New Oriental Education & Technology Group Inc (EDU) 2014 Q3 法說會逐字稿

Ladies and gentlemen, good evening and thank you for standing by for New Oriental's third fiscal quarter 2014 earnings conference call.

(Operator's Instructions) Today's conference is being recorded.

If you have any objects you may disconnect at this time.

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

Ms Zhao, please proceed.

Thank you.

Hello, everyone, and welcome to New Oriental's third fiscal quarter 2014 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 and our VP of Finance, Mr. Stephen Yang 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 that we are today reporting our fifth consecutive quarter of margin expansion and profitability improvement.

While we recorded a somewhat softer performance on the top line during the third quarter, by continuing to successfully execute on our Harvest the Market strategy, we delivered sustained improvements across all our key metrics of efficiency and profitability.

In the third quarter our GAAP operating margin increased 120 basis points to 12% compared to 10.8% in the same quarter of fiscal 2013.

And GAAP net margin increased by a very impressive 370 basis points to 16.5% compared to 12.8% a year ago.

These are significant improvements that highlight the success of the strategic approach and put us firmly on track to succeed -- to exceed our full-year GAAP operating margin target of 16% to 17% for fiscal year 2014.

As a result of the sustained improvement in efficiency across the network, we recorded net income growth of 50.2% year over year to approximately $42.1m.

I am particularly pleased that we've achieved a strong bottom line performance despite slightly lower-than-normal growth rates in both revenues and enrollments in the third quarter.

We maintained a steady revenue growth rate of 16.4% year over year, although this was below our guidance range.

This lower growth rate was due to a dip in enrollment growth in the third quarter to 4.5% year on year.

I want to spend a couple of minutes here to walk you through the three primary factors that impacted enrollment growth in the quarter.

First, we opened new learning centers at a slower pace than we had anticipated, and as a result, we had fewer schools and learning centers in operation than in the same quarter a year ago.

We ended the third quarter with 700 schools and learning centers in operation, 33 fewer than we had in the same period last year.

During the quarter we opened just five new learning centers but closed 16.

As you know, we have given our school heads very strict bottom-line targets consistent with our Harvest the Market strategy.

So over the last quarter many of them chose to focus on improving the profitability of their existing centers rather than investing in new openings.

From this quarter forward, we will adjust the incentive scheme for our school heads to encourage both top-line and bottom-line growth, so we expect to see a ramp up in new school openings and learning center openings from the fourth quarter of fiscal year 2014 in preparation for the crucial summer period in the first quarter of 2015 with the focus on fast-growing, high-profit cities.

In the fourth fiscal quarter and throughout fiscal year 2015 we aim to open 60 to 70 new learning centers.

Most of these centers will be designed to support our K-12 after school tutoring business.

The second factor impacting enrollments was a continued slowdown in our legacy adult English and domestic college English test preparation classes where revenue decreased 3.5% and 2.8% respectively year over year.

As we have noted in the past, this is a long-term trend, and we expect that the slowdown will continue.

As we and other English training schools have been teaching children's English for over 10 years, many of these children have reached adulthood and are already proficient or fluent in English, thus dampening demand for adult English classes.

In short, we have been cannibalizing our own adult English market by establishing kids English for the last decade.

Third, we are in the midst of rolling out a major refresh of our POP Kids programs targeting kids ages 6 to 12.

And as we transition from the old courses to the new courses we have seen a noticeable dip in enrollments.

During the quarter, enrollments declined 12.2% year over year to approximately 163,400.

This is the most significant new program introduction for our POP Kids offering since we launched this business in 2004.

The new program basically will be a complete renewal of the existing business line featuring updated teaching content, new teaching technologies as well as live blackboard and fully-integrated digital and online elements.

We are now trialing the new offering in a number of schools and learning centers across the country, and we'll be rolling it out to all schools during the first quarter of fiscal year 2015 this summer.

As we wind down our existing POP Kids program, we have reduced our marketing efforts behind these courses in preparation for a big push in support of the new offering.

As a result, we have seen enrollments decline across the network.

This is in line with our experience during previous program introductions as we expect to see a sharp uptick in enrollments once again as we roll out the new offerings across the network.

Before I move on, let me quickly look at ASPs which grew at a moderate 11% to 12% during the third fiscal quarter.

As I have noted in previous quarters we are looking to cap our VIP class offerings at about 30% of overall revenue, which we think is a good ratio to ensure healthy utilization and efficiency across the learning center network.

We have more or less achieved this target already, so we are now devoting more efforts to promoting our small and large class offerings, which, as you may know, have lower ASPs than VIP class offerings.

With that, let me address our performance across our individual business lines.

We continue to see healthy growth across our core offerings in the third quarter, in particular in our overseas study business and middle and high school U-Can business for kid's grades 7 to 12.

In overseas test prep and overseas study consulting business we continue to record healthy growth.

Revenues across the business lines grew approximately 22.2% and enrollments in test prep grew 12% during this quarter.

We continue to leverage our obvious competitive advantage versus peers in this sector to capture the most important opportunities in this market.

We have not noticed any impact in the business from recently announced changes to the SAT tests.

And in fact, we are confident that students will increasingly rely on New Oriental's demonstrated expertise in this area to navigate these forthcoming changes.

Our K-12 all-subjects after-school tutoring business achieved a gross revenue growth of 17.6% year over year for the third fiscal quarter, although the program transition in our POP kids offering dampened growth in this segment during the quarter.

