New Oriental Education & Technology Group Inc (EDU) 2011 Q1 法說會逐字稿

Good evening, and thank you for standing by for New Oriental's first fiscal quarter 2011 earnings conference call.

At this time, our 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'd now like to turn the meeting over to your host for today, Miss Sisi Zhao.

You may proceed.

Hello, everyone, and welcome to New Oriental's first fiscal quarter 2011 earnings conference call.

Our first 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 Michael Yu, New Oriental's Founder, CEO and Chairman; and Louis Hsieh, New Oriental's President and Chief Financial Officer.

After their prepared remarks, they will be available for -- to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1994 -- 1995.

Forward-looking statements involve inherent risks and uncertainties.

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

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

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

As a reminder, this conference is being recorded.

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

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

Michael, please.

Thank you.

Hello to everyone and thank you for joining us today.

To start our call, I want to take this opportunity to clear up some misleading and erroneous market share information, which has been disseminated by some of our competitors and concerns our key business segments of K-12 After School Tutoring, Overseas Test Preparation and English Language Training.

Our aggressive growth strategy, our reputation as China's premier private education service provider and our high quality instruction and customer service has made New Oriental the clear market leader in China across our three key business segments by both revenue and enrollment.

Specifically, our K-12 All Subjects After School Tutoring is the clear number one market share leader in China with -- in terms of both revenues, which totaled approximately $139m and in enrollments which totaled approximately 860,000 over the last two months -- 12 months.

We continue to be dominant in Overseas Test Preparation with revenues of about $124m and enrollments of approximately 272,000 in the same period.

In English Language Training, we are the runaway market leader with approximately $183m of revenue and enrollments of approximately 1.33m over the last 12 months.

To sum up, New Oriental has been one of the pioneers and a clear leader in China's private education market for more than 17 years and we are privileged to be the most trusted name in each of the markets we serve.

Though it is a competitive market, we are confident of expanding our market-leading position by growing our network of schools in the learning centers in a rational manner, controlling costs and maintaining our high quality instruction that got us to where we are today.

Looking to the past quarter, as we told you in our preliminary earnings announcement, although revenues were strong, our enrollments grew less than in previous quarters.

Enrollments were affected by this year's summer break which was one week shorter than usual because of the longer than usual winter break to accommodate the Chinese New Year.

This meant that students had less time to attend our holiday classes compared to the previous year.

Secondly, we found that the Shanghai World Expo had an effect on the enrollment in Shanghai which were down 6% year over year.

We believe that many students were discouraged from coming to study in Shanghai because of the crowds visiting the Expo and of the consequential increase in costs of accommodation and other living expenses.

In addition, we believe that the students that visited Shanghai mainly chose to spend their time and money visiting the Expo rather than enrolling in classes.

As we expected, as the Expo begins to wind down, enrollments are rebounding and growing steadily.

In September, the first month of our second fiscal quarter, we are seeing enrollments up around 27% year on year to about 198,000, and the revenues were up 40% for the same period.

Despite these challenges, during the first fiscal quarter we achieved net revenues of $192.3m, representing 28.8% growth year over year.

Well within our guidance range, enrollments grew 8.8% and blended ASP grew approximately 20%.

Turning to the business and financial highlights, once again our growth in the quarters were driven by our three core business segments.

Pop Kids remained a strong driver with the enrollments up 29% year on year to 168,800, and revenues up by more than 48%.

As we know, Pop Kids is a strong performer because of the trusted New Oriental brand, which parents know will give their kids the best start from an early age and allow them to continue on the right path to achieve success throughout their educational careers.

You may remember that, last quarter, we announced we were expanding our Pop Kids offering to include the Chinese Writing and Math classes.

We have now rolled these out to more than 20 cities and encouraged by the high demand, we have also expanded into Kids Music and Art.

These four new subjects attracted 9,800 new enrollments over the quarter and we are confident in the future growth of these classes.

We continue to target a full nationwide rollout of these classes during the current fiscal year.

Middle and high school U-Can All Subjects Training was also a strong performer in Q1.

We achieved enrollments of 482,500 and revenue growth of over --- over 39% during the quarter.

U-Can, our English program, in particular, outperformed with year-over-year enrollment growth of about 135% and a revenue growth of approximately 112%.

The strong growth in this business segment testifies to New Oriental's market dominance.

