operations, which have been consolidated since July 1. Total student enrollments are composed of enrollments of new students and retention of existing students. During this quarter, we scored a solid total student enrollment growth of 15% year-over-year and even stronger enrollments of new students of 19% year-over-year for regular courses at our self-owned learning centers. Due to the change in tuition collection schedule, we are going to begin disclosing student enrollment in the cities where we have been collecting the tuition every 3 months since December 2018 separately from the cities where we continue collecting full course tuition. During the third quarter, total student enrollments for our regular courses, including Rise Start and Rise On, were 14,700, an increase of 15% year-over-year. Of this, 6,492 students were from cities where the tuition is collected every 3 months. 6,782 students were from cities where the full course tuition is collected. And 1,426 students were from our newly consolidated Shijiazhuang learning center. Student enrollment from other Rise courses during the quarter were 1,175. Regulations mandating 3-month tuition payments and calculation of full-day classes have had an adverse impact on our total student enrollment in Beijing, which is our primary market. The impact is twofold. First, when it comes to new students, we are no longer able to offer students full-day classes and are restricting tuition payments to 3-month installments to give parents more flexibility to decide whether they want to continue their child's course at the time of payment rollovers. For this reason, we have begun to separately disclose enrollment numbers for the cities where this regulation applies separately. Second, we can no longer renew students' contracts ahead of their graduation as we did last year, which has impacted student renewals and retention as well as overall student enrollment growth this quarter. With such, I believe that our student enrollment will restore its strong momentum when we complete the full cycle operation under the new regulatory environment. These regulations have created an opportunity for us to enhance our operations to ensure higher student and parent satisfaction and drive the growth in payment fee rollover. We have already begun to see the fruits of our labor with improved marketing efficiency, and I'm confident this trend will continue going forward. Our quarterly retention rate was 69% compared with 71% during the same quarter last year. In the coming quarters, we will continue working hard to improve customer and employee satisfaction, optimize our marketing initiatives in order to drive new student enrollment and further enhance our retention rate. We added 7 self-owned learning centers with a total 78 classrooms from the consolidation of the Shijiazhuang operations during the quarter. We also added 36 franchised learning centers in cities such as Chengdu, Gongbei [ph], Jinan and Langfang. Right now has 87 self-owned learning centers in 8 cities and 364 learning centers and in 142 cities. We will continue to acquire franchised learning centers when the opportunity arises. We continue to enhance our curriculum and product offerings. We are developing new ways to integrate the technology into our courseware to further empower teaching and learning. We will begin testing an artificial intelligence-powered online teacher into our classrooms in December before deploying it more widely next year to satisfy current demand for native English teachers. At the same time, we are developing story and learning-driven animation content, which is particularly appealing to young kids. More importantly, the new content is designed to develop problem-solving skills and to motivate young children to apply what they have learned in classrooms to solve real-world problem. We want to get parents more actively involved in their child's education to ensure they fully understand what their kids have learned in the classroom and are able to closely track their progress. We also plan on introducing augmented reality technologies to enhance the immersive experience of our classrooms to help reduce the separation anxieties some younger students are having, increase their interest and attention span, expand the opportunities for active learning and positive development of social skills. Our new demo courses that have been designed to specifically engage and acquire prospective students are in the final stages of