TAL Education Group (TAL) 0 Q0 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the TAL Education Group third quarter of fiscal year 2013 earnings conference call. At this time, all participants are in a listen-only mode. There will be a presentation, followed by a question and answer session. (Operator Instructions). I must advise that this conference is being recorded today, Tuesday, January 22, 2013. I would now like to hand the conference over to your first speaker today, Ms. Mei Li. Thank you. Please go ahead.

Thank you all for joining us today for TAL Education Group's third quarter of fiscal year 2013 earnings conference call. The third-quarter 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 SEC.

Also, our earnings release in this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains the 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, Mei. And thank you all for joining us on our earnings conference call for the third quarter of fiscal year 2013.

We are pleased to report in-line revenue growth combined with an outstanding performance in operating income and net income in the quarter. On the revenue side, net revenues increased by 20.3% year-over-year to $48.9m, in the mid-range of our guidance. Revenue growth was supported by a 9.0% increase in enrolments. Our center-based business, consisting of small class and one-on-one, delivered this solid top line achievement, with small class continuing as our core business and our key growth driver.

We are very pleased to see the third quarter brought more improvements in our operational efficiency. Our operating profit margin improved by 340 basis points in the third quarter of fiscal 2013 versus the same period of the previous year. Net income increased by 288.3% year-on-year. We achieved this mainly through a combination of more effective utilization of learning centers and budgetary discipline.

For some years now, we have described our business development as a cycling of investment and harvesting phases against the backdrop of the growing tutoring services sector in China. We entered the current harvest phase in the business approximately four quarters ago, and have just started to come out of this phase and return to the investment cycle.

In the third quarter of fiscal 2013, we turned the corner to have a net addition of centers since the previous quarter for the first time in this fiscal year, opening a new small class center in both Guangzhou and Xi'an and a one-on-one center in Hangzhou, while closing one underperforming one-on-one center in Shenzhen. Of the 259 centers we had at this quarter end, 160 were small class learning centers, which includes four learning centers for our Mobby branded pre-K business and 99 were for one-on-one.

Let me now take some time to update you on key developments in the third quarter of fiscal 2013.

The key growth driver in the third quarter was once more the strong growth momentum in new markets for our small class business. In the quarter, small class revenues in cities other than Beijing and Shanghai each grew by over 100% versus the same period in the previous year. Year-to-date, small class revenues in cities other than Beijing and Shanghai have grown by over 150%, making it the primary driver of our overall growth this fiscal year. In terms of revenue contribution, cities other than Beijing and Shanghai accounted for 28% of small class revenues in the third quarter, compared to only 17% during the same period in the previous fiscal year, and 22% in the second quarter of fiscal 2013.

We continue to have great momentum in building our business in the markets we added in calendar year 2011. The combined total enrolments grew by over 200% year-over-year in Xi'an, Nanjing, Chengdu and Hangzhou. This underscores once more that our expansion strategy of focusing more on quality rather than quantity and managing our growth in the early stages of our entry into a new city continues to work well. It is still early days in the cities entered in 2012, Chongqing, Zhengzhou, Taiyuan, Suzhou and Shenyang, as we only first opened classes in these cities during the spring and summer terms.

As you are aware, we are facing some headwinds in Beijing with the change in policy on how math competency is being used as an entrance criterion for selection into key junior high schools. This change occurred just before the start of the fall term and created uncertainty for students and parents. As we expected, this adjustment had a near-term impact on student enrolments in our fiscal third quarter.

We see this impact continuing into the fourth quarter, both because the fall semester straddles both of these quarters and the current enrolments trend for the winter term suggests overall enrolments in Beijing will be down this winter term versus same period of the previous year. Students can still register or withdraw for the winter term and classes have not yet begun, so we still don't know for certain the final status. But this is the trend I see, based on the visibility I have at this time. The positive is that we do see improvement, with the year-on-year absolute decrease in winter term enrolments in Beijing already narrowing as compared to the year-on-year decrease we saw in the fall term. This gives us confidence that enrolment growth will come back to Beijing; we just do not yet have a lot of visibility on the timeline for when exactly that recovery should be complete. Even though the impact from the policy change will not likely disappear in the next couple of quarters, we believe the course improvements we have made and plan to continue to make will bring students back to our small classes over time, as we've created an even more effective and interactive environment for them to increase their academic competitiveness.