We are the largest after school private education provider K-12 in China, recording over 351,000 enrollments in the first quarter and around 860,000 enrollments and $139m in revenues over the last 12 months.

We are successful because students trust us to provide high quality instruction customized to their needs throughout their educational careers and across a wide range of subjects.

As U-Can has grown, we have developed customized learning programs to fit the various needs of our students, from more affordable larger classes to one-on-one tutoring.

We have also seen growth in demand for our smaller classes.

In fact, in Q1, we recorded over 14,400 of the IT students, one-on-one students, and one-to-six enrollments, up more than 100%, year on year.

This makes a total of approximately 44,700 enrollments and over $65m revenues over the last 12 months.

This allows at an average 8% to 10% price increase has driven growth in our blended ASP.

As we mentioned last quarter, we have been working to develop and roll out our proprietary computerized all-subjects testing assessment and learning system for U-Can over the quarter.

This system focuses on skills assessment development testing and improvement and is already proving its worth as a valuable tool to help students' development.

[Technical difficulty].

Ladies and gentlemen, there were technical difficulties but the speakers are now back on the line.

You may proceed.

Okay.

Sorry for the fall-off, for the disruption.

Yes, go ahead and start.

Okay.

So far this system has been rolled out across our entire network of cities and is being used across the board as a placement test for new students.

In addition, we are using it for all of our VIP students to provide a continuous assessment of their progress.

We plan to roll out the system to all of our U-Can classes by the third fiscal quarter this year.

We believe that this system is the best of its kind and will provide students with a comprehensive assessment tool in each subject at every level of middle and high school in China.

With the widest range of subjects in China, New Oriental has built a powerful education ecosystem and is truly becoming a one-stop shop for students' educational needs.

We deliver high quality instruction for students from kindergarten through college in convenient facilities located throughout China backed up by the individualized customer services and supplemental study materials.

As competition for high paying jobs remains intense in China, education has never been more important and we are confident that our trusted brand will make us the first choice for parents as they prepare their child, or their children, for the challenges ahead.

Our oldest business segment, Overseas Test Prep, where New Oriental has established a dominant market share position in terms of both revenues and enrollments in China, continued its undaunted strong growth.

Enrollments grew at around 21% year over year to 90,400 with revenue growth of about 38%.

This makes a total of 272,000 enrollments and $124m in revenue for the last 12 months.

The largest programs in this sector are TOEFL test preparation, which recorded about 100,000 enrollments and $46m in revenues during the year, and IELTS test preparation which achieved 65,000 enrollments and $33m of revenues in the same period.

We also maintained a dominant position in terms of enrollments and revenues for the GRE, GMAT and SAT test preparation courses.

Some of our newer businesses continue to develop nicely.

For instance, our online education platform, KooLearn, and our overseas study consulting businesses continue to perform well.

KooLearn is the clear market leader in China with over 6m cumulative registered users and over 260,000 paid users in the last 12 months.

And our consulting business is also a stellar perform with revenue growth of 190% during the quarter.

These businesses are growing steadily and although they make a small contribution to overall revenue compared to core segments, they serve to expand our platform and provide our students with further tools to help them achieve their goals.

As you know, we are in the period of investment into our business and in the first fiscal quarter we opened two new schools in the cities of [Tianjin] and Shanghai, respectively, as well as a net of 33 learning centers.

This brings our total number of schools and learning centers to 402, compared to 287 at the end of the fiscal -- the first quarter of fiscal year 2010.

Although New Oriental is primarily expanding organically, we do occasionally make acquisitions when good opportunities arise.

On August 24, 2010, we signed an agreement to acquire 100% equity interest in Newave Education, a Shanghai-based training school that specialized in English language training for students aged from three to 17.

Combining Shanghai's number two K-12 English language training schools with our number one K-12 after school tutoring, New Oriental will further extend its largest network in Shanghai with 63 schools and learning centers and over 105,000 K-12 after school tutoring enrollments in the last 12 months.

We have also been expanding our headcount.

As many of you know, our reputation is built on having the highest standards of teaching and we refuse to compromise this as we grow our network.

In the first quarter, we hired about 2,900 new staff, including over 1,900 teachers, bringing up our total teaching headcount to approximately 10,100.

As we look ahead to the rest of the fiscal year 2011, we are very confident.

Market fundamentals remain very strong.

