New Oriental Education & Technology Group Inc (EDU) 2018 Q2 法說會逐字稿

Good evening, and thank you for standing by for New Oriental's Second Fiscal Quarter 2018 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 meeting over to your host for today's conference, Ms. Sisi Zhao. Thank you. Please go ahead.

Hello, everyone, and welcome to New Oriental's Second Fiscal Quarter 2018 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 Stephen Yang, Chief Financial Officer. After hearing his prepared remarks, 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 U.S. 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 Mr. Stephen Yang. Please go ahead, Stephen.

Thank you, Sisi. Hello, everyone, and thank you for joining us on the call.

We're pleased, encouraged by our results for the quarter. Net revenues in the second quarter increased to $467.2 million, which is 36.9% growth, ahead of our expectations. The accelerated top line growth attests to the strengths of our business, and our sound strategy to acquire and effectively retain customers and expand capacity.

Total student enrollment in academic subjects tutoring and test prep courses went up by 43% year-over-year to approximately 1,877,100 in the second quarter.

To further tap into the booming private education market and to further strengthen our leadership in the market, we also added a net of 34 learning centers in 19 existing cities and expanded into the cities of Yinchuan, Shaoxing and Huzhou, with our dual-teacher model classes implemented in 6 new schools and learning centers.

In addition, we acquired a kindergarten in Hong Kong, extending the geographic reach of our quality education offerings.

Altogether, these boosted our total square meters of classroom area by a total of 38% year-over-year.

In the second quarter, we remained focused on our well-proven "optimize market" strategy. We're steadily working our capacity expansion across cities, where there is strong growth potential and where we could increase operating efficiency. We're making sound progress enhancing our online and offline integrated standardized teaching systems in our K-12 business, which contribute positively to our results in the second quarter. We're also rolling out standardized teaching system for overseas test prep business, such as IELTS, TOEFL and SAT programs in some of the large cities in China.

Our business has sustained strong momentum from the first quarter and yielded another strong top line performance in the second quarter of fiscal year 2018. This is mainly driven by the substantial increase in student enrollments. Our K-12 all-subjects after-school tutoring business augmented in the second quarter, with the revenue up by around 47% and enrollment up by around 52% year-over-year, continuing from the very encouraging growth from the recent quarters. The growth in our K-12 business can be broken down into outstanding performance from our U-Can middle school, high school, after-school tutoring business and POP Kids program, each of which achieved impressive growth respectively.

Our efforts to acquire and retain loyal customers, while expanding our capacity is enabling us to capture greater market share and solidify our leadership position.

Historically, the second quarter is the slowest quarter in the fiscal year. However, we achieved improvement in the utilization of facilities compared to the previous quarter. This helpped lift the pressure off the margins, as we remain committed to investing in capacity expansion. We're confident that the business is on the right track to regain grounds from the impact on the margin in the previous quarter.

Even more encouragingly, in the second quarter, the year-over-year decline of gross margin narrowed to 70 basis points comparing to 280 basis points in the previous quarter. The non-GAAP operating margin is down by 150 basis points year-over-year, showing significant signs of recovery as compared to 390 basis points in the previous quarter. We remain focused on driving both top line and bottom line growth through enhancements in cost efficiency and utilization of the facilities.

I will now turn to pricing. Per program blended ASP, which is cash revenue divided by total student enrollments, decreased by about 3% year-over-year. A few factors lie behind the fall of per program blended ASP. Firstly, our revenue mix shifted from the overseas test prep business to K-12 after-school business with lower ASPs. Secondly, the high ASP VIP business slowed down in this quarter. Starting from the third quarter last year, in an effort to streamline the registration process, we began to concentrate the registration for U-Can VIP classes in the first months of the first and the third quarters, rather than spreading the registration evenly throughout the year. As a result, there was a high year-on-year increase of enrollments for U-Can VIP classes in the first quarter, the lower-than-normal growth in the second quarter.

Besides from the streamlining of registration, we also currently expect that our VIP business growth will be slower compared to our overall revenue growth in the long run, which will continue to have a dampening effect on blended ASP.

Thirdly, the shortened class lengths of our Beijing U-Can program also diluted the per program blended ASP. We've launched a pilot program for U-Can classes in Beijing to adjust the length and format of each session from 3-hour in-class teaching to 2-hour in-class teaching, plus 0.5 hours after-class online learning. The progress of the adjustment is to improve student in-class learning efficiency and enable them to enroll in more classes for more subjects. The pilot boosted the average number of classes enrolled for students.

