Good evening and thank you for standing by for the New Oriental’s FY 2020 Second Quarter and Interim Results 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.

Thank you. Hello, everyone, and welcome to New Oriental's second fiscal quarter 2020 earnings conference call. Our financial results for the period were released earlier today and are available on Company's website as well as on newswire services. Today, you will hear from Stephen Yang, Chief Financial Officer. After his prepared remarks, 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 view we express 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, the 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 Mr. Yang. Stephen, please go ahead.

Thank you, Sisi. Hello, everyone and thank you for joining us on the call. We are very pleased to report a set of solid financial results in the second fiscal quarter of this year, delivering both accelerated topline growth and continued operating margin expansion. Total net revenue growth was $785.2 million, representing a growth of 31.5% or 34.8% if measured in RMB, exceeding the high end of our expected range. Net revenues from educational programs and services for the second quarter were $723.3 million, representing a 33.0% increase year-over-year. The growth was mainly driven by increase in student enrollments in K-12 after-school tutoring courses, which continued its strong momentum and achieved a year-over-year revenue growth of approximately 46% in dollar terms or 49% if computed in RMB. We continued to be guided by our Optimize the Market strategy in this quarter and carried out our capacity expansion in cities where we see potential for rapid growth and strong profitability. During this quarter, we added a net of 41 learning centers in existing cities, opened a new training school in the city of Huizhou, and a dual-teacher model school in the city of Chengde. By the end of this quarter, the total square meters of classroom area increased by approximately 25% year-over-year, and 6% quarter-over-quarter. Total student enrollments in academic subjects tutoring and test preparation courses in the second fiscal quarter of 2020 increased by 63.3% year-over-year to approximately 3,789,200. Please note that the higher-than-normal increase in student enrollments is primarily due to the division of the autumn semester into two parts, meaning that the student enrollments are reported separately and fall into separate quarters. At the same time, we continued our efforts in upgrading our online-merger-offline standardized classroom teaching system, while the interactive courseware in the POP Kids program was…

The question-and-answer session of this conference call will start in a moment. In order to be fair to all callers who wish to ask questions, we will take one question at a time from each caller. If you have more than one question, we please request to join the question queue again after your first question has been addressed. [Operator instructions] Your first question comes from the line of Mark Li from Citi. Please ask your question.

Hi, management. Congratulations on the very strong margin performance for this quarter. We think it’s beaten guidance by -- pretty nicely. May I know what are the reasons, major reasons for the non-GAAP OP margin beat for this quarter? Also, I would like to know maybe our revenue guidance breakdown across different segments? Thank you.

Okay, Mark. Yes. We’ve beaten the margin guidance a lot. Our non-GAAP operating margin rose by 720 basis points in this quarter. I think it's because of the following reasons. Number one is, I think the continued margin expansion is mainly driven by the better utilization of the facilities. Typically, our-top line growth is over 30% year-over-year in RMB terms, but the expansion in last trailing 12 months is just 25%. And also number two is, we’ve built a standardized and modularized and systemized operating process. So, you see the results. We achieved outstanding improvements in the operational efficiencies, and we get a lot of leverage on the selling, marketing, and G&A expenses. And finally, we're seeing the revenue acceleration. Typically, we're taking market share from the small player in the market. So, the revenues are very good. And I think those three reasons get us the better results of the margin expansion. As I mentioned in the prepared remarks, in the rest of the year, even in the Q3 and Q2 in fiscal year running, I think we’ve still got more leverage going forward. So, we believe, we will have the margin expansion in the rest of this fiscal year, and even for fiscal year 2021 I think our margin will get the expansion as this year, okay? And the revenue breakdown, yes, in the Q3 revenue guidance, I think the K-12, business will grow by 40% in RMB terms. What I’m saying is in RMB terms year-over-year growth 40%, and overseas test prep I think to the low-single-digit growth. And the domestic test prep, it will be down by let’s say 3% to 4%. And the overseas consulting business, the growth will be over 20%. So, this is the breakdown of the Q3 guidance.

