TAL Education Group (TAL) 2012 Q4 法說會逐字稿

Thank you for standing by, and welcome to the TAL Education Group fiscal, fourth quarter and full year 2012, 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.

Please be advised that this conference is being recorded today, April 25, 2012.

I would now like to turn the conference over to Caroline Straathof, you may begin.

Thank you.

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

The fourth quarter and fiscal year 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.

Joseph Kauffman.

Following his prepared remarks, Mr.

Kauffman will be available to answer your questions.

Before we continue, please note that the discussions today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995.

Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.

Potential risks and uncertainties include, but are not limited to, those outlined in public filings with the SEC.

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

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

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 now like to turn the call over to Mr.

Joseph Kauffman.

Thank you, Caroline, and thank you all for joining us on our fourth quarter and full fiscal year 2012, earnings conference call.

We are very pleased to report another quarter of rapid growth of our Tutoring Services business, as well as our continued rollout this quarter to the cities of Chongqing, Zhengzhou, Suzhou and Taiyuan.

As we extend the reach of our learning center network and brand, we have put increased emphasis in the quarter on improving cost control and operational efficiency and continuing to put into place the investment in core competencies needed to support this expansion.

On the revenue side, net revenues increased by 55% year over year, to $52.2 million, exceeding our top end guidance for the quarter by $2.4 million.

This growth was supported by very solid enrolments growth of 47%.

Our core business, consisting of small class and one-on-one, once more delivered outstanding top line growth.

We are also pleased to see the strong uptake in online courses sales to accompany the heightened investment we have put behind our online platform this year.

Of note in the fourth quarter is that due to the early Chinese New Year, our spring semester for Tutoring Services as usual began just after the holiday period.

But that was still before the start of our Company's fiscal first quarter which began on March 1.

As a result, we recognized some revenue from the spring term in our fiscal fourth quarter.

Excluding this revenue impact, our fourth fiscal quarter revenue still would have been within the upper end of our guidance.

Let me now take some time to briefly update you on key developments in the fourth quarter.

As I mentioned in our last call, our focus in the third and fourth quarters was on improving center utilization levels and efficiency, while further limiting the number of new learning center additions.

This more discerning approach has meant that while we added five small class centers, we also closed down or converted into consulting centers 10 underperforming one-on-one centers.

During the quarter, the total number of net learning centers was reduced by five.

So by year end, we had a total of 270 learning centers, 159 of which were small class learning centers, which includes four learning centers for our Mobby branded pre-K business, and 111 learning centers for one-on-one.

The net reduction in the fourth quarter brings the total new centers added in the full fiscal year to 138.

Having already more than doubled our learning center base, we chose to forgo our full year target of 150 learning center additions for the year in order to make sure we were achieving the operational efficiency we desire.

Overall, we are very pleased with the success of our center rollout plan that we have executed during this past fiscal year.

We have continued to grow nicely in our established Beijing and Shanghai markets, while realizing extremely rapid growth in cities outside of Beijing and Shanghai.

Since our founding in 2003, we have never been a first mover in any of our cities, from Beijing to Shanghai, Tianjin, Guangzhou, Shenzhen, and the four new cities of Hangzhou, Nanjing, Chengdu and Xi'an we launched in the first half of this most recent fiscal year.

Yet we have proven in each of these cities that we can come in with the right differentiated offering and products, and grow at a fast rate, even with established local competitors in the market.

As regards our city expansion plan, we added four new cities during the fourth fiscal quarter.

The fifth city, Shenyang, we have already entered in this current fiscal first quarter, slightly behind our original plan, but still very much on track.

We started with just one learning center in each of these new cities, and with small classes only.

We plan to then ramp up to more learning centers over time as utilization of the first center reaches capacity.

This is consistent with the approach that served us so well in Guangzhou and Shenzhen.

Our social network, called eduu.com, continued to be a key asset for us in this new city expansion.

Per plan, we had established a local eduu.com office in each of these cities many months before, in order to reach out to and build brand awareness among our targeted parent group well ahead of setting up our first new center.

I am pleased that again this past quarter we maintained the high growth momentum of our small class business segment in the cities outside of Beijing and Shanghai, our two core markets, which also performed well.

Cities outside of Beijing and Shanghai contributed 16% of small class revenues in the quarter compared to only [6%] (corrected by company after the call) during the same period in the previous fiscal year, and roughly in line with their 17% revenue contribution in the third quarter.

These cities outside of Beijing and Shanghai actually accelerated their growth in the fourth quarter, growing by a combined over 300% versus the same period in the previous year.

The sequential drop quarter to quarter was due to stepped-up performance in the combined Beijing and Shanghai business in the fourth quarter.

In our Zhikang branded one-on-one business, due to seasonality factors, we saw more scaling in the fourth quarter after the seasonally low and loss-making third quarter, as we expected.

For one-on-one, our objective is not market share, but managing the growth for ongoing profitability.

We continue to improve profitability in our one-on-one business by way of better center utilization and cost controls.

We further reduced advertising spend, while also limiting increases in non-essential new hires.

And as I mentioned already, there were 10 centers that we decided to close or convert into consulting centers in the fourth quarter.

As a result of these cost saving measures, combining importantly with the seasonally higher one-on-one revenues in Q4, this business turned quite profitable for us again in the fourth quarter, and one-on-one was also profitable for the full fiscal year.

Losses associated with our Mobby branded pre-K small class business and our online strategy, which comprises both online courses and our online social network, eduu.com, will continue into fiscal 2013.

