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Executives

Cynthia He – Investor Contact, Brunswick Group LLC

Louis Hsieh – President and CFO

Analysts

Catherine Leung – Goldman Sachs

Chenyi Lu – Cowen & Company

Mark Marostica – Piper Jaffray

Philip Wan – Morgan Stanley

Ella Ji – Oppenheimer

Brandon Dobell – William Blair

Eric Wen – Mirae Asset

Anita Chen – Jefferies

Chao Wang – Merrill Lynch

Jeff Mueller – Baird

Paul Ginocchio – Deutsche Bank

Charles Cartledge – Sloane Robinson

Ruby Zhang – Nomura Securities

Vina Satiadhi – Moon Capital

New Oriental Education and Technology Group Inc. (EDU) F3Q12 Earnings Conference Call April 17, 2012 9:00 AM ET

Operator

Good evening and thank you for standing by for the New Oriental’s third fiscal quarter 2012 earnings conference call.

At this time, all participants are in a listen-only mode. After 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 meeting over to your host for today’s conference, Ms. Cynthia He.

Cynthia He

Hello, everyone, and welcome to New Oriental’s third quarter of fiscal year 2012 earnings conference call. Our financial results for the period were released earlier today and are available on the company’s website as well as on Newswire services.

Today, you will hear from Louis Hsieh, New Oriental’s President and Chief Financial Officer. After his prepared remarks, Louis 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 our 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 New Oriental’s President and CFO, Louis Hsieh. Louis, please.

Louis Hsieh

Thank you, Cynthia. Hello, everyone, and thank you for taking the time to join us today.

As you have seen from our earnings release, our third quarter performance was disappointing and unacceptable to us. While our net revenues were affected by the early timing of Chinese New Year, which flows through to the P&L negatively impacted our profit margins as well. Now, profit margins were also affected by our efforts to increase penetrate in the K to college segment in our 50-city school network that we compete in with the addition of 81 learning centers in the quarter. We will strive to do better and are committed to maintaining a strong balance between growth and profitability in the quarters ahead.

I will now walk you through the details of our third quarter. First, as we predicted in January, this quarter’s financial results were negatively impacted by the early timing of Chinese New Year festival in 2012. Chinese New Year fell on January 23rd, which was a couple of weeks earlier than usual. Thus, our normal two-week early sessions before Chinese New Year were shortened by just to one week. Thus, many students who would normally signup for the New Oriental’s training courses doing one or both sessions before and after Chinese New Year elected not to enroll in the early sessions, but instead enrolled in the second session after Chinese New Year or chose to wait until the spring quarter, which has a longer course duration. Consequently, student enrollments and net revenues for the first two months in the first quarter and in this third quarter were soft. You may recall that in the third quarter of 2009 when the Chinese New Year fell on January 26th, our performance was similarly affected.

Encouragingly, we’ve seen a strong bounce back in enrollments and deferred revenues in February as students signed up for spring courses in order to prepare for the major exams in the summer, such as the college entrance exam or gaokao and the high school entrance exam or zhongkao. The back-loaded demand drove enrollments for language training and test preparation courses in the quarter to approximately 596,100, an increase of 21.6%. Furthermore, as of February 29th, 2012 our deferred revenue balance was $239.8 million, an increase of 59.2% year-over-year. This level of deferred revenue implies strong financial performance for the next fiscal quarter.

In order to take advantage of the strong demand for our services and the hugely promising market in China, we accelerated the implementation of our "fill in" strategy of building small learning centers in the 50 cities where we already have a presence. During the quarter, we opened a net 81 learning centers in about 25 existing cities. About 50% of the new facilities are small sized learning centers under 500 square meters and about 20% are medium sized learning centers between 500 square meters to 1000 square meters. In the past six months, we have added a net of 120 learning centers in total, with over 80 percent of them outside of Beijing and Shanghai. We also hired approximately 4,200 teacher and staff in the past half a year.

These expansionary efforts resulted in a significant decline in our non-GAAP operating margin to 21.4% for the nine-month period year-to-date as compared to 23% in the year-ago period. We’ve recognized the importance of balancing growth and profitability and we will manage the pace of learning center and staff expansion accordingly in the quarters ahead.

However, management made the decision to carry out the rapid expansion and increase G&A spending, based on the following considerations. First of all, as the market leader, New Oriental is committed to enhancing the company’s leading brand name through hiring, training, and retaining the best teachers, developing the best teaching and course materials, and providing the best customer service. We must continually invest in improving our teaching and course materials to sustain our number one brand name position in China.

Second, we are working on becoming the number one or number two player in the K to college tutoring market and test prep market in each of the 50 cities we compete in. To attain that goal, we must invest in each city to achieve the critical mass of learning centers, which helps us to become a credible player in each market and to achieve economies of scale at branches. We continue to see enormous demand potential outside of Beijing and Shanghai; we are acting quickly to establish our market leading position in these lucrative statutory markets.

We believe the short-term pressure on margins will be replaced by long-term market leadership and financial returns in due course and we continue to place emphasis on operational efficiency and network optimization, as we believe the impact can be offset over time by higher ASPs and higher utilization rates of each center. Once again, we are very confident the New Oriental strategic expansion in the fast-growing cities will lead to a long-term sustained market leadership and profitability.

Thirdly, short-term financial targets are tertiary and important behind being a leading brand and having a top market share. Our target 30% top and bottom-line growth each fiscal year has been achieved, best target in each of the past five years since we have been a public company, we hope to do so for a sixth consecutive fiscal year in 2012.

Across our business lines, our key growth drivers continued their strong momentum in the third quarter. Our overseas test prep programs recorded year-over-year enrollment growth of about 10% to about 80,500 and year-over-year gross revenue growth of over 26% to $55 million. Our K-12 All-Subjects Tutoring business recorded year-over-year enrollment growth of 30% to 371,500 and year-over-year gross revenue growth of about 48% to $69 million.

