Tarena International (TEDU) Q4 2018 Earnings Conference Call Transcript

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Tarena International (NASDAQ: TEDU)Q4 2018 Earnings Conference CallMarch 11, 2019, 9:00 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Q4 2018 Tarena International Inc., Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and answer session. (Operator Instructions) I must advise you that this conference is being recorded today March 12, 2019.

I would now like to hand the conference over to your first speaker today, Ms. Lei Song. Thank you. Please go ahead.

Lei Song -- Investor Relations

Thank you, operator. Hello everyone, and welcome to Tarena's fourth quarter 2018 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 fourth quarter 2018 and give guidance for the first quarter and full year of 2019. 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 US Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Tarena does not assume any obligation to update any forward-looking statements except as required under applicable law.

Also, please note that some of the information to be discussed includes non-GAAP financial measures as defined in Regulation G. The US GAAP financial measures and the information reconciling these non-GAAP financial measures to Tarena's financial results prepared in accordance with US GAAP are included in Tarena's earnings release, which has been posted on the Company's IR website at ir.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 -- Chief Executive Officer

(Foreign Language) Thank you Lei and welcome everyone to our fourth quarter 2018 earnings conference call.

(Foreign Language) I am very pleased to report that our net revenues in the year of 2018 increased year-over-year by 13.5% to reach RMB2.2 billion. The fourth quarter revenue contributed RMB615 million which is consistent with in the same period last year.

During this quarter our key programming education business has once more achieved rapid growth, in both student enrollment and revenue recognition. We enrolled 15,233 students during this quarter. The total K-12 business recognized revenue of RMB67 million and received cash of RMB159 million during this quarter, both of which achieved a year-over-year increase more than 300%. For our adult education business we saw a rapid growth year-over -year in student enrollment where our university partnerships, which contributed to an acceleration of enrollment growth in overall adult education business achieving year-over-year increase of 6.3% reaching student enrollment of 36,394.

Meanwhile we continuously improve the profitability of underperforming centers as well as optimize the staffing structure which led to improvement in many efficiency indicators.

(Foreign Language) 2018 was a year of achievement for both new and the traditional business. Also it's very challenging year for us. I would like to present 2018 performances by the following three areas and I'll share with you our 2019 plan.

(Foreign Language) Let's look at retail channel first new revenue (ph). In 2018 the Company operational cost has increased, which resulted in a decrease in profitability. The main reason was that we opened more than 40 centers in 2017, many of which were impacted by market economy and IT training market environment and did not meet our expectations in 2018. We have closed or merged underperforming centers in the second quarter to respond to the unfavorable market conditions. At the same time we continuously optimize the cost structure staffing structure and acquisition channels.

These matters significantly lower the number of nonperforming centers. In addition we also put a lot of efforts to improve teaching quality, which led job placement result even better. Based on the recent business data six month post-graduation job placement rate growth improved to 97% and the employment speed also improved. We gained widely recognition from our students with good teaching service quality which helped us to recruit more students through student referrals.

(Foreign Language) In 2019 our retail business report some recovering profitability. Operating KPI were not limited to contract revenue and contract profits. It also emphasized on operating cash flow to encourage cash collection and to improve operating efficiency. We believe that our retail business will regain its profitability gradually.

(Foreign Language) For university training, 2018 is a year of transformation and capital investment for our university partnership business. With support from government policy encouraging cooperation between schools and companies we successfully explored a featured program business model that schools provide teaching venues and academic credit flexibility, while Tarena provides faculty resources and builds teaching facilities. Both parties operate the teaching -- training center together on campus. Different from joint major programs the enrollment of featured program is up to student's decision and does not need government approval.

In 2018, we have established featured program partnership with more than 100 universities and we have built more than 100 learning centers on campus. Upon completion of the centers we expect to have steady new student enrollment in coming years.

(Foreign Language) Student enrollments through the featured program business model will become a main driver for our adult business growth. In 2018, we recruited approximately 20,000 students through this model. The students are currently in their first year or second year. However, our training is provided in the graduation year. Therefore the corresponding revenue is going to be postponed to be recognized in the year of 2020 and 2021. So the university business net revenue grew -- lagged behind its enrolment growth and also lower than the operating costs increases which brought losses of the university channel business in 2018.

