Earnings Call Transcript - TAL Q3 2023

Operator, Operator

Ladies and gentlemen, good day, and thank you for standing by. Welcome to TAL Education Group Third Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a Q&A session. Please be informed, today's conference is being recorded. I would now like to hand the conference over to Mr. Jackson Ding, Investor Relations Director. Thank you. Please, go ahead, sir.

Jackson Ding, Investor Relations Director

Thank you, operator. Thank you all for joining us today with TAL Education Group's third quarter fiscal year 2023 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. Alex Peng, President and Chief Financial Officer; and myself, Investor Relations Director. Following the prepared remarks, Mr. Peng and I will be available to answer your questions. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements 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 and this call include 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 to turn the call over to Mr. Alex Peng. Alex, please go ahead.

Alex Peng, President and CFO

Thanks, Jackson. I appreciate you all for joining us on today's call, especially as we are approaching the Chinese New Year holidays. I'd like to take this opportunity to wish you and your families a very happy Chinese New Year. One of the traditions of Chinese New Year is to recap the past and plan for the future. On this call, I'd also like to share with you our performance in the last quarter, as well as our expectations for the quarters to come. During this fiscal Q3, we continued to enhance our offerings while developing our go-to-market capabilities. We recorded US$232.7 million and RMB 1,658.5 million in net revenues for the quarter. The net revenues decreased by 16% and 21% in RMB and USD terms compared to Q2, respectively. Historically, our fiscal Q2 tends to benefit from seasonality effects in terms of revenue. So if we look at a quarter that's more comparable to Q3, for example, Q1, the net revenues increased 4% in US dollar terms and 14% in RMB terms. We expect to continue our development in the next quarter. In terms of profitability for the fiscal quarter ended on November 30, 2022, we recorded US$4.5 million and US$23.2 million in non-GAAP operating loss and non-GAAP net loss attributable to TAL respectively. You may have noticed that our operating income decreased by $47.6 million quarter-over-quarter. The decrease in operating income was primarily driven by the reduction in revenue due to seasonality, as well as our investment into new initiatives. So with that overview, I'd like to give Jackson the floor to share more detail on the operational developments and the financial performance of our core business lines. Afterwards, I will update our business strategy for you and then we'll open the call for questions. Jackson, please go ahead.

