Ladies and gentlemen, good evening, and thank you for standing by for New Oriental's First Fiscal Quarter 2016 Earnings Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to your host for today's conference, Ms. Sisi Zhao, New Oriental's Investor Relations Director. Ms. Zhao, please proceed.

Thank you. Hello, everyone, and welcome to New Oriental's First Fiscal Quarter 2016 Earnings Conference Call. Our financial results for the period were released earlier today and are available on the company's website as well as on newswire services. Today, you will hear from Michael Yu, New Oriental's Chief Chairman and Chief Executive Officer; and Stephen Yang, Chief Financial Officer. After their prepared remarks, Michael and Stephen will be available to answer your questions. Before we continue, please note that the discussion today will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. New Oriental does not undertake any obligations to update any forward-looking statements, except as required under applicable law. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on New Oriental's Investor Relations website at investor.neworiental.org. I will now turn the call over to Michael. Michael, please?

Thank you. Thank you. Hello, everybody, and thank you for joining us. I'm happy that I'm on this call today. I have decided that I will join the earnings conference call occasionally, providing me the opportunity to update our investors and the supporters of important strategic initiatives and answer any questions you all may have. As announced earlier today, the company has decided to promote Chenggang Zhou to the position of President, effective on January 5, 2016. At the same time, Louis Hsieh will step down as President, but he will remain on our Board of Directors and he will serve as a Nonexecutive Senior Adviser to our company. We would like to congratulate Chenggang on his new position as our President. He will focus on corporate strategy and oversee overall business development in China. He has been with New Oriental for more than 15 years has brought to us with this deep understanding of education service industry. Actually, Chenggang Zhou was one of my high school classmates, and I understand him a lot. He has been with New Oriental for more than 15 years, first served as the Head of Shanghai School. Actually, he's the Founder of Shanghai School, and then he served as the Head of Beijing School. And after that, he served as Standing VP for all New Oriental Groups, and then he served as the CEO of [indiscernible] overseas study. He's a really smart guy and has been helping me for all these 15 years for New Oriental's operations. So we are confident that he will make a great contribution to our continuous success in the market. In the meantime, I would like to thank Louis for all he has accomplished and the leadership he has provided during this important period of our business development in…

Thank you, Michael. Now let me walk you through the key financial details for the first quarter. Operating cost and expenses for the quarter were $328.6 million, a 15.9% increase year-over-year. Non-GAAP operating cost and expenses for the quarter, which excludes share-based compensation expenses, were $324.9 million, a 15.7% increase year-over-year. Cost of revenues increased by 15.6% year-over-year to $171.7 million, primarily due to increase in teachers' compensation for more teaching hours. Selling and marketing expenses slightly decreased 0.3% year-over-year to $49.4 million. General administrative expenses for the quarter increased by 25.9% year-over-year to $107.6 million. Non-GAAP general administrative expenses, which excludes share-based compensation expenses, were $103.9 million, a 25.6% increase year-over-year, primarily due to increase in R&D expenses and human resources expenses related to the development of our overall integration. Total share-based compensation expenses, which were allocated to related operating cost and expenses, increased by 35.6% to $3.7 million in the first quarter. Income from operations for the quarter increased by 17.5% to $129.8 million. Non-GAAP operating income increased 17.9% to $133.6 million for the quarter. Operating margin for the quarter was 28.3% compared to 28.1% in the same period of prior fiscal year. Non-GAAP operating margin, which excludes share-based compensation expenses for the quarter, was 29.1% compared to 28.8% in the same period of prior fiscal year. Net income attributable to New Oriental for the quarter was $128.5 million, representing a 14.4% increase from the same period of prior fiscal year. Capital expenditures for the quarter was $17.8 million, which were primarily attributable to the opening of 34 new learning centers and renovations of existing learning centers. Turning to the balance sheet. Deferred revenue balance, which is cash collected from the registered students for the courses and recognized proportionally as revenue after instructions and delivered -- are delivered…

[Operator Instructions] We have the first question from the line of Dick Wei from Crédit Suisse.