Your next question comes from the line of Yuzhong Gao. Please ask your question.

Hey, Stephen, Sisi. Congrats on the very strong results. So, we noticed that you seem to have revised up your capacity expansion target from 20% to 25%. So, how should we think about the margin expand -- scale in the second half of '20 -- fiscal year '20?

Okay. Yes. We -- this quarter, the quarter-over-quarter expansion was 6% combined with 3% in Q1. So, we got 9% in the first half of this fiscal year. And typically, in terms of the seasonality, we opened more learning centers in the second half of the year. So, it's more backloaded. And so, I think we believe the whole year expansion plan will be somewhere around 20% to 25%. Actually, it's close to 25%. But, the topline growth will be somewhere around 30%. I think it’s impossible to over -- to get over 30% topline growth in RMB terms. So, in the rest of the year, as I said, I think we do have more leverage on the GP level and the SG&A level. But typically we don’t give the detailed guidance of the margin expansion in the next quarter. But I believe we can get the margin expansion in the rest of the year and the year after.

Your next question comes from the line of Tian Hou of T.H. Capital. Please ask your question.

The question is related to your regional expansion. So now we have 1,300 -- more than 1,300 learning centers. So, for the newly -- for the new learning centers you're planning to open, where are those centers going to be, in what kind of a region? And to support the additional expansion, 20% to 25% and how do you prepare your teachers’ force, the team of teachers? So, that's the question related to expansion.

Yes. Tian Hou, we have 1,300 learning centers in total, and we plan to open let’s say the 20% to 25% new capacity in one year. And so, most of the new learning centers we set out going forward will be happening in the existing cities. Internally, we only allow the good performing schools to open more learning centers in those cities. And -- but, we have another business model called Dongfang Youbiao. So, it belongs to Koolearn and . And we will open more of the new business in low-tier cities. There’s two ways. For traditional offline business, we’ll open more cities -- schools or learning centers in existing cities. And as for teachers’ resource, we believe we pay the best in the market to our teachers. And also, since our last year, we built up the online teachers’ training system. So, that means we have more ability to generate or produce more qualified teachers than before. So, we believe we have the more qualified teachers to support the new opening of the new learning centers going forward.

Your next question comes from the line of Alex Liu of China Renaissance. Please ask your question.

I just wanted to follow up first on Tian's question. Could you share more color on, for example, how fast is the capacity growth in top cities, for example Beijing right now? And a follow-up question, I think the overseas test business is growing, if I remember correctly, it’s low-single-digit growth this quarter. And may I know what's the reason behind this seemingly a little bit unexciting growth in the past few quarters? Thank you.

Yes. Actually -- thanks Alex. Actually, we opened the learning centers almost everywhere. Basically, that city got the better results in last trailing 12 months. So, we opened the learning centers in the top tier, tier 1 or tier 2 cities and we opened -- we also opened the learning centers in like, tier 3, tier 4 cities. So, the only one indicator for us to decide whether or not open the learning centers is the performance of that school last year. But, I think even for the big cities, like Beijing and Shanghai and Wuhan and Guangzhou, I think there is a lot of room to open more offline learning centers. So, yes. And the overseas test prep, yes, this quarter, the numbers is no good, only the 5% in RMB terms year-over-year growth for overseas test prep business. I think, the main reason is because the United States, China, the two countries’ relationship change. So, I think non-United States based business [indiscernible], where other subjects [indiscernible] but the United States related businesses kept flattish this quarter. And in the Q3, I think the growth will be flattish again. So, I think, this is the main reason.

Okay. Sorry, one more follow-up. On the gross margin, there seems to be notable jump this quarter. May I know, what's the driver behind this, this notable improvement on the gross margin? Thank you.

Firstly, the revenue growth beat our guidance. As I said, we’re taking market share from the small players and also there are lot of schools provide very good numbers of this quarter on top-line growth. And certainly, if you compare the top-line growth with the expansion, capacity expansion, you know we have the better leverage on the rental side. And yes, I think those are the two key reasons to explain the GP margin expansion. Okay.

Okay. Thank you.

