TCTM Kids IT Education Inc.
Q3 2014 Earnings Call Transcript

Published: 6 Nov 2014

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Tarena International, Inc. Third Quarter 2014 Earnings Conference Call. At this time, all participants are in 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. Christina Zhu, Tarena's Investor Relations Manager.

[Christina Zhu:]

Thank you, operator. Hello, everyone, and welcome to Tarena's third quarter 2014 earnings conference call. The company's earnings results were released earlier today and are available on our IR website, ir.tarena.com.cn, as well as on newswire services. Today you will hear opening remarks from Tarena's Founder, Chairman and CEO, Mr. Shaoyun Han, followed by our Chief Financial Officer, Suhai Ji, who will take you through the company's operational and financial results for the third quarter 2014 and give guidance for the fourth quarter and full year of 2014. After their prepared remarks, Mr. Han and Mr. Ji 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 US 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 measure as defined in Regulation G. The US GAAP financial measures and information reconciling these non-GAAP financial measures to Tarena's financial results prepared in accordance with US GAAP are included in Tarena's earnings release, which has been posted on the company's IR website at ir.tarena.com.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 website. I will now turn the call over to Mr. Shaoyun Han, Tarena's Founder, Chairman and CEO. Mr. Han will speak in Mandarin and I will translate.

[Shaoyun Han:]

Thank you, Christina, and welcome everyone to our third quarter 2014 earnings conference call. I'm very pleased to report another strong quarter with the growth and profitability. We again achieved record revenue and profit in the third quarter of 2014. Our topline revenue grew by almost 41% year-over-year to reach $40.3 million, exceeding our previously issued guidance. And our non-GAAP net income increased by almost 87% year-over-year to reach $11.6 million. Our student enrollments in the third quarter of 2014 totaled 17,518, increasing by 30% year-over-year. Given our business seasonality, the third and fourth quarters are usually our peak seasons, and therefore the 30% increase is based on an already very strong enrollment number in the third quarter of last year. In particular, we have also seen positive results in our strategy to penetrate additional high-growth verticals and extend our reach beyond our core strength in IT. Non-IT courses comprised of digital art and online sales and marketing already accounted for 38.6% of the total student enrollments in the third quarter. And more recently on October 31st, we commenced our inaugural class in Beijing for our new course in accounting, which is the third non-IT course that Tarena offers. We will continue to execute on our strategy to diversify our course offerings and revenues to drive sustained growth. In addition to the early success enjoyed by the newly launched non-IT courses, several new IT courses such as Android and iOS continued to perform strongly. Android has become the number two IT course together with C++ in the third quarter. Our market-oriented demand-driven approach to identifying high-growth verticals coupled with our proven execution capabilities will enable us to continue our future expansion and growth. In the third quarter, our student enrollments from retail channel increased slightly to 81% of total student enrollment compared with 80% in the same period in 2013. Together with the tuition fee increase in the second quarter of 2014, this resulted in higher average revenue per student, a 9% year-over-year and contributed to our revenue growth exceeding our student enrollment growth. In terms of course offerings, we offered 11 courses in total in the third quarter of 2014, up from 10 in the same period a year ago and remaining unchanged from the previous quarter. Online sales and marketing was the only additional course that was launched in the fourth quarter of 2014. And as mentioned earlier, we just commenced our new course in accounting on October 31st. So as of now, we offer a total of 12 courses, of which three are non-IT courses. In terms of new learning centers, we opened three in the third quarter of 2014, one each in Hefei, Nanchang and Dalian. We also merged one learning center in Zhengzhou into a larger one due to the recently expanded lease area in that center. Plus effectively we added a net of two learning centers in the third quarter of 2014 and a net total of 13 in the first nine months of 2014 compared with 29 in the first nine months of 2013. And we plan to open another 10 to 15 new learning centers in the fourth quarter of 2014 compared with 10 in the fourth quarter last year. Consistent with what we stated in the previous two earnings calls, we have taken a prudent approach to new learning centers openings in 2014 in order to drive our margins and profitability. I am pleased to say that we are well on track to achieve the objectives we set at the beginning of the year to improve center efficiency and utilization. In the third quarter of 214, gross margin increased by 215 basis points year-over-year to 74.2%, and non-GAAP operating margin increased by 319 basis points year-over-year to 27.2%. Our overall center utilization rate has reached 77% in the third quarter of 2014 compared to 72% in the same period a year ago. Also in the third quarter, we began to implement a series of initiatives to improve our employee productivity and operational efficiency. These include