This is Jialong Shi, calling on behalf of Dick Wei. Could you share some color on the margin of each segment courses like overseas test prep, U-Can and POP Kids? I just wonder with revenue contribution from K-12 keep rising, is there any impact on the margin trend?

Okay, I'll take the question. I'm Stephen. For the different margin for different business lines, for the overseas test prep, the margin, the operating margin for overseas test prep is about 30%. And for the U-Can business, the operating margin for this business line is about 25%, and for POP Kids now, the margin's only 10%, but it's growth, up very fast because we are seeing the more students filling in the classroom. And yes, along with the K-12 business account for more and more a percentage of the revenue, now it's 45%, and it's like the 50% or more in the year after and -- but -- well, we don't see the -- like the margin dilution by these things because we are seeing more and more students filling in the classroom. That means it will help us to the -- to improve the utilization rates up. So I think the margin will go up, especially since the 2017 -- fiscal year 2017 because last year and this year, we are in the heavy investments, and we will spend $50 million in this year. And so I think next year, the margin will go up, and I think next 3 or 4 years, the 17% or 18% is our target for the operating margin. That's my question.

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

It's very great to have Michael in the earnings calls going forward, and congratulations on outstanding results. So I have 2 quick questions. The first one is regarding the overall industry landscape. Do you think in the pre-K and the K-12 market, we can see the market leader with considerable market share, i.e., above 20%, emerge in the medium or longer term just like what New Oriental has been able to achieve in the overseas test preparation area? And also, the second one is about the online education. So would you like to share with us more color about your U-Can Visible Progress Teaching System? What kind -- from what kind of perspectives you will see online will add value to your off-line facilities?

Yes. Sure. Looking forward for the next 5 years, I'm pretty sure that our K-12 business for Chinese students will be our -- one of our main business. Of course, our overseas current test preparation and the consolidated business will also be our main businesses, but I can see that K-12 business will be growing faster because this is a big market, a much bigger market than overseas consulting, overseas test preparation and consolidated business, and also, New Oriental is new in this market, actually. We have just going into this market for like about mainly for 3 years. So I can see that for the next 3 to 5 years, we can keep our growth in K-12 about 25% or even maybe if we are doing much better, maybe up to 30%. I'm pretty much confident on this actually. So this is a very good business. And also what a high value this business is that because these kids are growing up from like about from 4 years up to 18 years old. So I'm pretty sure that New Oriental have this strength on educating students and their families about how to build up healthy personalities and the characters for all these kids. That is if you're from China, you pretty much know that this is my strength also. And then secondly is the Online business and after longtime consideration, and of course, the independent [indiscernible], I'm pretty sure that even that there are -- there will be pure online business in China and New Oriental also is entering into all kinds of possibilities in this area, but I'm pretty sure by studying online businesses and off-line businesses all over China, and of course, all over the world actually, including studying the MOOCs system and other systems. I'm pretty…

We have the next question from the line of Anne Shih from Brean Capital.

So just, I guess, following up on what Michael just mentioned, it sounds like the online business, of course, is a key part of the company's growth strategy. Besides Koolearn, and I understand this is still early, could you share the total revenue from these 3 online kind of businesses? And as this reaches a more meaningful contribution level, I was just wondering where perhaps the margins are falling out and would normalize longer term?

Okay. Yes, this is Stephen. I will take your questions. And Koolearn, the GAAP revenue grows very fast than any other off-line business. The GAAP revenue of Q1 grows by more than 30% year-over-year. And the margin is now only like -- is just at the breakeven, because we -- as I told you, it's -- we call this investment year, and so the strategy we're using for pure online platform is to go after the market share first. That's why you saw our -- you are seeing the -- our paid users get 150% year-over-year growth. And -- but I think the margin of the pure online business in next 3 to 5 years, it should be higher than the off-line business, because there's like some -- they can like the -- that they will have like some rental expenses because they have a lot of money on that. And also -- but anyway, the GAAP revenue of the Koolearn only contributed 3% of the total revenues. It's only a small part of the total business, but it's growing very fast. Yes, does that answer your question?

