TAL Education Group Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to First Quarter FY2021 TAL Education Group Earnings Conference Call. At this time, all participants are in a listen-only mode. After the management’s prepared remarks, there will be a Q&A session. Today’s conference call is being recorded. I would now like to hand the call over to your first speaker today, Ms. Echo Yan, IR Director of TAL. Thank you. Please go ahead.

Thanks, operator. Thank you, all, for joining us today for TAL Education Group's first fiscal quarter 2021 earnings conference call. The earnings release was distributed earlier today. You may find a copy on the Company’s IR website, also with the newswires. During this call, you will hear from myself, the IR of TAL. Following the prepared remarks, Mr. Luo and Ms. Huo will be available to answer your questions. Before we continue, please note that the discussions today 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 are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in public filings with the SEC. For more information about these risks and uncertainties, please refer to our filings with the SEC. Also, our earnings release in this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release which contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures. I would like now to turn the call over to Mr. Rong Luo. Rong, please.

Thank you, Echo. Good evening and good morning to you all. Thank you for joining us today on this earnings call. Compared to the situation one quarter ago, we have been encouraged by the progress that the government and people in China have made to keep COVID-19 under control. We are still saddened by the strains that this pandemic has put on public and personal life and ongoing challenges in many other countries. At TAL, during the first fiscal quarter, we continued to operate within the possibility in the constraints of the organization. We managed to mitigate the negative impact on our offline business after the first quarter by the growth in student enrollments in online courses and related revenue. Net revenue growth in the first quarter was 35.2% year-over-year in US dollar terms to US$910.7 million and 41.5% in RMB terms. Total normal priced enrollments increased by 72.1% year-over-year, mostly driven by the online enrollment. GAAP income from operations was US$35.5 million, a year-on-year decrease of 26.8% from US$48.5 million. Non-GAAP operating income of US$68.8 million decreased by 7.8% from US$74.6 million in the same year ago period. I will now turn the call over to Linda Huo, our Vice President of Finance. She will give you an update on our operational progress in the first quarter. Then Echo Yan, our IR Director will reveal our first quarter financials. After that, I'll update you on our bidding strategy and discuss our business outlook for the next quarter. Linda, please.

