New Oriental Education & Technology Group Inc (EDU) 2012 Q4 法說會逐字稿

Good evening and thank you for standing by for New Oriental's fourth quarter and fiscal year 2012 earnings conference call.

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

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

This 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, Ms. Sisi Zhao.

Hello, everyone, and welcome to New Oriental's fourth fiscal quarter and fiscal year 2012 earnings conference call.

Our financial results for the period were released earlier today and are available on the Company's website, as well as on newswire services.

Today you will hear from Louis Hsieh, New Oriental's President and Chief Financial Officer.

After his prepared remarks, Louis will be available to answer your questions.

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

Forward-looking statements involve inherent risks and uncertainties.

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

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

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

As a reminder, this conference is being recorded.

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

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

Louis, please.

Thank you, Sisi.

Hello, everyone, and thank you for joining us today.

This has been another successful year for New Oriental, and I am pleased to report that we are moving into a new fiscal year in a stronger position than ever before.

Over the last 12 months, we have extended our undisputed leadership position in China's private education market sector and put even more distance between New Oriental and our competitors in terms of brand recognition, market share, service quality and reputation.

And we've achieved this while successfully looking -- tuning up our business to take advantage of major growth opportunities in new geographies and fast-growing segments.

Our results for the first -- fiscal year speak to its success.

Student enrollments hit 2.4m, up 15% year over year.

Revenue grew 38.3% year over year to $771.7m.

And in spite of heavy investment in expansion, with net of 177 new facilities, bringing our total to 664, we delivered a very impressive increase in GAAP net income, up 30.4% to $132.7m.

And non-GAAP net income increased 32.5% to $156.8m.

I'd like to spend a couple of minutes talking about the key drivers of this growth and highlight some of the exciting trends that we are building on.

First and foremost, I want to address the tremendous growth opportunity beyond China's tier one cities.

This has been a major factor in our success in fiscal year 2012, and I'm confident this will be a vital engine of our growth in fiscal year 2013 and beyond.

As we have stated previously, in addition to enhancing our market-leading brand name and maintaining the highest standards in teaching and content quality, one of our other primary goals is to establish New Oriental as the number one or number two language and test-prep tutoring service providers for K-12 in every one of our lucrative and fast-growing city markets.

To achieve this strategic imperative, we must invest in growing learning centers at a rapid pace, to achieve critical mass and economies of scale which will drive long-term sustained and increasing profitability.

In fiscal year 2012, second and third tier cities achieved about 43% of revenue growth, contributing around 48% of our total revenue, whereas Beijing and Shanghai collectively recorded about 29% revenue growth and accounted for about 37% of total revenue.

The cities around Beijing, like Xiahuayuan and Zhangjiakou, are good examples of an emerging paradigm within student attitudes.

Previously, many students from these cities would take -- would have traveled to Beijing during the summer and winter break to take classes at one of our boarding schools in the capital.

But now New Oriental has branches across these cities, where we offer the same or comparable premium standard education that a student can get in Beijing.

So, now more and more students choose to stay in their home towns, taking New Oriental courses locally instead of traveling into Beijing during these holidays.

A similar behavior is occurring with New Oriental Shanghai schools and in the surrounding areas.

Looking longer term, I believe we have only begun to scratch the massive opportunity of these fast-growing markets.

Over the next fiscal year, we will continue to aggressively invest in penetrating these lower-tier cities.

In fiscal '13, we intend to open over 200 new learning centers.

The vast majority of them will be small centers, 300 to 700 square meters, designed for our VIP and K-12 classes, rather than large-scale test prep courses.

The vast majority of these centers will be located in cities outside Beijing and Shanghai.

While they obviously means a significant CapEx outlay upfront, these smaller centers typically are profitable in their first year of operation because they fill up more rapidly.

We will endeavor to manage that expansion carefully, in order to ensure that these centers will not have a long-term drag on margins.

Furthermore, we expect most of our small centers will be at mature levels of utilization within two years, compared to the average three to four years it takes for a larger center to ramp up.

To be clear, we are still nowhere near the limits of expansion in the tier one cities.

We are confident that we will continue to expand -- to experience robust growth here, but just not blockbuster levels, and are seeing it at the smaller cities.

While growth in our traditional business lines like adult English and CET4 and 6 test prep are slowing in Beijing and Shanghai, we continue to see great potential to grow some of the other business lines such as K-12, overseas test prep and VIP in Beijing and Shanghai.

Looking more broadly at the performance across our business lines, the key takeaways from fiscal year 2012 is our continued success in developing winning product offerings to suit changing learning habits, and quickly dominating in these new markets.

In a strong year -- it's been a strong year across the board.

Our VIP personalized classes have been our star performer.

In fiscal year 2012, VIP classes saw year-over-year enrollment growth of 61% and year-over-year revenue growth of over 71% to about $207m.

This illustrates the enormous demand for more personalized classes, both in the tier one and lower-tier markets.

And, crucially, only New Oriental has the branding power and track record to command the premium fees that these courses command, so I am very confident in the long-term prospects for this segment.

