Aug 18, 2020 (Thomson StreetEvents) — Edited Transcript of OneSmart International Education Group Ltd earnings conference call or presentation Tuesday, August 18, 2020 at 12:00:00pm GMT
OneSmart International Education Group Limited – Chief Strategic Officer, CFO & Director
Good day, and welcome to the OneSmart International Education Group Limited Financial Results for the Third Quarter of 2020 Conference Call. (Operator Instructions) Please note, this event is being recorded.
I would now like to turn the conference over to Ms. Ida Yu, Investor Relations Director. Please go ahead.
Thank you, operator. Good morning, good evening, everyone, and thank you for joining OneSmart International Education Group Limited Third Fiscal Quarter 2020 Earnings Conference Call. The company’s earnings results as well as supplementary slide presentation were released earlier today and are available on the company’s IR website at ir.onesmart.org. Joining me on this call are Mr. Steve Zhang, Chairman and Chief Executive Officer; and Greg Zuo, our Chief Financial Officer and Chief Strategic Officer.
I will remind you that this call may contain forward-looking statements made under the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Such statements are based on management’s current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company’s control, which may cause the company’s actual results, performance or achievements to differ materially from those in the forward-looking statements. Further information regarding these and other risks, uncertainties and factors is included in the company’s filings with United States Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under the law.
With that, I will now turn the call over to Steve. Please go ahead.
Xi Zhang, OneSmart International Education Group Limited – Founder, Chairman & CEO 
Thank you, Ida. Hello, everyone, and thank you all for your interest in today’s earnings presentation.
The third fiscal quarter 2020 was the most challenging one in our 12 years operation history. Strictly following local governmental guidelines, we have taken proper measures to protect health and the safety of our students and employees. Meanwhile, our teachers and advisers dedicated to prepare our students both academically and mentally for the GaoKao and ZhongKao, which are key milestones in every Chinese student’s lifetime. Our efforts have been much appreciated of students and their parents. Greg will give you more details later.
Today, I’d like to take a few minutes to review our strategic focus with you. Consistently, our business and growth is guided by 3 priorities: firstly, OneSmart has a premium brand positioning. This is evidenced by our remarkable track record of OneSmart student’s academic excellence. College admission rate of OneSmart students is more than 50% higher than national average and high school admission rate of OneSmart students is 40% to 50% higher than the average for China major cities.
We invest in our premium quality education services and learning centers to meet the growing needs.
Secondly, we design products and services oriented by customers. We respond to their increasing needs for personalized learning with small caring and engagement. Personalized curriculum is designed for each individual student to make smart use of time and drive excellent results. Last but certainly not least, we continuously upgrade our products and technologies to enhance learning experience and effectiveness. We have developed a robust teaching system UPC, data-driven, OMO tools and platforms, AI-powered OneSmart Online [et cetera].
All those priorities mentioned above will enable us to enhance the brand value to expand the share further in the mature markets and to penetrate into new markets in a disciplined manner.
With that, I will now turn the call over to Greg, who will provide you more updates on the company performance. Greg, please go ahead.
Honggang Zuo, OneSmart International Education Group Limited – Chief Strategic Officer, CFO & Director 
Thank you, Steve. Hello, everyone, and thank you all for joining us today. Let me start with the overall business update.
The fundamentals continue to be solid with 1-on-1 demand becoming stronger through our short-term operations on impact by COVID-19. In Q1, the hardest hit quarter, all of our learning centers have been temporarily closed, all public schools in China have also being temporarily closed without reopen schedule being provided. All classes and customer acquisitions conducted through our online platform until late May.
The latest update is as of August 4, more than 90% of centers have been reopened. However, we think the work is hard, we remain very positive for the long-term outlook due to 4 main reasons: first, the demand for highly effective and premium education services is increasing and will gain market shares. Second, increasing numbers of consumers are better educated and become convinced that 1-on-1 format provides a better quality of education. Third, OneSmart’s upgraded services are receiving extremely positive feedback by parents and students. And fourth, industry consolidation opportunities are arising for OneSmart as a market leader in the premium 1-on-1 education service sector.
