Edited Transcript of REDU.OQ earnings conference call or presentation 13-Mar-20 12:00am GMT

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Jiandong Lu, RISE Education Cayman Ltd – CFO, COO & Director [4]

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Thank you, Lihong. Hi, everyone. Thank you for joining our earnings call. I will now go through our financial highlights for the fourth quarter of 2019.

Before I begin, please note that all numbers stated are in RMB.

Total revenues during the quarter increased by 17.5% year-over-year to CNY 416.2 million, driven primarily by a 17.2% year-over-year increase in revenues from our educational programs to CNY 379.9 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 an increase in prices for our regular courses at the beginning of 2019 in Beijing and on April 1 in Shanghai, Wuxi, Guangzhou and Shenzhen. The number of self-owned learning centers increased to 89 at the end of 2019 from 76 a year ago. We also added 213 classrooms as of December 31, 2019 when compared with the end of 2018.

Franchise revenues increased by 17.2% year-over-year to CNY 33.2 million during the quarter, primarily due to an increase in recurring revenue associated with an increase in the number of franchised learning centers from 304 as of December 31, 2018, to 383 as of December 31, 2019.

Cost of revenues for the quarter increased by 22.1% year-over-year to CNY 183.6 million. Non-GAAP cost of revenues for the quarter increased by 22.8% year-over-year to CNY 179.9 million. The increase was primarily due to personnel costs associated with an increase in teacher headcount, total teaching hours and the teachers’ compensation at our self-owned learning centers and the increase in rental costs associated with the expansion of our operations.

Gross profit increased by 14.1% year-over-year to CNY 232.6 million. Gross margin was 55.9% compared with 57.6% in the same period of the prior year.

Selling and marketing expenses for the quarter was CNY 87.8 million, an increase of 26.2% year-over-year from CNY 69.5 million. The increase was driven primarily by an increase in marketing channel expenses as well as the headcount increase and the incentive-related salary raise for our marketing staff. Non-GAAP selling and marketing expenses were CNY 86.6 million, an increase of 31.5% year-over-year. As a percentage of revenue, non-GAAP selling and marketing expenses were 28.8% compared with 18.6% in the same period of the prior year.

G&A expenses for this quarter were CNY 84.3 million, an increase of 13.4% year-over-year. The increase was mainly attributable to an increase in professional fees for our strategic projects. Non-GAAP G&A expenses was CNY 74.2 million, an increase of 13.2% year-over-year.

Operating income was CNY 60.7 million, an increase of 1.1% year-over-year. Non-GAAP operating income was CNY 75.6 million, a decrease of 0.9% year-over-year. Non-GAAP operating margin was 18.2% compared with 21.6% in the same period of the prior year. The decrease in non-GAAP operating margin was mainly due to an increase in teacher salaries and our investment in marketing activities.

Adjusted EBITDA was CNY 91 million, essentially flat on a year-over-year basis. Adjusted EBITDA margin was 21.9% compared with 25.7% in the same period of the prior year.

Income tax expense for the quarter was CNY 8.8 million compared with CNY 24.7 million for the same period of the prior year. Income tax expense decreased significantly because one of our major subsidiaries obtained the qualification certificate as a High and New Technology Enterprise in the fourth quarter of 2019 and was, therefore, entitled to a preferential enterprise income tax rate at 15% for the full year 2019.

Net income attributable to RISE for the quarter was CNY 51.1 million, an increase of 62.3% year-over-year. Non-GAAP net income attributable to RISE was CNY 66.1 million, an increase of 38.2% year-over-year. Non-GAAP net margin attributable to RISE was 15.9% for the quarter compared with 13.5% in the same quarter of the prior year.

Basic and diluted net income attributable to RISE per ADS for the quarter were CNY 0.91 and CNY 0.90, respectively. Basic and diluted non-GAAP net income attributable to RISE per ADS were CNY 1.17 and CNY 1.16, respectively.

Turning to our cash flow performance. We generated CNY 74.4 million in cash flow from the operating activities during the quarter compared with CNY 72.5 million in the same period of the prior year.

As of December 31, 2019, the company had a combined cash and cash equivalents and restricted cash of CNY 1,022.8 million, compared with CNY 1,316.8 million as of December 31, 2018.

As of December 31, 2019, total deferred revenue and customer advances was CNY 756 million, a decrease of 27.2% from CNY 1,038.8 million as of December 31, 2018. The decrease was primarily due to the change in tuition collection schedule in certain cities.

