Apr 24, 2013
Executives
Sisi Zhao - Director, Investor Relations Louis Hsieh - President and CFO
Analysts
Tian Hou - T.H. Capital Philip Wan - Morgan Stanley Mark Marostica - Piper Jaffray Ella Ji - Oppenheimer Steve Zhang - Macquarie Fei Fang - Goldman Sachs Chai Wang - Merrill Lynch Vivian Hao - Deutsche Bank Cynthia Meng - Jefferies Trace Urdan - Wells Fargo Securities Charles Cartledge - Sloane Robinson Peter Cannon - Black Crane Capital (ph)
Operator
Ladies and gentlemen, good evening and thank you for standing by for New Oriental’s Third Quarter of Fiscal Year 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode.
After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded.
If you have any objections, you may disconnect at this time. I would now like to turn the call over to your host for today’s conference, Ms.
Sisi Zhao, New Oriental’s Investor Relations Director. Ms.
Zhao, please go ahead.
Sisi Zhao
Hello everyone, and welcome to New Oriental’s third fiscal quarter 2013 earnings conference call. Our financial results for the period were released earlier today and are available on the Company’s website as well as on Newswire services.
Today, you will hear from Louis Hsieh, New Oriental’s President and Chief Financial Officer. After his prepared remarks, Louis will be available to answer your questions.
Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the 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. Louis, please.
Louis Hsieh
Thank you, Sisi. Hello everyone and thank you for joining us today.
First, the entire New Oriental family would like extend our warmest wishes to all the victims and those affected by the devastating Sichuan earthquake. We have donated RMB 2 million for the earthquake relief fund to help victims and assist reconstruction efforts.
New Oriental stands ready to do more as needed. And before we discuss results, I would like to make a correction, there is this error in the earnings release that was released several hours ago.
Under Michael Yu’s quote in the second page of the earnings release it says New Oriental’s Chairman and Chief Executive Officer, commented, we are pleased to report solid results for the third fiscal quarter with sustained top-line growth of 28.6%, which was well above the guidance range of 22% to 27% growth; that’s incorrect. The guidance range is actually 25% to 30%.
The 22% to 27% excludes the elite business. So, it should be at the high end of the guidance at 28.6% which is within the 25% to 30% guided that we have given.
So we apologize for that error in the earnings release. Now going to the third quarter, our results for the third quarter are encouraging and I am particularly pleased that after a tough few quarters, we are now seeing some very solid operating leverage and improvement in key areas.
As you know, since last October we have been committed to reducing costs and improving operating efficiency through our network. We are now seeing those efforts starting to pay off, with a healthy improvement in GAAP operating margin to 10.8% this quarter, compared to 10.2% in Q3 of last year.
But I'm also encouraged that this new improved bottom line performance has not come at the expense of revenue growth. We have maintained a very healthy balance between efficiency and expansion and as a result our revenues are up 28.6% year over year, and we are at the high end of our guidance range of 25% to 30% growth.
Reducing costs, these results demonstrate that our pivot from our previous occupy the market strategy to our harvest the market strategy, which was announced on our fiscal year 2013 Q1 earnings call last October is starting to bear fruit. But the core of the strategy is an emphasis on raising operating efficiency and improving profitability.
During Q3 we further reduced our headcount by approximately 1,200 to about 31,600 employees and we expect to decrease headcount by another 300 to 600 during this Q4. This means we will end the fiscal year at approximately 10% fewer employees than the number we had before we pivoted to the harvest the market strategy, which clearly demonstrates how committed we have been to reducing overhead and driving efficiency.
In the same vein, over the last quarter we reduced the number of learning centers in operation by 11, closing 22 underperforming centers and opening 11 new centers in fast growing markets. Learning center expansion is now strictly controlled from headquarters and new openings must have my finance department's approval to ensure that we are only opening in locations that make financial sense.
In Q4 we expect to close another eight to 10 more underperforming learning centers which, we're opening a small number of new centers in other profitable locations. In our peak Q1 2014 quarter during the summer, we will probably open very few new centers if any at all, because we intend to focus on maximizing utilization during all important summer season.
I want to make clear though that we are absolutely not sacrificing market share expansion in search for profitability, far from it. In fact thanks to the success of our occupy the market strategy, we are on track to being number one or number two in all of our key geographic markets.
Importantly, we are now focused on building up our utilization rates in those key markets and driving profitable growth. We recorded very healthy revenue growth this quarter driven by continued improvement in ASP’s and encouraging signs of turnaround in our two largest markets.
In Beijing and Shanghai, the management changes we implemented several quarters ago, are already having an impact. Senior management has been very focused on improving the performance of our schools in these two crucial markets.
I am pleased to say that our scores in these two cities combined, revenue was up 17% and net income up 9% in Q3. We still have some ways to go to get things right but the progress so far is very positive.
On a blended basis, ASPs have improved 14% this quarter. This is encouraging, particularly when you consider that much of our growth is now coming from cities outside of Beijing and Shanghai, where ASPs are lower.
Thanks to our premium brand, New Oriental is still able to command a premium price versus our peers in these markets. There are obviously in economically (ph) developed cities the price point is for the most far lower than in the Beijing and Shanghai.
This has a depressing effect on the ASP growth. This strict fiscal discipline and strategic activity to harvesting the market throughout Q3 has driven strong margin improvement.