I particularly want to highlight the VIP personalized courses continued to maintain the most rapid pace of growth among our business lines, with year-over-year enrollments up more than 62% to 25,500 and year-over-year cash revenue growth of over 73% to about $53.5 million in the quarter. This result demonstrates the huge demand to the Chinese market for our premium quality VIP courses. Our Vision Overseas Study Group – Consulting business continues to outperform with year-over-year growth revenue – gross revenue of approximately 55% to over $7 million in the quarter.

Following our efforts to promote the online courses registration, we continue to invest to keep up with new technologies and their new trends. As Chinese students increasingly use Apple, Android and Windows mobile devices to access the Internet and social networking sites to interact and learn, we are excited to announce that we are investing in a multiyear multimillion dollar per year IT initiative to create and distribute mobile apps and tools to allow our students to access our content and learn through their mobile devices.

Through the new initiative, we will be able to better target the students for our market programs and services and allow them to register and view our offerings from their mobile devices. In the long run, this investment will increase student stickiness to our courses and improve the efficiency and efficacy of learning methods and course registration.

We are pleased to declare a special dividend of $0.30 per ADS. The cash dividend will be paid on September 29th, 2012 to shareholders of record of the close of business on August 31, 2012 with an ex-dividend date of August 29th, 2012. The aggregate amount of dividend payment is approximately $50 million, which will be funded by a surplus cash on New Oriental’s balance sheet. New Oriental generates an increasing amount of free cash each year as a result of a highly profitable CapEx-like business model. The company’s senior management and Board of Directors are very cognizant of the need to create shareholder value. We will assess the cash needs of the company and we’ll consider returning a portion of excess cash to investors from time-to-time in the form of share buybacks and/or a special cash dividend.

You may recall that between 2008 and 2010, we have an aggregate repurchased approximately 5.6 million shares of our ADS for approximately $93 million from the market, which demonstrates our inclination and history of returning capital to investors.

Before moving to the question session, I would like to go through some financial highlights. Net revenues from educational program and services for the third fiscal quarter were up a $156.5 million, represents a 27.6% year-over-year growth. Growth was mainly driven by the increase in student enrollments and academic subjects, tutoring and test preparation courses, as well as an increase in average selling price and an increase in the number of students selecting more expensive smaller class options.

Total student enrollments in academic subjects, tutoring and test preparation courses in the third quarter of fiscal year 2012 increased by 21.6% year-over-year to 596,100 from approximately 490,200 in the same period in the prior fiscal year. As I mentioned, the strong bounce back in February was the driving force behind the high enrollment increase.

Operating cost and expenses for the quarter was a $157.9 million, a 41% increase year-over-year. And non-GAAP operating cost and expenses which excludes share-based compensation expense for the quarter was a $152.3 million, a 41% increase year-over-year. Cost of revenue for the quarter increased by 30.9% year-over-year to $71.9 million, primarily due to the increase in a number of courses being offered and a number of students and learning centers in operation.

Selling and marketing expenses for the quarter increased by 52.9% year-over-year to $28.1 million, primarily due to brand promotion expenses. General and administrative expenses for the quarter increased by 52.3% to $57.9 million. Non-GAAP G&A expenses which excludes share-based compensation expenses were $52.3 million, 49.8% increase year-over-year, primarily due to the increase in hedge account in the company, expanded network of schools and learning centers to a net of 31 facilities in the quarter and invest in content and new program development offerings, as well as in improving future training of resource.

Total share-based compensation and expenses since reallocating to relating operating cost and expenses increased by 67.6% to $5.6 million in the first quarter of fiscal 2012 from $3.4 million in the same period of the prior fiscal year – this third quarter. The increase was primarily due to a replenishment option grant to replace an expiring option grant from 2008 to retain key senior management team members.

Income from operations for the quarter was $16.6 million, a 21.6% decrease from $21.2 million in the same period of the prior fiscal year. Non-GAAP income from operations for the quarter was $22.2 million, a 9.6% decrease from $24.6 million in the same period of prior fiscal year.

Net income attributable to New Oriental for the quarter was $22.4 million, representing a 3.7% decrease in the same period of prior fiscal year. Basic and diluted earnings per share attributable to New Oriental was $0.14 and $0.14 respectively. Non-GAAP net income attributable to New Oriental for the quarter was $28 million, representing a 5.3% increase from the same period of prior fiscal year. Non-GAAP basic and diluted earnings per ADS attributable to New Oriental was $0.18 and $0.18 respectively.

Capital expenditures for the quarter were $25.2 million, which is primarily used to purchase three floors of a building in Guangzhou to be used for that school as headquarters, costing approximately $9.6 million and to add a net of 81 new learning centers.

As of February 29th, 2012 New Oriental has cash and cash equivalents of $408 million as compared to $379.2 million as of November 31, 2011. In addition, the company has $49.4 million in term deposits and $300.4 million in short-term investments as of February 29, 2012. Net operating cash over third fiscal quarter was approximately $66.9 million.

New Oriental’s deferred revenue balance, which is cash collected from registered students and courses recognized proportionately as revenues and instructions are given as of February 29th, 2012 was $239.8 million, an increase of 59.2% as compared to a $150.7 million as of February 20th, 2011.

For the first nine months of fiscal year 2012, New Oriental reported net revenues of $578.4 million, representing a 37.6% increase year-over-year. Total student enrollments in academic subjects tutoring and test preparation courses in the first nine months of fiscal year 2012 increased by 17.32% to 1.875 million or approximately 1.6 million in the same period of prior fiscal year.

