EDU 新东方

Operator

Good evening and thank you for standing by for New Oriental's fourth quarter and fiscal year 2007 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Ms. Sisi Zhao, New Oriental's investor relations manager.

Sisi Zhao

Hello, everyone and welcome to New Oriental's fourth quarter and fiscal year 2007 earnings conference call. Our earnings results were released earlier today and are available on the company’s website as well as on newswire services. Today you will hear from Michael Yu, our founder, Chairman, and Chief Executive Officer; and Louis Hsieh, our Chief Financial Officer. After their prepared remarks, Michael and 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 the view expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. New Oriental does not undertake any obligation to update any forward-looking statements except as required under applicable law. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on New Oriental's investor relations website at http://investor.neworiental.org. I will now turn the call over to New Oriental's CEO, Michael Yu. Michael, please.

Michael Yu

Thank you. Good morning and good evening, everybody. This is Michael speaking from Beijing, China, in the New Oriental building. Thank you for joining us today. It is my pleasure to review with you our fourth quarter and full fiscal year 2007 results. Overall, 2007 was a great year for us with the fourth quarter contributing to our solid overall growth. I would like to spend some time taking you through the highlights and some key developments for the last quarter before speaking a bit on our plans for the future. Before I go on, I’d like to give you some color on fourth quarter seasonality. The fourth quarter is typically a slow quarter in terms of revenues as school students focus on their end-of-year examinations. It is also the time when we ramp up our marketing efforts and spending to encourage enrolments during the summer holiday season, which is our busiest time of the year. Now we are in this season, actually. We’ve delivered strong results for the fourth quarter with healthy revenue growth in all of our key segments, leading us to beat the high-end of our revenue guidance by more than RMB 5.6 million, or $0.7 million. Driving our success in the fourth quarter was strong growth in new enrolments for traditional language training, overseas test preparation, and a pop quiz English courses. As a result of this growth, I’m proud to announce that fiscal year 2007 was the first year in which New Oriental student enrolment exceeded the 1 million mark and the net revenue exceeds RMB 1 billion in New Oriental's history. With China’s increased access to the Internet and the mobile form of communication, we have been consistently expanding into new medium of language learning and of test preparation. During the fourth quarter, we launched a couple of new initiatives that increased access to New Oriental courses. First, we partnered with Nokia to provide course content for Nokia mobile EDU learning platform, which allows students to access New Oriental course content via their mobile phones. We also introduced an online payment system to facilitate online enrolments for our traditional classroom courses. As a lead-up to the busy summer season, every year a group of New Oriental staff teachers travel throughout China to talk with students or give lectures to students about New Oriental's educational philosophy and offerings. This year, we traveled to over 30 cities. This dream tour, as we call it, is an important part of our marketing and contributed to the outstanding 31.5% increase year over year in language training and test preparation enrolments for the quarter. With demand for quality private education in China continuing to grow and an educational environment that is still highly fragmented, one of our key strategies is to rapidly extend our leading nationwide network. In fiscal year 2007, we opened 10 new schools, exceeding our target for the year. And in the fourth quarter, we opened one new school in the capital city of [Shanxi] Province. In fiscal year 2008, we will continue this strategy of expanding our footprint of schools and our learning centers to reach a growing number of students. Another key strategy is expansion through partnership. The initiatives like those with Nokia, Thomson Learning, and Dynamic Education International will allow us to further leverage our nationwide distribution channels, high student enrolments and online use to generate more revenue. We will continue to focus on building partnerships and the platforms that will enhance our offerings and revenues. While 2007 was a very positive year for us, we are looking forward to many more opportunities in 2008 and we have no doubt that we’ll be able to serve a growing number of Chinese students in the years to come. Thanks a lot. Now I will turn the call over to Louis Hsieh, our CFO, to take you through the financials. Thanks, Louis.

