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Rise Education Cayman Limited (NASDAQ:REDU)
Q3 2018 Earnings Conference Call
Nov. 15, 2018 8:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and good evening, everyone. Welcome to RISE Education's third-quarter 2018 earnings conference call. [Operator instructions] This call is also being broadcast live on the company's IR website. Joining us today are Mr.

Yiding Sun, CEO; Ms. Jiandong Lu, COO; Ms. Chelsea Wang, CFO of RISE Education; and Jack Wang, senior associate of ICR. Following management's prepared remarks, we will conduct the question-and-answer session.

Before we begin, I'll refer you to the safe harbor statement in the company's earnings release which also applies to the conference call today as management will make forward-looking statements. I am now turning the call over to Mr. Yiding Sun, CEO of RISE Education. Please go ahead, sir.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jack Wang -- Senior Associate of ICR -- Analyst

Thank you, [Inaudible]. Hello, everyone. This is Jack Wang, and I will translate for Mr. Sun.

Before I start reviewing our third-quarter results, please allow me to introduce our chief operating officer, Ms. Jiandong Lu. Ms. Lu served as our independent director from our successful listing on the NASDAQ Global Market in October 2017 and will be appointed as our chief operating officer on September 28, 2018.

Prior to joining us, Ms. Lu was an investment banker with JPMorgan where she held several senior executive positions and gained tremendous management experience overseeing the daily operations of the business. I am confident that her capital market expertise, her management experience and her leadership will be a great asset for our future expansion. Now I will turn the call over to Ms.

Lu to speak on behalf of Mr. Sun. Please go ahead, ma'am

Jiandong Lu -- Chief Operating Officer

Thank you, Jack. This is Ms. Jiandong Lu. I apologize if I'm losing my voice.

Now speaking on behalf of our CEO, Mr. Yiding Sun. During the third quarter of 2018, we continued our strong growth trajectory. Our total revenues grow by 33.6% year over year to RMB 347.4 million.

Our educational programs remain our primary growth driver, and revenue generated from educational programs grew by 32.8% year over year to RMB 270.3 million. During the third quarter, we opened 38 new learning centers, including four self-owned learning centers and 34 franchised centers, bringing the total number of our learning centers to 345 in our total network, including 72 self-owned learning centers, 2 of which are from Edge, and 273 franchised centers. As a result, we have added a total of 42 classroom in our self-owned learning centers. Our student retention rate remains high at 71% during the third quarter.

As we continued to execute our growth strategy, we have encountered some challenges in the marketplace, including tightening regulations in the education sector, increasing competition, more stringent fire safety code on commercial buildings and soften consumer spending in the PRC. Such challenges slowed down the growth rate of our student enrollment compared to the same period of previous years, while the total student enrollment at our self-owned learning centers and online courses increased by 26% year over year to 14,702, including the enrollments for short-term courses. Despite the temporary challenges, we are confident that RISE Education is well positioned to continue to lead the Chinese junior ELT market and enjoy healthy growth in the foreseeable future. First, in the first half of this year, the Chinese government issued a series of new regulations to reduce students' after-school workloads.

Such regulations targeted school-aged children and test preparation children services. Since about 75% of our students are preschool children and because of our education courses are more geared toward building soft skills and capabilities instead of test preparation, we are less impacted by the tightening regulation. However, as the industry adapts to the new regulations, many test-prep-orientated service providers in China are now shifting their demographics focus from school-aged to preschool children, intensifying competition in the ELT market has escalated marketing channel cost during the quarter. We have also adjusted our promotion strategies by increasing our investments in marketing.

The junior ELT market has a unique set of characteristics which makes it difficult to new entrants to prep within a short period of time. RISE Education has already changes successful operation, a premium and trusted bank and a large trajectory of high quality cost materials in China's junior ELT industry. Therefore, reducing the new regulations will have a material or lasting impact on RISE operations Second, local government agencies have recently imposed a more stringent fire safety code of commercial buildings. As our learning centers brand premises and commercial building such as shopping malls, it has taken longer time for our landlords to meet the more stringent fire safety codes.

Therefore, we're only about to open new learning centers as fast as we scheduled earlier this year. We're now more mindful of the fire safety standards when selecting our landlord while also working closely with our landlord to meet the requirements under the fire safety code as quickly as possible. As of now, the opening of our new learning centers has been slightly behind our original schedule, and we will be two centers short than what was originally planned by the end of 2018. Third, our business has been partially affected by the softened consumer spending amid the escalating trade war.

