Ladies and gentlemen, thank you for standing by and welcome to the Q3, Full-Year 2020 TAL Education Group Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would like to hand the conference over to your speaker today, Ms. Echo Yan, IR Director of TAL. Thank you. Please go ahead, ma'am.

Thanks, operator. Thank you all for joining us today for TAL Education Group's third fiscal quarter 2020 earnings conference call. The earnings release was distributed earlier today and you may find a copy on the company's IR website or through the newswires. During this call, you will hear from the Mr. Rong Luo, Chief Financial Officer; Linda Huo, Vice President of Finance; and myself, IR of TAL. Following the 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 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 solid growth momentum of both our overall small class business in the cities we currently cover and the continued scaling of our online courses. Net revenue growth in third-quarter was 47.2% year-over-year in US dollar terms to US$862.4 million and 50.7% in RMB terms. Total normal priced long-term courses student enrollment increased by 66% year-over-year, mostly driven by online enrollment as well as Xueersi Peiyou small class. GAAP income from operations grew by 9.9% to US$78 million in the third quarter. Non-GAAP income from operations increased by 16.4% to US$108.2 million. This quarter's results reflect the progress in our efforts to build a healthy and sustainable business model based on our product development, technology, customer satisfaction and operational efficiencies. I will now turn the call over to Linda Huo, our Vice President of Finance. She will give you update in our operational progress in the third quarter. Next, Echo Yan, our IR director, will review the third quarter financials. After that, I will update you on our key strategic execution and discuss our business outlook. Linda, please?

Thanks, Rong. Fiscal third quarter revenue was based on solid growth momentum in the various education services of our tutoring business. Let me review the business by different revenue streams. Let me start with small class and other business, which consists of Xueersi Peiyou small class, First Leap, Mobby and some other education programs and services. These accounted for 76% of total net revenue compared to 79% in the third quarter last year. The revenue growth rate was 41% in US dollar terms and 44% in RMB terms. Xueersi Peiyou small class, which remains our stable core business, represented 61% of total net revenue compared to 65% in the same year-ago period. The lower revenue contribution from Xueersi Peiyou was mostly due to the faster growth of xueersi.com online courses, which accounted for 18% of total revenue in the quarter compared to 15% in the same period last year. Net revenue from Xueersi Peiyou small class was up by 36% in US dollar terms and 40% in RMB terms, while our normal-priced long-term course enrollment increased by 51% year-over-year. This growth rate reflects the solid growth of both Xueersi Peiyou offline and online class. Peiyou offline small class revenue increased by a steady rate of 27% in US dollar terms and 30% in RMB terms, while our offline normal-priced long-term course enrollment increased by 32% year-over-year. With Peiyou online, we offer online courses with localized content as a bundle or as still complimentary service to Peiyou offline in over 30 major cities of our network. We have, in recent quarters, added more regular and short-term courses subjects and other promotion courses. These are increasingly synchronized with offline courses and support the learning process and learning experience for our students. In the third quarter of fiscal year 2020, Peiyou online accounted…

Thanks, Linda. Let me now go through some key financial points for the third quarter of fiscal year 2020. The breakdown of ASP for the various business is as follows. Normal-priced long-term Xueersi Peiyou small class ASP decreased by 7% in RMB and 9% in US dollar terms year-over-year. Peiyou offline normal-priced long-term courses ASP was almost flattish year-over-year. Normal-priced long-term Zhikang one-on-one courses ASP increased by 8% in RMB and increased by 6% in US dollar terms year-over-year. Normal-priced long-term online course ASP decreased by 9% in RMB and 11% in US dollar terms year-over-year, partly due to the mix change of our diversified online course offerings. Gross profit increased by 49.9% to US$477.2 million from US$318.4 million in the same year-ago period. Gross margin for the third quarter improved to 55.3% as compared to 54.3% for the same period of last year. Selling and marketing expenses increased by 87.9% to US$190.9 million from US$101.6 million in the third quarter of fiscal year 2019. Non-GAAP selling and marketing expenses, which excluded share-based compensation expenses, increased by 89.2% to US$186.4 million from US$98.5 million in the same year-ago period. The increase of selling and marketing expenses in the third quarter of fiscal year 2020 was primarily a result of more marketing promotion activities to expand our customer base and brand enhancement as well as a rise in the compensation to sales and marketing staff to support a greater number of programs and service offerings compared to the same period in the prior year. Operating income increased by 9.9% year-over-year to US$78 million from US$71 million in the same year-ago period. Non-GAAP operating income increased by 16.4% to US$108.2 million from US$92.9 million in the same period in the prior year. Other expenses was US$3.7 million for the third quarter of…