Yes. Let me add some of my ideas about pure online education. Koolearn.com is only contributing 3% of our New Oriental total businesses. I'm pretty sure that it will take some time -- I don't know how many years it will take for the online business like Koolearn and Koo.cn to have a significant contribution to New Oriental's total business. So really is that I think that people in China and all over the world, it takes peak time also for people to recognize that online teaching methods or online learning content sometimes will be much more efficient and effective than off-line business. So for the next several years, I'm pretty sure that the Koolearn.com and the Koo.cn will be the fast or fastest-growing business part in New Oriental. I'm pretty sure that they will grow about more than 30% every quarter or every year. But still, even though it grows more than 30% every quarter, it will take a long time to become a significant part contribution of New Oriental. Because as a whole, New Oriental business is also growing around like 15% to 20% every year, but we still have to pick gradations of this because maybe it will represent the future of education, not only in China but maybe all over the world. And of course, I'm paying greater attention to the offline and the online combination. We are still also using Koolearn.com to use as pure online business, but also we are telling students that sometimes if you really want to study offline, we are also ready for you here. So I'm pretty sure we are building up a chain of education business, our ecosystem here in New Oriental. So give us enough time. I'm pretty sure, you will see that we will have very good experience in the results in pure online business and off-line and the online business combined together. Thank you.

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

And good to have Michael on the call. So I've got a couple of questions. Yes, one is related to your loyalty program, and since the time you started, it has been for a while, and I wonder how do you actually measure the results of the loyalty program in terms of [indiscernible]? And if you compare last quarter with a year ago, and which is actually -- it's really why has this loyalty program impact? One didn't have the impact of this loyalty program. So how do you see the difference in the [indiscernible]? That's number one question. Number two is, you have a lot of cash. Certainly, I do know you haven't said cash -- the share repurchase program, but to better use the cash, there are lots of things for New Oriental you continue to buy. And so from past experience, your acquisition experience, you have some companies you acquired and then you also divesting some -- divested some company. So in education area -- in your area, what are the keys for a successful acquisition? What are the keys for not a successful acquisition? For you, what's your goal? Or what do you want to do with your cash in terms of acquisition going forward? That is the question.

Okay. Thanks, Tian. I'll take the first question about the loyalty program, and Michael will answer the second one. And for the loyalty program, we launched the customer loyalty program since last October, and that was done to kick off only since this April. So the negative impact of this quarter is very minimal and since next quarter, I think the impact will be positive. Last Q2, we had $4 million, that means the 2% of the total revenue net of impact for both bottom line and top line. But this Q2, I think the net impact will be only 1% of the total revenue. So we have a very easy comparison. So I think it's good for the -- both the top line and margins. So -- and I think this situation will be continuous in the rest of the year. So that's my question for your question about the loyalty program. And I think, Michael will answer the second question.

Yes. Thank you, Tian. First, let me express that I -- my love of cash. I really love cash in the company, no matter in good time or in bad time, cash is always the best thing for the company to go forward. As for the cash, we have especially those cash that has already been the net income for New Oriental and that we would like to actually in due time to have buy back shares program and also to have the dividend program to give more money back to our shareholders. Of course, on the basis that we don't have any more money to invest into new areas and also don't have any new acquisitions, that's what you mentioned, I would like to use money except besides to give money back to our shareholders as in dividends to use money to do the investments and to do the acquisitions for a better future of the company and for long-term development of the company. As for your question, what is the key factors for a good acquisition and for a bad acquisition? Let me tell you that as we are in education for more than 20 years, and since New Oriental has been at IPO for more -- almost 13 years, in education, it is really difficult, let me tell you, to get a very good acquisition. The reason for that is that education is a very low threshold business, and anybody can rush into this business, and also it's a very fragmented business. That means that not everybody can do a good business in education areas. You can see like about a little more than 5 to 6 years ago, there are many people carrying cash to invest into education areas in opening learning centers. There are about…

We have the next question from the line of Cynthia Meng from Jefferies.

