Earnings Call Transcript - NAAS Q2 2020

Operator, Operator

Thank you for joining us, and welcome to RISE Education's Second Quarter 2020 Earnings Conference Call. Please note that this conference is being recorded. I will now turn it over to your first speaker, Ms. Karen Gu. Thank you. Please proceed.

Karen Gu, Moderator

Thank you, Operator. Hello, everyone, and welcome to RISE Education's Second 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 for the quarter. Both will be available to take your questions in the Q&A session that follows. Before we proceed, I'd 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 laws. Throughout today's call, Ms. Wang and Ms. 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. Please go ahead.

Lihong Wang, Chairman and CEO

Thank you, Karen. Hello, everyone. Thank you for joining our earnings call. The first half of 2020 has been, in many ways, one of the most challenging periods we've faced as a business. As we emerge from the tough operating environment caused by COVID-19, we are pleased to report significantly improved results today. Our ability to swiftly transition our regular courses to the online model underpins our performance. Although the majority of the RISE self-owned learning centers were still closed throughout most of the second quarter, our financial and operational performance has shown very positive signs of healthy and encouraging recovery and progress. I will begin my remarks from Slide 3. In Q1, we moved aggressively to transition our services online, control costs and preserve liquidity. During the second quarter, we migrated all of our offline courses online so our students could resume learning. This also allowed us to recognize revenue. We significantly improved our online marketing and conversion capabilities, which resulted in a growing trend of new student enrollment throughout the quarter. At the same time, we also invested in upgrading our team and digital capabilities to be able to operate both online and offline, which will eventually allow us to transition the business into our long-term online-merge-offline, or OMO, model. Let's move on to our financial and operational highlights for the quarter on Slide 4. Revenue was RMB 165 million in the second quarter, up 51% from the preceding quarter and comfortably topping our guidance of RMB 135 million to RMB 145 million. Both adjusted EBITDA loss and net income loss narrowed significantly sequentially. Momentum in new student enrollment brought the total number of new students enrolled for RISE regular courses during the quarter to 3,749, more than double the first quarter number. As of June, we directly operated 88 learning centers nationwide compared with 89 in March 2020. We closed one underperforming learning center in Beijing, and we are in the process of optimizing the utilization of our existing learning centers. Despite adverse times, our franchisee partners had opened 11 new centers by the end of the quarter to bring the total number of franchised learning centers to 397 at the end of June compared with 386 at the end of March. Now on to Slide 5. As you know, in March, we rapidly upgraded our school-home communication platform, Rise+, into an open and interactive teaching platform, developed online courses and launched the small group online classes. By May, all classes had been successfully migrated online. In addition to our regular courses, we launched non-English courses, such as STEAM, an important step towards full deployment of our multidisciplinary model. We also revealed dual-teacher foreign class domestic teacher online small group classes. This small and light online course has supplemented our product portfolio, increased our existing student ARPU and captured a pool of new potential students. During the quarter, we have also taken numerous measures to promote new student enrollment, including expanding marketing channels, adopting innovative marketing tools and offering flexible payment schedules to our customers. As we entered June, our learning centers in Wuxi resumed offline operations first, followed by those in Shanghai, Guangzhou and Shenzhen, which had gradually resumed full operations by mid-July. However, the resurgence of COVID-19 cases in Beijing resulted in continuation of only online classes in Beijing and Shijiazhuang. Our ability to switch courses between online and offline has resulted in a more flexible teaching-learning business model. According to the recent government announcement, we expect to open our learning centers in Beijing and Shijiazhuang at a pace regulated by the local government. Turning to Slide 6. The migration of our regular courses Rise Start and Rise On to online, which started on April 20, was a success as demonstrated by the close to 90% participation rate. The majority of those who decided not to resume regular courses online either signed up for our dual-teacher small group classes or waited for our offline learning centers to reopen. Online class attendance rate was approximately 93%, similar to the rate achieved by our learning centers when students were studying offline. The high participation and high attendance rates demonstrate the strength of our brand and high customer loyalty. From the chart on the right, you can see that almost 100% of our educational program revenue in the second quarter was from online teaching. Moving over to Slide 7. You can see a V-shaped enrollment recovery starting in March driven by strong upward enrollment