Logo of jester cap with thought bubble.

Image source: The Motley Fool.

OneSmart International Education Group Limited (NYSE:ONE)
Q2 2020 Earnings Call
May 19, 2020, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and good evening, and welcome to the OneSmart International Education Group Limited Announces Unaudited Financial Results for the Second Fiscal Quarter Ended February 29, 2020 Conference Call. [Operator Instructions]

I would now like to turn the conference over to Rebecca Shen, Investor Relations Director. Please go ahead.

Rebecca Shen -- Director of Investor Relations

Thank you, operator.

Good morning and good evening, everyone, and thank you for joining OneSmart International Education Group Limited second 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 www.onesmart.investorroom.com.

Joining me today are Mr. Steve Zhang, Chairman and CEO; Mr. Greg Zuo, our CSO and CFO; and Ms. Helen Pang [Phonetic], head of Operations.

I'll 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 US 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 law.

With that, I will now turn the call over to Steve. Please go ahead.

Xi Zhang -- Founder, Chairman of the Board of Directors and Chief Executive Officer

Thank you, Rebecca, and thank you, all, for your interest in today's earnings presentation.

What we have achieved in the most challenging business environment in modern history demonstrates the adaptability and the resilience of OneSmart's business model and employees. Our years' investments and technology development in online space enables us to respond promptly to the unprecedented COVID-19 situation.

Our online platform has been serving over 160,000 student enrollments as of February 2020, a massive increase from just a few thousands in late 2019. The speed and volume proves the Company's strong ability to strategically manage and operate a premium online business and demonstrates its determination to build OneSmart Online into the largest premium online education company in China. While we expect our financial performance to be temporarily impacted for a couple of quarters by the pandemic, we believe it will bounce back fairly quickly as the schools reopen and the demand for premium education services prevails.

Going forward, we will benefit from OneSmart Online to penetrate the mid to high end K-12 education market in China, in both scalability and profitability, as it's helping us expand in a much larger addressable market. We see enormous growth potential ahead and will take advantage of opportunities that arise as the industry consolidates after the pandemic.

I will now turn the call over to Greg who will provide you more updates on the Company performance. Now, Greg, please go ahead.

Honggang Zuo -- Director , Chief Financial Officer and Chief Strategic Officer

Thank you, Steve, and thank you, all, for joining us.

Now let me start by giving you an update on the impact on our business by unprecedented COVID-19 pandemic and share with you our strong execution and the positive results so far. As you are aware, as part of government's measures against the pandemic, all public schools were closed since January 2020 in China, and at that time reopen schedules were unclear. Neither school and entrance exam schedule were confirmed. All of our learning centers have been temporarily closed. Therefore, all of our classes and customer acquisition were conducted through our online platform which we have never experienced before.

To make it worse, given the situation, all of our employees had to work from home till late April, which added extra challenge. However, the Company has reacted promptly and actively to manage the situation. For example, we migrated majority of our students to our online platform within just a couple of weeks since the outbreak. Thanks to our years' investment and development online, our online platform has been serving over 160,000 students enrollments as of February 2020.

Our employees have quickly adapted to the new environment and made tremendous efforts in executing our plan. As a result, for the second fiscal quarter 2020 from December to February, we managed to retain almost the same level of revenue compared with the same period last year. In addition, we booked RMB785 million cash sales in Q2, which represents a 20% increase from the same period last year, a large portion of which was generated in our online platform. Meanwhile, we also maintained a high customer satisfaction rate on online platform of over 90%, resulting in low refund rates and high renewal rates. This all demonstrates our ability to strategically manage and operate a premium online business.

We would also like to share with you our assessment of the situation. We see the impacts of the coronavirus as a one-off and as a swift pattern. We also recognize the duration of the impact may vary between core VIP business and the young children education businesses. For our premium K-12 1-on-1 business, i.e., our VIP business, there is a swift performance drop in an environment when public schools are closed and there is massive supply of free or low priced online classes. It is therefore temporarily challenging for us to deliver the distinguished value of our premium education services when the score improvement demand is not as urgent when all the students stay at home.

