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Earnings Call Transcript 2020-Q4

[Operator]

Good day, and welcome to the OneSmart Unaudited Financial Results for the Fourth Quarter and Fiscal Year Ended August 31, 2020 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today’s event is being recorded.

I would now like to turn the conference over to Ida Yu, IR, Senior Director. Please go ahead.

[Ida Yu, Investor Relations, Senior Director]

Thank you, operator. Good morning and good evening, everyone. Thank you for joining OneSmart International Education Group Limited fourth fiscal quarter 2020 earnings conference call. The company's earnings results as well as supplementary slide presentation were released earlier today and are available on the company's IR website at ir.onesmart.org.

Joining me on this call are, Mr. Steve Zhang, Chairman and CEO; and Mr. Greg Zuo, our CFO and CSO.

I will 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 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 United States Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statement, as a result of new information, future event or otherwise, except as required under law.

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

[Steve Zhang, Chairman & Chief Executive Officer]

Thank you, Ida. Hello, everyone. As we started our new fiscal year 2021 in September, we are excited to announce our Go Premium strategy. The three pillars of the Go Premium strategy will lay a solid foundation for our accelerated growth path in the next five years.

Number one, continuous launch of innovative new products with higher price, such as Elite VIP, SVIP and et cetera and constantly upgrade premium teaching and services. Number two, focus on key cities to maximize the market shares and enhance the premium learning center experience through continuous center upgrade. And number three, premium brand building to gain consumer recognition of OneSmart being the representative of China's premium education sector.

Our Elite VIP program, addressing our premium customers' core needs of one-stop school admission planning, is well-received by our customers after launching in fiscal 2020.

The recent robust sales growth encourages us to accelerate the upgrade of learning centers and enhance quality of teaching and services to catch the growing premium needs. In addition, we also launched the premium VIP products for young children education, which is expected to drive the incremental growth and margin improvement in fiscal 2021.

With the consumption upgrade in China's education sector, the premium K-12 education sector is an enormous underserved market. We will continue to launch innovative products and services in response to customers evolving needs. As a leading premium tutoring service provider, we are confident to expand our market share in this fast-growing sector.

With that, I will now turn the call over to Greg, who will provide you more details of our growth plan and the updates on company performance in Q4. Greg, please go ahead.

[Greg Zuo]

Thank you, Steve. Hello, everyone. Thank you for joining us. Before I walk you through the Q4 earnings presentation, which we uploaded onto our website earlier today, I would like to comment on our recent financial performance.

We are proud to overcome the unprecedented challenge of COVID-19 and achieved fiscal Q4 net revenue growth of 35.7% from the prior quarter, which exceeds the high-end of the guided range. We completed fiscal year 2020 with net revenue decrease of only 13.9% from the pre-pandemic fiscal year 2019.

More meaningfully, our new students and cash sales growth have been extremely robust during fiscal quarter four. In addition, for the latest period, during September to mid-November 2020, the average purchase ticket size for OneSmart VIP business unit has grown by 74% compared to the same period last year, driven by strong demand and customer convenience and more premium product mix.

These indicates the full recovery of our operations and strong revenue growth in the next few quarters when the new students gradually consume their class units in the peak tutoring seasons, particularly March to June entrance exam period. We expect our revenue in fiscal year 2021 to reach above fiscal 2019 level.

Now let's start the earnings presentation. First, to add more detail to - details to Steve's comment earlier on our growth strategy, please turn to page six of our presentation slides. The China premium K-12 after-school tutoring sector continues to grow up to RMB216 billion and RMB309 billion in 2023 and 2026, respectively, according to the latest market study by Sullivan & Frost.

This means that our current strategy and business plan will lead us to - extend to 5% and 10% in three years and six years in terms of market share from today's 3%. Based on our in-depth understanding of consumer needs and market trend, we launched new product following Go Premium strategy. It will further differentiate OneSmart from the mass market and strengthen our competitive advantages.

OneSmart will reaccelerate our growth and reach RMB10 billion size by 2023 and RMB30 billion size by 2026 through the two primary growth drivers, product innovation and city scale-up.

On page seven, we provided more details on the growth drivers for our core VIP business division. By 2023, we expect the higher end Elite VIP product to take up 60% of our VIP business sales, to open a total of 160 to 200 flagship centers and our average ASP to double buy then. The growth will be achieved in high quality and improved profitability as we will focus on the top 20 cities to achieve economy of scale, in addition to increased sale – sales price.

