NaaS Technology Inc. Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the RISE Education First Quarter 2020 Earnings Call conference. Please be advised that today's conference is being recorded. I now like to hand the conference over to your first speaker today, Ms. Mei Li. Thank you. Please go ahead.

Thank you, Operator. Hello, everyone, and welcome to RISE Education First Quarter 2020 Earnings Conference Call. Today, you will hear from Ms. Lihong Wang, Chairman and CEO; and Ms. Jiandong Lu, CFO. Ms. Wang will go over recent business updates, operations, and the company's long-term strategy, Ms. Lu will go over the financial results of the quarter. Both will be available to take your questions in the Q&A section that follows. 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 results to materially differ from those in the forward-looking statements, please refer to our Form 20-F filed with the SEC on April 17, 2020. We do not assume any obligation to update any forward-looking statements, except as required under applicable law. Throughout today's call, Ms. Wang and Mr. Lu will be referring to the earnings presentation that has been uploaded to our IR website as a supplement to today's call. Now I'd like to turn the call over to Ms. Lihong Wang. Lihong, please go ahead.

Thank you, Mei. Hello, everyone. Thank you for joining our earnings call. I'd like to begin by expressing our deepest sympathy to everyone across the globe that has been impacted by the COVID-19 pandemic. We sincerely hope that the situation improves quickly and allows everyone to return to work safely. I'd like to begin my remarks on Slide 3. The outbreak of COVID-19 in January 2020 had a significant and material adverse impact on our operations during the quarter. In accordance with government regulations to contain the outbreak, RISE learning centers were temporarily closed starting on January 19, 2020, and all our self-owned learning centers remain closed as of today. This has adversely impacted our ability to generate cash and GAAP revenue from regular courses and limited our ability to market our services and acquire students through our learning center network. While we have resumed online operations, the extent of the disruption on offline operations and the related impact on our financial and operational results and outlook depend on the further development of COVID-19 as the global pandemic. Before going into details, however, I would like to make three key points regarding our business. First, we have ample liquidity to make it through this extended period of uncertainty. As of March 31, 2020, we had RMB 925.1 million in cash, cash equivalents, and restricted cash. Second, we can run our business smoothly both online and offline. With the resumption of regular courses online, we achieved a participation rate close to 90%, meaning most of our students are learning online with their teachers from offline learning centers before the pandemic. Third, we are transforming into an online merging offline model. We also expanded our classes beyond English. So the OMO model, which is developing as we speak. Turning to Slide 4. Over the Chinese New Year holiday, which marks the beginning of China's shutdown, we immediately began strategizing a roadmap to navigate this challenging environment. The first stage is to stabilize our business by controlling costs and reserving ample liquidity. The second stage is to optimize our business by conducting our business online and enhancing digitalization capabilities. Now we are in a transformation stage to pursue our long-term strategy to transition into a digitalized cross-disciplinary skill-based OMO educational platform. I'd like to begin by addressing our efforts during the quarter to stabilize our business and offset the impact from the pandemic through targeted cost controls and adjusted capital expenditure and liquidity plans to reserve cash. With limited visibility on when our offline operations will be able to resume, we immediately rolled out a series of initiatives to cut rental, personnel, and overhead costs, which are laid out on Slide 5. We negotiated hard with all our landlords for rental concessions, and we were able to obtain a roughly 20% cut in monthly rents which will remain in effect until learning centers are able to reopen. At the same time, we began prolonging underutilized and unutilized support staff, restructured compensation schemes for management, reduced social security contributions by RMB 8 million per government policies, and strengthened the support we offer frontline teachers and sales staff to ensure business continuity and higher productivity throughout the period of disruption. This resulted in personnel costs falling by approximately 23% sequentially. Overall, G&A expenses fell by 35% sequentially during the quarter. Turning to Slide 6. You can see the measures we have taken to manage and preserve cash. Following a careful assessment of our expansion plan for the year, we rescheduled the openings of certain new learning centers to 2021, which will allow us to substantially reduce capital expenditure from the original RMB 140 million to less than RMB 50 million throughout 2020. The cutback on physical learning center rollout will not impact our growth going forward. The growth can be driven by a combination of ramping up the existing offline classrooms, leveraging our OMO model to free up capacity and adding online classroom capacity. The new OMO model will improve capital expenditure efficiency. Turning to Slide 7. The disruption to the cost of normal work business by the pandemic has compelled us to accelerate the execution of our strategy to digitalize our operations by moving OMO sectors online, including marketing, teaching, training, and