New Oriental Education & Technology Group - Earnings Call - Q1 2016

Transcript

Speaker 0

Ladies and gentlemen, good evening, and thank you for standing by for New Oriental's First Fiscal Quarter twenty sixteen Earnings Conference Call. At this time, all participants are in a listen only mode.

After the management's prepared remarks, there will be a question and answer session. 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. C.

C. Zhao, New Investor Relations Director. Ms. Zhao, please proceed.

Speaker 1

Thank

Speaker 2

you. Hello, everyone, and welcome to New Oriental's first fiscal quarter twenty sixteen 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 Michael Yu, New Oriental's Chairman and Chief Executive Officer and Stephen Yang, Chief Financial Officer. After their prepared remarks, Michael 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 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 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 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 Michael.

Michael, please.

Speaker 3

Yes. Thank you. Thank you. Hello, everybody, and thank you for joining us. I'm happy that I'm on this call today.

I have decided that I will join the earnings conference call occasionally, providing me the opportunity to update our investors and support us on important strategic initiatives and answer any questions you all may have. As announced earlier today, the company has decided to promote Chenggang Zhou to the position of President effective on 01/05/2016. At the same time, Louis Xie will step down as President, but he will remain on our Board of Directors and will serve as a non executive senior adviser to our company. We would like to congratulate Chen Gang on his new position as our President. He will focus on corporate strategy and oversee overall business development in China.

He has been with the Oriental for more than fifteen years and has brought to us with his deep understanding of education service industry. Actually Chen Guangzhou was one of my high school classmates and I understand him a lot. He has been the oriental for more than fifteen years. First, he served as the Head of Shanghai School. Actually, he's the Founder of Shanghai School.

And then he served as the Head of Beijing School. And after that, he served as standing VP for all the oriental groups. And then he served as the CEO of Qianchu Overseas Consultant. He's really a smart guy and has been helping me for all these fifteen years for Niallin Tor's operations. So we are confident that he will make a great contributions to our continuous success in the market.

In the meantime, I would like to thank Luis for all he has accomplished and the leadership he has provided during this important period of our business development in China. I'm pretty sure Luis is listening this conference, and I really thank you for that for ten years accompanying us for all these business decisions and the nice development of near rental in Chinese education areas. As our Chief Financial Officer, he led us through a very successful IPO on the New York Stock Exchange in 02/2006, and then he took on the role as President since 2009 to help us grow our business. Going forward, Luis will remain on the Board and serve as a Senior Advisor to Neorento and also to me. We thank Luis for his decade long contribution to the company and I wish him all the best.

I'm also very happy to be here today specifically because we had a very strong first quarter, which is a strong reflection of our ability to continuously meet our promises to students and the customers by delivering products and services of the highest quality. Also, has been a year since we embarked on the new strategy of optimize the market, switching our focus to balancing between top line and the bottom line growth as well as furthering our integrated ecosystem and pushing forward into the online space. Building out our O2O programs, we have had great success with this strategy, and our results today are testament to this. As you can see, our hard work in executing this strategy is paying off. To give you just a couple of high level examples, we opened two new schools in the cities of Wenzhou and the Quanzhou, where we see the most potential.

Also our You Can Visible Program teaching system is now being used in 52 cities across China. And our newly revamped POP Kids program continues to receive positive market feedback. This is a very encouraging signal and proves that we made the right decision to push so much effort to put so much effort into establishing the O2O ecosystem, which was still a very new concept in China not too long ago. And now our new products are helping hundreds and thousands of Chinese students progress much more quickly and effectively and efficiently. Above all, we hope to create an enjoyable learning experience for the younger generation.

Before I go into the details for the first quarter, I would also like to say a few words about the surrounding economic environment in China, which has, of course, had a great deal of attention domestically and abroad. I would like to point out that a softening Chinese economy is actually contributing a bit to our ongoing business recovery, which is quite the opposite of what people would normally expect. Here is what you have to understand about Chinese parents. When the economy is slowing down, they tend to enter into protection and preparation mode, meaning children will be facing a lot of competition in a few years, be it for a college entrance examination or for a job interview. So he or she needs to be more equipped to tackle those challenges.

Better education is what parents immediately think of and this is where New Oriental comes in. With this ready as a benefiting factor, we are contributing to work harder to create the best in class for our students and teachers. I would like to add another word that the Chinese parents have the habit of saving money for their kid for almost eighteen years. So no matter the economy is going up or going down, it doesn't matter. So parents would like to pay the full tuition or full money for their kids' future.

So that's why that in the orange zone, it doesn't matter whether the economy is going down or up. Parents are still paying money for their kids' education no matter what happened in China. The purpose of Chinese parents is to save money for their kids. It's not like United States parents. They use they rent money from the bank.

So it's totally different. So in addition, with the economic slowdown and the turbulence in China stock market, we do not expect as much wage inflation in the near future as private equity reduces the pace for the investment in online education startups, which is also a good news for us. Because investment in online education slows down, that means we have more time and more chances to find new opportunities in education areas. So we by saying this, we expect also better retention of our school heads, teachers and other staff, because they don't have much opportunities outside already. So New Oriental is still the best brand name in China.

