Rise Education Cayman Ltd (REDU) Q4 2018 Earnings Conference Call March 14, 2019 8:30 PM ET

Company Participants

Mei Li - IR
Jiandong Lu - CFO, COO & Director
Yiding Sun - CEO & Director

Conference Call Participants

Alex Xie - Credit Suisse
Sheng Zhong - Morgan Stanley
Yuzhong Gao - CICC
Felix Liu - UBS Investment Bank

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the RISE Education Fourth Quarter Full Year 2018 Earnings Call. [Operator Instructions]. I must advise you that this conference is being recorded today, Friday, 15th of March 2019. I would now like to hand the conference over to your first speaker today, CEO of RISE Education, Mr. Yiding Sun. Thank you. Please go ahead.

Mei Li

Thank you, everyone, for joining us today. I will read CEO Yiding's prepared remarks for him in English. We are happy to close off the year strongly by beating our expectations on both top and bottom line growth for the fourth quarter and full year 2018. This demonstrates our strong organic growth momentum. We've made a number of adjustments to our marketing strategy during the second half of 2018, which resulted in the number of student enrollments for full year 2018 increasing by 42.2% to 73,054 when compared to 2017. Our students retention rate remained high and stable at 70% in 2018, which is a testament of our dedication to customer service and parent satisfaction.

I believe this result speaks to our - these results speak to our strategic foresight, ability to rapidly adapt to a changing environment and the strength and quality of our education program. We made significant progress throughout the year as we continue to benefit from the strong demand for junior ELT in China. I'm also pleased with our team's ability to rapidly assess and adjust our operations to the new regulations. During the quarter, we added 35 new learning centers, including four self-owned learning centers and 31 franchised centers, making it an expansion of total 12 self-owned learning centers and 98 franchised centers on a net basis for the full year of 2018. Our education network now spans across 130 cities in China and is comprised of 76 self-owned learning centers and 304 franchised learning centers. We are confident in our ability to continue effectively executing on our expansion strategy and remain on track to drive robust organic growth. In 2019, we expect to add at least 11 self-owned learning centers and 50 to 60 franchised learning centers. While adding new centers will add pressure to our margins in the short term, maintaining the rapid pace of our network expansion is key to driving sustainable enrollment growth and gaining more market share.

We will continue to strike a careful balance between maintaining our operational efficiency and opening new learning centers that are fully compliant with the new regulations in 2019. Acquiring franchised learning centers into our self-owned network continues to be a key growth strategy in 2019. The acquisition of our franchise business in Shijiazhuang announced earlier has progressed well, and we expect to consolidate Shijiazhuang financials later this year as long as we obtained all the government approvals. We closely monitor markets we already have a leading market position. Currently, we are in discussion with a couple of other candidates and are likely to see meaningful progress soon. We are also attracting more students to our learning centers by showcasing our educational products to children in select K-12 schools. We are working with several public schools to have students there improve their English performance.

The strong test scores of students that were taught by RISE have impressed both school faculty and parents, who are amazed at how easily our quality - our engine education can improve results. We are also proactively looking for opportunities to form strategic partnerships that are complementary to our service offerings, student demographics or existing student acquisition channels.

On the product development front, in 2019, we will focus on reinforcing our distinct competitive advantage in course products. We continue to develop innovative educational products, and in particular, online, off-line integrated course products. We recently completed a full upgrade of our case three level courses, which has a broader version one technology to a version two. Designed with the students' needs in mind, the new course will encourage students to explore, cultivate their critical thinking capabilities and develop leadership skills.

I am particularly pleased with how our premium SSAT-related preparation courses have performed over the past year. We organized another elementary level SSAT test during the quarter for 400 students from nine cities across China, including Beijing, Shanghai, Tianjin, Changchun, Jinan, Suzhou, Hangzhou, Wuhan and Chengdu, where students who received the top scores placed in the 99th percentile of all SSAT test takers globally over the past three years. Among all SSAT test takers across China in 2018, 5 out of 8 students who obtained a score of 1,700 or higher out of 1,800 came from RISE learning centers. These results speak to the quality of our premium courses.