Our K-12 All Subjects tutoring school business also had a great year.

We recorded year-over-year enrollment growth of 25% to over 1.3m students and year-over-year revenue growth of over 52% to $294m.

Again, despite the strong performance last year, we see continued growth potential in this segment.

It is clear to us that market demand is shifting toward VIP and K-12 segments.

So we are very encouraged that we have had such a strong market presence here in a relatively short period of time.

K-12 and VIP accounted for 37% and 27% of revenue in fiscal year 2012, respectively, versus 33% and 21% respectively in fiscal year 2011.

Please note that these figures reflect some overlap, as many of our K-12 students are also taking courses in the VIP formats of one teacher to one student up to one teacher to six students.

There are, of course, lower-margin offerings, but these are also the segments with the best long-term growth opportunities, particularly in the lower-tier cities.

Having said that, we continue to deliver robust growth in the overseas test preparation business, a segment where New Oriental remains the clear and undisputed market leader.

Enrollments in fiscal '12 increased 7.3% year over year to over 340,000, while revenues jumped 43% to $238m.

Outside the classroom, we're also rapidly expanding our Vision Study Consulting business to help students study overseas, continue in China as it will probably be more affordable for more families than we've already positioned.

Sorry, let me start that again.

Outside of the classroom, we're also rapidly growing our Vision Overseas Study Consulting business.

Interest in studying overseas continues to increase in China, as the possibility becomes more affordable for more families.

And we're ideally positioned to capitalize on this existing dominance in Chinese test prep -- overseas test prep.

Naturally, the students seek our advice and counseling.

Vision Consulting recorded year-over-year revenue growth of approximately 85% to about $42.5m in this fiscal year.

Before we get into G&A, a quick review of some financial highlights for the quarter and the year.

The detailed numbers and figures are available in your press release.

Looking at enrollments, as I have mentioned, for the full fiscal year grew at a very encouraging 15%, as our new learning centers ramped up to mature levels of utilization.

I want to highlight that the relatively low enrollment growth of 7.7% in the fourth fiscal quarter was expected.

As I flagged last quarter, the Chinese New Year had an early holiday.

Students enrolled for their spring courses at the end of the third fiscal quarter, which naturally means that the enrollments in a little lower in the following quarter.

As you will recall, enrollments grew by 21.8% in Q3 last year, primarily due to a spike in spring registrations in February following the early Chinese New Year.

Operating margin for fiscal 2012 was 15.2% (sic - see press release "15.1%"), compared to 17.1% in the fiscal 2011.

Non-GAAP operating margin, which excludes share-based compensation expense, for the fiscal quarter was 18.3% compared to 20.1% in 2011.

We are encouraged that we maintain a healthy operating margin despite an aggressive pace in investment, and plan to slow down that pace of investment into next year.

For the fourth fiscal quarter, general and administrative expenses increased by 55% year over year to $71.8m (sic - see press release "$71.6m").

Non-GAAP G&A expense, which excludes share-based compensation expense, was $64.1m, a 49% increase year over year.

This is primarily due to increased headcount, in line with our expansion during the quarter.

We opened 56 new learning centers in the quarter and also continued to meet -- invest in content and new program development offerings, as well in improving teacher quality.

I am pleased with our performance this year, 2012.

Over the last 12 months, we demonstrated clearly that New Oriental is proactively and creatively managing our business to achieve long-term and deliver long-term value for our student -- shareholders.

This is not a company that is content to coast along on its reputation alone.

This is a company that is working hard to sustain its market dominance for years to come.

Moving into fiscal year 2013, we're very confident that New Oriental is ideally positioned for sustained, long-term growth.

In the immediate term, we are conscious that China faces some macro headwinds.

After many years of double-digit growth, there are signs that the economy is decelerating.

While education is a very resilient discretionary spending category for Chinese consumers, we do expect that this slowdown will have some limited impact on our business.

However, we believe that the growth potential for New Oriental is enormous as we push into untapped markets outside the tier one cities, and our offering to suit changing learning habits in China.

Clearly, there are some downward pressure on margins as we are in a transition period in investing in lower-tier cities to capture.

The growth opportunity, in addition to student preferences, are shifting toward lower-margin offerings.

However, I am confident that this is the correct strategy to position us for sustained, long-term growth.

Looking at the guidance for the year ahead, we currently expect total revenues in the first quarter of fiscal year 2013 to be in the range of $342.7m to $356.3m, representing year-over-year growth in the range of 26% to 31%, respectively.

The forecast takes into account slower growth in Beijing and Shanghai, the macroeconomic slowdown I just mentioned and the expected lack of RMB currency translation benefit seems to have halted and in some cases reversed in periods vis-a-vis the US dollar.

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

The SEC investigation.

On July 13, 2012, the Company was informed the US Securities and Exchange Commission had issued a formal order of investigation captioned "In the Matter of New Oriental Education & Technology Group Inc.".

The Company believes that the investigation concerns whether there is a sufficient basis for the consolidation of Beijing New Oriental Education & Technology Group Company Ltd., a variable interest entity of the Company, and its wholly owned subsidiaries, into the Company's consolidated financial statements.