However, the impact of the trade war has been mostly on discretionary spending such as overseas travel and new purchasing. In contrast, Chinese parents have always regarded their children's education as a nondiscretionary investment. Industry studies have also shown that among all subjects, spending on English education is the most resilient to economic downturns, more so than spending on math, science and other subjects. Above all, we believe consumers tend to focus more their efforts on their brands that they trust amid market uncertainty.

On August 25, we successfully concluded the seventh RISE Cup Competition. During the final one, 15 finalists out of more than 55,000 registered participants showcased soft skills, including communication, collaboration, teamwork and leadership to the audience of more than 2,000 people. This year's RISE Cup was a tremendous success, setting a new record in the company's history. This achievement demonstrates our significant brand of influence as well as the recommendation and the trust from our customers.

In a recent survey conducted by BBC international program provider, RISE is right as the No. 1 among the top 10 ELT providers in China based on our course curriculum, high-class style, education materials, teacher background and the quality of service. Our well-known brand have also manifested in our consistently high student retention rates allows the student retention rates remain high at about 70%, that is to say our students typically stay with RISE for a long time, in many cases, a minimum of three years once the students are enrolled into our educational program. With our ability to retain students and across new programs, we believe the long lifetime value of our students is actually increasing despite our increased upfront investments in student acquisition.

A high skilled and retention rate has been one of our key competitive advantages. Even so, we are constantly working to further improve it. In an environment where competition and regulation intensify day by day, we focus our changing -- further enhancing our consumer service and improving our management efficiency while expanding our business. We are building on our learning platform such as homeschool and artist homework will enable to closely monitor our student's learning outcomes and to further improve our communications with parents in order to improve on customer satisfaction.

We are also reinforcing our teachers' training and optimizing our teachers' composition structure to raise future satisfaction and to lower our teachers' turnover rate. At the same time, we are improving our operation system and accounting management system in order to improve our management efficiency and better control our operational risks. We'll use technology to empower our educational services, our teachers and our operations. As one of our growth strategies, we continued to evaluate our franchise essentially focused on consolidation.

I'm very pleased to report that recently, we signed an agreement with our existing franchise partner [Inaudible] for future reach purchase from her 51% of equity interest in all the five learning centers in [Inaudible]. These five learning centers have approximately 3,500 students in total. [Inaudible] is in a very attractive market for us as RISE is already the No. 1 junior ELT provider in the [Inaudible] market in terms of market share.

We see continued opportunities to increase student enrollment as well as the course prices. We believe this is a testament to RISE's ability to continue to roll out existing franchises centers. In addition to franchises center acquisition, we are evaluating all the potential acquisition opportunities which may be complementary to our service offering, student demographics and teaching philosophy. Looking forward, we believe that the market demand for junior English teaching training will remain strong because of Chinese parents' unwavering commitment to their children's education.

In order to fully capitalize on such market opportunities, we will continue investing in sales and marketing to attract the new students while enhancing our customer services to retain existing students. Our strong profitability, positive cash flow and sufficient cash reserve afford us with ample firepower to invest for our long-term and sustainable success. To demonstrate our strong conviction toward our long-term success, we have put a plan in place to buy back up to USD 30 million worth of ADS during the next 12 months. We believe our core competencies will enable us to thrive in any market condition.

This concludes the remarks of our CEO, Mr. Yiding Sun. I will now turn the call over to our CFO, Ms. Chelsea Wang, to go through our financial highlights.

Chelsea, please go ahead.

Chelsea Wang -- Chief Financial Officer

Thank you, Jiandong, and hello, everyone. Before I begin, please note that all numbers stated are in RMB terms. In the third quarter of 2018, our total revenues increased by 33.6% year over year to RMB 347.4 million from RMB 260 million in the same period last year. The increase was driven by a 32.8% year over year increase in revenues from our educational programs, which increased to RMB 270.3 million in the third quarter of 2018.

Such growth was primarily attributable to our industry retention rate which increased to 71% this quarter from 70% in the same period last year. The strong extension of our self-owned learning center network also contributed to our strong financial performance this quarter. Franchised revenues increased by 15% year over year to RMB 35.6 million in the third quarter of 2018 despite the impact on revenues due to the adoption of ASC 606. The increase is primarily attributable to the steady growth of recurring franchisees and increased number of franchised learning centers, which totaled 273 as of the end of September 2018 compared to 201 by the end of September 2017.

