New Oriental Education & Technology Group Inc (EDU) 2014 Q4 法說會逐字稿

Ladies and gentlemen, good evening and thank you for standing by for New Oriental fourth-quarter and fiscal year 2014 earnings conference call.

(Operator Instructions).

Today's conference is being recorded.

(Operator Instructions).

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.

Hello, everyone, and welcome to New Oriental's fourth fiscal quarter and fiscal year 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, and Stephen Yang, New Oriental's Vice President of Finance.

After their prepared remarks, Louis and Stephen 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 view expressed today.

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

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

As a reminder, this conference is being recorded.

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

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

Louis, please.

Thank you, Sisi.

Hello, everyone, and thanks for joining us today.

I am pleased to report that we are closing out our fiscal year 2014 with a good set of results which underline the very strong performance in fiscal year 2014.

The last fiscal year has been an important one for New Oriental, as we completed our pivotal Harvest to Market strategy, and I am delighted that the success of this strategy shift is clear to see.

In fiscal year 2014, we exceeded $1b in revenue for the first time.

This is a major milestone for New Oriental.

And just as importantly, we recorded a new record high of more than $200m in net income for the full fiscal year, up over 58% over fiscal year 2013.

Our fiscal year 2014 GAAP operating income increased by 61% to over $197m, and our GAAP operating margin improved by 450 basis points to 17.3%, easily beating our original target of 15% to 16%.

Looking at the fourth quarter, our performance was solid.

On the top line, we recorded respectable revenue growth of 20%, driven primarily by 4% year-over-year increase in student enrollments in academic subjects, tutoring and test preparation courses, as well as an increase in average selling price.

The top line increase is healthy particularly when we actually ended the year with 703 schools and learning centers, 23 fewer than the year-ago period.

Starting in the fourth fiscal quarter 2014, we again began to expand our network by adding a net of three learning centers, and also added more than 9,300 square meters of additional classroom area by expanding 10 of our existing learning centers.

Moving into fiscal year 2015, we plan to extend our penetration rate into existing markets by adding capacity in cities where we are experiencing rapid growth and strong profitability.

Looking at the bottom line, in the fourth fiscal quarter we continued to achieve dramatic improvement.

Operating income increased 26.3% year over year to $30.8m, and net income rose 52.2% year over year to $42.9m.

You will recall that we continuously recorded strong margin and solid bottom line results throughout the last several quarters.

These consistent improvements are obviously very encouraging, and again underline how we are benefiting from organic growth as well as the efficiency initiatives we have worked hard to implement as we've launched the Harvest to Market strategy.

Overall, we are very encouraged by our financial performance for this quarter and for the full fiscal year 2014.

Looking ahead, we expect to encounter some short-term headwinds in the first half of fiscal year 2015 that will dampen growth somewhat.

Nevertheless, we remain confident that we are well positioned for sustained, strong performance in the long term.

First, our online strategy is ramping up quickly.

We believe that New Oriental has unrivalled ability to answer the growing need in China for online education services, given our brand strength, depth and experience in China's education sector.

Online education is a major focus for us and we will invest heavily in R&D and marketing in this area.

Moreover, we are the market leader in the burgeoning online college education market in China, with approximately 9.2m registered users and growing rapidly.

Now I'd like to turn the call over to Stephen Yang, our VP of Finance, to provide more detail on our performance in the fourth fiscal quarter and our outlook for the coming quarter.

Stephen.

Thank you, Louis.

Hello, everyone.

Our K-12 all subjects after school tutoring business achieved a gross revenue growth of 15% year over year for the fourth fiscal quarter and 20% for the full fiscal year 2014.

Breaking this down further, our U-Can middle and high school all-subjects after school tutoring business performed extremely well, with gross revenue growth above 19% year over year for the fourth fiscal quarter and 23% for the full fiscal year.

These very impressive results for U-Can were dampened somewhat by slower growth in our POP Kids offering, where we are continuing to roll out a completely revamped program across our network.

As we expected, the initiatives have resulted in slightly slower enrollment growth as schools held off on marketing and promotion around this business line until we complete the rollout of the new program.

The rollout should be completed by the second fiscal quarter and we are very excited about the new program.

In particular, we think that the integrated online and offline learning capabilities, and we'll build it into the new version which I will talk about shortly, are completely unique.

So we are very confident that POP Kids' performance will improve again from the second half of fiscal year 2015, once this new product is out in the market.

Overall, the K-12 after school tutoring segment is now our fastest growing segment, which is very encouraging.

This is a rapidly growing segment in China's education sector, and New Oriental has been very successful in capturing a huge share of this important market.

However, bear in mind that the shift in our business mix will have some effect on the seasonality of our business, and I will discuss this in a few minutes when I address our outlook.

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

We recorded combined revenue growth of approximately 29% across the two lines for the fourth fiscal quarter and 22% for the full fiscal year 2014.

Finally, our VIP personalized class business recorded about 18% cash revenue growth year over year for the fourth fiscal quarter and 19% for the full fiscal year 2014.

As mentioned last quarter, we have already achieved what we believe is a very healthy revenue contribution from our VIP business, so we are continuing to focus on maintaining this ratio in the quarters ahead, while shifting marketing efforts to our larger size classes.

As we talk about our business lines, I want to spend a couple of minutes to update you on some important progress we're making with our online education strategy.

