Four Seasons Education (Cayman) Inc. (FEDU) Q3 2019 Earnings Report, Transcript and Summary

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

Hello, everyone, and welcome to the third 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 the Chief Executive Officer, will start the call by providing an overview of the company and the performance highlights of the quarter with English interpretation. Mr. Yi Zuo, our Director and the Chief Financial Officer, will then provide 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 the 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 these 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 the Four Seasons Education’s earnings press release and this conference call includes discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. Four Seasons Education press release contains reconciliations 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 third quarter fiscal year 2019 earnings conference call. [Foreign Language] Entering into the second half of fiscal 2019, we maintained our strategy of extending a greater variety of subjects and courses to broader age groups to better address the market demand for synchronized tutoring and customized learning. Our enrollment in the third quarter has reflected further diversification in various subjects and age groups. Our kindergarten and middle groups programs gained greater share in total enrollment, while maths classes remained our biggest enrollment contribution, we saw an increasing proportion of students participated in our non-math classes. Our small classes and other interest-oriented special programs have also been well received by our students and parents. We believe this diversification strategy will further enhance our competitiveness and help capture more opportunity in the evolving after-school education market. [Foreign Language] We have been adjusting our products and operations in accordance with the new regulatory requirements. Specifically, we modified our enrollment arrangements and class delivery process by restricting prepayment to cover a maximum of three months curriculum. As anticipated, this operational adjustment led to a year-over-year decrease in total enrollment for the quarter. However, we believe, the overall demand is not impacted by this change. [Foreign Language] Regarding our learning center network development, we have been optimizing our network with prudent expansion. In the third quarter, we added one learning center in Shanghai and Chongqing, respectively. At the same time, we moved three learning centers in Shanghai to new locations to better meet the related requirement and provide an optimal learning environment to our students. Our newly launched learning centers are also in the process of steady ramp-up. As of November 30, 2018, our total number of learning centers was 56. [Foreign Language] Backed by our strong teaching experience, our educational innovation and other initiatives continued to make strides during the third quarter. As we mentioned, we also proactively design and deliver a variety of interest-oriented classes to drive students’ engagement and accommodate market demand for practical and relaxing after-school activities. Especially, based on our rich teaching experience and educational capabilities in math and other science subjects, our featured classes for logic-based puzzle games such as Bridge, Sudoku, and the Rubik’s Cube have gained great popularity among students at different age groups. We have been teaching Sudoku for over 10 years and now we deliver Bridge classes at 10 Four Seasons learning centers. With students active participation and high enthusiasm, we have formed Bridge training teams in 2018 and 2019 for national competition. Recently, our teams and students also achieved outstanding performance and won various awards in the national and regional Bridge and Sudoku matches. It has always been our vision to help students find fascinating moments in maths learning, and we will host more of those dynamic and enjoyable activities which help students’ logical thinking development and nurture their interest in maths. [Foreign Language] Our another educational initiative, the math lab program is attracting increasing attention and recognition in the education space. We will consistently enhance and enrich the educational content in our math lab product to extend an evolving interactive study experience to students in our partner schools. [Foreign Language] On the compliance front, our continued efforts to comply with the latest regulations have been recognized by the government and the related authority. We are pleased to report that our Shanghai Four Seasons Education Training Company Limited, Four Seasons Class Training Company Limited and other entities in our group were among the white list of after-school tutoring institutions released by the Shanghai Education Bureau in later December 2018, which demonstrates our compliance in terms of operating license, educational content, and teaching facility environment. We are willing to continue working with related authorities while adapting our operation to the new regulatory environment, as we fulfill our commitment to providing the best-of-class educational services and learning experience to our students. [Foreign Language] Next, I would like to outline our strategy aimed at driving future growth. [Foreign Language] First, fortifying our strength in math education, the company has historically focused on maintaining leadership in math education. We will pivot around the maths subject and proactively develop more teaching content that accommodates the study needs of different grade levels. Specifically, for younger children, our next step in textbook development places emphasis on fun and education initiatives integrating maths-related cartoons and puzzles into lessons. For elder, elementary school and middle school age groups, we will continue to amplify our wellness and well-exercised programs, which reinforces school lessons in conjunction with tutoring. Furthermore, we’re extending math to strategic reasoning and logical lessons for general intellectual development, which integrates competitive games, such as Bridge and the Sudoku. [Foreign Language] Second. Second, expanding course offerings to other non-maths subjects. Beside our core maths classes, we are offering and promoting key subjects including Chinese and English to primary school students in an attempt to facilitate increased enrollment with relatively lower cost. In the meanwhile, we’re extending tutoring classes to – of all subjects for middle school age groups with the goal of providing a one-stop learning solution. [Foreign Language] Third, deepening R&D and the expansion of the maths lab program, we’re enriching the content of this program including maths culture, maths history, academic activities and sharpening its core self-test system for more precise maths knowledge assessment. In addition, we are strengthening cooperation across standard K-12 schools in implementing smart maths lab program and forge it into a signature educational package offering. [Foreign Language] Lastly, optimizing the utilization of our existing learning centers with stringent overall operational cost control by expanding the breadth of our course offering beyond maths. We’re optimizing the use of our facilities while extending the lengths of engagement with our students in the present and over time. We’re striving to realize steady margin improvement in the mid- to long-term with escalated operational efficiencies. [Foreign Language] With that, I would now turn the call over to our CFO, Joanne Zuo, who will discuss our key financial results.

