New Oriental Education & Technology Group Inc. (NYSE:EDU) Q1 2021 Results Earnings Conference Call October 13, 2020 8:00 AM ET

Company Participants

Sisi Zhao – Director, Investor Relations

Stephen Yang – Chief Financial Officer

Conference Call Participants

Tian Hou – T.H. Capital

Felix Liu – UBS

Jin Yoon – Newstreet Research

Mark Li – Citi

Alex Xie – Credit Suisse

Sheng Zhong – Morgan Stanley

Lucy Yufrom – Bank of America Securities

Alex Liu – China Renaissance

DS Kim – JPMorgan

Tommy Wong – China Merchant Securities

Liping Zhao – CICC

Operator

Good evening and thank you for standing by for New Oriental’s FY 2021 First Quarter Results Earnings Conference Call. At this time all participants are in a listen-only mode. After managements prepared remarks there will be a question-and-answer session. Today’s conference call is being recorded. If you have any objections, you may disconnect at this time.

I’d now like to turn the meeting over to your host for today’s conference, Ms. Sisi Zhao.

Sisi Zhao

Hey. Hello, everyone, and welcome to New Oriental’s first fiscal quarter 2021 earnings conference call. Our financial results for the periods were released earlier today and are available on the 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 views expressed today. A number of potential risks and uncertainties are outlined in our public filings with 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 Mr. Yang. Stephen. Please go ahead, Stephen.

Stephen Yang

Thank you, Sisi. Hello, everyone, and thank you for joining us on the call. Although the impact of the pandemic continues to raise hurdles for business across the globe, we’re pleased to kick off the fiscal year with a set of encouraging financial results in the first quarter of this year, that is in line with our expectation. While it’s showing signs of the recovery in some of our business lines, as domestic markets began its path to normalization.

Total net revenue was $986.4 million, representing a 8% decrease year-over-year, which is better than we’ve guided in the previous quarter. Net revenues from education programs and services for the first quarter were $935.6 million, representing a 6.1% decrease year-over-year.

Our U-Can middle and high school all-subjects after-school tutoring business shows a positive with a growth of approximately 9%, while our POP Kids program recorded a growth of approximately 4%.

Our industry leading OMO system has been vital in the previous quarters to ensure our service runs smoothly, and it has once again proved to be instrumental in this quarter, as it provides our operation with strong flexibility to help the vast majority of our students migrate from OMO online class back to offline learning centers, which have gradually resumed service made the easing of the pandemic restriction measures. Encouraged by its effectiveness, we have put more focus on executing our OMO strategy, including piloting the OMO online courses in around 20 existing cities and attracts a promising number of new customers in the summer quarter.

Total student enrollments in academic subjects tutoring and test preparation courses in the first fiscal quarter of 2021 increased by about 13.5% year-over-year to approximately 2,961,100 million.

The lower-than-normal increase in the number of student enrollments is primarily due to the delay of the enrollment for summer and autumn classes and the shortening of summer holiday in many major cities by one or two weeks this year, as well as the delayed resumption of the offline operation in cities such as Beijing due to the re-emergence of COVID-19 cases before the summer holiday.

A key highlight in this quarter is the highly successful summer promotion campaign. Despite the challenge of a shortened summer holiday, we are delighted to see the total promotion enrollments reached 1,079,000 million [ph], a 31% increase year-over-year, accompanied by improved student retention year-over-year.

In terms of the pricing, per program blended ASP, which is cash revenue divided by total student enrollment decreased by about 10% year-over-year in dollar terms. As for hourly blended ASP, which cash revenue divided by the total teaching hours decreased by approximately 2% year-over-year.

To provide the breakdown of the hourly blended ASP, please note that U-Can classes increased by 2%, U-Can VIP courses increased by 3%, POP Kids decreased by 1%, and Overseas test prep programs increased by 7% all year-over-year in dollar terms.

Comparing with our normal price increase of 5% to 8%, this quarter’s hourly blended ASPs decrease was mainly because of firstly, a bigger decline of overseas test prep program with hourly blended ASP was much higher than other programs.

Secondly, the piloting of promotional OMO online courses in some major cities with discounted price in summer. And thirdly, a bigger portion of the enrollments on promotional courses to encourage students to register for more subjects.

Now I would like to spend some time to talk about the quarter performance across our individual business line in detail. As the pandemic gradually fades in China, encouraging signs of recovery have started to emerge across our business lines with significant jump in student enrollments.

