Good evening and thank you for standing by for New Oriental’s Second Fiscal Quarter 2018 Earnings Conference Call. At this time all participants are in a listen-only mode. After management’s prepared remarks there will be a question-and-answer session. Today’s conference is being recorded, if you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host for today’s conference Ms. Sisi Zhao. Thank you. Please go ahead..

Hello, everyone and welcome to New Oriental’s second fiscal quarter 2018 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 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 US Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties.

As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. New Oriental does not undertake any obligations to update any forward-looking statements, except as required under applicable laws.

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. Stephen Yang. Please go ahead, Stephen..

Thank you, Sisi. Hello, everyone and thank you for joining us on the call. We’re pleased and encouraged with our results for the quarter. Net revenues in the second quarter increased to $467.2 million, which is 36.9% growth, ahead of our expectation.

The accelerated top line was attest to the strength of our business and our sound strategy to acquire and effectively return customers and expand capacity. Total student enrollments in academic subjects tutoring and test prep courses went up 43% year-over-year to approximately 1,877,100 in the second quarter.

To further tap into the booming private education markets and further strengthens our leadership in the market. We also added a net of 34 learning centers in 19 existing cities and expanded into the cities of Yinchuan, Shaoxing and Huzhou with our dual teacher model classes implemented in six new schools and learning centers.

In addition, we acquired kindergarten in Hong Kong, extending the geographic reach of our quality education offerings. Altogether, this boosted our total square meters of classroom area by a total of 38% year-over-year. In the second quarter, we remain focused on our well proven optimized market strategy.

We’re steadily working our capacity expansion across cities where there is strong growth potential and where we could increase operating efficiency. We’re making sound progress, enhancing our online and offline integrated standardized teaching system in our K-12 business, which contributes positively to our results in the second quarter.

We’re also rolling our standardized teaching system for overseas test per app business, such as IELTS, TOEFL and SAT programs in some of the large cities in China. Our business has sustained a strong momentum from the first quarter and yielded another strong top line performance in the second quarter of fiscal year 2018.

This is mainly driven by the substantial increase in student enrollments. Our K-12 all subjects after-school tutoring business augmented in the second quarter with the revenue up by around 47% and enrollment up by around 52% year-over-year, continuing from the very encouraging growth from the recent quarters.

The growth in our K-12 business can be broken down into outstanding performance from our U-Can middle school, highs school, after school tutoring business and POP Kids program, each of which achieved impressive growth respectfully.

Our efforts to acquire and retain loyal customers while extending our capacity, is allowing us to capture greater market share and solidify our leadership position. Historically even, second quarter is the slowest quarter in fiscal year. However, we achieved improvement in the utilization of facilities compared to the previous quarter.

This helps release the pressure off the margins as we’ll remain midst to invest in the capacity extension. We’re confident that the business is on the right track to regain grounds from the impacts on the margin for this quarter.

Even more encouragingly in the second quarter, the year-over-year decline of gross margin narrowed to 70 basis points comparing to 280 basis points in the previous quarter. The non-GAAP operating margin is down by 150 basis points year-over-year, showing significant signs of recovery as compared to 390 basis points in the previous quarter.

We remain focused on driving both top line and bottom line growth through enhancements in cost efficiency and utilization of the facilities. I will now turn to pricing. Per program blended ASP, which is cash revenue divided by total student enrollments, depressed by about 3% year over year.

A few factors lie behind the fall, the per program blended ASP. Firstly, our revenue mix shifted from the oversea test prep business to K-12 after school business with lower ASP. Secondly, the high ASP VIP business slowed down in this quarter.

Starting from the third quarter last year, in an effort to streamline the registration process, we began to concentrate the registration for U-Can VIP classes in first month over the first and third quarters rather than spreading the registration evenly throughout the year.

As a result, there was a high year-on-year increase of enrollments from U-Can VIP classes in first quarter, the lower than normal growth in the second quarter.

Besides from the streamlining the registration, we also currently expect that our VIP business growth will be slower compared to our overall revenue growth in the long run, which will continue to have a dampening effect on blended ASP. Thirdly, the shortened class length of our Beijing U-Can program also dilutes the per program blended ASP.

We launched the pilot program for U-Can classes in Beijing to adjust to the last and format of each session from three hours in class teaching to two hours in class teaching plus 0.5 per hours after class online learning.