Louis Hsieh

Thank you, Michael and welcome to everybody on this call. As Michael mentioned earlier, we had a good quarter with healthy revenue and student enrolment growth. Today, I will walk you through the contributions to our fourth quarter results and some financial highlights. Please note that certain figures I will talk about are non-GAAP, including all measures that are given excluding share-based compensation. You can find a reconciliation of these figures in the financial tables at the end of your press release. Our fourth quarter total revenues were RMB 190.6 million, equivalent to $24.9 million, an increase of 29.1% from the year-ago period. Revenues from our educational programs and services comprising our language training and test preparation courses and primary/secondary education programs, rose 28.8% year over year to RMB 168.9 million, or $22.1 million equivalent, driven by an increased in new student enrolment in language training and test preparation courses and we saw increased revenue from books and other education materials and services, which rose 31.1% to RMB 21.7 million, equivalent to $2.8 million from the year-ago period. Overall operating expenses for the quarter were up 21.8% year over year. Of these, cost of revenues increased by 27% year over year, mainly due to the increased number of courses offered to a larger student base and a greater number of schools and learning centers in operation. Selling and marketing expenses increased 47.7% year over year, primarily due to brand promotion expenses such as this year’s dream tour to about 30 Chinese cities. General and administrative expenses increased 9.1% year over year to RMB 88.7 million, U.S. equivalent $11.6 million, primarily due to increased headcount as the company further expanded its business. Operating margins for the quarter were negative 14.1% compared to negative 20.9% in the year-ago period. Excluding share-based compensation expenses, operating margins for the quarter were negative 4.9% compared to a positive 4.3% a year ago. The operating margins in this quarter were negatively effected by the increase in marketing expenses and G&A expenses, as described earlier. Total share-based compensation expenses for this quarter, which were allocated to related operating costs and expenses, decreased to RMB 17.5 million, equivalent to U.S. 2.3 million, from RMB 37.3 million a year ago. Net loss for the quarter was RMB 11.9 million, equivalent to a loss of $1.6 million, a significant improvement from a net loss of RMB 34.3 million in the year-ago period. Income attributed to holders of common stock excluding share-based compensation expenses, non-GAAP increased to RMB 5.6 million, equivalent to $0.7 million. Basic and diluted loss per ADS was RMB 0.31, equivalent to $0.04, and RMB 0.31, equivalent to $0.04 respectively. Excluding share-based compensation expenses, non-GAAP basic and diluted earnings per ADS were RMB 0.15, equivalent to $0.02; and RMB 0.14, equivalent to $0.02. Moving to our balance sheet, our total cash and cash equivalents as of May 31, 2007, were RMB 1.6 billion, equivalent to $204.4 million, a decrease of 54.4% from the February 28, 2007 period. This decrease was primarily due to the temporary holding of proceeds from the follow-on offering in the third quarter, which was subsequently distributed to shareholders in the fourth quarter. That was approximately $267 million. Net operating cash flow for the quarter was RMB 217.4 million, equivalent to $28.4 million. Before I give guidance, I would like to take a brief look at the comparison between fiscal year 2007 and our fiscal year 2006. For the fiscal year ended May 31, 2007, student enrolment in language training and test preparation grew 22.4% to $1.07 million from 872,000 in the year-ago period. Net revenues were up 35.5% year over year to RMB 1.04 billion, equivalent to $136.4 million, up from RMB 770.3 million in the year-ago period. Net income was up 359.1% year over year to RMB 226.7 million, equivalent to $29.6 million, up from RMB 49.4 million in the year-ago period. And our operating margin rose from 8.3% in fiscal year 2006 to 19.9% in fiscal year 2007. We are very pleased with these results. I will now read you New Oriental's financial guidance for the first fiscal quarter 2008. Please note that the following outlook statements are based on our current expectations. These statements are forward-looking and actual results may differ materially. Total net revenue for the first fiscal quarter 2008 that runs from June 1, 2007 to August 31, 2007, are expected to be in the range of RMB 520.0 million, equivalent to $68.0 million, to RMB 550.0 million, equivalent to $71.9 million, representing a year-over-year growth in the range of 21.1% to 28.1%. Now, let me turn the call back to Michael for his closing remarks. Michael.

Michael Yu

Thank you, Louis. Once again, thank you for participating on our earnings call for the fourth fiscal quarter 2007. Now we will be happy to take your questions. If you have any questions, please just feel free to ask us. Thank you.

Operator

(Operator Instructions) Your first question comes from the line of James Mitchell with Goldman Sachs. Please proceed, sir.

James Mitchell

Good evening. A question on your general and administrative expenses. If I strip out the stock-based compensation then it looks like your underlying general and administrative expenses were up very sharply year on year in the quarter. Was there anything unusual in the quarter that boosted the G&A or are my numbers just wrong?

Louis Hsieh

Stock-based comp in G&A RMB 15 million in the quarter, so that’s $2 million. If I look at total G&A, James, it was actually down year over year from last year for the total number already but I don’t have last year’s G&A stock-based comp. But to give you an answer, G&A should be over last year because our headcount is over 1,300 higher this year than last year.

James Mitchell

Okay, and then --

Louis Hsieh

If I look at it now, on G&A headcount, the number is now 1,240 and last year at this time it was 1,057, so it is 200 people more and that is due to the opening of the learning centers and the 10 schools. And then also, I think the other difference is the stock-based compensation.