We are in a unique position in this market as the leading player in after school private education and in test preparation, and we continue to grow at our target rate of around 30%, or higher year on year.

We understand that the market is increasingly competitive but as the only private education provider with a nationwide network and a premier brand in the business, we are confident that we will remain at the front -- at the forefront of the education industry here in China.

Now, I will turn the call over to Louis to go through the financials, and I look forward to speaking with you here in the Q&A session.

Hi, Louis.

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

For the first quarter of fiscal year 2011, New Oriental reported net revenues of $192.3m, representing a 28.8% increase year over year.

Net revenues from educational programs and services for the first fiscal quarter was $180.9m, representing a 27% increase year over year.

The growth was mainly driven by the increase in the number of student enrollments in academic subjects tutoring and test preparation courses and higher ASPs associated with students selecting more expensive, smaller class options.

Total enrollment in academic subjects tutoring and test preparation courses in the first quarter of fiscal year 2011 increased by 8.8% year over year to approximately 704,500 from approximately 647,500 in the same period of the prior fiscal year.

ASPs were up approximately 20% year over year.

Operating costs and expenses for the quarter were $126.4m, a 42.9% increase year over year.

Non-GAAP operating costs and expenses, which exclude share-based compensation for the quarter, was $121.4m, a 43.3% increase year over year.

Cost of revenues for the quarter increased by 39.4% year over year to $66.4m, primarily due to the increased number of courses and the greater number of schools and learning centers in operation.

Selling and marketing expenses for the quarter increased by 50.5% year over year to $23.3m, primarily due to promotional activities around our newer offerings, and also because of the addition of over 900 customer service representatives and marketing staff in the past year.

General and administrative expenses for the quarter increased by 44.9% year over year to $36.6m.

Non-GAAP general and administrative expenses, which exclude share-based compensation, were $31.9m, a 46.2% increase year over year, primarily due to increased headcount as the Company expanded its network of schools and learning centers.

Total share-based compensation expenses, which were allocated to related operating costs and expenses, increased by 33.7% to $4.9m in the first quarter of fiscal year 2011 from $3.7m in the same period of the prior fiscal year.

Income from operations for the quarter was $65.9m, an 8.2% increase from $60.9m in the same period of the prior fiscal year.

Non-GAAP income from operations for the quarter was $70.9m, a 9.7% increase from $64.6m in the same period of the prior fiscal year.

Operating margins for the quarter was 34.3%, compared to 40.8% in the same period of the prior fiscal year.

Non-GAAP operating margin, which includes -- which excludes stock-based compensation expenses for the quarter, was 36.9%, compared to 43.3% in the same period of the prior fiscal year.

Net income attributable to New Oriental for the quarter was $62.4m, representing a 9.3% increase from the same period of the prior fiscal year.

Basic and diluted net income per ADS attributable to New Oriental was $1.64 and $1.61, respectively.

Non-GAAP net income attributable to New Oriental for the quarter was $67.3m, representing a 10.8% increase from the same period of the prior fiscal year.

Non-GAAP basic and diluted net income per ADS attributable to New Oriental was $1.77 and $1.73, respectively.

Capital expenditures for the quarter was $12.4m, primarily used for the net of 35 schools and learning centers.

As of August 31, 2010, New Oriental had cash and cash equivalents of $293.3m, as compared to $281.1m as of May 31, 2010.

In addition, the Company held $194.3m in term deposits at the end of the quarter.

Net operating cash flow for the first quarter of fiscal 2011 was approximately $79.8m.

The deferred revenue balance, which is cash collected from registered students for courses and recognized proportionately as revenues as the instructions are delivered, at the end of the first quarter of fiscal year 2011 was $100.6m, an increase of 73.6% as compared to $57.9m at the end of the first quarter of fiscal year 2010.

Moving on to guidance.

For the second quarter of fiscal year 2011, New Oriental expects its total net revenues in the second quarter of fiscal year 2011, which runs from September 1, 2010 to November 30, 2010, to be in the range of $82.6m to $85.7m, representing a year-over-year increase in the range of 35% to 40%, respectively.

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

Thank you.

And at this point, we will take questions.

Operator?

(Operator Instructions).

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

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

(Operator Instructions).

And the first question coming from the line of Ella Ji from Oppenheimer.

You may proceed.

Thank you.

Hi, Michael.