The Company intends to fully cooperate with the SEC in its investigation.

The Company's outside independent auditors, Deloitte Touche and Tohmatsu, have not as yet completed the audit for the year ending May 31, 2012.

However, Deloitte continues to believe that the Company's historical financial statements are appropriate.

Please note that in light of the sensitivity -- sensitive nature of the SEC investigation, I will not take any questions or comment further on the situation in this Q&A session, other than to reiterate that we intend to fully cooperate with the SEC in this investigation.

At this point, I will take your questions.

Operator, please begin.

Thank you.

(Operator Instructions).

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

Please ask your question.

Hi, Louis.

Thanks for taking my question.

My first question is about your first-quarter guidance, which appears soft.

Could you please elaborate a little bit more on which business lines are slowing down and why?

And also, could you share with us your full-year expectation in terms of enrollment and ASP growth for the year?

Thank you.

Okay.

For the first quarter, there's several reasons why the guidance is a little bit lower than normal.

One is that -- one reason is that Beijing and Shanghai have begun to slow down, as we mention in there.

In fact, in RMB terms, Beijing and Shanghai only grew 24% and 20% last year, respectively.

Well, if I don't get a US dollar translation benefit, the growth rate has really slowed down from 29% down to 20% or so.

So that will take the slowdown.

The reason for that is a lot of the -- all the cities around Beijing and Shanghai are cannibalizing them, because the quality of New Oriental education in those cities is quite good.

And so students are finding it no longer necessary to travel to Beijing and Shanghai to take those classes.

So that's one factor.

A second factor is relating to the fact that our investment today is in cities outside of Beijing and Shanghai, because the growth rate is much higher.

So we expect those to continue to grow rapidly.

A third factor is last year we had a very strong Q1.

Remember, revenues were up 41%; profits were up 45%.

And so that makes it very challenging on year-over-year comps.

So we just tried to be a little more conservative.

And so those are primarily the reasons; foreign currency translation, some slowdown at Beijing and Shanghai.

As you know, Beijing and Shanghai both have new school heads, so there's going to be a transition period, and then the issues with managing -- with the cannibalization.

The fourth factor obviously is the slowing Chinese economy.

I think even though we seem very resilient, we're still growing [30-something percent] a year, it's still not -- we're not immune from a slowing Chinese economy, especially consumer discretionary spending.

As far as guidance for the year, I think our revenue guidance will somewhere be probably similar to our first-quarter guidance, 25% to 30%; 26% to 31%.

And I think the profit guidance is the one that's difficult, because we're expanding so rapidly.

And as we enter these lower-margin businesses, we haven't got the efficiencies down yet.

We need another one or two quarters to fix the efficiencies and get the margins turning the right way.

So I think we'll guide 25% to 30% probably on the top line and somewhere between 22% and 25% on the bottom line.

And as I said, that's our preliminary view.

As far as enrollment increases, we increased to 2.4m or 15% last year.

I'd expect that number to come down a little bit, given the larger base and the slowdown in the general economy.

So I would expect us to grow enrollments somewhere in the probably 10% to 13% range.

So I would think that's about 2.7m enrollments.

Okay.

You mentioned slowdown in Beijing and Shanghai.

Is it mainly for the overseas test preparations?

Well, it's partly overseas test preps.

It really is more the summer camps, the boarding schools.

So in the past we used to have thousands of students who would pay us like CNY5,000, CNY6,000, CNY8,000 to come into Beijing for 10 days and study the CET4, CET6, SAT, a whole bunch of tests.

But as we've been successful in growing our --

Like I said, if you look at Shanghai, our Shanghai school is very good, but our Hangzhou school and our Suzhou school are just as good.

So students who used to come from Hangzhou and Suzhou to go to Shanghai to take this no longer are traveling there.

So the margins for this business are actually quite high.

CNY5,000 per student, if they stay home in Hangzhou or Suzhou their ASP is CNY1,000.

And so it's -- we're a victim of our own success, but it's the right thing to do.

You can't ask -- it just shows you our quality is getting quite good across the country.

Same thing, as we explained, in Beijing.

And so I think that's just a -- it's a factor.

I think Beijing and Shanghai truly, without sounding too bad, have been mismanaged the last couple of years.

And so we are hopeful, with the new management teams in place there, we'll also begin to drive growth, especially the K-12 and the overseas test prep business as well.

So I think Beijing and Shanghai still have long legs, but they're growing, in RMB terms, in the low 20s, whereas the rest of the network is growing in the high 30s, low 40s.

So the emphasis has to be on the tier two cities.

We're already so big in Beijing and Shanghai.

We're over $200m a year in Beijing, about $100m in Shanghai.

The base is getting so large.

It's getting -- we're crowding ourselves out.

And then quickly on your VIP business, you provide cash revenues for the year and I just wonder how does that compare to the revenues that you actually recognized during the year?

Well, the cash revenue is when they sign up for the course.

So a lot of the cash revenue gets put into deferred revenue as it gets paid out over the course of the year.

