New Oriental Education & Technology Group Inc (EDU) 2007 Q4 法說會逐字稿

Good evening, and thank you for standing by for New Oriental's fourth quarter and fiscal year 2007 earnings conference call.

At this time all participants are in listen-only mode.

After management's prepared remarks there will be a question and answer session.

Today's conference is being recorded.

If you have any objections you may disconnect at this time.

I would now like to turn the meeting over to your host for today's conference Miss.

Sisi Zhao, New Oriental's Investor Relations Manager.

Hello everyone, and welcome to New Oriental's fourth quarter and fiscal year 2007 earnings conference call.

Our earnings results were released earlier today and are available on the Company's website, as well as on newswire services.

Today, you will hear from Michael Yu, our Founder, Chairman and Chief Executive Officer and Louis Hsieh, our Chief Financial Officer.

After their prepared remarks, Michael and Louis will be available to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor Provisions of the U.S.

Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve inherent risks and uncertainties.

As such, our results may be materially different from the view expressed today.

A number of potential risks and uncertainties are outlined in our public filings with the SEC.

New Oriental does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

As a reminder, this conference is being recorded.

In addition, a webcast of this conference call will be available on New Oriental's Investor Relations website at http/investor.neworiental.org.

I will now turn the call over to New Oriental's CEO, Michael Yu.

Michael, please.

Thank you.

Hello, good morning and good evening everybody.

This is Michael Yu speaking from Beijing, China New Oriental building.

Thank you for joining us today.

It is my pleasure to review with you our fourth quarter and the full year fiscal 2007 results.

Overall, 2007 was a great year for us, with the fourth quarter contributing to our solid overall growth.

I would like to spend some time taking you through the highlights and some key developments for the last quarter, before speaking a bit on our plans for the future.

Before I go on, I'd like to give you some color on fourth quarter seasonality.

The fourth quarter is typically a slow quarter in terms of revenues, as school students focus on their end of year examinations.

It is also the time when we ramp up our marketing effort and the spending to encourage enrolment during the summer holiday season, which is our busiest time of the year.

Now we are in this season actually.

We delivered strong results for the fourth quarter, with healthy revenue growth in all of our key segments, leading us to beat the high end of our revenue guidance by more than CNY5.6m, or $0.7m.

Driving our success in the fourth quarter was strong growth in new enrolments for traditional language training, Overseas Test Preparations and [comprehensive] English courses.

As a result of this growth, I am proud to announce that the fiscal year 2007 was the first year in which New Oriental students' enrolments exceeded the 1m mark, and the net revenue exceeds CNY1b in New Oriental's history.

With China's increased access to the Internet and the mobile phone of communication, we have been consistently expanding into a new medium of language, learning and of Test Preparation.

During the fourth quarter we launched a couple of new initiatives that increased access for New Oriental courses.

First, we partnered with Nokia to provide cross-content for Nokia mobile EDU learning platform, which allows students to access New Oriental course content via their mobile phones.

We also introduced an online payment system to facilitate online enrolments for our traditional classroom courses.

At the lead up to the busy summer season, every year a group of New Oriental [star] teachers travel throughout China to talk with students, or give lectures to students about New Oriental's educational philosophy and offerings.

This year we traveled to over 30 cities.

This Dream Tour, as well call it, is an important part of our marketing and contributed to [the other] spending 31.5% increase year over year in language training and the Test Preparation enrolments for the quarter.

With demand for quality private education in China continuing to grow, and an educational environment that is still highly fragmented, one of our key strategies is to rapidly expand -- rapidly extend our leading nationwide network.

In fiscal year 2007 we opened 10 new schools, exceeding our target for the year.

And in the fourth quarter we opened one new school in the capital city of [Changshee] Province.

In the fiscal year 2008 we will continue this strategy of expanding our footprint of schools and learning centers to reach a growing number of students.

Another key strategy is the expansion through partnership.

The initiatives like those with Nokia, Thomson Learning and the Dynamic Education International, will allow us to further leverage our nationwide distribution channels, high student enrolments and online [use of it] to generate more revenue.

We will continue to focus on building partnerships and the platforms that will enhance our offerings and revenues.

While 2007 was a very positive year for us, we are looking forward to many more opportunities in 2008.

And we have no doubt that we will be able to [absorb] the growing number of Chinese students in the years to come.

Well, thanks a lot, and now I would turn the call over to Louis Hsieh, our CFO, to take you through the financials.

Thanks, Louis.

Thank you, Michael, and welcome to everybody on the call.

As Michael mentioned earlier, we had a good quarter with healthy revenue and student enrolment growth.

Today, I will walk you through the contributions to our fourth quarter results and some financial highlights.

Please note that certain figures I will talk about are non-GAAP, including all measures that are given, excluding share-based compensations.

You can find the reconciliation of these figures in the financial tables at the end of your Press Release.

