New Oriental Education & Technology Group Inc (EDU) 2015 Q2 法說會逐字稿

Ladies and gentlemen, good evening and thank you for standing by for New Oriental's second fiscal quarter 2015 earnings conference call.

(Operator Instructions).

Today's conference is being recorded.

If you have any objections, 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 second fiscal quarter 2015 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 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.

Please, Louis.

Thank you, Sisi.

Hello, everyone, and thanks for joining us today.

I apologize if I sound not quite right; I have a sore throat, so you have to excuse my voice.

During the second quarter, revenue increased 13.4% compared to 1.4% in the previous quarter.

This increase and accelerated recovery was mainly driven by strong performance of student enrolment in academic subjects, tutoring and test preparation courses, which grew a total of 10% year over year to approximately 621,500.

One of the key segments -- one of our key segments, the U-Can business, saw an increase of approximately 40% in student enrolment.

This is encouraging as the second quarter is traditionally slow for our business, and we have moved past -- we've moved away from the uncertainty surrounding the Gaokao reform, which we discussed in detail last quarter.

I would also like to add that beginning in the middle of the second quarter, the Company decided to implement a new customer loyalty program to encourage repeat business, and this has resulted in deferred revenue of about $4.1m, which is expected to be recognized within two years without additional expenses associated with such revenues.

So, if including this, our topline growth would have been as high as 15.4%.

This is common practice in the education service market in China as a way to retain customers.

We consider this necessary for us to sustain customer loyalty and maintain competitiveness.

Under the new program, when customers purchase academic subjects, tutoring and test preparation courses, they will be able to earn points that are worth 2% to 5% of their total spending, which can be used to pay for the tuition fees over the next two years.

For now, this is temporarily dampening quarterly revenue.

This revenue deferred are expected to be recognized when the points are redeemed and the associated classes are taken, or when the points expire after two years, without additional expenses associated with such revenues.

So, essentially, that revenue will fall to the EBIT line 100% over the course of two years.

Also in the second quarter, as scheduled we started to roll out the revamped POP Kids program, and our new offerings have reached 35 cities across our nationwide school network.

Our efforts are starting to pay off, as POP Kids recorded sequentially strong revenue performance and enrolment growth of more than 13%.

For the second half of fiscal 2015, we will continue with the rollout and expect to see a reverse of revenue decline.

To accommodate the late timing of Chinese New Year, which will fall on February 19, 2015, we reduce class hours in some cities to fit in two terms of courses within the winter break, which hurt our ASPs.

Overall growth of ASPs was 2.4% year over year.

Breaking it down, ASP of U-Can decreased by 9% year over year due to class length reductions of 20% to 30%.

ASP of POP Kids program was flat, as we shortened class length.

On an hourly basis, blended ASPs grew between 5% and 10%, depending on business line and location.

Now I'd like to walk you through our performance across individual business lines.

Our K-12 all-subjects after-school tutoring business continued to be our key revenue driver, with recorded gross revenue growth of 16% year over year for the second fiscal quarter.

U-Can middle and high school all-subjects after-school tutoring business achieved a gross revenue increase of approximately 32% year over year.

Student enrolments grew approximately 40% year over year.

As mentioned before, the POP Kids program has previously been experiencing slower growth due to the revamped process.

As we started the nationwide rollout in the second quarter, we have been sequentially seeing improvement in revenue performance.

Revenue decline slowed to 4% compared to the decrease of 9% in the previous quarter.

Enrolment growth was also strong, reaching more than 13%.

We expect the strong momentum of our K-12 after-school business will continue, which is important as we move toward peak season in the second half of the fiscal year.

With the newly revamped POP Kids program, we are confident that the K-12 after-school tutoring business will continue to lead our growth in both revenues and enrolments.

As a market pioneer with such strong brand recognition and innovative capabilities, we are well-positioned in the ever-growing education services market in China.

Our overseas test prep and consulting businesses together achieved revenue growth of more than 16% year over year for the second fiscal quarter.

Finally, the VIP personalized classes business recorded a continued strong revenue growth of 18% year over year in the second fiscal quarter.

Turning to the balance sheet, New Oriental's deferred revenue balance, which is cash collected from registered students for courses and recognized proportionally as revenues as the instructions are delivered, at the end of the second fiscal quarter 2015 was $440.7m, an increase of 21.2% compared to $363.7m at the end of the second quarter of fiscal year 2014.

Now I will turn the call over to Stephen Yang, our VP of Finance, to discuss strategy execution progress and key financials.

Stephen?

Thank you, Louis.

Hello, everyone.

As mentioned previously, starting at the beginning of the fiscal year, we embarked on the new strategy of optimize the market, transitioning to a focus on maintaining a healthy balance between topline and bottom-line growth, as well as meeting the growing demand for online education services in China.

We continue to be at the forefront of the mobile Internet online learning, with significant investments in R&D, O2O integration and largest digitalized concepts library for K-college education courses and tools in China.

