New Oriental Education & Technology Group Inc (EDU) 2013 Q4 法說會逐字稿

Ladies and gentlemen, good evening and thank you for standing by for New Oriental's fourth quarter and fiscal year 2013 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 objection, you may disconnect at this time.

I would now like to turn the call over to your host for today's call Ms. Sisi Zhao, New Oriental's Investor Relations Director.

Ms. Zhao, please proceed.

Hello, everyone, and welcome to New Oriental's fourth fiscal quarter and fiscal year 2013 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 1995.

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.

I am pleased to say that we're closing out this year with a stellar set of results.

For most of fiscal 2013 we have been very focused on shifting toward a strategy of Harvest the Market which we felt would drive growth and improve profitability.

The excellent top and bottom-line results that we are reporting today have testified to the success in delivering on these goals.

Looking at the fourth quarter, our performance was very strong across the board.

But the real [trend] that stands out was the major improvement of our bottom line.

Thanks to our emphasis on strict fiscal discipline and improvement in utilization, we achieved a dramatic improvement in operating margins which expanded by 440 basis points to 10.2% to an operating income which grew by 122.5% to $24.4m.

And the net income it rose by a very impressive 73.4% to $28.2m.

You'll recall that we also recorded strong margins in the third fiscal quarter so these consistent improvements are a direct result of our successful pivot to the Harvest the Market strategy.

Since we commenced this strategic transition in November 2012, we have deliberately slowed down our pace of expansion and focused on ramping up utilization and efficiencies across our existing network.

We have shut over 50 underperforming schools and learning centers over the past eight months, allowing management to focus on improving utilization and profitability of our more productive locations.

Looking ahead, we will continue to strictly control new learning center openings in the first half of fiscal 2014.

We currently don't expect to open any new learning centers in this fiscal quarter.

However, we will probably look to open 20 to 50 centers beginning in the second half of the second fiscal quarter starting in late October or November to take advantage of an expected peak in demand for our K-12 and VIP classes in the second half of our fiscal year.

I will elaborate on this a little bit more when I discuss our outlook section.

We also reduced headcount by 8% to 10% from a high of 34,300 at the end of our first fiscal quarter of 2013 to 30,700 as at the end of the fourth fiscal quarter.

Importantly, we've accomplished this reduction in headcount without compromising the quality of our course offerings.

On the topline we recorded very healthy net income growth.

We also saw revenues up by 26.6% in the fourth fiscal quarter driven by continued strong demand across all our key business lines and importantly improved utilization across our network.

Overall, we are very encouraged by our financial performance for this quarter and for the full fiscal year.

Since the beginning of our strategic shift in November of 2012, we have struck a very healthy balance between driving growth and managing cost.

Our Harvest the Market model is generating tangible results, which sets us up well for sustained strong bottom-line performance in the quarters to come.

Turning to some of the other indicators of our business, student enrollments grew by a healthy 6.1% in the fourth fiscal quarter and by 5.7% for the full fiscal year.

After a strong start to Q4 when enrollments rose by 14% in the first half of the quarter, the second half of the quarter, i.e.

the back half of [Q4] was relatively flat compared to last year.

This is in line with our expectation as we continue to transition to our Harvest the Market strategy.

As I said previously, we have very strictly [constrained] the pace of network expansion since the second fiscal quarter.

So it's pleasing to note that this growth in enrollment was primarily coming from improved utilization of existing facilities rather than addition of new schools or learning centers.

As I've mentioned in previous quarters, it takes about two to three years for these facilities to reach maturity.

So what we're seeing now is that the locations we opened in fiscal 2010 and 2011 are filling out and beginning to contribute to operating margin improvement.

The deceleration in student enrollment growth rate compared to the previous fiscal year was largely due to two factors.

First, we have strictly controlled the pace of expansion during fiscal 2013 and closed or disposed of 73 underperforming learning centers.

Second, we continue to see a shift in market demand towards smaller classes and VIP format, which have one teacher to a maximum of five students.

As a result, enrollments in our large class formats have declined to about -- by about 200,000 from a peak of about [1.125m] (Company corrected after the conference call) in fiscal year 2011, when the large classes represented approximately 60% of educational services enrollments, to about 925,000 for fiscal year 2013, representing approximately 40% of educational services enrollments.

Finally our adult classes of English enrollment continues to decline by about 19% in fiscal 2013 to about 174,000 from 214,000 in the year-ago period.

As we have stated previously, we keep this legacy business because of its high profitability.

So far -- so as you can see our business mix continues to evolve and we're gradually transitioning to offering more small-sized classrooms at a higher-price point in the VIP and K-12 business lines to meet market demand.

As you know many of our newer learning centers are specifically designed to cater to on a more tailored learning experience in a smaller class.

We're also encouraged by the rapid growth in some of our newer businesses such as Kaoyan, the Chinese graduate school entrance exam which is similar to the US GRE test, where enrollments increased 19% to 212,000 in fiscal year 2013 from approximately 178,000 in the year-ago period.

And class revenues increased by 25% to $27.4m.

