Four Seasons Education (Cayman) Inc. (FEDU) Q2 2019 Earnings Report, Transcript and Summary

Hello, ladies and gentlemen. Thank you for standing by for the Four Seasons Education's Second Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions]. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Ellen Wang, Investor Relations Director for the company. Please go ahead, Ellen.

Thank you, Chen. Hello, everyone, and welcome to the Second Quarter Fiscal Year 2019 Earnings Conference Call of Four Seasons Education. The company's results were issued via Newswire services earlier today and are posted online. You can download the earnings press release and sign-up for the company's e-mail distribution list by visiting the IR section of our website at ir.sijiedu.com. Mr. Peiqing Tian, our Chairman and Chief Executive Officer, will start the call by providing an overview of the company and the performance highlights of the quarter with English interpretation. Ms. Yi Zuo, our Director and CFO, will then provide the details on the company's financial results and the business outlook before opening the call for your questions. Before we continue, please note that today's discussion will contain forward-looking statements made under the Safe Harbor provisions of U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's results may be materially different from the views expressed today. Further information regarding this and other risks and uncertainties is included in the company's prospectus as filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that Four Seasons Education's earnings press release and this conference call include discussion of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. Four Seasons Education press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I will now turn the call over to our CEO, Mr. Tian. Please go ahead.

[Foreign Language] Thank you, Ellen, and hello, everyone. Thank you for joining us for our second quarter fiscal year 2019 earnings conference call. [Foreign Language] During the second quarter, we proactively adjusted our business to adapt it to the evolving regulatory environment and market demand, and we were pleased to deliver solid operational performance and financial results. Notably we achieved 64% year-over-year growth in enrollment for the quarter as we consistently extended our cost offerings to cover more subjects for students at broader age groups. During the second quarter, we also launched a variety of shorter duration interest-oriented classes such as Rubik's Cube and Sudoku solutions to further enrich our cost offerings during the soft season. Such special programs that introduce and deliver solutions to various logical thinking development games also help to drive enrollment and student engagement. We also proactively offer special synchronous tutoring programs such as English phonetic symbols and Chinese writing as well as more customized classes that cover specific areas in different subjects. This initiative is also a reflection of the flexibility of our business operations and our strong teaching capabilities. As a result of our diligent efforts, we recorded high enrollment diversity in terms of subjects and grades in addition to encouraging enrollment grades growth, which is in line with our strategy to enhance our competitiveness in the evolving after-school education market. [Foreign Language] In addition, we continued our prudent expansion by adding 5 new learning centers in Shanghai and launching our first learning center in Zhuji city of Zhejiang province bringing the total number of learning centers up to 54. We are on track with our steady expansion plan for our learning center network. [Foreign Language] As we maintain a steady offline expansion, we have also made encouraging progress on our online programs. During the second quarter, we further upgraded our Four Season mobile app to enable course and seat selection as well as all our tuition payment. To better facilitate a students' course selection and provide a clear and quantified assessment of their math levels, we continue to enrich the question bank of our self-assessment system by adding thousands of questions covering primary school and middle school grade levels. Especially we have categorized our entire question library by tagging each set of problem set with its respective difficulty level and area of focus. A well organized and interactive database will serve as a solid foundation for our personalized teaching program and also improve our student learning experience. [Foreign Language] Moreover we continued our operation with East China Normal University Press and as a part of collaborative [Foreign Language] or one lesson one exercise learning center program, we launched the demo version of an online synchronous learning system during the quarter. We believe by developing and providing such convenient online educational services and tours, we are able to supplement students' after-school learning with great efficiency and engagement. [Foreign Language] In addition to delivering high quality class content, our strong teaching capabilities and extensive educational experience also allow us to develop effective educational products and organize attractive learning activities. Recently, together with East China Normal University, we were invited by Beijing Normal University to present our math lab program in the 4th China Education Innovation Expo, which is a clear testament to this program and a recognition of our educational quality and innovation capability. During the second quarter, our Summer Math Camp with East China Normal University came to a successful conclusion. We received enormous positive feedback on this activity from both students and parents, and we are confident that our brand has been further elevated through such activities. [Foreign Language] Lastly, I would like to share some updates on the latest regulatory requirements. Shanghai as a pilot area for educational reform has been a target of regulatory change designed to reduce study burden for over one year. Pursuant to the regulations, we have been actively adjusting our business operations by shifting our focus from math competition preparation to provide synchronous tutoring and interest-oriented classes on different subject. Based on our years of extensive educational experience, our strong teaching capability enable us to better understand the intellectual development of student in different age groups and develop the most suitable approach to supplement their study and to nurture their interests with high engagements. [Foreign Language] In general, we believe the market demand for after-school tutoring is significant. We will continue to address the market need of synchronous tutoring to help students in different age groups revise and consolidate knowledge to improve their study performance in various subjects. In addition, we are confidence in our ability to maintain compliance with the latest regulatory requirements in terms of operating licenses and educational content as well as teaching facility environment. As a leading after-school education service provider, we are committed to cooperating with related authorities to generate a more regulated market environment in the long run. [Foreign Language] With that, I will now turn the call over to our CFO, Joanne Zuo, who will discuss our key financial results.

