New Oriental Education & Technology Group Inc (EDU) 2010 Q3 法說會逐字稿

Good evening, and thank you for standing by for the New Oriental's third 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 would now like to 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 third fiscal quarter 2010 earnings conference call.

Our third fiscal quarter earnings results were released earlier today and are available on the Company's website as well as 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 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 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 to everyone on the call, and thanks for being with us today.

Let me begin by taking you through some highlights from the quarter, after which I'll go over some financial results.

We'll wrap up with some Q&A.

As many of you already know the third quarter is typically New Oriental's second strongest quarter, with students taking advantage of the month-long Chinese New Year holiday to catch up on their individual studies.

This year Chinese New Year fell on February 14, two and a half weeks later than it did in 2009, when the holiday fell on January 26.

As a result of the later Chinese New Year holiday this year enrolments for spring classes were logged both in the third quarter, which ends on February 28, and in the fourth quarter, which begins on March 1.

By contrast with the earlier Chinese New Year holiday in 2009, when Chinese students returned from vacation and signed up for spring classes, the enrolments were mostly logged in the third fiscal quarter.

In fact, student enrolments in Q3 last year increased by a whopping 31%, to approximately 351,700.

As such, the comparison of Q3 2010 to Q3 2009 is a difficult one.

So I'm very happy to say that, despite this tough comparison, our third quarter fiscal results were still very strong, with student enrolments up 18% to over 416,000, and net revenues up 36% to $89.2m.

In most years, in order to give students more options for Chinese New Year-time classes, we offer short-term sessions before and after the holiday.

This gives students more flexibility to fit in some extra training.

This year, in light of the later timing of Chinese New Year, in the majority of our schools we offered an additional special short-term session before the start of the holiday.

So we were offering two pre-Chinese New Year and one post-Chinese New Year short-term sessions.

This proved to be a good move because it gave students more options to fit a course in before leaving for the family vacation or taking part in the traditional Lunar New Year festivities.

This boosted our enrolments for this quarter, but at the expense of our ASP growth.

Since shorter duration classes carry lower ASPs, average ASPs for language training and test prep courses in at least -- came in at just over 10% for Q3, slightly before -- slightly below our norm.

Now I'll go into a bit more detail on each of the main major growth drivers for the quarter; POP Kids English, Middle and High School English, All-Subjects U-Can Training and Overseas Test Prep.

Pop Kids English saw continued strong growth in Q3 with enrolments up more than 40%, to over 121,000 for the quarter, reflecting the abatement of the H1N1 fears that had parents keeping their children inside in a precaution against illness.

We have emphasized before the crucial role early childhood education plays in China, with parents willing to pull out all the stops for their only one child.

The creative and fun Pop Kids English curriculum, combined with New Oriental's leading brand name and stellar reputation, results in an offering that parents turn to when choosing education solutions for their children from age 5 to 12.

In observing this huge opportunity for our Kids POP English program we have been thinking about ways to reach children at an even younger age, and helping instill in these kids and help them learn as they grow up.

So in the third quarter we launched our partnership with Kinderdance, the US-based provider of dance, music and motor development gymnastics and fitness programs for young children.

Through this partnership we'll be offering Kinderdance programs in which children engage with both their parents and the instructor in a series of dance movements to the accompaniment of music at New Oriental's Kinderplay Early Childhood Learning Centers.

So far the program is available in three centers and we'll be rolling it out into additional centers in new and existing cities throughout the fourth quarter and fiscal year 2011.

We expect to be in over 10 major cities by 2014.

We believe that this innovative new offering is a wonderful marketing opportunity for us, as it gives parents the opportunity to begin their child's education even earlier.

Another major growth driver this quarter was our Middle and High School English and U-Can All-Subjects Training.

Enrolments in this segment were up more than 25% to over 93,000 in the third quarter, with revenues up more than 70% to over $15m.

U-Can in particular saw strong continued growth.

As many of you know, we had originally targeted 80,000 to 90,000 U-Can enrolments and revenues of $25m for fiscal year 2010.

The 80% year-over-year enrolment growth we have seen in the first three quarters has brought us to more than 83,000 students enrolled in U-Can courses year to date, and total revenues of around $20m, which gives us confidence in our ability to meet or exceed the higher end of the original expectations for U-Can.

As we've said before demand for the type of All-Subjects Training offered by U-Can is very strong in China as students are eager for every advantage as they prepare for the diverse and demanding exams for entry into Chinese top high schools and universities.

As U-Can grows and continues gaining popularity, we have expanded the program to fit the varied needs of the students.

One example of this is the new customized learning program we launched earlier this year which offers courses with teacher-student ratios of one to one and up to one to six, for students who prefer more individualized training.

Another example is our new VIP Pass which allows students to buy a single 'all you can eat' pass that allows them to attend any U-Can class throughout the semester, and which provides even more popular -- and which proved even more popular this quarter as students increasingly recognized the benefits of shopping around courses and choosing the topics and the structures that fit their needs.

In fact, we recorded over 9,900 VIP one-on-one and one-to-six enrolments in the third quarter, up from approximately 3,800 in the year-ago period, representing an increase of about [160%].

We will continue to design customized learning options for the students' diverse needs and expect that such initiatives will continue to help drive Middle and High School English and U-Can growth.

With the enormous popularity that U-Can has enjoyed we have been rolling out the program out in additional learning centers and existing new cities -- in new and existing cities.

