TAL Education Group (TAL) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the TAL Education Group first fiscal quarter 2017 earnings conference call.

(Operator Instructions).

Please note this call is being recorded today, July 26, 2016. I would now like to turn the call over to your first speaker today, Miss Mei Li. Please go ahead.

Thank you, all, for joining us today for TAL Education Group's first fiscal quarter 2017 earnings conference call. The first fiscal quarter earnings release was distributed earlier today and you may find a copy on the Company IR website or through the news wires. During this call you may hear from Chief Financial Officer, Mr. Rong Luo. Following his prepared remarks, Mr. Luo 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. Rong Luo.

Thank you, Mei; and thank you all for joining us on our earnings conference call for the first fiscal quarter 2017.

We continue to enjoy a very good topline growth in the first quarter, driven by the high demand in all cities and supported by further capacity expansion. As happened in previous quarters, in this quarter we see the renminbi depreciate significantly against US dollar. Despite this negative impact, in dollar terms the topline growth rate was 51%, five one, to $195 million, ahead of our expectations. In renminbi terms, the net revenue grew by 58%, year on year, also more than expected. Revenue growth was primarily driven by a strong 57% growth in enrolments across the board.

Today, I will briefly review our operational progress in the first quarter. After that, I will provide some further analysis on the financials and our business outlook.

Let me first recap our progress for each business segment. In the first quarter, small class accounted for 83% of total revenue, compared to 77% in the same year-ago period. Net revenue for small class was up by 69%, in renminbi terms and 61% in dollar perspective. While enrolments increased by 61%. This is the first quarter that we have consolidated Firstleap for a full quarter. Firstleap contributed more than 5% of total revenue, better than our expectation. Revenue generated from cities other than the top five, which is Beijing, Shanghai, Guangzhou, Shenzhen and Nanjing, accounting for 35% of Peiyou small class revenue, an increase from 28% in the same quarter last year. As before, the outer cities show higher growth momentums, with net revenue in renminbi up over 90%, year on year. Out of the nineteen cities we have business last year, we've achieved over 100% renminbi terms growth rate in nine cities, including Chengdu, Wuhan, Suzhou, Chongqing, Shenyang, Jinan, Shijiazhuang, Changsha and Qingdao.

Another highlight for the quarter is the ongoing growth momentum in Beijing. We continue to see a robust recovery in Beijing in all subjects following our targeted summer promotions last year. We see an over 35% year-on-year enrolment growth in the first quarter in Beijing, a significant improvement from a flattish growth rate in the same year-ago period. With the strengthened management team and better operational efficiencies we have set the stage for further growth. In the meantime, Beijing summer enrolments are accelerated, not only in the grades for which we offer the promotion, but also across all grades and subjects. We expect continued strong growth momentums in Beijing in the coming quarters.

Let me offer a few more details about our targeted summer promotions in Beijing this year. We will offer a promotion specifically for the first grade of both junior high and senior high students, to grow the new enrolments, and increase the retention among the new students. This is the first time we have promotional offers for the first year of senior high students. We are very excited that the enrolments for the first-grade senior high students has by now more than doubled. Also, this is the second year in which we offer discounts for the first year of junior high students. Further building on our success of last year's campaign, enrolments in the first year of junior high students once again grew very strongly, even off last year's elevated enrolment base for this class. Other grades, other than the ones for which we have special offers are also growing faster than before. This means, first of all, the last years' promotions has worked effectively with lasting results; and secondly, it reflects how we are able to recruit a broader range of students through our wider curriculum offers. We expect that, once again, these limited offers this year will help us to gain more market share in promoting marketing consolidations in the coming quarters.

In terms of enrolments by subject in the whole country, we are also very pleased to see continued strong growth in enrolments for Chinese and English. As you know, enrolment growth in Chinese and English in the summer term is faster than other subjects year on year.

Turning briefly to our one-on-one business. One-on-one contributed 13%, of our revenue in Q1 compared to 18% in the same year-ago period. We opened three new one-on-one learning centers in the quarter: one in Xi'an and two in Chengdu as supporting businesses for the small class. We will continue to maintain a healthy growth of the one-on-one business.

