TCTM Kids IT Education Inc.
Q3 2017 Earnings Call Transcript

Published: 21 Nov 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to Tarena International, Inc. Third Quarter of Fiscal Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-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 today’s host for the conference, Ms. Helen Song, Tarena's Investor Relations Director. Please go ahead, ma’am.

[Helen Song:]

Thank you, Operator. Hello, everyone, and welcome to Tarena's third quarter 2017 earnings conference call. The company's earnings results were released earlier today, and are available on our IR website, 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 third quarter 2017 and give guidance for the fourth quarter and full year of 2017. 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 website 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 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 Mr. Yang will translate.

[Shaoyun Han:]

[Interpreted] Thank you, Helen. And welcome everyone to our third quarter 2017 earnings conference call. I'm very pleased to report that our net revenues in the third quarter increased by 18.1% to reach RMB558 million, almost reaching the high end of our previously issued guidance. This quarter we made strategic adjustment in our professional education business to better cater for changes in the market. By adopting active enrollment strategy and by rolling out new courses and upgrading existing courses, we achieved the smooth recovery in student enrollment growth this quarter. In the meantime through the positive investment into K-12 education programs in terms of network expansion, talents recruitment, new course research and development, we significantly increased its geographic coverage, total number of learning centers as well as student enrollment. We believe this new initiative lays a solid foundation for our full year target and growth outlook in the long run. In the third quarter of 2017, total course enrollment increased by 9.9% year-over-year to reach 32,526. This is the primary factor contributing our revenue growth this quarter. Our student enrollment this quarter reached to 36,220, representing 17.5% year-over-year growth. Enrollment growth has picked up from previous quarter. On one hand implementation of proactive marketing and management control strategy started to bear fruit. We're able to gather more student enrollment with stabilized acquisition costs. On the other hand, as we mentioned in previous quarter, enrollment season for students in joint major programs, the new cooperation mode in university channel as the beginning of each academic year, this also brought approximately 4,000 student enrolment this quarter. To meet the growing demand for artificial intelligence and big data talent, the company has launched new course content in the field of vocational education training this quarter. As we mentioned in the earnings call last quarter, currently IT industry is in transition period. Looking forward, artificial intelligence, big data, and cloud applications are expected to bring new growth and momentum in important markets. Among all professional education courses, big data and Linux cloud computing courses have shown robust growth this quarter. Big data, Linux together with Python contributed total of more than 2,000 student enrollments in the quarter. We believe that continuous content development and introduction to new courses to capture the future trends in IT industry will keep Tarena abreast of the changes in the market and continue to maintain our competitive edge in professional training programs. This quarter, we remain in the moderate pace in opening new learning centers, based on initiatives to expand center network and optimize lease areas in existing learning centers, our total seat capacity reached to more than 58,000 by the end of this quarter, up by 15.5% from the same period last year. We take very positive view on IT professional education market in Tier 3 cities and intend to build up more seat capacity in Tier 3 and Tier 4 cities, going forward. In terms of