Thank you. I will review the various strategies of our children’s learning for the first quarter. Let me start with the small class and other businesses which consist of Xueersi Peiyou small class, Firstleap, Mobby, and some other education programs and services. These accounted for 68% of total net revenue compared to 77% in the fourth quarter of the last fiscal year. The revenue growth rate was 21% in U.S. dollar terms and 27% in RMB terms. Xueersi Peiyou small class, which remains our stable core business, contributed 60% of total revenue in the first quarter compared to 67% in the same year ago period. The lower revenue contribution from Xueersi Peiyou was mostly due to the faster growth of online courses, which accounted for 25% of total revenue in the quarter compared to 15% in the same period last year. Net revenue for Xueersi Peiyou small class was up by 22% in U.S. dollar terms and 28% in RMB terms. Our long-term course enrollment increased by 43% year-over-year. In the fourth quarter, almost all of the Peiyou business continued to be delivered by online platforms due to the impact of the COVID-19 outbreak. In Q1, normal price long-term Xueersi Peiyou small class ASP decreased by 13% in RMB terms and by 17% in U.S. terms year-over-year. The decline was mainly due to the mix change of more lower-tier cities coverage as well as the discounts offered to online small class customers who had to transition from offline to online during the COVID-19 outbreak period. Our first quarter performance reflected stable growth of the small class business across our cities, in our geographic network. Xueersi Peiyou small class revenue from the top five cities, which are Beijing, Shanghai, Guangzhou, Shenzhen, and Nanjing, increased by 18% year-over-year in U.S. dollar terms and accounted for 56% of Xueersi Peiyou small class business. Revenue generated from cities other than the top five grew by 27% in U.S. dollar terms, and these cities accounted for 44% of Xueersi Peiyou small class business. Next, I would like to discuss our Zhikang Online business. This sector achieved year-over-year revenue growth of 5% in U.S. dollar terms and 10% in RMB terms. Zhikang Online accounted for approximately 6% of total revenue in the fourth quarter of fiscal year 2021, compared to 8% in the same year ago period. In this quarter, normal-priced long-term Zhikang online classes ASP was almost flat in RMB terms and decreased by 3% in U.S. dollar terms year-over-year. Now, let me update you on our current expansion strategy. We briefly slowed down our offline capacity growth plan in order to better deal with COVID-19's near-term impact. During the past month, except in a few cities, the situation in China has been continuously improving. Alongside this progress, we have cautiously improved our offline capacity expansion plan to cover the cities and areas which were already in our fiscal year 2021 annual headline. Before the COVID-19 outbreaks last year, our annual plan and foreseeable future, we will continue to pursue a healthy and sustainable Learning Center network expansion by following government guidelines and market demands. In Q1, we added 65 Learning Centers; we opened 78 new Peiyou small class learning centers and five one-on-one centers, and closed 13 Peiyou small class learning centers and one one-on-one center. During this quarter, we added 685 Peiyou small class classrooms. We entered 20 new cities, which accounted for one new Peiyou small class Learning Center each. As of May 2020, we have 936 Learning Centers in 90 cities, of which 89 are in China and one is a Peiyou learning center in the United States. Among the total 936 Learning Centers, 713 were Peiyou small class and international education centers, 91 were newly merged with deep and multi-small class centers, and 132 were one-on-one centers. As for Q2 of fiscal year 2021, with the gradual reopening in different cities and ongoing digital practices, we have conditionally rented Peiyou small class learning centers. We expect to add a few more and close down some learning centers based on standard operations. These estimates reflect our current expectations, which are subject to change. Moving now to our online business, fourth-quarter revenue for xueersi.com grew by 123% in U.S. dollar terms year-over-year and 133% in RMB terms, while our normal-priced long-term policies enrollments grew by 143% year-over-year to approximately 1.28 million. Online contributed 25% of total revenue and 43% of the total normal-priced long-term enrollments this quarter, compared to 15% of total revenue and 31% of total normal-priced long-term enrollments in the year-ago period respectively. The accelerated growth in the online business was supported by current circumstances that drive the secular demand for online education, as well as sales and marketing efforts and retention from the previous quarters. In addition, in Q1, normal-priced long-term online course ASP decreased by 9% in RMB terms and 13% in U.S. dollar terms year-over-year, mainly due to the mix change of our diversified online course offerings. With that, I will now turn the call over to Echo Yan for the update on the first fiscal quarter financial results. Echo, please.

Thanks, Linda. Let me now go through some key financial points for the first quarter of fiscal year 2021. Gross margin increased by 27.6% to US$481.1 million from US$377 million in the prior year period. Gross margin for the first quarter decreased to 52.8% as compared to 56% for the same period of last year. Sales and marketing expenses increased by 41% to US$219.1 million from US$155.4 million in the first quarter of fiscal year 2020. Non-GAAP selling and marketing expenses, which included share-based compensation expenses, increased by 39.6% to US$211.2 million from US$151.4 million in the prior year period. The year-on-year increase of selling and marketing expenses in the first quarter of fiscal year 2021 was primarily a result of more marketing promotion activities to strengthen our customer base and brand, as well as higher compensation to sales and marketing staff to support more programs and service offerings. Other income was US$42.1 million for the first quarter of fiscal year 2021, compared to other expenses of US$31.3 million in the same year-ago period. Impairment loss on long-term investments was US$2.3 million for the first quarter of fiscal year 2021, compared to US$50.6 million for the first quarter of fiscal year 2020. Impairment loss on long-term investments was mainly due to declines in the value of long-term investment in several universities. Income tax expenses were US$22 million in the first quarter of fiscal year 2021, compared to US$2.8 million of income tax benefits in the first quarter of fiscal year 2020. Net income attributable to TAL was US$81.7 million in the first quarter of fiscal year 2021, compared to net loss attributable to TAL of US$16.2 million in the first quarter of fiscal year 2020. Non-GAAP net income attributable to TAL, which excluded share-based compensation expenses, was US$114.9 million, compared to non-GAAP net income attributable to TAL of US$9.9 million in the same period of the prior year. From the balance sheet as of May 31, 2020, the company had US$2,323.8 million of cash and cash equivalents and US$590.6 million of short-term investments, compared to US$1,876.9 million of cash and cash equivalents and US$345.4 million of short-term investments as of February 29, 2020. As of May 31, 2020, the company’s deferred revenue balance was US$1,495.4 million, compared to US$968.4 million as of May 31, 2019, representing a year-over-year increase of 54.4%. Deferred revenue primarily consisted of the tuition for classes, the ongoing Peiyou small classes, and online courses. A final point concerns the repurchase program that the Board of Directors authorized on April 28, 2020. By May 31, 2020, the company had repurchased 185,000 ADS for a total of about US$10 million. Company management also bought back 36,000 ADS during this period. Now I will hand the call back to Mr. Luo to briefly update you on our strategy execution and provide the business outlook for the next quarter. Rong, please.