Hourly blended ASP, which is GAAP revenue divided by total teaching hours, increased by approximately 6% year-over-year. To provide a breakdown of the hourly blended rate, please note that U-Can increased by 6%, POP Kids increased by 5% and overseas test prep program increased by 15%, all year-over-year.

Looking ahead, we're confident that decline in margin will continue to ease through the remainder of the fiscal year. More importantly, as the business expands, it'll also benefit from the greater economies of scale, as we continue to make strategic investments, which will generate long-term value to our customers and shareholders.

Now we will move on to the second quarter performance across our individual business lines.

Our revenue driver, K-12 all-subjects after-school tutoring business, achieved revenue growth of about 47% year-over-year for the second quarter, driven by enrollment growth of about 52% year-over-year.

Breaking it down, the U-Can middle school, high school all-subjects after-school tutoring business reported a revenue increase of about 44.9% for the second quarter. Student enrollment grew approximately 48.6% year-over-year for the quarter.

Our POP Kids program, again, delivered outstanding results, with revenue up significantly by about 50.8% from second quarter. Enrollment went up about 55.1% for the quarter. Our overseas test prep and consulting business together reported revenue growth of about 21.1% year-over-year for the second quarter. Finally, our VIP personalized class business reported revenue growth of about 19.4% year-over-year for the second quarter.

Next, I'll provide some updates on the progress we're making with our "optimize market" strategy. We have been focusing on expanding our capacity by investing the build-out of our O2O integrated education system and this continues to produce very promising results.

We'll start with the offline business. In the second quarter, we added a net of 34 learning centers in 19 existing cities and rolled out dual-teacher model class in 3 new schools and 3 new learning centers in the cities of Yinchuan, Shaoxing and Huzhou. In addition, we acquired one kindergarten in Hong Kong. Our investments increased to the total square meters of classroom area by the end of the quarter by approximately 38% year-over-year.

In order to capture the growth opportunity in lower-tier cities, we continue to roll out our dual-teacher model schools, expand our business into remote areas in China. We started to pilot the new dual-teacher model class in select cities in July 2016. And by the end of the second quarter of this year, we have tested that new offering in over 30 existing cities and 10 new cities. And we're pleased to see the increased market penetration in the markets we tapped into. We also saw improved customer retention and scalability of this new model. With these encouraging results, we will continue to deploy the strategy in the rest of the fiscal year.

With respect to our online business, $18.7 million was invested in the second quarter to improve and maintain our O2O integrated education ecosystem. Most of the investments were recorded under G&A expenses. With the high customer retention rates and the acquisition of new customers, we believe the investment will yield significant return and bring sustainable and long-term benefits.

I'll first talk about O2O Two-Way Interactive Education System.

Since the launching of our U-Can Visible Progress Teaching System in September 2014, the interactive education system has been deployed in all existing cities. We launched the newly revamped POP Kids English program, "Shuang You" in most cities by end of second quarter of fiscal year 2018. This interactive education system has also been gradually used in more and more cities across China. The interactive education system for overseas test prep program, including IELTS, TOEFL, and SAT courses was rolled out and tested in most of the major cities by end of Q2 fiscal year '18. At the same time, we also standardized the product offerings in the city of Shenzhen, Xiamen and Changsha.

Now I will walk you through our progress in koolearn.com and other supplementary online educational product.

Koolearn.com generated net revenue of $28.2 million, representing a 59.6% increase year-over-year in the second quarter. The number of paid users increased about 23% year-over-year in the quarter. Koo.cn live broadcast platform achieved about 709,600 registrations in the second quarter. DONUT learning apps reported over 73.5 million downloads by the quarter end. And Le Ci app reported over 7.1 million users by quarter end.

These developments aim to extend New Oriental's traditional offline classroom teaching offerings to online educational services. This is an important front on which we set ourselves apart from other key players in the market. With the booming market and our advanced O2O product service, we're poised to gain more market share and strengthen our hold going forward.

Now, let me walk you through to the other key financial details for the second quarter.

As mentioned earlier, the business delivered outstanding year-over-year increase in net revenues and growth in the second quarter. Due to our expansion of capacity, operating costs and expenses for the quarter were $480.3 million, representing a 40.8% increase year-over-year.