(Foreign Language) Looking forward into 2019 university channel business is going to bear fruit. From 2019 there will be revenues contributed from the students enrolled in a year of 27 university programs. We will also enroll more students in their final year on campus. We believe that these measures will significantly reduce losses from university business.

(Foreign Language) Let's move on to Kid business 2018 is a year of rapid growth for our Kid's Education business. By the end of 2018 after adding 118 new Kid centers in the year we operated 148 learning centers covering 53 cities. Kid's business recorded a full year net revenues of RMB176 million and the total cash received from tuition fees were RMB455 million, achieving more than 400% year-over-year growth.

(Foreign Language) Looking forward into 2019, Kid Education Business is going to enter in period of steady growth. We plan to open about 80 new centers and expect to receive cash of more them RMB850 million, with a 100% annual growth. At the same time we're going to improve existing learning centers' operational efficiency. The KPIs for core management team will include both business growth achievement and profit target completion. We are confident that these changes will gradually improve profitability of Kid centers.

(Foreign Language) To sum up through the adjustment optimization and the investment in 2018, Tarena is entering a period of steady development. Our operation will focus on profitability improvement.

(Foreign Language) With that I will now turn the call over to our CFO, Dennis Yang to discuss quarter operational updates and financial results and outlook for the first quarter 2019 and the full fiscal year.

Yuduo Yang -- Chief Financial Officer

Thank you, Han, and hello everyone on the call. First of all, I'm very pleased to see the higher than expected results in our Kid's Education Business. We believe that in the Kid technology education will become widely known in China, forming a huge market with significant potential and rapid growth. The market size of Kid's programming education in China is expected to reach approximately RMB40 billion in the next three years, with a CAGR of over 50%. In this quarter Tarena's Kid Education Business delivered outstanding results in student enrollment, centers lay out, course development, revenue contribution on the profitability growth for older standards. The student enrollment in Kid Education Business continued the rapid growth, achieving over 300% year-over-year increase, reaching 15,233.

The Company will continue the investment in Kid's Education Business. We newly built 31 centers for our Kid Education in the quarter. By the end of the fourth quarter the Kid Education Business reached 148 centers. On top of that there are also 20 shared learning sites from adult education business, which provides additional classrooms. Our Kid Education Business expanded into 53 cities by the end of this quarter. According to this quarter's financials, Kid Education Business has made greater contributions to the Group.

On one hand the cash received from enrollment reached RMB159 million this quarter, achieving a 400% year-over-year growth and representing approximately 27% of Group's total cash received. On the other hand this quarter net revenue under US GAAP reached at RMB67.2 million for our Kid's business taking around (ph) 11% of the total. We believe the contribution from Kid Education Business will continue to grow in the future and we expect it will gradually become one core driver for Tarena's business growth.

In addition, in 2018 the Company gradually upgraded and improved the course system. We have built a complete Kid's programming course system suitable for kids aged between 3 and 18. The course system will be modified and perfected with more and more practical class experiences. We have also accelerated optimization in the center operation, improved business process standardization and served quality consistency, by which we won wide and positive recognition from our students and parents and made the business model of Kid Centers very replicable.

We will continue our investment in this field. With its extensive education experience in IT area and the solid talent reserve Tarena will be able to keep its leading position in Kid's programming education market by developing diverse courses to maintain its advantage with diversified course system, by standardizing operating procedures to improve the success rate of opening new centers by enhanced operational efficiency and increasing the number of students in schools to improve probability.

We know the recent changes in government regulation related to Kid's education industry. These policies encourage quality oriented extra credit from (ph) education business in order to promote young people's versatile development. Tarena's Kid Education Program consists of computer programming and the robot programming in its goal of quality-oriented courses. These courses focuses on cultivating kid's interest in information technology, programming skills and other standard skills. Therefore we believe that these policy changes are generally good for Kid's programming business.

With the greater importance of information technology and artificial intelligence skills, programming courses are becoming more attractive to young people. We believe this industry is going to experience high speed growth. The Company will keep investing in this area in the next couple of years in terms of new course research and development, network expansion as well as talent recruitment.

