Earnings Call Transcript - TAL Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the TAL Education Group Second Fiscal Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker for today, Ms. Echo Yan. Thank you. Please go ahead, ma'am.

Echo Yan, IR Director

Thanks, operator. Thank you all for joining us today for TAL Education Group's second fiscal quarter 2020 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 the Chief Financial Officer, Mr. Rong Luo; 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, good morning to you all. Thank you for joining us today on this earnings call. Our second quarter revenue performance was based on the robust and healthy growth of our overall small class business in the cities we currently cover and the continued scaling up of our online courses. Net revenue growth in the second quarter was 33.8% year-over-year in U.S. dollar terms to US$936.6 million and 38.7% in RMB terms. Total normal priced long-term course student enrollments increased by 54.5% year-over-year, most driven by positive growth in online enrollments, as well as the Xueersi Peiyou small class. GAAP income from operations decreased by 13.5% to US$69.9 million in the second quarter. Non-GAAP income from operations was almost flat at US$98.8 million. The rising operating expenses incurred in Q2 was mainly due to increased sales and marketing spending, as well as research and development spending in our online initiatives. 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 second quarter. Next, Echo Yan, our IR Director, will review the second quarter financials. After that, I will update you on our key strategy execution and discuss our business outlook for next quarter. Linda, please.

Linda Huo, Vice President of Finance

Thanks, Rong. Fiscal second quarter revenue was based on solid growth momentum in the various education services of our total business. Let me review the business by different revenue streams. Let me start with small class and other business, which consists of Xueersi Peiyou small class, First Leap, Mobby, and some other educational programs and services. These accounted for 76% of total net revenue compared to 81% in the second quarter last year. The revenue growth rate was 25% in U.S. dollar terms and was 30% in RMB terms. Xueersi Peiyou small class, which remains our stable core business, represented 63% of total net revenue compared to 70% 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 16% of total revenue in the quarter compared to 12% in the same period last year. Net revenue from Xueersi Peiyou small class was up by 20% in U.S. dollar terms and 24% in RMB terms, while our normal priced long-term class enrollments increased by 27% year-over-year. This growth rate reflects the solid growth of both Xueersi Peiyou offline and online classes. Peiyou offline small class revenue increased to a healthy rate of 12% in U.S. dollar terms and 16% in RMB terms, while offline normal priced long-term class enrollments increased by 12% year-over-year. With Peiyou online, as you know, we offer the online courses with localized accountants as a complementary service to Peiyou offline in more and more major cities of our network. Peiyou online offers regular and short-term courses and other promotional courses. In the second quarter of fiscal year 2020, which is this fiscal year, Peiyou online accounted for approximately 11% of total Xueersi Peiyou small class revenue and 20% of total Xueersi Peiyou normal priced long-term small class enrollments. In the second quarter of fiscal year 2019, which is last fiscal year, revenue and normal priced long-term enrollments from Peiyou online were 12% and 9% respectively of total Xueersi Peiyou small class business. We continue to enjoy stable growth performance across the board of the cities we currently cover. Xueersi Peiyou's small class revenue from the top 5 cities, which are Beijing, Shanghai, Guangdong, Shenzhen, and Nanjing, grew by 15% year-over-year in U.S. dollar terms and accounted for 54% of Xueersi Peiyou's small class business. Revenue generated from cities other than the top 5 grew by 26% in U.S. dollar terms, and the other cities accounted for the remaining 46% of the Xueersi Peiyou small class business. The drivers of this widely spread growth are solid market demand across our cities, incremental ramp-up of enrollments from our earlier classroom expansion, as well as our ongoing efforts to improve operational efficiency. We continue to enrich our course offerings with a growing number of offline and online courses in curricular and extracurricular subjects. As always, we believe that the quality and relevance of content are the foundation of our business. We have professionally expanded our curriculum with Chinese and English courses. At the end of August 2019, we had offered Xueersi Peiyou Chinese classes in 25 cities and English classes in 29 cities. Furthermore, First Leap, Mobby, and a few other education programs all grew at a steady pace, both in revenues and enrollments in the second fiscal quarter. We expect that these diversified courses will greatly contribute more to our business. Next, I would like to briefly discuss our Zhikang one-on-one business. This business sector had a strong second quarter and achieved year-over-year revenue growth of 40% in U.S. dollar terms and 46% in RMB terms. Zhikang one-on-one accounted for approximately 8% of total revenue, compared to 7% in the second quarter of fiscal year 2019.

