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OneSmart International Education Group Limited  (NYSE:ONE)
Q1 2019 Earnings Conference Call
Jan. 31, 2019, 8:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to OneSmart International Education Group Limited's First Fiscal Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by question-and-answer session. (Operator Instructions) I must advise you that this conference is being recorded today.

I would now like to hand the conference over to your first speaker, Ms. Rebecca Shen, Investor Relations Director, OneSmart International Education Group Limited. Thank you, please go ahead.

Rebecca Shen -- Investor Relations Director

Thank you, operator. Good morning, everyone, and thank you for joining OneSmart's First Quarter 2019 Earnings Conference Call. The Company's earnings results as well as supplementary slide presentation was released earlier today and are available on the Company's IR website www.onesmart.investorroom.com.

Joining us today is Mr. Dong Li, our Director and Chief Financial Officer. Dong will give you an update on Company's business strategy and key highlights of first quarter 2019 results. After his prepared remarks, Dong will be available to answer your questions.

I remind you that this call may contain forward-looking statements made under the safe harbor provisions 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 the U.S. 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 Dong. Please go ahead.

Dong Li -- Director and Chief Financial Officer

Thank you, Rebecca, and hello everyone. We are very pleased to start our first quarter of fiscal year 2019 with accelerated top line growth across all our business segments. Net revenues increased by 46.6% year-over-year to RMB647 million, of which OneSmart VIP business and HappyMath business continued the strong momentum and achieved top line growth of 33.8% and 51.1% year-over-year, respectively. The FasTrack English business and Tianjin Huaying class programs also expanded quickly and made significant revenue contribution during the quarter. These demonstrated our strong ability to execute our corporate strategy and to effectively manage our diversified business operations.

We will continue to leverage our operational excellence in managing premium education brands to expand into more diversified market segments and new geographic locations in China. As a leading diversified premium K-12 education company in China, we are well-positioned to benefit from the rapid growth of the premium education market and to further consolidate the fragmented market through both organic growth and acquisitions.

Going forward, we will further accelerate our top line growth and enlarge our overall market share through continuous expansion strategies. First, continuous opening of new learning centers and expansion of existing learning centers. We added 52 new learning centers during the quarter and the total number of learning centers increased to 367 as of November 30, 2018, which represents a total classroom capacity increase of 47.6% year-over-year and 13.3% quarter-over-quarter. We remain determined to maintain total classroom capacity increase of at least 25% to 30% in the next three years, which includes opening new learning centers and expanding classroom areas of existing learning centers.

Second, attracting more students enrollments and increasing cross-selling of more subjects to the students. For the first fiscal quarter of 2019, monthly average student enrollments increased by 70.5% year-over-year, of which monthly average student enrollment for OneSmart VIP business and HappyMath increased by 28.1% and 47.4% year-over-year, respectively. Our OneSmart VIP business has recently launched the new online broadcasting program during weekdays to provide more value-added services to our students. In the meantime, we are also expanding the operations of OneSmart K-12 class program and OneSmart K-12 small group program.

Third, on pricing, we targeted to maintain an average selling price increase of 5% to 7% per annum. For the first fiscal quarter of 2019, the average selling price of our OneSmart VIP business and HappyMath increased by 4.5% and 5% year-over-year, respectively.

Fourth, pursuing more investments and acquisitions when opportunities arise. We successfully acquired and integrated FasTrack English and Tianjin Huaying Education in 2018. We also acquired a minority stake in Juren Education, a leading K-12 after-school education service provider with national brand influence in October 2018. The business operations and the financial performance of Juren Education are in line with our expectations. Juren Education and Tianjin Huaying Education are both highly respected education institutions, renowned for their high-quality teaching, curriculum development capabilities, experienced faculty and management team and strong brand recognition. Leveraging our refined operation management expertise, our investment in Juren Education and our acquisition of Tianjin Huaying Education will further strengthen our capabilities in offering small class services and create great synergies with our existing business.