At the same time, The Edge had established their team in Mainland China that will provide RISE students with admission, consulting services from secondary schools through to graduate schools. Now moving to our nationwide branding event of 2019, we recently kicked off the ninth Rise Star contest of the year, where we work with the national Intangible Cultural Heritage Research Institute, to provide different discussion topics per case in each age group. Participants work in teams to create a short video and promote their video work online. This event was designed to develop students project management skills, English presentation skills as well as their sense of social responsibility. Up to now, over 76,300 students have signed up for the Rise Star contest, and close to 50,000 have submitted their entries. The number continues to rise as registration continues. During the Rise and Transform, our contestants produced a fun video titled A Foreigner's Guide to Eating Yuanxiao, which went viral on social media. This humorous video featured a RISE student explaining how to eat yuanxiao correctly in English. The video was viewed over 3.6 million times. The hashtag also became the second most popular food topic to trend on Weibo, where it's generated over 35 million views and 34,000 comments. We believe successful branding events such as the Rise Star contest not only drives growth in new student enrollment, but also strengthens RISE brand value.

On the technology front, we continue to invest in strengthening the technology that support our education network. During the quarter, we launched Rise Club, which is an in-house development online platform that offers after-class learning experience and facilitates the parents' supervision and the efficient communication between our teachers, parents and students. In its current iteration, Rise Club provides teaching learning management and evaluation activities. Future update iteration, we will leverage intellectual - will leverage intelligent technologies to enrich the platform with automated features that are highly customizable to each student. So far, over 40% of enrolled RISE students have downloaded and used the mobile application. In 2019, we will execute on our strategy of leveraging our investments in science and technology to scale our education services and upgrade our teaching quality and operations to in-house students learning efficiency.

The market for junior English training remains strong given Chinese parents' commitment to ensuring a good education for their children. During the recent Achieve sessions meetings in Beijing, China's government outlined its goal to make education more equally accessible and ensure higher quality and to expand the preschool educational offerings through emerging China's policies for 2019.

In order to capitalize on the opportunities created by these series of favorable policies and support, we will continue investing in sales and marketing to attract new students while simultaneously enhancing our customer service to retain existing students. With our stable retention rate, premium reputation and compliant practices, we believe our marketing initiatives will generate the best value and further enhance our brand recognition in China's junior ELT industry.

In conclusion, I'm extremely pleased with the progress we made during the quarter. The demand for junior ELT remains strong. We will continue to accelerate on our expansion strategy, we'll monitor opportunities of acquisition and strategic partnership that will either strengthen our service offerings or broaden our user acquisition. We will continue to invest in our technology, product development and selling and marketing. Our goal for 2019 is to enhance our brand and curriculum and leverage our investment in science and technology to improve our services, teaching and operations, which we believe will allow us to offer better services and improve the educational experience for both students and parents. Our efforts will, in turn, help us consolidate our leading position in China's junior ELT market and deliver long-term sustainable value to our shareholders.

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

Jiandong Lu

Thank you, Mei, and hello, everyone. Now I would like to go through our financial highlights for the fourth quarter of 2018. Before I begin, please note that all numbers stated here are in RMB terms. In the fourth quarter of 2018, our total revenues increased by 30.1% year-over-year to CNY354.2 million from CNY272.2 million in the same period last year, beating our guidance of a 28% growth rate. This was driven by a 26.7% year-over-year increase in revenues from our educational programs to CNY316.5 million in the fourth quarter of 2018.

Growth was primarily attributable to a significant increase in the total number of student enrollments for our regular courses operated by our own self-learned - self-owned learning centers. Other than the stable and high retention rate of 71% we attained this quarter, the increase was also driven by an increase in the course price, which became effective on January 1, 2019, in Beijing. We expanded our self-owned learning center network from 62 as of December 31, 2017, to 74 as of December 31, 2018, excluding two from The Edge Learning Center.