Rong Luo, CFO

Let me update you on our capacity expansion. As always, we pursue well-paced offline capacity growth. At the same time, we invest in new technology and online business to further improve our overall operational efficiency and closely follow all standards and regulations. We added a net 30 learning centers, of which 24 were Peiyou small class learning centers, four First Leap centers, and two one-on-one centers. During the quarter, we added 300 Peiyou small class classrooms. Meanwhile, we continue to enter new cities according to our strategic and operational planning. In the second quarter, we entered into 12 new locations with DOT small class learning centers in each. Our geographic coverage currently amounts to 69 cities across China. By the end of August, we have 758 learning centers in these 69 cities, of which 538 were Peiyou small class, 17 were Mobby small class, 86 were First Leap small class, 114 were Zhikang one-on-one, and 3 were Xueersi International. As for the third quarter, we have rented approximately 11 Peiyou small class learning centers and 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.

Linda Huo, Vice President of Finance

Moving now to our online business. Second quarter revenue from xueersi.com grew by 88% in U.S. dollar terms year-over-year and 94% in RMB terms, while normal priced long-term courses enrollments grew by 134% year-over-year to about 1.4 million. Online contributed 16% of total revenues and 40% of total normal priced long-term enrollments this quarter compared to 12% of total revenue and 26% of total normal priced long-term course enrollments in the same year-ago period. The rapid growth in online business was supported by dedicated sales and marketing efforts, retention from previous quarters, as well as the growing demand for online education. With that, I will now turn the call over to Echo Yan for the update and second fiscal quarter financial results. Echo, please.

Echo Yan, IR Director

Thanks, Linda. Let me now go through some key financial points for the second quarter of fiscal year 2020. The breakdown of ASP for the various businesses is as follows: Normal priced long-term Xueersi Peiyou Small Class ASP decreased by 3% in RMB and 6% in U.S. dollars year-over-year. Peiyou offline normal priced long-term courses ASP increased by a low single-digit percentage in RMB terms year-over-year. Normal priced long-term Zhikang one-on-one courses ASP increased by 10% in RMB and increased by 5% in U.S. dollar terms year-over-year. Normal priced long-term online courses ASP decreased by 10% in RMB and 13% in U.S. dollar terms year-over-year, mainly due to the mix change of a larger proportion of high school enrollments. High school long-term online courses ASP is relatively lower than overall average long-term courses ASP. Gross profit increased by 39.9% to US$517.8 million from US$370.2 million in the same year-ago period. Gross margin for the second quarter improved to 55.3%, as compared to 52.9% for the same period last year. Selling and marketing expenses increased by 73.5% to US$263.3 million from US$151.7 million in the second quarter of fiscal year 2019. Non-GAAP selling and marketing expenses, which excluded share-based compensation expenses, increased by 73.4% to US$258.9 million from US$149.3 million in the same year-ago period. The increase of selling and marketing expenses in the second quarter of fiscal year 2020 was primarily a result of more marketing promotion activity to expand our customer base and enhance our brand, as well as a rise in compensation to sales and marketing staff to support a greater number of programs and services compared to the same period last year. Operating income decreased by 13.5% year-over-year to US$69.9 million. Non-GAAP operating income decreased by 0.2% to US$98.8 million. Other expenses were US$55.6 million for the second quarter of fiscal year 2020, mainly related to loss from fair value change of an equity security with readily determinable fair value. Impairment loss on long-term investments was US$54.2 million for the second quarter of fiscal year 2020, compared to nil for the same period in the prior year. The impairment loss on long-term investments was mainly due to temporary declines in the value of long-term investments in several USPs. Income tax benefit was US$8.1 million in the second quarter of fiscal year 2020, compared to US$15.5 million of income tax expenses in the second quarter of fiscal year 2019. Net loss attributable to TAL was US$14.4 million in the second quarter of fiscal year 2020, compared to net income attributable to TAL of US$77 million in the first quarter of fiscal year 2019. Non-GAAP net income attributable to TAL, which excluded share-based compensation expenses, decreased by 84.8% to US$14.5 million from US$95.1 million in the same year-ago period. Basic and diluted net income per ADS were both US$0.02 in the second quarter of fiscal year 2020. Non-GAAP basic and diluted net income per ADS, which excluded share-based compensation expenses, were both US$0.02. From the balance sheet, as of August 31, 2019, the company had US$1,542.3 million of cash, cash equivalents, and short-term investments compared to US$1,515.6 million of cash, cash equivalents, and short-term investments as of February 28, 2019. As of August 31, 2019, our deferred revenue balance was US$497.6 million compared to US$859.8 million as of August 31, 2018, representing a year-over-year decrease of 42.8% mainly due to the change of tuition fees collection schedule to meet regulatory requirements. Now, I will hand the call back to Mr. Luo to briefly update you on our strategy execution and to provide the business outlook for the next quarter. Luo, please.