Thank you, Mr. Tian and hello everyone. The third quarter had been a challenging and transforming period for us. We achieved a 5% year-over-year growth in top line. This performance is in line with our expectations and encouraging as we came off a relatively high revenue base in the same period of last year. During the quarter, we proactively adjusted our cost offerings to better accommodate the evolving market needs. We also focused on strengthening our core business, as we strategically combined or rearranged a few classes order to improve the overall efficiency. As a result of our efforts, we are pleased that gross margin realized slightly sequential improvement to 52.8% in the third quarter from 52.3% in the quarter before. Looking ahead, we will maintain our strategy for quality growth of our business with prudent operational modification for efficiency, improvement and long-term sustainable growth. As of current, we’re in the progress of comprehensively evaluating our learning center and have plans to close a few centers with low utilization rate with a goal of streamlining our operational – of our operating network. Therefore, we expect to incur a certain amount of one-time expenses as we close the centers, which will lead to some pressure on our gross margin. Despite the short-term impact, we believe we are doing – we believe what we are doing will consolidate our strength and better adapt ourselves to the evolving environment and market competitions within our industry. Now, I’d like to walk you through more details on our third quarter fiscal 2019 financial results. Revenue increased by 4.5% to RMB91.2 million for the third quarter of fiscal year 2019 from RMB87.2 million in the same period of last year, primarily due to tuition increase in standard programs, increased revenue contribution from the Ivy Program and small class for standard programs, development of kindergarten, middle school and non-math programs, as well as at expansion after-school learning center networks. Including the contribution from the newly acquired business that closed the transaction in the first nine months of fiscal year 2019. This increase was partially offset by the decreased revenue contribution from maths competition focused classes as a result of changing regulatory requirement. Cost of revenue increased by 42.8% to RMB43.1 million for the third quarter of fiscal year 2019 from RMB30.2 million in the same period of last year, primarily attributable to costs associated with increasing faculty staff cost, as well as learning center rental, utilities and maintenance and depreciation costs, as a result of increased number of learning centers. Gross profit decreased by 15.7% to RMB48.1 million for the third quarter of fiscal year 2019 from RMB57.1 million in the same period of last year. Gross margin was 52.8% for the third quarter of fiscal year 2019, compared with 65.4% in the same period of last year. The decrease in gross margin was primarily due to the expansion of new centers, which yielded relatively low gross margin during the ramp-up period and the increase in faculty staff cost, as well as discounts granted to students to promote the company’s middle school and non-math programs. General and administrative expenses increased by 25.2% to RMB32.1 million for the third quarter of fiscal year 2019 from RMB25.6 million in the same period of last year, primarily attributable to increased staff cost of RMB4.6 million and RMB1.1 million of depreciation and amortization cost and increased share-based compensation expenses of RMB2.8 million. This increase was partially offset by IPO related expenses in the same period of last year. Sales and marketing expenses decreased by 15.3% to RMB8.3 million for the third quarter of fiscal year 2019 from RMB9.8 million in the same period of last year. Operating income decreased by 64.4% to RMB7.7 million for the third quarter of fiscal year 2019 from RMB21.6 million in the same period of last year. Adjusted operating income, which excludes share-based compensation expenses decreased by 40.2% to RMB16.7 million for the third quarter of fiscal year 2019 from RMB27.9 million in the same period of last year. Interest income decreased by 13.5% to RMB1.2 million for the third quarter of fiscal year 2019 from RMB1.4 million in the same period of last year, primarily due to the withdraw of short-term deposit. Other expenses, net were RMB2.6 million for the third quarter of fiscal year 2019 from RMB0.04 million in the same period of last year, primarily due to an RMB2 million fair value change of a two-year Pimco fund-linked note and a one year certificate on mutual fund, both with 100% minimum redemption level at maturity that the company intends to hold to maturity. Other expenses were partially offset by foreign currency revaluation gain. Income tax expenses decreased by 68.3% to RMB3.9 million for the third quarter of fiscal year 2019 from RMB12.3 million in the same period of last year. Net income was RMB2.7 million during the third quarter of fiscal year 2019, down 74.8% from RMB10.7 million in the same period of last year. Adjusted net income, which excludes share-based compensation expenses and fair value change of investments measured at fair value, decreased by 19.5% to RMB13.7 million from RMB17 million in the same period of last year. Adjusted net margin was 15% compared with 19.5% in the same period of last year. Basic and diluted net income per ADS attributable to ordinary shareholders for the third quarter of fiscal year 2019 was RMB0.06 and RMB0.05 respectively, compared with RMB0.27 and RMB0.26 respectively for the same period of last year. Non-GAAP basic and diluted net income per ADS attributable to ordinary shareholders for the third quarter of fiscal year 2019 was RMB0.28 and RMB0.27 compared with RMB0.46 and RMB0.44 respectively, for the same period of last year. Cash and cash equivalents as of November 30, 2018, the company had a cash and cash equivalents of RMB497 million, a decrease of 14.8% compared with RMB583.3 million as of February 28, 2018, primarily due to RMB139.1 million cash payments for the acquisition in Shanghai, and the increase in short-term investment of RMB34.8 million. The decrease was partially offset by the operating cash flow generated in the first nine months of fiscal 2019. To be mindful of the length of earnings call, for the nine months of fiscal 2019 financial results, I will encourage listeners to refer to our earnings press release for further details. Looking forward for the fourth quarter of fiscal 2019, we currently expect revenue to be relatively flat compared to the fourth quarter of fiscal 2018. The above outlook is based on the current market conditions that – and reflect the company’s preliminary estimates of market and operating conditions and customer demand, which are all subject to change. This concludes my portion of prepared remarks, we will now open the call to questions. Operator, please go ahead.