professional education business, this quarter we opened nine new centers and merged one. As a result, our total number of learning centers reached 179 covering 58 cities by the end of the quarter. More specifically, we opened one learning center in each of the following five new cities, which are Shenyang [indiscernible], we opened one learning center in each of Tianjin and Wuxi and opened two learning centers in Nanjing. Besides professional educational business, our K-12 education, which is another important business line, continued to achieve strong growth. In this quarter, kid education programs enrolled 3,590 students, which represent 108% quarter-on-quarter growth. These student enrollments for the first nine months recorded 6,309. We believe our K-12 business will remain ongoing powerful momentum because of favorable market environment. On the nation level, primary and secondary schools are expected to see education curriculum system upgrading and key science and technology courses are within the future direction. Moreover, more and more parents and students gradually increased the recognition of science technology education courses, because of its benefit on developing variety of basic skills for kids. We are very confident in K-12 education business and by the end of this quarter our kid education courses under Tongcheng and Tongmei brands have rollout into 21 cities, with 24 kid instruction centers and more than 20 shared centers with seven new additions in this quarter as well. While not really opening separate K-12 flagship centers, our K-12 education programs also leverage on sales, marketing and teaching facilities with professional education business. In 2018, Tarena will accelerate investment into K-12 business in terms of new courses, research and development, network expansion, as well as talent recruitment, which will strengthen the foundation for K-12 business and drive the sustainable growth in the future. There will be 100 new centers for K-12 next year. Although K-12 business in a fast ramp up period and may affect margin level into short-term as we are going to take more aggressive strategy to grow such new business. There will be significant returns on the efforts we have made. We are confident that K-12 business will become significant driver of the business in the long run. Our non-GAAP operating margin in the third quarter was 20.2% lower than the same period last year. This can be mainly attributable to K-12 business, which is viewed as fast growing period and have led to operating loss in short-term. For the benefit of new business growth in the long-term, it may be temporarily affect our margins. Furthermore, as we open more centers and continue to enter into new cities for professional education business, operational efficiency in this new centers and centers in recently entered new cities are still in the ramp up period and have not yet reached to the similar level to mature existing centers, which will in turn affect the overall operating margin. Our CFO Dennis will elaborate on this further in his later remarks. To sum up, during the third quarter of 2017 Tarena actively adjusted students recruitment and course offering strategies to meet market changes and achieve the stable growth in student enrollment for professional education business. From the more significant design in curriculum system and stringent control over teaching quality, Tarena will keep its leading advantage in professional education industry. In the meantime K-12 business has proven ongoing powerful momentum with robust enrollment growth in the third quarter. Going forward, Tarena will continue to make more investments into capacity expansion and new course development. Finally, we're confident that K-12 business will remain fast growth momentum in the coming two years and gradually deliver even higher revenue contribution to our financials. It will become more and more significant business component to Tarena. With that, I will now turn the call over to our CFO, Dennis Yang to discuss the third quarter financial results and outlook for the fourth quarter 2017.