Rong Luo, CFO

Thank you, Echo. In this fiscal year, we are in the midst of further transitioning our business model to a multi-pro educational service model. This diversified model includes our offline learning center and geographic network, online business, and various other education programs and projects, such as our smart education solutions and open platform business. I would like to update you on each of these models. Our core Peiyou small class business remains healthy and stable. In Q2, we have entered into another 12 new cities, and including the one new city we entered in Q1, we have covered 13 new cities in the first half of fiscal year 2020. Till now, Peiyou offline has around 13,000 classrooms in a network of nearly 70 cities in China. Together with the fast growth of Peiyou online and our ongoing efforts to improve our operational efficiency, the profitability of Peiyou was slightly improved in Q2 as well. Looking ahead, we expect the gross momentum of Peiyou small class to continue as we further develop our offline network at a reasonable speed and scale the business. We keep seeking to operate and scale our Peiyou business by leveraging our offline and online advantages and resources, and as always, with long-term sustainability in mind. Our online business is a high growth early stage business, which also faces intense competition and ever-changing market dynamics. As one of the pioneers in this sector, we are very confident about the huge potential in education. We strongly recognize the social value and market opportunities of online education, hence our ongoing explorations and development in this area. As an education provider and service provider, we will never just go after high revenue growth speed only, but more importantly, the fast growth rate should be achieved in a healthy and sustainable way. We will spare no efforts to pursue a superior online business model that brings students and parents lasting satisfactory experiences and learning outcomes. We will continuously invest to innovate our products, technology, and operational efficiency with full attention to the necessary details. Now a brief update on Smart Education Solutions and open platform business. Through the end of Q2 fiscal 2020, mainly in the lower-tier cities and geographic areas, we have cooperated with a growing number of public schools with our Smart Education Solutions. We also work with less than 2000 small and medium-sized education institutions through different service levels in our open platform business. Both Smart Education Solutions and open platform business are still small scale and in an early development stage, but as we mentioned before, by leveraging our vast educational resources in these ways, we continue to seek diversified development opportunities and contribute to the overall education sector's innovation and optimizations. As we gradually reach more and more lower cities and lower-tier local areas, a larger portion of our young people will have more options to enjoy equal and improved educational resources with easy access and affordable costs. Turning finally to our business outlook, based on our current estimates, total net revenues for the third quarter of fiscal year 2020 are expected to be between US$862.6 million and US$843.8 million, representing an increase of 41% to 44% year-over-year. If we do not take into consideration the impact of potential change in exchange rate between RMB and U.S. dollar, the projected revenue growth rate is expected to be in the range of 45% to 48% for the third quarter of fiscal year 2020. That concludes my prepared remarks. Operator, we are now ready to take questions.