Some of that cash revenue never gets recognized, because of students who cancel just before the class starts.

So it's a good proxy for demand, but it's not one to one.

Do you have roughly the level of cancellation, as a percentage of total?

It's very low.

It's like 1% or 2%.

Okay.

And lastly, could you also provide the recognized revenue for the year, so I can get a comparison against your cash revenue?

The recognized revenue for the year is $771m.

I don't know what the total gross revenue was.

Total gross revenue will be about 4% higher because we also -- don't forget we have to pay business tax.

No, I mean for your VIP business.

I don't have that breakdown, sorry.

Sisi can try to get that for you.

Sure.

Thanks.

Thank you for your questions.

Your next questions come from the line of Chenyi Lu from Cowen & Company.

Please ask your question now.

Thank you.

I have two questions regarding your school expansion in the year 2013.

You're talking about it's going to be over 200 new learning centers.

Can you give us a breakdown as to the schedule of the school expansion?

Are you going to be more focused on second half of fiscal year 2013?

That will be my first question.

And then after that I have another question.

Ideally, if I could do it, I would want expansion in Q2 and Q4.

The reason is that Q2 is kind of a slow quarter.

If you add the learning centers, then you can ramp them up right away in Q3, during the winter.

And also, in Q4 it's always a busy quarter but Q1 is busier, so if you can ramp up the expansion in Q4 and then do it in Q1.

But it doesn't work that way.

So we end up expanding relatively the same all year round.

I think the total capacity add for this year will be much lower than last year, even though the numbers look higher.

That's why we quoted them in square meters.

Last year we had a net 177 learning centers.

Each one was about 1,050 square meters, on average.

That means we added 200,000 square meters of space, taking our total space to 900,000 square meters.

Well, this year, even if we added 200 and something learning centers, so a higher number, we're unlikely to add more than 150,000, 160,000 square meters.

So the net add is actually much lower, which means that I think as the -- it won't be as negative to margins as last year.

And so that's why we're trying to manage these so that they become profitable quickly, and then that way the margin picture will turn relatively quickly, so we didn't need another quarter or two.

My next question also relates to the operating margin, just to be able to -- what you just answered.

So can you give us a view on operating margin in 2013?

Would that be the year also you're going to bottom and then you're going to (technical difficulty) in fiscal year 2014?

Thank you.

I think the difficulty is we will bottom some time in 2013.

Unfortunately, it probably won't be Q1.

So if it's not Q1, which is the current quarter ramp, Q1 is 60% of the profit, it will be hard -- it will make a dent in the rest of it.

So the -- we believe we will bottom some time in Q2.

But -- so if you go to core year-over-year comparisons, it's just starting to get better, but Q1 will not because we added 177 learning centers and like 100 and something in the two quarters beforehand, and those haven't filled up yet.

And as we mentioned earlier, the pickup has been a little slower than we thought.

The new enrollments are not as fast as in past years, because of the economic slowdown in China.

Okay.

So do you expect margin going to -- on an annual basis, to be flat or probably slightly down year over year in 2013?

We're going to fight like hell to get it flat or up.

But we haven't been winning this one the last year, year and a half.

We do our best.

But like I said, we're also fighting our own school heads because the -- and legitimately so.

I think we've taken a different picture.

We are focused on profit, but in cities that are high profit margin and growing really fast, we're not going to slow down the learning center growth.

So, for example, say like Hangzhou, Hangzhou has like 30% profit margins.

And if he wants to add learning centers, he's welcome to do it because he has such a high profit number, that kind of corporate overhead.

The same in Xi'an.

So all cities that are really well managed, that are growing like crazy, I'm not going to slow them down.

Some cities that are not as well managed and they still want to add learning centers, those are the ones we're going to target to try to slow down the learning center growth.

Okay.

Thank you.

That's all my questions.

Thank you for your questions.

Next questions comes from the line of Jeff Meuler from Baird.

Please ask your question.

Yes, thank you.

Louis, I guess could you just go over the impact that Chinese New Year had on Q4?

I understood why it negatively impacted Q2 and why Q3 may have been artificially high, but could you just clarify on the impact on Q4?

Yes.

What happened with Chinese New Year is that it occurred on January 23.

So if you look on a revenue basis, the timing was too early.

And so, instead of running two sessions during the winter, we really only ran one session.

So that had a negative impact on revenues and profit for Q3.

That's the warning we had.

Now, there's another impact, though, on enrollments.

So what happens during Q3 is that, because Chinese New Year was so early and the cutoff for our Q3 is February 28, the students come back early, because they left early for Chinese New Year, so they come back in the middle of February.

That means, when they come back, they have two weeks before our quarter ends to sign up for their spring classes.

And that's why you saw a 22% -- 21.7% jump in enrollments in Q3.

Those enrollments were actually for Q4.

And so when Q4 came along, the students had already enrolled during the Q3 period for the Q4.

Therefore, student enrollment in Q4 was like 7.7%.

If you blend the two together, you're right at 15% again.

Okay.

And it sounds like, if you look at the recent weeks or the last month, it's tracking up in the low double digits?