Now, move on to the performance update for the fiscal Q4 and the latest progress. In fiscal Q4, our offline operations continues to revamp, 98% of learning centers opened by September. As shown on page nine, we achieved fiscal Q4 net revenue growth of 35.7% from the prior quarter, which exceeds the high-end of the guided range.

Cash sales for the fiscal Q4 increased by 45.3% from prior quarter. Please note that as cash sales typically take one to two quarters to turn into class consumptions, we expect incremental sales growth to drive full recovery of revenue growth in the next few quarters.

More meaningfully, our new students and cash sales growth have been extremely robust during fiscal Q4, as shown on page 10. The number of OneSmart VIP new students increased by 79% in Q4 from Q3 and 89% sequential growth for young children education business unit. The strong growth is achieved through increased marketing efforts to catch up new student pool.

Average monthly student enrollments for fiscal Q4 totaled 171,000, including 6.8% sequentially and it’s turning into 8.0% yea-rover-year increase from negative 8.2% year-over-year growth decline in fiscal Q3.

Page 11 summarizes the key business focus for OneSmart VIP young children education and OneSmart online for the new fiscal year 2021. In general, we will continue to launch premium products focused on key cities and improve center environments for offline operations.

Online operation is complementary to offline business with same price in the form of OMO take-out services.

Next, I will report the updates for each of our three businesses. Let’s first start with our core OneSmart VIP business on page 12. For pure 1on1 program, average enrollment increased by 14.8% and cash sales increased by 52.6% sequentially.

During September to mid November 2020, the average purchase ticket size for OneSmart VIP business unit has grown by 74% compared to the same period last year, driven by one, slow demand to support price increase for all product lines. Note that we have not systematically increased our ASP for more than a year. And two, higher sales contribution from Elite VIP programs. And three, more subjects per average new students. We expect a strong momentum in price increase and sales growth to gradually translate into revenue recognition in the next few quarters.

We have resumed our learning center expansion and in particular, we plan to open 27 high-end flagship VIP centers for the Elite VIP program in fiscal year 2021, which will set a new standard for the industry. As shown on page 13, the upgraded study rooms are equipped with smart teaching system and a center [ph] environment is more premium and enjoyable.

The first batch of flagship center will open in December 2020. In the fiscal Q1 to date, about 13% of cash sales for OneSmart VIP business were generated by Elite VIP program, up from 3% in fiscal year 2020, and we expect this ratio will grow to 20% in fiscal 2021.

Please turn to page 14. To support the launch of Elite VIP program, we continue to invest in teacher talent and teaching services. The VIP teachers are certified by OneSmart star teacher framework. With extensive teaching experience, the interview acceptance rate is only 3%. They are graduates from key University in China by Project 985 and 211 and ranked top 5% in our nationwide on-job subject examination.

By leveraging our dedicated R&D experts and powerful OneSmart Online teaching bank, our Elite VIP program offers one-stop school admission planning comprising of top score oriented curriculum and upgraded premium services.

Elite VIP program is expected to generate higher margin compared to regular 1on1 program. We illustrate key financial comparison on page 15 for the two products set aside - stabilize sizes with 80% higher in price and 50% higher in teachers cost, we expect the gross margin expense by 3 percentage points and the center level operating margin to expand by 9 percentage points. This indicates that an improved operating average will be released for the premium product.

Let's turn to page 16 for updates of our Young Children Education businesses. During the fiscal Q4, both HappyMath and FasTrack English have been – a steady recovering in enrollments and in particular achieved strong sequential growth of 43.5% in cash sales. As the key part of the business plan for the new fiscal 2021, we have launched Premium VIP product, namely Practical Math Program and MBA kids English for Happy Math and FasTrack English as part of the Go Premium strategy.

We believe a more premium product mix, we will structurally improve the business model and the unit economics of our Young Children Education businesses. Likewise, we also upgrade centers and teachers profile. We plan to open five selection centers in 2021.

We adopt OMO model for young kids to increase the class consumption through weekdays to enhance the teaching effect, cultivate good study habits, and to relieve parents from tutoring by themselves.

Practical Math Program is designed to enlighten early math interest for kids. This program is priced at 1.5 times of luxury product taking up 7% shares of total cash sales for HappyMath to date, since launching in September. MBA kids English is designed to broaden international vision for kids. It is priced 70% higher than regular products, taking up 13% share for cash sales for FasTrack English to date since launch in September.