We see nice momentum in these business units, and they are likely to be areas of increased investment going forward.

I should note that through fiscal year 2012, eduu.com has been a no-revenue, cost-only, but highly successful effort that has provided an important service for parents and students, while also helping to increase awareness of our brand, thus reducing our need to spend on brand promotion and advertising.

We still expect losses in online courses in Mobby to be smaller in fiscal year 2013 than in fiscal year 2012, as I indicated last quarter, though we will be stepping up our investment in the eduu.com platform, given the important role it has played for us in our continued city expansion.

Overall, fiscal 2012 was a year of successful business expansion.

We achieved rapid revenue and center enrolment growth, while we notably enlarged our market presence, more than doubling the number of learning centers, and also rolling out to eight new cities during the year to a total of 14 cities.

Over the course of the year, we also enhanced our product offering in our core small class business, most notably through upgrades to the animated content, and the teacher-student experience in our interactive whiteboard-enabled classrooms using our ICS, or Intelligent Classroom System.

In addition, we made important inroads in two new businesses.

Online courses grew rapidly, nearly tripling its revenues in fiscal year 2012 versus a year ago period.

We also introduced the new tutoring format branded Mobby to address the highly complementary pre-K market.

Finally, we began to put in place a multi-level business unit structure, with headquarters functions to build a solid organizational foundation for our long-term growth and scaling.

In fiscal year 2013, we aim to balance growth opportunities with our ambition to further solidify the basis of our leading and innovative education brand.

We want to build on the success we achieved over the last year in our rollout to cities outside of Beijing and Shanghai with our proven small class business model.

As we ramp up revenues, we will also invest aggressively in our core assets and the operational support required to sustain our successful business expansion.

We believe now is the appropriate time to make these additional investments because we have brand strength, good growth momentum, solid financial resources, improved organizational management capabilities, as well as market opportunity.

At the same time, we will look for cost and expense optimization opportunities and increased scalability in our business model.

In particular, in both our small class and one-on-one businesses, we will seek to improve utilization of a large number of learning centers added, largely over the first two quarters of last year.

Key areas of investment for fiscal 2013 are the following.

We want to ensure that our innovative approach to new market entry, utilizing our leading social network, eduu.com, continues to be successful, and this will be an area of increased investment.

The online community of parents and students that we have already built is a key advantage, even in cities where we face established competition.

We plan to add more editors and writers, and develop more products for download, especially localized content.

In addition, we will further develop our competitive strength, particularly the top quality content and curriculum and outstanding teacher resources of our proven small class business model.

In particular, we will continue to invest in people, through teacher training and management programs for high potential employees.

Finally, we will further strengthen our organizational structure to realize our vision to build a long-lasting and respected brand in the K-12 space in China.

As you know, we have begun to put into place a multi-level business unit structure, with headquarters functions to set strategic direction and provide technical and functional expertise from the center to locally managed business operations.

In fiscal 2013, we will invest more in our organizational capacities.

Our Company is still small enough at this point in our development that we can put the right structure in place now that will have long-lasting benefits as we continue to grow.

As mentioned in our previous call, we engaged in some consultancy projects to make sure we had the right systems and processes in place for a sustainable scaling of the business.

We are now completing the organizational structure and model of the engagement, and will enter the IT design phase over the first half of this fiscal year 2013, and expect to implement IT systems for human resources, finance and administrative areas by fiscal year end.

The cost of these projects will likely begin to hit our P&L beginning in the second fiscal quarter.

All in all, we expect these investments will support a better managed national expansion and sustainable quality of our growth.

As we have said before, we are very positive on the outlook for fiscal 2013, targeting a 30% to 35% revenue increase.

We believe we can maintain the good traction we have built in new cities and become the go-to player in the small class Peiyou business for top performing students in each of the 15 cities in which we now have learning centers.

Let me now move to the financial results for the fourth quarter and full fiscal year.

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

The key driver of our revenue growth was our small class business followed by our one-on-one business.

Our online courses business is growing quickly, but is still small as a percentage of revenue, given the considerably lower ASPs in the segment.

That said, as a percentage of revenue, it has doubled its contribution to over 4% of total revenues in the fourth quarter versus only 2% of revenues in the year-ago period.

We delivered $52.2 million in revenue in the quarter, representing revenue growth of 55.2% versus the same period in the previous year.

Driving the quarter's revenue growth was strong enrollment growth of 47% combined with higher average selling prices.

Total student enrollments increased to approximately 228,500 from approximately 155,400 in the same period one year ago.

The increase in enrollments was driven primarily by small class in online courses enrollments, as well as the high pace of growth in one-on-one tutoring, which for the full year, contributed 23% of revenues compared to only 16% for the full year and fiscal year 2011.

On the ASP side, the year-on-year ASP increase of 5.5% for the fourth fiscal quarter was primarily driven by foreign exchange rate fluctuation, as our ASPs are quoted in US dollars, as well as hourly rate increases in a portion of our small class courses.

In terms of overall operating cost and expenses, the significant increase in the fourth quarter year on year was largely due to rapid expansion of our learning center network over the course of fiscal year 2012, as we both increased penetration existing cities and entered eight new cities.

In addition, the headcount increases associated with the city and center expansion, we also saw large head count increases in our sales and marketing and general administrative areas, most markedly in the first half of the fiscal year, as we began to put in the place the multi business unit structure necessary to manage our growth.

