Earnings Call Transcript - TAL Q1 2020

Operator, Operator

Thank you for standing by, and welcome to the TAL Education Group First Fiscal Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation, followed by a question-and-answer session. I must advise you that this conference is being recorded today, Thursday, 25th of July, 2019. I would now like to hand the conference over to your first speaker today, Mr. 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 first 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 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 first quarter revenue performance was based on the healthy growth of small class business in the cities we currently cover and the scaling up of our online courses. Revenue growth in the first quarter was 27.6% year-over-year in U.S. dollar terms to US$ 702.8 million and 36.3% in RMB terms. Total Student Enrollments of normally priced long-term courses increased by 40.6% year-over-year, mostly driven by positive growth in online enrollments, as well as Xueersi Peiyou small class. Cash income from operations decreased by 23.6% to US$57.3 million in the first quarter. Non-GAAP income from operations decreased by 7.3% to US$ 83.4 million. The decrease was mainly due to the increase in sales and marketing and IT investment in our online business, as well as other 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 first quarter. Next, Echo Yan, our IR Director will review the first quarter financials. After that, I will update you on our new business strategy execution and discuss business outlook. Linda, please.

Linda Huo, VP of Finance

Thanks, Rong. Fiscal first quarter revenue was based on steady growth momentum in the various education services of our tutoring 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, Firstleap, Mobby and some other education programs and services. This accounted for 78% of total revenue compared to 83% in the fourth quarter last year. The revenue growth rate was 20% in U.S. dollar terms and 28% in RMB terms. Xueersi Peiyou Small Class, which remains our core business, represented 64% of total net revenue compared to 71% 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 15% of total revenue in the quarter compared to 9% in the same period last year. As we announced on the previous earnings call, from this quarter onwards, we only disclose the enrollment and ASP performance of normally priced long-term courses for our business. Net revenue from Xueersi Peiyou small class was up by 14% in U.S. dollar terms and 22% in RMB terms, while normally priced long-term course enrollments increased by 21% year-over-year. This growth rate reflects the stable growth in both Xueersi Peiyou offline and online class. Peiyou offline small class revenue increased by 10% in U.S. dollar terms and 17% in RMB terms, where offline normally priced long-term course enrollments increased by 13% year-over-year. With Peiyou online, as you know, we offer online courses as a complementary service to Peiyou offline in major cities of our network. Peiyou online offers regular and short-term courses and other promotional courses. In the fourth fiscal quarter, net revenue from Peiyou online was up by 148% in U.S. dollar terms and 165% in RMB terms, where normally priced long-term course enrollments increased by 184% year-over-year. Peiyou online accounted for approximately 7% of total Xueersi Peiyou small class revenue and 10% of total normally priced long-term Xueersi Peiyou small class enrollments. In the same year-ago period, the first fiscal quarter of fiscal year 2019, Peiyou online accounted for 3% of total Xueersi Peiyou small class business and 4% of total normally priced long-term Xueersi Peiyou small class enrollments. Growth in small class business remains widely distributed across the cities we currently cover. Xueersi Peiyou small class revenue from the top five cities, which are based in Shanghai, Guangzhou, Shenzhen, and Nanjing grew by 11% year-over-year in U.S. dollar terms and accounted for 58% of Xueersi Peiyou small class. Revenue generated from cities other than the top five grew by 19% in U.S. dollar terms. And the other cities accounted for the remaining 42% of the Xueersi Peiyou small class business. This growth momentum is supported by broad market demand across all cities. Incremental ramp-up of enrollments from our earlier classroom expansion is 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. Chinese and English courses are well on the way to becoming mainstream courses in our curriculum and continue to grow at a steady pace. By the end of May 2019, we have offered Xueersi Peiyou Chinese classes in 19 cities and English classes in 24 cities. Furthermore, Firstleap, Mobby, and a few other education programs’ revenue and enrollments all grew at a healthy pace in the first quarter of fiscal year 2020. We expect that these diversified courses will gradually contribute more to our overall business. Next, I'd like to briefly discuss our Zhikang one-on-one business. This business segment had a solid first quarter and achieved year-over-year revenue growth of 21% in U.S. dollar terms and 29% in RMB terms. Zhikang one-on-one accounted for 8% of total revenue, similar percentage as in the fourth quarter of fiscal year 2019. Let me update you on our capacity expansion. As always, we pursue well-paced offline capacity growth, and at the same time, invest in new technology and online business to continue to improve overall operational efficiency and closely follow all the standards and regulations. We added a net 49 learning centers, of which 35 were Peiyou small class learning centers, two mobile learning centers; one Firstleap Center and 11 were online centers. During the quarter, we added 746 Peiyou small class classrooms. Meanwhile, we continue to enter new cities at pace according to plan. In the fourth quarter, we entered into one new location, long form, with the DOT Tramal Class Learning Center, further expanding our geographic coverage. Overall, by the end of May, we had 725 learning centers in 57 cities across China, of which 514 were Peiyou classes, 17 were mobile small class, 82 were Firstleap small class, and 112 were Chongqing. Looking to now, we have rented approximately 8 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. Moving now to our online business, first quarter revenue from Xueersi.com grew by 108% in U.S. dollar terms year-over-year and 122% in RMB terms, while normally priced long-term course enrollments grew by 121% year-over-year to over 500,000. Online contributed 15% of total revenues and 31% of total normally priced long-term enrollments this quarter, compared to 9% of total revenue and 19% of total normally priced long-term class enrollments in the same year-ago period, respectively. The rapid growth in the online business was supported by dedicated sales and marketing efforts, retention of the previous quarters, as well as the rising demand for online education. With that, I will now turn the call over to Echo Yan, for the update on the first fiscal quarter financial results. Echo, please.