During the quarter, we made significant progress in the effort overall and we're quickly building out our online and offline integrated education ecosystem.

Let me first talk a bit about the core of our business and our focus on further driving our offline initiatives.

As we are refocused again on gradually increasing the topline, we continue our effort to penetrate existing markets where we can optimize resources.

In the second quarter, we opened 15 new schools and learning centers and closed 13, adding a net of 2. In first two quarters of fiscal year 2015, we added a net of 10 learning centers.

In December, we added a net of 8 learning centers.

We have added a net of 18 new learning centers year to date, bringing our total learning centers at the end of the calendar year 2014 to 721, and expanded some existing learning centers, adding a total of about 2,000 square meters of additional classroom area.

This was a result of careful selection of areas that are driving both revenue growth and margin expansion.

Turning to the execution of our core strategy, again, I can't emphasize enough the great potential we see in mobile internet online education market in China.

And more importantly, our hard work and investments in new phase of online Oriental business will further distance us from existing competitors who lack the financial resources and scale to make such investments feasible.

We're making solid progress in all three levels of our online platform.

The first level, also the core of our online system, is an O2O two-way interactive education system across all our business lines.

The second level is our pure online learning platform Koolearn.com and supplementary online education products in the New Oriental brand.

The third level of our ecosystem is for New Oriental to take minority shareholdings in online education companies that complement our own online educational offerings.

Now let me get into the details of what we've achieved on each level.

As mentioned before, we invested about $25m to $30m in this fiscal year and for the second quarter we spent about $9m which were recognized as operating costs and expenses.

Let's start with O2O two-way interactive education system, which we rolled out and upgraded in the first quarter across all major product lines, and expanded New Oriental traditional offline classroom teaching offerings to online education services.

We launched the U-Can visible progress teaching system in over 30 cities in September last year.

This is an online platform that supports after-class self-learning, and we expect this to help us better retain customers.

By the end of the third quarter, we target extension to 50 cities.

As said earlier, in the second quarter we successfully rolled out the newly revamped POP Kids English program, "Shuang You", which offers interactive learning resources and multicultural experiences based on the student's own interests.

It has started to gain traction and boost our student enrolment and revenue.

In the second quarter, we also rolled out the O2O two-way interactive education system for the domestic test prep program.

We seized the opportunity when we thought it was the right timing and now it's being used in five cities.

In the first quarter, we will roll out O2O for overseas test prep program.

For the second level of our online education ecosystem, we will achieve the great outcome with our continual investment in Koolearn.com and other supplementary online education products.

In the second fiscal quarter, Koolearn.com has generated net revenue of $11.1m, representing a 56% increase year over year.

The number of registered users has increased by 52% year over year and now the cumulative registered users has reached over 9.9m by the end of the fiscal quarter.

Koo.cn, our own live broadcast open platform for both New Oriental and third-party teachers, achieved about 172,700 registrations in the second fiscal quarter of 2015.

DONUT, a series of game-based mobile learning applications for children, achieved a record 12m downloads by end of the second quarter.

Le Ci, an English language vocabulary training application we launched in the fourth fiscal quarter of 2014 for mobile phones and tablet apps, recorded over 818,200 users by end of the second fiscal quarter.

As announced in December last year, we partnered with Tencent and launched a mobile app named "uDA".

This is an exciting experience to gather China's most respected brand in 'kindergarten to college' private education and its largest and most successful Internet company.

This is another step that we made on the path of transforming how students in China learn academic curriculums and we hope to create more best-in-class mobile learning solutions for students in China.

Turning to the third level of our online education ecosystem, we have invested in select online education companies with minority stakes, and we never cease to search for new business opportunities that we can leverage so as to enhance New Oriental's products and services.

In December 2014, we made an investment in Kouyu100.com, an online platform where our K-12 students can practice oral English.

It's currently being used by approximately 1,400 elementary schools and middle schools in more than 50 cities, with about 1.6m registered users and 130,000 paid users.

Together with our previous investment in Alo7.com, Tarena and Juesheng.com, we've built a more comprehensive online education system that is enabling us to provide fresh and interesting learning experience to our students.

All of this said, I think it is clear that the Company has been working vigorously to drive both the core offline and developing online business.

It's very encouraging that our high-potential business lines maintained healthy growth in the second quarter and we made so much progress in building our integrated education ecosystem in this year of strategic transition.

Fiscal 2015 is an important investment year and while this will have an impact on our annual operating margin and net income, we do believe that these efforts will bear fruit and help us to achieve sustainable growth and long-term profitability.

Now let's take a quick glance at some key financial metrics for the second fiscal quarter, in addition to the financials we mentioned in the beginning of the call.

Operating costs and expenses for the quarter were $249.2m, a 20.0% increase year over year.

Non-GAAP operating costs and expenses for the quarter, which exclude share-based compensation expenses, were $243.9m, a 20.6% increase year over year.

Cost of revenues increased by 17.6% year over year to $114.6m, primarily due to the increases in teachers' compensation, which is in line with the revenue growth.