The purpose of the adjustments is to improve student in-class learning efficiency and enable them to enroll in more classes for more subjects. The pilot boosted the average number of classes enrolled per students.

Already blended ASP, which is GAAP revenue divided by total teaching hours, increased by approximately 6% year-over-year to provide a breakdown of the already blended rate. Please note that U-Can increased by 6%, POP Kids increased by 5% and overseas test prep program increased by 15% year-over-year.

Looking ahead, we're confident that the decline in margin will continue to ease through the remainder of the fiscal year. More importantly, as the business expands, we also benefit from the greater economy of scale as we continue to make strategic investments, which will generate long term value for our customers and shareholders.

Now, we will move on to the second quarter performance across our individual business lines. Our revenue driver at K-12 all subjects after school tutoring business achieved revenue growth of about 47% year-over-year for the second quarter, driven by enrollment growth of about 52% year-over-year.

Breaking down, the U-Can middle school, high school all subjects after school tutoring business reported revenue increase of about 44.9% for the second quarter. Student enrollments grew approximately 48.6% year-over-year for the quarter.

Our POP Kids program again delivered outstanding results with revenue up significantly by about 50.8% for the second quarter. Enrollment went up about 55.1% for the quarter. Our overseas test prep and consulting business together reported revenue growth of about 21.1% year-over-year for the second quarter.

Finally, our VIP personalized class business reported revenue of growth of about 19.4% year-over-year for the second quarter. Next, I’ll provide some updates on progress we’re making with our optimized market strategy.

We have been focusing on expanding our capacity by investing in the build out of our O2O Interactive Education System, and this continues to produce very promising results. We’ll start with offline business.

In the second quarter, we added a net of 34 learning centers in 19 existing cities, and roll out dual teacher model class in three new schools and three new learning centers in the city of Yinchuan, Shaoxing and Huzhou. In addition, we acquired one kindergarten in Hong Kong.

Our investments increased to the total square meters of classroom area at end of the quarter by plus nearly 38% year-over-year. In order to capture the growth opportunity in lower tier cities, we continue to roll out our dual teacher model schools and extend our business into remote areas in China.

We started to pilot the new dual teacher model class in select cities in July 2016. And by the end of the second quarter of this year, we have tested the new offering in over 13 existing cities and 10 new cities, and we’re pleased to see the increased market penetration in the market we tap into.

We also saw improved customer retention and scalability of this new model. With these encouraging results, we will continue to deploy the strategy in the rest of the fiscal year. With respect to our online business, $18.7 million was invested in the second quarter to improve and maintain our O2O integrated education ecosystem.

Most of the investments were reported in the G&A expenses. With the high customer retention rates and acquisition of new customers, we believe the investments will yield significant return and bring sustainable and long-term benefits. I will first talk about O2O Two-way Interactive Education System.

Since launching of our U-Can Visible Progress Teaching System in September 2014, the interactive education system has been deployed in all existing cities. We’ve launched a newly revamped POP Kids English program in most of the cities by the end of the second quarter of fiscal year 2018.

This interactive education system has also been gradually used in more and more cities across China. The interactive education system for overseas test prep program, including IELTS, TOEFL and SAT courses, was rolled out and tested in most of major cities at the end of Q2 fiscal year ’18.

At the same time, we also standardized the product offerings in City of Shenzhen, Xiamen, and Chongzhou. Now, I will walk you through our progressing Koolearn.com and other supplementary online education products. Koolearn.com generated net revenue of $28.2 million, representing a 59.6% increase year-over-year in the second quarter.

The number of paid users increased about 23% year-over-year in the quarter. Koo.cn live broadcast platform achieved about 709,600 registrations in the second quarter. DONUT’s learning apps recorded over 73.5 million downloads by the quarter end. And Le Ci app recorded over 7.1 million users by quarter end.

This development aim to extend New Oriental’s traditional offline classroom teaching offerings to online education services. This is an important front on which we set ourselves apart from other key players in market.

With the booming market and our advanced O2O product services, we’re poised to gain more market share and strengthen our hold going forward. Now, let me walk you through the other key financial details for the second quarter.

As mentioned earlier, the business delivered outstanding year-over-year increase in net revenue and growth in the second quarter. Due to our expansion capacity, operating costs and expenses for the quarter were $480.3 million, representing a 40.8% increase year-over-year.

