Ladies and gentlemen, good evening, and thank you for standing by for New Oriental's second fiscal quarter 2015 earnings conference call. At this time, all participants are in 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 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 second fiscal quarter 2015 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 your newsletter services. Today, you will hear from Louis Hsieh, New Oriental's President and Chief Financial Officer, and Stephen Yang, New Oriental's Vice President of Finance. After their prepared remarks, both 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 obligation to update any forward-looking statements except as required under applicable law. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on New Oriental's investor relations website at investor.neworiental.org. I will now turn the call over to New Oriental's President and CFO, Louis Hsieh. Please, Louis.
Thank you, Sisi. Hello, everyone, and thanks for joining us today. I apologize if I sound not quite right. I have a sore throat, so you have to excuse my voice. During the second quarter, revenue increased 13.4% compared to 1.4% in the previous quarter. This increase in accelerated recovery was mainly driven by strong performance of student enrollments in academic subjects, tutoring, and test preparation courses, which grew a total of 10% year-over-year to approximately 621,500. One of our key segments, U-Can business, saw an increase of approximately 40% in student enrollments. The second quarter is traditionally slow for our business. We have moved away from the uncertainty surrounding the Gaokao reform, which we discussed in detail last quarter.
I would also like to add that beginning in the middle of the second quarter, the company decided to implement a new customer loyalty program to encourage repeat business. This has resulted in deferred revenue of about RMB 4.1 million, which is expected to be recognized within two years without additional expenses associated with such revenues. If including this, our top-line growth wouldn't have been as high as 15.4%. This is common practice in the education service market in China, as it is a way to retain customers. We consider this necessary for us to sustain customer loyalty and maintain competitiveness. Under the new program, when customers purchase academic subjects tutoring and test preparation courses, they will be able to earn points that are worth 2%-5% of their total spending, which can be used to pay for the tuition fees over the next two years.
For now, this is temporarily damping quarterly revenue. This revenue deferred are expected to be recognized when the points are redeemed and the associated classes are taken, or when the points expire after two years without additional expenses associated with such revenues. Essentially, that revenue will fall to the EBIT line 100% over the course of two years. Also in the second quarter, as scheduled, we started to roll out the revamped POP Kids program, and our new offerings have reached 35 cities across our nationwide school network. Our efforts are starting to pay off as POP Kids recorded sequentially strong revenue performance and enrollment growth of more than 133%. For the second half of fiscal 2015, we will continue with the rollout and expect to see a reverse of revenue decline.
To accommodate the late timing of Chinese New Year, which will fall on February 19, 2015, we reduced class hours in some cities to fill in two terms of courses within the winter break, which hurt our ASPs. Overall growth of ASPs was 2.4% year-over-year. Breaking it down, ASP of U-Can decreased by 9% year-over-year due to class length reductions of 20%-30%. ASP of POP Kids program was flat as we shortened class lengths. On an hourly basis, blended ASPs grew between 5% and 10%, depending on business line and location. Now, I'd like to walk you through our performance across individual business lines. Our K-12 all subjects after-school tutoring business continued to be our key revenue driver with recorded gross revenue growth of 16% year-over-year for the second fiscal quarter.
U-Can middle and high school all subjects after-school tutoring business achieved a gross revenue increase of approximately 32% year-over-year. Student enrollments grew approximately 40% year-over-year. As mentioned before, the POP Kids program has previously been experiencing slower growth due to the rebound process. As we started the nationwide rollout of the second quarter, we have been sequentially seeing improvement in revenue performance. Revenues declined slow to 4% compared to a decrease of 9% in the previous quarter. Enrollment growth was also strong, reaching more than 13%. We expect the strong momentum of our K-12 after-school business will continue, which is important as we move toward peak season in the second half of the fiscal year. With the newly revamped POP Kids program, we are confident that the K-12 after-school tutoring business will continue to lead our growth in both revenues and enrollments.
As a market pioneer with such strong brand recognition and innovative capabilities, we are well-positioned in the ever-growing education services market in China. Our overseas test prep and consulting businesses together achieved revenue growth of more than 16% year-over-year for the second fiscal quarter. Finally, the VIP personalized classes business recorded a continued strong revenue growth of 18% year-over-year in the second fiscal quarter. Turning to the balance sheet, New Oriental's deferred revenue balance, which is cash collected from registered students for courses and recognized proportionally as revenues as the instructions are delivered. At the end of the second fiscal quarter 2015 was RMB 440.7 million, an increase of 21.2% compared to RMB 363.7 million at the end of the second quarter of fiscal year 2014. I will turn the call over to Stephen Yang, our VP of Finance, to discuss strategy, execution, progress, and key financials.
Stephen?
Thank you, Louis. Hello, everyone. As mentioned previously, starting at the beginning of the fiscal year, we embarked on the new strategy of optimized markets, transitioning to a focus on maintaining a healthy balance between top-line and bottom-line growth, as well as meeting the growing demand for online education services in China. We continue to be at the forefront of the mobile internet online learning with significant investments in R&D, O2O integration, and largest digitalized the concept library for K to college education course and tools in China. During the quarter, we made significant progress in the effort overall and we're quickly building out our online-offline integrated educational ecosystem. Let me first talk a bit about the core of our business and our focus on further driving our offline initiatives.