Non-GAAP operating costs and expenses for the quarter, which exclude share-based compensation expenses, were $470.9 million, representing a 39.0% increase year-over-year. Cost of revenues increased by 39.1% year-over-year to $227.3 million, primarily due to increase in teacher's compensation for more teaching hours and the number of schools and learning centers in operation.

Selling and marketing expenses increased by 38.2% year-over-year to $72.1 million, primarily due to increases in brand promotion expenses and selling and marketing staff's compensation.

General and administrative expenses for the quarter increased by 44.2% year-over-year to $180.9 million. Non-GAAP general and administrative expenses, which exclude share-based compensation expenses, were $171.6 million, representing a 39.2% increase year-over-year, primarily due to increased headcount as the company expanded its network of schools and learning centers as well as increases in R&D expenses and human resources expenses related to the development of our online and offline integrated education ecosystem.

To further align vision and interests of the company's external and internal shareholders, the company grant a total of 1.5 million restricted share units of the company to employees and directors in October 2017, with graded vesting over 3 years. Because of the granting, the costs involved drove the total share-based compensation expenses up by 330.2% year-over-year to $9.3 million for the quarter.

Operating loss for the quarter was $13.1 million, compared to net income of $0.2 million in the same period of prior fiscal year.

Non-GAAP loss from operations for the quarter was $3.8 million, compared to an income of $2.4 million in the same period in the prior fiscal year.

Operating margin for the quarter was negative 2.8% compared to positive 0.1% in the same period of the prior fiscal year. Non-GAAP operating margin, which excludes share-based compensation expenses, for the quarter was negative 0.8% compared to positive 0.7% in the same period of the prior fiscal year.

Net income attributable to New Oriental for the quarter was $4.3 million, representing a 58.7% decrease from the same period of the prior fiscal year.

Turning to the balance sheet. As of November 30, 2017, New Oriental has cash and cash equivalents of $818.1 million compared to $641 million as of May 31, 2017. In addition, the company had $87.5 million in term deposits and $1,522.8 million in short-term investments as of November 30, 2017.

New Oriental's deferred revenue balance, which is cash collected from registered students for courses and recognized proportionally as revenue as the instructions delivered, at the end of the second quarter of fiscal year 2018 was $1,137.3 million, a increase of 48.7% from $764.7 million in the same period of the prior fiscal year.

Before moving on to our expectations for third quarter, I would like to take a moment to reiterate our overarching goals and priorities under our "optimize market" strategy.

In terms of our priorities, first, we will continue to expand our offline business. We aim to add around 20% new learning centers and expand classroom area of some existing learning centers for K-12 businesses in existing cities. And we also plan to enter 2 to 4 new cities, where we identify as markets with the most business opportunities. In addition, we'll continue to roll out our dual-teacher model schools to about 5 to 10 new low-tier cities in China.

Second, we'll continue to leverage our investment in our O2O integration in online education offerings. In particular, we will continue our focus on product refinement and maintenance for the O2O system for K-12 business. Meanwhile, we'll continue to revamp and roll out our O2O standardized teaching system for our overseas test prep business. We will continue to make investments and we currently believe that total spending in absolute dollar terms in fiscal year 2018 will increase moderately compared with the prior fiscal year.

Third, we will continue to focus on driving up utilization of our facilities and cost control to drive operational effectiveness and deliver long-term bottom line goals.

As already shown in the second fiscal quarter, we believe that the expected acceleration of the revenue growth and anticipated boost in facility utilization in the coming quarters will mitigate the impact on the margins over the coming quarters. We will keep you updated as we move through the fiscal year. We're confident that our expansion strategy and recent incentives will drive additional growth of revenue and market share in a way that creates long-term value for all shareholders.

Looking at the near term and our expectations for the third quarter, we expect total net revenues to be in the range of $591.1 million to $604.2 million, representing year-over-year growth in the range of 35% to 38%.

Lastly, I must mention that these expectations reflect New Oriental's current and preliminary view, which is subject to change.

At this point, I'll take your questions. Operator, please open the call for this.

(Operator Instructions) The first question comes from the line of Fan Liu of Goldman Sachs.

So you added capacity back 38% year-on-year this quarter, faster than the previous quarter at 31%. May I know the rationale behind this acceleration? And also, a question relating to your guidance -- third quarter guidance. May I know the ForEx you applied behind this third quarter guidance. Since if we exclude the impact from RMB appreciation, your third quarter guidance will imply around 29% year-on-year in the midpoint, actually lower than this quarter at around 34%. May I know the reason behind this deceleration? Supposedly, second half should accelerate versus the first half?

