TCTM Kids IT Education Inc ADR (VSA) Q2 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing-by and welcome to Tarena International, Incorporation’s Second Quarter 2014 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 call 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.

Thank you, operator. Hello everyone and welcome to Tarena's second quarter 2014 earnings conference call. The company 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 second quarter 2014 and the guidance for third quarter and full year 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 U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risk 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 U.S. GAAP financial measures and information reconciling these non-GAAP financial measure to Tarena’s financial results prepared in accordance with U.S. GAAP are included in Tarena's earnings release which has been posted on our 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.

Thank you Christina and welcome everyone to our second quarter 2014 earnings conference call. I’m very pleased that we achieved an excellent second quarter in 2014, which reported record revenue and profit that exceeded our own expectations. Our top line revenue grew by more than 53% year-over-year to reach $31.9 million exceeding our previously issued guidance. And our non-GAAP net income increased by almost 251% year-over-year to reach $7.2 million. Our student enrollments in the second quarter of 2014 totaled 15,377, increasing by almost 36% year-over-year. Student enrollment growth was particularly strong in our newly launched courses, digital art and online sales and marketing. This further validated our strategy to diversify our course offerings and revenues by expanding into other high growth disciplines. Our digital art and online sales and marketing courses continued their robust growth and together accounted for more than 36% of the total student enrollment in the second quarter as compared with 25% in the previous quarter. Digital art was launched in the first quarter last year remains our second largest course, behind only Java while online sales and marketing launched only in the fourth quarter last year has now become our number four course after C++. Given the success of our new course offerings, Java and C++ together now accounted for 43% of the total student enrollment as of our second quarter compared to 75% in the same period a year ago. In the second quarter our student enrollments from the retail channel increased to 81% of the total student enrollments compared with 72% in the same period in 2013 which resulted in higher average revenue per student. Combined with a tuition fee increase in the second quarter of 2014 this contributed to our revenue growth exceeding our student enrollment growth. As expected we had a higher percentage of student enrollments from the university channel in the second quarter as compared to the first quarter 19% versus 13%, which resulted in slightly lower average revenue per student when compared to that of the first quarter. In terms of course offerings we offered 11 courses in total in the second quarter of 2014 up from nine in the same period a year ago and unchanged from the previous quarter. As discussed in our last earnings call we plan to launch one additional course in accounting by the end of 2014 and we are actually slightly ahead of schedule and are ready to start our first trial class in Beijing at the beginning of the fourth quarter. In terms of new learning centers we opened 10 in the second quarter of 2014, one each in [Shenzhen, Shanghai], Harbin, Jinan, [inaudible] Qingdao, [inaudible] and Guangzhou. We also merged three learning centers one each in Hefei, Hangzhou and two in Guangzhou into existing ones due to either the expiration of the lease contracts or changes to center management. Thus effectively we added a net of six learning centers in the second quarter of 2014 and a net total of 11 in the first half of 2014 compared with 19 in the first half 2013 and we plan to open another 10 in the second half of 2014 compared with 16 in the second half of 2013. As stated in the last earnings call we have taken a prudent approach to new center openings in 2014 in order to continue to drive our margins and profitability. And one key objective in place already for 2014 that we said at the beginning of the year was to drive our center efficiency and utilization rate, especially for newly opened centers. I am pleased to report that we delivered on that promise in the first quarter and again in the second quarter in terms of margin expansion. Gross margin increased by 300 basis points year-over-year to 71.2% and non-GAAP operating margin increased by 610 basis points year-over-year to 15.9% in the second quarter. Our overall center utilization rate already reached 70% in the second quarter of 2014 as compared to 66% in the same period a year ago. In particular, I want to point out that our advertising and marketing expenses in the second quarter of 2014 accounted for 13% of total net revenues compared to 16.7% in the same period in 2013. Advertising and marketing expenses per student enrollment or student acquisition costs declined to US$271 in the second quarter from US$306 in the same period a year ago. We will continue to focus on efficiency in our advertising and marketing spending to maintain a healthy balance between growth and profitability. In the second quarter the Chinese State Council issued the decision to Accelerate Modern Vocational Education in order to encourage the further development of the professional education market and to bridge the structural gap between the demand for and supply of skilled workforce. The number of college graduates in China has risen to a record high of 7.3 million in 2014 and the employment market is becoming increasingly competitive. It is against such a backdrop that Tarena’s consistent job placement rates of above 90% set us apart and accentuates our brand and reputation in the industry. We believe that as a leading professional education service provider with a proven track record of driving success Tarena is extremely well positioned to continue to be benefited from this strong market environment and capture the growth opportunities ahead. With that I will now turn the call over to our CFO, Suhai Ji to discuss the second quarter financial results and outlook for the third quarter and full year of 2014.