Now let's look in the details in some details at our quarterly performance in the 2016.

Speaker 4

During the first quarter,

Speaker 3

we saw an ongoing recovery in both top line and the bottom line with a wholesale operating margin of 28.3. Revenue was up 16.4% year over year to million dollars and were mainly driven by the enrollment recovery, which increased 13.8% year over year to more than $1,000,000 As Stephen mentioned last quarter, we are narrowing the scope of our loyalty program, so the impact on our revenue in the first quarter was minimal, and we would expect the same for the upcoming quarters as well. Our key revenue driver, the K-twelve all subjects after school tutoring business continued to excel. And very excitingly, our newly revamped POP Kids program recorded a gross revenue increase of more than 30%. This is a remarkable improvement from the single digit growth over the past two quarters and we consider this a big achievement since the revamp a year ago.

With the positive market feedback, we expect this growth trend to continue for the rest of fiscal twenty sixteen. In terms of pricing, per program blended ASP increased only by only 3% year over year, which is the lowest over the past two years. On an apple to apple basis, which is GAAP revenue divided by total teaching hours, hourly blended ASP increased by 5% to 6%. Breaking it down on an hourly base, blended ASP for EU Can increased 5% and ASP for overseas test preparation program increased about 5%. For our POP Kids, ASP increased about 7%, which is in line with expectations as our priority at this stage is to get into the market and take domination before raising our prices.

Moving on to performance across our individual business lines. Our K-twelve all subjects after school tutoring business saw gross revenue grow over 29% year over year for the first quarter and a year over growth of more than 23%. Yokam middle and high school subjects after school tutoring business achieved the gross revenue it's breaking down, increased of 28% year over year, student enrollments grow 24% year over year. For the POP Kids program business, as I said, saw increased momentum in the first quarter with gross revenue up more than 30% and enrollment up 23% year over year. Our overseas test prep and the consulting business achieved revenue growth of 10% year over year.

Finally, revenue for VIP personalized classes business increased 25% year over year. Now let me turn to a discussion of our optimize the market strategy. As we move into the second year of executing this strategy, we continue to enforce a healthy balance between top line and bottom line growth as well as building out our integrated ecosystem. Here are some updates on the progress we are making. For the offline part, to start with our core offline business first, we added two new schools in the cities of Wenzhou and the Quanzhou, which lie in the Southeast part of China.

In order to optimize our resources and facilitate the growth in the cities that can better drive up our operation margin, we closed a net of five learning centers while expanding some existing learning centers at a total of about 11,000 square meters of additional classrooms area. To be sure, we are right on the track to reach the annual plan to open about 30 new learning centers for our K-twelve business in fiscal year two thousand and six in existing cities and also into four to five new cities where we see most of growth potential. For our offline part for our online part, as for our online business, fiscal twenty sixteen will be another investment year as we look to fully build out our O2O integrated education ecosystem. Encouraged by the strong performance of U Can and POP Kids, we are confident that this investment will enable us to further penetrate into the market and deliver sustainable growth. As said before, we target to spend about $50,000,000 in fiscal twenty sixteen.

And for the first quarter, we invested about $10,000,000 most of which was recorded on the G and A expenses. Before I go into the details about our online business, just a quick recap of the 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 of our business lines. The second level is our pure online learning platform and the supplementary online education product under 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 education offerings.

Let's start with O2O two way interactive education system, which we rolled out and upgraded a year ago across all major product lines in order to extend New Oriental's traditional offline classroom teaching offerings to online education services, this system continues to mature. In the first quarter, U Can Visible Progress teaching system extended its coverage to all 52 cities in our network. This rapid growth is a solid proof of how much our new products are being welcomed by our students and the market. As said earlier, Shuangyo, our POP Kids English program picked up significantly this quarter with revenue up to more than 30% and enrollment up 23. By the end the first quarter, 42 cities in China are using this new interactive program and we will gradually roll out in more cities in the rest of the year.

The O2O for the domestic test preparation program are being used in more than five cities now by the quarter end. And we have been testing the O2O for overseas test preparation programs in seven cities since May. For the second level of our online education ecosystem, we have seen steady growth in our pure online learning platform and other supplementary online education products. In the first quarter of this year, kulearn.com generated a net revenue of US9.8 dollars up 32% year over year. The number of paid users increased over 150% year over year.

The number of cumulative registered users has reached more than 11,100,000. Ku.cn, our new live broadcast open platform for both New Oriental and third party teachers achieved almost seven and twenty three thousand registrations in the first quarter. Doughnut, a series of game based mobile learning APPs for children, recorded over 28,200,000 downloads in the fourth quarter, up from 22,500,000 in the fourth quarter for fiscal year twenty fifteen in the first quarter, sorry. Lei Zi, our English Chinese vocabulary training app for mobile phones and tablets app recorded over 3,000,000 users by end of the first quarter of this year. Turning to the third level of our online education ecosystem.