We are pleased that our middle and high school U-Can business for kids grades 7 to 12 all-subjects after-school tutoring continued to perform well and recorded year-over-year revenue growth of about 21% and enrollment growth of 12%.

Finally, our VIP personalized classes businesses recorded about 12.9% year-over-year cash revenue growth in the third fiscal quarter.

As mentioned earlier, we have already achieved what we believe is a very healthy revenue contribution for our VIP business, so we are focusing on maintaining this ratio in the quarter's ahead, while increasing our marketing efforts in the large class sizes.

While I talk about business lines I would like to talk you through some important progress with our online education strategy.

As I have mentioned previously, we have a clear strategy in place to leverage market leadership in private education in China, to grow and solidify our leadership position in the K-College online education market.

I do want to highlight that New Oriental has a significant advantage compared to our peers given our unrivaled brand recognition, extensive database of high-quality learning resources, and our pool of the best and most experienced teachers in China.

There are three main pillars in our online strategy, O2O integration, development of our online platform Koolearn.com and partnerships with leading online players.

I am pleased to say that we've made very encouraging progress across all fronts during the last quarter.

First, we continue to make an important progress in the development of our O2O two-way learning platform which involves integration between our online and offline offerings.

Our goal is to fully integrate our online and offline offerings and resources to provide a better learning experience for our students and drive cross-selling opportunities.

To achieve this, since 2012 we have been working on standardizing and digitalizing our education content and user database to establish learning modules for registered users.

We are now able to supplement our traditional offline classroom teaching offerings with online products and services that support student learning activity.

For example, we can provide online self-study elements and quizzes that help students progress more rapidly and learn more effectively.

And our system is able to track users past study records and performance so we can recommend personalized content or customized additional courses to them.

We are particularly excited by a new pilot program we started at certain schools in Beijing, which provide students across our U-Can middle and high school tutoring programs with a suite of online offerings to support self-learning, practice and assessment after class.

Reaction from the students so far has been excellent.

And over time we hope to roll out this across all our courses covering our entire network by the end of this year.

We believe the new O2O two-way learning platform will increase customer stickiness and create new revenue streams through the provision of value-added learning services.

Second, we continue to invest in our exclusive online platform Koolearn.com.

Koolearn.com provides students, teenagers and adults pre-recorded and interactive online sessions ranging from language training, overseas and domestic test preparation to vocational education.

Now it hosts over 2,000 online courses.

It has accumulated 9 million registered users at the end of the third fiscal quarter.

The real competitive strength of Koolearn.com for New Oriental is that there is no limit on the class size, which means that we can service any student anywhere on this platform regardless of whether they have access to a New Oriental school in a neighborhood or not.

We continue to integrate -- sorry, to migrate more and more popular offline courses to the online platform so students can choose to take our courses either in a classroom or via internet enabled devices.

We believe the online platform is ideal for large non-mission-critical, short-duration courses such as Chinese English test level four and six test preparations.

During the third quarter we continued to invest in the development of new offerings for Koolearn.com that uses our existing resources to create new revenue streams.

For example, a new training program featuring live broadcast in a series of New Oriental's most popular offline test preparation classes were launched through Koolearn.com in November 2013.

We have had over 167,000 registrations in the third fiscal quarter, and the first seven weeks of the fourth fiscal quarter.

At the same time, we have invested in migrating our Koolearn.com offerings from PC-based platforms to mobile and tablets.

In particular, our DONUT game-based mobile learning applications for children aged two to eight have achieved about 7.5m downloads since being launched in September 2012.

The third pillar of our strategy is to partner with the leading online players in China.

While we are making excellent progress with our own offerings, we believe that select partnerships with the online market leaders will offer a very exciting way for us to leverage our clear advantage in terms of brand recognition and teaching resources.

These partnerships will leverage New Oriental's brand, content and high quality education experience as well as our partner's technology and market reach to deliver more innovative, attractive and unique online education products to a larger range of users.

At this stage, I am not in a position to disclose details about the potential partnerships.

But I can say that this is -- we are very pleased with the progress we are making and excited about the growth prospects for this aspect of our strategy.

This is obviously a very exciting segment in China and one where New Oriental is ideally positioned to benefit, so we are investing to support our online initiatives.

In fiscal year 2014 we will have invested a total of approximately $10m in our online programs and associated R&D.

As we move into fiscal year 2015, we will step up our investment further and we expect to allocate between $25m and $30m in investments in our online programs.

Before I turn to the financials, I'd like to address some recent policy and testing changes that are relevant to our business as I'm sure some of you will have questions about this potential business impact.

Looking first at the SATs, the College Board announced the exam will be revised in 2016 to focus more on the practical aspects of learning.

For New Oriental we don't see this as having a negative impact in our business, and in fact we see an opportunity to us for further growth as a result of this.

Our experience when other exams like TOEFL and IELTS were changed was that even the most confident and prepared test takers get nervous about taking new formats and want some extra help in preparing.

When these SAT changes are introduced we expect that learners will look to the best-known, most reliable brand in the test preparation market for help and that is of course New Oriental.

Turning to changes in education policy within China, the government announced earlier this year that kids in grades one through three should not be assigned any homework.

Furthermore, the starting year of English teaching in public schools will be postponed from grades one to grade four.