Echo Yan, IR Director

Thanks, Linda. Let me now go through some key financial points for the first quarter of fiscal year 2020. The breakdown of ASP for the various businesses is as follows. Normal price and long-term Xueersi Peiyou Small Class ASP increased by 0.8% in RMB and decreased by 5.6% in U.S. dollar terms year-over-year. Peiyou offline normal price long-term courses ASP increased by a low single-digit percentage in RMB terms year-over-year. Normal price long-term Zhikang one-on-one courses ASP increased by 3.7% in RMB terms and decreased by 3% in U.S. dollar terms year-over-year. Normal price long-term online courses ASP increased by 7.8% in RMB and increased by 0.9% in U.S. dollar terms year-over-year. Gross profit increased by 33.3% to US$385.9 million from US$289.6 million in the same year-ago period. Gross margin for the first quarter improved to 54.9%, as compared to 52.6% for the same period of last year. Operating income decreased by 23.6% year-over-year to US$57.3 million. Non-GAAP operating income decreased by 7.3% to US$83.4 million. Net loss attributable to TAL was US$7.3 million, compared to net income attributable to TAL of US$66.8 million in the first quarter of fiscal year 2019. Non-GAAP net income attributable to TAL, which excluded share-based compensation expenses decreased by 77% to US$18.8 million from US$81.8 million in the first quarter of fiscal year 2019. Basic and diluted net loss per ADS were both US$0.01 in the first quarter. Non-GAAP basic and diluted net income per ADS, which excluded share-based compensation expenses were both US$0.03. From the balance sheet, as of May 31, 2019, the company had US$1,912.2 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. The company's deferred revenue balance was US$968.4 million compared to US$1,328.5 million as of May 31, 2018, representing a year-over-year decrease of 27.1% mainly due to the change of tuition fees collection schedule to meet certain regulatory requirement. 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. We have started fiscal year 2020 with a strong commitment to further transition our business model to a multi-dimensional 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’d rather give you some brief updates on each business model as below. Our core offline learning still remains a very healthy and stable basis for our innovative efforts in all fields of education. Our strategy remains the same as before. We will keep seeking opportunities to improve our operational efficiency and further enrich our curriculum and competencies across subjects. At the same time, we continue to pursue well-paced capacity expansion with Small Class and dual-teacher models to meet demand in more geographical areas. Our online business is continuously facing intense competition and changing market dynamics. Peiyou has recently launched online tutoring, and we have strong confidence in education development. We will maintain or enlarge, if necessary, a certain level of investment to strengthen all of our online business advantages such as industry knowledge, education technology, content, brand awareness, and so on. All these efforts will not only allow us to penetrate a large adjustable market but also establish a robust education network across China. More importantly, our investment also enables us to optimize the cost structure and overcome the traditional limits to promote school education, resources, and ideas to more families with affordable pricing and easy online access. Peiyou’s Smart Education Solution is the product we have developed for cooperation with schools, which I mentioned to you earlier, on our Q2 earnings call. This set of solutions will help to optimize and promote innovation in traditional teaching, implement the national core competence structure, strategy requirements, and provide essential education resources through AI and other technologies. Through the end of Q1 fiscal 2020, we have cooperated with a few hundred public schools after two years of development. Peiyou's open platform aims to empower the entire education sector. It gives small and medium-sized education companies in China access to our core education resources. The open platform allows more students to share high-quality tutoring experiences through science and technology. By the end of Q1 fiscal 2020, our open platforms have already provided various levels of services to hundreds of education companies nationwide. As you all know, Peiyou's mission is to advance education through science and technology. Peiyou continuously strives to integrate technology with education, promote innovation, and redevelopment within the overall industry. We provide quality products and services in order to create value for customers and brand long-term returns for both our customers and shareholders. Peiyou’s mission is to become a reputable education company. These new initiatives, online, smart education solutions, and open platform business are still in their early stages of development. They currently have limited contributions to our business scaling and require a certain degree of investment in terms of technology, customer development, and market awareness. However, they are growing very fast and bringing us new insights and opportunities in the market. On an ongoing basis, and as always, we have placed customer satisfaction first. And this continues to be our key concern. Our diversified and core product portfolios and services need to create real value for our students and parents. We will follow the government's directions in education reforms, standardizations, and regulations. Where needed, we will adjust our business operations accordingly. All these policies are aimed at elevating the standards and improving the entire education industry, which is the long-term benefit of our customers and shareholders alike. Turning now to our business outlook. Based on our current estimates, total net revenue for the second quarter of fiscal year 2020 is expected to be between US$895.7 million to US$916.7 million, representing an increase of 28% to 31% on a year-over-year basis. This figure takes into account the impact of potential changes in exchange rates between RMB and U.S. dollars. The projected revenue growth is expected to be in the range of 32% to 35% for the second quarter of fiscal year 2020. This estimate reflects the company's current expectations, which are subject to change. That concludes my prepared remarks. Operator, we are now ready to take your questions.