Selling and marketing expenses increased by 20.1% year over year to $44.2m, primarily due to the increases in selling and marketing staff compensation and brand promotion expenses.

General and administrative expenses for the quarter increased by 23.2% year over year to $90.4m.

Non-GAAP general and administrative expenses, which exclude share-based compensation expenses, were [$85.5m] (corrected by company after the call), a 25.6% increase year over year, primarily due to the headcount increase.

Total share-based compensation expenses, which were allocated to related operating costs and expenses, decreased by 0.8% to $5.3m in the second fiscal quarter of 2015.

In this fiscal quarter, we recorded a loss from operations of $13m, compared to income of $0.7m in the same period of the prior fiscal year.

Loss from operations would have been approximately $8.9m if not for the accounting effect of the Company's new customer loyalty programs.

Non-GAAP loss from operations for the quarter was $7.6m, compared to non-GAAP income from operations $6.0m in the same period of the prior year.

Operating margin for the quarter was negative 5.5%, compared to 0.3% in the same period of the prior fiscal year.

Non-GAAP operating margin, which excludes share-based compensation expenses, for the quarter was negative 3.2%, compared to 2.9% in the same period of the prior fiscal year.

Net income attributable to New Oriental for the quarter was $2.4m, representing a 44% [decrease] (corrected by company after the call) from the same period of the prior fiscal year.

Capital expenditures for the quarter were $15.2m, which were primarily attributable to the opening of 15 new learning centers and renovations at older, existing learning centers.

Now let me go through our expectations for the third fiscal quarter of 2015 before we move into Q&A session.

We expect total net revenue in the third fiscal quarter of 2015 to be in the range of $279.8m to $290m, representing year-over-year growth in the range of 10% to 14%.

There are some specific factors impacting our guidance.

First, approximately $5m revenue representing about 2% year-over-year growth were deferred, resulting from the Company's new customer loyalty plan.

Second, the recent depreciation of renminbi against US dollar negatively impacted revenue growth by about 2% to 3%.

If not considering the above-mentioned impacts, the projected revenue growth rate is expected to be in the range of 15% to 19%.

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

At this point, Louis and I take your questions.

Operator, please begin.

(Operator Instructions).

Jin Yoon, Mizuho Securities, Asia.

Good evening, Louis and the team.

Can I start off with the loyalty program?

Just kinda wondering what your thought process is.

Why start the program now?

Is this largely due to competition, or is there other external facts that really lead to this?

And really, at the end of the day, when we look at you historically, the Company has always prided itself having higher-quality, higher-caliber product that could continue to raise prices.

With the loyalty program, does that change the -- how the Company sees business going forward from historical levels?

Can you just elaborate on the loyalty program?

Thanks.

Sure.

Thanks.

I think the loyalty program was -- we started it -- piloted it in a couple of cities in September, and then we began to -- and it was quite successful so we rolled it out across the network in October.

So it's only been going on for a few months.

And you're right; part of it is due to competition, and it's also become a common practice in China.

And I think it's probably long overdue for us to have a loyalty program because, remember, our students start with POP Kids at age 5 or 6 and stay for six years, and they've always asked us for bundled breaks and this kind of stuff.

And so it makes sense for us to -- as we offer more classes like math and Chinese for young kids, to offer them some kind of discount as they sign up for more classes and they stay with us over a longer period of time.

And then -- and the key is to get them in seventh grade, so they'll -- because that's another transition period, from sixth grade to seventh grade, also in tenth grade, as they go in -- or ninth grade when they go into high school.

So we wanted to -- the marketing department decided it's something we wanted to do to keep student retention high and also to follow the norm of the market, where a lot of companies do offer these loyalty programs.

And so we were probably disadvantaged by not doing it.

So part of it is the increased competition.

Part of it is because we are seeing our fastest growth in the K-12 sector, and these kids usually stay with us for multiple years.

So we want to create some stickiness by offering them loyalty -- this kind of loyalty program, where they get a discount.

And the longer they stay with us, the more discount they get.

Alice Yang, Macquarie.

Hi, Louis, Sisi and Stephen.

Thank you very much for taking my question.

My question is about the O2O integration initiatives, especially the revamped POP Kids.

Can you share more color on the full-year FY 2015 growth of the POP Kids segment?

If you can bring it to enrolment growth and ASP growth, that would be great.

And whether you can share some of your view about how you balance the ASP further growth when your price is not very much cheap, versus the volume growth, especially in the less-penetrated market.

Thank you very much.

Thank you.

Good question.

For the POP Kids program, we've just started rolling out the new program this last quarter.

So it's in 35 cities, but it's probably only in about 25% to 30% of the total amount of POP Kids learning centers.

So it's not fully rolled out yet.

But it's really encouraging.

The enrolment growth is accelerating.

So we did 13% enrolment growth last quarter, and in the first five weeks of this quarter, enrolment growth is already 19%.

And we're going into the next two weeks, which is the fastest growth period for us because, remember, Chinese New Year is late this year.