As we focused again on aggressively increasing the top-line, we continue our effort to penetrate existing markets where we can optimize resources. In the second quarter, we opened 15 new schools and learning centers and closed 13, adding a net of two. In the first two quarters of fiscal year 2015, we added a net of 10 learning centers. In December, we added a net of eight learning centers. We have added a net of 18 new learning centers year-to-date, bringing our total learning centers at the end of the calendar year 2014 to 721, expanded some existing learning centers, adding a total of about 2,000 sq m of additional classroom area. This was a result of careful selection of areas that are driving both revenue growth and margin expansion.
Turning to the execution of our core strategy, again, I can't emphasize enough the great potential we see in mobile internet online education market in China. More importantly, our hard work investment in new phase online-oriented business will further distance us from existing competitors who lack the financial resources and scale to make such investments feasible. We're making solid progress in all 3 levels of our online platform. The first level of our online system is an O2O two-way interactive education system across all our business lines. The second level is our pure online learning platform, Koolearn.com, and complementary online education products in the New Oriental brand. The third level of our ecosystem is for New Oriental to take minority shareholdings in online education companies that complement our own online education offerings. Let me get into the details, what we achieved on each level.
As mentioned before, we invest about RMB 25 million to RMB 30 million in this fiscal year and for the second quarter. We spent about RMB 9 million, which were recognized as operating costs and expenses. Let's start with O2O two-way interactive education system, which we rolled out and upgraded since the fourth quarter across all major product lines, and extend New Oriental traditional offline classroom teaching offerings to online education services. We launched the YouCan Visible Progress Teaching System in over 30 cities in September 2014. This is our online platform that support after-class self-learning, and we expect this to help us better retain customers. By the end of the first quarter, we target expansion to 50 cities. As said earlier, in the second quarter, we successfully rolled out the newly revamped POP Kids English program, Shuangyu, which offers interactive and multicultural experience based on the students' own interest.
It has started to gain traction and boost our student enrollment and revenue. In the second quarter, we also rolled out O2O two-way interactive education system for domestic test-prep program. We seized the opportunity when we thought it was the right timing, and now it's being used in 5 cities. In the third quarter, we will roll out O2O for overseas test-prep program. For the second level of our online education ecosystem, we've achieved a great outcome with our continuing investment in Koolearn.com and other supplementary online education products. In the second fiscal quarter, Koolearn.com has generated net revenue of RMB 11.1 million, representing a 56% increase year-over-year. The number of registered users has increased to 52% year-over-year, and now cumulative registered users has reached over 9.9 million by the end of the fiscal quarter.
Hudao CN, our own live broadcast open platform, opening rents on third-party teachers, achieved about 172,700 registrations in the second fiscal quarter of 2015. Dona, a game-based mobile learning application to children, achieved a record of 12 million downloads by end of the second quarter. LeCi, an English language vocabulary training application we launched in the fourth fiscal quarter of 2014 for mobile phones and tablets app, records over 818,200 users by end of the second fiscal quarter. As announced in December 2014, we partnered with Tencent and launched a mobile app named uDA. This is an exciting initiative as it brings together China's most respected brand in kindergarten to college private education, and its largest, most successful internet company.
This is another step that we made on the path to transforming how students in China learn academic curriculums, and we hope to create more best-in-class mobile learning solutions for students in China. Turning to the third level of our online education ecosystem, we have invested in select online education companies with minority stake, and we never cease to search for new business opportunities that we can leverage so as to enhance New Oriental's products and services. In December 2014, we made an investment in Koyee100.com, an online platform where our K-12 students can practice our English. It's currently being used by approximately 1,400 elementary schools and middle schools in more than 50 cities, with about 1.6 million registered users and 130,000 paid users.
Together with our previous investment in ALO7.com, Tarena and JuE Shen.com, we'll build a more comprehensive online education system that is enabling us to provide fresh and interesting learning experience to our students. All this said, I think it is clear that the company has been working vigorously to drive both the core offline and developing online business. It's very encouraging that our high potential business lines maintain healthy growth in the second quarter, and we made so much progress in building our integrated education ecosystem in this year of strategic transition. Fiscal 2015 is an important investment year, and while this will have an impact on our annual operating margin like income, we do believe that these efforts will bear fruit and help us to achieve sustainable growth and long-term profitability. Now, let's take a quick glance at some of the key financial metrics for the second fiscal quarter.