Starting the fourth quarter of 2019, we’ll begin reporting the number of students in class and the new students enrolled on a quarterly basis. Students in class refers to the students who were taking our courses as of a given date. And new students enrolled refer to the newly acquired students who enrolled in our courses during a given period of time. We believe that these metrics more accurately reflect our business performance and provide a more meaningful comparative analysis than the previously reported student enrollment matrix, which included new student enrollment and renewed student enrollment.

Renewed student enrollment can be highly impacted by our promotional activities. The increase in course prices on January 1, 2019 incentivized existing students to renew their courses far in advance of their scheduled graduation date, making the student enrollment metric exceptionally high in the fourth quarter of 2018 and less indicative of our business performance on a year-over-year basis.

In addition, the adoption of the 3-month tuition collection policy in certain cities in December 2018 also significantly impacted the students of renewed student enrollments, which made them less comparable on a year-over-year basis than the number of new students enrolled who are newly acquired and have signed up for RISE courses.

New students enrolled during the quarter was 6,200, down 5.1% year-over-year from 6,536. For full year 2019, new students enrolled was 29,049, an increase of 12.3% from 25,862 in 2018. As of December 31, 2019, students in class were 54,383, an increase of 10.2% from 49,365 as of December 31, 2018.

In accordance with government regulations to contain the outbreak of COVID-19, RISE learning centers were temporarily closed throughout the majority of the first quarter of 2020, which will adversely impact our financial performance. In response to the outbreak, we immediately took measures to effectively move our off-line classes to online live small group classes through RISE class, our self-developed OMO platform, and begin monetizing them in early December 2020. With no set timetable for the lifting of government regulations on the temporary closure of learning centers, we expect the first quarter 2020 revenue to be in the range of CNY 95 million and CNY 100 million.

Now I will hand the call back to Lihong.

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [5]

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Thanks, Jiandong. Throughout my remarks today, I’ll be referring to the presentation that has been uploaded to our IR website as a supplement to today’s call.

I’d like to begin by outlining the 3 topics we will be focusing on today on Slide 2. First, a review of our 2019 performance and plans to drive better student enrollment and retention. Second, the impact from the COVID-19 outbreak and the measures we have taken to minimize the disruption cost to our business. And third, the launch of online small group classes, a milestone as we build out an Online-Merge-Offline model, or OMO model, which forms an integral part of our long-term digitalization strategy.

Turning to Slides 3 and 4, you can see that 2019 was a solid year in terms of our financial performance. Full year revenue and adjusted EBITDA grew by 20.3% and 16.4% year-over-year, respectively. As Jiandong mentioned, new students enrolled for regular courses increased by 12.3% during the year, while total students in class for regular courses increased by 10.2% year-over-year at the end of 2019.

Throughout 2019, we saw refund rates trend higher, and rollover rates came in lower-than-expected, which were primarily the result of the 3-month tuition collection schedule implemented in certain cities. This impacted the total students in class for regular courses, which came in below our targets for the year despite a strong pipeline of newly enrolled students. On top of that, a lack of effective digital infrastructure hindered management decision-making and operating efficiency, including marketing channel selection, ROI measurement and customer acquisition cost control. To resolve these issues, I launched Project Pioneer the day I came on board as CEO.

Turning to Slide 5. You can see that Project Pioneer was designed to achieve a number of specific objectives. First, deploying systematic approaches to increase referrals and optimize sales process to improve its digitalization and overall conversion rates; second, enhance product and services offerings to lower refund rates and increase rollover and student retention rates. And third, upgrade our business intelligence systems to support better management and operational decision-making. I’m fully confident that the successful execution of this project will improve our operations and reaccelerate top line growth in 2020.

Project Pioneer was also designed to fit directly into the long-term strategy I developed, which will facilitate RISE’s transition into a digitized cross-disciplinary skill-based education platform.

The start of 2020 brought with it the unfortunate outbreak of COVID-19, which has created significant challenges operationally. Since January 21, 2020, all of our learning centers have been temporarily closed. The disruption to the course of normal business compelled us to accelerate the execution of our strategy to digitize our operations and move all aspects of our business online, including marketing, teaching, training and communications with parents and students.

One of the first steps we took in response was to reach out to parents and students and offer free online content, which kept our refund rates very low. At the same time, we tightened cash management to ensure sufficient liquidity to support our business.