It's February 19 versus February 8 last year.

So the peak season for enrolment as kids get out of school now will be the next two weeks.

So if we continue this trend, the POP Kids enrolment is actually doing very well.

And I would just like to add that U-Can is also doing exceptionally well, with enrolments up over 26% in the first five weeks.

So we were seeing accelerated enrolment increase in K-12.

On ASPs, we are taking the strategy of not increasing ASPs as much, especially in this quarter -- third quarter, where we're rolling out a new program of POP Kids and we're trying to squeeze two terms in before the Chinese New Year, February 19, because it's so late.

So the term's a little bit shorter, so we're trying to -- so the prices won't be -- look like as much of an increase.

But we're still increasing on an hourly basis between 5% to 10%, and then higher for overseas test prep.

So it's not much -- we're still increasing prices at above market rates and above what our competitors are.

But you're right; I think it's a game that we want to get more enrolments, especially enrolments in seventh grade and ninth grade and tenth grade, when they're transitioning to junior high and they're transitioning to high school, because then they have the best chance they'll stay with us for two to four years.

And the idea is that the loyalty program will also create some stickiness in that regard.

I understand.

So -- please.

Yes.

Go ahead.

So, yes, very much helpful.

So you mean that ASP growth will be somewhere around 5% to 10% on average for full year FY 2015?

Yes.

So we're still raising prices on an hourly basis about 5% for POP Kids and up to 7% or 8%, 9% for U-Can, and then overseas is still over 10%.

So the price increases aren't quite as aggressive as past years, but we're also seeing a nice spike in enrolments because, remember, we had that terrible Q1 during the summer and so we're still recovering.

We're rolling out a new POP Kids program, so the more early enrolments we get, the more people will see how good the program is, and with a loyalty program, hopefully stay with us for many years.

So it's an integrated strategy to retain customers, to get more new customers and introduce them to our new O2O offerings.

I understand.

Very helpful.

Thank you.

Vivian Hao, Deutsche Bank.

Hi, Louis, Sisi and Stephen.

Thank you for taking my question.

First of all, I have a follow-up question regarding the new loyalty program.

Can you introduce what is the current redemption rate and also the average redemption period for such program?

And also, do you have any plan to retain this program permanently or is it just for a certain period of time?

And I do have a second question.

Sorry about this.

It's regarding the hiring plan you have right now.

Given the surge in G&A expenses, what is the total headcount we have?

And also, what is the additional headcount by function and also by segment for this quarter?

Thank you.

Okay.

I think Stephen can tell you the breakdown, but the headcount is at 32,500 at the end of the quarter, which is about 2,500 more than last year, with 600 more teachers.

So the G&A and S&M headcount did go up by about 1,900, which is a lot.

The growth -- also, don't forget we've added so far 20 -- 18 learning centers net, and so we've added extended capacity as well.

But a lot of the headcount increase is related to the O2O integrations and the new programs.

I think the headcount will not go up by as much in the next couple of quarters, but it will go up due to new center openings.

So I think you'll probably -- I don't know, is 500, 600 reasonable?

Yes.

33,000 is our original goal for the end of this fiscal year.

On the loyalty program, Vivian, the current plan is to keep it in place permanently, especially the early -- our retention rate last quarter, which is usually a slow quarter, Q2, was about -- was over 65%.

So it's a good retention rate.

But we don't know how much has been redeemed yet, because the loyalty program just went into effect in October.

So the beginning of redemption, we'll begin to keep track of that starting in this third quarter coming up.

But the idea is that the longer the student stays with us and the more classes they take, the more discount they get.

So it starts at 2% and moves to 5%, depending how long the student stays with us.

And the key is that it's revenue.

Like the $4.1m that came in this last quarter, only a half of a quarter, that $4.1m is direct revenue.

If we added, it would have been 15.4% on the growth side.

But all $4.1m falls straight to EBIT over time, because the costs are already accounted for in COGS.

We've delivered the classes.

Right?

And so it's pure revenue and pure operating margin -- operating income.

So that's why it's not apples-to-apples comparison with last year or in the past, so we're beginning to start this new one.

So after one year, we expect about $20m to $25m of this deferred revenue, about $5m to $6m per quarter.

And then it evens up, so next year's comparison will be apples-to-apples, so there'll be a neutral effect.

And in the second year, it should have a positive effect as some of these redemption points expire and they're recognized right away, so they were recognized as revenue and as profit right away.

So I think, as you'll see, over this year the revenue is dampened and the operating margin is dampened by about $15m for the three quarters' worth.

And then next year it should be a neutral effect, as the year-over-year comparison will be the same program.

And in the second year, as the initial set begins to expire, you'll see a slight bump up in the second year in revenue and in operating income.

But we intend to keep it permanently, assuming it's successful.

Right.

This is very helpful.

Just a very quick clarification.

So this is deferred revenue.

When they flow in as -- they're recognized as revenue on P&L, we should be expecting some positive impact to operating margins, right?

