TAL Education Group (TAL) 2014 Q3 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 2014 earnings conference call. At this time, all participants are in listen-only mode. (Operator Instructions). I must advise you that this conference is being recorded today, Wednesday, 22nd of January, 2014. I would now like to hand the conference over to your first speaker today, Ms. Mei Li, Investor Relations Manager. Thank you. Please go ahead.

Thank you for joining us today for TAL Education Group's third quarter of fiscal year 2014 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 the SEC.

Also, our earnings release in this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures.

I would 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 fiscal quarter 2014. We are pleased to report a stellar quarter, highlighted by both outperformance on our revenue growth versus guidance and strong profitability.

Cities other than Beijing and Shanghai enjoyed excellent momentum, while Shanghai performed well and Beijing has begun to show signs of recovery. At the same time, the costs of business expansion remained well under control as we tempered the pace of center capacity expansion and achieved greater leverage from our sales and marketing and general and administrative personnel as planned.

Net revenue for the quarter increased 50.4% year over year to $73.5m, which is $2.5m above the top end of our guidance. Revenue growth was supported by a 46.2% increase in enrollments. While we knew we were cycling an unusually low quarter in fiscal 2013 and expected revenue growth to be robust, revenue in the quarter still ended higher than our expectation.

We continued to execute on our plan to invest in capacity expansion through both new learning centers and the addition of classrooms to existing learning centers. But as guided, we did so at a slower pace than in the first half of the year.

The third fiscal quarter, which comes right after our summer term, is typically a more modest quarter for adding classrooms, as we tend to prepare the bulk of our classrooms ahead of the summer term each year. We had a net addition of 52 classrooms in the quarter, which includes both classrooms added to existing centers and classrooms in new centers.

Almost all of these net additions were in cities other than Beijing and Shanghai. You may recall we added a net 9 centers and 351 classrooms in the first half of the year. We intentionally added capacity aggressively during the first half of the year to ensure we have enough classrooms in place to handle the strong demand for our business from the summer term onward.

We carefully select the locations for our centers, considering many new criteria, and in most cases sought to add incremental capacity first to existing learning centers before expanding to new centers. This is especially the case in markets where we've reached a certain level of center penetration. This deliberate approach, while perhaps taking longer on the front end, often results in our achieving faster ramp-up in center utilization levels, leading to center gross margins reaching breakeven more quickly.

In terms of learning center adds, we increased our center network by one new center on a net basis in the third fiscal quarter, bringing the total to 265 centers. We opened a net 3 new small-class learning centers and closed a net 2 learning centers for one on one. By quarter end, of the total of 265 learning centers, 176 were small-class learning centers, including four learning centers for our Mobby-branded pre-school and young learners age 3 to 8 business, and 89 were for one on one.

In addition to strong top-line results, we had better-than-expected net income growth of 123.4% year on year, primarily driven by the carefully managed investment in learning center capacity I described. A continued shift toward the higher-margin small-class business, away from one on one, was also positive for margins.

Overall, gross margin increased by 590 basis points, from 45.3% to 51.2% year over year, reflecting our system-wide focus on teacher and center utilization, even as we expand. We also were able to leverage G&A and sales and marketing expenses through more efficient human-resources management, and improved the returns generated from our strong cash balance, as reflected in the growth of our interest income in the quarter.

Let us now go over the different business lines. The small-class business in new markets continued to drive our growth in the third quarter. Small-class revenues once again more than doubled versus the same period of the previous year in cities other than Beijing and Shanghai, driven by enrollment growth, combined with higher average selling prices.

In terms of revenue contribution, cities other than Beijing and Shanghai accounted for 40% of small-class revenues in the third quarter, compared to 28% during the same period last year and 35% in the previous quarter. This increased revenue contribution was primarily driven by robust enrollment growth for small class in these markets.

In Shanghai, as expected, we saw continued strong positive momentum in both enrollments and revenue growth for our small-class business. As a testament to our focus on improving the quality of our offerings in Shanghai, we were pleased to see a drop in our refund rate, which we define as the number of parents and students asking for a refund after classes have begun.

Our continued efforts around teacher recruitment, training and curriculum development over the past year have been recognized with higher customer satisfaction, which in turn has driven word-of-mouth referrals and returning enrollment. As such, we expect Shanghai to continue to do well in the fourth quarter.