development and will be launched soon. This new demo courses, which will incorporate virtual reality and artificial intelligence technologies, are designed to develop students' critical thinking and are consistent with the government's research into quality-oriented education as part of the Thirteenth Five-Year Plan. We continue to roll out updates of Rise Club, our in-house developed online platform, which are enriching its product offering and core contents to satisfy the increasing needs of our customers. Rise+ also offers a convenient way for students to extend the learning experience beyond the classroom. We continue to execute our strategy of strengthening the online/offline integration of our core course products. We maintain a competitive edge when it comes to education -- educational content and are working to further integrate technology into our courseware to empower the teaching and learning process. As I have said before, that offers the students and parents a personal touch when it comes to education or in Chinese. Nothing can replace the teachers' ability to engage with students directly in the classroom. Having said so, technology can definitely enhance the learning experience and extend it beyond the classroom, which is increasing demand for students and parents. We have decided to strategically scale down our online product Can-Talk, which has been in operation for over a year now but has not contributed meaningful revenue yet -- revenue and profit yet. Our ongoing effort to upgrade our curriculum and products to enhance teacher performance are expected to improve customer satisfaction, teacher performance, word-of-mouth referrals and student retention in the near future. At the same time, our investments in incentive-based compensation for teachers and the upgraded marketing strategy are beginning to pay off. After introducing performance-based rewards for our teachers and sales staff in September, teacher retention increased immediately and is expected to further improve going forward. Employee morale has also improved significantly. Highly motivated teachers are able to offer a higher-quality teaching product, which is one key aspect that students and parents are looking for. Students acquired through word-of-mouth referrals accounted for over 30% of the total new student enrollment acquired offline this quarter, a marked increase from the last quarter and the third quarter of last year. I firmly believe all of these initiatives will translate into increased new student enrollment and higher retention rate going forward. On the selling and marketing side, we continue to deploy marketing dollars in a targeted manner, optimizing educational resources among different channels to ensure solid return on investments. We managed to acquire close to 65% of our new students through offline channels this quarter by fully leveraging our offline learning center network. Higher contribution of student enrollment acquired offline have effectively driven down our average student acquisition cost by more than 30%. I believe this demonstrates how effective our new initiatives are. The challenging economic and regulatory environment is affecting every online and offline educational player in the market. We estimate the impact that the government regulations would have on our business and the parents' reaction to the tuition installment payments early this year. And we're pleased with our ability to rapidly respond to these challenges, which leads to the solid initial result. And I believe that this positive trend will take stronger hold going forward. I'm confident that our excellent ability to execute deep experiences and focus on building this business for the long run will ensure sustainable growth. Before handing the call over, I'd like to remind you that we completed a share buyback program announced last November. We repurchased approximately 1.2 million ADS in the open market at an average price of USD 8.66 per ADS for an aggregate consideration of approximately USD 10 million. We believe this demonstrates our continued confidence in the future of our business. It's a good use of the cash we have accumulated on our strong cash balance sheet and a very innovative way to return cash to shareholders. We remain positive about our future growth and will continue to focus on building this business over the long run and will 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 over our financial highlights. Ms. Lu, please go ahead.