In our Zhikang branded one-on-one business, we continued our efforts to manage the growth. Typically we see that in cities where our small class business thrives, one-on-one does well too. This confirms once more that one-on-one tutoring works well in our business model as a complementary offering to our core small class business. While the third quarter this year was again unprofitable, given the stronger seasonality patterns and proportionally higher fixed cost structure of this business line, Zhikang has historically been profitable on a full-year basis. And we expect it to be more profitable for us this year, given the operational improvements we have made over the last 12 months, than it was last year.

Let me update you on our other business units. We have recently launched a few new initiatives in online courses. We have introduced live webcasting of some lectures for some of our online courses, as an alternative to solely pre-recorded video, to make the offering more interactive. We're also providing after-class exercises and other online content on our speiyou.com platform to correspond more closely to what students are learning in small classes. Our intent is to be able to create a more blended learning model in which online course exercises and practice materials can be applied as complementary to small class. These initiatives are part of our efforts to invest in online tutoring for its long-term business potential and integrate it with our core business. Even as we continue to determine the best way to monetize parts of this new business, we have already seen our online courses make a significant contribution to our other business lines. Online courses help us build our brand awareness and increase parent and student understanding of what makes Xueersi so special in cities where we do not yet have a small class bricks-and-mortar business. For the quarter, online courses contributed approximately 4% of total revenue.

Meanwhile, our Mobby branded pre-school small class business continues to grow well. But rather than seeking to expand beyond the four centers in operation, our efforts are focused on getting the model right. We are broadening the concept of fostering 3-6 year olds to appreciate math and logic to also extend to practical life skills, character balancing and developing a sense of judgment to help children deal with everyday life issues. We expect this concept to have potential appeal to a slightly older age group of first- to third-grade students as well. We continue to believe in the long-term growth opportunity of these new business lines.

As always, we are allocating very little advertising spend to promote our products, even with our new business initiatives, as we believe in the strength of branding driven by word-of-mouth. This-word-of mouth, which allows us to be able to underspend on advertising versus our peers, continues to be based on the outstanding academic achievement of our students. Among our students' many achievements over the past several months, we are proud to report gold medal winners in 2012 at both the 53rd International Mathematics Olympiad and the 43rd International Physics Olympiad. Six of our students in Guangzhou were on the team that received the Hua Luo Geng Golden Cup for excellence in mathematics, and eight of our students in Beijing achieved the top score in their city districts for the Zhongkao, China's high school entrance exam. Looking ahead, we will continue to invest behind initiatives that are in line with an overall trend we see in the private education sector of "returning to the essence of what makes education education.".For those of you who understand Mandarin Chinese, "jiaoyu yao huigui jiaoyu."

What really makes us good at what we do is a strong core tutoring competency and an enjoyable and effective environment for students to pursue their studies. This has always been a core value for us, because it is the basis for our Company reputation in the market and why we have been effective in growing our brand based on word-of-mouth marketing. In the coming fiscal year 2014, we will be focusing on offering even more differentiated content to our students. We want to bring more interactive, multimedia based teaching to the classroom, as well as other innovative uses of technology. In addition, we will continue to put our utmost efforts into ensuring we are delivering top-level teacher quality in the market, based on solid training, competitive salaries and an overall positive working environment for our teachers.

Let me now go over the financial results with you.

We delivered $48.9m in revenue in the quarter, representing revenue growth of 20.3% versus the same period in the previous year. The revenue growth was partly driven by the higher average selling prices, or ASPs, and an increased number of total student enrolments.

Total student enrolments increased to approximately 153,800, from approximately 141,100 in the same period one year ago. The increase in student enrolments was driven primarily by small class.

On the ASP side, the year-on-year ASP increase of 10.4% to $318 for the third fiscal quarter was primarily driven by the hourly rate increases in the Company's small class business.

One-on-one tutoring contributed 19% of revenues for the third quarter of fiscal 2013, compared to 21% for both the previous quarter and the same period in fiscal year 2012.

Now, moving back from one-on-one to the total business numbers. Cost of revenues increased by 13.0% year-over-year to $26.7m. The increase in cost of revenues was primarily due to an increase in rental costs, teacher compensation, and other staff costs associated primarily with an expansion of learning center capacity. Non-GAAP cost of revenues, which exclude share-based compensation expenses, also increased by 13.0% to $26.7m.

GAAP and non-GAAP gross profit for the third quarter were $22.2m, as compared to $17.0m for the same period of the last year. GAAP and non-GAAP gross margin for the third quarter was 45.3% and 45.4%, respectively, as compared to 41.8% and 41.8%, respectively, for the same period of last year.

Selling and marketing expenses increased by 6.5% to $6.9m. The increase primarily reflected an increase in salaries and benefits for our sales and marketing personnel to support a greater number of programs and service offerings, which was mostly offset by reduced advertising and other expenses. Non-GAAP selling and marketing expenses, which exclude share-based compensation expenses, increased 4.6% to $6.4m.