Operator, Operator

Thank you. Ladies and gentlemen, we'll now begin the question-and-answer session. We have our first question coming from the line of Alex Xie of Credit Suisse. Please go ahead. Mr. Alex Xie, your line is open now.

Alex Xie, Analyst

Sure, sure. So, hi management. Thank you for taking my questions and congratulations on a very strong set of results. So, I would like to ask about our strategy for the Peiyou business. We have already introduced, I think Peiyou online to more and more cities and now in this quarter, it seems that we are also accelerating a little bit for the number of small classrooms. So what are our expectations for the full year or future of capacity expansion and what are our strategies to better integrate online and offline Peiyou business? Thank you.

Rong Luo, CFO

Thanks, Alex. Yes, that's a very good question. I think right before we answer these questions, we need to go back to see what happened in the past two years. And especially last year, through our earnings call, we highlighted the rest of the policies and history. I think which definitely has impacted our operations in the past maybe six quarters. With the new policies, a lot of new policies impacted us, the regulation became much stricter than before. The pressure of being compliant is also getting bigger than before. On the other side, internally frankly speaking, if you can go back to see our past maybe five years growth, several years, we grew very fast, more than 50%, even 80% capacity growth. So I think the policy was a very good timing for us to review our business models and be more cautious. In the past few years, you probably can see that we made a lot of efforts to improve our product experiences, how to improve our whole system's operating efficiency, and how to improve our status and healthy status. We have different KPIs to make sure our operation can be more compliant than before, which takes us some time. As a result, you probably can see that we slowed down the offline revenue growth in the past maybe six quarters. At the same time, we also spent a lot of efforts to develop the Peiyou online strategy and the Peiyou online products. That is not only a newly added product but also a much experience change in the learning process and the learning experience for our students. So after several quarters, we made a little bit of progress in offline business studies, so not only looking at the curriculums but also the products, the students, and their kind of interactions. We probably can see that all of these efforts paid off and where it seems our KPIs are also improving. For example, your probably can sit down in our seats fulfillment rate, our retention rate, and our refund rate, all of that has single-digit improvement, which is a very good indicator showing we have managed our business, improved the products and made things work even better. So starting from almost last year, we decided to gradually accelerate the offline learning centers expansion pace. All of this, you probably can also see that in this quarter we added 12 new cities, all of them used the dual-teacher models. That is based on all of our kind of development and investment in the past on online technology and made us easier to scale to more cities in a much bigger way. So looking forward, I think in the coming few quarters, we continue to be very cautious with the improvement in our management efficiencies and all and our Peiyou online kind of new technologies, and all of that we will gradually accelerate the offline expansion pace and that is a very good way for us to contribute to the whole company's total revenue and profitability. For Peiyou online, some special numbers I need to draw your attention to, I think in Q2, we grew our Peiyou revenue by 192% and in Q1 it grew around 165%. The percentage of Peiyou online versus total Peiyou revenue is around 11% versus last year's only 5%. In the enrollment, there are 20% versus last year it was only 9%. So looking forward, we will continue to add more classrooms into our networks using our Peiyou online technology to empower more offline students to give them better experiences. You probably can see in Q3 and Q4 where we have more incentives added to the network, which is a very important change because we spent one or two years doing a lot of product innovation, and now we decided to accelerate a little bit. But it doesn't mean we can go back to the high growth stage as you have seen in the past five years. So, we will still be very cautious ensuring policy compliance is the first priority, and we will be very careful about our curriculums and we will also be very careful about how to use our online technologies to empower offline students. So that's the general strategy for us regarding the Peiyou business, both online and offline. Thank you, Alex.

Alex Xie, Analyst

Thank you. Very helpful.

Operator, Operator

Thank you. Our next question is from the line of Yuzhong Gao of CICC. Please go ahead.

Yuzhong Gao, Analyst

Hey, thanks for the opportunity. Congrats on the solid results. So our question focused on your online business. Clearly, we have seen intensified competition in the past summer. And then, there seems to be a deceleration this quarter. So could you maybe share your thoughts on the latest competitive landscape and our online revenue growth trajectory in both the near term and long term, as well as this margin outlook? Thank you.