Correct.

So right now, it's going to be negative for this year, so about $15m negative for this year if you take $5m a quarter, because we just started it after the first quarter.

And then next year, because of the comparator year over year where they're all -- they're already in place, it will become a neutral effect.

And in the second year we'll have a slight positive effect.

But the key to recognize is that this deferred revenue is real revenue.

It's classed as already delivered, revenue that won't be refunded, and it will just pass to the bottom line just at a later date.

Got it.

Very helpful.

Thank you.

Thank you.

Philip Wan, Morgan Stanley.

Hi.

Thanks for taking my question.

Just a follow-up question on your guidance.

Given that you mentioned that enrolment is rebounding, including POP Kids, and ASP is also growing, I know that there's a couple of factors affecting this with the loyalty program and the currency impact, but the guidance, 10% to 14%, is still a bit soft, seems a bit soft.

Could you talk about the overall enrolment trend, the past two months?

And then also, given the weaker first half, what is your expectation on the full-year margin?

That's my question.

Thank you.

Okay.

Thanks, Philip.

I think on the -- the last two months' trend is quite good.

So we had 10% enrolment growth last quarter, which a lot of it will flow in this quarter.

And then it's hard to tell what this quarter will look like, because of the 11-day difference with the Chinese New Year last year and this year.

Last year it was February 8. So we already passed our peak period for last year already, week wise.

This year it's February 19.

We were entering the peak period the next two weeks.

So if you take -- if you don't take last week into account, enrolments were up over 10%.

But remember that enrolments in U-Can and POP Kids, the hours have been shortened a little bit because we've had to cram two terms into winter break before Chinese New Year.

Last year we didn't try to do that.

And so they're a little bit shorter.

But the average hourly increase is still 5% to 10%.

That's why we tried to explain in the script itself.

Okay?

So there's still price increases.

And enrolments are actually still growing very fast, so POP Kids really enjoyed a very strong positive revenue increase as well as enrollment increase this quarter, and U-Can well over 30%, so they're both doing really well.

The weakness is in the adult English.

It's down about 30% in enrolments, year over year.

So that's the weakness sector, and domestic test prep.

It's the old legacy businesses.

And overseas is down a little bit in enrolments this quarter.

So, like I said, it's too early to tell because the next two weeks are the key weeks for this year, because they're getting out of school now and they'll sign up for the winter term over the next two weeks.

That'll be the peak time.

But we're quite encouraged.

As far as margin goes, Philip, last year we did 17.3% operating margin.

This year we did better before, 14% to 15%.

But with the new loyalty program, you're going to take that down about 1 to 1.5 percentage points, so it's about $15m this year.

So we'd probably guide somewhere -- we don't want to give it straight because the loyalty program is new, but probably somewhere -- without the loyalty program, about 13% to 14% so down 1 percentage point.

And with the loyalty program, it'll probably look more like 12% to 13%.

So it's not -- that's why I want to separate with or without loyalty program, because otherwise it's not a fair comparison.

But don't forget this includes over $30m of spend this year on the new online initiatives, and then we expect that to really bear fruit in the second half of this year and in the next year.

We won't have the same $30m increase next year.

All right.

So most of the expenses are coming in this year, as we roll out O2O across the whole network.

Okay.

I see.

I just want to make sure I get it right.

So including everything, loyalty program, investment, so you're targeting around 12% to 13% this year, for full year?

Yes.

When everything goes in, which is equivalent to about 13.5% to 14.5% pre the loyalty program.

Okay.

I see.

Thank you.

Okay.

Thank you, Philip.

Ella Ji, Oppenheimer.

Thank you for taking my question.

First I have a quick follow-up regarding the loyalty program.

Just want to make sure, Louis, you said that the -- all the points, are they going to expire after one year?

Is that what you said?

Two years.

Two years.

Okay.

Thanks.

They'll expire after two years, Ella.

So that's why you'll see this year, where there's a lot of revenue that's built up, that will be either redeemed in the next two years or it will expire and we'll recognize it all.

That's why in the second year the points that aren't redeemed will get recognized.

That's why you'll see a bump up in the second year.

Right.

Okay.

Thank you.

But that revenue has already been collected, and it will fall 100% to the operating line.

Right.

Got it.

And regarding uDA, your new program -- your new product with Tencent, can you talk about your expected progress in the calendar year 2015?

And how much more support should we expect from Tencent, especially from Tencent's channels?

And do you think New Oriental will also need to spend more in sales and marketing to help promote uDA product?

Yes, that's a good question.

uDA is new, so it's been kind of test launched with English.

So right now, it's a soft launch.

It hasn't been blown out across QQ or Weixin yet.

We're waiting to add the math module, so that will happen in the next few months.

And also, we're testing it to make sure it's more accurate, the question and answering program is more accurate.

And so we're continually improving it.

But we want to do a soft launch to get it out in the marketplace, so students begin to test it and help us improve it.

This will be a long-term program that will include not just English and math, but hopefully all the subjects from Gaokao.

