New Oriental Education & Technology Group Inc (EDU) 2010 Q2 法說會逐字稿

Good evening, and thank you for standing by for the New Oriental second fiscal quarter 2010 earnings conference call.

At this time all participants are in a 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 will now turn the meeting over to your host for today's conference, Miss Sisi Zhao, New Oriental's Senior Investor Relations Manager.

Please proceed.

Hello, everyone.

And welcome to New Oriental's second fiscal quarter 2010 earnings conference call.

Our second fiscal quarter 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 Louis Hsieh, New Oriental's President and Chief Financial Officer.

After his prepared remarks 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 US Private Securities Litigation Reform Act of 1994.

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 statement 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 investor.neworiental.org.

I will now turn the call over to New Oriental's President and CFO, Louis Hsieh.

Louis, please?

Thank you, Sisi.

Hello, everyone.

And thank you for joining us today.

Let me spend a few minutes on highlights and updates on the quarter before going through the financials and then taking your questions.

Those of you who have been following New Oriental since our IPO know one of the top risks to our business if not the most significant risk is fear of disease outbreaks and pandemics, as we experienced with SARS in 2003 and avian flu several years ago.

And this year with the outbreak of H1N1, our first and second fiscal quarter operations were negatively affected.

The impact of the H1N1 flu pandemic has been especially strong in China given the population concentration and density in large cities and as parents worry about the wellbeing of their often only one child.

The number of reported cases of H1N1 in China increased throughout the quarter and peaked in the last week of November 2009.

That said, we do believe the worst is over for now.

As we anticipated with the H1N1 vaccine being widely rolled out in schools throughout China, the fear of H1N1 flu has begun to subside.

As of January 12, 58m -- approximately 58m people have been vaccinated in the mainland.

And in Beijing and Shanghai over 60% of school-age children have received the vaccine.

As the fear of H1N1 subsides we expect to see a pick-up in enrollments for Q3 which ends in February 2010.

In fact, for the first six weeks of fiscal quarter three we have already seen a noticeable bounce back in cash receipts which is cash collected in advance for enrollments.

During the last six weeks cash receipts have increased by at least 30% each week compared to the year-ago period, a good sign for our Q3 and Q4 of 2010.

As you all know, the second quarter of New Oriental's fiscal year is typically our slowest, as Chinese school-age children return to class for the first semester of their formal school year.

I'm pleased to say we still saw sustained revenue growth, with the top line increasing 23.8% year-over-year to $61.2m.

Driving these results was continued strong growth in our leading segments, POP Kids English, middle and high school English, and U-Can all-subjects training and overseas test prep which saw a revenue growth of over 40%, 50% and 20% respectively.

POP Kids English continued its successful track record this quarter, with enrollments up over 35% in Q2 despite H1N1 fears.

By now you are all familiar with the paramount importance Chinese parents place on the education of their often single son or daughter and the drive to begin the education process at a younger and younger age.

With our fun, interactive courses, talented teachers and exciting content, not to mention a longstanding and trustworthy brand, New Oriental continues to be a major beneficiary of the demand for early childhood education in China.

We plan to further capitalize on our brand strength and existing student base by introducing children's math and Chinese writing courses through a pilot program in several large cities, with expansion of these programs set for this summer or fiscal Q1 2011.

I'd like to talk a bit more about our U-Can all-subjects training program.

Q2 enrollments in U-Can were up more than 100% year-over-year, with over 13,400 students enrolling in this program during the quarter.

Revenue growth was also striking, increasing over 200% year-over-year.

And if you look at the first half of fiscal 2010, U-Can enrollments have more than doubled to over 46,900 and revenues have increased fourfold from the year-ago period.

As a result we are well on the way to meeting our target of $25m revenue for U-Can in fiscal year 2010.

We're pleased to see the extremely positive reception U-Can has enjoyed.

And we believe it will continue to be a major growth driver, as middle and high school students look to enroll in after-school, weekend and holiday classes to prepare for the all-important Chinese national examinations for entrance into middle school, high school and university.

The diversity of required subjects included in the national exams creates a tremendous opportunity for New Oriental to leverage our expertise, geographic reach and top brand to include new content offerings.

For example, as part of U-Can, this quarter we offered a science pack whereby students who signed up for the package had access to small-sized classes in biology, chemistry and physics.

As part of U-Can, during the summer quarter we also launched a customized learning program of small and one-to-one courses which has proven to be a very attractive option.

These courses are centered on non-English all-subjects U-Can's program content, but instead of the large class typically in U-Can, this program allows students to choose small class sizes of one to six students.

Students are increasingly choosing these smaller, more expensive courses to give them greater access to teachers and more individualized attention in class.

As the trend continues, we expect a shifting of our enrollment mix to smaller courses and higher blended ASPs.

In the first half of fiscal 2010 over 10,000 students have enrolled in VIP classes ranging from one-to-one -- one to six students in both English and non-English courses.

Many of these enrollments stretched over two to four quarters, but are counted as only one enrollment.

This trend toward higher priced multiple quarter enrollment will increase our blended ASP so will also slow enrollment growth as those multiple quarter enrollments will only be counted in the quarter the initial registration occurred.