[Suhai Ji:]

Thank you, Mr. Han. Thank you, Christina. And hello to everyone on the call. As Mr. Han mentioned, we're very pleased to have achieved another record quarter with both strong top and the bottomline results. Now let me quickly review our financial results for the third quarter of 2014. Please note that unless stated otherwise, all numbers that we discuss today are in US dollars. First on the topline growth, our net revenues in the quarter increased by 41% year-over-year to $40.3 million. The increase was primarily due to increased student enrollment and higher average revenue per student, as defined by net revenues divided by student enrollment. Total student enrollments in the quarter increased by 30% year-over-year to 17,518, which was driven by the number and popularity of our course offerings. The number of our course offerings increased from 10 to 11 in the third quarter year-over-year, while the number of our learning centers increased from 86 to 105 in the same period year-over-year to cater to the increased demand for our courses. Average revenue per student in the quarter increased by 9% year-over-year to $2,299. The growth was mainly driven by the increase of standard tuition fees for our courses and to a lesser extent the slightly higher percentage of retail channels in our student enrollment channel mix. Before moving on to the cost of revenues and operating expenses, I want to refer you to our disclosure on non-GAAP financial measures, which was included in our official press release. The only difference between our GAAP and non-GAAP numbers are share-based compensation or SBC expenses. SBC expenses included our cost of revenues and operating expenses on a GAAP basis, but are excluded to derive our non-GAAP numbers. We have included a reconciliation table in our earnings release showing the detailed calculation. In the third quarter of 2014, total SBC expenses were $1.2 million, up from $0.2 million in the same period in 2013. More than 95% of the total SBC expenses this quarter fell in the general and administrative expense line, with the rest being relatively insignificant across the other expense line. Cost of revenues in the third quarter 2014 increased by 31% year-over-year to $10.5 million. The increase was mainly due to higher personnel costs and the welfare expenses resulting from increased number of teaching and advisory staff at our learning centers and higher average salary, higher rental cost resulting from increased number of learning centers, and expansion of existing of learning centers, as well as higher depreciation expenses for our learning centers. GAAP gross profit increased by 46% year-over-year to $30 million. GAAP gross margin increased by 215 basis points year-over-year to 74%. The improvement in gross margin was mainly due to increased operational scale and efficiency for our learning centers in terms of lower personnel cost and welfare expenses as a percentage of net revenues and the lower rental expenses as a percentage of net revenues. Now moving on to operating expenses, selling and marketing expenses increased by 28% year-over-year to $11 million. The increase was due to higher personnel cost and welfare expenses related to the growth in our selling and marketing headcount and higher average salary and expanded marketing efforts primarily as a result of increased spending on advertising as we expanded our network of learning centers. Non-GAAP general and administrative expenses increased by 63% year-over-year to $6.5 million. The increase was mainly due to higher compensation cost for our increased number of general and administrative personnel to support our growing operations and higher bad debt allowance. Research and development expenses increased by 28% year-over-year to $1.3 million. The increase was mainly due to higher personnel cost and welfare expenses of our instructors allocated to their content development activities for our courses. Our operating income increased by 47% to almost $10 million in the third quarter of 2014. Non-GAAP operating income increased by 60% to $11 million. Non-GAAP operating margin increased to 27.2% in the third quarter of 2014 as compared to 24% in same period in 2013. In the third quarter of 2014 we had a decrease in effective income tax rate to 9.6% from 18.1% in the same period in 2013. The decrease was primary due to a tax holiday enjoyed by one of our wholly-owned subsidiaries that is qualified as the Newly Established Software Enterprise under the PRC Enterprise Income Tax Law, which provides a two-year full exemption from enterprise income tax from 2014 to 2015 followed by a three-year 50% exemption from 2016 to 2018. Our net income for the third quarter increased by 74% to $10.5 million from $6 million in the same period in 2013. Non-GAAP net income for the quarter increased by 87% to $11.6 million from $6.2 million in the same period in 2013. In the third quarter of 2014, our GAAP basic and diluted earnings per ADS were $0.21 and $0.18 respectively. Non-GAAP basic and diluted earnings per ADS were $0.23 and $0.20 respectively. We had a significant increase in cash, cash equivalents and time deposit balance from $38.3 million at the end of 2013 to $163.1 million as of third quarter of 2014 because of the IPO proceeds of $109 million and cash flow generated from operations. So looking forward to the fourth quarter of 2014, we expect total net revenues to be in the range of $39.2 million and $40.4 million, representing an increase of 38% to 42% on a year-over-year basis. The company also expects its total net revenues for full year of 2014 to be between $135.8 million and $137 million, up from its previously guided range of $134.5 million and $136 million, representing an increase of 46% to 48% on a year-over-year basis. This guidance reflects the company's current expectation, which is subject to change. So this concludes my remarks. And I will now hand the call over to the operator and open the line for questions. Operator?