This is significant for New Oriental because we expect that many parents will want to ensure that their kids are using their valuable after school time productively and will look to sign them up for after-school tutoring programs, especially for English subjects.

Our Pop Kids program is specifically designed to cater to learners in these age groups, so we expect to see strong growth and demand here.

In terms of high school, the government has also announced plans to change the gaokao or college entrance exam.

This slightly reduces the weighing of English versus other subjects in the overall exam score.

The English exam will be administered several times in a year and students will have an opportunity to take retake the exam.

We don't see this having a negative impact for New Oriental because we expect that there will be additional demand for test preparation courses throughout the school year due to the multiple exam administrations, which should lead to a growing retaker preparation market.

Furthermore, English is just so important to students in China right now when they apply for colleges or try to find jobs that we see continued large and growing demand for English tutoring programs regardless of exam weighting.

Simply put, more students will need to be fluent in English if they want to succeed professionally in a global marketplace.

Finally, as you probably know the government, the Chinese government has also announced the one child policy was eased and that families where one parent is an only child will be allowed to have a second child.

This change is expected to be rolled out gradually over the next few years starting in the large urban areas.

As a result, from 2018 onwards we expect to see an increase in the number of school age kids in tier one cities, which is of course a big exciting growth opportunity for New Oriental.

Now let's move to some of our key financial metrics for the third fiscal quarter in addition to revenue and profit which we already discussed.

Selling and administrative expenses -- sorry, selling and marketing expenses for the third fiscal quarter increased 19.9% year over year to $37.9m, mainly attributable to brand promotion expenses.

General and administrative expenses for the quarter increased 8.2% year over year to $78.1m.

Headcount at the end of February stood at about 30,300, a reduction of about 1,300 from the same time a year ago.

Thanks to our strict control of operating expenses we recorded a continued operating margin improvement of 120 basis points compared to the year ago period.

As I highlighted earlier, quarterly operating income increased 30.5% year over year to $30.7m.

Operating margin for the quarter amounted to 12% compared to 10.8% in the same quarter of the prior fiscal year.

On a non-GAAP basis, operating margin for the quarter was 14.2% compared to 13.8% for the same period last year.

Capital expenditure for the quarter was $7.1m compared to $16.1m in the same quarter of the prior fiscal year, and were primarily due to the opening of five new learning centers and renovations at older existing learning centers.

We generated approximately $78.7m in operating cash flow for the quarter compared to 68.1m in the year ago period, representing an increase of 15.6%.

Now let me quickly go through our expectations for the fourth fiscal quarter 2014 before we move onto the Q&A session.

We expect total net revenue in the fourth quarter to be in the range of $278m to $287.6m representing year-over-year growth in the range of 16% to 20%.

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

As always, we would like to thank you for your support of New Oriental.

At this point I will take your questions.

Operator, please begin.

Jiong Shao, Macquarie.

Hi, thank you very much for taking my question.

My question is on the revenue for the quarter and the guidance.

I think the third reason, Louis, you talked about the new curriculum for the POP Kids program.

When did you say you are going to roll that out?

I was just wondering about how much longer the impact may be.

But also related to that, you probably would have saw this impact coming when you launched this new curriculum.

Was that last quarter the negative impact was even greater than what initially anticipated.

And then just a very quick clarification with the lower revenue this quarter and the guidance the revenue reacceleration is still 16% to 20% not massive, do you have an update for us in terms of your full-year enrollment growth target.

Thank you.

Thank you, Jiong.

Yes, the impact was actually greater than we expected.

It's really reason one and three, meaning that we have 33 fewer learning centers in operation.

We expected to start opening more learning centers in Q3 and Q4 just that -- as we said the rate of expansion has slowed.

Also, our POP Kids program is being rolled out currently across the country and will be -- there will be massive launch in Q1 which is the summer quarter beginning in June.

And as a result, our marketing -- we also changed POP Kids directors last quarter, so the strategy is -- was a little bit in flux and so we didn't anticipate fully the impact of the new program launch in our forecast for Q3.

So I think -- and your other question regarding how long this impact will last.

It will last through this quarter Q4.

In Q1 we will step up marketing efforts.

We purposely didn't market in Q3 and we are not marketing much in Q4 in the kids' side as we are waiting to relaunch this new program.

This is the most significant refresh of our business in 10 years since POP Kids was launched.

The new content makes much better use of interactive teaching techniques online and offline integration.

And I think it will be a much better, a much more valuable experience for children ages 6 to 12.

So we are very excited about the new program launch.

And it will also increase ASPs as well.

So I think it's -- this is our attempt to increase the margin in POP Kids so it's consistent with something more related to U-Can and overseas test prep.

So I think this is a very important strategy initiative on the Company's part.

And we expect big things from POP Kids beginning in the summer of -- this summer in a month or so, month and a half.

Okay.

And my question on the enrollment target for this year.

Enrollment target for this year is we are at about 5.4%.

We expect it to stay between 5% and 8% as we originally had said.

So that's still in place although it's at the lower end of that.

We actually expect a revenue reacceleration next year, because as we roll out 60 to 80 -- 60 to 70 learning centers over the next five quarters that will significantly pop the revenue.

So we are kind at the, we believe at the bottom in the revenue growth side.

In addition, with the launch of POP Kids and the policy changes by the government that we have discussed, we expect there is a lot of growth drivers.