General and administrative expenses increased by 36.8% to $12.8m. The increase was mainly due to an increase in salaries and benefits for our general and administrative personnel to support an expanded number of cities in which the Company had learning center operations. Non-GAAP general and administrative expenses, which exclude share-based compensation expenses, increased by 33.6% to $11.0m.

Operating income was $3.1m, representing a year-over-year increase of 163.4%. Non-GAAP operating income increased 103.9% year-over-year to $5.3m.

Operating margin in the third quarter was 6.3%, as compared to 2.9% in the same period of the previous year. Non-GAAP operating margin was 10.9%, as compared to 6.4% in the same period a year ago.

For the third quarter of fiscal year 2013, other income was $1.8m, compared to other expense of $0.2m in the same period of the last year. This $1.8m of other income was primarily driven by an exchange gain. As the Company holds the vast majority of its cash balance in renminbi and reports in US dollars, it benefits from exchange gains in times of relative strength of the renminbi and incurs exchange losses in times of relative strength of the US dollar.

Our net income for the quarter was $5.6m, and increased by 288.3% year-over-year. Non-GAAP net income for the third quarter was $7.9m, up by 172.0% year-over-year.

Basic and diluted net income per ADS were both $0.07 for the quarter. Non-GAAP basic and diluted net income per ADS, which exclude share-based compensation expenses, were both $0.10.

From the balance sheet, as of November 30, 2012, the Company had $234.4m of cash and cash equivalents and $14.5m of term deposits, as compared to $188.6m of cash and cash equivalents and $10.3m of term deposits as of February 29, 2012.

As of November 30, 2012, the Company's deferred revenue balance was $107.3m, representing a year-over-year increase of 38.6%.

Total net revenues for the fourth quarter of fiscal year 2013 are expected to be between $58.0m and $60.0m, representing a year-over-year increase of 11% to 15%. Taking into account the continued near-term impact of the new Beijing policy and the Company's efforts to manage the growth of its one-on-one business, we adjust our full-year guidance from that provided earlier and expect our full-year revenue to be in the estimated range of $224.3m to $226.3m, representing an increase of 26% to 27% year-over-year.

That concludes my prepared remarks. Operator, I am now ready to take questions.

Thank you very much, sir. (Operator Instructions). The first question comes from the line of Chao Wang from Merrill Lynch. Please ask your question.

Good evening. Thanks for taking my questions. Firstly, just some housekeeping questions. Joe, could you give us the revenue split between small class and one-on-one, and also a revenue breakdown between -- sorry, enrollment breakdown between online versus offline and also the learning center expansion and shutdown plan for next year? Thank you.

Okay. That's a lot in one question. Let me handle them one at a time. The one-on-one as a percentage of revenue in the quarter was 19%. The online courses as a percentage of revenue in the quarter was 4%. And the remainder was small class.

In terms of offline and online split, offline -- rather online, online was 15% of enrolments in the quarter. And I mentioned already that it was 4% of revenues.

In terms of center expansion for next year, I gave a number last quarter of the equivalent of 30 learning centers for the first half of next year for us, which means ending August 31, since our fiscal year begins on March 1. And what I mean by the equivalent is either new learning centers or adding capacity to our existing learning centers. And the way I got to that number was thinking about five classrooms per one equivalent learning center, even though you'll see in the market that many of our learning centers have eight classrooms or more.

So that's what I can give in terms of next year. We tend to give a half-year at a time because, as you know, we're very focused on utilization and making sure that we're getting healthy growth out of our new learning center expansion. So we'll continue to update in terms of the second half of the year, based on how the first half of the year progresses.

Also, I might note that we're not expecting one-on-one learning center expansion next year, in the first half of the year. So that number I just gave was the small class number.

Right. Got you. So, just to clarify, that 30 is a net add, right?

Yes. That 30 is what we're planning on adding. I don't have a number for potential closures. I would expect, if we do have closures, it would be in the one-on-one area.

Got you. Thank you. My second question is could you maybe explain more on the soft guidance, like how much is due to the new policy versus how much is due to your scaleback from one-on-one? And also, how much is probably due to organic slowdown, especially in the mature markets like Beijing? Thank you.

Yes, sure. Directionally, I can give you some idea of that, Chao. So, as you know, students are still registering and withdrawing from classes for the winter term, our so-called Hanjiaban (spoken in Mandarin) for the Chinese New Year term. But based on the current numbers, the small class primary school business in Beijing is likely to continue to experience declines versus the year ago period, which is consistent with what we had expected and I talked about on last quarter's call. As you'll remember, I talked about the fact that we'd be impacted with repercussions from the Beijing policy likely through the summer term of next year. So I expect an impact on enrolments as well in the winter term.