Our key growth driver, K-12 after-school tutoring business, achieved year-over-year revenue growth of approximately 8% in dollar terms. Breaking it down, the U-Can middle school, high school all-subjects after-school tutoring business recorded revenue increase of approximately 9% in dollar terms for the quarter. Student enrollments grew 23% year-over-year for the quarter.

Our POP Kids program recorded a revenue increase of about 3.5% in dollar terms for the quarter. Enrollment increased by 17% for the quarter. Our overseas test prep – our overseas related business, including test prep and consulting and study tour business continue to face the difficult challenges due to the cancellation of the overseas exams and restrictions on travel, while the – and predictability of the pandemic situation in different parts of the world has raised the students hesitant to study abroad.

The overseas test prep business recorded a revenue decrease of about 51% in dollar terms for the quarter, while the overseas consulting and overseas study tour business recorded revenue decrease of about 31% in dollar terms year-over-year for the quarter.

And finally, VIP personalized – our class business recorded cash revenue decline of about 10% in dollar terms year-over-year for the quarter. We’re pleased to see that our summer promotion strategy delivered outstanding results. We offered a low price experience of courses for multiple subjects in a total of about 70 cities, targeting with seven secondary school and grade three primary school student customers before they start their new school year.

The promotion quite is similar with that of last year at around RMB400. It’s very encouraging that even we launched this summer promotion almost one month later from last year because of the huge challenge from the pandemic our daily operation, the summer promotion remains very well received by the market. To complete promotion enrollments we brought in this year recorded a 31% increase year-over-year, reaching 1,079,000 enrollments.

The encouraging results indicated the opportunity of the market consolidation as the COVID-19 pandemic phase and uncertain players mainly financial and digital capabilities to sustain their operations. It was well-proven that under this strategy we are able to better identify and retain customer with higher loyalty. Please note that this promotion enrollments are not recorded in our current reported enrollment.

Going into the autumn semester, we have returned about 60% of the students following the promotion, which will boost the revenue and margin recovery throughout the whole fiscal year 2021. And we do not foresee any negative impact of the promotions operating margin throughout the whole – throughout the whole fiscal year. As these students move to the higher grades, the continual improvement in retention rate and customer loyalty will drive revenue growth in the next three to six years.

We continue to be guided by our optimized market strategy in this quarter and carried out capacity expansion in cities where we see potential for rapid growth and strong profitability. This quarter we opened the seven new offline training schools in the city of Thando, Guara, Kito, Wuhu and altogether, this increased with the total square meters of classroom area by approximately 23% year-over-year, 1% quarter-over-quarter by the end of this quarter. The slight increase is in line with our expectation, as we tend to achieve a more modest growth in capacity in the first quarter of the year, and ramp up our expansion efforts in the latter part of the year to prepare us for recruiting more new student enrollment at the start of the following academic year.

The expansion in our offline education network have also made sure that we are fully prepared for when the pandemic is over and our service can resume with a strong presence across different Chinese cities. We rolled out our dual-teacher class model or POP Kids program in 46 existing cities, for U-Can program in 28 existing cities and for both POP Kids and U-Can K-12 business in 10 new cities by end of this quarter.

We’re happy to see increased market penetration in both markets we have tapped into. We also saw the improved customer retention and scalability of this new model. With this program results, we will continue this strategy in the rest of the year.

As the outbreak of COVID has highlighted the importance and demand of the online education we have placed more resources in this area and we invested $39 million in the quarter to improve and maintain our OMO integrated education ecosystem and as the COVID – outbreak of the COVID-19 has highlighted the importance and demand of the online education. Apart from the OMO infrastructure, we have allocated the part of the resources in advanced training programs for teachers to enhance their online offline integrated teaching skills in response to the growing demand.

At the same time, we continue to upgrade our technology platforms and will broaden the usage of online tools and contents in our OMO system for audiences line throughout the whole network, as well as further develop the faster teaching content and courseware to cater to online, offline integrated education method.

We’re glad to see that industry leading OMO ecosystem has not only successfully managed to cushion most of the impacts on our service operation caused by the pandemic, but we also see the customer retention rate from spring to summer semester and from the summer to autumn semester, we’re trending higher than the semester of last year, which further demonstrated our customer satisfaction and the effectiveness of our online courses through our OMO system. We believe those OMO initiatives will effectively boost the enrollment and speed up a recovery of business in the rest of the year.