By the end of this quarter U-Can was available in about 120 learning centers in 34 cities and we are on track to meet our target for fiscal year 2010 of 110 learning centers in a total of 37 cities.

For this customized learning program platform you may recall we raised our target from just eight to 10 cities, to over 30 cities, offering this program by the end of our fiscal year, a goal which we are well on our way to achieving.

We expect U-Can to continue to enjoy robust growth as we make the program available to more and more students.

Finally, Overseas Test Prep, the third major driver of growth this quarter.

Our Overseas Test Prep program, which helps prepare students for all sorts of exams they need to perform well in, in order to travel abroad for overseas education, saw enrolment growth of over 7% to more than 54,800, and revenue growth of over 34% to approximately $28m, as students took advantage of the Chinese New Year holiday to fit in prep courses for SAT, GRE, GMAT, ILs or TOEFL, for example.

So these were the main growth drivers this quarter.

In terms of some of other offerings, Adult English saw sustained revenue growth of about around 20% during the third quarter and Domestic Test Prep also saw growth, with net revenues up over 30%, as students geared up to take their all important Gaokao college examinations in June.

As China's leading private education provider we take very seriously our responsibility to help prepare Chinese students at all ages for the challenges and opportunities they face in life.

There are many companies in China who try to do what we do, but none show the nationwide brand recognition and excellent reputation that New Oriental has built over 17 years.

As we grow and adapt our programs, and as China's increasing -- increasingly engages with the global economy, there will be even more opportunities for us to develop offerings that address specific needs.

In fact, Michael and several of our teaching -- star teachers are about to hit the road for the Annual Dream Tour, which this year will target 29 cities throughout the country, personally reaching out to students who are looking for ways to enhance their lives with the sort of quality education which New Oriental can offer.

Now let me go through the financials.

For the third fiscal quarter 2010 New Oriental reported net revenues of $89.2m, representing a 36.2%increase year over year.

Net revenues from Educational Programs and Services for the third fiscal quarter was $82.6m, representing a 37.6% increase year over year.

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

Total student enrolments in language training and test prep courses in the second -- in the third quarter 2010 increased by 18.3% year over year to approximately 416,000, from 351,000 in the same period of the prior fiscal year.

GAAP operating costs and expenses for the quarter were $75.5m, a 33.1% increase year over year.

Non-GAAP operating costs and expenses for the quarter were $70.7m, a 34.1% year over year.

Cost of revenues increased by 36.1% year over year to $35.4m, primarily due to the increased number of courses and the greater number of schools and learning centers in operation.

Selling and marketing expenses increased by 31.3% year over year to $13.8m, primarily due to brand promotion expenses, especially for new programs such as U-Can and the customized learning program.

GAAP G&A expenses were $26.2m, a 30.1% increase year over year.

Non-GAAP G&A expenses for the quarter increased by 35.3% year over year to $21.7m, 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 by $4.9m in the third quarter of fiscal 2010, from $4.1m in the same period of the prior fiscal year.

Approximately $590,000 of the increase was due to the one-time, one-off adjustment to account for a lower than expected forfeiture rate in the first nine months of fiscal year 2010, due to the fact that fewer New Oriental employees who received stock-based compensation awards left the Company and forfeited their awards than anticipated.

GAAP income from operations for the quarter were $13.6m, a 57% increase, from $8.7m in the same period of the prior fiscal year.

And non-GAAP income from operations for the quarter was $18.5m, compared to $12.8m in the same period of the prior fiscal year.

GAAP operating margin for the quarter was 15.3%, compared to 13.3% in the same period of the prior fiscal year.

Non-GAAP operating margin for the quarter was 20.7%, compared to 19.5% in the same period of the prior fiscal year.

This rise is primarily due to improved operating efficiency as revenue growth outpaced the growth of operating costs and expenses.

GAAP net income for the quarter was $13.8m, representing a 33% increase from the same period of the prior fiscal year.

Basic and diluted net income per ADS was $0.37 and $0.36 respectively.

Non-GAAP net income was $18.7m, representing a 29.1% increase from the same period of the prior fiscal year.

Non-GAAP basic and diluted net income per ADS were $0.50 and $0.48 respectively.

Capital expenditures for the quarter was $5.2m, which was primarily used to add a net of 26 new centers and remodel older learning centers during the quarter.

As of February 28, 2010 New Oriental had cash and cash equivalents of $250.8m, as compared to $210.6m as of November 30, 2009.

In addition, the Company had $120.4m in term deposits at the end of the quarter.

Net operating cash flow for the third quarter of fiscal year 2010 was $22.7m.

The deferred revenue balance, cash collected from registered students for courses and recognized proportionally as revenue as the instructions are delivered, at the end of the third quarter of fiscal year 2010 was $69.8m, an increase of 29.5% (sic - see press release) from the year-ago period.

Before giving guidance for the fourth quarter, let me briefly compare the first nine months of fiscal year 2010 to the first nine months of 2009.

For the nine months ended February 28, 2010 New Oriental reported net revenues of $299.7m, representing a 28.8% (sic - see press release) increase year over year.

Total student enrolments in language training and test preparation courses for the nine months ended February 28, 2010 increased by 15.2% to approximately 1.370m, from approximately 1.189m in the same period of the prior fiscal year.

With one fiscal quarter remaining, we are well positioned to meet or exceed our target of 1.73m to 1.77m enrolments for the 2010 fiscal year.

