TCTM Kids IT Education Inc (TCTM) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Tarena International, Inc.

Third Quarter Fiscal Year 2017 Earnings Conference Call.

(Operator Instructions) 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.

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 releases.

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 of 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 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.

(foreign language)

Thank you, Helen, and welcome, everyone, to our third quarter 2017 earnings conference call.

(foreign language)

I'm very pleased to report that our net revenues in the third quarter increased by 18.1% to reach RMB 558 million, almost reaching the high end of our previously issued guidance.

This quarter, we've 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 a 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 courses research and development, we significantly increased its geographic coverage, total number of learning centers as well as student enrollments.

We believe this new initiative lays a solid foundation for our full year target and growth outlook in the long run.

(foreign language)

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 to 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 were able to get more student enrollment with stabilized acquisition cost.

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, is at the beginning of each academic year.

This also brought in approximately 4,000 student enrollments this quarter.

(foreign language)

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 application are expected to bring the new growth of 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 trend in IT industry will keep Tarena abreast of the changes in the market and continue to maintain our competitive edge in professional training programs.

(foreign language)

This quarter, we remain in moderate pace in opening new learning centers.

Based on initiative to expand center network and optimize lease areas in existing learning centers, our total seat capacity reached more than 58,000 by the end of this quarter, up by 15.5% from the same period last year.

We take a very positive view on IT professional education market in Tier 3 cities and intend to fill more seat capacity in Tier 3 and Tier 4 cities going forward.

(foreign language)

In terms of professional education business, this quarter, we opened 9 new centers and merged 1. As a result, our total number of learning centers reached 179, covering 58 cities by the end of the quarter.

More specifically, we opened 1 learning center in each of the following 5 new cities, which are Shenyang, (inaudible) and Guizhou.

We opened 1 learning center in each of Tianjin and Wuxi and opened 2 learning centers in Nanjing.

(foreign language)

Besides professional education business, our K-12 education, which is another important business line, continue to achieve strong growth.

In this quarter, kid education programs enrolled 3,590 students, which represent 108% quarter-on-quarter growth.

This student enrollment for the first 9 months recorded 6,309.

We believe our K-12 business will remain ongoing powerful momentum because of favorable market environment.

On a nation level, primary and secondary schools are expected to see education curriculum system upgrading, and key site and technology courses are within the future direction.

Moreover, more parents and students gradually increased the recognition of science technology education courses because of its benefits on developing the 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, and their Tongchuang and Tongmei brands, have rolled out into 21 cities, with 24 key instruction centers and more than 20 shared centers, with 7 new additions in this quarter as well.

While monitoring the opening separate K-12 flagship centers, our K-12 education programs also leverage on sales, marketing and teaching facilities with professional education business.

(foreign language)

In 2018, Tarena will accelerate investments into K-12 business.

In terms of new courses research and development, network expansion has brought us talent recruitment, which will strengthen the foundation for K-12 business and drive sustainable growth in the future.

There will be 100 new centers for K-12 next year.

Although K-12 business in its fast ramp-up period and may affect more than level in the short term as we're going to take a more aggressive strategy to grow such a new business.

There will be significant returns on the effort we have made.

We're confident that K-12 business will become a significant driver for the business in the long run.

(foreign language)

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 margin.

Furthermore, as we opened more centers and continued to enter into new cities for professional education business, operational efficiency in these new centers and the centers in recently entered new cities are still in a ramp-up period and has not yet reached to 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.

(foreign language)

To sum up, during the third quarter of 2017, Tarena actively adjusted student recruitment and cost offering strategies to meet market changes and achieve a stable growth in student enrollment for professional education business.

Through the more scientific 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 2 years and gradually deliver an entire revenue contribution to our financials.

It will become more and more significant business components to Tarena.

(foreign language)

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.

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 increased by 18% year-over-year to RMB 568 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 quarterly enrollment, which is the primary driver for revenue growth, increased by 10% year-over-year to 22,526.

Student enrollment growth recovered smoothly in third quarter from previous quarter as we carried out effective sales and marketing activities to acquire student in retail channel and recruited approximately 4,000 students under the university partnership new mode this quarter.