I have 2 questions. Is the higher gross margin is a result of higher pricing for the K-12 business, if management can give some more color on that, that will be great. Also wondering whether you could share with us how we can see the margin trajectory for this year? And maybe talk about because of the add-on businesses the new growth areas, how are you seeing margin trajectory going forward beyond this year?

Okay. I'll take this. I will answer the question first for your margin question. We're happy to see the margin improvement by 20 bps in this quarter. I think it's mainly due to the -- we got much more revenue than we expected at the end of the -- at the first of the quarter. And I don't want to give the detail expected like the guidance for this year margin, but I can say that we are seeing the business's resilience during the economic downturns, and the revenue growth is -- the trend is very good. So I think, the bottom line trend will be also very good, and we are quite confident about the -- like long-term margin expansion. Last year and this year are the peaks for the investments. We'll keep spending like $50 million for the investment -- online investment. So I think in next fiscal year, what I mean is fiscal year '17, I think our margin will definitely go up, 17% -- to get a 17%, 18% in next 3 to 4 years. And what's your first question?

Let me answer the question.

Okay.

Yes. For the margin projection, I'm pretty sure that the margin will go up, like Stephen said, but not really in new growth areas. New growth areas, it's in kind of a cultivation area. I'm pretty sure that we have to spend more money on these new areas that in the next few years will grow and will give us more margin. But I'm pretty sure that the margin growth will be from actually, let me see, from like POP Kids, U-Can and overseas test prep for all the areas. Because what we are doing is the strategy that to add more students in each classroom, to raise the teaching quality, so that the teachers can attract more students to their classrooms. This will raise our margin, I'm pretty sure for the next year or next several years. But we will pay great attention to the new growth area, no problem. For the high pricing, let me express my personal view, I myself am very strongly against the high-pricing policy in any education areas, not only in New Oriental but in other areas. So for this year, you can see the number of students that's rising in New Oriental is much faster than it was before. The reason is that I'm emphasizing the teaching quality and every teacher brings more skills into the classroom rather than raising each student's price for each class. I'm very against for -- I'm very against about those rising price strategies, the high-priced projects or programs. So I'm pretty sure that this first quarter had a good result, it's not because our high pricing. It's because we have the right strategies to emphasize our teachers' qualities and the teaching qualities and give teachers more salaries and the bonus for their good teaching. So this is what we will be insisting on for the next -- even maybe forever, I don't know. But I'm pretty sure, this will be -- of course, we will reasonably raising our prices for each student, but this is not our main strategy. The main strategy is to ask the teachers to give more -- the much better quality of teaching, so that we will attract more students and parents. Thank you, Meng.

[Operator Instructions] We have the next question from the line of Leon Chik from JPMorgan Hong Kong.