Our fourth quarter total revenues were CNY190.6m, equivalent to $24.9m; an increase of 29.1% from the year-ago period.

Revenues from our educational programs and services, comprising our language training and Test Preparation courses and primary and secondary education programs rose 28.8% year over year, to CNY168.9m, or $22.1m equivalent, driven by the increase in new student enrolments in language training and Test Preparation courses.

And we saw increased revenue from books and other educational materials and services, which rose 31.1% to CNY21.7m, equivalent to $2.8m, from the year-ago period.

Overall operating expenses for the quarter were up 21.8% year over year.

Of these, costs of revenues increased by 27% year over year, mainly due to the increased number of courses offered to a larger student base and greater number of schools and learning centers in operation.

Selling and marketing expenses increased 47.7% year over year, primarily due to brand promotion expenses, such as this year's Dream Tour to about 30 Chinese cities.

General and administrative expenses increase 9.1% year over year to CNY88.7m, U.S.

equivalent $11.6m, primarily due to increased headcount as the Company further expanded its business.

Operating margins for the quarter were negative, 14.1%, compared to negative 20.9% in the year-ago period.

Excluding share-based compensation expenses, operating margins for the quarter was negative 4.9%, compared to a positive 4.3% a year ago.

The operating margins in this quarter were negatively affected by the increase in marketing expenses and G&A expenses, as described earlier.

Total share-based compensation expenses for this quarter, which are allocated to related operating costs and expenses, decreased to CNY17.5m, equivalent to $2.3m from CNY37.3m a year ago.

Net loss for the quarter was CNY11.9m, equivalent to loss of $1.6m; a significant improvement from a net loss of CNY34.3m in the year-ago period.

Income attributable to holders of common stock -- shares, excluding share-based compensation expenses, non-GAAP, increased to CNY5.6m, equivalent to a positive $0.7m.

Basic and diluted loss per ADS was CNY0.31, equivalent to $0.04, and CNY0.31, equivalent to $0.04 respectively.

Excluding share-based compensation expenses, non-GAAP, basic and diluted earnings per ADS were CNY0.15, equivalent to $0.02, and CNY0.14, equivalent to $0.02.

Moving to our balance sheet, our total cash and cash equivalents as of May 31, 2007 were CNY1.6b, equivalent to $204.4m; a decrease of 54.4% from the February 28, 2007 period.

This decrease was primarily due to the temporary holding of proceeds from the follow-on offering in the third quarter, which was subsequently distributed to selling shareholders in the fourth quarter, of approximately [$267m].

Net operating flow -- cash flow for the quarter was CNY217.4m, equivalent to $28.4m.

Before I give guidance, I'd like to talk -- take a brief look at the comparison between fiscal year 2007 and our fiscal year 2006.

For the fiscal year ended May 31, 2007 student enrolments in language training and Test Preparation grew 22.4% to 1.07m from 872,000 in the year-ago period.

Net revenues were up 35.5% year over year to CNY1.04b, equivalent to $136.4m;up from CNY770.3m in the year-ago period.

Net income was up 359.1% year over year to CNY226.7m, equivalent to $29.6m; up from CNY49.4m on the year-ago period.

And our operating margin rose from 8.3% in fiscal year 2006 to 19.9% in fiscal year 2007.

We are very pleased with these results.

I will now read you New Oriental's financial guidance for the first fiscal quarter 2008.

Please note that the following outlook statements are based on our current expectations.

These statements are forward-looking and actual results may differ materially.

Total net revenue for the first fiscal quarter 2008 that runs from June 1, 2007 to August 31, 2007 are expected to be in the range of CNY520.0m, equivalent to $68.0m, to CNY550.0m, equivalent to $71.9m, representing year-over-year growth in the range of 21.1% to 28.1%.

Now, let me turn the call back to Michael for his closing remarks.

Michael?

Thank you, Louis.

Once again, thank you for participating in our earnings call for the fourth fiscal quarter 2007.

Now we will be happy to take your questions.

If you have any questions, please just feel free to ask us.

Thank you.

The question and answer session of this conference call will start in a moment.

In order to be fair to all callers who wish to ask questions, we will be -- take one question at a time from each caller.

If you have more than one question, please request to join the question queue again after your first question has been answered.

(OPERATOR INSRUCTIONS).

And your first question comes from the line of James Mitchell with Goldman Sachs.

Please proceed, sir.

Hello, good evening.

Hello, James, good evening.

A question on your general and administrative expenses.

If I strip out the stock-based compensation, then it looks like your underlying general and administrative expenses were up very sharply year on year in the quarter.

Was there anything unusual in the quarter that boosted the G&A, or are my numbers just wrong?

I'm trying to look up -- I'm trying to find stock-based comp.

Stock-based comp in G&A was CNY15m in the quarter, so it's $2m.

If I look at total G&A, James, was [CNY15m] -- it was actually down year over year from last year for the total number already.

But I don't have last year's G&A stock-based comp.

