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Sunlands Online Education Group (NYSE:STG)
Q3 2018 Earnings Conference Call
Nov. 23, 2018 7:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to Sunlands third-quarter 2018 earnings conference call. [Operator instructions] After prepared remarks by the management team, there will be a question-and-answer session. Today's conference call is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to your host today Yingying Liu, Sunlands IR director. Please go ahead.

Yingying Liu -- Investor Relations Director

Hello, everyone, and thank you for joining Sunlands third-quarter 2018 conference call. On the call, our CEO Tongbo Liu will give you an update on our operational performance this quota and update you on our strategic initiatives going forward. Our CFO Steven Yipeng Li will give you an overview of our financial performance in Q3 and guidance for Q4 2018. Following their prepared remarks, we will move into the Q&A session.

Before I hand over to the management, I would like to remind you of Sunlands safe harbor statement in relation to today's call. [Inaudible] for the historical information contained herein, certain matters discussed in this conference call are forward-looking statements. These statements are based on current events, estimates, and projections, and therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties.

We caution that a number of important factors could cause actual results to differ materially from those contained any forward-looking statements. For more information about the potential risks and uncertainties, please refer to the company's filings with the Securities and Exchange Commission. With that, I will now turn the call over to our CEO Tongbo Liu.

Tongbo Liu -- Chief Executive Officer

Thank you, Yingying. Hello, everyone, and welcome to Sunlands quarter-three 2018 earnings call. I'm pleased [Inaudible] that we made significant progress in strengthening our brand and, of course, offerings during this quarter. And we continued to provide access to affordable quality education to most students across China.

We grew our net revenue in line with guidance in the third quarter with net revenues increasing by -- the earnings 96%, RMB 570 million. This was mainly due to the strong brand reclamation, which drove new students to our platform, as well as and the expansion of our free trial classes that enable prospective students to experience our advanced online [Inaudible] platform first hand. Let me now share some of the initiatives we implemented in quarter three to enhance our new learning experience and [Inaudible] our nation to transform education through technology and innovation. During this quarter we continued to diversify our course offerings and improve user experience [Inaudible] engagement on our new learning platform.

The monthly average users of the Sunlands Ed increased by over 34% to more than 816,000 users compared to the same period into 2017. We expanded our value-added offerings such as our AI-powered personalized study programs, which tailor course content to suit the students' individual needs and enable to learn more efficiently. We've helped to improve our students' substantial needs on our platform. In this quarter, the total time spent on live streaming classes improved significantly, where students spending an average of 31.5 hours on live streaming classes, an increase of 20% year on year .

Furthermore, the total number of classes taken by older Sunlands students increased over 900% to nearly 600 million, and students took over 1,600 classes on average, which is four times the number of classes taken per student for the same period in 2017. With our value-added offerings and continuously investment in technology and content, we are confident that active student engagement on our platform will continue to increase. This in turn will enable our students to achieve higher passing rates, enhancing Sunlands industry leadership for this critical metric. Moving to the [Inaudible] of our business.

In the quarter two earnings conference call, I noted that participants in free-trial classes were significantly more likely to both become Sunlands students and enroll in classes with higher price points. We also noted that free-trial classes also increased the efficiency and effectiveness of our sales efforts. For example, the conversion rates for free-trial participants was more than double the conversion rate for our other sales channels. And on average, it took our sales team half the time to encourage the free-trial participants to sign up for our courses compared to students, who didn't participate in a free trial.

I'm pleased to report that we continue to see these trends as we're expanding free-trial classes in the third quarter. We also made further adjustments to the sales process by adding introductory seminars as a preliminary step to improve brand awareness among prospective students. Our introductory seminars are designed to educate potential students about the FT program as well as inform them about the effectiveness and the convenience of our industry-leading learning platform. We have found this to be an effective tool to attract potential students, introducing to Sunlands and start to build trust with other brand.

We now have an independent team of more than 200 people that are dedicated to attracting potential students through the introductory seminars while our sales representatives [Inaudible] engage with potential students on a one-on-one basis. With this new approach, leverage our technology platform and engage potential students to a one-to-many model and encouraging them to join our free-trial classes. This is a much more scalable and efficient approach. And I'm pleased to share that the combination of introductory seminars with free-trial classes has resulted in higher conversion rates and improved the productivity of our sales efforts.