Other revenues increased to RMB 41.5 million in the third quarter of 2018, up 63% year over year from RMB 25.5 million in the same period last year, primarily due to the revenue contributions from The Edge and our study tour program. Gross profit for the third quarter of 2018 increased by 37.8% year over year to RMB 183.5 million. Gross margin increased to 52.8% during the third quarter of 2018 compared with 51.2% in the same period last year. Selling and marketing expenses for the third quarter of 2018 was RMB 77.5 million or 22.3% of total revenue compared with RMB 45 million or 17.3% of our total revenue in the same period last year.

The growth of our selling and marketing expenses was mainly driven by the increases in our marketing channel expenses as we expanded our network of self-owned learning centers and increased our student enrollments. General and administrative expenses for the third quarter of 2018 were RMB 57.8 million or 15.6% of total revenues compared with RMB 44.8 million or 17.2% of our total revenues in the same period last year. The increase in our general and administrative expenses was primarily due to higher personnel costs and office expenses as a result of our business expansion. Our operating income for the third quarter of 2018 increased by 11% year over year to RMB 48.2 million.

Operating margin for the third quarter of 2018 decreased to 13.9% from 16.7% in the same period last year related to the increase in our selling and marketing expenses. Our non-GAAP operating income for the third quarter of 2018 was RMB 50.6 million, and our non-GAAP operating margins for the third quarter of 2018 was 14.6%. Adjusted EBITDA for the third quarter of 2018 remained stable at RMB 64.8 million compared with the same period last year. Adjusted EBITDA margin decreased to 18.7% from 24.9% in the same period last year, mainly due to the increase in our sales and marketing expenses.

Net income attributable to RISE for the third quarter of 2018 increased by 9.9% year over year to RMB 32.9 million from RMB 29.9 million in the same period last year. Non-GAAP net income attributable to RISE was RMB 35.3 million, and non-GAAP net margin was 10.2% for the third quarter of 2018. Basic and diluted net income attributable to RISE per ADS were both RMB 0.57 for the third quarter of 2018. Basic and diluted non-GAAP net income attributable to RISE per ADS was RMB 0.62 and RMB 0.61, respectively, for the third quarter of 2018.

Turning to our cash flow in the balance sheet. We generated RMB 74.7 million positive cash flow from operating activities for the third quarter of 2018 compared with the RMB 75.5 million in the same period of the prior year. The slight decrease was mainly attributable to an increase in operational costs and rental deposit as we opened more new self-owned learning centers. As of September 30, 2018, we had cash, cash equivalents restricted cash, short-term investments and loan receivable of RMB 1,299.6 million compared with RMB 1,084.9 million as of December 31, 2017.

As of September 30, 2018, total deferred revenue and the customer advances balance increased by 27.1% to RMB 1.03 billion from RMB 812.8 million at the end of 2017. This increase was primarily driven by higher prepaid tuition and fees from our rising level of student enrollment, partially offset by recognized revenue as our courses were delivered. Now let me provide you with our guidance. For the first quarter of 2018, we expect our total revenues to be between RMB 345 million and RMB 350 million, representing a year over year growth of approximately 28%.

At the same time, please note that with our plans to increase our marketing spending, we expect our full-year EBITDA margin, adjusted EBITDA margin to be between 22.5% to 23.5%. This forecast reflects our current and preliminary view in the markets and operational conditions which are subject to change. This concludes our remarks. Operator, we would now like to open up the call for questions from our audience.

For those who would like to ask a question, please state your question in Chinese first and then in English. Operator, please proceed. 

Questions and Answers:

Operator

Thank you, Chelsea. [Operator instructions] Your first question comes from Melissa Chen from China Renaissance. Please ask a question.

Unknown Speaker

[Foreign language] I will translate for myself. So thanks, management, for taking my question. So I'm calling on behalf of [Inaudible] our analyst. She has two questions actually.

So first of all, about the regulation. So I'm just wondering whether the regulation on the government has changed so far, specifically on the most recent regulatory change from the general state council. And the second question is about the sales and marketing. So as mentioned before, the total guidance for sales and marketing expense is going to be stable compared to last year.

So I'm wondering, will there be any change about the guidance and what's our guidance for the next year?

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

Let me answer Mr. Sun's answer to your question. Your first question is regard to the policies issued by the government recently on the kindergartens. I would say the policy is not related to our business.

Although we focus on the age group between three to six demographics, we provide only afterschool English training. So although we see some fluctuation in the market, I will say it has nothing to do with our business.

Chelsea Wang -- Chief Financial Officer

OK, let me answer your second question. So regarding the sales and the marketing expense, as a percentage of revenue, it will be increased by 2% compared with year 2017. As we explained in second-quarter earnings release call, we decided to invest the marketing spending to drive more student enrollment. So it is a long-term strategy.