As this organization structure came on before the revenues have ramped up, it has been a drag on margins.

In the near term, moving to more of a matrix structure is less efficient, but we expected over the medium term it will pay off in terms of the level of control and effective management we will be able to exert over our multi-location operations.

Finally, the increase in operating costs and expenses was clearly impacted by our investment in new growth businesses, which require a significant number of base personnel, even as their businesses are all very much in the startup phase.

Our gross profits in the quarter were $23.7 million GAAP, and on a non-GAAP basis excluding the impact of share base compensation, gross profits were $23.8 million.

Our gross margins were 45.5% on a GAAP basis and 45.5% in the quarter on a non-GAAP basis.

Our gross margins during the same period of the previous year were 52% on a GAAP basis and 52.4% on a non-GAAP basis.

We saw roughly 690 basis points of compression in non-GAAP gross margins due primarily to the increase in teacher compensation costs, rental costs and compensation costs for other staff to support the larger number of learning centers.

The increase contribution of our one-on-one business as a proportion of our overall business in the quarter also had a downward impact on gross margins.

This impact was offset partially by our benefiting from revenues recognized from the spring term that we did not have last year.

Total operating costs as a percentage of revenue on a GAAP basis with [33.3%, and non-GAAP were 30.7%] (corrected by company after the call) in the fourth quarter, compared to 28.2% GAAP and 21.2% non-GAAP in the same period one year ago.

Our selling and marketing expenses represent a 10.6% of revenues GAAP and 9.9% of revenues on a non-GAAP basis, versus 9.0% on a GAAP basis and 7.5% on a non-GAAP basis in the same period of the previous year.

The 160 basis points difference year on year on a GAAP basis was due largely to the increase in both center rollout support staff and sales and marketing personnel to support our city expansion learning center expansion, as well as greater advertising and promotional spending on online courses one-on-one in Mobby segments.

As I mentioned on previous calls, the sales and marketing personnel were mostly for the Xueke team, which consists of teacher marketers who work to promote our small class Xueersi Peiyou offering, including new cities where parents and students may not be as familiar with our programs.

Advertising as a percentage of revenue 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.

However, for both one-on-one and online courses, our advertising declined sequentially on both in absolute basis as a percentage of revenues versus the third fiscal quarter due to our cost control efforts.

General administrative expenses as a percentage of revenue were [22.7% GAAP and 20.8%] (corrected by company after the call) non-GAAP, excluding share based compensation expenses.

G&A expenses for the same period of the previous year were 19.1% GAAP and 13.7% non-GAAP.

The increases, both GAAP and non-GAAP, were mainly due to an increase in general administrative staff expenses to support extended operations and related rental and office expenses, as well as consulting fees incurred in the quarter.

The above factors combine to give us GAAP operative income of [$6.3 million, a decrease of 22.6%] (corrected by company after the call) versus the same period the prior fiscal year, and non-GAAP operating income, excluding share based compensation, of [$7.8 million, a decrease of 27.1%] (corrected by company after the call) versus the same period of the prior fiscal year.

Operating margins in the quarter were 12.1% GAAP and 14.9% non-GAAP versus 24.3% GAAP and 31.6% non-GAAP operating margin of the same quarter in the previous year.

These fourth quarter operating margins were similar to the fourth quarter of fiscal 2010 when our GAAP operating margins were 12.8%.

Our net income for the quarter was [$7.6 million, decreasing by 10.2%] (corrected by company after the call), and non-GAAP net income, which excludes share based compensation, was $9.0 million decreasing by [17.4%] (corrected by company after the call) compared to the same period in the last fiscal year.

Our GAAP net income margins were 14.5% and non-GAAP net income margins were 17.3% in the quarter, versus 25.1% GAAP and 32.5% non-GAAP during the same period in the prior fiscal year.

In summary, in the fourth quarter, we achieved strong top line results while, as expected, year-on-year profitability was affected primarily by the large investment we made earlier in fiscal 2012 in continuing to build out our learning center base, expanding the new cities, and beginning to put in place the right organization structure to support our future growth.

Moving to year as a whole, fiscal year 2012 was an outstanding year of growth for our business in which we delivered just over 60% revenue growth, driven by enrollment growth of approximately 42% and ASP growth of just over 13%.

TAL's net revenues reached $177.5 million for the year from $110.6 million in the fiscal year 2011.

Selling and marketing expenses increased 133.2% year over year, and were [13.1%] (corrected by company after the call) as a percentage of revenues for the year as compared to 9.0% in fiscal 2011.

On a non-GAAP basis, excluding share based compensation, selling and marketing expenses as a percentage of revenue was 12.2% compared to 8.1% in fiscal 2011.

We believe we continue to retain an advantage of our peers in the amount we need to spend on advertising and brand promotion, thanks to the proven track record of our tutoring Services, resulting in positive word of mouth references, the strength of our large and active online education community, and the higher barriers to entry and more attractive competitive environment we believe to surround the small class business, which represents the bulk of our revenues.

General administrative expenses increased by [98.1% in fiscal year 2012 to $37.8 million] (corrected by company after the call) from $19.1 million in fiscal year 2011.

Non-GAAP general administrative expenses, which excluded share base compensation expenses, increased by [108.4% to $31.8 million] (corrected by company after the call) from $15.3 million in fiscal year 2011.

The increase was mainly due an increase in general administrative staff expenses to support extended operations in related rental and office expenses, and also consulting fees incurred in the second half year of fiscal year 2012.