And then in 2016, which will start next year, 2015 fiscal year, there will be changes to the SAT.

And that's our fastest-growing overseas test prep course.

And we are very encouraged by the 17% increase in enrollments -- sorry, the 12% increase in enrollments for overseas test prep.

So we are seeing very, very nice market share gains in this area.

Great, thank you very much for the comments.

Thank you, Jiong.

Ella Ji, Oppenheimer.

Good evening, Louis, Steven, and Sisi.

So my first question is relating to your long-term strategy.

In the past few -- in past couple of years the Company has been trying to find a balance between the growth and the margins.

And obviously it's not that easy.

And now you mentioned that you will give school heads more incentives to grow top line and since that's a reverse back to your prior strategy before you emphasized margins performance, so can management talk about your long-term strategy between the growth and the margins.

What's your long-term target?

And how do you plan to achieve that?

Okay, thank you, Ella, very good questions.

Our long-term target is 20% to 25% top and bottom line growth.

And our operating margin this -- the fiscal year, our GAAP operating margin so far is 19.6%.

And we expect to finish the fiscal year now around 18%, which is actually our target for next year not this year.

So we are already well ahead of our operation targets for margin.

But in the long term we expect 20% top and bottom line growth with operating margins between 18% and 20% GAAP operating margin and non-GAAP 2 or 3 percentage points higher than that.

So that's in the long term.

As far as our incentive system, we -- in the past before we started the harvest the market strategy revenue accounted for about 70% to 75% of a school head's compensation, the bonus part of his compensation.

And so they are obviously incentivized to grow quickly, which we did on purpose because it was a land grab after the policy change in 2009, and so we opened circa 180 to 200 learning centers a year for several years and that was too fast.

So in November of 2012 we flipped to the harvest the market strategy and we changed the incentive so that 70%, 75% of the compensation for bonuses was tied to margin growth or profitability.

Now we think the balance should be back to 50/50, so we went too far on the revenue side at 75% then we went too far on the profit side at 75% and we think a nice balance for 2015 fiscal year starting in June 1 is 50/50.

So I think as we're trying to strike that balance is not -- it doesn't move as fast as we'd like.

And you have to remember also that over the last year we have changed 10 school heads, that's one-fifth of our schools and that also causes volatility and disruption.

And as I said with respect to Jiong's question we changed the POP school head last quarter, and that's why I think there is a slight disruption in that business as well and that's why there was a slight drop in the enrollments.

Okay, thank you, Louis.

That's very helpful.

And then my second question is relating to your online business.

Could you give us more color in terms of who -- what are the most popular courses on Koolearn.com?

Who are your enrollments?

Do they also take your offline courses as well or are you seeing some level of cannibalization?

I think -- that's a very good question.

I think most of our students are high school and college students and some adults, so it really is for -- probably ages 14 to 15 and up to 23, 25 those are the majority of the students.

They are taking mostly subject classes for high school and also overseas test prep and then some vocational classes is sort of the mix.

I think most of our students are offline students as well, and they are taking additional supplemental learning online, those who are in high school and in college.

So it's unlikely that for such an important exam as the TOEFL or IELTS or SAT that a student will rely purely on an online course.

Remember, the issue here is not money for most of these students its time.

And everyone knows the best way to learn is in a classroom or one-on-one experience and not to learn just by viewing it on a monitor or a tablet.

So I think as for us most of our students we cross-sell them, and that's why the O2O strategy is very important to us.

We want to sell students online products from offline and also offline products from online.

And I think as these two -- this combination is very powerful, don't underestimate it.

I think what's going to happen is that it differentiates us.

Our online competitors can't offer the offline business and our offline providers most of them can't afford to scale up to online.

We think the combination is very valuable to both students and to parents.

Younger kids can't learn purely online; they don't have the attention span.

And these exams are too critical to their future for parents to rely just on an online administration.

So we think the best strategy is offline to online and online to offline or O2O.

Got it, thank you for taking my questions.

I'll get back to the queue.

Thank you, Ella.

Vivian Hao, Deutsche Bank.

Hi Louis, thank you for taking my question.

Hi, Vivian.

Hi.

My question is could you please give us a split in terms of percentage of your current composition of large class, small class, one-on-one format and also probably a reference for a year ago?

And also, if possible, even in ballpark numbers can we have the earnings distribution in each of these format segments?

Thank you.

Yes, I don't have the second answer, unfortunately, Vivian, but as far as the breakdown of large, small, and one on one, or VIP, I think the current number is approximately a little bit under 40% is large class.

I think 53% or 54% or so is small class enrollment and 6% or 7% is one-on-one and VIP enrollment.

But VIP accounts for about 30% of revenues because of the higher price point, and I think the small class accounts for about 50% of revenue and then the large class, about 20% of revenue.

Okay, great.

And those are up significantly.

The shift is toward small class and one on one, although our utilization increased by 2% in the quarter year over year, to about 14%, 15%, because we were incentivizing large-class teachers and small-class teachers to fill their classes.

And so the utilization went up at the expense of one on one.

So we're purposely dampening -- as we said in the remarks, we're purposely dampening the demand for VIP in order to get a higher margin, so we're actually turning away some revenue.

Right.

Can I ask one follow-up question regarding the large class?

For large class, is it possible to split out between the different segments, say, K-12 versus for (technical difficulty).

