Sunlands(STG) - 2019 Q4 - Annual Report

Part I Key Information This section provides a comprehensive overview of Sunlands Technology Group's financial performance, capitalization, and significant risk factors. Selected Financial Data The company's net revenues increased from RMB 970.2 million in 2017 to RMB 2,193.9 million in 2019, with a net loss of RMB 395.2 million in 2019, a significant improvement from 2018. Selected Consolidated Statements of Operation Data (2017-2019) | Indicator | 2017 (RMB in thousands) | 2018 (RMB in thousands) | 2019 (RMB in thousands) | | :--- | :--- | :--- | :--- | | Net revenues | 970,162 | 1,973,985 | 2,193,902 | | Gross profit | 799,901 | 1,643,609 | 1,797,586 | | Loss from operations | (927,678) | (1,028,934) | (459,723) | | Net loss | (918,714) | (926,950) | (395,165) | | Net loss per share (basic and diluted) | (232.80) | (147.27) | (57.81) | Selected Consolidated Balance Sheet Data (as of Dec 31) | Indicator | 2018 (RMB in thousands) | 2019 (RMB in thousands) | | :--- | :--- | :--- | | Total assets | 3,739,138 | 3,968,702 | | Total liabilities | 4,078,121 | 4,707,065 | | Total shareholders' deficit | (338,983) | (738,363) | Selected Consolidated Cash Flow Data (2017-2019) | Indicator | 2017 (RMB in thousands) | 2018 (RMB in thousands) | 2019 (RMB in thousands) | | :--- | :--- | :--- | :--- | | Net cash provided by/(used in) operating activities | 819,538 | 180,543 | (533,547) | | Net cash (used in)/provided by investing activities | (615,895) | (1,186,721) | 729,546 | | Net cash provided by/(used in) financing activities | 341,472 | 1,587,343 | (64,150) | Risk Factors The company identifies numerous significant risks, including dependence on student enrollment, a history of net losses, and substantial regulatory uncertainties in China. - The company's revenue is primarily from student tuition, making student enrollment growth critical, as failure to increase enrollments cost-effectively could negatively impact revenues and growth[18] - The company has a history of net losses: RMB 918.7 million in 2017, RMB 927.0 million in 2018, and RMB 395.2 million in 2019, with profitability not guaranteed due to continued heavy investment[20] - Significant regulatory risk exists as the company's PRC operating entities do not hold a private school operating permit for online education services, which could lead to administrative sanctions[28][30] - The company relies on a VIE structure to operate in China, and if PRC authorities find these arrangements non-compliant, it could face severe penalties, including being forced to relinquish its interests in these operations[104][105] - The company's auditor is located in China, where the PCAOB is unable to conduct inspections, which could lead to a loss of investor confidence and potential delisting from U.S. exchanges under proposed legislation[155][156][157] - A triple-class share structure gives disproportionate voting power to founders and senior management, with Mr. Peng Ou (Founder) and Mr. Tongbo Liu (CEO) controlling approximately 54.8% and 21.2% of the voting power respectively, limiting the influence of other shareholders[119][183][184] Information on the Company This section details the company's history, business model, and operational structure, including its transition to online education and reliance on a VIE structure. History and Development of the Company Sunlands began as an offline education provider in 2003, transitioned to an exclusively online model in 2014, and completed its NYSE IPO in March 2018. - Commenced education services in August 2003 and transitioned to an exclusively online model in 2014[196] - Completed an initial public offering in March 2018, listing ADSs on the New York Stock Exchange under the symbol 'STG'[201] - In August 2018, the company was renamed from Sunlands Online Education Group to Sunlands Technology Group[203] Business Overview Sunlands is a leading online post-secondary and professional education provider in China, leveraging live-streaming courses and a counseling-oriented sales approach within a complex regulatory framework. - The company is a leader in China's online post-secondary and professional education, serving approximately 1,039,733 students in 2019[206][208] - The business model is centered on live streaming course delivery, a virtual learning community, and proprietary educational content structured via 'Learning Outcome Trees'[214][225][230] Key Operating Metrics (2017-2019) | Metric | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | New Student Enrollments | 387,878 | 526,014 | 363,013 | | Gross Billings (RMB in millions) | 2,381.8 | 3,214.4 | 2,358.5 | | Net Revenues (RMB in millions) | 970.2 | 1,974.0 | 2,193.9 | - Self-taught Higher Education Examination (STE) courses are the largest contributor to revenue, accounting for 80.5% of net revenues in 2019[221] - The company utilizes a large sales and marketing team (approx. 