We have invested in select seeing select online education companies with a minority stake. And we are constantly looking for new opportunities that will not only complete our own offerings, but also facilitate our auto integrations. Now I would like to turn the call over to Stephen Yang to provide more details on our financial performance as well as some information about our overall outlook. Stephen, it's your turn.

Speaker 4

Thank you, Michael. Now let me walk you through the key financial details for the first quarter. Operating costs and expenses for the quarter were $328,600,000 a 15.9% increase year over year. Non GAAP operating costs and expenses for the quarter, which excludes share based compensation expenses, were $324,900,000 a 15.7 increase year over year. Cost of revenues increased by 15.6% year over year to $171,700,000 primarily due to increase in teachers' compensation for more teaching hours.

Selling and marketing expenses slightly decreased 0.3% year over year to $49,400,000 General and administrative expenses for the quarter increased by 25.9% year over year to $107,600,000 Non GAAP general and administrative expenses, which exclude share based compensation expenses, were 103,900,000 a 25.6% increase year over year, primarily due to increase in R and D expenses and human resources expenses related to the development of our Ocho integration. Total share based compensation expenses, which were allocated to related operating costs and expenses, increased by 35.6% to $3,700,000 in the first quarter. Income from operations for the quarter increased by 17.5% to $129,800,000 Non GAAP operating income increased 17.9% to $133,600,000 for the quarter. Operating margin for the quarter was 28.3% compared to 28.1% in the same period of prior fiscal year. Non GAAP operating margin, which excludes share based compensation expenses for the quarter was 29.1% compared to 28.8% in the same period of prior fiscal year.

Net income attributable to NewRental for the quarter was $128,500,000 representing a 14.4% increase from the same period of prior fiscal year. Capital expenditures for the quarter were $17,800,000 which were primarily attributable to the opening of 34 new learning centers and renovations at existing learning centers. Turning to the balance sheet. Deferred revenue balance, which is cash collected from the registered students for the courses and recognized proportionally as revenue as the instructions are delivered at the end of the first quarter was $511,700,000 an increase of 28.3% as compared to $398,900,000 at the end of the 2015. Now let me talk about our go forward plans and expectations.

I wanted to first take a moment to reiterate our overarching goals for the year, which we outlined on the fourth quarter's call. During fiscal year twenty sixteen, we will continue to implement optimized market strategy. As part of this, we will have below key areas of focus. We will continue to expand our offline business. We continue to aim to enter four to five new cities where we identify the most growth potential and open about 30 new learning centers for our K-twelve after school tutoring business in existing cities that are driving both revenue growth and margin expansion.

Also, we will continue to invest heavily as we did in fiscal year twenty fifteen. Fiscal year twenty sixteen will also be an investment year as we work to fully build out our auto ecosystem. We'll continue to invest spending about $50,000,000 in the fiscal year. We consider this investment essential to helping strengthen our market dominance. And we're fully confident that all of these efforts will bring higher growth and sustainable profitability in the longer term.

Last but not least, we will drive further operating efficiencies. We remain keen on improving operational efficiency and cost control across the organization, so we'll continue to focus on this. As Michael mentioned earlier, we're seeing less pressure on wage inflation as economy slows down and private equity reduce the pace of the investments in online education startups. With this strategy as our guide for the year, we expect to achieve double digit annual revenue growth. At the same time, we're becoming more confident in our bottom line performance as operating margin for our offline business has been experiencing steady recovery over the past four quarters and operating margin for the overall business also improved year over year in this reported quarter.

With respect to the second quarter specifically, we expect total net revenue to be in the range of $267,000,000 to $276,400,000 representing a year over year growth in the range of 13% to 17%. If not including the impact from the recent depreciation of renminbi against the U. S. Dollar, the product revenue growth rate is expected to be in the range of 17% to 21% for the second quarter. This forecast reflects New Oriental's current and preliminary view, which is subject to change.

At this point, Michael and I will take your questions. Operator, please begin.

Speaker 0

Thank you, sir. The question and answer session will start in a moment. We one a question

Speaker 5

from

Speaker 0

We have the first question from the line of Dick Wei from Credit Suisse. Please ask your question.

Speaker 6

Thank you for taking my question. Good evening, Michael Stevens. This is Dan Zhao calling on behalf of Big Wave. Could you share some color on the margin of each segment courses like Overseas Test Prep, U Can and POP Kids? I just wonder with revenue contribution from K-twelve keep rising, is there any impact on the margin trend?

Thank you.

Speaker 4

Okay, I'll take the question. I'm Steven. And for the different margin for different business lines, for the overseas test prep, the margin the operating margin for overseas test prep is about 30%. And for the U Can business, the operating margin for this business line is about 25%. And for POP Kids now, the margin is only 10%, but it's grown up very fast, because we're seeing the more students filling in the classroom.

And yeah, along with the K-twelve business account for more and more a percentage of the revenue, now it's 45% and it's like the 50% or more in the year after. But we don't see the margin dilution by these things, because we're seeing more and more students filling in the classroom. That means it will help us to improve the utilization rates up. So, think the margin will go up, especially since the fiscal year twenty seventeen, because last year and this year we are in the heavy investments and we will spend $50,000,000 in this year. And so, I think next year, the margin will go up.