We are confident that, with our two-pronged strategy of offering both affordable larger classes and higher priced individual smaller classes, we will continue to enjoy 15 to -- 25% to 30% top-line growth.

With such high demand for U-Can and our customized learning platforms, we have increased our fiscal year targets for the rollout of these programs.

We have already made U-Can available in 32 cities and have raised our target for fiscal year 2010 to 110 learning centers in a total of 37 cities.

For the customized learning platform, we have raised our target from 8 to 10 cities to a total of 30 cities offering this program by the end of our fiscal year in May.

To accomplish these aggressive targets we plan to hire over 1,000 full and part-time U-Can teachers in fiscal year 2010, bringing the total count to over 1,400 for U-Can.

In addition, we plan to significantly augment our U-Can department by adding over 250 staff, primarily in marketing and customer service and R&D content development.

The incremental cost of this accelerated expansion will be approximately $4m to $5m for Q3 and Q4 2010.

But this will position us well for the seasonally most important summer quarter and beyond.

We are optimistic about the rest of fiscal year 2010.

It has been a challenging year so far, with unforeseeable external factors.

But as the economic situation continues to improve and the worst of the H1N1 pandemic appears to recede, we're focused on extending our reach in existing cities.

We're on track to open 65 to 70 new learning centers for fiscal year 2010 and rolling out new programs for our existing students.

As always, there's a large opportunity in our market.

Last week Credit Suisse released their results of an Asian consumer survey of Chinese households which found that respondents across eight Tier 1 and Tier 2 cities indicated that they save 30% to 35% of their household income for their children's education.

And 44% of respondents indicated that their children were enrolled in education programs outside of their formal schooling, a figure that was even higher for higher income households.

As a leading private education service provider we are well positioned to capture an ever greater percentage of the private education market and will continue to spend on marketing and promotion and hire the best talent in the industry to reach that goal.

In all, we're looking forward to what lies ahead.

Now let me take you through the financials.

For the second fiscal quarter of 2010, New Oriental reported net revenues of $61.2m, a 23.8% increase year-over-year.

Net revenues from educational programs and services for the second fiscal quarter was $53.6m, a 22.2% increase year-over-year.

The growth was mainly driven by the increase in the number of student enrollments in language training and test preparation courses.

Total student enrollments in language training and test preparation courses in the second quarter of fiscal 2010 increased by 5.1% year-over-year, to approximately 307,000 from approximately 292,200 in the same period of the prior fiscal year.

GAAP operating cost and expenses for the quarter was $62.1m or 27.9% increase year-over-year.

Non-GAAP operating costs and expenses for the quarter was $57.7m, a 30.5% increase year-over-year.

Cost of revenues increased by 28.1% year-over-year to $27.8m, primarily due to increased number of courses and the greater number of schools and learning centers in operation.

Selling and marketing expenses increased by 40.8% year-over-year to $11.7m, primarily due to brand promotion expenses, especially for new programs such as U-Can and the new customized learning programs.

GAAP general and administrative expenses were $22.6m, a 21.9% increase year-over-year.

Non-GAAP general and administrative expenses for the quarter increased by 28.5% year-over-year to $18.5m, primarily due to increased headcount as the Company expanded its network of schools and learning centers.

Total share-based compensation expenses, which were allocated to related operating costs and expenses, increased slightly to $4.4m in the second quarter of fiscal year 2010 from $4.3m in the same period of the prior fiscal year.

Stock-based compensation should decline in Q3 and Q4 as the 2007 stock option grants complete their vesting schedule this month.

GAAP loss from operations for the quarter was $0.9m, compared to an income of $0.9m in the same period of the prior fiscal year, and non-GAAP income from operations for the quarter was $3.5m, compared to $5.2m in the same period of the prior fiscal year.

GAAP operating margin for the quarter was negative 1.5%, compared to 1.8% in the same period of the prior fiscal year.

Non-GAAP operating margin for the quarter was 5.6%, compared to 10.5% in the same period of the prior fiscal year.

This decline in operating margin was primarily due to the negative impact from the H1N1 flu pandemic and the increased marketing expenses for brand promotion, especially for new programs such as U-Can and our customized learning platform.

GAAP net income for the quarter was $1.1m, representing a 63.9% decrease from the same period of the prior fiscal year.

Basic and diluted net income per ADS was $0.03 and $0.03 respectively.

Non-GAAP income was $5.5m, representing a 25.8% increase (sic - see press release) from the same period of the prior fiscal year.

Non-GAAP basic and diluted income per ADS was $0.15 and $0.14 respectively.

Capital expenditures for the quarter were $3.4m, which was primarily used to add a net of 11 new learning centers and remodel older learning centers during the quarter.

As of November 30, 2009, New Oriental had cash and cash equivalents of $210.6m, as compared to $238.7m as of August 31, 2009.

In addition, the Company had $141.7m in term deposits at the end of the quarter.

Net operating cash flow for the second quarter of fiscal year 2010 was $9.6m.

The deferred revenue balance, cash collected from registered students for courses and recognized progressively as revenue and the instructions are delivered, at the end of the second quarter of fiscal year 2010 was $71.1m, an increase of 34.9% from $52.7m as of period of second quarter of fiscal year 2009.