This is a first time in six quarters that we have grown year over year operating margin but I am very confident that we have plenty of room for further and faster improvement in the quarters ahead. First, we are still carrying through some of the costs associated with our school closures and headcount reductions and we'll continue to see some impact from these through the end of the fiscal year in May.
Second, utilization rates are now well below optimal, although they are improving so our classrooms in our newer buildings are still up, you would naturally see that transiting into a better performance on the bottom line. All in, I am confident that the 12% GAAP operating margin that we have seen over the last four quarters prior to this Q3 release represents the floor.
From here, I believe we can grow margins even more quickly in the coming quarters and we should be able to increase operating margins by at least 200 to 300 basis points by the end of fiscal year 2014 in May. Turning to enrolments, we experienced a slight decrease in this quarter, but it’s important to understand that this is not a trend.
First, you have to remember that we have closed around 30 learning centers over the past two quarters. Each of these facilities probably had an average of around 1000 to 2000 student enrolment each year.
Second, enrolments in our legacy offerings of adult English in CET 4 and 6 domestic test prep continue to decline in the quarter, and are down approximately 26% year-over-year to approximately 87,000; compared of 117,000 in the year ago period. And the third and most important factor is the later timing of Chinese New Year holiday this year.
As you noted in the release, the holiday was later in 2013 than in 2012. Therefore, a significant portion of spring enrolments were pushed into the Q4 quarter.
Those of you who have been following New Oriental for a number of years will be familiar with this effect. When Chinese New Year occurs early, spring semester starts earlier and we get a nice bounce in enrolments in Q3.
When it falls later, enrolments get pushed back into Q4. If you look back to last year for example, when Chinese New Year was two weeks earlier on January 23, 2012; we experienced a 22% growth in enrolments in Q3, and just 7.7% in Q4 of last year.
As evidence to this effect, in the first six weeks of our fourth quarter we recorded a noticeable 14% increase in enrolments year-over-year and 34% increase year-over-year in cash receipts, as cash collected in advance for enrolments. So as I’ve said, it’s important to look at Q3 and Q4 enrolments combined, rather than split them out because the timing of Chinese New Year often confuses the case.
If you strip out the seasonal factors for this year, we are still looking at a very healthy organic growth rate of 6% to 9% in a period of learning center contraction. If we add our total 80 to 120 learning centers per year, that’s a normal pace, the enrolment growth would likely be a healthy 10% to 13% or 3% to 4% higher than the organic rate.
Turning to our individual business lines, we continue to see strong and healthy growth across all our core offerings. Our K-12 all subjects after school tutoring business continue to impress.
We recorded very healthy gross revenue growth above 44% year-over-year during the third quarter. Our VIP personalized class business also did well with year-over-year cash revenue growth of about 29%.
I want to highlight once again that we hold significant price advantage over our peers in the VIP personalized classes, which is a big help in our operating margin in this segment. And in overseas test prep and overseas study consulting, we remain the dominant market leader in China.
As I mentioned last quarter, we have been rolling out our overseas study consulting services in more schools and centers where we already provide overseas test prep, and we're encouraged by the obvious synergy and cross selling potential between these two businesses. This quarter we recorded a combined revenue growth of over 22% across these two lines.
Finally as I mentioned just now, the popularity of our legacy businesses lines of adult English and domestic test prep is waning. We have long expected this fall off since the success of our K-12 and overseas test prep segments will obviously cannibalize the adult English and domestic test prep segment's market.
While this quarter's drop off in enrollments was sharper than previous quarters, we are encouraged that the decline is being more than offset by growth enrollment in revenues from our other business lines. Before I move on, we'd like to iterate that we haven't yet seen material negative impact from the spread of H7N9 virus in China and we're hopeful, so long as there are no cases of human to human transmission the impact on our business will be minimal.
Those of you who were with us through H1N1 and SARS will remember that once significant instances of human to human transmission were discovered, the Chinese government issued orders banning large gatherings of people and closing educational establishments. If this does happen with H7N9, and we hope it doesn't, past experience suggests that we will obviously see some short term impact for one or two months while the restrictions are in place but we will also experience a healthy rebound afterwards, once students are allowed to go back to class and pent up demand is released again.
Finally, let me give you some more color on some of our few financial metrics for this quarter. Selling and marketing expenses for this quarter increased by 14.5% year-over-year to $31.6 million, primarily due to the increase in the number of customer service representatives.
I do want to flag that this growth in selling and marketing expenses is well below the rate of revenue growth of 28.6%, and actually 8% down on selling and marketing expenses from Q2. This is in line with our goal of driving improved efficiency across the network.
Furthermore, the actual brand and marking promotion expense for the quarter declined approximately 13% year-over-year to approximately $11.1 million. General and administrative expenses for the quarter increased by 29.6% year-over-year to $72.2 million, primarily due to the increased headcount.
Again though, I wanted to highlight that G&A expenses are down 7% quarter-on-quarter, which shows how our efficiency measures are taking hold. Also, do remember that we are carrying through some cost associated with the closure of learning centers and headcount reductions as we still have more room to improve here.
As I have highlighted already, GAAP operating margin in the quarter was 10.8%, compared to 10.2% in the same quarter last year. On a non-GAAP basis, operating margin for the quarter was 13.8%, compared to 13.5% in the same period last year.
Capital expenditures for the quarter was $16.1 million. This was primarily invested in the opening of 11 new learning centers, which I mentioned above.
Also, we purchased one floor of a building in Changsha, that we're using the headquarters for the city’s operation. Before we move to the Q&A section, let’s quickly review our current expectations for Q4.