Thank you, Mr. Han, thank you, Christina and hello to everyone on the call. As Mr. Han mentioned we are very pleased to have achieved another record quarter with both strong top and bottom line results. So now let me quickly review our financial results for the second quarter of 2014. Please note that unless stated otherwise all numbers that we discussed today are in U.S. dollars. First on the top line growth our net revenues in the quarter increased by 53% year-over-year to $32 million. The increase was primarily due to increased student enrollments and higher average revenue per student as defined by net revenues, divided by student enrollment. Total student enrollments in the second quarter increased by 36% year-over-year to 15,377, which was driven by the number and popularity of our course offerings. The number of our course offerings increased from nine to eleven in the second quarter year-over-year while the number of our learning centers increased from 76 to 103 in the same period year-over-year to cater to the increased demand for our courses. Average revenue per student in the second quarter increased by 13% year-over-year to $2,089. The growth was mainly driven by the increase of standard tuition fees for our courses and a 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 include 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 second quarter of 2014 total SBC expenses were $1.4 million, $up from 0, 2 million in the same period in 2013. More than 88% 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 second quarter of 2014 increased by 39% year-over-year to $9.2 million. The increase was mainly due to higher rental costs resulting from increased number of learning centers and expansion of the existing learning centers, higher personnel costs and welfare expenses resulting from increased number of teaching and advisory staff at our learning centers and higher average salary as well as higher depreciation expenses for our learning centers. GAAP gross profit increased by 60% year-over-year to $22.7 million. GAAP gross margin increased by almost 300 basis points year-over-year to 71.2%. The improvement in gross margin was mainly due to enhanced operational scale and efficiency of our learning centers in terms of lower personnel cost and welfare expenses as a percentage of net revenues and a lower rental expenses as a percentage of net revenues. Now moving on to operating expenses, selling and marketing expenses increased by 34% year-over-year $10.3 million. The increase was due to higher personnel cost and welfare expenses related to the growth in our selling and marketing costs 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 74% year-over-year to $6.2 million. The increase was mainly due to higher compensation cost for our increased number of general and administrative personnel to support our growing operations, higher bad debt allowance and to a lesser extent higher professional expenses. Research and development expenses increased by 37% year-over-year to $1.4 million. The increase was mainly due to the higher personnel and welfare expenses of our instructors allocated to their content development activities for our courses. Our operating income increased by 95% to $3.6 million in the second quarter of 2014. Non-GAAP operating income increased by 150% to $5.1 million. Non-GAAP operating margin increased to 15.9% in the second quarter of 2014 and as compared to 9.8% in same period in 2013. In second quarter of 2014 we had a decrease in effective income tax rate to 10.5% from 17.8% in same period in 2013. The decrease was primary due to a tax holiday of a two-year full exemption from 2014 to 2015 followed by a three-year 50% exemption from 2016 to 2018 entitled by one of our wholly owned subsidiaries which is qualified as a Newly Established Software Enterprise under the PRC Enterprise Income Tax Law. So our net income for the second quarter of 2014 increased by 205% to $5.7 million compared with $1.9 million in the same period in 2013. Non-GAAP net income for the quarter increased by 249% to $7.2 million from $2.1 million in the same period in 2013. So given our total basic share count of 50.7 million ADS and fully diluted share count of 60.6 million post IPO our pro forma GAAP basic and the diluted earnings per ADS for second quarter of 2014 were $0.113 and $0.099 respectively. Non-GAAP basic and the diluted earnings per ADS were $0.142 and $0.125 respectively. In the second quarter we also had a significant increase in cash and cash equivalents and time deposit balance from $38.3 million at the end of 2013 to $151.5 million at the end of the second quarter of 2014 because of the IPO proceeds of $109 million and also cash flow generated from operations. So looking forward to the third quarter of 2014 we expect total net revenues to be in the range of $38.5 million and $39.5 million representing an increase of 35% to 39% on a year-over-year basis. The company also expects its total net revenues for full year of 2014 to be between $134.5 and $136 million, representing an increase of 44.9% to 46.5% 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?

