TAL Education Group (TAL) 2012 Q2 法說會逐字稿

Hello, ladies and gentlemen.

This is Desmond.

I'll be the operator for this conference call.

I would like to welcome everyone to TAL Education's fiscal year 2012 second quarter earnings conference call.

At this time, all lines are in a listen only mode.

After the presentation, there will be a question and answer session.

Please follow the instructions given at that time if you would like to ask a question.

In fairness to other callers, please keep your questions limited to two.

Now I'd like to turn the call over to Ms.

Willow Wu, Investor Relations Assistant of TAL Education Group.

Ms.

Wu, please proceed.

Thank you all for joining us today for TAL Education's fiscal year 2012 second quarter earnings conference call.

Our second quarter earnings release was distributed earlier today and you may find a copy on our company's IR website or through the news wires.

During this call, you will hear from Mr.

Joseph Kauffman, our Chief Financial Officer.

Following his prepared remarks, Mr.

Kauffman will be available to answer your questions.

Before we continue, please note that the discussion 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 our public filings with the SEC.

For more information about these risks and certainties, please refer to our filings with the SEC.

TAL Education does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under applicable law.

Also, our earnings release and 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 and most directly comparable GAAP measures.

I would now like to turn the call over to Mr.

Joseph Kauffman.

Thank you, Willow.

And thank you all for joining us on our second quarter fiscal year 2012 earnings conference call.

We are very pleased to share with you another quarter of rapid growth of our tutoring services business, combined with accelerated investment in our future growth.

Our total student enrollments grew by 44.1% from the same period last fiscal year, as the centers we added over the past three quarters began to ramp up and our online courses business grew rapidly.

In particular, our core business of small classes outperformed our expectation.

Small class enrollments increased 21% in the quarter versus the same period of the previous year.

Growth in online and one-on-one enrollments were faster than small class off of a much smaller base.

Online enrollments grew especially quickly in the quarter and comprised 12.9% of our total student enrollments by the end of Q2.

During the quarter we added 69 new learning centers, bringing the total new centers added in the first two quarters to 136.

With this accelerated investment in our learning center network in the quarter, we have now achieved in the first two quarters over 90% of our full-year target of 150 new centers.

Some 33 of the 69 net adds were in Beijing and Shanghai, the two largest K through 12 markets in China.

By the end of the quarter, Shanghai had 44 total learning centers between small class and one on one versus 138 in Beijing.

Our smaller center strategy, which I outlined to you on last quarter's call, is showing further progress, as is demonstrated by the strong 25% enrollment growth rate for the aggregate of our small class and one-on-one businesses.

And the excellent execution of our center roll-out plan in the first half of the year allows us to focus our energies on both ramping up enrollments in these new centers and preparing for entry into six new cities in the fourth fiscal quarter.

In addition to this solid execution of our center investment strategy in the quarter, we are also very excited by our city expansion plan, the second leg of our overall growth strategy.

Cities outside of Beijing and Shanghai continue to grow rapidly, and contributed 10.9% of small class revenues in the second quarter compared to only 3.6% during the same period of the previous fiscal year, and 8.3% in the previous quarter.

This increase from 3.6% to 10.9% of our overall small class business means that our small class business outside of Beijing and Shanghai grew by over 330% versus the same period of the previous year, which was already on the back of very strong growth in the first quarter.

For the two quarters combined, our small class business outside of Beijing and Shanghai grew by 338% versus the first half of last fiscal year.

The continued traction we are achieving in new markets is very encouraging, and demonstrates the scalability of our small class business model.

It also gives us confidence that the investments we have made in our new organization structure, with a dedicated headquarters and Senior Vice President to manage the expansion of our small class business, is already reaping nice rewards.

Our Zhikang-branded one-on-one business, which is the third leg of our growth strategy, also continues to exceed our expectations.

As we indicated we would last quarter, we continued our expansion of one-on-one in cities outside Beijing in the second quarter, adding 32 new one-on-one learning centers in cities outside Beijing.

We also added 19 new one-on-one learning centers in Beijing in the quarter.

Our Beijing business continues to grow at an extremely fast pace.

And based on what we see in the market, we believe our one-on-one is taking share in Beijing.

As those of you who know our story well will recall, we first got into the one-on-one segment because the top students we serve for small class also liked to use one on one in the winter and spring of each year to cram for the major examination, like zhongkao and gaokao, which take place in June each year.

More recently we have also viewed one-on-one as a feeder for our small class business.

Students need to test in the small class, so inevitably there are students who either are not admitted based on their test scores or self-select out of even our most basic small class offering.

We can now market one on one to this segment of the student population in each of our ten cities in which we offer small class.

This expansion of one-on-one has been very effective.