New Oriental expects its total net revenues in the third quarter of fiscal year 2010, which runs from December 1, 2009, to February 28, 2010, to be in the range of $82.5m to $85.1m, representing year-over-year growth in the range of 26% to 30% respectively.

Note that the Chinese New Year holiday will begin on February 14, 2010, 19 days later than last year, when the holiday fell on January 26, 2009.

We believe the late timing of Chinese New Year in 2010 will have the effect of pushing out some of our enrollments into the fourth fiscal quarter at the expense of the third fiscal quarter as students return to their studies in early March, which is our fourth fiscal quarter.

The opposite occurred in 2009, due to the early timing of Chinese New Year, when students returned to their studies in mid-February 2009, our Q3, and enrolled for spring courses in Q3 instead of Q4 2009.

Thus in fiscal year 2009, New Oriental recorded Q3 enrollment growth of 31% and Q4 enrollment growth of only 8% as enrollments shifted from the earlier quarter.

Thanks.

At this point, I will take your questions.

Operator?

(Operator Instructions).

Your first question comes from the line of Mark Marostica with Piper Jaffray.

Please proceed.

Hi, Louis.

I wanted to just dig into your 25% to 30% top line growth expectations going forward and with the focus on VIP and resulting slower enrollment growth and higher blended ASPs, I'm wondering how we should look at that 25% to 30% in terms of what growth you're expecting going forward on enrollments and what growth should we look at on the ASPs?

I think ASPs are going to continue to increase and probably be higher than this quarter, Mark, of 13.8%.

Enrollments should still be in line.

We've done 14% enrollment growth for the first half of the year and I would expect a similar number for the second half of the year.

But because the ASPs are going up we would expect revenues to be higher in the second half.

And we're also currently experiencing a relatively strong bounce back from the H1N1 quarter.

So as we said in the prepared remarks, the cash revenues and now it's the first seven weeks of the quarter, every week has been well over 30% and all of December was well over 40%.

So I think we expect faster revenue growth in Q3 and Q4.

But we're also going to begin to spend for the -- prepare for the summer given that U-Can demand is much stronger.

And the growth in Q3 and Q4 will continue to be driven by the same three groups, Kids English for 6 to 12 years old, and middle school, 12 to 18 year olds, including U-Can and overseas test prep.

So the same three drivers that have been driving this ship for the last year will continue to drive the ship.

And on the point on ASPs, what would you say your pricing increase was and is expected to be versus the effective mix shift?

I think the like-for-like price increases still remain in the 6% to 8% range.

But there is a very strong shift occurring toward one to six person classes.

And we're also getting a large number of VIP people, Mark, who are purchasing these.

I call them like Disneyland, all -- one year annual passes.

They basically pay CNY30,000 or about $4,300, and their parents buy for them, and they can go almost to any class within the New Oriental network for one year.

So these are proving to be quite popular.

And the same with the science pack that we talked about.

So students can enroll in a six person physics one quarter, biology the other quarter, chemistry another quarter, and enroll upfront.

So this is what's going to drive the ASP up in -- because these students are paying on average $3,000 to -- anywhere from $1,200 to $4,300 for enrollment.

And it's a growing number of students.

Okay.

Great.

Two final questions and I'll turn it over.

Regarding the $4m to $5m of incremental investment, was that $4m to $5m in each Q3 and Q4 or $4m to $5m total for the back half?

It's $4m to $5m total, Mark.

And like I said, we -- originally we had expected enrollments this year of about 80,000 to 90,000 in U-Can.

And now that we've already had 46,900 in the first half, the second half is seasonally stronger.

So we would expect that we're going to get a large -- we're probably going to beat that 85,000 number by a significant margin.

Given that, we would expect the summer to be quite strong.

The other thing is given the acceptance of customized learning and U-Can, we want to roll out into more cities than we originally anticipated.

We thought we'd go into anywhere from -- originally it was going to be three cities, actually two cities, Beijing and Shanghai.

Then we thought we'd roll out to eight cities.

And now we're talking about rolling out into 30 cities all this year.

So that kind of rapid expansion is going to mean that we're going to need to hire another 1,000 teachers for fiscal year 2010.

We've only hired 300 of them so far in U-Can.

So another 700 teachers to go in the next two quarters.

And that's what's going to drive up the G&A cost as we train these teachers.

But it's going to help us meet what we expect to be a very strong summer for U-Can and Kids enrollments.

And then last housekeeping question here, you mentioned stock-based comp should show some modest declines in Q3 and Q4.

Could you quantify that?

Yes.

Well, we have $8.8m a year that is tied to the 2007 stock option grant.

They expire January 29 of this year, so in a week or so, a week and a half.

So Q3 will get one-third of that benefit.

So we will get a $700,000 lowering.

And Q4 should get the full $2.2m.

Got it.

Thank you.

Your next question comes from the line of James Mitchell with Goldman Sachs.

Please proceed.

Sure.

Thank you for taking the question.

It's pretty amazing you've layered the U-Can business onto your existing model without crushing margins, despite H1N1.

Can you help us size the potential U-Can contribution to enrollments in fiscal '11?