New Oriental is the runaway market leader in Kaoyan test prep and we are excited by its long-term growth prospects.

Going forward, gross enrollments in our key two segments, the K-12 after school tutoring and overseas test prep and study consulting continue to be important indicator of the market health and our business.

But given the business mix is shifting, it will also be important to closely track ASP and revenue growth in assessing our overall performance.

Furthermore, we expect to see some changes in seasonality in line with trend, as K-12 after-school students tutoring continues to account for a greater proportion of our business, over 40% in fiscal year 2013 and expected to become over 45% in fiscal year 2014.

We should continue to experience greater revenue growth in Q3 winter quarter, and Q4 spring quarter of each fiscal year since winter and spring are the key test prep quarters for the Chinese gaokao, the college entrance exam, and zhongkao, high school entrance exam, which are administered in early June each year.

As I said earlier, beginning in late October we plan to add 20 to 50 new learning centers in fast-growing cities to take advantage of the seasonal demand.

Focusing on our performance across individual business lines, we continue to see strong and healthy growth across all our core offerings in fiscal 2013.

In particular, as I mentioned earlier already, our K-12 after-school tutoring, overseas test prep and VIP businesses enjoyed very strong growth.

Our K-12 all-subjects after-school tutoring business is doing exceptionally well.

We saw very encouraging gross revenue growth in this segment at 37% year over year for the fourth fiscal quarter and approximately 40% for the full fiscal year 2013.

Breaking that down further, our POP Kids offerings grew by over 30% year over year in the fourth fiscal quarter and around 36% for the full fiscal year 2013, while our UCAN middle and high school business was up over 40% year over year in the fourth fiscal quarter, and 42% for the full fiscal year.

Our overseas test prep and overseas study consulting business continued to perform well.

We recorded combined revenue growth of approximately 24% across the two lines for the fourth fiscal quarter and over 28% for the full fiscal year 2013.

Finally, our VIP personalized class business recorded about 36% year-over-year gross revenue growth in fiscal year 2013.

Let's look quickly at some of the key financial metrics for the fourth fiscal quarter.

Selling and marketing expenses for the quarter increased by 9.1% year over year to $36.7m.

This growth in selling and marketing expenses is well below the rate of revenue growth of 26.6%, which demonstrates how our measures to improve operating efficiency are driving improved performance.

Furthermore, actual brand and market promotion expenses in the quarter declined by approximately 4.5% year over year to approximately $16m.

As I mentioned already, on a GAAP basis operating income for this quarter was $24.4m, which represents an increase of 122.5% from $11m in the same period of fiscal year 2012.

Operating margin for the quarter was 10.2% compared to 5.8% in the same period of last year.

This is a significant improvement and it really demonstrates the results of our continued commitment to driving efficiency and profitability.

Capital expenditures for the quarter were $7.7m as compared to [$18.5m] (Company corrected after the conference call) in the same period a year ago.

This significant reduction of [58%] is in line with our focus on controlling the pace of expansion, lowering cost and driving improved utilization across our existing network.

We expect CapEx to remain low in the first quarter of fiscal year 2014 as we control the pace of school openings.

Moving on, I'd like to spend a couple of minutes talking about the expectations for the first quarter of fiscal year 2014.

We expect total net revenues for the first fiscal quarter 2014 to be in the range of $389.6m to $406.4m.

Compared to our reported net [revenue] (Company corrected after the conference call) for the first quarter of fiscal year 2013, our projected year-over-year revenue growth in the first fiscal quarter will be in the range of 16% to 21%.

This is somewhat lower than our usual guidance range, but I do want to highlight some important factors influencing our outlook.

First and foremost, in line with our shift from "Occupy the Market" to "Harvest the Market" we have strictly controlled our pace of expansion over the past fiscal year and will maintain that slower pace in the first half of the current fiscal year.

In fiscal 2013 we added a net of 62 schools and learning centers compared to a net add of 177 in the previous fiscal year.

Further, we are currently planning zero new openings for the first quarter of fiscal year 2014 compared to 89 centers we opened in the first quarter of fiscal year 2013.

This will obviously affect enrollment and topline growth, but it's important to remember that this also means that the growth in the first quarter will be primarily organic, driven largely by improved utilization of our existing schools.

This is a healthy trend and will contribute to continued margin improvement and better bottom-line results.

The second factor influencing our expectations is the shift in the seasonality of our business that I mentioned earlier.

Student demand for our K-12 and VIP offering is growing very rapidly and much more quickly than demand for our more mature overseas test prep adult English business lines.

This means that some of the peak demand is shifting from summer to late winter and spring quarters.

The overseas test prep is [popular] with college students who tend to sign up during the summer holidays when they have more time to commit to study for exams like TOEFL and GRE which they can do -- which they can take at any time.

The K-12 and VIP on the other hand are geared more towards school kids preparing for end-of-year exams like the high school and college entrance exams so the peak demand for these classes tend to be from December through May.

We noticed this trend over the last few years but it has become more pronounced this year as our K-12 and VIP offerings grow rapidly.

