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Hello, and welcome to the OneSmart International Education Group Limited announces unaudited financial results for the Second Quarter Fiscal 2019 Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Rebecca Shen, Investor Relations Director. Please go ahead.
Thank you, operator. Good morning, everyone, and thank you for joining OneSmart International Education Group Limited Second 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 website at www.onesmart.investorroom.com. Joining us today are Mr. Xi Zhang, our Founder, Chairman and CEO; and Mr. Dong Li, our Director and Chief Financial Officer. Dong will give you an update on the company's business strategy, and I will go through the key highlights of second fiscal quarter 2019 results. After our prepared remarks, management team 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 law. With that, I will now turn the call over to Dong. Please go ahead.
Thank you, Rebecca, and hello, everyone. We are very excited to announce another quarter of strong growth in both top line and student enrollment. Total net revenues increased by 42.1% year-over-year to RMB 942.5 million which was supported by 52.2% year-over-year growth in the monthly average student enrollments. OneSmart VIP business, HappyMath business and FasTrack English achieved top line growth of 30.8%, 45.1% and 257.5% year-over-year respectively. Tianjin Huaying also achieved satisfactory operating and financial results during the quarter. This demonstrated our strong ability to execute our corporate strategy and to effectively manage our diversified business operations. As the 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 we'll continue to replicate our operational excellence in managing premium education brands when we expand into more diversified market segments and more geographic locations in China. Our OneSmart VIP business, HappyMath and FasTrack English will continue to focus on accelerated penetration into existing and new Tier II and Tier III cities where we expect to enjoy more favorable operational cost structure and generate higher return on invested capital. On capital -- on capacity expansion, we remain determined to expand the total number of classrooms by at least 20% to 25% in the next 2 to 3 years, which includes opening new learning centers and expanding classroom areas of existing learning centers. Going forward, we will continue to focus on our 3T Foundation. This is Technology Integration, Teaching Innovation and Touching Services. Leveraging big data analytics and powerful artificial intelligence technology, we continued to invest heavily and develop new technology that can significantly improve the education experience for both students and teachers by providing effective tools to carefully evaluate the student performance, customize teaching plans and track progress in a more scientific and efficient manner. We achieved 40.4% year-over-year growth in gross profit and 24.8% year-over-year growth in non-GAAP operating profit during the second fiscal quarter of 2019, even though we added a total of 128 learning centers since second fiscal quarter of 2018 to meet the increased market demand. We incurred certain one-off costs and expenses to comply with the latest regulatory requirements, and we substantially increased investments in integration of the latest education technology and curriculum development. We added 34 new learning centers during the second fiscal quarter of 2019, and total number of study centers increased to 401 as of February 28, 2019, which represents total number of classrooms increase of 18.2% year-over-year and 4.9% quarter-over-quarter. We are delighted to see our Mature Learning Centers, which refer to those learning centers that have been under operation for over 24 months, continue to consistently deliver satisfactory operating and financial results. During the second fiscal quarter of 2019, gross profit margin of our Mature Learning Centers increased by 1% year-over-year, of which gross profit margin of our Mature Learning Centers for OneSmart VIP business, HappyMath and FasTrack English increased by 0.8%, 1% and 19.7% respectively. In the meantime, our newly opened learning centers are on track to ramp up quickly and are expected to achieve higher utilization when they become mature. We are confident that our expansion strategies are effective, and we are on the right track implementing our growth strategy to drive the revenue and profit growth. And in the meantime, we have maintained a good balance between expansion and operational efficiency to deliver more sustainable value for our shareholders in the long term. Juren Education, which we invested a minority stake in October 2018, also achieved steady growth since our investment. Total student enrollments for the Winter and Spring semesters in 2019 increased by 48.4% year-over-year, and Juren Education will further penetrate into more Tier II and Tier III cities in China. Lastly, following our USD 30 million share repurchase program approved by the Board of Directors in October 2018, we are delighted to announce that our Board of Directors has just authorized another share repurchase program of up to USD 50 million worth of our shares over the next 12 months. So we can repurchase a total of up to USD 80 million worth of our shares. These share repurchase programs reflect confidence in our future prospects and our ability to create and return long-term sustainable value for our shareholders. I would now like to turn the call over to Rebecca Shen who will go through key highlights of our core business segments and key financial highlights during the second fiscal quarter of 2019. Rebecca, please go ahead.