In addition to the financials we mentioned at the beginning of the call. Operating costs and expenses for the quarter were $249.2 million, a 20.0% increase year-over-year. Non-GAAP operating costs and expenses for the quarter, which excludes share-based compensation expenses, were $243.9 million, a 20.6% increase year-over-year. Cost of revenues increased by 17.6% year-over-year to $114.6 million, primarily due to the increase in teachers' compensation, which is in line with the revenue growth. Selling and marketing expense increased by 20.1% year-over-year to $44.2 million, primarily due to the increase of selling and marketing staff compensation and brands promotion expenses. General and administrative expenses for the quarter increased by 23.2% year-over-year to $90.4 million. Non-GAAP general and administrative expenses, which excludes share-based compensation expenses, were $85.8 million, a 25.6% increase year-over-year, primarily due to the high income increase.
Total share-based compensation expenses, which were allocated related to operating costs and expenses, decreased by 0.8% to $5.3 million in the second fiscal quarter of 2015. In this fiscal quarter, we encountered a loss from operations of US $13 million compared to income of $0.7 million in the same period of the prior fiscal year. Loss from operations would have been approximately $8.9 million if not for the accounting effect of the company's new customer loyalty programs. Non-GAAP loss from operations for the quarter was $7.6 million, compared to non-GAAP income from operations $6.0 million in the same period of the prior year. Operating margin for the quarter was negative 5.5% compared to 0.3% in the same period of the prior fiscal year. Non-GAAP operating margin, which excludes share-based compensation expenses for the quarter, was negative 3.2%, compared to 2.9% in the same period of the prior fiscal year.
Net income attributable to New Oriental for the quarter was $2.4 million, representing a 44% increase from the same period of the prior fiscal year. Capital expenditures for the quarter were $15.2 million, which were primarily attributed to the opening 15 new learning centers and renovations at older existing learning centers. Now let me go through our expectations for the third fiscal quarter of 2015 before we move into Q&A session. We expect total net revenue in the third fiscal quarter of 2015 to be in the range of $279.8 million-$290 million, representing year-over-year growth in the range of 10%-14%. There were some specific factors impacting our guidance. First, approximately $5 million revenue, representing about 2% year-over-year growth, was deferred resulting from the company's new customer loyalty plan.
Second, the recent depreciation of the RMB against the US dollar negatively impacts revenue growth by about 2%-3%. If not considering the above-mentioned impacts, the product revenue growth rate is expected to be in the range of 15%-19%. The above forecast reflects New Oriental's current preliminary view, which is subject to change. At this point, Louis and I will take your questions. Operator, please begin.
Thank you, Mr. Yang. Ladies and gentlemen, the question and answer session of this conference 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, please request to join the question queue again after your first question has been addressed. If you wish to ask a question, please press pound one on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. The first question comes from the line of Jin Yoon of Mizuho Securities Asia. Please ask your question.
Hey, good evening, Louis and the team. Can I start off with the loyalty program? Just kind of wondering what your thought process is. Why start the program now? Is this largely due to competition, or is there other external factors that really leads to this? Really, at the end of the day, when we look at EDU historically, the company has kind of always prided itself having higher quality, higher caliber product that could continue to raise prices. With the loyalty program, does that kind of change how the company sees business going forward from historical levels? Can you just kind of elaborate on the loyalty program? Thanks.
Sure. Thanks. I think the loyalty program, we started it, piloted it in a couple cities in September, it was quite successful. We rolled it out across the network in October, middle of October. It's only been going on for a few months. You're right, part of it is due to competition, it's also become a common practice in China. I think it's probably long overdue for us to have a loyalty program because remember, our students start with POP Kids at age five or six and stay for six years. They've always asked us for bundled breaks and this kind of stuff.
It makes sense for us to, as we offer more classes like math and Chinese for young kids, to offer them some kind of discount as they sign up for more classes and they stay with us over a longer period of time. The key is to get them in 7th grade, because that's another transition period from 5th grade to 7th grade, and also in 10th grade or 9th grade when they go into high school. The marketing department decided that it's something we wanted to do to keep student retention high and also to sort of follow the norm of the market where a lot of companies do offer these loyalty programs. We were probably disadvantaged by not doing it. Part of it is the increased competition.
Part of it is because we are seeing our fastest growth in the K-12 sector, and these kids usually stay with us for multiple years. We want to create some stickiness by offering them this kind of loyalty program where they get a discount, and the longer they stay with us, the more discount they get.
Thank you. The next question comes from the line of Ellis Yang of Macquarie. Please ask your question.
Hi, Louis, Sisi, and Stephen. Thank you very much for taking my question. My question is about the O2O integration initiatives, especially the revamped POP Kids. Can you share with us more color on the full-year FY 2015 growth of the POP Kids segment? If you can break into enrollment growth and ASP growth, that would be great. Whether you can share some of your view about how you balance the ASP further growth when your price is not very much cheap versus the volume growth, especially in the less penetrated market. Thank you very much.