And we expect this trend to continue.

So over time we expect some of the peak demand will shift from the first quarter to the third and fourth quarters.

This is healthy for our long-term business as we smooth out the seasonality within high-profit quarters, without depending on the summer quarter for the majority of our annual net income.

Third, results of the Shanghai school are still below optimal.

As you know, we made management changes in Shanghai last year.

The senior management team have been focused on getting things right in this important market.

We're not yet where we want to be but we are confident that we are on the right track.

On the positive side, Beijing is performing well.

Its gross revenue increased by 17% in fiscal year 2013 and that growth rate has carried on into the summer quarter thus far.

Finally, we are seeing some limited impact from the economic slowdown in China.

Spending on education has appeared to be among the most resilient areas of discretionary spending in China behind only housing and food.

So the education sector is less affected by the slowdown than many other consumer discretionary categories.

And as a premium brand in this sector we are the best insulated from the effects of the slowdown vis-a-vis our peers.

Having said all, this let me emphasize once again that the focus on executing the Harvest to Market strategy is generating tangible, sustainable results, while staying true to our core values of delivering the highest quality teaching and course materials in China.

And I believe that the approach will continue to drive margin expansion and strong bottom-line performance in the quarters ahead.

For the full fiscal year 2014, we are forecasting very healthy revenue growth of 18% to 22% for fiscal year 2014 and strong improvement in GAAP operating margin of between 200 to 300 basis points to 15% to 16% compared to 12.8% in the fiscal year 2013.

So I am confident that we can continue to capture market opportunities to deliver sustainable long-term growth.

Before I conclude, I want to take a minute to address our efforts over the last year to enhance shareholder value.

As we announced last month, we successfully concluded a $50m share repurchase program between late April and June of 2013.

And as you will have seen in today's press release, our Board of Directors has approved a special cash dividend of $0.35 per ADS representing a 17% increase from last year's $0.30 per ADS to be paid on October 7, 2013, which is another $54m capital return to shareholders.

These initiatives underlie our determination to deliver value to our shareholders.

Also we want to remind you that in the aftermath of the unfounded Muddy Waters attack last July 18, the senior management initiated a management buyback totaling about $33m to demonstrate confidence in our Company.

(Inaudible) frame of reference for your information, is that if you had ignored Muddy Waters and Carson Block's advice to short-sell New Oriental on July 18, 2012, that infamous day that Muddy Waters attacked New Oriental, when our shares closed at a multi-year low of $9.50 and instead you'd bought New Oriental shares at $9.50 a year ago, you would have been richly rewarded and made $13.75 per share based on the July 18, 2013 closing price of $23.25 or a whopping [145%] return in one year on your investment.

It's not a bad return at all on this Contra Carson investment.

New Oriental has overcome a number of challenges over the last 12 months.

Our business is in a stronger condition than ever before.

We, the Board management and employees, want to thank all of our shareholders for bearing with us and we look forward to your continued support.

At this time I will take your questions.

Operator, please begin.

Thank you, Mr. Hsieh.

By the way Mr. Hsieh, as a feedback from some of the participants, I would like to actually ask if possible for you to position yourself nearer to the phone to hear you more clearly, Mr. Hsieh.

Is this better.

This is so much better now, Mr. Hsieh.

Thank you.

So, ladies and gentlemen, we will now begin the question and answer session.

(Operator Instructions).

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

Please ask your question.

Hi.

Thank you for taking my question.

My question is about your enrollment growth trend.

Could you please comment on the enrollment growth for June and July so far for both overseas and K-12 business?

And also, given the increasing competition you mentioned, I wonder what would be your pricing strategy going forward.

Thank you.

Good question, Philip, thank you.

We don't disclose exact enrollments, but I can tell you that -- we don't break it down separately, but in May the enrollments were flat year over year.

That was the end of the fourth fiscal quarter.

And for the first few weeks of June enrollments were flat, with revenues up in the low teens in revenue growth.

The last three weeks however both enrollments and revenues have turned around and so they seem to be picking up quite well.

And I think we attribute that partly to the late timing of Chinese New Year vis-a-vis last year.

I think because Chinese New Year was two weeks later this year and the students in Q4 got out of their primary school late June early July, the summer was pushed back a little bit.

So now I think the last several weeks we've seen a much better trend and so that's part of the reason also for our lower-than-normal guidance.

What was the second part of your question, Philip?

On pricing, on pricing trends I think we continue to increase prices at 11%, 10%, 12%, 13% year over year.

But a bigger part of the revenue is coming from mix shift change, that we tried to address both in the earnings release and in the script, which is that our big-class format, which are popular mostly in the summers and which are for overseas test prep and adult English, are shrinking as a percentage of our total overall enrollment and shrinking overall as the market is moving towards smaller classes and one-on-one VIP formats.

So that also will slow down our enrollment growth.

But having said that it just means we'll get higher revenue per student for the students who do sign up.

Right thank you.

Just a very quick follow up.

Would you also try to manage the revenue contribution and enrollment growth from the VIP or smaller class?

(multiple speakers) to the margin.