As the leading premium K-12 education company in China, we may experience such one-off impacts in a bit more swift fashion than other big class education sector. We expect the demand to our business, however, will bounce back shortly as back-to-school dates and exam schedules are now announced and confirmed. Our month-over-month enrollments trend also reflects the impact, as you can see on the chart here. So the enrollments were mostly impacted in February and March when the virus hit China the hardest and rapidly picked up since April and May when situation got under control.

As far as for our young children education business, i.e., our HappyMath and FasTrack businesses, it may have a slightly longer period of impact as kindergartens and some primary schools will reopen a few months after other public schools, according to government policy. We noticed that there has been news that kindergarten will soon start to reopen in early June in some of our major cities we operate. Regardless, our management team of young children education businesses have successfully revamped products as well as online acquisition practices to handle the challenge.

We have passed the most difficult time as most of the provinces have announced back-to-school dates while our business operations are gradually getting back to normal. As of May 15, 2020, 54 of our VIP centers have reopened under government permission. We expect that number to increase over the next few months. We are confident that both of our online platform and offline operations will drive robust growth and profit going forward.

Now let me turn the call over to Helen who will provide you more details with the operational update of OneSmart Online, our key strategic focus. Go ahead, Helen.

Helen Pang -- Head of Operations

Okay. Thank you, Greg.

We aim to build OneSmart Online as the leading high-end online education platform in China. Leveraging our OMO model, we are able to acquire customers through multiple online marketing channels as well as our offline AI centers. Thus, we are able to effectively reduce the customer acquisition costs. OneSmart Online provides comprehensive product mix, including big class, small group class 1-on-1 curriculum, which allows us to cross-sell among the same age group of students and extend customers' lifetime value. Our OMO triple teacher model involves cloud teacher, cloud study keeper as well as a course advisor which ensures high quality teaching, high quality curriculum and high-quality services.

We continue to see [Indecipherable] with our OneSmart Online products and technology, including our latest online teaching platform, CTS, which stands for cloud teaching system version 6.0. Our 12 years' experience on middle and back-end platform technology, data and content provides us a solid support to build the business. As we have mentioned earlier, OneSmart Online is delivering strong momentum in customer acquisition. Going forward, we expect OneSmart Online [Indecipherable] incremental growth drivers in our top 10 cities to meet the needs of high cost efficiency departments as well as convenience.

We will still focus on offline learning centers in the top 10 cities where premium services [Indecipherable]. However, in Tier 2 and Tier 3 cities, OneSmart Online will serve as the main growth driver to rapidly gain market share. The classes will be delivered online with teachers involved and supplemented by AI technology. We are pleased to see that we have achieved multiple growth [Phonetic] of pure online student enrollment to over 13,000 as of mid-May, which is 4 times as the number February.

So [Indecipherable] earlier, page 7 gives you an overview on how we acquire customers. Offline acquisition includes AI cloud centers as well as other activities. We also get a lot of online traffic through multiple ways, including subscription accounts, personal WeChat accounts, mini programs, APP, etc. to form and manage our own private traffic pool. Through a series of [Indecipherable] cross-sell, etc., we are able to convert to our private traffic and deliver teaching and services through OneSmart Online APP. We would like to point out that acquisition cost is well managed thanks to our OMO model and private traffic pooling services.

Page 8 introduces our latest online teaching platform, CTS 6.0. Our class teachers are 100% fulltime teachers who just localize the curriculum development on our Smart Online platform and provide personalized teaching. Our cloud advisors provide customized teaching plans, personal academic planning as well as the assessments. Our cloud study keepers actively track the feedback through the Smart administrative system. OneSmart Online APP provides zero distance between home and school which uses smart content such as smart error track book and student performance track. Our live broadcasting classroom adopts six steps teaching method and interactive teaching from which we track relevant customer data.