Thank you, Mr. Tian, and hello, everyone. We are pleased to achieve solid financial results during the second quarter with a net revenue increasing 21% year-over-year, exceeding the high end of our guidance range. The strong top line performance was driven by the successful execution of our previous marketing strategies. In addition, our initiative of proactively providing different kinds of shorter duration classes and special programs also contributed to our top line growth as we partially recognize the revenues during the quarter. We have also realized further success in diversifying our program offerings for students in different age groups with greater revenue contributions from our Chinese curriculum, middle-school program and kindergarten program. On the expense front, we have diligently continued our online educational service development and team building to further sharpen our teaching capability and enhance educational quality. At the same time, we have prudently made investments in learning center network expansion and facility relocation to provide a better learning environment for our students. All these efforts in return will better prepare us in the evolving market and the regulatory environment. Looking forward, we are committed to maintaining our educational capability and business flexibility, while focusing more on quality growth of our business with efficient operating and stringent cost controls. Now I'd like to walk you through more details on our second quarter fiscal 2019 financial results. Revenue increased by 20.7% to RMB 93.4 million for the second quarter of fiscal year 2019 from RMB 77.4 million in the same period of last year, primarily due to tuition increase in the standard programs, increased revenue contribution from the Ivy Program and the small class of standard programs, development of kindergarten and middle school and the non-math programs as well as the expansion of physical learning center network, including the contribution from the newly acquired business that closed the transaction in the first quarter of fiscal 2019. Cost of revenue increased by 59.6% to RMB 44.6 million for the second quarter of fiscal year 2019 from RMB 28 million in the same period of last year, primarily attributable to cost associated with the increase in faculty staff cost as well as learning center rental, utility and maintenance and depreciation costs. Gross profit decreased by 1.3% to RMB 48.8 million for the second quarter of fiscal year 2019 from RMB 49.4 million in the same period of last year. Gross margin was 52.3% for the second quarter of fiscal year 2019 compared with 63.9% in the same period of last year. The decrease in gross margin was primarily due to the expansion of new centers and the increase in faculty staff cost as well as the discounts granted to students to promote our middle school and the non-math programs. General and administrative expenses increased by 41.6% to RMB 32 million for the second quarter of fiscal year 2019 from RMB 22.6 million in the same period of last year, primarily attributable to increased staff cost of RMB 4.7 million and RMB 2 million consulting service fee and increased share-based compensation expenses of RMB 1.7 million. Sales and market expenses increased by 6.4% to RMB 8.3 million for the second quarter of fiscal year 2019 from RMB 7.8 million in the same period of last year. Operating income decreased by 55.5% to RMB 8.5 million for the second quarter of fiscal year 2019 from RMB 19 million in the same period of last year. Adjusted operating income which excludes share based compensation expenses decreased by 34.5% to RMB 16.6 million for the second quarter of fiscal year 2019 from RMB 25.3 million in the same period of last year. Interest income increased by 46.1% to RMB 1.9 million for the second quarter of fiscal year 2019 from RMB 1.3 million in the same period of last year, primarily due to increased cash and cash equivalent, and efficient cash management. Income tax expense decreased by 5% to RMB 6.2 million for the second quarter of fiscal year 2019 from RMB 6.5 million in the same period of last year. Other expenses, net were RMB 1.2 million for the second quarter of fiscal 2019 from RMB 0.6 million in the same period of last year, primarily due to an RMB 1.2 million fair value exchange of a 2-year Pimco fund-linked note with 100% minimum reduction level at maturity that the company intends to hold to maturity. Other expenses were partially offset by foreign currency revaluation gain. Net income was RMB 6.4 million during the second quarter of fiscal year 2019, down 58.8% from RMB 15.5 million in the same period of last year. Adjusted net income which excludes share based compensation expense and a fair value change of the company's long-term investment decreased by 27.8% to RMB 15.7 million from RMB 21.8 million in the same period of last year. Adjusted net margin was 16.8% compared with 28.2% in the same period of last year. Basic and diluted net income per ADS attributable to ordinary shareholders for the second quarter of fiscal quarter 2019 was RMB 0.14 and RMB 0.13 respectively compared with RMB 0.42 and RMB 0.38 respectively for the same period of last year. Non-GAAP basic and diluted net income for ADS attributable to ordinary shareholders for the second quarter of fiscal year 2019 was RMB 0.33 and RMB 0.31 compared with RMB 0.64 and RMB 0.58 respectively for the same period of last year. Cash and cash equivalents. As of August 31, 2018, the company had a cash and cash equivalents of RMB 560.9 million, a decrease of 3.8% compared with RMB 583.3 million as of February 28, 2018, primarily due to an RMB 100.8 million cash payment for the acquisition of a renowned early childhood education provider in Shanghai. The decrease was partially offset by the operating cash inflow generated in the first 6 months of fiscal 2019. To be mindful of the length of our earnings call, for the 6 months of fiscal 2019 financial results, I will encourage listeners to refer to our earnings press release for further details. Looking forward for the third quarter of fiscal 2019, we currently expected to generate revenue in range of RMB 89.9 million to RMB 91.6 million representing year-over-year growth of approximately 3% to 5%. The above outlook is based on current market condition and reflects the company's preliminary estimates of market and operating conditions and customer demand, which are all subject to change. This concludes our prepared remarks. We would now open the call to questions. Operator, please go ahead.

