TCTM Kids IT Education Inc.
Q2 2018 Earnings Call Transcript

Published: 21 Aug 2018

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to Tarena International Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-and-answer-session. Today's conference is being recorded. If you have any objections, you may disconnect at any time. I would now like to turn the call over to your host for today's conference, Ms. Lei Song, Tarena's Reporting Director. Thank you. Please go ahead.

[Lei Song:]

Thank you, Operator. Hello, everyone, and welcome to Tarena's second quarter 2018 earnings conference call. The company's earnings results were released earlier today, and are available on our IR Web site, ir.tedu.cn, as well as our newswire services. Today, you will hear opening remarks from Tarena's Founder, Chairman and CEO, Mr. Shaoyun Han followed by our Chief Financial Officer, Dennis Yang, who will take you through the Company's operational and financial results for the second quarter 2018 and give guidance for the second quarter. After their prepared remarks, Mr. Han and Mr. Yang will be available to answer your questions. Before we continue, please note that the discussion today will contain certain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Tarena does not assume any obligation to update any forward-looking statements except as required under applicable law. Also, please note that some of the information to be discussed includes non-GAAP financial measures as defined in Regulation G. The U.S. GAAP financial measures and the information reconciling these non-GAAP financial measures to Tarena's financial results prepared in accordance with U.S. GAAP are included in Tarena's earnings release, which has been posted on the company's IR Web site at ir.tedu.cn. Finally, as a reminder, this conference is being recorded. In addition, a webcast of this conference call is available on Tarena's Investor Relations Web site. I will now turn the call over to Mr. Shaoyun Han, Tarena's Founder, Chairman and CEO. Mr. Han will speak in Mandarin and Mr. Yang will translate.

[Shaoyun Han:]