Moving on to OneSmart Online on page 18. As explained in previous earnings calls, we are committed to a healthy growth platform for OneSmart Online by sticking to positive cash flow and avoiding burning cash with scale. It charges the same online [ph] rate as our offline programs, but provide value-add in terms of convenience and the complimentary services through the OMO takeout business model.

We constantly improved online functionalities to enhance customer experience. The upgraded live online classrooms meet the requirements of a multiple class formats, and enhance the interactive teaching results and visual effects. The technology improvements also simplifies of online class scheduling and administration, as well as optimize the online teaching platform.

In Q4 of fiscal year 2020, online business generated RMB72 million in cash sales, a sequential increase of 22% accounting for 8% of the total cash sales in the quarter. Net revenue from online business totaled RMB52 million, a sequential increase of 13% accounting for 5% of total net revenues. The pure online enrollment increased 50% sequentially to 50,000 [ph] in Q4.

Before Ida walks you through the financial result in more details, I would like to comment on our anticipated market expansion. Although our originally expected market expansion is delayed by several orders due to the pandemic, w now expect our margin to turn to pre-pandemic level and expand in second half of fiscal 2021, driven by topline growth momentum, strong ASP increase and operating leverage, as our city and center level ramp-up continues.

In the past fiscal Q4, our gross margin year-over-year decreased was primarily caused by one-off revenue drop due to the COVID-19, coupled with increased teacher’s profile and improved learning centers to support our premium product innovation.

But we have already seen a sequential recovery trend in margins, as the topline rebounds. We also strategically increased marketing spending in fiscal Q4 to catch-up students acquisition efforts after center reopened, which helps generate robust cash sales growth.

With that, I will turn the call over to Ida. Ida, please.

[Ida Yu, Investor Relations, Senior Director]

Thank you, Greg. Before we go through the key financial results, let's review the performance of our OneSmart VIP centers ramp up, as shown on page 21. The performance has been solid and has a consistent trend as before, even the results are partially 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 19% and high as 29% on the third year. For VIP learning centers in our top 10 cities outside Shanghai, we have achieved a center level operating margins of 18% for those have - that have been operating for over two years, and 15% on the third year.

While taking a view from city level, Shanghai has a higher percentage of matured centers with normalized operating margins. The VIP centers in the other top 10 cities are maturing after years of operations and enhanced brand awareness following what we have achieved in Shanghai for more than 10 years.

We are optimistic that the solid growth in our existing key cities will optimize our group level profit growth and margin expansion, as we take a more focused growth strategy.

In the fourth quarter of fiscal 2020, net revenues were RMB1 billion, a sequential increase of 35.7%, exceeding the high end of guided range. The sequential increase was mainly due to a strong recovery after the resumption of our offline learning centers.

Cost of revenues decreased by 3.9% year-over-year to RMB641 million. Due to our lean cost structure, we managed down the staff cost, partially offset by the increase in teacher cost, the rental cost and depreciation and amortization cost related to our premium product offerings and new center expansion and upgrade after the offline business is gradually back to normalcy.

In Q4 gross profit increased by 41% to RMB370 million from the prior quarter. The gross margin stood at 36.6%, up 1.4 percentage points from the prior quarter.

Non-GAAP selling and marketing expenses, which excludes share-based compensation expenses, were RMB290 million, an increase of 11.6% from RMB260 million during the same period last year.

We increase our sales and marketing efforts in fiscal Q4, since most of our learning centers started to reopen in late June in order to catch up on new student acquisitions, as centers were closed in fiscal Q3. Strong growth achieved as new students grew 79% and 89% sequentially for the VIP and Young Children businesses, respectively.

General and administrative expenses decreased by 29.7% year-over-year to RMB216 million. Non-GAAP general and administrative expenses, which excludes share-based compensation, were RMB186 million, a decrease of 34% year-over-year.

We continued to control our G&A spending at headquarters, as well as regional offices. The expense ratio in fiscal Q3 and in Q4 successfully maintained at low level, while revenue impacted by COVID-19.

Let me now move on to cover some other key financial points. For the fourth fiscal quarter of 2020, operating cash flow for Q4 were RMB254 million, a strong rebound from slightly negative RMB22 million for the prior quarter.

Capital expenditures for Q4 were RMB 16 million, a year-over-year decrease of 79% from RMB76 million in the same period last year. Capital expenditures accounted for 1.6% of net revenue in Q4, representing a year-over-year decrease of 420 basis points from 5.8% in the same period last year. The decrease was mainly attributable to our adequate leasehold improvement and technology investments in prior quarters and disciplined cash flow control policy during the fiscal Q4.