To capture the huge market opportunity in the online education space, we continue investing more resources in executing new initiatives online K-12 after school children business fiscal year 2021. During the COVID-19 pandemic Koolearn did large scale market promotion by offering three large sites online live broadcasting classes to the public and attracted several times more traffic than normal time.

To capture this new market opportunity, Koolearn also added a meaningful number of customer service representatives and marketing staff to support the new initiatives in K-12 tutoring. This move has consequently raised our spending on marketing front, but we believe these are necessary and understandable measures as we found ourselves in unusual pandemic situation.

Our small size class currently enjoy a significant first mover advantage and stand to benefit from the increase in demand in larger cities. Koolearn are large size K-12 courses are able to offer the best in class learning experience through the investment in upgrading the app and online platforms, introducing new education technologies and adding more interactive features on online courses.

Koolearn also continued to establish teaching training centers in other locations to attract more qualified teachers and tutors to provide a systematic training programs. At the same time, Koolearn has dedicated a significant amount of investment to marketing and service enhancements in the past two quarters to attract customers during the peak of the pandemic, but we expect the spending to be normalized in the coming quarters. In the coming quarter as we will be cautious in identifying high ROI marketing channels and evaluate their units economics in real time, which will in return keep the average user acquisition cost at a relatively low level.

We believe as a result of the improvement of operational teams, as well as positive word of mouth promotion and brand loyalty, Koolearn will continue to quickly acquire new users, while enhancing the student retention rate.

Now let me walk you through the other key financial details of the quarter. Operating cost and expenses for the quarter were $836.1 million, representing a 1.3% increase year-over-year. Non-GAAP operating costs and expenses for the quarter, which exclude share-based compensation expenses, were $820.2 million, representing a 0.7% increase year-over-year.

Cost of revenues increased by 5.6% year-over-year to $464.9 million, primarily due to increase in teachers’ compensation for more teaching hours and higher rental costs for the increased number of schools and learning centers in operation.

Selling and marketing expenses increased by 15.5% year-over-year to $116.9 million, primarily due to the addition of a number of customer service representatives and marketing staff with the aim of capturing the new market opportunity, especially for new initiatives in K-12 tutoring on our pure online education platform, Koolearn.com.

General and administrative expenses for the quarter decreased by 10.5% year-over-year to $254.3 million. Non-GAAP G&A expenses, which exclude share-based compensation expenses were $242.6 million, representing a 11.3% decrease year-over-year.

Total share-based compensation expenses, which were allocated to related operating costs and expenses, increased by 43.7% to $15.8 million in the fiscal first [ph] quarter of 2021.

Operating income was $150.3 million, representing a 38.9% decrease year-over-year. Non-GAAP income from operations for the quarter was $166.1 million, representing a 35.4% decrease year-over-year.

Operating margin for the quarter was 15.2%, compared to 23.0% in the same period of the prior fiscal year. Non-GAAP operating margin, which excludes share-based compensation expenses for the quarter was 16.8%, compared to 24% in the same period of the prior fiscal year.

Net income attributable to New Oriental for the quarter was $174.7 million, representing a 16.4% decrease from the same period of prior fiscal year. Basic and diluted earnings per ADS attributable to New Oriental were $1.10 and $1.09 respectively.

Non-GAAP net income attributable to New Oriental for the quarter was $184.5 million, representing a 19.8% decrease from the same period of prior fiscal year. Non-GAAP basic and diluted earnings per ADS attributable to New Oriental were $1.16 and $1.15.

Net operating cash flow for the first fiscal quarter of 2021 was approximately $391.6 million. Capital expenditures for the quarter were $95.2 million, which were primarily attributable to opening of 42 facilities and renovations at existing learning centers.

Turning to the balance sheet. As of August 31, 2020, New Oriental had cash and cash equivalents of $1,047.6 million, as compared to $915.1 million as of May 31, 2020. In addition, the Company had $291.8 million in term deposits, $2,778.4 million in short-term investment.

New Oriental’s deferred revenue balance, which is cash collected from registered students for courses and recognized proportionally as revenue as the instructions are delivered, at the end of the first quarter of fiscal year 2021 was $1,563.1 million, an increase of 17.5% as compared to $1,330.7 million at the end of the first quarter of fiscal year 2020.

Looking ahead into the next quarter and the rest of the fiscal year 2021, despite the continued challenge from the COVID-19 pandemics are expected to remain, we are more clear about the recovery trends of the company in the near term financial performance and the market opportunity over the long run.