Thank you. Good question. For the POP Kids program, we just started rolling out the new program this last quarter. It's in 35 cities, but it's probably only in about 25%-30% of the total amount of POP Kids Learning Centers. It's not fully rolled out yet. It's really encouraging. The enrollment growth is accelerating. We did 13% enrollment growth last quarter, and in the first five weeks of this quarter, enrollment growth is already 19%. We're going into the next two weeks, which is the fastest growth period for us. Remember, Chinese New Year is late this year. It's February 19th versus February 8th last year. The peak season for enrollment, as kids get out of school now, will be the next two weeks. If we continue this trend, the POP Kids enrollment is actually doing very well.
I would just like to add that U-Can is also doing exceptionally well. The enrollment's up over 26% in the first five weeks. We were seeing accelerated enrollment increase in K-12. On ASPs, we are taking the strategy of not increasing ASPs as much, especially in this third quarter, where we are rolling out a new program in POP Kids, and we are trying to squeeze two terms in before the Chinese New Year, February 19th, because it's so late. The term is a little bit shorter. The prices won't look like as much of an increase. We're still increasing on an hourly basis between 5%-10%, and then higher for overseas Test Prep. We're still increasing prices at above market rates and above what our competitors are. You're right.
I think it's a game that we want to get more enrollments, especially enrollments in seventh grade and ninth grade and 10th grade, when they're transitioning to junior high and they're transitioning to high school, because then they have the best chance to stay with us for two to four years. The idea is that the loyalty program will also create some stickiness in that regard.
Understand.
Does that answer your question?
Please.
Yeah. Go ahead.
Yeah, very much helpful. You mean that ASP growth will be somewhere around 5%-10% on average for full year FY 2015?
Yes. We're still raising prices on an hourly basis about 5% for POP Kids and up to 7% or 8%, 9% for U-Can, overseas is still over 10%. The price increases aren't quite as aggressive as past years, but we're also seeing a nice spike in enrollments because remember, we had that terrible Q1 during the summer. We're still kind of in recovery, and we're rolling out a new POP Kids program. The more early enrollments we get, the more people will see how good the program is. With a loyalty program, hopefully stay with us for many years. It's kind of an integrated strategy to retain customers, to get more new customers, and introduce them to our new O2O offerings.
Understand. Very helpful. Thank you.
You're welcome.
Thank you. The next question comes from the line of Vivian Hao of Deutsche Bank. Please ask your question.
Hi, Louis, Sisi, and Stephen. Thank you for taking my question.
Hello.
First of all, I have a follow-up question regarding the new loyalty program. Can you introduce what is the current redemption rate and also the average redemption period for such program? Also, do you have any plan to retain this program permanently, or is it just for a certain period of time? I do have a second question, sorry about this. It's regarding the hiring plan you have right now.
Sure.
Given the surging G&A expenses, what is the total headcount we have, and also what is the additional headcount by function and also by segments for this quarter? Thank you.
Okay. I think Stephen can tell you the breakdown, but the headcount is at 32,500 at the end of quarter, which is about 2,500 more than last year, of which 600 of them were teachers. The G&A and S&M headcount did go up by about 1,900, which is a lot. Don't forget, we've added so far 18 learning centers net. We've expanded the capacity as well. A lot of the headcount increase is related to the O2O integration and the new programs. I think headcount will not go up by as much in the next couple quarters, but it will go up due to new center openings. I think it'll probably go up, I don't know, is 500, 600 reasonable?
Yes.
Yeah. 33,000 is sort of our original goal for the end of this fiscal year. On the loyalty program, Vivian, the current plan is to keep it in place permanently. Especially our retention rate last quarter, which is usually a slow quarter, Q2 was over 65%. It's a good retention rate, but we don't know how much has been redeemed yet because the loyalty program just went into effect in October. The beginning redemption, we'll begin to keep track of that starting in this third quarter coming up. The idea is that the longer the student stays with us and the more classes they take, the more discount they get. It starts at 2%, it moves to 5%, depending how long the student stays with us.
The key is that its revenue, like the $4.1 million that came in this last quarter, it's only a half of a quarter. That $4.1 million is a direct revenue. If we added it would've been 15.4% on the growth side. All $4.1 million falls straight to EBIT over time, because the costs are already accounted for in COGS. We delivered the classes, right? It's pure revenue and pure operating margin, operating income. That's why it's not apples to apple comparison with last year or in the past. We're beginning to start this new one. After one year, we expect about $20 million to $25 million of this deferred revenue, about $5 million to $6 million per quarter. Then it evens out, next year's comparison will be sort of apples to apples, it'll be a neutral effect.
The second year, it should have a positive effect as some of these redemption points expire and they're recognized right away. They were recognized as revenue and as profit right away. I think as you'll see, as Sisi, this year, the revenue is dampened and the operating margin is dampened by about RMB 15 million for the three quarters worth. Next year, it should be a sort of a neutral effect as you begin the year-over-year comparisons will be the same program. In the second year, as the initial set begins to expire, you'll see a slight bump up in the second year in revenue and in net operating income. We intend to keep it permanently, assuming it's successful.
Right. This is very helpful. Just a very quick clarification.
Yeah.
This is deferred revenue. When they flow in as recognized as a revenue on P&L, we should be expecting some.