Non-GAAP operating cost expenses for the quarter, which exclude share based compensation expenses, were $470.9 million, representing a 39% increase year-over-year.

Cost of revenues increased by 39.1% year-over-year to $227.3 million, primarily due to the increase in teachers’ compensation for more teaching hours and number of schools learning centers in operations.

Selling and marketing expenses increased 38.2% year-over-year to $72.1 million, primarily due to increase in brand promotion expenses and selling marketing staff compensation. General and administration expenses for the quarter increased by 44.2% year-over-year to $180.9 million.

Non-GAAP general and administrative expenses, which exclude share based compensation expenses, were $171.6 million, representing a 39.2% increase year-over-year, primarily due to increased headcounts as the company expanded its network of schools learning centers, as well as the increase in R&D expenses and human resources expenses related to the development of our online and offline integrated education ecosystem.

To further align vision in interest of the Company’s external and internal shareholders, the Company granted a total 1.5 million restricted share units of the company to employees and directors in October 2017 with graded resting over three years.

Because of the granting, the costs involved drove the total share based compensation expense up by 330.2% year-over-year to $9.3 million for the quarter. Operating loss for the quarter was $13.1 million compared to income of $0.2 million in same period of prior fiscal year.

Non-GAAP loss from operations for the quarter was $3.8 million compared to income of $2.4 million in same period in the prior fiscal year. Operating margin for the quarter was negative 2.8% compared to positive 0.1% in the same period of prior fiscal year.

Non-GAAP operating margin, which excludes share based compensation expense for the quarter, was negative 0.8% compared to a positive 0.7% in same period of prior fiscal year. Net income attributable to New Oriental for the quarter was $4.3 million, representing 58.7% decrease from the same period of prior fiscal year. Turning to the balance sheet.

As of November 30, 2017, New Oriental has cash and cash equivalents of $818.1 million compared to $641 million as of May 31, 2017. In addition, the Company has $87.5 million in term deposit and $1,522.8 million in short term investments as of November 30, 2017.

New Oriental’s deferred revenue balance, which is cash collected from the registered students for courses and recognized proportionally as revenue as the instructions deliver at the end of the second quarter of fiscal year 2018, was $1,137.3 million, an increase of 48.7% from $764.7 million in same period of prior fiscal year.

Before moving on to our expectations for third quarter, I would like to take a moment to reiterate our overarching goals and priorities and our optimized market strategy.

In terms of our priorities; first, we will continue to expand our offline business; we aim to add around 20% new learning centers and expand classroom area of some existing new learning centers for K-12 business in existing cities; and we also plan to enter two to four new cities where we identify market with the most business opportunities.

In addition, we'll continue to roll out our dual teach model schools to about five to 10 new low-tier cities in China. Second, we'll continue to leverage our investment in our O2O integration in online education offerings. In particular, we will continue our focus on product requirements and the maintenance for the O2O system for K-12 business.

Meanwhile, we'll continue to revamp and roll out our O2O standardized teaching system for our overseas test prep business. We will continue to make investments and we currently believe that total spending in absolute dollar terms in fiscal year 2018 will increase moderately compared with the prior fiscal year.

Third, we will continue to focus on driving up utilization of our facilities and cost control to drive additional effectiveness and deliver long-term bottom line growth.

As already shown in the second and first fiscal quarter, we believe that the expected acceleration of the revenue growth anticipate boost in the facility utilization in the coming quarters will mitigate the impact on the margins over the coming quarters. We will keep you updated as we move through the fiscal year.

We’re confident that our expansion strategy and recent incentives will drive additional growth of revenue and market share, in a way that creates long term value for all shareholders. Looking at the near-term and our expectations for the third quarter.

We expect total net revenues to be in the range of $591.1 million to $604.2 million, representing year-over growth in the range of 35% to 38%. Lastly, I must mention that this expectation reflect New Oriental’s current and preliminary view, which is subject to change. At this point, I will take your questions. Operator, please open the call for this..

Thank you. The question-and-answer session of this conference call will start in a moment [Operator Instructions]. The first question comes from the line of Fan Liu of Goldman Sachs. You may ask your question..

So you added capacity by 38% year-on-year this quarter, faster than previous quarter at 31%. May I know the rationale behind this acceleration? And also a question relating to your guidance, third quarter guidance.