Franchise revenues increased by 65.9% year-over-year to CNY28.2 million in the fourth quarter of 2018. The increase was primarily attributable to a steady growth of recurring franchise fees and the increased number of franchised learning centers, which totaled 304 as of the end of December 2018 compared to 2,000 - 206 by the end of December 2017.

Other revenues increased to CNY9.4 million in the fourth quarter of 2018, up by 74.4% year-over-year from CNY5.4 million in the same period last year, primarily due to the growth of the revenue contribution from The Edge. Cost of revenues for the fourth quarter of 2018 increased by 16.3% to RMB150.3 million from RMB129.3 million during the same quarter of last year. Non-GAAP cost of revenues for the fourth quarter of 2018 increased by 34.5% to RMB146.4 million. The increase was primarily due to an increase in rental costs associated with the company's expansion and personnel costs associated with the increase in teachers headcount and total teaching hours at the company's self-owned learning centers.

Gross margin for the fourth quarter of 2018 increased by 42.7% year-over-year to CNY203.8 million. Gross margin improved to 57.6% during the fourth quarter of 2018 compared with 52.5% in the same quarter of last year. Non-GAAP gross margin was 58.7% compared with 60% in the fourth quarter of 2017. Selling and marketing expenses for the fourth quarter of 2018 was CNY69.5 million, an increase of 12.6% year-over-year from CNY61.7 million. The increase was primarily due to an increase in marketing channel expenses and personnel costs associated with the company's expansion of self-owned learning centers and the growth in students enrollment.

Selling and marketing expenses as a percentage of total revenues dropped by 3% year-over-year, which positively contributed to our fourth quarter EBITDA margin. In order to maintain our growth momentum, we'll continue our investment in selling and marketing expenses in 2019. General and administrative expenses decreased by 40 - 64.6% year-over-year to CNY74.4 million for the fourth quarter of 2018 from CNY210 million for the same quarter of the prior period. The increase was mainly attributable to share-based compensation expenses of CNY69.2 million and IPO-related and one-off expenses of CNY81.8 million recorded in the fourth quarter of 2017. Non-GAAP revenue and administrative expenses accounted for 18.5% of total revenue in Q4 2018, a decrease from 21.7% in quarter 4 2017.

Our operating income for the fourth quarter of 2018 was CNY60 million, excluding the impact of share-based compensation expenses, IPO-related expenses, one-off expenses and amortization of certain intangible assets acquired as a part of 2013 acquisition, non-GAAP operating income for the fourth quarter of 2018 increased by 45.6% year-over-year to CNY76.4 million. Non-GAAP operating margin in quarter 4 2018 rose by 230 basis points to 21.6% from 19.3% in Q4 2017. Adjusted EBITDA during Q4 2018 increased by CNY22.9 million to CNY91 million, an increase of 33.6% from CNY68.1 million in Q4 2017. Adjusted EBITDA margin was 25.7% in Q4 2018, an increase of 70 basis points compared with 25% during Q4 2017.

Net income attributable to RISE for quarter 4 2018 was CNY31.5 million compared with a net loss of CNY138 million from quarter 4 2017, mainly attributable to the share-based compensation expenses and IPO-related and one-off expenses incurred in Q4 2017.

Non-GAAP net income attributable to RISE for Q4 2018 increased by 45.9% year-over-year to CNY47.9 million from CNY32.8 million for Q4 2017. Non-GAAP net margin attributable to RISE increased to 13.5% during the quarter from 12.1% for the same quarter of the prior year. Basic and diluted net income attributable to RISE per ADS were CNY0.55 and CNY0.54, respectively, for the fourth quarter of 2018. Basic and diluted non-GAAP net income attributable to RISE per ADS were CNY0.84 and CNY0.83, respectively, for the fourth quarter of 2018.

