Ladies and gentlemen, thank you for standing by, and welcome to the TAL Education Group Third Fiscal Quarter 2019 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, January 24, 2019. I would now like to hand the conference over to your first speaker today, Ms. Echo Yan. Thank you. Please go ahead.

Thanks, operator. Thank you all for joining us today for TAL Education Group's third fiscal quarter 2019 earnings conference call. The earnings release was distributed earlier today and you may find a copy on the Company IR website or through the newswires. During this call, you will hear from Chief Financial Officer, Mr. Rong Luo and Linda Huo [ph], Vice President of Finance. Following their prepared remarks, Mr. Luo and Ms. Huo will be available to answer your questions. Before we continue, please note that the discussions today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in the public filings with the SEC. For more information about these risks and uncertainties, please refer to our filings with the SEC. Also, our earnings release in this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures. I would like now to turn the call over to Mr. Rong Luo. Rong, please.

Thank you, Echo. Good evening and good morning to you all. Thank you for joining us today on this earnings call. Our third quarter revenue performance was based on healthy growth of small class business in the cities we currently cover and the scaling of our online courses. Revenue growth in the third quarter was 35.3% year over year in dollar terms to USD586 million, and 41.4% in RMB terms. Student enrollments increased by 68.4% year over year, mostly driven by the growth in the online enrollments as well as Xueersi Peiyou Small Class. GAAP income from operations increased by 59.2% to USD71million in the third quarter. Non-GAAP income from operations grew by 63.5% to USD92.9 million. I will now turn the call over to Linda Huo, our Vice President of Finance. She will give you an update on our operational progress in the third quarter. After that, I will update you on the business strategy execution and discuss our business outlook. Linda please?

Thanks, Rong. The healthy pace of fiscal third quarter revenue growth was driven by the demand for the various education services in the cities we currently cover. Let me review the business by different revenue streams. Let me start with small class as well as other business, which consists of Xueersi Peiyou Small Class, Firstleap and Mobby Small Class and some other educational programs and services. These accounted for 79% of total net revenue compared to 85% in the third quarter last year. The revenue growth rate was 26% in US dollar terms, and 31% in RMB terms. Xueersi Peiyou Small Class which remains our core business represented 65% of total net revenue compared to 72% in the same year ago period. The lower revenue contribution from Xueersi Peiyou was mostly due to the faster growth of online courses, which accounted for 15% of total revenue in the quarter, compared to 8% in the same period last year. Net revenue from Xueersi Peiyou Small Class was up by 23% in US dollar terms and 29% in RMB terms, while enrollment increased by 29% year-over-year. This growth rate reflects the stable growth in both Peiyou offline and online class. Currently, we offer Xueersi Peiyou online courses with a complimentary service, tailored to student needs in major cities of our network. Xueersi Peiyou online offers regular and short term courses and other promotion courses. Excluding revenue contribution from Peiyou online in both the third quarter of fiscal year 2018 and 2019, the Peiyou offline small class revenue increased by 19% in US dollar terms and 25% in RMB terms, while enrollments increased by 8% year-over-year. In addition, excluding Peiyou offline promotion and short term courses in this quarter, Peiyou offline normal prices [ph] courses revenue increased by 27% in RMB terms, while…

Thank you, Linda. These business results reflect that we are well on track with our fiscal year 2019 plans and expectations. As you know, the education industry, including after-school tutoring markets is currently in the midst of ongoing education reforms, standardizations and regulations. All these policies are aimed at further improving our standard in the ecosystem of the entire industry. We’re following government directions and where needed, we will continue to make adjustments to our business operations accordingly. TAL today is a technology driven education company in China and our mission is to advance education through science and technology. When the conditions are right, we’re waiting to give support education institutions in China, especially in lower tier cities and rural areas with our essential and innovative education products, contents, technologies, services and other teaching resources through our various program and solutions. We aim to offer students the knowledge and the skills they need through curriculum courses and after curriculum confidence building courses. Today, together with the payers in this industry, we will make continuous efforts and investments to explore further education models and opportunities. Turning now to our business outlook, based on the Company's current estimates, total net revenues for the fourth quarter of fiscal year 2019 are expected to be between USD670.5 million and USD685.6 million, representing an increase of 33% to 36% on a year-over-year basis. If not taking into consideration of the impact of potential change in exchange rate between RMB and the US dollars, the projected revenue growth rate is expected to be in the range of 40% to 43% for the fourth quarter of fiscal year 2019. These estimates reflect the company's current expectations, which is subject to change. That concludes my prepared remarks. Operator, we’re now ready to take questions.