May I know the 4x you applied behind this third quarter guidance? Since if we exclude the impact from RMB appreciation, your third quarter guidance will imply of around 29% year-on-year in the midpoint, actually lower than this quarter and around 34%.

May I know the reason behind this deceleration? Supposedly, second half should accelerate versus first half? Thank you..

In terms of the expansion plan, we add 41 learning centers, schools and learning centers in this quarter. And the total square meters of classroom area by the end of this quarter increased by 38% year-over-year.

I think the reason that we risk the extension plan is we -- because we’re seeing the growing momentum in our K-12 business due to the solid market demand. And that means we are more confident about our new O2O product as well and the effective operational as well.

So for the whole year, we plan to add 20% new learning centers combined with the 10% new square meters we rent for the existing learning centers. So altogether, it's 30%. And I think to drive the potential growth going forward, not only for the second half of this year but also for the next year.

And in terms of the guidance, yes, the guidance -- I think, we’re still seeing the revenue growth accelerations going forward. But don’t forget in the last year Q3, we had very strong Q3. It’s a little bit hard comparison that I think the K-12 business will bring to us very strong enrollment growth in the third quarter.

And I think we will see the acceleration of the growth of top-line in Q3 and also in Q4 as well..

The next question comes from the line of Ivy Luo from Macquarie. You may ask your question..

So a lot of my question is -- just to follow-up on the revenue growth. Because we do see like deferred revenue growth accelerated to 49 from 42 last quarter and the enrollment growth is really strong this quarter. I think part of, as you mentioned part of our recruitment plan of trying to have the winter and spring together.

So just want to understand how much percentage does that part account for? And my second question is regarding the Hong Kong kindergarten that we acquired.

Can management share more color what’s the consideration, how many students does that actually have a margin drag? Have we consolidated to this? Just some color on the kindergarten that we acquired and the logic behind it? Thank you..

Let me answer your second question first. The kindergarten we acquired in Hong Kong is very small one, so it’s not a big deal.

And in terms of the first question you asked about the revenue guidance, I think in the Q3 guidance, I think on the school level what I mean the short term school, the top-line growth in the Q3 in the coming quarter will be very strong. So that’s why it's that. We’re still seeing the revenue acceleration of the growth.

But in the Q3, we had a very strong quarter last year of the other business. So we had a very strong -- we had a little bit hard comparison for the Q3. And we had a great deferred revenue balance was in the quarter end.

And I think based on the historical data, 50% of our cash revenue we reported in the second quarter will be reported into the GAAP revenue in Q3.

Is it clear, Ivy?.

Maybe just to clarify, does that mean that in the total -- if we just look at enrollment number, how much can we attributed to maybe the straight quarter, the winter and spring like….

We don’t dispose like that but I think most of the enrollments where we have in hand are the winter classes doing this. That means we report most of the cash revenue we report in Q2 and into the Q3 the winter courses..

Next question is from Natalie Wu of CICC. You may ask your question..

Two single questions here, first one is that how to view VIP kid model. Just wondering how do management see the strategy and opportunities related with that in longer term.

Will New Oriental launch any initiatives regarding that model? And second one is what's the current utilization rates for different subjects? Would it be large gap between these? And if yes, do you expect the gap to close and how many years will the process take? Thank you..

I won’t make comments on the VIP kids business model. What I just want to say is that I think most of their business is the online verbal English training model. But we have already pilot the same patterns model, I think last quarter but I think we have the -- we're using the different way.

First for us the one teacher, the online teacher fit to three students at the same time. And we are opened the online class for the -- our POP Kids students only, that means we're now open for the students outside New Oriental. But for us we have allowed the POP Kids online -- the POP Kids enrollment.

So that means we don't have the acquisition cost to acquire student enrollment for online in place. And also, we would fit the teachers and the curriculum by the system accountants. We just piloted for one in Wuhan, Beijing only now.

And what's your second question?.

Utilization -- for different subjects….

We just disclosed the utilization rates for overall and the utilization rate of this quarter is about 20%, it's flattish compared to year-over-year. In the week we opened 41 learning centers in this quarter and I think it becomes more fast or becomes faster and faster for us to put the students into the classroom quicker than before.

So I think going forward you will see the high utilization rates for us..

Just one more question.

Can I know the average enrollment per student currently?.

At the same time, one student take two to three courses at the same time..