Hi, Louis.

You mentioned that you will shift the focus to increase utilization breaks and more stringent cost of controls, could you please elaborate a little bit on that?

And is there any update on your long-term learning center expansion plan?

Thank you.

Yes.

I'll start, then Michael can (multiple speakers).

Yes, yes.

We added 180 learning centers in the last two years and we added 76 learning centers in two quarters; that's too fast for us.

If you guys remember, it takes -- the first year of a learning center breaks even as marginally profitable.

The second year of a learning center's life, it typically will generate single-digit operating margins.

It takes the third year for that learning center to become profitable into the double-digit operating margin.

That means that half of our network is less than two years old.

So we added aggressively in the last two years because we started rolling out non-English U-Can programs and, in doing so across the 40 cities, we realized that our learning centers were not optimally located near middle and high schools, so we've been correcting that.

Also, we didn't have critical mass in some big markets, like Beijing and others, so we've been aggressively adding in these markets to get better coverage.

Now that we've done that, we will begin to slow down the learning center growth and, then, as the natural effect of this large network of learning centers fills up in the next quarters or so, you'll see the utilization increase, which will drive leverage which will drive operating margin up, so that is our intention.

We opened 33 learning centers in the first quarter; we would expect somewhere to open between 60 and 70 for the whole year.

Yes.

Okay?

Your next question comes from the line of Catherine Leung.

You may proceed.

Hi, good evening.

Thank you for taking my question.

So, the follow-up question is what should we be expecting in terms of the near term over the next few quarters?

What should we be expecting in terms of operating margin (inaudible)?

And also can you remind us what the longer term sustainable margins the Company is targeting both on the gross and operating levels?

Thank you.

The operating margin will obviously depend on revenue growth, so right now, we are growing faster than expected.

Q2 will still be challenged, as you know, because Q2 is normally a very slow quarter for us, so we will be hopefully profitable but it won't be a quarter to write home about.

Revenue growth is tracking well above expectations, though, on -- for the quarter so we would expect it to look better than our internal forecast.

Long term, Catherine, you know that our margin expectation for operating margin still will remain in the mid 20s.

And also our net income margin we expect to still be north of 20% so that remains our target.

And I think if you do -- if you run out these learning centers over time, you will see that we should be able to achieve them assuming our business continues on track.

Okay, understood.

Thank you.

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

You may proceed.

Thank you.

Can you talk about the acquisition of Newave Education?

Why did you feel like you needed to do that now?

And do you plan to do more acquisitions in the future?

Does this signal a new round of acquisitions for you?

No.

This is an acquisition that's been kicking around for two years.

We looked at Newave two, two and a half years ago and we couldn't agree on price.

And then -- so we continued to grow our Shanghai presence and then they came back to us.

So we got this at approximately a $3.6m payment, 7 times earnings over the next year or two payout, so it's a very attractive price.

It solidified New Oriental's marketing-leading position in Shanghai so looking backwards at 105,000 enrollments together and we will dwarf the competition, moving forward, as far as enrollment and revenues go in the K-12 sector.

(multiple speakers).

So just opportunistic.

We don't actively seek M&A, as you know; we do look around.

This is one of the many companies we've been talking to for two or three years.

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

You may proceed.

Hi, guys.

Louis, I wonder if you could give us any color on the September strength in enrollments.

Was there any particular region or program or service offering that was really better than expectations or that snapped back better than you thought it would or was it just across the board?

Well, I think it's across the board.

It's 198,000 enrollments, up 27%.

That momentum has carried into October, by the way, so it continues that --it's a bounce back from the Shanghai Expo and the fact that the summer quarter last -- this year was one week shorter.

So it's just a natural rebound that we always get when there's some adverse event.

Chinese students need to study so they will come back.

The fastest growth continues to be in the K-12 sector and overseas, so those continue to drive our growth.

And I think we recorded 351,000 K-12 enrollments, we targeted 1m for the fiscal year ending May 31.

We're well on our way to shattering that.

As a follow up, at what point do you think the upper school tutoring business will migrate completely to either one to one or small class size?

Or do you think you're always going to have 10% or 15% of that business is always going to be large class sizes?

I think it's always going to be a mix, right.

The large classes are more affordable, which we kind of own that market, the larger classes.

The smaller classes are becoming more popular because obviously you get more of your supervisor's attention.