Our continued investment in the technology has laid a solid foundation for OneSmart Online. Our back-end technology includes AI, big data and cloud, provides technical support to middle end business platforms, including teaching systems, customer center, assessment center, etc. as well as the data platforms, including big data computing, user profile, datacenter, etc.

With that, I would like to turn the call over to Rebecca who will go through details of our financial results during the second fiscal year [Phonetic] of 2020. Rebecca, please go ahead.

Rebecca Shen -- Director of Investor Relations

Thank you, Helen.

Let me first provide key financial highlights and discuss the performance in our business segments, and lastly walk you through the key financials during the second fiscal quarter of 2020. Let me start with strong metrics.

We've retained the vast majority of revenue year-over-year by converting students online, while margin trend is near stabilization and on track for expansion. We have been serving over 160,000 students online since the outbreak of COVID-19. Based on the latest information, we expect to generate net revenues of RMB3,200 million to RMB3,600 million for the full fiscal year 2020. However, this outlook represents OneSmart's current view which is subject to the change because of the COVID-19 impact is still going on and the opening schedule of majorities of our learning centers is not yet there, and the degree of full year contribution by our rapidly growing online products requires more data to assess.

Now let me go through the business highlights. We successfully migrated majority of our VIP students to the online platform during the first half of February 2020. Revenues generated in the online platform during Q2 reached the level of the same period last year. We upgraded our premium products, including smart assessments and academic planning, smart home assistance, live broadcasting classroom, etc. Net revenues of international education program grew by 71% year-over-year.

With regards to HappyMath and FasTrack English, our premium young children education program, we successfully migrated over 80% of offline students to the online platform. Our online services have been well received by customers, with customer satisfaction rates of over 90%. We rolled out interactive curriculum 2.0 adopting Harvard Case Method for better learning experience. We launched interactive online small group classes for children aging from three to six. Meanwhile, we started to provide children aging from six to 12 with full spectrum of subjects to help with them a smooth transition from kindergarten to primary school. We strategically penetrated our HappyMath business into cities outside Shanghai where be observed a robust revenue growth in cities such as Chengdu, Suzhou, Nanjing, etc. Average monthly student enrollments of FasTrack English increased by 34.8% as we continue to strengthen our position in Yangtze River Delta region.

Thanks to OneSmart Online, we successfully acquired over 13,000 pure online enrollments as of early May 2020 in addition to the 150,000 students enrollment migrated to online platform as of February 2020. We successfully integrated the advanced technologies that we acquired from Yimi Online Tutoring. Yimi's technology and development on big data analytics and artificial intelligence helped create synergies with OneSmart Online to drive interactive smart learning and further improve learning experience.

To provide you update on revenue by [Indecipherable] which we have been providing in last few earnings calls, the performance has been solid and has a consistent plan as before, given the results are generated from migrated existing students online. For VIP centers in Shanghai that have been operating for over two years, the center level operating margin turned 24% and high as 37% on third year. For VIP learning centers in our top 10 cities outside Shanghai, we have achieved a center level operating margin of 19% for those that have been operating for over two years and 17% on the third year. Please note that these 11 cities generate over 90% revenue of our VIP business.

Now let me walk you through the other key financial details for the second fiscal quarter of 2020. Net revenues were RMB885.8 million, a decrease of 6% from RMB942.5 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 government requirements, offset by the incremental volume from online platform.

Cost of revenues increased by 11.2% year-over-year to RMB529.4 million. We increased teacher compensation to attract high quality teachers to support the development of OneSmart Online, added rental costs to comply with new regulatory requirements.

Selling and marketing expenses increased by 2.8% year-over-year to RMB196.7 million. Non-GAAP selling and marketing expenses, which excludes share-based compensation expenses, were RMB196.6 million, an increase of 2.7% from RMB191.4 million during the same period last year. The increase was a mixed result of increased spending in online channels and decreased expense ratios driven by disciplined marketing expense control during COVID-19 period and more effective sales and marketing activities to support the growth of OneSmart online.