[Operator instructions] And the first question comes from Nicky Ge with China Renaissance.

[Foreign Language]

[Foreign Language] Okay. The question from Nicky is the top line guidance for the full year and the margin guidance for the full year. Based on the current condition, we expect our top line growth in the range of 15% to 20% for the full year fiscal 2019 and margin -- on the gross margin, our current expectation is to keep our gross margin in the range of 53% to 55% and operating margin to keep -- adjusted operating margin to keep at 20% to 25%. [Foreign Language]

[Foreign Language]

[Foreign Language] The additional cost in terms of the area per head, we are already in compliance with the new regulatory requirement. So we do not expect any additional cost and an active impact from the policy.

[Foreign Language]

So let me briefly translate for our CEO. Regarding the policy because Shanghai as a pilot city have -- the policy came out more than 1 year earlier, so the impact has already been reflected on the hardware. As I explained earlier that we are -- we have started earlier to comply with the new requirement and we believe and we don't -- on area per head as I explained, we're already in compliance and on the fire permit the company has -- even before the IPO we have been very actively to improve our compliance level. That's the hardware. On the software, which is the faculty and content, this is where we are striving. On the content, we work very closely with the local authority. And just very recently, the local authority came to our company, and they did a full evaluation, and we received a very high score on that. And we also -- we got the permit for our Shanghai City -- Beijing and the Shanghai [ center ] since the government started to accept the application. And on faculty team front, that -- as you know, that we always prefer the students from those normal teaching universities who typically will have license when they graduate, that's why -- and now when we do recruitments, we highly emphasize that this -- adjust -- the qualification permit is a requirement. So we are confident that we are doing very well on that as well.

[Foreign Language]

[Foreign Language]

[Operator Instructions] And the next question comes from Sheng Zhong with Morgan Stanley.

[Foreign Language] I'll translate my question. The first one is about the follow-up about the guidance. The third quarter guidance, it slowed down from the second quarter. So can you give some color on what the reason behind? Second one is on the in Shanghai, some schools already provide the flexible school hours. So do you think that will impact the after-school tutoring causes [ event ].

Thank you, Sheng Zhong. To your first question, yes, the guidance -- we lowered the guidances because as you know this, that our margin has declined in the second quarter and we internally we want to focus to strengthen the core of our business, we want to increase the margin. So were trying to combine some classes and for classes that where the students number is lower than our threshold, we decided not to open that class or we will close that class, trying to improve our margin. That's the key reason of why we lowered down the guidance. Of course, we want to be prudent as well. We do not want to miss the guidance for the next quarter. That's also one of the reasons why we don't want to have a high guidance on that. And, yes, I will let Tian to answer your second question. [Foreign Language].