Besides enrollment, ASP increase is another driver for revenue growth.

Average revenue per course enrollment this quarter was RMB 17,197, which increased by 5.8% as compared to RMB 16,256 in the same quarter last year.

Such increase of ASP resulted from the standard tuition increase in the past year and incremental charges for advanced module of selected 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 2 reasons; the first, our kid education business is in its fast-growing period, and K-12 teaching resources utilization has 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 9 months this year.

Such a rapid capacity expansion makes the utilization rate slightly decreased from 77% in the third quarter last year to 74% this quarter.

During the quarter, we started to optimize leased 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 draft the following key points.

First, student acquisition cost is one of our largest operating expenditures.

Advertising -- average advertising spending per student enrollment for the quarter was RMB 1,766, which was 11% lower than the amount last quarter.

This decrease was mainly due to the increasing enrollment contribution from recruitment channel and end of university partnership new mode, both of which were low advertising cost channels.

Looking forward, we plan to optimize student acquisition channel mix, improved marketing activities 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 a partnership with third-party financing providers and taken present internal controls over credit we granted to our students, we have managed account receivables well.

Bad debt expenses decreased by 31% from RMB 10 million in the same period last year to RMB 6.8 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 students taking our credit and improved internal controls over account receivables.

Our non-GAAP operating profit for this quarter was RMB 115 million as compared with an operating profit of RMB 127 million for the same quarter last year.

Non-GAAP operating margin was 20.2% for this quarter, 6.2 percentage points decline from that in the same quarter last year.

Our non-GAAP net profit was RMB 117 million for the third quarter in 2017 compared to non-GAAP net profit of RMB 134 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 non-margin in this quarter was due to the following key reasons: first, the number of new centers opened in both professional and kid education centers in previous quarters.

Overall utilization of center resources have not yet reached to the ideal level.

Along with business growth in the future, we'll see more and more centers reaching to mature utilization levels; second, in its fast ramp-up period, K-12 business recorded a loss in short term because K-12 revenue recognized in the 10- to 12-month period, while operating cost, especially marketing spending, recorded as selling expenses when they incurred; third, we launched Python and kid code mathematics courses in this quarter.

Other than these 2 courses, we also have a few new subjects under development for both professional training and kid education businesses.

New course development spending 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 a little bit on operating cash flows.

Net cash inflow from operating activities was RMB 38 million in this quarter as compared to RMB 245 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 expedited their credit review and loan payment procedures.

On the contrary, loan providers now become more risk conscious and normalized 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 temporary impact on our operating cash flows in the coming 1 to 2 quarters.

We believe that professional training business continue to grow in the future with solid foundation over 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 about 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 represents more than 300% year-over-year growth as compared to K-12 enrollment last year.

We're confident that our efforts 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 RMB 590 million and RMB 610 million, representing an increase of 27.2% to 31.5% on a year-over-year basis.

Operator?

.

(Operator Instructions) We'll take our first question from Mariana Kou with CLSA.

I actually have 2 questions.

I think I noticed on the announcement that you mentioned the joint venture program of the university channel is accounting for about 22% of your student enrollment of this quarter.

So just wondering, how should we expect this kind of percentage mix to change in the next year and also maybe your price 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 will you be able to kind of quantify how much of that OP margin decline is attributed to K-12 and new centers and also new classes?

Like would that be kind of 1/3, 1/3, 1/3?

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 -- 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 partner 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 coming from university channel.

Part of 22%, 11% we recruited entered 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 or factors have adverse impact on margin this quarter, including K-12 and professional education.

K-12, actually, we recruited -- we recorded around RMB 15 million to RMB 20 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.

And we'll take our next question from [Greg Zhou] with Crédit Suisse.

So actually, I also have 2 questions.

One is regarding the Kid Education program.

As we mentioned in the last earnings call, the current gross margin around K-12 is around 20%.

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 onto the right track in the next 2 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.

Well, K-12, our gross margin actually in Q3 overall -- in an overall basis is lower than Q2 because of we open 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 side of the question about the 2 years trend on K-12 margins, right?