We expect total net revenues in the fourth quarter of fiscal year 2013 to be in the range of $232.8 million to $$242.2 million. As you may recall, ELITE English contributes revenues of approximately $4 million for the fourth quarter of fiscal year 2012, and we disposed the business in the first quarter of 2013.
So if you strip out the impact of the disposal of ELITE English business, we are forecasting year-over-year growth in the range of 23% to 28%. Compared to our reported net revenue for the fourth quarter of fiscal year 2012, which includes revenues from ELITE English, our projected year-over-year revenue growth for the fourth fiscal quarter would be in the range of 20% to 25%.
This forecasted estimate is current and preliminary view, which is subject to change. At this point I will take your questions.
Operator, please begin.
Operator
Thank you. The question-and-answer session of this conference call will start in a moment.
In order to be fair to all callers who wish to ask questions, we will take one question at a time from each caller. If you have more than one question, please request to join the question queue again after your first question has been addressed.
(Operator instructions). Your first question comes from the line of Tian Hou from T.H.
Capital. Please ask your question now.
Tian Hou - T.H. Capital
I have a question regarding the learning centers in a closure and opens. So, I would like to know among of the 30 centers that you have already closed, what was the criteria for shutting them down and where are they located and so for what reason you shut them down.
So that’s number one. Also, related to learning center, now you are also opening more and just so, what is ongoing basis, what is the plan for how many you want to continue to shutdown, how many you want to open?
That’s the question.
Louis Hsieh
That’s a very good question Tian, thank you. What happens now is that the finance department and the HR department jointly do an analysis of every learning center in New Oriental.
So all 700 plus learning centers. We look at learning centers, the ones we look to close are the ones that are been underperforming for one or two years or we don’t believe will ever become profitable.
So that’s the criteria we look at based on the performance of the learning center to date, and whether it’s ramping according to what our typical learning center will do. In that case, we will go to the school head and ask for those centers to be closed and they'll have an opportunity to answer and make a case whether they should or should not be closed.
So those are how we have closed 30 in two quarters and probably another 10 to go. So we'll probably end up closing about 40 to 45 learning centers for the year.
And the learning centers are in all cities, including Beijing and Shanghai, any area where the learning centers are underperforming as far as utilization or as far as the ramp up in enrollments. They have been open for several years and still not profitable there.
On the how we open up new learning centers is that we look at utilization of the whole city and of each learning centers around there. So, the fast growing cities that are of high profit margin and have high growth rates, we will allow them open learning centers to capture the market.
So most of the learning centers are being open now in tier 2 and tier 3 cities, they’re not into tier 1 cities. So, as far as going forward, we'll probably end up this fiscal year with, we have 733 now, we’ll probably end up somewhere around 720 to 730 for the fiscal year.
So it means we’ve added zero almost of the whole year, and next year we will probably open no more than 50, of which we probably won't open them in Q1. The ideal for us to open them in the slow season of the fall and then some in the winter and spring but not in Q1 this summer.
So that’s why we are expecting the next three quarters to be very highly profitable as we are confident the operating margin is going to go up quite fast.
Operator
Next question comes from the line of Philip Wan from Morgan Stanley. Please ask your question now.
Philip Wan - Morgan Stanley
My question is about your VIP business. Could you comment on how much contribution in terms of revenue enrollment for this quarter?
And then also looking forward, as you mentioned previously that New Oriental would probably like to control the growth of 101 and focus more on the small to your large class format, but how effective could you be so if the demand in China is indeed shifting towards the 101?
Louis Hsieh
Well I do not know, we want to conform the 101 growth Philip. What we want do is that we don’t want to open up anymore learning centers in 101.
So, we want to make them as part of the other learning centers together. Therefore students can take 101 but what happens is if they want to stay on the 101 course, it's going to fill up quicker because we are not opening up a lot of new centers.
So to in the locations, we have they will fill up there. Second thing is that we are increasing the price on 101, so it's more cost effective for students to select a small class and large class offering and we are giving incentives to the learning center because operating margin is the key metric for the school head to encourage more large class and small class that is going up.
So you can call it control the growth of 101. I think it would be more as we opened up almost 500 101 centers in the last three years.
Once we stop doing that, the utilization will go up. When the utilization goes up obviously the enrolment growth there will go down.
So the utilization will go up, that means the margin will go up.
Philip Wan - Morgan Stanley
What about the contribution of…
Louis Hsieh
It is about 30% of revenue for the quarter. The enrolments is much less because the ASPs are so high I do not know exact percentage of enrolment were VIP but it is normally about 7% or 8% Philip.
Operator
Thank you for your questions your question comes from the line of Mark Marostica from Piper Jaffray. Please ask your question.
Mark Marostica - Piper Jaffray
My question is related to the expenses that your carrying forward that are tied to the learning center closures and the headcount reduction. Could you give us a sense of those expenses Louis and when you expect them to kind of peder out?
Louis Hsieh
I think they should peder out Mark by the end of this year so in Q4. I think the total amount, I do not have a student breakdown by quarter because it's a fluid process.
We will be somewhere between $4 million and $5 million for the whole process and that it should not occur again next year. We are looking in some closure and some reduction expenses each year.
I would like to make new policy of New Oriental that we left over the bottom 3% to 5% of performers each year. So we are discussing right now and if so that’s the case, then we will have other seventh class on an ongoing basis.
But for this one restructuring, I thing their cost should be finished by the end of Q4.