It is.

It is right around the low double digits.

So it's -- but the problem now is that the tickets are getting high, right.

There's a lot of VIP students.

So the revenue number is actually quite high relative to the enrollment number.

So, as we move to smaller classes and higher-priced classes, the revenue number is tracking higher than the enrollment increases.

Okay.

And then just in terms of the recent growth being slower than it was at any point during the 2008, 2009 downturn, excluding quarters where there was unusual events, I guess could you just speak to that in terms of what's driving it?

Is it just this penetration rate in Beijing and Shanghai?

Is there anything on the competitive front?

I guess if you could just address that.

Thank you.

I think Beijing and Shanghai, it is -- we are pretty mature in both cities, and also we face very stiff competition in Beijing and Shanghai.

The other thing is -- I think is people don't feel as good, right, because the economy is not good -- as strong.

Things are really slowing.

And so if you -- we just heard today that BMW sales are terrible in China this year, and the same with the Prada bags and things.

So you're seeing a across-the-board pullback in spending in the luxury sector, and New Oriental is one of those luxury spends.

So I think we are seeing a slight slowdown, although -- I wouldn't see the 31% revenue growth.

So I think we are hit much less, though, but we are going to get hit.

At the same time, as I said earlier, we believe Beijing and Shanghai have not been managed as well.

The two new school heads need time to transition, so give them six months.

So that's why Beijing and Shanghai will be under short-term pressure.

The third issue relates to the cannibalization.

As we build out the whole country, the quality of our instruction is becoming very, very good across all of China, with the systems we put in, with the same content, and the teacher training facilities.

Therefore, students are finding it less and less necessary to travel to the tier one cities to get the education.

They get it in the tier two cities.

And so, because of all these factors -- now, obviously they pay less in the tier two cities than the tier one cities.

So, all these factors have a dampening effect on our revenue.

However, dampening -- and of course the fourth one is, as you guys highlighted, is the fact that we report in US dollars.

So we're no longer going to get the RMB 5% translation benefit.

So if you look at it, we just took down our revenue projection 5% down, which is equivalent to the 5% we got from the translation benefits.

So I guess, in local currency terms, what do you view as a sustainable ASP increase, given all of the mix shifts you have, both between geographies as well as between (multiple speakers)?

Yes.

So, if we look at this in RMB terms, I think our growth rate is 25% to 30%.

So I'm assuming no RMB appreciation.

I think our ASP increase is about 13% to 14%, and our students about 10%, 11%.

So I think that's where you get that number.

Okay.

Thank you, Louis.

Thank you.

Thank you for your questions.

Your next question comes from the line of Steve Zhang from Macquarie.

Please ask your question now.

Thanks for taking my question.

In terms of the macro impact, which segment of your business are you seeing the most weakness?

Is it overseas test prep?

I would assume that's the, I guess what you mentioned, more luxurious item.

Yes.

The overseas test prep seems to have a little bit lower student base, but the revenues are fantastic, up 43%.

So that's telling me is that we are getting fewer students.

So we're losing -- actually, the bigger class students and the ones who are willing to pay anything are still willing to pay anything, and so the VIP overseas test prep is not slowing down.

Right?

So that's the contrary thing.

You would expect the highest paid ticket to slow down; it's not the case.

People with money still have money.

But I think you see a slowdown in the number of smaller class and students in the overseas test prep.

It also could be the fact that, if parents don't feel as good as they did in years past, they may not be as confident in sending their children overseas, or they may take lower-cost alternatives than New Oriental in the test prep area.

There are a lot of schools that compete with us that price a lot lower than we do.

Okay.

In terms of pricing power, maybe I could get a little more granularity on this.

Are you seeing less pricing power in some of the U-Can and POP Kids segments, given the macro environment?

We have -- we just really began to face this macro environment in the last three months.

We are continuing to raise prices.

Last year -- last quarter our ASPs were up 14% on a blended basis, so we haven't really toned back the price measure.

We may do that if demand slacks off significantly.

So we would maybe look at that as a way to drive up more students.

But as of now, we have not really slowed down our price increases.

Okay.

Thanks.

Okay.

Thank you for your questions.

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

Please ask your question now.

Mr. Marostica, your line is open.

You may [admit] yourself.

Yes, sorry.

Thanks for taking my question.

Just following up on the ASP theme, I'm curious, Louis, what you're seeing in terms of ASP increases in tier two cities as opposed to Beijing and Shanghai.

Well, tier two cities, pricing is actually quite healthy.

So it's just like Beijing and Shanghai were 10 years ago, so they're actually quite healthy.

But what they do is because when you blend it with Beijing and Shanghai, it looks like the pricing is going down.

This is what I talked about before.

But it's not.

So I think that for us the pricing is fine.

The pricing in tier two cities is actually quite strong.

And in Beijing and Shanghai it's also quite strong, but maybe not as strong as in years past.

But the blended effect is not going to look like the price is going up that much, because the tier twos have a lower ASP than tier ones.

Mark, this is something I highlighted a couple of quarters ago.

(Multiple speakers).