General and administrative expenses increased by 16% year-over-year to RMB214.5 million. Non-GAAP general and administrative expenses, which excludes share-based compensation, were RMB177.9 million, an increase of 2.9% from RMB172.8 million during the same period last year. The increase was primarily due to increased R&D expenses for OneSmart Online mixed with our expenses 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 second fiscal quarter of 2020. Capital expenditures for the second fiscal quarter of 2020 were RMB67.9 million, a decrease of RMB23 million from RMB90.9 million in the second fiscal quarter of 2019. The decrease was mainly because we prudently managed our cash flow and temporarily suspended leasehold improvements due to COVID-19.

As of February 29, 2020, the Company had cash and cash equivalents of RMB1,107.2 million and short-term investments of RMB384.4 million. OneSmart's prepayments from customer balance, which represents cash collected from enrolled students for courses and recognized proportionately as the training sessions are delivered, were RMB2, 385.6 million at the end of second fiscal quarter 2020, an increase of 21.1% from RMB1,969.5 million at the end of the second fiscal quarter in 2019.

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

Questions and Answers:

Operator

[Operator Instructions] The first question comes from Sheng Zhong of Morgan Stanley. Please go ahead.

Sheng Zhong -- Morgan Stanley -- Analyst

Hi, management. Thank you for taking my question. I have two questions. The first one is about your guidance. Actually that implies a very low revenue growth -- negative revenue growth in the second half. I can understand there is a lot of reason -- a lot of impact from the COVID-19, but can you please -- but also, we understand that the GaoKao and ZhongKao is delayed by one month. That is also the beneficial part. So wondering if you can give more color about the guidance maybe in the third quarter and fourth quarter and can also give us some updates on the learning center resumption progress. And secondly, you mentioned that for the online business, the AI center can help to improve the student acquisition efficiency. Can you be more specific on this statement? Thank you.

Honggang Zuo -- Director , Chief Financial Officer and Chief Strategic Officer

Thank you, Zhong Sheng. This is Greg. Let me take your first question regarding the guidance, and then I'll ask our operation head, Helen, to provide you the second question's answer. So the first question regarding guidance. First of all, let me point out that it is quite difficult to provide an exact guidance as we are experiencing unprecedented events. The nature of the virus impact has been up and down in China, as you noticed. And more importantly, it will be harder to judge the reaction of parents and students: how quickly they would return to our learning centers, how would they behave in our online platform. So, we provided guidance based on the current information we have. As we noticed, the situation is gradually improving, so the financial result may get better if we keep receiving positive information.

Now let me provide some specifics on a few factors we consider. On the challenge side, as you probably noticed, Q3 is March to May, which is -- China has been hit the hardest, so everything shut down, including our learning center and public schools. And the demand for exams has been pushed back by the parents, and students, they're staying home, and there are plenty of low-priced online classes available which takes a lot of students' time. With that, we see some impact to our business because our business requires experience, especially experience of our premium services, to justify our services.

So, for Q3, you may see a lowest point in our performance. But the good news is, we are already past the Q3, and in Q4 we see some positives which are following. One, as you know, the government has announced the back to school schedule by most provinces. And now, the ZhongKao and GaoKao dates are fixed in July, which, by the way, is one month's pushback from the original June, so which means more production period for us, which is positive.

And secondly, we have already 54 VIP centers reopened under government permission. Those are in the Jiangsu, Sichuan, Yunnan provinces, and we noticed that there is news Shanghai government may allow reopen of kindergarten and large qualified tutor institutions to open in early June as well. As you know, Shanghai takes about half of our business. So this is very, very important and positive.

So, as a result, we see in Q4 we'll have a very positive rebound on our performances. If you look at Q-over-Q from Q3, I think we're going to have at least 30% to 40% growth from Q3. So, to summarize, because the nature of our business is targeted to the score improvements and the premium services sector, so we may see a larger and more swift impact to our business than other formats in the education industry.

Now let me turn to Helen for your second question. Please go ahead.