OneSmart's prepayments from customers balance, which represents cash collected from enrolled students for courses recognized proportionately as the training sessions are delivered was RMB2.5 billion at the end of fiscal year 2020, representing a sequential increases of 7.7% from the end of fiscal Q3 and a year-over-year increase of 17.1% from the end of fiscal Q4 last year.

As of August 31, 2020, the Company had cash and cash equivalents, restricted cash, short-term investments of RMB1.8 billion. Based on the latest estimates, we expect to generate net revenues of RMB600 million to RMB700 million for the first quarter of fiscal 2021.

As September to November is a traditionally low season for personalized tutoring services and recent solid new customers - students and cash sales growth typically take one to two quarters to translate into revenue recognition. We expect our full year revenue to reach above fiscal 2019 level. However, this outlook represents OneSmart's current view, which is subject to change.

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

[Operator]

Thank you. [Operator Instructions] Today's first question comes from Sheng Zhong with Morgan Stanley. Please go ahead.

[Sheng Zhong, Morgan Stanley]

Hi, thank you for taking my question. I have three questions. The first one is about sales and marketing costs in this quarter. I understand you mentioned that is your strategic investment. But can you give us some details about what the student acquisition costs for each new enrollment for this quarter? And what do you think the customer acquisition cost trend will be given it seems like - so I was just wondering if the online’s CAC competition will impact your sales and marketing as well?

And secondly is for your online path, the GT margin in this quarter is about 20%. So wondering why this quarter’s GT margin is so low? And what should be the normal margin for online business?

And third one is about your FY 2021 revenue guidance. Actually, you mentioned it will be back to 2019 level. But if we look at your average monthly enrollment in Q4 is already higher than Q4 of 2019. So wondering why the revenue is at this level? And what's your expectation of the revenue contribution from your Elite program? Thank you very much.

[Steve Zhang, Chairman & Chief Executive Officer]

Thank you, Sheng Zhong. Let me take your question one at a time. So the first question is regarding the sales and marketing spending in Q4. Let me start by expanding a little bit more for the past Q4 performance, and then I'll give you an outlook for the new fiscal year 2021.

So for fiscal Q4, as we noticed, the sales and marketing percentage of revenue was 28.7% in Q4 versus the 20-ish percent historical level. That's because strategically, we increased our marketing spending and sales activity during the quarter after center reopened in late June. So that's the reason why we achieved 45% cash sales growth and close to 80% new students growth quarter-over-quarter that we explained earlier. So that's precisely what we try to do intentionally to build up the new student pool after a long - a few months of lockdown.

Now, there's also a impact by the summer spent – spending, as we all noticed by a lot of industry players, they burned a lot of cash in various channels during the summer. So that equates the spend - our cost structure as well. However, starting the new fiscal year in September, that's part of our Go Premium strategy. We are - we have much more cleared marketing strategy and we have - we're targeting the more premium sector, which will help us precisely avoid those competitions.

So we have started a well-organized marketing campaign study in September for the new fiscal year. We have a clear slogan, and in order to gain customer recognition of us being the premium players. As we noticed that, we explained as well in the previous earnings call, the percentage of success rates, especially for those of our students getting into the higher top ranked, either high school or college has reached historical level for this entrance exam seasons. That helped us to acquire student as well.

We also have a much more improved marketing channel strategy by targeting more precisely customer base in a more focused channels. Especially, we are going to promote more local premium seminars and PR activities to acquire students.

To summarize, going forward, we have a clear RO-based marketing approach in managing our sales and marketing expenses. And as you know, starting new fiscal year, our product price has increased materially, not only for the Elite VIP product, but also for the regular product. So that will offset the increased marketing spending and generate a much reasonable ROI going forward.

So I have to say, for the full fiscal year 2021, our marketing - sales and marketing spending as a percentage of revenue will go back closer to the historical level. That's your first question.

Your second question regarding online gross margin. As you mentioned, that is currently at 20% level. Let me give you an overall picture and then let me specifically comment on Q4. On the overall picture, we mentioned that we'll have a quality growth path for the OneSmart Online, especially for the profitability. So we are charging the same price going forward for our products.

But as you noticed during Q4, which is from June to August to the summertime on - first on the top line, we are currently still at relatively small scale to offset any initial investment and to have a reasonable level of gross margin.

And secondly, during the summertime, the ASP of OneSmart Online still relatively low in order to attract students study online. That's part of the competitive strategy as well as we noticed during the COVID-19 period as lots of summer promotional activities on the online space in China.

