New Oriental Education & Technology Group Inc (EDU) 2011 Q3 法說會逐字稿

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

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

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

Today's conference is being recorded, if you have any objections you may disconnect at this time.

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

Please proceed madam.

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

Our third fiscal quarter earnings results were released earlier today and are available on the company's website as well as on Newswire services.

Today you'll head 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 U.S.

Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve inherent risks and uncertainties and as such our results may be materially different from the views expressed today.

A number of potential risks and uncertainties are outlined in 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 Hsieh.

Thank you Sisi.

Hello everyone and thanks for joining us today.

I will start by taking you through the highlights for our fiscal Q3 2011 and then move on to the financial results before finishing with q & a.

We are pleased to report strong results for this quarter and particularly excited that we are reporting excellent performance on both the top and bottom lines.

Especially pleasing is the growth in our GAAP profit margin which improved to 17.6% from 15.5% in the year ago period, which reflects a successful implementation of the expense control initiatives that we outlined last quarter.

As we pledged at the end of Q2 we placed a very strong emphasis in Q3 on improving the utilization of our distance facilities and staff and scaling back expenditures on new facilities, staffing and marketing.

In addition to improving utilization of our existing facilities, these efforts have enabled us to increase profits by 68.1% year over year for Q3 on top of a very healthy revenue growth of 48.6% year on year.

A core focus for expense control during the last quarter has been a prudent approach to expanding our facilities.

In Q3 we only added in one new school in Nantong City in Jiangsu Province and a net of eight learning centers in seven existing cities, whereas in the previous three quarters we had built 43, 35 and 24 new schools and learning centers respectively.

As of February 28, 2011, we had a total of 456 schools and learning centers nationwide versus 447 in the previous quarter.

While we have slowed down the pace of expansion, this should not be interpreted to mean that we are missing out on a market growth opportunity.

Having very successfully expanded our network of schools and learning centers during previous quarters we have ensured that we already have a very strong presence in the key markets where we want to be.

So our focus in Q3 for the coming quarters is on improving our utilization and improving class offerings in these facilities to enable us to improve operating efficiencies.

In Q3 we have also kept a firm hand on headcount increases, in particular of non-teaching staff.

Naturally, we continue to focus on hiring, training and retaining the most talented teachers in the industry to ensure that we consistently provide the best-in-class service quality that New Oriental students have come to expect from us.

But as we do so we have also been very conscious of the need to improve internal efficiencies so that we control the number of non-teaching staff we hire.

As a result of this effort in Q3 we added a net of 600 employees (sic see presentation), of whom the vast majority, or about 470, were teachers.

This emphasis on achieving HR efficiency extends to existing staff as well as new hires.

In Q3 we effected more than 1,460 terminations, both voluntary and involuntary.

At the end of the quarter we had a total headcount of about 21,300, including about 11,300 teachers.

Another important driver of our improved margin in the last quarter was our strict control over marketing expenses in Q3.

Marketing costs totaled $18.3m, which is down significantly from $23.3m in the fiscal first quarter 2011 and also less than the $18.6m we spend in Q2.

Of our total marketing spend last quarter only about $7.5m was non-headcount related, or direct marketing --- or direct brand promotion spending, and this represented an increase of only 12%, or approximately $6.7m in the same period last year.

While we have very effectively reined in spending across our business, we have been careful to do so in a way that improves efficiency without impeding growth.

In fact, I am pleased to note again that we are reporting stellar top line growth of 48.6% for this quarter, driven by excellent performance right across the key business lines.

I think it speaks volumes about the enduring strength of New Oriental's brand that even as we eased off on spending and marketing and network expansion we nevertheless increased enrolments by 17.8% year over year.

We had approximately 490,200 enrolments in Q3, 2011 compared with approximately 416,000 in the same period last year.

In particular, I would like to highlight that we recorded over 1.6m enrolments in the first three quarters of 2011 fiscal year and are poised to exceed 2m enrolments for the full fiscal year, a significant milestone for the Company.

In the same three fiscal quarters of 2011 we have recorded an additional 159,000 paid online enrolments and are poised to exceed 200,000 paid online users for the full fiscal year.

This reflects how our customers continue to recognize the quality of the training environment that New Oriental provides as well as our unrivalled breadth of services with our one-stop-shop strategy.

Let us quickly break down these numbers and look at the performance in our fastest growing business lines.

Our overseas test preparation segment maintains strong momentum with year over year enrolment growth of more than 33% to over 73,100 and year over year gross revenue growth of about 55% to over $43.4m last quarter.