communications with parents and students. As I laid out during last quarter's call, our IT team was able to transform Rise+ into a robust open technology platform that is capable of supporting interactive online teaching nationwide within 20 days. This was followed by the official launch of online small group classes for our existing and new students in late February, which we began monetizing in early March. As of March 31, 2020, approximately 127,000 students across 144 cities had taken online small group classes. We also leveraged Rise+ to provide over 40 online training sessions to over 20,000 teaching and sales staff in franchised learning centers during the quarter. Rise+ rapidly proved to be a reliable, stable, and solid foundation for us to transition all regular courses online in late April. I'm proud to say that in just under four months, we have been able to successfully build and launch an online platform and online products that offer a truly unique value proposition and experience to an increasing number of students who choose to resume their courses online. On Slide 8, we've laid out the tangible results from moving our business online. We did not simply move our regular offline courses online; we actually modified our regular courses by adding sessions with foreign teachers and created pure online small group classes to supplement our existing students or students who prefer online courses only. The first online small group classes were launched in early March and have enrolled over 31,000 students and generated RMB 38 million in cash revenue. The second significant effort was to resume our regular courses online. The overall participation rate is close to 90%, which reflects the trust and loyalty our customers have in our brand and service online. In early May, we started to sell the dual-teacher small group courses. This is purely online, and we are likely to continue this going forward. I believe these solid initial results reflect our ability to offer high-quality classes and services online. There is enormous growth potential ahead of us as we scale up our online efforts and further accelerate our digitalization strategy. On Slide 9, you can see that RISE has a strong brand, unique curriculum, deep academic capabilities, and 13 years of proven educational experience and results. This pandemic has also helped RISE to build a proprietary technology platform suitable for online teaching and learning, training thousands of teachers that can teach both online and offline. All these position RISE well to be an OMO, Online-Merge-Offline player, as we have experienced ourselves, as the brick-and-mortar model has seen growth slowing down due to strong competition from online players and the disruption impact from the pandemic. At the same time, most of the pure online players still haven't figured out the economic model yet and often suffer from high acquisition costs and weak unit economics. The OMO model allows us to utilize our strong presence offline and online and combine it with our core competitive advantages in curriculum development, a nationwide student base of over 130,000 students, and a proprietary platform to emerge from the pandemic, bigger, better, and stronger and drive our transformation into a digitalized cross-disciplinary and skill-based OMO educational platform. On Slide 10, we've outlined the two steps that will drive this transformation. First, delivering courses online; and second, completing our digital transformation. As part of step 1, we will strengthen our core OMO curriculum by migrating portions of our offline regular courses online, freeing up space in our offline learning centers to enhance utilization and improve our return on capital expenditures. We will then diversify our product offerings beyond courses taught in English to include STEAM, math, and other subjects to expand cross-selling opportunities and increase average revenue per user (ARPU). Step 2, we will focus on generating higher ROI on digital marketing through social media and word-of-mouth referrals while at the same time leveraging private traffic to reduce customer acquisition costs and improve monetization. This will be followed by leveraging data from across our nationwide network to standardize processes through a more detailed business intelligence system. To help drive our digital strategy to the next stage and navigate our business through its transformation, we have brought on board additional highly experienced and seasoned industry professionals, which can be found on Slide 11. The appointment of Ms. Tai Hui, in particular, as our Chief Operating Officer, is exciting as she brings with her extensive experience in enhancing enterprises' operational excellence and digital transformation, which will be critical for transforming RISE into a digitalized education platform. The strengthening of our management team with a new COO, Head of Strategy, Head of OMO Product Development, and Head of New Media Marketing truly reflects our commitment to building a more digitalized platform. While the pandemic came as a shock to everyone, I'm proud of the progress we have made in stabilizing our business during the quarter and look forward to working closely with my colleagues to further optimize and transform RISE. We understand there is still a lot of work to be done. Strong branding, high-quality curricular and teaching resources, and the ability to offer both online and offline classes, all of which we already have, are critical to thriving in the post-pandemic era of education in China. Building an effective OMO model will ensure RISE's long-term growth and success. We all look forward to the exciting journey ahead. Now I will hand the call to Jiandong to go through the financial results.