momentum. This is the result of a number of our new marketing initiatives adopted during the quarter, which included developing new big impact channels such as social media and live broadcasting on various Internet platforms. We have provided intensive training to our sales team to enhance their online marketing capabilities. We have also readjusted the tuition payment scheme and have given customers more payment options. All these efforts have resulted in strong upward enrollment momentum and significantly improved conversion rates as compared to the first quarter. Turning to Slide 8. Our new co-branding program with Kung Fu Panda aims to increase brand awareness, retention rate, and ARPU as well as boost new student enrollment. Additionally, we strategically partnered with early education schools like NY Kids Club, Gymboree, and others to acquire new students at a lower-than-market unit acquisition cost. New students enrolled from these partnerships contributed more than 10% of the total enrollment in the second quarter. Let's move to Slide 9. Our franchisee network remained intact during the COVID-19 crisis, and none of our learning centers closed. All of our franchisee partners got through the crisis safely and stayed in business. We actually added 3 new franchise partners, and our franchisee learning centers even increased from 386 by the end of the first quarter to 397 by June 30. Our franchise revenues doubled in the quarter compared with the first quarter. RISE digital solutions played an important role in supporting franchisee business. More than 800 teachers from our franchised learning centers signed up for training in online teaching, online demos, online marketing via the RISE e-learning system, while more than 40,000 students from our franchised learning centers signed up for RISE online courses via the Rise+ learning platform. Our franchised learning centers started to resume offline operations in May. At the end of July, 92% of these centers had resumed offline activities and teaching. The learning centers which remained closed in some pandemic regions, such as Dalian and Xinjiang, continue to use the Rise+ online platform to provide services to their students. Going forward, we will continue to empower our franchised learning centers with digitalization tools and solutions to help drive their growth. Following this pandemic, we expect to have an even closer relationship with our franchisee partners and build a more trusted and reliable network together. Turning to Slide 10. During this quarter, we have run our schools and classes in multiple ways, sometimes entirely online, sometimes online and offline concurrently, and sometimes fully offline. Our operations technology platform and team have been tested hard and proved to be quite capable, versatile, and resilient. We built a digital curriculum, a teacher course that can teach both online and offline, a technology platform that can support multiple operational scenarios and a management team that can handle complex challenges. These capabilities as a whole are laying a solid foundation for us to fully digitalize and transform our core business. OMO, to me, is not a simple merge of online with offline. OMO is an integrated system, the components of which are illustrated on Slide 11. The 4 key components are: tech-based content embedded into the course system, well-developed and robust infrastructure that supports the operation of multiple instances, an extensive product portfolio that can support both online and offline student acquisition, and individualized teaching and learning both online and offline. Our OMO model will be built on RISE's core competency, which are our unique curriculum with proprietary content course system catering to students from age 3 to 18, our strong brand influence, and our extensive nationwide network. In the near term, we will optimize our OMO with 2 initiatives: to increase classroom capacity and improve utilization. Our first initiative is to optimize class scheduling and class size, which will start in the third quarter. The second initiative is migrating part of our offline teaching content online with foreign teachers so students can take weekday classes online. The combination of both initiatives will increase classroom capacity by more than 50%. This significant productivity improvement will help support meaningful near-term growth without opening new offline centers and will increase margin and profitability in the future. During the second quarter, we continued to invest in upgrading our human capital by proactively targeting talented personnel. Many of our new hires have extensive experience in technology and the Internet industry and will be an integral part of accelerating our digital transformation. In summary, we made significant and encouraging progress in the second quarter as our business recovered from a challenging start of the year. Although there is still uncertainty due to the unpredictable nature of the pandemic, I believe RISE has emerged as a stronger OMO educational platform provider in the Chinese education market post COVID-19. We are determined to accelerate the implementation of our transformational strategy. I'm fully convinced that RISE will be able to create a truly unique version of the OMO model to drive sustainable growth and profitability, therefore increasing shareholder value in the long run. I will conclude here and would like to invite our CFO, Jiandong, to talk about our second quarter financials.