Page 6 of our prepared presentation summarizes of our online and online — and offline class offerings, our 12 year’s solid offline operations cover premium K-12 1-on-1 After-school Tutoring and young children education aged from 3 to 18 years old. Premium education propelled by online education technology, OneSmart is able to better serve customers with more flexibilities in study schedules and teaching resources with less limitation on far flung locations.
The combination of offline and online products and services have enhanced customer experience and loyalty, increased smart teaching and management efficiency, and supported our long-term healthy growth. Now please turn to Page 7.
As shown on this page, OneSmart 1-on-1, our premium K-12 1-on-1 tutoring business has seen a solid V-shape recovery backed by rigid demand. As of today, more than 90% of nationwide learning centers reopened. Students in the cities affected by the resurgence of COVID-19 will continue to have access to OneSmart Online to facilitate their ongoing education until further notice.
After the GaoKao, cash sales have recovered to grow by 29% and 25% year-over-year in July and August to date, respectively. In fiscal year 2021, we will continue our centers upgrade and expansion in the top 20 cities.
According to recent market studies, we have visualized the key consumption habits of our direct customers, as shown on Page 8. They are mothers of K-12 students from affluent families in top 50 cities in China. They pursue high-quality lifestyle. They purchase iPhone, Estée Lauder, Louis Vuitton. They drive Mercedes-Benz. They stay in upscale hotels such as Marriott and Hilton for holidays. They engage private art teachers, private sports coaches for their children, and they are a target customer for OneSmart 1-on-1 business. Based on one of the global leading consumer consulting firm’s analysis, so far, OneSmart serves only 3% of those target families. We still have a huge potential to expand our shares in the premium education sector, a large underserved addressable market.
Page 9 shows a piece of good news from our OneSmart 1-on-1 learning center in Shanghai. We are proud to announce that student Yao has achieved top score in Shanghain GaoKao this year. He has been studying in OneSmart center for 6 years. Just quote this, his mother as saying, “We are grateful to OneSmart teachers for their dedicated efforts, especially during the pandemic this year. The personalized curriculum and the heartful teaching help my son to enhance his learning power and effectively improve his academic score.” Again, we congrats student Yao and his family for the excellent result. We believe more families across China will get engaged with OneSmart because of the results and a great experience.
As Steve mentioned earlier, we continue to solidify our premium positioning and the premium pricing power through upgrade in products and services. On Page 10, OneSmart 1-on-1 Elite VIP program launched since the beginning of fiscal year 2020. We have started to upgrade our learning centers to offer larger classrooms with intelligent and interactive teaching tools and platforms. The better environments enable us to facilitate enjoyable study experience. Under Elite VIP, our students will have highly selective teachers with extensive teaching experience to meet their higher requirements. Year to date, this newly launched product has generated cash sales of RMB 94.5 million, representing 3% of OneSmart 1-on-1 business cash sales. Elite VIP is priced 40% to 80% higher than our regular 1-on-1 class with a higher expected margin. We will continue to grow out in fiscal year 2021, starting September and onwards. Our goal is to generate about 20% of OneSmart 1-on-1 business cash sales from the Elite VIP program in the near future.
Now let’s move on to our younger children education business on Page 11. Its recovery has been slower compared with our K-12 1-on-1 children businesses, due to later resumption of school activities for younger children in the third fiscal quarter. Most recently, we see a good signal of its growth momentum, cash sales recovered to grow by 12% year-over-year in August to date. Based on our recent customer surveys, we believe the primary demand has shifted from elementary school admission preparation to the development of learning power for young children. We will adjust our products and service combinations to quickly capture the evolving needs in the coming years.
In fiscal year 2021, starting September, we are going to upgrade products, upgrade and open new centers in selected cities. We will also adopt a product upgrade program under these 2 brands.
Now move on to OneSmart Online business, as shown on Page 12. Our online classes provides convenience and complementary services to our children in the form of take-out services. For most of our customers, they become engaged with OneSmart education through our offline centers and most of classes are taken on weekends. However, with the introduction of OneSmart Online, those existing offline acquired customers are able to schedule their incremental online class throughout the entire week to achieve a higher frequency for better results with less limitation on locations.