Looking to 2019, we expect to continue to expand in K-12 business. We plan to open a total of 80 Kid's Education Centers in 2019, targeting the student enrollment of approximately 80,000 with the tuition cash of RMB850 million. The rapid growth of K-12 education business is also bringing certain short term impact to the financial profit. However in our view it is normal that new business generates temporary financial losses during its rapid growth period.

We closely monitor the cash flows and the probability of each learning center. In general it takes about six months for a Kid Center to have a positive operating cash flow and reach accounting breakeven in about 1.5 years period. We've seen a healthy growth in Tarena's Kid's Education Business and we expect it will start to record the profit in about two years, along with more Kid's learning center become mature and profitable.

These initiatives require more investment and may affect the margin levels in short term, as new centers are still in the ramp up period before they breakeven. However given the broad market prospect and rapid business growth, K-12 business will provide a strong foundation for the companies to grow in future years.

In addition to Kid's Education Business, Tarena's adult education business achieved RMB549 million net revenues in this quarter, representing an 8.7% year-over-year decrease. The year-over-year decrease in student enrollment through retail channel was the primary factor affecting the revenue. The enrollment of adult education business as a whole during this quarter was 36,394, achieving a year-over-year growth of 6.3%.

Enrollment through retail channels delivered 26,802, with a year-over-year decrease of 7.3%, while enrollment through university channels reached 9,592 with a year-over-year growth of 81%. Partnerships with universities become a main driver for the growth -- of growth in student enrollment, through student enrollment. With university partnership model we established deep cooperation with universities. And we are able to have a long-term student enrollment with high volume which will help us to enhance enrollment efficiency and to reduce the student acquisition costs. In this way our adult education business will maintain a continuous growth.

Usually the courses last two to four years under university partnership model, and revenue recognition period is also lengthened accordingly. Certain tuition with signed contracts is to be recognized in later years when education service will be delivered. This results in a gap between the rate of enrollment and the revenue growth. In terms of course contribution in adult business, Python, Big Data and the Linux Cloud computing course have become popular, contributing a total of 5,953 students in this quarter, or 59% year-over-year growth.

We expect that artificial intelligence-related courses will continue to grow in the future. Responding to current market changes Tarena starts to develop continuing education courses to meet demand from the large number of people to upgrade their skills for future career advancement through taking professional training.

Looking forward in 2019 Tarena plans to meet the diverse needs from different groups of people through a richer curriculum system, so that it can be better cope with the fluctuations in the market cycle, achieving steady growth in adult education business. During this quarter the Company continues to emphasize on resources distribution at the same time we made efforts to optimize human resources to improve operational efficiency.

In this quarter the Company closed or merged a total of 12 adult learning center, and entered into new one -- one new city, Baoding. By the end of this quarter we operated 184 adult learning centers in 70 cities. Seat capacity at the end of 2018 was 56,585, which represent 0.7% year-over-year decrease. By optimizing the seat layout the seat utilization rate improved to 71.6% as compared to the utilization of 69.6% in the same period last year.

This quarter we are further optimizing sales and marketing team and saw improvement in enrollment efficiency. For example, the student acquisition cost per student of adult education business was RMB 5,861, which is the lowest of -- in the past four quarters. The improvement in seat utilization rate and sales per capita productivity mentioned above proved the effectiveness of center resources optimization strategy. We believe that this strategy will have positive impact to future profit recovery.

And now let me address some more key item in income statement. Firstly gross margin in first quarter declined by 19 percentage points, year-over-year to 53.7%. Such a decline in gross margins mainly due to the following reasons. First, K-12 business gross margin dropped by approximately 800 bps. The Company built up 100 Kid's Learning centers in the past 12 months and by the end of this year we operated 148 centers, most of which have not yet reached an ideal utilization level.

Current gross margin of K-12 business is significantly lower than the margin of our traditional adult training business. Second less revenue recognized from adult business during the quarter brought around 400 to 500 bps impact on achieved margin. Because of slow down in retail channel and the referral (ph) of contract revenue from a student under university partnership programs, the revenue of adult business in this quarter decreased by RMB50 (ph) million as compared with the net revenue in the quarter a year ago. We expect the GP margin recovery for both adult and Kid's business, when the Company takes profits first strategy for adult business, where we focus more on operational efficiency than business expansion.