The following are key highlights of our core business segments during the second fiscal quarter of 2019. So OneSmart VIP business, we launched new online broadcasting program during weekdays to provide more value-added services to our students. We continued to see strong growth momentum when we expand into existing Tier II and Tier III cities. Monthly average student enrollment increased by over 50% year-over-year in Suzhou, Wuxi, Chengdu, Changsha, Xi'an, Chongqing, Yancheng, Taizhou, Wenzhou, Zhuhai, Tianjin, Lanzhou, Ningbo and Shaoxing, and we opened 17 new OneSmart VIP learning centers during the quarter and will continue to further penetrate into more existing Tier II and Tier III cities. We continued to accelerate our growth in HappyMath. Monthly average student enrollments increased by 57.3% year-over-year. We continued to see strong growth momentum in cities outside Shanghai. Monthly average student enrollment growth exceeded 100% year-over-year in Beijing, Shenzhen and other core Tier II and Tier III cities, including Hangzhou, Chengdu and Xiamen. Benefiting from customers' increasing demand for Chinese language training and science program, average subjects taken by each student expanded rapidly. More than 8,600 students were enrolled for the Chinese language training classes during the second fiscal quarter of 2019, and we opened 10 new HappyMath learning centers during the quarter and will continue to further penetrate into more existing and new Tier II and Tier III cities. For FasTrack English, monthly average student enrollments increased by 162.2% year-over-year. We launched the online i-Makii study master platform to enhance intelligent and interactive study assistance and to provide comprehensive visualized learning experiences to our students. We managed to substantially raise the average selling price of our upgraded products and services across all centers and accordingly, gross profit margin of FasTrack English increased by approximately 10% during the second fiscal quarter of 2019. We opened 7 new FasTrack English learning centers during the quarter and will continue to further penetrate into more existing and new Tier II and Tier III cities. Now let me walk you through the other key financial results for the second fiscal quarter of 2019. Operating costs and expenses for the quarter were RMB 852.3 million, an increase of 45.6% from RMB 585.4 million during the same period last year. Non-GAAP operating costs and expenses, which excludes share-based compensation expenses, were RMB 840.2 million, an increase of 44.5% from RMB 581.4 million during the same period last year. Cost of revenues increased by 43.8% year-over-year to RMB 476 million. The increase was primarily due to the opening of 128 new learning centers since the end the second fiscal quarter of 2018. Accordingly the company incurred more rental expenses as well as personnel costs for teaching staff and study advisers. Selling and marketing expenses increased by 47.8% year-over-year to RMB 191.5 million. Non-GAAP selling and marketing expenses, which excludes share-based compensation expenses, were RMB 191.4 million, an increase of 47.9% from RMB 129.4 million during the same period last year. The increase was primarily due to the opening of 128 new learning centers since the end of second fiscal quarter of 2018. Accordingly the company incurred more marketing expenses and employed more sales and marketing staff. G&A expenses increased by 48.2% year-over-year to RMB 184.9 million. Non-GAAP G&A expenses, which excludes share-based compensation, were RMB 172.8 million, an increase of 42.9% from RMB 121 million during the same period last year. The increase was primarily due to our enlarged investment in research and development on curriculum development and education technology, as well as the opening of 128 new learning centers since the end of second fiscal quarter of 2018. Accordingly, the company hired more research and development and management personnel. Total share-based compensation expenses, which were allocated to related operating expenses were CNY 12.1 million in the second fiscal quarter of 2019 compared with CNY 4 million in the same period of the prior fiscal year.
Operating income for the quarter was RMB 90.2 million, an increase of 15.6% year-over-year from RMB 78.1 million in the same period of the prior fiscal year. Non-GAAP operating income, which excludes share-based compensation, was RMB 102.3 million, an increase of 24.8% year-over-year from RMB 82 million during the same period of the prior fiscal year. Operating margin for the quarter was 9.6% compared with 11.8% in the same period of the prior fiscal year. Non-GAAP operating margin was 10.9% compared with 12.4% during the same period of last year. The decrease was mainly due to that we added a total of 128 learning centers since the second fiscal quarter of 2018 to meet the increased market demand, incurred certain one-off costs and expenses to comply with the latest regulatory requirements and substantially increased investments in integration of the latest education technology and curriculum development. Net income attributable to OneSmart was CNY 64.9 million compared with the net income of CNY 77.4 million during the same period of last year. Non-GAAP net income attributable to OneSmart was CNY 77.1 million compared with CNY 81.3 million during the same period last year. The decrease was mainly due to more interest expenses incurred from bank borrowings and share of losses from equity investees during the period. From the balance sheet, as of February 28, 2019, the company had cash and cash equivalents of RMB 480.8 million and short-term investments of RMB 584.4 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 CNY 1,969.5 million at the end of the second fiscal quarter of 2019, an increase of 9.8% from CNY 1,793 million at the end of the second fiscal quarter of 2018, which was reflective of the latest regulatory requirements that prepaid tuition fees cannot be more than 3 months. Capital expenditures for the second fiscal quarter of 2019 were RMB 90.9 million, an increase of RMB 3.1 million from RMB 87.8 million in the second fiscal quarter of 2018. The increase was primarily 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 remain on guidance and we expect net revenues to be between RMB 4 billion and RMB 4.15 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 over to the operator and open for Q&A. Operator, we are ready to take questions.
We will now begin the question and answer session. [Operator Instructions] The first question comes from Sheng Zhong of Morgan Stanley.
I have 2 questions. One is, you mentioned that -- you mentioned about your expansion in Tier II and Tier III cities. So what the growth expectation in these cities? And what the market impacts in your view? And secondly is on the regulation. The -- what's the current implementation status of the 3 months tuition fee precollection regulation now?