Thank you, Echo. Let me update you on our business and development strategy. We continue to develop our diversified business sectors and new programs and projects to offer more suitable and overall educational services to our customers. I will briefly discuss each major business sector. Our core Peiyou small class business remains healthy and stable. As I mentioned last quarter, we decided earlier in this fiscal year to the gradually accelerate a little bit the offline learning center expansion rate. Our network of 70 cities, of which 40 newly entered this year, currently consists of well over 13,000 customers. We will enter more cities in the coming years. Meanwhile, Peiyou online is growing rapidly this year. It's an attractive platform for students both as a course supplement and synchronized courses content to Peiyou offline. In this emerging model, we are cross-leveraging Peiyou offline and Peiyou online in both directions. The growth dynamic of this business and our operational efficiency efforts have made positive contributions and will continue to do so to help balance our growth and our profitability as well. In the coming two quarters, we expect the growth momentum of Peiyou small class continue as we further develop our offline network at a suitable speed and scale the business. We believe we can further leverage our offline and online advantages and resources, especially through our AI and other technologies. This will enable us to build an education services model which is demand-driven and sustainable for the long term. Meanwhile, our online business is a high-growth, early stage business in competitive and quickly evolving market. For every stage of the business, we will continue to promote the brand awareness of xueersi.com. At the same time, we do our best to continuously improve our overall online education services and operational efficiencies.…

Certainly. [Operator Instructions]. We have the first question from the line of Yuzhong Gao from CICC. Please go ahead.

Hey, management. Thanks for the opportunity. Congrats on a very strong third quarter. I noticed your offline capacity expansion has accelerated meaningfully and your Peiyou revenue, even excluding the effect from a low base last year, still proved pretty strong results. So, how should we see the capacity expansion pace and your Peiyou revenue growth for the upcoming few quarters? Thanks.

Thank you. I think for the Peiyou small class business, we talked about it last quarter actually. I think two quarters ago, after the evaluation of our current business model and evaluation of the environment of total regulation, we decided to accelerate a little bit the Peiyou small class. We tried to enter more cities. This year, we have entered around 13 cities, including one in the US. And we will try to enter more cities next year. And last year, you'll probably recall that we're only adding around 13% of total classroom capacities in the last year. And by the end of this quarter, we are already adding around 17%. And considering, by the end of the day, in quarter four, we have already opened 76 Peiyou small class learning centers already. And we expect to add in few more in the coming one month. So, overall, the Peiyou small class expansion rate will be in the range of 20% to 30%. But one thing I need to remind all of you guys is here when we report, we have a new learning center in the existing cities, which means we have signed a contract for the rental. But it generally takes a few quarters to finish the renovations, ask for the license, and then we will put them into use, which typically will take around two to three quarters. So, all the learning centers we added last quarter and this quarter probably will contribute revenue in this year's summer and fall. And looking to next year, I think we probably – with all of these learning centers we're adding in this year – Q2, Q3 and Q4 – Q2, 20-plus learning centers; Q3, 36-plus new learning centers; and while Q4, 76, even more. So we are confident about…

Thank you. Very helpful.

Thank you.

Thank you. The next question comes from the line of Mark Li from Citi. Please go ahead.

Hi, management. Congratulations. May I ask -- I think our non-GAAP operating margin particularly this quarter is better than the guidance of around 4 to 5 points. Could you rank the factors that is better than your expectations? And how are these factors changing for next quarter's color? Thank you.