Thank you. We will now begin question-and-answer session. (Operator Instructions). Your first question comes from the line of Fei Fang from Goldman Sachs. Your line is open. Please go ahead. Fei Fang from Goldman Sachs. Your line is open. Please go ahead.

Hi, good morning, Han and Suhai. Thanks for taking my question. Regarding the revenue guidance the third quarter outlook implies a slowdown from the second quarter. I was wondering if you can discuss the pricing and volume drivers behind the guidance and also how should we think about the profitability target for the full year? Then I have a follow-up, thank you.

Sure, I will take this question. I think our Q3 guidance versus Q2 if you increase more than about 20% and year-over-year is about a 36% increase versus the Q3 a year ago. We have decided to slightly reduce the full year revenue guidance against the Street estimates in light of our focus and priority on driving profits and utilization in 2014. But we are very confident to achieve the street estimates for the 2014 profit. And as you can see from our reported results now just released in Q2 we moderated our advertising and marketing spending as a percentage of revenue in the second quarter and we want to continue to strike a healthy balance between growth and profitability for the remainder of the year. I want to reiterate however that we still see a tremendous market opportunity and feel incredibly well positioned to capitalize on that. And I would note that even taking the middle of the range for our full year guidance we are projecting $0.45 year-over-year growth which positions us still as the fastest growing education company among all publically listed education companies from Greater China and we believe our margins will continue to expand for the rest of 2014 driven by the operating leverage in our hybrid learning model.

Well thanks Suhai, that’s great to hear. And regarding the student acquisition it’s great that Han mentioned that you are further optimizing the channels. I am wondering if you can give us an update on the current advertising channels that you are using and also the budget allocation across these channels. Thank you.

Yeah, so for the acquisition channels we did not change the types of acquisition, still search engine advertising accounted for the bulk of our advertising budget. However the progress we made in the second quarter and also in the first quarter is to optimize our search engine marketing in terms of SEO and the SEM and also for certain regions and learning centers we are diversifying to certain extent our other types of online advertising, for example on 58.com and other recruiting websites. So again mainly resulted from the efficiency in our marketing and ad spending.

Understood, thank you.

[Non English].

[Non English]. So my question is management can identify a specific, whether it’s a course or a location that you are revising down the revenue guidance for?

[Non English].

[Non English]. Thank you.

So to translate Mr. Han’s remarks to Fei Fang’s first question. Although we slightly lowered the top line guidance, our bottom line guidance and expectation remain intact, that’s because, the reason behind our slightly lowering top line growth to optimize our operating efficiency that’s why we couldn’t achieve the same bottom-line target with even slightly lowering our top line guidance. And Fei Fang’s second question regarding whether there is a particular course or area that we are seeing forward growth, the question and the answer to that is no, it’s just a general management strategy to control the balance and to control the pace of revenue growth. And operator, we can take the next question in line.

Your next question comes from the line from Ella Ji from Oppenheimer. Your line is open. Please go ahead. Ella Ji - Oppenheimer & Co.: [Non English]. So my first question is if my calculation is correct the total enrollments from Java declined year-over-year in 2Q. I just wondered if management can explain what happened.

