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Edited Transcript of ONE.N earnings conference call or presentation 30-Jul-19 12:00pm GMT

Q3 2019 OneSmart International Education Group Ltd Earnings Call

Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of OneSmart International Education Group Ltd earnings conference call or presentation Tuesday, July 30, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Honggang Zuo

OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director

* Rebecca Shen

OneSmart International Education Group Limited - IR Director

* Xi Zhang

OneSmart International Education Group Limited - Founder, Chairman & CEO

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Conference Call Participants

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* Edwin Chen

UBS Investment Bank, Research Division - Head of Hong Kong and China Small & Mid-Cap Research and Research Analyst

* Sheng Zhong

Morgan Stanley, Research Division - Associate

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to OneSmart International Education Group Limited Third Fiscal Quarter 2019 Earnings Conference Call. (Operator Instructions) I must advise you that this conference is being recorded today. (Operator Instructions)

I would now like to hand the conference over to your first speaker, Ms. Rebecca Shen, Director of Investor Relations.

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Rebecca Shen, OneSmart International Education Group Limited - IR Director [2]

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Thank you, operator. Good morning and good evening, everyone, and thank you for joining OneSmart International Education Group Limited Third Fiscal Quarter 2019 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. Xi Zhang, our Founder, Chairman and CEO; and Mr. Greg Zuo, our Director, Chief Financial Officer and Chief Strategic Officer. Following our prepared remarks, the management team will be available to answer your questions.

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 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 law.

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

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Xi Zhang, OneSmart International Education Group Limited - Founder, Chairman & CEO [3]

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Thank you, Rebecca, and hello, everyone. We are pleased to announce another quarter with solid financial and operational results as we continue to gain market share in the premium K-12 after-school tutoring market. We further strengthened our competitive advantages in the core premium 1-on-1 tutoring services, which are underpinned by its superior services and tutoring results, highly efficient operations and standardized learning center management system. We firmly believe that our premium 1-on-1 tutoring services is much more effective than other formats for majority students because it's more engaging, provides tailor-made teaching and individualized attention. We are also proud to accomplish our expansion plan to reach national coverage and scale as we approach the end of full year 2019, which is expected to be another successful year of solid growth. Our plan for the next stage is to focus on the 3 core service lines: OneSmart VIP, HappyMath and FasTrack English; adopt a balanced capacity expansion plan; and put more efforts on the ramp-up of learning centers in our target key regions and cities. These will help us accelerate the scale-up process to achieve both growth and the margin expansion at the same time. We are leveraging our operational expertise in the premium K-12 1-on-1 services to grow the HappyMath and FasTrack English programs. We will also spend our efforts on operational enhancement through premium service upgrade, technology innovation and a revamped incentive scheme in order to further advance our core competencies.

The Board and I would like to extend our warm welcome again to Greg Zuo, our new CFO and Chief Strategic Officer. I have known Greg since the business school days, and he plays an instrumental role in leading the pre-IPO launch of investment by Goldman Sachs and Carlyle back in 2017 as well as our IPO process in early 2018. We are confident that his extensive experience in corporate finance and in-depth industry knowledge will lead us to successfully execute this strategy and contribute substantial value for our shareholders.

I will now turn the call over to Greg who will provide a presentation of business update and our 3-year strategy.

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [4]

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Thank you, Steve. Good morning, and good evening, everybody. I am very honored to take this important role after taking an External Board Director and the investor position back in 2017 and 2018. I have been passionate about the business and I'm excited for the opportunities ahead of us. Since my joining in June 1, 2019, I have reviewed our business and was impressed by its consistently strong performance. OneSmart has proven itself as one of the very few distinguished premium 1-on-1 tutoring players that can replicate profitability and scale up at a national level in China.

For today's earnings presentation, I will first provide an assessment on our business model, then follow by an update on our refined strategy. The strategy has been reviewed for several runs from April to July among the management team and our Board of Directors. When already put into action, is reflected in our budget for the new fiscal year 2020, starting September.

I will now start with Page 3 on the earnings presentation deck. First, we want to emphasize our focus on the 3 core service lines in the next 3 years. We see substantial demand and growth opportunities in these 3 premium education services. Although we are already the #1 player in the premium tutoring service market in China, but we yet only have 2.4% market share, which indicates substantial room for further growth.

The premium 1-on-1 tutoring services is a fast-growing segment in the overall tutoring market driven by its higher effectiveness, growing trend of more parents and students favoring individualized learning and its largely improved affordability.