Thank you, Mark. I think, for Q3, in the first place, we did a better job in the Peiyou small class business than what we expected. So, you probably can see that we increased our gross margin by 1 point, which can also contribute a little bit better in the profit perspective. On the other side, we spent some of the online marketing in Q3. You probably can see that, compared to last year, same quarter, actually it's more than last year. [indiscernible] also well on track. We feel that it's – the promotion results were on track, so which can also give us some kind of buffer in the profit perspective. So, we're quite happy to see that Q3, in the margin perspective, is a little bit better than what we talked about before. Looking to Q4, I think there is two points we need to be very careful. Number one is you probably can see that we have already entered – opened 76 Peiyou small class learning centers already and we still will add a few more in the coming months. So, this number is almost equal to the first three quarters' numbers. There's a lot of new learning centers happening across China, so which will – when we decided to add more learning centers in the short term, they would have some pressure in the margin perspective. On the other side, I think the Peiyou – sorry, the Xueersi online school, in Q4, we still have one month to go. We need to evaluate the market dynamics, and especially what's happening most recently to decide whether we need to keep more promotional courses in the online perspective. So, I can't give you a clear answer now, but we will try our best to balance all the investment…

Thank you, Mr. Rong. Thank you.

Thank you. The next question comes from the line of DS Kim from J.P. Morgan. Please go ahead.

Hi. Good evening, everyone. Thanks for taking my questions. Just to follow-up on that point, can we discuss a little more detail on our guidance 4Q, i.e., like, versus this quarter, there was a meaningful – there will be a meaningful deceleration already baked in. How much of that is coming from higher comps from last year? And how much of the Wuhan class impact is baked in there? And can we also talk a little bit about Peiyou versus xueersi.com and other segment growth baked in for fourth quarter guidance? And I have another follow-up after this.

Thank you. I think the guidance today, we have considered the impact of Wuhan in our guidance based on what we see today. I think in Q3 and Q4, I recommend you guys to combine them together because, in Q3, we have [indiscernible] from Q4 to Q3. So, if we're looking to our comments on overall growth, the best we can look to do is combine Q3 and Q4 together to look at the revenue growth. Sometimes the quarterly split will be kind of misleading. And secondly, specific about the Wuhan coronavirus and disease, I think in the first place, as a Chinese citizen, we're also very kind of [indiscernible] to see this happen. I myself was in the college when the SARS was happening in the year 2003, so we have all experienced it at that time. And the trust in the government is much better and much stronger than before. So, we fully believe, with the government's all the measures in place, this will be controlled. And we support 100% of all their policies, all the requirements coming from government to make necessary changes in our schools. And in the second place, I think right after this happened, we have quickly made some changes. We have tried to recommend more students moving from offline to online offerings. Thanks to our investment in our teams in the past few years, we are successfully building our strong capability in the online perspective. We have both Peiyou live team and Xueersi online school team, so we have online capability in almost every city. So, we will – in Wuhan area, we have already recommended students moving from offline to online. And considering our Peiyou live offer has very good reputations in Wuhan area and it is where it is widely accepted…

Thank you very much for the color. If I may follow-up one more, can we talk a little bit about winter promotion for online in the past couple of months, i.e. how competitive it was? Any initial conversion figures? Or more importantly, were there any meaningful observations or lessons that we learned from promotions? That's all from me. Thank you very much again.

Yes. I think for the whole year, generally, the summer promotion is the most kind of competitive time. And going to the fall and winter, actually, the level of competition is actually less than the summer. And we're running our summer promotions for online, especially in the Q3 and Q4. So, what we are seeing is actually we have to make some progress in the conversion rate perspective, in the retention rate perspective. I think for online products, the promotion is part of the overall business. So, we have a very clear ROIC system to evaluate the return. If their return – considering the new customer acquisition cost, conversion rate, retention rate and the lifetime value, all of these measures can [indiscernible] our threshold, we'll continue to do the investment on the marketing strategies. But if one of those fail, the overall ROI doesn't work. We will stop investments. So, we will manage all of this very carefully.

Thank you very much.

Thank you.

The next question comes from the line of Sheng Zhong from Morgan Stanley. Please go ahead.

Thank you for taking my questions. Mr. Luo, you shared a lot of growth outlook for Peiyou. Can you please also share the management thinking about the xueersi.com in coming years in terms of the xueersi.com positioning in the company's overall structure? And also, comparing with the key competitors, how to differentiate and how to improve the overall process? And the last thing is what the current growth outlook for xueersi.com for next year.