Thank you, Lihong. Let me now go through the financial results for the first quarter of 2020. Before I begin, please note that all numbers stated here are in RMB. As Lihong mentioned earlier, COVID-19 caused huge disruption to our business. As an online education company, we rely heavily on our offline learning center network to offer services and market our products to students. Starting in late January, we temporarily closed all our learning centers in compliance with government regulations to contain COVID-19. All our self-owned learning centers remain closed as of today. The temporary closure of our offline learning centers has inhibited our ability to offer offline classes and market our products to prospective students. This has adversely impacted our ability to generate cash and recognize revenue. Our learning centers were in operation for only 18 days in January and were closed throughout the remainder of the first quarter of 2020, which significantly and materially impacted our financial performance for the quarter. Total revenues during the quarter decreased by 67.5% year-over-year to RMB 109 million. The decrease in revenues was driven primarily by a 64.7% year-over-year decrease in revenues from our educational programs to RMB 102 million. Starting this quarter, revenues from educational programs will include revenues generated by Can-Talk, which more accurately reflects our focus and long-term strategy going forward. Revenues from educational programs in previous years have been adjusted for comparative purposes. Revenue from regular courses, namely Rise Start and Rise On, was RMB 74.4 million, the result of just 18 days of offline operations in January. Revenues from other RISE courses, including Rise Up, Can-Talk, and short-term online small group courses, along with courses offered by The Edge, were RMB 27.6 million. Franchise revenues decreased by 84% year-over-year to RMB 6.1 million during the quarter, primarily due to a decline in recurring franchise revenue impacted by the closure of our franchised learning centers since late January. Other revenues decreased by 89.2% year-over-year to RMB 0.9 million, primarily due to the impact of travel restrictions on our study tour services, which have all been postponed to the summer or even a later time. Cost of revenues for the quarter decreased by 7.7% year-over-year to RMB 142.6 million. Non-GAAP cost of revenues for the quarter decreased by 8.1% year-over-year to RMB 138.3 million. The decrease was primarily caused by a decline in business resulting from the COVID-19 disruption. Furthermore, we made rigorous efforts in cutting costs, managing to cut rental expenses by about RMB 8 million, about 13% compared with the last quarter. Personnel costs decreased as a result of the reduction in teachers' headcount and reduced teaching hours during the period. Gross profit for the quarter was RMB 33.6 million compared with gross profit of RMB 180.6 million in the same period last year. Selling and marketing expenses for the quarter were RMB 43.2 million, a decrease of 34.2% year-over-year from RMB 65.7 million. Non-GAAP selling and marketing expenses were RMB 42.2 million, a decrease of 34.8% year-over-year. The decrease is primarily due to the reduced offline marketing activities and reduced personnel costs associated with the sales team downsizing and decreased incentives as a result of the lower enrollment. G&A expenses for this quarter were RMB 54.6 million, a decrease of RMB 11.8 million year-over-year. The decrease was mainly attributable to the reversal of share-based compensation expenses due to actual forfeitures in the first quarter of 2020. Non-GAAP G&A expenses were RMB 55.5 million, a decrease of 6% year-over-year. The decrease reflects our initiatives to cut administrative costs and to offset the adverse impact of COVID-19. Operating loss was RMB 131.4 million compared to operating income of RMB 53 million for the same period last year. Non-GAAP operating loss was RMB 127.1 million compared with non-GAAP operating income of RMB 60.7 million for the same period last year. Adjusted EBITDA loss was RMB 108 million compared with adjusted EBITDA income of RMB 80.5 million in the same period last year. Income tax benefit for the quarter was RMB 19.7 million compared with income tax expense of RMB 18.7 million in the same period last year. Net loss attributable to RISE for the quarter was RMB 103.8 million; non-GAAP net loss attributable to RISE was RMB 99.5 million. Basic and diluted net loss attributable to RISE per ADS for the quarter was RMB 1.84. Basic and diluted non-GAAP net loss attributable to RISE per ADS was RMB 1.76. Turning to our cash flow performance. Net cash flow used in operating activities during the quarter was RMB 82.4 million compared to RMB 5 million of cash generated from operating activities in the same period last year, mainly due to reduced cash collection for our regular courses, which resulted from the temporary closure of our self-owned and franchised learning centers. As of March 31, 2020, the company had a combined cash and cash equivalents and restricted cash of RMB 925.1 million compared to RMB 1,022.8 million as of December 31, 2019. As of March 31, 2020, total deferred revenue and customer advances were RMB 776.3 million, an increase of 2.7% from RMB 755 million as of December 31, 2019. The increase was primarily due to revenue recognition for offline and online courses lagging behind cash collection. As a reminder, starting last quarter, we began reporting the number of students in class and the new students enrolled, which we believe are more accurately reflective of our business performance and provide a more meaningful comparative analysis than the previously reported student enrollment matrix. Please refer to the earnings material we issued for the fourth quarter of 2019 for a more detailed explanation for the change in disclosure. The slide shows as of March 31, 2020, students in class for regular courses, including Rise Start and Rise On programs, was 52,585, an increase of 901 from 51,684 as of March 31, 2019. New students enrolled for Rise regular courses in the first quarter of 2020 were 1,507 compared with 7,406 during the same period last year. The significant decrease in student enrollment is the direct result of the closure of our learning centers throughout the majority of the first quarter of 2020, which severely limited our ability to leverage our offline channels to acquire prospective students. Students enrolled for other Rise courses, which were taught online, including Rise Up, Can-Talk, short-term online small group classes, and other Rise courses provided by The Edge, was 32,494 in the first quarter of 2020 compared with 1,470 during the same period last year. Students enrolled for online small group classes were 31,882 in the first quarter of 2020, with 92.6% of them being existing RISE students. Turning to the next slide. With the effect of the pandemic in China beginning to ease, we expect our performance to gradually improve on a sequential basis starting from the second quarter of 2020. As of April 20, we transitioned Rise Start and Rise On courses online with approximately 90% of our students signing up for the online courses to resume their original academic schedule. We also launched upgraded online small group classes earlier this month, which, combined with the initial online small group classes, are expected to contribute revenue in the second quarter. With back-to-school schedules rolling out in increasing numbers of regions, some of our franchised learning centers in certain parts of the country have already resumed offline business. Taking into account all these recent developments and excluding any potential revenue from our own self-owned learning centers, which are expected to resume operations sometime in the second quarter of 2020, we expect revenue in the second quarter of 2020 to be in the range of RMB 135 million to RMB 145 million. We'll continue exercising rigid controls over cost and expenses going forward, and we also expect our EBITDA loss to narrow substantially in the second quarter of 2020. The second half of 2020 should see our business rebound from the lows of the first half of the year. With that, I would now like to hand the call over to the operator so we can begin the Q&A session. Thank you.