Thank you, Lei. And welcome everyone to our second quarter 2018 earnings conference call. First of all, I’m very pleased to report that our net revenues in the second quarter increased by 13.6% to reach RMB580 million, meeting our previously issued guidance. During this quarter, the growth rate of our student enrollment in adult education business has recovered. Meanwhile, we focus on resources optimization and cost control which led to improvement in many efficiency indicators. In addition, our key programming education business has once more achieved record growth in both student enrollment and tuition cash receipts. We enrolled 10,570 students during this quarter, achieving year-over-year increase of more than 5x. The total K12 cash receipts of this quarter was approximately RMB127 million, and the total cost [ph] of revenue of K12 business is about 12.2% of Tarena's consolidated total contract value. In adult education business, student enrollment growth is a [indiscernible] factor of contributing to our net revenue growth. The adult education market is steadily improving and gradually recovering. Enrollment in this quarter was 37,138, achieving a year-over-year growth of 21.6%. Enrollment through retail channel deliver 29,448 with year-over-year growth of 12%, while enrollment through university channel reached 7,690 was year-over-year growth of 81%.The main driver of the growth in university channel is through joint major partnership with the universities. As we mentioned in previous calls, this kind of enrollment will help us to establish cooperation in depth with universities to ensure long-term growth, to enhance enrolling efficiency -- enrollment efficiency and reduce student acquisition costs. However, with the 2 to 3 year education period, the revenue recognition period is also lessened accordingly. Certain tuition with signed contract has deferred to later year's due to the education service will be delivered in the later years. These result in a gap between the growth of student enrollment and the growth of net revenue. For example, during the first half of 2018, the student enrollment through university channel contributed 18% of total student enrollment and was 17% of total signed contract. While the net revenue contribution from -- the revenue from university students were down 8% only. Despite the temporary short-term impact on our NAV revenues with business model of the student enrollment through university channel, the long-term partnership with universities will bring us rapid growth in student enrollment, which will lay a solid foundation for the company's adult education business in the future. Enrollment from Tarena's adult student, Python course, Big Data course and Linux cloud computing course become more and more popular contributing a total of 6,130 student in this quarter, which was 16.5% of total student enrollment which also improved from last quarter. We expect artificial intelligence related courses will continue their rapid growth in the future. Since last year, we promoted the advanced course modules and -- have successfully introduced to the market. We are going to continue the effort in promoting the advanced course modules. The percentage of the student take in advanced modules increased to more than 20% this quarter which helped the company to accomplish a better service quality and to realize an increasing tuition revenue. Tarena persists the -- in the development of both IT courses and non-IT courses. There are quite a few non-IT courses in our course development stage. Diversifying with more non-IT courses to be launched, Tarena's overall course structure will be better prepared to cope with the periodic fluctuation in education business brought by the IT industry business cycle. In this way, Tarena is able to achieve steady growth in its adult education business with its competitive edge in the professional education area. During this quarter, the company paid more attention to distribution of resources efficiently building new learning centers, adding more class rooms [indiscernible]. At the same time, efforts were put into optimizing human resources structures to improve operational efficiency. The company have evaluated nonperforming centers one-by-one and closed or merged total of 15 centers. Since we take very positive view on IT professional education market in Tier 3 cities, we also aim to extend our presence to build -- and build out more seat capacity in Tier 3 cities. Tarena opened 14 new centers, entering 6 new cities this quarter. At the end of second quarter there were 198 adult learning centers covering 67 cities with 52,153 seat, which represented 9% year-over-year growth. By optimizing seat layout and usage, the seat utilization rate indicated an huge improvement from last quarter to 73.2%, narrowing the year-over-year gap when comparing the same quarter last year of 73.6%. Meanwhile, the company is adjusting its human resources structures step by step to aim to improve business operational efficiency while ensuring to support new business growth. During this quarter, we saw improvement in total selling and marketing expenses for students, which reduced from an average