Yeah
impact to operating margins, right?
Right now, it's going to be negative for this year. About $15 million negative for this year, if you take $5 million a quarter, because we just started it after the first quarter. Next year, because it'll be compared to year-over-year where they're all, the base is in place, it'll be kind of a neutral effect. The second year, we'll have a slight positive effect. The key to recognize is that this deferred revenue is real revenue. It's classes that are already delivered, revenue that won't be refunded, and it will just pass to the bottom line just at a later date.
Got it. Very helpful. Thank you.
Okay.
Thank you.
Thank you.
The next question comes from the line of Philip Wang of Morgan Stanley. Please ask your question.
Hi. Thanks for taking my question. Just a follow-up question on your guidance. Given that you mentioned enrollment is rebounding, including POP Kids, ASP is also growing. I know that there's a couple factors affecting this with the loyalty program and the currency impact. The guidance 10%-14% still a bit soft, seems a bit soft. Could you talk about the overall enrollment trend the past two months? Also, given the weaker first half, what is your expectation on the full-year margin? That's my question. Thank you.
Okay. Thanks, Philip. I think on the last two months trend is quite good. We had 10% enrollment growth last quarter, which a lot of it will flow in this quarter. It's hard to tell what this quarter will look like because of the 11-day difference between Chinese New Year last year and this year. Last year was February 8th. We already passed our peak period for last year already, week-wise. This year is February 19th. We were entering the peak period the next two weeks. If you don't take that last week into account, enrollments were up over 10%. You have to remember that enrollments in U-Can and POP Kids, the hours are being shortened a little bit because we're trying to cram two terms into winter break before Chinese New Year. Last year, we didn't try to do that.
They're a little bit shorter. The average hourly increase is still 5%-10%, and that's what we tried to explain in the script itself. Okay. There's still price increases, and enrollments are actually still growing up very fast. POP Kids will enjoy a very strong positive revenue increase as well as enrollment increase this quarter, and U-Can well over 30%. They're both doing very well. The weakness is in the adult English. It's down about 30% in enrollments year-over-year. That's the weakness sector and [inaudible] . It's the old legacy businesses. Overseas is down a little bit in enrollments this quarter.
Like I said, it's too early to tell because the next two weeks are the key weeks for this year because the kids are getting out of school now, and they'll sign up for the winter term over the next two weeks. It'll be the peak time. We're quite encouraged. As far as margin goes, Philip, last year we did 17.3% operating margin. This year, we had guided before 14%-15%, but with the new loyalty program, you got to take that down about one to one and a half percentage points. It's about RMB 15 million this year. We'd probably guide somewhere, we don't like to give strict guidance because the loyalty program is new, but probably somewhere without the loyalty program, about 13%-14%, so down one percentage point.
With the loyalty program, it will probably look more like 12%-13%. That's why I want to separate with or without loyalty program, because otherwise it's not a fair comparison. Don't forget, this includes over RMB 30 million of spend this year on the new online initiatives. We expect that to really bear fruit in the second half of this year and into next year. We won't have the same RMB 30 million increase next year.
Right.
Most of the expenses are coming in this year as we roll out O2O across the whole network.
Okay, got it. I just want to make sure I get it right. Including everything-
Yeah
loyalty program investment, you're targeting around 12%-13% this year, for full year?
Yeah. With everything built in, which is equivalent to about 13.5%-14.5% pre-loyalty program.
Okay. I see what you mean. Thank you.
Okay. Thank you, Philip.
Thank you. The next question comes from the line of Ella Ji of Oppenheimer. Please ask your question.
Thank you for taking my question. First, I have a quick follow-up regarding the loyalty program. Just want to make sure, Louis, you said that all the points, are they going to expire after one year? Is that what you said?
Two years.
Two years? Okay.
It will expire after two years.
Thanks.
Yeah, Ella. That's why you'll see this year where there's a lot of revenue that's built up that will be either redeemed in the next two years or it will expire and we'll recognize it all. That's why in the second year, the points that aren't redeemed will get recognized. That's why you'll see a bump up in the second year.
Right. Okay. Thank you.
That revenue has been collected, and it'll fall 100% to the operating line.
Right. Regarding YuDa, your new product with Tencent, can you talk about your expected progress in the calendar year 2015? How much more support should we expect from Tencent, especially from Tencent's channels? Do you think New Oriental will also need to spend more in sales and marketing to help promote YuDa product?
Yeah, that's a good question. YuDa is new, so it's in kind of test launch with English. Right now it's a soft launch. It hasn't been blown out across QQ or WeiXin yet. We're waiting to add the Math module. That will happen in the next few months. Also we're testing it to make sure it's more accurate, the question and answering program is more accurate. We're continually improving it. We want to do a soft launch to get it out in the marketplace so students begin to test it and help us improve it. This will be a long-term program that will include not just English and Math, but hopefully all the subjects from Gaokao. We believe it will become the go-to program for kids middle and high school for sure. Tencent is behind it. We will require additional investment.