And so is the one on ones.

So it's the same thing like in the car market, right.

You've got the large classes equal the cheap cars that are available for CNY80,000.

The smaller classes represents the Hondas and Buicks and the like.

Then the smaller classes, the one on ones, represent the Mercedes and BMWs.

And so you're always going to have that trifurcated market.

And New Oriental plays in all three of them and we plan to -- we already lead the large and small class, and we're going to take the one-on-one market on as well.

So last year we've done 45,000 VIP enrollments in one year.

And don't forget our ASP is typically 30% higher than our competitors.

So you can see that we are clearly taking share in all three segments.

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

You may proceed.

Hi, my question is related to the computer based assessment system for U-Can.

Could you elaborate a little more in terms of how the system helps drive future growth, specifically for students who are deciding between New Oriental and other schools?

Is this assessment system available to them?

And for students who are already enrolled in your program, if you could talk about how the system helped drive revenue per student.

Okay.

Actually the most difficult is for parents to decide whether they choose a school or after school tutoring, is that they cannot see where their kid's level --- where the level is.

So we designed the assessment system to, in lots of subjects actually, mainly in such subjects Chinese Language, English, Mathematics, Physics and Chemistry, to -- so that when they come to New Oriental they can take the assessment test first and see what their level is.

So when their parents see that their kids score coming up, that their kid's score is not ideal enough then their immediate position is that they will let their kids to stay here in New Oriental to study.

Before the system, we did not have any powerful tools to tell parents that their kid should stay here in New Oriental study.

The whole system is designed based on student's intelligence system actually.

So not only we can test the students on their subjects, but also can test the students what it is their most talented areas.

What is their strong -- what is the strongest in their mind?

Some students have a very nice space sense and some students have a very nice time sense.

Some students have a very good imagination and some students have a very good logical reasoning ability.

But without this system, parents do not know what is the strong point of their kid.

And teachers do not know what is the strong point of the student.

So when students take these tests, when we know what is the strongest talent of the student then we can design teaching for the students according to their strong points, and try to overcome their weak points.

Then during the teaching time, every week, or every two weeks, we will come back to the assessment system, to see students, whether they make any progress or not.

If they make progress but there is still some weak point in some areas in the subject, then our computer can automatically draw up those weak points content for students to repeat and repeat, repeat again until the weak point becomes the student's strong point.

This system is very scientifically designed, and up to now at least, we have studied all the test systems offered by other schools, other tutoring companies, and see that up to today this system is the most welcomed by students.

And when we began to use the system like last month, almost 80% of the students who took the system test, assessment test, stay in New Oriental study.

When they finish one period of study, then they take another assessment test and then they continue to pay for the next stage of study.

Yes, so, Adele, what it does is it creates stickiness for students to stay with New Oriental.

It creates up-sale opportunities because if they want to focus on their weak points, they can do it in smaller class formats.

And it's a good tool for parents to assess, as Michael said, the strength and weaknesses of their child in different subjects.

So overall it's a great system and I think it will create much brand loyalty to New Oriental as we can work with them for years.

We have this system by year and by subject.

It's a good combination of content and technology actually.

And students later, they can do all the assessment tests at home with their computers.

Thank you.

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

You may proceed.

Thank you, Michael and Louis, for taking my questions.

I have a question about your deferred revenues.

It went up 74% this quarter which is very (inaudible).

I just wanted to take a look a little bit deeper on the deferred revenue.

How much of them are actually coming from the longer duration, such as the VIP enrollments and how much is just focused on the three-month classes.

So that way we can gauge how long the deferred revenue turnover would be.

The deferred revenue turnover lasts over three quarters.

The percent recognized in Q2 will be approximately 56%.

So about $56m of the $100m will come into Q2 and the rest will be recognized probably in Q3, with a little tiny bit in Q4.

It is almost zero now.

So most deferred revenue gets recognized within six months.

Okay, thank you.

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

You may proceed.

Yes, thank you.

I wanted to ask a question related to Michael, your comments about the U-Can growth in the quarter.

And I want to make sure I heard it correctly.

I thought you said enrollments were up 135% and revenue up 112%.

I know those are big numbers, but normally your revenue growth exceeds your enrollment growth and I'm wondering if there's something else going on there that's influencing revenue growth, (multiple speakers) or if I'm misquoting you.