Your next question comes from the line of Marianne Kou of CLSA. You may ask your question..

I think just a follow up on the previous analyst question on the enrollment for students, because you also mentioned just now and the ASP discussion that we are doing some piloting classes in Beijing to move like half an hour of the class online and shorten the in-classroom time to encourage more enrollments.

So just wondering if, and say like kind of longer term, if this model works out what will be expected in the year’s time to optimal enrollment for student ratio or other courses for students. And the second quarter is on the dual teacher model. Just want to see since now we have a pretty decent cost ratio from some cities using the dual teacher model.

Just wondering if we have any early indication in terms of the financial metrics, how that compares to traditional model, and also on the learning outcome side. Are we seeing better or comparable results compared to the traditional model? Thank you..

We started a pilot program in Beijing, U-Can program to change the class levels from three hours in-class teaching to two hours plus a 30 minute online learning. But as a result, as of the change in Beijing school where we sold the average member of enrolled classes per student increased from two classes to three classes.

So I think it's good for us to take more students and each of the students will take more classes as in time. So I think going forward we will spread it out to other cities, but it depends on the time. And your second question is about the dual-teacher model. We’re staffed into the 30 learning centers in existing cities for the dual teacher model.

And also we have already opened 10 new cities to open the dual teacher model, so far so good. I think the student retention rate is better than we expected. And also I think the one teacher can face to like the 10 or 20 classes as successfully piloted in the last year.

So in terms of financial model, I think the margin of the dual teacher model should be higher than the traditional classes, because of what teacher can face to the 200, 300 students at the same time. And all the other classes are the same compared to the traditional classes.

It’s too early to say, because we adjusted the pilot program in the summer of last year and it's being more time to spread out to the more cities and more learning centers..

The next question comes from the line of Jin Yoon of Mizuho. You may ask your question..

So perhaps you could give some color how to think about margins for the next quarter and perhaps for the full year. Should gross margin headwinds remain similar to Q2 levels? And how should we think about G&A, excluding O2O investments, should it be growing at similarly elevated levels.

And then second question Stephen is perhaps if you could give us a breakdown on your revenue guide by different classes that would be super helpful. Thanks..

I think the margin guidance, as you know we opened 41 learning centers, school to learning centers in Q2. But the operating margin is down 150 basis in the second quarter. But don’t forget our margin was down by 390 basis points in the Q1 so it's a recovery.

And going forward, we believe the margin pressure will lessen and reverse in the rest of the year. Because I think we will -- we expect to see the acceleration of the revenue growth, and also the higher facility utilization. So in terms of the margin, I think in the rest of the year the margin pressure will lessen and reverse.

But I won’t change my guidance of the margin in the long-term. So our op margin target is to get 17% to 18% in next three years. This year -- because we changed our expansion plan from 10% to 30%, but I think this is a good put for us because the market demand is there and the O2O products is better than before for us.

So I think for the long-term it's a good way for us to take more market share from the other key players in the market.

And what’s the second question, Jin?.

The second question is revenue -- can you give us a breakdown of your revenue guide by classes?.

You mean the guidance. The overseas test prep 10% to 15% and the K-12 business over 50%, and the domestic test prep is 20%, or what I side as the increase. And the only drag down is the add-on English it will be down by 5% to 10%. And the pure online, the Koolearn.com, the revenue growth will be over 50% in Q3..

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

I have two questions. So first just want to follow-up on your Fan’s question. Wondering how long does the management think or intends to maintain such high speed of capacity growth. And related what makes you so confident on delivering profitability improvement given that we are still aggressively expanding? My second question is on POP Kids.

It seems that, I think, we are getting more aggressive non-English subjects for POP. I was wondering, what types of students we are targeting? And how big you think this specific subject will be growing to? Just want to know your thoughts? Thanks..

Actually, only one-third of the POP Kids revenue comes from these non-English courses, Math and Chinese. But it grows faster than English courses. So going forward, I think the non-English courses the revenue grows faster than the English courses. That's for the POP Kids. And the expansion plan.

If you remember in the last two years, we took to open 10% to 15% new learning centers every year. But don't forget we just pilot the new O2O product since two and half years ago. So this year we raised our capacity expansion from 10% to 30%. I think way for us to take more market share. Next year, we don’t have to -- we haven't set up the budget.