James Mitchell

Okay, and then if I look at your revenue guidance, you are guiding for sort of mid-20s revenue growth rate in the summer quarter. It looks like your deferred revenue is up around 35% and your student enrolments at the end of the quarter are up around 32%, so should I interpret the gap between the kind of operating metrics pointing at a 30%-something growth rate and your guidance at a 20%-something growth rate -- should I attribute that to ARPU shift or students enrolling earlier, or just to you guys being a touch conservative, as usual?

Louis Hsieh

Probably it’s the latter. If you look at the numbers now, our deferred revenue at the end of this May 31 was about RMB 330 million. Last year at this time it was RMB 244 million, so you correctly point out it is up about 35.5% year over year. And then on student enrolment, you are right. It’s up 31% but don’t forget the student enrolment part is in Q3 of ’07, we only saw an 8% increase because there’s a shift from Q2 into Q3, because of the timing of Chinese New Year as we reported a quarter ago. So if you blend the two, the revenues are still up over 40% and student enrolment is still up in the low 20s, which is very healthy growth. And then the difference will be attributable to ASP, but our guidance as you know from the last three quarters tends to be a bit conservative.

James Mitchell

Thank you very much.

Operator

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

Mark Marostica

Good morning or good evening, actually. Just to follow-up on the last question, could you walk us through again why in the fourth quarter revenue growth fell short of enrolment growth? Perhaps just talk about pricing in the quarter, if you would?

Louis Hsieh

As you recall from Q3, the February 28th quarter, we reported revenue growth of 51% and we noted at that point on the conference call that 51% was way high. It’s because the revenue, we had an extended time period in Q3 this year due to the lateness of Chinese New Year. So the student growth rate at that time was low. So Q3 basically took some revenue from Q4, so Q4 was expected to be light. If you combine the two quarters together, which is a more meaningful measure, the revenue growth is well over 40%, which is still quite strong. As far as pricing goes, Mark, our prices Q4 over Q4 last year were up over 10%, closer to 13%, so we still have very strong pricing power.

Mark Marostica

Okay, and then on the selling and marketing spend in the quarter, up close to 48%, how much of that would you consider to be more one-time’ish in nature, like the dream tour you talked about, and how should we think about growth in that metric going forward? Thanks.

Louis Hsieh

I think sales and marketing for the year ended up being about 12%, if I look at it correct -- yes, it’s about 12% for the year. I think you can anticipate it being between -- around 10% to 12% next year, so it should be relatively consistent. The dream tour will each year get -- is part of our business, it’s just this year we really hit -- we only hit 12 cities last year. This year we hit 30 cities, so it was a significant contributor to the expense side.

Mark Marostica

Great. I’ll jump -- go ahead.

Louis Hsieh

Mark, also Michael had mentioned at the last call that we would be ramping up sales and marketing in Q4 to ensure the summer. If you look at the results of that marketing tour, you’ll see the student enrolments are up 31% year over year, which is our strongest year-over-year growth ever.

Mark Marostica

Plus a strong growth in deferred revenues as opposed to --

Louis Hsieh

Exactly and that translates right into deferred revenue. Exactly right.

Mark Marostica

Thanks. I’ll hop back in the queue.

Operator

Your next question comes from the line of Paul Keung with CIBC World Markets.

Paul Keung

Good evening over there.

Louis Hsieh

Good morning, Paul.

Paul Keung

I can’t get my times right. Now, the question has to do with the sales and marketing program you just did, the advertising. I was curious just how effective that’s been and I know you guys keep decent track of where your customers are coming from, whether it’s first-time versus word of mouth, so I was wondering how different channels are doing for you in terms of customer acquisition.

Louis Hsieh

I think if you look at the results, you can see that the dream tour was a tremendous success. We had 314,000 student enrolments this last quarter, up from 230,000 a year ago, so clearly the dream tour has a significant impact on the enrolment growth, which really bodes very well for the summer. That’s why we took up the guidance versus what we normally would guide, in the 20%, 25% range. I think all our channels were, we’re assessing the impact of them but the overall result is quite strong. The dream tour is our central package but we also do online advertising, flyers -- we do the whole gamut of advertising. But the dream tour is the central focus.

Paul Keung

Do you think you’ll do something like that again this year because of the success of this quarter or is it just something you do once a year?

Louis Hsieh

It’s something we do once a year in Q4.

Michael Yu

Usually in the spring because spring is the time that students would like to listen to your lectures and they have free time to stay with you so that they can get a touch of New Oriental before they come to New Oriental.

Paul Keung

Okay, great and then on pricing, is this -- I’m just curious of how pricing has been by the different products.

Louis Hsieh

I can tell you in general -- I’m looking at my sheet here. ASPs on a blended basis were up 13% year over year; overseas test prep ASPs were up approximately 16%; and domestic test preps, they were up about 4% year over year. And then the rest, comprehensive English up about 14%. And then kids and middle school were about 3% up. So overall, the strongest pricing is still in overseas test prep but everything else is still high single digits, so the blended turns out to be about 12%, 13%.