You'll see it come in the quarters ahead. I think you should stay tuned. We're actually very excited about this, and I think so is Tencent. You'll see a number of announcements from us in the near future on our cooperation. Okay. We can't go into detail.
Okay. All right. Okay.
The point I want to try to make, Ella, is this is the beginning of our cooperation. This is not a one and done. This is a long-term cooperation.
Thank you. The next question comes from the line of Tracey Ordan of Wells Fargo Securities. Please ask your question.
Thanks very much. Louis, my understanding was that with POP Kids, the plan was following the upgrade, that you were going to have much more pricing power, now it sounds like you've revised that expectation. I'm looking at that data point combined with the fact that you chose this quarter to introduce the loyalty program. I'm wondering if you are now seeing pressure in the consumer market and whether or not you believe that that's sort of temporary related to the economic conditions in China right now, or whether this is something related to growth in the large markets and approaching saturation, and if this is sort of an environment that's going to pass or something we can expect long term.
That's a good question, Tracey. I think for us, the Kids business has always been the most competitive on the POP Kids. The reason is because, as you know, you're not studying for a mission-critical exam like the Gaokao or the Zhongkao or the SAT. Pricing has always been a little bit more difficult, and that's why the POP Kids class is only about RMB 1,000 versus a U-Can class, which is more than RMB 2,400.
Right.
For the same length of time. It's because of the mission criticalness of the class itself. POP Kids has always been more competitive. For us, we've always been at the high end of the pricing point, and we have probably lost some market share as a lot of competitors come in because it's not a hugely differentiated product. What we've done with this new relaunch is we now have a differentiated product. We have the best program out there that's interactive and has interactive blackboard, is far better than everything out there. I think it's for us, we want to introduce it to as many students as we can early because of the repeat business that it generates, where they come in for many years.
This is an aggressive push on our part, especially given that POP Kids was declining for three quarters in a row to get market share by getting more students in. The market is not shrinking. The POP Kids market is still growing. It's growing nicely. It's just that we had an old offering and we weren't aggressively promoting it. Now we have a new offering, the best offering in the market, and we're aggressively promoting it. We believe with the loyalty program, it will keep students coming back. They'll have incentive, and we won't be that much more expensive than the other offerings. Part of the shift also, Trace, is because we have a new POP Kids head, as you know, that came in about four or five months ago. His philosophy, and he knows better than I do, is to go after market share first.
Raise prices as the students get hooked on your product, basically. Because there's really nothing else out there that's comparable. Maybe Disney's program, but that's two or three times our price.
Okay. I guess that answers my second question.
First get market share, then raise prices.
Right. I guess given that, PopKids is no longer the price leader in the market?
It is still the price leader, Disney's always been higher than us, right? They're only in a few markets, they're at a ridiculous price point.
Okay.
PopKids is at about $150, $200. They're in the thousands. There's a huge discrepancy where we can still raise prices. I think for us right now, given that we saw three consecutive quarters of decline, now we have the best product in the market, in our price category, we want to get market share first. It's been successful, right? We saw a 13% increase in enrollments, we stemmed the decline in revenues. This quarter, just in the first five weeks, we're already seeing almost a 20% increase in enrollments. That's unheard of, even for PopKids, in the last couple of years.
Got it. Okay, thanks.
The new program is taking hold, U-Can is doing the same thing. We haven't been as aggressive in U-Can pricing this last quarter, and you saw a huge spike, 40% enrollments, 32% in revenues because the courses are shorter. You can see a continuation in this third quarter, where already in the first five weeks before the peak season, enrollments are already up 26%.
Okay.
Okay? Thank you, Trace.
Thank you. The next question comes from the line of Tian Hou of TH Capital. Please ask your question.
Hello, Stephen and Sisi . My question's related to what you guided earlier this year regarding your O2O investment at about RMB 20 million-RMB 30 million. I wonder how you guys are using this RMB 20 million-RMB 30 million. Where are you investing this pot of money? How much of that is a one-time investment? How much of that is going to roll into next year? I try to figure out how much of that will disappear next year to improve your margin.
Okay. Steven has a better idea of the breakdown, my only comment on this is that you know Michael. Whatever budget he sets, he usually overspends. I think it'll be higher than RMB 20 million, probably closer to RMB 30 million, RMB 35 million.
Yeah.
You know the breakdown.
Yeah. Hi, Tian. We spent RMB 9 million.
Yeah
on O2O and online things, the expenses in Q2. We will keep spending the same amount, like RMB 8 million to RMB 10 million in the next two quarters. By the end of this fiscal year, I think we almost will finish the key step-
of the O2O and the investments. The next year, you will not see so much expense as the same as this year.
for the-
also--
for the expense and cost, more than half of them, we spent in the staff compensation because we hired more people.
IT people to do the O2O things.
The others.
we spent in the server or the other equipments. For the pure online, for our koolearn.com, we spent.
the $1 million for the selling expenses for the new product.
That's.
all spends.
Mm-hmm. Okay.
I think in the coming years.