Yes, I think our -- well, large class for us is 40 or larger, and for overseas test prep it's closer to 100 or larger.

I think there's very few classes that are kids that are large class.

So you're right, it's split between adult English, between domestic test prep, overseas test prep, particularly in the summer and the winter, and then also in the middle and high school business.

The middle and high school business usually is between 40 and 60 students, so I don't know the exact breakdown between overseas test prep and U-Can enrollments, but Sisi can give you that separately.

Okay, very helpful.

Thank you.

Thank you.

Fei Fang, Goldman Sachs.

Hi, Louis.

Thanks for taking my question.

First off, in terms of (technical difficulty).

Could you give some tips on which is (inaudible).

For some reason, I can't hear you.

Can you repeat the question or if Sisi or if, Stephen, can you answer it for Fei?

I'm sorry.

You're breaking in and out, or maybe my line is bad.

Can you repeat the question, please?

In terms of expansion plans, you had a (technical difficulty) plan to focus more on the high-margin (technical difficulty).

Could you maybe give us the details of what you did (technical difficulty).

Sisi, can you take that question?

I can't hear Fei's question for some reason.

I apologize.

I cannot hear, as well.

I think --

You're fading.

Can you, I guess, maybe get --

I apologize.

One second.

It's coming in and out.

I can't hear it.

Sorry.

Is the line better?

Yes, this is better.

Sorry.

Yes, this is better.

Go ahead, Fei.

Thanks.

I apologize.

So in terms of your expansion plan, you highlighted the focus here in high-margin cities, so maybe could you elaborate on which cities are the focus and what will be the format?

Yes, for the expansion, we expect to open middle and large learning centers, so probably 800 to 1,200 square meters.

That's about three floors of a building.

The high-growth cities, I think we will start opening learning centers in cities like Beijing and Shanghai and Xian, Chongqing, very high-margin, fast-growing cities like that.

Got it.

Great.

And for the online education initiative, Louis, you highlighted a few strategic focuses here and also $25m to $30m to pursue those strategies.

Can you elaborate on the details of the spending and the G&A or sales and marketing?

Are you going to bring in people?

And also, are we going to have meaningful incremental revenues on this?

We expect meaningful incremental revenues.

Our target for Koolearn and the online platform is 50% to 100% revenue growth for next fiscal year, starting June 1. So we do expect most of the spending will be on G&A, with some marketing effort, as well.

But the idea is that the G&A spending is mostly on R&D, like is aid, for the online-offline integration rollout.

So we want students to be able to do their homework online after class, take quizzes online and get instant feedback on their progress and for parents to track the progress of their students online, so they know that their child is doing the work and they can interact directly with teachers, as well.

So we think that's where most of the spending is.

Also, we're developing new programs, things like DONUT, and also, as I said, we have partnerships ongoing that we're not in a position to announce yet to develop new innovative programs.

So I think the winning strategy on the online side will be someone with an online-offline strategy.

It's just like the rest of China, right?

In the e-commerce side, it's online-offline integration.

In everything, even like in Korea with Megastudy, they found out that online itself doesn't work.

So you need the learning centers, as well as the online platform.

And we think that New Oriental, with its depth of content, its brand, our brand, our teacher base, is the best positioned to take this market, to take the lion's share of this market.

We don't think pure online players will work, sustainable, especially for mission-critical exams like the TOEFL, the IELTS and the SAT.

And ever since there was a certain announcement by YY last quarter that they were relaunching their online platform for the third time, by the way.

So they've been trying to do this for three or four years without success.

We still saw a 17% increase in IELTS enrollments and a 10% increase in TOEFL enrollments, so obviously, they didn't have any impact on our business, even with this massive launch.

All right, great.

And luckily -- sorry, go ahead.

Go ahead, Fei.

Last housekeeping question here.

Can you talk a little bit about the tax rate in 4Q?

Yes, the tax rate was 12.1%.

It was higher by I think 1.5% than the last quarter.

The tax rate will steadily move up, I believe toward 15%, as we lose the benefit of some of our tax-efficient structures.

Most of our technology developed in New Oriental is housed in high-tech entities, and they have a certain period of tax preference or treatment.

When they expire, our tax rate tends to go up.

Got it.

Thank you.

Thank you.

Trace Urdan, Wells Fargo Securities.

Yes, thank you.

Louis, could you describe maybe the revenue streams that come from online more specifically and then maybe how you expect those to change percentage-wise, going forward?

Yes, that's a good question, Trace.

Right now, the online revenue is pure online revenue.

So that's pure Koolearn revenue, where the class, everything is signed online and is given online.

There is a competitive advantage that we have with the online-offline integration.

With the online components in our classroom classes, we're going to begin to charge more, and that will be a hidden online revenue, basically.

I think that because it's such a much more valuable learning experience, when students can be much more productive inside the classroom and outside the classroom, we believe we can charge more for this, and that's sort of going to be hidden online revenue, and that's significant.

And it also creates stickiness, so what I think the investment communities understand is that we believe that this is the right way to go.

Just like you have Alibaba and JD.com competing in the e-commerce side, it doesn't work if you just have pure online orders.

You have to fulfill them offline.

In New Oriental, we believe it's the same thing.

Students have a certain fixed amount of time to take these classes.

They can't do it online, because many of them don't have the attention span, and second, because they can't ask questions, it's not effective.