Paul Keung

Thanks. I’ll get back in the queue.

Operator

Your next question comes from the line of Mark Chang with Merrill Lynch.

Mark Chang

Good evening. I look at your balance sheet and you’ve now got over RMB 1.5 billion on hand. Can you update us on the M&A front?

Louis Hsieh

I think on M&A, we don’t comment. We’re still looking at the three buckets that we’ve talked about in the past. We’re still looking at a few acquisition targets on the post-secondary college degree granting side. We’re also looking at buying some competitors in large cities, and we’re also looking at new areas for growth. I think Michael has touched upon it a little bit, that we would like to expand into other programs outside of just English language training, especially in the kids, in the pre-kindergarten area and also in the high school area.

Mark Chang

And how close are we on those areas?

Michael Yu

You mean close in M&A? Actually, we are very active in looking for the chance, opportunities to have acquisitions. First in language training, we are seeing different cities of China. Of course, some of our competitors also. Because this is our central business, I think if you can acquire some of our competitors it will be easier for us to expand even faster in this area. The second area we are looking for actually is kind of the same training style but a different subject. Chinese students, they use the extra time to study lots of other topics besides the English, like mathematics or physics or chemistry, so on and so forth. There are many, many schools -- actually, some of the schools are big schools, they are training students. These we call the traditional subject, where students take national interest examinations for university degrees. Actually, because the training style is the same and the system is also the same as New Oriental, so if we acquire some of these schools, it is easier for us to expand our business into student-related areas, especially high school student related areas. The third is that because the government said that pre-school education will mostly depend on our private education actually, so that means the government will not put on a limit on the tuition that private systems can charge and also it’s up to the private education companies to see what levels of pre-school education you want to do. Some of them are relatively mature pre-school education systems in China in big cities, so we are also actively looking to this kind of chance. My purpose of doing so is that we -- around our central business, English language training, we extend from six years old to two years old and up in the middle, around like 12 years old to 18 years old, and then up to the adult education and maybe looking to the career or professional education. But in my mind, it’s just kind of the same style of New Oriental because it is all we call the training, non-degree training or non-formal education training, actually, because this is easier and the government will have less regulations and the rules in all these areas, so that means it gives you more freedom to do all these things. So acquisitions actually is one of our strategies that look into the future to build up a strong business base for New Oriental and to venture into training-related businesses in China. Thank you.

Mark Chang

Thank you.

Operator

Your next question comes from the line of Alex Xu with Brean Murray.

Alex Xu

Good evening, Michael and Louis. Thanks for taking my call. I just want to go back to a previous question on the call regarding the G&A spend. If I exclude the option expense for this quarter as well as the year-ago quarter, the G&A expense for this quarter is about RMB 73 million, and a year ago it was RMB 45 million. As percentage of sales, a year ago it was 30% roughly and this quarter it is 38%. You mentioned the headcount increased about 200. That’s a 20% increase on headcount but that does fully explain why the G&A cost almost increased 70% on a year-over-year basis, excluding the options?

Louis Hsieh

It includes -- the 240 headcount includes 10 schools and another 20 learning centers in operation.

Alex Xu

Right.

Louis Hsieh

And also, there is some G&A costs associated with Sarbanes-Oxley that we haven’t completely quantified yet. Don’t forget this is the first quarter in the Q4 that we were comparing basically with year over year with Sarbanes-Oxley involved. Last year in Q4 we didn’t have to deal with it, so there’s accounting expenses and other expenses. As you know, when you become a public company, the accountants charge you more.

Alex Xu

Yes.

Louis Hsieh

So if you look at Sarbanes-Oxley and other auditing fees, it’s about $2 million.

Alex Xu

And then on a going forward basis, how should we look at the G&A line as a percentage of sales in terms of, on a full-year --

Louis Hsieh

The other thing, Alex, as you’ll recall, our business is that G&A also includes teachers’ salaries. So true G&A is actually less than half of that, of the G&A reported because the U.S. GAAP requires us to include teachers’ salaries, the fixed part, in G&A. So if you actually -- and don’t forget we added 600 new teachers this year, so it’s not just a 240 headcount in G&A but it’s also a portion of the 600 teachers.

Alex Xu

Okay, you mean the part-time teachers, basically?

Louis Hsieh

No, the full-time teachers.

Alex Xu

Okay.

Louis Hsieh

So we added 200, 300 full-time teachers as well. Part of their salaries get counted in G&A, so you are talking about headcount increase of about 500 people year over year.