6,600 personnel as of Dec 31, 2019) and a counseling-oriented sales approach to convert leads from online advertising channels[257][264] - The company operates under a complex PRC regulatory environment, requiring various licenses for value-added telecommunications, online publishing, and audio-visual program transmission, with significant uncertainties around requirements for online education providers[285][292][315][320] Organizational Structure Sunlands operates its PRC online education business primarily through two Variable Interest Entities (VIEs) to comply with foreign ownership restrictions, controlling them via contractual arrangements. - The company operates its PRC business through a VIE structure due to legal restrictions on foreign ownership in value-added telecommunication services[359] - Control over the VIEs (Beijing Sunlands and Tianjin Shangde) is maintained through a series of contractual arrangements, enabling the company to consolidate their financial results[359][360] - Key contractual agreements include: Exclusive Technical Consultation and Service Agreements (to transfer economic benefits), Business Operation Agreements, Equity Interest Pledge Agreements, and Powers of Attorney (to establish effective control)[362][363][364][367] Property, Plants and Equipment The company's principal executive offices are in Beijing, with additional significant office spaces in Wuhan and Guangzhou, all of which are leased. - The company's principal executive offices are in Beijing, with other major offices in Wuhan and Guangzhou[370] - All facilities are leased from independent third parties, and the company believes its current leased facilities are adequate for the foreseeable future[371] Operating and Financial Review and Prospects This section analyzes the company's financial performance and condition, highlighting revenue growth, narrowed net loss, liquidity, and critical accounting policies. Operating Results In 2019, net revenues increased by 11.1% to RMB 2,193.9 million, while net loss narrowed by 57.4% to RMB 395.2 million, primarily due to reduced sales and marketing expenses. Financial Performance Comparison (2018 vs. 2019) | Metric | 2018 (RMB in millions) | 2019 (RMB in millions) | Change (%) | | :--- | :--- | :--- | :--- | | Net Revenues | 1,974.0 | 2,193.9 | +11.1% | | Gross Billings | 3,214.4 | 2,358.5 | -26.6% | | Gross Profit | 1,643.6 | 1,797.6 | +9.4% | | Sales and Marketing Expenses | 2,152.8 | 1,792.3 | -16.7% | | Net Loss | (927.0) | (395.2) | -57.4% | - The decrease in gross billings and new student enrollments in 2019 was a result of adjusting marketing strategies to be more prudent and focus on cost efficiency[381][406] - The decrease in net loss in 2019 was primarily driven by reduced labor costs within sales and marketing, reflecting a disciplined cost management approach[410] - Product development expenses increased by 33.8% in 2019, mainly due to higher payroll-related compensation for development personnel, indicating continued investment in course content and technology[410] Liquidity and Capital Resources The company's liquidity is primarily from operations and financing, with RMB 1,402.2 million in cash as of December 31, 2019, despite negative working capital due to deferred revenue. Cash and Liquidity Position (as of Dec 31, 2019) | Metric | Amount (RMB in millions) | | :--- | :--- | | Cash and cash equivalents | 1,402.2 | | Working Capital | (195.4) | Summary of Cash Flows (2019) | Cash Flow Activity | Amount (RMB in millions) | | :--- | :--- | | Net cash used in operating activities | (533.5) | | Net cash provided by investing activities | 729.5 | | Net cash used in financing activities | (64.2) | - The company's negative working capital position in 2019 was mainly due to deferred revenue[459] - Capital expenditures decreased significantly from RMB 518.4 million in 2018 to RMB 25.5 million in 2019[471] Tabular Disclosure of Contractual Obligations As of December 31, 2019, the company had significant contractual obligations, primarily consisting of operating lease commitments totaling RMB 974.4 million and debt commitments of RMB 225.6 million. Contractual Obligations as of December 31, 2019 (RMB in thousands) | Obligation Type | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Operating lease commitment | 974,404 | 91,182 | 148,032 | 147,602 | 587,588 | | Investment commitment | 34,837 | 34,837 | — | — | — | | Debt commitment | 225,625 | 32,500 | 65,000 | 65,000 | 63,125 | Directors, Senior Management and Employees This section provides information on the company's leadership, board structure, and workforce, including key executives, board committees, and employee numbers. Directors and Senior Management The company is led by Founder and Chairman Peng Ou and CEO Tongbo Liu, with a management team including experienced executives and a nine-member board. - Mr. Peng Ou is the Founder and Chairman of the Board of Directors[480] - Mr. Tongbo Liu has served as Chief Executive Officer since January 2015[481] - CFO Yipeng Li resigned effective April 30, 2020, and was to be succeeded by Chief Strategy Officer Lv Lu[482][483] Compensation For fiscal year 2019, the company paid RMB 2.4 million in cash to executive officers and RMB 2.2 million to independent directors, with equity awards granted under a 2017 Share Incentive Plan. - In FY 2019, aggregate cash compensation for executive officers was RMB 2.4 million[493] - The company adopted the 2017 Share Incentive Plan, authorizing up to 829,349 ordinary shares for awards[494][495] - As of the report date, options to purchase 44,355 Class C ordinary shares were outstanding under the 2017 plan[495][503] Board Practices The Board of Directors consists of nine members, including three independent directors, and follows Cayman Islands' home country governance practices, exempting it from certain NYSE requirements. - The Board of Directors has nine members, including three independent directors: Mr. Yifan Li, Mr. Zheng Zhao, and Mr. Xiaochuan Wang[504] - The company utilizes the 'home country practice' exemption and does not have a majority of independent directors on its board[504] - The Audit Committee is composed entirely of independent directors, with Mr. Yifan Li qualifying as the 'audit committee financial expert'[509] - The Compensation Committee and Nominating and Corporate Governance Committee are not composed entirely of independent directors, in line with home country practices[510][513] Employees As of December 31, 2019, Sunlands had 2,880 full-time employees, a significant reduction from prior years, with academic and administrative faculty forming the largest group. Number of Full-Time Employees by Function (as of Dec 31, 2019) | Function | Number of Employees | Percentage | | :--- | :--- | :--- | | Academic and administrative faculty | 1,035 | 36.0% | | Technology development | 651 | 22.6% | | Sales and marketing staff | 570 | 19.8% | | Sales operation | 352 | 12.2% | | General and administrative | 272 | 9.4% | | Total | 2,880 | 100% | - The total number of full-time employees decreased from 3,847 in 2018 to 2,880 in 2019[517] Share Ownership As of March 31, 2020, share ownership and voting power were highly concentrated, with the Founder and CEO holding significant control due to a triple-class share structure. Beneficial Ownership and Voting Power (as of March 31, 2020) | Shareholder | % of Voting Power | | :--- | :--- | | Peng Ou (Founder, Chairman) | 54.8% | | Tongbo Liu (CEO, Director) | 21.2% | | All directors and executive officers as a group | 79.8% | - The calculations are based on 6,801,730 ordinary shares outstanding, comprising Class A (1 vote/share), Class B (7 votes/share), and Class C (10 votes/share)[520] Financial Information This section confirms the appending of consolidated financial statements, discusses a securities class action lawsuit, and states the company's dividend policy. - The company, along with certain directors, officers, and underwriters, was named as a defendant in a securities class action lawsuit filed in June 2019 related to its March 2018 IPO, which the company believes is without merit and intends to defend vigorously[532] - The company has never declared or paid cash dividends and has no plan to do so in the near future, intending to retain earnings for business operations and expansion[533] Additional Information This section details the company's corporate structure, governance documents, and provides an analysis of tax implications for investors, including the triple-class share structure and potential PFIC classification. - The company has a triple-class share structure: Class A (1 vote), Class B (7 votes), and Class C (10 votes), which significantly concentrates voting power[542] - As a Cayman Islands exempted company, Sunlands is not subject to Cayman Islands income or capital gains tax, and dividend payments are not subject to withholding tax there[564] - Under PRC tax