New Oriental Education & Technology Group Inc (EDU) 2010 Q4 法說會逐字稿

Good evening, and thank you for standing by for New Oriental's fourth fiscal quarter 2010 earnings conference call.

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

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

Today's conference is being recorded.

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

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

Hello, everyone, and welcome to New Oriental's fourth fiscal quarter 2010 earnings conference call.

Our fourth 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 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, everyone, and thanks for being with us today.

I will start by taking you through the quarterly and yearly highlights, and then move into financial results.

After that, we will finish with some Q&A.

As many of you are aware, Q4 is seasonally a slower quarter for us, as students look to year-end examinations.

Nonetheless, we reported continued strong revenue growth, and even stronger bottom line growth for the quarter, being the high end of our guidance.

As we mentioned last quarter, since Chinese New Year was relatively late this year, the vast majority of student enrolment for spring courses, which is our Q4, were logged in the quarter, which boosted quarterly enrolments, compared to past years where a significant portion of the spring quarter pre-enrolments occurred in the winter, or Q3, period.

Overall, enrolments across the businesses in the fourth quarter were very healthy, increasing more than 32% year-over-year to 437,000.

The blended average selling price increased about 13% year-over-year to about $235.

Full year results were also outstanding, especially given the disruption caused by the H1N1 flu outbreak last summer and fall, and the ongoing impact of the global financial crisis.

Total student enrolments for the year increased 19% to approximately 1.8 million, driving top line growth of 32% to $386 million, exceeding our 25% to 30% revenue growth target for fiscal year 2010.

Driving growth this quarter were our three key business segments.

Let me take you through some highlights for each of these.

POP Kids English continued to be a top performer, with enrolment growing more than 50% in the fourth quarter, and quarterly revenue growth at 43%.

Full fiscal year enrolments for POP Kids was over 40% to a total of more than 434,000 enrolments, with year-on-year revenues up over 44% to approximately $50 million.

As many of you know, one of the reasons POP Kids is so successful is parents trust New Oriental to begin their often single son or daughter on the right education path from an early age, giving them the best possible educational experience, and helping them attain the skills they need to succeed throughout their education careers.

On the back of our success with POP Kids English program, and with the continued high demand for early childhood education options, the first of our two large scale initiatives for fiscal year 2011 is to expand our offering for kids ages six to 12 with the addition of Kids Math and Kids Chinese Writing classes under the POP Kids brand.

With the widening growing base of POP Kids students, we expect these new offerings to be a natural next step for parents looking to start their kids off on the right track.

We've actually been piloting the program in several cities, and feedback in demand so far has been extremely positive, so we're looking forward to rolling this out across our entire nationwide network in fiscal year 2011.

Another significant growth driver, non-English U-Can courses for middle and High school students, also outperformed over the quarter.

Enrolments in Q4 were up [150%] to 36,800, making a total of approximately 120,000 enrolments for fiscal year 2010, well above our target of 80,000 to 90,000.

The non-English U-Can revenue in the quarter grew more than 200%, bringing us to $34 million for the full fiscal year, significantly higher than our $25 million target.

The success we've seen with U-Can since its launch in 2008 underlines the strength of the New Oriental brand and the trust that our students and their families have in our course offering.

It also demonstrates our ability to serve as a more robust and versatile education partner for our large student base, meaning a student can come to us for English language training and decide to stay for other subjects; Test Preparation training as well.

As at the end of fiscal year 2010, U-Can has been deployed across 39 of our 40 cities, or schools, forming a central part of our nationwide offering.

As U-Can continues to attract new enrolments in cities throughout the country, we recognize the need to enhance our systems to add additional value to our hundreds of thousands of students taking advantage of this program, so in fiscal year 2011, as a second large scale initiative, we will be launching a new proprietary learning system for U-Can English and non-English High School and Middle School students.

The system focuses on skills assessment, development, test preparation and improvement, and will serve as a quantitative measure of students' progress over time, while also giving us a useful tool to assess our students' needs and provide targeted support where it's best applied.

We believe this is the most comprehensive and scientific assessment system covering all subjects through each level of Middle School and High School in China.

With the addition of POP Kids Math and Chinese Writing and the U-Can Middle and High School learning system, we believe that we will present the most comprehensive highest quality learning and test preparation system for Chinese students aged six to 18 to complement their formal public school programs.

Thus, we fully become a true one-stop-shop for Chinese students as we look at afterschool, weekend, and summer/winter holiday academic subject training and test preparation programs for their child or children.

Finally, Overseas Test Prep, the other major driver this quarter, saw a 25% increase in enrolment and a 40% increase in revenues for the quarter.

For the full fiscal year 2010, enrolments grew 12% to over 256,000, and revenues grew about 32% to approximately $107 million.

In addition to these main growth drivers, our other business segments have been progressing well, thanks to continued smooth execution.

Koolearn, our online education offering, recorded over a 90% revenue increase this year, and now has over 6 million registered users; and revenue from our Overseas and [Talking] business grew more than 50% over the same period.

Our overall contributions into these segments are small.

They continue to grow healthily, and we believe serve an important offering outside of our core growth segments to meet the diverse needs of our students.

During the full fiscal year 2010, programs for six year old to 18 year old students became the largest portion of our business, generating over $115 million of revenue.