As demand for online education services grows in China, we see this as a very exciting segment for New Oriental, with the potential to drive growth across all of our existing business lines and to open up opportunities for us to tap into new market segments.

We firmly believe that no other company is better positioned than New Oriental to benefit from the growth of online education, given our premium brand position, high-quality content, extensive teaching experience and nationwide scale.

To fully leverage our strength, to build out our online base offerings, we are now working on developing a fully integrated online/offline learning ecosystem around the New Oriental brand.

This ecosystem will consist of three elements.

The first element is our online-based learning system providing O2O integration across all of our business lines.

This will be the core of our online education system.

The second element is our online learning platform Koolearn.com and other online products and services in the New Oriental brand.

And finally, the third element of our ecosystem is for New Oriental to take minority shareholdings in online education companies that complement our own online education offerings.

Let me talk about some of the very encouraging progress we made over the last quarter in building out the three elements and expanding our online education offering.

Let's look first at O2O two-way interactive education system.

We introduced this system on last quarter's call.

As mentioned, this is intended to be the core element in New Oriental's integrated online/offline education offering.

This system is entirely proprietary and works across multiple classes.

It consists of a series of online education modules that support classroom teaching, let students track their progress and learn by themselves after class, and facilitate interaction between students, teachers and parents.

Put simply, this platform enables us to harness the power of Internet to improve the quality of learning, level of service and enjoyment that the students get from studying with New Oriental.

Our goal is that students studying with us can use the system to get supplemental information during our in-classroom lessons, allow them from home in their own time and track their learning programs, do homework and complete online modules that the system recommends to improve their learning, and chat with teachers and other students, and can also access our modules, programs and information in our vast database of learning resources to suit their own individual learning needs.

We're very excited with the progress we're making in a pilot test of O2O two-way interactive education system that is currently underway, and we expect to roll this out across all major products by the rest of full year 2015.

At end of this fiscal year, we expect that the functionality will be extended across all our business lines, which will be a clear and obvious differentiator for New Oriental in the market.

We believe that the new system will increase customer stickiness, improve our pricing power, and over time create new revenue streams through the provision of value-added learning services.

I would like to point out here that the first business line to get full integration of this system will be our newly revamped POP Kids program, which will be called Shuang You, by the second quarter of fiscal year 2015.

Students who enroll in this new POP Kids offering will get access to this functionality as standard, which is very exciting.

Also, we are piloting an improved version of our U-Can all subjects after school tutoring program in several large cities.

The new program, named the U-Can Visible Progress Teaching System, will feature full integration of O2O two-way interactive education system and is expected to be rolled out across other major markets during the first half of fiscal year 2015.

Furthermore, the O2O two-way interactive education system will also be implemented in the overseas test class and domestic test class courses in the second quarter of fiscal year 2015.

Turning to the second layer of our online education ecosystem, we continue to invest in our exclusively online platform Koolearn.com and other supplementary online education products, including online education platforms, technology content and mobile applications.

Looking first at Koolearn.com, we continue to quickly get traction here.

We now offer 2,000 online courses in language training, overseas and domestic test prep and vocational education, with over 9.2m cumulative registered users by the end of fiscal year 2014 and about 177,700 paying users in fiscal year 2014.

This is very encouraging and reflects how our efforts to leverage New Oriental's expertise and resources for the Koolearn.com platform are bringing rewards.

For example, Koolearn.com recently launched an online test prep program which features live broadcasts of a series of New Oriental's most popular offline test prep classes, achieved over 264,400 registrations in the second half of fiscal year 2014.

We are also pleased to see that Koolearn.com's DONUT game-based mobile learning applications for children aged two to eight recorded over 8m downloads by the end of fiscal year 2014.

And Koolearn.com has reached agreements for DONUT applications to be used in about 20 major kindergartens by September 2014.

We are continuing to explore ways to build out products and services on the Koolearn.com platform, and have made some exciting progress here.

For example, in July 2014, Koolearn.com and ATA Incorporated, a leading provider of computer based testing and testing related services in China, established a joint venture company to provide online vocational training and exam prep courses in China.

Working together, we plan to leverage New Oriental's expertise in exam prep and training and ATA Incorporated experience in assessment deliveries, student resources, learning tools, software and other technical resources, which is very exciting.

Alongside Koolearn.com, we are very pleased with the progress we are making in developing other supplementary online education products and services under the New Oriental brand, either independently or majority held partnerships with other companies.

We believe that the strength of our brand and immense quality and depth of our learning resources should enable us to produce very high-quality online learning content, and we are making good progress here.

In May of this year, we launched an English language vocabulary training application, Le Ci, for mobile phones and tablets.

This application helps users memorize new English words and actually uses the techniques developed by New Oriental's Chairman and CEO, Michael Yu.

It's very encouraging to see that application has already recorded over 310,000 users in the two months since it was launched.

Separately, in July we launched a new online education platform called OKAY for primary and secondary schools.

This platform can track and analyze students' after class self-learning progress and automatically push customized content that can improve students' learning efficiency.

We developed this platform in cooperation with more than 30,000 teachers from 49 public schools in China, and it is specifically designed to support learning activities in primary and secondary classrooms.

Over time, we will be working with schools across the country to encourage adoption of this system, which we see as a potential growth area.

Moreover, we are very excited to announce that we have developed a strategic partnership with Tencent Holdings Limited, which as you know is one of China's leading Internet companies.