So it'll become -- we believe it'll become the go-to program for kids middle and high school, for sure.

And Tencent is behind it.

We will require additional investment, and you'll see it coming in the quarters ahead.

But I think you should stay tuned.

We're actually very excited about this, and I think so is Tencent.

And you'll see a number of announcements from us in the near future on our cooperation.

But, again, we cannot go into detail.

Okay.

All right.

Okay.

This is -- the point I was trying to make was this is the beginning of our cooperation.

This is not a one and done.

This is a long-term cooperation.

Trace Urdan, Wells Fargo Securities.

Thanks very much.

So, Louis, my understanding was that with POP Kids the plan was following the upgrade that you were going to have much more pricing power, and now it sounds like you've revised that expectation.

And so I'm looking at that data point combined with the fact that you chose this quarter to introduce the loyalty program, and I'm wondering if you were now seeing pressure in the market -- in the consumer market that -- and whether or not you believe that that's temporary, related to the economic conditions in China right now, or whether this is something related to growth in the large markets and approaching saturation, and if this is an environment that's going to pass or something we can expect long term.

That's a good question, Trace.

I think, for us, the Kids business has always been the most competitive on the POP Kids.

And the reason is because, as you know, you're not studying for a mission critical exam like the Gaokao or the Zhongkao or the SAT, so pricing has always been a little bit more difficult.

And that's why the POP Kids class is only about RMB1,000 versus a U-Can class, which is more than RMB2,400 for the same length of time.

So it's because of the mission criticalness of the class itself.

And so POP Kids has always been more competitive.

And, for us, we've always been at the high end of the pricing point, and we have probably lost the market share as a lot of competitors come in, because it's not a hugely differentiated product.

But what we've done with this new relaunch is we now have a differentiated product.

We have the best program out there that's interactive and has interactive blackboard.

It's far better than everything out there.

And I think it's for us -- we want to introduce it to as many students as we can early, because of the repeat business that it generates where they come in for many years.

And so this is an aggressive push on our part, especially given that POP Kids was declining for three quarters in a row, to get market share by getting more students in.

The market is not shrinking.

The POP Kids market is still growing, and it's growing nicely.

It's just that we had an old offering and we weren't aggressively promoting it.

Now we have a new offering, the best offering in the market, and we're aggressively promoting it.

And we believe with the loyalty program, it'll keep students coming back.

They'll have incentive.

And it won't be that much more expensive than the other offerings.

Part of the shift also, Trace, is because we have a new POP Kids head, as you know, that came in about four or five months ago.

And his philosophy, and he knows better than I do, is to go after market share first and then raise prices as the students get hooked on your product, basically.

Because there's really nothing else out there that's comparable.

Maybe Disney's program, but that's two or three times our price.

Do you -- so, okay, I guess the answer to my second question --

So you first differentiate, get market share and then raise the price.

Right.

So I guess, given that, you no longer -- POP Kids is no longer the price leader in the market?

It is still the price leader, but Disney's always been higher than us, right?

But they're only in a few markets and they're at a ridiculous price point.

Okay.

POP Kids at about $150, $200.

They're at about in the thousands.

So there's a large -- there's a huge discrepancy where we can still raise prices.

But I think for us right now, given that we saw three consecutive quarters of decline and now we have the best product in the market in our price category, we want to get market share first.

And it's been successful, right?

We saw a 13% increase in enrolments and we stemmed the decline in revenues.

This quarter, just in the first five weeks, we're already seeing almost 20% increase in enrolments.

That's unheard of, even for POP Kids, in the last couple of years.

Got it.

Okay.

Thanks.

So the new program is taking hold, and U-Can is doing the same thing.

We haven't been as aggressive in U-Can pricing this last quarter and you saw a huge spike, 40% enrolments, 32% in revenues, because the courses are shorter.

And you can see continuation in this third quarter where already, in the first five weeks before the peak season, enrolments are already up 26%.

Okay.

Okay?

Thank you, Trace.

Tian Hou, TH Capital.

Hello, Stephen and Sisi.

My question is related to what you guided earlier this year, regarding your O2O investment at about $20m to $30m.

So I wonder how you guys are using this $20m to $30m.

Where are you investing this pot of money?

So how much of that are like a one-time investment?

How much of that is going to roll into next year?

So I'm trying to figure out how much of that will disappear next year, to improve your margin.

Stephen has a better idea of that breakdown, but my only comment on this is that you know Michael; whatever budget he sets, he usually overspends.

So I think it will be higher than $20m, probably closer to $30m, $35m.

Yes.

But you know the breakdown, do you?

Yes.

Hi, Tian.

We spent $9m on overall and online things, the expenses in Q2.

And we will keep spend the same amount like the $8m to $10m in the next two quarters.

By the end of this fiscal year, I think we almost will finish the key steps of the overall and the net spends.

So the next year, you will not see the -- so much expense as the same as this year.

And for the expenses on top, half of -- more than half of them we spent in the staff compensation, because we have more and more people for the IT people to do the overall things.