Rong Luo, CFO

Okay. I think this online school business is growing on track. In Q1, the revenue growth was 122%, and enrollment growth was 121%. In Q2, we grew 94% in revenue and 154% in enrollments. I think now is the right timing for us to go back to see what happened in the past two quarters. In the very beginning, as I mentioned in the last earnings call, we are now fully prepared for this work. So we were a little bit behind other players in this market. The good thing is our team quickly adapted and we improved significantly, especially in operational strategies. We did a lot of adjustments and efforts. So we were trying to catch up and the final result has been positive, but we also want to give you additional color about that. From a strong perspective, how to reduce the cost to acquire one new customer is always a tough challenge for us. We are now a company that is well experienced in marketing and sales, and we have learned a lot last year, but this year has seen more players entering the battlefield, which means we have more lessons to learn. We are a little bit behind at the beginning but we will finally catch up. This is a very positive change, giving the team a lot of confidence that they could do even better than today. On the other side, we are also a little lucky because education is a very operationally intensive industry, and when Chinese students rush to online classes, that's not over; that's only the beginning. The whole teaching system and management system needs to ensure that students feel happy, feel they learned something, and feel satisfied with the learning outcomes, otherwise they will decide not to return. This requires much effort in operational strategies. We are fortunate because we have been running in this model for over 10 years as an education company. So we know how to improve. In the last few weeks, our Senior Management and our CEO also acted as teacher assistants in some certain classes. During this practice, we have also figured out a lot of challenges and many details that need progress in our system. Even if only a small number of studies are showing enrollment increases, there is a large potential for improvement. On the other side, as an education provider and service provider, we will never just go after high revenue growth; we also must achieve that growth in a healthy and sustainable way. Looking forward online, we still strongly believe that this model and new technologies can change the landscape of this market. Based on our experiences these past two quarters, especially in the summer, we have learned many lessons and need to balance the operational efficiency while continuing to leverage the offer to attract more students and gain more market share. However, we can expect that enrollment growth will continue to be quite healthy, while our revenue growth may be slightly lower than enrollment growth in the coming quarters, primarily due to a higher mix of senior high school students, who have a lower average spend per student than primary school students. All of these numbers only reflect one quarter’s figures. If we talk about online, it is necessary to look at this sector through a longer time frame, perhaps three years. Thus, we still believe strongly in this potential and will continue to improve our investments in research and development, technology, and product offerings to better serve our students. That's our key strategy moving forward.

Operator, Operator

Thank you. Our next question is from the line of Mark Li of Citi. Please go ahead.

Mark Li, Analyst

Hi management. Congratulations on the very strong results. I want to ask for our next quarter, I think the revenue guidance is around 5% ahead of the consensus expectation. So can we know what is the bigger factor to drive it, online or offline? Also, I would appreciate any color on the selling and marketing expenditure for future quarters? Thank you.

Rong Luo, CFO

Thank you, Mark. In the first place, I actually have no idea why the consensus expects growth for online or offline revenue separately. From our company's perspective, we only give revenue guidance at a group level. If we compare quarter-over-quarter in Q3 compared to Q2, I think Q2 will grow around 38%, while Q3 guidance is 45% to 48%. Most of the differences come from the Peiyou small class business. We see their growth rate in Q3 is higher than Q2. We are also seeing Peiyou online growing quickly. In the first one or two quarters, their growth reached close to 200% revenue growth, and we are forecasting this robust growth to continue in the upcoming quarters. Xueersi online school is also growing on track as we expected. But considering the high growth in Q1 and Q2, we do not foresee significant differences quarter-over-quarter. The most important contributor to revenue is Peiyou. Regarding the sales and marketing expenses, you probably noticed we are running our online campaigns in summer, and in Q3, we plan to run online promotions for the fall as well. Compared to last year, we will run fewer campaigns this quarter than in the previous year. Therefore, T3's marketing should be higher than the same quarter last year. That will cause some pressure on margins in Q3, but if you consider everything from a yearly perspective, this year, the online business may run at a loss but should be slightly lesser than last year's. Regardless, we do not foresee a significant loss. Given we still have one quarter to go—especially Q4—based on what we see now, we do not anticipate any surprises that require updates. Running our online business is challenging, and aiming for very high targets is no easy task. Our priority is to ensure growth for both online and offline is healthy and sustainable. Thank you, Mark.