Yes, we have done that.

VIP accounts for about 29% of revenue in Q4.

Many of the learning centers we closed this year were VIP.

So you have to understand that the slower than normal revenue growth is self-inflicted.

But if we want to grow revenue, it's easy.

We just open learning centers to take a lot of VIP kids, but it's low-margin revenue until the learning centers fill up and that takes a lot of time.

So we purposely tried to balance margin improvement with revenue growth.

So we closed many VIP, like I said, we could easily pick up the revenue quickly, just open up more VIP centers or open up more learning centers but that's not our goal.

Our goal is to improve the operating efficiency and the quality of our instruction and then going forward we'll balance revenue growth with profit growth so that in the future hopefully we won't go through these massive cycles and we'll get to a more balanced, sustained top and bottom-line growth rate.

Thank you, Louis, that's very helpful.

Thank you, Phil.

Thank you.

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

Please ask your question.

Thank you.

Louis, I was wondering if you can give us an update on the utilization performance in Q4 and your thoughts going forward on utilization in the coming quarter here.

Okay.

That's a great question.

I think we started with a new -- the new utilization system was started actually last year around this time.

So we don't have year-over-year real comparisons with -- in Q4.

But I can tell you the utilization was better than Q3 and so it's probably -- Q3 was probably between 15% and 18% total and Q4 is probably 18% to 19% and Q1 should be even better than that, obviously, since it's the busiest quarter.

Our new system is quite accurate; I get to count every seat in every learning center.

So it's every empty seat.

If we're lucky we'll get to 25% utilization rates.

If we do that, our operating margin will be much, much higher than it is today.

It will be spectacular.

And as a follow-up to that, your operating margin guidance today assumes what level of utilization on average?

It assumes about 6% to 8% enrollment increase for the fiscal year 2014.

So that would take -- if we don't add -- if we only add 20 to 50 learning centers, that should push the utilization rate right to around 20% for the whole fiscal year.

So it's not aggressive.

I think our cost cuts -- as of the end of June we are actually down to 30,200 employees.

So we cut another 500, so our cost base is quite low and our revenues are still coming up.

So it's a good formula for margin improvement.

That's how we're quite confident if these trends continue that our GAAP operating margin will improve by 200, 300 basis points and non-GAAP as well.

So non-GAAP will jump from 15.6% to 18% or 19% and our GAAP will go from 12.8% to 15% to 16%.

So you can do the math and see that that means that net income growth will be much, much higher than revenue growth.

Great.

Thanks, I'll turn it over.

Thank you, Mark.

Thank you.

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

Please ask your question.

Thank you.

Louis, I just wanted to clarify, did I just hear you that you said 6% to 8% enrollment growth expectation for FY '14?

Yes, that's for the whole fiscal year.

it will be higher in Q3 and Q4, I think, than in Q1 and Q2 because, like I said, Q1 you're looking against last year.

Over the last year we closed 73 learning centers and last year we opened 89 in Q1.

So that huge delta will dampen Q1 enrollment.

But we'll start opening learning centers in the second half of October and into November to prepare for the busy winter and spring season.

If you think about it, our enrollment in K-12 is growing 15% a year even though we haven't added learning centers.

So imagine what can happen when we start adding learning centers in the second quarter of this year, enrollment should be much higher.

So even though we expect 6% to 8% enrollment growth it will be more second-half loaded than first half.

So don't expect too much in the first half at the moment.

Okay, got it.

And then, so I wanted to ask you, this VIP/small class demand which seems to be very strong market, but you just mentioned that VIP obviously is of low margin.

So I want to get your thoughts with regards to your long-term expectation for VIP and the small class as a percentage of revenue.

So I think VIP and small class already are close to or more than two-thirds of our revenue.

So it is where the market's going, so we can either fight it or we can join it and we decided to join it.

So small class enrollments account for 1.5m -- almost 1.4m enrollments.

It's a huge number.

And VIP enrollments, even though it's only about 96,000 for last year, they account for 28%, 29% of revenue.

So that is where the market is going; we have to adapt to it.

So as we told you before is that we are premium priced in both small class and in VIP.

Now our definition of small class differs from other companies like TAL.

Our small class is actually 40 people and under not 20, so it's a larger format.

And the way we deal with it is we charge a much higher price for better quality teaching and for better quality content.

So, as I said, vis-a-vis our biggest competitor in one-on-one, we're premium priced by about 50% to 60% from what I can gather from the latest results.

So we will get higher margin that way.

Also half of our VIP enrollments are closer to one-to-five which also have higher margins than the one-to-one.

And the small class side, the goal for us is to get more students in the peak so to get closer to 40 than to 20.

If we do that then the margin will still be quite high given our premium pricing.

So going forward the two formats of classes using the percentage of revenue will continue trending up or (multiple speakers).

I think they will continue trending up because the large class is attributable to the adult English and overseas test prep have both been a lower percentage of revenue because K-12 will be the fastest grower.

And of the K-12, actually it's the middle and high school, it's the U Can program that's the fastest grower.