And also previously you expected gross margins to be up about 1 point for fiscal '10.

Do you now expect margins to be down in fiscal '10 due to U-Can spending?

Yes.

I think gross margin should stay about the same, James, that's the second part of your --.

The first question on U-Can enrollments, we don't have our projection for '11 yet.

But we do expect now that '10 enrollments will exceed the 80,000 to 90,000 that we originally had forecast.

And we -- the talk is that '11 should grow at least 50%.

So if you just -- if you assume we do 100,000 enrollments this year, we can do 150,000 next year.

The key here is the ASPs are going up.

So the ASPs in U-Can last year were around $120.

This last quarter they were over $300.

So that's why the revenue jumps from $7m last year to over $25m this year.

And it should again very close to double next year.

And do you expect structural differences between U-Can in the initial batch of cities versus U-Can in second tier cities where I'm guessing the market's smaller but there's less competition?

Absolutely correct.

And right now most of our competition is located in Beijing and Shanghai only, or at least 90% of the revenue is derived from Shanghai and Beijing only.

So we're doing very well in Shanghai and Beijing.

But we want to get early mover advantage in the other 28 cities or 40 cities that we're in.

So the key is that even though the ASP will be lower, let's say it's $300 per hour -- CNY300 per hour in Beijing for one-on-one tutoring, it only may be CNY150 in a Tier 2 or Tier 3 city.

Also the teacher costs go proportionally down as well.

And so we -- but we think it's important to get in there early because our early success, even in Tier 2 and Tier 3 cities, tells us that we want to get a foothold as early as possible and the market will develop much faster than we originally had thought.

Great.

On operating margins, James, we do expect operating margins to be down year-over-year because of the H1N1 virus.

If you think about it, our budget called for 28% revenue growth for the year, and that was conservative originally, and 27% expense increases.

So whenever we don't grow at least 27% we're going to take margin contraction on the operating line.

And then on top of that, when you layer in extra marketing spending because we went into the one-on-one program and also this rapid, more aggressive expansion plan into U-Can, it's going to wipe out the margin expansion hopes for this year.

But like I said, I think all we're doing is frontloading some of the expenses because the summer we expect to be quite a good one, assuming there's no more surprises ahead.

Thank you.

Your next question comes from the line of Catherine Leung with Citigroup.

Please proceed.

Hi.

I have two questions.

My first question is, firstly, would you be able to comment whether you're seeing similar demand for smaller classes in other segments, such as adult English and the test prep segment?

And secondly, regarding the accelerated expansion of the U-Can and the customized learning program, would you be able to comment on the demand trend for these small classes in Beijing and Shanghai versus Tier 2 cities.

So is your decision to accelerate expansion due to, as you said, trying to preempt the competition?

Or are you -- have you already started to see the demand for the smaller classes increasing in those Tier 2 cities as well?

Thanks.

I think the second question is we have seen demand in the Tier 2 cities being increased.

And that's why we're -- it's both, Catherine.

We're going to try and preempt competition and it's because we see the market, otherwise we'd be -- it'd be a money-losing operation to expand there too quickly.

On your first question regarding one-on-one, one-on-one started with English.

So English still remains our number one one-on-one category.

And so of the 10,000 enrollments that we received in VIP and one-on-one in the first half of this year, more than half are for English and then there's another probably 10% or 20% that are targeted for overseas test prep.

So one-on-one preparation for GRE, TOEFL, SAT, etc.

So it's only about 3,000 of the enrollments that are targeted at U-Can, the non-English subjects.

But they are obviously the fastest growing portion.

And if you think that for all of last year we got 12,000 one-on-one or one to -- anywhere from one to six enrollment size.

This year we expect over 20,000.

So this small class and this one-on-one format is extremely popular.

And as you know the ASPs here average over $1,300 versus $120 for the big classes.

So each one enrollment is already equal to 10 other enrollments.

So it's very significant in our revenue mix.

All right.

Thank you.

Thank you.

Your next question comes from the line of Adele Mao with OLP Global.

Please proceed.

Hi, Louis.

You mentioned that cash receipts since early December have increased at least 30% each week compared to last year.

I remember last year you had the enrollment figures for the first weeks actually reported and that number was, I think, 160,000.

Could you give us the enrollment figure for the first weeks -- for the first six weeks of this year?

I don't have it handy, Adele.

The enrollment increases are not as high.

They're probably in the 10% to 15% area.

What's happening is, as I said, the deferred revenue number is going to continue to get bigger and bigger because students are signing up for multiple quarter classes.

So I can tell you the cash receipts for all of December were well up over 40% for the month.

And so far in January they're tracking over 35%.

But don't translate one for -- they don't translate one for one in the revenue.

So what happens is that because they're multiple quarters, a lesser and lesser percent of the cash receipts will be recognized in the same quarter.

So that's why we were conservative in saying we expect 30% revenue growth for the quarter.

I see.

I understand.

And I also want to dig a little bit more into the impacts of the timing of Chinese New Year.

This year Chinese New Year is 19 days later, as you mentioned.

But when we look at the winter break duration for most of the students in China, it seems that the winter week -- or winter break is actually one to two weeks longer.