Okay.

And then on a relative basis, are you seeing more strength in VIP or K-12 in tier two cities?

It's both.

It's both.

It's K-12 primarily, but then many of their parents want them to take VIP as part of the -- VIP is just a format, right.

So a lot of -- K-12 is booming in tier two, tier three cities.

And then what happens is a lot of the parents want their kids to take one-on-one physics or one-on-one chemistry, and so they're both doing very well.

Basically, they work together.

Fair enough.

And then a last question.

You talked about 22% to 25% profit growth.

Were you referring to GAAP or non-GAAP?

GAAP.

Okay.

Great.

Thank you.

Thank you for your questions.

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

Please ask your question now.

Thank you.

Hi.

Louis, could you -- I just want to discuss further with you regarding this macro slowdown.

It's a little bit complicated to us that you are still seeing very strong growth in the VIP sector, and you said you do not plan to slow down the price increases in the near term.

So what's exactly -- which sector or geographically where are you seeing a slowdown of the amount?

Well, you see some slowdown in the number of overseas test prep --

(Multiple speakers) because of demand or because of the supply?

Yes, you see a continued slowdown in adult English.

You see some slowdown in the enrolment number of overseas test prep.

Right?

And then in K-12 it's very strong; VIP is very strong.

But those are our newer businesses, so they haven't really hit critical mass yet.

So they're expected to be quite strong because, number one, VIP and K-12 are applicable everywhere in China.

Every one of our 50 cities has those.

Whereas something like overseas test prep is stronger in the tier one cities, where there's a lot of colleges.

Things like adult English are stronger in the tier one cities, where there's a lot of businesses.

So the one that's universal, that goes across all of China, is K-12 and VIP, and you've seen that reflected in the strong growth.

It's very early in the penetration of those cities.

So you mentioned softness in overseas and also adult English.

Do you think it's also because of some landscape change in competition on the market?

I don't know.

We always have the competition.

I don't know if that -- I don't know of any players that challenge us in overseas test prep.

I think at some point the number of Chinese students can't keep growing.

Right?

It's been going up by 30%, 40% a year in students going overseas.

I don't see that number continuing.

So at some time you're going to have to plateau out.

Right.

Okay.

And then, in terms of your sales and marketing spending, those have been trending higher, growing above the revenue growth in the past two quarters.

So could you talk about your strategy in sales and marketing going forward, especially now we may face a slower revenue growth?

For the year it's the same, 14.8%.

14.8% is the same year over year.

But it started off lower and worked up a bit higher.

Part of that is because of the shift in Chinese New Year.

Our school heads kind of panicked and started marketing more to -- because they were worried in Q3.

Also, in Q4 it's usually a high marketing spending quarter, because we're preparing for the busy summer quarter.

And I think we're spending more money in Beijing and Shanghai in marketing than in the past, because the growth rates have slowed down.

So I think those three reasons is why the marketing may be a bit higher than normal.

For the whole year, it was flat year over year, 14.8%.

Right.

So what's the outlook for fiscal year '13?

Well, it should be lower than '12, but that varies depending on the school.

And then we'll adjust the marketing spending depending on how the business does.

So, because Beijing and Shanghai were not getting as many boarding students early in the quarter, we spent more on marketing to get those boarding students.

And then, in terms of teachers and staff hiring plan for next year, how does that trend year over year?

The teaching -- we'll still need to hire 5,000 teachers or so net, so that will continue the same.

If we add 200 and something learning centers with a capacity of about 150,000 square meters, we're going to add probably 300,000 more students so we would probably add another 5,000 teachers.

The key is to not add as much staff, the G&A staff.

And so if we can cut the staff, then our margins will go up right away.

Got it.

And lastly, I want to ask you about the corporate structure change announcement on July 11.

Could you provide more details?

And how is that going to impact the shareholder structure for the listing company going forward?

It doesn't impact it at all, right.

What happened was when New Oriental set up its original VIE in 2002 and then 2006, there was a lot of founders.

Remember, New Oriental had a lot of old founders in the Company.

There's like 11 of them who were the shareholders of the VIE.

In the last six years since the IPO, 10 of those people have left the Company, so they no longer have any shares or minimal shares in the Company and they're not involved at all in management or anything related to the Company.

So last year, after all the scrutiny on VIEs and on -- and the frauds that were coming out of those, we took it on ourselves to say, well, let's clean up our mess now; let's get rid of the other 10 shareholders so we can consolidate the VIE into Michael Yu, our CEO.

He had control before anyway, at 53%, but make it 100%, because those other guys have nothing to do with the Company.

There have been cases in other Chinese companies where the VIE shareholders who were disgruntled refused to sign, even though under contract they have to.

So we wanted to avoid future problems by cleaning up our VIE now.

But it seems like in doing that we triggered a review by the SEC, which is creating the current problems for us.

Because I think originally they probably thought, oh, it's another Jack Ma situation or something, and it's not.

This was completely above board, to clean up the structure, so that the old shareholders who don't have any involvement with the Company cannot influence the Company.

All right.