One on one had 141% year-over-year revenue growth in the quarter, and we expect one-on-one to continue to grow rapidly over the future quarters.

As our core business delivered outstanding top-line growth, we continued to invest heavily in new business segments for future growth.

First, I'd like to give you some more color on our online business segment.

We've invested aggressively in this business in the quarter to put in place the infrastructure for expansion.

Online courses offer a valuable supplementary segment to our small class and one-on-one.

Because we believe it helps us expand to areas where our physical presence is limited, and also attracts additional enrollments from our existing customer base.

Enrollments in our online courses are comprised of relatively small orders, averaging around 15 hours, but many much smaller and with much lower ASPs than small class or one-on-one.

The hourly rate for online is generally between RMB20 and RMB40 per hour.

While the growth in enrollments continues at a rapid pace, our expectation for revenue contribution from this business has been too optimistic.

We expect the online courses to continue to be loss-making for at least the next three to four quarters, but from now on we expect to need to make only limited additional investments in this business line.

As revenues ramp up over time, we expect the scalability of this business to come into force.

We strongly believe in the growth potential in the medium to long term.

Secondly, we have launched a new small class format to address a new target audience at pre-K levels.

Using the brand name Mobby, this business line is aimed at helping three to six-year-old students to build a solid math foundation and stimulate their interest in the subject through fun activities.

As of the end of the quarter we rolled out one standalone center in Beijing where we offer small classes with a maximum of 12 children per class.

In addition to mathematics, we also offer English and Chinese under the Mobby brand name.

Enrollments are showing encouraging growth, even at the relatively high rate of RMB133 per hour.

This business is also currently loss-making, and we expect it not to contribute meaningfully to revenue for some time.

While we expected a somewhat faster ramp up in these new businesses in terms of revenue contribution, we believe the growth potential is promising.

As our core business delivers strong, stable and sustainable growth, we believe that the timing for investing in these new businesses is right.

Before I move to a more detailed discussion of the financial results, let me first briefly point out some recent developments regarding corporate governance, which is an area in which TAL Education Group strives to maintain the highest standards.

Last year before IPO, we engaged PricewaterhouseCoopers as our independent consultant to work with our internal audit department to prepare for Sarbanes-Oxley compliance.

In the quarter, we have continued to work closely with PwC to improve our Sarbanes-Oxley readiness.

In addition, with two new independent directors joining in the past quarter, we have a majority of independent directors on our board.

Our audit committee, compensation committee and nominating and corporate governance committee is each entitled comprised of independent directors.

Let me now move to the financial results.

You'll find the complete financial information in the release, so I'll keep it reasonably concise to leave enough time for your questions.

I am pleased to report another strong quarter in which our results once more exceeded the high end of revenue guidance.

Our small class business was the primary contributor to the incremental revenue we drove in the quarter, followed by our Zhikang branded one-on-one business.

Our online courses business, operating from www.xueersi.com website is growing quickly, but still small as a percentage of revenue given the considerably lower ASPs in this segment.

We delivered $51.4 million in revenue in the quarter, representing revenue growth of 58.5% versus the same period of the previous year.

Driving the quarter's revenue growth was strong total enrollment growth of 44%, combined with higher average selling prices.

Total student enrollments increased to approximately 198,000 from approximately 137,400 in the same period one year ago.

The increase in enrollments was driven primarily by small class and online courses enrollments, and to a lesser extent by one-on-one.

On the ASP side, the ASP increases were primarily driven by our small class business where we still benefited from the shift from two to three hours for many of our classes, and also had an hourly rate increase for our most loyal students, who only in this most recent quarter began to pay the full RMB45 to RMB55 price increase in Beijing we took in May of last year.

In terms of overall operating costs and expenses, the significant increase in the second quarter in this regard was largely due to rapid expansion of our learning center network, head count increases, particularly in our sales and marketing and general administrative areas, as well as investment in new growth businesses.

Our gross profits in the quarter were $26.2 million GAAP, and on a non-GAAP basis excluding the impact of share-based compensation, were $26.3 million.

Our gross margins were 50.9% in the quarter, and 51.1% on a non-GAAP basis.

Our gross margins during the same period of the previous year were 56.4% and 56.7% on a non-GAAP basis.

The major driver of this margin compression was the 69 new centers we added in the quarter, versus only four new centers added in the same period of the prior fiscal year, and the fact that the 67 centers we added last quarter are still in ramp-up phase.

Overall, we have added 136 new learning centers in the first two quarters this year, versus only ten new centers added during the first two quarters of last year.

As the majority of the added centers in the quarter of one-on-one centers, which take longer to reach a gross margin breakeven, and even on maturity of lower-gross margins and small class centers, we can expect to see this impact carry into future quarters.