Operator, Operator

Thank you. Your first question comes from the line of Sheng Hong from Morgan Stanley. Please ask your question.

Sheng Zhong, Analyst

Thank you for taking my question. So can you just give some more color on the first quarter's margin? And secondly, the company actually opened four learning centers offline in the first quarter, and also, you have a more promotion in the first quarter for online business. So could you please share with us about the company's strategy in this full year on online and offline? And how do you see the full year growth in the margin? Thank you.

Rong Luo, CFO

Thank you, Sheng Zhong. In the first baseline, we try to recap some big numbers for Q1, which got us excited. In Q1, our topline for the small class grew around 28%, while the Peiyou Life, which is Xueersi Online, grew by 165%. The Xueersi Online School grew by 122%. All of these numbers actually matched what we mentioned last quarter, which is also the direction of our company strategy this year. Let me try to walk through that one by one. The small class offline business, which has been healthy in the past 10 years, is what our strategy is focused on today. We wish this segment can maintain healthy growth in the coming, maybe 3 or 5 years. By 'healthy', I mean that we seek stable growth without excessive expectations. In Q1, the growth rate was around 8%. At the same time, we wish to improve their margins quarter-over-quarter, year-over-year. Last year, the small class offline did a very good job delivering a much higher margin than before, and this year, we see the trend continuing with around a 2.3% year-over-year improvement in our gross margin. In Q1, we added around 49 learning centers, with 35 of them being Peiyou small class learning centers. We’re pursuing the healthy and organic development of our offline business along with stable top-line growth and ongoing operational efficiency improvements. So that's our key strategy for our small class offline business. You can likely see a similar trend in the coming quarters. The second driver we need to mention is what we call Peiyou Life, which is a complementary offline model to our Peiyou offline students with more localized content. The new model Peiyou online has grown very quickly in the past few quarters. Because they are complementary to our offline offerings, customer acquisition costs are quite limited. The development of Peiyou online will continue benefiting our overall profit. Coming to this quarter, we have Peiyou online operating in more than 30 cities, which is a significant improvement from last year. We're confident that Peiyou online will continue to be a vital driver for boosting enrollment revenue and profits for our Peiyou business. Furthermore, we have mentioned online education being our major focus. Last year, in fiscal year 2019, the whole online school grew around 187% in RMB terms, and this year, we anticipate the Xueersi online school will continue to deliver triple-digit growth, as it did last year. I’d like to provide a little more insight into the Xueersi online studies. Starting from three or four years ago, there has been a lot of discussions in the industry regarding the feasibility of online education companies scaling and gaining market share in light of various challenges, such as parent and student acceptance. Today, it has become an industry consensus that online is the future of this entire sector. Operating offline models alone makes one vulnerable to around 0.5 million competitors across various provinces. However, when we shift this competition to the online stage, the number of competitors significantly decreases. We recognize online education as vital for scaling up and providing affordable solutions to serve more students rapidly, whether they are in popular cities like Beijing and Shanghai or in less developed provinces. The previous summer promotions resulted in over a million students participating in our offerings. One of the major lessons learned from last year was regarding the supply chain challenges. The heavy marketing promotion attracted many new customers, but we faced challenges in providing enough teacher and assistant support at that time. In response, we have enhanced our preparations starting from last year’s Q4 to ensure we have adequate capacity for the upcoming summer term. This involves reinforcing our resources for pricing, hiring, and training to ensure that we're well-prepared for the future. We're following our online strategy closely, and we will keep measuring conversion rates and success metrics as the summer season progresses. In general, we believe the company is in a stronger position now with less risk than the previous year. Each segment of our offline, Peiyou Life, and Peiyou Online has demonstrated promising growth while being managed in a stable environment. The key in this quarter is whether our summer promotions conversion rates can maintain or improve further. Thank you for your interest in our performance.