But this was -- so you understand this was done with the best intentions.

Thank you for your questions.

The SEC investigation is triggered by this corporate structure change?

We don't know.

I don't know.

Like I said, Friday the 13th was not a good day for me.

That's when I heard about this.

So we don't know all the details yet.

We are working closely with the SEC.

We are fully cooperating.

We will get to the bottom of this.

Thank you for your questions.

Ladies and gentlemen, in order to take all the questions, please limit your questions to one question at a time.

If you'd like to have follow-up questions, you may ask to rejoin the queue.

Next question comes from the line of Trace Urdan from Wells Fargo Securities.

Please ask your question now.

Thanks.

Louis, I wondered if you could comment on the management changes in Beijing and Shanghai and to what extent you believe that current weakness in those markets is related to simply the management and whether the -- the management transition, and whether you would see that more on the top line or whether there's any sort of margin impact associated with that transition there.

It goes to both top and bottom line, Trace.

I think let's take one city at a time.

Shanghai was run by Wang Haitao, who's been with New Oriental for like 12 years.

He's an experienced manager, very, very smart guy, a great teacher.

But honestly, he's not as charismatic, not as energetic.

And so the last two or three years Shanghai has not grown.

It's grown by 20%, 25% a year.

It hasn't kept up with Beijing, even though it should; it's off a smaller base.

So ever since the last [2000], I think, we've been contemplating this change, but at the time we had nobody to replace him.

He's a fantastic school head, just not fit for Shanghai because you need somebody with more energy, more charisma.

And then over the last three years, there was a young guy in Xi'an named [Chen Hao], and he's a superstar.

He took Xi'an -- we're in the middle of nowhere -- to over 30% profit margin, not counting corporate overhead.

So Xi'an's profit margin is only 1 point below Shanghai, and Xi'an is not as lucrative a city as Shanghai.

So this guy has done 50% and 70% top and bottom line growth for four years.

So he was the best young school head we had.

So once he was ready, we moved him to Shanghai.

And right now the department heads in Shanghai love him.

So it seems to be a very good fit.

And he's very aggressive, very hardworking, and so we expect good things from Shanghai in the upcoming quarters.

Wang Haitao has done a great job.

He's a great administrator.

He's been with -- he knows everybody; everybody just likes him.

So we moved him to Beijing.

And what he lacks in charisma and energy level, Michael Yu has.

So Michael Yu and then Chen Xiandong is obviously our COO, is very good at operational issues.

So the three of them together are now running Beijing schools, and Zhou Chenggang as well.

So you've got our whole senior brain trust except me running Beijing schools, because we're all local in Beijing, so it's easy.

So it's basically a shared project.

I think that's acceptable to everybody in Beijing.

And so I think this system is working.

Wang Haitao does all the administrative type thing.

Michael and Chen Xiangdong do more of the spiritual, charismatic, strategic things.

And then Yang Zhihui, who is my VP of Finance, works with the Beijing finance manager to keep the costs in line.

So I think this is the best system we can have to take care of our two most important schools.

Thank you.

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

Please ask your question now.

Hi.

Yes, this is Eric.

Yes, I just have two questions.

First question is, Louis, you previously mentioned that New Oriental intends to grow its top line, bottom line by both 30%.

Do you mean that by US dollar or local currency?

By US dollar, and so I think if the RMB stops appreciating we'll probably take it down to 25%.

I would have meant 30% anyway, because we're growing so fast.

But I think with the slowdown in China, I want to give myself some room.

So I think 25% -- I would say 25%, 30% on -- closer to 30% on the top line, and probably closer to 22% to 25% on the bottom line.

Thank you.

Next question comes from the line of Anita Chen from Jefferies.

Please ask your question now.

Thank you, Louis.

I just have following question on teachers.

We're expanding so quickly.

Do we have any challenge in recruiting qualified teachers and how to manage it?

We always have that challenge, and that's why we invested heavily in the last two years in this teacher training system and materials that allows 75 people to spend most of their time, almost all their time training teachers.

We train 5,000 teachers a year.

So it is a challenge.

That challenge and also finding good school heads is our two biggest challenges.

Thank you.

Next question comes from the line of Brandon Dobell from William Blair.

Please ask your question now.

Thanks, Louis.

In relation to your comments about I guess less pricing power or the kind of consumer discretionary slowdown, do you see any change in the cost structure, primarily teachers' salaries or rents?

Are they following the same trend or are they still staying strong, even though pricing is now weaker?

Teachers' salaries are going up.

It's not as bad as a couple of years back, when inflation was higher.

But there is an additional cost that is costing us more, which is the social welfare payments.

So the government is encouraging us to take up the percent we pay -- part of it the employers withheld from their salaries, to pay for their social security or their retirement.

And so that number has gone up a lot.

So I would say probably 12% of salaries now is going to social welfare costs, and that's I think the big -- it's a negative for our bottom line.

Thank you.

Your next question comes from the line of Chao Wang from Merrill Lynch.

Please ask your question now.

Thank you for taking my questions.

Firstly, I notice that gross margin actually expanded 80 bps in the quarter, although operating margin declined.