Students who have had the opportunity to experience our platform prior to the enrollment also constantly register for courses at higher price points. This reflects the strength of our course offerings and our user center education [Inaudible].Looking ahead, we are confident that our live streaming  [Inaudible] and innovative teaching approach will drive long-term sustainable growth for Sunlands. With our industry-leading student pass rates and a lower-price point compared to traditional bricks-and-mortar tutorial institutions, we are well placed to continue to attract students and improve our pricing power in the future. We will continue to focus on three areas to grow our business.

First, we will continue to explore innovative ways [Inaudible] market and introduce more people to FT program and the Sunlands education platform. With hundreds or millions of people between the age of 18 to 48 that do not have a bachelor's degree, we have only just scratched the surface. We are committed to bringing affordable quality education to as many students as possible. And we will continue to expand our introductory seminars and free-trial classes to reach more prospective students and provide better access to our platform.

Second, [Inaudible] improving the quality of our courses and educational content that will help our students achieve higher pass rates. We have been very pleased with the increase in [Inaudible] of our platform and the improvements in students' engagement over the past 12 year -- 12 months. We are confident that our ongoing investment in AI-powered [Inaudible] will further enhance engagement and lead to better learning outcomes. Third, we will continue to invest in and develop our IT platform that is the foundation of our business.

Our IT  infrastructure [Inaudible] every possible of our business, from sales and marketing to finance, to learning, and the student engagement. It is central to our efforts to generate economies of scale and improve the profitability of our business. [Inaudible] initiatives will strengthen Sunlands position as a leading player in China's online [Inaudible] sector and the professional education market. Going forward, we will continue on our mission to transform education through technology and innovation.

This will enable us to make quality education available for everyone and significantly improve the lives of Sunlands students across all of China. Now I will hand over the floor to our CFO Steven to run through our financials.

Yipeng Li -- Chief Financial Officer

Thank you, Tongbo. And hello, everyone. Thanks for joining us. We are pleased to report that we delivered revenue in line of its guidance in the third quarter, reflecting the effectiveness of our initiatives to strengthen brand awareness and attract more students to our platform.

Let me walk you through some of the key financial results for third quarter of 2018. All comparisons are year over year and all numbers are in RMB. In Q3, our net revenues increased by 95.8% to RMB 517 million from RMB 264 million in the third quarter of 2017. The increase was mainly driven by strong growth in new student enrollments.

Our cost of revenues increased by 107.2% from RMB 44.7 million in the third quarter of 2017 to RMB 92.7 million in the third quarter of 2018. The increase was primarily due to the increase in compensation for our faculty members, primarily made up of teachers and mentors as we continued to retain our existing faculty members and attract new faculty members. Our growth [Inaudible] increased by 93.5% to RMB  424.4 million from RMB 219.3 million in the third quarter of 2017. Our operating expenses were RMB 696.3 million, representing a 45.4% increase from RMB 478.9 million in the third quarter of 2017.

While our sales and marketing expenses declined compared to Q2 of 2018, sales and marketing increased by 58.6% to RMB 542 million from RMB 341.7 million in the third quarter of 2017. The increase was mainly due to increase in compensation paid to our sales and marketing personnel and a spending on branding and marketing activities, including investments in broadening our search engine and mobile application channels. Our general and administrative channel expenses increased by only 3% to RMB 131.1 million from RMB 127.3 million in the third quarter of 2017. The increase was mainly due to the increase in employee compensation as a result of hiring more talent to further strengthen our general IT infrastructure development capability.

Our program development expenses increased by 134.7% to RMB 23.2 million in the third quarter of 2018. The increase was primarily due to an increase in compensation for our course and educational accounts and professionals and the product-related technology personnel during the quarter. Net loss for the third quarter of 2018 was RMB 226.3 million. For the first time since the listing of our company, our net loss declined substantially, reflecting our progress toward profitability.

In addition, our net loss as a percentage of net revenues dropped significantly to 43.8% in the third quarter of 2018 from 98.1% for the same period in 2017. Basic and diluted net loss per share was RMB 32.68 in the third quarter of 2018. As of September 30, 2018, we had RMB 1,278.7 million of cash and cash equivalents and RMB 1,088.2 million of short-term investments compared to RMB 559.5 million of cash and cash equivalents and RMB 353.1 million of short-term investments as of December 31, 2017. As of September 30, 2018, we had deferred revenue of over RMB 3,116 million.

Revenues related to our online courses are recognized on a streamline basis over the third period. Deferred revenue consists of tuition fees received from students, for which services have not yet been provided to students pursuant to the terms of those service contracts. Capital expenditures were RMB 10.3 million compared to RMB  86.7 million in the third qurter of 2017. Now turning to guidance for the first quarter.