We remain the dominant player in the overseas test preparation market in China with approximately $152m gross revenues and over 311,000 enrolments in the 12-month period ended February 28, 2011.

Our K-12 all subjects after school tutoring business recorded year over year enrolment growth of more than 35% to over 290,400 and very encouraging year over year gross revenue growth of over 70% to over $46m in the quarter.

We are pleased with the progress we are making with the business and we expect more than 1m enrolments in K-12 during fiscal year 2011 ending May 31.

Under this, umbrella our non-English U-Can all subjects business, now almost three years since its launch, continues to experience extremely strong growth in demand.

In Q3 we saw year over year enrolment growth of more than 83% to over 66,900 students, and year over year gross revenue growth of over 133% to over $18m.

We are the leading service provider in the K-12 all subjects after school tutoring market in China with approximately $173m in gross revenue and approximately 996,500 enrolments in the 12-month period ending February 28, 2011.

And finally I'd like to draw particular attention to our VIP personalized courses which are gaining traction incredibly quickly across many subjects.

Leveraging our existing position as China's most trusted private after school education provider we have been ideally placed adapt our existing service offerings to suiting smaller classroom environments to take advantage of this opportunity.

We now offer classes in a range of subjects to small class sizes of between one and five students, and I'm pleased to say that pickup has been very strong.

Year over year enrolment growth by more than 68% to over 15,700 students and year over year gross revenue growth of over 140% to about $31m in the quarter.

In the 12-month period ending February 28, our VIP personalized courses recorded over $104m in gross revenue and over 58,300 enrolments.

As a result of the success of our VIP offerings we have been able to increase blended ASPs by approximately 30% to over $250 per enrolment.

In addition, our online education business and our overseas consulting business continue to grow strongly with year over year revenue growth of 50% and 130% respectively.

Although revenue contributions remain below 5% of our total, we're encouraged by the fantastic progress we're making in these segments.

These platforms, which are complimentary to our business, provide our students with additional services and benefits from the enormous cross-selling opportunities of our business model.

Our other two major business segments saw modest gross revenue growth in the quarter with gross revenues up approximately 7% for Adult English and 1.4% for College English Test Prep or CET4 and CET6 tests.

To sum up, our results for Q3 are very encouraging, our strong performance across our core business lines drove excellent top line results and stringent cost control efforts have been reflected in exceptional growth in the bottom line.

In the quarters ahead we will strive for a balanced approach of rapid expansion to capture the enormous market opportunity in front of us and at the same time remain vigilant on expense control to realize operational efficiencies.

Turning to the financials.

For the third quarter of fiscal year 2011, we reported net revenues of $132.5m, representing a 48% increase year over year.

Net revenues from educational programs and services for the third fiscal quarter were $122.6m, representing a 48.6% increase year over year.

The growth was mainly driven by the increase in the number of student enrolments in academic subjects tutoring and test preparation courses, and higher average selling prices arising from students selecting more expensive, smaller class options.

Total student enrolments in academic subjects, tutoring and test preparation courses in the third quarter of fiscal year 2011 increased by 17.8% year over year to approximately 490,200 from approximately 416,000 in the same period of the prior fiscal year.

Operating costs and expenses for the quarter were $111.3m, a 47.4% increase year over year.

Non-GAAP operating costs and expenses, which exclude share-based compensation expenses, for the quarter were $108m, a 52.8% increase year over year.

Cost of revenue in the quarter increased by 55% year over year to $54.9m, 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 32.5% year over year to $18.3m, primarily due to the addition of over 900 customer service representatives and marketing staff in the 12-month period ended February 28, 2011.

General and administrative expenses for the quarter increased by 44.9% year over year to $38m.

Non-GAAP general and administrative expenses, which exclude share-based compensation expenses, were $34.9m, a 61.1% increase year over year, primarily due to increased headcount as we expanded our network of schools and learning centers.

Total share-based compensation expenses, which were allocated to related operating costs and expenses, decreased by 30.8% to $3.4m in the third quarter of fiscal year 2011 from $4.9m in the same period of the prior fiscal year.

Income from operations for the quarter was $21.2m, a 55.5% increase from $13.6m in the same period of the prior fiscal year.

Non-GAAP income from operations for the quarter was $24.8m (sic see presentation), a 32.8% increase from $18.5m in the same period of the prior fiscal year.

Operating margins for the quarter were 16%, compared to 15.3% in the same period of the prior fiscal year.