Okay. Thank you, Alex.

Your next question comes from the line of Lucy Yu of Bank of America. Please ask your question.

Hi, Stephen. I’ve got one question on the cross-scheduling. So, actually this year, Chinese New Year is earlier than last year. So, is it fair to say that we started our spring semester a little bit earlier than last year? So, theoretically, in February, we are seeing more positive benefit from this kind of calendar shift, is that true? If so, can you give us a quantified impact on the cross-scheduling? Thank you.

I think, yes. This year, the Chinese New Year is a little bit earlier. But, I think the impact from the cross schedules, the impact is very small, very minimal. But, I must mention that typically -- last year the Q2, we started to do some like facility movement and cross scheduling change in last year Q2, so, which led to a postponement of some K-12 classes from Q2 to Q3 last year. So that means, last year -- this year, we have easier comparison in Q2 but a little bit harder comparison in Q3. But anyway, it's a seasonal or just tiny difference, issue is not a big.

Okay. Thank you. And the second question is that in the first half, you have already expanded your non-GAAP operating margin by close to 5 percentage points. This is higher than your previous expectation of a 1.5% to like 2% for the full year. So, is it fair to say, the risk is on the upside to your full year guidance in terms of margin? Thank you.

Yes. I think -- I don't want guide the second half the year margin, the guidance. But, we do believe -- we will have the margin expansion in the Q3 and Q4. We'll see. I think for the whole year, the margin will be better than we expected several months ago.

[Operator Instructions] Your next question comes from the line of John Choi from Daiwa. Please ask your question.

Hey, Steve and Sisi. Thanks for taking my question. I have a question on your online. I know, Koolearn basically on the call said, they’ll step up more opening up in the lower tier cities. Can you kind of give a sense, will the EDU and Koolearn in general will kind of step up investment in online. And as a result, we'll see more on the backend loaded for the fiscal year in terms of marketing expenses and user acquisition costs? And just quickly after the regulation, which has been in place for more than about a year on the offline schools, are you seeing more visibility or better visibility compared -- given that the smaller players are being phased out, and as a result, you're seeing higher retention rate and better capacity growth in selected regions? Thank you.

Yes. So, the Koolearn, investment on Koolearn, yes, this year, we started to invest on the Koolearn.com, it includes the content development for teachers’ training or R&D and some marketing expenses since this fiscal year. And in the first half of the year, the margin drag from the Koolearn to EDU is -- roughly is 100 bps. Okay? This is the margin impact from the Koolearn for EDU. And, in the second half of the year we expect -- we still have some -- the negative impacts of the margins from the Koolearn. But, we believe the margin expansion of the core business or our school business, offline business, will cover the margin pressure from Koolearn. So, we believe on the whole, our margin will be expanded in the rest of the year, even though we spend a lot on the Koolearn. And, your number two question is about regulation. Last year, there were several of the new regulations. But as I said in the last two earnings calls, we almost meet all the requirements by new regulations in almost all the cities. And we have seen some small players disappear from the market and we have seen some students during our classes who were the students from the small player. So, I think our target going forward is to provide the better service to the Chinese students. And we believe we can take more market share from the old players in the market. Thank you.

Your next question comes from the line of Binnie Wong of HSBC. Please ask your question.

So, question here is that if you look at ‘20 like past year right, we see a wave of a lot of online education companies, small or middle size ones compete, especially, if you see the user acquisition cost has been rising up a lot. So, if you look into 2020, how do you see -- I mean, calendar 2020, how do you see that will change? Do you see that -- how our marketing strategy would be different from our players? And also, if you look at the I guess the deceleration of growth in Koolearn, do you think that we will continue or there will be some drivers to re-accelerate the online business growth? Thank you.

Okay. I think, firstly, Koolearn has been in transition mode in last two to three quarters, as you know, we changed the key members last year and we prefer to keep the new management team members more time. And, education is very special business. We don’t intend to do the business too fast by like spending the crazy dollars on the marketing activities. So, even in last year, we didn't attempt, like burning the money to acquire the students. And going forward, I think we will allow the Koolearn to spend a little bit more on the marketing expenses. But anyway, it's not a huge number. We prefer to make the more or huge investments on the R&D and like the teachers training or the product itself. This is our strategy.