Mark Marostica - Piper Jaffray
And then, one follow-up regarding utilization; could you talk about what your utilization was, you experienced in the quarter and then your goals going forward.
Louis Hsieh
Utilization, we change the way we measure it. So I think the current way is actually much more accurate which is that we look at every season, every time that can be open.
In past years we would measure utilization, that if the class opened, we’d count it as a utilized class, the whole class even if it is only half full or one quarter full. Now we count it by every seat that’s in that classroom.
So utilization rate always goes way down. So our total physical real utilization rate is somewhere around 20% to 25% and so it’s very low.
That’s why we believe we can afford not to open learning centers for the rest of this year, on a net basis, and also through Q1 of this year, and still maintain the high 20% to 25% revenue growth.
Operator
Your next question comes from the line of Ella Ji from Oppenheimer. Please ask your question.
Ella Ji - Oppenheimer
With regard to your performance that Beijing and Shanghai school, it’s good to see revenue growth rebounded, but it seems that net income is too growing slower than revenue. I wonder if you can talk about the margins outlook at these two schools and when do you think the margins will also achieve year-over-year improvement?
Louis Hsieh
I think the margins were improve in Q4 and Q1. So they will improve immediately now.
The reason the profit margin is lower is because Beijing and Shanghai had a lot of learning centers that were closed. So we had 17 learning centers last year, and it was too high, so some of them were closed.
Also Beijing and Shanghai have had more of the impact from adult English and the CT4 and 6 decline, and those are typically larger classes in higher margin. So those, I think, is beginning to subside and so I think Beijing is set up for substantial margin improvement in the quarters ahead and that will drive the whole company.
Because Beijing is so critical to our business. Shanghai is still work in progress, but as we said in the script it is actually encouraging.
So, we believe that Shanghai is getting better and the margin will also improve in starting in this quarter and for sure in Q1. So, you are borrowing some kind of disaster from a pandemic, Q1 is set up to be a very strong quarter either for Beijing and Shanghai.
Ella Ji - Oppenheimer
And if I can sneak in one more; I know you have close to 900 million of cash on balance sheet and you just announced the 50 million share buyback but any thoughts with regards to another dividend?
Louis Hsieh
Yes, we discussed that yesterday. And I saw your note and you jumped the gun on us.
I think as you know, if the share price is low, we will probably do a buyback. As one of the six Board members I am committed to pay a dividend this year.
But we would like to look at the Q4 results. So what the Board decided to do is look at after Q4, if the results are descent then we will most likely declare a dividend as well one equal to or larger than last year's.
But it's not done until it's done. The issue again is the sticking point is the tax that you have to pay to take the money out of China.
So, we will do what Apple does but we will do it in two steps. We will do a buyback first and then a dividend, just putting it together.
Yes, of being $100 billion, we will probably be $100 million to $110 million total, between the two. But like I said, you can’t hold me to that until we get Board approval.
Because this is just me talking, I of course want to pay a dividend. I don't think we can use the money more efficiently and I'd like to reward our shareholders for sticking with us.
And after the Q4 earnings we will have a Board meeting and that will be one of the top items in the agenda.
Operator
Thank you for your questions. The next question comes from the line of Steve Zhang from Macquarie.
Please ask your question now.
Steve Zhang - Macquarie
I just have a follow-up in terms of your school expansion plans in FY14. So, it seems like your competitor is also planning to start re expanding, one of your larger competitors to re-start spending in the second half of their fiscal year.
Is there a reason for this or do you see that this is a necessary move concerning how the landscape it is shaping out to be?
Louis Hsieh
Well I think for us is we've already gone through that expansion, right? I mean we have gone through 500 leaning centers in three years.
So, I think because you have had a prolonged expansion phase, we can have a longer harvest phase. I think, I know which competitor you’re talking about.
I think as they had one year expansion phase followed by a one year contraction. I think in their situation I think it’s because their key market of Beijing, because of a governance policy change has made that business stop growing or shrink and so therefore they have to see growth in other markets.
We don’t have that program. So there are other markets we’ve already established in 50 cities, we have all but 120 learning centers outside of Beijing and Shanghai.
So we have 80% of our network outside of Beijing and Shanghai already. We don’t need to grow those kinds of numbers.
In the ideal word, we would add 80 to 100 leanings centers a year, which means we have 80 to 100 learning centers, that’s about 80,000 to 100,000 enrollments a year. So, that’s why the enrollments look low because this is pure organic growth in existing learning centers and we’re cutting learning centers.
So, if you look at the normal year, we probably organically grow about 8% enrollments, another 4% from new learning center growth. So, that’s why the number looks low for this year because we’ve added no learning center in spite of cutting learning centers and basically enrollments are falling because the students went away because we close the learning center.
That will not happen in future years. So the knock on our numbers this time is your student enrollment decrease.
Of course they’re decreased, we closed 30 learning centers and we added none essentially for the whole year. So, enrollment year, like last year we added 200 learning centers that’s the enrollment numbers were so high.
So we want to get operating margin. So, we sacrifice some growth for that operating margin expansion.
I think it’s the right balance.
Steve Zhang - Macquarie
Okay, sure. Does that mean the linearity of your operating margin going forward would be more loaded in the first half of fiscal ’14 and the expansion won’t be as appearing this second half next year?
Louis Hsieh
I you are going to see a huge expansion in Q4, Q1, and Q2 of next year. So this time next quarter, Q1 and Q2, because they were quite poor last year, right, to be honest because we added large numbers of learning centers in those three quarters.