Okay. Thank you, Fan. In terms of the expansion plan, yes, we add 41 schools and learning centers in this quarter. And the total square meters of classroom area by the end of this quarter increased by 38% year-over-year. I think the reason that we raised the expansion plan is we're seeing the growing momentum in our K-12 business, due to the solid market demands. And that means we are more confident about our new O2O product as well and effective operation as well. So for the whole year, we plan to add 20% new learning centers combined with the 10% new square meters, we rent for the existing learning centers. So altogether, it's 30%. And I think this will drive the potential growth going forward not only for the second half of this year, but also for the next year. And in terms of the guidance, yes, I think we're still seeing the revenue growth acceleration going forward, but don't forget in the last year Q3 -- we had very strong Q3. It's a little bit hard comparision that, I think the K-12 business will bring us very strong enrollment growth in the third quarter. And I think we will see the acceleration of the growth of top line in Q3 and also in Q4 as well.

The next question comes from the line of Ivy Luo of Macquarie.

So one of my question is just a follow-up on the revenue growth. Because we do see deferred revenue growth kind of accelerated to 49% from 42% last quarter. And the enrollment growth has really slowed this quarter. I think part of -- as you mentioned, part is like our recruitment plan of trying to have the winter and the spring together, so just want to understand how much percentage does that part account for? And my second question is regarding the Hong Kong kindergarten that we acquired. Can management share more color on what's the consideration, how many students does that actually have a margin drag? Have we consolidated this? Just some color on the kindergarten that we acquired and the logic behind it.

Okay. Thank you, Ivy. Let me answer your second question first. The kindergarten we acquired in the Hong Kong is a very small one. So it's not a big deal. And in terms of the first question you asked about the revenue guidance. I think in the Q3 guidance, I think on the school level, what I mean the short-term schools, the top line growth in the Q3 in the coming quarter will be very strong. So that's why I said, we're still seeing the revenue acceleration of the growth. But in the Q3, we had a very strong quarter last year of the other business. So we had a little bit hard comparison for the Q3. And we had a great deferred revenue balance growth in the quarter end. And I think based on the historical data, 50% of the cash revenue we reported in the second quarter will be reported into the GAAP revenue in Q3. Okay? Is it clear, Ivy?

Maybe just to clarify, does that mean that in the total enroll -- if we just look at enrollment number, how much can we attribute it to maybe the spring quarter? Yes, the winter and the spring like in the annual report.

Okay. We don't disclose like that. But I think most of the enrollments, which we have in hand are from the winter classes. That means we report most of the cash revenue. We report in Q2, into the Q3, the winter courses.

Next question is from Natalie Wu of CICC.

Two similar questions here. First one is that how do you view VIP Kids model? Just wondering, how do management see the strategy and opportunity related with that in longer term. Will New Oriental launch any initiative regarding that model? And second one is, what's the current utilization rate for different subjects? What are the large gap between these? And if yes, do you expect the gap to close? And how many years will the process take?

Okay. Thank you, Natalie. I won't make comments on the VIP Kids business model. Well, what I just want to say is that, I think most of their business is the online verbal English training model. And -- but we have already pilot the same pattern model since last quarter. But I think we're using a different way. First, for us, one online teacher face to 3 students at the same time. And we open the online class for our POP Kids students only. That means we're not open for the students outside New Oriental. And -- but for us, we have a lot of the POP Kids online enrollments. So that means we don't have the acquisition cost to acquire student enrollments for online courses. And also, we reflect the teachers and the curriculum by the system and the content. We just piloted one in Wuhan and Beijing only for now. And what's your second question?

Utilization rate.

Okay. Utilization rate

Okay. Utilization rate yes, for different subjects?

Okay. I think we just disclosed the utilization rates for overall. And the utilization rate of this quarter is about 20%. It's flattish compared year-over-year. Even though we opened 41 learning centers in this quarter. And I think it becomes faster and faster for us to pull the students into the classroom, quicker than before. So I think going forward, you will see the higher utilization rates for us.

Okay. Just one more simple question. Can I know the average enrollment per student currently?

At the same time, one student takes 2 to 3 courses.

Your next question comes from the line of Marianne Kou of CLSA.