Fifth, we will continue to significantly increase our investments on research and development in both curriculum development and integration of the latest education technology, as well as incubating and investing heavily in new business operated both online and offline. We continued to benefit from the consumption upgrade in Tier 1 and Tier 2 cities, where we are incubating and investing heavily in new online and offline product offerings, in order to deliver rapid top line growth over the next five years. For example, Yimi Online Tutoring, a leading premium online K-12 tutoring company, which we incubated and took a significant equity stake, achieved accelerated growth since its inception. We also invested in UUABC an online kids English training service provider and BestMath an online kids mathematics training service provider, which will further expand our footprints in the online education market and form an integral part of our ecosystem. We are confident that our expansion strategies are effective and we are on the right track implementing our growth strategy and to drive the revenue and profit growth.

And in the meantime, we can maintain a good balance between expansion and operational efficiency to deliver more sustainable value for our shareholders in the long term. We are delighted to see our mature learnings centers continue to consistently deliver satisfactory operating results and our newly opened learning centers to ramp up quickly and achieve higher utilization rates.

During the first fiscal quarter of 2019, gross profit margin of our Mature Learning Centers increased by 120 bps year-over-year, of which gross profit margin of Mature Learning Centers for OneSmart VIP business and HappyMath increased by 90 bps and 70 bps, respectively. While we are accelerating our capacity expansion, which may lead to some pressure on our operating margin. However, we believe the impact would only be temporary, and we will continue our focus on improving the overall operational efficiency and profitability to achieve margin expansion when we maintain stabilized expansion speed.

The following are key highlights of our core business segments during the first fiscal quarter of 2019. OneSmart VIP business, which is the exam preparation, overseas study consultation, and study camps services business. Despite the fact that we opened six new learning centers in Shanghai during the first quarter. Non-GAAP operating margin in Shanghai in Shanghai for OneSmart VIP business remained above 40%. The gross profit margin for Mature Learning Centers, which refers to learning centers that have been under operation for more than two years increased by 90 bps year-over-year.

In the meantime, we continued to see strong momentum in monthly average student enrollment with the growth by over 50% in cities including Suzhou, Wuxi, Xi'an, Chongqing, Yancheng, Wenzhou, Zhuhai, Tianjin, Lanzhou, Chengdu, Shenyang and Huizhou. We opened a total of 17 new learning centers during the quarter for the OneSmart VIP business.

And for HappyMath, which is our kids mathematics training program. We continued to accelerate our growth in HappyMath. Revenue increased by 51.1% year-over-year to RMB106.5 million from RMB70.4 million in the same quarter of last year.

While the monthly average student enrollment increased by 47.4% year-over-year to 26,000 from 17,500 in the same quarter of last fiscal year. The gross profit margin for Mature Learning Centers of HappyMath increased by 70 bps year-over-year. Revenue growth exceeded the 100% year-over-year in cities outside Shanghai such as outside Shanghai such as Beijing, Shenzhen, Chengdu, Xiamen and Suzhou. Benefiting from our customers increasing demand for the Chinese language training and science program, the average subjects taken by each student expanded rapidly. More than 7,900 students were enrolled for the Chinese language training class during the first fiscal quarter of 2019 under the HappyMath program.

For FasTrack English program, which is our kids English training services. We repositioned FasTrack English as premium kids English training with a focus on STEM English and expanded the operation into new cities including Guangzhou and Shenzhen with a total of six new learning centers opened since our acquisition of FasTrack English. And the new student enrollments increased by 55.6% year-over-year, compared to approximately 30% historical growth before acquisition. The above demonstrated our strong acquisition and integration capabilities, which will continuously accelerate the growth of FasTrack English business nationwide.

Now let me walk you through the added key financial details for the first fiscal quarter of 2019. Operating costs and expenses for the quarter were RMB708 million, an increase of 54.7% from RMB457.5 million during the same quarter of last year. Non-GAAP operating costs and expenses, which excludes share-based compensation expenses, were RMB689.9 million, an increase of 52.7% from RMB451.9 million during the same period last year.

Cost of revenues increased by 53% year-over-year to RMB386.6 million. The increase was primarily due to the opening of 142 new learning centers since the end of the first of fiscal quarter of 2018. Accordingly the Company incurred more rental expenses as well as more personnel costs for teaching staff and study advisors.

Selling and marketing expenses increased by 56.4% year-over-year to RMB166.4 million. Non-GAAP selling and marketing expenses, which excludes share-based compensation expenses, were RMB166 million, an increase of 56.2% from RMB106.2 million during the same period last year. The increase was primarily due to the opening of 142 new learning centers since the end of the first fiscal quarter of 2018. Accordingly the Company incurred more marketing expenses and employed more sales and marketing staff.

