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TAL Education Group (TAL) Q3 2019 Earnings Conference Call Transcript

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TAL earnings call for the period ending November 30, 2018.

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TAL Education Group  (TAL -1.62%)
Q3 2019 Earnings Conference Call
Jan. 24, 2019, 8:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

See all our earnings call transcripts.

Prepared Remarks:


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.

Echo Yan -- Head of Investor Relations

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, 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.

Julius Luo -- Chief Financial Officer

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 $586 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 $71 million in the third quarter. Non-GAAP income from operations grew by 63.5% to $92.9 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?

Linda Huo -- Vice President of Finance

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 courses revenue increased by 27% in RMB terms, while enrollments increased by 19%.

In the third fiscal quarter, Peiyou online accounted for approximately 5% of total Xueersi Peiyou Small Class revenue and 34% of total Xueersi Peiyou Small Class enrollments. In the same quarter of fiscal year 2018, revenue and enrollments from Peiyou online were 1% and 22% respectively of total Xueersi Peiyou Small Class business.

Xueersi Peiyou small class revenue from top five cities, which is Beijing, Shanghai, Guangzhou, Shenzhen, and Nanjing, grew by 19% year-over-year in US dollar terms and accounted for 59% of Xueersi Peiyou Small Class business. Revenue generated from cities other than the top five grew by 30% in US dollar terms and other cities accounted for the remaining 41% of the Xueersi Peiyou Small Class business.

This growth momentum is supported by broad market demand across all cities and incremental ramp up of enrollments from our earlier classroom expansion. We make ongoing efforts to expand our course offerings. Chinese and English courses continue to grow at a solid pace. By the end of November 2018, we have offered Chinese classes in 15 cities and English classes in 24 cities. Furthermore, during the quarter, we opened four new multi centers to reach a total of 16 multi centers. The healthy expansion of Mobby reflects the unparalleled interest in early childhood activities that combined from learning with competency building. We expect that these diversified courses will gradually contribute more to our overall business.

Next, I'd like to briefly discuss our Zhikang one-on-one business. This business had a steady third quarter and achieved year-over-year revenue growth of 18% in US dollars terms and 24% in RMB terms. Zhikang one-on-one accounted for 6% of total revenue compared to 7% in the third quarter of fiscal year 2018.

Let me update you on our capacity expansion. As you know, we are pacing our offline capacity growth which we continue to invest in new technology and online business to ensure we are following the new standards and regulations that are currently being implemented.

We added a net 18 learning centers, of which 12 were Peiyou Small Class learning centers, four new Mobby centers, one Firstleap center and one one-on-one center. We closed down 19 learning centers based on our standard operations and regulatory requirements. During the quarter, we added 225 Peiyou Small Class classrooms. During the quarter, we entered into 11 new cities with dual teacher small class learning center in each city, further expanding our geographic coverage. Some learning centers have officially opened, while some others are in the process of decoration and application for relevant approvals. These new cities are Guiyang, Yantai, Nanning, Kunming, (inaudible), Haikou, Harbin, Hohhot.

By the end of November, we had 666 learning centers in 54 cities across China, of which 472 were Peiyou Small Class, 16 were Mobby Small Class, 78 were Firstleap Small Class and 100 were Zhikang one-on-ones. Looking to Q4, as you know, we have granted 13, that is 1-3, small class learning centers and we expect to add a few more Peiyou Small Class learning centers. These estimates reflect our current expectation, which is subject to change.

Let's now move to our online business. Third quarter revenue from grew by 157% in US dollar terms year-over-year and 169% in RMB terms, while enrollments grew by 220% year-over-year to over 1 million. Online contributed 15% of total revenues and 40% of total enrollments this quarter compared to 8% of total revenue and 21% of total enrollments in the same year ago period respectively. Compared to previous quarter, we ran fewer promotions for online.

The enrollment growth in the third quarter came mostly from retention of the summer semester as well as the ongoing dynamics growth in demand for our online live broadcast team. In the third fiscal quarter, short-term and promotion online courses accounted for 60% of enrollments and 4% of revenue. In the same quarter of fiscal year 2018, short-term and promotion online courses accounted for 36% of enrollments and 1% of revenue respectively.