Our operating margins in fiscal year 2012 were 11.8%, and on a non-GAAP basis we achieved operating margins of 16.3% for the year.

Income tax expense was $4.2 million for the full year of 2012 as compared to $2.6 million in fiscal year 2011, mainly because the exemption period of one of TAL's entities expired in calendar year 2010, and the entity has become subject to a still preferential but higher tax rate from calendar year 2011.

We ended up with an annual tax rate of approximately 14.6% this last fiscal year compared to around 9.7% in the previous year.

Net income from continuing operations decreased by 0.3% to $24.3 million from $24.4 million in fiscal year 2011.

Net income attributable to TAL increased by 1.1% to $24.3 million from $24.0 million in fiscal year 2011, giving us 13.7% net margins for the year.

Non-GAAP net income attributable to TAL, which excluded share based compensation expenses, increased by 9.8% to $32.2 million from $29.3 million in fiscal year 2011, giving us non-GAAP net margins of 18.1% for the year.

Basic and diluted net incomes per ADS were [$0.32] (corrected by company after the call) and $0.31 respectively in the fiscal year 2012.

Non-GAAP basic and diluted net income per ADS, which excluded share based compensation expenses, were $0.42 and $0.41 respectively.

From the balance sheet, I would like to highlight our strong cash position in growing deferred revenue balance.

As of February 29, 2012, the Company had [$188.6 million of cash and cash equivalents and $10.3 million of term deposits] (corrected by company after the call).

As of February 29, 2012, the Company's deferred revenue balance was [$85.6 million] (corrected by company after the call) versus $50.7 million as of February 28, 2011, representing a 69% increase year over year.

Finally, moving on to guidance.

Based on the Company's current estimate, total net revenues for the first quarter of fiscal year 2013 are expected to be between $44.2 million and $45.8 million, representing an increase of 33% to 38% on a year-over-year basis.

As I mentioned at the beginning of my remarks, the spring term had already started in our fiscal fourth quarter.

Our first quarter revenue guidance already factors in this impact.

We maintain our earlier revenue growth guidance for full fiscal 2013 ending February 28, 2013, reflecting our very positive view on the growth opportunities in China's K-12 after school tutoring market.

We expect total net revenues for fiscal year 2013 to be in the estimated range of $230.8 million to $239.7 million, representing an increase of approximately 30% to 35% year over year, assuming no material change in exchange rate.

Please note that while the percentage of our growth rate has maintained from earlier full year guidance we gave, we took the absolute revenue number [up] from last quarter to reflect the better than expected outcome in fiscal year 2012 versus guidance from last quarter.

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

That concludes my prepared remarks.

Operator, I am now ready to take questions.

(Operator Instructions).

Philip Wan, Morgan Stanley

My first question is about your ASP.

The growth rate for your ASP was lower than the previous quarter.

And also, taking into consideration that your raised price for small class in Beijing and Shanghai recently, just wonder how should we look at the ASP trend in coming quarters?

Sure.

Thanks a lot.

As you know, there are a lot of factors that go into ASP.

In addition to the exchange rate fluctuation, which benefit us because we report in US dollars, there are a number of other factors that positively impacted ASP.

We took our hourly rate increase in Beijing and Shanghai for small class beginning with the Chinese New Year, and we also took that price increase with one-on-one in October.

As one-on-one becomes a greater part of the business, that also has a greater impact on ASPs.

But in this quarter, this was partially offset by greater contribution of our online courses business, which is a lower ASP business, and also by lower ASPs in both small class and one-on-one in second and third tier cities.

As these cities become a greater part of the business, they will continue to moderate our overall ASP increases.

Also of course, we phase into the price increases that we take in the small class segment.

So in the fourth quarter, you had part of the third semester in there, the fall semester which didn't have any ASP increase, and then you also had the winter in there.

And in the winter, we took a price increase in Beijing from 55RMB to 60RMB and in Shanghai from 50RMB to 60RMB, but the actual price increase was actually in the low single digits, because we have a coupon program for a lot of our returning students.

So you'll continue to see ASPs be relatively moderate in the spring semester, and then we will likely take the full ASP increase in the summer semester.

Is that helpful in terms of the question on ASPs?

Thanks.

That's very helpful.

And then my second question is related to your gross margin.

Given that there's a change of business mix with, for example, more online and Mobby contribution going forward, what should we expect for the gross margin in one to two years down the road?

I think that one of the things that I talked about on the call is that we're managing the growth of our one-on-one business which is a lower gross margin business.

That, combined with a more moderate plan in terms of new center expansion, should lead to gross margin over a longer-term perspective that should have some moderate increases over time.

But I would think that it would still continue to be in the mid 40s range over the longer term.

I think it's too early to tell in terms of online and gross margin and Mobby what the impact will be on gross margin in terms of those businesses.

I would focus more in terms of the -- one-on-one will not have the same huge ramp-up in growth that it did this year on a going forward basis.

And we will have a more moderate take in terms of new center expansion each year, combining both new centers and then also seeking to expand existing centers, which should also be helpful in terms of margins vis-a-vis opening whole new centers.

Understood.

And sort of related to that, could you remind us your plan for the network in terms of opening how many new learning centers in 2013?

And also, are we expecting the evaluation process of the one-on-one continue as you may continue to close down more underperforming one-on-one centers?

Yes, I think that I'll first address the question in terms of new centers.