Alex Xu

Okay, and then going forward, what is your expectation on the G&A side in terms of a percentage of sales?

Louis Hsieh

I think it will go down a little bit because I don’t see auditing and 404 costs. It will be relatively consistent going forward, whereas the revenue will continue to increase. I think headcount will -- this year we opened 10 schools. The projection for next year is only four to six schools, but we’ll open more learning centers so the headcount will still go up but usually the school is what takes up a lot of G&A headcount, the learning centers less so.

Alex Xu

Okay.

Louis Hsieh

So we should do a little bit better next year.

Alex Xu

Okay, and just a quick follow-up on the tax rate. Are you still looking at 7.5% normalized tax rate for the next few quarters?

Louis Hsieh

We had said that we will probably go up 1%, or 1.5% and right now we have some tax provisions and we’re dealing with FIN-48, so we will be FIN-48 compliant by August 31, which is the regulation dealing with uncertain tax liabilities.

Alex Xu

Okay, and that impact will --

Louis Hsieh

We don’t know the impact until the end of August.

Alex Xu

Okay, so right now --

Louis Hsieh

We’re dealing with our auditors on that issue now. So you can expect the tax rate won’t be lower than 7.5%, but I don’t know how much it will go up. Probably to 10 or to --

Alex Xu

Thank you.

Operator

Your next question comes from the line of Lin Shi with Lehman Brothers.

Lin Shi

Good evening, Michael and Louis. I have a question regarding the student enrolment growth. I just wonder whether you can break down that growth by -- well, maybe just --

Michael Yu

By program, we can do that.

Lin Shi

Yes, just to get a better understanding. And also, given it’s already July, maybe we will have a clearer picture about enrolments in your secondary and primary schools in --

Louis Hsieh

Can you repeat the last part of that question? You’re fading out.

Lin Shi

Given it’s already July, we should have an idea about the enrolment status of the Yangzhou and Taijin school. I just wonder how is the growth over there and whether you can still keep the target of breaking even this year.

Louis Hsieh

Taijin and Yangzhou, the enrolment actually come in in August. The school term begins in September so we won’t have that number until the end of Q1. But as far as the other programs, overseas test prep on a ballpark figure last year was about 35,000. This year is about 58,000 enrolment, so growth about 64% year over year. Domestic test prep grew 27% from 81,000 last year to 103,000 this year. Comprehensive English grew from 64,000 to 70,000, up 8% year over year. High school English for the quarter last year was 33,000, this year was 42,000. And kids went from 19,000 a year ago to 30,000 this year, up 51%. So those are the main categories.

Lin Shi

Which are your fastest growing cities, if possible?

Michael Yu

Shanghai is our fastest growing city. Shanghai still has great potential, actually. Also, we have some other cities, some new cities like [Changsha], [Tangshan] and other cities. So cities that we have opened two years.

Lin Shi

Okay, understood. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Adele Mao with Susquehanna.

Adele L. Mao

Hi. Just a quick question related to teacher headcount. Could you give us the number of teachers at the end of the quarter, part-time versus full-time? And if you are seeing pressure in terms of teach salary increase?

Louis Hsieh

Teacher salaries are increasing between about, what, 5% to 10%?

Michael Yu

Yes, 5% to 10%.

Louis Hsieh

And as far as your question on teacher breakdown, at the end of Q4 we had 2,373 total teachers, up from 2,291 at the end of Q3 and actually up from 1,744 at the end of last year. So the total increase actually is more than 600 teachers for the year. As far as our part-time and full-time teachers, full-time teachers now are at 1,056, up 74 for the quarter and part-time teachers are now 1,317 as of May 31, up [inaudible].

Adele L. Mao

Great. If I could, it looks like you guys have this new course offering, iEnglish, and it looks like its focus is on [RO-English]. Could you generally discuss your expectation for enrolment trends, ASP profile, et cetera?

Michael Yu

iEnglish is a branding that we co-operated with actually Thomson Learning. Most of the books actually were added by Thomson Learning for us, and our teachers, our experienced teachers adding new materials into these books. IEnglish is a program we are trying to push and promote this year and next year. But under iEnglish, we have a lot of sub i's. We have iReading, iWriting, iListening. So it’s kind of a comprehensive English. Over the past 10 years in New Oriental when we are talking about adult comprehensive English, we don’t have a name for it. This year, actually at the end of last year we created a name and come in to talk with Thomson about our cooperation of adding books, compiling books within this series. So this is the first time we try to establish a brand name, a program brand name for comprehensive English. So under this comparative iEnglish, we can emphasize pronunciation or we can emphasize reading, but together we call it iEnglish and we have registered in the Commercial Bureau of China.

Louis Hsieh

Don’t worry. We didn’t register iPhone yet.