And the others we spent in like the [floor] or the other equipment.

And for the pure online, for our Koolearn.com we spent the $1m for the selling expenses for the new products.

That's the spends.

So talking (multiple speakers).

Okay.

That was helpful.

And also, you guys have a lot of cash.

Hello?

Go ahead.

Yes.

Pardon me.

So you guys have a lot of cash on your balance sheet and certainly you guys have got to think about how to use it.

I wonder, what's the plan in that front?

Well, I think the cash -- the first idea or the first use will be looking at business partnerships and M&A, and also to make sure that we get this O2O and we're the leader in the online education space, in the online/offline integrated space and the mobile learning space.

That's our first priority.

Excess cash beyond that, we will be -- usually what we've been doing is buying back shares.

So we've spent about $40m so far in the first three or four months buying back shares in this kind of program.

And then, every year after the fourth quarter, we look at how much cash flow we generated and we'll either try to pay a dividend or do a share buyback to return some capital to investors, depending on the needs of our business and how much excess cash we generated.

That's very helpful.

That's all my questions.

Thank you.

Thank you, Tian.

Jialong Shi, Credit Suisse.

Hi.

Good evening, management.

Thanks for taking my question.

First of all, a quick follow-up on the previous question.

Louis, you just mentioned you will probably consider paying cash dividend or continue to do the share buyback for the coming fiscal year.

So if you guys were to pay dividends, what is the target payout ratio you may consider?

Could you give any guidance (multiple speakers)?

Yes.

We don't have a target payout ratio, but last year we paid about $50m something in the dividend.

So you can calculate it was about $0.35 or so a share, and it was up about 16% from the year before that.

This year, we're doing a buyback one, but next year depends on how much -- we'll generate less cash this year that we did last year, because of the investment.

And it's not my decision.

We don't have a set payout ratio, but the Board does consider it each year and actually in multiple board meetings throughout the year on return of capital.

We know it's a big issue among US stocks these days, so we're very sensitive to it.

And you know me; I'm always pushing to return capital back to the shareholders.

Okay.

Just a quick clarification on your dividend policy.

I understand for the current fiscal year you guys already have a share buyback program which is effective.

So is it fair to say for the current fiscal year probably you guys won't have any dividend to announce, even by Q4?

I think that's fair.

I think by Q4 we may, so it's only in a few months.

So I think we'll make the decision after Q4, so we'll probably make it sometime around the July board meeting.

That's what we did last year and the year before.

I understand.

Okay.

I have a last (multiple speakers).

So in the fiscal year we do the budgeting for the next year.

I see.

I see.

Very clear.

I have another question about your Koolearn program, and your Koolearn appeared to do very well in the past quarter.

Just wonder what is the key competitive edge for Koolearn compared to other online learning platforms, especially those platforms operated by Internet companies?

And what sort of revenue contribution do you expect to generate from Koolearn by end of next fiscal year?

Thank you.

Yes.

As we said in the script, the Koolearn.com, the revenue growth was very strong in the Q2, about 6% year over year.

And in last year the revenue of Koolearn.com accounts for the 2% of the total revenue.

But in the last -- in the Q2, it generate -- the revenue accounts for the 5% of the total revenue.

So we're very happy to see that the revenue of the Koolearn gets more and more growth, so we hope next year the revenue of the Koolearn will get the growth rate by about 50% year over year.

(Operator Instructions).

Clara Fan, Jefferies.

Hi.

Thank you for taking my question.

I just want to clarify, for the last quarter we see that enrolment is recovering well, ASP is quite soft.

And you mentioned that the ASP on an hourly basis is increasing by around 5% to 10%, but even on an absolute basis are we seeing a softer ASP growth compared to what we have expected before, especially after we introduced some loyalty program?

Thank you.

Yes.

I think the intention that Michael and the marketing team and we agree with is to go after enrolment growth in the short term, especially as we roll out O2O.

We believe that our program is superior -- far superior to anything else in the marketplace, so we want as many students to try it as we can because we think we'll get them hooked.

So the short-term plan is to reduce the amount of increase in the ASP.

So we'll still increase it about 5% to 10%, but it won't be as aggressive as in past years because we want to get the students on this new online/offline integrated system.

Once they get on it, we believe that along with the loyalty program it'll create incredible stickiness and that -- also, Michael has spent a lot of time improving our content and improving our teaching quality, so that's where our focus has been.

So we believe that that combined with the technology advantage we have and a loyalty program and the brand name will -- is a winning strategy for us.

So you're correct, Clara, that we have slowed down the amount of ASP increase, but it's still quite healthy at 5% to 10%.

It's just not as high as 10% to 12%, like in the past.

Fei Fang, Goldman Sachs.

Hi, Louis, Sisi, Stephen.

Can you update us on your expansion plan for 2015?

How many centers would you like to add this year and which segment would you focus on and in which cities would you add the capacity?

Thank you.

Thank you, Fei.