However, the impact on gross margins from this accelerated center investment we believe was at least partially mitigated by our expanding using smaller centers on average beginning last quarter.

On the sales and marketing side, we ramped up our investment as planned in order to support the continued rapid growth of our business, which now spans ten cities nationwide.

Our selling and marketing expenses represented 13.3% of revenues GAAP and 12.5% of revenues on a non-GAAP basis, versus 7.7% on a GAAP basis and 7.2% on a non-GAAP basis during the same period of the previous year.

The increase is primarily due to a significant increase in sales and marketing staff to support our expanded program and service offerings, and increased advertising expenses for marketing and promotion.

Part of the reason for the additional head count is we have deployed teachers with business acumen as marketers to groom them for school head positions in the new cities, solving a potential key bottleneck for future growth.

In addition, we added a sizable number of IT and editing staff to launch local online platforms in new cities and build online social communities with active discussion boards for viral marketing and customer feedback.

Advertising as a percentage of revenues remained very low for our small class business, while for one-on-one and online courses we increased advertising versus the same period of the previous year, as planned.

General and administrative expenses as a percentage of revenues were 17.8%, but only 13.9% non-GAAP, excluding share-based compensation expenses.

G&A expenses for the same period of the previous year were 12.5% GAAP and 10.5% non-GAAP.

As a listed company, we have different business units in a multi-level structure.

With this revised organization structure, we have needed to increase the total number of general and administrative staff to support our expanded operations.

The above factors combined to give us GAAP operating income of $10.1 million, a decrease of 14.1% versus the same period of the prior fiscal year, and non-GAAP operating income excluding share-based compensation of $12.6 million, a decrease of 0.3% versus the same period of the prior fiscal year.

Operating margins in the quarter were 19.6% GAAP and 24.6% non-GAAP, versus 36.2% GAAP and 39.1% non-GAAP operating margins in the same quarter of the previous year.

Income tax expense in the quarter was $1.9 million, as compared to $1.3 million in the second quarter of fiscal year 2011.

The increase in income tax expense in the quarter was mainly a result of the exemption period of one of our entities expiring in calendar year 2010.

From calendar year 2011, this entity has become subject to a still preferential, but a higher tax rate.

Our net income for the quarter was $10.7 million, growing by 2.0%, and non-GAAP net income, which excludes share-based compensation, was $13.2 million, increasing by 15.9% compared to the same period of the last fiscal year.

Our GAAP net income margins were 20.8% and non-GAAP net income margins were 25.8% in the quarter versus 32.4% GAAP and 35.2% non-GAAP during the same period of the prior fiscal year.

In summary, in the second quarter we achieved better-than-expected top-line results, and as we executed well in our core business, we stepped up investment in our future business growth.

In the quarters ahead, we will continue to focus on ramping up revenues and invest in the operational support required to sustain our successful business roll out, including additional consultant fees from the firms IBM and Roland Berger that we have engaged for the second half of the fiscal year.

At the same time, aside from previously committed items, we will keep costs and expenses in check in the new businesses until they scale.

Moving on to guidance.

Based on the Company's current estimates, total revenues for the third quarter of fiscal year 2012 are expected to be between $36.1 million and $37.3 million, representing an increase of 50% to 55% on a year-over-year basis.

Based on the current momentum and visibility in our businesses, we are increasing our full fiscal year 2012 total net revenues guidance to between $166 million and $171 million, representing revenue growth of approximately 50% to 55% versus the fiscal year ended February 28, 2011.

These estimates reflect management's current expectation, which is subject to change.

Finally, as you have seen in the press release, our Board of Directors has approved a share repurchase program of up to $50 million.

Given the current trading price of our shares, and considering our anticipated investment needs and expected future cash flows, we believe that this is an appropriate use of our current cash balance and will best serve our shareholders.

That concludes my prepared remarks.

Operator, I am now ready to take questions.

Thank you.

Ladies and gentlemen, we will now begin the question and answer session.

(Operator Instructions)

Your first question comes from the line of Mark Marostica from Piper Jaffray.

Please ask your question now.

Yes.

Thank you.

Yes, my first question relates to your learning center expansion plans for the back half of the fiscal year, noting that you've already achieved over 90% of your full-year target of 150.

Are you -- are you planning to exceed that 150 number, and could you give us a sense of how many new learning centers you will open in the back half?

Sure, Mark.

We will likely exceed that number.

And it'll depend on how well we're able to execute in each market, but we're looking at probably between 160 and 170 learning centers.

Overall though, we'll of course be slowing down our learning center growth significantly in the second half of the year.

As you mentioned, we already have 136 learning centers through the first two quarters.