Thank you, Echo. Firstly, I would like to express gratitude for the recent government progress in stopping the spread of COVID-19 in China and the concerning efforts of our teachers, technology staff, and all our employees. We have been able to offer our children's services online and deliver some free online courses and technology services in support of our educational continuity. Secondly, I would like to emphasize that achieving long-term success for our business requires a strong foundation, which is more important than just pure short-term gains. We will continue to offer the best possible quality of goods and services while truly understanding and adjusting to the needs of our students and satisfying parents' expectations at different times. Based on this principle, our market share gains and profitability optimizations have to go hand-in-hand with our serious ambition for long-term quality service. Last but not least, given the situation in China continues to improve under all government policies and regulations regarding the protection of National Public Health, we always treat the health and safety of our students and employees as our first priority and operate our business based on that priority. Overall, we are confident in our future development and education market options in China. Let me turn finally to our outlook based on our current estimates; total net revenue for the second quarter of fiscal year 2021 is expected to be between US$1,077.6 million and US$1,105 million, representing an increase of 18% to 21% on a year-over-year basis. If we do not consider potential changes in exchange rates between RMB and U.S. dollar, the projected revenue growth rate is expected to be in a range of 20% to 23% for the second quarter of fiscal year 2021. That concludes my prepared remarks. Operator, we are now ready to take questions.

Your first question comes from Natalie Wu from CICC. Please ask your question.

Hi, good evening, Rong, Linda, and Echo. Thank you for taking my question. I was just wondering for your next quarter guidance of 20% to 23% year-on-year in RMB terms, how does that imply the goals of offline Peiyou and online xueersi.com respectively? How should we think about the margin going forward? Also, in the long run, how should we think about the online business model profile as well as the competitive landscape? Just curious if there are any changes in your thoughts on long-term prospects for online business given the dynamics in the latest months. Thank you.

Thank you, Natalie. Firstly, we need to correct our numbers; in Q1, we grew our revenue by 41.5% in RMB terms, whereas our Q2 guidance is 20% to 23%. We need to consider that actually costs are trending differently, with some revenue shifting from Q2 to Q1. To best understand our numbers, we should combine Q1 and Q2 together. This alignment is quite similar with our counterparts in the industry. If we combine the two, our first half revenue growth will exceed around 40%. Secondly, if we look deeper into different segments, we need to monitor our numbers one by one. Firstly, for the Peiyou small class business, we need to be very careful. The Peiyou small class primarily transitioned from offline due to COVID-19. During the last quarter, most offline learning was delivered through our online platform. Regarding Peiyou's small class business, we face challenges alongside pressures that affect other companies in the industry. We are pleased to see the latest government efforts. Operationally, most of our cities have resumed operations. We recognize the recovery will be gradual, necessitating vigilance on the health and safety of our teachers and students as our first priority. Overall, if the pandemic does not worsen throughout the second half, we anticipate growth during that period to be stronger than the first half. Furthermore, our Peiyou Life business, which is our online offerings associated with the Peiyou small class, will continue to experience sustained growth. Last year, Peiyou Life grew by triple digits, and we expect similar trends for Q2. The online school segment contributes 25% of revenue this quarter, and new enrollments grew by 143% year-over-year, forecasted to also grow at triple digits in Q2. In summary, our growth trajectories across our offerings remain promising. Finally, while we cannot provide precise guidance on net margins, we’ll maintain a focus on our operational efficiency and sustainable growth based on our strategic investments. Thank you.