Income from operations for the first nine months of fiscal year 2012 was $107.4 million, representing a 26.2% increase year-over-year. Non-GAAP income in operations for the first nine months of fiscal year 2012 was $124 million, representing a 28.2% increase over year.

Operating margin for the first nine months of fiscal year 2012 was 18.6% compared to 20.2% for the same period of prior fiscal year. Non-GAAP operating margin, which excludes share-based compensation for the first nine months of the fiscal year was 21.4% compared to 23% for the same period of prior fiscal year.

Net income attributable to New Oriental for the first nine months of fiscal year 2012 was $116.4 million, representing a 33.1% increase over year. Basic and diluted net income attributable to New Oriental for the first nine months of fiscal year 2012 amounted to about $0.75 and $0.74 respectively.

Non-GAAP net income attributable to New Oriental for the first nine months of fiscal year 2012 was $133.1 million, representing a 34.2% increase year-over-year. Non-GAAP basic and diluted net income per ADS attributable to New Oriental for the first nine months of fiscal year 2012 amounted to $0.86 and $0.85 respectively.

Turning to our outlook for the third fiscal – fourth fiscal quarter of 2012. New Oriental expects total net revenues in the fourth quarter of fiscal year 2012 from March 1, 2012 to May 31, 2012 to be in the range of $182.7 million to $189.6 million, representing year-over-year growth in the range of 33% to 38%. The forecast reflects New Oriental’s current and preliminary view which is subject to change.

At this point, I will take your questions. Operator?

Question-and-Answer Session

Operator

In order to be fair to all callers who wish to ask question, we will take one question at a time from each caller. If you have more than one question, please request to join the question queue again after your first question has been addressed. (Operator Instructions). Your first question comes from the line of Catherine Leung of Goldman Sachs.

Catherine Leung – Goldman Sachs

Hi. Yes, my question is really on – if you can discuss this how you are pacing your network expansion to attain your long-term market share goal, particular in terms of accelerating – to signing to accelerate the expansion this quarter versus spreading it out more evenly and if the expansion is affected by the seasonality of your faster growing business lines? Thank you.

Louis Hsieh

Thank you, Catherine. For us, I think, if you think about the seasonality in our business, it makes sense to add more learning centers in Q2 and Q3 of each year, meaning in the fall and in the winter. In that way, we can take advantage of the busy season, which is really the winter, the spring, and the summer. So if you look at Q2, we had 30 learning centers, because it’s a slow season, but it’s preparing for the winter and the spring, and in this quarter we added 81, so bring it to 120 for those two quarters. That pace will slow going into Q4 and Q1. It doesn’t make a lot of sense to add too many learning centers in the summer, because Q2 is usually a slow quarter. So you will see us sort of add more centers in Q2 and Q3 than we do in Q1 and Q4.

Having said that, the reason we’re expanding so fast is because we are seeing explosive growth outside of Beijing and Shanghai. And so to take advantage of that, right now we have between zero and 10 learning centers in most of these cities and our largest competitor in each city, which is either a local or small player will usually have between 10 and 30 or 40 learning centers, so we’re playing catch-up. If we want to be credible and be the number one or number two player in every market that we play and we’ve got to get to a critical map size. And so it’s because of a strong demand and because we want to get the economies of scale in these you know cities outside of Beijing and Shanghai that we’re expanding so rapidly. There is a significant early mover advantage in these areas. It’s easier for us to establish a learning center and get a brand new student than it is for us to pull an existing student from another school that is already there. So for us, it’s kind of a race to get as many flags planted in each city as possible, to reach critical mass and then to improve the operating margin of that city.

Did I answer your question, Catherine?

Catherine Leung – Goldman Sachs

Yes, thank you.

Louis Hsieh

Thank you.

Operator

Your next question comes from the line of Chenyi Lu of Cowen & Company.

Chenyi Lu – Cowen & Company

Thank you. I have a question regarding the operating expense trend going forward. Given the spending more in the sales and marketing this quarter for printing purpose and also for more teachers to support the school expansion, can you give us a view in terms of operating margin in the 2012 and also fiscal 2012 and the fiscal 2013? Thank you.

Louis Hsieh

Yes. Fiscal 2013, I don’t have the numbers yet, because we’re going through budgeting now. Fiscal 2012, because of the early timing of Chinese New Year and probably the more rapid expansion these last two quarters, the margin will probably come in you know GAAP operating margin somewhere around 15% to 16% maybe. And then I think – I know I have said this before, but I do believe we are troughing on margins. And the management team is committed to slowdown the pace of learning center growth for the next two quarters. And so I think you will see some benefit in Q4 and certainly by Q1 you will see the benefit of the slowdown in hiring and the slowdown in new learning center growth. So I’m very optimistic that 2013 empowering any kind of disaster will be a good year for New Oriental. And so basically the margin should not be lower than in 2012.

Chenyi Lu – Cowen & Company

If you say you’re going to slower the expansion, can you give us a view as to how many learning center you plan to open?

Louis Hsieh

Well, I think what we’re going to do now is, we are going to start changing it to the number of capacity, because remember a large learning center is usually 1,000 to 2,000 square meters, a small one is only 200 square meters to 500 square meters. So if you’re getting to absolute number, it’s not going to be as meaningful. So if you think about our network of 608 learning centers to date, 300 of them approximately are large, they are larger than 1,000 square meters. Then you have another 55 schools, which are also larger, the school is the largest building typically in the city. We have 355 large ones; we have approximately a 120 medium-sized learning centers, and 80 small ones. The 80 small ones, the 205 [ph] have all been built in the last two or three quarters.

So going forward, you are going to see more of these small and medium-sized learning centers that you will as a large learning centers. So what we will try to do is start giving a more capacity increase based on square meters increase. And I think that number will somehow come out to approximately 100,000 square meters or so as a ballpark number. So equivalent to a 100 large learning centers.