Meanwhile we expect GP margin improvement in Kid business because more Kid's learning centers are operated for more than one year and those learning centers start to make a profit.

Now let's take a look at G&A expenses. For the fourth quarter the Company record bad debt allowances for doubtful account receivables of RMB52 million to reflect the difficulties in the collection of account receivables from 2017 students. The Company believes that receivable collectability risk around 2017 students have been largely covered by better provisions in our books.

As Mr. Han said cash flow improvement is one of the key performance indicators for our operational team in 2019. Center managers are encouraged to expedite tuition collections from students. As the Company maintains long term partnership with a group of loan providers in our view, relatively high risk of account receivables from 2017 students is an isolated case and won't change long term outlook of bad debt provision levels in our adult business.

Our non-GAAP operating loss in this quarter was RMB166 million lower than non-GAAP operating profit, RMB99.6 million in the same period last year. On one hand in the past years rapid expansion of Kid's education business, more than 100 new learning centers opened and 21 centers were added through acquisition, many of these learning centers are not in the mature and kind of loss making, which led to greater non-GAAP operating losses for the Kid's Education Business in this quarter. We believe that more Kid's Education Centers will start making profit along with the number of students in schools increases.

On the other hand there are non-GAAP operating losses, RMB29 million from adult education business. The reason of a year-over-year decrease in the profits was due to the significant decrease in the revenue from adult business, caused by the smaller number of student recruited through retail channels and additional market cost to achieve the higher enrollment as well as a greater amount of bad debt expenses to doubtful account receivables.

Looking forward to the first quarter 2019, we expect the total net revenue are between RMB395 million and RMB415 million, representing a decrease of 2.9% to an increase of 2.1% on a year-over-year basis. The Company also expects its net revenues for the full year 2019 to be between RMB2,430 million and RMB2,580 million, representing an increase of 8.5% to 15.2% on a year-over-year basis. So operator?

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Your first question is from Mariana Kou from CLSA. Please ask.

Mariana Kou -- CLSA -- Analyst

Hi, good morning management. Thanks for taking my question. I have two questions. First one is about the Kid's business. I noticed that I think at as of end of 2018 we are covering about 53 cities. So just wondering what's our strategy there for the Kid's business, are we are looking to kind of do it more of a wider network? Was this going deep into existing cities because I think some of the leading players in like K-12 type children businesses, they are covering a similar range of cities, but definitely got a lot more like hundreds of centers. So just a bit of more thoughts on that would be quite helpful in terms of how we think about margins, operating revenues et cetera from an operational angle.

And a kind of -- more of a -- a little bit followup on the Kid's businesses. If you could also help us understand the breakdown on GP -- because I think just know you shared a bit on the margin driver at Group level but if you could help us get a bit more clarity on the GP margins between those two business -- like adult and K-12 for Q4, because I think Q3 there were some disclosures on the cost of revenues for kids so, we could kind of calculate that adult business was more in the 70s percentage, and K-12 was at a loss level for GP. But if you could help us kind of get some clarity on Q4 margin for those would be helpful.

And I guess lastly is just on the outlook for the full year and also kind of going forward for revenue, do we just expect this more of a high single-digit to low teens revenue growth to be the level that we should be thinking about in the next few years? Thank you.

Shaoyun Han -- Chief Executive Officer

(Foreign-Language) Okay Mr. Han, addressing Miriana's first question about our future Kid's business expansion plan, the Kid's business for Tarena actually leverage our human resources from adult business. As you may know that we operated our adult business in 70 cities. So out of 70 cities we are very quickly to expand our K-12 business in 53 cities. But look if we look into 2019 we plan to focus on first tier cities and those provincial capital cities. So well, we don't expect to expand our K-12 business into more new cities in 2019.

Yuduo Yang -- Chief Financial Officer

So Mariana second question is on margins of K-12 business. I can share with some data, but beware of those data are mostly based on our management report that K-12 gross margin, non-GAAP gross margin about in Q4, about minus -- no, sorry gross profit negative 90 million. So the GP margin about minus 29%.

In terms of operating -- non-GAAP operating losses, which was RMB137 million for the first (ph) quarter, K-12 business. So based on our forecast in the future we would -- if we look per learning center on the K-12 -- K-12 per learning center, we are expect the high teens or low 20s, margin level when the learning center can mature. So this is also the long term perspective, from management perspective for K-12 business.