Our strategic focus and the investment approach this year aim at improving product quality, increasing teacher salaries and enhancing our industry leading system, which fully reflects our ethos of focusing on the essence of education in view of market competition and opportunities to take advantage of post-COVID market consolidation, we firmly maintain a stable and balanced investment strategy that would improve the quality of our education service, with aim to achieve sustainable and long term growth, as opposed to unhealthy short term growth that often requires excessive investments and higher cost to acquire customers.

As such, we will continue to focus on the following key areas. First, we will continue to expand our offline business. We aim to add around 20% to 25% capacity, including new learning centers and expanding classroom area of some existing learning centers for K-12 business in this fiscal year.

We believe our capacity expansion will prepare us to further take market share from the other players post-COVID, as we believe some small players without strong financial position and online class capability may not be able to sustain their business during the period. We expect the industry will undergo a wave of market consolidation upon the pandemic fade. The fact that we are a major player with strong financial capacity and fresh offline facility enable us to further strengthen the market leading position and penetration.

Second, we will continue to leverage our investment into digital technologies and introduce our OMO system in more offline language training and test offerings, especially for the K 12 distance and overseas test prep key business. The usage of the online tools and content in our OMO system for all business lines throughout the whole network will be enhanced. To our belief the whole online teaching experience will place more efforts to developing the best teaching content and courseware and also developing more advanced training programs to our teachers.

With all the above mentioned infrastructure in place, we’ll continue to pilot our OMO online initiatives in some major cities with high demand and higher operational efficiency. We believe that our OMO initiatives will be one of our growth engines to increase our customer acquisition post to COVID and enabling us to capture the market consolidation opportunity.

This revamped new business model will also accelerate our margin recovery in the rest of the year and further expand our long-term margin target. Here I have to highlight that all of these OMO products are supported by our offline classes. This supplements each other in a hybrid format. All the teachers, all the teaching content coursework materials, as well features and technologies are developed and originated from our existing offline centers and resources.

This integrated system continued to broaden our customer base, as we will enable us to reach students in satellite cities, as well as the cities where we have fewer learning centers to catering our – to cater a lot of customers. Furthermore, we will continue to invest in and implement new initiatives, including product development, teachers recruiting training, R&D, as well as the sales and marketing in pure K-12 after-school tutoring business, our Koolearn.com platform.

Third, our top priority will remain as the focus on controlling costs and reducing expenditures across the company to minimize the negative impact from the pandemic on bottom line. We believe we will resume the expansion of the overall non-GAAP operating margin this year-over-year as COVID-19 subside gradually.

Here I would like to stress that we have great confidence in the fundamentals of our business which we believe will continue to remain strong. Although we are facing various [indiscernible] impact from the pandemic, and we have been increasing our investment in different strategy. We remain optimistic of the brighter prospects of our business and believe our investments now bring us fruitful returns in the long run.

As the pandemic situation and restricting measures begin to ease in China, the timely reopening of old schools and our offline learning centers in September, the start of the new fiscal year. Its deemed to be a massive boost for our business. We believe this will we enable our recovery to pick up the momentum, which will likely to be reflected in the results in the coming quarters. We’re certain that with New Oriental’s leading brands, superior education products and system and the best teacher resources, we have the ability to and further into market share in China’s huge after school tutoring market and deliver long term value for our shareholders.

We’re looking at the near term and our expectations for the next quarter. We expect total revenue to be in the range of $863.7 million to $887.3 million, representing year-over-year increase in the range of 10% to 13%.

To provide to put down of the expected top line growth for key business lines, K-12 business expects to grow around 25%. Overseas test prep program is expected to decline 30% to 35% and overseas study consulting and study tour business is expected to be – to decline 0% to 5% all year-over-year in dollar terms.

We also expect to the overseas related businesses, including overseas test prep and the consulting service will continue to decline due to the pandemic around the globe caused by the cancellation of our overseas exam, suspension of the overseas schools and restriction on travel. The negative impact on this overseas related business will affect the entire education industry in China, not only for New Oriental and may last over the coming two or three quarters. Thus that, in contrast, China’s effective controlled pandemic situation has shed a more positive light on our business domestically. We’re pleased to see that we gradually resumed our offline operation in all cities that we are in by mid September, and the vast majority of the students in these cities have successfully migrated back to our learning centers from our OMO online classes.

To conclude, we’re now talking on all the operational actions to boost the enrollments and classroom utilization for the autumn semester, and to speed up the recovery of the business after the resumption of the schools and learning centers.