But I think we will open the 20% to 25% new learning centers in the next fiscal year, it depends on the market. But anyway, we're quite confident about our product and the market demand. It's a huge market. Our market share is just below 2%, it's too early. So that's why we raise our expansion plan this year..

Thank you [Operator Instructions]. The next question comes from the line of Tia Hou of T.H. Capital. Please ask your question..

So since the company is entering into a relatively high speed expansion space. So I wonder what’s the Company's plan for next two quarters in the fiscal year. How many new learning centers do you plan to open in next two quarters? And also for next year and to what kind of opening plan do you have? So that's my question..

I think in the rest of the fiscal year, in coming Q3 and Q4, we plan to open 50 to 80 new learning centers, in total, in the next six months. So can combine with 85 new learning centers we set up in the first half of the year. The total number will be 150 to 170.

And next year, as I said, in the last question we haven't finished the budget of next year that we expect to open 20% plus new learning centers next year. But based on the current estimation, I think the new learning centers we set up for the next year will be below 30%, because we opened a lot this year..

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

Stephen, I’ve got one question on the revenue growth. In this quarter, your revenue grow at around 34% in RMB terms.

Can you please break that down into firstly the retained student from summer promotions and other students? And also break down that by new learning center that has been opened within the past four quarter, and contribution from the mature learning center that has been opened over one year? Thank you..

Actually we have 550 for summer enrollments in the summer, and the retention rates in autumn courses was close to 50%. So the enrollment in the autumn class we’ve got from the summer promotions. But we don’t have the details of the how many students from the new learning centers and how many students from the existing ones.

It’s really hard for us to divide with students by two parts. But what I can say is yes we opened lot of learning centers, it drives the enrollment growth up, and it spans less time for us to fill the students into the new learning centers.

Typically, for the new learning center, it typically takes five to eight months breakeven that, we’re thinking about whole class but we can see the students in new learning centers..

Your next question is from Thomas Chong of Credit Suisse. Please ask your question..

Just a quick question about the revenue growth and contribution in Beijing, Shanghai, Guangzhou and Shenzhen, and then a quick follow up is about the utilization. Can I ask the breakdown between the old and new learning centers in the past one year? Thanks..

I think the top five cities, Beijing, Shanghai, Xi'an,, Wuhan, Hongzhou, the top five K-12 business revenue contribution cities contributes 46% of total revenue. And in last trailing 12 months, the growth rate was 37% in last trailing 12 months. This is the largest contribution of our top five cities and the growth rates..

The next question is from Sheng Zhong of Morgan Stanley. Please ask your question..

So my first question is about our deferred revenue, it has a very strong growth. And Stephen also said that the VIP enrollment policy has changed to first quarter and third quarter.

So may I take that to think that the deferred revenue has even stronger growth if we look at K-12? So maybe can you give more color on the breakdown of your deferred revenue growth this quarter? And second question is about our pilot program in Beijing. So you said that it’s still not the time to expand to other cities.

So may I understand what your key concern about to extend the program to other cities? And maybe when you think or when you think it's more appropriate time to expand this program to other cities and to like POP Kids? Thank you..

With the deferred revenue balance, I think the actual number if we don’t change the VIP registration window last year, I think the deferred balance will be better than the 48% year-over-year growth. So I think you see the deferred revenue strong growth of the balance.

I think that means we will have a very strong top-line growth in the coming quarter Q3. And we are within the deferred revenue balance most of the cash revenue we collect from those customers are K-12 business. And so your second question is about the pilot program that we change the class, the length of class session in Beijing school.

We’re just a pilot program in this summer. So I think it's good that we expected. So we need more time to summarize advantage of this program. I think we will do more and more in more cities..

Next question from Tallan Zhou of Deutsche Bank. Please ask your question..

Most of the questions have been covered by previous analysts, so I have two follow-up questions. You mentioned about utilization rate remains pretty much same under such a high expansion on capacity.

Do I understand correctly that for mature learning centers, the utilization rate actually increased in this quarter? And second quarter, so is also follow-up question on deferred revenue. So can you put it down by like how much will be collected from spring season or winter season? Thanks..

I think the utilization rates, yes -- for the mature learning centers, the utilization rates of facilities is still going up in this quarter. But I think we have a lot of room for the mature learning centers to get improvement of the utilization rates.