The best way to do it is to learn in the classroom and, if you miss a class, take it online.

If you need to do additional testing, take it online, and you can interact with your teachers.

I think this is the most effective way to maximize your use of time, and I think that's the critical factor.

So we believe that this online-offline strategy is going to generate a lot of stickiness amongst students and will differentiate us in the market and will also create a lot of semi-online revenue that will be counted as offline revenue.

But the online part itself, pure online, should still grow 50% or more.

Got it, so I understand, as you pursue this O2O strategy and the online components are added to the offline programs, you won't specifically be asking the students to pay something incremental?

That will just be included in the price of the program?

Correct.

And the price -- just like our POP Kids program that's being rolled out this summer, there'll be a significant price increase for that program, because it's going to have live, interactive blackboards.

It's going to have a lot of online components, and there's nothing even seen like that in the kids sector in China, so we're going to charge more for it.

We may not -- this is a way for us to drive the profitability of kids up.

And then with the policy changes where the kids have nothing to do after school in grades one to three, anyway, we think that many of them will choose to come to New Oriental.

So we're basically targeting the very high end, and that's been consistent with New Oriental's strategy for years, is we're kind of the very highest end of the market.

Got it.

Thank you.

Thank you, Trace.

Tian Hou, T.H. Capital.

Hi, Louis, Steven, Sisi.

I have a couple questions.

The first one is related to the rate of expansion.

I think the past three quarters of this fiscal year, the rate of expansion somehow, and I believe it's below expectation.

I wonder what's the reason, and also, you also give guidance for the next several quarters, about 65 to 70, and how can you make sure you can accomplish that opening target?

That is number one.

Yes.

Number two, when you open such amount of centers with larger size, and can you still maintain the margin at a stable level while growing the top line?

So that's --

Good questions, Tian.

Yes, I think for revenue growth, it's slower than we expected for this last quarter and slower in Q1, but Q2 is actually better than expected.

In Q4, like I said, we tempered the expectations at 16% and 20%.

I think the reason for that is because of our shift to the Harvest the Market strategy.

When you incentivize school heads to focus only on profitability and not on revenue growth, you get the result, so we took our operating margins up significantly.

It's at 19.6% now, from 12%, 13% a year ago.

So you can see that it has the desired effect.

Now, we're going to incentivize them half-half.

So going forward, in the new budget, starting June 1, the school heads will be incentivized to both generate top and bottom line in a balanced approach, so I think it should have the desired effect.

Also, we've changed 10 school heads, and those 10 school heads, when the new ones come in, they've closed more learning centers than we expected them to.

We thought we had closed up most of the nonperforming learning centers over the last several quarters, but new school heads come in and have their own way of doing things, and they have closed more, another 11 -- another 16 in the quarter, 11 of which were closed for nonperformance.

So I think is for us is that we're pretty confident that our revenue should reaccelerate as we open learning centers, and there will be 33 fewer learning centers this year than we did a year ago.

Thirty-three fewer learning centers is 50,000 to 100,000 enrollments a year, so you can see that that would have a 5% to 7% effect on revenues, anyway.

As far as making sure our margins don't go down, when our margins dropped from 20% down to 12% because we were opening up 150 to 200 learning centers a year for several years.

Opening 60 to 70 should not be margin dilutive.

It should be neutral or margin accretive, so we believe that that 5% to 10% add is not going to be margin accretive.

What we were doing is we were doing a 30% to 50% add in the past, and that was margin dilutive.

That's very helpful, Louis.

And also, you are doing the online application at Koolearn.com.

Yes.

And you also mentioned that you are going to form a partnership with some leading Chinese Internet company.

I wonder what could be the difference.

What are you going to offer on the new partnership platform different than what you're currently offering in the Koolearn.com.

Yes, I think Koolearn will be part of that partnership, those partnerships.

So I think it will give us two things, as we said.

One, the most important thing is marketing reach.

We have 9m registered users, but as you know, the Internet leaders in China have 500m users or more, and so that gives us significant distribution help.

Also, they have technologies that we don't have, and so we believe it's a win-win partnership, where they will provide advanced technologies that we don't have the R&D capability to have.

We provide -- we're like Walt Disney.

We have the content.

We have all the brand-name content that we've invested in the last 20 years, and so we've married that and then with their distribution, can increase Koolearn and our classes' distribution power.

And we can come up with the innovative programs because of the technology that no one else has in China, currently.

And those, I said, will be new offerings for Koolearn and for New Oriental and our distribution partners, our technology partners.

And so I think it will create a win-win situation.

But I think we're hoping to announce something sometime this calendar year.

Thank you.

That's all my questions.

Thank you.

Yes, I can't be more specific because of confidentiality.

That's okay.

Thank you.

Thank you, Tian.

Clara Fan, Jefferies.

Hi.

Thank you for taking my question.

I've got two questions.

Firstly, since we'll be picking up the rate of opening centers in the next few quarters, what kind of enrollment growth should we be looking at?

I guess it should be higher than the 5% to 7% that we are looking for the fiscal year 2014?

And, secondly, could you give us a little bit more color on the financial and operating statistics of your Koolearn platform?

Thank you.

Sure.

Thank you, Clara.

On the enrollment growth, we expect 5% to 7% for this year.

We're at 5.4%.

We expect that number to increase to 7% to 10% next year, so that 3% or 4% enrollment increase will mean at least 5 or 6 percentage points in revenue growth, so we'd expect to go back well over 20% revenue growth for fiscal year 2015.