We’re confident that the demand for after school tutoring will gradually kick-off and trend toward normalized level in the rest of this fiscal year. I must mention that this expectations reflect New Oriental’s current preliminary view, which is subject to change.

At this point, I will take your questions. Operator, please open the call for this.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the line of Tian Hou from T.H. Capital. Please go ahead.

Tian Hou

Good evening, Stephen, Sisi. Congratulations on a good quarter and guidance in those kind of challenging time. So the question is related to the margin, on the gross margin on a year-on-year basis was down pretty significant. So I wonder how much is cost by the overseas business? And going forward, what’s the gross margin is going to trend? Thank you.

Stephen Yang

Hi, Tian. Yeah, the gross margin was down by roughly 6% year- over-year this quarter. I think the first reason is that, you know, the revenue was down by 8% in this quarter year-over-year. And in this quarter we still raise the salary of the teachers. And because we think the teachers quality is the core competence of the education business. So as we did in last several years, you know, we raised the teacher salary. And also, you know, we acquired the top teacher from the other small players during the pandemic.

And the rentals, I think that, you know, during the COVID-19 period, we still expanded our capacity in the areas where in the cities that we are – we feel the comfort to drive the potential of growth in the future. And this quarter the year-over-year expansion was 23% at the quarter end. So its drive the gross margin down, but I think it’s just out one time, okay, because, you know, as I said, our business is in the process of the recovery, and we have already give the guidance of the Q2 and within it in the Q2 guidance, you know, the K-12 business will be increased by 25%. So I do believe the GP margin recovery will be happened in the second quarter.

Operator

Thank you. Our next question comes from Felix Liu from UBS. Please ask your question.

Felix Liu

Good evening, management and congratulations on a good result, given the challenging environment. My question is on utilization. I understand that a lot of offline classes have resumed in most of the cities. So could you give us some color on what the utilization is like currently? And how is the trajectory going forward? Thank you.

Stephen Yang

Yeah. Hi, Felix. You know, it’s a little bit hard for us to disclose the utilization rate because, you know, we’re still during the – we’re still in the time of the pandemic. For example in Beijing school, our Beijing school – we opened all the learning centers in mid September, that means we lost almost 10 to 15 days in September. And during the whole summer, you know, I think some of our learning centers were not open. So it’s really hard for us to disclose the utilization right now. And I think we will disclose the utilization rate in I think the Q2 or Q3.

And – but you know, we believe the utilization rates will get higher and higher after the pandemic is over because typically our revenue growth is higher than the expansion plan. So I think that means, you know, we do have to leverage on the learning center utilization. So this is the near long term trend, Felix.

Operator

Thank you. Our next question comes from Jin Yoon from Newstreet Research. Please go ahead.

Jin Yoon

Hi, good evening. Just wanted to just talk about overseas test prep, your guidance kind of suggests obviously, the bottom is – the bottom is in, in terms of its site improvement from last year’s quarter – last year – last quarters numbers, can you just kind of talk about if that’s really the case or if we’re seeing a kind of a seasonal head fake?

And then – and on the other – the second question I have is, I think we’re seeing a massive testing in Qingdao [ph] approximately like 9 million people or something like I can just hit the press. Just wanted to see how big that revenue from that city is and in case there is a second wave in that particular city? Thanks.

Stephen Yang

Hi, Jin. The overseas test prep, the relative decline of this quarter for [ph] Q1 was 51%. But we give – we have already given the guidance of the Q2, the overseas test prep will be down by 30 – somewhere around 35%. So the things turn to be – turned to be better in Q2. And because you know, we have seen some like the TOEFL or GRE test were reopened in China in different cities. And – but anyway, I think our overseas test prep business will be negatively [ph] to some extent, negatively impacted by the by the COVID. And you know, the Q1 this quarter will be the – was the worst.

And I do believe the overseas test prep business will be recovered step by step. So, this is my answer focused about overseas test prep. And Qingdao, we know what happens in Qingdao since last week. And so far, we don’t get any notice from the governments of the surrounding [ph] schools. So that means our learning centers in Qingdao are still open now. But anyway, we’ll leave [ph] the requirements of the government.

But you know, during the – I think during the peak time of the COVID-19 times, I think we have the ability to move all the offline courses to online. You know, we tested the effects for yeah for too long [ph] of the pandemic. And so I don’t think it will negatively impact our revenue of Qingdao. Anyway, Qingdao is now [ph] the relative contribution from Qingdao is very small, Jin.