The other important thing I'd say is that we do not expect to add any more one-on-one centers in the second half of the year.

So all additional centers will be for small class or potentially for our new pre-K business line that I mentioned in my prepared remarks, called Mobby.

And then, Joe, just to follow up on that last remark on Mobby, how many centers do you expect to end the year at for that new business line?

Sure.

We expect to end the year with about four centers.

Right now we have one standalone center for Mobby.

Okay.

And then, a question in regards to the spending levels in the quarter.

With the elevated selling and marketing and G&A spending that we saw this quarter, could you give us a sense whether these levels in terms of raw dollar amounts should persist in the coming quarters?

And then tied to that, what does that portend for operating margins in the next few quarters?

And if you can give us a sense, while it's a ways away, what fiscal '13 might look like on an operating margin basis.

Sure.

There's a lot there.

Let me take each of them.

First off, let me stress that margins outlook has never been part of our official guidance.

That said, I have given my sense of expectations on margins trending on past calls.

Mark, I think I recall you were the one who asked the question on the last call as well.

At that time I said I expected full-year non-GAAP operating margins this year to be on the low end of what we believed to be that long-term sustainable operating margin range of between 20% and 22% non-GAAP.

We will need to revise that expectation for this year downward because on the growth of our core business we've committed this year to the extra investments in our future growth that I talked about in the prepared remarks.

So moving on to your question about sales and marketing and G&A, I would say that the reason that we will have to revise downward is because apart from the accelerated investment in the new learning centers we will be -- have the increased take on in sales and marketing and G&A areas that we had in the first two quarters of this year, which will lead to that higher cost base that you talked about.

And we will also be setting up our investment in the new business lines.

The other thing that will affect the G&A expenses is the fees from the two consultancy firms that I mentioned, IBM and Roland Berger, that we engaged for the second half of the year.

So based on what I know now, I'd give a range of 15% to 17% non-GAAP operating margins for the full fiscal year.

That would reflect a relatively favorable outcome in terms of revenue growth for our one-on-one business.

Should the one-on-one business underperform, there could be some risk to this number.

We'll be focusing on both ramping up enrollments at our newly-added centers, and also implementing cost controls over the remaining two quarters of the year.

I'd also like to highlight though to keep in mind that we have increased full-year revenue guidance given the better-than-expected strength of core small class business.

We're now expecting 50% to 55% revenue growth versus 40% to 45% growth, which was our best guess last quarter.

In terms of -- I think that I addressed the question about this year operating margins.

In terms of next year, I think it's a bit too early to give a sense of my expectations for margins as we haven't yet kicked off our budgeting process for next year.

Remember, our fiscal year doesn't begin until March of 2012.

So I'll expect to be able to provide a better sense of where we come out for next year on next quarter's call, as we will be in the middle of our budgeting process by then.

I don't know if I've addressed your question.

I'd say on the sales and marketing side the current level of spend is roughly in line.

I'd say on the G&A side, there may be some uptick there because of the consultancy projects that I talked about, as well as the fact that some of our G&A incremental costs in terms of headcount and IT and finance, internal audit, etc.

made their way in part of the way through this Q2, so the Q2 number may not reflect what it will be in the coming quarters.

It may be higher than that.

Okay.

Thank you very much.

I'll turn it over.

Okay.

All right.

Thanks, Mark.

Yes.

No, you covered it fine, Joe.

Thank you.

Thank you for your question.

Your next question comes from the line of Philip Wan from Morgan Stanley.

Please ask your question.

Thanks, Joe, for taking my question.

I have two questions.

Let me start off with the online business.

Can you please comment on what are the key drivers for the enrollment acceleration for your online class for the -- for this quarter?

And it would be helpful if you could share with us more about your online business strategy and your expectation for the online business in the near term to medium term.

And I have a follow up.

Thank you.

Sure.

Yes, the online business has definitely been an area of focus for us.

I would say that our strategy remains the same, which is to use online courses as a way of extending our reach to areas where we don't have physical learning centers.

And of course they'll also add incremental enrollment to our existing cities.

So part of that, and I talked a bit -- a little bit in the prepared remarks, is that we've gone with a lower price point strategy and lower ASPs in general because we're trying to develop trial in new markets.

And we feel like this is really the right approach for the online courses business currently.

We've -- part of the reason that it's loss-making is that we have been adding a lot of the infrastructure that we will need to grow that business, so in terms of the technical support, the development of products.

We've increased also our advertising spend, etc.

That's -- we -- that's been reflected in kind of the current headcount that's already in the online business.

But overall, I mentioned that we're quite excited about online in terms of the medium to long term.

The reason is that we think that eventually online is a way to continue to get scale in our business.