In addition to OneSmart VIP, we will also focus on growing our premium young children education programs. They are not only the 2 most sought after young children education services, but also helps expand our target customer base to younger population, building the future K-12 customer pool for OneSmart VIP program.

On Page 4, we want to recap the 3 core competency in our business model, which explains why we can consistently replicate our success in a profitable and scalable fashion. First, we have a precise premium positioning, provide superior customer experience and deliver outstanding tutoring results. The high pricing premium as a result of this is the first major factor to achieve profitability for our 1-on-1 tutoring business model. Second, we have an industry-leading and best-in-class highly efficient operating system and culture, which is underpinned by robust KPI-based incentive structure proportionately tied to revenue and net profit. This helps control, actually almost fix our cost and operating expenses at a reasonable ratio of revenues. This is the second major factor I would like to highlight to achieve profitability for a 1-on-1 tutoring business. Third, we have run a highly standardized learning center management system with fixed organization structure, procedures and deliberate succession plans. This enables us to replicate a system with consistent quality throughout the country. We plan to further strengthen our core competency in the premium tutoring services in the coming fiscal year to advance our competitiveness and customer experience.

Moving on to Page 5. We would like to elaborate on the 3-step growth plan and provide a status update. Our step one is to reach national coverage and scale, which we have already accomplished. Step two is to focus on ramping up newly opened centers. And step three is to optimize profitability as the outcome of that ramp-up. The plan is based on the deep understanding of the fundamentals of the tutoring business model, including a source of growth, ramp-up nature and time requirements for profitability.

Looking back last 5 to 6 years, we basically experienced 2 stages of capacity expansion, a controlled stage prior to fiscal year 2017 and a rapid expansion stage after fiscal year 2017. We've more than doubled the total center numbers in fiscal year 2018 and the first 3 quarters of fiscal year 2019. But strategically, we successfully expanded our footage from an regional play to a national geographical coverage, which laid the foundation for future growth. We are very proud to claim that we are now among the very few truly national players in the tutoring service industry in China.

As a result, our non-GAAP operating margins reflect the normal and reasonable financial impact of capacity expansion and the time-consuming nature of the scale-up of a chain franchise. Given the strong ramp-up performance, which I will illustrate on the next page, we are very confident that it is a matter of time when the margin number will return to a normal level, which our competitive business model delivers.

We understand that it is a critical aspect to disclose the actual ramp-up result thus far for the large number of new centers opened in recent years. So Page 6 shows you the satisfactory ramp-up result of all of our OneSmart VIP learning centers opened during fiscal year 2016 to 2018, and demonstrate operating leverage in both Shanghai and other top cities. We divide them into 2 groups, for those in Shanghai and those in the top 10 cities outside Shanghai. It is understandable that cities in Shanghai have a faster ramp-up as we have stronger presence and brand awareness. The top -- the total 11 cities generated 92% of fiscal year 2018 total revenue of OneSmart VIP business. So it is quite representative.

We organized the learning center into 3 baskets. For those that have been operating for over 1 year but less than 2 years, we are showing here their margin numbers for their performance during the first year of operations. For those that have been operating for over 2 years but less than 3 years, we are having showing here their margin numbers for their performance from 13 to 24 months of operations.

For those more than 2 years, we are showing here their margin numbers for their performance from the 26 and 36 months of operations. So we use both gross margin and non-GAAP operating margin at learning center level prior to allocating regional headquarters overhead as the indicators of ramp-up result.

So the 2 sets of margin numbers showing here on the 2 tables present a clear, healthy and a satisfactory trend. To add to the full picture, we also disclosed here the margin information for older centers opened in fiscal year 2015 or earlier. As you can see, the results are also satisfactory. So due to such a strong ramp-up performance, the management is having a high visibility of margin expansion in the coming fiscal year 2020, when we will have lower numbers of new openings.

We are now taking a further step to share with you on Page 7, the output of our management planning model for fiscal year 2020 to 2022. Please note that this is not a financial guidance for future company performance. That situation may change. We will provide an official guidance for next year's performance in our Q4 earnings presentation. So the management planning model here has 2 key assumptions: first, applying the historical ramp-up economics that I just discussed in the prior page; and second, the capacity expansion plan for fiscal year 2020 to 2022 shown here in the bottom table. We are comfortable to share with you this encouraging picture as we believe the ramp-up assumptions which can be even further improved once we focus more on the existing centers rather than new capacity expansion, unlike the past 2 years. Our goal is to ensure margin returns to a normal level under balanced capacity expansion plan going forward. With margin expansion, we expect our net profit to increase substantially within next few years as our top line continues to grow strongly. This means substantial value creation potential for our shareholders in the next few years.