GAAP income from operations for the first nine months of fiscal year 2010 was $73.7m, a 26% increase year over year.

Non-GAAP income from operations for the first nine months of fiscal year 2010 was $86.6m, a 22.5% increase year over year.

GAAP operating margin for the first nine months of fiscal year 2010 was 24.6%, compared to 25.1% for the same period of the prior fiscal year.

Non-GAAP operating margin for the first nine months of fiscal year 2010 was 28.9%, compared to 30.3% for the same period of the prior fiscal year.

GAAP net income attributable to New Oriental for the first nine months of fiscal year 2010 was $72m, representing a 23.4% increase year over year.

GAAP basic and diluted earnings per ADS for the first nine months of fiscal year 2010 amounted to $1.91 and $1.86 respectively.

Non-GAAP net income attributable to New Oriental for the first nine months of fiscal year 2010 was $84.9m, representing a 20.2% increase year over year.

Non-GAAP basic and diluted earnings per ADS for the first nine months of fiscal year 2010 amounted to $2.25 and $2.20 respectively.

Now moving into revenue guidance, New Oriental expects its total net revenues in the fourth quarter of fiscal year 2010, running from March 1, 2010 to May 31, 2010, to be in the range of $75.5m to $78.4m, representing year-over-year growth in the range of 27% to 32% respectively.

This forecast reflects New Oriental's current and preliminary view, which is subject to change.

At this point I want to thank you and then take questions.

Operator.

Thank you.

(Operator Instructions).

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

Please proceed.

Thank you for taking my question.

It looks like you saw a pretty meaningful revenue acceleration in Adult English and in Domestic Test Prep, which I think have been historically somewhat more mature businesses.

Can you talk a little bit about what drove the revenue acceleration in the quarter?

For Adult English and Domestic Test Prep, I think part of it -- there's several factors.

In Adult English, I think it has been down for several quarters.

There was a meaningful bump up for two things.

One was the aftermath of H1N1 and, number two, was the Shanghai Expo coming up.

So Shanghai saw a nice jump up in enrolments in Adult English as people wanted to get jobs in the Expo and needed to improve their English skills.

So that was those.

Actually, the number of enrolments didn't go up much.

It was actually due to ASP increase which was about 10%, a little bit over 10%.

The second one was Domestic Test Prep, and this one had basically -- remember last year we had the scheduling problems in Shanghai and a number of cities, and so this is -- this had easier comparisons versus last year, and also because Chinese New Year this year we ran two sessions before the actual holiday of February 14.

In past years we typically ran one session before Chinese New Year and one session after.

And when you run the [second] session before the Lunar New Year, does that extra, shorter, lower ASP session generate comfortable margins to a normal extended session?

It does, James, because it's priced at the same amount per hour.

But because there's more actual hours, because Chinese New Year break was a little bit longer this year than last year, that helps the revenue on both the Domestic, on Gaokao and on Overseas and across the board on any kind of test-based subject for school-age children.

Great.

Thank you for taking my question.

Thanks, James.

Your next question comes from the line of Ella Ji with Oppenheimer.

Please proceed.

Hi, Louis, good evening.

Congratulations on the strong quarter.

I want to follow up on the earlier question on your strong revenue growth in the quarter, which is 36%, and it's above the normal range of 25% to 30%.

So could you talk about how much of that is driven from the pent-up demand of H1N1?

And do you think this above-the-range growth is sustainable into the summer quarter?

Thanks.

Thank you, Ella, for your question.

I think the growth -- we are -- New Oriental is about to embark on a revenue acceleration again.

After a few quarters of slowdown, not due to the H1N1, but also due to the fact that we were building the customized learning platform in U-Can, and U-Can and the customized learning platform are now taking critical mass.

So as you guys have all known we have been investing heavily in the Middle and High School programs.

But it's now -- the number of students is reaching -- is up to 83,000 this year and we should go very close to, if not exceed, 100,000 for the year, with revenues exceeding $25m from U-Can.

So because of that, if you think about it, if we have a base of $370m or $380m of revenues this year, $25m from U-Can is already about a 6% increase.

And we expect U-Can to grow -- typically, if we do $28m this year it should grow well over $40m next year.

So we do expect revenue acceleration to continue.

Now I want to make the point, though, that Q4 we have very difficult comparisons.

Q4 last year we grew over 45% in revenues so it has difficult comparisons.

And for us to guide 27% to 32% it means that demand is strong.

As far as the summer goes it's too early, because the Dream Tour is just beginning next week and the enrolments for the summer really begin to pick up at the end of -- at the second half of May and into June.

So it's too early to know how the summer will go.

But if we have a net of an extra 70 or 80 learning centers opened this year, and if demand continues to grow as we expect it to, we expect a good summer, obviously.

Okay, great.

Great to hear that.

I want to switch gears a bit and talk about your gross spending.

Could you give us an update on the 425m of gross spending?

Is it remained on track?

Gross spending?

What do you mean gross spending?

The 425m additional spending that you mentioned last quarter.

Yes, we are spending that, and more, essentially.

So what's going to happen this quarter is -- Q3 was a little bit light on marketing.

We grew marketing about 31% year over year.

Q4 is the big marketing season because it gears up for the summer.

And we are going to make an aggressive push into where we face the strongest competition in Beijing and Shanghai, and then we're going to spend across the country where we don't have so much competition, where we can establish an early mover and hopefully a dominant position in the other 38 cities that we are planning to go into.

So we will spend heavily in marketing.