Moving to Slide 7. I’m pleased to report a significant milestone with the official launch of online small group classes for our existing and new students earlier this month. The accelerated development of our online small group classes was the direct result of the dedication and [perseverance] (corrected by company after the call) of our highly skilled teams who worked tirelessly to build out the product and platform in record time to accommodate the challenging operating environment. We mobilized the entire company the day after the start of the Chinese New Year to begin working on this, and within 3 weeks, I’m proud to say, we were able to launch 3 levels of online small group classes for all of our students nationwide. As of March 11, 2020, more than 116,000 students have enrolled in online small group classes, of whom approximately 30,000 have enrolled in the paid classes.

Moving on Slides 8 and 9, offer some deeper insights into how we have positioned online small group classes and the unique value they can offer. First, we offer 1 on 4 to 6 student classes, where students have the same teacher, same classmates and same class schedule as they normally would have in our off-line learning centers. This means that students and teachers are already very familiar with each other. Secondly, the classes were developed by our academic team, leveraging their extensive course development capabilities and deep experience in building other online courses such as Can-Talk and Rise Up. Third, the 3-level courses emphasized age, suitability and key skill-based capabilities which are consistent with our educational philosophy. And last but not the least, they are deployed through our in-house developed proprietary online platform, which supports all online operations. We quickly established internal process to support online operations with expanded in-house tech and customer team.

I won’t go into too much detail on the courses themselves. I’d recommend you purchase them for your child or friend’s children to experience them firsthand. I would, however, like to highlight the high participation rate for existing students across all age groups.

I’m particularly proud of our growing technological capabilities to support the rollout of online classes. As you can see on Slide 10, our IT team was able to transform Rise+ into a robust technology platform capable of supporting live interactive online class nationwide within 20 days. Over the last 4 weeks, Rise Up has delivered a total of 82,000 classes to 116,000 students in 136 cities. During the peak study hours, over 7,200 students are concurrently taking classes in 1,400 virtual classrooms. Since the launch of online small group classes, Rise+ has been operating stably and reliably.

We’ve accomplished much more than just rolling out online classes, but I’ll save that for next time. I would like to share with you my views on the market trends we are seeing throughout the COVID-19 outbreak.

Turning to Slide 11. You can clearly see that the outbreak is driving significant online penetration, shifting both demand and supply online. This penetration of online education has been facilitated by the deployment of enhanced and proven technologies, growing acceptance by parents and students, and more aggressive online educational product offerings. We nevertheless believe that in-person interactive group classes remain an effective and favored model, particularly for younger kids.

Education companies with the ability to implement an OMO model will be better positioned to succeed in the future. Despite current challenges created by the outbreak, we remain confident in the fundamental health of our business today and our ability to implement these strategic initiatives to achieve our long-term objectives. We will continue to accelerate the digitalization of our operations to help us solidify our leading position and penetrate deeply into the market over the long run. The education market in China continues to present enormous growth opportunity for companies with strong branding, high-quality curricular and teaching resources and the ability to offer both online and off-line learning experience. I firmly believe that our ability to build an effective OMO model will ensure RISE’s long-term growth and success. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from the line of Sheng Zhong from Morgan Stanley.

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Sheng Zhong, Morgan Stanley, Research Division – Associate [2]

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I have 2 questions. The first one is, can you give some more color on the first quarter revenue guidance, what the impact from the coronavirus and the work on moving them to online? And second — and what do you expect the coronavirus impact in next few quarters and the full year?

And second question is — can you give more details about your strategy of the digitalization? Like what kind of format you will provide in the long-term for the students? And how do you see the competition going forward after coronavirus, especially now a lot of players joined the AI interactive courses for the young children program, what’s your view on that?

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [3]

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Thank you for your question. Can you hear me?

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Sheng Zhong, Morgan Stanley, Research Division – Associate [4]

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Yes, very clearly.

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Jiandong Lu, RISE Education Cayman Ltd – CFO, COO & Director [5]

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Okay. All right. Good. At the end of my remarks, I have already given the guidance for our first quarter. As I mentioned, that the COVID-19 outbreak, so basically, in order to respond to the government’s regulations, we closed our learning centers for most of the first quarter, starting from right after the Chinese New Year until now. And that there is no clear timetable when the learning centers can be reopened and we can resume to our normal businesses. Although we have made great efforts moving our off-line students online, and we have already, as you’ll hear from Lihong’s presentation that we started to charge the students at the beginning of March for them to register for online small group classes. So having given you the background as that, our revenue guidance for the first quarter can be in the range of CNY 95 million to CNY 100 million.