As for Beijing, after the challenging prior 12 months, we saw some strength coming back in enrollments, as small-class enrollments increased by a high-single-digit percentage in the third quarter. We are very pleased to see reviving demand for math tutoring for primary school students, and higher retention rates, especially for our high-school segment. We also had better enrollment than expected for our short-term small-class training, which typically consists of on average approximately three classes in a targeted knowledge area, rather than the typical 15 classes in the regular fall and spring terms.

Revenues from our Zhikang-branded one-on-one business contributed 16% of total revenues in the quarter, versus 19% in the same quarter of the prior year. We continue to position one on one primarily as a complement to our small-class business, given it is relatively low-margin with comparably lower barriers to entry.

Zhikang showed good momentum in markets outside Beijing. In Beijing, one- on-one is recovering at a slower pace than is small class, but a bright spot is the promising momentum we've seen in one-on-one demand from high school students, complementing our traditional strength in primary and middle school.

Meanwhile, we continue to dedicate Company resources to our evolving online strategy. As a company, our vision is to be at the intersection of where education meets technology and in so doing, to ensure we are providing more efficient and effective tutoring services to our students. We place high priority on introducing new tutoring practices where technology makes that possible.

For example, we are taking the interactive classroom to a new level with the recent launch of ICS 3.0 in Beijing. This new version is a major upgrade and provides an interactive whiteboard and pad-based environment to our students in order to heighten student engagement in class.

As we've discussed on previous calls, we use the online platform Eduu.com as a substitute for more expensive and less differentiated traditional brand promotion efforts. In the coming months, our focus for Eduu.com will continue to be on providing the best possible online service to our parents and students as they navigate the K-12 learning process, rather than seeking to monetize the Eduu platform.

Revenues from our online courses on Xueersi.com again accounted for approximately 3% of revenue, while its enrollment contribution in the quarter crept up to 17%. We continue to be innovative at our online school and are testing how to provide greater levels of interaction in our prerecorded video courses while experimenting with various live formats.

Overall, we believe that our Company is ready to explore the tremendous new growth opportunities in education. Mobile Internet is changing consumer behavior, while government efforts to modernize education are well underway. Fundamental changes are taking place in the demand for labor and the skills that young adults need to have good employability. These trends are revolutionizing the ways in which students learn in and around school. We see a host of new opportunities, such as widening the range of subjects, introducing new tutoring formats and expanding addressable markets.

One case in point is the recent indication from the Beijing Education Ministry that it will change the relative point scale for different subjects for the high school and college entrance examinations such that Chinese composition will be a more important subject than English in these exam scores. Pilot projects will start in 2014.

Since this announcement in October, we've increased our investment and focus on our Chinese composition tutoring website, Zuowen.com -- that's Z-U-O-W-E-N-dot-com -- to stay ahead of the expected increase in interest from parents and students.

During the quarter, we also acquired a domain name called Kaoyan.com. That's K-A-O-Y-A-N-dot-com. This website offers information, online community and study materials for university students to help them prepare for postgraduate school admissions to Chinese universities. Through Kaoyan.com, we extend the lifetime value of a portion of our customers while also gaining access to a new customer.

We do not yet have a center-based business for graduate school admissions exams, but Kaoyan.com is a nice complement to Eduu's array of websites, including youjiao.com, aoshu.com, zhongkao.com and gaokao.com, among others. Our websites now span the duration of the student's learning from pre-K to college. We may be able to apply our proven strategy of using Eduu that works so well for geographic expansion also to new business verticals, as we first feel out the market through our online community before investing in center-based business operations. At the same time, we can also explore synergies such online communities may have with our existing business units.

Over the coming year, in addition to new business opportunities, we will also explore additional online to offline opportunities across our business segments. We will increase the number of interactions with each student through mobile and online practice exercises during the week, and with that the stickiness of our students to our brand and platform. We will also seek to increase convenience for parents by experimenting with registration centers that are primarily using technology rather than people to register, refund or switch classes.

Looking ahead, we continue to explore both the possibilities for online and mobile learning and also how better to utilize technology and the Internet in our existing center-based businesses. As mentioned before, we will likely participate in this transition through a combination of in-house product development and selective strategic equity stake investments. We seek to truly embrace the technology advances that will transform the education sector.