General and administrative expenses increased by 57.3% year-over-year to RMB155 million. Non-GAAP general and administrative expenses, which excludes share-based compensation, were RMB137.3 million, an increase of 47.6% from RMB93 million during the same period last year. The increase was primarily due to our enlarged investment in research and development as well as the opening of 142 new learning centers since the end of the first fiscal quarter of 2018. Accordingly, the Company hired more management personnel. Total share-based compensation expenses, which were allocated to related operating expenses, increased by 220.8% year-over-year to RMB18.2 million in the first fiscal quarter of 2019.

So on the balance sheet, as of November 30, 2018, the Company had cash and cash equivalents of RMB775.4 million and short-term investments of RMB748.3 million. OneSmart's prepayments from customers balance, which represents cash collected from enrolled students for courses and recognized proportionately as the tutoring sessions are delivered, was RMB2.2 billion at the end of the first fiscal quarter of 2018, an increase of 11.4% from RMB2.0 billion at the end of fiscal year 2018, which was reflective of the latest regulatory requirements that prepaid tuition fees cannot be more than three months.

Capital expenditures for the first fiscal quarter of 2019 were RMB80.2 million, an increase of RMB53.6 million from RMB26.6 million in the first fiscal quarter of 2018. The increase was mainly due to leasehold improvements as a result of the opening of new learning centers and renovations of existing learning centers.

Turning to guidance for fiscal year 2019. We maintain our guidance and expect our net revenues to be between RMB4 million and RMB4.15 billion, an increase of 40% to 45% from fiscal year 2018. This forecast reflects OneSmart's current and preliminary view, which is subject to uncertainty.

This concludes our prepared remarks. I will now turn the call to the operator and open for Q&A. Operator, we are ready to take questions.

Questions and Answers:

Operator

(Operator Instructions) The first question is from Sheng Zhong of Morgan Stanley. Please go ahead.

Sheng Zhong -- Morgan Stanley -- Analyst

Hi, thank you for taking my question. I have two questions. The first one is just wondering now how much revenue and profit contribution is from Shanghai, and if I look at the top five cities for the contribution now. And secondly, is what's your estimate that the -- your teachers certificate holding ratio will be after this written test and the interview? So to think the teachers license requirement will be some uncertainty for your fast growth outlook in this year. Thank you.

Dong Li -- Director and Chief Financial Officer

Thank you, Zhong Sheng. Okay, so your first question is about the revenue and profit contribution from Shanghai and also the top five cities in terms of the revenue and profit contribution. Okay, so for the first fiscal quarter of 2019, Shanghai I mean combined contributed about 60% to our total revenue and compared with the first quarter of fiscal year 2018 the number was 62%. So there is -- so it decreased from 62% to 60%.

And for the top five cities, so other than Shanghai the average four major cities that contributed significantly to our revenue and profit are Guangzhou, Hangzhou, Beijing and Nanjing. So basically I think Guangzhou and Hangzhou they contributed about 5% during the quarter and Beijing and Nanjing, they each contributed about 4%. This is in terms of the top line revenue.

And then on the profit, I think the Shanghai contributed about 70% in terms of the total revenue contribution and then the top five, I'm sorry, in terms of the total profit contribution and then the top five 5 cities contributed about 85% for the first quarter. Okay, so this is for your first question,

And then, your second question is about the teachers teaching permits compliance rate. So based on our -- OK, based on our internal logistics. So as of now our overall teachers teaching permits compliance rate is about 50% and we expect our overall teacher compliance rate will reach to 90% or above after the next two, like teachers promoting examinations in 2019. And on the other hand for all those new teachers that we hire, we basically require them to have the teachers teaching permits as a must. So, our current expectations that we are helping our teachers who do not have the teachers teaching permits to take the examinations. We are helping them to attend related examinations and we provide related trainings and we expect our overall teachers' compliance rate will be about 90% by the end of 2019.

Sheng Zhong -- Morgan Stanley -- Analyst

Thank you. That's helpful.

Dong Li -- Director and Chief Financial Officer

Thank you.