[Operator:]

(Operator Instructions) Your first question comes from the line of Fan Liu of Goldman Sachs.

[Fan Liu:]

It's good to see your revenues up by 41%, while sales and marketing only up by 28%. So regarding the optimization of the advertisement spending, could management show us how is marketing budget allocated across different channels, i.e., search engines and job verticals? Could the management add more color on the progress of accounting courses? How is the enrollment, given the inaugural class has commenced in end of October?

[Suhai Ji:]

The first one is our advertising dollar spending among different channels remained essentially unchanged between the last quarter and this quarter. So it is about 80% to 90% is search engine marketing and the rest 10% to 20% spread among the job recruiting websites such as 51job.com or Zhaopin.com or 58.com, those websites, and also some of the offline advertising that we do in terms of university channel. What's improved is really the efficiency in the advertising dollars. So basically if we spend $100 on Baidu before versus now and we are more efficient in generating more traffic, so on a per dollar basis, we realize the benefit of the scale, which will drive our involvement and revenue and also the utilization rate.

[Shaoyun Han:]

We started our accounting course October 31st, so actually have two classes, one full-time, one part-time, totaling about 100 students. So it's on track as we stated in the previous earnings call and the initial results were very encouraging, actually slightly exceeded our original expectations. We only started to do advertising for the accounting course in October. We had a full class already commenced. So we hope to deliver similar kind of results as the other two non-IT courses that we launched in 2013, digital arts and online sales and marketing. And this is consistent with our strategy expand beyond our core IT courses into some other high-growth verticals that are in the non-IT area and hopefully will be proven that we have another successful non-IT course offering. I just want to add that we just started our first class in end of October and this is only in Beijing, in one center. So we plan to commence the second class in end of December and then third one in the end of January. So we would not roll it out to the rest of the country probably until March next year. So that's the similar strategy we adopted with the UID course as well, the digital art course.

[Operator:]

Your next question comes from the line of Jialong Shi of Credit Suisse.

[Jialong Shi:]

I have a question about the policy. I remember the Chinese State Council issued a policy to encourage the development of professional education industry. Just wonder, two quarters have passed, if you guys have seen any positive impact on your business from these policy tailwind.

[Shaoyun Han:]

So we have already seen some positive results benefited from the policy. We have been talking with roughly five universities to offer joint major programs with the universities. And also regarding our university channel, both year-over-year and for quarter-over-quarter, this quarter student enrollment from the university channel has increased.

[Suhai Ji:]

That's another we are actually separating the retail channel and university channel. We see potential in growth in our university channel as well. So we are hiring dedicated managers who are responsible for this particular channel.

[Jialong Shi:]

Could you give us a breakdown of your cost of sales for Q3, and how was it compared to a year ago?

[Suhai Ji:]

For the total cost of sales, our gross basically in the third quarter this year is 26% of the total revenue and the same quarter a year ago was 28.1%. And within the COGS, the personnel cost and welfare as a percentage net revenue in Q3 is 9.7% compared to 10.1% in the same period a year ago. And in terms of rental cost as a percentage of revenue in Q3 this year is 69% and Q3 last year was 8.7%. So you can see that we are realizing more leverage from the general cost base. And the depreciation, the third largest cost, remained unchanged, 4% of the total revenue. So most of that leverage is coming from personnel cost and rental cost.

[Operator:]

The next question comes from the line of Ella Ji from Oppenheimer.

[Ella Ji:]

This is Fiona Zhang calling on behalf of Ella and I have two questions today. Firstly, I just wanted to follow up on the question on the non-IT verticals. I was wondering longer term for the goals, what revenue contribution level are you expecting.