No, the enrollment is correct.

The revenues are recognized as they come in.

The enrollments are counted when they come in, but the enrollments usually are for two or three quarters.

So it's a funny time, right now enrollments are so strong, but they're coming into Q2 and Q3.

So the revenue will actually be recognized at that point, but the actual enrollment growth is phenomenal into the autumn quarter.

Because remember one of the things we're doing, Mark, is our business model is changing.

We've been criticized by the investors and the analyst community for years for having a business model that is very profitable in the summer, Q1, and then we just kind of chug water -- tread water the rest of the three quarters.

We are transforming our business model so that it's profitable all four quarters.

And as part of that transformation, we need to do marketing during the summer.

So that's part of why the marketing dollars are higher.

We didn't have to used to do marketing, because we want to attract students for the fall quarter.

But we did attract a lot of students for the fall quarter, which are U-Can students who register in the summer, so that's why the registration is so high.

But the revenue will actually get recognized, partly in the summer and partly in the fall.

Partly in the winter.

Yes, so part of these are one-year enrollments or three-quarter enrollments and so that's why there's a disconnect between the enrollment number and the revenue number.

So the enrollments are correct.

We went from 35,000 to 78,000 non-English enrollments and a total of 182,000 enrollments total for the quarter for 12 to 18 year olds.

We also recorded 168 -- 169,000 kids enrollments.

So we had that 351,000.

Your next question comes from the line of Chenyi Lu from Cowen & Co.

You may proceed.

Thank you.

My question is regarding the operating margin for 2011.

Given the heavy spending in the first quarter this year and also you reduced your schools pension fund, 100 school centers to about 50 or 70.

So can you give us a view as to what the gross margin -- what the operating margin looks like in 2011?

Well, I mean last year it was right around 20%, a little bit higher than 20%.

This year it should be not quite as high, because we already missed the summer.

But I think that you will continue to see steady improvement in Q2, Q3 and Q4 versus last year's numbers.

And I think assuming we don't again accelerate our learning center growth, you will see it much higher in Q1 next year.

So we're not in a position to give guidance.

I want to see what Q2 looks like first and see how much our cost controls have had an effect on our expenses.

Your next question comes from the line of Gordon Lasic with Robert W.

Baird & Co.

You may proceed.

Hi, thank you.

Wanted to talk a little bit about your teaching staff.

With over 10,000 teachers, how much more difficult is it getting to track quality talent, given the increased level of competition?

And how much do you expect to increase salaries in fiscal 2011 and how much of that expense do you expect to pass on in price increases?

I think we increased salaries this year about 8% for Beijing and Shanghai, probably less in other cities for teachers.

The way we track the best teachers is because we pay high in our markets.

So despite what you're hearing from competitors in the market, we actually out-pay them, and so will attract teachers from our competitors as well as from colleges, universities and high schools.

And then we train them, and the way we keep the high quality is we make them go through this three-month training program, before we let them teach in our classes.

As far as 2011 teacher salaries, we don't know.

We know we will be one of the highest paying in our key markets and we will continue to attract teachers away from our competitors and re-train them for our needs.

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

You may proceed.

Hi, good evening, Michael, Louis and Sisi.

Thank you for taking my question.

My first one will be about the K-12 program.

What is your expectation for margins of these tutoring programs long term?

We understand that [CEU] in the investment phase now, really in the long term, once they started to contribute meaningful revenue, what's your expectation?

What I think is right now they are in the 55%, 60% gross margin area.

We expect that to improve as utilization in the learning centers improves and as we're able to pass on price increases through to the students.

So I would expect gross margins around the 60% to 65% level.

And I would expect operating income to be somewhere between 25% and 30% once these programs are mature.

It may be a long time before they mature though, because they're growing so fast.

At a time when we add 90 to 100 learning centers a year, it's very dilutive to our business.

If we add 50 to 70 learning centers it's very accretive to our business and the margins will go way up.

The other factor is marketing spend.

It doesn't -- we don't need to spend a lot of marketing dollars going forward, after we establish ourselves in the market.

So if you look at like, Beijing, right, some of our competitors who are on the road shows now saying that their marketing dollars are low, that's because they're only in Beijing.

So in Beijing our operating profit is well north of 45%.

But in the other cities where we're growing we need to spend on marketing.