We are targeting over 1 million enrolments in programs for six year olds to 18 year olds in fiscal year 2011, up from 790,000 in 2010, driven by our ongoing success of our POP Kids and U-Can all-subject training for Middle and High School students, and a new math and Chinese writing initiative.

Combined with the over 1 million adult enrolments we are expecting in the same period, we are targeting a total of well over 2 million enrolments for fiscal 2011.

In fact, we estimate that we will surpass the 10 million cumulative student enrolment milestone by the end of this calendar year, 2010, demonstrating once again the strength of our brand and the trust that Chinese families place in our high quality education programs and instruction.

I'd like to take you through some of the things we're going to do to drive the expansion of our network and achieve our ambitious growth targets.

In Q4 2010, we added a net of 43 new learning centers, bringing us to a total of 367 at fiscal year-end, 97 more than we had at the end of fiscal year 2009, and exceeding our expected net adds of 70, showing us -- allowing us to better penetrate existing key cities throughout our network.

In fiscal 2011, we plan to ramp-up expansion by adding another 100 learning centers in existing cities and entering into two to four new cities.

Expanding our network allows us to capitalize on increasing demand for high quality education all over China, particularly in the fast growing tier 2 and tier 3 cities.

Moreover, our hub and spoke business model allows us to leverage our on the ground network of teachers and administrators to measure demand nationwide, identify the best areas to grow, and scale our business quickly and effectively where we can see new opportunities.

Those of you who have been following us for a while will know that central to our success is the quality of our teachers and administrative staff, and so as we grow, we continue to make recruitment a major focus.

In fiscal year 2010, we employed a total of 5,400 new staff, over half of which are teachers, bringing total headcount to approximately 16,000.

Another important element of our expansion plan is the investment we are making in upgrade our IT infrastructure and implement a completely new customer relationship management system, or CRM system, which will allow us to improve our customer service and business management.

We expect to invest about $3 million to $4 million in IT upgrades and this new CRM system over the next two years.

The new CRM system will give us an important set of tools, which will let us tailor new products and focus existing offerings based on student needs, ultimately serving our student center.

And we firmly believe that investing in better systems and infrastructure is essential if we want to continue delivering strong top line growth of 25% to 30%, although at the same time, we will continue to pay close attention to cost control.

We are targeting profit growth of 25% or higher in this new fiscal year, notwithstanding our aggressive expansion plans.

Looking into Q1 and fiscal year 2011, we have every reason to be confident.

Our brand continues to be the most trusted in our markets, with more and more students of all ages coming to us for help in their personal development.

We have overcome some large obstacles in the past year, not least among which is the H1N1 and the global economic challenges, and emerged a stronger business, and education has never been more important in China.

As the economy grows, we fully expect it to remain a priority for families who want to see their child or children get ahead in this very competitive market.

New Oriental continues to provide these ambitious students with quality education to help them achieve their goals.

Now let me take you through the financials.

For the fourth fiscal quarter of 2010, New Oriental reported net revenue of 86.6 million, representing a 45.7% increase year-over-year.

Net revenues from educational programs and services for the fourth fiscal quarter were 74.3 million, representing a 44.7% increase year-over-year.

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

Total student enrollments in language training and test preparation courses in the fourth quarter of fiscal year 2010 increased by 32.4% year-over-year to 437,200 from approximately 330,200 in the same period of the prior fiscal year.

Operating costs and expenses for the quarter of $82.9 million is a 45.7% increase year-over-year.

Non-GAAP operating costs and expenses, which exclude share based compensation expenses for the quarter was $79.9 million, a 51.9% increase year-over-year.

Costs of revenues for the quarter increased by 41.1% year-over-year to $36.4 million, primarily due to the increased number of courses and the greater number of schools and learning centers in operation.

Selling and marketing expenses in the quarter increased by 69.4% year-over-year to $17.4 million.

As we mentioned previously, this is primarily due to brand promotion expenses, especially in relatively new programs such as the U-Can all-subjects training program, which has been successfully rolled out throughout the entire network of 39 cities.

This program allows us to target higher revenue opportunities in the future, and gives us better penetration in cities, and we expect the relatively high level of sales and marketing expenses as a percent of revenue to come down in the coming two years.

General and administrative expenses for the quarter increased by 39.7% year-over-year to $29.2 million.

Non-GAAP general and administrative expenses, which exclude share-based compensation, was $26 million, a 56.2% increase year-over-year, primarily due to increased headcount as the Company expanded its network of schools and learning centers.

Total share-based compensation expense, which were allocated to related operating costs and expenses, decreased by 27.2% to $3.3 million in the fourth quarter from $4.5 million in the same period of the prior fiscal year.

Income from operations for the quarter was $3.7 million, a 46.3% increase from $2.5 million in the same period of the prior fiscal year.

Non- GAAP revenue from operations for the quarter was $6.9 million, a 0.9% decrease from $7.0 million in the same period of the prior fiscal year.

Operating margin for the quarter was 4.2%, the same as last year.

Non-GAAP operating margin, which excludes share-based compensation in the quarter was 8%, compared to 11.7% in the same period of the prior fiscal year.

Net income attributable to New Oriental for the quarter was $5.8 million, representing a 118.7% increase in the same period of the prior fiscal year.

Basic and diluted net income per ADS attributable to New Oriental were $0.15 and $0.15 respectively.

Non-GAAP net income attributable to New Oriental for the quarter was $9 million, representing a 26.9% increase for the same period of the prior fiscal year.