In terms of new centers, we may not add a full 50 or 60 centers, but as I tried to allude to just now, we're looking to achieve the equivalent of 50 to 60 centers through a combination of new centers and adding capacity to our existing centers, which we think is actually much more cost efficient.

And most of this added capacity will likely come on in the second half of the year, and primarily in our small class business.

In the first half of the year, we'll be focusing more on improving the utilization of our existing centers.

In terms of one-on-one, yes, you should see us continue to look at managing the growth in that area.

I was very pleased to see the return to profitability from one-on-one in this quarter.

And it takes one-on-one centers longer to ramp up - we've always talked about it taking close to a year for them to ramp up - but at the same time if we see something that's not working, we will likely seek to consolidate one-on-one centers.

One of the things that we did this quarter was some of the centers that were standalone centers we actually consolidated into centers that also have small class.

So they were in the same building as small class, which helped us to get much more complementary business from our small class offering.

So we'll be looking to do those kind of optimization moves with one-on-one going forward as we continue to manage that business for profit.

Very clear.

Thanks, Joe.

Thank you, Phil.

Ella Ji, Oppenheimer.

Congratulations.

Just a follow-up on a prior question.

I'm wondering if you can talk about the lessons that you learned from those underperforming one-on-one centers that you closed, and if there's going to be any change in your daily operation going forward.

Yes, sure.

I think that we decided to close down one-on-one centers primarily in Guangzhou and Chengdu.

And like I said before, we were focusing on standalone one-on-one centers.

So as I mentioned, most of our one-on-one centers are actually in the same building as small class.

That way, we can realize the cross-sell benefits from small class and generally have a lower cost to serve.

In Guangzhou and Chengdu, we discovered the cost to serve the standalone one-on-one centers was higher, and we were also not realizing the same kind of cross-sell benefits.

So based on our forecast for uptake and enrollments and revenues, made the decision to shut them down.

So that's a key lesson that we learned that one-on-one, it's always been a complementary business for us and it makes sense for us to have it in the same building as small class in most of our cities.

That way, we can really realize the cross-sell on the revenue side, and then also have a lower cost to serve, which will make it more profitable.

In Chengdu, we actually converted one center from one-on-one to small class, which was a win-win for both business units.

So if we can do that kind of thing, we will as well, if there are opportunities that present themselves.

In terms of the centers that we converted to consulting centers, these one-on-one centers were in the same building as our small class centers but had too few cubicles to make them efficient to serve.

So that was the other lesson we learned that there's a certain number of cubicles where you have an economy of scale that it makes sense to have a learning center and you can support all that staff needed to manage the cubicles.

If you don't have that, then it makes sense just to have the consulting center where parents can come in for registration.

From a people utilization perspective, it was a lot better to convert the learning center to a consulting center.

In those cases, we can still realize the cross-sell benefits from small class, but we can consolidate the cubicles into a larger learning center so we can leverage the staff managing the tutor cubicles more efficiently.

So going forward, the lesson is we're going to be quite disciplined in managing growth for one-on-one business.

We'll focus on improving the utilization of our one-on-one centers rather than having new centers, at least for the first half of the year.

For centers that are quite low utilization levels, or where utilization levels have not improved enough, we'll have to close them down so we can focus more energy on ramping up our high potential centers.

I believe that that's the right way to approach the business.

Great, thank you.

In terms of utilization improvements, how much do you think you can improve in the next year?

Just can you give us some more details in terms of where are the areas that you think you can improve?

Is that the capacity of the learning center, or the teachers?

Just any details would be very helpful.

Okay.

Well, everyone in the industry defines utilization a little bit differently, so I don't know how helpful this is in terms of doing cross company analysis within the sector, but I can give you a sense that for us, our overall utilization for small class, for example, is still approximately 50%; lower in some markets and higher in others.

And for one-on-one, it's approximately 20%; again, lower in some markets and higher in others.

So there is plenty of room for us to meet our revenue growth objectives by focusing on improving our execution in our existing centers.

This will also of course be helpful for profitability.

So I think this gives you a sense that there's a lot of room for us to grow, particularly in the one-on-one, just by improving our utilization, Ella.

I think that essentially gives you an idea of how we're thinking about it.

We look mostly at center utilization.

Future utilization is affected by what we call class fulfillment rates, so making sure that if we have a maximum of, say, 15 students in a class that most of the classes actually have 15 students in that class.

That way, you get better utilization out of your teachers.

We look at that, and then we look at class utilization, which helps us get to an overall utilization number.

So the class utilization number is obviously more about the classrooms in the centers.

The class fulfillment number is more about the teachers.

But both of those get you to an overall utilization number, which is the number that I was just talking to you about.

So they're both factors.

Hopefully, that gives you some sense of how we think about it.

Yes.

That's helpful.

Thank you.

And then switching gears to the spending in G&A area.

I think you had two consulting projects.

Are those completed, or are you going to continue spending on that?

And also, could you also talk about the salary increase for your teachers; overall, how much year-over-year increase are you seeing in that line?

Yes, sure.

In terms of the consulting project, the engagement that we engaged in last year continues into this next year, so we haven't engaged any new consultants for next year, but we still have costs and expenses from the engagement we engaged in last year which will carry into the next year.

Also, of course, once you hire a consultant, you can either put the report up on the top shelf and let it collect dust, or you can actually start to execute what they're recommending, and part of their recommendation has to do with the organizational structure improvements that I talked about, and also the investing in systems like an HR system, like an OA system, improving our finance system, etc.