The good news is that the absolute number and percent decline for small class is not as great as in the fall, as I mentioned in my prepared remarks. So we've definitely entered into recovery mode. And then a further positive which has been consistent for a long time now is that we expect cities outside of Beijing and Shanghai to continue to perform well in the upcoming winter term.

For the one-on-one business, we are continuing to manage the growth of this business for quality. In Q4, we expect to see single-digit revenue growth for this business versus over 100% revenue growth in the same period last year. But remember that last year's high revenue growth was on the back of center expansion targets for this business that were quite aggressive in the fiscal year of 2012. So we're seeking to change the model for one-on-one away from one that's dependent on rapid center expansion for its growth.

So hopefully that's given you some indication about what we're seeing in terms of potential Olympic math related impact and one-on-one and what we're seeing in our out-cities, which we talk about as the cities other than Beijing and Shanghai.

[As we look to the first half of fiscal 2014, we'll have some upside, given the timing of Chinese New Year. Last year we were able to schedule at least one session in the fourth quarter, depending on the city, which we weren't able to do this year. So that should give us a nice bump of an estimated CNY22m for Q2, which we weren't expecting previously. If you think about it, with the incremental CNY22m in Q4, the year-over-year revenue growth would look more like 22%, at the high end of our guidance, versus the current 15%. ] (Company corrected after the conference call)

So hopefully that gives you a little bit of color on the guidance for Q4, Chao.

Yes, yes. It's very helpful. Thank you.

Thank you.

Thank you very much. The next question comes from the line of Fei Fang from Goldman Sachs. Please ask your question.

Hi, Joe and Mei. Thanks for taking my question. My first question is if we can talk about the 3Q margin. So the revenue came in broadly in line with the guidance, but margin was substantially higher than consensus. So what drives the strong profitability of the quarter? And specifically, which cost item do you see upside or downside opportunity going into 4Q? Then I have follow-up questions. Thank you.

Sure. Thanks, Fei. No, we did out-deliver on the margin side again in the third quarter, as we focused on utilization and cost control. There were some partly one-off events that were working in Q3's favor, so we'll expect to incur some additional costs in Q4. So I think it's important to note that a meaningful portion of the operating income mentioned in Q4 has already been realized in Q3. Operating in Q4 will likely be lower, actually, than the same period of the previous year. What we have was essentially a shifting of profit from Q4 to Q3.

In terms of the specific things that -- or items that hit Q3, I'll list out a couple of them for you, just so you get a sense. Q3, we received a $500,000 government subsidy which was included in operating income. We also just turned the corner in center expansion in the quarter, which will pick up in Q4. So you saw our very strong gross margin in the most recently reported quarter, partly due to that strong utilization, but as we add new learning centers you'll see more costs associated with that.

The renovation expenses related to our new headquarters office space in Beijing, only began to hit in the last part of Q3 and will hit for the full quarter in Q4, along with the depreciation of the purchase price of this building.

Then there are other things that hit Q4, like we do accrue bonuses each quarter for our senior management. But we've actually had many senior management out-deliver on their profitability targets for their business units this year, so we may be adding on top of the amount that we accrued in terms of the annual bonus.

And finally, every year we do have a year-end party, Chinese New Year party, Company meeting, etc., which is an expression of goodwill to employees, very important in terms of boosting morale for the coming year. So that typically hits in Q4 too. So there are a number of expenses that will hit in Q4.

That said, and you asked about the full year, you know I don't give guidance in this regard. But given what I see now, the trend for full year still looks consistent with what I mentioned last quarter. So, based on the outperformance we've seen in the first three quarters of the year, we could indeed see some nice operating margin expansion, likely around that 100 basis points that I talked about. Last quarter I said 50 to 100 basis points. I think it'll look more like 100 basis points, based on my visibility now, for the fiscal -- for the full fiscal year, when we're talking of fiscal year 2013, ending in February of 2013.

That's great. My second question is regarding the current macro conditions. We have seen that the macro in China is stabilizing and picking up. So, on the ground, Joe, are you seeing any change in customer behavior? For example, the more expensive one-on-one pre-K segment, are we seeing incremental traction?