[Operator Instructions] Your first question is from Tallan Zhou from Deutsche Bank.

Congratulations management on such a solid result. I have two questions. First, Rong, can you talk about the guidance of the margin for next quarter and probably like the growth outlook for online, off line for next year. And also second question is, seems like the margin for this quarter is quite, it's much better than I previously mentioned, any particular reason on that? Thanks.

Thank you, Tallan. And I will start from the Q3 margin questions and then walk through Q4 and the next year. Right before I answer the question, I have to say is nothing comes easy. All the numbers we can deliver today actually require a lot of efforts from the team. And I personally appreciate all the people in our company who have worked closely and make it happen. Specifically in Q3, you probably can walk through the numbers. If we're only talking about non-GAAP op margin spend, if you probably can see, we’re making progress in the gross margin [indiscernible] previous two quarters. Q3, we increased our gross margin by more than 5 points. The reasons are almost similar to what we've seen in the previous quarters, which is we’ve slowed down our expansion in offline, which gives some buffers for us to deliver in the margin leverage. And by the end of Q3, we have including -- we have expanding the classroom numbers by around 14% year-over-year compared to last year, which is a little bit slower than our previous years. Part of that is because of the policy reasons. Part of that is because we want to control the offline growth pace a little bit. And we also see the other positive reason factor to contribute to the Q3 margin, which is better, that is because we scaled on [ph] the marketing investment. Compared to Q2, Q2 actually, that's very important and very prime time to do online promotions, because it’s summer. Most of the parents will make decisions for their kids, which school they will go in the coming few quarters, they make decisions in summer. So Q2, you probably can see that, we run much bigger scale promotions in Q2. But running into Q3, which…

Your next question is from Natalie Wu from CICC.

This is [indiscernible] on behalf of Natalie. We have two questions. The first one is on your deferred revenue. I guess, how much of your deferred revenue has been impacted by the new tuition collection policy and I mean, which cities have adopted such new policy, if not all of them? The second question is on your online promotion plans, for summer of 2019, whether if you plan to do the usual RMB50 courses, just like last summer or some free trial courses, just like this winter and how much marketing budget have you prepared for that and how should we look at the growth outlook of Xueersi online into fiscal year ’20?

Let me clarify. The second question is about my marketing plan for next year's summer, right?

Yes. The online promotion plan for summer of 2019?

Yes. Okay. So I will give first question to Ms. Linda Hou who is Finance [indiscernible] quite familiar with all the comments about deferred revenue and I will answer the second question.

Sure. Hi. This is Linda. Thanks for the question. All the government policies and regulations are aiming to improve the whole industry’s level of service and standards and also the overall environment. And all players in the industry should follow the relevant standards and requirements. And for your question, yes, according to the regulations issued last year in August, parents cannot be build for more than 3 months. It’s that have impact our deferred revenue and cash flow. Since the policy has been issued, we have followed the government's requirement to make necessary adjustment of our past situations, the charging policies if needed. This particular policy actually gives right of choice, back to the parent, which we believe is a right and good practice for types of parents to drive interest. And as just mentioned have improved the overall industry environment. And as you all know, we have always had an open duration refund policy ever since the company was established. For example, the Peiyou Small Class business refund policy is that the parents and students have the right to refund the tuition fee for courses they have not attended before the end of the courses if they are not satisfied. And in addition, another relevant factor is the new accounting standard and that has been adopted since the first quarter of fiscal year 2019, which requires the company to estimate the refund rate and to reclassify part of the deferred revenue or accrued expenses and other current liabilities. And in terms of the pro forma, we charge tuition fee based on the spring, summer, autumn, winter semesters. Among the 4 semesters, summer and winter semesters comp period is normally 3 months, whereas spring and autumn semesters comp period is normally longer than 3 months. So if we took consideration of both the refund reclassification and the schedule change in tuition fee collection and made an apple to apple comparison, the deferred revenue in the end of third quarter of fiscal year 2019 would increase by more than 30% year-over-year. I hope this answers your question. Thank you.