Helen Pang -- Head of Operations

Okay. Thank you, Zhong Sheng, for the second question regarding the AI center. The reason we built AI centers in different cities is for two reasons. Number one, we believe that to make sure that OneSmart Online will be successful, we need to penetrate deeply in one city as well as in one province. So we really want to build the brand strong in one city of that province. Having a physical center there definitely help us to get the trust from the customers and build the brands well there. So that's the purpose of building the AI center there.

And secondly, building the AI center there equipped with well-trained cloud advisors, which will help us to effectively cover the students in the nearby regions, and this way, it's even more -- how to say -- it's actually even more -- the cost of acquisition will be even cheaper than the online channel. For example, through the online marketing channels, the cost of acquisition of one student could be RMB3,000 or even higher, while the local AI center provides us a acquisition cost of something around RMB1,000 to RMB2,000.

And how did our course advisors achieved that is that they are based local, so they know the local curriculum, they know the local situation well, and so they are really the advisors and they are reaching out to the business communities nearby, they are reaching out to the public schools nearby, they are also holding different seminars and do a lot of community sessions. So, through these different ways they are applying, they will be able to cover students in that region and acquire those customers at a relatively low cost.

I hope that answers your question.

Sheng Zhong -- Morgan Stanley -- Analyst

Yes. Thank you very much.

Operator

The next question comes from Felix Liu of UBS. Please go ahead.

Felix Liu -- UBS Investment Bank -- Analyst

Hello. Good evening, management. Thank you very much for taking my question. I have two questions. One is on margin. I think definitely this year we'll have some headwinds because of the inevitable nature of the COVID-19. But could you sort of walk us through what are the margin trajectory that we could be expecting in Q3 and Q4 and later on in FY '21? I understand that utilization ramp-up was a focus before the pandemic. So how is the progress with the utilization ramp-up currently and perhaps what is our expectation going forward?

My second question is on our strategy. Number one, I definitely pick up the shift to online. Could you sort of break that down, the online unit economics that OneSmart is seeing? My concern is that, currently, the prevailing online model hasn't been very profitable. So just want to look at how OneSmart think of the unit economics for our online.

Also, on the strategy part, I think previously you mentioned you're launching more premium courses and perhaps diversifying away from 1-on-3 classes. So, any update on that initiative? Thank you very much.

Honggang Zuo -- Director , Chief Financial Officer and Chief Strategic Officer

Thanks, Felix. It's Greg again. Let me take your first question regarding the financial margin and then I'll let Steven and Helen answer your second question regarding strategy.

So, for the margin, as we discussed in the past earnings calls, our original expectation is, the margin expansion will be quite notable in second half of this year, i.e., Q3 and Q4. The reason behind is that we have about 250 learning centers opened in FY '18, FY '19 which are ramping up pretty on track. We have been consistently providing that data in the last few earnings calls. Even if you look at this Q2 numbers, as Rebecca provided earlier, those ramp-ups are largely on track. So we are pretty confident that margin will have expansion in H2. Now, given the pandemic situation, we think it's going to be pushed back for around two to three quarters. But why are we saying that? Let me give you a breakdown. On the top line, the fundamentals of our business, especially demand, is unchanged. We are seeing the quick return of demand of our business starting this month as children go back to school and entrance exam is back on the horizon. So, that's quite certain, and we are seeing that trend. We've shown you the enrollment trend as well.

And secondly, the nature of our 1-on-1 business is that we have clear advantage on customer learning experience and the learning result has been as we have been disclosing. Now, we believe this is the best format for students to improve, and that fit for majority of students. So we are pretty confident that demand and performance, especially top line growth, will bounce back fairly quickly, and we're already seeing that in May's data.

On the cost side, as we mentioned, one of the positive things we have done very well and we executed very well is the cost control during the pandemic period. We now have pretty lean cost structure. Even though our revenue is lower than the last year, our margin are largely still at healthy level. This happened in the most serious financial and economic conditions. If we go back to normal conditions, we expect the margin expansion will return.