And that's what the students study for the high school entrance exams zhongkao and gaokao for the college entry exam.

So those formats are the preferred formats from parents in the market is small class 40 students and under or VIP on-to-one up to one-to-five.

So those will continue to grow and I think our large class will continue to shrink as -- like I said, it used to be 60% enrollment, it's down to 40% and declining, and it's a much smaller percent of revenue.

Got it, thank you.

I'll get back to the queue.

Thank you, Ella.

Thank you.

The next question comes from the line of Jiong Shao of Macquarie.

Please ask your question.

Hi, thank you very much for taking my question.

I have a question on operating margin as well.

I wondered other than the 6% to 8% enrollment growth assumption what are the other assumptions that we should be thinking about behind the 18% to 19% operating margin guidance for this year.

And additionally, as [you] mentioned earlier that this margin trend in [driver] is multi-year for the new schools to ramp up and generate.

So in period of time what do you think the operating margin can be and what are some of the drivers behind this.

Thanks.

Thank you.

Those are excellent questions, Jiong.

I think for us the assumptions that go into the 200 to 300 basis points improvement are not aggressive.

We are assuming revenue growth about 20%.

We are assuming that we don't open more than 20 to 40 learning centers in fiscal year 2014.

And we are assuming that we continue with our usual price increases and 6% to 8% enrollment increases.

So they are not aggressive by any means.

As far as long-term trend in margins, if we can get 18% to 19% this year I am fairly confident that we will reach 20% non-GAAP the follow year, of which we've got 17%, 18% GAAP operating margin two years from now.

So I think long-term we should, assuming the utilization rate can keep going up.

If we get 25% utilization rates, our operating margin will both be in the 20s.

That would be a very good result if we could do it.

Okay, great.

Thank you very much for the comments.

Thank you.

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

Please ask your questions.

Hi, Louis.

Thank you for the opportunity, these are great results.

My questions is again on margin the year-on-year improvement of the operating margin was very impressive, but if we dig into the numbers it seems like the bulk of the margin improvement actually came from the sales and marketing savings, meaning the margin improved largely because there was significant leverage with advertising spending.

So my question is how do you plan to sustain margin improvement into the next year?

Are we going to see more cuts on advertising spend or would you expect other cost lines, meaning cost of revenues or G&A to give leverage in the next few quarters.

Thanks.

Well, I think the bulk of the savings actually came from the G&A line, so I think it's just both sales and marketing G&A.

They're both a direct result of the headcount reduction.

I think the brand promotion expenses were down in the fourth quarter, but they are only 7% total spend, our total revenue each year anyway so at 6% or 7% they are not a large number.

So I don't think we need to do much as far as we won't be cutting sales and marketing much more, we won't be cutting G&A much.

But I think if we can still keep current levels, like I said we did cut 500 more people in June alone so the cost base of G&A and sales and marketing is going down.

At the same time, revenues are still projected to go up 16% to 21% this quarter.

So it's just similar to the -- to say to your Goldman model right, you don't need to go up much if you cut costs.

So I think we will continue to do prudently the reduction where we can save money but we won't compromise on our core value which is having the best quality teaching the best content in the industry, so we'll continue to do that.

I think if we can get the revenue growth at 20% our cost base will as it currently stands will result in operating margin expansion well in excess of 200 basis points actually.

I see, thanks.

Louis, if I may have a follow-up question on that, so I noticed that the number of learning centers over fiscal 2011 -- '13 actually grew by 10% versus the total enrollment grew by approximately 6%.

So how should we think about that discrepancy between the 10% and 6%?

Well, I thought I explained that.

Well, the number of learning centers were opened in Q1 so that was before we shifted to the strategy.

And I think we lost 120,000 enrollments just in the shift from big class to small class and that's pretty much the bulk of it.

So I think if you do that it's pretty consistent.

The square footage that was added was much less than 10% of learning center capacity.

And if you can look at it now we are still trending up 16%, 21% in revenue.

We've actually closed six learning centers this quarter, so we are actually doing it with fewer learning centers than last year.

And last year (inaudible) was 89 learning centers.

So if we can still get higher utilization rates the margin will actually be quite good.

That's very helpful.

Thank you.

Thank you.

Thank you.

And the next question comes from the line of Clara Fan of Jefferies.

Please ask your question.

Hi, thank you for taking my question.

I've got a question on you mentioned about in terms of how local competition, particularly in large cities such as Beijing and Shanghai, I'm just wondering whether you can give us more color on is it mainly affecting your U Can business or your other businesses.

Thank you.

Yes, I think the typical, in our business our strongest competitors are local competitors primarily in kids English and middle school test prep but also in overseas test prep.

And this is something we mentioned a couple of quarters ago, and we told investors who had asked about it as well is that a lot of the public schools in China in the high school level have been teaching kids SAT and basically coercing their students, public school students to take their classes in lieu of New Oriental SAT and TEOFL classes.

That's hurt our overseas test prep business over the last year.

But, like I said earlier, they are beginning to backlash against those public schools because the students are not scoring as high as they should because of the poor preparation studies.