Working with Tencent, we will research and develop unique mobile-based English language learning offerings that will build on New Oriental's deep resources in terms of content and educational research and Tencent's technological expertise and unrivalled online penetration and marketing reach.

The first product is expected to be launched by the end of 2014, and will be promoted through Tencent's online channels and our offline network.

Now, looking at the third element of our ecosystem strategy, as we look to develop a comprehensive online and offline education system, we are now exploring investment opportunities with selected online education companies.

Currently, we plan to focus on acquiring minority shareholdings in online education companies that have business models and technologies that are complementary to New Oriental online education strategy.

We think that this is a great way to leverage the power of our brand, our learning resources, by partnering with exciting young companies that have interesting business models and services that complement our own offerings.

Online education is obviously a very exciting segment in China, and one where New Oriental is ideally positioned to benefit.

So we will continue to invest here to capture market opportunities as we move into fiscal year 2015.

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

Sales and marketing expenses for the fourth fiscal quarter increased 40.9% year over year to $51.7m, mainly attributable to brand promotion expenses.

General and administrative expenses for the quarter increased 12.2% year over year to $94.8m.

Total headcount at the end of May 2014 stood at about 31,600, an addition of about 900 from the same time last year.

As we highlighted earlier, quarterly operating income increased 26.3% year over year to $30.8m.

Operating margin for the quarter amounted to 10.7%, compared to 10.2% in the same period of the prior fiscal year.

On Non-GAAP basis, operating margin for the quarter was 12.1% compared to 13.1% in the same period last year.

Capital expenditures for the quarter were $8.9m, compared to $7.7m in the same period of the prior fiscal year, and were primarily due to the opening of 24 new learning centers and renovations at older existing learning centers.

We generated approximately $93.6m operating cash flow for the quarter, compared to $102.6m in the year-ago period.

Moving on, I would like to spend a couple of minutes talking about our expectations for the fiscal quarter or fiscal year 2015.

We expect total net revenue in the first quarter of fiscal year 2015 to be in the range of $412m to $427.5m.

Compared to our reported net revenue for the fourth quarter of fiscal year 2014, our projected year-over-year revenue growth for the first fiscal quarter 2015 will be in the range of 6% to 10%.

This represents a somewhat slower rate of growth than usual, but I do want to highlight some important mitigating factors influencing this outlook.

First and foremost, in line with our Harvest the Market strategy, we have strictly controlled our pace of expansion over the last fiscal year.

As a result, we are actually entering the first fiscal quarter of 2015 with a net of 23 fewer schools and learning centers than we had in the first fiscal quarter of 2014, so this will obviously affect enrollment and top line growth.

But it's important to remember that this also means that the growth in the coming quarter will be primarily organic, driven largely by improved utilization at our existing schools and learning centers, and we think this is a very healthy trend.

The second factor is the ongoing rollout of the revamped POP Kids program, which will impact enrollments and revenues in this business line in the first fiscal quarter.

As mentioned earlier, we expect the rollout to be fully completed in the second quarter of the fiscal year 2015, and we anticipate an improvement in enrollments starting from the second half of fiscal year 2015.

The third factor influencing our expectations is continued decline in enrollment for our Le Ci business line of adult English and domestic college English test prep.

We've talked about the trend before whereby the success of our K-12 businesses is pulling demand away from the adult English classes.

We are now bringing the students into our program earlier in their learning lifecycle, which means that by the time they need to take overseas and domestic exams they are better prepared and have less need for our language training services.

Fourth, we expect to see a certain amount of uncertainty around the implementation of newly introduced policies relating to the English test for the Gaokao, or college entrance exam.

These policies will determine the format and content of the revised English exam to be introduced in the coming years but will be implemented on a province-by-province basis.

As such, at this stage, it's unclear what changes each province will introduce to the exam, and so we expect to see some impact on domestic tests per class as a result.

Fifth, with the very noticeable shift in the seasonality of our business, as I mentioned earlier, our K-12 after school tutoring business is experiencing rapid growth and is now one of the most important business lines.

However, we experience the greatest demand for this device during the school term, which means the second, third and fourth fiscal quarters, and we actually see something of the slack period with schools closed during the first fiscal quarter.

Traditionally, the summer quarter will have been the peak period for our test prep class, but now we are seeing that some of our peak demand is shifting from summer to the late winter and spring quarters.

We expect that this will be a long-term trend, so bear that in mind in the coming quarters.

Sixth, we are seeing intensified local competition in the second and third tier cities in the K-12 after school children segment.

This is not surprising, considering the huge success we've had in this business line and the obvious demand in the market for this service.

For example, we did some one-off promotions for U-Can summer courses in certain cities with a price cut of about 10%.

In the short term, the competitive environment in this market will have some impact on our enrollments and pricing power.

However, over time, we are very confident that the strength of New Oriental's offering will clearly differentiate us from our competitors in those markets.

In particular, our integrated online/offline service which, as mentioned, we plan to start rolling out this year, will be a very obvious differentiator that our competitors simply won't be able to match.

Seventh, the Chinese economy continues to slow.

As we have highlighted before, this will impact discretionary consumer spending, though we expect demand for education services to remain quite resilient.

And finally, we expect the recent depreciation of renminbi against the US dollar will have a certain impact on our results for the first fiscal quarter of 2015.