And I think in next three or four years, the 17 or 18% is our target for the operating margin. That's my question. Thank you.

Speaker 6

Thank you very much.

Speaker 4

Okay.

Speaker 0

Pardon me, sir. Can we move to the next question?

Speaker 4

Sure. Okay.

Speaker 0

We have the next question from the line of Fan Liu from Goldman Sachs. Please ask your question.

Speaker 7

Thanks. Hi, Michael, Stephen, this is Sisu. So thank you for taking my questions. It's very great to have Michael in this call going forward and congratulations on results. So I have two quick questions.

The first one is regarding the overall industry landscape. Do you think in the pre K and the K-twelve market, we can see the market leader with considerable market share, I. E, above 20% emerge in the medium or longer term, just like what New Oriental has been able to achieve in the overseas test preparation area? And also the second one is about the online education. So would you mind to share with us more colors about your U Can visible process teaching system?

What's from what kind of perspective you will see online will add value to your offline facilities? Thank you.

Speaker 3

Yes, sure. Looking forward for the next five years, I'm pretty sure that the K-twelve business for Chinese students will be our one of our main businesses. Of course, our overseas test preparation and the consulting business will also be our main businesses. But I can see that K-twelve business will be growing faster because this is big market, a much bigger market than overseas consulting overseas test and preparation and the consulting business. And also the oriental is new in this market actually.

We have just gone into this market for like about mainly for three years. So I can see that for the next three to five years, we can keep a growth in K-twelve about 25 or even maybe if we are doing much better, maybe up to 30%. I'm pretty much confident on this actually. So this is a very good business. And also what I value this business is that because these kids are growing up from like about from four years old up to 18 years old.

So I'm pretty sure that the auditor have this stress on educating students and their families about how to build up healthy personalities and the characters for all these kids. That is if you are from China, pretty much know that this is my strength also. And then the second is the online business. And after long time consideration and of course, independent thought, I'm pretty sure that even though there will be pure online business in China and the Oriental also is venturing to all kinds of possibilities in this area. But I'm pretty sure by studying online businesses and offline businesses all over China and of course all over the world actually, including studying the MOOC system and other systems.

I'm pretty sure for New Oriental, the online business, the main part will be online and offline altogether. That is it's kind of synchronized or merged business from offline to online and then from online to offline. That's what you mentioned, the U. Visible progress system is kind of online and offline combined together, which you can see that the students are so much interested in this because they are studying in the classroom, but they can use all those online gadgets and the APPs to see how their progress are made and then how parents are viewed about their progress and then how teachers value their progress and then intellectually assign the new studying contents for them to finish offline and online altogether. And after that, we can collect the bigger data after all these students' studying habits.

And then we can research the new products for students and the new content for students. So I'm pretty value this online and offline together business. I'm pretty sure for if we can use online and offline business much better, then this kind of strategy can push Niallito forward for the next five years. Of course, I'm also valued for online only business, online study, because like which I divided for students from 18 years old above, I'm pretty sure these eighteen years above students who are very conscious in these students that they want to study by themselves. So if they can save time and save money, they want to get online to study.

So one of my focus nowadays is to

Speaker 4

put

Speaker 3

some of my focus actually, very important focus, our online business for those subjects above 18 years age for students, which I'm pretty sure we will have great results. Let me give you an example. Like we have a domestic business for students to study English and then graduate school entrance examination. For this year, for the first quarter, actually, we are combining online and offline together. For students, if they want to get online, they can take online freely.

And then if they want to get offline, they can get offline freely. Before that, online group and offline group are two independent groups and they fight with each other. But now they cooperate with each other because I put these two groups into one group. We can see a growth, a very, very good growth in domestic businesses nowadays in the Oriental. I'm not very sure how much the growth will be, but for the second quarter and the third quarter, if we are still by the phone for our quarterly report, I'm pretty sure I can give you a very good results for this.

So I myself are pretty open for online, for all the technologies, for advanced all ideas used into education. And I'm pretty sure the Orientor is in the position for combining online and offline and then to develop those purely online businesses into the future. So this online business and onlineoffline combined together will be a main part of New Oriental business strategy in the next three to five years, but will be with a very good result, I'm pretty sure. Thank you. Thank Thank you, Haendel.

Speaker 7

Thank you, Michael. It's very helpful.

Speaker 0

We have the next question from the line of Annie Scher from Breen Capital. Please ask your question.

Speaker 2

Hi, good morning. Thanks for taking my question. So just I guess following up on what Michael just mentioned, it sounds like the online business of course is a key part of the company's growth strategy. Besides Coolearn and I understand that this is still early, could you share the total revenue from these three online kind of businesses? And as this reaches a more meaningful contribution level, I was just wondering where perhaps the margins are falling out and would normalize longer term?

Thank you.

Speaker 3

Thank you.