Non-GAAP operating margins, which exclude share-based compensation expense, for the quarter was 18.5%, compared to 20.7% in the same period of the prior fiscal year.

Net income attributable to New Oriental for the quarter was $23.3m representing a 68.1% increase from the same period of the prior fiscal year.

Basic and diluted net income per ADS attributable to New Oriental was $0.61 and $0.60, respectively.

Non-GAAP net income attributable to New Oriental for the quarter was $26.6m, representing a 42.4% increase from the same period of the prior fiscal year.

Non-GAAP basic and diluted net income per ADS attributable to New Oriental were $0.69 and $0.68, respectively.

Capital expenditures for the quarter were $9m, primarily used to add one school and a net of eight learning centers.

As of February 28, 2011, we had cash and cash equivalents of $348m as compared to $248.1m as of November 30, 2010.

In addition, we had $190.6m in term deposits at the end of the quarter.

Net operating cash flow for the third quarter of fiscal year 2011 was approximately $40.1m.

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 third quarter of fiscal year 2011 was $150.7m, an increase of 115.9% as compared to $69.8m at the end of the third quarter of fiscal year 2010.

Turning now to the financial results for the nine months ended February 28, 2011.

For the first nine months of fiscal year 2011 we reported net revenue of $420.5m, representing a 40.3% increase year over year.

Total student enrolments in academic subjects, tutoring and test preparation courses in the first nine months of fiscal year 2011 increased by 16.8% to approximately 1,600,500 from approximately 1,370,500 in the same period of the prior fiscal year.

Let me re-read that.

Total student enrolments in academic subjects, tutoring and test preparation courses in the first nine months of fiscal year 2011 increased by 16.8% to approximately 1,600,500 from approximately 1,370,500 in the same period of the prior fiscal year.

Income from operations for the first nine months of fiscal year 2011 was $85.1m, representing a 15.5% increase year over year.

Non-GAAP income from operations for the first nine months of fiscal year 2011 was $96.7m, representing an 11.7% increase year over year.

Operating margin for the first nine months of fiscal year 2011 was 20.2%, compared to 24.6% in the same period of the prior fiscal year.

Non-GAAP operating margin, which excludes share-based compensation expenses, for the first nine months of fiscal year 2011 was 23% compared to 28.9% in the same period of the prior fiscal year.

Net income attributable to New Oriental for the first nine months of fiscal year 2011 was $87.5m, representing a 21.5% increase year over year.

Basic and diluted net income per ADS attributable to New Oriental for the first nine months of fiscal year 2011 amounted to $2.29 and $2.24, respectively.

Non-GAAP net income attributable to New Oriental for the first nine months of fiscal year 2011 was $99.1m, representing a 16.7% increase year over year.

Non-GAAP basic and diluted net income per ADS attributable to New Oriental for the first nine months of fiscal year 2011 amounted to $2.59 and $2.54, respectively.

Moving to our outlook for the fourth quarter of fiscal year 2011.

We expect total net revenue in the fourth quarter of fiscal year 2011, March 1, 2011 to May 31, 2011, to be in the range of $114.3m to $118.6m, representing year over year growth in the range of 32% to 37%.

This forecast reflects our current and preliminary view, which is subject to change.

At this point I would take your questions.

Operator.

(Operator Instructions).

Your first question comes from the line of Catherine Leung.

Please proceed.

Hi, congratulations on a strong quarter.

My question is on your costs.

So to clarify on your balancing rapid expansion with expense control, going into the fourth quarter is the Company more focused on improving utilization and digesting the fixed costs built up over the past year, or are you gearing up for more expansion ahead of the summer quarter?

And related to this, I assume the terminations you mentioned happened towards the end of the third quarter after Chinese New Year.

So how much material would the full quarter impact be from these reduced costs?

Thank you.

The second part of your question Catherine is that they didn't have that much impact on Q3 yet because, you're absolutely right, most of the terminations came after the Chinese New Year.

So they will be reflected more fully in the Q4 quarter ending May 31.

And your first question relating to the expansion plans, as we are doing the budget for fiscal year 2012 right now, we're probably going to expect to expand learning center growth about 70 to 85 learning centers, and we will gear up for the all important summer quarter this year.

But it won't be the same as last year in Q4 where we added 45 learning centers and schools.

This year we're going to look much more closely at utilization in the centers -- in the cities that already have significant capacity that's not utilized.

So we won't be adding as much as we did last year.

At the same time we will look at areas where utilization is constrained because we're growing so rapidly, especially in the newer cities.