Turning to our cash flow performance in this quarter. We generated CNY72.5 million positive cash flow from operating activities during quarter 4 2018 compared with CNY14.7 million in the same period of prior year. The increase was mainly attributable to the prepaid tuition fees from our growing student enrollment and the impact from one-off operating expenditures which were incurred during the fourth quarter of 2017.

As of December 31, 2018, the company had a cash and a cash equivalent and restricted cash of CNY1,316.8 million compared with CNY1,084.9 million as of December 31, 2017. As of December 31, 2018, total deferred revenue and customer advances were CNY1,038.8 million, representing an increase of 27.8% from CNY812.8 million as of December 31, 2017. Even though we have begun collecting tuition in installments to comply with new government policies, we still see the increase in our deferred revenue, which was primarily due to higher prepaid tuition fees from growing students enrollment and more initial franchise fees from our franchise partners.

Now let me provide you with our 2019 guidance. For the first quarter of 2019, we expect our total revenues to be in the range of RMB330 million to RMB335 million, representing a year-over-year growth of approximately 22% to 24%. For full year 2019, we expect our revenue growth to be approximately 25%. This forecast reflects our current and preliminary view on the market and operational condition, which are subject to changes.

This concludes our prepared remarks. Operator, we would like to open up the call for questions from our audience. [Operator Instructions]. Operator, please proceed.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from Alex Xie from Credit Suisse.

Alex Xie

[Foreign Language]. I'll translate by myself. So my first question is about the sales and marketing expenses, as a percentage of revenue, obviously, decreased in this quarter, and sales and marketing expense per student enrollment also decreased. So could management share the outlook for 2019 on sales and marketing expenses and margins? And my second question is about the first quarter '19 guidance. The guidance implied larger seasonality impact, I think, from fourth quarter compared with last year. So could management explain the reason behind such guidance?

Jiandong Lu

Thank you, Alex, for your questions. This is Jiandong. I'm going to answer your two questions. The first one, sales and marketing expenses as a percentage of revenue dropped in quarter 4 2018. If you look at the sales and marketing expenses in absolute dollar amount, which actually increased roughly about 13% compared to the same period last year. If you compare the same period, the revenue growth, actually our revenue growth, at a much higher degree in the fourth quarter of 2018 versus the 2017, which is roughly 27 - more than 27%. So which explains partly why the total selling and marketing expenses as a percentage of revenue in Q4 dropped. Meanwhile, as we stated in our Q3, we increased our investment in selling and marketing expenses starting from Q3 2017.

We started testing a few new online channels, and we collected more data in Q3, which give us a better understanding of the effectiveness of different channels. And we can do a much more effective targeted marketing by using the channels in a more effective way, which actually increased the return in our investment in selling and marketing expenses. And the other factor contributing to a drop in selling and marketing expenses as a percentage of revenue is because we actually maintain a pretty steady selling team, sales team in quarter four, which actually increased our conversion rate. So in short, I will summarize in 3 points. One, because the investment in selling and marketing expenses in Q4 2018 actually drives a much higher growth degree for our Q4 revenue; and second, because our investment in online marketing channels are more effective, which generates better quality leads, and that increase the return on our investment in selling and marketing expenses. Meanwhile, we maintain quite a stable sales team, which increased our total conversion rate. So in short, that explains the drop of the selling and marketing expenses as a percentage of revenue.

However, given the overall understanding of the market computation, we still feel we need to further - in order to further maintain our growth momentum and further increase our total student enrollment, we need to further increase our investment in selling and marketing expenses. So we'll kind of maintain our investment in selling and marketing expenses and keep it as a steady percentage of our revenue in 2019. Sorry to be wordy. So for question 2, for our Q4 - Q1 guidance 2019, I would say that in the second quarter of 2018, we were hit by the market pressure. And our total enrollment of new students in the second quarter of 2018 as well as in Q3 2018 was somewhat increased, but not at an expected degree, when it's all those enrollment study to recognize revenue in Q4, which lead to a lower revenue recognition in Q1. So that somewhat explains why our Q1 revenue increase is a bit lower. Did I answer your question on the second one?