The additional online class offering will also drive our subject to student ratio, which is average subjects taken by each student. For example, the student takes math course in our offline centers while taking history course through our online platform. Currently, our subject to student ratio is about 1.3, and then we expect students would take additional subjects, thanks to the convenience and high-quality provided by OneSmart Online as it rolls out, this is target to drive up the subject to student ratio to 1.7 as our target.
In fiscal Q3 of 2020, online business generated RMB 59 million in cash sales, a sequential increase of, 128% growth, accounting for 8% of total cash sales in the quarter. Net revenues from online business totaled RMB 46 million, a sequential increase of 47%, accounting for 6% total net revenues. Those figures reflect pure online users only. If we add back online courses taken by offline students, cash sales and net revenue were RMB 165 million and RMB 54 million for fiscal Q3, representing 543% and 74% sequential growth, respectively.
Before Ida walks you through the financial results in more detail, I would like to elaborate on the one-off impairment loss in the fiscal Q3, as shown on Page 21.
In Q3, we booked impairment loss of RMB 335 million related to 15 investee companies. This was primarily caused by COVID-19 outbreak. We used prudent approach in evaluating financial performance of these investee companies and decided to mark down our investment amount by at least 80% for 14 of the 15 investee companies. We will continue to stick to a highly selective investment discipline and will only consider opportunities that can immediately help the growth of our core business. After this mark down, our long-term investment balance dropped significantly to RMB 1.1 billion at end of Q3 of fiscal year 2020 from RMB 1.5 billion at the end of fiscal year 2019. The remaining investments are expected to be solid, with more upside potential than downside in the future.
In summary, under the unprecedented event of the pandemic, the nature of our personalized education program demonstrated a clear V-shape performance as students waited in fiscal Q3 for back-to-schools and exam season to resume our services. As demonstrated by recent swift rebound and the return of strong year-over-year growth in fiscal Q4, our business fundamentals remain solid and consumer demand for highly effective and premium education services is increasing.
Currently, we expect fiscal Q4 revenue to grow 21% to 34% over fiscal Q3, and the margin to return to the pre-COVID-19 level for the next few quarters. Looking forward, we expect strong revenue growth and margin recovery in fiscal year 2021 and beyond, primarily underpinned by 2 major factors: firstly, the maturing of previously opened learning centers as 57% of them were opened in the last 3 years and now are ramping up as planned. And secondly, the new offerings of upgraded premium products, which are bringing improved economics over the next few years.
With that, I will turn the call over to Ida. Ida, please.
Ida Yu, 
Thank you, Grant. In the third quarter of fiscal 2020, net revenues were RMB 744.9 million, a decrease of 31.9% from RMB 1,093.3 million during the same period last year. The decrease was mainly attributable to the temporary shutdown of our offline learning centers for COVID-19-related governmental requirements, offset by the incremental volume from online platforms.
Cost of revenues decreased by 11-point — 11% year-over-year to RMB 482.6 million. We actively managed down the staff cost, rental cost and other related costs, partially offset by the increase in the depreciation and amortization cost related to our center expansion and upgrade prior to the pandemic.
Selling and marketing expenses decreased by 17% year-over-year to RMB 165 million. Non-GAAP selling and marketing expenses, which excludes share-based compensation expenses, were RMB 164.8 million, a decrease of 17% from RMB 198.5 million during the same period last year. The decrease was primarily due to our disciplined expense control and less cash sales generated during the quarter when all learning centers remained closed until late May 2020.
General and administrative expenses decreased by 23.7% year-over-year to RMB 174.7 million. Non-GAAP general and administrative expenses, which excludes share-based compensation, were RMB 136.9 million, a decrease of 35.9% from RMB 213.8 million during the same period last year. The decrease was primarily due to our expense control policy to keep a healthy financial condition during COVID-19.
Let me now move on to cover some other key financial points for the third fiscal quarter of 2020. Capital expenditures for Q3 this fiscal year were RMB 20 million, a year-over-year decrease of 45% from RMB 37 million in the same period last year. Capital expenditures accounted for 2.7% of net revenue in Q3, representing a year-over-year decrease of 70 basis points from 3.4% in the same period last year. The decreases were mainly because we prudently managed our cash flow and temporarily suspended leasehold improvements due to COVID-19.