Operator

Thank you. Our next question comes from Mark Li from Citi. Please go ahead.

Mark Li

Hi. Thank you for taking my question. I want to ask…

Stephen Yang

I’m sorry, I can’t you very clearly.

Mark Li

Hi. Is it better now?

Stephen Yang

Hi, Mark. I can’t hear you.

Mark Li

Hi. Is it better now? Hello.

Stephen Yang

I think the line has some problem. Try it again.

Operator

Mark, can you come closer to the mouthpiece please?

Mark Li

Hi.

Operator

Raise your voice, okay?

Mark Li

Okay. I just want to ask how is our FY ‘21 guidance? Could you share the latest guidance for the full year with us? And also our OP margin target if we haven’t changed and the timing to reach that? Thank you.

Stephen Yang

Okay. Yeah, actually, you know, we have already given the guidance – give the guidance of the Q2 and by 10% to 15%. And, you know, actually the business is not fully recovered in Q2 the autumn quarter. Beijing school was reopened in mid September. And we expect the revenue growth in the coming Q3 and Q4 will be better than Q2 because of the more recovery of our business and easy comparison of this year, you know, the COVID-19 started seems a lot easier [ph] to please. So we do believe our top line growth performance in Q3 and Q4 will be better than Q2. Okay.

And margin guidance. Yeah. I think I see Q2, the next quarter, the margin, we believe the margin decline in Q2 will be continues to narrow down compared to this quarter to Q1. And we’re confident that we’ll be able to deliver the continued margin expansion after the pandemic is over, especially in Q3 and Q4. And we don’t want to change our near long term margin guidance. Mark, is it clear?

Operator

Thank you. Our next question comes from Alex Xie from Credit Suisse. Please ask your question.

Alex Xie

Hi, Steven. So thank you for taking my questions. So my first question is about the good time [ph] of your net quarter K-12 revenue guidance. So I think in all the August quarter, its very unusual that POP Kids was a little bit slower than U-Can business and what about the next quarter?

And the second question is about the rollout of your OMO business model? I think I read from the news report that you launched the pure online and small class model in our Hangzhou school and received very positive feedback from the province wide students. Would you please share more color on that? And what’s the time for the further rollout? Thank you.

Stephen Yang

Yeah. Your first question about – Alex, can you repeat your first question again?

Alex Xie

Sure, sure. So I noticed that in August quarter, the POP Kids business was a bit slower than U-Can business and what about the next quarter within the 25% growth, what about the difference between POP Kids and U-Can?

Stephen Yang

Okay. I think, you know, next quarter, Q2, I think the growth rates of the U-Can business will be a little bit higher than the Pop Kids business growth. Because, you know, the U-Can business is more mission critical. So for the middle school, high school students, they tend to study more, especially after COVID-19. So that’s why the growth of the U-Can business growth higher than the Pop Kids business.

And yeah, it’s a great question. Actually, we started the OMO business 3 years ago, for our Beijing school U-Can business, but after the COVID-19, you know, we strengthened the development of our OMO, because, you know, during the COVID-19 almost all of our students took the courses, pure online. But you know, after the COVID-19 vast majority or students goes back to the offline learning centers, but it will choose some percentage of the online course for those part of the students and also for some new solid cities, we started to roll out the new OMO model. Yeah, I think the Hangzhou is very good case. And, you know, this is the first year that the Hangzhou school did the OMO model. So you know, Hangzhou school acquired a lot of the new customers of the grade 10 students from the satellite around Hangzhou. So I think it’s a very good start, and we will roll out in more and more cities and provinces.

Okay. And, and one more thing is that you have a retention rate of OMO model in how the school, I think, you know, after the summer is over 50%. So I think it was a very good sign for the study results of the OMO model. So we’ll do it more and more in more cities. Sisi, do you want to add something?

Sisi Zhao

Yeah, we’re – as Stephen emphasized earlier in the prepared remarks, actually we have piloted this OMO model in around 20 cities already, just in the summer only recovered – resumes the offline operation from the summer. And then we have already testified this model in several cities, key cities, and the feedback is good. So that continued to be the key strategy going forward. Yeah.

Alex Xie

Okay.

Operator

Thank you. Our next question comes from Sheng Zhong from Morgan Stanley. Please go ahead.