Is it fair to assume that during this winter break more students are going to be able to take classes in more days and allow EDU to actually book more revenue during the winter break versus the same period last year where you had a scheduling issue in cities -- in Shanghai?

That's a very good question, and thanks for raising that one.

Chinese New Year is February 14 this year.

So what we expect is actually a long flat cycle now.

So the first half of Chinese year is actually a week longer so that's going to happen is the first half of Chinese New Year we'll see hopefully much stronger revenues than the same period last year where it was shortened because of the early timing Chinese New Year.

The second half is the same length so it's still one or two weeks after the February 14 date.

But the point we made about enrollments is that because Chinese New Year is February 14 this year, similar to what happened a few years ago, is that students go back to school in early March which is already Q4 so by the time they enroll for Q4 classes, the spring courses, they will be enrolling in Q4 so those enrollments will count in Q4.

Last year because Chinese New Year was so early, it was January 26, students went back to class around February 10, February 14 so when they signed up for their spring courses they got counted in Q3 of 2009.

So Q3 2009 saw 31% enrollment increase but then of course it just borrowed from Q4 and Q4 only saw 8% enrollment increase.

This year is a more normal year.

So Q3 will be, because of tough comparisons versus last year were enrollments were 31%, we'll see hopefully better revenue but lower enrollment growth and Q4 should have better enrollment growth because it will get the bulk of the spring enrollments in Q4 when the students go back in March.

It's a little bit complex, I hope I explained it so you understand that.

Right.

The enrollment growth you're referring to is just the quarter end enrollment growth because students may not (multiple speakers).

Right because our quarter ends February 28 and so whenever Chinese New Year is late, enrollments get shifted from Q3 into Q4.

Whenever Chinese New Year is early, Q4 enrollments get pushed into Q3.

And this year happens to be a late Chinese New Year so enrollments will get pushed from Q3 into Q4.

I see.

Thanks very much.

If you take a six-month view it'll all wash out, be the same.

Right.

It should grow (multiple speakers) 12% to 14%.

Okay, great, thank you.

Thank you.

Your next question comes from the line of [Ela Ji] with Oppenheimer.

Please proceed.

Hi, Louis, good evening.

Hello, Ela.

I'm wondering if you can provide a mix of your revenue and the enrollment of your larger class, middle class and one-on-one small class with your U-Can segment.

Okay, that's a great question, luckily I had that prepared.

The one-to-one enrollment in the quarter was 1,200 out of the 13,000, the one to six was 605 and the seven to 40 or seven students and more was 10,100 and change.

And we also had some [Mishatong] about 1,400 enrollments in short term.

Great and do you have any target enrollment mix by end of even longer term?

Yes, for fiscal year 2010 we expect between U-Can and Mishatong over 5,000 one-on-one enrollments.

And over 2,500 one to six enrollments and over 85,000 in the larger than six people per class enrollments.

So were going to be right around 90,000 to 100,000, that's the target.

But obviously we were tracking better than that in the first two quarters, we're already at 47,000.

Right, great.

And then usually we have higher enrollments in Q3 and Q4 than we do in the first half.

And shifting gears a bit, I want to ask about I remember the last year in third quarter you had a weak -- your adult English had a relatively weak performance.

I'm wondering if you can talk about the year over year comp in this year for that segment.

Unfortunately, that's not a positive point for us.

We had 50,000 enrollments last year in Q2, we only had 41,900 this year.

So basically it was an 11% drop in enrollments.

Sorry, enrollment growth was down 17% and revenue was down 11% year-over-year.

But this has been a long term trend anyway as we teach kids in middle school English it's obviously going to cannibalize adult English.

Because these adults aren't 40-year-old people, these adults are 18 to 25 most of them.

So as we do a better and better job in middle and high school English and Kids English there'll be no need for adult English among many of our students in China.

So this is I think is a longer-term trend anyway.

So do you think, do you believe it's, you are believing that it's market size for adult English is likely shrinking versus it could be likely that's there's higher competition in the market.

Which one is the primary driver?

Well, I think our competitors are probably doing worse than us, from what I've heard in the market on the adult side, so I think we're probably doing relatively better.

For the first half of the year our enrollments in adult English are down from 173,000 last year to 166,000 this year.

So the enrollments are down 3% but the revenue is up 6% for the year.

So it's still growing in revenue, it's just much slower rate than five years ago.

Okay.

And my last question is regarding your marketing and the related promotional spending for U-Can.

Can you just talk about how much you've spent versus your originally budgeted?

Originally, we had not budgeted for one-on-one spending at all so we originally budgeted for U-Can, we had a $39m budget for fiscal year 2009 -- 2010 when we budgeted last April and then that's before we started the one-on-one programming.

Of that $39m, more than $10m was allocated for U-Can and middle and high school English for 12 to 18 year olds.

When we decided to go into one-on-one customized learning during the summer we increased the budget by $6m just for one-on-one learning and of course it benefits U-Can as well.

So we increased it from a little over $10m to $16m in marketing spend for 12 to 18 year olds.

And then the total budget went from -- I'm sorry, the total budget was $49m, I apologize.

So went from $49m to $55m for the year.

For the first two quarters we're at $26m, so we're a little bit less than half of the revised budget of $55m for sales and marketing and promotional expenses.