Speaker 4

Okay. This is Steven. I will take your questions. And Koolearn, the GAAP revenue grows very fast than any other offline business. The GAAP revenue of Q1 growth by more than 30% year over year.

And the margin is not only like it's just the breakeven because as I told you, we call this investment year. And so the strategy we're using for pure online platform is to go after the market share first. That's why you saw our you are seeing our paid users get 150% year over year growth. But I think the margin of the pure online business in next three to five years, it should be higher than the offline business, because they do have some rental expenses, they can save a lot of money on that. And also the but anyway the GAAP revenue of the coolers only contribute 3% of the total revenues, it's only a small part of the total business, but it's growing very fast.

Does that answer your question?

Speaker 3

Yes. Let me add off some of my ideas about pure online education. Koolearn.com is only contributing 3% of New Oriental total businesses. I'm pretty sure that it will take some time. I don't know how many years it will take for the online business like Coolen and cool.cn to have a significant contribution to the Oriental's total business.

The reason is that I think that people in China and all of the world, it takes time also for people to recognize that online teaching methods or online learning content sometimes will be much more efficient and effective than offline business. So for the next several years, I'm pretty sure that the koolearn.com and the koo.cn will be the fast or fastest growing business path in the Oriental. I'm pretty sure that they will grow about more than 30% every quarter or every year. But still, even though it grows more than 30% every quarter, it will take a long time to become a significant part of contribution of New Oriental because as a whole, New Oriental business is also growing around like 15 to 20% every year. But we still have to pay great attention to this because maybe it will represent the future of education, not only in China, but maybe all over the world.

And of course, I'm paying greater attention to the offline and online combination. We are still also using koolearn.com to use as pure online business, but also we are telling students that sometimes if you really want to study offline, we are also ready for you here. So I'm pretty sure we are building up a chain of education business or ecosystem here in the Oriental. So give us enough time. I'm pretty sure you will see that we will have very good experience and result in pure online business and offline and online business combined together.

Thank you.

Speaker 8

Thank you.

Speaker 0

We have the next question from the line of Tian Hou from T. H. Capital. Please ask your question.

Speaker 1

Hi, Michael, Steve and Sisi. Congratulations on a good quarter and good to have Michael on the call.

Speaker 3

Thank you.

Speaker 1

So I have a couple of questions. Yes, one is related to your royalty program. And since the time you started, it has been for a while. And I wonder how do you actually measure the results of the RoTE program in terms of Xu Bandi? And if you compare last quarter with a year ago, and which is actually it's really what has this royalty program impact, one didn't have the impact of this royalty program.

So how do you see the difference in the Qi Band Lu? That's number one question. Number two is, you have a lot of cash. Certainly, I do know you have this cash, the share repurchase program. But to better use the cash, there are lots of things for new or rental you can actually buy.

And so from past experience, in your acquisition experience, you have some company you acquired and then you're also divesting some company. So in education area, in your area, acquisition? What are the keys for not a successful acquisition? For you, what's your goal or what you want to do with your cash in terms of acquisition going forward? That's the two questions.

Speaker 4

Okay. Thanks, Tian. I'll take the first question about the loyalty program and Michael will answer the second one. And for the loyalty program, we launched the customer loyalty program since last October and narrowed down to K-twelve only since this April. So, negative impact of this quarter is very minimal.

And since the next quarter, I think the impact will be positive. In the last Q2, we had $4,000,000 that means the 2% of the total revenue negative impact for both bottom line and top line. But this Q2, I think the net impact will be only 1% of the total revenue. So, have a very easy comparison. So, I think it's good for both the top line and the margins.

And I think this situation will be continued in the rest of the year. So that's my question for your question about the loyalty program. And I think Michael will answer the Thank second

Speaker 3

you, Tian. First, let me express that my love about cash. I really love cash in the company. No matter in a good time or in bad time, cash is always the best thing for the company to go forward. For the cash we have, especially those cash that has already been the net income for the rental and we would like to actually in due time to have buyback shares program and also to have the dividend program to give more money back to our shareholders.

Of course, on the basis that we don't have any more money to invest into new areas and also don't have any new acquisitions. That's what you mentioned. I would like to use the money except besides to give money back to our shareholders as in dividends to use the money to do the investments and to do the acquisitions for a better future of the company and for long term development of the company. As for your questions, what is the key factors for a good acquisition and for a bad acquisition? Let me tell you that I've been in education for more than twenty years and since the auditor have been get IPO for almost thirteen years.

In education, it is really difficult, let me tell you, to get a very good acquisition. The reason for that is that education is a very low threshold business and everybody can rush into this business. And also it's a very fragmented business. That means that not everybody can do a good business in education areas. You can see like about a little more than five to six years ago, there are many people carry cash to invest into education areas in opening learning centers.

There are about like more than I'm pretty sure thousands of those schools who opened the lending centers in China, but half of them are gone. They disappeared because they lose money or they cheated parents out of their pockets and they cannot refund the money back to parents or students. And then about two years ago, there are also many investors like Venture Capital or Angel Capital, who invested lots of money into online business. And they value the very high for online business in education because they think that online education business will be the future of education in China and all over the world. But we can see that up to today, there are many, many online education businesses have been closed because there is just no business model in this area.