I think just a follow-up on the previous analyst's question on the enrollment per student because you also mentioned just now in the ASP discussion that we are doing some piloting classes in Beijing to move like half an hour of the class online and kind of shorten the in-classroom time to encourage more enrollment. So just wondering if, and say like kind of longer term if this model works out, like what will we expect in a year's time to optimal enrollment for students ratio or other courses for students? And the second question is on the dual-teacher model. Just wanted to see since now we have a pretty decent coverage in some cities using a dual-teacher model, just wondering, if you have any further indication in terms of financial metrics. How that compares to traditional model? And also on the learning outcome side, are we seeing better or comparable results compared to traditional model?

Yes. We started a pilot program in Beijing U-Can program to change the class lengths from 3 hours in class teaching to 2 hours plus 30 minutes online learning. As a result, after the change in Beijing school, we saw the average number of the enrolled classes per student increased from 2 classes to 3 classes. So I think it's good for us to take more students and each of the students were taking more classes at the same time. So I think going forward, we will spread it out to other cities, but it depends on the time. And your second question is about the dual-teacher model? Yes. We stepped into the 30 learning centers in existing cities for the dual-teacher model. And also, we have already opened 10 new cities to open the dual-teacher model. So far so good. I think the student retention rate is better than we expected. And also, I think that one teacher can face to 10 or 20 classes is successfully piloted in the last year. So in terms of the financial model, I think the margin of the dual-teacher model should be higher than the traditional classes, because the one teacher can face to like the 200 or 300 students at the same time. And all the other classes are the same compared to the traditional classes. It's too early to say because we're just pilot program being summer of last year. And we need more time to spread out to more cities and more learning centers.

The next question comes from the line of Jin Yoon of Mizuho.

A couple of questions. So perhaps you can give us some color of how to think about margins for the next quarter and perhaps for the full year? Should gross margin headwinds remains similar to Q2 levels? And how should we think about G&A excluding O2O investments? Should it be growing at similar -- similarly elevated levels. And then second question, Stephen is, perhaps you could give us kind of a breakdown on your revenue guide by different classes? That would be super helpful.

Okay. Yes, I think the margin guidance yes, as you know, even though we opened the 41 learning centers, the schools and learning centers in Q2. And, but operating margin is down by 150 bps in the second quarter. But don't forget our margin was down by 390 bps in the Q1. So it's a recovery. And going forward, we believe the margin pressure will lessen and reverse in the rest of the year because, I, think we will -- we expect to see the acceleration of the revenue growth, and also the higher facilities utilization. So in terms of the margin, I think in the rest of the year, the margin pressure will lessen and reverse. And -- but I won't change my guidance of the margin in the long term. So our op margin target is to get 17% to 18% in the next 3 years. This year, because we changed our expansion plan from around 10% to 30%. So -- but I think this is a good for us because market demand is there and the O2O product is better than before for us. So I think for the long term, it's a good way for us to take more market share from the other key players in the market. And what was the second question?

The second question is revenue -- can you kind of give us a breakdown of your revenue guide by classes?

The overseas test preps is 10% to 15% and the K-12 business is over 50%, and the domestic test prep is 20%. What I said is increase, and the only drag down is the adult English. It will be down by 5% to 10%. And the pure online, the koolearn.com, the revenue growth will be over 60% in Q3.

Your next question comes from the line of Alex Liu of Daiwa.

I have 2 questions. So first, just want to follow-up on Liu Fan's question. How long does the management think or intent to maintain such high-speed of capacity growth? And related, what makes you so confident on delivering profitability improvement given that we are still aggressively expanding? My second question is on POP Kids. It seems that I think we are getting more aggressive on non-English subjects for POP. I was wondering what types of students we are targeting? And how big do you think these specific subjects will be growing to? Just want to know your thoughts.

Actually only 1/3 of the POP Kids revenue comes from these non-English courses - Maths and Chinese. But it grows faster than the English courses. So going forward, I think for the non-English courses, the revenue grows faster than the English courses. That's for the POP Kids. And the expansion plan. I think, yes. If you remember in the last 2 years, we just opened like 10% to 15% new learning centers every year. And this -- but don't forget we just piloted the new O2O product since 2.5 years ago. So this year, we raised our capacity expansion from 10% to 30%. I think you can wait to see us taking more market share. Next year, we haven't set up the budget. But I think we will open like 20% to 25% new learning centers in the next fiscal year. It depends on the market demands. But anyway we're quite confident about our product and the market demand. It's a huge market. Our market share is just below 2%. It's too early. So that's why we raised our expansion plan this year.