Non-GAAP basic and diluted net income per ADS attributable to New Oriental were $0.24 and $0.23, respectively.

Capital expenditures for the quarter were $6.4 million, primarily used to add a net of 43 new learning centers.

As of May 31, 2010, New Oriental had cash and cash equivalents of $281.1 million as compared to $250.8 million as of February 28, 2010.

In addition, the Company had $137.9 million in term deposits at the end of the quarter.

Net operating cash flow for the fourth quarter of fiscal year 2010 was approximately $48.2 million.

The deferred revenue balance, which is cash collected from registered students for courses and recognized proportionally as revenue as the instructions are delivered, at the end of the fourth quarter of fiscal year 2010 was $107.1 million, an increase of 43.2% compared to $74.8 million at the end of the fourth fiscal quarter 2009.

Before giving guidance on the fourth quarter, I would like to take a look at the comparisons between fiscal year 2010 and fiscal year 2009.

For the fiscal year ending May 31, 2010, New Oriental reported net revenues of $386.3 million, a 32.0% increase year-over-year.

Net revenue from educational programs and services for the fiscal year ending May 31, 2010, was $352.9 million, representing a 32.5% 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 for the fiscal year ending May 31, 2010, increased by 19.0% to 1,807,700 from approximately 1,519,500 in the fiscal year ending May 31, 2009.

Let me repeat that.

This year, we had 1,807,700; last year 1,519,500.

Income from operations for the fiscal year ending May 31, 2010, was $77.3 million, a 26.9% increase year-over-year.

Non-GAAP income from operations for the fiscal year was $93.5 million, a 20.4% increase year-over-year.

Operating margin in the fiscal year ended May 31, 2010 was 20 %, compared to 20.8% for the fiscal year ending May 31, 2009.

Non-GAAP operating margin for the fiscal year ended May 31, 2010 was 24.2%, compared to 25.5% for the fiscal year ended May 31, 2009.

Net income attributable to New Oriental in the fiscal year ended May 31, 2010, was $77.8 million, representing a 27.5% increase year-over-year.

Basic and diluted net income per ADS attributable to New Oriental for the fiscal year ending May 31, 2010 was $2.06 and $2.01 respectively.

Non-GAAP net income attributable to New Oriental for the fiscal year ending May 31, 2010, was US$94.0 million, a 20.8% increase year-over-year.

Non-GAAP basic and diluted net income per ADS attributable to New Oriental for the fiscal year ending May 31 was US$2.49 and US$2.43 respectively.

Moving on to revenue guidance; I would like to note that here, that because Chinese New Year was relatively late this year taking place on February 14, the winter break was a little longer than usual and the summer break consequently shorter by a week or more in most provinces this year.

In addition, the recent massive flooding in South and Central China has made it difficult for many of our students in the affected areas to register for and attend New Oriental classes.

These are likely to have a negative impact on our Q1 2011 revenues and profitability.

Now notwithstanding these challenges, we expect total net revenue in the first quarter of fiscal year 2011 from June 1, 2010, to August 31, 2010, to be in the range of $188.2 million to $197.2 million, representing a year-over-year growth in the range of 26% to 32%, respectively.

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

Once again, thank you for participating in our quarterly earnings call, and at this point, I will take your questions.

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

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

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

Hello.

Philip Wan speaking.

Thank you for taking my question, and now first of all, congrats on a very strong quarter.

Thank you, Philip.

I have a question -- sure.

I have a question on your U-Can program.

Could you share with us what's your expectation in terms of enrollment and ASP growth for this year?

And also, how does the growth rate compare (inaudible), like older cities like Beijing and Shanghai versus the new cities that you have penetrated into in recent years?

And what are the revenue contributions for Beijing and Shanghai?

Okay, those are good questions.

The last one first.

Beijing and Shanghai is approximately one third, maybe a little bit more than one third of revenues for U-Can currently.

The whole country's growing very, very fast in U-Can.

As you know, we booked 57,000 enrollments to over 120,000 in one year.

Revenue basically more than tripled, so our ASP went from about $135 to $280 -- sorry, $110 to $282 in the last fiscal year, and that's driven by the move towards smaller classes.

As far as forecasts for 2011, you would expect the enrollments to grow in the range of 40% to 50% to about 170,000 U-Can, and then you add that on to the English enrollments.

We expect 12 year old to 18 year old enrollments to be pushing very close to 0.5 million students, and so the revenue should grow probably faster than the enrollments.

Revenue should go up at least 50% for the U-Can segment.

So we would expect somewhere north of $50 million in the U-Can non-English.

If you're adding English together, this number will be much higher.

It's really the same students, right?

So that will be the same 12 year old to 18 year old students.

So the enrollments -- that's the whole beauty of the cross sell, and that's why we'll do the same thing for children -- the POP Kids, 6 year olds to 12 year olds, and add in Math and Chinese, the other two subjects that parents want.

Just to clarify, you said $50 million for non-English U-Can for next year?

Yes.

And mainly driven by annual enrollments, right?

It could be both.

It will be the continuation of ASP increases, as well as the increase in enrollment, as well as the shift towards to smaller one-on-one and one-to-six classes.

So all three will have a -- will play a role.

Okay, thank you.

Thank you, Philip

Your next question comes from the line of Chenyi Lu of Cowan and Company.

Hi, good morning.