of three quarters, although the advertising spending per student is slightly higher than the last quarter. The improvement in seat utilization rate and per capita activity improved the effectiveness of center resource optimization strategy. We believe that the strategy will have positive impact in the future. Next, I would like to report the exciting progress in our key education business during this quarter. As I mentioned previously, the student enrollment of kid education business continued the rapid growth to be more than 500% year-over-year increase, reaching 10,517. The company will accelerate its investment in kid education business without 15 centers for kid education. By the end of this quarter kid education business reached 99 learning centers. There are also 21 shared learning sites with adult education business, which provides classroom for K12 education service. Our kid education business cover 39 cities by the end of this quarter. We believe that IT technology education will become more and more widely known in China, forming a phenomenal market with significant potential. Our core competitiveness to rapid expansion of K12 education business in short period are our strong IT course development ability, uniquely originated from our adult education business. Our dual-teacher teaching ability, our exceptional skills to recruit and train IT teaching faculties, as well as our operating management teams in 67 cities. Tarena will continue to invest in course development, targeting to build a complete kid programming course system covering kids of age from 4 to 18 years old, maintaining our leading position in kid programming education market. We noticed that recent change in government regulations related to kids education industry and believe that this will have positive impact on quality oriented courses including children programming education. With the increasing importance of information technology and artificial intelligence skills, programming courses become more and more important. Tarena will continue to invest in K12 area in 2018 and in next 2 to 3 years. In terms of new course, research and development, network expansion as well as talent recruitment. We plan to open a total of 70 to 80 K12 new centers in 2018 as well as adding another 20 to 30 centers by acquisition. Total number of learning centers reach around 140 by the end of this year. This initiative is required for more investment and may affect the margin level in short-term as we -- as the new learning centers are seeing a ramp up period before it could breakeven. However, given the broad market prospect and rapid business growth, K12 business will provide a strong foundation for the company to grow in the coming years. Our non-GAAP operating loss in this quarter was RMB128 million, lower than non-GAAP operating profit of RMB55 million in the same period last year. On one hand, with the past year's rapid expansion of kids education business, 70% of the K12 centers are less than 1-year old and they’re in a financial loss position, which led to a non-GAAP operating loss of RMB77 million. We believe that was more and more students in class, more and more K12 education learning centers will start to make profit. On the other hand, there were non-GAAP operating loss of RMB51 million from adult education business. The reason for year-over-year decrease of profit were due to the significant portion of revenue was deferred to later periods caused by the student enrollment in joint major program model as well as the positive impact resources integration from adult learning centers and human resources have not been fully realized in this quarter. Our CFO, Dennis will elaborate this further in his later remarks. To sum up, I am very pleased to seeing a great recovery of student enrollment in adult education business during the second quarter of 2018. The smoother progress in joint major program with partnering universities as well as the positive effect from improvement of enrollment efficiency. We believe that the main drivers for the growth of adult education business will continue to exist. For example, the number of annual university graduates and the fact the lower job placement rate of university graduates, we’re confident in the long-term growth in adult education business. We will continuously upgrade our course contents, and the business model according to the change in the market to maintain Tarena's leading position in the industry. In addition, Tarena delivered higher than expected student enrollment and growth of cash receipts in our K12 business with broad market, Tarena's inherent competitiveness and the favorable government regulations, we have every confidence in this business segment will further expand our standard network, recruit talent, and improve course structures, ensuring rapid improvement of business indicators. The solid performance and growth in both adult and kid education business ensures the company to meet this business target in 2018 and will lay a strong foundation for the long-term growth. With that, I'll turn the call over to our CFO, Dennis Yang, to discuss the quarter financial results and outlook for the third quarter.