But to give you an answer, G&A should be up over last year because our headcount is over 1,300 higher this year than last year.

Okay, cool.

And then --

Yes, if I look at it now, on G&A headcount the number was now 1,240 and last year at this time it was 1,057.

So it's 200 people more and that's due to the opening of the learning centers and the 10 schools.

And then also, I think, the other difference is the stock-based compensation.

Okay.

And then if I look at your revenue guidance, you are guiding for mid-20s revenue growth rate in the summer quarter.

It looks like your deferred revenue is up around 35% and your student enrolments at the end of the quarter are up around 32%.

So should I interpret the gap between the operating metrics pointing at a 30% something growth rate, and your guidance at a 20% something percent growth rate, should I attribute that to ARPU shift, or students enrolling earlier, or just to you guys being a touch conservative as usual?

Probably it's the latter.

If you look at the numbers now the -- our deferred revenue at the end of this May 31 was about CNY330m, and last year at this time it was CNY244m.

So you correctly point out, it's up about 35.5% year over year.

So -- and then on student enrolment, you are right, it's up 31%.

But don't forget the student enrollment part is in Q3 of '07 we only saw an 8% increase because there's a shift from Q2 into Q3, right, because of the timing of Chinese New Year as we reported a quarter ago.

So if you blend the two, the revenues are still up over 40% and student enrolment is still up in the low 20s, which is very healthy growth.

And then the difference will be attributable to ASP.

But our guidance, as you know from the last three quarters, tends to be a bit conservative.

Okay, thank you very much.

Thanks, James.

The nest question comes from the line of Mark Marostica with Piper Jaffray.

Hello, good morning, or good evening actually.

Just to follow up on the last question.

Could you walk us through, again, why in the fourth quarter revenue growth fell short of enrolment growth?

Perhaps just talk about pricing in the quarter, if you would?

Okay, the -- as you recall from Q3, the February 28 quarter, we reported revenue growth of 51%.

And we noted at that point on the conference call that 51% was way high, and it's because the revenue we had the extended time period in Q3 this year due to the lateness of Chinese New Year.

And so the student growth rate at that time was low.

So Q3, basically, took some revenue from Q4.

So Q4 was expected to be light.

If you combine the two quarters together, it is a more meaningful measure, its -- the revenue growth is well over 40%, which is still quite strong.

As far as pricing goes, Mark, our prices Q4 over Q4 of last year were up over 10%, closer to 13%.

So we still have very strong pricing power.

Okay.

And then on the selling and marketing spend in the quarter, up close to 41.8%.

How much of that would you consider to be more one-timeish in nature, like the Dream Tour you talked about?

And how should we think about growth in that metric going forward?

Thanks.

I think sales and marketing for the year ended up being about 12%, if I look at it correct.

Yes, about 12% for the year.

And I think you can anticipate it being between 10 -- around 10% to 12% next year.

So it should be relatively consistent.

The Dream Tour will each year get -- will become part -- is part of our business.

It's just this year we really hit -- we only hit 12 cities last year; this year we hit 30 cities.

So it was a significant contributor to the expense side.

Great.

I'll jump -- go ahead.

Yes Mark, also Michael had mentioned in the last call that we would be ramping up sales and marketing in Q4 to ensure the [summer].

And if you look at the results of that marketing tour, you see that student enrolments are up 31% year over year, which is our strongest year-over-year growth ever.

Plus a strong growth in deferred revenues, I suppose, too?

Exactly.

And that translates right into deferred revenue, exactly right.

Okay thanks, I'll hop back in the queue.

Thank you.

Your next question comes from the line of Paul Keung with CIBC World Markets.

Yes, hello, good evening over there.

[Say goodnight].

Good morning, Paul.

Can't get my time straight.

My question has to do with the sales and marketing program you just did, the advertising.

I was curious as to how effective that's been.

And I know you guys keep decent track of where customers are coming from, whether it's first time versus word of mouth.

I was wondering where -- how the different channels are doing for you in terms of customer acquisition?

Well, I think if you look at the results you can see that the Dream Tour was a tremendous success.

We had 314,000 student enrolments this last quarter, up from 230 something odd thousand a year ago.

So, clearly, the Dream Tour has a significant impact on the enrolment growth, which really bodes very well for this summer.

And that's why we took up the guidance versus what we normally would guide in the 20%, 25% range.

I think all our channels were -- we were [expecting the impact of them], but the overall result is quite strong.

The Dream Tour is our central package, but we also do online advertising, flyers, we do the whole gamut of advertising.

But the Dream Tour was the central focus.

Do you think you will do something like that again this year, because of the success of this quarter?

Or is it just something you will do once a year?

It's something we do once a year in Q4.

Usually in the spring, because spring is the time that students would like to listen to your lectures, and then wants to -- they have free time to stay with you so that they can get a touch of (inaudible) for the coming [senior intake].

Okay, great.