I have a question regarding these new programs for POP Kids, Math and also for Chinese Writing.

Can you give us here what revenue view and enrollment view currently you have for next year?

Yes, I think this year will be similar to what U-Can did two years ago.

It's the pilot year, so we're going to begin to roll it out.

The truth is, we'll actually begin to roll out more seriously in the winter quarter.

So this is a second half of 2011 exercise, although we are piloting it now in Beijing and Wuhan and in Shanghai and some other cities.

We'll begin to roll out in the winter quarter.

So I wouldn't expect a large contribution, maybe 15,000 to 20,000 enrollments in non-English for POPs, but that number will accelerate dramatically in the -- if it's successful, the year after, similar to what U-Can did.

So basically, you're going to select a few major cities to roll first, and then you [poll] and get pretty good receptions, and then you're going to roll it out across the country?

We expect to roll out across the country in the second half of this year.

The reason is that we have our hands full with U-Can new learning system, and so it's hard for us to do two major rollouts exactly at the same time, even though it's different age groups.

It's just our management resources are really stretched.

We're trying to add 100 learning centers.

There's too much going on.

So we are -- it is proving to be very successful in Beijing, Shanghai, Wuhan and other cities, and so we fully expect to roll it out in 20 to 30 cities by the end of this fiscal year.

But because it's more of a second half event, it won't have as big a revenue contribution as if it was started this quarter, let's say.

And then can you just give us what ASP you have in mind?

The ASP will be about the same as for POP Kids, which is about $110/$120 a class.

Okay, great.

Thank you.

So if you it's 20,000 times $120 you get at least several million dollars, but it's not as big an impact as U-Can.

But we expect that program to grow very quickly.

Yes.

Well, we've seen the momentum that U-Can, right, in the beginning was really small, and then --

Exactly, exactly the same track.

It doesn't have as big a potential as U-Can because the ASPs in U-Can are much higher.

Right, right; agreed, agreed.

Because U-Can generally, you can offer more multiple subjects.

In this case you only have Math and the Chinese Writing, so --

Exactly, you're limited to three subjects; you're limited to 25 students per class.

But don't forget, this is all a strategy, right, for New Oriental.

If we get the children between six years and 12 years and we offer them quality, top quality programs and services, we're their natural choice when they turn 13 and they move forward to 13, and they move into the U-Can program.

So it's a feeder program for us, and so it's our way of keeping those students from age six all the way to 25 in the New Oriental system.

Remember, I re-emphasize again to our investors really, it's the one-stop shop; it's the recurring revenue model, and it goes right toward our goal to be the trusted education partner for Chinese families for their children between ages six and into their 20s.

And it makes sense because you already offer classes from 12 years to 18 years.

It's very easy to offer for six to 12.

Exactly, and it also leverages the same teachers.

We're not going to add that many new teachers in POP Kids because most POP Kids English teachers can actually teach first grade Math, etc.

So it really leverages the infrastructure we already have in the POP Kids English centers, so it's a natural extension that we've been planning for a couple of years now.

Okay, great.

Thank you.

Your next question comes from the line of Marisa Ho from Credit Suisse.

Hello, Louis.

Hey.

Good evening, Marisa.

Hi, how are you?

I want to better understand your revenue comparison dynamics on the q-on-q basis going into FY '11.

You just mentioned that because of the floods and also some of the other difficulties, you're expecting these to have somewhat of an impact on the first quarter, and that's probably one reason why you're guiding towards relatively conservative revenue numbers in the first quarter.

But as you move into the second half of FY '11, you're probably running into a proper comparison base as well, because you've been doing so well in the second half of FY '10.

So if I look at the full year, does it mean that you're probably looking at a revenue growth range more towards the high end of the 25% to 27% range rather than over 30% for the full year?

Would that be (multiple voices)?

Well, what I really think -- yes, I think what's going to happen will be if we are successful in rolling out 100 learning centers throughout the year, which means that our business is good, we should be at the top of that range of 25% to 30%.

Right.

And during the summer, don't forget, we have the benefit of an easier comparison because of H1N1 last year.

That's what offset the floods and the other -- the floods and the shorter summer quarter.

There's two other things I didn't mention.

There are also negative headwinds.

They're smaller, like the World Expo, right?.

Many of these Chinese students who are 12 years to 18 years old are supposed to be studying this summer but they're learning a different way.

They're going to Expo to learn about the different cultures around the world, which is a very useful educational experience, so they've been slow to register for classes this summer.

And the other thing which cracks me up is a lot of students waited to register for summer classes because they wanted to watch the World Cup.

So we had a slow start to June, and then the last three weeks, we have had the three best weeks in the history of New Oriental in registration in revenues.

So it was a slow start but it's beginning to pick up, and the reasons we heard were World Cup, Expo, floods, and I think we did calculate that the summer's actually shorter than last year, so that would maybe impact our revenue as well.

But the underlying demand is still very, very, very strong, so we expect to be in that 26% to 32% range.

And when you're talking about the profit guidance maybe at being at least 25% year-on-year growth in FY '11, you're taking quite a bit of margin reduction to get a 30% plus top line growth to 25% bottom line growth.

Yes, and that -- we tried to highlight in this, Marisa, that we are trying to build -- we don't care about one year.

We care about five years, 10 years, 20 years from now.

So we're trying to build the systems and put in new contacts and this new learning system that'll give us competitive advantage for years to come.