[Dennis Yang:]

Thank you, Shaoyun Han, and hello everyone on the call. We are very pleased to see the professional education business student enrollment growth recovery, an exciting result from our K12 education segment in the second quarter. Since you already have the detailed numbers in press release, I will review financial results for this quarter briefly by focusing some important areas. Let's start with net revenues. For the second quarter of 2018, our net revenue increased by 13.8% year-over-year to RMB518 million which consisted of RMB488 million from adult education business and RMB29 million from kids training program. One major driver for adult business net revenue growth is enrollment growth. The total quarter enrollment in this quarter increased by 5% year-over-year to 29,355 which was the main contributor to the net revenue growth this quarter. [Indiscernible] professional training market gradual recovery in this quarter and our total student enrollments reached at 37,138 which represented 21.6% year-over-year growth. Accelerated student enrollment growth will be an lead indicator of fast revenue growth in the future quarters. Besides enrollment growth, ASP increase is another driver for adult business net revenue growth. In this quarter, average revenue for course enrollment was RMB15, 638 which was 3% higher than the same period a year-ago. Higher ASP resulted from the increase of our standard tuition fees for selected courses and the rollout of advanced course modules since 2017. In the second quarter, the company slowed down adding new seats and optimized central resources by closing down and merge -- merging 60 nonperforming learning centers. By the end of this quarter, our adult business seat capacity was 62,153, which represented a 9% year-over-year increase. We also saw better seat utilization rate which was 73.2% in this quarter, narrowing the year-over-year gap when comparing the same quarter last year of 73.6%. Despite the seat utilization rate improvement, gross margin declined by 790 basis points year-over-year to 60.7%. Such a decline in gross margin was mainly due to the following couple of reasons. First, K12 business gross margin drag by approximately 500 bps. The company have build up 57 K12 learning centers in the past 12 months and by the end of this quarter we’ve 99 learning centers. As most of K12 learning centers have not yet reached to an ideal utilization level, common gross margin of K12 business have significantly lower than the margins of our traditional adult training business. Second, deferral of revenue from joint major program students. As we communicated in previous quarters, Tarena started to partner with universities to promote joint major programs from 2017. Joint major program normally lasts 2 to 3 years and majority of the training has delivered in the students third year on campus. In 2017, we recruited more than 5,000 students in such multi-year programs and most of the revenue with these 2017 joint major program students will defer into 2019, which is the third year of 2017 student. Overall speaking, the key reasons for the decline of gross profit margin was ramp ups of two new businesses, K12 [indiscernible] and on campus multiyear joint major programs. We expect gross margin will improve along with the maturity of such businesses. Meanwhile, the company continues to improve center resources utilization of our traditional business by aligning seat capacity increase with enrollment growth and by optimizing our current learning center resources. We believe that the improved seat utilization can also drive future gross margin expansion. And now let's move on to operating expenditures. First, let's talk about student acquisition course. As mentioned -- as Han mentioned, the professional training market continue to recovering in the second quarter and at the same time the company also attempted to adjust acquisition channel mix and to improve sales team productivity. Although average advertising spending per students were pretty much flattish in second quarter as compared within the prior quarter, the total student acquisition cost per student which is defined as total selling and marketing expenses divided by total student enrollment of adult business was RMB6,134 in the second quarter as compared to RMB5,083 in the same quarter in 2017 and to RMB6,789 in the first quarter of 2018. We noted approximately 21% year-over-year increase of average student acquisition cost. However, we also observed a 10% quarter-over-quarter improvement. We believe that our center resource optimization strategy start to bear fruit in the quarter and we plan to further improve the sales efficiency by adherence to our current acquisition optimization strategies and continued sales team skill development. Second, in G&A expenses, we recorded bad debt allowances for doubtful [ph] account receivables of RMB33 million this quarter to reflect the difficulties in collection of account receivables from 2017 students. Company extended credit to some of 2017 students who failed in securing loans from third-party loan providers due to [indiscernible] credit policy of loan companies in the second half of 2017. As company has established the partnership with a group of loan providers since late 2017, in our view relatively high-risks of account receivables from 2017 students is an isolated case and won't change the long-term outlook of bad debt provision levels in our adult business. Third, let's discuss about R&D expenses. Non-GAAP R&D expenses increased by RMB17 million year-over-year to RMB35 million this quarter. The incremental R&D spending were our research investment of [indiscernible] new courses in both adult and K12 business sectors. We believe this investment are crucial to make our courses a breadth of industry changes and continuously attractive to our students. For K12 business, we enrolled 10,570 students this quarter. The total tuition cash receipt were RMB127 million and net revenue recorded was RMB29 million. Despite broader business growth, our typical K12 course last for an about 1-year and during this ramp up -- during the K12 business ramp up period, an operating loss for the business segment comes from K12 student acquisition cost occurred ahead of revenue recognition. By the end of the second quarter, about 70% of our K12 learning centers have been in operation less than 1-year and those learning centers are still loss-making. Non-GAAP operating losses from kids business were about RMB77 million for this quarter. Although K12 segment operating losses recently, we are confident that the K12 business will be profitable in a couple of years. Our non-GAAP operating losses for the quarter were RMB128 million as compared to an operating profit of RMB55 million in the same quarter in 2017. Such a decline in non-GAAP operating profitability in the quarter were a combination of increase of losses from K12 business and an increase of losses from Arnold business due to deferral of revenues from joint major program students of 2017 to later years, higher student acquisition cost and incremental costs for some one-time issue. Income tax expenditure for this quarter included and withholding tax of RMB24.7 million paid to Mainland China which was risen from the payment of cash dividend made from our onshore entities to offshore parent company during this quarter. Finally, let me talk about -- talk little about operating cash flows. Net cash inflows from operating activities for the second quarter of 2018 was RMB81 million, which was the highest quarterly amount in the past 1-year. This increase resulted from our accelerated tuition collection of our adult business in 2018 and our K12 business enrollment growth, both of which brought us a more significant deferred revenues in the balance sheet. In the quarter, the company also used the cash balance in stock repurchases and the cash dividend payment with a total amount of US$16.9 million. Looking forward to the third quarter of 2018, we expect the total net revenues are between RMB675 million and RMB705 million, representing an increase of 18.8% to 24.1% on a year-over-year basis. So now, operator, we are open to pick questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Mariana Kou from CLSA. Your line is open.