So to answer your question, I think once our revenue growth return to normal level, you will see a very quick margin expansion. We think that's going to happen in FY '21. What do you see in the first half FY '21 is still to be seen, but we think we're pretty confident that's going to happen in FY '21.

Now let me turn to Steve and Helen for your second question regarding the strategy, one is on the UE online model and second one on the status on premium products.

Helen Pang -- Head of Operations

Okay. Thank you, Greg. So regarding the strategy, actually, we have launched OneSmart Online in all the cities that we have been in, but we do have different strategies for those different cities. For the top 10 cities that we have been there for around eight to 10 or 12 years, OneSmart Online is the incremental product there. So this is a product that can meet unmet needs in the market that we haven't been serving before. However, for the other cities -- for the other 30 cities that we have been in, OneSmart Online is our key expansion strategy. And so this is on the strategy side. For the top 10 cities, we definitely will still focus very much on the premium offline business where OneSmart Online is just an incremental product whereas we want to gain more market share in the Tier 2, Tier 3 cities with OneSmart Online as our expansion strategy.

Regarding the UE of OneSmart Online, we have different products in OneSmart Online, including big class, small class as well as 1-on-1, so carefully using economics calculation on all the products. And taking 1-on-1 product as an example, regarding the gross margin, we are able to maintain our gross margin fairly close to the premium offline business given the two reasons. Number one, that we are saving on the rental side, and number two, we are able to manage the teacher utilization better than in the offline business. So that gives us -- although the price, the ASP of the online business is lower than the offline business, not as premium as the offline one, but given the saving on rental as well as the high utilization of the features, we are able to maintain a fairly same gross margin.

And then, we spend more on marketing and selling, for sure, given that we want to gain more market share in the Tier 2 and Tier 3 cities so that margin of selling and marketing will be lower than the premium business. However, we did save some on the G&A, because on the premium business we have 30 center directors as well as a lot of administrative staff on the ground whereas, online, we save quite some on the G&A. So, overall, the economics -- the unit economics doesn't look as good as the offline business. But it still gives us a pretty positive UE model. So that's why we are pretty confident about this model and we want to take this as a key strategy in Tier 2 and Tier 3 cities. I hope this answer your question.

Felix Liu -- UBS Investment Bank -- Analyst

Thank you. Any update on the premium strategy and 1-on-3?

Helen Pang -- Head of Operations

With that in the premium setting, we still believe, although we are facing a very tough time now -- the COVID-19, it's tough for everyone, but we believe that with schools back to normal and also the segment that we are targeting in China is still growing and the need for premium service and premium curriculum is still there, we are still very confident there the market is growing pretty good on that side. So that's why we still want to focus on the premium business in the top 10 cities there.

And regarding 1-on-3, we actually have launched a new program this year, which is the VIP business, tailored to a more premium segment. With that product, we see a pretty good feedback so that we -- we'll focus very much on the VIP business as well as the normal 1-on-1 business instead of the traditional 1-on-1 and 1-on-3 business. So our next focus will definitely be the VIP and 1-on-1.

Felix Liu -- UBS Investment Bank -- Analyst

Okay. Thank you very much.

Operator

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

Rebecca Shen -- Director of Investor Relations

Thank you, operator. In closing, on behalf of the entire management team, we would like to thank you again for your participation in this call. If you have any further inquiries in the future, please feel free to contact us. You may now disconnect.

Operator

[Operator Closing Remarks]

Duration: 39 minutes

Call participants:

Rebecca Shen -- Director of Investor Relations

Xi Zhang -- Founder, Chairman of the Board of Directors and Chief Executive Officer

Honggang Zuo -- Director , Chief Financial Officer and Chief Strategic Officer

Helen Pang -- Head of Operations

Sheng Zhong -- Morgan Stanley -- Analyst

Felix Liu -- UBS Investment Bank -- Analyst

More ONE analysis

All earnings call transcripts

AlphaStreet Logo