Jiandong Lu, CFO

Thank you, Lihong. Let me now go through our financial results for the second quarter of 2020. Before I begin, please note that all numbers stated are in RMB. As expressed by our Chairwoman Lihong, we are indeed very excited to see a very strong and encouraging recovery of our business in the second quarter. And we are also very pleased to see that our momentum continued into the second half of 2020. We are proud of how we responded to the crisis by rapidly upgrading our digital capabilities as we executed a smooth transition from offline to online in April and then from online to offline in June. Such accomplishment has made us more confident than ever in our ability to successfully transform our business into an OMO model. Turning to Slide 12. Total revenues for the second quarter of 2020 increased by 51.4% quarter-over-quarter and decreased by 55.1% year-over-year to RMB 165 million. Revenues from educational programs increased by 48.5% quarter-over-quarter and decreased by 53.7% year-over-year to RMB 151.5 million. The quarter-over-quarter increase in revenues from educational programs was primarily due to most of our offline regular course students resuming their studies online starting late April 2020. In addition, our online small group classes continue to contribute to revenue in the quarter. Our self-owned learning centers located in Shanghai, Guangzhou, Shenzhen, and Wuxi have reopened starting in June 2020 at a pace regulated by the government. Therefore, their contribution to revenue was rather small this quarter given the limited period of offline operation in these regions during the quarter. Therefore, revenue recognized during the quarter is predominantly from online delivery of our services. This year-over-year decrease in revenues from educational programs was primarily due to the temporary closure of our self-owned learning centers from late January 2020 as a result of the outbreak of COVID-19. Franchise revenues increased by 111.7% quarter-over-quarter and decreased by 67.5% year-over-year to RMB 12.9 million. The quarter-over-quarter increase in franchise revenues was mainly due to the growth in recurring franchise revenues as a result of the gradual reopening of franchised learning centers. The year-over-year decrease in franchise revenue was primarily due to the decline in recurring franchise revenue as a result of the outbreak of COVID-19. Other revenues decreased by 33.8% quarter-over-quarter and increased by 54% year-over-year to RMB 0.6 million. Cost of revenues decreased by 0.7% quarter-over-quarter and decreased by 11.7% year-over-year to RMB 141.6 million. The quarter-over-quarter decrease was primarily due to our continuous efforts to control rental expenses and personnel costs. The decrease in personnel costs is the combined results of reduced teaching hours, personnel optimization, and social insurance exemption prompted by the government. The year-over-year decrease was primarily due to the decline in teachers' compensation as a result of reduced teaching hours and the social insurance exemption as well as rental concession. In addition, the year-over-year decrease was also caused by a decrease in the direct costs associated with our study tour services and costs of learning materials. Non-GAAP cost of revenues for the quarter decreased by 0.5% quarter-over-quarter and decreased by 11.3% year-over-year to RMB 137.6 million. Gross profit for the quarter was RMB 23.4 million compared with a gross loss of RMB 33.6 million for the preceding quarter. Our gross profit for the quarter decreased by RMB 183.2 million year-over-year from RMB 206.6 million a year ago. Slide 13. Selling and marketing expenses decreased by 1.7% quarter-over-quarter and decreased by 40% year-over-year to RMB 42.5 million. The quarter-over-quarter decrease was primarily associated with our efforts in personnel optimization, which was partially offset by increased expenditure on advertisement. The year-over-year decrease was primarily due to better