Jackson Ding, Investor Relations Director

Thank you, Alex. I'm pleased to share more details on the progress we made in our three main business lines this quarter. Before we start, please note that the financial data is based on our unaudited results for the quarter. I'll start with our learning services and other business. Learning services and other continues to be our largest revenue stream and accounted for slightly more than two-thirds of our total revenues for the quarter. Within learning services, we continue to fine-tune our enrichment learning programs and as a result saw an increase in average retention rate for two consecutive quarters. We believe a healthy retention rate is key to the long-term sustainable growth of our enrichment learning programs. We'll continue to monitor our learner retention and optimize our offerings to drive healthy retention levels. In terms of learner enrollment, we recorded a quarter-over-quarter decrease in average learner enrollment from Q2 primarily due to seasonal fluctuation. However, if we compare the enrollment of Q3 to that of Q1, we recorded growth in learning enrollment between these two periods. Further, some recently rolled out enrichment programs such as rhetoric and international chess demonstrated initial customer reception in this past quarter. Like I mentioned in our prior conversations, our enrichment programs are designed to facilitate learners' all-around development. This is a concept that requires some time for the market to digest and accept. Aside from operating metrics, we're also closely monitoring customer feedback on our enrichment programs. We're encouraged about our customers' feedback and appreciate their trust and support. We'll continue to fine-tune our enrichment offerings to deliver value to our customers. In this past quarter, we also witnessed recovery in our offline learning centers. In fact, revenue generated from offline enrichment programs increased in Q3 when compared with Q2. Despite that typically and historically Q3 has been a down quarter from Q2. We increased our offline learning centers by single digits in this past quarter. This is the second consecutive quarter where the number of our learning centers grew slightly. In this increasing age where OMO learning experiences continue to proliferate, we see online and offline presence both as important components in our learning services business. Our online presence reaches customers despite their geographic locations, while our offline presence provides us the opportunity to interact with our customers face-to-face. We continue to optimize our learning center network and will gradually and cautiously increase the number of our learning centers in the next few quarters to come. While our domestic learning services business continues on its development path, Think Academy, our overseas learning services business maintains its momentum with online operations covering a global market and offsite operations in countries such as the US and Singapore. Think Academy again booked a year-over-year triple-digit growth in this quarter. We see significant market potential for Think Academy and will continue to drive the growth of this business. Moving on to our content solutions business, which accounted for roughly 20% of total net revenue compared to slightly more than 15% a quarter ago. Revenue from content solutions grew quarter-over-quarter driven by growth from multiple product lines. I talked about smart books in the last couple of quarters, the products where we embed videos into print books to supplement the learning experience of all users. In this quarter, we're glad to see that a significant portion of the users who purchased and activated the online features of the smart books are learners who historically never enrolled in our learning program to the best of our knowledge. We see this as a positive sign that our content products are reaching new customers and increasing our total addressable market. Within content solutions, we also made progress on the exploration of smart learning devices. We tend to think of smart learning devices as comprehensive content solutions that combine our exclusive learning content and personalized learning experiences supported by AI technology. We'll continue to enrich our products based on our insights into users' learning habits and their learning demands. In addition to product development, we also continue to build our go-to-market capabilities for our content solutions business. In an industry where offline distribution channels typically constitute a large portion of the total volume, the majority of our content solutions are sold through online channels, such as e-commerce and live streaming. We're embracing these new distribution channels and we'll continue to build our capabilities within these channels. Finally, let's look at our learning technology solutions business. Total revenue for our learning technology solutions business accounted for more than 10% of our total net revenues in Q3. In this past quarter, we updated our products and further developed our selling and marketing efforts. For learning technology solutions, we sell to both private and public sectors. I talked about the private sector before and will shed more light on our effort in the public sector today. In this past quarter, we released a new sub-brand called Meixiao Smart Education, which targets the market for schools. Our solution for schools primarily includes smart homework, smart lesson preparation, integrated teaching platform, and small after-school care. This business is still in its early stage and we'll provide more details as the business matures. After updating the above business progress now let me take you through the key financial results for the quarter. Our net revenues totaled US$272.7 million, representing a 77.2% decrease from US$1.02 billion in the same period last year. The decline in revenue was a result of the succession of our K through ninth Academic Services in the mainland of China. Cost of revenue decreased by 80.2% to US$103 million from US$519.5 million in the third quarter of fiscal year 2022. Non-GAAP cost of revenues, which excluded share-based compensation decreased by 80.9% to US$99.4 million, from US$519.2 million in the third quarter of fiscal year 2022. Gross profit declined by 74.1% to US$129.7 million, from US$501.4 million in the same period last year, while our gross margin increased from 49.1% to 55.8%. Selling and marketing expenses decreased by 74.3% to $70.4 million from $273.6 million in the same period last year. Non-GAAP selling and marketing expenses which excluded share-based compensations decreased by 75.3% year-over-year to $63.8 million from $258.6 million in the same period last year. The year-over-year decrease was primarily the result of a reduced number of selling and marketing activities. General and administrative expenses decreased by 69.0% from $93.0 million to $300 million in the third quarter of last fiscal year. Non-GAAP general and administrative expenses which excluded share-based compensations decreased year-over-year by 72.7% to $74.8 million from $274.4 million in the same period last year. Loss from operations was $32.9 million compared to loss from operations of $108.4 million in the third quarter of fiscal year 2022. Non-GAAP loss from operations which excluded share-based compensations was $4.5 million compared to non-GAAP loss from operations of $67.6 million in the same period last year. Net loss attributable to TAL was $51.6 million in this quarter compared with net loss attributable to TAL of $99.4 million in the same period last year. Non-GAAP net loss attributable to TAL, which excluded share-based compensations, was $23.2 million compared with non-GAAP net loss attributable to TAL of $58.6 million in the same period of last year. Turning to the balance sheet. As of November 30th, 2022, the company had $1.86 billion in cash and cash equivalents, $1.18 billion of short-term investments, and $447.4 million in current and non-current restricted cash. The company's deferred revenue balance was $270.8 million by the end of the third quarter. Now, I'll hand the call back to Mr. Alex Peng to briefly update you on our business strategy outlook. Alex, please go ahead.