Let me now turn to our online course segment, which recorded 50% year-on-year revenue growth in renminbi terms. Online courses through Xueersi.com contributed to 4% of total revenue this quarter, flat with the year-ago period. Online enrolments were 20% of the total enrolment, same as the year-ago period. In the first quarter Xueersi.com has been transforming from an online platform of pre-recorded content to live broadcasting. For revenue from pre-recorded content will recognize revenue evenly over the subscription period. For the revenue from the online live class, revenues are recognized proportionately as the tutoring sessions are delivered. As most live classes start from the second quarter, the tuition collected was almost all recorded in deferred revenue in the first quarter, and will be recognized as revenue from the second quarter.

Now, I would like to update you on our capacity expansion. In the quarter our Peiyou small class business entered Hefei city where we already have one learning center for Firstleap small class. Last quarter I mentioned we expected to add between 20 and 35 new small class learning centers. In the quarter we added 27 new centers for Peiyou small class and which is 768 classrooms in cities with strong demand and high capacity utilization rates, such as Chengdu, Shanghai, Guangzhou, Beijing, Shenzhen, Chongqing, Xi'an, and Hangzhou. We closed four old learning learning centers in Beijing and Guangzhou. This classroom capacity increase represents a 50% year-on-year growth rate. In addition, we have opened three one-on-one learning centers, and six centers for Firstleap, making a net total of 32 new learning centers. By the end of the first quarter we have totaled 395 learning centers, of which 269 are Peiyou small class, 47 are Firstleap small class, and 79 are one-on-one. We expect the classroom capacity we have added to contribute to our growth this year.

In fiscal year 2017, our expansion plan for the physical network is similar to that of last year. You may recall that in fiscal year 2016 we added 51% of classroom capacity for small class versus the previous year through a combination of new centers and the expansion of existing centers. We will maintain a similar expansion pace this year to balance the teacher training process and a growing demand from the parents and the students. Particularly, we plan to add between 20 and 30 class learning centers based on the market demand in the second quarter.

As I already mentioned last quarter, in addition to our fast pace of learning center network expansion, we have started to hire more teachers and teaching assistants from the fourth quarter. We need more teaching staff not only for our fiscal network expansion, but also for our new hybrid online learning models and learning platforms. For Xueersi online courses we have finished the early stage of building the online platform and putting together the IT and product teams to run these platforms. Xueersi.com has been transforming from an online platform of pre-recorded content to live broadcasting. Before we could roll out our live online classes in the summer term we have hired teachers and teaching assistants. At the same time, we have strengthened our training programs for new teachers to maintain high quality that our students have come to expect from TAL. Finally, we have hired more teachers and assistants to ensure we have the extra teaching capacity in place for our summer term. Taken altogether, this additional spending on the personnel ahead of the summer term has put some temporary pressures on our margins. We see this as an important investment and mostly transitional costs that will translate into a long-term future growth.

While the transition is still underway, margins may see some short-term impact. But in the longer-term margin positive impacts should kick in, such as the higher ASP from the live cast platform compared to pre-recorded content in the online school. We believe we will see improving margins over time with the ramp up of the online school enrolments, and a strong enrolment growth from the summer term.

On another subject, I would like to update you on our overseas study initiatives with which we are building an important new pillar for the Company. TAL management has, for a long time, been passionate about overseas studies, transforming our brand to a global education brand is the a long-term key strategic goal.

In the past months we have acquired a majority stake in Shunshun, a leading overseas consulting company in China, following our minority investment in 2015. Shunshun offers professional counseling services to the students who desire to study abroad through its online-to-offline platform. We expect to consolidate the company in the second half of this calendar year. Shunshun's revenue is growing at an exciting pace and we expect the company to break-even by the end of the year.

Shunshun is the latest addition to our wide portfolio of international oriented offerings. We organically built the small class Lejiale English business that specializes in exam-oriented English subject tutoring. Last year we acquired Firstleap, which offers all-subject tutoring services in English to the students aged 2 to 15. Another very good brand is Lewaijiao provides the one-on-one English tutoring services from the foreign teachers, who have the teachers from the Europe and United States, and also coming from Southeast Asia. In addition, we have made a number of small deals in the past. We expect that Shunshun, together with these other offerings, will strengthen our presence in international education service market.

I think we face tremendous opportunity to become a leading player in the overseas study market. First of all, throughout China the rapid growing numbers of parents and students are asking for these services. Secondly, as the number one player's lead in this area is diminishing, the market has become more and more fragmented. And thirdly, new business models for education, including online teaching which we're very actively developing, must be able to operate in larger market in order to be successful.