management of our online and offline marketing activities as well as our efforts in personnel optimization. Non-GAAP selling and marketing expenses for the quarter decreased by 2.3% quarter-over-quarter and decreased by 40.9% year-over-year to RMB 41.2 million. General and administrative expenses increased by 0.4% quarter-over-quarter and decreased by 40.8% year-over-year to RMB 54.8 million. The year-over-year decrease was primarily due to a decrease in share-based compensation expenses due to vesting arrangements and our personnel optimization efforts. Non-GAAP general and administrative expenses for the quarter decreased by 3.5% quarter-over-quarter and decreased by 17.9% year-over-year to RMB 53.6 million. Operating loss narrowed by RMB 57.5 million to RMB 73.9 million from an operating loss of RMB 131.4 million for the preceding quarter compared with operating income of RMB 43.3 million a year ago. Non-GAAP operating loss for the quarter was RMB 67.5 million compared with non-GAAP operating loss of RMB 127.1 million for the preceding quarter and a non-GAAP operating income of RMB 76.8 million a year ago. Adjusted EBITDA loss was RMB 44.5 million compared with adjusted EBITDA loss of RMB 108 million for the preceding quarter and EBITDA income of RMB 89 million a year ago. Income tax benefit was RMB 11 million compared with the income tax benefit of RMB 19.7 million for the preceding quarter and income tax expenses of RMB 19.2 million a year ago. Turning to Slide 14. Net loss attributable to RISE for the quarter was RMB 58 million, narrowed by RMB 45.8 million compared with the preceding quarter and compared with a net gain attributable to RISE of RMB 21.2 million a year ago. Non-GAAP net loss attributable to RISE for the quarter was RMB 51.6 million, narrowed by RMB 47.8 million compared with the preceding quarter and compared with a non-GAAP net gain attributable to RISE of RMB 54.8 million a year ago. Basic and dilutive net loss attributable to RISE per ADS for the quarter was RMB 1.03. Basic and diluted non-GAAP net loss attributable to RISE per ADS was RMB 0.92. On our cash flow performance, net cash outflow from operating activities for the quarter was RMB 118.1 million compared with RMB 82.4 million for the preceding quarter and RMB 129.2 million a year ago. The quarter-over-quarter increase in cash flow was mainly due to reduced cash collection from regular courses as a result of the temporary closure of self-owned and franchised learning centers for almost the entire quarter. As of June 30, 2020, the company had combined cash and cash equivalents and restricted cash of RMB 753.5 million compared with RMB 1,022.8 million as of December 31, 2019. As of June 30, 2020, total deferred revenue and customer advances were RMB 677.8 million, a decrease of 10.3% from RMB 756 million as of December 31, 2019. The decrease was primarily the result of the fact that the revenue recognized for our courses and services is larger than the tuition fee collected from new and renewed students during the quarter. Now let's look into the second half of 2020 on Slide 15. Although the depth and scale of the impact of COVID-19 is still unknown, we believe we are well-positioned to navigate the rapidly evolving market environment and capture potential market opportunities. Our learning centers in Shanghai, Guangzhou, Shenzhen, and Wuxi have resumed full offline operations in the third quarter, and our learning centers in Beijing and Shijiazhuang are expected to reopen in September at a pace regulated by the government. Our ability to flexibly switch between the online and offline models and to manage our offline and online operations concurrently will help us mitigate the risks of any potential resurgence of COVID-19 to our business. Taking all this into account, we expect our revenue in the third quarter of 2020 to be in the range of RMB 325 million to RMB 335 million. With that, I would now like to hand the call over to the operator so we can begin the Q&A session. Thank you.