We believe we will reach our return of earnings that return on investment in the future. Thank you.

Unknown Speaker

Thank you.

Operator

Your next question comes from Alex Xie from Credit Suisse. Please ask a question.

Alex Xie -- Credit Suisse -- Analyst

[Foreign language] So I'll translate the questions for myself. Firstly, I would like to ask management about our short-term courses. What are the enrollment numbers for short-term courses online and offline? And secondly, I'd like to ask about our margin guidance. Is the margin guidance more due to regulation pressure or competition pressure? What lines are mostly affected? And my third question is about the regulation for the three months prepayments.

I have seen many news about regulation checks on the rural and local government, and how RISE is going to respond to such new regulation? Thank you.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

Thank you very much for your question. Let me first answer your first question with regard to our short-term courses. I would say that we have made pretty good progress on this program. It is the first time for RISE to launch summer short-term courses, and we have recruited a total of approximately 4,000 students, some of them are from RISE programs and some of them are from outside of RISE.

And we try to convert some of the outside students to enroll into RISE educational programs. I would say that this is the first time our effort has been pretty much paid off reasonably well. It's going to help us to recruit -- continue to recruit students from the market.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

OK. With regards to your question on the impact of the new policy on RISE operations, I would analyze it from the following aspects. It's true that since the announcement of the stage counsel No. 8 circular which regulates the overall education industry, RISE, itself, started -- worked very hard to comply with whatever is required by the new policies.

And as a matter of fact, the new policy targets to further regulate the market and to improve the overall education service. I will say that it is in line with the RISE education objective and education philosophy. With regard to the three months challenge, I think in our franchised learning centers like in Suzhou and the [Inaudible], the implementation, first, is really from the government is very serious. We can also see Beijing government also starting to investigate the learning centers, I mean, the overall market, and this is start to put it on top agenda, government agenda.

In response to the policy of charging customers no more than three months, on the one hand, we improved our IT systems to make it compliant with government policies. In terms of the business operation, since our curriculum is one year [Inaudible] so we signed the contract with our customers, signed a one-year contract with our customers. The payment is just divided in three installments to make sure each installment covers no more than three months. The second policy is about the fire safety code.

As I stated in my speech, it is becoming increasingly rigid, which has somewhat delayed our efforts in opening new learning centers. Therefore, we're very mindful of the more rigid fire safety code and with regard to the land loss, we have make sure that the landlords are in for compliance so that it wont affect so much our speed of opening new stores. And to be very honest, it's true, it has, as I've stated, our speed of opening new learning centers is slightly behind our schedule. The third policy with regards to the teacher certificate, I would say since the IPO of RISE [Inaudible], we have made increased efforts to comply with regulations -- various amounts of regulation.

We put compliance at top of our agenda. In general, I won't say the policy impact on RISE's business is significant.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

So [Inaudible] side, all this policies has impacted obviously in the short term, but in the long run, I don't think it's going to be a lasting or material. I don't think it's going to be material or lasting impact on our operations.

Alex Xie -- Credit Suisse -- Analyst

[Foreign language] So a quick follow up -- thank you, management, for answering the above questions. A quick follow-up about teaching licenses. In my understanding, RISE is not -- it is not mandatory for RISE teachers to have teaching licenses because RISE is not test-oriented teaching provider. Has RISE already received some instructions from the governments to obtain teaching licenses? And how much of RISE teachers have obtained such licenses? Thank you.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

Thank you, Alex. You're right, we're not a test-oriented, subject-based education institution. So far, we haven't got any notice from the government requiring our students to have the certificates in order to start their education [Inaudible]. However, we have set a very high bar for ourselves in order to comply with government policies and also improve the quality of teaching.

We have restructured our teachers compensation. Part of that is to reward the teachers who get teacher certificate. So it's a measure of encouragement of our teachers to take courses, to take the tests and to get the certificate.

Alex Xie -- Credit Suisse -- Analyst

[Foreign language] Thank you, Jiandong. Very clear.

Operator

Your next question comes from Felix Liu from UBS. Please ask a question.

Felix Liu -- UBS -- Analyst

[Foreign language] Let me translate myself. So the quarter's GPM is a bright spot. The rental percentage as a percentage of sales is declining year on year. But given the higher standards on fire safety, is this low level of rental expenses sustainable in the mid to long term? Second question, can management provide some breakdown on the [Inaudible] enrollment and the enrollment from RISE Starts? And my third question is that, we know the company ran a lot of promotion in the summer, and the summer, we recorded 4,000 short-term enrollment.