Alex Peng, President and CFO

Thanks, Jackson. I think Jackson has just given everybody a pretty detailed picture and lots of numbers. So, what I'll try is to maybe take a step back and paint the big picture. As we continue to transform our business into a smart learning solutions provider, we remain committed to executing our company's long-term growth strategies with each of our four business blocks. Although the revenue of this quarter was affected by exchange rate fluctuation and seasonality, our new business has maintained the momentum of continuous development. We expect our main businesses to continue to develop in the next few quarters. The first, our learning services and other business. We will continue to strengthen the quality of the products and services, while also gradually roll out more programs and increase our physical footprint. We are believers in enrichment learning and all-around development. As the market for enrichment learning evolves, we plan to leverage our operational know-how to further serve our customers. For our content solutions business, we're encouraged by the progress, but we also understand that we have a long way to go, before we become competitive in this relatively new market. We intend to increase our total addressable market through serving our customers with quality content in various form factors. In the next few quarters, we'll roll out new product SKUs, while investing in our go-to-market capabilities, especially in our OMO channels. Turning to learning technology solutions. We are committed to enhancing our services for clients in both private and public sectors, with quality content, innovative devices, and advanced technologies. Our goal is to work with our clients to deliver a better learning experience to end customers. About the outlook for Q4, we expect our development to continue in the fourth quarter. We do not expect to break even in the next quarter as we continue to invest in certain new initiatives. We believe the transformation into a smart learning solutions provider is a long journey and are currently focused on creating value for our customers through our offerings. And as I come to the end of my remarks, I'd like to just say, we're just a few days away from Chinese New Year. And there's another name for Chinese New Year, which is Spring Festival. Spring is the season of renewal and growth. I think on the previous call with you all, I reflected on the fact that we changed our mission statements, and how critical it is for us to adopt a growth mindset going forward. So as we head into the spring season, it is with that growth mindset that we'll embrace the future. So that concludes my prepared remarks. Operator, we're now ready to open the call for questions.

Operator, Operator

Thank you. Our first question comes from Lucy Yu at Bank of America. Please go ahead. Your line is open.

Lucy Yu, Analyst

Thank you. Thank you, Alex. Thank you, Jackson for sharing the results details. I have a question on margins. So, can you shed a bit more color on the margins for this quarter, and also expectations of the main business operating margins going forward? Thank you.

Jackson Ding, Investor Relations Director

Lucy, thanks for the question. This is Jackson. I'll take this one. Before I spend more about the numbers, I would just say, as we transform our business and how we think about profitability, we probably focus more on creating more value for customers and having a structurally healthy business model as opposed to focusing on near-term operating profitability as well. But let me break this down for you a bit. When I look at the three main business lines, for learning services and other, in this past quarter, we had a positive operating margin. For learning technology solutions, we are also operating profit and had double-digit operating margin. For content solutions, if we look at the more mature SKUs, they're profitable on a contribution margin basis. But some of the newer SKUs are still in the investment phase. You also asked about margin outlook in the future. I would say, as we look in the long run, when we think about learning services and other, we tend to think operating margin will have some fairly small room for margin improvement as the business goes up, and the improvement will be quite gradual. And for content solutions, we'll carefully manage our operating profitability, as we balance the mature and new SKUs. Lucy, I hope that answers your question.

Lucy Yu, Analyst

Thank you so much, Jackson.

Operator, Operator

Thank you. We will take our next question. Our next question comes from the line of Liping Zhao from CICC. Please go ahead. Your line is open.

Liping Zhao, Analyst

Good evening, Alex and Jackson. Thanks for taking my question. Iterating and your introduction report, the content solutions business is still in the investment period. Can you share the main direction of investments? And could you also share your thoughts about how the company becomes an industry leader, sir? Thank you.