I think that our business -- I still maintain that the education sector's a very defensive sector. So, in times of economic slowdown, we don't see as much of a slowdown as perhaps other sectors, and in times when the economy may be rebounding we maybe won't see as much of a rebound. I think that I gave some indication in my answer to Chao's question that we're not expecting one-on-one to grow particularly fast in the Q4 quarter as well. We think that's largely driven by our own efforts. Keep in mind that we've actually been reducing the number of centers for one-on-one for several quarters now.

So on one level it's great that we're getting growth out of this business, given a fewer number of centers. We're intentionally managing the growth of that business because that business, we haven't seen it on an industry-wide level be particularly healthy. So we want to be first to make it more healthy, through a combination of better teaching quality, focusing on what I was talking about, the essence of what makes education education, better utilization of the centers, making it healthy and profitable business.

So I don't expect, because of this rebound, for one-on-one to have a huge pickup in traction, but I think that's largely because of our doing and the focus we have on our business, which I adamantly believe is the right focus.

Okay. Congratulations on the strong set of results.

Thanks, Fei.

Thank you very much. The next question comes from the line of Ella Ji from Oppenheimer. Please ask your question.

Hi, Joe. Hi. How are you? So my first question regards -- is with regard to the Olympic maths in Beijing. So, currently, what is the management's best guess in terms of the timing? Do you expect this to be another temporary ban or will this becoming an eternal change? And also, have you seen any changes in other cities in China?

Sure. So, yes, our view is pretty consistent with what I said last quarter, which was that it would take a few quarters to rebound. So, in terms of the Beijing business, we are expecting to get back to enrolment growth starting with the fall term, which is kind of our Q3 of next year. So I would expect that you could see enrolments down in Beijing in Q1 and Q2, as it will take us a couple of quarters. That's our best guess in terms of when we would see a rebound.

But keep in mind even in Q3 the small class business in Beijing did experience low-single-digit revenue growth. So, while enrolments were down, because of the ASP increase we were able to see a bit of revenue growth there.

And then there was a second part of your question.

Yes. I was asking if you've seen any other cities in China.

Sure. So, in terms of other cities, no, we are not seeing an impact. In fact, our other cities are just doing really well. I mentioned the out-cities, and I've particularly highlighted the four cities that we entered in the fiscal year '12, Xi'an, Hangzhou, Chengdu, Nanjing. Those markets I mentioned in my prepared remarks have 200% plus enrolment growth. They are really doing well. And Guangzhou, Shenzhen. We are having a lot of strong traction in a lot of our markets. So, no, we are not seeing an impact, at this point, of the policy change in Beijing in other markets.

Good. And then let's -- a follow-up question is, if these changes in Olympic maths in Beijing is taking much longer than what you expected, how would you say your operating costs and expenses would change? Do you think is it likely that you will adjust your corporate overheads accordingly?

Sure. I think that what you've seen is that we've made a pretty good effort in terms of keeping the expenses under control in terms of our headquarters functions over the last few quarters, so I would think that we would continue in those efforts. We have made some investments at the business unit level. But in terms of the corporate overhead, I would think that going forward -- and it's a little bit early to say, Ella, because we haven't yet finalized our fiscal 2014 budget. That will happen in March. We've been going through that process. But that's directionally what we seek to do.

And then, on top of the overhead piece, you've also seen very good strength in terms of gross margins as we've been able to really improve the unit economics of our centers. So I think that will continue to be the effort and something that we've really taken the lead on doing four quarters ago now, as we continue to focus on those health indicators, well ahead of this Beijing policy change. So I think that those efforts that we have been making and will continue to make will continue -- will help us be able to continue to reap rewards on the margin side even as we -- there is some uncertainty in terms of when exactly the Beijing business will recover next year.

Okay. And then my second question is regarding your long-term learning center expansion plan, especially given the changes in the competitive landscape. Currently, we are seeing a lot of your peers slowing down in learning center expansion as well. I wonder, how would that change your plan of learning center expansion? Would you say this is a potential opportunity for market share gain and thus become more aggressive in terms of learning center expansion in the coming year?

I don't think so, Ella. I think that we operate in a different business than some of our listed peers, and we are really focused on making sure that we are delivering very high-quality teaching and delivering outstanding outcomes for our students. And we are going to be focused on our own metrics, which are the metrics I've been talking about for several quarters now -- utilization rates, retention rates, how the teaching quality is in the classroom in terms of our teachers, what their attrition rate is, these kind of health indicators of our business. That's what we are going to be focused on and that's going to guide our learning center expansion plans.

So we have a different footprint than some of our competitors. We are in 15 cities. Our competitors are in many, many more cities. And we really believe that the best opportunity for us, because the market is so big, is really to focus on what we do well, on that top Peiyou student and making sure we are delivering the absolute best outcomes for that student. That means that what really is going to drive our center expansion plans is these internal metrics that we have for our business and how we are achieving versus those metrics.