Adele L. Mao

I see, and I assume these courses are small classes?

Michael Yu

Actually, we can design big classes but our target is to build a small class or medium size class so that we can attract some of what white collar people, those elite people who come into our system to study. And we are publishing very nice books. These books are very good and [inaudible] of the content or the page so that people think that it’s a real serious type of study. It’s a nice English, actually because all these books were added by Thomson Learning so the content is very good.

Adele L. Mao

I see. Great, thanks very much.

Operator

Your next question comes from the line of Trace Urdan with Signal Hill.

Trace Urdan

Good evening. My question is going back to the M&A discussion and I’m wondering of these different areas that you’ve identified that you are looking at seriously, how did growth and margin characteristics of those offerings, either the post-secondary or the high school, compare with your core business and whether you would be willing to consider dilution for the right type of strategic acquisition?

Louis Hsieh

The answer to the second question is yes, we would consider dilution for the right strategic business but the growth profile, it varies depending on the acquisition target, obviously, but the growth profile will be typically these companies are growing relatively quickly, at least 20% to 25%, and they are in varying degrees of profitability. So we have to -- until we get into deep due diligence, we can’t pull out all the hidden costs and expenses in these schools but in general, they are profitable.

Trace Urdan

I was going to say, those growth characteristics, how do those jive with the regulated nature of enrolment growth in those instances?

Louis Hsieh

They are, most of them, as Michael discussed, aren’t regulated so much. Pre-school is not regulated by the government very heavily. Same with supplemental education in Chinese language or in mathematics is not really regulated. It’s only the core -- because we are not offering any diplomas or degree.

Trace Urdan

But the high school and post-secondary are regulated, correct?

Louis Hsieh

Post-secondary is regulated. High school, we’re not going to acquire any high school. We’re only going to look at acquiring companies that do the high school test preparation for the [GAUCAU], or the equivalent of the U.S. SAT. [GAUCAU] is the Chinese SAT.

Trace Urdan

Very good. Thank you.

Operator

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

Brandon Dobell

Good evening. Maybe if you could talk about some of the pricing dynamics from a couple of different perspectives. One would be looking at the four big cities which still account for over half the business, what is pricing like in those areas? And then maybe splitting it between tier-1 and tier-2 cities, do you see any differences in pricing and if there are any out layers, either in test prep or instruction that stick out as very strong or having more pricing pressure than you thought they might, I’d be curious to hear about those as well.

Louis Hsieh

I don’t have that great a detail in front of me, Brandon, but I can tell you from generally the pricing is still strongest in overseas test prep and the four big cities -- across the country, actually, overseas test prep pricing is quite strong. The other businesses are all going to be in the high single digits. It doesn’t matter if it is a tier-2 city or a tier-1 city. The strongest pricing power continues to still be in Shanghai.

Michael Yu

The big four cities have a great power of pricing, more power of pricing than those other cities. For the second-tier cities, non-capital cities of each province, the pricing power is relatively weak.

Brandon Dobell

I think last quarter or two quarters ago, you guys talked a little bit about some smaller class sizes in some of the programs to get a higher price point. If you could go back and address that issue again, where are you in moving that --

Michael Yu

We are moving very smoothly in this area. Actually, you can see that from last year quarter four to this year quarter four, we have added almost I think 800 teachers. These teachers, half of the teachers go to smaller size classes. These small size classes, we charge students higher but are welcomed very nicely by the student and by their parents because they want their kids to have a nice environment. But still we are keeping our bigger sized classrooms growing, actually, especially this summer. There are so many students who come to New Oriental to study so that sometimes we have to put students in one classroom with 400 seats, or even 500 seats. But at the same time, we are keeping the small-sized classrooms growing very smoothly. By doing this actually we have a very strong pricing power but the students do not feel that we are raising their price because they can see that they are sitting in a nicer environment.

Louis Hsieh

Brandon, I’ve actually asked some of our finance team to do a more comprehensive analysis of this. I don’t have it yet. It will probably be done at the end of this quarter.

Brandon Dobell

Okay.

Louis Hsieh

But typically, the margins should now -- the margins in the big test prep classes will continue to be the best margins, gross margins as well as net margins. But the idea of the smaller classes should be that it’s almost margin neutral, so it won’t hurt our bottom line. It should be relatively close to what a larger class would have. So if a class has 60 then at 30, the price should be almost double.

Michael Yu

Yes, that’s right.

Louis Hsieh

So the idea is to make it margin neutral.

Brandon Dobell

Final quick question if I could; you talked about opening four to six schools next year. Any reason that’s not eight to 10 or 12 or 15 schools? It seems like you guys are doing such a good job.