So you won't see the 40 number; you'll most likely see something between 15 and 25 and then going forward it will be at that kind of clip of 15 to 25 centers per quarter as we try to maintain a more balanced approach to our cost expenses as well as our expansion.

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

Please proceed.

Hi Louis.

Thanks for taking my questions.

Very quickly, could you provide us any margin guidance for the next quarter?

And also, looking forward to fiscal 2012, given that we may see an easier comparison with the soft first quarter this year, what kind of growth rate do you expect and it would be great if you could provide any color on the breakdown between enrolment and ASP growth going forward?

Thank you.

Thank you Philip.

We don't provide margin guidance on a quarterly basis, so I'll defer that.

I think, as you can see, the margin trend is upward so we're confident that margins will begin to trend upward from here versus year over year comparisons.

As far as the ASP and enrolment breakdown going forward, this year ASPs are much higher due to the fact that the fastest growing segment of our business is VIP, which is one-to-one to one-to-five, and these have average $1,700 to $1,900 ASPs which is driving the ASP up well over 30% on a year over year basis, on a blended basis.

Going forward I would expect revenue growth, we're doing budgeting now so don't hold me to this for sure, we're expecting revenue growth well over north of 30% for next fiscal year.

And of that, let's say 30% to 35% in revenue growth we would expect about 15% to 16% enrolment increases and 15% to 16% price increases, ASP increases.

So it should be about half and half.

If anything the ASPs will probably go up a little bit faster than the enrolments.

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

Please proceed.

Mark, are you there?

Yes I'm here, sorry I had you on mute.

Nice job on the quarter Louis.

I wanted to touch on the selling and promotion spending in the quarter and specifically your spending on direct brand promotion which obviously was a lot slower than revenue growth.

Can you talk about your budget for direct brand promotion spending in the coming quarters?

Should we expect it to continue to be at these low levels of growth relative to the rest of your selling and promotion spend?

I wouldn't expect it to be 36% lower than our revenue growth.

But our budgeting does call, I mean, like I said, I've been telling the street that most of the increase in terms of marketing for the whole year has been hiring as we change our business model from overseas test prep and large classes and Adult English to this K-12 model that requires customer service reps, especially if we do VIP instruction where a lot of these personnel that are being hire are in the marketing department.

So I would expect brand promotion expenses to grow but at a much slower pace than revenue.

So if revenue grows at 30%, I would expect brand promotion expenses not to exceed 80% of that growth, or about 24% or 25%.

Like I said, the direct brand promotion expenses actually are not that much.

Most of the increase is actually just due to advertising rates going up.

It's not even like we're advertising more.

We're advertising the same or less; it's just purely rates have gone up.

So I would expect most of our expenses to grow at a slower rate than revenues which is why we expect margin expansion in fiscal year 2012.

And as was pointed out earlier by Philip, we do have easier comparisons versus the summer.

You guys have to understand we added about net over 110 learning centers in the last four quarters.

That's not going to happen next year.

And so as you slowdown learning center growth utilization increases given the strong demand for our programs, the margins are expected to go up.

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

Please proceed.

Thank you.

Congratulation Louis.

Could you talk about what's your current utilization rate for your learning centers open more than 12 months?

To be honest, we don't track it that closely because it depends on how you define utilization.

But Q3 utilization is quite high, right, because it's our second busiest quarter behind the summer.

Q4 utilization would typically be lower than Q3 just because it doesn't include the winter Chinese New Year break.

But I can tell you that utilization rate has gone way up in the last quarter from last year, versus Q2 because of the winter break, also because we added only nine net schools and learning centers.

So it's easily over 50% now, but remember, we have only the potential to reach 70% because our school learning centers are shutdown during school hours when kids are in school.

So I think we're getting closer to full utilization but, as you know Ella we never get there.

So the ones that have been open longer than 12 months would typically have utilization rates greater than 50%, especially as we open smaller ones.

The larger ones that we opened after 12 months will probably be about one-third to 40% utilization after one year and then will slowly grow over the next two years to about 65% to 70% utilization rate.

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

Please proceed.

Thank you.

I have just one or two questions regarding the U-Can program, I know this quarter it has been again very strong.

Can you give us a view of non-English U-Can program in 2012?

And also, can you give us an update of Kids Math and the Chinese course in terms of momentum?

Thank you.

Yes, our Kids Math and Chinese courses are growing very rapidly.

We had 10,400 enrolments in Kids Math and Chinese in the quarter which brings the total to almost 30,000, 29,800 in the first three quarters since their launch.