Lastly, the analysis here leads us to a clear and focused company strategy for the next 3 years, which we will summarize here on Page 8. First, we will focus on the 3 core services lines. We will prioritize our resources to support top 20 cities in order to achieve faster growth and margin expansion. We will also adopt a highly selective approach in M&A and investments, with a primary focus to support the 3 core services lines to help them expand faster into target cities where we would like to have a larger scale and local presence. Second, we will adopt a balanced capacity expansion plan to ensure both top line growth and margin stability. We budgeted at 15% to 20% new center opening rate for fiscal year 2020 and plan to increase our focus on the ramp-up of new centers opened in the last 2 years. Third, we will further strengthen our core competencies as a premium service provider and drive continued product and service innovation through new technologies.

To conclude what I have said, leveraging our well-established brands, clear advantages in our business model, a focused strategy and increasing demand for premium education services, OneSmart is poised to deliver outstanding growth and profitability results in the coming years.

I would now like to turn the call over to Rebecca, who will go through the details of our financial results during the third fiscal quarter of 2019. Please go ahead, Rebecca.

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Rebecca Shen, OneSmart International Education Group Limited - IR Director [5]

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Thank you, Greg. Let me further provide key financial highlights and discuss the performance of our core business segments and lastly, walk you through the key financials during the third fiscal quarter of 2019.

Let me start with 2 strong growth markets. Average monthly student enrollments increased by 40% year-over-year and total center number reached 430, with 29 openings during the third quarter. On top line, we are largely on track to meet our expectations, except some one-off regulatory impact in select cities that enhance enforcement of the higher regulatory standards starting late last year caused relocations of some of our learning centers in several cities. This had a slight impact to our service enrollment activities as we primarily used on-site consultation for sales conversion purpose, which carries the impact over to revenue generation in following months, in particular, March to May, which is our third quarter. After we made quick adjustments and given the recent enforcement development, we expect these small scope and temporary disruptions to normalize in the next few months, and its financial impact will be mostly reflected in fiscal year 2019 results.

ASP for the company during the quarter was down by 1% year-over-year, which is due to the consolidated (inaudible) volume whose primary business is class programs. ASP of OneSmart VIP increased by nearly 5% compared with the third fiscal quarter of 2018, turning into a geographic revenue contribution as we continue to further sell in cities outside Shanghai. Revenue of Shanghai accounted for 57% of the total revenue, down from 60% same quarter of 2018.

Move on to segment discussion. OneSmart VIP business, our core premium K-12 1-on-1 tutoring services, the business continued to perform strongly in both Shanghai and most of the cities outside Shanghai. Despite the one-off regulatory impact in select cities, we continued to see average monthly student enrollments grew by over 50% in cities including Tianjin, Suzhou, Chengdu, Zhengzhou, Chongqing, Yancheng, Taizhou, Wenzhou, Zhuhai, et cetera. The one-off regulatory impact already started to normalize, and our Q4 performance thus far has exceeded our expectation in terms of enrollment and revenue growth.

We continue to expand the capacity to drive future growth and opened 25 new OneSmart VIP learning centers during the quarter.

New students increased by 43.1% compared with the same period last year. Revenue of International Education grew by 143.9% year-over-year, while average monthly enrollments grew by 142.1% compared with the same period last year.

For HappyMath, the premium young children STEAM education programs, we remain optimistic in the fast-booming sector. Revenue grew by 41.9% year-over-year, which was slightly lower than expected, as there has been a one-off regulatory impact in admission procedure for public and private primary schools in China -- in Shanghai. We continue to see strong growth momentum in cities outside Shanghai. Revenue in cities outside Shanghai grew by 90.3%. New students grew by 43.2% compared with the same period last year. Average monthly student enrollment growth exceeded 100% year-over-year in Guangzhou and Chengdu, the other 2 major cities outside Shanghai. We opened 5 new HappyMath learning centers during the quarter.