Before I move to the financial review I would like to touch on our investment philosophy. As you know, in the past year we have invested in fewer but larger growth opportunities that were highly complementary to our own business model. We will continue to do so. On June 30, we signed a three-year $400 million term and revolving facilities agreement. The facilities consist of $225 million three-year bullet maturity term loan and a $175 million three-year revolving credit facility. We have no potential deals lined up in the short term. But for the longer term, we continue to look for targets in our core K-12 segment and look for the best time to do the potential share buyback program, or pay dividend. Our investment focus will be geared towards driving the transformation of our business into a global education brand, which is our key long-term strategy goal.

In the coming quarters, we expect our business momentum to continue giving us a strong and positive outlook. We plan to maintain a healthy pace of demand-driven learning centers and network expansion in FY17. We will continue to invest in new initiatives, including the double-teacher model and online live class, and further advance our global brand building.

Let me now review our financial performance in the first quarter. After that I will provide some further analysis and our business outlook for the second quarter.

In the first fiscal quarter, small class ASP in renminbi terms increased by 5% year over year due to the rise in prices in the selected cities, including Beijing, Guangzhou, and Shenzhen. These will be even better in Q2. One-on-one ASP in renminbi terms was flat. We expect small group class within our one-on-one business to continue to gain popularity in the future and lower the ASP of the overall one-on-one business through, even though we have increased the price of one-on-one class in some selected cities. Online course ASP was down by 4% in renminbi terms in the first quarter, partially resulting from the initial transformation into the live-class model. Most live class will start from the second quarter and we will recognize revenue as we deliver the class.

Cost of revenue increased by 64.8% to $100.5 million from $61.0 million in the same year-ago quarter. The increase in cost of revenues was mainly due to, in the first place, an increase in the teacher compensation and the rental costs; and secondly is the new business acquisition of Firstleap. Non-GAAP cost of revenues, which excluded the share-based compensation expenses, increased by 64.8%, to $100.5 million, up from $61 million in the first quarter of FY16.

In the first quarter, gross profit was $94.6 million as compared to $68.4 million for the same year-ago period. Gross margin for the first quarter was [48.5%] as compared to [52.9%](corrected by company after the call) for the same period of last year, due to accelerated capacity expansion and teacher recruitment for the coming summer term.

Operating income was $17.6 million. Non-GAAP operating income increased by 5.3% year over year to $26.0 million.

Basic and diluted net income per ADS were both $0.16, for the quarter. Non-GAAP basic and diluted net income per ADS, which excluded share-based compensation expenses, were $0.27, and $0.25, respectively.

From the balance sheet, as of May 31, 2016, we had $684.6 million of cash and cash equivalents and $3.2 million of term deposits, compared to $434.0 million of cash and cash equivalents and $17.3 million of term deposits, as of February 29, 2016.

Capital expenditure for the first quarter was $12.7 million, representing an increase of $6.4 million from $6.3 million from the same year-ago period. The increase was mainly due to the leasehold improvement and the purchase of servers, computers, software systems, and other hardware for the Company's teaching facilities and the mobile network research and development.

As of May 31, 2016, our deferred revenue balance was $558.7 million as compared to $331.3 million as of May 31, 2015 representing a year-over-year increase of 68.7%.

Let me turn now to the Q2 revenue guidance. For the second quarter to date the impact of RMB depreciation against US dollar is estimated to be around 7%. Taking this into consideration, and assuming no change, based on our current estimates, total net revenues for the second quarter for FY17 are expected to be between $247.9 million and $251.3 million, representing an increase of 43% to 45% on a year-on-year basis. In renminbi terms, the projected revenue growth rate is expected to be in the range of 50% to $52% for the second quarter of FY17. These estimates reflect our current expectation, which is subject to change.

That concludes my prepared remarks. Operator, we are now ready to take questions.

(Operator Instructions). Claire Cao, Morgan Stanley.

I think you mentioned that we will remain very strong capacity expansion plan for FY17. So could you provide us with more details on the capacity expansion for each business line? And what percentage will be contributed by the addition of new cities?

Also, given such aggressive expansion plan, how should we think about the margin outlook for the coming quarter as well as for the full year? Thanks.

In the first place, I think we already decided how much classrooms, or how much capacity, we want to add in the coming quarter. We need to consider two things.