And then on pricing, I am just curious of how pricing has been via the different products?

I can tell you in general, looking here at my sheet here, ASPs on a blended basis were up 13% year over year.

Overseas Test Prep ASPs were up over approximately 16%.

And Domestic Test Prep they were up about 4% year over year, and then the rest, comprehensive English, up about 14%.

And then kids at Middle School were about 3% up.

So, overall, the strongest pricing is still in Overseas Test Prep.

But everything else is still high single digits.

So the blended turns about to be about 12%, 13%.

Okay, thanks for that.

I'll get back in queue.

Okay, thank you.

Thanks, [Michael].

Your next question comes from the line of Mark Chang with Merrill Lynch.

Hello, good evening.

Hello, good evening, Mark.

I looked at your balance sheet, you now got over CNY1.5b [on here] and can you update us on the M&A front?

Yes, I think at M&A we don't cover -- we are still looking at the further three buckets that we've talked about in the past.

We are still looking at a few acquisition targets on the post-secondary college degree-granting side.

We are also looking at buying some competitors in large cities.

So we are also looking at new areas for growth.

And I think Michael has touched upon it a little bit, that we would like to expand into other programs outside of this English language training, especially in the kids, in the pre-kinder garden area and also in the high school area.

And how close are we on those areas?

[Being] close in M&A.

Actually, we are very active in looking for the chance, opportunities to have acquisitions.

First, in the language (inaudible) areas, in different cities of China, of course, some of our competitors also, because this is our central business I think that you can acquire some of our competitors it was easier for us to expand even faster in this area.

And as a second area we are looking for actually M&A, is the same [train] style but a different subject.

Our Chinese students they use the actual time to study lots of other subjects besides the English, like mathematics, or physics, or chemistry, so on and so forth.

These -- there are many, many schools actually, some of them are big schools, training students in these, we call, the traditional subjects where students take a high -- take national interest examinations for university degrees.

And actually its -- because the training style is the same, and the system almost the same as New Oriental, so if we acquire some of these schools its easier for us to expand our business into students related areas, especially high school related areas.

And the third is that because the government said that pre-school education was totally dependant on a private education actually, so that means the government will not put a limit on the tuition that private system can charge.

And also it's up to the private education companies to see what levels of the pre-school education you want to do.

Some of them are relatively mature, pre-school education systems in China in big cities.

So we are also actively looking to these kind of channels.

My purpose also is that we -- around our central business, English and Chinese, we extend from six years old to two years old and up in the middle, around like 12 years old to 18 years.

And then up to the adult education then maybe looking to the career or professional education.

But in my mind it is -- it's just kind of the same style of New Oriental because it's all we call the training, non-degree training, or non-formal education training actually, because this is easier.

I know the government will have very -- will have less regulations and rules in all these areas.

So that means it gives you more freedom to do all these things.

So acquisitioning, actually, is one of our strategies actually looking in the future to build up a strong business base for New Oriental, and then to venture into training relating to businesses in China.

Thank you.

Okay, thank you.

Your next question comes from the line of Alex Xu with Brean Murray.

Hello, good evening Michael and Louis.

Hello, Alex.

Good evening.

Thanks for taking my call.

I just want to go back to a previous question on the call regarding the G&A expense.

If I exclude the option expense for this quarter as well as the year-ago quarter, the G&A expense for this quarter is about CNY73m and a year ago was CNY45m.

And as a percentage of sales a year ago was 30% roughly and, this quarter, it's 38%.

And you mentioned the headcount increase, about 200, let's say, a 20% increase on headcount.

But does that fully explain why the G&A cost almost increased 70% year on -- on the year-on-year basis, excluding the options?

Well, like I said it includes -- you had 240 headcount, includes 10 schools, another 20 learning centers in operation.

Right.

And also there is some G&A cost associated with Sarbanes Oxley that we haven't completely quantified yet.

Don't forget this is the first quarter in the Q4 that we were comparing basically with -- year over year with Sarbanes Oxley involved.

Last year in Q4 we didn't have to deal with it.

So there is accounting expenses and other expenses.

And as you know, when you become a public company the accountants charge you more.

Yes.

So, yes, if you look at Sarbanes Oxley and other odd increases, it's about $2m.

And then, on a going-forward basis, how should we look at the G&A line as a percentage of sales in terms of -- on a full year --?

And the other thing, Alex, is you recall our business is that G&A also includes teacher salaries.

Right.

Right.

So full G&A is actually less than half of that -- of the G&A reported, because the U.S.

GAAP requires that to include teachers' salaries, the fixed part in G&A.

So if you actually, in -- don't forget we added 600 new teachers this year.

So it's not just a 240 headcount in G&A, but it's also a portion of the 600 teachers.

Okay, you mean the part-time teachers basically?

No, the full-time teachers.

Okay.

So we added 200, 300 full-time teachers as well, and part of those salaries get counted in G&A.