In terms of -- I would like to say it in this way.

Every year, we plan to open new K-12 learning centers.

And I will say, we see on the K-12 margin in multiple pieces.

One piece is our learning centers operated for around 1 year and above, and we have the rest of group of K-12 learning centers operated within 1 year.

So for those K-12 learning centers operated within 1 year, that margin level will be very low and maybe even suffer losses.

For the K-12 learning center operated more than 1 year, very likely that operating margin can reach to high teens or even higher 20%.

Let me cite some analysis which we recently done internally, that we traced -- where we traced K-12 learning centers, probably 12 or 10 to 12 K-12 independent learning centers operated more than 1 year.

We started our K-12 business since 2015.

So we have around 10 learning centers with more than 1-year operational history.

We traced those group of K-12 learning centers and shown that the potential margin level, we do an assumption that keep its current operational efficiency maintained for the future 1 year.

And after 1 year, those learning centers can reach -- overall can reach to high teens -- operating margin level of high teens.

And the best ones can reach to more than 30% operating margin.

So this is why we believe our K-12 business is very promising.

And very tough question for me to give you very simple guidance, the margin outlook for K-12 as a whole because we opened very big number of new learning centers next year.

Very likely in the K-12 business can still or will still suffer losses.

But we will look at the learning centers with longer operational history that are getting better utilization and getting better margin levels.

We'll take our next question from Alex Liu with Daiwa.

(foreign language) 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 segments?

And my second question is that 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 3 to 5 years?

And also, how should we think about the subject expansion for K-12 business?

Alex, thank you for the question.

Your first question about...

(foreign language)

Okay, Mr. Han said mass production I think probably question #2.

Actually, from Tarena perspective, we have a 3-year plan for K-12 development.

Actually, for -- from the cash revenue level, we expect in 2018, the cash revenue can reach to RMB 215 million.

And in 2019, we expect to double the cash revenue to RMB 500 million.

And then 2020, the cash revenue can reach to RMB 800 million to RMB 1 billion level.

So this is why we believe in the K-12 very promising.

In terms of accounting revenue, we expect in 2018 the revenue can reach to RMB 150 million.

Very likely in 2019, the accounting revenue, GAAP revenue for K-12 business can reach RMB 300 million in 2019.

In terms of margins, operating margins.

K-12 in 2018 is still suffering loss, marketing losses.

But we expect in 2019 for K-12 business can reach in the breakeven level.

In 2020, in the K-12 can start to earn profit in the current.

So this is our 3, 2-year plan for K-12 business.

As for your first question about next year, 2018 revenue outlook, overall, we believe we can reach to a more than 20% year-over-year net revenue -- top line growth, actually.

If you split the total top line into K-12 and more 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 around 5% next year in 2018.

Alex?

Follow-up question?

No, no, I'm good.

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

So a couple of questions from me.

Why is that in the last quarter, you have mentioned that your Shanghai, I mean, segment has came across weaker than expected performance in terms of the sales and marketing efforts.

Would you mind to share with us any color on Shanghai during the quarter, any improvements from there?

And the second question is that would you mind to share with us what's your unit economics look like right now?

So how long would it take for typical new learning centers to break even and how long would it take for the new learning centers to compare to with the mature learning center in terms of the margin level?

And then also third question about -- I think you have mentioned that your loan providers have a longer payment period during the quarter.

Would you mind to share with us the reason behind that?

Anything related to the affordability quality of your students?

Any color will be appreciated.

(foreign language)

(foreign language)

Fan, the first question about one the company give further color on the update of Shanghai region performance.

Mr. Han gave his answers to this question.

He addressed 2 points.

In the third quarter, we changed the original Director for that region probably in early September.

And we also observed that the Shanghai region, the completion rate or the part of completion can reach to the average level of the whole group, whole Tarena group.

So we are -- actually, we are seeing the performance is getting better in Shanghai region in the recent quarter.

Let me address, Fan, the second question about the overall -- the growth trends for the new centers.

Overall for professional business new center can reach to breakeven or profit in 1 year, within 1 year of reaching the breakeven but not necessarily to reach to the mature level.