Having said all this, let me emphasize once again that we believe that the fundamentals of our business are stronger than ever.

As we continue our Harvest the Market approach and execute our strategy to more tightly integrate our offline/online offerings, we are confident that New Oriental will continue to capture obvious growth opportunities in the market, extend our clear leadership position in China's education market and deliver sustainable long-term growth.

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

As you will have seen in today's press release, our Board of Directors has authorized the repurchase of up to $120m of the Company's shares during the period from July 28, 2014 through March 31, 2015.

We expect to implement the share repurchase program in a manner consistent with the market conditions and the interest of the shareholders, and we plan to fund this program from the Company's available cash balance.

Our Board of Directors will review the share repurchase program periodically and may authorize adjustments of its terms and size accordingly.

This initiative is once again underlining our determination to deliver value to our shareholders and our confidence in the long-term prospects for our business lines.

At this point, Louis and I will take your questions.

Operator, please begin.

(Operator Instructions).

Jiong Shao, Macquarie.

Hi.

Can you hear me okay?

Yes.

Go ahead, Jiong.

Okay.

Sorry.

Thank you for taking my question.

Do you have the result on the (inaudible) for the fourth quarter, sorry if I missed it, and also for the whole year, in terms of the guidance on (inaudible), and also if you can comment on (inaudible) for revenue for the whole year after the more challenging first half?

And related to that, there have been some mentions of senior management departures in your Beijing school.

I was hoping you can comment on that a bit as well.

Thank you.

I don't think I heard it all clearly, Jiong, but I think you related to the revenue.

One thing I want to make clear to the investors on the call and the analysts is that if you look at our numbers in April, we had a good -- we had a very good April month.

As far as cash revenues, they were up 26%.

May was actually not too bad.

It was up 13%.

What happened in June is what the -- is what caused the guidance to be adjusted for this quarter, is that June we saw a 7% decline in revenues.

We've never seen that before.

And also we saw a 10% decline in enrollments during the June month last month.

July, we're going to do a little bit better, so things are picking up again.

So that's why the guidance was revised down.

Now, if you look at last year, we grew 15.7% during the summer quarter, but in RMB terms we only grew about 12.7%.

So we had a 3% bump from the RMB.

This year's guidance is going to be the opposite.

We'll lose 1% or 2% from the decline in the strength of the RMB.

So that's why that factor is in there.

The other change in our business that we -- so once we saw the slowdown in June, we immediately started talking to all the school heads to find out why there was a decline in our enrollments.

And what we could come up with so far, we're trying to fix this, one of the big changes is the fact that the new Gaokao exam, the rumour is that the Gaokao exam is going to make the English section much easier, and so parents aren't so pressed to get their children into summer English boot camps anymore.

And so we've seen a huge drop off in the number of summer camp enrollments and also adult comprehensive English enrollments.

So English usually declines 15%.

It declined 30% so far this quarter.

And the adult -- and the summer camps for U-Can English and middle to high school English have declined over -- about 25%, 26% for the summer, and we've never seen that before.

And so that's why we have the reason in there about the Gaokao, the policy change.

This caused a decline in our summer camps.

I also think that as the quality of the competition intensifies in tier two and tier three cities, students don't feel the need to spend the money to come to Beijing or Shanghai to learn English.

So that's why all those reasons are tied together.

The seasonality of our business is shifting toward K-12, which is the peak season in Q3 and Q4, which is the winter and spring and not the summer.

So we've seen the summer has been challenged for the last couple of years, but this year is particularly challenged.

And the other reason we gave, which we mentioned last quarter, is the relaunch of our POP Kids program, and that is taking longer than we expected.

So we expected to launch originally in Q1.

It's now launching in Q2, which is the winter -- which is the November quarter.

So that's another reason there.

So we've seen a dramatic drop off in Kids enrollment.

In fact, POP Kids enrollments were down year over year by 12%.

That has never happened before either.

They were actually up in the first half of the year, so only the last two quarters have they begun to fall.

And we think it's because the uncertainty over English and also because of the relaunch of our program, people -- we haven't spent a lot of money on marketing in this area.

So that's the long way to answer your question, Jiong.

I don't know if I got all of it, because you didn't come in very clear.

Okay.

Sorry, Louis.

Thanks.

I was also hoping you can comment on your guidance for the enrollment growth for the first quarter and for the whole fiscal year next year, and your revenue, if you have a revenue guidance for the total fiscal year.

Yes.

Okay.

Originally we wanted -- we were forecasting about 20% -- 18%, 22% in revenue growth for the whole year.

Obviously, Q1, we didn't get off to a good start in June, with revenues down 7%.

Enrollments were down 10%.

So we are revisiting our guidance now.

We want to see how the launch of the Kids English program goes off.

Right now, our growth is going to be driven by U-Can and by overseas test prep, so those two.

So we're hopeful the second half will be much better than the first half of this fiscal year.

Because of the flat in June, we're not going to be as aggressive in rolling out new learning centers.

So we added 24 learning centers during the quarter last quarter, but we ended up moving nine of them, so there were relocations, and 12, we actually closed 12, which we didn't expect to close that many.

So we would expect -- we're revisiting the whole budget for the learning center openings, depending on demand, so I don't want to give a concrete forecast.

I would expect Q2, Q3 and Q4 revenue growth to definitely be better than Q1, so I would think this will be the low, and this is sort of what happened last year as well.