With that, I'd like to move on to a more detailed overview of the financial results. We delivered $73.5m in revenue in the quarter, representing revenue growth of 50.4% versus the same period in the previous year. Driving the quarter's revenue growth was strong enrollment growth of 46.2%, combined with higher average selling prices.

Total student enrollments increased to approximately 224,810 from approximately 153,800 in the same period one year ago. The increase in student enrollments was driven primarily by increases of enrollments in the small-class offerings.

On the ASP side, the year-on-year ASP increase of 2.8% to $327 for the third fiscal quarter from $318 in the third quarter of the previous year was primarily driven by the hourly rate increases of a portion of the small-class course offerings and the foreign exchange rate fluctuation. The increase from the hourly rate was partially offset by more short-term classes and online courses, as well as the greater percentage of revenues derived from cities outside of Beijing and Shanghai, which on average have lower tuition rates.

One-on-one tutoring contributed 16% of revenues for the third quarter of fiscal 2014, compared to 19% for the previous quarter and for the same period in fiscal year 2013. The lower revenue contribution from one-on- one also was a drag on overall blended ASP, as tuition rates for one-on-one are higher than our other offerings.

Now moving back to the total Company numbers. Cost of revenues increased by 34.1% to $35.9m from $26.7m in the same year-ago quarter. The increase in cost of revenues was mainly due to an increase in teacher compensation, rental costs and other staff costs associated primarily with an expansion of learning center capacity, as well as increases in wages and teacher fees versus the year-ago period.

Non-GAAP cost of revenues, which excluded share-based compensation expenses increased by 34.2% to $35.9m from $26.7m in the third quarter of fiscal year 2013. GAAP and non-GAAP gross profit for the third quarter were both $37.7m, as compared to both being $22.2m for the same year-ago period. GAAP and non-GAAP gross margin for the third quarter were both 51.2%, as compared to 45.3% and 45.4%, respectively, for the same period of last year.

Selling and marketing expenses increased by 34.8% to $9.3m from $6.9m in the third quarter of fiscal year 2013. Non-GAAP selling and marketing expenses, which excluded share-based compensation expenses, increased by 40.0% to $9.0m from $6.4m in the same period of last year. The increase of selling and marketing expenses in the third quarter of fiscal 2014 was primarily a result of an increase in compensation to sales and marketing staff to support a greater number of programs and service offerings.

General and administrative expenses increased by 35.2% to $17.3m from $12.8m in the third quarter of fiscal year 2013. The increase was mainly due to an increase in compensation to our general and administrative personnel in recognition of the outperformance against budget and to support a greater number of programs and service offerings. Also, the depreciation of the Beijing office space was an expense the Company incurred this quarter but not in the same period of the previous year.

Non-GAAP general and administrative expenses, which exclude share-based compensation expenses, increased by 41.0% to $15.5m from $11.0m in the third quarter of fiscal year 2013.

The above factors combined to give us operating income of $11.9m, representing a year-over-year increase of 287.5%. Non-GAAP operating income increased 162.3% year over year to $14.0m. Operating margin in the third quarter was 16.2% as compared to 6.3% in the same period of the previous year. Non-GAAP operating margin was 19.0% as compared to 10.9% in the same period a year ago.

Our net income for the quarter was $12.5m, and increased by 123.4% year over year. Non-GAAP net income for the third quarter was $14.6m, up by 85.6% year over year. This gives us a net profit margin of 17.0%, as compared to 11.4% in the same period of last year. Non-GAAP net profit margin was 19.8% versus 16.1% in the same period of last year.

Basic and diluted net income per ADS were $0.16 and $0.15, respectively, for the quarter. Non-GAAP basic and diluted net income per ADS, which excluded share-based compensation expenses, were $0.19 and $0.18, respectively.

Capital expenditures for the third quarter of fiscal year 2014 were $3.3m, representing an increase of $2.0m from $1.3m in the same year-ago period. The increase was mainly due to leasehold improvements in the purchase of servers, computers, software systems and other hardware for the Company's teaching facilities.