Operator

The next question is from Edwin Chen of UBS. Please go ahead.

Edwin Chen -- UBS -- Analyst

Hey, Li Dong, we saw that in the first quarter you certainly delivered a strong top line growth, but in the meanwhile margins came down year-on-year quite a bit. So I was wondering, can you update us first of all the capacity expansion guidance for the full year '19, and also in order to achieve that what's the margin expectation for the rest of the year? That's my first question. And the second question is, given the very strong capacity expansion in the first quarter, do you experience or do you -- are there any regulatory impact to your capacity expansion plans or if not can you give us the outlook for the potential regulation updates for the rest of the year? Thank you.

Dong Li -- Director and Chief Financial Officer

Okay, sure. Thank you, Edwin. Okay, sure. So on the first question in terms of the overall capacity expansion, so the Company (inaudible) our current capacity expansion plan that we are on the right track to open a total of 140 learning centers for the full year. And yeah, and in the first quarter, we definitely accelerated our school opening and we opened 52 learning centers during the first fiscal quarter. And then for the whole year, we are still on track to open a total of 140 learning centers. And in terms of our capacity expansion for the next fiscal years, we have to achieve, and I believe the 25% to 30% capacity expansion in the next three years.

And then in terms of our guidance on the margin, so I think for the operating margin for the first fiscal quarter of 2019, I would like to add the following. First, please note that the first fiscal quarter is usually the slowest season of the year. So the effect from some incremental costs and expenses on margin would be scaling up. And secondly, we are accelerating the capacity expansion of our new and existing learning centers. We added 142 new learning centers from the end of the first fiscal quarter of 2018 which represents a total of 63.1% increase in the total number of learning centers. And this may lead to some pressure on our operating margin.

However, we believe the impact would only be temporary and we will continue improving the overall operational efficiency and profitability to achieve margin expansion when we maintain a stabilized expansion speed. And we are pleased to see the gross profit margin for our Mature Learning Centers increased by 120 bps year-over-year during the first fiscal quarter of 2019 and we are confident that our newly opened learning centers will ramp up quickly and achieve higher utilization rates when they become material.

And certainly on the new regulatory matters, so we do not see like material negative impact on our overall school opening and growth opportunities. And there could be some incremental admin cost and the earned expenses incurred as a -- without implementing the policy in certain cities, and we -- but definitely, we do not think that's going to have a material negative impact.

So turning on to our guidance on the margin for the whole year, we remain confident and positive to achieve a non-GAAP operating profit increase by 20% to 25% for the fiscal year 2019, so this is our guidance on margin for the whole year, a non-GAAP operating profit increase of 20% to 25%.

And then your second question is about the new regulatory environment and whether this has had any impact on our business, so on regulation, the recent enhancement of regulatory measures in relation to (inaudible) companies, we think it has significantly raised the entry of barriers for the industry and it's promoted and improved the market standard and enhanced the overall customer experience and supported the healthy growth of the overall market in the long term. So as always, we are committed to build a high quality and sustainable education platform for our students, and we are formally supportive of these reforms.

As a leading educational service provider in China, we believe this will be at the high level in the industry to meet this new government measures. And we also expect China's after-school education market to further consolidate and as a -- without OneSmart Education as the leader in the industry, we will further consolidate the fragmented industry and acquire more market share in the mid to long term.

And at this stage, the new regulation matters are currently being implemented on a city by city basis, even though we continue to foresee some uncertainties around the implementation procedures. The current impact we're seeing so far is in line with our expectations. And overall, we do not expect to see material negative impact on our growth opportunities nationwide. Okay, so this is our comment on the second question.

Edwin Chen -- UBS -- Analyst

Thank you.

Operator

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Rebecca Shen for any closing remarks.

Rebecca Shen -- Investor Relations Director

Thank you, operator. In closing, on behalf of the entire management team, we would like to thank you again for your participation in today's call. If you have any further enquiries in the future please feel free to contact us. Thank you.

Operator

The conference call has now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 30 minutes

Call participants:

Rebecca Shen -- Investor Relations Director

Dong Li -- Director and Chief Financial Officer

Sheng Zhong -- Morgan Stanley -- Analyst

Edwin Chen -- UBS -- Analyst

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