Operator, Operator

The first question we have is from Sheng Zhong from Morgan Stanley.

Sheng Zhong, Analyst

Congratulations on the well-improved financials and operation. So my first question is kind of high level one. As Lihong said, the young children's English learning market is very dynamic now. I think there are some big institutions going bankrupt and exiting the market. While at the same time, we see a lot of competition from interactive apps for young children. So what is the management's view on this dynamic and how this will impact your offline expansion in the rest of this year given the offline is already resumed operation and maybe the long-term plan for your offline and franchise development? This is the first one. And second one is you have a pretty impressive improvement in OpEx, sales, marketing, and G&A. So I’m wondering now, do you see the trend of customer acquisition costs? And with also the offline operation restart, do you expect more sales and marketing going forward in the next quarter and in the third and fourth quarters?

Lihong Wang, Chairman and CEO

Thank you, Zhong Sheng. I will answer the first question, and then the second question, I'll answer together with Jiandong. You're right. I do think that the market is quite dynamic now with some entities exiting the market. We also see remaining players improving in terms of the methods that they operate. At the same time, we also feel that, as an attractive market, there are new entrants. Some new entrants rely on so-called AI courses through apps. This is a sort of replacement for what we call Disney-like language learning. I would say it's not really an educational product per se. I'm sure they will improve continuously to achieve some educational goals. So right now, we can see their customer base is somewhat different from our offline customer base. The evidence is one that we do see very strong growth in inquiries into our offline learning centers. In fact, for Shenzhen and Shijiazhuang, for example, even in June, the new student enrollment already surpassed what they had in the same period of 2019. In July, we actually see Shanghai adding to that list to surpass the enrollment number compared to 2019. So there is a very strong momentum in most of the cities that we operate. That's number one. Number two, even for RISE, we offer our online classes through dual-teacher small group classes, and we are developing AI-related courses as well but mostly to attract traffic. Therefore, later on we can convert them into more learning-related programs like the dual-class small group classes or the offline regular courses. So I think the market is still expanding and growing, with different market segmentation. People sometimes subscribe to more than one program, as they believe offline delivers a different learning experience, while online serves as a supplement. So yes, it is dynamic, but we do see our market growing both offline and online. On OpEx, as you can see for the second quarter, we actually control our customer acquisition costs very well. Part of the reason is that we have the offline network so that we can generate referrals and help with customer acquisition. In fact, the CAC number this quarter compared to the same time last year is basically flat. For the third and fourth quarters, sales and marketing costs will definitely increase because we believe that with offline practices resumed nationwide, we have very strong demand. Therefore, we also want to significantly improve new student enrollment. So the absolute number of expenses will increase significantly, but at the CAC level, we hope to control it at a reasonable level. Jiandong, you can supplement.

Jiandong Lu, CFO

Okay. Just to supplement a little bit to Lihong's remarks on client acquisition cost. If you look at our financials, our marketing expenses remained flat compared to the first quarter, while our new student enrollments doubled compared to the first quarter. This is attributable to a number of measures taken, as highlighted in Lihong's speech. We expanded our marketing channels and entered into partnerships with Gymboree and early education schools, which contributed roughly 12% to 13% of our new student enrollment in the second quarter. So this is what we call offline channels. The percentage of students acquired from offline channels actually increased compared to the same quarter of last year. That helps to reduce our overall acquisition costs. And going forward, we will continue to invest in marketing to significantly increase our student enrollment. At the same time, we are going to further increase our classroom utilization. Lihong mentioned that we will make the best use of technology and our online platform to transition into OMO, which will free up some physical classroom capacity and accommodate more students. This will also give us pressure to acquire more students from the market, which is why we want to continue our reinvestment in marketing. Regarding our offline network expansion, we want to leverage our OMO model to increase our classroom capacity as well as utilization while optimizing capital expenditure. At the same time, we plan to open 3 more new learning centers in the second half of 2020. We believe our offline network of learning centers is a huge asset to RISE, which significantly differentiates us from other educational institutions. Considering our students' age group, primarily 3 to 6, parents prefer offline teaching over online teaching. Therefore, we will continue our capital expenditures in building our offline network. I hope I answered your question.

Sheng Zhong, Analyst

Yes. That's very clear. Can you also add some color on your franchise development plan given the current situation?

Lihong Wang, Chairman and CEO

Yes. As I mentioned, our franchise network actually remains strong and healthy. We even added three more franchisees and opened 11 new centers in the second quarter. Overall, they also see very strong recovery once they open their offline centers. New student enrollment almost doubled every month, system-wide. At the same time, we empower them with more online courses and online training for their teachers. With academic support, they are able to swiftly switch online and continue with online education. Going forward, as mentioned, we have new courses like STEAM and online dual-teacher small group classes, which we can offer through our franchisees as our sales partners. They can acquire students, and we, from the headquarters, deliver those courses online. This means they become our partners both offline and online. This can help mitigate some of the market impact you mentioned regarding the AI new entrants. At the same time, they can expand their market beyond physical locations. I believe we can utilize the franchise partner network to reach lower-tier cities without opening more stores. This combined offline and online network will make franchisees closer to families, which I see as a unique advantage for RISE to expand our market, reaching lower-tier cities and developing our online capabilities simultaneously.

Operator, Operator

There are no further questions from the participants. This concludes today's conference call. Thank you all for participating. You may now disconnect.

Lihong Wang, Chairman and CEO

Thank you.

Jiandong Lu, CFO

Thank you.