This is Math and Chinese classes and Art classes for kids six to 12.

We expected only 20,000 enrolments for the whole fiscal year so we'll probably double that to 40,000.

I'd expect this business to grow very rapidly in the years ahead just like U-Can did two and a half years ago.

So it will follow that kind of same pattern of 100% growth for a couple of years.

As far as the outlook for U-Can for fiscal year 2012, I don't have the numbers yet because we are doing, as I said, we're doing budgeting right now because it's the end of our fiscal year in May.

I would expect U-Can to grow at least 50%, non-English U-Can at least 50% and growing closer obviously to 100%, so that's probably quite a conservative number, but I don't want to be aggressive when we haven't finished the budgeting process yet.

Thank you Chenyi.

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

Please proceed.

Congratulations on the quarter Louis.

Thanks Jeff.

You've had rapid growth in VIP since you rolled it out with big sequential increases in enrolments of several thousand students, and those sequential increases have sort of leveled out over the past few quarters.

So going forward, do you expect more, bigger potential increases going forward or has it just sort of leveled off because it's not a brand new offering anymore?

No, I would expect VIP enrolments to continue to grow very rapidly, I don't think they've leveled off at all, I think they're growing over 50% on a year over year basis with ASP growing as well, so you can see that revenue is up over 140% in the VIP sector.

Typically, if you try and compare Q3 to Q1, it's not a fair comparison because Q1 is our busiest quarter, so I would expect VIP to continue to grow rapidly and it accounts for about 22% of our revenue today.

I would expect that to be well north of 25% in the next fiscal year.

So it is probably the fastest growing segment of our business and will continue to grow.

Your next question comes from the line of Tom Dillon, William Blair.

Please proceed.

Morning Louis.

Hi Tom.

How many cities do you plan to move and expand this year?

And then with traffic in Beijing, how many other major cities -- how in other major cities, how do you plan to change the utilization all that much?

Tom, I think for next year we are probably going to move into three of four new cities.

We've moved into three cities already this year and probably into three to four new cities in fiscal year 2012.

Like I said, we're still studying that in our budgeting process.

We will continue to expand fastest in the cities outside of the major cities like Beijing, Shanghai where we have decent coverage today.

So the fastest growth in our business will continue to be the second and third tier cities outside of Beijing and Shanghai.

That's where the demand is the strongest and that's where our learning center growth will continue to grow.

And part of our focus for next year is that we've grown so fast in the last year with over 110 net adds of learning centers, we want to begin to fill those so the utilization rate goes up.

At the same time we don't want to stop growing so we'll still add another 75 to 85 learning centers.

That balanced approach, I think, is much more sustainable than a rapid expansion and then harvest and then rapid expansion and then harvest type strategy that's used by many of our competitors.

Your next question comes from the line of [Min Li] SIG.

Please proceed.

Thank you for taking my questions.

Can you please comment on the competitive landscape?

How is EDU positioning overseas test preparation and after school tutoring training particularly, given competitors that have gone public and continue to invest in these areas.

Thank you.

That's a good question.

I think for us you need to understand and I know the analysts understand this, the market opportunity is huge, according to IDC it's over $24b now.

So we position ourselves with our superior brand name and our nationwide brand name.

We're the only nationwide brand name that's known across China in the sector.

Both in overseas test prep and in K-12, we're always positioned at the top where we are premium price with premium service and a premium brand name.

So we're typically, we don't try to go after the whole market.

We're also positioning ourselves vis-a-vis our competitors as one-stop shop where students can come and they can pick one-on-one classes, one-to-small, one-to-large and online, so we offer all formats as well as all subjects.

So we become the one-stop shop is where we're positioned.

We have 30,000 or more competitors in China, but not one of them is even one-quarter our size.

So we face strong competition in ever city that we have schools and learning centers in but most of the strong completion is actually from local competitors which you guys haven't even heard of because they haven't gone public yet.

So where we compete against some of the more recent entrants in only a specific area, like VIP, or in a specific area, a city like Beijing but we do not really compete head-to-head with anybody nationwide.

We compete against very strong local players.

It's sort of like Wal-Mart without a Target.

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

Baird.

Hi Louis, thanks for taking my question.

Can you just help me understand I guess, what level of mature learning centers should you be able to withstand the margin pressure from opening new centers?

Do you essentially need to reach 300 to 350 mature centers?

And if so, when do you think you'll have a large enough base to withstand the kind of normalized rate of openings going forward?

Thanks.

I think we are there now.