For FastRack, average monthly student enrollment increased by over 150% year-over-year. We opened 2 new FasTrack English learning centers during the quarter, both of which are in Shanghai. Going forward, we will continue to focus on cities in Yangtze River Delta. We continue to upgrade our products and premium services, which creates additional pricing premium and margin improvement opportunities. We started to provide live broadcasting programs during the workday to help the students prepare and review the courses. Our Smart Classroom and intellectual evaluation system help to create a visualized learning process for the students.

Now let me walk you through the other key financial details for the third fiscal quarter of 2019. Net revenues were RMB 1,093.3 million, an increase of 32.6% from the same period last year. The increase was mainly attributable to the growth of average monthly student enrollments in OneSmart VIP, HappyMath, FasTrack English, improved referral and renewal rates as well as the consolidation of Tianjin Huaying business. Average monthly enrollments increased by 40% year-over-year to 174,835.

Operating costs and expenses for the quarter were RMB 970.2 million, an increase of 26.4% from the same period last year. Non-GAAP operating costs and expenses, which excludes share-based compensation expenses, were RMB 954.6 million, an increase of 45.2% from the same period last year.

Cost of revenues increased by 47.3% year-over-year to RMB 542.4 million. The increase was primarily due to an increase in teacher compensation and rental costs as a result of center openings and relocations for regulatory compliance purpose.

Selling and marketing expenses increased by 23.6% year-over-year to RMB 198.9 million. Non-GAAP selling and marketing expenses, which excludes share-based compensation, were RMB 198.5 million, an increase of 24.5% from the same period last year. The increase was as a result of adoption of more effective sales and marketing channels, some temporary withholding of sales and marketing activities while learning centers were relocated for regulatory compliance purpose as well as an increase in compensation and rentals to sales and marketing staff to support the rapid growth of the business in a more effective manner.

G&A expenses decreased by 4% year-over-year to RMB 229 million. Non-GAAP G&A expenses, which excludes share-based compensation, were RMB 213.8 million, an increase of 64.3% from the same period last year. The increase was primarily due to a rise in G&A personnel expenses incurred to learning center openings and investments in R&D development, education technology and curriculum material to enhance the teaching quality and improve students' learning experience.

Total share-based compensation expenses, which were allocated to related operating expenses, were RMB 15.6 million in the third fiscal quarter of 2019, compared with RMB 110 million in the same period of the prior fiscal year, which was a historical high contributed by the one-off IPO event in March 2018.

Operating income for the quarter was RMB 123 million, increase of 117% from the same period of last year. Non-GAAP operating income, which excludes share-based compensation, was RMB 138.6 million, a decrease of 16.9% in the same period last year.

Operating margin for the quarter was 11.3% compared with 6.9% in the same period of the prior fiscal year. Non-GAAP operating margin was 12.7% compared with 20.2% during the same period last year. If excluded the financial impact of new centers opened in last 12 months from Q3 fiscal quarter 2018 to Q2 fiscal quarter 2019, non-GAAP operating margins would have been 17.6% from -- for the third quarter.

Other income, which mainly represents government subsidies and other gains, was RMB 46.6 million, compared with RMB 30.3 million during the same period last year.

Income tax expenses were RMB 47.1 million compared with RMB 32 million during the same period last year.

Net income attributable to OneSmart was RMB 109.5 million compared with net income of RMB 58.4 million during the same period last year. Non-GAAP net income attributable to OneSmart was RMB 125.1 million compared with RMB 168.5 million during the same period last year. The decrease was mainly due to the rise of selling and marketing expenses and G&A expenses to support center openings, complying with enhanced regulatory requirements and interest expenses as a result of the increased balance of bank borrowings.

Let me now move on to cover some of the key financial points for the third fiscal quarter of 2019. Capital expenditures for the third fiscal quarter of 2019 were RMB 36.7 million, a decrease of RMB 26 million from RMB 62.7 million in the third fiscal quarter 2018. The increase was mainly due to the payment schedule difference related to leasehold improvements.

As of May 31, 2019, the company had cash and cash equivalents of RMB 1,326.1 million and short-term investments of RMB 683.5 million.

OneSmart's prepayments from customer balance, which represents cash collected from enrolled students for courses and recognized proportionately as the tutoring sessions are delivered, was RMB 2,216.8 million at the end of third fiscal quarter of 2019, an increase of 12.7% from RMB 1,966.4 million at the end of the third fiscal quarter of 2018.