Hello, everyone. Now I would like to go through our financial highlights for the third quarter of 2019. Before I begin, please note that all numbers stated are in RMB. Total revenues during the quarter increased by 18.4% year-over-year to CNY 411.1 million, driven primarily by a 20.2% year-over-year increase in revenues from our educational programs to CNY 333.3 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 an increase in prices for our regular courses since the beginning of year 2019. The number of our self-owned learning centers increased to 87 as of September 30, 2019, from 70 as of September 30 of last year. We added 205 classrooms as of September 30, 2019, as compared to the same period of last year. Franchise revenues increased by 27.4% year-over-year to CNY 45.4 million during the quarter, primarily driven through an increase in the initial franchise fees and recurring franchise fees associated with an increase in the number of franchised learning centers from 273 as of September 30, 2018, to 364 as of September 30, 2019. Our revenues for this quarter -- other revenues for this quarter decreased by 5.8% year-over-year to CNY 32.5 million. Cost of revenues for this quarter increased by 19.8% year-over-year to CNY 196.3 million. Non-GAAP cost of revenues for the quarter increased by 20.3% year-over-year to CNY 192.4 million. The increase was primarily due to personnel costs associated with an increase in teachers' headcount, total teaching hours and teacher compensation at our self-owned learning centers and an increase in rental costs associated with the expansion of our operations. Gross profit increased by 17.1% year-over-year to CNY 214.9 million, while gross margin was 52.3% as compared with 52.8% in the same period of last year. Selling and marketing expenses for this quarter were CNY 83.3 million, an increase of 7.4% year-over-year from CNY 77.5 million. The increase is associated with a headcount increase and incentive-based pay raise of approximately CNY 1.5 million for our marketing staff. Non-GAAP selling and marketing expenses were CNY 82 million, representing an increase of 7% year-over-year. As a percentage of revenue, non-GAAP selling and marketing expenses were 19.9%, 220 basis points lower than that of the same period of last year, reflecting the success of our initiatives in optimizing the allocation of our marketing resources between offline and online channels so as to enhance the return of our investment. We'll continue to invest in selling and marketing to further expand our market share and to grow our student base. G&A expenses for this quarter was CNY 65.8 million, an increase of 13.7% year-over-year from CNY 57.8 million. The increase was mainly attributable to an increase in personnel costs associated with our expanding business. Non-GAAP G&A for this quarter was CNY 61.8 million, an increase of 10.5% year-over-year. Other operating income was CNY 65.8 million. Non-GAAP operating income was CNY 74.9 million, representing an increase of 36.5% year-over-year. Non-GAAP operating margin was 18.2%, 2.4% higher than that of the same period of last year. The significant improvement in our operating margin was -- resulted from an optimal use of our selling and marketing resources and a good control of our G&A costs. Adjusted EBITDA for the third quarter was CNY 88.9 million, an increase of 37.1% from CNY 64.8 million in the same period of last year. Adjusted EBITDA margin improved to 21.6%, 290 basis points higher than that of the same period of last year. Income tax expense for the quarter was CNY 24 million as compared with CNY 17.3 million for the same period of the prior year. Net income attributable to RISE for the quarter was CNY 39.4 million, an increase of 19.7% year-over-year. Non-GAAP net income attributable to RISE was CNY 48.5 million, an increase of 22.4% year-over-year. Non-GAAP net margin attributable to RISE was 11.8% for the quarter as compared with 11.4% for the same quarter last year. Basic and diluted net income attributable to RISE per ADS for the quarter were CNY 0.70 and CNY 0.69, respectively. Basic and diluted non-GAAP net income attributable to RISE per ADS were CNY 0.86 and CNY 0.85, respectively. Turning to our cash flow performance. We generated CNY 10 million positive cash flow from the operating activities during the quarter as compared with positive CNY 74.7 million for the same period of the prior year. The decrease was mainly attributable to the change in the tuition collection schedule mandated by government regulations. As of September 30, 2019, the company had combined cash and cash equivalents, restricted cash, short-term investments and loan to a related party of CNY 1,036.9 million as compared with CNY 1,316.8 million as of December 31, 2018. As of September 30, 2019, total deferred revenue and customer advances were CNY 831.6 million, a decrease of 20% from CNY 1,038.8 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 quarter 4 guidance. For the fourth quarter of 2019, we expect our total revenues to be in the range of CNY 410 million to CNY 418 million, representing a year-over-year growth of approximately 16% to 18%. This estimate takes into consideration of the impact of our full compliance with relevant government regulations mandating the cancellation of full-day classes in Beijing and the 3-month tuition payments in selected cities. We expect the impact to be temporal and will not affect our long-term growth prospects. This forecast reflects our current and preliminary view on the market and the operational conditions, which are subject to change. This concludes my prepared remarks. Operator, we would like to open up the call for questions. For those who would like to ask a question, please state your question in Chinese first and then in English. Operator, please go ahead sir proceed.