We will also add -- we are planning -- we're going through budgeting now.

We're expecting to add another 70, 80 learning centers next year.

So that spending will be more than taken up.

I think the demand for U-Can also is outstripping our expectations, which means, of course, we're going to have to aggressively hire teachers and customer service representatives at learning centers.

So it's a good problem to have, but it's still a problem.

So we will continue to spend aggressively in this area.

But what I think many of the investors and analysts didn't get was that when we spend all this money, it's not just on the expense side.

It creates additional incremental revenue that will drive our revenue hopefully above 30% going forward for the next couple of quarters.

So it's not just the spending and that it's an expense line.

There's revenue associated with it.

And we believe that by summer of this year we'll have turned the corner and that the U-Can program will begin to really kick into gear as it begins to generate even faster revenue growth than in past summers.

Great, thanks.

Just to clarify, so the 425m of spending, so could you help us break down how much you spent really in this physical third quarter?

We added 26 learning centers and we added -- let me check the number of employees.

It was more than four or five -- it was more than half of the [425m] and the rest of it will be spent up this quarter.

It's not so much for marketing because marketing was already in the budget.

It's more for adding staff and teachers.

And also we are going through the budgeting process now, but we are also spending heavily on IT upgrades for -- more specifically for U-Can.

And the idea is that we will reach 1.75m, plus or minus 20,000 students, this fiscal year.

We expect to come very close, if not exceed, 2m student enrolments next fiscal year, which means that our IT infrastructure needs a large upgrade.

We also are spending a lot of money on content development for the 12 to 18 year-old group as well as hiring customer service representatives.

So all this is -- our budget for U-Can is actually going above our original forecast, and that's only because of the strong demand we're seeing.

(Inaudible - microphone accessible)?

I don't know exactly right now, but we will spend more.

We won't rest at the [425m] and we will exceed that (inaudible).

But the margins aren't falling because of the increased revenue that it is generating.

So, net net, do you anticipate the margins for next fiscal year -- will you see year-over-year growth or will that be still temporarily pressured because of --?

We should see year-over-year growth because the first half of this year was hindered by the flu virus, H1N1 virus, so we should see some growth but it's not going to be very dramatic.

Partly it's a tug of war between U-Can and Kids English.

Kids English has lower gross margin -- in the long run Kids English has lower gross margins than U-Can, which could have larger classes.

Remember a Kids English class has on average 18, 19 students per class.

U-Can, for 12 to 18 year olds, can have as many as 80 to 90 students and, typically, there are many student classes with over 40 to 50 students.

So the gross margins are going to be higher for U-Can in the long run.

But they're both growing very fast so we expect gross margins to still be 62% to 63% next year on a blended basis.

And I think operating margin, we should get within -- we should improve, hopefully, about a 100 basis points over this year, whatever we finish this year at.

But, like I said, we're going through budgeting now so that's just my preliminary estimate that we're trying to target.

Great.

I will carry it over, thanks.

Say that again.

I'll carry it over, thanks.

Okay, thank you, Ella.

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

Please proceed.

Hi.

Thank you, Louis, for [cranking] a very strong quarter; congratulations.

Thank you, Jeff.

I wanted to ask about enrolment expectations for next quarter and how -- is there any way to quantify how much Chinese New Year should help with that, the timing of Chinese New Year?

It should help a lot, because last year Q4 the enrolments were only up 8%, because, remember, Q3 was up 31% so it basically -- Q3 borrowed from Q4.

This year's the opposite.

So Q4 should see very strong enrolment growth.

But Q4 had very strong revenue growth last year at 45% top-line growth, so there's very, very difficult comparisons.

The enrolments are easy, but the revenue is difficult.

So I think you will probably see enrolment growth in the 20% plus range for Q4, but you'll see revenue growth somewhere between 27% and 32%.

Much of the second half of the enrolments in Q4 would actually be for the summer.

It's the enrolments that come into May that is actually for the summer quarter.

Okay.

The bottom line is you'll see strong top-line growth of 27% to 32%, but you'll see even stronger enrolment growth of relatively above 20%.

Okay.

Could you break out what -- how many of your enrolments in this quarter were due to the short sessions?

And is there any sort of effects where you think those short-session enrolments this quarter take away from next quarter's enrolments?

The short-session enrolments won't take away from next quarter's enrolments, but what it did was it reduced the ASP but increased enrolment.

So if I -- if it was a normal spring quarter or winter quarter, I would have expected about probably ASP growth in the 13% to 14% range, which means enrolment should not be 18%, should be probably 14% to 15%.

So it probably added 3% or 4% just because of the shorter sessions because there's two of them.

Yes, okay.

(Multiple speakers).

I'll turn it back over.

Thank you, Louis.

Thank you, Jeff.

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

Please proceed.

Hi.

Good evening.

I just wanted to add my congratulations.

My question is on your geographic strategy.

Specifically, would you be able to tell us how much revenues you currently generate from Beijing and Shanghai and which have been the fastest-growing cities recently year to date?

And also, secondly, the Company hasn't really expanded in terms of [new] city coverage over the past few years.

Under what circumstances would the Company consider expanding again?

We're going to expand this quarter, so we will be adding three to four new cities in the next 12 months.

So we are going back to expansion on a geographic basis.

We did hold it off because of a number of factors, as you know, Catherine, related to -- we wanted to focus on U-Can.

We had enough on our plate with U-Can, with H1N1 and a host of other -- a host of other programs and execution issues.