[Dennis Yang:]

Thank you, Han Shaoyun and hello everyone on the call. Since you already have all detailed numbers in the press release, I'll review our quarterly financial results briefly and focus on a couple of more important areas only. First, let's start with net revenues. For the third quarter 2017 our net revenue increase by 18% year-over-year to RMB568 million, which is close to high end of our revenue guidance. Enrollment growth is one major driver for our net revenue growth. Total student enrollment increased by 17.5% year-over-year to 36,220. Total course enrollment, which is primary driver for revenue growth increased by 10% year-over-year to 22,526. Student enrollment growth recovered smoothly in the third quarter from previous quarter, as we carried out effective sakes b marketing activities to acquire student in retail channel and recruited approximately 4,000 students under the university partnership new mode this quarter. Beside the enrollment, ASP increase is another drive for revenue growth. Average revenue per course enrollment this quarter was RMB17,197, which increased by 5.8% as compared to RMB16,256 in the same quarter last year. Such increase of ASP resulted from the standard tuition increase in the past year and incremental charges for vast module of selective courses starting from July 2017. In the third quarter, gross margin decreased by 2.7 percentage points year-over-year to 72.2%, such decrease in gross margin was mainly attributable to the following two reasons. The first, our kid education business is in its fast growing period and K-12 teaching resources utilization have not yet reached to the ideal level. Therefore, K-12 gross margin was currently lower than that of our professional education business. The second, for our professional training business we have opened 34 new centers and entered 12 new cities in the first nine months of this year. Such a rapid capacity expansion made see utilization rates slightly decrease from 77% in the third quarter last year to 74% this quarter. During the quarter, we started to optimize lease areas in underperforming centers. Total seat capacity increased by 15.5% year-over-year this quarter and we believe that we remain at a relatively healthy level and was generally in line with our expected enrollment growth. Now let's move on to operating expenditures. I would like to address the following key points. First, student acquisition cost is one of our largest operating expenditures. Average advertising spending per student enrollments for the quarter was RMB1,766, which was 11% lower than the amount last quarter. This decrease was mainly due to the increasing enrollment contribution from recruitment channel and under university partnership new mode. Those of which were low advertising cost channels. Looking forward, we planned to optimize student acquisition channel mix, improve marketing activity effectiveness and the target to reduce advertising cost per student enrollment gradually. Second, let's briefly talk about bad debt allowances. As we communicated before, after having partnership with third party financing providers and taking stringent internal controls over credit we granted to our student we have managed account receivables well. Bad debt expenses decreased by 31% from RMB10 million in the same period last year to RMB6.8 million in this quarter. We believe that bad debt expenses for 2017 will continue to decrease as compared to the amount in 2016 reflecting the reduced proportion of our student taking our credits and the improved internal controls over account receivables. Our non-GAAP operating profit for this quarter was RMB115 million as compared with operating profit of RMB127 million for the same quarter last year. Non-GAAP operating margin was 20.2% for this quarter, 6.2 percentage point decline from that in the same quarter last year. Our non-GAAP net profit was RMB117 million for the third quarter in 2017 compared to a non-GAAP net profit of RMB134 million for the same period last year. Non-GAAP net margin was 20.6% for this quarter, 7.2 percentage points lower than the level same period a year ago. Such a decrease in operating margin and net margin in this quarter was due to the following key reasons. First, with the number of new centers opened in both professional and kid education businesses in previous quarters. Overall utilization of center resources has not yet reached to the ideal level. Along with business growth in the future, we will see more and more centers reaching to matured utilization levels. Second, in its fast front up period, K-12 business recorded a loss in short-term because K-12 revenue recognize in a 10 to 12 months period, while operating costs especially marketing spending recorded as selling expenses when they incurred. Third, we launched Python and kid mathematics courses in this quarter. Other than these two courses, we also had a few new subjects under development for both professional training and kid education businesses. New course development spendings made non-GAAP R&D expenses as a percentage of net revenue increase from 3.3% in the same quarter last year to 4.6% in this quarter. Finally let’s talk about little bit on operating cash flows. Net cash inflow from upgrading activities was RMB38 million in this quarter, as compared to RMB245 million same period a year ago. The decrease in net operating cash inflows were mainly attributable to lower net income and longer period of tuition collection from student loans providers this quarter. In 2016 loan providers normally is to be guided their credit review and loan payment procedures. On the contrary loan providers now become more risk conscious and normalize their loan review and payment procedures. And therefore it turns out to take a longer time for us to receive tuition fees from loan providers. Such a change will bring temporarily impact on our operating cash flows in the coming one to two quarters. We believe that professional training business continue to grow in the future with solid foundation of our high quality services, up-to-date course offerings and extensive nationwide business network. In addition, K-12 business is a new segment with tremendous potential for future growth by leveraging our core experience in IT related education. Taking a very positive view on K-12 growth potential, we plan to open more K-12 learning centers, as well as to launch new courses in 2017 and 2018. The total K-12 student enrollment for 2017 is expected to reach to more than 9,000, which represent more than 300% year-over-year growth as compared to K-12 enrollment last year. We are confident that our effort in rolling out K-12 business has started to bear fruit with robust business momentum in the rest of 2017 and also in the future years. Looking forward to fourth quarter 2017, total net revenues are expected to be between RMB590 million and RMB610 million, representing an increase of 27.2% to 31.5% on a year-over-year basis. Operator?

[Operator:]

Thank you. And ladies and gentlemen we'll now begin the question-and-answer session. [Operator Instructions] We'll take our first question from Mariana Kou with CLSA.