So you are talking about a headcount increase of about 500 people year over year.

And then, going forward, what's your expectation on the SG&A side in terms of a percentage of sales?

I think it will go down a little bit, because I don't see auditing and forecast it will be relatively consistent going forward, whereas, the revenue will continue to increase.

Okay.

And I think headcount will -- this year we opened 10 schools; the projection for next year is only four to six schools.

But we will open more learning centers.

So the headcount will still go up, but usually the school is what takes up a lot of G&A headcount; the learning centers less so.

So we should do a little bit better next year.

Okay.

And just a quick follow up on the tax rate, are you still looking at a 7.5% normalized tax rate for the next three quarters?

We had said that we will probably go up a percent or a percent and half, and right now is where we have some tax provisions and we are dealing with [1048].

So we have to be 1048 compliant by August 31, which is the regulation that -- dealing with uncertain tax liabilities.

Okay, and that impact will --

But we're not talking about impact; we don't know the impact until the end of August.

Okay, so right now --

So we are dealing with our auditors on that issue now.

Okay.

So you can expect the tax rate won't be lower than 7.5, but I don't how much it will go up; probably a percent or two.

Okay, thank you.

Thank you.

Thank you.

Your next question comes from the line of Lin Shi of Lehman Brothers.

Hello, good evening, Michael and Louis.

Hello, Lin.

Good evening, Lin.

I have a question regarding the student enrolment growth.

I just wonder whether you can break down that growth by maybe just --

By program, we can do that.

-- lines etc.

just to get a better understanding.

And also, given it's already July, maybe we will have a clearer picture about enrolment in your secondary and primary schools in [Yang Jo].

Can you repeat the last part of that question, you are fading out?

Okay.

Given it's already July, we should have an idea about the enrolment status of the [Yang Jo] and [Tai Sing] school.

Just wonder how was their growth over there and whether you can still keep the target of breaking even this year.

Pricing in Yang Jo, the enrolments actually come in in August.

So actually the school term beings in September.

So I won't -- we won't have that number until the end of Q1.

Okay.

But as far as the other programs, Overseas Test Prep, on a ball park figure last year was about 35,000.

This year it is about 58,000 enrolments.

So it's growth of about 64% year over year.

Domestic Test Prep grew 27%, from 81,000 last year to 103,000 this year.

Comprehensive English grew from 64,000 to 70,000; up 8% year over year.

High school English for the quarter went from -- last year it was 33,000; this year it was 42,000.

And kids went from 19,000 a year ago to 30,000 this year; up 51%.

So those are the main categories.

And which are your fastest growing cities, if possible?

Shanghai is our fastest growing city, I think.

Yes, Shanghai still has great potential actually.

And also we have some other cities, some new cities like [Tanchow] City.

So cities that we have opened in two years.

Okay, understood.

Thank you.

Thank you.

(OPERATOR INSTRUCTIONS).

And your next question comes from the line of Adele Mao with Susquehanna.

Hello, just a quick question related to teacher headcount.

Could you give us the number of teachers at the end of the quarter, part-time versus full-time?

Are you seeing [any] pressure in terms of teacher salary increase?

Teachers' salaries are increasing in -- probably between -- by about 5% to 10%.

Yes, 5% to 10% [of] growth.

Yes.

As far as your question on teacher breakdown, at the end of Q4 we had 2,373 total teachers; up from 2,291 at the end of Q3 and actually up from 1,744 at the end of last year.

So the total increase actually is more than 600 teachers for the year.

As far as part-time and full-time teachers, full-time teachers now are at 1,056; up 74 for the quarter.

And part-time teachers are now 1,317 as of May 31; up [84] for the quarter.

Great.

If I could just -- it looks like you guys have this new course offering [iEnglish] and it looks like it's focused on oral English.

Can you generally discuss your expectations for enrolment transferees, ASP profile etc.?

Yes, iEnglish is a brand that we cooperated with Thomson Learning.

Most of our books actually were edited by Thomson Learning for us [and then] our teachers, our excellent teachers, are adding new materials and a newsprint into these books.

And IEnglish is a [general name] of a program we are trying to push and promote this year and next year.

But under iEnglish we have a lot of sub i's, like we have iReading, iWriting, iListening.

So it's kind of a comprehensive English.

And over the past 10 years in New Oriental when we are talking about adult comprehensive English, we don't have a name for it.

And this year actually -- at the end of last year we created a name, and it's then coming to talk with Thomson about a cooperation of adding books, compiling books we do this [series].

So this is the first time we try to establish a brand name, a program, a brand name for comprehensive English.

So under this comprehensive iEnglish we can emphasize still the pronunciation, or we can emphasize then the reading.

But put these together we call it iEnglish, and we have it registered in the Commercial Bureau of China.

Don't worry, we didn't register iPhone yet.

I see.

This iEnglish, I assume these courses are small classes, five --?

Yes.