And they said they want to build a bridge between the parents and the teachers. And then they said that there's no training education companies needed or school needed between them. But up to today, I have seen none of these companies has made any money out of this and most of them are losing big money. I'm pretty sure that there are many, many companies who will close their businesses within this year or the next year. So for acquisitions in the Oriental, I'm pretty sure I'm planning to acquire those companies or schools.

We'll build up the ecosystem, the ecosystem of the Oriental education environment. And also that the business which especially the vertical businesses, even small business will add up values for the oriental businesses. And we have also investing in minority shareholding stocks for some companies, about like 10 of them up to today. And every one of them are very successful to helping the Oriental in doing further business and we are helping them to do further business. So for acquisition, a successful acquisition will be the acquisition that will be supplementary to our business and will add values to your business and will have the same cultural environment or same culture with our business.

And for a bad acquisition, it's only for money, for revenue. Then after your acquisition, those management teams go away and you do not have a management how to manage this company and then the company goes little by little and then goes down. So for me, my focus for the next several years will be on acquisitions because this is necessary path for the Oriental to become a great company. But I will be very careful which kind of companies I'm going to acquire. But, Chen Ho, be pretty sure that I will be a person who can be called that kind of expert with expertise in China education.

So believe me, I will be trying my best to do everything right.

Speaker 1

Thank you, Michael. That's very helpful.

Speaker 0

We have the next question from the line of Cynthia Ming from Jefferies. Please ask your question.

Speaker 7

Thank you. I have two questions. Is the higher gross margin as a result of higher pricing for the K-twelve business, if management can give us some more color on that, that would be great. Also, we're wondering whether you could share with us

Speaker 2

how we can see the margin trajectory for this year and maybe talk about because of the add on businesses that the new growth areas, how are you seeing margin trajectory going forward beyond this year? Thank you.

Speaker 4

Okay. I'll take I'll answer the question first for your margin question. We're happy to see the margin improvement by the 20 bps in this quarter. I think it's mainly due to the we've gotten much more revenue than we expected at the end of the at the first of the quarter. And I don't want to give the detail like the guidance for this year margin, but I can say that we're seeing the business resilience during the economic downturns and the revenue growth is the trend is very good.

So I think the bottom line trend will be also very good and we're quite confident about the long term margin expansion. Last year and this year are the peak for the investments. We'll keep spending like $50,000,000 for the investment online investments. So, since the next fiscal year fiscal year what I mean is fiscal year 2017, I think our margin will definitely go up. And the 2017 to get a 1718% in next three to four years.

And what's your first question?

Speaker 3

Let me answer the question. Okay. Yes, for the margin projection, I'm pretty sure that the margin will go up like Steven said, but not really in new growth areas. Because new growth is in the kind of cultivation area. I'm pretty sure that we have to spend more money on these new areas that in the next few years will grow up and will give us more margin.

But I'm pretty sure that the margin growth will be from actually, let me see from like POP Kids, UK and overseas, all the areas because what we are doing is a strategy to add more students in each classroom to raise the teaching quality so that the teachers can attract more students to their classrooms. This will raise our margin, I'm pretty sure, for the next year or next several years. But we will pay greater into the new growth area, no problem. For the high pricing, let me express my personal view. I myself are very strongly against the high pricing policy in any education areas, not only in the Orange, but in other areas.

So for this year, you can see the number of students that writing in the oriental is much faster than it was before. The reason is that I'm emphasizing the teaching quality and every teacher brings more students into the classroom rather than raising each student's price for each class. I'm very against for I'm very against about those rising price strategies, the high price projects or programs. So I'm pretty sure that this first quarter have a good result. It's not because of our high pricing.

It's because we have the right strategy to emphasize on the teachers' qualities and the teaching qualities and give teachers more salaries and bonus for their good teaching. So this is what we will be insist on for the next even maybe forever, I don't know. But I'm pretty sure this will be of course, we are reasonably raising our prices for each student, But this is not our main strategy. The main strategy is to ask the teachers to give more the much better quality of teaching so that we will attract more students and the parents. Thank you, Min.

Speaker 4

Thank you.

Speaker 0

We have the next question from the line of Leon Chik from JPMorgan, Hong Kong. Please ask your question.

Speaker 9

Yes. Hi, Michael, Cici. Remember when I started covering you guys before, there was a lot of drama last year in first quarter in terms of English, whether it's required or not in universities and then these English camps in the summer kind of went down a lot. So my question is, has that basically like old news been resolved and things are now like at least stable and growing? And there's like nobody worried about the uncertainties of like English required in the Chinese universities?

Yes, thanks a bit.

Speaker 3

Yes. Actually English is always required, always needed by Chinese people and the Chinese parents. But for the Oriental, we like about a year ago, we once had a department project called English learning programs. But we see that actually those students who are in English and The UK middle school, high school program and also overseas or domestic, these students have divided themselves into different departments of near rental. That is for those students from four years to 12, they were studying public kids for English.