Sorry, in Q3, Q4 and Q1 of last year. Therefore, I think this year because we’re not adding any learning centers we’re actually making that zero because of the closures.
Then that means that you’ll see what this business model really looks like, which is a much higher operating margin than 12%. Our target operating margin should be 18% GAAP and 21% non-GAAP over the next couple of years.
Operator
Thank you for your question. Next question comes from the line of Fei Fang from Goldman Sachs.
Please ask you question.
Fei Fang - Goldman Sachs
First question is regarding your deferred revenue. So on the balance sheet the revenue growth has declined sequentially from about 38% or 39% in the past few quarters to right now it is about 23% year-on-year in 3Q.
So, how much of the decline was related to the Chinese New Year timing versus say the controlled expansion of the 101 format? Thanks.
Louis
Yes most of it is related to the CNY change Fei. So if you look at the first six weeks of this quarter, revenue reaches about 34%.
And so really probably most of it is due to the CNY affect and then there is a significant affect due to the controlling 101 as well as you call it controlling because 101 students pay for two or three quarter in advance. So they pay a much larger amount that builds up the balance, two quarters they built up balance of the deferred revenue.
So I think is that it is probably slightly more because of the Chinese New Year effect the 101 slowdown is an intentional slowdown on our part is also having affect. I think the revenue for Q4 is shaping up quite healthy.
I think overall we will still grow 20%-25% total and higher than 23% or 28% if you exclude the ELITE business.
Hsieh
Yes most of it is related to the CNY change Fei. So if you look at the first six weeks of this quarter, revenue reaches about 34%.
And so really probably most of it is due to the CNY affect and then there is a significant affect due to the controlling 101 as well as you call it controlling because 101 students pay for two or three quarter in advance. So they pay a much larger amount that builds up the balance, two quarters they built up balance of the deferred revenue.
So I think is that it is probably slightly more because of the Chinese New Year effect the 101 slowdown is an intentional slowdown on our part is also having affect. I think the revenue for Q4 is shaping up quite healthy.
I think overall we will still grow 20%-25% total and higher than 23% or 28% if you exclude the ELITE business.
Fei Fang - Goldman Sachs
Second question, regarding the margin expansion for the quarter, what is some of the rationale for management to control amortizing budgets and in a constant spend and what impact should we expect on revenue growth in the medium term say after 1Q next year?
Louis Hsieh
Well you would remember if you are not opening your learning center you do not need to spend money on marketing. So contrary to what some people believe, most of the marketing spending is when you open new learning centers.
So, if you are not opening new learning centers, the marketing spend already goes down. New Oriental's word of mouth is so strong, the brand name is strong, the existing leaning centers fill up on their own.
We do not really need to spend a lot of money in marketing. It is for the new one.
So that’s the reason. It is not we intentionally cut it, it is because we are not opening up learning centers, so there is no need to spend a lot on marketing.
Operator
Thank you for your questions. Next question comes from the line of Chao Wang from Merrill Lynch.
Please ask your question.
Chai Wang - Merrill Lynch
Firstly as a follow up on previous one, I felt given that Beijing and Shanghai margin was actually down, so I am wondering if the margin improvement is from other schools or from the headquarter? And secondly I remember you mentioned in last earning call that you are facing competition from international program of public school.
So wondering any updates on that front? Thank you.
Louis Hsieh
Yes, I think the market is declining in Beijing and Shanghai. I think you will see margin pickup in Q4 and Q1, especially in Beijing.
Shanghai may be not as much and the reason is because Beijing has some restructuring cost and now I think most of those are gone and I think the business in the Beijing is improving. So we closed some learning centers there.
In Shanghai, we closed learning centers as well. Actually the margin should improve but Shanghai has more management related problems than Beijing.
I think it was just an overbilled. So I think it the second part of your question, sorry Chao Wang, was related to?
Chai Wang - Merrill Lynch
As with the first one, I am asking whether the margin improvement is from other schools performance or headquarter levels costs.
Louis Hsieh
Well, this is from other school’s improvement and also the restructuring, the fact that we have almost 2800 fewer employees now than two quarters ago. So, this operating efficiency, in past years we were adding a lot of cost out of the revenue by opening learning centers not doing that any more.
So you are getting a better sense of the real margin of the business of each learning center as it fills up.
Chai Wang - Merrill Lynch
Got that and second question is regarding the competition from international program of public school.
Louis Hsieh
Yes, that is still ongoing, especially the northeast of China. I think these things have a way of working themselves.
I mean that they do have a short term negative impact on us but I think the parents will realize may be too late in this year’s case that the quality of those public school programs is just not as good as New Oriental’s English or overseas test prep. They are just not as good.
And so I think there will be a typical what’s happening in past incidents where schools have tried this, they will be a rebellion by the parents and they’ll send their kids to our school any way. The quality is just not the same.
Chai Wang - Merrill Lynch
Do you expect any cooperation opportunity with those public schools?
Louis Hsieh
We do, in most cities we do have cooperation with public schools, but some of them I guess, to make extra money, they will go through these kind of exercises, of setting up at sister schools whether it’s in line with the policy or against the policy, they do it any way. And then they kind of coerce the parents to send their kids to that program but ones that they are hurting actually the kids because their programs typically not as good and the teachers are not good as the campus is not as good as New Orientals.
And so I think a lot of the parents will see through this and I think they have and many of them will come back, even against the wishes of the school. This happens to us all the time.