Let me now go through some other key financial points for the third quarter of fiscal year 2019. The breakdown of ASP for the various businesses is as follows. Xueersi Peiyou Small Class ASP decreased by 1% in RMB terms year-over-year. Excluding the impact from Peiyou online course and promotion short term Peiyou offline courses, Peiyou offline normal price cost ASP increased by single digit percentage year-over-year. Zhikang one-on-one ASP increased by 5% in US dollar terms and 10% in RMB terms year-over-year. Online course ASP decreased by 20% in US dollar terms and 16% in RMB terms year-over-year during the third quarter, partially due to the increase in the amount of low ASP short term courses.

Cost of revenues increased by 21% to $267.6 million from $221.1 million in the same quarter one year ago. The increase in cost of revenues was mainly due to an increase in teacher compensation and rental costs. Non-GAAP cost of revenues which excluded share-based compensation expenses, increased by a similar percentage of 21% to $267.5 million from $221 million in the same year ago period.

Gross profit in the third fiscal quarter was $318.4 million, up 50.1% year-over-year from $212.2 million in the same year ago period. Gross margin for the third quarter was 54.3% as compared to 49% for the same period of last year. Selling and marketing expenses increased by 64.4% to $101.6 million from $61.8 million in the third quarter of fiscal year 2018. Non-GAAP selling and marketing expenses, which excluded share based compensation expenses, increased by 62.9% to $98.5 million from $60.5 million in the third quarter of fiscal year 2018.

The increase of selling and marketing expenses in the third quarter of fiscal year 2019 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 59.2% to $71 million. Non-GAAP operating income increased by 63.5% year-over-year to $92.9 million. Other income was $98.7 million for the third quarter of fiscal year 2019 compared to other income of $5.4 million in the third quarter of fiscal year 2018. Other income in the third quarter of fiscal year 2019 was mainly due to the fair value changes of a long-term investment. The fair value changes were transferred from accumulated other comprehensive income to other income as the investment was converted from available-for-sale investment to equity security with readily determinable fair value upon listing in Hong Kong Exchange in November 2018.

Income tax expense was $10.4 million in the third quarter of fiscal year 2019, compared to $11.4 million same year ago period. Basic and diluted net income per ADS were $0.22 and $0.21, respectively in the third quarter of fiscal year 2019. Non-GAAP basic and non-GAAP diluted net income per ADS, which excluded share-based compensation expenses, were $0.26 and $0.24, respectively.

From the balance sheet, as of November 30, 2018, we had a total of $1,612.3 million in cash, cash equivalents and short term investments, compared to $1,498.9 million as of February 28, 2018. Capital expenditures for the third quarter of fiscal year 2019 were $73 million, representing an increase of $44.7 million from $28.3 million in the third quarter of fiscal year 2018. The increase was mainly due to leasehold improvements and the purchase of land use rights, servers, computers, software systems and other hardware for the company's teaching facilities and mobile network research and development.

As of November 30, 2018, the company's deferred revenue balance was $866.3 million, compared to $1,074.9 million as of November 30, 2017, representing a decrease of 19.4% mainly due to the change of tuition fees collection schedule and the adoption of Revenue from Contracts with Customers, which is Topic 606, beginning March 1, 2018.

Now, I will hand the call back to Mr. Rong to briefly update you on our strategy execution and provide the business outlook of the next quarter. Rong, please.

Julius Luo -- Chief Financial Officer

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 $670.5 million and $685.6 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.

Linda Huo -- Vice President of Finance

Hello, Edison?

Questions and Answers:


Yes, we will now take questions. (Operator Instructions) Your first question is from Tallan Zhou from Deutsche Bank. Please ask.

Tallan Zhou -- Deutsche Bank -- Analyst

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, offline 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.

Julius Luo -- Chief Financial Officer

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 operating margin spend, if you probably can see, we're making progress in the gross margin thing as were doing in the 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 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 is fourth term, most classes are on track, so we don't have the plan to run that much bigger promotions at that time. All the promotions we're running today, we have a very cautious plan to (inaudible) make sure every money we put there are kind of to their values. So Q3, we're probably going to see the promotion for online is a little bit slower, smaller than what we see in Q2.