OneSmart’s prepayments from customers balance, which represents cash collected from enrolled students for courses and recognized proportionately as the training sessions are delivered, worth RMB 2,359 million at the end of fiscal year 2020 Q3, a year-over-year increase of 6.4% from the end of fiscal year 2019 Q3.
As of May 31, 2020, the company had cash and cash equivalents, restricted cash and short-term investments of RMB 1,805 million. Based on our latest estimates, we expect to generate net revenues of RMB 900 million to RMB 1 billion for the fiscal Q4, representing a sequential growth of 21% to 34%. This outlook reaffirms our revenue guidance of RMB 3,330 to RMB 3,430 million for the full fiscal year 2020. However, this outlook represents OneSmart’s current view, which is subject to change because the COVID-19 impact is still ongoing, and its future development remains unclear.
This concludes our prepared remarks. I will now turn the call over to the operator and open for Q&A. Operator, we are ready to take questions.
Questions and Answers
We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Sheng Zhong of Morgan Stanley.
Sheng Zhong, Morgan Stanley, Research Division – Associate 
Steven and Greg, the first question is, can I ask what the margin outlook for Q4? And secondly, the — your online business looks — the trend is very good. And so can you share some of the near-term target of the online business maybe as a percentage of your VIP business? And do you see any cannibalization with your offline business? So we see the online business growth, what’s your plan for the offline business capacity expansion in the rest of this year and also in next year?
Xi Zhang, OneSmart International Education Group Limited – Founder, Chairman & CEO 
Thanks, Sheng. I appreciate your questions. Thank you so much for joining this call. Let me take your questions 1 at a time. First question regarding margin outlook for Q4.
So as we mentioned that we have received very strong cash sales in the recent months for July and August. Both are actually a record number historically for us. So that indicates very strong demand in our core business, especially after ZhongKao and GaoKao. So with that, we provided a guidance of RMB 900 million to RMB 1 billion revenue for Q4.
So as we also mentioned earlier that during the COVID-19 period, we have done an excellent job in terms of cost and expense control, so which means we have now a leaner cost structure. So we are pretty optimistic on our margin outlook for Q4. It will still be hard to provide exact margin number as a guidance. But if you use Q4 results as a proxy, which, as you know, we generated RMB 745 million in revenue and a small loss — operating loss of RMB 39 million for non-GAAP operating losses. If we — our revenue can increase and generate RMB 900 million to RMB 1 billion, we expect a pretty sizable positive operating income for Q4.
So for your second question regarding OneSmart Online, our target share and in terms of percentage of our offline 1-on-1, let me elaborate that OneSmart Online will continue and grow as part of our core business strategy. We appreciate its value in terms of providing convenience and complementary services to our existing students and potential new students. So currently, as you know, in Q4, OneSmart Online took about 8% of our cash sales. We expect consumers to continue to experience of OneSmart Online, it’s quality and good earnings results. So that market share, we expect to continue to grow in the future.
We don’t have the internal target, but we will let consumers to decide to let the convenience and value drive its growth. But in any case, OneSmart Online will create incremental growth for us going forward, which means it can serve additional demand for additional customers in the future. So we’re very thankful to our team building OneSmart Online, especially during the COVID-19 period.
Your third question regarding potential cannibalization with offline operation corporations. So we — I think it’s a fair question. I think we have observed and studied similar situations in other players of the industry who experienced the same thing. That clearly was a problem. But let me elaborate. Let me emphasize that. The OneSmart one-on-one business, it service a different demand, especially online channel. It provides convenience, provides flexibility, and more choices for our students.
So we have explained in the previous earnings call that OneSmart Online growth provides a complementary services to the existing students as well as provides access to us for additional new students in the areas that our offline centers couldn’t recover yet. So having that in mind, so we have clearly organized our teams in the format that, for example, for the mid of the week, additional higher frequency online hot demand, we have our existing offline team to handle those businesses. Clearly, that the alignment of interest, there’s no conflict. But for additional new customers that where our existing management cannot serve, we have a separate team to run that business because it is clearly a different nature.