The first one is the market demand. Even today if you have time to read through most of cities we have offerings, actually we have seen we still have a lot of parents and students they are lining up in front of our gates. Every year we threw entrances exam and we push a lot of people away, so compared to the huge market demand we have a long way we can go. In the second place we need to consider our own capability. So because we have central teaching model, we have quite centralized models. We were running this model for more years, actually, we made things more and more mature, so we will get some operating leverage. Now we in the right time and right place to try to speed a little bit to increase the speed of the new network development there.

So let me recast the numbers there. In first quarter the capacity has increased by 50%. In the fourth quarter, which last quarter, is 51%, so -- which is around 768 classrooms. Let me remind you, last year Q1, actually, we only added around 517 classrooms. This is a very good number for us to show we are on the right track to grow even stronger.

Of course, we probably need to maintain a reasonable ongoing pace in our expansion. In the second quarter, as I mentioned, in the prepared remarks, we plan to add between 20 and 30 small class learning centers based on the market demand.

We probably will add most capacities in the cities, such as Beijing, Xi'an, Shenzhen, Nanjing, Shanghai, Hangzhou, Guangzhou, and etc. Of course, some of our new hybrid models we will also plan to add more in the suburb areas of the big cities.

For full year FY17, we plan to maintain a healthy pace of demand-based learning centers capacity expansion. So at the same time, we also will try to enter more new cities. Last year we entered five new cities. This quarter in Q1 we entered Hefei. We are confident to say we'll probably enter more cities in the coming quarters, at least four for the whole year. But, of course, I will give you more updates when we enter the places.

If we recap the programs of all the new places we are adding, we have entered in the past two years, actually, we are seeing the ramp up of cities is even better and stronger than what we're seeing in the past. We believe if we enter the new places, they will contribute to my revenue and the profits much earlier than what they have in the past several years.

In addition, when we talk about a lot of capacity, that means classrooms. But more importantly is we also hire a lot of teachers and teacher assistants, which is corresponding to more classrooms.

Today, I think we hire more teacher and teacher assistants not only for our traditional physical centers, the small class business, but also for our Xueersi online school and Haibian platform, which is the live broadcasting platform.

In the past quarter we added few hundred teachers and teacher assistants who are related to the online initiatives. So far, based on the numbers we have seen, we are very happy to share we have seen a very positive dynamic in online live class in the summer term. We can foresee we will enjoy a much faster growth with our online revenue growth of our online sector in the second half of fiscal year.

We are also happy to see when we can continually improve our capacity fulfillment rates and we continue to improve the retention rates of all these new capacities, new teachers, we have added, will contribute to our revenue growth in the coming quarters.

Again, in general they take around two quarters to ramp up. But we believe with the much stronger numbers in summer term, we're happy to see we probably can see some positive things a little bit earlier.

And especially above the new network developments impact on margin, what I can say is short term, yes, they have some temporary impact, because, in general, we need to train the teacher for two quarters. We need two quarters to ramp up the new classrooms.

But when they go into the summer term, and fall term, and winter term, when everything is running more smoothly, we can see more and more margin leverage coming from there.

So that's our expectation for my network development. I hope I answered your questions.

That's very helpful. Thank you.

Thank you, Claire.

Zoe Zhao, Credit Suisse.

Just to follow up on the margin; can management share with us a bit of the different segments of operating margin, especially the online initiatives by the pre-recorded video, as well as the Haibian dynamics? Like how would they evolve and how the operating margin will kick in in the future?

And secondly, on the O2O model expansion plan, what's our target for the rest of the three quarters? Could management share about the number of learning centers that we plan to add? Thank you.

Thank you, Zoe. You're asking a very hot question. I think especially about the margin guidance for the second quarter, I think we have some pros and cons, we have some positive things and we have some challenges.

In the positive side is we're happy to see all the capacity we have added in the past two quarters actually come into production very smoothly. I think the summer term we have been enjoying a very high growth rate in enrolment perspective, across the country, not only in Beijing.

With more and more of our classrooms, they put into production, which is a very good benefit to our margin, because both the classrooms and the teachers, before they don't generate any revenue, but starting from summer, they are doing, they start to be very important generators.