We're spending money for the future and therefore our expansion in the other cities because we have to try to attract new people from other cities to come into New Oriental.

It's not higher in Beijing.

In Beijing we spend less marketing than any other cities in the percentage.

And if you take away the headquarters, we have 50% operating margin in Beijing.

So you can see the potential for the businesses as we grow.

But we're a nationwide company; we're not a Beijing based company like our competitors are.

So we need to spend to grow a nationwide network and we're doing that.

But that spending doesn't last forever.

So over three to four years we will build that brand name then we can really reduce the marketing spending without much diminution to our growth.

That's when you begin to see the very strong leverage.

The same thing happens, so it's a dual spend right.

It's spending on marketing, it's also spending on learning center growth.

You need a critical mass of learning centers in each city to serve that community.

So we are taking the cost upfront.

And then we will milk this puppy over time.

And I think we're ambitious, we're going into 40 cities at one time.

Our competitors are typically in one city and they're just milking that one city until it's dry.

But then they have nowhere to go.

So we're thinking far ahead in trying to go into 40 cities at one time.

Thank you, Ingrid.

(Operator Instructions).

Your next question comes from the line of Eric Wen from Mirae Assets.

You may proceed.

Hi, Louis and Michael, thanks for taking my questions.

I just have a simple one.

Louis, you mentioned about new competition and you see fewer of them.

Do you see -- can you comment on the pricing environment in the K-12 segment, in the cities where you do run into competition against your competitors.

Not only now, but also the outlook in the next 12 months.

Thanks.

Okay, well, let's be very clear.

We don't face competition from the ones who are on the road show today, except for in Beijing.

They're both Beijing based.

[Shrada] has grown to outside of Beijing as well.

But we are premium priced to them even in Beijing by 30%.

So our pricing, because of our premium brand name, we price 25% to 30% above Shrada for one-on-one tutoring today.

And I don't see that changing any time soon.

(Inaudible) on the other hand is a Beijing based math school right.

They do 10 to 14 year old math programs right.

So their average ASP is about $170, $177 in their F1 prospectus.

Our average ASPs in those small classes are probably closer to $240.

So we also price 25% to 30% premium to them.

And the reason we can do that is because we pay our teachers more than they do.

And so it allows us to do that.

So if you look at our competitors, our competitors are saying a lot of big words.

But if you look at their real businesses, Shrada's a pure one-on-one tutoring school, and mostly, but they are pretty much nationwide.

(Inaudible) is pretty much a math school, with small section only in Beijing.

We don't see them anywhere else.

So it's not -- and we are premium priced to both of them.

And I think we will continue to do so.

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

You may proceed.

Yes, just a follow up on the competition side.

With everyone now getting into the after school tutoring and expand geographically, I want to hear, Michael, how do you plan to differentiate in the long term when you compete with them side by side?

You mean on the K-12?

Yes, in the K-12 tutoring, yes.

Yes.

That's a pretty -- seems pretty simple for us.

First is that our brand is much more bigger than our competitors.

And secondly, is that our nationwide channel, that means the learning centers, are much more than our competitors.

We have more than 400 learning centers and we are going to have more learning centers controlled in a rational manner actually.

Then the good thing is that we are building up systems.

I mean like U-Can assessment system, U-Can intelligence system, and the U-Can content system.

We spent almost a year to build up this system first, before we promote all these U-Can programs.

So systems speaking, we are now actually more advanced than our competitors.

And our teacher training system is much better than our competitors.

Because our brand name, we are easier to attract more able and talented teachers in New Oriental and get a better pay.

And the other thing is that I think that our management team is much more mature than our competitor's management team.

We have more than 40 schools in all the other cities, and these schools have more than, averagely speaking, have more than five years work experience and management experience in New Oriental.

So I am pretty much sure that all these guys know what we are doing and what we are headed for and we want in the future.

The culture is very strong in New Oriental, so we have very attractive elements to attract all the people, especially those expert people or talented people into New Oriental.

And, Ella, you should know, right.

I mean some of our competitors, the one that just filed last week, they do only one-on-one tutoring.

That's a smaller segment.

The other one that is on the road show and pricing this week, they only do -- 90 plus percentage of the business is in Beijing and probably 80% of that is in mathematics.

So they're very narrow, very single-focused system.

And they do mostly just small section tutoring.

We offer everything for students.