Great. And then my last question is if you can take -- give us some initial thoughts regarding your fiscal year '14 guidance or business plan. For example, do you plan to continue raise prices and how much would that be? And also, any color regarding your expectations on margins would also be very helpful.

Sure. I'll try to give you a little bit. But as I mentioned, because we haven't completed the budget process, it will probably be better after the next quarter's call to be able to give something more on that. But what I can tell you is that we do intend to raise prices for our small class business next year, likely in the summer term. So that will have some benefit on the ASP side, going into revenue.

And then, as I mentioned in my remarks with Chao, we do see a little bit of upside versus last year in terms of that one and a half or so classes, that [CNY22m that would have been recognized in Q4 last year that will be recognized in Q1 this year. That will give a little bit of a boost to Q2] (Company corrected after the conference call), keeping in mind of course that we are still seeing that Beijing enrolments will probably be down versus previous year. So I don't want to overstate the significance of that upside, but we do have a bit of upside there.

I've mentioned on previous calls that we don't expect to enter more cities at this point, so we'll probably stay with the 15 cities. But in terms of center penetration plans, we have pretty bold center penetration plans, as I talked about in my reply or in my response to Chao about the first half of this year. I think that the equivalent of 30 new learning centers is a good number. We're seeking that balance between growth and profitability, and I think that's a pretty good number to work with in that regard.

Keep in mind that the cities we entered last year, those five cities, they all each only have one learning center now. So there is a good amount of opportunity for increased center penetration not only in those cities but across our network, especially in cities other than Beijing and Shanghai.

Great. Thank you for taking my questions.

All right. Thank you, Ella.

Thank you very much. The next question comes from the line of Mark Marostica from Piper Jaffray. Please ask your question.

Thank you. Joe, you talked about seeing potential for recovery in enrolment growth in Beijing perhaps as early as the fall of next year or this coming year, I should say. But could you elaborate on the course improvements that you are making that presumably are the core in actually driving some of this recovery?

Sure. A big part of that is making sure that we have a very strong leveling system in terms of our classes. So you'll remember that we do have the four levels in our classes, but we are making that differentiation in terms of the leveling even more marked. So the entry level will be not focusing on as high a level of difficulty, and then the hardest level will have a higher level of difficulty. So that then kids, when they go through the assessment for getting into each of those levels, they are placed into what's the right level for their current capability. And I think that that's really important as we continue to focus on making what we deliver relevant for our students.

I think the other piece that I talked about a little bit was just we are linking our classroom, what we do in the classroom, with some stuff that they can do online on our Speiyou platform -- that's speiyou.com -- which allows kids again to make it more relevant, to be able to do a lot of exercises and practice during the week, in addition to being able to attend classes, which is largely on the weekend.

We are also experimenting with technology. I don't want to say too much about this yet, but we will be piloting some pretty innovative stuff in terms of technology that takes our ICS to the next level in terms of being interactive with our students. That's probably something that will be in the pilot stage next year, this coming year, fiscal year '14, with a broader launch if it's successful in fiscal year 2015.

All right. Thanks for the color there. And then, regarding operating margins and in particular sales and marketing, sales and marketing, I think due to advertising expense control you saw a lot of leverage there, of course, this last quarter. I am curious, are you planning to step up your sales and marketing expenditures, particularly advertising, in the first half of the upcoming fiscal year with the launch of 30 new learning centers, or do you think word-of-mouth is going to be the key driver of enrolment growth for the new learning centers?

Yes, word-of-mouth will definitely be the key driver. And remember that we typically will do a lot of pre-marketing in each new city. We are not adding new cities, but as we go into new districts and that kind of thing there should already be a strong foundation, not only from the learning centers we already have in that city but also the influence that our Eduu platform and some of our other online courses, etc., have already delivered in that market in terms of brand awareness and getting people to be able to experience our products before actually going to a learning center. So it will be very much word-of-mouth driven.

One-on-one, because it's more complementary and because we are not adding new one-on-one centers, shouldn't really be a factor. You will see some advertising spend in Q4 and Q1 for one-on-one, as that's the peak time for one-on-one. So we'll do some advertising spend there. But I would say for the bulk of our business it's absolutely going to be word-of-mouth driven. And even for one-on-one, given its positioning as a complementary platform for small class, you should see advertising levels be lower than when we experimented in the last fiscal year with higher levels of advertising. I don't expect us to go back to that model any time soon. So I guess that's what I would say.