The long-term margins should be better for online than some of our other business lines.

And we do think that it's a good way to kind of seed the markets for our very profitable, especially our small class business.

Just as a follow up to that, do you track the conversion rate from your online enrollment to your small class, one-on-one enrollment?

Yes.

It's a hard thing for us actually to track because we have different systems for the different business lines right now.

That said, we are seeing increasing numbers of enrollments in new cities, which I think is encouraging.

Thank you.

And my next question is about your new Mobby offering.

Just can you give us some color on -- in terms of competition or any synergy you expect with your existing business?

That would be helpful.

Thank you.

Sure.

Mobby I think is a great business for us.

It's in the pre-K segment and it really leverages off of our strength in the mathematics area.

We think we have a lot of differentiation in this area.

For students three to six years old, there are a lot of English offerings in the market right now for -- sometimes they do subject matter, but it's using -- it's a way of teaching English.

So you have sciences or math, but it's a way of teaching English, but there's no one out there who's right now helping students in a fun way to develop a math foundation.

And we -- and we believe that that's a good market out there.

We've already seen a very nice uptick in terms of initial enrollments in the summer quarter and we expect to be able to continue to grow that business in the coming quarters.

That's essentially the Mobby business.

It's a higher-end product.

I mentioned it's about RMB133 an hour.

And the spend on the centers is also higher.

So I hope you and our investors will be able to come to Beijing and see our center.

It's really quite an impressive center.

The CapEx was about RMB1.6 million per center in general, that initial startup cost associated with a center, which includes like how we look at CapEx for our small class.

It includes your renovation expenses and your renovation for air conditioning, etc.

all these -- initial pre-rental, et cetera.

RMB1.6 million for that business.

And we estimate that that will take one and a half to two years to break even for those businesses.

So it's a different kind of offering, but we think that there's a market for it and one that we can be really differentiated in, which leverages our key strengths.

I would mention -- yes, in terms of both of those businesses, Philip, they combined lost about $1.3 million for us in the quarter.

So just to give you a sense of the kind of investment we are making in those businesses.

We believe quite strongly in them and think this is the right time for us to be making those investments.

All right.

Thank you.

Thank you for your question.

Your next question comes from the line of Ella Ji from Oppenheimer.

Please ask your question now.

Thank you.

Good evening, and congratulations on a strong quarter.

I first want to follow up on a prior question.

You mentioned that you were paying two consulting firms in the next quarter.

What is the nature of their services?

Sure.

We really think that these -- this consulting fee is really setting us up for future growth.

The Roland Berger has really been helping us to define the strategy for our online courses segment.

As I mentioned before, we were quite positive of this in terms of medium, long term for the business.

There are other markets in Asia that have a similar customer that we do in this K-through-12 after-school tutoring space, and online courses is a much greater percentage of the overall business in those markets.

So we think it's only a matter of time before the catalysts will be right for the online courses business in China and we want to be in the right place to leverage that when it does happen.

So that's the reason that we brought in Roland Berger to help us on the strategy for our online courses business.

They have a lot of experience in internet, ecommerce.

The IBM is much more about setting the foundation for our core business and our national expansion.

So it's going from organizational structure strategy and then to IT implementation, or at least setting the direction in terms of IT design, so we have the right systems, process, organization, structure to make sure that we can manage our national expansion.

We're adding quite a number of cities and a number of centers over the coming years, and we want to make sure that we're set up to do so.

Got it.

And could you disclose how much your consulting fee in total for those two companies?

I think for -- from their perspective, they probably wouldn't want us to give an absolute number on that, but it's in the range this year of between $1.5 million and $2 million.

Okay.

And also, Joe, you mentioned a few business initiatives.

And I was wondering if you could give us a list of the areas you plan to spend in the next few quarters, such as Mobby, online, and preferably by the size of their investments.

Yes, sure.

We will be adding -- investing in both of these areas, but I'd like to say that for the online courses business we've largely invested in the headcount that we'll have for that business.

So we've done that investment in headcount in the first two quarters.

So we're not expecting incremental headcount there.

And on the Mobby side, it's going to be primarily the head count associated with the centers.

So as we add new centers, each center has non-staff -- or non-teaching staff counts or personnel that are about five people per center.

So most of the headcount has already been added.

But with that head count in place, and based on our best estimate of where we think each of those businesses are going to end up in revenue, we do expect that combined they will lose approximately $3.9 million for the year.

Got it.

And my second question is about you are now in ten cities already.

Outside of Beijing and Shanghai, are there any one or two regions that you see where particularly strong growth?

Sure.

Guangzhou and Shenzhen have grown exceptionally well, and we're excited about that because that really helps us define our real strength in those four top cities, Beijing, Shanghai, Guangzhou and Shenzhen.