Your first question today comes from Sheng Zhong from Morgan Stanley.

Thank you for taking my question and I am very impressed with your cost savings. My question is on the digital and online strategy. It seems like you accelerated this online movement. So I am wondering what the positioning of the online path is in your overall business? And can you share with us the plan regarding the operation of online including the student acquisition? Is it mainly from existing students or are you targeting more broadly? And related to online student acquisition, my second question is about the sales and marketing spending in the second quarter and maybe the full year. Given the offline in gradual resumption, what are the plans for the summer season marketing spending and longer term? Because we see smaller spending in marketing in the first quarter, but also the new student enrollment is also lower. But I understand it's also because of the coronavirus. Going forward, what’s the plan?

Yes. Sheng, thank you for the question. I will address the strategy of the online business or the OMO model. Then Jiandong can talk about the sales and marketing plan. Sheng, as I mentioned, we are currently able to offer classes both online and offline smoothly. Going forward, our plan is to modify our offline classes into an online/offline combination. The proportion of online will be around 25% to 30%. For higher grades from S1 to S6, we will have 30% to 40% online. For the younger ages K1 and K2, most of the classes will still be offline. To supplement these classes, we will offer what we call targeted enhancement classes, which are purely online with a combination of foreign and Chinese teachers. This is the OMO model. As I mentioned, the online small group classes were quite successful. We have upgraded to a dual-teacher model, so one Chinese teacher, one foreign teacher; the foreign teachers mainly focusing on knowledge as well as listening and speaking parts of language training. Meanwhile, the Chinese teacher will focus on how to complete a project, which is called inquiry-based learning online. This class started selling on May 8. Initially, we target existing students, and we will begin reaching out to prospective students as well. This is a lower ASP and shorter term on pure online classes, which we expect will continue. So this student segment differs from our existing offline students or the future OMO model students, targeting those with a lower spending preference and those desiring pure online classes.