So we'll be one of the few companies that reaccelerates revenue in the upcoming year with the new center openings.

As far as Koolearn's offerings, we don't break them out separately.

We will begin to track Koolearn with more detail in the next fiscal year, starting June 1, but Koolearn did about $25m to $30m in revenue over the last 12 months, and it was profitable, so the operating margin was between 10% and 15%.

However, for fiscal year 2015, Michael and I told them, don't make money.

We want you to expand rapidly, and we want you to spend on R&D and new products.

So we are not asking Koolearn to make money in fiscal year 2015 but instead to grow at a much faster rate.

It's been currently growing at 25%, 30%.

We want it to accelerate that growth to 50% to 100%.

Thank you.

Thank you.

Charles Cartledge, Sloane Robinson.

Hi, Louis.

Congratulations on the result.

Hey, Charles.

I think you would have had a Board meeting in April, and you can anticipate this question, I'm sure.

Can you tell us what the Board's thinking is as regards dividends and/or share buybacks, please?

The Board did discuss it.

We have not come to a conclusion yet, and so we will discuss it after Q4 earnings, typically, is when we'll come to -- and also, on share buybacks, we will always look at it on an opportunistic basis, when we feel our shares have fallen, so we discuss that at each Board meeting, but we really make the decision after Q4.

So it would probably be in July.

All right.

Great, thank you.

Okay, thank you.

Thanks, Charles.

Kenny Lu, FTIM.

Hi, Louis.

Thanks for taking my question.

Hi, Kenny.

Hi.

Yes, it's about this new program for POP Kids, because we never discussed it in the previous quarterly earnings call, so it's kind of a surprise to me.

And also, you mentioned that it's going out in this quarter and in Q4, but at the same time, the school heads for POP Kids have been changed at this special juncture.

Can you tell us more about the progress in -- I mean, school has been changed and you're rolling out new program, it's a bit interesting, right?

So can you tell me more on (background noise)?

Yes.

I think the prior school head of POP Kids was kind of in a temporary role, anyway, a transition period.

And so he has since left the Company, and yes, it is a little bit -- the reason we don't announce it earlier is for competitive reasons.

We don't typically announce things a year in advance, to let our competitors know.

But we had to this time because the results were a little bit even below our expectations on the Kids' enrollment side, so we had to give you the transparency to give you the reason why.

I think the new program, like I said, is the most significant change in our POP Kids program since it was founded more than 10 years ago.

So this is a big rollout for us, and so we wanted to find a more capable POP Kids head, and I think we've done that from internal hires.

We've brought in one of our best school heads to do that.

So we're excited about the new rollout.

It was not communicated a year in advance, which we typically don't do, but because of the earnings result, we had to let you know the reasons why.

I understand.

So can you tell us more about the strategic thinking behind this new program, so how will this new program help New Oriental's business in terms of growth and profitability in --?

I think it should help profitability a lot, because right now we charge about RMB1,000 or $150 per class, and I think this one will allow us to charge significantly more than that, although I don't want to discuss exact pricing at this time.

It also is a much better experience like I said, with interactive blackboards, where the content is revamped.

It's been completely modernized.

It has interactive components, online and offline components, as well.

So students can do their work while they're not in the classroom, as well.

And so this whole integrated approach with much more up-to-date content, and it's much more friendly, user friendly, for children.

It's a much better learning environment than just reading from a textbook or looking at pictures in a book, so the content is supposed to speak to you and come out live.

So we think it's a much -- and I think it's a differentiator in the market.

So we believe it will also improve the profitability of POP Kids, right?

Right now, POP Kids and the VIP have the lower profit margins, right, or operating margins, at 10% to 15%.

This will allow us to charge more, and we believe that the program will differentiate us in the marketplace and will differentiate us in the marketplace and will allow us to increase profitability and increase enrollment.

So in 2015, then, the POP Kids return to normal enrollment growth.

What is your expectation on the enrollment growth?

We expect POP Kids and U-Can to grow in the 10% to 15% enrollment range.

That's what's been driving most of the enrollment increases for several years now.

Adult English is shrinking.

Overseas test prep is growing 5% to 8% a year, so most of the enrollment growth has been coming from POP Kids and from middle and high school.

The problem has been that POP Kids is not very profitable, so this is our attempt to improve the profitability profile of POP Kids.

U-Can is very profitable.

Its operating margin is well over 20%.

POP Kids is half of that, and so this is our way to improve that picture, so that the margins will improve for that whole K-12 sector.

Understood.

And regarding the 4Q guidance, can you tell us, what's your assumption on the overseas test prep and U-Can growth?

Because you mentioned the --

Well, it's all being driven -- it assumes the continued decline in POP Kids enrollments for Q4, because we're not marketing, right?

We're basically -- we're beginning to build buzz for the Q1 launch of POP Kids.

I think overseas test prep remains healthy, and middle and high school is very healthy, so U-Can is doing very well.

Overseas is doing very well, but I think the negative will be the same thing as this quarter, which is kids will be -- adult English and will be the fact that it's taking us longer to ramp up learning centers than we had expected because of the incentive system we put in a year ago.

And also because -- usually, we change five to seven school heads.

This year, we changed 10, so these new school heads have their own way of thinking and their own decision-making processes on closing learning centers.