The second thing, especially for the online, what I can share with you is we are seeing very positive enrolments in the online, especially in the Xueersi online school and in the Haibian, which is the live-broadcasting model. We believe the second quarter online will be a very good growth contributor, which is because we have seen all the registrations are growing quite significantly.

So compared to the past quarters, this is also a good, is something positive and good things to happen.

But, at the same time, we have some challenges, similar to Q1. In the first place, we're maintaining a similar range of the capacity expansion. For Q1, actually, we added around 32 learning centers, which is around 768 classrooms, which will also take some time to ramp up. The second thing is for the new acquired business. For the Firstleap, we are very happy to see that they are growing very fast. In the budget time we only assumed Firstleap was around 5% of my business, but actually in Q1 they are around 6% to 7% of my business.

They are growing faster than we are expecting. Their break-even side -- they are break-even in Q1, so we are very happy to see all of these new businesses making very good progress.

But in a margin perspective, because they are break-even compared to my normal margins in small class business, they are a little bit dilutive impact.

And some thing is we -- you may also have noticed, or paid attention to the limited promotions we have running in Beijing. This year we are running promotions for the first year students in the senior high and junior high. Based on experience we have seen last year, temporarily, I think they should be having around several million impact in Q2, but going to Q3 and Q4, they will have, they will be very good profit contributors over there.

And in the fourth place, I also remind you there is around 2.6 million government subsidies last year, Q2. This year, until today, we don't receive anything, because the government subsidies, they don't have the fixed schedule. It purely depends on the department. So we don't put them in my forecast.

And lastly, I also need to remind you guys, last year we have around $50 million capital gains through a disposal of Guangzhou Zhikang business to the Changing Education, which is a one-off event. But this year we probably, we don't see any significant deals like that.

And so, if we balance all of these pros and cons, the positive things and the challenges, all I can say is in the direction perspective, the Q2 margins definitely will be better than Q1. But considering all of things we have today, I think the net margin compared to last year, should be slightly lower than in the same year-ago period. So that's the situation for Q2.

If we're looking forward to Q3 and Q4, again, it's a little bit early to talk about that, but based on the preliminary registration numbers, the people who enroll in our fall term, actually, we see compared to the previous year is also performing much better. So we have enough reasons to believe we should have some positive things in Q3 and Q4.

So that's my big picture for the margin in the coming several quarters. So we probably -- I think I can share more color or guidance about the full year maybe in the next quarter's earning call.

Especially for your second question about the O2O model, and again thank you for advice from some very kind investors, they told me sometimes I talk about O2O, they will think about Baidu. So I change it over to double-teacher model, actually in our Company we call them Shuangshi Ketang, which is the double-teacher classroom.

So in this model I think they are still in the early stage. We feel it's good to go, but we still need to be patient to build more and more double-teacher learning centers.

In the first place it's that we build more learning centers in the suburb area of the big cities, for example, like Beijing, Nanjing. In the second place we are thinking about to develop some purely new cities, which purely use the double-teacher models, which could possibly happen in the coming quarters.

So again, we don't have a specific target, how many learning centers we need to build for that model. We are maintaining our quality requirement, so we just base on what we can do and the market demands to open more and more double-teacher model new learning centers. Every quarter when I open the program I'll let you guys know.

So that's my answer. I wish it could be a little bit helpful.

Yes, very helpful. Thank you.

Thank you, Zoe.

Natalie Wu, CICC.

Congratulations on a strong quarter. So you just mentioned about your summer promotion program, so just wondering can you show us some color on your summer promotion this year, including in your promotion district, scope, promoted subjects, etc.

And how do you project the retention rate from summer promotion into autumn course this year?

Also, you mentioned that your net profit margin in the second quarter will be lower than last year. But just wondering, excluding the one-off items like the government subsidy, asset disposal, also impact from consolidation of lower margin business. So how shall we think of your, maybe, gross profit margin next quarter compared with a year ago?

I also have a question about the enrolment in Beijing. So I recalled that enrolment in Beijing actually recovered last year, thanks to your summer promotion plan. Also your growth in Beijing managed to re-accelerate last quarter, if my calculation is correct.

We all know that Beijing is already a very sophisticated city for K-12 after school tutoring market. So a strong growth for you guys maybe means that you are taking others' market share very aggressively I guess.

So how should we think about how fast you can grow in Beijing this year? And how deeply that you can penetrate into this city in the mid to long term -- maybe in mid to long term? Thank you.