That's helpful. Also.
We plan on high growth spending in the next few quarters.
You guys have a lot of cash. Hello?
Yeah. Go ahead.
Yeah.
Go ahead again.
You guys have a lot of cash on your balance sheet, certainly, you guys must think about how to use it. I wonder what's the plan in that front?
Well, I think the cash, the first idea or the first use will be looking at business partnerships and M&A, and also just to make sure that we get this O2O, and we're the leader in the online education space, in the online/offline integrated space, in the mobile learning space. That's our first priority. Excess cash beyond that, we will be using what we've been doing, is buying back shares. We spent about RMB 40 million so far in the first three or four months buying back shares in this current program. Every year after the fourth quarter, we'll look at how much cash flow we generated, and we'll either try to pay a dividend or do a share buyback. We turn some capital to investors depending on the needs of our business and how much excess cash we generated.
Mm-hmm. That's very helpful. That's all my question. Thank you.
Thank you.
Thank you. Yeah. Thanks.
The next question comes from the line of Jialong Xu of Credit Suisse. Please ask your question.
Hi. Good evening, management. Thanks for taking my question. First of all, a quick follow-up on the previous question. Louis, you just mentioned, you will probably consider paying cash dividend or continue to do this share buyback for the coming fiscal year. If you guys were to pay dividends, what is the target payout ratio you may consider.
Oh.
Can you give any guidance?
Yeah, we don't have a target payout ratio, last year we paid about RMB 50 million something in the dividends. You can calculate, it's about RMB 0.35 or so a share, and it was up about 16% from the year before that. This year we're doing a buyback one, next year depends on how much we'll generate less cash this year than we did last year because of the investment. It's not my decision. We don't have a set payout ratio, the board does consider it each year and actually in multiple board meetings throughout the year on return of capital. We know it's a big issue among U.S. stocks these days, we're very sensitive to it. You know me, I'm always pushing to return capital back to the shareholders.
Okay. A quick clarification on your dividend policy. I understand for the current fiscal year, you guys already have a share buyback program, which is still effective. Is it fair to say for the current fiscal year, you guys won't have any dividend to announce even by Q4?
I think that's fair. I think by Q4 being May, it's only in a few months. I think is we'll make the decision after Q4, we'll probably make it sometime around the July board meeting. That's what we did last year and the year before.
Understand. Okay.
We finish the fiscal year, and we do the budgeting for the next year.
I see. Very clear. I have another question about your Koolearn program, and your Koolearn appeared to do very well in the past quarter. Excuse me. Just wonder, what is the key competitive edge for Koolearn, compared to other online learning platforms, especially those platforms operated by internet companies? What sort of revenue contribution do you expect to generate from Koolearn by end of next fiscal year? Thank you.
As we said in the script, Koolearn.com, the revenue growth was very strong in the Q2, about 6% year-over-year. In last year, the revenue of Koolearn.com accounts for 2% of the total revenue. In the Q2, the revenue account for 5% of the total revenue. We're very happy to see that the revenue of Koolearn get more and more growth. We hope the next year, the revenue of Koolearn will get the growth rates by about 50% year-over-year.
Thank you. I'd like to remind all participants, we will take one question at a time from each caller, in view of fairness to all callers who wish to ask questions. Please request to join the question queue again, after your first question has been addressed. The next question comes from the line of Clara Fan of Jefferies. Please ask your question.
Hi, hello. Thank you for taking my question. I just want to clarify. For the last quarter, we see that enrollment is recovering while ASP is quite soft. You mentioned that the ASP on a hourly basis is increasing by around 5%-10%, but even on an absolute basis, are we seeing a softer ASP growth compared to what we have expected before, especially after we introduced the loyalty programs? Thank you.
Yes, I think the intention that Michael and the marketing team and we agree with is to go after enrollment growth, in the short term, especially as we roll out O2O. We believe that our program is far superior to anything else in the marketplace. We want as many students to try it as we can because we think we'll get them hooked. The short-term plan is to reduce the amount of increase in the ASP. We'll still increase it at about 5%-10%, but it won't be as aggressive as in past years, because we want to get the students on this new online, offline integrated system. Once they get on it, we believe that along with the loyalty program, it will create incredible stickiness and that, also Michael has spent a lot of time improving our content and improving our teaching quality.
That's where our focus has been. We believe that combined with the technology advantage we have and a loyalty program and the brand name is a winning strategy for us. You're correct, Clara, that we have slowed down the amount of ASP increase, but it's still quite healthy at 5%-10%. It's just not as high as 10%-12% like in the past.
Thank you. The next question comes from the line of Fei Fang of Goldman Sachs. Please ask your question.
Hi, Louis. This is Steven. Can you update us on your expansion plan for 2015? How many centers would you like to add this year? Which segment would you focus on, and which cities would you add the capacity? Thank you.
