Earnings Call Transcript - TAL Q3 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter Fiscal Year 2021 TAL Education Group Earnings conference call. At this time, all participants are in a listen-only mode. After the managements' prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. I would now like to turn the call over to your first speaker today. Ms. Echo Yan, IR Director of TAL. Thank you. Please go ahead.

Echo Yan, IR Director

Thanks, operator. Thank you all for joining us today for TAL Education Group's third fiscal quarter 2021 earnings conference call. The earnings release was distributed earlier today, and you may find a copy on the Company's IR website or through the newswires. During this call, you will hear from Mr. Rong Luo, Chief Financial Officer; Linda Huo, Vice President of Finance; and myself, 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?

Rong Luo, CFO

Thank you, Echo. Good evening and good morning to you all. Thank you for joining us today on this earnings call. In the third quarter, China's public health situations and economy continue to recover. We are pleased to see that our tutoring business as well as capacity expansion progress in all cities has delivered on track performance. During this fiscal quarter, we further executed our offline and online strategy, which remains on track. Our learning center network expansion resumed at pace after a brief lockdown in the second quarter. A quick overview of the key metrics is as follows: net revenue growth in the third quarter was 35% year-over-year in U.S. dollar terms to $1.1 billion and 28% in RMB terms. Total normal priced long-term courses student enrollment increased by 46.5% year-over-year, mostly driven by online as well as Xueersi Peiyou small class enrollments. GAAP loss from operations was $127.4 million compared to income from operations of $69.4 million in the third quarter of last fiscal year. Non-GAAP operating loss was $73.4 million compared to non-GAAP operating income of $99.6 million in the same year ago period. I will now turn the call over to Linda, our Vice President of Finance, who will give you an update on our operational progress in the third quarter. Next, Echo Yan, our IR Director, will review the third quarter financials. After that, I'll update you on our business strategy and discuss our business outlook. Linda, please.

Linda Huo, Vice President of Finance

Thank you. I will review the various revenue streams of our tutoring business for the third quarter. Let me start with small class and other business, which consists of Xueersi Peiyou small class, Firstleap, Mobby and some other education programs and services. These accounted for 66% of total net revenue compared to 75% in the third quarter last fiscal year. The revenue growth rate was 20% in U.S. dollar terms and 13% in RMB terms. Xueersi Peiyou small class, which remains our stable core business, represented 57% of total net revenue in the third quarter compared to 63% in the same year ago period. The lower revenue contribution from Xueersi Peiyou was mostly due to the faster growth of xueersi.com online courses, which accounted for 28% of total revenue in the quarter compared to 19% in the same period last year. Net revenue from Xueersi Peiyou small class was up by 21% in U.S. dollar terms and 15% in RMB terms, while our normal price long-term cost enrollments increased by 18% year-over-year. Our key operational metrics of Peiyou, such as retention rates, fulfillment rates, and job up rates remain very stable. In the third quarter, normal price long-term Xueersi Peiyou small class ASP was flat in U.S. dollar terms and decreased by 5% in RMB terms year-over-year. The decline was mainly due to the mix change of Peiyou online and offline business and more lower-tier cities coverage. Our third quarter performance in the various tiers of cities reflected the ongoing normalization trend after the earlier COVID-19 disruption. Xueersi Peiyou small class revenue from the top five cities, which are Beijing, Shanghai, Guangzhou, Shenzhen, and Nanjing, increased by 19% 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 24% in U.S. dollar terms. The other cities accounted for 44% of Xueersi Peiyou small class business. Next, I'd like to discuss our Quanzhou online business. This business sector achieved year-over-year revenue growth of 14% in U.S. dollar terms and 8% in RMB terms. Quanzhou online accounted for approximately 5% of total revenue in the third quarter of fiscal year 2021 compared to 6% in the same year ago period. In the third quarter, normal price long-term Quanzhou online courses ASP increased by 13% in U.S. dollar terms and 7% in RMB terms year-over-year. The increase was mainly due to regular increases of tuition fees in several cities in this fiscal year. Now let me update you on our capacity expansion strategy. Following a temporary slowdown in our expansion drive during the second quarter due to COVID-19, we resumed the pace of geographic coverage extension as planned for this fiscal year. After our entry into 21 new cities in the first half of the fiscal year, we added 11 new cities in the third quarter and surpassed the 100 cities mark to reach a total of 102 cities. These 11 new cities are Jinan, Dandong, and Changzhou. Similarly, we accelerated the widening of our learning center network in the third quarter, based on a healthy and sustainable approach, and by following government guidelines and market demand. In Q3, we added 64 new learning centers on a net basis, totaling 990 learning centers. We opened 59 new Peiyou small class learning centers and closed six Peiyou small class learning centers. We closed four Mobby and Firstleap centers, and we opened six one-on-one centers and closed one one-on-one center. During the quarter, we added 637 Peiyou small class classrooms. By the end of November 2020, we had 990 learning centers in 102 cities, of which 101 cities in China and 1 Xueersi Peiyou pay learning center in the United States. Among the total of 990 learning centers, 769 were Peiyou small class and international education centers, 87 were the merged Firstleap and Mobby small class, and 134 were Jiaxing one-on-one. As for Q4 of fiscal year 2021 until now, we have conditionally granted 31 Peiyou small class learning centers. As always, we expect to add a few more and close down some learning centers based on standard operations. We will continue to closely monitor the development with regards to COVID-19. These estimates reflect our current expectations, which are subject to change. Turning now to our online business. Third quarter revenue from xueersi.com grew by 102% in U.S. dollar terms year-over-year and 92% in RMB terms, while normal priced long-term courses enrollments grew by 92% year-over-year to over 1.7 million. Online contributed 28% of total revenue and 50% of total normal priced long-term enrollments this quarter compared to 19% of total revenue and 38% of total normal priced long-term enrollments in the same year ago period, respectively. The growth in online business was supported by increasing demand for online education, as well as sales and marketing efforts and retention from previous quarters. In addition, in Q3, normal priced long-term online class ASP was almost flat in U.S. dollar terms and decreased by 6% in RMB 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 third fiscal quarter financial results. Echo, please.