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

Yes. Let me tell you, actually English is always required, always needed by Chinese people and Chinese parents. But for New Oriental, we -- like about a year ago, we had a department project called English Learning Programs. But we see that actually those students who are in POP Kids English and U-Can middle school, high school program and also overseas or domestic, these students have divided themselves into different departments of New Oriental. That is for those students from 4 years old up to 12, they were studying POP Kids English. And at 12 to 18, they were studying U-Can. And above 18, they were studying domestic in universities. So that's why we break up our English programs, as those students will go to different age groups to study English. That doesn't mean that English is not needed for Chinese people. So we can see actually a raise of students numbers study English in New Oriental, but we -- nowadays, we don't have a pure English-studying department or pure English-studying project in Oriental, because those kids have been divided into all different groups. This is actually good for New Oriental because while they study English in the same age group, they also can choose to study maybe Chinese or mathematics or physics or chemistry. So that's why you can see a good raise in numbers of students in New Oriental in K-12 system. So I think this a good strategy. As for Chinese people, those adults who wants to learn English, we have now built up some pure online English-studying gadgets and apps for these people, like Le Ci [ph] -- which -- who helps students to study vocabulary. Like vocabulary actually is my strength when I was in university and when I was teaching in New Oriental. But nowadays, we do not ask the students to pay money to study in New Oriental for remembering vocabularies, because this app can help a student to remove all these work also. So after they remove all of those work, we invite students come to New Oriental to listen to other studies, maybe grammar or maybe to pass an examination or like test preparation. So this is more effective students. On the one hand, the students feel that they have been saving money. And on the other hand, they feel it's more effective because they can study vocabulary, for example, later maybe oral English or writing any time they want. So English has never been uncertainty in China. Chinese people have never been more eager to study English than ever before, because they know that their kids need English language proficiency in order to survive better in this world. Thank you, Leon.

We have the next question from the line of Julia Pan [ph] from Macquarie.

I think Michael just answered my question for the dividend.

Thank you, Julia [ph].

I noticed that there's $62.6 million dividend payables in balance sheet. Does that means we're going to pay the special dividend on fourth quarter of fiscal 2016? And another question, could you please give us some color on the overseas prep segment, the enrollment growth and the revenue growth, please?

Yes, we pay the dividends in October. So I think you will see the numbers in the financial statement next quarter. And for the overseas test prep in Q1, the GAAP revenue is up, increased by 9%. Don't forget in the last quarter in the Q4, the GAAP revenue for overseas test prep was only 3%. So I think the business is recovering. And also, we are doing the same thing as the U-Can -- and what we have done for the U-Can and the POP Kids, we're rolling out the new O2O initiatives -- new products for the overseas test prep. And for the student enrollment, overseas test prep was down by 6%. But yes, I think the whole margin doesn't grow very fast. So in the long term, I think the number, the student enrollment growth for the overseas test prep will be flat or a little bit decreased. And so most the increase will come from the ASP increase for the overseas test prep.

Julia, let me add some points. I myself am very interested in overseas test preparation. As you know, I'm from that area, New Oriental study from that area. We can see that there is a slowing down of the number of students who wants to go abroad to study, because the number always had reached the top because not every family can afford for their kids to study overseas. But I'm still feel regretting that New Oriental is not growing as fast as possible. Of course, one of the reasons is number of students is not growing all over China for overseas, but another reason is that for those past 2 or 3 years, we have paid a greater attention to K-12 education. So we have put our -- some of our resources in K-12, but from this year my personal attention and New Oriental's also, some of the resources will come back to overseas test preparation. Because in my mind, this is a great area to help Chinese people to have a bright future. So for the next -- the rest of the year and for the next several years, you can see that we will also build up some great systems for students who are studying overseas. And also, I personally will put my -- more of my attention in this area and maybe will do more lectures and also some encouragement for students to study in this area. So I'm pretty sure that the growth will not only come from the price increase, even though we also have space in this area to raise price, but I'm also pretty sure that by our efforts, more students will choose New Oriental to study for their test preparations and also choose New Oriental for their consulting overseas studies in universities. So I'm expecting not only 10% increase in this area, I'm expecting for the next several years maybe more than 10%. I don't know how much, but 10% or 15% is my expectation or even better than that. That's not my promise, but that's what I want to say that's my efforts in this area, because this is where we start out. It's kind of like if you are familiar with Chinese history, it's kind of like [indiscernible] in Chinese history for Communist Party. We cannot lose that.

We have the next question from the line of Jin Yoon from Mizuho.

Just to follow up on your previous remarks. I apologize in advance if I misunderstood, but you said that operating margins may be going up to 17%, 18% in the next few years. But you also followed that up and said that you don't believe that ASP increases meaningfully over that time. So can you just kind of help me reconcile how you get up to 17%, 18%, if ASPs are not necessarily increasing meaningfully and without a very significant reacceleration in revenue growth. So do you expect a majority of that growth to come from off-line -- online scalability as well as or new student growth? Trying to kind of ballpark the -- how we kind of reconcile to 17%, 18% margins without meaningful ASP growth?