Actually, we can design bigger classes but our target is to get it at small class or medium-size class, so that we can attract some of the white collar people, those elite people that come into our system to study.

And then we have published very nice books; these books are very good in the manner of the [cover], or the content, or the page.

So that -- people think that it's a real serious place to study these nice English actually, because all these books were edited by Thomson Learning, so the contents are very good.

I see.

Great, thanks very much.

Thank you.

Thank you, Adele.

And your next question comes from the line of Trace Urdan with Signal Hill.

Hello, good evening.

The question is going back to the M&A discussion.

And I am wondering if these different areas that you've identified that you are looking at, seriously, how do the growth and margin characteristics of those offerings, either the post-secondary or the high school, compare with your core business?

Whether you would be willing to consider dilution for the right type of strategic acquisition.

The answer to the second question is, yes, we would consider dilution for the right strategic business.

But the growth profile, it varies depending on the acquisition target obviously.

But the growth profile will be typically these [companies] are growing relatively quickly; at least 20% to 25%.

And they are in varying degrees of profitability.

So we have to -- until we get into due diligence, we can't pull out all the hidden costs and expenses in these schools but, in general, they are profitable.

And you know -- go ahead.

I was going to say those growth characteristics, how do those jive with the regulated nature of enrolment growth in those [instances]?

They are -- most of them, as Michael discussed, are regulated.

So much like pre-school is now regulated by the government very heavily.

Same with supplementary education in Chinese language, or in mathematics, is not really regulated.

But it's all in the core -- because we are not offering any diplomas or degrees.

But the high school and the post-secondary are regulated?

Post-secondary is regulated.

High school, we are not going to acquire any high school.

We are only going to look at acquiring companies that do the high school Test Preparation for the [GOLGal], or the equivalent of the U.S.

SAT.

GOLGal is the Chinese SAT.

Okay, very good, thank you.

Okay, thank you, Trace.

The next question comes from the line of Brandon Dobell with William Blair.

Evening, guys.

Good morning, Brandon.

How are you?

Good.

Good.

Maybe if you could talk about some of the pricing dynamics from a couple of different perspectives.

One would be looking at the four big cities, so, none of which are -- still account for over half the business.

What's pricing like in those areas?

And then maybe splitting it between Tier 1 and Tier 2 cities, do you see any differences in pricing?

And if there are any outliers, either in Test Prep or English instruction that stick out as very strong, or having more pricing pressure than you thought they might, I'd be curious to hear about those as well.

Okay.

I don't have that great a detail in front of me, Brandon, but I can tell you from generally, the pricing is still strongest in Overseas Test Prep.

And the four big cities, the price -- across the country, actually, Overseas Test Prep, the pricing is quite strong.

The other businesses are all going to be in the high single digits; it doesn't matter if it's a Tier 2 city or a Tier 1 city.

The most -- the strongest pricing power continues to be still in Shanghai.

Singapore city has the great power pricing -- more power pricing than those other cities.

For the second tier cities, like non-capital cities of each province, the pricing power is relatively weak.

Okay.

From a -- I think last quarter or two quarters ago, you guys talked a little bit about some smaller class sizes in some of the programs, just to get a higher price point.

And if you could go back and address that issue, again, where are you in moving that?

We are moving very smoothly in this area.

Actually, like a -- you can see that from last year's quarter four to this year's quarter four we have added almost, I think, 800 teachers.

Actually, these teachers -- half of the teachers go to smaller sized classes.

These smaller sized classes we charge the students higher [but] welcomed very nicely by the students and by their parents because they want their kids to have a nicer environment.

But still we are keeping our bigger sized classrooms growing, actually, especially in this summer.

There are so many students coming to New Oriental Studies, so that sometimes we have to put students in one classroom of 400 seats, or even 500 seats.

But at the same time we are keeping the small size classroom growing very smoothly and, by doing this, actually, we are -- we have a very strong pricing power but there is still a lot of feel that we are raising the price because they can see that they are sitting in a nicer environment.

Brandon, I've actually asked some of our finance team to do a more comprehensive analysis of this.

I don't have it yet, from the -- I'll probably -- done at the end of this quarter.

Okay.

Okay.

But in traditionally -- Typically, the margins should not -- The margins in the big Test Prep classes will continue to be the best margins; gross margins as well as net margins.

But the language training class, the idea of the smaller classes should be that it's almost margin neutral.

Okay, yes.

Okay?

So it won't be -- it won't hurt our bottom line.

It should be relatively close to what a larger class would have.

So if a class has 60, and has 30, the price could be almost double.

Yes, that's right.

Right.

So the idea is to make it margin neutral.

Okay.

And a final quick question if I could.

You talked about opening four to six schools next year.

Any reason that's not eight to 10, or 12, or 15 schools?

It seems like you guys are doing such a good job --

These four to six schools is that my target is the capital city of the provinces.