Q1 was 15.7%, Q2 was 26%, Q3 was I think 16%, 17%, Q4 was 20% last year.

So I think that trend, as Stephen mentioned, the K-12 is our fastest growing business.

It's 44% of our business now.

Overseas test prep and study consulting is 39%.

Together, they're 83%.

I think, as we've been saying for a couple of years, as adult English becomes less important, it will have less of an impact on the summer quarter.

But we didn't expect, like I said, the Kids summer camps to fall so dramatically.

But from our school heads, what we're hearing is that a lot of the parents are deciding not to send their kids, so far, to Beijing or Shanghai, instead keeping them in the local province.

And I think that's partly due to stronger competition in tier two and tier three cities.

Remember, we had a five-year head start earlier.

We were early in this area.

Now, competition is coming in.

And secondly is that I think the economy in China is not as strong as in the past, and it's quite expensive to send kids to Beijing and Shanghai.

And again, reemphasizing the third point, is that the uncertainty with the Gaokao, and the rumor is the Gaokao English section will become less important and will become easier, has given parents -- it's not so pressing that they get their kids into summer camp, English boot camp.

So I think those are what we've come up with from talking to all the school heads over the last month and a half.

So, on the guidance, I think the revenue will be [low for] Q1.

I would expect much better revenue growth in Q2, Q3 and Q4, but we're not clear on the -- I want to wait a few more weeks to see what the revenue looks like before we guide for the whole year.

Sorry about that, Jiong.

Okay.

No, that's okay.

Thanks, Louis.

Thank you.

Philip Wan, Morgan Stanley.

Hi, Louis, Stephen and Sisi.

Thanks for taking my question.

My question is about your margins.

Given a softer top-line growth in Q1, how should we look at the margin for Q1 as well as the full-year trend?

Thank you.

Yes, I was hoping to get slight margin improvement originally in the budget for fiscal year 2015, but obviously you're correct to look at the -- the slow revenue in Q1 will hurt our margin.

So I'm going to defer for one quarter on the margin question until I see how things shake out over the next several weeks.

We're going to become more aggressive on the marketing side to try to salvage this quarter, as well as prepare ourselves for the future quarters to come.

Also, we're investing heavily in the online business, as you heard from our call tonight.

In addition, we're beginning with the partnerships with ATA.

We are going to enter the professional training side on an online basis.

And we're entering, obviously, our partnership with Tencent.

We expect to roll out a number of new products that will require a lot of investment in the online side.

So we're going to invest heavily in online, both R&D and marketing.

I think we expected margin neutral to a slight increase in the core business, but that's now in jeopardy, obviously, because the revenues are going to come in short on the first quarter.

Thank you.

And the follow-up on your online strategy, since there are a lot of different things going on at the same time, would you share with us which one or two initiatives are mission critical that you must complete this year?

And also, if you could add some color on the financial budget for this year related to online, that would be great.

Thank you.

Okay.

The most mission critical part of the online strategy is the O2O integration, so that's the rollout of the new POPs program, which -- also similar rollouts for UK and overseas test prep across our whole network.

And that's the whole online/offline integration, where students can learn on mobile devices, can take their exams, can interact with teachers and social network with their peers.

So that's the key rollout.

The other ones are all more long-term initiatives.

So, like with ATA, we expect that that they have a wealth of knowledge about the professional test takers, and we are experts in content.

So we want to leverage together our partnership to develop professional training, testing materials in the finance and accounting area, in law, in civil service exams, in other professional IT and professional capacities.

So that's a more longer-term initiative.

The same thing with Tencent.

Our partnership there, we're going to roll out new technology products and courses, and so that's going to be done in a collaborative time, which will take some time.

So we're setting up teams to do that as well.

Also, the initiatives in DONUT and Koolearn are probably the second most important, as we want to get more classes and more of our ecosystem up and running.

So O2O and the ecosystem where we allow students to learn in the new environment, as well as the young kids, with DONUT, those are the ones that will have immediate mission critical impact over the next year.

The other ones are more long term.

As far as spending goes, we're looking at probably $20m to $30m was the original budget for online spending this year, both in IT and -- which is significantly more than last year.

As Michael said, it's 50% or 70% more than last year.

Yes, 60%.

Yes, 60% more than last year.

So it's a significant bump, and that will also obviously be margin dilutive.

But like I said, we're not going to back to the rapid expansion days where margin falls 200, 300 basis points a year.

That's why we're going to suspend our forecast for the number of learning centers until we figure out how we drive up the demand and get this Kids program rolled out quicker.

(Multiple speakers).

As you guys know, many of you know, we let go our POP school head, so we had a management change as well as a launch of a new program.

So it wasn't executed, obviously, as well as we would like.

All right.

Thanks, Louis.

Trace Urdan, Wells Fargo.

Thank you.

I wonder if you could describe the economic impact of O2O, just what the economics involved are at the top line and the margin line.

And then maybe related to that, Louis, if you could just comment on you've got all these different online initiatives going on.

Five years from now, what implication does this have for revenue and margins, the online activity that you're seeing?

At what point does it become kind of relevant to the P&L, and how should we think about that?

Thanks, Trace.

Yes, I think we have a lot of initiatives going on now.

I don't know what happens five years from now, but online's about 3% or 4% of our revenue today, but we expect obviously rapid growth from the online initiatives that we're undertaking today.