Sure. Thank you, Sheng Zhong. Okay, on your first question, on our expansion and further penetration into Tier II and Tier III cities. I think, firstly, we see very strong growth and market demand from Tier II and Tier III cities with the consumption upgrade. And we also see, if we take a look on our VIP business as an example, in the second fiscal quarter of 2019, the top line growth in Tier II and Tier III cities, including the cities like Suzhou, Wuxi, Chengdu, Changsha, Xi'an, Chongqing and Zhengzhou, actually the growth rate is over 50% compared with about like 25% to 30% in the other Tier I cities. So definitely we see very strong top line growth in the Tier II and the Tier III cities. And secondly, we see very favorable cost structures and relatively higher return on invested capital when we expand into these Tier II and Tier III cities. Taking Suzhou -- the city of Suzhou and Wuxi and Nantong as an example, so on average, its profit margin could be actually above 3% to 5% when those -- to 3% to 5% higher when these learning centers become mature. And so overall -- and we also see very rapid ramp up on those new learning centers that are opened in these Tier II and Tier III cities. And I think they're quite on track. So overall, we think our further expansion and penetration into Tier II and Tier III cities will drive our top line growth quickly and also help us to achieve margin expansion.
So a little feel is that, to add on that, actually we all see that second tier and third tier cities, both the real estate cost and the human cost are much higher versus the first tier cities. So once all these schools opened in the second tier and the third tier cities reach their maturity stage, which I'm really confident, we'll see the margin improvement of at least 3% to 5% because the housing price is so expensive in third tier cities and also the human cost.
And your second question is on this new government policy in relation to the 3 months tuition prepayments. So we're in the process to be in full compliance with this scale of change in terms of the tuition fee like payments. So currently I think out of our OneSmart VIP, HappyMath and FasTrack English, we are like in very good overall compliance status. Okay? And also we want to highlight that there is no impact on this 3 months prepayment policy on our top line growth. We continue to achieve very strong top line growth with 42% supported by over 52% students enrollment. So in general, we think this 3 months prepayment policy, we are actually -- we are going to be in full compliance, and there shouldn't be too much impact.
So just want to double confirm, you say in Tier II, Tier III cities margin 3% to 5% higher is comparably with Tier I cities or is what?
I mean overall these are [indiscernible]. I mean comparing to the all 4 Tier I cities with Shanghai, Beijing, Guangzhou and Shenzhen, on average Tier II cities, the housing price is much lower versus in Tier I cities and also the labor cost. So we can actually see a lot of like second tier cities and third tier cities in Eastern China, once the region is fully at a stage, both the gross margin and also the net operating margin are higher than versus the first tier cities such as like Beijing or Guangzhou and Shenzhen. And Shanghai itself, because it's the home base, we have really kind of a healthy profit margin. In coming years, we think we can continue to increase that, but just kind of not to less significant scale because once we reach the penetration -- maturity stage with clearly the second tier and third tier cities. And also today, our penetration in the second tier and third tier cities, the penetration is very low. So as Li Dong has mentioned, our growth in the second tier and third tier cities is much, much faster than first tier cities because of the recent consumption upgrade. We foresee the consumption upgrade will continue for the coming 3 years.
The next question comes from Edwin Chen of UBS.
Management, I'm asking on behalf of Edwin. Could you please share more color on the capacity expansion in the second half of this year and next year across different business lines. And how much is revenue or profit contribution from Shanghai?
Okay sure. So for the second quarter, we have opened a total of 34 learning centers -- 35 learning centers within the quarter. So we're on track to open a total of 140 learnings centers for the whole year. And in terms of overall capacity expansion, we are targeting to expand our total number of classrooms by about 20% to 25% this year and also in the next 2 to 3 years. So this is actually our total plan in terms of our capacity expansion. And then in terms of your second question, in terms of the revenue contribution from Shanghai, it is 56% for the second fiscal quarter of 2019. And I think compared with last quarter it is -- it was about 60%.
[Operator Instructions] And I see that we have a follow up from Sheng Zhong from Morgan Stanley, if I may.
Sure.
So just 2 small questions here. One is the -- you mentioned that you will invest more in the R&D technology. So can you give more color on what's the investment now and what's your target of the investment? And secondly is the new U.S. dollars loan, what's the interest rate?
Okay. So let me address your second question first. So the overall interest rate for the -- our U.S. dollar syndicated loan was LIBOR plus 2.7%. Okay? And then on your first question in terms of our overall targeted R&D investment. So basically in terms of our R&D investment, it comes from both in terms of our, like, the contribution from our teachers and in terms of their curriculum development and also our R&D expenses that we spend in the general and administrative expenses. So actually that will come from two cost items, one is from the cost of sales, the other is from the G&A expenses. So it's not only in G&A. Okay. And so overall, I think we are targeting about 4% to 5% at least of our total revenue in terms of our investment on R&D. So we are targeting like CNY 4 billion on the revenues. So this year, I think we are expecting to spend at least about CNY 200 million on R&D. So I think in the next year we're targeting to spend more than 5% of our top line revenue on research and development.
[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.
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 inquiries in the future, please feel free to contact us. Thank you.
The conference has now concluded. Thank you.