We haven't gone into [Jiangsu] province, Guizhou province or Gansu province.

And these capital cities, like Lanzhou, Nanjing or [Guangzhou] are our targeted cities.

And also there are some [post-lying] cities that are big cities, like Quingdao is a famous city and has very, very advanced economics, and [inaudible], also a big city.

So we are targeting all these like around five cities.

But two of the smaller cities I can see from last year's experience, and the year before last, that we have to open new learning centers in all these schools -- big, big cities that New Oriental has already exist because they are -- the car is commonly used by Chinese people nowadays.

Every city has become a traffic jam.

So the experience -- if we only have one or two learning centers in a big city, students have to travel every day for two hours back and forth.

You have four hours back and forth to study [inaudible].

So in this case, some of the students would rather choose a school nearby which is not a New Oriental school.

So in order to meet the challenge of students like to choose a school within 30 minutes of their travel distance to study, I think that the next year we are going to concentrate more on opening new learning centers first in those existing cities, rather than advancing into second tier cities.

By doing this, our revenue will be better, and then we can capture the main market, and we will have a stronger competitiveness than going to second tier cities.

And by second tier cities we are still -- we are looking for the chances -- opportunities to acquire some of the best local schools in these second tier cities.

It's easier.

And also for the second tier cities, mostly it's [triple] English, so it's easier to manage.

Thank you, Brandon.

Okay, great.

Thanks a lot.

Your next question comes from the line of [Lymia Tree] from Jefferies.

Hello, good morning.

Good morning.

Can you give us some guidance on the way business segments move fastest based on your marketing and M&A strategies?

And based on that what would be the outlook on margin, if you take a two-year growth -- two-year horizon?

Thank you.

That's a good question.

I think, for the year just concluded, our gross margins were right around 59.5%, and our net margins were -- EBITDA margins were around 20%.

So I think it will relatively be consistent.

It should trend up with some leverage a little bit on the margins, depending on how fast we want to grow.

So it should still be around 20% net margins and around 60% gross margins.

As far as the business lines that we will continue to focus on, the drivers will continue over the next two years to be -- in the current business will be Kids' English, Middle School English and the Overseas Test Prep.

Those will continue to be the drivers.

Because they have tremendous momentum and you can see already in the summer accounts that they are continuing to grow.

Especially Kids' English.

Yes, Kids' English will be a focus, but then don't forget, we're -- We've made the analogy before, we're like a Wal-Mart store.

So once we've set up these centers, it's easy for us to teach kids, not just English, but also Chinese and mathematics and other subjects that are going to be tested for their entrance exam.

So we are -- that will be the plan, to begin to add more programs to the same targeted students.

We should be able to grow that way as well.

Thank you very much.

Your next question comes from the line of Kevin Tang with Joho Capital.

Good morning, guys.

Just probably two quick questions.

One is, as you expand into the newer cities, or to the more rural cities, do you find yourself having to spend more, or making more effort into acquiring students?

And two, if I am to look at your Company three to five years out, how should I think about the total market size and your current penetration at this current point?

I want to say, how much more you can grow going forward, just based on your existing platform in terms of the Overseas Test Prep?

And just finally, you talked about, for example, the cram schools expanding into other subjects.

If you don't find any good acquisition targets, when do you think you will be launching those types of programs?

The very rural areas, like second tier schools, actually we find that it is a more difficult task to go into a second tier school than to find students immediately, because in the second tier schools our main -- majority of our students are Kids' English students.

So most of these Kids' English students, they study at the local schools before they come to New Oriental study, and it's [because] local.

But because the second tier cities, they don't have many universities.

We don't have a university-based [data] which New Oriental's brand name is most famous for.

So it -- usually, we spend a longer time and more effort in order to have kids to come from to New Oriental studies in second tier cities.

But that's so as long as we get the students, those who will stick in our school for at least three to six years, from six years old to maybe twelve years old.

So I can find, from the second tier cities, we have some mature second tier cities like [Xionpau] and still the number of students is growing steadily but not rapidly.

But it's very -- the [school] itself is running good, because they spend less marketing fees when it becomes mature.

And there was a second question?

The second question is, you talked about extending programs, so for example once you start teaching English, and more looking at, for example, your [Gawcow] area.

If you don't find good acquisition targets, when do you think you will be launching the other types of subjects?

Actually, we have a group of people now who are doing the research and make the plannings to -- if we cannot acquire in the ideal targets.

We are going to launch, actually, these programs this year.

We have launched the program of [Pre-School] Education and Research Group.

And we also have [pre-paying] teachers.

We actually have [doing the trying].

Last year we don't have any mathematical students and this year in the summer we have more than 4,000 mathematics students studying in New Oriental.

Because the good thing is that all those students actually -- the same group of students was studying English.

So we can use the same group of students to do the marketing and advertising and these students, then, after they finish the English studies they stay in New Oriental and study mathematics.

That means we don't have to do too much new marketing or adverts to attract students.