Michael Yu

These four to six schools is that my target is the capital cities of the provinces. We haven’t gone into the Guanxi province, Guizhou province, or [Jiangsu] province. These capital cities, like Lanzhou, [Nanjing] or [inaudible] -- these are our targeted cities. Also, there’s some cities, big cities, like [inaudible] is a -- very, very advanced economics, and [inaudible] is also a big city. So we are targeting all these, around five cities. But to those smaller cities, I can see from last year’s experience and the year before last that we have to open new learning centers in all these schools -- big cities that New Oriental has already exist because with the car commonly used by Chinese people nowadays, every city has become a traffic jam. So the students, if we only have one or two learning centers in the big city, students have to travel every day for two hours back and forth, even four hours back and forth to study in a New Oriental learning center. So in this case, some of the students would rather choose a school nearby which is not a New Oriental school. So in order to meet the trends of the students to choose a school within 30 minutes of their travel distance to study, I think that next year we are going to concentrate more on opening new learning centers first in those existing cities rather than venturing into second-tier cities. By doing this, our revenue will be better and we can capture the main market and we will have a stronger competitiveness then going into second-tier cities. By second-tier cities, we are still looking for the chances of different opportunities to acquire some of the best local schools in these second-tier cities. It is easier and also for the second-tier cities, most it is English, so it is easier to manage. Thank you, Brandon.

Brandon Dobell

Thanks a lot.

Operator

Your next question comes from the line of [inaudible] with Jefferies.

Unidentified Analyst

Good morning. Can you give us some guidance on the various business segment gross profit based on your marketing and M&A strategies? Based on that, what would be the outlook on margin if you take a two-year growth, two-year horizon?

Louis Hsieh

That’s a good question. I think for the year just concluded, our gross margins were right around 59.5% and our net margins were and EBITDA margins were around 20%. I think it will relatively be consistent. It should trend up with some leverage a little bit on the margins depending on how fast we want to grow, so it should still be around 20% net margins and around 60% gross margins. As far as the business lines that we will continue to focus on, the drivers will continue over the next two years to be, in the current business will be kids English, middle-school English, and the overseas test prep, so it will continue to be the drivers because they have tremendous momentum and you can see already in the summer counts that they are continuing to grow.

Michael Yu

Especially kids English.

Louis Hsieh

Kids English will be a focus but then don’t forget, we made the analogy before -- we’re like a Wal-mart store, so once we set up these centers, it is easy for us to teach kids not just English but also Chinese and mathematics and other subjects that are going to be tested for their entrance exams. That will be the plan, is to begin to add more programs to the same targeted students. We should really grow that way as well.

Operator

Your next question comes from the line of Kevin [Tien] with [General] Capital.

Kevin Tien

Good morning. Just two quick questions; one is as you expand into the newer cities or the more rural cities, do you find yourself having to spend more or making more effort in terms of acquiring students? And two, if I am to look at your company three or five years out, how should I think about the total market size on your current penetration at this current point? I want to see how much more you can grow going forward just based on your existing platform in terms of the overseas test prep. And just finally, you talked about the schools expanding into other subjects. If you don’t find any good acquisition targets, when do you think you will be launching those types of programs?

Michael Yu

Rural area schools like second-tier schools, actually we find that it is more difficult for us to go into second-tier schools and find students immediately because in the second-tier schools, the main majority of our students are kids English students. Most of these kids English students, they study before they come to New Oriental to study. It’s quite local because the second-tier cities, they don’t have many universities. We don’t have a university which New Oriental’s brand is most famous for. Usually we spend a longer time and more effort in order to have kids to come to New Oriental to study in second-tier cities. As long as we get a student, they stick in our school for at least three to six years, from six years old to maybe 12 years old. I can find for the second-tier cities, we have some mature second-tier cities like [inaudible] and there is still the number of students is growing steadily but not rapidly. But it is very -- the school itself is running good because they spend less marketing fee when it becomes mature. What was the second question?

Kevin Tien

The second question is you talked about extending programs. Say for example, once you start teaching English and more looking at say, for example, your [GAUCAU] kind of area, as to if you don’t find good acquisition targets, when do you think you will be launching the other types of subjects?

Michael Yu

Actually, we have a group of people now doing the research and making the plans to, if we cannot acquire ideal targets, we are going to launch these programs this year. We have launched the program a preschool education research group and we also, we have been preparing teachers. We actually have -- we have -- doing the trying, like last year we don’t have any mathematics students and this year in the summer we have more than 4,000 mathematics students studying in New Oriental because the good thing that our students actually are the same group of students who were studying English, so we can use the same group of students to do the marketing and advertising and these students, after they finish English studies they stay in New Oriental to study mathematics. That means we do not have to do too much new job, new marketing efforts to attract students.