[Mariana Kou:]

Hi, management. Good morning and thank you for taking my question. I actually have two questions. I think I noticed on the announcement that you mentioned to joint venture programs on the university channel is accounting for about 22% of your student enrollment for this quarter. So just wondering how should we expect this kind of percentage mix to change in the next year and also maybe like a five year target if you may provide. And then second question is really coming from the margin pressure, thank you for explaining kind of the different drivers, but would you be able to kind of quantify how much of that OP margin decline is attributed to to K-12 and new centers and also new classes, like would that be kind of one third, one third, one third? Thank you.

[Dennis Yang:]

Okay. Your first question about joint venture programs, just want to mention in the conference that in September we enrolled around 4,000 students, entered the new mode with [technical difficulty]. We believe there will be moderate growth in the coming years on this channel acquisition of new students. As well as we mentioned last quarter, in addition to the new mode partnered with universities, we still acquire new students in our traditional university channel, that you will see that for example this quarter, 22% of our students are coming from university channel. Out of 22%, 11% we recruitment under the new mode and the rest of the 11% coming from our traditional acquisition model from university. This is my answer to your first question. And your second question about margins. Yes, just want to mention there are a couple of impact factors have adverse impact on margins this quarter, including K-12 and professional education. K-12, actually we recruited, we reported around RMB15 million to RMB20 million loss this quarter. And from K-12 there will be 330 basis points on the margin year-over-year margin comparison this quarter. And in professional education wise, there will be around 250 margin decline on a year-over-year basis.

[Mariana Kou:]

Thank you.

[Operator:]

And we'll take our next question from Greg Zhu with Credit Suisse.

[Greg Zhu:]

Hi Han, Hi Dennis, thank you for taking my question. So actually I also have two questions. One is regarding the Kid education program. As you mentioned in the last earnings call, the current gross margin around K-12 is around 10%. Could you please offer some updates around this number, the gross margin for the K-12 programs? And going forward, as you mentioned, you plan to launch this business on to the right track in the next two years. So how should we expect this margin trend in the next quarter or in the next year? And I have a follow-up question after this.

[Dennis Yang:]

Well, K-12, gross margin actually in Q3 in overall basis is lower than Q2 because we opened more new K-12 learning centers. Those new learning centers with lower utilization of teaching resources dragged down the overall gross margin. So, for the K-12 business in Q3, the gross profit margin is single-digit – lower-single digit. And your follow-up -- you have another set of question about the two years trend from K-12 margins, right?

[Greg Zhu:]

Right.

[Dennis Yang:]

In terms of -- I would like to say in this way, every year we plan to open new K-12 learning centers, and I would say we see on the K-12 margin in multiple pieces, one piece is our learning centers operated for one year and above, and we have rest of group of K-12 learning centers operated within one year. So for those K-12 learning centers operated within one year, that margin level will be very low and maybe even it suffers losses. For the K-12 learning center operated more than one year very likely that operating margin can reach to high teens or even higher 20%. Let me cite some analysis which we recently have done internally that we traced -- where we traced K-12 learning centers probably 10 to 12, K-12 independent learning centers operated more than one year. We started our K-12 business since 2015, so we have around 10 learning centers with for more than one year operational history. We traced those group of K-12 learning centers and have shown that the potential margin level, we do an assumption that we keeps its current operational efficiency maintained for the future one year, and after one year, those learning centers can reach -- overall can reached to high-teens -- operating margin level of high teens. And the best one can reach to more than 30% operating margin. So, this is why we believe K-12 business is very promising. And very tough question for me to give you a very simple guidance, the margin outlook for K-12 as a whole because we open very big number of new learning centers next year. Very likely in the K-12 business can still -- will still suffer losses, but we will look at the learning centers with longer operational history are getting better utilization and getting better margin levels.

[Greg Zhu:]

Okay, thank you.

[Operator:]

Take our next question from Alex Liu with Daiwa.

[Alex Liu:]

So, my question -- first question is that could the management give us some preliminary outlook for 2018, revenue growth for both the professional education business and also the K-12 segment? My second question is I think if we are taking a longer term view, on the K-12 business what’s the scale will be look like for the K-12 segment alone in the coming three to five years and also how should we think about the subject expansion for K-12 business?