Echo Yan, IR Director

Thanks, Linda. Let me now go through some key financial points for the third quarter of fiscal year 2021. Gross profit increased by 29.2% to $603.6 million from $467.2 million in the same year-ago period. Gross margin for the third quarter decreased to 53.9% compared to 56.4% for the same period of last year. Selling and marketing expenses increased by 120.3% to $420.7 million from $190.9 million in the third quarter of fiscal year 2020. Non-GAAP selling and marketing expenses which excluded share-based compensation expenses increased by 118% to $406.4 million from $186.4 million in the same year-ago period, the year-over-year increase of selling and marketing expenses in the third quarter of fiscal year 2021 was primarily a result of more marketing promotion activities to strengthen our customer base and brands, as well as higher compensation to sales and marketing staff to support more programs and service offerings. Other income was $45.5 million for the third quarter of fiscal year 2021 compared to other expenses of $3.7 million in the third quarter of fiscal year 2020. Other income in the third quarter of fiscal year 2021 was primarily due to the value-added tax and social security expense exemption offered by the government during the COVID-19 outbreak. Impairment loss on long-term investments was $11.5 million for the third quarter of fiscal year 2021 compared to $46.4 million for the third quarter of fiscal year 2020. Impairment loss on long-term investments was mainly due to the decline in the value of long-term investments in several investees. Income tax benefit was $13.9 million in the third quarter of fiscal year 2021 compared to $16.6 million of income tax expenses in the same period of last year. Net loss attributable to P&L was $43.6 million in the third quarter of fiscal year 2021 compared to net income attributable to TAL of $19.6 million in the third quarter of fiscal year 2020. Non-GAAP net income attributable to TAL, which excluded share-based compensation expenses, was $10.4 million compared to non-GAAP net income attributable to TAL of $49.7 million in the third quarter of fiscal year 2020. From the balance sheet, as of November 30, 2020, the Company had $4,233.2 million of cash and cash equivalents and $864.8 million of short-term investments compared to $1,873.9 million of cash and cash equivalents and $345.4 million of short-term investments as of February 29, 2020. The Company's deferred revenue balance was $1,957.1 million compared to $1,251.2 million as of November 30, 2019, representing a year-over-year increase of 57.7%, which was mainly contributed by tuition collected in one of the former winter master and part of Spring Master of Xueersi Peiyou small classes and online courses through www.xueersi.com. 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.