Thank you, Natalie. In the first place, welcome to our earnings call for the first time. In the second place, you are asking four questions.

Sorry for that.

I'm happy to see that, because you do a lot of work. So in the first place, I answer from the last question, enrolments in Beijing. Yes, you perhaps see that.

Targeted promotions for last year summer, actually, enrollment in Beijing is fast growing, it's accelerating. The last year fall term is around 16% to 18%, and in the winter term is around 25% or 26% and this year Q1 is over 35%.

And for the summer term, based on the numbers we have seen today, actually, it's even a little bit accelerated, but because the summer term we have some kind of promotions in the first year students for the junior high and senior high. I can't comment too much on the numbers. But we believe when they have finished their retention from the summer to fall, we have much maybe happy numbers to share.

Yes, Beijing's penetration rate after the tutoring, actually, it's quite high. So that's part of the reason we believe the market players -- the top players in this market is, actually, very aggressively consolidating the market.

I think if you benchmark our enrolment numbers and the New Oriental enrollment numbers in Beijing, adding together, actually these two companies are getting more and more market share. We believe in the more mature market when the parents are more picky to select different schools or companies to send their kids for tutoring, the good brand companies and the market players will benefit.

We believe the market consolidation in the Beijing market will even accelerate in the coming years and we get ready for that.

The second answer to your margin, if we're taking all the one-off events, government subsidies, etc., etc., etc., I think if we -- it's a little bit difficult to provide you an apple-to-apple comparison, because the business is ongoing.

The key drivers for the margin pressure are coming from we have very high -- we have a little bit high development in the new learning centers and new classrooms; over 50% in Q1 and very similar to Q2. We also need to balance our investment in teachers.

But if we take all of this kind of unnatural things off, we just compare my mainstream business, small class Peiyou, small class, actually, I think in the coming quarters, we're still getting much leverage from there.

But as a whole Company, we need to consider a different investment there, for example, an online initiative we have invested in the past. Starting from last quarter and this quarter, we can see that they have started to generate more and more revenues. Their growth rate is much faster.

We believe they could already be a very important contributor, not only in revenue but also in profit. For example, in the hybrid model, double-teacher model and in the live online models, one teacher, actually, they can teach a lot of students. So -- which is a very important space, we could get some leverage from there, because in offline learning centers, around 20% of the revenue actually is teacher compensation. One teacher is saying they can only teach one class at the same time.

So what we need to do is try to be patient, control everything in a fair range where management feel comfortable and try to deliver a sustainable and reliable growth in the coming years.

And the third answer to your retention rate of these promotions and you also asked some details about promotions. I think I could combine them together is the promotions that actually we run today are mostly in Beijing.

I know my counterpart has to run very aggressive promotions across the country, in more than 30 cities, something like that. We don't want to follow that, and we have no excuse to follow that.

Beijing is a competitive market. I think that's the right way, because it's a little bit mature. So that's the right way for us to leverage the offer; it's to try to consolidate more market share.

Actually, we're not gaining market share from New Oriental and New Oriental is not gaining more market share from me. Actually, we are gaining more students and more shares from the small and medium companies in this market.

For the outer cities today, in the first place, the market is still fast growing and the penetration rate of the city is much lower than Beijing. In the second place, we don't have the similar level of fierce competitions in Beijing. All of our schools in the outer cities, they are doing quite well. We have seen very healthy numbers in the capacity utilization rates; retention rates; refund rates. So we don't have enough space to run a promotion like that.

For us, what we need to do is we want to leverage these kind of limited offers to penetrate some of the white space market and customers we don't penetrate before.

For example, I shared several -- some case in Beijing. In the past, we don't have many students coming from suburb area. But now, through some kind of offerings, we're building more and more double-teacher models in the suburb area of Beijing. We've placed something together. We are seeing -- we are making good progress over there.

So we still have long potential to go even in Beijing City. We believe all kind of these-- the promotions now is single, and that is not alone. Actually, it's one of the ramp ups or tools we can leverage. But it doesn't mean this tool or ramp up can be use everywhere.

So we will balance all the demands and the specialty and reality of the market to consider what kind of tools we need to use.

Again, based on experience we had last year, actually, we have a very good retention compared to ourselves. This year, because we even have made some changes and new designs in the promotions. So we have good reasons to believe that the retention rate for this year will be even better than last year.