So all of those kinds of things will also -- they're not the consulting projects, but they're areas of investment for this coming year.

In terms of the teacher salary increases, this isn't something that we disclose.

We see this kind of competitive area.

But I will talk a little bit about directionally we see more pressure on non-teacher staff salaries than teacher salaries.

There may be some upward pressure on teacher salaries as a percentage of revenue in Q1, as we will not have rolled out the full ASP increase until Q2, as mentioned in Philip's question earlier.

And then in terms of non-teacher salaries, we're purposely upgrading the levels of people we hire, especially for the headquarter staff positions, which is contributing partially to the increase in wages for non-teaching staff.

We also see some pressure among the front line staff in the learning centers.

Minimum wage law we've talked about before has a ripple effect upwards which impacts the expectation of employees, even for non-minimum wage jobs.

So overall, we expect wage inflation for non-teaching staff to trend in over 20% as TAL employees' wages continue to increase in that non-teaching area.

So hopefully, that gives you some sense.

Yes, that's great.

Thank you very much.

Janice Chen, Piper Jaffray.

I'm asking questions on behalf of Mark.

My first question is what are they in terms operating infrastructure build-out?

Also, what areas do you need to build out to complete the operating infrastructure, and when do you expect to complete the build-out?

Thanks.

Yes, sure.

As I mentioned in the call, the key areas in the investment are the following.

One is the social network, our eduu.com, which has been very successful for us, being an area of increased investment.

The online community to parents is a key advantage for us, especially for things where we have established competition.

So we plan to add more editors, writers, develop more products for downloads, local content and that kind of thing.

We'll also work on our competitive strengths, which for us is content and curriculum, outstanding teacher resources, our proven class model.

So that's another area.

And then finally, the area that I just alluded to was in the area of organizational structure and systems, which if we want to be the most respected, or respected K-12 education provider for the long term, these are areas that we need to put focus on.

So that will be IT systems, human resources, finance and administrative areas, which we expect to give us greater visibility also in terms of trends in our business.

So those will probably come in more in the second half of the year, as I mentioned.

Finally, the online courses and Mobby will continue to be loss making for this coming year.

So that all continued to have an effect on our cost structure.

Well, when do you expect -- when shall we expect the build-out to complete?

As I mentioned, second half of the year, I would say.

That's when -- it's hard to say.

The systems we'll be putting in in the second half of the year.

We're renovating the Danling center, which is the office space that we bought, in the second half of the year.

That may carry into 2014 fiscal actually.

We're targeting second half of this year.

So these systems and these processes, this kind of stuff we're targeting for the second half of this year.

So how much of incremental capital expenditure shall we expect from all this build-out?

In terms of CapEx, I don't have an exact number for you for that for now.

I would think that the way to think about it is that we have the center expansion which is from 50,000 to 100,000 RMB per center, I've given you some idea of what we're thinking about in terms of centers, so that all contributed to CapEx.

And then we also have the renovation expenses which will probably be between $5 million and $8 million, a portion of which will be capitalized.

And then a portion of the costs of IT and HR systems implementation will also be capitalized, but I'm not yet ready to give you a number for that because we're only now in negotiations with our vendors for that.

So I'll probably be in a better position to give you a number on that later.

Other than these items that are large capital expenditure items, we don't expect anything big like last year where we made a big capital expenditure, of the office space, to the tune of over $60 million.

It's more going to be in the range of what I just talked about.

The remaining items will likely be small like computer servers, equipment that will be added as we add headcount.

Thanks very much for -- very helpful for the color.

And my second question is that given you mentioned that the Company is going to implement more stringent cost control, although we have all this new investment in the new areas, what do you think will be the net impact on the operating margin in fiscal '13?

And then do you have any target for fiscal '13 for -- in terms of operating margin?

Thanks.

Yes, we won't be giving detailed margin guidance, but directionally fiscal year '13 will be another year of investment, as I mentioned, as we continue to separate ourselves from the competition in the K-12 space.

In terms of margins, as I mentioned, we expect to continue to be under pressure, at least with two quarters coming up, as we want to cycle the larger cost structure.

Remember, we added a lot of people in Q2 of last year, so after the significant headcount and center increases last year, so that needs to be cycled yet.

Also, you should note that we'll be taking ASP increase in Beijing Shanghai for small class, not right away, but it will phase in over a couple of semesters.

I mentioned before that returning students get a discount to the full price increase for the spring semester, so that will take some time before they get the full -- we get the full benefit of that.

And then I just talked through in the second half of the year how we had the new headquarters building in Zhongguancun, the implementation of IT systems.

We also -- I talked about continued wage pressure among non-teaching staff.

Part of this is through the general wage inflationary environment.

We actually had a third party perform a survey that showed that we were below the industry in terms of the compensation for our employees.

So as a branded player in the K-12 states, we can be lower to a degree, but will need to bring those levels up closer to norm.

But we're also paying higher compensation per head as we upgrade the quality of our non-teaching staff and manage our national expansion.

But on the positive side for margins, of course, we'll open a fewer number of centers this year, we're trying to improve utilization, which all should help to stabilize the gross margin line, again a question that was asked by Philip earlier, especially if one-on-one, which is a lower margin product, grows at a slower pace.

So I don't have enough visibility to quantify the overall effect, but -- at this time for you, but hopefully, this is helpful to give you a sense.

I think overall, there will be further downward pressure on operating margins in fiscal 2013 before beginning to stabilize in fiscal '14.

That's very helpful.