It's just this time it’s a bigger group in a bigger region, in the whole northeast.
Operator
Thank you for your question. Next question comes from the line of Vivian Hao from Deutsche Bank.
Please ask your question.
Vivian Hao - Deutsche Bank
Based on your current experience, what's the breakage cost on the per center basis, I guess including the measure of the lease and also severance. This is my first question and then second question is in terms of the centers that you closed, I understand a lot of them are probably mixed centers with all divisions, say VIV or test prep together with K-12.
So how to deal with the partially dis-functioning divisions? Are you going to close them down?
It just sounds difficult to just cut it off, two questions first.
Louis Hsieh
There isn't an average for center to center closing because each center had a separate lease, so the breakage costs of each lease are different, some are six months' rent, some are one year rent, some are, no breakage or one or two months' rent. So it varies by the size of the center and also by the terms of the lease.
As far as the employees that are released from that center it's the same thing, some of them have an employment contracts, some do not. The ones that do not, typically we pay one to two month severance for every year they've been in New Oriental.
So it varies a lot by the school, the learning center size, the city, the employee contract. So there's no average that's why I just gave you a ballpark number of about $4 million to $5 million for the whole thing, for the whole year.
Vivian Hao - Deutsche Bank
$4 million to $5 million?
Louis Hsieh
Yes, $4 million to $5 million. As far as the, how do you break off part of a learning center, typically if we close a learning center we'll get some of the students to go to nearby learning centers but we will lose some permanent students because they won't take the trouble of traveling to another learning center and go to a competitor, and that's why the enrollment numbers are not trending in the low teens, it's because of that breakage cost.
It's not because our business isn't doing well. It's because some of the students are actually leaving us because we're closing the learning center that they're used to going to.
This effect will also end by the end of this year. So we expect enrollments, as we open learning centers again to back up into the 10% to 12% growth range in the years ahead.
This is a funny year because as you close the learning centers you actually lose students and that's why the enrollment number looks lower than normal, but we're not opening centers. So this is an abnormal year.
Vivian Hao - Deutsche Bank
Understood, final question, the recording from last quarter, is there any update on the Shanghai school issue, fully resolved or?
Louis Hsieh
I mean the Shanghai school head has been changed nine months ago. He is now replacing many of the department heads.
So you've got almost a whole new management team in Shanghai. And I think he is making a lot of progress.
I think Michael was talking to him and I think yesterday Michael was saying that he is pleased with the things that are happening in Shanghai. So we would expect Shanghai to do better in the quarters ahead.
Vivian Hao - Deutsche Bank
In terms of margins?
Louis Hsieh
Yes. Because the closures have happened, right?
The learnings centers have already been closed. So this year has all the breakage cost in it.
Operator
Thank you for your questions. Next question comes from the line of Cynthia Meng from Jefferies.
Please ask your question.
Cynthia Meng - Jefferies
I will ask a few questions. Firstly, on this 101, is the revenue contribution from Shanghai and Beijing this quarter, and their respective revenue growth?
And secondly, I do want to know whether there are any guidance on your ASP growth rate for next year? And lastly I'm just wondering what is the difference in the operating margin between first tier cities and second to third tier cities?
Louis Hsieh
Yes, I think Beijing growth rate in the quarter was 17%, Shanghai was 9% for this third quarter. The percentage of revenue, Beijing was 23% and Shanghai was 9%.
And then for the profit margin for the quarter, Beijing was 34% operating margin and Shanghai was 20%. That answer your questions?
Cynthia Meng - Jefferies
Yes. And the second question on ASP growth for next year?
Louis Hsieh
I would expect it to be similar to this year, probably real ASP growth about 12% to 13%; and then because there is still a shift towards smaller classes, the overall effect will be 15% to 16% and we expect enrolments to grow probably 10%. So we will again 20% to 25% growth next year.
Let’s say that's the current expectation. The budget is not finished yet.
The budget, we would probably expect somewhere between 20% and 25% growth. We want to sacrifice some growth in the name of getting margin improvement.
Cynthia Meng - Jefferies
And the last question on the operating margin between first tier cities and second and third tier cities?
Louis Hsieh
Some of the second tiers cities have much better margin than Shanghai. So, the profit margin, just to give you a few examples, the profit margin in (inaudible) was 32% this quarter.
The profit margin of Chongqing school was 28%, profit margin of (inaudible) 20%. So many other schools in Shin Jung (ph) was 27%; many of the schools have much higher operating margin which are high.
Operator
Thank you for your question. Next question comes from the line of Trace Urdan from Wells Fargo Securities.
Please ask your question.
Trace Urdan - Wells Fargo Securities
Louis I wanted to go back to the share buyback and first of all ask, are there extraordinary costs associated with repatriating those dollars in order to execute the buyback?
Louis Hsieh
This one there is not because, well there is a little bit but it is the final amount of our retained profit before the new tax came into effect in 2008. So these are all the historical retained profits in New Oriental coming up, RMB 300 million with $46 million, that's paid for, no tax.
We just got the money yesterday. We just got approved to review.
But that’s why I said the fight in the Board will be in a dividend. The dividend we will have to pay the 5% or 10% tax.
We have no more way of getting tax free money of, so does that mean that we will have to pay the tax and that's why that's the fight we have to have at the Board level at the end of Q4.