So both of those markets very much exceeded my expectations for the quarter.

In terms of the other cities, I would say that Tianjin continues to be a very healthy business for us, continues to grow very nicely.

I would say that the new markets have also -- relatively lower number of enrollments obviously.

I mean, we're talking about high 300s to close to 900 enrollments for Q2 in each of those new markets, but it's definitely higher than what I expected out of Q2 for those markets as well.

So I would say that's how I would talk about the growth.

In Guangzhou, we had well over 300% revenue growth.

In Shenzhen, we had well over 500% revenue growth.

These are really strong numbers out of these markets and exactly what we wanted to see.

Great.

Last question is about one-on-one.

Recently one of your competitors had some disruptions in their business.

I'm wondering if you could talk about, one, the overall market -- of the overall market trend on the one-on-one side, and also if this would change your business strategy.

Sure.

I think for one-on-one it's always been for us a supplementary business line to our core, which is small class.

And that's always what it's going to be as a position in terms of our overall portfolio.

I mentioned in my prepared remarks the two functions it has.

One is for our small class students we don't want to lose them to a competitor for that time of the year when they're cramming for certain tests and competitions.

And we also see it as a feeder for our small class business.

And that's why you'll see that our one-on-one centers - we added a lot of one-on-one centers actually this past quarter because we're actually filling in for what has been kind of less aggressive one-on-one stance previously.

So now we have one-on-one in each of the cities where we have small class, so it can serve both of those roles I described in each of our ten cities.

In terms of the overall market, we still see it as strong.

I have mentioned on previous occasions that I think that the barriers to entry in this business are lower and that you have to differentiate more on advertising and real estate certainly than our small class business.

That said, we do think that our teaching quality and content transfers over to the one-on-one area.

And on the margins, we think we do have advantage in that area.

But overall I would say it's a less differentiated business.

And part of the reason that we did extend our footprint for one-on-one in the quarter is because of -- we do think that it's important to have a presence, and real estate is more important in the one-on-one business than small class.

We also spent more on advertising for one-on-one.

It has -- there is a lot of advertising in this area.

And traditionally we haven't spent as much there, but this quarter we spent about 7% of our one-on-one revenues on advertising, which is high for us.

I'd note that for small class we still kept advertising as less than 1% of revenue.

But that's why you'll see the tick up in terms of advertising as a percentage of revenue this quarter from what's typically been less than 2% to between 2% and 3% this quarter.

So I think that the overall market's strong.

In terms of the -- what's impacted some of our competitors, we don't really see that with our business.

As I mentioned, I think we're taking share in the Beijing market.

We've always had what I feel is a more balanced approach to our compensation structure for our consultants, which combines near term and longer-term incentives, so we haven't had to make changes in that regard.

And we think that's probably benefited us.

Great.

Just a quick follow up.

How much of your one-on-one students is now referred by small classes?

Yes.

It's hard for us to have an exact number on that, Ella.

So I can't give you anything right now that comes directly out of our IT system, but we're working on improving our IT system to get better actual data on that.

We think that it's at least a third based on our best sense, but I hope to be able to give better data on that over the next year as we improve our IT systems to reflect that.

Great.

Thank you for taking my questions.

No problem, Ella.

Your next question comes from the line of Vivian Hao from Deutsche Bank.

Please ask your question now.

Hi, Joe.

Thank you for taking my question.

Just two quick follow-up questions on the revenue split.

Can you give us a rough split between your one on one and small class contribution to this quarter's revenue?

Do you think the 20% guidance of the one-on-one business contribution is still realistic?

Secondly is about the total staff addition.

Can you also provide us the numbers of total teachers increase and also for admin staff?

Thanks.

Sure, Vivian.

First, in terms of the one-on-one, one-on-one was about 21% of revenues this quarter versus approximately 13% in the same quarter the previous year.

So going back to Ella's question, we are continuing to grow that business quite rapidly.

And it's seeing good momentum there.

In terms of the full year, I said on previous calls 20% to 25% of revenues for the full year.

I think based on what we have up to this point it'll be on the high end of that range, much closer to 25% than 20% for the full year.

In terms of your questions on headcount, I just break it down into kind of teaching staff and non-teaching staff.

On the non-teaching staff side, we did have significant year-on-year increases in headcount for sales and marketing and G&A.

There was approximately 1,900 additional non-teaching staff to bring us to a total of approximately 3,600 for the end of this quarter.

And then on the teaching side we added approximately 700 teachers, which is the combination of part-time and full-time teachers, to bring us to a total of over 31 teachers -- 3,100 teachers, rather.