Your next question comes from the line of Alex Xie of Credit Suisse. Please ask your question.

So, I'd like to ask about our magnitude of utilization rate improvement. I think, in the last quarter's earnings call, we mentioned it was 21% and 2% year-over-year increase. Thank you.

Yes. this year the -- I think the utilization rate for this year is somewhere around 21%, which means the we got 200 [ph] bps up of the utilization rates. So, that's why you see the margin expansion. And so, going forward, as I said, we plan to open 20% to 25% new learning centers. And it's bringing us like 30% top-line growth in RMB terms year-over-year. So, I think, you will see the high utilization rate going forward in the rest of this fiscal year and the after.

Your next question comes from the line of Sheng Zhong of Morgan Stanley.

I wanted to ask a question about our dual-teacher model, because you are still adding more dual-teacher in the cities. So, can you share some operating data about the margin of dual-teacher model and how -- what the current class and what the average class a teacher can teach in the dual-teacher model? And at the same time, I noticed that you have -- you still invest a lot in your digital technology. Wondering this is partly because of this dual-teacher model. And if possible, can you share more color on the spending going forward?

Okay. Yes, dual-teacher model. Yes. We changed our dual-teacher model strategy last year. So, we focused more dual-teacher model in the Hubei and Hunan. So now, we have the 7 low tier cities for POP Kids and U-Can programs to buy the dual-teacher model. And now, the revenue contribution from the dual-teacher model is very small. So, I think, the growth is very high, but revenue contribution is very small. And now, I think it's too early to say the margin of the dual-teacher model, because it's in the early stage. But it's relatively, as I said, I think dual-teacher model margins should be higher than the offline business. And this quarter, the OMO investment -- this quarter, we invested $44 million on the OMO ecosystem. I think, this is on track, because, we started to invest on the OMO things three, four years ago. And we started to bear fruits since last year. And I think this is - this year's very good result. I think that means we bear fruit from the investments we've made several years ago. So, the whole year, I think we planned to spend somewhere around $150 million to $160 million for the whole year. It's a little bit higher than we expected several months ago. But, I think, even though we spend a little more, but it should be covered by the offline school margin expansion. So that would be okay. We'll see the overall margin expansion, even though, we spent a little bit more.

Yes. We're happy to see you spending more on the technology improvement. So, can you give me some color on the spending areas of our technology?

Typically, we hire more IT people and the content development people in the head office for -- to provide more -- the better products for offline schools and the dual-teacher model schools. And also, we hired some -- the new people work for AI department. And, yes, so I think most of the investments we spent is only -- is happened in the head office. So, -- but, we believe it will bring us the better student retention rates going forward. And do we believe this money -- we spend the money today will bring us the better quality products in the future.

Your next question comes from the line of Hugo Shen of Macquarie.

I wonder if management could give us the breakdown of enrollment growth by business in the quarter.

Enrollment. Do we disclose the enrollment breakdown?

You can send email to me and I'll send the details, okay, after the call?

Okay. Thank you.

Your next question comes from the line of Felix Liu of UBS.

So, two quick questions for me. One is that you mentioned the ramp-up is getting faster than expected than previously. So, could you share as the latest timeline to ramp up a new center? And second one is a follow-up to the previous question on the OMO investment. So, I understand a lot of the costs are in staff salary. So, going forward, if we look at the second half of next year, do we plan to further increase the headcount or is it likely to stay at this level?

Yes. Historically, let’s say, the two to three years ago, typically, we needed 12 months to get at breakeven point for the new learning center. But now, it's only spend five to seven a month to get breakeven point. So that means, we ramp up new learning centers faster than before. And, I think, this is one of the reasons that we decided to open more learning centers in the every year. And your second question is about the 0 investments. Yes, I think we will have more people, more qualified, more talented people work for the IT departments and the content development team, also for the AI department. Because, firstly, I think it's a good investment. We spend more money today that we get better future. But anyway, I think total spending, it will be controlled by the management team. We don’t want to waste the money. So, as I said, even though we spend a little bit more on the OMO investment, but we do believe we have the margin expansion going forward, for the second half of the year and a year after. Okay.