For the remainder of 2018 we will continue to invest in the development of quality content, teaching, and our technology platform to attract more students to our leading live-streaming one-to-many platform. For the first quarter of 2018, we currently expect net revenues to be between RMB 540 million to RMB 560 million, which would represent an increase of 66.7% to 62.5% year over year. This outlook is based on current market conditions and reflect our current and preliminary estimates of market operating conditions and customer demand, which are all subject to change. With that I'd like to open up the call for questions.

Operator, please? 

Questions and Answers:

Operator

And thank you. [Operator instructions] Our first question today will come from Shawn Yan of CDC Capital. Please go ahead.

Unidentified speaker

Hi. Hello. I actually have two questions for Mr. Liu and Li.

The first is regarding -- that I noticed that in China in most of the marketing materials that Sunlands had changed its name to like Sunlands Technology, right? So I don't know if it's correct but I'm wondering if that represents some kind of strategic change of the company or you wish to be presented more in a sense of a technology company. While my second question is that I noticed that there are actually a cash of one -- of around RMB 1.2 billion and short-term investments of RMB 1 billion. So I'm quite curious about what is a main use of short-term investments, like do you have structure products or can you just specify a little bit? Thank you.

Tongbo Liu -- Chief Executive Officer

I'll take the first one. [Inaudible] OK. Yes. Yes, we did change our name to the technology company and the reason behind it is that we want to focus on the technology and education as well.

And as we mentioned the last quarter that we have over 1,000 IT employees in our company and the way -- and they are folks in every kind of IT infrastructure and help us to engagement and to -- learning outcomes, every kind of things. And right now they are focused on the AI IT assistance, which we have a product that is driven by the AI that helps students to save time to pass an exam, as I mentioned. And maybe Steven can take the second question.

Yipeng Li -- Chief Financial Officer

Yes. And I would just like to add a little bit to the first question. Yes like Tongbo mentioned, we want to add more technology flavor to our company. We used our older technology platform and AI to help students learn more effectively but at the end of the day, we are still an education company.

So we are doing our best to provide the best content -- educational content to our students. As you can see, our product development expenses increased by over 130% percent compared to Q3 of last year. So this change of name in no way means we are shifting our strategy both education and technology are the two key driving forces for our success. Regarding your second, yes among our cash and cash equivalents, about -- around RMB 1 million or RMB  1 billion are in short-term investments and RMB 1 billion in the cash.

For those RMB 1 billion in short-term investments, those are actually very similar to cash. It's just that for some of the cash, we are not expecting to use in the short term the [Inaudible] into some of the very low-risk financial products but -- and in case if we want to use those cash, those short-term investments, we can call them back right -- immediately.

Unidentified speaker

Well, sure. Thank you. Well, I mean, it's actually a little bit -- I mean, I'm worried but it's just out of curiosity, I mean, with such a huge amount of cash on your balance sheet, have you ever considered maybe to construct or to facilitate merger and acquisition or some kind of equity investment maybe in your peer companies or the kind?

Tongbo Liu -- Chief Executive Officer

Well, we actually mentioned this during our IPO and those -- that's actually part of the use of our IPO proceeds, which is we are open to any potential merge and acquisition opportunities. And the company is -- we are all actively looking for those kind of opportunities. Yes, so we are open to those ideas. It's just that so far as of now, we haven't done any merge and acquisition yet.

But if -- in the future, if there's good opportunities for the company to do either investments or even merge and acquisitions, the company is very open.

Unidentified speaker

All right. Thank you. Thank you so much. That's all my questions.

Tongbo Liu -- Chief Executive Officer

OK.  Thank you.

Operator

And our next question will come from Alex Hill of Credit Suisse. Please go ahead.

Unidentified speaker

Hi, management. Thank you for taking my question. So I'll several questions. Firstly I'd like to ask about our trend in the student enrollment.

It seems that in the last quarter we had quarter-over-quarter decrease about 10% in the number of new student enrollment. I would like to ask about the monthly trend and particularly [Inaudible] some color on the September and October. And my second question is about  ASP. I noticed that you also mentioned the improvement in ASP in the press release but I would like to know more about the reasons behind it.

Is it more due to the product offerings mix or is it due to our price increase in the same cost, and what's the plan going forward. And my third question is about our marketing effective risk ratio. Has it been stabilizing or improving, or what about the general -- the traffic of acquisition cost and conversion rates? Thank you.