Your first question on Beijing/Shanghai, this quarter they accounted for 35% -- 45% of revenue of the whole Company.

Most of the other cities are growing very fast, so the top 12 cities of the blended Group grew 32%.

These cities in 2005, this was over 44% and the schools from 2006 grew 58%, so that gives you an idea.

So, obviously, the newer schools grow faster because they have lower bases.

But even the 12 original schools that were started from 1993 to 2004 grew 32%.

So it's just as we expected.

So were hitting on all -- we do have some schools that are still laggards but we did overall see very, very good improvement.

And can I ask, for your faster-growing cities, is this a function of, for example, your having expanding the U-Can and your customized learning programs, these centers, or is there just the general economic development [we see] that is explaining this faster growth?

You remember, Catherine, that economic growth helps us.

But even during the financial crisis we still grew 35%, so it's because of the priority of spending for Chinese families.

So when you look at the different cities as they develop, the growth is being driven mostly by Kids English and Middle and High School English and U-Can.

So the cities that have a lot of universities, we entered those cities earlier, so we are -- we were growing Overseas Test Prep, Domestic Test Prep, Adult English there as well.

But every city has obviously grade schools and Middle and High Schools.

And so the fastest growth is actually being driven by the six to 18 year-old groups as POP Kids English and Middle/High School English.

And we expect further growth.

As we roll into the five to 12 year-olds, we're going to roll into Chinese writing and mathematics, so then we're going to have more opportunities for these students to take classes.

Remember, there's three things that we talked about on one of those slides.

We want to get lifelong value of the student from age five or even before, age two, all the way to adulthood.

We want to get that recurring revenue stream where they take us for many, many years and quarter after quarter.

And we want to become a one-stop shop.

We don't want the revenue leaking because of enrolments going to other schools.

So we want to offer them like the Wal-Mart model where they can come in and pick up all the classes that they'd want for their children.

So, because of that, that's going to -- that creates a lot of synergies in our centers and it will help utilization and also wrap up revenues, and I think accelerating versus last year.

Last year I think we put a target of 25% to 30%.

This year it should go down a little bit but, actually, we won't reduce the target.

It'll still be 25% to 30% for the next two to three years and, in fact, I believe it'll actually be at the high end for next year.

Okay.

And if I can -- just kind of a last follow-up on your decision to add the three or four cities in the fourth quarter, should we read anything into this, on the understanding that a lot of the focus over the past year, past 18 months, has been on the U-Can and the customized learning programs?

So that suggests that the initial or the bulk of the build-out for U-Can and the customized learning program seem to be behind the Company already and, hence, that's why you're --

Yes.

It's not behind us because the demand is outstripping our forecast, so it's a good problem to have, but it's still a problem.

So we -- our demand is outstripping our forecast so we're -- our build-out [isn't there].

We're at probably very close to 1,000 U-Can teachers now.

We still need to get to 1,400 by the summer.

We'll probably fall short by 50 or so teachers or so.

So it is -- we are not -- we are still building it out.

We have 120 learning centers that have U-Can now.

By next year I would expect that to be very close to 180 or more learning centers, maybe even close to 200.

So you can -- we're going to add another 70 learning centers next year, 70 to 80, so the same as this year.

So we were always -- we're always trying to plan ahead and grow learning centers.

The new cities is that -- you have to understand that Michael, our CEO, gets so many requests from cities all throughout China for us to open New Oriental schools there.

Many, many cities offer us land, offer us tax breaks.

They want New Oriental schools in their cities; they see the benefits.

And so we have slowed it down in the last year as we -- as the issues we discussed earlier, and I think now we're going back to a normal pattern of two to three, maybe four cities a year.

Okay, understood.

Thank you.

Thank you.

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

Please proceed.

Hi, Louis.

Thanks for taking my call.

I just had a couple of follow-up questions from previous.

But with respect to the teachers that you're ramping up are you finding it challenging at all to attract higher-quality teachers, and to what extent are you needing to perhaps raise salaries in order to get the people to start with you?

That's an excellent question.

Because we're early in the teacher hiring, what we're doing is we are spending a lot of resources in training teachers.

In fact, we have now over 7,000 teachers in the network.

We added 946 teachers just in the quarter.

So it is a big challenge for us to find qualified teachers and, even more importantly, when we find them we actually have to train them.

So we have a staff of approximately 100 people that are teacher trainers as well.

We're also using the Internet and online platforms to train teachers so it is a mammoth task for us.

It is our biggest challenge, and why we don't grow faster, is hiring qualified teachers.

Our employee base at the end of the quarter was 13,984.

So we're over 14,000 people now, an increase of 3,500 this year, so we are having to increase teacher hiring as well as staff hiring.

As far as salaries go, in order to attract the best teachers we have to pay up.

So we did raise teachers' salaries last quarter by 8% in Beijing and Shanghai, and probably 4% to 6% in most of the other cities across the country.

And so we do have to pay up, but luckily for us our ASPs typically outpace the increase in teacher salaries.

Okay.

And then I know a challenge that you've had is turnover among sometimes some of the school heads.

Can you talk about how that's been trending?

As far as I can remember, we didn't lose any school heads last quarter and we didn't fire any, so -- it's still a problem, though.

There are still some schools that aren't over the hump yet.

And so we're always -- that's a battle we always have, though.

So in any typical year we will probably remove between two and five school heads.