From the balance sheet, as of November 30, 2013, the Company had $304.0m of cash and cash equivalents and $29.2m of term deposits, as compared to $185.1m of cash and cash equivalents and $24.1m of term deposits as of February 28th, 2013. As of November 30, 2013, the Company's deferred revenue balance was $173.0m, as compared to $107.3m as of November 30, 2012, representing a year-over-year increase of 61.2%.

Moving on to guidance, total net revenues for the fourth quarter of fiscal year 2014 are expected to be between $84.7m and $87.1m, representing a year-over-year increase of 42% to 46% from the same year-ago quarter. If achieved, this will give us year-over-year revenue growth of 37.9% to 39.0% for the full fiscal year 2014.

You should note that the fourth quarter will include an extra week of classes due to semester and fiscal quarter reconciliation and the timing of Chinese New Year. So similar to the third quarter, in the fourth fiscal quarter, we will once again be cycling an unusually low fiscal quarter for the same period in 2013. This partially explains the added momentum as reflected in our business outlook for the fourth fiscal quarter.

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

Certainly. (Operator Instructions). Philip Wan, Morgan Stanley.

Hi, Joe and Mei. Congrats on the very strong results and thanks for taking my questions. My first question is regarding your performance year to date, especially on the margin side, with the very strong outperformance. So what should we expect for the remaining of the fiscal year? And then also, could you elaborate a little bit more on what were the key reasons for the better-than-expected performance for both the top line and savings on the cost side from year to date? Thank you.

Yes, thanks, Philip. Well, as you know, we don't provide specific operating margin guidance. I can say that we expect clearly to have operating expansion this year on the back of strong execution, outperformance on revenue and effective cost controls. In terms of the outperformance, the main reason is that we out-delivered on the top line. Cities other than Beijing and Shanghai continue to grow rapidly, and now that we have established ourselves in these markets, there's going to be a long runway for future growth.

Shanghai had a much stronger recovery than anticipated, and our expectations for Beijing were relatively low, so Beijing also surprised us on the upside, especially in the past quarter.

Okay, thank you. And then my second question is regarding your Q4 guidance. So you talked about an easy comp from the timing of Chinese New Year. I just wondered, could you quantify it in terms of the revenue considerations? Thank you.

Yes, sure. That was about a RMB23m impact, as we see it. That was probably what we had estimated the CNY impact. So if you take that out, we're probably looking at more like 35% to 40% revenue growth, without that number.

And then, going back to your previous question, it occurs to me that I didn't cover the cost side. In terms of the cost side for the outperformance in budget, I think a key part of it was our expansion drive we did in a much more effective way, so we used adding classrooms to achieve incremental capacity to our existing learning centers, so that, along with improved classroom utilization and class fulfillment ratios, helped us on the margin side.

And then some of the investments that we talked about in the first part of the year, like ICS 3.0 and other center investments, they took later in the year. So there is less cost that's going to be hitting this year. No other IT investments, like the finance system upgrade, office automation (OA) system, purchasing control system implementation, etc also, didn't happen in this year, so we still intend to make those investments in the coming years. So it'll likely impact us in the coming year, but that's part of the explanation as well for the outperformance this year.

The good news is that these are all discretionary investments that we are making in order to support our business.

Okay, that's very helpful. Thank you and I'll get back to the queue.

Thanks, Philip.

Fei Fang, Goldman Sachs.

Hi, good evening. Joe and Mei. Thanks for the opportunity. Very strong results. First, can you discuss the network expansion plan for 2014 and, just relating to that, what's the current utilization levels of your network and, whether you can quantify that or not, I'd like to know how much more revenue potential do we have with the existing geographical coverage and learning-center sites. Thank you.

Sure, Fei. Last quarter I talked about adding 200 classrooms for the second half of the year. So we had just over 50 net classrooms that we added this quarter. So we'd be looking to add 150 in the next quarter, at least on a gross basis. That number of 200 that I gave was actually a gross number.

We -- this is an execution-related matter, so it depends in terms of timing on negotiation with specific landlords. We are not going to give up on negotiating terms just to hit that number. But we also don't see the actual number signed in Q4 to vary too much. I would think there would probably be not more than 15% to 20% versus this number that I gave. And in any case -- this is capacity that we'll need to drive our business, so if it's not signed in Q4 then we'll look to sign in Q1 of next year.