That's the general situation about the promotion.

Great, thank you for the detailed answers. Very helpful, thank you.

Thank you, Natalie.

Alvin Jiang, Deutsche Bank.

I have two quick questions. The first one is on your investment plan. Are you still going to continue the investment and acquisitions to other education companies? And do you expect these companies to contribute to your business in the short term, not only in financial terms, maybe in the ecosystem and other values?

My second question is still on the margin side. Because we can see you are expanding into new business, like oversea test prep, and also your online business grows really fast. So how should we expect these parts of extra-fast business to impact your long-term margin? Thank you.

Yes, thank you, Alvin. I think the acquisition, actually, we all know it's not easy to do acquisitions. It's not easy to try to consolidate two companies into one. Every time we want to make the acquisitions, actually, we are very cautious.

For example, for Firstleap we have discussions for more than 18 months. For Shunshun, we have been in discussion for more than 12 months. We need to be very cautious about every acquisition target we want to make.

In the short term, what I can say is we don't have any acquisition target in the short term in my pipeline now, because we need to spend some time to improve the consolidation and integration between these new companies. We need to spend more time over there.

But in the longer term, we continue to look for some potential targets in these core K-12 areas, not only in China but also some potential targets outside China. But that's a long-term target.

We always keep eyes open to see some of the new models or new products, new contents, new ideas not only in China but also in the States or in some other countries.

And about your question regarding to the new acquired business impact to the margin. Frankly speaking, I think for the new acquired business, for example like Shunshun and Firstleap -- actually, Shunshun I can't say acquired, because we are only the majority shareholder. For them, what we need to care in the first place is whether they are generating a very good revenue growth rate, and whether they are fast growing -- growing faster than me. So we are happy to see that Firstleap is growing faster than me and Shunshun is even much faster, because they are still the second-year company.

The second reason is we also need to take care of whether the profitability is improving. Last year, Firstleap is loss-making position by more than 15%, but this year it's break-even already. We have enough reason to believe in the coming two years to three years, they could be -- reach a level of 10% to 20% operating margin.

For Shunshun, frankly speaking, that is because for the oversea consultancy companies, they have sometime delay to recognize their revenue, because they need to wait for students to receive their offer and go abroad.

If we -- we can foresee we will have much stronger revenue contributions and profit contributions from Shunshun, starting from the second half of this fiscal year, and even more to come into our P&L next year, because they need around 10 months to 12 months' delay.

These two companies are very good targets. They are -- in the first place, they are very good target and very complementary to my K-12 students. In the second place, it's team is also doing quite well. All the momentum is in both the revenue and profitability is also fast changing.

Right after our acquisition -- our investment there, we have seen we have more and more synergies between them. For example, at Firstleap, now in more and more places, we will set -- learning centers together. For Shunshun, we have established a channel to send more students to them to consult for the overseas studies.

All of them is right in the place. What we need to do is give them some time and they will provide us some good feedback; much better than what we expected.

That's our observation of the new acquired business. In short term, they should have some temporary pressures. But we believe these will become very positive in the coming year.

Okay, got it; got it. A very quick follow up on this, how big is the revenue contribution for Firstleap English, and how is the margin -- current margin level?

For the Firstleap, the whole year margin is around 5% of my total revenue. The Q1 actually is performing better than that, it's around 7%. They are break-even now in Q1.

Okay. What's your expectation on Shunshun in the second half?

Shunshun in second half, I think in revenue perspective, don't expect that much about it; it's very minimal, because the revenue they can recognize this year is actually the deals they did last year. But they only opened the Company last year, starting from June.

For the second half, I think the percentage of revenue coming from Shunshun should be very minimal. You even don't need to think about it. They will be break-even, I think, by the end of this calendar year.

Okay, got it. Thank you; this is very helpful.

Thank you.

Tian Hou, T.H. Capital.

One question regarding the expansion. On the one hand, this expansion seems to bring you tremendous top-end growth in enrollment. But, actually, seeing in many other companies, rapid expansion can also bring some trouble, such as the management capacity. If the management capacity doesn't really support expansion, the expansion can actually fall apart.

I wonder what's the management's thought on the management capacity. Actually in many thoughts, one is where do you get those teachers, all this expanded or newly entered -- newly opened centers, where do you get those who are masters to manage, to operate the schools. And how many cities actually do you think your capacity can cover? There are so many students in China, you can't cover all of China. How do you actually provide the services to the millions of peers in the places that you cannot have your presence? That's my question. Thank you.