But considering we have a big portion of the K-12 learning centers operated not reached to the mature level, so we expect still loss making from K-12 business, but we are -- we expect the operating losses from K-12 business will -- getting narrow over the future quarters and you will see those the net operating losses getting narrowed happening over the quarter in 2019. Mariana?

Mariana Kou -- CLSA -- Analyst

Yes. Thank you.

Operator

Your next question is from Alex Xie from Credit Suisse. Please ask.

Alex Xie -- Credit Suisse -- Analyst

HI, management. Thank you for taking my questions. Firstly I would like to ask about our adult business. So after closing down the 12 underperforming learning centers in the fourth quarter, how many learning centers are still underperforming in the adult learning center network? How many are we planning to close, say in 2019? And my second question is about the K-12 business. So for the overall K-12 business when do management expect the business to reach breakeven, yeah, thank you?

Yuduo Yang -- Chief Financial Officer

Thank you. Alex for the two questions. Your first question, talk about how many non-performing adult learning centers as of now. I -- in my view there are no more than 10 learning centers are still loss making or non-performing. So we about to further optimize those learning centers. However if that optimization doesn't happen, the good results we will continue to -- consider closing those learning centers, 2019.

Your second question about the K-12 business breakeven, as I mentioned that you will see that our operating losses from K-12 business getting narrowed in 2019. I expect we will see the quarter -- quarterly K-12 breakeven in 2020. So sooner or later in 2020 and 2021, our current expectation -- our current forecast shows that 2021 is the first year the K-12 business could be profitable.

Alex Xie -- Credit Suisse -- Analyst

Thank you.

Operator

Your next question is from Johnny Wong from Jefferies. Please ask.

Johnny Wong -- Jefferies & Co. -- Analyst

Hello. Good morning, management, and thank you for taking my call. My question is in regard to the traditional adult business. I recall that we had a strategy of hiring more sales people to try to increase the sell-through rate of inquiry. But it seems that I think in the fourth quarter our adult enrollment, I believe it probably decreased on a year-to-year basis, especially on the retail side. Can you let me know what the -- how the strategy of increasing the sales force is going, and whether or not we need to rethink about that strategy? Thank you.

Yuduo Yang -- Chief Financial Officer

Thank you, Johnny for the question about our sales strategy. We initially planned to recruit more salespeople to enhance our sales team to drive enrollment, but at the same -- but the overall IT industry saturated recently. So it's pretty challenging for Tarena simply to recruit more people to drive the enrollment. So we -- in doing that we try to focus more on profitability. So we make some changes in our strategy that we try to make more profits over to keep the business expansion.

Shaoyun Han -- Chief Executive Officer

(Foreign Language) Mr. Ham added that the sales people per learning center actually increased -- increases in the past quarters, but we downsized or closed the centers. So we have a chance to -- we have a chance to downsize the overall sales team in Q3 and Q4.

(Foreign Language) From the general sales and marketing costs for students in our adult business we've already seen some positive changes and the decrease of those per student acquisition cost.

Johnny Wong -- Jefferies & Co. -- Analyst

Thank you.

Yuduo Yang -- Chief Financial Officer

Yeah. I'm sorry, that I need to make a correction that addressing the Alex's question about -- just now, regarding the K-12 breakeven I would say, 2020, we'll see the quarterly breakeven -- sorry. Yeah, 2020, I should say in the 2020 it's likely that we -- we have seen quarterly breakeven for K-12 and 2021, it's likely that we'll see full year breakeven.

Operator

(Operator Instructions) We don't have any other questions as of the moment. Presenters please continue.

Yuduo Yang -- Chief Financial Officer

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

Operator

Ladies and gentlemen that does conclude our call for today. Thank you for participating. You may all disconnect.

Duration: 53 minutes

Call participants:

Lei Song -- Investor Relations

Shaoyun Han -- Chief Executive Officer

Yuduo Yang -- Chief Financial Officer

Mariana Kou -- CLSA -- Analyst

Alex Xie -- Credit Suisse -- Analyst

Johnny Wong -- Jefferies & Co. -- Analyst

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