I am happy to take that question, Ella. So we have achieved great success in our new courses like digital art and online sales marketing, both of which are growing very fast and help further diversify our revenue which in a sense also reduced the percentage of total student enrolled in some of the traditional courses like Java and C++. And actually a significant percentage of the students who come to Tarena, they come undecided on our which course to take and now we have a wider selection of high quality courses for them that are designed to prepare them for the fast growing job markets in China. And as we have discussed in the past our new course offerings they are based on the proper research on the local job markets. So we expect strong demand for training in those new offerings. So that being said the introduction of those new courses have given our students a greater selection overall which we view as a significant positive for our business and the brand long term even if it may result in some near term enrollment dislocation in our legacy courses like Java and C++. So on year-over-year basis we had a slight decline in the Java and C++ enrollment which are more than made up for by the growth in some other newer courses. And we do not feel particularly concerned because now we are -- have a much more diversified course offering and do not have any sort of overly dependence on any one single course. Ella Ji - Oppenheimer & Co.: Okay. Thank you for the color, Suhai. My second question is -- Han I wonder if you can also share with us some of your thoughts relating to the strategy of pursuing utilization and profitability over growth rate. It seems that your overall your utilization has already been very high. In this quarter it's 70%, it’s definitely above the industry level. So the question is how much higher do you think you can go and do you think it’s really worth it to pursue maybe another some more utilization growth over the growth rate.

So there are two aspects that we are focusing on to increase our overall profitability and utilization. First is to increase the utilization rate. So the overall utilization rate of between in second quarter of 2014 is 70% but our long-term target is between 75% to 80%. Some of our mature centers have already reached 80% but some are below, on average around 60%. So we are confident that there is still lots of room for utilization rate to further increase. And second aspect is to optimize our advertising organization structure and our training system for our sales and marketing people. So we want to spend some time, spend one year to optimize the overall infrastructure so we can get us ready to capture the growth opportunities in the years ahead of us.

Yeah, I just want to add that, we are not the sacrificing revenue, as we stated end of the year. Last year was a big expansion year of us, we opened 35 learning centers. So our operating margin actually came down from close to 19% to 15%. So the objective and priority we set for this year is to really drive the profitability, to get our profit margin back to the level we saw in 2012. We are still not there yet. I mean we do have a half year to work on. So we want to have a healthy balance between the top line versus the bottom line growth and we are confident that we can still achieve the Street estimate for the bottom line growth in terms of margin expansion even in light of this slight lowered revenue, which is less, around 3%. Ella Ji - Oppenheimer & Co.: Very good. [Non English].

Thank you, Ella.

(Operator Instructions). Your next question comes from the line of Clara Fan from Jefferies. Your line is open. Please go ahead. Clara Fan – Jefferies: Hi, hello. Thank you for taking my question. Quick question on the G&A as a percentage of sales, it was higher than what we expected and we noted in the announcements that was mainly due to higher bad debt allowance and higher professional expenses. I’m just wondering how much are those two separately just for my understanding, that allowance should be coming down because we are no longer giving out student loans. And secondly, in relation to the decision to facilitate Modern Vocational Education, can you give us more color on it on how we are going to benefit and whether we can quantify it? Thank you.

Hi, Clara I will take your first question and have Han to address your second question. First question yes, in the G&A category, in that order, detailed items the number one is the personnel cost and welfare and that increased by 35% year-over-year. So in terms of dollar amount it’s about $0.7 million, in absolute dollars, because we increased the number of centers, hired more admin people and also… [Technical Difficulty]. Clara Fan – Jefferies: Hello?

Hello? Can you hear me? Clara Fan – Jefferies: I can hear you now.

Did you hear what I said earlier on the personnel cost. Clara Fan – Jefferies: It was only up to only the $0.7 million and you got cut off.

$0.7 million in absolute dollar amount increase which is about 35% and that went up because we hired more people, admin people, finance people before the IPO and that's quite reasonable. And the second biggest item in Q2 is bad debt allowance. Yes, it's true that we generally read off the installment payment option but bad debt went up in Q2 many due to a couple of reasons. First is our cash collections speed was slower than the growth of the overdue AR amounts. So we actually collected more than RMB5 million in second quarter but 2012 that was a peak enrollment year for the legacy installment payment plan and many students are still repaying us now. So it takes longer to digest the AR from that year. But as we discussed previously we wound down that payment option in beginning of 2013, so last year. So again this is a legacy issue that will be resolved once we digest the associated AR balance. And secondly that’s relative new is for students who are receiving loans from the banks so who are paying us upfront by getting the loans from the bank. The approval process it usually takes about one to two months and if the loan is not approved or disbursed by the time students enrolled in classes we need to make a bad debt allowance as well. But that amount usually gets fully paid as soon as the loan is approved and historically this non-collection from this source has been negligible. So this is only a temporary and the other reason for the cash collection that we will take a number period of time, even though our overall balance will not grow but it has to do with collection speed versus the aging speed of the AR balance. Clara Fan – Jefferies: So appropriately how much was the bad debt allowance last quarter?