[Dennis Yang:]

Alex thank you for the question. Your first question is about…

[Shaoyun Han:]

[Foreign Language]

[Dennis Yang:]

Okay, Mr. Han answered last question I think probably question number two. Actually from Tarena perspective we have a three year plan for K-12 development. Actually for -- on the cash revenue level we expect in 2018 the cash revenue can reach to RMB250 million. And in 2019 we expect to double the size of cash revenue to $500 million. And then in 2020 the cash revenue can reach to RMB800 million to RMB1 billion level. So this is why we believe K-12 is very promising. In terms of accounting revenue, we expect in 2018 the revenue can reach to RMB150 million very likely in 2019 the accounting revenue GAAP revenue for K-12 business can reach RMB300 million in 2019. In terms of margins, our over margins K-12 in 2018 is still suffering loss, working losses, but we expect in 2019 for K-12 business can reach in the breakeven level. In 2020, the K-12 can start to earn profit in the current line [ph]. So this is our three year plan for K-12 business. As to your first question about next year 2018 revenue outlook, overall we believe we can reach to more than 20% year-over-year net revenue top-line growth actually. If you split the total top-line into K-12 and our traditional business, I have to say the traditional business the top-line growth will be very likely close to 20% maybe 18% to 20%. For K-12 the contribution -- top-line contribution can reach to 5% next year in 2018.

[Alex Liu:]

Thank you.

[Dennis Yang:]

Follow up questions.

[Alex Liu:]

No, no. Thank you.

[Operator:]

We'll take our next question from Fan Liu with Goldman Sachs.

[Fan Liu:]

Thank you management. So a couple of questions from me, why is that in the last quarter you have mentioned that your Shanghai earnings segment has come across some weaker learning [ph] factor and performance in terms of sales and marketing effort. Do you mind to share with us any color on Shanghai during the quarter, any improvements found there? And the second question is would you mind sharing with us what's your unit economics look like right now. So how long will it take for typical new learning centers to breakeven and how long will it take for the new learning center to convert with new mature learning center in terms of the margin level? And also third question about, I think you have mentioned that your loan providers have a longer payment period during the quarter, would you mind sharing with us the reason behind that anything related to the affordability quality of your students? Any color will be appreciated.

[Shaoyun Han:]

[Foreign Language]

[Dennis Yang:]

Fan’s first question is about when the company give formal color on the update of Shanghai region performance. So Mr. Han give his answers to this question, he address two points. In the third quarter, we changed the regional director for that region, probably in early September and we also observed that the Shanghai region the completion rate were the budget completions can reach to the average level of the whole group, whole Tarena Group. So we are -- actually we are seeing the outperformance is getting better in Shanghai region in the recent quarters. Let me address Fan’s second question about the overall the growth trends for the new centers. Overall for professional business, the new center can reach to breakeven or in profit in one year -- within one year reach to the breakeven, but not necessarily to reach to the mature level. Very likely in two years those new learning centers can reach to mature level or to reach to the Tarena group average margin level. So within two years those new learning center won’t be have any modern tracking path on the overall financials. This answers to your second question. The third question about the extended cash collection period from loan providers. We are not 100% sure the reason behind, but our feeling is in best way, in 2016 the loan providers want to take more market share, this is kind of competition among loan providers. So the loan providers give Tarena very good terms to expect tight the loan review and loan payment procedures. So in that -- last year normally take one minute or within a day the loan can be review and approved and within couple of days we got cash. But right now in 2017 there are more and more loan providers have their risk control mechanism in place. So they take a longer period of time to review the loans and to do the loan payment. So normally right now, we take a longer period of time to get tuition fees, but we believe this turnaround time, I mean, the time lag for we filed application our student’s loan application and Tarena to receive cash from the loan providers is reasonable, we see this kind of trend as normalization of the loan review procedures. Regarding the third question Mr. Han added, recently we observed kind of policy changes from third party loan providers, where the loan providers put more stringent loan review procedures. This is kind of the more risk conscious view from those third parties. This kind of change on policies have temporary impact on our cash collection. And on growing basis, after in two quarter, after two quarters those impact won't be there anymore. Recently we add as finance into our preferred loan provider to our students our strategy is to try to have more providers into our list, into our partners to provide student loans and with those efforts we can find the most favorable terms with Tarena for the future.