In terms of utilization, given that everyone seems to measure utilization differently, we don't give absolute utilization levels as part of our disclosure. But I can say that in terms of utilization trends in the quarter we had strong utilization gains for small class in all but two of our 15 cities. So we believe this deliberate approach to center expansion helps us to ramp up more quickly and in a healthier way.

In terms of on a going-forward basis, I wouldn't think that we'd have as much room for utilization improvement in the coming year, fiscal year 2015, as we've been able to achieve in 2014. The reason being that many markets have already reached a very healthy utilization-level situation, especially for our small-class business. That said, I do think that there are a couple of cities within small class that we still have opportunities, and the Zhikang one-on-one business I still think has meaningful opportunities for incremental utilization improvement.

So, as a back-of-the-envelope number, I would think that if we were looking for incremental 3% to 5% on the utilization improvement side for next year, I would think that that would be a reasonable assumption at this point.

Great, thanks Joe. Last question from me, so, last night New Oriental, your competitor, reported encouraging results from Beijing. So I just have a follow-up question on that. So how would you think about the competitive dynamics in the City of Beijing going forward, especially in the K-12 segment?

Sure. Thanks Fei, I appreciate that question. I think the most important thing to remember is that the K-12 market is extremely large. So based on third-party research the top five players combined only have a few percent of this huge market. So there's lots of room for each player to grow, without cannibalizing the others' market. We play in the Peiyou market, focusing on tutoring for top students. New Oriental plays in a different market. But -- I think the important thing to understand is there's enough demand for various players targeting various segments, it's definitely not a zero-sum game.

In terms of our business, overall we grew revenues over 50% in the quarter; enrollments over 40% in the quarter. Beijing's an important market for us, of course, but we are not relying on Beijing growth for our overall company growth. And, as I mentioned in my prepared remarks, Beijing has turned the corner and we are starting to get high single-digit enrollment growth out of that market, which is quite encouraging. And then with the price increase we are well into the double-digit sort of revenue growth.

And then just in terms of the dynamics, I think based on our understanding, New Oriental has the greatest success in Beijing in the high school segment. Given our retention model, we start with primary and we do middle school and then high school. So high school for us, even in a relatively developed market like Beijing, is still smaller than primary and middle school.

So we've been focusing on high school in recent quarters and have seen good improvements in retention, as I mentioned in my prepared remarks, both semester-on-semester, and also from first-year of high school all the way to last year when kids are preparing for Gaokao. So that's quite encouraging for us as well. Hope that's helpful, Fei.

That's helpful, thank you.

Clara Fan, Jefferies.

Hello and thank you for taking my questions. First of all, I would like to ask, because you mentioned about we added 52 classrooms in third quarter and probably another 150 in fourth quarter. So I'm just wondering, given that we didn't actually add that many classrooms, what is the reason for the exceptionally strong enrollment growth?

And secondly, what is the revenue breakdown for small classes, one-on-one and online? Thank you.

Sure. Well, keep in mind that the classroom adds are reflective of when we sign the contract with landlords, so they are not going to be contributing to enrollments in the quarter. So the enrollment growth that we got in the quarter has to do with all those classrooms that we added in the first half that are ramping up, and we are getting very strong utilization improvement there. That's what I would say about that, there's this delayed effect in terms of what you see in terms of classroom adds and when that's going to impact enrollment.

In terms of the breakdown, it's 3% online, 81% is small class and 16% is one-on-one.

Thank you. I've got one follow-up question. If we looked at the margin extension, we realize that it's mainly from gross profit market expansion. Can you explain a little bit more on that? Thank you.

Sure. So, for us the costs associated with the learning center are captured in COGS. So as you see strong utilization improvement, as reflected by classroom utilization, combined with what we call "manbanlv", which is class fulfillment ratios, combined with a moderate approach taken to incremental classroom center expansion, you can typically expect that you're going to get strong growth in terms of the gross margin line.

Thank you.

Dick Wei, Credit Suisse.

Hi, good evening, this is Jia Long on behalf of Dick Wei. First of all, congratulations on a very solid quarter and, based on your earning release, compensation growth seems to have played a big part in the increase of your overall expenses in the past quarter. So I just wonder how often you guys raise salaries, and what's the range of increase for your teachers? Thanks you.