Yes. I think the Peiyou small class business, the O-on-O model and xueersi.com, the online business, are equally important in our company, are equally important. And Xueersi online school, I think, this year in Q3, we grew the revenue by around 86% while we grow the enrollments by around 107%. And this is a very healthy growth, especially in enrollment perspective. And looking to the next year, because the base is bigger and bigger, so we believe we can continue to see the very good and very fast and healthy growth from online space, but we don't expect to see the revenue growth triple digit every quarter because the base is a little bit different. When we're looking into the online business actually, we care a lot about the quality and the students and the parent satisfaction above this, which can – represented by the retention rate. So, in the past few quarters, we're making a lot of efforts and we're also happy to see we improved our conversion rates and we improved our retention rates by high single digits. So, which is – all of it's showing the online business is becoming more and more healthy. Looking to next year, we believe the online still will grow much faster than offline and the enrollment growth may grow faster than revenue growth. So, that's still a very healthy growth. When we look into the online education side, we're probably going to see the top one guy can be around 20% to 30% market share, by profit perspective maybe even more. So, we will maintain our leader position in the online education area and make necessary investments, both in the technology perspective and in the teacher system perspective and the online market perspective. I think one thing, if one online product need to be differentiated from the other one, from the other company, it's the teaching quality and the operating efficiencies. Education, no matter offline or online, in the end, they try to teach the students and help the students to achieve very good outcomes. So, we need to care more about teaching quality, how we can leverage our platform know-how to make a student study more and more efficiently and better and better. So, that's something we can quite differentiate from the other one. The new customer acquisitions off some kind of the marketing channels, promotions, that's now the most important features which we are different from the other one. We care more is teaching quality and the students.

Thank you very much. May I follow-up, you comment that your retention rate – conversion rate improved by high-single digit. These are comparing with, well, when?

That compares with summer.

Okay. So, we can say that these are fall semester's conversion rate or retention rate comparing with summer?

Both fall and winter.

Okay. Thank you very much.

The next question comes from the line of Alex Xie from Credit Suisse. Please go ahead.

Hi, management. Thank you for taking my questions. So, we have seen the announcements about the board member changes. What are the implementations of these arrangements and how should we think about new roles of Mr. Zhang in the company? Thank you.

Yes. I think when we talk about when commenting long-term growth potential, on one side, we need to talk about the business, the business models, investment we make; on the other side, we need to talk about actually the corporate governance structure. I think six years ago, when I just joined the company, actually, at that time, we were a very small company, around 9,000 employees, around RMB 2 billion revenue. That's a small company. And coming to today, we are much bigger than before and we have more than 47,000 employees now. So, one thing in our management, we have reached our agreement is we need to establish a very balanced and more healthy corporate governance structures to drive the company's long-term growth. So, coming from these assumptions, we made some necessary changes. Mr. Bai Yunfeng, our Co-Founder and our President of the group today, will enter the board of the company as chairman of the board. And Mr. Bai is venturing our company who led our Peiyou business in the past 14 years and made a very good job. And in the most recent years, he also do a very good job into building the middle [indiscernible] for our company and also have represented our company while we're in front of government and media in a lot of occasions. And so, considering Mr. Bai's both doing well on inside and outside, so this kind of promotion will enable Mr. Bai to contribute more in the board level as he will lead the board of directors to give a wise – and lead the strategic directions of the company and support the management to do a much better job in the future. And on the other side is Tom, Mr. Zhang, our CEO and the former chairman, will continue…

Thank you. Very clear.

Thank you. The next question comes from the line of Alex Liu from China Renaissance. Please go ahead.

Thanks, management, for this opportunity. Two questions. So, the first question is on the offline Peiyou growth acceleration. We noticed, I think, enrollment for offline Peiyou has a notable acceleration versus previous quarter despite, I think, the capacity was relatively kept at the long-term level in the previous quarter. So, just wondering what are the major drivers for this notable offline enrollment acceleration. And second question is, we noticed, I think, for top five cities, the revenue growth was more or less in line with the non-top five cities this quarter. So, just wondering, what's the sort of the growth strategy we are seeing in the larger cities in the coming fiscal year? Thank you.