[Foreign Language] Yes. On the flexible school hour question, because first of all our classes are heavily concentrated on weekends. So the policy doesn't have an impact on us and besides even on workdays like Thursday and Friday, our class typically starts at 6 o'clock and end at 8:30. So this guidance is, the new policy, we don't expect any negative impact from that policy on our business. [Foreign Language]. On the contrary, we believe the new policy has a positive impact on the business because to delay the school hour, to extend the school hour, the schools will need more good content and we have been recently approached by quite a few schools that want us export our work with them, to deliver our course content out to their students. So we believe this actually have positive impact on us.

[Foreign Language]

[Foreign Language]

And the next question comes from Charlotte Wei with Citi.

[Foreign Language] Okay, let me translate my question. So thanks, Joanne and Tian, for taking my question. My first question is regarding the OP margin guidance. According to your guidance, I noticed that for this year, the guidance is about 4% to 6% lower than last year value. May I know the reason behind these margins now? So can you break it down to us? Also -- okay -- so first let you answer my question.

Yes. Thank you, Charlotte. Thanks for the question, first of all. I think that this is actually very straightforward. The reason for the decline in operating margin is really the [ forced growth ] of the gross margin, right? As you can see, the gross margin is lower by our previous guidance by similar percentage, right. And if you want me to explain the decline of the gross margin, which we have explained in our earnings call, is because first of all we have opened a lot of new centers and the ramp-up period is longer than we had expected and also because we have more new staff cost to develop those new program, which is non-math related. We have a strong R&D team to develop those new content for Chinese curriculum middle school program. That all attribute to the lower gross margin, which falls within the operating margin.

Okay. May I know the current utilization rate compared to the previous level?

Sorry, Charlotte, we don't disclose utilization rates to the public.

[Operator Instructions] And the next question comes from [ Zac Wang ] with First Beijing.

[Foreign Language] First I wonder that the second quarter reported 64% enrollment growth and like 21% revenue growth. I wonder what caused the revenue grow slower than the enrollment grow?

First of all, enrollment doesn't tie to the revenue in the same time period because enrollment is more forward looking. Enrollment is tied to cash, not to the revenue. You can enroll a student. When he enrolled, we record enrollment. The revenue is recognized over time. So the percentage doesn't tie actually. And second one -- that's the key reason. And the second delay, on the enrollment they have like short-term programs, special programs and the regular programs. A free class short program also counts as one enrollment and the 20 class regular program also count as one enrollment. So you can -- it does not always tie when you come to percentage.

Okay. Could you help me break down the -- sorry.

[Foreign Language]

Okay. Then like you said the enrollment is not tied to revenue, like it is not tied to the revenue in that quarter, right? So that means the enrollment is tied to the revenue of the forward quarter, but you said like 60% of enrollment growth, but the next quarter's guidance is above like 3% to 5% revenue growth. So there is still a difference there. Can you help me clarify?

Yes, because the second quarter is not big enrollment season. Like all after-school tutorials education companies, the enrollment season is April and November. So even the growth is 64%, but when you talk to -- when you translate to absolute enrollment number, it is not really high because second quarter is not an enrollment season, right, versus revenue in the third quarter is sort of a high season.

And the next question comes from [ Mario Gee ] with Credit Suisse.

I have a question about how regulators conduct regulation of content of tutoring classes. Do they require a preapproval of study materials or do they attend classes or through some other means?

[Foreign Language] One is they will contact us and they collect all of course materials and content program within like a very short time limit. Second is they will have ad hoc visits to our learning centers. They will basically attend one class and see what you teach and if the material you used is beyond what should be taught. [Foreign Language] They have special team to evaluate all those course content.

Thank you. And my second question is then what are the key considerations in the approval process of new learning centers for regulators? What do they look at in that process and have they become more lower or more strict than before?

[Foreign Language] We don't think the approval process for new learning center has got more stringent. It is similar to what the previous process is on the hardware, whether you have the fire permit, whether you have proper facilities for the students and faculty members and as we explained earlier that Shanghai adopted such a stringent policy more than one year earlier. So to us, we are fully aware of that, and we are fully prepared.

And as there are no further questions now, I would like to turn the call back over to the company for closing remarks.

Okay. Thank you once again for joining us today. If you have further questions, please feel free to contact Four Seasons' Investor Relations through the contact information provided on our website or The Piacente Group Investor Relations.

Thank you. This concludes the conference call. You may now disconnect your lines. Thank you.