Thanks very much, Joe.

No problem, Janice.

Anita Chen, Jefferies.

Thanks, Joe.

Can we have revenue contribution, your revenue split for one-on-one, small class and online for 2012?

I can give you the revenue breakdown.

The revenue breakdown for the full year was approximately 23% of revenue for one-on-one, approximately 3% of revenue for online courses, and then the remainder was small class.

And then in the quarter, one-on-one was 24% of revenue this quarter versus 18% in the same period of the previous fiscal year.

So one-on-one is continuing to grow very rapidly.

I don't want anyone to get the impression that one-on-one is not growing very rapidly for us.

It's growing gangbuster, so as you can tell from those numbers.

We're just seeking to make it a profitable business in an overall area of the K-12 market which has lower barriers to entry and can be a race to the bottom in terms of margins if you don't manage the profitability as we're trying to do.

In terms of the enrollments, what I can give you is online courses.

I'm not going to break down all the enrollments, but online courses was 16% of enrollments in the quarter.

Okay.

It ended up being 16% for the full year as well.

Okay, thanks.

Joe, do you have any outlook for the one-on-one business in 2013?

Yes, we're seeking to manage the growth of that business, so whereas it grew well over 100% revenue this year, we expect it to grow more like over 50% of revenue next year.

So we don't expect to have the massive jump from 18% to 24% in the quarter, or 16% for the year last year versus 23% for the year this year.

It will probably be a more marginal uptick.

I think it will still increase as a percentage of revenue, because it's still continuing to grow quickly.

But as we manage it for profitability, we'll also be managing it as a percentage of our overall business.

Thank you.

My last question is can you share with us what's your full time and part time teachers, as well as your total staff at the end of the year?

Sure.

Our total staff was approximately -- well, I'll give the full number when it comes to the annual report in 20-F time, but it was over 5,000 for the full year.

And for full time teachers, it was over 2,000 for the full year.

Again, I'll give the breakdown in terms of full time and part time when we file our 20-F in June, but directionally, we've been focusing more on -- trending towards more full time teachers.

The reason for that is these teachers help us with the functional areas of support.

We are laying into the headquarters functions for our small types of one on one business, including sales and marketing, content development and teacher training.

They are full time employees who -- they help us during the week in these functional areas, and then they teach classes in the weekend.

So teachers are great at that so it makes sense for us to skew more towards full time teachers.

However, there is a seasonality to our business, especially with one-on-one.

So part time teachers will always have a role in our business and are important for us in continuing to keep our cost structures in line.

Thank you.

Vivian Hao, Deutsche Bank.

Just quickly, what's the roughly the financial impact of the closed down centers on your P&L?

This is first question.

Secondly is the other -- the $1.2 million other income on your P&L for 4Q '12, could you give us some color on that?

Yes, sure.

On the first question, I don't have an exact number for you, but as the majority of those centers were converted to consulting centers, they weren't actually -- we count them as being not learning centers for the purpose of our external reporting, but they still exist.

They just don't have the cubicles there where kids are doing the one-on-one learning.

So there is an effect of shutting down the center and there being some kind of a cost for going on lease, or whatever.

So that's the first point.

The second point is that where we can, like in Chengdu, we're converting it into a small class center, so again, if anything, that would be positive for the financial statements because small class is a more profitable business than is one-on-one.

So it's only in a couple of cases where we actually closed down the center altogether where you'll have a short-term effect of that process of shutting down the center, but over the longer term, we think it will be made up very much so by -- these were standalone centers that had a high cost to serve where we weren't having as much benefit from the cross sell in small class.

So I think it's definitely the right move that we made in the quarter.

In terms of the other income, as in past quarters, it's primarily driven by the exchange rate gain, because we report in US dollars.

Chao Wang, Merrill Lynch.

My question is regarding your first quarter guidance.

Could you explain why it slowed down from fourth quarter?

Is it because of closure of one-on-one centers?

And why is it much lower than deferred revenue growth.

And how much of the deferred revenue will be booked next quarter?

Thank you.

Okay, sure.

Yes, you hit on one of the reasons for the revenue guidance, but there were a number of factors that went into it, so let me talk you through all of that.

One of the things that affected our guidance was the earlier Chinese New Year.

We recognized one week of classes for spring term and fiscal quarter 4 instead of fiscal quarter 1.

I mentioned that in my prepared remarks.

So on an apple-to-apples basis, our revenue growth outlook would be more like 42% to 46% in the first quarter rather than our current 33% to 38%.

The other factors were, as you mentioned, managing growth of our one-on-one profitability.

So we still expect it to grow over 50% revenue, but it will unlikely grow 100% revenue like last year.

Online courses revenue is so far also a little bit softer for the quarter than we previously expected, so we're not going to turn that around, but I really want to note that our full year guidance has actually increased versus the range I offered last quarter by a full $5.6 million for the year.

So I would keep that in mind as you think about the quarter.

In terms of the deferred revenue, the deferred revenue, it's really driven a lot by one-on-one, so one-on-one, people sign up for more months at a time, so you have a large deferred revenue balance which is recognized over a longer period of time.

So as one-on-one becomes a greater part of your business, then you're going to have higher deferred revenue.

Most of the deferred revenue is from one-on-one business, right?

No, you have deferred revenue from all of the businesses.

For the small classes, it's also you have deferred revenue as well because there is a semester-to-quarter reconciliation in the small class business as well.

But the small class business typically in the spring, it's 15 weeks.