Alex Xie

Yes, I think it's okay. And may I have a follow-up about the sales and marketing expenses? I think in 2018, the online channel sales and marketing expenses per student increased significantly. So do we see the selling and marketing expenses in online channel per student go down in this quarter? And will it continue to go down in 2019?

Jiandong Lu

In terms of online cost - online channels, the cost still remains pretty high. It remains almost the same as our Q4 2018.

Operator

Your next question comes from Sheng Zhong from Morgan Stanley.

Sheng Zhong

[Foreign Language]. And I will translate by myself. I have three questions here. One is, can management share the guidance for next full year on the new learning center expansion plan and the margin outlook? And secondly is, the franchise business, franchised learning centers opened faster than I think the - than originally planned. So can management share more color on the reason and management view about the lower tiers - Tier 2 and the lower tier cities' demand for the junior English language learning? And third one is about the enrollment growth in the fourth quarter. That is a very fast growth, and understand part of the reason is push ahead because of tuition fee hike. So I want to know roughly how much is pushed ahead on the future's register.

Mei Li

Thank you for your question. I would like to answer your first two questions then defer the third one to Jiandong. For the first two questions, in 2019, we are planning to add at least 11 new learning centers of our - into our stuff on the learning network. And in terms of the franchised learning centers, we plan to add 50 to 60 new learning centers. And we would like to maintain our strong growth rate in - for this whole year. Second question about the faster growth of our franchise business, I think that's because of our franchise partners, they have more confidence that actually their confidence is even stronger than before. Right now, we have, on average, around five franchised learning centers in each local city.

Jiandong Lu

Okay. Zhong, let me answer your question about the margin and also the preregistered renewed students. On the margin question, I would like to take the margin question from a different angle. As a growing company, we managed to maintain pretty high EBITDA margin, delivered in 2018 above 25%. At the same time, we maintain about 30% top line growth. So going forward, while we continue to pursue our expansion strategies, and it's going to - as CEO stated in his script, it's going to give us a short-term pressure on our margin. I can give you an example. In 2018, we opened a total of 12 new learning centers. And all the 12 learning centers combined actually contributed a negative EBITDA of close to USD 30 million - RMB30 million. So assuming that we haven't opened all these 12 new learning centers, which would have given us additional RMB30 million EBITDA, which would make our 2018 EBITDA RMB330 million instead of RMB300 million. And getting into 2019, we are going to open another 12 - 11 new learning centers. So you can calculate either way from our total group EBITDA by how much percentage. So the other, generally, for our new learning centers, it's going to take roughly like 16 to 22 months for the EBITDA to break even.

So combined these two factors, I would say in pursuing the growth strategy, it's going to give us pressure in short term on our EBITDA markets, but long term, we'll be able to sustain the EBITDA growth. So in terms of selling and marketing expenses, as I stated when I answered the first question, in 2019, we'll continue to invest in selling and marketing expenses. And in terms of the percentage revenue for selling and marketing expenses, which is going to be slightly higher than the whole year 2018. I hope you've got enough information on the margin guidance. On the students, preregistered students, because of the course price rise, it's only affected the students in Beijing because we launched the new course price effective January 1 only in Beijing. So that's only affected enrollment of renewed students and also the new student - renewed students as well as the new students for students in Beijing. I don't have the percentage, but I can share with you a rough number. So based on our regular renewed students pay, we will have roughly 1/3 left of the students registered in the fourth quarter. Did I make myself understood or no?

Sheng Zhong

Yes, that's very helpful. But can you repeat the last sentence again? How much is retained from last quarter?

Jiandong Lu

Okay, excluding the course price increase factor, and we probably would have 1/3 less renewed students registered, only for the renewed students. We will - it doesn't affect our enrollment for new students.

Operator

Your next question comes from Yuzhong Gao from CICC.