Thank you, Tian. I think for the development pace, I think -- I know the company you have mentioned as benchmark. What I can say is actually our model is different from them. We are a central teaching model and we are quite centralized and, certainly, more standardized. So we have a little bit of leverage coming from there.

Our key subject, actually, is also math and science, which is more standardized than English. Compared to them, we have a lot of things which are quite different.

Second place, yes, more expansion will lead to more students and more teachers, and will create more pressures on management. But one can say is, actually, you can see when we try to expand more classrooms, actually, most of them coming from the cities -- or the centers we have already there. So we try to make the learning centers bigger and bigger instead of going to too many new cities.

When you're running one learning center in one city for a long time, sometimes you're adding more classrooms. It doesn't mean the management capacity is much bigger than before, because actually they are still one learning center.

A good example is we have the Dazhongsi learning centers in Beijing previously, maybe 20 to 30 classrooms and now it's more than 100 classrooms. But the management capacity actually is much lower than we open five learning centers of more than 20 classrooms. So that's kind of a philosophy we have today.

Of course, if we also provide some kind of capacity, especially you have more teachers, more students, you need taking care of.

But so all we are doing today is, actually we continue our practice in the past. We strongly believe technology and the platform. We strongly believe the very important role of the data and technologies here. That's why in the past we invest in the ICS 2.0/3.0, and starting from this year we invest in IPS.

We also try to develop more online offerings, not only through Xueersi.com, but also from Haibian and other platforms to try to reduce the complexity of the whole teaching, which more and more staffs can be centralized and standardized in the IT platform.

So in short, it's we tend to invest more in our IT new technology and data, and to drive the much bigger size in business in future.

About your questions, how many places I can penetrate, and what should I do for the place that I don't have presence. Again, I think on a physical network, the learning center-base models they have their limits. In our assumption is we only will target around 40 cities in the whole country, compared to my counterpart, New Oriental, has more than 50 cities; Xueda has more than 80 cities; and some other companies, like Longwen, they even have more than 100 cities, something like that. We're only targeting around 40 cities in the offline learning center and networks.

But for the rest, what should we do? We have two options. The first one is the double-teacher model we have mentioned to you guys last quarter. Even if we're still in a very early stage, and we believe it's a very good offering today.

That's the very effective way to leverage the best teachers in the big cities, and can provide a high-quality teaching services to the students in Tier 3 and Tier 4 cities.

And the Xueersi online school and Haibian platform is also big try. We are the first Company in the industry to try the live broadcasting models since three years ago. Based on what we see today, and based on our number -- registrations in the summer to today we are very happy to see this is the right way to go.

We believe this is the right strategy to try to penetrate and try to cover more students all over the country. But again, China is too huge. You know we leverage all these methodologies and new models, we cannot cover all of them.

But we -- but -- we as a Company, even 10% of market or 15% of market is way -- is very big enough for us to develop really.

So what we need to do is to control the development to grow too fast and control the desire to, one, to be successful maybe overnight. Just follow our current pace; just continue to focus on the quality of the teaching services; continue to care more students; continue to invest and leverage the IT and the technology and the platforms to standardize and centralize the model, and which is the right direction for us to go.

Thank you.

Thank you again.

Jason Huang, Goldman Sachs.

Congratulations on a strong quarter. This is Jason on behalf of Fan Liu. May I ask what's the current utilization rate? And also what's the rate we can expect for FY17, especially on the back of this fast capacity expansion rate? Thank you.

Yes. The fulfillment rate for us is a little bit different from our counterparts, because we only evaluate the time slots we can use to teach the students.

For example, in the spring term and the fall term most students they are in their school in the daytime from Monday to Friday, so we don't call them into our base. We only call the slots we can provide in the weekend.

So in -- but in summer and fall, because in the summer and winter, because there's vacation, so we actually we can have a lot of classes from Monday to Sunday. So the capacity utilizations will be very different.

What I can say, so what I suggest is you care more about the increase in the numbers. I think Q1 the overall capacity utilization increased around 5%. In the long -- I think in the whole FY17, they were -- we will still maintain a healthy level of low single-digit growth rate increase.

Thank you.

Thank you.

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