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [6]

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Sheng, this is Lihong. Just to supplement what Jiandong has been saying. I think the way you can think of is, for January, because Chinese New Year is early this year, so we basically have 2/3 of the month, which can generate revenue. And then February, all the major efforts we’ve made is really reach out the parents and students, help them to study learning online. So the trial classes are free during the first 2, 3 weeks. Basically, February, the regular courses are closed. Only the other courses, like Can-Talk and Rise Up, Edge continued to generate revenue.

For March, we launched the paid online small group classes. So the revenue recognition will mainly from these online small group classes. However, this classes, they have shorter duration and also priced differently. Therefore, the March revenue would be almost like 1/3 of the normal months. So that’s the first quarter revenue guidance is based on.

In terms of next few quarters, I think the 1 major uncertainty still is when we can open off-line learning centers. There is no clear guidance from the government yet. However, to counter these challenges, we already prepared to move all off-line classes, regular classes to be online. So the preparation is ongoing. We expect to move everything online towards the third week of April, which, at that time, we will finish all the current online small group classes offered. So the next few quarters, the uncertainty is still there, but our plan is to move everything online as much as we can. And once the off-line center opens, we’ll try to catch up on the classes that we can offer. So it’s very difficult to give a full year guidance, but that’s the plan to counter the challenges we have now.

If that answers your first question, let me very briefly talk about the second question regarding the strategy. We are developing the digitalization strategy all across our operations. So the so-called online small group classes is just one of the elements. The thinking is not yet complete. However, what I would say is from marketing, student acquisition, to learning experience, to after-class tutoring, we’ll try to build the online/off-line platform so students can learn in the off-line centers as scheduled. And after they return to home, they will also have online courses or online content that they can continue to learn at home. At the same time, we are upgrading our core curriculum. As you mentioned, in certain age groups, we will also offer a combination of online/off-line classes. Certain group with AI teachers and afterwards, we will also have an online live teacher even one-on-one to be a supplement to the off-line courses. So the combined online/off-line courses will start to launch towards the end of this year to some of the classes — some of the ages and levels, and then hopefully, roll out throughout the whole year next year.

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Sheng Zhong, Morgan Stanley, Research Division – Associate [7]

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And if I may, I want to ask, what’s the current transition rate of your off-line student to the online? And how do you see the new enrollment? Is it charged? And also, a follow-up for my second question is, what do you see the competition landscape from the AI interactive courses?

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [8]

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Okay. So the first question is how much students moved online? Yes. Sheng, if you see — I think it’s on the slide — let me see, I would say for the first 3 weeks of free trial, most of our students are moved online. The participation rate is from close to 90% at the small age group, and for the higher age group, it’s 100%. For the paid class, as I showed on the slide, right now, we have close to 30,000 students paid for the small online group classes. This is mainly now enrolled in our directly owned centers or the cities, so the participation rate is above 50%. And this is still ongoing, selling in other cities like Shanghai, Guangzhou, Shenzhen, because they started the online small group classes later than Beijing. So that’s the participation rate. In this 30,000 students, we also have brand-new students coming in all over the country.

In terms of competition, we actually take a look of the competitors. We do think the online/off-line — the combined offering is a trend, and some other players are also offering this type of classes. However, I would say there is no fixed program, meaning which way is better. I do think the age group and also educational purpose are different from different players. Therefore, the combined courses, the weight of online versus off-line and also involving AI teachers or live teachers are all different. We think this is the trend. However, there is no so-called direct comparison. Therefore, we will move online and off-line — make a combination suitable to our case and also educational philosophy that RISE has.

I’ll also say, at a very young age, for example, 3 to 4 years old, we still believe off-line is the best way, and online should not be the majority of the learning experience for age 3 to 4.

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Operator [9]

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Your next question comes from the line of Alex Xie from Crédit Suisse.

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Alex Xie, Crédit Suisse AG, Research Division – Analyst [10]

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My first question is based on, I think, I’ve seen 30,000 students enrolled in the paid classes online, and about 54,000 students in the regular classes of fourth quarter. So that doesn’t mean like 60% of students were successfully shifted to online? Or is that a correct understanding?

And secondly, I would like to ask about the new student enrollments in the fourth quarter. It seems that the new student in the fourth quarter, I think it’s still relatively weak compared to the same period of last year. I think that — would you please elaborate more on this one. I think we have already been making some changes in the sales team and then the teachers in the second half.