Trace Urdan - Wells Fargo Securities
Got it and then the Board is obviously not happy with the stock price, I wonder if you guys have debate or if you can discuss the issues that would be associated with leaving the U.S. market and re-listing in an Asian market and whether that's something that comes up at the Board level.
Louis Hsieh
It have not come up at the Board level, I came up a lot during the Muddy Waters issues in the fall and we went as far as talking to several investment banks several investment banks about it and our accounts and lawyers. It seems like it would not be difficult for us to relist in a venue like Hong Kong.
So it certainly has come up. I am getting questions on all this, as has the privatization issue and everything else.
So those are things that we have explored and we kind of hold those in our back pocket.
Operator
Thank you for your question. Next question comes from the line of Charles Cartledge from Sloane Robinson.
Please ask your question.
Charles
Congratulations on a good quarter. Just a follow-on from your earlier comment, you likened New Oriental to Apple and so far as you have trying to catch and which the previous question also mentioned.
So, Apple as I understand has a lot of cash oversees that we would have to pay, just like you would to repatriate that, but their solution, as I read in paper this morning is to borrow money in the U.S. against that cash overseas and I was wondering if you had explored that option also.
So I think another Chinese company has also done, I borrowing money in U.S. against cash there into China.
Okay.
Cartledge
Congratulations on a good quarter. Just a follow-on from your earlier comment, you likened New Oriental to Apple and so far as you have trying to catch and which the previous question also mentioned.
So, Apple as I understand has a lot of cash oversees that we would have to pay, just like you would to repatriate that, but their solution, as I read in paper this morning is to borrow money in the U.S. against that cash overseas and I was wondering if you had explored that option also.
So I think another Chinese company has also done, I borrowing money in U.S. against cash there into China.
Okay.
Sloane
Congratulations on a good quarter. Just a follow-on from your earlier comment, you likened New Oriental to Apple and so far as you have trying to catch and which the previous question also mentioned.
So, Apple as I understand has a lot of cash oversees that we would have to pay, just like you would to repatriate that, but their solution, as I read in paper this morning is to borrow money in the U.S. against that cash overseas and I was wondering if you had explored that option also.
So I think another Chinese company has also done, I borrowing money in U.S. against cash there into China.
Okay.
Robinson
Congratulations on a good quarter. Just a follow-on from your earlier comment, you likened New Oriental to Apple and so far as you have trying to catch and which the previous question also mentioned.
So, Apple as I understand has a lot of cash oversees that we would have to pay, just like you would to repatriate that, but their solution, as I read in paper this morning is to borrow money in the U.S. against that cash overseas and I was wondering if you had explored that option also.
So I think another Chinese company has also done, I borrowing money in U.S. against cash there into China.
Okay.
Louis Hsieh
Yes, we are looking at that.
Charles
Is there any apparent obstacle?
Cartledge
Is there any apparent obstacle?
Sloane
Is there any apparent obstacle?
Robinson
Is there any apparent obstacle?
Louis Hsieh
Well, the only obstacle honestly so far has been you guys because all of sudden when we talk of, they are talking about convertible bond or doing the same thing, taking a loan offshore and then collateralizing it with RMB in China. Then everyone says well, does that mean that New Oriental's $800 million dollars is fake and so it's not.
So we tabled that for this year because of the all of Muddy Waters into anything, and the cloud over our VI structure and our cash. The cash is real, it’s not fake, it’s not there.
But because common shareholders are like you don’t need to borrow money; if you can take it, out take out, even though it saves this money to actually borrow it because we can earn 4% or 5% interest in China in RMB and we get the RMB appreciation. It’s actually not a bad thing to do.
So, we have looked at it and we can’t do it as far as I know, there’s no restrictions, but we held off this year because of cloud of Muddy Waters from last year and we want to demonstrate our cash is not fake, it’s real so we don’t need to borrow against this.
Charles
I’m kind of confused by that. No one lend to you unless they had proof that money was real on the other side.
Cartledge
I’m kind of confused by that. No one lend to you unless they had proof that money was real on the other side.
Sloane
I’m kind of confused by that. No one lend to you unless they had proof that money was real on the other side.
Robinson
I’m kind of confused by that. No one lend to you unless they had proof that money was real on the other side.
Louis Hsieh
I agree but…
Charles
I mean we should probably debate this offline but I'd prefer a strict backed bank loan as opposed to convertible bond with Chinese equity holders.
Cartledge
I mean we should probably debate this offline but I'd prefer a strict backed bank loan as opposed to convertible bond with Chinese equity holders.
Sloane
I mean we should probably debate this offline but I'd prefer a strict backed bank loan as opposed to convertible bond with Chinese equity holders.
Robinson
I mean we should probably debate this offline but I'd prefer a strict backed bank loan as opposed to convertible bond with Chinese equity holders.
Louis Hsieh
But this is a sensitive year because of the Muddy Waters thing. So we thought we would be prudent to hold off on that.
Charles
Right, and so that I take it might be something that's up for debate at the Q4 result Board meeting.
Cartledge
Right, and so that I take it might be something that's up for debate at the Q4 result Board meeting.
Sloane
Right, and so that I take it might be something that's up for debate at the Q4 result Board meeting.
Robinson
Right, and so that I take it might be something that's up for debate at the Q4 result Board meeting.
Louis Hsieh
Correct. They did a lower cost of a way out charge or right.
It’s a lower cost way out of getting money, I agree with you. So we have explored it.
Operator
Thank you for your questions. You have a follow-up question from Steve Zhang from Macquarie.
Please ask your question now.