Got it. Very clear. Thank you, Rong Luo.

Your next question comes from the line of Mark Li of Citi. Please ask your question.

Hi, Rong Luo. Congratulations on the results. I want to ask a few more questions about the online business. I recall you mentioned last year that you were focusing on improving your online strategy, and it seems that your online growth has considerably outperformed expectations in recent quarters. Looking back on your online promotions, could you share what has worked well, and what are your strategic focuses moving forward for the latter half of the year? Thank you.

Thank you, Mark. To recap some numbers, last year, our Xueersi online school revenue grew approximately 86% to 87%, nearing 90%. This year, Q1 saw growth by 133%, and Q2 is projected to maintain a triple-digit growth rate plus or minus in a similar range. Part of this growth can be attributed to market changes, as many students in China were compelled to stay at home due to COVID-19, which increased the demand for online education. It is essential to recognize that our brand has advantages in this landscape, but its contribution is reflective of broader market dynamics. Additionally, over the years, we have significantly enhanced our product competitiveness and effectively adapted our services for remote learning. Transitioning students from offline to online involves a comprehensive redesign of our offerings to ensure engagement remains high and instructional quality consistent. Furthermore, we continue to seek efficiencies in hiring teacher assistance to support students; the demand for these roles is increasing. Our investments in technology are critical to sustain our growth trajectory. Summer will be an important time for us, and we will maintain our focus on delivering high-quality educational experiences during that period to ensure we attract and retain more students. The market is competitive, and improving our operational processes will remain as we adapt to the evolving education landscape. Thank you for your questions.

Next question please.

Your next question comes from the line of DS Kim from JP Morgan. Please ask your question.

Hi, everyone. Good evening. Thanks for taking my questions, and congrats on the good results. First, I have two questions if I may. First on margin, I noticed that your gross margins this quarter went down by over 300 basis points despite the positive impact of our optimized pricing strategy. Can you help clarify why Q2 margins are showing lower performance, and if there was a significant drop in a lower-margin segment? I have one small follow-up after this. Thank you.

Thank you for your question. The slight decline in gross margin for Q1 is primarily attributed to the transition of Peiyou small class students from offline to online learning, which has been successful overall. However, during our retention phase for the students, we provided discounts and promotions that affected revenue. Thus, our gross margins reflected this decrease. This is the predominant factor influencing our current margins. Can you please clarify your second question regarding operating margins?

Yes, you are right; thank you for clarifying that. For my follow-up, how do you see the balance between online Peiyou and offline offerings? Given the blurred lines that COVID-19 has created, are you considering matching online prices to offline or are you planning to keep these segments distinct in order to serve different groups of students?

To answer your question, I believe the best response lies in understanding the needs of parents. The structural drivers of our models are fundamentally based on market demand, which varies among parents and students. The months following the COVID-19 pandemic were unique, and it wouldn’t be prudent to base long-term strategic shifts on such a brief period. We will analyze what has transpired and continue monitoring if the observed patterns are temporary or lasting. As for now, we recognize that our Peiyou small class and Peiyou Life offerings serve interconnected but separate student segments and local needs. We remain committed to each segment’s distinct blueprint. Looking ahead, we’ll continue to adapt our strategies to best match parent expectations while maintaining a focus on quality and student engagement across all offerings. Thank you.

Your next question comes from the line of Sheng Zhong of Morgan Stanley.