We have clearly separated the 2 teams in terms of geographic divisions. That really help us to avoid any cannibalization and potential conflicts. So, so far, we have been operating pretty smoothly in that. We don’t see any major internal conflicts and the cannibalization from a customer perspective.
Your forth question is regarding capacity expansion plans going forward. For the near future, as we mentioned, our strategic focus is in the VIP program. So in Q4 and fiscal year 2021, we will continue and spend a lot of time to upgrade our learning center and open new VIP learning centers as well as open more VIP platforms for our students. That’s a clear focus. But in terms of number of learning centers expansions, we have 2 separate expansion strategy. For the 1-on-1, we have been very clear, we want to further continue to grow our top 20 cities, so we can achieve the economy of scales for those 20 cities. So we’ll continue to open more learning centers in the new fiscal year for the 1-on-1 business. But for young children education programs, as we mentioned earlier, it took a little bit long time to resume its normal operations as the COVID-19 impact and public school reopening schedule being a little bit behind schedule. So we will — our priority for — our priority is to fill in existing centers for the young children. But in the meantime, we will also upgrade our young children’s program by opening some VIP learning centers as well as upgrades some classes. So this summarize our expansion strategy going forward.
Our next question comes from Felix Liu of UBS.
Felix Liu, UBS Investment Bank, Research Division – Research Analyst 
My first question is regarding to our growth trajectory from here. I understand that Q3 has been negatively impacted by COVID-19. But when do you expect the revenue level to return back to normal going forward? What are the recovery trajectory for the top line as well as the margin?
My second question is on consumer preference post COVID-19. We hear some competitors saying that a portion of the parents are now becoming more open to the online format. Is that consistent of what we’re seeing in the 1-on-1 space?
My third question is on our learning center resumption or ramp-up by city tier. We understand that you have a very matured or successful operations in Shanghai. How are the situations outside Shanghai? I recall previously, during the period after rapid expansion, the utilization of non-Shanghai are relatively under pressure. So when do we expect that to improve going forward?
Xi Zhang, OneSmart International Education Group Limited – Founder, Chairman & CEO 
Thank you, Felix. So the first question regarding the revenue and margin trajectory from here. So obviously, Q3 has been a quarter mostly hit by COVID-19. But as we have explained earlier in the call that we have seen and observed very strong demand for our business in the recent months. So I think in our discussion with our consumer parents and students, this people experienced pretty difficult and special time during the February to June, they experienced the lockdown in the country and closed out public schools. They have lots of uncertainty for ZhongKao and GaoKao schedule. So they have taken a lot of online classes during the period of time. And later on, they all have to face the exams, especially GaoKao, which is delayed 1 month this year, as you know.
So they have leaned a lot during that period of time to compare different education programs, whether it’s online/offline. But their conclusion is clearly, that OneSmart 1-on-1 program is clearly very effective to provide the best customer experience in helping them, as we have elaborated earlier in this discussion ZhongKao and GaoKao results for our students has been very excellent this year.
So that probably explains why we have seen cash sales growth of 25% to 29% year-over-year, we reported recently. So we are very encouraged by this result. So with that, we would predict a pretty strong growth for new fiscal year 2021, starting September. We would — we expect to resume our historical top line growth add of 30%-plus next year. So it’s just margin, if top line growth resumed to the normal level with the leaner cost structure that we achieved during the COVID-19 period, we are optimistic on margin as well. So we expect the margin to be back to the pre COVID level in the next few quarters.
But the exact number is hard to say for margin, as you can imagine. And so Q1 next year, still will have some tail impact by COVID-19 and Q1, which is September to November, historically has been a low season in terms of productivity. So I think we look at more positive margin expansion towards the later half of the year. So that answers the first question.
The second question regarding consumer preference. I think that’s an excellent question. We have done a lot of research, consumer surveys internally as well because during that period of time, obviously, consumer experienced a lot of learning education programs online/offline. But let me — want to point a few points.