Okay. Sheng, it's Jiandong. Let me address your question on sales and marketing. For the first quarter of 2020, our sales and marketing expenses in total were about RMB 43 million. Half of that was personnel costs related to sales and marketing and the other half was related to marketing branding and expenses. Since all our offline learning centers were closed, we began exploring new media marketing channels. We are monitoring closely the investment in these new channels to maximize the return on investment as well. Since we just started marketing online, it will take time for us to accumulate experience in new media marketing. Looking for the whole year, when business resumes in the second quarter and the second half of this year, we will endeavor to invest more in marketing to increase our total student enrollment. However, we will watch carefully the acquisition cost per student and maintain the marketing investment percentage in line with revenue as we did in 2019.

Our next question today comes from the line of Alex Xie from Credit Suisse.

My first question is about second quarter guidance. Could you please provide a breakdown of your second-quarter guidance? What are the assumptions for regular costs? What is the portion from the new, upgraded online class and what’s the expectation for offline resumption contribution? Secondly, I would like to ask about your head count in terms of teachers. I think in this quarter, you achieved quite significant cost reduction in G&A and sales and marketing, but there's a decrease in personnel costs in COGS. Can you share your thoughts on that? And lastly, regarding the long-term loan with CTBC, have you spoken with the bank? Is there any chance for the bank to allow early repayment, or is there any risk?

Yes. Alex, thank you very much for the questions. I will ask Jiandong to answer the first one, regarding second-quarter revenue guidance and its composition, then I'll talk about headcount. Regarding the CTBC loan, I'll let Jiandong address that as well.

Thank you, Alex. On the guidance, our offline regular course students resumed their studies online starting from April 20. As Lihong explained, the participation rate is around 90% for the senior age group and about 88% for the junior age group, which is much higher than our originally expected. The majority of revenue for the second quarter will come from the resumption of our offline students studying online. In a normal business environment, our offline revenue per month exceeds RMB 100 million. With 90% of students enrolling in online classes, you can do the math—80% of our revenue in the second quarter should come from these online courses. Additionally, we will continue to see revenues from the online small group classes that generated cash revenue of about RMB 38 million recognized in the first quarter, with half of that recognized. The online small group classes are anticipated to contribute approximately RMB 20 million in the second quarter. We also expect a growth in franchise revenues, as the franchised learning centers have already resumed operations covering about 15,000 students. We've not included potential revenue from our own self-owned learning centers in our guidance. Is that clear to you, Alex? We have started conversations with our lender, CTBC, discussing the impact of COVID-19 on our business and the cash burn expected in the second quarter. Our lender has verbally granted approvals to waive our covenants. Regarding the principal repayment of approximately RMB 19.25 million due in September 2020, that will be divided into two installments. RMB 9.25 million will be paid in September, and the balance will be postponed to the first quarter of 2021. Given our ample cash in the bank, we do not foresee any liquidity issues and we remain confident in our ability to sustain operations given the uncertain environment.

Overall, I think the second-quarter guidance is very conservative, as we cannot predict when the self-owned learning centers will open. However, there are guidelines for kindergartens to open in early June in Shanghai and Beijing. We believe that will be the next to resume operations. Regarding headcount, we initially disclosed that by the end of March, our headcount was around 3,700. However, that number is now down to about 3,400, representing a decrease of 15% since the beginning of the year. The government did not allow enterprises to lay off people in February; we started in March and have continued to optimize personnel but have retained our most productive salespeople and teachers. We do see opportunities to later hire better qualified individuals to support growth in the second half of the year.

Yes, Lihong is correct. The total headcount at the end of March was indeed around 3,700, and as of early May, it is about 3,400.

I think we have no further questions on the line today. I would like to conclude today's conference call. Thank you all for your participation. You may now disconnect.