Just to give a little bit of additional color in that regard, I would say -- I'd like to emphasize on the sales and marketing side, the reason you see a sales and marketing expense increase is largely driven by headcount.

I did mention some increase in advertising expenses in one-on-one, and we also had some in our online courses.

But it's mostly head count driven.

We're not going out there and trying to chase enrollments with a lot of one-off kind of spend in that regard.

We're really trying to position ourselves for strong future growth by adding the headcount we need.

And to that, in the sales and marketing area you'll see that a lot of the head count came from that area that we call Xueke, which are the folks that are doing the on-the-ground marketing for us, as well as the editors for our social community.

So in terms of Xueke, you can think of them as kind of teacher-marketers who do the lectures, the parent teacher meetings, seminars, to enhance the word-of-mouth and attract the parents to our offering.

And importantly, I mentioned this in the prepared remarks but I'd like to say this again, is that these teacher marketers form the bench for our future school head pool.

On the social community side, we have significant headcount to allow us to enhance the quality of the online discussion boards and content for our various websites that are all part of that EDUU platform.

So gaokao.com, zhongkao.com, etc.

So I'd like to mention that we're already in 26 cities with our aoshu.com, which is our Olympic math website, and in 40 cities already with our discussion boards.

So this is all about kind of setting that groundwork for future growth of our physical platform.

So we're really kind of investing in headcount ahead of our learning centers.

On the G&A side, I would just emphasize that we're really adding in areas that are going to help with the management of our business expansion and control.

So IT system support, finance, HR, internal audit, internal control.

So that's the additional bit I would say about the headcount increases.

Right.

So what is advertising as a percentage of revenue for this quarter?

Direct advertising.

Yes.

So I mentioned previously it was between 2% and 3%.

I think the exact number is 2.8%.

So it's still pretty low because we're spending less than 1% on advertising for our small class business.

That remains still a word-of-mouth driven business.

We're just spending more on advertising for one on one and online courses, as we said we would.

One-on-one, more of an advertising-driven business.

It's part of driving sales in that business segment.

For online courses, I mentioned that we're really setting the stage right now for continuing to ramp that up.

So it's a new business and we're spending advertising behind that new business.

Right.

Just one last question on Mobby very quick.

Sure.

Do you plan to design Mobby offering as one of the high-end product offerings going forward?

Yes, absolutely.

It's already at the high end.

So it's RMB133 an hour, and that's for 12 students in a class, okay?

So Mobby has a real opportunity to be quite a profitable area for us.

We believe we can do that because we're competing in the same segment as a lot of the other players in that pre-K space.

I'm sure you know many of the names in that area.

And that's kind of typical what you can expect in terms of the hourly rate in that segment.

And we think we're not really competing with them directly because we're offering something completely different that the market doesn't have right now but that is of course very important for Chinese parents.

So we're quite excited about this business.

Okay, great.

Thank you.

Thanks, Vivian.

Thank you for your questions.

Your next question comes from the line of Jennifer Gao from Credit Suisse.

Please ask your question then.

Hi, Joe.

Congratulations on a successful quarter.

My question is about your city expansion strategy.

It seems to me that unlike your competitors that Xueersi is not in a hurry to expand your city -- I mean physical presence.

Can you tell me more about your strategy in city expansions?

And in terms of those cities that you don't have like physical presence, you talked about the 26 Aoshu websites and 40 discussion boards.

Can you tell me about how do you do marketing in those cities that you don't have physical presence and you don't have your, like, word-of-mouth strength?

Do you do, like, advertising or how do you attract, like, parents and students to your boards?

Thanks.

Sure.

Let me address the question in terms of cities first.

For this year, we'll be adding between four and six new cities.

So we've budgeted for six, but we'll continue to assess that number.

But that's what we're looking for in terms of the February quarter.

And we'll probably add those cities in January.

And that's going to be our strategy going forward.

We think adding cities in January each year makes a lot of sense because it gives us sufficient time to select and train new school heads, teachers, other staff, so we can ramp up over the spring and summer terms.

So going forward, our fiscal year '12 of course ends February 28 of 2012.

The next year is our fiscal year '13, and we probably won't add cities again until January of 2013.

And right now we're targeting about four to six new cities then as well.

So I would say you're right.

Our focus is definitely on having a very strong foundation in the cities that we enter rather than getting too big too quickly.

That's part of the philosophy of Xueersi to really make sure that we are going deep into these cities, establishing proper teacher quality, being really able to establish that word-of-mouth in each of our cities.

So that's why we're really excited about what we're seeing in markets like Guangzhou, Shenzhen.

We will continue to focus our energy on building our capability in those cities which we see as the highest potential for K through 12, rather than spreading ourselves too thin and trying to go into too many cities too quickly.