Rong Luo, CFO

Thank you, Echo. Despite the unprecedented challenges this year, our business has managed and delivered 30% revenue growth year-to-date on par with our long-term growth expectation. Our investment strategies for the long-term remain unchanged regardless of the challenges posed by COVID-19 and the growth in competitive pressures. We aim to remain the top brand in quality education services through our long-term sustainable growth strategy, innovative technology-based education, comprehensive and cutting-edge product portfolios, and with a strong and proven operational foundation. As China continues to recover from the pandemic, we have resumed expansions in our learning center networks and geographic coverage in Q3. We expand both our learning center coverage in the cities and enter into more lower-tier cities. We have seen that our offline presence and localized content together have a clear advantage in more precisely meeting our customers' demand in different locations, supporting us in building both offline and online brand and reputation in all cities that we have covered. We have continuously developed and rolled out more Peiyou education products to further build out our comprehensive OmO model. With this, we can better serve our customers by offering them more flexibility and efficiency. As always, we will conduct business in line with all relevant government policies and regulations, including those regarding national public health. Our offline and online operations remain ready to deal with any public health contingencies that may arise. In this time of rapid technological advancement and the impact of COVID-19, online education, with its easy access and affordable prices, has been pervasively effective, and China's online market opportunity is attractive, yet the competition landscape is intensive. There are simply no shortcuts in building a sustainable big business, and I would like to reiterate that we will consistently pursue our long-term strategy regardless of the short challenges we are facing. To that end, we will continue investing in technology, teachers, and marketing and make every effort to build our online services with top-quality content and customer experiences. We firmly believe that, as an education player, our long-term accomplishment is defined only by the quality of our products, services, and technology, rather than purely marketing. Let me turn finally to our business outlook. Based on our current estimates, total net revenue for the first quarter of fiscal year 2021 is expected to be between $1.17 billion and $1.2 billion, representing an increase of 37% to 40% year-over-year basis. That concludes my prepared remarks. Operator, we are now ready to take questions.

Operator, Operator

Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from the line of Mark Li from Citi. Please ask your question.

Mark Li, Analyst

Hi management. Thanks for the presentation. May I ask for your next quarter's guidance, how much have you baked in the latest impact from the unfortunate offline tutoring lockdown in the Beijing area? And how are we handling the Beijing latest policy?

Rong Luo, CFO

Thank you, Mark. I think it's very important to recap the guidance and Q3 results again because sometimes, if we only focus on one quarter, it can be misleading. For Q3, we have some numbers that need to be highlighted. Our Peiyou small class business grew 21% compared to previous quarters. And here, one thing we need to mention is actually the Peiyou life revenue growth in U.S. dollar terms this quarter was 148%. Also, our Xueersi online school growth in Q3 was 102% in U.S. dollar terms and it has been around 28% of total revenue for the entire company. More importantly, starting from maybe last quarter, the enrollment from Xueersi online school has already surpassed 50% of the total enrollments in the company. Additionally, if we consider Peiyou life together with our online schools, the total online revenue growth in the third quarter was 114.2%. This has been around 41% of the company revenue and 64% of the total enrollments. With all these numbers in Q3, as we move into Q4, the current guidance is as follows: unfortunately, we have seen some confirmed COVID-19 cases in Beijing and maybe in some other cities. We fully respect the government and follow their requirements to ensure we always put students' interests first. However, based on last year's experiences, we are more prepared than ever to handle these situations. We have learned how to transition from offline to online classes effectively. Our current visibility to provide more offerings, as well as the acceptance rates from both parents and students, have improved significantly compared to last year. We don't anticipate any major or material impact from transitioning classes online in Beijing this month. For Q4 guidance, Peiyou revenue continues to recover, and we expect growth to be even faster than Q3. Similarly, Xueersi online school growth is also on track. However, we need to consider the timing of the upcoming Spring Festival this year, as it is later than last year. This may lead to an approximate 10% revenue reduction in Q4 due to scheduling differences. So, we must account for this when making comparisons to previous quarters. Overall, we are better equipped to handle online teaching, flexible offerings, and the ongoing public health situation. We believe that, with the strong execution of government measures, we can continue to navigate these challenges effectively. Our entire team is prepared for whatever may come, and we remain confident in our growth trajectory.

Alex Xie, Analyst

I would like to ask two questions about Peiyou. Firstly, regarding the Peiyou offline business, could you please share with us the reason for the relatively slower growth compared to offline peers? And when can we expect acceleration after your proactive extension of learning centers? What will be your target for the CapEx expansion in the next fiscal year? Secondly, for Peiyou online, congratulations on the very strong results, which are quite impressive for the 148% growth. How should we think about our OmO strategy in the next year? What are the growth targets for next year?

Rong Luo, CFO

Thank you, Alex. In the first place, I think when we're running our business in this market, the only comparison that matters is against ourselves. Different companies choose different strategies and have various beliefs when it comes to promoting education through technology. I believe that the offline business is recovering, and we will carefully expand our learning centers, focusing on existing major cities while exploring new locations. Over the past few quarters, we have merged our online and offline strategies, learning from our experiences to better serve our customers. Our online and offline models must integrate, ensuring that we continually offer quality educational services. This strategy allows us to cover cities more densely than we could through traditional models alone. Looking forward even to this quarter, despite the new COVID-19 cases in Beijing and Shanghai, we remain confident in the long-run success of our OmO strategy. We believe that we can improve and keep learning in this competitive landscape. Thus, we are setting a revenue growth' target range of 30% to 50% over the next three years.