They've closed more than we thought they would, but I think in the new fiscal year, starting June 1, they're incentivized not just to make money, but also to grow.

So I think that 50 to 70 learning centers should add probably 100,000 to 150,000 enrollments next year.

That's significant.

That's 6% -- 5% to 6%.

So I think that itself will drive enrollments way up and revenue way up.

I see.

So basically, in Q4, you expect the overseas test prep and U-Can to continue to grow above 20%, while the POP Kids enrollment --

Yes, it will stay subdued.

I actually think that -- and don't forget, Q3 and Q4, for the last three years, have seen stellar growth, on average over 30%.

So we've had three years of really fast growth in Q3 and Q4, which I think came to an end this year because of the learning center closings and the rollout of the new programs.

But I think it's that, typically, the opening up of K-12 in U-Can, especially, has muted our seasonality.

We used to make all our money in Q1.

Now, we have three out of four very profitable quarters.

Q1, the summer, Q3, the winter, and Q4, the spring, and so we think that will continue.

Q3 and Q4 in future years should grow faster than Q1, the summer.

Understood.

Thank you very much, Louis.

Thank you.

Angus Coupland, CCAM.

Hi, Louis.

I know we've sort of been over this, but I just wanted to get a bit more of an idea about what revenue guidance should look like for 2015.

As you said, you're adding 5% to 10% more learning centers.

In the future, you don't expect that to be margin dilutive, and also your ASPs will continue to increase, in fact, if mix continues to improve.

Should we be looking at our existing 2015, 2016 forecasts and adding revenue to that and upping our numbers 5% to 10%, as well?

I think for us, we will guide fiscal year 2015 next quarter, but tentatively, we're expecting probably 21% to 26% revenue growth for fiscal year 2015, so that's a significant increase from the 17%, 18% we're at this year, so it's about 5% more.

And that's a direct result of the new center openings, and we don't believe that the utilization will go down much, if anything, and so it should be margin accretive because of the price increases.

Okay, great.

Thank you.

So, yes, we expect enrollments to go from 5% to 7% growth to 7% to 10% growth and revenue to go from 17%, 18% to more normal 21% to 26%.

Yes.

And for how many years do you think you can sustain that build out of learning centers?

Is this just one or two years, or would this become a more general build out from now on?

I would like to see it a more general build out.

I would like to see -- we went too far one way by super-fast expansion, because we had a chance to grab the market.

This was a land grab five years ago.

Yes.

And then I think this last year, we've gone too far the other way, where we've actually trimmed the number of learning centers.

We peaked at 746.

We have 46 fewer learning centers than we did a few quarters ago.

So 46 learning centers is over 100,000 enrollments, typically, and so -- but the profitability picture has jumped to 19.6% from 13.8%.

So I think we're already at 2015, 2016 targets for operating margin, so I want to see that balance back down to 20%, 25% top-line growth and 20% to 25% bottom-line growth.

I think it's a nice balance for us.

Given that, then, it's very measured growth, you're carrying a lot of cash.

You talked about making decisions about that cash after the fourth quarter.

If you talk about a buyback, that should be something that you look to do through the year, rather than more in fits and spurts.

And where does the dividend argument lie, as well?

Yes, I think for us, part of the issues we face is something similar to what US companies are aware of, is that all our cash is in RMB.

Almost all of our cash is in RMB.

And then like last year, when we paid you a dividend, we had to pay 10% tax to the Hong Kong government -- sorry, yes, to the Chinese government to take the money out of China.

And that doesn't sit well.

It's not tax efficient.

So that's one of the reasons we haven't been more aggressive on the buyback and dividend side.

But if you think about it, over the last several years, we've paid $105m in dividends, and we've bought back $150m in stock.

So we've returned almost $250m the last several years.

Yes, look, I think that's fine.

What about the argument you can probably borrow in the US what you can yield on your cash in RMB?

That's one of the things we're considering now.

And reward shareholders that way?

Yes.

Yes.

That's one of the things we're considering now.

Last year, we didn't do it, because if you recall, a year and a half ago, Muddy Waters attacked us and said that we had a phony structure, blah, blah, blah.

We proved to you and to the SEC, which had asked us about this, that we're able to take money from the operating entities within China and upstream it to the [Wufis] and then pay it to the Caymans company and pay it to you.

So we showed that the system works, and that's part of the reason why we did it that way last year and we paid the full tax on it.

But you're right.

A more tax-efficient way is to do a loan structure, which we are looking into, as well.

Right.

Excellent.

The other thing is, don't forget, of the $1.1b in cash on our books, about $300m to $400m doesn't belong to us.

We can't touch it, anyway.

Those are prepaid.

Oh, yes.

We understand.

I think the market understands that.

Yes, so I don't think we can really -- and we need about $300m or $400m.

Don't forget that the biggest risk to New Oriental is a pandemic.

So remember 2003, SARS almost bankrupted us, so we need to keep $300m to $400m in operating cash as a reserve fund, in case there's another pandemic or something where we wouldn't be able to collect revenue for a year.

Yes.

Even ex that, though, there's plenty of cash.

Yes.

Okay.

Thank you.

Thank you, Angus.

Thank you for your question.

We are now approaching the end of the conference call.

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

Again, thank you, everyone, for joining us today.

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

Bye-bye.

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

Thank you for your participation.

You may all disconnect.