Chenyi Lu – Cowen & Company

Okay, great. Thank you.

Operator

Your next question comes from the line of Mark Marostica of Piper Jaffray.

Mark Marostica – Piper Jaffray

Yes, thank you. Louis, can you talk about cities outside of Beijing and Shanghai where you feel you have already reached critical mass and what margins look like in those cities?

Louis Hsieh

I think there is only a couple that we have hit critical mass outside of Beijing and Shanghai. Most notably will be cities like Wuhan. And I think in those cities, if we don’t count corporate overhead, the operating margin is somewhere between 20% and 25%. We believe that in the most two tier 2 cities when you – when this number of learning centers begins to slow significantly, the operating margin will go into the 20s for that city, between 20% to 25%. From Beijing and Shanghai it’s over North of 35%.

And the only difference – the biggest difference is that Beijing and Shanghai have the biggest dose of overseas test prep, which is our most profitable business. The second reason is Beijing and Shanghai have a slightly higher ASP about 30%. You know the costs are higher at Beijing and Shanghai, the ASP premium is actually even above that. So those two reasons, Beijing and Shanghai is the most profitable. But any city in our network when it hits critical mass should have over 20% operating margin, because every product line outside of books and you know the private schools should have over 20% operating margin.

Mark Marostica – Piper Jaffray

Okay, thank you. And just as a follow-up and is maybe a little bit early to ask this question, but can you talk about any visibility that you might have on the all-important August quarter?

Louis Hsieh

It’s too early for the August quarter, but I mean – I think the August quarter, there seems to be a slight pent-up demand in overseas test prep that seems to be the big quarter for that. And because – and the reason I say that is because overseas test prep was light in Q3 and the other time to study forward is the winter holiday, because of the shortened Chinese New Year holiday. I have a feeling, because similar to 2009 you will see a big bump in overseas test prep during the summer, students who didn’t study in the current Chinese New Year holiday would defer it until Q1.

Mark Marostica – Piper Jaffray

Okay, thank you.

Louis Hsieh

Yes.

Operator

Your next question comes from the line of Philip Wan of Morgan Stanley.

Philip Wan – Morgan Stanley

Hi Louis, thanks for taking my question. My question is regarding your VIP business, which has become an equal driver for the company.

Louis Hsieh

Yes.

Philip Wan – Morgan Stanley

Among your VIP enrollment, I am wondering how much of them belongs to K-12 and also overseas test prep respectively. Also, to understand the margin profile better, how there is a margin for a mature VIP center compared to a small and large class center? Thank you.

Louis Hsieh

Can you please repeat the last part of the question, Philip, regarding the center?

Philip Wan – Morgan Stanley

Yes, I want to compare on a mature basis, what kind of margins can your VIP center achieve, as compared to a small and large class center in Beijing or Shanghai?

Louis Hsieh

Okay. Well, Beijing and Shanghai, they are going to have high margins. I think your first part of your question, about 25% of our VIP enrollments are overseas test prep. Those have a very, very high ASP and a very, very high profitability. They’re probably over $3000 a class. The other probably 60% of our – 50% to 60% of our VIP students are K-12, and then you have English language in there probably 16% are K-12 are English related, so that’s the majority of the VIP.

The margin for VIP, the way New Oriental does it is higher than our competitors by far, because half of our enrollments are really VIP one-to-five and the other half are one-on-ones. So number one-to-five is five students per class, each student paying approximately $1000. So it’s not the one-to-one where the student pays $2000, it’s five-to-one where students pay you know four or five when the students pay $4000 to $5000 to one. And then – for one student. So our margin profile in a mature center will easily be over 20% operating margins for our VIP program in any city. So it gets relatively full. Means when the center is full or 60% to 70% full, the margin profile will be over 20%.

Philip Wan – Morgan Stanley

Okay. So the margin will be very similar to a – even the large class.

Louis Hsieh

No, nothing will be similar to a large class. Large class will be the highest, but it will be similar to a small class.

Philip Wan – Morgan Stanley

Okay, understood. Thank you, Louis.

Louis Hsieh

Yes.

Operator

Your next question comes from the line of Ella Ji of Oppenheimer.

Ella Ji – Oppenheimer

Hi, thank you. First I want to clarify regarding the learning center expansion. Louis, did you just say you seek to increase the capacity by 100,000 square meters?

Louis Hsieh

Right. I mean that’s sort of a target – I mean it’s a nice round number. We are somewhere between 90,000 and a 110,000 square meters that’s equivalent to 100 100,000 square meter learning centers. What most likely what that will mean is we’ll probably have you know 30 or so 1,500 square meters centers and probably a 100 small centers.

Ella Ji – Oppenheimer

Okay. And then how long do you plan to achieve that target?

Louis Hsieh

Well, I think that will be an annual target. So you will probably see most likely if the school has listen to us, we will basically slow down learning center growth in Q4 and Q1, and they will pick up again in Q2. That’s the right pattern, right? Because if you think about it, the strongest demand cycle is Q3, Q4, and Q1. So the time to get capacity on line is in the summer Q1 and in the slowest quarter Q2. The problem with getting too much capacity online in Q2 is it makes the fall quarter negative operating margins. So it’s a very delicate balance.

Ella Ji – Oppenheimer

Right. So that’s your like annual running rate for capacity expansion.

Louis Hsieh

Correct.

Ella Ji – Oppenheimer

So my question is, in order to achieve leading positions in all the cities, how long do you expect to keep in this growth mode in – three years or –

Louis Hsieh

I think we could easily do it for the next 10 years unfortunately. But yes, as you know Ella, it won’t matter soon, because right now we have about 200 to 250 mature learning centers. And in three years the percentage of – so we only have about 40% of our centers are “mature” that means it’s been around for more than three years. In the next three years that number will go from 40% to 65% if we continue the current expansion pace. And then over the next six years that number will go to 75%. So you can see that over time, the number of mature centers that are generating on average 20% operating margin is going to trough and overtake the newer learning centers, so then the number of – as long as – yes between you know 100 to 120 learning centers a year, it won’t impact the margins much.

Ella Ji – Oppenheimer

Sure. And then my next question is regarding your margins. Although operating margins are down, but I actually see growth margin up year-over-year and it’s the same case for the past few quarters. So could you please give us some colors, because my understanding is expenses such as learning centers, rental payments recorded in the cost of revenues? So I am just wondering why you are still seeing improving in growth margin.

Louis Hsieh

Because we didn’t increase salaries as much for teachers this year as we did last year. So if you think like last year we increased teachers’ salaries about 11%, 12%, this year it was 8% to 10%. So you’re seeing some margin advantage. Also you are seeing the effect of the – all the learning centers getting filled up. When they fill up, the rental cost goes down because there are more students to defer the cost base. So you will see the growth. And also we’re just raising prices above while our costs are going up. So I think it’s a very healthy sign.

And the reason that the margin – the operating margin goes down is because when we have so many learning centers, like a 120 in six months, each learning center has like 10 to 15 employees. While those people are basically getting paid and the learning center is not profitable yet, that’s what drags down the operating margins.

Ella Ji – Oppenheimer

Okay. Thank you for the color.

Operator

Your next question comes from the line of Brandon Dobell of William Blair.

Brandon Dobell – William Blair

Thanks Louis. Just two questions on mix, first in the overseas test prep business. Maybe the mix between the different test prep programs you offer, so GMAT or IELTS or TOEFL, and is there one area that’s growing a lot faster and is that area or that particular test more expensive for the kids to take from you? And the same kind of question within tutoring. I guess I’m just trying to get a better feel for the mix within those two segments and how we should think about the ASPs in terms of both price and mix?

Louis Hsieh

Okay. Good question, Brandon. On the overseas test prep, IELTS and TOEFLs together are about two-thirds of overseas test prep and they’re each growing about 50% year-over-year in revenues and about 15% or so enrollment per year. So I think the price of IELTS and TOEFL is now like seven hundred and something dollars per class. It’s $750 per class. So that’s the scale and size.

The rest – but the fastest growing part of overseas test prep is actually SAT. And so as we – as SAT, ACT and AP test is for high school, and that’s growing very fast, and the other one that’s growing quite fast is GRE and GMAT. So those are – but I would SAT is the fastest growing, although it’s smallest like 35,000 enrollments, it’s growing over 50% a year typically. So I think that’s the margin profile.

What was your second part of your question, Brandon? Sorry.

Brandon Dobell – William Blair

Same kind of question within the all subjects tutoring; is there a particular kind of greater subject that’s a higher price point for you guys?

Louis Hsieh

Well, for us the higher price point is the one-on-one tutoring program. And most of the one-on-one tutoring program each students either want English or they want Science, so that’s where – so those are the very high price points. And the highest price point in the VIP is really the – is the – in the U Can is probably the SAT one-on-one tutoring, that’s $3000 to $5000. So I think those are the higher price points. Within the U Can Subjects, English is still number one obviously, because it’s the most important subject. Math is number two, and then it’s followed by Physics, Chemistry and a lot. Now, Physics and Chemistry typically will have a higher ASPs than Mathematics, because more of those students want to take small class for one-on-one, you know those are more difficult conceptually.

Brandon Dobell – William Blair

Okay.

Louis Hsieh

But the encouraging thing is for our middle and high school students, right, if you think about when we started this U Can program three-and-a-half years ago, the hurdle for us was whether our brand would extend to non-English classes. Well, now, non-English part of U Can is almost 65% revenue, one-third English, it’s two-thirds other things. So that shows you that the powerful brand of New Oriental extends outside of the English classes.

Brandon Dobell – William Blair

Okay. And then the final question, I want to make sure I understood your comments about fiscal 2013 margins. It kind of sounded like the next couple of quarters could still be a little rough when comparing it to the previous year with the back half of 2013 should start to see some margin expansion or might –

Louis Hsieh

Well, I don’t know about that part. What I think is going to happen is because we added so many learning centers in Q2 and Q3, there is a period where those learning centers are going to fill up and that will probably be Q4. The margins will still be a little bit depressed in Q4, but revenue growth should be very strong in Q4. So the number –anyway we always try to get you guys 30% top and bottom-line growth. Top line is never a problem, so the bottom-line we’re going to make sure we maintain. We are 33% net income growth so far this year. Want to make sure we’re well above 30% for the whole year. Okay, so that’s one thing.

On the – what’s going to happen is I think Q2 – Q1 and Q2, if we don’t open a lot of learning centers in Q4 and Q1, it will begin to work its way through the system by Q2. So it depends on how many we’ll add in Q2 and Q3 that would determine where the margins in the backend look like next year. But I have a feeling that we will become more steady stay between 100 to 140 centers, occupying about a 90,000 to 100,000 square meters. If we do that every year, the margins will trend up.

Brandon Dobell – William Blair

Okay, great. Thanks Louis.

Operator

Your next question comes from the line of Eric Wen of Mirae Asset.

Eric Wen – Mirae Asset

Good evening, Louis. Thanks for taking my questions. I just have a simple question. If I divide your sales and marketing cost over your cash revenue, which you also mentioned in your press release, I got roughly about the same level over the last two years. Can you comment on what’s the sales and marketing cost per cash revenue which is like how much money you would spend to get $1 of your revenue by sales and marketing, how this is going to trend over the next few years for the company? Thanks.

Louis Hsieh

Well, I think our marketing is changing. I think historically and I think is consistent this year, we are spending approximately 7% of our total revenue on promotion expense, not counting sort of marketing people, but just direct advertising on TV, Internet and things like that. The reason I don’t know the number going forward is because more and more of the marketing is going online. So – and that’s part of what our you know iPad, iPhone initiative is, is we want to begin to target the sites the students spend most of their time at, and then target more target their needs and send ads to them. So I think it’s moving more online, but I will say the percent is 7%, it’s been the same for five or six years. So I don’t really see that changing.

I think marketing expenses were high this last quarter, because the school has a little bit panic, given that the early timing of Chinese New Year, our enrollments were actually very poor in January, they are down 17%, that’s why we have cut our guidance for the –we had a low guidance for this quarter. And then we got extra marketing. The enrollments for February were crazy, they were up like 50%, 58%. So but that – so a lot of it is Chinese New Year timing. But I think the enrollment, the extra marketing actually paid-off and it helped us to be in a very position in this fourth quarter.

Eric Wen – Mirae Asset

Thanks.

Operator

Your next question comes from the line of Philip Wan of Morgan Stanley.

Philip Wan – Morgan Stanley

Hi Louis, thanks for taking my follow-up question. Just about your comment about controlling the pace of the investment and also balancing the profitability, given the decentralized operation for New Oriental, is there any plan to better control the pace of investment for the school head or in the regional operation?

Louis Hsieh

Yes, I’m not – I’m not the – I mean honestly you know our system is not centralized, it’s more decentralized, and that’s part of our problem. That’s why I’m a – I find out about expenses that go off the rails after they’ve gone off the rails, and you’ve known that for many years that that’s part of our problem with New Oriental is the finance team usually see things after they’ve already been spent. And so what happens is, that’s why I always ask you guys as investors and analysts is don’t look at a one-quarter snapshot, because when we over expand like this quarter in Q3, then you will see us under invest in the next couple of quarters to make up for it. So overall whole-year period, it all works out.

So that’s why I said don’t panic when we have one bad quarter, don’t panic when we over invest in one quarter, because then when we see it, then we will correct it. I wish I could correct it on the spot, but there is so many contracts and so many school heads, 55 – we have 29,000 employees. I can’t keep track of what you guys are doing, right? And so the – and some school heads don’t really worry so much about the budget, because they’ve already missed it. If they missed it, then it’s in their incentive to miss it big, so then they can get a bigger bonus the next year by adding capacity. So we have all these dynamics in place. It’s not – it’s – I wish it was more centralized. We do have budgeting that is centralized. But it’s because we depend so much on the school heads that’s one of our weaknesses in managing the cost. And so sometimes you will see – whenever you see an overspend in one or two quarters you will see an under spend the following two quarters. So over the long-term it works fine, but in the short-term it’s quite bumpy.

Philip Wan – Morgan Stanley

Just a quick follow-up, how bulky your hiring plan, given your 100,000-square meter network expansion –

Louis Hsieh

We’re going through budgeting now, but for Q4 (Steven Yang), our Vice President of Finance, when I told everyone last week to stop hiring. So except for teachers, except for teachers, I told them to stop hiring. And so I think you will see a slowdown in employment growth for the next – this Q4 and probably into Q1, then they’ll pickup again. We can always slowdown for one or two quarters, because we’re going to keep expanding to keep our market position. I think we will finish this year right around 29,000 to 30,000 headcount which is – which is like a 8,000 add. That’s a lot. But about 16,000 of those or 17,000 will be teachers. Going forward, the number of new teachers will be much higher than the number of other staff. So we were just joking before the call, we were paying – we are paying a consultant a lot of money to tell us exactly what we are in now.

Operator

(Operator Instructions). Your next question comes from the line of Anita Chen of Jefferies.

Anita Chen – Jefferies

Thank you, management. Can you elaborate the headcount number of this quarter including full-time and part-time teachers and what is the utilization rate of the current quarter? Thank you.

Louis Hsieh

We have a total of 15,500 teachers at the end of the quarter. Of those teachers, full-time is 7,000, which means there were 8,500 part-time teachers at the end of the quarter. I mean the utilization rate is still not that high and that’s part of the reason why we are adding more learning centers, because especially in Tier 2 and Tier 3 cities, you have to recruit massive teachers, and they don’t get in enough hours unless you have enough students to cover them, and that’s how we need more learning centers. The teachers move around from learning center to learning center. And what they care about is getting more hours.

So I would tell our utilization in Q3 is not very high, because the first week of the quarter was – the first half was slow, because Chinese New Year was so early, as students didn’t want to signup for a one-week course, they normally get a two-week course, and so the utilization was probably quite low. Normally would be about 60%, 55% to 60% in this quarter, it’s probably little bit lower than that, because of the timing of Chinese New Year.

Anita Chen – Jefferies

Okay, thank you.

Operator

Your next question comes from the line of Chao Wang of Merrill Lynch.

Louis Hsieh

Hi, good morning, Chao. Maybe his question was answered.

Operator

Chao your line is open.

Chao Wang – Merrill Lynch

Hi, good evening.

Louis Hsieh

How are you, Chao?

Chao Wang – Merrill Lynch

Hi, I have two quick questions. First one is by opening 80 centers this quarter, how much one-off expenses are recorded?

Louis Hsieh

Of the $25 million in CapEx, about – probably $10 million or $11 million of it is for the new center openings.

Chao Wang – Merrill Lynch

I mean in the $10 million, how much cost expenses is one-off?

Louis Hsieh

Well, I mean each – I don’t know the exact amount per learning center. The total cost per learning center is $50,000 to $70,000 for small one and over $100,000 – it’s the headcount that comes in, so I don’t know how – which one and when during the quarter they came in, but we added 180 learning centers. You’ve got an extra 800 to 900 people in the system plus teachers that are – we’re paying full-time salary to.

Chao Wang – Merrill Lynch

Okay.

Louis Hsieh

Right. So whatever that average is, I don’t know the exact amount.

Chao Wang – Merrill Lynch

Sure. And secondly is regarding Vision Overseas Consulting business, what is the margin of that business, both margin and profit?

Louis Hsieh

Margin is very high; it’s well into the 20s on an operating margin basis. It’s a very profitable business. I just – I don’t know how long-term it is. I think Chao at some point, Chinese kids like other regions will figure out how to do it themselves. They won’t need us to do that.

Chao Wang – Merrill Lynch

Okay. That’s correct.

Louis Hsieh

But I think the profit margin is very high, if you think about students paying $7,000, $8,000, $9,000, $10,000 for guidance and an SAT test prep class, right, and so I think the margin is quite high it’s well into the 20s.

Chao Wang – Merrill Lynch

Okay, got it. Thank you very much.

Louis Hsieh

Yes.

Operator

Your next question comes from the line of Jeff Mueller of Baird.

Jeff Mueller – Baird

Yes, thanks for taking the question. Let’s just talk about the implications for, I guess brand promotion spending as you grow more into the Tier 2 cities and pursue your “fill in” strategy there, because on the one hand I would think the ad buys would be cheaper than Beijing and Shanghai, but maybe your brands not quite as well known or you don’t have a stronger position yet in those cities?

Louis Hsieh

Yes. I think our brand – that’s a good question, Jeff. Our brand promotion expense are really trending toward online, so actually it won’t matter what city it’s in. The only difference would be in the Tier 2 cities, the TV buy will be cheaper, because it’s not in Beijing and Shanghai TV shows. So in that case it will be cheaper. But I think as most of our market is moving online and so there because the web is all over China, so there is no delineation of local versus other areas. You will see that – so it all depends on – ad buys will depend on how much Baidu and SINA and Tensen, and those companies increase their ad rates. So I think still they are going to increase some 10% to 15% that’s what – and then we’ll probably increase our shift of our ad buys toward online from the traditional media.

Jeff Mueller – Baird

Okay. And then, I guess, this is related to that, but just a follow-up on the initiative around the mobile tools. Is it more for advertising or is this learning tools that you guys are rolling out on the mobile platforms?

Louis Hsieh

So what we want is we want to have a global strategy, because as you guys know, Chinese students are the earliest adopters of smartphones. Every Chinese child wants a smartphone and iPads and things like that. And so we want to make sure that we are on those mobile devices and they are going to be learning from those. They are going to start web registering for classes online with their credit cards and then through their mobile devices. I think they will start accepting learning tools and listening to their courses through their mobile devices. And so we want to have the tools and the applications and also we want to market to them directly, we want to know which sites via their mobile devices that students visit and target and market them. And so it’s a combination of all those.

Jeff Mueller – Baird

Okay, thank you.

Louis Hsieh

Yes.

Operator

Your next question comes from the line of Paul Ginocchio of Deutsche Bank.

Paul Ginocchio – Deutsche Bank

Hi Louis, good morning. Just go back to the margin question. I think you’re pretty clear saying the margins would go up annually if you slowed down your growth. I just want to be – if you’ve kind of factor in the mix impact of going towards one-on-one and VIP and in going through the second and third tier markets, just to confirm you still think you can grow margins even with that sort of negative mix impact as long as you slow down growth a little bit, but still deliver the 30% top line?

Louis Hsieh

Correct. I believe the key is in the number of new learning center openings, because that’s what brings in a lot of headcount that don’t produce anything that quarter. And so if we can – even the smallest cities will have 20% operating margins when they’re mature. So everything is in our favor as the bigger we get, the more economies of scale we get in Tier 2 and Tier 3 cities. And so as the utilization improves in each of these cities, we will get higher margin, even though we’re moving toward a one-on-one format.

Don’t forget we’re raising prices in one-on-one and kids at a higher rate, those were the two lowest margin products. So I think it is. So the key thing is utilization and the key is new learning center openings. So if you look at the period of Q2 last year through Q1 of this year, one full year, we only added 86 learning centers in that four-quarter period. Our operating margin gap went from 16.5% to 19.5% in those four quarters. If you can see it directly, as soon as you slowdown learning center growth, the margins win a fair basis points and no other change. And so it doesn’t take much to go even a little bit lower than that. Let’s say, we have 80 learning centers, the margin will be 20% right away. But we probably won’t do it for a while.

And then even over time, Paul, as the all these learning center mature that margin will trend up by itself. That will be partially offset. You are right by the fact that the move is towards small and smaller classes. But we also intend to keep increasing the price in small and smaller classes, so then the margin degradation impact is much less.

Paul Ginocchio – Deutsche Bank

Perfect, thank you.

Operator

Your next question comes from the line of Charles Cartledge of Sloane Robinson.

Charles Cartledge – Sloane Robinson

Hi Louis, congratulations on the result.

Louis Hsieh

Thank you. Well, you got it what you wanted, Charles.

Charles Cartledge – Sloane Robinson

In fact that’s what I was referring to.

Louis Hsieh

The dividend.

Charles Cartledge – Sloane Robinson

I wanted to ask you about the dividend. You said previously in the last call that we’ve done on the last result you delineated how much cash you could broadly define this excess cash and we discussed the taxation that may apply to funds remitted out of China. Could you address – I mean you did say this is a special dividend, but how do – how should we think about the excess cash generation in the business which could be throwing off more than $50 million a year?

Louis Hsieh

Well, it's clearly throwing out more than double a year right now, right? And so I think is that what we would like to do and we discussed in the Board – like as you guys know, it took me two years to get this dividend passed, so you should give me a little bit of break – is that we want to look at every year the cash generation of the company around budgeting time around this time. We also want to look at the cash needs of the company with vis-à-vis acquisitions or vis-à-vis buying buildings like we just bought our Guangzhou headquarter building, three floors, so we can have a stable headquarters there. So we’ll look at those different needs.

So let’s say next year we generate 100 – I’ll just throw out a number, a $150 million of cash. If we used $20 million to $30 million to buy buildings and we don’t – and we have a couple of small acquisitions, I could see this conceivably paying out whatever is left, half or a little bit more in another special dividend or some share buybacks. On a taxation side, we deducted 5% to 10% of the money that we missed you actually.

Charles Cartledge – Sloane Robinson

Thank you. And could I ask also on the Northeast China schools you’ve said that they’ve been performing badly in the last call, have you been able to turn them around, or is it too early? And then finally as you move onto the Internet, what we’re seeing with other businesses in China and I’m sure elsewhere is that as the Internet disintermediates the physical world, it can compress pricing, and I was wondering if you thought about that.

Louis Hsieh

Well, you did – we did, and that’s why you don’t see us being the big proponent of putting everything online, right? But it’s not just us, it’s what students want. We have to follow what students want. So I think we will have a low – I mean the – our average ASP for online is about $80, our average ASP on the ground or in the classroom is $300, so it does have that effect. But I think yet the delivery cost obviously are a lot lower too. And so it depends on what content you put online and what content you will leave offline. I don’t think, I think students always prefer to learn one-on-one as they can in a small class. So one-on-one online we’ll have – we always have a presence and a growing presence, but it won’t be placed in the classroom, okay? So it will be a mix, and yes so it will have a dampening effect on ASPs if more – but right now we don’t count the online ASPs for you guys, right, that’s a separate group. We have – even in students we don’t count.

So off the 2.4 million students that should be added the online, you probably we have 2.7 million and 2.8 million students, so we really don’t count the online students, we do count the revenue obviously, but not in our classroom mix. What was your first part of your question, Charles? I’m just getting late –

Charles Cartledge – Sloane Robinson

Northeast China schools?

Louis Hsieh

Northeast China schools; three of them are turned around, Shenyang, Dalian and Harbin are doing well. Changchun is still having some difficulties. But that’s because the school head there that quit a year-ago took some people with him and started his own school. And so it’s – this is the soap opera that is New Oriental and so Changchun got hit harder than the other three schools where we’ve made school head changes. So I think it will recover.

It’s actually a funny story there, I don’t know if I should say on air, but – so I won’t say on this. If you guys want to ask me later, I can tell you the story.

Charles Cartledge – Sloane Robinson

All right, thank you very much.

Louis Hsieh

It’s really common in New Oriental house, a school head quits a year ago, and then over the next you know six to nine months he is potting to take teachers and take – and start his own school, so that’s what happened.

Operator

Your next question comes from the line of Jin Yoon of Nomura Securities.

Ruby Zhang – Nomura Securities

Hi, this is Ruby sitting in for Jin Yoon. I just have a quick question. Can you give some color on kind of state developments on your MaxEn classes?

Louis Hsieh

Yes, MaxEn is progressing slowly. I mean I would say the enrollment for Q3 were little bit disappointing, it was like a 140 and 150. We have 300 enrollments the last two quarters or so. It is progressing though. Q3 is not a big quarter for that kind of an English. I think it’s mostly Q4 and Q1 is better time for that. So we still have this five centers, we haven’t added any more that’s still in the private place. So it will take us some time to get the formula correct, the right number of classes, the teachers in place, and then to give a – to give the student experience that we expect. So moving along, it’s not a blockbuster, it’s not a fast pace, but it’s moving along.

Ruby Zhang – Nomura Securities

Okay, I see. So in the next two quarters, do you plan to add new centers for MaxEn?

Louis Hsieh

No, I think if we do we won’t go above eight for the whole year, right now we have five. But I think even though the next three are subject to getting some traction in the first five centers.

Ruby Zhang – Nomura Securities

I see, thank you.

Louis Hsieh

Thanks Ruby.

Operator

Your next question comes from the line of Vina Satiadhi of Moon Capital.

Vina Satiadhi – Moon Capital

Can I just check as well on the income tax rate for this quarter? It’s quite low at 5%. If that’s right, some excess one-off gains that will benefit and what’s kind of full-year guidance if it’s still within – you have mentioned before like 11%, 12% range?

Louis Hsieh

I can’t hear you see. What are you referring to? The tax –

Vina Satiadhi – Moon Capital

Income tax rate.

Louis Hsieh

Yes, the income tax rate will come out probably about 8.5%, 9% this year, and will be even much higher next year to probably 11%.

Vina Satiadhi – Moon Capital

Okay. And on the cash balance, are they all in Renminbi right now and is in onshore and have you –

Louis Hsieh

I think there is $55 million that’s offshore, which is $50 million we are going to use to pay the cash dividend. But yes the majority, it’s – $680 million of it is onshore.

Vina Satiadhi – Moon Capital

Okay. And in local banks.

Louis Hsieh

Yes, in local banks. And about yes they are in the local banks. They’re used for working capital in our different schools and then we have a lot of short-term deposits. We have no risky investments, they are principal protected investments.

Vina Satiadhi – Moon Capital

Okay, great. Okay, thank you.

Louis Hsieh

Thank you.

Operator

We are now approaching the end of the conference call. I will now turn the call over to New Oriental President and CFO, Louis Hsieh, for his closing remarks.

Louis Hsieh

Okay. Well, thank you everybody for taking the time to join us today. We hope to see you at future earnings call. Have a good day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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