Hi, good evening. Thank you for taking my questions. My question is about your online business. Can you provide us with a rough estimate of how many of your current students are from lower-tier cities? Additionally, previously, you had mentioned trials of different business models in lower-tier cities. Could you share some insights and observations regarding future strategies for those areas? Thank you.

Thank you, Sheng Zhong. This is a very important question regarding our impact in lower-tier cities. Last year, we had approximately 20% of students coming from lower-tier cities. In light of COVID-19, we launched various free offerings and promotions that have attracted an increasing number of new students from these areas. While I cannot declare a definitive strategy to penetrate lower-tier markets currently, I can state that our ongoing efforts are yielding results. As we evaluate the data, we will strive to deliver quality offerings while ensuring they remain accessible to lower-tier students — aligning demands with competitive pricing while maintaining high teaching quality. Overall, we have seen better engagement from students in these areas, and I anticipate this trend to continue in the coming quarters. Thank you.

Your next question comes from the line of Felix Liu of UBS. Please ask your question.

Thanks for taking my question, and congratulations on a strong Q1. My question is regarding the deferred revenues, which currently stands at US$1.5 billion. I noticed that your guidance for the next quarter appears to be slightly below that. Could you help me understand what is influencing this balance? I understand the government is limiting prepayments for extended durations.

Thank you for your question. The deferred revenue growth was impacted by the overall business growth, as well as the consolidation of newly acquired online one-on-one English tutoring providers. This consolidation began effective May 1 of this year, and I hope this answers your question. Thank you.

Okay, thank you very much. As a follow-up, could you clarify the timeline for recognizing increased deferred revenue from consolidation? What is the typical period to recognize this?

These acquisitions occurred in Q1 of the fiscal year, but when it comes to recognition on revenue, it is dependent on their individual revenue structures. The revenue recognition is more nuanced and will vary based on their service offerings.

Your next question comes from the line of Alex Xie with Credit Suisse. Please ask your question.

Hi, thank you for taking my question. I would like to ask about your online small class model. In the last quarter, you provided online small classes to millions of students, and retention metrics appear to have improved. Moving forward, will you continue offering online small classes within your previously dominated large-class Peiyou Life, and do you foresee demand for that segmentation? Additionally, do you plan to implement online small classes in higher-density cities as a strategy to penetrate lower-tier cities? Thank you.

As cities return to normal, we've observed that both students and parents are returning to offline learning environments. Our decision-making regarding future offerings will heavily rely upon parental satisfaction with our services. Today's early signs or results over a few months may be temporary; it is premature to make conclusive decisions. As we resume offline instruction in cities that are becoming stable, we'll assess parent and student needs to refine our strategies accordingly. Thank you.

Your next question comes from the line of Lucy Yu of Bank of America. Please ask your questions.

Thank you. I have two questions. First, regarding your expansion strategy, you have entered more new cities this quarter despite previous delays. Looking forward, will your strategy focus on new cities or existing ones? As you mentioned, penetrating new cities may dilute or exert pressure on margins in the near term. Second, about the revenue forecast of 20%, given you mentioned that xueersi.com and Peiyou Life are likely to grow at triple digits in the next quarter, it appears there may be pressure from other parts of the business. Could you help us understand this revenue forecast better? Thank you.

Regarding geographic expansion, we are aligned with our plans from last year, which have been slightly altered due to COVID-19 impacts. We are cautiously ramping up our expansion pace, focusing on analyzing health trends post-pandemic. In Q1, we entered 20 new cities, while Q2 has already seen the renting of about 10 new learning centers. Our goal is to maintain our pace of entering new cities while optimizing existing city performance. In terms of revenue forecast, I encourage the perspective to observe multiple quarters instead of just one. Q1 was somewhat accelerated with an influx of students due to the pandemic, thereby creating strange dynamics in the numbers. This is unlikely to be replicated in Q2, where the previous student influx may have been artificially inflated due to external factors. We anticipate our performance to balance out through the year. Thank you.

Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may now all disconnect.