Sheng Zhong

Hey, good evening. Thank you for taking my question. My question is on the OMO as well. So want to understand more about how to offer this OMO model. So for the local who had what’s the key KPIs for OMO? And so if – so how will he balance to open new learning centers or push more OMO into these new cities? Or is this because you have pure online as well? Or is pure online will mainly focused on the surroundings? Thank you.

Stephen Yang

Yeah. Hi, Sheng Zhong. I think it’s a great question. We set up the KPI, you know, off the school has [ph] I think KPI of the school has divided by two parts, the tradition – number one, the traditional offline business. And second is the new OMO model. So two different KPI.

And I think its easy to understand the local school have made the decision, you know, for those areas that we are aware, we do have the learning centers, I think we need to be OMO, okay. And, you know, we will still use our learning center, our learning centers to acquire the new student enrollment.

And – but for the areas where we don’t have the learning centers or for the new cities, we don’t have the learning center where the OMO will be first deployed. And – but, you know, as I said in the pre prepared remarks, all the content and courseware and teacher resources, even the teacher training system of the OMO model are reasonably from the local city, okay. But you know, the head office will give the fully support to the different areas and different cities. So we will go out [ph] feed OMO model to more cities going forward. And as you believe the OMO model will contribute more and more revenue going forward.

And yeah, one more thing to add, and, you know, we don’t want to spend crazy money on marketing expenses for the OMO model. So I think the students acquisition cost for the OMO model will be very low. I think it will be the same as the – our traditional offline business.

Operator

Thank you. Our next question comes from the line of Lucy Yufrom from Bank of America Securities. Please ask your question.

Lucy Yu

Thank you, Stephen, Sisi. So I would like to ask the question on dual teacher. Stephen, you just mentioned that when we penetrate into new cities, actually OMO will be the first choice. So how about dual teacher model, are we still going to roll that out? And as far as I can understand that previously, before OMO rollout, we were using the dual teacher to penetrate into lower tier city. So nowadays, what’s and offer choice in terms of business model in new cities?

And secondly, you mentioned that in dual teacher model we have seen improving probability and the retention. So we – so could you share more number on the probability and retention of dual teacher business model? Thank you.

Stephen Yang

Yeah. I think going forward the OMO model will be the first choice we run a business in the new cities, especially for the larger cities. But you know, we are doing well for the dual teacher model. We opened more and more the new cities by the – of the Pop Kids and U-Can program. But you know, going forward, we will focus more on the model, but the teachers in the head office will test [ph] the dual teacher model class to the low tier cities. Typically it will – it’s focused – more focused on the past students in the high tier and low tier cities. So we have the two way to run the business in the low tier cities OMO and dual teacher model, Lucy.

Operator

Thank you. Our next question comes from Alex Liu from China Renaissance. Please go ahead.

Alex Liu

Thanks, Stephen for taking my question. First on teacher compensations, how fast should we think about a teacher compensation world [ph] Going forward, especially some online players are rather aggressive in terms of teacher paying out?

And second question is that, you know, regarding the strong summer enrollment growth, I was just wondering, you know, is there any specific reasons behind or any specific sort of observations in the summer? Why we did so well this year, and how much of the growth is coming from small player exiting the market? Thank you.

Stephen Yang

Alex, I think the teacher salary, yeah, we think the teachers quality is the core competence of the education business. So we raised the teacher salary by 8% to 9%, every year, even with phase to the challenge during the period of the COVID, we still – we still did the same thing. I don’t think the teacher salary increase will drive the margin. On the contrary, paying the teacher more will bring us the high quality or high quality feedback from the customers, students and parents and drive the utilization rate up and revenue up.

So I think we pay – I think we pay more the teachers will help the GP margin performance better near term and long term. So, you know, I think this is our strategy for the teachers.

And, yeah. And the second question is about a summer [ph] enrollment. Yeah, I think, you know, spring semester we met some problems par of the new customers, because of the COVID. Well, we couldn’t – or couldn’t see the students and parents face to face. But, you know, during the summer [ph] quarter, you know, most of our learning centers were reopened. So we can give the – like the study advices to the parents and kids face to face.

And as for the competition environment, yeah, we know some small players disappear from the market. So I think its great opportunity for the big players like us to take more market share from the markets post COVID. And, and the numbers especially, you know, since the second half of July, because revenue and the enrolment numbers was booming. And so that’s why we give the guidance of K-12 business growth in the second quarter will be somewhere around 25%. And I do believe the enrolment growth and revenue growth in Q3 and Q4 will be even better.

Alex Liu

Thank you.