And that was another reason, Catherine's earlier question, was that's why we didn't expand in too many cities is because at that time, at the beginning of the year, we felt many of the schools were actually underperforming so we wanted to make sure that we righted our ship before trying to go in to new geographies.

So that was a third reason why we had held off on going to new cities.

Michael and Zhou Chenggang, and Chen Xiangdong, and the whole team spend a lot of time in recruiting school heads and also vice school heads.

So we're actually increasing the depth of management at each of the schools in preparation for even -- for continued expanded growth across the country.

Remember, we used to pick the school heads from vice principals or vice school heads at existing cities.

So we're adding more and more vice school heads at each school, especially the larger ones and that's actually a training ground for us to pick new school heads.

And you feel that those underperforming schools from earlier in the year have those turned around at this point?

Well, the turnaround process is a gradual process.

It takes -- typically, when a school is what I call broken or just underperforming, if we put the right school head in it still takes four quarter to eight quarters, so one to two years, to right the ship.

But you can definitely see by the performance last quarter that the numbers are much better than the previous quarter.

And the schools that were having trouble, most of them showed a marked improvement.

And can you quantify how many schools you think still have room for improvement?

And I guess I'm thinking of it more on what's the margin potential upside once these schools actually turn around?

Could it be really, really meaningful?

I think at any time we're going to have between four and six cities that I think are candidates for replacing a school head.

Let's say we have 40.

Of the other 34 or 36 cities there's probably another 10 that are on an annual basis going to be below budget.

But then at the same time you're going to have 10 that are just knocking the cover off the ball.

They're exceeding the budget by a substantial amount.

And so I think at any one time there's probably 15 schools total that are probably underperforming what we would expect them in a budget.

But like I said as long as it's not Beijing and Shanghai you won't see a material difference yet, although Beijing and Shanghai are becoming smaller and smaller.

When we IPO'd they were about 60% of revenue, now they're down to 45%.

Okay.

And then the last question, switching gears over to U-Can.

As you go into newer cities what kind of brand loyalty are you up against in the non-English subjects?

And, on the flip side of that question, are you seeing any first-mover advantage in cities where larger competitors currently aren't established?

That's exactly our strategy and why we went in -- we were going in to 37 cities by the end of this year, is that outside of Beijing and Shanghai, in most of the cities there's not large established players.

And so when we go in we have -- maybe not first movers.

We're usually never first into a city.

But we have early-mover advantage and we're much larger than the indigenous schools.

And so we feel our brand name -- in most of these cities, don't forget, Amy, we already have existing schools so this is just adding more programs.

We may have adult schools already.

We may have POP Kids English schools already and Middle and High School English.

So when we go in to U-Can it's just another offering in our arsenal of programs that students can pick from.

And so that gives us a huge advantage because we already have the mind share of a great number of students who've used New Oriental in the past and so that helps us a lot in going into cities outside of Beijing and Shanghai.

And the competition, not being quite as strong or as large, helps as well so we're very confident when we go into most of our cities.

Beijing and Shanghai we're also very confident because we've been established in English there for -- in Beijing for 17 years and in Shanghai for nine years.

So even though we are not the number-one player in All Subjects, we are the number one player when you count Middle and High School English and All Subjects, which is a fair way to compare, because English is probably the Gaokao.

And so each of these other -- our competitors in these cities have their own specialties, whether it be mathematics or sciences.

And if you add them all together our enrolments outstrip any one of them.

So we will -- we expect to become one of the top two or three players in Beijing and Shanghai, we already are, but climbing all the way to the top in a couple of years.

Great.

So we're battling hard in the two most difficult cities, Beijing and Shanghai, and we think we have a big head start in the other 38 cities.

Great, thanks a lot.

Thank you.

Your next question comes from the line of Brandon Dobell with William Blair & Company.

Please proceed.

Thanks.

Good evening, Louis.

Just a couple of quick ones for you.

Could you frame out how big the Dream Tour is going to be this year versus last year, versus two years ago, just in terms of the number of cities or the length of days, something like that, with respect to how big it is?

Yes.

Two years ago it wasn't that big.

It was about 15 cities.

Last year became a bigger deal.

We hit 30 cities.

This year is very comparable with last year, about 29 cities, and so it's comparable.

But I think the number -- I don't know exact number of attendees because it's -- because we have many teams.

Many of the star teachers will go on different tours.

So Michael's tour this year goes down the coastal cities, so from Beijing down to Guangzhou along the coast.

And then we have other star teachers and other senior management into the middle of China and into the western side of China, so there's a number of tours.

I would say it's comparable to last year but I don't know the exact number of speeches that are given.

But you can imagine in a year it will be several million students will attend these Dream Tour events.

The other thing that Michael was commenting about which was interesting was that in the past, when we did these Dream Tours or we went to schools, we used to have to pay for auditorium space, so we'd have to rent facilities to house all our students.

Now in many cases the schools are giving us the space for free because they want us to come and talk to their kids.

So it just shows you the popularity of the Dream Tour and how schools see the benefits of having their parents and the students learn from New Oriental, basically star teachers and management team members, about the benefits of spending on training for their children.

Right, okay.

Within the Gaokao business any commentary you can give us on how many programs or courses a single kid is going to take?

Is it just one subject, two subjects, three subjects?

I'm trying to get a sense of the -- probably the kind of same-customer growth opportunities you're seeing.

Yes.

We're in a process -- one of the investments we're making is, as I said earlier, is in the IT area.