I think we opened 10 as of the first two quarters, but we opened 8 in December alone, net.

So we were up 18 now.

So I would expect it to be somewhere 30 and 40, but probably the lower end of 30 to 40, so right on our schedule with our 30 to 40 target we announced last quarter but probably not at the high end.

And mostly the learning centers are Kids, K-12 and overseas centers, so they are kind of mixed use.

So we're not really opening adult centers, given that's a declining business.

And we're opening mostly in cities that have a high profit margin.

So it still includes cities like Beijing and Shanghai and some of the larger cities.

Some people may think it's saturated, but it's not.

And then also high profit second-tier cities, like Changsha, Xi'an, some other cities, Wuhan, that are doing quite well.

Is that all your questions?

Yes.

Thank you for that.

Jin Yoon, Mizuho Securities, Asia.

Just a follow-up question.

Even after the loyalty program, the (inaudible) that you provide, do you know how competitive your pricing is in your top-tier cities?

And if the pricing gap is still there with your main competitors, does that mean that the potential rebates could go higher going forward?

Thanks.

I think right now we will address the rebate depending on market conditions.

Our initial shot is 2% to 5%.

So the longer -- the more years or the more classes you take with us, the loyalty program goes up.

Starts at 2% and moves toward 5% of your total purchase, so it does go up right now.

We always can adjust it higher or lower, depending on market conditions.

Right now, we're priced probably 20%, 25%, above our competitors in most classes.

So that includes U-Can, POP Kids.

Overseas, we're probably 20%, 25% higher than our competitors -- most of our competitors.

We think that will continue to hold, because we usually are the ones who initiate the price increases and they usually fall in behind us.

So we think, unless something changes, that that price gap will continue to be in force.

But we think the difference now is that we believe the quality gap will expand, so our quality and our Internet tools and our mobile learning system will be better than anything else that our competitors can offer.

So not only do we have a pricing gap that's the same, but we'll have a higher quality gap.

That's the goal.

With a higher quality gap, we'll get more customer loyalty, and then at that point we'll probably consider raising the price more aggressively.

Charles Cartledge, Sloane Robinson.

Hi, Louis, Stephen and Sisi.

Thanks for taking the question.

About three quarters ago, some of the debate or the conversation was about occupancy.

I was wondering if you could -- notwithstanding the fact that you calculate it and maybe it's worth reminding people how you calculate it, but I'd be interested in seeing how that's developed over the last few quarters, please.

Thank you.

Thanks, Charles.

The utilization rate has continued to go up.

It's probably up 2% year over year.

But now we're adding more capacity.

So that may not be the case in Q3, because we added 8 learning centers in last month alone.

So we'll keep you posted.

But the utilization rate is definitely up over the last two years about 2 percentage points, from when we were at 743 learning centers and we were imploded.

So I think that you'll continue to see the utilization rate go up, but maybe not quite 2% a year because of the more aggressive expansion plan this year versus the contraction plan of last year.

But we're definitely seeing more students filling the seats.

Thanks.

And the fact, Charles, that we're not being as aggressive on price I think will also increase the utilization rate as well.

And the new programs are attracting -- as I said, the enrolment growth is picking up.

So the new programs are attracting a lot more students, so you should see pretty good utilization rate increases, but not quite as it was when we were reducing learning centers.

Trace Urdan, Wells Fargo Securities.

Thanks very much.

Louis, there was some coverage in December about plans to reform the gaokao, this idea of deemphasizing gaokao in favor of other measures of student achievement.

I wonder if you could put that into some context for us, whether you think that's going to go forward, what it means and whether it creates any opportunities for other types of student support for you guys.

I think there's a debate every year, Trace, you're right.

You'll see a lot of writings about how it's unfair that one test determines a child's future, so you'll always hear that kind of rhetoric.

At the end of the day, in a country with 9m to 10m high school graduates, there's no fair way to assess people for higher education for the limited spots.

But if China started looking at teacher recommendation letters, the teachers would be the richest people in China.

Right?

So there's no fair way that -- you really can't argue with that objective test.

So, all the rhetoric that happens, usually the gaokao still remains the main factor.

In fact, they've gotten rid of all the other stuff, like they got rid of all the points you get for the Olympic math, and that's what's killing in Beijing in the Olympic side.

Right?

And they've gotten rid of all the other external factors.

They've actually made the gaokao even more important.

And then, of course, you know earlier this year they talked about reducing the English point and they backed off from that, so English is the same as it was in past years.

And they even helped us by saying you can take the English test twice in Shanghai and then soon over the whole country.

So it's not only they've come back; they've actually come back even stronger for English.

So I think there's talk every year of this, but there's no -- no-one's come up with a fair system that people will accept other than the standardized test.

Okay.

That's helpful.

Thank you.

Thank you all.

We are now approaching the end of this conference call.

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

Mr. Hsieh, please go ahead.

Again, thank you for joining us today.

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

Thank you very much.

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

Thank you for your participation.

You may all now disconnect.