These two reasons contributed our OP margins a little better than what we planned in the last quarter. One last point I want to make is, you probably can see that Q4 net profit and net margin, which is good, that's because we have a capital gain in the other income line, that's because that is the investment we made a few years ago, now they go lifting in Hong Kong in November. And -- but all these numbers are non-cash, non-operating items. So as a company, we still recommend you guys into our operations and operating numbers, including operating margin profits, which is maybe much -- makes more sense to do in the real business compared to a net profit number.

And guidance for Q4, you probably are asking specific about margin guidance in Q4. And let me recap a little bit, in the previous three quarters, we increased our margin Q1, we declined the margin Q2 and we recovered a little bit in Q3. So year to date, in the previous third quarters, we are slightly better in margin perspective compared to the same year ago period for the previous three quarters around 1%. And so right into Q4, we are also going through our different growth drivers. For offline, we'll continue to make cautious expansions and we continue to see some much leverage coming from offline, which is similar as to what we can see in the previous quarters.

But for online, we believe winter maybe is also the other window for us to run some promotions. So we are -- and some of you guys probably have seen that in the online marketing channels with that to run some promotions in the online space, which will cost some money. And the scale of the online marketing is lower than Q2 level, were higher than Q3 level. So moving to Q4, I think we both have some pros and cons, good news and challenges over there. In general, we don't give the detailed guidance about Q4 margins, but we want to let you guys know it's actually -- also quarter for us, we want to make sure we can ask you our online marketing strategy to deliver our growth results.

And specifically question about the revenue outlook and for next year, what I can say actually, if you guys have followed us for long time, (inaudible) 2018, that's a very important year, because in that year, we have seen a lot of new dynamism in this market, including the policy and regulation uncertainty, including the new technology development (inaudible) is coming up, and also including some of the new market dynamics. So as all of these factors make us more cautious now, when giving maybe -- when giving long term guidance, so we suggest we only give you guys guidance quarter-over-quarter, because we have high visibility over there. And looking to the whole year, I think we need to evaluate all the dynamism of assets over there and when we finish all our -- our full year reporting, have more information to share at that time.

Thank you, Tallan.

Tallan Zhou -- Deutsche Bank -- Analyst

Thank you.


Your next question is from Natalie Wu from CICC. Please ask.

Zhao Haiying -- China International Capital Corporation -- Analyst

This is Zhao Haiying (ph) 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?

Julius Luo -- Chief Financial Officer

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

Zhao Haiying -- China International Capital Corporation -- Analyst

Yes. The online promotion plan for summer of 2019?

Julius Luo -- Chief Financial Officer

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

Linda Huo -- Vice President of Finance

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 three 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 four semesters, summer and winter semesters comp period is normally three months, whereas spring and autumn semesters comp period is normally longer than three 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.

Julius Luo -- Chief Financial Officer

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 ask you. 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 sure every investment, every money we make can do that well, can bring some value.

And so, if you ask me, the format of the kind of pilot classes will change or not, my answer is yes. Some of that integral will be the same, but we need to continue to be innovative to think about new ways to do the classes. And specifically about the month, how much money we want to take, we want to spend next summer, I think to date, it's still too early to talk about that, because we need to fit -- we need to figure or finalize the way of marketing where we're running for online in the coming few quarters. We may change the strategy when we change the way of operations, so today, it's too early to talk about the detail amounts for that.

But what we can say is, we continue to believe online is one of very good way to be scalable for the company and we're leveraging the online, not only cover more students, but also try to offer affordable solutions to support students as many as possible. We don't ask for crazy high margins for online. And all we want is we can leverage this kind of offerings to cover more students. So, we will -- we as a company, we also be cautious about that and we will be very, very serious about how much money we spend and which will not bring too much pressure to our margins. So, we probably elaborate when we have more informations. Please stay tuned for that. Thank you.

Zhao Haiying -- China International Capital Corporation -- Analyst

Thank you. Very helpful.


Your next question is from Thomas Chong from Credit Suisse. Please ask.

Thomas Chong -- Credit Suisse -- Analyst

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 FY '20 and should we expect win or losses for next year? Thank you.