So we have developed our own customized customer relationship management system.

So we're adding an extra 100 IT staff.

Right now we have one or two IT staff in each of the schools.

We want to improve that, increase that and one of the initiatives is to create this CRM so we can track the students more closely.

Anecdotally, one idea is that the average student takes five classes a year, Brandon.

And the repeat rate within New Oriental I've heard as high as 80% to 90% plus, so they come once, they'll stay and take more classes.

And we would still -- in a year or so we we're going to track that very, very closely.

The other benefit of the CRM system is that when students move their registrations if their families move, that registration will follow them.

It will enable the customer relationship manager to be able to give them much, much better service as well.

But you can tell -- you know us very well.

You know from the brand awareness studies we don't lose that many students.

And I think the average spending is about $500 per year in cities for supplemental training, with a wide band.

Some will spend $100 or $200.

Some will spend tens of thousands per year.

Right.

And I may have missed this, but did you give the number of cities the Kids' business is in right now, or some kind of expectation how that should look in a year or two?

The five to 12 year-old Kids' business is in every city, all 40.

Any sense of how it's skewed towards Beijing, Shanghai, Guangzhou with the majority of the business?

Well, the Kids' business is actually skewed towards Wuhan, because Wuhan is where it started.

(Multiple speakers) Wuhan.

So, yes.

So Wuhan -- but the percentage of Kids in Wuhan is shrinking every year.

It was 22% compared to -- it's right down to 14%, 15% now.

Beijing and Shanghai are taking off and so are all the other cities.

Our enrolment in Kids English two years ago was 150,000 -- sorry, was 200,000.

Last year it was 300,000.

This year is going to be probably 420,000, a 40% increase in enrolments.

And next year we would expect that number to continue to climb somewhere north of 550,000, very close to 600,000 enrolments.

Those enrolments are across the country.

Okay.

So it is a product that is operable everywhere.

It's not like Overseas Test Prep where it only works in the college towns, --

Right.

-- the towns that have a high concentration of higher Tier 1 type universities.

The Middle School, U-Can and the Kids program is universal across China.

And you're still comfortable with how the ASPs look in those Tier 2 cities?

You're still getting enough price there?

Yes.

I think for the larger classes it's within 30% of Beijing and Shanghai.

For the one-on-one classes it's within 50% of Beijing and Shanghai.

But as you know, Brandon, the costs are also lower there.

So the margins are still going to be very, very good.

The ASP was still somewhere at least north of 55% re the one-on-one tutoring.

And the operating -- don't forget, below the gross margin [on this] there's really nothing except marketing.

Got it.

Okay.

So when we -- as soon as we take off the marketing accelerator the margins will be quite high.

Yes, makes sense.

Thanks.

Thank you.

Next question comes from the line of Chenyi Lu with Cowen & Company.

Please proceed.

Thank you.

I have two questions.

The first question is you have talked about the strong growth in the Kids English and also Mid to High School segment.

Can you give us an indication for your Overseas Test Preparation in fiscal year 2011, given that this quarter you see the enrolment growth by 7% and revenue growth by 34%?

So I just want to get a sense of what you see in fiscal 2011 in terms of ASP and also enrolment for the Overseas Test Preparation.

Yes.

I think we would see -- we expect enrolment growth to be somewhere between 8% and 10%, and revenue growth north of 30%.

So it will be --as we always said, Overseas (inaudible) would grow between 30%, 35%, which will be no change for next year.

The drivers will be number of students actually leaving China studying abroad, but also the shift toward more and more students taking the SAT and the total [for it] at a younger age in the [IO].

So I think it's beginning to move less so.

The growth rate for GMAT and GRE will not be as fast as the growth rate for SAT and TOEFL.

So how about your SAT growth for the 2011 for these overseas?

We haven't done it yet but I would expect it to be somewhere -- we're doing budgeting right now.

I would expect -- unless something changes, I would expect it to be north of 20%.

North of 20%, great.

My next question regarding the ASP of -- for the (technical difficulty).

I know the overall ASP growth is about 10%.

Can you give us an indication for ASP growth for Kids English and the Mid to High School segment?

Last quarter, let me find the data.

The Kids English program -- don't forget, this doesn't track exactly because enrolments came in this quarter; some of the students will go into next quarter.

But the Kids English program, the ASPs -- I don't see it here.

The average ASP was $123 for the quarter.

And I don't have the actual growth rate.

I apologize.

It was relatively flat.

It was -- actually, that's right, it's flat for this last quarter.

But don't forget, partly it's because the sessions were shorter than last year, (inaudible) because we have two sessions before Chinese New Year.

So the normal ASP growth for Kids English is 8% to 9%.

But this quarter was anomaly and that's why the ASP was only 10% versus the normal 13% or 14%.

And for Middle and High School blended the ASP growth was over 50%, about 58%.

For U-Can itself the ASP increase was 141%.

I see.

Okay.

That's driven by the shift toward one-to-one classes and one-to-six classes, and VIP.

So you can see the power of the platform for Middle and High School students, and not just English, but the whole variety.

It's just the analogy I've used in the past with investors and analysts is to say, look, we offer all kinds of cars.

You can buy a Hyundai.

You can buy a Buick or a Toyota at the middle end.

You can buy a Mercedes or BMW at the high end.

So we offer the full product and it's up to the students to pick.

Great.

Thank you, Louis.

One more question.

Regarding your sales and marketing, I know you always spend heavily in 4Q to promote for the summer.