Yes. And the second question about marketing, online marketing, including the format of marketing and including marketing for next year budgeting, I think that's a very good question. This year, we run the marketing promotions with RMB50 classes and some more classes through that and we’re investing online marketing channel including WeChat channels, Baidu channels, Total channels and other channels to attract new students. I think this kind of marketing promotion driven growth works at least for Q2 and the coming maybe one or two quarters. But we have to see that, if we don’t change the way of marketing, we don’t change the way to attract students in, if we continue to do the same marketing in the same way, actually, the marginal cost will want new users will be hiring higher. So one question giving back to us, in fact, what’s the right decision for us to make next year, how to attract new customers, how to maintain high growth? The way we’re running today, some of the good learnings will probably continue to grow. For example, the RMB50 class, pilot class, but some of the ways, maybe we will not implement again. For example, if we went into the lower tier cities, maybe we need to be more innovative, not only in online, but also need to consider some other to leverage our offline presence, offline advantages. Coming to today, we can say with group model, our perfect model, how to penetrate the low tier cities and how to try to optimize the return of marketing in a more efficient way. What we need to do is and what we can do is, list out all the possibilities and all the way of channels and then we do pilots. We use our online check assistance to make…

Your next question is from Thomas Chong from Credit Suisse.

Hi. Thanks management for taking my questions. I have two questions. The first question is on regulations. Can management give us some update about the offline and online regulations, updates, if there is any as well as the teachers possibly for the exams, if there's any expectation or color on that would be great. Second is about our online investment, can management give us some color about how we should think about the online investment as we go into FY20 and should we expect win/losses for next year?

Thank you, Thomas. About regulations, I think starting from the July earning call, which is the first time we head off to the story, much earlier than the other companies to notice the uncertainty and the risk coming from policy and regulations. And coming in to today, it's almost 6 months now, so we probably see a lot of documents and policies that was issued from the government and which has greatly improved the service spend there of the whole industry. And we, as well as we say before, as the leading player in this industry, we fully agree with all the policies and try to execute policies in our operations as much as what we can. You're probably going to see that one-off examples this quarter, we closed around 19 learning centers, some of that is because the standard operation schedule, for example, the lease is still so we move to the other place, but some of that is because, we want to follow the government regulation to make sure our incentives can be combined, so we closed down unqualified centers and rent the other one and to move that we’re seeing to try our best to be compliance with all the government kind of policies. And we believe all of these policies, at the end, their purpose is not try to cure the industry, their purpose is try to protect the rights of parents and give more rights of choices back to the parents, which is also -- can propel the whole industry and will be beneficial to all of compliance companies in the long run. And besides what you have seen, the offline regulation policies and we have disclosed and make you very open to all of your guys in the past earnings calls, based on today's…

Your next question is from Mark Li from Citi.

Congratulations on the very strong results. My question is, for the last quarters, non-GAAP op margin, I think you actually hit management’s guidance by like about -- more than 300 basis points. I know at that time compared to right now, what is the difference that explain the better margin that we previously estimated. What would you rank the factors?

The first one is the trust pay us more cost, operating efficiencies and their pace of expansion is better than what we expected and we also start to see the capacity in addition is also a little bit better than before. And because of the slowdown, the new capacity, so that's the way we probably can see some maybe bigger leverage is what we expect in the early time of the quarter. Second think I think is the things I mentioned just now is because their promotion of offline plus online is smaller than what we expected and the online investment definitely, we need to evaluate from day by day, because we need to evaluate their OIs and make sure the checking is well on track. If we see some of the rating is not going quite well, while we reduce the investments and reduce the total amount. So that is a dynamic process. It’s hard to pretty much earlier before the end of quarter. So we probably see two drivers which contribute to a much better, a little bit better margin status. But again, I think in the long run, the story with for offline this year, we continue to improve in the operating efficiency to make the budget a little bit better than last year, while online, we continue to seek for market share and we will balance their investment over there to make sure we can maintain a high growth and try to save as many as possible to make sure all the investment we make have better than before, so that's kind of the mixed result of these two drivers.

I just want to make sure, so you didn’t mention regulation, maybe related factor. So do you think actually the regulation is not meaningful to the margin better than expected for the last quarter?