Turning to outlook for fiscal quarter 2019. Based on our current estimates, net revenues for fiscal year 2019 are expected to be between RMB 3,865 million to RMB 408 million (sic) [RMB 4,008 million], an increase of 35% to 40% from fiscal year 2018. This fully reflects the one-off regulatory impact. This outlook represents OneSmart's current and preliminary view, which is subject to uncertainty.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Edwin Chen of UBS.

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Edwin Chen, UBS Investment Bank, Research Division - Head of Hong Kong and China Small & Mid-Cap Research and Research Analyst [2]

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Congratulations to Greg in joining OneSmart. I have a couple of questions, especially on your presentation that Greg mentioned those capacity slides. Number one that -- you mentioned the capacity expansion, the center opening rates will be 15% to 20%, which is much slower than past couple of years. So can you elaborate more the rationale behind that slowing down of the capacity expansion? Also, can you also provide more colors on the distribution by geographic and by cities and by business lines of those capacity expansion? And the second question is, on your -- on the Slides 6 and 7, on the 3-step growth plan that you have here, some of the ramp-up of newly opened centers. Just wondering the -- if you can explain a little bit more on those final -- those numbers that what kind of signposts do you expect in which kind of cities that those newly opened centers could ramp up on that pattern or that schedule? And also, if anything goes wrong that those newly opened centers do not achieve those utilization, those revenue targets and margin targets?

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [3]

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Thank you, Edwin. I appreciate the questions. So your first question is on the opening plan for fiscal year 2020. Yes, we will -- we have finished our budget for next year, so we have a clear view on that. So in terms of thinking behind that slower opening plan is that: one, as I mentioned earlier, we have already achieved our national coverage and scale. So we're very comfortable with the position we have. Secondly, we have enough newly opened centers in the last 2 years that we can use as a reserve to further grow and generate profit. As you know, we generate actually a lot of additional growth from the second, third and fourth year of operations of a center than the first year. So ramping up newly opened center can generate even higher growth potential for -- to open a new center. So that's the thinking behind. Our strategy going forward, as I mentioned, will be a more balanced approach, where we want to make sure we can generate growth, but also we can show our margin. So in -- to answer your question, in terms of the number of openings going forward, in terms of business lines, in our budget, we said about 50 centers for OneSmart VIP program, about 10 for HappyMath, about 10 for FasTrack. So the total is 80. That's in our budget. In terms of geography, we will -- as I mentioned earlier, we will have a much more focused strategy going forward. We will optimize the locations where we open our centers. We'll focus on top 20 cities, where we try to scale up faster because every new center we open is a very precious resource we have. So we try to optimize it opening the cities where we can scale up faster. So for HappyMath and FasTrack for the 10 plus 10, meaning 20, we will focus on the Yangtze River Delta area where we have much stronger presence that we can scale up in the nearby areas.

I think your second question is regarding the ramp-up we're showing here on Page 6. So the first question regarding how we select those centers, and second question is about our view because of this historical pattern, how would that be impacted going forward? Let me answer first question first. So we select here, we -- all of the VIP learning centers opened during fiscal year 2016 and 2018. So we divide them in Shanghai and in top 10 cities outside of Shanghai. So this is all within our VIP programs, which is our core premium main businesses. So including the last 3 years, which is very much representative of the chunk of our future growth. So the -- as you can see, the trend here is pretty satisfactory and healthy. That's where our comfort and confidence is coming from going forward.

Now to your second question. We have to say we are even actually much more positive going forward than this current historical pattern because one, we achieved such ramp-up record in a very fast-growing and expansion stage, where the whole company is working hard to open new centers in new territories. But going forward, with a slower rate of opening, the organization and people would more focused on running the existing center rather than hiring people or deploying resources for new centers. So we're much more focused on the personnel part. And secondly, I think geographically, we'll be much more focused as well as we will be focused on the top 20 cities rather than expanding to the entire 42 cities. So with a much narrow and focused geographic territory, we think that's going to help the performance as well.

And thirdly and most importantly is the experience our management team is building in terms of expanding and ramping up the new centers. So with all these 3 factors favoring us, I think the future performance could be even better than this current assumption. I hope that answers your questions.

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Operator [4]

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The next question comes from Sheng Zhong of Morgan Stanley.