Great, thanks for the time.

Thank you.

Your next question comes from the line of Jeff Lee with Signal Hill.

Please proceed.

Thank you very much.

What kind of impact would you say that H1N1 had on enrollments during this quarter?

Obviously it was quite a bit negative but were there any other factors leading to the 5% enrollment growth.

Well, I think is the enrollment growth was also impacted by students signing up for multiple quarter classes, which is a good thing because obviously we lock them in longer, we get the cash up from.

So that's also -- but I think H1N1 we only grew 5% in enrollments in the quarter.

Even last year we grew 13% and that wasn't a very good Q2.

So if we grew 13% this year like we had done last year it means a difference of about 30,000 enrollments for the quarter.

You add that with, if you do the same thing add several percent for the Q1 it impacted us by 80,000 to 100,000 enrollments, by 80,000 enrollments in the first half of the year.

Okay, great.

Thank you very much, Louis.

Thank you, Jeff.

Your next question comes from the line of Philip Wan with Morgan Stanley.

Please proceed.

Good evening, Louis.

I have two questions and number one is about the increase in enrollments for December.

Are they mainly from U-Can or the new customized learning program or from the traditional English training classes?

And number two is, before introducing the U-Can and small class tutoring do we expect margin expansion on utilization improvement?

And how should we look at the margin trend going forward as we are expecting higher revenue contribution from the smaller classes with lower margin?

Thank you.

Yes, that's a good question.

I think on the December enrollment the growth is in the same area.

Within U-Can it's in Kids English and it's in overseas test prep.

Those are the three fastest growing areas.

And that's expected because it's during the school holidays.

Now the other thing that you should be aware of, though, is that as U-Can grows it also has a negative impact on middle and high school English.

Because remember the students who used to take New Oriental only for English, now are switching and taking some quarters they're taking U-Can classes other subjects than English.

So English enrollments are growing slower than in the past because they're being cannibalized by U-Can, which is fine.

But the net effect is that the overall number of classes a student takes is increasing and the dollars they're paying is much higher.

So it's the effect we expected but it's happening faster than we thought because of the rapid increase of U-Can.

I apologize, Philip, what was the second part of your question -- margins, sorry.

Our margins is that before H1N1 came in and before we decided to do one-on-one tutoring we had a budget that, like I said, called for 28% top line growth conservatively and 27% expense growth.

So what happens is if we didn't change the budget, any time if revenue growth is below 27% you're going to see margin contraction.

If revenue growth is above 27% you're going to see revenue -- you're going to see margin expansion.

And since we expected it to be above, we expect to get margin expansion.

That obviously didn't occur so revenues only increased 25% in the first two quarters and also because we are expending a lot of money, over $6m in sales and marketing that's new, and another $8m to $10m in building out U-Can in a much faster rate than we expected.

So that of course is going to be negative to margins all around.

Now gross margin should stay relatively the same for the year, about 61% to 62%, but operating margin should be below by about 100 to 150 basis points.

Now I also want to make one more point though we have not changed our EPS for calendar year 2010.

All we're doing is frontloading some of the expansion expenses from next year into this year because of the rapid growth of U-Can.

So we were going to have to spend that money in the next 12 to 18 months anyway, we're just frontloading it.

And so I think as -- and we expect to get -- we don't expect to do it for nothing, so we expect summer enrollments to and the numbers beyond that to pick up.

Q4 and Q1 of next year to pick up.

So we do expect $2.60 to $2.70 in GAAP EPS for the whole year.

Okay, thank you very helpful.

Thank you, Phil.

Your next question comes from the line of Amy Junker with Robert W.

Baird.

Please proceed.

Hi, Louis.

Thanks.

If I can just touch on the margins again and make sure I understand in your comment about the full year EPS, calendar EPS guidance not changing, which I guess I'm a little surprised by that comment.

One, so the $4m to $5m in incremental spend, first, can you help us understand how that's going to split between third and fourth quarter, will it be pretty even or is one quarter going to be hit more than others?

Q3 will probably be a little bit hit more.

So let's say it's $4.5m, probably Q3 will incur $2.7m, $2.8m of it and Q4 will probably be $1.7m.

And does that account for, does the $4m to $5m account for any additional drag on margins because I would assume as you invest there's going to be more of an incremental hit than just the $4m to $5m.

Am I thinking about that the right way?

And with executions?

The drag is on Q -- is on fiscal year 2010.

It will benefit fiscal year 2011.

So it's building ahead of the demand.

So if we don't add these 700 teachers in the next two quarters we won't be ready for the summer because we're expecting better demand than we had.

If you think about it, I want to step back a bit, if you think about what New Oriental did in rolling out one-on-one programs is that we could have bought our way in, it would have been very expensive.

So if we bought our way in by buying two or three large competitors in this space, we probably would have had to pay somewhere between $200m and $300m dollars.

That would have been a huge dilution to our shareholders.

What we would have gotten is a business that looks like U-Can in about six months.

So in 18 months we can build a build a similar sized program, as we would have bought last year.

So we're 18 months to 2 years behind but we can do it for $30m to $40m.