[Operator Instructions]. Your first question, I mean, is from Alex Xie from Crédit Suisse.

So I have two questions. Firstly, I noticed that our guidance for the fourth quarter revenue, to be frank, was a little bit lower than my previous forecast. And I think it showed -- it indicates a slowdown even from this quarter. I would like to know whether this is still an impact of regulation. And what is the outlook going forward? Are we still expecting sales over 20% -- recovering to over 20% in the future? And secondly, I noticed that in this quarter, we have quite some meaningful operating leverage in terms of OpEx, selling and marketing expenses. And would you please share the reason for that and the trend of customer acquisition costs?

Thank you, Alex. I will translate our CEO's answer for the first question. The macroeconomic headwinds have an active impact to the whole education impact -- to the whole education market. For RISE, we believe that the regulations will benefit the whole junior English learning market and RISE in the long term, and we remain very positive. But in the short term, the involvement of regulations such as the collection schedule for the restriction of the 3-month tuition payment policy did generate some negative impact to our business, which is higher than our expectation at the beginning of the year. For example, in Beijing, we are required to cancel the full-day courses -- the full-day classes. At the same time, we humbly recommended to the parents to take the replacement classes such as the half-day classes. But due to the stop -- due to we stopped offering the full day classes anymore, the replacement of the half-day classes, we -- the actual revenue were -- our actual revenue were reduced by approximately CNY 20 million. And also we -- in Beijing, according to the government requirement, we will change our collection schedule from December 2018 and the refund rate and -- the refund rate is higher than our early expectation and the rollover rate is lower than our early expectation, which leads to the decline of our -- the reduction of our actual revenue of approximately CNY 30 million than our annual budget expectation. We gradually -- the impact of those regulations gradually show. But the company is very -- is actively launching a lot of the initiatives in order to counteract the situation, and we try hard to improve the retention rate. The detailed measures includes such as we try to shortening the waiting period for the students before the open of the class in order to reduce the refund rates. Also, we leveraged our in-house developed online platform Rise+ to strengthen communication with parents in order to sell to a variety of parents, also, to better help the parents and the students to get through the separation anxiety in the first 3 months. Second, you may already hear that some organizations -- some education organizations in the market ran out of money and stopped operations. Those issues generated some negative impact to the purchase decision of the parents. And we tried some -- we tried to offer a separate pure online product, Can-Talk. But in over 1 year's operations, we find the actual demand from the parent is not as high as we expected. As a result, we strategically decided to scale down the standalone -- the separately owned -- the separately running business. We scaled down the investments and reinforced the integration of our current courses and the online offering. This change of our strategy will benefit our development in the long term. But in the short term, it reduced our -- in this year, it reduced our online revenue by approximately CNY 5 million. And also in Hong Kong, the Hong Kong situation also caused the expected revenue to decrease by approximately CNY 5 million. So all of those reasons caused the lower-than-expected revenue of RISE than our earlier guidance. I hope this helps you.

Okay. Alex, let me answer your second question on G&A and also -- selling and marketing expenses and G&A. We're very, very happy to see that the initiatives we launched early in the year with regard to marketing and sales started to show a very, very positive outcome. What we have done is to try to leverage, make best use of our offline learning center network, try to acquire more students from offline than the more expensive channels online. I can share with you the statistics. So early in the year, acquisition from offline accounts for approximately 60% of our total student enrollment. As of third quarter, we managed to increase the offline the student acquisition to close to 65%. So we'll continue the efforts in this regard. At the same time, when we launched our Rise+ platform, which helped to increase the communications with the parents and that helps to improve the parents' satisfaction and the word-of-mouth referrals, which is even a cheaper way of acquiring students, started to contribute more of our total offline student acquisition. Roughly, close to 30% of our offline student enrollments are actually from the word-of-mouth of -- parents' referrals. So it's also a good proof of our improvement in our services to the parents and also a reflection of the parents' satisfaction with our overall teaching quality. The other thing we have focused on is to improve the conversion rate. I'm very happy to tell you that the third quarter conversion rate overall had increased by more than 30%. This is the result of an overall package offered to our sales -- selling staff. One, we actually increased their salaries starting from June. Also, we have restructured the incentive structure that better motivates the course consultants and the salespeople to do a better job. Third, we actually increased the frequency of trainings to make sure that they actually understand our product and that they will learn to present our teaching philosophies and also our product in a better way to our prospective parents. Fourth is throughout all those initiatives, we see our sales team actually become more stable. And the churn rate dropped pretty dramatic. So we'll continue the efforts in all the areas I have just explained to you, and we are pretty confident that selling and marketing expenses will be better used to maximize optimal outcome. Overall, we will continue to invest in selling and marketing. The purpose is to further increase our student enrollment and further increase our market share as well as the student base. With regards to the G&A, we're very cautious in managing our administrative expenses. You can see, as a percentage of revenue, it remains pretty stable as compared to the same period of last year. So we're very cautious in the headcount increase for the administrative staff and try to manage to keep the expenses with regard to G&A flat so as to improve -- continue to improve our margin. So we'll continue the efforts in that regard.

Your next question is from Felix Liu from UBS.

My first question is a follow-up on the margin. So with the good cost control in the third quarter, is there any update to our full year EBITDA margin target? Second question is on the tax rate. I think that we paid around 40% of our pretax income as tax, which is higher than last year and a lot higher than the peers. May I know any particular reason behind this? And my third question is on the share-based compensation, which increased as a percentage of revenue. May I know any particular reasons behind this? And how should we forecast this going forward?