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Sheng Zhong, Morgan Stanley, Research Division - Associate [5]

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I have 2 questions. One is -- thanks for -- to give us long-term 3 years outlook. That's pretty clear. So if we look at the next 3 years' time, what the company's expectation of your revenue structure from your business lines and also the geographic breakdown? And secondly is, in the reporting quarter, third quarter, the gross margin declined about 5 percentage points year-over-year. Can you give a little more color about this margin decline? So maybe to the capacity expansion and maybe a regulatory impact. And how is company's current compliance level with the regulation?

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [6]

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Yes. Thank you, Zhong Sheng. So the first question regarding the -- our management planning model outlook for the next 3 years, which we are showing you on Page 7 of the presentation. So regarding the business lines structure, as you know today, the VIP program is our flagship program, takes about 81% of our revenue for third quarter year-to-date and HappyMath is about 12% and FasTrack is about 4%, and Huaying is about 3%. That mix is going to change the next 3 years, as we have much faster growth in HappyMath and in Fastrack as the 2 young children programs are having smaller base, but much bigger demand going forward. So in -- by end of year 3, in our model, we have roughly 2/3 revenue coming from VIP program and then about 25% coming from the 2 younger children programs, which means HappyMath plus FasTrack, and then we have about 8% from other programs.

In terms of geographic that you mentioned for the next 3 years, as you know, Shanghai used to be our home base and takes majority of our revenue streams, but that number has been gradually going down to about 57% by this quarter. That number compared to last year Q3 was 40 -- sorry, was 60%. So we think the trend will continue in a similar pattern. So Shanghai becoming less than 50% in 3 years. As I mentioned earlier, our focus is to really scale up the remaining of the top 20 cities where we try to open more centers. So we think the top 20 cities, as a whole, will take a majority of our revenue, but Shanghai as a percentage was much lower. So that helps diversify our portfolio as well.

Now your second question regarding gross margin, that's true. Compared to last year, we are about 5 percentage point lower. I think there are 2 major reasons behind. The first reason is that our revenue got impacted on one-off regulatory requirement, which I can elaborate a little bit more. As you know, starting late last year, the enforcement of the tutoring industry regulation has been pretty much intense. That had impact on the centers where we operate. As you know, our business model, we recruit students on-site through a consultation process and then we convert them into our students because we had to relocate our centers to make them compliant with the requirement. So we didn't have this site open for a short period of time. That affected our signing of new enrollments. So that -- for timing purposes, if you roll to the next few months, which is precisely March and May, which is this quarter, so that will have an impact on the revenue. So basically, top line has been off than what we normally would have seen. So that's number one factor. Number two factor is the cost structure. As you know, if you move around your learning center, you have to sign new contract for the rent. Normally, it's much higher. And we had to sign up for a much larger space to comply with the requirements of the regulation. So on the rent, we're going to have higher increase. Same for teachers. We need to hire teachers with certificates or we need to organize -- prepare our teachers for certificates exams. That would increase our teachers cost as well. So all these 2 major factors combined that made our margin a little bit higher, but we think this is one-off going forward as we are compliant -- becoming more compliant with the regulation, the regulation impact has been gradually eased as everybody witnessed in the industry.

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Operator [7]

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Was there a follow-up, Ms. Zhong.

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Sheng Zhong, Morgan Stanley, Research Division - Associate [8]

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Yes. And so can you give a little bit more of your explanation about how much margin is impact by the regulation and others, maybe by the capacity expansion?

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [9]

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We did -- actually it's a high-level analysis, I can share with you. But obviously, we did an analysis that if this regulation doesn't happen, what will be the impact, right? So in our analysis, the top line would grow 40% as we normally deleverage in a quarter. With that impact, the margin then will only -- on the rent and the labor cost, which I mentioned is also because of regulations. If without the regulation impact, it will be at normal level, which is similar to what you see last year, which means 5 percentage points higher as you see last year.

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Sheng Zhong, Morgan Stanley, Research Division - Associate [10]

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So can I understand that means -- actually from -- in first and second quarter, gross margin also has a slight -- has also a slight year-over-year decline. And so can this be understand as the new capacity actually is ramping up, so the capacity impact now is much less, due to the company's overall margin?

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [11]

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Yes. Definitely, that is good observation. Thank you for sharing with me on that. Regulatory impact started earlier than Q3. So you will see that impact in Q1 and Q2 as well. And secondly, as you mentioned that as we open more centers in a very fast rate across 1 year and 2, so the percentage of the new centers are much higher than before. So as the ramp-up will take time, normally take 2 to 3 years, so that would definitely have the impact on the margin. So because of portfolio mix, that contribute as well as you rightly mentioned.