Operator

Thank you. Our next question comes from DS Kim from JPMorgan. Please ask your question.

DS Kim

Hello, sir. Hi, Sisi, congrats on good set of results and very good guidance. Actually, most of my questions have already been answered. So maybe I can just follow up on OMO. Can I double check when you say this new piloting [ph] OMO are we referring to pure online, localized curriculum classes, like PO [ph] online? And if so, can I check what’s the size of the each class ASB gap [ph] with the similar offline courses and if there’s any difference in offering i.e., you know, this OMO is more for the weekdays versus weekends or more for short term courses or is really just same as our offline offerings?

Stephen Yang

You know, we were really the new OMO model by three ways. Number one, the large classes, that means the large classes. And, you know, this is totally, you know, majority of the classes haven’t [ph] been online, and I think the price of the – or that part of the course, I think it’s 20% to 30% lower than our normalized classes.

And secondly, [indiscernible] OMO class, you know, its a hybrid class or – and its offline and online the integrated classes. And the last one, and number three, is there’s some very short term courses. I think the typical purpose of those part of the business is to acquire the new student enrollment [indiscernible] courses. And we ask for the famous teachers to record the courses. And I think this is kind of the way to ask the banking way. So we have the three ways.

Anyways, OMO is still in the early stage, having so far, so good, and we’ll do more going forward. So in last quarter or even the rest of the year, the earnings [ph] call, I will show more information with you.

DS Kim

Thank you.

Operator

Thank you. Our next question comes from Tommy Wong from China Merchant Securities. Please go ahead.

Tommy Wong

Hi. Thank you, management and Stephen, congrats on the strong results. Just a quick question, I guess we don’t have a lot of time left, can you comment about secondary listing in Hong Kong. And, you know, potentially, you know, we need more funds to compete on the online space, you know, all these other guys tell whoo [ph] they’re all burning a lot of money. And if we want to play in this game, we have to kind of participate. So just wondering, you know, if the secondary issue bring some more money and play the game. Just wondering, what’s your thought on that? Thank you.

Stephen Yang

We’re not in a right position to make comments on secondary listing. And as I said, you know, our strategic focus and investment approach this year, not only this year, but also the mid and long term, okay, well, is aimed at improving the product quality, increasing the teacher salary, and enhancing our system. I think these are the essence of the education.

So we know there’s a huge opportunity in the market, especially after COVID. We firmly maintain the stable and balanced investment strategy. And we want to spend pretty money on marketing and get helping short term growth. So this is our strategy, not only for now, but also for the mid and long term. Thank you.

Operator

Thank you. Our next question comes from Liping Zhao from CICC. Please go ahead.

Liping Zhao

Hi, Stephen, for taking my questions. My question is about the capacity expansion. How should we expect the impact of this pandemic on your capacity expansion plan, especially for your K-12 business? And any chance we can see an accelerated expansion during the market consolidation? Thank you.

Stephen Yang

We aim to add around about 20% to 25% new capacity in the fiscal year ‘21. And so you know, last year we plan to open 20%. Finally, we opened 26%. And this year, we made the same plan. And anyway, I think it’s a great opportunity for us to take more market share. So we will open 20% to 25% new capacity to acquire new student enrollments. And also you know, we do have the OMO model. And so the two is new capacity expansion and OMO will bring us to new customers in the whole fiscal year ‘21. And yeah, our strategy of the expansion is very stabilized. Thank you.

Operator

Thank you. Our next question comes from Felix Liu from UBS. Please go ahead.

Felix Liu

Thank you. Just want to have a follow up question on our deferred revenue balance. I noticed that the growth in deferred revenue is a lot stronger than our Q2 revenue guidance, can I know there is the reason behind? Thank you.

Stephen Yang

Because of the pandemic phase in China, especially in the summer, and so as I said, in the second – since the second half, July and the revenue and enrollment gross was booming. And so that’s why we got the higher deferred revenue balance this quarter end. And I think, in the Q2, the – you know, we’re still in the process of the recovery. I think even in the Q3 and Q4 you will see higher enrollment and top line growth of the – especially for the K-12 business, because I do believe we are taking the market share from the small players and also – and we do believe we will have – even higher student retention rate going forward, because we invest a lot since 4, 5 years ago. And we do believe we are providing the one of the best products in the market. So I think the recovery will have step by that and more back loaded Q3 and Q4. Thank you.

Operator

Thank you. 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.

Stephen Yang

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.

Operator

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

Source Article