[Shaoyun Han:]

Our non-IT courses' growth momentum is pretty strong. The target market, the potential market for non-IT courses is also larger. So the percentage of total revenue contributed by non-IT courses will continue to increase. For the next year, we are expecting roughly over 40% revenue contribution from the non-IT courses.

[Ella Ji:]

And my second question is on the 2015 outlook. Are you still targeting to open about 25 to 30 learning centers for the coming year, and how many will be opened in the first half? And also, given this nice improvement on your learning center utilization, how should we think of the margin trends for the 2015?

[Shaoyun Han:]

We are planning to open 10 to 15 new learning centers in the last quarter this year. There are some seasonality in terms of new learning center openings, so some of the centers opening the last quarter this year is preparation for the next year. And for the first half of 2015, we are planning to open more or less 20 new learning centers during the first half.

[Suhai Ji:]

In terms of margins, you can see that in Q3 this year, we're already at 74% in gross margin and 27.2% in non-GAAP operating margin. So those are very healthy metrics. And our overall utilization or the seat occupancy rate is already at 77%. So we think we are ready to step on the gas a little bit to open more centers to cater to the demand as our existing centers are already ramping up to a more mature stage. That's why in Q3, we only have net of opening of two new learning centers. And in Q4, we plan 10 to 15, probably close to 15 new centers in the fourth quarter this year, and most of them would be opened in December. It's basically getting ready for next year. And the next year overall, we are targeting 35-plus learning centers, all stats probably around 20, as Shaoyun mentioned, will be opened in the first half. So obviously as you saw in the past quarters, there is always balance in between the growth and the margins. The faster we open the learning centers, it will dilute our margins. So we expect slight decreasing margins, but the impact would not be as great as in the past year when we have a fewer more mature learning centers, because now we already have over 100 learning centers. So on top of that, open another 30, the impact won't be as great as, say, we only had 50 learning centers, adding another 30. So we expect the margin to come down a little bit in Q4 compared to Q3, because Q3 is really typically our highest season. But we are already on track to achieve the full year profit target. We're quite comfortable with that. And that's why we are stepping on the gas and opening more learning centers. And the next year, we hope the margin will be similar at a comparable level, at the level of this year.

[Operator:]

Your next question comes from the line of Leo Fan of SWS Research.

[Leo Fan:]

Regarding our 10 to 15 new learning centers in the fourth quarter, in which cities and which course offerings will be these centers based? And the second question is regarding our new course development plan, whether we are setting any new IT courses.

[Suhai Ji:]

So in October, we basically opened new accounting center in Beijing and another one in Weifang. And in November, we'll have two in Tianjin and Qingdao. And in December, we have more in Chengdu, Chongqing, Shanghai, Qingyang, Kunming, Guangzhou, Hangzhou, (inaudible) Nanjing and also maybe another one in Taiyuan. So that's about 15 in total.

[Shaoyun Han:]

In October, we opened one new UID center in Weifang, one new accounting center in Beijing. And for Shenzhen and Qingdao, new learning centers will be expansion of current course offerings, Java and UID, because we went out of full capacity in our current centers. And in December, we'll open accounting learning centers in Chengdu, Chongqing, (inaudible) Guangzhou, Hefei, Hangzhou and Nanjing. So there is nine new learning centers will be in preparation work forward for our accounting course next year. The new learning center in Gaoyao is a new city, so we'll have the new Java course in Gaoyao.

[Shaoyun Han:]

So as we mentioned earlier, we won't commence our classes in accounting until the beginning of March next year, but we need to set up those centers and get them decorated and ready for the incoming class. And because the Chinese New Year next year falls in February, so we need to get prepared ahead of the time. So that's why in Q4, our margin should come down a little bit, because once those new centers are opened, we need to incur the rental cost and all the other costs associated with it. But we have not started enrolling students in those centers.

[Operator:]

Thank you. Now I will revert the call back to Christina Zhu, Tarena's Investor Relations Manager, for any additional or closing remarks.

[Christina Zhu:]

Thank you operator. If there are no further questions at present, we would like to conclude by thanking everyone for joining us on the call. We welcome you to reach out to us directly by emailing [e-mail] should you have any questions or requests for additional information and encourage you to visit our Investor Relations website at ir.tarena.com.cn. This concludes Tarena's earnings conference call. Thank you all and have a good night.

[Operator:]

That concludes the conference for today. Thank you for participating. You may all disconnect.