So I think with 456 learning centers, by another two quarters from now three-quarters of them will have already been quote-unquote mature, which means they're over two or three years old.

So I think we're right at the cusp right now of the critical mass that new openings won't really impact our margins that much, unless we go nuts and open 200.

So I think it's a good pace.

As far as our competitors go, if they open new learning centers it depends on how many learning centers they open versus how many they have.

For us, at 450 we could easily open 100 again next year and not impact the margin that much.

We probably will not, just because we want to continue to improve the utilization to 75% to 85%.

But at this point we're at the most difficult time as far as margin pressure, in the last two years, when we added over 200 learning centers on a base of only 200.

So that was what was putting the margin pressure on over the last few quarters, or last year and a half.

In addition, we're also rolling out brand new businesses in non-English U-Can and also VIP businesses for the K-12 sector.

Those put tremendous resource drains on our business by making us open a lot of learning centers as well as hiring a lot of staff ahead of the revenue.

And, like I say, we did this two and a half years ago, we said give us three years.

Well it's now three years so now's the time for us to basically put up or shut up and we're trying our best to rationalize the business to make it more efficient and streamline it.

At the same time, contrary to the concern on the street, it has not really slowed down our top line growth, which was the big worry as we begin to rationalize costs.

Your next question comes from the line of Chao Wang, Bank of America.

Please proceed.

Hi, thanks for taking my question.

Just a little quick one.

Could you provide us with guidance on share-based compensation for the next couple of quarters?

Thanks.

For Q4 it should be quite low also, $3.4m this quarter; something in the same range for next Q4.

But Q1 again will have another set of option grants, so it will replenish itself, so it will go up again in Q1 from the $3.5m level.

I don't have that number yet because we haven't granted those shared-based comp.

We usually do it at the end of the year after the fiscal year is done, so we will have a better picture in Q1.

I do not expect share-based compensation to -- as a percentage of revenue, will continue to decrease as it has for the last three years.

Your next question comes from the line of Eric Wen.

Please proceed.

Hi Louis.

Thanks for taking my call.

Congratulations on the good quarter.

I have two questions.

The first question is your deferred revenue continued to be grow very strong, starting from the spike last quarter.

Could you tell us where that deferred revenue continued to come from; whether it's in English or in one of your VIP private instruction business?

And I have two follow-up questions.

Thanks.

The deferred revenue balance was an all-time high of $150m this quarter.

Actually it's not as big as you think.

Remember last year Chinese New Year occurred on February 14.

This year it occurred February 3.

That two weeks makes a bit difference because last year it wasn't as big a deferred revenue because students finished Chinese New Year holiday early March and went and enrolled students in classes.

That means the revenue is actually recognized in Q4.

Whereas this year, because Chinese New Year was a normal period of February 3, students went back to school around February 17 and then enrolled in classes.

So it distorted higher than -- it looks like it's 115% growth.

It's really not that high.

Having said that, actually the deferred revenue balance is still a very high number even without that Chinese New Year timing effect and so most of that is really related to VIP and U-Can for Q4 which is the biggest businesses in Q4, the one we're in today.

We are, we do have a big backlog, of $150m.

I would expect more than half of it to be recognized between 50% and 55% in the current quarter today.

Your follow-up question Eric?

Yes, sorry I missed your last part.

You said how much of your deferred revenue is already booked in the current quarter?

I think it will be over 50%.

Somewhere between 50% and 55%, closer to 55%.

I understand, okay.

My second question is you seem to have a very unique offering in the K-12 business which is a VIP maximum five.

How do you reach your target customers as you compete against both [Shrader] and [Shirasu] but you are probably the most expensive, most high end product out there.

But how do you market the product differently compared to your competitors?

I think it's been a long process for us, because I think the way we compete is our brand name is second to none in China, and so students will typically come to us if they can afford us.

That's how we look at it.

It's sort of like Mercedes and BMW in China; if they can afford it they'll usually come to New Oriental.

So we actually don't really try to do anything to Shrader or Shirasu.

All we do is just market our own brand name.

It just has a premium brand.

But it's the same strategy we use for our businesses, we make sure we have the best teachers because we hire and train them and we pay them the best.

At the same time we spend a lot of money on developing the best content.

We also have a computerized testing system that's second-to-none in China.

We think it's the best product out there for K-12 right now which we spent three years developing.

So I think we have a superior offering, I think we have superior teaching and that's what's built our premium brand name which allows us to charge more.