So we're asking our investors to understand this is the right strategy for the long term benefit of the Company but it's a make or buy decision and we weren't successful in buying it.

But it would have cost probably 8 to 9 times as much and we would have had to deal with overlapping learning centers, we'd have to deal with cultural issues and redundancies among different departments and things.

So the analogy I use is that you had a choice of buying a house that's been remodeled or starting with a foundation and building the house the way you want it.

And the way -- in building the new house it takes you an extra 18 months, 2 years, but it's exactly the way you want it and it's only one-eighth or one-ninth the cost.

But you do take a hit in the market in the meantime and so we are building it ourselves, we are taking the hit now but I think it will be a much better product when it comes out in the next 6 months to 9 months when we catch up.

But in the meantime it is short-term pain.

And I guess help me understand what's the execution risk of going into 30 cities?

And maybe to use your analogy, what's the risk that this house that you're building that you think is only going to take 18 months, the contractors are slower than what you signed on for and it really take 24 or 36 months to build?

I won't take that long because it's rolling out as we speak.

And we are part -- the 700 teachers we are hiring in these next two quarters are right on schedule.

We are actually ahead of schedule on demand and we're right on schedule as far as teacher hiring for the first two quarters.

We didn't expect demand to be that strong so that's why we're adding incrementally in Q3 and Q4 knowing that Q1, the summer, is our all-important quarter.

And so if we're ready by then we will see even more demand in Q1 as a result of preparing in Q3 and Q4.

Just the idea of -- same thing as we used to do with learning centers.

We'd add a lot of learning centers in Q3 and Q4 to prepare for the summer, now we're just doing it with teachers as well as for staff.

The other thing we're doing which is new in New Oriental, relatively new, we're actually spending a lot of money in building our content.

So we want a competitive advantage in the market.

New Oriental wins through best brand and through teacher quality and now we are expanding our content development team drastically by about 60 to 80 people, so more than doubling it, to focus on 6 to 18 year old student content.

And that's included --

(multiple speakers).

That's included in the $4m to $5m, I'm sorry, that's included in the $4m to $5m -- okay.

It is included.

So the 250 headcount that's included in U-Can for this year, 60 to 80 is in content development.

Another 100 or so is in customer service and marketing.

So those people, those customer service agents that help families decide on the course of study for their children we're increasing that significantly.

Because customer service becomes obviously more and more important as you build an expensive one-on-one offering platform.

So you have very demanding clients and we want to be -- so we want to compete not just based on our brand and best teachers but also on best content and best service.

And we think that formula works all throughout China.

At least in the 40 cities we're in today.

Great, that's really helpful, thank you.

And just last housekeeping question on tax rate because it looks like you got a benefit this quarter.

What are your expectations for the full year?

Our expectation is 9% tax rate for the year.

Great.

Thanks so much, Louis.

Yes, we did get a benefit because we didn't make as much money as we thought.

Good and bad problem to have.

Exactly.

That's one of the few benefits of the slowdown.

And your next question comes from the line of Ingrid Yin with Brean Murray.

Please proceed.

Hi, Louis.

Thank you for taking my questions.

So we talked a lot about U-Can program.

Could you give more guidance on the U-Can program revenue growth rate going forward?

The year-over-year growth rate is really impressive, it's 100%.

Do you still see the market still under-penetrated, what kind of rate, growth rate we could expect going forward for the rest of 2010 and if possible for 2011?

Yes, I think for 2010 at this point if we take fiscal year 2010.

Last year we had 57,000 enrollments or so, $7m in revenue.

This year we expect probably close to 100,000 enrollments and probably revenue of $25m or more.

So basically enrollments will grow by 70%, 80% but revenues will almost quadruple.

Next year we would expect probably enrollment growth of at least 50% from what we do this fiscal year and we would expect revenues to grow faster than that because ASPs continue to climb.

So we would expect revenue growth to be probably 10 to 15 points higher than our student enrollment growth.

Great, the second question is increased selling and marketing costs.

So it really makes sense to me to invest early to get prepared for the summer but how many quarters will we need to invest in this segment to get established in the U-Can even in the second cities, second tier cities?

Well, what I think is that this year is the high point as far as the percentage of revenue so I think this year I don't think we'll hit 15% but we'll get very close between 14% and 15% of revenue.

I don't believe it will be that high going forward.

So I think revenues, so this is the year we have U-Can going, one-on-one going, and we're also beginning to ramp up in kids marketing as well as we roll out kids math and kids writing.

So we have many programs going at the same time right now.

Can you comment on the --

I don't see that many new rollouts in the next few years.

I see.

Can you comment on the potential share buyback and dividend payout plan?

We haven't discussed it for calendar year 2010 yet but last year we spend $30m and we bought back 400,000 and some odd shares.

The year before we spent $64m and bought back 1m shares.

So right now we have about $350m, $360m in cash so we will -- we usually discuss that in the second half of the year.

So we usually, the last two years we started our buyback program in April in or in July.

So we'll most likely look at that again at the next Board meeting in March or April.

We just finished our one end of November so we'll look at another one depending on other -- on cash flow factors and how the business is doing in the next Board meeting.

Great, thank you for taking my question.

Thank you.

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

Please proceed.