Yuzhong Gao

[Foreign Language]. I'll translate myself. The first question is on the magnitude of the price hike we mentioned starting from January of 2019. The second question is we have started the three months prepayment tuition collection policy for a while. I wonder if that is going to impact our retention rate. And the cost-driven question is how do we calculate our retention rate in a given quarter? The third question is, we just mentioned our acquisition for franchised learning network in - network in Shijiazhuang. I wonder on the size of this franchised learning center, and how is that going to impact our financials? And lastly, when we define - when we evaluate how and where to acquire a potential learning center, what criteria are we adopting?

Mei Li

Let me answer your first question. Typically, we will raise the price of all our courses provided by some of our learning centers from April 1 every year. But this year, because we have a new regulation policy in terms of the tuition collection in installments, so we, in Beijing, we start the price increase from January 1, 2019, earlier than our normal date, and we raised price in Beijing by 7%, a little bit higher than the normal range. And for your second question, from December, we gradually - from December, we start to change our tuition collection policy in Beijing and in Wuxi. And from March this year, from March 2019, we started to see the students start to renew their courses. Currently, based on our observation, the renewal rate is pretty good. It's almost 100%. But that is to say, we do not see any negative impact from the change of our tuition collection policy.

So that means we will maintain our stable and high retention rate over 70% as before. For your third question, it's for the acquisition of Shijiazhuang we announced earlier, this acquisition has progressed well, and we expect to consolidate its financials later this year as long as we obtain all the government approvals. Going forward, when we look at other acquisition opportunities, we will consider - we will look at some key indicators, the first, of course, is the scale of - in each local city, the scale of the franchise business of each local city or number of learning centers in each franchise cities. And the second one, the brand value, and of course, it includes the number of student enrollment in that city and the academic capability of that franchise partner in that local city. So I'm very confident that based on our discussion with a couple of the partners right now, their intention is pretty clear. We always see the sincerity, their strong intention. So I'm sure that it's likely to - we are likely to see meaningful progress quite soon.

Operator

Your next question comes from Felix Liu from UBS.

Felix Liu

[Foreign Language]. Two questions from me. Number one, the deferred revenue growth was 27% year-on-year, which is faster than the revenue guidance over the next year. So could management give more color on the difference between the growth number? Second question is on regulation. Can management give an update on the compliance status of the learning centers and teacher licensing?

Jiandong Lu

Felix, let me answer your first question, deferred revenue. From our ER, you can see that in our fourth quarter, our total number of students in enrollment increased quite dramatic, by 80%, 85%, right, 85%. So excluding those short-term courses, by only looking at our regular courses operated under the self-owned learning centers, the increase will be roughly 75%. It's actually much, much more higher than we expected earlier. So that's the primary reason, which actually increased our deferred revenue beyond our guidance. Mr. Sun will answer the second question.

Mei Li

For your question about the certification, we do see the regulation on the certification of teachers and learning centers is higher - is higher and higher. For the teachers certificate, we always - try always to proactively prepare to meet the new requirements of the government. And so we always encourage our teachers to take the test, and we give them the training and other supporting services to help them to get a certificate. And also, internally, we have a compensation structure to well reward those teachers who can get their certificate. For the learning center, we noticed that the government increased the requirement in terms of - increased the requirement for the premises and fire protection requirement. We will always support governments efforts, the government requirements.

So we will try our very best to meet all those requirements and get - the best premises, the best commercial premises of our learning centers. Again, we fully support government's efforts, and we do believe that a pure and definitive regulatory environment will have a positive impact on the whole education industry. New policies continue to enhance the overall educational experience, and we'll help - it will help support a healthy and a sustainable growth of the education market over the long term. The new regulations increased the barrier to entry and are gradually weeding out the education companies that are financially weaker and unable to maintain compliance standard, leaving only the best operations remaining. For RISE Education, we always have the highest - we always give the highest requirement to meet all the governmental requirements, and we have the strong brand name across the whole China. So we feel that we will benefit from the education policy reforms.

Operator

[Operator Instructions]. There are no further questions at this time. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.