[Mariana Kou:]

Hi, management. Good morning. Thank you for taking my question. I just have two questions. One is on the gross profit margin for the adult business. I understand, I think, just now on the explanation Yuduo Yang explaining this was always due to the joint major program. But just wondering in terms of the mix of the adult business in revenue terms or student terms, when do we expect that sales mix to kind of stabilize and then also on the student margin to stabilize? And the second question, I guess more of a high-level at the operating profit margin level, I understand that this year is an investment year for K12. So how should we think about the next few years? I think we’re kind of planning to expand into K12 and [indiscernible] a lot? If management could give us a little bit of color on when we should expect [indiscernible] to level off? Thank you.

[Dennis Yang:]

Thank you, Merin -- Mariana. Let me address to two of your questions. The first question, your question about the gross profit margin. Yes, it's true that joint major program revenue deferral have an adverse impact on our GP margin in 2018 as well as we also mentioned there is a adverse impact in 2017. And also I will talk about this in our -- in the call that the most of revenue for the joint major program of 2017 will be recognized in 2019, which is the next year. So my view is gross profit margin we are getting stabilize starting from 2019 and maybe in a span of couple of years that GP margin impact will be phased out. That will be a gradual change in the future a couple of years. Your second question about OP margin. The K12 that’s definitely on the huge track of OP margin of 2018. And we believe that K12 was more and more the learning center -- K12 learning center is getting matured in the future couple of years. And we also are about to open 80 to 100 learning centers each of the future two years for kids business, that means a percentage of matured learning centers getting greater over the years. So our projection shows that in 2020 the K12 business were at close to breakeven. This is the OP margin for K12 and for the adult business OP margin that’s due -- you will see that in a gradual recovery over the years in 2019, 2020. Again, the joint major program business model still have a sort of adverse impact in 2018, 2019 because [indiscernible] more students are recruited under such multi-year program in 2018. With those -- the huge increase of the student to sign up for the multiyear program and those revenue will be recognized in later years as you have sort of adverse impact there. It is very likely that 2020 the joint major program OP margin we are getting stabilized.

[Mariana Kou:]

Thank you. That’s very helpful.

[Operator:]

Your next question comes from the line of Fiona Chan from Buena Vista Fund. You may ask your question.

[Fiona Chan:]

Hello. Thank you management for taking my question. My first question is on the University channel. I wanted to ask about the volatility in university enrollments. Is the seasonality or is this due to new university partners that we made and how many university partners do we now have? Thank you.

[Dennis Yang:]

The fluctuation were significant growth for the student enrollment in university channel this year I think the core reason is the joint major program started in 2017 with the low base last year. We stand in more universities and colleges this year and that showed very strong growth, 81% year-over-year growth. Currently we stand about 50 -- sorry, 123 universities for joint major program or specialty classes, both of which are the partnership model between Tarena and universities. Going forward, we still believe the enrollment growth from joint major program will be very fast in the growth rate for the future couple of years.

[Fiona Chan:]

Thank you. So just to clarify, the students enroll quarterly for the joint major program? It's not an annual enrollment?

[Dennis Yang:]

Majority of the students enter joint major program again enroll in full, I mean, in the third quarter. By the end of first two quarters or the fourth quarters -- sorry, in the fourth quarter they still have some -- it is not in their freshman year again enrolled [indiscernible]. So they still have new addition in enrollment for joint major program in the quarters other than Q3.

[Fiona Chan:]

Got it. Thank you. My second question is on you are increase in staff. I noticed that you attribute a lot of the increase in expenses to headcount. What is your total number of instructors now?

[Dennis Yang:]

Can we get [ph] the number?

[Lei Song:]

The total instructors is 391.

[Dennis Yang:]

391 instructors.

[Fiona Chan:]

Okay.

[Dennis Yang:]

By the end of Q2.

[Fiona Chan:]

Okay. Thank you.

[Operator:]

Your next question comes from the line of Alex Xie from Credit Suisse. Your line is open.