I think the reason that we can’t guide higher utilization rates in this quarter is because we opened 85 learning centers, new learning centers in the last six months. But I think we will see students click into the new learning centers quicker than before.

We’ve in the deferred revenue balance -- it’s really hard for us to define the students in the winter class and the spring class. But….

But for your reference actually the deferred revenue by end of Q2, about 47% of it will be recognized as GAAP revenue in Q3. So that’s roughly how we talk about the deferred revenue guidance and deferred revenue number and the indicator for next quarter..

Next question comes from the line of Wayne Wang of HSBC. You may ask your question..

So I have a question regarding to our capacity expansion trend in both high tier city and low tier city. And also, I just want to confirm that or it seems that management in managing that in fiscal year ’18, our total spending will remain largely flat year-on-year.

So what could be our like full year margin guidance? And also what's our full year plan for the O2O investments? Thank you very much..

At the capacity expansion, we are opening the learning centers in the 20 to 25 cities with the higher performance in last year. So this is our plan. And as I said, we will open 20% new learning centers combined with the 10% new square meters we rent for the current learning centers, altogether 30%.

And the online investments, we spend for $7 million on the online investment this quarter. It’ll fully be the higher than we expected. Actually we bought it for $2 million, so that means we spend $5 million more than we expected. But I think it’s worth it, because we started to spend the online investment since three years ago.

And we spent [$57 million] in the last year and $39 million in the year before last year. But I think the high investment of the online drive the higher student retention rates, and also will require the new student enrollment and improved the teaching quality and feedback from the students and parents, much better than several years ago.

So that's why I said it’s worthy. And we plan to spend $60 million to $70 million for the whole year on the online investment, which will be the higher than expected last year's [$57 million] this year’s $60 million to $70 million. But I think it's worthy. And what's your question….

The second question is regarding to the full year margin guidance. So it seems previously we have talked that our total expanding in fiscal year '18 could be larger to flat year-on-year. I'd like to -- add more color on that..

I think going forward in the rest of the year, we believe the margin pressure will lessen and reverse in Q3 and Q4. But I won't give specific guidance for the margins in the rest of the year..

Next question is from Eric Qui of CCBI. Please ask your question..

I have two questions, one is you mentioned that top four cities account for 46% of revenue. I was just wondering how many percentage of learning centers are in the top five cities? And also how many cities have you been entered into and what do you think the potential number of the cities you may enter into eventually.

The second is what's utilization rate this quarter and what's the trend for the utilization rate? Thank you..

I mentioned the top five cities contribute 46% of total revenue. So in the top five cities, I think the learning center number took altogether -- Beijing is 105, Shanghai is 56 and Guangzhou is 32 and Xi’an is 35..

I can send you the detail after the call, it's on our presentation..

And we are in 70 cities. And I think our ultimate goal is to set that into more than one city, but most of the new cities we expect by this dual teacher model. But don’t forget even in the current -- in existing cities, like in Beijing, we have 100 learning centers in Beijing. But I think the maximum learning centers in Beijing will be over 150.

So there is a lot of room to open more learning centers in the existing cities..

And we will take the final question from [Marilyn Mo of Indus]. Please ask your question..

I have a follow up question on margin. If I understand correctly, so for this quarter, our utilization rate is flattish year-over-year and the GAAP revenue per teacher is also up 6% year-over-year.

So what drives the gross margin dilution year-over-year for this quarter? And also for operating margin, besides the investment in online, what other factors drive the margin dilution? Both talk about year-over-year, not quarter-over-quarter..

I think within the G&A selling expenses, I think besides the $18 million of the online investments, I think the headcount was increased because we opened more learning centers and schools in the last two to three quarters.

So within the cost effect, because the rental is over 40% year-over-year increase year-over-year this quarter, don’t forget we opened 120 new learning centers and we have more square meters in last three quarters.

So at the quarter-end the square meters are 38% higher compared to last year, that’s why we guided the 45%, 44 to 45% rental increase in this quarter..

So the rental increase is 44% to 45% increased?.

Yes..

But if our utilization rate is flattish, that should be largely offset?.

Yes, partially its offset, but these new learning centers -- we need more time to fill the students into the classrooms. So it's dragged the margin. But on the GP level, the gross margin level is just down by 70 basis points so it's not a big number..

So still because of the expansion, okay..

Yes..

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

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..

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