Kevin Tien

And just one final question; if I look at the size of the company today, if I am to think of the growth opportunity three, five years out, how much more can you grow in terms of your penetration rate currently in the market? Just say, for example, on the key current drivers, like the overseas test prep segment?

Louis Hsieh

I think overseas test prep, we’ve been growing extraordinarily fast this year. I don’t think that could continue because we are, we have the dominant position in the market already. In the kids and middle school, there’s huge growth opportunity. We just scratched the surface of that are because it’s highly fragmented and there’s 20 million Chinese kids at each age group, of which half are going to take the national entrance exam for college. So if you take those six years or three years of prep times 10, it’s 30 million. We just have 1 million total students this year. It’s a small penetration for now. On the overseas test prep, as I said, it’s already -- we have over 160,000 enrolments this year, up from only 115,000 or 120,000 last year. So we will grow with the market but in that area, we also have more pricing power as well. So those three will continue to be the growth drivers.

Operator

Your next question comes from the line of [inaudible] with [inaudible].

Unidentified Analyst

Hello, guys. Thanks for taking my questions. A quick question; what was your deferred revenue at the end of Q4?

Louis Hsieh

At the end of Q4, the deferred revenue was RMB 330 million approximately, up from RMB 244 million a year ago at the end of Q4 and up from RMB 135 million at the end of Q3.

Unidentified Analyst

Thanks, and could you just remind us why deferred revenue last quarter was negative year over year?

Louis Hsieh

It’s because the enrolment growth in last quarter was only 8% because of the timing of Chinese New Year. So again, what happened was when Chinese New Year was around February 17th or 18th this year, students didn’t go back to their schools until late February, early March, which means when they signed up for classes in New Oriental it was already in March, which is our Q4. Last year when Chinese New Year was at the early February, those students were picked up in Q3 counts, and therefore the revenue that they paid was deferred revenue for Q3. This year, that revenue was pushed into Q4.

Operator

Your last question comes from the line of Jeffrey [Shau], a private investor.

Jeffrey Shau

Hello. Good evening. I have one question about your pricing. Can you give me some update about how much have you already been increased your charge to the students in general, like one course and year over year, how much have you already increased your tuition fee for them?

Louis Hsieh

Overall it’s about 12%. Overseas test prep is a little bit higher.

Jeffrey Shau

So basically 12% year over year.

Louis Hsieh

Yes.

Jeffrey Shau

Another question is I noticed that your sales and marketing is up in the quarter. Can you tell me what is your focus, your focus on the big city to do these sales and marketing or the second-tier cities or lower country?

Michael Yu

Usually we will focus on the cities that we think has a great student potential there, like Shanghai and Beijing, we think it is material and the New Oriental brand is so great that we really don’t have to do further marketing. We only have to often tell students what programs we offer. But in those cities like [inaudible] and [inaudible] or [inaudible], these cities have going only for one-and-a-half or two years, so we think that is too -- and the parents still don’t understand New Oriental a lot, so that’s the cities we focus on. Also, we focus on the cities that we have strong or fierce competitors in, so that we can use our advertising or our dream tour to stop just to give speeches to a few students to attract the students and the parents so that they will register in New Oriental. So that’s mostly what we are doing. So actually in fourth quarter, we were doing marketing and advertising and the speeches in [inaudible], [inaudible], and [inaudible] and [inaudible], which is we think that these four cities have great potential to grow for the next two years.

Jeffrey Shau

I understand. My second question is about your expanding and you plan to open four new schools in the next year, right? And my question is if you focus on the kids English, kids math for your expansion and where do you get the teachers? Is that the high school teacher or the university students?

Michael Yu

Most of the teachers are trained by New Oriental, our system because those teachers from high school or middle school, or even from university, cannot suit the New Oriental qualification so mostly we train our teachers. We train them, including kids teachers. We train our teachers and locally, we find teachers, some in local place or we send teachers from other cities to that place to teach. So usually in a city our teachers have two kinds of teachers, which is we send them from other cities, like from Beijing or Shanghai, maybe in other part -- maybe 60% of the teachers are from local cities, actually. We train them for a month or half-a-month and then send them into the classroom to teach.

Operator

We are now approaching the end of this conference call. I will now turn the call over to New Oriental's Chief Executive Office Michael Yu for his closing remarks.

Michael Yu

Thanks again for joining us today and I am pretty grateful that all of you paid so nice attention to New Oriental. If you have any further questions, please do not hesitate to contact Louis especially, and then myself, or any of our investor relations representatives, like Sisi. We are more than happy to answer your questions. If you are coming to Beijing, just drop in the New Oriental headquarters for a visit and we can treat you to tea or coffee. Thank you.

Operator

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