Sure, thanks Jia Long. We don't disclose teachers specifically, because we view that as competitive. But typically you can expect around a 10% to 12% increase in overall salaries, across the board. In terms of -- and that will vary of course but that's an average number.

In terms of the frequency, for staff it's usually once a year. For teachers, the performance-based aspect of their pay will be evaluated on a quarterly basis. It's actually term-based; it's a study term base because we have the four terms throughout the year -- spring, summer, fall, and winter.

Thank you. That's my question.

Thank you, Jia Long. I appreciate your joining us.

Tian Hou, TH Capital.

Thank you and my congratulations on a good quarter. I have a question regarding your opening plan. So you do say you are planning to invest in the coming year. So can I interpret that, like this year, you are not going to increase learning centers; you are going to concentrate on adding classrooms? So that's number one.

Number two, so you say investing in coming years, what exactly is your plan? Are you going to add more rooms -- classrooms, or are you going to be adding new centers, go to new places? What exactly does it mean? So that's the first part of the question. I will follow up with the second one after this.

Sure. In terms of classrooms versus centers, we are pretty opportunistic. So our preference, especially in cities that are relatively penetrated with centers, is to go with classrooms to existing centers because then you can scale up the staffin your existing centers. So you are able to create a little bit of economies of scale in this business.

That said, landlords are not always rational, and if they are not rational, we are not able to reach a deal then we will sometimes add a new center quite close to an existing center, in order to address the spillover of demand from the center which has already reached maximum utilization.

In a new market, where we start with just one learning center, we'll typically add another centerto at least get a bit of a footprint in the city. So you may see us go with more new centers in a new market.

But overall I think if you look at the overall adds, in terms of new centers and classrooms, we've had a nice balance this year, adding new centers, and also adding incremental classrooms to existing centers. And I would expect to achieve a similar type balance in the coming year.

So for your existing learning centers, how much room do you have to continue increase classrooms? Are they fully penetrated, or are you still can add a lot to classrooms without adding new learning centers?

It's really a case-by-case basis. It really depends. It's hard to tell now, because a tenant may move out of one of the buildings we leaseour facilities. So there may be a tenant that moves out of the building and then we see that as an opportunity for us to take that space. It's not really something that's predictable; it's something that we seize the opportunity when we see it.

Okay. So I didn't really capture what you said, how many learning centers or classrooms are you planning to add in the next quarter, in Q4.

Right. So I won't give guidance in terms of learning centers versus classrooms for any quarter because, as I said, it's opportunistic. So I can't predict. What I can talk about is the incremental capacity, and that's really what's most important because that's what's going to drive your enrollments.

So, what I said was 150 classrooms, gross adds, is what we talked about last quarter. And I think we should achieve that within a 15% to 20% margin of error, based on execution and whatever. But whatever we don't add this quarter we expect to add in the coming quarter.

Okay, okay. I think the last question is regarding the guidance. So the guidance was really strong. So I wonder how much of that strong growth comes from enrollment growth, how much come from ARPU growth?

Right. I would expect it, like this quarter, to be driven primarily by enrollment growth.

Okay. Thank you, Joe, that's all my questions.

Okay, thanks, Tian.

Ella Ji, Oppenheimer.

Thank you for taking my questions, and congratulations on a strong quarter. My first question is a follow up regarding your network expansion plan. Given that you already have very high utilization rate, and that you achieved a very strong growth in second half of this year, can you talk about your thoughts for the expansion plan for next year? Do you think the expansion for next year will be in a bigger scale comparing to this year?

I think it's early to say, Ella, because as you know we are a February fiscal yearend, so I'm working very hard with each of the business units to get the budget done for next year. But I would expect that you'll see less of this invest and harvest situation, which has been something that the education industry in China has dealt with over the last few years. And you'll see more of a moderate approach, where we are trying to balance the right level of incremental capacity investment.

I think that this year was a great example of that. So I think that we should expect to see more adds in the first half of next year than in the second half of next year but I think that overall it'll be the kind of moderate approach to capacity increases that we saw this year.

Okay, got it. And then my second question is regarding online education development. Obviously this is a very popular topic in the industry, and some companies have made some progresses in this area. You always have online education courses. Can Management talk about if you are going -- also going to offer online live courses in the near future?