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Sheng Zhong, Morgan Stanley, Research Division - Associate [12]

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So -- and yes, if you don't mind, I also want to follow up the regulation question. How compliant you are now to the regulation requirement in terms of teachers certificates, in terms of the 3 months tuition fee collection, et cetera?

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [13]

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On the teachers certificates, we are actively preparing our teachers to participate in those exams. We encourage everybody to take exams when it was set up. And then in our hiring process, we require a teacher to have the certificate. But unfortunately, the government only organize the exam twice a year. So we had the first one in March and then we had second one in October -- sorry, in November. So that will take some time. I think the government understands that. So although our percentage of teachers who have their certificates has increased substantially, but it will take time to be fully compliant. I think the whole industry has the same trend. On the 3 months hurdle, in terms of taking the tuition payment, we are also actively changing our practice and to make it fully compliant with the requirement. As you can see, that did have the impact on our cash flow in the last 3 quarters. Q1, Q2, basically down from last year, and Q3 a little bit up from last because we had a very good enrollment. As you can see, we disclosed our new students growth rate was 42.7%, closer to 43% in Q3. So we had much strong signing of new students, but our cash flow wasn't growing as strong as before. That's precisely because of 3 months requirement compliance purpose. So we're doing our best to make it compliant. It does have impact on our business, but it's within our -- the limits we can control. But in general, I want to mention we are in a very cash-generative business. So we are less concerned about 3 months and other regulatory requirements because as one of the leading player in the industry and as the player that we have been operating in Shanghai, who -- where the regulatory requirements used to be very much higher than the other parts of the country. So we're in a pretty good position to be on the compliance front.

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Operator [14]

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(Operator Instructions) And I see that we have a follow-up from Sheng Zhong from Morgan Stanley.

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Sheng Zhong, Morgan Stanley, Research Division - Associate [15]

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I also want to ask 2 numbers. Previously, you disclosed the average monthly active student enrollment number. So can you give us the number of VIP business and HappyMath, what the active monthly students number in this quarter?

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [16]

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We did disclose that number before in terms of total enrollment on a monthly average basis. Starting this month, we'd like to mention that our business model is more a -- rather than a class format, right, they're more organized on semester basis. On 1-on-1 business model, we are signing student on a rolling basis regularly, as you -- as we discussed before. So we think a more accurate metric to show our performance in terms of growth is really on new students. So starting this quarter, we want to disclose with you the new student growth rate rather than enrollment. So that's precisely why we disclosed new student starting this quarter. I think we did provide a breakdown of new student growth by segment. That should give you a pretty good picture on our growth.

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Sheng Zhong, Morgan Stanley, Research Division - Associate [17]

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Yes. We did see the new students growth. So can you also give us -- because this is the first time seeing new students. So can you give us now more guidance on how to use the new students to link that with your revenue growth because like -- can we get more information about your current students and retention and how much new? So what your logic to link the top line forecast?

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Honggang Zuo, OneSmart International Education Group Limited - Chief Strategic Officer, CFO & Director [18]

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Yes. I understood. Let me walk you through the -- how we generate revenues. Basically, we generate revenue by having the monthly average enrollments to come to our center to do their tutoring basically. So as you pointed out, student enrollment is a good factor to calculate starting with. So to calculate the total enrollment who is attending our centers, that number equals to -- every month is a new number of students, which we are showing here, plus a renewal of the learning center plus referral, then minus refund of the month. So that we posted a total monthly average enrollment. Then you apply that number to number of classes they take and multiply that ASP number, so you get your revenue number. So I understand where you're coming from. We'll try to provide more color in the future release how to derive our revenue from the new disclosure of new students.

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Sheng Zhong, Morgan Stanley, Research Division - Associate [19]

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Yes, sure. So yes, maybe I can follow up this with you later.

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Xi Zhang, OneSmart International Education Group Limited - Founder, Chairman & CEO [20]

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Okay.

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Operator [21]

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(Operator Instructions) And at this time, I would like to return to Ms. Rebecca Shen, Investor Relations Director of OneSmart International Education Group Limited. Please go ahead.

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Rebecca Shen, OneSmart International Education Group Limited - IR Director [22]

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Thank you, operator. In closing, on behalf of the entire management team, we will 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 us.

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Operator [23]

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Once again, the conference has ended. You may now disconnect your line. Thank you for attending today's presentation.