I think in the past three years 4Q, basically, the sales and marketing [expand] as the revenue continued to decline.

I just want to give a sense -- get a sense of what you see the sales and marketing expense as the revenue for the 4Q fiscal year 2010, given that you're probably going to spend heavily on U-Can program.

Q4 marketing will increase.

We said about $40m, $41m in marketing.

We still have another $15m in the budget.

And Michael may go slightly above that because there's a push in the U-Can.

And also we want to make sure we have a strong summer.

So I can see marketing being quite high in Q4, to be honest.

Because this quarter your sales and marketing actually are coming slightly below everyone's estimates.

Yes.

Last year we spent $10.3m in sales and marketing in Q4.

So this year I would expect that number to be probably 40% or 50% higher, to $14m or $15m.

Okay, great.

Thank you.

The budget was $56m.

We're at $41m.

So there is some room in there to do it.

And then that means if I take the overall percentage, it's about 13.8% for the year, but then it should come down hopefully in subsequent years.

Okay, great.

Thank you, Louis.

Thank you.

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

Please proceed.

Yes, thank you.

I'm just wanting to talk about your comments concerning spending on IT systems, content development and customer service reps.

Should we expect that spend to be concentrated in any one particular quarter in the first half of fiscal '11, back half?

How should we think about the timing of that spend?

That timing will be gradual over the next 18 months, so a year and a half.

But once you hire these IT people they're permanent, so that will -- they will continue to be there.

The development of the CRM system is targeted for this next 12 months.

So we want to roll it out in the next 12 months and get it -- and be -- roll it out to as many schools as possible.

So as far as the customer relationship management people, it's the same.

It's like a marketing percent.

They will continue to grow.

We want to have 250 of them for U-Can by the end of this fiscal year and we'll probably come in a little bit short, 200 to 230.

And then that will grow depending on the needs and the growth of U-Can, but that will continue to grow as well.

But at the end of the day we have to serve our customers so we have to give them a high level of service.

We have to be able to track them wherever they go and deliver a higher level of service.

On a content management side we have -- we've more than doubled our staff.

I think it's fairly close to 160 who developed content for six to 18 year olds.

Content differentiation and quality is part of what builds the brand, along with teaching quality.

So even though it's a lot of money it's going to pay off dividends in the long run, and it's going to sustain our brand name and our leading position.

Regarding the systems development work that you're planning to do to build a better customer interface, I'm curious whether or not any of that spend or development work actually will be concentrated in your peak enrolment period or your peak delivery period, and whether or not you see any execution risk tied to any of that systems development work.

No.

I think it's a separate group is developing the -- like we're hiring in the next few quarters 100 additional IT people to develop the systems and upgrade our IT systems across the whole country.

So I don't think it will interfere until the implementation stage, which will probably be in -- we'll slowly -- what we typically do is try it in Beijing first and then work out the kinks, and then begin to roll it to Shanghai and other cities gradually.

And over the course of two years we usually get it out to all the cities.

And the timing of the Beijing launch will be when?

I don't have that yet.

We are just in development right now so, like I say, we're going through budgeting now.

So I'll have a clear answer by the end of May.

But the idea is to have it rolled out in most of the schools in the next two years, so the gradual -- spend will continue to grow.

But don't forget, Mark, and when we do this, it serves our customers better.

There's a payout, a payback as far as the customer loyalty, as far as customers taking more classes, as far as helping us to market to them better because we know the whole history and we know what their needs are.

So it's going to pay for itself.

And it creates a huge barrier to entry for anybody who wants to enter this space, who wants to go nationwide.

Understood.

And one last follow-up question and I'll turn it over, regarding stock-based comps.

They've been a little bit higher than we modeled, even if we took [the clear comps] and lower forfeitures.

I'm curious as you look to Q4 and fiscal '11 what we should be looking at for stock-based comps now.

Right now -- that's a good question.

Stock-based comps shocked me too, because the lawyer came in and told us we had to take down the forfeiture rate again based on the -- Michael's not getting people to leave yet.

So we are lower on a forfeiture -- our forward rate keeps going down which means our stock-based comps keep going up.

Q4, the stock-based comp will definitely come down because the '07 options are done with.

They finished on -- they expired on February 28 at end of the quarter.

So, as I said to you guys earlier, in Q4 you'll begin to see a noticeable decline in stock-based comp.

But Q1 we expect to issue the annual set of options.

We haven't issued any options yet this year, so -- or stock-based comps.

So that will -- it'll jump back up probably in Q2.

Q1 will still be better than Q4.

It'll go down.

And then Q2 will begin to rise again.

But I would expect Q4, if I -- when I map it out, it looks like about $3.2m in stock-based comp, so a $1.7m drop.

And then Q1 right now, it's under $2m, because a lot of options expire in Q1.

But there'll be a new group to replenish those.

But as a percent of revenue every year stock-based comp should begin to decline, unless we begin to be very, very generous with stock-based comp.

Ladies and gentlemen, this concludes our Q&A session.

This is all the time that we have for today.

Thank you for your participation.

I would like to turn the call over to Mr.

Louis Hsieh.

Please proceed.

I just want to say thank you to everyone who participated on the call.

And Michael and I and all at New Oriental, we really appreciate you guys' continued support.

And see you guys at future conferences.

Thank you and have a good day.

Thank you for your participation in today's conference.

This concludes our presentation.

You may now disconnect.

Have a great day.