So I think we would like to get it to probably at least 15%, 20% of revenue in five to seven years.

Now, as far as the -- I'm sorry, what was the first part of your question?

I'm sorry.

I missed it.

I got distracted on something.

I'm trying to understand what the economic impact of that is.

So, specifically with O2O, since that's something that's immediately relevant, but then even more broadly, if you're talking about 15% to 20% of revenue, how much of that is replacing revenue and how much of it is incremental revenue, and what kind of margins do you expect to have on that revenue?

Well, the O2O is not part of online revenue.

So it's mission critical because it sets our programs well above other competitors' programs, so the ability -- O2O will be integrated into the offline business, but it will have a significant online component.

The revenue won't be broken out separately, Trace.

So, for instance, a POP Kids class that today will cost $180 to $200, we expect at least a 30% to 40% premium when we roll out the O2O program, the new program that has online/offline features.

So it will be a much more expensive offering, because it's much more effective in teaching kids and helping kids to learn.

It may actually end up having a negative impact on enrollments because of the cost, but it will have a positive impact as far as margins and as far as revenue in the kids sector.

So it's hard for us to make forecasts, given that the program is delayed by a few months, so I want to suspend that forecast until we get the program rolled out in the big cities.

Okay.

Thank you.

But the most important one is O2O for us and the ecosystem, because from those platforms a lot of offline/online revenue will be combined together, and it will give us higher margin as well as higher revenue, even if it means not as rapid an enrollment increase.

Fei Fang, Goldman Sachs.

Hi, Louis, Stephen, Sisi.

Thanks for taking the question.

Can you talk a little bit about the share buyback?

How do you plan to finance the repurchase, and how much of your current net cash is parked onshore versus offshore?

And also, should we bake in any withholding tax to our numbers?

Thank you.

Right now, we have probably one-third or a little bit maybe more is offshore cash, and the rest will be done in an onshore/offshore loan.

So right now, we're not required to book the 10% withholding.

Great.

Also, a follow-up question here on the POP Kids program, and also the difference between old POP Kids program and the new Shuang You program.

What exactly is the upgrade here?

What's the difference in terms of user functionality?

And should we expect a meaningful pickup in the segment's revenue contribution after the second quarter?

Thank you.

We're certainly hopeful that the pickup will be quite rapid, beginning in the second and third quarter of this year.

The difference is that the old program was more paper and pen with blackboards, the old way of learning.

The new program has a lot of interactive blackboards, allows the students to do their work from tablet devices and mobile phones and PCs.

And the teachers will -- why don't you answer?

You know the program better than I do, Sisi.

Yes.

The new POP program, actually, the teachers can use software to teach students in class, and also in the classroom they have an interactive whiteboard, to be more interactive and more interesting learning process, and also have a platform integrating the communication between teachers, students and parents, and also recommend homework and also after school practice and [PK] with students and more interesting.

It's what we've been saying for the last two quarters, where it allows parents to more closely monitor their children's progress.

It lets children be much more effective in working, because they can work from any device, anywhere.

And also, the classroom environment will be much more fun, because it won't be just boring, listening to a teacher pronounce work, but it will be listening to characters and watching the interaction between the students, the teacher and the programs.

So they're being rolled out now.

We expect to charge, obviously, a premium for this, and so we would expect higher margins from this product, assuming that the consumers adopt it in a big way.

Got it.

Thanks very much.

Tian Hou, TH Capital.

Hi, Louis, Stephen, Sisi.

I have a question related to your Internet education.

So you mentioned you guys formed a joint venture with Tencent, so I wonder if you could give us some details.

I guess I would like to know what kind of course are you going to put online and when are you going to launch it?

And how do you plan to charge it, and how many additional students do you think those online classes will reach?

And what's the relationship of online course with your existing offline course?

So all those details, I would like to have as many details as possible.

Thank you.

Yes, I think it's -- yes, we said in the press release what we can on a competitive basis say.

The idea is to form a long-term partnership that will launch many programs.

The beginning ones, what I can tell you, will be applications.

They won't be full courses, initially.

They'll be more application based.

So it will be new ways of -- new applications that will draw students in.

I can't tell you what they will be specifically, for competitive reasons.

As far as launch dates, we are targeting late this year, early next year, for the first programs to come out.

And then we -- like I said, both sides have invested a significant amount of money into this cooperation, and so we have teams working furiously to develop these programs.

So this is a long-term initiative.

It's not going to have any short-term impact on our revenues, but I think it's part of the things we need to do to get our tentacles into all of online education, so that we're everywhere.

So, the same way as the partnership with ATA is to get into professional training.

It's an area that I think is perfect for online, and we want to be the leader in the space, and so we will leverage their knowledge and their database of professional test takers and our content strength.

We invested in [Turina] for that reason, as well, to get access to the professional content and professional training.

So you'll see us -- similar to what Tencent and Alibaba have been doing in the Internet world, you'll see us reach our tentacles into many areas of online education and to find out the ones that we can make a difference in and grow our online business, where we are by far the market leader.

But don't expect any short-term results.

Okay.

So I have one more question, related to expansion and the competition.

So as the Company's expansion, the new learning centers, was slowed down, I would imagine the demand for the children's service has not slowed down.

So in the lower-tier cities, if EDU are not going there yet, I would imagine a lot of local vendors are going to start their own tutoring service.