Thank you, Felix. Let me answer your questions. On margin, for the full year, we expect it will remain the same, as we shared with the market early this year. So it will remain unchanged. On the tax rate, currently, we are still -- for the income tax, we still pay 25% income tax. We are trying to get -- the high-technology preferential tax treatment efforts is still ongoing, in progress, so we don't have a definite deadline when the government will grant that approval. So we're still working hard trying to obtain the approval from the government on the tax treatment. And the other reason for higher effective tax rate is because of the different tax rate jurisdictions. And that actually increased our tax rate by 1% this year -- this quarter -- this year, yes, this year. And also because of outside basis difference on the investment in the space, this is quite technical. So when we actually make a payment to Hong Kong, we need to actually withhold VAT tax. And also, we need to withhold the dividends. Even though we don't pay dividends, we still need to withhold the dividend tax. So all this combined increased our effective tax rate for this year. So I think that's my explanation for the tax rate. On share-based compensation, this year is relatively higher compared to last year. It's because in April, we have actually launched the second part of our stock option program to our management as well as the key employees. So once it's launched, a part of the options becomes immediately vested after April 1. So that actually has a pretty significant impact on our expenses actually in the second quarter. In the third quarter, it becomes normalized. If you need a -- I think starting from -- if we normalize the SBC expenses going forward, projecting for next year, roughly -- based on the current performance-based and as well as the years of working experience based option vesting schedule, we would estimate for each quarter, it's probably 4 million to 5 million.

Your next question is from Alex Liu from China Renaissance.

Just on the remark of CEO basically on the online business, he noted some parents are not really -- the acceptance was not really as high as the management previously anticipated. So just wondering whether there is any color that the management can share on that point, whether this is due to a format issue for the class or whether there's something other that we can have.

The Can-Talk is our online 101 service, the standalone service. We started to test this online product from end of 2017. So right now, it's over one year's time. Based on our observation, this class is targeted to aged 4 to aged 6 students. While the students are at that age, they pay much more attention to the personal touch, like we mentioned that nothing can replace the teacher's ability to engage with the students directly in the classroom. So for this reason, the pure online courses is not what they want the most. So probably when they grow older, we can offer more online -- they will take more online courses. Also, if you look at the online competitors, the online education organizations in the market, I think most of their students are above age 7. So our students does not overlap with most of those online players. The second is if you look at the economics of this 101 business, we use foreign teachers. Also, even though we don't have a lot of student acquisition costs because we don't open this product to the students outside of RISE, but still it's very difficult to make a profit. So from this point of view, we probably will not offer this in the long term. And the third reason is we mentioned that we have a long-term strategy that is to integrate our current product -- our existing product with the online offering. We have been trying harder for a long time. So going forward, we will have more supplemental online offering into our existing classes that we have expertise to do exercises at their homes after class. And for example, we are testing the AI technology and online small class product using native English teachers online right now in some -- in selected learning centers. And I think the most -- when we decide what direction to go, the most important thing is the demand -- the actual demand of our parents, their feedback, their experience.

Your next question is from Chongguang from CITIC Securities.

I noticed that your retention rate is much lower than the past several quarters. Could you please explain this? And do you have guidance for the next quarters?

First, let me explain the retention rate of 69%. We use this retention -- how do we calculate this retention rate? We use the number of students who are registered for the next course divided by the number of students who completed the current courses to get the retention rate. The impact -- the reason why the retention rate was a little bit lower in this quarter is -- I think it's primarily due to the regulatory impact in Beijing because Beijing contribute a material student enrollment in our business and Beijing adopted the new tuition collection schedule from December 2018. After we adopted the new collection schedule, our salespeople and our teachers have very limited time to prepare for the renewal and the retention of the students after each session before we have -- our standard, of course, is 9 months or 10 months. But right now, every 3 months, we have to get prepared for the rollover. So it's really a challenge for all of ourselves in the learning centers. And because we just adopted the new schedule from end of 2018, so material -- we can see material student retention from the third quarter. It's just we just see material retention in the third quarter. So gradually, we will have a more accurate number. But right now, we already see a turnover. We already see very a positive change on the retention, on the rollover rates. So internally, we're tracking closely, and we are finding any opportunity to further improve the retention and rollover in Beijing. We remain very positive in this retention rate going forward.

We don't have any other questions as of the moment.

We can conclude. Yes, we can conclude.

Ladies and gentlemen, that does conclude our call for today. Thank you for participating. You may all disconnect.