Okay. I think the key driver for the future margin expansion is the more -- I think that's more utilization rate we'll get, because we received like more and more students filling in the learning centers, yes. And look at this quarter, I think the most of the 13% student enrollment growth come from the organic growth. We didn't open any new learning centers this quarter. And also, as Michael said, and during the -- like the whole China economy downturns, I think the wage inflation will benefit us. I don't think it will give the -- as higher as the -- as same as the latest inflation for the staff as before. So -- and also, we still have likely some rental leverage for the margin expansion. We sign the 5 or 10 years leasing contracts typically for the learning centers. So the rental will be only up by 5% to 6% year-over-year. So we also have this kind of leverage.

Yes, let me add. For the revenue growth in New Oriental, I'm pretty sure that our studies to attract more new students into New Oriental. So the revenue growth mostly will be the number of students, more and more students will enter into New Oriental to study, and also the utilization of our existing facilities. And also for the margin growth, I'm pretty sure we are optimized all kinds of management procedures, especially with the help of the information system, I'm pretty sure that more money will go to our teachers, so to push our teachers, to encourage teachers to teach more quality lessons. And by the same time, actually we are going to reduce the supporting staff members because the system is going up, so that we can help more people for one person to do more job. So I'm pretty -- that's why I'm sure that for the next several quarters and also for the next several years that the revenue will grow very healthily, because we are expecting a number of students to come to New Oriental, and the margin growth will also be fine because I'm expecting like at least 1% of increase every annual year for the net revenue -- net income. The reason is that we are more effective and efficiently doing our job every day. That's also my attention. Thank you, Jin Yoon.

We have the next question from the line of Dick Wei from Crédit Suisse.

I have a question regarding Khan Academy. I guess kind of the free education is gaining more popularly in the U.S., particularly for the past year or so. When do -- how should we think about the threat or the opportunities that it poses to New Oriental in terms of the free education system is kind of like getting popular in China? I wonder if Michael has anything...

Let me answer this question for you, because my son, who is just studying Khan Academy every day. But my son is from the United States -- from Canada. So his English is very good. So he has no difficulty listening to Khan Academy. So Khan Academy by translating into Chinese, it needs to take some time. But if it's translating to Chinese, it's...

The Chinese economy.

Khan Academy. Chinese economy? Is it China economy or Khan Academy?

I mean Khan Academy, like the free education, like the Khan...

My answer is right, right?

Yes, that's correct.

Let me tell you, I'm actually I did some research about American, North American students and about Chinese students. Chinese students are very, very much -- they don't like to study. So most of Chinese students, about 90% of Chinese students, are forced by their parents to study. So it's rather study conscientiously online, they don't have this patience and that they cannot pay greater attention to this. We have tried a lot, like the best New Oriental teachers tried to put their classes -- courses online for students to study even for free. By doing this, we can see that there are much, much less of students registered for studying than we expected. So actually then, we can find that for Chinese parents and for Chinese students, the best way for them to study for a best result is to send these kids with a face-to-face teachers, no matter at home or in the learning center. We can see also by our research that Chinese parents would much -- very much like to send their kids to a learning center nearby with some -- if, of course, if New Oriental is nearby, it's their best choice, I'm pretty sure. But they will also choose some other learning centers by some schools, because it's nearby for their convenience. But the reason is that the teachers can supervise the students to study much more effectively, and also the teachers can teach these students to study face-to-face. So that's why I try my best to persuade New Oriental people to insist on face-to-face teaching children, which proves up until today is a good strategy for us. So I'm pretty sure Khan Academy, the form of the academy, it's not Khan Academy maybe itself, will have very, very much less impact on Chinese…

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

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

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