So how do we deal with this?

On one hand, we can't expand too much, but the other hand, if we don't expand, we're going to have some new, smaller competitors here and there.

So how do we win such kind of competition going forward?

How do we deal with that?

Yes, that's a good question, Tian.

I think our strategy in the kids sector is to be at the high end.

So I think we will always face competition in every market we enter into, city, geography or product.

Our strategy has always been to be at the high end.

So I think the competitors can come into the lower-tier cities and other areas, and they will take most of the lower end of the market and the mid end of the market, and we'll play at the high end, and so that's our strategy.

We still want to grow.

If a city is doing well with a product, we will add learning centers.

The 9,300 square meters capacity we added is equivalent to seven learning centers, so actually we added 10 learning centers for the quarter in Q4.

The reason I'm slowing down in Q1 is because we didn't expect a huge drop-off in enrollments in June.

So we're beginning to rethink it, because I don't want to get into a situation where we add a lot of capacity and the margin starts to fall then.

So we want to wait.

And it partly is because of the delay in the rollout of the Kids program.

It's a tough integration.

We have a lot of IT that needs to go into this, and we're doing it in 50 cities.

The other problem we have, honestly, it's endemic, is that there's a lot of PE money flying into -- in the online education sector, and so they're beginning to try to hire away a lot of our people.

And so it's a problem that I know it's been endemic in the Internet sector for a long time, and now it's hitting the education sector, the online education sector, as well.

So we are struggling to find enough qualified IT people to help us with these rollouts.

They're getting lured away by huge valuations from private equity funds.

Okay.

So that's a tough situation.

At least (multiple speakers).

Yes.

So I think we will play.

We will go after the kids market, but we'll go after the high end, the middle of the high end.

Okay.

That's very helpful, Louis.

So that's all my questions.

(Operator Instructions).

Leon Chik, JPMorgan.

Hi.

Thanks for taking my question.

My question is you mentioned the changing Gaokao is taking money -- parents taking money away from the English classes.

Are there any other courses that benefit from parents allocating their money, maybe K-12 or math or physics?

That's my question.

Thanks.

Well, I think what's happening is that they're not -- we used to get a lot of students in U-Can to come to our summer camps, middle and high school kids that start English camps.

We saw like a 25% drop-off this summer, which was unexpected.

And when we asked the school heads what's going on with the summer camps in Beijing and Shanghai, the answer that came back is what we said, is that a lot of parents are uncertain, because the Gaokao, like I said, is being rumored to be easier in English, the future one.

And also, if you're allowed to take multiple administrations of English, you're not so pressed to do English boot camp in one quarter.

You get more than one chance at it.

So those are -- I think who will benefit from that will be obviously the science and math classes, if they're going to allocate the money anyway for the quarter, and Chinese as well, because Chinese is being reemphasized, right, on the Gaokao.

We're the leader in Chinese prep, but we're famous for the English summer camps and we've seen a huge drop-off there, as well as adult English, as well.

So those are the two biggest impacts to our business, along with the POP Kids revamp.

So it's something on the Gaokao, where we don't know until the provinces come out with their concrete rules.

We're kind of in a state of flux.

We think long term it will help us, because you allow multiple administrations of the Gaokao.

But in the short term, because of uncertainty, parents don't want to spend a lot of money to send their kids to Beijing/Shanghai for English boot camp.

I also believe that if you read all the local press, the economy is slowing in China.

Real estate prices are falling.

So they don't have as much discretionary income as they may have had in the past couple of years.

So, potentially, if you have a benefit in the science, math or Chinese classes, that's like second and third quarter, right?

Yes.

I think students still have to do the studying, so they will come back, but parents don't want to spend the money when there's a lot of uncertainty.

It's what happens to us whenever there's a new SAT coming out or a new GRE or something.

When there's uncertainty at the beginning, people wait until there's more -- it's crystallized.

And I think that New Oriental doesn't have the most up-to-date offerings, because everyone knows we're going through a product refresh.

So there's a lot of reasons why parents may want to wait a quarter or so.

It's not as pressing as where English was such an important -- the Chinese government has been effective in trying to downplay the importance of English over the last six months.

It's been all over the press.

Okay.

Thank you.

Clara Fan, Jefferies.

Hi.

Thank you for taking my question.

I've got a question on the ASP growth for first quarter, fiscal year 2015.

Previously, we've mentioned about 10% to 15% ASP growth, but with a lot of O2O investment that we're doing on top of or in addition to POP Kids that we mentioned will raise the price by 30% to 40%, I guess the other ones like U-Can or overseas test prep were also improving, investing in the O2O difference.

So would we be raising ASP by a lot more than before, as well?

That's my question.

Thank you.

Yes.

I think at this point our budget is still to raise prices about 10% to 12% on an apple-to-apple basis.

As the new products come out, if they're adopted well, the price will go up there, probably at a rate faster than the 10% to 12%.

Like I said, the O2O English program is starting out at a much higher price point.

Okay.

Thank you.

I've got --

Obviously, if demand is not as strong as we expect it to be, then we won't raise price as much.

Yes.

And just one follow-up question on us investing on so many online initiatives.

Would that potentially cannibalize some of our existing offline business?

Thank you.

I think it will, and we fully expect it to and we're ready for it.

That's exactly what we expect to happen.