So if we exclude that, long-term enrollment is largely flat year on year. So how does management think of this going forward? Thank you.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

Thank you for your question. Let me answer your first and the third question and leave the second one to Chelsea. In expanding our business, we actually pretty strict control on the rental expenses, as you can see reflected in our gross margin. As you mentioned that fire safety code implementation has becoming increasingly rigid, stringent.

It's not going to affect our rentals, but more of the approval process since most of our learning centers are located in shopping malls which basically are in compliance with the fire safety code meet the governmental requirement. However, in opening new learning centers, the approval process has already been extended. Part of the reason is the regulator for fire safety has been transferred from the armed police to emergency management department. So in process of the transition, many application has been slowed down.

So that's a fact. The speed of getting the approvals, as a result, it affects the opening of the speed of opening up our new learning centers.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

On your third question, we had good reservation, and we started our summer courses this summer on a pilot basis, which turned out to be a good success. We managed to convert some outside students to enroll into RISE Education program. So we'll continue our tryout for our programs to be launched in summer and also winter vacation as a new channel of recruiting students. We do feel the increasing competition in our market, and I would say the market is more crowded than before.

However, RISE does not rely on a single marketing channel to enroll students, and we also changed our marketing strategy and also promotion strategy and to develop the new channels to record more students in the future.

Chelsea Wang -- Chief Financial Officer

Yes, so for online business, actually, the RISE online business includes RISE Start and the Can-Talk. Can-Talk is a new product launched in the middle of last year. So by the end of September this year, around maybe 13% of our new enrollments come from online business. It was just -- we're seeing far below the 10% last year.

Felix Liu -- UBS -- Analyst

Thank. you. And any color on the online enrollment contribution from the RISE Start online business?

Chelsea Wang -- Chief Financial Officer

So you mean RISE Start? So for Rise Start is our core business. Yes, for the new enrollment, we maintain about maybe 60%, 50% to 61%.

Felix Liu -- UBS -- Analyst

OK. Thank you. Thank you very much. [Foreign language] Thank you.

Operator

Your next question comes from Sheng Zhong from Morgan Stanley. Please ask a question.

Sheng Zhong -- Morgan Stanley -- Analyst

[Foreign language] So I'll translate myself. Considering all of these pressure from the competition and the regulation, so what the management's outlook for the growth plan in next year? Thank you.

Yiding Sun -- Chief Executive Officer

[Foreign language]

Jiandong Lu -- Chief Operating Officer

Thank you very much, Sheng. So let me answer your question in the following two aspects. Currently, our regulatory environment where government policies cause uncertainties in the market as a whole, so we have somewhat modified our growth strategy for next year. We're going to adopt a prudent growth strategy.

However, we believe the uncertainties caused by government policies and also the increasing competition from -- increasing competition will be short term. Generally, the market demand is -- remains strong and resilient, and we believe the market will be covered. In terms of the prudent growth -- to be more specific on our prudent growth strategy, we're going to slow down the pace of opening up our self-owned learning centers. However, this can be compensated -- made up for by our efforts in acquiring a franchised learning centers.

Acquisition of [Inaudible] is a good example. [Inaudible] franchisees has a good reputation, has good market share in [Inaudible]. It's an attractive market. It is also located close to Beijing and easy to manage by our head office.

So acquisition of franchised partner will be one of our key growth strategies next year. In expanding our operations in a prudent manner next year, we also will focus on services. Our objective is to focus our brand building word-of-mouth by the parents to further increase our enrollments. So we actually -- the focus of our next year will be our services.

The service will target to our customers. And as I have mentioned that we are building the parent communications will improve through our platform, we increased our communications with the parent so as to improve the customer satisfaction. We also tried to reinforce training management of our teachers so that they can have a better working the teacher satisfaction and to lower the turnover rate. Meanwhile, we're going to improve our ITC spend as well, we're going to improve our operating systems, COS, as well as accounting systems and to further improve our management efficiency.

Sheng Zhong -- Morgan Stanley -- Analyst

[Foreign language] Thank you, Jiandong.

Operator

[Operator signoff]

Duration: 60 minutes

Call Participants:

Yiding Sun -- Chief Executive Officer

Jack Wang -- Senior Associate of ICR -- Analyst

Jiandong Lu -- Chief Operating Officer

Chelsea Wang -- Chief Financial Officer

Alex Xie -- Credit Suisse -- Analyst

Felix Liu -- UBS -- Analyst

Sheng Zhong -- Morgan Stanley -- Analyst

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