Number one, OneSmart 1-on-1 premium education services serves a very different demand than the typical mass-market class format as well as those online education programs. As we mentioned in the last Q2 earnings call, we are serving the students in the middle school and high school, all who appreciate very effective 1-on-1 personalized learning experience, which can help them quickly improve their score and do well in their exams, especially at ZhongKao and GaoKao.
So we did — in our survey of 2,500 parents, more than 90% of them have responded and said they prefer OneSmart 1-on-1 education services, especially the offline centers, which basically provides better results than other online platforms. Having said that, I think we also recognize that some of the parents, they still appreciate online channels because online provides convenience, more choices, some better teachers, right? So I think as I mentioned earlier, we will let parents and students to decide whether they want to do online or offline, but we provide both services in a high quality fashion.
So I think, to summarize, I think if the consumer, wanted to have a quality education and premium experience then clearly OneSmart Online and OneSmart offline provides the best services. So I think that answer your second question regarding consumer preferences going forward.
I think your last question is regarding the learning center ramp-up situation, especially in non-Shanghai learning centers. As I mentioned, we still have pretty large number of learning centers that are quite young. So I mentioned 57% of them opened in the last 3 years, so clearly they are ramped up excellent, as I mentioned, in Shanghai as well as non-Shanghai cities.
We didn’t provide the ramp-up results this quarter because those are during the May — so March to May period, the COVID period, but we will continue to disclose our ramp-up numbers in Q4 and beyond. But I can tell you, our ramp-up is still largely on track as we have been previously provided, which means that they follow a pretty healthy pattern of margin run cost and top line growth. So with these large number of learnings centers been ramping up at the same time, we are very confident of our performance and margin recovery going forward, which ties back to earlier questions.
Our next question comes from Tommy Wong of China Merchants Securities.
Tommy Wong, China Merchants Securities (HK) Co., Ltd, Research Division – Research Analyst 
Greg, just a quick question. I think a lot of people in offline business right now are talking about the industry consolidation. But I think it’s not about this year, I think it’s about next year or even a year after. I know we have added a lot of capacity before and we’re trying to increase utilization. But on the other hand, I heard from the other players like 40%, 30% of Shanghai learning centers have shutdown. And so it seems like a lot of the competition has disappeared. And so how do we — how do you think about the investments? What are you — what does the management think about investment for the expansion over the next year? And what are you hearing from the local market about this so-called industry consolidation?
Xi Zhang, OneSmart International Education Group Limited – Founder, Chairman & CEO 
Yes. Thank you, Tommy, for the question. I think this is a good question as well. We actually mentioned this earlier in our presentation that consolidation is a long-term positive factor for our performance going forward. And we echo your observation and discussions with other players, we have observed similar trends. There — a lot of smaller scale players has been pretty challenging for them to recover. So we observed that when the government allowed reopening of learning centers, we found many of them cannot be reopened forever. So I think this is factor in our onetime impairment losses as well. But a lot of smaller players that we invested in, we gained the insight that their performance being hit. That means opportunity for a larger player like us. We are a market leader in a 1-on-1 space. As you’ve seen, a very rapid and V-shaped rebound of our cash sales. Actually, I think probably, it’s because of that reason.
We — previously, we will find it harder for our new — signing of new students to work in. But we found out our conversion rates and number of walk-in to our learning centers much improved than before. So that’s very encouraging in the sense for us to going forward.
So with that in mind, we’ll continue to focus on the cash sales and signing of new students, which, as you know, will generate future revenues. And also we will also do opportunistic acquisitions of maybe not companies, but also — but students near by. We try to acquire students of other players in a larger number through some transaction and arrangements to take advantage of these opportunities.
So to summarize, we do believe industry consolidation provides a positive opportunity for larger players like us, and we will continue and — to take advantage of that.
This concludes our question-and-answer session. I would like to turn the conference back over to Ms. Ida Yu for any closing remarks.
Ida Yu, 
Thank you, operator. In closing, on behalf of the entire management team, we’d like to thank you again for your participation in today’s call. If you have any further inquiries in the future, please feel free to contact. Thank you. Bye-bye.
The conference has now concluded. Thank you for attending today’s presentation, and you may now disconnect.