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

[Foreign Language] I’ll translate it myself. So the first question is about, you mentioned that your students structure have been changed along with business restructuring. So what is – can you give more color on your student profile? And secondly, it is about revenue guidance. You are expecting a flattish year-over-year growth in fourth quarter. What’s the reason behind this outlook and what’s your outlook about FY 2020? And third one is about regulation impact including the teacher certificate requirement and also to see more schools in Shanghai, it’s promoting the after-school classes in the school. Thank you.

Sheng Zhong, thank you. Sheng Zhong, so let me answer question number one, number two and I will leave the third question to Tian. So on your first question, contribution from age groups that are beyond the primary school and subjects that’s not math, I cannot really – I cannot disclose too detailed numbers. But our third quarter revenue contribution is roughly 20% to 25% in terms of age group, 20% to 25% was contributed by non-primary school students and roughly 25% to 30% was contributed by non-math subjects. So, that’s on the revenue contribution from non-primary school students and non-math subjects. On your third question – on your second question, the guidance for next quarter is flat is because we’re still in the process of transitioning heavily concentrated maths type of business model to a more diversified business model. We do see decline in lower age groups, grade 1, grade 2 students for maths subject, but we see enrollments for our senior grades to be steady and enrollments for grade 4 and grade 5 actually increased. But because our revenue was heavily concentrated on primary school maths, the decline was not fully offset by the increase in other subjects and age groups. So that’s the reason why we give a flat guidance for next quarter. For next year, full year, we expect that our top line will grow at 20%. That’s our current estimate. And for your third question, I will ask Tian to answer.

[Foreign Language] On your question regarding the teacher certificate, we actually think this is a reasonable policy and we strongly support this policy. As you know that Four Seasons has always been focused on teaching content and the faculty development. And the mass majority of our faculty staff as well as our management have teacher certificates already. So we don’t expect this new policy will have a huge negative impact on our business. And on your third question, flexible school hours, I think the key is what school can offer after those school hours. So that’s why a lot of schools actually actively looking to purchase quality content, which also provide us good opportunity. Our intellectual maths program such as Bridge and Sudoku, are well received by those schools and we send our teachers to train their students and sometimes also train their teachers to let the students have a good content to have an interesting class to attend after 3:30 school hours.

[Foreign Language] Yes.

[Operator Instructions]. The next question comes from Melissa Chen with China Renaissance. Please go ahead.

[Foreign Language]

[Foreign Language] Nicky, let me translate for Mr. Tian. The math lab is actually an initiative that we are currently work on. It basically is a physical lab, which has a series of different content, and we intent to have this lab setup in both standard K-12 schools as well as some of our learning centers. In the lab, you will be able to access a series of programs, including maths culture, which talks about maths history et cetera. And the second module is maths activity, such as Sudoku or Bridge, which helps to increase the interest of students in maths. And the third module that we work on is a self-assessment feature, which help the students and teachers to assess the true ability of students in maths. So this is a series of content that we portend to have in this math lab. And our math lab project, we had this – we participated in the innovation exhibit, the fourth innovation exhibit in Zhuhai that’s organized by the National Education Bureau and our math lab is very well received by some of the educational experts. Now, we are working to complete this project and we plan to promote this math lab to both standard K-12 schools, as well as we also intend to have a setup in our own learning centers. So this is the math lab initiative. On your second question, sorry what’s your second question, Nicky?

Yes. So second question was on the demand part, like, any changes on the overall demand? And also any special promotional events for our winter and summer promotions? Thanks.

We actually see a steady demand, we don’t see a decline in the demand or just from the enrollments – of our current enrollments in the winter season we think we are able to achieve 20% growth next year. And for this winter semester, we didn’t offer any aggressive promotions as you know that Four Seasons unlike many of other institutions that we don’t really offer aggressive promotions. So, in the enrollment season that’s in November, we didn’t offer any huge promotion either.

Got it, thank you. That’s super helpful. Thank you.

As there are no further questions now, I’d like to turn the call back over to management.

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

This concludes this conference call. You may now disconnect your line. Thank you.