And like I said, we'd rather cannibalize our own business than have somebody else do it to us.

But it won't affect as much the Kids business.

I don't think it will actually affect the SAT business that much, either, the overseas test prep.

Where it will be will be in new areas.

I think it will affect the professional services area, which we want to go into.

We believe it will affect mostly professional education and adult education.

And our adult English business is slowing anyway, so we'd rather cannibalize it ourselves than have somebody else do it.

Okay.

Thank you.

So we're fully prepared for it and we expect it to happen.

Thank you.

The tradeoff is bigger reach, right?

You reach a lot more students and also higher margins, because online doesn't cost you as much to deliver the services.

Kenny Lu, Flowering Tree.

Hi, Louis.

Thanks for taking my question.

Hello?

Can you hear?

Please go ahead.

Yes, go ahead.

Yes.

So, actually, it's a follow-up question on Clara's question about the ASP.

So just now you mentioned about the competition in the second and third-tier cities from the local tutor incentives, so can you give us a breakdown on so far what you see in terms of the enrollment and ASP for the three key business segments, the overseas test prep, the U-Can and POP Kids, for the [first view], so far?

Yes, for overseas test prep, we expect for the year continued 0% to 5% growth and price increases of 10% to 12%.

So I think it's going pretty standard for overseas test prep.

U-Can, probably something similar, although Stephen did mention we had a one-time promotion, a 10% price cut to get market share in Beijing, and that was very effective.

So we do have occasional promotions there, but I would expect U-Can price to continue to rise 10% or 12% a year.

Now, one thing we didn't mention in the call earlier, what we decided, is that New Oriental students again outperformed everybody on the Gaokao as far as award wins.

We had 12 Gaokao students who scored one, two or three in their province or city.

That means 37 for the last four years, and I don't think our competitors, anyone, can match that.

So the results speak for themselves.

On the kids side is where we obviously have the issue right now, so enrollments are down in the first quarter.

Pricing is up about 5% so far this first quarter.

But like I said, we're not spending a lot of money marketing it, because it's not the most up-to-date program.

So we are marketing the new program as it rolls out.

So it's not rolling out as fast as we [want].

Yes.

How much is the U-Can down in the first Q, so far?

Well, U-Can is not down.

Kids is down.

Kids is down.

Kids is down.

U-Can should not be down.

I don't have the number for Q1 yet.

(Multiple speakers).

Because you mentioned that the U-Can English enrollment rate --

Enrollment was down.

It was down about 10% for the month of June, and we've never seen that before.

Mostly, it's in the kids -- in adult English.

So the adult English we expected, but not a 29% decrease in revenues.

So it's mostly in adult English and kids.

It's not in U-Can and overseas test prep.

So if we can fix kids then it goes back to the same old problem of adult English, which is fine.

So we need to get kids righted, and then I think it will be fine.

So the so-called summer English camp business that you're talking about is in the kids segment or the U-Can segment?

It's in the kids -- yes.

Well, it's boot camp for kids and middle school kids, so it does overlap a little bit in U-Can.

The day school U-Can is doing fine.

It's just the kids, the summer camps, where students travel and live there.

So the dorm-based classes for U-Can English are down 28% in revenue for the first seven weeks of the quarter, so that's your answer.

But the day school class for U-Can is up 22%, and the overall revenue for U-Can is up 10% for the first six weeks, and it's beginning to pick up in July, as well.

So when we entered May, we had a 14% backlog in deferred revenue.

June was down 10%.

July is back up.

So that's why we're guiding 6% to 10% for the quarter.

Don't forget, we lose 2 percentage points, 1 to 2 percentage points, because of RMB depreciation, as well.

So it's not as dramatic a slowdown on RMB terms as it is on US dollar terms.

Sure.

But you think (multiple speakers)?

Q1 has for the last three or four years always been slower revenue, because of the slowdown.

That's a big quarter for adult English.

Adult English means CET-4 and college level English.

That's always been declining, and we've been telling you for years it's going to decline, because as we teach kids English, they don't need to learn it as adults anymore.

We cannibalized our own business for the last 10 years.

Yes, but the English, in terms of percentage of revenue, is lower, right?

So even though it slowed down, it should not drag the growth by too much.

It's lower, but we have (multiple speakers).

Seven or eight years ago -- seven years ago, when we IPOed, it was 25%, 30% of revenue.

Now it's down to 10%, 12% of revenue.

So like I said, at some point it won't matter.

But this year, for some reason, in June it was down 29%, which is a lot.

Usually, it's down 15%.

Okay.

And that's partly, we think -- 28%.

That's partly because we think it's the fact that this whole thing of English being deemphasized, and especially like the CET-4 is not as important an exam, anymore.

So a lot of college kids aren't taking English during the summer.

They've been learning it for 10 years as kids, so they don't need to learn it as adults anymore.

Okay.

Thank you.

Okay.

So our future going forward, the one we have to fix is kids.

Overseas test prep remains healthy.

U-Can remains healthy.

If we get kids going, that's 83% of our revenue, and those programs have been over 20%.

So we need to get the kids rolled out correctly, and then long term we want to add growth drivers like online and also professional training -- online professional training.

Okay.

Thank you very much.

Okay.

We are now approaching the end of the conference call.

I will now turn the call over to New Oriental 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 representatives.

Thank you.

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

Thank you for your participation.

You may now disconnect.

Have a nice day.