And at 12 to 18, they were studying in UK. And above 18, they were studying domestic in universities. So that's why we break up our English programs, ask those students to go to different age groups to study English. That doesn't mean that English is not needed for Chinese people. So we can see actually a raise of students' numbers in studying English in the Oriental, but we nowadays we don't have a pure English studying department or pure English studying project in Oriental because those kids have divided into all different groups.

This is actually good for the Oriental because while they study English in the same age group, they also can choose to study maybe Chinese or mathematics or physics or chemistry. So that's why we can see a good raise in numbers of students in the Oriental and K-twelve system. So I think this is a good strategy. As for Chinese people, those adults who want to learn English, we are now build up some pure online English studying gadgets and APPs for these people, like LUT, which will help students to study vocabulary. Like the vocabulary actually is my strength when I was in university and when I was teaching the oriental.

But nowadays, we do not ask the students to pay money to study in the oriental for remembering vocabularies because this APP list can help students to remember all these words also. So after they remember all those words, we invite the students come to Niorento to listen to other subjects, maybe grammar or maybe to pass an examination or like test for provisions. So this is more effective students. On the one hand, the students feel that they have been saving money. And on the other hand, they feel it's more effective because they study vocabulary for example, later maybe oral English or writing anytime they want.

So English has never been uncertainty in China. Chinese people have never been more eager to study English than ever before, because they know that their kids need English language proficiency in order to survive better in this world. Thank you, Liao. Okay. Thank you.

Speaker 0

We have the next question from the line of Julia Pan from Macquarie. Please ask your question.

Speaker 8

Hello, management. Congratulations on the strong result. I think Mike could just answer my question for the dividend.

Speaker 3

Thank you, Julia.

Speaker 8

Thank you. I noticed that there is 62.6 dividend payables in our balance sheet. Does that means we're going to pay the special dividend on 2016? And another question, could you please give us some color on the overseas press segment, the enrollment growth and revenue growth, please? Thank you.

Speaker 4

We paid the dividends in October. So I think you will see the numbers in the financial statement next quarter. And for the overseas test prep in Q1, the GAAP revenue is up, increased by 9%. Don't forget, in the last quarter, in the Q4, the GAAP revenue for overseas test prep was only 3%. So, I think the business is recovering.

And also, we're doing the same thing as The UK and what we have done for The UK and the POP Kids, we're rolling out the new O2O initiative new product for the overseas test prep. And for the student enrollment, overseas test prep was down by 6%. But yes, I think the whole market doesn't grow very fast. So in the long term, I think the number student enrollment growth for the overseas test prep will be flat or a little bit decreased. And so most of the increase will come from the ASP increase for the overseas test prep.

Speaker 3

Julia, let me add some points. I myself are very interested in overseas test preparation, as you know that I'm from that area. Starting Now, from that area. We can see that there is a slowing down of the number of students who wants to go abroad to study because the number almost have reached the top, because not every family can afford for their kids to study overseas. But I'm still feel regretting that the inventory is not growing as fast as possible.

Of course, one of the reasons is number of students is not growing all over China for overseas. But another reason is that for those past two or three years, we have paid a greater attention to K-twelve education. So we have put out some of our resources in K-twelve. But from this year, my personal attention and the importance also some of the resources will come back to overseas test operations, because in my mind, this is a great area to help Chinese people to have a bright future. So for the next the rest of the year and for the next several years, you can see that we will also build up some great systems for students who are studying overseas.

And also, I personally will provide more of my attention in this area and then maybe we'll do more lectures and also some encouragement for students to study in this area. So I'm pretty sure that the growth will not only come from the price increase, even though we also have space in this area to raise price, but I'm also pretty sure that by our efforts, more students will choose Niorento to study for their test preparations and also choose Niorento for their consulting overseas studies in universities. So I'm expecting not only 10% increase in this area, I'm expecting for the next several years, maybe more than 10%. I don't know how much, but $10.15 is my expectation or even better than that. That's not my promise, but that's what I want to say, that's my efforts in this area, because this is where we start out.

It's kind of like if you are familiar with Chinese history, it's kind of like in Chinese history for Communist Party. We cannot lose that.

Speaker 8

Thank you, Michael. Thank you, Steve.

Speaker 3

Thank you, Julian.

Speaker 0

We have the next question from the line of Jin Yun from Mizuho. Please ask your question.

Speaker 10

Hey, good evening, guys. Just to follow-up on your previous remarks. I apologize in advance if I misunderstood, but you said that operating margins may be going up to 17%, 18% over the next few years. But you also followed that up and said that you believe that ASP increases meaningfully over that time. So can you just kind of help me reconcile how you get up to 17%, 18% if ASPs are not necessarily increasing meaningfully and without a very significant reacceleration in revenue growth?

So do you expect a majority of that growth to come from offline scale online scalability as well as new student growth? Trying to kind of ballpark the how we kind of reconcile to 17%, 18% margins without meaningful ASP growth? Thanks guys.