And so a lot of the parents are complaining.

And so we've heard many stories about how the rate of acceptance into some US colleges is exceptionally low this year from the schools who are forcing the students to take their SAT class.

So one of our solutions to this is many of those public schools have now come to New Oriental and asked to cooperate with us.

So they will basically provide the students and the classroom and we'll provide the teacher in a 50/50 arrangement.

So we are considering that now to ameliorate the competition, the local competition from the public schools.

So I think other than that our competition in K-12 sector, there's usually one strong local player.

And so like I said and we've said in previous years we expect to be number one or number two in all our key markets in every city we play in within six years, five or six years of entering that city.

And that's still our target, and we are largely successful in that endeavor.

So we perceive that income for overseas test prep we don't see that competition to be persist in the long-term.

Well, I don't think it's sustainable what the public schools are doing because the quality is inferior and the Chinese consumers won't put up with it for long.

So I believe it's not sustainable.

And many of those -- parents are actually secretly sending their kids to New Oriental anyway, so I think it's not -- that public competition is not sustainable in the long-term.

There is a second source of competition in overseas also and it's -- some of it is responsible for our weakness in Shanghai.

Our own overseas test prep head in Shanghai defected and started his own school taking many of our star teachers.

So that's part of the reason why Shanghai has had difficulties over the last couple of years, we are talking about a year and half two years ago.

So that does -- that's also hurt us.

So competition from defecting teachers, it's also competition from local public schools that's hurting the overseas sector.

And despite all that it still grows 28% of revenue.

Even in the fact of intense competition our brand name and our results speaks for itself.

And I just want to clarify on your center openings plan.

So we are not going to open any centers in first half of this fiscal year or we are going to start opening in second half this year?

And wondering whether you will be closing down any more unprofitable centers then.

Thank you.

(Multiple speakers).

And those centers will reopen.

Yes, the second one is easier we will continue to close down underperforming learning centers.

Another one we will do is we will open up a couple of learning centers in fast-growing cities maybe before October if it justifies it based on the profit level of that city and the utilization rate.

So I think we will open a few, but the bulk of the 20 to 40 will come in late October, early November.

And the reason for that is last year (inaudible) learning centers in August, during the August quarter.

And those learning centers sat mostly empty in Q2 which is our slowest seasonal quarter during the fall.

And so it doesn't make any sense to bear that cost across a slow quarter.

So we want to begin to ramp up in Q2 in the fall in order to prepare for the busy winter and spring quarters.

So our priority will be to back-end load the learning centers towards the end of this calendar year.

But we may open a couple in fast growing cities before then.

And what type of centers will these be majority?

Most of them will be K-12 centers multiple use, some will be small class one-on-one and maybe a couple of large classrooms.

So they will be typically 1,000 to 1,500 square meters covering three floors of a building.

Okay, thank you.

(multiple speakers) floor, so that's the typical center.

Okay, thank you.

Thank you, Clara.

Thank you.

The next question comes from the line of Vivian Hao of Deutsche Bank.

Please ask your question.

Hi.

Louis, I have two questions.

So out of the total 56% to 7% of enrollment growth estimate for FY14 can you give us a directional guidance of how much will be for the overseas test prep segment versus the (inaudible) K-12..

And also the second question is given that most of the underperforming, non-performing learning centers are closing or have already been closed the VIP centers, do you see that [40%] of the large classes, I mean total enrollment of the large classes to stabilize or it will continue to -- the percentage of large classroom will continue to be lower.

Yes, I think the second question the large classes will continue to be lower because the K-12 is outgrowing the declining adult English business and the overseas test prep business as far as enrollment goes.

So I think to answer your first question we expect K-12 enrollments to increase probably around 15% or so the next fiscal year, which means the adult enrollment will continue to decline probably in the mid-teens.

And overseas test prep should grow somewhere between probably low single digits on the growth side.

So the growth will come almost all from K-12 as far as enrollment goes.

But overseas study consulting and overseas test prep will still grow probably 20%, 25% of revenue whereas K-12 should grow over 30%.

And that's why we, assuming we continue to execute and the market holds up, our revenues for the full year should be around 20% or higher.

Okay.

Thanks.

Okay.

Thank you.

Thank you.

Thank you.

And the next question comes from the line of Tian Hou of T.H. Capital.

Please ask your question.

Hi, Louis (inaudible).

The question regarding the guidance, so the guidance is 16% to 21% year-on-year growth.

So the deltais kind of like 5 percentage points.

And I just wonder under what kind of circumstances the company expects growth could be 16% and under what kind of circumstances could be 21%.

Okay, thank you, Tian.

Our normal guidance range is 5%.

So I think we are probably currently at about 18%.

So if we have a good next few weeks, because remember the summer has two halves right, the July month and the August month.

So the July month the enrollments were lackluster but the August month that's starting the enrollments are much better.

So it depends on the next two or three weeks whether we track 20% or we stay at 17% to 18%.

Okay.

So the range, we usually give a 5% range so that's pretty normal.

I see, yes, okay.

So one follow-up question is really on the trends of English education.