Hi, Louis.

Just two questions for you.

First on teacher retention, how have things been going, are you satisfied with the trends there?

And then second, the overseas test prep business.

Any updates on dynamics there, enrollment growth, pricing and opportunities for different kinds of business models?

Those kinds of things would be great, thanks.

Yes, thanks, Brandon.

Teacher retention has not really been much of a problem since the IPO, as you know, given that we gave stock options to our star teachers and that we continue to pay among the highest in the industry if not the highest in many cities.

So teacher retention is not an issue.

We still hire less than one in every 10 applicants or so.

So I think the percentage will probably go up a little bit as we hire more part-time teachers for U-Can but we are not having tremendous difficulty finding teachers right now.

Overseas test prep.

The trend is TOEFL is still going to grow, the number of test takers still growing 20% or so.

Same with IELTS.

GRE -- they're all growing, they're growing low single digits for us in enrollment.

But the key is the price increase is still up about 20%.

The other thing that's important about overseas test prep is that there's a shift towards the SAT and younger students leaving China to go directly overseas to college.

So that kind of test prep, TOEFL and IELTS and SAT test prep, are all growing in the double digits.

And we don't see any change at least in the next 12 months.

Okay.

Any opportunity there to migrate that model to some kind of an online format or do you think that the test taking population is ready for that kind of switch yet?

What I think is that don't forget that the students, most of the students who take SAT test prep, they usually come from very wealthy families.

If that's the case they're not going to want their test prep online, most of them, because that's the least effective way to learn versus a live teacher versus one-on-one.

So if anything it's going to migrate toward one-on-one and one to six teaching.

We have students now who want one-on-one writing instruction for the SAT, you can't do that online.

And so the shift is actually towards smaller classes and more expensive classes.

And online is a much less expensive option.

Okay, great.

Thanks a lot.

You think about it even in Korea right, where you have Megastudy, you have these super star teachers and things that go on online and this great online platform, don't forget that probably 50% to 70% of Korean high school students take one-on-one tutoring for the KSAT.

So they use online as a supplement not as the key studying tool.

Okay, great.

Thanks, Louis.

Thank you, Brandon.

And you next question comes from the line of Marisa Ho with Credit Suisse.

Please proceed.

Hi, Louis.

You now seem to be positioning for margin expansion in FY2011, which was pushed out from FY10.

What is the risk of that happening?

I mean, for example, if over the next six months you continue to expand into U-Can and you find the market is actually a lot larger than you were originally thinking, and would you find yourself frontloading more investment into FY11 and thereby the margin expansion not happening?

I don't think we'll frontload any more than we are now.

Part of our calculus is that the summer is all-important.

So if we frontloaded in Q3 and Q4, we're ready for the summer.

After the summer Q2 is a slowdown so the right time to frontload it if any will be in Q3 and Q4, which is what we're doing.

It's unlikely we'll have to do that again in 2011.

If we do it'll be at the end of fiscal 2011, which will be Q3 and Q4 of next year.

That'd be a high-class problem to have.

If we don't have H1N1 our revenue growth, that means is well north of 30%.

So we'll have plenty of margin to play if that happens.

Right, great, thanks.

You understand my point, right, is that we usually do the frontloading or the capital building in Q3 and Q4 so if we do it this year we're fine until Q3 of next year.

If Q2 next year's demand is so strong that means that the margins have already gone up.

This year, if we didn't have H1N1, our revenue growth was in excess of 20%, we would still have relatively margin neutral or margin expansion despite the buildup.

It's because our revenue growth is trailing, that's the issue.

Thank you.

Thank you, Marisa.

Your next question comes from the line of Ming Zhoa with SIG.

Please proceed.

Thanks for taking my questions and good evening.

I just want a question on in your expectation do you have a breakdown of revenue for each segment, each major segment, in fiscal year 2010?

And what's the percentage of revenue U-Can can contribute in this fiscal year?

Well, I wouldn't count U-Can as a separate group but U-Can should contribute 250 -- sorry $25m out of approximately $360m, $370m.

U-Can should be about 6%.

But if you take U-Can, plus it's the same student right, 12 to 18 year olds, the English portion will contribute $40m to $45m.

Together that's $70m out of $360m, $370m in revenue for fiscal year 2010.

If that segment grows, let's say, 40%, 50% next year it will grow to about $100m out of about $430m or so for next year.

It becomes over 20%.

You can see that it, within -- we expect the 12 to 18 year old segment within 4 or 5 years to be the number one revenue contributor in New Oriental and the number one profit contributor within New Oriental.

So it's going to overtake overseas test prep.

It will probably overtake overseas test prep in three years in revenue and it will overtake overseas test prep in four or five years in contribution to the bottom line.

That's how important this business is to us.

Okay, thank you.

We're now approaching the end of the conference call.

I would now like to turn the call over to New Oriental's President and Chief Financial Officer, Louis Hsieh, for closing remarks.

Please proceed.

Thank you.

I just want to thank everyone for joining this call today and we look forward to seeing you in the course of the quarter.

Thank you very much.

Ladies and gentlemen, thank you for your participation in today's presentation.

This concludes our call, you may now disconnect.

Have a good day.