Operator, Operator

Thank you. Our next question is from the line of Sheng Zhong of Morgan Stanley. Please go ahead.

Sheng Zhong, Analyst

Thank you for taking my question. As you mentioned a lot about regulation at the beginning of this call, could you give us some more updates on the regulation now, and whether it will impact your offline and online both going forward? And secondly, I want to follow up on the online business, can you give us some breakdown on the online students from Tier 1, Tier 2 cities and lower-tier cities? Also, what is your strategy to move to these lower-tier cities? Thank you.

Rong Luo, CFO

Okay, Sheng Zhong. I think for the regulations, the offline regulations have been in place for more than a year now. Frankly speaking, our company has experienced a tough time due to these new policies. I can't say today that everything is perfect, but compared to one or two years ago, we are much better than before. As for the online regulations, I will leave it to Linda to give you more information about that because the government just launched a new policy two weeks ago.

Linda Huo, Vice President of Finance

Yes. On September 30, together with two related departments, the China Ministry of Education issued a document regarding important general guidance for the hastily developed online education industry in China. The document continued to lay out and provide the policy level of support for China online education's next steps and long-term development. As one of the leading online education pioneers, we are very happy to see and even welcome these online education regulations as always. We will do our best to support and work with the industry and the government to keep improving the online education products, technologies, and services. We believe that with government support, technology development, and industry efforts, online education will benefit more and more students, especially the kids based in lower-tier geographic areas. Finally, I’d like to emphasize again that we welcome and fully support all these regulations and policies, which help improve the level of the centers and services of the industry and further strengthen the overall industry environment.

Rong Luo, CFO

Yes, and you asked the second question about our strategy for the lower-tier market for the online offerings. I think that is one of the best questions. I must say that by the end of today, I think the enrollment coming from lower-tier cities and the enrollments from areas without Xueersi networks are still below 20%. Peiyou's leading online offerings are more popular in Tier 1 and Tier 2 cities because that is where we have a strong presence, brand recognition, and everything else, making it easier for students and parents to access our offerings. So, initially, we have focused a lot on those areas. If we compare profitability, most profits also come from top cities based on our experience in the Peiyou offline business network. Moving forward, definitely, we need to find effective ways to penetrate into Tier 3, Tier 4, and even lower-tier cities. I can’t say I have found the perfect approach yet. Over the past few months, some of our investors have provided very helpful suggestions, and we are piloting some of these suggestions in selected cities. Based on our small pilot successes, we’ve found progress in some areas and not in others. It has become a crucial topic for us—how we penetrate into lower-tier cities in the coming two years. We can’t rely on the same online marketing approach to penetrate into those markets, so we will need to find more creative and innovative approaches. I don’t have perfect answers right now, but we are still conducting numerous pilots. What we can say is that in Tier 1 and Tier 2, where we have a presence, we are making good progress and we will continue to enhance our competitive advantages. As for the lower-tier areas, I don’t want to rush to conclusions because rushing can lead to mistakes. We will continue to experiment and, even among our senior management, we are spending time exploring the best ways to approach these areas. We are receptive to ideas from our investors and others in the industry. We will figure out a method to balance the cost of new customer acquisition and lifetime value. We will keep you posted on our progress.

Alex Liu, Analyst

Hi, thank you. Thanks a lot, Luo and Echo, for giving us this opportunity. Just on a really high level, we noticed a lot of new players coming into the market for online business. Whether this means just want to hear your thoughts on this, does this lower the entry barriers in the tutoring business, now that it’s purely an online model? If this is the case, should we think about going forward that the company in general will be conducting user acquisition every single year from now on? Thank you.