(Operator Instructions) The next question comes from the line of Tian Hou of T.H. Capital.

Congratulations on a good quarter and also strong guidance. So since the company is entering into a relatively high-speed expansion phase, so I wonder what's the company's plan for the next 2 quarters in the fiscal year? How many new learning centers? And do you plan to open in the next 2 quarters and also for next year? And what kind of opening plan do you have? So that's my question.

Okay. Thanks, Tian. I think in the rest of this fiscal year in coming Q3 and Q4, we plan to open 50 to 80 new learning centers in total, in the next 6 months. So combined with the 85 new learning centers we set up in the first half of the year, the total number will be 150 to 170. And next year, as I said in the last question, we haven't finished the budget of next year. But we expect to open like 20% plus new learning centers next year. But based on my current estimation, I think the new learning centers we set up for the next year will be below 30%, because we opened a lot this year.

Your next question comes from the line of Lucy Yu of Bank of America.

A follow-on question on the revenue growth. In this quarter, your revenue grew at around 34% in RMB terms. Can you please break that down into firstly, the retained student from summer promotions and other students? And also, break down that by new learning center that has been opened within the past 4 quarters and the contribution from the mature learning center that has been opened over 1 year?

Yes. Actually, we have 554,000 summer enrollments in the summer. And the retention rates in autumn was close to 50%. So it's the enrollment in the autumn class we got from the summer promotion. But we don't have the details of how many students from the new learning centers, and how many students from the existing ones. It's really hard for us to divide the students by 2 parts. But what I can say is, yes, we opened a lot of learning centers. It drives enrollment to grow up and spend times for us to fill the students into the learning centers. Typically for the new learning center, it takes 5 to 8 months to get a breakeven. That is how fast we can fill the students into the new learning centers.

Your next question is from Thomas Chong of Credit Suisse.

I have a quick question about the revenue growth and contribution in Beijing, Shanghai, Guangzhou and Shenzhen? And then, a quick follow-up is about the utilization. Can I have the breakdown between the old and new learning centers in the past 1 year?

Okay. I think the top 5 cities, Beijing, Shanghai, Xi'an, Wuhan, Guangzhou - the top 5 K-12 business revenue contribution cities contribute 46% of total revenue. And in the last trailing 12 months, the growth rate was 37%. This is the contribution from top 5 cities and the growth rates.

Next question is from Sheng Zhong of Morgan Stanley.

So my first question is about our deferred revenue. It has a very strong growth. And Stephen also said that the VIP enrollment policy has changed to first quarter and third quarter. So may I take that to think that the deferred revenue has even stronger growth, if we look at K-12? So maybe can you give more color on the breakdown of your deferred revenue growth this quarter? And second question is about our pilot program in Beijing. So you said that this is still not the time to expand to other cities. So may I understand what your key concern about expand the program to other cities and maybe when you think it's an appropriate time to expand this program to other cities and to like POP Kids?

Okay. We have a different revenue model. Yes, I think the actual numbers, if we don't change the VIP registration window last year, I think the deferral balance will be better than the 48% year-over-year growth. So I think -- yes, you'll see the deferred revenue strong growth of the balance, I think, it means we will have a very strong top line growth in the coming quarter, Q3. And within the deferred revenue balance, most of the cash revenue we collect from those customers are from K-12 business. And yes, we reach -- so your second question is about the pilot program where we changed the length of the class session in Beijing school. We just piloted program in this summer. So I think it's good than expected so we need more time to summarize the advantage of this program. I think we will do more and more in more cities.

Next question is from Tallan Zhou of Deutsche Bank.

Stephen, most of the questions have been covered by previous analyst, so I have 2 follow-up questions. You mentioned about utilization rate remains pretty much same under such high expansion on the capacity. Do I understand correctly that for mature learning centers, the utilization rate actually increased in this quarter? It's also a follow-up question on deferred revenue - So can you put it down by like how much will be collected from spring season or winter season?

Okay. Okay. I think the utilization rates, yes, for the mature learning centers, the utilization rates of facilities is still going up in this quarter. But I think we have a lot of room for the mature learning centers to get improvement of the utilization rates. I think the reason that we can't guide higher utilization rates in this quarter is because we opened 85 new learning centers less than 6 months. But I think we will fill the students into the new learning centers quicker than before, okay. Within the deferred revenue balance, this is really hard for us to define the students in the winter class and the spring class, but yes.