In addition Eric, as you know, you visited our Beijing facilities and other cities, you know that our facilities typically are at a level much higher than our competitors, so it commands a premium pricing.

Your next question comes from the line of Vivian Hao, Credit Suisse.

Please proceed.

Hi Louis, good evening.

Hi, congratulations for a good quarter.

Thank you.

Just two quick questions.

First is what's your current maximum marketing budget by advertising format?

Probably just divided by offline versus online?

And also do you see increasing pressure from rising private players in certain local markets such as [Ching-Rai] in Beijing and also [Geray] etc.

We do, we've always had those competitors though.

I mean [Geray] have been around for as long as Shirasu and Shrader and they don't, like you said, we've secured the market, they play at a much lower point than we do, they're must.

The market is clearly segmented and we're at the high end, most of them are the middle and low end.

So that hasn't changed at all.

As far as our brand promotion expenses, it is moving more and more online.

We find the young people, obviously as you all know, are spending more and more time online so the way to reach them is to target them online and that's what we're doing.

So most of our, probably I would say our brand promotion expenses, more than half, or very close to half now, are done online and that's where the trend is going, is to reach these students online through the major sites like Baidu, Sina, Sohu, 10 Cent.

Those sites where a lot of students hang out we are targeting those sites.

Your next question comes from the line of Catherine Leung, Goldman Sachs.

Please proceed.

Hi I just have a follow-up question.

For the summer quarter, is the seasonality affected in any way by VIP classes now being a much greater proportion of your revenue?

It should not affect the year over year progression, although the growth rate will be high because of the VIP.

As you know, the ASP, each VIP ASP is equal to 10 regular ASPs.

So I think the Q4 you should expect a lower enrolment growth because, as I said, the enrolments came into Q3 but the growth rate should still be intact because of the huge deferred revenue balance.

All it means is that students pre-register for Q4 so I wouldn't expect any difference.

I think over time you will see that Q3 and Q4, the winter and the spring become a much bigger part of our business than they have in the past because, as you all know, the Gaokao is given in June and the Zhongkao is give in June or July each year, so the six months before that is Q3 and Q4 for us and that's the prime preparation season.

So I would expect Q3 to Q4 to continue to outperform, probably at the expense of Q1.

Q1 will continue to grow but it's driven mostly by overseas test prep and summer preparation.

But it also carries this burden of these excess learning centers from Q3 and Q4 for the U-Can that aren't quite as full during the summer as students take a break.

So the business will continue to trend towards Q3 and Q4.

Q1 should outperform this year because of the easy comparison versus last year, as was mentioned earlier.

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

Please proceed.

Hi, I have some follow-up questions.

Firstly I want to ask about the margin outlook for the long term.

With you doing those cost controls but also VIP classes are representing a higher percentage of revenue, VIP will have lower margins, So in the long term do you think your operating margin can go back to your historical high above 20%?

Well I believe it can Ella because you have two things, you have things working in our favor.

One is our pricing policy, so you've been able to raise prices and you know raising prices higher than the level of your costs growing will obviously drive margin expansion.

That will be number one.

Number two is utilization.

So we still have a lot of excess capacity across our network and as that begins to fill up we're going to have this giant mass or base of 450 learning centers that are mature and your incremental adds are under 100, then that will also drive very positive margin expansion.

So basically price increases and utilization will drive margin expansion.

At the same time, you're right, the fastest growing business, VIP today has about 55% gross margins, so it's lower, and also Kids is the same thing, it's about 55% gross margin.

Those two are two of our faster growing business lines.

But in the quarter, we raised Kids prices significantly.

I think it was over like 15% or so, so we're beginning to get pricing power even in the Kids side of the business which is usually the most competitive.

So I think it's, it was over 18% in the last quarter, so we would expect, if we can continue to see pricing power in these VIP and Kids, and we raise VIP prices over 30% on a year over year basis, then I think that will more than offset the fact that the mix is moving toward lower margins because they won't lower margins for long.

So I would expect us to get over 20% in the next couple of years on operating margin.

We're probably around 15% this year.

We'll move to 18% to 19% hopefully next year if we execute well, and then go back to historical numbers the year after.

Your next question comes from the line of Vivian Hao, Credit Suisse.

Please proceed.

Hi, just quickly, I understand you plan to penetrate further into more lower tier cities.

What's the general ASP level in those regions compared with the top tier cities?

Maybe, in other words, do you see that ASP trends to be dragged down in the long run?

The ASPs are lower for non-VIP.

The level is about 25% to 30% lower than for cities like Beijing or Shanghai.