So we're not worried about each year.

I keep telling investors that every time I meet them.

If you want to buy New Oriental stock for one quarter or two quarters, don't bother.

This management team is building this Company to last for a long period of time, and so we need this in IT infrastructure in order to grow into 50 cities or 60 cities.

We need that upgrade.

The CRM system will let us serve better our students.

This new system we've been working on for a new year now, the content that -- much of it's computerized, that will help assess a student's skills between 12 years and 18 years in a specific subject, identify weak points, set up a program to help that student improve on those subject areas, and really test their mastery of each of the subjects.

That kind of system doesn't exist in China right now.

So we think we have the best preparatory system out there for 12 year to 18 year old learning, and we're going to roll it out starting this quarter.

And I think it will be (inaudible) so there'll be more within China this week.

If I can just ask one more question before I go, and you've bought this new computerized content system, is the investment mainly in the form of OpEx or CapEx?

It's mainly in the -- well, it's headcount and CapEx.

So if you think about it, our CapEx last year was $19.9 million.

This year, we expect to be $26 million to $28 million, so it's a net increase of $6 million to $8 million.

That's funding the 100 learning centers but it's also for the -- $3 million to $4 million is for the IT and CRM systems, and those are necessary in order for us to deliver this computerized system for 12 year olds to 18 year olds in a very effective and timely manner.

So this whole upgrade is all part of the same exercise in delivering an unparalleled experience and -- education experience for kids 12 to 18.

There's nothing else like that we believe in China right now.

Excellent.

Thank you so much.

Thank you, Marisa.

Your next question comes from the line of Ingrid Yin of Brean Murray.

Good evening, Sisi and Luis.

Hello, Ingrid.

Congratulations on a great quarter.

Thank you for taking my question.

So my first one will be on the fiscal year 2011 guidance.

So you've guided about 25% to 30%, similar with what you do every year.

How much do you think it will come from enrollment and how much it will be from mainly the ASP growth?

I think it'll be about half and half, so I think it'll probably be 15% enrollment increases and probably 15% or so from blended price increases.

Most of our price increases will be due to smaller class sizes.

Direct price increases are probably the same; 6% to 8% or so.

Yes, so you just mentioned we're going to grow a kids program this year and really growing the Company as a long term horizon.

So what will be after U-Can and the kids program?

This is the focus for the next two or three years.

This is what we said last year.

We said for the next two or three years, we're going to focus on six year olds to 18 year olds.

So there is nothing we expect to roll out new in 2012 for now.

So this is it.

So if we get it to roll out successfully -- I know I say this every year, but if we get this rollout successfully, then 2012, there shouldn't be any new large scale marketing initiatives that we need to do.

Marketing will still, we believe, will -- in our budget it's scheduled to decrease.

As a percent of (inaudible) is all time high at 15%.

It should be somewhere between 13% and 14% for fiscal year 2011, and it should go down from there.

Yes, we should expect operating margin to go up from -- starting 2011 or after that?

Yes, well, probably not early because of the expenditures we're going to spend on the IT side, so it's going to be more infrastructure additions.

In addition, because we're rolling out 100 learning centers, right, we need to add another 4,000 to 5,000 people, and that's what happened this year where we added 5,000 people ahead of the demand.

And that's the same thing we'll do again this year.

We'll get another 4,000 to 5,000 people, half of which are teachers, but they aren't fully deployed.

They're trained and they're in there, but they're fully deployed.

so they're not -- we're not able to leverage them the way we'd like to.

Okay.

If we look at U-Can together, not English together, how much did they contribute to the total revenue?

Together they were about almost $60 million; I would say more than that, sorry.

More than $60 million -- almost $70 million.

We've got about 386,000 enrollments for fiscal year 2010.

So if they increase 25%/30% we will be very close to 0.5 million enrollment in U-Can.

Kids is 434,000 this year.

We expect that to increase about 35%/40%, so that will be probably over 600,000, which means combined, it will be 1.1 million enrollments for six year olds to 18 year olds.

That with the 1 million adult enrollments we expect this year, we should be round about 2.1 million enrollments, 2.05 million to 2.1 million enrollments.

Okay, great.

Thank you for that.

Right.

And then the other flip of that is that we're -- at the end of this calendar year, we'll hit -- we should hit 10 million cumulative enrollments since New Oriental was established in 1993, and then by fiscal year 2011, that should hit 11 million.

So we're really ramping up here.

Wonderful.

Thank you.

Thank you.

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

Hi, Louis.

I just wanted to touch on your comments regarding operating margins in fiscal '11.

What, to what degree, and perhaps if you could bracket it for us, to what degree should we see operating margin compression in fiscal '11 versus '10?

Well, I think it's what we try to do is -- it's hard for me to answer that, Mark, because what we try to do is we typically outgrow on revenues, right?

So we've got [equivalent of] (inaudible)%, but we've gone 41%, 35% and 32% over three years.

So our goal is to grow earnings 25% or more, and that's what we said in the earnings release, but because -- so we will see --.

If we do get margin compression, we should see gross margins stable, similar to what they are; 61%/62% or so.

Grow our operating margins; because of the investments we're making this year, I don't expect it to fall more than 1 percentage point, if that.

And so --

But a lot of it depends on revenue growth.

Like if we outgrow on the revenue side and the EPS side, we'll be very healthy.