Yes, but for your reference, actually the deferred revenue by end of Q2, about 47% of it will be recognized as GAAP revenue in Q3. So that's roughly how we talk about the deferred revenue guidance and deferred revenue number and the indicator for next quarter.

Next question comes from the line of Wayne Wang of HSBC.

So I have a question regarding to our capacity expansion plan in both high-tier city and low-tier city? And also, I just want to confirm that it seems the management had mentioned that in fiscal year '18 now the total spending will remain largely flat year-on-year. So what could be our full year margin guidance? And also, what's our full year plan for the O2O investments?

Okay. As for the capacity expansion, we are opening the learning centers in 20 to 25 cities with a higher performance in last year. So this is our plan. And as I said, we will open 20% new learning centers combined with the 10% new square meters we rent for the current learning centers, altogether 30%. And the online investments, we spend $18.7 million on the online investment this quarter. It's a little bit higher than we expected. Actually, we expected $14 million, so that means we spent $5 million more than we expected. But I think it's worthy, because we started to spend the online investment since 3 years ago. We spent $67 million in the last year, and $39 million in the year before last year. But I think the high investments of the online drive higher student retention rate. And also, we acquire new student enrollment and improve the teaching quality and feedback from the students and parents much better than several years ago. So that's why I said it's worthy. And we plan to spend $60 million to $70 million for the whole year on the online investments. This will be a little bit higher than expected. Last year, it's $55 million; this year $60 million to $70 million. But I think it's worthy, okay. And what's your question? I think it's margin?

So the second question is regarding to the full year margin guidance. So it seems previously, we have talked that our total expanding in fiscal year '18 could be largely flat year-on-year? I'd like you to add more color on that?

Yes. I think going forward, in the rest of the year, we believe the margin pressure will lessen and reverse in Q3 and Q4, okay. But I won't give the specific guidance for the margins in the rest of the year.

Next question is from Eric Qui of CCBI.

I have 2 questions. One is, you mentioned that top 4 cities account for 46 percentage of revenue. I was just wondering, how many percentage of learning centers are in the top-5 cities? And also, how many cities have you been entering into and what do you think are the potential number of these cities you may enter into eventually? The second is, what's the utilization rate this quarter? And what's the trend for the utilization rates?

Okay. Yes, I mentioned the top 5 cities contribute 46% of total revenue. So in the top 5 cities, I think the learning center number took altogether, Beijing is 125, Shanghai is 56, and Guangzhou is 32 and Xi'an is 25...

I can send you all the details after the earnings call. It's on our presentation.

Yes. And we are in 70 cities. And I think our ultimate goal is to step into more than 100 cities. but in most of the new cities we will enter with the dual-teacher model. But don't forget, even in the existing cities like in Beijing - we have 100 learning centers in Beijing, but I think the maximum learning centers in Beijing will be over 150. So there is a lot of room to open more learning centers in the existing cities.

And we will take the final question from Marilyn Mo of Indus.

I have a follow-up question on margin. If I understand correctly, so for this quarter, our utilization rate is kind of flattish year-over-year and the GAAP revenue per teacher hour is also up 6% year-over-year. So what drives the gross margin dilution year-over-year for this quarter? And also for operating margin, besides the investment in online, what other factors drive the margin dilution? Both talk about year-over-year, not quarter-over-quarter.

Okay. Yes, I think within the G&A and selling expenses, besides the $18 million of the online investments, I think the headcount was increased because we opened more learning centers and schools in the last 2 to 3 quarters. So the cost of that, because the rental is over 40% year-over-year -- increased year-over-year this quarter. Don't forget we opened 120 new learning centers, and we're renting more square meters in last 3 quarters. So at the quarter end, the square meters are 38% higher compared to last year. That's why we got the 44%, 45% rental increase in this quarter, okay.

So the rental increase is 44% to 45% increase?

Yes. Yes.

But if our utilization rate is kind of flattish that should be largely offset?

Yes. So partially it's offset, but for the new learning centers, we will need more time to fill the students into the classrooms. So it dragged the margin, but only the GP level. The gross margin level is just down by 70 bps. So it's not a big number, okay?

Okay. Okay. So still it's because of expansion? Okay.

Yes. Yes.

We are now approaching the end of the conference call. I will now turn the call over to New Oriental's CFO, Stephen Yang, for his closing remarks.

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.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating, and you may all disconnect.