In the summer and the winter it's shorter, whereas the one-on-one business, you're putting a certain amount of hours on the card which you're paying upfront, and then it's a very customized business so you can take that over a longer period of time.

So it's not like the small class business where it's over a set number of classes.

So that's the difference.

So I think as all of the K-12 players, as one-on-one becomes a bigger part of the business, the deferred revenue will not necessarily be as indicative of what is going to be happening in the immediate next quarter.

It gives a nice direction, but there may be some gaps between what we're giving in terms of revenue guidance and what you see on the deferred revenue line.

And secondly, do you have guidance on tax relief in fiscal'13?

On what rate?

I'm sorry.

I didn't hear that.

Tax rate.

Oh, tax rate.

Yes, when the question was asked last quarter, I said that it was 15%.

We're continuing to try to work on that.

So for fiscal '13, I feel more comfortable with a range of 13% or 14% now for the tax rate for fiscal '13.

Okay.

Thank you.

Jennifer Gao, Credit Suisse.

This is Wallace.

Just a very quick macro question.

Do you feel like the whole K-12 market in China is over competition is like -- there's a huge pressure from the last few years from various VC leading to some players our utilization rate may not be as high as what management expected, not necessarily just you, but the whole industry.

Thank you.

Yes.

Sure, Wallace.

Yes, the first point is for the K-12 sector as a whole, no.

I think it's a huge market that is -- it's a $40 billion market.

It's projected to grow 18% plus, at least that's what our third party research told us when we looked at this.

And I think that dynamic continues to be the case.

The top five players I think are still probably less than 2% of the market.

For our small class business, I think that we continue to have a very attractive competitive set.

VC is not as interested in the local players which are our primary competition for small class.

We have a great competitive offering where we're really differentiated.

We have outstanding outcomes for students, which you need to have great teachers and great content, and we're rolling that out to each of our new cities.

That's why you're seeing our small class business growing over 300% in cities outside of Beijing and Shanghai.

We're really rolling very effectively versus local competitors in each of those markets, and Beijing and Shanghai is continuing to grow well also.

So I think in the area that is 70% plus of our business, the competitive set remains very attractive, and we're not seeing a huge amount of increased competition.

Where there is a lot of competition, from what we can see, is in the one-on-one set.

That's where you've seen a big amount of VC funding in these two large not yet IPOed companies, just in the last several months.

And it's also an area where some of the other listed players have also grown their business and focus energy.

But we've been growing very well in that space, growing over 100%, and you can see that our revenue for one-on-one, as I mentioned before, is 23% of the percentage of revenue for the year versus 16% in the same period last year.

So we're really, I think, growing that business also quite in line with the competition.

But whenever you're in a market where there are lower barriers to entry, where there are highly funded players that are spending on things that are easily replicable, like advertising, like centers, like renovation, our view is it makes sense to return to our core and what is our real strength, which is teachers, content, and the outcomes of our students.

So that's why with one-on-one, you'll see that we spent less on sales and marketing over the last two quarters.

We're focusing on the shared centers rather than the standalone centers where we can realize the complementary nature with our small class, which is really very strong for us.

And like I said, it's 70% of our business.

So I think what you describe as a heating up of the sector which may lead to lower utilization rates is a reflection of the one-on-one business, but not a reflection of the K-12 tutoring market as a whole.

Great insight.

I just want to get a sense about the competition further.

As we're seeing a lot of players expanding their learning centers, quite a lot, obviously mostly in the one-on-one space, as you mentioned, do we see any signs that expansion phase is getting to a plateau stage, slowing down?

Or are we seeing a more speeding of the growth.

What we're trying to do is to get a better sense about the margin trend, not just on the economy, but also as a whole of the industry, whether we still have a couple more quarters, even a year ahead, before we breach this trough and get into a more normal stage.

Thank you.

Sure.

I think some of the listed competitors have talked about increasing their centers in this coming fiscal year by 100 centers, or the equivalent of 100 centers.

So that suggests that there will be more center rollout by some folks.

For us, as I mentioned, we feel like there's enough capacity in our existing centers, certainly for the first half of the year, for us to focus on improving classroom utilization, improving what we call class fulfillment rate, which is how full our classes are, and manage that part of the business.

It's important, especially for the small classes, that you have nice full classrooms because it adds to that great dynamic in the classroom where you have lots of top students that are interacting with each other, you have that real vibe in the classroom that people come for.

That's part of it.

Part of it is getting to meet with kids from other schools in a weekend environment to see how you stack up, to have fun.

So you need to have full classrooms for that.

So we're going to be focusing on that because that's the nature of what we do.

We're -- that's our differentiation, and small classes, Peiyou, that's 70% of our business focusing on top students.

And that's going to continue to be our focus going forward, because that's where we can differentiate best.

The competition, I can't really speak for, but I would say that it's a different strategy.

If we were leading with one-on-one, then maybe we would also have more centers ramping up.

But for us, small classes are core.

One-on-one is an important part of our business which is complementary to what we do with small classes.

Thank you very much for insight.

Thank you.

And at this time, there are no audio questions.

I would like to turn the call over to Mr.

Kauffman for any closing remarks.

Thank you all for taking time to be with us tonight, and we really do look forward to having you come to Beijing, come to see our centers.

And please feel free to reach out to me or to any of our IR personnel if there are any other questions that we were unable to answer on the call.

Thanks so much.

Thank you for your participation.

This concludes today's call.

You may now disconnect.