About $1.5 million but please remember those are the allowances that we made. They do not mean that we would not be able to collect them and they will only impact the balance sheet and not the income statement. So it went up by another $0.5 million. Clara Fan – Jefferies: And the professional expenses, how much are they?

That's not much, for the last quarter professional expenses went up by $140,000. That mainly has to do with the audit, lawyer, legal fees. Clara Fan – Jefferies: Okay. Thank you.

Okay. I will have Han to address your second question. That was your second question, right Clara about the impact of the recent resolution by the State Council? Clara Fan – Jefferies: Yes.

Okay.

So in the long-term it’s definitely a great news for Tarena because basically the government is increasing encouraging universities to work with enterprises to strengthen the training for skilled workforce and training the college students all practical skills. But that translates to more opportunities for Tarena to work with colleges and universities. So on one aspect we expect the policy to further develop. In the last quarter we signed a cooperation contract with six universities in Jiangsu province to build joint major program. So that means from the first year the major will integrate professional training service provider institute into the college curriculum and university will share tuition revenue with us, Tarena. And right now we have only seen such big collaboration, like joint major programs in the southern part of China due the further development of local policies. And going forward we hope the northern part of China will follow the practice in the southern part and will hope to see more joint major programs cooperation in the northern and south area going forward. Clara Fan – Jefferies: I got a one follow-up question on -- for these joint majors what’s the tuition fee level, would that be lower than from our retail channels and what’s the margins like? Thank you.

It would be lower but it will come at a much lower marketing spending, because if we imagine like once the university signs up you know those joint major program with us, so the students are automatic to enroll in this program. So that does not incur any marketing or ad spending on the part of Tarena. So it’s still a very, very good business for us.

[Non English].

Yeah, the most of the courses are hosted at university facilities. So that will not take up our space in our learning centers that will save additional cost as well. Clara Fan – Jefferies: Thank you.

Okay, any next question?

The next question comes from Jialong Shi from Credit Suisse. Your line is open. Please go ahead.

Yes, good morning, Han, Ji and Christina, thanks for taking my question. I just wonder if the management can share your thoughts on the broad IT professional training market and just wonder from management perspective if there has been a change in the student demand, demand for your courses or if there is any change in the competitive landscape now compared to year beginning. And my second question is about how many quarters you guys expect this internal restructuring may last before you can achieve the desired operating efficiency. Thank you.

To address your first question regarding the overall market environment we have seen two changes. First on the demand side, in the last quarter the IT industry for the first time overpassed the real estate industry and has become the largest employing the industry. So that also translates to our own graduates employment rates in the second quarter has reached record height of 95%, post-graduation employment. And the second change we have seen is we are seeing more students from non-IT background interested in our training services. Currently about 50% to 60% of our students they are from non-computer science majors. So those are the two changes that we are seeing in the overall market environment. So your second question regarding the schedule and progress of our optimizing project. So we are optimizing three aspects, the first is on advertising spending, the second on organizational structure and third, the training system for our employees. The first one, the first aspect, advertising spending we're already seeing encouraging results from this optimizing aspect so that this one part kind of finished and accomplished. And second part regarding organization structure, it’s ongoing and we are expecting another quarter to finish the concept. And third the training system for our employees. We are also pushing it forward. We are expecting another quarter to accomplish that. So we are, overall we are expanding the optimization schedule to ramp-up towards the end of this year in quarter two -- in the fourth quarter. So for the next year we are hoping to be ready for expansion and growth.

Thank you.

(Operator Instructions). Thank you and I will revert the call to Christina Zhu, Tarena’s Investor Relations Manager.

Thank you operator. If there are no further questions then perhaps 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@tarena.com.cn should you have any questions or requests for additional information and encourage you to visit our investor relations website at tarena.com.cn. This concludes Tarena’s earnings conference call. Thank you everyone.

That does conclude our conference for today. Thank you for participating. You may all disconnect.