Julius Luo -- Chief Financial Officer

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 six 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 opinion, we don't have any more information to share. If we have some new policies, we will see with that they will disclose and communicate with you guys in the first time. And, especially for online environments, I think which is the same, I think in last few months policy, the government has made a general principle as the need to regulate online what they did in offline. From our comments standpoint, we welcome all the regulations, policies in online environments, if any new policy was all, we definitely will become their first companies who will go and implement all the policies in place.

We have a very strong IT and technical team now, more than 3000 people in our company today. So we definitely will make our system adaptive and sensible enough to adapt all of the new changes, which is possible to come because of policies. And again, I strongly recommend all of you guys can watch their government's policies if they have more new things to come and when those come, we will discuss and communicate that if we have more information about that.

And about your question about the teacher event passing rate, what I can say is this year's teacher events actually will have many more applicants than before and our teachers, most of them graduating from top universities, so based on the preliminary results, we can see our performance is a little bit better than the whole industry average. But that's only the paper based event results, they still need to go through the interviews. And no matter how many people they can pass off these events, we will continue to encourage our teachers who don't have license to go and apply for the new teacher events and try to get teacher license by the end of events. We are continuing to encourage all of them to do so.

And your question about the online investment and I think you're asking maybe our online business next year is profitable or not. I think it's too early to say that. On one side, we have this good news, good signals. We have seen parents is getting more and more familiar with online approach and they are getting used to use online to teach their students, especially the primary school students and we also are going to see after a few quarters, appreciations, we have a lot of lessons learned and we try to continue to innovate our classes and products. But on the other side, as you know, we also face other constraints. For example is the way we're doing online marketing today maybe not as efficient as today next year.

And we need to think about some of the newer marketing to make it happen and we need to expect some new progress if possible. So I can't estimate today, in today's same point say, hey, we will spend less money or more money. What we can say is, we will continue to work hard on all the investments we make and we will continue to be very confident, we will continue to grow our online business in a much more scalable way. So we will keep you guys posted about our progress in online quarter over quarter and that's why we believe that is the right direction to go and which will give us much bigger opportunities in the long run.

Thank you, Thomas.

Thomas Chong -- Credit Suisse -- Analyst

Thank you.


Your next question is from Mark Li from Citi.

Mark Li -- Citi -- Analyst

Hi, Rong, Linda and Echo. Congratulations on the very strong results. My question is, for the last quarter's non-GAAP op margin, I think you actually hit management's guidance by like about -- more than 300 basis points. May 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? Thank you.

Julius Luo -- Chief Financial Officer

Thank you, Mark. 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 hours than before, so that's kind of the mixed result of these two drivers.

Thank you, Mark.

Mark Li -- Citi -- Analyst

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

Julius Luo -- Chief Financial Officer

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.

Thank you, Mark.

Mark Li -- Citi -- Analyst

Thank you. That's very useful and congratulations again.

Julius Luo -- Chief Financial Officer

Thank you, Mark.


Your next question is from Yanhuan Wang (ph) from Macquarie. Please ask.

Yanhuan Wang -- Macquarie Group -- Analyst

Congratulations on your very solid results and thank you for taking my questions. So my question is, can you share some colors 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? Thanks.

Julius Luo -- Chief Financial Officer

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 -- please stay tuned, we definitely will give you guys numbers quarter-over-quarter. Thank you.

Yanhuan Wang -- Macquarie Group -- Analyst



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

Lucy Yu -- Bank of America Merrill Lynch -- Analyst

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? Thank you.

Julius Luo -- Chief Financial Officer

Thank you, Lucy. Online marketing, that margin impact in Q2 (inaudible) 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 quarters after we emphasize the team, the retention of online can be higher than today.

Thank you, Lucy.


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

Duration: 58 minutes

Call participants:

Echo Yan -- Head of Investor Relations

Julius Luo -- Chief Financial Officer

Linda Huo -- Vice President of Finance

Tallan Zhou -- Deutsche Bank -- Analyst

Zhao Haiying -- China International Capital Corporation -- Analyst

Thomas Chong -- Credit Suisse -- Analyst

Mark Li -- Citi -- Analyst

Yanhuan Wang -- Macquarie Group -- Analyst

Lucy Yu -- Bank of America Merrill Lynch -- Analyst

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