Right.

And then tied to that then, if you look at these incremental spending initiatives, the new learning system and the IT upgrades, the RM system, I know you said 3 million to 4 million IT upgrades, is that entirely expensed?

That will -- well, the Kids system will be expensed over three years -- will be capitalized over three years, three or four years over time.

But we're adding over 100 IT personnel, Mark, and those are permanent, right?

So these are people that maintain the system, help develop and maintain it, and this is across a -- it's soon to be 480, or 470 learning center networks.

Right, right.

They'll be permanent hires, right?

If we strip out the incremental costs tied to the new learning system and the CRM system for fiscal '11, I'm trying to get at in my mind what the organic operating margin expansion might be.

Well, if you've got $4 million, you can look at -- you're looking about --.

And if you strip out to a more realistic -- I mean, we should grow 70, 80 learning centers a year.

We're aggressively growing because of the strong demand, right?

And so I think it's that -- and the new rollout of the content.

I think normally, we should grow toward that -- right now we're 20%.

We should grow about 23%/24%, Mark, over several years, but we're just not going to stop rolling out new initiatives until there's nothing else that we think that we can do that's worthwhile.

And we may reach that point next year, so -- but we don't know.

There's all these new things.

We want to be dynamic.

We want to change where the market changes, and so if we think we can have a very profitable business in a new area, we'll go there.

Right, right.

I guess what I'm trying to get at, Louis, is that you're saying operating margins may be down a percentage point in fiscal '11 year-over-year, but if we stripped out the incremental spending initiatives this year and looked at organic operating margin expansion --

Well, they should go up, right?

Because the market isn't going to go down next year.

Yes, but I'm just trying to quantify what perhaps that might be.

So if you've got 4 million --

Well, it's what I've always been saying; it should be 100 basis points/150 basis points, but improving each year.

If we don't have new initiatives which are, of course -- I'm the bean counter and Michael's the strategic big picture thinker, right?

So he looks at new opportunities and they look great to us, and so far, he has been right most of the time.

So like U-Can was worth going after.

We believe Kids' Math and Chinese is worth going after, and so we're going to do it.

And in fairness, who knows in fiscal '12 what you'll be looking at in terms of new initiatives?

But what I wanted to make sure you guys understood it that we're committed to trying to grow the bottom line at least 25%, and the top line should grow better than it would --.

If you look at the top line, well over 30%, then the bottom line will also go up well over 25%.

Right.

And then my last --

So, you know --?

My last question, and I'll turn it over.

You mentioned 100 new learning centers in this coming year with a tier 2 to tier 3 focus is what I thought you said.

Maybe give us a sense of what proportion of the 100 will be in tier 2/tier 3 and then look at what that same percentage was in fiscal '10.

Trying to get a sense of --

I think the numbers that are going in tier 2 and tier 3 is increasing.

If you look at the map, Beijing, Shanghai and some of the other cities only added a net of 10/12/13 learning centers, right?

The other 80/85 are in what they call tier 2 cities.

Similar year as last year.

Similar this year, right?

So we would expect probably another 10 or 15 learning centers in the top two or three cities, but then the majority of them will be tier 2 cities.

Got it.

Okay, I'll turn it over.

Thank you.

Thank you, Mark.

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

Great.

Thank you for taking my question.

I had a couple, actually.

So one was with regard to the Overseas Test Prep business.

It looked like the enrollment growth was the softest seen in a couple of years.

Is that just because you had a relatively easy comp from the fourth quarter fiscal '09, or is there anything else that's happening in Overseas Test Prep that's --?

No, that is correct, James.

As I said, the Chinese New Year was late this year and it was early last year.

What happened was that this year, we didn't -- we had easier comparisons.

We only had 8% enrollment growth last year at this time, so this is just -- it should be steady 12%, 30%; 12% enrollment growth, 30% revenue growth for us, so it was an easy comparison, right?

Right.

And then for the Kids' Math and Kids' Chinese Writing courses, am I right in thinking those are general training courses rather than test prep?

And when you look at your business as a whole, is there a notable margin difference between general training courses and Test Prep?

I guess Overseas Test Prep is high margin, but Domestic Test Prep's lower margin.

Domestic test prep is lower margin.

For kids six to 12, we're not trying to emphasize test preparation obviously, so this is general learning, and that's the way we're moving toward U-Can as well.

And we're not trying to, say, just prepare for the gaokao.

You can't tell a 12 year old kid to prepare for the gaokao, right, which he's not going to take for six years.

So what we're trying to emphasize is just mastery of key academic subjects like physics and chemistry, biology, by year.

So we're trying to teach, and then as they get closer to their senior year in high school, then we'll begin emphasize the Test Prep aspect as well, so the courses are geared that way.

As far as the margins go, well, the Kids will always have a lower margin because of the size.

You can't have more than 25 people per class.

The ASP is lower at about $110/$120, versus with U-Can, you can have as many as 60/80 students per class, and the ASP is over $200.

Okay, that's great.

Thank you.

Okay, great.

Thank you, James.

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

Baird.

Hi.

Thanks for taking my question.

Louis, if you can just talk a little bit within the U-Can business, obviously, the strength that you've had there is attracting some competition and I think forcing you to market a bit more aggressively.

At what point do you think your land grab strategy and brand establishment will beat those pressures?

And do you have evidence that that strategy is working outside of Beijing and Shanghai against the two current dominant players?