For VIPs, it's about 50% lower.

But at the same time the costs are commensurately lower.

So teacher salaries are much lower in the second tier cities, as are rental costs.

So the profit margins of those are pretty much -- should still be north of 20% when those cities are mature.

The other thing to remember is these are just little Beijings and Shanghais from 20 years ago.

You know, they're going to grow up into Beijings and Shanghais as far as they are basically where the growth in China is today.

The growth is migrating away from the Eastern Seaboard towards the middle and western parts of China which is what the government planners want.

So we would expect the fastest growth in the middle and west and we're positioning ourselves for long term growth in these areas.

We're seeing a rise in Adult English again, one of our oldest products, because of factories and personnel move to the middle and west of China so do the jobs.

Where the jobs move there they need to speak to English as investment goes into these cities.

So I think that these cities are similar to Shenzhen, Guangzhou, Beijing, 15, 20 years ago and we're well positioned to capture that and be the leader in these second and third tier cities.

That's where the growth is going to be in China over the next 20 years.

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

Yes a follow-up, another question also about long term growth perspective.

I know that you have a new website, an xdf.cn coming online recently.

So far China's education market has been mostly brick and mortar or offline tutoring services.

So Louis, do you see in the long term there may be some shift towards some online offerings?

Do you think that market is now attractive?

I think it's very attractive.

I think the only thing is it has lower ASPs and I think it's mostly targeted at the lower end of the market currently.

Our ASPs are probably among the highest in China online and it's only like $50, $60 a class, but it's doubled in the last three or four years so it's growing very rapidly and we are the largest K-12 online site in China, so we are well positioned if this market takes off.

But if you ask Chinese kids their first choice, and their parents, their first choice is one-on-one instruction.

So it's like if you ask someone what kind of car they want the first is choice is probably a BMW or Mercedes.

Then if they can't afford that then they'll move down and they'll move down to small sections of 15 to 20 students.

If they can't afford that they'll move to large classes of 40 to 100 students.

If they can't afford that, then they'll go online.

So I think right now our online is more supplementary, initial questions and some courses online as well, but it's typically, it is mass marketed.

You can scale it, but it typically has lower price points and it's not as effective.

Usually money is not the issue for our high end students.

What the issue is, is time and how fast, given the limited time, can they learn the materials and obviously in this kind of format the fastest way to learn is one-on-one and that's why you're seeing the ones who can afford it move one-on-one.

Your next questions comes from the line of [Min Li] SIG.

Please proceed.

Hi Louis.

Thank you for taking my question again.

Just a follow-up question on the revenue growth.

Seeing it's already late April, can you give us some color on the first quarter revenue growth?

I think last year your top line growth is 29% in the first quarter 2011.

I have another follow-up question.

Thank you.

I would expect, because Q1 was weak last year you would expect Q1 this year to be much, much stronger than that.

I would expect easily over 30% top line growth for Q1, but we haven't done the budget yet and Q4 is tracking obviously very well given the ballooning deferred revenue balance.

So Q4 is tracking fine.

We don't have much visibility in Q1 yet but given how we performed so poorly last year because of the Expo and our own too rapid of an expansion I would expect Q1 to be much better than that this year, barring any kind of pandemic or other external event that we didn't anticipate.

Okay thank you.

My other follow-up question is about the CapEx.

I think this quarter it's $9m which is primarily due to the addition of new learning centers, so basically the CapEx for the learning centers is close to $1m which seems to be a big increase from previous quarters.

So can you please give us some color on that?

Yes it's really not.

I think the learning centers are more expensive than the past just because of inflation in China in the schools.

But most of that $9m CapEx is actually refurbishing existing learning centers, because, don't forget, we have now 450 -- 400 plus existing learning centers.

Many of them are more than three or four years old which means they need new decorations, so a lot of that is actually refurbishing this bigger base of learning centers.

But CapEx as a percentage of revenue should go down over time.

We also bought two buildings this year, as you know, in Qingdao and in Xiamen because the opportunity was there and it's cheaper to actually renting.

So $11m to $12m of that for the year is actually building purchases.

So I would expect CapEx to be $30m to $35m next year, real CapEx, which is a declining part of our business.

It's less than 5% so it's staying in that 4% to 5% range that it has been historically.

So it's really not going up at all.

We are not approaching the end of the conference.

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

Thank you.

Again, thank you for joining us today.

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

Have a good day.

Thank you for your participation in today's conference.

That concludes the presentation.

You may now disconnect and have a great day.