Rong Luo, CFO

Okay, thank you for the question. First, let's compare the numbers. For offline education companies in China, there are more than half a million, while the online players in this market are fewer than 100. So 0.5 million versus 100 means that the competition and entry barriers are quite different than before. If we consider that it is comparatively easy to replicate the online model right now with live broadcasting and recorded content, we must acknowledge that the model itself does have low entry barriers. However, simply moving offline classrooms to online is not all there is to it; we see there's a large transformation that affects the entire learning process. For instance, how students conduct pre-studies, how they ask questions, how they complete homework, and how data statistics can aid in finding effective study routines. The online challenge today is that if our online offerings are perceived as adequate, there is no guarantee that any profitability will follow if we don't innovate. Education remains an operation-intensive business. When Chinese students rush online for education, it’s just the beginning—there's still a lot of improvement needed. The management and organization of the teaching system must ensure student satisfaction in order to retain them. Our long-standing experience gives us a competitive edge in this regard. However, we must continue to innovate further and improve our offerings to keep up. I do think that competition is only part of the landscape; there is still vast potential in the market. The penetration rates in primary and middle schools suggest that. Today, we don’t view massive competition as the real challenge; we see our internal progress and how we build upon our capabilities to provide better education. We believe that our competition will yield diverse experiences for students, ultimately benefiting them and raising standards. We are committed to continuously improving our product quality and operational efficiency.

Lucy Yu, Analyst

Thank you, Luo, thank you, Echo. I've got two questions. Firstly, could you please share with us about the conversion rate and the retention rate for the summer online promotional costs compared to a normal cost? That's the first question? And secondly, regarding third quarter guidance, Luo, you mentioned that Peiyou small class will accelerate. How much of that is attributable to class scheduling shifts? Because I recall last year’s third quarter, some teachers took one day off to take exams, so actual revenue in the third quarter was shifted. If we exclude that impact, will Peiyou small class still be accelerating?

Rong Luo, CFO

Yes, in the first place, thank you for your excellent memory! I think yes, we have one vacant advantage this year: compared to last year, we expect to see one variant impact of around 3% to 5% of the total revenue of this fiscal year due to teaching time lost. If we look at total revenue growth, you will see that in Q2, Peiyou revenue growth was around 23% to 25%. Hence, even with this impending 5% offset for Q3, growth in Peiyou remains significant. Regarding conversion and retention, I can tell you that the online conversion rates this year compared to last year are generally at similar levels. The retention rate for online has shown low single-digit improvement compared to last year. So that's the important information we can share with you.

Felix Liu, Analyst

Hi, Rong Luo, Linda, and Echo, congratulations on the very strong results. I just want to come back to the summer promotion. Our summer marketing investment increased significantly. So I just want to ask how do you think about the efficiency, say on a scale of 1 to 10, how do you rate your summer promotion campaign? And coming into the next quarter, if we compare on a quarter-on-quarter basis, how will the Q3 and Q4 marketing dollars or marketing budget be? Thank you.

Rong Luo, CFO

Thank you for your questions. I think we feel happy to see the team tailor challenges and navigate through them effectively. You'll probably know that in the year beginning, we had a staff turnover, so the team needed some time to adapt. During this time, some of our competitors worked hard and captured market share. So we feel positive that our team has adjusted well to the new challenges and improved, even though we haven't reached perfection yet. Also, I should add that we didn't see massive differences in our conversion rate compared to last year, and at times, our conversions have been lower than peers, particularly in the early summer. I have to emphasize that we invest in the front but need to be careful about supply chain efficiency to complement those investments. For the Q3 and Q4 marketing dollars, I cannot comment on total figures right now, but we are working on reviewing Q3 and studying Q4’s marketing budgets. The summer provided us with valuable lessons, and we're dedicated to refining our operational and marketing strategies. Thank you for your questions. Operator, thank you for handling the Q&A. Ladies and gentlemen, this concludes our Q&A session and our conference call for today. Thank you for participating. You may all disconnect.