I think out -- can you repeat that last part, Amy?

You mean outside of Beijing and Shanghai against the two dominant players?

Or --

Correct.

-- within Beijing and Shanghai against the dominant players?

Outside.

Well, outside Beijing and Shanghai, we are probably the dominant player, right?

So any new city we go into, we quickly will become the largest in six year old to 18 year old training.

We already are today across the country.

We are already the largest.

As far as enrollment goes and our revenues, as far as we know, we are the largest by far in six year olds to 18 year olds in all of China.

Okay.

So I think [strategies] are clearly working.

We've 790,000 enrollments going to over 1 million this year.

There's no one even close to 1 million enrollments in China, so we're already the largest.

As far as the marketing spending goes, don't forget this marketing spending -- we're spending about 15% of our revenue, which is much, much less than most of our competitors.

Most of them spend between 20% and 60% of the revenues on marketing.

So we do have to spend to keep up, let's say, and to roll out new programs.

But after a while, as you said, the marketing spending [abates] because you don't get the same bang for the buck.

So I think as over time that number goes out.

And the example of that is like Adult English and Overseas Test Prep.

We don't always spend -- we spend well less than 10% of our revenue on marketing in both Overseas Test Prep and in Adult English and Domestic Test Prep.

So as the program where all your percentage of revenue on marketing goes way down.

We expect the same thing will happen with Kids in middle school over time.

Great.

Can I just sneak one more in?

It's a small one.

But if we look at the impact of both inflation and having to pay up for your teachers, what confidence do you have that you'll be able to -- that your pricing increases will be able to outpace salary increases as we had end of fiscal 2011, especially given that you held pricing for some of the larger classes last year given the environment?

I think our pricing went up 13.1% for the quarter.

Inflation was not very high in China.

I think our biggest issue is wage inflation, and wage inflation in the bigger tier 1 cities like Beijing and Shanghai went up about 8% for the year.

We only raise salaries once a year so that's done for the year.

Okay, great.

So we're pretty confident that we can still raise prices above what we're -- the price increases in Beijing and Shanghai were much higher than 8% on an organic basis, so we're [able to] raise prices still above what our costs are going up, the direct costs.

Perfect.

Thank you.

Thank you.

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

Hey, Louis.

Hey, Brandon.

Hi.

Following on Amy's question about pricing, and you may have heard this earlier, and if you did, I apologize, but as you extend in these Tier 2 cities, especially in Kids, can you talk to us about the pricing differentials of those programs versus Beijing and Shanghai?

And what do you expect on a go-forward basis your ability to raise price in the Tier 2 cities will look like compared to what you've been doing in Beijing and Shanghai?

I think they will attract Beijing and Shanghai over time.

Currently, for one-on-one classes, the price is about half of what Beijing and Shanghai are.

The larger classes of, let's say 15 students or more, it's about 65% to 75% of what Beijing and Shanghai are, so there is a slight decrease.

But don't forget, the costs are so much lower in these cities.

The teacher's salaries are lower, the rent's lower, so the operating margins in most of these cities after a school's been around for six to eight years is still north of 25%.

So I think over time, if these are developed where they are very similar to Beijing and Shanghai were five years ago.

So basically as they grow and develop, the parents see the same thing; they see a need to get their children ahead by spending money on education, and as they get wealthier, they're willing to do so.

So, yes, we've seen this with Wuhan, with Guangzhou.

We're seeing it now with [Changsha], we're seeing it with Tianjin.

So many of these cities are developing quickly.

We're likely -- we'll call it tier 2 cities, the profit margins for us in these cities is going up every single year.

We expect the same to continue.

And as well as in Xi'an, some of the -- [Shenzhen], the profit margins are going up year-over-year.

Got it, okay.

And with this numbers of centers, previous fiscal, your current fiscal you're going into, are you at all concerned with your ability to find the right people to manage?

That's a lot of new --?

That is a concern, and that's always been a concern for us, and that's why I personally believe 100 learning centers is too fast.

So I've always been a proponent of about 70 learning centers.

I mean, last year, we had a net add of 5,400 people, 2,900 teachers.

I think it's hard to hire and train 2,900 top quality teachers in addition to the teachers you lose.

So you've got to hire about 4,000 teachers.

So it's a very daunting task, and that is what I do worry about.

And I think many of the senior management, same thing; is our ability to continuously find top quality teachers.

We don't -- our brand name is tied to the quality of our teachers and the quality of our materials, so that is an issue.

That's always the biggest issue for us.

So as we think about the timing with the 70/80/90 or 100 centers (inaudible) -- historically, you guys have started to concentrate the opening in advance of the summer session just to maximize the opportunity.

Should we expect that same kind of [distributable] trend this year as well, that -- you know?

Yes, I think you'll see Q4 higher, Q1 lower as far as net adds; Q2 higher, Q3 lower, and the same again.

Q2 and Q4 are a little bit slower, so there'll be time to add centers in advance of the two busiest seasons.

Okay, and then just a couple of housekeeping ones.

What do you think about stock based comp and tax rate versus 2011 model?

Stock based comp will remain at where it is now -- should remain at about $16 million a year; $16 million/$16.5 million.

So all the old grants are gone now, so we just have one grant that recurs every year.

It's about $16 million, so $4 million a quarter.

The tax rate will go up because of new regulations, so it should be between 9% and 10% for fiscal year '11.