Okay. Thank you, Fei. I think, we opened 10 as of the first two quarters, but we opened eight in December alone net. We are up at 18 now. I would expect us to be somewhere between 30 and 40, but probably the lower end of 30 to 40. Right on schedule with our 30 to 40 target we announced last quarter. Probably not at the high end of that. Most of the learning centers are kids K-12 and overseas centers, so they're kind of mixed use. We're not really opening adult centers any, given that's a declining business. We're opening it in mostly in cities that have high profit margins. They still include cities like Beijing and Shanghai and some of the larger cities that some people may think is saturated, but it's not.
Then, also high profit 2nd-tier cities. Like Changsha, Xi'an other city, Wuhan, that are doing quite well.
Thank you.
Do you have any questions?
Our next question.
Yes. Thank you, Fei.
Comes from the line of Jin Xin, of Mizuho Securities Asia.
Hey, just a follow-up question. Even after the loyalty programs and the rebates that you provide, do you know how competitive your pricing is in your top-tier cities? If the pricing gap is still there between you and competitors, does that mean that the potential rebates could go higher going forward? Thanks.
Yeah. I think, right now we will adjust the rebate depending on market conditions. Our initial shot is 2%-5%. The more years or the more classes you take with us, the loyalty program goes up, starts at 2% and moves toward 5% of your total purchase. It does go up. Right now, we always can adjust it to higher or lower depending on market conditions. Right now we're priced probably 20%-25% above our competitors in most classes. That includes U-Can, POP Kids. Overseas, we're probably 25% higher than most of our competitors. We think that will continue to hold because we usually are the ones who initiate the price increases, and they usually follow in behind us. We think, unless something changes, that price gap will continue to be in force.
We think the difference now is that we believe the quality gap will expand. Our quality and our internet tools and our mobile learning system will be better than anything else that our competitors can offer. Not only do we have a pricing gap that's the same, but we'll have a higher quality gap. That's the goal. With that higher quality gap, we'll get more customer loyalty, and then at that point, we'll probably consider raising the price more aggressively.
Thank you. The next question comes from the line of Charles College of Watts Sloane Robinson. Please ask your question.
Hi, Louis, Stephen and Sisi. Thanks for taking the question. About three quarters ago, some of the debate or the conversation was about occupancy. I was wondering if you could, notwithstanding the fact that you calculate it, and maybe it's worth reminding people how you calculate it, but I'll be interested in seeing how that's developed over the last few quarters, please. Thank you.
Thanks, Charles. The utilization rate has continued to go up. It's probably up 2% year-over-year. Now we're adding more capacity, so that may not be the case in Q3 because we added eight learning centers in last month alone. We'll keep you posted. The utilization rate is definitely up over the last two years, about two percentage points from when we were at 743 learning centers and we were kind of fat and bloated. I think is that, you will continue to see the utilization rate go up, but maybe not quite 2% a year because of the more aggressive expansion plan this year versus the contraction plan of last year. We're definitely seeing more students filling the seats.
Thanks.
The fact, Charles, that we're not being as aggressive on price, I think will also increase the utilization rate as well. The new programs are attracting As I said, the enrollment growth is picking up. The new programs are attracting a lot more students. You should see pretty good utilization rate increases, but not quite as it was when we were reducing learning centers.
Thank you. The last question of this question and answer session is a follow-up question from the line of Trace Urdan of Wells Fargo Securities. Please ask your question.
Thanks very much. Louis, there was some coverage in December about plans to reform the Gaokao, this idea of sort of de-emphasizing Gaokao in favor of other measures of student achievement. I wonder if you could put that into some context for us, whether you think that's gonna go forward-
Yeah
what it means and whether it creates any opportunities for other types of student support for you guys.
I think there's a debate every year, Trace, you're right. You'll see a lot of writings about how it's unfair that one test determines a child's future. You always hear that kind of rhetoric. At the end of the day, in a country with 9 to 10 million high school graduates, there's no fair way to assess people for higher education for the limited spot, right? If China started looking at teacher recommendation letters, the teachers would be the richest people in China, right? There's no fair way that you really can argue it other than objective test. All the rhetoric that happens usually, the Gaokao still remains the main factor. In fact, they've gotten rid of all the other stuff, right?
They got rid of all the points you get for the Olympic math, That's what's killing TAL in Beijing and in the Olympic side, right? They've gotten rid of all the other external factors. They've actually made the Gaokao even more important. Of course, you know earlier this year they talked about reducing the English points, They backed off from that. English is the same as it was in past years. They even helped us by saying you can take the English test twice in Shanghai and then soon over the whole country. It not only did they come back, they actually come back even stronger for English. I think is that there's talk every year of this, No one's come up with a fair system that people will accept other than the standardized test.
Okay. That's helpful. Thank you.
Okay.
Thank you all. We are now approaching the end of this conference call. I will now turn the call over to New Oriental's President and CFO, Mr. Louis Hsieh, for his closing remarks. Mr. Hsieh, please go ahead.
Okay. Again, thank you for joining us today. If you have any further questions, please do not hesitate to contact me or any of our investor relations representatives. Thank you very much.
Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation.