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New Oriental Education & Technology Group Inc. (NYSE:EDU)

Q1 2013 Earnings Call

October 29, 2012, 08:00 am ET

Executives

Sisi Zhao - Senior Investor Relations Manager

Louis Hsieh - President & CFO

Analysts

Philip Wan - Morgan Stanley

Mark Marostica - Piper Jaffray

Jinkyu Yoon - Nomura

Steve Zhang - Macquarie

Ella Ji - Oppenheimer

Vivian Hao - Deutsche Bank

Jeff Meuler - Baird

Chao Wang - Merrill Lynch

Tian Hou - T.H. Capital

Operator

Good evening and thank you for standing by for New Oriental’s First Quarter of Fiscal Year 2013 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. Sisi Zhao.

Sisi Zhao

Hello everyone, and welcome to New Oriental’s first quarter of fiscal year 2013 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 US Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. New Oriental does not undertake any obligation to update any forward-looking statements, except as required under applicable laws.

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, Sisi. Hello everyone and thank you for taking the time to join us today. We at New Oriental would like to take a moment to wish all of you on the US East Coast well as Hurricane Sandy approaches. Please stay inside, stay dry and stay safe.

Now back to business. We are pleased that we maintained topline growth in the first quarter against tough comps from a year ago when revenues were up 41% and net income was up 45% year-over-year. We continued expansion into rapidly growing second and third tier cities and strengthen our market leading position. And we've shown tremendous versatility in terms of the reach of our network in a variety of our program offerings and an ability to ramp up utilization in our new facilities and locations. We continue to be resilient in the slowing macro economy in China as New Oriental brand name is as strong as ever.

Our focus going forward will be on a better management of our crucial network expansion to ensure we are growing in a profitable manner. A key part of this is moving from our Occupy-the-Market strategy which allowed us to double the centers in just over two years from 367 to 726 as of August 31, 2012. We are now shifting to harvest the market strategy that focuses on increasing utilization at learning centers and driving profitability; more on this in a moment.

Results of the quarter were a bit disappointing. Total revenues increased 25.8% year-over-year to $336 million and we added a net of 62 learning centers largely in high growth lower tier cities. Enrollment growth was 11.3% which is slightly lower than anticipated. We believe that part of the enrollment softness can be attributed to a slowdown in Beijing and Shanghai schools as the China macro economy slowdown effects consumer discretionary spending like education even though education is more resilient than normal consumer discretionary category. Furthermore, enrollments from our Chinese College English Test Level 4 and 6 (Later corrected by the company: Adult Comprehensive English) actually declined almost 20% year-over-year from about 97,000 last year to 78,000 this past quarter.

Finally, the negative media coverage and negative publicity in the aftermath of the baseless and false allegations made by short seller Muddy Waters on July 18th certainly hurt our reputation and contributed to student enrollment softness. The good news is that New Oriental has been a subject of very positive Chinese media coverage after we filed our Annual Report on Form-20F on October 12th and a clean auditor’s opinion from Deloitte Touche Tohmatsu and no historical accounting or financial restatement.

The Special Committee’s investigation by Independent Counsel Simpson Thacher who was assisted by before forensic auditor, Ernst & Young and leading PRC counsel, Commerce & Finance concluded no substantive basis for the main Muddy Waters allegations.

Now that we've been effectively exonerated media coverage has been much more positive and we are confident that there won't be any long-term impact on New Oriental’s reputation, which for years has been second to none in the education sector.

Year-on-year net income growth was just 5.7%, which was very disappointing. This was partly the result of poor performance in Beijing and Shanghai as well as investment in our network expansion and we incurred significant expenses related to the SEC investigation and defending ourselves against the Muddy Waters unfounded allegations.

In the first fiscal year of 2012, we were still focused on building our presence in high growth lower tier cities and we are pleased that the new centers we have in these areas are making an immediate contribution to the topline. Revenue from second and third tier cities grew 35% in Q1 which gave us a sense of both the speed of our expansion and how quickly we have been able to utilize new learning centers. As I mentioned before, the new additions are performing, are predominantly centers of 500 square meters or less which tend to come online quicker and are generally profitable within a year.

Our aim is to be the number one or number two player in language and test prep focusing on K-12 in all our locations where we operate. And in order to build this kind of position, we would have to move quickly to achieve critical mass. At the same time, other education players have been slowing down their network expansion which gave us an even greater imperative to cement our position. We now have a presence in 49 cities across China which is far ahead of any of our competitors. And we are confident that this would ensure long-term leadership in the sector as we transition to harvest the market strategy.

As I have mentioned bottomline performance was disappointing this quarter; our expansion obviously explains part of this, but there are a few other factors of play here. First, our performance in Beijing and Shanghai was relatively weak; revenue growth in these two cities is only 12% which is modest for us. Operating margin was actually down year-on-year. What’s happening is that many students who used to travel to New Oriental Schools in Beijing and Shanghai during the holidays are now attending New Oriental Schools in their local cities, where margins are typically lower. So the declining performance of Beijing and Shanghai are a reflection of our success in building our national network is also having an impact on bottomline in the short term.

Another factor was those expenses related to the SEC investigation and to the defending ourselves against Muddy Waters accusations. As you also have to factor in demand, has put great stray in some management bandwidth and resources and the negative impact it has on our reputation. Now that we’ve been effectively exonerated media coverage has been much more positive and we’re confident that this long-term will have no impact on New Oriental’s reputation. We do expect the burden to carry into the second quarter. Across Q1 and Q2 we estimate that we have incurred somewhere between $8 mill and $10 million in expenses as a result of SEC and Muddy Waters issues. So combined with our recent network expansion, this is going to put further pressure on our bottomline next quarter.

We are confident that the current size of the network positions us for leadership in all our markets in which we operate. So we feel that this isn’t a right time to shift from our Occupy-the-Market approach to we call Harvest-the-Market strategy. The purpose is to make sure we’re really driving bottomline results by improving utilization of the centers that we have, refrain from new business lines and requiring upfront – and refraining from new business lines that require large upfront investments. And finally, we will strive to control costs much more effectively than we have in the past.

We are confident this strategy will result in better bottomline results from Q3 onwards that means starting in December of this year. We of course need to continuously invest in teaching staff, but we are looking other areas of G&A particularly broader headcounts, where we can cut some headcount going forward.

Now a quick look at the performance of our various business units this quarter. Overseas test prep remained strong again growing around 31% and our K-12 all subjects after school tutoring business grew 34% on the top line year-over-year. Overseas and K-12 after school tutoring are growing strongly in most of our cities where we have a presence, and we expect these two businesses will continue to be our key growth drivers in the quarters ahead. The standard of our offerings speaks for itself. In this year’s Gaokao or college entrance examination four New Oriental’s students achieved the number one score in their respective provinces, and three others achieved the highest scores in their respective cities.

This is the second year running and it’s a statement to the New Oriental’s superior products we are offering. VIP was once again a fast growing segment with cash revenues growth of about 85% year-over-year this quarter. Our unrivaled brand and reputation put it in a great position to continue benefiting us for the long term. Domestic test prep and adult English as mentioned earlier continued to be a drag. Revenue was flat in both segments and we experienced continued slowing. CET4 enrolment actually declined 20% year-over-year from 97,000 to 78,000, that's the English exam for college students which affected enrolments by 2% to 2.5% points.

Vision consulting; overseas study consulting outperformed yet again this quarter with revenues growing approximately 55%. Just like last quarter, the studying overseas is becoming a realistic aspiration for more and more families, and our pedigree makes us the clear choice for this kind of consulting business. Of course there's an obviously link here with our overseas test prep business; so we expect these two areas to continue to grow in tandem. Before we move into and run into the key financial matrix, I want to update you on a couple of recent developments.

As mentioned in the press release, we've reached an agreement to sell Elite English to its head for $5.5 million. This is part of our effort to dispose the loss making businesses and focus on more profitable growth segments. On the Muddy Waters allegations, we feel exonerated and vindicated by the findings of independent committee of the Board namely that there's no subsequent basis for Muddy Waters claims against New Oriental, and the SEC investigation.

As you know we were informed by the SEC and their staff they had no objection to the consolidation of our VIE, Variable Interest Entity into the company's consolidated financial statements and also no objection to the consolidation of our schools into New Oriental China, Oriental or wholly-owned subsidiaries in China. We subsequently filed our 20-F on October 12. The SEC no objection is based on our representations being correct that we made to them. We are glad to have these issues behind us and we are focused on managing the growth of our business going forward.

Before we move on in the Q&A, I want to give you a brief roundup of key metrics for the quarter. Total student enrolment last quarter increased by 11.3% year-over-year to around 899,000 from about 808,000 in the same period of the prior fiscal year. Operating margins for the quarter was 30.2% compared to 35.7% in the same period of the prior fiscal year. Non-GAAP operating margin was excluding the impact of share based compensation expense for the quarter was 32.2% compared to 38.2% in the same period of the prior fiscal year.

General and administrative expenses for the quarter increased by 42% year-over-year to 76.6 million. Non-GAAP general and administrative expenses which exclude share based compensation were 69.9 million, a 48.1% increase year-over-year. This is primarily due to increased headcount through the continued network expansion and an investigation related expenses accrued in the quarter. We opened a net of 62 learning centers in the quarter, opening 89 centers and closing 27, 19 of which came from the disposal of Elite English, and we also invested further in new content and program developments and improving teaching quality.

Moving on to the coming quarters; we're pleased with the progress we’ve made in deepening our presence and cementing our leading positions in the cities where we operate. There should be some impact going forward from the macro slowdown although we will be minimal as families show continue willingness to maintain their education spend. We anticipate some overhangs on the SEC and Muddy Waters related expenses I mentioned earlier, which will affect near-term profitability. But from Q3 onwards, we expect improved bottom line performance as our harvest to market strategy takes hold.

We're confident our investment strategy has put us in a prime position to sustain long-term market leadership. Turning in to our guidance for the second fiscal quarter; we expect total net revenues in the second quarter of fiscal year 2013 to be in the range of $165 million to $171.6 million, representing year-over-year growth in the range of 25% to 30%. This forecast takes into account slower growth in Beijing and Shanghai and the macroeconomic situation.

At this point I will take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Philip Wan with Morgan Stanley.

Philip Wan - Morgan Stanley

My first question is about your profitability going forward. You mentioned that the company is going to be focused on profitability, but I wonder how does that impact your expansion strategy for your VIP business which is less profitable with further competition. And then I have a follow-up question. Thank you.

Louis Hsieh

I think what we will plan to do is open up much fewer learning centers. As you think about it we opened up a 177 last year [net] and we opened up 89 in this quarter minus the 27 that we disposed off; it’s still a heavy spend. Our headcount increased by 10,000 year-over-year from 24,000 to 34,000. So how we get to profitability? We stop expansion of most learning centers, so you will see a drastic decrease in the rate of growth starting in December 1st.

So we are finishing up what we call the occupy the market strategy where we basically make sure we are number one or number two in each of our 49 cities for all schools that have been operating for at least six years. So we are well on track in that regard. The other thing is our competitors have not been inclined to challenge us in many of these cities. We don't need to continue to invest heavily.

So one way is that we will slow down learning center growth, whereas we don't expect much impact on revenue growth. The VIP business continues to grow well, and as I told you guys in the past, our VIP margins are much higher than any of our competitors for several reasons. One is that half of our enrollments were actually one to five, so its not one to one, one to five, usually the average price to $1200 U.S. for three months is 6000 revenue.

Most of our competitors charge about 1000 to 1500 for six months, so that 6000 we get from one to five is much higher margin. Second is that we charge higher price than our competitors anyway. So our average one-on-one or VIP enrollment pays us about $2300 U.S., so we have higher margins as a result. And finally about 15% of our VIP and raw material actually overseas test prep enrollments and their ASP is also much higher; well over $4000 U.S. on average.

So we think that the VIP business is not a low margin business the way we run it. And we will focus on increasing the utilization of our billing centers, as you know we have almost between 400 and 500 VIP learning centers now that after VIP and those schools are heavily under utilized right now. So the goal will be to begin to fill those utilization rates before expanding too much faster in VIP. Your second question, Philip.

Philip Wan - Morgan Stanley

You mentioned (inaudible) investigation we need to expand, including this quarter. Could you disclose how much did you incur this quarter and then how much should we expect for next quarter or the remaining of this year?

Louis Hsieh

Yeah, it’s hard to say because the SEC enforcement investigation is still open. You know it’s been quite quiet on their front as they review our 20-F. There hasn't been anything new. We accrued about a little bit over $5 million US in Q1 ending August 31 and so as we said in the prepared remarks we expect that to be somewhere between $8 million and $10 million before it’s done. That doesn't include any class action, pending class action issues that there have been sort of consolidated, but given we receive pretty much a clean bill of health, I don't expect those to be material. We also have $5 million of D&O insurance that will pick up some of those costs related to litigation charges.

Philip Wan - Morgan Stanley

Yeah, so what would be the next step as you see on the investigation is still like open on SEC side, so what does the company going to do next or should we just wait for any update from the SEC?

Louis Hsieh

Yeah, we are not doing anything actually. I think our counsel had a call with the SEC enforcement division last week and they haven't asked for any documents from us since the special committee led by Simpson Thacher gave a report to the SEC enforcement division of their findings. So that was on September 30. Since then what we heard back is the SEC enforcement division is just looking at our 20-F filings and they have not asked for anymore documentation or not asked for any further information from us. So we have nothing we could do. We just leave it open until they are satisfied that things are okay.

Operator

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

Mark Marostica - Piper Jaffray

My first question is in regards to other businesses, Louis said maybe earmarked for potential closure or potential pulling back in size. Can you give us a sense outside of ELITE what other areas might be not performing as well where you might consider exiting those businesses?

Louis Hsieh

Well, we wouldn't disclose that here in the public forum Mark. Yeah, it’s a very good question. As you know over the last two years, we've been closing businesses that have been underperforming. So ones that are loss making like ELITE it has contributed about $18 million in revenue last year but lost $400,000 or so and we didn't see profitability coming this year as well. So we sold that off. Other loss making ventures included Mingshitang, the acquisition we made of the Gaokao re-taker school which we disposed off last year. We closed our bar and CPA exam school which was not making money. So we will examine all of our business lines and the ones that we don't think have a profitable future. We will close those to improve margins but I don't want to mention anything on tonight’s call or at this morning’s call for you guys.

Mark Marostica - Piper Jaffray

And then just a follow-up question; as you consider the slowing growth scenario coming forward here and focus on [pasturing] Tier-2, Tier-3 cities; can you give us a sense of what operating margins could potentially look like and maybe a way to attack the question might be to talk about fully loaded operating margins for mature centers older than a year, just trying to get a sense of organic operating margins ex the rapid growth that we've seen?

Louis Hsieh

I think if you look at organically at our learning centers that have been operating for more than two years and that are relatively full. Those operating margins are typically in excess of 20%, not counting corporate overhead. Now, if you think about the expenses you need to continue to grow the business and to train teachers for the future. I think, we're probably about 12%, 13% operating margins now which is as we believe is our low point and I think it will be sort at the (inaudible) of this quarter ending November 30 this Q2 because of the SEC investigation charges and others. So we think that their margins will turn around. Our two or three year goal is to attain 16% to 18% operating margins and we think potentially if we don’t grow too rapidly, 20% is not unreasonable.

Operator

Your next question comes from the line of Jinkyu Yoon with Nomura.

Jinkyu Yoon - Nomura

Louis, couple of things, if you mentioned that the growth is slowing in Beijing and Shanghai, can we assume that pricing in the near-term maybe a little bit muted or how you just think for pricing in the near-term and I have a follow-up question regarding your P&L. Thanks.

Louis Hsieh

I think, you will find it ironic but we probably plan to pick up pricing. So I think for Beijing and Shanghai, the slowdown for the summer is a [consequence] of couple of factors. Beijing and Shanghai have more CET 4 and CET 6 students at the Chinese English level 4 and 6 exam that Chinese students or many of them has to take to graduate from Chinese colleges. That test is getting easier for Chinese students as their ability, English ability increases; probably find New Oriental kids in middle school programs. And that’s similar to what happened with the adult English. As Chinese students learn English as a child, they need to learn it again as adults; so both of those businesses have been slowing. The slowdown was actually much more, was much stronger than anticipated this quarter with enrollments actually declining from 97,000 last year in CET 4 and CET 6 down to only 78,000 that in itself accounted for over 2%, 2.5% or so in the student enrollment growth.

In Beijing and Shanghai as you know, we have installed new school heads just this last year about two months or three months ago. They need time to turnaround the situations, but as part of our harvest the market strategy, we actually are beginning to going to begin to increase prices more aggressively especially in the kids’ English side and other offerings because we believe and the results speak for themselves. We have as much more superior offering than our competitors. And we are going to begin to tear the market where we are going to after the high end and the high profit business and we will leave the middle to high end and we will leave the lower end to the other 30,000 competitors or so that we have in China. So it sounds ironic but most likely we will begin to take our pricing to improve profitability, may be sacrificing some enrollments in the process.

Jinkyu Yoon - Nomura

Got it and just a follow-up, if I may this in your in the beginning of the call, but it looks like the 1Q ‘12 last year first quarter P&L where someone restated is that just merely taking out your EILTE English in just normalizing the business or is it something…

Louis Hsieh

That’s correct, no other reinstatement. It’s just as when we sell off ELITE, it’s not meaningful comparisons if you don’t take them out from both.

Jinkyu Yoon - Nomura

But is there a reason why it wasn’t taken out of the S12, the annual report when you recently filed?

Louis Hsieh

Because the annual report as of May 31st, don’t forget.

Jinkyu Yoon - Nomura

Got it.

Louis Hsieh

We (inaudible) unit yet until this quarter.

Jinkyu Yoon - Nomura

Got it, got it okay.

Louis Hsieh

For there is a timing issue, so the main number of our fiscal year is May 31, so all things are on the 20-F speak as off May 31, except for a recent developments.

Operator

Question comes from the line of Steve Zhang with Macquarie.

Steve Zhang - Macquarie

My first question is related to your presence in the 49 cities. You mentioned that you want to slow down expansion in these areas. So after 49 cities, how many are you already number one and two. And what do you plan to do with the remaining cities that you were not number one and two?

Louis Hsieh

Well, we believe we can't obviously prove this but just from our on the ground evidence, we believe we are number one and number two in every city that we have been around for at least six years. And once who haven't where (inaudible) and number two is because we haven't been there six years yet. So we know this model works and so we are going to continue to expand in those cities but the key focus will be on utilization rates and existing learning centers.

We will also going to begin to close down learning centers that have not been profitable after two years or you can see the trend that they are not going to be profitable anytime in your future, those are going to begin to shutdown and there will be staff reductions accordingly. So if you think about revenue grew 25.8% year-over-year, our headcount grew 40% year-over-year that is not sustainable. So we are going to take some actions to correct that.

Steve Zhang - Macquarie

Okay, but you have no plans to exceed any of these markets?

Louis Hsieh

No, no, we have no plans to exceeding in the 49 cities.

Steve Zhang - Macquarie

Okay and this is just a follow-up. I just want to clarify little more on your CET 4 to CET 6 enrollments. You have attributed part of it, part the enrollment decline to potentially the bad press you received after the Muddy Waters’ report. Are you seeing any recovery in demand following filing of your 20-F this quarter?

Louis Hsieh

Well, we have seen, and we just filed the 20F on October 12th. The enrollments the last couple of weeks have been quite encouraging. So we’ve already begin to see a build up into Q3 for our winter quarter which is also our second most important quarter. So we basically would just take all as much as of the bad news as we can in Q1 and Q2, given that we have $8 million to $10 million in SEC investigation of Muddy Waters charges then we will sort of hopefully have a come out of this much stronger in Q3 and onwards.

Operator

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

Ella Ji - Oppenheimer

Thank you. So first I have a follow-up question regarding your price increase. So historically, organic price increase has been in the range of 8% to 12% and how much shall we expect going forward?

Louis Hsieh

For this last quarter, let me see here, I believe pricing was up about; let me double kind of, it is about 13% to about $330 to $335. So I think the pricing, we will continue to take our pricing in overseas test prep in U Can and the big change will be probably to pick up pricing more on the kids side where we've been sort of reluctant to, because kids is a more competitive sector and we use it as a last leader in some sense to get students into our system in order to sort of monetize them at the middle and high school and overseas test prep levels. So I think is that model needs to be where we will loose some enrollments on the kids’ side, but we’ll pick up a lot of margin points as we raise the price in the kids sector. We believe we have a better offering. So we should take up pricing.

Ella Ji - Oppenheimer

Sure. So yeah, how much would the average price growth be with your new plan; should we expect it to grow up to like 15 or even high teens?

Louis Hsieh

Well, I think, like I would expect in certain categories for it to go up. I think typically we’ll take up pricing between 10% and 12% as we mentioned Ella; and probably be slightly higher than that, maybe 12% to 14%. But at the same time there is some drag from the fact that our growth in second tier cities is much faster now than our growth in Beijing and Shanghai that typically have higher ASPs. So the blended ASP as I mentioned for three quarters now may not reflect the true price increases we are taking because they are being influenced by more second tier city enrolments, which have a lower pricing point. So on average you would expect somewhere between, you know probably widen the range from 10% to 12% probably to 10% to 14% price increases.

Ella Ji - Oppenheimer

And then, well you mentioned that you are going to move toward middle to high-end of the market. Is it only for Beijing and Shanghai or for other lower tier cities as well?

Louis Hsieh

I think it’s for all lower tier cities as well. I think Ella that the price increases last quarter on a year-over-year basis was about 16% to 17%. So we are already beginning to do it.

Ella Ji - Oppenheimer

And then Louis, in the third quarter you have been switching to this harvesting mode and then you quickly switched back to the growth mode. So I am just wondering how long will this time, how long will the harvesting mode be, is it only for maybe one year or is it for a long time?

Louis Hsieh

I don't know the answer to that to be honest; I think for now as when we look at our utilization rates, they are not as highest, because we've added in the last year in one quarter over 230 units and over the last two years, we’ve doubled our network, a little bit over two years. So we need to increase utilization in the number of learning centers. I don't know how long that will last; it depends on how quickly these centers fill up and as we get closer to our profit targets. And then also the other side, it depends on demand. If demand is so strong, then we will make the right decision for the long-term and add centers again at a more rapid pace.

Ella Ji - Oppenheimer

And my last question is, can you give us an update on how much does Beijing and Shanghai represent as a percentage of your total revenue now?

Louis Hsieh

Well, typically for the summer it’s usually a high number and this year it went down a couple of percentage points, but it's still about 41% to 42%, but overall Beijing and Shanghai now are well under 40% for the full-year. So I believe that will actually even be a lower number this year given the Q1, Beijing and Shanghai only about 12% whereas the rest of the network about 35%. So I would think that number will kind of come down, last year it was about 37%, 38% of revenue; that should come down more this whole fiscal year. The summer is usually higher because of the overseas test prep students, who study in Shanghai and Beijing.

Operator

Your next question comes from the line of Vivian Hao with Deutsche Bank.

Vivian Hao - Deutsche Bank

So apart from the ELITE English and domestic test prep decline, just implying from the revenue growth, it looks like the overseas test prep enrollment probably not as robust as previous years, do I take this as a structural slowdown or more on a macro side or other reasons?

Louis Hsieh

We think in general, the growth of overseas test prep will not be at the torrid paces as far as enrollment has been in the past and the enrollments were up about 6% for the quarter and the revenues up 31%. I think in general, the world can only absorb a certain number of Chinese students and the growth rate is just not sustainable at 20% plus; whenever students for the overseas increase year-over-year. So I think in the long-term it will be slightly lower, but given the New Oriental’s pricing power and premium brand here, I think revenue growth in this sector will still stay well above 25% year-over-year for the foreseeable future.

Vivian Hao - Deutsche Bank

Okay. But it seems like for the students who are going overseas for undergrad are still growing quite robust; and just wondering how New Oriental will try to capture, what kind of strategy New Oriental will take to try to capture this growth?

Louis Hsieh

Yeah, that’s a good question Vivian, I think we dominate the SAT, ACT test prep in China already. We have probably higher market share than, usually higher than all of our competitors combined in the college entrance exams for overseas study. There is one downside right, one thing overseas that you usually don’t need our services anymore, so it’s a plus and a minus for us. So we will continue to capture that by having the highest quality SAT and ACT and other provisions for test prep, but I think is that, that sector I am actually not too worried about.

Vivian Hao - Deutsche Bank

Right, so for this faster growing test prep segment, that segment of SAT, do we have a rough percentage of contribution to the total overseas test prep revenue?

Louis Hsieh

I don't have the enrollments for this past Q1, but typically we have been doubling in SAT enrollments and we probably have 70% or 80% of the China market in this category. So I would expect it to be, to continue to grow faster than TOEFL and IELTS which are growing about 10% a year; I would expect SAT to continue to grow about well in excess of 20% to 25% a year in line with the market, as the number of Chinese student increases to go overseas for college; I don’t have the exact enrollment breakdown of SAT for this quarter, we do it once a year.

Operator

Your next question comes from the line of Jeff Meuler with Baird.

Jeff Meuler - Baird

I guess first a follow-up to Ella’s question; if a little under 40% of revenues been coming from Beijing and Shanghai, do you have any estimate of what percentage of the company’s profit has been coming from those two markets?

Louis Hsieh

If you strip our corporate overhead, it’s probably closer to 60%, Jeff.

Jeff Meuler - Baird

Okay. And in Beijing and Shanghai, what percentage of students or the revenue has historically been from students that did not live in those metro areas?

Louis Hsieh

Well, typically what happens is about one-third of the revenue from the summer itself come from what we call dorm students and students enter the summer camps where students from outside of Beijing and Shanghai travel there for (inaudible), there is a reputation that Beijing and Shanghai have and students want to come there and spend their summer there; they think the teaching quality is better. That percentage has, for this summer we expected another 30% increase in sort of dorm based study, and we actually got almost no increase and that in itself accounts for the whole difference in Beijing and Shanghai.

And when we did a research into this matter we found out that many of the students who were thinking about kind of Beijing or Shanghai decided just to stay in their home cities because the view now as New Oriental has established its premium teaching in the second or third tier cities is not worth the extra expense and time to go to Beijing and Shanghai where you can get very comparable if not the same education level as in your local city. So that's what's hurts Beijing, it’s a (inaudible) revenue through the summer and there was no growth there.

Jeff Meuler - Baird

And then I think you said you don't expect much impact on revenue growth from slowing the network expansion, and it also sounds like you are maybe narrowing your target market a little bit in terms of leaving the less profitable lower price stuff for your competitors. Just if you could maybe reiterate or clarify that potential comment on revenue growth and if you are not expecting any negative impact relative to the historical revenue growth. Is it just the taking up pricing more than you historically did that’s offsetting that or if you could just comment on that.

Louis Hsieh

One thing we didn't really mention in the prepared remarks right, its been mentioned in the past calls is Jeff right is that currency last year accounted for 6% of the revenue increase. So if you strip out currency where it was flat year-over-year for Q1, there was no currency bump. The revenue rate is right in line with what I thought it was, right in line, its 25% to 30%. If you strip out currency from last year’s growth its only 32%. So it’s not much of a decline other than what happened in Beijing and Shanghai.

So revenue growth has never really been our problem right. As far as in that we've only missed revenue guidance one time in seven years or six years plus as a public company. So 24 I think we really missed once and I think we only missed by $0.5 million and that was because of a snow storm that blanketed of China during the winter. So I think in general revenue is not our challenge, its how to manage our business more profitably, and the way we know how to do it, we just have to have the will and we have to force the school head to do it, which is to shut down on profitable units, its to increase utilization rates and to pick up pricing. We have that pricing power; we just have never really used it to the full extent we were capable of.

Jeff Meuler - Baird

I wasn’t as much focused on this quarter as going forward and just wondering if you can maintain this type of revenue growth on a constant currency basis if you are slowing the learning center expansion and potentially walking away from some of the lower end business.

Louis Hsieh

I believe we can.

Jeff Meuler - Baird

Or should see some deceleration?

Louis Hsieh

Yeah, I believe we can. Assuming we can fix them, then we need a transition period of six months for new management in Beijing and Shanghai schools. Assuming they can turn around those two schools, the rest of the network is growing over 35%. So if we can just fix Beijing and Shanghai which we are devoting a lot of management resources (inaudible), I don't think you will see much of a revenue split out.

Jeff Meuler - Baird

But I'm confused there because I thought that you said that Beijing and Shanghai that basically the whole difference versus the prior growth rates was that a third of summer revenue from dorm students was basically zero.

Louis Hsieh

Correct so you would see zero growth. So that means there won't be a drag next year really.

Jeff Meuler - Baird

Right. But you're saying that Shanghai and Beijing that new management is working on fixing them, but are there issues besides the dorm students staying in their local markets that you guys have identified and can turn around.

Louis Hsieh

I think Beijing and Shanghai need to become more profitable right Jeff. I think there is probably several unprofitable learning centers in Beijing that should be closed. I think there is probably more headcount in Beijing, Shanghai than are necessary. So I think there is ways to rationalize, to monetize Beijing, Shanghai even more than they are currently being monetized.

Jeff Meuler - Baird

Perfect.

Louis Hsieh

It doesn’t mean in Beijing, Shanghai the growth is slow. We think if you raise prices in those cities, which I think we can do. If you rationalize the business, so you have less headcount doing the same amount of work, and if you increase the utilization rates in the existing learning centers, I think Beijing Shanghai profitability should be much higher. I think that’s the focus of the new management teams there.

Operator

Your next question comes from the line of Steve (inaudible). Goldman Sachs.

Unidentified Analyst

Just relating to the center additions in the previous quarter? Do you have any particular focus or any cost format? Have you added more cost based or the actual programs given the new focus on how is the market? Than I have a follow up question.

Louis Hsieh

I think the ones that opened in the quarter it was a gross of 89 centers. I think most of them are VIP and [you can] and kids related centers. So if you do a combination of three or their sub-set of the three, and I think that will continue. But I think as I said before is that, it doesn’t make sense to keep opening up more and more centers without fully utilizing them.

So it takes them a year or two to get wherever they are quite profitable, so I think the focus now is to now we will open up a lot of centers is to begin to increase the utilization rates even as they means we lose some students because we don’t have a center close to their homes. I think also you are right as you close a couple of a non-profitable centers what’s going to happen is those students who will remain in the (inaudible) network will move to other centers and actually increase their utilization rates. So there is some positive there is too.

Also as you slowdown learning center growth, you don’t have the incremental headcount increase. Because when a learning center is fully operational it’s got 25 to 30 employees even relatively small ones. It starts off with 10 to 12. So if you don’t have the learning center growth, you don’t have all these charges ahead of the revenue as you also accrue the bottom line.

Unidentified Analyst

My second question is on the recent policy change in Beijing regarding elementary school math and [Olympic] training program. Do you foresee any impact on enrollment and revenue?

Louis Hsieh

I think you will have some impact on us but obviously not the impact it has on (inaudible) which is much more dependent on Olympic much than New Oriental is, math has been a new subject for us just a few years ago and it will have some impact on us. I don’t expect it to be as big for as compared to (inaudible).

Operator

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

Chao Wang - Merrill Lynch

I have two questions; first one is regarding the VIP business. So despite the weak (inaudible) were strong so I am wondering if it’s because of the low base or because [CIG] students are less (inaudible, and also we being the [CIG] business, do you see some business lines are more sensitive to the economy than others, thank you?

Louis Hsieh

I heard this recent really before Wang Chao. I think it certainly probably has slowed down (inaudible) growth rate. For New Oriental our VIP is [20%] to 85%, its only for now because the base is getting larger, it’s the $240 million business already, and I think given our trajectory and given (inaudible) trajectory we’ll become the largest VIP or you know one-on-one training in china this year.

So we do see, it could, but I think given New Oriental’s reputation and given that as you said is the high-end consumers that will purchase one-on-one. It’s still going to be less affective than most, although we have been saying for years that the luxury sector is more mute, but you always saying this luxury sector in China get hit by the recent slow down.

I think the argument, I would make is based on our enrollment increase; we don't see a much of slow down at all. That's probably because education is probably much more important purchase than handbags or cars or things like that. So we don't except to see much. I think our enrollments for VIP went up from 21,000 last year to 34,000 in the quarter.

So our enrollments were up 59%, so I think there was much of a slow down there and revenue was up, sorry enrollments were up 59% and revenues were up 85% and ASP is about 15%.

Chao Wang - Merrill Lynch

This is been the growth is quite strong, so?

Louis Hsieh

Yeah, so I don't think it’s hurt us yet, much if any. Like I said, I think by revenue this year we’ll become by far the largest given our growth trajectory and VIP we should pass revenues in this category. So we will be the by far the largest [one-on-one], the largest K-12, the largest overseas test prep. So all our businesses will be the largest by far.

Chao Wang - Merrill Lynch

And also since you have this VIP format across the board, so do you see some segments like more impacted by the method than the other segments?

Louis Hsieh

I think we are still in the rapid growth phase of VIP so if it is, we were not seeing it. Certainly, overseas [one-on-one] are growing. Clearly [one-to-five] is growing, VIP is growing very, very fast in the middle and high school sectors as students prepare for the Gaokao exam and given our tremendous track record in these tests most VIP students if they can afford it will certainly come to New Oriental. So we haven't, like I said, we, I mean it’s the impression we really haven't seen the impact, I think it’s because, probably because we are still growing so rapidly in the space and because of our premium brand here. This is the one category where parents if they are going to pick up a brand, New Oriental clearly stands out.

Chao Wang - Merrill Lynch

Okay, second question is on the share buyback. So basically do you disclose the average price kind of buying back price?

Louis Hsieh

I don't know the average price to be honest. The management team after we heard those ridiculous allegations by Muddy Waters, we basically you know just a few days later we all said we are going to buy shares and we did. All the way to August 31 until the window closed, we bought over $33 million of shares in New Oriental stock, probably if I had to guess the price would be somewhere between $12 and $14 somewhere in that area.

Operator

Your next question comes from the line of Tian Hou with T.H. Capital.

Tian Hou - T.H. Capital

Hi, Louis, I have a couple of questions. One is the ELITE program, the one you disposed, will you give this quarter 1Q guidance, was that a part of the guidance?

Louis Hsieh

Actually it was because we didn't know when we would close the disposal. So actually part of the revenue slow down is actually because we've been disposing off a lot of old businesses as well. So yeah, ELITE did about $18 million in the last 12 months but it lost $400,000 and the long-term growth trajectory is not there. As we said earlier, as children learn English in China well, they don't need to learn it again as adults and certainly not at the high end where ELITE is really premium priced. So I, at that time we didn't know when we will close the disposals, so it was actually included in the forecast even though we didn't encounter this.

Tian Hou - T.H. Capital

So how much that could be?

Louis Hsieh

It was about $4 million to $5 million is the revenue from ELITE during the summer last year.

Tian Hou - T.H. Capital

Okay. So another thing is about your ASP. So as you grow in your VIP program and kids program K-12 program you know particularly the VIP program, you know I would imagine your average ARPU is supposed to grow and grow in the pace much faster if not lower than before. However, if I look at your ASP and last year Q1 is more than 25% and you know 2011 in a similar pace on a year-on-year basis and this year end it’s less than 10%. I just wonder what contributed to that lower pace to ASP?

Louis Hsieh

No, the ASP for language and test prep programs increased 18% for the quarter year-over-year and so it's actually quite high increase. It went from an average, let me see here. Last year, I believe it was $285 or so on average for the quarter last year and it was $335 this year. So it was actually an 18% increase year-over-year. And I think part of that, I think part of that because of the shift for [one-on-one] but VIP this quarter accounted for only 23% of revenue. So that actually, it was this much higher than last year but I think it's not going to, we don’t think it will go over 30%. So it is probably, what I mean by that VIP will continue to outgrowth the other categories but it won't have such a dramatic impact on ASPs as it has in the past because its growth rate will begin to slow a little bit as well. It's had a dramatic impact on the ASPs on average for the last couple of years as it ramps up over 100% a year.

Tian Hou - T.H. Capital

Okay, so the other question is that you have several disposals in the past and are there any plans for upcoming disposals?

Louis Hsieh

Well, I think for us is we will review the performance of our business sectors each year and we’ll come together and we’ll argue about which units to dispose and which ones to not to. Personally, I think the business can’t make money after three or four years after they start they should be closed or if there is no long-term prospect of them being quite profitable, we’ll close them. And you saw that with the bar and CPA exams, you saw that with the gaokao re-taker school. And so we do, and you see it now with ELITE. So businesses that don’t make money, we’ll look at it and close down overtime, but I think as right now we don’t have any plans to dispose off anything else currently and I couldn’t tell you if we did.

Tian Hou - T.H. Capital

Okay, so the other thing is, is that possible for you to give us some kind of your enrollment allocation in each business line?

Louis Hsieh

Yeah I think if you e-mail Sisi Zhao, our director she can give you the information, Tian. I don’t want to spend all the time on the call on that. You can see that the growth rate is, the enrollment growth is very, very healthy in the fastest playing area of middle and high school and kids’ right. I mean middle and high school enrollment was, it was over 19% growth year-over-year and kids was 22% growth year-over-year. So you can see that the growth of this, the future of New Oriental enrollment comes from K-12 we have 1.4 million K-12 faster that number will be almost 1.7 million this year. If that’s the case that means rest of our enrollments are just flat, right. So the growth in enrollment is has driven by the K-12 clearly and they continue to do well. I mean they are still going to grow revenues over 35% and enrollments around 20% year-over-year.

Operator

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

Louis Hsieh

Again, thank you everyone for joining us today. If you have any further questions please do get in touch with me or any of our Investor Relations representatives and like I said we are very grateful to our investors who have been very supportive of us during this very difficult period. And finally, we just want to wish our friends and colleagues in the US East Coast good luck and please stay safe. Thank you very much.

Operator

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

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