Steve Zhang - Macquarie
Just quick question on the enrollment growth. I’m wondering if you have any same school or same learning center year-over-year enrollment growth, excluding the closure of the learning centers.
Louis Hsieh
We don’t have with the closures because the closures, some of the students actually stay in the network. We will have it probably more near the end of this year.
We have growth rate by enrollment by city. So you can ask Sisi for that if you want, I do not want to go, I do not want to read that off in this venue.
You can follow up with Sisi and she can get you some of those numbers.
Operator
Thank you. We also have a follow up question from Ella Ji from Oppenheimer.
Please ask your question.
Ella Ji - Oppenheimer
Yes Louis, what is the revenue of the vision oversees consulting in this quarter?
Louis Hsieh
You have that number?
Sisi Zhao
For this quarter right?
Louis Hsieh
Yes, what is the growth rate?
Sisi Zhao
Our growth rate?
Louis Hsieh
And the amount also.
Sisi Zhao
60% revenue growth year-over- year.
Ella Ji - Oppenheimer
Percent, 6%?
Sisi Zhao
60%
Ella Ji - Oppenheimer
60% because I am seeing these books in other line and the revenue growth is a lot lower than previous quarters. Is there any particular reason?
Sisi Zhao
Actually books revenue is lower than average, yes.
Ella Ji - Oppenheimer
So, is there any particular reason or is this related also to the enrolments being pushed to the next quarter?
Louis Hsieh
I think part of it is the timing difference, I think it is part of the same timing difference Ella, because what Sisi is reading to you is the enrolments for the quarter where some of them are their actual revenue was recognized in the quarter versus the enrolment which will come in, some of them will come in next quarter, yes some of the actual process. It is a timing difference.
You should always take Q3 and Q4 together right. See whenever there is a Chinese New Year that's not right in the middle between January and February, you should always take the average of the two quarters combined.
Operator
Thank you for your questions. The last question comes from the line of Peter Cannon from Black Crane Capital (ph).
Please ask your question.
Peter Cannon - Black Crane Capital
Just a quick question on declining, the trend in number of students per class or class size. I presume on smaller class sizes the gross margin or incremental margin is lower.
To what extent has that sort of being part a cause behind operating margin decline and where do you see that trend going forward versus the trend of increasing utilization, that obviously works against the positive fashion.
Louis Hsieh
I think you are going to see both go up Peter as the utilization goes up. So when utilization of the learning center goes up, the gross margin also goes up.
Now the gross margin looks like it is a little bit lower this quarter because our accounts have us reclassifying some of the expenses from the G&A line into the cost revenue line in the cards (ph) of that line and it’s just adjustment for this year. So the actual gross margin relatively stays flat around 60%, 61% for years.
As the smaller classes get, as utilization goes up, the gross margin will go up. The operating margin decline was mostly due to, you’re right, the fact that we have even smaller classes but also because of the heavy expansion.
The 500 learning centers we added in three years as really what did it. It's headcount that was associated with that and the low utilization rate.
Once we stop opening learning centers, utilization rate will start going up and then the classes will start flowing up, all those margins will go up.
Peter Cannon - Black Crane Capital
What do you I mean maybe kind of disclose this but what sort of margin difference is they’re cross products by size of class, obviously…?
Louis Hsieh
Well, it's not by size of class. It's more by, we do it by group.
So overseas test cart has the highest margins, its well over 30% on the operating margin side. The UCan in business the voting list will be in the mid-20s.
The two that are low right now is Kids English and one-on-one, outside overseas test prep and those are in the high single-digit, low double-digits but that’s because of utilization and so if the utilization goes up, and the kids, right now we have like 30 kids per class. The class was at 25 seats because 18 seats, all of sudden yes, you get it right, all of sudden the margin goes from 11% to 16% to 18%.
And one-on-one the same thing. If you have 50 seats and we have 10 seats full, once you get the 25 seats full, the margin goes way up.
Peter Cannon - Black Crane Capital
Yes what with one-on-one class utilization was 100% of the class.
Louis Hsieh
No but it's just a classroom rental fee and so the more seats that are full, the less the classroom rental fee, the burden. So it makes a big difference.
Also it goes to the fact of the consultants, right, the marketing consultants that customer service rep for the one-on-ones, if they had only 25 students as they capable of, the margin goes way up. If they have only 6, as there are 6 to 7 students there now the margins will be very low.
So it takes time for those to fill up. Once the utilization goes up, the margin is actually still quite high at least 15% to 20%.
Peter Cannon - Black Crane Capital
All right okay. So, the two issues are really in the trend.
Louis Hsieh
Correct. That’s why I think you’re going to see a rapid increase in operating margin because as utilization goes up, we’re not adding a lot of learning centers employees ahead of the revenue and utilization goes up, the margins will all go up across the board.
What we’re concerned about was if there is more rapid than expected decline in revenues that we’ve not seen yet. That’s why we’re keeping our fingers crossed.
Operator
Thank you for your questions. We’re now approaching the end of the conference call.
I’ll now turn the call over to New Oriental’s President and CFO, Mr. Louis Hsieh for his closing remarks.
Thank you.
Louis Hsieh
Okay, we just want to say thank you for everyone for taking the time to be in this call and if you have any further questions, please do not hesitate to contact me or any of our Investor Relations representatives. Have a good day.
Operator
Thank you. Ladies and gentlemen, that does conclude the conference call for today.
Thank you for your participation. You may now disconnect the line.