Okay, great.

Thanks a lot.

Thank you, Brandon.

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

Hi, Louis.

Congratulations.

Thank you.

My first question is, do you have a target number of learning centers in the schools in the next three to five years?

What I think is we will -- we should add two to three new cities per year.

So in the next three years, we should be in 46/47 cities, or 48 cities in China, with 56 total schools or so.

Learning centers, we normally would target 70 or 80, but because of the enormous opportunity, school leavers are telling us that demand is very strong for six year olds to 18 year olds and we need to be closer to the local elementary schools and [year] highs.

The number will probably be somewhere between 80 and 100.

So my guess is we should be at 470 learning centers in schools by next year, and probably in two years after that, we'll be probably around 620 to 650.

Other than that, we'll always still be two thirds of the way penetrated in the first 40 cities, which usually have over 1,000 learning centers.

Right.

So it appears that your expansion in learning centers in the schools, well, you will just maintain this speed in the next three to five years, right?

Yes, my guess it was a little bit fast last year.

It will be a little bit faster this year because of the stronger than expected demand for UK and then for Kids English, and the rollout of Kids Math in Chinese.

So I think it's 100 last year, 97 last year; 100 this year.

It'll probably go back to 80 or so the year after, which will obviously -- will be margin accretive for us.

Right.

So you mentioned earlier that you expect margins to return higher in physical year '12, so most of that margin improvement will be coming from -- you know, you'll spend less in sales and marketing expenses.

We'll spend less in sales and marketing, and the time we start the slowdown in the number of learning centers we open, we will get, just like we did in 2006 and 2007, we'll get huge margin accretion.

Right, got it.

And also a follow-up with your earlier discussion in terms of teachers' salary.

As some of your major competitors are preparing for maybe become public, will that increase the cost of teachers going forward on a market --?

I think the pressure is always in the big cities, in Beijing and Shanghai, so it does, and that's why we raised salaries 80%.

Yes, and I think it is necessary for us to keep the best teachers by paying more.

And you're absolutely right, all our competitors are lining up to go IPO.

The school year starts in September, and I think that there's a huge class of education companies trying to IPO out of China.

So I would call it the also ran class that's trying to coming in this next calendar year.

Okay.

And for your proprietary new learning system, I just want to clarify, it is a customer services' tool, right?

It is.

It is a -- well, no, the --.

Well, it's two things.

We're rolling out a customer relationship management system that will help us identify and learn more about each student, what classes they pick, and help us serve them as they move from city -- let's say their family moves from one city to another, all their profile and everything will follow them.

So that's a separate system.

It gives us better data about our students and it lets us suggest and market to them better, and it lets us serve them better on a customer service side.

A second thing we're doing, which is a little bit more hard to explain unless you see it, is we are trying to -- we've been spending a lot of time in the last year building a new testing, computerized testing system for children for up to 18 years old by subject, and that's being rolled out now.

The culmination is that as students come in, they will take an assessment test in a subject, let's say, Math.

That assessment test tells that student and tells the parents and the teacher exactly what areas that student needs to work on, what they're weak in, in that subject, and then we will customize a class targeted at that student's weak points.

And we can measure as the student begins to master each of the subjects that they didn't understand at the original assessment stage, and that's how you -- and that's a better way to learn.

We believe that instead of just going over all the subject matter by rote, is why not test the student, find out what there is that they need help in, identify those areas and work only on those areas, or focus on those areas?

And then by the time they're done, they should have mastered that subject.

So that the idea is that this system is a better way of learning.

It's computerized, it's a better way of learning than the old everyone learns the same way, the same book, the same materials.

Got it.

So I guess how you are going to capitalize on that is just by -- via this system, you hope to attract more enrolments.

Well, I think it will attract more enrolments.

I think it's just a better way to learn it, so I think we'll attract more enrolments and they'll realize this is better, and they'll stay.

So it's just something that our competitors don't offer, so I think it's something that we think it will give us a big competitive advantage in this market.

And it also has a lot of stickiness.

Once a student, we expect, gets on this system and we identify their weak points, then only our system can teach them exactly where they're weak and help to improve on those areas, so it creates a stickiness factor as well.

Got it.

And lastly, we --

By the way, we think it's a better way to learn.

It's better content, better learning system.

Right.

And lastly, your deferred revenue balance increased 43% as of the quarter-end versus your guidance of 26% to 32%.

I know there's always a time difference, but is your guidance relatively conservative when comparing to this?

Well, I think it's realistic given that this summer is actually 10 days shorter than last -- seven days to 10 days shorter than last year.

That's a lot of revenue for us.

10 days is a lot of revenue.

We can't have [classes] because the actual vacation is shorter; the number of courses is actually shorter, right?

So it's a big difference.

The other thing is the flooding is a real issue, right?

I mean, if you can't get to your school in Wuhan or [Changsha] or [Chongqing], right, what do you --?

how you [calculate] it, how do you cost it]?

So it is -- those are real issues.

So -- but I think it's the underlying demand remains very strong, and so I think it's the 26% to 32%, probably the higher side of that is realistic.

Okay.

Thank you.

That's very helpful.

Thank you, Ella.

We are now approaching the end of our conference call.

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

Okay.

Again, thank you for joining us today.

If you have any other further questions, please do not hesitate to contact me or any of our investor relations representatives.

Bye bye.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.