So does that imply utilization rate was improving while other expenses were out of control?

And specifically within G&A, I'm wondering how much is labor related costs, and how does that ratio compare to previous quarters?

Thank you.

G&A is almost all labor, right?

Okay.

It was all labor.

And it's all labor related to opening up new learning centers that haven't started yet.

So the big increase in G&A is people working on learning centers, being hired for learning centers before they've opened.

So that's the big cost.

Gross margin was up 50 bps for the year, so we're getting better utilization.

But it's being swamped by the fact that we added 177 learning centers, which means we added -- you do the math, we added 3,000, 4,000 people who didn't produce a profit this year.

Thank you.

Your next question comes from the line of Fei Fang from Goldman Sachs.

Please ask your question now.

Hi.

Thanks.

This is Fei Fang calling on behalf of Catherine Leung.

I have a very quick question.

So for your sales and marketing, how much of the growth is related to advertising spend versus headcount increase?

Thanks.

Both have gone up a lot.

I think the advertising for this last quarter was quite high.

It's about 40%, 50%.

The headcount is slowing down, because the VIPs at the beginning had more students per headcount.

But I think advertising spends in the last quarter and a half really have gone up.

And that's because we were challenged to get more students into Beijing and Shanghai for this boarding program during the summer, and also because when business begins to slow the natural inclination is to market more.

Thank you.

Your next question comes from the line of Kevin Tan from Joho.

Please ask your question now.

Hi, Louis.

Just one quick one on Q4 revenue and enrolment growth respectively for kids, high school and overseas tests.

Q4, I just have Beijing.

Hold on.

I've got to find out.

Sisi can send these to you.

Is that okay, Kevin?

Yes, that's fine.

Sisi, can you send Kevin the growth rates for those four programs?

I have it in a separate sheet and I can't find it right now.

(Inaudible).

Thank you.

Your next question comes from the line of Jennifer Gao from Credit Suisse.

Please ask your question now.

Hi.

Thanks for taking my question.

[Chen Xiangdong's] recent speech mentioned some focus for fiscal year '13, and it seems to me that the Company's focus has been number one overseas test prep, number two Vision Overseas and number three global study tour, and then K-12 and etc.

I'm interested to understand how New Oriental views and positions global study tour, as it had only like 10,000 enrolment for fiscal year '12 but contributed nicely to the top line.

And margins I think is quite low for this business, right?

Overseas study tour is quite high in margins.

And it's also -- I think it's a very important piece, as we lock the student up basically for the study tour, for the SAT test prep, for the study consulting, and it means all part of the same -- and the English language training is all part of the same marketing tool.

It's very popular.

It's high dollars, high profit.

And it's similar to the boarding programs in Beijing and Shanghai that I was talking about.

It's very similar to that.

And those are slowing down, and I think that's partly -- that's probably because our schools around Beijing and Shanghai are getting better.

It's also probably because of the slowdown in China in general.

People don't want to spend large amounts of dollar on travel and vacation, especially a vacation for the kids to look at different colleges.

They feel like that's an expense that's not necessary.

Thank you.

Your next question comes from the line of [Ken Shi] from SAC.

Please ask your question now.

Hi, Louis.

Thanks for the presentation.

Again, we have another strong quarter with the cash balance still growing.

I remember we had a discussion earlier this year about potential use of this cash balance to return to shareholder by a stock buyback when share price is volatile.

Is that still viable in this environment?

Well, we've already announced a dividend, so we will look at other return of capital depending on the share price movement.

We already announced a 50m dividend last time.

Thank you.

Your next question is from the line of Jin Yoon from Nomura.

Please ask your question now.

Good morning.

Thanks for taking the question.

I apologize if this question has been asked before, but your expansion plan of a couple of hundred new schools or small outlets going forward, I guess what's the strategy behind that?

Considering the fact that you're seeing cannibalization, considering the fact that you're seeing a slowdown in potential pricing and these schools are not going to be profitable for 18 months plus, in this environment, is there a need to expand so aggressively in markets where you're not going to be profitable, for a long time anyway?

I think all those statements are incorrect.

I think these schools are profitable in year one.

These schools are necessary because in the smaller cities, you build a 2,000 square meter learning center, it's going to take five or six years to fill up.

These fill up within a year, year and a half.

This is just the way it's done in these cities right now.

So it's sort of like large Walmarts everywhere.

In the smaller cities, you typically have your smaller facilities.

So this is the new model for second and third tier cities.

And because in second and third tier cities there isn't really much adult English and overseas test prep, that's what you need the big centers for.

So these are more VIP and kid centers.

So it's exactly the model we need for this size city, and that's why we're doing it.

Thank you.

Ladies and gentlemen, we are now approaching the end of the conference call.

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

I just want to thank everyone for taking the time on this call.

It is a bit of a shocker, but I think we will do our best to pull through.

Thanks, everybody.

I look forward to talking to you guys on the road shows.

Bye.

Thank you.

Ladies and gentlemen, that does conclude our conference for today.

You may now disconnect.

Good day.