Okay.

And just one final question.

If I look at the size of our Company today, if I were to think of the growth opportunity three to five years out, how much more can you grow, in terms of your penetration rate currently in the market?

Just, for example, on the key current driver like the Overseas Test Prep segment.

I think Overseas Test Prep, we've been growing extraordinarily fast this year.

I don't think that can continue because we are -- we have the dominant position in the market already.

In the Kids' and Middle School there's huge growth opportunity.

We haven't even -- We've just scratched the surface of that area.

It is highly fragmented.

And there's 20m Chinese kids at each age group, of which half are going to take the national entrance exam for college.

So if you take those six years, or three years of prep, times 10 it's 30m.

We don't -- just have 1m total students this year.

So it's a small penetration for now.

On the Overseas Test Prep, as I said, it's already -- we have over 160,000 enrolments this year; up from only 115,000 or 120,000 last year.

So we will grow with the market.

In that area, we also have more pricing power as well.

So those three will continue to be the growth drivers.

Okay, thanks.

Excellent.

Thank you.

Your next question comes from the line of [Quinn Slattery] with [Slimens TCA].

Hello, guys.

Thanks for taking my question.

A quick question.

What was your deferred revenue at the end of Q4?

At the end of Q4 the deferred revenue was CNY330m, approximately; up from CNY244m a year ago at the end of Q4, and up from CNY135m at the end of Q3.

Okay, thanks.

And can you just remind us why deferred revenue last quarter was negative year over year?

It's because the enrolment growth in last quarter was only 8% because of the timing of Chinese New Year.

So again, what happened was, when Chinese New Year was around February 17, or 18 this year, students didn't go back to their schools until late February early March, which means when they signed up for classes at New Oriental it was already in March, which is our Q4.

Last year, when Chinese New Year was at the early February, those student were picked up in Q3 counts and, therefore, the revenue that they paid was -- in deferred revenue from Q3, this year that revenue was pushed into Q4.

Thank you.

Your last question comes from the line of [Jeffrey Zhao], a private investor.

Hello?

Hello.

Hello.

Hello, good evening.

I have one question about your pricing, and -- Can you give me some update about how much do you -- have you already been -- increased your charge to the students in general?

[One cost], and year-over-year how much have you already increased your tuition fees for them?

Overall, it's about 12%.

Okay, and so --

Perhaps a little bit higher.

So basically it's 12% year over year.

Yes.

Okay.

And another question is, I notice that your sales and marketing [is up] this quarter and can you tell me what's your focus?

You are focused on the big cities to do this sales and marketing, or the second tier cities, in rural country?

We are focused on the cities that we think has the greatest student potential there.

Like the Shanghai and Beijing, we think it's mature and the Oriental brand name is so great that we really don't have to do further marketing.

We only have to often tell students what program we offer.

But in those cities, like in Harbin and [inaudible] or [inaudible], these cities have been going only for a year and a half or two years.

So we think that there are too many students and the parents still don't understand the New Oriental a lot.

So that's the cities we focused on.

And also we focused on the cities where we have strong or fierce competitiveness, so that we can use our advertising, or our Dream Tour, for our star teachers to give speeches to students, to attract the students and the parents so that they will register in New Oriental.

So that's mostly what we are doing.

So actually, in the fourth quarter, we are doing -- were doing marketing and advertising and speeches in Xi'an, [Zhengzhou], and Chengdu, and Harbin, which is -- we think that these four cities have great potential to grow for the next two years.

Okay, I understand.

And my third question is about your expanding and you plan to open four new schools for the next year, right?

Yes.

And my question is, and -- if you focus on the Kids for your expansion -- Kids' English, Kids' Maths, for your expansion, where do you get your teachers?

It's just the high school teachers, or the university teachers?

Most of the teachers were trained by the New Oriental system.

Because those already teachers from high school or Middle School, or even from universities, cannot suit New Oriental qualification.

So mostly we train our teachers, like -- we train them, including Kids' teachers.

We train our teachers, they're locally.

We find teachers in some local place, or we send teachers from other cities to those so they have a place to teach.

So usually in the city, our teachers have two kinds of teachers.

One is, we send them from other cities like Beijing or Shanghai, maybe.

Then other parts of the teachers, maybe 60% of the teachers, are from local cities, actually.

We train them for a month, or half a month, then send them into the classroom to teach.

We are now approaching the end of this conference call.

I will now turn the call over to New Oriental's Chief Executive Officer, Michael Yu, for his closing remarks.

Well actually, thanks again for joining us today, and I'm pretty grateful that all of you have paid so nice attention to New Oriental.

And if you have any further questions please don't hesitate to contact Louis, especially, and then myself, or any of our Investor Relations representatives like Sisi, and we are more than happy to answer your questions.

If you are coming to Beijing just drop in the Oriental headquarters for a visit and we can treat you to a tea or a coffee.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.