So as Chinese kids they start to learn English when they are really young, and so I could imagine more and more students will move to overseas testing or English training less as they become adults.

So do you see the trend that education go to a younger age kid like shifting from a much older age to a much younger age?

You're absolutely correct and that's why our adult business has been declining, but it's been declining for years for exactly the reason you just mentioned.

So that's why we -- it was a choice for us that either we feed our own young or let somebody else do it.

So we wanted -- we didn't want our market to be cannibalized by someone else, so we are the market leader in kids English.

So we were going -- it just means we shifted the revenue from the adult level down to the kid's level, and actually get more revenue from kid's level because they are studying English for many, many years.

Okay.

So compared with the margin of two education like for adults and the kids so are you at a similar level of margin or you expect higher margin from adults.

Yes, we do get a higher margin from adults and that's why we keep the business and it's also because it's a mature business so we are not expanding at all.

So the adult business will have, typically have operating margins between 20% and 25% whereas the kids are in the past were around 10% to 15 and are improving now as we slow down learning center growth.

So the adult margin will be higher because the kids, the maximum class size is usually typically 25 and most classes have between 13 and 14 students, so often the price point is much lower, it's about CNY1,000 or $150 per class, so it is lower margin.

But if we get the utilization rates up, it's still a very healthy margin of over 15%, and that's our goals.

Because the U Can margins are actually very high and that's the fastest-growing business, the middle and high school business where kids have to take those six subjects for the gaokao or the zhongkao the margins are actually quite high they are 20%, 25% and growing.

So eventually I think our cash cow will become the middle and high school business the U Can business and the kids will continue to be a feeder in to that business.

It's still profitable so we'll do it, but the real profit driver will be U Can will even surpass overseas test prep in the next two or three years.

Got it.

Thanks so much.

Thank you.

Thank you.

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

Please ask your question.

Thanks.

Hi, Louis.

My question was regarding you referenced slowing economic growth in your guidance and I am wondering if that was just sort of a prudent statement or whether you're actually seeing evidence of that in terms of consumer behavior.

And if you are, what form that's taking in terms of a weaker economy.

Is this in terms of volumes or are people inclined to spend less in certain areas?

Can you elaborate?

I think to be honest it's something we kind of throw in because it's one of the prudent statements.

I don't know.

We are -- we definitely have seen a slowdown in enrollments in May and also for the first few weeks of June, so that's just a fact.

We don't know all the underlying reasons, so we are trying to cover our bases.

I think it's -- the last -- like I said the last two or three week's things have picked up again.

So it's hard to tell.

I think in general from all the anecdotal evidence is that parents are being more discriminating in their purchases.

And so you have to remember that we are a very high end purchase, so we are the most expensive typically or one of the most expensive in every market we are in.

And so some parents will maybe trade down to a small class instead of a one-on-one or they may trade down to a big class instead of small class.

But I think the children will still get the education and still get the test prep it just may not be in an as expensive a format.

And some people maybe turn away from New Oriental because they are too expensive and take a lower-priced alternative.

And so I think it's just to be prudent we threw that in.

But for those who think that our business is slowing, and if we really wanted to pick up the revenue we'd just lower our price.

There are many ways for us to accelerate revenue and one is open learning centers, one is to lower our price and take -- capture the middle of the market which we are not willing to do yet, because like I said we want to balance a high profit margin model, we want to have the highest profit margin in the industry and have the premium brand.

So we haven't -- we've resisted that temptation.

Okay thank you.

Thank you, Trace.

Thank you.

And the next question comes from the line of Charles Cartledge of Sloane Robinson.

Please ask your question.

Hi, Louis.

Hi, Charles.

Congratulations on the result.

I am curious to ask, so thank you first of all for returning capital to the shareholders both by way of the dividend and the share buyback.

Yes, you're welcome.

You've got by my estimate you've got about $640m of net cash that is net of customer deposits if you like.

What's your intention going forward, and cognizant of the fact that it's hard to move money out of China now?

So I guess please tell us how much money is offshore?

Is that how you're paying this $54m?

And will that be (inaudible).

Well, none of the money, well, we don't have any money offshore or very little, just enough for expenses so the money we are using for the dividend is surplus funds that was moved from the VIE into the [WOFI] and is moving -- is not offshore, so we will pay tax on it.

Okay.

And how is easy is that process and what implications might that have for a recurrent dividend of some kind as opposed to the two specials you've announced.

What I think is we would unlikely announced a recurring dividend, so most likely we will reassess every year after our Q4 earnings how much cash flow we have for the year and how much we will need for the following year too and how we'll need as a security blanket and then we will distribute a percentage of what's left.

So I think we'll, as I told you and other investors in the past, we would like to take every fiscal year, see how much we make and then see how much we can prudently distribute to shareholders whether in the form of a dividend or share buyback.

The share buyback will be opportunistically whenever the share price falls whether the Board will consider that.

We have (inaudible) at every board meeting in every quarter.

Okay.

So just thinking this through if you have a security blanket and winter coming, I'd love to hear how much you feel you need.