Very likely in 2 years, those new learning centers can reach to mature level or to reach to the Tarena group average margin level.

So within 2 years, the new learning center won't have any more direct impact on the overall financials.

This answers to your second question.

And third question about the extended cash collection period of loan providers.

We are not 100% sure of the reason behind, but our feelings, if -- in this way.

In 2015, 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 expedite the loan review and loan payment procedures.

So in that -- last year, normally takes 1 minute or within the day, the loan can be reviewed and improved.

And within a couple of days, we got cash.

But right now, in 2017, there are more and more loan providers who have their risk control mechanism in place.

So they take a longer period of time to review the loans and to do the loan payments.

So normally, right now, we take a longer period of time to get tuition fees.

But we believe this turnaround time, I mean, the timeline for with all the application we have that our students are on application and Tarena to receive cash from the loan providers is reasonable.

It's -- we see this kind of trend as normalization of the loan review procedures.

(foreign language)

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 a rolling basis, after -- in 2 quarters -- after 2 quarters, those impact won't be there anymore.

Recently, we added finance into our preferred loan provider to our cities.

Our strategy is to try to have more loan providers into our list -- into our partners to provide student loans.

And with those efforts, we can find the most favorable terms with Tarena to -- for the future.

(Operator Instructions) We'll go next to Clark Sun with Goldenwise Capital Management.

Just a quick one on the deferred revenue part.

I noticed that your deferred revenue has been decreasing for 2 consecutive quarters on a quarter-to-quarter basis.

So do you mind to offer like more color behind the decline of the deferred revenue?

Okay, I think there are probably 2 reasons behind.

The first reason is just what we have discussed about in cash inflow extended a tuition collection period from loan providers.

In the past -- I'm sorry, last year, 2016, the loan providers review and pay loans very fast and paid once for all.

So when the students got their loan approved, we got a 10% tuition on our bank account.

So last year and in the second quarter of this year, those practice obviously have been taken for the third-party loan provider and in the third quarter, they kind of changed for 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 entered university collaboration new mode.

For those 4,000 students, we have mainly -- or have even no advances from those students or from universities because we delivered service first and they -- and we collect the money later.

So those 4,000 students have mainly no contribution to deferred revenue by the end of -- on the end of Q3 balance sheet.

And we'll take our next question from [Juan Jiang] with the London Business School.

(foreign language) So my question is, so in recent years, especially in 2016, the smaller competitors of Tarena like [ID CAST], Emerald Education and [Line O] Technology, et cetera, they have been growing very quickly in 2016, like 3-digit growth.

And then they're picking up market shares, and the competition seems to intensify.

So what strategy do you like to apply to keep your competitive edge and differentiate Tarena from competitors?

(foreign language)

Mr. Han answered this question.

You see that you observed our smaller competitors growing as well.

That's very good evidence that the IT training market still have a really good potential.

Let me tell you what -- those smaller competitors are doing a few verticals.

They are with a smaller size, they're doing a couple of verticals.

And if those verticals with very good market upward trends, those competitors can benefit from those market trends in pure -- in a certain period of time.

For example -- and those smaller competitors also use differentiated selling channel or student acquisition channel.

For example, [Line O] more focused on cooperation with universities, and (inaudible) more focused on social networking acquisition.

On the contrary, Tarena will be a larger player in the market.

So we do -- we cover -- we have 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 a presence, and we also cover much wider areas in Mainland China.

For example, we actually have very strong growth for certain courses, for example, digital art.

In third quarter this year, digital art year-over-year growth grows around 50%, and we also have some new courses like Linux, like big data and Python.

Those 3, the growth rate also higher than 100%.

And ladies and gentlemen, there are no further questions in the queue.

I want to thank you.

And now I'd like to turn the call back to Ms. Helen Song, Tarena's Investor Relations Director.

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 requests.

For additional information, we encourage you to visit our Investor Relations site at ir.tedu.cn.

This concludes Tarena's earnings conference call.

Ladies and gentlemen, this does conclude today's conference.

We appreciate your participation.