[Operator:]

[Operator Instructions]. We'll go next to Clark Sun with Goldenwise Capital Management.

[Clark Y. Sun:]

Hi, management. Thanks for taking my question. Just a quick one on the deferred revenue part, I noticed that your deferred revenue has been decreasing for two consecutive quarters on a quarter-to-quarter basis. So do you mind to offer like more color behind the decline of the deferred revenue?

[Dennis Yang:]

Okay, thank you for the question. I think there are probably two reasons behind, the first reason is just when I -- what we have discussed out in cash inflow extended tuition collection period from loan providers. In the last year, in 2016, the loan provider reviewed and paid loans very fast and paid once for all. So when the student get the loan approved we got them 100% tuition on our bank account. So last year and in the second quarter of this year, those practice what been taken for in the third party loan provider in the third quarter that kind of changed for the third party. So this make our deferred revenue kind of the cash inflow is not that strong. So deferred revenue have adverse impact that’s the first reason. And the second reason bear in mind that in the third quarter we have 4,000 students enter the university cooperation new mode. For those 4,000 students, we have merely or have even no advances from those students or from universities, because we deliver service first and they -- and we collect the money later. So those 4,000 students has merely no contribution to deferred revenue by the -- at the end of Q3 balance sheet.

[Clark Y. Sun:]

Yes, it’s very clear. Thank you.

[Operator:]

We will take our next question from Yuan Zhang with London Business School.

[Yuan Zhang:]

So my question is so in recent years, especially in 2016 the smaller competitors of Tarena and IT Cast, Emerald Education, Ilano [ph] Technology, et cetera, they have been growing very quickly in 2016 like three digit growth and they are picking up market shares and the competition seems to intensify. So what strategy would you like to apply to keep your competitive edge and differentiate Tarena from competitors? Thank you.

[Shaoyun Han:]

[Foreign Language]

[Dennis Yang:]

Mr. Han answered this question. You see that you -- you observe that our smaller competitors growing very fast, that’s very good evidence that on the IT training market still have a really good potential. Let me tell what those smaller competitors doing a few verticals, as they are with a smaller size, they are doing a couple of verticals. And if those verticals with very good market upward trends, those competitors can benefit from those market trends in the certain period of time. For example, and those smaller competitors also use differentiated selling channel for student channel. For example, now we are focused collaboration with universities and try to more focus on social networking acquisition. On the contrary, Tarena will be a larger player in the market. So we do -- we cover -- we have a better coverage in the market as compared with those smaller competitors. For example, we have more courses, we have IT training, we have non-IT training, we have 20 courses in our portfolio. We have large geographic coverage than those smaller competitors. They may focus on big cities, we focus on all of the cities they have presence. And we also cover much wider areas in Mainland, China. For example, we actually with very strong growth for certain courses for example, digital art. In third quarter this year digital art year-over-year growth around 50% and we also have some new courses like Linux, like big data and Python those three the growth rate also higher than 100%.

[Yuan Zhang:]

Okay, thank you.

[Operator:]

And ladies and gentlemen there are no further questions in the queue. I want to thank you. And now I would like to turn the call back to Ms. Helen Song, Tarena’s Investor Relations Director.

[Helen Song:]

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 ir.tedu.cn. Should you have any questions or request for additional information, I encourage you to visit our Investor Relations site at ir.tedu.cn. This concludes Tarena’s earning conference call.

[Operator:]

Ladies and gentlemen this does conclude today’s conference. We appreciate your participation.