Speaker 4

Okay. I think the key driver for the future margin expansion is the more utilized I think the more utilization rates will get, because we are seeing more and more students filling in the learning centers. And look at this quarter, I think most of the 13% student enrollment growth come from the organic growth. We didn't open any new learning center this quarter. And also, as Michael said, and during the whole China economy downturns, I think the wage inflation will benefit us.

I don't think we will give the as higher as as same as the wages inflation for the staff as before. And also, we still have likely some rental leverage for the margin expansion. We send the five ten years leasing contracts typically for the learning centers. So the rental will be only up by five to 6% year over year. So we also have this kind of leverage.

Speaker 3

Yes, let me add. For the revenue growth in the Oriental, I'm pretty sure that our strategy is to attract more new students into the Oriental. So the revenue growth mostly will be the number of students, more and more students who are entering our internal study and also the utilization of our existing facilities. And also for the margin growth, I'm pretty sure we are optimized all kinds of management procedures, especially with the help of the information system. I'm pretty sure that more money will go to our teachers so that to push our teachers and encourage teachers to teach more quality lessons.

By the same time, actually, we are going to reduce the supporting staff members because the system is going up so that we can help more people for one person to do more job. So I'm pleased that's why we I'm sure that for the next several quarters and also for the next several years that the revenue will grow very healthily because we are expecting number of students to come in the oriental And the margin growth will also be defined because I'm expecting like at least 1% of the increase every annual year for the net revenue net income. The reason is that we are more effective and efficiently doing our job every day. That's also my intention. Thank you, Jim.

Speaker 10

Great. Thanks, guys.

Speaker 0

We have the next question from the line of Dick Wei from Credit Suisse. Please ask your question.

Speaker 5

Hi, good evening. Michael, Steve and Cici, thanks for taking my questions and congrats on a good quarter. I have a question regarding Khan Academy. I guess kind of the free education is gaining more popularity in The U. S, particularly for the past year or so.

I wonder how should we think about the threat or the opportunities that poses a new Oriental, if kind of the free education system is kind of like getting popular in China. I wonder if Michael

Speaker 3

has any Yes. Thoughts me ask one question for you because my son, who is just studying Khan Academy every day. But my son is from The United States, from Canada. So his English is very good. So he has no difficulty listening to Khan Academy.

So Khan Academy, by translating in Chinese, it needs to take some time. But if it's translating into Chinese, it's economy. Can Academy. Is it China economy or Can Academy?

Speaker 5

I mean, Academy. Yes, like the free education, like the Khan It is my answer is right, right?

Speaker 3

Yes, that's correct. Let me tell you. I'm actually, I did some research here about American North American students and about Chinese students. Chinese students are very, very much they don't like to study. So most of Chinese students, about 90% of Chinese students are forced by their parents to study.

So if let them study conscientiously online, they don't have these patience and they cannot pay great attention to this. We have tried a lot, like the best New Orient teachers try to put their classes courses online for students to study even for free. By doing this, we can see that there are much, much less students registered for studying than we expected. So actually then we can find that for Chinese parents and for Chinese students, the best way for them to study for a better result is to send these kids with face to face teachers, no matter at home or in the learning center. And we can see also by our research that Chinese parents would very much like to send their kids to a learning center nearby with some of course, if they're interested in nearby, it's their best choice, I'm pretty sure.

But they will also choose some other learning centers by some schools because it's nearby for their convenience. But the reason is that the teachers can supervise the students to study much more effectively. And also the teachers can teach these students to study face to face. So that's why I try my best to persuade the analyst people to insist on face to face teaching tutoring, which proved up to today is a good strategy for us. So I'm pretty sure Kung Academy, the form of Kung Academy, it's not Kung Academy maybe itself, will have very, very much less impact on Chinese students' learning habits than the impact on maybe United States students.

And also, we are also building our current academic system, but it's very different. We call it it's called a SPOC system, which is a small private online lessons for students. The SPOC system is like this. The students have already learned some lessons in the classrooms with their teachers and they become like their teachers a lot. So the teachers will tell students that there are some other content that I don't have any time to teach in the classroom.

So would you like to pay some extra money to listen to my online courses when you're at home? Then most of the students will say yes. So we have already begun this program for some maybe most of this year. And we can see a success. That means there are about 80% of the students who have already studied in the classroom has already paid the money for their teachers' online courses.

This is we call that Nioring course specialized academy system actually. So I want to tell you that this is a good system, but have to combine with Chinese people's studying methods and kids studying habits. We are venturing to this area almost every day. I'm pretty sure that we will give you some maybe detailed report if you want.

Speaker 5

Yes, great. Thanks, Michael for the detailed explanation. I'm pretty sure this is your second question, right? I apologize for calling late. So I just want to catch up.

Speaker 3

Thank you. You. Ladies

Speaker 0

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

Speaker 4

Okay. Again, thank you for joining us today. If you have any other any further questions, please do not hesitate to contact me or any of our Investor Relations representative. Thank you.

Speaker 0

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