And then the other thing that I would mention in terms of sales and marketing is that you also have what I've talked about before, the Xueke Group, which is essentially people that manage the seminars and lectures for the small class business. And those people we may add as we add new learning centers, but I think we've also gotten good scale out of those people over the last year. So I don't expect us to be adding those people at a level that's greater than the amount that we have from the new learning centers that are coming on board.

So, I'd expect overall for us to get some scalability out of the personnel side of it, and also not to be adding a lot on the advertising side.

Thanks, Joe. That's helpful. And last question relates to the system implementation effort. Can you give us an update on the status of the efforts there and your desire or plans to continue to spend on consulting and systems implementation into 2014? Thanks.

Sure. Well, first of all, in terms of the consulting that we have with IBM and Roland Berger that we've mentioned in past quarters, that's come to a close. The last payment hit the P&L in this most recent quarter. That said, we did launch the e-HR platform, which is in the process of testing and making sure it's good to go. Based on the current timeline, we expect that those expenses will probably hit in the first quarter of next year. So that's what we know about now, in addition to an OA platform that we are setting up that will allow us to do a lot more authorization and approvals online, which in the long term should reduce the amount we are spending on people to do those equivalent tasks.

We are looking at potential other systems developments for next year, particularly in terms of forecasting and other things that will help us on the finance side to reduce people costs, essentially to be able to get better leverage out of our people in both of our finance and treasury functions. But it's early to say about those, because they are just in conversational phase right now and we haven't completed our budget yet for 2014.

Very good. Thank you, Joe. I'll turn it over.

Thanks, Mark.

Thank you very much. The next question comes from the line of Vivian Hao from Deutsche Bank. Please ask your question.

Hi, Joe. Hi.

Hi, Vivian.

Hi. I guess my question probably has been covered by the previous analysts already, but just want to get a view on your strategy in coming year for balanced growth and profitability. But in particular, what would you consider as the leading on margins through utilization improvement or efficiency, and also in what circumstance you would consider a more aggressive expansion mode, especially given the vast demand in newer markets? So it's just I try to understand, because I guess apart from the negative impact on the Olympiad math because of the regulatory change, we also see that it seems that there is a correlation between the center opening pace versus the growth in top line.

Right. Yes, I am not going to give too much guidance in terms of what our revenues look like for next year. I think that this year I mentioned that we are expecting operating margin improvement as of the yearend. February time should be about a percentage point greater than last year. So that's much better than what we were expecting at the beginning of the year, when we were expecting some declines. I think going forward I wouldn't expect those kind of operating expansion levels on a going forward basis. I think that we'll be doing the best we can in terms of getting further operating expansion, but I don't think it will be at this kind of level.

In terms of what the criteria would be, it really has to do with the degree to which we are growing our utilization levels and the health indicators of our business, so it has to do really with those metrics. And we have seen very good growth in the cities that we've entered since IPO. And if they continue to grow well, then we will look to add new learning centers as they continue to grow, if we are getting very good utilization levels out of our existing learning centers.

What we are not going to do is chase top line growth by losing control over the center expansion process. And I think that it was good that four quarters ago we already started to rein in that tendency of the one-on-one business. So that's the balance we are looking for. And I mentioned in the response to the previous question that I think that what we are offering now in terms of guidance, in terms of the number of centers we are looking to add in the first half of next year, is an indication of what we view as that healthy balance between center expansion and top line growth.

So, if things end up looking better in August, will we add more centers? Certainly. But we are looking for very strong utilization levels in order to achieve that. I've talked about what our expectations are in the past in terms of utilization, and we'd like to see at least 80% class fulfillment, at least 80% classroom utilization. When we start to see that, yes, we'll look to expand learning centers, but not before that because we don't believe that that leads to the long-term health of our business.

Right. So can I understand that you are satisfied with the current utilization rate? But based on the historical number, you only added about 16 small class in the past year, and actually scaled down about 20 of one-on-one in the past year. So will this be the price to pay for higher utilization going forward?

I don't think so, Vivian. I think that it's very clear that we are reining in what was an over-expansion of our one-on-one business in the previous year. So we added something very high, like 80 plus centers, in the one-on-one business in the previous year, on a base of something like 30. So we are reining that back in in this year. That doesn't mean that that's what's going to be the trend going forward. In fact, we've added capacity to the business this quarter, so we've made the turn in terms of investment. We added two learning centers, but we actually added over 80 classrooms.

So, in terms of adding capacity, we added a lot of capacity in terms of new signed lease agreements for new learning centers, even in this most recently reported quarter. And we do intend to have additional capacity along the lines of the 100 additional classrooms that I mentioned in my previous remarks on the last quarter's call. So I think we are on track in terms of our capacity and our adding capacity, and we are moving back into this investment stage.