I don't think so, because of the policy and regulations, we slow down the capacity expansion rate. We probably can see that already. Last year, we grew our capacity by more than 51%. The year before last year is over 50%. Two years before last year actually is around 80%. The numbers, today, by the end of today, that's only 14%, 1-4. So I think in the short term, if we want to combine with the government policy and regulations, so we change the way off expansions definitely, this has been reflected in the numbers and all and in the long run, we still believe with all the regulations in place, which aim to protect the parent's rights and which aim to improve the service level of – service quality of the whole industry. The compliance companies in the long run will be beneficial. And about the – and at the same time, I also have one point I want to make is, based on our own numbers, we don't see significant or meaningful number of students who move from Dallas more coming in to us. Most of our revenue still is contributed by our organic growth. We have the Xueersi Peiyou small business, we have Xueersi online, we have Xueersi online school and we have all of our offerings ready, we continue to improve our teaching quality and service level and to make sure we could satisfy the parents and students. We strongly believe most growth, we need to drive most growth through our organic drivers, now from Dallas company. And that's what I said today, looking forward, we don't have any kind of expectations about whether policies are being worse or will be better. What we can do is wherever have new policies coming on with this and communicate to you guys, as well as where we can and we as a company, we need to make sure we feel ourselves stronger, which make us, can be more flexible when we face policies and challenges over there. Sometimes, the people will get something very easily. The story happened two quarters ago and some people will forget after one or two quarters, but we as a company, we're running the business in this market, we cannot forget all of that. We need to follow the new rule, new politics with environment and we need to change our growth drivers to be more adaptive to the new challenges. So that's the only way for us to continue to grow substantially and sustainably in the long run.

Your next question is from [indiscernible] from Macquarie.

Congratulations on your very solid results and thank you for taking my questions. So my question is, can you share some color on current utilization rates of the existing learning centers and how much further can we go and also do you need to expand aggressively next fiscal year in order to meet the demands, can we share some guidance on the next fiscal year capacity ramp up?

Thank you so much for the questions. Last quarter, our utilization rates have been slightly increased, around 1% and because in our classes, the – since fulfillment is always high, and retention rate is also very healthy, so we believe maybe in the long run, we still have maybe low single digit percentage of potential to increase in these metrics. But that's it, don’t be too optimistic about that, because we are already quite high. And secondly, about expansions, this year, you probably can see in Q3, we entered 11 new cities, so dual teacher models. So let me clarify, since around one or two some 18 months ago, we have decided we don't expand our offline model to new cities. Most of the places we enter actually through dual teacher models, last year, we entered around 12 cities, and now, this year, by the end of today, it’s 11 cities. And at the same time, we also see huge, sorry, we also see very healthy growth form the online segment respective with tripe digit. So we need to, as a company, we need to balance, we have the high growth drivers in online, we have a new model called dual teacher models and we have the offline, which is our traditional models, we need to balance all of that. If we can drive the growth through online, which is more kind of -- which is better, then we can drive the growth simply from offline. So, looking forward, we will continue to balance our three drivers and making sure we can leverage the advantages of different drivers to try to penetrate more cities in a more healthy way. But I can’t figure out today to say, we will expand faster or slower of next year offline network. So we probably will continue to give you guys numbers quarter over quarter and we will continue to follow all of the government policies and regulations to make sure the new living standards we enter is compliant with the government requirements. So, we definitely will, just stay tuned, we definitely will give you guys numbers quarter over quarter.

Your next question is from Lucy Yu from Bank of America Merrill Lynch.

I got two questions regarding online in the third quarter. Can you talk about online margin impact in the third quarter in terms of non-GAAP operating profit. Secondly is, can you give us some color on the online retention rate going from fall semester to winter semester?

Online marketing, that margin impact in Q2 [indiscernible] gross margin, which is because we are slowed down a little bit in offline network, which give us more buffer in the much expected as well as the online marketing. I think these two drivers contribute to a little bit better in non-GAAP op expenses. Same as before, because of the competitive reasons, we don't go through detailed numbers about online marketing, but we can say is the scale of online marketing in Q3 is significantly lower than Q2. And the retention rate for online, here, I think what we mentioned is retention rate of the regular class. The regular class retention online compared to the offline is slightly lower and since in Q2, we’re running a large scale of promotions, so in Q3 and Q4, especially in Q3, it’s very important time for us to focus on the product and services we deliver to make sure we can improve retention rates as much as we can. And we still have a lot of efforts we can pay and we still have a lot of kind of spaces we can improve in the long run. So we wish maybe in the future quarter after we emphasize the team, the retention of online can be higher than today.

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