And also at this point most of the online education are serving as a complementary services to offline tutoring. I wonder if Management can talk about your thoughts, if you think the online education can become stand-alone classes, or type of stand-alone offering in the near future.

Sure. We do see that opportunity. We don't know when the catalyst will be for that, so, how near that near future will be we're not sure. But we are preparing and the online courses is a great example of how we use it as a separate business. We are going after that primarily to help us to get incremental users in markets that we don't yet have a physical presence.

That way we can continue to focus on a relatively smaller number of cities. We are right now in 15 cities, but to become the number one player in each of those cities, in our Peiyou segment, while also being able to address the opportunity that exists in other markets that we can't yet economically serve through learning centers.

So we very much do believe in the additional opportunity in online as a standalone business, and that's why we've continued to invest in it year after year, from 2010 when we started investing in that business up to now and going forward, even though it hasn't been profitable for us. So we very much believe in that as a longer-term story.

In terms of the live aspect, we are already starting to experiment with some live offerings. For example, on our Xueersi.com we are doing some live as a complement to our pre-recorded video content. So we are not doing it as a separate offering, but it's a way to increase the interaction for our existing content. That's just an example. We are also doing live with some other websites as well, but that's one example of the kind of thing we are doing there.

But as you mentioned, it's also very important from a blended perspective, so we talk a lot about how Eduu is very complementary to us in terms of bringing new enrollments to our offline business. We talked about all that we're doing in terms of developing apps and exercises during the week, to help students be able to have more interaction with us and our content and create more stickiness between us as a company and our students and parents.

So I think that all of those aspects are quite important, but over a longer period of time we definitely do think that there will be a standalone opportunity that will present itself as well.

Thank you, I appreciate the color. My next question is with regarding to your acquisition strategy. So you acquired a website such as Kaoyan.com. Are you going to make more of such acquisitions in the coming year?

I think we'll be opportunistic in terms of looking at various forms of strategic investment. So it doesn't necessarily have to be an acquisition, but Kaoyan.com is a great example of how we are able to extend our product line into a whole new segment and, in so doing, extend the life of our student from high school into the college years, and even address a new customer that we haven't been addressing before.

So we'll look for those kind of opportunities. As I mentioned, our vision is to be at the intersection of where education meets technology and in so doing to be able to create a more effective and efficient way for students to study. So we will be looking at various forms of strategic investments that are in line with that vision whether that's investing ourselves, by having our own small team go after a particular opportunity organically, or whether we look at various forms of strategic investment with players from the outside.

Get it. That's helpful. And my last question is an accounting-related question. So with regards to development of the ICS 3.0, I wonder what's the accounting policy in terms of the development cost. For example, how long are you going to amortize this cost, over how long a period?

And also, given that you've achieved such strong performance in most recent two quarters, is there going to be a spike in the bonuses in the fourth quarter, before your fiscal year ends?

Sure. So on the ICS 3.0, it's mostly equipment costs that you'll see amortized. We developed all the content ourselves, so we've been bearing the cost of all those developments, through the people costs that have been in our business, mostly reflected in the G&A line over the last few years. So this is something that takes a long time to develop and we've been bearing that cost, even though we haven't been able to generate incremental revenue from it, over a longer period of time. But the equipment cost, like the computers and servers, are typically going to be depreciated over a period of three years.

In terms of the bonus question, we will be giving incremental compensation based on our performance for this year. So you should expect to see some impact, most likely in the G&A line in Q4. But based on current trends I still think that you should see overall operating-margin expansion to the full year, so it won't take away that general healthy trend.

Thank you very much, Joe.

Thank you, Ella.

Thank you very much. There are no further questions at this time, and I would like to turn the call back to Mr. Joseph Kauffman, Chief Financial Officer, for closing remarks.

Thank you, and thank you all for spending time with us tonight. I really appreciate your being here with us, and look forward to seeing you in Beijing or at future conferences and meetings over the coming months. If you should have any further questions, feel free to reach out to me at any time, or Mei, or any of our IR professionals.

Thanks so much. Have a great day.

Ladies and gentlemen, that does conclude the conference for today. Thank you for your participation. You may now disconnect.