Sheng Zhong, Analyst

Thank you very much.

Rong Luo, CFO

When we think about our guidance for full-year margin growth, it's important to note that we prioritize long-term value for our students over short-term quarterly results. Our full-year guidance remains unchanged, targeting approximately 30% to 40% revenue growth. We expect Q1 growth to be around 36%, with our current guidance for Q2 at 35%. We also anticipate positive results in Q3 and Q4, particularly as we gain clearer insights into Xueersi online school's transition from promotion classes to regular-priced classes. In terms of margins for Q2, please keep in mind that marketing investments will increase during the summer promotion, which may affect margins. However, I want to reiterate that we have no plans to alter our full-year guidance. The main factor influencing this year's performance will be the conversion and retention rates from our summer promotion.

Sheng Zhong, Analyst

Thank you very much. And also very glad to know that all the strategy and implementation are well on track. So, I just want to double-check with you about the triple-digit growth of online business, is that about revenue?

Rong Luo, CFO

Yes. Both revenue and enrollment.

Operator, Operator

Your next question comes from CICC. Please ask your question.

Unidentified Analyst, Analyst

Hey, Rong, Linda, Echo. Thanks for the opportunity. So, it's on the online business. So, we see to notice a shift in strategy for your online promotion. Before May, we seemed to be rather conservative in our online promotions, but after June, we seemed to have stepped up the investment. So far, we have noticed the conversion rate may not reach our expectations. So, if we go back to six months earlier and decide, again, what kind of investment strategy should we choose? Also, could we have some comments on the trend for customer acquisition costs and our retention conversion rate? Are they still balancing each other so that even if the short-term costs may rise a little bit, we are still confident in our long-term business profitability? Thanks.

Rong Luo, CFO

Thank you. I think I'll address your question about the online strategy. Last year, we made significant progress online, connecting over a million students during Q2. However, we also faced challenges in product management. So, by the end of the previous year, we decided to refine the management of our online strategy, ensuring it is product-driven rather than solely marketing-driven. If it were to go back six months, we would probably recognize the need for earlier promotions. Despite being behind competitors at the time, we quickly made adjustments, and I'm happy to report that our team's execution capabilities are improving. As for customer acquisition costs, they fluctuate due to competitive pressures but we are still confident about our long-term profitability based on the lifetime value of our users. The conversion rates have been improving turn over turn as well. As we proceed through the summer promotions, I will be able to disclose more information in the next earnings call.

Operator, Operator

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

Unidentified Company Representative, Company Representative

Thank you for participating. You may all disconnect.

Operator, Operator

Hello, hello, presenters?

Linda Huo, VP of Finance

We shouldn't finish online. We should continue our call please.

Operator, Operator

I see. Sure ma’am. So our next question comes from the line of Alex Sierre from Credit Suisse. Your line is open.

Alex Sierre, Analyst

Hi, management. Thank you for taking my questions. I would like to ask about our strategy for the offline Peiyou business. So in this quarter, the normal price enrollments, I think, grew by 13%. This is kind of behind market expectations. So what is the reason for the significant slowdown in offline lower price enrollments? And are we still committed to our plan to accelerate our offline capacity expansion and also offline enrollment growth rates in FY 2020? Thank you.