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [11]

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Okay. Alex, I will answer the first question and Jiandong will answer the second question.

For the online small group classes, I wanted to explain a little bit more. This is actually additional class we offered. It is not part of the regular courses. So the 30,000 students actually paid extra money to take all these classes. So this is a step 1 to move students online. The second step to move, we hope everyone to be online is to recognize revenues through the regular courses. So those online classes will be, I would say, is basically moving the off-line content online and teach the off-line classes online. So this is the second step. Therefore, the 30,000 paid, Alex, as you mentioned, 55%, these people paid extra to take that classes. And later on, we do hope moving everyone online to take the so-called — the online version of off-line classes.

Jiandong, can you answer the second.

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Jiandong Lu, RISE Education Cayman Ltd – CFO, COO & Director [12]

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Okay. Hi, Alex. Let me answer your second question on the new students enrolled in the fourth quarter. It looks a little bit weak as compared to the quarter of the prior year. So roughly, it’s a 5.1% drop. Actually, 2 reasons for that. The first is, if you look at the calendar, in the third quarter, particularly in September, normally, enrollment happened during the weekend. And in September, there are actually 5 weekends in September. And so they somewhat advanced the enrollment in the third quarter than what should have happened in the fourth quarter. So if you look at the numbers in the third quarter, the students enrolled in the third quarter, year-over-year basis, the increase is actually close to 15% increase.

And then back to the drop in the fourth quarter. I should say that the conversion rate in the fourth quarter dropped — are slightly lower as compared to the third quarter. That’s one of the key reasons that actually drive total enrollments, new student enrolled in the fourth quarter are lower. So that basically explains the weaker enrollment in the fourth quarter of 2019.

As Lihong explained, so as soon as she joined the company and she launched the Pioneer Project, which will address the conversion issues. And we already set the target for the year 2020, and we believe we’ll be able to achieve that.

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Operator [13]

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(Operator Instructions) Your next question comes from the line of Alex Liu from China Renaissance.

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Zhangxiang Liu, China Renaissance Securities (US) Inc., Research Division – VP [14]

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Just very quickly, could the management share some observations on how are our off-line competitors are doing during this tough period? And how is our company’s strategy on industry consolidations going forward?

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [15]

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So just wanted to make sure I got your question right. So you’re asking how our online competitors doing during the outbreak? Is that the question?

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Zhangxiang Liu, China Renaissance Securities (US) Inc., Research Division – VP [16]

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Sorry, it’s off-line competitors are doing.

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [17]

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Off-line competitor. Okay. I would say that the bigger companies all made efforts to move classes online. As we can see, some of them are using more aggressively, moving online than others. Basically, I do think the first week after Chinese New Year, people trying to figure out the technological issues. So most of the competitors offer free content kind of outreach to parents. And then some launched the online classes earlier than us. Some later. Some did not even have the capability to offer online classes.

The second difference is, some people use the third-party platform, use the content sourced by the third party. It is really kind of an emergency measure. They — the courses may not be consistent with the core curriculum, and the platform also is the outsource. For us, we do think the courses, also the technological capability are strategically important to us. So we think, even we took 1 week longer than all sorts of content and rely on third-party platform, we feel we built the content very solidly and also upgrade our technology capabilities for the long run as well.

The last thing, the difference could be some people move the so-called off-line regular classes online directly. Therefore, they — in some ways, start to recognize revenue from the regular courses. And for us, we took a different approach because we do think this is the first time that our students are online, and they need to get used to the online learning experience. Therefore, we created a specific online program, which is lighter, more suitable for the first 2, 3 weeks and then also sell that in March. And later on, we feel both the students and also our teachers would be used to the online teaching and learning experience. Therefore, we can move our off-line classes online. Off-line classes are, I would say, content-heavy, need more interactions. So the step is, first, lighter online classes, and then move off-line classes online. Different companies use different approaches. But I think, really, you need to think about the suitability, the experience online and also your key purpose. Our key purpose, first, is to retain students. No refunds during the COVID-19 outbreak. Second is to provide a good learning online experience. The third is really move off-line classes online so they can continue the learning as they scheduled.

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Operator [18]

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(Operator Instructions) There are no further questions at this time. Ladies and gentlemen, this will conclude today’s conference call. Thank you for participating. You may now disconnect.

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Lihong Wang, RISE Education Cayman Ltd – CEO & Chairwoman [19]

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Thank you very much.