Alex Peng, President and CFO

Thank you, Liping. Let me clarify that question. In terms of our investment direction, we will likely focus on several areas. Firstly, our goal remains to develop world-class content, much of which will be created in-house. We also plan to enhance our partnerships to bring this content to market. This includes expanding topics for print and smart books and improving the digital features of that content, along with investing in core hardware factors. Secondly, we aim to enhance our channel capabilities. As we've discussed, a significant portion of our content products is sold online, and these channels are evolving quickly, enabling us to strengthen our competitive presence. We need to keep investing in these capabilities, and we’ll adopt an omnichannel approach to ensure our customers have a seamless experience across all touchpoints. Lastly, I want to highlight infrastructure, particularly regarding the supply chain. As we explore various form factors, we are diving deeper into different supply chain aspects, which are crucial for us to enhance our experience and capabilities while improving product quality and maintaining a competitive cost structure. So, in summary, our investments will focus on these three main areas. Regarding our strategy, I’ve mentioned in previous calls that we are committed to building world-class content, integrating more technology like AI into our products, and ensuring an integrated experience for our customers across all form factors. I hope that addresses your question.

Liping Zhao, Analyst

Yes. Understood.

Operator, Operator

Thank you. We will take our next question. Our next question comes from the line of Felix Liu from UBS. Please go ahead. Your line is open.

Felix Liu, Analyst

Good evening. Thank you, Alex. Thank you, Jackson for taking my question. My question is on the COVID outbreak that happened in China recently. How does that impact our business in the February quarter? And given offline activities have largely resumed in many cities in China now, how should we think about the online and offline strategy from here? And would you expect a reacceleration of our offline expansion? Thank you.

Jackson Ding, Investor Relations Director

Felix, thanks for the question. Regarding the first part of your question, the impact of the epidemic, I would say historically we carefully manage that impact through offering an online option to students who enrolled in our offline classes when the epidemic caused inconvenience. In looking forward, obviously, as the impact of COVID starts to diminish in China, we'll offer a balanced and hybrid online and offline learning experience to our learners. We do see both online and offline offerings as important components in the learning experience we provide to our learners and they each have their own merit. The second part of the question asked a bit about offline expansion plans and future outlook. I would just say with regard to our offline learning centers, for the last two consecutive quarters we increased the number of our learning centers by both single-digit increases in the last two quarters, and we currently have somewhere between 100 and 200 learning centers. In the next few quarters to come, we'll continue to slowly but gradually increase the number of our learning centers. Felix, I hope that answers your question.

Felix Liu, Analyst

Got it. Thank you very much.

Operator, Operator

Thank you. We will take our next question. Our next question comes from the line of DS Kim from JPMorgan. Please go ahead. Your line is open.

DS Kim, Analyst

Hi, Alex. Hi, Jackson. Happy New Year. I was actually going to ask about profitability but both of you have already provided great insight, so thanks for that. May I then follow up with quick housekeeping questions, perhaps three if I may ask. First one is, what was this $32 million other expenses this quarter in the below OP line? Just curious any details there? And can you remind us on the nature of the restricted cash on our balance sheet, which was quite sizable, I think at $450 million total including non-current? I remember this was somewhat related to some financial products, wealth management products and whatnot but just wanted some clarification or elaboration would be really appreciated. Thank you very much.

Jackson Ding, Investor Relations Director

Got it. Yes, this is Jackson. Thanks for the question. I understand your inquiry about the restricted cash. To clarify, the first part of your question was regarding the $32 million in other expenses.

DS Kim, Analyst

Yes, correct sir. Thank you.

Jackson Ding, Investor Relations Director

Got it. Yes. So that $32 million of other expense obviously is not related to any operating activities and that is a combination of multiple factors including: one, exchange rate fluctuations and two, some of the equities we hold and booked according to fair value. And the second part of your question with regard to restricted cash, again, it's a combination of multiple factors including: one, some of the payments we collect from learning programs are restricted; and two, some of the wealth management products depending on the nature of the underlying instruments are restricted as well.

DS Kim, Analyst

Thank you so much for the clarification. Yes. Thank you, sir, and congrats on the decent and strong restructuring and greater performance. Thank you again.

Alex Peng, President and CFO

Thanks, DS.

Operator, Operator

Thank you. I would now like to hand back to management for closing remarks.

Alex Peng, President and CFO

Great. Again, thank you everybody for joining us today. A Happy Chinese New Year and we'll see you next quarter. Bye-bye.

Operator, Operator

This concludes today's conference call. Thank you all for participating. You may now disconnect.