Rong Luo, CFO

Yes. Thank you for the question. I think we need to answer this professionally. When some individuals inquired about how many costs were added or how many seats were added for capacity expansion in the full year, they are often asking questions rooted in old traditional growth models which focus on strictly classroom numbers. However, we have transformed our model from purely traditional classroom-based teaching to an offline and online integrated model. The significant growth in offline learning centers should be viewed under the understanding that we have expanded into more cities. While last year we added around 13% in total classroom numbers, we entered more than 12 cities, which is three to four times more than we did with traditional models three to four years ago. This year, we intend to continue entering more than 10 new cities. We are focusing less on merely increasing classroom counts in a short timeframe. While our Peiyou brand will maintain stable growth in offline revenue, the team needs to find synergy between offline and online models while ensuring high-quality product delivery. In Q1, we added 35 learning centers, and we will continue with similar approaches over the coming quarters. It's crucial that we measure not just classroom growth, but also the synergistic relationship between Peiyou offline and offline offerings.

Alex Sierre, Analyst

Sure, sure. Thank you. May I have a follow-up? So how do we view the difference between Peiyou online and xueersi.com? Are we seeing a sort of competition between the two?

Rong Luo, CFO

Yes, that's a very good question. I think Peiyou online operates entirely independently from Peiyou offline business. While they share some content elements and technology, they are primarily independent in their operations. Peiyou online primarily targets a broader market, aiming for more students across the country, while Peiyou Life focuses on providing tailored content and solutions. So while Peiyou online focuses on breadth, Peiyou Life delves deeper into student needs for localized content. Based on our current data, we do not observe any significant overlap between the two; both segments are experiencing double-digit growth and are complementary rather than competitive.

Operator, Operator

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

Mark Li, Analyst

Hi management. May I ask a question regarding this quarter's enrollment? I understand we exclude the short-term enrollment, but do we have any insight on what the growth would look like if we added back the short-term and promotional enrollment to make it comparable to previous quarters?

Rong Luo, CFO

Yes. First, let me explain why we are reporting only normal price enrollments this quarter. Last quarter, around 30% of total Peiyou enrollments came from promotions, and for Peiyou Online, around 65% of enrollments were promotional. In Q4, approximately 42% of Xueersi enrollments were from similar promotions. Continuing to include short-term and promotional enrollments could misrepresent our performance. Therefore, we chose to be conservative and focus on the normal price enrollment growth rate. For the growth rate perspective, in Q1 and particularly Q2, we ran a number of promotions. This means that if we include those promotional enrollments, the growth rate would appear much higher; however, we believe that it is more meaningful to track normal price enrollment growth. Thank you, Mark.

Mark Li, Analyst

Thanks. May I have a quick follow-up regarding the revenue guidance? I note we have two quarters of soft revenue guidance. Could you provide more color on this? Could we potentially see online promotions from Peiyou starting to impact next quarter's revenue?

Rong Luo, CFO

Yes, that's a good question. Looking at the full-year guidance, we maintain our growth target between 30% to 40%. Last year, we achieved around 50%, but given the increasing base, we project 30% to 40% as a solid figure. As for Q2 guidance, we’re running various promotions now, each targeting different segments. While our promotions are significant in enrollment numbers, the immediate revenue impact tends to be limited. The real growth effect will be observed when students transition from promo classes to regular classes. Therefore, our revenue for Q2 is expected to align with Q1 metrics. By monitoring summer terms, particularly through retention rates after promotions, we will gain clearer insights for the remainder of the year.

Mark Li, Analyst

Thank you.

Operator, Operator

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

Lucy Yu, Analyst

I got two questions here. Firstly, it's also related to our offline enrollment. Because we have already explained this at the business level over the past four quarters in terms of capacity, we can see that normal price enrollment growth is also moderating at the business level. So, similar to our capacity growth, should we expect that normal price enrollment growth will closely align with our capacity growth going forward? That's the first question. The second one is regarding the margin for the first quarter, which has contracted by around 450 basis points. Can we have more color on online versus offline margin trends? Yes, that does conclude my question. Thank you.

Rong Luo, CFO

Thanks so much for your questions. I think for the offline capacity and enrollments, if we were using traditional growth models from three or four years ago, purely adding more classrooms and teachers, then capacity growth would correlate closely with revenue growth. However, these days, since we're aiming for more balanced growth between offline and online, we recognize the rapid growth of online and its variables influencing revenue. Consequently, the dynamic between capacity growth and revenue growth may not be as straightforward as before. As for the online and offline margin trends, offline margins are set to improve, and the operational margins are expected to maintain an upward trajectory. While the online sectors are gradually scaling, they currently do not indicate a significant reduction in profits. Given the ongoing success in online environments, there is an expected change in our revenue mix which might exert upward pressures on margins. We’re continuously seeking to strike a balance between our offline drivers and the investment in online to ensure stable profitability.

Operator, Operator

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