Okay, great. Thank you. And glad to see we have the budget in the longer term growth. Congratulations again on the strong quarter. Thank you.

Okay. Thank you, Felix.

You next question comes from the line of Christine Cho of Goldman Sachs. Please ask your question.

Thanks, Stephen and Sisi. Just a quick question on the revenue guidance. You mentioned that you consider the Wuhan situation in terms of coming up with third quarter guidance. Can you give us a little bit more detail here? And also, if this situation prolongs, what are some of the alternatives you can consider to kind of mitigate the impact from this situation? Thank you.

Yes. We -- our Wuhan school actually decided today to move the two days courses before Chinese New Year to sometime after the Chinese New Year because of the new business. But also, we have the plan B. Let's say, if after the Chinese New Year, we cannot run the business by offline, we will make it up by the online courses. Actually, we are ready. But so far, we have not made a decision of the class adjust or suspend in the other cities, except for Wuhan. So, Wuhan is the only one. And yes, we have taken some impact from this in Wuhan but the amount is not material. Wuhan’s revenue contribution for New Oriental is 4%. But, don't forget, 45 days have passed. And also, we have to make plan B to make it up. So, I think the impact will be immaterial so far by our current estimation. Okay?

Thank you.

Thank you.

Your next question comes from the line of Youngrin Kim of CLSA. Please ask your question.

Hi, management. Congrats on the good quarter. I have two questions. The first is, how much of revenue growth is actually coming from organic growth versus stealing market share from other small players? That's my first question. My second question is, I know in the past, you have provided mid to long-term margin guidance of 17% to 19%. But, do you still stick by this margin guidance or do you see room for increase or things like that? Thank you.

Okay. Yes. The organic growth, I think, typically, in the first 12 months after the new learning centers opening, it will bring us, let’s say -- for example we opened 20% new learning centers. But in first -- year one, it will bring us 5% to 10% new revenues. And so, all the others are the organic growth. And the -- we don't make -- we don't have the numbers of how much market share we get from the small players. We just do our small business to get a 30% top line growth. That’s it. Okay? Sisi, do you have the numbers?

No. It's hard to quantify. But, we keep getting market share from small players every day, almost every day. And the market growth is like 10%, 15%. But our K-12 business are growing over 40%. So, definitely, majority of the growth is from taking market share from other small players in the -- in each city.

And the long-term margin guidance, we don't change the mid to long-term -- actually midterm it’s medium-term margin guidance. We keep it as a 17%. But, this year, the market expansion is better than we expected. And we are more optimistic on the overall margin expansion in the rest of the year and the year after.

Thank you very much.

Thank you.

Your next question comes from the line of Joy Wei of 86 Research. Please ask your question.

Thank you for taking my question. So, my question is, again in the quarter, we saw that U-Can and POP Kids growth accelerated. What's driving that? Do you see more opportunities in terms of prospective like cross offering and also product format? Thank you.

I think that there are several reasons. Number one is, if you remember clearly, in the last quarter’s earnings call, the summer promotion and retention rate is 5% higher of this year than last year. So, this is number one reason. Number two, is we are seeing the higher student retention rates for both U-Can and POP Kids program. Actually, the U-Can business, the retention rate is close to 80%. And the POP Kids retention rate is close to 90%. So, it's a higher than the those numbers of last year. And third, we don't spend a lot on marketing expenses, selling and marketing expenses. And this quarter, it’s just increased by -- am I right, by 17%. Okay. I think we typically will rely on word of mouth to acquire the new student enrollments. And that means we're providing better -- the products to the students than before. So, it bring us the good result, better result than we expected.

We are now approaching the end of the conference call. I will now turn the call over to New Oriental's CFO, Mr. Stephen Yang, for his closing remarks.

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

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.