So last year is not indicative of what we'll be looking at in the future. Last year was about rebalancing for the very aggressive expansion we had in the previous year. Remember, in the previous year we added something like 138 centers on a base of 132 or something at its peak. So we more than doubled our learning center base last -- in the year prior to this fiscal 2013 year. So clearly that is making up for the over-expansion in the previous year, but that's not indicative of the new normal in terms of what we'll be looking at in terms of expansion in the future.

We do go into these invest and harvest phases. This year is much more of a harvest phase. I mentioned in my prepared remarks we are moving back into an investment stage. So that's why you'll see, as I gave in the indication for the first half of the year, more like the equivalent of 30 learning centers. So that's very different than what you saw for this most recent year.

Understood. Okay. So the second question on the online segment. So could you please give us an economic indication for online segment as a standalone business, because it looks like this segment is serving more like a branding and also marketing facilitation to the other businesses?

Yes. What I can tell you, Vivian, is that it still is not profitable. And I can also say that it's doing a lot better in terms of making the move towards profitability than what I would have expected last quarter. So when I previously gave guidance around the loss that I expected out of the Mobby plus Eduu plus online school business, I said $8m to $9m loss for the full year in fiscal 2013. At this point, it looks more like a [$7m] (Company corrected after the conference call) loss. And online school's path to profitability, or at least having less of a loss, has been part of that.

Okay. Great. Very helpful. Thank you.

Thanks, Vivian.

Thank you very much. The next question comes from the line of Clara Fan from Jefferies. Please ask your question.

Hi. Thank you for taking my question. I'm just wondering, given that the revenue contribution of the one-on-one classes are trending down, what do we expect in the long run for the revenue contribution?

And also, if you look at decline in one-on-one revenue contribution, would that mean a slower ASP growth trend going forward? And what would be the impact on your recruitment plan for next year? Thank you.

Sure. In terms of the contribution of the one-on-one business, I think that it will probably end up being around flat in terms of contribution versus last year. So last year we came around 23% for the full year. I think that's probably what it's going to look like for the full year this year. And I do expect that small class will grow faster than one-on-one, based on what I can see in terms of visibility for this next fiscal year. So I would think that it will probably decline a little bit in terms of its contribution next year, but I still think it will probably be 20% plus of our business even next year.

And then, in terms of the impact on ASP, yes, if you take that in isolation then it would have an impact on ASP. But remember that I mentioned in response to Ella's question that we are expecting to take a price increase for our small class business in the summer next year. So I still expect to have an ASP bump for next year as a result of that.

What about your recruitment plans?

I don't know what you mean. Teacher recruitment?

As in how many in terms of teachers.

Yes, we will factor that in in terms of how we think about teacher recruitment. We are working through those numbers now. I expect that there is still a lot of utilization improvements we can make to our existing teacher base for one-on-one, which remember for the one-on-one business tend to be more of a full-time teacher base than a part-time teacher base. So I think there is a lot of improvements we can still make with our existing teachers, so I would expect that that would be reflected in terms of recruitment for next year.

Just one follow-up question. So what is the average salary increment for teachers this year?

We don't disclose that. What I've said on previous calls, which I maintain, is that we may see teacher salaries increase at a greater level than ASPs because we are raising ASPs each year by a lower amount. But we still think that there is enough improvements to be had from utilization gains that you should still see potential margin improvement, or at least margins being flat, and you won't see margin dilution as a result of teacher salaries increasing at a greater rate than ASP.

Okay. Thank you.

Thank you very much. The last question comes from the line of Philip Wan from Morgan Stanley. Please ask your question.

Hi. Thanks for taking my question. I know you don't break down margins by city, but could you comment on how profitable are the relatively mature cities outside Beijing and Shanghai, such as Tianjin, Guangzhou and Shenzhen? And also, how long do you expect the new cities you entered the past two years to turn profitable? Thank you.

Yes. We don't really give a breakdown in terms of profitability by city, so it's hard for me to answer the first part of your question.

In terms of the second part of your question, we are seeing cities that are turning to profitability quite quickly. So we see cities that definitely can turn to profitability within a year on an operating margin basis, and less than that time if you look at it just on a gross margin basis. So it depends on how quickly we then decide to add new learning centers. In the case of the most recent cities that we added, those five cities, they turned to profitability -- or cities in there that turned to profitability in less than a year.

That's helpful. Thank you.

Thank you very much. I will hand the conference -- thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may all disconnect.