I think previously it was in the order of $300m or $400m.

And given your growth rates and the cash generative nature of the business would it not be possible therefore for the dividends with a base of say 100 -- I mean a dividend and share buyback together $104m this financial year, that should grow faster than revenues because as I say if you can think about it as an element of operating leverage there with the security blanket, how (multiple speakers).

Well that assumes, like this year we did $134m in net income we paid out $104m, that's around 7%.

That's a high payout ratio.

So it depends on the Board, it depends on the Board's thinking about the business and competitive threats and other items.

And so I think we will obviously evaluate this every year.

But it doesn't -- that doesn't address it, whilst I take your point totally it doesn't address the stock of excess cash on your balance sheet.

Well, I think it can be used for acquisitions, it can be used for other items as well.

So we -- I don't know what's going to happen in the future.

I know I need $350m of my fixed cost base for -- if we -- if Armageddon's here and we need to pay to keep our doors open for a year.

At that stage probably another $200m, $300m is excess cash is correct, but having a little bit of excess cash is not a bad thing.

Sure.

And is it restricted in any way by local requirements, because I remember (multiple speakers).

It is, a small part of it is restricted as a sort of reinvestment requirement for education companies and some of it is locked up because there is -- been a tax-free manner.

So about -- of the $600m probably $200m, $250m is somewhat restricted by that.

But that money can be used as part of security blanker as well, don't forget.

Okay.

Right, so it's over (multiple speakers).

Yes, got it.

Thanks.

Okay.

Thank you.

Thank you.

And the last question comes from the line of Mr. [Jamie Liu] of Flowering Tree.

Please ask your question.

Hi Louis.

In quarter four you mentioned that [probably] 25% of utilization rates so I just want to know what were the long-term utilization rates after you want to finish closing down the unprofitable learning centers.

And then also on that can you tell again how is (inaudible) or can the management do further to improve the utilization rate.

That's question number one.

And question number two is I guess the enrollment of 2.5m is regarding the course enrollment.

You are talking about the number of students and the course enrollment per student, what are the trends that you are seeing?

Does each student in New Oriental sign up for more courses.

What's the trend?

Thank you.

Well I think the trend is that students in New Oriental will sign up for multiple classes especially between the ages of 6 to 18, so the Pop kids and the middle and high school students will usually stay for many years and sign up for more and more classes as they get older.

So that was the whole basis of this one-stop shop for New Oriental.

So that's definitely the trend, the 2.5m.

Of the 2.5m enrollment, 1.5m is K-12 and so the -- that is still the enrollments are being multiple year, multiple (inaudible), multiple recurring enrollments.

As far as utilization rate, your first question, we didn't track it this way before.

We used to just count the classes as one if the class was open and zero if it wasn't open, so that's why there is a much higher [division].

Now we're counting every single seat in a very detailed, much more accurate way.

So I don't know the utilization in past years because we didn't count it this way.

But the new way is absolutely accurate, we could every hour the learning center is open and every seat in that learning center.

If we can get the 25% utilization our operating margin will be probably north of 25% so there is huge room to improve.

But like I said it's hard for us to execute that perfectly.

I think Beijing has the highest utilization rate, but if I had to guess, I don't know because we don't have the full -year data yet.

Beijing is probably close to 25%.

And not counting corporate overhead Beijing has a 41% operating margin.

Thank you.

So there is huge improvement potential but it's hard to execute on that potential.

Can I understand that your business exactly why it's going to improve the utilization rate more than 25%.

Because I can -- take a look at some of one-on-one centers, it's not cost effective to open a center unless you have 30 to 50 seats in the first floor for our VIP center.

Right now you probably have 10 students in there at one time.

But you want more seats because in the peak seas in Q4 you may have 15 students or 20 students in those seats.

And you also have to plan for growth because you're signing that lease for five years, five years to 10 years.

So you've got to plan that it's going to fill up all over three or four years.

And so it's that kind of analysis that it's hard to fill up because the business is relatively new.

Where we get the number is that we opened 500 learning centers, not this year but in the previous three years.

It takes two or three years for them to mature to even get to 20% enrollment.

So you've got most of our network's still not mature yet.

So it's those two factors of most of the learning centers were opened after 2009 and they are not fully utilized yet.

Second thing is that like, I said if you have to build bigger than you want because of the five year, seven year leases.

We don't usually get the option to expand, it's not -- most landlords don't want to do that.

So we take the space up front, expecting to grow in the next three to five years and so it doesn't -- it takes that time to fill up.

Understood.

And also like I said for a kids class we have many kids -- a kids class is 25 students, but the average is only 13 or 14.

And so we -- but we have to -- if we -- for the peak classes there are certain times that students want if you don't let them in the class you are cutting off your own revenue.

So it's still cost effective for us to have 25 seats even though almost half are empty most of the time.

Okay, understood.

Okay.

Thank you.

We are now approaching the end of the conference call.

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

Mr. Hsieh, please proceed.

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.

Thank you Mr. Hsieh.

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

Thank you for participating.

You may all now disconnect.