On the cost structure side, we are still at early stage, where we need to spend, in turn, relatively high proportion to build up the OneSmart Online during the Q4 period. We are very proud and glad that our online platform has received very good customer feedback. And as we explained in the earlier presentation, we have – we have continuously improved the functionality of OneSmart Online to gain market recognition and customer satisfactions.

So going forward, we do not expect to spend more money for the online platforms. As a result, we think as the scale gradually increased, and the cost maintained at a reasonable level, we will have a much reasonable and attractive gross margins going forward. I think by the second-half of 2021, you will see the numbers will change materially from the current level.

I think your third question is regarding the new fiscal year 2021 guidance, why its relatively low. We said earlier that we believe, for the new fiscal year, our revenue will reach above the level of fiscal year 2019. Let me give you some background here.

On the one hand, as you noticed, we provided a very strong and robust recovery of our cash-out ticket sizes, and that we are launching our Elite VIP product, which has been well received by the market. So we're very optimistic about the outlook of our top line growth in the next few quarters.

But on the other hand, that we all know, the COVID-19 situation in China, especially during this current winter is still evolving. We have some predictable nature. So we tend to be a little more conservative providing a – really a normalized or aggressive guidance for the new fiscal year.

So on the – to give you more details, we believe our topline growth will start lower in the near term. That's why we provided the current Q1 topline growth, but you know, will accelerate [indiscernible] for the second half of the year. I think a couple of reasons.

One is seasonality, that as we noticed Q1 is September to November, which is snow season for our students that take classes and are - typically will start up and midterm exam, which is in November, and it will accelerate during the entrance exam season from March to June.

And secondly, as we explained earlier, there is a gap of one to two quarters between cash sales and revenue recognition. So as you see in the current robust sales growth, including our premium product growth, that will translate into the revenue recognition later on during the year.

In addition, as we noticed, we told you earlier that the teacher size growth of 74% was phenomenal. We’re continually seeing the trends. We believe that will translate into robust growth in a few quarters. So net-net, we are very optimistic for the fiscal year 2021. And we believe while there is a little bit more challenge in the near term, but on a full year basis, especially for the second half the year, we will have a very strong topline growth, as well as margin expansion. Thank you again for your questions.

[Operator]

Thank you. [Operator Instructions] Our next question today comes from Felix Liu with UBS. Please go ahead.

[Felix Liu, UBS]

Good evening, management. Thank you for taking my questions. I just want to follow up on the COVID-19 situation. Our [indiscernible] revenue guidance for the first quarter of FY ‘21 [indiscernible] a revenue decline. Could you just remind us the reason behind it? I think, if I recall correctly, the learning center should be back to full operations in September?

My second question is on the unit economic. Posting to slide 15 showed as a pretty impressive economics for the 1on1 [ph] and Elite VIP business. I understand it takes time for that business to recover to fully reflect the economy. So could you just give us a mid to longer term outlook, how will the overall company level or margin catch up whether you had economics of close to 30% or even 40% for 1on1?

And thirdly, I want to discuss for a longer-term strategy on the VIP side, to slide seven, page seven size a very strong growth for the VIP side also FY ‘23. So, could you just elaborate a little bit on the driver behind the VIP growth, you know, what gives you the confidence that the VIP can be - can gain this much momentum in the midterm? Thank you.

[Greg Zuo]

Thank you, Felix. There is a bit background noise. I think I get most of the questions. So for the three questions. The first one, your question is regarding the guidance for Q1 that we provided, which was RMB600 to RMB700 million. So your question is regarding why it is lower than you would think, right?

[Felix Liu, UBS]

Yes. Why its declining year-on-year?

[Greg Zuo]

Yeah, that's - thank you. So as you know, the Q1 it's bigger seasonality. If you look at our financials in the past few years, you always been that, our revenue will have much lower levels. If we move on from Q4 to Q1. Q4 is a peak season, at least in the summer. So as you witnessed from many of our industry players, their revenue are at pretty high level during the summer, but Q1 when the new semester started AT September. But before any major exam taking, which is the first one was the midterm example, which is November. So during this period, it's more a low season for us. So that's why, if you look at historically, the revenue level will drop by about 40% to 50%.

For this particular fiscal year 2021, Q1, for this particular range of RMB600 million to RMB700 million and the guidance. That's because in the short term, we think there's still a short-term impact, near term impact by COVID-19. As you know, our Beijing operation only started in September, that will - our number, one of our top 10 cities is still being closed today.