Sheng Zhong, Analyst

My question is about the online education customer acquisition costs. We see from the market that the CAC is rising quickly. What is xueersi.com's economic model considering different customer acquisition channels, and what is the company's plan for sales and marketing in the coming year?

Rong Luo, CFO

Thank you, Sheng. When most people discuss online education, the first concern that often arises is customer acquisition costs, which can oversimplify the complexity of the online education models. First, online education is still education, offering numerous advantages like time flexibility. However, it follows similar rules as traditional education in terms of quality. If we prioritize content development, our Peiyou life program will provide localized content tailored to the specific needs of our students. Content is our first investment priority going forward. The second area we focus on is technology. We serve millions of students on our platform, so we must provide stable, high-quality technology solutions to meet their needs. The third essential area is our investment in teachers and training. It's crucial to provide teachers with proper training and compensation to ensure they are equipped to serve students effectively. Finally, marketing investment is also necessary. We need to strike a balance between brand awareness and customer satisfaction. We intend to invest or continue investing in content, technology, and teacher systems while cautiously managing marketing expenses. As for CAC, it is increasing, particularly in non-branding channels like WeChat. We need to ensure our investments in these channels remain healthy while leveraging our existing student and parent networks for organic growth. In the end, we will continue to focus on managing healthy growth while prioritizing the needs of our students and parents above all.

Felix Liu, Analyst

Just a follow-up on the previous comment. You mentioned that you are investing in content development, especially on the Xueersi online school to create more tailor-made content. Is there any opportunity to build more synergy between the two business lines, particularly regarding content and tuck-in acquisitions? My second question recalls your previous mentions of wanting to maintain a high level of IPO investment to protect the number one position of Xueersi online school. It seems you're expressing a more balanced perspective on sales and marketing. Can you confirm whether you still intend to invest adequately to maintain that number one position?

Rong Luo, CFO

Thank you, Felix. Both our Peiyou small class business and Xueersi online school business continue to be conducted under the same brand umbrella. We certainly have a lot of synergies between these two business lines. Firstly, regarding content, we are strategically leveraging resources across both areas to maximize benefits. We don’t want to create redundant content for each line; rather, we synergize where we can. Second, student data is a crucial aspect we can utilize effectively across both platforms. We have observed students transitioning between online and offline offerings. This flexibility is important for us as we cater to differing preferences. Regarding technology, we have also started to incorporate technologies from Xueersi into Peiyou, reflecting our efforts to synchronize operations. For the path forward, while we want to maintain our leadership in the online education space, we will not solely pursue growth through aggressive spending. Instead, our focus remains on delivering quality educational services. We will continue to invest diligently in product development, teacher training, and overall service quality to remain a reputable leader.

D. S. Kim, Analyst

Perhaps to continue on the similar vein, what's our big picture strategy for online? Are we becoming more aggressive in trying to diversify our traffic sources, given the rising channel costs from various platforms? I noticed that we are pushing certain strategies much more aggressively lately. How do we think about growing proprietary traffic?

Rong Luo, CFO

Thank you. That's a very good question. We are investing some resources into solutions to assist parents with challenges they face. It's important that we offer support in their educational needs, but this should not be perceived simply as a new channel for customer acquisition. Instead, our intention is to create tools that simplify the educational experience for families. Additionally, yes, diversifying our branding channels is essential as education-related branding has multiple levels, from awareness to repute. We must enhance marketing efforts while ensuring our core focus remains on providing excellent service quality. By establishing a positive reputation through consistent quality, customers will seek us out directly. This model of reputable branding will be our priority.

Alex Liu, Analyst

I noticed TAL entered 11 new cities this quarter. Most of these cities are actually Tier 2 or Tier 3 cities. Will the business ramp-up strategy differ in these cities compared to our existing locations in terms of the speed of the ramp-up, the scale of offline capacity, and the mix of the Peiyou online and offline business?

Rong Luo, CFO

Thank you, Alex. When we enter lower-tier cities, we focus on maintaining the operational practices that have served us well over the past 17 years. Initially, we will offer single grades and subjects, building our reputation in each new market. Once we've established a foothold, we will promote additional offerings leveraging our Peiyou life program. Our experiences in larger urban areas have provided valuable lessons, and we aim to replicate that success in new locations methodically. We remain patient and gradually build our presence. We believe that the time invested in establishing strong reputations in these areas will yield greater returns over time. Overall, this approach is fundamental to our growth strategy. Yes, that's a fair question. A few years ago, the expectation was to target around 70 to 80 cities for our offline operations. Now that we've surpassed 100 cities, we see potential for further expansion. With improved flexibility and efficiency through our OmO model, we aim to strategically increase our reach even further across China while ensuring service quality and operational effectiveness.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect your lines.