[Alex Xie:]

Hi, management. Thank you for taking my questions. I have two questions. One is that, I noticed that G&A expenses -- the non-GAAP G&A expenses increased by 81% year-over-year or in this quarter. I wonder what is the main driver of increasing G&A expenses and what’s the trend going forward? And the second question is about K12 education business. Management has mentioned their plan to increase learning centers to 140 by the end of this year, and I think it seems that it's higher than previous expectations. And I’m wondering, whether management also expects higher student enrollments from the kid education business with a new target for enrollment this year? And I also noticed, we launched online K12 programming courses in Q2 and I’m wondering what's the rationale behind that and how much are we going to invest in online education model of kid education business? Thank you.

[Dennis Yang:]

Yes, I’m -- your first question around G&A expenses, in this quarter a part of that expenses, the G&A increased by about 50% year-over-year. The main driver are the additions in headcount and related leased areas and the depreciation. This is the main driver. So the key drivers in our G&A is the headcount. So on the long-term, the G&A, we believe the growth rate will be year-over-year 30%. This is our forecast right now. Based on my comments to such [indiscernible]. Your second question on the K12 enrollment, our expectation in 2018, yes, we recorded very strong enrollment in the second quarter and first -- the first half of 2018, the total student enrollment of K12 business already reached at 14,000. So we expect around 30,000 student enrollment in total for the K12 business in 2018. Yes, this is also once again we put in a higher target for K12 as enrollment. Your third question about online coding -- K12 coding business, I’m actually -- we -- that’s an online business right now, that is still in the pilot operating stage. We just put it online in mid of July and with a few hundreds of the students online to run pilot process. The rationale behind we want to step into online K12 coding business is that our off-line learning centers currently could not fully satisfy the demand in the market. Some of our students and parents comes to a local learning centers have [indiscernible] program they very like, they want to participate, but our learning center may not that close to their location, maybe [indiscernible] location or some of the students in cities other than we already have our K12 presence want to have a chance to participate in our courses. So we deliver an option to those group of customer in the market to have them a chance to have our courses. So in the longer term we may consider the online class off-line business, we do it both. But again, the online business just in the pilot stage.

[Alex Xie:]

Thank you.

[Operator:]

Your next question comes from the line of Jenny Wong of Jefferies. Your line is open.

[Jenny Wong:]

Hello, good morning management and thank you for taking my question. My question is actually quite similar to the ones asked previously, but I just want to ask about our sales staff, that is -- I think there is one of the main reasons why our selling expenses have been going up. Can -- maybe management give us more color on the level of sales staff that we would be happy with and whether or not this will increase and where do we see a suitable level going forward? Thank you.

[Dennis Yang:]

Jenny, can you speak in Mandarin for the benefit of Shaoyun Han? I think this question is better for Mr. Shaoyun Han to address.

[Jenny Wong:]

Okay. Thank you.

[Dennis Yang:]

Let me translate Mr. Han's comments on the sales staff outlook. In the second half of 2017 the company started to use aggressive marketing strategy to hire more sales staff in the team to improve the sales lead conversion rate. So this is why in the past couple of quarters you observed that a increase in sales account. We put the rationale behind that each sales staff -- the sales staff can acquire one new incremental student that will be good to drive higher probability at the mature level -- mature adult learning center because the situation from that incremental student could cover an incremental cost for that additional sales staff. So this is the rationale we used for -- behind for the strategy. And in the most recent quarter you already seen that the improvement in the overall acquisition for students even that the sales leads cost I mean not that significantly improved. This is because we improve the sales team efficiency that we to evaluate the capability of each sales team member and to have the better who are more talented sales staff stay and allow then and the poor performing staff to leave the company. This is the kind of adjustment. We are an organization of the sales team going -- continue to fulfill in the future quarters. In the second quarter of 2018, the number of headcounts of sales team there's still gradual increasing, but not that much.

[Operator:]

Thank you. And there are no questions at this time. I will now refer the call to Ms. Lei Song, Tarena's Reporting Director.

[Lei Song:]

Thank you, operator. If there are no further questions at present, we would like to conclude by thanking everyone for joining our conference call. We welcome you to reach out to us directly by e-mailing at ir.tedu.cn. Should you have any questions or requests for additional information, we encourage you to visit our Investor Relations site at ir.tedu.cn. Thank you.

[Operator:]

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