One on one, small section, small classes, large classes, whatever you want, all the subjects, across the whole country.

We don't see our competitors anywhere outside of Beijing.

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

You may proceed.

I want to go back to something that Michael mentioned a 30% growth target.

Are you expecting 30% revenue growth for fiscal year '12?

At this point, yes.

But we will do our budgeting at the end of '11.

But the momentum is clearly at our back.

As we grow out these learning centers we are seeing increasingly very strong demand for our services.

I think we had 780,000 enrollments in K-12 last year.

We expect to do somewhere between 1m and 1.1m million this year.

That's triple anybody else in our industry.

And the revenues from this sector will exceed $200m next year.

So I think we are expecting continued strong growth in this area, assuming the economy and other factors hold up.

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

You may proceed.

Hi, a follow-up question.

So the Q2 will grow faster than you had expected.

You talked about it's a bounce back in Shanghai from the Q1.

Is it also because of some recent investments started to pay off?

For example, like a higher utilization rate, will that momentum extend to the rest of the year?

We think the momentum will extend at this point.

It's too early to tell though because we need to see what the winter enrollments look like.

But clearly the investments that we have made in the past year are clearly paying off.

We are seeing K-12 enrollment growth well above our expectations.

And even though the revenues didn't look like it in the first quarter, that's because of the shortened summer.

It was one week shorter and so students didn't have as much class time, which affected the revenues.

Also because of Shanghai Expo, students didn't want to [fight] in Shanghai with all the high expenses.

And many students have a fixed budget; they spent the money on Expo instead of studying this summer.

Well, they all came in this quarter.

They still have to study.

So after every event, like the Beijing Olympics, like H1N1, we always have a bounce back and we're in the middle of that bounce back today with the K-12 tutoring graph.

Your next question comes from the line of Eugene Yeoh from Deutsche Bank.

You may proceed.

Hi, a quick question.

I just wanted to delve a little bit more into your enrollment.

You mentioned that tutoring was up 140% but can you give some idea about which were the slower segments between domestic, English test prep, Adult English (technical difficulty)

I can't hear you, Eugene, you've got to repeat your question please.

I just wanted some idea about the first quarter enrollment growth for overseas test prep.

And which were the slower areas?

Were they adult English and what are they growing like in the first quarter?

Okay, overseas enrollment growth was 21%.

It went from 74,800 last year to 90,400 this year.

With 17% price increases, the revenues are up 38%.

Adult English was slower; Adult English went from 124,000 last year, to only 110,000 this year.

So it was down 11%.

But ASPs were up 13% so actual revenue was up 2%.

So even though we expect Adult English to slow because we as we teach K-12 students in English they don't need to learn it as adults anymore.

As long as the growth is gradually slow and the revenues are still up slightly year over year.

Domestic test prep CT4 and 6, was pretty flat.

125,000 enrollments last year, 122,000 enrollments this year.

And revenue was up about 4%.

So these two, Adult English and domestic test prep -- as long as the slowdown is gradual, we're okay.

Together they only represent about 22% of our business.

So, it would be more than offset by the growth in K-12 and in overseas test prep and in our overseas study consulting and online businesses.

We have a follow-up question from the line of Ella Ji from Oppenheimer.

You may proceed.

Hi, it's me again.

Could you please provide a breakdown of enrollment between larger class and smaller class and one-on-one class in your after school tutoring sector.

Thank you.

I don't have that handy.

We do have it.

We can provide it to you offline, Ella.

I remember we had about 15,000 one-on-one enrollments this quarter, more than double from last year just in the K-12 tutoring.

45,000 one-on-one enrollments overall.

I believe probably 60% of our students are still in large class format on average.

Yes, about 55%.

Yes, 55 percent are still in large class.

Large class means greater than 20 people per class.

But one on one and small classes are growing very, very rapidly.

Okay, thank you.

We are now approaching the end of the conference call.

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

Well, again, thank you all for joining us today.

Michael and I are very happy to hear your questions and please do not hesitate to contact us or any investor relations representative for any further.

By the way, Sisi and I will be on the US non-deal road show starting October 25 in Boston, October 26 in New York, October 27 in Chicago and October 28 and 29 in San Francisco.

So we look forward to meeting some of you during our travels.

Take care.

Thank you.

Thank you for participation in today's conference.

This concludes the presentation, you may now disconnect.

Have a great day.