So I think your understanding of us and our approach and how it's different from other competitors in the market is spot-on.

And then you had a second question, I remember, about how we approach marketing in new cities.

And this is important.

And this is why that social community and all the discussion boards in the 40 cities and the Aoshu websites in the 26 cities are important.

What we do is we actually go in several months -- and in this case for some of those cities it will be longer than that, even over a year ahead of time, before we actually set up a center.

And the reason we do that is because through the discussion boards we want to be able to establish that word-of-mouth in each of the markets.

So for us, for our small class business, advertising isn't really a very effective way of addressing those students because those for our small class tend to be at least the top half of students.

And they come to your class largely because they're convinced of your teaching quality.

They're convinced of the stronger outcomes that you can give them.

So a word-of-mouth platform where you are approaching those parents that are really interested in what's happening with their kids through a social community where they can communicate with other parents of similar interests.

They can learn about what we've achieved in our other markets.

They can interact with our teachers on an informal basis.

This is a much more effective way to go about marketing for our small class business.

So that's our approach and that's how it's different I think from our competitors and also from what we're doing ourselves in our other business formats.

Was that helpful?

Yes.

Very much.

Thank you very much.

Can I ask a follow-up question in terms of the new school heads?

Sorry.

Where do you, like, find those new school heads for new schools?

Are they from, like, the traditional bigger schools or --

Yes.

That's a great question.

We do have to generate them internally.

It's not like other businesses.

Like if you're looking for a Coca-Cola manager, you can maybe poach someone from P&G or Nestle and it'll work out okay for you.

For us, we really do need to cultivate our teachers and our school heads internally, and it's something we spend a lot of focus on organizationally.

So I mentioned for why we're adding a lot of these Xueke or these sales and marketing people that help us with lectures and the other parts of our businesses.Part of it is it helps to drive our word-of-mouth and the small class business as a whole, but another important thing is that it really forms a very good pool for future school heads.

So typically a school head will come from a teaching background.

And then through the sales and marketing area they can demonstrate project management capability, certain commercial sense.

And then we're able to select these people on a less high-stakes environment to eventually be our school heads.

Rather than going straight from being a teacher to a school head, they have an opportunity to go through something of a rites of passage I guess in the Xueke area.

And we're being much more planned in terms of our school head cultivation.

We've already selected those school heads which we intend to go into those four to six new cities in January.

So that's something that we've done much further ahead than we have in the past.

We selected them a couple months back now and we've already had them do training in various different areas as well in terms of recruiting students, in terms of we'll be giving them basic financial management.

We -- we're doing that process much earlier.

And then in terms of where we select these school heads, they are largely selected from our existing schools.

Now, what I'm happy to report is that before all of our school heads had come from our Beijing school.

Now as our other schools like Shanghai , like Guangzhou, like Tianjin are starting to really perform and have a really strong business themselves, we're able to recruit school heads from other schools as

Great.

Thanks.

Thank you for your questions.

Your last question comes from the line of Chao Wang from Merrill Lynch.

Please ask your question.

Hi.

Thanks for taking my question.

Just firstly, not sure if I missed it, wondering what's the offline enrollment growth.

Yes.

Chao, I did mention that in my prepared remarks.

It's 25%.

Oh.

Got it.

And also, do you expect any cannibalization from online courses?

We don't see any evidence of that now.

It's hard for us to measure with a lot of precision based on what I talked about earlier in the call, but I think the positive is that we're seeing strong enrollment growth in our small class and one-on-one businesses.

So at this point we're seeing the online courses business as largely incremental both by helping us to address students and cities where we currently don't have learning centers.

And then also for places where we do have learning centers, it's not all subject areas that students are willing to come to a class.

Some subjects where they may not need as much help or they think are less important, they could potentially do online or they could do some review of just some concepts.

That's why they're kind of smaller number of hours, lower ASPs, that they wouldn't necessarily need to go to a full class in an offline setting.

So that's a longer way of saying that I think that at this point we don't see evidence that it's cannibalizing our offline business.

And lastly, wondering what the 1.5 million other income.

Is it foreign exchange gain?

Yes.

It's primarily driven by that, as it was last quarter.

There are some other things in there, but it's primarily driven by that.

All right.

Thanks.

Thank you for your questions.

There are no further questions from the phone line.

I would like to hand the conference back to your presenter.

Please continue.

Thank you all for joining us today.

And if you should have any further questions, please don't hesitate to contact me or Willow.

And we'd also very much welcome you to our cities to check out our learning centers when you're in this part of the world.

Thank you very much.

Ladies and gentlemen, that does conclude our conference for today.

Thank you for your participation.

You may all disconnect the line now.