So - and as you know, the for the younger children space, there is still impact for - and also concerned for parents to send their kids to our learning centers. For those reasons, that's why they will still have some prolonged impact from the COVID.

So, with that, within RMB600 million to RMB700 million represent a pretty similar level of revenue for us. And then as you probably noticed, our recent robust cash sales growth, especially the robust sales of our Elite VIP product, as I mentioned in the earlier question, that would take time, pick up in the quarter or two to translate into revenue to which we believe it will be Q2 and Q3. So with that three reasons that explain to you why we provide such a range of RMB600 million to RMB700 million guidance for Q1.

Your second question, I think, regarding the Elite VIP programs unique [ph] economics. As we lay out on page 15 of the slide, this is a result of a much more comprehensive financial analysis that we did when we designed this product. So we took a quite a couple advantage with our CEO and the rest of the team, exploring the options. At the end, we fixed the price at 1.8 times, as you know in the previous year, we priced at 1.4 times, but with the strong demand we see and also the market study positive parent feedback. We believe 1.8 times is a good price range to justify a much improved product.

So at the same time, as you noticed, we increased our teachers profile by offering more salaries and hourly rates for the teachers for better teachers. So as the teacher costs increased by 1.5 times, so as a result, teacher costs will drop from regular products 30% to 22%. And the rent will increase as you know, we will open more flagship stores and then open more VIP learning special rooms, larger rooms for our students.

So rental cost as a percentage of revenue we increased from 5% to 11% for the Elite product. So net-net, our gross margin will have a 3 percentage point increase, and operating margin will have a 9 percentage point increase. That's because we'll see much some more operating leverage we’re coming out of this higher price, but relatively lower numbers of students operations. So we'll stay on, say acquisition costs for each of the students, as well as we’ll save more on G&A cost to run this product.

I think your third question is regarding the growth driver picture we provided on page seven, which we showed a clear 3-year growth drivers for OneSmart VIP business, I think you comment that, this are pretty positive and optimistic projection, we have? To be honest with you, we think this is very reasonable projection to support our growth strategies, we lay out earlier, to our CEO and Chairman Steve.

But it was - to be more specific, there will be two fundamental drivers for us going forward. One is product innovation. So we showed you already the Elite VIP how we look like the features. So we are confident that we're going to generate about 20% cash sales from this product within this year. Within three years, we believe this product will take up to 60% of our total VIP sales.

This is based on our comprehensive market study we did and a lot of interviews we’ve done with our parents. So very confident. And throughout the organization, not only the top management here, but also our school level management, they're very optimistic that we can achieve a 60% within three years. As I mentioned, within first year we’ll get 20%. So 60% looks very reasonable.

And flagship centers will open up to 150 to 200 flagship centers. For the first year, we're going to open 27 flagship centers, but you know, 200 flagship center is only about 40% of our current center base of 480. So that's our belief, within the next three years, that's a reasonable growth rate we have.

And in terms of ASP increase of two times by three years. That's a combination of two factors. One, the higher percentage of Elite VIP product, which I mentioned, it will be 60% by year three, as you know, we're charging 1.8 times higher price, and we believe the vertical of in the next few years as we further improve our products.

As also the other factor is the ASP increase for regular VIP products, which we already increased, it's about 20% this year. So far, we believe as we further use content product and features and learning center experience, we'll be able to increase our ASP for regular products, as well. So as a combination basis, we believe ASP will increase two times by year three.

And the second point of the driver is city scale up as we mentioned - as mentioned earlier, that we will focus on the key cities to maximize the shares, put those cities and in which a quality growth and probability levels that we think will be attractive. As a result, we lay out operating margin here. This margin, as you know, is supported by the existing centers performance we provided in the financial sectors.

Its quite in line with our current performance. But again, will further improve as we promote more premium products, as well as focusing more on the top cities to maximize the scale. So we believe in summary, this driver, the economics are much reasonable, a much better result, our focus strategy. So we're very optimistic for the near strategy, the Go Premium strategy we have. Its clearly the right strategy for us, it meets the customer needs and differentiate us from the rest of the market. So we're very, very, very confident that this strategy will help us reach the scale mentioned earlier and also the economics that we lay out here.

[Felix Liu, UBS]

Okay, thank you very much.

[Greg Zuo]

Thanks, Felix.

[Operator]

And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.

[Ida Yu, Investor Relations, Senior Director]

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

[Operator]

Thank you. This concludes today's conference call. You may now disconnect your lines. And have a wonderful day.