law, dividends paid by the company's PRC subsidiaries to its Hong Kong subsidiary may be subject to a 10% withholding tax, potentially reducible to 5% under a tax treaty[432] - There is a risk that the company could be classified as a PRC resident enterprise, which would subject it to PRC tax on its worldwide income and could result in PRC withholding tax on dividends paid to non-PRC shareholders[566][567] - For U.S. investors, there is a risk that the company could be classified as a Passive Foreign Investment Company (PFIC), which could result in adverse U.S. federal income tax consequences[195][583] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risks are interest rate risk, foreign exchange risk, and inflation risk, with no hedging instruments currently in use. - Interest rate risk relates to interest income from bank deposits and interest expenses for student loan financing programs, with the company paying RMB 118.0 million (US$16.9 million) in interest to credit providers in 2019[601] - Foreign exchange risk arises because substantially all revenues are denominated in Renminbi (RMB), which is not freely convertible and its value fluctuates against the U.S. dollar[602] - The company has not entered into any hedging transactions to reduce its exposure to interest rate or foreign currency exchange risk[600][603] Part II Material Modifications to the Rights of Security Holders and Use of Proceeds This section details the use of proceeds from the company's March 2018 Initial Public Offering (IPO), including share repurchases and capital injections into subsidiaries. - The company received net proceeds of approximately US$176.8 million from its March 2018 IPO and concurrent private placements[612] - As of December 31, 2019, US$9.6 million of the proceeds were used for a share repurchase program and US$70.0 million was used for a capital injection into its PRC subsidiary, Wuhan Zhibo[613] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2019, without an auditor attestation report due to its emerging growth company status. - Management concluded that as of December 31, 2019, the company's disclosure controls and procedures were effective[615] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2019, based on the COSO framework[616] - As an 'emerging growth company', the annual report does not include an auditor attestation report on internal control over financial reporting[619] Other Information This section covers various governance and compliance topics, including the audit committee financial expert, principal accountant fees, ADS repurchase program, and adherence to Cayman Islands home country practices. - The board of directors has determined that Mr. Yifan Li, an independent director, qualifies as an 'audit committee financial expert'[621] Principal Accountant Fees (RMB in thousands) | Service | 2018 | 2019 | | :--- | :--- | :--- | | Audit Fees | 9,650 | 7,714 | | Tax Fees | 495 | — | | Total | 10,145 | 7,714 | - From August 2018 to March 2020, the company repurchased a total of 2,708,185 ADSs at an average price of US$3.5367 per ADS under its publicly announced repurchase program[628] - The company follows Cayman Islands corporate governance practices, which exempt it from NYSE requirements for a majority-independent board and fully independent nominating and compensation committees[631] Part III Financial Statements This section contains the audited consolidated financial statements for Sunlands Technology Group for 2017-2019, prepared in accordance with U.S. GAAP, detailing financial position, operations, and cash flows. - The independent auditor, Deloitte Touche Tohmatsu Certified Public Accountants LLP, issued an opinion that the financial statements present fairly, in all material respects, the financial position and results of operations in conformity with U.S. GAAP[640] - The company operates as a single segment: the provision of online education services, with all operations and long-lived assets located in the PRC[815] - Revenue from online education services is recognized on a straight-line basis over the service period, with the weighted average service period in 2019 being 32 months for degree-oriented courses and 19 months for professional courses[716] - The company adopted the new lease accounting standard (Topic 842) on January 1, 2019, resulting in the recognition of right-of-use assets of RMB 560.2 million and lease liabilities of RMB 607.2 million[748] - As of December 31, 2019, the company had restricted net assets in the PRC of RMB 1,189.3 million, which are not available for distribution to the parent company as dividends[820]