Yes. I can answer the second question first. In the past few years, we developed or making more perfect offline dual teacher models. So, when we enter the new cities, starting from three years ago, actually, we leverage dual teacher model to do so, which can [indiscernible] burden of the teachers and can give more interactive experiences, leveraging the online technology we have today to the students. Actually, all of this has received very positive feedback from students. And they're becoming our one of most important way when we go into the low-tier cities. I think this year we entered around 13 cities. And last year, we entered around 15 cities. And next year, we will enter more cities than this year. And this kind of acceleration is because we leveraged the power of dual teacher model and the power of technology. And online – offline growth accelerations in Q3 and Q4, I think, on one side, is we're adding more classrooms starting from Q2. But more importantly is actually we improved a little bit in our key operation KPIs, including the refund rate, retention rate and the [indiscernible] rate and all of that. We try to manage and improve our operational efficiencies in the Peiyou small classes every day. So, this has resulted in very good positive numbers in both Q3 and second half. And about the capacity growth, let me repeat the numbers. Last year, we added around 13%. And in this year, Q3, we added net 36 learning centers. And overall, we have added 17% of the total classrooms. And considering the 76 new learning centers we have already rented in Q4, so we foresee, the whole year, we'll be adding capacity by around 20% to 30%, which will contribute to our next year growth from summer. So, our Peiyou small class revenue growth next year will be strongly supported by this kind of [indiscernible] classrooms next year. Yes. So, that's our current situation. Thanks, Alex.

Thank you.

Thank you. The next question comes from the line of Lucy Yu from Bank of America. Please go ahead.

Thank you a lot. I've got two questions. The first one is on the guidance of next quarter of 35% to 38% growth in RMB terms. So, could you elaborate a little bit on like how much is the online share stock comp growth embedded in this kind of assumption and how much is the Peiyou small class growth? And my second question is on the margin side. I noticed that, in this quarter, the GP margin only expanded by 1 percentage point versus like more than 2% in the first half and over 6% in 2019. So, is it because our acceleration of expansion, so that we see less margin expansion? So, if that's the case, if we continue to accelerate in the following quarter, are we going to see margin contraction or maybe flattish margins in the fourth quarter?

Thank you, Lucy. I think the Q4 guidance – because, at the end of the day, we receive a lot of information, both offline and online, especially some information from Wuhan. So, current guidance, what I can say is, we have reflected our – the best estimation we have. Especially for the online and offline, what I can say is, in general, we don't disclose the online and offline separately because of competitive reasons. But what I can say is online is still growing much faster than offline. And the online, if we're based on the number of winter class, actually it runs quite well. When we talk about Q4 guidance, we need to be more cautious about what will be happening in the coming months. So, we will have more preparations to offer the Peiyou live classes and Xueersi online classes to our students, if necessary. So, this guidance, that's the best numbers we have today. And the margin perspective, yes, you are right. Part of the reason is we're starting acceleration. We're adding more classrooms which will lead to short-term pressure in gross margin perspective. Looking into Q4, because we're adding a lot of new learning centers [indiscernible] so the pressure in the gross profit perspective will be a little bit bigger than before. But all of this will contribute to the revenue growth after two to three quarters. So, we believe that is the necessary cost we need to pay. Thank you, Lucy.

Thank you very much. One follow-up quickly. On the Wuhan virus, so now that we got Peiyou online for like 30 out of, in total, 70 cities, so in those 30 cities, students can actually transform seamless to the Peiyou online because online/offline are offering the same thing. But how about for the other 40 cities that do not have Peiyou online? What do we do with them?

I think you asked a very good question. Actually, I think for most of our cities we enter, we have the IT capability to provide online offerings. Of course, we need some time for preparations because we have that – because the new cities we enter, all of them are dual teacher models. For the dual teacher model cities, they need to build out their online capability over there. So, at least, we have the basic capabilities ready. So, we need to make some necessary change in arrangements and investments in IT team perspective to make this offer available all over China, which is something we can do. It takes some time, [indiscernible] and investment, but that's something we can do. And we also have Xueersi online school, which is already available for all the cities and all the geographies. So, we have – we will consider -- if something get any worse, which we don't see today, but if something get any worse, we will have both Peiyou line and, of course, Xueersi online offerings ready for the students, no matter if they are our current existing students or maybe they are new students coming from the other schools. So, we're always ready for that.

Thank you so much. That will be all of my…

Thank you, Lucy.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may all disconnect now. Thank you.