Yipeng Li -- Chief Financial Officer

Yes, OK. For the first question, regarding the new student enrollments, yes, the new student enrollment for this quarter declined slightly compared to last quarter and -- well, the main reason for that, as our CEO Tongbo mentioned, we started to do those introduction seminar and free-trial classes during the second quarter [Inaudible] we are expanding the scope in the third quarter. For those students who take part in free-trial classes and introductory seminars, they are not defined as a new student enrollment if they are not contributing to our current quarter revenue. So that's actually the major reason for the company why there's a decline in terms of new student enrollments.

But we are very confident in the long-term once those students the -- once they take the free seminar -- introductory seminar and free-trial classes, they will have a much higher conversion rate and much lower refund rates. And based on right now, the limited data we have, we have noticed this trend. So that's the answer for your first question. And for the second questions, in terms of our ASP, our ASP for Q3 increased significantly concurrently as in Q2, and that's mainly due to the product mix.

Like Tongbo mentioned, we introduced a AI-powered class and some other value-added services class in Q3. And the students who applied for those classes are actually willing to pay a higher ASP compared to the product without those value-added services. So that's the major reason for the company -- our ARP is much higher compared to last quarter because of the product mix and not because we increased our product price. And for your last question regarding the market effectiveness ratio, the marketing effectiveness ratio for this quarter is a little bit higher compared to Q2 just mainly due to right now the traffic [Inaudible] in China is more and more expensive.

But the company is [Inaudible] all kinds of [Inaudible] and we think in a few quarters, we will see very positive results. Well, actually one thing I want to add here is the entire sales and marketing expenses as a percentage of our net revenue actually declined in Q3 compared with Q2. And although the marketing spending is more expensive that's because in terms of employee sales personnel productivity, it actually improved a lot compared to last quarter. So that's why the total sales and marketing expenses as a percentage of net revenue declined compared to last quarter.

Unidentified speaker

Thank you. Thank you. That's very clear.

Operator

[Operator instructions] Our next question will come from Christine Cho of Goldman Sachs. Please go ahead.

Christine Cho -- Goldman Sachs -- Analyst

Hi. Thank you for the presentation. I have two quick housekeeping questions. The first one is related to your efforts regarding the diversified course offerings.

So if you can provide any color in terms of STE versus non-STE in terms of enrollment or revenues, etc., that would be great. And then second question relates to the G&A expenses. It seems like on a Y-O-Y basis it's only up 3% but on a Q-o-Q, it has a sharp increase. Is there any seasonality related to this item that we should consider going forward? Thank you.

Yipeng Li -- Chief Financial Officer

Yes, OK. For the first questions, yes, we actually mentioned during our IPO that our STE account for like 89% of our total gross billings and non-STE course account for around 10%. And now the non-STE, the contribution is a little bit higher than 10%. It's somewhere 13% to 14% as the company is -- diversify our course offerings and the STE contribution is a little bit lower compared to about half year' -- three quarters ago.

But overall, the structure is roughly the same. And regarding the G&A expenses increase compared to Q3 of 2017, one thing I want to remind here is for last quarter -- sorry for the Q3 of last year, among G&A expenses, there are some onetime ESOP expenses recorded in Q3 of last year. So I think that's probably part of the reason for the 3% increase compared to last year.

Christine Cho -- Goldman Sachs -- Analyst

Sorry. To clarify, I was just wondering why there was such a sharp Q-o-Q increase in that time rather than the Y-on-Y. So in the second quarter --

Yipeng Li -- Chief Financial Officer

I see. You men the -- compared to Q2 of this year, right?

Christine Cho -- Goldman Sachs -- Analyst

Yes, yes, yes and whether there were some things included.

Yipeng Li -- Chief Financial Officer

No, that's not a seasonality issue because the majority of G&A expenses are actually our R&D personnel. Our R&D expenses will be recorded into our cost sales and marketing expense, G&A expense, and the product development expense based on their functions. And the most of them will be recorded in G&A expenses, so the increase in Q3 compared to Q2 is mainly due to the company is hiring more R&D talent to build up our platform and everything. So that's the major reason, not because of seasonality.

Christine Cho -- Goldman Sachs -- Analyst

OK. Thank you.

Operator

[Operator instructions] Showing no further questions, this will conclude our question-and-answer session. At this time I'd like to turn the conference back over to Yingying Liu for any closing remarks.

Yingying Liu -- Investor Relations Director

Once again thank you, everyone, for joining today's call. We look forward to speaking with you again soon, and good day and good night.

Operator

[Operator signoff]

Duration: 32 minutes

Call Participants:

Yingying Liu -- Investor Relations Director

Tongbo Liu -- Chief Executive Officer

Yipeng Li -- Chief Financial Officer

Christine Cho -- Goldman Sachs -- Analyst

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